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Crescenzi: The Questions of Our Age
The below note refers to the U.S. debt burden and the extreme bear case, which in actuality has been around since the 1980s and has been a failed investment approach since then, but which demands a bit more respect now given the scale of de-leveraging taking place. It is the type of big-picture thinking I feel is essential and which I describe in my third book, Investing from the Top Down.
The questions of our age are : Can the U.S. exit its debt problem by borrowing money and without having to bring the debt-to-GDP ratio down via a sharp economic contraction? In other words, will Keynesian and monetarist policies work as they have for decades, or are they powerless in this tsunami? Is the U.S. economy a going concern or must it contract sharply to give back growth gained from the surge in debt?
Federal Reserve data show (the Flow of Funds report, Levels Table) that the U.S. (the private and public sector) has $51 trillion of debts, up from $31 trillion five years ago and $20 trillion ten years ago. With debts at $51 trillion and GDP at $14 trillion, the ratio is 3.5, a record and the only other period that comes close is the period ahead of the Depression when it was about 2.5.
Mind you, Depression-era levels were reached in the late 1980s and we've heard the bears howl about it since then. Those that used the debt/GDP ratio as a basis for investing lost, having missed out on large gains in equity prices (still intact), a massive decrease in interest rates, and a plethora of business and investment opportunities in the U.S. and abroad. I worry nonetheless that because high debt levels are being recognized and realized in ways not yet seen that the dire warnings of the 1980s have only now begun to have credence.
I worry as the bears do, that when we say conditions "should" improve as a result of Keynesian and monetarist policies we are basing our conclusion on decades of success in this regard. The problem, though, is that maybe it won't work this time because we've reached a level of debt that is simply too high to bear. Maybe, in an optimistic scenario, the debt/GDP ratio is faulty (because U.S. entities have tentacles all around the world and we have immensely more assets, and because the federal government's share of the debt is just $5.3 trillion--it was more than 100% of GDP in WWII). This is the question of the day. I worry some days that if the answer to the question is that debt levels must fall that there could set in a panic-like situation where debtors are forced to liquidate and do so because they know others need to, too.
I stress that I, like others, am hoping that Keynesian policies and the Fed's printing press will prevent all of this and that the debt metrics we cite require a watering down (maybe because the debts held by the financial sector mean less to the economy than debts held by other sectors), but one can't help but respect the power of this de-leveraging process and how its co-mingling with the human element of fear could result in days and weeks such as we have seen.
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market." Crescenzi is a contributor to RealMoney.com."
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