The Dangers in Extrapolating GDP Growth Trends — Part One

According to Indian legend, the serving of the dish Paal Payasam to visiting pilgrims owes its origins to an 18th century game of chess.

The local king was a chess-playing tragic. Whenever a wise person visited the king’s region, a challenge to a game of chess was issued. To motivate his opponent, the king offered the visiting sage any reward they could name.

One wise man, thought to be Lord Krishna, accepted the challenge. His reward, should he win, was to place one grain of rice on the first square and then double it for every subsequent square.

The king eagerly agreed to the request.

Lord Krishna won the game. The king, being a man of his word, ordered a bag of rice to be delivered in payment.

The king opened the bag and began to count…

One grain led to two, then to four…and so on.

By the time the king reached the 21st square, he was required to count out more than a million grains of rice.

Had the exercise continued, it’s estimated that by the 64th square, the king would have needed the equivalent of 210 billion tons of rice…an amount that would have covered India in a blanket of rice a metre thick.

Due to the king’s inability to honour his promise, he agreed to repay his debt over time…and to this day, the debt is still being repaid with the serving of the dish Paal Payasam to visiting pilgrims. At least that’s how the legend goes.

True or not, the legend serves its purpose in exposing the limits to exponential growth. If something cannot continue, then it won’t.

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Yet, we continue to fall for versions of this myth.

Madman or economist?

Professor Kenneth E Boulding is not nearly as well-known as his 20th century economic contemporaries…those of the ilk of John Maynard Keynes, Milton Friedman, Hyman Minsky, et al.

While he lacked his peers’ public profile, Boulding was well respected within his profession.

According to The New York Times:

‘[Professor Boulding was] nominated at different times for Nobel Prizes in both peace and economics, Professor Boulding was renowned less for a single contribution to economics than for a large number of interesting intellectual and moral insights that both charmed and challenged his fellow social scientists.

One of his observations was (emphasis added):

Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.

This statement is so simple and so obvious that it hardly warrants being considered sage advice.

But it is.

Why?

Because people lose sight of the basics…especially amid a period in exponential expansion.

Infinite growth in a finite world is an impossible proposition. Yet we’re told repeatedly it’s all about growth.

Jobs growth.
Wages growth.
Asset price growth.
Export growth.
GDP growth.
Profit growth.

The investment industry even promotes ‘growth’ funds. Everything is literally geared for growth.

Growth is the mantra of politicians, investment professionals, business leaders and central bankers. Are they madmen or economists?

On 8 June 2021 it was reported:

The global economic outlook has improved since the first quarter (Q1) of 2021 with the global real GDP growth this year now expected to be the fastest in more than 40 years at 5.8%, followed by 4.5% growth in 2022, said market research company Euromonitor International (EI) in a new report.

The forecast upgrade is mainly driven by advanced economies, which are now expected to grow by 5% in 2021 and by almost 4% in 2022…

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And according to CNBC, the Fed also upped its 2021 real GDP forecast to 4.2% from 4.0% expected previously.

Economists are positively salivating at the prospect of 4% annual GDP growth.

To see whether the drooling practitioners of the dismal science are mad or not, here’s a simple mathematical exercise based on the much longed for growth target.

Global GDP is currently around US$85 trillion. Based on the Rule of 72, a 4% annual rate of return doubles the value every 18 years.


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Is this possible?

When you know the dynamics behind our so-called economic ‘success’, it’s highly doubtful.

In recent decades, GDP growth has been achieved solely based on debt accumulation and population growth.

Logic dictates we need more of the same to reproduce past results.

By most estimates, it takes around $4 of debt to produce $1 of GDP.

Let’s amuse ourselves and assume that ratio remains constant (which it won’t because the more debt you have, the greater the drag on the economy and therefore, the more debt you need to take on)…

Anyway, to keep this exercise relatively simple, we won’t get bogged down with the reality of compounding debt.

Therefore, to generate a further US$1,275 trillion in GDP between now and 2092 would require (based on a 4-to-1 ratio) the addition of another US$5,100 trillion in debt.

For some perspective on this Herculean task, the current global debt level is US$280 trillion…a mere 5% of US$5,100 trillion needed to maintain the desired 4% annual growth.

What about population?

When you exclude Africa from the UN’s global population forecasts, we’re either at, close to or past peak population in the developed and developing worlds.


Global Population

Source: Econimica

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Folks, the numbers simply do not add up.

This is a finite world and the multipliers of the past are reaching expiration.

We may — like we are at present — experience the occasional period that tantalises us with a return to the good old days. But these will be fleeting…not lasting.

Only madmen could believe growth on the scale outlined above is possible.

However, this is what a sustained period of exponential growth does to you…it distorts your thinking. The mob starts believing the abnormal is normal.

The bearings in the compass of reason get thrown all out of whack.

And if you accept GDP growth is destined to be stuck in the slow lane, then, by extension, you have to question the widely-accepted long-term returns of 6%, 7%, 8% and even 10% per annum from the share market.

Over the past 40 years the share market and the economy have both been beneficiaries of the debt and demographic phenomena.

But those drivers are on the cusp of changing. Slower economy, lower share returns.

Extrapolating the past into the future is a very dangerous assumption.

Tomorrow we’ll look at an example of how extrapolation can go horribly wrong…especially if you’ve borrowed believing the trend could continue indefinitely.

Regards,

Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.


Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.


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