By Hugo Dixon
LONDON- There are many reasons for dysfunction in the American political system. There are also many reasons why “Pax Americana” — the period of US dominance since World War Two – is under stress. But the end of the era of free money is a new toxic ingredient in the witches’ cauldron that links domestic political conflict and Washington’s struggle to rise to a host of global challenges.
The combination of high bond yields with a large fiscal deficit and rising sovereign debt is making it harder for politicians to govern the country. Witness President Joe Biden’s battle to get Congress to approve $106 billion in military aid for Israel and Ukraine, as well as cash to push back against China in the Indo-Pacific.
The federal government doesn’t just need money to boost its defenses and those of some allies. It needs extra funds for pensions, health care and low-carbon technologies, as well as to compete with China for influence in developing countries. Meanwhile, higher interest rates will ratchet up the cost of servicing its borrowings.
Rising bond yields are having similar effects on other rich countries. Many will also struggle to fund both domestic and international priorities. If anything, they may have a tougher job to make their fiscal maths add up than the United States because their growth prospects are not as rosy.
American allies in Europe and Asia are hiking their own defense spending in response to the rising threats from Russia and China. But the money has to come from somewhere. Post-Brexit Britain, for example, has cut its foreign aid budget, undermining its soft power.
The Federal Reserve held short-term interest rates last week, saying it wasn’t sure whether further hikes would be needed to bring inflation down to 2 percent . But even if they don’t rise further, short and long-term rates are much higher than in the 15 years between the global financial crisis and Russia’s invasion of Ukraine last year.
While borrowing costs may just have reverted to their long-run average after a period when central banks kept them artificially low, a generation of politicians grew up believing money grows on trees. They threw cash at a raft of problems, including the Covid-19 pandemic and climate change.