Change comes at a price. The US electorate voted to go in a different direction from the prevailing policies of the past 30 years. Moving forward, the US will focus on enriching the US economy at the expense of the global economy but it will prove costly for many because changing directions means losses for those who are still investing for the old cycle.
The old cycle represented a triumph of capital over labor. US workers lost all bargaining leverage with US companies thanks to off-shoring much of our manufacturing operations to emerging economies of the world, saving the most profitable operations for the developed world. We can see this in the following chart that reflects labor’s declining portion of GDP, or gross domestic product.
This is the reason why the border has been open for four years, since the end of Covid when fewer Americans returned to the workforce. Not wanting to experience a shortage of labor nor an economic downturn, the decision was made surreptitiously at the top of the US government to open our southern borders and allow unfettered immigration. This allowed the government to spend VERY aggressively to keep economic GDP expanding while preventing widespread labor inflation that would have forced the Federal Reserve to move interest rates even higher.
The Biden Administration succeeded in keeping the economy expanding but failed to keep consumer prices in check. It appears that the people harmed the most by these policies voted for a different set of policies and that is why we’re at the end of this great market expansion. But it’s not just happening in the US, Canada and Europe are experiencing similar populist movements that promise to give Labor a higher share of the economic pie and that won’t be good for the stocks and bonds of economic entities that profited from the past cycle. Our portfolio is structured to profit from this change.
US Economy
Today’s US economy is akin to a body builder strung out on steroids – the muscles are impressive but the overall health is poor. It’s normal for the party in power to spend aggressively in an election year but the Biden/Harris Administration went far beyond normal electioneering. It’s the reason why consumer inflation has remained elevated and the debt has exploded from $27 trillion when Biden took office to $36 trillion today.
The chart tells the story up until July 2024. We’ve since added another $1 trillion to debt over the past six months. When we consider that strong factions in the Republican Party are against adding further to debt, it’s realistic to expect deeper spending cuts by the incoming administration to pay for its initiatives. Furthermore, deeper spending cuts will result in a deeper initial economic downturn than many expect.
If we go by campaign promises, the new administration will look to reduce the size of the federal government while expanding investment in the private sector. To succeed, the incoming president will need extremely low interest rates. The problem is that it will take a sharp decline in the economy to force the Federal Reserve to cut rates.
A sharp decline in the economy is inevitable regardless of who occupies the White House. The folks in both parties who have been in-charge have gotten every drop of economic activity out of their policies over the past 30 years but the rise in consumer inflation reflects policies that no longer work for the US population. The old cycle is over; it’s time for a new cycle. The political situations in Canada and across Europe tell us that voters across the developed western economies have reached the same conclusion.
China
The western policies of the past 30 years have depended on the flow of cheap goods from China, especially in electronics. Cheap consumer goods were the trade-off to Labor that made losing their manufacturing jobs more palatable. It was a short-sighted strategy.
I’ve been writing about the economic problems in China for over 10 years and now China’s economic collapse has started. I’ve been showing you the chart below for years and I said that when the value of the Chinese yuan falls below 0.137 yuan to the US dollar, the Chinese economy would collapse. It’s happening.
Unfortunately, our supply-chain is still dependent on this broken nation and it’s going to take years to shift to other sources for what we buy. It’s entirely possible that key sources of electronics and automotive parts simply go out of business without warning, such is the lack of transparency in this Communist state.
The potential invasion of Taiwan is a second major risk for the global supply chain. The Chinese Communist Party is in a desperate situation. The Chinese people are tired of communism making their lives miserable and have been expressing their frustrations over the past two years. Furthermore, efforts to fix the Chinese economy continue to fail because the problems are structural, not cyclical.
Invading Taiwan may prove to be a “Hail Mary” by the CCP to remain in power. They have already started building the barges necessary to move heavy equipment across the Taiwan Strait. Removing Taiwan from the global supply chain would prove to be devastating because Taiwan Semiconductor is the preeminent chip producer in the world.
Ultimately, I expect China to amass their invasion forces in Fujian and attempt to bluff their way to victory without firing a shot much like Hitler annexed Sudetenland in 1938. Success will depend on the resolve of the US.
Bond Market
The bond market seems to be convinced that the new administration is going to borrow and spend aggressively; I expect the opposite. The chart below reflects this fear.
To revive the private sector in the US, interest rates need to drop dramatically. This will be possible once the last-minute spending by the Biden Administration is exhausted, allowing consumer inflation to begin to decline. Based on this, I believe current levels of the 10-year Treasury represent a potentially lucrative entry point.
Yes, Fed Chairman Jay Powell has expressed his reluctance to cut interest rates further but he’s basing his decisions on the past year of extraordinary levels of federal spending which correlate closely with consumer inflation. Some fear the inflationary potential of trade tariffs but the 10% rise in the value of the US dollar since September has nearly cut the impact of prospective tariffs in half. Exporters are likely to eat the rest themselves. Such is the state of global weakness.
The cupboard is bare for the new president; his own party won’t allow him to spend aggressively and we’re facing a sharp global economic downturn. Before the end of the second quarter of 2025, the Fed will likely be taking a machete to interest rates. Locking in bond purchases near 5% looks like a potential windfall of positive returns in an otherwise ugly environment.
Deflation is gaining across the globe. China is leading the charge with the sharp decline in their housing and stock markets. Emerging economies, in general, are close to failure. They all have dollar-denominated debts that they can’t service. It will ultimately hit the US before long which is why I expect 0% interest rates once again. Even the Swiss Central Bank has warned that they a prepared to bring rates down to 0% in 2025 if economic pressures continue.
Bitcoin and the BRICS
Everyone wants to be a bitcoin trader these days but it really is nothing more than imitation electronic gold. I suspect it will work for individuals in emerging economies that fear devaluation of their local currencies but I don’t believe it has the potential to replace national currencies for a simple reason – it requires fiscal discipline. If global leaders want fiscal discipline, then it would be relatively simple to return to a gold standard. The problem is that economic systems are incapable of such discipline because the whole system is built on the expansion of money supply. Limit money supply and half or more of your country returns to poverty.
The BRICS nations, which include Brazil – Russia – India – China – South Africa are all fiscally irresponsible, except for Russia when it’s not at war. All the rest need to grow money supply to stay ahead of deflation.
Look at India which presently has the strongest economy of the group. Here’s the value of the Rupee versus the US dollar – a rising value against the dollar means the value is falling.
In 2011, it took roughly 45 rupees to equal one dollar. Today it takes 87. This represents a hefty devaluation that is only getting worse. If I lived in India, I would be hoarding gold, bitcoin, and US dollars wherever possible. It’s the same for the rest of the nations in BRICS as well as most emerging nations.
As it pertains to bitcoin and other cryptocurrencies, my biggest fear is that the growing secular trend towards deflation removes the impetus for obtaining bitcoin because deflation involves money supply contraction. Money supply contracts when previously valuable assets fall in value, reducing the banking systems ability to lend against the asset. This is happening in China today and I believe it will likely impact the rest of the world before long.
The GeoVest Approach
Change brings opportunity. It doesn’t matter if the change is good for everyone or difficult for everyone, there are still ways to profit. We proved this in 2008.
The stocks and bonds we own for clients are the right investments for the present climate which is why we are hopeful for a good year despite the challenges. French scientist Louis Pasteur once said: “fortune favors the prepared mind.” If you have been reading this missive for years, you’ll know that we have done our homework.
Part our preparation was in acknowledging our need to bring on another seasoned professional to join the GeoVest team. I would like you all to welcome Paul Hurley who brings 40 years of banking experience to the firm. He is also a fellow alumnus of the University of Rochester’s Simon School of Business.
The United States enjoys the most favorable economic position in the world as we approach this new economic cycle. The key to future success is to switch gears in our thinking about investments and to focus on the industries and regions that are ready to lever their advantages for producing capital gains. You can see more of our work on this subject by visiting www.geovestadvisors.com and reading the pieces filed under the “2nd Derivative with GeoVest” section as well as the longer version of the newsletter. Thank you and it is our continued pleasure to serve you.
Philip M. Byrne, CFA
