The American Government's outstanding debt to GDP ratio (1790 to 2009)

As can be seen in the above chart provided by reader Marius, the American Federal Government's outstanding debt to Gross Domestic Product ratio has never, with the exception of WWII and its immediate aftermath, been higher than it is now.

It's of interest how the WWII debt was steadily paid off every year after the war ended until it was back to what it was before America got involved, and how sharply this contrasts with how the very large amount of debt incurred since 1980 has never been paid off more than fractionaly.

To quote from the Jan. 2010 Jim Jubak article 'Approaching the Debt Tipping Point':

The threshold is when government debt rises above 90% of national gross domestic product (GDP), economists Carmen Reinhart and Kenneth Rogoff argue in a paper headed for publication in the American Economic Review.

After looking at data from 44 countries spanning 200 years, they’ve concluded that at ratios of debt to GDP up to 90%, there’s not much correlation between government debt and economic growth.

Above 90%, however, median economic growth rates fall by one percentage point and average economic growth rates fall by about four percentage points.

That makes the 90% level a kind of make-or-break point for countries that are hoping to grow their way out of debt. If the government debt load climbs above 90% of GDP, economic growth slows so much that growth is no longer a viable solution to reducing that debt.

Above the 90% level, governments serious about reducing their debt load have to increasingly rely on “solutions” such as reducing wages and depreciating their currencies, which might over time increase global economic competitiveness enough to give a boost to national economic growth. In the short to medium term, however, these “solutions” inflict real pain on the citizens of the countries since they reduce standards of living.

The scary thing about Reinhart and Rogoff’s conclusion is how close the United States and other major developed world economies are to the 90% cutoff thanks to the global financial and economic crisis.

The United States finished 2009 with a debt-to-GDP ratio of 85%, according to the International Monetary Fund (IMF). On current trend, the United States will finish 2010 at 94% and 2011 at 98%.

According to the Reinhart and Rogoff study:

1. When America has had a debt to GDP ratio of less than 30 percent, it's averaged GDP Growth of 4.0%.

2. When America has had a debt to GDP ratio of 30 to 60 percent, it's averaged
GDP growth of 3.4%.

3. When America has had a debt to GDP ratio of 60 to 90 percent, it's averaged
GDP growth of 3.3%.

4. When America has had a debt to GDP ratio of more than 90 percent, it's averaged GDP growth of negative 1.8%.

The the study finds a similar pattern in the totality of twenty Advanced Economies it looked at, with a medium growth rate of 3.9% when they had less than 30 percent debt to GDP, a medium growth rate of 3.1% when they had from 30 to 60 percent debt to GDP, a medium growth rate of 2.8% when they had 60 to 90 percent debt to GDP, and a medium growth rate of only 1.9% when they had a 90 percent of more debt to GDP.

Of course correlation shouldn't be assumed to prove causation here, as Paul Krugman has pointed out, but this fact may be less important than Krugman seems to think.

A correlation can have predictive power irrespective of whether it's based on one variable causing the other.