The Buy-den Calculus
[6 minute read] Explaining the US government's aggressive attempts at staving off a hard landing for the economy. It might be too late.
Famed hedge fund manager Ray Dalio recently published an article titled “What’s Happening with the Economy? The Great Wealth Transfer”. In it, he discusses why the stock market has been surprisingly and relentlessly bullish despite the Fed’s aggressive interest rate hikes and quantitative tightening.
Dalio believes the stock market’s defiant optimism is the result of…
“…a big government-engineered shift in wealth from 1) the public sector (the central government and central bank) and 2) holders of government bonds to 3) the private sector (i.e., households and businesses).”
In this newsletter issue, I’ll try to simply explain what a government-engineered shift in wealth from the public sector to the private sector means with respect to the Biden administration’s recent actions and also discuss their economic implications. I like to call this the “Buy-den Calculus”.
The Buy-den Calculus
The two major financial institutions of the US government are the Federal Reserve (aka the Fed) and the US Treasury. While the Fed is the country’s central bank, the Treasury manages the government’s bank account.
This bank account resides with the Fed and is known as the Treasury General Account (TGA). The TGA contains the US government’s cash on hand. It’s mostly topped up by proceeds from the government selling bonds but tax revenue also helps. The TGA is drained when the government has to pay its bills, such as to fund the Federal workforce, the military, or new laws like last year’s Inflation Reduction Act.
Generally, the US Treasury likes to keep about $750 billion in the TGA as financial ballast. Think of this as the government’s “rainy day” fund.
This ballast amount is not a hard requirement, it’s more like a rule of thumb. The US Treasury has the power to spend money in the TGA whenever it sees fit.
This is exactly what happened throughout the past year as the Biden Administration brought the TGA’s balance to almost zero to stave off a government shut down from the debt ceiling.
While this had its intended effect of keeping the government’s lights on until the last minute, it also introduced hundreds of billions of $$$ into the economy and was a massive but subtle stimulus. The amount of TGA dollars that inundated the economy dwarfed the Fed’s ongoing efforts to shrink the money supply (to fight inflation).
As such, even as the Fed hiked interest rates at their fastest ever pace while shrinking its balance sheet by tens of billions of dollars each month, the stock market defied conventional wisdom and roared upwards.
Going back to Ray Dalio’s recently published article, this is what Dalio meant by “a government-engineered shift in wealth from the public sector to the private sector”.
The End Game
Everyone knows that aggressively spending down the TGA to keep the economy (aka the stock market) propped up is not a viable long-term strategy. The TGA’s balance is limited and once it’s spent, the government needs to raise more money by issuing and selling US government bonds.
This is exactly what happened once the debt ceiling was raised in June. The Treasury issued and sold new bonds to refill the TGA and meet the government’s ongoing expenses. This process pulls out money from the economy as investors convert their dollars into US government bonds.
When money from the TGA stops flooding the economy while new bond issuances pull money away, there is less of it available to buy stocks. This is bad for stock prices. By corollary it’s also bad for everyone’s retirement prospects. It’s a terrible look for our elected officials and they are mortified by bad publicity.
The Biden Administration desperately wants to avoid this painful outcome and one way it could do so is to beat down inflation, thus allowing the Fed to stop raising interest rates and stop quantitative tightening.
To the administration’s credit, it has wasted no time to quell inflation the moment the debt ceiling was raised in June. Last month, the administration’s top two policy makers, Anthony Blinken (Secretary of State) and Janet Yellen (Treasury Secretary) made surprise visits to China to repair seriously damaged geopolitical and economic relations with the Eastern economic giant. China is the world’s de facto factory and if the US government can mend economic relations, it can hopefully increase the supply of goods into the country and thus cool inflation.
Amusingly, right after Blinken and Yellen’s China visits, the Pentagon swiftly declared that the infamous Chinese balloons that were shot down while flying over the country did not contain any spy equipment.
In theory, appeasing China to stave off inflation is a good idea. In practice, relations have been undermined so many times over the past few years that it’s a tall task to win China over. China is irrevocably fed up with the US’s aggressive foreign policy and the US government’s fiscal health is deteriorating rapidly. Time is running out.
Government Financial Crisis
It’s become more and more evident that the delayed costs of the pandemic’s wanton money printing and debt issuance are suddenly coming to bear for a hapless administration. Major warning signs for a financial crisis in the US government are appearing.
For one, the government’s interest payments are skyrocketing. Last year, the government paid almost $1 trillion to service its debt. This is almost double what it paid annually just before the pandemic.
Last week, a major credit rating agency (Fitch) brazenly downgraded US government debt by a notch from AAA to AA+. Although the scale of the downgrade appears small by itself, doing it to US debt is monumental and extremely rare. This has happened only once before when S&P downgraded US debt in 2011.
Finally, many highly respected and ultra successful macro-focused investors have come out of the woodwork to warn of the government’s worsening fiscal situation. They include Ray Dalio (mentioned at the start of this newsletter issue), Bill Ackman, and Stanley Drunkenmiller.
Bill Ackman recently tweeted that he was shorting 30-year US government bonds. Although never one to shy from publicity, Ackman rarely “talks his book” in public and seems to only do so during pivotal moments for the market. In the same tone as Ackman, Stanley Drunkenmiller had this to say about the government’s dismal fiscal trajectory:
“Secretary Yellen drew down the TGA. That’s basically the Treasury savings account from 700 billion to practically nothing last week. That also ended up in non issuance of government debt. So that was a big boost to liquidity. All that is set to change. Now.
TGA is gonna go the other way. So you’re gonna have probably about 800 billion in Treasuries issued between now and year-end, the Fed will be continuing QT, you’ve got the student loan thing, which I think has kept consumption up, that’s all changing in September.”
Needless to say, Drunkenmiller is not a near-term optimist.
Fin
With inflation nipping at the economy’s heels, soaring government interest payments, and shattered relations with its largest trading partner, the US government is financially stuck between a rock and a hard place. It’s not a stretch to say that a storm is brewing on the horizon.
Caution is advised.