Wednesday, February 20, 2013

"roughly offsetting movements" and economic growth

It is 4:56 AM as I write this.

I love the mornings. I wake with a clear head and often with a fresh understanding of something that puzzled me the day before. I turn the computer on, and I write. Even the dogs are still asleep.

...and I've been up for three hours now.

From Fisher Dynamics, page 3, in a discussion of "the overall trends in leverage in the economy", Mason and Jayadev write:

And sixth, while in some periods the private and public balances show roughly offsetting movements (1950-1980, 2008-2010), in others they move roughly together. In the 1980s and 2000s, there are are significant increases in all three sectors' leverage.

The three sectors represented are Federal government, Households, and Nonfinancial Businesses.

Figure 1 from the Fisher Dynamics PDF
The "roughly offsetting movements" are the 1950-1980 decline of Federal debt (relative to GDP), offset by an increase of household and business debt; and the 2008-2010 increase of Federal debt, offset by a decline of household and business debt. (The word "offset" here implies only "movement in the opposite direction".)

The "move roughly together" comes after 1980, when all three sectors show increase.

The good economic growth of the 1950s and '60s was fostered by the growth of private debt, because we live in a world where we use credit for growth. In the early 1960s, private debt was still relatively low, and not much of a burden.

By 1970 debt had accumulated enough that the cost of debt service was hindering economic growth. Fed Chief Arthur Burns astutely recognized "cost-push" pressures at work, but attributed those pressures to labor when the source was financial cost. To alleviate cost pressures the Fed allowed prices to rise, creating the Great Inflation.

Despite the inflation -- or, because of it, really -- economic growth was good in the 1970s. But times change, and inflation became unacceptable. In the 1980s, accommodation by the Federal Reserve went out the window. In its place we saw increased Federal spending and bigger deficits. The good economic growth of the 1980s was fostered by rapid increase of the Federal debt.

Either way -- by monetary accommodation or fiscal -- money growth kept the private sector afloat, postponing a day of reckoning that finally arrived in 2008.

Because we use credit for growth, the key to a good economy lies in maintaining the affordability of debt. When debt was relatively low it was affordable. When inflation was high, erosion kept a growing debt relatively low and affordable. And, when Federal debt growth was rapid, that debt provided the funds to make a growing private debt affordable via sectoral balances.

Today debt is high, inflation is low, and Federal debt growth is seen as a problem. No method remains to make private debt affordable. And the economy cannot grow.

The quick, easy solution is to reduce debt by forgiveness, and prevent accumulation of debt by the design of policy.

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