PLEASE NOTE: This is Part 2 of a portion of the Year-End Summary that Jeremy Roll writes each year for his Investor Group. He granted Left Field Investors permission to publish excerpts of the report. If you would like to contact Jeremy, please see his contact information at the end of this article.
Thinking Further Ahead – Debt, The Next Cycle And Beyond
Before I begin this section, I wanted to be sure it’s clear that I am including it as “food for thought” for everyone in terms of longer-term thinking that likely won’t be applicable for some time (ie. 5-10+ years) but I think is very important to consider because I believe there’s a good probability that we will eventually run into the challenges I outlined below, depending on future debt levels and other key times. I hope this section is helpful in terms of providing you with some food for thought for the long-term but I do want to be clear that it’s not something that I am concerned about in the short or medium term from an investing perspective.
Given that I am waiting for the 6 events that I outlined above to unfold so I can better understand how our current recession will potentially impact the economy, markets, and asset prices, I have spent some time contemplating the potential impact that the current government intervention and increased debt could have on the longer-term investing landscape and, while this is definitely a bold statement for which I reserve the right to change my opinion as our next cycle unfolds, I can’t help but think that the next economic cycle could very well be the last “normal” economic and investing cycle that we will experience in the US for decades to come due to the increasing burden that the debt will have on our economy’s annual GDP potential.
In fact prior to the pandemic, the US was already on a trajectory of an increasingly burdensome amount of debt that was greatly weighing on the economy’s annual GDP potential. It is widely believed that, once an economy reaches a debt-to-GDP ratio of greater than 60%, the debt becomes a significant burden on that economy and the debt burden beyond this threshold begins to have very significant effects on that economy. Furthermore, it is widely believed that once an economy reaches a debt-to-GDP ratio of greater than 90%, the economy faces such a large debt burden that it will eventually slow to stall speed as the debt burden increases over time and eventually will no longer be able to register consistent and predictable positive annual growth during an economic cycle. It’s important to note that, in the decade leading up to the Great Recession in 2009, the US annual GDP potential was roughly 4% (in other words, in a given year it was very difficult for GDP to grow at an annual pace exceeding 4% per year) in part due to the debt burden that was already creating headwinds at that time. In 2009, the government chose to launch a very large quantitative easing program to stimulate the economy and reduce the duration of the recession and the additional burden of the increased debt caused further headwinds and, as a result, the US economy experienced a reduced annual GDP growth potential during our most recent decade that was capped at roughly 3% (which explains why, despite all of the stimulus he provided for the economy, President Trump was unable to register annual GDP growth beyond 3% despite his 4%+ target). Now, with the enormous amount of newly added debt in 2020 and additional debt that will be added in 2021, the US economy is once again facing a reduction of its annual GDP potential in the coming decade to what I believe will be the 1-2% range during our next economic cycle. While this is simply an estimate on my part and could very well be incorrect, it’s worth noting that the CBO is currently forecasting average annualized GDP growth of roughly 2% over the next decade and many previous CBO forecasts have proven to be too optimistic in hindsight. Not only is the debt burden likely going to cause GDP growth to eventually slow to stall speed but, if we continue to increase our debt in the future, we will likely eventually achieve a level of debt that will place our economy in a very precarious position: our GDP growth potential would be near 0%, meaning that it would be slightly above or slightly below 0% growth (say -1% to +1% growth) in a given year. This is the exact scenario that has plagued Japan’s economy since the 1990s due to its very high debt-to-GDP ratio and it’s the most probable scenario that we will face in the US if we continue to go down the path of significantly increasing our debt (if you’re not familiar with Japan’s economic challenges since 1990 then I would strongly recommend that you research it further, as I believe that their experience over the last 30 years foretells the highest probability scenario that we will face in the coming decades if we continue to increase our debt burden, with the Japanese government fighting very low growth with enormous amounts of stimulus and asset purchases that have resulted in the government owning over 40% of publicly traded stocks, among other assets). And with the size of China’s economy projected to exceed that of the US as of 2026-2028, investors will likely place more focus on and more capital into China’s economy, which will shift some capital away from the US and which will likely create additional headwinds for the US economy during the next economic downturn and beyond.
It’s extremely important to consider all of this when making investing decisions during the next economic cycle, as the uncertainty of our future economic growth that will likely result if our debt continues to increase over time (which, based on the government’s actions to-date, seems inevitable) could make investing in the US extremely challenging after our next economic downturn (to be clear, I am not referring to our current economic downturn but our next economic downturn that will likely be in 5-10+ years). While it seems highly likely that we, as investors, will be able to rely on positive GDP growth in the US during each of the years of the growth phase of our next economic cycle (as we have in past economic cycles), the possibility of having a lack of predictable positive annual GDP growth in a given year during future economic cycles (beyond our upcoming next cycle) is a very scary prospect for lower-risk cash flow investors (like me) who target consistent/predictable cash flows. In fact a lack of predictable positive annual GDP growth would likely make me reconsider whether employing a long-term passive cash flow strategy would be the optimal strategy, as the possibility of registering negative or flat GDP growth in a given year could have huge implications for investors who target both passive cash flow in general and, perhaps equally importantly, increasing cash flow levels to keep up with inflation over time (putting investors in the challenging position of potentially falling behind to inflation and possibly requiring a shift of focus from cash flow to value-add and appreciation to keep up with inflation). This is honestly not something that I have researched thoroughly yet, as I don’t believe this will likely be a challenge until after our next downturn, but it’s something that I believe is critical to consider in the long-term, as negative or flat annual GDP growth would create a very different investing environment than we have experienced in the US during our lifetimes. And, to be clear, this is currently only a long-term concern of mine that could change depending on many factors, including future debt levels. While it might seem like being concerned about the investing landscape in 10-20 years could be thinking too far ahead, it is definitely something that I plan to monitor very closely in the coming years because it’s important to think as far ahead as possible (as a passive cash flow investor) to help avoid potential investing “land mines” in the long-term and to enable investing strategy adjustments as far in-advance as possible to help reduce risk and increase returns in the long-term.
Jeremy started investing in real estate and businesses in 2002 and left the corporate world in 2007 to become a full-time passive cash flow investor. He is currently an investor in more than 60 opportunities across more than $1 Billion worth of real estate and business assets. As Founder and President of Roll Investment Group, Jeremy manages a group of over 1,500 investors who seek passive/managed cash flowing investments in real estate and businesses. Jeremy is also the co-Founder of For Investors By Investors (FIBI), a non-profit organization that was launched in 2007 with the goal of facilitating networking and learning among real estate investors in a strict no sales pitch environment. FIBI is now the largest group of public real estate investor meetings in California with over 30,000 members. Jeremy has an MBA from The Wharton School, is a licensed California Real Estate Broker (for investing purposes only), and is an Advisor for Realty Mogul, the largest real estate crowdfunding website in the US. Jeremy welcomes e-mails ([email protected]) to network with or help other investors and to discuss real estate or business investments of any size.
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