Welcome to our Friday mailbag edition!
Every week, we receive great questions from your fellow readers. And every Friday, I answer as many as I can.
This week, we’ve got questions about the U.S. debt… and what happens next if the Securities and Exchange Commission (SEC) approves a spot Bitcoin exchange-traded fund (ETF)…
There is no end in sight to the national debt growing larger, and the interest expense on that debt growing larger. What is your best guess as to what is going to happen when the interest expense gets to the point that it is larger than the revenue taken in by the government?
– William B.
Hi, William. That’s a great question.
So, when the interest expense on the national debt gets bigger than the money the government brings in, things can get messy.
First off, we’ve got ourselves a situation where a chunk of the budget is just going toward paying off debt.
This leaves way less cash for things many people depend on, like programs, services, and projects.
To plug the budget hole, the government might have to borrow even more. But that would just be kicking the can down the road and causing an even bigger mess further down.
So let’s break down the potential fallout.
As the borrowing piles up, lenders might start thinking twice about lending more cash to a government with a mountain of debt.
That could jack up interest rates on those government bonds, making borrowing and debt servicing even pricier.
On top of that, to handle the rising interest bill, the government would probably end up slashing spending in different areas, like services, programs, and projects.
This could include things like education, healthcare, and building infrastructure. Less investment in these areas could weigh on the economy and severely affect growth.
But there’s more.
If history is anything to go by, a debt-heavy government will likely decide to pump more money into circulation to cover the tab.
But that move would cause inflation, making prices soar and your wallet feel the burn. And if things really get out of hand, it could potentially lead to hyper-inflation.
Another alarming outcome could be a situation where the government resorts to extreme measures to cover its obligations. What could those be?
Well, in really bad cases, the government might try to redo its debt deals or even default on payments.
This is called debt restructuring. It involves the government negotiating with its creditors to change the terms of the debt. They might try to extend the repayment period, lower interest rates, or even reduce the principal owed.
This can give the government some breathing room and a chance to avoid immediate default. But it’s far from ideal. It sends a signal to the world that the government is struggling to meet its obligations and can’t manage its finances.
This will almost definitely lead to a loss of confidence from investors, potentially making borrowing more expensive in the future.
Now, onto the even graver scenario: defaulting on payments. This means the government misses a scheduled interest or principal payment on its debt. It’s like telling creditors, “Sorry, we can’t pay you back as promised.”
This would be a major sign of financial distress, and it can lead to chaos in financial markets. Investors might start to panic, causing interest rates to spike, and potentially triggering a chain reaction of economic instability.
A lot of this would have long-term consequences.
It would make it harder and costlier to borrow money in the future. It would also lead to credit rating downgrades. And that would make borrowing even more expensive. Plus, it would also erode investor trust in the U.S. economy.
In a nutshell, we’re looking at what could be an ugly scenario of ballooning debt, less essential services, higher borrowing costs, more inflation, and even a default.
But what happens would depend on a lot of things – like how the economy is doing, politics, and more.
Do I think a scenario like this is likely? Let’s look at the numbers.
In 2022, the federal government spent $476 billion on net interest costs on the national debt. That was a 35% increase from 2021.
It was also the largest amount ever spent on interest in the budget and came out to almost 2% GDP.
Compare that to the government’s revenue. In 2022, the government brought in $4.9 trillion from taxes and other sources.
In other words, in 2022, the government would have been able to cover its net interest costs 10 times over with its revenue.
Let’s look further out.
In 2029, interest costs could reach $1.1 trillion. That’s going off a report from the Congressional Budget Office (CBO).
This fiscal year, the government’s revenue is already at almost $3.7 trillion. As long as the government’s revenue stays steady, I don’t see it struggling to cover its payments years from now.
In short, we’re still a long ways away from the disaster scenario above unfolding, if ever.
Just read your article “What Could Happen to Bitcoin’s Price If the SEC Approves a Spot Bitcoin ETF?”
And while I won’t argue against it, I’m wondering if a different scenario might not be as likely.
I can see an initial surge in Bitcoin and Ethereum, if the big institutions start buying them in order to “stock” and run their ETFs. But I am not certain that this surge won’t end soon thereafter.
It seems possible that after they vacuum up all they want, the trading will simply be done in their own holdings. With all retail transactions from their retail clients simply clearing in the institution’s own wallets, such that they would essentially be “wash trades.”
I’m also concerned about the likelihood that BlackRock, Fidelity, and other monster-sized funds will be holding so much of the 21 million Bitcoin maximum that will ever be created… That the supply will be so centralized, it leads to the same kind of manipulation that saw JPMorgan gold traders so heavily fined.
With the present size of the Bitcoin market being only about 5% that of the gold market, it seems the likelihood of manipulation would be great. Any thoughts?
– Al R.
Thanks for your thoughts and questions, Al!
So, the SEC has always been wary of the unregulated crypto space.
And it’s put off greenlighting a spot Bitcoin ETF in the U.S. for that exact reason: the fear of potential market manipulation.
Just consider this…
Over the years, we have seen 30 attempts by different companies to launch Bitcoin ETFs. But none of them succeeded. VanEck, Invesco, Valkyrie, ARK, you name it, have all been rejected by the SEC.
However, spot Bitcoin ETFs do already exist elsewhere. For instance, there are several currently trading in Canada, like the Purpose Bitcoin ETF.
And the current Bitcoin ETFs haven’t led to the issues you’ve outlined.
Now, I’m not dismissing your concerns outright.
First, it’s possible that institutional players could accumulate Bitcoin for their own holdings and to conduct retail transactions within their ecosystem.
This scenario could be viewed as an attempt to establish a controlled trading environment. Or even as potential market manipulation – which might prompt regulatory bodies like the SEC to take action.
Second, the concentration of Bitcoin holdings among large funds like BlackRock and Fidelity does raise the concern of centralization.
After all, as you pointed out, the Bitcoin market is only about 5% the size of the gold market.
If a few entities control a significant portion of the total Bitcoin supply, it could raise manipulation concerns similar to what we’ve seen in other markets.
But here’s the main issue with these observations: They assume that demand for Bitcoin won’t change.
As an example, take the SPDR Gold Trust ETF (GLD). I wrote about it in a recent essay.
GLD was the first gold spot ETF. Its debut in 2004 played a crucial role in boosting the demand for gold in the years that followed. Investors now make up almost 48% of global gold demand, compared to 11% before GLD launched.
GLD made it easier and cheaper for people to hold gold in their portfolios. It legitimized gold. And it transformed gold into a mainstream investment that pretty much anyone could access… without the hassle of owning and storing physical gold.
In other words, it was a product for the masses. And as the market responded to this newfound demand, it set off a chain reaction of surging prices.
When GLD came out in 2004, you could buy one ounce of gold for less than $450. Seven years later, the price of gold had soared to almost $2,000 per ounce.
A spot Bitcoin ETF would be a financial product for the masses too. So, I expect a similar surge in demand and price.
Now, there is no crystal ball to tell us how this will all play out. Anyone who says otherwise is either misinformed or lying to you.
But I’m optimistic that, if the first Bitcoin spot ETF in the U.S. gets approved, it will attract a lot of new demand.
And so, the idea that institutional players will “vacuum up” Bitcoin and then retreat from the market underestimates the long-term appeal of Bitcoin and cryptocurrencies.
Just consider this…
In just over a decade, the crypto space has gone from being an obscure corner of the financial world to an evolving ecosystem. It has captured the attention of individuals, businesses, investors, and regulators alike.
At the start of 2020, the crypto markets were worth around $200 billion. Less than two years later, that number was close to $3 trillion. And despite recent struggles, it’s still at $1.1 trillion.
This growth was fueled by rising demand, driven by:
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Increased Adoption: Microsoft, PayPal, Tesla, and other high-profile companies swiftly integrated digital currencies, enabling Bitcoin transactions for products and services. This rapid adoption enhanced Bitcoin’s credibility in the eyes of the masses and paved the path for mainstream acceptance.
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Institutional Impact: Hedge funds and investment firms acknowledged the potential of digital assets. Prominent players like Grayscale Investments created cryptocurrency-focused investment trusts that quickly garnered significant investments from institutional entities. This had a substantial impact on the demand for cryptocurrencies.
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User-Friendly Exchanges: The proliferation of user-friendly cryptocurrency exchanges and online payment gateways made getting into digital assets a breeze. Everyday investors can easily dive into the world of cryptocurrencies through user-friendly platforms and, in certain cases, even their own brokerages. This has opened up the investor club to more people and boosted demand from those who usually stay away from financial markets.
This notion also overlooks the competitive nature of how financial markets work.
Institutions are all about getting the best returns for their clients and shareholders. And that usually means they’re not just going to keep things to themselves.
So, to make their investment game stronger, they’re incentivized to tap into outside markets. It’s a way to get better liquidity and price discovery.
That’s why, if more big players step in, they’re more likely to add to Bitcoin’s overall use and spread, rather than concentrating ownership to a problematic degree.
Just take the gold market as an example again…
There’s been numerous manipulation attempts. Despite this, a diverse range of holders – including individuals, institutions, and even central banks – have played a role in upholding its value and stability over time.
I think we’ll see something similar with Bitcoin. A spot ETF would spread out Bitcoin among more retail investors, miners, traders, and institutions. That would help ease the risk of market manipulation.
And when it comes to worries about centralization and manipulation, the Bitcoin network’s decentralized nature is a countermeasure too.
In the end, if people don’t like what institutions are doing, they can skip the middleman and trade Bitcoin with each other.
This peer-to-peer trading dynamic chips away at any control institutions might want to flex over the market.
This is a unique feature of cryptocurrencies, unlike assets like gold. You can trade crypto without intermediaries.
So if you’re looking for another reason to include Bitcoin in your investment portfolio, this could be it.
The price of Bitcoin is still down about 62% from its November 2021 all-time high of about $68,000.
And that’s a good thing. It means you can still buy it at lower prices before big financial institutions like BlackRock swoop in.
That said, I don’t recommend you put all your savings into Bitcoin – or any other asset, digital or not.
Instead, consider investing a fixed amount of money on a regular basis, such as monthly or bi-weekly. That way, you can get a better average price per Bitcoin over time. This is called dollar-cost averaging.
But again, cryptos are speculative assets. Remember, even Bitcoin is only 14 years old. It’s still a very new form of currency.
So, as with any speculation, don’t bet the house on it. You don’t need to put a big chunk of your portfolio in crypto to see big gains. Even a small investment can go a long way.
And that’s all for this week’s mailbag! Thanks to everyone who wrote in.
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. Write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
P.S. Last month, without much fanfare, the financial elites unleashed the foundation of an all-digital dollar. It’s the first step towards embracing a new kind of currency.
The good news is, I’ve identified one-little known asset you can use to position yourself for what’s coming. And I reveal all the details in a special video presentation. Watch it here.