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National Debt: A Long-Term Trend

People and politicians are finally beginning to accept that the federal deficit has become an albatross around our neck.

The Ship of State Has Turned!

Stockpiling Light Bulbs

One High-Potential Stock

I’m a big fan of long-term trends.

Knowing that trends, once in motion, tend to persist longer and run further than most investors expect is valuable. It’s also valuable to know that a trend, once ended, will give way to a new long-lasting trend in the other direction.

For example.

Back in September 2007, as the subprime mortgage industry was collapsing, I wrote this in Cabot Wealth Advisory.

“A few nights ago, as I found myself sitting at a dinner table with a group of strangers, by way of making conversation (and doing research) I asked, “What do you think will happen with the real estate market?” Their answers: “It’ll come back” and “We’ve been here before.”

“Not wanting to be a wet blanket, I didn’t disagree. But I think they’re wrong. I think there’s a lot more downside ahead, and that getting there will take much longer than most people imagine today. My main argument (which I’ve mentioned before) centers on the demographic forces created by the baby-boom generation; they’re finished with buying houses, and next they’ll be pumping up the health care industry.”

That was 43 months ago, and the statistics from the housing industry are still terrible. But when a 60-year trend ends, that’s what you get. Interestingly, last week there were 12 economic reports released, six of which had to do with housing. Not until we watch other indicators more carefully and housing less carefully will housing “stabilize” ... whatever that means.

But the good news is that the collapse of the housing bubble was just the first domino in a long line of dominos that have begun the process of bringing our balance sheets back to rational levels.

First, it encouraged--or forced--consumers to reduce their levels of borrowing. And they did so fairly quickly, generally within a year.

Second, within two to three years, reduced economic activity and shrinking tax revenues forced cities, towns and even states to institute their own austerity programs.

And now, the biggest player of all--our own federal government--has finally begun knuckling under to these forces that can be ignored no longer. The ship of state has turned.

Barack Obama has now publicly acknowledged the value of addressing our huge deficit. Democrats and Republicans are arguing over how much the deficit should be cut ... while over in the corner, the Tea Party is quietly celebrating the fact that its competitors have adopted of the main planks of the rickety campaign platform.

The day-to-day machinations are interesting to some observers, but to me, the long trend is the real story.

In fact, I believe this is just the beginning of a trend that will run a generation or more, resulting in debt reduced to levels that are currently unimaginable.

To understand my thinking, consider a little history.

In 1913, the 16th Amendment to the Constitution established the federal income tax.

In that year, total receipts were $714 million. Total outlays were $715 million.

The national debt was $2.9 billion.

The national debt then ballooned to $27.4 billion (a 10-fold increase), largely because of World War I.

It was wrestled back down to $16.2 billion (a 41% reduction) at the end of the Roaring Twenties, partly courtesy of Calvin Coolidge, who as a Republican with Federalist leanings thought states should do the heavy lifting in government.

But it was soon climbing again--and fast--as Franklin Roosevelt used federal money to fund programs designed to end the Great Depression.

One result of these federal programs was the building we at Cabot are fortunate to have as an office today.

Erected as a WPA project in the record time of nine weeks, the North Branch of the Salem Public Library opened on May 17, 1934, and operated until dwindling usage and shrinking city funds forced its closure on Jan. 29, 1977.

By 1940, the national debt was $43 billion.

And it’s been growing ever since!

So what makes me think this uptrend will end soon?

Well, for one, this chart looks a lot like the charts of famous stocks that have topped out in spectacular fashion, like Broadcom, JDS Uniphase, Crocs and First Solar.

But more importantly, it appears that people and politicians are finally beginning to accept that this debt has become an albatross around our neck, and not just because S&P recently downgraded our national debt. They’re beginning to recognize that if we don’t reduce our debt voluntarily, our creditors might show up one day (just as they do to homeowners), and ask for their assets back. And they’re taking concrete steps to reduce our annual deficit, slow the growth of our national debt--and eventually reverse it--and generally put our balance sheets in order.

So, while Calvin Coolidge, from one perspective, represented the last gasp of a “small government” movement (by 1927, only the richest 2% of taxpayers paid any federal income tax!), and FDR marked the beginning of a “big government” movement that lasted 78 years, I believe that trend was nearing its end when even pro-business Republicans like George Bush saw no problem with increasing our debt and it reached its extreme with the TARP bailouts and Cash for Clunkers program.

Note that these inflection points were accompanied by first, the Great Depression, and second, the Great Recession. It takes a big shock to change the prevailing attitudes and behaviors of the American public.

Now forces are pushing the pendulum the other way.

Interestingly, Coolidge, who came at the end of the small government movement, is consistently ranked a sub-par president; he simply carried the movement too far. Roosevelt, who kicked off the new movement toward greater government involvement, is regularly ranked as one of the best. If the pattern repeats, Barack Obama, who carried the big government theme too far, will be ranked closer to Coolidge than Roosevelt.

Time will tell.

And time will tell exactly how this new trend evolves. Of course, there won’t be a steady change. There will be starts and stops, grand achievements and major setbacks, and that is normal. Most people will not even recognize that the new trend is in place.

But I can tell you that investors love improved balance sheets. And I can speculate that after a decade in which the stock market has made no progress, it is ripe for a broad renewed uptrend, and the growing perception that our fiscal house might finally be put in order could be a real tonic to that effect.


Calvin Coolidge Says

Calvin Coolidge became president in 1923 upon the death of Warren Harding, and to some extent his experience reminds us that we should be careful when choosing vice presidents.

He was elected in his own right in 1924, in part because life in America was good in the Roaring Twenties. Business was booming, and an asset bubble was inflating rapidly. But “Silent Cal” was never a real leader; he was more content to listen. And in keeping with Republican ideals at the time, he was loath to grow government and happy to cut taxes.

Book cover photoInterestingly, we have on our shelves (in this old library) a copy of a book titled Calvin Coolidge Says.

Published by the Calvin Coolidge Memorial Foundation in 1972, on the centenary of Coolidge’s Vermont birth, it was doubtless bought by Cabot founder Carlton Lutts.

It’s primarily a collection of the daily newspaper columns Coolidge wrote from June 30, 1930 to June 29, 1931. They were widely syndicated, and he was paid more than $203,000 for them, a great sum at the time.

For the most part, Coolidge’s daily columns voiced his confidence in the ability of hard work and smaller government to produce an economic recovery. He called on his readers to be generous to those in need and thrifty in regard to their own affairs, but above all he carried the message that the American people would eventually triumph through the adversity of hard times.

On this very day in 1931, for example, Coolidge wrote:

“Contemporary opinion is usually too critical and misdirected. In the perspective of history many of our present seeming imperfections will disappear and the qualities of our society and government will be more apparent. Before becoming entirely discouraged and hastily deciding everything has so deteriorated that confidence is no longer warranted, it would be well to read some former opinions. Discouraging conclusions are not new. They have continually been expressed even by the able and the thoughtful from the foundation of our republic. As judicially minded a man as Chancellor Kent wrote in 1845, ‘I think we have at Washington the meanest man, malignant, party hacks and tools that ever were doomed to curse a republic.’ Yet the country not only survived, but the government of that day is now conceded to have included some of our most brilliant statesmen.

“Sometimes the whole body of the Congress falls into disfavor because of the actions of a few members. The blame lies with the voters who elect undesirable persons. When elected, other members have to work with them.

“This republic has a good government. The future undoubtedly will judge this period as a time when the country met its difficulties remarkably well.”

Coolidge’s philosophy is aptly summarized in his famous remark during a 1925 address to the American Society of Newspaper Editors: “After all, the chief business of the American people is business.” And despite today’s political turmoil and the recent recession, businesses are in good shape.

Moving on, a few weeks ago, I stopped at a Home Depot in New Hampshire, where there’s no sales tax, and bought 50 “Crystal Clear” 100-watt light bulbs.

This past weekend, I bought a dozen more.

And why?

Because these are the bulbs used in the light fixtures in my kitchen and breakfast nook--no substitutes are esthetically acceptable--and the federal government, in its eternal wisdom, has decreed that beginning January 1, 100-watt incandescent bulbs must be 25% more efficient.

To date, only one manufacturer has achieved that goal. Philips Lighting produces a 70-watt Halogena Energy Saver that emits the same amount of light as a 100-watt incandescent. The bulbs cost about $5 each, and Philips claims they last about three times as long as traditional bulbs.

But there’s no clear model of the Halogena bulb available.

Yes, the Halogena bulbs are dimmable. And yes, they emit a warm white light like traditional incandescent bulbs. So Philips is almost there.

But for my lighting fixtures, the frosted bulbs just won’t do.

When Philips or someone else makes what I need, I’ll be happy to buy them.

Until then, I’m hoarding.


Finally, today’s investment idea.

It’s Shutterfly (SFLY), the #1 online resource for storing and sharing photos, while using them to create photo albums, invitations, coffee cups, T-shirts and more.

Founded in 1999, the company, historically, has lost money in the first three quarters of every year, making it all up--and then some--in the fourth quarter. But it’s been profitable on an annual basis since 2003, and it’s grown revenues every year as well, telling you its own growth cannot be stopped by a weak general economy.

I like Shutterfly because it’s the industry leader, because it’s becoming better known every year, and because there are no limits to its growth.

And I like the stock because it’s still fairly young. The company came public in 2006, it completed a textbook consolidation at 52 last week, and now it’s trading at new highs.

So you could just buy SFLY here, but to get the best advice, as well as regular weekly updates on the stock, I suggest you follow the advice of Mike Cintolo, editor of Cabot Top Ten Trader, which has recommended it three times this year.

Yours in pursuit of wisdom and wealth,
Timothy Lutts


Cabot Wealth Advisory