More Government Debt Means Less Economic Growth

The US government continues to borrow money at a frenetic pace in order to cover its massive spending spree. It runs huge deficits month after month and there is more spending coming down the pike. The national debt is over $28 trillion and it is about to begin surging upward again. But with the exception of a few contrarians, most people don’t worry about the national debt. The conventional wisdom seems to be that since none of the doomsday predictions about skyrocketing debt haven’t come to pass, there’s nothing to worry about.

Of course, nothing is a problem until it is. And even if the borrowing and spending don’t ultimately precipitate a crisis, it is undermining the economy. The bottom line is more debt means less growth.

Based on relatively conservative CBO projections, the national debt will balloon to $140 trillion by 2050. On average, the Fed monetized about 30% of the total debt. If that trend continues, the central bank will have to expand its balance sheet to $40 trillion.

This is a giant millstone tied around the US economy’s neck.

As Lance Roberts notes in an article published by Investing.com, “Since 1977, the 10-year average GDP growth rate steadily declined as debt increased. Using the historical growth trend of GDP, the increase of debt will lead to slower economic growth rates in the future.”

The growth of government debt diverts resources away from productive activities. It also tends to create a downward spiral. As debt increases, it takes more and more money to service the debt and fund government programs. That requires more borrowing and an increase in debt. Since 1980, the growth in debt usurps the entirety of economic growth.

In this environment, the Fed has to keep interest rates low and debt has to grow faster than the economy just to keep the economy from stalling out. This is why the Fed can’t possibly tighten monetary policy – at least not significantly.

The conventional wisdom is that borrowing and spending will jumpstart the economy and lead to economic growth down the road. But history doesn’t support this theory. Japan provides a good example. Japan’s QE program since 2008 has been three times larger than the US on a relative basis. But economic prosperity there is no higher than it was at the turn of the century. Japan’s borrowing and spending spree have produced — nothing.

According to Roberts, “Even though the BOJ’s balance sheet owns a majority of the ETF, corporate, and government debt markets, Japan has been plagued by rolling recessions, low inflation, and low interest rates.”

While many argue the US economy will eventually ‘grow’ its way out of debt, there is no evidence such a capability exists. We know that interest rates in the US and globally are telling us economic growth will remain weak in the future.”

Roberts believes, “Japan is a microcosm of what the U.S. will face in coming years as the ‘3-D’s’ of debt, deflation, and the inevitability of demographics continue to widen the wealth gap.”

A study by economists Jones and De Rugy at George Mason University reveals that excess debt actually has a zero to a negative multiplier effect on economic growth.

“The multiplier looks at the return in economic output when the government spends a dollar. If the multiplier is above one, it means that government spending draws in the private sector and generates more private consumer spending, private investment, and exports to foreign countries. If the multiplier is below one, the government spending crowds out the private sector, hence reducing it all.

“The evidence suggests that government purchases probably reduce the size of the private sector as they increase the size of the government sector. On net, incomes grow, but privately produced incomes shrink.”

The study found:

There are no realistic scenarios where the short-term benefit of stimulus is so large that the government spending pays for itself. In fact, the positive impact is small, and much smaller than economic textbooks suggest.”

And in conclusion:

If you think that the Federal Reserve’s current monetary policy is reasonably competent, then you actually shouldn’t expect the fiscal boost from all that spending to be large. In fact, it could be close to zero.

“This is, of course, all before taking future taxes into account. When economists like Robert Barro and Charles Redlick studied the multiplier, they found once you account for future taxes required to pay for the spending, the multiplier could be negative.”