Pretty much everybody is focused on spending cuts and balancing the federal budget. Everyone sees the federal debt as a problem. But for thirty years or more, we have been unable to solve the debt problem. To me this suggests that something is wrong with our solution. So I thought it time to take another look at the debt.
The size of itPeople say the massive government debt is a problem. I agree. And yet... private debt is four times the size of government debt. Graph #1 shows public and private debt as shares of total U.S. debt, against a background showing recession years.
|GRAPH #1: THE PORTIONS OF TOTAL DEBT|
The red line that starts high, drops in a sharp "V" during World War II, then rises again and ends high, is private debt as a percent of total U.S. debt. Private debt is very high.
Government debt is low by comparison. The black line that starts low, rises to a peak during World War II, then drops off and ends low, is government debt as a percent of total U.S. debt. That's federal, state and local government debt, combined.
If the debt is too big -- and there can be no doubt it is too big -- private debt is by far the biggest part of it. If we reduce government debt to zero, 80 percent of our debt problem remains.
Numbers for the graph come from different sources, older and newer. This is why the red and black trend-lines both have "mis-match" areas from the mid-50s to 1970.
The cost of itIf the federal debt was by some magic totally wiped out, we might see a 5.3% reduction in our taxes. That's all it takes to cover the interest on the federal debt. By contrast, if corporate interest costs were reduced by half, that would free up enough corporate revenue to give every employee a 30% raise!
Debt drives up cost and reduces profit in the private sector, and competes with labor for income.
|GRAPH #2: TOTAL DEBT IN BILLIONS|
The red line on this graph is private debt; the black line is public debt. These trend lines show great increase of debt.
And remember, the area under these trend lines represents thousands of billions of dollars of debt. And for each of those dollars somebody paid 2 cents or 3 cents or 5 cents, or maybe 9 cents interest for the use of that money, each and every year. It is the cost of debt that kills us.
The numbers in context
|GRAPH #3: TOTAL DEBT AS A PERCENT OF GDP|
The previous graph showed great increase in the dollar-amount of our debt. This one shows that same debt, relative to GDP.
The trend in government debt relative to GDP (the black line) is essentially flat from 1960 until the Paulson Crisis. And all that time, private debt (the red line) was climbing. So, if the increase in debt relative to GDP is a problem, the fault lies entirely with the private sector.
The timing of it
|GRAPH #1 (REDUCED)|
But it was not the decline of government debt that drove economic performance. The private sector drove it. The economy grew because the private sector grew, and the private sector grew because private debt was growing. And private debt was able to grow, because it was low to begin with, after the war.
Graph #4 shows private debt, relative to public debt. A relative increase in public debt will drive the red line down, as it does here during the Depression and World War II. A relative increase in private debt will drive the red line up, as it does here from 1947 to the 1974 recession. Roughly equal growth of public and private debt will leave the red line roughly flat, as we see for 20 years after the 1974 recession.
|GRAPH #4: PRIVATE DEBT AS A MULTIPLE OF PUBLIC DEBT|
During our 1947-1973 "golden age," private-sector debt increased. 1974 was when the trouble started. By 1974, interest costs took so much out of wages and profits that our "golden age" came to an end.
Since 1974, by no coincidence, the best-performing part of our economy has been the financial sector. Since 1974, the level of debt has been too high and the cost of debt too great to permit the productive sector to grow with vigor.
Graph #4 also highlights a difference between Arthurian economics and Modern Monetary Theory. MMT wants to increase the denominator. I want to decrease the numerator.
The MMT way -- increasing the federal deficit -- is exactly what we have been doing since Reagan. That is why the federal debt is so large. It's why people are up in arms about the federal debt. Moreover, even in a weak economy the method fails, because no matter how fast government debt increases, private debt increases as fast or faster.
The thing we need is some measure of balance between public and private debt. We don't need public debt to increase in dollars, but we do need it to increase relative to private debt -- not forever, but only until balance is achieved. And, since it is private debt that shows inordinate increase since the 1970s (see Graph #3), the appropriate solution is to reduce private debt.
Recently, our economy took that task upon itself. Economists call it "deleveraging." A better solution to the problem would be to apply forethought to the task, late as it may now be. The solution is to use policy to reduce private-sector debt, in the least painful and most productive way we can.
The best solution is to achieve balance, painlessly. And how will we know when the task is done? We will know balance has been achieved because economic performance will be at its peak.
SummaryIn the years after World War II, there was no significant interruption of increase in private debt relative to GDP, until our recent financial crisis. By contrast, since World War II, government debt relative to GDP fell and then stabilized at a comparatively low level. Private debt is now four times the size, and the cost of it much greater, than the size and cost of our public debt.
Economic growth depends on the growth of private debt. But the accumulation of private debt ultimately hinders growth, as it has for us since 1974. Once that limit is reached, the further increase in private debt cannot significantly improve growth. Meanwhile the increase in public debt leads only to popular discontent.
The solution, the Arthurian solution, is to have the Federal Reserve take all that bad debt it bought up, and use newly printed money to pay that debt off. The Fed gets this money back immediately, so it cannot cause inflation. But private debt is reduced by a significant margin. And no new taxes, and no government spending are involved.