The Dollar Frontier

The US Treasury Department is likely to try printing its way out of it eventually. When that happens–higher rates won’t reflect the risk of inflation from an overheating economy but of debt default.

Source: Congressional Budget Office

Friday, January 17th, 2025

Laramie, Wyoming

By Dan Denning

If you read the Congressional Budget Office’s latest budget outlook for the next ten years (and I don’t recommend it, unless you’re into suffering), you’ll understand why the incoming Trump Administration and new Treasury Secretary Scott Bessent desperately need a weaker dollar and lower interest rates. The chart above is taken from the CBO update. And it shows America’s debt has crossed the frontier into…danger.

Never mind that a strong dollar is currently killing the rest of the world, funneling the world’s capital into the US and driving up financial asset prices (especially the Mag 7), while also and triggering debt repayment problems for foreigners who borrowed in dollars. This ‘strength’ is not what it seems.

We are close to a dollar turning point (one that looks good for gold). We have to be, unless the dollar is going to break the whole world. But the devil is in the purple ink for the US government—the ink that shows total debt crossing 130% of GDP and leading to currency/bond crisis.

CBO’s report is supposed to be positive. It claims that because of technical revisions to expected tax revenues and GDP growth, the ‘primary deficit’ expected over the next ten years has fallen from 122% of GDP since they last estimated it (in June of 2024) to 117% today. It’s a 12% decline to a deficit of ‘just’ $8.1 trillion.

But the ‘primary deficit’ doesn’t include interest expense–the cost of that $36 trillion in debt we already have. Once you include that, the TOTAL deficit will grow by $21.1 trillion over the next ten years. That’s $1 trillion lower than CBO projected last June. But that’s based on ‘expected’ higher tax revenues from GDP and lower annual deficits.

Even so, CBO projects annual deficits of $1.8 trillion, $1.7 trillion, and $1.6 trillion for the next three years. After that, every annual deficit is just below $2 trillion or well above it until 2034, where CBO projects a $2.5 trillion deficit (as spending on Social Security and Medicare peaks). The public debt-to-GDP ratio will be–at a minimum–118% by 2034. And the government will run annual deficits over 6% of GDP–something we only used to do when fighting a World War.

Scott Bessent was right about one thing when he testified in front of the Senate earlier this week. The US government has a spending problem. And it will take a growth miracle in the real economy (higher productivity, lower energy prices, less red tape, and a MUCH weaker dollar) to reduce the deficit in real terms. A resort to inflation is the only other way. Which brings me back to the necessity of a weaker dollar and the chart below.

The chart above is the US dollar index [DXY]. And since our main task at BPR it to connect the dots, I’ve taken a long-term view of it, to see if we can make sense of the peaks and valleys and where we’re headed next. Short answer: lower.

We COULD go higher from here. The most-recent high for the dollar index was 112 in August of 2022. We’re around 109 now, but with interest rates now fully 200 basis points higher than they were then (albeit 100 basis points lower than they were in September of last year, before the Fed started cutting). But the 10-year Note backed off its run at 5% by the end of the week and even the 20-year note ended under 5% after cresting above it.

Is inflation beat? No. The CPI ‘beat’ on expectations earlier this week was a statistical mirage. But markets seemed to latch on to comments from Fed Governor Christopher Waller that the core inflation will be lower in 2025, allowing the Fed to cut rates multiple times.

That ‘V’ shaped bottom in the dollar in 2009 is about when US stocks started their 16-year run of outperforming foreign stocks. We’re now more than three standard deviations above the mean of historical US out-performance, according to Charlie Bilello. And we’re not that far from the 120 level the DXY reached as the dot.com crash began to destroy stock prices. What next?

The US organized the Plaza Accords in 1985 to devalue the dollar against the rampaging Yen. The aim was to boost US exports. It worked. The dollar fell by 40% against a basket of foreign currencies over the next two years and US trade deficits with Japan and Europe (and the government’s budget deficit) fell.

Is the plan this time around to engineer a dollar devaluation through sky-high sanctions? We’ll see. But one of the only things that would drive the dollar even higher from here (and rates lower, paradoxically) is a global financial collapse.

If THAT happened (for whatever reason), capital would seek the safest liquidity it could find (US blue chip stocks at any price, US Treasury bills and notes). But it’s not like US stocks are cheap. Check out the chart below.

If you were looking for a way to express the ratio between stocks investors love the most (at any price) versus stocks that investors not only don’t hate, but don’t even think about (at any price), it would look a lot like the chart above. This is the ratio between the Nasdaq 100 (the biggest US tech stocks by market capitalization) and a basket of 190 international value stocks.

International. Value. It makes you want to take a nap just saying it. And that’s more or less what the ratio shows. The steep run up in the ratio from 1997 to 2000 shows the dizzy heights of the dot.com bubble. And then the nauseating crash.

The ratio has reached new extreme levels, but this time gradually, over the 16 years since the Lehman collapse. At that point, the Fed’s support of US stocks through low rates and Quantitative Easing, plus the Europe Union’s turn to over-regulation and energy policy suicide (net zero) has resulted in what you get now: an unprecedented level of outperformance by US big cap tech stocks versus international value.

Does this chart mean ‘international value’ stocks will outperform US big tech for the next 10 years? Well, it’s hard to imagine that. Stranger things etc. And you probably couldn’t participate in that rally through an ETF or index fund. You’d have to do some research and find the good investments.

But it at least suggests that either the US economy and stock market–driven by their frantic embrace of tech–have either permanently decoupled from the rest of the world…or some mean reversion (in the form of lower US stock prices) is inevitable.

What about bonds? If the Fed cuts and rates have peaked, shouldn’t we be buying them? Next chart.

Bonds are in a structural bear market. But they may be due for a cyclical rally. That’s one way of reading the chart above (from Tom McClellan on X). And it checks out with the long-term data, a long-term trend toward higher rates, punctuated by cyclical downturns (what Tom has called ‘inflation volatility’)

US government bonds are entering the sixth year of the their third great bear market of the last 240 years, according to Bank of America research. The first great bond market was between 1899-and 1920. The second, between 1946 and 1981 (this included the era of financial repression in the US where war debt was paid off by capping interest rates below the rate of real inflation and the debt-to-GDP levels were reduced to manageable levels).

The bull market in bonds from 1981 to 2021 was the greatest in US history and lasted a full forty years. The big question now is how long this third great bear market in bonds will last and how much higher rates will go. The smaller question is whether cyclical rallies within a structural (long-term) bear market could or should be traded for fun and profit.

Do you feel lucky punk? Well do ya?

Nothing in the long-term chart of TLT, the exchange traded fund (ETF) that tracks long-term US Treasury bonds is screaming ‘buy’. You can see the last twenty years of the bull market. And the first six of the bear market. And now?

Lower-highs. Lower-lows. Maybe some cyclical softening in rates (and a bond price rally). But you can’t read the CBO report without concluding the US fiscal ship has both sailed and IS doomed. We are not spending our way out of a crisis. And this is not a rally we’ll try and trade in 2025.

Whomever is running the US Treasury Department is likely to try printing our way out of it eventually. When that happens–and it’s already begun–higher rates won’t reflect the risk of inflation from an overheating economy. They’ll reflect the credit and default risk of a borrower that can’t stop borrowing and a central bank that won’t stop printing.

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A quick announcement. On Friday, January 31st, I’ll conduct a live Private Briefing with Dr. Pippa Malmgren. Pippa writes on geopolitics, tech, and the economy and is an entrepreneur, author, and former Presidential advisor. You can find her here on X or here on Substack.

Our friends at Substack reached out to ask if we’d be part of their first-ever Market Forecast Summit. Since BPR first got in board in late 2021, Substack has added dozens of useful, unique, and insightful newsletters on economics, finance, investment, and geopolitics. This live event is designed to introduce readers to some of the other voices out there.

I’m going to ask Dr. Pippa about something she posted on X earlier this week. DJI, China’s leading retail drone manufacturer (and the world’s largest, in fact), removed the geofencing feature on the software update for its commercial drones. Drone pilots can now fly them in restricted airspace (airports) or over secure facilities in America (like, say, an inauguration, although that has now been moved indoors due to….’cold temperatures’ expected in DC).

The timing of DJI’s move is…very particular. I’ll ask Pippa about it. If you have a question you’d like me to ask her, please send it in via email to research@bonnerprivateresearch.com. Also please note you’ll need to download the Substack Reader App on your phone to access this live event. You can do so here.

You don’t need to register for the event. When we go live, you’ll be notified either by email or a a a notification from the App. And if you can’t make the live event, don’t worry. I’ll have it recorded and transcribed and make it available as quickly as possible.

I’m not sure we’ll do live events like this in the future. It MAY be useful for reporting on breaking events, especially as it allows us to present a live conversation with any of the contacts in our large network, wherever they happen to be. We’ll give it a shot to see how it works and go from there.

Until next week,

Dan

PS The thermometer is expected to plunge this weekend in Laramie, down to 15 below zero. And that’s before the windchill. It’s snowing outside as I write.

The past few years I’ve avoided the winter deep freeze by heading to Australia or New Zealand. But my Australian passport is off at the consulate being renewed right now. Why not Spain? Or Portugal?

My friends at Opportunity Travel have organized a tour for interested investors and retirees. The tour of Spain begins on March 25th and the tour of Portugal begins on April 7th. You can go on either tour, or both. And in between, our friends at International Living have organized a conference on living and retiring in Europe.

You can find out more details and sign up to go to Spain this spring right here.

I’m not sure I’d retire anywhere in Europe, to be honest. I like the American West (and will watch the new series on Netflix called American Primeval about the settling of the American frontier). But if I were looking at places with a nice climate and a lower cost of living, Spain would be on the list.

And if I WERE looking, I’d go on a guided tour like this first. It’s the best way to get the quickest and broadest overview of what life might be like living in a foreign country. Barb Sedita and her team at Opportunity Travel are real pros at organizing these tours and have been doing it for over 25 years.

As for Spain itself, one last note for you this week. According to Denning family lore, 2025 marks the 100th anniversary of an epic trip by our Great Uncle Arthur Kramer. ‘Uncle Art’ (my father’s uncle) left from Pau in Southern France on a counter-clockwise tour of Spain in a rented car with his wife.

He didn’t say what kind of car they drove…but he did say that due to low-tariffs on American cars…and the lack of a Spanish auto-maker…they saw ‘Studebakers, Buicks, Hudsons, Essexes, Dodges, an occasional Packard, quite a few Cadillacs, and, of course, an abundance of Fords,’ on the Spanish roads. What is an Essex?

An account of his trip called Motoring Through Spain was published by PL Turner and Company of Dallas, Texas, in 1928. I have a hard copy here in my office in Laramie. But as the book is out of print and out of copyright, you can find an electronic copy on the Internet. I’ve taken the liberty of downloading that copy and including it here if you want to have a look (see below).

Motoring Through Spain (3)

9.31MB ∙ PDF file

Download

Download

Later this year, to celebrate the 100th anniversary of Uncle Art’s trip, I’m going to recreate it with some family members. We’ll go in the fall, when Spain is a bit cooler. And though we won’t follow the route exactly, I’ll try to visit some of the same places. If there’s anywhere in particular you think I MUST visit in Spain, let me know in the comments below or send an email to research@bonnerprivateresearch.com