On the Precipice: Rewriting the History of Financial Crashes

Legendary Federal Reserve Chairman Alan Greenspan knows a thing or two about the history of financial crashes. He often stated that every financial crash in U.S. history can trace its roots to a cause that was unanticipated and unexpected prior to the calamity. That held true from the Panic of 1873 through the financial crisis of 2008.

However, Greenspan’s adage no longer holds true, because today we are teetering on the edge of an economic abyss in plain view for all to see.

The next financial calamity will be a seismic one, claiming a full spectrum of victims. The root causes will be self-induced through ill-advised policy instituted by government across local, state, federal, and international levels.

The looming crisis will be catalyzed by a handful of massive missteps that share one thing in common: this country lacking the political will and leadership to stop unsustainable fiscal and monetary policies that are doing irreversible harm.

Any one of these missteps has the potential to wreak economic damage on its own. Together, they offer a toxic cocktail.

Let’s meander through a rogues’ gallery of economic fright.

Monster Government Debt

Start with the biggest – federal debt level. The national debt sits at nearly $28 trillion (within a few weeks of posting this commentary, it will likely exceed $28 trillion). That’s over $84,000 per citizen, over $220,000 per taxpayer, and over 130% of annual GDP. These numbers should shock anyone with a sense of financial acumen.

Today, everyone on all sides of political and ideological spectrums knows only one thing: government spending more than it brings in.

Here’s an even more shocking metric to put the level of federal government debt in perspective: debt-to-revenue ratio. The federal government carries a debt-to-revenue ratio over 8. The S&P 500 index of public corporations posts a debt-to-revenue ratio less than 0.5.

That’s right, our government carries over 16-times the proportional debt load that the companies in the S&P index carry. If the federal government were a corporation, it would be in default of its debt obligations today.

Worst of all, government debt is only going to continue to grow, because of the following problem.

Perpetual Government Budget Deficit

Remember the good old days, when conservatives and Republicans advocated for balanced budgets and when liberals and Democrats pushed for budget deficits only during times of duress or crisis? Such days are long gone.

Today, everyone on all sides of political and ideological spectrums knows only one thing: government spending more than it brings in. Budget deficits are now a wired-in reality during all economic cycles, in good times and in bad. After all, that’s how we racked up $28 trillion in national debt.

The current annual “official” federal deficit, counting only president- and Congress-approved expenditures, is projected at over $3.2 trillion. The actual annual federal budget deficit, which adds off-budget expenditures to the tally, will exceed $4.6 trillion. Every dollar of outspend grows the national debt.

Balancing the federal budget will require many things, including getting the administrative state out of the path of economic growth. But most of all, it will require meaningful entitlement reform to Social Security, Medicare, Medicaid, and so on. To say the will of the political leadership to take on entitlement reform is weak borders on misleading. The fact is there exists no political will to perform necessary entitlement reform in Washington, D.C.

The Higher Education Racket Lays a $1.7 Trillion Egg

The American higher education system has been collaborating with government to bilk trillions of dollars from students, their families, and taxpayers. Student loan debt sits at over $1.7 trillion, or almost $40,000 per student. The portfolio is a dumpster fire in the process of imploding.

Many of those carrying the largest student debt loads earned degrees that don’t garner anything close to a wage in the job market that will cover the loan debt payments, let alone a legitimate rate of return on the student’s invested time and money. Academia sold students and families a fiction about job prospects that never had a hope of materializing.

Government played along by offering endless subsidy to colleges and universities and student borrowers. The government interventions created an inflationary bubble, with tuition doing nothing but exponentially increasing and administrative bloat at colleges ever expanding. Students were goaded into borrowing more and more, while the probability of being able to get a job to pay the debt off went lower and lower.

The federal government took over wide swaths of the student debt portfolio, at the time promising that taxpayers would enjoy a return on the “investment.” With default and forbearance levels at epidemic-crisis levels, that promise looks ridiculous today. The reality is taxpayers are going to have to absorb a gargantuan loss across the more than $1.7 trillion toxic portfolio, making the government debt situation worse.

All of this is about to come crashing down. When it does, don’t expect the higher education system to reform or our political leaders and government bureaucrats to own up. Instead, expect a lost generation of workers and taxpayers having to eat another bailout.

Poking the Inflation Bear

Economists, the Fed, and government bureaucrats assure us constantly that inflation is tame, despite the government turning the money printing press at a dizzying pace. Many of these experts cite modest consumer-price-index (CPI) levels as evidence that inflation is held firmly in check. The experts have nuzzled into an all-is-well on the inflation front slumber.

Yet common sense tells us something quite different than this pleasant inflation narrative. Everywhere we look, the inflationary warning signals are blinking red. We already discussed how college tuition levels have escalated at fantastic rates. Real estate prices are once again raging in regions and cities all over the nation, creating speculation and extended, heavily mortgaged homeowners. The prices of art, rare coins, expensive wine, and other collectibles continue to skyrocket.

Even commodities are experiencing price run-ups. This is noteworthy when you consider the pandemic and global shutdowns of economies throttled the demand for virtually every traditional commodity. Yet the prices of commodities such as oil, copper, and gold are percolating up. Even the prices for prior owned vehicles (what we used to call used cars) sit at elevated levels.

If wage rates experience similar increases once workers are allowed to return to job sites, it will only further stoke the inflation flames. Bureaucrats and politicians hand out pay raises to the public unions they answer to throughout the pandemic and shutdowns, stoking wage inflation in the public sector.

Everything is getting more expensive, no matter what the experts tell us about the CPI. The inflationary bear is coming out of hibernation.

Monetary Policy Morphs Investing Into Online Gambling…and the House Always Wins

Stock market indices sit at all-time highs. Debt prices are also at historic highs while bond yields sit at historic lows. That’s true for Treasury, municipal, corporate investment grade, or junk bonds. Rank speculation (GameStop) and day trading (Robinhood) have become normal as millions of investors gambling on laptops believe the market can only go in one direction.

Fed monetary policy induced this crazed, herd behavior. When the Fed cuts interest rates to zero and signals it has no intention to raise rates for years, it is eradicating traditional investment options in portfolios. Options like bonds and cash savings accounts provide little-to-no yield, forcing the smallest to largest investors to pile into riskier asset classes like equities and alternative investments to chase returns. Inflows into those asset classes drive their valuations higher, destroying the risk-reward balance.

Most markets, including equity and debt, increasingly feel like they are balanced on a precarious bubble. The slightest of jitters could precipitate a quick rush for the exists, leading to a rapid and severe popping of the bubble(s).

The Fed’s Cred Crumbles

The Federal Reserve convinced global markets far and wide that the United States can continue to pump money supply at unprecedented rates, purchase trillions of dollars in bonds to place on its balance sheet, and perpetually outspend revenues so that debt runs up. Amazingly, the global markets have witnessed all this largesse and have been perfectly comfortable receiving next to nothing in yield for lending to the U.S. federal government.

That magic trick is poised to fray, with dire consequences.

Money is nothing more than a barometer of value in society and confidence in the government printing it. If value is vilified or appropriated by government or if government acts irrationally, a central bank will go from the entity setting the terms to the one having the terms dictated to it.

The Federal Reserve may be rapidly approaching that point. As its balance sheet bloats and it inflates asset bubbles, it looks to expand its already multi-faceted mandate under pretense of everything from fixing economic inclusion (worthy but not exactly in the Fed’s wheelhouse) to tackling climate change (creating a mandate of “weather”).

If the Fed loses the trust of the market, it loses control of the value of money. That will surely equate to much higher interest rates. Higher interest rates will drown this nation in more debt and larger budget deficits, since interest payments on our massive accumulated debt pile will expand.

What to Do?

The cumulative headwinds facing our economy have never been stronger.

Massive national debt, huge annual budget deficits, growing student loan defaults, awakening inflation, risky market bubbles, and a Fed spread way too thin are all parading in the open, staring us in the face. Wrap all of it in the government-induced economic coma of the pandemic-justified shutdowns and the Left now setting economic policy in the corridors of federal power, it is amazing that things have held together for as long as they have.

But that may change quickly. What to do? Perhaps it’s time to pay down debt, tread lightly in riskier investments, think twice before you pay-up for that mint rookie Jordan card, and instead build a little cash. To do otherwise ignores those red-blinking signals and puts your personal full faith and credit in government bureaucrats and politicians.

On the Precipice: Rewriting the History of Financial Crashes