As debt levels continue to soar, investors seem to have forgotten what debt means and the impact it will have on their retirement.
Debt represents a future claim on goods and services. The lender is owed money which can be used to purchase goods and services from the real economy. That’s fine when the real supply of goods and services is growing faster than the claims on that supply. In that case, real standards of living are rising. But since 1980, debt has been growing three times faster than the economy. Someone is not going to get what they bargained for.
Total U.S. debt now stands at $66.6 trillion, representing claims on an economy that is only $18.6 trillion in size. When push comes to shove (in the next recession?), many claimants won’t get what they expect. Who owns much of this debt? You do, dear reader, in your federal, state, local and private pension plans. We are about to learn a lesson of great importance: Debt is an asset only when the borrower can pay and agrees to pay. Otherwise, not so much. Debt is not like owning something real. It’s only a promise to pay.
But, you say, I have a 401K full of stocks. My company pension plan is largely in equities. Ok. Let’s take that into the equation. The value of U.S. listed equities is nearly $28 trillion. That’s a further claim on our $18.6 trillion economy (bringing total financial claims to more than $85 trillion) but those equity claims rank after the debt. Companies must remain solvent. The stock market must remain high. But in any case, the problem remains the same: there is a lot more ‘wealth’ (in the form of financial assets) than there are real consumables to spend it on. Fortunately, much of that ‘wealth’ is tied up in the chase for assets, not goods and services, but as America ages and retires….
Ah, but you remind me that there is U.S. residential real estate worth more than $25 trillion. You have your house. That’s a real asset, real wealth. But look at it my way. As the population ages and population growth slows down, who needs those houses? How much are they worth in terms of scarce goods and services? Add real estate to the pile of debt and equities. Now we have $110 trillion in assets looking for a share of that $18.6 trillion economy. And while we are adding real estate, let’s also add the present value of unfunded future liabilities for medicare and social security, estimated conservatively at more than $100 trillion.
Something has to give. The choices are few and none of them are good. Essentially, the real value of assets measured in terms of goods and services must fall drastically. Defaults can help to close the gap. The relative value of goods and services can soar as inflation runs wild. The dollar can collapse. But one way or another, the irrational value of assets must realign with the real need for goods and services. What that means is that retirement will not come soon or easy for many Americans. Faster economic growth is not going to solve this mismatch, as we have learned over the last few years. Soon, in my view, we are going to get the surprise of a lifetime as financial and economic realities hit us head-on.
What is needed is a store of wealth that mimics the scarcity of goods and services in the real world…an asset that cannot be easily created or destroyed. More on this in the next few days.