by Frank Thomas
We mustn’t forget that Carmen Reinhart and Kenneth Rogoff in their massive economic research highlighted in part in a paper entitled, “Growth in a Time of Debt,” came up with the central conclusion that nations grow slower when their public debt levels rise above 80-90% of GDP. Another conclusion was that private debt tends to fall off sharply after financial crises which is also another factor slowing down growth.
U.S. total private and public debt exploded from $26 trillion in 2000 to $53 trillion in 2008 or 9.5% annually – private non-financial debt rose from $17.5 trillion to $36.4 trillion and public debt from $7.2 trillion to $ 12.3 trillion in same period – increasing to $17.8 trillion now, including government debt needed to replace funds confiscated from the Social Security Fund. Public debt has risen over $5 trillion since the end of 2008. During 2000-2008, household debt rose from 68% of GDP to over 100% by 2008. On the positive side, private debt has fallen almost $5 trillion since the end of 2008. Since the 3rd quarter of 2008, there have been 12 consecutive quarterly declines as total household debt has fallen by almost $1 trillion. (data from Ned Davis Research) But, this ongoing private debt deleveraging process, while vitally necessary, simultaneously slows GDP growth made worse by a 100% plus public debt to GDP ratio (as Reinhart/Rogoff concluded in their study that countries face limits for Debt/GDP levels above which the effects on economic growth are non-linear).
This brings up point noted earlier that I believe U.S. is afflicted with an inherently, unstable out-of-balance economic model where GDP growth must be achieved by an excessive, debt-inducing dependence on Consumption (at 70% of GDP) in combination with low savings, stagnant wages, soaring trade deficits from unfair trade, loss of manufacturing base knowhow, relatively low public and private investments, and declining rate of tax revenue growth – all together accelerating public debt, credit card debt, and consumer spending beyond our means. Resulting U.S. huge trade balance deficits have been contributing a negative 3-4 percentage points to annual GDP growth … driving the vicious cycle of high Consumption with stagnant wages, and ever higher export deficit to the next worse financial crisis. We critically need to counter gross unfair trade practices and to shift R&D and productive investment resources to a more export led growth pattern. This requires a vast improvement in the contribution of net exports to GDP growth even if this means a 1% percentage point negative impact on GDP growth rather than historical 3-4%.
TABLE 5 gives a rather shocking picture of just how far our nation has become addicted to debt to achieve GDP growth. Note particularly that starting in the early 80s, total U.S. debt relative to GDP took a gigantic jump upwards!
During the period 1949-1959, total debt of $337.6 billion was incurred to generate $268 billion of GDP – resulting in a Debt/GDP ratio of 1.36. In simple language , this means that in the decade 1949-1958 it took $1.36 of total debt to generate $1.00 of GDP. As stated, the last three decade trend of total Debt to GDP ratios showing how much debt is necessary to generate $1.00 of GDP is truly disturbing to say the least:
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TABLE 5: TRENDS IN RATIO OF DEBT TO GENERATE $1.00 GDP –1959-2009
1959 to 1969 1.53 = $1.53 Debt to generate $1.00 of GDP
1969 to 1979 1.68
1979 to 1989 2.93
1989 to 1999 3.12
1999 to 2009 6.02 (deregulation, stock, housing bubbles)
Source: Ned Davis Research Using Data from Commerce & Labor Departments
During the 1980s and beyond, the amount of U.S. total debt sharply accelerated relative to GDP as consumers were pressured to buy, buy, buy – at 70% of GDP using flaky consumer credit vehicles accompanied by stagnant wages – more goods and services than they needed. This was facilitated by convenient necessity to buy artificially cheap (often low quality) Chinese products thanks to that country’s grossly undervalued currency and “the devil’s contract” of buying our Treasury bonds to finance resulting huge national trade deficits and persistent federal budget deficits … with debt growing much faster than GDP.
Ned Davis Research confirms the correlation between an increase in total debt (public and private) as a % of GDP and the growth rate in real GDP as follows:
- 1947-1980: total debt was less than 160% of GDP and GDP growth averaged 3.7%
- 1980-2000: total debt was 270% of GDP and GDP growth went south to 3.2%
- 2000-2011: total debt has risen to 350% (vs. 375% in 2008) of GDP and annualized GDP growth has plummeted to less than 1.8%.
Conclusion? Our over-debted and undercapitalized financial system spells slower average growth over next few years until sensible debt to equity and deficit ratios (budget deficits past three years have been at a sky-high historical level of +-10%) are effectively implemented and enforced … precisely what the EU 27 nations have recently agreed to do with the appropriate legislative adjustments and sanctions.
Contrary to what Paul Krugman is saying about the financial failure of EU countries as a whole to date, the total debt relative to GDP ratios of EU mature countries over last 30-40 years are not anywhere near the U.S. development shown above. Yes, there are 5 financially very troubled EU countries, but how does this compare to 48 troubled states whose budgets are in the red with many also near insolvency … where in a number of states public employees are being fired and scanty social nets are being further marginalized left and right? How does this compare to a EU credit card use and debt level far below that of the U.S.? How do household debt levels of the mature EU countries compare when taking into consideration the millions of U.S. home foreclosures vs. the relatively tiny number of foreclosures in most EU countries? How does the U.S. debt situation compare to that of the mature EU countries whose austerity measures do not also include cutting back on continued strong investments in education, R&D, innovation, infrastructure? The EU social-economic picture is not as black as reputable economists are painting with exception of the problem countries.
We need new policies to correct the structural, destabilizing imbalances in the GDP growth components at work in our economic model. We need to listen much more closely to Reinhart and Rogoff’s warning that, “The sharp run-up in public debt will likely be one of the most enduring legacies of the 2007-2009 financial crises in U.S. and elsewhere. High debt levels of 80-90% of GDP and above are associated with notable lower growth outcomes. Seldom do countries grow themselves out of deep debt burdens.”
In short, our excessive reliance on a mounting pyramid of public and private debt to achieve GDP growth is a formula for repeat financial crises, carrying the middle-class further down the bare survival-wage, poverty line.
