Since the financial crisis of 2008, the major world powers have implemented accommodative monetary policies, which have included tools such as quantitative easing (QE) and zero to negative interest rate policies (ZIRP and NIRP, respectively). These unprecedented policies have been enforced with the goal of increasing gross domestic product (GDP) growth in the wake of the worst global recession since the Great Depression of the 1930s. In order to implement these policies, the Bank of Japan (BOJ), the European Central Bank (ECB), the Federal Reserve (Fed) and the People’s Bank of China (PBOC) have taken on exorbitant debt loads, which equal to 615%, 457%, 370% and 350% of their respective total-debt-to-GDP ratios. These ratios are way above the 250 to 300% level which academic studies find debt to decrease economic growth. Furthermore, the debt-to-GDP problem is expected to amplify as aggregate nominal GDP growth slows further to 3.6% in 2015, quite lower than the 5.8% expansion in 2010 and barely above 2009 GDP growth.

Financial Engineering

The biggest problem surrounding the central banks’ monetary policies revolves around the corporations that have seen their share prices skyrocket in the years after the recession. As of June 1, 2016, the Standard and Poor’s 500 Index (S&P500) has appreciated by 33% from its 2007 peak; however, much of this growth has been artificial, which is a result of financial engineering in the form of stock buybacks and dividend increases. In 2015, business debt, minus off-balance-sheet liabilities, had increased to $793 billion, with the majority of that money being allocated to financial operations and less than 12% going to actual private domestic investment.

This presents a big problem to the U.S. economy. When business debt is appropriated to financial engineering, it does not develop an income stream to honor interest and repayment requirements. Such debt usage fails to support productivity growth, employment, higher wages or economic growth. Due to this, the economy weakens as debt grows.

Declining Debt Efficiency

As a result, debt has become incredibly inefficient at driving economic growth. From 1955 to 2000, $1.70 of debt, on average, had resulted in the generation of $1 of GDP growth in the United States. However, in 2000, the debt-to-GDP ratio had reached detrimental levels. Now it takes approximately $3.30 of debt to achieve $1 of GDP growth.

China, the world’s second-largest economy, has even greater problems with its debt efficiency. Currently, it takes four units of debt to culminate into a single unit of GDP growth, which is the lowest point of debt efficiency for China since 2009. This comes as no surprise, as China has the highest corporate-debt-to-GDP ratio of any other country, at 160%. In 2015, 44% of corporate bonds issued went to repaying outstanding debts. However, the problem extends well beyond Chinese corporations and into local municipalities that began issuing bonds two years ago. Since then, 97.5% of muni bonds issued have gone to repaying existing debts, rather than investment projects.

Deteriorating Money Supply and Velocity

To fully grasp the diminished productivity of debt, the supply and velocity of money in the economy must be examined. Nominal GDP is equal to the supply of money (M2) multiplied by velocity (V), or turnover. In 2015, the M2 growth for the United States, China, the eurozone and Japan, combined, had equaled 6.9%, 70 basis points below the average since 1999. Historically, governments lose control over the growth of their money supply when debt becomes unreasonably high.

Moreover, the velocity of money plays a huge role in economic recoveries. While many factors influence velocity, the productivity of debt is essential. If debt generates a sustainable income stream to pay down principal and interest, then V increases as GDP rises above the level of initial borrowing. However, if the debt is a blend of unproductive or counterproductive debt, then V declines. Since 1998, the velocity of money in the U.S., the eurozone, Japan and China has fallen by 30 to 40%. Besides China, which many scholars believe has been inflating its economic growth, the level of each country’s indebtedness follows a pattern of its velocity of money. Japan’s velocity is lower than the eurozone’s velocity, which is lower than America's velocity. This is consistent with the fact that Japan is more in debt than the eurozone, which is more in debt than the United States.

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