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Debt is a drug...Danger of Overdose?

Interest-Rates / US Debt Apr 04, 2009 - 02:57 PM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleKids are diff-erent today, I hear evry mother say...but there's a little yellow pill...Doctor please, some more of these...outside the door, she took four more. (Rolling Stones: Mother's Little Helper).

The problem with drugs is you develop a tolerance to the thrill part, without necessarily developing a tolerance to the addictive part.

The situation at the moment is that USA and UK and a few other "developed" nations ran up some large debts (private sector plus public sector (collectively)), and there is a problem "servicing" the debt. The solution apparently is for the government to take on a load more debt. And that's smart...because?

The economy can't survive without debt.

According to legend every $4 of debt creates $1 of GDP growth. So that's it then? Just pile on more debt, as much as you can get.

I wonder, ever since Secretary Paulson said in July 2008 "The US banking system is safe and sound", I don't know who to believe.

If debt is really that essential for GDP Growth, you would have thought that there would be a relationship between the amount of debt (as a % of GDP) and GDP growth.

Eyeballing those lines it's hard to see a clear relationship between piling on more debt and increased economic growth, rather the opposite, unless my astigmatism is playing up again.

How about the effect of an increase in total debt in USA on the increase in GDP the next year - it's a pretty crude analysis but perhaps it serves to illustrate a point:

OK the "confidence" in the best-fit line is pretty useless, but there does appear to be a trend. And by the way I'm using nominal because I don't believe CPI numbers (but it works similar for "Real").

Bang for buck?

Over the past seven years USA in aggregate has been increasing it's total debt by an average of about $2,500 billion dollars a year (private + public), so I suppose that's about where that "rule of thumb" 4:1 figure comes from? What I'm wondering is what the current commitment to increase debt, will achieve if the net increase TARP + TALF + PPIP etc goes much over $2,000 billion a year (I lose count of the trillions, but it seems that every time you blink there is another trillion for this or that).

From this simple analysis it does look suspiciously like the amount of bang for buck is going to go down as the amount of debt that is piled on, goes up.


I don't know what the US total debt was end 2008, but there is a chance that it could have been less than 2007 simply because a lot got written off. That's a good way to deal with the debt to GDP "problem", just don't pay the debt back and it will go away.

That's the beauty of non-recourse, if you walk away the people holding the notes get stuck with the loss (no more cutting out a pound of flesh - which might make more sense in the USA at the moment than the death penalty).

What just happened is that a lot of people walked away and the people who got stuck with the loss were ordinary Americans with savings plans, plus foreigners who had made the mistaken assumption that, as Hank Paulson said in July 2008, "the US banking system is safe and sound " and as Allan Greenspan said a few years earlie r - "Don't worry, it's just a bit of froth".

But hey, like the man said in Under Siege 2 "assumptions are the mother of all F@@K ups". Tough cookie, everything was not as it seemed, that's what happens when you believe people like Hank Paulson and Allan Greenspan; my suggestion is chose your guru more carefully next time!

That might explain why USA can expect a drop in nominal GDP of 5% to 6% in 2009 as was forecast by Professor Roubini, if indeed the amount of "performing" debt went down net $1,000 billion, that would look like a very probable outcome.

So how much debt does America need for it's next fix?

Paul Krugman says that a $1,000 billion for the stimulus plan is nowhere near enough, looking at the chart it looks to me like he could be right.

No one likes government going on a spending spree with borrowed money (unless you know a good lobbyist), but the simple fact is that the main mechanism for piling on private sector debt (the MBS market), is busted. Whether it was a proper market, or whether it was crooked is another subject, like it or not, the process of "originating and distributing" those "cans of sardines" is dead right now (XXXXXXXX).

So if GDP growth is an objective then the ONLY way is for government to borrow and spend instead. The effectiveness of that will depend on how much gets spent on things that can be expected to generate enough money in the future to pay back the debt, as opposed to how much gets stolen or wasted on things that have no chance of paying back.

Which is always the problem with government spending, and it might explain why that curve levels off, the more "easy" money there is floating about, the easier it is for people to grab a bit and party, or steal "just a little bit".

So is PPIP a good idea?

No it's not, it will not generate a profit, it will cost easily $1,000 billion and there is a limit on funds. Big picture - forget about mark-to-market, basically those loans are performing, so just put that aside and deal with it later. $1,000 billion could profitably be spent somewhere else.

And talking about the perennial problem of waste (or perhaps something worse), personally I don't like the look of those guys who have been brought in to help out, not one bit!

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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