The comity (or should I say comedy) of government

By Todd Kirsch

Kirsch Wealth Advisors, An Independent Firm/Raymond James

The famous blues man B.B. King sings, “Only my mother loves me, and she could be jivin’ me, too.” That’s probably how President Obama and House speaker John Boehner have been feeling lately. Approval ratings are not exactly cresting all-time highs for these gentlemen. And get ready, because the drama could be coming again to a theater near you.

So, what does it all mean for investors? Like October, it probably won’t mean much. There are two broad issues. First, how do government shutdowns impact markets? And second, how would a government default impact markets? I’m not concerned about a government shutdown, but the U.S. defaulting on its debt is an entirely different matter. It’s a complex topic, but a default would probably impact markets in a severe, perhaps catastrophic way.[1]

Much of the lending market is collateralized by “risk-free” U.S. debt. If lenders and investors begin to question the quality of that debt, then lending markets could freeze up. Given the amount of U.S. debt used in lending markets, it would give new meaning to the phrase, “Houston, we have a problem.”

Throughout the drama back in October, not once did I hear a commentator or pundit posit the question, “How is it that one debtor ended up with this much power over the entire world economy. Should we fix it, and if so, how do we fix it?” Every American — every global citizen — should be asking these questions.

It’s not always been this way, but the U.S. Treasury and the Federal Reserve have become very powerful institutions. Go back 101 years, and there was no Federal Reserve. U.S. government debt has been around since the beginning of the nation, but in addition to this debt, bank notes circulated and served as collateral for lending, and this resulted in a diversified collateral market. Lenders, of course, had to determine the credit quality of these bank notes serving as collateral. We can certainly argue whether we have a more efficient market of collateral versus 100 years ago. Perhaps we do. But we also rely too heavily on rating agencies and governments to somehow make everything uniform and, allegedly, understandable. That didn’t work out so well in the 2008 financial crisis once everyone figured out that the AAA-rated, mortgage-backed securities were toxic, yet serving as high-quality collateral in credit markets. And remember that the AAA-ratings were bestowed on these securities from a small oligarchical group of rating agencies sanctioned by the government.[2]
The point above discusses the power of government debt in lending markets. A related but separate issue is the total amount of overall government debt. This, too, is an issue, but it helps to get past the headlines and screeching to understand it. Governments have been here before, though there are few modern, Western examples. We reached extreme levels after World War II, and England reached even more extreme levels — well over 200 percent of GDP — in the 1820s[3]and after World War II. Impecunious England powered through its 1820s debt problems with innovation in the private sector. The first Industrial Revolution was winding down, but the technological breakthroughs — textiles, steam power and iron making — were working their way through the economy that eventually enabled England to overcome the debt. Similar economic growth after World War II helped both the United States and England overcome their debt problems.

I’m not a biologist, a physicist or an inventor, and I’m certainly no expert at computers or nanotechnology. But I thoroughly enjoy reading articles, books and anything else I can find on where innovation is taking us. These longer-term technological trends are exciting when the potential for investors and our everyday lives are considered[4]. Our crucible will be whether governments and businesses can work together. Most days, I wonder if this is possible, as do most Americans[5] In years past, businesses did not have to work this hard to please government, but they are now “partners” in many industries.

Let’s end on a positive note. Here is what well respected Jeremy Siegel, professor of Finance at the Wharton School of Business at the University of Pennsylvania, had to say on September 27, 2013:
    “With all the debate about raising the debt ceiling, it is of interest that the gross government debt is now $16.7 trillion, almost exactly equal to GDP of $16.66 trillion. Of course, this is no “magic number,” since the debt is a stock variable and income is a flow. There are many very prosperous individuals and corporations that have gross debt that far exceeds their annual income. And one-third of the government debt is owned by governmental agencies, and the federal government owns 654 million acres, more than 30 percent of the total United States land mass and is estimated to contain oil that is more than five times the proven reserves of Saudi Arabia.”
Bottom Line: Patient, disciplined investors have historically been rewarded in the United States. If there was ever such thing as an “all-clear” bell that somehow magically alerts investors that the coast is clear and the risks are gone, then investors might earn the rate of inflation on their investments — probably less. Of course, that wouldn’t be called investing, now would it? Stay invested, my friends.


[2] The European crisis in 2011 (and arguably continuing on many levels) blew up because government debt, issued by the PIGS (Portugal, Ireland, Greece, Spain), was allegedly top-rated as a result of the introduction of the Euro. Somehow, the debt of these governments was transformed into debt on par with high-quality German debt. This financial alchemy sounded good … until it didn’t work.



[5] See the editorial in the Wall Street Journal, November 26, 2013, titled “The FDA and Thee,” in which the editorial board was critical of the FDA for ordering a company called 23andME to discontinue their product marketing. 23andMe analyzes a customer’s genome to reveal information about predisposition for some 250 diseases, along with inherited traits and ancestry. The alleged infraction was that “serious concerns are raised if test results are not adequately understood by patients.”