One of my favorite places on the planet is a mere day’s drive and four-hour boat ride to the north in Michigan. Isle Royale National Park is a 45-mile long, 8-mile wide island positioned in the northwest quadrant of Lake Superior. The island park is a well-preserved north woods wilderness, comprised of dense forests, inland lakes, barrier islands, bogs and high ridges. It is a truly special place to explore.
The island is also home to the longest running continuous wildlife study in the country, called the Isle Royale Moose and Wolf Survey. This predator and prey interaction study observes the relationship between roughly 800 moose and 25 wolves calling the island home. The isolated ecosystem provides an ideal laboratory to learn how these two apex species impact each other and their environment over time.
The survey data shows when conditions are right the moose population flourishes on the island. This explosion in the moose population provides ample supply of moose calves, which are the primary dining interest of the wolves on the island, and the huge moose population also tends to eat all the desirable plant food on the island, leading to an eventual shortage of moose food. With an excess in moose protein from both moose calves and adult moose weakened by hunger, the wolf population also explodes, but with a lag, and the growing population of wolves tends to become larger and more proficient at hunting adult moose. The lagging result of more and stronger wolves is the now starving moose population eventually crashes, leading to ensuing starvation among wolves and smaller wolf litters. Ultimately, fewer wolves leads to the right conditions for a moose population boom and the cycle starts over again. And it’s all happening in our neighboring state to the north. How cool is that?
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The survey reminds us balance is perhaps not necessarily inherent in any complex system. Left unchecked, species can literally prosper into decline. Unfortunately, financial systems can also subscribe to this inherent lack of balance, and we may soon discover what happens when a financial creature eats all the food on the island. In this case however, the creature is the U.S. federal government.
With the rhetorical distraction of cultural issues and wars overseas, our politicians know the topic of budget deficits and the national debt can be a real sleeper. The $34 trillion national debt, however, is a real portfolio of securities needing to be managed, serviced and refinanced. While Americans may take this management process for granted, as with any portfolio, interest rates, market conditions, timing and maybe even a little luck also impact the operations required to maintain the colossal federal bond portfolio. For the remainder of 2024, a couple of these factors present very serious challenges for the Treasury department as it endeavors to fund the federal government’s gigantic spending deficit and more impactfully refinance already existing bonds maturing in the next nine months.
The federal government is projected to spend about $1.5 trillion more than it takes out of the private economy in revenue this year. With the exception of the pandemic years, this represents the largest dollar deficit ever recorded. This huge amount of money needs to be borrowed out of the financial system, through a series of bond sales occurring on a regular basis, but based on the size of the U.S. economy this amount should actually be manageable.
The other leg of the stool, however, is the truly disturbing part. Not only does the government need to raise the money to cover its spending deficit but it also needs to reissue nearly a quarter of the entire existing U.S. Treasury bond portfolio, which matures this year. When these amounts are added together, the federal government needs to borrow over $10 trillion in the next three quarters. This amount is unprecedented and represents a pull on the financial system which has never before been confronted or sustained.
Where are these dollars going to come from? It’s not clear at this point. According to the St. Louis Fed, there is about $18 trillion in U.S. bank deposits and a paltry $400 billion in the Fed program (Reverse Repo) typically used to provide liquid capital to the treasury markets. It’s reasonable to assume over 50% of all bank deposits are not available to be used to purchase treasury bonds. Maybe the capital comes from overseas investors, which I don’t think most Americans would find attractive.
As Americans I think we have become complacent to the Federal Reserve simply expanding the money supply to satisfy the federal leviathan. With inflation still not under control and a contentious election in a few months it’s unclear how the Fed can risk spiking inflation by printing more money this time.
The result could be a government-driven liquidity crunch, which is never good for markets or investors. While I hate to be the boy who cried wolf, it looks like the federal government is eating itself off the island. Maybe this plays out OK, but maybe it doesn’t, and smart investors will remain very aware.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.