More than 10 years ago, I wrote the first version of what became Black Hole Economics, although I called it The Limits of Debt at the time. In that piece, I showed for the first time, what a picture of an economic Black Hole actually looks like. With the election of Donald Trump, The Limits of Debt morphed and expanded into Black Hole Economics when it became clear that his election was going to mean that the debt pressures on the US economy were only going to strengthen and deepen to such an extent that the US may well be propelled into its second Black Hole condition since 2007-9. Please note that this is not another anti-Trump diatribe. Trump is only finishing a trend inadvertently set in motion by the late great economist, John Maynard Keynes. In its very simplified form, Keynes’ solution to the Great Depression was for government to issue enough additional debt to get the economy into a forward motion again. Not much has changed in all these years, and this solution to any weakness in the economy has become beloved of not only Republicans and Democrats alike, but also governments around the world – including, most recently, China.
Increasingly, I am reading and hearing references to Black Hole Economics in the popular financial press. Since it was I who coined the term several years ago, of course I am pleased that it is finally starting to get around. However, I am equally concerned that the term is so (what I might call) cutesy, that serious students of economics, whether they are economists, politicians, or pundits may elect to dismiss it as being somewhat flippant, and therefore inconsequential. I must disabuse anyone who thinks that way. Black Hole Economics is a deadly serious subject. As there have been at least 58 Black Holes in as many countries since 1900, with profoundly negative consequences for every country that has fallen into one, this condition should not be treated carelessly or in an offhand manner. There is nothing cute or frivolous about a condition that has already destroyed at least than 58 currencies and shredded the GDPs of those countries.
What it says in very simple terms is that if the ratio of Total Debt to the GDP of a given country exceeds 3.5/1.0, the GDP will start to collapse. In other words, if total debt exceeds $3.50 per $1.00 of GDP – or whatever the currency unit is – then the GDP will begin to go into reverse – that is, decline.
Now, when I said above, “finishing the trend set in motion”, I mean that it looks very much as if Trump could well push the limits of debt beyond the point where that Black Hole in Economics begins to catch fire if, in fact, we are not already there and knocking on its door. Again, to be fair, it was not Trump that got us to the edge of the Black Hole (the “event horizon”, to use Stephen Hawking’s famous term). That was a joint effort of George W Bush and Barak Obama, with assists being awarded to that so-called economist, Arthur Laffer, along with President Ronald Reagan. What Trump is doing is running with an 86 year-old error, although quite possibly he may take it to its unfortunate absurd conclusion.
Certainly, in terms of pushing the issuance of debt to and beyond the limit, Trump is not a pioneer. In the last century, 55 countries, including Germany and Zimbabwe, have already beaten him to it, and Venezuela, Greece, and Argentina (to name but 3 countries) already have the edge on him in this century.
Adding fuel to the fire, in recent time, Keynes’ theory has given way to something called Modern Monetary Theory which is not only not modern, but further is not even a theory. It is piece of non-sensical sophistry, but it panders to those who naively want to believe – hope may be a better word – that there is no limit to the amount of debt that the US can issue (or any government, for that matter). It fundamentally says that as long as there are buyers for their debt, governments can issue any amount of debt that they want, because, well, we owe it to ourselves. [Try using this argument next April at tax time and see where it gets you when you offer your personal IOU in place of a cheque.]
Having gone bankrupt four times previously, Modern Monetary Theory obviously appeals to Mr. Trump, as it makes it much easier for his government to meet its bills. To give away a bit of my exposition, however, the US got a brief taste of its own home-grown American Black Hole in 2007-9, and suffered through one of the worst recessions since the Great Depression when the US banking system, their auto companies and almost the entire real estate industry went belly up. To go back there again strikes me as beyond masochism.
So…let me explain what an Economic Black Hole is in a sort of an analogy, in very simple, layman’s terms, in a way that I trust that you will never forget it.
Imagine that you are somewhere near the Sahara Desert watching a camel driver loading his camel with box after box after box after box. You start to wonder how much more that poor camel will be able to carry before his back will finally break. And sure enough, true to what you thought was a fable, the driver actually does add a single straw onto his camel’s load and crunch(!), the camel buckles, and down the unfortunate beast goes down in a shriek of agony (or whatever camels do in such circumstances).
Well, suddenly that old saying makes all too much sense. And now, you have a real-life flavour for what that expression really means. The camel driver did not see it coming; you did not see it coming: and the camel could not speak for itself, but it turns out that there is a point – a precise point – where too much is too much.
What has a camel’s back got to do with the economy, you might well ask? Everything, is my reply. What sort of thing do we expect the economy to carry? Well, that’s easy: it is the load of indebtedness that we place on it. And that means all the debt, not just government debt. The government is sort of a proxy for you and I, so whether you and I take on debt or the government does it instead, it is the overall economy of which we are a part that carries that burden.
Well, how much of a load can an overall economy carry, then? Well, its easy for me to give you the precise answer, but it isn’t going to be quite so easy for you to grasp and understand the reason why at one sitting, as it were. I certainly did not the first time that I was introduced to the mathematics of what we call ‘Accounting Dynamics’. However, years of observation and use have made me – as it will you – a willing disciple of the work.
Allow me to now refer you to my article entitled Black Hole Economics. In the appendix to that article, I laid out the underlying mathematics, which the founder of my company and their original author, the late Dr. Verne Atrill, developed more than 38 years ago. Developed from first principles, they take the form of a theorem which, like the Pythagorean Theorem, cannot be refuted. And in practical terms, it has yet to be disproved, using practical experience or the Null Hypothesis.
If you would like some fun with figures, get the OECD figures and watch what happened when Greece – for one – crossed that threshold. For even more fun – if that is the word that is appropriate here – use the Federal Reserve Board figures to track what happened when the US crossed that threshold in the 3rd quarter of 2007. And then you can answer me the question, do you really want to find out what will happen if the US crosses that number again?
Now, I do not happen to have – nor am I really interested in obtaining – the Total Debt/GDP ratios for the 55 countries that collapsed in the last century. My math already tells me what I will find. However, Ken Rogoff, Thomas D. Cabot Professor of Public Policy and Professor of Economics at Harvard University did examine a number of the economies whose currencies and GDPs collapsed and he figured out that something seemed to happen when that 3.5:1 ratio was exceeded. Of course, since he had no math to back up his observations, it was safe for economists in general and central banks in particular to simply ignore his findings. And ignore him they did. I really can’t tell you if he saw Greece and Spain heading for disaster, and, if he was following Venezuela and Argentina before they got into real trouble, I didn’t hear of it. But he was hot on the right trail. He just didn’t have the hard math to back his judgements up, and given what I see as the hostility of central bankers and economists to taking action on anything short of extremely hard evidence (and all too often not even then), statistics and statistical evidence alone are merely a mote in the mind’s eye, and rarely seen as hard proof of cause and effect.
As I am leaving you with some heavy research homework, that is enough for now. In my next Tweet, I will visit the mathematics of Black Hole Economics and then I will discuss further what some of the implications are.