Thursday, July 25, 2013

Why We Can't Borrow and Spend Our Way to Prosperity

The following charts go a long way to explain why the US can no longer create prosperity by deficit spending and pushing more debt into the economy/population.  The charts show the diminishing returns to national income (GDP) for each additional dollar of debt creation.  They are extrapolated to show that the year 2015 is the year where an increase in debt gives no increase in GDP.

The charts help explain what we've all witnessed in recent years; that after trillions of deficit spending and money printing, that the economy has been extremely lackluster.  It may be because of the diminishing returns of debt.

If so, it's also a dagger in the hearts of the Keynesians who live, breath and die espousing their belief that MORE and MORE deficit spending is the right prescription. The charts show that their 'prescription' is still true,  but it would now involve HUGE amounts of additional debt for very paltry return.  Remember the 2009 stimulus that created (or saved) 1.5 million jobs at a cost of over $500,000 per job ($790 billion divided by 1.5 million)?  It's the same phenomenon.  If the charts are true, then at some point debt accumulation might even be detrimental to GDP growth. 


Here's another chart that doesn't show the 2009 meltdown but also shows the approximate endgame of debt accumulation also occurring on or about 2015.


I've read from Ambrose Evans-Pritchard that China is also well down the paths shown above.  Their return on debt accumulation is reported to be about $0.20 dollars change of GDP versus $1.00 of debt accumulation, or where the US was in 2002 (approximately).

The next chart shows a nearly exponential trend in total debt while GDP plods along at low single digit increases.  How in the world can we expect this to continue?  If interest rates are ever allowed to rise, how can this be sustainable?  It's not!


Total Debt Versus GDP Showing Exponential Debt Creation    (from http://www.economicnoise.com/2013/07/26/extreme-fear-is-a-reasonable-reaction/ )











The charts raise some interesting questions:
  1. If increasing debt has little effect on GDP growth, does it follow that a reduction in debt accumulation (more balanced budgets) also would have limited effect on GDP?
  2. Will the chart go negative where debt actually hurts growth after 2015?
  3. Can this really be true when the definition of GDP is GDP=Consumption+Government+Business Investment+Net Exports?  After all, government spending is supposed to be exactly equal to a dollar for dollar increase in GDP.  Let me think about that one.

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