"Debt"

 

I do not claim expertise about U.S. Treasuries, nor about any fixed income securities. And I am not an economist; so there are those that may argue with some of my assertions and conclusions. Nevertheless, I worry as to what the unprecedented period of exceptionally low interest rates we experienced, beginning in the wake of the 2008 credit crisis and then re-adopted during the Pandemic, may have done to our attitudes toward debt.

 

By the way, if you get a chance Google Daniel Hannan and his March 24, 2009 speech to the European Parliament, the speech from which the rubric heading this essay comes. In the speech he eviscerates the British Prime minister Gordon Brown, as only an English Parliamentarian is able.

 

Sydney M. Williams

www.swtotd.blogspot.com

 

Thought of the Day

“Debt”

May 3, 2024

 

“You cannot spend your way out of recession or borrow your way out of debt.”

                                                                                                                                Daniel Hannan (1971-)

                                                                                                                                British Member of European Parliament

                                                                                                                                Speech, March 24, 2009

 

Many problems we face make the front pages, and deservedly so: seven and a half million illegals through our southern border over the past three years; A Messianic belief that man alone is responsible for climate change; pro-Palestine and anti-Semites protesting on college campuses for misogynistic Hamas; rising crime; an aggressive China and revisionist Russia; a domestic education system that focuses on identity politics rather than fundamentals of learning; a belief that equal outcomes should replace equality of opportunities; and that energy inflation can be cured by controlling prices and limiting supplies. With that, debt and deficits are relegated to the back pages.

 

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Yet too much debt moves the hands of the doomsday clock closer to midnight. However, when entered into judiciously, debt can be a good thing. Mortgages, auto loans, and the purchase of appliances on time have allowed consumers to live lifestyles unavailable to their forebearers. Student loans, when not overwhelming, lead to improved earnings. We should, however, live within our means. As for the state – a nation must be able to keep secure its people and its principles. As well, it must be able to fund infrastructure projects and other necessary expenses. Because the state has the ability to print its currency, living with a balanced budget, while preferable, is not necessary.

 

However, when too much leverage is employed – examples being NYSE margin requirements of 10% in the 1920s and reduced/no-down-payments on housing in the 2000s – debt leads to a collapse in pricing and a loss in values. When incomes fail to keep pace with debt accumulation, risks of bankruptcies rise, as happened in 2023 when bankruptcies reached a 13-year high. And when a nation’s spending causes it to raise taxes to a level that inhibits, or limits, economic growth, everyone suffers. 

 

Over the past several years, we have become addicted to low interest rates, which encourage borrowing and discourage savings. After years of near-zero Fed Fund rates, following the 2008 credit crisis and despite 23 subsequent quarters of positive GDP growth, the Fed only began to raise rates in the 4^th quarter of 2015. With the advent of Covid in the first quarter of 2020, the Fed again lowered the rate to near zero, which is where it remained for two years, until the second quarter of 2022, despite strong GDP growth in 2021. When inflation became a problem the Fed raised its benchmark rate. Now, despite inflation still running ahead of the Fed’s target, many are urging the Federal Reserve to lower rates before year end. And perhaps they will. Politically it is tempting, especially in an election year. However, consequences of years of exceptionally low interest rates include government bloat, an increase in debt, a rise in asset prices, and inflation – an unsustainable burden on our children and grandchildren, a burden they will have to bear. 

 

Between 2003 and 2022 total household debt almost doubled, rising from $8.3 trillion to $16.4 trillion, while median household income rose 13%, from $65,860 to $74,580. These numbers are disturbing, but it is what happened at the national level that is of more concern. In 2000 federal debt was $5.63 trillion, a little more than half of that year’s GDP of $10.3 trillion. Twenty-three years later, federal debt stood at $32.99 trillion, while GDP in 2023 was $27.4 trillion – the first time since World War II that federal debt exceeded GDP. Interest expense on that debt in 2023 was $659 billion, or about two percent. Should interest rates remain at current levels (4.6% on the 10-year and 5.00% on the 2-year) interest expense will more than double over the next three to four years. Of course with continued deficit spending total debt will increase, further raising interest costs. Since both political parties have contributed to deficits and debt, the outlook is daunting. Neither party offers solutions.

 

In contrast, consider the immediate post-War years: In 1945 the U.S. generated $250 billion in GDP, with national debt of $258 billion. Fifteen years later, GDP had more than doubled to $543.3 billion, while debt had increased less than 50% to $382.6 billion. According to Trading Economics, GDP growth averaged four percent in the 1950s. Since the start of the new century, GDP growth has averaged about two percent. 

 

So, what are the risks? For one: In an August 7, 2011 interview on Meet the Press, Alan Greenspan said the issue was not one of credit rating: “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” The risk, rather, is Milton Friedman’s “hidden tax”– continuing inflation. A second risk is higher taxes to pay for swollen government, an impediment to economic growth as high taxes limit returns on investment. A third risk is increased regulation, which hinders innovation. Adding to fiscal and economic problems has been a dearth of births. Economic growth is dependent on innovative products and services, productivity gains driven by technology, an increase in purchasing power of a nation’s consumers…and growth in the nation’s population.

 

The latter is a concern and a risk. In 2023, in the U.S., there were 3.6 million births and 3.46 million deaths – a year in which America’s birthrate hit a new low, with a total fertility rate (an estimate of the number of children a woman is expected to give birth to over her lifetime) of 1.62. A total fertility rate (TFR) of 2.1 is needed to keep population steady, absent immigrants. As China has discovered, a low TFR is difficult to reverse. So our future population growth will be dependent on immigration, suggesting to this observer that what is needed is a two-to-three fold increase in legal immigration, along with a closing of our southern border. Illegal immigration, over the past three years, has amounted to over two million per year. While some of these people will become productive residents, most incur costs. Legal immigrants, according to the National Immigration Forum, number about a million per year. Most of these people, many of whom have waited years to become citizens, add almost immediately to our nation’s economic growth.

 

Solutions to problems do not usually announce themselves in advance, so perhaps there is a way out of the quagmire in which we find ourselves. Nevertheless, smooth sailing does not seem to be in our immediate future. Federal debt (forget unfunded liabilities for Social Security, Medicare and Medicaid) exceeds GDP, with deficits continuing to expand, and with interest rates having returned to, historically, more normal levels. The Administration is adamant about writing more rules, increasing regulations and placing further restrictions on fossil-fuel energy production and distribution, all of which will increase costs to consumers. To pay for their expansion of government, they talk of raising taxes which will disincentivize investment and savings. Added to this unhappy picture are the demographic challenges we, and most of the West, face. It is hard to be Panglossian about the world we will leave for our children and grandchildren.