The Truth About Budgets, For Both Left and Right
The Market Ticker - Commentary on The Capital Markets
2011-07-17 11:51 by Karl Denninger
in Editorial , 118 references Ignore this thread
The Truth About Budgets, For Both Left and Right*
 

The lies are flying fast and furious this weekend (and all last week for that matter) related to the "debt ceiling" and partisan wrangling has reached a fever pitch, with some representatives now claiming that the Republicans are "racist" for refusing to raise it.

Let's look at the facts, and deal with them - because we really have no other choice here.  I apologize in advance for the length of this post, but there's simply no way to make it shorter.

I'm going to start with some indisputable history.  We'll begin with this chart, because it tells us exactly what the outcome of each quarter of economic activity has been since 1953.  It draws on two official data sources - The Fed's Z1 and The BEA's GDP series:

I've presented this chart many times before (although the previous versions had a sign extension problem during the 09 time period which was just recently caught) and it is important to understand what it shows you.  This is simply a graphing mathematical ratio relationship of the number of dollars of GDP created and the number of dollars of new debt created anywhere in the economy.  It does not distinguish as to where the credit is created, just that it is, nor does it distinguish as to how the GDP is created (e.g. is it consumption, net investment, etc)  If, for each dollar of GDP expansion there was one dollar of debt expansion, then it is "0".  If there are two dollars of debt expansion for each dollar of GDP expansion, then it is "-1".  And if there are two dollars of GDP expansion for each dollar of debt expansion, then it is "1".  Mathematically it is "((Quarterly Change in GDP) - (Quarterly Change in Debt)) / ABS(Quarterly Change in debt).  Yes, it is possible for this calculation to throw an error (attempting to divide by zero) if the change in debt is exactly zero.

Therefore, for any quarter in which this indicator is positive, debt is being used predominantly for expansion of output, and is productive.  The more-positive, the more productive.  For any quarter in which it is negative debt is being used for either speculation or consumption and is destructive.  The exception is if debt is actually contracting.

Here's another way to look at it that addresses this problem:

The amusing part of both of these charts is what they tell you about the sustainability impact of the collapse: What happened during that time was actually net good!  From Q2 2009 through Q1 2010, we had actual debt-adjusted positive growth!  Note, however, that we're right back to our sinful ways and again, other than during the "collapse" we never had positive GDP growth from 1980 onward. From a formula perspective this one is ((Change in GDP - Change in Debt) / Previous GDP).  Since the GDP is never zero, this one cannot error out.  It also expresses the change in terms of percent of GDP as opposed to a ratio between GDP and debt itself, which may be more-useful to some.

The problem, which ever way you choose to express the ratios, is this: Since 1980 there has not been one three month period in which GDP expanded faster than new debt did, except during the collapse itself.

Read that again: There has not been one quarter in which actual economic expansion occurred, on net, funded by improvements in actual economic output since 1980 during the so-called "great economy" we have enjoyed over the last 30 years.  Not one time, even with the introduction of the personal computer, the introduction of the Internet, and with the so-called "great productivity" improvements that we have been sold as "facts" by the so-called mainstream media.  Only the collapse produced net-positive results even though they felt like Hell on Earth for the population as a whole!

We have literally put the nation's forward "progress" on the credit card in each and every three month period since 1980!

This is the root of the problem we now face and there is nothing we can do about history; it is fact.  We can only change the future.

This is what that chart looks like in terms of what we actually had to do to achieve that horrific outcome:

This is the quarterly change in dollars of GDP and debt in the economy in all sectors since 1953.  You will notice that while the best we've ever managed to achieve is around $250 billion in net GDP additions, we have added approximately $1,300 billion in debt in one single quarter.  Again, these are historical facts and nothing we can do will change them.  This is where the distortions in our economy have come from, and they have occurred in both Democrat and Republican administrations along with Republican and Democrat Congresses.  President Clinton, for whom many pine, in fact promoted private business Ponzi Finance at a faster rate than he was "helping" on the Federal side. 

Ironically, it was George HW Bush (Bush the Elder) who was the last President to make any sort of actual progress in getting those two lines to cross, albeit unsuccessfully.  As for President Obama, the collapse in credit accreation was due to the economic meltdown, but it was short-lived as you can see.  The reason for that is found here:

Federal Debt creation skyrocketed starting in 2008, Bush's last year.  But it has only accelerated under President Obama.  To those who claim that President Obama has somehow "inherited" Bush's problems, irrespective of whether you believe that or not he has continued the destructive policies of his predecessor in this regard.

President Bush tried to cover up an economic depression.  We know this to be factually true for the following reason:

The last calendar year of Bush's Presidency, 2008, he ran government deficits as a percentage of GDP to 10%.  Absent that deficit spending, since GDP is defined as "C + I + G + (x-i)" GDP would have contracted by at least 10%.  This is 2nd grade mathematics - specifically, subtraction.  Since the cessation of that deficit spending would have a multiplier effect (and economists fight over exactly how much all the time) the actual contraction would have been more than 10%.  The 10% line is the barrier behind which economists call an economic contraction "Depression." 

Ergo, we have been in an economic depression for the last three years which government has covered up through massive deficit spending exceeding 10% of GDP.  Again, this is mathematics, and irrespective of whether you wish to believe it or not, these are the mathematical facts.  Again, both Democrats and Republicans are equally responsible.

Unfortunately the news gets worse.  As I pointed out in the spreadsheet on Friday, our government currently spends about 11% of it's budget on interest.  It cannot, of course, spend more than its budget on interest, nor can it spend anywhere near all of it, since there are functions of government that are essential (even if only to provide lighting to the Capitol building!)  If we continue to expand government at 5% (over the last ten years it has in fact been 7%) annually and interest rates do not go up at all (3% blended, roughly) then at present rates of government debt creation within ten years more than 20% of the budget will be interest payments, in another 10 it will be nearly 40%, and so on. 

You can see the problem immediately - for each decade the percentage of interest payments in relationship to the budget doubles

You might look at that spreadsheet and deduce that we have some time.  You'd be wrong.  We already used up our "reserve" of time by suppressing interest rates via The Fed. This bought us a few years of time, but that bullet has now been spent.

The reason we cannot continue on the present course is that the important factor is the spread between government debt creation and government revenue increase.  But remember, government revenue can only go up as GDP does in a sustainable fashion.  That's because government by definition gets its money by imposing tax upon production.  If taxes rise faster than GDP does the attempt to raise taxes fails over the intermediate term for the same reason that debt cannot rise faster than GDP (you can think of taxes as simply an interest payment on GDP if you wish; mathematically they're identical.)

Right now we have about 2% of "reported" GDP growth on an annualized basis.  We are borrowing and spending, however, almost 12% of GDP.  That means the "spread" is about 10%. 

In order to actually begin to increase stability in government debt, that spread must be negative!  Making it "less positive" slows the slide in stability, but does not reverse it.

And that's where the problem comes in that confounds accurate analysis of where the event horizon lays.  Let's assume we stop deficit spending tomorrow.  GDP contracts by 12% from where it is now immediately and the spread does not change.  That is, government has not improved its fiscal sustainability at all!

It's worse; in the short run sustainability will get worse because of the aforementioned multiplier effect.  That is, GDP will contract not to -10% but to something more based on that multiplier!  So in the short run, until that works its way through the system, you actually go further into the hole!

Most economists agree that this effect requires somewhere between three and six quarters to stop percolating.  That is, when you stop (or increase) government deficit spending the GDP impact is "absorbed" in somewhere between nine months and a year and a half.  What we do not know, and nobody can give you can accurate number on, is what the "knock-on effect" percentage is going to be.

We thus cannot go to the "wire" before we decide to take this problem on and fix it.  If we do we will blow up for certain.  There is also nobody, myself included, who can give you an accurate read on exactly where the cliff-edge is.  I don't know, they don't know, nobody knows.  But what is absolutely certain is that the longer we take to deal with this the higher the probability that we will initiate a downward spiral where government revenues effectively collapse while interest rates skyrocket, making it impossible for the government to cover its debts.  This is what happened in Greece; they danced too close to the line and when they tried to pull back went off the edge instead.

The following facts are in evidence and cannot reasonably be disputed:

  1. We do not have ten years to get to the point where government deficits grow slower than GDP does.  We may have five years.  It is possible we're already beyond the event horizon and squandered our chance in 2007.  Nobody knows exactly where the cliff-edge is, and anyone who claims they do is lying.  The longer we take to get to sustainability the greater the risk is that we're too late, and there are no "mulligans" in this game.

  2. The mathematics are immutable facts in regard to the sustainability of what we're doing.  There is no arguing with the law of exponents.  Those "economists" who claim otherwise are lying.  If they do not understand the spreadsheet linked here and elsewhere it's due to willful blindness - the properties of exponential functions are taught in middle school.  There is no complicated math required nor can you change the outcome of exponential functions irrespective of what sort of mathematical model you throw against the wall. 

  3. Due to the immutable law of exponents the longer we wait to get government debt level growth below that of GDP the worse the economic damage will be.  It does not matter if you cut spending or raise taxes; both are immediately subtractive to GDP since taxes must come from either "C" or "I" in the GDP computation and spending comes out of "G".  This is subtraction, which is typically taught in second grade.  No amount of arm-waving can change these facts.

  4. We cannot avoid recognition of the economic depression we entered in 2008.  The worst GDP change we recorded in 2008/09 was -4% annualized.  We must, inevitably, absorb at least three times that much damage.  "Postponement", known in the media as "kicking the can", makes the problem worse.  To illustrate my back-of-envelope computations show that the total damage necessary in 2000 to restore balance was approximately 10% of GDP.  Now it's at least 20% and may be more.  Not far from that level is catastrophic collapse.

  5. Printing money, QEx and whatever else cannot change this outcome.   Distorting the interest rates on government debt, which is what QE does, temporarily changes the amount of time you have before everything blows up but for any positive interest rate you blow up anyway.  Simple emission of currency (which is what unbacked QE eventually devolves into if you keep at it long enough) destroys the purchasing power of each unit of currency (the dollar) which cannot work either; due to slippage and offshoring of labor this simply destroys your tax base and therefore trashes the government's coverage ratio (or the ratio of interest payments related to tax revenues.)

  6. The best time to take the economic hit is right now.  The second-best time is over the next two years.  If we don't get this adjustment in federal spending and revenues completed by that time, it may not matter what we do.  This is simple mathematics - every year we fail to accept this hit the size of the hit we must accept grows!  This means that the charades where there is a claim that you have "cut spending" when in fact you really just didn't increase it as much as you planned must stop.  The facts are simple: Over the next two to three years the size of government must shrink by about half, tax revenues (not rates) must roughly double, or some combination of the two.  But remember: both cutting spending and raising taxes will reduce GDP dollar-for-dollar.  Therefore the question is not which is "more harmful" to GDP - both will be.  The question is simply "what services are the people both desiring government to provide and are willing to pay for here and now through taxation."  For any service which is either undesired or the people will not fund it in the present tense government cannot provide it.  Period. 

  7. We must fix the medical system.  If we don't, nothing else matters.  Notice I didn't say "Medicare" or "Medicaid."  I said the medical system.  I have written extensively on this and cover it in depth in my upcoming book Leverage, which is currently in copy editing and will be out soon (estimated publication date is currently in November.)  The simple fact of the matter is that we can write checks with technology in the medical space we cannot cash, and we've tried to cover this up with all sorts of ridiculous and destructive distortions, from EMTALA to providing $1m births "free" to illegal immigrants to cartel-like behavior in diagnostics to barring re-importation of drugs and devices.  It's simply outrageous that the local Best Buy must post a price on their 46" TV and honor it for everyone, yet I cannot walk into a doctor's office or hospital and get a price on having my gallbladder removed which must be honored for everyone.  This sort of behavior is illegal in many other industries (see the Sherman and Clayton Acts specifically) but the medical and insurance industries are, through various devices, exempt.

  8. We must fix the tax and trade systems. While we cannot prevent the economic contraction we can try to blunt it's impact by putting a stop to the incentives to offshore production that are based on near-slave labor, environment arbitrage and tax preference.  These are big issues and must be debated in the open and fixed.  Among the problems with the tax system is that many Americans have literally no skin in the federal tax game.  That must end.  So must the fiction of a "Social Security" and "Medicare" trust fund.  Either cut them loose and turn them into true trustee arrangements (in which case you can opt out and walk away) or stop lying about them and fold the entire mess into the general operating budget.  When it comes to taxes either a flat tax only on people (no corporate income tax) with zero deductions (yes, I said zero!) or The Fair Tax on consumption makes sense.   What doesn't make sense is what we do now.  Key among the things we must stop doing is allowing deductibility of any interest expense - by anyone.  There's much more (again, covered in the Ticker over the years and in Leverage.)

  9. We must have an actual energy policy. A real one.  This is a tough, tough issue but we must face it.  30 years of blowing Arab Shieks is not an energy policy, but this must be dealt with anyway.  Roughly half of our military expenditure goes, directly and indirectly, to securing energy supplies.  We import about 1.5 billion barrels a year from nations that are deemed "dangerous or unstable" by the US State Department.  If $300 billion a year of our military expenditures go toward protection this access, directly and indirectly, then each of those barrels does not cost $100, it costs $300 and our net cost of a barrel including domestic and "friendly" imports (think Canada) is approximately $200!  This is idiotic and must stopIt cannot, however, stop with "greenie" promises and premises - they do not work when analyzed on the basis of thermodynamics.  There are solutions (again, I've gone over them extensively in The Ticker and they feature in Leverage as well) but what we cannot do is continue on the path we're on today.

These eight points are ones I'm willing to have a debate on with anyone who cares to - whether in the comment section of The Market Ticker, on Capitol Hill either in private with the staff of legislators or in public via testimony (taking as long for questions as the Reps and Senators involved would like.)

I recognize that the short-term pain involved in addressing these issues will be considerable.  There is no way to avoid that outcome - there wasn't in 2007 and there wasn't in 2001.  The economic pain required is significantly worse now than it would have been in 2007, but that doesn't matter.  We either do it or we go off the cliff - that's indisputable and is easily proved.  Those who argue otherwise have the burden of proof upon them to show how, given the relentless reality of basic mathematics, they're going to avoid what is before us.  The "Ryan Plan" originally put forward was bereft of this ability, as have been President Obama's claims - both relied on utterly unreasonable assumptions for GDP growth in the future along with doing nothing to address the underlying debt ponzi that has been accumulated over the previous 30 years.

I understand fully that partisan political bickering and deadlock are first and foremost how Washington DC scores "points."  But today we can no longer pretend that we have time, nor that phony-baloney "solutions" will work.  Three years into the alleged "solutions" that were put forward by both Republican and Democrat administrations nothing has been resolved, employment has not come back and deficits have not stabilized.  The claims made over these previous years, in short, have been shown to be false.

These issues, and the debt trajectory for our government and nation, must be addressed now.

Go to responses (registration required to post)
 
Main Navigation
Full-Text Search & Archives
Archive Access
Get Adobe Flash player
Legal Disclaimer

The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions.

NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES.

The author may have a position in any company or security mentioned herein. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Market charts, when present, used with permission of TD Ameritrade/ThinkOrSwim Inc. Neither TD Ameritrade or ThinkOrSwim have reviewed, approved or disapproved any content herein.

The Market Ticker content may be reproduced or excerpted online for non-commercial purposes provided full attribution is given and the original article source is linked to. Please contact Karl Denninger for reprint permission in other media or for commercial use.

Submissions or tips on matters of economic or political interest may be sent "over the transom" to The Editor at any time. To be considered for publication your submission must include full and correct contact information and be related to an economic or political matter of the day. All submissions become the property of The Market Ticker.

 
Comments.......
User: Not logged on
Login Register Top Blog Top Blog Topics FAQ
User Info The Truth About Budgets, For Both Left and Right in forum [Market-Ticker] Item is Pinned
Login Register Top Blog Top Blog Topics FAQ