The Debt Squeeze

The Debt Squeeze

Friday, 9th August 2019

The Federal Reserve’s Job 1

Perhaps you think that the Fed’s priorities are defined by its official mandate…price stability and full employment. Or, if you have been following the news, you may add the third mandate which has emerged in Chairman Powell’s statements…continuing the current economic expansion. Or as a cynic, you might also add the preservation of the banking system because, after all, the commercial banks own the Fed.

But I think there is one more mandate that eclipses all the rest…maintaining the current debt bubble. If the Fed fails in this regard, all the other mandates go down the drain.

US credit market debt now exceeds $72 trillion which is secured against an economy of just $18.8 trillion. To keep rolling over expiring debt and accrued interest and to finance massive government deficits, which at the Federal level are now verging on $1 trillion per year without a recession, total debt must increase at least $3 trillion per year. This is no small task. Banks have to be willing to lend and borrowers have to be willing to take on more liabilities despite already high debt loads.

For the Fed, this is job 1… keep the debt growing. Once debt begins to contract, the game ends in a massive wave of defaults. The Great Recession of 2008/9 was caused by a small contraction in debt growth…actually more a flattening of the growth curve. The Fed CANNOT let that happen again with debt now 30% higher.

In our view, rate cuts aren’t likely to induce enough new private lending/borrowing to keep the debt bubble expanding, especially as the economy is clearly slowing down. More QE will be necessary and perhaps even more aggressive policies.

Assuming an average interest rate of 3% (likely too low), the debt eats $2.2 trillion per year…11.5% of real GDP (hat tip to Mike Shedlock at MishTalk). That’s why economic growth after the Great Recession has been so poor…the economy is choking on too much debt. And that is why the Fed’s one and only policy…growing the economy by growing the debt…is unsustainable. As Shedlock points out, in 1984 it took $1 of additional debt to create an additional $1 of Real GDP. As of the fourth quarter of 2018, it took $3.8 dollars to create $1 of real GDP.

We believe that gold is on its way to a new all-time high because the Fed is going to do its level best to look after Job 1. Owning gold is, in our view, a prudent response.


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