Key Points: The "Debt Productivity" Problem

From mine of 30 June and 2 July:

Second, it is not the failure of debt to increase that hinders growth. It is the success of debt. The excessive cost of excessive debt is the problem. Salmon himself reports that the ratio of debt to GDP increased from 1.6 to 1 (in 1970) to 2.8 to 1 (in 2000) to 3.7 to 1 (by mid-2008). All of that happened before the crisis. All the while, Real GDP growth was in decline:

Using credit for growth works well when the accumulation of debt is not large. It works less and less well as the accumulation grows. Ultimately, the accumulation of debt grows so large that the economy can no longer function normally. That's when people start noticing there is a problem.

By that point, of course, we're not just using credit for growth. We're using credit for everything.

I love the internet

My morning mosey turned up a guest post by Zero Hedge at SilverIsTheNew. Or maybe it's a guest post by SilverIsTheNew at ZeroHedge. Can't say.

Several very beautiful graphs. Some English that torques me. (He writes: "In the US, literally nobody purchases a car with money form a savings account." I think he means that virtually nobody purchases a car with money from a savings account. Reminds me of Penny's boyfriend Zac (who also didn't know what "literally" means) getting beat on by Sheldon Cooper and the boys, in the episode that drew me in to Big Bang Theory.

Everybody makes mistakes, especially me. But don't people proof-read their stuff?)

Yeah, I love being frustrated by bad English literally virtually almost as much as I love looking at pretty graphs  pretty girls both.

Never mind. Here, deserving a better introduction than I can muster, is the last graph and the accompanying text from the ZeroHedge/SilverIs post:

Has debt-to-GDP, or the debt-bearing capability of the US economy, hit a ceiling?

Look at how little additional GDP (blue area, below) we obtained in comparison to ever increasing amounts of additional debt (red area):

The dotted black line is the marginal utility of debt (right-hand scale). Think of it like this: how much additional GDP do you get out of one dollar of additional debt (in %). In 1992, for example, you get $0.30 in additional GDP for every additional dollar of debt.

Problem: this marginal utility of debt has trended lower and lower over the years, and actually reached zero in 2009.

Meaning: you can add as much debt as you want, and it still won’t give you any additional GDP.

To repeat: no amount of additional debt seems to be able to get economic growth going again.

That is a dramatic revelation. We might have reached the maximum debt-bearing capability of the economy. If true, no growth is possible unless debt-to-GDP levels fell back to sustainable levels (in order to restart the debt cycle). This could take years.

At this point, the only way to reset the debt cycle is to get rid of debt.

 

// Related post: The Elusive Growth. (Move your mouse on-and-off the graph.)

I got this one by accident

After you make a FRED graph, you have to check the formula in the left side border.

I put TCMDO on a new graph and changed the units to "Change, Billions of Dollars". Then I added GDP to the graph to use as a denominator. FRED automatically set the units to the same as I had selected for the previous series. Makes sense FRED might do that, maybe. But it wasn't what I had in mind.

Graph #1: LOG of (Change in Debt per Change in GDP)

To my eye, the trend is flat at 5 from start-of-data to maybe the mid-1970s. Thereafter, it slopes up. Reading from right to left, perhaps the upslope starts earlier.

By accident, this graph turned into another look at "debt productivity", which Jim looked at a while back:

This graph shows how debt and GDP have have grown relative to each other

[increase in GDP]/[increase in debt]

Prior to the meltdown there seem to be a steady trend of declining productivity increase per dollar borrowed.

Downsloping from 1966 to the crisis. (Divide GDP by debt (like Jim), and the line goes down. Divide debt by GDP (like me) and the line goes up.)

Ron Robins also looked at debt productivity a while back:

For decades, each dollar of new debt has created increasingly less and less national income and economic activity...

Getting less and less economic benefit from each dollar of new debt is becoming an enormous and onerous problem for the US...

According to Dr. Kurt Richebacher, writing for The Daily Reckoning, US credit expansion in 2005 was $3,335.9 billion and matched by nominal GDP growth of $752.8 billion, equalling $4.43 in new debt for each dollar of GDP growth. In 2006 total credit market debt increased $3.9 trillion while nominal GDP (seasonally adjusted) grew by $686.8 billion showing that it took $5.68 of new debt for each dollar increase in GDP.

Grandfather Hodges also considered debt productivity:

Please note this is a ratio chart - - a plot of debt as a ratio to national income - - called the 'debt ratio.'

If the economy performed with less debt each year per dollar of national income growth, meaning better debt productivity, then the chart trend line would be pointing downward.

But, the line points up - - each year more and more rapidly upward it soars.

This means the economy has been performing with less debt productivity each year...

Even The Economist looked at debt productivity:

Like alcohol, a debt boom tends to induce euphoria. Traders and investors saw the asset-price rises it brought with it as proof of their brilliance; central banks and governments thought that rising markets and higher tax revenues attested to the soundness of their policies.

According to Leigh Skene of Lombard Street Research, each additional dollar of debt was associated with less and less growth.

And just as I was looking for a way to wrap up this post, a new comment linked to an interview with David Stockman and provided this teaser:

Q: Why are you so down on the U.S. economy?

A: ( Stockman ) It's become super-saturated with debt. 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.

 
// Related posts

• Accumulation
• Why
• Credit Efficiency

Another day older and deeper in... Well, you know.

I wrote this post back in August of 2010. For some reason I never posted it. But I'm back on the same theme now, and I found it, so I'm posting it today. Hodges has since updated his numbers.

I've come across pages of The Grandfather Economic Report a few times lately. Found one on debt just now. I want to review it in this post.

Clicking the image at right will take you to Grandfather Hodges' summary of debt, the page I'm reviewing here.

Hodges sets the tone right away: "America has become more a debt 'junkie' - - than ever before with total debt of $57 Trillion." Big number. Hodges uses the "debt junkie" imagery more than once.

Hodges points out the size difference between federal debt and total debt:

"The Federal Government Debt Report covers just the federal government debt of $12.3 Trillion... This chapter covers all U.S. debt... Total Debt in America is now $57 Trillion"

Then he presents a graph comparing that $57 trillion debt to National Income:

"This is A SCARY CHART - showing trends of total debt in America (the red line) reaching $57 trillion in 2009 vs. growth of the economy as measured by national income (blue line). (adjusted for inflation)."

Hodges does a lot with large fonts and capitals, and red and blue text and such. I'm not trying to duplicate that when I quote him. (The capitals copied over, of course.) To distinguish his text from mine, I'm putting his words in quotes and italics.

"This chart shows, for the period 1957 to mid 1970s, total debt (red line on chart) was increasing close to the growth rate of national income (blue line on chart), despite war debt for WW II, Korea and Vietnam."

"But, in the last several decades total debt has zoomed up, up and away - - growing much faster than national income. As of beginning 2010 total debt was $57 Trillion ($42.3 trillion private household/business/financial sector debt PLUS $14.7 trillion federal, state and local government debt)."

Yeah, debt grew only a little faster than National Income in the early years of the graph. Then it started growing a lot faster. Hodges puts a date on the change: the mid 1970s. Minor point: I would put the change around 1981, at the time of the K-R Shift.

Hodges makes some interesting observations about the graph:

"Total debt (red line) increased about $3 trillion per year the past several years. BUT - last year, for first time EVER, total inflation-adjusted debt stopped growing at $57 trillion, as if it hit a brick wall - and national income (blue line) stagnated and declined."

Yeah, that was the Paulson crisis, and the recession.

"It took $9 of new debt to produce but $1 of added national income - a new record."

I prefer to think of it as $9 of credit-use that produced $1 of National Income. Debt is only the record of credit in use. It's another minor point. But sometimes the little things help to clarify the big things.

"Although total debt in America stopped growing last year, federal, state & local government debt zoomed upward FASTER than EVER - by more than $1.8 trillion, while private sector debt decreased by about same amount."

Another consequence of the Paulson crisis, of course.

"This chart shows < 2009 debt of $57 trillion was 505% of national income; the debt ratio in 1957 was 186%. If 2009 debt had been at the 1957 debt ratio then 2009's debt would have been $21 trillion, not $57 trillion - - indicating excess debt in America today of $36 trillion."

Oh, I like the arithmetic! If not for our increasing reliance on credit, we'd have had $36 trillion less debt in 2009. With that much less debt, we'd have avoided the Paulson crisis. And by the way, economic growth was better in the 1950s and '60s, when there was less debt. Hodges makes another excellent point:

"In this graphic, note how the debt ratio data plots are nearly flat during the first half of the years shown, indicating debt was growing at approximately the same rate as the economy - - not faster than the economy. This proves America's economy can grow without increasing debt at a faster pace (because it has in the past)."

One more little thing:

"Please note this is a ratio chart - - a plot of debt as a ratio to national income - - called the 'debt ratio.' If the economy performed with less debt each year per dollar of national income growth, meaning better debt productivity, then the chart trend line would be pointing downward. But, the line points up - - each year more and more rapidly upward it soars. This means the economy has been performing with less debt productivity each year..."

Accumulation

UPDATE 5/4/2011 -- Gene Hayward has recently convinced me there is a problem in my breakout of public and private debt. I have to look at the numbers again, enough to get it right. Meanwhile, I am scratching out phrases like "only one-sixth the size" when I come across them.


Remember how it was after the towers fell? Immediately, it seemed, everyone recognized the world was different. For years, it seemed, people spoke of pre-9-eleven and post-9-eleven. Still do. That day -- that moment -- was a turning point.

The financial crisis of 2008 was a comparable turning point; bigger, I think. For me, the "moment" was Treasury Secretary Henry Paulson's speech of 19 September 2008.

To put the moment in context, check out Bill Luby's graph in Another Friday of Testing VIX Lows?. It shows a huge run-up in the Volatility Index against a background that shows a huge drop -- at the same moment, September '08 -- in the Dow (I think).

"From July 2007 to September 2008," Luby writes, "volatility was elevated, but seemingly contained." September '08 was the volatile moment, the moment of crisis.


An old post from January, 2008: Ron Robins' Is the Amazing US Debt Productivity Decline Coming to a Bad End? Robins writes:

For decades, each dollar of new debt has created increasingly less and less national income and economic activity. With this ‘debt productivity decline,’ ...

Now, see, I like that: "debt productivity." It's wrong, of course. Debt cannot be productive. Credit-use can be productive. Debt is only the record of credit-use. But let's be flexible and go with common usage, for now.

The "productivity of debt" has been in decline for decades, Robins says. Agreed. It is an extremely important point, far more important, anyway, than media-people seem to think. I want to come back to this topic.

But first, let Ron Robins finish his thought:

...With this ‘debt productivity decline,’ new evidence suggests we could be near the end-game in this economic cycle. American collective consciousness will need to change to accept the new reality.

Yeah, I don't know about any "end-game" or what Robins may mean by that. And I don't know which cycle he's thinking of; the long-wave, I would guess, the one that ends in Great Depressions.

So then the end-game would be the depression.

I also don't know about "collective consciousness." Consciousness is a concept, like "moral argument," that is difficult for me to grasp. Kinda like the difficulty other people have to distinguish between "debt" and "credit."


Anyway, Robins. He says, "Getting less and less economic benefit from each dollar of new debt is becoming an enormous and onerous problem for the US." That's the debt productivity thing. Robins quotes Grandfather Hodges:

“In 1957 there was $1.86 in debt for each dollar of net national income, but in 2006 there was $4.60 of debt for each dollar of national income – up 147%. It also means this extra $2.74 of debt per dollar of national income produced zilch extra national income. In 2006 alone it took $6.32 of new debt to produce one dollar of national income.” (Underlining added.)

"According to Dr. Kurt Richebacher..." Robins writes, "in 2005 ... [there was] $4.43 in new debt for each dollar of GDP growth. In 2006 ... it took $5.68 of new debt for each dollar increase in GDP."

The exact numbers differ, depending who reports them. But the numbers are close, and big, and increasing. On that, there is resounding agreement.

Yeah. Declining credit efficiency or, as Robins calls it, declining "debt productivity." Some people may relate that concept to the observation that federal deficit spending doesn't do much to stimulate the economy.

Eh. Yes and no. The decline in debt productivity affects government debt as well as private debt. And though government policy is responsible for this whole mess, that is not to say it is government debt that is responsible.

President Obama's large increases in federal deficits didn't happen until after the crisis, so clearly they didn't cause it. And if we look at accumulated debt, federal debt total combined debt of U.S. federal, state, and local government is small potatoes compared to total private-sector debt, only one-sixth the size.

Moreover, total government debt was roughly stable in the U.S. from 1960 to 2008, relative to GDP, while total private-sector debt did nothing but increase. So lets jump away from any conclusions about government debt being the cause of the problem, and maintain for now a focus on total debt.


Ron Robins focuses on total debt. He has a good feel for the problem. But in my view he has no understanding of the cause, and no understanding of the solution.

Americans have gotten to this point as they sought fulfillment almost exclusively in the material world around them.

Robins blames... character, I guess. Another word I don't rely on. There is some kind of pathetic irony in blaming people rather than policy for the economic environment we're in. Some holier-than-thou superiority that interferes with reasoned discussion, and supersedes evidence.

The problem is not bad character. The problem is bad policy.

It is possible that the US Federal Reserve and the financial system will continue to produce ever increasing amounts of debt relative to national income and GDP...

Well Robins is right about this. In fact, I'd say that continuing to produce ever-increasing amounts of debt is the only plan that makes sense to Ben Bernanke and other policymakers. Curse the luck.

In the years ahead many Americans will need to look more within themselves, rather than to material goods, to find personal fulfillment.

Yeah, the character thing again. The problem is debt, Ron. And the cause of the debt problem is policy. You know: "We need credit for growth." That policy. And: "Since growth is so hard to obtain, we need even more credit for growth." That.

Stop, Ron. Take a step back. Look at the insanity in those policies. They create debt.

The policies create the problem.


Robins does not answer the question why we are "getting less and less economic benefit from each dollar of new debt." He does not even ask this question.

It is the total accumulation of debt that makes new debt less productive.

Existing debt creates a drag on the economy. New additions to debt don't boost the economy unless they are more than big enough to offset the drag created by existing debt. And every new addition to debt creates more drag, making the problem worse.


We use credit for growth, but credit-use creates debt, and debt hinders growth. So we use credit, and we grow, and we let debt accumulate, and we repeat the process until the accumulation kills off the golden goose age.

And then we need a President like Reagan, bold enough to vastly increase federal deficits, to generate enough new credit-use to compensate for accumulated debt. But that solution is unsustainable, for it makes the accumulation bigger. Today, as a result of past policy, even Obama-size deficits cannot offset the accumulated debt.

It becomes a pointless exercise.

As long as people think we need to use more credit and accumulate more debt to make the economy grow, our policies are bound to fail. The more debt accumulates, the more it contributes to credit inefficiency and debt productivity decline.

Credit Efficiency

In a post titled Debt And Transfiguration, Paul Krugman argued against the view that a high level of debt causes problems in the economy. Inadequate growth, he said, makes debt appear excessive. He thinks the people who worry about the debt have cause and consequence reversed.

Then (ha ha) he added: "I’m not denying that high debt can be a problem."

Specifically, Krugman was arguing against the view that "bad things happen when debt goes above 90 percent of GDP." As evidence he said that in both Japan and Europe, debt increased after growth slowed. And in the U.S. he said, "the only period when debt was over 90 percent of GDP was in the early postwar years, when real GDP was falling."

Now I don't know whether Krugman was referring simply to the denominator problem -- that the value of the debt/GDP ratio can rise because of lagging GDP -- or whether he has a meatier argument. But to the people who already don't agree with Krugman, that couldn't possibly make the least bit of difference.

People who already disagree with Krugman -- those, let's say, who worry what will happen when debt goes above 90% of GDP -- will be scratching their heads, wondering why he is talking about World War II debt. The problem is not some old debt from 65 years ago that everybody knows wasn't a problem. The problem is the current high level of debt, and current projections of even higher debt to come. After all, not even Krugman denies that high debt can be a problem.

Still, he has a point: Debt was over 90% of U.S. GDP once, and it turned out not to be a problem, that time.

For the 90-percenters, Krugman creates a dilemma: Why was the World War II debt not a problem? They say debt is a problem now. They know they are right. I know they are right. I think even Krugman knows they are right. But he raises a question they cannot answer. As things stand now, the only solution is for 90-percenters to reject Krugman more completely. Dilemma and all.

Krugman suffers the same dilemma. He knows that high debt can be a problem. And yes, he knows that it turned out once, at least, not to be a problem. But he doesn't know why. He doesn't know why high debt was not a problem after World War II. If he knew, surely he would tell us.

The dispute between Krugman and the 90-percenters is fought on a particular playing field. That playing field is the graph "debt relative to GDP." When the trendline reaches 90% it is a huge problem. Or it is no problem at all.

To settle that dispute, answer one simple question: What does the graph show?

Consider first what the graph does not show: It does not show that debt is high. It only shows that debt is high relative to GDP: Gee, this mountain looks big compared to that mole-hill. Yes, we have a mountain of debt. But the graph does not show that. It shows a thing we already knew: The graph shows that GDP growth has been laggard. But that was our original complaint. We don't have the growth of output, the growth of jobs, the growth of living standards, the growth of profit that we need, that we expect, that we want, that we demand. GDP is a mole hill.

What does the graph show?

The graph shows the efficiency of credit use. If an increase in debt is efficient, it produces a lot of growth. So GDP increases more than the debt, and the trendline goes down. But if an increase in debt is not efficient, it produces little growth. So then GDP increases less than the debt, and the trendline goes up. The trendline rises or falls depending on the efficiency of credit-use as measured by improved growth.

There are discussions you can find on the internet, regarding the size of the "multiplier" -- the size of the effect we get per dollar of economic stimulus spending. Formerly, the multiplier was thought to be quite large. Now it is often said to be quite small. If you come across such a discussion, it may be presented as an argument: someone is right; someone is wrong.

Here's what I think: In the days when credit-efficiency was high, the multiplier was high. In the days when credit-efficiency is low, the multiplier is low. It is not a matter of someone is right and someone is wrong. It is a matter of credit efficiency.

What does the graph show?

It shows a steep decline from the 1946 peak to about 1952. We got a lot of growth for every dollar of credit use. Credit efficiency was extremely high.

It shows a less steep decline from 1952 to 1966, the year I graduated high school. Credit efficiency was somewhat less.

It shows a mild decline from 1966 to 1974. We gained only a little growth for every dollar of credit use. Credit efficiency was quite low.

It shows flat from 1974 to 1981. At this point there was no gain from credit use. (The multiplier was about 1.) We had reached a Laffer limit.

And it shows a sharp increase after 1981. There was a loss from credit use. If growth was better in the 1980s than in the '70s, this trendline shows why: It took a lot of debt to boost economic growth. Credit use was inefficient.

After the mid-1990s the trendline loses its "bowl" shape. We'll look into that later. Meanwhile I should point out that the trendline, which disappears behind the graph border in 2009, approaches 90% in that year: last year. I know this sharp spike in the trend is part of a policy designed to boost economic growth. But low credit efficiency makes that policy ineffective.