"Hot potato" is a favorite children's game. Unfortunately, as adults, we're playing an economic version that has the potential for much more serious consequences.
It started with consumers going into debt over their heads to help fund an ever-increasing lifestyle.
For example, total household debt rose from $1.1 trillion in 1978 to $13.5 trillion at the end of 2009, according to the Federal Reserve. That's more than a 12-fold increase over the past 31 years. By contrast, our economy, as measured by gross domestic product, grew from $5.3 trillion to $13.3 trillion during that same period--a more modest 2.5-fold increase, according to the Department of Commerce.
Then it moved to the financial sector racking up huge liabilities on the back of newfangled derivative securities.
Total financial sector debt, which includes various government-related enterprises and private financial institutions, rose from $0.4 trillion in 1978 to $15.6 trillion at the end of 2009, according to the Federal Reserve. That's a 39-fold increase over the past 31 years. With this high leverage, is it any surprise that our banking system nearly went kaput in 2008?
Then it moved to the local, state, and federal governments incurring unsustainable debt to keep the world economy from collapsing.
Total U.S. local, state, and federal governmental debt rose by a factor of 11 from 1978 to 2009, according to the Federal Reserve. Overseas, the picture looks bleak, too, as many of the European Union countries are sitting on huge piles of IOUs that look increasingly less likely to be paid back in full. Not surprisingly, gold prices hit a record high last week as people turn to the perceived safety of the yellow metal in times of doubt, according to the Financial Times.
With the potato of debt having passed from party to party over the past three decades, the financial markets are now saying the potato stops here. As John Mauldin, president of Millennium Wave Advisors, LLC, says, "You don't cure a debt problem with more debt unless you have a clear path to grow your way out of the debt." In the U.S., we can grow through population growth and productivity gains. That, coupled with higher taxes and lower spending, may do the trick. In Europe, structural headwinds make the growth story much more difficult and that's partly why the value of the euro is declining and street protests are rising.
How this unwinding of debt plays out with the world populace will likely affect the financial markets for years to come.
|
Data as of 5/14/10 |
1-Week |
Y-T-D |
1-Year |
3-Year |
5-Year |
10-Year |
|
Standard & Poor's 500 (Domestic Stocks) |
2.2% |
1.9% |
28.6% |
-8.9% |
-0.5% |
-2.4% |
|
DJ Global ex US (Foreign Stocks) |
2.6 |
-6.4 |
23.6 |
-10.6 |
3.0 |
0.8 |
|
10-year Treasury Note (Yield Only) |
3.4 |
N/A |
3.1 |
4.7 |
4.1 |
6.5 |
|
Gold (per ounce) |
2.8 |
12.0 |
33.6 |
22.6 |
24.1 |
16.2 |
|
DJ-UBS Commodity Index |
-0.6 |
-8.1 |
6.4 |
-9.5 |
-2.7 |
2.2 |
|
DJ Equity All REIT TR Index |
3.7 |
14.3 |
70.5 |
-9.0 |
3.4 |
11.2 |
Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, Barron's, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable or not available.
