Jim: Do you feel the debt ceiling debate and the political theater in Washington are hurting U.S. credibility and our capital markets in the long-run?
Kyle: No...the entire world is in the same position we are in one way or another. That’s painting the world with a broader brush, but when you look at the developed western economies (and, of course, we’ll exclude countries with no net debt like Australia and Canada that are natural resource heavy), but the developed western economies with the largest debt loads are all in the same boat. Whether or not they have debt ceilings in the U.S. or bank note agreements like they had in Japan until they recently abolished them, there are all of these potential glass ceilings that are put on the marketplace that always tend to move. I think since 1960 we’ve raised our debt something like 82 times.
Jim: Economists have often said—I’m thinking of “This Time Is Different” by Reinhart and Rogoff—when countries have debt-to-GDP ratios over 100%, they get into trouble; Japan’s is 230%. Why have they not had trouble up until now?
Kyle: When you think about what Reinhart and Rogoff’s book says, it kind of gets to an answer but it’s not the right way to look at things; there are many more variables to analyze the situation with. One is, of course, debt to central government tax revenues—that ratio. Another one is what percentage of your central government tax revenues do you spend on interest alone? Those barometers are much more impactful than just using a debt-to-GDP barometer. And then when you think about Reinhart and Rogoff’s work, if you’ve read all the white papers that they’ve written prior to writing the book, one of the other conclusions that they draw is when debt gets to be about 100% GDP it becomes problematic. Well, what that means is, typically—and, again, painting the world with a broad brush—central government tax revenues are roughly 20% of GDP. So what they’re telling you is when debt gets to be 5 times your revenue, that’s when you start to have a problem. Historically, the analysis that’s been done empirically by academics has focused on the countries that have fallen into a restructuring or a default as a result of this ratio that you and I are discussing. Historically, those have been emerging market economies that have higher borrowing costs. So, it actually makes complete sense that that number is too low when you’re talking about a developed market economy versus an emerging economy because, in theory, a developed economy can borrow at lower rates than an emerging economy can. That being said, in Japan, when the debts are 24 times their central government tax revenue, they are already completely insolvent—it’s just a question of when does it blow up.
Jim: I want to turn our attention to the stock market right now and your view of where you see the markets right now. They don’t seem overvalued when you compare them to 2000 or 2007, but they’re not cheap; and, where do you go in a market when the rate of return on cash or bonds is hardly anything?
Kyle: I think that as long as the Fed—for instance, the Fed is still buying $85 billion a month; almost a trillion a year—you could argue that the Fed is being more stimulative today than they were a year or year and a half ago. When we were running a trillion to a trillion and a half deficits, the Fed, at a trillion dollars in a deficit, was buying every bond that was issued. Today, you have a scenario where the fiscal deficit in the U.S., we think, is somewhere around 650 to 700 billion dollars. So, in theory, the Fed is actually adding more money to the economy today than it was a year ago because the deficit is lower and they’re still buying the same number of bonds. So what I’m saying is the monetary base continues to expand. What the economists are saying is velocity continues to drop at a faster rate than the base is expanding. Well, velocity, I believe, is a coincident indicator at best—possibly a lagging indicator. So, when the v [velocity] turns around that’s when inflation shows up, but for now--you’re asking about stocks…I think, given the lack of nominal yield in the bond market, all of the new money is going to continue into stocks. The interesting thing is it’s going to make the rich people richer and the middle and lower class won’t be any better off, which is the opposite of what the administration is trying to pull off.
Jim: What is your outlook on when the Fed will taper or, eventually, raise interest rates?
Kyle: I personally think that what enables the Fed to taper, again, is a contraction in the fiscal deficit. Now, part of that equation will be remedied by higher tax collections; unfortunately, the other side of that equation is, of course, lesser spending, which isn’t going to happen. So, I believe they can taper to the extent that the fiscal deficit has contracted. I don’t think that they’ll be able to raise the Fed funds rate any time in the foreseeable future—3 to 5 years.
Jim: So, that would argue that stocks would be a better play.
Kyle: Unfortunately…because it feels like they’re making it the only game in town. It’s not your choice, but it’s the only answer though.