Myth Busters: U.S. Debt
This myth buster will be sure to bring some criticism and have a few asking, “has Mick finally lost his mind?” It would be very hard to find anyone, that wouldn’t agree that the U.S. has too much debt, right? I know, I’ve been asking friends, family and strangers I meet over the past few weeks. They all agree that the U.S. has too much debt and that is bad for the economy. I think that’s WRONG.
First, before I attempt to show you some statistics and basis behind my belief, I think the initial bias is that Debt is Bad. That has been engrained in us from an early age, debt is bad and being out of debt is good. If I really asked you to think about it, I may get you to agree that debt by idiots is bad, and debt by smart borrowers is good, but overall, it’s still bad. If I use the example of a company like Apple borrowing money to build a new plant or hire some new people, and that money is used to increase sales, which ultimately is spent by the contractors and employees through the community, I may get you to concede that this is a smart borrower and that is ok or maybe even good. However, borrowing by the City, State or the feds is bad.
So, we now agree not all debts are bad, but the government is a terrible borrower because they are a bad spender of that debt. They do not efficiently spend the money measured by their return on investment. Pork barrel buffets, boondoggles and excessively luxurious trips and benefits for politicians touches the surface of government spending inefficiencies. What if I were to tell you that when new borrowing is done, it generally is recycled through the economy six times in the first 12 months? Meaning that even if the initial borrower spends it poorly (say on pens that write upside down in space), it is then spent 5 more times by others who spend it more wisely, i.e., the road construction company (paid by government contract) who employs labor and purchases materials, the supermarket that supplies groceries to the employee, the truck driver that delivers the groceries and so on. You see where I’m going. So even the worst borrower “Uncle Sam” will ultimately assist the overall economy and end up with a decent return on investment of that borrowed capital, because of the average every other spender. Not buying yet? OK I’ll keep going.
The U.S. Debt at the time of writing (according to the Department of Treasury) was 21,101,359,553,390.92, just over $21 Trillion, yes, that’s huge. However, the first point I want to make is that the U.S. Government is the biggest holder of its own debt. They call it intergovernmental holdings, that they don’t pay interest on. That figure is $5,675,531,809,567.35 or over $5.5 Trillion, leaving what’s called the Debt held by the public or Net Debt of $15,425,827.743,823 or just under $15.5 Trillion. That’s the figure we service the debt on. Yes 15.5 Trillion is a large number, and you might even say that’s too much debt. To say that however, you must agree that here is a right amount of debt. Some people say zero, others say what we can afford, others say a percentage to GDP. I prefer to look at it through the debt cost as a percentage of revenue we bring in. The same way a bank will look at your Debt to Income Ratio. The interest we pay each year on debt according from the federal budget is $310 Billion, and the government is estimated to bring in $3.27 Trillion, which by my math equates to about 9.48% of total federal revenues and around 7.5% of government spending. In the mid 80s to mid 90s the percentage was over 15% of revenues, mainly due to higher interest rates. All in all, that’s lower than the average household in the U.S., so not as bad as you would think. Still not buying yet??
I hear that if China stops buying our debt then that would send us into a tail spin. Yes, China is the largest foreign owner of U.S. government debt, but would it surprise you that they only own slightly more than Japan? In fact, according to the Dept of Treasury, China (In Sept of 2016) owns approximately 9.5% of Public Debt, which equates to approximately 6.3% of total US debt. Considering China is now 12% of Global GDP, (US is around 19%) it could be argued that, a 6.3% position in U.S. debt is not unreasonable. Another reason I can argue is that if China did start to get out of their positions of U.S. Debt, then they would ultimately be flooding the market with supply and in effect hurting themselves. Still not buying???
We mentioned earlier smart vs. dumb borrowing and what would an appropriate amount of debt be. For these that say zero, I feel that’s unrealistic. I don’t see how as a country you would issue currency without a debt mechanism. It’s just not viable, however I’m yet to find any evidence as to the right amount of debt. That you can’t owe more than you own.
In fact, I’ve long held the opinion that if you can pay debt from current cash flow and keep a debt to income ratio in check then you’ve created the opportunity to utilized leverage to your advantage and increase your return on investment. What we haven’t stated thus far is the asset side of the U.S. Government balance sheet. That is reported to be over $177 Trillion, in fact a recent report by the Institute of Energy Research showed that the US owned;
- More than 900,000 separate real assets covering more than 3 billion sq. ft.
- Mineral rights, on and offshore, covering 2.515 billion acres of land, more than the total surface land in Canada
- 45,190 underutilized buildings, the operating costs of which are $1.66 billion annually
- Oil and gas resources on and offshore worth $128 trillion, roughly eight times the national debt of the country
If you equate the ability of one to borrow, surely a basis for that loan needs to be the assets of the borrower as well as the ability to repay. If these statistics are remotely accurate then our public debt to assets sits around 9%. Remember as the economy grows so does the return on our assets, which is on a basis over 177T. Am I moving the needle a little????
Another question I receive is what if they downgrade our debt and I won’t go into a lot of detail here, due to everyone reading this will remember what happened in the recent S&P downgrade after 2008 financial crisis, (which mind you was not based on the ability to repay, rather that S&P felt that the two political parties wouldn’t agree on a resolution), rates actually went down thus pushing up the price of U.S. Bonds. Despite this all the ratings agencies tend to tell you what we already know.
Can debt be an issue in the future? Sure. But I feel that the level is when we get into uncharted territory of interest expense as a percentage of revenue. That figure is 15% which is substantially higher than where we are now.
So, at this stage I’m going to rest my case and lift my hands to protect my head, like an exhausted fighter trapped in the corner waiting for the bell to ring.
Here is the Buy/Sell this week
Source: MG&A
As always please feel free to call with any questions or concerns.
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any opinions are those of Mick Graham and are not necessarily those of RJFS or Raymond James.
