Government Debt: A Parasite Consuming the Economy

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‘Nothing can be created out of nothing’
Lucretius

‘This is what I call Gundlach’s Rule of Investment Risk. If you run things and you try to get them very smooth, without ever any downside, you’re trying essentially to eliminate the frequency of problems.  I believe the frequency of problems times the severity of problems when they occur equals a constant. Frequency times severity equals a constant.  That is Gundlach’s Rule of Investment Risk.  When you try unnaturally to push into the future problems, and quantitative easing is designed to do that, you end up increasing the severity of the problem.’
Legendary investor Jeff Gundlach

Titus Lucretius Carus was a Roman poet and philosopher who died in 55BC.

Jeff Gundlach runs the highly successful US$50 billion DoubleLine funds management company.

What does an ancient poet have in common with a billionaire investor? They both agree you cannot manufacture something from nothing. There will be a price to pay for this conjuring.

Gundlach has made a fortune from investing in bonds (debt issued by government). His continued investment success is highly dependent upon him understanding the machinations of the US government bond market — how the market evolved, maturity dates, the prospect of further issuances, interest rate movement, etc.

In 2012, Gundlach delivered a controversial presentation comparing the United States to the Roman Empire. Gundlach’s presentation went into great depth on where the trillions of dollars of government debt have been spent (or, more accurately, squandered). Defense, health, and welfare (the big three) have by far been the major drains on US tax dollars.

The government may have accrued the debt, but the debt servicing obligation belongs to each US citizen. The following chart from Gundlach’s presentation shows the household debt load that has been foisted upon the shoulders (wallets) of US citizens.

In the 1970 s, a median household income of $44, 762 supported a national debt per household obligation of $20,564.

In 2011, median household income had risen 13% to $50,876 while the national debt obligation went stratospheric with a more than 400% increase to $84,793.

The only reason this imbalance can be supported is due to the reduction of interest rates over this period from 15% to 1% .

When money is virtually free, you can have as much of it as you like — which is precisely why an app company with non existent revenues can be valued for billions of dollars. The problem with this exponential debt scenario comes when the cost of money rises.

Years of soaring national debt

click to enlarge

If we go back to the chart, you’ll see the inset chart shows the areas of expenditure that would both enrich society and ensure continued service quality — research and development and Infrastructure spending — declined over this period. These are not vote winners.

The US defense and medical sectors are very powerful lobby groups, while welfare spending is a guaranteed vote buyer.

The parasitic nature of the big three drained the host.

Gundlach believes this is the parallel with the Roman Empire’s demise — the cost of the empire’s military might together with its society- placating projects becomes too much for the tax base to support.

In the time since Gundlach produced this chart in 2012, the equation has deteriorated further — debt level per household has increased while median income has stagnated.

To ensure the masses remain sedated and unaware of the tax burden they are accruing, Gundlach has correctly identified the policymakers’ ruse to ‘eliminate the frequency of problems’. In essence, it’s a policy of ‘do anything to ensure the natives aren’t restless’.

The near obsessive desire of policymakers to avoid the hard decisions on how best to manage the debt in the system and reigning in expenditure is only pushing these serious problems into the future.

And when that future problem arrives, as Gundlach notes, you end up increasing the severity of the problem.

As a professional bond investor, Gundlach appreciates the potential price to pay for the Fed’s efforts to create something from nothing . The bond market has in the past, and can in the future, react quite violently to unexpected shocks.

What price will be paid in the future is unknown, but in the past it has been in the form of rising interest rates — investors demanding more return for the increased risk.

Rising bond rates would wreak havoc on the capital values of bond portfolios and this, I suspect, is what keeps Gundlach up at night.

Gundlach was well aware you get nothing from nothing when he said that, ‘While these efforts may limit economic volatility in the near-term, it never eliminates the risk. Ultimately, you end up with much larger imbalances later.’ The equal and opposite forces that exist in our universe ensure balance will be restored — no matter how unpleasant that process may be.

The Fed has tried to create something out of nothing — the elimination of market volatility using ex-nihilo money.

Over 2000 years ago, Lucretius knew the concept of something from nothing was not possible. Yet the Fed persists in trying to prove otherwise.

The reality is that when the severity of the problem manifests itself and triggers the expected chain reaction in markets, we’ll likely find that all the US Federal Reserve’s efforts amount to something worse than nothing.

The financial carnage and social unrest is likely to be more severe than would have otherwise occurred if the Fed had left well enough alone.

The only good thing to come from this nothing from nothing scenario is the prospect of cashed up investors being able to take advantage of the greatest discounted asset sale in their lifetime. Then, in time, a little something will turn into a much greater something.

Regards,
Vern Gowdie
for The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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5 Comments on "Government Debt: A Parasite Consuming the Economy"

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Jason
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This debt cycle is a cancer!

At some stage this debt ponzi scheme will fail. Currently the entire economy is based on expanding debt with obligations to pay it being passed on to the future but the day will come when oil production begins to fall and the future prospect of repayment falls as ‘growth’ becomes impossible, then the entire fiat currency ponzi scheme will collapse.

slewie the pi-rat
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Pox Americana?

Mark Tomarket
Guest

What’s to say the vested interests who have engineered this mess and continue to control interest rates, won’t keep them at all time lows and try to inflate their way out? They seem to be very slow if they’re the same guys who will be cashing out, jacking rates up and then buying back in at much lower valuations. I suspect they sit in the former camp, such is their delusion.

Ross
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Reagan-Volcker gave you the public debt J curve enabled by exporting US factories & inflation; and following we had the Clinton-Rubin/Sumner J curve enabled by the private funny money.

Both extreme gorge now on new debt for the benefit of the 1% and pay later by the taxpayer solutions that doubled down on dividends for the 1% when the bail out calls came.

After the GFC? Another solution – call it the balance sheet baloney & double down on the air for collateral bailout solution.

Patterned solutions? No, just patterned systemic degeneration.

Lachlan
Guest

Contemplating the scale of the universe, is it measurable even, and the inevitability of all that is, and mankind’s vanity barely seems wasting a thought on.
Now back to the credit bubble…

wpDiscuz
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