Wednesday, November 9, 2011

Highlights from a Year-Old Article

From The Telegraph: UK's total debt forecast to hit £10 trillion by 2015, by Emma Rowley, 09 Nov 2010:
Britain's total debt will top £10 trillion by 2015, according to Pricewaterhouse-Coopers, which warned the burden could slow growth for decades...

These next two paragraphs are presented below just as they are in the original:
Property-related borrowing and lending between financial institutions helped the collected debt of households, businesses and government balloon from roughly twice gross domestic product (GDP) in 1987 to around 5.4 times by 2009, when total debt stood at £7.5 trillion, according to the report.

Despite government austerity measures, the firm's latest economic outlook sees the UK's debt to GDP ratio sticking near historic highs as borrowing hits £10.2 trillion by 2015.

What are those four words doing there? "Despite government austerity measures"?? This article is about total debt -- it's right there in the title. The phrase threw me off, after that pointed opening.

But perhaps Emma Rowley is simply reminding us that government austerity does nothing to solve the problem of excessive total debt.

It would seem so:
Deleveraging will go well beyond the immediate challenge of getting public finances under control, PwC warned.

While attention is on reining in government borrowing, the "debt explosion" seen since the mid-1980s has been most marked in the private sector, it said.

Even in 2009, government debt was still less than a sixth of the size of the private sector's total debt...

Now, as for a solution:
"The UK's addiction to debt has reached alarming levels during the past decade," said John Hawksworth, chief economist at PwC.

The unprecedented levels of private sector debt would, sooner or later, have to be addressed, "either through debt being run down sharply, which would risk triggering another recession, or more likely through a persistently heavy debt service burden that could dampen economic growth for decades to come".

He added: "Either way, deleveraging will be a painful process for the UK."

I am largely satisfied with PwC's analysis of the problem. Of course, after the crisis it should be obvious to all.

The trouble now is to get out. PwC sees two options: Rapid debt reduction and recession, or slow debt reduction and stagnation. Neither option is acceptable. Both make the employment picture worse.

The excessive accumulation of debt is a result of economic policy: Sins of commission and sins of omission both, as it were. Policy did the wrong thing, and failed to do the right thing.

Probably most people would agree with that. But what comes next is the nitty-gritty.

I take policy down to basics, down to simplest terms:
  1. Printing money causes inflation, and
  2. We need credit for growth.

By Rule 1, we have driven down the quantity of money in circulation, in the effort to fight inflation:

Graph #1: MRTO

By Rule 2, we have borrowed and encouraged borrowing and allowed the accumulation of debt, in the effort to stimulate growth. So debt accumulated:

Graph #2: DPD

These long-term trends created an imbalance in the money, so that we now use credit for money. As a result, the cost of credit has increased relative to all other costs.

Now, everyone sees these costs in terms of interest rates, and that is certainly one element of the cost. But how frequently is that interest cost applied, per dollar of spending? More and more and more frequently, as the reliance on credit grows. This frequency is the other element of the cost. This frequency is clearly visible in the excessive accumulation of debt -- debt that before the crisis had reached some 35 times the size of circulating money, suggesting that the interest rate is applied as much as 35 times per dollar of M1 money.

The imbalance between circulating money and circulating credit is a monetary imbalance created by the conflicting rules of policy. The excessive accumulation of debt is a result of economic policy.

The reasonable solution is for policymakers to admit they got the rules wrong, and to make amends for their sins. The reasonable solution is for policymakers to correct the imbalance they created.

If they just go ahead and make the corrections, there is no reason to have a recessionary or sluggish economy. The Federal Reserve suppressed money growth; this must be corrected. Congress encouraged credit-use and allowed debt accumulation; this also must be corrected.

Make the corrections, and our economy will rise from the dead.

UPDATE: Quick and dirty, a graph showing both the debt-per-dollar increase and the fall in money relative to output.

Graph #3: DPD and MRTO

Interesting, the way the two seem to interfere with each other, there in the middle. Probably has something to do with instability of M1 money growth:


Gene Hayward said...

Would it be possible to combine these two graph onto a single one? Even my high school students can understand this... :)

The Arthurian said...

Hi Gene. I updated the post to include a FRED graph showing both trends. The FRED numbers for M1 start at 1959, so that's where the update graph starts, but the trends are still obvious.

Gene Hayward said...

1995 seems significant. Any specific reason for this. A particular policy or combination of policies to lead to such a rapid divergence?

The Arthurian said...

Yes, absolutely a particular combination of policies.
1. There was a slowdown in the growth of total debt between 1986 and 1995 or so, and
2. There was a strong increase in the quantity of M1 money (and also of Base money) beginning around 1992.

The combination of policies reduced the ratio of debt-to-money, and appears on the graph.

The combination of policies also eased debt burdens somewhat in the economy and allowed incomes to rise. The result was the "macroeconomic miracle" of 1995-2000, when we actually managed to balance the Federal budget!

The Arthurian said...

Oh by the way: policy.

1. "In the U.S., people used to be able to write off the interest they paid on credit cards. That tax break was abolished in 1986, and, the same year, the mortgage-interest deduction, which used to be unlimited, was capped." -- James Surowiecki

2. The Fed.