Inside today’s Daily Journal…

Editor’s note: Although Erez Kalir ordinarily focuses on technology, blockchain, and biotech issues in Porter & Co.’s Tech Frontiers, Porter turned the Journal over to him today so Erez could tell the story of America’s slow descent into what he calls “the Endgame”… when the U.S. can no longer scale the mountains of debt it has accumulated. He lays out four potential ways out…

In 1944, as World War II raged across Europe and the Pacific, delegates from 44 Allied nations gathered at the Mount Washington Hotel in Bretton Woods, New Hampshire, to design the postwar financial order. The United States emerged from those negotiations financially on top of the world. Our industrial base was intact. Our gold reserves were unmatched. Our economy represented nearly half of global GDP.

The arrangement forged at Bretton Woods was elegant in its simplicity: the dollar would become the world’s reserve currency, convertible into gold at $35 per ounce. Other currencies would anchor themselves to the dollar. And because the dollar sat at the center of global trade, the United States gained something extraordinary: the ability to finance itself more cheaply than any empire in history.

For decades, that “exorbitant privilege,” as the French foreign minister described the U.S. position, seemed inexhaustible.

Then came 1971, when President Richard Nixon closed the “gold window” and severed the dollar’s final tether to gold. America’s debt began its long upward spiral… first slowly… then rapidly… then exponentially.

Today, America’s fiscal situation is well within the zone from which there is no painless exit. Indeed, the U.S. is almost certainly already in the chapter that may ultimately be remembered as the Endgame.

Let me explain…

The United States federal debt now stands at roughly $40 trillion – more than 120% of GDP. Historically, America has reached debt levels this extreme only once before: during World War II, when debt briefly surged above 119% of GDP in 1946 as the nation financed a global war for survival.

But there’s a crucial difference between then and now.

In 1946, we possessed the youngest industrial workforce in the world, a manufacturing base untouched by war, and a demographic boom just beginning. Debt was high, but the country’s growth trajectory was even higher. We could effectively grow our way out of the problem – and we did.

Today, the opposite is true.

The U.S. faces aging demographics, rising entitlement costs, persistent fiscal deficits, and an economy increasingly dependent on debt-financed consumption. More ominously, the debt itself has become self-reinforcing: the government must now borrow staggering sums simply to pay interest on prior borrowing.

Stan Druckenmiller, the greatest macro investor of his generation, indeed perhaps of all time, has warned repeatedly that America’s fiscal trajectory is unsustainable. And the numbers explain why. Interest expense on the federal debt has now become one of the largest items in the federal budget, surpassing defense spending and rapidly converging with Medicare and Medicaid combined.

Pause for a moment to appreciate the absurdity of that sentence.

The United States government is increasingly borrowing money to pay interest on money it already borrowed.

That is not a stable equilibrium – it’s a debt spiral.

And once countries enter debt spirals of this magnitude, there are only four ways out.

The first is austerity: Slash spending, raise taxes, and restore fiscal discipline. Politicians occasionally pretend this remains possible. It is not. No modern American administration, Republican or Democrat, has demonstrated the slightest willingness to impose the level of austerity necessary to stabilize a $40 trillion debt load. The math is simply too brutal. Meaningful austerity would require politically toxic cuts to Social Security, Medicare, defense spending, or all three simultaneously. It would likely trigger a severe recession and possibly a depression. Democracies rarely choose this path voluntarily. America certainly will not.

The second possibility is outright default: This, too, won’t happen. The United States borrows in its own currency. Unlike Argentina, Greece, or Zimbabwe, America does not owe debt in a foreign currency it cannot print. Treasury default would detonate the global financial system and destroy the dollar’s reserve currency status overnight. Washington will choose virtually any alternative before permitting that outcome.

The third path is growth: In theory, sufficiently rapid economic growth could outpace the debt burden. This is what happened after World War II. But once again, the arithmetic is merciless. Nominal GDP growth would need to remain sustainably above the government’s borrowing costs for many years while deficits simultaneously narrowed. In an aging, indebted society growing at roughly 2% real GDP annually, that outcome borders on fantasy.

Which leaves only the fourth and last option – one we already know well: Money printing.

Not explicitly, perhaps. Not in language central bankers will use publicly. But effectively and functionally, the Endgame leads to the same place: the monetization of government debt.

Many investors believe this process must inevitably culminate in a collapse of the Treasury market itself – a violent upward spiral in long-dated Treasury yields as buyers refuse to finance America’s deficits.

I don’t believe that will happen.

Why?

Because the Federal Reserve will never allow it to happen.

Instead, when the pressure becomes sufficiently acute, the Fed will almost certainly impose some form of yield-curve control.

Yield-curve control (“YCC”) sounds exotic, but the concept is straightforward. The central bank sets a ceiling on Treasury yields and enforces it by printing money to purchase bonds whenever necessary.

Imagine the Fed effectively standing up and announcing:

That is yield curve control.

And despite sounding radical, it’s not theoretical. The Federal Reserve itself implemented YCC after World War II, pegging long-term Treasury yields to help the U.S. manage its enormous wartime debt burden. More recently, the Bank of Japan deployed YCC for years to suppress Japanese government bond yields amid Japan’s own debt super-cycle.

Ben Bernanke, the former Fed Chair and perhaps the world’s foremost scholar of monetary crises, wrote extensively about such policies and their historical precedents. The new Fed Chair, Kevin Warsh, emerged intellectually from the Bernanke era and is deeply familiar with both the theory and historical YCC implementation.

Investors should not underestimate how quickly the policy consensus can shift once debt servicing costs become politically intolerable.

But there’s a catch: The Fed can control Treasury yields, even at the long end of the yield curve. It cannot simultaneously preserve the purchasing power of the dollar. That’s the price of the Endgame.

When the Fed intervenes to limit yields, it does so by creating new dollars to absorb Treasury supply. The bond market remains orderly because the central bank becomes the buyer of last resort. Treasury yields stay artificially suppressed. But the currency absorbs the pressure instead. In effect, the government escapes default not by refusing to pay its debts, but by repaying them in increasingly diluted dollars.

This is why sophisticated investors increasingly understand that the real risk is not Treasury default. The real risk is dollar debasement.

So how should investors prepare?