Tuesday, April 14, 2009


Over the last few years many individuals, firms and governments took on massive amounts of debt. Incomes and profits were rising and leveraged players appeared to significantly outperform their conservative counterparts.

And then the party ended! With falling incomes (job losses etc) and crashing profitability, how exactly are these debts going to be serviced?

While researching this topic I came across the concept of ‘The Marginal Productivity of debt’

Here is an excerpt from a recent article by Professor Antal E. Fekete. http://www.professorfekete.com/
Its really incredible how the Financial Media and government really ignores anyone who is opposed to taking on unsustainably high levels of debt.

"""""The concept of marginal productivity of debt is curiously missing from the vocabulary of mainstream economists. They are watching the wrong ratio, that of the GDP to total debt, and take comfort in the thought that by that indicator 'there is lots more room' to pile on more debt. As a consequence, the marginal productivity of debt went into further decline. This was a danger sign showing that additional debt had no economic justification. The volume of debt was rising faster than national income, and capital supporting production was eroding fast. If, as in the worst-case scenario, the ratio fell into negative territory, the message would be that the economy was on a collision course with the iceberg of total debt and crash was imminent. Not only does more debt add nothing to the GDP, in fact, it necessarily causes economic contraction, including greater unemployment. Immediate action is absolutely necessary to avoid collision that would make the 'unsinkable' economy sink.

Negative marginal productivity
Why is a negative marginal productivity of debt a sign of an imminent economic catastrophe? Because it indicates that any further increase in indebtedness would inevitably cause further economic contraction. Capital is gone; production is no longer supported by the prerequisite quantity and quality of tools and equipment. The economy is literally devouring itself through debt. The earlier message, that unbridled breeding of debt through the serial cutting of the rate of interest to zero was destroying society's capital, has been ignored. The budding financial crisis was explained away through ad hoc reasoning, such as blaming it on loose credit standards, subprime mortgages, and the like. Nothing was done to stop the real cause of the disaster, the fast-breeder of debt. On the contrary, debt-breeding was further accelerated through bailouts and stimulus packages.
In view of the fact that the marginal productivity of debt is now negative, we can see that the damage-control measures of the Obama administration which are financed through creating unprecedented amounts of new debt, are counter-productive. Nay, they are the direct cause of further economic contraction of an already prostrate economy, including unemployment

A lot of leveraged players are going to struggle to service their debts.

Real Estate Moguls, Casion Moguls, Car Companies, Home Builders, Failed LBO deals, indebted and now jobless home owners and creditcard holders, Governments in Eastern Europe needing bailouts etc etc.

Even if none of the above wants to go into default --- just how are they going to service their debts ?

In many cases the current market price of an asset previously acquired is so far below its price of purchase - that it may make more sense to default! ( Think overvalued property deals and underwater home and commercial real estate mortgages)

As Professor Fekete says, focus on the marginal productivity of debt and not just GDP to total debt.

While we may be all set for a deflationary collapse, the only way out may be to trigger a tidal wave of massive inflation.


1 comment:

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