Government debt

As Washington continues to be stuck in a seemingly endless spending spiral, with the belief that “spending more money” is always the right solution, it is essential to address the issue of debt and budget deficits. To understand how debt and deficits affect economic growth, we need to understand where we are now and how we got here. The data visualization demonstrates the average growth rate of the economy over a decade.

It is obvious that the average growth rate from 1900 to 1990, apart from the period of the Great Depression, was approximately 8%. Since then, we have seen a noticeable slowdown in economic growth.

What is the reason for this? This question has been the subject of intense debate in recent times, particularly as the US debt and deficits have risen dramatically.

Is it a direct cause or merely a correlation? In this article, I will argue that the increase in debt can be seen as a reason for the decline in growth. But first, let’s focus on Keynesian theory, which has set the pace for fiscal and monetary policy over the last three decades.

Keynes argued that an economic dip occurs when the total demand for products does not match the supply. This leads to an unnecessary loss of potential output due to high unemployment resulting from cautious producer decisions.

Keynesian economics postulates that in such times, government intervention is necessary to increase demand, stimulate the economy and reduce both unemployment and deflation. A government cash flow increases incomes, which in turn boosts overall spending. This then increases production and investment, which ultimately leads to further income and spending. This initial stimulus triggers a series of reactions, with total economic output increasing by a multiple of the initial investment.

Keynes had a point. For debt-based spending to be truly effective, the “return on investment” should be higher than the debt taken on to finance it.

Here we encounter a twofold problem.

Firstly, debt-based public spending should only be used to stimulate during a recession and then turned into a positive balance during the growth period. However, since the early 1980s, the debt-based spending approach seemed to be the only one of interest. Along the lines of “a small deficit is good, so a big one must be even better”, right?

Secondly, the focus of debt-based spending has shifted from productive investments that create jobs mainly to social spending and debt payments. Such uses of money generate a negative return.

According to research by the Center On Budget & Policy Priorities, about $88% of every dollar raised in taxes goes to non-productive projects.

This is where the critical point comes in: in 2022, the US government spent USD 6 trillion, which amounts to almost USD 20% of total US nominal GDP (USD 19.74% to be precise). Of this massive spending, only USD 5 trillion was covered by government revenues. The remaining USD 1 trillion was financed by borrowing.

In plain language: If 88% of all expenditure is spent on social benefits and interest expenses, then a total of USD 5.3 trillion (i.e. 105%) of the USD 5 trillion income is spent on these items.

Do you recognize the difficulty in this? In the financial markets, it’s called a “Ponzi scheme” when you borrow money from third parties just to pay off debts that you can’t actually bear.

Debt is the problem, not the bailout
This raises questions about MMT (Modern Monetary Theory), which claims that “debt and deficits are fine” as long as inflation does not come into play. But this approach is on shaky ground when you look at the trends in debt and growth.

I am not saying that “debts, especially those caused by deficit spending, cannot also have a productive value”. I have already emphasized that:

“The word “deficit” alone does not say much. Dr. Brock uses the example of two countries to illustrate this.

Country A has expenditure of USD 4 trillion and revenue of USD 3 trillion. With this 1 trillion deficit, the Ministry of Finance takes on new debt in this amount. This debt only covers the additional spending requirement, but does not generate any revenue. This creates a future financial chasm.

Country B also has expenditure of 4 trillion and income of 3 trillion. However, the difference of 1 trillion, financed by debt, flows into projects and infrastructure with a positive return. There is de facto no deficit here, as the return on investment compensates for the “deficit” over time.

The relevance of public spending is undisputed. The point of divergence, however, is the excessive use and waste.”

The USA corresponds to the model of country A.
A significant proportion of government debt went into the expansion of social programs and ultimately into increased debt servicing – inevitably leading to a negative return on investment. An increase in debt has a devastating impact on the economy as more and more resources are diverted from productive sectors to debt servicing.

The role of debt in relation to economic growth is clear. Since the 1980s, total debt has grown to such an extent that it has eclipsed overall economic growth. With the current historically low growth rates, debt dynamics are diverting more and more resources from productive areas to debt servicing and social systems.

There is a certain irony in the fact that debt-based economic growth requires ever-increasing debt to underpin the ever-diminishing growth potential of the future. It currently takes USD 3.02 of debt to generate USD 1 of real economic growth.

When you put this amount into context, you begin to recognize the profound challenges that are holding back economic growth.

The debt dilemma
It is hardly surprising to anyone that the Keynesian approach has not brought the hoped-for consistent economic upturn. From measures such as TARP to QE and tax cuts, all of these strategies have merely delayed the inevitable adjustment process. However, this delay has only exacerbated the future problems. As Zerohedge notes:

“What the IIF is highlighting is not really news. The fact that lower borrowing costs as a result of loose central bank monetary policy have encouraged nations to borrow further will not surprise anyone. Tellingly, it is precisely this policy that makes rising interest rates almost unthinkable. It is challenging enough for the world to manage a debt to GDP ratio of 100 %, let alone three times that.”

Ultimately, the adjustment process will be significant. A return to a sustainable level of debt would require a reduction of almost USD 50 trillion from the current level. USD from the current level.

The “Great Reset” theory

The term “Great Reset” has become increasingly important in recent years. It is often used in reference to sweeping economic, social and political changes that could reshape the world. Some analysts and economists believe that the current debt levels and financial system as we know it are unsustainable and that a “reboot” or “reset” is needed to put the economy back on a sustainable footing.

The “end game” of the current economic structure could indeed be the point at which the reduction of the enormous global debt burden begins. If this debt cannot be reduced in a way that sustains or stimulates economic growth, the resulting economic downturn could indeed be devastating.

The comparison with the Great Depression is alarming, but not unfounded. The Great Depression of the 1930s was a time of massive economic contraction, massive unemployment and economic deprivation. If deleveraging is not handled properly, the economic impact could be similarly severe.

However, there are also counter-arguments. Some experts argue that the modern global economy and the financial system are more resilient and adaptable than in the 1930s. With the right political decisions and reforms, a catastrophic downturn could be prevented.

Regardless of where you stand in this debate, it is important to recognize that the future is uncertain. A ‘Great Reset’ could mean profound changes for the global economy and how policy makers, businesses and citizens respond will be critical. There will be both opportunities and challenges, and the ability to adapt and innovate will be critical to future success.