Weekend Commentary - Dangerous Ratios
Aug 29, 2014
You would have thought that the most newsworthy event in Washington this week was the shade of suit that Obama wore at a press conference. While tan in not a color you often see on a President, it probably was not worth the amount of blog posts and other fashion advice that it generated. Outside of that, most of the attention was centered on the Russia/Ukraine situation and ISIS; but believe it or not, there was actually a spot of positive economic news in the mix. The second quarter GDP was released by the Commerce Department and, low and behold, it would appear that we have shaken off the winter blues. After the dismally negative 2.1% number posted for the first quarter, our economy grew a solid 4.2% during the second three months of the year. Additionally, this growth came across all sectors not just with a boost in inventories, and corporate profits appear to be soaring. Contrast this with the EU who could possibly be sliding into recession once again.
While this as well as the job growth provide us with much to be thankful for, it can also blind us to two very import elements and the long-term ramifications. First, how many trillions of dollars of public money has it required to finally jump-start this economy? Secondly, while I do not have the exact figures as to what TARP and the QE programs have cost, a glance at the ongoing escalation in the Federal debt load looks anything but encouraging. Granted, Federal debt began to rise soon after 1980, moving from around $1 trillion to $6 trillion over the next 20 years. But since the Great Recession, we have seen this number escalate from less than $10 trillion to closing in on $18 trillion this coming year. Herein lies one of the fallacies of deficit spending at the public level; in theory, it is a useful tool to stimulate an underperforming economy or stem a decline, but in reality, a politician is never going to take away money he or she has doled out, at least not if they want to be reelected. Furthermore, if this money is in the form of social programs that are not reformed within the context of the demographics of the country, such as Social Security and Medicare and Medicaid, the drain on the finances just continues to compound.
The second element or ill-effect is related to the amount of debt we continue to accumulate as a percentage of the overall economy and this seems to be the factor that has been brushed aside as the economy has improved over the last few years. The theory is that as the economy expands, the debt as a percentage of the whole will become less significant so the deficient spending becomes irrelevant. The pace of deficit spending has slowed down, and we hear discussion about how the continued low interest rates have been such a benefit to slow this down, but who on earth believes interest rates can remain here for an extended period? Even at current rates, the Congressional Budget Office estimates that just the interest to service the debt will reach $799 billion dollars within a decade. Compounding this issue, no pun intended, is that from 2018 forward, the drain coming the baby boom generation will accelerate. Some will argue that the number to watch is the Federal Debt held by the public as a percentage of GDP, which is closing in on 75%, is the key number to watch; others believe it is the total federal debt as a percentage, which is already above the 100% mark. Regardless of which number is watched, each have climbed a near linear path since 2009 and historical research tells us it is when we have pushed beyond that 100% threshold that the debt becomes a serious drag on the economy. Japan has existed with a debt to GDP ration in excess of 200% for years now and should provide living proof, for, as outside of a temporary spurt here or there, their economy has been flat lining.
So by all means, we should celebrate the growth we have posted in this most recent quarter. But soon, the politicians will begin crowing about the fantastic things they have accomplished to turn our economy around. Let’s not forget to remind them that they have still done nothing to confront the real long-term issues that our children, grandchildren and possibly even great-grandchildren will need to confront in the decades ahead.