From Madeline Schnapp, Director of Macroeconomic Research at TrimTabs

Stimulus Tactic of Increasing Government Debt to Increase GDP Broken and Unsustainable. How Long before Massive Government Debt Buildup Triggers Another Financial Shock?

Sometimes a picture is worth a thousand words. A recent post on the popular ZeroHedge financial blog compared the annualized growth in federal debt to the annualized growth in GDP in Q1 2012. ZeroHedge reported that while U.S. government debt rose by $359.1 billion in Q1 2012, the U.S. GDP grew only $142.4 billion. Durden noted that, “It now takes $2.52 in new federal debt to buy $1 worth of economic growth.”

http://www.zerohedge.com/news/chart-day-change-q1-american-debt-and-gdp

The surprising observation prompted us to examine the relationship between growth in debt and growth in GDP from 1975 through 2012. What we found is both astonishing and frightening.

In Q1 2012, GDP rose $142 billion, while debt rose $359 billion. In other words, it took nearly $2.50 in debt to generate $1.00 in GDP. We wanted to understand how this relationship compared to those that prevailed in previous decades. The graph below shows our findings.

Source: Bureau of Economic Analysis – www.bea.gov and Treasury Department – www.treas.gov.

Note: The negative value in 2008 was due to negative GDP growth.

From 1975 to 1980, each $1 increase in GDP was accompanied by an increase in debt of between 20 and 47 cents. In other words, the increase in GDP was two to five times the increase in debt.

From 1981 to 2007, the amount of debt required to produce $1 of GDP growth crept higher, and it ranged from a low of 3 cents in 2000 to a high of $2.25 in 1991. In only eight of those years did it take more than $1 of debt to produce $1 of GDP growth—1982, 1986, 1990 to 1993, 2002, and 2003. On average, it took 79 cents of debt to produce $1 of GDP growth. In other words, the increase in GDP was nearly 1.3 times the increase in debt.

Along came the Great Recession. Since 2009, the traditional relationship between debt and GDP growth has been turned upside down. Each $1 increase in GDP has been accompanied by, on average, a $2.50 increase in debt. Before the recession, an increase in debt generally generated a greater increase in GDP, but now it takes an enormous increase in debt to eke out a small increase in GDP. At some point, the amount of debt required to generate even modest GDP growth will suffocate the economy and trigger another financial shock.