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Monday, January 30, 2012

Why U.S. Economic Growth Must Outpace Debt Growth ... And Why It Won't without the Private Sector's Resurgence

Speeding Dragon, Hidden Debt Pile tells the simple story of the Chinese economic juggernaut and its impact on a nation's finances.

It also serves as a reminder of why a resumption of solid private sector driven economic growth in the U.S. is the only viable way to solve our many financial and employment related issues.

That's because sustainable and meaningful economic growth will turn large debt related problems into much smaller ones.

The referenced article contains lessons from China that we in America need to both hear and heed:

"Objects in the rearview mirror may be closer than they appear, but China's rapid growth means objects in the rear view of the world's economic powerhouse are actually shrinking at a rapid rate.

In 2011, China's gross domestic product came in at 47.1 trillion yuan ($7.4 trillion). That represented nominal growth of 17.5% from 2010, a blistering pace that makes many of the problems of debt and credit that trouble investors and hang over valuations for Chinese stocks appear a little more manageable.

Take local-government debt. The government's auditor put the number at 10.7 trillion yuan at the end of 2010. That was equal to 26% of China's GDP. In 2011, it shrank to 22%. Even if weaker demand and reduced inflation mean a slightly lower nominal growth rate in 2012, by the end of the year local-government debt could shrink to 19% of GDP. The debt may be creeping up, but not enough to push the ratio in the wrong direction.

Investors also worry about China's credit binge, which saw the ratio of loans to GDP soar from 96% at the end of 2008 to 119% at the end of 2010, as loan growth ran far ahead of GDP. An expanding economy means that ratio is also moving in the right direction—down to 116% in 2011. That reduction reflects the fact that banks' loan books are expanding, though not as fast as GDP.

China's happy situation stands in stark contrast to that of neighbor Japan, crisis-ridden European countries and the U.S., where slow or even negative growth does little to make the debt problem smaller.

Growth hides a multitude of sins. The trouble for China's competitors is that achieving any significant increase in nominal growth without a large portion coming from higher inflation looks hard to do."

If growth indeed covers a multitude of sins, which it does, then excessive government spending and high deficits make an already difficult debt problem that much harder to solve.

Simply stated, if a country's GDP growth exceeds its incremental debt addition for a year, the sovereign's financial condition improves. Accordingly, solid economic growth is THE key ingredient to a nation's financial health and well being.

To repeat, if GDP growth outpaces deficits as a percentage of GDP, that means things are getting better. The relationship of economic growth to increases in debt represents the key to a nation's financial well being.

Conversely, and as an example, if a nation's annual deficit as a percentage of its GDP is 5% and GDP grows less than that, that country's financial situation will become worse. It's just math.

In our case, we have debt of ~$15 trillion and annual deficits of ~$1.2 trillion. That's 8%.

If our deficits were to be reduced by 50% to $600 billion, that would still represent 4% of GDP.

With an estimated less than 3% growth in GDP in 2012 (and for several years thereafter as well), deficits would have to be at or below $450 billion to keep our financial condition from becoming worse.

Ain't gonna happen.

That's why a focus on reduced government spending accompanied by solid private sector economic growth is job #1 and the key to our financial future.

The sooner we seriously address this dangerous imbalance between economic growth and operating deficits, the better our chances to reverse our nation's deteriorating financial condition.

This financial stuff involves simple math and is actually quite easy to understand. I wonder why our politicians don't seem to want to talk straight to us about it and what we need to do.

Maybe it's because they have no clue about what to do.

Or perhaps it's because they do know what would be required-- a much smaller government and a much bigger private sector.

Thanks. Bob.

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