Depending on whether the forecast emanates
from the White House or the Congressional Budget
Office, the nation’s income statement in 2012 will
either be in balance or markedly in the red for years to
come.
Should this scenario concern investors?
The simple answer is yes, but not for simple
reasons. You see, there is an emerging school of
economic thought suggesting that too little
government debt issuance may adversely affect the
investment demands of the Baby Boom generation.
Writing in The Wall Street Journal, Nobel Prize
winning economist Edward C. Prescott reminds
investors that “the optimal amount of public debt is
two time the gross national income or GDP.”1 The
problem, as he sees it, is that the current level of
privately held debt is less than one-third of GDP and
only moves to one and two-thirds times GDP by
including the obligations of Social Security. In other
words, as politically incorrect as it may appear, the
federal government may not be issuing enough debt
to optimize the unimpeded expansion of credit needed
to foster economic growth. In essence, and with great
simplification, what I believe he is suggesting is that
the political correctness of a balanced budget or even
a government with no privately held outstanding debt
is way off the mark.
Needless to say Dr. Prescott’s proposal continues
to generate enormous interest—both pro and con.
Nevertheless, while all of this may seem far afield
from issues concerning equity investors, I assure you
it is of the utmost importance.
Most serious studies on government deficits
conclude that government deficits in and of
themselves do not hurt the stock market or the
economy. Instead, deficits set in motion an increase in
the velocity of money, an increase in total debt levels
and essentially put more money in the hands of the
private sector.
On the other hand, shrinking or eliminating
federal budget deficits appears to have the exact
opposite effect, reducing velocity and monies
available to the economy. And, if my research is
correct, since World War II a marked slowing of
government debt issuance—such as occurred around
the turn of the century—roughly precedes periods of
below average equity returns.
Granted, correlation is not causation, but the data
raises some interesting questions in my mind about
how investors should view federal deficit spending
projections. You see, what might seem politically
incorrect may turn out to be the correct move for
assuring adequate credit creation in the years ahead.
1 Five Macroeconomic Myths,” Edward C. Prescott, The
Wall Street Journal, December 11, 2006.
This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its
accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information
in this report does not pertain to any Van Kampen product and is not a solicitation for any product.
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