I'd like to start with you, not with the presidential elections—we'll get to those later—but I want to start with the topic of the U.S. debt ceiling, because this is something where we seem to have gotten past the worst of it, but you've been very, very clear. You recently revived a presentation you gave 10 years ago to students at UVA, and you told them that the economic storm brewing with U.S. spending is worse than you ever imagined. I also want to show some of the charts you showed them on screen, like the pace of entitlement spending in the United States. I want to ask you, what are the consequences now that we've seemingly gotten past the initial problems in Washington? What is the country, the economy, and investors actually ignoring?
Thanks, Sonali. Glad to be here. I don't think the entitlement situation is something you should be trading in the next three to six months. What I've been focused on for more than a decade is actually the long-term picture and the long-term consequences. So the last thing you should do is run out of this conference after I say something about entitlements and think there's a trade to be made. That's not the situation.
Look, I have to go back a bit, but back in the '90s, someone sent me a paper about how high the birth rate was in the '50s and how it fell, and that we would be hit by this demographic storm sometime in the 2020s, and it was basically predictable because demographic data is public information. This was on top of the fact that since Medicare and Medicaid were added to Social Security as entitlements in the '60s, the share of seniors in government spending had already dramatically increased, let's say from 30% to 58% of spending over that time. And even then, I was concerned that sometime in the 2020s, something like a python swallowing a pig, when the baby boomers become seniors, they will already be associated with a high percentage of government spending. The increase in the number of seniors would be dramatic, and at the time I was looking at it, the birth rate of the current generation was below 2. So you're going to have this huge increase in seniors at the same time as a decline in workers. The way our system works is that you take taxes from current workers to pay for seniors.
It really seemed bad to me around 2011 or 2012, so much so that I said I would go out and try to move the needle on this issue. I was really successful. The only thing Donald Trump and Hillary Clinton agreed on was that entitlements should not be touched. In other words, nobody listened to me.
It was a tough situation then and the outlook was really scary, but when you use the phrase 'worse than I ever imagined,' I didn't know that for the next 10 years we would witness a sharp increase in state debt, even outside of entitlement spending. And then when COVID came, it was just the cherry on top. In hindsight, it's hard to believe that during those 10 years with interest rates near zero, we had two major economic booms. One around 2018 under Donald Trump, supposedly a Republican, supposedly with a party that cared a lot about spending. And at 3.5% unemployment, we experienced something unprecedented. We had a trillion-dollar deficit. Usually, when the economy is humming, tax revenues grow and the deficit shrinks.
Then we had the post-COVID boom in 2021, which was accompanied by a wild increase in technology and tech stock prices. To the point that we had capital gains $600 billion higher than the annual average. We sold spectrum for $100 billion. We had 10% nominal growth due to inflation. So you might ask, since the last tech boom in '99 under a Democratic government—by the way, we had a surplus—how big was the surplus with all these anomalies in '21? I asked myself the question again. We had a deficit of over a trillion dollars. We didn't even get below 5% of GDP.
So what I was worried about 10 years ago is now capped off with a huge amount of debt. Zero interest rates somewhat suppressed concerns about this situation. Of course, if you have a lot of debt and you're not paying any interest on it, who cares, but now that inflation has hit, interest rates are going to go up. So the point is, I'm rambling more than I wanted to. The point is, if you take the current situation and ask yourself, well, I should actually say something else. Current debt has risen from let's say 20 trillion to 35, I'm sorry, 15 trillion to 31 trillion over that time. This debt, and this is important because most people don't understand it, assumes that we will never pay out any more health or social security benefits.
200 trillion is the present value, as you calculated it, for the students?
Not me, but credible people like Larry Kotlikoff and others. So if you assume we will never pay out social or health benefits, the 31 trillion, but if you accounted for it like every company and assumed those payments would happen, yes, the present value is about $200 trillion.
So I should also say that the main title of this presentation was, 'Is American Exceptionalism at Risk?'
Yes, I think it is. America is an amazing country with an amazing system, and if you look at the innovations in this country, just look at what happened since 1980. We led the personal computer revolution. We led the development of the internet. We led the development of the cloud. We led the development of mobile technology. Maybe it's not a good thing that we led in cryptocurrencies. Who knows. And obviously, we lead in generative AI. So we've been the leader all along, but we've also been the reserve currency. And currently, we're consuming so many basic resources that I'm worried about the future.
If you take what economists have this, only economists could come up with this term. It's called the fiscal gap. What is the fiscal gap? It's how much you would have to raise taxes today to guarantee the benefits you've promised to seniors in the future. It's 7.7% of GDP. What does 7.7% of GDP mean? To truly pay for the claims we've promised in the future, you would have to raise all taxes by 40% today and forever, or cut all spending by 36% today and forever.
So what I'm looking at here is that these things are a loan from the future. You crowd out private investment, you crowd out the kind of investment that made us the leader in all these things. But again, this is a long-term concern. But the statement from both parties that entitlements are off the table is like 70% of the federal budget and it's growing. And now that interest rates have risen, it's a fantasy. It's actually a lie. We will definitely have to cut entitlements. It's just a question of whether we cut them today or in the future. And the longer we wait, the more it piles up. A year or two ago, or right now, interest costs are about 1 to 2% of GDP. It's about 6% of spending. The Congressional Budget Office estimate, not mine. Interest costs will be 27% of spending by 2050. And just entitlements and interest costs, just these two things alone. No defense, no running the government, no money for the disadvantaged will be 117% of taxes by 2050, and by 2040 it will be more than all taxes. But again, for investors in the room, these are just things to deal with long-term. I like to think long-term, but for trading, it doesn't affect your question.
As you told the students, it's a tsunami that's 3 miles from the horizon. But you know, another thing is, I think it's safe to say you've been quite critical of fiscal and monetary policy. The question is, and I want to show one more chart here about the history of bubbles, which you also showed the students, because my question to you is, do you believe there are many more hits coming while the central bank remains tight?
That's my main premise. I operate in the world of risk and reward. There's a 500-year history of asset bubbles, well-documented in a book you had some issues with, 'The Price of Time.' And it basically documents, and I already knew about the last 100 years, but it's been happening for 500 years. Every time you've had a significant asset bubble, major economic problems followed. But yes, when you've had 11 years of free money, people do stupid things. Just look there, but the stupidest thing is, someone paid $80 billion for Dogecoin, which was invented as a joke. I mean, that can only happen in a world of free money. It also suppressed people's concerns about the things I was talking about two or three minutes ago, because you keep rates at zero. But the fact that this was clearly the most disruptive economic period since the end of the 19th century and there were no bankruptcies, which clearly started in the last few weeks, tells me there's a lot under the hood when you go from this environment of the biggest and broadest asset bubble ever and then raise rates by 500 basis points in a year. I think probability suggests that Silicon Valley Bank, Bed Bath & Beyond are probably just the tip of the iceberg. Nothing is guaranteed. I've been wrong many times, right a few times, but yes, our main premise is that more hits are coming, especially not just in asset markets but economically.
What are you most worried about? We'll definitely get to the opportunities and great chances you see on the horizon. But before we get there, what's going to start sinking?
I would see a 20 to 30% drop in corporate earnings. Normally, for a hard landing, I'd say 40 or 50, but this recession is so expected. I don't think a lot of companies will be caught unprepared, which is how you usually lose a lot of money, by not being prepared for what's going to happen. Commercial real estate, you know, I'm not telling anyone in this room anything they don't know, but offices are a problem. It would be a problem anyway, but the lifestyle change and COVID make it an even bigger problem. Rising financing costs make it a problem. I'm worried about credit tightening in the next six to nine months. Of course, banks are entering an economic period where, if a recession really happens, their balance sheets are already damaged. Not by where they usually lose money, which is loans. But by the fact that the Fed convinced them to keep rates at zero until '24. So they bought a bunch of government bonds yielding 1 or 2% and are now holding them at five, so their balance sheets are damaged. But if we get into a recession, then real losses will come, things like credit cards, commercial real estate, and so on. That's what I would be worried about.
You asked about my worries. That's different from my predictions.
Me? Well, the predictions you were talking about.
I'm tired of being a pessimist and being labeled as such.
But to that pessimistic view, we haven't seen it yet. We haven't experienced that hard landing yet. And today, after you, a lot of people are coming who predict a soft landing. So if you still believe a hard landing is coming, when will it happen? What will it look like? Will we even see it?
Yes. Many people, because the economic decline hasn't started yet, have changed their forecasts from a hard landing to a soft landing, and many others from a soft landing to no landing. I haven't changed mine at all. The fact that it hasn't happened yet doesn't change the probability of how deep it will be if it happens. I mean, during COVID, $10 trillion was poured into the system, $5 trillion monetary and $5 trillion fiscal. What happened was this huge, huge stockpile of liquidity was created. I think Jamie Dimon said a couple of years ago there were $2.5 trillion in excess demand deposits. We've been slowly draining this liquidity. This reduction in liquidity was interrupted when the Bank of Japan changed yield curve control, entered the market and bought $400 billion in bonds to protect its bond market. A very strange situation. They raised rates, but then liquidity reacted sharply, and then of course the debt ceiling.
Secretary Yellen last week drained the Treasury General Account, which is basically the Treasury's savings account, from $700 billion practically to zero. That also led to not issuing government debt, so it was a big boost for liquidity. All of that is now set to change. In fact, it will go in the opposite direction with that account. She's already announced she wants to bring it back to normal levels. So from now until the end of the year, probably about $800 billion in government bonds will be issued. The Fed will continue quantitative tightening. We have these student loans, which I think have been supporting consumption. All of that will change in September. They will actually have to, God forbid, someone in the United States actually pay interest on a loan. So for me, the probabilities haven't changed, it's just been pushed out relative to expectations, but the fact that it hasn't started yet doesn't change the probability of whether it will be hard or soft. I would actually argue that because it's taken so long, the Fed ended up with a higher terminal rate and inflation is actually becoming more intractable the longer it stays in the system, that it increases rather than decreases the probability of a hard landing. By the way, after the crash in 1987, I was convinced we would have a depression. So I've been wrong before, and if I'm wrong on this, I'll adjust. But I have to weigh probabilities and do what I do within my process. And right now we're just at this point.
I was? I think in September it was the first time I went from being a guy who was worried about the economy overheating and inflation to being more worried about growth than inflation. And originally I was guessing Q4 of '23. I temporarily maybe lost my mind or maybe I was right when the Silicon Valley thing happened and I got unofficial reports and so on. What traditionally leads, like freight and retail, that pushed it to now. I think I'm probably wrong and I'll go back to the end of '23, but the real answer is, I don't know.
So whether there's a recession or not, one thing is interesting, and that includes you, that a lot of people are very bullish on certain areas of the market, especially the AI boom.
There's always something to do. We had a hard landing in '74 and '75 in chemicals and railroads. Those things did great. Sorry, go ahead with your question.
Do you think the entire AI space will survive this recession, or do you think some areas of the market, especially in AI, are starting to look like they're in a bubble?
Well, the entire AI space won't survive, whether we have a recession or not, because it hasn't separated the wheat from the chaff yet. But I believe, unlike crypto, AI is real. It could probably be as transformational as the internet. It's a huge thing. And I think I've argued publicly that if commodity prices can rise in a recession, why couldn't a company like NVIDIA, if their orders and earnings go up 70% in a hard landing, which I think would probably happen. It's not clear to me that NVIDIA would fall despite high valuations. History has shown that if you have very good earnings in a recession and they're sustainable, if they're not, the market will figure it out. These stocks will do well. So we have long and short positions, and AI has managed the long positions for about five or six months.
How do you think about short positions in this market?
