Monday, December 18, 2006

The Debt Intensity of Economic Growth or,

The Sardine Can

The previous post (see below) showed the un-sustainability of current trends in new debt creation in the US economy. But how important is debt creation to GDP growth – how much additional debt does it currently take to produce one additional dollar of GDP? Let’s call that ratio “Debt Intensity of GDP Growth”. The chart below shows this ratio since 1965.

It immediately becomes apparent that the US economy has lately become a desperate debt junkie, needing increasingly massive hits of borrowed dollars to create economic growth. As the economy transformed from “production-based” to “asset-based” it had to find additional capital to sustain higher asset prices so as to create consumption through the wealth effect. Unfortunately, it has been “debt” capital instead of “equity”. Indeed, such a massive amount of “money” (total US debt is currently $44 trillion) is simply not available in "equity" form, since it is equivalent to 330% of US GDP or 140% of the world’s combined GDP, ex-the US.

Such capital, therefore, has been created as “money” via the ever expanding synergy between lending and asset appreciation, i.e. a debt bubble. At some point, however, “someone” may want out of the game and wish to liquidate his asset(s). If there is no lender immediately available to provide incremental credit then the seller must find a buyer with “equity” and/or accept a lower price. That is how debt bubbles burst, historically.

There is a story that illustrates this point (NB - thanks to Sandra):

Andy convinces Billy to buy a can of sardines at a high price by telling him how wonderful they taste. Billy, being greedy, decides to resell them to Charlie for a profit at an even higher price by convincing him too about how great those sardines are. The process gets repeated several times until the last buyer, let’s call him Zebediah, pays a million bucks to Yorick for a can of the “world’s absolute best sardines – EVER”. Well, Zebediah decides to open the can and eat the sardines, only to discover they are ordinary, plain sardines. Furious at being swindled, he yells at Yorick:

“You crook! You liar! I paid you a million bucks for just plain ordinary sardines. They were not the greatest tasting sardines - EVER”, yells Zeb.

Yorick shrugs and replies…

“Hey Zebediah, you are such a schmuck. Those were not eating sardines – them were trading sardines!"

Likewise for overinflated assets, if someone decides to "eat them", instead of just "trade" them.

But what consitutes "eating" an asset?

And what does that mean for the economy?

Stay tuned.


  1. You've got my attention and I am staying tuned.

    This run-away debt business is like crack cocaine...things are so out of whack, so go into some more debt to feel better.

    It is such a crock. We have been "hood winked" into a classic bait and switch swindle of "buy this and it will bring you comfort and happiness." It is society wide.

    That path weakens us and certainly doesn't bring happiness. When was the last time you felt good after eating cotton candy?

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