19th March 2022
This is a summary of Raoul Pal’s comprehensive macro framework. It traces the origin of the current debt crisis from the fall of the British Empire through a generational lens borrowed from The Fourth Turning. Pal’s belief is that emergent technologies will replace important functions of the nation state with new distributed internet communities. True to Strauss and Howe’s work, Pal contends that in so doing a historic generational wealth transfer will be brought about.
By 1900 the power of the British Empire had waned. The cost of projecting global power was becoming unaffordable, and Britain faced a contintenal threat from an increasingly assertive Germany. By contrast to Britain, Germany was on the rise economically and was making strides to fill the power vacuum left by the fall of the Ottoman Empire. The stage was set for World War One which saw Britain and Germany fight it out in the bloodiest conflict the world had ever seen.
After Germany was defeated, the Treaty of Versailles required Germany to pay unrealistically onerous war reparations to the allies. Germany responded by debasing its currency to meet the payments which caused hyperinflation, and ultimately economic ruin.
It was in this climate that Hitler rose to power, setting the stage for the next global global conflict: the Second World War.
The allies were again victorious, and post war euphoria spawned the eponymous baby boomer generation. The global population increased 30% in twenty short years. A raft of new supranational bodies were created to institute an outward looking – or globalizing – mood. But it was fundamentally an American order, with the dollar chosen as the world reserve currency following Bretton Woods. The new institutions included the UN, NATO and the EU.
The Baby Boomers came of age in the late 1960s and the biggest generation ever entered the workforce. As they earned more money they created an unprecedented demand for consumer goods. This demand shock soon hit the oil and commodity markets causing price rises across the economy. In addition to rising prices, the US was on the gold standard at this time and was being squeezed by twin deficits (fiscal and currency account). The cost of maintaining the dollar’s peg to gold grew unsustainable, and in 1971 Nixon abandoned the peg, and the global fiat money system was born.
A demographic or a monetary phenomenon?
By 1975 wages had stopped increasing, with the poor and middle class disproportionately affected. At the same time, asset prices rose. This social disparity generated political polarization, and an Americaan Awakening gave way to the Unraveling.
In the United Kingdom Margaret Thatcher offered people living in government housing the chance to buy their home from the government below market value. Whilst financially empowering, it had the unintended consequence of creating a nation of debtors, particularly among the lower echelons.
In the US a concurrent phenomenon was unfolding as a consequence of financial deregulation. Consumer debt had been unlocked for the ordinary family, and Wall Street created a burgeoning stock trading business to furnish it. A flywheel took effect, with consumers taking on debt in an attempt to profit from rising stock markets.
At the same time, the globalist vision of Bretton Woods was starting to become a reality. 1990 marked the end of communism in Europe, and in China a quiet economic miracle was underway. It was no coincidence that at home manufacturing was being offshored, and the advent of the silicon chip exacerbated an already dismal outlook for the American worker.
The flywheel eventually came off the American equity market in 1987. More consequential, perhaps, was how the federal reserve responded. For the first time interest rate cutting was used as a policy tool – and it worked. A recession was averted, and policy makers took note.
Going into the nineties US denominated debt was on the rise globally. This proved disasterous for the Asian Tigers, who endured the 1997 financial crisis. American household debt had also skyrocketed, and asset prices rose in lockstep with consumer borrowing, but the US was protected by its reserve currency status.
Interest rate cuts were used to stabilize the 1997 crisis after their successful deployment in 1987. But a complacent world overlevered itself once again, and in 2001 a stock bubble burst in the US and Europe. The federal reserve responded yet again by slashing interest rates – and the crisis was placated. At a household level wealth was destroyed, however.
A weary generation of baby boomers wondered if the stock market they had bet on in midlife would serve them in old age.
2008
They turned to real estate – affording them the opportunity to take on even more debt – which set the stage for 2008. As a consequence more baby boomers entered the workforce to service this debt, yet at the same time their children were coming of age. For the first time parents were competing with their parents in the workforce. Spending dried up, with boomers stashing any money left over for retirement.
Eventually the property bubble burst like the stock bubble before it. The average household’s balance sheet was propped up by it’s home, and families were hit hard.
With far reaching consequences for America’s social fabric, the Federal Reserve opted to bail out lenders and avert widespread repossession. Most notably a new form of fiscal stimulus was tried: quantitative easing (or money printing), in addition to rate cuts. It was successful in the short term, but led to swelling asset prices while wages remained flat for a fourth decade.
Although asset prices rose in dollar terms, when measured against the expansion of the federal reserve’s balance sheet, they were flat. The same was true for the property prices of the UK and Germany during this period.
In addition to everyone becoming poorer, inequality increased. Populism emerged in time for the advent of Facebook, and common grievances bifurcated along political lines.
The Pandemic
While households’ ability to borrow was greatly curtailed post 2008, corporate borrowing was not. Going into the 2019 Pandemic corporations were in the same vulnerable state as households and government treasuries. Against this backdrop the federal reserve simply didn’t have the option of letting businesses fail as they had had in 2008 (but chose not to).
The system was flooded with new money and everyone was bailed out again. In two months the V shaped asset recovery was complete. Asset prices jumped 30% in a matter of months, but were again flat against monetary expansion.
Bond yields were destroyed and the dollar traded sideways, because all developed countries were growing their balance sheet at the same rate. Nasdaq tech companies attracted disproportionate capital, and employment opportunities for millennials dwindled.
The first generation to be poorer than their parents witnessed the federal reserve deliver once again for the baby boomers.
Looking ahead: Pal’s predictions for the future
With millennials getting the short end of the stick for so long, the adoption of cryptocurrencies can be seen as an adaptation to generational marginalisation.
For the first time a generation got to frontrun a nascent asset class which was alien to their parents, but as comfortable as any video game currency to them.
It remains to be seen if crypto growth continues. If it does, it is likely to attract investment way from traditional “productive” asset classes, and this threatens to slow the velocity of money.
At the state level digital versions of fiat money, or CBDCs, are an inevitability. What remains to be seen is the extent to which western democracies engineer them in a way that is consistent with western values.
In addition to cryptocurrencies, Pal predicts that internet communities will replace important functions of the nation state, particularly as the metaverse blossoms. The metaverse stands to create an unlimited new economic arena, with the younger generations granted majority asset ownership. This theme of generational wealth transfer is central to the Fourth Turning hypothesis.
In the industrial world, new technology will push the price of food and energy to zero, with all non-metaverse sectors automated. This will push the cost of living to near zero. The technology will most likely take the form of programmatic AI and its ownership will be highly centralized towards a few individuals or companies. As a consequence they will accrue almost all wealth, so although living standards will skyrocket, they will be outstripped by wealth inequality.