Federal Debt Crisis? It's Over (And Overblown), So Stay With Stocks

The Wall Street Journal placed a large, misleading graph on page 1 last Thursday (Oct 16). In "Congress Strikes a Debt Deal," the graph highlighted the 20-year, fourfold increase in U.S. government debt and the historically large growth over the past four years. While the numbers are correct, the WSJ's presentation is not. Here's what's wrong and how the interpretation changes when the data are viewed appropriately.

First: Incomplete time period

While the 20-year span sounds long and meaningful, starting at 1993 leaves out the previous 30 years of significant changes in the U.S. Moreover, when examining the recent Great Recession and its repercussions, we must go back to the similarly problematic late-70s, early 80s to find relevant comparisons.

So, the first change is to reset the beginning date. I have chosen 1966 because 1965 was a key watershed year for a number of economic, financial and social changes. Major U.S. companies post-war superiority peaked, inflation and bond yields began their long ascents (the UST 10-year bond was 4-1/4%, a level not seen again until 2002), the Dow Jones Industrial Average hit ~1,000 (an all-time high not to be surpassed for 17 years), the sizeable Vietnam War expansion began and Medicare was born. Augmenting these items was growing social unrest, heightened by JFK's assassination (1963) and the Civil Rights Act's passage (1964).

So, let's see what happened from 1966 to today, using the WSJ's charting approach. (I have added my observations in the graphs, below.)

This graph's 55x growth is overstated because it includes inflation.

Second: Inflation-adjustment

We all know that today's dollar doesn't have the purchasing power of yesterday's – much less that of 1993 or 1966. Therefore, we need to adjust those nominal numbers for inflation to get comparable readings. Here's what happens when we do. (I used the Gross Domestic Product Implicit Price Deflator because the Federal Debt is often compared to GDP – as we will do later.)

The inflation-adjusted numbers show the "real" 10x growth in Federal Debt. However, the graph is still misleading because of dollar scaling. This makes the 100% move from $0.3T to $0.6T look puny compared to the same percentage move from $1.5T to $3.0T.

Third: Logarithmic (log) scale adjustment

To allow for visual examination of percentage growth, analysts use log scaling. Any series being analyzed for growth (think Google's stock price) requires such an adjustment.

Now we get our first "Ah-ha!" moment, seeing that the past few year's Federal Debt growth is not historically large. This adjusted series raises another issue, though: How about the growth "rate" – i.e., the speed of change. In the graph, this rate is shown by the slope of the line. However, as can be seen, the line is rarely straight, meaning the growth rate is changing. So, we need to do something else to our graph.