Facing Fiscal Reality: Navigating the End of the Debt Supercycle

The following article is based on our recent Big Picture podcast, Taxes and Inflation: The Final Stages of the Debt Supercycle, with Financial Sense Wealth Management President and Founder Jim Puplava.

Introduction

The past decade has seen unprecedented levels of deficit spending and debt accumulation by the US government. According to the data, this unsustainable path will eventually lead to fiscal and economic crises if left unaddressed. As the eventual problems come into clearer focus, prudent Americans would be wise to understand the challenges and start preparing proactively. In this article, we will explore the current state of affairs in the United States, analyzing the growing debt, the impact of deficits on GDP growth, and the impending need to address these issues. Additionally, we will discuss the potential implications for the Federal Reserve and the Treasury, as well as strategies individuals can employ to prepare for the future.

US Debt Rises by 50% in Four Years

One of the key concerns in the United States is the rapidly growing debt and its impact on the economy. Debt and interest expenses are increasing at accelerating rates, outpacing GDP growth. Consider this: in 2019, US national debt stood at $22.72 trillion and, as of today, US national debt now stands at $33.8 trillion. That’s an increase of over $11 trillion in just four years. Or, said another way, since 2019 the US national debt has risen by 50%. This surge in debt has resulted in the US debt-to-GDP ratio reaching 122% today, compared to 55.3% in 2000. In fact, debt is now growing at twice the rate of GDP growth during this period.

us national debt
Source: FiscalData.Treasury.gov

Increasing Budget Strains

US spending is a significant contributor to the growing debt. The government spent approximately $6.301 trillion in fiscal year 2023, with major allocations for Social Security ($1.5 trillion), Medicare ($1.4 trillion), Defense ($830 billion), and interest payments, which previously came in at $690 billion but are quickly rising towards $1 trillion as US debt gets rolled over at significantly higher interest rates. Because total tax revenues only amounted to $4.4 trillion, this left a significant gap between spending and revenue. This necessitates borrowing to fund government operations, as well as the payment for wars and other expenses. Similarly, with 10,000 baby boomers retiring each day into the end of this decade, mandatory spending programs will face even greater strains in the years ahead.

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US Debt Market Volatility

Historically, the US has relied on foreign buyers to purchase its debt. However, since 2014, this trend has shifted, and the government has had to find alternative methods to finance its deficits. Changes in laws governing banks and money market funds made it more favorable to buy US debt, which resulted in significant Treasury holdings across the banking system. Nevertheless, with the Federal Reserve’s sharp increase in the fed funds rate from zero to 5.5%, this led to substantial losses on bank’s US treasury bond portfolios. To prevent potential bank runs after the collapse of Silicon Valley Bank and Signature Bank in 2023 (the second and third largest bank failures in US history), the Fed quickly responded with emergency support. This helped to prevent a wider crisis from forming, however we’ve seen a higher-than-average amount of volatility in the US Treasury market as massive amounts of US debt continue to flood the market.

Fed and Treasury Dilemma

The Federal Reserve and the Treasury face a challenging dilemma. Higher yields on US bonds result in a stronger US dollar, forcing foreign central banks to sell treasuries to buy oil and defend their currencies. However, the government cannot sustain interest rates of 5-6% due to the large amount of debt maturing at this level. This situation has prompted discussions about potential debt crises between 2025 and 2028, where the Federal Reserve may need to monetize the debt and initiate yield curve control. Such actions could lead to higher inflation and a devaluation of the US dollar.

Impending Tax Increases

Given the growing debt and the need to address budget deficits, massive tax increases seem inevitable. If President Biden wins re-election, these tax hikes could begin as early as 2025. Proposed tax changes include increasing the top tax rate from 37% to 39.6%, reducing estate tax exemptions, raising corporate taxes from 21% to 28%, and imposing higher capital gains taxes on high-income earners. Additionally, lifting the cap on Social Security earnings, raising the Medicare surtax, and increasing both Social Security and Medicare tax rates are being considered. These changes could significantly impact wealthier Americans, with potential tax rates reaching levels not seen since World War II.

If no changes are made to current tax legislation, here is a table of what current tax rates will revert to once Trump’s tax cuts expire at the end of 2025:

2017 tax rates
Source: SmartAsset.com

Preparing for the Future

In light of these potential challenges, individuals can take several steps to prepare for the future. Accelerating Roth conversions before 2026, especially for those with large IRAs, 401(k)’s, or pension accounts, can be advantageous. Utilizing the current estate tax exemption by setting up exempt trusts and wealth replacement trusts can help mitigate potential estate tax burdens. Building a laddered municipal bond portfolio, investing in hard assets such as real estate, commodities, precious metals, and cryptocurrencies like Bitcoin, and focusing on dividend aristocrats that can weather inflationary pressures are also potential strategies.

For low to middle-income taxpayers, strategies include purchasing hybrid vehicles to offset potential increases in gasoline prices driven by environmental policies. Transitioning from interest income to dividends may also provide tax advantages, and relocating to low-tax or no-tax states with a lower cost of living is another viable option. Additionally, opting for natural foods over processed alternatives can promote healthier living while saving money. Lastly, given the increasing price of gold, consider investments in silver as a more affordable alternative in providing a potential hedge against inflation.

Conclusion

The United States is currently navigating the final stages of a debt supercycle, with rising deficits, growing debt, and the potential for higher taxes and inflation on the horizon. Understanding the implications of these factors is crucial for individuals and policymakers alike. By taking proactive steps to prepare for the future, such as implementing tax-efficient strategies, diversifying investments, and making informed lifestyle choices, individuals can position themselves to mitigate the potential impact of these economic challenges. It is essential to stay informed and adapt to the evolving financial landscape to safeguard personal finances and long-term prosperity.

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This material has been provided for informational purposes only. Financial Sense does not provide tax, legal or accounting advice and this is not intended as such. Prospective investors and clients should consult with their own tax, legal, accounting or other advisors to determine the potential benefits, burdens and other consequences of engaging in a particular strategy or transaction.

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