Tales of Debt Mountain

Graph #1

A few days back I showed you a mountain of United Kingdom debt spanning two centuries and more. Remarkably, that mountain of debt occurred at the same time as the Industrial Revolution, and the same time as the rise and reign of the British Empire.

To expand upon coincidence, the two centuries of the mountain of U.K. debt completely envelop the 150 years Keynes called "the greatest age of the inducement to invest." As I noted in the earlier post, one is almost forced to wonder whether that mountain of debt actually helped the economy along, encouraging the Industrial Revolution and leading Britain to the top of the heap.

Graph #2

Outrageous thought? Maybe. Maybe not. Numbers from Measuringworth show GDP increasing at an accelerating pace in the early years of the Industrial Revolution. The 2nd and 3rd dots on the trendline at right (years 1759 and 1801) show the awakening of growth. The 4th, 5th and 6th dots (1811, 1821, and 1830) show accelerating GDP growth. The sharpest growth occurs in the 1821-1830 period, just as the UK's mountain of debt peaks and begins its descent.

So the general trend was a steep increase in debt from 1700 to 1820. And after more than a century of persistent increase in debt, GDP was growing like never before.

Graph #3

Debt numbers for Graph #3 come from Robert J. Barro, in Macroeconomics: A Modern Approach, Chapter 14, page 342. Barro's mountain (Figure 14.2, page 344) is smaller than Chantrill's (Graph #1, above), but both show a mountain when debt is compared to GDP.

This look at the raw numbers shows that public debt in the UK did not "peak." It simply stabilized after 1820. It was the growth of GDP that made public debt seem to shrink.

The increase in government debt comes before the increase in growth. We have public debt increasing (1740-1790), increasing rapidly (1790-1820), then stabilizing at a high level. We have Real GDP stable (before 1759), increasing slightly at the beginning of the Industrial Revolution (1759-1811), accelerating (1811-1830), and then achieving the sort of growth we long for today.

We have the increase in public debt first, followed by the increase in GDP. Then there is an acceleration of public debt first, followed by acceleration in GDP. And then we have public debt stabilizing while GDP growth continues, causing the long decline in debt as a percent of GDP that appears on Graph #1. In these events, I think, we witness the birth of capitalism.

Did the growth of debt help the British economy grow? Can't say. But I think we can say with confidence that the massive public debt did not hinder, harm, or cripple growth.

Aren't you tired of this kind of stuff??? I am.

It showed up in the blogger page after I edited a post.

I don't know what the guy is selling. I didn't go there. But every time you turn around there's another guy, horning in on the business of government abuse. Abusing the government by accusing the government of abusing us. Trying to make a living off it.

Where are the people who are willing to say that most of this "abuse" is the result of economic mismanagement? Where are the people who understand that most of these problems will go away if we just fix the economy? And where are the people who are still trying to understand the economic problem, so that we may finally solve it?

So, I went to the site. It's an advertisement. The whole site is an advertisement for a book.

Topics?

* deceit in government accounting.
* “entitlements.”
* the incredible bloat of government.
* the hidden inflation tax.
* the politicians “buy the votes”
* the rationing of healthcare
* the Progressives invaded the media.
* “catch and release” immigration

Oh, and the "$14 trillion national debt."

You never heard any of that before, I bet.

Excerpt:

In the fall of 2008, America’s financial wheels starting coming off... so I began reading and researching – just as I have always done when thinking about a new business venture.

So this guy started looking at the economic problem after the Paulson crisis hit the fan.

Decline of the Dollar

The M1 money multiplier has in general declined since 1960 or before. What is the significance of that decline?

The decline shows that we rely less and less on money. I have already mentioned (elsewhere, repeatedly) our excessive reliance on credit. The two fit together: As our reliance on credit grew, our reliance on M1 money fell.

The accelerating decline in the money multiplier corresponds to the accelerating increase in credit use and the increasing accumulation of debt.

The changes in our economy -- deregulation, financial innovation, increasing reliance on credit, increasing concentration of income, and a reserve requirement of zero for money in savings -- influenced the trend of the money multiplier and the decline of M1 money. Policy caused the decline of the dollar.

Print This Post

I caught a bit of Richard Florida on Fareed Zakaria GPS today. A very animated fellow. He seemed to be selling the notion that we're a creative people and we'll soon recover from this terrible economic meltdown.

Well, that's all very nice.

He also said it's going to take 20 to 30 years to recover. In other words, Richard Florida has no plan for recovery.

There are specific problems, specific imbalances that must be corrected. Everybody knows the main one: debt. We have to reduce debt. Everybody knows it. Clarity is not at issue.

If we know what the problem is, then why can we not solve the problem quickly?

We can solve it quickly, if we take the right approach. Otherwise we can make it worse, just as we have been making the problem worse since the 1970s.

Our economic problem is not just "debt." Our problem is an imbalance in the money, an imbalance between credit-money and fiat-money. An excessive reliance on credit.

The problem is not just debt. Debt is nothing but evidence of credit use. The problem is an imbalance between credit money and fiat money. To solve the problem, we must correct this imbalance.

People say we had inflation because they printed too much money. That would be fiat money, the printed money. But that is not the problem. We had inflation because they loaned and we borrowed too much money. Too much credit money, the borrowed money, is what caused inflation. It's also why we have so much debt, of course.

Do not miss this subtle point: They did not print too much money. Rather, the opposite. They restricted the quantity of fiat money to fight inflation. That plan did not work, because we did not have an excess of fiat money. We had an excess of credit money, an excess of debt.

If one wishes to reduce debt, one needs money to do it. But our anti-inflation policy removed money from the economy. So we did not have the money we needed to reduce our debt.

What we should have been doing for 30 years now is not restricting the quantity of fiat money, but accelerating the repayment of debt to fight inflation. Imagine: a plan that fights inflation by reducing debt, and leaves us with enough interest-free money to have a healthy, growing economy!

The problem is not debt. The problem is imbalance. If we take the trouble to figure this out, we can solve the problem quickly. If not, it will be a long, rough ride downhill.

It is not a complex problem. It is just a really really really stupid mistake.

29 August 2010, Arthur Shipman

Oh, I thought I was gonna have to post a retraction

A little googlin' of the phrase "debt intolerance rogoff" turned up this link --

Oh!, I thought, They do look at domestic debt! As I write this, my post-of-the-day is Growth in a time of icebergs. As the post points out, Reinhart and Rogoff's Growth in a Time of Debt is grossly incomplete because it ignores domestic private debt. Now I was thinking I might have to retract that post. Oh, well.

So I read R&R's Scribd paper. Here's what I found.

From the Abstract --

1. "Comparatively little is known about sovereign default on domestic debt." Ah yes, sovereign default. Government debt. I got a little less concerned for my iceberg post.

2. "First, domestic debt is big—for the 64 countries for which we have long time series, domestic debt accounts for almost two-thirds of total public debt." Okay. R&R refer to "domestic debt" but they mean domestic public debt.

3. "Domestic debt (a significant portion of which is long term and non-indexed) is often much larger than the monetary base in the run-up to high-inflation episodes." Again, by "domestic debt" they mean "domestic public debt." I think it shows gall to omit the word "public," as if domestic private debt is of no consequence whatsoever. But that's not the point I want to make here. What R&R are saying is that government debt "is often [of] much larger [significance] than the monetary base in the run-up to high-inflation episodes." This is an important point. It suggests that government debt is in some ways fundamentally similar to the monetary base -- and private-sector debt is not. I have long had a vague notion that public debt is "special" or different from private debt because it is more money-like in ways I cannot yet identify. Reinhart and Rogoff's remark supports this notion.

From the Introduction --

4. "Historical data on domestic (internal) government debt has been ignored for so long that many observers have come to believe that the issuance boom of the early 2000s is something entirely new and different." Oh I'm grinnin' now. R&R are complaining that domestic debt is ignored. I sympathize. I have the same complaint. Their concern is over public debt and mine is about private debt. And my complaint about their work is justified. But I'm starting to see where they're coming from.

5. (A reiteration of point 3 above) "Although domestic debt is largely ignored in the vast empirical literature on high and hyperinflation, we find that there are many cases where the hidden overhang of domestic public debt was at least the same order of magnitude as base money, and sometimes a large multiple."

6. By page 4 of the Scribd paper, I get the feeling that R&R are so caught-up in their quest for data on public debt that they do indeed forget the larger significance of the larger private debt.

7. On page 6, R&R present their Figure 1 with the title Domestic Public Debt as a Share of Total Debt in an eye-catching font. However, two pages earlier they say "Figure 1 plots the share of domestic debt in total public debt." (Emphasis added.) I don't think their method is purposefully deceptive, but I do find it deceptive.

Reduction (3)

From this morning's post:

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

The solution we applied since the 1980s included a great increase our reliance on credit, as evidenced by the growth of public and private debt.

The great irony is, the cost of existing debt was the source of the problem in the first place. Our solution only made the problem worse.

The great mistake is, we failed to use accelerated repayment of debt to fight inflation.

Reduction (2)

THIS POST IS BASED ON MINE OF 20 MAY PAST.

I don't dispute the quantity theory of money. I take it as a "given." But suppose something weird happened: Suppose it came about that we needed 3% annual money growth to keep prices stable, but we needed 6% money growth to keep the economy growing at a satisfactory rate. This would be a problem.

It would be a problem because the money growth required to keep the economy growing would be too much to assure price stability. It would be a problem because reducing money-growth enough to assure price stability would undermine growth. It would mean that we couldn't have growth without inflation, and we couldn't reduce inflation without reducing growth.

This is not a problem that would be. It is exactly the problem that we have had since the 1970s. Because of this problem, we cannot get growth enough to balance the budget. We can't get growth enough to keep unemployment low. We can't get growth enough to keep living standards rising. We can't get growth enough, period.

And still we've had inflation -- too much inflation, for too many years.

Worst of all, we cannot solve the problem. The problem arose in the 1970s. This is 2010, and we still have not solved the problem. And now on top of it we have financial crisis: Out of the frying pan, into the fire.

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

Q: What is it that might inhibit growth, except in conditions of high inflation?

A: Cost. Rising costs inhibit growth. Rising costs, for consumers, mean pay hikes are necessary or, barring that, living standards must fall. Rising costs for businesses mean prices must go up, profits are squeezed, and business is not good.

Cost is the problem that inhibits growth. But as it turns out, creating some inflation compensates for rising costs, and gets us a little growth. So policymakers have opted for low but continuous inflation.

Cost is the problem that inhibits growth and demands inflation.

Costs are rising. We knew this in the 1970s. Back then, people said there was "a wage-price spiral." Basically, policymakers and the media said prices were going up because wages were going up. So it was our fault. That was nonsense. Still, the problem is that costs are rising.

Q: If not wages, then what is the problematic cost?

A: You know the answer to this. Simon Johnson has pointed it out. ContraHour has pointed it out. Probably many others as well. Finance is the problem.

The excessive growth of finance is the problem. But of course, finance fills a need. So then, we may say the excessive reliance on credit is the problem.

Now it sounds like our fault again. We did the borrowing. For that matter, we did the lending, too. There is too much borrowing and lending, too much reliance on credit, too much cost of credit use. This is the cost that created our economic problems in the 1970s. And since that time, finance has only grown.

If I have said this well, there is only one loose end. Your question must be --

Q: Why is our reliance on credit so high?

A: Policy.

Reduction

If I've learned one thing from my time at computer programming, it's that to solve a problem, you break it into smaller problems and solve the smaller problems. It's a rule I rely on. But it is not infallible.

After the death of Keynesian economics, the reduction of the economic problem into smaller, more manageable problems caused incorrect solutions to be developed.

From mine of 5 July:

The shift from Keynesian economics to Reaganomics was an attempt to fix a problem. That problem was slow growth. (The problem was that we could grow faster only by accepting more inflation. Since we (reasonably) rejected that alternative, the problem was reduced to "slow growth." But perhaps this reduction muddied the analysis from which the solution emerged.)

We didn't have a problem making the economy grow. The problem we had was that we were getting inflation along with growth. When we stamped out inflation, we lost the growth. When growth came back, inflation came back. It was the Seventies.

Reduction of the problem encouraged us to think of inflation and slow growth as two separate problems, to be dealt with separately. But there were not two separate problems. We did not have a problem getting the economy to grow. We did not have a problem keeping inflation under control. We could do either one exceptionally well.

The problem that caused the death of Keynesian economics and gave birth to Reaganomics was not an "either/or" problem. The problem was that we couldn't get healthy growth and price stability at the same time. Splitting the problem into two smaller problems was not a reasonable approach, because it was the combination that was the problem.

At the time, people did not understand that the combination was the problem. People still don't understand it today. Let me give you one example. Paul Krugman writes:

Here’s what I think: inflation did have to be brought down — and Paul Volcker, not Reagan, did what was necessary. But the rest — slashing taxes on the rich, breaking the unions, letting inflation erode the minimum wage — wasn’t necessary at all.

Paul Krugman in 2010 -- May 24, 2010 -- still separates the monetary policy from "the rest" of policy. Still separates anti-inflation policy from pro-growth policy. Still sees the separate application of these two policy tools as the right way to approach the economic problem.

We still have not solved this problem, which emerged in the 1970s, because we still think of it as two separate problems. But it is not two separate problems. It is one problem. The problem is that we can't get healthy growth and price stability at the same time.

Imagine Recovery

Imagine a good, strong recovery.
Credit-use grows like crazy.
Debt grows like crazy.
And, before you know it,
we have another financial crisis.

It's the best we can hope for,
unless we change the policies
of the Venn Overlap.

Copernicus

After a "golden age of post-war capitalism" we had a decade of failed Keynesian economics, followed by three decades of debt and Reaganomics, followed by financial crisis.

Now, after forty years of bad economics, economists are telling us austerity is necessary, to maintain "confidence."

We couldn't balance the budget when times were good. Do they really think we can balance it now? Don't you think we need a different plan? A plan that can work?

After leading us into financial crisis they march on, saying This way, this way!

I think not.

There came a day when Copernicus said: Wait a minute. I've been looking at the numbers here, and things just don't add up. I know everybody thinks the sun goes around the earth, but it just isn't here in the numbers.

It's like that with the economy. Things people say all the time, things people believe about the economy, things people know to be true -- these things are just not in the numbers.

Blank Slate

My friend Khan passed along a link to me: No, We're Not Turning Into Japan, by James Ledbetter, 18 August, Slate.

Under the heading The strength of corporations, Ledbetter writes

Stimulus skeptics tend to be evangelists of private-sector virtue, yet they spend very little time discussing just how healthy the balance sheets of American corporations are. Yes, America's financial and auto sectors fell into near-death, but nonfinancial corporations have been delivering healthy, even record profits lately, and are not carrying much more debt than they ever have.

"Nonfinancial corporations are not carrying much more debt than they ever have."

That's the sort of thing people say when they don't really know for sure. If you don't mind me quoting me quoting myself, I recently wrote:

I also said "No one has any money, but there is just as much money in circulation as ever there was." And that was dead wrong.

Sorta has the same rhythm to it, no? Kind of a poetry of ignorance. When ya don't know, but ya figure there's only one reasonable option, ya say there is just as much money in circulation as ever, or ya say they are not carrying much more debt than they ever have, or some other sweeping generalization that is easily recognizable in others, once you've recognized it in oneself.

Well, you know I had to look into it.

Nonfinancial corporate debt doubled from 25% to 50% of GDP between 1956 and 2009.

So you know.

Nope, not health care.

Mark Thoma writes

The vast majority of observers agree that we will need to address the debt problem, which is mostly a health care cost problem, at some point.

Mostly a health care problem??? Here. Here's a graph of debt:

How does health care cause this?

It's three colors because there are three sources for the debt numbers. It doesn't matter. Answer the question: How does "health care" make debt do this?

It doesn't.

Growth in a time of icebergs

PREFACE

MUCH TALK LATELY ABOUT GOVERNMENT DEBT CREATING PROBLEMS WHEN IT REACHES 90% OF GDP.
I DON'T KNOW IF YOU NOTICED, BUT THE PROBLEMS HIT THE FAN, COUPLE YEARS AGO NOW.
SINCE THEN, GOVERNMENT DEBT HAS BEEN GROWING LIKE CRAZY.

THAT 90%-OF-GDP NUMBERS SEEMS TO HAVE ORIGINATED IN A RECENT STUDY BY CARMEN REINHART AND KENNETH ROGOFF. THAT STUDY IS THE TOPIC OF THIS POST.

24 AUGUST 2010, ARTHUR SHIPMAN

S'pose I told you I've been studying icebergs. Studied a lot of 'em -- 44 of 'em, to be exact. Looked at each one several times at least, for a total of 1483 observations.

It has been known for some time that a relation exists between icebergs and shipwrecks. We were therefore careful not to get too close to the subjects of our study. Also, we did not peer beneath the surface, as the water was very cold. Anyway, we were too far from the 'bergs to see very much.

We did manage to lasso one iceberg and tow it to warmer waters. We chanced approaching it there, and we made what we think is an important discovery: Apparently icebergs sink in warmer waters. Our inspection beneath the surface revealed that a large portion of the 'berg was submerged in the warm waters. This submerged ice was not visible in the colder waters.

During the journey to warmer waters, we noticed the iceberg getting smaller. Some thought it was melting. Others said it was sinking. Our observation beneath the surface seems to confirm the latter view.


In a PDF titled Growth in a Time of Debt, Carmen Reinhart and Kenneth Rogoff write:

In this paper, we exploit a new multi-country historical data set on central government debt as well as more recent data on external (public and private) debt to search for a systematic relationship between debt levels, growth and inflation.

Reinhart and Rogoff examine government debt and external debt.

In this paper “public debt” refers to gross central government debt. “Domestic public debt” is government debt issued under domestic legal jurisdiction. Public debt does not include debts carrying a government guarantee. Total gross external debt includes the external debts of all branches of government as well as private debt that is issued by domestic private entities under a foreign jurisdiction.

By "government debt" they mean (for the U.S.) the debt of the federal government. By "external debt" I think they mean debt owed to foreigners.

Our topic would seem to be a timely one. Government debt has been soaring in the wake of the recent global financial maelstrom

Yes. But Reinhart and Rogoff's motto seems to be Don't look back. They have little interest in the debt that actually created that global financial maelstrom.

Our main focus has been on total public and total external debt, since reliable data on private internal domestic debts are much scarcer across countries and time.

Reliable data on private internal domestic debt is "scarce." That's why they ignore it. Somebody has to make a big deal of this, I think. The water was very cold.


From this Federal Reserve site you can get the most recent stats on U.S. debt. I got the June 10, 2010 release. I downloaded the PDF of "Debt growth, borrowing and debt outstanding tables." It's a three-page paper. Page 3 is "D.3 Debt Outstanding by Sector."

This is the kind of information Reinhart and Rogoff wish they could get for all the nations in their study. I wish it, too. But there is no reason to ignore the available data, from any nation that does make the data available.

From the "Debt Outstanding" PDF I took Federal government debt and Foreign debt, added them together, and called it debt that is "considered" by Reinhart and Rogoff. Then I took Total Households debt and Total Business debt and State and local governments debt and Domestic financial sectors debt, added them together, and called it debt that is "not considered" by Reinhart and Rogoff.

I apologize if I'm tedious. It's what I'm best at. If you want more, click this to see the breakdown of "sectors."

Anyway, I took the available info and made a graph of it. The graph doesn't show what Reinhart and Rogoff were talking about. It only shows the portion of debt they looked at, and the portion they didn't look at, for the United States.

The zero line, where pink and blue meet, is the water line. Above the waterline, the blue shows the amount of U.S. debt considered by Reinhart and Rogoff. Below the waterline, the pink shows the amount of U.S. debt that Reinhart and Rogoff ignore. The debt they ignore is between four and five times larger than the debt they consider.

Their search for systematic relationships gives new meaning to the word "incomplete." Their conclusions cannot possibly be of much value. Their study is as flawed as my tale of the icebergs.

M1 is the Money we Spend

M1, not M2, is the money that we spend.

I know: Economists like to use M2 all the time. But if you spend M2 money, you're spending the part of M2 that is M1 money. Either that, or you withdraw money from savings and spend it; in that case it comes out of the "savings" part of M2 and into the M1 part.

Either way, you are spending M1 money.

It is not informative to look at M2 when we consider spending. M1 is spending-money. M1 is one part of M2, and savings is the other part. But you can't spend savings.

Free Enterprise

Free enterprise? Oh yeah, I'm all for it! I say let's get rid of tax code that favors bigness, so Mom'n'Pop can compete with Big-Box.

And let's get rid of the free trade agreements that impede the domestic policies of national economies. Adam Smith wrote about The Wealth of Nations, after all.

If we don't honor and respect and preserve the system of nations, we're going to end up with global government. If we don't reverse present trends we're going to end up with global government. I know, I know, Star Trek A Piece of the Action, Babylon 5, and all that. That's fine. We can get to global government eventually. We have to get to it eventually. But we have to evolve into it. You can't just cram it down our throats, force it on people like they forced the European Union on people, with all that BS about how it would make the economy better.

That didn't work out so great for the European economy anyway, did it.

We have to make the economy better first. Then -- after we satisfy each other that we know how to do that -- then we can spend the next thousand years working on global government, trying to write a Constitution better than the one we have now.

After that, we can aim for those five-digit years.

"The Greatest Age of the Inducement to Invest"

My eyes bugged out the first time I saw the above graph from Christopher Chantrill.

It makes U.S. debt (this graph, also by Chantrill) look small by comparison. Not to minimize the U.S. debt problem, not at all. (Since 1986 the US figure has been above the UK number.)

The great mountain of UK debt spans two centuries. During those centuries (where numbers are available) peak US debt was only one-tenth as much. And at maximum, US debt (relative to GDP) was half peak UK debt.

Debt is a problem. But the bigger problem is that debt is out of control. The great challenge, then, is to bring debt under control. Toward that end, an improved understanding of debt and its consequences is in order. Let us consider the great mountain of UK debt, 1692-1914.


The mountain of debt did not interfere with the Industrial Revolution. The Revolution rose in concert with the mountain. Wikipedia offers the following notes:

The industrial use of steam power started with Thomas Savery in 1698. He constructed and patented in London the first engine, which he called the "Miner's Friend" ...

The steam engine was arguably the most important technology of the Industrial Revolution. From Englishman Thomas Newcomen's atmospheric engine, of 1712, through major developments by Scottish inventor and mechanical engineer James Watt, the steam engine began to be used in many industrial settings, not just in mining...

A fundamental change in working principles was brought about by James Watt. With the close collaboration of Matthew Boulton, he had succeeded by 1778 in perfecting his steam engine which incorporated a series of radical improvements...

These developments occur early-on in the years of that mountain of debt. And Adam Smith's Wealth of Nations came out in 1776, opening the door to a new world of economic thought. The dates 1776 and 1778 occur about half-way up the up-slope of the mountain. The Industrial Revolution climbed that mountain and rode down the other side, picking up speed along the way.


The mountain did not interfere with the rise of British power.

From 1776 to the start of World War I in 1914 is a span of 139 years. During those years UK debt rose to its mountainous peak, and fell again. During those years the sun never set on the British Empire. The dates fit well with the "Rise of the 'Second British Empire' (1783–1815) and Britain's imperial century (1815–1914).

Those were not so-so years for the United Kingdom. Those were the years the UK was on top of the world. Coincidence or no, those were the years of the mountainous rise of UK public debt and the century-long decline of that debt.

I observe that the position of the UK in the world after 1820 allowed the reduction of its mountainous public debt; but the growth of that debt in the century before 1820 did not prevent the UK's rise to the top.


The mountain of debt did not interfere with the inducement to invest.

Back in May I wrote:

Keynes identified the interest-rate trough in the cycle of civilization as "the greatest age of the inducement to invest." He called it "a limiting point" ... "a period of almost one hundred and fifty years."

A period of almost one hundred and fifty years. But which years? By my rough estimate, the 139 years from 1776 to 1914, the 139 years from The Wealth of Nations to World War I, define the greatest age of the inducement to invest. James R. Crotty (PDF, see page 5) seems to agree, finding the age ending with the onset of World War I.

There is a remarkable alignment between this "greatest age" and the mountain of public UK debt. That debt obviously did not prevent investment and growth. One is almost forced to wonder whether it helped.


Two, two and one-half, three centuries ago, a truly massive public debt did not hinder investment, growth, accumulation of power, or invention, industry, and innovation in the United Kingdom. Debt is not always a problem.

Debt is not guaranteed to cause economic troubles. Sometimes it does. Sometimes, it does not. Why? Because the growth of debt is always a by-product, never an objective. Sometimes debt is merely a convenience. Sometimes debt is a symptom of a serious problem.

Our debt today, which interferes with investment, growth, and political power, is a symptom of a serious problem. It is this other problem that must be solved. Solving that problem will make the debt problem disappear.

None of our attempts to solve the debt problem have succeeded. Debt is out of control, because our attempts to control it have failed. Our attempts fail because our methods are inappropriate. Such actions as cutting spending and balancing the budget are inappropriate: They focus on the symptom. This is why we cannot solve the problem.

Consumer Confidence is a Fickle Thing

I left for work this morning as usual, except I was a few minutes behind schedule.

Holy cow, it's a different world! I didn't have the roads to myself. I was stuck in traffic. I even got stuck behind a school bus.

So much traffic. It's like the recession is over, or something.

The Force of Gravity

Looking at the St. Louis Fed's MULT graph, used in my previous post, we see nothing but decline: a long, slow, gradual decline followed by the abrupt, sharp decline of the Paulson crisis late in 2008.

But MULT covers the years 1984 to 2010. I like to look at more years. I don't want to say nothing but decline because I don't know what happened before 1984. I've shown a lot of graphs with a turning-point right around 1980. Maybe the MULT graph would show the same thing?

So I did my own version of the MULT graph, using the data FRED provides for the period 1959-2010:

Nothing but decline. For the 25 years or so before 1984, a long slow decline. Then (discounting for now a couple interesting bumps there) a long, faster decline until the Paulson crisis. And then the shocking drop. Nothing but decline: Accelerating decline.

The money that the Fed creates is multiplied by economic activity. Let's say fractional reserve banking, or bank lending, multiplies the money.

How much? How much does it multiply the money? Good question. Around 1960 every dollar created by the Fed became about $3.50 of M1 money. By 1973 or so that number had fallen to about $3.30 or $3.35. But then the number fell faster and was a little below $3.00 in 1980.

Then two or three years of stability, and two or three years of increase. And then the number fell faster than before, say from 1987 to 1991. Then two or three years of increase again. and then the number fell faster than before, say from 1994 to 2000, to something under $2.

Then the decline tapered off and from 2000-2008 or so the number fell about as fast as it did in the 1970s. It fell to $1.60 or so. And then it fell again. Faster than before: Like a rock. To about 80 cents.

So we can say that the general tendency is for the number, the M1 money multiplier, to fall faster and faster. To accelerate downhill. As if gravity was at work on it.

And we can also say, frankly, that the really really fast decline of the Paulson crisis, the decline there in 2008, should have been easily predictable, because it was all downhill.

The Money Multiplier

Much talk of late about the fiscal multiplier being less than one, so that a given amount of stimulus spending would decrease economic performance in some proportion. I think there is more to that story. But in any case, there is also the money multiplier to consider, and I've not heard much talk about that.

In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base.

The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10.

Mine of July 3rd provides two graphs that suggest the money multiplier may be very small. I want to look into it more, having now read about the money multiplier. The St. Louis FRED offers this graph, which shows a sharp drop in the M1 money multiplier from about 1.6 to about 0.8 (in the fat gray bar at the right):

Before that drop, a $1 increase in the monetary base would have led to about a $1.60 increase in M1 money. After the drop, a $1 increase in the monetary base adds maybe 80 cents to M1 money. Half as much as before the drop.

For the record, the M1 money multiplier as reported by the St. Louis Fed is less than one. So the people who say fiscal policy doesn't work, the people who say the fiscal multiplier is less than one, the people who say let's depend on monetary policy instead, to those people I say... I just shake my head and shrug my shoulders.
"My guess is that scholars will ultimately decide that fiscal policy was far less important than monetary policy and measures to stabilise the banking system." -- Kenneth Rogoff in the Financial Times, 20 July 2010


Not to be ignored: the drop from a little over 3 (around 1987) to a little over 1.5 (around 2007). The multiplier fell by half in this period as well. Granted, it took twenty years. This decline was not a shocker, because it was not instantaneous. It was less disruptive and less worrisome, because it was not instantaneous. But it was an otherwise comparable decline in the multiplier.

Perhaps it was a warning. If so, it was a warning ignored.

Something Borrowed

There is always some level of borrowing in an economy. That level is a variable: It changes as years go by.

In the years leading up to the Great Depression there was a high level of borrowing. During the Great depression, that level fell. And since the end of World War II the level of borrowing has been increasing again -- or had been, until our recent financial crisis and the great deleveraging.

Arthurian economics claims that the level of private-sector borrowing is a significant factor affecting economic performance.

Tradeoff

Suppose we eliminate the tax deduction for interest expense. Yeah, I know: Most of that deduction was eliminated back in 1990-91. But now, suppose we eliminate the rest of it. All of it. Gone.

That would be hard on a lot of people. I expect it would be good for the economy, after a few years maybe. But it would be hard.

So I propose a trade-off: Eliminate the tax deduction for interest expense, and replace it with a tax deduction for accelerated repayment of debt. That way, taxpayers break even, and we do good things for the economy.

Or set up the tax deduction for accelerated repayment of debt as an option. Give taxpayers the choice: Either take the existing deduction for interest expense, or take the new deduction for accelerated repayment of debt.

Oh, one more thing: It applies to everybody. Not just to people filing the individual tax form. It applies to businesses as well.

Then you'd start to see some changes in our economy!

It's Salvageable

The Economist provides A Special Report on Debt. It has a kind of odd view of things. It gives the impression that what happens in the economy is beyond our control. As if economic policy does not exist, or serves no useful purpose.

The article does contain a few goodies: A wonderful quote from Samuel Johnson. And some good graphs. But the article is poorly focused and unsatisfying.

The answer to all problems seemed to be more debt. Depressed? Use your credit card for a shopping spree... Want to get rich quick? Work for a private-equity or hedge-fund firm... Looking for faster growth for your company? Borrow... And if the economy is in recession, let the government go into deficit to bolster spending.

You know, if people who live and work in this economy (but don't make graphs of it and such) want to equate government debt with private-sector debt and shopping sprees, I guess ya gotta expect that. But I expect more from The Economist and its special reports. I expect them to at least consider the possibility that there may be a significant difference between my debt and the debt of my government.

This Special Report on Debt doesn't make the distinction. It blurs all debt together. It is designed to appeal to people's gut reaction to debt. It is not written to get people to think and evaluate our circumstance.

"Throughout the 1980s and 1990s..." the article says,

Debt increased at every level, from consumers to companies to banks to whole countries. The effect varied from country to country, but a survey by the McKinsey Global Institute found that average total debt (private and public sector combined) in ten mature economies rose from 200% of GDP in 1995 to 300% in 2008

Why the Special Report picks the particular numbers 200% of GDP and 300%, I do not know. But the impression I get is that 300% is a problem, and 200% was not a problem. Fair enough?

So we might say that our situation in 1995 was okay. And in thirteen years we went from okay to the brink of disaster. So it's maybe a medium-term problem, not long-term. That's good. That means undoing the damage won't be so difficult and won't take so long. It's salvageable.

Friday the Thirteenth

Yesterday I quoted (Reuters) from Monday the 9th:

Evidence the already sluggish recovery has lost momentum has shifted discussion at the U.S. central bank from exit strategies to whether the economy needs more backing, which would most likely come in the form of buying more longer-term assets...

On 24 July I wrote:

So again I say, let's not have the Federal Reserve print money and use it to buy up debt. Have them use that money to pay off debt.

On 8 July I wrote:

Here's what I want the Fed to do, Paul. I don't want them to buy debt. I want them to make debt go away. I want them to take their trillions that they're gonna use to buy debt. And I want them to use that money to pay off debt. Pay it off. Just pay it off. Make the debt go away.

On 7 March I wrote:

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.

On 4 September 09 I wrote:

What rule says we must lend out Bernanke's newly printed trillion? If it really is free money, if it really is money from nothing, then what do we lose by giving it away? Nothing. What do we gain by using it to pay down debt? Plenty! But the Fed is not doing that. At the Fed, they don't want to do things to remind people that Federal Reserve Notes are money from nothing.

On 19 August 09 I wrote:

We need to get out of the slump. To do it, we need to reduce the level of existing debt. The slump was caused by excessive accumulation of debt. We couldn't run fast enough to stay out in front of it anymore. It caught up with us. And now, we're in a hole.

We need to fill that hole. That's my solution. That's how we get out of the slump.

I say, let the Fed print one more trillion dollars. And use it this time to pay down debt for people. Something in the neighborhood of twelve thousand dollars for a family of four.

On 6 July 09 I wrote:

The quickest way out is just to print money and use it to pay off debt. But it's like touching a snake, isn't it? You can't stand the thought of it.

"Fed to weigh pick-me-up for flagging U.S. recovery"

WASHINGTON | Mon Aug 9, 2010 12:48pm EDT

(Reuters) - The Federal Reserve on Tuesday may send a clear signal it is prepared to print more money to support a faltering economic recovery if necessary.

The central bank is widely expected to renew its vow to keep rates near zero for "an extended period" and markets will watch closely for signs officials are growing more concerned the recovery is at risk...

Evidence the already sluggish recovery has lost momentum has shifted discussion at the U.S. central bank from exit strategies to whether the economy needs more backing, which would most likely come in the form of buying more longer-term assets...

FED NOTES GREATER RISKS, VOWS ACTION IF CONDITIONS WORSEN

The Fed cut rates to near zero almost two years ago and has been promising to keep them extraordinarily low for an extended period at every meeting since March 2009.


Almost two years ago, and we're still waiting to see if the economy is gonna recover. Big Ben Bernanke is still waiting. He doesn't seem to understand the meaning of the word urgency.

Look. It's not up to me whether we fix the economy or not. But if we're gonna fix it, the sooner we do it, the better. The longer it takes the more things fall apart, and the harder it is to recover.

SEE ALSO: DUNDERHEADS

The Pattern of Debt

This pattern of debt is the opposite of what you might expect. At the level of individual consumers, people tend to borrow when they are young because they are hoping for higher incomes in the future. As they reach middle age they start to pay off their debts and save for retirement. By extension, rich countries with their greying populations should be saving whereas younger, fast-growing developing countries should be borrowing heavily. But in fact it is the other way round.

FROM: A Special Report on Debt: In a Hole, The Economist, 24 June 2010.

Why? Rich countries with their graying populations should be saving, but they are borrowing heavily? Maybe it's just a bad analogy or something.

Or maybe this misbehavior is the result of policy -- policy that restricts the quantity of money and encourages the reliance on credit, and fails to encourage the accelerated repayment of debt. That would be my guess.

//

The Economists presents a multi-post article explaining that the growth of debt was unsustainable.

Now that life has shown the growth of debt to be unsustainable, the article attempts to show, not why it was unsustainable, but simply that it was unsustainable. As if paving the way for future articles that will claim it was nobody's fault.

I think, if you know why it was unsustainable, you write an article explaining why it was unsustainable. If you don't, you write the article explaining that it was unsustainable. I think, at The Economist they don't know why it was unsustainable.

This is a problem. If we don't know why it was unsustainable, it will happen again.

Public v Private (5)

Very happy with yesterday's graph. It shows a good long history of a relation I've been pondering for a while -- the relation between public and private debt.

And for the full 90-plus year period, my graph shows events and conditions clearly: It shows World War I. It shows the Roaring '20s, two phases of the Depression, WWII, the "golden age" of the 1950s and '60s, and the end of that age in the 1970s. It shows the budget-balancing of the 1990s, and it shows the onset of the Paulson crisis.

The graph also shows little difference between the 1970s and the 1980s, which in itself is interesting and invites further investigation.

But one thing the graph fails to show is the level of debt. Do we have a lot of debt, or just a little? This graph gives no hint. But I think I have a way to fix that.

Graphs of total debt relative to GDP are a dime a dozen on the Internet. Here is one you may have seen a while back. It shows  debt very high recently -- three and one-half times GDP as of 2008. The graph also shows a tall, thin spike at the time of the Great Depression. But if you look at it, you'll notice this spike starts as the Depression hits. It was not the high level of debt that caused the Depression, but the Depression's falling GDP that caused this spike in the trend.

Here's a critique of that graph, and an alternative graph. Two thoughts on the alternative:
1. There is a discontinuity in the debt numbers, just as there is on my graph from yesterday. So, I'm thinking I didn't misinterpret the numbers.
2. Their graph emphasizes non-financial debt, the low line in this graph. Perhaps there are reasons to separate financial from non-financial debt. But debt is debt. Separating debt into two categories only makes it look like less debt. That's not a solution.

Come to think of it, the recent financial crisis was primarily a crisis in the financial sector which spilled over to the productive sector. So perhaps it is true that financial debt is the problem child, but all debt suffers because of it. If financial debt is the problem, total debt is the bigger problem. No problem is solved by pretending debt is less than it is.

And, come to think of it... Why do they always talk about the "financial" sector and the "non-financial" sector? Shouldn't it be the financial sector and the productive sector??? Don't ya think?

Here's my own version of total debt relative to GDP. The three colors indicate three data sources, the same sources that stand behind yesterday's graph. This one also has the discontinuity.

In order to make yesterday's graph show whether debt is high or low, I want to multiply this graph into that one. I want to factor it in, the way Milton Friedman factored the price level into his MRTO graphs before comparing them to the price level.

So I took the numbers behind that graph, found the biggest value (3.52577... for 2009) and divided all the values by the biggest value. This gave me a version of the graph where all the values are between zero and one.

Then I took the values from yesterday's graph and multiplied them by these index values. The result is a history of the relation between public and private debt, stretched in proportion to the total debt in our economy.

The resulting trend-line will be (and should look like) a combination of yesterday's graph and the "total debt relative to GDP" graph.

This graph is the result of my efforts. It looks much like yesterday's graph, but is stretched upwards where index points are high: The increase since the mid-1990s is much bigger. The Roaring 20s increase is somewhat bigger. And the plateaus are gone -- stretched upward to look like increases, because total debt really was increasing.

Yesterday's graph, for comparison ---------------->

You know, I like yesterday's graph better. The "indexed" version fiddles too much with the numbers and doesn't show much for the effort. Anyhow, we already know the debt was increasing. The "public versus private" graph is a look at other things, things too often overlooked.

And I like this one better because it is full of easily identifiable features. One can see the wars. One can see the Depression and the Crisis. One can see the "golden age." One can see the federal budget coming briefly into balance. And one can see plateaus.

Like I said: Very happy with my "Public v Private" graph.

Public v Private (4)

Now we're getting somewhere. This is the graph I had in mind. This is the debt comparison I wanted to see:

Suggestion: Click on the graph to enlarge it, then print out a copy. (Print it in color if you can.) Because, unless you have a really really tall display, you'll have to keep scrolling back and forth between the graph and my description of it. Also, mark up your printout to identify events like "WWI" (1916-1918)... "Start of Great Depression" (1929)... "Bottom of Great Depression" (1933)... "World War II" (1940-1945)... and so on. That'll help you'll make sense of the following remarks.

The blue and red lines run from 1916 to 1970. The green and gold run from 1956 to 1995. The gray and dark blue lines run from 1975 to 2009. These last two lines hide a good portion of the green and gold lines, because numbers from the two sources are very similar.

Starting at the left side we have red and blue lines. The red is total U.S. private debt relative to total U.S. public debt (federal, state and local). The red line starts around 13.4, meaning there was $13.40 of private debt for each dollar of public debt in 1916. I'm thinking government debt was very low at that point, making private debt look exceptionally high.

Perhaps more significant than the height of the red line is how quickly it drops. I'm thinking that federal spending grew rapidly during World War I, and the increase in government debt, though it appears slight on the blue line, was enough to bring the red line down to about 3.5 ($3.50 of private debt per dollar of public debt) by 1918.

The Roaring '20s are visible as the red line climbs quickly to a little over $5 (1929). The line then drops as private debt declines during and after the Great Depression -- quickly at first, then slowly, then quickly again during WWII. During the Depression the blue (public debt) line rises only a little, until World War II. Then it ramps upward, crossing the red (private debt) line.

After World War II, public debt (the blue line) gradually falls. The second set of data begins with the gold line in 1956, and though the numbers do not match perfectly, the same downward trend is visible.

After World War II, the increase in private debt (the red line) resumes. The second set of data begins with the green line. The red and green lines are substantially different, meaning the two sets of debt numbers are not exactly equal. However, the red and green lines do run parallel, meaning both sets of numbers show the same trend. The similarity of trend is more significant than the mismatch of the numbers.

The red-green overlap -- in fact almost the whole of that long upward trend -- occurs during the so-called "golden age of post-war capitalism" (from 1947 to 1973) when economic growth was exceptionally good. Private debt (relative to public) increased regularly and consistently. Public debt (relative to private) declined persistently.

Following that "golden age" increase of private-sector debt, we find a long period of relative stability stretching from 1973 to 1993. Then from perhaps 1993 to 2001, a dramatic doubling of private debt relative to public -- from $2.50, back up to $5. This increase occurs during the "golden decade," during which federal deficits were reduced and the federal budget came briefly into balance.

Again: The private-sector debt increase of the "golden age" (1947-1973) was followed by a twenty-year plateau of stability (1973-1993). That plateau was followed by another, sharper increase in private debt relative to public. And that increase appears to be followed by the start of another, higher plateau, but this time the plateau is interrupted by the Paulson crisis and the beginning of a sharp drop in private-sector debt, a drop comparable (so far) to the drop we saw during the Great Depression.


In overview, we have the Roaring '20s followed by a period of "crisis and adjustment" (from 1929 to 1945) during which time private debt declines relative to public. Then there is a period of healthy growth (1945 to 1973) followed by a time of troubles (1973 to the Paulson crisis). By this overview, we appear to be at present in the painful beginnings of a new "crisis and adjustment."

The private/public increase between 1993 and 2001 looks very similar to the red line increase during the Roaring '20s. The sharp drop of 2008-09 looks very similar to the drop of the Great Depression. What's different in the later years is that we see plateaus arise. There are no plateaus in the earlier years.

I think the plateaus are the result of economic policy -- basically successful economic policy which is able to maintain certain conditions for extended periods. Policymakers lacked such finesse in the earlier years, which is why we see no early plateaus.

However, since debt climbed to evidently unsustainable levels, and since we have had the recent financial crisis, and since "nobody" saw the crisis coming, I don't think it's a stretch to say that economic policy, though successful, was bad policy.

Public v Private (3)

One PDF from the Fed provides "debt outstanding" numbers for the years 1975-2009. Another provides numbers for the years 1956-1995. For earlier years I turned to the Historical Statistics (HS) "Net Public and Private Debt," series X393-409. The HS PDF provides debt numbers for the years 1916-1970. So now I have overlapping numbers that take me from 1916 to 2009. Nice.

The HS PDF is an older format or something, and I couldn't copy the numbers into a textfile. I had to type it all in by hand. When I finished, I did a graph of it. Visual inspection, looking for typos. Anyway, here it is:

No obvious errors. But something struck me: This graph looks just like every other graph of debt. It looks just like those graphs of all the debt we've accumulated recently. It has the same upward sweep of increase.

The reason the graph looks like this is? That's what growth always looks like: faster and faster increase. I wouldn't read too much into this, but there is no reason for panic when we look at current debt numbers. Debt graphs are often presented to stir up panic. We need to fix this problem surely and soon. But panic won't help us fix it.

Public v Private (2)

While we're looking at debt by sector, here's a longer-term and slightly revised version of the graph from yesterday's post:

That vertical-axis label is supposed to say "Debt in Billions" just like yesterday's graph, but I couldn't get it legible this time for some reason.

There are only three trend-lines this time. I combined financial and non-financial debt together into one line for business debt. That's the red line here. The gold line is government debt -- again, federal combined with state and local. The blue line, as before, is household debt.

What do we see here? Business debt is the largest and fastest-growing component. Total government debt runs neck-and-neck with total household debt, tied for second place from 1975 until the mid-1990s when (as we saw yesterday) government debt growth slowed. The blue line, showing household debt, continued its upward trend with no such slowing evident.

From about 2000, government debt resumed an upward trend. But it increased more slowly than household debt, and both increased more slowly than business debt until we approached the Paulson crisis.

The crisis upon us, household debt flattened in 2008 and fell slightly in 2009. Business debt slowed in 2008 and fell sharply in 2009. And government debt grew sharply in 2008-09, in response to the economic slowdown.

Public v Private

Part One of a series

Googlin' total US public and private debt got me to a Bailouts blog post, which links to the Federal Reserve Statistical Release website. From there I grabbed the newest (June 10, 2010) and the oldest (September 12, 1996) available "Debt growth, borrowing and debt outstanding" (PDF) files. Each is only 3 pages long. Nice.

To get Debt Outstanding numbers into GoogleDocs in a useful form, I copied the relevant portion of each PDF to a notepad file, saved it, renamed it from "TXT" to "CSV" and then added a bunch of Cs -- commas -- in all the right places, hoping for the best. Not a great deal of work, but more than it should take. The data format is not "friendly." But it's the Federal Reserve, so what can you expect? (This is not the St. Louis Fed. Their stuff is good and friendly.)

But I don't mean to complain too much. Unfriendly formats are better than not having numbers to look at. Thanks, Fed; good job. Two or three tries to get the commas right, followed by a little formatting in the GoogleDocs spreadsheet, and we're good.

And wouldn't you know it, now I have a problem. Couldn't miss it, the dip was that obvious. Notice the red line in this graph rising until 1990, then a kink, and it runs basically flat until 1994. None of the other lines show a comparable slowdown.

A while back I wrote

In 1990 and 1991 the tax code changed. The personal tax deduction for interest expense was eliminated. As a result, people cut back on credit use.

Well... It's true, sort of. As the graph shows, some people cut back on credit use. But it looks like the people who cut back were business people, not "personal tax" payers. The red line here, the one that shows a slowing, shows the debt of nonfinancial businesses, not household debt. Why did debt growth slow in the business sector? I don't know. Why did it not slow in the sector where the tax code actually changed? I don't know... I guess this is why I need to be nice to economists.

Anyway, while we're lookin' at the graph, look at the green line. The green line shows government debt -- federal, state and local, combined. The green line  in this graph rises until 1993, then kinks and runs pretty close to flat until 1999. And then it actually drops. And that's government debt, total government debt that flattened and dropped. People don't talk much about this slowdown, when they talk about government debt.

And while we're looking, take a look at the gold-color line. On this graph it starts out as the lowest of the four, and finishes up as the highest of the four. Obviously, it had the fastest increase during the years shown. This fast-growing, golden line of debt is the debt of financial business.

Into Africa

From the Center for International Finance & Development at the University of Iowa College of Law:

Do not be mistaken, there is still hardship in Africa, but a recent report has carefully examined and explained why the African economy has the potential to thrive. Africa has an abundance of natural resources as well as human capital. Furthermore, African economies were more resilient through the worldwide recession of 2009 than many more developed economies . This resilience may have proven to investors that the African economy is not as risky as was once thought, resulting in an increased willingness to invest.

If they were "more resilient through the worldwide recession," if they can bounce back quicker, then I expect they have less debt. They may be poor, but they have less debt.

I expect they have less private-sector debt, so that the private sector is less disturbed by the sorts of problems that plague debt-ridden nations -- financial crisis and the threat of deflation chief among them.

How the Scientist Thinks

Darwin and a fellow scientist were searching for fossils in the north of England. They were not aware of the glacial theory at the time. Years later Darwin revisited the area, and he was now astonished to discover how clearly marked were the glacial ridges on the rocks. He had not noticed them on his earlier visit because he was not looking for them.... Darwin was able to appreciate the glacial markings only after he became aware of the glacial theory.

Lionel Ruby, "How the Scientist Thinks." In From Paragraph to Essay. Ed. Woodrow Ohlsen and Frank L. Hammond. New York: Charles Scribner's Sons, 1966.

• Glacial Theory
• Lionel Ruby lookup

KeenWatch

Conclusion

The core propositions shared by the Bezemer-Fullbrook group were that the superficially good economic performance during “The Great Moderation” was driven by a debt-financed speculative bubble, which would necessarily burst because the debt added to the economy’s servicing costs without increasing its capacity to finance those costs. At some stage, the growth of unproductive debt had to falter, and when it did a serious financial crisis would ensue as aggregate demand collapsed.


All debt is unproductive. There is no such thing as productive debt.

Ricardian Equivalence

Ricardian Equivalence is an attempt to explain why deficit spending does not boost economic growth.

This is important, because Keynesian economics says deficit spending does boost economic growth.

The better question is not whether deficit spending does or does not boost growth, but rather why in some periods is does, and in other periods does not. The Arthurian alternative to Ricardian Equivalence is Credit Efficiency, and it answers that question.

A Look at Federal Spending

At the PerotCharts site we read:

For the past 28 years the government’s share of GDP has fluctuated in a narrow 5% range, with a high of 23.5% in 1983 and a low of 18.4% in 2000.

According to Perot, federal spending "fluctuated" during those years. Varied at random. It is more accurate to say federal spending declined from 1983 to 2000.

The graph at right is my version of the PerotCharts graph, based on the numbers Perot used. For copyright reasons I don't want to use Perot's chart. (That, and his graph color clashes with my blog background.)

Perot has an absolutely beautiful graph that shows a decline in Federal Spending from 23.5% of GDP in 1983 to 18.4% in 2000. You'd think people would be thrilled with that 5-point decline.

But no one was thrilled. No one seemed to notice the victory over federal spending. Everyone just kept calling for more spending cuts.

Why? I think, because we didn't get the economic growth we expected. We didn't get the good results. And since we didn't get results, it's like the reduction of government spending never really happened.

Either that, or the theory was wrong, the theory that says starve the government and the economy will grow:

In Wanniski's view, the Laffer curve and supply-side economics provide an attractive alternative rationale for revenue reduction: that the economy will grow, not merely that the government will be starved of revenue.

If the theory was right, that five-point drop in federal spending should have paved the way for a significant economic boom. But that didn't happen. Instead, we got a recession, a war, an increase in federal spending, and an increase in deficits.

If government spending cuts were the thing we needed to make the economy grow... If government spending really was the thing holding back growth... Then the 17-year decline in federal spending relative to GDP should have had a cumulative, steam-roller effect, making things better and better toward the end of that period.

Things should have been better toward the end of that decline, and better even for some years after the end of that decline. That did not happen. If Wanniski's theory was right, that five-point drop should have positioned us to bounce back strong from the 2001 recession. That did not happen.

We thought the growth of federal spending was the cause of economic problems. We thought federal spending cuts were the solution. But we tried this solution, and it did not work. We may conclude the growth of federal spending is not the cause of the problem, and federal spending cuts are not the solution.

The solution we have not tried is to restore monetary balance -- balance between circulating money and money in savings. Balance between the two sides of M2 money.