The eleventh stage of America’s Financial Endgame™ will be when the higher interest rates ripple through to the US government budget, expand the size of the annual budget deficit, and accelerate the pace of the US government debt spiral. The basis for this effect comes from the unbelievably large amount of government debt that is already out in the marketplace. The reason for this is because a very significant portion of this debt is financed with a maturity date less than one year away. Thus, any increase in market interest rates for government treasuries will eventually inflate the interest expense that the government is liable for as the debt is re-financed with the issuance of new treasury notes.
What makes this effect especially dangerous is the fact that government payments on interest are approaching the annual rate of growth for Gross Domestic Product. This is very significant, because when the liability for annual interest on government debt exceeds the rate of growth for the economy, then it will become almost impossible to “grow” out of the problem.
Historically, whenever a nation gets to the point where its annual interest payment obligation exceeds its annual rate of economic growth, the ultimate result is a default on their debt.
- Sometimes this takes the form of an actual default where the nation refuses to pay on its prior financial obligations.
- In other cases, this takes the form of a nation inflating its currency and destroying its purchasing power by monetizing debt.
- In either case, the net result is the same … all of the people who trusted the government to honor its financial obligations (either in nominal or real terms) are devastated.
However, the path toward this ultimate end is neither straight nor short. The road toward default typically begins with a debt spiral where interest obligations that exceed GDP growth, expands to dramatic increases in taxation, results in perpetual economic stagnation from distorted incentives, and ultimately results in some form of default on the government debt obligations.
The true danger that is created by this situation comes from the millions of people who will fall into the “safety trap” of bonds. The bait in this trap is the perceived safety of bonds for pension funds and conservative investors who are looking to reduce their exposure to equities. The problem is that the safety of bonds only lasts as long as the government’s financial obligations are paid, and/or the real value of those payments are not inflated away.
The unfortunate reality of the situation is that many people who are currently invested in bonds, and almost all of the “late money” into the bond market leading up to this debt spiral will be completely decimated. This will result in one of the single largest aggregate real wealth transfers in the history of the United States.
The taxonomy of this wealth transfer will be as follows:
- Net savers such as bond investors will see the purchasing power of their financial capital be absolutely destroyed. This also includes people who are on a fixed income such as pension retirees and people on social security.
- The government will dissipate the responsibility for repaying its financial obligations by decimating the purchasing power of net savers.
- Net borrowers will see the real value of their financial obligations be dissipated by the impact of inflation.
- Astute investors who have learned to profit from volatility will be presented with a stream of historic opportunities as America’s Financial Endgame™ unfolds.
The looming financial collapse is very frightening, and will be absolutely devastating for many millions of people. The unfortunate situation is that as individuals, we do not possess the ability to make the national policy changes that would be necessary to avert such a disaster. However, we do have the ability to protect the financial future of ourselves and our families through prudent decisions and astute investing.
In the next stage of America’s Financial Endgame™ we will examine how the government debt spiral will precipitate a broader yield spike and bond market collapse.