## Thursday, August 18, 2011

### A Basic Math Lesson

One of the major problems in Washington is their inability to perform simple math. So, consider this my contribution to the national dialog on the economy. And -- a warning -- it involves some math.

Everyone is concerned with the debt/GDP ratio. Right now, total US debt is about \$14.6 trillion, while nominal GDP is about \$15 trillion. Going back to first or second grade, we can now make a fraction with the total debt as the numerator (the number on top) and the GDP figure being the denominator (the number on the bottom). Pulling out the ol' HP12C (which still works even after being commandeered as a chew toy), we get a ratio or percentage of 97.33%. So, there is also most as much debt as GDP.

However, looking at the preceding paragraph, we see two numbers (the miracle of fractions in action). There is a numerator (which is causing tremendous consternation right now) and a denominator (which has been remarkably absent from the national discussion). So, what if we focus on the denominator for just a minute, which represents growth. Forgive me here, but, again, I must use more math, but this time it's simple addition.

The GDP equation has four variables (long-time readers, please be kind. I'm talking to Washington here and they are stupid): C (consumer spending) + I (gross private investment) + X (net exports) + G (government spending). Right now, the consumer is OK but not great, investment is fair, but not great and the US is a net importer, so that subtracts from growth. That leaves government spending.

Now, let's also assume that we can borrow at insanely low rates (say, 2.12%) and use that money to invest in something like infrastructure (not like we need to, but let's assume the American Society of Civil Engineers has a certain level of expertise in this area).

Now, let's say we borrow \$500 billion in next years budget and target that spending on infrastructure. Let's also assume we have an additional \$900 billion in borrowing, increasing our total borrowing to \$1.4 trillion. At the same time, we increase out GDP growth to 3%. That means we get the following numbers. \$16 trillion in total debt and GDP at the end of next year of \$15.45 trillion, or a debt to GDP ratio of 103%. Yes -- the ratio is still increasing, but so is GDP. Now, let's also assume that -- thanks to investment in infrastructure -- we can project a higher rate of growth for the next few years -- say 3%. By the end of the second year, GDP is \$15.91 trillion and \$16.39 trillion at the end of the third year. In short, by growing the economy and making prudent investments, we can slow the debt/GDP percentage growth rate, increase economic activity and lower unemployment. And no, a major investment in infrastructure is not a boondoggle, as I've demonstrated by looking at my city, Houston which could not have grown to become the fourth largest city in the US without major infrastructure investment. I should also add -- this is the entire secret formula to China's growth rate -- a rate which many in the US drool over. And finally, as GDP grows, unemployment starts to drop as businesses now see this thing called aggregate demand.

The point, boys and girls of Washington, is borrowing money at insanely low rates and making prudent investments with that money will grow the economy at strong enough rates to neutralized the increase in debt in the debt/GDP equation. It will also lower unemployment. In the above examples, I've used 3%. When you're talking about \$15 trillion, an addition, 1/10 of growth is meaningful, so if we get to 3.5% (a not unheard of growth rate with prudent investment), we can really start to slow the ratio increase, lower unemployment and make everybody that much happier.

This has been a public service announcement of the basic math department. I hope I have not caused too much trouble or too many headaches.