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It’s Okay to Talk About it …

March 2024

“Sell with Zell,” my first investment newsletter which I penned in the spring of 2007, urged investors to follow the actions of Sam Zell, who made headlines when he sold his real estate empire given frothy market valuations. In that letter, I freely discussed U.S. elections and Fannie Mae’s impact on the housing market. (Can you even imagine?) Such a letter would be virtually impossible to write now, given the growing list of taboo topics in the public sphere. What a shame to avoid the discussion of important issues recategorized as “untouchable,” simply to avoid unintentionally offending someone in an increasingly polarized world. Setting that risk aside, let’s tackle one such subject affecting all investors — the U.S. national debt.

THIRTY-FOUR TRILLION DOLLARS! That’s the way the media typically quantifies the U.S. national debt (in a red-letter banner, of course). I argue this message is long on hysteria and short on context. If someone told you they took out a “$50,000 CAR LOAN!”, wouldn’t your reaction depend on whether the borrower’s salary was $500,000 or $50,000? Let’s frame the U.S. national debt in a similar context. The annual U.S. Gross Domestic Product (GDP) — the monetary value of goods and services produced in a year — is $27.9 trillion, making the current debt to GDP ratio 124%. Our country’s debt to GDP ratio has been steadily rising since 1980, when it was 32%. Examining the chart below illustrating the U.S. debt to GDP ratio over the past 45 years, one would note periods of relative stabilization (1991 – 2007), and periods of large jumps higher (the Great Financial Crisis and the Pandemic). The trend of rising indebtedness seems destined to continue for the foreseeable future. The population is aging, the interest cost on our debt is rising, and we cannot recall the last time meaningful legislation targeting deficit reduction was implemented.

U.S. Debt to GDP Ratio Over Time1

Spend now, spend later?

Examining debt relative to our country’s net worth also allows us to examine the wealth that government stimulus (i.e. spending or tax cuts) has helped create. After all, the debt is the public accounting of what government owes on our behalf as Americans. The net worth of households and nonprofit organizations was $30 trillion in 1995 but has grown to $156 trillion today. To make this easier to digest, this is akin to our nation’s “house” being worth $300,000 in 1995 with a $50,000 mortgage versus us owning a $1.5 million house now with a $340,000 mortgage. Yes, America’s government debt has grown, but so has our collective net worth.

As the envy of the developed world, the U.S. economy can afford our current debt situation. The problem, however, is that our debt growth is outpacing our economic growth. This year, the country’s deficit will approach $1.7 trillion (approximately 6% of GDP), while our economy is projected to grow by 4-5%. By spending more than the country takes in through tax receipts, we may end up with a new highway, higher incomes and/or rising corporate profits (and stock prices) – likely explaining the lack of urgency to tackle deficit spending (near-term indulgence beats frugality when it comes to re-elections).

As a country goes deeper into debt it may face a variety of issues. As interest costs rise, debt becomes too expensive for many companies and individuals to take on, thereby “crowding out” public and private investment in future growth. Higher levels of indebtedness inject more volatility into an economy, often in the form of more frequent financial crises in which a government has fewer options to respond as both its citizens and foreign investors may be less willing to lend. High debt burdens can increase social unrest as countermeasures to contain debt often cut government pensions and social programs while large tax hikes target the wealthy. All of these consequences are negative for growth, yet continued economic growth is necessary to lowering an economy’s debt, in relative measures.

On that point, rising interest rates may appear unequivocally bad for the U.S. debt conundrum, but that is not necessarily the case if interest rates are higher because of higher levels of growth and inflation, as they are now. All else equal, the country’s debt to GDP ratio can fall each year, even while running a modest deficit, as long as economic growth outstrips the country’s debt growth. Of note, higher interest payments also increase income to the government’s lenders (two-thirds of U.S. public debt is held domestically2 – think owners of government bonds, investors in money market funds and U.S. Social Security Programs, for example).

Ignorance is not bliss

Thus far, there have been few repercussions for the U.S.’s rising debt burden. However, that will not likely hold if the U.S. continues on its current trajectory. As any consumer who has struggled with debt can tell you, going from low leverage to moderate leverage is not a big problem, but from moderate leverage to high leverage is a different story. Ernest Hemingway put it more eloquently in The Sun Also Rises when a character is asked how he went bankrupt, “Two ways. Gradually, then suddenly.” Bankruptcy is not a realistic forecast for the economic darling of the world. However, a dark scenario that could come to pass might resemble what has happened in Japan, whose economy has sputtered for decades as the effects of an over-leveraged system and no population growth left a generation significantly worse off financially than the one preceding it. China seems perilously close to following a similar path.

The U.S. national debt is a pressing challenge, but not insurmountable if policymakers collectively do something other than demagogue the issue to win the next election. Despite what a talking-head may profess, there is no simple solution to this complex problem. The current situation necessitates a multi-faceted approach to enact change that can stop the current climb in our country’s indebtedness. Whether through higher taxes, reduced spending, or more likely a combination thereof, lowering the deficit can help stabilize how fast the U.S. national debt is growing. Then, we can let our economy’s growth reduce (in relative terms) the debt burden over time.

Ultimately, the story of the U.S. debt is a tale of choices, tradeoffs, and consequences. Over the last 45 years, as a country, we have chosen to increasingly go into debt for “the now” at the expense of “the future.” Fortunately, our debt and currency have been a safe haven for the global economy for decades, which has given the country leeway to be fiscally undisciplined. Markets do not allow undisciplined behavior infinitum though; of this we are certain.

We would prefer our growing debt problem to be addressed in a more thoughtful manner, as opposed to a “forced” solution that may be delivered chaotically by the financial markets. I bet the ramifications of such an event would be far more painful in the long-term than the near-term discomfort of objective discourse to solve a complex and politically-charged issue. Let us find the willingness to talk realistically about the choices we can make now to keep the U.S. economy the envy of the free world.

All market data is sourced from Bloomberg unless otherwise noted.




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