From Ivo Mosley's Bank Robbery: Economists and the Banking System (from Medieval times to Adam Smith) at PositiveMoney:
Petty recognised that banking increased the money supply and he recommended it for that reason ...
Petty’s recommendation of banks included no assessment of how the new money, its creation and allocation, might advantage some and disadvantage others. His preoccupation was: will the new money be put to productive use? (if so, good); or will it be frittered away in idle consumption? (if so, bad). This way of thinking has come to dominate economic thinking.
The notion of "good" debt versus "bad" debt has come to dominate economic thinking, Mosley says, and that's not a good thing.
I agree. Mostly, it is the excessiveness of debt that makes debt bad.
6 comments:
The failure to see why some debt is toxic while other debt is not toxic is purely a failure to understand the nature of debt.
A debt is a contract to pay from future income. It is an agreement to give up future income to get in return something in the present.
It doesn't much matter whether the borrowed money was used for a productive enterprise or for consumption. Anyone who makes that distinction also doesn't know what they are talking about. The
effect is the same whether the car buyer gets a loan from a bank to buy a car or whether the car manufacturer gets a loan from the bank and extends credit to the car buyer. To claim that the bank made a good loan in one of those cases and and a bad loan in the other is nonsense.
The question of whether the debt is toxic centers on the nature of the future income that will be used to pay the debt. When the future income comes from productive work and further the loan itself helps enable that productive work then the synergy should be obvious to anyone.
Debt becomes toxic when the future income to pay the debt comes from financial asset appreciation. And further, debt is doubly toxic when the borrowed money is used to finance the very same financial asset appreciation.
So in the US in the 1920's when huge amounts were borrowed to fund purchases on the stock market and the only income to pay the loans was
the realization of gains from rising stock price it should be obvious why this type of debt arrangement is toxic.
Likewise during the US housing bubble - private investors financed $6 trillion in US mortgages where the vast majority of those mortgages could only be paid out of income from rising house prices.
The fundamental problem with being blind to the rxistence of toxic debt is that any policy that flows from the belief that all debt is bad will almost certainly tend to favor toxic debt over all other debt and thus is sure to make the situation worse instead of better.
Well said!
JzB
Jim, we are not so far apart. I have said before that you seem to look at the crisis economy, and I look at the long period before the crisis. You look at the crisis, and I look at the evolution toward the crisis. You see it as an event; I see it as a process. I think this same distinction still applies.
You wrote: The question of whether the debt is toxic centers on the nature of the future income that will be used to pay the debt. When the future income comes from productive work and further the loan itself helps enable that productive work then the synergy should be obvious to anyone.
Debt becomes toxic when the future income to pay the debt comes from financial asset appreciation.
So... that sounds to me very much like William Petty: His preoccupation was: will the new money be put to productive use? (if so, good); or will it be frittered away in idle consumption? (if so, bad). Except you have finance in place of consumption, But you and Sir William Petty both demand that debt be used for productive purposes.
If I can make money from "financial asset appreciation" then surely that is productive ... for me. So you have a higher or a broader standard. You want something that is productive for the economy as a whole. Would we measure that in terms of GDP, then? But finance is included in GDP!
Incorrectly included? No.
But there is too much finance in GDP, some have argued -- and I have agreed.
As I see it, debt has a cost no matter what use it is put to. As the accumulation of debt grows, so grows the cost. You seem to be arguing that financial asset appreciation is wrong in principle, like slavery. I don't think moral principles apply to the economy. Economic forces apply. Forces like cost.
// (continued)
Here's the thing. After World War Two, the U.S. economy started out with little [private sector] debt, but a willingness to expand that debt. Therefore, the economy grew with vigor.
Time went by, and finance expanded faster than the economy. Why? Many reasons: human nature, tax deductible interest expenses, the idea that private debt doesn't matter.
As finance grew, faster than the economy, the income from finance also grew -- faster than the income from productive activity. This made finance even more appealing and it kept finance expanding more rapidly than the economy.
The trouble with finance (as we both know, Jim) is that the income to finance is a cost to the rest of the economy. A rapidly growing financial sector creates two trends:
1. Greater desire to move money into finance; and
2. Higher costs (and less profit) in the productive sector.
Together, these trends induce people to move money out of the productive sector and into finance. Productivity is hobbled thereby, and finance fostered. This reinforces the two trends, inducing further growth of finance and greater difficulties in the productive sector. A positive (self-reinforcing) feedback loop arises: Finance grows at the expense of productivity until production can no longer carry the load created by finance.
And then we have a financial crisis.
///
I agree with you that debt devoted to financial asset appreciation is more problematic than debt devoted to, say, the purchase of productive equipment. But if finance can be contained at a low and stable share of GDP, the economy can function forever.
Here is your conclusion:
The fundamental problem with being blind to the existence of toxic debt is that any policy that flows from the belief that all debt is bad will almost certainly tend to favor toxic debt over all other debt and thus is sure to make the situation worse instead of better.
I think you are saying that my view is "blind to the existence of toxic debt" (where "toxic debt" is when "the future income to pay the debt comes from financial asset appreciation"). I think your definition of "toxic debt" is a little too limited. You are only considering the last stages of the evolution of finance. You refer to "the US in the 1920's" and to "the US housing bubble" -- the last stage of the evolution before crisis, both times.
"His preoccupation was: will the new money be put to productive use? (if so, good); or will it be frittered away in idle consumption? (if so, bad)."
I thought I made it pretty clear that that opinion comes from someone who doesn't know what they are talking about. Its a clear indication that the person who holds that opinion does not understand debt. The issue in regard to whether debt arrangements are sustainable is where is the money going to come from to pay the debt.
And don't tell me I don't take a long view. Your claim that asset appreciation is productive is the epitome of the short myopic view. Like any Ponzi scheme in the short run it may appear to be productive.
Ponzi schemes work for a while because people for a while fail to see why they don't work. Counting on asset appreciation as a source of future income can work for a while, but you can also be certain that at some point in time the realization of why it can't be sustained will reach a critical mass and then it will work in reverse.
The trouble with finance (as we both know, Jim) is that the income to finance is a cost to the rest of the economy. A rapidly growing financial sector creates two trends:
1. Greater desire to move money into finance; and
2. Higher costs (and less profit) in the productive sector.
Together, these trends induce people to move money out of the productive sector and into finance. Productivity is hobbled thereby, and finance fostered. This reinforces the two trends, inducing further growth of finance and greater difficulties in the productive sector. A positive (self-reinforcing) feedback loop arises: Finance grows at the expense of productivity until production can no longer carry the load created by finance.
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