The Fiscal Trap: Why America’s Debt Spiral Shows No Signs of Slowing

Lost in politics as a combat sport where one side "wins" is the fact that the United States is going off a financial fiscal cliff.

Our national debt is around $35T - which increases by a trillion dollars every 100 days or so.

Despite calls for fiscal responsibility, the probability of reducing the nation's staggering deficits anytime soon is practically nonexistent.

This financial reality carries significant investment implications, underscoring the challenges of managing a portfolio in such an environment.

The Congressional Budget Office (CBO) projects persistently high deficits for the foreseeable future, assuming an optimistic scenario with no recessions.

Even under these rosy assumptions, the U.S. is on track to add over $20 TRILLION in public debt over the next decade.

In reality, the situation is likely to be even worse, with deficits typically ballooning during economic downturns.

One key reason for this bleak outlook is the concept of fiscal dominance, where fiscal policy—deficits and public debt—exerts more influence over the economy than monetary policy.

As deficits grow, they start to limit the Federal Reserve's ability to manage inflation and unemployment effectively, creating a vicious cycle where fiscal policy overshadows the Fed's actions.

This isn't a new phenomenon.

The U.S. has been on this path for decades, but the problem has accelerated in recent years.

Social Security, for instance, was designed during a time of rapid population growth.

Today, with an aging population and fewer workers supporting each retiree, the system is unsustainable without major reforms.

Similarly, healthcare spending continues to rise, driven by inefficiencies and the increasing prevalence of chronic conditions like obesity and diabetes.

Military over-spending exacerbates the problem. According to the Peterson foundation, the US accounts for 40% of global expenditures and is more than the next 9 countries combined.

As interest rates have risen, the proportion of our GDP dedicated to servicing the debt has dramatically increased.

This leaves little room for maneuver, as any significant fiscal tightening risks tipping the economy into recession.

Given this environment, investors need to be cautious. While equities and scarce assets may perform well in nominal terms, the real returns may be underwhelming.

Bonds, particularly long-term government debt, seem less attractive given the inflationary pressures and rising debt levels. Instead, defensive assets like T-bills, inflation-protected securities, and gold may offer better protection in this uncertain landscape.

The bottom line is clear: the U.S. is locked into a debt spiral with no easy exit. For investors, this means navigating a landscape where traditional strategies may need to be rethought. The fiscal dominance of today will likely continue to shape the markets for years to come.