By Mr. Maverick 🕵️‍♂️🚁

Although some scholars find the cyclical theory of social change somewhat vapid and outmoded, a more detached look on the current financial situation shows that the U.S. is approaching the end of a long-term debt cycle. The U.S. national debt has exceeded $32 trillion, rising day after day.

The threat has surfaced just as the world economy is confronted with an array of threats — from growing inflation and interest rates to the ongoing backlash of Russia’s invasion of Ukraine to the tightening grip of authoritarianism. On top of all that, many countries have grown skeptical of America’s extensive role in global finance. The sole fact that the global superpower has recently been debating over the option of defaulting on its debt is more than alarming.

In a nutshell, feeding the anxiety is the fact that so much financial activity hinges confidence that America will always meet its financial obligations. Its debt, long viewed as an ultrasafe asset, is a bedrock of global commerce, built on decades of trust in the United States. A default could crush the $24 trillion market for Treasury debt, cause financial markets to freeze up and ignite an international crisis. “A debt default would be a cataclysmic event, with an unpredictable but probably dramatic fallout on U.S. and global financial markets,’’ said Eswar Prasad, professor of trade policy at Cornell University and senior fellow at the Brookings Institution. But how has the U.S. deteriorated in such a critical financial condition, threatening the global economy with a, possibly unprecedented, financial turmoil ? How have we ended up here ?

To begin with, when faced with a debt crisis, policy makers have four levers at their disposal to bring debt and debt-service levels down in relation to the income and cash flow levels required to service debts. They can either succumb to a) austerity, b) default and restructure their debt, c) transfer money and credit from the haves to the have-nots by e.g. raising taxes, or, d) print money and devalue it. Compared to the others, printing money is the most convenient, least wellunderstood and most common big way of restructuring debts. When one can create money and credit and pass them out to everyone, it is very difficult to resist the temptation to do so.

More precisely, when credit cycles reach their limit, reasonably central banks and central governments will create a lot of debt and print money which will be spent on goods, services and investment assets to keep the economy moving. That was adopted during the 2008 debt crisis, when interest rates could no longer be lowered because they had already hit 0 percent. It also happened a few years ago in response to the plunge triggered by the COVID pandemic. Similarly, this monetary policy was followed in response to the 1929-1932 debt crisis, when interest rates had also been driven to 0 percent. At the moment, the creation of debt and money has been happening in extreme amounts, surpassing all previous levels since World War II.

After decades of real economic prosperity, the U.S. entered the “bubble prosperity phase”, as pointed out by Ray Dalio. In other words, the U.S. has been facing a situation where there is a rapidly increasing debt-financed purchase of goods, services, and investment assets and where debt growth has been outpacing the capacity of the future cash flows to service debts. This approach has been adopted for decades. Today, as before, the Federal Reserve continues to print a lot of money and buy a lot of federal government debt, financing the government spending that is much bigger than the federal government’s intake. This policy has facilitated the federal government and those it is trying to help, though it has at the same time cost those who are holding dollars and dollar debt a lot in real purchasing power.

Right now, the U.S. is in a position where debt levels are extremely high, interest rates can’t be sufficiently lowered, and the creation of money and credit has increased the financial asset prices more than it has increased actual economic activity. At such times, plausibly, those who are holding the debt (e.g. U.S. Treasuries, corporate bonds, etc) typically want to exchange the debt they are holding for other storeholds of wealth (e.g. gold), a tendency that creates a “bank run” dynamic. Subsequently, once it is widely perceived that money and debt assets are no longer good storeholds of wealth, the long-term debt cycle has reached its end, and a restructuring of the monetary system ensues.

At the moment of writing, holding debt is similar to holding a ticking bomb that rewards while it keeps on ticking and blows you up when it stops. Historically, it has been observed that huge financial eruptions, namely big defaults or big devaluations, happen every 50 to 75 years. So at which point are we now ?

On May 31st, 2023, the debt ceiling bill passed by the House of Representatives suspended the government’s borrowing limit until January 2025, ensuring that the issue will not resurface before the next presidential election. Within two days, President Joe Biden signed the debt ceiling bill, averting, or postponing, an economically disastrous default on the federal government’s debt. The stakes couldn’t be higher, with the President pulling the country from the brink of default, which would have sent shockwaves through the global economy. But the question is, has the bomb been defused ? It definitely hasn’t. The problem hasn’t been solved, it has just been swept under the carpet.

An indisputable economic principle that hardly anyone recognizes, is that governments aren’t themselves rich entities with stacks of money lying around. They are their people collectively, who will ultimately have to pay for the creation and giving out of money. In short, when push comes to shove, the U.S. will inevitably have to address this urgent issue, and its repercussions will be porfoundly felt internationally.

In a worst case scenario situation, one might reasonably ponder over the following questions: does a possible depreciation of the dollar, the world’s reserve currency, signal a wider depreciation of paper money in general, rendering a restructuring of the current fiat monetary system necessary ? Will people flee, in the long run, from the depreciating paper money towards hard currency coinage and other storeholds of wealth, like Bitcoin and cryptocurrencies ? It all remains to be seen.