Friday, January 31, 2020 - Stocks plunged on Friday on fears of the Coronavirus causing a global slowdown, but market history is loaded with such frights. The Standard & Poor's 500 performance over the course of the 128-month expansion illustrates the transitory nature of unexpectedly bad world news.
Stock prices are almost whimsical when it comes to discounting risks. While the Coronavirus is suddenly a huge concern, the threat posed by the long-term U.S. debt is arguably a far more serious risk to global growth, and yet it has not frightened stock investors. Why? The answers tell us a lot about the nature of financial market risks.
Federal spending outpaced revenues by an amount equal to 3.9% of GDP in 2018. Unchecked, this annual gap widens to 4.8% in 2029, according to the Congressional Budget Office and is forecasted to make the long-term debt soar in the next decade.
The CBO's projections indicates that the U.S. debt will become financially unsustainable unless it is checked by either cutting spending or increasing revenue. Though it's a financial disaster waiting to happen, the stock market is not collapsing. The next chart explains the fundamentals driving the market's view.
The market knows that the U.S. government will eventually be rational and fix the deficit, probably by raising the federal payroll taxes, which show up as FICA withholdings on your paycheck. It won't require an onerous change in tax policy.
Fritz Meyer, an independent financial economist whose analysis we license, calculated the breakeven point for fixing the long-term debt problem, as is shown in the dotted line. Budget deficits of 2.9% of GDP annually would result in no increase in the long-term debt as a % of GDP. To be clear, if federal revenue were increased annually to level the annual level of deficit spending at 2.9% of GDP, the long-term debt would stop soaring. The financial disaster would be averted. And what's more interesting is that the annual average budget deficit annually since 1969 is precisely 2.9%! If the nation can simply run a deficit in line with the long-term norm for the past 50 years, the risk posed by the long-term debt of the United States would be solved!
The U.S. has one of the lowest total tax burdens among the 34 OECD countries. The U.S.'s comparatively low tax burden allows some flexibility in solving the long-term entitlement spending problem.
This chart includes data for the 36 countries that belong to the Organization for Economic Co-operation and Development but not non-OECD countries, such as China, Brazil, India and Russia. It includes all forms of taxes: federal, state and local; income taxes, sales taxes, VAT taxes, estate taxes, property taxes, etc. and the U.S. ranks among the lowest-taxed of all the developed nations.
The Standard & Poor's 500 dropped 1.8% in value on Friday, closing at 3,225.52, on fears about the Coronavirus. The drop occurred after airlines in the U.S. cancelled flights to and from China amid growing fears of a worldwide slowdown. Past performance is never a guarantee of future performance but the market's resilience after earth-shaking events plaguing modern society indicates that this sudden new fright will be resolved. If the stock market believes the long-term debt will be resolved, as the numbers indicate, curing the Coronavirus may also be very doable.
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