Fiscal debt drama has chill for markets

The burden has gotten too big; tough love is the answer

he following comments were overheard at a recent meeting of Debt-aholics Anonymous.

Sam: My name is Uncle Sam, and I'm a debt-aholic.

DA: Hi Sam.

Sam: It's been 12 years since I was in surplus. And I've only been there twice in the last 50 years. Recently I have been on quite a binge. I may have finally hit bottom. I need help.

DA: We've all been there, Sam.

Sam: I'm looking for a sponsor, but there are so few nations in the world that I can turn to. I have been running annual deficits for 12 years and have accumulated $16 trillion in debt.

DA: Won't taxing the rich solve the problems? Isn't that what the election was about?

Sam: That was good politics, but taxing the rich will only get us around $50 billion per year and our annual deficit is $1.2 trillion.

DA: Wow, small potatoes. How did we get into this mess?

Sam: Both Republicans and Democrats found the much overrated “common ground.” That is, making promises and doling out goodies but paying for them by going into debt, rather than raising revenue. Then we had a Great Recession and no savings to help tide us over. It made things worse, but we were headed for problems anyway.

The 2012 federal budget spent $3.6 trillion but only received revenue of $2.4 trillion. It's as if an individual spent $36,000 per year and only earned $24,000. How long can you keep that up?

DA: But can't the Federal Reserve fund our deficit? If things continue to go wrong, won't they just print money and lower interest rates?

Sam: The Fed has done a lot already including keeping short-term rates near zero for over four years. You might have noticed that when rolling over your CDs you earn practically nothing. It makes it tough for the elderly who have done the right thing and saved for retirement, but now earn paltry returns.

And yes, the Fed is adding liquidity by printing money and buying U.S. government bonds. In fact, it now owns almost one-third of all longer government bonds. It's not having much of an effect, almost like pushing on a string. Besides, printing money can lead to inflation.

Remember this. The Fed can dole out aspirins and ease a fever, but it can't cure the disease. How can the Federal Reserve effect long-term growth? That comes from new technologies and productivity improvements, things outside of the Fed's control.

In fact, many believe that by keeping monetary policy so loose for so long, the Federal Reserve is enabling our politicians' profligate spending and borrowing ways.

DA: What does it mean? What does the future hold?

Sam: It's going to be tough. We need to hunker down and reduce the debt. That means saving more and consuming less. The road to recovery will be slower economic growth than we are used to. Stock market returns will likely be subpar (5% to 7%) for several more years and you shouldn't expect much more than 2% or 3% from the bond market.

In a sense we lived beyond our means for many years. We issued debt to do it. Now the debt burden has gotten too big. It's payback time.

DA: Can't we just grow our way out of it?

Sam: That would be nice, but the headwinds from an overhang of debt are fierce. Tough love is the answer. Besides, isn't fiscal responsibility part of the program?

DA: It all sounds depressing. Cheer me up, please.

Sam: I am optimistic that eventually I'll recover and be stronger than ever. My founding fathers left a Constitution and rule of law that has served the country well. The American free-enterprise system that rewards work and entrepreneurship has raised the standard of living of our citizens over the years.

And there's so much brainpower in the world, and it's being connected by the Internet. The OECD reported that “of all the scientists that ever lived 90% are alive today.” With all those scientists, entrepreneurs, inventors and businessmen hard at work, why shouldn't I believe that things will get better?

DA: OK. Thanks Sam. Is there anyone else who would like to share?

Speaker: My name is Greece ... n

Jeff Pantages is chief investment officer of Alaska Permanent Capital Management Co., Anchorage.

This article originally appeared in the February 4, 2013 print issue as, "Fiscal debt drama has chill for markets".