Debt: The Good, the Bad and the Ugly

At The Institute for New Economic Thinking, Lee Price interviews Moritz Schularick regarding his research into private debt. I have transcribed a portion of the interview, beginning about 3:40 in:

Q: What's led you to believe that you would have an even better understanding if you had a breakdown of the types of private credit?

A: That's where the link comes in to the title of our project -- finance and the welfare of nations -- is that the economic function played by lending differs substantially... It's not the same thing whether a bank extends credit to a company for a productive investment, or whether a household borrows from a bank to finance the purchase of an already existing house or an already existing apartment.

One is positively linked with economic growth and development. The other one is a financial transaction that, from a consumer point of view might seem beneficial, but it's much less clear what the welfare implications are of these housing booms.

Q: So you'll also be looking at whether investment was occurring that would improve the capacity to repay the debt later.

A: Right. This is crucial focus of them going beyond the aggregate credit data will be to as far as possible try to distinguish between lending and debt that was used for productive purposes, productive investment, to the degree we can define that, and lending that went into construction, went into mortgage lending, etc, to see whether there are different economic implications... consumer lending being the third kind ...

Now I'm gonna say this is a waste of time, investigating these differences.

And you will misunderstand, and you will think I cannot see the obvious differences between productive and nonproductive uses of credit. And then I could quote Adam Smith, or quote myself quoting Adam Smith to show you that I *DO* see the differences that Moritz Schularick sees and wants to study. And I say let's move along here, we don't have time for that.


Back in the 1970s, at the end of the Golden Age, the only way to keep the economy growing gangbusters was to let prices go up. And when policy suppressed inflation, policy suppressed growth. And growth never recovered.

Why? Because already by the end of the Golden Age, financial costs were making the productive sector less profitable. More to the point, those same costs were making the financial sector more profitable.

So then, when Supply Side economics made things better for business, it was finance that benefitted most. And since there was no thought given to reducing the reliance on credit, or to reducing private debt, or to reducing the financial costs to the non-financial sector, the productive economy never recovered. But finance grew.


At Angry Bear, Steve Roth responds to a Jazzbumpa post:

...the finance industry has created a huge pyramid of new financial assets (ultimately funded by bank fractional reserve lending/money printing). That new money is "locked up" in those assets, but it was created for that purpose in the first place. If real investment had offered similar risk-adjusted prospective returns, banks would have created money for that purpose.

Which raises the question: how to make real investment more attractive than financial investment? I'd start by taxing financial-investment returns at the same rate, or higher, than real business profits. Rather than at a lower rate, as we do now...

This is exactly right. Finance grew, and production didn't, because finance was more profitable than production. And the question is exactly right: how to make real investment more attractive than financial investment?

Roth suggests using taxes to make finance less profitable. I like the idea. That's what taxes are for. Yet I must insist that the problem is simpler and the analysis cleaner than Steve Roth has seen.

When the productive sector increases its reliance on credit, it increases its own costs, reduces its own profits, and increases the profits of finance. Ergo, the growth of finance.

Finance is the problem, gentlemen, because finance is the problem.


In an interview I reviewed a while back, Robert P. Brenner made the following points:

1. The basic source of today’s crisis is the declining vitality of the advanced economies since 1973, and, especially, since 2000.

2. Since the start of the long downturn, state economic authorities have tried to cope with the problem of insufficient demand by encouraging the increase of borrowing, both public and private.

3. A stepped-up assault by employers and governments on workers’ wages, working conditions, and the welfare state ... prevented the fall in the rate of profit from getting worse.

Yes, exactly. However, Mr. Brenner fails to emphasize the fact that the cost of finance was a central element in the decline of wages and profit.

The problem with finance is cost. Sure, yes, yeah, if we use all our borrowed money for consumption spending it's not as good as if we use it all for productive investment. Probably. But no one yet sees that the fundamental problem with credit use is the cost of credit use. Robert Brenner misses it. Steve Roth misses it. Moritz Schularick misses it. And you miss it too.

When there is so much debt that the economy can no longer function, it doesn't really matter anymore whether that debt was used for productive purposes. The problem is cost. At this stage, today, the only thing that matters is the cost.