Debts, Deficits…and Death to the Middle Class

Let’s slow down for a moment and take stock.

Investors are mostly bewildered but hoping that inflation has peaked, and the Fed will soon ease up. Easing up seems likely to us…but not decisive. There’s more to the story, which we’ll come to in a minute.

Consumer prices are still rising at an unacceptable rate. And workers — that’s most of us — are still losing ground. Wages are going up. But after inflation, we are poorer.

Meanwhile, real estate, where most people keep their wealth, is going down. We saw yesterday that house prices may fall 30% — in line with the last bear market in real estate. Many families only have ‘equity’ of 30%…or less…in their houses. So the expected drop will wipe out 100% of their accumulated wealth. And most likely, the Fed will continue its ‘tightening’, forcing those who need to refinance to pay higher rates (mortgage rates have already more than doubled since 2020).

Hypotheses, one and two…

We expect the Fed to continue its rate hikes until one of two things happen: A big bankruptcy, crash on Wall Street, or other financial emergency will cause the Fed to panic and ‘pivot’ towards lower rates. That is our hypothesis number one: that the Fed will continue to raise rates ‘until something breaks’.

But there’s another possibility, hypothesis number two: that the Fed will be forced to raise rates by the federal government. The Fed caused today’s inflation; it’s trying to redeem itself by getting it under control. But the elite who control the national government are still very much in spend, spend, spend mode. No cutting back for them. They have elections to win…battles to fight…claptrap to promote and boondoggles to finance. And they’re increasingly turning not just to spending money they don’t have…but also guaranteeing credits they can’t really afford.

Yes, the feds are running huge deficits. If everything goes well, you can expect another US$1 trillion shortfall this year. In case of recession — which is likely — the deficit will be much greater. But in addition, they’re steering private spending towards their favourite projects by offering an expanding system of tax breaks and credit guarantees. Homeowners are promised public money if they put solar panels on their roofs, for example, or insulation in their walls. Buyers are given credits if they purchase an EV. Young people are promised loans (later to be forgiven!) if they submit to further indoctrination, rather than finding a job where they might actually learn something useful.

The primary trend

This spending, direct and indirect, has to be covered. Meaningful tax hikes are out of the question. So the money has to come from borrowing or printing. Borrowing will drive up interest rates, thereby also increasing the cost of carrying the government’s US$31 trillion debt pile. Either way — borrowing or printing — the Fed will be forced to make low-cost funds available.

Thereby, one way or another, along comes the much anticipated ‘pivot’. And with it comes a new phase of the developing catastrophe, with the Fed supporting federal spending and the economy with lower rates, and probably more QE.

When this happens, many people will see a boom. Stocks are likely to go up. It’ll seem like an early spring thaw, with flowers coming up everywhere. Investors will remember how the Fed goosed up stocks after the dotcom crash…and again after the mortgage finance crisis…and again after the economy was shut down in the COVID Panic. They will think: ‘here we go again’.

But this time, it’ll probably turn out much differently. In our view, the primary trend is what counts. And the primary trend…

…for stocks…
…for bonds…
…for real estate…
…for the US empire…
…for the dollar-dominated currency system…
…for Western democracy…
…for Congress and the administration…
…for the economy…
…for standards of living…

…is down. That’s the ‘cluster’ we’ve been exploring when many things go wrong together. Night follows day. Bust follows boom. A young man becomes an old man. And a church warden sneaks into a brothel. You get the idea.

In ‘n’ outta whack

The primary trend is merely the process by which that which was out of whack gets back into whack…and then goes out of whack again. In the bond market, for example, we have seen only two major course reversals in our entire lives. Bonds fell in price from the late ‘40s until the early ‘80s. Then, the primary trend turned…and they rose for the next four decades. The second turn only happened in 2020, when they finally topped out, and yields (which go in the opposite direction) began to rise. Since then, the 10-year Treasury bond, the most common brick of the whole modern financial edifice, rose from barely one half of one percent in July 2020 to 3.7% — seven times as much.

We pay attention to the primary trend because 1) it is almost impossible to make any real money by trading in and out, trying to pick winners or anticipate the markets’ moves, 2) primary trend changes destroy fortunes as well as make them, and 3) when you invest in the primary trend you don’t have to pay so much attention to Wall Street.

We should probably add that the primary trend also brings us in contact with the ironies and disappointments of real life. ‘He that did ride so high doth lie so low’, we say, with the gravitas of a sage, after a crash. What goes up must come down. The last shall be first. The chambermaid will be queen. And the jerk, who gets elected to Congress, eventually gets what he has coming.

So many opportunities to say, ‘I told you so!’.

But wait…how can the ‘primary trend’ be down…and yet, after the Fed pivots, the economy may boom, and stocks may go up?

Stay tuned…

Regards,

Dan Denning Signature

Bill Bonner,
For The Daily Reckoning Australia

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