August 2023
“To preserve our independence, we must not let our rulers load us with perpetual debt.” Thomas Jefferson
On August 1 rating agency Fitch announced it had reduced the credit rating of US long-term debt, citing “erosion of governance and expected fiscal deterioration over the next three years.” The downgrade stunned pundits and financial markets alike, and resulted in a not surprising sell-off of stocks and bonds.
Former US Treasury Secretary, Larry Summers, called the report bizarre. “The decision of a credit rating agency today, as the economy looks stronger than expected, to downgrade the US is bizarre and inept.” Treasury Secretary Janet Yellen responded in similar fashion, stating “I strongly disagree with Fitch Ratings’ decision. The change is arbitrary and based on outdated data.”
But was the decision to downgrade Uncle Sam’s debt obligations bizarre and arbitrary? Following the June 2 vote to suspend the debt ceiling for two years, the Treasury borrowed $1.1 trillion in just two months, increasing total debt to $32.6 trillion. In 2006 public debt (which does not include intragovernmental debt) to GDP was 37% and the deficit (to federal revenues) was 10%. Today public debt to GDP is 98% and the deficit exceeds 18%. By 2033 the CBO forecasts debt to GDP at 119% with a 20% deficit. Similarly, debt service in 2006 was 9% of tax revenues. Today it’s 14%, and by 2033 will exceed 20%. At the present rate of growth, by 2050 just the net interest on the national debt will cost taxpayers nearly $6 trillion per year. Bizarre and arbitrary? No. Careless and irresponsible? Absolutely.
Over the years I’ve often been asked, when does the national debt matter? My standard and somewhat flippant response being, debt doesn’t matter—until it does. When might that be? When the market says it does. How does the market communicate its concern? Loudly and clearly via higher interest rates on Treasury securities, a falling US dollar, and subsequent higher inflation. To be clear, inflation is nothing more than an implicit tax, and higher interest rates compress risk asset values, meaning it makes us poorer.
Sustained imprudent fiscal policy eventually leads to a weaker currency and higher interest rates, both of which lower living standards and threaten national security. To put this into proper context, since January 2021 inflation has increased by 18% and mortgage rates have risen from 2.65% to 6.90%, or more than 4%. To illustrate the impact on new home buyers, the principal and interest payment on a $323,780 mortgage (the current average balance) soared from $1,302 to $2,120 in less than three years; a 63% increase. And this doesn’t include a commensurate increase in taxes and insurance.
History is littered with sovereign debt defaults. The story is always the same; politicians promise the polity ever more free stuff in order to remain in power. However, they have but two options by which to pay for their handouts; raise taxes or print money. As George “read my lips” Bush Sr. learned the hard way, raising taxes oftentimes comes with a heavy political cost. However, inflationary Keynesian money printing is far more subtle, and allows bureaucrats in the capital city to point their accusing fingers elsewhere, inevitably placing the blame on central bankers, geopolitical events, supply chains, and the like—everywhere but themselves and their reckless spending.
But the US isn’t just any nation. The 1944 Bretton Woods Agreement anointed the US dollar the world’s reserve currency, conferring both benefits and obligations. Since the dollar would be the basis for global exchange rates, the United States’ government (and consequently its Federal Reserve System) was bound by obligation and duty to maintain a stable currency. But unlike defaults by the likes of Argentina, Venezuela or Ecuador, the occurrence of which neither surprises nor threatens global stability, a faltering US financial system would be catastrophic. Every foreign central bank has a large exposure to Treasury securities and US dollar denominated assets, as do financial institutions around the world. Bad fiscal policy doesn’t just threaten domestic stability, but that of the global financial system.
In 1776, and by no means coincidental to the American Founding, Adam Smith published his epic tome, An Inquiry into the Nature and Causes of the Wealth of Nations. Typically referred to as simply the Wealth of Nations, Smith’s magnum opus served to create a deeper understanding of economics, and had an enormous impact on the Founders and their philosophies regarding the (limited) role of government and stewardship of the public purse. However, over the past century Keynesian policies have supplanted free markets with big government, demand-side spending schemes, which always lead to greater debt, and stifle innovation, growth, and economic freedom. If Smith were alive today, he may very well pen a new book entitled, The Poverty of Nations.
Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
pathwaytoprosperity.com
The Poverty of Nations
August 2023
“To preserve our independence, we must not let our rulers load us with perpetual debt.” Thomas Jefferson
On August 1 rating agency Fitch announced it had reduced the credit rating of US long-term debt, citing “erosion of governance and expected fiscal deterioration over the next three years.” The downgrade stunned pundits and financial markets alike, and resulted in a not surprising sell-off of stocks and bonds.
Former US Treasury Secretary, Larry Summers, called the report bizarre. “The decision of a credit rating agency today, as the economy looks stronger than expected, to downgrade the US is bizarre and inept.” Treasury Secretary Janet Yellen responded in similar fashion, stating “I strongly disagree with Fitch Ratings’ decision. The change is arbitrary and based on outdated data.”
But was the decision to downgrade Uncle Sam’s debt obligations bizarre and arbitrary? Following the June 2 vote to suspend the debt ceiling for two years, the Treasury borrowed $1.1 trillion in just two months, increasing total debt to $32.6 trillion. In 2006 public debt (which does not include intragovernmental debt) to GDP was 37% and the deficit (to federal revenues) was 10%. Today public debt to GDP is 98% and the deficit exceeds 18%. By 2033 the CBO forecasts debt to GDP at 119% with a 20% deficit. Similarly, debt service in 2006 was 9% of tax revenues. Today it’s 14%, and by 2033 will exceed 20%. At the present rate of growth, by 2050 just the net interest on the national debt will cost taxpayers nearly $6 trillion per year. Bizarre and arbitrary? No. Careless and irresponsible? Absolutely.
Over the years I’ve often been asked, when does the national debt matter? My standard and somewhat flippant response being, debt doesn’t matter—until it does. When might that be? When the market says it does. How does the market communicate its concern? Loudly and clearly via higher interest rates on Treasury securities, a falling US dollar, and subsequent higher inflation. To be clear, inflation is nothing more than an implicit tax, and higher interest rates compress risk asset values, meaning it makes us poorer.
Sustained imprudent fiscal policy eventually leads to a weaker currency and higher interest rates, both of which lower living standards and threaten national security. To put this into proper context, since January 2021 inflation has increased by 18% and mortgage rates have risen from 2.65% to 6.90%, or more than 4%. To illustrate the impact on new home buyers, the principal and interest payment on a $323,780 mortgage (the current average balance) soared from $1,302 to $2,120 in less than three years; a 63% increase. And this doesn’t include a commensurate increase in taxes and insurance.
History is littered with sovereign debt defaults. The story is always the same; politicians promise the polity ever more free stuff in order to remain in power. However, they have but two options by which to pay for their handouts; raise taxes or print money. As George “read my lips” Bush Sr. learned the hard way, raising taxes oftentimes comes with a heavy political cost. However, inflationary Keynesian money printing is far more subtle, and allows bureaucrats in the capital city to point their accusing fingers elsewhere, inevitably placing the blame on central bankers, geopolitical events, supply chains, and the like—everywhere but themselves and their reckless spending.
But the US isn’t just any nation. The 1944 Bretton Woods Agreement anointed the US dollar the world’s reserve currency, conferring both benefits and obligations. Since the dollar would be the basis for global exchange rates, the United States’ government (and consequently its Federal Reserve System) was bound by obligation and duty to maintain a stable currency. But unlike defaults by the likes of Argentina, Venezuela or Ecuador, the occurrence of which neither surprises nor threatens global stability, a faltering US financial system would be catastrophic. Every foreign central bank has a large exposure to Treasury securities and US dollar denominated assets, as do financial institutions around the world. Bad fiscal policy doesn’t just threaten domestic stability, but that of the global financial system.
In 1776, and by no means coincidental to the American Founding, Adam Smith published his epic tome, An Inquiry into the Nature and Causes of the Wealth of Nations. Typically referred to as simply the Wealth of Nations, Smith’s magnum opus served to create a deeper understanding of economics, and had an enormous impact on the Founders and their philosophies regarding the (limited) role of government and stewardship of the public purse. However, over the past century Keynesian policies have supplanted free markets with big government, demand-side spending schemes, which always lead to greater debt, and stifle innovation, growth, and economic freedom. If Smith were alive today, he may very well pen a new book entitled, The Poverty of Nations.
Mark Lazar, MBA
CERTIFIED FINANCIAL PLANNER™
pathwaytoprosperity.com