The Myth of the U.S. Economic Soft Landing

Last week I wrote extensively about a variety of serious issues which could individually or collectively, create huge problems for the US.  I am not sure how I would rank these issues, as any of them could mutate into a crisis that our country needs to address in the relatively near future.  Collectively, the risks become almost overwhelming.  Whether I look at the ever-widening wealth gap between the mega-rich and the rest of the population, the massive national debt, or the cumulative crushing impact of years of inflation, the negative implications are highly concerning to say the least. These are only a few of the issues, and unfortunately, there are many, many more.  

As the Fed’s initial interest rate cut is imminent, please don’t accept the nonsense that various experts will spout when they tell us how wonderful our economy is due to the soft landing that the Fed has engineered.  Yes, it is true that the level of inflation is slowly drifting down to the Fed’s contrived 2% target.  That inflation target is a canard, however, a clever stratagem that is designed to intentionally deceive us and effectively cheat us.  As you saw in the charts from last week, the cumulative impact of our so-called stable monetary policy has resulted in huge price increases and crushing unaffordability in housing and other critical aspects of modern life.  Consumers are severely stretched, and millions of people are now working multiple jobs just to try to pay the bills.  The month-to-month change in inflation presents more of a rounding error, since tremendous damage has already been done and people are seriously struggling with the cumulative effects of many, many years of significant price rises.  For sure, salaries have not kept pace with the rising costs of essential living expenses.

Housing prices are already too high for most first home buyers, considering that house prices are at all-time highs and borrowing costs are prohibitively expensive.  When the Fed cuts rates – as they surely will next week – the problem will likely stay the same or perhaps even worsen.  Sure, borrowing costs may come down a little, but prices will likely tick higher at the same time.  

The whole situation with housing costs and shelter costs is yet another confusing mess when it comes to measuring inflation.  Aside from the obvious problem that inflation is measured typically on a month-to-month basis rather than on a cumulative basis over a more sensible period of time measured in years, the data is highly misleading for other reasons.  The BLS (Bureau of Labor Statistics) considers average rents in force rather than looking at the cost of new rents.  This leads to extreme lags in the official figures.  

In fact, just to continue my harangue about the process used by the Fed, it is quite remarkable that the Fed likes to consider core inflation data, excluding food and energy.  Seriously?  Are we supposed to accept this insane premise that somehow food and energy aren’t absolutely critical components of our basic living costs?  Headline inflation suggests a much rosier picture on the pricing front, while the core numbers are warning us to tread carefully. This sort of data manipulation reminds me of several memorable quotes from my professor of statistics at Wharton – “Facts are stubborn things, but statistics are pliable.”  This quote was attributable to Mark Twain.  My professor also quoted  Benjamin Disraeli’s famous line, “There are three kinds of lies: lies, damned lies, and statistics.”  These were essentially my professor’s warnings to be very careful when government entities are throwing statistical data at us.  

We see evidence of the deleterious impact of cumulative price rises in nearly every aspect of modern life.  Consider student loans, for example.   These loans are catastrophically expensive for over forty-two million Americans.  College education is hardly affordable any longer.  The total amount of student debt in the US is nearly $1.8 trillion, with the overwhelming percentage of this debt being federal loans.  Student loans in and of themselves won’t lead to a meltdown at the government level, but they are symptomatic of just how painful the cumulative price rises of consumer goods, housing, energy, and education have become. The loans are way too large to simply forgive, as that would amount to nothing more than a government handout, which our government can ill-afford to do now given their decades of cumulative, gross budgetary mismanagement. 

The danger facing all of us is that there is a point at which our government’s access to cheap, plentiful funds will dry up, and we are no longer creeping closer to that point.  I would say that we are now hurtling towards that point, yet the government officials refuse to sound the alarm.  Of course, there are political reasons why both of our major parties have no interest in alerting our nation to the impending crisis, but at some point, the truth will become clear, and changes will be necessary – either by wise, disciplined, and preventative choice, or by the force of a market crisis of unprecedented size. Our government spending will have limits, and we are going to learn this lesson one way or another.  

Another very serious issue is the growing BRICS movement that is starting to take shape.  This movement is a very real and imminent threat to our government’s ability to keep borrowing and spending without restraint.  The BRICS movement is essentially a developing threat to the hegemonic power of the US and the US dollar.  The dollar has been the primary reserve currency since the signing of the Bretton Woods Agreement in 1944.  That agreement ensured that all the signatories to the Agreement, including the United States, Western European nations, Australia, and others would cooperate to guarantee convertibility of their currencies into US dollars within a very narrow range.  The dollar was gold-backed, and it was convertible into gold at a fixed rate of $35 per ounce.  Due to the inflationary impact of the guns and butter program of the US in the 1960’s, the US was finally forced to abandon the fixed rate regime and suspend the convertibility of the dollar into gold in the early 1970’s.  Thus we have the free-floating world of fiat currencies that are essentially backed by some empty promises.

Coming out of the second World War, the US was by far the strongest economy in the world, with roughly 50% of the global GDP.  Many countries were in tatters, trying to recover from the war’s devastation, and the US was in a position to offer extremely advantageous trade arrangements to Germany, Japan, and others along with broad  economic support.  This helped cement peaceful relations as trade between the nations expanded.  This also established the US dollar as the primary currency for international trade.  

The US was so strong on a relative basis that it was able to provide extremely favorable trading terms while also maintaining overall military security and peace in exchange for its firm establishment as the global hegemon.  Over time, it has been a real struggle for the US to force its trading counterparties around the world to adjust the terms of their trade arrangements to more fair arrangements.  At the same time, however, the US has reaped huge rewards through the establishment of the dollar as the overwhelming predominant currency for international trade.

Nations around the world have had to hold US dollars as part of their reserves, and this has led to constant demand for dollar-based assets.  It has ensured our government’s ability to raise money through debt issuance as there were always many global buyers for our paper.  There are a host of other advantages that come with having the world’s predominant trading currency, but the value of having a huge number of ready buyers of our government bonds cannot be overstated.

Unfortunately for the US, this hegemonic role of the US dollar is now being aggressively and directly challenged.  The dollar’s supremacy as the global reserve currency is being threatened as nations around the world are banding together in a global de-dollarization campaign.  The campaign is gaining momentum as countries such as China, Russia, Brazil, the ASEAN nations, certain countries in Africa, and others are actively seeking alternatives to trading in dollars.  

The UAE is selling gas to China in yuan.  Beijing and Brazil have dropped the dollar in bilateral trade.  Russia is trading in their own currency.  For sure, China wants to undermine the US dollar as the universal petrodollar for gas and oil trade. The list goes on, and the implications for the US are very, very serious.  If the US dollar loses its hegemonic status, then the global power of the US will start to dissipate.  This could have severe negative ramifications for the ability of the US to fund its ever-growing federal deficits.  

Already, the interest on US debt exceeds the budget of the Defense Department. This number is already over $1 trillion per annum, and it is growing.  Civilian and military personnel in the US government now total about 4.5 million people.  Spending is broken into different broad categories:  mandatory spending, discretionary spending, and interest on debt.  The mandatory spending comprises about 64% of the total budget, and it includes things such as social security, Medicare, and Medicaid.  There are other support programs such as food stamps and unemployment insurance.  On the discretionary front, we have defense, education, and health and human services, transportation, and health and human services.   

Without going into lots of depressing details, let me simply summarize the reality in one simple line – the US is heading towards bankruptcy!!  The US, however, will not relinquish its power without a fight.  My hope is that the fight is resolved commercially rather than militarily.  We have seen some early warning shots in the form of tariffs, but things could get much, much worse on that front.  

Rather than speculate on how the US fights to preserve the hegemonic status of the dollar, I would prefer to shift to how I see things playing out in the markets.  We already know that the US will gladly borrow and spend essentially unlimited amounts of money to maintain an illusion of prosperity.  We also know that the Fed will gladly revert to quantitative easing at the first sign of serious economic trouble.  This is how the US has essentially kicked its financial problems down the road for many, many years.  It is their tried-and-true process. 

Accordingly, I stick to my idea that we are in the very latter stages of the stock market’s bull market.  There is a chance that we get yet another thrust higher once the Fed starts its rate cutting, but I don’t expect that rally to new all-time highs to be sustained.  More likely, we should get a blow-off top that will be followed by a very, very long-lasting bear market.  The bear market will have periodic fierce, sharp corrective rallies, but the market needs to adjust to more sensible valuations.  I am uncomfortable putting a specific downside target in writing, but I will share that I have structured a variety of option plays that will earn enormous returns if the market drops more than twenty-five percent from current levels. The returns will continue to expand if the move turns out to be even larger, and we were able to structure the play for zero cost!  

I have structured similar bets in dollar yen, although we have already had a twenty-yen drop.  In the relatively short term, I am playing for an additional twelve-to-fourteen yen drop before we enter into a broad consolidation for a while.  I am using similar option structures in dollar yen so as to have lots of upside with zero cost for the structure.  

Please note that these forecasts are based on very conservative valuations without extreme crises developing.  In dollar yen, there is a growing possibility that significant repatriation and/or hedging of dollar-based assets by Japanese investors could trigger a liquidation of dollars that could eventually send dollar yen to new all-time lows.  These moves take time to develop, but do not be lulled into complacency by smooth-talking officials.  The risks of this sort of move are real and growing, and they are quite imminent.

In the meanwhile, I wish you all the best of luck with your trading.