The Two Ugly Paths Now Facing The U.S. Economy
And the rocky path I think gold takes to get to $10,000...eventually.
I was watching Andrew Ross Sorkin on 60 Minutes last Sunday. Sorkin was on the show to promote his new book, 1929: Inside the Greatest Crash in Wall Street History — and How It Shattered a Nation.
When Leslie Stahl asked him during his interview whether we would have another crash, Sorkin answered: “The answer is, we will have a crash. I just can’t tell you when, and I can’t tell you how deep. But I can assure you, unfortunately, I wish I wasn’t saying this, we will have the crash.”
At one point he says “We are either living through some kind of remarkable boom, [or we’re reliving] 1929.”
I thought to myself: hell, I can do better than that, and I didn’t even write a book about 1929. Because at this point, the real question is not whether we are headed toward some sort of financial reckoning…the question is what form that reckoning takes.
And after looking at the current economic landscape, I increasingly believe there are only two realistic outcomes over the next several years: a soft default through inflation or a hard default through financial crisis. The former seems more likely than the latter, and can be confusing to people because nominal prices staying steady or rising while inflation runs out of control won’t look like a “crash” that most of 60 Minutes’ viewers will expect. It’ll be a crash upward.
To understand why, let’s start with where we are right now and summarize a lot of what I’ve written about over the past month or two. There’s four key things I’m watching:
inflation
market valuation
the consumer
the bond market
These four things have worked together to produce a combination that I believe is close to locking up the economy and taking away any response options from the Central Bank that won’t have immediate and ugly consequences.
Inflation remains structurally above the Federal Reserve’s target despite one of the most aggressive rate-hiking cycles in modern history. Even now, inflation is still running around 3.8%, nearly double the Fed’s stated objective. This is no longer a temporary post-pandemic distortion that policymakers can dismiss away with optimistic forecasts and revised models.
Inflation has become embedded across the economy, from housing and insurance to healthcare, wages, food, and government spending itself. The cost structure of modern American life has permanently shifted upward, while policymakers continue pretending that a return to stable 2% inflation is just around the corner. It’s not.
At the same time, financial markets continue to trade at historically stretched valuations. The Shiller P/E ratio sits around 42x versus its mean of 17.3x and market capitalization relative to GDP has surged above 230%, levels associated not with healthy long-term expansion but with periods of deep speculation and excess.
A better way to look at this instead of valuations are high is that the market is extraordinarily vulnerable to falling further in percentage terms. When valuations become detached from underlying economic reality, the downside risk grows larger because there is simply farther to fall once confidence breaks. Expensive markets do not automatically cause crashes, but they create the conditions where even modest disappointments can trigger violent repricing. Especially if the market’s rally has been on poor breadth and the result of speculation on options and the passive bid.
Beneath the surface, delinquency data shows that the consumer is tapped out. Student loan delinquencies have surged back toward record levels as repayments resume into an economy where borrowing costs and living expenses have both exploded higher.
Credit card delinquencies are now sitting at their highest levels since the aftermath of the financial crisis, while auto loan defaults, especially among subprime borrowers, have reached multi-decade highs. Americans are financing $50,000 vehicles with monthly payments exceeding $750 at interest rates that would have seemed absurd just a few years ago.
Consumers have largely maintained spending not because household finances are healthy, but because they have increasingly relied on debt to sustain a standard of living that inflation has steadily eroded.
And the rate at which consumers are saving is dwindling significantly now, Zero Hedge writes on Thursday morning:
But the most important warning signal in the economy is not the stock market or the consumer. It is the bond market.
Under normal economic conditions, weakening growth and financial stress would push long-term Treasury yields lower as investors seek safety and begin pricing in future Federal Reserve easing. Instead, the opposite is happening. The 10-year Treasury yield remains around 4.5%, while the 30-year Treasury has pushed above 5%. Those are not comforting numbers. They reflect a growing discomfort with the long-term fiscal trajectory of the United States itself.
This is the trap the United States now finds itself in.
And because of these four factors, I believe there are only two paths we can go down. The more likely path I think puts gold eventually on a (rocky and volatile) tracjectory to eventually get to $10,000.