Stimulus Vs. Debt: Which Will Prevail?

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Last week we had the pleasure of interacting with well over 100 clients and friends at Mission Management & Trust’s Tucson fall seminar.  We analyzed the conflicting forces of massive government stimulus and unprecedented levels of debt, characterizing these respectively as the irresistible force versus the immovable object.

We have emphasized in prior blog postings that certainty is impossible in assessing the denouement of such massive economic forces and conditions. In the present case, investing aggressively to benefit from either the inflationary or deflationary environments that would logically result from one of these forces overwhelming the other could be extremely dangerous.  Investments that would likely benefit from widely expected inflation stemming from the huge stimulus package would probably do very poorly should a deflationary debt spiral overwhelm the stimulus efforts.  On the other hand, investing in long-term top-quality bonds to benefit from an anticipated deflationary environment could lead to giant investment losses if inflationary forces dominate.

While investors can speculate on probable outcomes, the magnitude of uncertainty is vast.  It has been obvious from the beginning that even the government doesn’t have a clear idea of how it wants to apply stimulus.  The goals for the first stimulus amount approved by Congress were changed by Treasury Secretary Hank Paulson less than two weeks after the funds were authorized.  There is wide disagreement today about the wisdom of the program and the amounts to be expended.  In the months ahead the political will to continue or discontinue the program or to add to or subtract from its size could change dramatically for reasons that are not yet on our radar screens.

Because of the stimulus, already huge debt burdens have grown monumentally.  As we pointed out at the seminar, the federal budget deficit now exceeds 10% of nominal GDP.  Economic analysts have traditionally viewed a deficit above 6% of GDP as the trigger point for potential financial crisis.

At the seminar we also highlighted that our nation’s combined federal, state and local government debt had just climbed above the $14.1 trillion GDP level.  The 100% of GDP reading is a trigger for the rating agencies to consider downgrading a country’s sovereign debt.  Such an eventuality would be a game changer for the United States, the greatest borrower in world history.  While no single debt auction constitutes a trend, today’s auction of $16 billion in long-term debt attracted less bidding interest than expected.  Should such major holders of U.S. Government debt as Japan and China slow their investments, the cost of servicing our debt could skyrocket.  Our profligate spending over the past quarter century has resulted in the U.S. ceding partial control of its financial markets to interests outside our borders.

We marvel at the irony of the government’s solution. To remedy the problem of excess cumulative debt and excessive credit availability, they would attempt to make credit more readily available and add massive amounts of new debt.  The future will tell us whether this approach was wise or whether we have simply stolen from future generations to fund our generation’s consumption.

David Rosenberg, who does excellent economic research at Canada’s Gluskin Sheff & Associates, finds it remarkable that the U.S. Government:

  • • is trying to promote consumer spending at a time when the consumption /GDP ratio is at a record high of 71% and well above the long-term norm of 64%;

 

  • • is trying to promote credit creation at a time when the household debt/income ratio at 125% is still near an all-time high and twice the historical norm;

 

  • • is trying to promote a higher homeownership rate even though, at 67.4%, it is just about the highest in the world and still well above the historical norm of 64.0%.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.