Monday, March 16, 2009

Where Do We Go? Where Do We Go Now?

Quite the slip & slide so far this year.......

The Dow Jones Industrial Average was down as much as 2,229.34 points or 25.4% before rebounding the last few sessions. The Index has gained 622.53 points or 9.44% since 3/5/09. Financial stocks have lead the rebound, with market participants focusing on operating earnings for the first quarter. This appears to be a tradable rally, perhaps taking the index over 7,500 before the month is out. In fact, I think that is the most likely scenario. Gold has topped out in the short term, as well as Treasuries. In the intermediate/long term however, the prospects are far different.

The graphs below depict the grim reality of our fiscal situation. Nominal (unadjusted for inflation) GDP growth has been slowing for the last thirty years. Technological achievements notwithstanding, this is typical of a mature economy.

The problem is the growth rate of debt to support this economic expansion. We have come to expect 6% growth rates, but this is simply not rational. Take a look at the leverage necessary to get our economy to run at those rates. For simplicity, I have only used Treasury data when calculating debt growth rates. Both household mortgage debt and consumer credit have expanded at similar rates over the last thirty years. The sum of the three is stunning: $23 trillion.

An economics professor of mine once commented that the debt load of our country was a curious development and made little practical sense. His rationale was that a mature economy should be lending to other nations as a supplement to its own decreasing opportunities. An economy as large as ours shouldn't be borrowing, we shouldn't need to. Little attention was paid to this in the 1990s, growth kept going and there was always a buyer for our debt. This current crisis is forcing the rest of the world to look behind the curtain and critique our system. They can't like what they see.

1 comment:

MK said...

As a further illustration: as an economy gets larger, it takes a larger effort to grow at the same pace. If the GDP is $10 billion, 6% growth adds $600,000 to the economy. For this now $10.6 billion economy to grow at 6%, GDP must increase by $640,000 the following year.