U.S. Debt - Trouble Ahead For Markets ?
by
Stanley C. Clayton, Ph. D.
February 7, 2010
Economic Tea Leaves
Our nation, businesses, families, and individuals face considerable economic headwinds. Perhaps foremost among these is debt. In Tea Leaves, I take a longer perspective than most looking primarily at where we are in the overall scheme of things especially as it applies to investing. I have argued that we appear to be in the early phases of nation decline following more the pattern of England rather than the Roman Empire. Today we look at the role of national debt in that decline, and then the implications for investing in such an environment.
The actions of the Federal government in response to the “crisis” are perhaps best understood as a desperate and often frantic effort to recapture the glory days of our republic when we were the unquestioned powerhouse of the world. One of the many measures of this decline is the shift from being the greatest creditor nation to the greatest debtor nation. In the 1980's, we crossed the line into debt and have not looked back. Now Congress has increased the debt limit to 14.3 trillion dollars. A few trillion here or a few trillion there, does it really matter? Many economists of the Keynesian school of thought would argue no. After all, it is only about 85% of GDP (gross domestic product). That is a correct calculation, but I find it is an erroneous interpretation. I suggest we are in the process of learning the hard way and in real time that Keynesian economic theory has critical flaws. Downplaying the importance of debt is one of them.
Just to get a feel for just how much $14.3 trillion debt amounts to in terms we can grasp, look at this. Interest per year on that amount of debt at 2.5% = $3.975 Billion. Estimated (from U.S. census data) number of households in USA 2010 is 121.1 million. Interest divided by number households equals on average about $3,000.00 per year interest only owed per household per year.
$14.3 trillion means that each family in the U.S. is on the hook for about $160,000. If we could all sell our homes and apply the proceeds to the debt, we might have it about paid off, but then we would all experience living on the streets.
These are not precise numbers, but they are close enough for us to get the picture. Debt matters and it matters big time. Life on the float may be fun while it lasts, but it has its way of ending in tears. As many individuals, families, and businesses large and small have discovered, as your dept goes up, so do your risks. Pushed far enough, even the slightest setback results in insolvency (bankruptcy). At the national level, it is often referred to as national default on its debts. The challenge then becomes to avoid nation failure.
Where are we now? We have passed the tipping point or the point of incipient decline, and with every increase of the national debt, the downhill slope steepens. It not only increases national risk, but it increases the headwinds for all of us. National debt sucks money out of the economy that could be used, for example, by businesses. It means increased taxes through either or both directly by increasing taxes, or indirectly through inflation. With highly skilled stewardship, our nation can follow a somewhat graceful decline to several notches lower. Without such stewardship, however, it could get ugly.
Ultimately, the voter will determine the outcome: be very careful who you elect to office at all levels of government. Only the best will do.
How long will all this take? It is likely to follow an uneven geometric decline. It has started with a rather steep decline, but it is likely to ease, voters willing, during this decade (2010's), then settle more slowly for decades to come. Look to the ups and downs of England over the past 200 years for guidance on this issue. Can the decline be avoided entirely? I suggest that is the wrong question. It may be more productive to ask what actions can we take as individuals and as a nation to limit our decent to a level that is still rather agreeable.
Tea Leaves will devote a portion of these pages in the future to that question. We will find there are constructive things we can do and actions we can avoid that provide a sound basis for cautious optimism about our chances.
Stock Market Tea Leaves
Past general market predictions remain unchanged. The current market is one of the rough spots predicted. While it could be the beginning of a major decline, remember the Fed is still in easy money mode. This makes a stiff decline difficult. As noted before, people are uneasy. Sooner or later a major market turn down seems likely, and the high U.S. debt appears to me likely to play an important role. Notice in this past week that Moody's stated that the U.S. Aaa investment status may soon be in jeopardy because of its debt. Even more troubling is that Timothy Geithner (Treasury Secretary) publicly claimed that will never happen. Such government denials often portend the denied event. Why? Because no high ranking government official will bother to deny something that obviously has no merit. Such an event would have major implications throughout, the stock market included. It is interesting that in such a case, easy money could quickly become seen as part of the economic problem and thereby become a negative rather than a positive for markets. Tea Leaves has argued that easy money has been the major driver of the 2009 market rally. If that becomes as much a negative, well... .
Remember the focus of Tea Leaves is long term market understanding. Short term timing is not within its purview.
