Analyst: Aggregate debt drove economic damage in Great Recesssion

posted at 2:15 pm on May 9, 2011 by Ed Morrissey

In response to the Great Recession, the US government has gone on a spending spree in the hope of using Keynesian stimulus to restart the economy.  However, according to a new analysis by Dr. Polina Vlasenko at the American Institute for Economic Research, that approach may make us even more vulnerable to future recessions.  The amount of economic damage done to Western economies by the downturn directly relates to the aggregate debt in each economy as a percentage of GDP, she argues — and Japan and the Eurozone paid a steep price for their public and private debt.  From the extract:

In comparing the experience of the United States, Canada, Japan, and the Eurozone of 16 countries, two conspicuous findings emerge. One of these, which we address on the back page, is the relationship between different regulations governing employment and the unemployment rates during both recession and recovery. The other, discussed here, is the relationship between debt financing and the decline of output during a recession.

The primary differences in the severity of this recession across nations can be explained by the levels of debt each had going into the downturn. Countries that had built up high debt loads suffered deeper and longer recessions. The immediate implication is that nations that run up high debt-to-GDP levels through deficit spending now may be compromising their ability to survive the next recession…

Vlasenko compares the US, Canada, Japan, and the Eurozone for the depth of the damage done to GDP and the extent of the recovery.  Canada did best, Vlasenko writes, because it had the lowest aggregate-debt-to-GDP ratio of the four economic zones, with public and private debt at 233% of their GDP and lost 3.4% in their GDP during the downturn.  The US came in second in peak-to-trough performance at -4.1%, with aggregate debt at 329% of GDP.  Both nations have returned to previous levels of production, with Canada ahead of the US.

The news for Japan and the EU is much worse.  The Eurozone has a debt ratio of 388%, and they slid 5.4% during the recession and have yet to recover fully.  Japan has a whopping 572% debt ratio and lost 10% off of their GDP in the recession and were farther back than Europe from full recovery even before the quake and tsunami in the first quarter of this year.  They will have little choice but to spend money on their recovery, which will force them into even higher debt ratios and further burden their recovery.

Why should debt be the main driver for predicting performance?  Vlasenko explains that higher debt ratios reduce flexibility, which freezes capital:

Certain kinds of expenditures are most often financed through debt. Businesses borrow to finance a new factory. Households borrow to buy a house or a new car. Following a contraction in credit, these sectors of the economy contracted sharply as well. …

The impact on an economy of an interruption in financial flows is directly related to the extent that the economy relies on lending. A financial crisis would trigger a more severe recession in an economy heavily reliant on debt, as compared with an economy that uses debt financing less extensively.

Vlasenko points out that this is true within the Eurozone as well.  Heavily leveraged economies like Greece, Ireland, and Spain got hit the hardest by the recession and have had the toughest time recovering.  Other nations in Europe that managed their debt loads better rode out the storm with less damage.  The implications for this analysis are rather clear:

If leveraging is treacherous ground for an individual investor, imagine the implications for an entire economy. Before the recent crisis, when real estate and other asset prices were rising, debt loads were less problematic. When asset prices began to fall, high debt loads became destructive. The financial crisis ensued.  Recession followed.

All this implies that an economy can be made less susceptible to the devastating effects of a financial crisis if the reliance on debt financing is kept at a reasonable level.

So far, we have seen little real growth from the spending spree conducted by the Obama administration and the Democratic Congress that preceded it.  What we have seen is a sharp increase in our debt ratio over the last few years.  While that didn’t cause the Great Recession, Vlasenko’s analysis shows that it will make the next one that much worse.  Unless we get our fiscal house in order, we’re setting ourselves up for a very bleak future.

Breaking on Hot Air

Blowback

Note from Hot Air management: This section is for comments from Hot Air's community of registered readers. Please don't assume that Hot Air management agrees with or otherwise endorses any particular comment just because we let it stand. A reminder: Anyone who fails to comply with our terms of use may lose their posting privilege.

Trackbacks/Pings

Trackback URL

Comments

Obviously this isn’t true …

Bush refused to tax rich people in the US – and this drove the whole planet into recession!!

/S

HondaV65 on May 9, 2011 at 2:16 PM

higher debt ratios reduce flexibility, which freezes capital:

Wow!. Its a good thing I was sitting down when I read that! Shocka!!!

KMC1 on May 9, 2011 at 2:19 PM

higher debt ratios reduce flexibility, which freezes capital:
Wow!. Its a good thing I was sitting down when I read that! Shocka!!!

KMC1 on May 9, 2011 at 2:19 PM

WHO KNEW?!
This must be why our profit margin is so tight at the ranch.
Bcs we have debt.

Badger40 on May 9, 2011 at 2:21 PM

…and swimmers with no barbell weights tied around their waste drown at a lower rate than those who do.

RBMN on May 9, 2011 at 2:21 PM

The amount of economic damage done to Western economies by the downturn directly relates to the aggregate debt in each economy as a percentage of GDP, she argues —

This can be filed under the ‘Well, Duh!’ category.

sharrukin on May 9, 2011 at 2:23 PM

You know, I can’t wait until someone in Obama’s administration floats the idea of wage and price controls when inflation starts creeping up higher and higher.

ButterflyDragon on May 9, 2011 at 2:23 PM

This study is obviously racist. Did anyone consult our resident Nobel Prize Winning President?

search4truth on May 9, 2011 at 2:24 PM

Wait a minute, you mean that taking money out of the people’s hands and into the government does not help the economy?
You are telling us that if you take $100 from someone, give it to the government, and they return $15 back to them, that doesn’t help the person?
They are actually stating that the government doesn’t produce but only consumes?
Someone has the audacity to state that the federal government programs, the cost of the programs, outweigh the benefits?
Imagine that…something that conservatives have known all along, and that liberals have no concept of.

right2bright on May 9, 2011 at 2:26 PM

You know, I can’t wait until someone in Obama’s administration floats the idea of wage and price controls when inflation starts creeping up higher and higher.

ButterflyDragon on May 9, 2011 at 2:23 PM

When 50% or so of the country doesn’t pay taxes and could give a flying fig about those who do, this is an idea who’s time has come in liberal minds I bet.

WitchDoctor on May 9, 2011 at 2:27 PM

and swimmers with no barbell weights tied around their waste drown at a lower rate than those who do.

RBMN on May 9, 2011 at 2:21 PM

I really like this.
Awesomely said.

Imagine that…something that conservatives have known all along, and that liberals have no concept of.

right2bright on May 9, 2011 at 2:26 PM

Corruptocrats & nosy wannabe do-gooders have been nothing but a pain in the a$$ to democracy since the dawn of time.

Badger40 on May 9, 2011 at 2:30 PM

A good look at the Canadians, who weathered this thing rather well, says it all. They reduced government spending as a function of GNP and reaped tremendous benefits.

unclesmrgol on May 9, 2011 at 2:31 PM

Gotta love me some Commerce Clause!

Del Dolemonte on May 9, 2011 at 2:32 PM

What we have seen is a sharp increase in our debt ratio over the last few years. While that didn’t cause the Great Recession

Credit expansion , bubble, pop. Boom bust cycle fed by fed low interested rate and lending standards.

the_nile on May 9, 2011 at 2:33 PM

Bottom line is the 1%ers want to keep control of the price of oil for their benifit and woe be unto anyone who steps out of line.

The Strange Case of Gold, Oil and Mummar Kaddafi.

What with the world’s attention diverted with demise of Osama Bin Laden and dubious controversies over whether or not to release any photographic evidence of his brain matter, the story of the ongoing violence in Libya has been moved to page 12 so to speak. That is until just the other night when Kaddafi’s forces managed to blow up the last remaining oil facilities in rebel hands at the port city if Misrata. Going up in the smoke of the fires was not only the rebels last hopes of holding the city but any potential of funding there little revolution with oil and any financial viability to the curiously and hastily created new Central Bank of Libya.

I’d say that it’s a pretty safe bet that Kaddafi is a low life tin pot dictator not much different than any other low life tin pot dictator found all across the Arab world. This raises the questions of why Libya and why now? As the wave of violence spread across the Middle East Kaddafi was hardly the only or the first to turn his guns on his subjects. In particular, as in Syria, where using unarmed protesters for target practice is now a daily ritual.

So is there something going on under the surface with Libya that is perhaps not being discussed but is also perhaps a driving force behind the “humanitarian mission” that NATO has undertaken? Well let’s look at a few elements, some not necessarily making the front page in the New York Times.

1. Shortly after the so-called rebels took control of the city of Benghazi it was announced that it would become the home for a new Central Bank of Libya and would seek association with both the (International Monetary Fund (IMF) and the Bank for International Settlements (BIS).

2. This new “Bank” would also become the financial clearing house for new oil export agreements between the new rebel “government” and other Arab states that would provide the logistical support to get the oil out of Libya, i.e. tankers and refinery capacity.

3. Libya’s existing Central Bank is wholly owned by the State and is not affiliated with either the IMF or the BIS. (Not to mention that it also owns about 12% of the major Italian banks.)

4. Just a few months before this “revolution” spread to Libya, Kaddafi (through the state owned bank) announced that they were seeking to create a “Gold Dinar” to be used by Arab and African States as the medium of exchange for oil transactions within the region.

5. Any such transaction would be outside the reach of the IMF and BIS and would not necessarily be based on any translation of the spot price value based in U.S. Dollars, and whatever the agreed to transaction price was, based in Gold Dinars.

With any such transactions now taking place directly between the buys and sellers and cutting out the western spot market and banking interests and eliminating whatever their cut of the action is for the currency trades certainly casts an additional if not different light on the above questions of “Why Libya and why now.”

I’ll be waiting for Osama Ben Bernanke to be asked about this at his next propaganda press conference. But I won’t be holding my breath.

http://theeveningchronicle.blogspot.com/

LCT688 on May 9, 2011 at 2:35 PM

Unless we get our fiscal house in order, we’re setting ourselves up for a very bleak future.

In the bowels of the Fed, this message was shouted to a sweaty man frantically shoving green paper into a machine…

“What…?!?!

… I can’t hear you over the noise of this printing press. Let me turn it up a few more notches and increase the volume.

That should fix things…”

Seven Percent Solution on May 9, 2011 at 2:36 PM

Keynesianism is a cargo cult, sparked by the New Deal and America’s later entry into World War II. People believe Keynesian economics work because they were perceived to have worked in the 1930s. What was perceived by Americans as a recovery from the Great Depression through government spending was in fact the economic buildup to the Second World War.

The New Deal didn’t work, and could not work. We need to make this more widely known.

Sekhmet on May 9, 2011 at 2:40 PM

You know, I can’t wait until someone in Obama’s administration floats the idea of wage and price controls when inflation starts creeping up higher and higher.

ButterflyDragon on May 9, 2011 at 2:23 PM

They know it didn’t work when Nixon did it so they won’t do it.

LODGE4 on May 9, 2011 at 2:40 PM

This outcome is obvious to anyone that looked at the results of the New Deal. Keynesian economics prolonged the downturn of 1929 and turned it into the great depresion. So who thinks obama is stupid and who thinks he is evil?

chicken thief on May 9, 2011 at 2:43 PM

Bushs fault….see what I inherited
- dear leader

cmsinaz on May 9, 2011 at 2:47 PM

Couldn’t help being struck by the irony of this having just read the Lawrence Wright article linked in the headlines. Rand Paul, you just may be onto something…

cynccook on May 9, 2011 at 2:48 PM

One of these, which we address on the back page, is the relationship between different regulations governing employment and the unemployment rates during both recession and recovery.

More bad news for big government progressives.

cartooner on May 9, 2011 at 2:49 PM

The New Deal didn’t work, and could not work. We need to make this more widely known.

Sekhmet on May 9, 2011 at 2:40 PM

The more I read about FDR’s ‘accomplishments’ the more disgusted I am by him.
He was not a communist. But he sure as he!! sympathized with them & was fooled by them time & again.
Even his wife was fooled by them.
More of us need to read up on FDR & what he did to help destroy America.

Badger40 on May 9, 2011 at 2:50 PM

Um, it took an official economist with a PhD to tell us this?

Hasn’t your ‘average joe’ been yelling this from the rooftops for… oh, a few years now?

Midas on May 9, 2011 at 3:08 PM

They know it didn’t work when Nixon did it so they won’t do it.

LODGE4 on May 9, 2011 at 2:40 PM

Want to bet? Socialism has proven to be an utter failure at every turn, but they keep trying to push that.

ButterflyDragon on May 9, 2011 at 3:09 PM

Hasn’t your ‘average joe’ been yelling this from the rooftops for… oh, a few years now?

Midas on May 9, 2011 at 3:08 PM

People evidently always need ‘studies’ that ‘prove’ what is seen in nature by everyone who sees.

Badger40 on May 9, 2011 at 3:18 PM

The more I read about FDR’s ‘accomplishments’ the more disgusted I am by him. He was not a communist. But he sure as he!! sympathized with them & was fooled by them time & again.
Badger40 on May 9, 2011 at 2:50 PM

Those are the same things. Communism isn’t an exclusive club you have to get accepted into; it is just a belief system. Anyone who believes in Communism is a Communist – period.

BTW, did you ever read FDR’s letters? Yalta was no accident; FDR genuinely thought that Russia would help save the world from English “Imperialism.”

logis on May 9, 2011 at 3:25 PM

They know [wage and price controls] didn’t work when Nixon did it so they won’t do it.

LODGE4 on May 9, 2011 at 2:40 PM

If they suggest it, they won’t use that term.
It’s all in the messaging doncha’ know.

PackerBronco on May 9, 2011 at 3:25 PM

LCT688 on May 9, 2011 at 2:35 PM

Thanks. Makes sense.

Kadaffi forgot to get Saudis on board first. Wonder who actually does have an alternate replacement reserve currency plan maturing? Right now nobody wants it, IMHO.

Caststeel on May 9, 2011 at 3:26 PM

Anyone who believes in Communism is a Communist – period.

BTW, did you ever read FDR’s letters? Yalta was no accident; FDR genuinely thought that Russia would help save the world from English “Imperialism.”

logis on May 9, 2011 at 3:25 PM

Yes. FDR disgusts me.
And anyone who can saygreat things about him is either ignorant, or evil.
I cannot otherwise explain how you could in good conscience say this man was anything but overall BAD for our country.

Badger40 on May 9, 2011 at 3:46 PM

logis on May 9, 2011 at 3:25 PM

BTW-this is an excellent book.

Badger40 on May 9, 2011 at 3:48 PM

That same debt is still there; in fact, there’s far more debt today than yesterday. If debt was what was responsible for the “Great Recession”, then we have never recovered out of it. There is going to be no “double-dip recession” because we never recovered out of it in the first place. All of this inflation is artificial due to Fed shenanigans. We’re in a long-term deflationary period.

Weebork on May 9, 2011 at 4:23 PM

. So who thinks obama is stupid and who thinks he is evil?
chicken thief on May 9, 2011 at 2:43 PM

I think Obama is stupid and his Puppetmaster is evil…

CCRWM on May 9, 2011 at 4:33 PM

LCT688 on May 9, 2011 at 2:35 PM
Thanks. Makes sense.
Kadaffi forgot to get Saudis on board first. Wonder who actually does have an alternate replacement reserve currency plan maturing? Right now nobody wants it, IMHO.
Caststeel on May 9, 2011 at 3:26 PM

Could you two explain in layman’s terms what this means?

CCRWM on May 9, 2011 at 4:36 PM

This is a great article.

What we are seeing is that the United States suffered a heart attack — brought on by the bursting of the housing balloon.

It’s as if we’d had caffeine once too many times. Constriction of the arteries, indeed.

unclesmrgol on May 9, 2011 at 7:43 PM

Duh! People, people, wake up before it’s too late. Since around 1980 our societal (personal, business and public) debt growth has exceeded the real growth (GDP net of government) of our economy, or, i.e. our ability to pay off our debts. It’s really that simple. There are many ways to spin the debt crisis, but it all leads back to the fact that we have taken on more debt than we can pay for. Will the process of removing unproductive debt and malinvestment REQUIRE a short term decline in the economy (read recession, although some say a depression). You betcha! The pain CANNOT be avoided. The problem then is who and what political party is prepared to tell people the bitter truth and provide a plan for managing the tough times? … Still waiting!

boqueronman on May 9, 2011 at 8:13 PM