Thousands of years ago on the 27th of July, 54 BC, the famed Roman senator Cicero wrote a letter to his friend Atticus complaining about all the corruption and bribery that was destroying Rome’s political system.
There was an important election taking place that year for Roman consul, which had once been considered among the highest political offices in the republic.
But by 54 BC, the consuls were just political stooges… because the real power was held behind the scenes by none other than Julius Caesar, and his rival Pompey the Great.
Caesar and Pompey both spent enormous amounts of money to make sure their people won the elections; it was very similar to how today’s biggest political donors spend millions of dollars to push their hand-picked candidates into office. The politicians are just puppets; the real power is the money behind them.
Caesar and Pompey were certainly wealthy guys at the time. But the election of 54 BC set off a financial arms race between the two, with each one trying to out-spend the other to manipulate the election.
One of Pompey’s candidates– a man named Scaurus the Younger– was actually charged with extortion.
Two other candidates allegedly attempted to bribe a large voting bloc known as the centuria praerogativa for a whopping 10 million sesterces; this would be the equivalent of hundreds of millions of dollars today.
Another candidate alleged that the two outgoing consuls had been bribed with four million sesterces. The bribery allegations went on and on.
The election of 54 BC was so corrupt and cost so much money that Caesar, Pompey, and their candidates had to borrow heavily from investors to finance all the bribery.
And this is what led Cicero to remark to his friend Atticus, “Bribery is raging. And I will show you a sign of it: the interest rate has gone up from 4% on the 15th of July to 8% [on the 27th of July].”
In other words, the politicians and their financial backers spent so much money to rig the election that they had borrowed nearly all of the capital in Rome’s financial system… causing a spike in interest rates.
This makes sense when you think about it: the election of 54BC created a sudden, overwhelming demand for loans; Caesar and Pompey borrowed heavily in a very short period of time. Just like the basic law of supply and demand, that surge in demand for capital caused an increase in the “price of money”, i.e. interest rates.
Now, imagine being an ancient Roman businessman in the summer of 54 BC looking for a small business loan, perhaps to finance expansion or fund the season’s agricultural harvest.
But then you find that there’s no more money… or only very expensive, high-interest loans available… because the politicians had already borrowed all the money in the financial system.
Economists call this the ‘Crowding Out’ effect, i.e. what happens when someone borrows so much money that there’s very little capital left over for everyone else.
In modern times that ‘someone’ is typically the government, i.e. government borrowing is so extreme that they monopolize all the liquidity in the financial system, thus causing interest rates to rise and ‘crowding out’ the private sector from accessing capital.
And we’re starting to see the Crowding Out effect in our daily lives.
For most of the past 15 years, the Federal Reserve kept interest rates in the US at nearly zero. Capital was infinite. And if the government wanted to borrow more (which they did every year), the Fed simply created more money.
Between 2008 and 2022, in fact, the size of the Federal Reserve’s balance sheet soared from $850 billion to $9 trillion… a more than 10x monetary expansion.
One obvious effect of such reckless monetary policy has been historically high inflation… which ultimately prompted the Fed to reverse course and hike interest rates.
What few people talk about, though, is that the Fed has also begun the lengthy process to reduce the size of its gargantuan balance sheet… essentially draining liquidity from the financial system.
Right now the Fed’s balance sheet stands at around $8.6 trillion, down from a peak of $9 trillion a year ago. So there’s still a looooooong way to go before they get back to the 2008 level of $850 billion, or even the pre-pandemic $4 trillion.
And this takes me back to the Crowding Out effect.
We all know the federal government is addicted to unsustainable spending. Just look at the debt ceiling fiasco– the Treasury is weeks away from default, and yet the guy who shakes hands with thin air refuses to make any spending cuts.
The Congressional Budget Office currently projects an average $2 trillion annual budget deficit, EVERY YEAR, for the next 10 years. And this estimate is probably quite optimistic; it doesn’t take into consideration any exigent funding requirements like war, natural disasters, or pandemics.
Nor does it take into consideration the multi-trillion dollar bailout required to save Social Security in only a few years’ time.
But even if we go with the government’s own projection of $2 trillion per year, that’s STILL a lot of money to borrow.
For most of the past 15 years, the government never had to worry about borrowing; the Federal Reserve was always standing by to create more money and lend it to the Treasury Department at record low rates.
But now the Fed has reversed course. They’re not loaning any more money to the federal government… meaning Uncle Sam has lost its #1 lender.
One of the government’s other top lenders– Social Security– is also out of the picture. Social Security has loaned trillions of dollars to the federal government over the years. But now the government is going to have to pay back those loans in order to keep the program funded, PLUS provide an additional bailout on top of that.
Another major lender– China– is also off the table. In fact China has SUBSTANTIALLY cut its holdings of US government debt, from a peak of $1.3 trillion, down to $848 billion today… a reduction of more than 34%.
You’re probably starting to see this ‘Crowding Out’ effect; with nearly all of its top lenders gone, yet absolutely no plans to restrain spending, the federal government is already starting to monopolize debt markets.
The amount of available capital in the financial system is falling due to the Fed’s new monetary policy. And the government is sucking up every available penny for themselves.
That leaves very little capital (compared to the last several years) available for businesses… which is actually fantastic news for investors.
Over the past decade when the money supply was expanding and capital was abundant, businesses could easily raise money from investors or borrow from banks.
And the investment terms were usually very one-sided in favor of the business; companies with no hope of ever turning a profit commanded valuations going into the tens of billions of dollars. And some businesses even sold bonds with negative yields.
But today’s conditions are totally different: businesses have to compete with the government for scarce capital. And as a result, many deals are now outrageously good for investors.
Just because the economy has slowed doesn’t mean there aren’t great investments out there. Quite the contrary. There are incredibly productive and innovative businesses all over the world that can achieve enormous success, regardless of economic conditions.
In fact the most successful company in the world today– Apple– is a great example. Even during peak stagflation of the 1970s, Apple earned sensational profits after releasing its highly innovative Apple II.
There will most certainly be similar examples from today’s businesses. And yet, because of this Crowding Out effect, they’re all having to roll out the red carpet to investors in order to raise money.
Well it’s about time. Investors have spent the last several years overpaying for stocks, bonds, real estate, NFTs, and just about every asset under the sun.
But right now, finally, investors can get fantastic deals on great businesses. We just don’t know how long these generous conditions are going to last.
Personally I think the Federal Reserve is going to chicken out– and we’ve talked about this before.
Their rapid interest rate hikes have already caused so much financial destruction, including multiple bank failures. Next up we’ll probably see defaults in commercial real estate, corporate bonds, municipal bonds, and even a sovereign government or two overseas.
Most importantly, though, the Fed’s higher interest rates will eventually bankrupt the US government. The national debt is already $31.4 trillion, and it increases by $2 to $4 trillion per year. They simply cannot afford to pay 5% interest.
The Fed knows this… which is why I expect them to chicken out and start slashing rates again. The survival of the government depends on it.
And when they do, financial conditions will reverse again. Companies will easily be able to raise capital, and the deals that we see now will no longer exist.
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