Sunday, December 17, 2006

It's the Cash Flow That Does You In
Ask anyone: the repo man only comes calling when you stop making payments. His boss doesn't care where the money comes from, so long as the check is in the mail. Maybe you took out a cash advance from yet another credit card, or some sub-prime lender agreed to give you a third mortgage. Could be, you got to meet Guido. Provenance of cash doesn't matter to the lender. Cash flow matters.

Cash flow matters to the US, too. The chart below is net new debt assumed every year, as a percentage of GDP. For every dollar produced, the US now borrows 25 cents. If this goes on any longer debt will swamp the economy and edge out everything else. You will notice it is rising exceedingly fast, partly because compounding is savaging free cash flow. Since total debt is already at 326% of GDP and since government and households are running deficits, financing interest payments by more debt is already accounting for most new debt.

How long can this last? Not very long at all. Projecting out current conditions (25% debt growth, 6% nominal GDP growth and an average interest rate of 5%) we produce the following pretty absurd chart.

Within just 10 years debt would be 14 times GDP and interest alone would take 72% of GDP!
Reductio ad absurdum. It cannot happen and will not happen.

So what
will happen? Stay tuned.


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