Remember when you were in the seventh, or maybe eight grade, and your teacher came in and said you were going to learn something called “Algebra”? Remember how you were all like, “What could I possibly ever need to know this for?! I’m never going to need to know this stuff!”.
Guess what? This week is that week. This is why you need to know this stuff.
We have some fairly important decisions to make in the near future as U.S. Americans on the direction our country needs to take. I’m sure many of you have divergent opinions on what that direction is, or what we need to do to get there. So do I. This post isn’t about that. This post is about math. Basic economic math.
Without having this foundation in verifiable, repeatable reality (1+1 always equals 2 in basic math), it is difficult to build a framework of understanding for large and complex systems. If you don’t know how much of something something else is, or if it’s becoming smaller or larger relative to that thing, it’s hard to make important decisions regarding how you would like things to change (and how to functionally make that happen).
I’ve touched on this subject before. I think it is fundamental to the disconnect we are now experiencing in this country. We suck at math. So without further ado…let’s define terms.
WHAT DO YOU MEAN BY THAT WORD?!
The two most important numbers in the debt equation are the Debt [D] and GPD [GDP]. Debt is *numerator*. GPD is the *denominator*. This gives us a debt-to-GDP ratio. D/GDP = Debt Ratio.
The largely agreed upon goal for the U.S. economy, that is considered “stable” by pretty much everyone, is a 50-60% Debt to GPD ratio. What this means is that at any given time, we are carrying a debt load that is slightly larger than one-half (.6 or 60%) of our yearly earning power. Countries in such a balanced situation to do a few things easily…one, they can borrow quickly and cheaply to deal with crises; two, they can quickly pay down debt if need be to smooth out boom/bush business cycles and three, they aren’t as exposed to downturns in others markets (as opposed to a country with no debt that instead uses a “sovereign wealth fund“).
So…now we have the main component of this this quation…the D/GPD ratio.
You have probably heard a LOT a about “spending” over the past few months, and how it is “out of control”. You may have even seen some folks cite *yearly deficits* as evidence that “spending is out of control.”
A deficit (and it’s alter ego the “surplus”) is simply the difference (negative for deficits, positive for surplus) between the amount of revenue the government takes in and the amount of spending it puts out.
Part of the disconnect that is happening right now is we are seeing huge deficits, focusing solely on the “spending” side of the equation, and don’t seem to be largely aware how badly *revenues* have dropped off during the recession.
To simplify: Revenues [R] – Spending [S]= Deficit(-)/Surplus(+) [I]
HOW DO ALL THESE THINGS WORK TOGETHER?!
Remember how I mentioned how there would be Algebra? Here’s where it all comes together…..(and perhaps, can all fall apart).
There are two final factors that need to be addressed before we can get a final equation that captures the situation. The are interest rate (i) and growth (G). Interest, in this case, is interest on our debt. Growth, in this case, is the change in GDP.
This gives us a Debt-to-GPD ratio that looks like this:
(D+I)*i/GPD*G = Debt-to-GPD Ratio
Which read as “Debt (D) plus income (I) times interest rate (i) divided by GPD times Growth.
Notice that last equation. We’ve been hammered by folks that this whole problem is caused by a single thing *spending*. However, when we look at the whole forest instead of that one tree, we see that spending is a part of the annual deficit/surplus which changes the debt which is the divided by GPD that has been multiplied by the amount of growth (both positive or negative).
When someone says spending “is the whole problem”, they are lying to you through omission. The deficit/surplus isn’t solely created by spending, it is the *difference between spending and revenues*. As I’ll illustrate in the next segment of this piece, a good portion of recent huge deficits have been created by corresponding huge drops in revenue.
When you understand that “spending” is one of that largest factors in GROWTH, you should start to wonder about what the point of cutting spending, and hampering growth, is going to do to *help* our overall fiscal situation (the GDP-to-Debt Ratio).
Cutting spending during a recession is like taking the foot off the gas and declaring, “We’ll coast up this hill!”
Coming in the next Part…
FREQUENTLY ASKED QUESTIONS ABOUT RECENT U.S. AMERICAN HISTORY BY U.S. AMERICANS?! (these are actual responses to actual questions I’ve answered over the past few days…hopefully this covers yours as well)