Thursday, September 17, 2009

Diminishing returns for each dollar of new debt

Or 'why the economic stumuli won't go very far'.
"According to Antal Fekete [1] if you take this chart further back, we used to get $3 of GDP for every $1 of debt. Sometime in the late '60s, the line crossed below $1, meaning every new Dollar of debt returned less than that in GDP. Antal thinks we actual went negative in 2006, but regardless of whether his data is the same as this chart, we are approaching that point. This is truly a point of no return. This means every new $1 borrowed reduces GDP."[2]

Hmmm... could consumers be on strike whilst they pay off their debt? Could wealthy investors be purchasing gold and hiding it under their mattresses instead of creating 'real' wealth in the community? Could indebted oil-producing nations be hiking up the price of oil so that they can pay down their sovereign debt? And I wonder how much extra money is now being spent to repair the damage from (what used to be avoidable) climate change. So many questions and so few dollars!

[1] I do not subscribe to all of the view expressed by Antal Fekete. In particular, I am not a fan of 'the gold standard' because the application of it would not guarantee the absence of a debt bubble and the hoarding of 'gold' does make for a prosperous and healthy economy.

[2] Why The Stimulus Won't Work: The Marginal Productivity of Debt


Anonymous said...

Just because GDP is decreasing while government debt is increasing it doesn't mean that the national debt is causing the GDP to shrink.

In fact, government debt is not the cause of this slowdown in the US. The actual cause is most probably the huge but plunging debt in the private sector.

Creating a of huge amount of base money is the only thing that will stop the deflationary spiral ahead. This will take down the value of the dollar, which should have dropped a long time ago.

It's a choice between devaluation, "internal devaluation" (also known as deflation), just like in Latvia. The loss of purchasing power will come anyway. It can not be completely avoided.

Anonymous said...

Actually, the chart doesn't tell us anything at all about the "marginal productivity of debt"

They conflate government debt with total debt in the economy. At the start of 1951 there was $1.11 of nongovernment debt for every dollar of government debt. By mid-2008, there was $8.72 of nongovernment debt for every dollar of government debt. (And this has since plummeted to $6.37)

If you look at NON-government debt, what you show in that chart is pretty much the pattern-- the eight-quarter change GDP divided by the eight-quarter change in non-governmnt debt has fallen from between 0.6 and 0.8 from the mid 60s-70s to below 0.2 the last few years.

But government debt is much much smaller. If you restrict to government debt the picture is very very different-- particularly because government debt is countercyclical. The "marginal product" is often negative because deficits grow in a recession and shrink during a boom. Thus, the "marginal product" of government debt looks very high when the government runs small deficits during boom years and turns negative when government runs any deficit during a downturn.

So what the chart is actually showing is that private sector debt to GDP has grown.

Myrtle Blackwood said...

Thanks for your feedback.

Fekete does tend to give the impression that the debt itself is causing the problem. That's why I posed the questions below the quote.

Printing money seems a logical response to a 'deflationary spiral'. But doesn't the success of this action depend on the use to which these new funds are put and the effectiveness of this investment in terms of (i) the creation of real wealth or (ii)the prevention of the loss of real wealth?

In the latter case, 'debt forgiveness' strikes me as being more effective in the current context of great wealth inequality.

Can the world afford its billionaires?

Anonymous said...

When debts are forgiven the money supply shrinks.
The debtors no longer need to work as hard.
Creditors feel disillusioned and some might opt out of the system in favor of alternative low consumption lifestyles.
Debt free responsible citizens feel envious and perceive a sense of injustice decreasing their probity and virtuousness.

TheTrucker said...

Equity prices are rising and so too the price of gold and oil, The dollar index is falling quite handily. All of this is a sign of monetization. But that _IS_ what is needed. Gasoline prices are going back up and so too the price of everything else. That includes homes.

Deflation is over.. Fasten yer seat belts as we enter the stagflation era. Perhaps this time government will have the good sense to cure the problem with topside taxation as opposed to the stupidity of raising interest rates.

Kaleberg said...

In the 1960s government debt went to spending, often on infrastructure and working class jobs or for the poor or elderly. They spent every penny they got and it went through several layers before it trickled up.

Starting in the 1980s government debt went to pay for tax cuts for the rich. The rich don't spend very much money. They tended to buy symbolic goods like securities or bonds which can be produced with minimal effort or employment.

I'm not surprised in the least, and I can't imagine why anyone else would be. FDR faced this problem in the 1930s, and he went for the big multiplier helping the poor and middle class instead of politically correct tax cuts for the wealthy.

Kaleberg said...

BTW, you can see this in the chart. The step function is highly visible if you ignore the silly trend line which was placed to obscure the obvious.

TheTrucker said...

Yer right, Kaleberg!

That stuff really jumps out at you in the Reagan tax cuts for the rich 80's and then creeps back to the other side of the trend line when a modicum of tax progressivity is reinstated in 1993. But it wasn't really enough.

But what does it mean? In 1999 and 2000 there wasn't any real debt by virtue of government spending. Yet the blue snake keeps going down.

And all the fear and spouting is about debt, debt, debt. What happens to monetize, monetize, monetize?

Myrtle Blackwood said...

It seems helpful to look at the dynamics of the escalation of third world debt to discover what the consequences are of continuing to pile debt up.

"....And this is exactly what the IMF and the World Bank have done, they have been interfering in other people's affairs and making decisions about thing of which they new nothing basically. And they have, in effect, just taken the Soviet kind of system and imposed it on the Third World. ...."

ABC Radio National - Background Briefing: 30 May 1999 - Global Finance: Dismantle or Reform?
Paul Hellyer, Leader of the Canadian Action Party