Subtraction by Addition: Why Federal Borrowing Makes No Sense

Following up on my last post on Total Federal Debt, another angle to consider is its productive capacity. In other words, we would like to know exactly how much “bang for our buck” we are getting for each dollar we borrow. If borrowing does not generate value greater than the amount borrowed, then we must question the rationality of continuing to do so. For example, if we borrow $1,that means that I am hoping to achieve more than $1 in total output in order to make it palatable to borrow. If we borrow $1, which we then invest, and then observe that total output has declined by more than the amount we borrow, then it stands to reason that the productive capacity of debt is actually negative for us. In this last case, the more we borrow, the more we are sinking deeper in debt. This is exactly what has been happening in the US.

Just take a look at this graph of Total Public Debt to GDP, courtesy of the St. Louis FED Fred:

Source: https://fred.stlouisfed.org/series/GFDEGDQ188S

In particular consider the time period since 1992. During the Clinton Administration, it can be seen that borrowing was sustainable because as debt increased, GDP increased at a faster pace, thereby reducing the ratio. But post-2001, under what was supposed to be a conservative Administration of Bush, the trend reserved upward. But starting in 2Q2008 the Total Debt/GDP ratio has been on a steady upward trend. The trajectory is particularly stark, especially when compared to the previous years. And that trajectory in a longer term perspective, we can see that it has been deteriorating even more so recently. 4Q2015 was a pivotal time in that it marked the beginning of the marginal decline in debt utility. In other words, prior to 4Q2015 we see that each dollar of Federal Debt created more than one dollar of GPD. To take the example of 2Q2008, at that time the Total Debt/GDP ratio stood at 64, which meant that 64 cents of debt generated $1 of GDP. But in 4Q2015 it took $1.029 of Federal Debt to generate $1 of GDP. And as can be seen by the latest available figure for 3Q2020, the ratio stood at 127.279, which in other words says that it takes about $1.28 cents to generate $1 of GDP. 

As GDP improves in the subsequent quarter, we would expect the current elevated ratio to decline or somewhat stabilize. But if history is any guide, just as noted in 2008, there is reason to expect a new trajectory has been established.