U.S. Flash PMI
Output growth falters and payrolls decline in February, as optimism slumps and costs rise
US business activity growth came close to stalling in February, according to flash PMI® survey data, as a renewed fall in services output offset faster manufacturing growth. New order growth also weakened sharply and business expectations for the year ahead slumped amid growing concerns and uncertainty related to federal government policies. The upturn in manufacturing output was also in part linked to the front-running of tariffs, hinting at merely a temporary boost.
Input cost pressures meanwhile spiked higher, notably in manufacturing as suppliers passed on tariff-related price hikes and wage pressures persisted. However, intensifying competition helped limit the pass through of selling prices in the services sector, where inflation sank to a near five-year low.
The headline S&P Global US PMI Composite Output Index sank to 50.4 in February from 52.7 in January, according to the preliminary ‘flash’ reading, which is based on approximately 85% of usual survey responses. The drop took the index to its lowest level for 17 months to signal a near-stalling of business activity.
Weakness was centered on the services economy, where output fell slightly in February to signal the first contraction of the sector for 25 months, representing a sharp contrast to the robust expansion seen late last year. New business inflows into the services sector came close to stagnation, showing the smallest rise for ten months to indicate a marked worsening of demand growth in the sector since last year.
Service providers commonly linked the downturn in activity and worsening new orders growth to political uncertainty, notably in relation to federal spending cuts and potential policy impacts on economic growth and inflation outlooks.
Manufacturing output meanwhile rose for a second successive month, rising at the sharpest rate for 11 months, principally buoyed by higher new orders. However, new order growth slowed slightly, caused in part by a steepening loss of export orders. Many manufacturers also reported that the rise in production and demand was in part linked to front-running potential cost increases or supply shortages linked to tariffs.
Optimism about the coming year slumped to its lowest since December 2022, except for last September, when business was unsettled by uncertainty ahead of the Presidential election. The deterioration in February was primarily a reflection of increased uncertainty about the business environment, especially in relation to federal government policies related to domestic spending cuts and tariffs. Worries over higher prices, and broader geopolitical developments were also noted.
Future sentiment remained relatively elevated in manufacturing by recent standards, though fell from January’s 34-month high. Service sector confidence showed a steeper decline, deteriorating further from December’s one-and-a-half year high to sit at its lowest since last September.
Having accelerated to a four-month high in January, selling price inflation cooled to a three-month low in February. However, trends varied markedly by sector. Whereas intensifying competition was often cited as driving service sector price inflation to its lowest in the current period of rising prices (which began in June 2020), manufacturing selling prices showed the largest monthly increase for two years.
Cost pressures meanwhile intensified to the highest since last September. Service sector input cost inflation edged up to a four-month high, with companies citing tariff related price hikes from suppliers alongside rising food prices and upward wage pressures. But it was manufacturing which saw the steepest increase in costs, with raw material prices showing the largest monthly gain since October 2022, with the increase overwhelmingly blamed by purchasing managers on tariffs and related supplier-driven price hikes.
Employment fell slightly amid heightened uncertainty and concerns over rising costs. It was the first decline in employment for three months to represent a marked change in hiring after jobs growth hit a 31-month high in January. Services providers reported renewed job losses after two months of net hiring, while manufacturing payrolls rose only very marginally to contrast with the more-robust gains seen over the prior three months.
The S&P Global Flash US Manufacturing PMI rose from 51.2 in January to 51.6 in February, signaling a second successive monthly improvement in business conditions within the goods-producing sector and the sharpest upturn recorded since last June.
Factory production rose for a second month in February, increasing at the steepest rate for 11 months. The drag from falling input inventories also eased to the lowest since last June, helping to lift the PMI.New order growth weakened, however, with employment also rising at a reduced – near-stalled – rate. Suppliers’ delivery times meanwhile lengthened for a fifth straight month, adding support to the PMI (longer lead-times often indicate busier supply chains), albeit to the weakest degree since last October.
S&P Global’s PMI surveys don’t get as much media attention as the ISM’s. S&P Global’s earlier Flash PMIs get even less press even though they are a pretty good preview.
This February Flash PMI is particularly troubling:
- A 2.3 points drop in the Composite is not unusual but this one suddenly signals “a near stalling of business activity” after 9 strong months.
- The less cyclical services were particularly weak, falling into contraction from their highest level since 2022.
- New orders stalled, signaling “a marked worsening of demand growth” in services, reducing the probabilities that this is but a one-month thing.
- Manufacturing demand surged due to front-running expected tariff increases that could prove fleeting.
- “Employment fell slightly amid heightened uncertainty and concerns over rising costs.”
- “Cost pressures intensified to the highest since last September”.
- “Manufacturing selling prices showed the largest monthly increase for two years” as everybody is scrambling to secure supplies pre-tariffs.
- “Intensifying competition was often cited as driving service sector price inflation to its lowest” since June 2020, suggesting a protracted demand slowdown and compressed margins.
It may be too early to use the word “stagflation” but it’s fair to say that visibility has declined on both demand and profit margins.
Commenting on the flash PMI data, Chris Williamson, Chief Business Economist at S&P Global Market Intelligence said:
The upbeat mood seen among US businesses at the start of the year has evaporated, replaced with a darkening picture of heightened uncertainty, stalling business activity and rising prices.
Optimism about the year ahead has slumped from the near-three-year highs seen at the turn of the year to one of the gloomiest since the pandemic. Companies report widespread concerns about the impact of federal government policies, ranging from spending cuts to tariffs and geopolitical developments. Sales are reportedly being hit by the uncertainty caused by the changing political landscape, and prices are rising amid tariff-related price hikes from suppliers.
Ed Yardeni remains optimistic:
We also expect that February’s consumer confidence report on Tuesday and Thursday’s weekly jobless claims will confirm that the labor market remains strong. That should relieve some of the concerns about the resilience of the consumer following the weather-related weakness in January’s retail sales and the odd drop into contraction territory in February’s NM-PMI compiled by S&P Global. We expect that the similar index compiled by the Institute for Supply Management will show that services industries are still expanding, when it is reported in early March.
Other recent surveys are also gloomier as Goldman Sachs illustrates:
Yardeni blames the January weather but S&P Global sprinkles its February survey report (compiled 10-20 February) with comments reflecting “growing concerns and uncertainty related to federal government policies”.
BTW:
Speaking at a lunch yesterday [Feb. 20] hosted by the Economic Club of New York, St. Louis Fed president Alberto Musalem said a high-inflation, low-growth combination was not his base case, but called it out as “plausible” nonetheless.
“These days, higher tariffs and immigration policies are often discussed and thought likely to increase prices, cool aggregate demand and possibly soften employment,” Musalem said.
“From the standpoint of monetary policy, it could be appropriate to ignore, or ‘look through,’ an increase in the price level if the impact on inflation is expected to be brief and limited,” he added.
But there is an exception where that might not be the case: if consumers expect higher inflation to stick around longer — i.e., inflation expectations becoming unanchored, as was the case in the 1970s.
“In that scenario, a more restrictive path of monetary policy relative to the baseline path might be appropriate,” Musalem added.
“I think there is a potential for inflation to remain high and for activity to slow — I wouldn’t call that stagflation,” Musalem said.
“You could have a situation where inflation is between 2.5%-3% and growth moderates. Would you call that stagflation area?” he added. “Stagflation would be a wider divergence between the two indicators, employment and inflation.” (Axios)
Right on cue:
US Consumer Inflation Expectations Spike to 30-Year High
Their reasons? Growing concern that President Donald Trump’s accumulating number of tariff threats against friend and foe alike will translate into higher prices.
Consumers said they expect prices will climb at an annual rate of 3.5% over the next five to 10 years, according to the final February reading from the University of Michigan. The rate is the highest since 1995, based on data compiled by Bloomberg. All five components of the index deteriorated, including a drop in buying conditions for big-ticket items. And more than half of consumers in the survey expect the unemployment rate to rise over the next year, the highest since 2020.
Interestingly enough, and perhaps a sign of how America’s furious polarization may in part tinge economic attitudes, the spike was almost entirely driven by views among survey respondents who identify as Democrats.
- Trump’s 10 per cent oil tariff could cost foreign producers $10-billion annually, Goldman Sachs says The investment bank estimates U.S. consumers would face an annual tariff cost of $22-billion, while the government would generate $20-billion in revenue.
EARNINGS WATCH
From LSEG IBES:
425 companies in the S&P 500 Index have reported earnings for Q4 2024. Of these companies, 75.8% reported earnings above analyst expectations and 16.5% reported earnings below analyst expectations. In a typical quarter (since 1994), 67% of companies beat estimates and 20% miss estimates. Over the past four quarters, 78% of companies beat the estimates and 17% missed estimates.
In aggregate, companies are reporting earnings that are 6.5% above estimates, which compares to a long-term (since 1994) average surprise factor of 4.2% and the average surprise factor over the prior four quarters of 6.6%.
Of these companies, 63.8% reported revenue above analyst expectations and 36.2% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 62% of companies beat the estimates and 38% missed estimates.
In aggregate, companies are reporting revenues that are 1.0% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.2%.
The estimated earnings growth rate for the S&P 500 for 24Q4 is 15.7%. If the energy sector is excluded, the growth rate improves to 19.1%.
The estimated revenue growth rate for the S&P 500 for 24Q4 is 4.9%. If the energy sector is excluded, the growth rate improves to 5.5%.
The estimated earnings growth rate for the S&P 500 for 25Q1 is 8.3%. If the energy sector is excluded, the growth rate improves to 9.8%.
Analysts keep revising down:
Note the big slowdown in consumer-centric and financial companies’ earnings growth in Q1:
One of the risks the Trump administration faces by imposing tariffs is the negative impact of tariffs on exports. Tariffs are an additional tax on imported goods, increasing the costs of those products. However, tariffs are never in isolation, as the countries we impose tariffs on will likely impose tariffs back on the U.S. This “tit-for-tat” process threatens to raise costs on exports to countries already impacted by the purchasing power differential caused by a strong dollar. The chart below shows net corporate profit margins during the previous Trump-era tariff policy. Logically, given the high corporate revenue derived from international sales, investors should expect that any cost increase will immediately impact profitability. (Lance Roberts)
Apple, Under Threat from Trump Tariffs, Will Add 20,000 US Jobs $500 billion planned to be invested in US over next four years
Apple Inc., as it seeks relief from US President Donald Trump’s tariffs on goods imported from China, said that it will hire 20,000 new workers and produce AI servers in the US.
The company said Monday that it plans to spend $500 billion domestically over the next four years, which will include work on a new server manufacturing facility in Houston, a supplier academy in Michigan and additional spending with its existing suppliers in the country. The disclosure comes days after Trump and Apple Chief Executive Officer Tim Cook met in the Oval Office.
“He’s investing hundreds of billions of dollars,” Trump said after the meeting last week. He implied that the iPhone maker is investing locally because it does not want to pay tariffs. Trump has threatened an additional 10% tax on items imported from China, where Apple builds the vast majority of iPhones and other products. But he has traded investment in the US for relief in the past.
The $500 billion investment and 20,000 new jobs over the next four years mark Apple’s biggest US commitment to date. Apple said it hired 20,000 research and development workers over the last five years and said in 2021 it would invest $430 billion locally over the next half-decade.
“We are bullish on the future of American innovation, and we’re proud to build on our long-standing US investments with this $500 billion commitment to our country’s future,” Cook said in a statement. “We’ll keep working with people and companies across this country to help write an extraordinary new chapter in the history of American innovation.” (…)
During his first administration, Cook was able to successfully sway Trump into sparing the iPhone from tariffs by arguing that the tax would serve to benefit competitors like South Korea-based Samsung Electronics Co. Apple also made multiple announcements during Trump’s first term about US investments and credited Trump with Mac Pro manufacturing in Texas despite its manufacturing computers there since 2013. (…)
Apple didn’t say whether the new investments were already underway before Trump’s win.
Apple said that it, together with Foxconn Technology Group, will later this year begin producing the servers that power the cloud component of Apple Intelligence — a system called Private Cloud Compute — in Houston. That marks a relocation, at least for some production, from overseas. Next year, it says a 250,000-square-foot facility for such manufacturing will open in the city.
The Private Cloud Compute servers use advanced M-series chips already found in the company’s Mac computers. Those chips themselves, however, continue to be produced in Taiwan.
Apple will also expand data center capacity in Arizona, Oregon, Iowa, Nevada and North Carolina, all states with existing Apple capacity. The company confirmed that mass production of chips started at a Taiwan Semiconductor Manufacturing Co. facility in Arizona last month. Bloomberg News recently reported that plant is building chips for some Apple Watches and iPads.
The 20,000 additional jobs, Apple said, will focus on research and development, silicon engineering and AI. The company is opening up what it calls a manufacturing academy in Detroit, where it will help smaller companies with manufacturing. It already operates an academy for app developers in the city. It’s also doubling its manufacturing fund in the US to $10 billion.
Trump Directs CFIUS to Restrict Chinese Investments in US Energy, agriculture, health care, tech will be off limits. Trump also weighing curbs on US outbound investment to China
Trump laid out the plan in a national security presidential memorandum signed Friday that commits to using “all necessary legal instruments” to bar Chinese affiliates from investing in US technology, critical infrastructure, health care, agriculture, energy, raw materials and other industries.
Trump’s directive sets the stage for a more muscular use of CFIUS, a secretive panel that scrutinizes proposals by foreign entities to buy US companies or property, to thwart Chinese investment.
The People’s Republic of China “does not allow United States companies to take over their critical infrastructure, and the United States should not allow the PRC to take over United States critical infrastructure,” Trump wrote in the memo. “PRC-affiliated investors are targeting the crown jewels of United States technology, food supplies, farm land, minerals, natural resources, ports and shipping terminals.”
The president has also committed to establish new rules meant to curb the exploitation of capital, technology and knowledge by foreign adversaries such as China. At the same time, according to the memo, the administration will consider new or expanded restrictions on outbound investment to Beijing in sectors including semiconductors, artificial intelligence, quantum technology, biotechnology and aerospace.
The administration will also seek to protect US investors by auditing foreign companies on US exchanges and ensuring foreign adversary companies are ineligible for pension plan contributions, Trump added in the memo. (…)
While the president’s action Friday singles out China, he is also trying to spur investment from allied [???] trading partners through a new “fast-track” process to facilitate projects. The US also also will expedite environmental reviews for any investment over $1 billion, Trump said in his memo. (…)
The WSJ:
The memo containing the order to the Committee on Foreign Investment in the US — a secretive panel that scrutinizes proposals by foreign entities to buy US companies or property – seems to be the most impactful of the flurry of moves. Referring to Beijing as a “foreign adversary,” it says the changes are needed to protect “the crown jewels of United States technology, food supplies, farmland, minerals, natural resources, ports, and shipping terminals.” (…)
After the memorandum was released, Beijing urged Washington to stop weaponizing economic and trade issues. The US government’s push to strengthen reviews of business ties on security grounds would seriously undermine the confidence of Chinese companies investing in the US, the Ministry of Commerce said.
The memorandum also says the US government should also review a 1984 tax deal with China that frees individuals and companies from double taxation. “Eliminating these kind of treaties just makes things very uncertain and complicated for investors because they don’t know if they’re going to be taxed,” Chorzempa said. (…)
Also, a call in the memo for new and expanded limits on investment from US pension and endowment funds in high-tech sectors in China could affect companies along the Asian nation’s artificial intelligence supply chains, UBS Group AG said in a note. The rule could impact hardware, software and internet firms, strategists including James Wang wrote.
And the Trump administration called for a review of arrangement known as “variable interest entity” that Chinese firms use to list on American exchanges. It also pledged to look into “allegations of fraudulent behavior by these companies,” without going into details. (…)
FYI, Trump’s memo includes this definition of “foreign adversaries”:
For purposes of this memorandum, the term “foreign adversaries” includes the PRC, including the Hong Kong Special Administrative Region and the Macau Special Administrative Region; the Republic of Cuba; the Islamic Republic of Iran; the Democratic People’s Republic of Korea; the Russian Federation; and the regime of Venezuelan politician Nicolás Maduro.
Trump Proposes New Ship Fees to Challenge China’s Maritime Might
The Office of the US Trade Representative outlined a plan for fees on Chinese-built ships that transport traded goods as well as mandates requiring a portion of US products to be moved on American vessels. (…)
If adopted, however, the proposed fees could translate to additional costs for American consumers, since higher shipping costs could be passed on in the form of higher prices. It’s also not clear that the proposals would be enough to restore American shipbuilding capacity, which has eroded despite century-old protections meant to encourage the use of US-built and -operated vessels.
While the US churns out its own steady supply of warships and Europe leads the world in building cruise ships, global merchant shipbuilding is dominated by three Asian countries: China, South Korea and Japan, which together account for well over 90% of commercial shipbuilding. (…)
China’s market share has grown from less than 5% of global tonnage in 1999 to more than 50% in 2023. China owned 19% of the commercial world fleet as of January last year, and it controls production of 95% of shipping containers, the office said.
Higher costs for shipping on Chinese vessels could present an opportunity for shipbuilders in South Korea and Japan.
Katherine Tai, who served as Joe Biden’s trade representative, last month said the US ranks 19th in the world in commercial shipbuilding, with a volume of less than five ships being built each year. China, in comparison, builds more than 1,700 per year, she added. (…)
The US trade representative is proposing several service fees — including a levy of as much as $1 million — to be charged when Chinese-built vessels enter a US port.
The administration is also proposing steadily escalating restrictions on maritime transport of all US goods. Initially at least 1% of American products exported by maritime vessels would have to be carried on vessels that are both US-flagged and -operated. The requirements would steadily rise, with the threshold climbing to 15% after seven years and eventually encompassing requirements the ships be built in the US too. (…)
German election victor Merz plans pivot from US
Friedrich Merz, set to become Germany’s next chancellor after his opposition conservatives won the national election on Sunday, vowed to help give Europe “real independence” from the U.S. as he prepared to cobble together a government. (…)
Merz took aim at the U.S. in blunt remarks after his victory, criticising the “ultimately outrageous” comments flowing from Washington during the campaign, comparing them to hostile interventions from Russia.
“So we are under such massive pressure from two sides that my absolute priority now is to achieve unity in Europe. It is possible to create unity in Europe,” he told a roundtable with other leaders. (…)
Hitherto seen as an atlanticist, Merz said Trump had shown his administration to be “largely indifferent to the fate of Europe”.
Merz’s “absolute priority will be to strengthen Europe as quickly as possible so that we can achieve real independence from the USA step by step,” he added.
He even ventured to ask whether the next summit of the North Atlantic Treaty Organisation, which has underpinned Europe’s security for decades, would still see “NATO in its current form”.
- The FT:
Merz, who said he was unsure about the future of Nato, also highlighted Washington’s interventions in the German election campaign, and compared it to Russian interference.
The Trump administration has openly courted the AfD and has criticised Germany’s mainstream politicians for refusing to co-operate with a party that has flirted with Nazi-era slogans, urged an end to sanctions on Russia and called for mass deportations of migrants. (…)
Germany hosts the largest contingent of American troops stationed in Europe. (…)
But the AfD and Die Linke won enough seats to block changes to the “debt brake” that limits German government borrowing, making it more difficult for a new government to overhaul crumbling infrastructure and significantly raise defence spending.
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Goldman Sachs:
(…) dramatic changes in fiscal policy still seem unlikely. And while there may be broader agreement on the need for more proactive policy in principle, the outcome helps spotlight still-divergent views on how to deliver it, both within Germany—the clearest case for additional fiscal stimulus, rather than a shift in the mix—and across the EU.
Trump’s Myth of the Trade Deficit Economic growth depends on deregulation, tax cuts and the budget deficit, not on the balance of trade.
It seems to be a matter of faith among protectionists that trade deficits make the U.S. an economic loser. President Trump considers America’s trade imbalances with Canada, Mexico and China a matter of grave concern. At the same time, since taking office he’s announced several ambitious plans to increase foreign investment in the U.S. economy. The commitment both to eliminate trade deficits and to pursue foreign investment shows the inconsistency of the Trump administration’s policy. Trade deficits and capital surpluses are two sides of the same coin.
(…) if the U.S. has a surplus in its capital account balance, it must have a corresponding deficit in its trade balance.
Protectionists can’t turn the tide of markets. If Japanese tech-investing firm SoftBank fulfills its Dec. 16 commitment to invest $100 billion in the U.S., as SoftBank acquires dollars to fund the investment, the value of the dollar will rise relative to what it would have been without the investment, the cost of U.S. exports will rise, the cost of U.S. imports will fall, and the country’s trade deficit will rise. Fortunately, foreign capital investment creates American jobs and fuels economic growth no less than do foreign purchases of American exports.
Trade deficits don’t stifle growth, nor do trade surpluses foster it. (…) Between 1890 and 2024, it is impossible to find a statistically significant correlation between America’s trade balance and its economic growth. (…)
U.S. industrial production today is more than double what it was in 1975, the last time we ran a trade surplus. It’s 55% higher than in 1994, when the North American Free Trade Agreement went into effect, and it’s 18% higher than it was when China joined the World Trade Organization in 2001. Real wages are up 19% from 1994 and 10% from 2001. The inflation-adjusted value of America’s capital stock is 36% higher today than it was in 2001, 66% higher than it was in 1994, and 178% higher than it was in 1975.
Manufacturing as a share of total nonfarm employment peaked during World War II and has declined ever since, following the pattern of employment in agriculture, which fell from 40% of the labor force to 2% over the course of the 20th century. This is attributable not to globalization, but to the spread of modern technology and the rise in demand for services relative to goods. Neither Nafta nor China’s membership in the WTO notably increased the secular rate of decline in the share of workers employed in manufacturing. (…)
Mr. Trump and Congress should focus on advancing economic growth by deregulating, controlling the budget deficit and extending the 2017 tax cuts. Fixating on the trade deficit, an imagined problem, will only draw the nation into a trade war that could overpower the positive effects of the Trump economic program.
Debt Has Always Been the Ruin of Great Powers. Is the U.S. Next? From Habsburg Spain to Trump’s America, there’s no escaping the consequences of spending more on interest payments than on defense.
By Niall Ferguson
(…) What I call Ferguson’s Law states that any great power that spends more on debt service than on defense risks ceasing to be a great power. The insight is not mine but originates with the Scottish political theorist Adam Ferguson, whose “Essay on the History of Civil Society” (1767) brilliantly identified the perils of excessive public debt. (…)
What I call Ferguson’s Law states that any great power that spends more on debt service than on defense risks ceasing to be a great power. The insight is not mine but originates with the Scottish political theorist Adam Ferguson, whose “Essay on the History of Civil Society” (1767) brilliantly identified the perils of excessive public debt.
The crucial threshold is the point where debt service exceeds defense spending, after which the centripetal forces of the aggregate debt burden tend to pull apart the geopolitical grip of a great power, leaving it vulnerable to military challenge.
The striking thing is that, for the first time in nearly a century, the U.S. began violating Ferguson’s Law last year. Annual defense spending—to be precise, national defense consumption expenditures and gross investment—was $1.107 trillion in 2024, according to the Bureau of Economic Analysis (BEA), while federal expenditure on interest payments (the government long ago gave up on paying down principal) topped out at $1.124 trillion.
These outlays can also be expressed as percentages of gross domestic product. The Congressional Budget Office (CBO), which uses a narrower definition of defense spending than the BEA, places it at 2.9% of GDP for last year. Net interest payments (adjusting for the interest received by bonds held by government agencies) amounted to 3.1%.
We have seen nothing like this since the era of isolationism. Between 1962 and 1989, U.S. defense spending averaged 6.4% of GDP; debt service was less than a third of that at 1.8%. Even after the end of the Cold War, the federal government was still spending, on average, roughly twice as much on national security as on interest on the debt.
The fact that the U.S. is currently projected to spend a rising share of its GDP on interest payments and a falling share on defense means that American power is much more fiscally constrained than most people realize. By 2049, according to the CBO’s latest long-term budget projection, net interest payments on the federal debt will have risen to 4.9% of GDP. If defense spending maintains its recent share of discretionary spending, it will amount to half that share of GDP.
Nor is there any real possibility that defense spending will increase dramatically. Because such spending is discretionary, it has to be appropriated by Congress every year, unlike spending on entitlement programs (which is mandatory) and interest payments (nonpayment of which would be default). If anything, budgetary constraints are likely to put downward pressure on defense spending in the decades ahead.
Ferguson’s Law—that it is dangerous for a great power to spend more on debt service than on defense—is borne out by history. (…)
But the best example of all—and the one from which Americans have the most to learn—is that of Great Britain. (…)
In the wake of World War I, debt service exceeded military spending every year from 1920 to 1936. It was this breach of Ferguson’s Law, much more than any trust or sympathy toward Adolf Hitler, that inspired the policy of “appeasement.” Of paramount importance to the Treasury was the concern that higher spending on armaments would jeopardize Britain’s precarious recovery from the Great Depression.
In seeking to appease Hitler, British Prime Minister Neville Chamberlain failed, of course, to deter him and his confederates from launching another world war. Despite the fact that U.K. defense spending rose above debt service in 1937, the signal was not sufficiently strong to dissuade Hitler from invading Poland, even when accompanied by an explicit pledge of support for Poland in the event of a threat to its independence. The most that belated rearmament was able to achieve was to ensure that the British military survived the retreat from Dunkirk and won the Battle of Britain. (…)
What are the implications for America today? Geopolitically, the U.S. finds itself in a situation comparable with that of Britain in the 1930s. Its military commitments are global, as has been true since 1945, and it confronts a new axis of authoritarian powers.
Yet America’s fiscal position is far more constrained today than ever before. The U.S. government is now in violation of Ferguson’s Law and is likely to move further beyond its crucial limit in the coming decades.
Can the U.S., like Victorian and interwar Britain, find a way back? Can it do even better, successfully deterring its foes—as Britain failed to deter Germany—and averting the possibility of a ruinous World War III? Or is America doomed to follow Habsburg Spain, the Ottoman Empire, Bourbon France and Austria-Hungary down the path of default, depreciation and imperial decline—even revolution?
There are four important differences between Britain in the 1930s and the U.S. in the 2020s, and all of them work to America’s disadvantage. First, the term structure of U.S. debt is shorter, making it more sensitive to changes in interest rates. That makes it inherently harder to “inflate debt away” like the U.K. after World War II. Second, much more of it is in the hands of foreign investors. Third, the trend of real interest rates in the U.S. seems less likely to be downward than it was in 1930s Britain.
Whereas British real interest rates fell in the Depression, in America they are currently projected by the CBO to rise from 1.7% in 2024 to 1.9% in 2026, declining slightly to 1.8% in 2034. The real growth rate of the economy is projected to be almost identical. In this scenario, America’s debt will cost more to service in the period 2025-2035 than it did in 2015-2025, when the average real rate was 0.3%, especially because the stock of debt will continue to grow.
Finally, the U.S. today is encumbered with an expensive welfare system designed for a society with a higher fertility rate and lower life expectancy. Entitlement programs such as Social Security and Medicare are now the biggest items of federal expenditure. They will only become more expensive as the population ages.
History suggests that any sustained period when a great power spends more on interest payments than on military capabilities is likely to see its strategic rivals challenge its position. The tension between “guns and coupons” (as the interest-bearing parts of bonds used to be known) may also undermine its domestic stability, as governments try and fail to meet the competing demands of generals, bondholders, taxpayers and welfare recipients.
In the absence of radical reform of America’s principal entitlement programs—which successive administrations this century have either failed to achieve or ruled out—the only plausible way that the U.S. can come back within the limit of Ferguson’s Law is therefore through a productivity miracle.
Today, it may seem that the world is divided between a mighty American “Trumpire” and the feeble foreign competition. But the real contest of the second quarter of the 21st century may be between the much-vaunted economic promise of artificial intelligence—and history, in the form of Ferguson’s Law.
- About That 8% a Year Pentagon Cut Sen. Wicker says it’s not a cut in defense muscle. Let’s hope he’s right.
The Trump Administration is moving so fast it’s hard to know what’s real and what is a media panic. An example is this week’s brouhaha over Defense Secretary Pete Hegseth’s memo calling for Pentagon officials to seek cuts of 8% a year in defense spending. That would be a recipe for national decline if true. (…)
[Senate Armed Services Chairman Roger] Wicker added that the President “intends to deliver” on his campaign promise to rebuild the military. Mr. Wicker has credibility on the point as he has been a rare voice in Washington warning that U.S. defenses are inadequate for the dangerous world now and ahead. (…)
U.S. defense spending as a share of the economy is roughly half its Cold War peak of about 6%. Mr. Trump wants European allies to spend 5% of their economies to defense, yet we haven’t heard Mr. Trump mention a single hard target for U.S. spending on the military. The current budget trend is heading to less than 3%.
Mr. Wicker says his goal is to get back to 5%. With an aggressive China, a malign Russia, nuclear North Korea and perhaps nuclear Iran, and new missile and cyber threats to the U.S. homeland, he’s right.
Let’s hope the Senator is also right about Mr. Trump’s defense intentions. But he and other Republicans in Congress will need to find their voice on defense and foreign policy to make sure Mr. Trump follows through.
- See How Xi and Putin Are Ramping Up Joint Military Drills China and Russia expand cooperation from Alaska to Taiwan in a challenge to the U.S. and its partners
The militaries of China and Russia, America’s top two global adversaries, are working together as never before in their long partnership, probing the defenses of the U.S. and its allies.
The message to America from the growing partnership is that, if drawn into a military conflict, U.S. forces could find themselves confronting both countries.
Chinese-Russian joint patrols and military exercises have become more frequent and increasingly assertive, a review of recent activity shows—and the U.S. and its allies have been forced to respond more frequently as well, scrambling jet fighters and other assets to safeguard territory.
Beijing and Moscow have been displaying close cooperation near Japan, South Korea and the Philippines, nations that the U.S. has pledged to defend, and Taiwan, to which the U.S. sells weapons and provides training. Washington has maintained a policy of ambiguity as to whether it would defend Taiwan from a Chinese invasion.
Alongside growing military ties between Russia and U.S. foe North Korea, the prospect of battling multiple enemies compounds the challenge for the U.S. as it prepares and develops strategy for a potential conflict in Asia.
The point was made closer to home in July, when Russian and Chinese warplanes took off from a Russian air base and flew together past Alaska, prompting the U.S. and Canada to send jet fighters to intercept them. U.S. officials said it was the first time strategic bombers from Russia and China operated together near North America.
“The locations and assets involved in these exercises are becoming more expansive and aggressive,” said Jacob Stokes, a senior fellow at the Center for a New American Security, a Washington think tank. “It’s projecting military force at a scale sufficient to target other powerful states, which is a major shift.” (…)
The flyby was followed in October by a joint patrol to the Arctic through the Bering Strait involving two Russian border-guard ships and two cutters of the Chinese coast guard, a force that has grown in strength and assertiveness.
The two powers made another joint display in December at a sensitive Asian hot spot. As China’s navy was massing for one of its largest shows of force around Taiwan in years, four Russian warships sailed past the self-ruled island. Three Russian corvettes took part—vessels designed to operate in shallow and coastal waters.
The corvettes, accompanied by a Russian fuel-supply ship, communicated with Chinese warships as they approached in what appeared to be a coordinated drill, a Taiwanese security official said. (…)
Working together at an increasing tempo, Russia and China have now conducted more than 100 joint exercises since 2003, according to a database maintained by the Center for Strategic and International Studies’ China Power Project.
The geographical range of the cooperation has expanded, sending a message of broader reach and widening the range of potential conflict. (…)
Meanwhile, also in the WSJ:
(…) By pivoting to support Russia and backing away from Ukraine, Washington is already alienating its allies in Europe, who are collectively the U.S.’s largest trading partner and top foreign investor. The sudden U-turn in American foreign policy could also spook partners in Asia that the U.S. would want on its side in any conflict with China.
On Wednesday, Trump echoed Russian propaganda and directed a stream of invective at Ukrainian President Volodymyr Zelensky, calling him a dictator and blaming Kyiv for starting the war that began when Putin ordered a full-scale invasion of his smaller neighbor in 2022.
That outburst, following a barbed speech delivered to European leaders by Vice President JD Vance in Munich earlier this month and other signs of waning U.S. support for Ukraine, have already caused the biggest rift in relations between the U.S. and its trans-Atlantic allies in several decades. (…)
Trump is “attempting to split an entente between two powers that have ideological affinity and shared strategic interests,” he said. “And what it has done instead is to split the West, while Russia aligns with the U.S. and with China simultaneously.”
In addition to bringing Russia closer to China as Western sanctions inflicted economic pain, the war in Ukraine has solidified Moscow’s alliances with Iran and North Korea, which supply ammunition, drones, missiles and, in North Korea’s case, troops, to the Russian war effort.
U.S. officials cite the emergence of this new axis of autocracies as a strategic threat that the American military would be hard-pressed to handle simultaneously—and say that Trump’s urgent desire to end the war in Ukraine is driven by the need to weaken, if not break up, that common front of adversaries. (…)
Secretary of State Marco Rubio, in remarks after talks with senior Russian officials in Saudi Arabia this past week, highlighted “the incredible opportunities that exist to partner with the Russians geopolitically on issues of common interest.”
At these talks, the most senior-level encounter since 2022, U.S. and Russian negotiators discussed the possible economic benefits that would result from improved relations and the lifting of U.S. sanctions that have stunted the Russian economy—and forced it to rely even more on Beijing. (…)
In remarks at the Halifax Security Forum in November, U.S. Navy Adm. Samuel Paparo, the commander of the Indo-Pacific command, said Beijing and Moscow have a “transactional symbiosis,” and that “to think that we will be able to drive a wedge between them is a fantasy.” (…)
“Russia knows that China is its giant neighbor, that the Communist Party of China will keep ruling it for as long as Russia can foresee—and that alienating China creates a mortal danger for Russia,” said Alexander Gabuev, an expert on Sino-Russian relations who heads the Carnegie Russia Eurasia Center in Berlin.
That doesn’t mean Putin won’t engage. Trump’s overtures offer the prospect of getting from Washington something his armies couldn’t achieve in three years of war: regime change in Kyiv and the return of Ukraine, and possibly other parts of Europe, to Moscow’s sphere of influence.
“I don’t see why Russia wouldn’t pocket all that Donald Trump brings it on a platter, undeservedly, while at the same time maintaining the tight bond with China,” said Thomas Gomart, director of the French Institute of International Relations, a Paris think tank that advises the government.
While China is watching Trump’s pivot to Russia with some apprehension, it is also cashing in a strategic windfall: Its two main goals in Europe, propping up the Putin regime and splitting the rest of Europe from the U.S.—objectives that were mutually exclusive until now—are suddenly within reach.
As Washington heaped scorn on Zelensky and European leaders, Chinese Foreign Minister Wang Yi spoke of the need to maintain international law and the charter of the United Nations. He recently described Ukraine as “a friend and a partner” as he met his Ukrainian counterpart.
Rather than a “reverse Nixon” as some are suggesting, Trump’s support of Putin looks more like “another Chamberlain”. Hopefully, this history won’t rhyme…
