Debt, Denial, & Illusions: America Has a Spending Problem

Driving by Cherry Creek High School in Denver, you may notice a sign by the road that advertises “bus drivers wanted, $23 per hour plus benefits.” Even though it is a part-time job, that annualizes out to $48,000 per year full-time. This isn’t a problem only at Cherry Creek, many kids have been forced to find other modes of transportation to school. In Denver, if you want to take the train to commute, help the environment, or avoid traffic, good luck predicting when you will reach your destination. Trains are canceled throughout the day because they can’t find enough operators. RTD is offering $4,000 signing bonuses and $24 per hour plus benefits for new hires. That equates to over $50,000 per year. Neither of these are glamorous jobs, yet a dual-income family could easily earn $100,000 per year. There is an abundance of entry-level jobs, even while parts of the economy are suffering.

 

 

Inflation is having a real impact on the economy. A carton of organic eggs costs $10, gasoline is once again over $4, and the cost of a $400,000 mortgage has gone from 3.5% two years ago to 7.4% this week. That translates into an extra $1,000 per month in interest payments. Consumers are uneasy about inflation and are unsure how this will get resolved. Meanwhile, Washington hasn’t offered any solutions.

 

 

In the 2023 annual budget released by The Office of Management and Budget at the White House, there is a projection for the annual interest cost of the national debt to be $400 billion this year. They project that in 2027 interest payments will be $729 billion on the nation’s debt. If you perform a simple back-of-the-envelope calculation, you quickly come to the same conclusion that the Apollo 13 crew is known for saying, “Houston, we have a problem here.” In 2003 total public debt was $6.4 trillion, now it is over $31 trillion. Our national debt has grown at the rate of 8% per year over the last 20 years, which is not sustainable considering the economy only grows by around 5% per year. The average maturity of our debt is approximately five years, and interest rates, the cost of that debt, have increased significantly since last year. If you assume 1.5% as the average interest rate on the debt two years ago, you arrive at the current $400 billion budget number. Assuming 4.5% in 2027, which would be five years of our current interest rates, our debt costs could easily be almost $2 trillion or 35% of the budget. Unlike NASA who immediately set about solving the problem, we as a nation don’t seem willing to admit we have one. Even worse, the budget predicts we will run 5% annual deficits out to 2032. Why is the government willing to forecast much lower interest rates in 2027 but unwilling to forecast spending less money? From 1929 through 2008, the budget deficit averaged 1.7% and rarely reached 5%. After 2008 deficits started to climb but low interest rates made them easy to finance. Those days are over and this brings us back to those undesirable jobs.

 

 

China was once the growth engine of the world. The Chinese economy used to add more to incremental global growth than the US economy because even though it was smaller, it grew much faster. Now they have a big problem. According to the Chinese National Bureau of Statistics, youth unemployment (ages 16-24) is 21% as of June 2023. However, Peking University estimates it to be closer to 40%. In response to these unpleasant statistics, China has stopped reporting monthly consumer confidence after 33 years, and now also the youth unemployment numbers. According to the Shanghai Academy of Financial and Legal Studies, “Young people aspire to go to big cities,” they want well-paying jobs in technology, education, culture, and entertainment. Does this sound familiar? The economy isn’t doing well but jobs remain unfilled. China’s situation is more dramatic than ours, but neither country’s youth want an undesirable job. China’s lower growth may eventually become a drag on our own economy in the coming years, they clearly have debt problems of their own. There are a few takeaways from this not-so-rosy scenario.

 

 

We are a very entrepreneurial society. Technology gains, and/or some form of AI may fundamentally increase productivity. We should also never underestimate the power of the average voter to demand change when they start to feel an issue’s impact on them specifically. Based on global economic events and the inflation in your local store, we may be getting close to that inflection point. Ideally, Americans will view 5% deficits as unacceptable for the next 10 years. Politicians only change when they feel they must, and both parties are responsible for our current plight. Fortunately, Corporate America has learned to adapt.

 

 

From 1972 to 1982 interest rates rose from 5.9% to 14.2%. From June of 1972 to June 1982 earnings for the S&P 500 grew from $5.97 to $12.64. The market experienced little price gains over that period, however, with reinvested dividends returns were 7% annualized. The 1970s were a tough decade to invest in, but Corporate America responded. Investing in bonds is hazardous in inflationary times as we saw last year, and owning low-quality investments could become very challenging as the country resolves its debt issue— it may not go smoothly. We have an extremely dynamic economy that has millions of interconnected pieces; however, corporate America always seems to figure it out. Plus, if it gets bad, you can always drive a bus.

 

Observations On The Market No.386