Roger Lipton: Can the Economy Overcome the Post-Tax Debt Load?
Roger is an investment professional with decades of experience specializing in chain restaurants and retailers, as well as macro-economic monetary developments. He turns his background, as restaurant operator and board member of growing brands, into strategic counsel for operators and perspective for investors.
An archive of his past articles can be found at RogerLipton.com.
Nobody needs to tell me how painful it is to not be participating while the financial world "dances". Back in 1998 and 1999, the investing partnership I manage was not benefiting while the dotcom mania roared. On January 1, 2000 I wrote: “we have seen this movie before, and know how it ends.” From March of 2000, when the dotcom bubble burst, our portfolio more than tripled over the next five years. The distortions within the financial markets today are much larger, and worldwide, in scope.
We could go back to the tulip mania of the 1600s, the Mississippi bubble in France and the South Sea bubble in Britain of the 1700s, but much more recently: the Japanese stock market peaked at 40,000 in 1990, descended to under 10,000 fifteen years later and still trades about 50% from that high; the dotcom mania of 1998-1999 was a “new paradigm” and housing prices couldn’t come down, according to Ben Bernanke, Fed Chairman. The TV commentary was just as positive in the beginning of 2000 and 2008 as it is today.
Whatever modest strength there is in the worldwide economy has been supported by over TEN TRILLION DOLLARS of newly printed currency by the major Central Banks. It would be great if prosperity were that easy to create. The unintended consequences are still to come.
At the moment, with taxes and deficits all over the news cycle, it may be useful to reflect upon the fact that gold prices made their last major move, doubling in price from 2008 to 2011, just as it became clear that the annual deficits and cumulative debt were going nowhere but UP. The last several years, as there has been less concern about deficits, the gold price has in fact “consolidated”, but as described below: here we go again.
First, recall that, as we described a year ago, over the nine years ending September 2016, the reported annual deficits were a total of $7.755 trillion. However, the cumulative debt increased from $9.0 trillion to $19.4 trillion, an increase of $10.4 trillion. So, as disturbing as $7.755 trillion of deficits are, an extra $2.64 trillion (a lot of money) was spent, somehow “off budget”, as “capitalized “investment”, or whatever. The cumulative US debt was $20.24 trillion at September 30, 2017, up $700 billion from a year earlier, though Congress approved $503 billion in February 2016.
I am not making this up.
The site: www.usgovernmentspending.com, describes it this way: “People naturally assume that the annual deficit is the total that the federal government borrows each year. Actually, this is not so. The deficit is simply the difference between the Federal Outlays and Federal Receipts. Usually the Feds borrow a lot more than the annual deficit. The difference is “Other Borrowings”. Only in D.C. Honestly, I can’t make sense of it, but the result is clear.
The reason that increasing debt cannot be ignored is that the higher the debt load that any organization carries, the more difficult it is to invest for the future. This applies to an individual family unit as well as a government. A classic book, “This Time is Different: Eight Centuries of Financial Folly,” written by Reinhart and Rogoff in 2011, researched hundreds of situations over eight centuries, showing that when a government’s debt exceeds roughly 100% of their Gross Domestic Product, it becomes a serious burden on its ability to grow. The United States debt is now about 105% of our GDP, and that could be one of the key reasons we have been stuck in a 2% economy for the last ten years. Some observers counter that Japan, after all, has a debt load that is 260% of their GDP, and their economy hasn’t collapsed, so our debt is modest in comparison. True enough, but their stock market is still down 50% from its high 28 years ago, and their government is frantically printing money to avoid a deflationary collapse. Right now, the Japanese government is buying $60 billion of securities monthly to keep interest rates low and stimulate their economy. Since their economy is one third our size, that would be the equivalent of us printing $180 billion monthly, over $2 trillion annually, which would not be viewed favorably by capital markets if it were necessary here.
The Current Situation – Talk about “Fake News”
This is what politicians do: The new tax proposals and budgeting discussion revolves around limiting the tax reductions (and therefore the potential “increase in the debt”) to $1.5 trillion over ten years. The Republicans, of course, are arguing that a better economy, scored “dynamically,” will “reimburse” the theoretical deficit with offsetting tax revenues. That debate aside, this whole discussion leads one to think that the $20.5 trillion today shouldn’t be allowed to be more than $22 trillion a decade from now. WRONG. What nobody tells you is that the $1.5 trillion increase is on top of the already budgeted TEN TRILLION DOLLAR increase based on present expectations by our Congressional Budget Office. (This is the so-called "baseline,” but you haven’t heard that word uttered by either political party). The current “baseline” debt is projected to increase roughly $1 trillion dollars every year over the next ten years. The debate therefore is not whether the debt is going to go from $20.5 trillion to $22.0 trillion, but whether it will go from $20.5 trillion to $30.5 trillion or $32.0 trillion. Keep this in mind as you watch the celebratory dance of the Republicans after the tax reform and it becomes law. The Democrats will be screaming about the new Ponzi scheme, but it's just like the old Ponzi scheme.
Back to the Facts
Of course there are lots of assumptions built into all these projections, and they could be materially inaccurate. Unfortunately, governmental agencies are notoriously overly optimistic, and spending is usually higher than projected, as described above. In the current fiscal year, ending in September, the CBO projection is an increase of $1.03 trillion. With spending on the storms, higher defense spending, higher health care expenses, I’ll take the “over” side of the bet on the size of this year’s deficit. As a corollary to this discussion, think about the fact that it is only the very low interest rates that have allowed us to carry the $20 trillion in debt without blowing up the deficit even further. If interest rates should be higher, along with an additional $10 trillion (or whatever) of debt, the prospect of ever reducing the total debt burden is really remote. If Reinhoff and Rogart’s “This Time is Different” is even only directionally correct, we’re "screwed”.
As far as the proposed tax cuts stimulating the economy through lower taxes for the middle class, it is now clear that that many of the tax cuts will affect the wealthier citizens, which is why the Democrats have been screaming. The details currently in play are in a continuous state of flux and too numerous for us to analyze, and the House and Senate proposals are about to be modified further, no doubt further muting the potential benefits of this “huge” tax reform. Overall, however, we don’t expect the final “reform” to substantially stimulate the economy through better middle class consumer spending, perhaps on the business side, though. In terms of public discretionary spending, the economy will continue to be burdened by higher health care, education and housing expenses.
The public subsidies will continue, deficit spending will be at an increasing rate for the foreseeable future, and the much higher governmental debt load will be a drag on the desired economic growth. If there is any part of the current administration’s agenda that will work, it will be the reduced administrative burden, which is being implemented by executive order rather than legislation. We fear, unfortunately, that with an incomprehensible amount of debt. It could prove impossible to grow the economy faster than the debt load and achieve, in essence, “escape velocity”.
All of this is to say that there will be no political will to reduce deficits or debt, “normalize” interest rates, or implement the necessary adjustments to “the swamp”. The capital markets, including the ridiculous cryptocurrency mania, will adjust to more realistic economic expectations.