Thursday, December 17, 2009

Increasing US Debt And Its Impact On Investing

In previous articles, we focused a lot on the financial considerations of those who were attending or thinking about attending law school.  Frankly, that's gotten old.  It's time now to shift focus for a time to other financial considerations that may face an attorney later in their career.  In this acticle, we are going to take a look at how the increasing US debt may impact investment returns in the future.  Some specific recommendations that may lead to a higher return are presented after the jump.
In this article, we note that the US debt has already risen past the limit established in the spring and is up about 20% in the last two years.  Here are the two most important things in this article:
  1. The latest posting by Treasury shows the National Debt at nearly $12.135 trillion.
  2. The White House projects a record $1.5 trillion dollars deficit this year alone, and a 5-year deficit total of $4.97 trillion.
Here are some facts that are not in the article that help us put this in context:

  1. The American economy is contracting and is expected to continue to contract in the near term.  Consequently, even if the debt remained constant, the debt would represent a greater share of the economy.
  2. How we have been solving the problem is by increasing the money supply.  This lowers the value of the dollar and maintains the debt-to-GDP ratio even in light of a falling GDP.  The US has a huge advantage over other countries because our debt is denominated in dollars - and we can change how much a dollar is worth by increasing or decreasing the money supply.
  3. Most other countries have their debt also demonimated in dollars - instead of their local currency.  This means that they don't have the opportunity to debase the currency of their debt.  However, they like it when the value of the dollar goes down. At least DEBTOR countries like it - lender countries see their investments dwindle, like China's purchase of US securities.  However, debtor countries vastly outnumber lender countries at this time, so there is unlikely to eb overwhelming pressure to change.
OK, so here is what the financial impact will be:
  1. The US Dollar will continue to decrease in value.  Consequently, if the demand for a commodity remains level, then that commodity will appreciate against the dollar.  Similarly, if a foreign country is debasing their currency less than the dollar, (or not debasing their currency) then that currency will rise against the dollar.
  2. Most of the SP500 include assets that are demonimated in foreign currency or are located in foreign countries. They also obtain revenue in foreign countries - about 36% of their total revenue.  Revenue obtained in foreign countries will now be worth more in the US, which means that these companies will report increased earnings in dollar terms.  Unfortunately, most small caps will not see this advantage because they typically only get revenue in the US.
Ways to play it -
  1. You could always trade currencies, but most people don’t like to do so.  
  2. You could own foreign bonds demonimated in an increasing or stable currency (Chinese yuan or Swiss Franc).  In this situation, you get the currency bump plus the interest payment.  
  3. You could also buy foreign companies.  With regard to buying foreign companies, recognize that it is harder to get capital 1) outside the US, and 2) when the company is smaller - and that capital is still fairly hard to come by now.  Consequently, look for large companies that are fairly valued and throw off a lot of cash and are denominated in a foreign currency.
  4. If you want to stay in the US, you might want to trade in your small caps for the SP500
As always, I would be interested in any comments or feedback!


  1. Managing Partner - Doesn't this mean that taking large student loans now is wiser (not that it was ever wise) than doing it ten years ago? It seems like increasing the money supply will make them easier to pay off over the next 25 years, as long as we have locked in our interest rates.

  2. 3:40 -- HA HA - We have an optimist! I agree that all other things being equal, having a loan with a locked-in principal amount and locked, low interest rate can be beneficial when the currency denominating the loan is highly inflationary - as long as everything else rises with inflation. That is, if inflation is 10%/year and your compensation goes up 10%/year, then you have no net loss in your purchasing power, but are now able to pay back the loan easier.

    However, that's only the case when all other things are equal. Unfortunately, the falling dollar will make many items more expensive and your compensation is unlikely to keep up with inflation in this economy. For example, as the dollar falls, it will take more dollars to pay for a gallon of gas - that leaves fewer dollars to pay for anything else. Also recognize that the cost of gas is built into just about everything, from the cost of production and transportation of food to the cost of housing (as gas prices go up, housing that is close to work appreciates).

    Personally, I think right now is an even more dangerous time to take a loan because of the supply/demand disparity. There are too many lawyers relative to hours in many fields, but law schools are still churning them out. Lawyer compensation has crashed and will remain stagnant for at least another 5 years.

  3. Hmmm...It looks like you are assuming a couple things that really aren't true: 1) the sovereign debt of the United States has not been monetized (at most only a very small portion) and 2)for that to be inflationary, it will be funneled into the economy via the financial system.

    Because we're in a period of secular credit revulsion and a deflationary debt spiral, the increase in the sovereign debt will not be inflationary. The bonds are being purchased - not by the Fed - but by investors.

    Welcome to our deflationary nightmare - no end in sight. So, while I disagree with your reasons, the advice to the 0L thinking about taking on large debt to attend law school was correct - don't do it.

  4. Thank you for your brutal honesty. We need more of that, in this country. Too many young people have been inundated (by teachers, TV, parents, society) with the message that they can accomplish ANYTHING they set their minds to.

    It also doesn't help that many American faux "middle-class" parents heap unrelenting praise on their incredibly average kids, plus shower them with tons of expensive toys. (The disappointment that awaits the younger generations SHOULD give rise to a revolution. But it won't; everyone will go back to watching the football game, eating another bag of cheese puffs, swilling some more beer, and scratching their asses.)

    However, this optimism and constant priase will breed some DEEP anger and resentment. Especially, when more MBAs, MAs, MSs, and JDs in their thirties are playing Wii in their mother's basement (while wearing their underwear) and wondering what the hell happened.

  5. 3:16 - Thanks for your thoughts! I certainly agree that the increase in soverign debt has not been inflationary in the near term. However, I think that you would acknowledge that the value of US dollar has been declining. According to this article:
    the dollar has declined 40% from 2002-2008, with the increase in soverign debt being a major source of the decline. Also, see this article:

    I had not reviewed this article before I wrote my post, but it seems like they reach the some of the same conclusions:
    "Ask your financial planner about including overseas funds. These are denominated in foreign currencies rise when the dollar falls. Focus on economies with strong domestic markets, such as Japan and Europe. Also ask about commodities funds, such as gold, silver and oil, which increase when the dollar declines. "

    For myself, I would substitute China for Japan in the list because Japan is stagnant. Also, gold seems to be emotionally overbought right now, so I am not interested in holding it. Other than that, it seems pretty sensible.

  6. Nando - You are right! Too often the repeated mantra of "we can do anything" is said when the person really means "reality will conform to my wishes just because I want it to." This is not to disparage the drive to accomplish things and be greater than one is right now, but such plans and activities have to take place in the realm of reality. For example, you can't make yourself fly by will alone.

    Also, if there are 10 applicants for only 3 jobs, then only 3 people will get jobs - regardless of how well-qualified the applicants are, 7 more jobs will not miraculously appear. The applicants that don't get the job will be left wondering what they "did wrong" and will focus on things like "if I only got a slightly higher grade." In reality, they did nothing "wrong", but they did not analyze the opportunity correctly.

    Also - and this is where your comments about parents not giving accurate feedback to their children is relevant - the students had an inflated sense of their worth and a belief that they could not fail, that somehow it would all work out for them. Well, that's not the real world. I look at this attitude and I think about how it has become fashionable to give a trophy to every kid participating in sport - and how this trains kids to think that they will be rewarded just for participating. This creates a reality in a kid's mind that they expect to see repeated when they enter the real world. However, that is not the case. I certainly agree that this dissonance can cause great resentment. Also, although it feels like pampering our kids in this way is the right thing to do, I would advocate using "supportive truth" instead of fantasy land. Help your child identify their strengths and weaknesses. Work with them to help improve. Give clear feedback coupled clearly communicating that you believe in them and will help them. Then help then identify a field that caters to their strengths where the odds are with them when it comes to employment (so that it is closer to 10 jobs for 10 applicants).