Q&A: Election Years, Debt, & More
You asked (a while ago), we answered
What are your views on the national debt? How critical is it that we take action now?
Anirban: We just hit $34 trillion on the national debt. Current dollar GDP during the third quarter was $27.61 trillion. If I’m doing my math correctly, our debt/GDP ratio is now 120%. During the first quarter of the federal fiscal year (four quarter of the calendar year), America’s budget deficit surpassed half a trillion dollars.
We are playing with fire. I know what you’ll say – Japan, current low bond yields, only occasional debt downgrades to date. I’m not saying collapse is imminent (Japan’s debt to GDP ratio is higher than ours, yet people still buy Japanese bonds that yield extraordinarily low rates of interest), but within five to seven years, I suspect that at our current trajectory we are looking at the fall of Rome (or the British Empire, etc.). Enough is enough. Time to make some tough decisions so we don’t have a needless Treasury bond crisis that will make 2008-2009 look like nothing. Can we please elect some adults to represent us in Washington – adults who love America above all else?
Zack: I’m betting against the imminent (5-7 year) collapse of America. Quite literally, I have most of my investments in assets that would crash if that happened.
First, the rising national debt is a problem, yes, but debt service (i.e., interest payments on that debt) as a share of GDP stood at 2.4% in 2023. That’s the highest level since 1998 but is lower than at any point between then and 1982. Rapid GDP and productivity growth in recent quarters should help here.
Second, we just went through an unprecedented economic crisis with covid, and with a few quibbles, I think most of the recent borrowing was justified. We overshot the right level of disaster relief spending, and while we’ll never know what would have happened if we had undershot the target, I’m guessing it would have been lot worse.
To an extent, I agree with Anirban here. There’s no appetite on either side of the aisle to address it. The right talks a good game, but unfunded tax cuts are just deficit spending in disguise. The left doesn’t even talk a good game on this.
My mother used to say that election years are always good for the economy because incumbents make sure that’s the case. Is this true?
Zack: I don’t think this is true, if only because presidents don’t have that much power over the economy (if they did, it would be). Notably, two of the past four elections (2008 and 2020) occurred in the midst of generational economic crises.
Conversely, I think a lot of private sector decision makers enter a holding pattern during election years. If you think one candidate will create a significantly different economic environment than the other, you might wait to make a big capital expansion or new round of hiring. I’m not sure this really moves the needle either. Big picture, if you look at charts of virtually any economic indicator, you can’t spot the election years if the axis isn’t labeled.
Anirban: Actually, recent presidential election years have tended to be quite bad for the economy. Let’s start with 2000, which is the year of the dot.com bust. That eventually helped produce the 2001 recession. 2004 was a good year for the economy, but really an extension of 2003 as the housing market continued to boom. 2008 was tragically bad, ushering forth the global financial crisis. In 2012, U.S. GDP expanded a lackluster 2.3%. In 2016, it expanded 1.7%. And then there was 2020…
Is repopulating our urban centers the solution to the affordable housing crisis? Is there the political will to address crime and failing schools in order to make urban centers attractive places to live?
Anirban: Yes, cities and denser development will play a major role in dealing with our affordable housing crisis. One could argue that the issue is democracy. Sounds blasphemous I know but in many suburban jurisdictions around the nation NIMBYs rule. They do not want to approve an abundance of new housing, they certainly do not want density, and apartment development is an anathema. But there are many cities around the nation that would like to experience population gains. These cities need, of course, to deal with issues like high taxes, crime, and schools (of course), but their respective renaissance will be critical to addressing America’s structural shortfall of housing/affordable housing.
Zack: I agree and will also note that crime fell pretty sharply in most cities last year and, with the exception of the upswing during the pandemic, is near all-time low rates. Despite the common narrative, crime is significantly less of a problem now than it was in the 1990s.
Who should get credit for disinflation and the economic recovery: the Fed or the U.S. free market healing itself through supply chain improvements?
Zack: I’m willing to give credit all around. The Fed took a lot of criticism early on, but even their naysayers will have to admit the Fed did all right if they manage a soft landing.
Supply chains have improved but also just normalized. The pandemic was logistically challenging, and now that those challenges are gone, shipping costs and product/commodity availability are much better. The U.S. private sector remains undefeated in this regard, but it’s important to note that a lot of the supply chain normalization occurred at a global scale.
All that said, I think businesses, especially in the U.S., have done a remarkable job adapting to the new labor-constrained economic reality, and that’s reflected in recent productivity data.
Anirban: Oh I definitely credit the supply chain improvement. When supply improves in the context of unmet demand, one gets a ton of transactional volume as supply meets ready demand and lowers inflation as scarcity abates. Americans have been taking on additional debt like crazy, which suggests that in certain quarters higher interest rates haven’t had must impact at all.
Will we experience any deflation in 2024?
Anirban: I do not think so. I continue to believe that inflation above 2% will remain in place thanks to an ultra-tight labor market and an emerging set of supply chain challenges (e.g., Red Sea, Panama Canal, ongoing strife in commodity rich parts of the world). There has been some deflation already in certain categories (e.g., certain foods, certain types of energy), but overall deflation is not coming our way in 2024.
Zack: I agree here, and this comes down to the difference between disinflation (prices rising at a slower rate) and deflation (prices falling). The latter is bad for a number of reasons and would be a bigger problem than the inflation experienced over the past few years.
What’s the greatest threat to western economies from outside of the U.S.?
Zack: This is a tough one. I want to say a collective turn away from globalization, but I feel like that threat is coming from inside of western economies (The calls are coming from inside the house!).
If I had to pick an answer, I’d first point to supply chain dependence on other countries (specifically China), though I think we’re doing a decent job of addressing some of that with the recent investment in microchip manufacturing.
My second answer would be geopolitical uncertainty and spreading conflict in eastern Europe and the Middle East. Needless to say, nuclear war would be bad for the U.S. economy. That said, I’m hesitant to speculate about how geopolitics will affect western economies, because even intelligence experts are bad at predicting these things.
My third answer is a scenario under which some country displaces the U.S. as the best place in the world to work or start a company. I’m not concerned about this—America is a cultural juggernaut, and that won’t change anytime soon—though I wish we’d make it easier for talented foreigners to emigrate.
Anirban: This is a tough one. The natural thing to say would be Russia, China, North Korea, Iran, etc. But I think the real problem is the growing pervasiveness of national leaders who are autocrats and therefore do not answer to public opinion. A man like Putin doesn’t worry about losing elections, so he can throw thousands of Russians into a pointless war while draining national resources. In the late-1990s, the thinking was that democracy had won and that would result in a more peaceful world. Ugh.
When will we start to see rate cuts and how far do they have to fall to get mortgage rates back below 5%?
Anirban: I’m going to say July will be the onset of rate cuts (quarter point) and that 30-year fixed mortgage rates will be in the high-fives by early next year. That is akin to saying that we will get three rate cuts during this year’s latter half, which is my expectation.
Zack: I’m writing this response a few weeks after Anirban wrote his answer, and it now looks like March is firmly off the table for a rate cut. July seems like a plausible guess.
Are we making progress "on-shoring" manufacturing? What policies would elevate this opportunity/need?
Zack: Yes! We’re building a ton of new factories at the moment, and that has a lot to do with federal incentives in the (poorly named) Inflation Reduction Act. There are two big policies that would help here. The first is permitting reform, specifically with regards to the National Environment Policy Act, which lets just about anyone bog down a project in endless lawsuits. The second is immigration reform. Construction on some of these megaprojects has stalled due to worker shortages, and some of the new factories have already expressed concerns that they won’t be able to find enough workers.
Anirban: Supply chaining is coming back to America and will do so for decades. It took decades for supply chains to leave these shores, and it will take that much time to restore it. In general, America is ill-prepared for reshoring. We don’t have enough industrial workers. Our infrastructure, including our electrical grid, isn’t ready. But it’s happening nonetheless, and there is more to come as CEOs seek to protect their intellectual property, simplify logistics, transact in areas with functional court systems, avoid intrusion from foreign governments, and take advantage of massive federal subsidies.
What three things could our government do to keep the economy going and reduce the national debt?
Anirban: This is a tough one. I don’t like new taxes, but for Number 1: a federal retail sales tax of 1% to 1.5%. I would rather tax consumption than effort at work or gains from investments/savings. That would raise a ton of revenue.
Number 2: I would make Social Security and Medicare means tested. I know – ouch. But these respective trust funds are headed for insolvency within roughly the next decade. We just cannot pay promised benefits. Someone will need to take a haircut. It makes sense that it should be those who proved victorious in the free marketplace. They do not need to collect on social insurance. And yes, I’m perfectly well aware that a promise made to them will be broken, but I didn’t create a $34 trillion debt. Sins of the past and all that . . .
Number 3: Accelerate legal immigration. We need more workers. We need more taxpayers. Let’s recruit the world’s greatest tech talent, carpenters, truckers, mechanics, machinists, etc. We have an opportunity to regain our status as the world’s leading industrial power. If we accomplish that, we will have a lot more money to press down on our debts and deficits.
Zack: Only thing I have to add here is that immigration is key, and it’s way, way, way too hard to come here as a worker. There’s low hanging fruit here, including extending automatic visas to any would-be immigrant who graduates from a U.S. university. Why are we subsidizing higher education for foreign students only to tell them they can’t participate in our workforce once they graduate?
Assuming the Federal Reserve cuts interest rates three times this year, will USA Manufacturing grow faster than the overall economy?
Zack: It’s possible, but that might have more to do with inventory cycles than interest rates. The manufacturing sector has now contracted in 15 straight months, but there are some signs that activity might pick up due to cyclical factors. What makes this question particularly hard to answer is that if overall growth slows, that will hurt the manufacturing sector (and vice versa).
I’ll predict that the recent trend of services outperforming manufacturing continues, and the overall economy grows at a faster pace than the manufacturing sector in 2024.
Anirban: Manufacturing is poised to expand faster than the broader U.S. economy whether there are three rate cuts or six. Inventories are in better shape in 2024 than they were at the start of 2023 and those massive federal subsidies will remain in place irrespective of what Jerome Powell and the Fed do this year.
What's the opportunity costs of the Ukraine/Russia war? Where does the US money that supports this effort come from and how deep is this pool of money?
Zack: We’ve spent about $75 billion on aiding Ukraine, though about a third of that takes the form of weapons and equipment, some of which are outdated and just sitting around in DoD warehouses.
I think it’s easier to contextualize this number than to examine the opportunity cost; $75 billion is enough to fund social security for about 19 days, with the caveat that you can’t send a retiree an M18A1 Claymore mine in lieu of their social security check. It’s also about the same as the annual budget for the Environmental Protection Agency, and a little more than twice NASA’s annual budget.
I have no idea what costs the U.S. might incur if Russia won (whatever “won” means in this context) in Ukraine, nor the potential expenses associated with broader Russian expansion efforts were that to happen. Because of those unknowns, I’m really not sure how to answer this one.
Anirban: Oddly enough, the short-term opportunity cost is zero. That’s right. Nothing. That’s because all this spending just adds to the national debt. But that means that in the future, when we really need money because of insolvent Medicare and Social Security trust funds, etc., we won’t have it. So the opportunity cost of all spending is large, but that impact won’t show up until sometime in the future. I’m guessing that it will be at some point during the 2030s.