Podcast: Should You Be Worried About The Explosion In Our National Debt?

Mike:

Welcome to the Advisor Financing Forum, a weekly podcast presented by SkyView partners. My name is Mike Langford, and in this episode, I'm joined by John Merante, Chief Economist at SkyView. John and I delve into his latest report titled Should an Explosion in the National Debt Cause Us to Worry? You can find the report on skyview.com under the media section.

I think you're really going to enjoy this conversation with John. First of all, John is an incredibly approachable guy. He manages to take really complex and interconnected economic concepts and relate them in a conversational language that your average client would find easy to understand. Second and perhaps most important, John is the rare economist in my experience. And I've spent a lot of hours with economists over the course of my career, going back to my grad school days. John's one who truly understands his audience and their needs.

So John understands the world that financial advisors live in and he packages his analysis in such a way that you could use it to inform your clients and make the necessary adjustments to your business planning. I'm thrilled to have John on the show. I look forward to bringing many more conversations with him to you in the future. Before we jump into the conversation with John, I thought you might appreciate a quick overview of his background.

John is a Chief Economist at SkyView partners. He holds a CFA, Chartered Financial Analyst designation and masters of science in finance from George Washington University. Prior to joining SkyView in April of 2020, John's experience, as you'll hear him relate, included several leadership roles at world-class firms, such as Neuberger Berman and the Principal. He also worked for a little organization called the United States Department of State. You might have heard of them in your travels, I don't know. Kind of a big deal. Right?

Anyway, John is incredibly right and he really knows this stuff. You're going to love him. Like always, please do subscribe and like the podcast on your favorite podcasting platform, the Advisor Financing Forum podcast is available on Apple podcasts, Spotify, Google Play, and Stitcher. If you have any questions or suggestions for the show, please don't hesitate to reach out via podcast@skyview.com or you can find SkyView partners on LinkedIn, Twitter, Facebook, YouTube, and Instagram. Okay. Now let's get to our conversation with John Merante.

Well, Hey John, it's really exciting to have you on the show. I've been enjoying your work from afar, seeing that you joined SkyView and the reports that you're putting out. Actually the first report that I've seen, and that we're going to talk about that a little bit here on the show and more in depth to give people, I guess, a taste of what to expect from the analysis that you're doing. But I thought it might be fun to kind of kick things off with a, what does a chief economist do and why does SkyView have one? Even though our audience is largely comprised of folks from the wealth management world who are likely relatively well versed in financial stuff, I think it's probably fair to assume that very few are economists and most have no idea what a chief economist actually does. So why don't we kick it off with that?

John:

Sure Mike, thank you. I'll start with a little story. Years ago, I worked for Neuberger Berman and at that time, Roy Neuberger was still alive that he was really coming into the office. But one of the stories that would go around is that Neuberger was known for not having economist. I was working in different capacity on the international equity fund, and he was asked why he had never hired an economist. And his response was, "Well, I haven't hired an economist because if I hired one, I'd have to pay him. And if I paid him, I'd have to listen to him and no one ever made money listening to an economist." I'll use that as a disclaimer before we go any further.

But largely what I do and what I've been doing for a number of years now is looking out, both the domestic and global economy, trying to forecast what we expect to happen, and then interpret what that would mean for various asset classes and how best to reflect your views on the economy, in terms of investments in domestic bonds, corporate bonds, emerging market equities or bonds, or just generally equities.

That's basically what my long term job is going to be. And what we're doing at SkyView is trying to provide people who are interested with additional thought capital that we hope would help them make decisions and they'd stay operations. What I'm working on right now however, is really dominated obviously by what everyone knows going on with COVID pandemic and what that means both in terms of how to deal with the closures and the problems that we're facing in the economy, how to interpret governmental action, and really just thinking in terms of what is all this going to mean for small, medium-sized businesses, that might be interested in ... And larger businesses too obviously, that might be interested in putting events in context. And hopefully that's what we're going to be providing.

Mike:

That's really interesting. You're basically as you're describing it, you're trying to help people make decisions through a lens of analysis. Looking at what's happening in the world, judging it based on things we've seen in the past. And kind of try to make a projection on where things are headed.

John:

Yeah, exactly. It's really looking at the data and putting it into a broader context, including an international one and a historical one.

Mike:

I think one of the questions that immediately jumped to my mind when we discussed that we're going to have you on the show and I read your report and I started thinking about, okay, so what would I want to know in talking to John, and one of the first big questions was, how should a financial advisor or an RIA firm digest the analysis that you publish? Obviously your goal is to publish analytical reports, as you described that are informative and hopefully useful to the SkyView community of advisors and RIAs. But what are your thoughts on how the community should use the analysis that you publish in their business? Is it just to be a formative or are there other ways that you expect that they're going to take what you put out there and use in their business?

John:

Well, I hope as we go forward, we'll be able to make some recommendations that are going to be helpful, but really is going to ... We're providing information. And there is a lot of other information. We would like that they take our views into consideration as they make those decisions about what's best for their own business. I can talk about the deficit or inflation or what looks like progress in opening up economies, but how to best apply that information, I can't tell the RIA community how to do their business. I can provide them with information that we hope will be useful in their own decision making process.

Mike:

Right. I think that's a good way of framing it. That listen, you're going to get some really good information, some good insights that you can use in your business to make a decision, but we're not making specific recommendations to you when your reports are presented to the community.

John:

Exactly. At some point, depending on what the topic we could think about how to apply it within an asset class framework, but broadly speaking, the implications are going to be different for pretty much every business. And it's only the business owners and managers who can decide what's appropriate for them.

Mike:

Right. Right. Let's dive into the report that you published. It's titled Should an Explosion in National Debt Cause Us to Worry? It was published on May 7th, 2020, and it's available for download on skyview.com. Real easy to find. We'll link that up in the show notes here for people to find it easily if they're seeing this podcast and they want to just kind of click below. Let's start with the core concepts that you outline in the report to kind of level set what people can expect from reading the report.

John:

Well, basically what we're dealing with now is something that we truly haven't seen since the great depression. You're looking at GDP that is likely to fall on a quarterly rate in this current quarter at almost 12%, which if you look at it and how it definitely be published by commerce is a fall of 40% on an annualized basis. And that is deeper than anything we've seen since the great depression. And you are looking at unemployment rates that are likely to exceed 20% when we get the main numbers in. The April numbers were bad enough with unemployment hitting 14.7%.

But that probably underestimated true levels of unemployment, because a lot of people identified themselves as employed, but not working this week. Right now there's a view that much of the unemployment is going to be temporary, but unfortunately the longer people stay at work, the harder it becomes for them to come back in. So we're looking at very, very severe levels of unemployment that will be beyond anything we saw in the great recession.

Mike:

What do you mean by that? Just real quick, if I can interject because that just hit me. What do you mean that the longer somebody stays out of work, the harder it is for them to come back in? What do you mean by that? Why is that, I guess?

John:

Well, after a while, I mean, if your company thinks that they're going to be closed down for a month, they'll keep your job open in a sense, and they would look to rehire you as business picks up. But if it becomes two months, then three months, it's going to be harder for that business to open up. That's from the demand side for workers. On the supply side waver, the longer you're out of work, the further you become from your own network, the further you get from keeping your skills up to date.

So thus finding a new job becomes that much more difficult, which is why it took so long for people who were long term unemployed, following 2009, to get back into labor force. Many of them simply dropped out. If they weren't hired by 2010, 2011, many people just dropped out of the labor force and they only started coming back in really in about 2017 when you saw unemployment dropping to under 4%. And when you saw wages really beginning to pick up. And so as the labor market got tighter, then it becomes easier for people who have lost contact with labor market to come back in. But as long as there's slack out there, the longer you're out of work, the longer you're likely to stay out of work.

Mike:

That's really interesting. As I've been thinking of it, a little bit of a trickle up effect, right? The more people that are out of work, the harder it is for the other businesses that are relying on business as an employee, a lot of people to make their money, and then it kind of keeps going up.

John:

That's one of the great dangers we're facing right now. In many ways, particularly when the pandemic or at that point, not quite a pandemic, got started in China, people were saying this as a supply shock, it was an interruption to the supply chain and that began to spread and as the disruption to the supply chain spread. And then in addition to that, the spread of the infection, what happened was more and more people were not able to get to the office or to the factory or to the bar or restaurant. And it wasn't just the supply chain any longer. It was now people didn't have the income or didn't have the ability to go out to make purchases.

And so what you're beginning to see or what's actually started already and is developing further, unfortunately, is what started as a supply shop is now morphing into a demand shock. And you saw that in the first quarter where we had a drop in personal consumption that was, if I remember the number correctly, it was over 7%. So people stopped spending and their purchases fell by 7% for what it had been in the prior quarter.

Mike:

Wow!

John:

And that is a very extreme fall and it's very hard for businesses to operate when consumption, especially when you consider, when you go into recession, it's usually led by trade and investment. Those are the two most volatile components. Consumptions usually pretty stable. What led us into the recession this time was a fall in consumption.

Mike:

That makes sense, if you're closing places where people can spend money, obviously consumption is going to fall. And then if people who are not making as much money anymore, they don't have as much money to spend. Really make sense. Let's pivot back to the debt question, because that's the title of the report. How does the national debt actually affect financial consumers? We're talking more about product and other services consumers before. I want to think about the clients of financial advisors in RIAs.

If I'm a financial advisor, the one big thing that I want to know is how is the increase in the debt going to affect my clients? And of course, how is this going to affect my business kind of by extension, advisors are there to kind of translate these things, these big macro economic events for clients. And I'm sure most of their clients, frankly, will ask like, what do you think it's going to happen next? What's happening in the world? What are some thoughts on like, how does this affect people on the financial consumer side, their portfolios, I guess?

John:

Sure. Well, to get the scary numbers out first, what we're looking at is a massive increase in the deficit and the national debt. If you look at what the estimates from the congressional budget office on the fiscal deficit for 2020 earlier this year, they were expecting it to come at 4.6% of GDP. Right now they're expecting it to come in at 17.9% of GDP, much larger than anything we saw in 2008, 2009, 2010. And really we haven't seen numbers like this since World War II.

What we expect to see happen is that the federal debt held by the public, that's including what the fed owns, but it's not including money that one part of the government owes to the other, like the social security trust fund. It was 79% in GDP in 2019. It's going to be over a hundred percent for the first time since the end of World War II in 2020. It's expected to rise to 108% of GDP by 2021.

Now, those are scary numbers, but what's important to understand is that one of the main concerns around rising debt is that the increased supply of treasuries will put upward pressure on interest rates. And this was the major concern with debt, the rising debt, if you go back to the seventies and eighties, but something happened in 1986. One thing was that people started having faith in the federal reserve to keep the inflation rate under control. That inflation was falling and expectations for future inflation began to fall.

When that happens, interest rates come down. And then as we saw additional changes happening in the global economy with the increase in trade, with the increase in financial flows, with the growing demand for the dollar, both by foreign companies and foreign governments essential banks, we saw new pressures pushing interest rate down. When you add in pages of banking regulation, demand for safe assets, and we learned that commercial paper, no matter how high quality, commercial bonds, no matter how financially engineered like collateralized debt obligation, so as we had in 2006, 2007, they are not going to be safe assets. The only safe asset is U.S. treasuries.

So with the demand for safe assets, for the demand from overseas investors, and yes, because of conventional and nonconventional monetary policy, interest rates have fallen, and a larger supply will still put upward pressure on interest rates. These other factors, more than offset that pressure. And really since 1986, the correlation between high debt levels and government debt levels and interest rates has broken down. And all you really need to do is look at the increase in the debt since 2008, where interest rates haven't budged over the last really 10 years now. You can see that that relationship isn't there.

Well, if interest rates aren't going to go up, then what is the impact on individuals and on their businesses? Well, what the government is attempting to do and the fed for that matter, is provide disaster relief at this point. We shouldn't think about the programs, whether it's the programs the federal undertaking, or the money that Congress has approved push out the door as a stimulus. Because what the purpose of this is, is to try to prove that the economy falling into a free fall that could lead to a deflationary spiral.

And what the purpose now is, is to maintain a level of consumption in the economy so that when we get past the worst of the pandemic, when people can go out again, when businesses open up, when people aren't afraid to ride in the elevator to get to their jobs, we won't be so far behind that it'll take us two, three, four years to catch up. So what we're trying to do now is maintain the economy so that we don't fall so far behind, that will take us so much longer to catch up again.

And that's why, in my view at least, people should look at what's being done by the government at this point as a positive for their business, because it makes it more likely that going forward, businesses that are temporary closed now will be able to reopen. People who are interested in selling their business or expanding their business, will be able to do that as the economy begins to come around. And much of that is going to depend on the policies that the federal reserve and the U.S. Congress approves to keep the economy running so that we don't have the type of collapse that we saw in the great depression.

Mike:

Yeah, that's really smart. They basically effectively putting a little bit of a floor there through which people can't fall through so that they're able to rebound a little quicker because what's the consequences of not doing that, as you said, great depression style software we have soup kitchens. People lined up around the block for miles type of thing. People not being able to afford the basic necessities of life like rent and other stuff. Really hard, like you said earlier for them to get back to work because they can't even afford to get to work. Right?

John:

Yeah. I think really looking at it as a natural disaster is the best way of looking at it. The virus could be viewed as an act of God, the same way insurance companies and everyone else look at a hurricane as being an act of God. The difference is a hurricane plays out over one, maybe two days at most, or at least in one area, kind of go to coast, but that's another story. This virus is going to be with us for a long time. So you need more disaster relief than a hurricane hitting Miami and then going out to sea. But it's similar. Do you leave Miami in ruins or do you help it rebuild so that it can get back to where it was before?

Mike:

Hey, let's take a quick break to learn a little bit about SkyView partners. Are you an independent financial advisor or a member of the ownership team at an RIA? If so, chances are, you've thought about taking advantage of historically low rates to expand your business, restructure existing debt or finance a merger or an acquisition, or perhaps you'd like to take some cash out of the business and use the liquidity for other pursuits. SkyView partners works exclusively with independent and registered investment advisors. The team at SkyView and their extensive network of banking partners, understand your business and are ready to help you with your financing needs, visit skyview.com to learn more. And now back to our conversation with John Merante.

One of the things you mentioned in your report was there's a big difference between government debt and consumer or business debt. And you say that that really kind of gets overlooked. And people often like to think about the government spending and the government budget and everything as the same way that they think of their home budget or their business's financials. But you mentioned that it's significantly different and there's reasons for that. Would you mind elaborating on that a little bit?

John:

Sure. Think of it this way. You have a mortgage and you're paying it every month, depending on when you took it out, you're either paying it all in interest or you're paying some more of your principal debt, but you pay it every month. It's 30 year mortgage. And at the end of the 30 years, you pay it off. Or maybe after seven years, you sell the house, pay off the mortgage and take on a new mortgage. But at the end of the day, even if you die, your state's going to have to pay off that mortgage. There's no getting around that other than losing your house.

With the government though, what works in the government's advantage, particularly for the U.S. because we're the reserve currency, but what works for the government is that they're able to borrow at a cost that's lower than the growth rate of the economy. And if you think about how the government pays off its debt, well, it's not because they have assets, they were tied and they're safe and they have their bonds and stocks and they're earning money that way, or they're working, hopefully they'll get raised this year, but maybe they won't. What's the government's basic asset is us, the tax space.

And every year we produce more and more. And by doing that, when we do that and the economy grows while our income grows. And that means even if you don't change the tax code, the government's taking in more money in revenue. Well, if you're growing faster than your interest rate, well, that means your GDP is going to grow faster than the rate of interest. Which also means even if you're at a hundred percent of GDP, as long as you are not adding any ... I'm sorry, I'm about to get wonky here. As long as you're not adding any debt beyond what you're paying in interest, you're going to reduce the ratio of debt to GDP because the denominator is going to be growing faster.

Right now we're adding a lot more debt than the interest payments, but the fact that we don't need to run budget surplus to reduce our deficit is kind of made an evidence. If you look at the history of the U.S., we ended World War II with a debt to GDP ratio of 112%. We worked at down into the 30 percentages by the 1960s. And the years in between, we only ran eight budget surpluses. We were adding to the debt every year on those eight. If you look at the history since World War II, taking it through to 2019, we've only run 14 years with budget surpluses. But for most of that time, we were reducing ratio of debt to GDP. Since the great recession, that changed, but that had to do with the death of great recession. And now with shut down to the economy because of COVID-19. So the more the government can do to maintain growth and ideally spur it on, it actually works to reduce our debt burden.

Mike:

That really makes sense. If you borrow money and especially now, historically cheap rates, it's kind of like an investment. You're investing, as you talked about kind of from a disaster relief perspective, but you're investing in America with really, really cheap money. And when the economy recovers, it's going to grow significantly faster than the rate of debt that you need to pay off, the interest rate you need to pay off.

John:

Right. I mean, right now the 10 years around 0.6%, six tenths of 1%, by the end of-

Mike:

You can borrow money that cheap, basically like, here's free money. Pay it off when you feel like it.

John:

Yeah. And it's expected to stay under 1% for the rest of this year going into next year. And it may, depending on whether we're able to return to growth, and what level of growth, the expectation for tenure rate is that it'll be under 1.25% by the end of 2021. So we're looking at very, very low rates. And even if we only get 1% inflation, we're looking at real rates that are going to be either negative or slightly positive, but basically zero, any way you're going to look at it.

And right now we're in a period of deflation and that's one reason why we really need to avoid just trying to go to austerity now, because what we don't want to do is to create a deflationary spiral where prices are coming down. And really the only option for businesses will be to lay off more people. Businesses find it very difficult to cut wages. Now, that doesn't mean they can't, but even if they're able to keep people on the payroll, but they cut the people's wages. Well, that's going to depress consumption also, because maybe the price of gasoline will come down. Maybe one day the price of meat will come down again, but not for a while I'm afraid.

But, what about your mortgage? What about your car payments? Those aren't going to change. Now you have to renegotiate all those contracts at lower rates or else effectively you default. You really don't want to get into that top inflationary spiral where people either get laid or their pay is cut so much that they can't afford their monthly bills.

Mike:

Or you just make a decision. I have some big purchases that are kind of in my horizon for the next year or so. Like being at another house where we're kind of considering buying a new house from the house we're in now. And when I think about that, I'm like, well, I'm kind of expecting prices to come down. I think the market was overheated and I have a feeling there will be some new houses coming on the market at lower prices. So, this kind of weight. If you think the price of something is going to be lower tomorrow why would you buy it today?

John:

Right. I think there are a few things that go into that. I mean, very large purchases. My lease was up on my car back in February, so I renewed. If my lease was coming due now, I probably be able to get a new lease at a much better price, but it was just a matter of timing that I had no control over. But if you own your car and you're planning on buying one, you'll keep your current car if you think prices are coming down, but you'll do that with large purchases and durables. You're not going to be doing that with your day-to-day purchases.

And also anything that has fixed payments tied to it, like your auto loan or your mortgage, you get stuck with that. Now, part of the problem though is that as people wait, that means there's less demand out there. And that is one of the problems we have right now, which is why it's so important to try to maintain the income of individuals so that you're keeping a level of consumption that doesn't simply cause the economy to fall even deeper into a hole.

Mike:

Right. So the big question, and I guess it's kind of a spoiler alert for those who are planning to read the report, by the way, read the report because it's really well done. And obviously we're covering a lot of ground here, some of which is not actually in the report, we've been kind of covering some extra stuff, extra value for the podcast listener. Should advisors and their clients be concerned with rising debt?

John:

If you're talking about personal or corporate debt-

Mike:

Yeah. Yeah. Exactly. I'm talking about the U.S. debt. Exactly, yeah. Your own debt, yeah. Be concerned.

John:

But if you're talking about the government debt, no, not at this point. And if you look at other countries in the past and currently even the UK, the United Kingdom came out of World War II with over 200% of debt to GDP. And that was worked out over time, not by paying it down, but through growth. Right now, Japan has over 200% debt to GDP and they have no problem borrowing. Their interest rates are lower than ours. And people can say Japan is special. They can point to deflation. They can point to a lot of problems that Japan has, but real growth in Japan hasn't been as bad as people think.

Now, part of that is because they have low levels of deflation and that supports real growth. But that doesn't mean people's standard of living didn't improve. And this is being done with very high levels of national debt. Governments are not like people. They are not like families and they can live, especially if ... Well, let me rephrase that. If you're borrowing in your own currency and you have your own central bank, then you can do this. If you're in Italy or Greece, and you're basically at the mercy of the Germans and the Austrians and the Dutch who are running the European central bank, then you have a problem, but that is unique.

We are in a different position. We're in the same position that the UK after the World War II, or Japan today, isn't it? We can continue to borrow. And that is the most effective way of addressing the debt in the long term, because we may be adding debt now, but by ensuring future growth, we will be in a better position to reduce the debt burden going forward.

Don't forget, when you focus on the debt, you're focusing on the numerator, the top of the ratio. The denominator mat is a lot. And if we were to go into an austerity mode, well, the denominator, the GDP would fall by a greater extent than we currently expect it to because of all the relief that's been collide by Congress. But if that happens, then you're only going to be in the situation where going forward, you're going to have to wind up spending more money anyway, because you're going to have to provide more in unemployment insurance as more and more people lose their jobs. You're going to have to apply more in terms of Medicaid as people lose their health insurance, you're going to provide more for food stamps. What I call automatic stabilizers start kicking in at a graver extent. You're going to save money, but you're going to be adding to the debt burden anyway. And you're going to be adding to it from a time when your economy is weaker than it should be.

The key point should be for us right now is how do we keep the economy strong or prevent it from weakening so much that we're looking at a 1930s type of scenario. I mean, the great depression didn't have to happen. It was a combination of very bad monetary policy and very, very bad fiscal policy that didn't end until 1933. And even then the steps that were taken were insufficient to fully get the economy going again. And it took the buildup for World War II that finally kicked the economy into second gear.

Mike:

I guess one of my fun questions that I had for you teed up as we kind get close to wrapping it up here is what are you working on next? Have you decided on the next topic for your next report? If so, can you give us a hint?

John:

I'm actually thinking about inflation. Spoiler alert, my view on inflation versus to my view on debt. Don't worry about it. But I'm open to suggestions.

Mike:

Oh, that's great. That's awesome. That was kind of my last question of the day is do you take requests? Because I'm sure many of the listeners have questions. Maybe they are dealing with these questions from their clients, or they're thinking about it in their practice. How are we going to allocate capital and client portfolios? So if someone wanted to hit you with a question or maybe see you cover a topic, what's the best way for them to get that to you. They just reach out via SkyView or they reach out via LinkedIn. What's the right way to get a suggestion to you?

John:

The best way is to reach out via SkyView. And I encourage it because I could be sitting in front of my computer delving deep into the latest working paper out of the National Bureau of Economic Research, I'm thinking, "Wow! This is wonderful." I mean, the way I think I'm most helpful is by addressing what's on people's minds today. And so I really encourage questions and suggestions.

Mike:

I love that approach because it is really so important for people to feel like they have somebody like yourself that we can go to and ask that question so that they can then use that guidance and the insights that you provide and bring them out to their clients at which in the end, that's what they're being paid for, right? To advise your clients on what they should do, the course of actions they should take to achieve the goals for their financial future. Well, John, this has been absolutely fantastic. I really enjoyed having you on the show. I think we've got like a great report going on here and I have a feeling we're going to be doing this every time we come out with a report.

John:

Okay. Sound good. I look forward to it.

Mike:

All right. Thank you very much.

John:

Okay. Thank you.

Mike:

Thank you very much for listening to this episode of the Advisor Financing Forum. I hope you found it engaging and informative. If you would like to explore financing for your RIA or independent financial advisory business, the team at SkyView partners with love to help, simply swing by skyview.com and click the get pre-approved button or call (866) 567-6282 or shoot off an email to info@skyview.com and someone will get right back to you. Well, until next time, please make sure you stay safe and check in on someone you haven't heard from in awhile. I'm sure it would make their day to hear from you. We'll see you next week for another episode of the Advisor Financing Forum.