The information provided in the enclosed chart comes from John Mauldin. He sends out a weekly email in which he weighs on the global economy. He meets with many global leaders of all kinds. You can subscribe for his email by clicking on his name above, going to his site, and registering. It is good stuff.
In his most recent email, he basically spells out, in a simplified model, how we got to our current predicament of having a bankrupt government. The underlying theme is that, eventually, this will turn out badly — very badly.
Readers of this site know that I believe that the policies that our government has followed over the last few years (equivalent to years 25 & 26 above) have been wrong-headed and make the problems we face even worse. The clock is ticking.
The following text steps through Year 1 and Year 24 above. Year 25 & Year 26 are my interpretation of the end of his analysis. Note, I do not include a sample modeling the eventual large increase in interest rates that will come just like it has now started in France.
Let’s assume a country that has a gross domestic product (GDP) of $1,000. In the beginning it taxes its citizens about 25% of GDP and spends the money for the public’s benefit. But alas, it spends about 30% of GDP, so it must borrow the overage (about $50) from its citizens or from the citizens of other countries. Because the country starts out with relatively little debt, interest rates on this loan are low, because those who buy the debt can easily see that the the country can pay them back. If the debt of the country is only 5% of GDP ($50) and the interest rate is 4%, then the amount that must be paid as interest is only about $2 per year. Not a whole lot, about 0.2% of GDP.
But this goes on year after year. Sometimes the deficits get smaller and sometimes they get larger, depending on the economy; but government expenditures grow at the same rate as the country grows, and the debt keeps growing at an average of 5% of GDP per year. Now, if the country is growing at 3% a year, after 24 years the economy will have doubled to $2,000 GDP. That means the debt has grown (roughly) to a total of $1,800, which is now a debt-to-GDP ratio of 90%. Debt has grown faster than the country’s economy. Note that if the country had held its budget down to where it grew slower than GDP, thus reducing its need for debt, that ratio would be lower, even if the debt had grown. You can indeed grow your way out of a debt problem if the growth of government spending is less than the growth of the economy.
But what if the size of government grows to about 50% of GDP, rather than 25% or 30%, over the 24 years, as politicians decide to spend more money and voters decide they want more benefits? (Think France.) Then the private sector must pay about 50% of its production to the state – plus, the debt is now growing unwieldly. The private sector has less to invest in new businesses and tools, and the growth of the economy slows.
And then along comes a very nasty recession. The revenues of the government fall as the economy shrinks. If the economy shrinks by 3% and total taxes are 50%, then tax revenue falls to $970. But the government does not cut back; and indeed, because it must pay unemployment benefits and welfare (because unemployment rises in a recession), its expenses actually rise by 5%! So it now needs $1,050 to pay all its budgeted expenses. And it must now borrow $80 to pay everyone it has promised to pay, in addition to the $100 it was already borrowing every year to cover its deficit, or a total of $180 a year, which is 9% of GDP.
I’m an optimist on human potential and freeing the private sector to grow jobs, wages and the economy. I’m a pessimist about our government, because they haven’t looked at the very simple spreadsheet that I put together based on Mr. Mauldin’s simple model of our economy. We are in for a long, long, long slog.