The Consequences of $50 Trillion of US Debt

Raising taxes will not solve the problem. Of course, it could help reduce the deficit some, but it would be more of a token. That is just the reality. From the Tax Foundation here are the real numbers as of 2017.

If we double taxes on the top 25% it would only bring in another $1.3 trillion, assuming people didn’t change their behavior. (A 75% marginal rate plus 4% Medicare for a 79% top rate certainly will change behavior.) A less-shocking 20–25% increase would only bring in about $3-400 billion and would have to raise rates on incomes above $83,000. Not exactly the rich. They already think they pay their fair share.

If we raise taxes next year in the teeth of a recession it will only make the recession worse. If we raise taxes but they don’t actually take effect until 2023 and then get phased in? That would probably avoid creating a double-dip recession.

One reason we cut corporate taxes was to make US companies more competitive. It worked. Do we really want to lose that? Not to mention what it will likely do to the stock market. Just saying.

I know I keep saying this, but debt is future income brought forward. There is a point at which debt becomes a drag on US economic growth, and we have likely reached it. GDP growth in the US is going to increasingly look like Japan and/or Europe, i.e. almost nil. So, the CBO’s continued 2% average growth forecasts will simply get thrown out the window and the deficits will get worse.

US Economy

• The Conference Board’s index of leading indicators showed slower gains last month.
• Inflation expectations eased this month.
• Household income expectations are rolling over.
• Weaker factory orders were among the subindices contributing to the slowdown.
• The current account deficit widened sharply in the second quarter.
• US household net worth rose sharply last quarter (biggest quarterly gain since 1952) as the stock market recovered.
• The expiration of the $300/week unemployment benefits this month will reverberate through the economy.
• Existing home sales remain above last year’s levels and remarkably strong.
• Inventories of houses for sale are multi year lows.
• With mortgage rates near record lows, price gains are accelerating.
• Credit card spending has slowed after the $600/week incremental unemployment checks stopped. They will slow further once the $300 payments expire.
• The lack of additional stimulus will have a substantial impact on the GDP, as incomes decline sharply.
• School closures are creating a material drag on the economy.
• The Richmond Fed’s regional factory activity index came roaring back over the past few months.
• The employment expectations index hit a record high.
• The NY Fed’s weekly index of US economic activity has stalled.
• The CBO’s long-term projections of the nation’s fiscal picture look grim.
• Bloomberg’s report shows that Americans are much more upbeat about personal finances than the state of the economy.
• There is a divergence between retail sales and consumer confidence.

The Federal Reserve

Federal Reserve Board Chairman Jerome Powell warned Wednesday that a lack of further fiscal support from Congress and President Trump could “scar and damage” a U.S. economy restrained by the coronavirus pandemic.

This is an interesting position from the head of the Central Bank who has flooded the system with liquidity.

While the Federal Reserve can calm and support public markets, they have little impact on the non-public markets. The real crisis is in small and medium-sized businesses that do not have access to public markets, either equity or debt, to raise needed capital.

Currently, the Federal Reserve is continuing to run “Quantitative Easing” at $120 billion per month, but much of that is just replacing bills that are maturing. As shown below, the Fed’s balance sheet has been stagnating since June as the uptake from its various programs has waned. Subsequently, excess bank reserves, which have supported the market recovery from the March lows, have also peaked.

So, in what may come as a big surprise to all those praying for the Fed to bail them out, or to at least telegraph that he is keeping an eye on the current tech-led market mess, Powell did no such thing. In fact, the Fed’s latest weekly report showed that the corporate credit facilities held $12.911bn of corporate bonds and ETFs as of Tuesday, up a tiny $44 million from $12.867BN the prior week.

The US Markets

Given the challenges facing the markets over the intermediate term from a “contested election,” a lack of financial support, a pandemic resurgence, and economic disruption, the risk of a deeper correction remains.

If we look at the weekly chart below, we find that when the market has historically broken below its short-term weekly moving average, it has, with some consistency, tested the longer-term average. Currently, that is almost 7% lower than where we closed on Friday.

Debt

All debt shares one common characteristic. A bill comes due at some point and, if the borrower doesn’t pay, the lender either loses their money or finds someone else to pay. Governments often do this.

I’ve warned for several years now that our growing global debt load is unpayable, and we will eventually “reorganize” it. I believe this event is still coming, likely later in this decade. Recent developments suggest it will be even bigger than I expected.

The underlying spending and revenue numbers came straight from the CBO. They make numerous unrealistic assumptions yet still show a bleak picture.

What would happen if we had a recession in 2022?

The most obvious change is a big spike in the blue “Mandatory Spending” area. That’s the unemployment and other benefits triggered by the recession. Less obvious is a small dip in tax revenue, after which the line continues upward as before. Even with the optimistic V-shaped recovery assumption, revenues barely cover mandatory spending (basically entitlements and social programs), defense, and only a little of the actual interest costs.

Here is the change in marketable Treasuries by quarter.

If we plug that into CBO’s revenue and spending estimates through 2030, we get something like this.

Here is where the wonderful www.USdebtclock.org says we are today:

We are so going to blow through $30 trillion total debt sometime early next year, making my milder projections wildly wrong. Just a year ago, I naïvely expected it would be 2025 before we got to $30 trillion, and we would be short of $40 trillion by 2030.

The next question is how we will finance all that debt. Americans and a shrinking group of foreign investors have been surprisingly willing to buy as much paper as Washington can print, even at near zero (or below zero, adjusted for inflation) interest rates. But there are limits, at least in theory, and they may draw closer if the global recession drags on.

The most obvious solution is for the Fed to buy whatever amount of bonds the Treasury needs to sell using quantitative easing. Powell is definitely willing. Depending on how the Fed disposes of its bonds, it might be the practical equivalent of MMT. And the Fed’s willingness will not be lost on a future Congress, which could easily decide to test the limit. $50 trillion could just be the start.

The other question is what effect all this federal debt will have on private markets. Will it have a “crowding out” effect that reduces private lending? How will it affect legitimate business and investment activity? We’ll see the result in lower growth.

Remember, we aren’t just talking about federal debt. States and local governments owe over $3 trillion more, plus trillions more in unfunded state pension liabilities, some of which could easily end up at the Fed or Treasury. Then there are the wildly underfunded pensions (both government and corporate) that could easily default and force some kind of federal takeover. Plus, corporate bonds, mortgages, student loans, auto loans, SBA loan.

Market Valuation

The median global sector price-to-earnings (P/E) ratio is at the highest level since the dot-com bubble.

Most countries are close to record P/E levels.

US industrial stocks are trading at multi-decade high P/E levels.

Demographics

For decades, the rising number of working-age folks in the U.S. (considered people aged 15 to 64) has been a big driver of the American economy.

From 1980 to 2020, that figure jumped by 45%, to nearly 206 million people.

But early last year, this figure went into reverse for the first time since being recorded. That’s right… In 2019, the number of Americans of working age declined, by 0.11%.

That’s a tiny drop. But as you can see in the chart below, the trend has been down since the start of the century. The available workforce grew by 2.19% in 2000… 1.26% in 2007… and 0.65% in 2015. And so far, this year, it’s falling more.

The number of people of working age is determined by the birth rate and by immigration.

For centuries, the American brand of “the land of opportunity” has attracted the smartest and most motivated people from the rest of the world.

Since 2016, the number of legal immigrants entering the U.S. has fallen by an average of 43,000 annually, according to Foreign Affairs magazine.

When the fertility rate in the U.S. hit a 35-year high in 2007, at 2.12 births per woman, even that was only just above the “replacement level” fertility rate of 2.1.

The replacement level is what it sounds like… the average number of children born per woman so that a population replaces itself from one generation to the next.

This rate has mostly declined since then, to 1.73 children per woman in 2018, according to the World Bank. That matched the all-time low from 1976. (As recently as 1960, the average American woman had 3.6 children.)

If “demography is destiny” – a quote attributed to 19th-century French sociologist Auguste Comte – then economic growth in the U.S. will suffer over the next decade.

As the number of new additions to the working population falls, unborn children can’t join the workforce 15 years later.

Many countries in Europe, along with China and Japan, have a fertility rate even further below replacement levels than the U.S. (South Korea is the least-procreative country in the world, with an average of just one child per woman.)

This isn’t good for the American economy either… These are major trading partners.

That means one of the long-term structural advantages – and growth drivers – of the American economy is slowly vanishing. But what about productivity, the other part of the growth equation?

US Economic Productivity

Growth in productivity – which is output per employed person – has been declining over the past few decades in the U.S. From 1990 to 2000, productivity was rising by an average of 2.3% every year.

But over the past 10 years, it has been increasing at only 1.3% per year. That’s partly because the one-off jump thanks to the computer boom has long since worn off. And also, during times following eras of increased productivity, it’s harder to get better from a higher base level.

Still, like the fertility rate, the American productivity improvement is better than other developed economies. For example, Germany – notwithstanding its historical reputation for efficiency – has become just 1% more productive per year since 1980, compared to 1.7% in the U.S. over that period.

Unless productivity growth improves – or there’s a coronavirus-inspired baby boom – American GDP growth is going to be sailing into some stiff winds in coming years.

The same goes for most of the rest of the developed world – as well as in a lot of emerging markets, where the population is growing old before it’s rich.

COVID Update

Here is the number of new COVID cases in select economies.

Market Data

• Unprofitable companies are becoming a large component of the market.
• For the first time since May, fewer than 15% of financials managed to hold above their 50-day moving averages. This comes during a poor market environment for the sector, with fewer than 50% of them above their 200-day averages. This has led to much worse returns than when more than 50% were above their long-term trends.
• The Russell 2000 became the first of the ‘big four’ indexes to close below its 200-day average after all 4 had been rallying. It also ended a medium-term rally within a much larger downtrend for the index.
• According to Lipper, investors pulled nearly $15 billion from equity funds over the past week, the most since mid-June.

•  Breadth in the high-yield bond market has turned negative for the first time in months, with more bonds hitting 52-week lows than highs.

All content is the opinion of Brian J. Decker