Saturday, March 12, 2011

More Debt Than Money


Reviewing this morning's post, one sentence sticks in my throat:

There is more debt than money to pay it off.

That sentence is an argument waiting to happen. I want to head it off at the pass. But first, a little documentation:

Under the heading "The 'Mathematical Flaw'" in Money and the Federal Reserve System: Myth and Reality by G. Thomas Woodward, one reads:

Nor is there any reason why there must be enough money outstanding to pay off all outstanding debt. The money needs of the economy are much smaller than an economy's total debt. Money circulates; it gets used repeatedly in the course of a year. Transactions take little time. As soon as money is used in one transaction, it is available for use in another. Consequently, the money stock need only be a fraction of the total transactions that take place in a year.

An economy only needs enough money to complete the transactions that occur in the course of normal business -- not a sum related to total debt.
And now I'm ready.


It has been pointed out that money circulates, so it is okay to have more debt than money in the economy.

Well, yeah. But that's the simplified version.

When there is $3.50 of debt for every dollar, money doesn't have to circulate very fast to cover the payments. When there is $35.00 of debt for every dollar of money, the money has to move ten times as fast. That's a big difference. There is a much greater chance that payments will be missed.

And there is a much greater chance of a cascade effect from missed payments.

Finally, it is worth noting that G. Thomas Woodward's view depends upon continuation of "the course of normal business," which is itself put at risk by the growth of debt.

Other than that, there is not much effect from excessive debt, except that the costs related to debt are much greater and more of a hindrance to growth. You know.


7 comments:

Bigvic said...

First, I want to ask: Where did you get that amazing graph?

I am of the opinion that we just went through an enormous bubble, and through the stimulus were just trying to continue this bubble. The problem is that to deleverage will lead to destabilization. This is one enormous credit fueled bubble. I agree with you that any explanation that leaves out money and debt is deficient, but I think an explanation that only takes money and not value into account could be equally deficient. I think credit and easy money might have distorted value, that's more of an intuition than a fact though.

The Arthurian said...

THANKS!! That's my graph.

Two things about it:
1. The dates of the 1933-1947 downtrend correspond almost exactly with the presidency of FDR.
2. When I first started drawing this graph in the late 1970s, the most recent high point (then) was not much higher than the 1933 peak. That made the 1933 peak look much higher and more menacing than it appears today.

The downtrend means that the quantity of spending-money (M1) increased relative to the total accumulation of existing debt. Bankruptcies and foreclosures and such during the Great Depression helped reduce debt. More significant, I think, was that because of the Depression people didn't continue to increase their debt. (We might have had another Depression at any time since 1974, except out economic policies did their best to prevent it... which means the accumulation of debt continued to grow until 2008 or whatever.)

On top of that, FDR's policies -- including devaluation of the dollar and deficit spending -- increased the quantity of money in circulation, or spending-money, or M1 money (all the same thing).

So the limitation of debt-increase, combined with the government policy of increasing the money, was exactly the fix out economy needed. (Remember, we had a "golden age" after FDR, from 1947 to 1973! Look at it on the graph.)

So the $787B "stimulus" specifically, I do not see as a "bad" thing. It was a move similar to what FDR would have done. (But I'm not sure anybody in power understands that they needed to do it to reduce Debt-per-Dollar. I think they were just imitating FDR.)

You write:
I agree with you that any explanation that leaves out money and debt is deficient, but I think an explanation that only takes money and not value into account could be equally deficient.

By "value" I take it you mean the value of the dollar: inflation. So then you are saying we need to consider money and debt (and debt relative to money) but we also need to worry about inflation. Agreed!

And when you say, "I think credit and easy money might have distorted value," I think you mean that credit and easy money contributed much to inflation. Or again, that the excessive reliance on credit (which produced the result we see in the graph) contributed to inflation. Agreed!

Existing policy encourages the use of credit (to encourage economic growth) until inflation becomes unacceptable. Then the policy makes interest rates higher, to choke off additions to credit-use.

Existing policy encourages the use of credit and the accumulation of debt until X, and then chokes off the use of credit BUT DOES NOTHING ABOUT THE ACCUMULATION OF DEBT.

I say it is the use of credit that has contributed to inflation. And I say we must fight inflation BY PAYING DOWN DEBT. We must fight inflation not by choking off additions to credit use, as we do now, but by paying off debt faster than we did from 1947 to 2007. (I suggest tax incentives to accelerate the repayment of debt.)

I think I just agreed with everything you said. :)

Bigvic said...

No, by value I actually meant a return to Ricardo, that is an intrinsic value, whatever that may be.

Inflation goes without saying, but I would lump that up with money and debt, and as the only realistic way moving forward. There is no realistic means (at the current) without inflating away the debt or destabilizing the country (which I suspect the politicians will not do). There is no disagreement here that the debt per dollar needs to be decreased, I just think that the policies that got us here is more than just actors acting on bad faith. I think it is a symptom of marginal utility theory.

The Arthurian said...

Bigvic, could you explain this part:
I just think that the policies that got us here is more than just actors acting on bad faith. I think it is a symptom of marginal utility theory.

Bigvic said...

What I mean by bad faith in this respect is one acting on with good intentions one a basis which is bad, but one has convinced himself of it being good. In this sense, I do not belief that the bad policies are a result of bad faith (I have to agree with Sartre's view of "Bad Faith", although I have always preferred Camus). I think it would be too easy to say that smart people were really not that smart, and mistakenly picked wrong policies that led us to this mess.
I believe they knew that something was wrong. I want to quote Krugman here (because I agree with his initial diagnosis, but his argument).

"During the golden years, financial economists came to believe that markets were inherently stable — indeed, that stocks and other assets were always priced just right."

To this I must add, I don't think these people were idiots, I think they knew something was up, that is, they knew that assets were not priced just right. The major problem with saying something like that of course would that you would undermine what has held neoclassical economics together for the past one hundred years, marginal untility theory. Anyone who was (and in some respect still is) stupid enough to try to undermine this today might as well find himself underemployed in the economic profession.

Of course I can't proof any of this (or else I would have a Nobel Prize right now), these are all just my speculations. I am just of the opinion that with out an intrinsic value system for all commoditties, money lacks any true value (just a subjective one) and that is where the distortion to it is to occur. This probably has to be the greatest contradiction of neoclassical economics, the idea of no free lunch, and yet marginal utility makes everyone better off.

The Arthurian said...

I didn't go to school for this stuff, you know. I think of "utility" as usefulness or benefit (to the user). I think of "marginal" in terms of the next economic decision. All the web definitions refer to "one" unit. It only makes sense to me as the NEXT one. So then marginal utility is the usefulness to me of the next [whatever I want].

This is beautiful: This probably has to be the greatest contradiction of neoclassical economics, the idea of no free lunch, and yet marginal utility makes everyone better off.

You say, I think it would be too easy to say that smart people were really not that smart, and mistakenly picked wrong policies that led us to this mess.
I think it is easy to say the people in power are bad people. I prefer to say they were wrong about policy. My way opens the door to fix a problem. The other way opens the door to revolution.

Bigvic said...

"I didn't go to school for this stuff, you know."

Sorry, I have an annoying habit of doing that.

I think your definition of marginal utility is pretty much correct. I think marginal utility works on a micro-economic level subjective level. But I see it as a mistake to treat microeconomics and macroeconomics the same exact way. I think that greatest thing learned from the 1930s. On a macro level, I think the idea of aggregate subjective values adding up to an objective level is absurd (this is completely postmodernist thinking). It is like saying popular opinion is now fact.

"I think it is easy to say the people in power are bad people."

I agree with you. That is not what I was trying to say. By no means did I mean that the people in power were bad, I just meant they were human. The were easily pressured to conform to a system that discourages (and reprimands) you for undermining it. I see it everyday in my classes. Students might have a pretty valid reason for questioning a professors assumptions, but he knows better, for the ethical teachers will just ridicule your position, and the unethical ones will make your life (and grades) hell. Then of course comes time for employment (or internships, and you have to study the economists working at a place and say what they want to hear). I by no means believe people who were conforming in order to maintain their livelihoods are bad people. I am an editor of a peer-reviewed undergrad journal, try getting published writing something that deviates from the mainstream, it won't happen. The other editors know better than to let a paper that could "jeopardize" the reputation of journal (because for most this is a resume filler) and therefore it forces and anyone serious about trying to make it into graduate school or academia conform to the standard. This is not a conspiracy by any means, this is just the logic of the system. There is a reason for my general apathy, not that I mean to personalize this. I am not arguing for revolution (not in the traditional sense), the only real way to change anything is the exact same way as it has been, through a paradigm shift (as Kuhn argues).