Wednesday, February 22, 2012


From The Money Illusion:

Back in late 2008 and early 2009 most people focused on “the debt crisis” as being “the problem.” But debt is a problem only to the extent that it exceeds one’s ability to repay the loans, which depends on one’s income.


I say again: MICRO BS. "One's income" is micro. The relation of one's debt to one's income is micro. The sum of all debts relative to the sum of all incomes IS STILL MICRO.

Ours is a MACRO problem.

The fly in Sumner's ointment is the pretense that income can exist without debt. He says debt is only a problem if it is too heavy for your income, but he forgets that in our economy, almost all income comes from somebody using debt. We do not increase income without increasing debt; at the macro level, this is the problem.

Income CAN exist without debt, of course, but only if we change the way we do things. We have to increase the quantity of money relative to output and at the same time decrease the amount of credit generated from every newly printed dollar. But as long as people continue to think money and credit are the same, that will never happen.

Sumner does not call for the necessary change. He says:

A few of us market monetarists argued that you also needed to look at the denominator of the debt/income ratio, not just the numerator.

By looking at the denominator of the debt/income ratio, he means: Look at income. Well yeah, income is too low. Income is GDP, and GDP is too low, so income is too low. If you don't get a headache because this is such basic stuff, well, you should.

GDP growth has been too slow since the mid-1970s. What's that, going on forty years now? GDP growth has been too slow for 40 years, for the most part getting worse all the while. The money illusionist waves his hand and pretends that the whole GDP problem never existed until "late 2008" or something. And with that magical analysis, Sumner declares that the problem is not excessive debt, but insufficient income.

Does it matter? Well, yes: Excessive debt IS THE REASON INCOME HAS BEEN LAGGING for forty years.

The solution that calls for "more income" is likely to be nothing but an inflationary solution. That's because we're not getting growth. If we don't get growth, all we get from an expanding NGDP is more "N". And don't forget, it's debt that hinders growth.

Sumner ignores the numerator. He ignores debt, the hinderer of growth.

Debt relative to income is high. Sumner says we can solve the problem by increasing income via inflation. Did that work, say, in the 1970s?

Graph #1: Debt-to-Income (blue) and Debt-to-CPI (red)

Not really. Here's a close-up through 1980:

Graph #2: Debt-to-Income and Debt-to-CPI (up to 1980)

Maybe it did work for the latter half of the 1960s. Inflation pushed NGDP up, and at the same time inflation reduced the burden of existing debt: Inflation increased Sumner's denominator and decreased his numerator simultaneously. And all it took was a 23% increase in prices in the five years between 1965 and 1970. Meanwhile, total debt increased 44.6%, almost twice the rate that prices went up.

Prices couldn't go up fast enough to keep up with the growth of debt. After 1970, inflation got worse, but Sumner's "debt to income" ratio WENT UP ANYWAY.

As long as debt continues to increase, inflation cannot solve the problem of excessive debt. And debt hinders growth.

Dwell on it.


Greg said...

Excellent Art. I agree completely except for the fact that you dismiss debt to income as a purely micro issue, but I dont want to focus on where we disagree. Im off to India and will be out of pocket for ten days so I want to leave with an agreeable post.

Sumner is a despicable tool. He openly admits to not really considering /understanding banking ( a common mea culpa by many right leaning economists) and then wants to comment on our private debt issues. ALL private debt is owed to banks or bank like structures. It is not owed to individuals. If you dont understand banking you CANNOT understand how private debt dynamics affect the economy. It would be like saying you dont understand governments and then talking about government.

I still say the crux of the issue is that too many people still think a bank is simply an intermediary between borrowers and savers and therefore that one mans debt is always equal to another mans surplus. Banks are not a man. They are more like a govt in that they issue "currency" (yes their currency is in fact backed by the REAL currency of the US govt but.....) and they charge a tax on their currency (interest). So when their tax gets too high (either as a % or in the total amount taken in) we all suffer. Would anyone ever say "Hey, high taxes arent a problem, because tax surplus will be offset by someone elses tax deficit!"

As an outside third party govt and banks CAN extract TOO MUCH from the systems they are supposed to be supporting. Right now banks are extracting too much.

Jazzbumpa said...

I agree totally with Greg.

I gave up on Sumner long ago.