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The Wedge Slammer

The Wedge at Newport Beach, California, getting ready to slam a surfer.

The US is closer to being sucked into The Wedge Slammer than most people think.

The Wedge is a storied surfing spot at Newport Beach, California, about an hour down Pacific Coast Highway #1 from my home in Lunada Bay.

The Wedge is a graphic analogy to help simplify the complex set of macro-economic factors confronting the US and other countries determined to follow Japan down the deflationary path of low growth, low investment returns and limited options for macro-economic policy adjustment.

Because of a jetty and an unusual bottom formation, the Wedge is an awesome and fearsome place to surf. The waves have great form and size, but the closer you get to the beach, the harder it is to safely pull out of a wave at which point, without warning, Wedge waves explode upward and slam surfers onto the sand, like what is about to happen to the surfer in the picture above.

I surfed the Wedge, once. Everything was great fun, until it was too late. That is The Wedge Slammer.

How does the Wedge relate to the US economy and financial markets today?

The US markets are like the surfer that is getting too close to shore. Interest rates are too low and debt too high. If US policy makers do not reduce debt and normalize interest rates, the US will follow Japan into The Wedge Slammer.

Where are we now? The Wedge Indicator gives us an idea.

The Wedge Indicator takes the amount of interest that a country would have to pay for a 1% across the board increase in interest rates of all public and private debt in the country, divided by the country’s GDP. This gives us the percent of GDP needed to pay for the 1% increase in interest rates. Here is a graph of the Wedge Indicator since 1966:

The Wedge Indicator was a low risk 0.2% in 1966. By 1981, the peak of interest rates, The Wedge Indicator was still a low 0.6%. Today, it is 2.8%, above the UK and Germany, and close to Japan’s 3.1%.

2.8% on The Wedge Indicator is pretty high risk. It means that for every 1% increase in interest rates, the US has to grow 2.8% faster just to pay for the added interest. A real anchor on the economy.

Unfortunately the theory was proven last year as the Fed raised interest rates the economy slowed and then the Fed had to reverse themselves and cut rates recently. Poor showing given the massive Trump tax cuts and trillion dollar deficits also in play. The Wedge Slammer is real.

The so called smart guys that brought us the 2008 financial crash have come with some new theories on how they are going to fix the damage they caused. They call it “Modern Monetary Theory,” or MMT.

This theory says monetary authorities can push rates even into negative territory and produce as much debt as they want because they can always print more money to pay for the debt.

The MMT crowd points to Japan which has twice as much government debt as a percent of GDP as the US and negative interest rates. Problem is Japan has savers that will buy the debt. The US has many foreign treasury owners, such as China’s central bank. Foreign treasury holders will not simply allow the Fed to inflate their debt away. They will stop buying more debt, and even sell what they have.

Sorry folks, at this point, when you are this far into the tip of the wedge, you have to change your actions. Fine when you are way offshore. It is a whole different ball game once you have been playing the lower interest rate and more debt cards for over 30 years to keep economic growth going. At some point they stop working, at which time it is too late to pull out. You are pinned at the high risk tip of the wedge with no way out.

We are not there yet, but we are much closer than the smart guys think. They may be able to keep the game going a little longer, but each new low in 10 year yields or increase in debt simply brings us closer to shore.

There are only two choices, pull out before it is too late, or suffer the consequences of The Wedge Slammer.

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