For a third year in a row mainstream economists and analysts are once again planting the seeds of hope for a return to stronger GDP growth. The White House, if you look at their budget estimations, are banking on it as part of their long term deficit reduction plan. Unfortunately, it is highly unlikely that we will see growth in the economy return to 4% for a very long time.
Currently, the deficit between real GDP and the CBO's estimated potential GDP, is at the greatest deviation on record. However, that data point really doesn't tell us much other than the economy is currently operating well below its potential level. While most economists will point to the likely culprits of employment, wages, industrial production and consumption as the problem, which is correct, those issues are byproducts of the 50-Trillion pound Gorilla that sits quietly in the corner. That seemingly invisible Gorilla is simply - debt.
To get a better idea of what I mean let's take a look at economic growth in relation to debt levels. Prior to 1980 it took on average, beginning with 20 cents in 1952 and rising to 80 cents at the end of 1980, 37 cents of debt to finance of GDP. Today, that same dollar of GDP growth requires a little more than dollars to finance it. That's right - of debt to finance of GDP.
Therein, of course, lies the problem of returning to 4% economic growth in the foreseeable future. With real GDP currently at .4 Trillion and debt at .1 Trillion the ratio is 4:1 debt to GDP. In order for GDP to reach 4% growth in 2012 - GDP would have to expand to roughly .97 Trillion. This means debt would need to expand to .3 Trillion or a whopping .17 Trillion in the coming year.
To repeat that process in 2013 GDP would need to expand to .5 Trillion. In order to achieve that growth debt would need to expand further by another .25 Trillion. So forth and so on. Are you seeing the problem here?
The problem is simply the math. Furthermore, the current economic malaise is not something new that was caused by the financial crisis in 2008. The reality is that economic growth has deteriorated consistently since 1980. Economic growth cannot be supported by debt growth. Increases in debt reduce savings and productive investment. Debt, like a cancer, consumes income which detracts from consumption and investment. The larger the debt the more consumption it requires.
As interest rates began their long march lower in the 1980's so did economic growth. As growth began to slow the need to maintain higher standards of living required a reduction in the personal savings rate and increases in debt. In turn there was less available for productive investment. As each year passed quietly by the cancer of debt spread, undeteceted and ignored, until it became terminal. What we now realize, yet still try to ignore, is at the very heart of Austrian economic theory.
As we stated in "The Breaking Point" the Austrian school of thought views the current cycle “as the inevitable consequence of excessive growth in bank credit, exacerbated by inherently damaging and ineffective central bank policies, which cause interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings.”
In other words, the proponents of Austrian economics believe that a sustained period of low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. Low interest rates tend to stimulate borrowing from the banking system which in turn leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money and, therefore, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities. Finally, the credit-sourced boom results in widespread malinvestments.
Does any of this sound familiar?
The problem is that today exponential credit creation can no longer be sustained. The process of a “credit contraction” which will continue to occur in fits and starts over a long period of time as consumers, and the government, are ultimately forced to deal with the leverage and deficits. The good news is that process of "clearing" the market will eventually allow resources to be reallocated back towards more efficient uses and the economy will begin to grow again at more sustainable and organic rates.
Today, however, expectations of a return to economic growth rates of the past are most likely a just a fairy tale. The past 3 years of stock market returns have been fueled by trillions of dollars of support and direct injections into the financial system - that support is not sustainable in the long run. While the injections have kept the economy from falling into a depression in the short term - the unwinding of that support will suppress economic growth for many years to come.
Furthermore, the impact on the psyche of the consumer will continue to be impared much to the same degree as those that survived the depression era. The mantras for frugality and conservatism are very hard to reverse and have economic consequences. With the economy mired at lower growth rates likewise the stock market, which is ultimately a reflection of the economy and not vice versa, will remain mired at lower rates of growth.
The processes that fueled the economic growth over the last 30 years are now beginning to run in reverse, and when combined with the demographic shifts in the U.S., the impact could be far more immediate and prolonged than the media, economists and analysts are currently expecting.
Source: Street Talk
