The Theory of Economic Performance

There is no such thing as “the central challenge to growth”. Proof is impossible to come by with respect to all macroeconomic controversies.

- Steve Waldman

Back in the late 1970s when I started making graphs of the economy, one that amazed me was the debt-per-dollar graph -- dollars of total (public and private) debt per dollar of money in circulation:

Graph #1: Total (Public and Private) Debt per Circulating Dollar

It covers a period of more than half a century, but shows just three major trends. Three trends with turning points at historic dates. Remarkably, the turning points coincide with the start and end of the FDR Presidency.

Before FDR, the debt-per-dollar (DPD) ratio increased until the bottom of the Great Depression. During FDR, the DPD ratio fell in a "great reset". After FDR, the ratio started climbing again and for a time the economy was especially good.

Based on the Bicentennial Edition of the Historical Statistics, the old graph ran from 1916 to 1970. It ended with debt already higher, in 1970, than it was at the worst of the Great Depression.

As years went by, I added to the graph from new releases of the Statistical Abstract. The ratio continued to climb.

The more I looked at those three trends, the more certain I was that the debt-per-dollar ratio was central to both the Great Depression and the golden-age vigor.

Hypothesis: The debt-per-dollar ratio is the key to economic performance.


In more recent years I've turned to FRED at the St. Louis Fed for my debt graphs. The next graph shows total debt relative to two different measures of circulating money:

Graph #2: Total Debt per Circulating Dollar (two measures)

On this graph debt rises to a 2008 peak. The red peak shows $25 debt for every dollar of M1 money. The blue peak shows almost $40.

Our economy has been having trouble since the peak. But if you chase it down, economic performance deteriorated for 30 years before the peak while debt-per-dollar increased. And, for a decade or more before that, the cost associated with credit use was the prime mover responsible for the Great Inflation. Meanwhile, the glut of credit-based dollars forced the US off gold and drove up the price of oil.

The peak shown on the second graph, and the trouble leading to the peak, is confirming evidence for the hypothesis arising from the first graph: The debt-per-dollar ratio is the key to economic performance.


By 1970 one could have predicted that the debt-per-dollar ratio would rise until either (a) policy intervened or (b) catastrophe intervened. We waited, and in 2008 catastrophe intervened. Now in another great reset, we wait while the DPD ratio falls. We wait for it to fall low enough that the economy is willing to grow again. We wait, hoping the ratio falls enough that when it turns and starts to rise again, the economic vigor that accompanies the increase will not soon dissipate.

Low-and-increasing debt breeds economic vigor. A high level of debt creates a time of troubles. The problem is that while you wait, low-and-increasing debt becomes high debt. We don't do anything different. We continue to use credit, and we go about our daily lives. While we wait, the benefit from credit use deteriorates; economic performance deteriorates.

The effect of credit use follows a Laffer curve. For taxes, the Laffer curve shows that as the tax rate rises, tax revenues first rise, then stabilize, then fall. For debt, the Laffer curve shows that as the level of debt rises, new uses of credit first create a vigorous economy, then a stagnant economy, then a declining economy.


There is more. There is a wiggle in the DPD ratio around 1990, just before the red and blue lines split apart. That wiggle was another peak -- a relatively painless peak, but a peak nonetheless, with the same properties as the peak that caused the Great Depression and the peak that caused the Great Recession.

The 1990 wiggle is a second confirmation of my hypothesis.

On Graph #2, debt-per-dollar rises consistently until the 1990 recession, then falls for three years. If the theory is correct, we should find that a time of improved economic performance follows the decline in the ratio.

Think of potential GDP as a "best case" estimate of our economy's performance. Then look at the "percent change from year ago" picture of that best-case estimate:

Graph #3: Percent Change from Year Ago in Best Case Economic Performance

The whole of Potential GDP shows a downhill trend, except briefly, for about a decade, just after the early-1990s decline in the debt-per-dollar ratio.

The economy's performance as measured by "capacity utilization" also shows improvement following the early-1990s decline:

Graph #4: Total Capacity Utilization

Again, the overall trend visible on this graph is a downhill trend. Again, the single exception is the period of above-trend performance that followed soon after the early 1990s decline in the debt-per-dollar ratio. But not only does the peak of the 1990s rise above trend; it is also a double-peak. It was an extended period of above-trend performance.

Both Potential GDP and Capacity Utilization show significantly improved economic performance as debt-per-dollar increased in the aftermath of the early-1990s decline.

The 2008 peak confirms the theory of economic performance. The 1990 peak is a second confirmation.

That early-1990s decline was created by policy intervention. The growth rate of total debt fell, beginning in the mid-1980s. The growth rate of circulating money increased, beginning in the early 1990s. These growth rate changes, in combination, reduced the debt-per-dollar ratio. A significant improvement in economic performance followed hot on the heels of the Debt-per-Dollar decline.

You can buy the assumptions, methodologies, and mechanisms implicit in those parsings or not, it’s your choice. But you won’t find a clear, incontrovertible relationship between any simple thing and developed world, per-capita growth. It’s too complicated a phenomenon. You have to buy someone’s stories, and interpret the numbers through those stories, to claim the evidence is strong.

- Steve Waldman

Related post: Everything You Need to Know About Economic Performance