Escape Velocity

So, President Obama has proposed a nearly $4 trillion budget and he expects real GDP growth to reach 3.1% during the year. This, let's just call it unrealistic, assumption regarding real GDP growth got me to thinking about one of those terms that has become quite prevalent of late, escape velocity.

In the investment world, the concept of escape velocity has to do with the economy reaching a growth rate in real GDP terms of somewhere between 3-4% per year. This is consistent with historical patterns. It is, in this analyst's opinion, unobtainable given present policy choices, however.

Today, analysts believe that the money-from-thin-air department (otherwise known as the Fed) has generated sufficient amounts of fresh cash that high rates of growth in real output are unavoidable. These analysts are morons. The printing of money, and credit, from thin air does nothing to increase the potential growth rate of the economy. It only changes who has access to the available real capital in the system. Those who sit closest to the Fed, those that have access to the freshly printed counterfeit money first, get to decide where it will go and those items will be the first to rise in price. Financial assets have been where the Fed's largess has wound up, benefiting only those who own shares.

In fact, as the Fed prints, interest rates move to a point lower than where they would have been without the Fed's distortions. This actually lowers the amount of  real savings in the system. It is this real savings that is responsible for future growth. If we lower the amount of savings available to the system, the system is going to see a lower real growth rate.

Think about any investment that will drive output higher in the future, I don't care if it is a steel plant or some crappy app at the Apple store, someone has to build something that will generate output in the future. While that steel plant is being built or that app is being written, there is no money coming in to pay those who labor away at the completion of the plant or the app. The same is true regarding the materials needed for its completion. Someone has to provide them with real savings to get the job done and build the infrastructure for increased growth. Lower the savings rate and you lower the future growth rate of real ouput.

There is no getting around this.

On a secular basis, we can see this playing out. In the 1950s and 60s, the  savings rate averaged around 10% of GDP and the result was real growth of 4%. After the end of Bretton-Woods, the savings rate fell to 8% in the 1970s and the growth rate moved down to 3%. In the 1980s and 1990s, the savings rate fell to around 5% of GDP while the rate of real GDP growth stayed at 3%. I think that the rate of real GDP growth in the 1990s was artificially boosted by heavy hedonic pricing adjustments and the fact that the Berlin Wall fell and the Chinese also entered the global economy. This fortunate set of circumstances is unlikely to be repeated unless NASA finds plenty of life on Mars or some other distant planet that we can colonize. For the past decade real GDP growth has slumped to about 1.6% due to a crash in the rate of net savings to about 1% of GDP. If you graph savings vs. real GDP over time you get a line that is down and to the right. This is bad.

So, if you want real GDP growth of 3-4%, you probably need a savings rate of somewhere between say 6-10% of GDP. With the Fed punishing savers with rates a 0%, the odds of the US economy reaching escape velocity are also 0%.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.