Saturday, January 19, 2013

Some evidence, and a vision

I am by no means an economist. Sometimes, that comes back to bite me. Because what I need is economists who are willing to take what I say, translate it into economist language, evaluate it, and then translate their evaluation back into Art-speak. But it's difficult to find economists willing to do that. (And who can blame them, really?)

But I am on to something, and I have been on to it since the late 1970s when I drew my first debt-per-dollar graph. Based on data from the Historical Statistics, Bicentennial Edition, it showed the debt-per-dollar ratio for the years 1916 to 1970. (It was still the 1970s when I first looked at it, remember.) Covering a period of more than fifty years, the graph shows only three trends:

Graph #1: Total Debt relative to Circulating Money, 1916-1970

Highly significant are the locations of the turning points: one comes at the worst point of the Great Depression, and the other at the beginning of a golden age of US economic performance. I don't know much economics now, and I knew less then. But I never had a doubt about the significance of this graph.

Today, you might dismiss that graph as ancient and therefore meaningless. I would remind you of the importance of older work in economics. Besides, the same kind of peak you see in 1933 on Graph #1, you can see repeated on Graph #2 in 2009:

Graph #2: Total Debt relative to Circulating Money, 1967-2012

Plus, there's a little one there, a little peak in 1990. So, that's three peaks. There's a lot of evidence here to work with:

1. The 1933 peak, followed by a long downtrend, set the stage for the long period of exceptionally good growth that began after World War Two.

2. The 1990 peak, followed by a brief downtrend, set the stage for several years of exceptionally good growth that began in the mid-1990s.

3. The 2009 peak, followed by


It's up to us.

We need to get that line down to a low level: maybe down around $10 of debt per dollar of circulating money. Just a guess. That is still very high; after the 1933 peak, the debt-per-dollar ratio went below $4!

But in the 1990s, debt per dollar fell only to just below $15 before we got a period of really good growth.

Still, the '90s growth did not last long, because debt soon climbed to too high a level. So I say, the lower the number goes, the better our chances of sustaining good growth.

We need to get that line down, and keep it down. This is a goal for policy.

Why is it important? Cost. The debt-per-dollar graph shows one of the two factors that make up the total cost of the money that circulates in our economy. The interest rate is the other factor, and I suggest that the debt-per-dollar ratio is just as important as the interest rate.

The two factors together -- the cost of borrowing a dollar, and the number of dollars we pay interest on -- determine the total cost of money or the "factor cost" of money.

If out of a typical paycheck you end up paying $2 in interest on your debts, or $200, it will make a big difference for you. If your interest costs are high, they interfere with your other spending plans.

And if we're all in that boat, then the things you buy cost a lot more because of the interest cost embedded in them. And the things you sell don't sell as well, because your customers' interest costs are interfering with their spending plans, too.

Finance is great. We need it. We just don't need so much of it.

When the debt-per-dollar line is going down, financial costs are being reduced. That frees up money for non-financial activity. It frees up money for productive activity. That's the reason growth is good after debt-per-dollar goes down for a while.

When the economy grows, the debt-per-dollar line goes up. That's because we use a lot of credit and we don't pay it off very fast. If we paid it off fast enough, we could use a lot of credit, and the resulting debt might never accumulate. That would be good.

But it would be better to not use a lot of credit, in order to keep financial costs to a minimum. The optimum level, we'll have to work out. For now, we just need to be heading in the right direction: the direction of less credit use.

When the line goes down, financial costs go down. When the line goes up, the economy grows. We want both of those things, so eventually we want the line to go flat.

When the line goes flat at a high level, growth is not good because financial costs interfere. But when the line goes flat at a low level, growth can be very good for a long time, as long as we keep the line flat.

What I'd like to see is, I'd like to see the debt-per-dollar line trend down and flatten out asymptotically, gradually. When we get the line low, financial costs are low, so economic growth can be very good.

When we keep the line low and flat, debt is contained, financial costs are contained, financial costs do not hinder economic growth, and the door is open at last for very good economic growth. For a very long time.


Luke Smith said...

The pivot point, in the first graph, occurs after WWII near the start of the baby-boom. Kids ain't cheap - they don't work, they eat your food, whine, beg and generally cost a lot of money to keep for about 20 years.

I think this is why the Debt:GDP ratio took off in the 1980s when the baby-boomers came of working age. Later debt cycles may have involved the boomers sending their kids off to college, retirement and 'empty-nest' spending (i.e. remodeling the house, down-sizing, up-sizing).

Certainly no fate involved, but just how in control are we, and, how aware are we of our actions?

I think the 1990 peak in your second graph may have been the normal reaction to a debt spending spree; much like the one we are now experiencing.

The Arthurian said...

Luke, I think the "debt spending spree" was driven by policy. Even today, Bernanke is trying to get banks to lend more and people to borrow more. Because he thinks it will be good for growth. His is an incomplete thought that fails to consider the effects of accumulated debt.

Same with Felix Salmon in my recent post. The mindset drives everything, and the mindset is wrong.

The Arthurian said...

Oh yeah... You said: I think this is why the Debt:GDP ratio took off in the 1980s...

Nah. The Debt:GDP ratio took off in the 1980s because inflation relented.

The growth of debt 1965-1980 was nearly as rapid as the growth of debt 2000-2008. But inflation increased the whole of the GDP denominator, while increasing only the additions to the accumulating total debt numerator.

Without the inflation, there is no "take-off" of debt after 1980. Without the inflation, the growth of debt is relentless. Everyone overlooks this; everyone is wrong.

Luke Smith said...


I've been looking at some new stats that FRED recently added. In my most recent post, I made a simply analogy between the US and Japan. The demographics aren't entirely the same, but I feel that the worker:retired ratio has always been a strong arguement to say that personal consumption must increase at a faster rate than production.

This phenomena may be revealed through the downfall in the Nikkei 225 and the decline in the inflation adjusted S&P 500.

The boomers, when they retire, will draw down pension reserves funded almost entirely through American stock markets and American government debt. Therefore, the stock market will rely on a body of workers that is growing at a rate that is slower than the retired.

Naturally, these workers will also not be able to sustain large increases in government debt; this should drive down interest rates. Overall, in the next 10-20 years, boomers may see their pension reserves decline in value based soley on this demographic shift.

I agree in many ways that Bernanke's desire to see another housing boom is odd. We are having enough trouble paying-off our debts from the most recent bubble. However, certainly, the worst part about deflating incomes and prices is that it means debt payments as a percent of income will increase - even with no new debt accumulation.

Sorry for the long post; lots of residual caffeine from earlier in the day.