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What Comes After the Great Liquidation
MN Gordon

Expectations were great.  When 2023 started, there was a general sense that the stock and bond markets had turned over a new leaf.  A repeat of 2022 was out of the question.

The primary assumption was that inflation would relent.  After that, everything else would neatly fall in line.  Specifically, interest rates would decline, and the next great stock market boom would bubble up just in time to bailout the meager retirement savings of aging baby boomers.

That was the general outlook when 2023 commenced.  But instead, the opposite is now happening.  Inflation is persisting.  Interest rates are rising.  And stock and real estate prices are headed down, down, down.

This week, for example, Fed Chair Jerome Powell, in his semi-annual Congressional testimony, clarified that interest rates would go “higher than previously anticipated.”  He also noted that, if needed, he’s “prepared to increase the pace of rate hikes.”

In other words, the much-anticipated Powell pivot has gone on indefinite hiatus.  You can fight the Fed and buy stocks if you must.  But you won’t likely be very happy with the results.

Moreover, Fed rate hikes are only part of the story.  To be clear, the Fed’s rate hikes are to the federal funds rate.  However, they do, in fact, influence Treasury rates.

Since March 2022, the Fed has hiked the federal funds rate from a target range of 0 to 0.25 percent to a range of 4.50 to 4.75 percent.  As a result, and over this duration, the 2-year Treasury yield has jumped from 1.75 to over 5 percent.

What to make of it…

Radical Action

Rising interest rates mean higher borrowing costs.  And higher borrowing costs mean a greater percentage of income is needed to service the debt.

This has various ramifications.  For example, if more income is being used to service the debt there is less income available to use for savings, investments, or to buy other goods and services.

With less money available to spend or to invest in capital markets, economic growth stagnates.  This, in short, intensifies the problem.

With less capital and savings available, and less spending taking place, there’s ultimately less economic activity.  And when there’s less economic activity taking place there’s less cash flow available to service the debt.

To then make up the difference, consumers must use greater amounts of consumer debt to attain the consumer spending needed to preserve their lifestyle.  This, again, is a dead-end street.  Applying additional amounts of debt is a short-term solution for a long-term problem.

The debt, unfortunately, doesn’t magically disappear.  It piles up until a point where radical action must be taken.  Creditors get stiffed.  Or debtors massively reduce spending to pay down the debts previously incurred.

It is all very basic.  A simple acceptance of reality, and the determination to take the necessary footwork, can result in great things.  In this case, it can turn the pain involved with digging one’s way out of debt into the foundations for building wealth.

A debtor that is successful at digging themselves out of a hole by massively reducing spending will then have the opportunity to build real wealth.  Because once there is no debt left to pay off, the excess money can be saved and invested.

Americans on the Hook

Structuring your lifestyle and spending habits to be less than your income is fundamental to building real wealth.  The best investment opportunity in the world could be right in front of your face.  Yet if you don’t have the capital, you won’t have the ability to capitalize on it.

We’re not sure why, but few people have the discipline to spend less than they make, and then save and invest the difference.  This is why most people should be prepared to eat canned lima beans in retirement – the puke green ones the cafeteria served you in grammar school.

Over the years, U.S. debtors – including consumers and the government – have spent their way into a massive debt hole.  For several decades, these massive debts have been masked by low interest rates.  The days of refinancing at ever lower rates are over.

Interest rates are rising.  But what if interest rates must increase much, much higher than Powell anticipates?

The truth is, there are groundbreaking events that are well beyond Powell’s control.  For example, Japan may be the world’s largest holder of U.S. Treasuries.  But the appetite Japanese investors have for Treasuries may be souring.  In this respect, the Wall Street Journal recently posited the following:

“Last year, the Federal Reserve’s interest-rate increases weakened the yen and lifted the cost of hedging against currency fluctuations for Japanese investors buying U.S. assets.  That drove many to unload U.S. bonds, in a shift from years of purchases that made Japan the world’s largest foreign holder of Treasurys.  Now, investors are growing worried the selling will resume, especially with Treasury yields hurtling toward decade-plus highs.

“Without that support, Americans could be on the hook for higher borrowing costs on everything from single-family mortgages to business loans.”

Are you an American?  Do you delight in the prospect of being on the hook for higher borrowing costs?

What Comes After the Great Liquidation

Fed rate hikes, to contain the inflation of its own making, are contributing to higher Treasury rates and higher borrowing costs.  This will continue to push borrowing costs higher and higher until something breaks.

What will that something be?  And what will be the first something to break?

Will inflation break first?  That’s the soft-landing scenario that Powell is after.

Or will the economy and big banks break first?

In this scenario, there would be mass layoffs, business closures, and a giant wave of bankruptcies.  There would also be the blow-up of several big investment banks or significant investment funds.

Alas, we believe the soft-landing scenario is highly unlikely.  The recklessness that was committed in the run-up to the coronavirus panic, which then went into complete overdrive when the whole world lost its mind, must be reconciled.

There’s no easy way out of this one.  Mass liquidation is coming.  Still, when the dust settles consumer prices will remain higher than they were at the start of 2020.

There’s no going back to the prices of January 2020 for the same reason there will never, ever be penny candy again.  The dollar debauchery that took place has permanently disfigured prices.

The central planners, eager to deliver something for nothing, caused an epic disaster.  And they won’t stop.  They’ll continue to act – and they’ll say they’re acting with courage.  What then?

More than likely, through money supply expansion and currency debasement, the central planners will continue down the inflationary path.  Maybe it will continue at a subtle or moderate rate over many years or decades.  Or they could trigger runaway inflation, where velocity spikes up and prices double and triple in just a few weeks.

No doubt, we’ll all find out soon enough.  In the meantime, pay down debts, save cash, buy gold, and stack silver.  With a little luck, you’ll make it though with a slimmer waistline and a greater mistrust of the planners in charge.

[Editor’s note: There’s also the unthinkable to consider.  Is China secretly planning to attack Taiwan?  Are your finances prepared for such madness?  Answers to these important questions can be found in a unique Special Report.  It’s called, “War in the Strait of Taiwan?  How to Exploit the Trend of Escalating Conflict.”  You can access a copyfor less than a penny.]


MN Gordon
for Economic Prism


MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

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