Right but still Wrong
'No one believes a liar even when they are telling the truth.'
- The boy who cried wolf
Many of my macroeconomic fears are now widely recognized, but markets do not appear worried. I continue to believe that US government overspending and Federal Reserve failures will lead to economic disaster. I remain essentially alone in crying wolf.
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| Wolf! |
Government overspending
My financial fear is grounded in US government malfeasance. The US government is running a very large budget deficit. This overspending is taking place in a benign environment, consisting primarily of three factors.
1. Interest rates are low by historic standards, meaning the government interest payments are low.2. The US is spending less on defense that it has in almost every year since World War II ended, and3. The US is not (yet) in recession.
In spite of these financial tailwinds, we are overspending.
These should be the best days for US government finances, and, yet, we are overspending by historic amounts.
I have been pointing out the fiscal problem for years. In 2019, for example, I wrote that US deficits could hit $6 Trillion or more. Furthermore, I highlighted the historical first of huge, peacetime deficits during economic growth: "What's amazing is that our (2019) $1 Trillion deficit comes with no large-scale war, very low debt service cost, and no recession."
This October 2024 Wall Street Journal article says almost exactly what I noted in 2019; large deficits without war, recession, or high interest costs.
Higher Real Rates
The primary economic consequence of overspending should be higher real interest rates. As a proxy for real rates, I subtract the trailing 12-month Consumer Price Index (CPI) from the 10-year Treasury rate. For example the 10-year treasury today is 4.10, and the most recent CPI reading was 2.40%.
So the current real interest is, by this metric, 1.70%. There are other approaches to measuring real rates, and all measures paint the same picture.
In theory, government overspending creates competition between the government and the private sector for borrowing. With a lot of competition to borrow, the price of borrowing ought to rise. The price of borrowing is the real interest rate. So high government debt and deficits should, and usually do, lead to high real interest rates.
Real rates have been low- historically low
Rather than go higher, real rates have been historically low - until recently. Here is the full picture of real rates:
The blue line in the graph is the real rate. The real rate peaked at just under 10% in the early 1980s. It fell persistently for decades, and then was essentially zero from 2009 to the beginning of COVID. The massive response to COVID by spending and e-printing money led to a jump in inflation with a consequence push of real rates deeply negative.
In chart form, we can divide the periods in many ways. I have chosen World War II -> housing crisis, then from housing crisis up until the last two years of high inflation, those two high inflation years, and then finally this year.
From World War II (1953 for the data) until the 2009 housing crisis, the real rate averaged 2.56%. Then from 2009-2021, the rate plunged toward zero with an average of 0.80%. For the period 2022-2023, inflation surged and real rates became extremely negative, averaging minus 2.62%. Recently the real rate has turned positive.
Real rates can go much higher
How high can real rates go? I think the answer is 10% or more. Real rates almost hit 10% in the early 1980s, and our government financial situation is much worse today. Given the 50+ year average of 2.56%, it seems very likely that real rates will exceed that historic average - easily moving toward 5%.
What does a world of 5% or higher real interest rates look like. The short answer: the opposite of the world we have lived in for the last fifteen years. Saving will be favored over spending, frugality and prudence over opulence and speculation.
September 2024 performance
The Dow Jones Industrial Average gained 1.94% in September 2024. The Chicken Little Portfolio gained 0.71%. Year to date, the Dow is up 13.65% while Chicken Little is up 3.56%
September 2024 was a positive month for all major asset classes. Emerging market stocks, gold, and bitcoin, each returned in excess of 5% in the month.
It has been a very good year for investors so far. Year to date, all major asset classes are showing strong, positive returns except for long-term US Government bonds which, although positive, have returned close to zero. Bitcoin and gold are the best performing assets (by a significant margin).
October 2024 portfolio position
The Chicken Little portfolio remains positioned for financial apocalypse. No trades in the month of September. Gold position is larger because gold prices increased.
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