Should financial advisors be worried about Uncle Sam's debt problems?

Americans got their household finances in order during the COVID recession, thanks to billions and billions of dollars in government support. By shoveling out all that relief, however, good old Uncle Sam saw his balance sheet substantially deteriorate.

The question now is whether Washington’s profligacy is one more thing financial advisors need to worry about for their client portfolios.

The US Treasury Department finished 2023 with a national debt of more than $34 trillion. That $34 trillion tab also happens to be bigger than the entire American economy. US GDP increased 4.8 percent at an annual rate, or $327.5 billion, in the first quarter to a level of $28.28 trillion.

Net interest costs on all that debt reached $659 billion in fiscal 2023, up 39 percent from the previous year, according to the Treasury Department. That means a lot more money that could have been spent on business investment is going to bondholders. It also erodes confidence in the U.S. dollar and creates concerns that the government will be forced to cut funding for programs like Social Security and Medicare.

It also means taxes will likely be going up in order to chip away at the debt, something financial advisors absolutely need to consider for their clients financial welfare.

And the problem will only grow more acute in coming years, according to Stephen Rich, chairman and CEO, Mutual of America Capital Management.

“There's almost $9 trillion which is coming due this year or maturing that needs to be reinvested, so our interest payments alone for fiscal 2024 are $870 billion. That's going up to almost $1 trillion next year,” said Rich. “So there is not only the absolute amount of debt we have, but then also the continuing of having higher and higher interest rate payments.”

One of Rich’s biggest concerns is that it will affect the credit worthiness of the US government and eventually spur inflation, even as the Fed is trying to fight it.

On the other hand, Daniel Lash, certified financial planner at VLP Financial Advisors, says he not that worried about Uncle Sam’s mounting IOUs. Or at least, not yet. That said, he does expect increased conversations about how the servicing of America’s debt will reduce government spending in market areas of the economy such as defense spending and R&D in healthcare going forward.

“Japan has shown that economies can still grow with a larger debt to GDP ratio but with much slower growth,” said Lash. “Fortunately, the US does not have the same demographic issues as Japan and we are a more diverse economy as well which should help the US. 

And while America’s massive debt may seem insurmountable to some, Lash believes “there are multiple ways to accomplish this and time will tell if or how this is done.”

Christopher Davis, partner at Hudson Value Partners, believes the explosion of the US debt has turned the nation into a “vast experiment overseen by academics at the Federal Reserve and Treasury Department.”

“Historically there have been only two ways to get out of such a hole - inflate it away or default,” said Davis. “While we would hasten to say we do not see default in the cards, the profligate spending does threaten the US dollar's reserve currency status - that ability to print the currency in which the nation borrows is what keeps things afloat.”

He adds that leaders have sought to use the dollar system as an instrument of foreign policy, weaponized through sanctions, thereby imperiling its value as a reserve currency.

“We are glad to have some hard asset exposure in energy, materials, precious metals, and within the property, plant, and equipment of industrial concerns whose replacement value continues to rise,” said Davis. “Having some exposure to global companies with revenues denominated in other currencies is another potential defense.”

Michael Leverty, CEO of the Leverty Financial Group, is very concerned about the excessive US debt, saying it highlights a significant and growing challenge for the American economy. While deficit spending is common and often a necessary response during recessions or extraordinary events such as the COVID-19 pandemic, the current level of spending and debt accumulation is not sustainable in the long term, according to Leverty. 

“Historically, deficit spending has been utilized to stimulate economic activity and provide a safety net during periods of economic downturn.  However, persistent, and a growing deficit in a period of relative economic stability raises serious concerns about the future financial health of the nation,” said Leverty.

Leverty maintains that diversification remains the cornerstone of risk management in order to protect client portfolios. 

“We need to ensure portfolios are well diversified across asset classes while focusing on quality and sectors that typically perform well in periods of sustained higher interest rates,” said Leverty.

Jake Miller, chief solutions officer at Opto Investments, believes the immediate impact of the national debt on assets is often overstated.

“Just as the total amount of a mortgage often, if not always, exceeds the borrower's income in any given year, there is no magic to the United States’ outstanding debt being higher than its yearly income,” said Miller.

The reason why Miller is more sanguine than other advisors is the fact that $6 trillion of this debt is held by the Federal Reserve, with nearly 30 percent owned by various other federal agencies, which poses minimal risk since the government owes this money to itself. He adds that the US controls its own currency and can implement quantitative easing if necessary, which is less inflationary than direct stimulus spending, though excessive printing could undermine faith in the dollar.

“Given stickier-than-expected inflation, we recommend investors look beyond traditional 60/40 portfolios to find diversification,” said Miller. “Private assets offer longer-term capital bases, less sensitivity to interest rate changes, and the potential for true alpha, which remains valuable regardless of shifts in interest rates and risk assets.”

Meanwhile, Stephen Tuckwood, director of investments at Modern Wealth Management, says the big question now for the entire country is at what point does the cost of servicing the debt cascade into a national debt spiral? At a minimum, in his view, the large debt level leaves little room for future emergency spending, whether that be a large-scale conflict or an exogenous shock to the economy. He adds that this higher interest rate environment is also adding a strain as the servicing costs of new debt being issued is significantly higher than just a couple of years ago.

“In our view federal tax rates will likely increase and there will be less fiscal support during the next recession. That means focusing on tax-efficient investing and building resilient portfolios,” said Tuckwood.

Craig Warnimot, CIO of Venture Visionary Partners, points out that a long line of market commentators has predicted an economic crisis due to outsized government debt. Nevertheless, those economic doomsday predictions have always failed to materialize.

“We are reminded of a line from an old Hemingway novel when a character is asked how he went bankrupt. The answer: Slowly at first, then all at once,” said Warnimot.

In the meantime, he says the best protection for investors to preserve wealth from inflation or currency devaluation is to invest in the stock market. 

“At the opposite end of the risk spectrum, cash feels safe to some, but typically offers no long-term protection from inflation,” said Warnimot.

Elsewhere, Michael Lehman, CEO of Premier Path Wealth Partners, says despite Uncle Sam's debt problems, the US remains “the cleanest shirt in the hamper pile of world economies,” as there is no serious contender to replace the dollar.

Regarding investment strategy, he believes a higher interest-rate environment coupled with higher taxes will become the norm.

“The era of zero interest rates is over,” said Lehman. “In this environment, cyclical companies that perform well with moderate inflation and commodity-based investments will be more favorable.”

The massive national debt is unlikely to have significant detrimental effects on current retirees or those near retirement as most of their wealth accumulation is completed, according to Eric Amzalag, certified financial planner at Peak Financial Planning. For those between 35 and 54 years old, however, he says accumulation will be more difficult as they will have to buy assets at peak prices resulting in their wealth accumulation happening more slowly if at all.

“They will suffer significantly more from inflation which is likely to continue and end cataclysmically in the next 50 to 100 years,” said Amzalag.

Those people under age 35 years of age will be "screwed," according to Amazalag.

“Incomes will not keep up with inflation, meaning savings rates for this cohort will go down over time as inflation of cost of living outpaces people’s ability to earn and save beyond that,” said Amzalag. “This group will possibly live to see the end of the US financial dominance unless major policy changes are put into effect.”