Investor Letter #004

Last week, Stan Druckenmiller published a Wall Street Journal op-ed titled 'The Fed Is Playing With Fire'.

In it, he explained how the Federal Reserve's policy of continued asset purchases has "enabled financial market excesses" and is threatening America's global reserve currency status.

I want to highlight a few important points he made.

Specifically, he mentioned that buying $40 billion of mortgages and $120 billion of bonds each month is an unnecessary and dangerous policy measure for the Federal Reserve, considering the fast economic recovery already under way.

With home prices and consumer spending already at all-time highs, Druckenmiller's fear is that the additional debt on the Federal Reserve's balance sheet is becoming a bigger long-term risk to both the economy and the Fed than any short-term risk of slowing down America's economy with higher interest rates.

How so?

For starters, the Federal Reserve is now the primary buyer of US debt. In the last 12 months, 54.8% of America's debt issuance was bought by the Fed. That is causing a meaningful shift in the ownership of all outstanding Federal debt.

Today, over 18% of all outstanding US debt is held by the Federal Reserve, more than at any point in the last 50+ years.

Without government support, demand for US debt would be far lower and interest rates on that debt would be far higher.

In fact, raising trillions of dollars in the last year may not have even been possible without Federal Reserve support. Private and foreign buyers are clearly showing that they don't want US debt at the interest rates the Fed is trying to maintain.

As a result, the debt being issued today is not sustainable, and is only a result of the Fed temporarily distorting interest rates.

As Druckenmiller noted in his op-ed, such price control measures have proven to be unsustainable in the past, and are even more risky given America's current debt levels.

The Congressional Budget Office released a report recently that shows how American tax revenues are being spent. In 2020, the US government earned $3.4 trillion in tax revenues, and spent $345 billion on debt interest payments alone.

Total spending came in at $6.6 trillion, resulting in a $3.2 trillion deficit, but for a second let's focus just on the interest.

At historically low interest rates, America spent over 10% of all tax revenues just to support the interest on their debt. What happens when the Federal Reserve stops buying debt and interest rates rise to their natural levels?

The CBO made some estimates in their 2021 long-term budget outlook.

They project that by 2042, debt interest payments will account for 38.4% of America's revenues. That leaves only 61.6% to fund Social Security, Medicare, and all of America's other government programs.

Of course that's not enough money left over, so the CBO is also projecting that annual deficits will exceed 60% of total revenues. Below are the CBO's detailed projections for the next 30 years with total revenues and interest payments highlighted in red.

Final Thoughts

After a record year of deficits and money printing, another 30 years of increasing budget deficits is not sustainable. This is exactly why Druckenmiller is arguing against more debt issuance.

As deficits and interest burdens rise, the pressure to inflate the US dollar to finance the debt grows larger. In turn, that threatens to dethrone the US dollar as the world's reserve currency.

If that happens, the second-order effects for the global economy are anyone's guess, but the possibility of it is terrifying.

Stan Druckenmiller even went on CNBC after his article was published, and predicted the US dollar would lose reserve currency status within 15 years.

I highly recommend watching Stan's entire talk on CNBC this week. He is one of the world's clearest macro thinkers, and the concerns he raises should not be taken lightly.

My Writing This Week

This week I wrote about how Maker is using real world assets (homes, streaming rights, inventory, etc...) to back the value of their DAI stablecoin.

I also wrote about Bitcoin's latest dip, and why I'm so optimistic about it.

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