By Dan Steinhart, Casey Research
The US has too much debt. This is no longer a controversial statement. Some may believe other problems are more urgent, or that we need to grow our way out rather than slash spending. But even the most spendthrift pundits acknowledge that the debt-to-GDP ratio of the US must decrease if we are to have a stable, prosperous economy.
The private sector has reacted to this over-indebted reality as you would expect: by deleveraging. Since 2008, households and businesses have extinguished of 67% of their debt when measured against GDP. Some paid debt down purposefully, and others defaulted. For our purposes, it doesn't matter how the debt went away. Only that it did.
Meanwhile, the government has done the exact opposite. It has upped its own borrowing by 52% of GDP since 2008.
As a result of these countervailing forces, the aggregate debt-to-GDP ratio has declined only slightly since 2008. Had the government not stepped in, the US economy would we well on its way to a sustainable debt path. Instead, it has shed a paltry 15% of GDP. In other words, government borrowing largely offset private deleveraging.
Why, in a country in that so desperately needs deleveraging, would the government do such a thing?
The typical response is that such a quick and drastic drop in debt would have flung the US into a depression. That's probably true, as far as it goes. There's no denying that debt growth correlates strongly with GDP.
But it's only half the story. And the other half is more important.
Filling the debt gap with just any borrowing doesn't cut it. In order for debt to aid in economic growth, it needs to be productive. Borrowing for the sake of borrowing is worse than ineffective – it's destructive. Debt itself is neither good nor bad. It depends on what the borrower uses the money for.
Consider a businessman who borrows money to invest in a new project. If his endeavor is successful, it generates enough income to service the debt and return a profit. His income rises more than his debt. Viewed from a macro perspective, GDP rises faster than debt, and so the debt-to-GDP ratio declines. Paradoxically, he actually reduced the debt-to-GDP ratio by taking on debt. This is good debt.
Then there's unproductive debt, which is bad. And in times of over-indebtedness, it's really bad. Think your neighbor buying a TV on credit. He now has more debt with no additional income. He has added to debt, but not productivity. This is bad debt.
The government is the undisputed champion of creating bad debt. Borrowing to spend on weapons, relics (the post office), and losers (Solyndra) does not produce wealth. Even if you argue that some of these expenditures are necessary, they are certainly not productive, in the sense that they add only to the debt side of the ledger without even the prospect of producing income.
That's the fatal flaw of the government stepping in to fill the borrowing gap. Government debt is dead weight. It is a detriment without a corresponding benefit. And even worse, it crowds out private investment, accomplishing the exact opposite of its alleged goal of spurring growth.
The borrowing gap should be filled either with productive debt or not at all. Private businesses are indeed beginning to grow credit, albeit very slowly. That's a good sign, especially for equities – a factor that is shifting the balance between stocks and bonds that investors should have in their portfolios, and just one of the factors covered in our recent free investor bulletin on striking the right balance in your portfolio. But glance up at the chart one more time. Government borrowing has metastasized to the point that it consumes a third of all debt in the US, leaving private borrowing precious little room to grow.
All debt is not created equal. If the debt doesn't produce growth, it's a waste at best, and a destruction of wealth at worst.
If Casey research keeps putting out this nonsense, then INO would be well-served to sever their content agreement.
A couple points about the article.
"As a result of these countervailing forces, the aggregate debt-to-GDP ratio has declined only slightly since 2008. Had the government not stepped in, the US economy would we well on its way to a sustainable debt path. Instead, it has shed a paltry 15% of GDP. In other words, government borrowing largely offset private deleveraging."
In this point the author shows remarkably little sensitivity to the fact that we are all each other's consumption and each other's finance sources. The vast majority of money creation does not occur by "Printing" it, but rather through increases in the debt multiplier. Those familiar with basic economics know that the money multiplier goes up when new loans are taken out (debt is created) and goes down during deleveraging. If the author truly understood what deleveraging meant, then he would be a little bit more reluctant to mourn the sad fact that we didn't enter Great Depression II in 2008.
"In order for debt to aid in economic growth, it needs to be productive."
Hmmm, Why do I suspect that the author and I have completely different definitions on what productive means when talking about debt?
There are two Grand Questions of economics that every economist should answer as a basis for discussing his theory. If you are giving economic advice and you don't have answers to these questions, it is time to put aside the prognosticating and replace it with a sound session of studying.
1) In the most simple economic model, wages come out of revenues and revenues come out of wages. What makes up the difference? Different economists will emphasize different aspects of this dynamic, but if you don't have an answer to this, you don't even have a starting point for beginning the discussion. Unless you want to throw around value-laden terms like "productive" without really knowing what they mean in terms of effects on the overall economy.
2) What is the relationship between Potential to produce efficiently and actual efficient production? This is closely related to the Farmer conundrum. 200 years ago, farming was half the economy, and now it is under 1%. Where did the farmers go? Of course, they went into producing other things and that is an important ingredient for growth. But ironically, this means growth occurs through movement of people from a very efficient industry to an industry with low efficiency. Further, knowing that this transition has to happen is quite different from understanding what helps it along.
But in an even broader sense, if increased economic efficiency involves getting people to do the same amount of work, but merely ensuring that they engage in less consumption as a result of their value creation, is it fair to call that efficiency? Remember 1) as you answer that.
Our economy doesn't work as efficiency in a vacuum. In fact, the sum of all rewards for value creation divided by the sum of all value creation is our value utilization. A small difference between our actual utilization and perfect utilization can be made up for with Debt, asset growth (eg. buy groceries when your house increases in value), and monetary expansion, but a large gap cannot exist forever and it is sheer lunacy to assume that consumption capability has to increase to match value creation capability rather than the opposite happening. And one of the big lessons of the Great Depression (and of other examples like Argentina at the beginning of the Naughts) is that when value creation (which is based partially on efficiency) starts to move down to meet consumption capability (which is based entirely on negotiating leverage when there is a big gap between consumption capability and production capability), this move can happen very quickly and dramatically.
Ironically, it is when the gap between consumption capability and production capability is the largest that the "free market" ideologues are screaming the loudest that the economy would come back to balance, if only people could be cajoled, enticed, or forced to just produce a little bit more efficiently, and any attempt to help out with bargaining leverage or to fund public infrastructure that we all know society will be better off with in a way that decreases the wages revenue gap is met with fierce opposition on the grounds that were we ever to utilize our economic resources fully, the maximum reachable point might be a little bit higher if we err on the side of efficiency.
Every pundit who wishes to talk about economics should answer the following question first or shut up.
Corporate wages are a portion of revenues, with the rest being profits (in aggregate, after divvying up other costs between these two buckets). The bulk of profits will fall outside of the radius of consumption, which, ignoring real estate today, is probably around 200k per year (Michael Bloomberg will never go out to times square and order 6 million hot dogs for lunch. The number of dollars you can have and potentially consume with is the radius of consumption). These profits can be reinvested in capital, but there is a catch. A dollar going into capital should result in more than a dollar coming out of consumption, at least in the long term. This means that in average of the lifecycle of corporations, capital dollars will have an overall effect of increasing the consumption capability/production capability gap. Obviously something has to, but what?
When you have a good and convincing answer to that question, you have earned the right to be an economic pundit.
That last should read "Obviously something has to make up the difference, but what?"
Hey Keynes! In the end we are all dead
Who created this plot and how? Household debt if it includes all mortgages on houses, debts on cars, installment plans, credit card debts, etc, while hard to estimate, is likely much greater than the federal debt by a factor of two or more. This is not seen in the plot and deserves an explanation.
What is really interesting about the chart is the growth in US debt under the watch of George W Bush ( a Republican) from just over 200% to over 400% and the current Republican Candidate Romney wants to embark on another round of red neck policies if elected.
There needs to be a major change in direction from the profligate policies of the Bush era.
Agreed. If you look at all the big debt jumps, they started from the same conditions. Tax cuts for the rich. Ronald Reagan told us all to imagine a stack of dollars going to the moon and back twice. Way to use creative visualization!!! What the mind can conceive and the eye can perceive, the body can achieve! When Clinton took over, that stack of bills would have gone back and forth to the moon 8 times, not just 2. Meanwhile, if you adjust for the Reagan bush debt and the interest on that debt, then the Clinton years paid off the WWII debt in it's entirety.
But I guess you can't raise taxes on the campaign contributors.
Everyone should carefully note what slope changes match which administrations and the split among Nobel Prize-winning economists as to whom they endorse -- those seeking maximum returns for very large private investments (Scholes, et al): Romney; vs. small investors and public investments (Krugman, et al): Obama.
"Alan Greenspan has proclaimed himself 'shocked' that 'the self-interest of lending institutions to protect shareholders equity' proved to be an illusion... The Reagan-Thatcher model, which favored finance over domestic manufacturing, has collapsed. ... The mutually reinforcing rise of financialization and globalization broke the bond between American capitalism and America's interests. ...we should take a cue from Scandinavia's social capitalism, which is less manufacturing-centered than the German model. The Scandinavians have upgraded the skills and wages of their workers in the retail and service sectors -- the sectors that employ the majority of our own workforce. In consequence, fully employed impoverished workers, of which there are millions in the United States, do not exist in Scandinavia." - Harold Meyerson, "Building a Better Capitalism", The Washington Post, March 12, 2009.
I still find it funny that Alan Greenspan was shocked when he discovered that corporations were not people with motivations that could be modeled and instead you have to model the motivations of the Actual people -- the CEO's to have predictive power.
John Keynes would have chocked to be sure. The Fed's debasement of our money in order to support the insane borrowing habits of the Govt has got to come home to roost, most likely sooner than later because of the size the bubble has become. As Chicken Little said, "Run for your lives, the sky is falling"!!!
Reagen said,"The Government is like a baby's alimentary canal, with a happy appetite at one end and no responsibilty at the other."
Ronald Reagan said, talking about progressives, "If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it." We all saw how that turned out. After 30 years of Reaganomics, the average person is 5 times as likely to be in prison as in 1980, the National debt has gone up from 30% of GDP in 1980 to over 100% today with Republican administrations accounting for more than 100% of the increase if you include effects of their policies and interest on their debts. The average person's wage divided by their value creation has gone down by about 40%. If the average person making 50,000 today were making the same percentage of their value creation they were making in 1970, then they would be making over 80,000 dollars. I don't know of any middle class person who couldn't find a good place to put an extra 30k dollars. Our trade deficit was very manageable in 1980. But when we caused lots of dollars to accumulate at the top, that had the side effect of creating an artificially strong dollar. Our inadvertent dollar manipulation has had a significantly more profound effect than China's more visible currency manipulation. Our growth has also slowed significantly. In fact, 1984 was our last year of over 5% growth. Before 1970, we had 5% plus years all the time, and at the height of the New deal, growth was steadily closer to 10%. Of course, one-income families reached their high point in the 50s and 60s and have been reversing ever since.
Just about everything Americans care about has been going in the wrong direction since the Ronald Reagan Elbow, and the fact that politics have been so divorced from cause and effect is testament to the power elites can wield to shape our access to information and to influence public opinion and is evidence of the dangers of feeding the sharks by making a business model of deception and acquiring negotiating leverage more profitable than a business model of innovation and value creation.