The Thrill Is Gone

From A special report on debt: Repent at leisure, The Economist, 24 Jun 2010

Hyman Minsky, an American economist who has become more fashionable since his death in 1996, argued that these debt crises were both inherent in the capitalist system and cyclical.

Inherent, and cyclical. Agreed. At The Economist, they know an impressive statement when they see it, at least if the speaker is fashionable.

Debt increased at every level, from consumers to companies to banks to whole countries. The effect varied from country to country, but a survey by the McKinsey Global Institute found that average total debt (private and public sector combined) in ten mature economies rose from 200% of GDP in 1995 to 300% in 2008... There were even more startling rises in Iceland and Ireland, where debt-to-GDP ratios reached 1,200% and 700% respectively.

"Debt increased," the Special Report says, but "the effect varied." The excerpt suggests the "effect" was that debt increased, and the variation was that it increased to various levels. This is not an impressive analysis.

At The Economist, they are unable to identify the effect of increasing debt. They are also insensitive to warning signs from the economy:

From early 2007 onwards there were signs that economies were reaching the limit of their ability to absorb more borrowing. The growth-boosting potential of debt seemed to peter out.

"The growth-boosting potential of debt seemed to peter out." All they can muster is that the beneficial effect of debt "seemed to" peter out. Are they not sure of it?

The growth-boosting potential of debt has been bending the support beams of our economy in obvious ways since the early 1970s. Not "from early 2007 onwards." At The Economist, they are grossly insensitive to the signals our economy sends to us. As their own graph shows, debt is a depressant and it is getting worse.

Oh, and I think the word is "onward," not "onwards."

To understand why debt may have become a burden rather than a boon, it is necessary to go back to first principles. Why do people, companies and countries borrow? One obvious answer is that it is the only way they can maintain their desired level of spending. Another reason is optimism; they believe the return on the borrowed money will be greater than the cost of servicing the debt.

They are still unwilling to commit to the notion that debt has become a problem: "...why debt may have become a burden..." Unbelievable.

And the "first principles" story only shows they don't know why debt has become such a burden. Why is debt a burden? Because of the cost of it, plain and simple.

Remember when "buy now, pay later" was a sales pitch and a way of life? Well, the economy today is in the "pay later" phase. "Buy now" stimulates the economy, but "pay later" is the counterbalancing depressant. It's a yin-yang thing.

Or we can do cost-benefit analysis: The benefit of credit use is clear to the user, and stimulative to the economy. But credit-use creates debt. And the cost of debt is the counterbalancing depressant.

It is not debt that boosts growth. The use of credit boosts growth. Debt -- the evidence of credit use -- is the burden we're left with, after the thrill is gone.

The problem with debt, though, is the need to repay it.

No. Debt must always be repaid. Every act of lending is supported by the assumption that the debt will be repaid. And though it may sometimes happen that a debt goes unpaid, borrowers also recognize the obligation they assume. The "need to repay" is not the problem with debt. The problem is the excessiveness of debt.

To use numbers from the Special Report, debt at 200% of GDP is not such a problem, but it becomes a problem at 300% or 700% or 1200% of GDP. It becomes a problem when it becomes excessive. It's not rocket science.

Another reason why debt matters is to do with the role of banks in the economy. By their nature, banks borrow short (from depositors or the wholesale markets) and lend long. The business depends on confidence; no bank can survive if its depositors (or its wholesale lenders) all want their money back at once.

Is the problem confidence, or is the problem debt? And if the problem is confidence, is it not a problem because of the excessive level of debt?

This excerpt, if it says anything at all, says it would be wise to prevent debt from reaching excessively high levels. Only, The Economist doesn't say that.

CONCLUSION

The beneficial effect of debt, as the Special Report points out, is its "growth-boosting potential." But at The Economist, they cannot identify the effect of increasing debt on that potential. They do not understand the economy's response to excessive debt.

They are vague and unsure of the problem. They say the benefit of debt "seemed to peter out." But they are confused as to whether the trouble is with debt or with "confidence." They say debt "may have" become a burden, but they are not certain. They are unwilling to commit even to the view that debt has become a problem.

They present us with an awkward phrase: "economies were reaching the limit of their ability to absorb more borrowing." And they observe this limit arising in 2007. But in 2007 the recession was beginning, and our financial crisis was in the works. Surely the problem was glaring by then, at least in hindsight.

They ignore the long-term difficulty we've had, since the early 1970s, achieving an acceptable level of growth. They fail to relate that difficulty to levels of debt that were already high in the 1970s. They fail to observe that everything we've done to boost growth, everything we've done since the 1970s has fallen short, and that only debt itself has continued to grow with any vigor.

They cannot even identify the problem with debt: Excessiveness.