The End of a Dream

Unbeknownst to economists, the Keynesian bedrock of modern economics — using financial repression and government spending funded by debt to manage the business cycle of growth and recession — is an artifact of a century of expansive cheap energy and virtuous demographics.

Presented as quasi-scientific “laws of economics,” Keynesian policies of suppressing interest rates and funding stimulus with debt were only possible in an era in which energy per capita always became more abundant and affordable in terms of the purchasing power of wages, i.e. how many hours of labor does it take to buy the energy to fuel a vehicle, prepare a meal, etc.

The demographics of the 100 years of Keynesian supremacy were also uniquely favorable.

The workforce paying taxes and funding pay-as-you-go social benefits to retirees (Social Security and Medicare) and the less fortunate (welfare, Medicaid) expanded smartly decade after decade, expanding government revenues and spending as the natural result of an expanding workforce.

A third uniquely favorable condition was the vast pool of natural capital that had not yet been financialized, i.e. turned into a commodity that could be used as collateral for new debt and leverage. Tapping this untapped pool of capital enabled the vast expansion of debt, public and private.

A fourth uniquely favorable condition was globalization, a benign-sounding term for the brazen exploitation of the planet’s remaining reserves of resources and cheap labor. Profits swelled as these last pockets of easy-to-exploit sources of wealth were tapped.

These four conditions have all topped out and are now reversing.

The End of the Road

The cheap-to-access energy has been consumed, the workforce has shifted from expansion to stagnation while the populace of retirees explodes, globalization has run its course, having stripmined the planet and human populace, and every potential source of new collateral has been financialized/leveraged to the hilt.

Keynesian policies of pushing interest rates to near-zero to boost private debt and government deficit spending morphed from being “emergency policies” to permanent status quo.

Given that greed and laziness are the human default settings, it was always unrealistic to think that the “emergency tools” of borrow-and-spend would be reserved for recessions/depressions.

Now consumption, private and public, depends entirely on the permanent expansion of debt to fund not only consumption but the rising costs of servicing the ballooning debt.

The Keynesian fantasy always rested on one dynamic: We can expand production and consumption faster than we’re expanding debt and the cost of servicing that debt.

With the four virtuous conditions now reversing, the cost of debt is rising far faster than the tepid increases in production and consumption generated by debt-funded spending.

The Fantasy of Free Money

The final desperate trick of the Keynesian fantasy is the wealth effect generated by speculative credit-asset bubbles, in which assets that were once grounded in utility and costs escape gravity and soar into the stratosphere, generating trillions of dollars in “free money” for those fortunate to have bought the assets before the bubble inflated.

The consumption afforded by this bubble-generated “free money” was the last source of Keynesian “growth”: Just suppress interest rates to juice private borrowing, flood the financial system with liquidity and voila, trillions in unearned “free money” flows to those who were already rich enough to own the assets catapulted to the moon.

But all dreams end, even the Keynesian one. The risks and costs of rising debt cannot be dreamed away, and the inevitable result is the cost of capital rises along with the risks and costs of soaring debt.

Bubbles inflated by policies encouraging speculative leverage all pop, devastating those who thought the “free money” would never end.

The Return of Reality

The planet has already been strip-mined of cheap-to-access resources and cheap labor. Costs are rising and playing financial games with interest rates can’t reverse real-world costs or the rising costs of capital.

Demographics can’t be reversed by financial trickery, either.

The Keynesian fantasy is drawing to a close. Financialization and endless debt-funded stimulus were artifacts of four unique conditions (cheap, abundant energy; demographics; globalization; and financialization) that have all topped out and are now sliding down the backside of the S-curve. AI can put lipstick on the mirror but it is incapable of reversing the endgame decay of these four unique conditions.

Since there’s no alternative to the Keynesian dream of eternal “growth” funded by magic, we’re doing more of what’s failed until the system collapses in a heap: We’ll do more of what’s failed until it fails spectacularly.

It’s worth recalling Peter Drucker’s observation that enterprises don’t have profits, they only have costs. The same can be said of governments and entire economies. Borrowing to pay rising costs has a short half-life because debt accrues its own costs and piles up risks which have their own uniquely asymmetric dynamics.

Where does that leave us?

Three Options

There’s a make-or-break financial fork in the road ahead for the United States. There are only three options:

  1. Slash trillions of dollars in annual federal spending to align with current tax revenues.


  1. Raise trillions in additional tax revenue from the only entities able to pay more, corporations and the top 5%.


  1. Monetize the soaring federal debt by the central bank “printing money” and using this new money to buy Treasury bonds, as issuing new Treasury bonds for sale is the way the federal government funds its stupendous deficit spending.

One approach might be to do some of each, but there are political obstacles to any rational response to unsustainable federal debt expansion.

Any cuts in spending large enough to be consequential will slash-and-burn either the cash overflowing in the federal trough that politically powerful cartels are gorging on, or entitlements that buy the complicity/passivity of the general populace. Neither is politically viable.

Those who can afford to pay more taxes — corporations and the top 5% — are (surprise) the most politically powerful groups in the nation, and they will never accede to tax increases high enough to be consequential.

Politically, the only viable option is the politically painless one of monetizing the soaring federal debt via the Federal Reserve creating $2 trillion a year with a few keystrokes and using this $2 trillion to buy virtually all the newly issued Treasury bonds.

If private owners of existing Treasury debt find the yield they’re receiving doesn’t even keep up with inflation, they will sell their Treasuries, forcing the Fed to print additional trillions every year to monetize portions of the existing $30 trillion in debt.

Since capital flows to the highest and lowest-risk yields, yields have to rise to attract private capital. This creates another problem: As yields rise, so does the interest paid on the entire portfolio of bonds.

Higher interest payments then pressure other government spending. The politically painless solution is to monetize not just the newly issued debt but the rising interest payments due on the soaring debt.

The Perpetual Money Motion Machine

Monetizing government debt is what I call the perpetual money motion machine. Just create another trillion to buy newly issued bonds, an additional trillion to pay higher interest and more trillions to buy up old debt that private owners are selling.

Is there anything that could break the perpetual money motion machine?

First, let’s ask a simple question of history: if monetizing debt works so wondrously, why hasn’t it been the go-to solution for every free-spending government? In the good old days, creating money out of thin air was accomplished by replacing the silver or gold in coins with lead or other base metals.

Alas, people catch on to this devaluation of money, and inflation skyrockets accordingly. Proponents of adding $50 trillion to the Fed’s balance sheet (i.e. monetizing the soaring debt and interest payments) claim this hocus-pocus won’t spark inflation. But since all that newly issued currency enters the economy one way or another, how can it not generate inflation?

The status quo answer is: If it only inflates assets owned by the wealthy, that inflation is really rather grand. But suppose inflation leaks into Cheetos instead of Big Tech stocks? Since “We can’t eat iPhones,” that eventually matters.

In other words, there is a governor built into the perpetual money motion machine: real-world inflation. There is also a social governor built into the “painless” expansion of asset bubbles that favor the already-wealthy: Eventually this systemic inequality distorts and destabilizes the social and economic order.

This is one reason why history shows government debt in excess of 100% of GDP (the real economy) eventually leads to disorder, default and bankruptcy. Or revolution. Take your pick.

There’s no going back once we select a pathway. The systemic damage cannot be reversed, regardless of what happy stories are told around the campfire by credulous believers in the magical powers of waving dead chickens around.

We either make the future or break the future, so choose wisely.

Now that debt is rising faster than “growth,” and “growth” is dependent on speculative credit-asset bubbles, the collapse of the Keynesian dream looms large. Plan accordingly, i.e. reduce your own exposure to risk via self-reliance.

The Daily Reckoning