Debt, GDP And Refuting Mohamed El-Erian's Advice

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Summary

Since 2000, Total US Federal Debt has grown 8.85% annually up to Fiscal Year 2015.

Since 2000, US GDP has grown 2.84% annually up to Fiscal Year 2015.

"Bond Bubble" might have a little more room to run.

In an interview with Bloomberg, well-known economist and market strategist, Mohamed El-Erian suggested that monetary policy makers pass on their "stimulus" baton to fiscal policy makers.

"The answer to high-growth financial stability is not in the hands of the Fed but is in the hands of the other policymakers."

The "other policymakers" being politicians, and is a call for more deficit spending by the Federal government.

This made me look at how the "fiscal side" of policy measures has acted since 2008.

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Source: FRED & US Treasury Direct

One can see that since the "Great Recession," in 2008, the total federal debt has surpassed GDP. The growth in government debt has been substantial as shown in the table below.

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Source: FRED & US Treasury Direct

Of course, this is mixing economic stocks and flows, but adding to the stock of US government debt should add to the flow of GDP according to Keynesian "orthodox" equation of:

Y = C + I + G + (X-M)

Indeed, a year ago, US debt "only" grew by 1.83%. However, I did check that most recent data available, from Treasury Direct, and found that from July 22, 2015 to July 22, 2016 US debt grew faster than the previous three US government fiscal years, as shown in the table below.

Intragovernmental Holdings Public Debt Total Debt
7.42% 6.67% 6.88%
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Source: US Treasury Direct

(Intergovernmental Holdings is the Social Security Trust Fund while the Public Debt is debt that is available for trading in the markets).

Total US Debt now stands at $19.4 Trillion, as of July 22, 2016. At the end of Q3 2015, the total was "only" $18.15 Trillion. An increase of $1.25 Trillion in less than a year. The Public Debt portion increased by $0.87 Trillion.

The Bureau of Economic Analysis (BEA) reported an $18.23 Trillion US economy in Q1 2016.

The math is fairly simply .87/18.23 = 4.77%

How are fiscal policy makers not doing enough stimulus?

An economist might point to the BEA data showing that "Government consumption expenditures and gross investment" grew only 2% from Q1 2015 to Q1 2016. This seems plausible towards the argument El-Erian is making.

However, I then went back to the Treasury Direct data. It showed that on March 31, 2015, Social Security debt was $5.06 Trillion and it increased to $5.34 Trillion on March 31, 2016. An increase of $0.278 Trillion.

Further, the "Public Debt" on March 31, 2015, was $13.09 Trillion and a year later, on March 31, 2016, it was $13.925 Trillion. An increase of $0.834 Trillion. The combined total debt increased by $1.1 Trillion.

Now, let's go back to the BEA's GDP data from Q1 2015 to Q1 2016

Source: Breau of Economic Analysis (BEA) reported

This data shows that nominal GDP had a YoY change of $0.58 Trillion in Q1 2016. Further, this shows that total government spending rose only $0.064 Trillion, and State & Local spending was $0.047 Trillion of this. Leaving about a $0.017 Trillion increase in Federal spending.

So let's get this straight. In the course of one year, the Federal US government went in hock, for another $1.1 Trillion. However, during this same year, nominal GDP only grew by $0.581 Trillion, or about 53% of that amount.

Why was there not a larger increase in Federal expenditures in the BEA data? Because "social" programs, such as transfer payments and government employees are not considered government expenditures in national accounts accounting.

Only a Keynesian economist could make this up!

"Government purchases combine all goods and services bought by all forms of government: form paper clips to bridges and hospitals. This does not include government payment for work or any transfer payment."

Source: Link

The government goes into debt to the tune of $1.1 Trillion, or only $0.87 Trillion if using "Public" debt. This intake of cash is spent, but then categorized somewhere else in the national income accounts.

"In gauging the relative size of governmental vis-à-vis private activity, Due [an academic economist - who is footnoted] warns that the sum of governmental expenditures should not include transfer payments, which "merely shift purchasing power" without using up resources. Yet this "mere shift" is as much a burden upon the producers-as much a shift from voluntary production to State-created privilege-as any other governmental expenditure."

Rothbard, Murray N. Man, Economy, and State with Power and Market: The Scholar's Edition (LvMI) (pp. 1294-1296). Ludwig von Mises Institute. Kindle Edition.

This thinking led me to consider if increasing nominal US government debt is hurting nominal GDP. I gathered more data from Treasury Direct (debt outstanding) and FRED (GDP) from 1993-2015, and made returns out of the data; i.e. (X - X(-1))/X(-1)

Here are the regression results, which also include a seasonal factor:

We find that the percentage change in debt has a negative coefficient to current GDP growth and that it is statistically significant.

The empirical evidence refutes El-Erian's hypothesis that the fiscal sector needs to "do more" to achieve economic "lift off." If anything, it implies that the size of government should be cut in order to boost nominal GDP growth!

If Reinhart & Rogoff's critics are correct, then 2.2% GDP growth would be the "New Normal" (it is unclear if this is real or nominal from the article).

"When the Amherst economists reworked Reinhart and Rogoff's calculations to take account of programming errors and data omissions, they came up with a figure of positive 2.2 per cent for average growth in countries with a debt-to-G.D.P. ratio of ninety per cent or more."

Lower Debt = More Growth ?

Data since the 1990s says so, along with the studies of Reinhart & Rogoff and their critics. This research showed that all lower debt countries had faster GDP growth.

While no statistically valid inference was found between stocks, bonds, and the debt level, a statistically valid inference was found between the change in nominal GDP and bond returns since the year 2000. VUSTX, a Vanguard Treasury Bond mutual fund was used as the benchmark for bond returns, since it has a longer price history than TLT (data was from Yahoo Finance).

Here is the data for the cross-correlogram of GDP change and returns of VUSTX, from Q2 1993-Q1 2016.

Let's follow the train of thought:

  1. Increasing government debt is shown to be detrimental to nominal GDP growth.
  2. Nominal GDP is negatively correlated to bond returns.
  3. Hence, increasing government debt leads to positive bond returns.

Evidently, the Fed's QE operations stifle any attempted rise in interest rates when the government attempts to demand more money.

In summary, fiscal deficit spending leads to the same old, "Good for Wall Street, Bad for Main Street" place. And no, I am not making a political statement for either party.

And "quants" can use this data set to further "tweak" their models.

The "Bond Bubble" might have a bit more room to run until economists and politicians figure this out, and I don't think Wall Street will ever want to cut back on one of its largest profit centers; that is, being a primary dealer of US government bonds.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long TLT options