Guest Post: Our Era’s Definitive Dynamic: Diminishing Returns

Tyler Durden's picture

Submitted by Charles Hugh-Smith via Peak Prosperity,

We all intuitively grasp the meaning of diminishing returns: Either it takes more effort to maintain a project’s payoff, or the payoff declines even though the effort invested remains constant. This graphic illustrates the two types of diminishing returns:

Studying is one common example of diminishing returns. When we’re fresh, we learn a great deal from intense study. As our energy and concentration flag, the return on the effort of studying declines until it reaches near-zero. We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

While it is tempting to identify a political, emotional, or economic factor as the root cause of our structural troubles - human greed, poor enforcement of regulations, Federal Reserve policies, etc. - I think a compelling case can be made that the one dynamic that ties all the other causal factors together is diminishing returns.

Diminishing Returns and the S-Curve

The key driver of diminishing returns is easy to understand. We naturally continue to do more of what was successful in the past. As the returns decline, we redouble our efforts, confident that what worked in the past will once again be successful if only we invest more labor, energy, and capital.

Let’s consider some examples.

Financialization—relying on expanding debt, leverage and the packaging of debt for growth—pays handsome returns in the early stages of the process. But returns on expanding debt diminish as the low-hanging fruit are plucked and credit expands to buy low-yield, high-risk investments.  Returns also decline as rising interest payments on all of the accumulating debt eat away at yields.

Eventually, returns decline to zero or even negative territory, and doing more of what worked well in the past fails in a spectacular fashion.

We can see this same dynamic in this chart of household debt and earnings: The expansion of debt was paralleled by rising earnings until the late 1990s. After that, household earnings continued rising, but the rate of growth was outstripped by debt, which more than doubled from 2000 to 2008.

In other words, adding debt yielded diminishing returns in terms of household income.

Efforts to reduce debt (i.e., deleveraging) have barely moved the needle, as shown on this chart of total debt per capita (per person) in the U.S.

The S-Curve helps us understand the tendency to respond to diminishing returns by redoubling what worked in the past. For example, if regulating the financial sector worked in the past, then let’s do more of it. Thus the Glass-Steagall Act, at 37 pages in length, was the inspiration for the 2,319-page Dodd-Frank Wall Street Reform and Consumer Protection Act.

Higher education offers another example. While costs have skyrocketed 1100% since 1980, the yield on that investment has declined.  A recent major study, Academically Adrift: Limited Learning on College Campuses, concluded that "American higher education is characterized by limited or no learning for a large proportion of students."

While student loans have soared to over $1 trillion, with direct Federal loans ballooning from $115 billion to $674 billion in a few short years, only 37% of freshmen at four-year colleges graduate in four years (58% finally graduate in six years), and 53% of recent college graduates under the age of 25 are unemployed or doing work they could have done without going to college.

Housing offers yet another example of diminishing returns. While the Federal Reserve has pulled out the stops to boost housing by lowering interest and mortgage rates to historic lows and taking the unprecedented step of buying over $1 trillion in mortgages, housing valuations remain far below their bubble levels.

The $1 trillion F-35 Lightning fighter aircraft program is an excellent illustration of the dynamic. Despite claims by the contractor to the contrary, numerous reports of fundamental inadequacies continue to surface even as delays and cost-overruns have driven the fly-away cost of each fighter to over $200 million each.

Though some published reports assign a cost of $110 million each to the F-35, this grossly understates the true cost, as the research and development costs were paid separately. These might run as high as $50 million per aircraft, if the number purchased globally declines. (Even more absurdly, some published prices for the F-35 neglect to include the engine, which adds $34 million.)

By comparison, the previous top-line U.S. aircraft, the F-18 Super Hornet, costs $57 million each. In the view of many defense analysts, the F-35 is decidedly inferior to the aircraft it is replacing.

We might expect that an aircraft that costs almost four times more would be four times more capable than the previous generation. Instead, the complexity of the aircraft is yielding such severely diminishing returns that the new aircraft may prove less capable than upgraded F-18 Super Hornets in real-world air-to-air combat and bombing missions.

Continuing to do more of what was successful in the initial high-return phase of the S-Curve ends up failing spectacularly when it is applied in the topping phase of the S-Curve: More energy, effort, and capital must be expended just to keep the yield from dropping into negative territory. This is not a static dynamic; as yields plummet, defenders of the status quo divert an ever-increasing share of the national income to feed their diminishing-return sacred cows.

Sunk Costs, Institutional Culture & Peer Pressure

Three other factors motivate this devotion to systems beset with diminishing returns: sunk costs, institutional culture, and peer pressure. Sunk costs are the investment plowed into the system over the previous decades that cannot be recovered; abandoning these assets goes against the grain.

Every institution has a culture built over time of procedures and priorities. Abandoning diminishing-return programs typically requires radically transforming (or jettisoning) the institution’s existing organizational order. From the perspective of those inside the institution, such a radical change looks like a potentially costly gamble; the lower-risk strategy is to do whatever it takes to maintain the existing order.

Though we may dismiss peer pressure as a teen-era phenomenon, it is just as powerful in adult circles. Anyone pointing out diminishing returns within an organization risks being sacrificed as the messenger of unwelcome news: shunned, demoted, or discredited. There are too many masses of inertia and too many people with stakes in the current system to welcome radical changes and potentially risky attempts at transformation.

The Accelerating Costs of Diminishing Returns

This default diversion of treasure to support diminishing returns has two costs: the opportunity costs of what else did not get financed because available resources were poured down the rat hole of failing programs, and the largely hidden increase in systemic fragility as productive investments are starved by the diversion of resources to the rat holes of diminishing returns.

This dynamic leads to the final phase of doing more of what has failed spectacularly.

In Part II: How to Overcome Diminishing Returns, we examine the inner workings of diminishing returns and consider strategies to avoid being ensnared in diminishing-return systems.

Though we have no control over systems such as the Federal Reserve, we do have some control over our exposure to such large-scale systems. This is one definition of resilience and self-reliance; the lower our exposure to failing systems, the greater our resilience and self-reliance. Identifying systems doomed by diminishing returns is a solid first step to reducing our exposure.

Click here to access Part II of this report (free executive summary; enrollment required for full access).


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Seize Mars's picture

Sorry to threadjack, thought this was important:

The photo presented by the media as the wounded shooter at LAX here:

Is fake. It is a dummy, called a "Dapper Cadaver" and manufactured by this company here:

Another false flag, another government bullshit operation designed to assassinate the Bill of Rights.

LetThemEatRand's picture

Great find.  The piles of strawberry jello next to him were also a "dead" giveaway.  How would someone with his wounds expel that much jello?

EDIT:  not jello.  Permablood.

Skateboarder's picture

And they're about to start auditions for Star Wars VII. Everything is so gross these days.

Zer0head's picture

`twas ever thus

AP reports


"High cost of living not inflation, say economists"


New York (AP) -- The cost of living continues to rise but the government assures us that this isn't inflation.






moneybots's picture

"High cost of living not inflation, say economists"


Then it must be deflation.

LetThemEatRand's picture

This is an excellent article and it shows the futility of printing money for the supposed benefit of the broader economy.  But the only chart that really matters is the one that documents the increasing wealth of the people who pull the strings of the government and the Fed.  They had to redraw that chart because it went parabolic in 2008.   The S that motivates these guys as a straight line through it ($).

disabledvet's picture

Absolutely top shelf intro. I wish you all the best in subscriber growth. I like simple and simple is a 42% approval rating. Clinton and Reagan were in the 60's when they were done...George HW Bush lost his re-elect. The pollsters are telling you something is wrong. There was a test case for new taxes in Colorado that went down in flames. A "revolt" of sorts is well underway. "Blame the tea party"? Really? They're the majority now? Good luck with that. How about a "turn off the television day"? Where is that in all the rhetoric. The "message is the medium" is easily the greatest truism as far as what you "watch" or (think you) "see." Think that was Marshal McLuhan. In any case "consistency in spite of evidence" is a dead give away that you're being sold something. Survey's are one thing but polling is called "data" for a reason. Simple "yes or no" or "up or down" will always say more about how people feel than "the payment mechanism built into the concept that revolves around the entity that works the mechanism will then....

wisehiney's picture

Just reading in the local paper about an interview with the finest, sweetest old lady. 87 years. Just outlived her 4th husband.

Gal from the local (really good) newspaper, is interviewing her.  "It is really interesting about your life, your experiences, and the variety of the men you marrried.

After a bit, the little old lady brightens up and says:

"Oh yes! When I was in my twenties, I married a banker.

When I was in my forties, I married the Ring Master for the circus.

When I was in my in my sixties, I married a Preacher,

And as you know, now, in my eighties, I am marriing the Funeral Director.

Reporter asks "How did you come to marry men from such diverse occupations?

Sweet little old lady says..

I married one for the money,

Two for the show, 

Three to get ready,

And four to go!


Stuck on Zero's picture

Crashes are absolutely essential to economies to prevent all the wealth concentrating at the top.  After a crash the only value left is goods and human labor.


hooligan2009's picture

you cannot affect the return on assets by changing the mix of the way the assets are financed. you cannot expect to borrow more to buy similar assets forever, eventually, you satisfy all possible demand, and/or your assets become obsolete.</p><p>the same applies to the Fed. it cannot affect the rate of growth of the economy one iota by substituting cash 1's and zero's paying zero interest for government debt paying interest. in fact the economy loses the interest previously paid by the government to the private sector and instead this is "captured" by the fed. so in this instance the fed is impoverishing the economy, by removing interest.</p><p>where would government borrowing rates be if the fed was not acting as lender of last resort? well, real returns historically vary between 2-4% above inflation for 10 year debt (to reflect a reward for tying money up longer), so instead of 2.7%, with headline CPI at 1.2% means that a AAA US government would be paying around 3.2 to 5.2% for its borrowings. if you use a hostile rating agency like the chinese one the US would be paying the single A spread (<a href=""></p><p>this would add a further 100 bps for default risk. that puts the ten year treasury at 4.2 to 6.2% lets say that the Fed has rigged the markets by the difference between the mid point of 5.2% and the spot rate of 2.7% or by 2.5%.</p><p>the cost of servicing 17 trillion of debt has been reduced by around 425 billion in exchange for purchasing 45 billion of treasuries...or 540 billion a year..fully sterilizing treasury debt issuance. (another 40 billion is spent on mortgage financing).</p><p>the Fed cannot reduce the bill by another 2.5%...the interest expense is not subject to dimishing returns..this is a key point missed in the get diminishing returns on assets, but not on debt..that is a fundamental flaw in the capitalist system...much along the lines of how you dont pay a lower interest rate as you pay down more and more of your mortgage, despite the fact that you are a better and better credit risk..governments however plunder tomorrows treasures today, living like pirates raping and pillaging as they go.</p><p>the interest burden is escalating famously despite lower rates. check out here:&nbsp;<a href=""></a></p><p>t... interest bill was 416 billion on treasury debt..a lot of it paid to the Fed admittedly, in the way that all the feds actions obfuscate the truth. but next year the interest will be higher, because the debt will increase from 16.4 trillion to over 17 trillion, despite the cyclical improvement we are seeing this year. the year after it will be 18 trillion, so it two short years, debt interest will be approaching half a trillion dollars...thats before any food stamps, medicare, medicaid, vet is already the single largest line item of expenditure and will not suffer any diminishing returns whatsoever until the government runs a surplus.</p><p>and if, there is a return to normal with ten year rates at 5%, the interest alone will approach 1 trillion as more debt is refinanced at that new rate, not all at once..but it will happen.&nbsp;</p><p>how long can beneficiaries vote for trillion dollar deficits? as long as there are more beneficiaries than there are tax payers. the US is already beyond that there is a reversal (a negative one) of dimisnihing returns on the liability side..people will always opt for doing nothing if some idiot says its ok to steal from others who are working.</p><p>just saying...diminishing returns applies only to assets and positive things. negative things have no such constraint.</p>

wisehiney's picture

Good stuff, flowed downhill nicely. But way too verbose. More conscise. More efficient. To the point. People quit way before that. Especially when they have sore, tired eyes. And never enough time to spoil themselves.

Trimmed Hedge's picture

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

We find ourselves re-reading the same line again and again, and basic errors pile up in our work.

Fuh Querada's picture

Hi Chuck,
Are you going to explain sometime what the x-and y-axes of your ( top 3 ) graphs represent.
This is a recorded message.

new game's picture

diminishing species, humans that is...

Oldwood's picture

Through debt,securitization and currency devaluation we are reaching farther into the future to pay for consumption today. We are broke. How much farther we can reach into the future to steal productivity is yet to be seen, but we all understand what bankruptcy is. It is typical for those facing bankruptcy to run up all the debt they can prior to filing as they know the aftermath will be harsh. I think that is happening globally right now.

DOT's picture

When we look at events or information, often,we are tripped up by our confirmation bias. In societies where the spending of the State supports even the most mundane of activities we suffer from conformation bias.

Mareka's picture

A take away from years of working in manufacturing and calculating the cost of goods sold is that as a product approaches zero profitibility, tiny changes in cost of materials, labor, scrap, payment terms have huge implications.  If you are down to making only a 3% real return on a product and your costs, scrap, whatever increase by 1% it is not a 1% hit, it is a 33% hit.  The next 1% would be a 50% hit and the next 1% a 100% hit.  At the margin all gains can get wiped out by small moves.  No news to anybody here.

Our governments, Federal, State & Local extracting maybe 60+% of all economic activity in the form of taxes and providing huge incentives to not work.  Once at the brink of being un-sustainable, one more bad policy decision, give away or a little more printing can put the system over the edge... I suspect we may have already passed that point and are just waiting to see it all play  out.

Seize Mars's picture


Yes I see your point. (Ignoring your arithmetic, heh heh.)

Anyways I think you are exactly right.

ThisIsBob's picture

As soon as the OP mentioned NSA "supboneas" I realised he didn't know WTF he was talking about.  But, when preaching to the choir, one needn't worry about pesky details, details...

Flakmeister's picture

It is very hard to milk a dead cow...

SmittyinLA's picture

Look at the mass immigration "bang for the buck", to get the same effect we had from immigration 10 years ago we have to import 4X more immigrants, worse still their water, food, fuel, road, and housing requirements will cost significantly more (not that 10 years ago we were profiting from mass immigration).