Saturday, February 19, 2011

Everything You Need to Know About Economic Performance

An excerpt from mine of 15 November 2010:

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.


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.


Our best economic performance is associated with a rising trend-line. We see it between 1946 and 1974 on this graph, and again from 1994 to 2000 or so. The earlier uptrend matches up to the "golden age" of postwar capitalism. The latter uptrend matches up to the "golden" decade. These match-ups are not coincidence.

The uptrends occur when private-sector debt is increasing faster than public-sector debt. Uptrend means the private sector growth is good. That's what we want, I think. But the graph shows more than this. Not only the tilt of the line is important. The level also matters.

The postwar golden age came to an end when private-sector debt climbed to too high a level, relative to public debt. The level 3.0 appears to be where our troubles begin.

For twenty years after the end of the golden age, the graph shows a holding pattern -- a roughly flat trend-line at 3.0. Economic growth in this period was nothing to write home about, and government debt grew like crazy.

Private debt grew just about as fast as government debt in those years, the graph shows.

The level 3.0 is when troubles begin for us. The level 5.0 is when troubles reach crisis. We see it once, at the onset of the Great Depression in 1929. We see it again at the onset of the Great Recession in 2008.

In order to achieve sustainable growth at a satisfactory rate, we must push the trend line down to about 2.0. Simple arithmetic says we can achieve this either by reducing the level of private-sector debt, or by increasing the level of government debt. But the graph tells us one of those options will not work.

The graph shows a roughly flat trend-line from 1974 to 1994. There was during those years a large increase in the level of government debt. But that increase did not push the trend-line down significantly. The trend-line did not fall because private-sector debt grew just about as fast as government debt. So the large increase in government debt did not pave the way for the new golden age that Ronald Reagan was looking for. All it did was permit a large increase in private-sector debt.

The simple arithmetic says we can push the trend-line down either by reducing private debt or by increasing government debt. But that arithmetic does not account for the way our economy behaves in response to a large increase in government debt.

If we want our restore our economy to vigorous and healthy growth, our only option is to reduce the level of private sector debt.


Greg said...

Maybe this is because the only way one can decrease the numerator is to first increase the denominator.

The increase in denominator gives you what is needed to pay down your private debt.

The Arthurian said...

Yes, I suspect you are right. Big-picture, that's what the graph shows for 1929-1946 and 2008-present.

And yet, when we increase the denominator, the numerator grows as fast, or faster. We have no policy to accelerate the repayment of private-sector debt.