Chris Whalen: The Economy Is At A Tipping Point
Today's guest wrote the book Inflated: How Money & Debt Built The American Dream
In it, he wrote: "The first rule of any fiat system is no fiscal deficit"
Well, the US -- and virtually every other G7 country -- is breaking that rule six ways to Sunday given the unprecedented record levels of deficit spending currently underway.
Does that mean we're headed for trouble?
To find out, we'll ask the author himself, Chris Whalen, Chairman of Whalen Global Advisors LLC and expert on the banking, mortgage finance and fintech sectors.
Chris sees the economy at an inflection point, where rising unintended consequences are going to start placing restraint on future deficit spending, no matter how badly our fiscal leaders may want to spend.
Here are my key takeaways from this discussion:
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Chris assesses the global economy as stable but heavily burdened with debt. He notes that throughout history, borrowing has become a common solution for societies unable to meet their immediate needs through taxation, a pattern that repeats in roughly every century. This cycle is similar to the American experience, where borrowing eventually becomes unsustainable.
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He rates the current economic situation as a 7 out of 10 on the "out of hand" meter (10 being the worst score), indicating significant concern about the $36 trillion debt and social security obligations. He argues that addressing these issues requires a level of focus and purpose that is currently lacking in Washington, where political actions are often influenced by the highest bidder. He draws parallels to historical instances, such as the inflation caused by post-Civil War policies and the subsequent impact leading to the Great Crash of 1929.
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The enormous size of the U.S. Treasury's debt and its cash operations are a major source of instability in the financial system. Chris highlights that the Treasury's large-scale borrowing, often with short-term debt like T-bills, significantly impacts the markets. He mentions that the Treasury General Account's large cash reserves, now parked at the Federal Reserve, drag the markets around. This substantial borrowing requirement, approximating 20% of federal spending, forces the government to raise vast sums, such as $800 billion in a major refunding event later this year, which destabilizes the system.
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Chris anticipates a potential consumer recession due to rising interest rates and consumer fatigue. He points out that higher costs, such as credit card interest rates reaching 24-25%, strain consumers' ability to manage their finances, including paying for essentials like housing and education. He advises investors to consider defensive stocks, given the likelihood of continued inflation in consumer prices and services. Chris also highlights that many homeowners are now selling their homes because they can't afford them, which may lead to fewer future buyers and a potential correction in home prices. He notes the historical context of inflation in America, such as the impact on housing demand during the post-World War I era and the double-digit inflation concerns during Jimmy Carter's presidency.
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Chris asserts that inflation is embedded in the economy due to the need to finance 20% of spending annually, which heats up the economy and drives prices higher. He highlights that housing supply constraints exacerbate this issue, with not enough homes being built and obsolescence reducing housing assets by a couple of percentage points each year. The result is continued upward pressure on housing prices and related costs, such as property taxes and insurance.
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While there is an inflationary bias in consumer prices and services, the substantial amount of public and private debt acts as a deflationary factor. Policymakers are concerned about this dynamic because it mirrors historical periods like the Great Depression, where overcapacity and unemployment led to deflation. Significant government spending was required to reignite inflation post-World War II. Today, similar concerns persist, with both inflation and deflation forces at play, complicating economic management.
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The commercial real estate market faces a significant shift from previously unrealistic return assumptions to more realistic ones, which lowers property values. This deflationary pressure, combined with higher refinancing costs, challenges property owners. Additionally, consumers are under strain, with rising interest rates and increased debt levels leading to potential rollovers in mortgage repayments. This situation could result in fewer home buyers and a market correction, as evidenced by the fact that 80% of mortgage payoffs today are from home sales rather than refinancing.
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He suggests that the current environment requires a shift from short-term, momentum-driven investing to a more fundamental approach. He recommends focusing on defensive stocks, given the likelihood of a consumer recession. He emphasizes the need for a broader understanding of market dynamics and warns about the potential for subdued earnings in the banking sector due to current economic conditions. He also notes that while normalized interest rates (5-7%) benefit banks' loan yields, they may result in fewer loans being made due to stricter lending standards, impacting overall economic growth.
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Chris's life lesson is to always challenge power by seeking a broader understanding of issues beyond what mainstream media offers. He recommends reading books and primary sources to gain deeper insights. He shares his own experience of learning from financial documents and working for receivers, which taught him invaluable lessons about life through navigating the complexities of failed companies. This hands-on experience provided him with a profound understanding that goes beyond conventional knowledge.
For the full interview with Chris Whalen, watch the below video:
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