I present an effort post on debt doom. This analysis is intended is to help non-finance people (such as myself) to understand the most basic mechanisms of inflation, the status of US Federal finances, and the role that the Federal Reserve Bank plays. We all know about usdebtclock.org and can see that federal debt is at least 30 trillion and rising. We know intuitively that this is a bad thing but might not know exactly what the consequences of that debt are. This is a data driven story of how the US debt is nearly certain to spiral out of control due to inflationary feedback loops.
I am not the first person to come to this conclusion or present these ideas. These are all my own original thoughts that were influenced by many sources that brought my attention to this coming crisis. The initial drafts of this were more focused on the coming recession but it became clear while writing that the next recession is just the opening act to something much much more dire.
I welcome any feedback on what I have written. I will try to clarify any concepts or correct any of my misinterpretations or errors. My goal was to make these ideas as accessible and simple as possible. I intentionally made many gross simplifications and sweeping generalizations that I think are appropriate for this level of discussion. I tried to keep this report focused on inflation and federal debt so I ignored a lot of complexity. This is because I don't live in the financial world and I don't want to spend weeks researching things. The sooner people are able to see this coming the sooner they can take steps to prepare. If you want to expand further on any of the concepts I talk about and account for the complexity that I ignored, that would be a welcome discussion that I am interested to hear.
This post does not offer much preparation advice, that is separate issue for another day.
This post is organized into 6 parts that build on each other. Part one talks about inflation and banks. Part two examines the federal budget. Part three is about the federal reserve bank. Part four is the debt doom model. Part five is the conclusion and part six talks about what to expect going forward.
Part I: Inflation and a normal bank
Inflation is a measure of the buying power of the dollar over time. I think most people have an intuitive sense of inflation. That level of understanding is all that is needed for this report. The inflation data in chart 1 comes from usinflationcalculator.com that they get from the BLS. There are other sources of inflation data out there and inflation is different across the various economic sectors. Right now inflation is 8%. This data gives a starting point for discussing some possible future outcomes.
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Inflation plays an important role in deciding how to manage extra money. Imagine you are a very simple finance 101 traditional bank owner. You have deposits of dollars sitting in the vault. In an inflationary environment those dollars sitting in that pile will be worth less in the future. Your bank has fixed costs like paying employees, heating bills, electricity bills, rent, pens on little chains, etc. The cost of all of these things are getting more expensive due to inflation. You, being a prudent business person, want to use your pile of money to earn some kind of return. In order for you to stay in business and be profitable the rate of return on those invested dollars must exceed the rate of inflation so you that you can keep up with the rising cost of doing business.
This is a very simple business model. It is a mathematical fact (in this simple model) that a rate of return lower than the rate of inflation is a money loser.
I realize there are other factors in determining where to invest money such as the cost (i.e. compensating your bank depositors), risk, liquidity, legality/regulations, and many other things.
If you are on board with my assertion that at a minimum returns must be greater than inflation to be profitable then lets keep going.
An obvious business case for a bank is to use that pile of cash to provide loans. The interest rate on those loans must be at rate of inflation at minimum to break even. On the other end you want the interest rate to be as high as possible so you can make more money. Borrowers want the absolute lowest rate possible because it saves them money. These are conditions for a very simple and straight forward free market model. At some interest rate the borrowers and lenders will agree and the transaction will proceed.
Inflation feedback loop type 1: rates too low
Imagine now you are a borrower and you manage to score a loan from a very badly managed bank at a rate that is below the rate of inflation. What do you do now? A very simple example investment would be to buy a good that is rising at the pace of inflation, for example a scarce asset like oil. You take the loan and immediately go buy a bunch of barrels of oil and store them in your garage to sell in the future at a higher price when the loan must be repaid.
It is easy to understand what will happen to the cost of oil using simple supply and demand. You buying supply causes prices to increase (assuming demand and production stays the same). Idiot Savings and Loan, who gave you this loan, is now seeing higher fixed costs due to rising oil prices (and thus energy prices among other things) and its bank vault is being depleted. At some point after repeating this exercise many times the bank goes bust. You as the borrower sucked money out of that dumb banks vault and into your pocket via simple oil trading.
Once the bank goes bust the feedback loop stops. That idiot bank went out of business you can no longer find a rate that is below inflation so you can't keep running this money machine. That eases the supply crunch on oil and prices either stay the same or go back to where they were before. When rates are above the rate of inflation borrowers have to make some kind of effort to use money in a productive manner.
Now we have a basic understanding as to why interest rates that are below the rate of inflation drive inflation higher. There is profit to be made using cheap money to buy inflating assets which drives up prices of those inflating assets.
I call this inflation feedback loop type 1. There is a proper name for this in some economic textbook that I am not going to read.
We just saw an example of this in action in the US and probably other places in the world. Type 1 feedback was an important contributing factor to the housing price inflation that occurred from 2020 until mid 2022. I recognize there were several other contributing factors because the real world is more complex than our simplified example. The rate of return on buying houses finally dropped below inflation so, as far as investors are concerned, buying a house at these rates is a losing proposition. Cheap money buyers are gone so prices are starting to drop. If cheap money were still available the prices would still be going up.
Part II: The Federal Government budget
We explored using very simple ideas the relationship between interest rates and inflation. Now we are going to examine a few key metrics of the US federal government budget. At the end we will examine a very simple model to explore the consequences of inflation and rates as it pertains to the federal government.
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The first factor to consider is the current total debt. Some important take-aways from chart 2 are that prior to the 2008 Great Financial Crisis the total debt was like 10 trillion. It took all 242 years (1776 until 2008) to get from 0 to 10 trillion, then it took 14 years to get from 10T to 30+T. That is well more than 1 trillion added each year. Also bear in mind that this debt is borrowed from someone. As we discussed in the previous section, any sane lender is only going to give out a loan if the rate of return is higher than inflation.
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Next there is the federal funds rate in chart 3. There is a fairly complex relationship between the funds rate and actual interest rates but for the sake of simplicity I will say that the funds rate is the interest rate that the US Government is charged for taking loans. At the moment the funds rate is around 4% and rising quickly. In the previous section we saw that the current rate of inflation is around to 8%. You may be asking yourself, how is the Federal government able to borrow at 4% when inflation is at 8%? We know that no sane lender would take that deal. For now it is sufficient to accept that there is a party out there willing to take that loss.
The Federal government is borrowing from some moron at a rate below inflation. However the government isn't an entrepreneurial enterprise trying to maximize profits so its not immediately just buying scarce assets so we don't have to worry about inflationary feedback loop type 1 occurring with the federal government. Ultimately being able to borrow below the rate of inflation is really just saving the government money on interest payments on its debt. That should be a good thing, right? We'll get to that. First we will look at how much it costs to service the debt.
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Chart 4 is federal expenditures on interest. It shows how much it costs for the federal government to service its debt level. The lower the federal funds rate, the lower the interest payments are on a given debt level. This represents the cost to borrow the money. It isn't the repayment amount. If this were a credit card balance then paying this amount would not reduce the balance it would just prevent it from getting bigger. As you can see in the graph that the payment is now pushing past 700 billion.
Quick math based on a balance of 30T and a rate of 4% would come out to 1.2 trillion. The actual payment is lower because a lot of the debt was financed in the past at a lower rate. Eventually all of the debt would get refinanced at the current rate but the effects of rate rises are not felt immediately on the entire debt ball.
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One question to ask is how affordable is this 700B payment. It is prudent to also consider income when evaluating total debt and interest payments. Maybe the US has an ungodly amount of income. There are many sources of income for the federal govt but I am going to just look at tax receipts in chart 5. Tax receipts are currently around 3.2 trillion and are the highest ever. This is good, it means that a 700B interest payment is below our total income so there is money to spare for other things in the budget. I'm sure you recall in the first graph that the debt ball is getting bigger and in the past 14 years it is growing by over 1 Trillion per year. Despite taking in record tax income the government is spending roughly 1 trillion more per year than it takes in. I'm going to assert without evidence that the tax revenue growth since 2020 is mainly a result of all the stimulus money and as a result tax revenue is likely to go down in the future.
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Chart 6 shows the budget surplus/deficit in slightly more detail. The US govt has been running deficits for a while but lately the deficits are getting bigger. The main takeaway here is that the federal budget deficit is increasing. The budget is controlled by congress so the only way the deficits can be reduced is if congress does something about it. The US Government has to borrow money to cover this deficit. We talked about how fed funds rates are at 4% but inflation is at 8%. Who is financing the US Federal government debt?
Part III: The hero idiot bank: The Federal Reserve Bank
Our simple banking model says that a lender cannot stay in business if it is giving out loans at a rate below the inflation rate. The reason is because the cost of doing business rises at the rate of inflation and so by giving out loans that return less than inflation, eventually they will run out of money.
This basic fact does not apply to the Federal reserve bank because they are able to legally counterfeit money, unlike every other bank. Money printing in this manner causes inflation because increases the money supply. Money printing is inflationary but on its own it does not create a feedback loop. It must be combined with Federal government deficits in order to create a loop.
The federal government spends every dollar it borrows on all kinds of things. In a simple non-clown world, the federal government would borrow what it needs from various regular banks. The money that the government borrows and spends in non-clown world existed in a vault somewhere. Here in clown world, where the interest rate is below the rate of inflation, no sane bank will lend to the federal government because that bank wants to stay in business. That only leaves the worst run bank, the federal reserve, to finance these loans. The federal reserve bank has deposits but not enough deposits to lend out trillions every year to cover the deficit. It gets the money for these loans by (metaphorically) printing it.
The federal reserve bank (the Fed) and the federal government are separate entities. The fed does a lot of banker things and the government does government things. They have different responsibilities and there is no important overlap. The most important thing the fed does as far as we are concerned is that the Fed acts just like a simple bank that provides loans to the federal government. The fed has three important differences that make it unlike a regular bank. First, it doesn't have to protect its bottom line. Unlike a normal bank the fed doesn't have to be profitable so it can give loans no matter how stupid of an idea it is. Second, the Fed is obligated to finance the Federal government when no one else will. I don't know if it is actually legally obligated but it probably is. Third, it can print money. It doesn't need to have deposits to give out loans. This also means it can never go bust no matter how many bad loans it gives out.
If normal banks don't loan money to the government then the Fed prints the money that it loans to the federal government. The money is spent by the government on all kinds of programs including government employee wages, medicare, military hardware (that gets sent to Ukraine), vaccines, and other infuriating garbage. This spending is simple one-time money supply inflation because its financed with printed money.
The more money that gets printed the higher inflation goes and the more it costs to run the government. In addition, the total debt gets larger.
Inflation caused by the printed money increases the cost to operate the government. It will need to borrow even more money during the next budget cycle. In addition, borrowing money increased the total debt which increased the interest payments. Those additional payments need to be covered by borrowing again. The money that is borrowed to cover operations and interest is printed by the fed. This process is inflationary feedback loop type 2. Its driven by the combination of printing money and federal debt.
Is there a way to reduce inflation that doesn't depend on rates? Yes, kind of. That way is to completely crater the economy. Covid-19 showed us exactly how an economy can be cratered. This will reduce demand because no one has a job or money to spend. That will necessarily reduce prices and tame inflation. Inflation will go down for a while but recessions do not fix the deficit so it won't help the government to escape a feedback loop type 2. In fact, recessions make the loop worse.
The type 2 money printing inflation loop gets supercharged during times of economic recession. The government has the option to stimulate the economy and it usually will. Stimulus means even higher deficits and more borrowing of printed money. In addition, usually tax receipts will go down during a recession because businesses go bust and don't pay taxes and fewer people are working and paying taxes. Usually asset prices crash during a recession as well so capital gains turn to capital losses.
All of this translates to bigger deficits, more borrowing, more debt, and higher interest payments on that debt. All this borrowed money has to be printed because again, no sane bank is going to lend money to the federal government when the return is less than the rate of inflation. A lot of times the fed funds rate will get cut during a recession to help finance the stimulus. Depending on what is going on with inflation this may or may not cause type 1 inflation feedback (buying assets), but it certainly will cause type 2 because the federal debt gets bigger and is financed with money printing.
Part IV: Debt doom
We know that having the fed funds rate below the rate of inflation causes inflation through two very simple inflation feedback loops. Naturally one might reasonably ask, why not raise the federal funds rate to above inflation?
There is point where the interest payments on that borrowed money hits 100% of all income. This is the point that I am calling debt doom: when 100% of income is needed just to service the debt. At debt doom no amount of cutting the budget can solve the problem. The only option is to raise taxes but that will come with its own set of problems because people would be paying taxes and getting absolutely no services for it. Debt doom comes at some combination of interest rates, total debt, and income level.
I whipped together a very simple debt doom model. The most glaring simplifying assumption in this model is that the entire debt is financed at the same rate. I still think it is a helpful tool.
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Each curve on the “Debt doom curves” graph represents of a level of income in trillions of dollars ranging from 5T on the high end to 1.2T on the low end. The y-axis represents the total amount of debt held and the x-axis is the interest rate on that debt. If you are on a particular curve it means that at that level of debt and interest rate 100% of income is required to service the debt.
The way to use this model is to draw a horizontal line at the a chosen level of debt. In this graph there is a red dashed line at about 31T. Follow the line where it intersects each income curve. As long as your income curve is above the horizontal debt line you can survive that level of debt at that interest rate. The point where your curve crosses below the horizontal debt line is the interest rate of death. That is the interest rate where you go fundamentally insolvent. For example if the debt is 31T and income is 5T (the highest curve), you are safe because the 5T curve never crosses the 31T debt line at any realistically possible interest rates. However if income is only 1.2T (the lowest curve), you go bust when rates hit 4%.
Another way to use this model is to follow the yellow 3.2T curve in the middle of the curves. That represents the current tax income for the US government. If interest rates were at 3% the total debt can reach 110T before all 3.2T of income is needed to service the debt. On the other hand at 11% is the interest rate of death: where the curve crosses the horizontal debt line.
The yellow curve with a 3.2T income is the curve that I consider us to be on right now. If rates hit 11% it is debt doom. Inflation is currently at 8% so in order to tame inflation the fed rate should be higher than 8%. As I said, that assumes the entire debt ball gets financed at 8% and that isn't true, but the direction is correct. If rates go up, interest payments go up. There is a limit to how high the payment can go before its unsustainable. Given that we are already running a deficit many would argue we are already past the point of debt doom.
Back in 2008 we were on the bottom curve with a total income around 1.2T. However total debt was around 8T. Inflation back then was around 5.5%. There was no need to raise rates beyond 6% so there was a lot further to go back then to get to debt doom.
As I said, this is a very simplified calculation. There are many other nuances to consider but the underlying principle remains the same. There is a known quantity of existing debt. There is some level of income that the federal government generates so pick the curve that you think that income level is. There is some interest rate on the current debt where all income is needed to service that debt. That is the point where nothing can be done about it. Congress can cut every program and collect the taxes and only pay the interest payments. The debt would never get smaller. Tax payers would receive absolutely no benefit from paying taxes. The tipping point may be well before the interest payment burden hits 100% so these doom curves are a worst (or maybe best) case scenario.
Once we hit debt doom, what happens? We get stuck in money printing inflation feedback loop type 2. No one is going to loan money at a rate below inflation so it gets printed by the Fed then loaned to the government. Every budget cycle inflation will be worse than the last cycle. The total debt gets bigger each time money is borrowed the pay the deficit and the cost to run the government grows with inflation. So in the next cycle more has to be borrowed to cover the bigger interest payments on the bigger debt and the higher cost of running the government. High inflation will eventually turn to hyperinflation. A much more detailed analysis on this inflation loop is covered in the Hyperinflation is coming - Explained thread.
You may have noticed on the chart that as interest rates move towards 0% the amount of debt that can be financed goes up (to infinity). What is the consequence of moving rates toward 0%, wouldn't that save the government a lot of money? The answer is yes, it would. However, the mechanism by which the federal funds rate is set means that other non-government entities can also access these 0% loans. Access to loans below rate of inflation will cause inflation feedback type 1 where borrowers take this free money and buy oil and other scarce goods causing inflation to rise. The bigger the spread between the loan and the rate of inflation the faster it causes inflation. Also another nuance to all this is that the fed prints the money to finance below market loans which will cause money supply inflation and supercharge the type 1 inflation feedback loop. Remember that a type 1 inflation loop only stops when the idiot lender goes broke. The fed can't go broke so this loop will continue for as long as the loan rate is below inflation.
Low rates will lead to inflation loop type 1 and also causes inflation loop type 2 if the government is running deficits. With rates below inflation no sane bank would lend to the government because it is a money losing proposition. The government must borrow to cover the deficit (in order to pay the capitol police to fend off the mobs) so it has to get the money from the fed. The fed prints the money and lends it to the government which causes inflation and increases the total debt. Both factors increases the deficit and so the government has to borrow more money next time.
Rates above inflation push the government into debt doom faster. Higher rates mean of the federal budget would be required to service the debt leaving less for everything else. The ever growing shortfall has to be borrowed at a higher interest rate. In theory if a regular bank give this loan it would not cause inflation. However, this regular bank knows that the Federal government is underwater. At debt doom the federal government is a deadbeat that has to borrow from Peter to pay Paul. It would be stupid for any bank to give that loan because a borrower in that position is a huge risk. A higher return to account for that risk may incentivize the bank to give the loan. Higher rates means higher interest payments which will increase the deficit which makes it a riskier loan so rates go up. Won't be long before the Fed is the only bank dumb enough to underwrite loans to the underwater government and it will do it by printing the money and its back to inflation type 2.
Of course the unspeakable option is for the US government to default on its debt. At debt doom, 100% of the income is spent on interest payments to its creditors. The Government could tell its creditors to jump in a lake. The government would collect taxes and only pay for government services and not pay the interest payments. This could theoretically
work as long as it never needs to borrow money again. There also are a lot of global implications from a US government default that I'll just say are very bad (because I can't even begin to unravel them).
The issue is that dumb idea is we are already running deficits to a degree that even if interest payments were wiped away there is still a budget deficit. Default does not solve the problem, it is already too late. if there were a default the US government would have burned every possible lender on Earth. The only bank stupid enough to lend it money to finance its deficit is the Federal Reserve Bank. This would lead right back to money printing and feedback loop type 2.
There is also the impossible options A and B. Right now today the interest payments are only 700b and tax income is 3.2 trillion and the total deficit is around 1T. it is still mathematically possible for congress to slash the budget and run a surplus. This will avert debt doom for as long as there are surpluses. Here are a few obvious issues with this option. First, under the false assumption that income stays constant in the future (it will go down), 1T must be cut from the budget somewhere. Second, if that amount were cut from the budget that would create a massive recession. Third, government services would be dropped but taxes would stay the same. People won't appreciate that. Lastly, debt doom won't happen today, it is the next administrations problem. Option B is to just raise taxes to generate more income instead of slashing the budget. I'll leave it to you to figure out why that's not likely to work.
Part V: Conclusion
The debt is too big and inflation is too high. This is different from the 2008 GFC because back then there was room to adjust rates up or down, we were not nearly as close to debt doom, and inflation wasn't as much of an issue. Government is currently being financed with money printing from the Fed. The deficit along with the fed funds rate being below the rate of inflation means that both types of inflation feedback loops are happening. The fed funds rate cannot rise above the current rate of inflation because that will push the federal government into debt doom. A deflationary recession will not save us because it will cause tax receipts to go down making the deficit worse. Whats more, the government will likely respond to a recession with stimulus spending making the debt worse. The fed lowering interest rates would ease the government interest payments for a while but would make inflation worse.
The fed cannot raise, lower, or maintain rates without causing inflationary feedback loops. The government can't default on the debt because even if the US wiped out its creditors it would build up a new debt with the fed as the sole lender and type 2 inflation feedback would continue, not to mention the international relations issues a default would cause. As said in the inflation write up, the fed has no way out.
A recession is coming and when it hits with full effect it is going to drive up deficits, drive down government income, and push the US government over the doom curve. If somehow there is no recession then debt doom is still coming eventually, unless we start seeing a lot of significant budget surpluses.
Part VI: what next?
I have referenced the Hyperinflation is coming - Explained thread
which links to a great post on reddit written by a user named peruvian_bull. After writing this I understand that a lot better. In this write up we examined only the past 20 years or so and focused on the interaction between four basic elements: federal debt, deficit, inflation, and rates. Peruvian_bull's report explores many historical events that lead up to current events. It also provides many more details and technical evidence to support his conclusion of hyperinflation. If you read this and you find my conclusions too simplistic or lacking sufficient detail to be useful, then go read that.
My very simple and relatively conservative doom curve model says the US Federal government is on the precipice of debt doom. Additional debt will push it into debt doom. Once that happens it doesn't matter what the Fed or the government does. An inflationary feedback loop cannot be avoided.
Maybe someone at the Federal Reserve is smarter than me and has a brilliant plan. Maybe congress will pull of a miracle and do something so stupid that it works. The inflation thread provides historical examples of how nations in the past were able to move forward. In most cases the nation wipes away the debt with a new currency. That is most likely what will happen in the US. The digital dollar will be almost certainly be the new currency.
In another thread I pieced together a timeline of events that was all speculation. In general I think we have 5-7 years from today until the collapse of the dollar. That is to say, within 5-7 years we will all be forced to use the digital dollar and the old dollar will be worth like .000000001 digital dollars or something equally insane. I say this because in the Weimar Republic of WWI Era it took that empire about 5 years for the price of an egg to go from 1 mark to 1,000,000,000 marks. Hyperinflation in Zimbabwe was on a similar time scale although their economy was a mess for longer, in 2004 inflation there was 100% per year which is already really high and by 2008 it was millions of percent per year.
There are two events to watch for that signal when this multi-year collapse has begun. One or the other or both may happen. First is that the federal reserve bank will start to lower rates rather than raise them. Second, the fed prints money directly in response to Government stimulus or there is a “financial accident” at home or abroad. Once the fed either lowers rates or starts printing we are done, start the countdown to doom. Also let me cover my ass and say there could be all manner of black swan events that change everything in this analysis: something in China, a major war, an actual plague etc.
That said, I don't think debt doom will be the end of the world as we know it. I don't think it will be the end of the United States of America. The country will probably survive but the dollar probably will not. I don't know what the country will look like. This isn't about how to prepare. There is an excellent book written on how to prepare for this called “Surviving the Economic Collapse” by Fernando Aguirre. A similar crisis happened in Argentina roughly 20 years ago and that book is all about what the aftermath was like.
The billionaires know this is coming so if you have great wealth there are all kinds of ways to try to profit from this. I do not have great wealth so I don't know anything about that. Talk to a financial advisor if you have wealth to protect. If you depend on social security or a government retirement and plan to live for more than 5 years really study up on this because the coming collapse is going to be hardest for those that depend on the government.
Hopefully this write up was helpful for you to understand the predicament that the US Government is in right now. I tried to keep the concepts very simplified because that is how I understand it as a financial outsider. Every time I do a review of this I end up adding more stuff so I'm just going to post it now as is. I hope this was worth your time to read.