AUSTIN, TX. I have a confession to make. When I first listened to Lacy Hunt years ago, I was skeptical. Like most people, my fear was inflation. I was sure it would return with a vengeance.
But Lacy Hunt said it wouldn’t. And he has been right, year after year. Hunt, a Ph.D. economist at Hoisington Investment Management, provides a meticulous barrage of statistics and graphics. They illustrate the increasing problem of a country — and a world — burdened with excessive debt.
How burdened?
“You’ve heard of the Law of Diminishing Returns, haven’t you?” he asked in a recent interview.
I nodded.
“That’s what this is about. It’s the big principle.”
Debt and Diminishing Returns
To demonstrate, he mentions the production function, the iron algebra that relates our standard of living to the three factors of production — land, labor and capital — multiplied by the existing level of technology. It isoutput – such as tons of steel, millions of cars and numbers of surgeries — that adds to our gross domestic product. That, in turn, determines our standard of living.
“We can see all three of the engines in operation,” he adds, “but we don’t know where the ignition key is.” Some economists, he points out, believe the ignition comes from consumer spending. Others believe that it comes from innovation.
Either way, he says, the law of diminishing returns starts to hurt when too much of a factor (that land, labor and capital triad) is used. When that happens, output will flatten, then decline.
This isn’t just algebra. It’s reality. “There are about a dozen peer-reviewed studies on the deleterious effects of excessive debt,” he said. “As total debt increases, the amount of GDP generated decreases. When total debt exceeds twice GDP, you can have a loss in the economic growth rate.”
Debt’s a Drag
And that’s where we are now: In the world’s advanced economies, it takes ever more debt to gain a bit of output.
But what about those other factors? Production doesn’t result from debt alone – it also involves land (natural resources) and labor (demography), with both funneled through whatever help we get from technology. Can’t they help?
That, according to Hunt, is where the dismal science starts to get really dismal.
Resources aren’t going to be much help. We’re well beyond the gold rush that supported American growth 150 years ago.
Worse, demography is no longer our friend. Japan’s economy has struggled with an aging, declining population for years. China’s population, he observes, is aging 6 months every year, pushing it toward being a second Japan. Don’t even talk about Europe.
Here in this country, he says, births recently exceeded deaths by only 1.48 million, the lowest reading on records going back to 1972.
But what about technology? I ask. It’s the magic rescue rabbit, ready to pop out of a hat whenever needed.
Technology won’t save the day
“Bill Gates believes technology will bail us out. So do many others,” he answered. “But that’s not what history tell us.” According to economist Robert Gordon, he points out, we’ve enjoyed several major spurts of growth due to a number of technologies.
In the 100 years between 1870 and 1970, Gordon documents, we’ve had five major inventions that have fostered demand for both labor and natural resources: electricity, modern communications, the internal combustion engine, urban sanitation, and pharmaceuticals and chemicals.
But technology isn’t a constant. “Today, technology is more evolutionary than revolutionary. It’s not enhancing demand,” Hunt adds.
The implication for our future is that even though the United States is in better shape than much of the world (and even though Texas is in better shape than our country as a whole), we’re heading into what Hunt calls “a protracted period of low to minimal growth.”
Diminishing Returns in Texas
Looking closer at Texas, I asked what role the oil and gas industry might play in our future. There, he says, even coming closer to energy independence is a mixed blessing. The closer we are to independence and the more oil Texas produces, the greater the impact of declining energy prices on the Texas economy. “It’s always been a boom or bust industry,” he adds.
Still, Texas is a bright spot that he describes as a magnet for people and businesses from states that have borrowed too much for too long.
Politicians, he observed, are fond of saying they will do “whatever it takes” to keep the economy going. “But there comes a point,” he nods, “where you cannot do whatever it takes.”
History says, “This isn’t new.”
A careful student of economy history, he closes the interview with a quote from essayist David Hume (1711- 1776).
“We have always found, where a government has mortgaged all its revenues, that it necessarily sinks into a state of languor, inactivity, and impotence.”
The big bottom line? With so much debt in all quarters, it’s very difficult for interest rates to sustain an increase.
Want to know more?
Lacy Hunt writes a quarterly review of the economy that is posted on the Hoisington Investment Management Company’s website. Located in Bee Cave, just outside of Austin, the firm manages $4 billion in fixed-income assets for pensions, profit sharing plans and other entities. You’ll find his quarterly reviews at this link: http://www.hoisingtonmgt.com/economic_overview.html
In spring Hunt will be among the speakers at John Mauldin’s Strategic Investment Conference. This year the conference is scheduled for May 13-16 at the Omni Hotel in downtown Dallas. For more information, visit: https://www.mauldineconomics.com
Related columns:
Scott Burns, “Lacy Hunt: Why interest rates won’t rise,” 8/28/2015 https://scottburns.com/lacy-hunt-why-interest-rates-wont-rise/
Scott Burns, “Lacy Hunt: The end of the yield famine is far away,” 11/02/2012 https://scottburns.com/lacy-hunt-the-end-of-the-yield-famine-is-far-away/
Scott Burns, “Interest rates can go lower, but you won’t like it,” 7/23/2010 https://scottburns.com/interest-rates-can-go-lower-but-you-wont-like-it/
Scott Burns, “High debt means deflation, not inflation,” 6/5/2009 https://scottburns.com/high-debt-means-deflation-not-inflation/
Scott Burns, “Different Drummer Investing,” 5/29/2005 https://scottburns.com/different-drummer-investing/
Scott Burns, “A somber view to a longer recession,” 2/19/2002 https://scottburns.com/a-somber-view-to-a-longer-recession/
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Kat Jayne from Pexels
(c) Scott Burns, 2019
2 thoughts on “The Iron Algebra of Diminishing Returns”
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I’m having trouble with the angst over debt. Isn’t debt just another form of money, used to consume now rather than stockpile potential consumption for later activation? What happens without debt? Isn’t consumption delayed? Why stockpile money over consumption? How does delaying achieve much of anything?
The argument seems to be that debt consumes faster than resources replenish. The whole fear of debt seems one of fearing an inevitable time of reckoning when resources won’t be there to settle debt. Doesn’t it view resources as limited by notions of its finiteness, and thus fears using them up too fast?
But, don’t we use debt as a vehicle for explanation: expansion of the provider’s, borrower’s and the lender’s wealth. Isn’t debt a win for all of them? Isn’t that the leverage debt provides? It is leverage across the board.
Why can’t that expansion keep going? Especially when the expansion is in something as ephemeral as wealth – whatever that is? Is it because of notions of finiteness that tend to box us in and limit us through our own fears?
I can understand anxiety over debt as a matter resource priority (shifting wealth from consumption to asset stockpiling through interest collection), but not in terms of indebtedness itself. Indebtedness seems to me the engine that expanded us out of the cave and into our modern economy of trade and broadband prosperity.
No, we didn’t emerge from caves through debt. We emerged through creative use of resources and then created the tool of debt to optimize our use of resources and to move them in time.
I know we can get very philosophical about this but I think you are ignoring something very important — that lack of debt provides a psychic benefit that is hard to beat. The best way to understand this is to experience it.