Matthew Erskine, principal of The Erskine Company, a strategic advisory firm located in Worcester, MA, discusses the effects on the investment climate of high government debt, and why specialized planning may be necessary. Views are the author's own but this website is grateful for permission to publish them. As always, responses are welcome.
A recent edition of Barclays Wealth Insight reports that the proportion of wealth held by taxable individual investors in art, jewelry, precious metals and other “treasure” has dramatically increased to nearly 20 per cent of net worth, especially in areas of the world where there is political and economic turmoil, as they increase their holdings of “flight capital.” In the US, that proportion is now nearly 10 per cent of net worth and rising.
Although part of this increase in holdings of tangible assets may reflect the relative decline in the value other forms of wealth, including a nearly 40 per cent decline in residential real estate and price declines in many stocks, another part of this increase may reflect purposeful reallocation of resources. Indeed, we have seen some clients allocate as much as 40 per cent of their net worth to treasure.
Since year 2000, stock market investors have suffered high volatility and low returns. With relatively high unemployment in the US and a stubborn ongoing financial crisis abroad, some worry about a repeat of the Great Depression of the 1930s, and they have been moving out of stocks. Low yields on bonds and money markets are not attractive, but reflect security in an uncertain world.
In the 1930s, cash and sovereign debt were safe havens, made more attractive by the Federal Reserve, which reduced the supply of money in the economy by 25 per cent after 1929. Cash is king when there is deflation and low interest rates. In the Depression, collectable treasures were bartered away at a fraction of their original purchase prices a few years earlier, just to pay for a meal, a place to stay or for cash. That is not happening today and is unlikely to happen again.
“This time is different”
An important difference between the 1930s and now is the level of government debt. Governments had high levels of debt when the financial crisis hit in 2008. The crisis moved governments to issue much more debt in an effort to prevent the complete collapse of their financial systems. The crisis, which continues to this day, has been blamed on the easy monetary policy of the Federal Reserve and other central banks, as well as governments' runaway deficit spending fiscal policies. For decades, central banks adopted easy monetary policies to keep credit flowing with low interest rates.
Governments and central banks seemed to assume that the normal business cycle could be replaced by a new era where everyone could have a decent income, every child could go to college, everyone could own a big new home, and everyone could consume more and more on credit.
The "new era" overextended and had to end when the bills came due. In order to save the banks from drowning in nonperforming loans, governments massively increased their debt as they took on large amounts of private debt, such as mortgages and student loans, which governments had guaranteed during the boom years. In addition, governments continue to run large and growing budget deficits as they attempt to maintain popular social programs that politicians promised voters in order to get elected. In some nations, we are seeing that high levels of government spending are no longer sustainable and existing debts cannot be paid.
In contrast to governments, private companies have cut costs and strengthened their balance sheets, leading to increased profits even in a sluggish economy. So, the main risk today may not be in the private sector, as was the case in 1929, but rather the risk is in the public sector. Thus, today’s economy is the antithesis of the Great Depression.