Sunday, January 28, 2018

Seeing past the aberrations in Debt-to-GDP

Total debt, relative to GDP:

Graph #1: Total Debt relative to GDP
I've seen a lot of people point out the low, flat area between 1965 and 1984. Debt was low then, they say, and the economy was good.

Maybe. But the low, flat part is low and flat because of the inflation of that era. People seem to think debt stopped growing for a while. In fact, we were adding to debt more rapidly during the flat years than before. From 1952 thru 1964 the average annual debt growth was 6.6%. From 1965 thru 1980, it was 9.9%. Debt growth was 50% more during the flat. It looks flat because inflation made NGDP increase as fast as debt.

It wasn't magic that kept debt low in those years. It was the raging inflation. Inflation changed the path of the debt-to-GDP ratio and created the low spot.

Inflation was an aberration. The low debt ratio was a result of it.

If you look at it the way I do, you can almost see the path that debt-to-GDP would have taken if we never had that crazy inflation. You could draw a straight line connecting 1960 to the late 1980s, bypass the low spot, and see what the path of debt might have looked like without that inflation.

Something like this:

Graph #2: As Above (but Annual Data) with a Trend Line Added
The years from 1987 thru 1997 occur shortly after the Great Inflation. They look on-trend to me. I show them in red. I had Excel create a straight-line trend based on that period.

In the early years, before the Great Inflation, the trend line (black) is a perfect fit for the years from 1956 to 1960. And it's a very good fit from 1952 to 1963. Those early years show the same trend as the years shown in red after the Great Inflation. The blue line, low and flat during the inflation, is an aberration.

I didn't have to try a dozen times to make the graph show what it shows. I looked at the years between the Great Inflation and the Great Recession, and picked dates where the blue line appeared to be on-trend rather than returning to or departing from it. Then I put a linear trend line on those years, and it came out just as you see above.

I did fiddle with it some, after that. I changed the trend line to exponential. Then I added a few years to the end of the red zone and watched the trend line change as I added them. I was exploring. This is what I found:

Graph #3: As Above (Annual Data) with an Exponential Trend
The trend line fits the red zone just about as well as it did before. It fits the years 1952-1963 even better than it did before. And, at the end of the graph, in 2016, the blue line meets the trend line! The two lines appear to show that debt-to-GDP has returned to trend after a decade-long recovery from the tech and housing bubbles.

Perhaps you can imagine the graph ten years out, with the exponential curve continuing and the debt-to-GDP data clinging to it. It could make you think debt finally got back to normal in 2016. And that could make the next ten years very good indeed.

Come to think of it, this is my "vigor" story again, from a different perspective.

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