Each year I make it a point to attend the Grant’s Interest Observer Conference in New York City. It is my favorite investment conference of the year, not only because I hold the witty writing of Jim Grant in the highest regard, but also because of the A-list investment thought leaders he brings together to share their insights. The fall conference in October 2016 included a stellar line-up of speakers from Lacy Hunt of Hoisington Investment Management to investing legend Julian Robertson, founder of Tiger Asset Management, to the current bond king, Jeff Gundlach, of the DoubleLine Funds, to famed value investor Seth Klarman of The Baupost Group. While all of the presentations at the conference were thought provoking, the one that really stood out to me was by Lacy Hunt entitled, Large Budget Deficits, High Levels of Government Debt – A Force for Lower Interest Rates.
As we have written about numerous times over these past six years, the developed world has one big problem: too much debt. From Japan and Europe to the United Kingdom and the United States, the level of total credit market debt is ballooning. As was referenced in a previous blog post, total credit market debt has increased by $57 trillion since the Great Financial Crisis in 2008. Mr. Hunt laid out a very cogent and compelling case as to why U.S. debt dynamics are likely to further impair long-term growth if we continue with the same old policy prescriptions. The following are some of the key points from his presentation.
- The government expenditure multiplier is already negative. This means that more government spending in the form of fiscal stimulus, while short-term positive for the economy, actually slows economic growth over the longer term. This is due primarily to the already elevated levels of debt.
- The composition of government spending indicates that the multiplier is likely to trend even more negative. Therefore if the government attempts to kick-start economic growth by spending even more money, the economy is likely to perform worse over the longer term. When Mr. Hunt speaks of the composition of debt, he is distinguishing between productive debt (debt which is incurred to make investments that will provide some future positive return), versus non-productive debt (debt which primarily entails borrowing to fuel current consumption). The current debt dynamics of the U.S. economy are heavily skewed towards non-productive debt, which is negative for the economy.
- The federal debt-to-GDP ratio moved above the deleterious 90% level in 2010 and has stayed above it for more than five years, a time span in which research shows the constriction of economic growth to be particularly severe. This ratio will continue to move substantially further above the 90% threshold as debt suppresses growth.
- Debt is likely to restrain economic growth in an increasingly nonlinear fashion. Simply put, the more indebted we become, the faster the rate of economic growth will decline.
- The first four problems produce a negative spiral from federal finance to the economy through the allocation of saving, productive investment, productivity growth and eventually to demographics.
- Policy makers force themselves into a downward spiral when they rely on more debt in order to address poor economic performance. More of the same does not produce better results, only more of the same -but worse, a situation we term a policy trap.
So what is the solution to our problem? In Mr. Hunt’s opinion, to cut federal spending and bring down the overall level of indebtedness. While acknowledging this would be a negative for the economy in the short-term, in the long-term it would be a net positive, improving its growth potential.
The problem with this solution? No politician is going to voluntarily enact an economic plan that causes short-term economic pain. And so the likely path of least resistance is more of the same. That is until something forces the change that is ultimately necessary.