The Congressional Budget Office (CBO) forecasts a staggering increase of $20.2 trillion in federal debt over the next ten years, pushing the national debt to approximately $54 trillion.
This growing national debt, which results from ongoing budget deficits, is escalating at a pace of around $2 trillion annually. A significant portion of this borrowing goes toward mandatory expenditures like Social Security, Medicare, and health care. Additionally, some funds are allocated for discretionary spending, including defense and transportation projects.
Furthermore, the net interest on this debt has recently surpassed $1 trillion annually for the first time in history. This means the government is effectively borrowing to cover the interest on its own debt—a precarious way to manage a nation’s finances.
These CBO projections—indicating $2 trillion annual deficits—rely on the assumption that various factors will hold steady. The forecast anticipates that real GDP will grow at an annual rate of 2.4 percent, and that there will be no new wars, pandemics, or other crises that could derail these financial assumptions
The recent COVID-19 pandemic illustrates how swiftly and severely a crisis can affect government finances. The resulting increase in money supply tarnished the purchasing power of wage earners and savers, driving up living costs.
The essential point is that the CBO’s projections overlook many potential calamities that may arise over the coming decade. Similarly, investors may underestimate the likelihood of the Israel-Hamas conflict escalating into a broader regional or global war.
The consequences of such an escalation would not only be devastating for human life and infrastructure but would also deepen the U.S. government’s debt crisis and disrupt financial markets.
During the initial confusion of a geopolitical crisis, financial markets often fail to grasp the potential risks involved.
Charlie Don’t Surf
The ongoing conflict in Gaza might turn out to be yet another prolonged struggle that enriches defense contractors while further adding to the federal debt. This has been the trend observed over the past several decades, as seen in the wars in Iraq, Afghanistan, and Ukraine.
But what if there is more at play? Will the potential for a stock or bond market selloff be overshadowed by the onset of an even greater crisis? Is the catastrophic self-destruction of civilization just around the corner?
Frederick J. Sheehan Jr. once wrote an insightful piece titled “War of the Nerds” for the December 2006 issue of Marc Faber’s Gloom, Boom & Doom Report. A few years ago, we happened to preserve an excerpt from his now-defunct AuContrarian website:
“Every generation harbors its own unique fantasies. A century ago, investors had grown so desensitized to the consequences of war that bond markets from London to Vienna didn’t react at all following the assassination that sparked World War I.”
“Just three weeks later, in the summer of 1914, the fear premium was a mere one basis point. Before long, European markets ceased to function. Notably, nothing fundamentally changed; war was not yet declared, yet anxieties escalated.”
Much like the phrase “Charlie don’t surf,” investor complacency toward risk can shift rapidly. The detachment many investors have regarding distant calamities can change in an instant. Sheehan’s analysis highlights how, even without any immediate conflict, financial markets can swiftly transition from functioning normally to a state of paralysis.
What Fear Premium?
When we discuss financial risk today, we aren’t referring to typical statistical measurements. We’re focused on how financial markets respond when a significant geopolitical crisis arises. Obviously, numerous macroeconomic factors come into play. However, it’s observable that bond markets tend to underestimate the potential for catastrophic capital loss.
The day of the Hamas covert attack was Saturday, October 7. From the market close on October 6, the yield on the 10-Year Treasury fell from 4.78 to 4.63. This indicates a fear premium—traditionally, bond prices rise as yields decrease—has either been minimal or nonexistent. Similarly, the price of a barrel of West Texas Intermediate crude oil dropped from $82.79 to $75.59.
The stock market, as represented by the S&P 500, experienced a dip in late October but has since rebounded, maintaining levels similar to those on October 6.
Stocks in the defense sector, such as Lockheed Martin, have thrived during this time. Since October 6, Lockheed Martin’s stock has risen by 41 points, more than 10 percent. Prior to this date, the stock was down 17 percent for the year, but this latest surge has decreased its yearly losses to 7 percent.
Meanwhile, gold—while showing more caution than Treasuries—has increased by approximately 7 percent since October 6. Most of this uptrend occurred between October 9 and October 27, with gold prices peaking at over $2,000 per ounce, before retracting by about $50.
In conclusion, aside from gold, the absence of a discernible fear premium across other markets one month after the start of this potential war is striking. What might this indicate?
The War and Peace of Secular Market Cycles
Geopolitical disruptions often heighten the demand for gold, as threats to stability naturally challenge the reliability of fiat currencies. Those who recognize the fragile nature of monetary trust tend to prefer gold over paper money.
Currently, gold still retains some of the fear premium it gained over the last month, unlike Treasuries and crude oil. Clearly, numerous risks loom large today; all is not well.
Escalating tensions in the Middle East, fueled by monetary expansion, present significant risks. These developments would exacerbate the longstanding accumulation of financial imbalances over the last fifty years.
Many individuals either overlook or refuse to acknowledge this reality. The specter of an impending financial collapse is too uncomfortable for most to confront, resulting in widespread denial regarding the financial storm that has been brewing for generations.
Although the specifics about how and when a crisis might unfold are uncertain, dismissing the possibility is not wise.
At the core of secular cycles is human nature. Secular bull markets typically begin with skepticism that stems from the previous bear cycle. However, as the uptrend gains momentum, investors often believe it will last indefinitely. Conversely, when interest rates rise, there is a tendency to view this as a passing phase.
Recently, the upward movement in interest rates had begun to outpace itself, necessitating a pullback over the previous three weeks. This behavior has been observed repeatedly over the past three years, indicating a market that may be experiencing a short-lived illusion.
The recent spike in interest rates serves as a reminder that the overall trend remains upward.
More conflict. More currency printing. More inflation.
…this cycle of rising interest rates has several decades ahead of it.
[Editor’s note: Today’s market environment demands innovative investment strategies. Discover ways to safeguard your wealth and financial privacy through the Financial First Aid Kit.]
Sincerely,
MN Gordon
for Economic Prism
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