The Problem Of Exponential Debt
A Chinese proverb known by Americans as the “Chinese curse” says: “may you live in interesting times”. Boy do we live in interesting times. This is a veritable golden age in economic evolution. New theories are being crafted as we speak and old theories that have stood the test of (our short) economic time are being torn down. No theory has come under fire in recent years like Keynesianism. After decades of success, Keynesianism doesn’t appear to be having the same magical effect. Economic theorists are confused. To their dismay (and with all apologies to Sir John Templeton, to whom I promised I would never utter these words) – it’s different this time. Literally.
We are fighting a very rare and wretched economic beast. As Bernanke’s great reflation experiment has ripped higher I have maintained that the hyperinflationists are wrong. Though we appear to have slipped through the hands of the balance sheet depression Grim Reaper, the balance sheet recession continues to nip at our heels. At his side always is his good friend Deflation.
A balance sheet recession is so rare that it has only occurred a handful of times in modern economic times. And thus far, he remains undefeated by all of the powerful economic minds who have stood in his path. In his path today is the great Sir John Maynard Keynes. The global economy has stood behind the theories of Lord Keynes as the economy has tumbled and Central Bankers have literally bet their printing presses on his theories. I fear they are not working and could be setting the table for an even greater catastrophe.
Over the course of the last 75 years governments around the globe have implemented policies of print and spend in times of economic downturns with great success. The truth is – Keynesianism works – in the right environment. It works well when debt is fairly low and organic economic growth is relatively strong, but exponential debt growth becomes an increasing concern every time you print your way out of an economic downturn. The larger the downturn, the larger the response. So on and so forth. If you happen to enter a period of severe irrationality and spending the problems multiply. If the recovery period is not used to pay down debts the problems become exponentially worse. The tipping point comes when the debt burden hinders future economic growth and destroys your ability to spend your way out of any future recessions. It effectively turns into one great pyramid scheme if it you let it get out of hand. We approaching a level of extreme inefficiency and wasteful spending. Spending which is not having the beneficial long-term impact that Keynesians might expect.
Marc Faber believes we are already there. He refers to the current period in U.S. history as “zero hour” – the point where we have indebted ourselves so deeply that we can’t be trusted to pay off our debts. Perhaps worse, however, is the inability to fend off future economic downturns. Not everyone agrees with this perspective, however.
Paul Krugman argues that the deficit worrying is entirely political. He’s correct to a certain extent, but as someone who loathes politics and understands that money has no political party I can say, without bias, that Krugman is also wrong to a large extent. Krugman argues that the economic downturn caused much of the current budget deficit – as if that somehow justifies it. But therein lies the problem. The prior Keynesian responses became multiplied and directly contributed to the current downturn. 20 years of easy money and accommodative print and spend monetary and fiscal policies have finally boiled over. In essence, we have tried to print and spend our way out of one too many recessions while failing to use the recovery periods to pay down our debts. The issues in the private AND public sector speak for themselves.
The problem is, as the United States economy has matured we have become increasingly confident of future growth and increasingly less fiscally prudent. The following chart shows the decade change in debt, GDP and debt/GDP. What was once a sustainable ratio in the 50’s, 60’s and 70’s has ballooned in the 80’s, 90’s and 00’s. The story in the private sector is largely the same as debt ratios have ballooned in the 90’s and 00’s.
![](http://pragcap.com/wp-content/uploads/2010/02/debt.png)
Now, as the recovery remains weak and worries of a double dip increase, Krugman and the other Keynesians are saying we’re not spending enough:
Reinhart and Rogoff recently published a paper titled “growth in a time of debt“. They found that debt at 90% of GDP begins to substantially impact future economic growth:
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.
We are fighting a very rare and wretched economic beast. As Bernanke’s great reflation experiment has ripped higher I have maintained that the hyperinflationists are wrong. Though we appear to have slipped through the hands of the balance sheet depression Grim Reaper, the balance sheet recession continues to nip at our heels. At his side always is his good friend Deflation.
A balance sheet recession is so rare that it has only occurred a handful of times in modern economic times. And thus far, he remains undefeated by all of the powerful economic minds who have stood in his path. In his path today is the great Sir John Maynard Keynes. The global economy has stood behind the theories of Lord Keynes as the economy has tumbled and Central Bankers have literally bet their printing presses on his theories. I fear they are not working and could be setting the table for an even greater catastrophe.
Over the course of the last 75 years governments around the globe have implemented policies of print and spend in times of economic downturns with great success. The truth is – Keynesianism works – in the right environment. It works well when debt is fairly low and organic economic growth is relatively strong, but exponential debt growth becomes an increasing concern every time you print your way out of an economic downturn. The larger the downturn, the larger the response. So on and so forth. If you happen to enter a period of severe irrationality and spending the problems multiply. If the recovery period is not used to pay down debts the problems become exponentially worse. The tipping point comes when the debt burden hinders future economic growth and destroys your ability to spend your way out of any future recessions. It effectively turns into one great pyramid scheme if it you let it get out of hand. We approaching a level of extreme inefficiency and wasteful spending. Spending which is not having the beneficial long-term impact that Keynesians might expect.
Marc Faber believes we are already there. He refers to the current period in U.S. history as “zero hour” – the point where we have indebted ourselves so deeply that we can’t be trusted to pay off our debts. Perhaps worse, however, is the inability to fend off future economic downturns. Not everyone agrees with this perspective, however.
Paul Krugman argues that the deficit worrying is entirely political. He’s correct to a certain extent, but as someone who loathes politics and understands that money has no political party I can say, without bias, that Krugman is also wrong to a large extent. Krugman argues that the economic downturn caused much of the current budget deficit – as if that somehow justifies it. But therein lies the problem. The prior Keynesian responses became multiplied and directly contributed to the current downturn. 20 years of easy money and accommodative print and spend monetary and fiscal policies have finally boiled over. In essence, we have tried to print and spend our way out of one too many recessions while failing to use the recovery periods to pay down our debts. The issues in the private AND public sector speak for themselves.
The problem is, as the United States economy has matured we have become increasingly confident of future growth and increasingly less fiscally prudent. The following chart shows the decade change in debt, GDP and debt/GDP. What was once a sustainable ratio in the 50’s, 60’s and 70’s has ballooned in the 80’s, 90’s and 00’s. The story in the private sector is largely the same as debt ratios have ballooned in the 90’s and 00’s.
![](http://pragcap.com/wp-content/uploads/2010/02/debt.png)
Now, as the recovery remains weak and worries of a double dip increase, Krugman and the other Keynesians are saying we’re not spending enough:
“The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs.”
Talk about doubling down on a losing bet….The truth of the matter is the U.S. economy is on an unsustainable path and our Keynesian economic responses have been large contributors. As the U.S. economy has matured and growth has slowed our inefficient spending has actually picked up pace. As we became more wealthy as a society we began to price-in increasing wealth expansion and with it came more debt – and more risk. That’s all well and good until the revenues begin to fall off a bit and then the debts become a substantial constraint. Real recovery relies not only on a strong public sector, but a strong private sector. Thus far, the private sector is not picking up the baton that the public sector is attempting to hand off.Reinhart and Rogoff recently published a paper titled “growth in a time of debt“. They found that debt at 90% of GDP begins to substantially impact future economic growth:
“The relationship between government debt and real gross domestic product (GDP) growth has been weak for debt/GDP ratios below a threshold of 90% of GDP. Above 90%, median growth rates fell by one percentage point and average growth fell considerably more. The threshold for public debt was similar in advanced and emerging economies.”
With the budget expected to reach 95% of GDP this year we are nearing the point of no return..
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