The bubble is dead. Long live the next bubble.
For the past few months I’ve been relentlessly optimistic about the outlook for the US economy and stock market over the next few years. Yes, I saw that the Dow fell by 800 points yesterday. Ouch. Yes, I saw that Toll Brothers reported a decline in new home orders. I’m not blind. I have laid out my reasons for optimism, which I won’t repeat here.
But being stubbornly positive near-term doesn’t obscure a long-term worry. The amusing story of bitcoin helped me link the two views.
Bitcoin and the “investor PTSD” corrollary.
Just a year ago, bitcoin was all that, in the midst of a massive 2-month rally from 4,600 to 19,000. And the pundit of that moment, Tom Lee of Fundstrat, had even bigger things in mind: “Lee expects the price of one Bitcoin will surge to $125,000 by 2022. That’s 400% higher than his forecast from October...” (Bloomberg, January 18, 2018)
Since then, of course, bitcoin nosedived back down to 4,000. That’s what bubbles do, they pop. But what has struck me recently is how quiet the popping has been. No wailing in the street, no public gnashing of teeth, no Congressional hearing for Mr. Lee.
How to explain this behavior? My guess is that I have to add a corollary to my “investor PTSD” theory. Yes, a financial disaster creates in investors an irrational fear of revisiting the scene of that disaster. But I now add the corollary that investors quickly dust themselves off and confidently hop on to the next bubble.
The handoff from bitcoin to FANG and friends.
I love this chart:
Source: Yahoo Finance
It took investors about five minutes to swap the cryptocurrency bubble for the FANG bubble, here evidenced by Netflix. And by the way, Netflix closed yesterday at $275 a share – a mere 100 times this year's earnings! – so its peak of $419 can safely be said to have been a bubble price.
OK, so investors need their lottery tickets. Let them have their fun. Where this “on to the next bubble” mentality gets risky is when it impacts the economy. And I have come to conclude that the U.S. is in Year 1 of a government debt bubble that probably has a decade or more to run, with frankly pretty scary consequences. (Ah, just typing that sentence has improved my psychological equilibrium!).
Let me elucidate…
Japan shows us the way.
This chart shows a history of Japan’s debt ratio, defined as private and government debt as a percent of GDP:
Source: Bank for International Settlements
I wish the data went back a little further, but you can see my key points:
- Japan had a significant consumer and especially business debt boom for nearly two decades that blew up in the mid-‘90s. Remarkably, the private sector has been de-levering since then, a period approaching 25 years. The mid-‘90s meltdown left its banking system weak and cautious.
- Japan rapidly transitioned from the private sector debt bubble to a serious government debt bubble. Its government debt-to-GDP ratio grew from 70% to about 215% today, with no sign of slowing down.
- Why the quick shift? Because without it, GDP growth would have been unacceptably weak.
The US – the new Japan?
This chart provides the same measures for the US as the Japan picture above:
Sources: Federal Reserve, Bureau of Economic Analysis
The chart suggests that the US is in the early stages of repeating Japan’s story:
- Private sector debt growth remains very slow, nearly a decade since the last recession. And bank regulation remains tough and lenders remain reasonably sane. The last private debt reading showed only 2% year-over-year real growth.
- I’ve been arguing that the slow private sector growth has created the benefit of few credit excesses and therefore little chance of a credit-induced recession. But the downside has been modest GDP growth, which has proven to be politically unacceptable. We need our debt bubble!
- As a result, last year saw a tax cut and spending increases that sharply ramped up government debt growth.
Why else the US fiscal deficit is about to balloon.
Its bad enough that the US society wants tax cuts and extra spending to goose GDP growth. But two other serious drivers of government deficits are in the works:
- Retirement spending. Those danged Baby Boomers want not only their MTV, but also their Social Security and their Medicare. And their hapless kids and grandkids are not increasing their payroll taxes fast enough to cover the Boomers’ growing care and feeding costs. As a result, the most recent Congressional Budget Office (CBO) budget estimate expects retiree costs to increase faster than payroll taxes by about $850 billion from 2017 to 2028.
- Interest expense on government debt will increase by $650 billion by 2028 according to the self-same CBO, due both to the growing debt and to an increase in interest rates from the recent historic lows.
The US budget deficit is about $1 trillion this year. Retirement and interest expense will increase by a combined $1½ trillion in a decade. That’s a target $2½ trillion deficit for 2028! Yowzah.
Why isn’t this fairly obviously unfolding government debt bubble not in the headlines? Probably because of my investing PTSD corollary; we confidently hop on to the next bubble without much soul-searching. We will only hop off when we have to, and quickly search for the next bubble.
I expect three consequences of the government debt bubble for investors:
- Near-term economic growth will be more resilient than pundits increasingly expect. I don’t expect a recession for the foreseeable future.
- Interest rates will be lower than they should be. Tariff Man will not be the last President to whine about Federal Reserve interest rate increases. Bonds may be done as a profitable investment alternative for a long, long time.
- It is hard to figure out what bubble can follow the bursting of a government debt bubble. Looking at Greece’s government debt implosion doesn’t give one comfort.