Shaky Foundations

“If you establish a democracy, you must in due time reap the fruits of a democracy. You will in due season have great impatience of the public burdens, combined in due season with great increase of the public expenditure. You will in due season have wars entered into from passion and not from reason; and you will in due season submit to peace ignominiously sought and ignominiously obtained, which will diminish your authority and perhaps endanger your independence. You will in due season find your property is less valuable, and your freedom less complete.”
–Benjamin Disraeli
Keith has tightened up his hockey hair this morning and will be appearing on Bloomberg TV as co-anchor, as a result I’ve been handed duties as lead author of the Early Look.  I was recently in Colorado visiting some old friends and had the opportunity to stay in their beautiful home with a mountain view, located half way in between Vail and Aspen.  Everything about their home, and life for that matter, is quite picturesque, including a cute puppy named Riggs, except for one thing, their house. Due to no fault of their own, it has a less than stable foundation.  This unstable foundation is leading to premature cracks in the walls.  In many respects, I think it is the perfect analogy for the U.S. economy.
Any economy, or company for that matter, is only as solid as its balance sheet, which is equivalent to the foundation of a house.  As a balance sheet’s debt ratios increase, the very foundation of the economy or company begins to crack.  We’ve recently handed the responsibility of surveying sovereign debt loads to Darius Dale, a recent Yale grad who joined our team about 6-months ago.  Every morning Darius emails out, by 630a.m., Darius’ Debt Download. After reviewing these reports for the last week, there is an obvious conclusion, the economic foundation of the United States is crumbling.
I discussed this in some detail to our subscribers yesterday in a note, but wanted to replay the key facts again this morning.  These are facts that every investor of every asset class needs to keep front and center.  They are as follows:
·        Total current U.S. National Debt - ~$12.17 trillion;

·        Total current U.S. National Debt per taxpayer - ~$111,622; and

·        Debt to GDP ratio – 83.5%.

These numbers are subject to some debate and we have sourced them from and government data sources.  Setting aside specific debate on the precise numbers, the irrefutable point remains: the U.S. National Debt is massive and expanding.  The key components of this debt are as follows:
·        Medicare and Medicaid 21.9%;

·        Social Security 19.2%; and

·        Defense and Wars 19.1%.

U.S. National debt as a percentage of GDP has been climbing steadily since 2000, and has seen exponential growth in the last two years.  At the current ratio of ~83.5% debt to GDP, we are at a level not seen since the 1950s. In lieu of our etf portfolio this morning, we have outlined this metric in the chart below going back 90 years. By the end of 2010, this ratio is projected to be near 100% of GDP absent a dramatic shift in domestic budgetary policy.  As with any borrowing, the more a person, entity or company borrows, even the United States of America, the higher their cost of borrowing will go, all else being equal.  
Interestingly, the national debt of ~$12.17 trillion, actually excludes Fannie Mae and Freddie Mac debt. The U.S. government became the effective conservator of both of these entities with the Housing and Economic Recovery Act of 2008.  The estimated combined on and off balance sheet debt of Fannie and Freddie is purported to be just over ~$5 trillion. Including this additional ~$5 trillion in debt, U.S. Government debt as a percentage of GDP is actually more than 120%.  On that basis, U.S. government debt as a percentage of GDP is the highest ratio it has ever been, or at least since the numbers have been recorded, which is since 1792.  Needless to say, both ever, and since 1792, are a long time.
Globally, this data hasn’t been updated since 2008, but based on 2008 data, the U.S. has the fifth highest indebtedness as a percentage of GDP, just barely above Singapore and just below Jamaica, man.  The only other countries more indebted than the U.S., on this basis, are the economic stalwarts of Zimbabwe, Japan, and Lebanon  . . .
Keep your eyes on U.S. government debt . . . this Queen Mary is not turning any time soon and will hold investment implications related to many asset classes for years to come. We cannot increase our debt exponentially without increasing our borrowing costs.  
Setting aside actually investment considerations, as former British Prime Minister Benjamin Disraeli states above, there are also implications for our very freedom and prosperity. Specifically, even if she had to, America couldn’t afford to fight another large scale ground war.  The only positive from this situation is that the government may be constrained from implementing policy “from passion and not from reason”.  And that, at the end of the day, is a good thing.
Keep your head up and stick on the ice,
Daryl G. Jones
Managing Director


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