This comment
discusses the assumptions we have been using in our commentaries over the past
20 years or more. We have been consistently
reminding our viewers that the debt built up over the years has a major bearing
on the economic health of the U.S. economy, as well as the economic health of
other developed countries, who have also built up significant debt positions. It should be clear to investors that are as
concerned about the debt how these same countries’ GDP slowed down, just like
the U.S. We will also discuss why the plans of the two candidates running for
the Presidency of the U.S. will not begin to solve the debt problems that are
overwhelming us.
It is clear
to us that the increase in debt in the U.S. is responsible for the slowdown in
the economy that we discussed for many years.
It was made even clearer when the GDP revisions were reduced sharply
downwards this past week. In fact, the
GDP results have been significantly lower in all of the developed countries
than virtually all the U.S. economists have been predicting for the past eight
years (ever since the “Great Recession”).
We are glad
to have recently seen another individual who is also of the same opinion on the
worldwide debt as we are. His name is
Atif Mian and he was interviewed by one of the financial networks recently about
this situation. He is a Princeton
University professor and he wrote a book, entitled “Household Debt &
Business Cycles Worldwide”. He showed
that whenever Household Debt (H/H Debt) rose sharply, it would be followed by a
consumption boom. But debt financed
booms of any kind are not permanent as at some point the debt has to be paid
back. This boom would be followed by a reversal in the trade deficit, as
imports collapse. Countries with an H/H
Debt cycle more correlated with the global debt buildup would be followed for
years with a sharper decline in GDP growth.
Over the
past 11 years we have consistently pointed out that the level of H/H Debt
caused the “Great Recession” in the U.S.
We believe the same consequences were also prevalent in virtually every
advanced economy that built up their H/H Debt before the “Great Depression”. It is the result of the fluctuations of
aggregate demand as monies are borrowed and spent. But, once that spending
dries up, something else is needed to substitute for the missing aggregate
demand. When borrowers can’t or won’t
borrow any more the economy slows.
This is a
key cause of the economies’ sub-standard growth since the “Great Recession” of
2008 and 2009. Since then, the Fed tried
to increase demand through monetary policy (with QE 1, 2, and 3 as well as
building up their balance sheet from $500 bn to over $4.5 tn.). The US ZIRP and the European and Japanese
NIRP, that were intended to solve everything by stimulating financial assets
directly and then have a spillover effect to spending and growth, have only
successfully stimulated the former.
People are saving what they can, but growth remains anemic. While debt remains at near record levels, bond
yields are near all-time low levels and stock prices are near all-time highs. Valuations are also not far from all-time
highs. In the meantime corporations are
buying back stock, hand over fist, and in many cases borrowing the money to do
it at the expense of long term capital investment. This is not the formula for a vibrant economy
and financial markets.
Countries
that have been able to weaken their currencies have been able to handle these
shocks more effectively than those that haven’t weakened their respective
currencies. But as we have stated many
times in referring to the “Cycle of Deflation” (see attachment), devaluations
and competitive devaluations (as countries attempt to export their deflation to
other countries) are followed by protectionism and tariffs. It appears to us that is exactly the mantra
of candidates Trump and Clinton. The Fed
and financial press have many times used the term “escape velocity”, referring
to an acceleration of growth that would allow the Fed to normalize rates. So far, unfortunately, “escape velocity” is
nowhere to be found. We believe it will
be very difficult to extricate our country from this unprecedented situation.
From our
point of view, neither Trump nor Clinton have articulated policies that will
solve our debt problems. Though Trump
has payed lip service to the size of the $19 tn public debt the protectionist
policies he espouses, we believe, will only slow the economy further and thus
decrease tax revenue while at the same time adding to the debt and
deficit. For her part, Clinton has not
made any mention of the debt as that would be critical of the third Obama term
for which she appears to be running. When viewed from the standpoint of Total
Credit Market Debt and GDP growth (see attachment courtesy of Ned Davis
Research) it is crystal clear to us that as debt has grown at higher rates than
GDP, the economy continues to slow further.
Please note that the Total Credit Market Debt to GDP Ratio, while off
its all- time high, is still in the stratosphere. We believe Trump’s stated tax and trade
policies should drive debt up by a staggering number. Clinton’s giveaways to the middle class (such
as free college tuition) and the continuation of the Obama regulatory morass should
also make our debt problem even worse. And
keep in mind we have not even addressed unfunded liabilities (Social Security, Medicare,
etc.) which are estimated to be between $80 - $200 tn.
In summary,
we once again state that we are in the “Central Bank Bubble”. The Fed got things rolling with ZIRP and the
Europeans and Japanese upped the ante with NIRP. The Chinese, it should be mentioned, do have
“normal” interest rates. That’s the only
thing that’s normal for their economy and stock market that are not remotely
free. They too are ultra-extended and
sitting on a Mount Everest of debt. The
politicians do not appear to have the answers currently, so in closing we say,
“Buyer Beware”!