The New Arthurian Economics: Speaks for itself

Sunday, May 15, 2011

Speaks for itself

8 comments:

LiminalHack said...: Indeed it does speak for itself, but there are many interpretations.

In our last length discussion you said this in response to my question about why using credit creates a drag on growth. You said:

"Labor and capital are factors of production. Money is a factor of facilitation. Money is the grease that makes productive factors perform better -- but only up to a point. Too much grease does no good.
"

...which is all well and good but it doesn't answer the question in a mathematical/scientific way, it answers it in a philosophical way.

Is there a mathematical/economic justification for the claim that debt produces drag. As I said before, all interest payments end up back in the economy don't they?

As for interpreting the graph, if one agrees with the MMT-ers that the natural rate of interest is zero, then the smooth exponential since the war is explained simply as a system seeking natural equilibrium. There are many other "narratives" about this graph, but I am not aware of any other good mathematical explainations.; May 15, 2011 at 5:28 AM
The Arthurian said...: >> Labor and capital are factors of production. Money is a factor of
>> facilitation. Money is the grease that makes productive factors
>> perform better -- but only up to a point. Too much grease does
>> no good.

> ...which is all well and good but it doesn't answer the question in a
> mathematical/scientific way, it answers it in a philosophical way.
> Is there a mathematical/economic justification for the claim that debt
> produces drag.

The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue, unless perhaps the borrower is a spendthrift, who contracts a second debt in order to pay the interest of the first. -- Adam Smith, The Wealth of Nations, Book One Chapter VI, "Of the Component Parts of the Price of Commodities"

Smith's "other" sources of revenue are Wages and Rent which, together with Profit make up his "three original sources of revenue", or what today we call the Factors of Production. (Which is where I started in your excerpt, before I got metaphorical.)

We could use the word cost if you find that more scientific than 'drag' :)

See also by three-part, menu-driven series How Debt Works. And the "debt accumulation" item in my sidebar.

> As I said before, all interest payments end up back in the economy don't they?

By the look of it, it seems most of them do end up back in the economy, but above the red line on the graph where the cost of money is greater.

It is the goal of saving, to leave the money (and interest) in savings. That money is by definition for consumption that we want to postpone. It is only when we cannot meet this goal that we must take money from savings to spend in the present. So, yes, some of the money in savings comes out of savings and enters back into the economy directly. More of it does, probably, when times are hard. But when times are good, the money in savings generally enters into the economy only at interest. And it is the growth of interest cost that is the 'drag' that makes times hard.

As the MMT-ers suggest, the government can introduce money into the economy at will (unlimited by gold). I propose simply that we use more of this low-cost money, and less of the high-cost money that counts as the debt of the private sector.; May 15, 2011 at 7:17 AM
LiminalHack said...: "By the look of it, it seems most of them do end up back in the economy, but above the red line on the graph where the cost of money is greater."

I don't think so. When a debt repayment of X (principal) + Y (interest) is made, X+Y base money is transferred from debtor to creditor. This reduces total debt by X. The creditor now holds base money equal to X+Y, and must spend or lend it back to the economy. As long as he does so, then there was no cost arising from the use of credit since the borrowers purchasing power was reduced by the same amount that the creditors purchasing power was increased.

A drag problem only arises if the new holder of the base money hoards it, like under the mattress.

So I think the economic drag you are focussing on, if it exists, must come from saving. Since saving can only be achieved (in real terms) if an equal amount of borrowing happens.

All savings always re-enter the economy as base money moving from A to B, except in the case where physical currency is placed under the mattress, or when banks hold excess reserves. In the latter case, prior to 2008 there were no excess reserves, except in Japan.; May 15, 2011 at 12:26 PM
The Arthurian said...: "The creditor now holds base money equal to X+Y, and must spend or lend it back to the economy. As long as he does so, then there was no cost arising from the use of credit since the borrowers purchasing power was reduced by the same amount that the creditors purchasing power was increased."

Really! I would say just the opposite: The amount that the borrower's purchasing power was reduced and the creditor's purchasing power was increased, is exactly the cost arising from that use of credit. This is (as you said on 10 May) "a simple effect of wealth distribution".

It is a shift from the productive ("non-financial") sector to the financial sector. A shift from the Labor and Capital factors to the Money factor. It increases costs for labor and for capital with no compensating increase of output. Thus it leads to inflation -- cost-push inflation -- and to declines in demand and profit, which lead to stagnation. Thus it is a cause (or the cause) of stagflation.

And as long as that difference (your "+Y")continues to be lent back into the economy rather than spent back in -- in other words, as long as total debt continues to increase -- then for that period of time we may consider the extra cost permanent.; May 15, 2011 at 1:50 PM
LiminalHack said...: "It is a shift from the productive ("non-financial") sector to the financial sector. A shift from the Labor and Capital factors to the Money factor."

Well, its a transfer to savers ultimately. Banks are intermediaries, creaming off a fee on the spread. Borrowers owe interest to banks and banks owe interest to savers.

If banks have been making too much money over the last 30 years then that is a result of the decline in rates. Its change in interest rates which cause money to flow to the financial sector. Now we are at zero, and assuming we remain there, then the flow, the change in total debt, is going to be minimised, and so would financial sector profits.

Which brings me to ask, how you imagine we might reduce total debt to a level below maximum, and keep it there?

"And as long as that difference (your "+Y")continues to be lent back into the economy rather than spent back in -- in other words, as long as total debt continues to increase -- then for that period of time we may consider the extra cost permanent."

It will be lent back in rather than spent back in as long as there exists a premium for lending it, will it not?

Remove the premium for risk- free re-lending and then maybe the problem goes away?; May 15, 2011 at 3:12 PM
The Arthurian said...: >> And as long as that difference (your "+Y") continues to be
>> lent back into the economy ... then ... we may consider the
>> extra cost permanent.

> It will be lent back in rather than spent back in as long as
> there exists a premium for lending it, will it not
>
> Remove the premium for risk- free re-lending and then maybe
> the problem goes away?

Not sure what 'remove the premium for risk-free re-lending' means. I think it might refer to Michael Hudson's idea to tax rentier income more than other income (if I have the WHO and WHAT right).

That would be a step in the right direction. But it does not get at the root of the problem.

You say the money will be lent rather than spent "as long as there exists a premium for lending it." Well, that's the supply side. What about the demand side? What about creating tax incentives that help and encourage people (and businesses) to pay off our debt faster than we do, faster than we have for the past 60 years.

Reduce the demand for credit, by reducing outstanding debt.

We have all sorts of policies that encourage the use of credit, but no policy to encourage accelerated repayment of debt.

We have artificially stimulated the demand for credit with our policies. That is why the plan to penalize lenders by 'removing the premium' is not quite right. I would prefer to remove the artificial stimulations, rather than to add artificial depressants to the credit-control mechanism.; May 15, 2011 at 8:26 PM
Jerry said...: > A drag problem only arises if the new holder
> of the base money hoards it, like under the mattress.

I don't know the answer, but I wouldn't rule this out? I think that it might well be going under the mattress.

It might alternatively be going out of our not-closed system (e.g. to invest in China or something).

If either of those turns out to be true, then there would be a "drag" and many of the conclusions here would be generally correct, right?

From a sort of casual observation, it sort of looks like there is some of this hoarding or accumulation going on.
(i.e. "money is going in faster than it's coming out", which by sort of "Gauss's Law" equates to either hoarding/saving, Or nonzero divergence (i.e. money going to China).)

For instance, some pictures of accumulation (since 1980 or so):
Income:
http://i.huffpost.com/gen/98738/thumbs/s-GILDED-large.jpg (Saez graph)
http://sociology.ucsc.edu/whorulesamerica/power/images/wealth/Figure_5.gif

Net worth (harder to find numbers, but it looks like there is the same trend): http://sociology.ucsc.edu/whorulesamerica/power/images/wealth/Figure_5.gif; May 16, 2011 at 7:32 PM
scepticus said...: "For instance, some pictures of accumulation (since 1980 or so):"

Indeed. But like I said elsewhere, of you focus just on the US of A you miss the real picture.

For example see
http://www.housepricecrash.co.uk/forum/index.php?showtopic=163151

look for my comments (search for "scepticus" in the link above.; May 17, 2011 at 5:42 PM

Subscribe to: Post Comments (Atom)