When This Liquidity Bubble Pops, We’ll Face The Biggest Crisis Yet

John Mauldin  |

Debt is a huge a drag on the economy. It’s especially true after it rises over the 80 to 90% of GDP level.

US government debt is now 106% of GDP. And if you add state and local debt, total government debt is over 120% of GDP.

Shades of Italy and Greece.

Off-Budget Deficits Congress Glosses Over

Congress wants you to believe last year’s deficit was $779 billion. They don’t mention the off-budget deficit, which adds a lot to total debt.

It is not easy to find that number, but fortunately, my friend Michael Lewitt writing in The Credit Strategist brings us this pithy note:

Our current prosperity is built on an explosion of debt; it is therefore unsustainable. The US added roughly $1.3 trillion of GDP in the fiscal year that ended in September but also added $1.271 trillion of debt. Interest rates, while still running well below real-world inflation, are rising in a heavily leveraged economy. The $1.271 trillion increase in federal debt was nearly $500 billion or 39% higher than the official annual deficit of only $779 billion, which means that politicians are keeping significant amounts of debt off-balance sheet. I don’t know who they think they’re fooling, but they aren’t going to be able to keep this con game running much longer. Over the past five years, the official deficit was reported as $2.977 trillion whereas the federal deficit grew by $4.777 trillion, meaning that 38% of the actual shortfall was hidden by our feckless leaders. And all of these figures do not include trillions of more dollars of off-balance sheet entitlement obligations promised by the government to future retirees and other voters.

That deficit was for fiscal year 2018, which ended on September 30. The CBO’s latest projection is we will add close to $1 trillion of debt in 2019 and over $1 trillion in 2020.

The off-budget deficits have averaged around $360 billion for the last five years, generally increasing over time.

But if we take just that average and add it to the projected deficits, the US government deficit will be (drumroll, please) approximately $1.4 trillion per year for the next five years, which will mean $29 trillion total debt by 2024.

And that’s without a recession. Throw in a recession, and we’ll get to $30 trillion long before then. Care to speculate what interest rates will be? What quantitative easing will look like? What all the other market disruptors will look like?

A Sea of Liquidity That Will Soon Drain Away

My friend Chris Cole at Artemis Capital writes a rather brilliant client letter. He graciously sends it to me. Here’s a quick bite.

Chris notes that investors have been swimming in a sea of liquidity for so long that we notice it only when it disappears. Then central banks provide more liquidity. And things go back to what we think is normal.

But liquidity is simply investor willingness to buy and sell. It is as much about market and investor sentiment as any true “fundamental.” Here’s Chris Cole:

In markets and in life, we swim in mediums of thought abstractions… the same way a fish swims in water. When the medium collapses, so does the reality… causing us to question the nature of both. As Foster Wallace eloquently explains, “The immediate point of the fish story is that the most obvious, ubiquitous, important realities are often the ones that are the hardest to see and talk about.” Volatility is always the failure of medium… the crumpling of a reality we thought we knew to a new truth. It is the moment where we learn that we are a fish living in a false reality called water… and that reality can change... or there are other realities. True volatility isn’t the change of the thing, it’s the changing of the medium around it and the realization that the thing never really existed in the first place.

This is all you need to know to understand when the volatility storm will truly come. It is not about valuations, money printing, or where the VIX is at any point. When the collective consciousness stops believing growth can be created by money and debt expansion, the entire medium will fall apart violently, otherwise it will continue to be real. The belief that the medium is the reality is what holds the edifice together temporally.

You might dismiss this as way too bearish.

Maybe it is, right now and for the next few years. But when global debt starts suffocating economic growth and liquidity, the relative Sea of Tranquility in which we have been swimming for a while could become quite stormy indeed.

That is why I keep harping on The Great Reset. I think we will set a new standard for what the word volatility (absent a shooting war) really means.

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Sharp macroeconomic analysis, big market calls, and shrewd predictions are all in a week’s work for visionary thinker and acclaimed financial expert John Mauldin. Since 2001, investors have turned to his Thoughts from the Frontline to be informed about what’s really going on in the economy. Join hundreds of thousands of readers, and get it free in your inbox every week.

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