It's All in Perspective
Considering all the recent economic, political, and
social upheaval within our economy, within individual states, within government
and on a global
scale, it's difficult to keep things in their proper perspective.
But how exactly did we get here? And how did we get to the point where
headline writers can so casually write things such as "US Budget
Deficit Rises Above $1 Trillion", or "Debt Level of United
States to reach $11.5 Trillion," and then seamlessly go back to covering
Jon & Kate Plus 8?
Trillion is the new billion. And it occurred in such a fashion that reporters
so carelessly type out "trillion", as if it really just is
one letter removed from "billion" and "million",
and isn't precisely the same as $1,000,000,000,000.00.
Public concern over our nation's state of fiscal deficit and debt
are valid, and the increasing awareness and education of the issue will
create positive ripple effects going forward. But what exactly are the
issues at hand? How does our current state compare using historical context?
And given our debt load, are we really on the verge of financial disaster?
Life's Certainties: Death, Taxes…..and Government Deficits & Debt?
Just
as we're not so quick to casually toss around "trillions" (the
word, nor the amount), we're also careful in defining exactly what
portion of our governmental fiscal standing has eroded to such levels.
Additionally -- and more importantly -- we feel it's beneficial
to provide proper historical context.
Deficits are what occur within a given fiscal year when an organization,
in this case the US Government, spends more money than it takes in (tax
receipts). Deficits aren't out of the ordinary; in fact, according
to the CIA Factbook, over 55% of countries operated deficits in 2007. The
United States has operated a budget deficit throughout most of its history,
and was only recently spoiled by budget surpluses at the turn of the century.
In fact, looking at annual deficit levels since 1900, the US has run a
budget deficit over 70% of the time.
Despite our deficit rich history, current deficit levels far exceed anything
we've experienced in the past 40 years, with current 2009 fiscal
year estimates seeming to near $2 Trillion each passing day.
What's important to keep in mind is not only the absolute level
or value, but also how they measure out in relation to other inputs. One
popular method (which we will later debunk) is comparing our current budget
deficit to the overall size of our economy which, when measured by GDP,
is estimated to be approximately $14.05 trillion for 2009.
Regretfully, it's difficult to construct anything positive when viewing
this data in percentage terms, as this is the first time in the past
four decades that our annual fiscal deficit has exceeded 10% of GDP.
Now that we're spending in excess of 110% of our annual economic
production, one logically wonders how you might support that extra debt.
I mean, money doesn't just grow on ... governments?
Debt issuance, not trees, is the most simplistic form of money creation
by the government. And though our parents were ultimately right in that
money doesn't grow on trees, the magical components involved in the
actual money printing process is eerily similar.
Simplistically, the US Government actively manages its own balance sheet
by both issuing and purchasing Treasuries and T-Bills. If you buy a Treasury
Bill for $100 from the government, you're effectively lending them
$100. To compensate you for lending them money, the government will pay
you a coupon payment and return your principal after a predetermined period,
based on the Bill's duration.
Like deficits, debt isn't a foreign concept to governments. Nations
all over the world issue debt, and the United States' debt is known
to be the most secure investment in the world, as it has never defaulted.
Historically, the US Government has had an average outstanding debt approximate
to 50% of its GDP. In the early 70's this figure was closer to 30%,
and more recent estimates approaching 100%. So who is buying all of this
debt? Saying that the $100 example I provided earlier, in the context of
a $14 trillion GDP, is a drop in the ocean would be an enormous understatement.
There are actually a number of parties involved in the ownership of US
debt. They range from individuals like you and I, to mutual funds, pension
funds, the Federal Reserve and -- most importantly -- foreign
nations (China, Japan and the UK are the top three US debt holders).
These parties actively participate in the systematic buying and selling
of US debt securities. To put it lightly, we continue to push on a string
by expecting (hoping?) that these large debtors will continue to blindly
purchase the debt we issue, as we're in heavy reliance on this debt
to fund our current and future deficits. However, the discussion revolving
around the question "what happens when there is no more demand for
US debt?" is an entirely separate topic.
Both Sides of the Balance Sheet
Your humble author will freely confess the fiscal scenario under which
we currently find ourselves does not engender a very positive feeling.
Just as the public consciousness has shifted to a mindset geared more towards
fiscal prudence, our own government seems to be doing the exact opposite.
A trillion here, a trillion there ... it all adds up after a while,
you know. Believe it or not, this cooperatively inverse consumer-government
spending relationship is proceeding exactly as designed.
That being said, the questions and concerns which have arisen are valid:
with the new precedents being set by our nation's fiscal dilemma,
how on earth will we find our way out of this? The aimless printing of
money, never ending issuance of government debt, corporate lay-offs and
bankruptcies, increased social acrimony, state issued IOUs and impending
higher tax rates. Disaster and depression will surely ensue, right? Buy
gold, bullets and canned goods! Under which GICs sector does bomb shelter
building material fall under, and is there a triple leveraged ETF for that?
Despite the typically espoused data point comparing debt to GDP (as discussed
above), it really isn't a true and fully accurate depiction of our
nation's financial state. And looking just through the debt lens
is but only one side of the balance sheet ledger.
A less frequently discussed data point is the growth in the asset base of our nation over the same period. These assets include, amongst others:
real estate, stock/mutual fund holdings, checking/money market account
balances, retirement & pension savings, inventory, buildings, equipment,
etc. Sure, we've heavily leveraged our balance sheets to obtain these
assets, but over decades of high-90% credit card and loan pay-off rates,
these items become progressively realized on the asset side of our individual
balance sheets.
Luckily, I have someone with a few more notches of credibility in my corner.
As Warren Buffett wrote in a recent New York Times Op-Ed:
I want to emphasize that there is nothing evil or destructive in an increase
in debt that is proportional to an increase in income or assets. As the
resources of individuals, corporations and countries grow, each can handle
more debt. The United States remains by far the most prosperous country
on earth, and its debt-carrying capacity will grow in the future just as
it has in the past.
A more accurate analysis would fall in-line with how corporations and
individuals analyze their own financial health -- comparing total
debt to total assets. As the chart to the below shows, our nation (made up of household, corporate,
and government entities) has experienced levels of asset growth in excess
of growth in debt -- as depicted by a positive national net worth
of over $20 trillion.
Yes, the explosion of household and government debt in recent decades
is alarming and will need to subside. Consumer behaviors and expectations
will need to change and realign to more moderate standards. But Armageddon
and imminent disaster? I think not.
Breaking out each of the components that comprise the above graph and
adjusting the data to only include non-financial corporations (with household
and government making up the other two) provides some rather interesting
insights.
The multi-decade long process of consumer leveraging comes into full
view -- as in the 1950's consumers had $10 of assets for every dollar of
debt,
this ratio is now closer to $3.50 of assets to $1 of debt.
Corporations have historically been more leveraged, but are currently
near early 1990's levels. This supports the theory that corporate
balance sheets, in general, are actually in very good shape (aside from
the obvious and extreme exceptions of AIG, Citibank, etc.)
Most interestingly, in light of the headlines and societal upheaval, the
government balance sheet has maintained a fairly steady level of debt and
leverage throughout its history, with just $0.30 in assets to $1 in debt.
In the aggregate, and again being admittedly concerned about the recent
path and trajectory of our nation's debt burden, this data affirmatively
shows we are not on the verge of bankruptcy, meltdown, or whatever other
Quentin Tarantino-type gruesome destruction scenarios are currently circulating.
Fallacy of Division
At a recent community festival, a sign promoting the
product of on one of the vendor's confidently read: "Thousands of customers can't
be wrong." Really?
How about the other 6.7 billion people in this world who have made no
attempt to try your product? Is it equally absurd to say that they can't
be wrong either?
It's a fun and entertaining story to preach death and destruction,
especially when you're able to toss words such as "trillion" in
the mix. But deducing too much from such a data point as government debt
or deficit, especially to the point which it would cause one to make unprecedented
and thinly educated alterations to their investment portfolio, would surely
be fallacious.
This is especially true given the almost constant state of debt through
which our nation has operated. In fact Alexander Hamilton, our nation's
first Secretary of the Treasury, once said that "the United States
debt, foreign and domestic, was the price of liberty."
Though we find ourselves in a tough predicament, we're not in entirely
uncharted territory. There are ways out of this, and a re-alignment in
consumer behavior will play a key role in traversing up the other side
of the hole we've dug ourselves.
Stocks, bonds and other asset classes have likewise been through this
before -- some more successfully then others. Winners will be separated
from losers throughout the asset class spectrum, and a new breed of leaders
will emerge, while some others will surely fail.
Maintaining exposure to a variety of asset classes, through top tier investment
vehicles and with managers who have performed exhaustive research and analysis
on what they hold, is almost as important as maintaining a clear head.
Irrational investment decision making has never outperformed a balanced
and diversified portfolio in the past, and though we deal with some very
real and serious issues, making future investment decisions that are deduced
from contextually lacking headlines is nearly assured to provide uninspiring
returns.
-- Bryan Keller, Research Analyst
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