Thursday, June 12, 2008

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.

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.


  1. Your efforts are well appreciated.

    So what's the epilogue?

    A never ending rotation in and out of the asset bubble du jour?

    Or, a Depression like crash that resets all the markers?

    And what to do with my modest nest egg so mom has something to retire on?

    my head hurts - next time just the pretty picture of cute gosslings.

  2. So what if America pays its debt in debased currency? Quoting the immortal Calculus: Bis vivit qui bene vivit.

  3. Paul asked..

    "So what's the epilogue? A never ending rotation in and out of the asset bubble du jour?"

    If I may extend the analogy a bit further, after hubris comes catharsis. America needs to cleanse itself of its enormous debt.

    It may do so willingly and gradually over several decades (the preferred method), or it will be forced into an abrupt mode shift that will feel like a collapse into poverty.

    Advice? Hope and fight for the best and prepare for the worst.


    The best revenge may indeed be to live well, but our creditors are already balking at accepting debased dollars. Like all merchants, Venetian or not, they are finally asking for their pound of flesh.


  4. good god, the sheer arrogance! "The series concludes in present day America, the most global and powerful empire in the history of man."

    pluhease! hubris anyone?

  5. America's 5% of the global population consuming 25% of the Earth's annual output of resources makes it indisputably the biggest empire in history. That may be hubris, but my pointing it out is definitely not.

    A spade is a spade, even if we don't like agricultural implements.

  6. This is an honest question, what possible source of revenue (other than printing or more borrowing) would allow the payment of $4T in interest plus $400B+ for energy imports? All this portends massive destruction of ficticious capital either through defaults (likely) or a stiff wealth tax (less so) negotiated globally to prevent evasion. If the earning potential of labor can't compete with financial liquidity for the essentials of life then only death can result either through violence or deprivation, most likely both.

  7. An interesting side effect of debasing the currency is that capital will look for a new home. It finds it in foreign currencies, real estate and various commodities. If your objective is to preserve wealth/savings the dollar might not be the optimal medium to store this wealth.

  8. Can you explain (or direct me to a link in which you explain) how law of thermodynamics applies to GDP?

    I am unclear and want to become clear on this

    I appreciate your help

  9. Thermodynamics is the science of the transformation of energy into work, i.e. what we commonly term "activity".

    GDP attempts to quantify this activity in dollar terms. But (fiat) dollars are infinitely expandable whereas energy and work aren't.

    Thus, measuring activity (GDP) in dollars is akin to measuring length with a very stretchy tape measure..

  10. I'd just like to say that the picture of that poor goose being cruelly force fed really upset me.

  11. Hell,
    First comes inflation then deflation?

    In your estimation are we now destroying more debt (deflation--through asset destruction, default...) or creating more debt (inflation)?

  12. Deflation or Inflation?

    The Fed is trying very hard to prevent deflation induced by credit destruction. Look at all those programs it has for turning trash into Treasurys using its own balance sheet.

    But in my opinion, its operations are one crisis away from failure. If there is another Bear in the closet then I think they won't be able to do anything much about it. And that's not necessarily a bad thing, either. We need to have debt destroyed.

  13. I think I'm a bit more cynical than you Hell, at least about our representatives in Congress.

    I think they will replenish the Fed's balance sheet without limit.

    What will be the end point then, a collapse in the bond markets?

  14. ... our creditors are already balking ...

    So what? Maybe they will send us the policeman? I forgot, WE are the world's policeman.

    Rome's problem was Atilla and his Hunnish hordes. But today no one is more Hunnish than ... guess who?

  15. J, Let's look at the balance sheet of the "Great Hun".

    175,000 troops in Iraq, at a cost of $300 billion/year +/-, and for what in return? $130/barrel oil?

    Ever hear of the word "sustainability"?

    The true Hun is efficient and cunning taking out million dollar hardware with hundred dollar bombs--guess who that would be?

  16. It seems a nearly certain that this system is going to collapse one day. It may be in fact collapsing already.

  17. Marcus,
    You're disregarding the price in lives the Iraqis are paying. Their struggle is no more sustainable than the occupation. It literally comes down to who runs out first; the US out of money or the Iragis out of corpses? Money is alot easier to replace.

    I share your sentiments about the cruelty towards the goose but have you noticed that Hel seems to have a certian fascination with foie gras? In addition to the forced over-feeding many breeders nail the feet of the geese to a board to prevent the geese from trying to get away at feeding time. I wish more people cared how animals are treated before and when they are killed.

  18. Hell,

    What happened to the CDS spread on the US Government as a result of doing all this treasury swapping?

    And who do you think would take a punt?

  19. Hell said... "they are finally asking for their pound of flesh"

    Is this really true?

  20. I either missed Hell's fascination with foie gras, yoyomo, or I repressed it.

  21. where is all the extra money created by this debt going?


    In black garbage bags in our dumps, polluting soil and water.

  22. I find it interesting that GDP to debt started to diverge in the early 1970s - anything to do with the US reneging on its obligations to exchange dollars for gold. Did gold act as a control on issuance of excessive dollars/debt?

  23. The gold bugs say 'yes'.

    I am not so sure.

    Vietnam and the War on Poverty changed our trade balance-- again a trade deficit is really just the amount foreigners are willing to lend us to buy their goods.

    But perhaps more significantly, there was a fundamental change in the way government appropriations were spent after Watergate- the effect was to eliminate what had unknowingly functioned as a line item veto since the founding of our republic.

    Before Watergate "reforms" (i.e. limits on executive power) were enacted, the way federal spending worked was that Congress would pass an appropriations bill, but it was the actual cabinets that spent the money congress authorized.

    Presidents since the beginning of the republic had been basically telling their cabinet secretaries that Congress might earmark 10 to a particular department, but the cabinet secretaries (appointed by the president and part of the executive branch) were only allowed to spend 8 of the 10 they were given.

    This issue had never been fully decided by the courts and Congress had always resented this executive encroachment on what they felt the constitution had specified was their domain, but the precedent stuck and it was how spending worked for almost 200 years. The net effect is it acted as a 'functional' line item veto.

    Gerald Ford, the only non-elected president to serve as our executive, was fundamentally a man of Congress and had always disagreed with this presidential encroachment. He (a Republican) signed a law stating that Cabinets were required to spend EVERYTHING Congress earmarked.

    Federal spending started spiraling out of control the very next day and we have never been able to get the genie back in the bottle.

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