How Debt Destroys Solvency

Includes: DIA, SPY
by: Michael David White

Every loan officer knows the story begins with debt and income. Debt and income define the financial health of a borrower. Is it any different for a country? If yes, then what do you use to determine the financial health of a country?

One method I suggest is a shaman. Mine uses a divining rod. He stands himself inside a circle of cow chips, and keeps a rabbit’s foot, resting on top of his head, but hidden under a baseball cap. And then he sees everything. I wish I could tell you what his chant is, but his guidance is proprietary.

When the shaman won’t work with me, I go back to basics. Debt and income for a borrower’s home or a country’s economy are perfectly synonymous factors: They are the decisive fact defining financial health or sickness.

A mortgage lender wants the borrower’s monthly payments, after taking on the new debt, to equal no more than 36% of income. Less is better. More sometimes works.

So how do you determine a country’s income? That’s very simple. Substitute gross domestic product (GDP) for income. Then review the chart immediately below.

If, after reviewing the chart, you aren’t crying now, then you don’t know what you have just seen.

What does the chart say? It predicts we have unpayable debt equal to $21 trillion. Where all the lines go up in the chart, assume they all have to come back down again. If we write off $21 trillion, the job gets done.

And how big is $21 trillion? If you play your cards right, it’s enough money to buy every residential property in the United States. And after you buy all those homes you can put a serious killer deck on each and every one of your new property investments. And then, as a closing present, you can easily pay for every family in the United States to travel all around the world for 80 days – at least. Tell them to eat and drink whatever they want. If you like to buy wars, wait it out six or 12 months, and buy the property then. The change will get you the Iraq war. You can do it all. It’s crazy what you can do with $21 trillion. Know what I mean?

Before signing off, I should mention a gaping hole in the preceding argument. I have assumed that 1980 was a year of sanity for debt. And I have assumed 2008 was the denouement of decades of debt insanity. Nobody, to my knowledge, has published a detailed report defining the correct ratio of debt-to-GDP/income for a country. I have seen a few mentions here and there, and a few graphs, but nothing convincing or serious.

And if nobody has done that work, what does it mean? It quite simply means that we are all dumb and we don’t know what we are talking about. Now that I’ve said it, doesn’t that sound like the world we all know? I’ve been there anyway.

We can and should confirm that economics is a dismal science. And the herd, including you and me, really should think about going back to school.

That’s it for now. Enjoy the bull market. Isn’t it fun to be confident again? Enjoy your holiday weekend. And, if you don’t mind, please pass the Kool-Aid. I’ll take a pitcher if you don’t mind? I love that stuff.

Post Script: If you have research on debt-to-GDP ratios, its history, or any work relevant to the theme, please send it along.