Debt doom-and-gloomsayers

The headlines these days are thick with fearmongering over impending debt crises.

In the US, politicians from both sides of the aisle declare in stentorian tones that a failure to raise the debt ceiling (or, in some cases, a decision to raise the debt ceiling) will put the US Treasury in danger of default. Credit agencies are threatening to downgrade the US government's credit rating, due to the country's impending inability to service an ever-growing debt burden.

Elsewhere in the world, fear of a Greek debt crisis has pundits in the financial media declaring that conditions are right back to the summer of 2008. Greece's inability to service their own outsized debt, it is predicted, will set off a domino effect which will cause European banks to implode, sending the economy back into a panic crisis like that of 2008-2009, or worse.

While recognizing that bloated spending by governments is a serious problem (a problem so serious, in fact, that we have called it "The Question of Our Time" in previous discussions on this blog), we nevertheless disagree with the doom-and-gloomsayers predicting certain catastrophe from seemingly every street corner of late.

As the graph above created from data provided by the Federal Reserve Bank of St. Louis illustrates, the US is in no real danger of defaulting on its debts. The graph shows Federal receipts (the money that the US government takes in, primarily in the form of taxes) versus Federal outlays on interest (the money the US government must pay to service its debt). The top line in blue represents the receipts, and the bottom line in red represents the outlays, and it is clear that there are more than enough receipts to service the debt.

If we were to create an analogy for ease of understanding, the top line would represent a household's income (taxes being the "income" of a government), and the bottom line would represent that household's periodic mortgage payment. In the case of the US, this is a household that has a bigger mortgage than any other household in the world, and a bigger mortgage than at any time in the nation's history. However, it is also true that if the US were a household, it would have a higher income than any household on the block, and that its income was higher than at just about any time in its history as well.

To suggest that this household might seriously have problems paying its mortgage is ridiculous. The data shows that Federal receipts total almost $2.2 trillion, while the interest on the nation's debt is closer to $250 billion. This situation is analogous to a household with an annual income of around $2.2 million and an annual mortgage of around $250,000. If such a household was complaining that it needed an additional home equity line of credit in order to be able to pay all of its bills, one might reasonably ask what on earth it is spending all of its money on. It might need to cut back on some of its other discretionary spending, but most families would not stop paying their mortgage first -- if anything, that is the one bill that absolutely needs to be paid. If the US Treasury doesn't pay the service on the debt, it won't be because of lack of income.

Thus, all of the talk about a US default is really a gigantic red herring. The real problem is outsized government spending. In our analogy, the household with the $2.2 million annual income appears to have joined so many charitable organizations, signed up for so many expensive club memberships, and purchased so many subscriptions to worthwhile but expensive products and services that it is wondering if it can pay them all and still pay the mortgage. It is these extras (which in the case of the federal government are government programs on which it spends the tax receipts) that need to be cut and which are causing the budget pressure.

Similarly, the European debt problem also stems from over-zealous spending on programs that might have seemed like a good idea at the time, but which have completely overwhelmed the ability to pay the mortgage. In countries such as Greece, which doesn't have a very large income to begin with, there is a very real possibility that it will be unable to service its debt. However, as we have written before, the answer for every country that finds itself in this unfortunate circumstance is to increase its income through policies that promote economic growth and innovation -- not to raise taxes, the death-knell of economic growth!

In spite of the very real problems in Greece (and the likelihood that the Europeans will try to fix them in many of the wrong ways, stifling growth instead of encouraging it), we don't think the debt situation there is about to cause an economic Armageddon either. As economist Scott Grannis wrote over the weekend, the recent fears of "Carmageddon" in Los Angeles over the closing of Interstate 405 turned out to be unfounded -- as so often happens, it's usually not the crisis that you're expecting that turns out to be the real problem.

While the rest of the US and the world frets over impending debt-driven doom, we would advise investors to simply continue looking to invest their capital with well-run, growing companies, positioned in front of fertile fields for future expansion.