Economic Brake Lights



But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
Warren Buffett (b. 1930), 1987 Berkshire Hathaway Annual Report
Those who do not learn from history are doomed to repeat its mistakes.
—George Santayana (1863–1952), Spanish-American philosopher
Those who don’t study history are doomed to repeat it. Yet those who do study history are doomed to stand by helplessly while everyone else repeats it.
—Tom Toro (b. 1982), American cartoonist for The New Yorker
All good things come to an end, even economic growth cycles. The present one is getting long in the tooth. While it doesn’t have to end now, it will end eventually. Signs increasingly suggest we are approaching that point.
Whenever it happens, the next downturn will hit millions who still haven’t recovered from the last recession, millions more who did recover but forgot how bad it was, and millions more who reached adulthood during the boom. They saw it as children or teens but didn’t feel the full impact. Now, with their own jobs and families, they will.
Again, there’s no doubt—none, zero, zip—this will happen. The main question is when. Just a few weeks ago, I had hopes we could postpone it possibly even beyond the 2020 elections. It could still happen, but a barrage of data in the last few weeks suggest this may be more hope than reality. And as I constantly remind you, hope is not a strategy.
Last week (and indeed for the last year), I talked about our growing debt problem and how it could trigger a crisis. Excessive leverage may light the fuse, but the real problems are deeper. A new report, just out this week, highlighted an important one.

I titled this letter “Economic Brake Lights” because it’s a fitting metaphor. If you’re driving down the highway and the cars in front of you put on their brakes, they aren’t necessarily stopping. They are probably just decelerating, i.e. reducing their forward speed in reaction to conditions ahead. The other cars could be coming to a complete stop, however, so you slow down until you have better information.
Likewise, we are starting to see businesses tap their brakes. The initial US GDP report showed continued growth in the third quarter, a 3.5% annual rate. That was good, but the report had some warning lights, too. Non-residential business investment grew only 0.8% annualized, a sharp deceleration from the first quarter’s 11.5% rate.

As I’ve written, and as my friend Dr. Lacy Hunt has demonstrated from the economic literature, increasing debt becomes a drag on an economy, especially after it rises over the 80 to 90% of GDP level. US government debt is now 106% of GDP, and if you add state and local debt, which causes similar drag, total government debt at all levels is over 120% of GDP. Shades of Italy and Greece.
Congress wants you to believe last year’s deficit was $779 billion. They don’t mention the off-budget deficit, which adds just as inexorably to total debt. It is not easy to find that number, but fortunately, my friend Michael Lewitt writing in The Credit Strategist brings us this pithy note:
Our current prosperity is built on an explosion of debt; it is therefore unsustainable. The US added roughly $1.3 trillion of GDP in the fiscal year that ended in September but also added $1.271 trillion of debt. Interest rates, while still running well below real-world inflation, are rising in a heavily leveraged economy. The $1.271 trillion increase in federal debt was nearly $500 billion or 39% higher than the official annual deficit of only $779 billion, which means that politicians are keeping significant amounts of debt off-balance sheet. I don’t know who they think they’re fooling, but they aren’t going to be able to keep this con game running much longer. Over the past five years, the official deficit was reported as $2.977 trillion whereas the federal deficit grew by $4.777 trillion, meaning that 38% of the actual shortfall was hidden by our feckless leaders. And all of these figures do not include trillions of more dollars of off-balance sheet entitlement obligations promised by the government to future retirees and other voters.

That deficit was for fiscal 2018, which ended on September 30. The CBO’s latest projection is we will add close to $1 trillion of debt in 2019 and over $1 trillion in 2020. If the Democrats take the House next week, even narrowly, is there any real hope of cutting that deficit without tax increases? Which both the Senate and Trump will not accept?
The off-budget deficits have averaged around $360 billion for the last five years, generally increasing over time. But if we take just that average and add them to the projected deficits, the US government deficit will be (drumroll, please) approximately $1.4 trillion per year for the next five years, which will mean $29 trillion total debt by 2024.
And that’s without a recession. Throw in a recession, and we’ll get to $30 trillion long before then. Care to speculate what interest rates will be? What quantitative easing will look like? What all the other market disruptors will look like?