REINVENTING GOVERNMENT
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Javier Milei, President of Argentina
There is no doubt the United States is in dire need of dramatic change. Its city, state and national debts are largely unpayable, public pensions are woefully underfunded, regulations suffocate large and small businesses, home, auto, insurance and food costs continue to rise, health, welfare and defense costs consume an ever growing portion of tax revenues. The nation is knee-deep in military conflicts (Ukraine, Israel, Syria, etc), its major cities are rapidly decaying due to long-deferred maintenance of hundred-year old essential services such as water, electric, sewer and roads, and they are plagued by crime and failing public schools.
The poor quality public schools have produced a growing legion of former students who have dropped out and others that are failing to achieve basic reading and math competencies assuring them difficulty, if not the impossibility, of securing life-sustaining employment. These problems have been building for more than fifty years under the "leadership" of both major political parties. More of the same from this "Uni-Party" (Republicrats) has proven not to be the answer. Voters re-elected Donald Trump hoping that he was enough of an outsider that he would be able to cut back and re-set an obviously broken government. Many hoped he would be the US version of Javier Milei, an economist who was elected president of Argentina - a nation suffocated by decades of socialists who vastly expanded government, ran up monstrous debts, repeatedly defaulted on those debts, turned the Argentine peso into Monopoly money and workers into peasants.
The Argentine Miracle
Milei quickly eliminated a raft of government departments, terminated tens of thousands of government workers, produced the first budget surplus in many decades and reduced the inflation rate by over 80% - all in the first year of his presidency. Of course, the entrenched government bureaucracy and its many beneficiaries opposed his every move because they personally benefited from the existing swamp of crony political insiders taking money from and granting government benefits to special interest groups. Despite their resistance, he proved that reform of a deeply corrupt and inefficient government is, in fact, possible. While Milei has not achieved all of his goals, the International Monetary Fund is sufficiently impressed with his efforts that it agreed to lend the nation another $20 billion to move forward with his renewal process. Argentina is an exceedingly rare example of a bankrupt socialist nation turning itself around. It only came to pass after voters realized the status quo was unbearable and a profound change was necessary.
Trump and Milei's backgrounds are very different. Milei is the son of a bus driver and homemaker. He obtained a bachelor's degree and two master's degrees in economics, became a professor of macroeconomics and often appeared on Argentine television as a vocal critic of the failing socialist political establishment. In 2021 he was elected to the Chamber of Deputies representing his home town of Buenos Aires and donated his legislative salary to the people through a monthly raffle. In the second round of the 2023 presidential election he defeated the incumbent economic minister after arguing that the nation's political leaders were responsible for the country's long monetary crisis and social misery.
Milei is denigrated by his political opponents as being a "right-wing populist." He describes himself as a "anarcho-capitalist." While that sounds alarming, the term describes his belief that people should be allowed to pursue their lives freely exchanging goods and services with a minimal amount of government interference and protecting their wages and savings from government capture. He argues that most government "services" can be better provided, and at less cost, by private entities. He is a follower of what is known as the "Austrian" school of economics. It resists government's continuous encroachment over all aspects of the nation's businesses that negatively affects the economy and results in a diminution of the people's fundamental rights. Austrians argue that big government always creates endless social and economic problems that are then said to warrant ever more government to solve those new problems.
The First Trump Presidency
Donald Trump, by contrast, was raised in the Queens section of New York City in a wealthy family. He graduated from University of Pennsylvania and went into the family real estate development business. For eleven years he hosted a "reality" television show called "The Apprentice" that gave him national exposure. He became famous for his abrupt and imperious manner. He ran for president in 2016 and defeated his equally abrupt and imperious opponent, Hillary Clinton. His first term in office saw the "Tax Cut and Jobs Act," appointment of three Supreme Court justices, withdrawal from international agreements on climate and trade, and renegotiation of the North American trade agreement with Canada and Mexico.
His presidency was abruptly faced with Covid, a virus that now appears to have escaped from a lab in Wuhan, China. We have since learned that the US funded some of the work at that lab and its efforts to make the Covid virus more virulent - in hindsight, maybe not such a great idea. Although it became quickly evident that the virus most affected the elderly and immune-challenged, Trump was badgered by Dr. Fauci into shutting down the entire US economy and keeping children out of school for what turned out to be a very long time. He was impeached twice by House Democrats and acquitted both times in the Senate. After leaving office he was the subject of endless Democratic inspired civil and criminal litigation - the goal of which was to prevent him from running for office again. Enough voters took umbrage at that "Lawfare" onslaught to return him to office.
Trump's Second Presidency
Trump's current obsession is to punish foreign nations he believes have been "cheating" the US on trade. His one-size-fits-all solution is the imposition of import tariffs. The calculus he has employed to determine the size of a given tariff is to take into account the US trade imbalance with that nation. That approach makes little sense in many cases. If a poor Caribbean nation exports a local product (e.g. sugarcane) to the US but is unable to afford to buy most US goods, that nation is to be punished with a tariff high enough to "balance" out the trade difference. Another "feature" of the Trump tariffs is their imposition on "friend and foe" alike. This has predictably resulted in "counter-tariffs" that impede the export of US goods. It also gives the US' largest antagonist, China, a great opening to approach the affected countries, play the "good guy," and enter into favorable trade agreements with them - to the US' long-term political and economic disadvantage.
While Trump insists that tariffs are paid by foreign producers, that is simply not true. Tariffs are paid by the US importer. A foreign producer may agree to lower its price somewhat in an effort to facilitate the sale, but the importer must pay the full tariff. To stay in business, he will be forced to increase the price of the product to his customers. Thus, the US customer either loses access to the foreign made product because it is sold elsewhere to avoid the tariff, or he ends up paying a higher price due to the tariff. Tariffs are taxes imposed by governments on local businesses. They disproportionately harm the low-end consumer. They also lead to slower economic growth as financially squeezed buyers reduce their overall purchases. Slower growth often leads to layoffs, higher unemployment costs, lower tax revenues and a host of other problems. Tariffs will not "Make America Great Again" for the obvious reason that no one ever gets richer by paying more in taxes.
US businesses are now unable to provide forward guidance on their future sales due to tariff uncertainties. Ford Motor Company has warned that it will suffer a $1.5 billion hit to profits due to increased costs of imported auto components and has withdrawn its previously issued earnings guidance. Numerous other companies have withdrawn their business and profit guidance leaving investors in the lurch. With the unknown effects of tariffs, fewer companies are incurring capital expenditures to grow their businesses or increase their staffs. They may instead start laying off staff to reduce their overhead expenses to compensate for their loss of sales. Tariffs need to be dialed back promptly before they plunge the world into a deep recession - one that Trump will own and will hurt him at mid-term elections. Were he to lose a majority in either the House or Senate in 2026, his chance of achieving any part of his agenda will be lost.
A predictable result of Trump's campaign promises to impose tariffs was a surge in imports in Q1 to front-run the cost of the coming tariffs. One effect of this was for GDP to drop to -.3% because imports are a negative in the calculation. Since then, imports have dropped significantly. The port of Los Angeles handles 31% of all containers coming into the US. Container deliveries there are now down 35%. Some 37% of all imports from China are "intermediate products" meaning components needed by US manufacturers to produce their goods. The steep fall off of Chinese imports warns of potentially "empty shelves" for Christmas. Trump, summoning his best Grinch impression, responded to that concern in an interview saying that "girls will have to make do with two dolls that are more expensive instead of thirty."
Trump's War on the Fed
Being a real estate developer by trade, Trump loves low interest rates because they facilitate borrowing for property development. History proves that long-term low rates lead to price inflation that must then be contained with much higher rates, often throwing the economy into a recession. The Federal Reserve Bank is supposed to carefully modulate interest rates to maintain growth without driving prices higher. It has utterly failed to do that. Jermey Warner, economic editor at the Telegraph writes,
While Mr. Warner is right on point, the last thing that anyone should want is for politicians to decide what market rates should be. Most are not economists and will always favor low rates at the expense of stable prices.If you plan to do radical things, you need to tread carefully and methodically in a consistent manner which takes markets with you. To simply plunge in fists flying is nearly always doomed to fail, if only because financial markets – always a fragile and complex construct of positions, assumptions and conventions – find it hard to adjust to rapid change without a serious bout of indigestion. Pierre-Olivier Gourinchas, the IMF’s chief economist, warned that the independence of central banks must be preserved at virtually all costs if financial stability is to be maintained.“Central banks need to remain credible,” he said, “and part of credibility is built on central bank independence.” Fair enough, but it is not as if these overlords of the financial system have done much in recent decades to deserve the “credibility” they supposedly possess. Rather, the reverse: despite their financial stability mandates, they failed to see the financial crisis coming, and then in an attempt to mitigate the consequences engaged in trillions of dollars of quantitative easing that left a devastating legacy of excessive debt, ballooning fiscal deficits and inflated asset prices.Unforgivably, they also failed to see post-Covid inflation coming, and even when it could no longer be ignored, almost universally described it as “transitory”, a groupthink for which there has been no apology, still less any sign of a resignation. If they find their independence under attack, they only have themselves to blame. But that doesn’t mean Trump is wrong to question the Fed’s judgment and powers.The same goes for what Scott Bessent, Trump’s Treasury secretary, had to say about the IMF and World Bank in Washington on Wednesday. His attack on these institutions as having strayed from their core mission was long overdue, and it was a breath of fresh air to hear a leading politician finally say so. Bessent has expressed growing concern over internationally set bank capital requirements. To his mind, the US should not be outsourcing key decisions affecting the provision of credit to unaccountable multilateral organisations such as the Basel Committee on Banking Supervision. America should be setting its own rules in pursuit of its own goals, he insists.
[There are] five pivotal U.S. economic considerations, including tariffs, monetary policy, fiscal policy, debt overhang, and demographics, aligning to depress economic growth for the balance of this year and into 2026. Decreasing regulation, increasing domestic energy production, shifting back to lower-cost fossil fuels, suppressing crime and its cost, and making the government more efficient are all disinflationary measures that help boost the standard of living. However, restoring the U.S. to its historical trend rate of economic growth depends heavily on reversing the debt overhang. The five convergent factors mentioned initially suggest that the risk of recession is high, and the transition to meaningful recovery will be fitful, uncertain, and labored.
Hunt fears that the US economy will stagnate unless and until all five factors are addressed in intelligent ways. We are confident they will not be so addressed. Rather, the far greater likelihood is that they will be addressed in chaotic and counterproductive ways, suggesting that investors should be assuming the "brace" position because the landing may be rough.
His highest priority is to reverse the debt overhang. That will not be done. Exhibit A is the Continuing Resolution recently passed by Congress that perpetuates current spending and adds yet more for defense. The budget deficit for the first six months of this fiscal year was $1.3 trillion and is certain to reach $2 trillion or more, meaning that the "debt overhang" is not being reduced but is instead being expanded. The national debt now exceeds $37 trillion. Consider this: it took the spendthrifts in Congress 235 years to reach $12 trillion of debt. That debt is up another $25 trillion in just the last fifteen years. To say this is not sustainable is to state the obvious.
If it is not sustainable, what can we expect to happen? History provides us with helpful examples. Historian Niall Ferguson writes,
This chart shows the US' government's expenses by category. Interest expenses well exceed money spent for defense and this disparity will continue to grow as the debt continues to rise.Any great power that spends more on debt service (interest payments on the national debt) than on defense will not stay great for very long.True of Habsburg Spain, true of ancien régime France, true of the Ottoman Empire, true of the British Empire, this law is about to be put to the test by the US beginning this very year.
What might trigger a crisis is uncertain because so many things could do it: a banking crisis such as the US suffered in March of 2023 when many depositors wanted their money back all at once from thinly capitalized banks, a trade war, another hot war, an abrupt decline in the dollar, the list goes on. The problem is that when either the economy or financial system is confronted with an unexpected challenge, things can go from what appears to be "normal" to abnormal very rapidly.
For a time it looked as if Elon Musk's Department of Government Efficiency was going to be able to hack back the kudzu that has overgrown US government. He said he would find $2 trillion in fraud, waste and mismanagement and eliminate it. Doing so would eliminate the ongoing annual budget deficit. Many taxpayers were delighted by this because it was obvious no insider would do so. Soon the promised savings shrunk to $1 trillion. That would still make a difference in improving the fiscal path forward. But actual "savings" to date amount to around $150 billion. And that will not be "saved" but go to the military budget. He failed because he needed Congressional support in his efforts and was completely rebuffed. Elected officials survive on campaign contributions from those on the receiving end of government money. Looking out for themselves instead of the country, they were not about to risk losing those contributions. So, the "bread and circuses" will continue until the tent collapses.
There are signs suggesting that the debt problem could be reaching a head. The Fed recently had to buy $20.4 billion of three-year Treasury notes that failed to find a buyer at the Treasury's auction. Did the Fed have a spare $20 billion sitting around? No, those dollars were created out of thin air. The Fed has also engaged in more unannounced QE by injecting another $3.5 billion into banks through its Discount Window. When that became public knowledge, the price of gold rose by $100. Was that effect a coincidence or are some investors beginning to see the handwriting on the wall?
Another problem is that Social Security tax withholdings are not segregated to fund the costs of the program. They are deposited in the Treasury's general revenue fund. The Treasury then issues what are know as "intergovernmental bonds" to Social Security representing those monies. That is a nice way of saying the Treasury issues "I.O.U's" to Social Security. Those I.O.U's now amount to $2.7 trillion. While participants in the plan think their money has been set aside for them, most of their lifetime contributions have long since been spent. Social Security is a Ponzi scheme where today's withholdings are used to pay retirees' current benefits. This will end in tears the way all such schemes end. The same will be true for the many underfunded public employees' pension plans.
So too, many banks continue to be at risk due to the loss in value of bonds held in their reserve accounts. In the past, they bought long-term bonds that pay low interest rates. Since then, bonds with higher rates have been issued causing the value of the old, low-rate bonds to fall. This chart from Wolfstreet.com reveals the extent of the problem through last year. The Fed is extremely coy about which banks are most at risk, not wanting to cause a run on those banks.
Many large banks also have tremendous exposure to derivative risks such as caused the 2008 Great Financial Crisis. Below is a dated chart setting out those risks. Note that these bank's derivative risks far exceed their total assets. The 2008 GFC resulted in part from banks buying interest rate risk derivatives from AIG insurance company. When the housing bubble burst, risks soared and AIG was unable to make good on its derivative obligations to the banks. It was bailed out by the Fed so that the banks that counted on AIG's coverage would not fail. As of December 31, 2024, the Office of the Comptroller of the Currency shows JPM holding $3.5M in total assets and total derivative exposure of $47.4M. (Important note: the numbers in these reports are reported in the "Millions of Dollars" so the actual numbers are in the trillions).
Another risk threatening the banking system is commercial real estate. In Q1, the office vacancy rate was 22.6% - nearly double the pre-pandemic rate. Vacant space grew another 8 million square feet to now total over a billion square feet. Lenders holding mortgages on these properties avoid declaring defaults by agreeing to extend repayment terms, pretending that a recovery is near at hand that will allow the loan to be repaid. At some point they may be forced to foreclose. Then they have the Hobson's choice of trying to manage the properties - at a continuing loss - or sell them, realizing a large loss. A glut of properties coming on the market would crush prices and exacerbate losses. Wolf Richter reported that a San Francisco building that was bought in 2016 for $141 million sold last month for just $44 million. Banks, pension funds and private equity firms holding CRE mortgages may be hit with huge losses. Check your investment exposure to these entities. Local governments raise a large proportion of their revenues from real estate taxes. Due to falling property prices, they will see rapidly shrinking revenues just as their costs are rising. Property prices are also falling in disaster-prone areas such as California and Florida where property insurance costs are soaring, exacerbating minicipal revenue losses.
Home sales remain in the doldrums as the next chart shows. The reasons are fewer homes on the market and high mortgage rates. Homeowners with low, existing mortgage rates (4% +/-) are loath to move as they will be forced to get a new, higher rate mortgage (currently near 7%).
Many argue that the simple answer is to "tax the rich" - make them pay their "fair share." There is a flaw in this "solution". According to Forbes, there are 806 billionaires in the US with a combined net worth of about $5.8 trillion. If the government were to confiscate their entire wealth, it would pay US government expenses for about nine months. Then what? Start confiscating money from the next richest? You can see where this leads. The tax collector will soon be coming for your savings, pension and investments. The only honest solution is for the government to dramatically reduce its spending. That will not happen. Ray Dalio, founder of the world's biggest hedge fund, Bridgewater Associates, warns of the coming financial storm that he says will be "worse than 2008."
To state the obvious: we are now facing a radically different economic and market environment that threatens the existing world order and monetary system. We have been transitioning to this world for several years, but now the shift has sharply accelerated and become chaotic. This new macroeconomic and geopolitical paradigm is turning past tailwinds into headwinds and reshaping global flows of capital.
Conclusion
There are few places to hide. Currencies (e.g., dollars, euros, yen, pounds) are not the answer. Governments can, and will, print them into oblivion so currencies, and bonds denominated in them, may dramatically lose value. Should the world fall into a global recession/depression, history shows that stocks will sink like rocks. No asset class (real estate, art, etc) is immune from losses during a prolonged financial crisis. Recall that following prior major market collapses, returns to former highs can take a very, very long time. It took twenty-five years following the 1929 Dow's loss of 82% that began in 1929. The Japanese Nikkei 1989 crash of 80% took thirteen years, and after NASDAQ lost 77% between 2000 and 2002 it took fifteen years to recover. Are you prepared to wait that long for a recovery? If you are thirty, perhaps so - assuming decades of sleepless nights are not a problem. If you are at or near retirement, such a set back would be devastating.
It is interesting that more than $82 billion of gold bullion recently moved from London vaults to New York, pushing the Comex Exchange's physical gold holdings to a record high 1,347 tonnes. This allows traders to now take physical delivery of gold as opposed to taking monetary (dollar) profits on their trades. There appear to be some people with very deep pockets anticipating a crisis that will create a heightened demand for gold - the historic crisis hedge.
Note too, that in 2024 central banks bought 34 million ounces of gold, marking the third year in a row of record buying. They "officially" hold some 1.2 billion ounces - out of the 6.9 billion ounces that have been mined throughout history. It is believed that some central banks (Russia and China in particular) have not disclosed their full holdings for strategic reasons. Why have they been buyers of an asset they publicly deride as an anachronism? To protect themselves with a liquid asset that has been valued for thousands of years.
Is gold currently overpriced and at risk of falling? That is always a possibility. Its fifty-year mammoth price increase ($35/oz. to $3,500/oz) has not been in a straight line. But one should ask, "overpriced compared to what?" You can see the steady loss of purchasing power of your local currency every time you go to the food store. The dollar has lost 98% of its purchasing power since the creation of the Federal Reserve Bank (whose primary task was to maintain the value of the dollar). The value of gold has not gone up over the last half century, rather the value of the dollar has collapsed, so it takes many more of them to buy an ounce of it. Yes, gold does not pay interest or dividends. Thus, it is not an "investment." Its purpose is very different. It is bought to maintain one's wealth, not grow it. That feature is what one wants when storm clouds are growing on the horizon. Stocks are the wise choice during periods of steady growth, prosperity, and political calm. This does not appear to be one of those periods.
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