Is the US Going Greek? Protecting Investors in Times of High Debt

Posted by Joseph Giulitto on May 8, 2012

By Joseph Giulitto

No, the US is not switching from high fashion to togas. We are also probably not going to convert our economy to a fishing/tourism model anytime soon. However, like Greece, the US is assuming debt at a rapid pace. Two years ago, we were actively criticizing Greece for its lack of fiscal discipline and unwillingness to accept austerity. Now, we stand exactly where the Greeks stood just 24 months ago. Does this mean that looking at Greece is looking into our future?

In 2009, Greece claimed to have a debt-to-GDP ratio of just over 100%. Economists and the world laid claim to its imminent failure. The US-of-A, while facing its problems in early ’09, was sitting at a comfortable 74% debt to GDP. While not ideal – still manageable.

Jump forward to today, and the US is now at 100.4% of debt-to-GDP…

A Look at Rising National Debt

Debt as a percentage of GDP is the standard barometer in which most the world’s economies judge the health of a country’s economy. How much you produce vs.
how much you owe. The US as of 12/30/2011 had a total debt of $15.69 trillion (as of this writing we are crossing the $15.75 trillion mark with current GDP $15.46 trillion according to BEA). That takes into consideration both publicly-held debt and intergovernmental holdings. Currently, total debt as a percentage of the production of the United States is a staggering 100.4%. Clearly there is no precedent for this kind of fiscal malfeasance. Or is there?

I believe Roghoff and Reinhart said it best, “When you’ve studied eight centuries of financial folly, patterns begin to emerge.” The most striking pattern they’ve found is that people never learn. When we carry a debt that exceeds a certain margin the question is – can we pay it back? If history has anything to say about this (and it usually does) we may be looking at the point of no return.

Debt certainly has its place in functioning of government, business, and personal affairs. The question you have to ask is – how much is too much?

Typically economists identify that once a country surpasses the 80% debt-to-GDP ratio, there is no going back. While this theory has been proven wrong in few cases, the incidents where countries are able to pull themselves from the brink of failure are rare and with circumstance. Japan as an example, with a national debt that is roughly 220% of gross domestic product certainly has not pulled itself from the abyss, it simply has become accustomed to living with the terms of that debt. By the aforementioned standard, Japan should have collapsed. Yet Japan has somehow avoided a massive debt crisis (at least as of this writing).

Protecting Clients in Times of High Debt

The proverbial canary in the coal mine for the RIA is looking at local debt as an indication of potential risk. As most advisors define investing from the standpoint of stock to bond exposure. What happens when the “safe side” of the portfolio is being impacted? As recently as of April 30th California may be facing a $2 billion shortfall with its income tax receipts. If the individual states start having municipal defaults en-masse can the Fed save the day?

This leads us to the big issue for the advisor – protecting clients from massive drawdowns. From finding the right blends of investments, to creating the proper portfolio relative to your clients’ risk tolerance, to adding asset classes to further develop protection in volatile markets. While there is no perfect answer, the one thing we know for certain is that being able to react and respond to market conditions and changes is fundamental to an RIA’s business practice. If you have to spend days rebalancing your portfolios or even several hours, it can cost you and your clients.

Whether we can successfully navigate the peril that exists in the domestic markets or even the globe will be evident in the next 3 years. How we build value and protect clients will be evident daily.

While Greece panders for future bailouts and attempts to protect its citizens from total economic collapse, the world waits to see if we all share the same fate.

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