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Guest Post: Some Thoughts On Debts, Deficits & Economic Growth
Submitted by Lance Roberts of STA Wealth Management,
I recently posted some thoughts on "The Most Dangerous Line Uttered During The Debt Ceiling Debate" in which I discussed the idea of having to increase the government's debt limit in order to pay its bills. The premise was rather simple. As the government continues to increase its borrowing in order to meet spending requirements; the additional interest service requirement detracts dollars from productive uses. As a consequence, over time, economic growth has slowed. This article, along with my conclusions, elicited some excellent questions that deserved some follow up.
Scott N. stated that:
"Not all government debt is created equal. We have bad deficits and good deficits. Good deficits are used to fund investments that will have a positive rate of return, properly determined. Those contribute to GDP."
He is absolutely correct. This comment falls within the realm of Austrian economics which is something that I addressed in a previous missive entitled"The Breaking Point:"
"The Austrian business cycle theory attempts to explain business cycles through a set of ideas. The theory views business cycles 'as the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings.'
In other words, the proponents of Austrian economics believe that a sustained period of low interest rates, and excessive credit creation, results in a volatile and unstable imbalance between saving and investment. In other words, low interest rates tend to stimulate borrowing from the banking system which in turn leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money.
Therefore, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities. Finally, the credit-sourced boom results in widespread malinvestments. When the exponential credit creation can no longer be sustained a 'credit contraction' occurs which ultimately shrinks the money supply and the markets finally 'clear' which then causes resources to be reallocated back towards more efficient uses."
This point was also addressed by Dr. Woody Brock during his presentation at the 2012 Altegris Investment Conference, wherein he stated (these are my personal notes):
"There is a huge debate over 'Austerity' versus 'Spending' which leads to increases in debt.
High debt to GDP ratios must ultimately be reduced. There is no question of this.
Rising debt levels erode economic prosperity over time. However, the word, 'deficit', has no real meaning – let me explain.
Let's take two different countries.
Country (A) spends $4 Trillion with receipts of only $3 Trillion. This leaves Country (A) with a $1 Trillion deficit. In order to make up the difference between the spending and the income; the Treasury must issue $1 Trillion in new debt. The new debt that is issued is only used to finance current spending (welfare) but generates no income. Therefore, the gap that is created continues to grow as the cycle is repeated.
Country (B) spends $4 Trillion and receives only $3 Trillion in income. However, the $1 Trillion of excess debt created was invested into projects and infrastructure that produced a positive rate of return. There is no real deficit as the rate of return on the investments ultimately fills the 'deficit' by paying for itself.
There is no disagreement about the need for government spending. The disagreement is with the abuse and waste of it.
Keynes' theory is that when private spending is low it should then be stimulated with public spending. The problem with this theory, while correct, is that it was badly abused. When the economy is strong and growing the public spending should be sharply reduced. This was never the case.
The problem today is that government spending is primarily unproductive in nature (roughly 70%) with only 30% going towards productive investments. This is against the Arrow-Kurtz principles. Today we are borrowing our children's future with debt. 'We are witnessing the 'hosing' of the young' he stated.
The U.S. has the labor, resources and capital for a resurgence of a 'Marshall Plan'. The development of infrastructure has high rates of return on each dollar spent. However, instead, the government spent trillions bailing out banks and supporting Wall Street which has had virtually NO rate of return."
The problem is that we have been running deficits since the beginning of 1980. These deficits have retarded economic growth as the borrowed dollars were used for non-productive purposes. Currently, it requires in excess of $5 of debt to produce $1 of economic growth. This is ultimately unsustainable. The chart below shows the annual change in GDP, the annual net increase in Federal Debt and the surplus or deficit. The red dotted line is the polynomial trend line of the annual rates of economic growth.
This chart goes to address the point made by John L. in relation to economic growth rates versus debt:
"A vast majority will agree with your assertion. But the time lag effects I have pointed out have been bothering me ever since the seemingly perfect Rogoff and Reinhart bubble got deflated. That was another 'question everything' wake-up call."
This is an excellent point. There are MANY factors that go into the reality that economic growth rates are slowing. In fact, as I stated in "A History Of Real GDP & Population Growth" we are now running the lowest rates of economic growth in the history of the U.S. This is not only because of the massive increases in debt but also to low rates of inflation, population growth, and real employment and wages.
In regards to Reinhart & Rogoff's work on debt levels versus economic growth, while there was great controversy over the calculation of certain metrics, the end conclusion that rising debt does impede economic growth remains intact. (R&R's Response To Critics Here) The only question is whether it is 90% or 130% or some other level. The reality is that the "bang moment" has much to do with the underlying metrics of the country in question such as whether they are a sovereign currency issuer, a net exporter or importer, population growth, dependency ratios, wage levels, and, now, the level of central bank interventions.
The questions posed by John, and Scott, were excellent. My hope is that I have made a decent attempt at answering them. There are no simple solutions to the issues that currently plague the U.S. and, unfortunately, the latest debt ceiling debate/government shutdown did nothing to institute any reforms whatsoever. The "kick-the-can" solutions by fiscal policy makers continues to show little understanding about the drivers of real economic growth, the need to reduce governmental dependency or a real "wealth effect" that impacts more than just 1% of the population.
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Enforce the Constitution of the United States of America.
Buy stocks. We are in a bull market of a life time. Take the money from Dan Loeb and give it to Cramer, watch miracles happen. That's all I have to say.
this situation is the system called the fed reserve.
the system is working perfectly.
the system has taken 100 years to bring the only uncontrolled nation to its knees.
the system is, if you haven't seen it yet.
to enslave a free people to debt with paper created out of thin air,
and capture all productive assets through boom and bust cycles the system creates.
How about Country (C) that doesn't have $4 trillion taken by government and almost entirely wasted.
A conservative cost for government is $6 trillion each year. What the fuck are the people getting that's worth $6,000,000,000,000?
Screwed?
The solution for not getting in this mess are simple and easily implemented: never, ever spend more than you take in. The options for getting out once you have promised too much to too many are actually quite simple, but unpalatable to politicians or the public. The inability of people in washington to accept that they caused this and that to fix it they have to stop promising people stuff we can't pay for is what is complicating things.
Translation: We're all fucked!
All of such discussions as above are well and good
But it's high time we start considering the realities we will face AFTER the collapse and what to do about them.
If there's anything left we can do.
I thought the White house trashed the constitution and we are now under king Obama's law.
Too many fiscal liberal Republicans and Democrats.
it is cool. hedge fund managers still playing poker - http://hedge.ly/178ibZ0
A crashing US dollar and retail goods, food spiking should help.
Loss of confidence in the US dollar as a reserve currency should really help.
In the mean time the Fed increases QE and adds gasoline to the fire.
The premise was rather simple. As the government continues to increase its borrowing in order to meet spending requirements; the additional interest service requirement detracts dollars from productive uses. As a consequence, over time, economic growth has slowed.
Hate to be critical but there is no "additional interest service" detracting from productive uses...the USofA pays less now in interest on its debt of $17 T than it did in '00 when it had $10 T. US pays about $20 or $30 billion less annually (not as a %, but total). Author can certainly point to the means by which debt service costs have been kept so low (QE, lack of economic growth) but not to the debt service.
Only through the addition of more crap on the balance sheet of the FRB and issuance of worthless digital script.
What the author should really be talking about is what would happen if we did get GDP growth (as this may be part of the reason we are not and will not see growth).
Any increase in economic activity (say a 3.5% jump in GDP) would increase economic activity by $560 B but the increase in taxes would be @ 20% of that or $110 B…historically, the parallel rising interest rates to say 3.5% would raise interest costs to $600 B…a net deficit increase of $140 B. One step forward economically would create two steps backward budgetarily due to the debts being larger than the economy (hello Reinhart and Rogoff). Now of course the Fed will remit the increase in interest on it's $2.2T in treasuries back to the Treasury (+$25 B) but still the deficit grows due to growth and overindebtedness...not shrinks.
The real question is how economies can have growth (the elixir to all our problems...so we are told) without simultaneous interest rate rises???
There is a maximum level of debt that any economy of a certain size can support. So what sise of economy does the USA require to support a 17 trillion debt? It is not just the USA though is it, apply the same principal to all economies around the world and see how everybody has done this.
There is a very simple solution. Break up the syndicate of mega banks(BANK MAFIA). Then instead of having a few people committing fraud and taking home $50 Million we could have normal people taking home normal salaries. Just think oil $35/barrel, home prices falling to a normal level so you can have actual money instead of paying some outrageous mortgage with the inflated property tax, food would drop to it normal level instead of being juiced by commodity traders with access to unlimited printing, heck who knows...banks might pay interest to savers. And banks would make loans to make money and not fraudulently trade currencies and bonds. Just think what an ACTUAL capitalistic society with supply and demand controlling things, instead of K Street and Wall Street and the FED?
There are a lot of "simple" solutions to our woes but, none of them will ever be implemented.
For the simple and sometimes painful solutions to work. There must be political will to have them done. Much of this can be knocked down with commercials of mean politicians pushing granny off a cliff.
There isn't anyone that can stop the high power lobbies, banks and bankers that are to big to jail... politicians on both sides of the isle that will not let the money stop because that stops THEIR ability to hand out favors to lobbies and bankers and, the last thing they would do is to stop money into their own districts.
The simple and direct solutions that make sense will never fly in a world where the Tea Party that only wants fiscal restraint are deemed to be "terrorists" and "anarchists" by BOTH parties... no, I'm afraid this will not end well.... There must be MOAR, MOAR, MOAR... MOAR shrimp on treadmills I say!!!!! MOAR!!!!!!!
Nature has its way of destroying parasites. It may take time, but they will be destroyed.
Debt % of GDP numbers are simple. Once debt passes 100% of GDP AND interest rates rise to greater than annual growth of GDP, then MORE than every dollar in growth is going to pay interest. System implodes.
Nah,
That's what the Turbo-Boost button on the printer is for...Escape Velocity.
The article is right, but WTF are the "drivers of real economic growth?" The drivers have been missing since about 1970.
So, Mr. Roberts, please define the quoted phrase.
"The drivers have been missing since about 1970."
Yes, the US hit Peak Oil in 1970 and it's been downhill mostly the whole time since. That's one of the main reasons why the US trade deficit exists (or existed)!
This article is OK, but a bit oversimplistic, as are all Austrian Economics analyses, in that it misses the main point that you can't have increased ecoomic activity when the natural resources driving that economic activity are in decline. And there is never, ever, any attempt to define what this thing called "economic production" actually is. It's just taken as a given, without much thought put into the factors that actually create "productivity".
Yeh so.... the US is 17T in debt and growing.... so what? The stock market is at all time highs, everyone can get health insurance, everyone can get food, everyone can get housing, gays can marry, and we will be adding another 30 million undereducated, largely spanish speaking migrants to our economy. What's wrong ?
Ultimately Democracy doesn't work - love this quote:
“We've all been raised on television to believe that one day we'd all be millionaires, and movie gods, and rock stars. But we won't. And we're slowly learning that fact. And we're very, very pissed off.”
http://hongkong.asiaxpat.com/on-location/greece.html