LIVING IT UP UNTIL YOU CAN'T ANYMORE
Foremost, I have to warn you: this post is quite a bit lengthy. I am sorry, but each word is necessary.
Secondly, I do not mean to leave anyone out here, but this is a question that I reserve for all of my friends who came of age in the late 1990’s, here, along the unassuming bayous and waterfronts of southeastern Louisiana: do you guys remember those nights at Visions in Houma, at Bullwinkle’s in Thibodaux, at Kenny’s Key West in Metairie, or even at that mega-club known as The Plaza in Lafayette? If your immediate answer is either “no” or “vaguely”, that is not entirely surprising. I always figured that, at least for a few of you, your early twenties were probably a pretty big blur. After all, those were heady times, and we were living them up – some of us, just a wee bit more than others.
That said, though, let’s return to what you might (or might not) remember about the nightclubs that made life in our swampy part of the world so exciting. Whether you were knocking back nickel drinks at Bullwinkle’s on a Thursday night, or strolling through the crowd of well-dressed Cajuns at The Plaza on a Saturday night, there was something that was identical about all of these places: the energy, the music, and the people made for an experience that was profoundly life-affirming. The clubs were loud, filled with voices competing for supremacy against one another and a seamless and booming strand of music. The dance floors were packed with hordes of people whose bodies moved like puppets to the DJ’s symphony of sound. And overhead a festival of lasers, lights and strobes transformed otherwise dark warehouses and storefronts into the hippest places on the planet…Do you remember it now? It was clubbing as it was meant to be and, no doubt, as it would actually never be again in this part of the world.
Interestingly enough, all of these clubs had one more thing in common. When the DJ announced the last call for alcohol, all of that high energy morphed into something different, something far less exhilarating. The lasers and strobes quickly faded into nothing. That seamless and booming strand of music, one that somehow mixed DMX’s “Ya’ll Gonna Make Me Lose My Mind” with DJ Icey’s “Escape”, was also gone. In its place were a few disjointed and low-key, slow songs, and among them, as if pre-negotiated by all of these disparate DJs, was the ultimate musical downer, Eric Clapton’s “Wonderful Night”. By that time, most of the dancers were giving up hope, and only the most faithful of couples remained on the dance floor. Then, as the main lights came up and the exit door opened, DJs across South Louisiana resorted to the most awful of sign-off anthems, “Closing Time” by Semisonic. Alas, the party was over – and it seems that the warning of its ending had come with the last call.
Ah, the memories…
So, you are probably wondering why I am bringing this up. Well, on Monday, the Standard & Poor’s rating agency announced that it was losing confidence in quality of United States sovereign debt, and that in 24 months or so they would likely downgrade its rating of the nation’s creditworthiness. When I heard the news, believe it or now, the rumpus behavior of our lives as young adults in South Louisiana was the very first thing that came to mind.
Most other investors did not have the same response, I am sure. In fact, they did not take kindly to the warning from S&P, and the immediate reaction from the sophisticated public seemed a bit more visceral. On Monday, the VIX, which measures market volatility, jumped roughly 300 basis points, while the Dow closed down 1.14%. Gold prices moved up as investors sought safe haven in the metals. And the White House could do nothing more than bristled that this was a political maneuver. The selloff did not end on Wall Street; it proceeded to Tokyo, Shanghai, and Hong Kong. Most investors may have not thought of South Louisiana nightclubs in the wake of the S&P warning, as I did, but that news was tantamount to any DJ announcing the last call for alcohol to a vibrant club full of partiers and, instantly, killing the enthusiasm and energy that he helped to build.
Fortunately, by the time the markets opened in Europe, investors seemed to be calm again. On Tuesday afternoon, Wall Street was finding solace, as well, redirecting its focus to earnings news rather than the coming debt woes facing the country. All told, according to most investors, the announcement from S&P, however impactful, was a minor episode in the scope of all things trading. Investors apparently would live to party on – I mean, trade – another day.
Even if the warning was truly a minor episode, its premise does seem to deserve some attention. Just take a minute to consider the facts – or, more aptly, the AxSA factoids – which have also helped to telegraph this same message about America’s debt problems for some months now:
· 04.03.2010: When Ronald Reagan was sworn into office as President of the United States, the national debt was only $1 trillion…[N]early thirty years later, it is over $12.5 trillion, with approximately $100,000 in interest accruing every two seconds. In order to repay this colossal sum of borrowed money, every American would have to shell out about $53,000—an unlikely amount, given that the per capita income in the United States, according to the IMF, is only about $46,000 per annum. [Today the national debt stands now at over $14.3 trillion, and the cost of it to each American is about $46,000.]
· 07.03.2010: Every once in a rare while, a leader of the free world seems to utter statements that, both, ring of absolute truth and capture the import of the difficulties we face. So it was, during the G20 summit, that President Obama said, “We have to be mindful that the debt and deficit levels that many advanced countries have right now are unsustainable and have to be dealt with in a serious way.” His words are more accurate than most people realize, particularly in the United States, where our nation’s debt burdens is now being described as “beyond excessive”. The total debt of our nation, in Q3 of 2009, amounted to $3.70 for every one dollar of economic output, and that was up from a total debt at roughly $3.50 to every dollar of GDP just three years prior. The last time the U.S. experienced such enormous levels of total debt was in 1933, when it peaked at 300% of GDP, while the nation was mired in its deepest depression. Perhaps the history of vast and unsuccessful government-spending efforts in that time will provide a solid lesson to this president, if he is, in fact, sincere in his commitment to return the republic to fiscal sanity and stave off the likelihood of a debt crisis.
· 11.13.2010: Fifty percent of our national debt is held by sovereign and private interests beyond our borders. The average maturity period for outstanding United States Treasurys is currently 58 months. Servicing a heavy debt load such as ours, which stands at almost $14 trillion, is an arduous task, and it will ultimately have profound implications on every American. To illustrate, in 2012, alone, the United States will need to roll over approximately $1.2 trillion of that national debt. This means the government will have to issue new debt to replace the amount coming due at that time, simply because it will lack the ability to pay it outright, and in doing so, it will increase the supply of outstanding U.S. debt in the marketplace. To entice the market to buy these new issuances, the government will have to raise the yields paid on the debt, thereby impacting interest rates and raising the likelihood of new taxes in the years to come.
· 01.07.2011: As a whole, Americans pay the equivalent of 14% of the nation’s annual economic output in the form of federal taxes. Coupled with the equivalent of 1% paid by corporations, today’s federal tax burden is the lowest that it has been in sixty years. Meanwhile, government spending is much higher, totaling 25% of GDP. Hence, year after year of whopping deficits. Understanding the unsustainable nature of this glaring disparity has not been easy for most elected officials, but a number smart people from different sides are beginning to articulate a common approach to resolve our dilemma. From the right, individuals like David Stockman, a former Reagan budget director, has railed against the Bush tax cuts, and has advocated major cuts in spending, lest we face, in his words, “global monetary conflagration”. And from the left, even Howard Dean has called the need for a balanced budget “a big priority”, adding “We cannot have programs that aren’t paid for; we cannot have tax cuts that aren’t paid for.”
· 03.12.2011: The budget battle in Washington is truly one being waged over the nation’s spending priorities. That is because, at present, the federal government spends $300 billion per month, and $120 billion of that amount per month must be borrowed. What’s more, in order to accommodate for the spending proposed in the President’s new budget, the federal debt ceiling, now thought of as a quaint suggestion, rather than a definitive line, will have to be lifted from $14.3 trillion to $26 trillion over ten years.
The facts are pretty hard to dispute. Investors and the general public can go on partying like a bunch of crazed twenty-somethings for as long as we think we’re able, but a day of reckoning is coming. More and more DJs are going to sound the clarion of last call, and all of the carefree partying is going to come to an end, for good.
“HOW DID WE GET HERE?”
Once he heard about the S&P announcement for himself, a close associate, Edmund Fos, asked me if there was any one moment that really marked our descent down this perilous road for fiscal insanity. Rather off the cuff, I gave him an answer, but as time passed, I thought better of it, and I realized that that answer was wrong. Sure, there is a defining moment, but few of us will even remember it, because it occurred in earnest over twenty years ago.
In a GOP primary debate, on April 24, 1980, then-Gov. Ronald Reagan and George H. W. Bush squared off over Reagan’s plan to cut tens of billions in taxes, while boosting defense spending, and while also hoping to balance the budget in tandem. Reagan claimed that the tax cuts would result in greater personal and commercial prosperity and, hence, additional federal revenues from income taxes on this new private wealth. However, Bush, who supported in a balanced budget before tax cuts, was not sold on his rival’s idea; he contended that the Reagan tax cuts would only result in “deficit after deficit”, as government remained deprived of the money it needed to function. (He later called Reagan’s approach “voodoo economics”.) But for all the sense that Bush seemed to make at the time, Reagan used plain-spoken rhetoric to appeal to the American people. Republicans quickly fell in love with the Reagan Gospel of Prosperity, and he, not Bush, was headed to the White House in January, 1981. Ironically enough, however, Reagan did get it wrong. Though the economy grew substantially, his approach only secured about 8% on average in federal revenue growth, and the national debt, thanks to big spending, climbed from nearly $1 trillion to $2.85 trillion. In short, one debate opened the doors to a new period of sovereign indebtedness in the United States.
We had a bit of a reprieve in the 1990’s under William J. Clinton, a Southerner who came to office under the banner of a New Democrat. He was an advocate of deregulation, a supporter of a balanced budget, and an opponent of the trickle-down Reagan Gospel of Prosperity. During his two terms as POTUS, Clinton reformed welfare and, among other things, cut military spending; he ended Glass-Steagall, which deregulated banking and investment firms; and he passed NAFTA into law. (You probably could not ask for a better Republican disguised as a Democrat.) More importantly, years of political brinkmanship between the Gingrich Revolutionaries and Clinton left the country with a budget surplus, one of the few times when our tax revenues exceeded governmental expenditures. Unfortunately, that great moment would not last long.
Enter George W. Bush – brash, unapologetic, Texan.
To Bush, a surplus was all the more reason to return money to the people’s wallets. Once in office, he cut taxes, famously, to the tune of $1.35 trillion dollars. Said this President, “Across-the-board tax relief does not happen very much in Washington…In fact, it has happened only twice: President Kennedy's tax cut in the '60s and President Reagan's tax cut in the '80s.” What Bush neglected to mention, of course, was that, under both of those Presidents, such huge tax cuts resulted in terrific amounts of deficit spending. (Kennedy’s plan was implemented under the Johnson administration.) The very same would be true for his own presidency.
During his first year in office, Bush found cause to actually go against the Republican edict of limited government, which was necessary when operating with a small pool of federal revenue. The events of 9/11 moved his administration into a war footing against an ideology and its shadowy army. To combat this foe at home, Bush created the colossal Department of Homeland Security, as well as beefed up spending on intelligence and in other arenas. The American people did not seem to mind, because they wanted this enemy vanquished, and because they also were not paying for this war directly. Indeed, while American soldiers went into combat, the American people at home were enjoying cheap piles of credit, and they were out making their own new debts. To go after the bad guys, Bush needed to fund two ground wars, as well as any number of other classified ones, and Congress gladly passed his annual supplemental packages “for the sake of the troops”. All of this, a nearly 4% increase in government spending in eight years (with the disappearance of a Clinton surplus), was made possible with borrowed money, and alas, the son gave the nation what his father feared most – “deficit after deficit”.
Exhausted from war and mired in debt, the nation sought “Change We Can Believe In.” Barrack Obama seemed to be the embodiment of that change. He was cool, charismatic, intelligent, and seemingly driven to restore Hope to a nation that had exhausted so much of its own. In fact, at the Democratic National Convention, in 2008, Obama said, “…And we are here, because we love this country too much to let the next four years look like the last eight.” The nation (and even yours truly) agreed, and in a historic election, Barrack Obama became America’s first minority President.
Unfortunately, the only real change that followed the spectacular inauguration of this president was, ugh, almost indiscernible, particularly when it came to the nation’s indebtedness. For his own part, Obama doubled down on this same spending trajectory as his predecessor. In fact, following the passage for a large, albeit terribly misguided, stimulus bill meant to bolster a wrecked economy, he quickly angled for a budget with the most enormous deficit ever seen in the country. Unflinching, Obama and his ilk muscled forward, and he also continued the use of big war supplemental packages to fight the same wars, while pushing out the massive reform bills for finance and healthcare. For all of this, like his predecessor, Obama borrowed heavily, contending that it was necessary in order to correct the economic disaster that he inherited. In fact, Obama had borrowed so much in his first 1.5 years in the White House that his own Democratic Congress feared passing his 2011 budget before their own elections (which many did lose in the House, anyway), and his emissaries from the U.S. Treasury and State departments had to routinely travel to China to court favor with our benefactors (who still lectured us on the perils of overspending).
THAT LAST HOUR
For anyone who is accustomed to Southeast Louisiana nightlife (beyond Orleans Parish, that is), 1:00 AM tends to have a pretty significant meaning. It typically marks the last hour of your partying on for the night. Consequently, if you are having a pretty good time, you’re probably going to do everything that you can to live it up until you just cannot do it anymore, when that DJ says “last call”. Well, for the politicos in DC, as well as the traders and financiers on Wall Street, this is that last hour.
Prior to the warning from S&P, many smart people had an idea that a day of reckoning with our sovereign indebtedness was on the horizon. In fact, it was largely evident. The Tea Party movement spread in response, primarily enough, due to the concerns about spending. However, that did not change matters much. The Federal Reserve accommodated the federal government’s largess by printing dollars and buying up hundreds of billions in new debt. Indeed, the party was going strong, as Wall Street took much of that new money (which cheapened the overall value of money), and they piled into assets of all types, from metals and oil to stocks and land. “Who cares about fiscal responsibility if we can print our way out of the problem?” one investor-partier might exclaim, and then he would add something that might suggest that all of the new money was needed to get the economy going again. Indeed, this was, and is, the posture of the Fed and so many others. Inflationary pressure, be damned (but that’s a blog for another day).
As an operating entity, the federal government currently spends $300 billion dollars per month, and as stated earlier, it borrows $120 billion of that amount each month just to meet its spending obligations. Of course, any rational person would tell you that this is unsustainable, and without a serious thrust from DC politicos to fix this problem, the inevitable consequence of traveling down this path is a debt crisis. This is why S&P questioned the quality of our debt, because no one is taking serious action to rectify the problems that we face. In fact, until very recently, Congress and the President tended to put off any real discussion about budget cuts and austerity, and now, as they do take up the issue, even just rhetorically, we can see that both sides are too far apart to make a real and substantive difference any time soon.
The reality of our situation, though, is simple and pretty irrefutable. Our country takes in 15% of its economic output, annually, in the form of tax revenue; however, it doles out 25% of GDP in the form of government spending. No matter how you do the math, this only adds up to “deficit after deficit”, and those yearly deficits add to a national debt that stands at over $14.5 trillion, today. Of course, some politicians would contend that “deficits don’t matter”, but any rational person, again, would be rightfully cynical about that way of thinking. The fact is that deficits do matter, because, just like in any hot nightclub, at some point, the music will have to come to a stop.
To be sure, the kind of change that we need is not easy to make. While some say the answer is to simply institute more tax cuts and spending cuts, we all know now that we will not be able to cut enough of today’s spending to match federal revenues. Why? Well, history notwithstanding, we only need to look at how money is spent by our federal government. Nearly 64% of federal spending goes to entitlement programs, while another 20% goes to defense spending. And with all of that, only 6% has gone to the repayment of our debts. Together, that comes to 90% of spending, and every penny of that is defended to the death by one constituency or another. Moreover, the things politicians have been so keen to fight over – NPR, foreign aid, NEA, school lunches, Planned Parenthood, etc – those things don’t even come to ten percent of federal spending, and as such, they represent the easiest target for feckless politicians who would rather not deal with the juggernauts, but who also still need voters to think that they are doing their jobs.
Clearly, the solutions to our problems will not come until both sides of political spectrum realize that no one will get what they want. We will have to have significant spending cuts. We will have to bolster federal tax revenues, as a percentage of GDP, by reforming the system and collecting more money…But any politician who actually campaigns on such a platform isn’t likely to stay in office for long, if he makes it there, at all.
The music is thumping, and the crowds are jumping to the beat. The borrowed dollars are flowing, and the government is spending. There really is no difference. Whether on a bustling dance floor or in the corridors of power, reality can be easily distorted, but when the party is over, it truly is over.
S&P surveyed the precarious situation of the U.S. government for 928 days, according to a recent article from Reuters, and following the latest battle over funding measures intended to carry the government through October, the ratings agency became disenchanted with what it saw. Citing all of the differences between the political parties in power – what one S&P executive called “the gulf” – the agency believed it prudent to discount any hope for an expedient series of resolutions over the nation’s long-term debt problems. However, such efforts to address spending are necessary, particularly as the nation continues to push forward to raise yet more new debt and to over-leverage itself far beyond its current degree of indebtedness.
As the quality of our debt erodes, there will be consequences. Fortunately for us, I am hesitant to believe that a downgrade of our federal creditworthiness, on its own, will result in a full-blown debt crisis, or even one of my prophesized mini-crises, for that matter. In fact, because an announcement like this one was made far in advance of any actions, the astute investor seems to be getting enough fair warning, and like any good clubber, he will check out, hopefully with profits, just before the party ends and before confusion spills out onto The Street. That said, though, we should not be surprised to see, over the next two years, an uptick in the unloading of U.S. debt from the portfolios of many institutional investors. (Some simply cannot hold debt with less than AAA ratings.) This will, of course, raise the cost of borrowing for our federal government, because it will have to raise the interest rate on its new debt in order to attract buyers. That, in turn, does impact the average American borrower, who will, among other things, see his own mortgage rates rise, because they are directly tied to the rates on the 10-Year Treasury bond. Indeed, at the point, the age of cheap money will be coming to a close. The party will be ending.
S&P was right to raise questions about the creditworthiness of our nation and, inadvertently, about the seriousness of our politicians in confronting the mess we have made. After all, there is no greater threat to this nation than the fiscal disorder of its own house. We have strolled over to the bar and borrowed and borrowed, unabatedly, for too long, both as consumers and as governments. At some point, we have to end the night, or have it done for us. Indeed, if our leaders will not take up the cause of correcting our course, then the markets surely must…We should just feel grateful that we got a two-year warning, a last call - probably the first of many - before someone shut down the party and took it elsewhere.