Real GDP - Part V: Goose Eggs

The series concludes in present day America, the most global and powerful empire in the history of man. It is also the largest debtor nation by a wide margin, a curious development for a superpower. But then again, no other empire had the benefit of a worldwide fiat currency regime to help it flood the Earth with its own IOUs.

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United States, 2008 A.D.

Calculus has been dead two thousand years but his spirit lives on famously. His "financial reforms" at the orders of Debitus and Fat Flavius gave Old Rome an inch and New Rome is taking a mile. Immortality, after a fashion, for the cunning Greek...

But let us, at long last, dispense with allegory and dive into hard facts. First, the data in chart form.

Since the early 1990's debt has been rising much faster than GDP (see charts below). During 2007 nominal GDP grew by 647 billion dollars while debt of the non-financial sector increased by 2.37 trillion dollars. Total debt, i.e. including the financial sector, rose even faster by 3.96 trillion dollars. These are frightfully large numbers - where is all the extra money created by this debt going?

Annual Changes in GDP and Debt (Data: FRB Z.1 Release)

Ratios of Debt Growth to GDP Growth

Excess debt is frequently (and highly deceptively) labeled as "liquidity", giving the unaware a sense of financial comfort. Nothing is further from the truth for, in reality, it works towards the debasement of our fiat currency's purchasing power. Like Milton Friedman said, "inflation is always and everywhere a monetary phenomenon". The more dollars in circulation, above and beyond the real economy's incremental requirements, must by definition raise prices.

Let's use a simple example: if there are only one dollar and one egg in existence, the price of one egg cannot exceed $1. If, however, next year there are two eggs and three dollars around, the price of each egg may rise to $1.50.

Since the excess debt generated in the US is obviously not going into productive economic use (debt is rising much faster than GDP), this "liquidity" results in higher prices for assets like stocks, real estate, ships and even paintings or Bordeaux wine futures. And now the flood is spilling over into consumables, i.e. commodities like fuel and food.

It's a simple balance sheet: if the liability side (debt/fiat money) expands, then the asset side must expand to match it. Let this expansion go on unchecked and pretty soon you have a rapidly ballooning balance sheet, also known as a bubble.

We can call this process any manner of names, but my favorite is "goosing", as in force-feeding debt to the economy to induce unnatural growth. Turning to pictures again:

This is natural growth...

...and this is growth, American-style.

What's worse, such a debt-spinning machine eventually gets out of control and self-destructs. For 2007, I estimate that interest alone on the $43 trillion in total debt outstanding came to $3 trillion out of the $3.96 trillion in new debt that was created during the same year. In other words, three quarters of all new debt went into paying interest on the old debt - and remember that GDP rose only by $647 billion.

Putting it in dollars and eggs, nearly 4 trillion more dollars went into circulation while only 647 billion new goose eggs were hatched. No wonder then that the price of geese is rising. Furthermore, for as long as this "goosing" goes on, national accounting becomes a messy omelette. Using a fiat currency to keep accounts in such circumstances makes it impossible to distinguish between real growth and mere bubble-blowing. At a minimum we should realize that reported GDP growth bears little resemblance to thermodynamic activity which, in my opinion, is the only unfailing yardstick.

I believe that traditional macro-economic measurements like GDP, debt, etc., will soon have to be retooled or replaced entirely with new ones based on real activity (e.g. see my Greenback suggestion).

In closing this "blast from the past" series, I thank you for your kind words left in the comment section. I had lots of fun with Debitus, Flavius and Calculus and it seems you liked them, too, by Jove.