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The crisis explained in one chart: Debt-to-GDP

Tuesday, January 13, 2009, 9:41 AM

If I was ever given just one chart, just one piece of data, to make the case that we were on an unsustainable path that had a date with a long period of contraction and economic hardship, it would be this one.

Debt_to_GDP_with_light_blue_arrow.jpg

Figure 1: This chart compares total debt (or “credit”) in the U.S. to GDP (or Gross Domestic Product) on a percentage basis. Current total credit-market debt stands at more than 340 percent of total GDP.

As we can see on this chart, the last time debts got even remotely close to current levels was back in the early 1930s, and that bears a bit of explanation. The debt-to-GDP ratio back then didn’t start to climb until after 1929 (blue arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts. With the exception of the Great Depression anomaly, our country always held less than 200 percent of our GDP in debt (green circle). In 1985 we violated that barrier and have never looked back.

What does this chart tell me? It says that what each of us knows to be “just how the economy works” is really a historically unusual experiment with debt that is barely 25 years old. In the sweep of economic history, this barely qualifies as a blink.

It says, if you listen carefully enough, that all of our global economic growth has been fictitious. An illusion of debt.

Consider that debt had most recently been growing at a rate six times faster than the underlying GDP and you’ll begin to appreciate just how bogus the recent “growth” really was.

Here's an example.  Consider two families living side by side. Each is earning $50,000/year. At our first “GDP snapshot” of these two families, we find that each has a GDP of $50k. But the next year one of the families goes out and buys an additional $50k of goods and services for itself, using a combination of auto loans, credit cards, student loans, and a home equity line of credit (HELOC).

At our second “GDP snapshot” one family is still mired in a $50k GDP but the other has undergone an exciting 100% growth in their economy and is now sporting a GDP of $100k.

But the underlying reality is that each family still has $50k of earning power. The measurement itself introduced a fallacy by neglecting to factor out the use of credit when measuring “growth.” That is exactly analogous to the US GDP situation and explains why the US, and much of the world, is now in for a very painful adjustment process.

Debt-to-GDP for family #2 assures that they will be living under the strain of paying down those loans for years to come. Time spent living beyond one’s means necessitates a future period of living below one’s means.

And this is why “unlocking the credit markets” is pure fiction.

Nothing needs to be unlocked. What we need is to recognize the vast damage that we did to ourselves as we elevated and then clung to a set of falsehoods.

The interesting part, as is always true of every bubble, is looking back and wondering how it is that we ever believed these falsehoods.

  • It never made sense that one country could consume wildly beyond its production forever.
  • One cannot borrow and consume one’s way to greater prosperity.
  • It is not possible for an economy to be 80% service based, at least not sustainably. 

A point I made in the Crash Course chapter on debt, which was that assets are variable but debts are fixed, can be broadened to include the claim that incomes are variable but debts are fixed.

That same spike in debt-to-GDP that weighed down the US during the Great Depression is now set to vault to some new stratospheric record of possibly 500% or 600% or more.

And the choices for reversing this ratio to a manageable level, notwithstanding Paulson’s confusing alphabet soup array of government bailout programs, are quite limited.

  1. Pay the debts down
  2. Default on them
  3. Inflate them away

That’s it. Those are all the options. All you have to do is decide which is the most likely outcome, and position your life and investments accordingly.

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52 Comments

TimesAwasting's picture
TimesAwasting
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Re: The crisis explained in one chart: Debt-to-GDP

Looks like choice # 3 is "Our Leaders" chosen course... Brilliant!

I guess we'll just have to "hunker-down" and prepare for the worst as this Ponzi scheme plays out... it's not like they (the Pols and Banksters) will listen to reason, or US for that matter (remember how well they listened to We The People as they passed TARP?).

Simple, easy to understand presentation... great work Chris!

Davos's picture
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Re: The crisis explained in one chart: Debt-to-GDP

 Chris wrote:


 

Here's an example. Consider two families living side by side. Each is earning $50,000/year. At our first “GDP snapshot” of these two families we find that each has a GDP of $50k. But the next year one of the families goes out and buys an additional $50k of goods and services for itself using a combination of auto loans, credit cards, student loans, and a home equity line of credit (HELOC).

  

Would it be safe to say: Family one fudged their earnings, with fuzzy math, by 40% using imputations, and a funky deflator and therefore really takes home $20,000.00? Of course, to make up for the $30,000.00 shortfall they scan money in their basement and print it on their laser color printer.

 

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Re: The crisis explained in one chart: Debt-to-GDP

Let me get this straight.

Option 1, pay them down.  It seems like do this the US would have to renegotiate them, as the US currently borrows to pay the interest, there is no way (especially given the direction of the US GDP this year and next etc) that the USA could even service the debt without renegotiating which is pretty close to defaulting on them, at least that is how the creditors would feel.  So option one seems like a lot like a soft option 2.

Option 2, default on them.  When I try to imagine that happening, even in the renegotiate version of doing that, it seems like that would really make the dollar toast.  No one would want it and anyone with it would try to get rid of it, as it would be losing value.  Which makes me think defaulting would pretty much look like option 3, but with a little more honesty about what the USA was doing, probably better option for the world economy if the US can't get its creditors to renegotiate the terms.

Option 3, inflate it away.  The dollar loses value, no one wants dollars, the USA actually has to produce something to get a hard currency (gold?) to buy things in the "global" economy like oil or cheap chinese consumer goods.  The US tries to print its way out of the problem, hyperinflation, etc.

Chris, these don't seem like much of a set options (they pretty much all amount to the same thing).  Is there a black swan option out there that no one has thought of yet?  Is there a global crisis that might shift the effect of these options so that their outcome is not so dire, in the short term, for the US dollar.  Thanks,

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Re: The crisis explained in one chart: Debt-to-GDP

Isn't one of the concepts in the Crash Course the link between the need for exponential growth in the economy and rise of debt?

In that case what was the situation prior to 1985 and the expansion of debt? Hasn't the pursuit of growth been with us for much longer than that?

I guess there's another ingredient that I'm overlooking, but I'm not sure what..

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Re: The crisis explained in one chart: Debt-to-GDP

This chart seems to explain or reflect the difference between the experience of my parents and me. My father worked intelligently and dilengently during the green circled area and was able to support the family on a single income, enjoy prosperity, pay off debt, and save significantly for retirement and childrens' college funds. I've spent my working life in the red circle so far and, though I'm a reasonably well paid professional and a frugal yankee, I've seen my debt grow and my savings shrink and have little hope to receive Social Security in the future.

waterdog's picture
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Re: The crisis explained in one chart: Debt-to-GDP

"The debt-to-GDP ratio back then didn't start to climb until after 1929 (blue arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts."

And what happens when GDP plummets out from under rising debt this time?  You can't have 10%+ unemployment without a concomitant decrease in production.  Even if most of the jobs lost are in the service sector (like mine was), they still ostensibly produced something of value. 

 

montypelerin's picture
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Re: The crisis explained in one chart: Debt-to-GDP

Yesterday, I inquired specifically about this very chart (not necessarily anticipating it would appear today) on the Subscribers Only section. I believe that you are right in using this is the one single chart that "explains" everything. However, my question, still unanswered and even more pertinent today, was expressed as follows:

 " The relationship between Total Credit and GDP puzzles me. I have seen this curve where Total Credit to GDP rises from about 150% of GDP (circa 1960) to 360% of GDP in 2007. I have no doubt that Credit has exploded. However, it is the mechanics of such a relationship that are troubling. if I interpret this correctly, even back in the old days of 1960, if GDP rose by $1,000 then Credit rose by $1,500. It just doesn't seem plausible to me that $1.50 in debt growth only produced a $1.00 in GDP growth. Or put differently, if you received a salary increase of $10,000 that year and you behaved as an "average" person, you increased your debt by $15,000. Recently, the data would suggest that a $10,000 increase would produce a $36,000 increase in debt. What am I missing?"

I agree that the chart is key to why things got so messed up. But, I have difficulty believing that, historically, a $1 of credit expansion never, ever produced a $1 of GDP expansion. What am I missing?

Downrange's picture
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Re: The crisis explained in one chart: Debt-to-GDP

Well, I keep coming back to those last few chapters of the Crash Course, where I saw quite clearly that we cannot continue to grow as we have, using the finite resource base of the planet to sustain us in the ways that we have.  Everything that we've been doing for the past hundred years, the duration of the oil boom, has been based upon a virtual cornucopia of surplus energy and resources, which are no longer going to be available in limitless quantities.  It's clear to me that this "run-up" is directly proportional to that resource spike, and that what we've had since 1985 or so is an economy designed for such an impossible world beginning to accomodate a dawning new reality. 

It hasn't worked.  Pouring more of the "same ole" into the battle has resulted in the emergence of a worldwide crisis in all markets and all things monetary.  The basis, the bedrock itself, has been revealed porous and crumbling.   What path appears most likely other than a rather fast collapse, and what happens during and after that?  These are the questions I am wrestling with.  

 

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Re: The crisis explained in one chart: Debt-to-GDP

So what happened in 1985 and the next couple years that caused the chart to rise so dramatically during that time?

Nichoman's picture
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Re: The crisis explained in one chart: Debt-to-GDP

Chris, Erik and Others...

 

Isn't an equally important question to understand and answer is comparing the rising Debt-to-GDP of USA to other World Nations changes in their Debt-to-GDP?

 

If someone has data on how this is evolving, seems critical in the future of the dollar, inflation, deflation, etc.

 

If I'm missing something or this is not relevent, please explain.

 

Thanks,

 

Nichoman

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Re: The crisis explained in one chart: Debt-to-GDP

If I understand the concepts that are presented then I'd have to say that yes - the pursuit of growth has been around much longer than that.  If you go back to the chapter on exponential growth, he talks about how even a small percentage every year eventually leads to an exponential graph.  However, this is also affected by outside political and economic issues.

Why 1985?  My personal opinion is that it was really the first time that the effects of Richard Nixon removing the gold backing of dollars in 1971 was felt.  Throughout the 1970s was a period of stagflation which culminated in Paul Volcker at the Federal Reserve raising interest rates drastically in the late 70s and early 80s.  The change in the rate of increase of the debt corresponds with the US economy emerging from the recession of the early 80s.  I could be wrong about this and I'd love to hear somebody elses explanation. 

 

eternal sunshine wrote:

Isn't one of the concepts in the Crash Course the link between the need for exponential growth in the economy and rise of debt?

In that case what was the situation prior to 1985 and the expansion of debt? Hasn't the pursuit of growth been with us for much longer than that?

I guess there's another ingredient that I'm overlooking, but I'm not sure what..

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Re: The crisis explained in one chart: Debt-to-GDP

Would defaulting on the debts to the FRB not be a possibility? That money was made 'out of thin air' anyway, so no real damage wil be done. Serious question!

i think defaulting on foreign countries will be seen as an act of war, because the amounts are too large.

Inflating them away has been the strategy from the start. If not done too fast you can get away with it.

 

rainbird's picture
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Re: The crisis explained in one chart: Debt-to-GDP

Not sure this isn't an intended effect, but FYI ... the chart does not appear to be visible until you register and log in.  At least, I couldn't see the chart until I logged in to post that I couldn't see the chart ... now I can.

SkylightMT's picture
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Re: The crisis explained in one chart: Debt-to-GDP

Nichoman wrote:

Isn't an equally important question to understand and answer is comparing the rising Debt-to-GDP of USA to other World Nations changes in their Debt-to-GDP?

 

This is exactly the same question I have.

Also, does anyone know or have an estimate as to what the "real" GDP is, and what the ratio of real GDP to govt debt is right now?

Damnthematrix's picture
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Re: The crisis explained in one chart: Debt-to-GDP

I have a different theory.....

Once the oil shock was over and oil became very cheap again, technological innovations flooded the market with 'new improved' gadgets.  This was the start of colour TVs, fuel injected  cars, computers, mobile phones, air conditioning....  the list is long.  Everyone 'wanted' one of the new gadgets, and year after year, they got better abd better, flashier, with more buttons, and so the old ones became garbage faster and faster.  Oh, and I forgot the innovation of credit cards.

This frenzied consumerism could only be fed with debt. And credit cards are absolutely responsible for fuelling this frenzy, because they don't 'feel' like you're borrowing.....  repaying doesn't even enter one' mind whilst the buzz of retail therapy pumps adrenalin through your veins!

Then I guess it just became a habit.

There's another scenario Chris M doesn't mention:  cancel all debts.  After all, they can NEVER be repaid....

Mike 

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Reply to Nichoman - Regarding other nations ratios

Hi Nichoman,

Good question regarding other countries and how they are faring. I did a little research and found the following chart from the Government of Canada:

http://www.fin.gc.ca/afr-rfa/2008/afr2008_1-eng.asp#Federal

It's a good deal better than the US situation at about 30% of GDP.

PS: That's why the idea of the "amero" is only catchy for americans - Canadians have little interest in buying into that plan. See the following quote from our Finance Minister:

"A North American common currency would undoubtedly mean for Canada the adoption of the U.S. dollar and U.S. monetary policy. Canada would have to give up its control of domestic inflation and interest rates."Chase, Steven (2007-11-22), "Consider a continental currency: Jarislowsky", The Globe and Mail, retrieved on 28 November 2007 

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Re: The crisis explained in one chart: Debt-to-GDP

see post #7

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Damnthematrix - "another scenario"

Hi Damnthematrix,

Your "another scenario" is actually much more plausible than most people realize - Well not exactly just wiping the debt out, but stopping payments and usually following by severely "renegotiating" the debt - It's called a debt moratorium and has been exercised by countries such as Peru, Brazil, Mexico, Russia, Argentina and guess who? Yup, the US, during the last Depression.

It's based on the old saying "If you owe a little, the bank owns you. If you owe a lot, you own the bank.".

Sounds more likely doesn't it?

On a side note, once you know you're going bankrupt you might as well live big. Citi needs another 10 billion? What the heck, give them 20... ;)

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Re: The crisis explained in one chart: Debt-to-GDP

Default by annihilation, obliteration or otherwise destruction of all of the lenders is one of  black swan options.

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Re: The crisis explained in one chart: Debt-to-GDP

The only other nation's debt/GDP ratio I'm aware of is ours in Australia.  We have this great Professor of Economicss, Steve Keen, who runs a blog called debtwatch where you can find the info below (and a whole lot more - much of it relevant to you guys)  http://www.debtdeflation.com/blogs/2008/11/30/debtwatch-no-29-december-2...

In recent history, there have been two depressions.....  and there are no prizes for guessing when they occured!  Whilst our situation is not as dire as yours, there is no way we are going to escape the mire...  and neither will the rest of the world.

Mike 

This was more than confirmed when RBA Deputy Governor Ric Battellino
published a graph showing Australia’s long term debt to GDP ratio
during a speech in September 2007 (see Figure 8, which is augmented to
include estimates of non-bank credit prior to 1953). 

Figure Eight

The model I’ve outlined above is extremely simple, and would need to
be substantially embellished to capture the main dynamics of a market
economy. But it is already streets ahead of neoclassical models by not
making an artificial distinction between the short and long term. To
paraphrase Keynes, “in the long run we are still in the short run”.

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Re: The crisis explained in one chart: Debt-to-GDP

I've been through the CC several times, and given it  to lots of friends and family.  But, I am not completely clear on some issues Chris covers.  For example:

If the Fed Res prints money and loans it to the U.S. gov, then what does the U.S. gov give the Fed Res as collateral for that debt?  Isn't it various kinds of treasury instruments?  And, if so, does the Fed Res then turn around and sell those instruments to U.S. citizens, and foreign interests, to get their money back?    If so, then the money the U.S. gov gets really comes, indirectly, from the public and foreign interests, who receive the treasury instruments as evidence of the "loan."   So, now we have the public and foreign interests holding U.S. gov instruments, that passed through the Fed Res to get to these holders.  And, the hope of the end holders is that the U.S. gov will make good on these instruments when they come due.  

So, does this mean that the Fed Res is just an entity that handles the transactions, so the U.S. gov can get their funds instantly, and then the Fed Res is really the one that we will turn these instruments back in to, when they mature?   If so, isn't the Fed Res making interest from the U.S. gov on the money they loaned them?  Yes.  And is the Fed Res paying back the exact same amount to the end holders of these instruments as the U.S. gov is paying them?  Or, is the Fed Res paying the end holders less than the U.S. gov is paying the Fed Res, so that the fed Res is making money on both ends?  And, if the amount is the same, why is the Fed Res even involved in the process in the first place?  i.e. Why doesn't the U.S. gov just issue the instruments directly to the end holders, and eliminate the Fed Res altogether?  I may be dense, but it seems to me that the U.S. gov is paying somebody else (Fed Res) a handsome amount to do what they could do themselves, i.e. print and distribute their own currency and instruments.  Is this is not true, then how does the Fed Res make its money to stay in business?

Another way of phrasing it, is this:  "Why the heck don't we, the U.S. gov, handle our own issuing of currency and debt instruments?"  What was the reasoning, in giving that job to private business? And, exactly what would be involved in firing the Fed Res and giving it back to us, the U.S. gov? 

And finally, can somebody who fully understands capitalism, explain to me in simple terms why both households and businesses don't use their own savings for expansion, research, etc. and earn the interest themselves that they pay to somebody else?  Yes, I know that it might mean slower growth, but is that necessarily bad, if growth that is too fast just winds up making us illiquid and insolvent?

Maybe our greedy need to acquire more, faster, (over expansion) has been at the root of all our problems. 

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Re: The crisis explained in one chart: Debt-to-GDP

Yes, I too have been hearing the word "jubilee" a lot lately.

 

Would love to hear Chris weigh in sometime on the idea.

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Re: The crisis explained in one chart: Debt-to-GDP

Beautifully explained; elegant simplicity.

If only they would listen to such reasoning!!!

What madness.

In an interview with Barron's when asked, "What do you think we'll learn from this financial crisis?," investment advisor Jeremy Grantham replied:

"An enormous amount in the short term, a fair amount in the mid-term, and in the long term, absolutely nothing."

Pretty much sums up the history of humankind.

Sigh.

(By the way, Jeremy Grantham predicted this fall from grace. And he's Dick Cheney's investment advisor. So much for Cheney's claim that none could see this coming. What a farce.)

Wendy

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Re: The crisis explained in one chart: Debt-to-GDP

For New Zealand (NZ) Debt graphs see http://www.johnpemberton.co.nz/html/debt_graphs.html

The data is current to March 2008 (end of NZ Financial tax year).  The site points to the raw data at the Reserve Bank of New Zealand so you can go off and verify the data and see more recent data if you wish

The charts tell their own story of NZ's love afair with debt

Regards,

Gibber

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Re: The crisis explained in one chart: Debt-to-GDP

csstudent wrote:

Why 1985?  My personal opinion is that it was really the first time that the effects of Richard Nixon removing the gold backing of dollars in 1971 was felt. 

Splitting the data into two at 1985, based on the 170% level, seems arbitrary.

If you work back from now, the trend has been more or less exponential since 1970, following a flat period in the late 1960s. It was then that the US experienced Peak Oil, and became an oil importer. It now imports 5 billion barrels of oil each year, and at $147/barrel that is $741 billion/year, which is a huge slug out of any economy - enough to make it crash, in fact.

If the economy hadn't crashed with oil at $147/b, the price of oil would have gone higher still. From the start of 2007 to mid-2008, the oil price tripled yet only 3.3% more oil was brought to market. This is the proof of worldwide Peak Oil, and of the failure of the economic theory of "free market mechanisms".

The breaking of the peg to gold was a default of sorts, and the lack of that solid backing has been used by the US Government to inflate their problems away. 

In the end though, China and Russia may decide to drop the US Dollar as the world trading currency, and they will be eagerly joined by Iran, Syria, Venezuela, Bolivia, Cuba, etc. The Gulf States may also ditch the dollar for their own currency for oil exports and trade. That will prick the US bond bubble we are currently seeing, and bring in the great hyperinflation.

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Re: The crisis explained in one chart: Debt-to-GDP

Thanks Chris for the easy-to-understand explanation. I have passed it on to all those who might be receptive. Here is a complementary article that I think CM.com readers might find enlightening (if also a bit frightening) I would encourage all to take a look.

The bond bubble is an accident waiting to happen

The bond vigilantes slumber. As the greatest sovereign bond bubble of all time
rolls into 2009, investors are clinging to an implausible assumption that
China and Japan will provide enough capital to keep the happy game going for
ever.

for more go to:

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/421821...

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Re: The crisis explained in one chart: Debt-to-GDP

Chris and his followers:

I am trying to grapple with the ultimate truth. I don't want to get so caught up that I become a "believer" - it is not my nature. So I was reading this post for the xx time and comparing it to all I have learned. I came upon a post by Chris on FSU in 2006: "The United States is Insolvent" at http://www.peakprosperity.com/martensonreport/united-states-insolvent which stated: 

"If we perform the same calculations for the US, however, we find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our “off balance sheet” items the national debt stands at $53 trillion or 403% of GDP."

This debt/GDP % of 403% from 2+ years ago compares to the % in today's post of "340 percent of total GDP. "

Are these calculated differently or has the percentage actually dropped from 2006?

Any help here? I am getting lost.

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Re: The crisis explained in one chart: Debt-to-GDP

Lisa G wrote:

"If we perform the same calculations for the US, however, we find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our “off balance sheet” items the national debt stands at $53 trillion or 403% of GDP."

 

This debt/GDP % of 403% from 2+ years ago compares to the % in today's post of "340 percent of total GDP. "

 

Are these calculated differently or has the percentage actually dropped from 2006?

 

Any help here? I am getting lost.

 

I'm having the same issues with not always being able to figure out which method is being used to calculate debt to GDP ratio. There are four measures floating around - one which gives a figure of 8.3%, one which gives a figure of 74.3% (this one does not include citizen debt or our longer term obligations such as social security, its the number most frequently used among mainstream economists as far as I can tell), one number gives a figure of 340%, and the last I have heard gives a ratio of 403%.

 So I will join you in being confused!

 However, I think I understand the difference in the last two numbers. Where Chris reports the GDP as 403% he is (probably, I think) including our long term debts (social security, medicaid) AND the debt of private citizens in addition to regular old govt debt, and in the 340% figure (I THINK but could be wrong) he is either leaving out private debt or he is leaving out social security/long term debt. So the two ratios aren't using the same measure.

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Re: The crisis explained in one chart: Debt-to-GDP

I think the following chart that I prepared will explain the matter, but not in any comforting way:

 

SOCIETY REVENUE AND DEBT BURDENS

(Based on 2008 Fiscal Year)

(Tabular $ in Billions)

 

OVERALL

Total GDP $ 14,500

Total Credit (3.6X GDP) 52,200

Unfunded Debt of Government 50,000

Total Debt of Society $ 102,200

Percentage of Total GDP 705%

 

Equivalent to Individual Earning $50,000 per year owing $353,000 in debt

 

FEDERAL GOVERNMENT PORTION

Gross Revenue $ 2,500

Total Debt 60,000

Debt as Percentage of Total 24,000%

 

Equivalent to Individual Earning $50,000 per year owing $1,200,000 in debt

 

REST OF SOCIETY

Gross Revenue $ 12,000

Total Debt 42,200

Debt as Percentage of Total 352%

 

Equivalent to Individual Earning $50,000 per year owing $175,800 in debt

 

 

 

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Re: The crisis explained in one chart: Debt-to-GDP

There's some interesting discussions on Financial Sense from 1/10: http://www.financialsense.com/fsn/main.html

Go to 3rd hour with Jim and John and listen to the forecasts.  They cover the normal range from gloomy to optimistic, and then talk about the more "outside the box" forecasts of a serious crash. Good listens.

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Re: The crisis explained in one chart: Debt-to-GDP

monty -

Nice work.  I'll use your numbers to help me illustrate the severity of the current and coming situation when I try to engage people and spread the word about this site. 

Skylight, Lisa: 

The calculation is done the same way.  Remember that there are two dynamics though.  Debt can go up or down and GDP can go up or down driving the percentages in directions that don't make sense on the surface.  You could have an increase in debt with a corresponding increase in GDP that makes the % drop.  On the surface that would seem good, but you have the combination of two effects at work - GDP increasing (Good) more than the increase in debt (Bad).  You could get a false sense of security from this.

On the other hand you could have rising debt and falling GDP (both bad, like we currently have) which makes the % rise even faster.

As long as you keep track of which factor is driving the direction the % is going, you can keep it in perspective.

Now let's hope we can see debt start to fall while GDP rises - but that would require responsible actions by our government and society - and why would we expect that to change?  Besides, hope without action is a losing strategy.

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How is the GDP calculated in this graph?

One of the things that made me FURIOUS when I watched the crash course was how our government has eroded the power of GDP by changing how it is calculated. 

Was the calculated GDP used in this graph the number used by the government or a real GPD calculated by an impartial source?

 The graph might appear different if we were to use actual numbers.

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Re: The crisis explained in one chart: Debt-to-GDP

To those who were wondering about "real" GDP, Davos does a nice breakdown of how cooked Uncle Sam's numbers most likely really are (scroll on down to post #7), which makes the implications of the subject of this particular thread even more ominous.  

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Re: The crisis explained in one chart: Debt-to-GDP

Hi montypelerin,

I think what you're getting at has to do with what's explained in this article, which was widely circulated on-line a couple weeks back.

The subject of GDP$ return on Debt$ injection was most recently addressed by Matt Savinar of lifeaftertheoilcrash.net, which just so happens to also refer to the aforementioned article.

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Re: The crisis explained in one chart: Debt-to-GDP

The 'debt' should be no mystery, revelation or 'shocker'. When a society uses 'evidence of debt' for its medium-of-exchange there will be debt and lots of it because there is nothing else. We need a medium-of-exchange that represents wealth monetized debt-free as an asset not a liability. Curently, the money supply only increases with more borrowing. Time does not increase the money supply. Time only increases the indebtedness. The unpayable cost of money (interest) is constantly added to the costs of production. However, no like amount of money is ever created to pay the cost of money resulting in a constant and growing spread between the price of raw products and the cost of finished products.

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Re: The crisis explained in one chart: Debt-to-GDP

Mainecooncat,

Thanks for your response and references. I had seen one of the articles but not the other.

Debt has become less effective because it has polluted our economy. Rational enitities realize the unsustainabilty of the current overleveraging and will repair their balance sheets. So-called economists push for a stimulus package because they claim a tax cut would be "saved" by the unwashed masses. This rationale is incredibily stupid and elitist. To these economists, Individuals don't matter; it is the collective good that must be served. It is hubris and desperation of the highest order that causes them to think that the will of the people can be subverted. The people will not alter their objectives because they know they cannot sustain their own personal levels of debt. They will remedy this imbalance in whatever ways they can, regardless of what the government does.

I guess my problem is still with the notion that a dollar of debt appears to have never been able to produce a dollar of GDP. The data set I have goes back to 1960 or 48 years ago. I grouped years into four year periods where my first four years ended in 1964. The change in debt over that four years when divided by the change in nominal GDP for that period was 1.7. So, even back then it took $1.70 of debt to produce a $1.00 of GDP. That relationship was relatively stable up until the late 70s when it started its dramatic rise. The most recent period the relationship was over 6.

It would seem that at some point in the past a dollar of debt had to produce at least a dollar of GDP growth. Further, up until the late 1970s both the Monetarist and Keynesian models appeared to reasonably reflect underlying reality. Yet, with the relationship of 1.7 or thereabouts to 1, I am unsure how that relationship would have held, especially using something as straightforward as the Quantity Equation.

Still perplexed.

 

 

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Re: The crisis explained in one chart: Debt-to-GDP

"The surest way to overturn the existing basis of any society is to debauch the currency. It engages all the hidden forces of economics on the side of destruction as does so in a manner in which not one man in a million is able to diagnose." John Maynard Keynes

This is what's happened. Our medium-of-exchange has been corrupted ...switched from an evidence of wealth to an evidence of debt. It must once again represent wealth not debt.

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Re: The crisis explained in one chart: Debt-to-GDP

csstudent wrote:
Why 1985? My personal opinion is that it was really the first time that the effects of Richard Nixon removing the gold backing of dollars in 1971 was felt. Throughout the 1970s was a period of stagflation which culminated in Paul Volcker at the Federal Reserve raising interest rates drastically in the late 70s and early 80s. The change in the rate of increase of the debt corresponds with the US economy emerging from the recession of the early 80s. I could be wrong about this and I'd love to hear somebody elses explanation.

The effects of the Monetary Control Act?

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Re: The crisis explained in one chart: Debt-to-GDP

cmartenson wrote:

If I was ever given just one chart, just one piece of data, to make the case that we were on an unsustainable path that had a date with a long period of contraction and economic hardship, it would be this one.

Debt_to_GDP_with_light_blue_arrow.jpg

Figure 1: This chart compares total debt (or “credit”) in the U.S. to GDP (or Gross Domestic Product) on a percentage basis. Current total credit-market debt stands at more than 340 percent of total GDP.

As we can see on this chart, the last time debts got even remotely close to current levels was back in the early 1930s, and that bears a bit of explanation. The debt-to-GDP ratio back then didn’t start to climb until after 1929 (blue arrow), because debts remained relatively fixed in size, while it was the GDP that fell away from under the debts. With the exception of the Great Depression anomaly, our country always held less than 200 percent of our GDP in debt (green circle). In 1985 we violated that barrier and have never looked back.

What does this chart tell me? It says that what each of us knows to be “just how the economy works” is really a historically unusual experiment with debt that is barely 25 years old. In the sweep of economic history, this barely qualifies as a blink.

It says, if you listen carefully enough, that all of our global economic growth has been fictitious. An illusion of debt.

Consider that debt had most recently been growing at a rate six times faster than the underlying GDP and you’ll begin to appreciate just how bogus the recent “growth” really was.

Here's an example.  Consider two families living side by side. Each is earning $50,000/year. At our first “GDP snapshot” of these two families, we find that each has a GDP of $50k. But the next year one of the families goes out and buys an additional $50k of goods and services for itself, using a combination of auto loans, credit cards, student loans, and a home equity line of credit (HELOC).

At our second “GDP snapshot” one family is still mired in a $50k GDP but the other has undergone an exciting 100% growth in their economy and is now sporting a GDP of $100k.

But the underlying reality is that each family still has $50k of earning power. The measurement itself introduced a fallacy by neglecting to factor out the use of credit when measuring “growth.” That is exactly analogous to the US GDP situation and explains why the US, and much of the world, is now in for a very painful adjustment process.

Debt-to-GDP for family #2 assures that they will be living under the strain of paying down those loans for years to come. Time spent living beyond one’s means necessitates a future period of living below one’s means.

And this is why “unlocking the credit markets” is pure fiction.

Nothing needs to be unlocked. What we need is to recognize the vast damage that we did to ourselves as we elevated and then clung to a set of falsehoods.

The interesting part, as is always true of every bubble, is looking back and wondering how it is that we ever believed these falsehoods.

  • It never made sense that one country could consume wildly beyond its production forever.
  • One cannot borrow and consume one’s way to greater prosperity.
  • It is not possible for an economy to be 80% service based, at least not sustainably. 

A point I made in the Crash Course chapter on debt, which was that assets are variable but debts are fixed, can be broadened to include the claim that incomes are variable but debts are fixed.

That same spike in debt-to-GDP that weighed down the US during the Great Depression is now set to vault to some new stratospheric record of possibly 500% or 600% or more.

And the choices for reversing this ratio to a manageable level, notwithstanding Paulson’s confusing alphabet soup array of government bailout programs, are quite limited.

  1. Pay the debts down
  2. Default on them
  3. Inflate them away

That’s it. Those are all the options. All you have to do is decide which is the most likely outcome, and position your life and investments accordingly.

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Re: The crisis explained in one chart: Debt-to-GDP

Great article.  Interesting concept.  We borrow & spend thus creating a higher GDP.  With a higher GDP our debt to GDP ratio is lower, making us more credit worthy.  Good time to buy US Treasuries I guess:<)  (Yes that's a joke)

The article states how unbelievable it is that people didn't see this coming.  I read countless articles from people who saw this coming including, Warren Buffet, Jim Rodgers, Nouriel Roubini & Peter Schiff to name just a few. Warren bet against the dollar.  He was 100% right by his style of investing he just didn't count on the new style market manipulation we see today.  Rodgers hit the nail on the head.  He predicted a suckers rally.  I sold 400k in euroes at 1.57, missed the bottom by a little & bought the euro back at 1.34.

The next phase of this crisis isn't far off and everyone should see it coming.  Yes Bond market troubles.  Once the economy crashes & equities crumble, people have problem paying their debts & so do corporations & so do governments.

The stock market crash of 1929 led to the bond market crash of 1931.  That was when the great depresssion got really bad.

Good news though.  Governments are working together to print money like crazy now.  This will create a wave of mega inflation thus reducing debt to earnings ratios & people can start borrowing & spending again.

I have just explained what is going to happen to you ahead of time.  Don't buy bonds with a fixed rate of return. Dont keep any more money in your bank account than you dare.  Taxpayers will pick up some of the tab for this scam but the rest of the tab will be paid for by the holders of fiat currencies.

Turn your money into real stuff...soon.  You may have till fall at the latest.  It looks like the inflationary period is already beginning.

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Re: The crisis explained in one chart: Debt-to-GDP

There is no real way to print or talk our way out of the fact we have been sending the world pieces of paper & they have been sending us stuff for nearly 40 years.

A couple of options are available although I'm not so sure they are less dire.

War

Intentionally let the problem get so bad we are the last man standing

Never forget.  They new what would happen when they flooded the markets with as much money as they did.  This is not an uncontrolled event.

Think about it for a moment.  What is the problem?  Workers of the world can make more than they can afford to buy.  The workers of the world go to work every day and build 10 cars and are paid enough to buy 9 of them. The 10th car is sold on credit.  Through globalization, the workers of the world have had to compete at levels never before seeen.  To make the econom function, governments have forced banks to loan at ever increasing levels to get that 10th car sold.

Forgetting, New World Order or other options I mentioned above, Inflation is the way out.  Under the current system, ever increasing debt is required (look at the chart if you doubt).

This is not just happening in the US either.  It is a worldwide phenomenon.

Look at it from a global picture.  Banks put 100 into the world global money supply.  They demand the 100 back plus interest.  For example if 150 dollars needs to be paid back where does the other 50 come from?

It comes when the Goverment prints it which is what is happing now. This has happened before with inflation rates to the tune of 10 - 15 percent.  You've seen the graph, what kind of inflation are we looking at this time.

My prediction.

The banksters are about to create a globlal currency.  They are no longer afraid to debase the US dollar.  They will use the US dollar for a time (few years) along with other currencies to back the global currency to avoid a major meldown.

I've got a feeling I'm right on this one.  If you've got insight on any topics email me at [email protected]

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Re: The crisis explained in one chart: Debt-to-GDP

All this stuff we want to buy must be fueled by debt.  Don't forget we are the ones who go to work everyday and make all this stuff.Year over year productivity has far outpaced year over year pay. THIS IS THE PROBLEM.  WE MAKE MORE THAN WE ARE PAID TO BUY. To get the rest sold we are lent money.

I challenge anyone to refute this most common sense statement from an engineer.  I've recently become interested in economics and it looks to me like people need to throw all the garbage they read out the window & think like enginneers.  It especially reminds me of thermodynamics with energy in & energy out.  Energy is never created or destroyed, it merely changes form.  I think we are experiencing more of an entropy problem.

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Re: The crisis explained in one chart: Debt-to-GDP

I believe the differnce between debt growth & credit growth is interest on loans.

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Re: The crisis explained in one chart: Debt-to-GDP

Lately, we’ve heard a great deal about the federal debt/GDP ratio. This surely is one of the strangest ratios in economics, because it involves unrelated measures, questionable definitions and different time periods – the classic “apples/oranges” comparison.

Federal “debt” is the net amount of money the federal government ever has created in our 200+ year history. GDP is the total dollar value of goods and services creating in America, this year. The two are unrelated.

For example, let’s say that in its first year, a government runs a $10 trillion deficit (i.e., creates $10 trillion), and in the twenty subsequent years runs $0 deficits. What would be the national debt? Answer: $10 trillion. The national debt would remain at the same $10 trillion level for all twenty-one years.

But the debt/GDP ratio would change every year, depending on that year’s GDP. Assuming money creation has some effect on GDP, presumably more recent events have a stronger effect. That is, the more recent balanced budgets surely would have a stronger effect on GDP than did that original deficit of twenty years ago. Yet, that strength would not be reflected in the debt/GDP ratio, which would continue to use $10 trillion as the numerator of the fraction. In measuring federal debt, what happened many years ago is identical to what happened yesterday.

Also, the amount of money in the U.S. presumably has more effect on GDP than does the amount of money outside the U.S. Yet, the debt/GDP ratio does not take this difference into consideration. In measuring federal debt, the location of money is irrelevant.

Finally, the government creates debt first by creating T-securities out of thin air, backed only by full faith and credit, then selling these securities for dollars it previously had created from thin air. The government just as easily and as prudently could create dollars from thin air, also backed only by full faith and credit, and dispense with the creation and sale of T-securities. That would reduce and ultimately eliminate federal debt, and over time the debt/GDP ratio would = 0. Perhaps that would make the debt hawks feel better, but fundamentally nothing had happened. The three-step method for creating money merely had been reduced to a one-step method.

Today, Japan’s ratio is close to 200%, the U.S. is close to 100% and has been much higher. By contrast, Russia’s, Chili’s, Libya’s, Qatar’s and others are below 10% – which tells you nothing about their economies.

And that is why the debt/GDP ratio is meaningless.

Rodger Malcolm Mitchell
http:www.rodgermitchell.com

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Re: The crisis explained in one chart: Debt-to-GDP

The Black Swan is WarCool This is not really a response to your writings, more just my own ramblings!)

Since the last market crash in 2000 2001 the fed has been reinflating, but now they inflated away 30 years of growth in just 6 years. This entire market move to 15 000 dow was an illusion built on nothing more than monopoly money. The money changers are still running this country and they got a large bonus for doing such a fantastic job to boot.

I think the great minds of wallstreet and government came to the conclusion back in 2000 to create a massive arms development program so that they could spend away this dollar as fast as possible and build out their war machine at the impending thrashing of the dollar and eventual move to a single north american currency! Now as it stand the US has a well trained large army with tremendous technology advantage over many other nations. This is no coincidence going into the all painful 'payment' stage of bubble economics. This bubble was so large and so widespread that people are not going to want to pay these debts. They will walk away in droves.

Because we are already seeing smart debtors simply walk away from assets that can be paid! This is going to be a mass exodus out of assets and banks to cash in the mattress. This becomes worse at every turn with lowering wages, increasing unemployment and riots in the streets as families get hungry. So called well meaning elitist politicians start discussing tearing down homes once again, and yet families are left homeless.  Civil rest is already occurring in many parts of the world, and will only really be understood here when California falls soon.

This debt repayment phase may not go as well as paid, since the bankers are not required to pay for their bad loan practices neither should well intentioned and mislead Americans.

I believe that once hunger strikes more americans will hit the streets and give up the middle finger to those that have and to governements that have destroyed their future with lies and deceipts.

War being the fourth becomes easier and easier as the bottom rung feel defeated and lose hope. These individuals are a growing segment of the population, and as their numbers grow so does their strength. No matter how neurotic their ideals become, locally they become the dominant force ready to join the cause, any cause.

In Africa we see all the time the ill effects of no food or hope, and that is war. How this could happen is infinite in possibilities, but it could simply be a spread of war in the middle east to Iran and then Russia. Ideally as far away from China as not to upset them, and why not take out Venezuela while their at it. Protect them from the tyrrany of evil as well. Anything to keep peoples minds of their lack of quality of life and dreams they once enjoyed. In other words a reset of the mind to lower expectations so once again men can be happy with less. Human expectations if renewed every so many years is a great tool for slavery of the debt tool once again.

Earlier someone said that a default of the debt would threaten war, absolutely a real possibility. It would hardly matter with that many nukes and large airforce and navy.

The inflation theory does not work when velocity of money comes to a screeching hault because of sickening money changer carry trades that steal from the people and pay the banks. Vile anarchists that enslave the working class and syphon off all of their value created by interest and taxation.

The last cycle will not be seen for years, any velocity will be quickly destroyed when fear of not having ones next meal arises. As well any income earned is being grabbed by the Buffets of the world who enslaved large companies with huge arm twisting interest rates.

I am not sure when or if a larger war would occur, but a quick  Reichstag fire in the white house or senate. Perhaps a quick bomb in the senate whiping out the cabinet would allow someone to step in and make decisive actions knowone else could make. This would then give power to a sole individual that could send all of our kids to their deaths.

I may come accross as somewhat over the edge, but all of us here were calling this years ago and we were all conspiracy theorists back then. Now what are we?

I will never bother studying the numbers in depth, the exact nature and how or why doesn't matter one bit. What matters are the facts that we can simply not afford to repay all of the debt, and all these ideas of no interest on debts etc, only hinder growth and help create a nation of hording zombies moving from town to town looking for a job or a loaf of bread.

The powers that be will not allow a 10 or 15 or god for bid 20 year pay back cycle, tha is far too slow for their greed. War is much faster and much more profitable for those that can avoid it and supply it.

Just my ramblings on the 4th option.Surprised

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Re: The crisis explained in one chart: Debt-to-GDP

And one more thing on the large war machine of the US, they have the ability to use their own leverage of living in America to attract a massive number of immagrants.

Access to a huge low paying army with ideals of living in one of the richest countries in the world is at their door step in Mexico. As well by simply offering a green card to those who are willing to fight for their new country could drive possibly 1 or 2 hundred million of age soldiers to the doorsteps of uncle sam. So the fear of China is quite mute if they posess first strike capabilities.

More impaired ramblings on my part, but I enjoy the reading on this site, great thinkers here.

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Re: Damnthematrix - "another scenario"

Investment strategies.....?  ME!

My strategy is spend everything you've got.......  on debt first, then essential items like tools, fertiliser, livestock, and a lifestyle that runs on the smell of an oily rag.

Mike

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The Federal reserve doesn't loan money to the government

I always hear that, but isn't that one of those myths?

The US government gets their deficit money by issuing bonds?

The amount of federal reserve "bunk" on the internet is staggering, but I'm pretty sure they're not loaning the government anything!

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Yeah the S+P report that just came out will probably mean

the interest on the bonds will go up?

That's trouble? Right now the Chinese are probably wondering if the US government is taking any of this seriously?

I don't think they are, which is astounding to me!

It's like we're represented by two parties, the Homer Simpson party vs. the Peter Griffin party.

Don't ask me which one is democrat and which one is republican, what difference does it make?

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