Reading tealeaves

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I'm backing up. Back to Tuesday's post where I quoted Cullen Roche from comments below William Vickrey’s 15 Economic Myths Debunked at Prag Cap.

But hold on now. It's not Vickrey's 15 Myths. It's Vickrey's debunking. Just to be clear on that :)

Roche opens the post, dated 16 September 2014, with these words:

This is an oldie but a goodie. William Vickrey was a Canadian economist and Nobel Laureate. He was well known for being critical of most things out of the Chicago School of Economics. This piece on 15 economic fallacies has been largely ignored, but the lessons are important and certainly as relevant today as they were in 1996 when Vickrey wrote them.

"... Largely ignored ..."

In some circles, maybe. I want to point out that Vickrey's debunking was brought to our attention more an three years ago by our very own nanute:

... an interesting working paper from the late Bill Vickrey on economic fallacies... Pay close attention on what he has to say about inflation and employment.

Oh. Yeah, I'm sure Prag Cap has more readers than The New Arthurian Economics. No doubt Cullen made a bigger dent in the ignorance of Vickrey's work than we did here. But that only means that Prag Cap's readers should have been coming here first....

But, to the point: The oldest comment on Cullen's Vickrey post is from tealeaves who writes:

If we look at the monetary interest paid on debt as a percentage of GDP, we see that the total interest paid on debt is recent lows (currently at 15%). Monetary interest peaked in 80s at 30% (the series doesn’t start at that point). The drop in monetary interest fell to 15% largely because interest rates have fallen since the 80s. And this drop in in monetary interest occurred even though the aggregate debt levels as a percentage of GDP have risen. (TCMDO/GDP).

http://research.stlouisfed.org/fred2/graph/?g=lZV

Obviously when interest rates rise, this “steals” away from corporations future profits or from consumers disposable income. This situation is probably not a problem for a long while if rates are low (below the 4% range). But because TCMDO (total credit) increases as at faster rate then GDP, isn’t here a potential for “crowding out” by monetary interest stealing more and more of future production as rates and total debt rises?

Yes, absolutely, yes.

I've said many times that interest costs, profit, and wages compete with each other for dollars of income. A dollar that goes to wages doesn't go to profit. A dollar that goes to interest doesn't go to wages or profit. You just have to look at the economy as Adam Smith did in Book I Chapter VI: Of the Component Parts of the Price of Commodities. Look at shares of income.

I prefer to say interest "competes" with wages and profits. But "steals" does get the point across. And tealeaves' description of interest costs "crowding out" wages and profit is exactly right.

Now, how does Cullen Roche respond to tealeaves? He evolves a bit. Cullen starts out rejecting the idea:

Interest is just another form of income.

But then he thinks about it for a moment:

If interest rates rise substantially then someone is earning a high income from this and someone is paying a higher fee for holding money.

He's being honest with himself, and a detail slips into his brain. "This doesn't necessarily 'crowd out' anything," he writes,

but I guess it could if it causes undue pressure on any particular sector (like the household sector when housing prices began to decline in 2006).

Yes indeed: "undue pressure". I guess you could get undue pressure if there was excessive reliance on credit, say. Only, it's not "pressure". It's a shift of income out of wages and into interest. It's a shift of income out of the productive sector and into the financial sector.

Excellent work, tealeaves! You opened Cullen's mind.