Barron's Streetwise - Should Investors Worry About the U.S. National Debt?

Episode Date: September 20, 2024

Jonathan Pingle, Chief U.S. Economist at UBS, weighs in. Learn more about your ad choices. Visit megaphone.fm/adchoices

Calling all sellers, Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. The US's ability to inflate their way out of this debt is in my view, not a realistic scenario. The extent to which we erode the value of the dollar

actually undermines our economic strength as well as things like the credibility of the dollar actually undermines our economic strength, as well as things like the credibility of the central bank and its ability to manage business cycles effectively. Hello, and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard is Jonathan Pingel. He's the chief U.S. economist at UBS. And in a moment, he's going to tell us all about the national debt. What can be done, if anything, to fix it? How big of a problem is it for investors? Listening in is our audio producer, Jackson hi jackson hi jack we're pulling a little slight of hand here with this episode the podcast will be off for a couple of weeks i had this interesting conversation with jonathan back in august and we're going to play that conversation

for listeners i wouldn't exactly call it a slight of hands mean, it's kind of a ruse, more of a scam. No, no. Don't they record like all of Jeopardy for the month in one day and just make everyone change clothes a bunch of times? You make a good point. This is we're doing it like the pros now. OK, but the important point is that we are recording this before the presidential debate. So we don't yet know how much the candidates will talk about the debt. I was struck by how little they talked about it over the summer at the party conventions.

And I contrasted that in Barron's with what happened just over 30 years ago. Here's then Governor Bill Clinton at the 1992 Democratic National Convention in New York City's Madison Square Garden. He promised to balance the budget, but he hasn't even tried. Clinton at the 1992 Democratic National Convention in New York City's Madison Square Garden. He said he promised to balance the budget, but he hasn't even tried. And he said, in fact, the budgets he has submitted to Congress nearly doubled the debt. See, that's good old fashioned fiscal mudslinging. And I must say, I miss it. It was directed at President George Bush, the elder who fired back a month later from the Republican shindig at the Houston Astrodome.

He said he has already proposed two hundred and twenty billion dollars in new spending, along with the biggest tax increase in history. One hundred and fifty billion dollars. And that's just to start. 150 billion dollars and that's just to start. All of those statements from both candidates were, let's call them truth adjacent, but not quite what I would characterize as truth. I mean, the debt under Bush didn't actually double. It did grow 72 percent and Clinton's proposed tax increase was smaller than Bush said, if you netted out some targeted tax cuts. Call the statements directionally true-ish. The backdrop that year was a $290 billion budget deficit. We're all clear on the difference, by the way, between deficit and debt, right? The debt is the amount you owe. The deficit is the amount by which you go further into the hole

each year. So if you hear a candidate for some office talking about the possibility of shrinking the deficit, they're not talking about making us owe less. They're just talking about slowing the rate by which we're going further into the hole. Okay, so $290 billion budget deficit back during Clinton-Bush, and that was the largest ever in nominal terms, and it was equal to 4.4% of the economy of gross domestic product. And as I wrote in Barron's, imagine two politicians having the decency to smear each other over numbers that today seem so manageable. It's as quaint as a knee patch on a kid's play pants or a bowl of lollipops at a bank teller's window. I'm old enough to remember the lollipops at the bank. Are you, did you ever have a knee patch? You ever have a patch in your play pants? No,

I don't think so. I'm pretty sure I had a patch on the patch on my Sears tough skin size Husky pants. I didn't need to say size Husky. I'm now realizing Jackson marked that down as an overshare. I'll definitely edit that out. So I promise. All right. So we all know what happened next. Clinton won the election and Republicans two years later, flipped both houses of Congress.

Federal spending fell as a percentage of the economy, and deficits eventually turned to surpluses. The debt shrank over three straight years ending 2000. And both parties can claim credit. And there were some external factors like a rip roaring stock market that produced capital gains taxes. I don't know if people remember just how chipper the outlook on the debt became at one point. Here's a quote by Federal Reserve Chairman Alan Greenspan in 2001. He said,

current forecast suggests that under a reasonably wide variety of possible tax and spending policies, yes, Chairman Greenspan, don't beat around the bush, let's get to it, quote, the resulting surpluses will allow the treasury debt held by the public to be paid off. I added the dramatic pause. Paid off as in no more treasuries. There was talk about whether that might be disruptive to the bond market because investors have come to rely on treasuries as a benchmark. How do they solve that problem? They solved it thoroughly. It's no longer an issue, I can assure you.

The U.S. debt recently was over $35 trillion. That's a lot of treasuries. There's no talk of paying it down today or even really holding it steady. For the fiscal year ending in September, the last forecast I saw was a deficit of $1.9 trillion. That's 6.7% of GDP. Remember, that compares with the 4.4% figure back in 1992 that was the talk of the town. Here are some more not-so-fun facts. of the town. Here are some more not-so-fun facts. Yearly interest on the debt is already surpassing military spending. I saw one forecast that interest on the debt could double over the next decade to $1.7 trillion. That'd be like having a second Medicare. Is this the worst it's ever been? Well, we're headed there soon. In 1946, U.S. debt hit 106% of GDP. We had some things going on at

the time, World War II. We had to arm 16 million Americans to fight a 70-nation war. Thank goodness we don't have to do anything like that today, although we'll still top our World War II debt to GDP record by 2028, according to estimates from the Congressional Budget Office. And its estimate is probably too sunny. We'll probably get there a year or two earlier. Here's why. There's something called the 2017 Tax Cuts and Jobs Act,

or some people call it the Trump Tax Cuts. And key parts of that are set to expire after 2025. If we wanted to fully explain why, we'd have to bring back that anthropomorphic bill from the Schoolhouse Rock cartoon. Jackson, can you sing a quick bar? I'm going to pass on that one. I'm just a bill sitting here on Capitol Hill.

Only we need to update the lyrics to talk about reconciliation and the bird rule. The upshot is that temporary stuff is easier to pass in Congress. So in 2026, taxes are set to go up. And you can argue all you want that tax cuts that are not fully paid for with corresponding spending cuts and which result in higher debt, that those are more like credit card advances, so that when they expire, it's not really a tax hike. You can argue that if you want, but as I wrote in Barron's, that's like bringing a knife to a you're raising taxes fight.

So no matter which party wins in November, the TCJA, Tax Cuts and Jobs Act, is getting extended. The only question is, how much of it? As things stand now, we're headed for $50 trillion in debt by 2034. If you fully extended the TCJA, you could add another $5 trillion to that. UBS predicts that we'll take out that World War II debt record in 2026 or 2027. It depends on the election outcome, but either way, it ain't great. And that is enough of an opening spiel for me. Wouldn't you say, Jackson, time to get to my conversation with Jonathan? You're going to say after this quick break, aren't you? Yeah, after this short break.

You said short break just because I said quick break. You're trying to throw us a curveball, i gotta establish my own brand i'm learning a lot here and the break will be especially short and quick for everyone who just hits the fast forward 15 seconds button during the ad we don't we don't talk we don't talk about that we forget that part we'll be back after this not that quick break. Welcome back. Jonathan Pingel is the chief economist at UBS. I spoke with him in August about the U.S. national debt and what could be done about it, what it means for investors.

Let's hear part of that conversation now. Have we passed the point of no return? Is there even a point now of being concerned about these numbers? Is anything here fixable? It looks to me like the size of the deficits, it's on a one-way trip to just being unmanageable. Yeah, I mean, I would agree. It is, I think, headed on a one-way trip to being unmanageable. I mean, that's a little bit different from, is it fixable? You know, I think there are probably policy choices we could make that, you know, could address a lot of that trajectory, but they're tough choices. I mean, there are, you know, decisions are going to have to be made, they're going to have to be interests that are prioritized. And that's not always an easy thing to do. But we can debate whether it's a three-year problem, a 10-year problem, 20-year problem.

But at some level, the math is unmistakably unsustainable. And how do we know when we're going to get there? We can see the example of other countries who maybe have a bigger debt figure as a percentage of GDP, but different dynamics. I mean, I guess the bond market doesn't seem panicked right now. How do we know when the numbers are going to get so large that something important could go kablooey? Well, everybody's always asking me, when does it break? And I think if you're waiting around until it breaks, you've already taken on board a lot of social cost. Just look at last year, last fall, we saw a 20 basis point move in treasury market term premium. So that's the share of the bond yield that's sort of unrelated to future policy by the Fed or inflation,

that really moved quite a bit around the November Treasury Department's refunding when they said that they were going to curtail the amount of bond issuance they were going to deliver to the market in the coming quarters. I mean, that's a sign that the bond market is actually starting to wake up and pay attention. And if you think about 20 basis points, I mean, that's 0.2 percentage points. I mean, they may not sound a lot to somebody, but you know, I mean, if we were going and getting a 30-year fixed rate mortgage, I think we'd prefer two-tenths of a percentage point lower mortgage rate than otherwise. So it is something where the bond market's starting to care. And over time, that risk's getting worse, even on the way to something breaking. You have some projections in here about how things might go under a red sweep, how things might go under a divided government. In your report, it says that the deficits might

be a little bit bigger under a red sweep. The difference seems like a smidgen on top of numbers that are just gigantic. How would you characterize the potential difference? Right. So what I mean by that is, you know, the 2017 tax cuts expire at the end of 2025. You know, the CBO has estimated that if you count both the cost of fully extending the existing tax code plus the added payments on that debt, that's $5 trillion over 10 years. So that's a big cost to extend the existing tax code for 10 years. Otherwise, taxes go up on a lot of people, including the standard deduction. So it affects a pretty wide range of the income distribution. Now, our assumption was that Republicans would generally want to extend the tax cuts. But the Democrats and President Biden

have also been quite clear that they don't want taxes to go up for households making under $400,000 or $450,000. That's the bulk of that cost. If the two parties are going to agree on that, it's going to be more debt to GDP and higher deficits than the CBO is projecting under either of those political outcomes. When people put money away for retirement, they can get the tax break now, or they can stick it into a Roth account and they can, you know, have the money come out tax-free down the road. And I heard someone say, hey, you know, your taxes are going to go up later. They're going to have to look at the deficits, look at the debt. So you better take the deal where you get a tax break later because

the rates might be sky high. Is that sound thinking that if you're projecting 20 years down the road or more that you can expect that your tax rates might be much higher than they are today? You know, when we look at some of the options for some of the fiscal problems we face, and a good example of this is, you know, we're expecting the Social Security Trust Fund to be exhausted in the early sort of 2030s. And at that point, you're going to have real decisions to make whether or not, you know, benefits to all recipients of Social Security get cut, or we find another method of funding. And one of the

most straightforward solutions would be to say, raise the cap on taxable earnings and increase taxes in order to fund Social Security. So, you know, when you look at a lot raise the cap on taxable earnings and increase taxes in order to fund Social Security. So, you know, when you look at a lot of the options on the table, you know, Republicans make the case that revenues over time have been, you know, pretty flat as a share of nominal GDP running about 18 percent or so. I think that was the average from 74 to 23 and about where it is now. And it is the true that spending is what has been trending higher over the course of the

last decade and has been expected to continue to. But a lot of that's mandatory spending on programs like Social Security and Medicare that people have come to depend on. So if we want to maintain those programs, one of the solutions is clearly higher taxes to pay for them. I've heard people say, well, there's a possibility that inflation will be higher than expected and not just in the near term, but down the road. They say, if you look what's going on with the fiscal situation, we'll just have to run

this higher inflation ongoing to deal with this debt. this higher inflation ongoing to deal with this debt. Do you think structurally higher inflation long-term is a possibility or is in the cards? Well, when we think about structural inflation being higher long-term, I mean, there are some reasons you might think that's the case, deglobalization or the greening of the economy. I mean, there are other things that could drive inflation in the coming years. However, when we think about what's going on with our fiscal trajectory, the U.S.'s ability to inflate their way out of this debt is, in my view, not a realistic scenario. First of all, we have a very short-term structure of our debt, so any

increase in inflation could translate into higher interest rates and higher net interest payments very quickly. And secondly, the extent to which we erode the value of the dollar actually undermines our economic strength, as well as things like the credibility of the central bank and its ability to manage business cycles effectively. So when we think about the options on the table, you know, things like, you know, inflating away the debt with other real economic costs, I mean, that's not a very attractive solution to the problem. Now, the debt in itself right now and the way we see it structured going forward is not particularly inflationary. And in fact, I would argue it runs the risk of

structurally higher term premium that pushes up structural longer run yields in the future, which risks dampening economic activity and crowding out private investment and private sector activities. Got it. The last question I want to ask you about the debt is just, it's kind of the toughest one, I guess. How do you fix it? How do you fix everything? I mean, you must look at where the money goes, right? And you must think to yourself, boy, if I ran this place for a year, we'd get things ship-shaper out here. I mean, I know it's not easy, but do you see any low-hanging fruit? I know that this gets into politics and policy choices and so forth, but are there any paths that you see to getting spending down or getting the deficits under control that are more benign than others? So I'm afraid to have actually kind of the opposite answer to what you're getting at. And that is that by waiting, we've made many of decisions increasingly difficult. Think about it this way. So when I was

born, defense spending was about 9% of nominal GDP. When I graduated from high school, it was about 6% of nominal GDP. Now it's 3%, and the Congressional Budget Office predicts it's headed towards 2% of nominal GDP. That has freed up a lot of economic resources for us to fund other parts of mandatory spending and other spending priorities. It sounds like great news so far. Tell me, what wise choices have we made? The problem we have is defense spending is not going from three to zero. So we've kind of exhausted to some extent, you know, the ability to just shrink our other spending in order to free up more resources. So we really are now at a point where we have to make some choices. I mean,

we have to make some choices about, you know, do we start to restrain the growth of the old age programs? Do we raise taxes? You know, how do we want to structure the federal budget to put it on a more sustainable path going forward? And that's going to be trade-offs between a lot of different interests, whether it's funding for education, the inner cities, transportation infrastructure, the military defense environment, the national's funding for education, the inner cities, transportation infrastructure, the military defense environment, the national park. I mean, everything that Americans use and enjoy, the weather service, the national hurricane. I mean, list on and on and on the role and features of the government in our society and economy. And we're at a point now where we're going to have to start deciding

how to fund it better and also what we really want to fund. But Jonathan, we're big, right? The economy is big. And when you're big and you spend a lot, you're supposed to get economies of scale. I mean, that's how Costco works, right? You load up with so many rolls of paper towels, they give you a good deal. Let's put it this way. Even if you don't have the specific prescription, there is a way to run this economy with the amount of money we have at our disposal that could be sustainable and manageable, right? This can still be done, would you say? Oh, no, no, no. I do. I do think it is. I mean, it's not really for me to say, hey, we should get rid of this component of the Department of Labor's program

on X or the Commerce Department Office of Y. But you can make a case that certainly there are big parts of these agencies that might be able to run better as well. But overall, when you look at the budget and you think about some of the big parts, I mean, they really are some of the mandatory spending programs like Medicare and Social Security and even Medicaid. So when you start to think about the remainder, that's actually a relatively small part. Now, there's probably room to better manage it as well. And I think you're right that if you think about the size of the economy, you know, we should be able to effectively fund and run a government. But we've gotten ourselves into a position now where revenues and spending are not aligned. And going forward, they're not projected to align.

I'm just curious. Would you say that you personally are an optimistic investor when you're setting aside money and you're like, let's say, talking with your family? Do you say, hey, you know, we've got some problems, but things are going to be okay long-term. This is still a place of opportunity. Or do you say, hey, you know what? I've seen under the hood on this thing and we've got some big issues here. There's trouble brewing. I mean, how optimistic are you as a long-term investor? First of all, I love the United States of America, and I think we are the greatest country on earth, and and pick up on this defense spending point,

the US is at risk of having to pay a premium to be able to finance the magnitude of this debt over time. And if we do that, that's only going to make the spending and revenue decisions harder because we're going to crowd out important investments that we expect the government to make in infrastructure, education, or elsewhere if we are continuing not only to pile up debt, but then also if the private markets start to add a tenth, another tenth, and another tenth, and another tenth as a cost of financing. But there's also these implicit costs have been taken. I mean, take the defense spending experiment for a second or the thought exercise.

You know, right now, defense spending as a share of nominal GDP is 3%. But let's say it was still 5% of nominal GDP. And then you thought about the US'sS.'s ability to project power, fund allies, et cetera. I mean, would we be facing the same geopolitical environment we are now? The same volatility in macro markets that that's caused periodically in the last few years? I mean, I think that's a good question of whether or not we're already paying some of these costs from having allowed the budget outlook to deteriorate to the extent it has. Thank you, Jonathan, and thank all of you for listening. Jackson Cantrell is our producer. He's a baby millennial.

That means he's old enough to remember bank lollipops, but never had a patch in his knee. Subscribe to the podcast of apple podcast spotify or wherever you listen to podcasts if you have a question you can tape it on your phone use the voice memo app send it to jack.how that's h-o-u-g-h at barons.com see you next week