Wednesday, December 5, 2012

Opportunity Knocks

Two views of Federal Debt relative to GDP:

Graph #1: The Gross Federal Debt, and Federal Debt not held by the Federal Government.
Click graph for FRED source page.
Don't ask me about the gap between the two lines, why it gets narrower or wider or anything like that. At the moment, I'm not thinking about the difference between the two lines. I'm thinking about the similarity. Yes, the one line is a little higher, and goes up and down at a different rate than the other line. That's true. But both lines show the same general shape. Very much the same shape.

Oh by the way, the higher line there, the red-and-green line is made from two different sets of numbers. The one starts in the early 1950s but ends before the year 2000. The other includes more recent values, but only goes back to 1966. To cover the maximum years, I put them both on the graph and, since they fall one atop the other, I call them one line.

So anyhow the early years show the blue and the red-and-green lines both falling until the 1974 recession, then a bit iffy until 1982, then working their way up until maybe 1993. Then they fall until the 2001 recession, are iffy again until the 2008 recession, and then go up again, faster this time. Both lines show the same repeating pattern. So I will refer to them now as "the blue line".

There are two zones where the blue line falls significantly: 1950-1974 and 1993-2001. Those are the only places where the downtrend is more than just a wiggle. We'll come back to this in a moment.

The sharpest uptrend appears at the last part of the blue line, in the years since the 2008 recession. In these recent years we have seen a severe recession (when GDP went down), a sluggish recovery (when GDP increased only slowly), and a large volume of Federal spending (trying to get GDP to grow more rapidly).

These two factors -- a rapid increase in the Federal debt, and little or no increase in GDP -- work together to push the Debt-to-GDP ratio up. That is the first point I want to make: The path the line takes is the result of two different numbers changing, each in its own way.

Down Trends

Table #1: Compound Annual Growth Rates
For the first two decades shown on the graph, economic growth was good. Incomes went up. Unemployment was down. And, Federal debt growth was well-contained. But it is the relation between the debt and the GDP that is key: For those two decades, GDP grew much faster than government debt.

For a few years in the 1990s, economic growth was good. Incomes went up and unemployment went down. And yes, deficits turned into surpluses. But it is the relation between the Federal debt and GDP that is important. Again, for those few years, GDP grew much faster than government debt.

I see a relation between the line falling on the graph, and times that the economy is good. I'm not alone in seeing this; I imagine everyone who calls for a reduction of the Federal debt and deficits sees the same thing. It's tricky, though. It only works when the blue line starts out relatively high.

Look at the first period on the graph, 1950-1974, the Golden Age. The blue line goes down and down and down. Soon it will run out of room to fall. But just before that happens, the economy goes bad: The blue line was too low.

And then we struggled with a so-so economy for 20 years. During that time the Federal debt increased, and the blue line worked its way back up again.

And then for a few years the blue line fell, and the economy was good again.

Okay? So what I'm saying is, if the Federal debt is low it cannot fall. But if the Federal debt is high, and then falls, the economy will be very good for at least a little while.

And the Federal debt is high, now.

Now... There is more to it than that. For one thing, we have not considered the level of private debt at all in this post. For another, the distribution of income created by all that Federal spending is massively important. But the fact that the blue line is now very high creates an opportunity. It should be easy now, to get the economy to grow.

It should be easy.

The great danger is that we will grow, but we will not take advantage of the chance to change a few policies. If we fail to change the policies we will get right back into the same mess again, only worse. But if we do make the necessary changes to our policies, we can stabilize the economy at a high level. We can surf the long wave.

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