Our Legacy - Part 1 debt

Whether you're 20, 35, 45, or 55, you're paying for it. The debt taken on in the past 12 months across businesses and governments has been astronomical.

The problem with a moonshot of debt is that it pulls forward economic activity. Growth is "borrowed from the future" through debt. Indeed all debt really does is borrow from the future growth in exchange for growth today, assuming of course we have the intention to repay it. On a micro scale we can all relate to it - for those who have racked up credit card debts, you know that once that happens the payments required to rid yourself of that debt takes away from your spending and hinders other areas of potential spends or savings.

So what happens when that micro example gets translated into a macro reality we are seeing in our globe today across governments and corporations? We only need ask Japan. Since 2013 their central bank has quadrupled its assets. It's not only purchased its own government debt to keep rates low, it's actually been purchasing stocks directly. In fact the Bank of Japan (BOJ) has been busy purchasing more ETFs than any other buyer, and continues today. Meanwhile interest rates have stayed near zero, resulting in lower payments on each dollar/yen borrowed. However, GDP has barely moved, hovering between 1% and 2% per annum. In fact it has taken proportionally more investment from the BOJ each and every year to achieve the same outcome in GDP growth. What that means in "non-geek" speak is that the BOJ has to spend more each year to achieve the same result, which works while rates are low and debt levels can be serviced. But it also creates distortions in the market by pulling forward growth from the future - so the question arises "what happens when each dollar / yen invested no longer drives any growth?" More on that later.

Productivity was the de facto measure of economic health and growth used by economists in decades past. Because it factors in the economic output improvement per worker by taking inputs against outputs. However, in recent years the narrative by economists has switched to GDP and inflation. GDP growth since the Great Financial Crisis (GFC) has been tepid at best. But productivity? Even worse. See table below showing the dramatic increase in US federal debt measured against much lower productivity growth since the GFC:

So, like Japan, the USA is facing the challenge of a reducing efficiency of feds' spend against the desired economic growth, which ultimately results in more fed spending OR less growth, or both. This situation has not only escalated in 2020/2021, it has exploded. See chart below representing the federal reserve's (Fed's) balance sheet and projected balance sheet by end of 2021, from Morgan Stanley:

If the projection is accurate the US federal reserve will triple its asset base during the COVID recovery in 2020/2021. The net result is the largest injection of liquidity into the US market in history, bar none. So with that, comes faster growth, right? It's certainly injected enough liquidity into stock markets to reach all time highs. Open market purchases of US treasuries have kept rates low, much like BOJ has achieved in Japan. Even with lower efficiency of spending the fed can create quite the party with that kind of liquidity injection.

For those looking for an explanation into why stock markets have exploded while jobs are shedding and entire industries are suffering one need only take a look at money supply and the liquidity flushing around. Liquidity drives stock markets, and the fed is putting more liquidity into markets now than ever before. See chart below on M2 supply growth:

Looks like a bitcoin chart doesn't it? M2 has exploded into an area it has never been. Undoubtedly this will result in inflation. You know the saying "too many dollars chasing too few goods" - well that will come true with that kind of money supply growth. It means inflation is coming, and coming fast.

And what lever do central banks use to combat inflation? They raise rates. Yet if they do, government interest payments get higher, and debt service becomes an issue. Lots of investment experts talking inflation now, market crashes, and their rationale is simple; the fed will have to raise rates due to inflation created by spending and that will create a knock on effect. For those in that camp I say this:

The man himself that created money printing ideology said it best. Because the markets can remain irrational for much longer than most expect.

The financial experts I follow say we are entering the roaring 20s, 2.0, driven by all this liquidity. Meaning we will see explosive growth, inflation, significant liquidity, innovation and wealth creation. And all that could be true, until the music stops. Because the debt will not go away - it will get heavier and heavier, the more we create.

So that leaves us with a question around the future - what legacy will we leave our children from the actions we have taken to support current economic activity? Debt. We will leave them debt, a lot of debt. And they will be paying for it for decades. All while they face a significant climate crisis and multiple threats to peace.

We are creating a legacy of debt that history will not be kind to. I believe we will reflect on these times and see we were chasing short term solutions to long term problems. Your thoughts?