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What Comes After The Great Liquidation?

Authored by MN Gordon via EconomicPrism.com,

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.