In a normal world with adults at the helm a higher interest rate environment is good for the Dollar. A higher rate environment makes the Dollar an attractive store of value relative to other currencies, thereby driving up Dollar demand. This demand principle remains true today. However, today is different than years past. There is a new wrinkle that must be considered – outstanding Treasury debt – which stands at $34.4 Trillion and threatens the Dollar’s standing as the reserve currency.
The U.S. is in the untenable position where it must issue new Treasury debt to raise the capital required to pay off maturing Treasury debt, not to mention to cover the ever-growing fiscal deficits created by the Liberal fiscal policies of Presidents Bush, Obama, Trump and Biden, exacerbated by the Liberal monetary policies under Fed Chairs Greenspan, Bernanke, Yellen and now Powell.
If the $34.4 Trillion of Treasury debt outstanding were to roll over at an average interest rate of 5% (the largest tranche of Treasury debt is short-term), it would create annual interest expense of $1.7 Trillion – equivalent to 39% of 2023 Federal Tax Receipts – meaning the interest expense alone immediately puts the Federal Government in a fiscal hole.
As it stands, the average interest rate on the Treasury debt outstanding is 3.2%, which means this year’s annual interest expense will be approximately $1.1 Trillion, or approximately 25% of Federal Tax Receipts.
Exploding interest expense ensures fiscal deficits: The $1.1 Trillion of Federal interest expense is now the equivalent of the Defense Budget (which also needs to shrink as battles across the globe today are being won with $50K drones, not $ billion-dollar attack helicopters).
Therefore, every day that interest rates remain elevated, the underlying Treasury debt and related interest expense moves higher, thereby creating larger fiscal deficits and the need to issue new debt and to print new Dollars to subsidize that debt.
Dilution Principle: New Dollars/money printed (represented below by M2) means Dollars/money in circulation is worth less (represented below by CPI). That is the dilution principle at work. This is the worst of vicious circles.
T-Day: Treasury yields will move sharply higher one day and we won’t see it coming. The catalyst will be a large institutional or sovereign Treasury debt holder will reach the conclusion that it no longer wishes to play this game of musical chairs and will dump its Treasury holdings all along the yield curve. Other institutions will follow. There will be a cascading effect. No bond house will want to hold Treasury debt until yields move significantly higher – much higher than yields during the 1980s. Concurrently the Dollar will plummet.
Growing Treasury debt faster than Federal Tax Receipts in perpetuity simply is not an option. The fools that repeat the mantra “debt does not matter” have blinders on. Simply observe what has happened to real world prices since 2020. The United States’ insatiable appetite for debt is why price increases have exploded higher and persisted for longer than what is captured by CPI. How can one observe what has happened since the foolish fiscal and monetary COVID response polices and conclude that debt does not matter?
This endgame of a forever weakened Dollar is baked in the cake unless the United States starts to run fiscal surpluses while the Fed shrinks its balance sheet. The Fed could do its part by radically shrinking its balance sheet, just as it radically grew it from 2020 – May 2022.
However, I fear that the status quo will persist until the Public demands less fiscal spending. Until such time, asset prices and the prices of goods and services will rise. Wages unfortunately will not keep pace.
The Public should demand that Congress spend dramatically less. However, my expectation is that the Public will demand a greater handout. Instead of putting the Federal Government on a much needed fiscal diet, Government will spend more than ever on welfare, what some call “entitlements”.
In fiscal 2023, 62 cents of every Dollar that the Government spent went to entitlements. That is unsustainable. Here is what Federal spending looks like fiscal year-to-date (October 2023 through January 31st). Keep in mind that the year-to-date fiscal deficit is $532 billion, up 16% from the same point in time a year ago.
The next big welfare package that will be passed by Congress and signed by the next President will be Universal Basic Income (UBI). We already see a version of UBI allocated to those who cross the border illegally as the Democrat party seeks to buy votes with money it does not have, underwritten by Americans who did not vote to do so. UBI will be institutionalized while our taxes increase at year-end 2025 – both of which will make the fiscal situation worse. I believe this will happen regardless of who takes office in January 2025.
