Beyond the Red Line: Bond Market Crisis and America’s Debt

MIKE BARNES 0:10

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. Today we’re talking about not just one national crisis, but two, and they both have to do with finances. And we’re also going to talk about something we haven’t seen in the economic world since the end of World War II. Let’s bring in a couple of experts to talk about all these things. Philip Diehl and Brad Chastain join me now. Glad you’re with me today. And Philip, I want to start with you. As the 35th director of the U.S. Mint and president of U.S. Money Reserve, this national debt crisis, I think, has a lot of people worried. Can you explain things to us?

PHILIP N. DIEHL 0:44

Yeah, well, of course, we’ve seen uh the debt continue to rise since about 2020, 2021. There was a short period of time for about three years at the end of the Clinton administration when the budget was balanced, actually creating small surpluses. So the debt level was declining. Those were the only years in uh since 1969. What is that? Uh 57 years in which the budget uh was balanced or created um surpluses. So what we’ve seen now is uh budget debt, uh budget uh deficits and the debt climbed to levels we haven’t seen since the end of World War II. And of course, at the end of World War II, we were we had financed uh the war uh against uh Nazi Germany and uh the Empire of Japan. But fortunately, we were headed into a period of tremendous economic growth, sustained economic growth during the 1950s, which reduced the the uh debt as a percentage of the GNP, all of the the value of all the products produced in the United States in any given year. And that is really the important measure here. Debt as a percent of GDP. And that, you know, that’s like with our households, debt can be very high. But if you were making uh, you know, five million dollars a year, then you can afford to carry more debt. But if you are making $50,000 a year, then debt can get you in trouble pretty fast.

MIKE BARNES 2:26

Brad, the numbers that I show here says the national debt held by public is $31.27 trillion. The GDP is $31.22 trillion. We haven’t seen that as Phillips said since World War II. And that affects a lot of things: economic growth, interest rates, borrowing costs. How do we survive this?

BRAD CHASTAIN 2:44

Yeah, I think it goes back to the thing we talk about all the time, is being diversified. Uh, we’ve this is um the it’s a lot of debt, and it’s not just the United States, of course. Um, the uh former IMF director, International Monetary Fund, you know, is talking about Europe, developed European countries in a similar situation just the other day with the UK and France and um even Italy. And so you’ve got a lot of sovereign debt in that same sort of situation. And this is something for individual portfolios, that’s why we talked so much about being diversified. We’ve talked for a long time about how this is a different world that we’re entering in, and the traditional stock-bond relationship has not held true like it did, you know, um a couple decades ago, and that people became accustomed to. In fact, the bond portion of folks’ portfolios, if they’re owning something like a total bond market index inside of a target date and fund in their investment in their retirement plans, they’re down 25% on an inflation-adjusted basis since uh since 2020. And so as we get closer to retirement and people get more conservative, and financial advisors tend to move people from stocks into bonds, at the point of retirement, many people are 50% stocks, 50% bonds. Several years after retirement, and some of those target date investments, for example, they’re about 70% bonds, 30% stocks for somebody five, six years into retirement. And so increased living expenses in retirement, trying to keep care help um keep pace with healthcare costs, uh being diversified and having protection against um against rising costs is really important. And bonds just have not been providing that. And this, these um, these overall debt levels are a big reason why.

MIKE BARNES 4:26

I want to talk more about bonds in just a second, but you mentioned sovereign debt. I think that’s a key. Philip, I want to talk to you about that. Sovereign debt, private debt, there’s a difference there, and I’ve got a couple of graphs for us to look at. And the first one mainly has to do with private debt.

PHILIP N. DIEHL 4:42

That’s right. What we see here is the different types of private debt that uh, you know, really dominate the marketplace. And the most important one at the bottom is mortgage debt in the United States. And we can see that that has grown some over the last five years. This graph only covers five years, so this growth rate is over a very short period of time. Above that is non-AI corporate debt. And uh, we’re gonna talk about the AI corporate debt uh in a minute, but the non-AI corporate debt has grown uh as well. Um, and uh, but as a, I’d say as a percentage of the debt, it has actually shrunk. The next level is a municipal debt. That’s bonds issued by municipal and other local, state, and local government agencies. Green energy debt has been a really uh big factor because of, especially because of power requirements and as a means of reducing power requirements. One of the big stories in this graph is the AI and related power debt that has grown over the last five years. And as you can see from the left side, uh that golden area virtually disappears. It doesn’t really exist just five years ago. And now it is grown to uh about a half a trillion dollars, so it’s substantial. Now, anyone who follows this uh will say, well, half a trillion dollars, I thought it was a lot larger than that. Uh the kinds of capital expenditures that the AI firms have been making. Uh, that’s right. Um, capital expenditures uh this year is probably going to be uh three times this number. Uh but that uh that difference is funded not through debt but by huge companies like Microsoft, Amazon, um uh Google and the like uh funding their uh investments through their own revenues. But nevertheless, we’re looking at a half a trillion dollars this year, and this is expected to rise rapidly in uh the year ahead. So over that five years, in summary, we’ve seen uh corporate debt uh increase from $3.5 trillion to five uh to five trillion dollars. So in only five years, we’ve seen that debt increase by 50%.

MIKE BARNES 7:33

And now you have another graph that shows the sovereign debt.

PHILIP N. DIEHL 7:37

The sovereign debt in the in the bottom quadrant, the red c quadrant, you see uh US government debt, and you see how rapidly that has risen over the last five years. On top of that, we have foreign uh sovereign and institutional debt. It is just like Brad was saying, it is increasing rapidly as well. And then the the rainbow of colors, the narrow rainbow of colors you see above that are the corporate debt that we’ve just been discussing. So the story, one of the stories this graph tells is how small that corporate debt portion is uh compared to the sovereign debt. And that’s really important. The one of the stories this tells us is that um the uh private debt is competing in the marketplace with this public debt. And uh and it becomes all of this debt must be uh purchased by investors around the world uh in order to fund the operations of these companies and these governments. So uh the cost of debt is rising for all of the players because of these rapid increases. And if you follow the news, even though these tiny segments of debt like AI or commercial real estate uh seem so small that if they were to crash, it would present a nationwide and global uh economic and financial problem for us. More than a problem. A crash could be uh as bad as the uh dot-com crash, or as bad even as the financial crisis.

MIKE BARNES 9:40

Brad, I know that you’re a numbers guy, kind of like I am, and graphs are fun, but when you look at these numbers, what do they tell you?

BRAD CHASTAIN 9:48

How much more money is going to have to be put into existence to service it? Something we talk about a lot is that the world, and not just the United States, but the entire world works on a debt-based monetary system. As that new debt is taken on, um, ultimately, depending on where it’s funded from, commercial banks, or if the Federal Reserve is monetizing it by putting reserves in the system and buying debt, or other central banks are doing that, um, ultimately that’s a required increase in money supply that has to take place in order to service that debt, to roll it over, to pay the interest on that debt. Um, and so ultimately down the road it means more printing, money printing. Otherwise, there’s the um you know liquidity or or debt it uh debt crisis that Philip alluded to if that doesn’t happen. And so one of that’s one of the reasons we are so long-term bullish on gold, is because an increase in availability of money out there, which gold is tied to and gold’s price is tied to and relates to over a long period of time, it’s kind of baked in the cake in order in terms of what has to ultimately happen down the road in order to deal with the consequences of this debt expansion.

MIKE BARNES 10:59

Brad, looking at all these numbers, is it tied to the inflation that we talked about last week?

BRAD CHASTAIN 11:04

Some of it ultimately can be, um, especially around the demand for um where that debt is being spent. So AI infrastructure and things like that is driving increased demand. Most of the inflation we’ve seen more recently, I believe, is much more tied to the supply shock overall and energy prices that we’ve that we’ve seen. So I think that spells a more longer-term inflation uh story. Whereas more most recently, I believe it’s a lot more tied to the geopolitical events going on, specifically in the in the strait.

PHILIP N. DIEHL 11:41

Other thing I think we need to recognize is uh because of this incredible wave of debt that has to be refinanced. And that’s what we’re talking about here. We’re not talking about the total amount of debt that is held by the governments or by these companies. What we’re talking about is the demand for new debt or rollover debt that will come uh or has come over the years and will come in the future, even more in the future. So uh all of that debt must be sold and it’s competing against stock prices, gold prices, but you know, investors can put their money in any of these areas and different kinds of bonds. And so these bonds are competing in the open market for investors’ money. And so as more debt is issued, then governments and businesses have to offer higher interest rates to draw uh investor money in. And so this drives higher interest rates. Now, one of the things that we know is that uh governments intervene to stop inflation or mitigate inflation by raising interest rates, raising interest rates on their own, the basis on which all the business and consumer loans uh and personal loans is best based. And that can add to inflation as well. Uh but in the short term, but in the longer term, uh the intent of raising rates, governments raising rates, is to suppress inflation. Um one of the implications here that isn’t really shown in this graph, but uh is is is there nonetheless is not just the threat of inflation, but the threat of recession and the possibility of severe recession. So we don’t know what would be the domino that might topple over and uh bring on a recession like this, but there are a number of candidates out there. And just before the dot-com uh blow up and the financial crisis, people saw it coming, uh, but they didn’t know when it would happen because they didn’t know when the domino that mattered toppled over and knocked the rest of them down.

MIKE BARNES 14:19

This bond market crisis is going to affect us, I think, more than a lot of people understand. Brad, I want to ask you because in all that I’ve always learned in my younger years is that stock market goes up, bonds would go down. Stock market goes down, bonds would go up. But it’s not that way anymore, correct?

BRAD CHASTAIN 14:35

No, not at all. Um, I mean, 2022 we’ve talked about as a great example where both of them were down in the double digits during that time. So there is um a lot more correlation than there has been in the past. One of the things that’s really important right now is actually volatility in the bond markets, not just the absolute level of rates, but how volatile they are, because in a debt-based monetary system, the bonds themselves are collateral to borrow and get new money put into existence. And the more volatile they are, the um the the more it takes in order to generate that new money in the system that leads to the rollovers uh that Philip was talking about earlier. And so um this is a world where when you see that bond volatility, you actually see liquidity contractions, which then ultimately it can impact stock prices because liquidity is what supports all asset prices out there at the end of the day. And so, yeah, right now, when you see like right now, bond volatility is up about 25% or so over the last few months. And so that’s certainly been weighing on that you know progression of what the stock market was doing uh you know, going into a few months ago.

MIKE BARNES 15:52

Well, Philip, that was another number I want to ask you about. $8.5 trillion of outstanding U.S. treasury bonds held by foreign investors. If they’re going down because of the bond crisis, would they switch to gold?

PHILIP N. DIEHL 16:06

Yes, there’s multiple reasons why uh foreign governments and would switch to gold and sell treasuries or stop buying as many treasuries and buy more gold. And in fact, I think that is going to happen. We’ve seen for four years running uh central banks uh buying 100, I’m sorry, 1,000 uh tons of gold on average every year. And so far this year, we’re on a similar pace. My expectation is that we will maintain this average pace over the next five years as the dollar deteriorates in value, as as uncertainty develops around U.S. security policies and economic policies, around its budget policies, uh, as it fails to really exercise the control that we need over uh our fiscal situation. So there are really strong reasons for our central banks, and for the same reason that you and I as individuals would do it. If we expect one uh element of our uh portfolio to fall in value, and that would be dollar-based assets, then you’d want to buy uh and substitute um other assets such as gold that are expected to increase in value. So yeah, I I think it’s really important that people uh take uh those numbers in mind because when you look at the average Americans portfolio, on average they hold only 2.8 percent allocated to gold. And here we are with recommendations between 15 and 25 percent. And I think there’s gonna be a substantial shift in those private portfolios from 2.6 uh percent uh to five percent, uh toward certainly toward that 15 to 25 percent range. Who knows where it will be? But that shift has enormous implications for gold prices, and it’s really something I’d like us to look at uh in another uh podcast.

BRAD CHASTAIN 18:34

And Mike, another point on that. We I mean, like Philip said, we’ve already seen this shift quite a bit where foreign central banks have not been buying as many treasuries as they once were. Um, however, foreign holdings of treasuries is at an all-time high. And it’s because the private sector has really taken that over. And the private sector is much more interest rate sensitive because they’re looking at it from a pure investment standpoint, whereas central banks, it’s partially investment, but it’s also partially managing the financial order of their country, making sure that they are able to meet financial needs internally, be able to manage their currency, make sure that they’re circulating the right currencies throughout their financial system and things like that. So we’ve seen this shift into the private foreign holders being the dominant buyers that have driven foreign holdings to an all-time high. And like I said, they’re much more interest rate sensitive. When they’re losing money on that, that is, you know, uh oftentimes a forced unwind where they have to sell it whether they want to or not. They can’t just sit on it like a central bank can. And if you get that cascade of a sale, we’ve talked about it in the past. There’s a huge trade out there called the basis trade, where the Federal Reserve even just came out six, eight months ago and identified, and I forget the exact number, but it’s something like 37-ish percent of all treasuries sold in the last few years have been acquired by the basis traders, which are making very small amounts per trade, but they’re very, very levered, meaning they’re borrowing a tremendous amount of money in order to do it. And and if that many hedge funds and and basis traders out there are doing that, and it’s actually only a few, just really big ones, if that that arbitrage opportunity becomes unprofitable, that becomes a forced unwind. And you that the the devastation that that would do to the world is unimaginable. Um so that’s a much more precarious market structure than what we’ve seen in the past when it was more central banks buying.

PHILIP N. DIEHL 20:34

That is such an important point. I’m glad brought it up. Uh the think about it like this the central banks, for the most part, buy treasuries and stick them in a vault. And, you know, they’ll buy and sell, but it it is basically a buy and hold uh market um in uh in terms of the percentages. Whereas in the basis trade business, this these are highly liquid instruments that um that private sellers can sell at any time, and as Brad says, can get into a situation where they are forced to sell. And sometimes that has a snowball effect where some of the private owners have to sell and that forces and they sell and that drives down prices for treasuries, and then that forces others to sell. So there’s much greater uh vulnerability and volatility that is in the structure that Brad has described.

MIKE BARNES 21:40

So I think from hearing from both of you, we need to keep our eyes open about what’s going on, especially with the foreign private sector, and keep in touch with our financial advisors to make sure that everything is going the way we need it to go for what we invest in. Philip Diehl, Brad Chastain, thanks so much for joining me today. Thanks, Mike. Thank you, Mike. So I think what we’ve learned is we need to keep our eyes on the national debt crisis. The debt held by public continues to grow, and that’s going to affect economic growth, reduce private investment, and raise interest costs. We also need to watch the bond market crisis. Yes, two crises out there. How is this affecting foreign private sectors, which could affect us, and that could lead to another reason to move more of your portfolio into gold? That’s all the time we have for today’s episode. On behalf of all of us here in the U.S. Money Reserve Studios, thank you so much for tuning in. If you have any questions or you want to learn more about today’s episode, you can call the number in our episode description and speak with one of our friendly account executives. They’ll be more than happy to answer any questions you may have about precious metals and the strategic role they can play in achieving a secure and comfortable financial future. I’m Mike Barnes. We’ll see you next time on America’s Gold Authority Podcast.