Oooh, isn’t that a teasing headline? What follows is a lighter version of what I might write for an institutionalized professional audience because on my very personal blog I hope most readers are not institutional investors and will get the gist of this sort of writeup. I’m sure I’ll hear otherwise if I’m wrong. Cutting to the chase, I worry about debt in the US, and the world, in its many forms. High debt ALWAYS causes recessions and we certainly have a lot of debt to fret about.
Let me start with my eternally pessimistic bias for the US and global economies for the next decade or so. If anything, I risk being too negative in my views though those have served me well in terms of cautionary approaches to investing, saving and spending in my personal life. Investing-wise I could have afforded more risk taking, but at this stage I’m content with the very modest approach.
I’ll digress for a second. I’ve read in a lot of places about retirement planning and all with a rule of thumb that you can extract about 4% a year from your portfolio and that will last you about 25-30 years. That’s 4% REAL return, after inflation. I’d use 3% or less. Why? Because interest rates are low and will remain low and I think stock market returns will be less than average given they’ve been better than average for the last 10 years. And inflation is one way to work off a lot of debt. Simple as that.
I’d also be careful about taxes and benefits in retirement because, as you’ll soon see, all the risk is that taxes will go up and benefits decline (means testing on Social Security and Medicare, for instance) in retirement. So let me begin.
This happy chart shows you the total Federal Debt, held by the public, as a % of GDP. Note the vertical line is now and the debt % grows forever. The data do not anticipate the fact that if and when we hit a recession the deficit will grow even more. Why is this a problem? Because,
1) it means that government borrowing will crowd out the more productive and economically boosting borrowing from businesses and individuals,
2) the fact the deficit has grown when the economy is strong is an anomaly. We should be reducing borrowing as a percent of income/GDP when things are good,
3) if we have high debt in growth, we have less room to borrow when things are bad, i.e. government spending (or lower taxes) to boost the economy during a recession,
4) more and more government spending will be on interest payments on the debt, aka debt service, which means less for other purposes,
5) when the deficit gets larger, there’s the real risk of higher interest rates demanded by investors because the US become a riskier credit,
6) taxes will have to go up to pay for the deficit and or spending decrease, which gets back to Social Security and Medicare for retirees,
7) there’s more, but all the above will dull you enough.
Then there’s the consumer. We all know that while unemployment is low, wage gains have been pitiful for most people. This explains the doofus populism of Trump’s economic policies that ultimately will make things worse (see deficit above). But here’s the thing; we are a materialistic, short-sighted, stupid people who are envious of things. So when we don’t earn enough to support buying habits — tattoos on, tattoos off — we borrow. That means less for difficult times, the proverbial nest egg, and, of course retirement.
Don’t believe me? This next chart shows Consumer Credit, i.e. what we borrow, at $13.5 trillion. That’s $1.4 trillion more than just before the last recession, which was caused by too much borrowing. But here we are in a growth phase when, in theory, we should be relying on incomes to consume, not borrowing. With interest rates now higher, evidence is there, in softer auto sales and housing, that they are taking a bite. People will borrow to maintain lifestyles but watch out when they lose their jobs in a recession.
US corporations have borrowed hugely. Why? Mostly to buy other companies and buy back their own stock. US corporations have been the largest buyer of the stock market in case you didn’t know that. It maybe made sense when rates were low and corporate borrowing rates (known as credit spreads) were very tight to US Treasury rates. Well, the Fed is tightening, rates are up, and people are pondering all the corporate debt out there.
Corporate debt is 46.4% of GDP, a record high. It traditionally gets over 40% in a recession, not in a growth phase, which means when a recession hits the quality of corporate debt — the credit rating — will get worse in the form of downgrades. Too, if fears of corporate indebtedness are strong (they are) then there’s less room for borrowing to buy back stocks which means we lose the biggest buyer of the stock market in the last 20 years. That’s not good for stocks is it? (Oh, and the fact they’ve used debt to buy back stocks means they’ve haven’t been investing for organic growth that boosts productivity and real profits.”
A related issue is that the investment-grade corporate bond market is of lesser quality now than it was. That’s because there’s been a lot of triple B issuance, so that the overall credit rating of the corporate market is weaker. In a recession then, credit spreads will widen more than tradition making it more difficult for them to borrow and expand after a recession.
In “Bye Bye Birdie” they sang the song “What’s the Matter With Kids Today?” I don’t know about then, 1962, but can tell you the matter today is debt. Students owe about $1.44 trillion in student loans, the delinquency rate is rising on those, and it’s been one of the large components to rising consumer credit in general. So, poor kids, have to pay that stuff back which means less money for cars, snowboards, houses etc etc.
I won’t argue about the value of a college education, but young people with jobs are burdened by this reality and there won’t be any relief except maybe from their parents which constrains their spending/saving habit.
This last chart puts it in a nutshell; total debt as a % of GDP. It appears flat, which is a function of less borrowing for mortgages and by Federal agencies after the last recession and to a degree more stable borrowing by consumers (think about less Home Equity Lines of credit). If I’m right, there will be a surge in this measure as a recession causes people to go into debt and that means coming out of the next recession in worse shape than ever before which translates to a slower economy for a long while to come.
How do we get out of this in the long run? I suppose we’ll have to accept lower income gains or negative income gains due to higher taxes to pay for some of it, maybe higher inflation the government will tolerate (higher inflation means you’re paying it back in cheaper dollars). I won’t offer grand investment strategies but assume that cash should hold up, dividend stocks from companies that won’t go out of business should do okay (at least give income), and gold and TIPs offer some allure against the inflation ideas (but not for a couple of years yet). Oh, I’m thinking about converting IRAs to a Roth given lowish taxes now (and my tax will be really low given my job situation), and stocks still quite high and worthy of a sale to pay the taxes on the conversion. The idea is that taxes will rise in a few years and a Roth avoids that risk.