The Experts Are Wrong About the Debt by Ben Strubel of Strubel Investment Management

Dear Investors,

June 2014 Newsletter

Arguments. We’ve all had them, and they came in many different forms. I’m going to talk briefly about the classical type of argument, the formal debate kind. Specifically, a type of argument known as the “appeal to authority” or “argument from authority” that leads to a logical fallacy.

Wikipedia gives this example: “A is an authority on a particular topic. A says something about that topic.

A is probably correct.”

An appeal to authority is the form of argument I most often encounter in my business when I discuss the national debt and the deficit. I’ve written a lot about the topic, saying why it isn’t a cause for concern or even anything that deserves attention (insofar as managing the economy is concerned). On the flip side, a lot of well-educated, wealthy, presumably intelligent, and well-spoken men and a few women say the opposite.

A lot of clients tell me they really like what I write about the debt and deficit, and then they say something along the lines of this: “But Person X says we have a debt crisis.”

Person X is sometimes a more-famous-than-me market prognosticator or money manager. Other times the “authority” is a smarter-than-me professor, and sometimes it’s a more-corrupt-than-me politician (although I don’t think my clients think I am corrupt). Sometimes it’s a wealthier-than-me political donor. (In the United States, we frequently equate wealth with intelligence.)

The unspoken issue is this: How can Ben Strubel, an investment advisor at a tiny RIA in middle of nowhere Lancaster, PA, be correct and Person X be wrong?

Let’s start off with one issue that we should all be able to agree on. The national debt is composed of all the treasury securities (bills, notes, and bonds) currently in existence. This is an indisputable fact. Even the biggest debt-fearmongers know this. In order to pay down the national debt, we would have to somehow collect all outstanding treasury securities. Again, this point is not in dispute.

The method of collection could vary. You could simply take them from their current holders at gunpoint. Or you could induce their current holders to surrender them through a mixture of raising taxes and cutting government expenditures. The resulting increase in tax burdens would force holders to sell them to satisfy their taxes or to fund economic activity (consumption) to take the place of reduced government spending. In any case, all treasury securities must be removed for the debt to be paid off.

Most, if not all, of my clients own some treasury securities. My question is this: If paying down the debt means you will no longer have your treasuries, then how does that make you better off? How is being less wealthy an improvement for you? (Or for anyone for that matter?)

The answer is simple: You are not better off. You would be poorer. Paying off the national debt WILL make you LESS WEALTHY.

In fact, there is a memo from the Clinton-era White House, when we were running budget surpluses, that details all the problems that our banking and monetary system would face if the national debt were actually paid off. The memo basically says that if we paid off the national debt, then our monetary system as we know it would collapse.

By now, we should have established that the “authorities”—the market prognosticators, CEOs, think-tank academics, and politicians—are wrong on at least one point. Paying off the national debt will make you very poor.

So, if all the experts are wrong about at least one point, then shouldn’t we at least consider an alternative theory?

What if the national debt and deficit aren’t bad? What if they are an important part of a well-functioning economy?

And that’s exactly what they are. Remember above when I talked about how the national debt is all of the outstanding treasury securities? What that means is that the national debt is actually all of the private sector’s savings. Not only are treasuries in your investment account, they are also in your bank account, although you might not realize it. Any money saved in a bank account, whether in checkings, savings, or CDs, is also represented by treasuries via reserve banking. The bank holds these treasuries. Banks must maintain a certain amount of reserves for all customer deposits. Each night, most of these reserves are deposited at the Fed and then they earn interest (the Fed Fund’s rate).

The graph below shows the government deficit and private sector savings rate. As you can see they are mirror images of each other.

Debt gdp
(Graphic source: Orcam Financial Group)

In order for the private sector to save money, the government must allow it to do so by giving it money to save. The government does this by running a deficit.

Whenever the deficit shrinks, the government is taking more wealth out of the economy.

All of what I’ve said is a factual description of how our monetary system works and none of it is not in dispute by anyone.

While there are many people richer, smarter, more politically connected, more powerful, and better educated than I am who are saying that reducing the debt and deficit is a good thing, just ask yourself why and how making you and the rest of America poorer will help? If they are wrong about one fact regarding the debt and deficit it shouldn’t be much of a stretch to believe they are wrong about other aspects as well.