Blue Point Trading Market View – November 30, 2012
US debt parabolic – what does this foretell? First lets understand the terms and what we are talking about. As of 2009 the total US debt was around 369% of GDP. This is derived from taking all US government debt and private debt and dividing it by the GDP. The US being the largest economy, other major economies have similar pictures, so this is not just a US phenomenon – its global (click here for a view of the EU countries). When looking at the historical chart (in the thumbnail chart), we see that today we are at the highest peak of debt to GDP in recent history. Understandably back in the 1940s, due to WW2, we also had high debt to GDP ratios (260%), but nothing as compared to today.
Some very minor good news has occurred in terms of this data point in recent years, the number has ticked down a bit – though very little. Private debt has de-leverage somewhat, but has been replaced by government debt (as we see in the attached chart below).
So again, what does this foretell? Perhaps another way to look at this debt is to ask: how much can a country afford, before the debt payments outstrip income? A very rough calculation of an average 4% rate, which is about 2% over the US 10 year bond, the amount the economy must pay would be: $50 Trillion * 4% or $2 Trillion per year. If the Fed did not artificially keep rates low and the rate would be allowed to float, many experts would say this number could easily double. This is a little more than what the US takes in taxes each year. Most experts would agree that this is unsustainable. So for the future, the Fed will be obliged to keep rates artificially low for years to come. Worse yet, this assumes it does not get any worse. A parabolic bubble can go farther than you think – these charts should scare us.
So for the economy this means that this represents, using the current interest rate assumptions, about a 2% drag on GDP. To correct the problem would require even further drag, depending on how fast you correct the problem. So we can kiss goodbye any idea that, we can have an economy that can grow above a nominal rate of 4%, as it has in the past – at best we need to subtract the 2% GDP drag, understanding it can get worse if recessions occur. The only real solution is to print money and devalue the currency – or face a horrific depression. On the other hand the amount of money that would need to be printed could be just as horrific. Of course the Fed will try to thread the needle, which will result in economic stagnation. Guessing Fed policy will be key to understanding where asset prices go. Death by hyper-inflation or depression. Currently the best guess is the later, after a period of stagnation. But it will be a roller coaster ride to get there – and timing will be everything.
Daily Market View: (click here for the video)