The text below is a transcript of the audio from Episode 34 of Onward, "Race against recession: Growth vs. Debts in America."
Disclaimer: This transcript has been automatically generated and may not be 100% accurate. While we have worked to ensure the accuracy of the transcript, it is possible that errors or omissions may occur. This transcript is provided for informational purposes only and should not be relied upon as a substitute for the original audio content. Any discrepancies or errors in the transcript should be brought to our attention so that we can make corrections as necessary.
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Cardiff Garcia:
Hello and welcome to Onward the Fundrise podcast, where you'll hear in-depth conversations about the big trends affecting us and global economies. We are recording this on Thursday, March 7th, 2024. Before we start today's show, we'd like to ask that you please keep rating and reviewing the show in those podcast apps. We really love hearing from our listeners. Also, evergreen reminder that this podcast is not investment advice. It's intended only for informational and entertainment purposes. With that, let's get on with this episode. This is, everyone has a plan until they get punched in the face, but what if your plan includes getting punched in the face episode? I'm Cardiff Garcia Bazaar Audio, and I'm joined as always by my very pugilistic co-host, Ben Miller, CEO of Fundrise. Ben, hi.
Ben Miller:
Don't think there's a compliment, Cardiff. Now it
Cardiff Garcia:
Is. It absolutely is. Man. This episode is all about planning for the future, including what happens if we or the economy at large gets punched in the face proverbially. Of course, yeah. We're going to do another scenario planning episode. You and I, Ben, have done this in the past, but it's been a while, so I feel like we should explain, especially to all our new listeners what scenario planning is and why it matters so much
Ben Miller:
Yeah, I love scenario planning because it's a structured way to think about the future, and a lot of times when people do planning, they don't realize that there are best practices. So the one I use, the practice I use comes from Peter Schwartz and actually he tweeted at me at one point saying, I heard you've been using my structure.
Cardiff Garcia:
That's great. It's worthwhile giving a shout out, giving credit where it's due, especially in this case, since this is something that you like to repeat, this is a process that you like to keep updating.
Ben Miller:
love it. I love it as a framework to think about complexity. So framework has three parts or three scenarios, scenario one, and that is a more of the same scenario or a linear extrapolation of the present into the future. So that's scenario one typically, and that's normally how people think about the future as they think of it as more of the same, more of what's like today.
Cardiff Garcia:
Yeah, that's almost instinctive. We see what's visible in front of us, we see what's concrete, what's evident, and we just kind of automatically assume that the future will be quite similar. That's true,
Ben Miller:
Yeah. And Kahneman calls that recency bias
Cardiff Garcia:
And then what's scenario two? Scenario
Ben Miller:
Two is something bad, a shock that's bad. And then scenario three is something surprising
Cardiff Garcia:
And I noticed it's interesting that when planning for the future and doing this kind of scenario planning, we don't include a best case scenario, so we have more of the same. We have a kind of worst case scenario and then we have a, Hey, what could possibly just surprise everybody scenario? I guess it's because in best case scenario, you wouldn't have needed to scenario plan in the first place. Everything just kind of worked out. This really is an exercise in how to prepare yourself, your organization, your company, in this case fundrise for different futures, for different scenarios in the future. And it's most useful when the future is either surprising or if the future turns out worse than we think. How are we protected?
Ben Miller:
Yeah, I read his book a long time ago, but my recollection was that the first scenario of more of the same implicitly is positive, and so that's not necessarily true, but generally when people extrapolate the present into the future is mostly positive. So we have sort of a mostly positive scenario one, mostly negative scenario two, and then a surprising scenario three. And just the point of doing scenario three is that if you plan for things that are unexpected and they happen, your mind's more mentally prepared. And so it's meant to stretch your mind not to predict something that's actually high likelihood, inherently low likelihood or surprising.
Cardiff Garcia:
Okay. Well in today's episode, Ben, you and I are going to go through those three different scenarios and perhaps how to prepare for each one. But before we do that, I feel like we need to establish a kind of common context. We need to kind of agree on what's happened in the past, at least the recent past before we discuss what might happen in the future. So where do you want to start there?
Ben Miller:
Yeah, I wanted to set a shared context and I had a mentor who always said, if I get you on the windup, I get you on the pitch.
Cardiff Garcia:
All right, well let's hear it.
Ben Miller:
I want to share some research. I went out and did a bunch of research for this episode and I found things that were surprising to me, and you probably know all this, but if I didn't know, probably most other people don't. So let me start by asking you a question about the past. So Cardiff, did the US grow its debts both public and private? So all debts, did the US grow its debts faster the 1990s or from 2008 to 2023? So from the bailout of great financial crisis 2008 all the way to the pandemic. So which period 10 years versus 15 years, which period grew us debts faster?
Cardiff Garcia:
Yeah, that's a fascinating question. And look instinctively, I want to say the latter period from 2008 to 2023. And the reason for that is because that has involved quite a lot of government borrowing. In other words, there was a lot of government borrowing fiscal stimulus and so forth to fight off the effects of the great financial crisis. And then later on, of course, the covid crisis. And we know that the us, especially in recent years, the US government has run very large budget deficits. We also know, however, that private balance sheets and business balance sheets in recent years have been in very good shape. And I have a feeling that because of the way you asked the question that actually the answer is the 1990s precisely because my temptation is to argue that it was not the 1990s, which was of course an excellent economic period. We associate it with the closing of the government budget deficit, but maybe private balance sheets went in a totally different direction and I'm just not remembering. So yeah, I'm curious to hear what the answer is.
Ben Miller:
Yeah, exactly. So I'm going to broaden this to a few decades, but in the 1990s, 1990 to year 2010 years total US debt, so all public and private debt doubled. So a hundred percent growth in 10 years. And to put numbers on that, total US debt according to the Fed was about 13.5 trillion and by 2000 it was 27 trillion. So a little bit more than a hundred percent growth. One of the things interesting is that you don't hear a lot of people talk about total US debt. They talk about US federal debt or government debt talking about household debt, but in a way, what matters is all the debt of the United States citizens and its governments because to some extent you can move the debts between the two, but it's the total US economy that carries it. And so it basically doubled in 10 years and from 2008 to 2023, which is 15 years, it only grew 80%. So it basically grew at half the speeds. It was growing at eight and half percent in the nineties, and it grew at four and a half percent in the 2000 tens. And I was surprised because it feels like the popular notion is that US has been growing debts by a lot and this big problem, but actually the real story is that the US grew debts from 1980 to 2010 by a huge amount. So during that sort of period from Reagan to Obama, all US debt went from 150% of GDP to 350% of GDP.
Cardiff Garcia:
Yeah, that's fascinating.
Ben Miller:
Yeah, huge. Basically debts increased from 150% of GDP, right? So basically debt was three times as much as US GDP to seven times. So basically all debts are now seven times US, GDP, and then from 2008 to now it's been flat at three 50%. Basically US debts have not grown faster than GDP, it's basically been even on a nominal basis. So the notion that we've been having this runaway debt is actually not consistent with the data. The data is actually, we basically stopped accumulating debt faster than GDP from 2008 to the present, and that was shocking to me.
Cardiff Garcia:
Yeah, that's fascinating. And I definitely had not looked at those big aggregate numbers before. I think I might gently push back on the idea that the composition of the debt is irrelevant. I think that that actually can have different effects on the trajectory of the overall US economy and the fragility of the financial system and so forth. But I was not aware of those big formal numbers and certainly not the idea that the debt had grown faster in the nineties, which again, we sort of just associate that with a period of debt reduction because we usually just think about the government. But yeah, that's quite fascinating.
Ben Miller:
Yeah, I think you're right. I didn't mean to say it wasn't relevant. Some people would say that we nationalized a lot of the private debts after the great financial crisis. So point taken then how I think I frame the sort of conversation we have in front of us is that there is a race now between growth and debt. That is really the essence of the American challenge. And the question I'd frame it is can the United States grow faster than its debts? Then those are the essence of my scenarios when I present is basically, does it grow faster than this debts? Does it not grow faster than this debts? And I think of it as a great contest against leverage. So that's my setup for today's conversation.
Cardiff Garcia:
Yeah, one of the realizations of the last 15 years for a lot of people, a lot of economists, a lot of people who follow this kind of thing, is the idea that we don't really have a great sense of what the upper boundary is for how much a country can borrow. In other words, there's a lot of different things to take into account. A lot of times I think what people do is they compare, for example, US government debt to GDP to let's say Japanese government debt to GDP, which is much, much higher than in the us and yet there's been no run on Japanese bonds. It just doesn't seem to have the debilitating effects that a lot of people in the past might've sort of expected. If a government runs up the kind of debt and deficits that we've seen in the last 15 years, we just don't know what the upper boundary is in terms of the sort of overall debt levels.
Cardiff Garcia:
I think that also is shrouded in mystery in terms of what a country can handle. Some of this probably has to do with the composition of the buyers who's holding the debt. Some of this I think frankly also has to do with what you might refer to as a country's assets. If you think about the US government for example, and if the economy, let's say does continue growing well into the future, well, the government always has the option of let's say, raising taxes of raising more money to offset the debt if that does become a problem. And you can kind of think of that as a sort of implicit asset of the US government, its ability to impose higher taxes or to cut spending or to make other decisions that make the debt more manageable. But what we've seen, I think I'd have to double check this with economists, but I think is that a lot of this truly is mysterious. We're just not sure what the upper boundary is of the amount of debt that a country can take on. Keeping in mind also that for every entity that borrows something and has to take on that debt, well there's another entity that is holding that debt for them that is an asset. And so when you start thinking about these two things in alignment, like I said, it becomes a little bit unclear to me what the consequences might be, but let me stop there. What do you think about all that?
Ben Miller:
Totally agree with you, and I'm still going to take a shot at trying to clear up some of the fog around it because I think there are some guideposts that you can more or less rely on, even though there is a lot of complexity and as a result uncertainty. But I think that there are some takeaways from this and I'm going to take a shot at doing that and that should be interesting at the very least.
Cardiff Garcia:
Okay, awesome. Well, should we get into our scenario planning? Should we go through scenarios one, two and three? Scenario one, which is more of the same, what do you see as the kind of salient characteristics of a scenario one?
Ben Miller:
Yes. Okay, I'll go first because I did do the setup and I think we're going to have some similar scenario ones. So it's easy to call this one soft landing scenario one, and the subtitle is GDP grows faster than debts. I'll put some math on this along the way, but basically the US has to grow nominal GDP at least 1% faster than its debts. So if it's debts are growing at 4% a year, GDP has to grow 5% a year. And I'll get to explain why that is. So essentially how could it grow faster than debt? And there's three possibilities. You can have high real growth, high nominal growth, a, a money printing, or you could slow down your debt growth.
Cardiff Garcia:
Yeah. Let me add in a point of clarification for listeners. So high nominal growth is the combination of real growth, so the actual growth of the US economy and inflation. So nominal growth can go up by a lot if either of those things is very high and the other one isn't taking away from it essentially. So if real growth is extremely high, the economy's doing great, but inflation is very low, that will keep somewhat of a lid on too high nominal growth. If both the economy's growing very fast and inflation is kind of high and this is something we've seen in the last couple of years, then nominal growth will be very, very high. And I just wanted to interject that real quick. Please continue. Yeah,
Ben Miller:
For sure. Okay. So those are the three possibilities and I have a little bit on each. So high real growth, that's the first possibility and that one's very promising these days. And so there's three ways you could have high real growth. My three if you will, predictions for scenario one, and those are ai, which we've talked about and which we talked about last year, and it continues to fulfill its promise. And one of the last episodes we talked about the potential impact of it, and McKinsey and Goldman Sachs and other institutions have forecast productivity growth of anywhere from half a percent to 3.5% a year. So if we say within my framework here, if we need at least 1% more than normal in real growth, AI alone could deliver that and then some. I think that's basically, I mean we're investing in it or building with it.
Ben Miller:
I think it's absolutely going to happen. And I believe that's one. Two is broadly you and I call the end of the great stagnation. And the great stagnation is that there's been very little change slowed inside a US society. And I basically say the pandemic shocked the US society globally at global society. And that drove change and essentially change is growth over a medium term. And so in the types of change that just to name a few so big and we take for granted how much they were different from before the pandemic, but telehealth work from home, downtowns have changed where people live housing because of work from home, how we spend goods, we spend a lot more on goods, labor shortages, onshoring,
Cardiff Garcia:
A lot of biotech type stuff by the way. Yeah,
Ben Miller:
Biotech vaccines, I mean there's RNA technology, crispr,
Cardiff Garcia:
A lot of amazing stuff that could raise productivity growth to a very high sustained level if the promise of all these technologies is realized.
Ben Miller:
Yeah, it's not even technology, it's change in and of itself as an optimistic frame where there's change, there's opportunity for improvement and it's hard to change things that are stagnant. It's hard to improve things that are stagnant rather. So this as an example, US manufacturing construction went from 3% a year to a hundred percent last year. So pandemic shock is sort of a master category for me. And the last one, which is actually counterintuitive is high interest rates. I think high interest rates drive productivity.
Cardiff Garcia:
That is, I guess the idea of high interest rates depends on what you're comparing them to, like high interest rates relative to let's say the zero interest rates that we had in the 2010s. Is it high interest rates just elevated that stay high forever? Is it high real rates, high nominal rates? What is your sort of understanding of that?
Ben Miller:
It's a good question. I mean it very narrowly in that the transition from zero interest rates to approximately 5% fed funds rates has forced executives and consumers to be more disciplined. And if you look at productivity growth in fed data for example, you often see huge productivity growth during recessions because basically companies do layoffs and you saw tons of companies do layoffs and not see any impact to their revenue. And so that by definition increases in productivity. And so I think more discipline around decision-making actually drives productivity.
Cardiff Garcia:
Yeah, I had have to think about that one too. And part of the issue there is that there is a difference between sustained underlying productivity growth over the medium term versus these kind of short-term swings in measured productivity growth. We know for example, that the layoffs that happen in a recession might temporarily raise measured productivity growth just by virtue of the mathematics. The workers who are left tend to be the higher productivity white collar ones and so forth. But over time, we also know that a lot of those other workers are going to need to be rehired because companies still need to staff up when the economy recovers. So usually I try to point to the underlying trend of efficiency, technological innovations, that kind of thing. I do think for example, that discipline can raise productivity growth when it's being driven by very high demand where companies are competing for workers, they can't get them wages go up.
Cardiff Garcia:
And so companies then end up investing in the kinds of technologies that then can drive productivity growth over time. That is a story. I do believe in terms of what the effect is of higher interest rates. I'm not so sure. I have a feeling that the calsl arrow might go in the other direction where very fast productivity growth, very fast economic growth ends up justifying higher interest rates. And we've seen that over time. Interest rates tend to go up when nominal growth is promising to go up very much. But I'm open to different arguments on this and we certainly have seen for example in the past that when there's a big recession, a lot of manufacturing companies lay off a lot of workers and those workers don't get restaffed to higher levels later on when the economy recovers. And so there can be, I think some effect of what happens when you have to impose some discipline even because of a downturn. But I don't know how big the magnitude of that effect is.
Ben Miller:
Yeah, I guess I'm looking at my firsthand experience and see how discipline can really drive productivity becomes a priority and there's a lot of low hanging fruit. And then I'll make one last point about real productivity growth and that it is happened before. So my whole looking in the past, so there were two periods where we had really high productivity growth in two periods where we had not so high productivity growth. And the obvious comparison is the internet bubble. So from 1995, 2005, total factor productivity and capital intensity. So all productivity was 2.9% a year, which is twice what it was in the last decade. And so that makes me optimistic. It feels like what's happening now is similar to what happened then. And so I think a doubling of productivity growth is realistic considering the types of drivers we're seeing and the similarities to what I think we've seen in the past.
Cardiff Garcia:
Yeah, 95 to 2004, those were the salad days for you and me. Man, our hair hadn't turned gray yet, but what's interesting about the point you made is that the adoption of the internet and information technologies that were new at the time, they were what's known as general purpose technologies. They weren't just limited to the improvements that you see in productivity in that specific sector. They ended up raising productivity across the entire economy and a lot of the technologies that you were referencing earlier seemed to have the promise of doing that as well. So yeah, so I'm open to that possibility also. Okay, great. So in terms of what's necessary for the US to keep growing under scenario one, then you've listed a few possibilities here. So faster real growth, faster overall nominal growth, you've made this connection between interest rates and I think faster growth and so forth. Yeah. What else would you include under that scenario one?
Ben Miller:
Well, let me just reiterate a point, which I think but maybe not everybody knows, is that the US grew a lot slower from 2010 to 2020. Real growth really slowed materially around you could say 2006 seven A exactly when you can debate, but basically there was a paradigm shift downshift and that had all sorts of negative consequences. And I believe, and I'm arguing that we're now upshift again, but not everybody realizes that US growth was on a nominal basis, 5.7% a year from 1980 to 2008, and it shifted down to 4% a year from 2010 to 2020. So it really, you get 40, 50% less growth a year, that's a lot less, and that on a compounded basis is huge. The other two points I'll make and then I'm interested to hear your scenario. One, I'm going to make a controversial point about high nominal growth.
Ben Miller:
I think that everybody hates inflation, but debt monetization, which basically you print money and that basically makes the debt worth less is something that governments can do to try to lower debt loads and is something that did happen. Just to put some numbers on this, and you may want to debate maybe the specific numbers, but essentially inflation was about 20% from 2020 to 2024 in totality, and that's about equal to 20 trillion of debts we monetized away because basically there was a hundred trillion dollars of debts before and you can now pay it back with dollars that are worth 20% less. So I think that people may not have liked it, and I'm not saying it was a good idea, but the unintended benefit was that even though the government during that period increased, the debt load and government deficits were a total of $10 trillion, we actually ended up with 20 trillion of essentially debt monetization. That's another way that governments have dealt with high debt loads in the past and we did, and for all his negatives, it did reduce the effective debt load of the United States.
Cardiff Garcia:
Yeah, I mean there's again the sort of question of in which way is the arrow going? Because a lot of people I think would attribute some of that to the rising demand that we saw because of those policies that were passed in the aftermath of Covid, that there was a lot more government spending both to combat covid, to combat the Covid recession and so forth. And then later in new policies that were passed under both Donald Trump and then later under Joe Biden and the respective congresses at the time, and that contributed to inflation. But also what we saw was that some of the inflation was driven by the problems with the supply side, the supply chains. And we sort of already know, and we've discussed in the past what's happened there. It really looks like in the past year or so, a lot of those pressures have eased.
Cardiff Garcia:
And so part of scenario one I think is inflation that is above 2%, but has been coming down towards 2% for roughly the past year or so. But before that it was very, very high climbing to I think eight or 9% depending on which measure you use. And that was something that we just hadn't seen in the United States in literally decades, many, many decades, almost a half a century. It was incredible and a lot of people were quite frustrated by it, but that has been coming down even as economic growth, real economic growth has remained quite strong. And so in this case, the scenario one more the same in the near term at least, would be quite a positive outcome for most of the economy. Not every sector of the economy, but most of the economy I think.
Ben Miller:
Yeah. So that's more or less my scenario one, you make this point, which is that a lot of drivers are also effects and exactly which is the correlation and which is the cause is unclear and sometimes both, maybe I oversimplified it. And so my last point, which is a scenario one is that high interest rates slows debt growth and it has been slowing debt growth. So 2023 total US debt growth only increased about 2%, which is a lot less than normal. Normally it was growing 4% a year in the 10 2010s and it was growing at six 8% in the previous decades. In the 1980s, debt growth was 14% a year. That explains why the eighties was so I didn't appreciate that debt growth in the eighties was triple what it has been. So anyways, the more of the same is high real growth, stabilizing inflation and slower debt growth. So basically soft landing best of all worlds. And I think that's what's been happening so far and I think that's very exciting positive outcome that looks more and more feasible every day.
Cardiff Garcia:
Yeah, let me just throw out there a few more variables that represent significant parts I think of the US economy that would be part of scenario one, this more of the same if we're lucky enough to get it. One is that oil prices remain in a range around 80 to $85 a barrel. And one of the things that's happened in the last couple of years is that OPEC seems to have lost control both over its own members and of global oil prices. And a big part of the reason is simply that US-based frackers have taken up the slack, they've taken market share, they've reac accelerated production of oil in a way that I think has surprised a lot of people. So obviously they did an amazing job in the mid two thousands, but there were a lot of theories about whether or not US frackers could keep up.
Cardiff Garcia:
Were they starting to exhaust some of the places where they'd been taking the oil out? Well, it turns out that to this point at least they have in fact taken market share where it's been given up by OPEC when it tries to enforce production cuts, which by the way, it has also in some cases failed to do. And if that continues, that's both a positive geopolitical story for the us but it's also positive for consumers generally because it means that oil and gas prices would stay somewhat range bound. We'll see, but that would be a positive scenario. One outcome. Another one, a kind of quiet success story in the US is that legal immigration has rebounded and the numbers keep getting higher and higher.
Cardiff Garcia:
The amount of legal immigration, by the way, and I'm separating this entirely from the problems at the border and so forth, legal immigration numbers fell every year under the Donald Trump administration for a variety of reasons. And that included Covid, which had nothing to do with the administration and so forth, but they have rebounded every year under the Joe Biden administration, and they're now, last year, according to preliminary estimates, it was about 1.2 million people who got their legal, I forget the exact name for it, but people who obtained legal status in the US green cards and so forth. And so immigration has rebounded legal immigration. That can be a positive story for the US economy because it both means a growing labor force. Yes, of course, but it also means more consumers and whatnot if that continues. So that could be a potentially positive story. Finally, profit margins have been quite high, and at least according to Goldman Sachs, which I think has been on the optimistic, but so far correct end of the spectrum, they're going to remain high for a few different reasons. And if that happens, then the corporate sector, the stock market should all be okay, and that continues to have positive wealth effects on the economy and could continue driving positive real growth. So all of those things I think are pretty important parts of what we see as a possible scenario one if we're again fortunate enough to get it.
Ben Miller:
Yeah, those are great. It's amazing that the US has become the largest oil producer, oil and gas producer in the world. I remember a decade ago when we were in decline, and I always wonder what's downstream of fear of oil sources and whether our involvement in the Middle East is actually downstream of oil policy. And so being oil independent I think really gives a lot of latitude that we didn't have before and a lot of knock on positive effects. So I think that's totally right. And one thing I wanted to do actually on scenario one is connect it to real estate for a second. I think that it's not always clear to everybody how this kind of soft landing would be positive for property,
Cardiff Garcia:
Especially if interest rates stay elevated as they are now.
Ben Miller:
Yeah, well, so my scenario is soft landing and soft landing is essentially I'm just taking the fed's forecast, which basically is a slow but steady decrease in fed funds rate over a couple of years. I'm more focused on a slightly longer timescale than a year. It's hard to predict what's going to happen within 12 months. It's easier to see larger trends and see that they have large impacts at some point. So I think that I'm arguing in my scenario that rates do
Cardiff Garcia:
Gently decline. Gently decline.
Ben Miller:
Yes. And we can talk about if they don't, I have that a little bit in scenario too, so okay,
Cardiff Garcia:
We're getting to that worst case scenario. We're getting there. Yeah. Well let's stay on scenario one. Let's close the loop on this one. Yeah,
Ben Miller:
Right. So let's do, why is this scenario positive for real estate? So in some ways, real estate returns, it's very simple. Real estate investment is a levered GDP. So you say, okay, I believe that the United States is going to grow. I believe that Texas will grow more than the United States. I believe Dallas will grow more than Texas, and I believe this neighborhood in Dallas will grow more than Dallas. So basically you have the GDP of a location, so that's the GDP part of it, and you can get very specific to where I think there'll be the most growth. And the leverage is just interest rates. And so as interest rates come down, you get a magnification of the GDP growth. So if you have high GDP growth and falling interest rates, you have a double or magnified effect on returns because cheaper leverage and high growth is very good for estate. So the soft landing would be extraordinarily good for real estate.
Cardiff Garcia:
Excellent. I'm glad. And we should by the way, make sure that we tie all three of these scenarios to real estate and what it potentially could mean for Fundrise. Let's go now to scenario two, and just to remind everybody, scenario two is negative shocks, a kind of worst case scenario. Scenario three, which we'll get to later, is things that could surprise people. And you can see how there are some events that could conceivably fit under either of those two categories. I have tried to include under scenario two things that have prominently been worried about by the kinds of commentators and economists that follow, I dunno, geopolitics and other potential economic events, negative shocks. And then scenario three is the more out there stuff. So scenario two, what's under your scenario two, Ben?
Ben Miller:
So following my framework I set out in the beginning, which is that there's a race between growth and debt. Scenario one, growth wins, then scenario two, debt wins, AKA hard landing a K, great deal leveraging. So why would debt outpace growth? I think there's two main categories, and you may have some more to me, there's obviously government deficits and entitlements which are actually hidden formal liability as time passes and more boomers retire. So there's that one. But the second one is one that it goes back to when I looked at the picture from the past and this was really interesting to me. So rising interest rates, let's talk about that. I think one of the things that has been puzzling me has been why the great de-leveraging has not played out. And so I actually have done a fair amount of analysis, I want to put this out at some point. I have a lot of numbers. So lemme just walk you through this scenario. So total US debts both public and private at the end of Q3 2023 was $96 trillion. And just to kind of segment that for you, federal debt is 28.8 trillion held by the public. Sayan local was 3.6 trillion. Home mortgages, 12.25, household other debt, 7.5 trillion business debt, corporate debt, 21 trillion and bank debt about 2023. So approximately 96 trillion across the United States. So call that a hundred trillion in 2024 for round numbers at what interest rates is all that debt fixed at?
Cardiff Garcia:
So you're taking a kind of average of the interest rates for all of those different kinds of debt and then putting together some kind of weighted thing. I don't know.
Ben Miller:
So this is very hard to get and I think I can only get at it very indirectly. I essentially looked at federal and state and business and essentially it's not so unreasonable to use basically the mortgage rate, a long-term mortgage rate as being about the average because federal debt's a little less, most consumer debt and business debt a little more. And so it's in the low force today, low 4% on average across all of the different segments. So just say 4% for a second. So basically we're paying 4%, a hundred trillion of US debt. So it's 4 trillion a year of debt service paid on all the debts in America.
Cardiff Garcia:
Just point out quickly that a lot of that debt is held by other Americans, and so it's people who both hold debt but are also getting paid interest on the debt of the others that they own.
Ben Miller:
Yes, for sure, for sure. It's the zero interest rate environment from the last decade was in direct tax on savers because if you were saving money, you weren't paid a very high savings rate. And yeah, it's complicated when you try to figure out the consequences of the cost of debt, but let me just keep making this argument here for you and see what you think. So okay, 4 trillion a year of debt service is about 15% of GDP. So basically 15% of all US GDP goes to pay debts. And interestingly, it's been 15% all through 2010s. And actually it was higher in the nineties in the two thousands, it was actually the nineties was 17.5%. There was less debt but higher interest rates. So interest rates in the nineties were closer to 7.5%, and so there was a higher debt to income ratio in the nineties than today.
Ben Miller:
But what happens when the interest rates that were locked in the 2000 tens and beginning of this decade, what happens when they start to reset to the new higher interest rate? So you have to have a forecast of what the interest rate might be. And so I ran kind of like a few possibilities. Basically a few possibilities are higher for longer soft landing or hard landing higher for longer. Probably mortgage rates stay where they are, which is about 7% soft landing, they come down maybe to 6% or a little less than that, and then a hard landing, they probably come down to 5%. So you have sort of three general possibilities of where long-term rates and inflation end up. But basically if you multiply 7% times a hundred trillion, that's $7 trillion a year in debt service versus 4 trillion. And so the US debt to income ratio can go from 15% to a higher for longer scenario to 25% of GDP.
Ben Miller:
And so you're talking about in let's do hire for longer for a second, why I think that's unrealistic, why I think higher for longer being higher for forever. I think a lot of people are starting to argue that we're going to see a high interest rate and it's basically going to stay this high more or less permanently, or at least for the next half decade or longer. If that were to happen and US debts were to reset at those higher rates, you're basically paying $3 trillion a year more in debt service and just give you a round number how much $3 trillion is the size of the entire US manufacturing. GDP retail trade is one and a half trillion. So on the low end you're talking about debt service equal to one and a half trillion more, and on the high end 3 trillion more. So that's like liquidating a Nvidia every year, liquidating a Google every year, that's how much more interest you're going to pay.
Ben Miller:
And most economists would call that problematic for growth because instead of using those dollars for investments into r and d or technology or education, you're using it to pay debt. And so typically high debts cannibalize growth. I'll just make one more point and then I'm interested in your counterpoint, but basically the reason why we haven't seen this or negative consequence yet is that most debts are fixed over a longer period. And I looked at every single segment home mortgages and businesses and federal debt and the average duration, first of all, US debts approximately six years, so it takes three years for half the debt to reprice, and we're only one year into it. So there's a very positive scenario. A soft landing is again, going back to scenario one where GDP grows fast enough, by the time most of the debts have repriced, we've actually grown into the higher GDP and it sort of brought down the debt to income ratio. There's scenarios where if we're growing at that said 1% faster GDP than debts, that we end up at 15% debt to income ratio by 2028. So there's a version where rates come down, growth goes up, and it sort of all works out as long as basically we're growing GDP faster than debts and as long as interest rates do gradually come down over a few years,
Cardiff Garcia:
Yeah, economic growth, fast economic growth is something close to divine, right paper's overall problems, there was a lot to absorb from that analysis. Ben, let me focus on one thing, which is the concerns about what happens when a lot of debt resets because this is something you and I have talked about a lot and it's something I'm definitely worried about for some parts of the economy, notably for the real estate sector, right? Notably for commercial real estate and other parts of the economy where that does apply, but I am kind of old fashioned in a way. I try to think about assets and liabilities in conjunction. And one of the big lessons that we learned after the great financial crisis of 2008, 2009 is that you have to pay attention to what happens to collateral because higher arising debts in and of themselves don't have to be a problem if the collateral underlying them also stays very valuable is high and rising.
Cardiff Garcia:
Also, the problem is what happens when you have debts that stay elevated, but the collateral collapses because then you have fire sales. And I worry about something like that obviously in the housing market because again, I'm still partly traumatized from what happened in 2008 and 2009. I worry about it for the banking system in particular because we've seen what happens when again, and this was tied to the housing market back then, underlying collateral starts to fall apart and you have these cascading effects. And so something that can be originated in one part of the economy ends up spreading everywhere else. And so that is the thing that I worry about most of all. And that's sort of the part of the analysis that you mentioned there that I would focus in on as a big concern and a scenario too, a kind of worst case scenario, you have collateral in some part of the financial system, some part of household balance sheets or for the government, whatever, that completely begins to fall apart.
Cardiff Garcia:
And that could be represented by all kinds of things. It could be falling housing values, it could be, by the way, something like the problems that we're seeing with democratic institutions and the government's ability to function. This is more of an abstract concern, but it's one that I think can be tied into all this. And so that is sort of what I focus in on, the cascading effects that could begin because interest rates have to reset for some parts of the economy. And I don't think we're kind of done seeing that. Partly I'm convinced by your own analysis on what's happening in real estate, commercial real estate in particular, and the kind of smaller part of the banking system, the smaller banks, I think we could see more of that. And I just am not sure the extent to which that could spread elsewhere.
Ben Miller:
Yeah, that's the traditional analysis. And if you go out and look at Fed data and other sources, they typically look at debts to assets, and I had to build this data myself, but rather than looking at the ability to carry the debt service, and that's an income test, not an asset test. And so I would just go to the extreme to sort of make the point if interest rates stay at their current rate, I have a hard time imagining that the GDP can support 25% debt service. Where does that come from to pay higher debts and a microcosm if you have a property or if you have a consumer and they have a certain amount, let's say as a consumer, that a hundred thousand dollars in income and now they have to pay twice as much in debt service, it has to be in exchange for something else. So consumer spending would probably be the thing that would be cut. And so I don't understand it. It's basically I can't really imagine a scenario where the country can afford a higher debt to income ratio either GDPS to grow, which I think we're arguing is very likely, or debt accumulation has to slow. And if basically you don't get one or both of those, then you have basically a hard landing, you have a downturn because it eats up consumption, you basically debt service eats up consumption and you end up having aggregate demand decline. How
Cardiff Garcia:
Do you adjust that analysis for the likelihood that there will be a response from the Fed and from policymakers if we see the kinds of devastation to growth that you're describing here? In other words, yes, this could be caused by higher interest rates, interest rates resetting, but of course the response then would be to lower interest rates to fight the resulting downturn.
Ben Miller:
Well, you can look at basically every other time this has happened, which must be
Cardiff Garcia:
It's too late. By the time it happens, there's a lot of damage in the streets. Yeah. Yeah.
Ben Miller:
I mean it takes a long time for interest rates, rising interest rates to slow the economy, and it takes a long time for lower interest rates to speed the economy up. I mean, in oh eight took four or five years in oh one, it took three or four years. There's a big lag in monetary policy. The lag effect is a matter of years at this point. And in the meantime, that's a long time for economic distress. I can see it in all parts of the economy I deal with where one of the best sort of windows into it is the industrial market where people build wherever you're building things or you're doing logistics, and we have industrial across the country, most industrial tenants are not opening new facilities. The cost of building things is still very high. Cost of rent is still very high. The cost of interest is very high.
Ben Miller:
And so mostly they're trying to make do with what they have and really tighten the use of their existing facilities. And that's good for productivity, good for efficiency, but it's not good for growth. And so everywhere I see in my world now that's excluding ai. There's a slowdown, is a tightening. And I think that basically is because interest rates are higher and that basically slows down the economy and it's happening. And there's nothing scary about that as long as basically it sort happens gradually and the fed follow it on the way down. And if it happens in a much faster break, something breaks like Silicon Valley Bank broke, and it's harder to get it back under control when that happens than the scenario two, a hard landing happens. So
Cardiff Garcia:
Plus this is scenario two. This is necessarily speculative. We're trying to figure out what could be the worst case scenario here. The biggest negative shock imaginable.
Ben Miller:
Yeah, and I think that the likely one, and we've talked about this before and I want to hear yours, but basically the consumer ultimately slow spending because the excess savings they had from all the pandemic stimulus is spent. And businesses also, especially small businesses, have also run their reserves down. So I believe that will slow things down. Typically, organic systems, like if you've ever read Jared Diamonds collapse. Typically organic systems don't break gradually. They break all at once.
Cardiff Garcia:
Well, here's my scenario too, and in case that wasn't cheerful enough, my scenario too has to do with inflation reigniting and essentially reversal of the progress we've seen on inflation in the past year. How could this happen? Well, there's a few possible worst case scenarios here. One is it could happen because of a protectionist arms race. We've seen a lot of really incendiary commentary on EVs, politicians responding all throughout the world, not just in the United States, trying to keep out essentially cheaper Chinese EVs. If that leads to more protectionism everywhere, then that could raise costs. Of course, critical commodities as well, critical inputs to some industries. If there's a protectionist arms race that won't help. I mentioned oil prices earlier and the fact that the frackers had kept up well, what if the US frackers stopped being able to keep up and OPEC decides to be a bunch of jerks again as they're trying to be and cut production?
Cardiff Garcia:
Well, that also could raise costs. The Fed could overreact to a supply side driven inflation spike and keep interest rates very high, which would be a huge problem for other parts of the economy, would probably keep, for example, housing inventory quite low. And I think that would end up maintaining the sort of elevated housing prices that we've had in the last couple of years because construction would stop. There could be an invasion of Taiwan, which is something that a lot of geopolitical commentators and observers have been worried about in the last few years that could send the price of semiconductors through the roof. And that's obviously a massive critical input for big parts of the US economy. And in fact, the parts of the US economy that are considered the most cutting edge, that could be a problem. So you put all of these things together and if you end up with a reigniting of inflation, you end up damaging both real growth, the economy itself, and you keep interest rates potentially very highly elevated, having all of the devastating consequences that you just speculated on in your scenario too.
Cardiff Garcia:
So those are all the things that I would really be worried about. And there'd be offshoot effects as well. For example, the stock market would collapse under a scenario like this, and that would lead to a negative wealth effect, which would lead to people pulling back on spending and so forth. There could be then a financial market meltdown. So that to me is the big negative shock to worry about is inflation for some reason, for whatever possible, cause essentially reigniting and going all the way back up to four or 5, 6, 7, 8, 9%. That to me is a kind of a nightmare scenario and I would hate it. So hopefully scenario two is will remain strictly in the abstract.
Ben Miller:
Is your scenario a stagflation? So is it high inflation, low growth?
Cardiff Garcia:
Yes, it is. I think stagflation is most plausible when you have a supply side driven spike in inflation, something that curtails the ability of the economy to produce, which means it curtails the ability of workers to keep their jobs and to make money. And then it has this kind of negative spiraling consequence. And it doesn't happen every single time that you have these kinds of supply side shocks, but that is one, I think the stagflation story is most likely to happen, and I think we've seen that throughout history. So that's my nightmare scenario.
Ben Miller:
Do you think that's mostly as a consequence of, I'm going to say broadly political decisions, whether it's war in the Middle East that caused Z OPEC to raise rates or the war in Taiwan? Are there economic drivers of stagflation or are they mostly consequences of exogenous factors?
Cardiff Garcia:
I think it's probably usually these kinds of exogenous factors related to commodities and oil in particular. At least we've seen that throughout history, but I don't want to rule out the possibility that there can be some economic forces that can lead to it. And in the last few years, it really was a combination of things like covid, the Ukraine, Russia war, and the fact that the US economy shifted from services to goods the way it did, which caused a kind of temporary problem in producing enough goods to keep up with demand. And that sort of thing can lead to very high inflation and to slower growth while the economy adjusts. But I think there's typically a cause that originates in these kinds of exogenous forces, but there can be policy responses that make things better or worse. The Fed doesn't have to overreact as it has historically to supply side driven spikes in inflation when it's not supposed to raise interest rates to fight them.
Cardiff Garcia:
It's supposed to raise interest rates to fight too hot demand. It can't really do as much about supply. I mean, this story is complicated. I'm being very simple about it. Too simple really. But in general, there are policy responses that can help alleviate the strain and fend off stagflation. And I think by the way, we did in the last few years, we successfully fought off a stagflationary situation, and I think it was quite impressive. And part of that is because policymakers took the steps to keep the economy growing in real terms, even as inflation got very high. And I think we should all be very proud of it. But that is still to me, when stagflation is the most plausible. And since this is scenario two, worst case scenario, that's the thing that I worry about, not inevitable, just speculating on a possible worst case.
Ben Miller:
Yeah, it's interesting. So my scenario two is hard landing, slow growth, low inflation as a consequence of low growth. Yours actually worse, you have low growth and high inflation. So at this point, obviously there's plenty of those to go around. Yeah,
Cardiff Garcia:
I out doomed you, man. That's what just happened in scenario two. Yeah.
Ben Miller:
Yeah. Wow. Wow.
Cardiff Garcia:
Impressive, huh?
Ben Miller:
Yeah, it's scary. It's my job.
Cardiff Garcia:
Well, let's get out of the land of ghouls and goblins and go to scenario three, which can include totally unexpected, positive or negative surprises.
Ben Miller:
This one is the hardest, actually. It's easy to imagine something good and easy to imagine something bad, but it's sometimes hard to imagine something surprising. The definition of it is meant to challenge people's assumptions. I actually tried this out on a couple of people and they're like, there's no way that could happen. So I was, okay, good.
Cardiff Garcia:
That's perfect. It's perfect for inclusion.
Ben Miller:
It's meeting the definition of a scenario three. And I just to go back to the framework, Peter Schwartz sort of became famous for scenario planning because shell, the oil and gas company, Dutch Shell did a scenario planning in the eighties, and they scenario plan something that the CIA said was impossible, which was that the Soviet Union would fall. And that was really shocking when it did, but shell actually was prepared and ended up dominant as a result. So the point is that something you assume is always going to be true, that ends up not being true. And the pandemic was like that. It was a shock. Okay, here's mine going with it. Actually dovetails nicely off of what you just said because a surprise to the upside where we end up with responsible political leadership.
Cardiff Garcia:
Okay,
Ben Miller:
Good governance,
Cardiff Garcia:
That would be delightful.
Ben Miller:
Yeah, A decline of polarization. And this has happened before you sort of ended up with a Lincoln or a Truman, which were both not what the establishment would've thought. And actually, I dunno if you know this, I was just reading about this, that Truman was FDRs fourth vice president, but his third vice president was a guy named Henry Wallace who turned out to be a Soviet sympathizer. And so if FDR had died while Wallace was in office, you could have ended up with a very different history today. So a positive would be something that at the moment seems extremely unlikely. We end up with just a very different political environment, very different governments. Why could that happen? I think a generational transition, so sort of a new generation finally ends up in power and they end up being different. Also, I can imagine a world where AI actually kills social media and social media basically goes away. It's like the radio or something. Nobody uses it anymore. And I think a lot of
Cardiff Garcia:
Our minds are free.
Ben Miller:
I think a lot of polarization is downstream of social media. And so what would happen if we saw this sort of surprising cultural shift would be balanced budgets, entitlement reform, immigration reform, both skilled and unskilled, maybe really smart geopolitical moves, and then thousands of other things that would happen as a result of good leadership. So we could go on as sort of a golden era if that were to happen in 2024.
Cardiff Garcia:
Yeah, I like that. And that's definitely hopeful. One of the things that I realized as I was trying to come up with some items for scenario three was that for every possible negative surprise, there was a kind of corresponding possible positive surprise, and there was this kind of internal tension. So I'll give you a few examples. One was you could have a new covid strain or a new coronavirus entirely that could devastate the global economy again, but there could be a positive surprise instead where you have much better new vaccine discoveries, maybe even before the next big pandemic, where we just have much better vaccine technology that's more responsive, more powerful, more impressive that can ward off the worst effects. And so essentially we're prepared. Either of those two things, I think would be surprising, but not impossible. And the next one is, for example, it's easy to imagine a big environmental catastrophe, something really horrible that we hadn't expected perhaps as a result of global warming or pollution or carbon emissions or something else that leads to a worsening of the environmental effects in some parts of the country or some parts of the world.
Cardiff Garcia:
On the other hand, you could also imagine some astonishing new tech breakthroughs that help prevent these kinds of environmental catastrophes. And of course, there's a lot of people, a lot of countries, a lot of institutions that are already working on tech breakthroughs like that. You could have something happen with the Chinese economy that could be either terrible for global economic growth or could end up being better. It could be that if there's a slowdown in the Chinese economy, maybe it's not great for global growth, but it has the offsetting effect of keeping commodities prices low because the Chinese economy is such a big absorber of global commodities, and so it's hard to sort of figure out what the effects might be there. Similarly, you keep mentioning ai, and I think that's crucial because it's going to be fascinating to see what happens with AI in the coming years.
Cardiff Garcia:
You can imagine a scenario where AI leads to an incredible productivity boom, maybe even faster than it was anticipated. It could arrive sooner. Who knows? That could be magnificent for the US economy. It could also though have some offsetting effects where, for example, lots of jobs are lost in the meantime. And so even though productivity growth is fast, and that's good for some people, especially the people who happen to own the AI systems, it also creates chaos in other parts of the US economy. And maybe that leads to, I don't know, chaos, dysfunction, political problems, hard to anticipate, but I could see surprises in either case. So I'm going to stop there, but I would just note that a lot of the surprises we try to envision now have this sort of inbuilt tension because for every positive surprise there is something related to it that could be negative and vice versa,
Ben Miller:
I guess it finally happened. So I'm the optimist and you're the pessimist.
Cardiff Garcia:
Only when we have these imagined scenarios in general. Yeah, I fall on the optimistic side of the spectrum. That's absolutely true.
Ben Miller:
I know, but I've gotten optimistic and my friend said, I've smoking. Yeah,
Ben Miller:
So optimistic, which is a break. I don't think I'm optimistic because it's a shortcut for thinking. Let's just try to recapitulate the whole thing now for a second. I believe that most of the things we described in scenario one, which is ai, which is lots of positive change from the pandemic. We sort of suffered through a lot of the negatives and now we get a lot of the positives. Most of those things aren't really that speculative. I mean, they're definitely happening. They're definitely positive. We're already living through it. And so it's not hard for me to imagine that we just see a really tremendous GDP boom. Even if we have to go through at some point, some kind of a reset around debts or interest rates or inflation. The fundamental drivers are there, even if there are some, you said exogenous or more like nominal effects we have to work through before we get to the roaring twenties that I think that we have in store.
Cardiff Garcia:
Last question, Ben, is there anything in particular that you would want to leave Fundrise listeners with about these three different kinds of scenarios about scenario planning in general or what they themselves might be worried about when it comes to real estate investing, tech investing, the kinds of funds that Fundrise happens to run and in which they are invested in?
Ben Miller:
Yeah. I actually almost thought about producing a two by two matrix because there's only four scenarios, and that's basically high GDP growth, low GDP growth, high inflation, low inflation, and you end up with a combination you ended up with. The worst of both worlds was low GDP and high inflation, and that's bad for everything. I did a low interest rates, which is low inflation and high GDP growth, which is basically best for real estate. And the next scenario, which is basically high GDP growth and high inflation, which I think is next most likely, is also good for real estate because most real estate companies, including us, have reset to the higher interest rate, which basically meant valuations came down. If real estate returns is GDP times leverage, high GDP will basically drive returns. I guess the last one is low inflation, low GDP, which is what happened in 2010s, and that was also good for real estate.
Ben Miller:
So all three of the scenarios are good for real estate except for stagflation, which is bad for everything. And in the past, it's actually worse for companies than it is for properties. Typically, stagflation was really bad for the stock market and real assets like gold and real estate end up picking up a lot of the inflation benefits. So basically the worst case scenario for real estate was rising interest rates and interest rates have peaked, I think I don't think the Fed is going to raise interest rates materially much, much more likely to lower them. So basically the two parts of the equation, which is interest rates times real estate as interest rates fall basically, you get that benefit and as GDP rises, you get that benefit. So I am all around optimistic. It's a much slower moving asset class than stocks, and that sometimes can drive our investors up the wall, but in the long term, I think we're in a great place, but it takes time and certainly the FOMO we're seeing with Nvidia, Bitcoin has made a lot of our investors ponder the immediate gratification versus the long-term value of real estate. That was 2023, that's what happened in 2023, but I don't think that's what happens in 2024.
Cardiff Garcia:
Fomo, the most powerful force in finance. Ben Miller, my newly optimistic, positive, hopeful, co-host on Onward. Always a pleasure man.
Ben Miller:
Yeah. Oh, Cardiff, you're fabulous. Thank you.
Cardiff Garcia:
You have been listening to Onward, the Fundrise podcast, featuring Ben Miller, CEO of Fundrise. I'm Cardiff Garcia of Bazaar Audio. We invite you again to please send your comments and questions to onward@fundrise.com, and if you like what you heard, rate and review us on Apple Podcasts and be sure to follow us wherever you listen to podcasts. Finally, for more information on Fundrise sponsored investment products, including all relevant legal disclaimers, please check out our show notes. This podcast was produced by the podcast consultant. Thanks so much for listening. We'll see you next episode.
