THE FINANCIAL CLIFF WE MIGHT BE DRIVING OVER!
STAPLES CONSULTING
DECEMBER 1ST, 2018
THE FINANCIAL CLIFF WE MIGHT BE DRIVING OVER
OR
HOW WE SOLD OUR CHILDREN’S AND GRANDCHILDREN’S ECONOMIC FUTURE FOR OUR OWN CURRENT GAIN
This newsletter is based upon my own original research. First, I need to give some background about scientific theory in general and economic theories and economic history more specifically.
In science we have the principle called Occam’s razor, also called the law of economy, that became best known from the works of a Franciscan friar and scholastic philosopher William of Ockham in 14th century England. In Latin it is called “lex parsimoniae,” or “the law of briefness.” It generally states that among competing hypotheses or theories, the simpler explanation or the one that uses the least speculation is usually better, if both explanations work equally well. As Albert Einstein once stated; “Everything should be kept as simple as possible, but no simpler.”
Often it seems when I talk to my students, or amateur economists, or conspiracy theorists, they have some very elaborate theories to explain economic and financial events. They also seem to look at a forest of economic events and data and will use only that certain set of data that supports their position and disregard any other that contradicts their beliefs (Confirmation Bias). Here I hope to present a simple case of explaining and showing the economic decline of the United States economy. We are putting off some hard decisions now, which is going to cause suffering for future generations.
One economic theory we need to deal with is called the “Crowding Out Effect’” It argues that the rising of public sector (government) spending, done by the borrowing of money, drives down private sector borrowing and spending. The Crowding Out Effect was a reaction to the Keynesian economic model that stated that during a recession a government needed to stimulate the economy by deficit spending. But this increase in government spending, it was believed, would be at least partially offset by reduction in personal consumption and business investment (individuals and businesses couldn’t borrow, because the government had already borrowed the available funds.) This theory can be found in nearly every economic textbook published. It was an extremely popular idea in the 1950s, 60s, and 70s, but didn’t have a lot of research or data to support it; it was more of a thought exercise.
Two developments put the Crowding Out Effect onto the back burner of economic thought. The first, in the 1950s when this theory was being fleshed out, it was thought there were only a limited amount of savings that could be borrowed. In 1955, 100% of the United States national debt was funded by domestic sources; only Americans held American debt. The United States was the largest creditor nation in the world and it was thought that only American savers had the savings to finance the borrowing needs of the nation. Between 1975 and 1985 the United States went from the largest creditor nation to the largest debtor nation and more and more of our debt was held by foreign investors. Today, recent estimates have foreign investors holding 31% of our national debt and currently buying as much as 40% of new debt being issued. This globalization of debt was a major blow to this theory. The second, was the use by central banks of a financial tool call Quantitative Easing, particularly after the “Great Recession” 2008-09. Central banks around the world began to create currency “out of the thin air” and purchased trillions of dollars’ worth of their own national debt. If a single central bank attempted this “dollarization of debt” it could have lowered the value of that nation’s currency, but since at least three of the four largest economic areas (the European Union, the United States and Japan) pursued this policy, it didn’t seem to have this affect. Today, Crowding Out Effect is believed to happen only if the economy of a nation is operating at full employment.
This brings us to some things in economic history that we need to be made aware of. I’m often amazed by people’s reaction to a single monthly economic report or that quarterly statement from some corporation or governmental agency or that annual report of Gross Domestic Product (GDP) or inflation; they often declare that this information supports their position. But the economy doesn’t work that way; we think far too often in the short-term. When we think about the economy and how it changes, we need to imagine an aircraft carrier in the ocean and less of a kayak on a pond. An aircraft carrier needs lots of room and time to change its direction, which is how we need to think about the economy in the sense we need to be flexible, willing to change course, and give it lots of time to happen. The economy cannot change direction or stop on a dime like a kayak in a very calm pond, and we need to stop thinking in those terms.
We have two excellent examples for the fall of Great Powers in the last one hundred years. The first is England, most historians place the apex of English Empire in 1922 just before the Irish independence. England suffered through two world wars and the Great Depression but could not adjust itself economically to keep its empire together after the Second World War. It is generally accepted that by 1956 England had been delegated to be second rate or regional power in the world. (This was not totally recognized for another couple of decades, particularly by the British.) This process took 34 years to occur, from peak to collapse. The second is the old Soviet Empire; most economic historians place the peak of the Soviet economic power around 1965. The Soviet Empire came to its end in 1991 with the breakup of the old USSR into 15 independent republics. The process of this economic and political collapse of the Soviet Empire was not seen coming by any world power or intelligence agency. This peak to collapse took some 26 years. (A wonderful book about the fall of the Soviets is “Armageddon Averted” by Stephen Kotkin.) What we need to take away from these examples is that economic collapse takes a very long time and can happen without warning.
Now on to the main body of my research. The two major sources of my data are the Department of Treasury website treasurydirect.gov and the Bureau of Economic Analysis website bea.gov. From Department of Treasury I obtained the end of the fiscal year total of the United States Public Debt from 1950 to 2018. (Please note: from 1950 to 1976 the fiscal year ended on June 30th; starting in 1977 the fiscal year ends on Sept 30th of each year.) From the Bureau of Economic Analysis, I obtained the GDP and the percentage of growth in the Real GDP for the calendar years from 1950 to 2018. I then divide my research into three time periods, 1951 to 1975, 1976 to 2000, and then 2001 to 2018. My focus was how much debt had been created and how much growth we gained over these three time periods. To keep this newsletter a manageable length, I have only shown my raw data from the final time period of 2001 to 2018, but I’ve included a summary of the other two for overall comparison.
Below I’m comparing the rate of debt as measured by the percentage of GDP of that year with the rate of growth in GDP and seeing which is the larger of the two. I’m using the data from the Department of Treasury Public Debt rather than the “official” budget deficit or surplus of each year, because I believe it is a more accurate measure of the size of the budget deficit or surplus. If we look at the budget surplus of the fiscal year of 2000, we will see a great example of what I mean. I remember in 2000 every politician (Republican and Democrat) was raving about how wonderful the United States Federal Budget Surplus was; and everyone was taking credit for creating the largest budget surplus ever. But was that really true? The way the federal government records revenue and expenses is a bit different from the way of a corporations handle normal accounting practices. The Social Security Amendments of 1983 reformed Social Security and raised Payroll taxes that help create large annual surpluses from 1985 to 2010. These Payroll taxes are considered revenue by our government and it reduces the size of the “official” federal budget deficit; this money is then deposited into the Social Security Trust Fund, whereupon it is immediately borrowed back by the federal government. This borrowed money then shows up in the amount owed and becomes a part of our Public Debt. The federal government has a number of these trust funds that it treats the same way; the Social Security Trust Fund is just the largest. If we look at the “official” Budget of 2000 it is recorded as a $236.2 billion surplus for that year, but the national public debt went up that same year by $17.9 billion. Only in the federal government accounting system where can you claim a surplus as you go further into debt.
FIRST TIME PERIOD 1951-1975
Year % inc./dec. national debt GDP % inc./dec. GDP
TOTALS 1951-1975 28.24% 94.50%
AVERAGE 1.13% 3.78%
TO OBTAIN $1 IN GROWTH DURING THIS PERIOD WE HAD TO GENERATE 30 CENTS IN NEW DEBT
SECOND TIME PERIOD 1976-2000
Year % inc./dec. national debt GDP % inc./dec. GDP
TOTALS 1976-2000 101.34% 86.40%
AVERAGE 4.05% 3.46%
TO OBTAIN $1 IN GROWTH DURING THIS PERIOD WE HAD TO GENERATE $1.17 IN NEW DEBT
THIRD TIME PERIOD 2001-2018 WITH RAW DATA
Year % inc/dec national debt GDP % inc/dec GDP
- 2001 1.26% 1.00%
- 2002 3.85% 1.70%
- 2003 4.84% 2.90%
- 2004 4.88% 3.80%
- 2005 4.25% 3.50%
- 2006 4.16% 2.90%
- 2007 3.46% 1.90%
- 2008 6.91% -0.10%
- 2009 13.05% -2.50%
- 2010 11.02% 2.60%
- 2011 7.91% 1.60%
- 2012 7.88% 2.20%
- 2013 4.00% 1.80%
- 2014 6.20% 2.50%
- 2015adj 4.12% 2.90%
- 2016adj 5.34% 1.60%
- 2017adj 4.59% 2.20%
- 2018adj 5.22% 3.10%est
TOTALS 102.93% 35.60%
AVERAGE 5.72% 1.98%
TO OBTAIN $1 IN GROWTH DURING THIS PERIOD WE HAD TO GENERATE $2.89 IN NEW DEBT
First, a few clarifications. In the fiscal years ending in 2015, 2016, 2017, and 2018 you see where I indicated an adjustment (adj). Because Congress failed to raise the debt ceiling in the fiscal years of 2015 and 2017, I needed to combine the total debt raised in fiscal years 2015 and 2016, also 2017 and 2018. Then I took the “official” budget deficit of these two years combined them and discovered the percentage of each year. I then multiplied that percentage with the total debt raised for both years. This was the fairest and most accurate way I felt that would show how much new debt was raised in each year. Also, the total for each block of years is just a simple adding of each year to come up with a total, and then dividing by 25 or 18 accordingly.
Looking at the raw data of the earlier periods, (which is not shown here) during 1951 to 1975 there were just four years (4/25) where the growth in the economy was not greater than the growth in the national debt. Each of those years was a recession year, where one would assume that debt percentage increase should be higher than the growth percentage rate, a classic Keynesian economic response. Also, every president of the United States was able to grow the economy faster than growth of debt. (This includes Truman, Eisenhower, Kennedy, Johnson, and Nixon.) The national debt at the end of the fiscal year 1951 was $255 billion, about 74% of GDP, by the end of the fiscal year 1975 it had grown to $533 billion, but because of the more rapid growth in the economy, as a percentage of GDP it had fallen to just 32%. If you look at it in the simplest terms, on average, for every 1 dollar of growth, it cost the United States just 30 cents in new debt. (A great book that deals in greater detail about this period is “An Extraordinary Time” by Marc Levinson.)
During the second period, 1976 to 2000, we see slowdown in the growth rate but a real rise in the creation of new debt. In fourteen years (14/25) we see that the creation of debt rose faster than the growth rate of the economy. Out of those fourteen years just three were recession years. Every president during this period had difficulty growing the economy without a large dose of deficit spending. Presidents Carter, Reagan, and Clinton all had some good years and bad; but President Bush (41) became the first president in the modern era who could not grow the economy without much larger growth in debt creation, each and every year in office. The national debt at the start of this period was $533 billion, or about 32% of GDP by the end of this period it had grown to over $5.8 trillion and was about 55% of GDP. And, looking at it in the simplest of terms, on average, for every dollar of growth in GDP, it cost the United States $1.17 in new debt during 1976 to 2000. (I’ve excluded President Ford from either list, because of his short-term of office and it bridged both periods.)
It’s during the last period, 2001 to 2018, where things really turn troubling. (Just a note of clarification here, it seems most people don’t understand how the budget process works here in the United States. Every president “inherits” their first federal budget from their predecessor and then “wills” their last budget to the next president. As an example, let’s look at President Clinton’s last budget and the election of President Bush (43). During the Spring of 2000, President Clinton submits his last budget to Congress, Congress then passes that budget and it starts on October 1st, 2000. George W. Bush is elected to be president on November 7th, 2000 and takes office on January 20th, 2001. President Bush comes into office nearly four months into the fiscal year. President Bush really couldn’t influence the budget or the economy that much until he submitted his first budget that would start in October 1st, 2001. The best way then to evaluate how well a president (in this case President Bush) has done, it is look at the time between their first and last budget, in this situation it would be October 1st, 2001 to September 30th, 2009.) Between 2001 to 2018 there was no year (0/18) where the economy grew at a faster pace than the growth in debt. We had only two years that were in annual recession. The national debt at the end of the fiscal year of 2001 was just over $5.8 trillion, about 55% of GDP, by the end of the fiscal year of 2018 it had grown to over $21.5 trillion or just over 104% of GDP. Presidents Bush (43), Obama, and Trump have been unable to grow the economy at a faster rate than the rate of debt creation. On average, over the past 18 years, the federal government has spent $870 billion in new debt each year; growth based upon debt is not real growth. To show how we are still playing games with the budget deficit, the “official” budget deficit for the fiscal year ending September 30, 2018 was stated at $779 billion, but the adjusted total of new debt created during that year was $1.048 trillion. Looking at it in the simplest terms, between 2001 to 2018 on average, for every dollar of growth in GDP, it cost the United States $2.89 in new debt.
Now there is a long and on-going debate about whether budget deficits have any meaningful impact upon current or future economic consequences. That would take another newsletter to deal with in any depth or accuracy. The main point of this newsletter is to show that it is taking more and more debt to keep the United States’ current economy growing. In Carmen Reinhart and Kenneth Rogoff’s book “This Time is Different,” it seems to indicate that as amount of debt grows, as measured by the GDP, there is a correlation with a slowing down in the growth of the economy. The greater the national debt, the slower the economy grows. Now they are not claiming causation, but there is a correlation between these two economic measures. Here I’m stating that something is wrong with our economic growth model in the United States. The recent administration’s have not been successful in improving the economy without masking it with increasing amounts of debt. We need to ask ourselves how is it that Germany currently has good growth, a budget surplus, and can pay down their national debt and we cannot?
For the United States to cut its budget deficit it either must increase taxes (someone suffers) or cut spending (someone suffers) or both (even more people suffer). At this point it seem no one wants to make any of those choices. It takes a very long time for an economy to collapse or for market forces to make government change current economic policies. I would suggest that our examples in history would tell us, it is better for nations to chose to make changes; we then get to decide who is going to feel the pain, rather than having the market take away our choice and cause everyone to suffer.
Christian M. Staples
756 Worden Avenue
Kalamazoo, MI 49048
2963