Wednesday, May 3, 2017

Regarding the debt of non-financial business

In Finance is not the Economy, Bezemer and Hudson

distinguish between two sets of dynamics: current production and consumption (GDP), and the Finance, Insurance and Real Estate (FIRE) sector.

On the one hand, production (and consumption); on the other, finance (and insurance and real estate).

Under the heading The Significance of Household Debt they say

In our time, arguably the most significant form that rent extraction has taken is in the household credit markets, especially household mortgages. The contrast is with loans to non-financial business for production.

Loans to non-financial businesses help the economy grow, they suggest; mortgages don't.

Under the heading Conceptual Differentiation of Credit, they are more explicit:

Loans to non-financial business for production expand the economy’s investment and innovation, leading to GDP growth.

In context, to me, they make it sound as if all (or nearly all) loans to non-financial business are for production.

They may not explicitly say that loans to non-financial businesses are almost always for non-financial purposes, but they open the door to that thought. I think the thought is untrue, and it is unfortunate that the door is opened.

The thought is untrue; consider non-financial corporate business.

Consider the financial assets of non-financial corporate business. Thirty percent of GDP in the early 1950s, financial assets rose to 60% of GDP four decades later, to 90% of GDP two decades after that. Today, they are over 100% of GDP:

Graph #1: Financial Assets of Non-Financial Corporations as a Percent of GDP
Not all of the assets of non-financial corporations are for production. Some of those assets are financial assets which produce financial income but generate no output.

If we look at all of the assets of non-financial corporations to see what percentage of those are financial assets, it turns out that the financial share has doubled, from about 25% to about 50% of assets:

Graph #2: Financial Assets as a Percent of All Assets of Non-Financial Corporations
Today, about half the assets of non-financial corporations are financial assets. That is to say, about half the assets of productive corporations are non-productive assets.

Bezemer and Hudson tell us that

Since the 1980s, the economy has been in a long cycle in which ... [s]peculation gains momentum — on credit, so that debts rise almost as rapidly as asset valuations.

Half the assets of non-financial corporations are financial assets. So probably about half the borrowing of non-financial corporations is for the purchase of financial assets. And if debts rise almost as rapidly as asset valuations, then probably half the debt of non-financial corporations is for financial -- non-productive -- purposes

So when they tell us that loans to non-financial business lead to GDP growth I have to say maybe only half those loans lead to increased output. The other half create financial costs that only increase the price of output.

Oh, and if you are wondering why finance has grown so much, the answer is that financial income is a cost to the non-financial sector. Bezemer and Hudson are absolutely right about that. The growth of finance makes the non-financial sector less profitable, driving investors out of productive investment and into finance, further increasing the growth of finance. This "long cycle" continues until the productive sector can no longer support the financial sector and then, oddly, what happens is called a financial crisis.

1 comment:

Oilfield Trash said...


We have substituted debt for income.

I often ask people how you can increase the growth of Real GDP per capita at a faster rate than Real Household Incomes.

You need access to credit markets to grow and sustain the gap.