In previous discussions, we've delved into the dynamics of short-term and long-term debt cycles and the role of productivity in shaping economies. Now, it's time to assess where we currently stand within these cycles and what that means for the health of our economy.

The Short-Term Debt Cycle: A Slowing Economy

We are nearing the end of a short-term debt cycle. During and after the pandemic, the Federal Reserve and the Treasury infused the financial system with money (debt) to assist workers who had lost their jobs and businesses that had lost customers. This influx of cash predictably led to inflation. In response, the Federal Reserve raised interest rates an unprecedented 11 times to bring inflation down from a 40-year high of 9.1% to just over 3% in less than a year. Although the Federal Reserve's target inflation rate is 2%, they still have some ground to cover, which likely means a slower economy for now.

Since the Fed began raising rates in February 2023, we've observed some falling consumer goods prices, declining housing prices, and more cautious lending from banks. These are all indicators that the Fed's monetary tightening policy is taking effect and slowing down the economy. However, not all economic parameters are behaving as the Fed would like. Unemployment remains stubbornly low, and the stock market is near its all-time highs. These are not the hallmarks of an economy in recession, which many had predicted would occur when the Fed started raising rates so rapidly. This situation is both a relief and a concern, as it complicates the Fed's future course of action. They aim for a "soft landing"—an economy balanced with lower inflation and interest rates—but the mixed signals make this challenging.

The Waiting Game

So, where does that leave us? We're in a "wait and see" mode. We're waiting to determine if the economy will slide into a recession and how severe it might be. We're waiting to see if the stock market can continue to defy a weaker economy burdened by high national debt. We're waiting to see if low unemployment rates will persist or if businesses will begin slowing down and laying off workers.

The Crazy Bond Market

The other area of uncertainty right now is the volatility in the bond market. The yield curve inverted about a year ago, which usually means that the economy is going into a recession in about 15 months, putting us in that recession this October. But as I said, the other factors, like the stock market and unemployment, do not align with that projection unless they change rapidly. Under normal economic circumstances, the yield curve trends upward: short-term bonds provide less income to investors because holding an investment for a shorter time involves less risk. A downward-tending or “inverted” yield curve means that you earn less on bonds that you plan to hold for longer and is a sign that something in the economy is amiss.

When the yield curve is inverted, it's hard to sell long-term bonds because businesses that want guaranteed investments usually opt for short and long-term treasury bonds but are starting to wonder if accepting plummeting Treasures as collateral was a smart move. So, the bond market gives us no clues about the economy either.

The Long-Term Debt Cycle: A Glimpse into the Future

The more pressing issue is that we are approaching the end of a long-term debt cycle. Depending on when you believe this cycle began, we may have 20-40 years left. The Federal Reserve's ability to manipulate the economy through money printing and high debt policies will eventually wane. Traditional monetary policy tools, like manipulating interest rates or injecting liquidity, become ineffective when debt levels become too high. Did you know that America’s national debt is so large the interest expense now dwarfs what it spends on defense? The United States is famous for spending more on its military than the next ten highest countries combined. On top of that, Washington routinely borrows money to pay off prior debt coming due, a habit akin to using one credit card to pay off another. And this has us spiraling into the end of a long-term debt cycle. And we know that this will be no fun indeed.

Social unrest has risen since the 2016 presidential election, and China's growing influence as a global superpower adds another layer of complexity. Historically, every 100 years or so, a shift in world power results in the recalibration of global economies. If you believe this long-term debt cycle began in 1945, we have until 2045. But a lot can happen in 20 years.

Ray Dalio's Three Rules

Investor Ray Dalio suggests three primary rules to stave off painful deleveraging and possibly even depression or war:

1. Don't let debt rise faster than income, as debt burdens will eventually become unmanageable.

2. Don't let income rise faster than productivity; you'll eventually become uncompetitive.

3. Do everything you can to raise your productivity, which matters most in the long run.

These simple guidelines apply to both individuals and policymakers.

What Now?

While I'm skeptical that income will ever rise faster than debt again, I am optimistic about increasing productivity. The convergence of AI, cryptocurrency, robotics, and possibly quantum computing will be our saving grace. As our populations age and we continue to allocate resources to debt repayment, we can only hope that technological advancements will boost our productivity and GDP.

Although the economic uncertainty is bound to cause the markets to bounce around for another two or three quarters, I think the Fed will have to turn on the money printer sooner rather than later to inject the system with liquidity again so businesses can access the capital they need and the economy will heat up again.

Enter Crypto:

When the Fed pushes liquidity into the system, crypto is the best-performing asset in the last ten years.

In the final article of this series, I'll discuss where I think the economy is headed and where I plan to invest—mostly in crypto. Surprised? I hope not.

If you're interested in how I plan to invest in crypto to bolster my savings and retirement, please reply to this email and set up a 15-minute free consultation, as I offer private crypto coaching sessions.

Stay tuned, and let's navigate these uncertain economic waters together.

Again, stay tuned for the video version of this article on my Crypto For The Rest Of Us YouTube channel.

Thanks For Reading

J. Scott