Tuesday, March 6, 2012

Second look at the Stockman quote


David Stockman:

Typically the private and public sectors would borrow $1.50 or $1.60 each year for every $1 of GDP growth. That was the golden constant. It had been at that ratio for 100 years save for some minor squiggles during the bottom of the Depression. By the time we got to the mid-'90s, we were borrowing $3 for every $1 of GDP growth. And by the time we got to the peak in 2006 or 2007, we were actually taking on $6 of new debt to grind out $1 of new GDP.

Somebody the other day pointed out that the relative stability of debt/GDP ratio, expressed here as "$1.50 or $1.60 each year", that the stability arose from the combination of a rising private sector debt ratio and a declining government debt ratio. (Sorry, I have no idea where I read that.)

It's true. From 1960 to 1975 give or take, the declining red line of Federal debt balanced the rising blue line of non-Federal debt, so that total debt (the green line) was really quite flat for those 15 years or so:

Graph #1
RED: Federal debt, declining until the mid-1970s.
BLUE: Non-Federal debt, rising 1960-1980 and generally.
GREEN: Total debt, apparently stable from 1960 to the mid-1970s.


In closeup:

Graph #2: Same as Graph #1, but ends with 1985
Yeh, the green line is sort of stable between the 1960 recession and the 1970 recession, after which a slow increase is visible. Lots of people consider 1970-1980 stable. I consider it the start of an uptrend. I see David Stockman's $1.50 in the 1960s, rising through the 1970s to $1.60, on its way to still higher numbers.

"Relative" stability. True enough. It's important, too: If the Federal debt could have kept declining at a fast enough rate, the increase in non-Federal debt would not have resulted in the growth of total debt.

Unfortunately, as the Federal debt ratio approached zero, it became impossible to maintain a rapid rate of decline. Here, leave GDP out of it, and look at Federal and other debt as shares of total debt:

Graph #3: Federal (blue) and Non-Federal debt as shares of total debt (thru 1985)

They start out just about equal in the early 1950s. But by 1974 Federal debt (the blue line) falls to about 15% of the total. And non-Federal debt (the red line) rises along a mirror-image path to about 85% by 1974.

Look at the path of the red line: It is not a straight line. It slopes up more at the beginning, and less at the end. It's a curve that shows a very gradual slowing of private debt increase. Similarly, the Federal debt shows a gradual slowing of decline.

These curves are typical mathematical patterns that you often see when something is approaching a limit. Private debt cannot possibly increase beyond 100% of total debt. Not can Federal debt decrease beyond zero. The slowing of these curves is a natural and unavoidable phenomenon.

Where was I going with this? Oh, yeah. After Stockman's "$1.50 or $1.60" observation, he says: That was the golden constant. It had been at that ratio for 100 years save for some minor squiggles during the bottom of the Depression.

I don't think so. I think "some minor squiggles" was the last time we had the sort of economic problem we have today, the monetary imbalance, the excessive debt. And I think it is no coincidence that those minor squiggles happened at the time of the Great Depression. Those squiggles are related to economic depressions.

Here. Here's Stockman's minor squiggles as seen by Global Finance:

Graph #4: Three Peaks in Total Debt relative to GDP, 1870-2008
There -- that towering peak in the middle, starting right around 1930, that's Stockman's "minor squiggles". What the hell was he thinking?

See the low point then, near 1950? Below 150% of GDP. Then in the 1960s it rises to 150% -- Stockman's $1.50 -- stays there only briefly, then begins to climb by 1970.

If you look at just that part of it, there where debt is at or below the 150% line, that was our "golden age". Those were the good years. A long time ago.

To the left of the Great Depression peak, just before 1930, there is something more like "minor squiggles" there, in the so-called Roaring 20's. Those squiggles were a warning sign that was ignored. And the decade before that? 1910-1920? Similar squiggles, not so big as in the 1920s but bigger than those before 1910. Ignored.

Oh. And that lump way over there on the left, between 1870 and 1880? That lump, that's the start of the Long Depression. Wikipedia says of it:

At the time, the episode was labeled the Great Depression, and held that title until the Great Depression of the 1930s. Though a period of general deflation and low growth began in 1873, (ending about 1896), it did not have the severe "economic retrogression [and] spectacular breakdown" of the latter Great Depression.

It did not have the severe economic retrogression and spectacular breakdown of the latter Great Depression. I should say not. And you can see why in the Global Finance graph there.There is no sharp peak in the 1870s, as there is in the 1930s. The sharp peak is a "spectacular breakdown" that occurs when the collapse of GDP sends the debt/GDP ratio through the roof. Didn't happen in the 1870s.

As a result, the depression of the 1870s lasted a long time as monetary balances were only gradually restored, balances between circulating money (not shown) and debt. I'm talking out my ass here, as I have no data on circulating money in the 1870s. But based on what I've analyzed in the years following the first World War, I describe what must have happened with the 1870s depression. If you have the data and you prove me right, then consider these remarks a prediction, and your confirmation of these remarks a confirmation of my economic theory. If you prove me wrong, so be it.

The long depression lasted so long because there was no severe and sudden breakdown that purged the system of debt and freed the economy to grow again. Absent the severe breakdown, it took many years to resolve the imbalance created by excessive debt. We see exact the same situation persisting in Japan today, after twenty-some years of "the lost decade."

Exactly as we will have for ourselves if we manage to avoid a GDP collapse while failing to resolve the debt problem. We're half a decade in, already.

The solution, of course, is to wipe out private debt while avoiding that spectacular breakdown. Easier said than done? Dunno, I'm not there yet. I'm still trying to get people to accept my analysis of the problem.

No comments: