Weekend Reading: Keeping You Awake At Night

In her last testimony before Congress as head of the Federal Reserve, Janet Yellen made a curious statement:

“I would simply say that I am very worried about the sustainability of the U.S. debt trajectory. Our current debt-to-GDP ratio of about 75 percent is not frightening but it’s also not low. It’s the type of thing that should keep people awake at night.”

 I find this statement interesting given that both Michael Lebowitz and I have been arguing the point that tax cuts and reforms “pay for themselves” through stronger rates of economic growth, employment or wages.

As Mike stated this past week:

“The historical evidence above tells a different story than the bill of goods being sold to citizens and investors.  Corporate tax rates are positively correlated with economic growth which means that lower corporate tax rates equate to slower economic growth. Further, there is strong evidence that corporate profits are largely unaffected by tax rates.

Investors buying based on the benefits of the tax proposal appear shortsighted. They value the benefits of corporate tax cuts, but they are grossly negligent in recognizing how the tax cuts will be funded.”

But while Janet Yellen was focused on Federal Debt, the real issue is total debt as a percentage of the economy. Every piece of leverage whether it is government debt, personal debt and even leverage requires servicing which detracts “savings” from being applied to more productive uses. Yes, in the short-term debt can be used to supplant consumption required to artificially stimulate growth, but the long-term effect is entirely negative. As shown in the chart below, total system debt how exceeds 370% of GDP and is rising.

It now requires ever increasing levels of debt to create each $1 of economic growth. From 1959 to 1983, it required roughly $1.25 of debt to create $1 of economic activity. However, as I have discussed previously, the deregulation of the financial sector, combined with falling interest rates, led to a debt explosion. That debt explosion, which allowed for an excessive standard of living, has led to the long-term deterioration in economic growth rates. It now requires nearly $4.00 of debt for each $1.00 of economic growth.