Tuesday, September 24, 2013

The Economist: Wrong and wronger (2)

(continuing yesterday's critique)

Regarding the second topic, the purchase of existing assets: Sure, if we spend new money to buy old things, debt will increase faster than GDP. Okay, I'm not disputing the obvious. I'm disputing the significance of it.

I'm not going to call it buying existing assets. I'm going to call it the speculative use of debt. (It would be more accurate to call it the speculative use of credit, but people would mostly fail to understand.)

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

I think the speculative use of debt in general happens late in the economic cycle. I see this as a result: a changed behavior arising in response to conditions that are created by the increasing reliance on debt that happens in the earlier part of the cycle.

People get more and more into buying existing assets, after the debt problem arises and before most people even see there is a debt problem.

I think people see the rise of debt being used for speculation, and recognize it as a problem, but fail to dig into it and fail to realize that the debt problem started much earlier and that speculation developed in response to that problem.

Thus, while debt-for-speculation is a significant problem, it is a resultant; to focus on it is to assign it too much significance, in the larger picture of causalities.


jim said...

Hi Art

Loans create money and its important to remember that extinguishing debt destroys money. This is just double entry accounting.

If I borrow $200k and buy a new house that creates $200k credit money. If I then sell the house for $200k and repay the loan that destroys the credit money. If the buyer of the (now) used house borrows $200k then no new credit is created just as no new assets are created. The debt just moved from me and my bank to the buyer and their bank.

The Arthurian said...

I understand it is possible to stabilize the quantity of debt, relative to something. In fact, that is what I want policy to do.

But surely you are not saying that the quantity of debt *IS* stable. Surely you are no saying that running debt up for 60 years, and then suddenly reversing course, is the same as stability.

jim said...

Hi Art,

The point I was making is that borrowing to buy existing assets does not necessarily increase total debt or debt to GDP ratios.
What I was trying to do was explain how the accounting works. I wasn't commenting (in that particular post) on the question of stability. But since you brought stability up...

If house prices (and the prices of other collateral assets) remained constant then the ratio of debt to GDP would be less likely to rise. Take the example I gave. Suppose this time I buy the new house for $200K and sell it for $250k. Let's say the buyer has to borrow $250k. That increases the quantity of debt by $50k (and the quantity of money) but does not increase GDP. The point of my original example was that borrowing to buy an existing house does not in itself increase debt levels. What increases debt is borrowing to buy an existing collateralized asset for more than is already owed.

Take another example. Suppose I buy the 200k new house and then lose my job and default, the bank can only get $150k in a foreclosure sale. That means someone borrows $150k and the bank eats the $50k remaining on my loan. In that case the quantity of total debt (and money) decreases by $50k. Falling prices of existing stock tends to make the process reverse course just as rising prices tends to drive debt and the money supply higher.