The western financial system appears to be destined for a financial crisis of epic proportions. The governments of Europe, Japan, and the United States have become flooded with debt, and these debts levels continue to rise to more unmanageable levels every single day. The United States has incurred over $18 Trillion dollars of debt. If one considers future unfunded liabilities such as Medi-care, Social Security, and a vast assortment of entitlements promised to American citizens, then the number owed by the U.S. Federal Government is well over $100 Trillion. With this is mind, a sensible person must begin to question: What is the viability of this amount of money every being successfully and honestly repaid? Furthermore, contemplating the viability of a successful debt repayment against the backdrop of relentlessly unsuccessful sovereign debt negotiations in Europe should leave a person with a pretty concrete conclusion: Western governments are going to drown in the sea of debt they have accumulated.
One of the greatest ironies that exists in the financial arena is the fact that the yield on U.S. treasury bonds are often referred to as the “riskless rate” or “risk-free” rate of return. What makes this terminology so ironic is that that virtually every single government in the history of the world has defaulted on their debt. There are very few exceptions. More specifically, from our preliminary research, GFC has identified a cyclical pattern of sovereign defaults that occur globally every 70-90 years on a large scale. It should be noted that during WWII, almost all the industrialized nations of the world defaulted or came dangerous close to default. This led to the creation of the Bretton Woods monetary system in 1944 where the United States assumed the leading role of managing the reserve currency of world. That was 71 years ago, and despite a clear history of cyclical defaults, financial professionals look at yields trading in the U.S. Treasury bond market and refer to them as “risk-free” implying there is absolutely zero risk of default.
Proponents of today’s sovereign debt levels contest that everything is manageable because we’ve successfully managed similar debt levels before. It is true that during WWII, the last time the U.S. came dangerous close to default, the United States debt-to-GDP ratio exceeded 100% as it does today. However, there were some stark fundamental differences between the debt accumulated during WWII and debt the U.S. government is on the hook for today. GFC believes it would be beneficial to highlight these differences to the reader who may be unaware. The differences are as follows:
- The debt sold by the U.S. Treasury department in the 1940s was predominantly sold to American citizens in order to finance and win the war. During the war the Treasury developed an incessant marketing campaign directed towards Mom and Pop investors urging them to buy war bonds. Many patriotic Americans bought as many war bonds as they could afford in order to help do their part in financing the great conflict. Today, very little of U.S. debt is held by average American investors. Instead, much of the debt has been sold to foreign central banks, financial institutions, and foreign government creditors. Therefore it is equally important to understand that the interest expense that is being paid on today’s $18 Trillion of debt is not necessarily being recycled into the American economy the way it was after the conclusion of the war, but rather the interest coupons are being exported out of the American economy. The debt used to finance WWII literally paid dividends stimulated the American economy until the 1970s as Americans collected a stable interest check for 30 years and were able to reinvest that money back into the American economy in whatever way they chose.
- The maturity duration of the bonds sold to finance WWII was long-term paper, generally close to 30-years which provided a great deal of stability for the Treasury. Today, much of the U.S. debt has been continually rolled over into shorter and shorter durations at lower and lower interest rates to where today the vast majority of U.S. debt resides beneath the 7-year mark on the yield curve. This makes the debt we are carrying inherently unstable and highly sensitive to a change in interest rates. If interest rates were to rise significantly, the Treasury would have to roll over a disproportionate share of the total debt in a relatively short amount of time which would drastically raise the cost of financing the existing debt. To put that into perspective, it could be argue that today’s U.S. treasury debt is tantamount to the mother of all adjustable-rate-mortgages.
- The debt accumulated in the 1940s and the debt accumulated in the last 30 years were put to use in remarkably different ways. To win the war the U.S. invested heavily in industrial capacity, which later after the war was converted to commercial use. The U.S. became the largest producer in the world and subsequently became the largest exporter of manufactured products in the world. The trade surplus achieved after the war undoubtedly helped reduce the national debt. Today, the majority of the debt has gone to finance government largess, undeserving corporate bank bailouts, and general economic consumption. The manufacturing capability of the U.S. economy today is a shell of its former self. Service sector jobs now define the U.S. economy as the trade deficit continues to widen. The United States today has extremely little to show for all the debt that has been borrowed.
Even with interest rates near historic lows, the U.S. Treasury still paid $230 billion dollars in interest expense to foreign creditors last year, which represented just the annual burden of carrying this monstrous amount of debt. In reality, that $230 billion is the annual bill that the American tax-payer had to cough up in order to pay for fiscal profligacy in Washington. If the 30+ year trend in bonds ever reverses course, the annual interest expense for American tax-payers will definitely get a lot bigger. The baby-boomer generation collectively entering retirement represents a tectonic shift in the relationship between Washington and its historic tax-base. The boomers are in the beginning stages of transferring from productively employed members of society who pay income taxes, to people who are retired, pay no income tax, collect social security, and now healthcare benefits from the federal government. In short, America’s largest demographic asset is in the early stages of transforming into a massive liability on Uncle Sam’s balance sheet. The implications of this for the Treasury bond market are utterly disastrous as this will be occurring on top of an already over-indebted fiscal situation. The politicians in Washington will soon be facing a nearly unsolvable challenge where kicking the proverbial can down the road will no longer be an option.
One well known economist who has impressively tracked the evolution of this crisis in detail is Martin Armstrong. Armstrong is famous for building proprietary computer software based off the number pi which is allegedly capable of tracking global capital flows in real time. The defining aspect of his computer model that it is widely regarded as superior to other economic forecasting models in its ability to incorporate historic market cycles and then make market timing forecasts to a precise degree. Recently (for at least the past 5 years) Martin Armstrong’s economic confidence model has been highlighting the date of September 30th, 2015 (or 2015.75 as his model says) as being of extreme importance for the global economy. Martin himself seems to think this could represent the high in sentiment in sovereign debt markets and sentiment shifts away from public assets to private. We at GFC find this date to be extremely intriguing to say the least. Armstrong believes this time period could represent when the change in trend pertaining to global bond yields is likely to occur. We thought it would at least be beneficial for our readers to be aware of this date so they have the opportunity to monitor sovereign debt markets closely as the date approaches. If Armstrong is correct, being short sovereign debt is likely to be a very prosperous proposition in the years ahead. A financial crisis of epic proportions is undoubtedly brewing in global bond markets. The only question is: when will all this debt spiral out of control?