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There once was a time where adding more debt to the system was easy to do, made sense to do it and each dollar of debt added would create $5 or more in additional GDP.  Debt was like a “magic elixir” that could be administered at will to solve nearly any problem with nearly immediate results.

I want to go back in time and put “debt” in perspective.  Debt, or better said overuse of debt was a main cause of the Great Depression back in the 1930’s.  Much of the accumulated debt was “liquidated” through default and bankruptcy.  In essence the debt was washed away and we started with a slate that was cleansed by the late 30’s.  The experience left mental scars for nearly 30 years and debt was viewed as scary and dangerous until sometime in the late 50’s or early 60’s.  My point is that from a “clean slate” whenever $1 of debt was employed it would lever growth by $5.  Even though it was scary…it was good.

As like anything else, too much of a “good thing” can become less good and even morph into something “bad” which is what has happened.  Over time the ratio of 5 to 1 shrunk.  Back in the 90’s it dropped to 2 to 1 and the most recent numbers I’ve seen show that each dollar of debt added creates only .42 cents of GDP.  The law of “diminishing returns” has gone so far, as to become NEGATIVE returns on the margin!

I don’t believe it is possible to see an additional $1 of debt to actually create “negative” GDP where say additional $1 would actually shrink the economy in a system that uses a fully backed currency.  However, in a fiat system we could actually see this occur as additional debt could “BE” the cause that creates a financial panic that spreads to and infects the real economy.  …And this is where I believe we are now.  The chart below shows Federal debt to GDP now over 100%.  “They” say that above 130% is where the danger zone kicks in…Which means that the U.S. is not in the danger zone?

Total Public Debt GDP

But are we really at 102% debt to GDP levels?  No, the true level of debt when you add in FNMA and Freddie guarantees, social security, Medicare and all of the other future benefits and guarantees the true debt number is over $100 trillion.  We are sitting AT LEAST on top of a 500% debt to GDP time bomb.  The debt level of course is one of those things that can be hidden or swept under the rug for convenience but… it won’t go away…because it is debt which one day sooner or later must be paid or “come home to roost.”

Speaking of “come home to roost,” Zerohedge put out a great piece by Michael Snyder which asked “Who will buy our bonds if this war causes Russia, China and the rest of the world to turn on us?”  I asked this question last week…and the answer is…only the Federal Reserve.

So this is the problem in a nutshell.  We already have far too much debt.  Everyone in the world knows this (with the exception of most Americans) and has now stopped purchasing our debt.  The Federal Reserve is already purchasing the lion’s share of Treasury debt because there are no other open market buyers.  The system is sputtering and needs to be reflated which means issuing more debt.  The problem is that “more” debt now REALLY means more debt because as I wrote above, new debt only creates .42 cents of added GDP rather than the $5 in the old days.  …And on top of all of this we have already hit the so called “debt ceiling” which is another battle scheduled for October.

Which brings us to another question, how un “patriotic” would it be for Congressmen not to increase the debt limit if we were in the middle of a war?  How would it look if we ran out of gas on the battlefield?  Or if we ran out of ammo (of course they borrow some from Homeland Security) or if our troops went hungry (they might ask FEMA if they could spare some cheese)?  You get my point, a war would pretty much take care of any debt ceiling “debate” wouldn’t it?

The Catch 22 that we all knew was coming has arrived, on the one hand we have too much debt yet on the other hand we MUST issue more.  And we must issue MUCH more because just as a drug addict continually needs more of the drug to reach the same level high, $1 of incremental debt no longer creates $5 or even $2 of additional GDP.  We now need to borrow $2 in debt just to get $1 of extra GDP.  This situation obviously cannot continue as it will lead to a “crack up” of the financial and banking systems which of course bleeds its way directly into the real economy.

We are now very close to something having to “give way” because of the situation we “not so suddenly” have found ourselves in.  We are where we are now because of our own doing.  We created the debt, we lived beyond our means and very few spoke up along the way.  Those who did say anything at all were shouted down as fools.  Those who bought gold were also portrayed as “strange” or even alarmist.  I plan to write a piece tomorrow called “Fact or Opinion?”  Whether over the long term a higher gold price in dollars is my opinion or is it a fact?  All of what I have written above argues that over the long term (or not so long as the case may be) a higher dollar priced gold is the absolute fact!