I just started reading Ray Dalio’s new book “Principles For Navigating BIG DEBT CRISES” and I decided to ask my money manager about his thoughts on some of the concepts in the book. My first question was what he thought about the USA’s National Debt situation and if it was going to have an impact on the future economy/stock market. His answer, “it’s been an issue for years and if you worried about it you would have never made any returns.” He pontificated about a few other charming variables but for a guy that likes more detail, it was NOT a great answer—so let’s start digging and taking some notes. Ray’s book makes some assumptions that the reader understands these concepts so it’s good to do a review as I forgot most of what I learned in high school finance (wait, they didn’t teach finance in my high school–well, they should…).
We must start with the basics: What is credit, trust, spending power, and debt?
Debt is money a borrower owes in the future to a lender. Credit is the trust which allows a lender to provide money to a borrower where that borrower repays the money (and usually interest) at a later date. Credit creates both spending power and debt. The key is to use the borrowed money productively to generate enough income to pay back the debt.
What is the national debt?
The national debt of the United States is the funds that the country borrowed (via selling securities issued by federal government agencies such as the Treasury). If the federal government runs a “deficit” (spends more than it takes in) the country has to borrow to cover the delta and this increases the debt.
Who is lending the US money to cover the debt?
The current US National Debt can be found here.
You can find details here but ~28% of the debt is held by intra-governmental agencies and the rest (public debt) is held by foreign governments other governmental entities (Federal Reserve and state and local governments), mutual funds, private pension funds, holders of savings bonds and Treasury notes, banks, insurance companies, trusts, companies, and investors.
In regards to foreign ownership, in October 2018, China owned $1.14 trillion of U.S. debt, Japan at $1.023 trillion. Why? Because, both Japan and China want to keep the value of the dollar higher than the value of their currencies to keep their exports affordable for the United States, which helps their economies grow.
What are unfunded obligations?
Note that the US published National Debt number does NOT include Medicare, Medicaid and Social Security—these are considered “unfunded obligations”. It’s estimated that the US has between $47 Trillion and $210 Trillion of unfunded obligations (here or here).
What is GDP (Gross Domestic Product)?
GDP is a measure of the total size and output of the economy of a country in a year.
Why is the Debt-to-GDP ratio important?
A debt-to-GDP ratio under 100% simply indicates that the economy produces and sells goods and services enough to pay back debts without incurring further debt. Here is a chart that shows this % since 1900 –note that we were over 100% around the time of World War II. The current ratio is~106% and climbing.
How does the USA’s debt-to-GDP ratio compare to other countries?
You can find a chart comparing all countries here. If you take all the countries around the world and sort them by the % highest to lowest you will see the following:
How do we stack up if you include unfunded obligations in our numerator?
So, what’s the problem?
Borrowing is OK if it allows for development. However, if the return on the loan is such that it doesn’t produce enough to repay the loan then we are essentially bankrupt. We see above that for several recent years the US has been borrowing from its future. How much is too much?
What happens if we default? Great article here.
What is Reserve Currency status and why does it matter?
By the end of the 20th century, the United States dollar (USD) was considered the world’s most dominant reserve currency. Most countries hold most of their reserves in USD. Why? It’s because the United States has:
- large, liquid financial markets capable of taking huge investments
- a reputation for safety and rule of law, so that other countries are willing to invest billions and billions of dollars in that country’s government securities
- a willingness to run current account deficits indefinitely since that’s the counterpart of a capital account surplus.
Being a dominant reserve currency causes the country’s currency to appreciate due to foreign demand. This then dampens growth, and it causes unemployment (US exports would be more competitive, and more people in the US would have jobs making goods for exports).
The fact that the USD is the world’s major reserve currency is one of the main reasons why it has run a current account deficit for most of the last 30 years. (known as the Triffin dilemma).
So, what are the benefits of being the country with the dominant reserve currency? From Michael Pettis in 2016 “it isn’t easy to list these benefits because for all the conviction that they are substantial, few analysts can identify them except very vaguely. The main benefits seem to include:
- It lowers US government borrowing costs.
- It allows Americans to consume beyond their means.
- Outstanding currency notes provide seignorage benefits.
- The US sells economic insurance.”
Others are pointing out that the debt will cause the US to lose it’s reserve currency status and it has already started (see here). Others refute that it will happen (more) – “the US dollar will continue to be the dominant reserve currency for the next several decades unless the US government itself decides to prevent or limit the ability of foreign central to accumulate reserves in US dollars”.
More on the subject of ‘what happens if…’ (consider source with caution given HQ in Moscow)
Take the following propaganda with MAJOR CAUTION GIVEN THE SOURCE but if you want to see a very negative view of the US debt situation from the RUSSIAN accounting firm Awara read “An Awara Accounting Study on US Economy 2018: Signs that the US Debt-Fueled Economy Might Actually Collapse” found here. “it is clear that the present US economic system will not survive over the coming 5 to 10 years. Massive changes in the economic model would have to be undertaken either in an organized fashion (hardly imaginable) or through a mega financial crisis.”
One of the best debates that leans toward the US debt NOT having a big impact on the future economy can be found here at a podcast that I enjoy called: Money for the rest of us
Net/Net: It’s really hard to tell when/if the US National Debt will eventually sink our economic ship and I think my money manager gave me the best advice he could as I’m sure he has no clue either…
Great info to share with your kids:
OK, back to Ray Dalio’s new book…