RUTHFULLY YOURS

Sound investment advice (which I have too often ignored) suggests that one should pay attention to outliers – valuations that are out of the ordinary, either too high or too low, like the extraordinary low level of interest rates today. Good investors (which I am not) find them in stocks, commodities, bonds, real estate, etc., and either purchase or sell the attractive or offending instrument. It strikes me that debt, driven by unusually low interest rates (or, at least, low by post-War measurements) has risen as a percentage of GDP to risky levels. When unfunded pension and health liabilities are included, and when one considers demographics, the picture darkens.

Examples of our unusual situation abound. In the U.S., federal debt as a percent of GDP has exceeded 100% for eight years. By the end of World War II federal debt – understandably – reached 118% of GDP. Subsequently, it declined as a percentage for thirty-five years – during a time that included the Cold War, the construction of the interstate highway system, the birth of the Great Society and the landing of a man on the moon. It reached a nadir in 1981 at 31% of GDP. Since, that ratio has risen.

I would be remiss in not pointing out that Japan and Singapore have government debt as a percentage of their GDP that exceeds ours, along with far worse demographic trends, so perhaps we should not be worried. But I am. Federal debt is $22 trillion. State and local debt are $2 trillion. Unfunded pension and health liabilities are estimated at $46 trillion. (Forbes puts the number at over $200 trillion). Mandatory spending, which includes Social Security, Medicare, Medicaid, student assistance, veterans care and supplemental nutritional assistance programs, accounted for 72% of the 2017 budget. Such “transfer payments” are immune from budget cuts. In 1962, the comparable number for transfer spending was 28%. The effect on investments, in education, highways, R&D, etc., has been substantial – from 35% of the 1965 budget to 13% today. Complaints about roads, bridges and tunnels are understandable. Given trends, conditions are likely to worsen, not get better.

Debt is a necessary tool for a growing economy, and it serves as a vehicle for savers. But when the cost of servicing that debt becomes excessive, it becomes a curse. Debtors have been living in a blessed time for borrowers, with corporate rates still a couple of hundred basis below where they were pre-crisis. Easy credit terms have caused non-financial corporate debt in the U.S. (approximately $15.5 trillion), to increase as a percent of GDP from 65% pre-crisis to 73% today. Consumer debt tells a different story. As a percent of GDP, it is lower now than it was pre-crisis – $14 trillion versus $12 trillion. Mortgages represent about 70% of the total. Student loans have replaced credit cards as the second largest category. The former carry average interest rates of 5.8% versus 15% for credit cards. The point is to suggest that corporate and consumer debt, while manageable now, are nevertheless vulnerable to a rise in interest rates.

It is government debt and unfunded liabilities where concern lies. Low interest rates have the effect of making debt more bearable. In 2008 when federal debt was 80% of GDP, interest expense was 8.5% of the federal budget. In 2020, with federal debt exceeding 100% of GDP, but with interest rates lower, estimates are that borrowing costs will approximate 10% of the budget. Should interest rates revert to 2007 levels, borrowing costs would consume closer to 14% of the budget, further squeezing discretionary spending.

Compounding the situation are unfavorable demographics. In 1960, the average age in the U.S. was twenty-nine. Today the average is thirty-eight. In 1960, 9.0% of the population was over sixty. Today, 16.9% is over sixty. We are having fewer children; the total fertility rate (TFR) in 1960 was 3.65, today it is 1.8. We live longer. Life expectancy in 1960 was seventy; today it is seventy-nine. In 1960, there were 5.1 workers for every Social Security beneficiary; today there about 2.6. That ratio will continue to decline. Unless significant changes are made there will be less moneys available for the elderly and the sick. The recent passage by Congress of a bill overhauling the private retirement system was a good start. But more needs to be done. Congress could means-test benefits and increase the age to receive Social Security and Medicare benefits; they could boost worker and employer contributions beyond the $106,800, and they could permit diversification of investments in the Trusts that would allow some ownership of equities.

Today, the Country is focused on impeachment. We honor Cassandras who warn that man-made climate change will bring an end to the world, while we ignore the specter of debt, a more likely portent of collapse. Issues like moral relativism, race, gender, sexual orientation, political correctness and victimization consume the media. As a prosperous society, we can afford the time to fixate on social problems. The answers to climate change, for example, lie in continued prosperity. With almost 50 million more people, greenhouse emissions in the U.S. are lower now than they were twenty years ago, despite an economy double the size. So, should we not spend some of that time ensuring our future prosperity? We face obstacles. Will the average age in this country increase by another ten years over the next half century? Will a smaller number of working age people be able and willing to support a growing number of centenarians?  What happens to debt service if rates return to their average post-War levels of approximately 200 basis points above where they are now? Politicians tell voters of what government can do for them. Neither Party is addressing concerns of debt, interest rates and demographics. Little time is spent instructing people how to become productive, self-reliant, responsible and accountable members of society – to learn the dignity that comes from work and to appreciate the values that come from having a family.

Panglossians argue that hindrances to economic growth are greater in other parts of the world, that their economies are more at risk than is ours. And they are right. Demographic trends in Europe, and much of Asia are worse. Negative interest rates in Europe are a salve, not a cure for what ails their economies. The lack of rule of law adds risk to investing in China. But the responsibility of our politicians is to ensure that the U.S. economy continues to grow, improving standards and qualities of living and providing economic opportunity to the aspirant. Instead, like lemmings, we are led blindly forward and backward, mindless of the demographic boogeyman, and the interest rate and debt demons that guide our future.

History never repeats itself. Nevertheless, it provides lessons, which is why Mark Twain said it rhymes. Europe is a case in point. A grandson recently pointed out the startling fact that the average age in Europe in 1914 was 17. For a hundred years after the Congress of Vienna in 1815, Europe had been at peace. The industrial revolution and the empires of European nations in Africa and Asia had allowed Europe to become wealthy, peaceful and blind with over confidence. The consequence was two wars, which, over thirty years, killed fifty million Europeans (excluding Russians). Today the picture is quite different. Europe has been at peace for sixty-five years. Gone are the empires. Social democracy has replaced royalty. A communication/technology revolution is underway. The average age is 43. Today’s TFR is 1.6. In 1914, it was about 4.8. With an older population, the future is unlikely to include land wars, but economic growth – with capitalism under attack, rising state welfare obligations, aging populations and low interest rates masking high levels of debt – is at risk, something that should concern us all, in Europe, Asia and the U.S.