Wednesday , June 20 2018
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Broken Promises

Summary:
Demanding More Debt Consumer debt, corporate debt, and government debt are all going up.  But that’s not all.  Margin debt – debt that investors borrow against their portfolio to buy more stocks – has hit a record of 2.8 billion.  What in the world are people thinking? A blow-off in margin debt mirroring the blow-off in stock prices. Since February of 2016 alone it has soared by ~0 billion – this is an entirely new level insanity. The current total of 643 billion is more than double the level of margin debt at the tech mania peak and 15.4 times the amount of margin debt just before the crash of 1987. [PT] Clearly, they’re not thinking.  Because thinking takes work.  Most people don’t like to work.  They like to pretend to work.

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Demanding More Debt

Consumer debt, corporate debt, and government debt are all going up.  But that’s not all.  Margin debt – debt that investors borrow against their portfolio to buy more stocks – has hit a record of $642.8 billion.  What in the world are people thinking?

A blow-off in margin debt mirroring the blow-off in stock prices. Since February of 2016 alone it has soared by ~$170 billion – this is an entirely new level insanity. The current total of 643 billion is more than double the level of margin debt at the tech mania peak and 15.4 times the amount of margin debt just before the crash of 1987. [PT]

Clearly, they’re not thinking.  Because thinking takes work.  Most people don’t like to work.  They like to pretend to work.

Similarly, people may say they care about debt.  But, based on their actions, they really don’t.  When it comes to the national debt, the overarching philosophy is that it doesn’t matter. Government debt certainly doesn’t matter to Congress.  Nor does it matter to the President.  In fact, their actions demonstrate they want more of it.

Big corporations with big government contracts want more government debt too. Their businesses demand it. They’ve staked their success on the expectation that the debt slop will continue flowing down the trough where they consume it like rapacious pigs.

The higher education bubble is also based on a faulty foundation of debt. The business model generally requires signing credulous 18 year-olds up for massive amounts of government backed student loans. From what we gather, federal student loan debt is closing in on $1.4 trillion.

Total student loans outstanding (red line – the data are only available from 2007 onward) and total federal government-owned student loans (black line). The former figure was closing in on $1.5 trillion as of Q4 2017. [PT]

Now what would happen to all these high paid professors and fancy country club style college campuses without all this government sponsored debt? The automobile business is also based on a model that demands more debt.  Outstanding auto loan debt is now somewhere around $1.2 trillion.

Fundamental Divergence

You see, this is how the world works circa 2018.  After decades of expanding consumer, corporate, and government debt, the entire economy has been retooled and restructured to be entirely dependent on it.  What’s more, Federal Reserve policies have promoted it.

The fact is we are on a collision course with disaster.  Take government debt, for instance. Over the last decade, nominal gross domestic product (GDP) has increased from about $14.7 trillion to about $19.3 trillion.  Over this same period, the national debt has increased twice as fast; it has doubled from $10 trillion to $20 trillion.

In short, there is a fundamental divergence between economic growth and government debt growth.  Broadly speaking, the U.S. Economy is growing at a rate of roughly 2.5 percent a year.  And U.S. government debt is growing at a rate of roughly 6 percent a year – or more.

Over an extended period, this divergence results in two dramatically different growth curves.  Government debt has now overtaken GDP.  Over the next decade, government debt – which is projected to spike up another $10 to $15 trillion – will absolutely dwarf GDP.

Presumably, at some point between now and 2027 the economy will slip into reverse.  GDP will contract.  At the same time, government debt will accelerate as Washington feels compelled to do something – like spend borrowed money – to somehow jump-start the economy.

Nominal GDP (black line) vs. total public debt (red line). A few things worth noting: in the late 1990s, the stock market boom combined with fairly solid economic growth rates  led to a flattening out in public debt growth; it may be less well known that early in Bill Clinton’s administration, the Greenspan Fed was very vocal about the need to cut government spending. Some of the events at the time subtly hinted at the possibility that a compromise was struck behind closed doors. Moreover, in the years after the Soviet Union’s demise it became possible to freeze defense spending for a little while – at least until the MIC got its ducks back in a row by discovering new enemies. When Congress fell to the Republican party, the uneasy cohabitation again scotched any spending plans that may have been on Clinton’s wish list (both parties tend to discover their fiscal conservatism when the administration is in the hands of the other party). [PT]

While this divergence between GDP and government debt is problematic, it ignores a much larger story.  Specifically, it ignores the story of unfunded liabilities…

Broken Promises

One generation always incubates the bacteria of the ailments which dominate the next one.  Yesterday’s actions reared the things which control the present. So, too, today’s actions breed the things which will control tomorrow.

At this very moment, we are living with several unfavorable gifts from our forbears. Namely, social safety nets constructed many decades ago that don’t pencil out. These safety nets are now stretching and fraying at the seams, at the precise moment when tens of millions of Baby Boomers will rely on them most.

The first ones into a Ponzi scheme always make out like bandits.  For example, Ida May Fuller cashed the first Social Security check, Check No. 00-000-001, dated January 31, 1940, in the amount of $22.54. With just one check, she nearly recouped the full value of the $24.75 that she paid in.

Broken Promises

Ida May Fuller and the famous first social security check. The state-run pay-as-you-go retirement schemes of developed nations around the world are running into trouble. It is simply mathematically impossible for the promises to be kept indefinitely. The fact that they are “non-discretionary”, i.e., legally mandated, is akin to trying to repeal gravity by law, or ordering the sun to rise and set according to a politically determined schedule. Central economic planning fails for a similar reason: it is an attempt to deny reality, and reality just doesn’t care. [PT]

Poto credit: AP

However, Fuller continued to cash these checks until she died on January 27, 1975.  In total, the $24.75 she paid in, ended up paying $22,888.92 back out to her.  Is it any surprise this system is now on the fritz?

Medicare, another marque social safety net of the U.S. government, is also based on the broken promise that people can get more money out of something than they pay in. Like Social Security, Medicare faces a funding gap that is mathematically insurmountable.  People that have paid into these systems their entire working lives have been set up for a grand disappointment.

According to the recently released 2017 Financial Report of the United States Government, which Simon Black alerted us to, the “total present value of future expenditures in excess of future revenues” for Social Security and Medicare represents a shortfall of $49 trillion.  How in the world are taxpayers going to fill this $49 trillion funding gap, which is above and beyond the exploding national debt?

What we have here, folks, is a conundrum.  There is no respectful way out.  But there are several shameful ways out:

Uncle Sam can drastically cut or cancel its commitments to Social Security and Medicare recipients, and leave them flapping in the wind. Uncle Sam can continue to pile these obligations onto the backs of younger workers via escalating taxes, thus subtracting productive value from the economy and dooming it to a century of declining growth.  Or Uncle Sam can unconditionally trash the currency, inflate it away, while turning the United States into a banana republic – if it’s not already one.

Broken PromisesThe problem is evidently a sizable one. [PT]

Most likely, Uncle Sam will try all three options in order of political expedience. Look for this inter-generational conflict to come to a head during the next recession, which may well arrive sometime in the next 18 months.

Charts by: SentimenTrader, St. Louis Fed

Chart and image captions by PT

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 

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Broken Promises 
 

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