T Nation

Marginal Productivity of Debt

Can someone explain this? I am not an economist. Help?

"In the 1950’s when the dollar was still redeemable in the sense that foreign governments and central banks could convert their short-term dollar balances into gold at the fixed statutory rate of $35 per ounce, the marginal productivity of debt was 3 or higher, meaning that the addition of $1 in new debt caused the GDP to increase by at least $3. By August, 1971, when Nixon defaulted on the international gold obligations of the United States (following in the footsteps of F.D. Roosevelt who had defaulted on its domestic gold obligations 35 years earlier) the marginal productivity of debt has fallen below the crucial level 1. When marginal productivity fell below $1 but was still positive, it meant that total debt (always ‘net’) was rising faster than GDP. For example, if the marginal productivity of debt was ½, then $2 in debt had to be incurred in order to increase the nation’s output of goods and services by $1. An increase in total debt by $1 could no longer reproduce its cost in the form of an equivalent increase in the GDP. Debt lost whatever economic justification it may have once had.

The decline in the marginal productivity of debt has continued without interruption thereafter."

http://www.marketoracle.co.uk/Article9753.html

Why does marginal productivity of debt go negative? I’m unclear on the author’s reasons.

A negative marginal productivity of debt means that incurring an additional dollar of debt leads to a decrease in the GDP.

As for why this occurs, think of the mounting interest payments. Eventually, the capital gained from taking on debt is completely wiped out by the increase in interest payment.

A company takes out a loan, expecting to pay the interest from revenues that stem from the expansion of their business. Instead, the company has so much debt that the expansion of their business doesn’t even fully cover their interest payments. Now, they’re on the hook for even more interest payments without getting additional profitability from their larger business.

Taking on the additional debt has reduced their overall profitability, thus the marginal profit of the debt was negative.

In the macroscopic case for the U.S., replace “profit” with “production”. The idea is still the same.

The marginal productivity of debt is negative, because taking on additional debt reduces the GDP. It reduces the GDP because the increase in interest payments due to the debt outweigh the increase in production due to the debt.

[quote]tGunslinger wrote:
A negative marginal productivity of debt means that incurring an additional dollar of debt leads to a decrease in the GDP.

As for why this occurs, think of the mounting interest payments. Eventually, the capital gained from taking on debt is completely wiped out by the increase in interest payment.

A company takes out a loan, expecting to pay the interest from revenues that stem from the expansion of their business. Instead, the company has so much debt that the expansion of their business doesn’t even fully cover their interest payments. Now, they’re on the hook for even more interest payments without getting additional profitability from their larger business.

Taking on the additional debt has reduced their overall profitability, thus the marginal profit of the debt was negative.

In the macroscopic case for the U.S., replace “profit” with “production”. The idea is still the same.

The marginal productivity of debt is negative, because taking on additional debt reduces the GDP. It reduces the GDP because the increase in interest payments due to the debt outweigh the increase in production due to the debt. [/quote]

To which the only solution is to crank up the printing press and print money by the metric ton and pay off debts with a devalued dollar. I suspect this was the plan all along, which could actually work, but it is a risky bet with huge consequences if it fails.

The key with this forced inflation is to get the money to the public at large. That’s tricky because everybody pretty much would have to get substantial cost of living increases pretty much simultaneously. This will in turn require more governement intervention and the vicious cycle continues.
I am not fond of this model, but if it does in fact work, I will be much, much richer. The price of failure is the entire country on it’s knees economically for a loooong time. The second part scares me, really.

[quote]pat wrote:
tGunslinger wrote:
A negative marginal productivity of debt means that incurring an additional dollar of debt leads to a decrease in the GDP.

As for why this occurs, think of the mounting interest payments. Eventually, the capital gained from taking on debt is completely wiped out by the increase in interest payment.

A company takes out a loan, expecting to pay the interest from revenues that stem from the expansion of their business. Instead, the company has so much debt that the expansion of their business doesn’t even fully cover their interest payments. Now, they’re on the hook for even more interest payments without getting additional profitability from their larger business.

Taking on the additional debt has reduced their overall profitability, thus the marginal profit of the debt was negative.

In the macroscopic case for the U.S., replace “profit” with “production”. The idea is still the same.

The marginal productivity of debt is negative, because taking on additional debt reduces the GDP. It reduces the GDP because the increase in interest payments due to the debt outweigh the increase in production due to the debt.

To which the only solution is to crank up the printing press and print money by the metric ton and pay off debts with a devalued dollar. I suspect this was the plan all along, which could actually work, but it is a risky bet with huge consequences if it fails.

The key with this forced inflation is to get the money to the public at large. That’s tricky because everybody pretty much would have to get substantial cost of living increases pretty much simultaneously. This will in turn require more governement intervention and the vicious cycle continues.
I am not fond of this model, but if it does in fact work, I will be much, much richer. The price of failure is the entire country on it’s knees economically for a loooong time. The second part scares me, really.[/quote]

I severely doubt the long-term stability of the Keynesian model because the idea that our debtors will not recognize that we’re attempting to pay them with worthless dollars and will not call in their T-Bills while they’re still worth something is ridiculous. Once that happens, the party’s over.

The only reason China hasn’t already wrecked us by calling them in is because they need our demand more than they need us to get out of their way. But first, that will not be the case forever. Second, China is not stupid, and they will pull the trigger on us before they’re ready instead of watching their receivables vanish.

To think that we can win this game of chicken is outrageous.

[quote]tGunslinger wrote:
pat wrote:
tGunslinger wrote:
A negative marginal productivity of debt means that incurring an additional dollar of debt leads to a decrease in the GDP.

As for why this occurs, think of the mounting interest payments. Eventually, the capital gained from taking on debt is completely wiped out by the increase in interest payment.

A company takes out a loan, expecting to pay the interest from revenues that stem from the expansion of their business. Instead, the company has so much debt that the expansion of their business doesn’t even fully cover their interest payments. Now, they’re on the hook for even more interest payments without getting additional profitability from their larger business.

Taking on the additional debt has reduced their overall profitability, thus the marginal profit of the debt was negative.

In the macroscopic case for the U.S., replace “profit” with “production”. The idea is still the same.

The marginal productivity of debt is negative, because taking on additional debt reduces the GDP. It reduces the GDP because the increase in interest payments due to the debt outweigh the increase in production due to the debt.

To which the only solution is to crank up the printing press and print money by the metric ton and pay off debts with a devalued dollar. I suspect this was the plan all along, which could actually work, but it is a risky bet with huge consequences if it fails.

The key with this forced inflation is to get the money to the public at large. That’s tricky because everybody pretty much would have to get substantial cost of living increases pretty much simultaneously. This will in turn require more governement intervention and the vicious cycle continues.
I am not fond of this model, but if it does in fact work, I will be much, much richer. The price of failure is the entire country on it’s knees economically for a loooong time. The second part scares me, really.

I severely doubt the long-term stability of the Keynesian model because the idea that our debtors will not recognize that we’re attempting to pay them with worthless dollars and will not call in their T-Bills while they’re still worth something is ridiculous. Once that happens, the party’s over.

The only reason China hasn’t already wrecked us by calling them in is because they need our demand more than they need us to get out of their way. But first, that will not be the case forever. Second, China is not stupid, and they will pull the trigger on us before they’re ready instead of watching their receivables vanish.

To think that we can win this game of chicken is outrageous.[/quote]
Stability is an issue as well…If you forcibly devalue the dollar you may not be able to stop the bleeding.

Putting your fate in the hands of your enemy is always a bad idea. China is no friend of ours and they will turn on us in a second.

“China” as a whole is not going to turn on anyone, it’s the individual businesses and debt holders that will…just as any prudent business person would if they suspected they were getting paid in counterfeit money.

[quote]Headhunter wrote:
Why does marginal productivity of debt go negative? I’m unclear on the author’s reasons.
[/quote]

Because the loan ends up costing more than what is gotten out of it. This is just a fancy way of saying that people used debt to consume rather than to produce.

[quote]LIFTICVSMAXIMVS wrote:
“China” as a whole is not going to turn on anyone, it’s the individual businesses and debt holders that will…just as any prudent business person would if they suspected they were getting paid in counterfeit money.[/quote]

China’s government, last I read, held $1.2 trillion-with-a-T worth of U.S. debt. I don’t know how much debt individual Chinese hold.

[quote]tGunslinger wrote:
LIFTICVSMAXIMVS wrote:
“China” as a whole is not going to turn on anyone, it’s the individual businesses and debt holders that will…just as any prudent business person would if they suspected they were getting paid in counterfeit money.

China’s government, last I read, held $1.2 trillion-with-a-T worth of U.S. debt. I don’t know how much debt individual Chinese hold.

[/quote]

Are we “enron-ing” our debt to china? We saw the results of that…

[quote]tGunslinger wrote:
A negative marginal productivity of debt means that incurring an additional dollar of debt leads to a decrease in the GDP.

As for why this occurs, think of the mounting interest payments. Eventually, the capital gained from taking on debt is completely wiped out by the increase in interest payment.

A company takes out a loan, expecting to pay the interest from revenues that stem from the expansion of their business. Instead, the company has so much debt that the expansion of their business doesn’t even fully cover their interest payments. Now, they’re on the hook for even more interest payments without getting additional profitability from their larger business.

Taking on the additional debt has reduced their overall profitability, thus the marginal profit of the debt was negative.

In the macroscopic case for the U.S., replace “profit” with “production”. The idea is still the same.

The marginal productivity of debt is negative, because taking on additional debt reduces the GDP. It reduces the GDP because the increase in interest payments due to the debt outweigh the increase in production due to the debt. [/quote]

I was going to try and explain but I couldn’t do it nearly this well. Good post.

[quote]tGunslinger wrote:
China’s government, last I read, held $1.2 trillion-with-a-T worth of U.S. debt. I don’t know how much debt individual Chinese hold.
[/quote]
the rest of it…?

[quote]LIFTICVSMAXIMVS wrote:
tGunslinger wrote:
China’s government, last I read, held $1.2 trillion-with-a-T worth of U.S. debt. I don’t know how much debt individual Chinese hold.

the rest of it…?[/quote]

The rest of what?

I am pretty sure our debt to China is bigger than $1.2 trillion.

Plus, I have heard that the BOC is starting to open up private banking and allow foreign capital investment.

[quote]LIFTICVSMAXIMVS wrote:
I am pretty sure our debt to China is bigger than $1.2 trillion.

Plus, I have heard that the BOC is starting to open up private banking and allow foreign capital investment.[/quote]

Oh, well yeah. Thank you Captain Obvious. :slight_smile:

I was looking more for a specific number.