Many people have become painfully aware of the large and growing magnitude of the US national debt. It is a subject of great concern among many in the government, and the great multitude of people who are responsible for the tax burden that finances the government’s ongoing operations. These concerns are well founded, since the size and scope of the national debt is on the cusp of a magnitude that is so large, it cannot be addressed in any way other than by de-valuing the dollar through inflation that is driven by continued quantitative easing.
This trend is most certainly disturbing, but it is really a symptom of a much deeper and much more insidious problem that portends extremely dire consequences if it is not addressed within the next few years. This problem relates to the national debt, but exposes a deeper economic problem brought about by failed government policy. The scope of this problem is expressed by examining an extended trend of the ratio between annual growth in Gross Domestic Product and the annual Net Government Deficit.
What this trend shows is that the deficits of the past were accompanied by GDP growth that exceeded the magnitude of the government deficit and resulted in the economy growing more than the size of the national debt. The problem that emerged prominently in 2009, and has expanded in every year since is one where the size of the annual government deficit exceeds the total economic growth of the nation.
The chart below shows the ratio between government debt growth and the growth in GDP for a series of time periods starting in the early 1980’s and continuing to today. The startling trend that emerges is that from 2009 through 2011, the level of government debt grew 4.79 times as fast as GDP. This means that for the past 3 years, each dollar of growth in the economy has been accompanied by approximately 5 dollars of new government debt. Simple mathematics shows that this trend is not sustainable for any length of time.
The key driver of this unbelievable explosion in government debt has been an accompanying explosion in government spending. The following chart demonstrates the growth in government spending from year to year relative to the growth in GDP. From 2009 through 2011, approximately 84% of every dollar in GDP growth has been driven by a dollar in government spending growth. What this ultimately means is that the supposed signs of recovery are nothing more than borrowing from the future for the purpose of government spending today. Unfortunately, much of this government spending has been funnelled toward politically powerful interest groups, and has done very little to drive the real economy forward.
The third chart shows the trend of nominal GDP growth over time, plus a second chart that shows nominal GDP growth less the growth in government debt. What this chart illustrates is how the reported GDP is really an illusion. When subtracting the public borrowing against future production in the form of government debt, “Net” GDP hasn’t grown since 2007. In past economic cycles, there was very rarely a disruption that pushed GDP into negative territory for an entire year. Furthermore, most years of the past half-century have experiened net economic growth that exceeded the government borrowing for the year. The current environment is one where the government is borrowing at such a large magnitude that creates a perpetual drag on the economy.
What this means is that under the current governmental regime, each successive year results in net destruction of the real economy as it is displaced by government activity. A principal deficiency of GDP accounting is that it counts all spending as equal, regardless of whether it is financed by real production or whether it is financed by debt. A more “real” way to articulate economic output of the nation is measured by subtracting the growth in government debt from the measured GDP growth. This demonstrates the extent to which the economy has experienced real growth above and beyond what the government has borrowed to finance spending.
The fundamental problem that the US and most of Western Europe finds itself in is that the economies have become less about productivity growth driven by private industry and more about subsidies, entitlements, and government programs. What this ultimately means is that with the world’s largest economies all simultaneously headed on an unsustainable government spending trajectory, that multiple years of high inflation are all but guaranteed. Individual investors should seek to build their financial self-defense in short order
Action Item: Prepare for the coming economic disruptions with financial self-defense. Build a portfolio of real income-producing assets that are financed with fixed-rate debt. By harnessing the power of properly structured investments, you can harness the power of inflation to your benefit.