When Will We Learn? Fueling Economic Growth With Debt Doesn’t Work!

Humans tend to have short memories, especially when it suits them. We ignore danger in favor of pleasurable — albeit short-lived — outcomes.

You’d think that after the last stock market devastation, we would have learned that fueling economic growth with debt does not work. Well, here we are again.

Economic growth has, one again, been driven in large part by dramatic increases in debt in recent years. Debt can be a good strategy to propel growth further, but when we start issuing debt just to finance the debt, we reach the point when we’re squeezed the last bit of juice out of a week-old lemon.

Now, I’m not just pointing fingers at the U.S. government, though they certainly haven’t set a good example. U.S. businesses and corporations are to blame for this mess, too.

The chart below illustrates what happens to growth rates when they’re pressured by such high levels of debt leverage:

economix growth debt

If you look in the small boxes toward the top, you’ll notice that at current levels of debt over 300%, real GDP is about half the growth rate compared to debt levels around 156%. Even worse, nonfarm payroll growth plummets 70%, from 2.4% to 0.7%. Let’s not ignore that impact on the majority of U.S. workers — that would be like your boss raising your salary $600 after a series of $1,500 raises the years before.

To investors both foreign and national, this makes the U.S. less attractive than other regions. Why would you invest in a country that spends an inordinate amount of its tax revenue on debt when you can find a better deal elsewhere?

This hurts U.S. companies as well, especially given that they’re also taking on record levels of debt. When you consider companies like IBM — long considered a leader in the economy — that have increased their debt levels just to buy back their shares, compounded by the fact that they’ve significantly under-performed the market in recent years, you understand why investors are left scratching their chins. With stocks at all-time highs, this is not how you drive growth!

Then there’s the people. When individuals and families are cut off from using debt to finance consumption, this could lead to a mad dash out of assets to cover liabilities. Sure, savings rates have rebounded since ­­­2009, but they’re still slightly negative with this explosion of debt, and the scenario I’m describing would make it even worse.

And no, I don’t mean to prophesize imminent demise just because debt levels are flashing warning signals. My point is that, at least in the near term, debt will be an even less effective means of driving growth.

Going forward, we’ll have to create new initiatives to grow our economy. And the only way to get there — cut off our addiction to debt. A major economic correction may be the catalyst we need to do that.
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John DelVecchio

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Categories: Forecasts

About Author

In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.