25 Mar Nationalizing America’s Debts
“The canaries have stopped singing.” – Cassandra
“The canaries are nervously pacing their cages.” – The Lonely Realist
Cassandra’s warnings in prior TLRs presaged today’s widely-held conclusion that the global economy has passed a tipping point. The failures of Silicon Valley Bank, Credit Suisse, First Republic and others indicate that the economic tide is going out, revealing a host of naked swimmers. Governments have responded to the potential for economic mayhem with bailouts that substitute government debt for privately-held debt – in short, debt nationalization. Will doing so prevent economic contagion? Or will bailouts serve only as a short-term fix? After all, there are a great many leveraged businesses, student loan-holders, venture capital firms, private equity investors, commercial real estate-owners, etc. With the world emerging from an extended period of historically low interest rates and extravagant credit-creation, today’s higher interest rates and tighter monetary policies necessarily will impact on holders of leveraged assets. Will excesses that to-date have revealed themselves only as bank failures, poor pension trust investing and crypto losses ripple through the global economy? For perspective, below is an excerpt from a conversation TLR had this past week with Cassandra (noting that the views expressed in TLR are not investment, legal or tax advice).
CASSANDRA: … As you and I have often discussed, Mr. Realist, economies grow and contract in predictable ways. Human actions repeat, creating economic boom and bust cycles. This is as true today as it was 2500 years ago.
The 21st Century has seen unusually strong economic performance driven by borrowings that, in effect, stole growth from the future. Those borrowings fueled two decades of wild spending. The predictable consequences of that spending spree have historical precedents that should have triggered alarm bells with those in authority. The resulting imbalances and misallocations inflated bubbles, created wealth disparities and resulted in exorbitant increases in the costs of food, energy, healthcare and education. Some of the more significant borrowings were triggered by the Federal Reserve’s Quantitative Easing campaign that began in 2009. Inflationary fuel was added by lax fiscal policies, COVID stimuli, and technological advances. Americans came to expect that the benefits of excessive borrowing-and-spending would continue indefinitely, that the resulting debt and deficits would have no consequences, and that crypto values, commercial real estate prices, and stock market earnings would increase forever. Understanding the consequences of Federal Reserve and government spending policies surely did not require my prodigious predictive powers. Yet the bursting of 21st Century bubbles – which has been limited so far – appears to have shocked investors and surprised America’s regulators.
Today’s metrics speak to the extent of the problem. Based on a share price’s multiple of sales, the S&P500 index today is more expensive than it was before the bursting of the ludicrous dot-com bubble in 2000. Add to that the fact that banks today are borrowing at the Fed’s discount window at an unprecedented rate, demonstrating that the banking industry’s liquidity concerns are widespread and serious. The alarming fact is that those problems no longer appear to be merely about liquidity – they most certainly are about solvency and therefore will continue squeezing both banks and businesses. The media have been hyping the banking crisis as a discrete problem that America’s government is addressing. The reality is that the banking industry bailout is a mere prelude to the coming economic storm.
America’s commitment to nationalize an enormous quantity of private debt has consequences. Not only does the American Treasury have no reserves, America is a debtor nation with a debt load that already is difficult to service, a sad reality that America’s government refuses to meaningfully address. Although the U.S. can print more Dollars, doing so is inflationary and will further weaken the Dollar, for the time being the world’s reserve currency. With the banking crisis likely to metastasize into corporate and investment sectors, further government bailouts can be expected. They necessarily will increase that debt burden. The U.S. response will be to print yet more money and purchase yet more private debt at the same time as demand for U.S. debt is declining. With so much national debt destined to overhang the markets, it will be impossible for the government to maintain a high-enough interest rate to allow it to incur still more debt. The high interest rates necessary to attract purchasers of U.S. obligations will pauperize the American economy as well as private industry borrowers whose assets consequently will be declining in value.
The fact is, Mr. Realist, that the current borrow-and-spend cycle cannot continue much longer. With U.S. debt and liabilities already at unsustainable levels and more debt and liabilities to come, America’s economy is rapidly approaching a reckoning. Given the inflationary risks, the Fed will continue raising rates until government payments approach the breaking point, at which time it will lower rates until there is inadequate demand for America’s debt. It will then have to raise rates again, in part to address accelerating inflation. This push-pull of raising and lowering interest rates (together with on-and-off QE and QT) will result in a true monetary crisis. The Fed cannot tame inflation at the same time as recessionary forces require stimulus. The time for crisis therefore is fast approaching.
THE REALIST (clearing his throat): Thank you, Cassandra. True to form, you’ve provided a chilling reminder of what it means to be “a Cassandra.” Please allow me, however, to paint a somewhat less dire picture.
Although economists have acknowledged the reality of America’s ticking debt bomb, when, how and at what megatonnage that bomb might detonate have been hotly debated. There are a great many variables as well as external events (like war, pestilence, and natural disasters) and remedial actions by America’s government that could mitigate timing and impact. Moreover, a number of economists point to modern Japan as providing an appropriate parallel. It enjoyed an era of unprecedented growth that ended more than three decades ago and was followed by extreme money-printing, stagflation and a series of disasters. Yet Japan did not experience the level of economic devastation that you are predicting for America. Japan’s debt today at >260% of GDP far exceeds America’s at ~130%. In fact, it is and for many years has been the highest of any developed nation. Fully 50% of that debt is held by the Bank of Japan and Japan spends more than 20% of its national budget on interest payments alone. Japan’s economy nevertheless continues to motor along, as does its bond and stock markets. Japan’s excessive borrowings and money-printing therefore might be viewed as a success story. Although America is not Japan, many believe the American economy should be able to continue its borrowing-and-spending on a similar basis, perhaps for many years to come.
CASSANDRA: Unfortunately, Mr. Realist, they are wrong.
[TO BE CONTINUED.]
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Finally (from a good friend)