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Lance Roberts is an investment advisor who also hosts a radio show in Houston, Texas. Recently, he had a Twitter exchange with Chicago Tribune columnist Steve Chapman, in which Steve asked the following question:
Does rising debt cause slow growth or does slow growth cause debt to rise?
Roberts’ response to the question makes for fascinating reading. After reviewing some basic macroeconomic theory developed by John Maynard Keynes on the role of government deficit spending in stimulating economic growth, he identifies a problem with how the government spends the money it borrows that leads to economic stagnation:
Keynes’ was correct in his theory. In order for government deficit spending to be effective, the “payback” from investments being made through debt must yield a higher rate of return than the debt used to fund it.
The problem is that government spending has shifted away from productive investments that create jobs (infrastructure and development) to primarily social welfare and debt service which has a negative rate of return. According to the Center On Budget & Policy Priorities nearly 75% of every tax dollar goes to non-productive spending.
Here is the real kicker, though. In 2014, the Federal Government spent $3.5 Trillion which was equivalent to 20% of the nation’s entire GDP. Of that total spending, $3.15 Trillion was financed by Federal revenues and $485 billion was financed through debt. In other words, it took almost all of the revenue received by the Government just to cover social welfare and service interest on the debt. In the financial markets, when you borrow from others to pay obligations you can’t afford it is known as a “Ponzi-scheme.”
But wait, there’s more! Roberts goes a step further to identify debt as the cause of slow economic growth, not its cure:
Debt, if used for productive investments, can be a solution to stimulating economic growth in the short-term. However, in the U.S., debt has been squandered on increase in social welfare programs and debt service which has an effective negative return on investment. Therefore, the larger the balance of debt becomes, the more economically destructive it is by diverting an ever growing amount of dollars away from productive investments to service payments.
The relevance of debt growth versus economic growth is all too evident as shown below. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the growth in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.
That’s a pretty strong argument for why today’s increases in government spending, which are almost entirely funded through borrowing, would have less and less of a positive impact on the economy compared when such policies were first adopted back in days of the Great Depression.
Back then, the government would borrow to fund projects like power producing dams on the Colorado and Tennessee rivers, or build interstate highways – things that can actually have a positive rate of return on the investment in them because they expand the potential for real world commerce.
Today, the government borrows billions of dollars to lend to students to obtain college educations that for many, represent an increasingly poorer return on the investment, where according to President Obama’s Fiscal Year 2015 budget, nearly one out of five people who took out subsidized student loans from the U.S. government will default on paying them back, which means that they weren’t able to earn enough money from the kind of real world jobs they could actually get after obtaining a college education or degree.
Overall, without taking its full costs of making such loans into account, including the full extent of defaults and delinquencies in payments, we estimate that the rate of return on the government’s student loan racket is about 0.1%. In reality, the U.S. government is not getting a boost from its student loan business – it is earning a negative rate of return on its investment.
The costs of that failure may be seen in the abnormally high rates at which welfare spending has continued since 2009, even after so many years of economic recovery following the official end of the last recession. Consequently, more government spending is going to nonproductive uses.
And then, the cycle repeats.