Credit Efficiency

In a post titled Debt And Transfiguration, Paul Krugman argued against the view that a high level of debt causes problems in the economy. Inadequate growth, he said, makes debt appear excessive. He thinks the people who worry about the debt have cause and consequence reversed.

Then (ha ha) he added: "I’m not denying that high debt can be a problem."

Specifically, Krugman was arguing against the view that "bad things happen when debt goes above 90 percent of GDP." As evidence he said that in both Japan and Europe, debt increased after growth slowed. And in the U.S. he said, "the only period when debt was over 90 percent of GDP was in the early postwar years, when real GDP was falling."

Now I don't know whether Krugman was referring simply to the denominator problem -- that the value of the debt/GDP ratio can rise because of lagging GDP -- or whether he has a meatier argument. But to the people who already don't agree with Krugman, that couldn't possibly make the least bit of difference.

People who already disagree with Krugman -- those, let's say, who worry what will happen when debt goes above 90% of GDP -- will be scratching their heads, wondering why he is talking about World War II debt. The problem is not some old debt from 65 years ago that everybody knows wasn't a problem. The problem is the current high level of debt, and current projections of even higher debt to come. After all, not even Krugman denies that high debt can be a problem.

Still, he has a point: Debt was over 90% of U.S. GDP once, and it turned out not to be a problem, that time.

For the 90-percenters, Krugman creates a dilemma: Why was the World War II debt not a problem? They say debt is a problem now. They know they are right. I know they are right. I think even Krugman knows they are right. But he raises a question they cannot answer. As things stand now, the only solution is for 90-percenters to reject Krugman more completely. Dilemma and all.

Krugman suffers the same dilemma. He knows that high debt can be a problem. And yes, he knows that it turned out once, at least, not to be a problem. But he doesn't know why. He doesn't know why high debt was not a problem after World War II. If he knew, surely he would tell us.

The dispute between Krugman and the 90-percenters is fought on a particular playing field. That playing field is the graph "debt relative to GDP." When the trendline reaches 90% it is a huge problem. Or it is no problem at all.

To settle that dispute, answer one simple question: What does the graph show?

Consider first what the graph does not show: It does not show that debt is high. It only shows that debt is high relative to GDP: Gee, this mountain looks big compared to that mole-hill. Yes, we have a mountain of debt. But the graph does not show that. It shows a thing we already knew: The graph shows that GDP growth has been laggard. But that was our original complaint. We don't have the growth of output, the growth of jobs, the growth of living standards, the growth of profit that we need, that we expect, that we want, that we demand. GDP is a mole hill.

What does the graph show?

The graph shows the efficiency of credit use. If an increase in debt is efficient, it produces a lot of growth. So GDP increases more than the debt, and the trendline goes down. But if an increase in debt is not efficient, it produces little growth. So then GDP increases less than the debt, and the trendline goes up. The trendline rises or falls depending on the efficiency of credit-use as measured by improved growth.

There are discussions you can find on the internet, regarding the size of the "multiplier" -- the size of the effect we get per dollar of economic stimulus spending. Formerly, the multiplier was thought to be quite large. Now it is often said to be quite small. If you come across such a discussion, it may be presented as an argument: someone is right; someone is wrong.

Here's what I think: In the days when credit-efficiency was high, the multiplier was high. In the days when credit-efficiency is low, the multiplier is low. It is not a matter of someone is right and someone is wrong. It is a matter of credit efficiency.

What does the graph show?

It shows a steep decline from the 1946 peak to about 1952. We got a lot of growth for every dollar of credit use. Credit efficiency was extremely high.

It shows a less steep decline from 1952 to 1966, the year I graduated high school. Credit efficiency was somewhat less.

It shows a mild decline from 1966 to 1974. We gained only a little growth for every dollar of credit use. Credit efficiency was quite low.

It shows flat from 1974 to 1981. At this point there was no gain from credit use. (The multiplier was about 1.) We had reached a Laffer limit.

And it shows a sharp increase after 1981. There was a loss from credit use. If growth was better in the 1980s than in the '70s, this trendline shows why: It took a lot of debt to boost economic growth. Credit use was inefficient.

After the mid-1990s the trendline loses its "bowl" shape. We'll look into that later. Meanwhile I should point out that the trendline, which disappears behind the graph border in 2009, approaches 90% in that year: last year. I know this sharp spike in the trend is part of a policy designed to boost economic growth. But low credit efficiency makes that policy ineffective.

HEADLINE: Stocks climb after Fed pledges to hold rates low

The Fed won't be tight'ning its grip, and prices go up. That's inflation, isn't it?

I was gonna title this post Same old same-old... Same old economic policy. Same old go-ahead-and-borrow-more, go-ahead, go-ahead, GOTCHA! Same old we encourage you to increase your reliance on credit until someone yells INFLATION in a crowded theater... and then they jack up interest rates.

Wrong, wrong, wrong.

Don't jack up interest rates to fight inflation. Fight inflation by paying off debt a little faster. Fight inflation by removing the money that threatens to cause inflation, the money that's been created by borrowing. Fight inflation by completing more of those credit-use transactions. Fight inflation by reducing debt.

Fight inflation by reducing debt. Tax policy can do the deed. And keep interest rates low to encourage growth. This is Arthurian economics.

Here's the link to the news clip.

More Shostak

From: Is Velocity Like Magic? by Frank Shostak:

The idea to label the demand for money as stable or unstable is preposterous. What does it mean? The fact that people change their demand for money doesn't imply some kind instability.... It is simply the same that goes for any other goods and services: demand for them changes all the time.

"Demand for them changes all the time." Isn't that the essence of instability?

Speeding Ticket Fix

The next time you get a speeding ticket, try this: Tell 'em they can measure distance, and they can measure time, but they can't measure velocity. So there's no way they can know how fast you were going. Tell 'em Frank Shostak says so.

"Velocity Does Not Have an Independent Existence," Shostak says:

...velocity does not have a "life of its own." It is not an independent entity--it is always [one number] divided into [another number]. On this Rothbard wrote: "But it is absurd to dignify any quantity with a place in an equation unless it can be defined independently of the other terms in the equation."

Good luck with that speeding ticket.

Creating Slack

Since the financial crisis I've heard people say it's good for us, we needed this crisis, we don't need to have so much stuff. There was somebody like that on Colbert the other night: "Annie Leonard says our quest for more stuff is taking the place of things that provide deeper happiness."

It's not exactly sour grapes, but it is some kind of rationalization. We can't have more, so we'll give up and say we're happy with less. Good. Good for them. Me? I don't see it.

Anyhow, the principle of self-interest sort of means people should do what they want to do. If you want "deeper happiness" go get it. If you want "stuff" go get it. Your choice. But I don't like it when some bimbo tells me my personal decisions are wrong.

I'm one of those still saying we must increase output. I readily admit that since the 1970s -- when lagging output growth first became an issue -- we've not been able to sustain the economic growth we need. But that only makes the matter more pressing.

I have shown a relation between productivity growth and the DPD trend. In 1990 DPD peaked, then declined; then we had "golden age" productivity as DPD rose again.

One of the fundamentals of Arthurian economics is the importance of DPD. It is an indicator at least, though I think it is the driving force that permits or prevents the improvement of economic growth. Driving force or not, DPD is a key factor.

Now, you don't need to take me at my word. (You need to investigate the notion and expand upon it.) But suppose I'm right: Suppose the debt-per-dollar trend determines the viable range of economic growth. If it is important to improve growth, then it is important to understand what drives DPD.

What drives the debt-per-dollar trend? Here's a clue, from a Los Angeles Times article on tax law changes, dated 27 December 1990:

Personal interest deductions have also fallen to 10% on federal tax returns. That means that the interest you pay on credit card debt and car and boat loans, among other things, is only 10% deductible for 1990 taxes. The deductions will be phased out completely next year.

Once upon a time, interest expenses were deductible. In 1990, that changed. People lost a tax advantage, and it made the use of credit less beneficial. So people stopped using so much credit. The growth of debt slowed. And debt-per-dollar declined.

Policy -- specifically, tax policy -- had a significant effect on DPD; and DPD had a significant effect on growth.

A little something from the Tax Foundation:

Homeownership has come to be viewed as an integral part of The American Dream, and tax policy is just one way that politicians have sought to promote it. The mortgage interest deduction is the second most expensive tax subsidy, second only to the tax exclusion for employer-provided health insurance.
From the Tax Foundation. Dated 2 December 2009

Okay. But then they really should say it's the second most expensive tax subsidy of the individual income tax. As opposed to the corporate or business income tax, where almost every dollar spent is tax deductible. Advertising, for example. Think there are too many ads on TV? Get your Congressman to sponsor a law that eliminates the tax deduction for business advertising expenses.

The difference between the individual and business tax systems is universally assumed to be proper. I think it leads to tremendous distortions in spending. I think that kind of thinking ultimately leads to Supreme Court decisions that say things like corporations are people, too, and the recent Citizens United v. FEC decision that spending unlimited amounts of corporate money to influence political campaigns is simply free speech.

Ironically, one category of business spending that is not legally deductible is the political and lobbying expenses category.

Short memories...

"Laffer professes no recollection of this napkin"

Keynes wrote a book called A Treatise on Money. I wanted to look up something in it. I searched Google Books, found a book by that title, and started reading.

I know: I depend heavily on Google. But anyway...

The book struck me a little odd. Unexpected. I couldn't find what I was looking for. And I found something I was not looking for:

Impose a tax of a very onerous amount, and instead of increasing the revenue you may kill the revenue altogether; whilst, on the other hand, the progressive diminution of a tax, by increasing the demand, may also increase the revenue obtainable.

First of all, that's not Keynes. There are some writers -- Keynes, Tocqueville, Adam Smith -- whose work is so beautiful as to be almost immediately recognizable. And then there are the rest of us.

Second: Wow, this is Laffer-Curve stuff. Who did write it?

The book is "A Treatise on Money and essays on monetary problems," by J. Shield Nicholson, from 1901.

1901.

Brute Force Recovery

I summarize an article from Scripps Howard News Service in today's local paper:

A homeowner in these hard times still owes over $390,000 on the house ("after 14 years"), sells the house for about $188,000, and the bank forgives over $202,000 of the homeowner's debt. The homeowner asks "How much of this amount is taxable?"

Debt adviser Steve Bucci replies that "normally" any forgiven debt over $600 must be treated "as income that's fully taxable even though you received no cash."

But these are not "normal" times. "Because so many people were faced with potentially huge tax liabilities through debt forgiveness," Bucci says, "Congress passed an act that exempted a forgiven mortgage loan from taxation."

(Bucci notes time and circumstance constraints on the exemption; I omit these in order to focus on his central issue: the taxation of forgiven debt.)

So. This act that Congress passed -- the Mortgage Debt Relief Act of 2007 -- makes allowance for particularly bad economic conditions by canceling the tax on forgiven debt, a tax that presumably makes sense in better economic times.

In other words, things are so bad Congress had to take steps to prevent a normal tax policy from making things worse. We're in such a hole that something had to be done about the debt forgiveness tax.

Okay. I'm glad they did it. But I have a problem here. Let me ask a simple question: What are they trying to accomplish? Are they trying to keep a bad situation from getting worse? Or are they trying to turn it around and make things better?

If we only want to keep a bad situation from getting worse, the Mortgage Debt Relief Act is just what we need: Let things get so bad that "so many people" are faced with "huge tax liabilities" from debt forgiveness, and then cancel some of those tax liabilities to prevent things from getting a lot worse.

But if we want to turn the situation around and make it better, the Act falls far short. People have been borrowing and accumulating debt for decades now, until the load finally became unsupportable and our economy gave out.

To prevent things from getting worse, you cancel a tax that would really hurt a lot of people that are really hurting already.

To make things better, you admit you made mistakes in your policy decisions, and you start cutting down on accumulated debt any way you can. You cut debt and cut it until you have sure signs that the economy is solidly improving. And you make sure nobody has to deal with huge tax liabilities arising from your solution. You establish recovery by brute force.

It's not difficult, after we get past admitting that mistakes were made.

Memories...

Keynesianism made its biggest breakthrough under John Kennedy, who, as Arthur Schlesinger reports in A Thousand Days, "was unquestionably the first Keynesian President." Kennedy's economists, led by Chief Economic Adviser Walter Heller, presided over the birth of the New Economics as a practical policy and set out to add a new dimension to Keynesianism. They began fo use Keynes's theories as a basis not only for correcting the 1960 recession, which prematurely arrived only two years after the 1957-58 recession, but also to spur an expanding economy to still faster growth. Kennedy was intrigued by the "growth gap" theory, first put across to him by Yale Economist Arthur Okun (now a member of the Council of Economic Advisers), who argued that even though the U.S. was prosperous, it was producing $51 billion a year less than it really could. Under the prodding and guidance of Heller, Kennedy thereupon opened the door to activist, imaginative economics.
from Time Magazine, 31 December 1965

Definitions

Money you put into the bank adds to a pool of funds available for lending. That pool of funds is available credit.

When you take a loan, you dip into the pool of funds and put some of that money to use. When you take out a loan, you put credit to use.

When you take out a loan, you expect to pay it back. The bank also expects you to pay it back, and they keep track of it. The total amount of credit you have in use is your debt.

The borrowed money goes into circulation when you spend it. It becomes credit in circulation.

Credit in circulation looks and acts just like money. The person who receives it from you may never know you obtained it by borrowing. To that person, it is money. But you know it is credit in use, because eventually you have to pay it back.

To pay it back, you capture money that is circulating, remove it from circulation, and return it to the bank. At that point, everything is un-done. The credit is no longer in use, no longer circulating. It no longer counts as debt. And it becomes available again.

"History doesn't repeat itself, but it rhymes" -- Mark Twain

If, in America, every man rises on his own merits, then he falls through his own failings. "Anyone," it was said, "could find a job if he really tried." That people who were economically secure should perpetuate this myth is understandable; what is, at first glance, more surprising is that the jobless themselves should do so.

The unemployed worker almost always experienced feelings of guilt and self- depreciation. Although he knew millions had been thrown out of work through no fault of their own, he knew too that millions more were still employed. He could not smother the conviction that his joblessness was the result of his own inadequacy.

from: Franklin D. Roosevelt and the New Deal, by William E. Leuchtenburg. Chapter 6: "One Third of a Nation." Harper and Row, New York. 1963. pp.118-119.

Blizzard Conditions Prevail

William E. Leuchtenburg, in Franklin D. Roosevelt and the New Deal:

In primitive societies, homage was paid to the witch doctors who could control those forces -- sun, rain, and wind -- which could spell the difference between plenty and privation in a primitive economy and before which most men stood helpless. The crisis of the Great Depression revealed that the American people had come to view their financial "wizards" in the same light; the businessman had been thought of as a magic-maker who could master the forces of a complex industrial society which the common man viewed with awe, and which were as much out of his control as the wind or tides. By the winter of 1932, the businessman had lost his magic and was as discredited as a Hopi rainmaker in a prolonged drought.

America's Adam Smith, in The Roaring 80s:

Kenneth Boulding, the distinguished economist, wrote that in the Great Depression, economists wrote about unemployment as if it were a bad hailstorm; then the Keynesian revolution gave some hope that nations could do something about the 'economic blizzards' that had previously been considered as random as the weather.

From a Google search, 2 March 2010: