Debt and deficits. Everywhere I look, read, listen, observe, or encounter in person or by text or by email, there are wannabe Cassandras predicting a calamity over debt and the deficit. These are all just opinions. Remember: Cassandra could predict the future, yet no one believed her. Modern-day, wannabe debt-and-deficit Cassandras predicting the future are often believed, but that future doesn’t seem to happen. The future remains the future!
Let’s discuss this issue of the debt and deficit and see where it stands. IMO, most of these disaster-predicting wannabes are just plain wrong.
Here’s why.
Debt is a burden. It is an exchange of something today for something tomorrow. The borrower uses the value today and promises to return the value tomorrow. The lender does the reverse. But is it not relevant who owes it if the aggregate debt burden remains unchanged. Why? Because those who owe have the burden and those who are owed have the asset and the problem of the debt holder is getting paid. So, if the total debt burden remains the same and its distribution changes, it is the composition that matters. That is where the United States has been for the last 15 years.
Let me first prove what I just wrote and then offer a case study to back up my assertion. Here’s a link to the aggregate debt of America and how it is distributed. At the bottom of the chart you will see that the total debt-to-GDP ratio has been flat (nearly constant) since the Great Financial Crisis occurred over 15 years ago. So while federal debt to GDP went up, state and local debt to GDP went down. So did other debt-to-GDP ratios. But total debt to GDP is essentially unchanged. Here’s the proof through Q3, of last year. Note both chart series are interactive and available on the Fed’s website. You pick the date; you get the numbers: https://www.federalreserve.gov/releases/z1/dataviz/z1/nonfinancial_debt/chart/#units:percent-of-gdp . Here’s the breakdown of the aggregate: https://www.federalreserve.gov/releases/z1/dataviz/z1/nonfinancial_debt/chart/#units:usd .
If I have borrowed from you and owe you money, when I pay you back, you have the cash and you make a choice of what to do next. You can take the same cash and lend it to somebody else (business or personal) or to the federal government (Treasury bills) or to a state or local government (municipal bonds) or to another borrower. You are replacing one form of debt or asset with another. If you decide to buy some other asset class like real estate or gold or Bitcoin or stocks, you transfer that cash to someone else (the seller) and that person now must make the same type of decision.
So, what about the aggregate, the total of all debt and the total of all the agents in this economy, where these types of transactions are occurring every day? If the total hasn’t changed in relation to wealth or income, then it is the composition that matters. That’s my opinion. I admit there is a debate about it.
Let’s present a case study involving a nation I will call Coconut Ville (CV). This case study will actually present three versions of CV.
Coconut Ville is an island nation. It produces coconuts. It has its own currency, an independent central bank, a government, a culture, business practices and a rule of law.
In Coconut Ville #1 the culture forbids personal and business loans and has usury laws. All private activity is funded on a pay-as-you-go basis. Only the government can borrow, and the government levies taxes to pay the interest on the debt and rolls over the principal.. They have inflation when the coconut crop declines and triggers a shock and deflation when it is too abundant. They have workers and wages, their coconut product is key to their international trade. The aggregate debt-to-GDP ratio is 200% of GDP. All debt is federal.
CV #2 has no federal debt. It operates its government on a pay-as-you-go basis. It collects enough taxes to cover the operating budget payments. All debt is personal or business, and the rest of the composition of economic agents and actors is the same as in CV #1 and includes an independent central bank, same production, same trade, etc. The country maintains a total debt-to-GDP ratio of 200%. Remember, in CV #2 all debt is personal or business – there is no government debt.
Now let’s look at CV #3. Here the setup is 50-50: Half the debt is federal, and half is personal or business. The taxes levied cover the federal debt. Personal and business debtors must adjust their cash flows because they must pay some taxes to the federal government for debt service. So, when the federal share goes up, the private sector share goes down and vice versa. The total debt-to-GDP ratio remains at 200%.
Dear Readers, I ask a simple question: Is there a macroeconomic difference between #1, #2, and #3? Total debt and total debt to GDP is the same aggregate. Only the composition is different. Inflation, disinflation, production, labor, and all other variables are the same. Central bank policy is the same. Currency and international trade are the same.
I have used this example to describe the United States for nearly two decades. Look in detail at the two charts above. CV #3 is what we look like, and you have the source of the aggregates in the charts. The chart is interactive, so you can adjust dates and watch the composition of the aggregate change. Look for yourself. Example: Muni issuance is about the same total as the last 15 years. So, state and local debt to GDP went down while federal government debt to GDP went up; total of all debt to GDP didn’t change. GDP is the proxy for income.
We’ve had over 15 years of a stable aggregate total debt-to-GDP ratio. And it continues. Meanwhile, all the variability in inflation, wages, the pandemic shock, banking crises, war risk, and more has been reflected in the composition of the debt aggregate but not in the total.
Wannabe Cassandras have been crying wolf for decades and decades and decades; they have been particularly vociferous since the Civil War. No one ever succeeds in politics by claiming “We don’t have enough debt.” No, all we hear is that we have too much.
No market newsletter or pundit podcaster gets attention by saying things are okay. The prediction of a catastrophe gets more attention than the prediction of stability. Catastrophe sells. The prediction folks are selling to anyone who will listen to them and pay them for the privilege of being wrong.
I think the debt composition matters and helps us determine how to invest by looking at the details of who owes and who receives and how the debt burdens shift. I do that daily. We have an aggregate American debt-to-GDP ratio of about 250%, if you count all types of debt. It hasn’t changed much in 15 years. Today, we have about $75 trillion in debt and a $30 trillion GDP. I’m rounding and close in those numbers. Turn the clock back fifteen years, and the ratio is the same.
The opportunity for the investor is to get into the weeds and determine the risk attached to each sector category and piece of debt. I do that daily.
As for the catastrophe and doom forecasters, they are in a race with Godot. IMO, right now, it’s a dead heat.
PS. If you really think about it, the entire US stock market is really a claim on the entire economy of the United States in the form of a variable-interest-rate, very long-term, unsecured, subordinated debt instrument. Note that Bitcoin and other tokens (of the unstable variety) are a claim on the speculative outcomes of the sponsors of these new versions of electronic payments.
Here’s a history link to the Cassandra of mythology: https://en.wikipedia.org/wiki/Cassandra.
In my opinion Cassandra wannabees will be right someday. History proves that. But they will be those Cassandra wannabes who are talking about external shocks, not the current size of the national debt and deficit. Our new book, The Fed and the Flu: Parsing Pandemic Economic Shocks, demonstrates this. It is officially released on February 12 and available from Amazon and Barnes & Noble. See www.thefedandtheflu.com for reviews and details.
