Wednesday, September 25, 2013

"I'm going to talk about an economic cycle without defining or identifying it."

Graph #1: Accumulated Debt relative to the Quantity of Base Money
The Google Drive Spreadsheet.


The Arthurian said...

There are two ways to reduce the ratio of debt to base money. One way is to reduce debt. That's the right way.

The other way is to increase base money. (Think: excess reserves.) That's the Bernanke way.

geerussell said...

Why is reducing the ratio of debt to base money desirable? Or to put the question another way, what's the idea being expressed with that ratio? Leverage?

The Arthurian said...

I'm no economist, geerussell, so maybe I can't explain this in a way that lives up to your expectations. I just know a little about the economy, and I've been looking at graphs like this one for a very long time. So...

Reducing the ratio of debt to base money is desirable because the ratio is high.

Too simple for ya? Try this:

Debt is the measure of money that we have borrowed and spend into the economy. Every dollar of debt represents a dollar we put into circulation, after borrowing it. And all these dollars have a cost attached, the cost of interest, and this is the cost we think of when we think of debt.

It is more useful to think of that cost as the cost of money we put into circulation, rather than as the cost of debt. It is useful because we can compare the cost of this money to the cost of base money.

Again, I'm no economist and I don't rightly know, but I think the cost of base money is zero. At any rate, the cost-per-dollar of base money is much less than the cost-per-dollar of the money we measure as debt.

So the graph allows us to think about two costs: the cost of money created as debt, and the cost of base money.

For argument's sake lets say the cost of base money is half the cost of the creditmoney recorded as debt. So if there are $2 of base per dollar of debt, then the two costs are equal.

If there is $5 of debt per dollar of base, then debt costs 10 times what base money costs.

If there is $50 of debt per dollar of base, then debt costs 100 times what base money costs.

And that's if a dollar of base costs half what creditmoney costs. I think base costs much less than half.

Why do I think that? Because I see how the economy responds when the debt-to-base ratio is high.

The cost of money is a cost that competes with wages and profits. When the ratio is high, the cost of money is high. Therefore, when the ratio is high, wages suffer. (Profits suffer, too, if you strip out financial profits.)

When the debt/base ratio is low, the cost of money is relatively low. Wages (and profits) are relatively high. The economy does well.

Notice on the graph, the first great peak (1930) corresponds to the Great Depression. The third great peak (2008) corresponds to the mess we've been in for five years now. And the second great peak (1990) corresponds to changes in policy that caused a slowdown in the growth of debt, and which led to the "macroeconomic miracle" that started mid-1990s.

I need to come up for air now.

geerussell said...

No, expectations to live up to. Just to be clear, I intended my question as friendly with no suggestion of shortcoming on your part, rather confusion on my part about what your first comment meant. I didn't understand what information is contained in "base money" that might make it useful in a ratio with debt to tell a story about debt burden. Confusion which you generously cleared up with your explanation about cost of debt.

Because of my inclination to view debt burden in terms of net financial position (the ratio of debt to equity) from a balance sheet perspective, I had a hard time figuring it out because base money doesn't really map to equity for any entity.

The Arthurian said...

Oh wow, I didn't mean that opening like it sounds! Sorry bout that. Geerussell, I still remember our first exchange on Reddit, all very polite and mature. No, sorry about that opening.

By "expectations" I was referring to what you call your "inclination to view debt burden in terms of net financial position".

I just look at the economy in terms of cost. People have reasons for doing the economic activity they do, but cost interferes. So cost (for me) is the crux of it all.

(Plus, I have a mental block about balance sheets.)

Again, my apologies.

Greg said...

Hey Art

I know I send you you to other places frequently but I found this online Money and Banking course you can watch for free. Its taught by an econ profesor form Barnard named Perry Mehrling and I think you would really like it. He starts form square one and builds to our current shadow banking system and the crisis it caused.

I think you wont be able to stop watching it