The U.S. Doesn't Have A Debt Crisis: Don't Let It Scare You Out Of Stocks

Includes: C, F, SPY, WFC
by: Convex Strategies

"Everything gets destroyed a hundred times faster than it is built up. It takes one day to tear down something that might have taken 10 years to build. If the economy starts to go with the kind of leverage that is in it, it will deteriorate so fast that people's heads will spin.

I know from studying history that credit eventually kills all great societies. We have essentially taken out our American Express card and said we are going to have a great time. We borrowed against the future, and soon we will have to pay."

That quote could very well have been from today, but it wasn't. It was actually from the 1987 copy of Market Wizards, straight out of the wise mouth of Paul Tudor Jones. I love quoting Jones - he's arguably one of the best macro traders of all time and despite the recent flack he's taken as a result of his comments regarding women and macro trading (unjustified if you ask me), he's an amazing philanthropist and seems like a genuinely nice guy.

But while Jones correctly predicted the '87 crash, the long-term, perilous implications for the economy that he predicted never came to fruition. Here's the long-term S&P chart (Yahoo! Finance):

You see the '87 crash? For all the short-term fear that it created, it was merely a blip in the United States' long-term economic growth story. A year later stocks were up 11%, and by the same time five years later, stocks were up nearly 75%. The debt crisis and perceived culture of overspending were simply illusions. Contrary to popular opinion, today's debt crisis is, much like it was in 1987, an illusion.

One of the most prevalent bear cases since 2009 has been that the United States' soaring debt is a ticking time bomb. The argument usually concludes that either the Treasury market is going to collapse, or "we're going to have to have to pay the price for all this spending at some point."

If you've been objectively following the ongoing economic recovery and slight (and I mean slight) progress our government has made in terms of cutting items like defense, you've probably noticed that the estimated 2013 deficit was recently cut to $642 billion - 4% of GDP.

Granted, some of the cuts were a result of temporary payments from Fannie and Freddie and potentially some prematurely recognized capital gains, but we're moving closer to running a sustainable deficit.

"You mean deficits can be sustainable?"

Yes. The government doesn't work like a household does. When your economy grows 2-4% a year, you can afford to take on annual deficits of about 2-3% of GDP. People like our debt. We don't have a lot of societal upheaval, our economy has a tremendous track record, and the dollar is remarkably stable.

"Yeah, but the Fed is debasing the dollar."

Ok, first of all, every country debases its currency. There isn't one currency in history that's maintained its value over the long haul. Moreover, while you've been worrying about our money needing to be backed by real money, everyone else has adapted to the reality that the way you buy things in this country is by having dollars. The way you get to buy more things, I might add, is by having more of these dollars. Besides the obscure stories of the politician from Montana, who wanted his paycheck in gold coins (how'd that work out? Gold coins were quoted at $1,800 when he made his request, so his paycheck would have been down about 19% by now - so much for a stable currency), Americans are generally content with receiving dollars, despite the obvious fact that it won't hold its value. Foreigners have the same information we have, and yet they can't get enough of our Treasuries.

Of course, the Fed's unprecedented easing policies are what are really driving this renewed fear of dollar debasement. When we hear stories of open-ended QE in the order of $80 billion per month, and see charts like the one below it's reasonable to be a bit concerned.

However M1, or base money, is a mere 10% or so of the total money supply. In reality, the money supply as it relates to inflation is determined by the extension of credit on behalf of financial institutions. It's that simple. As for all that cash being "printed," it's almost entirely held as reserves at the Fed where it earns a tiny amount of interest:

The dynamics of inflation and the value of the dollar aren't as simple as many seem to think. Commentators often state, "More dollars, all else equal, means higher prices." Logical enough, but in the face of relatively weak consumer and business activity and the general process of deleveraging, enough credit is simply not being extended to catalyze meaningful inflation. The enormous amounts of base money being created aren't making it to the real economy, and the "supply" component of the equation isn't really impacted.

With the understanding that the U.S. dollar is actually still in good shape, and the knowledge that we're running a $423 billion cyclically adjusted annual deficit - meaning what the deficit would be if we were near full employment ~6% - the U.S. fiscal picture looks a lot less intimidating.


We're not quite there in terms of sustainable spending, which most economists peg at 2-3% of GDP, but we're a heck of a lot closer. We'll have to continue cutting big-ticket items like defense and work on reducing healthcare costs, but it's undeniable that progress is under way.

It's a travesty that the public's concern regarding the U.S. debt has kept so many people out of stocks since 2009. There's a pervasive mentality out there that says, "If the status quo remains, we're in big trouble." Yet, the status quo never remains. We've always found the solutions to our problems in this country, and the improvement in this case is right before our eyes.

If you're just looking at getting into equities now after a near 150% gain in stocks (NYSEARCA:SPY), make sure you're not overpaying for income-generating stocks that have the perception of being safe-havens. There are plenty of bargains available still, my personal favorites being Ford (NYSE:F), Wells Fargo (NYSE:WFC), and Citigroup (NYSE:C). All three of these names trade at deeply discounted multiples and have strong growth prospects given the macro tailwind of a steadily improving U.S. economy and some company-specific catalysts. Don't let the seemingly perilous U.S. debt and annual deficit keep you out of equities any longer.

A final word regarding "unfunded liabilities," as I expect a few will bring these up. These liabilities are merely promises the government has made, and are calculated based on hypothetical accounting. We know we're going to need to do things like raise the minimum retirement age and reform Medicare. Simple (but very slow to pass and implement) procedures like these have an enormous impact on a 75-year accounting chain. These aren't going to "bankrupt the United States" as some prominent fear mongers would have you believe.

Disclosure: I am long F, WFC, C. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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