Is The Debt Issue Phony?

Includes: DIA, KO, SPY, TLT
by: Arne Alsin

It sure sounds like a lot, doesn't it? $17 trillion in federal government debt. Wow. It's a big, scary number, no doubt about it. But other than saying it's a big, scary number, a rational observer does not attribute meaning to $17 trillion, absent a frame of reference. Without context, how can anyone (politicians included) offer up an intelligent opinion on our debt?

FACT: Coca-Cola (NYSE:KO) has $15 billion in debt, up three-fold in the last five years.

Is that enough information with which to make a judgment about Coca-Cola's debt? It's a big number and it's jumped three-fold in a short period of time, but can we say anything else about Coke's debt load? Of course not. We need more information. We need to know Coca-Cola's income and resources before we can make an informed judgment.

In the same vein, we need to know America's income and resources before rendering an informed judgment on $17 trillion in debt. It sure seems awfully big, and it's a lot bigger than in years past, but is it really that bad? Could it be that our debt profile has been grossly exaggerated?

We're going to take a look at how much debt is costing us as a percentage of GDP, to gauge how well (or how poorly) we're servicing the debt. Then we'll take a look at our resources, to see how much we've got backstopping the debt.

Before we go any further, though, let's establish this much: There is nothing wrong with debt. Debt is not evil. All governments use it, as does every major corporation, even those flush with cash. Debt is a necessary tool, as it allows corporations and governments to operate more efficiently, to manage disparate and inconsistent cash flows.

Let's take a look at how much debt is taking out of the economy. The chart below shows you how much debt service (interest) is costing us, as a percentage of the economy (GDP).

(Click to enlarge)

Ahem. So what's all the hullabaloo about? The data show that the cost of public debt is currently below the 10-year average, the 20-year average, the 30-year average. In fact, by this time next year, our debt service costs are expected to drop to levels not seen since the 1960s, to about 1% of GDP.

Wait a minute, the fear mongers will say, what happens when interest rates go up? Not much, it turns out. The government has locked in low rates on much of the debt. And there's an offset to calculate, as higher tax revenues follow higher interest rates. And, too, we have lots of capacity. Our debt service cost could double, to 3% of GDP, and it would still be manageable. That's the level it was in 1989, the year Reagan left office.

An interesting fact the fear mongers may have neglected to tell you: A big part of the federal debt is a phantom, an accounting entry booked when one government agency borrows from another government agency. The real debt - the debt owed to outside creditors - is $12 trillion. But let's not quibble over a few trillion. As I'm about to show you, $17 trillion does not constitute excessive debt leverage, given the size of the economy and our assets.

America's Resources: You and Me

The government belongs to the people. We're backstopping the debt accrued by the government. And, yes, $17 trillion is a lot of coin. Are we good for it? What are our resources?

I've got good news on that score. While $17 trillion is a big, scary number, it turns out the left side of our balance sheet (the asset side) has plenty of heft in it, too. Turns out net assets are way more than the federal debt. Way, way more.

Net household assets exceeded $75 trillion last quarter, an all-time record. The ratio of $75 trillion in assets to $17 trillion in debt, though not as good as it was under Reagan, is moderate, not excessive. When Reagan left office, we had $18 trillion in net household assets, which covered $2.6 trillion in debt by a healthy margin. Factor in phantom debt and our debt to assets ratio is the same it was under Reagan.

It's true, we put on several trillion dollars of debt during the credit crisis, but that's what debt leverage is for, to smooth over rough patches, to provide fresh capital when it's not readily available. Relative to assets, and relative to how much it costs us as a percent of GDP - and with apologies to media hounds who need fodder for their content - alas, we do not have a debt problem.

If and when we develop a real debt problem - as opposed to a media fiction - the way to deal with debt is simple: Grow assets. Net household assets double every 10 to 12 years. We should be at $150 trillion in 10 years and $300 trillion in 20 years. My guess is we'll grow debt more slowly in the years to come, as the economy appears poised for several years of healthy growth. It's reasonable to expect debt will grow to something like $25 trillion in ten years, and to $40 trillion in twenty years. I'm sure we could comfortably grow debt to $60 trillion over the next twenty years, and we'd generate a lot more assets, but let's not get greedy. Slow and steady, you know.

Another thing: America won't pay off its debt, and it shouldn't. Ever. Our debt isn't a credit card bill. You can't compare the American government to a family's finances. They're not even close to the same thing. It's a line of credit, and it will always be rolled over. (Assuming we have good credit, of course.) Unless we want to do a lot of harm to the economy (it would shrink it), we're not going to make a dent in the $17 trillion of debt. Debt is going to grow, cherubs. Get over it.

What about entitlements?

We do not have a problem funding entitlements today, but if you linearly extrapolate the data (always a suspect game), there may be a funding shortfall beginning around 2030. It's a fair question: Should we reform entitlements now, in anticipation of problems down the road?

Let's chew on this a bit. Should we ask today's politicians… cough, cough… to fix entitlements down the road, for the people in 2030? Do today's leaders really know the best way to divide up the pie in the distant future?

May I submit, we don't have a clue what the economic ecosystem will look like in 2030. The magnitude and speed of disruptive change in the economy is, in a word, breathtaking. Every industry vertical is being re-imagined. From the ground up.

Think Tesla and the auto industry. From out of nowhere comes innovation at a pace we never dreamt possible. And in five or ten years, we might see another wave of re-imagination in the form of self-driving cars. We can't predict how disruption will play out in autos, or any other vertical. Not ten years out. Not even five. Yet people want this Congress to legislate entitlement reform on behalf of people in 2030?

We don't know what income and resources will be in 2030, and we certainly don't know life expectancy. Social Security reform will have to adjust for life expectancy at some point, but why, exactly, do we need to figure it out in 2013? By 2030, life expectancy may suddenly surge to 125 years, who knows. What if it's 150 years?

This much we do know. Things are changing fast. Awfully fast. As far as the entitlement system goes, like everything else (including the government), it will be disrupted in due course. When the time is right, entitlements will have to be re-imagined. From the ground up. Changes in life expectancy will require it. But is now the right time? Should today's Congress re-imagine entitlements for people in 2030? The idea is way scarier than the phony debt issue.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.