The Dividend Cafe - Debt and You
Episode Date: November 5, 2021Most of the attention in the markets this week was on the Fed’s announcements Wednesday – (a) That interest rates aren’t being changed any time soon, and (b) the quantitative easing program laun...ched 20 months ago will start to be slowly eased back later this month with a goal of no additional bond purchases in roughly nine months). But very little attention is ever paid to why these policies exist, and what their impact is to the various things we investors care about. In the Dividend Cafe today, we will look at the state of monetary policy, the fiscal policy that has necessitated it (yes, those two things are married right now), and what investment lessons we can extract. Earnings season is preparing to wrap and it was a solid one. Congress is continuing to bat around legislative things that have not gone the way most people anticipated (or even close). There was huge election news this week that speak to the current political landscape. And yet through it all, the major investment story of the week may be the one least discussed. Come on in to the Dividend Cafe. DividendCafe.com TheBahnsenGroup.com
Transcript
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Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio
and dividends in your understanding of economic life.
Well, hello and welcome to another week of the Dividend Cafe.
I am excited to be near the end of the week.
I don't even really know what week, I guess it's still first week in November.
It's been a whirlwind.
And we have plenty to go here in November.
It was a busy week in markets.
And I've written a lot about that each day in DC Today, the week's activity with the Fed and with earnings season, with the election, with whatever the House is about to do.
I guess I'll interject and talk about the stuff I said I wasn't going to talk
about.
I don't think what the house is going to do or not do in the next couple of
days really matters much at all because everyone is clearly aware that it
then has to go to the Senate and,
and whatever the house does is not what's going to come out of the Senate,
whether anything comes out of the Senate or something different,
it's going to be different. And so, you know, from the policy standpoint to Fed to earnings, this was one of those weeks, you had a little bit of everything. And I chose to focus
this week on the subject of debt. And yet it isn't really about the debt. I talk about the
debt a lot. And yet this week, I want to kind of make a point as to why our focus on the Fed
is so connected to debt, and why our focus on health and the corporate economy is so connected
to the Fed. And so that there is sort of a little rhyme and reason to how
these things all play together. Okay. The easiest part to understand is that the government has
spent a lot of money in recent years. And I guess some people may not know exactly when it all began and when the percentages of debt level, debt to GDP growth started to go higher.
You know, the history of all of it is stuff I may study a lot and it may not be very important to a lot of you.
But, you know, most people know that the national debt has blown out since COVID.
And because we've had these huge headline spending
bills, it's a little bit more front and center. And I suppose somewhat less people, but still a
lot of people know that that trend actually had begun before COVID, that out of the financial
crisis, we began really increasing the level of debt, while at the same time decreasing the growth of the
denominator, which was the economy, the GDP growth. So we were growing debt faster than we
were growing the economy. And the economic growth really slowed post-crisis. And then the COVID
moments have created all that complexity. But the period of really high government spending did start even before the financial crisis.
I go through this history, by the way, because I want to be as clear as anyone is willing to allow me to be and take me at my word that this is not a political comment for me.
this is not a political comment for me. I could make the argument that a real big portion of the criticism, if I were making political criticism here, would be targeted at the party
I happen to have been registered in for my whole voting life. And so this is not
about present policy prescription exclusively. And it isn't about left wing, right wing.
This is through two Republican presidents and through two Democrat presidents in the last 20
years. I can go further back as well, but there's different dynamics that would be at play. We have
had an explosion in national debt. And now this week, you have a week where we're really focused on the Fed. And there's a
lot of wondering right now how healthy the corporate sector is. And I think my point is
that none of these things are as disconnected as people believe. So you go back to the controversies
that have played out about what the Fed's doing. Are they being sensitive enough to inflation? Are they trying hard enough to get full employment? Those are the two
stated mandates of the Fed, price stability and full employment, maximum employment.
I think that there's just no way to come out and say what everybody has to know to be true in the most apolitical sense possible, that the Fed also
knows it carries the burden of facilitating the governmental spending. The Fed doesn't get a vote
in what the government spends money on. Neither really does the Treasury Department, although
they're part of the executive branch of government, they get to influence what
the legislator does. Technically speaking, the pen of the president can veto. And so the treasury
is under that executive branch. But as a matter of law, what gets spent in our country is a
byproduct of what the legislator does. And our legislator is bicameral across the House of Representatives and the United States Senate.
We have a process by which bills become law and laws create spending.
And spending is then the responsibility of the Treasury Department to administer.
So the Treasury has to raise debt to pay for what they are doing. And the fact of the matter is that the Fed
cannot allow an environment where the Treasury is unable to finance the debts that they've taken on.
The Fed has become burdened with being an accomplice to the activity of Treasury and the legislature.
And I do know what the argument is. Fed critics can say, no, the Fed can stand up to them and say,
we're not going to do it. So you guys can go figure out yourself how you're going to spend
this money. But we're not going to help with interest rates or with bond purchases to facilitate
the madness. So I guess you guys are just going to have to go rates or with bond purchases to facilitate the madness.
So I guess you guys are just going to have to go spend less money.
And that's the point of an independent central bank.
And I get it.
And there is a pretty high amount of truth to the argument in theory.
But in practice, the Fed's burdened with full employment.
The Fed's burdened with full employment, and you can't have full employment with 10% inflation, with 10% interest rates.
And the Fed has taken it on themselves to be an arbiter of the business cycle. as operators, if they believe the path to least resistance is to facilitate government spending
so as to allow these engines to keep churning. Well, the reality I would offer to you is that
while it has plugged some holes and band-aided some otherwise tricky economic realities,
and band-aided some otherwise tricky economic realities, that it's catching up because the marginal revenue product of the debt, it's a dollar of GDP growth you get for every dollar
of debt you add, has collapsed. So by facilitating increasing government spending, it's no longer
creating the sustenance of economic
growth that's been needed to keep the whole thing going, which plays into price stability,
which plays into maximum employment. And so now all of a sudden, the tools that were used to
create the problem, excuse me, to treat the problem are now adding to the problem because you've gotten this
decline in the, it's a diminishing return effectively of the debt. And it's appropriate
to have a social or a political conversation about what is the appropriate level of debt,
whether it's a company, whether it's a company, whether it's a household,
whether it's a government. There are social objectives sometimes to debt, what kind of social safety net we want to have in the country, how we want to pay for it. There are matters of
national defense that are not productive in a business sense, but they're necessary to the
legitimate function of government to protect our country. And then, of course, there are these Keynesian arguments for government spending
and helping to stimulate aggregate demand.
And that is, I guess, the area in which no one seems to be arguing that anymore.
No one seems to be saying that increasing transfer payments are necessary to stimulate
the economy.
That word stimulus was very common coming out of the financial crisis.
And you recall President Obama famously passed under the direction of economic advisor Larry
Summers a stimulus project.
And a lot of people, candidly, I was one of them, were critical of that package, not believing
it to be as effective as promised.
But regardless, that was the stated intent.
That's not really the stated intent now.
We now talk about social objectives for good or for bad, transfer programs for good or
for bad, transfer payments.
And so that redistributionism does become less productive in terms of what it does into the debt,
the use of debt towards the economic growth in our society. So the Fed has to bear the burden
of this and the Fed isn't the one creating it, but of course they're facilitating it, but that's,
you know, I don't have an argument as to what they should do or shouldn't do for our purposes now.
I have an argument as to what investors should do and shouldn't do.
In a perfect world, I would say, okay, governments are not in a position to add to aggregate demand right now.
Governments are not in a position to stimulate productive growth.
Governments have spent and indebted themselves into a corner where marginal revenue product on the debt has really declined.
But you know what?
That's where corporate America has to step up.
They'll re-lever.
They'll take on more debt, more expenditure to get more growth, to get more productivity and kind of offset where the government, they'll fill in where the government can't.
And I think that you've got a lot of re-levering of corporate America post-financial
crisis. And that a lot of the de-levering that took place that always takes place out of a
recession, that's what a recession is effectively, is companies lowering their investment, lowering
their borrowing, lowering their output in response to an anticipation of declining economic growth.
And yet, to be very candid, that played out and it generated more jobs, it generated more tax revenue.
and deficits exploded because the output we were getting from corporate America was not able to keep up with the growth in the size of spending and government and indebtedness. So what happened?
You've re-levered corporate America, but you can re-lever corporate America from a de-levered
position. You can't re-lever corporate America from an already re-levered position, you can't relever corporate America from an already relevered
position. And this is why the debt levels of corporate America matter to me. Because even
though I think many of them are healthy ratios, are very affordable, in some cases, they're zombie
companies that are relevered and take advantage of low rates to keep the wheels turning of what
is otherwise a dead, defunct, and kaput business. But for the most part,
there's been a lot of productive use of debt in the last 10 to 13 years in our economy.
But they already went from three times debt to income to five times. They can't go further.
And so we can't look to the deficiency that exists and say, well, let's get that made up
for out of the corporate sector,
where the corporate sector has already given it its best shot. And here we are. So now the Fed
has to keep rates low to keep businesses borrowing and obviously keep the government borrowing.
And I don't think you're ever going to hear any Fed governor say, yeah, we have to be
hyper-accommodative because we're trying to help the government borrow money. We have to be hyper accommodative because to whatever
degree we can get any output, it's got to come from a continued attempt to leverage in the
corporate sector. They can't say it, but I can say it. And I don't think it's remotely controversial.
totally controversial. And yet that does tell us that there is downward pressure on yields.
And unfortunately, for all the reasons I've talked about, downward pressure on growth expectations,
the growth levels necessary to grow our way to get output out of this is utterly incomprehensible at this point in time. So I don't want to talk about what the policy prescriptions ought to be. I mean, I guess I do want to talk about it, but not right
here. What I think it means to investors is this ongoing understanding that there's a lot more that
goes on than what you hear talked about regarding the dual mandate
and why when they say, oh, well, inflation's picked up around these supply shocks, so the Fed
might have to really see rates go higher. I would just suggest that the Fed has more going on than
just where they see price levels, price stability, let alone the employment number. The employment
number thing is what's got to be talked about, but they can move that all they want.
We saw that.
Ben Bernanke had said back, I think it was 2010, we want to get to 6% unemployment.
And then it got to 6%, and he said 5%, and then it got to 5%, and he said 4%.
And then he was long gone out of the Fed before they ever started raising rates higher.
Unemployment target can become a very moving target.
rates higher. The unemployment target can become a very moving target. And I think that ultimately,
whether you look at price levels, price stability, inflation, all these factors,
apart from a conversation about causation, which is another topic I've addressed heavily this year,
but the fact of the matter is that the Fed has other things going on in their now assumed role as the administrator of the business cycle,
the smoother of the business cycle, if you will, and then their facilitator of government obligation.
That is a tricky couple of hats to ask the Fed to wear. And that is the environment for investing
in which we manage. And I hope this has been helpful, useful to you here in the Dividend Cafe.
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