Luke Gromen: Expect Market Turbulence Ahead Due To Tightening Liquidity

Why is dollar liquidity starting to dry up?

Former Vice President Dick Cheney famously said: "Reagan proved that deficits don't matter"

True or not, running greater and greater federal budget deficits has become standard operating procedure for Washington DC.

When Cheney uttered those words, the annual deficit was in the low hundreds of billions. It's projected to be $2 trillion this year.

At that scale, today's guest expert would argue that deficits are indeed starting to matter, because the US is now increasingly challenged to service the debts and other associated liabilities that have accreted from all the years of rising deficit spending.

In fact, he concludes we're on a collision course for a sovereign debt crisis, one that will take the purchasing power of the US dollar down with it.

To find out why, and what can be done about it, we're fortunate to welcome Luke Gromen, founder of macro research firm FFTT, LLC, back to the program.

In the near term, Luke is warning investors that dollar liquidity is starting to tighten, which threatens to inject a lot more downside volatility into financial markets than Wall Street currently expects.

To find out why, click here or on the image below:

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Adam’s Notes: Luke Gromen (recorded 7.8.24)

EXECUTIVE SUMMARY

• The Congressional Budget Office (CBO) recently increased the US fiscal deficit projection from $1.5 trillion to nearly $2 trillion. This immense deficit compared to global GDP growth, estimated at $110 trillion with a conservative nominal growth rate of 6%, equates to $6.6 trillion. The US government's need for $2 trillion of this growth (around 30%) to finance its deficit is likely too high, leading to tighter dollar liquidity and slower global growth.

• If global nominal GDP growth decreases to 3%, the US may require approximately 70% of this growth to finance its deficit, intensifying a vicious cycle of a strengthening dollar and economic slowdown. As the dollar appreciates, countries with dollar-denominated debt face increased repayment difficulties, further straining the global economy.

• Foreign entities hold $57 trillion in US dollar-denominated assets, with $8 trillion in US Treasurys. This concentration of foreign ownership can cause significant volatility in the Treasury market, especially when the dollar strengthens. When foreign holders sell large amounts of Treasurys to defend their currencies, it disrupts the market, prompting policymakers to inject more dollar liquidity to stabilize the situation.

• Gold is advantageous in both tightening and loosening dollar liquidity scenarios. As the US debt load increases and interest rates rise, concerns about the US government's solvency grow, driving up gold prices. Historically, as real interest rates rose, gold prices fell, but this correlation broke in late 2022. With the US debt and fiscal position beyond the tipping point, rising rates now benefit gold, making it a preferred asset for investors.

• The US and other G7 countries are nearing a sovereign debt crisis due to both deficit spending and debt accumulation outpacing GDP growth. Entitlements, defense, and interest expenses now consume approximately 110% of US receipts, up from 67% eight years ago. As the true interest expense on federal debt grows, the US economy faces increased volatility. Historically, surpassing 90% in this metric has led to higher volatility and firm dollar environments, pushing the economy closer to a critical point.

• Luke argues that inflation is the primary governor on economic management. Policymakers often distract the public with social issues, avoiding discussions about debt and deficits. This strategy buys time as the boomer generation, which holds significant wealth and obligations, passes on its assets. However, as inflation erodes purchasing power, the sustainability of this approach is questionable, and the economic impact on younger generations becomes more pronounced.

• Luke’s investment strategy recommends focusing on