Why Inflating Away the Debt Won't Work This Time

When in the course of human history, governments are staring down the barrel of a sovereign debt crisis, usually they try and solve this problem by inflating away the debt. And while that has worked in the past, even in the United States, I'm going to show you why it's not going to work this time. Right now you are looking at a chart of the total debt that the federal government owes as a percentage of the size of our economy measured by GDP. You can see right now the debt to GDP ratio is over 120% and it has been that way for about 5 years now. You can also see that the United States has been here before, in 1946, as a result of the spending and borrowing for WWII. While having a very high debt to GDP ratio like 120% isn't the definition of a sovereign debt crisis, it is generally accepted by most economists that this is a level that is very difficult if not impossible to come back from. Which gives some people hope because the United States has been here before and has come back from it. While there is no firm definition for sovereign debt crisis, the one I like the most is when interest payments on the debt exceed total tax revenue. In that situation, a nation cannot pay down its debt because the only way it can pay any of its expenses is by borrowing. All of the tax dollars are already getting soaked up just to pay the interest on the debt. It's worth noting, we are not there yet. The United States collected about $5 trillion in taxes this last fiscal year, yet it only spent just under $1 trillion on the net interest cost of the debt. If you include the total interest cost on the debt, it is higher than $1 trillion. But some of that goes to other places inside the government, so they look at the net interest. As I'll show you, if nothing changes, we are headed to that point where total tax revenue will be surpassed by the interest on the debt. But again, we are not there yet, so again, that's giving people hope there's still time to come back from this, especially if we can just inflate away the debt. The reason why that's the playbook is because that's what they did last time to come down from World War II. Some simple yield curve control and financial repression meant the US government was able to borrow, issue bonds, at an interest rate that was below the rate of inflation. The entire economy really had no choice but to absorb this loss themselves, as that purchasing power was transferred to the US government. As all the men came home from war, women had already been starting to add to the workplace, we had a big productivity boom, and GDP exploded. As a result of that, as the economy grew, and the government borrowed below the rate of inflation, the total debt load for the US government, as compared to the size of the economy, shrank for about the next 40 years. But that's only looking at one side of the coin. We have to take a look at everything else that was happening during that time, mainly the spending. This chart that you're looking at is the net federal outlays as a percent of GDP. In other words, this is the total amount of money the US government was spending compared to the size of the economy. One thing you'll notice is that outside of the spike from World War II, this has been on a general trend higher for the last 100 years. But let's focus in on what happened here during World War II. There was an insane spike from about 10%, meaning the size of the economy, the government was spending about 10% of GDP, had an insane spike to over 40% of GDP, and then very quickly crashed back down to just under 11% of GDP. This highlights very clearly that it wasn't just the yield curve control and the financial repression and trying to inflate the debt away that allowed the government to escape its sovereign debt crisis. The US government decimated its spending. Of course, they didn't get back down to where they were before, but they got pretty close. The most important thing, though, was they didn't stay at these elevated levels, near 40%, where they were spending during the war. Contrast that with what has happened recently. If you take a look at really ever since 1975, the average amount that the US government has spent as a percent of GDP has been around 20%. Some years have been higher. Some years have been lower. But even up until 2019, the US government was spending about 20% of GDP. Obviously, spending spiked in 2020 and 2021, getting up to about 30% of GDP. But you can see, as of 2023, the US government's spending as a percent of GDP did not come back down to where it was before at 20%. And in fact, now it's headed back up higher. So last time we were facing a sovereign debt crisis, it was because spending and borrowing spiked temporarily by a lot. And then after World War II, that stopped and spending crashed back down. And it took decades for that average to get up to about 20% of GDP. But the government has been spending about 20% of GDP for decades now. And that has slowly but surely been piling on to the future costs, increasing that debt slowly but surely. This is why when we look at the debt to GDP ratio, it spiked going into World War II, and then it took a long time to come back down. But this time where we're at 120%, it didn't just now spike to here. It's been slowly but surely rising for the past 40 years. Now, to be fair, if this spending was supported by taxes and they weren't running massive deficits in order to support this spending, then there wouldn't be a sovereign debt crisis because there wouldn't be a ton of debt to have to deal with. But when we take a look at this chart, which is the deficit or the surplus as a percent of GDP, you can see for about 50 years we've been running chronically increasing deficits. Again, contrast this with what happened during World War II. Surpluses were fairly normal. We had a big deficit spike getting to 26% of GDP was the deficit spike and then quickly rebounded to a surplus as a percent of GDP. But for 50 years now, we've been running chronic deficits that have been increasing on average every year to the point where last year the deficit was over 6% of GDP, a level that had never been seen prior to the Great Financial Crisis and World War II. And now that's just normal. Considering the deficit is the amount that they spend in excess of taxes, so they have to borrow for that, seeing this number increase is why I'm looking at this as a sovereign debt crisis, or at least getting to that point, because it's growing the debt so fast that eventually there won't be anything they can do to pay for it other than trying to inflate it away, which as I'm going to show you, it's not going to work that way. Now, some of you are looking at this chart and thinking that we should just raise taxes because if the issue is piling on debt and debt only gets piled on when they spend more than they take in taxes, let's just increase taxes. After all, everybody knows that they used to tax us a lot more and now because of those evil Republicans and those evil conservatives or those evil libertarians or whoever you want to blame, they're taxing corporations and billionaires so much less than they used to. Sorry to burst your bubble, but the data just doesn't back you up in that, especially considering that income taxes weren't even a thing prior to 1913. That's a video for another time. The important thing about the debt spiral here is the amount that they tax the entire economy. This chart is total federal revenue or taxes as a percentage of GDP, and you can see that really the maximum amount that the US government can take in taxes from the economy is about 18%. Anytime it gets to that level, the economy then shrinks. You can see when it got above 17 and a half here, we hit a recession. When we got above 17 and a half here, we hit another recession. When we got above 17 and a half here, we hit two recessions. Got above 17 and a half here, we hit another recession. Now, don't hear me wrong. I am not saying that recessions are only caused by too high taxes, but what I am saying is that the government tries to extract too much purchasing power from an economy, it cannot keep growing. That's kind of self-explanatory. We also see that anytime taxes get to around 15%, they quickly rebound, and the government has learned over the past almost 100 years that that is the sweet spot. That is the perfect amount that you can extract from the economy to allow it to keep on growing so that you can extract as much money as possible because that is the only thing the government cares about is extracting as much from you as it possibly can, even if it has to promise you something you won't get in return. We can see very clearly, ever since about 1950, the amount the United States has taken from the economy in taxes has been about the same as a percentage of the size of the economy, and they cannot take much more, otherwise the economy grinds to a halt. The government right now is facing a 120% debt-to-GDP ratio, rising expenses, increasing costs just to pay for the debt, and it's having to borrow more and more every single year just to pay for all of that, which makes next year's expenses even more because now they have to pay for all of that borrowing that they just did. This is a debt spiral, and the way they're going to try and deal with it, and already have started to, is to inflate away that debt. In other words, instead of trying to borrow it from the economy or tax it from the economy, we're just going to print the money into existence in order to pay for those expenses. Like I showed you, that's what they did following World War II, and it worked, but the reason why it worked after World War II is because the spending dropped off of a cliff. Right now, we don't have any spending that is going to drop off a cliff. We don't have any spending that's even going to slow down. Social Security is $1.6 trillion every year and growing. Medicare is $1 trillion every year and growing. Health is $1 trillion a year and growing. The interest on the debt is $1 trillion a year and growing. National Defense is $1 trillion a year and growing. Income Security is three-quarters of a trillion dollars per year and growing. In fact, two-thirds of the spending from the federal government are considered mandatory, required by law. That's things like the Social Security, Medicare, and Medicaid. You could get rid of the entire discretionary budget, and you still wouldn't be running a surplus. In fact, right now, as I'm recording, the government is still shut down because they're arguing about how to spend the discretionary part of the budget. You could take that to zero, and they would still be running a deficit. They still wouldn't have enough tax income to pay for the mandatory expenses, and those are growing every year. Not only that, but just look at Social Security, which the trust fund for Social Security will be empty in seven years, which means there's not enough coming in to pay for everything that's going out, which means that the expenses, borne by inflation, borrowing, taxpayer, that's going to go up in seven years by at least 25%. This is why it has been a slow grind higher to 120% and why it is not going to drop just because they start to print to pay for their expenses like they did after World War II, because they're not cutting any of their expenses this time. In fact, the act of printing to cover those expenses is going to make those expenses grow. Before I explain why, it's worth noting what I mean by print. In terms of the federal government itself, they're only allowed to get their revenue from two sources. They can tax it, which means take it from you directly, or they can borrow it. However, given the fact that they're borrowing it from the financial system, and the financial system is backed up and backstopped by the Federal Reserve, and the Federal Reserve is going to be switching from QT to QE, quantitative easing, that's called debt monetization, where they buy U.S. Treasuries off the open market in exchange for newly created dollars that they just printed into existence by the federal government borrowing in order to cover their expenses, as long as it's the Fed doing the lending, doing the printing, then the net result is that the government prints that money to inflate away the debt. I know that that's not the exact mechanics, but when you zoom out and you look at the whole piece, including banks, including the Fed, including the Treasury, if the Fed's balance sheet is increasing, then you can look at that process and say, okay, they're trying to inflate away the debt. Right now, the Fed's balance sheet is declining, which means they're not doing this yet, but the Federal Reserve did just announce that they're going to be ending the decline of their balance sheet soon, and then will likely be resuming QE, increasing that balance sheet. I made a YouTube video on this, it was the last one I made last week. If you're interested, go watch that once this is done. So why in the world is inflating the debt rate going to make their expenses actually go up? Well, number one, it's because there's no such thing as a free lunch. Like I mentioned earlier, the U.S. government can only spend money that it's taken from you either directly or indirectly by taking that purchasing power away from all existing money. Remember what happened in 2020 and 2021? They print trillions of dollars, hand that out to everybody in the economy. Now there's an increase in demand because there's more money, but there's not more stuff. And so all that does is bid up the price of goods and services. As the U.S. government continues to rely more and more on inflationary financing, in other words, new money coming into existence that's being lent to them for their spending, that has the exact same effect, just at a slower pace. More money chasing the same number of goods and services, which bids up prices. Here's the problem. As prices get bid up, that means cost of living goes up. And so expenses of the mandatory stuff all across the board for the U.S. government goes higher. Medicare, Medicaid, Social Security, military, all of those expenses go through the roof as the purchasing power of the dollar that they are printing into existence to pay for their expenses declines. After World War II, I mentioned that we had a big productivity boom with women entering the workforce and all the men coming home from war and beginning to work again. Not to mention all that wasting of resources, literally destroying energy and materials in the act of war. How all that all ended led to a big productivity boom. It is possible that we are on the cusp of another very large productivity boom. And to be honest, everybody should be hoping that this is true. Because if not, there is no wealth that can be extracted by the government to pay for all of their stupid and reckless spending. At least if there is a productivity boom, then there will be an increase in net wealth in the economy in order to offset the pain of the wealth that's going to be extracted by the government. And for all of our sakes, I hope that's the case. And if not, you definitely want to be an asset owner. This is why valuations across the board are so extreme right now, because everybody is preparing for debasement. Not the basement, debasement of the currency. The money losing value. It's why gold is at all-time highs. Real estate is not crashing near all-time highs. Stocks at all-time highs. It's just big money hedging against a falling dollar. And like I mentioned earlier, if you want to hear more about the Federal Reserve and why they're ending QT soon, I made a video about that last week. You can check that out. As always, thanks so much for watching. Have a great day. Bye-bye.