I have a PhD in financial economics and took PhD level macroeconomics courses. However, this doesn’t make me an expert on this topic. I laugh to myself when I see hedge fund managers like Bill Ackman, David Einhorn, John Paulson, or Kyle Bass making macroeconomic calls about the imminent demise of currencies or economies of Japan, China, Hong Kong, or the United States. Dozens and dozens of hedge fund managers piled into gold trades in 2009 and their investors underperformed the market by a large margin (they still collected fat fees from their clients, so the real losers were their clients).
Warren Buffett seemed like a shrewd investor for a while avoiding permanent capital destructors like airlines and gold miners. However he couldn’t help himself in recent years to make the same mistakes made by other investors. First he invested billions in US airlines and lost billions after selling out his stake at the bottom of the equity markets this spring. Then we heard that Warren Buffett initiated a brand new position in Barrick Gold (GOLD) which was valued at $564 million at the end of June. Investing in Barrick Gold is a leveraged bet on gold prices. If gold price increases 75% Barrick Gold shares will most likely to increase more than 75%, and if gold price declines by 75%, Barrick Gold will probably go bankrupt.
Warren Buffett
To be honest I am also concerned about the long-term health of the U.S. economy. On the one hand we are still the technological leader of the world even though China and Europe seem to be closing the gap. Especially China is making significant investments in cutting edge technologies and likely to challenge the United States leadership in artificial intelligence, robotics, and several emerging technologies in the coming years. On the other hand we are deficit financing wasteful political priorities such as defense spending, lower taxes for corporations and billionaires, subsidized healthcare for the poor and the elderly. We are also discouraging the influx of talented and smart immigrants who might be inventing the next great technological breakthrough that may create millions of jobs for American workers.
Three weeks ago bipartisan Congressional Budget Office (CBO) revealed that federal debt held by the public is projected to rise to 98% of U.S. GDP in 2020 compared with 79% in 2019, and 35% in 2007. CBO also expects the U.S. debt to GDP ratio to exceed 100% in 2021 and reach 107% in 2023, the highest in America’s history. The projected U.S. budget deficit for 2020 is $3.3 trillion (bigger than the entire GDP of India, France, or England). Things won’t improve dramatically next year either. For every $2 in tax revenue, we are expected to spend nearly $3 in federal spending. “The deficit in 2021 is projected to be 8.6 percent of GDP,” according to CBO. By the way total U.S. debt is projected to be around $20.3 trillion in 2020 (versus $20.6 for the U.S. GDP).
Despite the ballooning deficits politicians and economists are pressing for more stimulus and federal spending at the moment. The main argument in favor of more deficit spending at this point is that federal government has to spend or give away more money to lift the economy out of the pandemic induced deep recession. Even the economists who don’t think “deficits don’t matter” say things like “this isn’t the time to have a discussion about fiscal prudence”.
The second argument in favor of more deficit spending is historically low long-term interest rates. The inflation adjusted 30-year interest rate is around zero right now. Economists like Paul Krugman believes we are in a liquidity trap and we need to spend an additional $400 billion per year on infrastructure projects and not pay for it.
Finally, the third argument in favor of more deficit spending is that the United States borrows money in its own currency. U.S. dollar is the global reserve currency. The Great Financial Crisis of 2008 didn’t diminish the dominance of the U.S. dollar and the statuesque will probably not change until another country comes up with a bigger economy, better institutions and deeper financial markets. Until then, the argument goes, we can continue to run moderate amounts of budget deficits without paying any meaningful repercussions.
The conventional wisdom tells us a country running large deficits will experience inflation, higher interest rates, and lower growth. This is probably why we are seeing investors piling into precious metals and hard assets today. So, what exactly is the connection between debt, inflation, and growth? In 2010, star economists Kennett Rogoff and Carmen Reinhart tried to answer this question in this academic paper. Later that year they revisited the topic in a VOXeu paper. The main findings of their study were as follows:
“First, the relationship between government debt and real GDP growth is weak for debt/GDP ratios below 90% of GDP. Above the threshold of 90%, median growth rates fall by 1%, and average growth falls considerably more. The threshold for public debt is similar in advanced and emerging economies and applies for both the post World War II period and as far back as the data permit (often well into the 1800s).
Rogoff and Reinhart emphasize that these relationships are highly non-linear and thresholds play a critical role in understanding the debt-growth dynamics. I reached out to Ken Rogoff and asked about the relevance of the 90% debt/GDP threshold for the United States. He said the following:
“The main point is that our paper does not claim a SHARP break at 90%, the comparison is between all episodes above 90% AS A GROUP and all episodes below AS A GROUP. We note in a companion VOXeu paper that driving at 56 miles per hour instead of 55 miles does not mean much higher chance of accident nor does having your cholesterol level go from 199 to 200 suddenly mean you are going to have a heart attack. We also note that individual characteristics differ by country, so some countries can carry high debt much more easily than others. In 2020, the dominance of the dollar is greater than ever, which helps the US have more debt capacity than any other country.”
Rogoff doesn’t think debt/GDP levels above 90% aren’t benign as claimed by some, but he also believes the US can handle higher levels of debt than other countries can.
On the inflation front Rogoff and Reinhart didn’t find any systematic relationship between debt levels and inflation for developed countries. However, in our email exchange Rogoff was more cautious. “Even for the United States, if we try to pay for things indefinitely by printing money, we will eventually have high inflation that might not be easy to get rid of,” Rogoff said.
The most critical word in Rogoff’s statements is “non-linear”. The relationship between debt and growth and inflation is non-linear. Right now we don’t see any signs of higher inflation and interest rates. This may go on for several years, but one day, all of a sudden, we can see dramatic effects of high debt levels on inflation and growth.
What bothers me the most about high U.S. budget deficits is that the money is spent on mostly unproductive areas. Chinese government is investing in R&D, smart roads, and accelerated research of future technologies such as self-driving cars. Our budget deficit exceeded $1 trillion even before the pandemic so that we can cut taxes for corporations and the rich and spend the money on social security ($1 trillion in 2019), defense (~$700 billion), Medicare (~$650 billion), Medicaid (~$400 billion), and interest payments (~$400 billion). Nondefense and all other federal spending totaled $1.3 trillion in 2019. Basically we are spending nearly all of our $3.5 trillion of federal revenue to care for the elderly and the poor, and to defend them, and finance the rest of the government spending by borrowing money (or printing it).
Right now we don’t see any signs of inflation or higher interest rates. The people in power don’t care about budget deficits today, and they didn’t care about budget deficits before the pandemic. I think CBO’s debt/GDP projections are overly optimistic. Republicans bend over backwards to reduce our revenues and Democrats bend over backwards to expand government spending. It looks like the United States will be forced to monetize its debt at one point in the future. However, I believe the time frame for this isn’t years but decades (anywhere from 10 to 40 years).
That’s why I am not recommending any positions in precious metals or miners in our monthly newsletter at the moment.
Below we present the list of 25 most indebted countries. I am going to rank them by using debt/GDP ratios with a twist. I will multiply emerging economies’ debt/GDP ratio by 2 and non-major Eurozone economies’ debt/GDP ratio by 1.5 for ranking purposes because these countries either borrow in foreign currencies or don’t have the power to print themselves out of their debt problems. I will also list each country’s total debt, total debt per capita, and total debt to GDP ratios so that you can find country with the highest debt or highest debt per person. We used IMF’s October 2019 World Economic Outlook Update for our data. We excluded economies that are smaller than $25 billion in GDP from our list. We should also note that Debt/GDP ratios increased by 20-33% for most countries because of pandemic induced contraction in GDPs and fiscal stimulus measures taken to counter the economic effects of the pandemic.
Initially we will share the statistics for the major economies that weren't among our top 25 list and then we will list the statistics for the top 25 countries that have more serious debt problems:
84. Australia
Debt (Billions): $574.71 Debt Per Person ($): $22,476.85 2019 Gross Debt/GDP (%): 41.76
77. China
Debt (Billions): $7,857.26 Debt Per Person ($): $5,611.64 2019 Gross Debt/GDP (%): 55.57
75. Germany
Debt (Billions): $2,263.03 Debt Per Person ($): $27,275.79 2019 Gross Debt/GDP (%): 58.58
56. United Kingdom
Debt (Billions): $2,347.25 Debt Per Person ($): $35,103.00 2019 Gross Debt/GDP (%): 85.55
54. Canada
Debt (Billions): $1,514.38 Debt Per Person ($): $40,431.62 2019 Gross Debt/GDP (%): 87.49
48. France
Debt (Billions): $2,688.37 Debt Per Person ($): $41,472.04 2019 Gross Debt/GDP (%): 99.31
39. United States
Debt (Billions): $22,773.20 Debt Per Person ($): $69,162.19 2019 Gross Debt/GDP (%): 106.22
25. Israel
Debt (Billions): $239.83 Debt Per Person ($): $26,489.64 2019 Gross Debt/GDP (%): 61.86
24. Ghana
Debt (Billions): $42.77 Debt Per Person ($): $1,417.68 2019 Gross Debt/GDP (%): 63.76
23. Uruguay
Debt (Billions): $38.39 Debt Per Person ($): $10,912.00 2019 Gross Debt/GDP (%): 64.08
22. Morocco
Debt (Billions): $77.74 Debt Per Person ($): $2,184.47 2019 Gross Debt/GDP (%): 65.31
