Saturday, January 16, 2010

Food for Thought: Debt to GDP Ratio

Politicians are very good at spending other people's money. Heck, we're all good at that! Give me a Best Buy gift card for Christmas and I suddenly need something from Best Buy!

Despite what politicians think about deficits, they do actually matter. Or at least, they matter when they all get added up and turned into debt someone else needs to service or -- shudder -- pay back. Okay, yea, you can stop laughing over that last bit. It's been a loooong time since any of the federal debt actually got paid back (don't get me started on using SS trust fund surpluses to make the general fund deficits look smaller).

It can be dangerous to just look at debt levels without normalizing by something. Usually the federal debt is normalized (divided by) the U.S. Gross Domestic Product (GDP) yielding a chart of the debt something like this:

The optimist looks at this chart and says "See, it's been higher before, what are you so worried about?"

The pessimist notes a couple of things:
  • GDP includes all goods and services produced or consumed in the country in a given year. Given that large deficits allow consumption way beyond the natural level, and we are consuming much more than we produce these days, it's not hard to get a little worried that normalizing debt with debt-driven consumption (rather than true production and income-producing activity) doesn't yield much happy factor.
  • The previous peak was during a World War: Fighting for survival, all young men to the front, buy war bonds, that sort of thing. This peak (and it hasn't peaked yet, not by a long shot) is a year or two into a recession following an long period of peace and prosperity (fueled by debt, but prosperity nevertheless).
Color me pessimistic. I see the federal debt with nowhere to go but up. I ran in to this chart the other day. Seems pretty optimistic to take a clearly accelerating up trend in debt/GDP and suddenly flatten it for 8 years!

In a future post I'll talk about what countries do when their debt becomes impossible to service.

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