Global macroeconomic trends and challenges

From: allin

The Alarming State of US Federal Debt

The United States faces significant fiscal challenges, with its federal government debt standing at $36.4trillion.Thisfiguresignificantlyovershadowsthenatio{n}^{\prime }sGDPof$29.1 trillion, resulting in a debt-to-GDP ratio of 125% [00:00:54]. This ratio has steadily risen since the start of the pandemic in 2020, when federal debt was $20trillionandGDPwas$21 trillion [00:01:08]. Since 2020, federal debt has increased by 80%, while GDP has only climbed by 38% [00:01:16].

Steady inflation, fueled by substantial money stimulus from central banks and the US government, prompted the Federal Reserve to raise interest rates [00:01:25]. Despite recent efforts to cut interest rates, markets have traded treasuries down, causing long-term interest rates on US debt to spike to levels not seen since just before the 2008 Global Financial Crisis [00:01:35]. To sustain economic growth, the US government is currently running a nearly $2trillionannualdeficit,approximately7$1 trillion per year is allocated solely to interest payments on existing outstanding debt [00:02:00].

The Congressional Budget Office (CBO) projected annual budget deficits to be 6.1% of GDP through 2035, significantly higher than the 3.8% average over the past 50 years [00:02:05]. The national debt is expected to rise by nearly $24 trillion over the next decade [00:02:22].

Ray Dalio’s Perspective on Debt Cycles

Ray Dalio, a prominent global macro investor and author, addresses these critical issues in his new book, How Countries Go Broke [02:47:00]. He emphasizes a mechanical process that explains when and how debt becomes problematic for countries [00:03:58]. Dalio’s analysis is based on publicly available empirical data collected over decades [00:05:06]. His work highlights that only about 20% of the 750 currency debt markets that have existed since 1700 still remain, and all remaining ones have devalued [00:05:54].

The Big Debt Cycle Explained

Dalio identifies two main debt cycles:

• Short-term debt cycles: These typically last about six years, plus or minus three years [00:06:34]. The US has seen 12.5 such cycles since 1945 [00:06:41].
• Big debt cycles: These longer cycles typically last around 80 years and are often forgotten [00:06:28]. The US has been in a big debt cycle for about 80 years [00:06:46].

Dalio uses an analogy to explain the debt cycle: credit is like blood providing nutrients, and debt is like plaque that builds up in arteries, constricting the circulatory system [00:07:26]. A healthy debt cycle involves debt creating enough income to service it [00:07:47]. When debt service rises, it consumes more consumption, leading to less available money [00:08:25].

Economic “heart attacks” occur when the supply of debt overwhelms demand [00:08:46]. If the government (specifically the central bank) doesn’t print money to buy the debt, interest rates rise, constricting borrowing and weakening the economy [00:09:51]. If they do print money to buy and monetize the debt, it’s inflationary and lowers the debt’s value [00:10:21].

Stages of the Big Debt Cycle

The big debt cycle follows five stages [00:17:57]:

1. Sound Money Stage: Low net debt levels, sound money, and a competitive country [00:18:01].
2. Debt Bubble Stage: Debt and investment growth outpace the ability to service them from produced incomes [00:18:07].
3. Top Stage: The bubble pops, leading to contraction in credit and debt markets [00:18:14].
4. Deleveraging Stage: The Central Bank buys debt and issues more cash, causing inflation and devaluation [00:18:19].
5. Crisis Recedes: The big debt crisis eventually recedes, and the cycle begins anew [00:18:28].

Debt Crisis Indicators (Red Flags)

A debt crisis often manifests as a “death spiral,” where a country must borrow to service existing debt, making its credit worse and driving up interest rates [00:18:54]. Key red flags include [00:19:46]:

• Selling of debt by existing holders beyond new supply [00:19:51].
• Long-term interest rates rising while short-term rates remain stable or fall [00:20:00].
• Currency depreciation, especially relative to gold or Bitcoin [00:20:25].
• Central banks being forced to monetize everything [00:21:05].

Dalio notes that all currencies have depreciated relative to gold and Bitcoin [00:23:00]. Gold is now the third largest reserve currency after the dollar and euro [00:23:46]. Central banks and sovereign wealth funds are shifting away from debt bonds towards gold or hard assets [00:23:30].

Investing in a Devaluing World

As governments print money, the money supply increases, leading to inflation [00:14:18]. While nominal market values may rise (e.g., NASDAQ, Dow), the purchasing power of money decreases [00:15:05]. The real question for investors is whether their purchasing power or net worth has increased [00:15:18]. You cannot get richer just by making more money; purchasing power is what truly matters [00:16:11].

Money serves as both a medium of exchange and a store of wealth [00:16:27]. If saving is not an effective store of wealth, the long-term credit market is not viable [00:16:39]. When central banks create severe negative real rates (interest rates below inflation) by being the primary buyer of debt, it encourages leveraging up, which creates problems [00:17:18].

Alternatives to Currency-Denominated Assets

In an environment of devaluing currencies, it’s crucial to store wealth in assets that benefit from, rather than suffer from, the reduced value of money [00:27:15].

• Gold: Considered an international, mobile, and relatively private store of wealth [00:27:30]. It’s less prone to confiscation through taxation compared to real estate [00:28:10]. Gold is the “purest play” because it can be transferred between countries and is held by central banks as a reserve [00:31:33].
• Bitcoin: Shares some qualities with gold but is more easily taxed by governments who know its location and ownership [00:27:36].
• Commodities: Commodities can perform well in inflationary environments, particularly those less economically sensitive [00:29:17]. However, in real terms, commodities have historically declined over long periods due to productivity gains [00:30:23].
• Productivity-Producing Assets: Assets that increase productivity and cannot be easily taxed or are mobile are desirable [00:30:42]. Equities of a certain type, especially those that benefit from inflation and currency depreciation, can go up in nominal terms, though not necessarily in real terms [00:30:59]. However, even good companies can become overvalued, making pricing critical [00:37:30].

Diversification is key, especially with uncorrelated assets like gold, to reduce portfolio risk in a leveraged market [00:39:11]. From 1966 to 1984, equities experienced negative real returns when adjusted for inflation [00:40:32].

Addressing the US Debt Crisis

Ray Dalio uses a “risk gauge” for US long-term government debt, which is currently at 100% – the highest it has ever been [00:42:44]. This gauge measures projected debt supply and demand issues and Debt Service squeezes [00:43:24]. The Central Bank’s long-term risk gauge is at 46%, nearly its highest ever, indicating a risk of a “seizure” where the market is actively selling debt [00:42:56].

The “Beautiful Deleveraging” and the 3% Solution

Dalio proposes a “beautiful deleveraging” where multiple actions are taken to resolve the debt crisis with minimal harm [00:42:00]. There are four primary actions for governments to address debt [02:41:00]:

1. Increased Taxes: Citizens lose assets and income [00:46:22].
2. Austerity (Cutting Spending): Citizens lose government services and benefits [00:46:32].
3. Central Bank Buying Debt: Increases inflation, devaluing currency and assets (a form of taxation) [00:46:40].
4. Debt Restructuring: Currency devaluation and asset loss [00:46:55].

Dalio advocates for a “3% solution”: the US must cut its deficit to 3% of GDP [00:47:32]. This would require cutting the deficit by more than half from its current 7.5% projected level, amounting to roughly $900 billion annually [00:47:45]. This can be achieved through government expenditure cuts, though only a small percentage of total spending is truly flexible [00:50:56].

He emphasizes three critical aspects for success [00:48:44]:

1. Act Soon/Fast: The sooner action is taken, the less severe the cuts need to be, as debt accumulation is nonlinear [00:52:50].
2. Act When the Economy is Good: It’s difficult to implement cuts during an economic downturn [00:49:03].
3. Unified Agreement on the Number: Politicians must commit to reaching the 3% deficit target, regardless of how they achieve it [00:47:55].

If the federal government cuts spending significantly and quickly, the market would naturally react by lowering interest rates [00:51:52].

Political and Social Implications

The path forward is fraught with challenges. Dalio expresses concern about the timing of potential productivity gains from AI and new technologies, as these may not materialize quickly enough to offset the immediate supply-demand issues in debt markets [00:56:18]. Furthermore, AI could lead to significant job losses, which might fuel demand for public support programs and increase government spending, exacerbating debt problems [00:57:03].

Dalio identifies five major forces shaping the global landscape [01:01:48]:

1. Debt and Money: The core fiscal challenges discussed.
2. Internal Conflict: Growing polarization (left vs. right) and potential for conflict within the US, testing the legal system and leading to fragmentation between states and the central government [01:01:34].
3. International Conflict: A shift from cooperation to “might is right” in the global order, with international institutions becoming obsolete [01:02:07].
4. Technology War: A crucial “AI War” that no country can afford to lose, as losing it means losing the military war [01:07:30]. This drives increased military spending, creating further budget issues [01:02:35].
5. Climate: An increasing economic and environmental issue that will add to expenses [01:02:46].

The combination of these forces creates a period of increased conflict and decreased cooperation worldwide [01:05:01]. Historical patterns show that periods of great invention and productivity (like the 1920s) can coincide with large debt increases and wealth gaps, leading to tension [01:07:51].

Dalio contrasts the US approach to conflict (head-to-head confrontation) with China’s (Art of War-style deception and manipulation to avoid direct fighting) [01:09:17]. China’s “tribute system” philosophy emphasizes hierarchy and harmony based on power, aiming for prosperity over destructive conflict [01:10:22].

Ultimately, Dalio stresses that while the current economic conditions may seem stable, they are “very bad” in the long term, akin to a patient needing a drastic lifestyle change to avoid a heart attack [00:44:57]. Without immediate and significant changes in fiscal policy, the power of the United States is likely to be greatly diminished [01:14:47].