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BWC Market Update - September 16, 2016

“If something cannot go on forever, it must stop.”
- Herb Stein (Chairman of the Council of Economic Advisors, 1972-1974)

The U.S. national debt is now approximately $19.5 trillion. I say “approximately” because it has been growing at a rate of $2.5 billion per day for the past five years! This cannot go on forever, or even too much longer. According to the Congressional Budget Office (Wall Street Journal, August 2, 2016), over the next 30 years interest on the national debt alone will total $55 trillion. This exceeds Social Security spending ($14 trillion) and Medicare spending ($34 trillion) combined over the same period. By comparison, the net value of all assets held in the U.S. by both individuals and businesses is $121 trillion. How is this going to stop? From our perspective, there are only four alternatives.

One, grow our way out. This is simply impossible. Even 20 straight years of 3.5% growth (which has never been achieved), starting now, would only add $55 trillion in cumulative national income (vs. 2.5% growth, which now seems hard to achieve). At current tax rates, this would yield about $8 trillion in total Federal taxes over the period (and current tax rates actually inhibit such growth). Simply not enough! We are just in too deep a hole to dig our way out. And, in any case, just last week the Fed lowered its long-term growth forecast for the U.S. economy to 2% per annum. To be clear, higher growth would be very good (and help alleviate other problems), but it just can’t solve the debt/debt service problem by itself.

Two, shrink our way out. That is, reduce government spending dramatically so (1) the deficit stops growing, and (2) we can use the freed up resources to pay down the debt. This is wholly unrealistic. The aforementioned Social Security and Medicare spending alone makes significantly shrinking government expenditures impossible. Keeping these from growing exorbitantly with our aging population will be challenging enough. Add in defense and security spending, even at a reduced level, and government isn’t going anywhere!

Three, default. While always an option, it is really unthinkable. A default by the United States, the largest economy on the planet and the backer of the world’s reserve currency, would not only roil markets in apocalyptic ways, it would likely lead to a major worldwide depression in addition to many other bad outcomes (wars, social unrest, etc.).

Four, inflate our way out. This tried and true strategy has been employed in the past and is, in our opinion, the only realistic way to prevent financial Armageddon. At the end of World War II, the U.S. national debt stood (for the first time) at over 100% of GDP, as it does today. Over the ensuing 35 years, investors in U.S. Treasury Bonds lost a cumulative 91% of their purchasing power as inflation eroded their real value at an average rate of 2% per year (The Economist, October 19, 2013). And the economy grew at a rate that now seems unsustainable throughout this post-war period (see #1 above). A 50% default would have been significantly more preferable! It is almost certain that over the next generation we will see a sustained inflationary period. This alternative appears to be the only feasible way to defuse the debt bomb we have ignited. There really seems to be no other feasible option.

That said, what is the policy prescription for investors? Keep bond holdings to a necessary minimum and hold equities, using dips in the market as entry points. It may take the Fed a while to induce the necessary inflationary pressure, as witnessed by the struggles of European and Japanese central bankers to fend off deflation, even with negative nominal rates. But at some point, the realization that we cannot go on forever living off debt will force their hand and the current nonsense should stop.

About Beirne Wealth Consulting Services, LLC
Beirne Wealth Consulting Services, LLC (“BWC”) is a growing, privately owned, SEC Registered Investment Advisor with about $2 billion in assets under management and over 25 employees in Connecticut, Pennsylvania and Florida. BWC provides independent, fee-based investment management services and customized financial planning solutions. Our institutional business provides consulting expertise to defined benefit and defined contribution plans, endowments, foundations and non-profit organizations. Our private clients include high net-worth individuals and prominent families, many of whom bring complex wealth management challenges and multigenerational planning needs. For more information, please visit www.beirnewealth.com or give us a call today at 888-231-6372.

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