The future ain't what it used to be… -- Yogi Berra
Back in October we described the "axis of artifice" which links Washington, DC and Wall Street. This alliance, which exists to prop up both the financial markets and (less successfully) the U.S. and world economies, has been in place since the financial crisis of 2008. It issues and sells prodigious amounts of debt on behalf of the U.S. Treasury, debt which is funded in various measures by U.S. taxpayers, foreigners and newly-minted cash from the U.S. Federal Reserve.
It was put in place to buffer the nasty aftereffects of the previous credit binge, which ended with the collapse of the U.S. housing market in 2007. As such, it offers a lesson on the limits of what even well-intentioned policymakers can do to improve the economic prospects of the common man. Not to get ahead of ourselves, but we think Yogi was on to something.
The U.S. Treasury has issued over $5 trillion in new debt since the fall of 2008. Over this same period, U.S. Gross Domestic Product increased $1.2 trillion in current dollars. Private sector debt was basically flat during the period, as most households and businesses reduced their borrowing after the financial crisis. The upshot is that here in the U.S. we've gotten about $1 in growth for each $5 in net debt issued since 2008. Compare this ratio with the historic growth/debt ratio depicted on the chart below. Fifty years ago, $5 of new debt generated nearly $4.50 in additional GDP:
Click to enlarge.
Some say this graph depicts the single most important economic trend of the past half century. This trend of diminishing returns from debt is one which most people can't explain mathematically, but feel viscerally; they feel it in their bones. As we discussed in our essay last fall, this is the trend which spawned both the Tea Party and Occupy Wall Street movements.
Tea Partiers know that spending 24% of GDP year after year, while taxing only 18%, is a path to perdition. They know that "shovel ready" projects such as the $527 million Solyndra "investment" can't provide the bang-for-the-buck that private, profit-seeking endeavors can. How could they? People never spend other people's money as efficiently and effectively as they spend their own.
At the same time, the Wall Street Occupiers know that issuing debt to bail out failed bankers is an equally bad strategy. It not only throws good money after bad, it sets the precedent for future bankers to be just as profligate, but with zero downside!
We're on a bad track and people know it. Politicians, bankers, hedge-fund managers and friends of politicians have ridden out the storm in relative comfort, at the same time proffering policies which never quite reach to the end of the economic line. Imagine a carnival strongman repeatedly whipping a heavy, 100-foot bull rope. Those near the front of the rope see plenty of action. In fact, people with strong stomachs and a taste for risk might profit handsomely from the ongoing cycles of "stimulus."
Those at the opposite end, however, see barely a ripple. Ben Bernanke and Barack Obama are whipping away. Large-company profits, as measured by the earnings of the S&P 500 Index, have more than doubled from the bottom in early 2009, as have share prices. Meanwhile, small business sentiment remains at recession levels, and real earnings of the average worker have actually declined since the recovery began in July of 2009. If it continues, this is a formula for political upheaval.
As we've said repeatedly, it's good to be a capitalist these days. And who knows? Ongoing rounds of federal spending and money printing may buy enough time for those at the end of their economic rope to resolve their debts without bringing down the entire system. We could muddle through. This is obviously the hope of policymakers in Washington, Brussels and Tokyo.
We remain skeptical. The Japanese (who are admittedly in worse shape demographically than we are) have been at it for 20 years. Their debt has grown so large that a minor increase in interest rates could leave them bankrupt. Growth in Japan is tepid at best, and deflation remains a scourge. If the U.S. continues to see weak economic growth and rising debt in coming years, we could end up in a similar spot. Debt service will begin to outpace income, and the game will be over. Or the insidious political effects of the "extend and pretend" regime described above could undermine the productive impulse at the heart of our nation's success. This is a risk as well.
Whatever the ultimate outcome, we remain focused on these risks and the seemingly omnipresent "uncertainties" which characterize today's investment climate. We're cognizant of the various forms of artifice in the system, (i.e.; intermittent bouts of borrowing, spending and money printing). Simply put, these policies are designed to make the present look better by pulling future earnings forward to services debts from the past. The future ain't what it used to be.
"It ain't over till it's over" is another famous Yogi-ism. We don't know when the current grinding economic interregnum will end, but we know it can't happen until our leaders deal with yesterday's debts in a transparent, rational and comprehensive fashion. We're waiting.