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‘Til Debt Do Us Part

We are awash in a sea of debt. A recent reminder of the scale of our debt binge was the report that the US total government debt has now reached $22 trillion. This is the cumulative amount of debt issued by the United States Treasury since 1790. The budget deficit is the annual net borrowing of the Treasury, so the total debt is the sum of all the annual budget deficits. Numbers in the trillions are hard for even the most experienced economists to grasp, but in more prosaic terms, the federal debt amounts to $67,280 per person. You can see the US debt clock in real time here:

If this amount sounds daunting, it is worth noting that the above number does not include state and local debt, “agency” debt, or unfunded liabilities of entitlement programs like Social Security and Medicare. Agency debt is debt issued by government sponsored agencies such as the Government National Mortgage Association (GNMA), and estimated to be $9.5 trillion fo fiscal 2019. State and local debt is estimated to be $2.1 trillion. And the unfunded liabilities for entitlement programs? Let’s not go there, except to say that politicians touting “Medicare for all” will have to pull a magic rabbit out of a hat to make that work under our current structure.

In the world of tweets and 90-second news bites sandwiched between commercial breaks and panels of talking heads, these numbers are just words. But what is the real importance of these debt levels, and do they pose a danger?

There are two relevant metrics to consider when thinking about national debt. The first is the percentage of debt compared to gross domestic product (GDP). This measures both the ability of the government to pay its way via economic growth, and also it provides insight into how much growth the debt has helped generate.

Total debt-to-GDP remained pretty low for decades until it began to climb in the early 1980s while President Ronald Reagan fought the Cold War against the former Soviet Union.

Debt-to-GDP was about 31% when Reagan took office in 1981, then steadily climbed to a peak of 65% in mid-1995, according to data from the St. Louis Federal Reserve Bank.  At that time, President Bill Clinton and the Republican-controlled Congress eventually carved out a short-lived government surplus, resulting in a diminishing need to borrow, and the debt-to-GDP ratio receded to 30% percent in 2001.

From there, borrowing exploded.  George W. Bush’s decision to finance two wars, along with the two recessions of 2001 and 2008, sent debt-to-GDP to 77% by the time Obama took office. When Obama left, the level had risen to 103%, and under Trump, there’s been a small uptick in that regard, with the level standing now at 104%.

The other relevant metric is “debt held by the public,” which parses out “intragovernmental holdings,” or money the government borrows to operate its various trust funds like Social Security and Medicare.  That figure, too, began to rise in the early 1980s, from less than $1 trillion to its current $16.2 trillion. In the Obama years alone, it surged from $6.3 trillion to $14.4 trillion.

In debt-to-GDP terms, the public debt rose from 75% when Trump took office to 78% at the end of 2018. As a contrast, that level rose from 48% at the start of Obama’s term to 75% when he left.  The history of debt expansion is sobering enough, but it’s the future path of debt that has many economists concerned.

The most recent projections from the nonpartisan Congressional Budget Office (CBO) indicate that debt held by the public will rise to 96% of GDP in the next 10 years, or the highest since the post World War II years.  From there, the level is expected to hit 150% by 2049, which is well above what economists consider a sustainable level.  Moreover, should current tax policies stay in place, rather than sunset as they are designed to do, the debt burden will get even worse.

The main culprit of public debt is budget deficits, which have surged under Trump, though the CBO now expects the shortfall to be a cumulative $1.2 trillion less than previous projections. The office estimates that annual deficits will start topping $1 trillion in 2022, from an estimated $900 billion in fiscal 2019.

The Trump administration has said economic growth will pay for the added debt and deficit burden, but so far that hasn’t been the case, despite the fastest GDP gains of the recovery.

And that brings us to the most relevant questions regarding debt: At what point does adding more debt cease to be stimulative or productive?  Is there such a thing as too much debt?  To answer that question, we should look at the micro picture of households and businesses.  Both have expanded their debt holdings since 2008, and of course, that was the point of the Federal Reserve’s “quantitative easing” policy.  Consumer credit has reached new post-recession highs, and some signs of stress are starting to emerge.  Specifically, delinquencies on credit card, student loan, and auto loans are starting to rise.  While they are a far cry from the high default levels of the post-recession period, they do underscore the idea that there is a change in the wind, and that maybe at the consumer level, the capacity to shoulder debt is topping out.

Over the past decade, companies have taken advantage of low rates both to grow their businesses and reward shareholders.  Total corporate debt has swelled from nearly $4.9 trillion in 2007 as the Great Recession was just starting to break out to nearly $9.1 trillion halfway through 2018, quietly surging 86%, according to Securities Industry and Financial Markets Association data.  One reason markets worry about debt is that there’s not as much cash around to cover it. The cash-to-debt ratio for corporate borrowers fell to 12% in 2018, the lowest ever.  This is an early sign that corporate debt levels are reaching their practical limit.

Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash available yet. Whether it’s wise depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.

Moreover, debt is manageable as long as cash flows are adequate to make your loan repayments.  It’s when the breadwinner loses a job, or a company’s revenues drop in the midst of a recession, that the burden of debt is truly felt.  That makes the recent softening of global economic indicators all the more important to watch.

In the Eurozone, growth has ground to a near halt as the trade war is clearly having negative effects on this export dependent region, and the uncertainty of Brexit has made long-term planning problematic at best.  In China, economic softness is becoming more pervasive, with manufacturing feeling the effects of US tariffs, and Chinese exports dropping.  Finally, in the US, the recent jobs report was a dud, as only 20,000 job creations were reported for February, and the Atlanta Fed’s GDPNow forecast for the first quarter of this year is estimated to be an anemic 0.5%.  Should these trends continue, the debt burden for all sectors of the economy will become heavier, and our ability to cope with a recession that much more difficult. 

Wall Street is also taking note.  After rallying smartly for the first month and a half, a more hesitant tone has pervaded trading.  To be sure, trend indicators are uniformly bullish, with the NYSE Bullish % (below), NYSE advance/decline line, and new high vs. new low index all on buy signals and “bull confirmed.”

This new year’s exuberance can be attributed to hopes that a trade deal with China was imminent.  But the reality of such complicated negotiations has become clear, with sober reality replacing Wall Street’s Alice in Wonderland hopes for a quick resolution (that would also somehow entirely favor US industries).  That, plus the latest reports of expanding budget and trade deficits, have thrown cold water on the bullish herd, who are beginning to question whether we have the capacity to cope with the debt load we face.  Should business slow markedly, the ability to keep profits and revenues growing, in the face of our growing debt load, is going to be weakened.

We have become addicted to debt, and are reaching the point where more debt is less and less stimulative to growth.  Our ability to control debt will be a key driver of investors’ returns over the next 10 to 20 years.  Hopefully, we can curb our appetite for debt before our debt ends up controlling us.

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