Back With More Background Information

I used ta do a little but a little wouldn't do it
So the little got more and more
I just keep tryin' ta get a little better
Said the little better than before

Guns N’ Roses

American Rock Group Guns N’ Roses lived a lifestyle that rendered them subject matter experts on the subjects of oversaturation and diminishing marginal returns. Their Appetite For Destruction CD featured a track entitled “Mr. Brownstone”* which is about the pain and disappointment experienced by heroin addicts as their tolerance grows and they need more and more of it to get off.

Blogger Nathan over at Economic suggests that the United States government is undergoing an analogous situation under the influence of deficit spending. In a post entitled Monetary Madness Part II – Diminishing Returns, he lays out a case that the US Economy may feel the same way about overdosing on debt the same way Izzy Stradlin and Slash felt after abusing way too much Brownstone Heroin.

I posted a brief commentary on Nathan’s d(GDP)/d(Debt) Chart that was admittedly skimpy on the nuts and bolts details. Much more follows below. Nathan describes his methodology below.

This is a very simple chart. It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt backed money system. Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

He hypothesizes that two things will happen if the deficit binging continues. First, the continued additional debt will add less and less marginal present tense benefit to the current economy. In mathematical terms, as we continue to accrue debt over infinite time it will become of nearly zero benefit to the present GDP. It won’t grow the economy anymore. Utilizing economic terminology, Nathan describes this eventuality below.

DIMINISHING PRODUCTIVITY OF DEBT - Is the phenomena of decreasing real productivity gains for a given amount of debt creation. In a non-saturated economy, the introduction of credit does work to increase productivity. However, approaching the Macroeconomic Debt Saturation point, the productivity gain begins to decrease, and at the saturation point is zero, turning negative as we get beyond the Debt Saturation point.

This hypothesis makes total logical sense and is in keeping with nearly every facet of traditional microeconomics. It’s only logical that the behavior would show up in any macroeconomic framework that properly builds on a microeconomic theoretical foundation. I tend to think the trend line on his chart demonstrates a troubling current phenomena.

His second, more speculative hypothesis is that we have hit a debt saturation point. Nathan describes this phenomena below.

DEBT SATURATION - Occurs when collective income can no longer service more principal and interest under current credit terms & conditions. Debt saturation can occur for you personally, for your family, and it can occur for the people collectively. It can also occur, and has occurred, for local municipalities, city, state, and Federal governments, as well as corporations (financials in particular). Because the same income earners ultimately are responsible for all these debt (a key concept), there is a point that occurs overall, that point I call Macroeconomic Debt Saturation. Debt saturation can occur and then recur as credit terms are changed - for example, the lowering of interest rates moves the allowable amount of debt prior to reaching saturation up.

This would imply that continuing to carry more debt is now reducing rather than enhancing our GDP. In other words, we lose more than we gain. It’s possible, and the final two years of his chart suggest we’ve hit that particular inflection point with respect to the continued influence of "stimulus" on the economy.

It’s fair to point out that Nathan isn’t a lonely exponent of this point of view. CBO Director Douglas Elmendorf has offered a similar analysis during testimony in front of the US Senate. Thus we have a respectable theory backed by qualified expert opinion. The only factor preventing me from endorsing the Debt Saturation hypothesis outright is the fact that our supporting data trend has only two consecutive confirming points.**

In conclusion, we have a confirmed negative trend that may well turn full-blown dangerous to our economic commonweal. Or as Axl Rose would have put it:

But that old man he's a real [Deceny Edit]
Gonna kick him on down the line

And that blessed event will have to happen soon or else the American Economy can tighten its shoes for the long walk home.

* - The song also has a tragic back story similar to “Helter Skelter” by The Beatles. The gunman who perpetrated mass murder at Va. Tech was fond of the song.
** - N=2 doesn’t make for a tight 95% Confidence Interval.