A baby elephant in captivity will be held in place by a metal chain attached to a wooden peg in the ground.
Try as it might, the baby elephant doesn’t yet have the strength to pull out the peg and escape.
An adult elephant, however, can weigh several tons and top 10 feet in height. It would have little difficulty pulling out such a peg and escaping with the negligent weight of a metal chain behind it. If an adult elephant wanted to, it could uproot an entire tree.
But adult elephants, raised to expect such an action to be futile since they were babies, don’t bother trying.
It’s time we talk about the elephant in the room.
In finance, that can be only one thing: debt.
There’s mountains of the stuff. Between government debt (nation, state, local, and so on), corporate debt and even personal debt, we own a lot. Estimates vary, but there’s at least $331 trillion out there.
More importantly, the debt to GDP ratio is 318 percent. That’s like racking up $318,000 in credit card debt against a $100,000 income. A lot of future money earned needs to be directed just towards paying the interest. With interest rates on the rise, new debt will only prove more expensive to finance as well.
Finally, the worst part is how effective that debt is at creating wealth. While you might want to use debt to buy the home of your dreams or a reliable car, today’s debt creation is buying little of dubious value.
State and local governments are going into debt to pay out lavish pension plans for city employees. Governments are paying out for medical care and retirement money far in excess of what they’re bringing in. Social Security and Medicare are both expected to start running deficits in the next decade. Many corporations have used their debt to buy back shares at any price irrespective of value, even at all-time highs. They’ve increased their earnings per share by significantly reducing the number of shares, not by increasing earnings.
It’s no wonder that every dollar of new debt created is expected to create only $0.44 in value. That’s a terrible return. It’s one thing to finance a project that is expected to provide ten-fold returns to investors, or perhaps even provide some useful, non-monetary value, like a new car.
The fact of the matter is, the sum total of all debt, of all types, is one huge elephant. And it can’t be kept held up by a small peg forever.
Many investors are backwards-looking. They expect the next financial crisis to look a lot like the last one. And in some cases, that may be true. When the debt-binge party ends, it won’t go well.
But a debt-fueled binge is a bit of a different party than a bank-fueled lending binge, like the housing crisis and subsequent collapse was.
When home prices fell and folks stopped paying, banks foreclosed. How can you foreclose on the government? Or on your city’s pension fund as a taxpayer? You can’t. You can only take it on the chin as taxes go up. And they will go up. The cold calculus of government programs is it’s better to slightly increase taxes on a large group than to offend a small, but vocal minority of beneficiaries. And for the biggest governments of all, the easiest way to increase taxes may be to print some more money instead. The first to receive freshly printed money get the best benefit, because they can enjoy goods and services before the prices start to rise. Those at the end of the process—typically the taxpayer class—benefit the least.
Of course, we can’t call it class warfare. After all, at some point, we’re all beneficiaries of a myriad of government programs (whether we want to be or not). Government has insidiously placed us on both sides of the equation. And if we want to benefit in a very small part from the money taken from us earlier, it’s best to ignore the elephant in the room, isn’t it?
There are several conclusions from our growing debts. The first is that it’s a ticking time bomb. Nothing continues indefinitely. The tree grows toward the sun, but not to the sun. Eventually private sector buyers of debt will find the terms unpalatable.
Knowing there’s an elephant in the room is the first step. The second is knowing the places most likely to be trampled when it gets loose. Avoiding the danger spots is critical.
Inflation, while low in the post-financial crisis era, is starting to rise again. While I doubt we’ll get back to the double-digit levels of the 1970’s anytime soon, it’s been a long time since we’ve seen real inflation and memories are short. For an inflation hedge, gold fares well, particularly when inflation expectations start to soar.
There are plenty of doom and gloom folks out there predicting far worse things to come. I’m not one of them—yet.
There’s still a possibility we can grow our way out of this problem as we have with so many in the past. That’s a case for investing in leading companies doing innovative work—particularly those with strong balance sheets light on the debt. Perhaps it’s no wonder that Amazon (AMZN) has done so well in the past year, up nearly 80 percent. It has only $44 billion in debt against a market cap of over $800 billion. It’s only leveraged 5 percent, a far cry from the surging debt-to-GDP ratios of governments.
Finally, the younger you are, the more you need to think about a retirement without any government assistance behind it. In real terms, payouts on Medicare and Social Security will have to adjust downward. It may not happen quickly, but it will happen. That’s another reason for both caution, and an investment in growth.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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