I admit it: I check my Blogger stats often. Too often. It borders on neurosis.
Sometimes I will look at the list of recently-visited posts, and click one to see what people have been reading. Did that just now. The post was from May, 2011. Fourteen comments, some good ones. The first comment on the post was from Liminal Hack. Liminal asked me:
Going back to basics, if you think there is too much debt and too little money how would you propose to change that? Add more base money? Raise rates? Increase capital requirements?
I've not seen him for a while, but Liminal always struck me as a sharp guy. Me, I don't know anything but my graphs. Liminal Hack knew lots of events and facts and details. He was interesting. So I don't mean to be critical. But I do want to answer his question.
If you think there is too much debt and too little money how would you propose to change that? Add more base money?
Well, first of all, the Fed is already doing that. You could see it in the first two graphs of the May, 2011 post.
Second, I didn't say that in that post. I don't say "there is too much debt and too little money" except possibly to emphasize that there is too much debt relative to money. Increasing the quantity of money could help reduce the imbalance, if it was done the right way. Beckworth's "program that gives money directly to households" would be one way to do it.
But if there is too much debt, you don't really need to increase the quantity of money. If there is too much debt, what you really need is to reduce debt. How Liminal could have missed that, I do not know.
I would reduce private sector debt. There is too much debt relative to the quantity of money because there is too much debt, period. The solution is not to increase the Q of M, but to reduce debt.
Raise rates?
Raising rates is a way to reduce additions to debt, by reducing new uses of credit. That slows the economy. But it does nothing to relieve the existing burden of debt.
The economy growing too fast is not the problem. The existing burden of debt is the problem. So, really, raising interest rates is irrelevant. The interest rate is irrelevant. But the interest rate is one of the main things policy makers and policy critics talk about.
The noise of all that talk clutters the mind and makes people forget obvious things. Obviously, existing debt is not dissipated by an increase in interest rates. So if the problem is "too much debt", why bring up the interest rate at all? Because it's what people talk about?
Stop listening.
Increase capital requirements?
I shouldn't say, because I know nothing of this. Capital requirements may be a good way to limit the growth of debt. That could be useful for the future. But what does it do about the existing burden of debt? I think it skirts the issue.
Knowledgeable as he is, Liminal Hack missed something that's obvious to me: We have many policies in place, designed to increase our use of credit. But we have no policy in place that is designed to accelerate the repayment of debt. Policy is the reason there is "too much debt and too little money". Policy is the reason. I propose to change policy.
The purpose of policy is to change the economy. And I have to say, until the Crisis, policy was most successful. For policy demands of us that we increase our reliance on credit, and that we "manage" rather than pay down debt. The suck-ass economy we have today is a monument to that policy.
9 comments:
Art wrote: "We have many policies in place, designed to increase our use of credit. "
It might help if you were to provide some supporting evidence for this claim instead of just expecting your readers to accept it without question.
The govt does promote home ownership because it results in more stable productive communities. But there is zero evidence that those govt policies had anything to do with the disaster that occurred in the US housing markets. It is reasonable to suppose that without those govt policies the mortgage disaster would have been even greater. The mortgage bubble occurred because a huge amount of private investment money flooded into the US mortgage market. A lot of that money came from Europe which is why the Euro economy crashed and burned when US house prices headed down. I don't see what the govt can do to change bad private investor decisions. Do you want the govt to prevent investors from putting money into investments when some bureaucrat deems the price has gone to high or the market too volatile?
For 80 years the federal govt has been helping people become home owners by reducing the cost of financing to credit worthy borrowers. If that were to come to an end, mortgage lending would become a huge cash cow for Wall Street and its clients. As far as I can see those potential profits to the financial sector is the entire basis for the current propaganda campaign that tries to blame govt policy for the current economic mess. In reality govt policy not only did not cause the mess it may well be what prevented the mess from being much larger.
"The mortgage bubble occurred because a huge amount of private investment money flooded into the US mortgage market."
Wait wait wait, I thought it was the loans that created that money.
Art wrote:
"I thought it was the loans that created that money."
What are you claiming is "that money"? As Pozsar's article on shadow banking (thanks Geerrussel) shows there was a lot of money like instruments created (and then destroyed after the collapse). But that monetary activity was outside the realm of govt policy.
Bank loans create new deposit money, but that has little to do with the housing bubble which was created by reckless lending of private lenders like CountryWide and other subprime lenders that were not banks and not subject to the constraints of loans funded by deposit taking institutions.
Residential mortgages are only 20% of total US Debt and less than half of the mortgages have federal govt guarantees. Govt policy accounts for a small portion of total debts and govt policy accounts for even much smaller portion of total defaults and delinquencies.
Why are you thinking in terms of Federal loan guarantees??? There is far more to policy than that.
The the business income tax is a policy. It encourages spending, always.
The 401(k) and Individual Retirement Accounts are examples of a policy that encourages saving, always.
Our pro-spending and pro-saving policies conflict. Saving subtracts from the money available for spending. Saving undermines spending.
We all have our reasons for borrowing money, of course. But from a macroeconomic point of view, and given the policy that encourages saving, in order to satisfy the policy that encourages spending, our hand is forced: We must borrow. And the longer our conflicting policies coexist -- and the more policymakers strengthen those policies -- the more we must borrow.
Thus, the growth of borrowing is a consequence of policy.
And then we have the policy called "monetary". This policy moves interest rates up and down. When rates are down it only costs a little extra to replace the spending-money that has been lost to savings. When rates are up it costs more to replace that money. Either way, financial costs in the economy are higher because of our pro-spending, pro-saving, and monetary policies.
We have two policies that conflict, which drives down the quantity of money available for spending and encourages the use of credit. And we have one policy that decides how much it should cost to replace the money that was lost to savings.
These are the policies that concern me.
This statement sounds very unconvincing to me:
"But from a macroeconomic point of view, and given the policy that encourages saving, in order to satisfy the policy that encourages spending, our hand is forced: We must borrow."
First of all the policy that you claim promotes spending you said is directed at businesses while policies that promote saving are directed at households. Saving is promoted because it is viewed as more worthy to spend after you've saved than to borrow before hand to spend. When borrowing is up and saving is down interest rates go up and when borrowing goes down and saving up interest rates go down. That seems to me to be what the laws of supply and demand would predict.
It seems to me that you are confusing Madison Ave advertizing with govt policy. The modern human is certainly bombarded constantly with promotions to borrow but the promotions aren't coming from govt policy.
I think the last dozen or so years have demonstrated that interest rates does little to affect how much borrowing or saving occurs. In fact it is pretty obvious to me that interest rates are a direct consequence of how much borrowing and saving occurs and not the other way around.
The housing bubble was driven by loan contracts that had super high interest rates. That is what a sub-prime loan is - a loan with extremely high interest rates and fees. The private investors that funded the bubble fooled themselves into believing that if you charged high enough interest and fees you could make profitable loans to anyone with a pulse.
To be clear, I'm not defending the policies that you name. I just don't see them as forcing people to borrow. They may well be flawed policy.
I would also like to hear what policy would encourage repayment of debt. It seems to me the only policy that would do that effectively is to treat borrowed money as income for tax purposes and treat repayment on principal as deductions from income.
Is that how you see it?
"It seems to me the only policy that would do that effectively is to treat borrowed money as income for tax purposes and treat repayment on principal as deductions from income."
Ooh, that would work! I was thinking of tax credits for making extra payments on debt. Deducting repayment of principal is definitely aiming for the same goal.
Plus eliminate the tax deduction for interest payment from the business tax form (and, later, from the individual tax form). I'd rather to this than create new rules ("treat borrowed money as income for tax purposes") that are at cross-purposes.
This comment is in response to the top two comments where Art talks about credit use policies which increase the debt to dollar ratio and jim talked about private investment money flooding into our mortgage market.
Art and jim seemed to think that these were mutually exclusive things and that acknowledging one meant the other was less important. Ill suggest that both were operative during our crisis..... and likely continue.
The credit (debt) growth occurred at the level of mortgage originations and were certainly encouraged by govt and CB interest rate policies but the private investment money, much from outside the US, came in as the mortgages became packaged and securitized and sold as a "thing" rather than held on the originating banks balance sheet.
It seems to me it was the transformation of run of the mill mortgages, simple debt contracts, into these fancy slick "investment vehicles" that was the problem.
So I think both of you are right about the creation of the crisis.
jim
I was not clear. What I meant by ..." both were operative during our crisis..... and likely continue"
is that the creation of debt via private banking is obviously going to continue (the growth of which depends on incomes and risk appetites of borrowers) AND that outside investors will always attempt to be satisfied by banks/Wall St.
I agree that private label MBS are kaput for now and that it may be a while for them to return, but Wall St will still try and find ways to take bank created debt contracts and turn them into something for people to buy. So, to use Arts language, our debt to dollar will continue to rise if banks and Wall St get their way AND this will create opportunities to create new CDOs for the world to purchase.
Let me be clear, I am in no way trying to add any backing for the claims of people who want to blame "govt policy" for our crisis, other than the fact that its always been a govt policy to try and allow people to own homes. I am 100% in agreement with you that the story you tell of the crisis is true. I don't think Art is trying to blame govt in the way that you might think either.
"I don't think Art is trying to blame govt in the way that you might think either."
Thanks Greg!
Jim, policy is not only what the government itself does, but also (and more) policy is the behavior that government encourages and/or fails to discourage in its citizens.
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