Thursday, February 28, 2013

Explaining the growth of private-sector debt

Originally posted 19 April 2011

I've done several posts lately on the same theme and largely all showing the same graph of public and private debt.

I've tried to suggest that private debt is the big debt, and that the big debt is the big problem.

Before I get too far off that topic I want to restate my thinking on the reason private debt grew so large.

Debt is not the result of spending, nor of excessive spending. Debt is the result of credit-use, plain and simple.

All of our economic policies encourage the use of credit, because we think we need credit for growth. None of our policies encourage the repayment of debt.

So we accumulate debt, and we just let debt accumulate. It's policy.

Meanwhile, on the other hand, and at the same time we think that printing money causes inflation. So (despite what you've heard from everybody else on the planet) our economic policy has reduced the quantity of money relative to GDP.

So we have less spending-money, and we use more credit. That is my explanation of the growth of debt. Simple, right?

It's all policy. We think we need to use more credit for growth (no matter how much debt we have). And we think printing money causes inflation (and using credit doesn't). It's all just bad policy.

And apparently almost nobody realizes that the cost of all that debt is the cost that drives prices up and living standards down, and hinders economic growth besides.


Luke Smith said...

I think Americans do have more spending money, and it is a matter of policy: foreign policy. Domestic jobs sent off-shore is labor arbitrage: finding the lowest cost. The owner of capital receives higher profit margins, the owner of land receives greater appraisal values, and the consumer receives lower prices.

I think once the household budget is reduced by a sufficient supply of cheap imports, such as fuel efficient automobiles and textiles, there is a wealth effect which takes place. Households draw down their savings which lowers the personal saving rate, and it lowers the interest paid on saving.

That is another way of saying the cost of borrowing goes down. In that case, credit becomes more readily available. This cycle helps to fuel higher consumption rates, higher unemployment and a more negative net exports.

Whether this is sustainable, I do not know. Whether it is bad or good, all I can say is, that the trade-off for higher consumption rates is greater unemployment.

However, I can see how it is counter intuitive to say: consume less for greater employment. But because there really is no net loss of employment (because jobs went offshore) what must be tolerated is greater household budgets. In the wake of so much debt, I cannot say if that is good for the US.

The Arthurian said...

Luke, I would like to chew this over with you. In your remarks here I see some of the same thoughts I see in the post on your blog. Sometimes I don't follow your logic, so let me take this opportunity to pursue that.

I don't know about "arbitrage" -- I'm a rank amateur and I do best by avoiding such technical terms -- but I certainly agree that jobs are attracted to lower-cost labor with the three results you specify.

Nevertheless I have trouble with your opening sentence. I measure the quantity of spending money relative to output (like Friedman, except he used "real" output). Spending money circulates, so that is M1 or M1SL or M1ADJ at FRED.

FRED doesn't go back far enough in time, but "circulating money relative to GDP" declined from 1947 to Reagan, and tried to decline thereafter. Therefore I am forced to conclude that Americans have LESS spending money (relative to the things we produce).

I admit that if prices go down (because of cheap imports or whatever the reason) then people will have more money relative to the things we buy...

Six percent is way too much of a trade imbalance, but I'm not convinced it's enough that we can say people have MORE money, when M1/GDP is (or, was) down down down for decades. (Obviously it's different since 2008, but that is a different story. That increase of the money is an attempt to repair the damage done by the long-term decline of the quantity of circulating money.)


The Arthurian said...

I think the question whether Americans have "more" spending money can be answered by looking at a graph.

The blue line shows M1SL. The red line shows M1ADJ which includes "sweeps" but doesn't go back as far in time.

The graph divides my "m1/gdp" by the CPI. If falling prices meant relatively more money in people's hands, the trend line should go up.

It doesn't go up.

There is a tenfold decline before 1980, followed by a much slower but continuing decline until the crisis.

I have not thought a lot about this graph. It could be way off base. But I am just comparing the M1/GDP ratio to the price level by division.

ps... M1, because as FRED says, "M1 includes funds that are readily accessible for spending."

Luke Smith said...

Personal savings has been down 80% against MZM since since the early-1980s; PMSAVE/MZM is currently 5%. Extra spending money comes from the personal savings. So when money is withdrawn from savings at a rate that exceeds the ability to make future payments from savings then interest rates should come down. I see like taking a loan out against ones' self.