U.S. Debt, Where’s the Money Going to Come From?

A lot of what passes for analysis of the US economy is far too complicated. The reality is that you only need to do basic arithmetic to see that the US is STILL in a recession if not depression.

Let’s break it down.

The US consumer accounts for 70% of the US GDP. The US GDP (after the recession’s impact) is in the ballpark of $11 trillion. So the US consumer accounts for $7.7 trillion in dollar terms.

This is THE driver of our economy. So let’s focus on the consumer’s balance sheet.

According to the Fed, total US household wealth currently stands around $53 trillion. Personally I think the Fed’s number is bogus since it lumps non-profits and households together. It also claims $20 trillion of this wealth comes from real estate including “All types of owner-occupied housing including farm houses and mobile homes, as well as second homes that are not rented, vacant homes for sale, and vacant land.”

I’m sorry, but a house is not “wealth.” It is a MASSIVE debt you owe until you own it outright. And given the housing prices are falling (the assets are depreciating) and home sales anemic, I DO NOT agree that you can identify your home as a status of wealth in this market.

So let’s create our own measure of household wealth by focusing on liquid assets and deposits that can be sold relatively easily or transferred in a pinch.

So total liquid assets equals roughly $41 trillion. Total liabilities equals $14 trillion. This brings household net-worth to $27 trillion.

On the surface, the debt seems somewhat serviceable, except it isn’t without some kind of systemic implosion. Let’s say consumers wanted to pay off the $14 trillion in debt by cashing out deposits. Well, total deposits in the US only equals $7 trillion. Setting aside what would happen if there was a $7 trillion “run on the bank” (hint: KABOOM), even if consumers cashed out every last cent of savings they’d still owe $7 trillion in debt ($14 trillion -$7 trillion= $7 trillion).

Ok, so savings don’t take care of the mess… what about stocks? All told, consumers own (through pension funds, mutual funds, and private holdings) $30 trillion in equities. The pension funds are not easily accessible so we’ll take them out, leaving roughly $20 trillion in equities available to be sold. That’s definitely enough to cover the $14 trillion in debt consumers owe.

So let’s put that scenario into perspective. The total market capitalization of EVERY stock in the world COMBINED is $36 trillion. So IF consumers sold their equity holdings to pay off their debt, we’re talking about worldwide markets trading 40% lower than they are now.

Obviously, neither of the above scenarios will happen. After all, debt can be paid off gradually and doesn’t require immediate full payout. But given that consumers cannot print money out of thin air, and that incomes are falling off a cliff (as evinced by the 17% year over year drop in tax receipts and the fact that Uncle Sam currently accounts for 17% of all US incomes) the money needed to pay off the $14 trillion consumers currently owe will HAVE to come from somewhere at some point in the future.

This means that at some point stocks or deposits or some other asset will have to be sold to pay off debt or the debt will be defaulted on. Given that both US corporations AND the US government get most of their money from the consumer, this has DIRE implications for the US economy and corporate earnings going forward (not to mention how on earth we’ll roll over our trillions in Federal debt since foreign governments are increasingly loathe to lend us money).

At best we shall see anemic growth in the real economy and corporate income statements (the year over year 20-30% drop in sales is just the beginning). At worst this means a full-scale depression marked by continued deflation in most major asset classes as consumers sell what they OWN (stocks, homes, etc.) to pay back what they OWE.

This also indicates that bank stocks are in for a very rough decade going forward. The banks that do not engage in investment banking or trading (the non-Goldman Sachs) will suffer from a lack of consumer borrowing, continued defaults on consumer debt, and more. Our new era of frugality is the product of consumers owing too much money. And whether they try to pay it off quickly or bit by bit is irrelevant. Either way the economy, corporate profits, and banks will suffer going forward.

This is the medicine we all must take. The government is trying to fight it by shifting private debts onto the public balance sheet. But the consumer cannot fund those debts as well (none of my above math includes the federal debt). In a sense, the government is throwing in a spoonful of sugar in the form of continued spending on social programs to make the medicine more palatable.



The only problem is that this is a bursting credit bubble… not Mary Poppins.

Speaking of which, I’m already preparing investors for what’s to come with a FREE Special Report detailing THREE investments that are set to explode when the next Crisis hits. I call it Financial Crisis “Round Two” Survival Kit. Not only can these investments help protect your portfolio from the coming carnage.. they can ALSO show you enormous profits: they returned 12%, 42%, and 153% last time stocks collapsed.

Swing by www.gainspainscapital.com/roundtwo.html to pick up a FREE copy today!

Good Investing!

Graham Summers

http://gainspainscapital.com

Graham Summers: Graham is Senior Market Strategist at OmniSans Research. He is co-editor of Gain, Pains, and Capital, OmniSans Research’s FREE daily e-letter covering the equity, commodity, currency, and real estate markets.

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

© 2009 Copyright Graham Summers - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors. Graham Summers Archive

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Comments

Jack Lasater

01 Jan 10, 16:47 How do you short a 30 year treasury?

A lot of financial news letter recently are quoting Bill Tedford, VP of Fixed Income for Stephens Financial in Little Rock. He is disagreeing with Bernake and predicting inflation. He personally is shorting 30 year treasuries. How does he do that? Do you agree that this is a good way to fight inflation? There are ETFs and mutuals that are inverse bond strategies. I checked on them but Rydex says that they are for short term trading and don't correlate over the long term. I really like your articles. Your illustrations do a remarkable job of picturing various economic topics. Thanks

TJ

03 Jan 10, 16:07 shorting bond

I am not sure how to short the 30 year other than the futures market. You can short the 20 year 2X in TBT, ETF.

