Thread by @maxjanderson

The only chart you need to understand macro economics and personal finance for the next 30 yrs 👇

Coming out of WW2, the US federal debt hit a whopping 120% of GDP

Which was a problem, because of the next thing:

There's a law of nature when it comes to taxes

No government has ever been able to sustainably collect more than ~20% of it's GDP as tax revenue

Regardless of what it tries to do with taxes rates

The US learned this lesson the hard way in 1945, when in an attempted to deal with our 120% debt to GDP conundrum, we raised the top marginal tax rate to 94%

What happened over the next 5 years?

Federal revenue absolutely cratered

From 20% all the way down to 13% of GDP by 1950

Raising taxes wasn't a solution

So what does it mean if your debt is 120% of GDP and your revenue is capped at 20% of GDP?

It means you have to grow the size of your economy SIX TIMES FASTER than prevailing interest rates, or you spiral into bankruptcy

Which is pretty fucked

Because it's hard to grow an economy

Even emerging economies (like the US in the 1950's) are typically only able to grow at ~5% per year

And mature economies (like the US today) only grow at 2-3% per year

And remember -- that growth number has to remain 6 times bigger than interest rates, else you get a debt spiral

Put another way, if your debt is 120% of GDP

Your tax receipts are capped at 20% of GDP

And your growth is capped at 5% per year

Then your government will quickly spiral into bankruptcy if interest rates ever push above a measly ~0.8%

That's a sticky situation

But thankfully for the US in the late 1940's, we had a special advantage

America had all the guns

The rest of the world was rubble

And scientists at the Federal Reserve had just discovered a magical new pixie dust

This discovery appeared to be a one-stop miracle cure for any dangerously over-indebted nation's financial woes

They called it ✨Inflation✨

So what did America do?

We took everyone's gold and we crammed the dollar down their throats

Held at gunpoint, we made all the other countries peg their currencies to the dollar

And then we unleashed our magical miracle cure

We let inflation rip, more or less unencumbered, for the next 35 consecutive yrs

And what happened?

America's financial cancer magically went into remission

By applying an inflation multiplier atop our economy's natural growth rate, we drove nominal growth through the roof

Which means the denominator of debt / GDP got really big really fast

And as a result, we crushed debt to GDP all the way down to 30% by the early 1970s

From the US government's perspective, things were looking pretty good

But there was one problem

Well, two problems actually

Problem #1:

After nearly 30 years of making steady progress using inflation to grind down our debt-to-GDD

In the mid 70's, suddenly our debt-to-GDP bottomed and began to rise again

The US had stumbled its way into another war in a tiny little country called Vietnam

And the problem with wars is they're really expensive

America likes its wars, so we definitely weren't going to stop spending that money

But funding another war meant were likely just going to go right back to where we were at the end of WW2

With a really messy debt to GDD situation

Reversing all the progress of the past 30 yrs

So what was the answer?

You guessed it

Mas ✨inflation✨, por favor

Problem #2:

The more we juiced inflation

The more everyday people in America began to figure something out

Our magical wonder drug turned out to have some pretty nasty side effects

And the bigger inflation got, the harder those side effects were to hide

As the 1950's rolled forward into the 60's and then the 70's

It started to become difficult for everyday Americans to afford their groceries, or even put gas in their cars

And people started to get suspicious about whether this inflation thing really was the consequence-free miracle cure it had been purported to be

Political pressure on the maker of inflation, Federal Reserve Pharmaceuticals Inc., began to mount

All of a sudden everyday people couldn't make ends meet, and they were pissed

This supposed miracle drug had terrible side effects

And as it turned out, these side effects had shown up in clinical trials previously in other countries throughout history

Many times in fact, with disastrous results, every single time

And when people found out that Federal Reserve Pharma Inc. knew about those trials

and their disastrous results

and then decided to cram inflation down everyone's throats anyway

People had some questions

So what did Fed Pharma Inc do?

They raised interest rates

Not enough to actually stop inflation, but just enough to slow it down cyclically

This way the Fed could trick the public into thinking they cared about inflation

And they could even point to cyclical downturns as evidence that they were doing a good job fighting it

While still making progress on their real goal of keeping inflation high enough to continue grinding down debt to GDP to a more sustainable level

And by 1981, it was mission accomplished

We paid for our silly war

AND we reversed the rise in debt-to-GDP

pinning it back down to a cozy 30%

Fuck yea America

Yea, fine, we might have reduced the purchasing power of the dollar by 2/3 from the mid 40's to the mid 70's

And then cut it in half again from there by 1981

Ultimately destroying 80% of the value of everyone's savings...

But our debt-to-GDP was looking great!

And we didn't have any overly-expensive wars we needed to fund on the immediate horizon

So we entered a golden era

Interest rates and inflation peaked in 1980, and we were able to drive them straight down for the next 40 years

This was fucking awesome

A steady march down in interest rates for 40 years meant you could buy pretty much anything you wanted

with as much debt as you wanted

and it didn't matter

because you could just refinance at lower interest in a few years

And refinancing at lower interest rates meant you could literally get cash back

on an asset you bought with borrowed money

and your debt service payments either stayed the same or went down

and you still own the asset

the infinite money glitch

So there began the biggest bull market off all time

Every asset went up

But especially the assets that were easiest to lever up or buy with debt

And in a culture of buying more and more stuff

With more and more borrowed money

At ever cheaper interest rates

With the ability to refinance forever

At even lower interest rates

Everyone jumps in

Even the government

So we let the deficits rip, and took debt-to-GDP right back to 120%

And now we're right back where we were at the end of WW2

So what does that mean for the next 30 years?

Well as they say, history doesn't repeat, but it rhymes

With rates having it the zero lower bound in 2020, and debt-to-gdp teetering on the edge of federal bankruptcy, we’re starting the 70-80 year cycle over again:

Inflation is likely to continue trending up for the next ~30 years

There will be cyclical spikes and troths, but the underlying trend will be up-and-to-the-right

The Fed will maintain the appearance of caring about inflation, raising rates whenever inflation spikes up

But always a bit too far behind the curve, with rate increases a bit too small to actually stop inflation

They will cause cyclical cool-offs in inflation, and claim credit for successfully combatting inflation

But the overall level of inflation will remain high and on a steady long term trend of up-and-to-the right

Investors lured in by recency bias of everything that worked over the 40 years from 1980-2020 are in for a rude awakening

Bonds will be the best way to lose money over the coming decades as interest rates continue their march up-and-to-the-right in line with, but always lagging, inflation

Similarly, the easy money made in real estate over the past 40 years is likely gone, with the refinancing dynamic that steadily drove asset prices up no longer in play

Boomer parents who got rich in real estate will continue to tell their kids that real estate is the best and safest investment

That is no longer true and hopefully their kids don't listen

That leaves risk assets -- stocks and crypto -- plus commodities, as the attractive places to play

We'll likely see risk appetite continue its trend up, as the hurdle rate to beat inflation continues to rise

We all know the CPI is both a cooked and lagging metric, so its not really useful to measure the hurdle rate you need to clear to stay ahead of inflation

Over the long term, the main driver of inflation is government deficits, as those deficits ultimately get monetized by the central bank, resulting in monetary debasement.

So with the US federal deficits running around 6%, on their way to 7%, that's a better long term hurdle rate to keep in mind

If an asset doesn't grow > 7%, and/or yield > 7% on a POST TAX basis (so likely needs to yield 10%+ on a pre-tax basis depending on your situation) it's likely a money-loser on a real basis over the decades ahead

If DOGE does a good job, maybe we can actually reign deficits in to something more reasonable like 4-5%

In that case, the hurdle will be less severe, and investors will be able to move in on the risk curve a bit

But in either case, the inflation hurdle rate set by ongoing deficits is just what’s required to keep debt-to-GDP where it is

And we know 120% is a scary and precarious level, so it’s likely we’re going the government is going to want an average level of inflation above that to gradually start grinding debt / GDP back down

So personally, I like to use 2x the ongoing federal deficit as my hurdle rate I need to target to stay ahead of inflation over the next 30 years

With deficit current running around 6.5%, that means I need investment returns >13% to expect to actually accumulate wealth over the long term

Hopefully DOGE does a good job and deficits come down to 4-5%, meaning inflation hurdle comes down 8-10% over the next 4 years

But either way, anything that yields <10% over the next several decades is dumb and not actually an investment

Bonds, dividend stocks and real estate are out