This is a guest post by “Shunyata.” Shunyata has training in financial engineering, actuarial science, statistics, and mechanical engineering. While he does not work directly with structural economic theory, his background in financial engineering gives him insights. The observations below represent Shunyata’s personal opinions based on his study of economics and monetary policy to protect his personal interests. This post is not intended to represent investment advice.
Since 1952, US Nominal GDP has grown by about 6% per year. Why did this growth occur?
A. Did the economy discover new efficiencies and/or develop new natural resources?
B. Did Government monetary policy artificially inflate GDP?
C. Did Society borrow against tomorrow to purchase luxuries today? (…meaning that Society borrowed against tomorrow’s GDP to inflate today’s growth.)
Certainly reality is a mixture of all three mechanisms, but is one dominant? We would hope for (A). We can live with (B). But (C) would be troubling.
We can evaluate the impact of monetary policy by examining Real GDP trends. Figure 1 shows Gross GDP divided by CPI to bring everything to 2011 levels.
Figure 1
NOTE: Throughout most of this analysis, only data up to the 2008 crisis is presented. The reason for this is that since 2008 non-debt policy tools such as government guarantees, government equity positions in private companies, and Quantitative Easing are used in large scale – a very different paradigm than previous years. So data up to the 2008 crisis is used to build insight about the mechanisms affecting economic growth and evaluate our current economic policies.
In Figure 1 we can see that Real GDP has been growing at about 2.8% per year. Although about half of GDP growth has been nothing more than inflation, there clearly has been genuine growth in the productive economy.
But not all is rosy. Looking at this sequence on a log-plot, however, we can see that this rate has SLOWED over time from about 3.5% down to 2.5%:
Figure 2.
Clearly, something fundamentally changed in the economy beginning around 1980. There are three obvious candidates for this change.
- During the ‘70s and early ‘80s, inflation was quite high which dampens Real GDP.
- Since the mid ‘80s, annual debt growth has been at about half the rate incurred during ‘70s, which dampens real economic expansion.
- Energy and raw material availability/price has increasingly become a constraint on real growth.
We can further evaluate the impact of borrowing on GDP by examining the relationship between Debt and GDP. Here is the one-year change Nominal GDP compared to the one-year change in US Total Debt. These points represent overlapping quarterly intervals since 1952.
Figure 3
Here we see a very strong linkage between Debt and GDP. A few features are very important:
- Debt growth around 5% has no impact on GDP. This result suggests that GDP income alone is insufficient to service our societal obligations. This result suggests that we have to borrow 5% per year just to maintain our current lifestyle. This result should be troubling.
- Debt growth above 10% has no incremental benefit to GDP (possibly even a negative benefit). This result should raise serious questions about current fiscal policy.
- 5%-10% borrowing only creates 4%-8% GDP in the short-term. The longer-term benefit may be more significant.
Debt isn’t necessarily a bad thing – if it is “investment” in permanent productive capacity that will permanently raise GDP. Think about using debt to build a steel mill that supplies high quality material to the economy for decades to come. But if debt is used to purchase “ephemeral” goods like vacations or lawn service there is no return on the debt and you have created a future drag on the economy.
In a non-equilibrium economy is it not easily answerable whether an economy’s borrowing is “investment” or “ephemeral” in net. When money is borrowed today to make capital investments in the economy, the returns are realized over time. In a rapidly expanding economy, GDP growth will lag debt growth but eventually GDP will catch up and grow to a permanently higher level.
If debt is not used for “investment” or if growth occurs too quickly, however, debt can accrue to unsustainable levels resulting in default and lower economic activity. Since 1952, Total Public, Corporate and Private Debt has grown by about 8% per year while Nominal GDP has grown at about 6% per year. We can see this disparity in the Debt-to-GDP Ratio.
Figure 4. (Note from Gail--this is the sum of "Governmental Debt" (Figure 3) and "Non-Governmental Debt" (Figure 1), in my 65-year Debt Bubble post. http://ourfiniteworld.com/2011/10/10/the-united-states-65-year-debt-bubble/ )
Even if all of this borrowing is “investment”, it is clearly occurring at a rate faster than we are accruing the benefits of that investment. At some point, the debt service will exceed our short-term ability to pay it, even if all of the investments we made were sound in the long-run. Evidence all around us suggests that we have reached that point. Individuals are defaulting on personal debt. States and municipalities are defaulting on public debt. Nations are defaulting on sovereign debt. Financial Institutions have only escaped default by borrowing from tax-payers. Corporations have escaped default by cutting expenses and relaxing accounting standards – neither of which is a permanent solution.
From this viewpoint, our economic situation cannot possibly be corrected with MORE borrowing. Fortunately, we are not borrowing more.
Figure 5
Despite record expansion of Government debt, total debt in the economy has not increased since 2008! But unfortunately, until we pay down the debt burden (or default) that got us in this trouble we have not escaped or corrected the problem. What we have done, however, is:
- Relaxed accounting rules to allow corporations to inflate the reported value of assets and reduce the reported value of liabilities. This tactic obscures the true financial health of corporations, focuses attention on current earnings rather than long-term viability, and preserves poorly managed companies in expectation of a better tomorrow.
- We have shifted who is responsible for paying debts from financial institutions to private individuals. As large corporations, insurance companies, investment banks and savings institutions have found themselves unable to fully back their obligations, the Government has provided bailout funds, taken equity positions and issued guarantees – ultimately making the taxpayer responsible for these obligations. But this solution is no more sustainable than the original problem, either financially or socially.
What comes next will eventually be a debt contraction. Since we are fundamentally unable to even pay interest on the current debt, let alone pay it down, the contraction will eventually come through default. When this default happens, large swaths of “assets” will suddenly be worthless. This default will directly impact financial assets like pension plans, insurance contracts, and investment accounts. And this reduction in wealth will spill over into reduced demand for goods and services (including labor) throughout the entire economy. Prices for all goods and services will fall or cease to be available – this is deflation.
Central Banks are trying to avert this outcome by engaging in Quantitative Easing to indirectly pump money into the economy, avoid direct defaults, and stabilize the value of financial assets. Here is the one-year change in S&P500 Log Returns compared to the one-year change in US Total Debt. These points represent overlapping quarterly intervals since 2000.
Figure 6
Here we see what mechanism the Central Banks are trying to leverage – pumping money into the markets very effectively drives equity returns (either through inflation or by increasing GDP).
More recently, this has been accomplished through Quantitative Easing rather than direct debt issuance. Some reasons for this approach are that it is quicker to flow into the economy and allows economic planners finer control over the outcome. But another consideration is likely recognition that the economy cannot easily absorb greater debt levels.
One consequence of Quantitative Easing is devaluation of debt, both for the note holder and the debtor, by fueling inflation in the broad economy, especially in liquid financial instruments. (And the parallel consequence of deflation is inflated valuation of debt, both for the note holder and the debtor, an outcome economic planners are deliberately trying to avoid.) This Quantitative Easing / inflation approach can help if the Average Citizen holds financial assets and can reap the benefits of this “liquidity infusion”. But the wealth concentration in the developed world precludes this escape. The Average Citizen does not have a pension, does not have meaningful savings. Central Bank actions benefit those few who need it least and extract a terrible unemployment and inflated cost-of-living penalty on the rest. And this reduction in wealth will spill over into reduced demand for goods and services (including labor)throughout the entire economy, reduced tax base, and debt service default. Again,prices for all goods and services will fall or cease to be available – this too is deflation.
So how do we summarize our current economic health?
- Almost half of our “growth” has been monetary inflation.
- Our real growth has been heavily funded by debt accumulated at an unsustainable rate.
- Our debt is at a level that is not serviceable. Inflation and resource availability (especially energy) further reduce the serviceable level of debt.
- Our debt level has not been materially reduced since the crisis began.
- Our policy response has been to fuel inflation. This course will ultimately adversely impact resource affordability and further reduce the serviceable level of debt.
- Debt level and economic activity will ultimately be reduced.
Both financial and physical factors suggest that we cannot enjoy a resumption of Business As Usual. Credit availability must contract to sustainable levels and natural resource availability is unlikely to materially expand. Together these factors have a profound impact on societal features we have taken for granted. Imagine a return to cash-based transactions rather than credit. In a zero-growth economy, what happens to investment portfolios, pensions, social insurance, and public works? Without readily available credit or energy, business models such as “mobile warehousing”, disposable goods, and e- tailing may no longer be viable. Managing these transitions requires prudent rethinking of our expectations, physical lifestyles, and financial positioning.
See you on ASPO TV I expect.
IMO you underestimate how much double speak and general skulduggery is going on around you.;¬)
The powers that be (TPTB) are running psychological operations against us, some of your conference attendees are obviously playing their part.
This latest ‘efficiency’ eureka moment is TPTB new meme in the ongoing quest to dominate and so set the agenda.
What ever happens TPTB want to be wearing the white suit and smoking the cigar metaphorically.
The government is certainly doing its part to cover up our problems, and to see that articles are published showing how “wonderful” things are–more efficiency, more places to drill, natural gas forever, etc..
La Curee, I think you have made a great point, the psychological manipulation is massive, and the amount of dollars that are invested in that research just on the commercial side are amazing. I withheld much television from my children, and had them read books, and engage in conversation instead. The difference in both socialization and critical thinking skills is pretty dramatic. I come from a very conservative political and theological community but I would send my son to American University in the Summer, my community was extremely puzzled. I had no qualms about the incredibly rich liberal exposure that he got, and the conversations that it engendered – because he had the critical thinking skills to decide on his own.
I’m not sure how many people are really awake out there.
To be immune to the pyschological manipulation is a real advantage now.
Hi Gail
Daniel Yergin from ~11:00 – 15:40:
http://www.youtube.com/watch?v=5cqijm_RRvw
~ “tech. will save us – esp. shale oil and gas.”
“efficiency is another great source” and other gems, LMAO.
Regards
La Curée
Thanks! I am at a conference (where I am speaking) with incredibly bad internet service, so will have to wait until later to watch this.
I keep explaining that these things take time, when they do work. They don’t always work.
Footnotes:
In Keen’s blog he has a list of Essential Posts on the left. Reading these will give you a good summary of his position as a heterdox economist.
Australia’s Steve Keen does lot of work on the burgeoning debt crisis which started after WW2.
http://www.debtdeflation.com/blogs/
Keen was one of only about 13 economists worldwide who are known to have predicted the big recession of 2008. In Australia we call it the GFC (Global Financial Crisis). Keen was predicting this disaster from before 2000. Most boosters of the Great Moderation never saw it coming.
Keen’s work explains why he was able to make the prediction. Gail and Sunyata are on the same track by looking at unsustainable debt. Keen’s critique of current othodox economics is devastating and he has empirical method and empirical evidence on his side.
Tom:
My own observation is that the participants in this irrationality were largely aware of the irrationality. Lenders KNEW debt could not be repaid. Borrowers KNEW they did not have the ability to repay large principal amounts. But there were large short term gains to be made participating in collective ignorance, and few obvious gains from prudence.
My grandfather said it is generally hard to tell the difference between crookery and incompetence. No underhanded cadre was needed to create our current mess. Thoughtful regulation can limit the effects of ignorance. Thoughtful prosecution can limit the gains of crookery.
Understanding our Economic Trajectory (Tragedy) – 1952 to Today
True Greek tragedy is a consequence of hubris.
Back in the 1960’s and 1970’s there was a teaching called Public Budgeting and Management. This was before the advent of VisiCalc, Lotus 123 and Excel, that could make achieving the goal of tracking expenses against budgets, keeping debt repayment costs known and visible. This was to meet fudiciary responsibilities. I learned it in my Master of Urban Affairs program at Virginia Tech in 1972 and used it early on in my career.
In 1975, I did consider an MBA. In the VA Tech accounting course for those with non-financial degrees, we were given an accounting problem where, based on the data, the company expenses exceeded income projections.
The prof asked what was to be done? There were about 75 in the class, all working I suppose, but no one offered an answer.
From my local government experience I said, “Cut the budget to match income.”
Wrong — by a mile. “No,” the Prof said, “You borrow the money.”
So – that was the business/government difference. Business borrows for operating costs on the assumption that the value added will result in income that repays the debt, covers costs and generates profit.
Governments do borrow for long term capital expenditures which are to raise the collective community value, resulting in higher property values, resident incomes and sales which generate the revenue to pay the bonds back.
Public budgeting and management was a feature of Jimmy Carter’s Governorship in Georgia. As a practice, it didn’t last long.
Debt became the solution, since taxes could not be raised when needed. Could this be seen way back in the 1980’s? Certianly.
In a 1986 article for the World Future Society I wrote:
“Revenue sharing may soon become deficit sharing, as the crisis of the U.S. Federal debt causes the national government to retrench from its fiscal assistance to state and local governments. With programs being eliminated or severely cut back, state and local governments are getting financial and program responsibility for their own self-help for urban, suburban and rural development. This decentralization is occurring at a time when the shift to a global economy is causing havoc in many industries and likewise in the tax base of local government. As they seek to broaden the tax base to help take up the federal fiscal slack, they find themselves in competition with other regions of the country or their own state, for existing as well as new development. Since no industry is safe from downturns, greater diversity is being sought in the local economic base. Economic development is the goal of the day for most state and local governments.”
The issues with Social Security funding and infrastructure maintenance were all common topics in the day.
Since 2008 I’ve been trying to understand what happened. In the prior 35 years, I had continuous access to the economic data for the local and greater regions. It was clear that in spite of growth of nominal income, most households were loosing ground in terms of housing affordability. Like most, now that I understand the role of credit, I judge it as failed economic policy, but the real question is: Why was the build up of debt and the risk that that created not recognized?
At the 2010 American Association of Geographers Annual Meeting, in the Regional Studies Association sponsored Plenary Session by Paul Krugman I asked Mr. Krugman whether or not any of the economists had Excel spreadsheets to add up debt and keep track of its impact? He didn’t have an answer.
The hubris of the economists, the financiers, the bankers, the quants along with the fraud of asymmetic information – lies – created the statistical history which you’ve illuminated.
Debt really doesn’t make you rich long term unless managed carefully.
When home equity lines of credit first became available in the 1980’s, Consumer Reports warned that the funds should be used for home improvements that added value, not vacations. Debt really isn’t that hard to understand, so the level of debt must be managed consciously. There is a need for the Nanny state to manage the issue for those who can’t do it on their own – laws against predatory lending – because the savers ultimately pay.
I think you are unwilling to assign blame. Robert Prechter says that in the run-up, the socio-economics of the situation will always generate the “this time is different” delusion that enables people to ignore the past.
We may need Glass-Stegal x 10 to put a stake in the irrational debt monster. Don’t hold back in assigning responsibility for the “failure of intelligence” in creating this tragedy.
I certainly agree with you that Glass Stegal has to be implemented, getting that in place way back when was a huge political effort, maybe the OWS will effect that outcome. I’ve been somewhat involved in my local township of 42,000 people and have seen much of what you talk about. If you follow the news you’ll see my neighboring democracy, the city of Harrisburg (pop 45,000) has been having fun. I resigned over 10 years ago from one of its boards after 9 months and then did my best to talk to the people above them in the State about the chicanery that was going on there. This may not be your local situation, but i suspect from my readings this is more than the city of Harrisburg. One of the responses that I would universally receive was “this is democracy, we elect people, deal with it”. I wonder if they said that when Hitler was elected vice chancellor.
David,
I’ve been working on something sort of similar to what you’re talking about (and what Gail mentioned above). Just for fun I’ve been playing with numbers for net GDP and peak US oil. Based on the data I’ve graphed, the trend lines for US oil production and net GDP (gdp-total debt) show a pretty close correlation (.74 using Excel). Debt starts running up around the early 70s, but it doesn’t go parabolic until the mid 80s. Looking at the BPD numbers it shows a brief spike (I’m guessing from peak North slope), then quickly continues its decline; it’s at this point that net GDP really falls off the ledge. I need to look a little more in the data I have and work on the analysis portion, but so far I’d say peak US oil has a lot to do with the financialization of the US economy over the last 30 years. Anyway, I’m sure someone else has probably already done this analysis, but it’s fun to play pretend analyst sometime.
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Gail
Insightful
Recommend comparing the change in GDP growth shown in Figure 2 with the foundational change from increasing oil production, which peaked in 1970, to declining oil production in the USA.
Certainly, when you owe money, tax cuts are an indirect form of debt expansion and have exacerbated the problems we face today. But I think the political parties are not solely to blame. American households have saved virtually nothing while purchasing electronic gadgets with abandon. We are living in a time of unsustainable societal expectations, at all levels.
Shun
Can I refer you to a lecture given by Elizabeth Warren back in 2007? You are right about the change away from saving among American middle from 1970s, but less so on purchases. Lecture still available on Utube just now I find http://www.youtube.com/watch?v=akVL7QY0S8A
I’ll check it out.
The way I see it. The Bush tax cuts of 2001 & 2003 where the beginning of the end.
For most of us, it helped us buy more things (computers, cell phones, big screen tv’s, BMW’s) that our lack of wage growth did not supply in an economy of more products. For the wealthy, instead of paying taxes they loaned the money to the government. The government becomes in slaved to the wealthy or today known as the 1%.
Money is power and the control of government controls of that power. It’s what the policial fight in Washington is all about. Notice when the Republicans are in power ( Reagan, Bush & Bush), debt doesn’t matter (Cheney). But when the Democrats are in power ( Clinton & Obama ), the Republican only focus is on debt (this summers debt crisis, pay as you go during the 90’s and Fox news 24/7). It’s how one trys to hold on to power when out of power.
This financial war between workers (99%) and owner (1%) has been around forever. Add to it resource constant, heavy debt and disinformation (MSN) and you have 2011.
We are at the beginning of a new standard of living, way of life and view of the future for most of us here in America(or returning to an old one). The sooner one changes and understands this, the better off one will be.
Good luck, because that’s the only thing most of us have.
Looks like something really fundamental happened in 1980 (cough, Ronald Reagan)…
My original draft made a similar (cough, identical, cough) observation. It think it is important, though, to remember that this behavior has been a pattern and isn’t really associated with a particular political party.
Shunyata, I’m going to have to disagree with you a little here. Back in 1980 there was clearly a different approch to the countries ecomonics and energy problems. On one hand, we had supply side economics and on the other we had conservation. Do you remember Jimmy Carter wearing “the sweater”, turning down the thermostat to 68 degrees and solar panel on the roof of the White House ? Well, I know you what “supply side” looks like.
Today we still have one side kicking the can down the road (Drill Baby Drill) and now the other side affaid to lose by making the hard choices. We are just going to have the hard choices forced on ourselfs. I do find it easy to agree with you about Americans having “unsustainable societal expectations”.
Here at “Our Finite World” I’m guessing most would have to believe that “supply side economics” is doomed to fail in the long run. But, it does feel good for a short period of time as does cocain and meth. Again today, we face the same problems we faced back in 1980 but just larger.
There are two thing in history that seem to always hold true. The bigger they are, the harder they fall and none of us are getting out of this mess alive.
It’s been a good 30 years for me. Excellent guess post
I think part of the change was moving manufacturing offshore, as our own oil supply depleted, and substituting growth in financial institutions and health care for growth in manufactured goods. In the late 70s, we went from big cars, to little cars as well. With all these changes, the growth we got was a quite different kind of growth.
Presume the numbers relate to USA (with parallels elsewhere)?
I like this quotable sentence:
“Without readily available credit or energy, business models such as “mobile warehousing”, disposable goods, and e- tailing may no longer be viable”.
What might be the position for the complementary other sides to these models: flexible labor and associated worker productivity; two-earners two-cars per house; flexible shopping at the retail ‘depots’ alongside ‘centers of excellence’ health facilities? I know one new hospital in the UK that is really an out-of-town shopping center with the hospital attached. I have wondered whether suburbs until recently were part of the necessary infrastructure for the business efficiency models, using cheap motoring among other labor-saving tools?
Dmitri Orlov has noted that “efficiency” is your enemy in a downturn. In a crisis you want robust, monolithic systems that are hard to collapse. It seems that our complex world is likely to simplify considerably.
In Panarchy theory, we appear to be entering the “Omega Phase” of the panarchy loop.
Our current state is characterized by high energy availability combined with high connectivity. This cannot be sustained, and inevitably results in a crash to a much lower energy level, followed by a rapid reduction in connectivity.
Thanks for the reference to Orlov regarding efficiency. When I first started studying Permaculture, I was amazed at how little regard Permaculture had for efficiency. But highly efficient systems are brittle, rather than resilient, sitting atop the “K Phase” of a panarchy loop.
There’s a reason why some 4.5 billion years of evolution has not been successful at turning sunlight into chemical energy at an efficiency of better than 4% to 6% or so. What makes us clever monkeys think we can do better than 4.5 billion years of evolution, and sustain it for the long term? I predict that technical attempts to do better than photosynthesis won’t last the rest of a baby-boomer’s lifetime. We might have 20% solar cells today, but will we still be able to make and maintain them while in the low-energy, low-connectivity Omega Phase?
I am not familiar with Panarchy Theory, but the thought that 4%-5% energy conversion is all the more that is RELIABLY possible is intriguing!
I am not familiar with panarchy theory as well, but I am a bit with permaculture. Highly efficient systems designed by man can in fact be brittle, there are many examples. But depending on what layer you are looking at, there are some disciplines in systems design which are not brittle because that was a consideration in the design. Most memory systems (DRAM, Flash, whatever) tend to be very efficient with significant redundancy in them. The Internet protocols themselves (specifically IP, TCP) are efficient and not brittle. Some of the modern county or municipal storm sewer systems seem to me as an engineer very efficient and resilient (tideflex’s non mechanical check valves seem pretty impressive).
On the negative side the grocery store fresh vegetable production systems seems enormously brittle, last year they killed 25% of all commercial “starts” of tomatos in the US through one bio-terrorism event.
i dunno if im ready to tackle panarchy theory at this late hour, but will soonishly. A very thought provoking point about efficiency, jan. One very, very clever monkey might have a chance. Why? The ladder, the catapult. (but presumably not the e-cat) Evolution tends to move via migration, whereas we can be more targeted.
E-tailing certainly relies on an infrastructure that costs energy and dollars to run, from the Internet switches to the UPS/FEDEX trucks, but there is probably a reason why classical retailing is contracting and most forms of e-tailing are still expanding in the current environment and in the US – they have that set of features: max-selection, “instant”-gratiication, and cost effectiveness that is increasingly impossible for the classical retailers to meet. One could construct a future world, where my food and energy is local (and limited) but where my education, and key acquisitions (that mitre saw for my business) are still e-tailed (even if the saw is used). I am rather skeptical in the long term for Internet video and such, but electronic mail, and other things operated over very thin connections once upon a time (1200bps). Ebay was running in data centers that were 3 generations ago in technology/power/bandwidth/size would be another example to consider.