This morning I received an email about the level of outstanding debt to GDP which got me to thinking about the difference between all of the arguments that currently exist about the issue. The question that came to mind is that if 350% of debt to GDP is imbalanced and inhibits economic growth (which we know is true from the decline in annual GDP growth versus the increase of debt and reduction in personal savings) then what level IS structurally maintainable?
For this answer looked back to the last time in history where the economy as represented by GDP was growing at 6% or more on an average annualized basis. For this we found ourselves back in the 1960-1970’s. At that time debt to GDP was running at about 150% of debt to GDP with actual total credit market debt increasing each year at about 25% more than GDP itself. I then extrapolated this out and increased total credit market debt at a rate 25% greater than the economy grew each year.
The assumption behind this is that IF the economy is growing then the total market can increase their leverage overtime as the economy grows. However, as we can see by the chart the amount of leverage that was applied to the economy to boost growth over time was far greater than the growth in the economy can most likely support for an indefinite period going forward.
This is turn reinforces our argument that this is a “balance sheet” recession that we are currently in which is very similar to the 1930-40’s where debt was being reduced. However, during that time (The Depression Era), the economy grew at almost 9% on average with a recession at the beginning and the end of the period. The markets rallied almost 150% during this period before losing roughly 50% of their value during the second recession. The point to be made here is that even though the economy is trying to show signs of recovery – the overriding issue that we need to stay focused on is the unwinding of the balance sheet. The process of reducing the total credit market debt to GDP from 350% to a growth adjusted long term structurally maintainable growth rate of 200% at the current time is going to inhibit growth, create more frequent recessions and keep unemployment levels high as companies fight to keep profit margins intact.