Authored by Lance Roberts via RealInvestmentAdvice.com,
In her last testimony before Congress as head of the Federal Reserve, Janet Yellen made a curious statement:
“I would simply say that I am very worried about the sustainability of the U.S. debt trajectory. Our current debt-to-GDP ratio of about 75 percent is not frightening but it’s also not low. It’s the type of thing that should keep people awake at night.”
I find this statement interesting given that both Michael Lebowitz and I have been arguing the point that tax cuts and reforms “pay for themselves” through stronger rates of economic growth, employment or wages.
As Mike stated this past week:
“The historical evidence above tells a different story than the bill of goods being sold to citizens and investors. Corporate tax rates are positively correlated with economic growth which means that lower corporate tax rates equate to slower economic growth. Further, there is strong evidence that corporate profits are largely unaffected by tax rates.
Investors buying based on the benefits of the tax proposal appear shortsighted. They value the benefits of corporate tax cuts, but they are grossly negligent in recognizing how the tax cuts will be funded.”
But while Janet Yellen was focused on Federal Debt, the real issue is total debt as a percentage of the economy. Every piece of leverage whether it is government debt, personal debt and even leverage requires servicing which detracts “savings” from being applied to more productive uses. Yes, in the short-term debt can be used to supplant consumption required to artificially stimulate growth, but the long-term effect is entirely negative. As shown in the chart below, total system debt how exceeds 370% of GDP and is rising.
It now requires ever increasing levels of debt to create each $1 of economic growth. From 1959 to 1983, it required roughly $1.25 of debt to create $1 of economic activity. However, as I have discussed previously, the deregulation of the financial sector, combined with falling interest rates, led to a debt explosion. That debt explosion, which allowed for an excessive standard of living, has led to the long-term deterioration in economic growth rates. It now requires nearly $4.00 of debt for each $1.00 of economic growth.
[image]https://realinvestmentadvice.com/wp-content/uploads/2017/11/Debt-TotalSystem-GDP-1dollar-Growth-112917.png[/image]
Yellen is right. The level of debt, not just at the government level, but on the whole, should keep investors “up at night.” The Fed’s monetary interventions over the last 9-years to aggressively push interest rates lower led to a high-degree of “complacency” as the assumed “riskiness” of piling on leverage was removed. However, while the cost of sustaining higher debt levels is lower, the consequences of excess leverage in the system remains the same.
The illusion of liquidity has a dangerous side effect. The process of the previous two debt-deleveraging cycles led to rather sharp market reversions as margin calls, and the subsequent unwinding of margin debt fueled a liquidation cycle in financial assets. The resultant loss of the “wealth effect” weighed on consumption pushing the economy into recession which then impacted corporate and household debt leading to defaults, write-offs, and bankruptcies.
[image]https://realinvestmentadvice.com/wp-content/uploads/2017/11/Debt-TotalSystem-SP500-112917.png[/image]
You will notice in the chart above, that even relatively small deleveraging processes had significant negative impacts on the economy and the financial markets. With total system leverage spiking to levels never before witnessed in history, it is quite likely the next event that leads to a reversion in debt will be just as damaging to the financial and economic systems.
Of course, when you combine leverage into investor crowding into “passive indexing,” the risk of a “disorderly unwinding of portfolios” due to the lack of market liquidity becomes an issue.
While Ms. Yellen dismisses her own warnings…maybe you shouldn’t.
In the meantime, here is your weekend reading list.
Trump, Economy & Fed
- Pressure On Households Intensifies by Danielle Dimartino-Booth via Bloomberg
- Can Powell Bridge The Gap At The Fed? by Caroline Baum via MarketWatch
- GOP Tax Bill: “Fuggedaboutit” by David Stockman via Daily Reckoning
- A Conservative Uprising Confronts Deficit Hawks by Russell Berman via The Atlantic
- Can Tax Reform Add 0.4% Growth? by Committee For A Responsible Federal Budget
- Why Lowering Corp Tax Rate Will Create Jobs by Simon Constable via Forbes
- Budget Deficits Still Matter by Kevin Williamson via National Review
- Congress Is Hijacking Trumps Tax Plan by Jonathon Trugman via NY Post
- GOP Tax Plan Can Help Small Business by Stephen Moore via The Washington Times
- Corporate Tax Cut Won’t Boost Economic Growth by Patrick Watson via Forbes
- America’s Supply-Side Scam by Stephen Roach via Project Syndicate
- Why The GOP Tax Plan Is So Unpopular by Derek Thompson via The Atlantic
- GOP Plans To Hike Capital Gains by Robert Graham via The American Spectator
- Senate Making Tax Bill Even Worse by NYT Editorial
- Fed’s Window Is Closing by Eddy Elfenbein via Crossing Wall Street
- Not Much Evidence Tax Cuts Boost Wages by Marc Chandler via Real Clear Markets
- GOP Idea Of Tax Relief To Poor Disappeared by Jeff Stein via Washington Post
- Taxes & Growth: A Cautionary Tale by William Gale via Brookings Institute
Video – Myths About Tax Cuts
Markets
- DB Explains 5-Biggest Market Conundrums by Tyler Durden via ZeroHedge
- Throw Out The Stock Market Playbook by Mark Decambre via MarketWatch
- Some Options For Protecting Your Gains by Brett Arends via MarketWatch
- From $60 To $450 Million by SA Gil Weinreich via Seeking Alpha
- Today’s Rational Exuberance by Anatole Kaletsky via Project Syndicate
- The Source Of The Next Crisis by Kevin Muir via The Macro Tourist
- How To Interpret Today’s Yield Curve by David Andolfatto via MacroMania
- The Most Ridiculous Statement In Finance by Shawn Langlois via MarketWatch
- Can You Afford To Bet On BitCoin by Michael Kahn via Barron’s
- Complacent Investors Run Risk by William Watts via MarketWatch
- Risks To The Bull Market by Charlie Himmelberg via Goldman Sachs
- Bubble Dynamics & Market Crashes by James Rickards via Daily Reckoning
- What To Worry About In This Bull Market by Bloomberg Staff Writers
- Corporate Tax Cuts Seen & Unseen by Michael Lebowitz via RIA
- An Earnings Driven Meme by Doug Kass via RIA
Research / Interesting Reads
- National Debt Jumps By $723 Billion In 12 Weeks by Wolf Richter via Wolf Street
- The Fiscal Burden Of Illegal Immigration by Tyler Durden via ZeroHedge
- Blowing Up The Debt Is A Threat To America by Leon Panetta via USA Today
- We Are In The Most Dangerous Part by Edward Harrison via Credit Writedowns
- Annoying CAPEX vs Buyback Narrative by Lawrence Hamtil via Fortune Financial
- Lessons From A Short Seller by CFA Institute
- What Does A Flat Yield Curve Mean For Stocks by Stockcharts
- Chance Of A BitCoin Crash Greater Than 80% by Market Hulbert via MarketWatch
- Hindenburgs & Titanics by John Hussman via Hussman Funds
- Great Expectations by Dana Lyons via The Lyons Share
- BitCoin Is Bigger Than Beyonce, Swift & Kardashian by Jesse Felder via The Felder Report
“You never go broke taking a profit.” – Old Wall Street Axiom