Editor’s Note: Mutual assured destruction, or MAD, was what kept the peace during the Cold War. Neither the United States nor the Soviet Union dared be the first to launch nuclear weapons because each knew that there would be retaliation… and that, in the end, both sides would be doomed. But if either side had reached that point of desperation where they felt that they were doomed anyway… might they have tried a first strike?

We’ll never know. But I can’t help but ask the same question when I look at the Treasury market. Our government has managed to borrow $35 trillion, and a lot of that debt is held by foreign central banks… including China’s. And in case you hadn’t noticed, relations between the U.S. and China haven’t exactly been friendly in recent years. 

China could cripple the US economy by dumping its massive stockpile of U.S. Treasuries… but it could only do so at the risk of wrecking its own economy too, killing its exports and destroying the balance sheet of its own central bank.

But what if something upset this fragile balance? Our Freeport Society friend Justice Litle has an interesting take on this. Read on and enjoy! 

-Charles

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The Plague of the Black Debt Revisited

By Justice Litle, Chief Research Officer, TradeSmith

In 1993, James Dale Davidson and William Rees-Mogg published the book Plague of the Black Debt, forecasting a pending U.S. debt crisis thanks to out-of-control debt and deficits.

They were too early.

The U.S. debt-and-deficits situation improved throughout the 1990s due to the post-Cold War peace dividend (reduced military spending) and Washington political gridlock.

Thirty years later, though, they seem prophetic. Their “plague of the black debt” is on the verge of coming true. America has seen decades of runaway debt build-up, and a budget deficit once in the vicinity of $200 billion is now closer to $2 trillion.

The likely trigger for a U.S. sovereign debt crisis — the Plague of the Black Debt scenario — will likely be the aggressive protectionist policies of a new Donald Trump administration poised to have unchecked power in 2025. 

The withdrawal of President Joe Biden from the presidential election race has increased the odds that Republicans gain not just the White House but majorities in the House and Senate.

The debt crisis trigger concerns the nature of foreign U.S. Treasury holdings. Countries like China and Japan — so-called “surplus countries” because they run a trade surplus and sell the United States a surplus of goods — have accumulated large quantities of U.S. Treasuries as a specific act of trade policy. When a surplus country sells goods to the United States and receives dollars in return, it parks those dollars in U.S. Treasuries.

Picture the Hoover Dam, a structure that can hold back 9.2 trillion gallons of water. If one were to bore a hole at the bottom of the dam, water rushing out under extreme pressure would widen the hole, spread cracks through the dam, and cause the whole dam to fail.

Now, rather than trillions of gallons of water, picture a dam holding trillions of dollars’ worth of U.S. Treasuries… 

Cutting off the trade flows of surplus countries by subjecting them to high tariffs, while deliberately weakening the dollar, would be akin to boring a hole in the bottom of the dam, causing a flood of U.S. Treasury selling.

The core thing to understand is that countries like China and Japan have spent decades (from the early 2000s onward) accumulating trillions of dollars’ worth of U.S. Treasuries as the other side of a surplus-trade transaction. To end that situation is to cut off a major source of demand for U.S. Treasuries, and to reduce the income of surplus countries is to induce net selling of Treasuries from their existing stock of Treasury holdings.

Simply put, a top priority of the incoming Trump administration — stopping America from being “ripped off” by a series of unfair trade deals — means the end of the surplus arrangement that has financed America’s debt accumulation at the margins for more than 20 years, ever since China started buying U.S. Treasuries aggressively in the early 2000s.

That means providing the trigger for a U.S. sovereign debt crisis…

Which means a global crisis because there are no suitable replacements for U.S. Treasuries as the premier safe-haven asset in the global financial system.

It’s a recipe for chaos. But chaos is also the perfect breeding ground for opportunity. If you play your cards right, you can navigate this Age of Chaos with your sanity intact… and you might even add a zero or two to your net worth. 

You need to be agile, trading the shorter term opportunities as they arise, which is what Charles helps his Freeport Alpha subscribers do. They use the C.H.A.O.S. Cash System, which you can learn more about here.

Investing in the right sectors is equally as important: Technology, energy, and good old cash cows.

And you need to hedge your portfolio against a declining dollar. 

Remember, it’s usually while the world is falling apart that real wealth can be made.

Until next time,

Justice Clark Litle

Chief Research Officer, TradeSmith