Bonus Distillation: A Coming Recession

Our economic engine got its fuel tank from a Ford Pinto.

10 points if you got the joke in the subtitle.

Okay so you’re reading this because you read the last article about how sovereign debt is near its all time peak. You want to know how bad it's going to get.

I’ll lay it out for you with some facts, statistics and possibilities. Everything in this newsletter is based on the idea that central banks have chosen to print money and not default on their debt.

Facts

1. I already mentioned that 2 weeks ago the Bank of England already had to stop raising interest rates because they broke their pension funds. The UK Pension fund industry controls nearly 4 trillion dollars in assets.

2. The war on energy and fossil fuels has led to a current energy crisis in Europe that has seen inflation in energy prices of up to 500%. Imagine paying up to $1000 for your monthly energy bill at home…

3. The USA attained global reserve currency status after WW2 thanks to its intact manufacturing base as the rest of the world rebuilt. We’re now seeing the dollar milkshake theory play out in real time as US dollar becomes increasingly strong against other currencies like the EUR, GBP and YEN.

4. The growth of the United States Economy is entirely built on the idea that the stock market will go up indefinitely. During the stock market crash in 2008 the USA lost 350 billion dollars in tax revenue, ~13%.

Statistics

1. The United States sits at a current debt to GDP ratio of 121%, the last time it reach 120% was in the 1940s.

2. The USA likely needs a nominal GDP growth (Normal GDP Growth+Inflation) of 15-21% for 5 years to bring the debt ratio down to a level where the federal reserve can begin tightening rates again.

3. Israel’s debt crisis in the 1980s saw inflation rates of 100%-400% YoY in order to reduce sovereign debt.

Possibilities

1. The USA is likely to lose its status as the primary reserve currency of the world as geopolitical and monetary policy decisions are likely to create a more multipolar world.

2. The Federal Reserve will likely be required to grow their balance sheet orders of magnitude larger than it is now.

3. Real rates on bonds will likely be negative for the better part of a decade (loan% - inflation%). In the 1940s real rates were between -6% and -20% for most of the decade (USA).

4. As inflation increases it will come with wage growth, increases in asset prices (homes, stocks, crypto) and a weakened value of USD.

So what does all this mean?

Here is a realistic possible outcome: Inflation hovers between 5-15% for the next 5-8 years. The temporarily raised rates causes housing affordability to decline and home prices drop slightly. The energy crisis in Europe and rising USD causes a continued economic slowdown which could see the stock market test lows beneath the March 2020 dip. After that dip, inflation will cause wages and assets to rise fairly substantially over the next decade.