I just saw the movie I.O.U.S.A, where the film follows former U.S. Comptroller General David Walker as he travels the country explaining America's unsustainable fiscal policies. With the US Gov now proposing a $trillion bail out, it shows how serious this problem is. I have to say I'd rather be writing about stocks, but I think this issue needs to be addressed for the future health of our market, especially if there is a serious crisis. This will probably be the most depressing post and hopefully a sign of a market bottom. Here is the movie trailer and an interview with David Walker on Lou Dobbs.
Our country is now a sub-prime credit on the earths balance sheet. I'm going to present major points of the movie which consisted of the total public debt and fiscal deficit, trade deficit, foreign treasury ownership, historical savings percentage and household debt to GDP ratio. I will look at the current state of the U.S Dollar and treasury swap spreads in the next post.
First I'm going to show this artistic historical chart of the annual increase in national debt. It is interesting that Clinton was close to paying down the national debt, while the Reagan and Bush administrations were out of control. Of course both Bush's spent lots of money on wars (Gulf War and Iraq, and of course there are heated debates on the actual net worth of that spending, and who knows how much Al Gore would've spent finding Bin Laden in Afghanistan after 9/11), but here's an article from CNN, on May 1, 2000, about Bill Clinton's success.
Clinton announces record payment on national debt
"WASHINGTON (CNN) - President Bill Clinton said Monday that the United States would pay off $216 billion in debt this year, bringing to $355 billion the amount of the nation's debt paid down in the three years since the government balanced the budget and began running surpluses. In a written statement, Clinton said the $216 billion payment represented the largest debt paydown in American history, and he said that the federal government's long-term debt is now $2.4 trillion lower than projected to be when he first took office. However, the U.S. government still has a long way to go before it pays down the entire national debt, which now stands at $5.7 trillion. Clinton also used the announcement to take issue with Republican tax cut plans, noting that "the debt quadrupled in the twelve years before I came into office," a reference to his Republican predecessors, Ronald Reagan and George Bush."
First let's look at the Total Public Debt from data used by the St. Louis Fed (FRED Database). As of 6/30/2008 total debt stood at $9.49 Trillion. Of that $9.49 Trillion, $5.28 Trillion was held by the public (savings bonds/treasury debt held by individuals and entities excluding the US Gov). Of that $5.28 Trillion, $2.64 Trillion was held by foreign and institutional investors. The total national debt increased by 67%, or $3.8 Trillion from 6/30/2000 to 6/30/2008. Every year deficits add to the total debt. An important note from the movie mentioned that if we continue to add to our existing debt, the Gov will not be able to afford social security and health care benefits down the road. Here is the chart.
What is also alarming is the Foreign Holders/Total Debt Held By Public ratio. It now stands at 50%. Foreign countries have been using dollar denominated income derived from our imports to finance our country. That is a big deal because if we can't service the debt, or foreign owners want to diversify out of the US Dollar or sell treasuries in the open market to raise cash, who will support the treasury market or take the other side of the trade without using the printing press?? Do the American people have enough savings to buy up Liberty Bonds like WWI? Since these foreigners own debt guaranteed by the Government, if we can't pay them back will they be entitled to ownership of our assets in a liquidation or reorganization?! That's what happens in a bankruptcy right? That would be interesting. Also I don't think the trillions of hedge fund money and billionaires would be the white knights in this situation. The Government would just inflate the money supply which would create massive inflation, a run on the dollar, a big tax hike and an end to many entitlement programs. Comparing this situation to the proposed financial bailouts we're experiencing today, our Government would have to bail out our Government. I'm sure these foreign nations wouldn't dump all their treasuries at one time because they do have an indirect interest in our country's prosperity, that's if we continue to import their goods, provide a valuable export, and have a good relationship... Either way, as a person in the movie said, we won't wake up until we're in a crisis.
Next, the movie talked about our savings rate trend and our trade deficit. American's do not save anymore and we continue to import more than we export. However, what is interesting is that the savings rate actually increased dramatically in the past 3 months of this year (2008) showing people were getting nervous about their financial situation. With loose lending over the years, we've seen that people would rather buy a house with nothing down, lever it up, and consume goods rather than save for a rainy day. Of course these people used their leverage and income to buy imported goods at cheap prices based on cheap overseas labor and currency intervention, which is probably the main reason why foreign governments have been financing us. The movie had an example of a scrap metal company. It's a cycle, the owner of the company said all he does is gather steel scraps/old cars here in the States and ships it to China & India who in turn produce the actual products that are imported by the U.S and other countries! The question I have is what if we lose our capacity to afford those imported goods or these trade flows stop being profitable for both the domestic (U.S) and foreign entities. How would this affect the foreign buyers of our financial assets? Here are stories by Jim Jubak that explain situations (mainly currency/trade inflation effects) that could change trade flows and indirectly affect US consumer prices. Basically the movie I.O.U.S.A (Warren Buffett) was saying that there could be problems down the road if we keep consuming more than we produce.
1. Our biggest export: Inflation by Jim Jubak (10/27/2007)
2. China's newest export: Inflation by Jim Jubak (5/20/2008)
I want to also include a chart of the Household Debt/GDP Ratio trend. As of April, 2008 it stood at 98%, and 10 years ago it was at 62%, which is a dramatic increase. Is household net worth overinflated due to mortgage debt that's worth more than the underlying asset? Is our GDP being supported by debt?? Being at about parity, the Housing Debt/GDP Ratio could create a risky situation if the consumer has a problem servicing its debt or defaults, and eventually the ratio spread would have to widen, or come down together. There will be a tipping point with the overinflated household which could eventually lower the country's domestic consumption and production because once the household starts to crack, employment, income, spending, production and deflation follows suit, as well as the demand for imported goods. And if imports decline, there will be less demand for our financial exports (dollar) that finances our imports which could create a change in interest rates, currency values, asset prices and trade flows all around the world. It's a crazy never ending global fibonacci spiral of economic supply and demand adjustments. Either way, something will have to happen and I'm sure all economists have different views. The question I have is, will there be a smooth transition if a crisis mounts, or will a lag affect create more economic problems.
Here is a video of Peter Schiff vs. Steve Forbes on Fox Business News. Peter Schiff has been very bearish on the U.S economy mainly due to our fiscal and monetary policies for some time now. Here is also footage of Peter Schiff in 2002.
Moody's Thinks About Lowering U.S Debt Rating