Why the Deficit Won't Derail This Bull Market

March 28, 2014
Alexander Green

Those who claim the US budget deficit has placed us on the verge of national bankruptcy are misinformed. Debt is meaningless except in relation to income and assets.

This article is published with permission from InvestmentU.com.

Our national debt reached an important milestone last year— it became as big as the entire U.S. economy.

This is not a good thing.

Among advanced economies, the only countries with debts larger than their economies are Greece, Iceland, Ireland, Italy, Portugal, and Japan. With the exception of Japan, these countries are at the root of the European debt crisis. Greece, Ireland, and Portugal needed bailouts from European central banks. The International Monetary Fund is monitoring Italy. And Japan has been stuck in an economic funk for the past 25 years.

Clearly, it would be better if the US budget deficit were smaller. But at least the situation is improving on this front. Those who claim the US budget deficit has placed us on the verge of national bankruptcy are misinformed.

Debt is meaningless except in relation to income and assets. For example, if you were responsible for servicing $50 million in debt, you might have a few sleepless nights. But Bill Gates wouldn't lose a wink. Why? Consider his $76 billion net worth. He could lose $50 million and not notice.

It bears repeating again: Debt is meaningless except in relation to income and assets.

Taking a risk

Let me give you another example. Fifty years ago, my dad made a bold financial move. He needed a new home to house his growing family. (I am one of 4 boys.) So he decided to take out—hold your breath—a $30,000 mortgage.

Well, OK, having the courage to take out a $30,000 mortgage today doesn't qualify you for the Congressional Medal of Honor. But at the time, my dad was earning less than $30,000 a year. He borrowed an amount larger than his annual income.

Over time, however, the mortgage amount (and the monthly payment) became trivial, thanks to inflation and his growing earnings. Still, he took a risk. It isn't likely, but his earnings could have declined. If so, that mortgage would have been much harder—and perhaps impossible—to service.

Let's turn again to the federal deficit. It's inexcusable. Politicians on both sides of the aisle have spent improvidently for years.

But the debt—at 100% of GDP—is still manageable. Especially since things are getting a little better. The deficit fell to $680 billion last year from $1.1 trillion in 2012. That is the lowest deficit since 2008 and the end of a 5-year string of $1 trillion-plus annual deficits.

Thanks to a growing economy—and Obama's hike in top marginal rates (although I'm not sure “thanks” is the right word)—the Treasury received $2.8 trillion in tax revenue, $324 billion more than in 2012. And when the 2 parties couldn't agree on spending, the sequester forced cuts in federal outlays.

The budget deficit is projected to continue falling over the next few years, from 4% of GDP to less than 3%. In other words, the deficit is becoming less of a problem, not more of one. Like my dad's mortgage in 1964, it is large but still manageable. Inflation and a growing economy will chip away at it over time. It will take fiscal responsibility, too. My dad didn't take out second and third mortgages.

The biggest fiscal threat, of course, is not the $17.5 trillion in current red ink, but the more than $128 trillion in unfunded liabilities for entitlement programs like Social Security, Medicare, and Medicaid. However, the dire forecasts all begin with the same caveat: "If nothing is done..."

Something will be done. Bank on it.

How can we be sure? Because this number is grotesque … and growing at $8 trillion a year. To put this in perspective, if the U.S. government confiscated all the profits of every publicly traded company in the nation and all the income of every household earning more than $66,000, it still wouldn't pay for the annual growth in these liabilities.

So it's not a matter of raising a tax here and cutting a program there. The whole system has to be radically reformed. Every serious person knows it. But—trust me—it won't happen before this year's elections. Members of this Congress can't even agree on what to have for lunch.

But national reform is coming. And the annual deficit as a percentage of GDP is coming down. That's why the national debt—as huge and indefensible as it is—isn't derailing this market. And won't for the next few years.

Alexander Green is the chief investment strategist at InvestmentU.com. See more articles by Alexander here.

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