The current state of the US economy is of interest. What will happen next? In the worst case, this could cause shocks throughout the global economic system, the consequences of which could have a painful impact both on the territory of the Russian Federation and beyond its borders. To understand this mystery, let’s go back to the background.
In 2020, the US Federal Reserve launched an unprecedented monetary effort, injecting a staggering amount of funds into the economy. A quick look at the Fed’s balance sheet chart clearly illustrates the extent of this expansion in 2020-2021.
However, every action has its consequences, and in this case, the price of such a cash injection was. The jump in inflation in 2020-2022 was quite significant.
The central bank fights inflation by increasing . This move encourages people to spend less, save more and reduces overall business activity. And this could potentially push the economy into crisis.
In response to rising inflation, the US Federal Reserve decided to raise interest rates, which is a key step in modern economies to reduce rising inflation.
There is a basic economic law that states that when interest rates rise, bond prices fall. During the period of low rates in the US from 2020 to 2021, those who invested in long US government bonds suffered significant losses of approximately 45%.
This spring, a threat loomed over American banks. Simply put, customers entrusted their money to banks, which in turn invested in bonds. When these bonds depreciated by 45%, banks found themselves in a precarious position, unable to fully repay their customers.
To prevent this crisis, the Fed stepped in and took action to save these banks. While the decision was widely received positively, it raises questions about the stability of other banks facing similar difficulties.
Let us remember how this situation affected the price of bank shares in the spring.
The US regional bank index posted a sharp one-day decline, highlighting the gravity of the situation. Stocks fell sharply.
In the midst of these tumultuous events, the United States found itself forced to address another pressing issue: the national debt. In an era of low interest rates, increasing the national debt seemed like a no-brainer. However, with borrowing costs rising, the debate around increasing debt has reached a critical point. Notably, President Biden has delayed a decision on the national debt until 2025, effectively passing the torch to his successor.
Although discussions about the US national debt have been a constant topic in the media for many years, the situation has only now taken a radical turn. The national debt has transformed from a formality into a problem, although out of habit it is still talked about with a touch of frivolity. This is a serious mistake.
The screenshot below is a graphical representation of the costs associated with servicing the government debt. In 2024 it could exceed a trillion dollars. This means that servicing the national debt will become a key item in the US budget (in the second screenshot).
In the previous one, I wrote about the budget trap of 2024 in the Russian Federation. The United States is also trapped in its own financial quagmire:
• To fight inflation, interest rates must be kept high.
• Prolonged high interest rates lead to expensive borrowing.
• Consequently, servicing the government debt becomes a huge burden.
One way to alleviate this situation is to print more money to cause a new round of inflation and depreciate the value of current debt.
Traditionally, the system has worked smoothly. High interest rates, inexpensive bonds and attractive yields have all attracted capital to US Treasuries. However, the situation has changed and investors are no longer flocking to these assets despite increasingly attractive interest rates. As an additional factor, we saw a decline in the US credit rating.
Let’s look at the profitability chart. Such a situation has never happened in the 21st century.
BlackRock, the world’s largest investment fund, predicts returns could top 5%.
Conclusion
If the market continues to have faith in the Federal Reserve and responds by moving money into Treasuries, as it has historically, then funds will be pumped out from all directions, including equities in the broader market. This could create room for growth in bonds and some other assets.
In any case, the longer the market remains skeptical, the more agonizing the future of the US debt system could become.
It is possible that we are approaching the final chapters of conventional US monetary policy, ushering in a period of profound global economic transformation.
2023-10-03 10:29:00
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