Revolt of the Masses

A ‘time bomb’ is only useful if it blows up. And a crime must have a victim. People, not wanting to get blown up, seek shelter. This is the problem the Fed’s researchers were trying to solve.

Source: www.USinflationcalculator.com

Tuesday, October 22^nd, 2024 

Bill Bonner, writing today from Baltimore, Maryland 

The most obvious narrative for future economic historians is probably something like this... 

In the early 21st century, politicians lost control of spending. Debt rose much faster than GDP. Then, inflation made it much harder for the Fed to continue ‘printing’ money. But as soon as inflation moderated, in 2024, it went back to its old habits — lowering interest rates and inducing more and more people to borrow and spend.  

By then, lowering interest rates was no longer an option; it was a necessity. The feds needed low rates to finance and re-finance their runaway deficits. But investors became reluctant to lend more money to a borrower who was clearly going broke. Interest rates rose, and the only recourse was to ‘print’ money – trillions of it. The result was more inflation — the defining feature of the 2024-2034 period. 

Pretty straightforward. Simple. Maybe too simple? 

‘What are we missing,’ is the question we left you with yesterday. Today, we explore one possibility, coming to us in a startlingly candid research report published by the Minnesota Fed a few days ago. 

Entitled ‘The Unique Implementation of Permanent Primary Deficits’ the paper gives a hint of what the feds might have up their sleeves. 

You can read the report yourself. Or this handy summary from the authors (emphasis added is ours): 

In an economy with incomplete markets and consumers who are sufficiently risk averse, we show that the government can uniquely implement a permanent primary deficit using nominal debt and continuous Markov strategies for primary deficits and payments to debtholders.  

But this result fails if there are also useless pieces of paper (bitcoin for short) that can be traded. If there is trade in bitcoin, then there is no continuous Markov strategy for the government that leads to unique implementation. Instead, there is a continuum of equilibria with distinct real allocations in which the price of bitcoin converges to zero.  

And there is a balanced budget trap: continuous government policies designed for a permanent primary deficit cannot eliminate an alternative steady state in which r - g = 0 and the government is forced to balance its budget. A legal prohibition against bitcoin can restore unique implementation of permanent primary deficits, and so can a tax on bitcoin at the rate -(r - g) > 0. 

Some background... 

The IMF reports that governments are creating a “$100 trillion fiscal time bomb.” 

When government bases its fiscal policy on large quantities of ‘printed’ money, the system becomes unstable. That is, there is no ‘Markov strategy’ that the feds can use to defuse the bomb. In plain English, if they continue printing more and more dollars, people will soon want no more dollars. They’ll look for alternatives. They will find Bitcoin, for example. And gold. 

But before we see where this leads... let’s try to understand what inflation does for the feds and why it is so important.  

A ‘time bomb’ is only useful if it blows up. And a crime must have a victim.  People, not wanting to get blown up, seek shelter. This is the problem the Fed’s researchers were trying to solve.   

Inflation is a form of theft. But it only ‘works’ as a federal policy so long as someone gets robbed. The feds ‘print money,’ pretend it is valuable, distribute it to people... who are then ripped off by it.

In 1971, for example, a saver might have worked hard his entire career to lay aside $100,000. By 2024, his money would have been devalued by about 90%. In other words, he was cheated out of $90,000.  

That’s why an inflationary system is unstable. People try to protect themselves. And if they succeed, the policy fails. Or, to put it differently, inflation is just an underhanded way to tax people. But it only works as long as someone ‘pays’ the tax. 

So, let’s imagine a ‘revolt of the masses.’ Alert to the scam, and seeing more and more debt... and more and more ‘money printing’... consumers might switch to gold... or bitcoin, instead. Then, government is forced into the ‘balanced budget trap,’ because it can no longer borrow at reasonable rates... and no one wants its ‘printed’ currency. 

This time a year ago, Argentina was almost there.  People had gotten so fed up with inflation, and so savvy about how to avoid it, they were switching to dollars as fast as they could. Almost all substantial real estate prices were quoted in dollars, not in pesos. Machinery and equipment, most of it imported, was priced in dollars, too. On-line remote workers were paid in dollars…or Bitcoin.  And cab drivers... waiters... and hairdressers, were happy to get dollars whenever they could. 

The elites were beginning to realize that they could no longer exploit the masses with inflation. Then, it was almost as if they wanted to lose the election and leave the mess to someone else to clean up.  

And what about the US? The rich can easily switch out of dollar-dependent assets and into stock, commodity, gold, or property funds. But what about consumers? Could they just move to Bitcoin... and avoid the inflation tax? What’s to stop them? And then, would the feds be ‘trapped’ into balancing the budget? 

We’ll look more at that, tomorrow. 

Regards, 

Bill Bonner 

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Market Note, By Tom Dyson

This 100-year chart from Bank of America shows the yield pick-up savers earn for investing in corporate debt instead of holding T-bills or money market funds.

Corporate bonds, in this context, represent “adventuring with your savings.” Whereas t-bills represent cash safely in the bank.

When the extra yield is negligible – as it is now – it shows savers don’t discriminate between the two very different risks. When the extra yield is wide, as it was in 2008 and 1982, it shows investors are hyper-sensitive to the different risks. 

Source: BofA Global Investment Strategy

Today T-bills yield 4.61% and investment grade corporate bonds (BBB rating) yield 5.14%, so the yield pick-up for investing in corporate bonds over cash is just 0.53%. 

History shows that indiscriminate risk taking — signaled by corporate bonds offering near-cash returns — usually marks a peak in risk taking and a good time to sell stocks. 

The excerpt above was taken from Investment Director Tom Dyson’s weekly note to subscribers (Run, Don’t Walk). You can receive all our investment and economic research for the next year by clicking the button below.