America’s Achilles Heel

What if your greatest asset is also your Achilles Heel?

We might just be dangling over the ledge of that abyss.

My bet: It doesn’t play out well.

The asset in question is America’s ability to borrow without limit. I mean, there is a limit—the debt ceiling—but it’s only theoretical because Congress always raises it… though only after performatively slinging dirt at one another in a necessary show of circus freakery.

Thing is, when you run around alienating your friends, you’ve got yourself un problema when it comes to debt.

For decades, America sold its debt to any and all takers. In the last 25 years, however, Uncle Sam has all but begged foreign buyers to take on more and more loads of debt because the amount that he must sell to keep the country’s main breaker box from tripping is much too large for American investors to digest.

And that’s where we come to debt and alienated friends as Achilles Heel.

Maybe you saw the news a couple of weeks ago, whereby European governments are quietly debating an extraordinary economic countermeasure as fears grow that President Trump is looking to strike a Ukrainian peace deal with Russia that A) largely sidelines Ukraine, and B) threatens the security of the European continent.

Oh, and Europe is not involved in the negotiations, though the war and peace directly impact European nations.

So, European officials are circulating continentwide a drastic and nuclear response: dumping vast holdings of US government debt to destabilize the American economy should the US sign a Ukraine peace deal that excludes Ukraine and Europe.

Now, lots of bricks have to fall into place before we reach that disaster. So whether the threat materializes, who knows?

But uncertainty isn’t the point.

The point is that America’s debt, especially the debt held by foreign nations, renders the US a far more fragile economy than people want to believe.

Europe’s coordinated, mass purging of US debt would cause unprecedented damage to America and American households, without a single bullet fired. Europe owns about 10% of America’s overall debt. And while that might not sound like much, it’s large enough to cause widespread damage.

Here’s what would happen:

• A massive, coordinated sell-off of US Treasuries would flood the global market with supply, driving down bond prices and pushing up interest rates sharply—potentially by 1-2 percentage points or more in a short time.
• The 10-year Treasury yield, which America’s financial industry uses as a benchmark to price consumer and corporate loans, would jump from current levels of about 4% or 5% to 6% or 7%, maybe even higher.
• The stock market would plunge 10-20% initially, as higher rates make equities less attractive and increase corporate borrowing costs, which squeezes profits.
• The Federal Reserve would try to step in and buy Treasuries, what we know as “quantitative easing,” but the scale of the coordinated purge would very likely overwhelm these efforts.
• Mortgage rates would surge higher, up towards 10% on a 30-year mortgage. Housing prices would plunge.
• The dollar would plunge too, toward historic lows, which would send inflation spiraling higher. A deeper stagflation would root as prices race higher and as Corporate Americas dumps workers and scales back on spending to preserve what profits it can.

I could keep going, but you get the picture.

Of course, a debt purge isn’t a one-way street. Europe would feel the blowback.

• Prices for American debt would be falling as those vast sales occur, so European central banks would risk capital losses.
• The dollar collapsing means European currencies would be rising, which would make European goods increasingly unaffordable. Plus, the US would likely respond by imposing extreme tariffs on Europe or even banning the sale of European goods in the US.
• European banks doing large business in dollars would face paper losses that have to be marked-to-market because of banking regulations, and that would potentially trigger liquidity issues and runs on local European banks.

Again, I could go on…

The impacts of European actions are detrimental to all involved. So, Europe’s threat to dump vast quantities of US debt isn’t likely to happen… at least not at that scale.

But there is a likelier scenario that would cause just enough pain…

Europe sells off 5% to 10% of its US debt holdings.

This is a scenario the Fed has actually gamed out in the past, which tells you the Fed for years has been worried about America’s biggest Achilles Heel…

Europe dumping 5% to 10% of its US Treasury holdings—roughly $150 billion to $300 billion or so—would plausibly test the waters. That amount would exert noticeable pressure on US bond markets, consumers, businesses, and the economy, but it would not inflict catastrophic self-harm on European central banks.

Economic models from the Dallas branch of the Federal Reserve figure that such a coordinated sale would raise Treasury yields by about 0.3%. Doesn’t seem like much, but it’s enough to cause pain in the borrowing markets for consumers, homebuyers, car buyers, and companies needing to borrow cash to run their operations.

The Fed would step in, of course, to hoover up the supply… but that necessitates printing more money, which just adds to America’s debt burden and causes even greater inflation.

Plus, you gotta wonder who’s gonna buy that debt? Certainly not Europe. China for years has been purging its US debt and has no interest in buying more. And Japan is pushing its own interest rates higher after 30 years of near-zero rates, so Japanese money is more likely to head into Japanese bonds than into more US debt.

All this, all of these dots and how they connect, this is the kind of rupture in the status quo I regularly write about.

Few in the mainstream see this stuff coming.

They report on the dots, but they never see the connections.

One day, Trump signs a peace plan that excludes two of the most important participants… and the next day, chaos is ripping through the US bond market… the dollar is diving… inflation is rising even more… stocks are plunging… US household wealth is evaporating… and American families are feeling the pain.

Sounds bleak.

But there’s always a bull market somewhere, and in this instance the bull would be rampaging through alternative assets.

Gold would be soaring.

Silver, too.

Copper as well (more on copper soon).

Bitcoin, though down at the moment, would be well setting new all-time highs, and dragging with it a bunch of other cryptocurrencies.

And that, by the way, is the real point of today’s dispatch.

Achilles had no remedy for his heel.

We do have remedies, however, for America’s Achilles heel.

Use them wisely and apply them liberally while you still can, because we live in an age where the status quo is under constant attack.