Wednesday, February 15, 2012

Can the economy grow without debt?

By Bill Wilson

In high-brow business seminars as well as casual conversations and in every form of discourse in between, there is a strong sense of foreboding; a nagging sensation that something is fundamentally wrong.

There is, of course, no end to the partisan and ideological warriors claiming to know the answer and offering solutions. And, to some degree, this missive must fall into that category.

But I offer no solutions because I am not sure there are any. There is, however, a set of relationships that I believe explain our collective dread. Simply put, the economic, fiscal, and monetary system that has been in place since the end of World War II just doesn’t work anymore. What we expect is not happening. Let’s examine the numbers.

Total debt to GDP
This table is alarming for several reasons, but first we need to study the relationship between total outstanding credit nationwide and the economy to understand them.

Beginning in 1945, the growth in total debt — government, corporate and household — has had a direct relationship to the growth in the overall economy. For 25 years up to 1970, the relationship of total debt to GDP remained relatively constant. True, there were variations. But the relationship remained inside a narrow range of 140 percent to 160 percent.

There was another relationship that was pretty constant as well. For every additional unit of debt we incurred, we saw an equal or greater expansion of GDP — as debt grew the underlying economy grew at an equal or greater amount.

From 1945-1950, GDP grew at 31 percent versus a credit expansion of 20 percent. From 1950- 1955, the economy grew 42 percent and credit 37 percent. And from 1965-1970, GDP expanded 56 percent while credit at 44 percent. During those days, credit expansion was predicated on economic growth.

All’s good. Credit, otherwise known as debt, expanded at varying rates but always related to underlying value. Then, with the stroke of a pen, these basic relationships were changed.
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