|Forbes.com, Fall, 2018. This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.|
If you’re reading this, then it probably means you have also watched pundits scream at the top of their lungs about the impending doom brought about by the US deficit. Numbers like $20 Trillion are enough to scare anyone, so concern is warranted, however, panic is not.
For many individuals, debt is another dirty, four-letter word, but others view debt as the rocket fuel to above average growth. The truth is, it depends entirely on the kind of debt we’re talking about and all debt is not created equal.
For instance, debt can be seen as an asset. Each bond issued is a debt of the U.S., but an asset to the holder, which is generally a U.S. pension plan, bank or domestic institution. In a way, one could argue U.S. debt that is internally financed (held by U.S. citizens) resembles parents acting as their children’s bankers for down payment assistance, college tuition, etc. While we know of several parents who have offered loan forgiveness on money they’ve lent to children, we don’t expect U.S. investors to behave as generously and outright forgive the governments’ debt, i.e. give up their interest or principal returns. That said, they may be slightly less demanding than foreign debt holders in regard to the terms they require.
National Debt Situation Specified and Summarized
The federal government is projected to add $985 billion to the federal deficit during fiscal year 2019. That’s because the government plans to spend over $4.4 trillion dollars, while bringing in only $3.42 trillion dollars. Nearly $400 Billion of the spending will go to service debt that’s already accrued over the years and that figure will only rise as interest rates increase.
While those numbers are astonishing and difficult to really wrap your mind around, it’s not as bad as it sounds. According to the non-partisan Congressional Budget Office’s (CBO’s) Budget and Economic Outlook: 2018 to 2028, “In CBO’s baseline projections, which incorporate the assumption that current laws governing taxes and spending generally remain unchanged, the federal budget deficit grows substantially over the next few years. Later on, between 2023 and 2028, it stabilizes in relation to the size of the economy, though at a high level by historical standards.”
This ties back to my earlier observation that debt can be positive or negative depending on how it’s used and the absolute amount of debt you have isn’t what matters most. Generally speaking, the finance industry has not effectively explained the national debt into categories of good debt versus bad, or efficient versus inefficient debt. As a result, the average American doesn’t have the full picture of how our debt is working for, or against, the U.S. at any given time. What matters is your debt relative to your current and future income and what purpose the debt financed.
Think about the United States’ income as Gross Domestic Product (GDP). If you do that, then our debt to income ratio is about one, or equal today. Now if your individual debt to income ratio is one-for-one and you have nothing to show for it (i.e., no hard assets), then you might be in trouble. However, many individuals also have debt three times their income on their primary residence and that may be just fine. Clearly the context and application matter. If the U.S. borrowed to invest in bridges, roads, the military via the G.I. bill, even a social safety net, etc., this should have a beneficial impact on our future income. The problem is that it’s not always immediately clear if the benefits will outweigh the costs. If our debt keeps rising faster than our income, we won’t be able to continue borrowing at the attractive terms we do today. That means government revenue must increase or spending must decrease over time to ensure we remain a trusted borrower.
“It’s The Grandparents Stealing From The Grandchildren.”
It’s sad to say, the above quote, often credited to Kurt Vonnegut, has transitioned from a warning to a fact. As we look to address the debt and deficit situation, one must recognize that a substantial portion of the projected spending in the future appears set to go to social safety nets that will need to be adjusted, including Medicare. If you look at transfer payments, projections indicate that by 2040 every dollar of taxation (revenue) will be eaten up by these payments and interest on the debt. As a result, fighting over debt repayment, education spending, military spending, etc. is almost futile because it’s all set to go out the door before that conversation can be had.
The question is how much pain it will take to get politicians focused on fixing the rate of growth of the deficit. Now I said not to panic earlier, because there are a number of adjustments and scenarios that will let the U.S. keep borrowing and spending long after any individual would have had their credit cards canceled. That said, at some point time will run out and our options to fix the situation will be less and less friendly. It’s the equivalent of waiting until you’re in the hospital to make lifestyle adjustments. By then, it might be too late.