We've been looking, over the past three days, at the Federal debt relative to Non-Federal debt, and at Non-Federal relative to Federal. I want to focus now on just the Non-Federal relative.
|Graph #1: The Non-Federal Relative, 1949-2010|
This graph shows the size of Non-Federal debt, relative to the Federal debt. It shows a generous up-trend after World War II, until things went bad in 1974. After that, it may appear to be pretty much a random walk. I don't think it is.
The generous up-trend indicates that Non-Federal debt accumulated much faster than the Federal debt for a long time after the war. To be fair, I should say that the Federal debt was very high as a result of spending during the second World War, so that there was plenty of room for Non-Federal debt to grow.
To be fair I should also say the post-World War II uptrend period is widely recognized as a Golden Age of capitalism.
These "fair" things -- rapid growth of private-sector debt, and rapid growth of the economy -- are closely related to each other and closely related to the debt relative, to the ratio of Non-Federal to Federal debt. We use credit for growth, and credit-use creates debt. So we should expect to associate a growing private sector with growing private-sector debt.
And indeed, the economy's performance through the whole period of the graph can be read from the variations of the trend-line. The Non-Federal relative rises while the economy grows, and flattens or falls during recessions. The trend-line increase that ends in 1974 matches up with a golden age; the next largest increase (1994-2000) matches up with economic performance that economist Robert J. Gordon has called a macroeconomic miracle.
In addition, the smaller uptrends typically occur during economic expansions, and recessions typically occur during the smaller downtrends. This generalization holds, with two exceptions. First, there is brief flat spot in the long uptrend, around 1967-68, and there is no recession at that time. However, there was a "mini" recession or a "near" recession severe enough to create that flat spot, even though it is excluded from the NBER recession dates. So the generalization holds for this outlier.
The other exception is the unusually long decline of the Non-Federal debt relative, which begins during the double-dip recession of the early 1980s and continues until 1994. This decline lasts more than a decade and drives the debt relative below 3.0 for the first time since 1969. Then, the next uptrend -- a big one -- aligns with Robert Gordon's "miracle" economy. This exception merits further examination, and we will get to it shortly.
The rise and fall of the Non-Federal relative is a significant metric. But it is not only the direction of the trend that is significant; the level of the debt relative at any given point is also significant. The long straight-line increase associated with the golden age was low when the golden age began, and high when it ended.
Likewise during the second long increase, 1994-2000. The debt relative was unusually low when Robert Gordon's macroeconomic miracle began, and high when it ended.
By contrast, the Non-Federal relative was high all through the decade of the 2000s. And the economic performance of the decade "was -- by far -- the weakest of the postwar period" says Robert P. Brenner. According to The Economist magazine, it was "almost a lost decade".
Given that we use credit for growth, it stands to reason that we should see the Non-Federal debt relative rising during periods of growth and falling during recessions. But the cumulative effect of the risings and fallings may push the trend line to unusual levels, high or low, and these levels play a major role in determining economic performance.
If we narrow our focus a bit -- enough to get a good look at that unusual decline, but not so much we can't see a few surrounding years -- the Non-Federal debt relative looks like this:
|Graph #2: The Non-Federal Relative, 1974-2004|
The unusual decline is important, because it created the conditions required for a burst of vigorous economic growth, brief though that burst may have been. If we can understand how this process worked, we may be able to improve economic policy. If we can learn to recreate those conditions at will, we may be able to guide the economy to a sustained period of "miraculous" growth.
Who else says such things? No one.For the graphs that follow, the Non-Federal debt relative (shown in blue) is identical to that shown on Graph #2 above. Each of the graphs compares one new data series to the debt relative. The new series is always shown in red. In each of these comparisons, I want to show in particular the behavior of the new series either during the unusual decline or during the miraculous years. I begin with results, and then show causes.
Unemployment (shown on Graph #3 below, in red) fell during the whole "miracle" period, beginning just before the end of the long decline of Non-Federal debt relative (the blue line). Unemployment peaked in 1992, fell, and did not resume increase until 2001:
|Graph #3: The Non-Federal Relative and Unemployment|
Shifting the Phillips curve homeward, inflation remained low during the "miracle" years. Graph #4 shows a fall from 6% to 3% by 1991. It stabilized there, then fell to less than 2% in 1998 and did not exceed 3% again until 2000:
|Graph #4: The Non-Federal Relative and Inflation|
Total Capacity Utilization also did well during the miracle years. Reaching in late 1994 a peak as high as any since the 1970s, it managed to sustain the high, and peak again late in 1997:
|Graph #5: The Non-Federal Relative and Capacity Utilization|
The Miracle of Good Policy
That brief miracle, from the mid-1990s to the recession of 2001, is something we might like to be able to duplicate at will. The question is, how?
This is half of it:
|Graph #6: The Non-Federal Relative and M1 money|
The quantity of M1 money experienced an unusual increase at an opportune moment. An acceleration of the quantity of money began immediately after the 1991 recession. This was well before the Non-Federal relative bottomed out.
The unusual acceleration of M1 money growth was encouraged by a Federal Reserve policy that held base money growth high for an unusually long moment. Just as the Non-Federal debt relative finds a bottom (near 1994), the growth rate of base money reaches a peak and plateaus there. The growth of base money is shown in red on Graph #7:
|Graph #7: The Non-Federal Relative and Base Money|
It was a policy decision.
The Other Shoe
But inflation remained low in those years, despite the burst of money growth. How is that even possible?
The unusual increase in the quantity of money was not inflationary because it was offset by an unusual decrease in the growth of debt.
Reduced debt growth implies reduced growth of credit use. Reduced growth of credit-use implies a reduced growth of spending. A reduced growth of spending creates less upward pressure on prices. It may even create downward pressure on prices. The increase in the quantity of M1 money offset the decline of debt growth. It helped us avoid the reduced growth of spending. It helped us avoid deflation.
The decline in debt growth, accompanied by the increase in money growth, effectively took debt out of the economy and put money in its place. The change reduced aggregate interest costs significantly. The net reduction of interest costs left more money to flow into wages and profits, which stimulated growth. In addition, the net reduction of interest cost lowered cost-push inflationary pressures.
The red line in Graph #8 below shows the growth rate of total credit market debt. Debt growth fell from its late-1985 peak to a "normal" low in 1988, burped, and fell again before resuming increase. The post-burp decline occurs precisely at the moment that the Non-Federal debt relative (the blue line) made its remarkable, unusual decline.
|Graph #8: The Non-Federal Relative and the Rate of Debt Growth|
And then, coming out of the 1991 recession, the quantity of M1 money increased at an unusual rate. So we had money enough to enjoy a healthy economic expansion, without incurring the extra cost of interest that is a by-product of debt growth.
|Graph #9: The Non-Fed Relative, Debt Growth, and Money Growth|
The growth rate of M1 money (appropriately green on graph #9) rises above the growth rate of total debt (red) just in time to take the declining Non-Federal debt relative, turn the trend, and create a few years of "miraculous" economic growth.
As Graph #9 shows, there are two other times in the 1980s when the growth rate of M1 money exceeded the growth rate of total debt. If your analytical skills are up to it, you might want to take a look at those two occasions. I am confident that what you find will confirm what I have said here.
What created the miracle of the late 1990s? Two factors: We reduced the growth rate of debt, and we increased the growth rate of money. Essentially, we replaced debt with money. That is what made the economy better. And the economy was very good until the level of debt rose again to an unsustainable level, as the Non-Federal debt relative shows.
Given that we use credit for growth, it follows that the Non-Federal relative rises during periods of growth and falls in periods of decline.
A high level of the Non-Federal debt relative is associated with economic troubles. A low level of the debt relative opens a door to a period of improved growth.
It follows that economic growth undermines economic growth because Non-Federal debt is allowed to accumulate.
One must conclude that we can no longer allow debt to accumulate as a matter of policy. We must find ways to prevent debt accumulation while continuing to rely on credit for growth.
One option is to rely less on credit and more on M1 money. This is exactly what happened in the years before and during the "macroeconomic miracle" we have been examining.
Another option is to change the way we fight inflation. At present we fight inflation by raising interest rates to make borrowing more expensive, until people cut back their borrowing enough to reduce aggregate demand. This is monetary policy. It is no longer appropriate.
I propose instead to use fiscal policy to fight inflation. I propose to fight inflation by letting the tax rate vary in proportion to the taxpayer's indebtedness, and to offset potentially higher tax rates by offering tax credits that help and encourage people to accelerate their repayment of debt.
There must be at least 535 ways to do these things. But there can be no question as to whether they should be done. They must be done. Everything depends upon it.