May 2024
“Dad, what is debt?” she asked. Excited that I could bring a bit of my world as a financial advisor into her realm, I explained that you can borrow money from someone else to buy something that you want. Well, I missed the mark since my daughter was even more confused with the concept of being able to buy something with money that you don’t actually have. Her innocent and unfiltered mind intuitively understood that buying something with money that you don’t have is fraught with potential problems. Yet the use of debt in modern society is widely embraced as an ordinary part of our financial lives.
Too much of a good thing
While debt has driven global growth tremendously, the fundamental problem goes back to the adage of “too much of a good thing.” A thoughtful use of debt can of course progress societies forward by helping to advance productivity at a faster rate. But too much debt can be a shackle, crippling a society with an overwhelming burden of ever-growing interest payments and debt service. As a country, we have officially reached the point where the hazards of our debt levels far exceed the benefits.
Here are some numbers that are shocking to say the least. Our growth in federal debt has been astronomical in recent years. In 2002, our federal debt was approximately $6 trillion. What is it today? $34 trillion! In over two hundred years of our nation’s history, we accumulated $6 trillion of debt and then in the roughly 20 short years since, we quintupled it! One quick but incredibly important side note is that these debt figures don’t include our future commitments to the entitlement programs of Social Security and Medicare. Per the U.S. Department of the Treasury, if you included these unfunded future liabilities, that $34 trillion figure actually balloons to $112 trillion.
The word “trillion” is nearly impossible to wrap our head around so let’s illustrate what this means for the average U.S. taxpayer. The average American earns $64,000 of income a year and pays roughly $14,000 in taxes. What is the average taxpayer’s share of the $34 trillion in federal debt? $267,000! Think about this—you make $64,000 a year and have $267,000 in debt, growing at roughly $20,000 per year. If we include the unfunded commitments to Social Security and Medicare ($112 trillion debt referenced earlier), you would have $870,000 in debt. Who in their right mind would have allowed themselves to get anywhere close to this point?
We’ve been harping on this topic for more than a decade at Morton. Since the 2008 financial crisis, we have voiced concerns around the endless pursuit of money printing, zero-percent interest rates and relying on exponentially increasing debt to solve our nation’s stagnant growth. While we felt like a lone voice in this crusade, of late I’m finally starting to see snippets in the media raising this concern as well. While this is better late than never, my hope is that the American public wakes up to the realization that this is no longer the problem of the next generation, but something we have to face as soon as possible.
The U.S. is spending like a drunken sailor
Have you checked out our yearly deficits lately? Using a similar timeframe as the earlier statistic I shared, in 2002, our budget deficit was $158 billion, which amounted to 1.4% of GDP (gross domestic product, which is a proxy for the size of our economy). Today? We are running a $2 trillion annual deficit, which amounts to 7% of GDP. In fact, our interest expense alone is now approaching $1 trillion annually (exceeding our military budget) so it’s hard to imagine a scenario of balanced budgets when just covering our debt service eats up a large portion of our tax revenue.
These levels of annual deficits are absurd. Running deficits at this size is unprecedented outside of wartime or deep recessions. Our economy is in solid shape and the unemployment rate is low, yet we continue to spend like drunken sailors. What will happen in the next recession when tax revenue dries up? Those deficits will likely turn into $3 and $4 trillion deficits, north of 10% of GDP.
These numbers are beyond all logic or reason, and our political representatives are not talking about this. We are bankrupt as a country and I’m afraid to say that there are no longer any good solutions to this debt crisis. We only have a handful of choices ranging from bad to disastrous.
The lesser of many evils
What are our options from here, you ask? The most hopeful scenario is that we can accelerate our growth as a country and generate more tax revenue to help pay for these bills. This is wishful thinking since the math simply doesn’t work. We have been hovering around a 2% annual growth rate as a country for the last decade. Even if we can miraculously move to the 3% growth rate of the 1980s, or the 4% growth rate of the baby-boomer decade of the 1950s, this growth rate will barely put a dent into our ever-increasing debt burden.
What about fiscal austerity? At a certain point, we may have no choice but to drastically cut many government services and entitlement programs. But the political will to do this is low at best and candidates who would promote this message in the current environment are unelectable.
Raise taxes? This is a potential option, and it’s likely we will have higher taxes going forward as opposed to lower. But the magnitude of our debt burden calls into question if a tax hike will even make much of a difference. Current tax revenue is roughly $5 trillion per year and our expenditures are $7 trillion (the difference is our $2 trillion of annual deficits). So even if we raise taxes by a meaningful 20% to get our tax revenue up from $5 trillion to $6 trillion, we will still have $1 trillion deficits annually. And our economy will likely stall if tax hikes to that degree are imposed, thereby even worsening our fiscal situation.
How about inflation? In past commentaries, we have stated that the path of least resistance to fix this debt crisis are policies that promote inflation. These accommodative policies (money printing and low interest rates) have been embraced since the 2008 financial crisis and we believe they are likely to continue in the years to come. Why is elevated inflation likely in the cards going forward? Inflation is the “easiest” way for a borrower to pay off their debt over time, namely with cheaper dollars. The government will never advertise this strategy, but they are incentivized to generate consistent inflation (debase our dollars) over time so that when our debts come due in the distant future, they will be easier to pay. Would you rather pay a $1,000 debt today or 30 years from now? Paying the $1,000 in 30 years will be much easier to pay simply because of inflation and the fact that that $1,000 will be worth much less at that point in time.
Door number three
While the above scenarios seem grim, there is a way to protect your investment portfolio. A debt-burdened society with inflationary pressures is not a rosy one for many traditional assets. This is why true diversification, employing asset classes that march to the beat of their own drummers and will retain value in a variety of scenarios, is so crucial. Specifically, it’s a focus on real assets, things that you can touch and feel like real estate, commodities and other hard assets. This is in contrast with most of the traditional investment world, which is obsessed with financial assets. The key difference between real versus financial assets is that real assets have value NOW while financial assets are bets on the future. For example, most stocks are bets that a company will execute on its business plan and sell its products at an ever-increasing rate, years into the future.
While we participate in financial assets and stocks when we invest for our clients, our strong bias is towards real assets. With the headwinds and increasing uncertainty I describe above, I believe investors will flock to the security of real assets, which will be more resilient as we navigate through these debt and inflationary pressures. The wonderful aspect of the current environment is we can have the best of both worlds, focusing on the resiliency of real assets while capitalizing on an attractive lending environment where we can generate consistent income along the way.
While most traditional investors are either unaware of these risks or choose to simply look the other way, at Morton we tackle these economic challenges head on. We have no crystal ball related to when the consequences of these profligate policies will manifest themselves, but we choose to invest with our eyes wide open to the risks that we face as a country. The numbers above are not doom-and-gloom predictions, but rather just math. We’ll ultimately get through this as a country, but we must be mindful of the various consequences we face, as well as the unique opportunities that present themselves when most other investors are simply not paying attention.
Read Jeff's previous Perspective letters here:
Resilient Investments to Combat Uncertainty
Embrace Uncertainty When Investing
Disclosures: Information and references to specific investments presented herein are for illustrative purposes only. It is not intended as investment advice and should not be construed as an offer/solicitation with respect to the purchase of any security. Morton makes no representation that the strategies described are suitable for any person. Investment opportunities described may only be available to eligible clients and involves a higher degree of risk. Each investment opportunity is unique, and it is not known whether the same or similar type of opportunity will be available. Morton makes no representations as to the actual composition or performance of any security. All investments involve risk, including the loss of principal. Past performance is no guarantee of future results. You should consult with your financial advisor to thoroughly review all information before inting any transactions and/or strategies concerning your finances
