As you may have heard, debt is a bit of a problem in America. As a whole, The Federal government, state government, corporations, and households have never been as insolvent as they are today. Of course, today many profess the concept of "Modern Monetary Theory" that suggests debt can grow ad infinitum as debt creation boosts the GDP. The problem, which is terribly obvious, is that debt growth is far above GDP growth and the GDP is highly asset price dependent which easily disproves the basis for MMT. In my opinion, such a theory can only be expected in a period of hubris and complete complacency.
I admit that it is hard to see a problem when it is not yet an immediate concern, but it is a problem all the same. The real problem is that most do not fully understand how much debt is growing faster than the ability to repay it. In 2008, the problem was too much household debt.
Today, that household debt was kicked over to the Federal government's balance sheet and many have been falsely led to believe "The government saved us, the coast is clear!" when in fact the "savior" not longer saves a dime.
I'd like to detail how much debt exists in the U.S, including the often forgot and increasingly important off-balance sheet liabilities. Even more, I'd like to demonstrate how the problem may, once again, bubble into an immediate problem, likely during the peak of the next recession.
Tallying Public Debt
When most consider public debt they stop at the total value of Federal paper debt. As you likely know, this form of debt stands at $22 trillion today and is rising at a faster pace than normal. To compare, the total GDP of the U.S is just under $20 trillion a year. This equates to around $67,300 for every man, woman, and child in the U.S. Per working adult, that is around $130,000.
The other major portion of public paper debt is state and local government debt (excluding pensions) which stands at just over $3 trillion and brings us to a total paper public debt of $25 trillion.
But wait there's more, a whole lot more. There is an additional $5 trillion in unfunded state and local pension liabilities, bringing our total up to $30 trillion dollars. Now we are at a staggering $190,000 in debt per working adult, very near the median value of a home in America.
Take a look below:
(Data Source - Federal Reserve)
There is an additional form of liabilities that is nearly completely undisclosed: social security and medicare liabilities. In the last Social Security trust fund report, there are $13.2 trillion in the present-value worth of unfunded social security liabilities (up from $12.5 in year-end 2017) and is expected to run out of reserves around 2032.
While Social Security is much more of a well-known problem, the real problem is Medicare which has a staggering $37 trillion in present value worth of unfunded pension liabilities. To make it worse, according to the Federal government they are expected to run out of money in either 2025 or 2026 which is very soon. Medicare-for-all? More likely, Medicare-for-none when you consider the numbers (and not the potential votes gained from impossible promises).
This brings the U.S total public debt to a monstrous $80 trillion dollars or $500,000 per working adult and we have not even touched on private debt. Some may say the government "can just increase taxes" to pay for this, but elected officials cannot raise taxes this much. Even more, austerity tends to make elected officials into non-officials very quickly. Thus, it is likely that bond investors will take the brunt of these losses.
Tallying Private Debt
Private debt comes in two forms: household (mortgages, credit cards, student loans), and corporate (financial sector and non-financial sector). This section also includes pension obligations, but that data is much less available than it is for public pensions.
As with the past section, I will continue to calculate debt per working adult. While it may seem weird to corporate debt this way, it is still the U.S citizens that must indirectly foot the bill for corporate debt via higher prices to pay interest & principal or bond/stock market losses due to bankruptcy if not repaid.
Today, this stands at roughly $16 trillion (around $100,000 per working adult) and is about $1.5 trillion higher than it was in 2007-2008. Remember, high household debt was the primary cause of the crisis in 2008 and it is even higher today. The fastest-growing segment of this debt is student loans of which less than half are currently being repaid. Evidence suggests more people are defaulting on the likely false belief that the government (i.e the taxpayer) will assume their debt.
There is another $6.5 trillion in non-financial corporate debt (the fastest-growing segment since 2008 with only $3 trillion back then). If we add on financial sector corporate debt (banks), there is an additional $16.5 trillion in private debt which brings the total corporate debt level to $23 trillion which is roughly equal to the total Federal debt.
In total, this gives us $39 trillion in private debt or roughly $245,000 per working adult. Take a look at how this figure has changed over time:
(Data Source - Federal Reserve)
Of course, this does not include unfunded private corporate pension liabilities which are likely to be in the many trillions (possibly up to $70 trillion according to usdebtclock.com), but as (GE) demonstrated on Monday, it is becoming easier for companies to avoid making due on those promises. Quite frankly "defined benefit" retirement programs look much more like "legally ill-defined potentially-no-benefit" programs.
Tallying the Tallies
If you only count basic liabilities, there is around $70 trillion in debt or nearly $430,000 per working adult, more than a high-end home in most of America or about eight years of income for the average working adult (if one could somehow live while devoting 100% of their income to debt payments). Take a look below:
(Data Source - Federal Reserve)
Of course, corporate debt is likely to be largely paid via investor losses on stocks and bonds (as opposed to from consumers via prices), but as investors, we care most about the prior.
If you add in unfunded social security and medicare unfunded liabilities, that figure rises from $70 trillion to $120 trillion. This equates to $765,000 per working adult, more than a high-end McMansion (with a pool and spa) in most of America. Now, the average adult would have to devote 100% of income to repayments for over 14 years to make that payment.
This figure has been rising at about $10,000 or 2.3% per year in the last few years and is likely to accelerate higher in the coming years due to increased interest expense and retirees.
What This Means for Investors
While many are probably reading this article and thinking "I effectively owe $750,000 in debt? I'm not paying it". Indeed, that is probably a correct statement. While there is little chance Americans will get out of their roughly $100,000 in average household debt, I see it as entirely impossible that the Federal debt is repaid in real post-inflationary terms. I also see it as extremely likely that retirees get around half of what they were promised.
I expect bond investors to take the brunt of the losses. In my opinion, they ought to consider they are lending to governments and individuals who are completely insolvent at such low-interest rates. Even more, I think it is safe to say that policymakers as a whole are much less interested in bailing out investors than they were in the past.
The way I see it, there are three potential outcomes. First, the "prudential route" where everybody in America drastically tightens there belt and saves money to pay off debt without creating inflation. Likely, this would mean further constraining the already constrained middle class which is no longer a major creditor. Considering the fact that most American politicians want to further increase government deficits and those who want to pay off public debt are kicked out of office, I view the "prudential route" as entirely unlikely.
The second possibility that most view as likely is very high inflation and money printing. Indeed, wage inflation is already rising much faster than nominal inflation, so there is ample reason to believe that an inflationary spike is around the corner. Many will say "the Fed printed money to save us in 2008, they can do so again". Well, the Fed did not actually fix anything. Debt is higher today, so the prospect of a potentially hyperinflationary spike (as is historically common in this situation) is still reasonable.
The problem with that possibility is that it would completely destroy the value of the U.S dollar which is absolutely vital for the international standing of the country. Quite frankly, I don't know if most Americans realize how disastrous the long-term consequence of this outcome would be.
I believe the most likely scenario will be essentially financially restructuring wherein everybody loses, but no group will lose much more than the others. Most likely, this will mean long-term bond investors who hold to maturity will receive (effectively) 50 cents on the dollar (after inflation or less) and an end to the era of endless deficits and a cut to social programs and bureaucratic excess.
I suspect that these events will finally come to fruition in the next recession (which is potentially beginning today). Inflationary fundamentals are rising and the Fed is unlikely to cut rates again, thus long-term bonds are likely to fall with stocks. This would cause liquidity problems for pension funds and retirees which would likely catalyze a reversal in debt creation.
As inflation rises, so too would credit risk perception which would eventually cause interest expense to rise for all indebted parties and encourage deleveraging. Of course, this would cause huge bond devaluations wherein a bond delivering a 2.5% return today could fall over 30%-40% and burn investors on a risk-adjusted perspective. But, because wealth has become so concentrated and "Robinhood Populism" is on the rise, letting investors take the fall may be the only politically viable strategy.
In my personal opinion, considering the huge risks in the bond market that investors are willfully accepting today, this expected crash in bonds may serve as an important lesson for generations to come. I am short long-term bonds (TLT), mortgage-backed securities (MBB), investment-grade corporate bonds (LQD), and global sovereign bonds (BWX).
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Disclosure: I am/we are short TLT,MBB,XLU,BWX,LQD,GE. 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.