No alternative “better” with less risk, less volatility, higher convertibility into immediate cash. And higher Return on Investment.
Investment value is multidimensional.
Arnold is doing exaggerated clickbait here, which he usually decries in others, but like a very seldom used F-bomb, provides emphasis to a point particularly important to him.
The lack of alternatives is a form of financial no-exit, so “voice” is enhanced by clickbait.
The point is if US debt crashes and burns, pretty much all dollar based financial investments will crash and burn. Not much besides hard assets would survive and many of them wouldn't either.
So why aren’t you buying 10 year TIPS and shorting 10 year nominal bonds? They currently imply a 10 year inflation rate of 2.4%, if you think there’s a better than even chance of inflation being 8% over the next 10 years you have tons of money to make.
The best traders of our age might outperform the market but pundits aren’t going to do better than chance.
I know that you are redefining "default" to be intentionally provocative, but I don't think it's very constructive. Corporate bonds and other debt with (hard) default risk also pay back (typically) in nominal dollars and, thus, also carry inflation risk. (Hard) default risk is different from inflation risk so it makes sense to have two different terms. Credit ratings rate (hard) default risk, not inflation risk.
Second, the government's fiscal profligacy is separate and distinct from inflation. Although it's possible that profligacy can lead to inflation, one can get inflation without profligacy and profligacy need not lead to inflation. (Profligacy could just lead to greatly diminished private investment and lowered living standards, but without inflation.) Hence, your P.S. comments about inflation-indexed bonds. Profligacy leads to higher real rates as government borrowing competes against ("crowds out") private investment for scarce savings. That hurts inflation-indexed bonds, separate from any inflation adjustments.
(Hard) default, inflation, profligacy --- three separate, albeit interconnected, concepts. Better to keep them that way. How else can we discuss and understand their interconnectedness without using separate terms?
There is no such thing as 'scarce savings' in a fiat regime. Us debt is just a transfer and those receiving the transfers could invest in corporate bonds if they chose. The restraint is real goods and services, the government consumes them pushing the marginal cost for companies up and marginal profits down. This is what causes low growth.
Inflation indexed bonds don’t do as well as expected because they use government calculated inflation which is ALWAYS less than the real rate of inflation since the basket of goods they use is not representative and it doesn’t include services.
I was thinking exactly the same thing. Inflation indexed bonds are indexed to the inflation numbers the government chooses, which... well the incentives aren't great :)
"There were no geopolitical independent economic competitors in the last 30 years ...."
Pfft. Who? China? Their whole economy is a house of cards, based on selling to us. They depend on us far more than we do on them. But never mind that. Go back ~35 years and I'd argue most people were more afraid of competition from Japan than anything today.
"... and we had an industrial base."
First, I'd argue our industrial base is in better shape than 30 years ago. Be that as it may, services and technology have become more important worldwide and nobody comes close to US in either of those areas.
I'm not saying everything is great or things won't fall apart but your arguments for a negative outlook seem really weak to me.
Since you asked I’m happy to share some data points. Thank you.
China’s industrial capacity is as large as the U.S. and EU combined. They have trade turnover with ASEAN as large as that with the U.S. and the EU is in second place. The main thing that China depends on the U.S. for is certain high end chip technology and the USD based financial system. Other than that, they get their raw materials from everywhere and sell everywhere. If tomorrow China disappears the whole world economy would implode.
In fact, WE are so dependent on them the CEO of Lockheed Martin recently said that we cannot go to war with China because we need FROM CHINA essential weapons components that we cannot get anywhere else.
Japan: the reason why Japan was neutralized was because they opened up their financial system. Japan used to operate the same closed financial system that China does now. When their industrial output in quantity but more importantly in quality started to exceed the US, that threatened the industrial base of the U.S. and at the same time Western banks and investors wanted to benefit but couldn’t. The 80s was the start of the era of financialisation of the U.S. economy. They were told by the U.S. that they have to open up or suffer sanctions and crippling trade tariffs. They did. By opening up their financial system to outside investors they gave up market control to them, which in part caused the wild speculation in equity and real estate markets. After every bubble there is a crash and that bubble was so big that the crash created what is known as the lost Asian decade. Since Japan at the time was the largest Asian economy that other Asian economies depended on, other economies suffered as well. China, on the other has not and will not open their financial system to uncontrolled capital flows. They learnt that lesson from Japan.
As for the US industrial base I have one example that proves that it is in the worst shape it has been in the last 100 years. We supply weapons and ammunition to Ukraine. Recently we switched from regular 155mm ammunition to cluster munitions which are banned. Know why? Because we don’t have anymore and can’t produce them fast enough. By the numbers: Ukraine fires about 6k per day, we - after making every effort to increase production - went from 14k to 24k PER MONTH. Do you know how much Russia produces ... 250k per month.
We should all admit that Scenario B is inevitable. Smart people would advocate for spending money on their allies between now and then so that when the reset happens you and your allies are in better shape.
Since my allies are generally middle class people with kids, I would advocate gigantic child tax breaks for middle class people with kids even if we can't pay for it. Given that not having enough kids is the fundamental problem driving all this it seems like a good investment.
1. In the private sector it is commonly said that a corporation cannot earn its way out of a bad balance sheet. Most mature companies cannot generate the growth or become efficient enough to accomplish the task so they end up in bankruptcy where debt to equity exchange takes place.
2. Sovereign debt buyers are not completely stupid; they are buying US debt and are aware of all the variables you point out. So, why are they buying UST bills/bonds? Maybe because the relative value is there ; and maybe because they view the US government as still having the ability to raise taxes; in other words compared to other nations from whom they can buy debt US tax rates are low and can be raised over time.
Yes, that will affect economic growth, activity but bond buyers do not care.
3. All credit analysis only looks at risk of repayment in nominal terms; it is understood that an underlying estimation of inflation is incorporated in to the yield, the so called risk free rate. Of course it can prove to be wrong.
Wealth preservation has always been the primary purpose of government, going back to when the earliest kingdoms were able to store grain behind walls manned by armed men. There is nothing "natural" about being able to transfer wealth across time that one is entitled to by cosmic right.
Much less a transfer as complex as "I will consume fewer services now so I can consume more later using these pieces of paper", which is a magic of government far beyond storing grain.
Since the government can tax it stands to reason that if it were in trouble it would make sure every other investment option was liquidated to support it first.
I can't think of many long term investments that the government can't tax. You are basically stuck having to consume now if you don't want it confiscated later. Perhaps the memories of that consumption are the only remains of the investment.
Note that time is a form of consumption (stay at home moms, etc) with perhaps greater short and long term value then what we typically think of as consumption.
The increase in interest rates by the Fed has decreased the value of low-interest T-bonds & T-bills; this decrease in value in the (falsely called) "risk free" US Treasuries is why SVB went bankrupt, and many other banks' capital asset values are actually below regulation levels. The rapid increase stole money from bond buyers-or at least this a claim with a lot of truth.
"This flood of government bonds seems certain to fuel inflation." Looking at Japan's increase of debt to over 250% of annual GNP/GDP and suffering more from low inflation than high, is a clear and certain case of FAILURE to fuel inflation. Their yen is not even the world reserve currency.
The Kling (& Cochrane & most responsible economists) failure to explain Japan's actual experience for the last 30 years makes me certain that such economists' "certainty" is intellectual hubris. I don't know, and don't believe Kling knows, why Japan hasn't suffered hyperinflation, or even 10% inflation, but the facts are that it hasn't, despite their "flood of gov't bonds". So it's possible in the USA, too - tho not certain.
My own theory (brainstorm idea?), is that the rich elites in America have found ways to funnel higher gov't debt into financial assets, & house investment prices, which they are the main owners of and thus increase their wealth, while the consumer prices remain market priced stagnant with most producers in the "cash cow" quadrant. (Can Apple be a $3 trillion company? or 4? or 10 trillion?)
In Japan, I suspect they are still paying off their real estate price asset inflation of the 80s, without having the big companies go bankrupt.
This is one of the key reasons more people are allocating to Bitcoin as a straight up store of value or just a hedge. Constrained supply vs. QE infinity has real attraction over the next decade. That community is constantly pointing at this same problem.
"That would boost tax revenue and enable the U.S. government to run a balanced budget, or even to enjoy surpluses."
LOL
"Another way to avoid soft default is for a bipartisan effort to reduce growth in government spending."
LOL ... Ok, Clinton kind of did this except his success was mostly gutting defense spending and switching debt to shorter term, lower rates.
Despite my laughter, we can hope for a little of both A and B. And even historically average growth will make a big difference.
As I see it. We can muddle along for decades yet. That said, doing so leaves at increasingly greater risk from some kind of really big shock, whatever that might be.
If you hold inflation-indexed bonds, there are two risks to worry about. The first, as with any bond, is a (hard) default by the issuer. The second is market risk, as measured by fluctuations in the real rate of interest. If you hold the bonds to maturity, e.g. to build a retirement nest egg, then the market risk goes away and you are left with only the (hard) default risk.
Scenario A is impossible without scenario B. Government debt is a drag on long term growth and the best case is AI growth getting taxed at such a rate that we 'only' get low growth or stagnation. If inflation runs at 10% then buying baskets of commodities becomes the dominant investment solution, not investing in tech companies. Low investment means low growth and high debt means low growth.
Practical question: if you are someone who is saving for retirement, and following the "transfer your stocks into 'low risk' bonds as you age" advice, what instead should one do?
To add insult to injury, the illusory interest returns are taxed, and at ordinary income rates, even as the loss of purchasing power is incurred. The late Franz Pick (d. 1985) used to refer to government bonds as "certificates of guaranteed confiscation."
Soft default is a misconception. There might be investments with zero or negative real return, it doesn’t mean soft default. Actually the underperformance, in real terms, is largely attributable to the investor not asking for an adequate inflation premium. The point is that inflating debt away was the easiest way for governments to address the load of debt taken on during the Covid madness. Unfortunately the FED played ball and here we are with a serious problem, worldwide. Fiscal policy is reckless and needs to be trimmed asap and it is good that Fitch downgraded US debt.
Yeah, I've never understood why if the US government were to tell their creditors they will have to take a 5% haircut on their payments, we'd expect everyone would lose their goddamn mind, but it they called it a tax, or if the fed caused inflation with the same economic effect, we'd expect it to be more or less be business as usual.
"I would rate long-term U.S. bonds as junk bonds."
I can sympathize with this opinion but the problem with it is that if US federal debt is junk, everything else is something worse than junk.
No alternative “better” with less risk, less volatility, higher convertibility into immediate cash. And higher Return on Investment.
Investment value is multidimensional.
Arnold is doing exaggerated clickbait here, which he usually decries in others, but like a very seldom used F-bomb, provides emphasis to a point particularly important to him.
The lack of alternatives is a form of financial no-exit, so “voice” is enhanced by clickbait.
"Everything" is a big word. It includes bullion, Bitcoins, and bullets.
The point is if US debt crashes and burns, pretty much all dollar based financial investments will crash and burn. Not much besides hard assets would survive and many of them wouldn't either.
I thought we were only talking about bonds and maybe similar INTEREST BEARING alternatives I'm not aware of a Fitch rating on those other things.
So why aren’t you buying 10 year TIPS and shorting 10 year nominal bonds? They currently imply a 10 year inflation rate of 2.4%, if you think there’s a better than even chance of inflation being 8% over the next 10 years you have tons of money to make.
The best traders of our age might outperform the market but pundits aren’t going to do better than chance.
I know that you are redefining "default" to be intentionally provocative, but I don't think it's very constructive. Corporate bonds and other debt with (hard) default risk also pay back (typically) in nominal dollars and, thus, also carry inflation risk. (Hard) default risk is different from inflation risk so it makes sense to have two different terms. Credit ratings rate (hard) default risk, not inflation risk.
Second, the government's fiscal profligacy is separate and distinct from inflation. Although it's possible that profligacy can lead to inflation, one can get inflation without profligacy and profligacy need not lead to inflation. (Profligacy could just lead to greatly diminished private investment and lowered living standards, but without inflation.) Hence, your P.S. comments about inflation-indexed bonds. Profligacy leads to higher real rates as government borrowing competes against ("crowds out") private investment for scarce savings. That hurts inflation-indexed bonds, separate from any inflation adjustments.
(Hard) default, inflation, profligacy --- three separate, albeit interconnected, concepts. Better to keep them that way. How else can we discuss and understand their interconnectedness without using separate terms?
There is no such thing as 'scarce savings' in a fiat regime. Us debt is just a transfer and those receiving the transfers could invest in corporate bonds if they chose. The restraint is real goods and services, the government consumes them pushing the marginal cost for companies up and marginal profits down. This is what causes low growth.
We’re heading into a inflation/debt spiral.
Inflation indexed bonds don’t do as well as expected because they use government calculated inflation which is ALWAYS less than the real rate of inflation since the basket of goods they use is not representative and it doesn’t include services.
I was thinking exactly the same thing. Inflation indexed bonds are indexed to the inflation numbers the government chooses, which... well the incentives aren't great :)
We've been heading into an inflation/debt spiral for nearly all of the last 40+ years. I'm not saying it won't happen but ...
There were no geopolitical independent economic competitors in the last 30 years and we had an industrial base.
Most of the inflation happened since the GFC due to QE and has accelerated enormously due to Covid spending (money printing).
Total debt (including entitlements) now is 120% of GDP and rising.
It’s coming....
"There were no geopolitical independent economic competitors in the last 30 years ...."
Pfft. Who? China? Their whole economy is a house of cards, based on selling to us. They depend on us far more than we do on them. But never mind that. Go back ~35 years and I'd argue most people were more afraid of competition from Japan than anything today.
"... and we had an industrial base."
First, I'd argue our industrial base is in better shape than 30 years ago. Be that as it may, services and technology have become more important worldwide and nobody comes close to US in either of those areas.
I'm not saying everything is great or things won't fall apart but your arguments for a negative outlook seem really weak to me.
Sorry, I can’t compete with complete delusion.
Moving along nothing to see..
Sorry to hear that. I'm kind of curious what parts you disagree with.
And even more curious to know if you are old enough to have experienced the 80s first hand.
Yes I am old enough to have experienced the 80s.
Since you asked I’m happy to share some data points. Thank you.
China’s industrial capacity is as large as the U.S. and EU combined. They have trade turnover with ASEAN as large as that with the U.S. and the EU is in second place. The main thing that China depends on the U.S. for is certain high end chip technology and the USD based financial system. Other than that, they get their raw materials from everywhere and sell everywhere. If tomorrow China disappears the whole world economy would implode.
In fact, WE are so dependent on them the CEO of Lockheed Martin recently said that we cannot go to war with China because we need FROM CHINA essential weapons components that we cannot get anywhere else.
Japan: the reason why Japan was neutralized was because they opened up their financial system. Japan used to operate the same closed financial system that China does now. When their industrial output in quantity but more importantly in quality started to exceed the US, that threatened the industrial base of the U.S. and at the same time Western banks and investors wanted to benefit but couldn’t. The 80s was the start of the era of financialisation of the U.S. economy. They were told by the U.S. that they have to open up or suffer sanctions and crippling trade tariffs. They did. By opening up their financial system to outside investors they gave up market control to them, which in part caused the wild speculation in equity and real estate markets. After every bubble there is a crash and that bubble was so big that the crash created what is known as the lost Asian decade. Since Japan at the time was the largest Asian economy that other Asian economies depended on, other economies suffered as well. China, on the other has not and will not open their financial system to uncontrolled capital flows. They learnt that lesson from Japan.
As for the US industrial base I have one example that proves that it is in the worst shape it has been in the last 100 years. We supply weapons and ammunition to Ukraine. Recently we switched from regular 155mm ammunition to cluster munitions which are banned. Know why? Because we don’t have anymore and can’t produce them fast enough. By the numbers: Ukraine fires about 6k per day, we - after making every effort to increase production - went from 14k to 24k PER MONTH. Do you know how much Russia produces ... 250k per month.
I rest my case.
We should all admit that Scenario B is inevitable. Smart people would advocate for spending money on their allies between now and then so that when the reset happens you and your allies are in better shape.
Since my allies are generally middle class people with kids, I would advocate gigantic child tax breaks for middle class people with kids even if we can't pay for it. Given that not having enough kids is the fundamental problem driving all this it seems like a good investment.
1. In the private sector it is commonly said that a corporation cannot earn its way out of a bad balance sheet. Most mature companies cannot generate the growth or become efficient enough to accomplish the task so they end up in bankruptcy where debt to equity exchange takes place.
2. Sovereign debt buyers are not completely stupid; they are buying US debt and are aware of all the variables you point out. So, why are they buying UST bills/bonds? Maybe because the relative value is there ; and maybe because they view the US government as still having the ability to raise taxes; in other words compared to other nations from whom they can buy debt US tax rates are low and can be raised over time.
Yes, that will affect economic growth, activity but bond buyers do not care.
3. All credit analysis only looks at risk of repayment in nominal terms; it is understood that an underlying estimation of inflation is incorporated in to the yield, the so called risk free rate. Of course it can prove to be wrong.
Wealth preservation has always been the primary purpose of government, going back to when the earliest kingdoms were able to store grain behind walls manned by armed men. There is nothing "natural" about being able to transfer wealth across time that one is entitled to by cosmic right.
Much less a transfer as complex as "I will consume fewer services now so I can consume more later using these pieces of paper", which is a magic of government far beyond storing grain.
Since the government can tax it stands to reason that if it were in trouble it would make sure every other investment option was liquidated to support it first.
I can't think of many long term investments that the government can't tax. You are basically stuck having to consume now if you don't want it confiscated later. Perhaps the memories of that consumption are the only remains of the investment.
Note that time is a form of consumption (stay at home moms, etc) with perhaps greater short and long term value then what we typically think of as consumption.
The increase in interest rates by the Fed has decreased the value of low-interest T-bonds & T-bills; this decrease in value in the (falsely called) "risk free" US Treasuries is why SVB went bankrupt, and many other banks' capital asset values are actually below regulation levels. The rapid increase stole money from bond buyers-or at least this a claim with a lot of truth.
"This flood of government bonds seems certain to fuel inflation." Looking at Japan's increase of debt to over 250% of annual GNP/GDP and suffering more from low inflation than high, is a clear and certain case of FAILURE to fuel inflation. Their yen is not even the world reserve currency.
The Kling (& Cochrane & most responsible economists) failure to explain Japan's actual experience for the last 30 years makes me certain that such economists' "certainty" is intellectual hubris. I don't know, and don't believe Kling knows, why Japan hasn't suffered hyperinflation, or even 10% inflation, but the facts are that it hasn't, despite their "flood of gov't bonds". So it's possible in the USA, too - tho not certain.
My own theory (brainstorm idea?), is that the rich elites in America have found ways to funnel higher gov't debt into financial assets, & house investment prices, which they are the main owners of and thus increase their wealth, while the consumer prices remain market priced stagnant with most producers in the "cash cow" quadrant. (Can Apple be a $3 trillion company? or 4? or 10 trillion?)
In Japan, I suspect they are still paying off their real estate price asset inflation of the 80s, without having the big companies go bankrupt.
This is one of the key reasons more people are allocating to Bitcoin as a straight up store of value or just a hedge. Constrained supply vs. QE infinity has real attraction over the next decade. That community is constantly pointing at this same problem.
"That would boost tax revenue and enable the U.S. government to run a balanced budget, or even to enjoy surpluses."
LOL
"Another way to avoid soft default is for a bipartisan effort to reduce growth in government spending."
LOL ... Ok, Clinton kind of did this except his success was mostly gutting defense spending and switching debt to shorter term, lower rates.
Despite my laughter, we can hope for a little of both A and B. And even historically average growth will make a big difference.
As I see it. We can muddle along for decades yet. That said, doing so leaves at increasingly greater risk from some kind of really big shock, whatever that might be.
If you hold inflation-indexed bonds, there are two risks to worry about. The first, as with any bond, is a (hard) default by the issuer. The second is market risk, as measured by fluctuations in the real rate of interest. If you hold the bonds to maturity, e.g. to build a retirement nest egg, then the market risk goes away and you are left with only the (hard) default risk.
Scenario A is impossible without scenario B. Government debt is a drag on long term growth and the best case is AI growth getting taxed at such a rate that we 'only' get low growth or stagnation. If inflation runs at 10% then buying baskets of commodities becomes the dominant investment solution, not investing in tech companies. Low investment means low growth and high debt means low growth.
Practical question: if you are someone who is saving for retirement, and following the "transfer your stocks into 'low risk' bonds as you age" advice, what instead should one do?
Buy inflation protected securities if you’re worried.
Buy real estate. Or maybe good stocks, like ... Apple? Amazon? Microsoft? X? already highly priced, but likely to go higher.
Because the alternatives are worse.
Follow the rich investors.
To add insult to injury, the illusory interest returns are taxed, and at ordinary income rates, even as the loss of purchasing power is incurred. The late Franz Pick (d. 1985) used to refer to government bonds as "certificates of guaranteed confiscation."
Soft default is a misconception. There might be investments with zero or negative real return, it doesn’t mean soft default. Actually the underperformance, in real terms, is largely attributable to the investor not asking for an adequate inflation premium. The point is that inflating debt away was the easiest way for governments to address the load of debt taken on during the Covid madness. Unfortunately the FED played ball and here we are with a serious problem, worldwide. Fiscal policy is reckless and needs to be trimmed asap and it is good that Fitch downgraded US debt.
Yeah, I've never understood why if the US government were to tell their creditors they will have to take a 5% haircut on their payments, we'd expect everyone would lose their goddamn mind, but it they called it a tax, or if the fed caused inflation with the same economic effect, we'd expect it to be more or less be business as usual.