Happy Chinese New Year and welcome to the year of the rabbit!
Even a decade ago, not one reasonable individual would have said that it was even possible – but here we are…
The U.S. government is bumping up against its borrowing limit that is now set at $31.4 trillion, and they have just raised short-term interest rates four hundred basis points. The Federal Government is in debt roughly 120% of the U.S. GDP. Interest payments on the debt alone are now north of half a trillion dollar per year and ROCKETING higher. Soon we will be staring at debt payment totals that are rivaling the biggest budget items of social security and Medicare. This is not sustainable in the long term.
Historically there seems to be something about a government that gets to 90% of its GDP in sovereign debt. Growth slows and some sort of debt restructuring, or default happens in short order (see Reinhart and Rogoff’s “Growth in a Time of Debt.”) So, we are obviously beyond that point and it doesn’t take a rocket scientist to understand that the U.S. liabilities on top of that debt (social security and Medicare for an aging population) take an accounting standard’s estimation of total debt to near $100 trillion. That is a dark cloud of liability hanging over America that would have even made Bernie Madoff blush at the height of his profligacy. The only historical example that we could find of a large economy growing its way out of anything like this kind of debt is the British government after the Napoleonic Wars. Some estimates say they were north of 200% of their GDP in debt – but the industrial revolution and some financial discipline powered them out of that tough situation. Obviously, they didn’t have the sort of social spending burdening their government budget the way we do though. And our government discipline is clearly getting worse at an alarming rate – take an historical look at our National Debt as a percentage of GDP…
But before anyone panics and sells everything they own and move to the mountains into a compound with bomb basements, razor wire and machine gun turrets around the perimeter - let’s look at the other side of the ledger.
Of course, on top of the list is the situation of the U.S. dollar as the world’s reserve currency in an environment that has debt-based currencies rather than backed by gold – and this time there is no new frontier or different alternative. The concept of “this time is different” is of course very dangerous. We like to say that history rhymes rather than repeats and there will be drastic differences in situations that on the surface may appear to be mostly parallel. But as the Federal Reserve clearly still leads the entire world in monetary policies, we see that there may be a quite some time remaining in the U.S. dollar’s advantage. As we have mentioned many times before, Japan and Europe are much further down the bad debt trail than the U.S.
The near term is not super doom and gloom contrary to what the financial news wires are saying. As a matter of fact, some of the money managers are starting to push money back into risk-based assets. Inflows to stock funds have picked back up over the last couple weeks. While earnings and future forecasts from the S&P 500 are relatively soft, fund managers see inflation coming down and are assuming the Federal Reserve will back off on interest rate rises. This is obviously good news for the near term. For the medium term we still see some large headwinds and the debt load that the U.S. government, businesses and households have with rising interest rates is the biggest. We like that the stock and bond markets are holding together well, but if the financial news media starts to get more comfortable like some of the fund managers, we will start to get more nervous.
As far as the debt ceiling – it has been hit and the Treasury Department is maneuvering through payables and receivables – even playing some shell games to keep things going with the Federal Government. They say that Congress is going to have to figure something out by summer or the gig is up. Political grandstanding will probably continue in DC on both sides of the isle until that crunch time hits – so stay tuned…
Regards and good investing,