Printing Yuan for Oil and Hegemonic Demise

In his recently published book entitled, The Mr. X Interviews: Worldviews From A Fictional U.S. Sovereign Creditor, author Luke Gromen outlines global efforts by key emerging market countries to end the reign of the U.S. dollar as the world’s reserve currency. Although these efforts have been underway for several years, Mr. Gromen says the day of reckoning is upon us; warning investors to be prepared for potentially cataclysmic change in the near term - perhaps as early as 2021.

Most notably, Russia and China are making significant strides in establishing a system for trading oil that obviates the need for the U.S. dollar. Avoiding the dollar relieves them of the financial oppression the U.S. imparts through the use of the U.S. dollar to settle trade imbalances and enables them to hold fewer FX reserves – a construct that moves China closer to printing yuan for oil.

Without a demand for U.S. Treasuries from China and Russia, the U.S. government faces a potential funding crisis that could lead to significant problems in the near term. The U.S. military refers to this crisis as the greatest threat to U.S. national security. Military officials have actively called out China’s game plan to reduce the hegemonic rule of the U.S., a role it has played for 70 years, through the reserve currency status of the U.S. dollar: cut off the capital flow to the U.S. through reduced U.S. Treasury purchases and thus starving the dependent U.S. government of its needed funding.

The foundation of China’s plan is the re-opening of a new and improved gold window that will back China’s oil purchases from oil-exporting countries, principally Russia. Historically the U.S. has been the only country able to print its own currency to purchase oil. China’s goal is to do the same. However, their path for achieving such status entails tactics highly detrimental to the well-being of the U.S. economy and country.

To understand this dynamic better a little history is in order.

Hegemonic Stability Theory

Although Mr. Gromen doesn’t delve into the topic of historical hegemony in his book it's an important piece to better understand the historical significance of where he describes the global economic system is today.

A hegemon is defined as the state who exercises predominant influence over all other states. Hegemonic status extends as far back as the Colonial Period with Portugal who was succeeded by the Dutch. Great Brittain had multiple reigns and was unseated by the U.S. at the end of WWII. Of utmost importance is periods between hegemonic dominance are periods of great global turmoil. When GBR was fading its first time, and France was on the rise, we had the American Revolution, the French Revolution and the rise of Napoleon. When GBR was fading a second time, and the U.S. was unwilling to accept the role, we had WWI, the Great Depression, and WWII. When you don't have a functioning hegemon the world goes awry.

Harry S. Truman became the voice Americans heard calling for the U.S. to become the next hegemon on the basis of avoiding WWIII sometime in the future. Truman effectively sold the American public the benefits of hegemon status without weighing those benefits against associated costs.

A hegemon, by definition, must provide a variety of public goods to the rest of the world. Two are of particular importance: global security and global reserve currency. To promote global trade the hegemon must protect sea lanes and overland trade routes and prevent small, regional wars from escalating into big wars. Second, the hegemon must provide to the world the financial infrastructure needed to support global trade and investment, thereby facilitating less developed countries becoming developed ones. These requirements mean the hegemon must possess one of the world’s largest economies and it must act as the world’s consumer of last resort.

If the U.S. dollar is to be used as the world’s reserve currency (the BIS estimates 85% of worldwide trade involves some form of the USD) then other countries must acquire dollars to trade with other countries. Acquiring dollars happens in two ways. Countries can either borrow in USD or, the more preferred method, is to run trade surpluses with the U.S. This second method is often referred to as export promotion and was how Germany and Japan rebuilt after WWII left both economies in shambles. Export promotion is accomplished by foreign countries implementing a list of measures specifically designed to cause trade surpluses. These measures include no social safety net, causing citizens to save more than they spend, placing restrictions on capital outflows, and often, devaluing their own currency.

Post-WWII export promotion and the concomitant U.S. trade deficits were initially not impactful enough to cause much domestic strife. Throughout the ’50s and ’60s, the U.S. economy was so much larger than any other in the world that the U.S. consumer could buy both cheap imports and domestic goods as services as well. This relative size differential began to disappear in the 1970s as other nations began to catch up to the size of the U.S. economy. Now trade deficits mattered, especially to the U.S. manufacturing industry and others who were forced to compete with cheap imports.

Pax Americana

After President Nixon closed the gold window in August 1971, the global monetary system transitioned from a USD/gold system to a USD/UST system. The importance of this shift was profound because it defined an unwritten agreement between the world’s largest economies or Pax Americana. Pax Americana simply said the U.S. will export its jobs and factories to foreign countries in exchange for those foreign countries to stockpile U.S. Treasuries purchased with their trade surplus revenues. This was a boon to the U.S. consumer as it ensured a steady flow of cheap imported goods. However, the system was also a phenomenal way of ensuring the financing of U.S. fiscal deficits and thereby centralizing power in Washington D.C. This all came at the expense of farmers and manufacturers in the flyover states, as well as a good chunk of the U.S. middle class. With Pax Americana the U.S. could print USD to pay for whatever it desired – an exorbitant privilege that required prudent stewardship.

For most of the 20th century, the U.S. government operated under the principle that it should finance its spending mostly by the collection of taxes as opposed to borrowing. Although temporary deficits were supported during wars and recessions, no one espoused growing debt faster than the size of the economy on a persistent basis. Prudent governments kept their fiscal house in order during good times so they had more fiscal room to deal with bad times.

Declining macroprudential stewardship of sound monetary policy was always a temptation in this system and it was only a matter of time until U.S. policymakers caved. When President Clinton left office the U.S. Federal debt stood at $5 trillion. Bush 43 doubled it to $10 trillion and Obama doubled it again to $20 trillion. Today the Federal debt sits at $23 trillion and represents more than 105% of U.S. GDP.

Economist Robert Triffin envisioned this arrangement unfolding in unflattering terms as early as 1959, and hence the term Triffin’s Dilemma was born. It says: If one nation uses its currency as the reserve currency for the world, it must run ever-growing deficits to supply the currency needed for global economy. Ultimately, these deficits drive such a significant hollowing out of domestic productive assets that foreign creditors of the issuing nation begin to question the issuing nation's ability to repay sovereign debt in real terms. Mr. Gromen claims we arrived at this point in 2008, and we've spent the last 10 years muddling along.

The Petrodollar System

Mr. Gromen begins his historical backdrop with 1973 and the petrodollar system. The petrodollar system meant the U.S. dollar became the sole asset to settle oil trade imbalances between importers and exporters of oil. Having the world settle oil trade imbalance with USD was enormously beneficial and at the expense of U.S. creditors. The U.S.’s printing U.S. dollars for oil ensured adequate oil supplies and provided it the opportunity to receive 10-15% of its oil for free every year, in real terms. But that wasn’t all. The dominance of the U.S. dollar meant the U.S. could control geopolitical issues through the weaponization of the U.S. dollar by denying recalcitrant countries access to the global financial system.

Inside the original petrodollar system were unwritten rules, or price stabilizers, that all countries abided by to make the system work. On the supply side the largest oil exporters, especially Saudi Arabia, slashed production when oil prices were too low. For those countries whose single largest source of revenue was oil exportation, low oil prices meant national revenues would diminish and their budgets hard to balance. Oil exporting countries burned down their foreign exchange reserves to fill the deficit and in so doing placed their own economies at risk. On the demand side was the U.S. When oil prices rose too much the Fed tightened monetary policy to slow down the largest oil importer in the world - USA, as Volcker did in the early '80s. Slowing down the demand for oil helped slow the U.S.’s exportation of inflation back to those suppliers and helping them maintain their purchasing power in terms of oil. Maintaining exporter purchasing power in this way told the world’s oil exporters that the USD was "as good as gold" for oil.

Beginning in the late 1980’s Wall Street developed a number of financial derivatives designed to lessen or minimize future uncertainty – or so the pitch went. Specifically, for the petrodollar system, this meant the derivatives market could replace the role of the Fed as a stabilizer. By using interest rate derivatives and foreign exchange hedging in place of the Fed tightening monetary policy. These products were supposedly designed to allow foreign investors to hedge exposure to diminished purchasing power that rising oil prices would normally have portended without forcing the foreign investors to sell their U.S. Treasuries and dollars. Oil exporting countries bought these instruments in earnest, causing the interest rate derivative market to rise from $50 trillion to $500 trillion from 2000 to 2008 - from 1x global GDP to 9x global GDP in 8 years.

Around 2005 conditions in the global oil patch began to emerge causing marginal cost curves to rise rapidly. This happened concurrently with the rapid growth of a few emerging markets, especially China. This combination led to a sharp rise in the price of oil, which was always priced in terms of the U.S. dollar. But this time the Fed didn't tighten. In 2005 the housing market had been on a steep trajectory and the Fed’s concern that the housing bubble couldn’t withstand the effects of a rate hike. This decision forced oil exporters to rely on the strength of their hedged positions. In simpler words, the Fed didn't uphold its end of the petrodollar bargain and now it was up to the strength of the counter-parties standing behind the oil exporters hedged position to save the day. Everything was fine until it wasn’t.

America Reneges on its Petrodollar Promise

In 2008 the global financial system imploded and the illusion of hedged risk through interest rate derivatives disappeared with counter-party risk realized. When the system finally stabilized investors began to question whether the global monetary system needed to change.

An early sign of change came in 2014 as the world’s largest oil importer, China, and one of the largest oil exporters, Russia, began reducing their purchases of U.S. Treasuries. This trend rapidly evolved into net selling of U.S. Treasuries by 2016. Forgoing U.S. Treasury purchases allowed both countries to aggressively pursue gold acquisitions. From 2008 through 2018 these two countries amassed more than 80% of the world’s official supply, and have simultaneously accelerated the pace at which they are net sellers of UST’s.

More change occurred a few years later when these two governments initiated an oil contract premised on China’s ability to pay for its oil in yuan but backed by gold held in reserve. As Mr. Gromen notes, China and Russia are using the petrodollar system to force change on the global monetary system. The petrodollar system is a good choice to drive such reform since the oil market is the largest driver of global balance of payment imbalances.

A Maturing Inflection Point

This dynamic has been developing for a while without much tangible consequence. Mr. Gromen cites several events signaling the maturing trend of the breakdown of the current USD-centric petrodollar system: a) China admitted to the WTO 16 years ago; b) The Euro began trading 18 years ago; c) The U.S. financial system was deemed made of balsa wood and baby tears 8 years ago; d) China and Iran began transacting oil in CNY 5 years ago; e) Global FX reserves peaked and began falling nearly 3 years ago; f) China and Russia began transacting oil in non-USD 2 years ago; g) The tell-tale sign of a U.S. balance of payments crisis took place in 3Q16 when the U.S. Federal deficit began widening as a % of GDP for the first time since 2009, more than 1 year ago. Furthermore, Western neoliberal economists are beginning to realize there will be no entitlement reform in the U.S. Every single penny owed will be printed and paid out.

Beyond these signs of a maturing trend, Mr. Gromen cites five historically unique factors no one alive has ever seen before in the global economy. Each of these factors is accelerating the need for Russia and China to move away from a U.S. dollar-centric system, and thereby bring forward a U.S. funding crisis:

Demographics - Because of the U.S.'s Baby Boom generation cohort size and age, U.S. entitlement program problems are finally upon us. U.S. entitlement programs are in or near a "net disbursement mode", or free cash flow negative, for the first time ever. Social Security, a major component of America’s social contract, is a pay-go system, meaning new employees contributing to the system are to replace retirees leaving the workforce and opting to receive their promised benefits. Net disbursement mode is reflective of more Baby Boomers leaving the workforce than Millennials coming in. This is a critical milestone. To put this issue in the proper context consider the estimated entitlement liability, which ranges from $100 to $200 trillion (the wide range is a function of entitlement promises are inflation-adjusted in terms of medical goods and services), in light of U.S. GDP equal to $20 trillion and U.S. Federal tax receipts of $3.3 trillion. Mr. Gromen likens U.S. entitlements to war reparations Germany owed to the Allies after WWI. War reparations were impossibly large relative to the size of the economy's GDP, and they were inflation adjusting. When the U.S. begins printing U.S. dollars to pay for entitlement obligations it will massively inflate the price of oil and other commodities for every other nation and in particular the largest creditors to the U.S.

Geology – In terms of U.S. dollars, production cost curves of the world's marginal oil supplies have shifted markedly higher over the past decade. From China's perspective, this is very important. It holds $3 trillion in FX reserves, which is its savings account, and it's yielding close to 0%. Furthermore, the cost of finding new oil is rising sharply in USD terms globally. Thus, the purchasing power of that savings account is falling sharply. Gromen assets, we must stop thinking of global FX reserves in U.S. dollar terms and begin thinking of them in oil terms, because that is how much of the world thinks of them, certainly China. China recognizes that U.S. dollars will not be a good store of value for future oil imports. Thus, China has two choices: a) Find a lot more oil; b) Pay for oil in a better currency than U.S. dollars.

For China, the better currency is the one they can print. However, no oil exporter will take CNY over USD, and this is where the gold comes in. Every oil exporter would take physical gold over USD for payment. China's heavy gold purchases are not about gold, they’re about oil, and more specifically the ability to print CNY for oil. This promises to give China economic and monetary independence from the USD.

Levels of Debt - Global debt levels have reached all-time record highs and interest rates have hit 5,000-year lows. Mr. Gromen says, if you are a nation that earns its income by exporting a finite product, such as oil, you'd be stupid to stockpile your national surpluses in sovereign debts of nations with record-high levels of debt and record low levels of interest rates. All sovereigns eventually default once debt gets too high. Either in nominal terms or real. There is no sovereign that has never defaulted. The U.S. did in 1933 and 1971. Since 2Q13 global central banks have purchased far more gold than U.S. Treasuries. The new rules are being driven by China's desire to create an escape valve to get away from the oppression of the U.S. dollar. U.S. deficits matter again for the first time in 70 years.

Economic Reality – The USA’s Fiscal Problem – As Mr. Gromen describes the setup, historically, in global recessions, the U.S. strengthens the USD until emerging market currencies break, (since they can't print their own currency) covering their U.S. dollar short in a violent risk-off episode. Once that happened, the U.S. dollar strength filters back into the U.S. economy, driving a sharp drop in U.S. government tax receipts that the Fed addresses by lowering interest rates and/or otherwise weakening the U.S. dollar to restart the entire game, with the U.S. comfortably on top of the entire system. All that had to happen was any country other than the U.S. to break first triggering a flood of investment into the U.S. dollar as a safety trade and thereby maintaining the U.S. dollar hegemony.

Today, for the first time in 40 years, U.S. government Treasury receipts are falling before the U.S. has induced a key emerging market currency (China, Russia) to break. Not only have they weathered the U.S. dollar’s best punches but they are now accelerating their efforts to move away from the U.S. dollar. And it’s the U.S. government, not Russia or China, that's seeing its funding choked off by the Fed's efforts to strengthen the U.S. dollar. This is a script investors have never seen before, and many have yet to pick up on it. China and Russia are strengthening their defenses against U.S. dollar attacks with gold hoarding and their positions as the world's largest energy importer and exporter respectively.

The U.S. is already seeing a decline in Treasury receipts, consumer delinquencies are rising, and oil prices have fallen rapidly which will affect the resurgent U.S. energy sector negatively as its continued position as the world's highest marginal cost producer. Furthermore, entitlement programs are soon to turn cash flow negative which will necessitate a further acceleration in U.S. Federal borrowing. Raising rates in this environment means interest expense would spike as Federal tax receipts plummeted while the financialized U.S. economy imploded. U.S. entitlement obligations mean a massive amount of money printing which means USD oil inflation for energy importers like China, Germany, and the EU. It's a matter of national security for these countries to have access to cheap energy cost inputs of production.

All of this indicates a continuing increase in U.S. deficits and therefore Federal borrowing. However, this time the foreign official sector is no longer funding Federal spending. The U.S. will either have to cut Federal spending, which will make the U.S. situation worse before its better, or have the Fed reimplement massive QE and/or devalue the USD. The U.S. can't afford the effects of higher interest costs on its Federal debt, given the already high percentage of interest costs to Federal tax receipts.

Here Mr. Gromen delivers the punchline: by 2021 we will no longer have choices. That’s when the combined burden of entitlements, defense costs, and interest expense rises above U.S. revenues. By 2021 the U.S. will be running a $200 billion deficit just to pay for entitlements, defense, and interest expense. Not including any of the other Federal government spending equaling about $2.2 trillion or 11% of GDP. China must only avoid a shooting war with the U.S. between now and then and let the magic of compound interest do its job - the U.S. economy caving in under the weight of its own, self-imposed burdens.

Unfunded social security and Medicaid/Medicare liabilities added to the current federal debt takes U.S. obligations to 300% versus 100%, which is more than Greece's debt. In the next crisis, traders may not flood into USD for safety.

Repeated Weaponization of the USD – Although Gromen doesn’t elaborate on this factor I believe this concern is widely understood. Throughout history, the U.S. has used its dominance of global financial transactions to conduct foreign policy and play geopolitics. Through controlling the world’s supply of dollars, limiting access to the American financial system to conduct foreign country affairs, including bond sales, and denying access to the SWIFT system for countries opposed to U.S. interests, the U.S. can push down their adversaries without ever having to leave the front porch. By joining forces the formerly oppressed can respond in kind and bring the bully to its knees.

China’s Key Objective

China has made significant progress on re-opening the gold window and thus enhancing its ability to print yuan for oil and permanently lowering FX reserves. This means even fewer purchases of U.S. Treasuries by China in the future and a further de-funding of the U.S. government. Currently, the U.S. is the only country capable of printing its currency to purchase oil, and it holds FX reserves equal to 0.6% of GDP, compared to China’s current FX reserves of 26.1% of its GDP. And this is happening at the same time that skyrocketing U.S. entitlement, healthcare, and defense demands are driving huge needs to issue greater and greater amounts of UST's to pay for them. As Gromen points out, in this scenario the U.S. will quickly have a Balance of Payment problem.

Although China is pursuing a gold window its design is different – namely, it considers its creditor's purchasing power. China learned from the U.S.’s mistakes and will make its new gold standard friendly to creditors by allowing its currency value to float against the value of gold. This encourages oil exporters to sell oil to China in CNY because they understand that by allowing gold to float in CNY terms, China is communicating to oil exporters that oil exporters purchasing power will be maintained in those currencies through the floating gold link.

Gromen points out that once China gains the full-blown ability to print its own currency for oil there are three possible outcomes for the U.S.:

Slash U.S. government spending to maintain the value of the USD - At approximately 22% of GDP, the U.S. can't slash Federal spending without counterproductively crashing both the U.S. economy and U.S. Federal tax receipts - thereby widening the deficit.

Have the Fed print all the helicopter money needed to fund U.S. Federal deficits - This would be negative for the U.S. dollar, and it’s a strategy frowned upon by the BIS. Furthermore, it would provide disastrous results for retirees, commercial banks, and pensions all holding U.S. Treasuries and other low-rate fixed-rate debt.

Devalue/weaken the U.S. dollar significantly - This would increase tax receipts and rebalance the U.S. economy away from consumption towards production, centered around U.S. energy and alternative energy sectors and infrastructure as U.S. energy costs rise. Without a USD devaluation, we are likely to witness a very disorderly transitioning of the global monetary system.

The Real Game Being Played

According to Mr. Gromen, the real game in process is that if U.S. dollar gold prices continue to be restrained (gold pegged to the U.S. dollar) then the price of oil must continue to fall so that its total size fits into the physical gold market. The only way out of this dilemma is for a debt jubilee of some sort. In the next recession its unsecured debt that's most at risk of never being serviced or repaid, and the largest source is sovereign debts. We can't write down sovereign debt, but we can write up gold. Gold can be inflated to infinity with no practical impact on the real economy because it’s not used for anything. Central banks only care about the ability of their foreign exchange reserves to buy oil and other critical imported goods and services. Gromen says, let oil exporters and creditors load up on gold and then massively devalue oil against gold. Creditors don't care because they've been made whole for past production surpluses through the write-up of gold - this is the debt jubilee. All we need is a crisis to get this started. Gromen tells investors to keep focused on what happens to the price of oil after the CNY oil contract goes live and with the U.S. fiscal situation.

Once China launches a CNY-denominated oil contract the previously capped gold market will increasingly force the oil market to fit into the gold market. The price of oil will collapse to levels that make large percentages of the world's oil supplies uneconomic – and U.S. shale is the highest cost of production. And if a significant percentage of the world's oil production is uneconomic and hence goes offline, what will happen to the global economy and humanity? King Dollar will have no kingdom to rule over. However, Gromen believes, because gold is not used for anything it can and will be inflated enough to act as the settlement asset for oil trade imbalances since the world wants to avoid huge amounts of oil production from going offline.

Trump’s End Game

Since the 2016 Presidential election, the U.S. and Trump are saying to the rest of the world, the old USD-centric money deal is off. If you're going to stop taking our UST's then we're going to take back our jobs and factories. This will happen by the U.S. devaluing the USD significantly, allowing U.S. industry to compete.

Trump’s domestic battles stem from the fact that U.S. Treasury issuance is predominantly used to pay for U.S. costs of defense and entitlements. Such issuance also centralizes power (vis-à-vis money) in Washington D.C. and marginalizes flyover country and the middle class. Like him or hate him (there seems to be no in-between) Trump is threatening to reverse this by reindustrializing the U.S. by various means including the devaluation of the U.S. dollar and the addition of tariffs on foreign products. Both moves are intended to strengthen the competitiveness of U.S. manufacturers. However, this maneuver could backfire by exacerbating the current U.S. dollar shortage and accelerate the pursuit of an alternative to the U.S. dollar.

If Trump fails in his efforts to devalue the U.S. dollar, we are likely to get a disorderly resolution of a new global monetary system with interest rates rising and the U.S. economy collapsing under the weight of the U.S. dollar. Alternatively, the U.S. could start WWIII with either Russia and/or China. We can no longer kick the can down the street given the Baby Boomer demographic trends and the impending entitlement wall the U.S. faces. This issue is now a matter of national security. Either: a) the world must begin growing U.S. dollar stockpiles (FX reserves) again; or b) Washington must massively cut deficits; or c) The Fed must renew QE to provide needed U.S. dollars to the world - thus continuing the status quo. Until one of these three is chosen, U.S. Treasury yields, LIBOR, and the U.S. dollar will likely continue to rise until something somewhere in the world breaks. For Gromen, eventually the USD gets devalued and/or change in the money system drives the same outcome.

The U.S. Balance of Payments "Vicious Cycle"

Where the U.S. ultimately finds itself is in the grips of a real dilemma, with the Fed on the tip of that spear. According to Gromen the Fed could admit defeat and reverse course by devaluing the U.S. dollar and thereby admitting that its entire post-2008 experiment had failed. The Fed's other option is to aggressively raise rates to keep the U.S. dollar strong and the global private sector remaining interested in buying a growing amount of U.S. Treasuries. But if the Fed chose this path it would be confronted with raising rates at the same time U.S. Federal tax receipts are already falling Year over Year. This won’t sit well with a White House already committed to using the Fed as its scapegoat for anything that goes wrong.

From the perspective of Beijing, the challenges the U.S. faces in the very near term and how they will choose to deal with it could be seen as the equivalent of a financial attack – U.S. Treasury printing lots of dollars and exporting inflation to other countries.

Mr. Gromen claims the following cycle will continue until either the U.S. nominally defaults - either internally with entitlements, or externally with UST's - the USD is massively devalued, or the Fed implements "helicopter money".

  1. U.S. deficits rise, driving an increase in U.S. Federal borrowing, due to either a fall in tax receipts or a rise in spending

  2. Since foreign central banks aren't lending to the U.S. government any longer, the U.S. government is forced to borrow from the U.S. private sector.

  3. Since U.S. Federal borrowing demand is secularly rising far in excess of U.S. private sector income growth, Federal government borrowing crowds out the U.S. private sector - i.e. LIBOR and UST yields rise.

  4. As U.S. Federal borrowing crowds-out the U.S. private sector the U.S. economy slows.

Mr. Gromen suggests there will be one of two outcomes:

  1. Positive Outcome - a systemic restructuring of the global currency system that ends up significantly reducing the U.S. dollar's role as the primary global reserve currency, effectively devaluing the USD against some neutral asset like gold or SDR's, or that devalues SDR's in gold and thereby devalues all currencies in favor of gold.

  2. Negative Outcome - World War 3 and Thucydides Trap. This was avoided for now by a Trump presidency. Mr. Gromen asserts that Hillary Clinton was viewed by the Chinese as a symbol of impending war.


My key takeaway from this book is that once again deficits matter and they’ve always mattered. The budget deficit this year exceeds $1 trillion. The U.S. government is financing the gap between its outlays and tax revenues by borrowing. The accumulation of these deficits is known as the Federal debt, which today stands at more than 105% of GDP – the highest amount during peacetime ever recorded. The highest ever was just after the end of WWII when the figure stood at 106%. However, what was different in 1945 versus 2019 was the U.S.’s ability to rapidly grow GDP. During the ’50s the U.S. enjoyed rapid GDP expansion in both real and nominal terms. In 2019 the U.S. faces many headwinds in achieving any growth at all. This is a topic Dr. Lacy Hunt, of Hoisington Investment Management, addresses often. Dr. Hunt states when one factor of production is overused (global debt is 327% of global GDP) you initially experience growth but at a slower and slower rate of change until that growth flattens out and eventually turns negative. Through the global overuse of debt, the world is trapped in this vicious cycle. Dr. Hunt uses comparison in most of his writings about the productive capacity of debt and how it declined over time. In 2007 a dollar of debt generated 36 cents of GDP growth as compared to 2017 where it only generated 31 cents of growth. The overuse of debt is causing the money supply and bank credit to collapse – a problem exacerbated by a declining velocity of money that now at a low that hasn’t been seen since 1949.

Even with readily apparent signs, the U.S. continues to run deficits. The argument for deficit spending relies on achieving rapid expansion of GDP in the near future – the very concept unavailable to us BECAUSE we’ve borrowed so much. Proponents of further deficits argue if interest rates the government must pay on its debt are less than GDP growth then we can grow our way out of the national debt. This brings to mind what Mr. Gromen said about 2021, the year entitlements, defense, and interest costs exceed tax receipts in the U.S.

Valerie Ramsey, a professor of economics at UCSD, says the same thing in a different way: interest payments are expected to account for 50% of the entire deficit in 2020 and grow after that. This will rapidly become a crisis of investor confidence. As Robert Triffin predicted many decades ago, the U.S. will have a crisis of investor confidence, and if Luke Gromen is right, it won’t be long until it happens.

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