Despite the abundance of optimism welcoming 2024, John Mauldin says “There’s No Way Out”—the U.S. economy will crash. He hopes the building crashes around us rather than on top of us, but economic disaster is certain. It might not happen soon, but it will happen because there is no way out.
I agree with John and explain why in this video. Mr. Mauldin lays out the unfortunate reality and we provide the ugly facts in the video.
In Imminent Crises are Opportunities for Financial Advisors I describe how the imminent crisis does indeed present an opportunity for investment advisors. In this article I highlight the causes for the upcoming crisis and offer suggestions for investors to deal with it because stocks and bonds won’t do.
Blame COVID. We will all pay this bill.
More than $5 trillion spent to fight COVID has broken the U.S. economy, although there is little discussion of this reality, yet. There is too much money in the economy and the Federal Reserve is going broke trying to fight the inflation it caused. The following four graphs tell the story.
The U.S. spent more than all other countries on COVID: $5 Trillion, which is 25% of GDP.
This increased the money supply, especially the “helicopter money” sent to most taxpayers. There is currently $3.5 trillion “too much” money in circulation that will cause “cost-push” inflation on top of our current “demand-pull” inflation.
Money printing has pumped the Federal Reserve Balance Sheet up to $8 trillion: 8 times the historical average. Money is “printed” when the Treasury issues bonds that the Fed buys. The Fed is an arsonist charged with fighting the inflation fire.
Fighting inflation by Quantitative Tightening is bankrupting the Fed with huge operating losses. It’s ugly. The Fed “pays” for these losses with a bookkeeping entry for “deferred assets” which is basically an IOU to itself.
And there are even more repercussions from COVID.
More bank failures ahead
The failures last year of Silicon Valley and Republic banks are just the beginning.
Another consequence of COVID is the abandonment of office buildings and brick-and-mortar stores. Consequently, owners are going out of business and defaulting on their loans.
Compounding these banking problems, depositors are withdrawing their savings because they earn higher interest on CDs and money market funds. This is called disintermediation.
Monetizing the debt is a prescription for hyperinflation
Interest payments on the national debt break the bank when interest rates are not manipulated down to zero with a Zero Interest Rate Policy (ZIRP). At 6% interest, debt service becomes the most expensive federal outlay and the deficit balloons from $1.8 trillion to $3 trillion. Printing money to pay the debt is called monetization.
Monetization leads to hyperinflation. Inflation benefits debtors and we are one of the world’s largest debtors.
Dealing with it
Dr. Wade Pfau, Professor of Retirement Income, calls Bonds Useless and Equities Risky. So, what should you own at this perilous time of increasing interest rates, overpriced stocks and collapsing economy?
There are two choices: (1) void your portfolio of stocks and bonds, and/or (2) hedge.
If you’re not going to hold stocks and bonds, there’s a long list of investments you could hold. The following should protect against inflation: certain real estate, precious metals, commodities, natural resources, agriculture and, yes, even cryptocurrencies.
Some mix of these assets could make up your risky portfolio, instead of stocks.
To control risk, you’ll want to use inflation protected low risk assets like short-to-intermediate TIPS (Treasury Inflation-Protected Securities).
For guidance on the blending, you could look to the Talmud that advises a third in land, a third in business and a third in reserve. In this case the third in business would be inflation protected assets. The initial portfolio would look something like the following:
Risk can be managed by combining these two portfolios, moving more or less into the Stabilization portfolio to decrease or increase risk. You can tinker with the sample allocations based on your comfort and understanding.
Another—but very expensive—choice would be to hire some hedge fund managers or a fund-of-fund of hedge funds. But there are plenty of tools available to do your own hedging, including:
• Sell short
• Buy put options or sell call options
• Buy ETFs that bet against the stock market like SPXS
• Buy ETFs that profit from interest rate increases like PFIX
• Buy buffered ETFs like Innovator’s
• Buy volatility, like the VIX
The list goes on.
You control the amount of the hedge. In hedge fund parlance your “direction” can be long or short, which means you are betting for or against the market. You control the size of your bet by the mix.
Conclusion
There is no way out. Our economy will collapse. Deal with it.
Market pundits have declared an end to inflation that has launched a stock market rally—the Santa Rally—in anticipation of a Fed pivot. The markets are counting on renewed manipulation. But the Fed historically has lowered interest rates to buoy up a falling economy and stimulate stock investing—rather than to fuel a rising stock market.
Professor Jeremy Siegel (Stocks for the Long Run) warns that the anticipated Fed pivot would be bad for stocks because it would mean that we have a recession. The Fed should only lower rates to alleviate a recession.
The Fed should let the market determine fair prices for stocks and bonds. It should continue its abandonment of ZIRP. It should also continue to shrink its balance sheet, even though the consequences are unknown—and possibly catastrophic.
It should let the economy find its own course and let us deal with it. This can has been kicked down the road long enough.
SEE ALSO:
• Imminent Crises are Opportunities for Financial Advisors
• Feel the Pain of the U.S. Debt Problem