Thursday, June 14, 2012

PART #2 ... Relationship of U.S. Debt to Growth ... And Why Politics Sucks


(A) If country X owes $50 and produces $100, its debt to GDP is 50%.

(B) If that same nation increases its debt level to $100 while still producing $100, its debt to GDP percentage is now 100%. Twice as high as in example A.

(C) And if that country's economic pie size then expands to $150 while its debt increases to $150, its debt to GDP would still be 100%.

(D) But if the pie in a severe recession shrinks to $100 while the total debt load expands to $200, the debt to GDP percentage will then be 200%. And that means really big trouble for country X.

Now here's why all that matters to We the People.

Creditors will adjust interest rates upward as borrower X becomes more risky. And when that credit risk becomes great enough, creditors will refuse to loan anything to X. Of course, the same works in reverse if borrower X becomes less risky.

{NOTE: Interest rates are historically low both due to (1) depressed economies worldwide and (2) the intervention of governments' central bankers currently. We'll set aside today the impact of rates resulting from government intervention. This is called "financial repression" and you may wish to bing or google it for a more complete explanation of today's situation and the role being played by the world's central bankers in keeping rates artificially low. But now let's get back to today's story concerning the relation of debt to the size of its economy and the necessity to grow that economy.}

(A) So if our low risk borrower X is Germany, and Germany's economic pie is growing, interest rates charged to Germany will be low. Such as the ~1% rate they are paying for ten year loans today.

(B) And borrower B may be charged 3% because it is more indebted than A relative to the size of its pie.

(C and D) But C may have to pay 6% or so, and D probably won't be able to borrow at any rate.

The Near Term U.S. Situation

Our total pie size is about $18 trillion and our debt is roughly $15 trillion today. Unfortunately and unless we reverse course soon, we'll probably reach parity in terms of pie and debt at around $20 trillion in five years or less.

That guesstimated $20 trillion in each pie and debt assumes nominal annual pie growth of 2%+ and ongoing annual deficits of $1 trillion. Thus, the GDP will expand in an approximate amount of $400 billion next year ($18 trillion X 2%+ = ~$400 billion) and the nation's debt will grow to $16 trillion ($15 trillion plus $1 trillion = $16 trillion). Those annual pie and debt expansion numbers times 5 equal $2 trillion and $5 trillion, respectively. Hence, we get to $20 trillion each after five years.

Here's What's Scary for Us

Within the next five years, if U.S. borrowing rates rise to anywhere close to those being experienced today by Spain, Italy or others, we would go from borrowing at today's 1.6% for ten year bonds to roughly 6.6%. That's an increase of 5%. Using broad numbers only to illustrate the point, today we pay 1.6% on $15 trillion in borrowings, or roughly $240 billion in annual interest expense (to repeat, these are not actual numbers but are sufficiently close for our purposes).

So that all means that if in five years we're borrowing $20 trillion and paying over 6% to do so, we'll incur an increase in interest expense of approximately $1 trillion.

As a result of that alone, our annual fiscal deficits in the U.S. would double from the estimated $1 trillion next year to $2 trillion or more in another five short years.

And the bottom line is this --- a $2 trillion deficit and $20 trillion in debt in a $20 trillion GDP economy is simply unsustainable. The economic pie isn't big enough, the debt is too large and the annual deficits are too high. A trifecta of the worst kind.

Creditors would balk and then all hell would break loose.

My Take is No Time to Lose

Politics sucks. Our U.S. politicians of all stripes like to spend OPM while neglecting to inform We the People that piling debt on top of debt will soon put us in the dangerous position where Spain, Italy and others are today. And continuing down the path we're on means it won't take very long for us to get to that sad Spanish et al state of affairs.

So when we hear our elected officials talk about stimulating the economy by spending more to build government buildings and hire more public sector workers, let's be clear about what they're really saying. They're saying grow the debt in relation to the size of the pie. They're saying to follow Greece, Spain, Italy and others to the edge of the cliff. They're saying that it's ok to waste more time and that it's going to be "business as usual" in the government, at least until the elections are over this fall. They are also saying the same thing about tens of billions in postal deficits, Solyndra "investments, auto bailouts and other government knows best expenditures.

But more important, they are saying  that it's ok for our private sector companies to not be investing in greater domestic energy output and infrastrucuture which would increase the size of the nation's economic pie. They're saying that it's ok that OPEC remains in control of energy prices. At least that's what they're doing.

Summing Up

It's much more important to watch what people do rather than to listen to what they say. As one old saying goes, "What you're doing speaks so loudly that I can't hear what you're saying."

Politicians spend OPM today to get today's votes.

They don't do what they do to assure a better tomorrow for We the People and following generations.

And they don't dare talk candidly about the long term consequences of today's OPM spending and failure to enable things like greater energy production in the private pie growing sector.

While the European mess is spreading quickly, at least here in the U.S. We the People are still in charge of our own destiny.

If our U.S. (and global) politicians have been acting in the best interests of the people, then how in the world did we end up in today's "debt to pie size" debacle?

And if anyone tries to tell you that the size of debt in relation to the size of the pie doesn't matter, then why are Spain, Greece, Ireland, Italy, Cyprus, Portugal, and others in the "fall-off-the-cliff" shape they're in right now?

Yes, pie growth matters very much. Similarly, debt containment and shrinkage matters very much as well.

When viewed in combination, the relationship of the economy's pie size to its total debt makes all the difference in the world.

Thanks. Bob.

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