Recently I went to the bank and asked to borrow $1 million.
It’s really not a big deal.
You see, I live in a cul-de-sac of 10 houses, and each of these households has a primary income earner. In some cases, a secondary earner too. We are all good neighbours and get along with each other reasonably well. We would be classified as a stable middle-class neighbourhood and our average annual income, before tax, is approximately $85,000 per household.
The bank manager asked all the usual questions, but the most important was related to my household’s annual income. This would be used to pay off the principal and interest owing on such a sizable loan. With a straight face, I told him that the annual income at my disposal was $850,000.
After reviewing my documents, the bank manager stated that he had a couple of fairly significant issues with my application. The most important was that I was using the income of all of my neighbours (over which I had no legal ownership) and that this was patently incorrect.
My loan was disapproved as nobody was going to lend $1 million to somebody who had a before-tax income of $85,000. An interest rate of 5% would cost $50,000 annually in interest payments.
So the bank manager was quite right to reject me.
But here’s the shocking part: this is precisely what is happening in most (if not all) of the creditor nations around the world.
Because economists have a favourite ratio to measure the credit-worthiness of a nation: “debt to GDP”.
Debt to GDP is a basic ratio that divides the debt owed by the government by the GDP of the country. The lower the ratio, the better, as it implies that you have the capacity to take on more debt. At least according to mainstream economists.
But here’s the thing. GDP is the income of the economy, and the government does not own the economy. The same as I don’t own my neighbours’ income.
The government, of course, has the right to the tax revenue it can collect from GDP, and income from services it can provide to the country for a fee.
But that is all.
Consider an example (these numbers are dated, but the point remains the same). At December 2015 the U.S. had an official debt[1] of $18,775,084,981,440 (by the time you read this it may be a lot higher). Let’s call it $19 Trillion. Current GDP[2] is estimated at $17.42 Trillion.
Using these numbers, the debt-to-GDP ratio of the U.S. currently stands at 107%. Not sounding so bad, right? In fact, many mainstream economists claim that governments like the U.S. should continue to borrow, as their debt-to-GDP ratio is well within historical norms.
The U.S. government collects approximately $3.3 Trillion in tax revenue and other receipts annually. So their debt to income ratio stands at a staggering 566%. And again this is before they start spending on items such as healthcare, social security, defence, etc.
Still not sounding so bad?
Consider that the USA is estimated to owe an additional $80T in unfunded liabilities, and you can see the writing on the wall. If they had to use conventional accounting measures like every other person and company in the country, then their debt to income ratio would be a staggering 2969%.
This would be the same as me owing $2.5M and having only my $85,000 income in which to pay all my expenses as well as servicing my debt.
Any sane bank manager would turn down my loan in this case. How much longer do you think the U.S. can keep borrowing?
[1] http://www.concordcoalition.org/issue-page/national-debt?gclid=COzdprDh2skCFdcRvQodtb8ImQ
[2] http://data.worldbank.org/country/united-states