Friday, March 11, 2016

Repeating the key point, since I buried it yesterday

Noah identifies his biggest problem with the Folk Theory of business cycles:

The story the Folk Theory tells is that you can't have good economic times without increasing debt, and that increasing debt always causes a bust. So good times come at a price - you can't have prosperity today without disaster tomorrow.

My response:

You have to understand that the problem with debt is cost. There is a benefit from using debt, but there is also a cost. If we increase our use of debt for 75 years, and increase it enough to offset the cost of the debt we're accumulating all the while, at some point the shit is gonna hit the fan.

The shit doesn't have to hit the fan. But you have to understand that it will, unless we do something to prevent it.

It will, unless we do something to prevent it.

We have all sorts of policies that encourage people to use credit, because using credit is good for economic growth. Because of policy, our use of credit is unnaturally high.

We have all sorts of policies that encourage people to use credit. But we have no policy that encourages people to pay down debt.

Because of policy, we borrow money faster than we pay it back. This is how debt got so big. But it doesn't have to be like this.

We could set up policies to encourage people to pay off debt a little faster. We could counterbalance policy-driven borrowing with policy-driven debt repayment.

We could. It would be easy to do. But we will never create these policies until people come to believe they are necessary. And that may never happen, because people like Noah insist that debt might not be a problem.

Toynbee was right. Civilizations die by suicide.


The Arthurian said...

For the record, these new policies that serve to accelerate the repayment of debt, these policies can serve as our new way to fight inflation.

Notice, this is symmetrical. The way things are now, we encourage credit use, and then we decide to jack up interest rates. In the Arthurian future, we encourage credit use and encourage repayment of debt, both, always. Incentives to repay counteract the incentives to borrow. The way it is now is not symmetrical: We get everybody deep in debt, and then we jack up interest rates. That is fool's policy.

We can still use interest rates to fine-tune things. But if we find interest rates tending to be unusually high or unusually low, it will mean we need to adjust the "balance" between our incentives to borrow and our incentives to repay.

My intuition says we have used incentives to borrow for a very long time, and we always strengthened those incentives instead of counterbalancing them with incentives to repay. So we probably need to cut back on some of the incentives to borrow, *and* create some incentives to repay.

The Arthurian said...

Again, when you have incentives to borrow and no incentives to repay, you end up with a lot of debt.

And when you have a lot of debt, you end up with financial crisis.

Greg said...

One of the things that skews the incentives I think is how banks collect and distribute payments. All amortized loans work by paying the interest first and principle later. They get their skin early.

Maybe if they couldn't take all their profits up front so to speak, if they had to get their profits all along the way, they might be more interested in making sure that borrowers could continue to make payments. As is , if someone stops paying mortgage after two years say, banks have made a lot of the profit already and so long as house prices haven't dropped more than 10% in 2 years (which is a rare event) they make out like bandits. They get the monetary profits plus the real asset back for resale. The entire game is set up so banks always win big, which means non banks (us) lose big. We lose financially and we lose the real assets in the end.

Credit cards are even worse but they are a smaller share of the total credit markets. Real estate is overwhelmingly the largest channel by which lending practices do their magic. As Mike Sankowski says (paraphrasing) monetary policy IS real estate lending policy. That is the channel by which it works. And it relies on ever rising prices of real estate to be attractive to buyers.