Monday, June 11, 2012

David Brooks: The Debt Indulgence

From the Opinion Pages of the New York Times, by David Brooks, 4 June 2012:

Every generation has an incentive to borrow money from the future to spend on itself. But, until ours, no generation of Americans has done it to the same extent. Why?
Why? Because policy does nothing to prevent it. Policy only encourages it. Still today, Federal Reserve policy is to grow the economy by getting everyone to borrow more. This must change.

A huge reason is that earlier generations were insecure. They lived without modern medicine, without modern technology and without modern welfare states. They lived one illness, one drought and one recession away from catastrophe. They developed a moral abhorrence about things like excessive debt, which would further magnify their vulnerability.
Try to focus, David Brooks. You are not doing economics here. Your stories are irrelevant.

In case you didn't notice, in the 1990s and 2000s we had a growth industry dedicated to making money by helping people out of debt. So even then, we had "a moral abhorrence about things like excessive debt". Some kind of abhorrence, anyway.

Our character is not the problem. Our policies are the problem.

Recently, life has become better and more secure. But the aversion to debt has diminished amid the progress. Credit card companies seduced people into borrowing more. Politicians found that they could buy votes with borrowed money. People became more comfortable with red ink.
It is policy, David, plain and simple. There is no need to make up these stories.

Today we are living in an era of indebtedness. Over the past several years, society has oscillated ever more wildly though three debt-fueled bubbles. First, there was the dot-com bubble. Then, in 2008, the mortgage-finance bubble. Now, we are living in the fiscal bubble.

Wait a minute -- the fiscal bubble? No, you misuse the word "bubble".

In this country, the federal government has borrowed more than $6 trillion in the last four years alone, trying to counteract the effects of the last two bubbles. States struggle with pension promises that should never have been made. Europe is on the verge of collapse because governments there can’t figure out how to deal with their debts. Nations around the globe have debt-to-G.D.P. ratios at or approaching 90 percent — the point at which growth slows and prosperity stalls.

It all goes back to the increase in the tolerance for debt.
No, David. As Rex Nutting says, excessive private debt created the problem. But what it all goes back to is policies that encourage credit use and the accumulation of debt.

Private debt and public policy. Focus on these two things. Everything else follows.

Democrats and Republicans argue about how quickly deficits should be brought down. But everybody knows debt has to be restrained at some point. The problem is that nobody has been able to find a political way to do it.
No, David. The problem is that nobody considers the economic way to do it.

What about private debt, Brooks?
  1. Excessive private debt leads to inadequate growth.
  2. Inadequate growth leads to excessive public debt.
What about private debt?

The era of indebtedness began with a cultural shift. It will require a gradual popular shift to reverse. Today’s Wisconsin vote might mark the moment when the nation’s long debt indulgence finally began to turn around.
What about private debt, fool?


Jazzbumpa said...

Pretty good effort, but you are too kind and gentle.

I say, if you're gong to go, go all the way. I had to reach deep in the archives for this example. It's a hell of a lot of time and effort spent to do this right.


Anonymous said...

Whether Brooks is looking for a "cultural shift" , or more properly , as you said , a policy shift , a glance at this should help him pinpoint the timing of the shift ( and the shaft ? ) :

Jazzbumpa said...

Anon -

Yep - Reagan and Bush, Jr.


The Arthurian said...

I was gonna let this go but now I can't.

The noticeable flat spot on that graph is due to the Great Inflation. Not to any slowing of the growth of debt:

And not to any uptrend in real output:

BTW, in the post I was trying to be reminiscent of B A Baracus, nothing more than that.

Anonymous said...


You need to think about this some more. I noticed a while back you were twisting yourself in knots over the concept of real vs nominal debt and I could see that you were getting sidetracked.

The plots of debt/gdp or debt/income are all time plots of the nominal measures of both components , combined into a ratio at the time of collection ; that is , inflation (or deflation ) comes out in the wash.

That's why the ratio is so useful , and you use it in evaluating your own situation. If you made $50k in 1980 and had a $150k mortgage , you had a 3x debt/income ratio. If someone at that time told you you'd have a $300k mortgage in 2010 , you might have thought that would be big trouble , but if they told you your income would be $100k , your concern would have vanished , because you know what a 3x ratio feels like. It wouldn't matter if your salary went up because of inflation , while the house went up for some other reasons , as long as the ratio stayed the same.

When you say that the flat spot is not due to slowing growth of debt or rising gdp , you show that you misunderstand the notion behind the ratio.

The flat spot is hugely significant. We had equal or better gdp growth while maintaining a stable debt/gdp. Since then , we've ramped our debt/gdp right into a second depression.

Don't let ideology blind you to what the non-ideological data is showing you.

The Arthurian said...

For every dollar borrowed, there is a dollar lent.

Every penny of debt that is eroded by inflation is a penny of benefit to me, and a penny of cost to my lender. This is zero-sum, I think. I am willing to admit that the erosion is nonetheless "good" because (1) there are more borrowers than lenders, so the benefit is distributed while the cost is concentrated; and (2) spending is good for the economy, and not-spending is not. Nonetheless, a dollar of benefit to me by debt-erosion is a dollar of cost to someone.

You need to think about this some more...
The flat spot is hugely significant."

Yes, and yes.

"The plots of debt/gdp or debt/income are all time plots of the nominal measures of both components , combined into a ratio at the time of collection ; that is , inflation (or deflation ) comes out in the wash."

Yes and no. Inflation affects debt and income differently, because income is current but debt is cumulative. For income, only the current price level is relevant. For debt, all the different price levels at all the different moments when loans were taken out, all must factor in to the equation if we want to figure, for example, how much (in dollars) we have benefitted by the erosion of debt by inflation.

If I borrow $150k in 1980 this is 3x my income, as you say. Now suppose this debt has not yet come due, so that I still owe the full $150 ( at zero interest, to simplify matters ). In 2010 the $150k is only 1½ times my income.

Now (to break with your example) suppose I borrow another $150k. My total debt rises to 3x income again. But the total, inflation-adjusted value of what I have borrowed is 4½ times my income. I think you are saying that this does not matter. You may be right. Nevertheless, the inflation-adjustment calculation works fine for a flow like GDP, but gives the wrong answer for a stock like debt.

"When you say that the flat spot is not due to slowing growth of debt or rising gdp , you show that you misunderstand the notion behind the ratio."

And yet the graphs show that the flat spot is not due to the slowing of debt growth, nor to the quickening of GDP growth, but to the inflation of that era. Fisher dynamics, maybe.

The Arthurian said...

What matters with debt is always what do I owe, now?. So looking at it "nominal" is always useful.

If we are to look at inflation-adjusted debt, it seems to me that the base year should be the present, or anyway the most recent year: the year closest to "now".

If we look at debt "now" and we agree that there has been some erosion of debt by inflation, then the debt we have now must be less than the debt we would have had without the inflation.

But when we use the standard calculation for inflation adjustment, and use "now" for the base year, the "real" and "nominal" values are equal in the "now". This cannot be correct.

I conclude that the standard inflation-adjustment calculation is wrong for a stock like debt.

Anonymous said...

It might help to think about how you view similar metrics regarding investments. Debt/equity or debt/free cash flow are useful things to monitor to see if a company is getting into trouble. If those ratios are rising , you'll want to know if debt is securing investments that will provide higher future revenues. If not , and particularly when the growth rate of the ratio is accelerating , trouble is probably imminent.

Nobody corrects the components of those ratios for differential inflation effects - it's nominal over nominal at each given point in time , and you simply monitor the ratio over time.

Carrying costs can vary with prevailing interest rates , of course , so value of the ratio that provokes concern can vary some too , but since future interest rates are unknown , it also pays to attend to historical precedents when evaluating the ratios.

The Arthurian said...

"Nobody corrects the components of those ratios for differential inflation effects - it's nominal over nominal at each given point in time , and you simply monitor the ratio over time."

Nobody corrects for differential effects -- by "differential" I take you to mean the debt from many different years that is included in any one year's accumulation of debt? If so, excellent, for you have understood my concern exactly. (Nice phrasing, too.)

However, people sometimes *do* correct for the non-differential effect of inflation on debt. Sometimes we do adjust the debt numbers for inflation. But we do it by using the same calculation that is used to strip inflation out of NGDP: We divide each year's total debt number by the same year's GDP Deflator or CPI number, as if accumulated debt were a flow.

I have done it. Clonal and Sackerson have done it. Reuven Glick and Kevin J. Lansing in the FRBSF Economic Letter 2009-16 dated May 15, 2009 (see Figure 1 at the link) have done it. And Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli in The real effects of debt (see their Graph 1, right-hand panel) have done it.

Reuven Glick was kind enough to email me the spreadsheet used for the FRBSF Economic Letter. I observe that in the calculations for Figure 1, "DISPOSABLE_INCOME_REAL" is calculated by dividing "DISPOSABLE_INCOME" by the "GDP_Deflator" for each year in the series -- the standard calculation, which is fine for flow numbers like income.

But "HH_DEBT_REAL" is calculated similarly, by dividing "HH_DEBT" by the "GDP_Deflator" for each year in the series -- with no consideration of the prior-year debt that is embedded in any given year's total debt.

If we are calculating "real debt" incorrectly, as I think, then perhaps it would be useful to know this, even if the "real debt" numbers themselves are seldom useful.

Why does it matter? It matters because people like Paul Krugman are talking about things like "the erosion of debt by inflation". This "erosion" can be calculated, but it cannot be calculated with the same formula used to remove inflation from flow numbers like Disposable Income and GDP.