THE BURDEN OF TARIFFS AND DEBT

Tariffs 

    Donald Trump has embarked on his "tariffs are the most beautiful word in the dictionary" program. Every business that brings a product or service to the market incurs costs in doing so. That includes labor, materials, insurance, equipment, shipping, taxes and many other expenses. If tariffs are added to the cost, someone must pay that cost. Trump assumes it will be the foreign exporter. While the exporter may choose to assume a portion of the cost, it is inevitable that most, if not all, of the cost will be passed on to the consumer either directly or indirectly. We noted in our September issue, 

[Trump] promises to impose tariffs on all imported goods. This additional cost will be passed on to the consumer in the form of higher prices. Tariffs have the pernicious effect of elevating all prices because the local producer can now raise his price to just below the now-higher cost of the imported good. Result? Consumers are left with fewer choices and higher prices - a "lose-lose" outcome.

    The Wall Street Journal had a sudden epiphany in a February 4th story titled "Tariffs Enable Steelmakers to Hike Prices."

Steel prices started rising for some U.S. companies even before President Trump announced tariffs on Canada and Mexico. Executives said they are bracing for more to come.... The duties are expected to strengthen U.S. steelmakers' pricing power by effectively raising prices for foreign steel - and enabling domestic companies to raise their own prices, too. Executives from U.S steel companies were enthusiastic backers of the 2018 tariffs and have urged Trump to deploy them again.

Many US consumers are in no position to pay these higher prices. Their real wages have not kept pace with inflation. Nearly 14% of Americans rely on food banks for their food security.  Here are rises in a variety of food costs December 2019 to December 2024.

    Source: Bloomberg via Zero Hedge

Mark Zukerberg and Elon Musk will not feel the pain of these price increases. But millions of working families will and they are being forced to load up their credit cards to pay such daily expenses. Eleven percent of card holders pay just the minimum balance on their cards causing their balances to soar due to high interest rates. The next chart shows the growing number of credit card defaults that resulted in $46 billion of losses to card issuers - in just the first three quarters of 2024. That is the highest default rate in fourteen years. The card companies will have to make up these losses with yet higher fees. Some banks now charge an extortionate 23.24% on unpaid balances. 

     Source: Financial Times via Zero Hedge

Government Debt

    We write frequently about soaring government debts. We do so to warn of the inevitable crisis to come. Ray Dalio, founder of the world's biggest hedge fund writes extensively about the economy and the looming debt crisis. You can read excerpts from his soon to be published book "How Countries Go Broke", on LinkedIn. Here is a short quote,

What has timelessly and universally (i.e., throughout the millennia and across countries) driven the Big Debt Cycle changes and has created the big debt and economic problems is the creation of unsustainably large amounts of debt assets and debt liabilities relative to the amounts of money, goods, services, and investment assets in existence. This always has and inevitably will always lead to big debt crises and “runs” on banks. The debts are almost always monetized, by which I mean that it is almost always the case that the central bank creates a lot of money and credit to make it easier to pay back the debt, which devalues the money and debt. During these times, we almost always see that it becomes relatively undesirable to hold the debt assets (i.e., bonds) for long relative to holding other storeholds, such as equities and gold, which don’t lose buying power when the value of money goes down.

Dalio used the following analogy to describe the problem.

The debt problem is like a medical condition, using a circulatory system metaphor. Just as plaque builds up in arteries, debt accumulates and "constricts the circulatory system" of the economy. The longer you wait to address it, the more dramatic the intervention must be.

    This chart shows that the US has run up a staggering $36 trillion of debt creating a monster, trillion-dollar annual interest expense. The Congressional Budget Office projects the debt will soar another $24 trillion over the next ten years. (Beware: the CBO has historically underestimated the growth of this debt.) Annual interest payments on that debt at 5% would be $3 trillion. Note that Treasury's total receipts in FY 2024 were just $4.92 trillion. Thus, the coming Big Debt Cycle crisis.

As government expenses continue to exceed revenues, the difference is made up with more government borrowing. The US' debt-to-GDP ratio now exceeds 123%. Historically, ratios over 90% have preceded fiscal crises.

    The traditional way governments address their out of control expenses is to print money in an effort to avoid a default. That has a predictable result. This chart shows the loss of purchasing power of the US dollar since the creation of the Fed. There is no reason to believe this trend will change before the fiscal crisis described by Dalio arrives. He reminds us that from 1966 to 1984, the nominal value of stocks rose - but their inflation-adjusted value was negative and you paid capital gains taxes on that nominal, but negative (fictitious) gain.

  Dalio warns that throughout history failing governments always resort to asset confiscations from the people - typically through a multiplicity of high taxes and devaluation of the currency.  He believes that stocks in solid companies producing essential goods and services, and gold, are the traditional methods to avoid being crushed during the threatened "reordering" of accumulated debt. The opening photo of King Tut's golden mask (made in the year 1323 BC) reminds us that gold has been revered as a store of value for thousands of years. The next chart shows that a growing number of people are now looking for a safe haven for their depreciating money and finding it in gold. 

                                    Source: Weiss Ratings

This next chart gives a longer view of what has been happening with gold and the US economy. The blue line shows the percentage growth rate of the price of gold since 2000, the red line shows the growth of the S&P 500, and the black line shows the tepid growth of US GDP.

                                Source: Bonner Private Research

    A fair question is whether this dramatic increase in the price of gold is sustainable. Is gold at risk of "returning to the mean" as do overpriced stock, real estate and other assets from time to time? We think the next chart answers that question. It shows the relentless rise of consumer prices as calculated by the US government (which we assert significantly understates inflation for political purposes). As the dollar continues to be devalued by the government, the price of gold rises to reflect that devaluation. 

    The problems facing the US economy can be viewed in many ways. For example, the US balance with its trading partners is shown below. The 2024 combined goods and services trade deficit was $918.4 billion. The deficit for goods alone was $1.21 trillion. Some argue that the US benefits by importing valuable goods and exporting a devaluing dollar. However, those dollars do not remain in limbo. They return and purchase real estate and other US assets, causing those prices to rise further, to the disadvantage of local buyers.

        Source: Wolfstreet.com

This chart shows the US trade deficits with its largest trading partners. 

        Source: Wolfstreet.com   

    Not so long ago, the US was the world's major producer and exporter of goods. That is no longer the case. The US now produces just 15.9% of global output and China produces 31.6%. This chart shows the abrupt reversal that took place between 1995 and 2023. 

                    Source: New York Times

Americans cannot afford their government 

    Love him or loath him, Elon Musk's DOGE crew has succeeded in disclosing highly questionable use of taxpayer's money. USAID is just the first place he looked. What he found will infuriate many taxpayers. David Stockman summarized a few of the ways USAID has spent taxpayer money.

$1.5 million to advance diversity, equity, and inclusion in Serbia’s workplaces and business communities.

$70,000 for the production of a DEI musical in Ireland.

$2.5 million for electric vehicles for Vietnam.

$47,000 for a transgender opera in Colombia.

$32,000 for a transgender comic book in Peru.

$2 million for sex changes and LGBT activism in Guatemala.

$6 million to fund tourism in Egypt.

Hundreds of thousands of dollars for a non-profit linked to designated terrorist organizations, even after an inspector general launched an investigation.

Millions to EcoHealth Alliance, which was involved in [Covid] research at the Wuhan lab.

Hundreds of thousands of meals that went to al Qaeda-affiliated fighters in Syria. 

John Mauldin adds,

$2 million for Moroccan pottery classes.

$11 million to tell Vietnam to stop burning trash.

Payments for transgender programs all over the world.

DEI programs all over the world

$8 million to Politico, large amounts to the BBC

Hundreds of millions of dollars to build schools and other theoretically good projects that Google maps shows either don’t exist or, that onsite inspection shows are abandoned or shoddily built. 

     Most Americans are very proud when they see on the news the off-loading of large sacks of rice and flour, with US flags printed on them, being delivered to foreigners suffering from earthquakes, floods, drought or other natural catastrophes. It is what we thought USAID was created to do. It turns out that this unelected, unsupervised, agency has gone rogue. No American voted for these programs nor did any Congressperson. The agency has been able to get away with this for years because the government is so vast that no one knows what many parts of it are doing. Why is the US taxpayer financially supporting Politico, AP, Reuters, Bloomberg, the BBC and countless NGOs (non governmental private entities)? The worst part is that the vast amount of money spent by USAID never finds its way to people in need. It is siphoned off by legions of administrative intermediaries. This chart shows, in black at the bottom, the amount that is actually finding its way to recipients.

     What DOGE has revealed to date is just the tip of an enormous iceberg of waste, fraud, corruption and mismanagement. The insider elite, who gain power and profit from the massive taxpayer funded government, will resist every effort to disclose to the public what has been going on. USAID is just the beginning. The US Defense Department (that consumes hundreds of billions of dollars each year) has failed to produce a Congressionally-mandated audit of its expenses - for the last seven years! Back in 2001, it was unable to account for $2.3 trillion in accumulated "untracked expenses" making up more than a third of the then, $5.8 trillion national debt. By 2016 a Pentagon inspector general estimated that the figure had risen to $6.5 trillion for the Army alone. In 2017 a Michigan State economist calculated that just between the Pentagon and HUD (Department of Housing and Urban Development) the figure was close to $21 trillion in unaccounted for expenses. That equals two-thirds of the entire national debt.

    Like in many western nations, the US government has grown like a giant cancer. It is so massive that oversight of its activities is impossible. Theoretically, Congress should be riding herd on all government agencies and their activities but the fact is that Congress is itself utterly dysfunctional and cannot even perform its basic function of passing a budget. Does the US really need three million people to run the national government? The US founding fathers created a federal government with very limited functions - with all remaining powers retained by the states. That has been turned on its head with the federal government now insinuating itself into every aspect of its citizens' lives. It is unsupervised, increasingly totalitarian, and needs to be drastically reined in. It will take a strong leader and an informed, demanding public to accomplish that herculean task. Failure is not an option. The ship of state has been taking on water for decades. 

Conclusion

    The world has advanced dramatically to the great benefit of mankind. In 1820, 90% of the global population lived in extreme poverty. Today that number is 9%. That is a remarkable achievement. We need to remember how that was achieved. For example, the transformation of the US from a poor, agrarian, frontier economy to a world power was accomplished through the hard work of innovators, entrepreneurs and workers - not by an army of government bureaucrats sitting in remote offices issuing an endless flurry of dictates affecting both big businesses as well as the thirty four million small businesses in the US that employ nearly half of the entire workforce. Government bloat is sucking the life out of the US economy and steadily impoverishing its workers. It now consumes nearly a quarter of the nation's entire GDP - and that percentage continues to grow. If that is not reversed, the US will face the national bankruptcy described by Ray Dalio.

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