Wednesday, July 10, 2013

The Marginal Productivity of Antal E. Fekete


So I googled debt productiv and one of the options was marginal productivity of debt -- comparing increases in GDP to increases in total debt. Exactly what I was looking for. The first result for that was Antal E. Fekete - The marginal productivity of debt... | Facebook. Fekete's got this graph:

Graph #1. Source: Antal E. Fekete
One nice thing. Antal Fekete shows his calculation:

Marginal Productivity of debt = (Change in nominal GDP)/(Change in nominal debt)

Unfortunately, he doesn't identify his data. I tried to duplicate his graph using FRED's TCMDO debt, but it didn't seem to match up. So I'll just go with Fekete's graph.

He writes:

The marginal productivity of debt measures the change in (dollar) economic output for a dollar change in the aggregate debt outstanding... What has been happening to this measure over the decades?

Nominal debt outstanding has, of course, been accelerating rapidly and since 2008, the government’s share of that has been soaring. Allowing for the short term variation – it can be seen that the trend in marginal productivity of debt has been most definitely down. Once the zero bound is reached, any incremental increase in aggregate debt will have a detrimental impact on the economy.

Agreed. Of course, implicit in that last sentence there is the idea that rising total debt caused the downtrend in GDP growth. Oh, I think that's true, certainly. But people who make policy don't seem to agree. And people who vote are iffy.

On second thought, I don't agree that once the zero level is reached, any incremental increase in aggregate debt will have a detrimental impact on the economy. I think debt already had a detrimental impact on the economy, since the 1980s when it slowed our GDP growth trend... in the 1970s, when monetary policy had to fight inflation... and in the 1960s, when financial cost gave the initial push to the cost-push inflation.

Would you wait until adding to total debt decreases GDP to say there is a harmful effect? Or would you say what I say: If adding to total debt produces a smaller increase in GDP than it formerly did, then harm has already been done.


We come now to Fekete's analysis of his graph:

It can be seen that the ratio was around 1½ during the mid-1970s – meaning that for each dollar in marginal debt, $1.50’s worth of GDP growth occurred. This ratio was as high as 3 in the 1950s. Deterioration in the ratio could be argued as deterioration in the quality of the debt. What would cause the quality of debt to decrease substantially? The removal of the ultimate extinguisher of debt: gold. Gold prevented & cleared the build-up of toxic unproductive debt.

I can almost see the 1½ he's talking about. (I'm glad Fekete uses the Alt-0189 version of one-half.) And I can believe that the ratio was higher in the 1950s. But it is odd he doesn't show the 1950s on his graph, as the decade adds so much to his argument.

His numbers -- as much as $3 in GDP growth for each dollar of unidentified debt growth -- don't ring a bell with me. I'm sure I looked at this before and I don't remember anything like $3 per. Maybe I had it wrong. But it sure would help if Fekete said what debt he was using, and linked to a data source. He doesn't.

I can live with that. That's not what drives me to write this post. It's the next thing he says that gets me. Fekete writes: "Deterioration in the ratio could be argued as deterioration in the quality of the debt." What is that -- moral philosophy? It is surely not economics.

When debt is going bad, it is because people are not making the payments. That's what causes deterioration in the quality of debt. When it happens, lenders are liable to stop lending, or set higher standards. You know, to keep the deadbeats out. And when the economy goes bad they think we're all deadbeats.

Is that what Fekete means? Clearly not. "What would cause the quality of debt to decrease substantially?" he asks. "The removal of the ultimate extinguisher of debt: gold."

Fekete says debt productivity is down because we pay off debt with money that isn't gold. The only way this can make sense is if you assume from the start that money has to be gold and if it isn't, then every problem we have is a result of not using gold for money. But that's really not an analysis of the problem.

Nor does Fekete's view explain the problems that arose in the past, that forced us off gold.

If we no longer use gold for money, one could possibly argue that the quality of money has deteriorated, the intrinsic value, say. But that has nothing to do with debt. Fekete takes advantage of people's confusion about money and debt to make his argument.

And there could be some vague connection between "what money is made of" and "how happy people are to get their money back" from borrowers. But really, if you lend paper you can't honestly expect to be repaid in gold.

Furthermore, there is no connection between "what money is made of" and "how productive the things are that are done with money". To assume that there is, is to say something like If money was gold I would invent a new technology for getting to Mars, but money is paper so I'm gonna just get drunk instead.

That's not "rational" behavior.

Fekete's analysis is terribly disappointing. But now, look at the timing. What caused the ratio to decline? Going off gold, he says. Going off gold in the 1970s. (President Richard M. Nixon "closed the gold window" on August 15, 1971.)

We can't see it on Fekete's graph, but he suggests that the marginal productivity of debt fell from $3 in the 1950s to less than $1.50 by 1975. Does he want us to think that all of this decline happened after 15 August 1971? I don't buy it. But even if that were the case, the decline could be due entirely to the very same cause that led to the closing of the gold window. Fekete does not discuss this.

Meanwhile, I don't see how any of this has any bearing on the things people do with the money they borrow, or how productive those things are.


I made a copy of Fekete's graph and eyeballed-in some trend lines:

Graph #2: Same as Graph #1 with Trend Lines Eyeballed In
I see a down-trend from 1975 to 1986, and a downtrend from 2000 to the crisis. And a downtrend overall, sure. But there is a stretch there, from 1986 to 2000, when the marginal productivity of debt increased with persistence and regularity. How is this possible? Did we go back on gold?

We did not.

Obviously it wasn't going off gold that caused the long-term decline.


Now, my version of the 1986-2000 phenomenon...

A decline in debt growth begins in 1986:

Graph #3: Beginning in 1986 there was a strikingly unusual fall in
the growth of total debt that lasted into the early 1990s.

An increase in money growth soon follows:

Graph #4: Before that decline of debt growth had ended, an increase in the growth of
circulating money was under way. This increase lasted to the mid-1990s.

These patterns shift the "debt per dollar" ratio, 1990-94:

Graph #5: The declining debt growth, combined with the rising money growth, meant for people who use money that we were relying less on money with the extra cost of interest, and relying more on money without that extra cost. We were able to save money on our money. That's got to be good for the economy!

In response, best-case GDP improves almost immediately:

Graph #6: Potential GDP shows a full percentage point improvement between 1993 and 2000,
in response to the reduced ratio of accumulated debt to circulating money.

As debt grows in size, the increasing cost of it increasingly hinders both production and consumption. As debt grows in size, therefore, the growth of output falls behind. Thus is the decline in the marginal productivity of debt explained.

The reverse is also true: As debt falls in size relative to circulating money, the cost of debt falls relative to the money we have. This reduces financial cost, boosting wage and profit income in the productive sector. Improved growth follows.

The downward shift of the debt-per-dollar ratio opened the door to improvement in real and potential GDP performance. We can repeat that success. We can do better.

We must do better.

11 comments:

The Arthurian said...

"There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money ... and ... it only exerts a distinct and independent influence of its own when it gets out of order." - John Stuart Mill, quoted by Milton & Rose Friedman in Free to Choose, Chapter 9, p.249.

jim said...

Art wrote:

"The reverse is also true: As debt falls in size relative to circulating money, the cost of debt falls relative to the money we have. This reduces financial cost, boosting wage and profit income in the productive sector. Improved growth follows."

The greatest fall in debt size to M1 is 2008 to the present. Where's the big wage boost and profit income that this is supposed to produce?

-jim

The Arthurian said...

1. I don't make predictions.
2. Something happened in 2008 that had not happened since 1929 or so, certainly not in the early 1990s. We waited too long to fix the problem.
3. The accumulated cost of interest is still extremely high. See Graph #5 from mine of 26 June.
4. Yes, I've been looking at that big drop in the TCMDO/M1ADJ ratio.

jim said...

Hi Art,

The bulge in growth of M1 that you show in your graph #4 seems to me to be due to the fact that in the late 80's banks started to pay interest on checking accounts at the same interest rate as savings accounts. But in order to get that interest one had to keep a minimum of $500 in one's checking account. So lots of people moved money from savings to checking (they kept more money in checking). I can see how that affects your graph. What I'm not getting is how that affects the economy.

The provision in bank regulation that prevented banks from paying interest on checking accounts was considered a major part of the bank reform laws after the banking system collapse in the 30's. Paying interest on transaction accounts was regarded as one of the major causes of the instability of banks leading up to the 1929 crash.

As for the cost of interest: The govt and the financial sector are the biggest payers of interest. Households only hold about 1/4 of the total credit market debt and according to FRED their debt burden has been dropping.

http://research.stlouisfed.org/fred2/graph/?g=ksj

The Arthurian said...

Oh, excellent observation, Jim! And if people had no intention of spending that money, then the bulge in M1 would not be significant.

And yet, if people are getting the same interest rate on checking as on savings, then what is the advantage of moving money from savings to checking? The only advantage that comes to mind is added flexibility: The option is there to spend the money if you want.

So I have to think that the M1 bulge DID affect the economy.

Jim, in this graph there are three spikes in M1 growth, three times that the growth of circulating money rose above the growth of debt: the early 1980s, the latter 1980s, and the early '90s spike we have been looking at here.

I don't claim to be good at ascertaining the causes of such changes on my graphs. But it looks to me like these three spikes were some kind of monetary experiment. And I want to say that paying interest on checking likely did not cause all three.

In fact I have no idea what DID cause them. And I would be happy to read your insights on what the cause might be.

//

The graph is number 9 from mine of 14 July 2011...
And (for the record) the final sequence of four graphs in the post are scheduled to repeat five times over the next few days.

jim said...

Hi Art,

FYI, the rules on interest paid to checking accounts started in the late 70's and evolved during the 80's.

The advantage of moving money from savings to checking (keeping more money in checking) is you get more interest paid.

If you have $1200 in the bank and you
have $200 in checking and $1000 in savings you get interest on $1000. If you have $700 in checking and $500 in saving you get interest on the full $1200.

Depositors decide what type of account they hold their money in.
It looks like depositors in the mid 90's chose to have a greater portion of their money in checking than they did at other times.

http://research.stlouisfed.org/fred2/graph/?g=ktj

I'm not sure of all the reasons but I suspect interest paid is a big part of it.

The Arthurian said...

Jim: "Depositors decide what type of account they hold their money in."

Sure, but as you also point out, depositors seem to respond to policy changes like paying interest on checking accounts. At least sometimes.

My early-1990s uptrend in M1 is pretty well matched by a downtrend in the Non-M1 Components of M2, so you do seem to be right about that.

And yet spending increased enough to support a rising RGDP in the latter 1990s...

jim said...

Yes, money moved from savings to checking as a result of banking policies.

However you haven't shown any evidence that produced a change in the quantity of money used for transactions and the quantity of money saved (in the banking system). In order to get the interest depositors have to maintain a minimum balance of $500. That is $500 of savings that is sitting unused in checking accounts. That shows up in the M1 graph, but I can't think of any reason it would show up in the economy.

Also there is no evidence that growth in spending increased. In fact, if anything growth of nominal spending decreased slightly.
The only reason you get higher real GDP is due to lower inflation.

The Arthurian said...

Jim: "In order to get the interest depositors have to maintain a minimum balance of $500. That is $500 of savings that is sitting unused in checking accounts. That shows up in the M1 graph, but I can't think of any reason it would show up in the economy."

You make a good point. I'm gathering my thoughts.

I have been thinking of the 1990-1993 shift in Debt-per-Dollar as evidence -- as a confirmation of what the debt-per-dollar graph tells me when I look at it for 1916-1970 in the Historical Statistics data along with the follow-up data thru the 1970s and '80s from the Statistical Abstract.

But if that is correct, there must also be evidence that the money was being spent. If it was just sitting in checking accounts, it may as well have been sitting in savings. I agree with you on that, and I think it's a good point. And you have given me a place to look for additional evidence.

I'm thinking about what graphs I want to make.

"Also there is no evidence that growth in spending increased. In fact, if anything growth of nominal spending decreased slightly.
The only reason you get higher real GDP is due to lower inflation. "

I'm thinking of an increase in the NGDP/RGDP ratio as comparable to a slipping clutch. I see the brief down-trend in DPD as a repair job that fixed the slipping clutch. I think we got better performance in the latter 1990s because of it. The NGDP/RGDP clutch slipped less.

To me, the decline of NGDP relative to RGDP that you point out, is not "no evidence". It is most certainly evidence.

I have to go do graphs now...

Anonymous said...

I think you are trying to analyze WHEN debt is OK and what makes it bad, or looking at short-term correlations.

That's not the point.

The point is much simpler: debt makes things look good until you have to repay the debt. In a national or in this case global environment, you can bring a LOT of resources on to the Ponzi scheme that IS the debt buildup used to fake productivity.

There comes a point where more resources are paying back debt, compared to new debt to borrow.

Krugmanites say aggregate debt doesn't matter. I disagree. There are too many people dependent on that debt and calculating it into either their expected survival or future productivity.

The "recovery" can only come when we pay off the debt, by living on less than what we make (as a society) for decades. OR by accepting defaults and a huge deflationary adjustment.

>>> Kim
not necessary to be anonymous but don't feel like dealing with 1 more signin

The Arthurian said...

Hi Kim. I think I agree with everything you said. Except your evaluation of what I'm trying to do. That caught me by surprise, and I have to think about it... You may be right about that, too.

"There comes a point where more resources are paying back debt, compared to new debt to borrow."

Yes, and in the meanwhile, the new borrowings must grow bigger always, just to offset the drag created by paying back existing debt. But as the new borrowings only increase the size of existing debt, the whole process is self-defeating.

"The 'recovery' can only come when we pay off the debt, by living on less than what we make (as a society) for decades. OR by accepting defaults and a huge deflationary adjustment."

I like to think that we need only a small adjustment in policy: Instead of (or in addition to) encouraging borrowing, policy should encourage the repayment of debt. If we could get debt to grow a little slower, and GDP to grow a little faster, the debt problem would eventually go away. And things would be getting better all the while. And yes, it would have been nice to start doing that some decades back, before things got so bad.

That's what the last four graphs in the post are about. For a while, debt did grow a little slower and, to keep that from being a problem, money grew a little faster. So the economy could continue to grow, but the accumulated cost of debt became relatively less, and economic growth improved for a time.

But we lacked policies to encourage debt repayment, and soon debt growth accelerated again.

I see the economy as always in motion. But yes, I am trying to analyze WHEN debt is okay and at what point the accumulation of debt makes debt a problem. Because debt is useful and we cannot abandon it altogether.

But maybe there is a Laffer Curve for debt, so that some level of debt-to-GDP or more likely some level of debt-to-circulating-money gives optimum economic performance. That's where I want the economy to be.