Answers To Questions From Advisors About The Economy And Investment Outlook

Monday, September 16, 2013 10:21
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Answers To Questions From Advisors About The Economy And Investment Outlook

 

At last week's economic and investment update, advisors asked me a number of questions that we did not have time to answer. Here below are answers to those questions. 

 

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Please touch on the labor participation rate.
Here it is, and you can see how it’s been in steady decline since the onset of recession. Its decline in part reflects peoples’ discouragement in being able to find a job. Its decline, in part, accounts for the decline in the unemployment rate even while the rate of new job formation has been sluggish.
 

 

And here is a picture that includes the Congressional Budget Office’s most recent 10-year forecast (through 2023) for the ratio of federal debt outstanding to GDP. The point is that the $7 trillion doesn’t get repaid. But it doesn’t have to. It can (and will) simply remain outstanding and, in fact, be added to with each passing year. The U.S. government can support steadily increasing levels of outstanding debt so long as the total stock of debt’s trend rate of growth does not exceed the trend rate of GDP growth – the engine with which we service the outstanding debt. Not repaying the $7 trillion you refer to has resulted in the new, higher level of debt to GDP in the 70% range which, as I say, is sustainable indefinitely. But, this leaves the U.S. with less flexibility should another crisis come along for which we need to borrow extraordinary amounts.
 
Can you address TIPS before leaving please?
Here is the yield on the 10-year TIPS. Note how the yield has recovered from almost -1% to the current almost 1%. -1% on the TIPS coincided with the record low 1.5% 10-year Treasury yield last year during investors’ frantic scramble for yield combined with the Fed’s QE program. At today’s  1%, you’re still not being adequately compensated, in my opinion, for making a 10-year loan to the government. Historically, as you can see, something in the range of a 2% real return on a 10-year loan to the government has made more sense. My hunch is TIPS yields will, in fact, work their way back to the historic 2% range.
 

 

 

What about the approximate $7 trillion that have been added into the economy from deficit spending?  How and when does that get repaid?

Here’s the $7 trillion added to the total stock of outstanding federal debt (since 2008) that you refer to.

 

 

 

And here is a picture that includes the Congressional Budget Office’s most recent 10-year forecast (through 2023) for the ratio of federal debt outstanding to GDP. The point is that the $7 trillion doesn’t get repaid. But it doesn’t have to. It can (and will) simply remain outstanding and, in fact, be added to with each passing year. The U.S. government can support steadily increasing levels of outstanding debt so long as the total stock of debt’s trend rate of growth does not exceed the trend rate of GDP growth – the engine with which we service the outstanding debt. Not repaying the $7 trillion you refer to has resulted in the new, higher level of debt to GDP in the 70% range which, as I say, is sustainable indefinitely. But, this leaves the U.S. with less flexibility should another crisis come along for which we need to borrow extraordinary amounts.
 
 
 
 
The Budget Office just announced that the expected debt level to reach $23 trillion within 10 years - how can we continue to fund the government and handle the increasing cost of the debt without any negative consequences to the private sector economy? 
As you will can see in the preceding chart (which extends out the 10 years that you refer to), even as the debt level hits $23 trillion, the economy is forecast to expand at a similar growth rate, leaving the key debt-to-GDP level approximately constant at ~70%. This means that the economy’s annual debt-service burden as a percent of the GDP would remain unchanged, which implies no greater negative consequences to the private sector economy 10 years from now than are imposed on it today. Obviously, all of this supposes that these relatively benign CBO forecasts will in fact come to pass. That may be a stretch without some substantive modifications to the big entitlement programs, Social Security, Medicare/Medicaid and now the ACA.
 
 
You also commented on auto sales yet Ford announced yesterday that they have over capacity in Europe and are shutting down 2 plants.  Please comment on these issues.  You paint such a rosy picture and there doesn't appear to be any problems on the horizon. Household debt has been reduced because of loan forgiveness.  We are at all-time highs of consumer debt.  Is what we're hearing inaccurate?
Regarding Ford’s shutting down two plants in Europe it is yet another symptom of Europe’s basic problem: outside of Germany, they’ve long had overcapacity in virtually every industry because their labor laws have precluded companies from doing the necessary restructuring as we have been able to do here in the U.S. – to our great benefit. Downsizing, layoffs, restructuring are all extremely painful but necessary for the long-term health of any competitive, constantly changing economy. Fortunately, as I pointed out, Europe’s macroeconomic picture is improving after two dismal years.
 
Re U.S. consumer debt, the stock of consumer debt has come down from its all-time high as you can see in this chart. That has occurred, yes, partially as a result of foreclosures, but principally from Americans using their rising aggregate income to spend less and pay down some of that debt.

 

 

 

In fact, the result of rising income combined with declining debt is today’s record-low Financial Obligation Ratio, next chart. This measure is the acid test of consumers’ ability to make discretionary expenditures – and it suggests that American consumers’ ability to cover the monthly “nut” and then some has rarely been better. It’s a Federal Reserve statistic and the numbers don’t lie.

 


 

 
With continued upward GDP growth in the US + the Eurozone + China  and with interest rates rising materially over the last couple of months - why have commodities in general been so weak?
I think what you refer to is linked to what I was saying about the Gold story. That is, the “Fed is printing money” that is ultimately going to cause rampant global inflation and currency debasement – that whole hypothesis – has been debunked. (Refer to what I was saying about the key difference between the Monetary Base and M2 Money Supply) Global inflation trends just keep heading flat to lower. There is zero wage push inflation – the key to inflation – anywhere in the world. The other part of the story is China’s attempt to move away from export-led, commodities-usage-heavy expansion, toward internal consumer demand-growth driven expansion. So, China’s voracious appetite for many commodities has slackened. It’s put Brazil and Australia, in particular, into very low growth mode as ore orders have fallen way off.

 

 

 

 

 
 
 
 

 

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