James Lavish Profile picture
Aug 23 33 tweets 8 min read
If you’ve never heard of a *debt spiral*, it’s time you did,

and ask the question, "is the US already in one?"

Let’s dig in and answer that.

A debt 🧵👇
🏛 The government as a business

Before we get into any debt specifics, let’s first cover the basics of how a government operates financially

And while it’s an absolute beast of an operation, it can be boiled down into some pretty simple parts that mirror a typical company.
First, like any business, a gov't has revenues and expenses and often borrows money using debt

~95% of US gov't revenues come from taxes: individual and corporate income, payroll, and excise taxes

~5% comes from estate taxes, customs, Fed earnings, penalties, and other fees.
Just like a business, there must be enough revenue to cover all expenses for it to keep operating

A budget

And in the business of running a country, taxes should cover all gov't expenses: infrastructure, defense, entitlements, etc., as well as interest payments on its debt.
Of course, they don't

We spend far more than we make, as the US is perpetually operating in a deficit.

Here’s what the US federal budget looked like it 2020:

(cbo.gov/publication/57…): Image
🌀 What’s a debt spiral?

If a government is operating in a deficit, it can either cut expenses (ha!), generate more income by stimulating GDP (think war), or raise taxes.
Problem is, cutting expenses costs votes; war can lead to future productivity damage, higher taxes can impact companies’ ability to grow and in turn hurt the country’s GDP, leading to lower tax revenues

The easiest thing to do?

Just issue more debt to cover the budget.
Problem solved, right? Right?

Well, we know what happens to a company that issues too much debt and winds up unable to pay the interest on it

Exactly

It becomes distressed, and if it cannot fix its budget problem, it eventually goes bankrupt.
The difference is, countries are given far more leeway in the amount of debt they can issue before investors begin to balk

We often look at debt to GDP to measure a country’s financial health

But we can also look at the country’s budget, its actual revenues and expenses.
Using these, we can calculate an interest coverage ratio:

(Tax Revenues - Entitlements - Defense) / Interest Expense

Note* This calculation is purposefully simplified, as the remaining budgetary items can swing considerably from year to year with legislation
Bottom line: if this number is lower than 1 to 1 (i.e., there are more interest expenses than revenues left over to pay them) then a country must borrow even more money by issuing more debt

This only leads to higher interest expense payments, which makes the ratio even worse.
Think of it like this: You run up the balance on a credit card

The monthly payments are then more than you have after mandatory costs like mortgage, car loans, and food

So, you open a new credit card to cover the gap...
But your credit score is now worse, and the interest rate on the new card is even higher--hence the monthly payments are even higher, plus you’ve borrowed even more

Solution?

Open yet another credit card to cover the raised expenses…and so on…you are trapped
It’s no different for a country perpetually operating in a deficit

more debt → higher interest rates → higher deficits → more debt

As it worsens, investors lose confidence in the country and demand higher rates for the country’s bonds, only worsening the situation
The dreaded debt spiral

(graphic by Guilbert Gates for The New York Times): Image
🇺🇸 What’s the situation in the US?

Well, let’s peek at the US budget situation

You can see, total US federal debt is now $30.7T, and US GDP is $24.8T

Including all federal, state, and local debt, the current debt to GDP ratio is 1.37 or 137%

Not great, at first glance. Image
But let’s dig deeper. How’s the interest coverage ratio look?

The debt clock shows $4.4T in tax revenues, but the US Congressional Budget Office counts $400B in “other taxes” to total $4.8T in 2022

Even if we give the CBO the benefit of the doubt, it still doesn’t look so good.
Why?

entitlement spending + interest on debt > revenues

Taking the same CBO report, we see mandatory expenses total $3.7T (includes all entitlements signed into legislation, considered absolute obligations)

Adding $800B of defense spending, and our expenses total $4.5T in 2022
$4.8T taxes - $3.7T entitlements - $800B defense = $300B budgeted for interest expense

Problem is, the US currently owes $400B on interest annually (you don’t have to be a math genius to see the problem here)

300B - 400B = -100B (oops)

Interest coverage ratio = .75X!
And here’s where the math gets really ugly

See, with rising rates, as current debt matures and needs to be replaced, the additional interest cost adds up rapidly

As @FossGregfoss pointed out recently, if we replace $30T of debt at 3.2%, the annual interest expense becomes $1T!
That’s $600B more than currently, pushing the interest coverage ratio down to .3X!

Forget distressed, that’s bankrupt. If the bonds were corporates, they'd trade pennies on the dollar at best and only because there'd be claims on assets to offset the risk

But wait. There’s more
As @FossGregfoss also points out, this is before reduced tax revenues due to lower capital gains as the market sells off in this recession

And I’ll add, fewer individual and corporate taxes with earnings lower than the above estimates
To avoid this immediate problem, the Fed likely pivots by lowering rates and resuming quantitative easing

They simply kick the debt can down the road

Inflation resumes, the Fed must raise rates to tame it, and US borrows at higher rates to cover the deficit

A vicious circle
The math remains simple but ominous

Even the CBO agrees in their own estimates

CBO projected debt to GDP: Image
And CBO's projected deficit, even with their generous baseline assumptions: Image
The other choice is to let inflation run higher than the 2% target, in order to raise GDP and monetize the debt

i.e., they use cheaper future dollars to pay for past debts, and stick it on the Fed balance sheet through QE
Still only a short term solution, investors will eventually demand higher Treasury rates to compensate for being paid back in cheaper dollars and increased default risk

It’s a debt trap that leads to a debt spiral, and though it'll likely last a while, IMO, we're already in it.
🛡 How can you protect yourself?

Though each investor requires personal advisor specific advice, you’ve heard me say it before, and I will reiterate it

I think it's prudent to have some % of investments allocated to hard assets: gold, silver, and at least a small amount of $BTC
As we continue to manipulate the money and kick the debt can down the road, there’s simply no way out for sovereigns

Whether it's in 10 years or 50, every single fiat based sovereign currency will eventually collapse under the weight of their own debts.
When this happens, those who own hard money like gold, silver, and #Bitcoin will have protection vs their own currency hyper-inflating and being reset

Some of you have seen this thread before, but if you haven’t, the scenario is all laid out for you here:
What we have learned that is most important for each of us to understand after the last two years, is that it is absolutely inevitable...
Fiat is backed by nothing

Our global financial system is built on debt and borrowing

Eventually these debts will grow too big, even for the USA

The chickens will someday have to roost.
This thread was a summary of a recent Informationist Newsletter. If you enjoyed it, make sure to:

1. Follow @jameslavish to see more investment related content
2. Subscribe to The Informationist Newsletter to learn one simplified concept weekly: jameslavish.substack.com

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More from @jameslavish

Aug 19
The Fed is in a real pickle now: raise interest rates and debt costs soar, lower rates and inflation soars

Why does it all matter and what can they do?

Time for a Fed 🧵👇
🏛 What is the Federal Reserve?

Most countries have a central bank, a governing body that manages a country's national monetary policy

The Federal Reserve (officially, the Federal Reserve System or FRS) is the United States’ central bank

But everyone just calls it 'the Fed'
Widely considered the world's most powerful financial institution, Congress established the Fed in 1913 to ‘provide the nation with a safer, more flexible, and more stable monetary and financial system'

Though created by Congress, the Fed is not technically a 'government entity'
Read 34 tweets
Aug 15
How is GDP calculated?
Is it accurate?
And why do we care so much?

Let’s answer all these simply, shall we?

a 🧵👇
💰 What is GDP?

Gross Domestic Product (GDP) is the total value of all goods and services produced by a country

Annual and quarterly GDP estimates are closely watched by economists, investors, and central banks

It serves as a primary indicator of a country’s economic health
GDP can be calculated as nominal, a simple percentage change, or real, which includes inflation

Real GDP is a more accurate measure of activity

Often most important is how it is *changing* from period to period Image
Read 24 tweets
Jul 26
Bond Ratings vs CDS Spreads. Which can you trust?

a 🧵👇
Drama is unfolding in the EU with the ECB raising rates, exposing Italy and Greece to credit stresses if rates get too high, and the CDS market is confirming this suspicion

Yet the credit ratings for these countries haven’t changed

Why?
🔠 What are Bond Ratings?

Just like credit agencies score your credit, similar agencies do the same with companies and countries

As you know, credit scores can significantly impact your ability to borrow money: get a car loan or mortgage, a credit card

Same for companies
Read 33 tweets
Jul 20
What exactly is the USD Index (DXY), and how does it relate to the Dollar Milkshake Theory?

a 🧵👇
💵 What is the DXY?

First, the *DXY* is a Bloomberg ticker symbol for what is known as the US Dollar Index (USDX)

and is often referred to as the *Dixie* by forex traders
Created in 1973 after the Bretton Woods Agreement (gold standard) was dissolved and to deal with and the beginning of floating exchange rates

The DXY basket contains the following USD exchanges:

euro, yen, British pound, Canadian dollar, Swedish krona, and Swiss franc
Read 22 tweets
Jun 7
If you own stocks, congratulations. You own the riskiest part of any company. And if you own speculative stocks today, you may want to reconsider.

Why?

It all comes down to *capital structure* and *claims on assets*

a 🧵👇
Cap Structure

To truly understand any investment, you must first know which part of the company you own vs. anyone else with claims on assets of the company

Like ownership of a house, there’s the homeowner, the mortgage lender, and possibly a second lender for a line of credit
For instance

You buy a house with a mortgage & put 20% down (the equity)
You borrow the remaining 80% from the bank (the debt)
Read 22 tweets
May 30
Why is $BTC a wildly positive asymmetric opportunity at $30K?

a short 🧵👇
First, we calculate our estimated downside risk.

Using an 80% drawdown from $BTC all time high of $69K, we calculate downside as:

.80 x $69K = $55.2K
$69K - $55.2K = $13.8K (Downside Target)

$30K - $13.8K = $16.2K (Downside Amount)
$16.2K / $30K = .54

Downside Multiple = .54X
Previous drawdowns can be seen here:
Read 7 tweets

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