The Debt Problem: Speculation or Excess?

In recent comments, Jim distinguishes between productive and unproductive debt, and associates unproductive debt with speculation:

Unproductive debt is when you are borrowing against the hope that some asset will increase in price, but the only reason the asset will increase in price is because you and other people are borrowing to put money in.

Jim is in good company: Steve Keen has expressed similar views:

At some stage, the growth of unproductive debt had to falter, and when it did a serious financial crisis would ensue as aggregate demand collapsed.

Keen has also done Non-mainstream modeling of the GFC and reports that

Without speculative borrowing—defined as borrowing that finances speculation on asset prices but does not finance the construction of new assets—the model generates a cyclical system which generally does not break down; with speculative borrowing, the model almost inevitably approaches a crisis caused by the accumulation of debt

Despite all that, I claim that the problem is not speculation. The problem is excess. But I don't want to seem to say that speculation is harmless. In the white box I present a complete list of new arguments explaining the problems with speculation:

 

 

 

 

 

 

New arguments, meaning the things I have to add to that discussion.

The DPD graph shows continuous increase in debt since 1947. The economy passed through several different stages during that increase:

1. The golden age (1947-1973) (Dean Baker and John Schmitt)
2. The great inflation (1965 to 1984) (Meltzer PDF)
3. The Age of Speculation (since the mid-1980s¹)
4. The Macroeconomic Miracle (1995-2000) (Robert J. Gordon)
5. Sluggishness and Crisis (2001-present).

Stage One -- golden growth -- occurred because the DPD was low. Or I should say, because DPD was low, DPD did not inhibit growth.

Stage Two -- inflation -- occurred because the growing financial costs associated with growing debt were eating into profits. The inflation of the period was cost-push, though that is not widely observed.

Stage Three -- speculation -- developed as policymakers suppressed growth in order to suppress inflation, and then tried to find alternative ways to encourage growth. They removed the prohibitions against excessive speculation.

Stage Four -- the miracle of 1995-2000 -- occurred because the DPD had fallen, making the debt level relatively low again, briefly.

Stage Five -- sluggishness and crisis -- occurred as soon as the slack in debt had been used up.


Despite the various responses of the economy to the increase in DPD, (and with a brief exception before the 1995-2000 miracle) debt expansion was continuous since 1947.

People variously view the onset of problems with the onset of inflation, or the end of golden growth, or the advent of Reaganomics, or of the sluggishness, or of the crisis. But these all are problems that people have with the economy. They are none of them the economy's problem.

The economy does not care that we don't like inflation. It does not care that we don't like unemployment. It does not care that we don't like crisis. It does not care. These things we see as problems are simply the economy's way of dealing with disturbances or imbalances that we the people create.

For the economy, they are not problems. For the economy, they are solutions.


The economic problem began in 1947 when the DPD started to climb.

The problem began in 1947 with the growth of debt. This does not mean that the solution would have been to keep debt at its 1947 level. But we do have to find the best level, the best range for the DPD, the range that gives us the best tradeoff between the benefits of credit-use and the harm of accumulating debt. We have to find that range, and we have to keep the DPD there.

I hold that the best range is what we had some time before the end of the golden age: the early 1960s, when inflation was at its lowest and growth was spectacular. So I would like to say that the problem began in the latter 1960s. However, as long as people refuse to look at the trend of debt, I am forced to argue that the problem is not speculation, but excess, and that the problem began in 1947.


I do have something to say about speculation after all. Back when the economy was going gangbusters, people could make money by investing in the productive economy. But as debt and financial costs grew, profits fell in the productive sector and made such investments less appealing.

As productive investment became less appealing, speculative investment became more appealing. Thus the growth of speculation is itself a result of the growth of debt.

In summary then:

1. The problem of excess arose before² the problem of speculation, and
2. The problem of excess leads to the problem of speculation.

The problem is not speculation. The problem is excess.


^NOTES
1. The conclusion of the Keen post referenced above observes that "the superficially good economic performance during “The Great Moderation” was driven by a debt-financed speculative bubble". I therefore think it safe to apply the dates of the Great Moderation to the Age of Speculation.

2. The problem of excess debt was evident already in the late 1960s when financial costs were pushing prices up. By the early 1970s the problem was obvious as it led to the end of the golden-age growth.