Thursday, December 22, 2011

Nuance??


Wikipedia:
Debt levels and flows
Debt is used to finance and pay for entreprises and business around the world. The levels of debt – how much debt is outstanding – and the flows of debt – how much the level of debt changes over time – are basic macroeconomic data, and vary between countries.

Within mainstream economics, levels and flows of public debt (government debt) are a cause of concern, while levels and flows of private debt (especially households and corporations) is not seen as being of central importance.

Apart from the spelling, there are at least two problems with this introductory bit of the article.

1. Debt is used "to finance and pay for" stuff.

No, it's not.

A debt is an obligation owed by one party (the debtor) to a second party, the creditor.

If I borrow a dollar from you to get a candybar from the machine, two transactions occur:
   1. You give me a dollar and I give you an IOU.
   2. I give the machine a dollar and the machine gives me a Milky Way.

Two transactions. The first one puts money into circulation and creates debt. The second one uses the money to make a purchase.

The second transaction is completed as soon as I have my candybar in my hot little hand. The first transaction is not completed until I repay the debt.

We might say debt is used "to finance" the candybar. But debt is not used to "pay for" it. The money I get in exchange for the IOU is what I use to pay for the candy.

I'm not inventing any stories here. I'm just trying to be clear about what happens.

2. Private debt is not seen as a problem.

No, it's not. It *IS* a problem, but it's not seen as a problem. And to be blunt, that is the reason we cannot solve the problem.


I've said it before, but you and I are like little versions of the Federal Reserve. The Fed puts new money into circulation by buying stuff from the private sector. So do we.

What's different is where the new money comes from. You and I have to go to the bank to get it. But the Fed *is* a bank, so they don't have to "go" to the bank.

The Fed is a special case. That's where our money comes from. The Fed has a limitless supply of money that they are keeping out of circulation. That's their job, to keep most of that money out of circulation.

If they want new money, they can get it out of an empty box.

You and I are not so lucky. We have to go to the bank for new money. We, unlike the Fed, create debt when we create new money. And we, unlike the Fed, are obligated to pay back that debt.


Every dollar of debt is the record of a dollar somebody put into the spending stream, and has not yet removed from the spending stream.

Every dollar of debt is a dollar somebody has to pay interest on. The money used to pay interest goes into the financial sector. Maybe it came from the financial sector, or maybe it came from the productive sector, but it definitely goes to the financial sector. And most of it comes from the productive sector.

Interest is income to the financial sector. Interest is a cost to the productive sector. You don't need any more explanation than that to see why excessive levels and flows of private debt can become the problem of central importance.

6 comments:

Jazzbumpa said...

Interest is income to the financial sector. Interest is a cost to the productive sector. You don't need any more explanation than that to see why excessive levels and flows of private debt can become the problem of central importance.

This is well put.

The other part of it is what the finance sector does with the money. Two things: 1) huge bonuses to their execs, who are basically leeches sucking the life blood out of capitalism, and 2) leveraged gambles in commodity and equity markets which raise costs for everyone else, and thus suck the life blood out of capitalism.

WASF,
JzB

Greg said...

Ill take it a step further. Interest is the TAX the banking sector gets to assess.

It seems Art like you are viewing banking thru the lens of a third party intermediary. By that I mean that you see your extra 1000$ of savings as going to me when I take a loan of 1000$ and the bank simply makes this process seamless and invisible and takes a cut.

I dont think that is what is happening at all. In fact I think it is more illuminating to view banking as just a private sector govt, so to speak. We both understand that it would be wrong to imply that the taxes I owe are simply offset by someone else who is receiving my tax dollars. That COULD be the case but in fact it could also be the case that everyone owes a lot of tax dollars to the govt. We could all be net in debt (in taxes) to the govt. The same is true of banking. We could all be in debt to banks (and probably are) Even the wealthiest people have huge lines of credit and loans that they choose to have rather than liquidate their savings to make big purchases. So just like we know that being net in debt to the govt in taxes does not make us better off (The govt has a surplus!!!...Yipppeeee) being net in debt to banks makes us equally worse off. If private debt were simply the same as me borrowing your surplus it would not be the problem that it is. Our output wouldnt change much. You dont need the 1000 to consume so you lend to me and I do consume. Then I de-consume(?) 1100 say over two years to pay you back. No harm no foul.

Its when we insert modern banking that the harm and fouls come in.


One more thing

I think your debt per dollar is a snapshot but we service our debt out of income. I owe 120000 on my house but my current savings (not counting 401K) is only about 25,000. However my future projected income for the next ten years is about a million dollars. The 120000 doesnt look so bad next to my future expected income.

Greg said...

Oh,

Merry Christmas Art.

Hope your 2012 is great!

The Arthurian said...

Merry Christmas, Greg. Oh, and thanks for the thumbs-up at heteconomist the other day. I'll be misunderstanding PeterC in posts here, soon.

The Arthurian said...

Greg,
It took a few days for me to respond. I hope you see this reply.

I printed out the post & comments so I could read it over some. I cannot figure out what I said that led you to say: "I mean that you see your 1000$ of savings as going to me when I take out a loan of 1000$ and the bank simply makes this process seamless and invisible..."

Far as I can see, I did not say anything in the post about where the bank gets the money to lend. I have to challenge you on that. Do you think that I did? Where??

The points I make (or, attempt to make:) in the post are these:
1. "Financing" a thing is not the same as "buying" a thing.
2. Private debt *IS* a problem.
3. The high factor cost of money is the reason private debt is a problem. (This is the part Jazz quoted.)

In my example of borrowing a dollar to buy a candy bar, I do borrow the dollar from "you". Borrowing only a dollar, I do not expect to need a bank.

If I borrow a dollar from you, there is no intermediary in that transaction. If I borrow $1000 from the bank, there is no intermediary in that transaction, either.

A bank is a "financial intermediary" in the same way that a shoe store is a "footwear intermediary" between the manufacturer and the customer. And the same way that I am an "intermediary" between my employer and the places where I spend my paycheck. I would file these observations under the heading TBI: True But Irrelevant.

To see a bank (or anybody) as an intermediary, you have to look at multiple transactions. You have to look at "before" transactions and "after" transactions. I'm not doing that.

The Arthurian said...

Oh I get it now Greg. I said
"If I borrow a dollar from you" it "puts money into circulation and creates debt."