In a recent and thought-provoking Twitter thread, Real Vision co-founder and Global Macro Investor (GMI) author Raoul Pal dissected the macro economy and its dependence on quantitative easing (QE) to survive recurring debt cycles. Pal’s insights reveal a troubling pattern of economic activity that seems to be locked in a never-ending loop, ultimately leading to an unsettling conclusion: QE has become an indispensable crutch for the global economy.
Pal’s analysis begins with a look at the “Magic Formula” that he believes drives GDP growth. This equation is defined as GDP Growth = Population Growth + Productivity Growth + Debt Growth. In essence, Pal argues that real GDP growth is a measure of the economic activity that generates cash flows, which are then either invested, saved, or used to service debts at an economy-wide level.
According to Pal’s calculations, the trend rate of GDP is a meager 1.75% and continues to decline. The issue arises when one considers that the US economy’s total debt amounts to a staggering 220% of its GDP. When interest rates average at 2%, interest payments equate to 4.4% of GDP, which results in negative GDP growth compounding at -2.65% per annum. The higher the interest costs, the more negative GDP would become.
In order to cover these costs, governments issue more debt, which is then monetized through QE. Pal asserts that without QE, there simply wouldn’t be enough cash flow to service system-wide debts. The fact that the median debt maturity for public and private debt post-2009 is 3 1/2 years seems to indicate that the global economy is now wholly reliant on QE to function. In other words, countries like the US, EU, Japan, and the UK cannot operate without constant injections of QE to keep them afloat.
Pal predicts that the end of 2023 and into 2024 will usher in the next debt refinance period, with more QE being necessary to fund it. Additionally, any crisis that emerges will only serve to pile on even more QE – as seen with the COVID-19 pandemic and recent banking issues. He estimates that the Federal Reserve’s balance sheet could swell to $12 trillion to $14 trillion within the next 12 months.
The ramifications of this reliance on QE are significant. There is simply not enough economic activity to sustain the public debt, which is equivalent to 100% of GDP. If the debt is not monetized, it would completely crowd out the private sector, resulting in widespread insolvency. This precarious situation is explored further in GMI’s article “The Truth and The Trap,” which expands on previous articles such as “Broken Markets” and “The Cowbell.”
Pal’s analysis reveals a cyclical economy that inevitably leads to QE and rate cuts for debt servicing. As these debt cycles continue to repeat themselves, one cannot help but wonder whether we are teetering on the brink of an economic disaster that could have global repercussions.
While Pal’s insights are primarily aimed at sophisticated investors, they serve as a stark reminder that our macro economy is in a precarious state. As we face an uncertain future, it is more important than ever to be aware of the economic underpinnings that drive our global financial systems and the potential consequences that await us if we continue down this perilous path.