The title is from my second most favorite New Yorker magazine cartoon. The cartoon was first published in August 1983 and created by Lee Lorenz.
Ok, so we all know debt levels around the world are becoming increasingly problematic. The purpose of this posting is to bring together a few key elements and comments regarding the growing worldwide debt and to monitor this trend.
Liz Ann Sonders, CIO of Charles Schwab and Co, Inc puts it succulently in her posting of February 1, 2010, titled, Debt: What Is and What Should Never Be
- Strong economy and stock market, but debt remains the No. 1 concern.
- Rising public-sector debt is threatening to long-term economic stability.
- Investors have grave concerns about inflation; but deflation may be the bigger threat.
and allow me to quote her further:
“Throughout the past year, although I’ve been very optimistic about both the economy and the stock market, when asked what concerns me most, my answer has been consistent: debt.
As you can see in the table below, which is broken out by decade, it took $1.36 of debt to create $1 of economic growth during the 1950s. The acceleration began in the 1960s and 1970s with the Vietnam War and the “Space Race,” and continued in the 1980s and 1990s with the leveraged buyout boom and the Internet bubble.
Fast-forward to the most recent decade (through September of last year) and it’s taken nearly $6 of debt to create $1 of economic growth. This is clearly not sustainable, and is a threat to the long-term stability of the US economy.”
I find her last statement chilling at best..
Sonders again,
“I’m a big fan of the work of economists Carmen M. Reinhart, of the University of Maryland, and Kenneth S. Rogoff, of Harvard University. They’re the authors of a new book, “This Time Is Different: Eight Centuries of Financial Folly” (Princeton, 2009), which I’ve just begun to read.
It highlights what happened in more than 250 historical crises in 66 countries, and it’s a fascinating read. They also recently published a paper titled, “Growth in a Time of Debt,” which looks at the relationship between debt and growth/inflation among 44 countries during the past 200 years.
90% … the tipping point “Growth in a Time of Debt” main findings:
- The relationship between government debt and real gross domestic product (GDP) growth has been weak for debt/GDP ratios below a threshold of 90% of GDP. Above 90%, median growth rates fell by one percentage point and average growth fell considerably more. The threshold for public debt was similar in advanced and emerging economies.
As you can see, there is plenty of work available to us in the field of how much debt governments can successfully take on before the weight of the debt causes unintended consequences.
Well how much debt is out there?
Again, Sonders on the matter,
“Public debt high … total debt stratospheric
The United States’ public debt-to-GDP number is high (84%) and rising (set to jump to more than 90% this year). We’re not the worst though; there are a couple of countries with even higher figures: Japan (182%) and Greece (119%). If you look at total credit-market debt (not just government), the numbers are really glaring.
According to a recent McKinsey Global Institute report, US total debt doubled from 2000 to 2008, from $26 trillion to $53 trillion, and rose again in 2009. This represents more than 370% of US GDP—the highest since the Great Depression, when it reached 260%.”
“But on this metric, we’re in “good” company: The United Kingdom’s total debt-to-GDP is a whopping 470%, Japan’s is 460%, Spain’s and South Korea’s are 340%, Switzerland’s is 315%, France’s and Italy’s are about 300%, Germany’s is 275% and Canada’s is 245%. These are all records.
The “BRIC” countries (Brazil, Russia, India and China) all have total debt-to-GDP under 160%. However, since this study ended in 2008, we have to add in China’s stimulus package, which was three times the size of the US package, not to mention China’s banks lending out $1.3 trillion during 2009. Some believe China could now be more leveraged than the United States.”
The Ring of Fire
Bill Gross of PIMCO wrote his February 2010 newsletter, titled The Ring of Fire..
Gross, too, quotes the authors Carmen Reinhart and Kenneth Rogoff of the book, This Time is Different.
“The Reinhart/Rogoff book speaks primarily to public debt that balloons in response to financial crises. It is a voluminous, somewhat academic production but it has numerous critical conclusions gleaned from an analysis of centuries of creditor/sovereign debt cycles. It states:
- The true legacy of banking crises is greater public indebtedness, far beyond the direct headline costs of bailout packages. On average a country’s outstanding debt nearly doubles within three years following the crisis.
- The aftermath of banking crises is associated with an average increase of seven percentage points in the unemployment rate, which remains elevated for five years.
- Once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.
Their conclusions are eerily parallel to events of the past 12 months and suggest that PIMCO’s New Normal may as well be described as the “time-tested historical reliable.” These examples tend to confirm that banking crises are followed by a deleveraging of the private sector accompanied by a substitution and escalation of government debt, which in turn slows economic growth and (PIMCO’s thesis) lowers returns on investment and financial assets. The most vulnerable countries in 2010 are shown in PIMCO’s chart “The Ring of Fire.” These red zone countries are ones with the potential for public debt to exceed 90% of GDP within a few years’ time, which would slow GDP by 1% or more. The yellow and green areas are considered to be the most conservative and potentially most solvent, with the potential for higher growth.”
Conclusion
One
Wage earners will continue to be challenged for some time as discussed in my blog posting: Nearly one in five Americans is either unemployed or underemployed
Two
Deleveraging will continue for some time
Three
What will be GDP growth rates of major economies going forward? Do Wall Street forecasters have this in their sights, and ‘dialed in’?
Four
Have world financial markets ‘priced in’ the plausible decline in economic and corporate growth as a result of high debt levels?
I say no to the above questions. I believe market participates have yet to re-price the finanical markets for these above concerns. What do you think?
Contact me and let me know what you think.
Thanks for reading.
Commentary | Where do the markets go from here?
Thursday, August 20th, 2009Although world stock markets have made excellent ground in recovering past years’ losses as reported in the Financial Times article dated August 15, 2009,
S&P surge beats post-war record (click to read article)
I continue to remain cautious regarding the longer term outlook for the US and world financial markets. Since nearly 70% of the US economy is consumer based spending, I don’t think the US consumer has gone far enough to repair his/her balance sheet from the past 20 years of accumulated debt loads and diminished savings, hence I do not see a typical recovery from the consumer. There is plenty to be concerned about; I will not elaborate on those matters in this blog. But rather, reflect on the current buzz phrase, ‘new normal’, as I have discussed this topic in previous blog postings found here. What will the new normal look like going forward?
I have found the following work of interest:
“Courtesy of dshort.com, here is another chart that makes the case to be cautious. The pattern of the 1929 crash adjusted for inflation is surprisingly similar to what we have seen since 2000.”
“Recognize that you can’t use the chart to predict the future. But what you can do is use the chart to realize the possibility of a prolonged bear market.”
Personally, I am still very cautious. We all have yet to fully understand, and appreciate, the debt loads the US Government is taking on and the full impact on both business and consumer alike. Is this mounting debt load a concern? Of course it is, and for that reason Warren Buffet inked an Op-Ed piece on this matter in the August 18, 2009 New York Times found here:
The Greenback Effect (Click to read article)
Selected text from Buffet’s article
To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.
An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.
Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
What is Buffet saying here? We need to quit our spending spree, but do elected officials have the will to get off the ‘drug of spending?’
By including the chart above, I am not saying that we are going to follow a 1920’s style market decline. First of all, this economic contraction has been much less (so far) than that of the early 20th century. Year-t0-date, this economy has shrunk 3.9% as compared to the 26.7% collapse of the 1920’s. See chart below.
What gives me comfort for my clients within my practice, is that I have asset allocation strategies that have endured much better than the S&P 500 index during the past ten years where the S&P 500 index returned a negative -1.3% annually.
In coming months, I may be recommending client’s shift more of their assets to wealth preservation and absolute return strategies along with continued use of inverse asset classes for such possible ‘range bound’ markets.
As Buffet said in the August 18, 2009 NYT piece,
The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.
With that quote then, the paddles are standing by, fully charged…..
Thanks for reading.
Sources: Morningstar Advisors, dshort.com, JP Morgan
Posted in 2009 Predictions, Bear Markets, Commentary, Consumer Confidence, Credit Crisis, Economy, Market Recovery, Market Views, New Normal, Preservation Strategy, Wealth Preservation | 1 Comment »