Nassim Taleb is a very smart man. He traded his way to wealth through options and derivatives. And his books have changed the way millions of people think about risk, fragility and probability.
You may have heard of his best-seller The Black Swan. It was published in April 2007 – months before the global economy began to crash. And it argued that the risk models used by financial institutions and lenders were faulty and would result in a crash.
He was right. Wall Street’s risk models were horribly flawed. They severely underestimated the chances of house prices falling. And they gave everyone a false sense of security. Taleb did very well on his bearish financial bets.
Today, Taleb is one of the few voices warning of another, larger debt crisis to come. In a recent interview with Bloomberg, he explained why more chaos is inevitable. (I am paraphrasing in some places.)
Where is the vulnerability? Is the world more fragile today than it was in 2007?
Of course it is. [The problem today] is absolutely the same disease [debt]. If you put novocaine on cancer, what happens? The patient won’t get better. He’ll feel better, but he won’t get better.
What was 2007? A debt crisis. We have more debt today… You don’t get a free lunch.
I strongly suggest watching the entire interview. It’s a sobering look at the sorry state of our financial affairs. Taleb notes that since the last crisis, debt has surged at the consumer, corporate and, especially, governmental levels. We papered over a debt crisis with more debt.
He points out that the U.S. government will pay more than $300 billion in interest on its debt this year. And rising interest rates will only increase those payments as the government rolls over its debt.
The United States Treasury is on pace to issue $1 trillion of debt just this year… And the already bloated deficit grew by 17% in the last fiscal year.
Taleb compares it to a giant Ponzi scheme:
It’s like a [Bernie] Madoff scheme, when you have to borrow more and more to pay interest. A Madoff scheme is when you have to borrow to pay off creditors. The minute you enter that phase, there’s nothing healthy about it from an economic standpoint.
Taleb’s not saying anything earth-shattering here. It’s a cold analysis of an ugly situation created by out-of-control government spending and corruption. He’s just one of the few prominent voices with the intestinal fortitude to say it.
Taleb says that real estate could be the first shoe to drop, particularly high-end real estate. And indeed, real estate is vulnerable to higher interest rates.
He hints that one of the “miracles” that could save us is significant inflation, which somehow doesn’t adversely affect the economy too much. But he sort of laughed when he said it. Sustained inflation is never pleasant.
Taleb is especially concerned that debt is becoming a problem while we’re still in a very low interest rate environment.
I am too. And I continue to believe the Fed will eventually need to send interest rates even lower, possibly to negative territory. Nobody wants a housing downturn or falling stocks. And if the Fed keeps hiking rates as it has been (and is supposed to do) recently, that’s almost certain to happen.
The Fed’s admitted interest rate strategy has been to create a “wealth effect” by keeping rates low, which pushes stocks and other assets up. Everyone feels wealthier, so they spend more.
Will it abandon that strategy now and let the wealth effect fade and reverse? I don’t see it. The pressure on it to loosen rates up again will be tremendous.
If equity and real estate markets get hit hard – which will probably happen if rates get back to 5% – everyone will be begging the Fed to lower rates and eventually restart quantitative easing. CNBC’s Jim Cramer is already screaming at the Fed to pause rate hikes so stocks don’t go down. So is President Trump.
At some point, I suspect inflation will be welcomed by the Fed, at least privately. Sustained inflation would start to erase the debt by devaluing the currency. I think inflation may be viewed as the “least bad” option.
Hey, we’ve got to get rid of the debt somehow! This is just one of the ways it could play out, and it may take 10 or even 30 years to do so. But debt crises are pretty much inevitable with a trajectory like this.
I’m sure the Fed will be very creative in trying to save the situation, but it’s not a wizard. The Fed’s toolbox is very limited. I think the eventual solution will involve a lot of money printing, debt monetization and, ultimately, inflation.
It’s not pretty, but it’s how I see it over the very long term.
This is the ultimate reason to own – and learn about – decentralized currencies like bitcoin. This is why people are building alternative financial systems. Many of us think the global debt bubble will eventually spiral out of control. If it happens, a lot of people will be looking for alternatives to fiat money.
It sounds crazy, but in the near future these issues are going to come to a head. We’ll be paying more than $1 trillion in interest per year before too long. It’s utterly unsustainable.
Now is a good time to start thinking about hedges – like crypto – against the traditional monetary system.