As we sit and sip our coffee every morning, reading the raft of new articles on our brightly lit screens, it is so easy to miss the bigger picture. The news about the US debt ceiling might make a brief appearance, to then quickly get drowned in the noise of other stories. However, there's a lot more to this issue than what meets the eye.
It's actually the fact that this isn't dominating the investing headlines that grabbed my attention. I'm afraid that this story will start with the U.S. banks but will reveal far more as we look below the water. Some of the macro greats have started heeding warnings. Stan Druckenmiller was recently quoted saying “I’m sitting here staring in the face of the biggest and probably the broadest asset bubble, forget that I’ve ever seen, but that I’ve ever studied.” Jamie Dimon, the CEO of JPMorgan Chase, also voiced his concerns, stating, "I think it's going to get worse for banks." Ray Dalio, the renowned investor and co-chairman of Bridgewater Associates, has famously said, "It's not [just] a banking issue. It is a global issue...all sorts of entities, pension funds, and insurance companies, all around the world...there was a lot of buying of these government bonds. Which have gone down in value..."
In the grand scheme of things, and in isolation, these statements might appear to be more noise. However, if we look closely, they hint at the financial fabric slowly unravelling, affecting not just the banks, but a host of financial entities worldwide. The reality is that the U.S. government did sell billions of dollars in assets to banks that it then devalued. This isn't necessarily a banking crisis; it's a central banking crisis. The mainstream media has started to admit that the banking crisis is real and that there are trillions of unrealized losses.
A matter of weeks away. Peeling back the curtain of the US government's fiscal operation reveals a precarious balancing act. Imagine, if you will, a household budget—only on a gargantuan, national scale. This budget collects funds through taxes, not unlike a regular paycheck, and it's spent on various public services, akin to rent, groceries, utilities, and so on. But unlike most of us, Uncle Sam's budget isn't always balanced. In fact, more often than not, the spending overshadows the income. When that happens, the government dips its hand into the proverbial cookie jar of debt to make ends meet.
But here's where the plot thickens. The cookie jar, controlled by Congress, has a limit to how many cookies it can hand out. Rather than the ‘cookie ceiling’ we call it the 'debt ceiling'. And as it stands, the US reached into the jar and hit the bottom on January 19th this year. Consequently, a request was placed to Congress, asking for a higher ceiling, more cookies, so to speak. Now, this wouldn't be a problem if the House of Representatives, controlled by the Republicans, agreed to the request without any conditions. But, alas, they have demanded a decrease in spending from the Democrats before they can raise the debt limit, leading to a veritable deadlock, while the clock continues to tick dangerously close to a deadline, leaving the US teetering on the brink of defaulting on its debt payments.
In the face of this looming financial crisis, the deficit for May is projected to be around $160 billion, sparking concerns about a potential partial shutdown by the end of the month or early June. The scene paints a dire picture, one of last-minute negotiations and a game of political chicken, the consequences of which may have far-reaching implications on the global financial stage. All eyes are on President Joe Biden, who assures his country there will be no default. Amidst the echoing sentiments of scepticism and apprehension, the world waits and watches as the date of reckoning, June 1st, draws perilously near.
The issue with the U.S. system is they let the cookie monster control how many cookies it can hand out. It’s a farce of a constraint that's predictably raised when the desire gets too strong. The real question is where does it stop? For example, consider the scenario where U.S. Interest payments equal Defence spending, as pointed out by Mark Moss. This paints a sobering picture of the U.S. financial situation. Coupled with the fact that 30% of the debt needs to be refinanced within the next 12 months at higher rates, it becomes evident that we are in a period of financial turbulence.
The situation becomes more understandable when we consider the concept of "duration risk." It's like advising people to fasten their seatbelts on an airplane. Of course, it's good practice! However, if you anticipate rates at 1% and they spike to 5% — especially after the promise of low rates or at most a gradual rise, as Jerome Powell stated in Nov 2021 — it's like a pilot crashing the plane and blaming passengers for not fastening their seatbelt. You can't hedge a plane crash.
Our Backyard: A Display of Hope Let's take a look a bit closer to home to understand how a developed economy can manage to pay down its debt, rather than constantly increase it. Australia, under the stewardship of John Howard, inherited a debt of $96 billion in 1996. By 2007, this debt was entirely paid off, and the budget was in surplus to the tune of $20B. It's a remarkable achievement for a technologically modern, Western country. It's worth noting that this feat wasn't achieved by slipping into autocracy or creating a dystopian reality. It was achieved through strategic measures. More importantly, this wasn't achieved merely by tightening their belts. A significant chunk of the debt was paid off via large asset sales, such as the sale of Sydney Airport to a private consortium for $4.2B.
Does this mean selling off assets is the way forward for debt-ridden countries? Not necessarily. But it does present a third option, in addition to cutting spending and raising taxes, the concept of asset sales is intriguing because it presents an innovative solution to what can often seem like an insurmountable issue. Countries worldwide have explored this strategy, selling land, railways, airports, and other state-owned assets, thereby taking those costs off the public books. It's important to note that the buyer doesn't have to be a foreign power; it could be a private consortium or other approved buyers.
Imagine, for instance, the concept of purchasing not just land, but a bit of sovereignty — the ability to build special economic zones without interference while also leasing basic services like police protection. This idea could be an effective way for states to pay their debts while promoting physical innovation.
The case of Australia demonstrates that it's possible to maintain a functional and balanced society while managing the nation's finances effectively. One could argue that our proximity to Asia, which necessitates a certain level of pragmatism, has played a significant role in shaping economic policies. Despite this, Australia’s strategic management of national debt offers valuable lessons for countries worldwide.
An Elevator to Where? Circling back to the U.S., as the noise around the US debt ceiling amplifies, there are some novel solutions to consider. One such solution is the idea of a revaluation of its gold reserves. The US holds 261 million ounces of gold, worth half a trillion dollars at the current market price. At present, the US values its gold at $42.22, nearly 50 times less than the market price. This valuation dates back to when the US fully went off the gold standard in the early 1970s.
Think of this as tapping into the strategic gold reserve, akin to tapping into the strategic oil reserve. It's a solution that might find consensus among Republicans and avoid a Supreme Court challenge while allowing the administration to extend the deadline by a few months.
For how long can the U.S. keep extending its debt? We need to reevaluate the underlying financial structure that influences global economics. It's about the need for nations, especially the ones grappling with mounting debt, to progress in paying these down, Australia has shown its possible. Otherwise, we are quickly approaching a time when treasury’s "risk-free rate” isn’t worth the textbook it's written on.
Beyond the noise In conclusion, we find ourselves at a crucial juncture in the evolution of global economics. The noise around the US debt ceiling, the banking crisis, and the central banking crisis are all part of a broader narrative. We are in the midst of a financial restructuring that will reshape the way we understand and approach economics. The lessons learned from Australia, the potential of asset sales, and the revaluation of gold reserves all present hope that innovative solutions can unwind the current trajectory. It's time to look beyond the noise and focus on the bigger picture.
