The Zero To Negative Multiplier Of Debt On Growth

The CBO (Congressional Budget Office) recently produced its long-term debt projection through 2050, ensuring poor economic returns. I reconstructed a chart from Deutsche Bank showing the US Federal Debt and Federal Reserve balance sheet. The chart uses the CBO projections through 2050.

At the current growth rate, the Federal debt load will climb from $28 trillion to roughly $140 trillion by 2050. Concurrently, assuming the Fed continues monetizing 30% of debt issuance, its balance sheet will swell to more than $40 trillion.

Let than sink in for a minute.

What should not surprise you is that non-productive debt does not create economic growth. As Stuart Sparks of Deutsche Bank noted previously:

A long-term historical look confirms the same. Since 1977, the 10-year average GDP growth rate steadily declined as debt increased. Using the historical growth trend of GDP, the increase of debt will lead to slower economic growth rates in the future.

Given the historical correlation of debt to GDP growth, such suggest future outcomes will be no different.

We can view this differently by looking at the dollars of debt required to create a dollar of economic growth. Since 1980, the increase in debt currently usurps the entirety of economic growth. The growth in debt diverts tax dollars away from productive investments into debt service and social welfare.

Another way to view this is to look at what “debt-free” economic growth would be. In other words, without debt, there has been no organic economic growth.

The economic deficit has never been more significant. From 1952 to 1982, the economic surplus fostered ab economic growth rate averaging roughly 8% during that period. Today that is no longer the case as the debt detracts from growth. Such is why the Federal Reserve has found itself in a “liquidity trap.”

Years of low rates, economic growth, inflation, and ongoing monetary interventions have led to a massive surge in debt. Both in the U.S. and globally. While many want to suggest “debt” isn’t a problem, we don’t have to go far to see what ultimately happens.

Since 2008, Japan ran a massive “quantitative easing” program. That program, on a relative basis, is 3-times larger than in the U.S. Not surprisingly, economic prosperity is no higher than it was before the turn of the century.

Furthermore, even though the BOJ’s balance sheet owns a majority of the ETF, corporate, and government debt markets, Japan has been plagued by rolling recessions, low inflation, and low interest rates. (Japan’s 10-year Treasury rate fell into negative territory for the second time in recent years.)

While many argue the U.S. economy will eventually “grow” its way out of debt, there is no evidence such a capability exists. We know that interest rates in the U.S. and globally are telling us economic growth will remain weak in the future.

Excess “debt” has a zero to a negative multiplier effect. Such was shown in a study by the Mercatus Center at George Mason University by economists Jones and De Rugy.

Personal consumption expenditures and business investment are vital inputs into the economic equation. As such, we should not ignore the reduction of privately produced incomes. Furthermore, according to the best available evidence, the study found:

Notably, politicians spend money based on political ideologies rather than sound economic policy. Therefore, the findings should not surprise you. The conclusion of the study is most telling.

I want to conclude by stating the obvious. Projecting anything 30-years into the future is highly problematic. Many things could happen that could change the trajectory of growth in the future. However, unfortunately, given the rise in the calls for socialism, demand for increased Government interventions, and lack of fiscal or monetary discipline in Washington, there are reasons to worry.

As is now evident, as global growth slows, the negative impact of debt expands economic instability and wealth inequality. Likewise, the hope that Central Bank’s monetary ammunition can foster economic growth or inflation is sorely misplaced.

Japan is a microcosm of what the U.S. will face in coming years as the “3-D’s” of debt, deflation, and the inevitability of demographics continue to widen the wealth gap.

What Japan has shown us is that financial engineering doesn’t create prosperity, and over the medium to longer-term, it has negative consequences.

Such is a crucial point.

What is missed by those promoting the use of more debt is the underlying flawed logic of using debt to solve a debt problem.

At some point, you have to stop digging.

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