When all you read is gloom, turn here for a much different perspective.

Tuesday, January 6, 2009

Adding a trillion dollars in debt is quite manageable

Said another way:  Another $1,000,000,000,000.00 in public US debt is manageable. Can you believe that?  I do now, because Professor Kenneth Rogoff said so and so do the numbers.

I stumbled upon this fascinating interview with Rogoff,  economics professor at Harvard -- his Alma Mater's: MIT and Yale.

The entire interview is here on the Minnesota Fed's website.

The attention grabber was Ken's statement, "Fortunately, adding a trillion dollars in debt is quite manageable for the United States." And on what basis? "...the United States grew decently until recently, so that our debt/GDP burden is still modest by European or Japanese standards."

Really? Let's have a look at that. The CIA fact book has the total listing here. And translated onto a map, the ratios are distributed like this (thanks to wikipedia):

Looking closely at the CIA fact book, indeed Japan's debt/GDP burden is 170%.  Italy 104%.  Germany, Canada, France... all around 64%.  And the US?  A pultry 61%.

So now that we know we are more qualified to take on more debt than Japan, or Canada, or France, historically how are we doing?  How has our GDP compared to our debt load over time?

As you can see even though our debt has increased over time, our ability to pay the debt (our GDP) has kept pace (or outpaced) our debt load.  And the ratio of debt to income is no where close to where it was in the mid-40s.

So what does the chart tell us?  The proper way to measure the impact of national borrowing is by calculating the total debt as a percentage of income...  Just like qualifying for a home loan.  Exactly the same exercise that banks use to determine if you are fit to buy that huge house.  Just because your debt may increase, your absolute debt number says nothing about whether the debt is too high for you.  Only by also looking at your income, does the bank determine whether or not you can afford your mortgage combined with your other obligations.  And what is the worst that can happen once you move into that house and start working that new mortgage book?  Your bonuses get cut.  Or you lose your job.  So then what?  Do you default?  Maybe.

Maybe not.

You are smart, productive and innovative.  Perhaps a new and better job comes along.  Or you get funding for that venture that you always wanted to start... and before you know it you are making more money, are more productive, and ready for a bigger house and bigger mortgage.  It's the American dream, a message of increased productivity and innovation in the face of adversity.  A message of hope and good news.

So the new Congress and President-elect talk of a $700-$800B stimulus plan.  Bring it on.  

Professor Rogoff continues, "bailing out the financial system is[was] not a fun way to spend money... we'd rather spend it on health, education, infrastructure or the environment."

Let's go for it.


  1. OK, I'll rise to this one.

    Let's look at the other side of the debt transaction shall we?

    I'm a bank and I loaned you, and Fred, and Jackson, and Jimmy each money.

    You, used it to buy your house.
    Fred went to the race track and lost his money.
    Jackson bought a case of Monster soda, kicked some old men down the stairs and doubled his loan by wisely investing it in the market.
    Jimmy made some coin trading commodities.

    But, you see - the money that I loaned you came from Tom, Sally, Jane and Louie over in the next block and I promised that their money would earn 3% this year.

    I only was required to keep 8% of their investment in my bank - here's the killer part now.

    Suddenly a bunch of bad loans hit like a tsunami and I'm in a bad way for several reasons which I'll list out.

    Fred defaulted on his loan and can't be located.

    You've been making your payments.

    But, when Jackson paid off his loan - I took the money and invested it in another bank that had a great SEC rating. And it turns out that the bank that I invested in was having fun with the way they were reporting their numbers.

    Jimmy did well in the first half of the year and is about halfway finished paying off his loan but, it's rough going because the commodities are all crashing.

    What's worse is that over three quarters of the money that I have invested is either simply gone, or is tied up in being repaid.

    Jane and Louie lost their jobs so they are making regular debits against their savings account and beginning to tap lines of credit that were the enticements for them to switch banks but, I was unprepared for them to actually begin using that money.

    Tom has been hitting the overdraft monthly and as soon as the payroll cheque hits - it's gone before the money is wired in.

    Sally still has her job but she's spending less money. She and her friends started saving so much money that it cost Louie and Jane's jobs at the local mall because no one goes there to buy stuff anymore.

    My controller tells me that if I don't do something, in 2009 the money that is required to be paid out will be more than I have coming from the loans and investments that were made.

    I decide to apply for TARP funding but the money that I am receiving is only making the payments on the interest to Sally, Jane, and Louie for their savings accounts.

    I decide to cut lines of credit and make it harder for qualified customers to get loans.
    Frankly, I don't want to give out any more loans because, it's looking like everything that is investment quality, has an air fools gold to it.

    So, I keep applying for TARP funds.

    Sound familiar?
    Let's replace "bank" with "government" and you'll see where I'm going with this.

    Final point: Look some time at how much US debt is owned by whom. Remember, the person who loans - controls him who borrows.

  2. Wow Laugh that was fun. Ever tried to walk close to the Saudi Embassy in DC?

    A question on your final point. So I'm the big bad controlling bankers for the US govt and the govt decides to default. Make no payments. Walk away like Fred.

    Then what?

  3. Oh something like this only a whole lot worse.

  4. It's a fun story. Looks like Fred got the best deal. What did I miss? A fun story, but not normative.

    Oh, by the way, most banks (save about 40 of the failed ones) are not cutting lines of credit and applying for TARP funds. Most banks today are doing just fine.

    The bailouts are over. The solid banks remain and continue to loan more. Check the Fed numbers... total bank lending continues to increase. The bailout of the stupid big guys who placed toxic bets worked.

  5. Fair enough to take the Devil's advocate to everyone else and I'm not here just to bust you for it but, to discuss points of view.

    I posit to you that we're still seeing new territory and that comparing this mess that's going on to previous situations can be very bad for the retail investor.

    By the way, do you read the 10Qs of the banks?
    I go here for a nice compendium of the banking situation in the States.

  6. Actually I like to think that I am playing Lord's advocate. Everyone else seem to be enamored with the devil and his gloom and doom...

    Yes I do ready 10Q's... more than I care to confess publicly...

    When it comes to actual failed banks, I go directly to the fdic here:

    You will note a total of only 25 failed banks in 2008. Many in October at the height of the mess, a handful in November, and a pitiful 3 in December.

    No, banks are not on the verge of implosion. With the tools they have been handed by the Fed last quarter, they are stronger than ever. Particularly the mid-tier guys who placed no bad bets.

    Read my post on why according to the fed's own data, there is no credit crunch for most banks...

  7. If it was only a trillion dollars of debt that has been added to the balance sheet. The fed and the treasury has given out trillions. We are still engaged in two wars. The stimulus package has huge tax breaks on top of Bush's tax breaks. The housing market is steadily declining. 44 states have budget shortfalls. The pension funds have 400 billion in unfunded obligations...the list goes on and on.

    Highlighting glimmers of hope are great but be careful in estimating these to be signs of bottoming and improvement in the works.

  8. You are right, but I am not sure if WWII like debt would be manageable. I would suspect that the WWII debt was financed mostly by US companies and households provided the overall chaos, lack of globalized financial system and that the US was making almost half of the world economy at the time.
    Today it is about a quarter of world economy but still, US household savings are still very low, I am not sure about corporate ones. It is also cheaper to manage debt domestically. What if China stops buing US Treasuries, what if inflation jumps up significantly, dollar starts falling...


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