Executive Summary

• Why GDP growth is very unlikely to support the rate of credit growth the Fed wants
• If it can't, what is most likely to happen?
• Why the current bubble threatens to end in one of the biggest wealth transfers in human history
• How to increase your odds of being on the right side of that transfer

If you have not yet read Part I: The Fed Can Only Fail, available free to all readers, please click here to read it first.

The (Delusional) Plan: Growth Will Cover Past & Future Debts

Currently, the U.S. debt-to-GDP ratio stands at around 350% in 2013.  This is an historically elevated number, so much so that we really don't have anything in our economic history books to tell us what comes next.  Robust economic growth, we suppose, that can reduce that imbalance painlessly.

But looking at the past 220 years of history, we find that the average yearly growth in U.S. GDP has been 3.8%:

(Source) 

Now, I have some quibbles with the idea that the U.S. will be able to sustain that long-run average of 3.8% over the next 30 years, because debt levels are already crushing growth, as are high oil prices (double whammy!).  But let's spot the Fed every advantage here. 

If U.S. GDP grows at 3.8% annually, but credit grows at 8%, this means the nation's debt-to-GDP ratio would balloon to 1,130% by 2043.  That's equivalent to someone with a $50,000 salary carrying $573,000 on their credit card. 

Again, this just seems to be so completely unworkable that I'm pretty certain it's not going to happen.

The alternative of growing credit at roughly the same rate as GDP, ~4% vs. 3.8%, means that not much really changes in regards to debt-to-GDP ratios, but they remain elevated at over 350%.

Of course, the difficulty in this story is that over the past thirty years, GDP has grown at only an average of 2.6%.  The most recent decade was the second worst in 220 years of U.S. economic record-keeping, clocking in at an anemic 1.7%.

If we use the past thirty years of GDP growth (2.6%) as our guide, then the numbers just get a lot worse.  Instead of 1,130% debt-to-GDP under the 8% credit growth future, we come up with a 1,600% debt-to-GDP figure.

Even under the 4% credit growth scenario, the ratio mushrooms from 350%