–Federal Debt/GDP– A Useless Ratio

An alternative to popular faith

Lately, we’ve heard a great deal about the federal debt/GDP ratio.

The Investopedia says, “The debt-to-GDP ratio indicates the country’s ability to pay back its debt.” This ratio often is quoted in stories predicting the demise of America if federal debt continues to rise and especially if the debt ever were to exceed 100% of GDP. (Since we are about to hit that level, and we still exist, the debt hawks now have moved the time of Armageddon too 200%. But Japan is there already, so maybe move it to 300%?)

This nonsense ratio is so important, the European Union once required, as a condition of membership, the ratio of gross government debt to GDP not to exceed 60% at the end of the preceding fiscal year.

What would you say if I told you the total number of hits the Chicago Cubs made in 2008 is 47% of the total number of runs the Cubs have scored in all of their 100+ year history?

You might well say, “Huh? What does one thing have to do with the other? One is hits; the other is runs. One is 100+ years; the other is one year. It’s classic apples vs oranges.” And you would be right.

Yet, that is exactly what the debt/GDP ratio represents. Federal “debt” is the net amount of outstanding T-securities created in the history of America. The GDP is the total dollar value of goods and services creating this year. The two are unrelated. The federal government does not use GDP to service its debt.

Actually, federal “debt” is not even related to federal “deficits” by function, though the two are related by law. During the gold standard days, the Treasury was required by law to issue T-securities in the amount of the federal deficit.

It was necessary then, because the Treasury could only produce money in the amount of gold reserves. In 1971, we went off the gold standard, which gave the Treasury the unlimited ability to create money.

The creation of T-securities no longer is necessary; it is a relic of the gold standard days. A government with the unlimited ability to create dollars does not need to borrow those dollars.

The government “borrows” by creating T-securities out of thin air, backed only by full faith and credit. Purchasers of T-securities instruct their banks to debit their checking accounts and credit their T-security accounts at the Federal Reserve Bank.

No dollars are created or destroyed.

Then, to “pay off” its debt, the process is reversed: The government merely transfers dollars from T-security accounts (essentially bank savings accounts) back to checking accounts.

Again, no dollars are created or destroyed.

Today, Japan’s ratio is above 200%. The U.S. ratio is near 100%.

monetary sovereignty

By contrast, Russia’s, Chile’s, Libya’s, Qatar’s and others are below 10% – which tells you nothing about their economies, but says a great deal about the meaningless Debt/GDP ratio.

As for GDP indicating “the country’s ability to pay back its debt,” again we have apples/oranges. The value of goods and services created by the private sector, has no relationship to the federal government’s ability to transfer dollars from T-security accounts at the FRB to checking accounts at private banks.

Finally, Debt/GDP (shown as “FYGFDPUN/GDP”) has no relationship to inflation:

Debt/GDP vs inflation

And that is why the debt/GDP ratio is meaningless.

Rodger Malcolm Mitchell
http:www.rodgermitchell.com

12 thoughts on “–Federal Debt/GDP– A Useless Ratio

  1. I think you’re talking hyperinflation on this one, which has been demonstrated to be a bad idea by such great countries as Zimbabwe, Angola, and Brazil: “The government just as easily and as prudently could create dollars from thin air,”

    While I might dispute your debt/GDP argument, the real concern is that by 2012 the interest on the debt will be the largest single program in the Federal government.

    http://seanfoote.wordpress.com/

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  2. I’m not talking about hyperinflation, which occurs when a government in response to inflation, prints money rather than raising interest rates.

    It is factually correct that there is no fundamental difference between creating T-securities out of thin air, vs creating money directly, also out of thin air. If T-securities were eliminated tomorrow, and instead money were created, the money supply would remain the same. However, all concerns about federal debt would disappear, as all federal debt would disappear.

    Why do you feel it is bad for federal interest to “be the largest single program in the Federal government”? Federal interest adds money to the economy, which grows the economy. (Do you own any T-bills?)

    Federal spending of any kind helps the economy grow.

    Rodger Malcolm Mitchell
    http://www.rodgermitchell.com

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  3. “By 2020, the agency estimates debt held by the public would reach $20.3 trillion, or 90% of GDP.” We are on an unsustainable path. It will never get there. Public debt of the United States: ~$8 trillion – Federal public debt ~$4.5 trillion – Intergovernmental Holdings ~$2 trillion – State and local governments. Total = ~$14.5 trillion We are already over 100% GDP.

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    1. Mr. Davis

      Your blog indicates you think it is wars, not reductions in debt growth, that cause recessions. Since 1970, we have had seven recessions, all but one of which were preceeded by reductions in debt growth (and that 1982 recession probably was a continuation of the 1980 recession). See: http://rodgermmitlchell.wordpress.com/2009/09/07/introduction/

      To which wars to do you attribute these recessions?

      By the way, you seem to demand perfect correlation between depressions and reduced debt, in order to believe that reduced debt causes depressions. Do you also demand perfect correlation between wars and recessions? If so, please post your graph showing that perfect correlation.

      Rodger Malcolm Mitchell

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  4. Rodger – the INTEREST on the debt is an annual number that can be reasonably compared with GDP and if you know the size of the debt you can do a sensitivity analysis of the impact of interest at different rates relative to GDP (that includes consumption) But I think a lot of people miss the fact that one person’s interest payment is another person’s income! (‘Person’ is used to include organizations both government and corporate.) The asymetric tax treatment of the payment (a deduction, except by government) and the receipt of the income makes for further analysis in an input-output model (that very few people use).

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  5. Really reading through your site ought to be very convenient with comments. A lot of people just throw lower a “thanksInch and move ahead. Not useful. Disagreeing rocks !, however i can’t care whether you disagree until you understand me why and support your situation. Your opinion (or mine) are useless without some reasoned arguments and (hopefully) details.

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    1. Debt Outstanding Domestic Nonfinancial Sectors – Federal Government Sector (FGSDODNS)

      Federal Debt Held by the Public (FYGFDPUN), Quarterly, End of Period, Not Seasonally Adjusted

      Consumer Price Index for All Urban Consumers: All Items (CPIAUCNS), Monthly, Not Seasonally Adjusted

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