What Cannot Continue - Will Stop

Explaining The U.S. Debt Crisis In Simple Terms

James Lavish, CFA, is a seasoned professional in institutional investing and risk management with over two decades of experience. He is currently the Managing Partner of the Bitcoin Opportunity Fund, which focuses on public and private investments in the Bitcoin ecosystem. Lavish is recognized for his work in educating others about financial fundamentals through his newsletter, The Informationist, which simplifies complex financial concepts for a broad audience.

James opened by talking about the fact that the numbers and what consumers are feeling are like having two different economies: "You’re seeing two economies out there. And that's causing a lot of confusion out there. You hear the Fed talking about inflation. You hear the White House saying they've got inflation tackled. You hear businesses saying that they're struggling. You hear consumers saying that they're struggling. They can't stand the inflation, the prices. They can't keep up. But yet you see these numbers that are coming out that seem to be okay. They're conflicting.”

🔉 Listen to the audio of this full hourlong interview here.

He added: “You're getting unemployment numbers that are conflicting with the actual job numbers. You're getting pricing that is conflicting. If you go to the grocery store, you're looking at the prices, you're saying there's no way this is up 3.2 percent from last year. This is up 10, 12, 15 percent. So there's confusion out there."

He then went on to try and explain why this is: "The confusion, Chris, is that you've got pockets of recession, which are natural when you have the Fed raise rates so quickly and hold them there for so long. And look, 5.5% is not an incredibly high rate on interest rates on the Fed funds rate historically. But when you raise rates from just over 0%, where they were holding for a decade, to 5%, it's massive because we've become incredibly indebted in this nation, which we're going to touch on quite a bit here. But the most important thing to understand is why people are asking, 'If the Fed has raised rates so steeply, why is the inflation rate not come down? Why is it not back to the two percent or under two percent target?'"

“And the answer is that it's because the government is spending wildly, like so incredibly irresponsibly, that it's causing what we're calling fiscal dominance, meaning fiscal spending is dominating the Fed's attempt to tackle inflation by raising rates. And so you're seeing pockets of recession and people are feeling it. People are feeling it in their pocketbooks and their wallets,” he continued.

James went on to describe the era of fiscal dominance we are entering: "So what's happening is it's the federal spending. It's the government spending so much money that you're seeing areas of deep recession. There's just no question about it. Commercial real estate has a problem, and that means regional banks have a problem. The Fed is all over this. The regional Federal Reserve banks are all over this. They are working with these community banks to make sure that they don't go under. And we've already seen them go under. We saw Silicon Valley go under. That's a little bit of a different situation that didn't have to do with commercial real estate, but that had to do with exactly what you talked about. So you have rates that rise catastrophically on a meteoric pace.”

He also talked about how the rise in rates has effected treasuries on corporate balance sheets: “Treasuries were considered riskless because in the last 15 years, they were riskless. If you owned a treasury, there was pretty much a certainty that the price of that treasury would just gravitate to par, and you would mature and get your maturity payment and all the coupons along the way. However, when you raise interest rates from 0.025% to 5.5% on a bond with a 30-year duration, you're basically saying that if you went to try to sell that treasury that you own, let's say a 1.5% treasury with a 30-year yield, and it's yielding 1.5%, and you try to sell that in the market, that's a difference of four percent annually for that bond. So if this thing still has 7, 8, 10, or 15 years of duration on it, that means you're marking this bond down significantly. It's not just a few percent."

James pointed out that protecting the market is crucial at this stage: "The economy is driven by this, and it's been shown for the last decade that the stock market really is a large part of the economy. It's not just because of tax receipts off of capital gains, but because people look at their net worth and see their net worth go up in their stocks. They're willing to spend more of their discretionary income rather than saving it because they think, 'Oh, well, look, my net worth is up 20%, 30%, 40% in the last couple of years. I'm fine. I'm going to go ahead and spend my paycheck. I'm not going to put any more money into the market. I'm good.' And so it just drives the economy."

Lavish explains that any crisis now will be kicked up to the sovereign level for the first time in recent history: "We have the tech bubble, and that's kind of kicked up to the banks. Then we continue on, and we've got this risk, this debt indebtedness, that's now kicked up to the banks. And now we're coming on the great financial crisis with the housing market. The housing bubble and all of these banks holding this mortgage paper, which is just garbage, end up going under. Where does it get kicked? It gets kicked up to the federal level. And now it's sitting on the Federal Reserve's balance sheet. Flash forward to 2020, and you've got the lockdowns that caused the entire economy to grind to a halt. The government, in a panic, went and monetized $6 trillion of debt. So now you've got a Fed balance sheet that's holding more treasuries than anybody else in the world.”

“What's going on today is that the problem is we have a fiscal policy that is absolutely unimaginably irresponsible,” he says. “We're running $2 trillion deficits at a time that we're not even in a recession. All this matters because the indebtedness and the risk have been kicked all the way up to the sovereign level. The punchline is that if you have a collapse of the economy, it's the sovereign level that must stomach it completely now."

And then he lays out the case bare: "We can walk through the numbers, but the bottom line is that the US government and the Treasury have entered a debt spiral. We now have $34.7 trillion of debt, which is over 120% of GDP. If you're a country with debt over 120% of GDP, your fiat currency fails. This is where we're at, and we're just spending and spending and spending.”

“What happens if you get into a recession? Your tax revenues drop precipitously, and your spending rises at a similar rate because of all your social programs like unemployment and wage security. You could wind up having a deficit that's not $2 trillion but could be $3, $4, $5, or even $6 trillion if it gets bad enough. Just imagine that. Suddenly, we are adding over 10% to our debt in a year, maybe 20% in a year. That is the debt spiral.”

He continues: “We can't do that because the rest of the world will turn around and look at our bonds and say, 'Why would I buy those bonds if they have to keep issuing new bonds to pay me for my bond?' We are in a situation where we have to continually issue more and more debt. This is rising exponentially, and there really is no way out. That's the problem.”

“Modern monetary theory proponents think it's just driving the economy; there's no big deal. However, when the music stops and people stop having confidence in the U.S. Treasury, that feeds into the US dollar. That's when you get into a problem. Why does that happen? It happens because of inflation. It all goes back to this central problem: this constant and relentless manipulation of the monetary system through central banks that create inflation.”

“That is a soft default on that debt every single day because the dollars you're getting paid back in the future are worth less than when you lent them out to the government initially. So, who wants to lend the U.S. Treasury dollars for 30 years when they know that inflation only has to go up to continue the charade?"

"They get into what's called a debt spiral. They can't get out of it. And this is where we are. So what is the option for the U.S. government if they continue to borrow? What does that mean? Well, that means that they must have inflation. There absolutely is no way around it. That inflation allows GDP to grow nominally. Remember that $28.5 trillion number? That has to go up. Nominally meaning just in terms of dollars, not inflation-adjusted.”

“When you have more dollars in the system, it creates more GDP because there's more dollars. And so that GDP number goes up. The productivity number goes up. But it's fake. It's not more stuff. It's just stuff that's more expensive. So there are more dollars in the system. And when you go to pay down that debt in the future, you're paying it down with dollars that are cheaper, that are worth less. This is called the debasement of the U.S. dollar. The U.S. dollar gets worth less and less and less every single year.”

He concludes: “And so this is the challenge. The U.S. government absolutely must have negative real rates. What do I mean by that? That means they must have coupons on their treasuries that are lower than the inflation rate, and they have to have this in perpetuity. That's the only way they can keep this charade going. It won't go on forever. Make no mistake, this cannot go on forever."

You can listen to the full hour long interview, including insights on when the market cracks, ugly looking treasury auctions and more, at this link.

The Genesis of Total Collapse

Let’s examine why the US (and the entire world) is committing economic suicide :

The Beginning of the End

JUNE 13, 2003 - There is increasing evidence that massive economic stimulus — monetary, courtesy of the Federal Reserve, and fiscal, thanks to the president and supply-side minded lawmakers — is taking hold. The magnitude of the policy turnaround, which caps a constructive, multi-year reflation process, should overwhelm the economic negatives — including the drag from expensive oil and poor finances at the state- and local-government levels.

Expensive oil and its impact on other energy costs remains a concern.

The current level of U.S. monetary stimulus is massive. Real interest rates have fallen 5.2 percent from December 2000 to March 2003, reaching -1.2 percent. A swing of this magnitude may be historical.

HIGH PRICED OIL DESTROYS GROWTH

According to the OECD Economics Department and the International Monetary Fund Research Department, a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. 

HOW HIGH OIL PRICES WILL PERMANENTLY CAP ECONOMIC GROWTH

For most of the last century, cheap oil powered global economic growth. But in the last decade, the price of oil production has quadrupled, and that shift will permanently shackle the growth potential of the world’s economies. 

THE PERFECT STORM (see p. 59)

The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy. But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel 

Faced with the powerful headwinds of increasing costs of oil production at the turn of the century, the Central Banks responded with extensive stimulus measures to ensure the global economy continued to grow.

In 2008, these policies careened off the tracks and the master franchisee of all Central Banks, The Federal Reserve, stepped in to back-stop the financial system.

The train was then fuelled with even more stimulus and continued to speed along up until 2019.

“The global economy was facing the worst collapse since the second world war as coronavirus began to strike in March, well before the height of the crisis, according to the latest Brookings-FT tracking index. “The index comes as the IMF prepares to hold virtual spring meetings this week, when it will release forecasts showing the deepest contraction for the global economy since the 1930s great depression.  Read More

At this point it got serious. The Central Banks determined that they were running out of track so UEP was activated. Many trillions of dollars were dumped into the global economy under the cover of Covid relief to prevent the above-mentioned collapse, and the Rat Juice death shots were rolled out to prepare for the end game - extermination.

This new stimulus, along with upwards of USD One Trillion Dollars of new debt in America every 100 days, has kept the train rumbling down the track. However in the past couple of years inflation has reared its ugly head, a product of trillions of dollars sloshing around the economy and increasingly expensive energy production costs.

The Central Banks are now screwed.

The massive private and public debt loads incurred when interest rates were at record lows are already unsustainable at 5% making further increases unlikely. Reducing rates will only fuel the raging inflationary fires.

This looks to be the final act of civilization. The camel is staggering under the twin burdens of high interest rates applied to eye-watering debt, and punishing inflation.

What cannot continue will stop. The question is when.

Tick Tock….