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3 Ways out of our "Fiscal Death Spiral."
Slash Spending, Crushing Taxes, or the Most Likely: Fire up the Money Printers.
A new article over the weekend by Charles Hugh Smith lays out the "fiscal meteor" headed for America, launched by federal debt now at unsustainable levels. He thinks it could lead to financial collapse and social disorder, echoing Ray Dalio's similar prediction I wrote about last week that we're headed for a "Great Disorder" as the Ponzi unravels.
Whatever form that Disorder might take, this fiscal death spiral is the most likely trigger, and Smith notes that there are only 3 ways out of the death spiral: slash spending, massively hike taxes, or fire up the money printers. I’d argue all lead to the same place: historic rates of inflation for a very long time.
The Fiscal Death Spiral
After a brief respite during the debt ceiling pillow-fight, the Treasury General Account -- where the federal government parks the money it borrows -- is up $342 billion in the 29 days since the battle. That’s an unbelievable $4 trillion annual pace. Meanwhile, the total national debt is up by $851 billion — an almost comical $10 trillion annual pace.
This is bleeding through to actual dollars, as May’s Treasury data says interest on the debt soared to $61 billion in May, a $730 billion annualized pace in interest payments alone — in fact, we're now paying more in interest than veterans, education, and transportation *combined.*
Bundled with soaring spending, so far in 2023 the deficit is 2.7 times higher than it was this time last year. And it's going to keep getting worse as old, low-rate debt rolls off and is replaced by much higher-rate debt. Because a year ago short term treasuries were yielding 2.9% -- meaning they could borrow $100 and pay $2.90 in interest. Those rates are now almost double at 5.35%, meaning interest goes from that $2.90 to $5.3t. If government rolls over old debt at 2.9% and replaces it at 5.3%, the interest doubles. Given the average maturity on marketable treasury debt is 62 months — just over 5 years — that means a slow-moving train-wreck as old debt is rolled over at almost $500 billion per month.
Keep in mind, all this is before the recession even hits in full. We're already seeing 2008-style numbers in output, hiring, profits, and now credit distress, signalling much worse to come. And, going by history, recessions hike government spending — several trillion in each of the past few. But even more important, recessions also crash tax revenue as fewer people have jobs, meaning fewer people paying taxes.
In the dot com recession revenue dropped 12%, in the 2008 crisis it plunged 16%. Taking the midpoint adds yet another $600 to $700 billion to the deficit in the form of lost revenue, plus whatever they pump out to try and battle the recession they caused.
Put it all together and we could see a deficit in the 2 to 3 trillion dollar range once the recession hits in force. For perspective, that was the roughly the entire federal budget in 2008. As in, if the government had stopped collecting taxes in 2008 we'd have today's deficit.
Who Would Buy a Multi-Trillion Deficit?
And that brings us to the death spiral: Who would buy all that debt?
Some would come from draining business loans or municipal bonds to the federal government. Of course, that would worsen the recession by starving companies of loans and speed the collapse of cities. But there's even sucking the productive economy dry can’t absorb it all: the entire stock of corporate and industrial loans currently stands at $2.8 trillion in total, and shrinking.
This means they’d have to go harder, raising the money by crowding out everything else in the economy: business loans, consumer borrowing, municipal borrowing, any spare dollar lying around. Not only does that drain the economy and consumers dry, it drives debt service costs up even higher, as higher interest rates to lure the money raise interest payments, in turn driving further deficits in a doom-loop.
All Paths Lead to Inflation
This all takes us back to Smith's 3 options -- cut spending, hike taxes, fire up the money-printing. Game them out and there's only one end-point: inflation.
On spending, Washington obviously won't cut it on its own -- it's what they live for, as we saw in living color during the debt ceiling “negotiations.” If there’s one thing the two parties agree on, it’s spend more trillions we don’t have.
As for taxes, the rich spend hundreds of billions lobbying and accounting their way out of taxes. So they're off the menu -- as Smith put it, the rich "have a political veto." The poor, of course, will get slammed, as always -- see taxes on booze, cigarettes, or gas. But that's only so much juice to squeeze.
Leaving the last man standing: the middle class. Who accounts for roughly 40% of income. Meaning they get to carry 2 and a half times their share.
Of course, $2 trillion is a lot of money, so you'd have to roughly double middle class taxes -- you'd be looking at 40, 50% marginal rates. There’s no way any politician with a brain would propose anything close to that.
And so we’re left with the deux ex machina: The Fed's magic money printers. Typing trillions into excel sheets, pretend that’s money, and use it buy up the deficit.
This would completely reverse everything the Fed’s done to the economy this past year, driving inflation back towards double digits. Moreover, it would lock the federal government and the Federal Reserve into a permanent codependency where inflation continues so long as the deficits run. Which, going by history since Nixon took us off gold, is approximately forever.
Now, it’s certainly possible inflation moderates in the near term, whether from recession cutting prices of unsold goods or plunging energy prices typical of recession or financial panic draining cash into savings. But at this point we are locked in a fiscal doom loop, and the only realistic way out is permanent inflation.
They will kick the can as long as they can. Then they will squeeze the middle class until it squeaks. Then it’s right back to what got us here: printing eye-watering quantities of money.
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