Empirical Proof of the Giant Con

I want to continue on with my recent focus on the giant con and if you’ve been reading my work lately you’ll certainly know what that is.  However, for those of you not familiar with the giant con, it is the idea that our economy is growing when, in fact, it hasn’t had growth in decades with the exception of the late 1990’s.  In a recent article I wrote for the benefit of Steve Liesman, I showed that the giant con is entirely a function of debt.  I explain why debt is actually a net negative given real interest rates and I strip out debt from GDP to show that GDP has actually been contracting for some time.  Recently I’ve been I looking for other ways to prove that the giant con is truly happening.  But let’s just have a quick look at what real GDP adjusted for Debt would like.  We see in the past 40 years the only period of real GDP growth was between 1996 and 2000 and has collapsed since early 2007 to date.

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Most of us are familiar with the concept of money velocity.  It is a measure of how effectively or efficiently we are utilizing our money stock to generate output.  The idea is that the more I invest the more notional returns I can generate.  However, in the economy there is a downside to ‘investing’ with additional money supply, namely, inflation.  And so we want to maximize the amount of output we generate from a given stock of money to optimize our returns.  We gauge this via money velocity and often we use M2 Velocity as the key measure.  Currently M2 Velocity is around 1.3, meaning that for every supply of dollar we are generating 1.3 dollars of output.  This is down significantly from the late 1990’s at which time we were generating around 2.3 dollars of output for every dollar of stock.

Now pondering this the other day my thoughts started drifting to debt and GDP.  See while the downside to increasing money supply to generate more output is inflation, increasing debt to generate more output can have far more dire consequences.  And it struck me as curious that despite hearing once in a while that total public debt is now larger than annual GDP we rarely hear about why this is bad.  And so I wanted to find a way to depict the problem.  I’ve always argued that debt is not inherently bad.  Debt, when used correctly can be extremely powerful and productive in regards to maximizing returns.  However, misallocated debt or malinvestment of debt ends in devastation, most of us have a pretty good grasp of that concept.

So it is important then that we ensure our debt is being allocated effectively so as to avoid devastation.  But how do we do that?  How do we know debt is being effectively put to work in the economy so that it actually returns both principal and some additional positive return at least sufficient to cover the interest payment on the principal borrowed?  Well I’ve put together a chart.

The chart depicts something I’m calling Debt Delta Velocity and M2 Delta Velocity.  All I’ve done is used the change in GDP and money stock to get the delta velocity. That is, for each dollar we’ve added to money supply in a given period (and I used annual periods) we gauge how much additional output was generated.  So then it’s change in GDP divided by change in M2 Stock (whereas M2 Velocity is total GDP/total M2).

And so in order to measure the effectiveness of our debt utilization I take change in GDP divided by change in debt.  Now the issue with debt is that it needs to be paid back.  And so if we are generating anything less than the principle + real interest rate we are actually losing money on each dollar of debt despite official total GDP increasing due to the inclusion of debt principal.  So let’s have a look at the chart.

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And so what we see is M2 Delta Velocity (green line) showing a positive trend from the late 1960’s through the late 1990’s at which point it goes into a nose dive that continues today.  This means that we’re being forced to print proportionately more dollars to generate the same amount of output.  But one dollar of additional supply is still generating more than a dollar of output.  However that does not appear to be the case with debt delta velocity.

The Debt Delta Velocity (blue line) is the change in GDP/ (change in debt + cumulative change in annual interest payments).  The idea is that the cost is not only the additional principal debt but the annual interest payment as well.  And so even a linear accumulation of debt results in an exponential growth in obligations requiring significantly more GDP growth than does M2 Delta Velocity to generate positive returns. The significance of this chart is that it shows us for every dollar of debt we take on we are generating less than a dollar of GDP.

Specifically, the chart depicts a negative trend for Debt Delta Velocity throughout the 1970’s while stabilizing through the 80’s and 90’s only to fall again throughout the new millennium.  One might initially point out that the recent downward trend is not as severe as M2 delta velocity.  That is true.  However, what we find is that since the late 1970’s we’ve not been generating enough output to pay back each dollar of principal plus interest.  In simple terms we are losing money on every additional dollar we borrow despite being told we have GDP growth.  The discrepancy is a result of the Fed adding debt principal into the growth factor of GDP.

This is obviously not a prudent calculation of GDP growth.  Think about debt as an investment into our economy.  We would measure the effectiveness of that investment by the gain or loss using an Internal Rate of Return (IRR) calculation.  So the above chart tells us that for each additional dollar of debt we invest into the economy our actual return on each dollar has averaged around -50% since the start of the new millennium.  This proves that while the actual GDP metric is growing, that growth is costing us 150% of the growth.  This is absolutely not something to celebrate.  The consequence of continuous negative returns on debt forces us to take on ever more debt, a process that has now become a death spiral for the economy, the USD and the nation.

In fact, with the exception of the late 1990’s we’ve been losing money i.e. misallocating our resources in economic terms since the late 1970’s.  That is the stark reality that has forced America into a perpetual state of borrowing.  That is, in order to keep the Giant Con going, specifically that our economy is growing, we have been forced to borrow ever increasing amounts of debt.  Due to the laws of compounding interest, the growth in debt should then theoretically be exponential.  And well that is exactly what we find.  Have a look, basically an exponential function to the order of ‘2’, exactly what we would theoretically expect.

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This is also why we see interest rates declining since the late 1970’s and we will continue to see them decline until the collapse of the USD at which point a binary switch will be flipped and interest rates will sky rocket in an attempt to defend the hyper inflating US dollar.  Have a look at an excerpt from my previous article “Interest Rates Cannot Rise, Here’s Why

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What I have laid out here is a green line that represents our total debt as a percentage of GDP.  The purple line is the historic 10 yr Treasury Note rate which we are using as a proxy for the average interest rate on total debt (AIR). And the blue line is the interest payment on our total debt as a percentage of GDP (again using the 10 yr rate as a proxy for average interest rate on total debt) let’s call it DSGDP.

Do note that total debt as a percentage of GDP (green line) recently exceeded 100%.  Also note that as the green line increases the spread between the purple and blue lines gets smaller.  This is really just an algebraic principle.  Historically the blue line is essentially a fixed rate (within a range) and so as the green line moves up the purple line (AIR) must move down so the DSGDP stays within the fixed range.  As total debt became a higher percentage of GDP the average interest rate on debt must move down toward that 2.5% line that we’ve held for 15 years.  As the total debt to GDP moves above 100% we should start to see the average interest rate on total debt (the purple line) move below 2.5% in order to keep the DSGDP around the 2.5% 15 year average.  As a side, I did regress these relationships and found both statistical significance and good explanatory properties.

But the reality of our economic situation is that we have dropped below a critical (mathematical) point of income distribution.  Below which growth becomes impossible regardless of the amount of money printed or borrowed.  The reason is that misallocation of resources has led to capacity reductions in order to remain profitable, which has led to slack in the labour market leading to declining real incomes.  The follow on from the poor policies fluttering their wings is that consumers have been saturated with debt in order to cover up demand deterioration resulting from the declining incomes resulting from the resource misallocation.

Additionally, all those printed dollars being pumped into the system are going to the very same small group of people whose marginal utility for consumption is now zero, and are thus allocating those excess funds to financial markets.  Financial secondary markets are actually outside of the economy proper and so are an inefficient use of funds exacerbating the downward spiral of the working class and perpetuating the need for more debt and printed dollars.

Those printed dollars being allocated to financial markets have led to the current all time high market valuations which makes for a great soundbite to cover up destruction resulting from the resource misallocation.  Additionally, our fiscal and monetary policies currently in place also exacerbate  the inefficient allocation of resources by continuing  to deter investors away from risky (effective) capital projects and into guaranteed financial markets.

So poor policies for decades have deteriorated natural demand to the point that debt was required to cover up the reality of demand deterioration (debt rather than changing policies was a choice by policymakers early on that allowed them to continue the misallocation of resources which obviously benefited them and their benefactors) which has taken us past the point of no return without suffering massive economic calamity.

This is essentially the perfect storm for a collapsing economy and we can see it manifest via velocity and income distribution.  Let’s have a look at what happens as resources become increasingly misallocated.  As discussed in depth in previous articles real median income is our proxy for both standard of living and income distribution (blue line below).

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What we see is that debt delta velocity (red line) mirrors almost perfectly with real median household incomes (blue line).  This further evidences that economic growth is a function of real incomes not income + debt.  We should understand that this correlation is not a cause and effect relationship but the result of an underlying driver common to both.  Specifically, efficiency of resource allocation.  We clearly see that as our economic policies have become fixated on financial markets (inefficient resource allocation), both debt delta velocity (red line) and income distribution (blue line) have taken significant hits.  Because of the inefficiencies we are required to print more money and take more debt.  While this might not be problematic so long as we can print money and monetize debt forever, the reality is that there will come a point when it puts too much pressure on the US dollar.

I can assure you if we were anyone but the USA we would already be on our knees praying to the gods of fundamentals for mercy.  Fortunately the central banking cartel, at least for now, is heavily reliant on the US dollar and military for its political power across the globe.  And as such the USD is being protected like the proverbial prodigal son.  But eventually the central banking cartel will grow weary of the pressure and difficulties of fighting the fundamentals and will shift their reliance to a new host, leaving the US dollar to lay in the bed they made for it.

If you think about it the past century has been all about transfer of wealth.  Every bubble and subsequent bust results in significant transfer of wealth from the working class to the those at the top of the economic food chain.  We saw tremendous wealth increases to America’s royal families subsequent to the collapse of 1929.  Make no mistake that was not wealth creation but a zero sum gain.  Millions of working class lost everything, being forced to give up assets at pennies on the dollar to America’s wealthiest families.

The same transfer of wealth takes place during every boom bust cycle.  We are on the precipice of the third major bust since the beginning of the new millennium.   This next imminent bust, however, could define the final transfer of America’s wealth because the working class has been forced to put everything into stocks given bonds are paying zero return.  And so when the market tanks this time it will literally be the largest single transfer of wealth in the history of the world.

Institutional trading groups are salivating with the thought of enormous profits that will be taken upon the inevitable coming market collapse.  Given we have in no way recovered from the last economic catastrophe, the next one very well could mean the end, at least for a period, of American wealth and power.  And the end of the US dollar as the world reserve currency, which will result in a new much lower equilibrium valuation.  With the central banking cartel, at that point, no longer having an interest in the USD, gold prices will be allowed to move up to natural supply/demand equilibrium as the extraordinary paper selling of gold will cease to occur.

If you take one thing away from this piece please understand the Giant Con is the result of the misallocation of resources by policymakers.  It has benefitted them and theirs and is why the political class chose to cover it up with debt rather than reallocate.  The misallocation has destroyed the nation, the dollar and standard of living of the working class.

The cost to the working class of falsify economic growth is beyond redemption.  In the end, the path is set and there is no escaping from the debt trap in which we snagged ourselves.  And so we bide our time until the weight of exponentially increasing debt collapses in on us.  But then we rebuild.  Well we prosecute those responsible for the destruction and then we rebuild with the ill gotten profits we strip from them in accordance with the laws of this nation that we will make clear apply to everyone in our reborn America.  And we ensure future generations know not to succumb to the sweet songs of the Sirens of the Central Banks as these central bankers are an evil, gluttonous, pride filled, sociopathetic people who are devoid of conscience and any sense of humanity.  They will be locked up next to the neoconsevatives in public cages to remind humanity of the monstrosity that once ruled this land.



18 thoughts on “Empirical Proof of the Giant Con

  1. “And the doctors said, as they took their fees,
    There is no cure for this disease.’
    The Death of Henry King.

  2. Well stated, sir. The depth of greed and the utter disregard for the broader humanity by the ‘elite’ few toward further enrichment has been staggering and saddening to behold. But your final paragraph indicates that you still have some faith in either the larger group of “the people” or that “the system” can be restored. You ask; “Will we prosecute those responsible”, and follow that with ensuring that future generations will understand ‘the giant con’ and prevent it from being repeated.
    I submit that this probably will not happen. The vast majority in America and the world are so dumbed down and have been bred for genuine stupidity that they will not see the truth when the next great downturn occurs. If I’ve learned one thing from my study of all this (through the efforts of scholarly works like yours), it is that the elites and their paid lackeys are very smart and that they take great pains to make sure that THEY NEVER LOSE. They hold the keys to the kingdom, hire and equip the goons that will put down the few sheep that will rise up in anger, and will be the saviors of the remainder that will put into place the next giant con. The next world monetary system, that is probably ready for implementation, whether it is based on SDR or not will be hailed by the masses via the controlled world media as the solution to all the worlds ills.
    Always remember two things: the sheep will not rise up, and the wolves never go hungry.

  3. Ponzi was an amateur in comparison. It is just amazing how easy a large part of the populations the globe over are mislead and conditioned to find ever increasing corrosive monetary policy as perfectly normal and how economists vigorously defend it.

  4. I share your anger and frustration. As the saying (now) goes, those who learn from history are condemned to sit around and watch it repeat itself.
    God bless you and keep up the good work. Apparently only sheer mathematics (exponential growth of debt) is gonna bring this thing down, so we wait.

    1. Hey Steve – I’m also one of the condemned but I have spent several years trying to think through how we might be able to change the historical outcome. To date my effectiveness at getting to a solution is no better than “sitting around and watching it repeat itself”. Incredibly frustrating, as you also mentioned, given how apparent it truly is to any person who gives it just a few minutes thought (Thad lays it out very succinctly). I hate the thought of just waiting for the next Dark Age, not for my sake at all as I have reaped all the benefits of our once great society but for my grandchildren…

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