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US Government's Debt Crisis
The US government is facing a challenging situation with its debt, which currently stands at over 32 trillion dollars.
"It's clear that the government is set up for a sovereign debt crisis."
Implications of Government's Spending and Debt
The government's spending is currently at 5.3 trillion dollars, and it is increasing. This, coupled with declining revenues and growing deficits, puts the government in a difficult financial situation.
Interest rates on government borrowing are projected to skyrocket, which exacerbates the debt crisis.
"The only way for the government to avoid default in the long term is to fire up the money printer again."
Wealth is expected to flow into assets or safe havens to protect against currency debasement caused by inflation.
Capital Controls and Financial Repression
If wealth flees and protects itself from inflation, the government may struggle to seize the wealth it needs to save itself from the financial situation. In such cases, capital controls and financial repression may be implemented.
"That's when Capital controls start. Financial repression sets in."
The US government, as well as other countries around the world, have used this playbook in the past, and they are preparing to do the same again.
Wealth is likely to be channeled into assets or places that offer protection against currency debasement.
Debt and Debt-to-GDP Ratio
Currently, the US government's debt stands at 32.7 trillion dollars, with almost half of it maturing within the next two years.
Exceeding a 90% debt-to-GDP ratio is considered difficult for a nation to recover from. The US has reached 120% before during World War II, but the circumstances were different.
"The United States though has gotten to 120 percent before and gotten out of it in World War II when we peaked out at 121 debt to GDP. But the reason why that situation doesn't really apply to today is because the spending that got us there could stop as soon as the war ended."
Declining Tax Revenue
Tax revenue is expected to decrease due to various factors, including a decrease in economic activity during a recession.
"Pretty much every angle you look at it, you're going to have fewer dollar transactions, which means less money going to the government."
The US Government's Dilemma
The US government is facing a difficult situation as it needs to borrow more money to cover its increasing expenses, while tax revenues are decreasing.
"As the government has to continue to borrow more and more to pay for its higher and higher expenses while it's taking less and less in taxes, that means that its expenses will very soon get to a point where it just can't afford to borrow at these high rates."
The Dual Mandate of the Federal Reserve
The Federal Reserve is obliged by Congress to focus on maximum employment and stable prices, which limits its ability to lower interest rates to help the US government.
"They are legally obligated by Congress to care about two things only: maximum employment and stable prices...they have to care about inflation."
Rewriting the Federal Reserve Act
If the government faces default and the Federal Reserve can't lower rates, Congress can rewrite the Federal Reserve Act to give the central bank a new mandate of supporting the government. This has been done before, with the original Act being written in 1913 and the dual mandate being added in 1977.
"You can bet your last dollar that if the government is facing default and the Federal Reserve is not lowering rates because they have to care about inflation, that the government Congress will simply rewrite a new Federal Reserve Act melding the federal government and the Federal Reserve."
The Choice: Dollar or Government?
The US government faces a tough choice: either save the value of the dollar and let the government default, or save the government and sacrifice the value of the dollar. Both options have consequences for the US economy.
"It is a choice between these two options. On one hand, you save the dollar and sacrifice the government or you save the government and sacrifice the dollar."
The Short-Term and Long-Term Implications
Choosing to prioritize saving the purchasing power of the dollar and avoid hyperinflation may lead to short-term problems for the US economy. However, it will also remove the burden of the government's ability to confiscate resources from the economy, setting the stage for long-term growth. On the other hand, prioritizing the government's survival may provide short-term benefits, but it can cause a misallocation of resources and destroy wealth in the long run.
"Now, if they do make the choice to save the purchasing power of the dollar and not risk hyperinflation and sacrifice the government's ability to borrow and tax and force them to default and restructure their debt, this will absolutely, absolutely be a big problem for the US economy short term. However, this will destroy, will remove, a very large tumour off the back of the American economy."
Precedence for Financial Repression
Financial repression, where the government takes measures to prevent the flight of wealth and protect its ability to print money, has been seen in history. For example, FDR's executive order 6102 in 1933 outlawed gold ownership in the US to prevent citizens from protecting their wealth as the government planned to print more money.
"Another example of financial repression is an exit tax, which California's proposed exit tax is an example of. Essentially, the government telling citizens, 'Hey, you can stay here and we'll continue to take money from you, but if you decide to leave, we'll take it from you anyway.'"
"Obviously, a central bank digital currency would make all this much easier if everybody is already using a digital currency run by the central bank."
"Desperate governments do all sorts of things to try and stop that wealth from fleeing and trying to capture and transfer that purchasing power to themselves in any way possible."
"This is not anything new. This is a very old playbook that has been used many times, many countries, many different government styles throughout history whenever the government gets..."
The Concept of Financial Repression
The IMF has explored the idea of liquidating government debt through financial repression.
Financial repression involves implementing measures like taxing bondholders and creating negative interest rates to reduce government debt.
This strategy is most successful when accompanied by inflation, as it prevents wealth from escaping the system.
The US government can potentially impose negative interest rates during inflation to transfer purchasing power from bondholders and savers to themselves.
"Through financial repression...government debt can be reduced...as long as your wealth doesn't have a back door to escape the system."
The Significance of Capital Controls
The IMF has stated that countries with pervasive capital controls are better off during times of crisis.
These controls shield countries from significant declines in capital flows during crises.
Governments around the world are being warned by the IMF to implement capital controls if they anticipate debt restructuring, sovereign debt crisis, or challenges in paying bills.
Introducing capital controls during a crisis may be ineffective as people would have already found a way to circumvent them.
The importance lies in establishing capital controls before a crisis, so that people become accustomed to the lack of options and remain stuck within the system.
"If you try and reintroduce [capital controls]...once the crisis starts, people will already have a way out...you've got to get your people used to having no way out and being stuck in the system now before the crisis hits."
The Need to Diversify Assets
It is advisable to purchase assets outside the system while it is still possible.
Owning assets like gold or Bitcoin outside of centralized systems provides protection and preserves wealth.
Having wealth outside the system is crucial in case the government introduces measures like a central bank digital currency without consent, enabling them to control transactions.
It is emphasized that diversifying wealth and avoiding sole reliance on the banking system is imperative.
"Buy assets outside of the system now while you still can...you've got to have wealth outside the system...by that moment, you already have to have some wealth outside that system, otherwise, it'll be too late."
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