Many pundits are waving their arms about a looming risk of a game-changing economic crash due to one existential threat or another.
I have a different opinion: the US economy is now effectively impervious to any sustained economic downturn.
That’s because the US government has taken unto itself virtually unlimited powers to deal with any serious threats to the economy.
Imagine the very worst of the scenarios that might lead to the devastating crash so many worry about. A short list of popular worries would have to include...
Out-of-Control Government Debt
Using even conservative estimates, Uncle Sam is on the hook for upwards of $18 trillion. When you add in all the unfunded liabilities, the debt is probably a multiple of that number.
Yet, over half of that total is effectively owed by the government to various forms of itself (Social Security, Federal Reserve Banks, etc.).
Given there are effectively no checks on its powers, in an emergency, what’s to prevent the federal government from rearranging that debt?
For example, perhaps it could change the terms on 30-year bonds to 100 years, or engineer a program to cancel intergovernmental debt? Following the subprime crisis, government regulators forced the investment banks to net down certain redundant or nonproductive derivatives contracts.
We have other precedents. Back in 1933, the government reneged on its pledge to redeem certain government instruments in gold by banning private gold ownership. After all, if gold was illegal, then redeeming gold-denominated instruments (including dollars) was, by default, illegal. By doing so, the government unshackled the Federal Reserve’s ability to create money.
In the modern context, the imperial US government can do whatever it wants and the average voter would either not understand the mechanics or, more importantly, wouldn’t care... as long as it doesn’t break their personal rice bowl.
Besides, the ratio of government debt to GDP in the US remains less than half that of Japan, and that government is nowhere near as powerful as that of the United States. We can, therefore, assume a debt cliff is not imminent.
Enter a Black Swan
Just for the sake of argument, let’s say that something sets off a global panic among the owners of US government debt. Ignoring the many more nuanced ways the government has at its disposal to deal with the problem, in a worst case scenario, the government can always fall back on repudiation.
How hard would it be for the US government to come up with an excuse to declare China a hostile power and renege on just its $2 trillion or so in Treasury holdings? Especially if it was the Chinese selling of Treasuries causing the crisis in the first place?
Would the average American citizen give a damn? Hardly.
Would there be repercussions? Sure, but history is replete with examples of full or partial sovereign debt defaults. The world goes on, and more to the point, so would the US.
As the world’s largest economy and keeper of the world’s reserve currency, other countries would have no choice but to play along. Just as they did when Nixon closed the gold window in 1974.
Besides, other than the short-term pain it would cause, a longer-term case can be made for repudiating all the many debts run up by previous US governments.
Russia, which defaulted on its government debt in 1998, today has one of the world’s lowest government debt-to-GDP ratios at just 17.70% versus the 104% of the US or the 250% of Japan.
In 2001 Argentina defaulted on its sovereign debt. While the country certainly went through a couple of hard years, people managed to get by primarily by reverting to the black economy… buying and selling life’s necessities out of sight of the government.
And by 2004, the Argentine GDP was experiencing a very strong level of growth, upwards of 20% per annum. Today, it has a debt-to-GDP ratio of less than half that of the US.
The point is that in the case of a serious debt crisis, the government has any number of options available to it, and absolutely no one and no institution in the world has the power to stop it from exercising those options.
What about the so-called bond vigilantes?
The actions of the government during the subprime crisis reveal much. Starting with an unprecedented increase in federal government debt. Where were the bond vigilantes?
The answer is that they were run over by the Fed, which ratcheted interest rates down to the lowest levels in a century.
In the modern context, the adage “Don’t fight the Fed” should be updated to “Don’t fight the government.”
Stock Market Crash Ahead?
A lot of people worry about a stock market crash. Yet, I think that worry is also overdone.
Consider the “flash crash” of 2010, where the DJIA fell 600 points in just minutes before snapping back.
What did the stock exchanges do? Cancelled the 21,000 trades that occurred during the worst part of the downswing. For most, it was like the flash crash never happened.
What did the government do? Once again demonstrating that the free market is little more than an illusion in the imperial age, the US government mandated that circuit breakers be instituted to ensure sharp market sell-offs can’t happen again.
Today, there are three levels of circuit breakers in place, with the final being that if the DJIA falls by 3,750 points (about 17% of the current level), markets close for the rest of the day.
But let’s say the worst case happens and the markets get really ugly?
In the case of serious pressure on the US stock markets, the US government has already shown that it can and will step in… aggressively.
Case in point: on September 11, 2001, after the World Trade Center attacks, the exchanges simply did not open—and, with the government’s insistence, they stayed closed until Sept. 17. When they reopened certain sectors—for example, airlines—took hits that today’s circuit breakers would largely mitigate.
However, within a month of the attacks, the broad markets were back to the pre-9/11 levels. The market needed some breathing room, and the government provided it.
And we have an example where the US government went so far as to close the banks and effectively take control of the levers of US industry.
Under President Roosevelt, the government passed the National Industrial Recovery Act of 1933. The NIRA gave the government dictatorial powers to heavily regulate the economy to the extent that about 95% of all the industrial workers in the US fell under the government’s control.
Today, outside of rare cases where individual banks get in trouble, the widespread bank runs of the Great Depression are a thing of the past, thanks to the government’s introduction of FDIC insured bank accounts.
Could the government come up with a similar program for stock market accounts? It wouldn’t be nearly as easy to implement, but when you have as much power as the US government, it’s not all that difficult either.
Other Big Risks?
A number of analysts warn that widespread adoption of automation will lead to a rising level of unemployment for the masses, resulting in a downward spiral of incomes and a falling quality of life—leading, perhaps, to social unrest.
To some extent, the secular decrease in the Civilian Employment Population Ratio helps confirm the trend.
But the idea that automation will lead to mass unemployment and the end of society as we know it is a Luddite view of the world. For starters, it completely overlooks the hallmark of humanity: our ability to adapt.
Consider the past overblown fears of Peak Oil, or Peak Food. Both of those fears were blown away by new technologies and efficiencies.
The US is already one of the most favorable jurisdictions to start a business and is a leader in many areas of technological development, but it could be a lot, lot more competitive. It would be as simple as a government decision to dial back anti-business regulations and lower taxes, freeing American entrepreneurs to be even more competitive domestically and globally.
The Trump administration is trying to accomplish those goals, but may be blocked by his considerable opposition. Would that same opposition materialize in the face of a serious downturn? Unlikely.
Additionally, in a crisis, the US government could unleash temporary work programs. Given the demonstrated ability of governments (such as Japan) to run far higher levels of debt, Uncle Sam doesn’t really have to pay too much attention to the right side of the menu.
In the last financial crisis, the government seamlessly altered the rules for receiving unemployment, extending benefits from 26 weeks to 99 weeks. Should another crisis materialize, the path towards a similar or even more strident action has already been paved.
Even so, the data so far don’t really support the idea of declining wealth or quality of life caused by demographics or automation or any of the other bugaboos people worry about.
In fact, other than normal cyclical dips, Global Gross Domestic Product per capita (adjusted for inflation) remains on a long-term, upward trajectory.
Likewise, on a personal level, Real Disposable Personal Income is also moving up firmly.
And, thanks to low interest rates, the cost of servicing debt as a percentage of disposable income is near historic lows.
Could interest rates rise and trip up the government?
Sure, maybe. Especially if the government did start messing around with its debt instruments, causing rates to spike .
But, the US government has a lot of tools available to help it manage interest rates.
And, more important, they have the will to do whatever it takes to keep things in check.
In fact, all of the steps they have taken to date have been, what might be considered, easy measures.
Ballooning the Fed’s balance sheet in the face of the 2007/2008 subprime crisis, setting up a line of credit to backstop the European banks, pushing interest rates down—these were decisions that could be implemented with a couple of meetings and some pecking away at the right computers.
None of the so-called economic threats now visible to us are beyond the government’s ability to handle.
And, as we can’t say what a real black swan might look like—perhaps a complete shutdown of all major infrastructure as the result of a hack-attack—it is hard to know how the government would react.
But given that the government’s options are literally unlimited, it’s a pretty safe bet it will exercise whatever powers are needed to stabilize the economy and get things back in the range of “normal” fairly quickly.
In time, the equivalent of the hordes may overrun the empire, and it will lose its power to respond. However, the odds are small that this will happen in our lifetime, so don’t spend a lot of time worrying about it… or about pending crashes, and making the mistake of over-allocation to so-called crisis hedges.
Instead, take the time to intelligently diversify your assets so that a black swan, should one appear, doesn’t eat your assets for lunch. To be effective, such diversification should spread your assets across asset classes (stocks, income-generation, tangibles, real estate), vehicles (regular and managed accounts, trusts, retirement accounts, peer-to-peer lending, etc.), and geopolitical boundaries.
The latter is especially important because should the government find its back up against a wall, it could decide your assets are part of the solution. You know, for the “greater good”.
Would I prefer less government and freer markets? Absolutely. But we don’t live in that world, so we must adapt. It’s what we humans do best.
Listen to the full podcast interview with David Galland and RiskHedge’s Jonathan Roth above.