A Scenario for Mark

Over at Illusion of Prosperity, Stagflationary Mark looks at Real Total Debt vs Real GDP.

Mark's graph shows the ups and downs of inflation-adjusted GDP growth (in red) and the ups and downs of inflation-adjusted Total Debt growth (in black).

The ups and downs match. It a darn good fit... except for one thing: Mark's graph shows debt growth stable while GDP growth declines. The "good fit" nests tightly at the start, but by the end there are big gaps caused by the decline of GDP growth.

Mark writes:

I'm not sure where I stand on the black [debt growth] trend line. It is unsustainable. Should it actually fall at some point then I would expect the red [GDP growth] trend line to fall even more though. (It is the trend in the black line that is propping up the trend in the red line.)

I do not see a scenario where the red trend line rises over the long-term.

I thought this a clear and accurate statement: "It is the trend in the black line that is propping up the trend in the red line." It is debt growth that is propping up GDP growth.

And I sympathize with Mark's assessment. Given the history the graph shows, it doesn't look like we should expect a long-term improvement in GDP growth. But then, how could we? We use debt growth to "prop up" GDP growth, and we just can't afford to do that anymore.


Troy commented on Mark's post:

But as Commander Mark opined, it's the debt take-on that's giving us much of this GDP in the first place.

I don't really know where we go from here.

I don't understand the mid-90s turnaround so I don't understand the economy all that well -- whatever kicked in in the mid-90s may or may not kick in now.

"It's the debt take-on that's giving us much of this GDP in the first place." Yep. We use debt for growth.


If we use debt for growth, and we're not growing, then why do we have all this debt?

Oh, yes. We're not adding to the debt, now, and we're not growing now. The debt is all left-over from when we were growing, before.

That's right. When we're growing, expanding the economy, we need to expand the money supply also. That's why we use credit for growth. And that's where all the debt came from.

But here's the thing. Say we use credit for growth, and as a result we grow. So then if we were going to stay at that new, larger size, we would need a larger quantity of money. We would need a quantity of money more or less equal to the old quantity of money plus the credit we used to get that growth.

So it would be okay -- not inflationary, I mean -- to monetize that debt. Or, to just print that much money and put it into circulation, as long as the debt from that credit-use was paid back at the same time.

If we did that, we would be as we were before, only with a bigger economy. The GDP would be bigger, and the quantity of money would be bigger in proportion, and the debt we created by using that credit would be gone. So there would be no increase of debt to hold the economy down. And enough money to keep the economy going.

And then we could do it again, and grow more.

But we do not do that. Policy does not do that. Policy does not allow the quantity of money to grow in proportion to GDP:

Graph #1: The quantity of spending-money per dollar of GDP

When policymakers want to fight inflation -- which, until the recent crisis, was always -- they restrict the quantity of money in circulation.

But you know what? Back in the early 1960s, when we had about 24 or 25 cents of spending-money for every dollar's worth of GDP, inflation was only about one percent per year.

Today -- at the very right end of the blue line -- we have about half as much: about 13 cents per dollar's worth of GDP. So, basically, it's twice as hard to get by these days.

And this 13 cents, this is well after all that Quantitative Easing. Before QE, we had only like ten cents of spending-money for every dollar's worth of GDP. Because they thought they were fighting inflation.

But you can tell from a glance at Graph #1 that increases in the quantity of spending-money cannot possibly be the cause of inflation. No. It was all that credit we used, that caused the inflation. All that credit, as measured by Total Debt:

Graph #2: Spending-Money and Credit-Use per dollar of GDP

It was credit-use that caused inflation. Not the quantity of money in circulation. And the reason? Policymakers restricted the quantity of money to fight inflation, but encouraged credit-use to make the economy grow.

Policymakers forgot that the debt created by credit-use should be paid off. And they forgot that the quantity of money in circulation should be allowed to grow along with the economy. I guess, they forgot.

If they had not forgot those things, we would have more money and less debt today. And the economy might not be growing like gangbusters, but at least growth would not be held down by the shortage of money and the burden of debt. At least growth would not be held down by a policy-induced imbalance.

And there would be no problem with unsustainable black trend lines. And it would be possible for the red trend line to rise over the long-term. And we would use money to sustain the existing level of economic activity. And we would use credit for growth. Only for growth.


To tie up a loose end...

Troy said, "I don't understand the mid-90s turnaround..."

The trouble we have today is too much debt. Too much debt, because we used credit faster than we paid it off, so debt accumulated. Too much debt means too much use of credit. The trouble we have today is too much credit in use, and not enough spending-money. The trouble is an imbalance between money and debt.

Graph #3: Debt per Dollar, 1916-2009

We had the same trouble before. In the years leading up to the Great Depression, we accumulated more and more debt, relative to the quantity of spending-money. It caused the Great Depression. And after the DPD ratio fell (1933-1946) the economy started upon its so-called "golden age" growth.

And you know what else? See that wiggle there in the early 1990s? The DPD ratio fell from 1990 to 1993. And immediately after that we had "macroeconomic miracle" growth.

Unfortunately, neither time did we learn that we must restrain the growth of credit-use. So we ended up with another Depression. And what do policymakers want now? They want to get credit-use growing again.

It's the wrong plan. We need to restrict credit-use. We can create tax-incentives for accelerated repayment of debt. We can use accelerated repayment of debt to fight inflation. And we can let the quantity of money grow in proportion to GDP.

That's the long-term plan. But we also have to fix the crisis. The problem is debt. Excessive debt. So, print money and use it to pay off debt. Paying off debt destroys debt. It also destroys the money used to pay the debt. So if we print money and use it to pay off debt, the debt is destroyed, and the money is destroyed, and we do not cause inflation.

That's the plan.