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
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The cost to service America’s $33 trillies of debt
grows to $1.8 trillies per year
Which sounds like a lot of fun coupons
But unless you’re a mouthbreathing giga🧠 turbo nerd
trillies are a silly concept
So to translate for the midwits like me…
1.8 trillies is enough to buy:
🚀 55 more NASAs
🎓 6 more Education Systems
👵🏽 3 more Welfare Systems
🪖 1.5 more US Militaries
🏝️ 1.2 more Pension Systems
🏥 1.1 more Healthcare Systems
But that’s not all, because we have to remember that
Watch RRP closely over the coming days. If RRP continues drawing down aggressively (esp by more than what's required to fill the TGA) it may indicate the time has finally come for that sidelined $2T to re-enter the game
$SPX is ~100pts above fair value based on USD Liquidity, looking forward 1-2 wks
$BTC is ~$500 above fair value based on same model
Neither divergence is significant on a coincident basis
But both are exceedingly offsides on a 3-4mo forward basis
Based on most recent TBAC recommendations:
⚠️ Treasury should issue $733bn of net-new debt between now & end of Sep
✅ Of this, ~75% ($554bn) will be in the form of short-dated T-Bills, which can be mostly funded by pulling funds from RRP (liquidity neutral, this is good)
⚠️ The other 25% ($179bn) will be in the form of longer-duration notes & bonds, which can only be funded by pulling reserves from the banking system (liquidity down, this is bad)