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US Debt: How Washington D.C. Could Cost Taxpayers $7 Trillion In New Wealth

 May 02, 2012 05:18 PM


(By Rich Bieglmeier) Last week's Gross Domestic Product (GDP) report was disappointing, for sure. Ah, but a new study titled DEBT OVERHANGS: PAST AND PRESENT says we better get used to it; 2.2% might be as good as it gets for a while - a looooooooooooong while. 

The analysis examines "major public debt overhang episodes in the advanced economies since the early 1800s, characterized by public debt to GDP levels exceeding 90% for at least five years."

Italy and Greece are the worst offenders with multiple transgressions (seems like some things never change). Meanwhile, the U.S. is a one- time debt delinquent during the years of 1944-1949 (WWII).  In total, there have been 26 cases and 23 occurrences experienced subsequent negative outcomes.

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The U.S. is currently two years away from joining the ranks of recidivism. Based on deficit and growth projections, it's pretty much a given we will cross the five-year finish line. Keep in mind that the analysis only considers the $16 trillion in debt the Federal Government holds, not unfunded liabilities like Social Security, Medicare, state and local debt, pensions, private corporate, and individual debt. Factor in those numbers and… well, we don't want your head to explode.

Overall, the analysis conducted by Carmen M. Reinhart, Vincent R. Reinhart, and Kenneth S. Rogoff reveals that, on an average, qualifying economies lose 1.2% per year in GDP growth i.e. 2% instead of 3.2%. The underperformance tends to last – are you ready for this – 23 years.

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With a 1% difference and an economy the size the U.S.A., that means Americans could lose roughly $7 trillion in economic output in the next couple of decades, reducing the potential size of the economy by 20% or more. And that's only if higher interest rates and taxes don't produce worse results.

According to the report, "Even assuming a more modest reduction in growth from 3.5 to 3 percent, the level of GDP at the end of 23 years would still be 11 percent lower than otherwise."

A show of hands, how many of you would take 3% right now? No doubt, all hands at 1600 Pennsylvania Avenue are reaching for the sky.

The working paper does make a distinction between war and peacetime debt. iStock supposes one could argue that war is a factor in our current debt picture, but future projections factor in Afghanistan and Iraq wars coming to a close and the debt numbers remain essentially the same.

There have been six "modern peacetime episodes in the advanced economies are comprised of Belgium, Canada, Greece, Ireland, Italy and Japan. Of these six, the shortest were Canada and Ireland, lasting 8 and 11 years, respectively."

Of these, iStock sees Japan as the most relevant comparison as it was preceded by equity and real estate bubbles popping. Sound familiar? The Y2K tech bubble and the subprime crisis? In Japan's case, it is called the "lost decade." Unfortunately, the lost decade started in 1990, and they still have subpar growth.

To make matters worse, if you can believe that, the existing run-up in mature economies' debt is unprecedented and, as mentioned up top, doesn't include "hidden debts."

What does all this mean for investors? With history as a guide, financials, durable goods and housing tend to be the hardest hit. So, all of you "experts" cutting in front of one another to call the housing bottom, cut it out.

In fact, where I live, Cook County, Illinois, Treasurer, Maria Pappas just said on the radio that people would be better off renting than buying homes in the county. She says the $140 billion in unfunded liabilities (hidden debt) means real estate taxes are going to have to pay for it. Wow, just wow.  Crook County, as it's affectionately called, is not alone. Many Americans are experiencing the double-cross of falling home prices and rising taxes. How does that happen?

The authors do acknowledge "it is possible that new developments in technology and globalization will provide such a remarkable reservoir of growth that today's record debt burdens will eventually prove quite manageable", and critics are sure to agree. We don't.

iStock  concurs with DEBT OVERHANGS: PAST AND PRESENT's conclusion, "the fact many countries are facing "quadruple debt overhang problems"—public, private, external, and pension–suggests the problem could, in fact, be worse than in the past" and "that the long term risks of high debt are real."

Let us know what you think in the comments section below or at Rich at wallsttools dot com.

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