 Sovereign debt is eating the world, how can you protect the assets you love? We are in a funny spot in terms of the global economy at the moment. In short, governments and central banks deluded themselves into thinking that unlimited deficit spending financed by unlimited money printing will not do what it has done for literally millennia, crash the economy. They are sadly wrong and we are seeing the catastrophe unfold before our eyes. The story really begins in the 1970s when Richard Nixon broke the gold standard, but the latest chapter starts in 2008 when central banks bailed out the financial system by effectively printing trillions of dollars. Thing is, everybody knew for centuries really, that so much money printing would cause inflation, perhaps with a 12 to 18 month delay, but it didn't in 2008. Why? Because the banks held on to the free trillions, they used it to plug trillion dollar sized holes in their balance sheets, combined with an ongoing freebie, as China's manufacturing miracle lowered the cost of consumer goods. Meanwhile, a second salutary myth was shattered by Japan. Again, everybody had known since forever, well since its entry, that public debt beyond a certain level was problematic. That was generally understood to be about 100 to 125% of GDP. But Japan crossed that line in 1998, 25 years ago, and nothing happened. Now there are idiosyncratic reasons for Japan, largely the proportion of debt that is domestically held, and to be fair Japan's economy has not been doing that well over the period. But the lesson was learned, debt is not catastrophic, meaning if debt doesn't matter, deficits don't matter. Now in both cases, these conclusions are contrary to literally millennia of economic history. In fact, printing money does lead to inflation, and in fact when debt gets big enough, governments do tend to default. In fact, we've had 14 sovereign defaults since 1998, since Japan crossed that 100% line. Still, 2008 in Japan gave governments and central banks around the world confidence that maybe this time is different. Unfortunately, this dangerous confidence was implemented worldwide with COVID. To bribe voters into lockdowns, countries around the world spent money as fast as humanly possible. Central bankers then financed those deficits as fast as humanly possible. It all came to roughly $10 trillion in new money in just a few years. In the US, by 2021, roughly $1 in $3 had fresh ink on it. So alas, this time was not different. Inflation did take off. As I mentioned before, COVID globalization was holding back inflation. The printed money didn't show up in prices, but COVID lockdowns overwhelmed it. That matters because it takes central banks out of the game. Central banks cannot finance government deficits if they are simultaneously trying to reduce the money supply. So, paired with debt to GDP ratios over 100% and basically the entire world, this is now causing investors to worry if governments, including major governments, will default. That fear can pull investors out of government bonds, leaving more for the central bankers to pick up, which they aren't because they're trying to fight inflation. We've got an ugly little twist here, which is that the main way central banks fight inflation is by choking off the private economy with interest rate hikes. It's exactly what they've done these past two years, hiking raised a total of 276 times worldwide. These are now crashing most of the world economy into recession, including Europe, the US, and China. Recession historically makes deficits and debt even worse. So we have the three horsemen, inflation, sovereign debt crisis, and looming recession. We can illustrate the perfect storm with the 2009 European debt crisis. That started when there was a loss of confidence increased by investors, which was flirting with the fall. Investor fear then spread to Portugal, Ireland, Spain, and Cyprus. All were ultimately bailed out by the ECB, the European Central Bank, promising to buy unlimited government bonds. Essentially, the debt was converted into money. And the problem is that with inflation today at 6% or 7% and rising, central banks can't do that. They can't convert debt to money because they're afraid that they'll lose their independence that they can't get a handle on inflation. So the standard recent solution to a debt crisis is out of the game because of inflation. So what does all this mean for investors? Well, first up, we have the dollar. It's a weird paradox where nobody wants the dollar, but its price is holding up just fine. Currency gurus Stephen Jinn put out a chart earlier this year showing that the US dollar reserve share went from 73% worldwide in 2001 to 55% by 2021, so relatively leisurely decline, but then it absolutely plunged by eight points in the wake of the Russia invasion of Ukraine. That was because the US seized the dollars owned by Russia's central bank. They did this to try to set off a bank run. By ironically enough, the US got bank runs instead, but it put every country on earth on warning that US dollars are a very dangerous thing to hold. So a lot of those countries shifted out of dollars into either currencies like the Yenna euro or into hard assets like gold. So nobody wants the dollar, and yet it's holding its value just fine. Since 2001, it's been steady. In fact, it's risen over the past year, even as the reserve share plunged. Why? Because the road to dollar death is paved with the corpses of other weaker currencies. Essentially, as the world falls apart, safe haven demand goes to the dollar. This happened in 2008, even though the crisis was literally coming from the US. This is related to Santiago Capital's dollar milkshake model. It means that the US could be the least dirty shirt over the coming decade, essentially getting stronger with each currency death all the way into the final ragnarok. Having said, an interesting threat to the dollar that's getting attention these days is a prospective replacement from some kind of gold-backed BRICS currency. Now, it's important to note that would not be a national currency. So like they wouldn't be backing the ruble or the Chinese yuan with gold because all countries want a weak currency, so their exports are cheap. Now, the idea would be that China or Russia would float an external gold rail that would replace the external dollar that they currently use for trade. So just as the dollar is outside, Chinese don't use the dollar day-to-day back home, they only use it for trade, they would similarly use some kind of gold-backed BRICS. Now, if this happened, it would be a very big deal because it would be genuinely superior to a dollar. Assuming, of course, the market trusts China or Russia to redeem the gold, which is a big what-if. And that's kind of the fly in the ointment. None of the BRICS countries are particularly trustworthy, plus the big ones are very distracted at the moment. So Russia has its war, China's economy is going through hard times. So I don't expect much from BRICS in the near term, but it is worth watching because it would set up a genuinely superior competitor to the dollar. All right, so all of that is what could happen, but what are the odds? So first off, we may know how the book ends, but we don't know how each chapter ends. Many times the financial system is seamed on the brink and we somehow muddle through. Because remember, the economy is made of hundreds of millions of people who are trying their best to dodge the falling boulders. So it could take months, it could take years, it could take decades. Having said, I think we can say how the book ends because the factors driving us to collapse don't have guardrails. To illustrate how could we stop a crisis, so there are two ways, fiscal and monetary. Fiscal meaning dramatically reduce government spending, perhaps even pay off the debt. And monetary meaning reduce the ability of central banks to finance those deficits via inflation. What it would take on fiscal is either voters waking up and realizing en masse that we are headed for the cliff, or some balanced budget mechanism, constitutional amendment, or perhaps Warren Buffett's plan that if Congress can't balance the budget, they all have to resign with a lifetime ban from politics they would probably find a way. Failing that default also balances the budget because nobody will lend to you after you default. Of course, in the US case, that would evaporate 34 trillion in paper wealth, which would wipe out thousands of banks, companies, pension funds, it would get ugly. And then the other way to stop the fiscal collapse is monetary. Here you could either end the Fed, in fact end all central banks, that would force governments to actually finance their deficits in the private market, which would not have the appetite for 10 trillion at a time. Of course, governments know that they're licensed counterfeiters, they're central banks, are their mother's milk, so that won't happen. Bringing us to the most likely solution, drain the Fed, meaning people shift into gold or Bitcoin or other non-fiat currencies, which takes the livestock off the table. Their dollars can no longer be diluted, siphoned to finance government spending, but of course, this is a frustratingly slow process. For getting into the punchline, I want to mention briefly commercial real estate, which is a huge asset class and could be a trigger for crisis. The sector has massively overbuilt after 15 years of near zero interest rates, and now that rates are soaring, it is unwinding. This is causing problems in Europe, Canary Wharf, Sweden's apartment developers, but it's really becoming a crisis in American cities, because that unwind is running into two compounding factors, post-COVID work from home and the abysmal urban governance in places like San Francisco, New York. This is driving companies out of large American cities, leading to write downs of 60% or more in cities like San Francisco. Commercial real estate as a concept isn't dead, so eventually prices fall enough that we see bargains, but I think near term you'd want to limit exposure until we see how especially the U.S. plays out. Voters are not getting as angry as fast as you'd expect in places like San Francisco, perhaps thanks to a gaslighting media, so those cities may continue collapsing for some time. So what are the implications of all of this for investors? In short, if sovereign defaults are coming, it would take banks and shares and pensions down with it. You'd want to insulate yourself both as an investor and as a business executive. Meanwhile, I think it's likely that we're in for years of high inflation, meaning 5% plus, which could boost nominal yields but could actually reduce post-inflation yields below zero. To illustrate right now, money markets are paying 5%, but inflation in the U.S. is close to 4%, so that's not that great of a deal, it's a little over one. Above all, higher inflation suggests hard assets, and the inflationary 1970s equities and residential real estate held up just fine. Gold went up 20-fold from 35 an ounce to nearly 700, so what is different this time is Bitcoin, which is an interesting asset class. It's basically what would happen if gold had a baby with a dot-com, so it's deep value paired with deep growth. After all, Bitcoin is essentially gold that governments can't seize, but it spreads a lot like people realizing the Internet is real in the 1990s. Remember Paul Krugman's fax machine. So I think Bitcoin could go up enormously if we're in for inflationary crisis, but of course subject to the fact that Bitcoin has idiosyncratic drivers that influence how wide it spreads, so regulation, institutional access, number go up. Finally, implications for humans. It looks dire, but remember we have been through a lot worse. It is true that some inflationary collapses can last centuries, so Rome or Song Dynasty China, but when the hard times come, men do get strong. Voters concentrate their minds. Post-Civil War America looked like it was done, for example. Half the country was flattened by General Sherman. The rest of the country was going through hyperinflation, courtesy of Mr. Lincoln's greenbacks, yet the crisis concentrated voters mind ushering in the re-establishment of the gold standard in 1879, which then led to about a 35-year period of the most epic golden age in U.S. history, really in the entire world. Essentially the entire modern world was invented in the 35-year stretch. The U.S. became the most prosperous country the world had ever seen. So don't lose hope. On the other side is a radically smaller government, radically expanded space for innovation, bottom-up community, and liberty. In short, a storm is coming, but it is likely to be beautiful on the other side.