THE HYDRO, DERBYSHIRE – Well the cat’s out of the bag now…

If you haven’t seen yesterday’s announcement yet, I suggest you do so now

That marks one of the largest events in the history of this company – certainly since I’ve been here anyhow.

Thus far, the reception has been very positive – but we’re only a day in, and considering the controversy the man is prone to attracting, we’ve a way to go yet…

The dollar debt dilemma  

I recently received an interesting question recently from a reader on the nature of debt and the US dollar, which we’ll explore a little today.

I have a question for you. If you go to Google and bring up “Truth in Accounting” you will find that the USA’s total debt now stands at 135.5 trillion dollars – not the 27 trillion dollars which is the official figure. Furthermore, Truth in Accounting” break this figure down. My question: can this vast debt  go on rising indefinitely or will we see a collapse of the US Dollar? If this happens, how will it affect world currencies and world trade? I look forward to reading your expert opinion.

The true size of the US government’s debt is a subject of much speculation. Washington’s public debt – the bonds it sells to banks and investors via the Treasury department – is the visible element of the iceberg. What’s hidden is its other debts: the promises it’s made to its citizens in welfare spending (Social Security, Medicare, Medicaid, and Veterans Benefits) and the built-in cost of maintaining the largest military force ever created.

These extra costs are, uh… rather significant. $100 trillion is often bandied around as the “true” measure of US government indebtedness, but you can find estimates of more than double that – and not just from folks at the fringe. Hell, an economics professor testified before the Senate Budget Committee back in 2015 that the actual figure was $210 trillion.

I’m no expert on the topic (I’m certainly no accountant), so I don’t have a specific figure in my head when it comes to the exact amount the Feds owe everyone else. I just know that it’s large enough that when the debt starts to really come due (baby boomers retiring en masse, for example), we’ll find out just how big a superpower’s wallet is. It’ll bend our perception of what can and can’t be paid for by a superpower, and I’ve no doubt it will shatter the beliefs of what many economists – and more importantly, market participants – believe is possible.

The question is, which beliefs will be revealed to be false? That the US can and will honour its debts… or that it can’t?

To answer the reader’s question, debt cannot go on rising indefinitely. Einstein’s 8th wonder of the world, compound interest, is an enemy that even superpowers cannot defeat. But if we’ve learned anything since the financial crisis, it’s that debt can keep rising for an awful lot longer than anybody expects. China is a prime example of a country where indebtedness has become so extreme and so rapidly that many have anticipated its collapse. And yet on it continues, and up goes the debt.

Another reader wrote in their take on how China has managed this, in response to last month’s letter Honeytrapped: China’s “beautiful person plan investment plan” (18 September):

I think you hit the nail on the head about those loans being a honeytrap. For as long as I can remember the “experts” have been warning that China had too much debt, too much of it had financed unproductive investments, and that China was due a recession. The only debate was, allegedly, whether China would have a hard or a soft landing.

Well, the experts have been wrong for 20 years straight, because they don’t understand that credit growth is what drives real growth, be that in China or the West. China, on the other hand, gets it. They learned lessons from their neighbours, and they have been replicating the Japanese economic miracle quite consistently since the 80s, without a single landing, either hard or soft! They know that they can finance as much investment as they need to through credit creation, and they don’t need to borrow a single cent from the US.

So why are they borrowing from the US? There is only one possible reason – to make it costly for the US to engage China aggressively.

They’re not dumb.

Following Japan’s crash in the late 80s (when the Japanese Economic Miracle ran out), the nation has still managed to stay afloat, much of that via government borrowing. Doing this for long enough has made it the most indebted country in the world. But that status doesn’t appear to be a problem for it – not yet, anyhow.

But now we look at the US, which has something that neither China, Japan, nor anyone else has: the ability to issue the world’s reserve currency. If anyone should be able to get away with gross indebtedness it’s the country that can print the world’s medium of exchange – the USD – and not yen or yuan.

So if Japan and China have managed it this far… I think the US has a fair way to go just yet. The question then is how much value the US dollar loses when the Feds do “whatever it takes” to honour their debts…

On that note, I’ll leave you today with an insight from macro analyst Julian Brigden which I found interesting – it was part of a broader presentation he gave on Real Vision.

The US is converging [with] Europe… it’s going down that socialist path. That, I think, is going to be important as we talk about the dollar in this whole idea that we have of US exceptionalism. We been here before, ladies and gentlemen. This is what we had in the late ‘60s, and also under Carter. This socialization [to] bigger government is a very, very bad route for the US to go. It has significant consequences. In the ‘60s, and also under Carter, it was associated with rampant rising inflation. That’s ultimately where we think we’re going to go as we move into 2021 and 2022.

Before you stand back and say, well, look, there’s no way that we’re going to do that, [here’s] just a couple of observations about what this pandemic has done to government. The first thing is that historically, pandemics are associated with tangential shifts in politics. If you go back and you look at the Black Death, there was this little German chap called Martin Luther who hung around and tended for the sick and the dying when the Catholic priests disappeared off to the monasteries in the countryside. That was the cycle high of Catholicism. That was a relatively big political shift.

Fast forward a few hundred years, you get to the second cholera epidemic in 1848, that was the end of autocratic monarchies in continental Europe. Louie Philippe fled and lived under basically Queen Victoria’s curtails until he died a few years later. That was a cycle high, it was hugely important. Spanish flu, killed so many men on top of those who died during the First World War that we needed to basically enfranchise women. Another huge, huge tangential shift.

You should expect government to be much more active as you move forward, and given the inequalities that we have in society, given the growth of greater equality that we need to build, they’re going to have all the excuses they possibly need from a social perspective to spend money. On top of that, the economic weakness that they will be inheriting, and there’s every single excuse to keep spending money. This time, they’re going to have to – because the level of debt [is so high]- they’re going to have to do it via financial repression, we think eventually we’re going to see the Fed be forced… to get more involved in the bond market and prevent those bond yields accelerating…

To clarify, what he says at the end there about “getting more involved in the bond market and preventing yields accelerating” is a technical term for “printing money”.

While we’ve focused on the US for today, the UK government faces many of the same problems. Instead of Social Security liabilities like in the States, we have National Insurance liabilities over here; instead of Medicare and Medicaid, we have the NHS. True, we don’t suffer the costs of being a superpower any more (nine carrier strike groups can put quite a dent in the budget)… but we don’t have the benefits either – there’s (sadly) no USD printing press on Threadneedle Street.

Both in Blighty and over the pond we’re going to see much more government, and much more of its costs in our daily lives. You want to keep your wealth away from those who might inflate it into oblivion, now’s the time… to take back control

Wishing you a good weekend,

Boaz Shoshan
Editor, Capital & Conflict

PS For those interested in some light weekend reading, the economics professor brave enough to tell the US Senate that it has a $210 trillion tab to pay is called Laurence Kotlikoff – you can read his testimony here.

Category: Economics

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