It is a simple statistic that continues to warn of huge economic problems ahead for the United States. Some economists call it the “marginal productivity of debt (MPD).” It relates the change in the level of all debt (consumer, corporate, government, etc.) in a country to the change in its gross domestic product (GDP).
Due to the message it is delivering, most U.S. economists employed in financial institutions, governments, and private industry, as well as financiers and politicians, want to ignore it. The MPD (and related variants of it) is continuing to indicate extremely difficult economic times ahead.
I have vague recollections of the MPD concept from my economics classes long ago. But I was reintroduced to it around 2001 by a renowned economist who, during the following few years prior to his passing, became alarmed as to the MPD path of the United States. His name was Dr. Kurt Richebächer, who had been chief economist and managing director of Germany’s Dresdner Bank.
Investigating Dr. Richebächer’s concern further, I wrote an article on my Enlightened Economics blog on January 23, 2008, titled, “Is the Amazing US Debt Productivity Decline Coming to a Bad End?” I found that, “for decades, each dollar of new debt has created increasingly less and less national income and economic activity. With this ‘debt productivity decline,’ new evidence suggests we could be near the end-game . . .”
Debt/National Income Ratio
Another way of viewing the debt productivity problem is to look at it in terms of how many dollars of debt it took to help create total national income, which is the wages, salaries, profits, rents, and interest income of everyone.
Again, from my above-mentioned article, which quotes Michael Hodges in his “Total America Debt Report”: “in 1957 there was $1.86 in debt for each dollar of net national income, but [by] 2006 there was $4.60 of debt for each dollar of national income—up 147 per cent. 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.”
Such data helps explain why U.S. exponential debt growth—after reaching certain limits—collapsed in 2008 and contributed massively to the global financial crash.
However, whereas the U.S. private sector debt has marginally ‘deleveraged’ (retrenched) since that crash, the U.S. government, as everyone knows, has run up mammoth deficits, purportedly to keep the country’s economy from imploding.
Structural GDP Concept
One fascinating way of looking at the declining MPD of U.S. government debt was presented by Rob Arnott on May 9, 2011, in his post, “Does Unreal GDP Drive Our Policy Choices?” Mr. Arnott subtracts out the change in debt growth from GDP, and refers to this statistic as “Structural GDP.” He finds “the real per capita Structural GDP, after subtracting the growth in public debt, remains 10 per cent below the 2007 peak, and is down 5 per cent in the past decade. Net of deficit spending, our prosperity is nearly unchanged from 1998, 13 years ago.”
In its effort to counter the significant economic difficulties since 2008, the U.S. government has added, or will have added, around $4 trillion in deficits (financed by new debt) in its fiscal years 2009, 2010, and 2011. Yet, all this massive government deficit spending has failed to really ignite economic growth.
Most likely this is because of the enormous dead weight of unproductive and onerous private sector debt, particularly consumer debt. Hence, real U.S. GDP will have increased probably less than $1.5 trillion during these years. Including some further economic benefit in the years thereafter, a total GDP benefit of only about $2 trillion is probable.
$4 Trillion Borrowed, $2 Trillion Gained
So, $4 trillion borrowed for $2 trillion in GDP gains. Thus, in very rough round numbers, each new one dollar of U.S. government debt might only produce $0.50 in new economic activity and probably only about $0.08 in new federal tax revenue. (Federal tax revenue as a percentage of GDP is around 15 per cent.)
Therefore, the economic marginal return for each new dollar of U.S. government debt is possibly around -50 per cent! If you loaned someone $10 million and they gave you back $5 million, you would not be happy.
It might not be long before those holding or buying U.S. government bonds perceive the reality that the U.S. government, and U.S. economy, are losing massively on government borrowings. This will result in much higher U.S. government bond yields and interest costs.
Most importantly, it may make the rollover of U.S. debt and new debt issuance incredibly difficult unless U.S. taxes rise to cover the deficits and/or Federal Reserve money printing goes into hyperdrive to purchase the debt the markets will not buy. Of course U.S. banks, pension funds etc., could also be forced to buy them.
Thus, the idea that U.S. government debt continues to be “risk-free” is absurd.
Ron Robins ([email protected]) is a financial and economics columnist for alrroya.com, writes the Enlightened Economics blog, and is founder of the ethical investing site Investing for the Soul. Article copyright alrroya.com. Used with permission.