Sunday, August 12, 2012


In a comment on Scott Sumner's Debt surges don’t cause recessions, Sumner wrote:

Woj, You said;

“As the aggregate amount of debt and interest rises, the percentage of income used to pay interest costs or pay down debt also rises, lowering the amount available for consumption/investment.”

This is simply factually wrong. Every debt payment is money received by someone else.

Let's put it a little differently, then. Let's stop confusing the financial sector with the productive sector. Let's look at them like two different sectors of the economy. You know: the same way the stats are presented all the time.

As the aggregate amount of debt and interest rises, the percentage of productive sector income used to pay interest costs and pay down debt also rises, lowering the amount available for consumption and investment in the productive sector.

It does not matter that "every debt payment is money received by someone else." It would not matter even if every debt payment was received by the same person who made the payment! What matters is that the money is moving out of the productive sector, and into finance. That is the problem.

Among economists, mind you, productivity is said to be of the highest importance.

I go back again and again to Adam Smith and his Factors of Production, though I do not think he called them that. Smith looked at the component parts of the price of commodities. He thought the topic important enough not only to write about, but to use in the title of the chapter where he wrote it.

Modern economists, or textbook writers at least, seem to think the Factors of Production are all about the inputs to the production process. That is incorrect or, if not incorrect, it is of no importance whatsoever to macroeconomics. (Why economics seems boring: Economists insist on talking about inconsequential and meaningless things. In place of math anxiety there is economics ennui.)

The issue is the component parts of price: The issue, gentlemen, is cost.

As the aggregate amount of debt and interest increases, the cost of finance rises in the productive sector. As Smith put it,

The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue...

The cost of finance, if not paid out of profit, comes out of wages...

Now who ya gonna listen to -- Sumner, or Smith?


Greg said...

First off Scott is wrong. A payment to a bank is not the same as a payment to someone else. Paying a bank debt is nowhere near the same as me paying back the thousand dollars I borrowed from Art. When I do pay back Art it is true that Art now has the money to do something with but in the instance of the bank it never needed my payment in order to lend or buy something. If I stop making payments to the bank it is not "out" some money that it no longer can spend or lend, but if my payments to banks get too high I can no longer consume as much in the present period. When 90% of the population owes too much to banks and therefor lower their present period consumption the other 10% cannot and will not fill the gap.

What Scott forgets (or never really knew) is that banks are simply in the business of making loans. They dont buy stuff other than govt bonds so they are not consumers that can generate activity on their own. They need willing borrowers to generate activity and when those willing borrowers are in too much debt already the will not borrow

Woj said...

Thanks Art and Greg for rephrasing my comment in much clearer (more correct) language. I have to agree that I doubt it would have altered Sumner's response.

On a related note, I've read some recent work by Michael Hudson that touches on similar topics frequently highlighted on this site. I'm going to try and post some excerpts and thoughts soon.

Jazzbumpa said...

The reason it would not have altered Sumner's response is either a) he is ideologically committed to a Chicago School position, and this commitment blinds him to the real world; or 2) he is a liar.

I guess there's a third possibility.

Note that there is no mutual exclusivity among these propositions.