Why It's Not Realistic to "Grow Your Way Out of Debt"

You've heard it said often. It also seems to be the premise of the Federal Reserve's "quantitative easing". Debt is not all that onerous if you can grow your way out of it. This is actually a true statement. But is this a plan for the US economy or just a wish?

Total debt in the US -- government, corporate and private -- is $58 trillion.

Total GDP in the US is $18 trillion, but $6 of that is government spending -- taking money from the production of the private sector and spending it on  non-productive activities like transfer payments to Social Security and Medicare. So the part of the economy that actually produces value is about $12 trillion.

Assuming an annual interest of 2%, even if you could restrain annual debt increases to 3% of GDP a year, the productive part of the economy would have to grow at 5% just to stay even. When was the last time you saw the economy grow that fast for more than a quarter?

Now imagine that interest rates jumped to, say, 5% (the ten year treasury was at 5% in 2002). At that level almost a quarter of private sector GDP would have to be devoted to debt service to break even. Hardly likely. So it's pretty easy to see why the Federal Reserve keeps backing off its promise to reduce its funding and allow interest rates to rise. Where (and how) does all this end? 

More Debt=Lower Growth=Family Budget Cuts

Manmohan Kumar and Jaejoon Woo of the International Monetary Fund (IMF) confirm the previously published findings of Reinhart and Rogoff that sovereign debt and economic growth are inversely related. Specifically they estimate that a 10 percentage point increase in the debt-to-GDP ratio is associated with a slowdown in annual real per capita GDP growth of 0.2 percentage points per year. On average high-debt economies grew 1.3 percentage points slower than their low-debt counterparts. A difference of 1.3 percentage points of growth would cost the US more than $200 Billion per year -- or about $2000 per household per year.

The current administration would like you to believe that $2000 per year is nothing your household should be concerned about. Unlike when the government's revenue decelerates, you will be expected to actually cut your spending by $2000 every year . . .  and reelect those whose profligacy cost you that amount.

This Looks Like a Recovery??

If you listen to the Obama cheer-leading squad at NBC, ABC, CNN, etc. you'd think that recovery was finally taking hold. Except that for economic growth to really gain traction you have to have more people working and producing something. Does this look like more people are working?