Debt to Support Growth

[woodstove]

This is an economics question and I hope someone can help me understand.

 

From time to time, an article says such and such country/economy is in

trouble, because it needs 4-5 dollars of debt to achieve 1 dollar of growth.

 

Dr Richebacher used to write something like that in his articles, for instance.

 

And recently, Satyajit Das, whose thinking I greatly admire, has written,

 

"The ability to sustain high rates of economic growth, decreed by governments

and central bankers, is questionable. The aggressive increase in debt globally

resulted in a sharp increase in sustainable growth rates. $4 to $5 of debt was

required to create $1 of growth. Approximately half the recorded growth in the

US over recent years was driven by borrowing against the rising value of houses

(mortgage equity withdrawals). As the level of debt in the global economy

decreases, attainable growth levels also decline."  (Article title is

"Lessons Of The Global Financial Crisis: 3. Built To Fail"

 

I don't really understand how that is measured, debt required to support growth.

What statistics go into the calculation?  if $4-5 of debt is a substandard zone,

then what would be normal amount of debt required to support $1 of growth?

 

Thinking about it in terms of a business, if we are considering simply capital,

and there was $1 of growth for $4-5 of capital used, that is a great return,

20-25 pct annually.  OK, debt is not capital.  But all capital used in an economy

is someone's asset and more likely some else's debt, right?  Is the question

of how much use of debt vs how much retained earnings, just a measure of

distribution of asset-ownership vs business-operatorship?  I'm very confused!

 

Anyway, would appreciate clarification of what Messrs Das & Richebacher mean.

[bablu]

I think what really matters is who holding the debt ...

if it's internal (national) just redistribution of wealth but if it's foreign then comes the trouble ..

[oldye]

Sounds like that debt is being put to work at a very high rate of return is a big net positive for society. If the U.S borrows at 4% and invests at 6% you have a huge net positive.  Problem is people were borrowing at 7% and investing at 1% w/ 6% transaction costs. 

 

 

[Parsad]

I think what he is saying is that debt-fuelled growth is usually not sustainable.  A large percentage of GDP over the last decade was precipitated from the liberal use of debt and leverage.  Eventually, you can only tap into your equity for so long until much of it has depleted and the whole economy falls apart.  The statistic is the same one that Prem stated...80% of the economy was supported by consumer debt, and now growth is trying to be stimulated by the remaining 20%.  Cheers!

[Guest Broxburnboy]

Debt is an input cost to growth... as the proportion of debt in a system grows there comes a time when real growth turns negative on that debt burden.

[oec2000]

This may not answer Woodstove's question but the numbers and charts in the following link, if accurate, are quite sobering to contemplate.

 

http://mwhodges.home.att.net/nat-debt/debt-nat-a.htm#ratios

 

I have no idea how reliable the statistics on this site are but they do seem plausible. The total debt to GDP ratio for the US economy is pretty close to the 480% Brian Bradstreet (of FFH) mentioned so appears right.

 

We may only be in the first inning of deleveraging.

[woodstove]

Yes, thank you!  That Hodges article is thoughtprovoking.

[oldye]

GDP is a straightforward function of total economic spending,  its kind of like comparing debt to revenue, not profit.  The numbers are scary but irrelevant.

 

  I think debt vs the value of all U.S assets both foreign and domestic is a more useful ratio.  Considering the fact that U.S debt is in U.S dollars, its impossible for the US to be insolvent! 

[oec2000]

GDP is a straightforward function of total economic spending,  its kind of like comparing debt to revenue, not profit.  The numbers are scary but irrelevant[/i

 

How can you say that the Debt/GDP ratio is irrelevant? You may not have noticed but we are going through a 1 in a 100 year financial storm right now - most people would attribute excessive leverage as one of the root causes of this crisis.

 

The reason Debt/GDP is important is because there is a critical level beyond which further increases in the ratio is untenable - this is the point at which debt servicing eats up a significant portion of GDP.

 

I think debt vs the value of all U.S assets both foreign and domestic is a more useful ratio.

 

If you were a lender, would you be more interested in a borrower's income (i.e. ability to service/repay his debt) or his assets (which may be non-income producing or illiquid)? We only have to look to the mortgage crisis today to understand that it is caused primarily by the inability of borrowers to service their debt.

 

If you were China and lending trillions to the US, would you consider the servicing ability or the assets of the US as a nation? In the event of a default, do you think you can take possession of Manhattan or California and foreclose on it?

 

It is conventional wisdom to assume that no country will default on sovereign debt denominated in its own currency - this was until Russia defaulted on its Rouble debt in 1998.

 

You are correct to imply that the US can simply keep on printing money to pay interest on its debt. But, this does not mean that such actions have no consequences - as Buffett has said, there will be a price to pay later. You can choose to control the supply or the price of a currency but you cannot control both at the same time.

[Rabbitisrich]

GDP is a straightforward function of total economic spending,  its kind of like comparing debt to revenue, not profit.  The numbers are scary but irrelevant.

 

  I think debt vs the value of all U.S assets both foreign and domestic is a more useful ratio.  Considering the fact that U.S debt is in U.S dollars, its impossible for the US to be insolvent! 

 

It's true that GDP doesn't measure profit margin, but it's not exactly a revenue measure. For example, one business' labor costs show up as an employee's PCE. The various expenses that erode the revenues of a single business instead become a component of GDP. The export-import difference acts as a proxy for expenses by measuring the capital that has left the country.

[oldye]

 

 

I don't think there is a relationship between the solvency of the United States and the amount of commerce that takes place here.  GDP = money supply x velocity of money  or C + I + G + (Ex - Im)...at the current pace money supply will double over the next 8-9 years.  Companies with sustainable growing economic moats by definition will earn a greater % of the money supply in the future.

 

 

As long as the Chinese want the U.S consuming its products they have no choice but to accept dollars, what scares the crap out of me is that for now they've chosen to put that money to work at 3-4% when they could have been buying up our best assets.