Here are some things I think I am thinking about this weekend.

1) Moody’s Downgrades US Government Debt.

After the close on Friday Moody’s dropped a bombshell downgrade of US government debt from AAA to aa1. It’s deja vu all over again for those of us who have been around too long. I still remember S&P downgrading the USA in 2011. I wrote about it in real-time and said how silly it was. A year later interest rates on US government debt were a full 1% lower. I’m a very broken record on this topic, but look, this isn’t that difficult. Here are the facts:

  1. The USA, like all fiat currency issuing governments has a printing press. It cannot run out of the money it can create.
  2. The USA is especially unique in this sense because not only can it print this currency, but it can tax the wealthiest private sector that has ever existed. Let’s put some figures on this. The US government generates $5 trillion of revenue every year from taxation. The next closest country is Japan, which generates $1.5T. Germany’s central government generates $550B+ per year. So the USA is 10X bigger than the country that many people cite as one of the most fiscally responsible entities in the world. The important conclusion here is that the US government isn’t special because it has a printing press. It’s special because it just so happens to be the entity that can tax the wealthiest private sector in human history. So, it has access to taxing a private sector that has $200T of total net worth. The incredible financial prowess of our private sector is what makes US government debt unique.
  3. The USA doesn’t borrow in a foreign currency and cannot be forced to pay debts in something it cannot either create or tax vast amounts of.

When you say the US government is at risk of default you are indirectly arguing that the US private sector will weaken substantially or that the US government will become so incredibly reckless with its spending that it will essentially destroy that private sector. I don’t see it. Even with the reckless Covid spending we still only have 2.5% inflation and low interest rates. And I think we’ve all realized that printing that much money during Covid was a mistake. In fact, Trump’s early deficit figures show meaningful sign of a slowdown in government debt expansion.

I can only assume there’s some political angle to all of this and that the argument is that US government debt has become riskier because of the tariffs or the more protectionist position. But again, that’s just not a realistic discussion on a relative basis. The US Dollar is 57% of foreign reserves. The next closest currency is the Euro at 19%. There just isn’t a remotely close second here, just like the revenue data. And that’s the nutty thing about this debate. There are 160 fiat currencies in the world. And that means there are 159 dirtier shirts in the fiat closet when compared to the Dollar. If the US government is a aa1 entity then that’s the new AAA because every other entity on this planet must have a lower credit rating given that nothing comes remotely close to having the same levels of income and credibility. For instance, Moody’s rates Johnson and Johnson AAA. And while I love baby wipes and will probably continue to buy them well past the days where I am cleaning dirty diapers there’s just no universe in which JNJ, with their measly $90B of annual revenue and non-existent printing press, can ever be placed on the same pedestal as the US federal government. JNJ is not even in the same universe when compared to the US government. And they’re far from the only entity that Moody’s claims is a higher quality entity. My point is, in terms of underlying financial resources and ability to pay, there’s no entity in the world that can claim to be as credible as the US government.

None of this is to say there isn’t inflation risk in the Dollar or that we couldn’t be creeping towards a level of government spending that erodes the value of the Dollar. As many of you know, I was rather alarmist about inflation during Covid due to government spending. But on a pure credit basis there is nothing that comes even close to the safe haven nature of the US government’s liabilities because there’s nothing that comes close to being able to generate the income it can generate.

But back to downgrade – does it matter? I would say 100% no. It might cause a market reaction, but again, we’ve seen this before. S&P downgraded the USA In 2011 and they had egg on their face just a year later. Fitch downgraded US government debt in August of 2023 and rates are largely unchanged since then. It was at least a little different in 2011 when the change from AAA impacted some derivatives contracts that could only be tied to AAA debts, but the USA hasn’t been a AAA entity according to the other agencies for a long time now so I don’t see the impact here.

Of course, if you’re making an inflation argument that’s a very different (and more valid) perspective. Then again, if you were going to downgrade US government debt based on inflation risk the time to be doing that was during Covid, not after inflation has come down to 2.5% and appears to be softening broadly. So, this just looks like a big nothingburger to me.

2) Why aren’t tariffs bleeding into inflation?

One of the big news stories late last week was Walmart announcing that tariffs are bleeding into prices. The President took to Twitter to decry the price increases. He seems to finally be acknowledging that tariffs aren’t paid for by China. So that’s good news. But in the same post he tells Walmart not to raise prices. I am beginning to wonder where the real Capitalists went in the last few years? Since when did it become okay to tell corporations where they can source goods or how they can set their prices? I generally consider myself a moderate, but the more I talk about tariffs the more I am beginning to think that I am the real Conservative Capitalist in the room here. But this isn’t political to me. It’s economics. America is a great Capitalist powerhouse because we’ve embraced free trade and free market principles.

But how worrisome is Walmart’s warning? And why hasn’t the tariff impact actually started to bleed into prices? After all, we got a CPI and PPI report last week and both were very tame. One thing to keep in mind here is that even though there’s been some tariff front running we haven’t really seen the actual bleed through yet. For example, if we look at last month’s Treasury Statement there was only $15B of tariff income. The government took in $815B of total income in the same month so $15B isn’t moving the needle much. But that’s because the 90 day pause means we’re not actually imposing this tax in any meaningful way. Yes, it’s higher than last year’s annual rate of $85B, but even if you annualize the $15B we’re still only running at a rate of $180B right now. The pauses will stop in phases with most of them ending in July and then the new China pause ending in August. At that time the effective tariff rate is likely to be 10-15% which would equate to a total annual increase of $300B-$500B. And that’s when firms will have to start passing along the costs they incur from the import duties. That’s likely to occur in waves over the course of the back half of the year. And that’s assuming the economy is even strong enough at that point for consumers to eat the full cost. Or that firms won’t eat the cost to some degree.

So, long story short, the actual economic impact of the tariffs hasn’t really hit yet. And while it’s meaningfully smaller than the worst case scenario that was in place 6 weeks ago, it’s still going to be a pretty meaningful tax increase that will NOT be paid by China.

3) LIV Golf and Socialism.

Since we’re on a big time Capitalism kick right now I want to revisit the Socialist entity that is LIV Golf. I wrote a piece 3 years ago about how the underbelly of LIV Golf was rooted in a Socialist style of economics that would be bad for golf. The basic argument was that paying individual golfers huge guaranteed contracts creates a bad incentive structure that will result in them playing worse golf. That’s great for the players who take the money, but it’s bad for the game and bad for fans who love golf. The example I cited was then #1 player Dustin Johnson, who was guaranteed $125 million for 4 years and simply had to show up and smash 180 shots into the water at each LIV event. The contract structure, which was constructed by a very centrally planned economy, destroys incentive structures in a game where the players are accountable to no one but themselves. This is totally different from a guaranteed contract structure in a game like American Football where you can’t just stop practicing. Team sports force the players to be accountable to the team and their teammates. So the guaranteed contracts do not destroy the incentive structure the same way it does in a game like golf.

And what have we seen over the last 3 years? With the exception of Bryson Dechambeau (who deserves a standing ovation for his continued dedication to growing the game) LIV golfers have been a huge disappointment. In Major Championships the LIV golfers have fallen an average of 45 spots on the leaderboard since signing with LIV. Out of the 18 LIV players who have played in 3 or more Majors their average score has fallen almost a full shot per round. Their average finish is up 13 spots and their T10 percentage is down 8%. Dustin Johnson has fallen an average 30 spots and dropped 2 shots per round. This is hugely damning evidence and in my opinion points to a terrible incentive structure.

Look, I don’t blame a single one of these guys for taking the money. I’d have taken the money, but as someone who stinks at golf and really enjoys watching elite golf, I feel like this whole thing detracted from the game and took a couple of really exciting players and paid them so much money that they now have no reason to try to be elite. And again, I don’t blame them at all, but I do blame the terrible economics that led to this.

Well, that’s all I got for now. Until next time I hope you enjoy the rest of your weekend and stay disciplined!