Let’s start with a story about the 24-year-old with no finance experience who blew up his $45 billion technology hedge fund (the fact that he managed a fund that size is laughable enough):

“For the past few years, at happy hours and dinner parties in San Francisco, Leopold Aschenbrenner kept confusing people by sharing his favorite outlandish idea. He wanted to buy galaxies. Some of his friends weren’t always sure what to make of Aschenbrenner’s intergalactic ambitions. He once left the room and they debated whether he was referring to physical galaxies or a type of private plane. No, he assured them when he came back, he meant galaxies His idea was that advances in artificial intelligence would soon unlock resources on a cosmic scale, enabling humans to colonize faraway planets. He planned to save money now so he could spend on galaxies, he told them, and make his mark across the universe. To almost everyone in this world, outside the AI bubble in Silicon Valley, the idea of scooping up property rights outside of Earth might sound improbable. But in Aschenbrenner’s world, that sort of fervent belief was among the reasons the 24-year-old investor was hailed as a visionary.”

Back here on earth, one man’s vision turned out to be another man’s margin call.

Elon Musk set a high bar for these kinds of claims at TSLA and then outdid himself with even more outrageous claims at SPCX. This has worked out pretty well for him despite not coming close to achieving his forecasts (though he has achieved quite a lot). But having normalized undeliverable promises that might have been treated as securities laws violations in a different time, Mr. Musk paved the way for others to make wild prospective claims they want with little consequence (though outright false statements about existing facts are still a no-no as demonstrated by Nikola Corporation). And the world of AI provides a perfect place for that.

Consider what Anthropic plans to tell investors with respect to its upcoming IPO:

“The maker of Claude [Anthropic] is likely to tell investors its potential revenue opportunities are above $30 trillion, topping SpaceX’s $28.5 trillion estimate, according to people familiar with the matter.”

Of course, the “potential” market for many things can be as large as one wants to claim it is. The people making these claims about AI may or may not achieve AGI but hey already cracked the code to human nature by demonstrating that the total addressable market for bullsh*t is infinite.

Mr. Aschenbrenner, of course, won’t be buying any galaxies; his spaceship crashed on take-off. As for Anthropic, its transparent attempt to out-Elon Elon is meaningless (i.e., literally devoid of meaning, as was Elon’s). In earlier periods, securities lawyers never permitted these types of statements in IPO prospectuses (standards started breaking down with the WeWork prospectus that read like the Whole Earth Catalog). But today they include every kind of nonsense in these documents provided their clients pay their egregious fees. And the SEC appears to believe that companies can say whatever they want provided their statements can’t be definitively disproved and are surrounded by language that hedges them into meaninglessness. Regulators believe investors are on their own and perhaps that is how things should be. If you believe Anthropic, however, Mr. Aschenbrenner has a galaxy he would like to sell you.

Interest Rates

I’ve been writing for months about rising global interest rates. Long-term borrowing costs in major economies are hitting multi-decade highs based on inflation fears (exacerbated by higher energy prices from the Iran war), runaway government deficits, and record levels of corporate borrowing driven by the AI buildout. In mid-August, U.S. 30-year Treasury rates hit 5.34%, the highest rate since 2007 after beginning the month under 5%. The U.S. 10-year Treasury yield is ending the month in the mid-4.70s. European rates also rose with the 30-year German Bund yield hitting 3.78%, its highest level since the Eurozone crisis in 2011. French 30-year yields followed to 4.91%, their highest level since 2008. UK 30-year gilts were trading at 5.86%, close to a post-1998 high reached during the Iran war. And most significantly, Japanese 30-year JGBs hit 4.16%, nearing their highest yields ever. All of these countries face rising debt burdens that will force painful political choices and economic strains. Rates are heading higher along with global debt loads and there is little to stop them.

This is a secular, not a cyclical move, as government debts compound. There is no sign of any serious attempts to address record deficits in the U.S. (or anywhere else) where $2 trillion (give or take) is likely the annual deficit floor as the total deficit crosses over $40 trillion. The only solution offered by politicians is more, not less, spending. Real rates are only marginally positive if you accept government inflation statistics (which I don’t). In the real world, where everyone except economists and Wall Street’s sell-side reside, real rates are negative as the prices of virtually all essential goods and services rise at higher rates than reflected in official government statistics (lowered by various statistical adjustments to suppress “official” inflation).

While various reasons are given for rising rates, the most significant factor is the flood of money-printing by governments that is inflating the prices of all financial assets. The prices of publicly traded stocks and bonds are boosted by liquidity poured into passive investing structures that encourage investors to buy groups of stocks or bonds bundled into products that diminish the importance and value of individual securities. The entire financial superstructure – stocks, bonds, commodities, real estate – is bloated in nominal value by the deteriorating value of the fiat currencies in which they are denominated and whose asset values are unsupported by their underlying earnings power. The AI trade is not the only one driven by a circular, Ponzi-like financing scheme; the entire world economy is dependent on such a structure whose basic constituent is debt.

On August 19^th, Treasury Secretary Scott Bessent announced that the Treasury Department would double its purchases of long-term government bonds (maturities 10 years and longer) to try to contain the rise in long-term interest rates. This is a version of the Fed’s Operation Twist used in 2011-12 when the Fed purchased $400 billion of bonds maturing in 6-30 years while selling shorter-term bonds to fund the purchases (it first undertook such a program in 1961). It is not quantitative easing because it doesn’t expand the balance sheet. Treasury yields dropped across the curve by up to ten basis points after the announcement but reversed most of those gains withing 24 hours and are now higher than before the announcement. Mr. Bessent’s plan was small in size; it was designed (along with the yen intervention a week earlier) to send a message to the market before the midterm elections. The market’s non-reaction led Treasury to tell CNBC a couple of days later that it was considering using its $950 billion General Account to fund larger bond repurchases. But Secretary Bessent isn’t managing a hedge fund anymore – and if he was, he would be shorting long maturity sovereigns across the board. He was reacting to political pressure to cap interest rates before the mid-term elections. But as much as some claimed the move was a game changer, the market made it clear that Treasury is gonna need a bigger boat. Unfortunately, there is no boat big enough to tame this shark.

Mr. Bessent’s mentor, highly respected investor Stanley Druckenmiller, didn’t mince any words in criticizing this short-term effort to tame long-term rates in an editorial in The Wall Street Journal (“Let the Bond Market Speak,” August 25, 2026):

“Markets aggregate information no committee possesses, and prices are how that information reaches decision makers. The long-term Treasury yield is the most important price in the world. It is also the only fiscal disciplinarian the U.S has left. Neither party will run on entitlement reform. Both have spent the past decade expanding commitments while ignoring arithmetic. Democracies don’t repair their finances because a budget office publishes a table. They repair them only when the cost of inaction becomes visible and immediate, when mortgage rates bite, when auctions fail, when the political price of a rising long bond finally exceeds the political price of touching spending.

“Every basis point of artificial yield suppression is a subsidy to procrastination. Suppressed long rates sugarcoat the interest-cost projections, shrink the apparent urgency, and let incumbents assure voters the debt is someone else’s problem. If Congress and the administration are unlikely to touch entitlements even with the market’s signal, they are certain not to touch them without them. Whatever this operation saves in basis points, it will cost multiples in delay.”

This set up an interesting triangular dialogue with Federal Reserve Chairman Kevin Warsh, another Druckenmiller mentee who spoke three days later at Jackson Hole. Mr. Warsh’s eagerly awaited speech was predictably short on details but heavily emphasized concerns about stubbornly high inflation. The clear message was that elevated prices need to be the Fed’s primary focus. Mr. Warsh described financial conditions as not broadly restrictive (a change from his July press conference), opening the door for a September rate hike. He also pointed to multiple inflation readings coming in well above the Fed’s 2% target. Reiterating that “short-term interest rates are the predominant tool to achieve the dual mandate,” it seems clear that higher interest rates are around the corner. The question is whether he will wait until after the midterms to move. There is no reason to delay other than politics as this point. Real rates are barely positive (based on phony government inflation numbers) and inflation is not easing meaningfully.

Mr. Warsh knows he needs to raise interest rates; he can’t tolerate another five years of inflation running well above a 2% target rate he refuses to abandon. The gap isn’t narrowing much despite optimistic forecasts by politicians and Wall Street talking heads. Demand for debt remains robust. But all this debt will be inflationary until it breaks the system and causes a deflationary bust. That is where we are headed.

Gold popped by $100/oz. on Secretary Bessent’s announcement (Bitcoin also rallied to over $80,000) as investors reacted to the continuing debauchment of fiat currencies by deficit-ridden governments (though viewing Bitcoin as a fiat alternative may prove to be an error). Gold should be bought as a hedge against inevitable and infinite fiat debasement. We will see $10,000 gold sooner than expected as the U.S. deficit hits $50 trillion by 2030 and $60 trillion by 2035. The AI hyperscalers may want to think about that as they borrow hundreds of billions of dollars based on the expectation (hope) of future revenues.

Every level of our economy, from the micro to the macro, is characterized by denial about debt and deficits. So much of modern wealth is counterfeit because it is grounded not in equity but in debt that can never be repaid, just deferred in an endless pattern of what Hyman Minsky called “Ponzi finance.”^[3] As long as refinancing is available, the wealth appears legitimate but once the Ponzi chain is broken, wealth evaporates quickly. Governments can engage in Ponzi finance as long as they can survive politically but businesses and individuals cannot. As the cost of refinancing rises for corporate and individual borrowers, many of them will see their wealth transferred to their creditors (or vaporized entirely). Many of their creditors will end up losing money on loans they thought were adequately secured by inflated collateral values. As Mr. Druckenmiller warns, measures seeking to save a few basis points in the short term end up costing hundreds of basis points in the long run when they don’t address debt metastasizing below the surface.

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When there has been inexplicable or at least highly unusual trading activity in individual sectors or securities, it often tracks back to one or more firms engaging in reckless behavior almost always employing dangerous amounts of leverage. Long Term Capital Management drove the prices of junk bonds to irrationally high levels before it blew up in 1998 by using leverage to buy those bonds at extremely high prices (it kept outbidding my firm for bonds and we couldn’t figure out who would pay those prices which generated very meager returns). Archegos Capital Management borrowed excessively to buy stocks large concentrated positions in stocks like Viacom, Baidu, Vipshop and Farfetch before vaporizing, sending those stocks to the moon and its manager Bill Hwang to jail. And now we see Mr. Aschenbrenner used enormous amounts of leverage to buy stocks like SNDK, BE, NBIS, CORZ and CRWV that rose far above any sustainable valuations until they fell back to earth faster than a SpaceX rocket (SPCX stock is doing the same and no doubt was in the portfolio as well). Large funds employing leverage far beyond that allowed by traditional margin rules with the able assistance of Wall Street banks touting their responsible lending practices to the media and politicians are distorting markets and damaging not only themselves but other market participants. Those attuned to abnormal price action are better able to step aside and avoid these episodes rather than surrender to the temptation to indulge in reckless behavior. The minute Mr. Aschenbrenner showed up on the scene, it was obvious he would blow up.

Situational Awareness L.P. was reportedly down around 67% in July, which left it up a meaningless 80% year-to-date (on mark-ups of private positions like a large investment in Anthropic, a position that seems to be singlehandedly inflating tech earnings this year). This 80% figure is largely meaningless because it only applies to investors in the fund at 1/1/26; anyone who invested later has a different return, and the later they invested, the lower that return would be (with the last ones in the door likely wiped out or nursing deep losses). Touting the 80% return as some kind of success is like a surgeon telling a patient’s family that the operation was successful, but the patient died. Mr. Aschenbrenner not only showed an appalling lack of risk management skills but a reckless disregard for his partners’ capital. Handing a 24-year-old tech bro with no investment experience billions of dollars of borrowed money was like handing an alcoholic the keys to a bar. The only question was how quickly he would drink himself into a stupor and drive his car into a wall. Now we know.

As noted above, Situational Awareness’s aggressive buying of the most overbought tech stocks contributed to their ridiculous rallies before its frantic sales of those same positions to meet margin calls contributed to the sharp sell-off in those same stocks in July. Whether the sale of the portfolio to Citadel ends, or just pauses, the sell-off remains to be seen. The larger forces depressing stocks remain in place – high inflation, a hawkish and close-mouthed Fed, legitimate questions about the AI buildout – are unaffected by this drama. After breathing a sigh of relief that Uncle Ken came to the rescue, markets still must wrestle with these other issues.

“Situational awareness” for a fund manager doesn’t only apply to the investments made by a fund but also to how those investments are financed and structured. On that last count, this fund was situationally clueless. “Situational awareness” requires humility, a deep understanding of financing structures, healthy respect for leverage, and knowledge of market history. If you think you know things that nobody else knows, or that you’re smarter than everyone else – and are dumb enough to say those things aloud or write them down and blast them to the world - you don’t know a thing. It took less than a month for excessive leverage to wipe out a $45 billion fund. All that’s left are private holdings that can only be sold at steep discounts, inflicting more losses on investors. Citadel was generous by only extracting a reported 10% discount on Situational Awareness’s public stocks, but likely Mr. Griffin wanted to help avoid a much more negative market event that could have also harmed his firm. Others might have been more short-sighted (which is why Mr. Griffin is justifiably highly respected).

The prime brokers who leveraged this fund to the gills seem to have avoided losses by helping arrange the sale of all of the fund’s public securities to Citadel. But they bear responsibility for allowing the situation to approach the brink of disaster. They failed to act like adults when clearly dealing with a child manager with very limited market experience. But then again, Wall Street isn’t there to protect anyone’s interests but its own. For the most part, it’s happy to load the gun and hand it to people who don’t know how to shoot. Unfortunately, as we learned during the 2008 financial crisis, Wall Street doesn’t recognize when it doesn’t recognize its own interests and aims the gun at its own head. Greed always trumps fear until it’s too late. The Street got lucky this time. Next time the outcome could be different.

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Vishal Misra, vice dean of computing and AI at Columbia University’s engineering school, notes that “you don’t need a model that knows quantum gravity. These open-source models are very capable, and the ability to charge a big premium for AI is going to diminish.” MSFT unveiled smaller AI models that operate more efficiently than leading-edge models while NVDA launched Nemotron, a family of cheaper models. Open-source Chinese models from Alibaba and DeepSeek and lesser-known companies like GLM also offer cheaper alternatives as do Small Vertical Language Models (SLMs) that can perform more modest tasks and run on desktop computers or even mobile devices.

The argument that Chinese models are inferior to those built at much higher cost by Western companies is coming under question. Part of that cost was driven by salaries that would make even profligate NBA owners (who overpay for mediocrity as one of their basic business practices) blush. Michael Green made this argument in his Substack column: “By optimizing training stability rather than relying on brute-force compute infrastructure, labs like DeepSeek and tech giants like Xiaomi have triggered a permanent, deflationary price war.” (“A Token China Shock,” June 28, 2026) He points out that DeepSeek’s R1 and Xiaomi’s MiMo-V2.5 models are undercutting major Western competitors by 90-99%, dropping the cost of tokens to fractions of a cent per million. This doesn’t mean that these Chinese models can do everything that Western models can do. But they don’t need equivalent capabilities to provide what users require. As noted above, you don’t need a supercomputer to solve a simple algebra problem.

Token prices will be a key issue in these companies’ forthcoming IPOs. These pressures are leading OpenAI and Anthropic to consider sharply lowering their prices which would likely slow their revenue growth even if usage numbers keep rising. OpenAI is now reportedly considering delaying its IPO until next year to secure a trillion-dollar valuation which Sam Altman seems to view as some kind of dick-measuring test, but this could backfire if pricing pressures continue or intensify as is likely. He also reportedly offered the U.S. government a 5% ownership interest in the company. Further price pressures will only hurt the valuations of both OpenAI and Anthropic. True believers won’t be deterred, however. Highly respected tech investor Gavin Baker said on the June 26^th All-In Podcast that he believes Anthropic would be worth $3 trillion as a public company mentioning the price war. With users doing everything possible to lower their token costs, the remarkably high margins cited by Mr. Baker in touting such a high valuation won’t be sustainable, however. He may need to rethink. A lot of AI usage will be required to lift Anthropic’s valuation to such an exorbitant level.

Intensifying price competition on top of opaque and increasingly leveraged financing structures also poses potential financial stability risks. The circular nature of the AI industry’s financing arrangements coupled with a reported $1.8 trillion of off-balance sheet obligations raises serious questions about what could happen if the ambitious financial projections of the AI hyperscalers and chip manufacturers don’t materialize. At the very least, the gigantic market caps of some of these companies may come under even more pressure than they’ve seen recently.

The Bank of International Settlements (BIS) warned about this in its latest Annual Report:

“The opacity of AI-sector financing compounds these vulnerabilities. Hyperscalers, chip makers and AI labs are linked through a complex web of private arrangements. The most prominent is circular financing: chip makers and hyperscalers take equity stakes in AI labs or neocloud providers, who in turn commit to multi-year purchases of chips or computing power. Data centre construction is increasingly outsourced to third parties that lease facilities back to hyperscalers on long-dated contracts with embedded exit clauses. The terms of such deals are typically poorly disclosed, with risks of the same asset being pledged multiple times. Together, such arrangements account for a sizeable share of sector-wide financing and forward revenue.”

The BIS also points to potential risks in the opaque private credit sector: “Any tightening in credit conditions could expose existing vulnerabilities in the less transparent private sector space, whose reach has expanded among middle market and small firms.” (25) As indicated by use of the adjective “existing” in that sentence, credit conditions in private credit are already tightening as lenders pull back on lending to software and related companies while dealing with higher levels of stress in existing portfolios and demands for redemptions for significant percentages of their funds.

Finally, META’s announcement that it plans to build out a new cloud business to help recoup its enormous spending on AI infrastructure raises questions about long-term AI demand. This news follows moves by SPCX to lease large amounts of xAI’s excess data center capacity to Anthropic and GOOG. If these hyperscalers are suddenly looking to offload capacity, what does that say about their outlook for AI demand? Is this just a short-term measure to lower costs or a signal about long-term demand trends? It certainly suggests that data showing that only a small percentage of announced capacity additions are currently under construction (less than 5%) or fully funded (less than an additional 18%), suggesting much of that future capacity may never be built or will be delayed significantly. I note that META’s announcement sent CRWV stock down sharply; CRWV is a company I’ve pointed out is particularly vulnerable to a slowdown in AI demand due to its lack of competitive advantages, history of losses, and heavily leveraged balance sheet. As noted above by the BIS and elsewhere (including in this newsletter), if AI demand doesn’t materialize as quickly or as robustly as its promoters expect, there are going to be serious losses among equity and debt investors. CRWV and APLD are at the top of that list.

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Last month, I featured several charts (borrowed from SocGen’s Albert Edwards) showing rising global long-term interest rates. Those rates rose further in May to the highest levels in two decades. They aren’t high enough to burst the bubble but they are moving in a troublesome direction for markets and government finances. Commentators attribute rising rates primarily to higher oil prices resulting from the Iran war. But the growth of debt not just in the U.S. but in Europe, Japan, and China. One way or the other the war will end, but debt accumulation will never end. Debt is a feature, not a bug, of the global economic system. The Ponzi finance structures of governments are essential to their existence (borrowing money without repaying it in constant dollars if ever).

So while reopening the Strait of Hormuz (the aspect of the war with the most immediate economic impact) should lower oil prices and relieve some inflationary pressures (though not as quickly as promised), the rising debt will maintain pressure on global long-term interest rates. Monthly inflation data and bond trading data are merely data points along an upward arc of higher prices, higher bond yields, and higher borrowing costs demanded by investors funding endless government Ponzi schemes. This is the nature of things. And as the world continues on this course, the system keeps devaluing fiat currencies to sustain itself. This is also the nature of things (which means everyone should be buying gold as a hedge). One of the factors driving stocks higher – one rarely discussed or acknowledged – is the continuing devaluation of the fiat currencies in which these financial instruments are denominated. Over time, currency devaluation/inflation is a significant contributing factor to higher equity prices. It is also in the nature of things that the more a bubble inflates, the less fiat-currency denominated stocks will be worth because rising prices contribute to the very financial asset inflation that chews away at their value. This is not merely ironic; it is structural.

AI

AI bulls claim this time is different than the last technology bubble in 2000. The bull market in hyperbole is running wild. AI no doubt allows the solution of problems that vexed mankind for years (like curing certain diseases or solving certain mathematical and scientific problems) due to its ability to analyze mass data in incredibly short amounts of time. Even with its imperfections, which are being cured at a remarkably rapid rate, this is an achievement on par with the most important landmarks of human thought. There are certainly meaningful differences between the Internet companies that attracted high valuations and ultimately failed two decades ago and many of today’s AI-related companies. Transformative as it is, however, we still don’t know precisely how AI will affect jobs, earnings, and the like. Wall Street is clearly ahead of itself in extrapolating or even imagining the future for AI, but that is Wall Street’s job – to finance he future (especially the venture capital business). It doesn’t have the luxury of waiting to see which businesses will succeed. Its mission is to fund as many promising new businesses as possible before they prove their worth and let markets sort out winners and losers. This is the gravamen of venture capital (and where venture capital separates itself from private equity, which invests in businesses using debt only after they prove themselves).

So naturally many AI companies deemed most promising by the market aren’t remotely profitable or in the case of AI losing billions of dollars building data centers or more likely announcing plans to build them on earth and in space without actually breaking ground (or whatever you break in space). But we are still in the very early innings of this effort. The industry is far from proving that many of its announced projects won’t turn out to be vaporware. Right now, there remains a yawning gap between reality and fiction.

According to British research firm Panmure Liberum,most of the AI build-out only exists on paper. Of the 811 gigawatts in additional U.S. data center capacity planned through 2030, only 37 gigawatts (4.6%) are currently under construction with only a further 146 gigawatts (18%) backed by firm commitments. It is going to be challenging to find financial institutions to finance the balance, especially if the private credit industry doesn’t turn things around. The remaining 628 gigawatts (77.4%) exists only in forecasts and press releases and podcasts or as Panmure Liberum puts it “in Excel spreadsheets of investors and businesses.” This is reminiscent of the Internet companies who built or planned to build enough fiber to circle the universe (many of whom borrowed money to do so and ended up in bankruptcy) long before demand for fiber caught up to supply. AI hyperscalers shifted from self-funding to borrowing to finance their data center buildouts (with much of the financing hidden off-balance sheet). Most, but not all of them (CRWV, APLD), are capable of handling this debt but all are shifting their business models from asset-lite to capital-heavy and will be left with big debt burdens to service if AI doesn’t prove as profitable as they expect. If there is a difference today from the Internet Bubble, it is the circular nature of today’s financing structures which feature a different kind of fragility that that seen in the earlier period

Trillions of dollars are being spent without any assurance it is being spent wisely. Demand for chips feels infinite today, but it only feels that way. Nothing is infinite except the universe. There are real limitations to demand that will hit sooner than later (especially in space). Companies are over-ordering and advance-ordering to secure scarce supplies. Will companies need to continue buying so many chips once their models are up and running, or will their capex demands level out? xAI’s Grok quickly fell behind its competitors and ended up leasing its excess data center capacity to Anthropic on the cusp of the latter’s IPO but may have knocked it out of the LLM race. How many LLMs do we need? How many data centers do we need? Nobody really knows. Jensen Huang says chip demand will hit $4 trillion in 2030. How are companies going to pay for that? AI revenues are unlikely to generate $4 trillion in revenue by then. What about the competition from cheaper Chinese models. Is anybody seriously looking at how Chinese models like DeepSeek are undercutting Anthropic’s and OpenAI’s pricing and whether American companies’ pricing models are sustainable (which may be why politicians are considering banning Chinese open-source models?). And what about Small Vertical Small Language Models (SMLs) that some argue can be trained on specific tasks and run on a desktop computer or even a mobile device rather than needing data centers to run (unlike LLMs). Will SMLs eat away at LLMs? Companies are already waking up to the high costs of tokens (AMZN employees reportedly ran up $500 million in token costs in a month which probably upset Jeff Bezos as much as his rocket blowing up) If we are still in the early innings of AI as virtually every respected participant and observer argues, then it is far too early to know how all these things will play out. Yet the expected capex growth of hyperscalers from 2025 to 2028 is around 29% per year (off trillion-dollar bases). These are the largest and riskiest bets in history. If they go awry, or are delayed in any significant way, the ramifications for markets and the economy are profoundly negative.

Everybody is rushing to buy the same stocks (in many cases purchasing them through different ETFs that own the same underlying stocks without) asking questions. There are more ETFs than individual stocks today which if you think too hard is absurd (and you will get a migraine like me). SpaceX stock will be included in so many ETFs that that virtually every investor will own it whether they buy it or not. ETF-dominated market structures that didn’t exist during the last bubble render this bubble much more powerful than the earlier one. SpaceX’s IPO, which is partly a datacenter play after xAI leased out its unused data center capacity to Anthropic (though there is some confusion over the length of the lease) will benefit enormously from inclusion in index funds and ETFs that will boost demand for the stock without regard to the aura surrounding Elon Musk. These are all classic signs of a bubble, one severely divorced from the fundamentals that determine what stocks are worth.[6]

And it is a glaring - not a glancing - risk factor that this is happening against a fragile macroeconomic background rendered fragile by epic levels of public and private debt and geopolitical instability. Michael Burry correctly noted that “the market is capitalizing the most expensive phase of AI adoption as if it were normal and indicative of future demand.”[ The bubble relies on belief in the infinite capabilities (and profitability) of AI as well as the ability of governments to print infinite amounts of money. Neither belief is true. As I wrote earlier, nothing is infinite except the universe. But unsustainable debt and this stock market bubble are joined at the hip, and the hip is rotting and will eventually need to be replaced.

Still, if only for historical purposes, it is instructive to compare current stock market behavior to the Internet bubble in 2000. Through the third week of March 2000, the top ten performing stocks in the Nasdaq Composite were up 622%. Through May 5^th, BTIG points out that they were up 784%. And they’ve risen even higher since then. The hottest stocks in 2000 had higher P/E ratios than those of NVDA, GOOG and MSFT today. But the S&P 500’s trailing and cyclically adjusted P/E multiples are almost as high. This is partially due to market structure (ETFs) as noted above. There is also much more capital in the system today to pump up these stocks due to the trillions of dollars manufactured out of thin air by governments since the 2008 financial crisis. Today’s market bubble is much larger than the Internet Bubble. There are differences but the underlying etiology is the same. And it will run its course the same way. Those who invested early in AI will earn enormous profits and those who hold on too long will see those profits vaporize. These are the laws of investing because they are the laws of human nature. AI can’t change that. AI is, after all, based on human nature. It is just human nature on speed.

Government Fueling the Bubble

Rockets require fuel and stock market bubbles require liquidity to lift them into orbit. The government is happily providing that fuel. The great economist Lacy Hunt provided a compelling explanation for the current stock market moonshot at the Mauldin Conference last month when he pointed to the Federal Reserve reinitiation of QE-by-another name (they called it “Reserve Management Purchases or “RMPs”) with $40 billion monthly purchases of Treasury bills. While Treasury described this as a technical liquidity or “plumbing” operation, Mr. Hunt described it more accurately as QE:

“The Fed said that they were upping the bill purchases because the banks were short of liquidity, and this was a technical operation. Nothing could be further from the truth. This was not a plumbing issue. If the banks were in dire need of liquidity…the bulk of those purchases would have gone into idle balances, but they were not. They were directly used and explosively sold.”

In fact, the money flowed directly into bank balance sheets and was put to work in the economy (including the market). Loans and leases grew at nearly a 10% annualized rate since then while commercial and industrial lending grew at twice that rate. Instead of ending back on the Fed’s balance sheet, that money was multiplied throughout the system, expanding the money supply and increasing inflation (including financial asset inflation).

This monetary policy stimulus is in addition to the two trillion-dollar annual fiscal stimulus pouring into the economy, funded largely with short-term paper. This short-term funding raises another problem. Double Line (quoted by SocGen’s Albert Edwards) points out the following troubling scenario regarding U.S. finances:

“Nearly 70% of U.S. fixed-income issuance over the past year has come from one source: Treasury bills. It is a subtle recalibration of the government’s balance sheet – a shift toward shorter-term debt as deficits deepen. The world’s largest borrower is increasingly financing long-term fiscal obligations with instruments that mature in a matter of months… This trade-off reflects the short-term temptation at the heart of fiscal engineering. Issuing short debt reduces cost today but magnifies risk tomorrow.”

Treasury Secretary Bessent was rightfully critical of his predecessor for failing to take advantage of low long-term rates to manage the Treasury’s borrowing needs during the Biden years. Those low rates are no longer available (not should they be), forcing Mr. Bessent to follow the same path to keep the cost of servicing the deficit as low as possible. Unfortunately, this increases pressure on incoming Federal Reserve Chairman Kevin Warsh to lower interest rates which would be imprudent with inflation running well above target for years. Fiscal dominance will continue to influence monetary policy in the years ahead despite being a path to high inflation and unsustainably higher debts. But for now, we can expect Treasury to keep borrowing short-term to fund growing long-term obligations while praying that the short end of the curve won’t follow the long end too much higher. However one chooses to look at things, it is difficult to forecast a future of lower inflation or lower indebtedness for America unless you buy into the AI optimists’ argument that technology will produce enough economic growth and productivity to solve our self-made problems. Reading Iain Banks’ Colony series of science fiction novels may help you through. It has inspired them to believe we can achieve a future in which these earthly problems are solved.

The SpaceX IPO could mark the zenith of the bubble. The Blackstone IPO did so before the 2008 financial crisis; it took years for BX stock to perform. Then again, maybe the market will wait for Anthropic and OpenAI to IPO before the trifecta of these huge IPOs mark a stock market top. But parabolic market momentum in semiconductor stocks and sectors related to semis and AI is going to prove unsustainable before long. Not only does the math undergirding these epic stock moves not add up, but even the massive money creation supporting them is going to reach its limits (set by the bond markets). Financial institutions also need to decide how much more exposure they want to the most overvalued market sectors. While some firms like APO have reduced their exposure (though APO is out leading a $35 billion data center debt deal for META who seems to be falling behind in the LLM race for the moment), Wall Street remains “risk-on” and keeps pushing things to the edge. With the S&P 500 trading at 22x forward earnings and 41.6x cyclically-adjusted earnings, there is little room for error. Investors should not short this market unless they are professionals (and even professionals should use puts and be very judicious). The momentum train is as powerful as any we’ve ever seen and as noted above market structure is as pro-cyclical as we’ve ever seen (and much more so than during the Internet Bubble). But at some point, this market will collapse of its own weight and owning stocks trading like baseball cards is best left to people of the age who play with baseball cards.

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Kevin Warsh will soon take the helm at the Federal Reserve now that the Department of Justice dropped its ill-conceived investigation of current Chairman Jerome Powell.His first test will be resisting political pressure to lower interest rates. Barring an unexpected change in the data, he shouldn’t cut rates for the foreseeable future in today’s stagflationary environment. The stock market is not the economy even if it plays one on television. Inflation is still far above the Fed’s 2% target (and is even higher in the real world than government statistics say it is). Economic growth is sluggish (2% in 1Q26) and unemployment is rising. Mr. Warsh would damage the Fed’s (and his own) reputation for independence by cutting rates soon after assuming the chairmanship. Part of his job should be restoring the Fed’s reputation for independence which suffered in recent years.

He is inheriting a central bank whose governing board is leaning against lowering rates despite inappropriate political pressure to do so. In the final meeting of Mr. Powell’s chairmanship that ended on April 29^th, three Fed governors dissented against including an easing bias in policy at this time. Including Stephen Miron’s predictable dissent in favor of a rate cut, the four dissents from the decision to leave rates unchanged were the most in 34 years. This means Mr. Warsh enters the chairmanship leading a group with a neutral bias. This is consistent with the mood of the market and likely means further upward pressure on long rates (see below). With 10-year yields on the cusp of 4.5%, the Fed has its work cut out for it. The most significant news from the April meeting was Mr. Powell’s announcement that he intends to remain a Fed governor until the DOJ definitively ends its investigation into him. U.S. Attorney for the District of Columbia Jeannine Pirro said she could still bring charges if she was presented with evidence of wrongdoing, suggesting that the investigation may not be over. While Mr. Powell expressed support for Mr. Warsh and made clear he has no intention of acting as a back-seat driver, he said he felt he needed to remain on the Fed as a reaction to the overt attempts by the president to interfere with the Fed’s interference. It is unusual for a chairman to remain after his term is over but we live in unusual times and President Trump has nobody but himself to blame for Mr. Powell’s decision. The president badly wants to appoint somebody willing to cut rates to replace Mr. Powell but for now that will have to wait.

Lowering rates would feed speculative and unproductive lending of which there is already more than enough in the economy. There is far too much impaired or worthless debt that needs to be flushed from the system. Positive real interest rates are needed to accelerate that process and impose discipline on economic actors; even taking government inflation statistics at face value, interest rates are not sufficiently positive in real terms to do that. Lower rates reflect not a booming economy but an overleveraged one relying on debt to keep afloat. Rates should be kept at a decent margin above inflation and the Fed should start shrinking its balance sheet (by, among other things, ending its recently implemented Reserve Management Purchases). Mr. Warsh speaks of shrinking the balance sheet but also said he thinks interest rates should be lowered, the latter statement necessary to convince President Trump to appoint him. But he knows that negative real interest rates are toxic to long-term economic stability and prosperity and will hopefully exhibit the courage to end them.

The only reason to cut rates is fiscal dominance (i.e., cutting rates to reduce the cost of servicing the federal debt). But lowering rates below the rate of inflation to compensate for reckless fiscal policy not only won’t bail out the government but will deepen the fiscal deficit. We’ve already seen that lowering the Federal Funds rate doesn’t guarantee that markets will follow and can just as easily lead markets to push them higher. That’s what markets did after the Fed started lowering rates starting in September 2024 (in that month, the yield on 10-year Treasuries hit a low of 3.63% and ended the month at 3.81% and have been higher ever since). With a $39 trillion deficit ($40 trillion by October, etc. etc.), $2 trillion annual deficits (and rising exponentially), and an annual interest bill exceeding $1 trillion (and rising exponentially), it’s difficult to envision markets lowering the cost of lending money to the U.S. government outside a flight to safety trade triggered by a serious economic or geopolitical crisis (more serious than the Iran war apparently). America’s reverse global charm offensive may further increase borrowing costs. All of this renders maintaining the ascendancy of the dollar crucial for America’s economic health, which among other things means protecting the dollar/oil linkage (efforts to replace it or even erode it meaningfully with a yuan/oil linkage have yet to make much of a dent).

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This graph, borrowed from Societe Generale’s brilliant Albert Edwards, illustrates the sharp drop in software equity values. Perhaps the decline hasn’t yet reached the software loans held in private credit funds (including BDCs and CLOS), but a loss of one-third of the value (on average - every loan is different) suggests that the debt is under pressure…

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“Because the individual parts of a complex adaptive system are continually revising their (“conditioned”) rules for interaction, each part is embedded in perpetually novel surroundings (the changing behavior of the other parts). As a result, the aggregate behavior of the system is usually far from optimal, if indeed optimality can even be defined for the system as a whole. For this reason, standard theories in physics, economics, and elsewhere, are of little help because they concentrate on optimal end-points, whereas complex adaptive systems ‘never get there.’ They continue to evolve, and they steadily exhibit new forms of emergent behavior. History and context play a critical role, further complicating the task for theory and experiment…It is the process of becoming, rather than the never-reached end points, that we must study if we are to gain insight.”

Even with the development of computer technology that Professor Holland predicted (“massively powerful computers should produce a revolution in the investigation of complex adaptive systems”), it remains extremely difficult to forecast the path of the global economy today. The serious stresses manifesting themselves as the war continues reflect conditions building up over decades including the massive growth of global indebtedness, increased interconnectivity among global markets, changing market structures including growth in derivatives, passive investment products, and computer trading, the shift from analogue to digital to tokenized finance, and other conditions that amplify and accelerate market moves. All of these changes significantly increase complexity which in turn renders the ability to forecast outcomes much more difficult.

In The Seventh Sense: Power, Fortune, and Survival in the Age of Networks (2016), Kissinger Associates’ Joshua Cooper Ramo describes how today’s world is dominated by networks. The digital and networked economy is brilliantly examined by my friend Professor Mark Taylor in his seminal book, Confidence Games: Money and Markets in a World Without Redemption (2004), where he identifies and explicates the philosophical/scientific/intellectual origins of our interconnected world. Both books are essential reading for understanding how transformations in technology affected economies and markets in ways that were expected to improve humanity but also destabilized the world. Improving man’s technological capabilities empowered not only his best but his worst instincts, lifting many out of poverty and ignorance while exacerbating wealth inequality, the spread of noxious ideologies, and corruption and violence. This double phenomenon is almost certain to repeat itself with artificial intelligence. In an ironic Hegelian twist, technology simultaneously makes us smarter and dumber, richer and poorer, saner and crazier by tapping more of man’s darkness and light.

In a networked world, everything is connected to everything else. The meaning of every event and the value of every asset is affected by its connection to everything else. Nothing can be understood or valued in isolation. And connections are almost always multiple, not singular. We must think about markets in a holistic way; talking about “small caps” or “large caps” or “investment grade bonds” or “high yield bonds” or “private credit” or “commodities” may be necessary for media or institutional presentations but is otherwise fails to capture the complex array of forces affecting asset values and investment prospects. The silos in which we divide different subjects does them a disservice because they all interact with each other and thereby affect each other’s value. The walls between different things are broken down in a networked world.

Most people are still catching up to this new reality. This is especially true of our political and business leaders who either willfully or ignorantly cling to old ways of thinking. Mr. Ramo wrote in 2016: “our world [is] led into the future by a class of old leaders who don’t understand networks, and a collection of new technologists who don’t understand the world.” Little has changed over the last decade. With octogenarians running Congress, and tech leaders drawn from the Asperger’s spectrum (or just acting like it) running the most valuable companies in the world, we lack leaders capable of effectively managing a networked world (and those who can are demonized by those threatened by change). As Mr. Ramo wrote: “we find our future not in our own hands but instead in the grip of two groups, one ignorant of networks, the other ignorant of humanity.” The incompetence of our political system and the obliquity of our business culture derive from either a refusal (in the case of corrupt politicians) or a failure (in the case of narrow-minded technologists) to understand not simply that everything is connected but how everything is connected and the human consequences of that reality. The “how” requires understanding that the world is constantly changing in ways that place networks and their connections at the center of all things. We need men and women who understand that truth to lead us and leave behind the silos in which we used to operate.

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Even before the attack on Iran, stocks were under pressure. The Iran military operation is likely to be inflationary by increasing energy prices and raising the federal deficit by increasing military spending significantly. That lowers the odds of the Fed lowering rates, odds that were already pretty low. War is among the most destructive economic forces in the world so the longer the Iran action goes, the worse it will be for stocks. If successful, however, the attack on Iran should be beneficial for the global economy and positive for markets. Investors should look through the attack. Traders will do what traders do.

Software stocks have been leading stocks down while the FAANGs are losing their buzz as well (their huge profits consumed by epic AI spending). AI-leader Anthropic inflicted three stages of grief on software stocks in February. On February 3^rd, it announced a legal plug-in for its large language model (LLM) Claude that sent Thomson-Reuters (TRI), LegalZoom.com, Inc. (LZ), and RELX PLC (RELX) down 10% or more. Then on February 20^th, Anthropic announced Claude Code Security, sending CrowdStrike Holdings Inc. (CRWD), Cloudflare Inc (NET) and Okta Inc. (OKTA) down sharply. And then on February 27^th, the company announced that Claude had the capability of modernizing Cobalt databases (used widely for banking, payroll, ATMs and other government services and run 95% on IBM machines) which sent IBM”s stock to its largest drop in 25 years. Despite its disagreement with termination by the Department of War, Anthropic appears to be taking the lead in important parts of AI competition while sowing fear in the software industry. As discussed below, this is causing serious problems in the corporate credit markets because of massive lending to the software industry in recent years.

Markets were also shaken by a negative reaction to another quarter of blockbuster earnings from NVDA. NVDA has dropped after each of its last four earnings reports, each one better than the other, suggesting it may be hitting a ceiling in terms of investor expectations. But there may be a deeper reason, concern that the company won’t be able to maintain its results once the AI building boom slows. OpenAI lowered its future spending forecast from $1.4 trillion to $600 billion shortly before raising $110 billion from AMZN ($50 billion), NVDA ($30 billion) and Softbank ($30 billion) at a $730 billion valuation (down from a previously projected $850 billion valuation). This was another circular deal that is not what it seems (other than it seems absurd to pour that much money into a company losing tens of billions of dollars a year) as AMZN is paying only $15 billion up front with the rest of the money contingent on reaching certain milestones. META and other hyperscalers are also spreading their AI spending beyond NVDA which may also be tempering enthusiasm for the stock. CoreWeave (CRWV) reported another horrendous quarter, driving its stock down sharply, and investors didn’t believe a single word spoken by its CEO in a long interview on CNBC claiming business is great (he doth protest too much). AI needs to start showing results to impatient investors to prevent further stock market declines. Headlines like Block Inc. (XYZ) cutting half its workforce and firing 4,000 may boost the stocks of companies ostensibly saving money but the other side of those announcements are cuts in software and other products that will hurt the economy and markets. AI is not a zero sum game. There is dark side to any efficiency gains it produces that has to be factored into future forecasts.

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“The misallocation of capital – goosing the price of the riskiest and least-productive of assets – set the conditions for boom and bust. The financing of the ‘big state’ set the country on an unsustainable fiscal trajectory. The extraordinarily loose financial conditions created herd behavior among market participants and firms and complacency among policy makers, including regulators. The surge in inflation substantially raised the cost of living for citizens and undermined business planning.”

Mr. Warsh’s diagnosis of the Fed’s errors was dead-on. Further, he possesses the temperament, experience, and intelligence to navigate the complex challenges facing U.S. monetary policy in a period of unsustainable deficits and financial dominance. Policy must change to avoid a reckoning that will damage markets and the economy. No doubt Mr. Warsh benefitted enormously from working with Stanley Druckenmiller, one of the best minds in the markets, over the last decade, as well as from his prior experience as a Fed governor during the Great Financial Crisis. By appointing Mr. Warsh instead of Kevin Hassett, the president wisely chose competence over the perception (valid or not) of blind loyalty. Mr. Trump may have limited his options with the ill-advised criminal investigation of current Fed Chair Jerome Powell (which should be dropped) and the failure to reign in ICE’s tactics, both of which increased the need for a nominee free of political taint (I give little weight to claims that Mr. Warsh’s was due to his relationship with the Lauder family, large Republican donors). Mr. Warsh laid out a bold and compelling vision for reforming a central bank desperately in need of change and stood out among a highly qualified group of candidates for the job. The other candidates, including Mr. Hassett, would have been excellent choices but Mr. Warsh was the best choice. Hopefully he will be confirmed without too much unnecessary political drama though that is probably too much to hope for (the lack of drama) in the current hothouse atmosphere in Washington.

The Fed wisely kept interest rates unchanged at its late January meeting. Even the two dissenters, Christopher Waller (who was a strong candidate for chair) and Stephen Miran (whose temporary appointment ends on January 31^st), only wanted a 25-point cut, which in Miran’s case was unusual because he pushed for 50-basis point cuts at every meeting. Mr. Waller argued that rates should be cut by 50-75 basis points to a 3% neutral rate and Mr. Miran wants even lower rates but neither pushed for that at the January meeting. With stocks trading at record levels, inflation treading above target, the job market stabilizing, and credit spreads sitting at or near record tights, there is little argument apart from fiscal dominance (lowering the cost of servicing the federal deficit) supporting lower rates. And with overt political interference including an ill-advised criminal investigation of Mr. Powell, it was incumbent upon the Fed to show independence and resist purely political calls to lower rates at this time. Rates markets barely reacted, suggesting they anticipated the Fed would stand pat (though stocks and precious metals reacted negatively – see more below). Rates markets are now pricing in little easing for the rest of 2026 and even 2027, but the consensus still argues that the “neutral” rate is 3% (I think it’s higher) which suggests that rates will eventually be lowered to that level (while President Trump still calls for 1% which would be, with all due respect, a terrible policy error). Mr. Powell also confirmed that nobody on the policy committee is thinking about raising rates at this time so hopefully we can snooze until Mr. Warsh takes over.

Paid subscribers can read the rest of the issue which also discusses precious metals prices, private credit fund valuations, AI-related borrowing, rising Japanese interest rates, the toll of fraud on state and federal government finances, and much more. Please consider subscribing today.

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As someone who has been calling for regime change in VZ for years, I strongly support President Trump’s move to seize illegitimate “President” Maduro and his wife and deliver them to the United States to face drug and weapons charged. But the indictment is clearly a pretext for a much more important geopolitical …

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Welcome to Kingstown

“In this world, five percent of people are truly good. Five percent are evil. The rest of us, we wrestle between the two. Who we are, what we are, what we’re willing to do.”

Mike McClusky, Mayor of Kingstown

In the television series Mayor of Kingstown, Mike McClusky (brilliantly portrayed by actor Jeremy Renner) tries to keep the peace among warring factions inside and outside the prisons that constitute Kingstown, Michigan’s primary industry. He manages this bloody task by cutting deals with prison gangs; prison guards; the local police department; the district attorney; and the street gangs terrorizing the city. As a former prisoner himself, and a member of the family that kept peace for decades in Kingstown, Mike exercises power and moral authority in an immoral world by judiciously using violence and persuasion while placing himself and his family at great personal risk.

Mayor of Kingstown vividly portrays uncomfortable truths about our world. Brilliantly written and acted, its violent, unforgiving, cut-throat universe reflects the vicious, ugly, and at times violent nature of American politics as well as the amoral, backstabbing character of financial markets. Mike McClusky spends his days dealing with bloodthirsty killers whose promises are etched in blood. His world is different in degree, but not kind, from politics and finance where people lie without compunction and betray each other at the first chance they get.

That is hardly a happy note on which to open my forecast for next year’s financial markets, and certainly contrary to the happy talk dominating Wall Street these days. But we live in Kingstown, not Mayberry. Our government is propping up the economy on a tissue of lies and borrowed money while driving it straight into another financial crisis. Rather than address problems staring it in the face (unsustainable debt burdens, dangerously widening wealth inequality, rising inflation, etc.), it keeps borrowing trillions of dollars that it knows can never be repaid. And it does so while exhausting its diminishing credibility by generating phony economic statistics and engaging in political battles over minor matters meant to distract from the train wreck caused by years of incompetence and corruption. The confidence game can no longer hide the consequences of its failures; it can only delay them.

Without government support, markets would collapse. Trillions of dollars of fiscal and monetary stimulus drive stock and bond prices higher. But those prices are illusory and unsustainable. Individual stocks and bonds are still affected by the performance of underlying businesses, but many trade at inflated valuations due to their ability to attract capital through passive vehicles like ETFs and the willingness of investors to suspend disbelief and discount the future into infinity.

My forecast for the year ahead is based on my belief that we are living in Kingstown and that market stability is an illusion. A market crisis is still several years away (Ray Dalio places it at three years, I place it in the three-to-five year range), but the conditions for a crisis are deeply embedded and worsening by the day. They are based on the growth of unsustainable public and private sector debt. That is why I repeatedly urge readers to buy gold and save themselves. Further, everyone should avoid investing in places that treat them like the inmates in Kingstown’s prisons which are dark, ugly, dangerous places that many won’t leave alive.

With that introduction, the following should be treated as a thought-piece regarding the major trends and biggest issues facing markets in the year-ahead. Feedback is encouraged and appreciated either directly or through Substack Notes.

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Back here on planet earth, the Fed cut interest rates as expected by another 25 basis points on October 29^th. The only news that emerged from the October Fed meeting was that another December cut was not a certainty which sent stocks down slightly because it contradicted market expectations. With the government closed and limited data to work with, the Fed is flying blind with respect to setting policy. But given the data that is available, it seems set on an easing cycle that has little to do with its dual mandate. Instead, its actions support the argument that we are in a period of “fiscal dominance” where monetary policy is driven by fiscal policy needs which in this case means lowering rates to reduce the cost of servicing the deficit.

Markets celebrated the September inflation report that showed inflation still stuck at 50% above the Federal Reserve’s two-percent target. Not only were markets relieved that inflation wasn’t higher but demonstrated how desperately reliant they are on government support. Markets and the economy look good on the surface because of massive fiscal and monetary stimulus in the form of annual deficits approaching $2.0 trillion (the official numbers are understated) and monetary policy maintaining interest rates barely above the government-calculated rate of inflation (and likely well below the real-world rate). Withdrawal of this support would collapse markets and the economy. At three percent, inflation will reduce the value of a dollar to seventy-four cents in ten years. That’s the best-case scenario. Out in the real world where government statisticians can’t hide and where many prices are rising faster, a dollar will be worth much less in a decade. That is one reason (there are other reasons such as new sources of demand such as Tether) why gold rallied more than 50% this year. As the Fed embarks on another easing cycle (including ending quantitative tightening as funding pressures appear in short-term money markets)[3], the all-clear signal for speculation is flashing red.

Unfortunately, that is also the signal that flashes after a terrible accident as well it should. By lowering rates with inflation fifty percent above its own target and financial markets at record levels of valuation, the Fed is not only abandoning its own target but hammering another nail into the coffin of its credibility. While the Fed retains enormous power over the economy, its claims to political independence and intellectual integrity are discredited by its actions and its track record. It failed to contain inflation, allowing it to hit double-digits a couple of years ago, while currently misinterpreting data from a changing jobs market. Now it is lowering rates without monetary policy justification which will lead to more inflation (dollar depreciation) and more wealth inequality while public and private debt rise and borrowers rely on government support for repayment. Neither the public nor private sectors generate enough money (from taxes in the case of government or revenues/profits in the case of the private sector) to service and repay all the debt being incurred.

Despite all the self-serving justifications offered by Wall Street for lower rates, there is only one compelling reason to lower them – to ease the burden of servicing out-of-control federal deficits. Tariffs are not going to solve the problem (and will contribute to higher inflation). Cost cutting on the DOGE model failed. Higher taxes won’t solve the problem. The deficit will keep rising while several things happen. The federal government will be forced to borrow more money which will force interest rates higher as buyers of government debt demand higher compensation that causes a systemic crisis. It will be forced to cut spending and raise taxes in the form of higher income taxes, use taxes and wealth taxes, but these will be only half-measures and trigger severe political pushback that further water them down. The value of the U.S. dollar will drop further against gold and cryptocurrencies. And wealth inequality will widen further leading to greater social unrest and more populism across the political spectrum (which is problematic because populism feeds racism and other noxious ideas). Such are the wages of “fiscal dominance.”

Since September 2011, public debt increased by 157% from $14.8 trillion to $38 trillion while GDP only increased by 95% from $15.6 billion to $30.5 trillion. Can we reverse this trend? On an intellectual basis, yes. There are ways to slow the rise of the deficit and alter the arc of insolvency. On a political basis, at least for the foreseeable future, the answer is a resounding NO. Currently and for the foreseeable future, there is no sign that the extremists who took over our major political parties are willing to compromise their views; if anything, they are growing more extreme, which means their ideas are becoming less constructive to solving our economic challenges (from which all other challenges flow). Extremists are taking over both political parties. Barry Goldwater famously said “Extremism in the defense of liberty is no vice. And moderation in the pursuit of justice is no virtue.” Today, sadly, we live in an age of extremism in the pursuit of vice and moderation in pursuit of justice and too few are willing to speak truth to power. Like everything in life, this situation will change but it likely will require the system to suffer more damage before that happens. Citizens will have to suffer enough pain to not only demand change but take action to effect change not only at the voting booth but by increasing their political involvement at the local and national level. The process will be difficult, contentious, and potentially violent, but hopefully lead us back to governance by a more moderate, rational, and responsible majority. Until that happens, however, there is virtually no chance that the current budget trajectory will change.

From a long-term investment standpoint, this favors gold and other assets that benefit from inflation but renders it increasingly difficult to generate positive real returns. If you are not earning at least high single digit returns on your portfolio, you are losing ground to inflation (I actually put the bogey in the teens with respect to my own investments). Many years ago, Ben Bernanke took a series of policy steps to encourage risk-taking (having never taken risk himself as an investor). He knew not what he wrought. Now investors have to take enormous risks to maintain their buying power. Hence the bubbles in equity and credit that keep inflating larger and larger.

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· Tariffs are a sales tax paid by producers or consumers; either way, they raise prices, increase inflation, and slow economic growth. The economy has yet to feel the full impact of tariffs but soon will and the impact will be negative.

· While employment numbers have weakened significantly since May, the causes are complex and still subject to question. Likely culprits are tariffs and strict immigration enforcement that reduces the pool of available workers. If the latter turns out to be a significant factor, then the poor jobs reports may be sending a misleading signal of economic weakness that could lead the Federal Reserve to lower rates too far or too quickly.

· The Federal Reserve is lowering interest rates with financial asset prices at record highs (and signs of excesses in financial markets), inflation still above target (it is flattered by comparison with Biden-era highs), and employment possibly stronger than reported due to structural changes in labor markets not reflected in government figures. Lower rates will reduce the cost of funding the federal deficit (assuming the government keeps borrowing short term) but will almost certainly fuel financial market excesses. But lowering short-term rates may lead to higher long-term rates (10+ years), resulting in higher mortgage and other financing rates for businesses as concerns about debt and deficits increase (as they should).

· Federal Reserve independence is at risk as is that of the Department of Justice. And the two are interrelated and damaging to markets. Politicians should respect, not threaten, the independence of these institutions. Not only America but the world looks to the Fed to act independently to protect global financial stability. It also looks to the American judiciary system as a neutral arbiter of justice (though it falls short of that standard). Politicians are foolish to interfere in monetary or judicial policy. They get blamed for enough problems without taking responsibility for setting interest rates or targeting political opponents for prosecution. By doing so, they are bound to commit economic and political malpractice. While other factors are at work, it is no accident that the US dollar is falling while the credibility of two of America’s most important institutions is questioned.

· Stocks are in a bubble. By every reasonable (or unreasonable) measure, even adjusted for inflation (see more on this below), stocks are significantly overvalued. The bubble could continue for a while for reasons outlined below; as the great Richard Russell (author of The Dow Theory Letter) taught us, bull markets are designed to pull in as many investors as possible before ending. That is what is happening now.

· Corporate credit is also in a bubble that could last a while. Not only are spreads (the risk premium) at near record lows, but covenant protections and liquidity are much worse than in earlier periods when spreads were tighter such as 2007. Further, borrower-on-creditor and creditor-on-creditor violence makes owning corporate debt a miserable experience and further lowers risk-adjusted returns.

· The artificial intelligence (AI) arms race is showing signs of a mania. Projections of future adoption and spending are highly unlikely to be realized in time frames required to produce reasonable returns on capital over the next decade. A hard look at payment commitments made by companies like OpenAI and CRWV (see more on CRWV below) are implausible at best. Longer term, nobody knows what will happen and anybody who claims they do is full of you-know-what. But applying common sense is always a good rule-of-thumb when evaluating future promises by technologists.

· All of these factors are interacting to create an incredibly challenging investment environment that looks much easier than it really is. Those who ignore the lessons of past bubbles or who think this time is different are exhibiting hubris that is rarely rewarded.

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Note to readers: This month we are offering the newsletter without a paywall so all of our nearly 10,000 subscribers can have an opportunity to read the entire issue. Hopefully this will encourage more of you to sign up for a monthly subscription. Have a Happy and Healthy Labor Day and everybody please stay safe.

“Nations have built welfare and entitl…

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As President Trump prepares to sign an executive order allowing Americans to buy private investments in retirement accounts, a Wall Street Journal story about the collapse of a high yield municipal bond fund should serve as a warning that priv…

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“Well-nigh two thousand years and not a single new god!”

Friedrich Nietzsche, The Antichrist (1888)

Or maybe not. The world believes it discovered a n…

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