“I toil beneath the curse,
But, not knowing the universe,
I fear to slide from bad to worse.”
-Alfred, Lord Tennyson
Keith was off managing domestic risk last night taking his wife out for their anniversary dinner, so I’ve been handed the pen for the Early Look this morning. Later today our firm will be having our annual picnic at our colleague Todd Jordan’s lake house in rural Connecticut. It has just been over two years ago since we welcomed our first client, and the growth trajectory since has been meteoric. On behalf of all of my teammates I’d like to thank all of our clients that have helped make this possible. It has been a pleasure working with every one of you.
We now have close to forty employees. We have three offices around the globe, with plans to open our fourth this fall. And with the pending launch of Energy Sector Head Lou Gagliardi in September, we will have seven senior sector heads who cover close to 50% of the SP500. Following our firm meeting yesterday, I can tell you this, we are just getting started.
So, as I was contemplating our firm’s growth yesterday at the Hedgeye Happy Hour following the firm meeting, I was also mulling over the future economic growth of the United States. While I’m not in the double dip camp, I do “fear to slide from bad to worse”. As Lord Tennyson would say. (Incidentally, Tennyson is the second most quoted person in the English language after Shakespeare.)
Earlier this week, Keith and I presented to our clients on the topic of U.S. Sovereign Debt. Debt and deficit issues in the United States are not exactly non-consensus as they are widely discussed and contemplated. In fact, in the spirit of “watch what they do and not what they say”, we had the second Obama administration economic official resign today in Christina Romer, the chair of the Council of Economic Advisors. This of course comes on the back of the July departure of Peter “The Paparazzi” Orzag, who ran the Office of Management and Budget. Watch what they do and not what they say . . .
Undoubtedly, both Orzag and Romer have come to the same realization as us, which is that U.S. economic growth is poised to slow in coming years. In our presentation on Tuesday, we narrowed this projection down to one key variable in our multi factor, chaos theory based model. This factor is sovereign debt. So if you are staffed with managing the budget or the economy in a slow growth environment, you better either wave the white flag and go back to teaching at Berkeley (Romer), or prepare your stomach for the new reality of Bad To Worse.
While many of you have read Reinhart and Rogoff’s book, “This Time is Different”, which studies the long term implications of large sovereign debt balances, the professors also wrote a fascinating paper earlier this year, “Growth in a Time of Debt.” This paper looks at over 210 years of data relating to sovereign debt balances and future economic growth. The key conclusion is that as debt-as-percentage-of-GDP crosses the Rubicon of 90%, future growth slows. And in dramatic fashion.
According to their paper, from 1790 to 2009, for 20 of the most modern economies, as debt exceeded 90% of GDP, average annual economic growth was 1.7%. This was compared to economic growth of 3.7% at less than 30% of debt to GDP, economic growth of 3.0% with debt to GDP from 30% to 60%, and economic growth of 3.4% with debt to GDP of 60% to 90%. In effect, as debt as a percentage of GDP passes the Rubicon of 90%, growth falls below the average by more than three standard deviations. As the quants will tell you, that is statistically significant!
Being the industrious young analysts that we are, we actually applied this thesis to Japan. In the attached chart of the day, we outline this point graphically. In the last three decades in Japan as we see a step up in debt, we see a corresponding step down of economic growth with the inflection point being . . . you guessed, it 90% debt-to-GDP. Specifically,
- 1981 – 1989 – Japan has average economic growth of just 4.6% and an average debt to GDP balance of 64%;
- 1990 – 1999 – Japan had an average economic growth of 1.5% and an average debt to GDP balance of 92%; and
- 2000 – 2009 - Japan had an average economic growth of 0.8% and an average debt to GDP balance of 179%.
As they say, facts don’t lie, politicians do. And the facts as it relates to debt and growth are quite clear, as debt climbs and exceeds the Rubicon of 90%, economic growth will slow. If you don’t believe me, believe the 200+ years of data.
It is clear to me that, “The old order changeth, yielding place to new.” With the new order being a meaningfully different growth trajectory for the United States than the prior thirty years.
But as always, “Tis better to have loved and lost, than never loved at all.”
The Poet Laureate of Hedgeye,
Daryl G. Jones