The economic outlook, Part 1

So what's the economic outlook going forward?

Well, first, let's start with the big question - what got us to this point of crisis in the first place? In a word, debt.

A combination of low interest rates from Alan Greenspan, excess Chinese savings, and Wall Street securitization led to investment banks, consumers, and government alike taking on too much debt. How much? Absolutely unprecedented amounts.

Let me show you why. At the level of a country, debt is usually expressed as a percentage of a country's GDP. At 100% Debt/GDP, you should start to get worried; Japan is in the worst debt situation of any major country, at over 150% Debt/GDP.

Let's calculate Debt/GDP for the US. According to the Bureau of Economic Analysis "National Income and Product Accounts" table, GDP was $14.4 billion in 2008 (nominal annualized rate as of the third quarter). According to the United States Treasury Department's "Treasury Direct" site, total federal debt is $10.6 trillion, less than 100% of GDP.

Not so bad, right? You know where this is going...there's a lot more, and the numbers are scary. According to the Fed's "Flow of Funds Accounts for the United States" (Q2 2008), total United States was nearly $50 trillion. Households accounted for $14 trillion of this, with $11 trillion coming from mortgages. Financial firms accounted for another $17 trillion. (Non-financial businesses made up the remainder.)

Of course, debt in itself is not a bad thing. It's when assets and liabilities are mismatched, and a borrower becomes insolvent, that debt becomes a problem. Even a federal debt of 100% Debt/GDP wouldn't be terrible if the federal government can pay that debt (and it can, because of its taxing power).

Obviously, as we learned in September-October 2008, it's an entirely different matter for households and financial institutions that can't work their way as easily out of excess leverage. Tomorrow we'll look at ratios of those entites' debt to GDP, which was totally out of control relative to historical standards.