Hamilton's $30 Trillion Invention

A shocking history of the US bond market...

WE DID IT! cheers Jim Rickards in The Daily Reckoning.

It took some hard work, but the United States finally managed to find itself with $30 trillion of government debt.

But if anyone is actually thinking of celebrating this dubious accomplishment, I have some advice for you.

Get ready for the hangover.

The US government bond market was invented by Alexander Hamilton early in the first administration of George Washington around 1790. The newly formed United States of America was facing claims from creditors who had financed the Revolutionary War.

The Congress had a simple solution: Default!

That's the American Way. But Hamilton had a better idea.

He said the new government should borrow more money and use that to pay off the old creditors. Once we did that, we would be deemed creditworthy and we could borrow even more money to pay off the money borrowed in the first round.

This plan was so successful that the US Treasury market is now celebrating its 230th anniversary. That's how long the US has been borrowing new money to pay off old debt.

In 1835, Andrew Jackson became the first and only President who cut the national debt to zero.

The story of US debt is not one in which the debt went up steadily for 230 years. The actual history is that the debt went up in times of war and it was paid back in times of peace.

Debt went up in the War of 1812, the Mexican-American War of 1846-1848, the Civil War, World War I, World War II, Korea, Vietnam and under Reagan to win the Cold War. (The only major debt increase without war prior to 2000 was during the Great Depression).

But the war debt was paid off during times of peace including the 1820s, 1870s, 1920s and 1990s. It was only after 2000 that things went off the rails and government debt went straight up under George W.Bush, Barack Obama, Donald Trump and Joe Biden.

Now the debt is unmanageable without inflation. Inflation favors debtors because they get to pay back the debt with depreciating Dollars. It's easier to pay down debt because you're paying back debt with Dollars that are less valuable than when you originally borrowed them. So inflation eases the real value of debt.

On the other hand, deflation increases the real value of debt. With deflation, the value of money increases, making it more burdensome to pay off debt. This is why debtors hate deflation.

The other way to deal with the debt is to default. But there's no reason for the US to default because the debt is in Dollars and we can print the Dollars.

That's the great advantage of having the world's leading reserve currency, what French Finance Minister Valéry Giscard d'Estaing termed the "exorbitant privilege" in the 1960s.

People who say, "We can't pay off the national debt!" don't understand this market. There's no need to pay off the national debt. We just have to keep rolling it over. But to do that we need to maintain our credit standing, as Hamilton understood. Once our credit is called into question, the entire house of cards collapses.

This shows up first in higher interest rates, then in a devaluation of the Dollar and finally in illiquid markets where the debt just can't be sold except to the Fed. The final stage is hyperinflation and complete collapse of the currency and the bonds.

It's not going to happen tomorrow, but we're getting closer to that endgame.

I've said before that the US is caught in a debt death trap. Monetary policy won't get us out because the velocity of money, the rate at which money changes hands, is dropping.

Printing more money alone will not change that.

Fiscal policy won't work either because of high debt ratios. At current debt-to-GDP ratios, each additional Dollar spent yields less than a Dollar of growth. But because it must be borrowed, it does add a Dollar to the debt. Debt becomes an actual drag on growth.

The ratio gets higher and the situation grows more desperate. The economy barely grows at all while the debt mounts. You basically become Japan.

The national debt is $30 trillion. A $30 trillion debt would not be a serious issue if we had a $50 trillion economy.

But we don't have a $50 trillion economy. We have about a $21 trillion economy, which means our debt is bigger than our economy. And it's stalling.

Although we're only about one-third of the way through the first quarter of 2022, the Federal Reserve Bank of Atlanta has published its estimate for first-quarter growth using the data we have so far.

The result is a forecast of 0.1% GDP growth on an annualized basis. That's a small rounding error away from a recession. That's significant because the Atlanta Fed is known for its highly optimistic forecasts.

There are several reasons for this weak start to the quarter. The first is that strong fourth-quarter growth in 2021 was mostly a mirage. Almost the entire growth came from inventory accumulation. That does not represent final sales; it represents goods piling up in warehouses.

If those goods get sold in the first quarter, they don't add much to GDP because they were already counted in GDP when the inventories were purchased.

If the goods don't get sold, it's even worse because supply chain managers will cancel new orders while waiting for the inventories to run off (probably at steep discounts). Also, the economic impact of Omicron is just being felt now. It hit hard in December but did not have much impact coming that late in the year.

After Jan. 1, the quarantines, hospitalizations and lockdowns started to pile up, so the first quarter will bear the brunt of it. When you combine this intrinsic weakness with Fed tightening today and rate hikes in March, you have a recipe for recession in the first quarter.

In basic terms, in the bigger picture, the United States is going broke. We're heading for a sovereign debt crisis.

I don't say that for effect. I'm not looking to scare people or to make a splash. That's just an honest assessment based on the numbers.

Tax cuts won't bring us out of it; neither can structural changes to the economy. Both would help if done properly, but the problem is simply far too large. You can't grow yourself out of this kind of debt.

So an economic time bomb is ticking. Velocity is dropping. Debt is growing while growth is slowing. The explosion will come in the form of asset bubbles bursting and stocks crashing.

There's no way out of the debt death trap except through inflation.

Say goodbye to Hamilton's master plan. Time to buy some gold before the rush into hard assets really begins.