Advice for Beginners: Toward a solution to the problem of debt

Nick Rowe, November 29, 2011:

Why has (private) debt increased?

Anyone got good graphs, showing private debt/income ratios back over several decades?

[and in comments]

http://krugman.blogs.nytimes.com/2011/11/29/debt-history/

He's got a good graph for the US, since 1916.

But debt to income ratios may not be the most informative way to look at debt. That's the way everybody looks at debt, and the problem remains unresolved. I suggest debt to circulating money, the money that is used to pay down debt. As this ratio increases, it becomes increasingly difficult to pay down debt. And I suggest the ratio of private debt to public debt, because it is closely related to good times and hard times.

Paul Krugman, November 29, 2011

Debt History

As part of that long-term project, I’ve been looking at the long-term debt history of the United States, using both the Fed’s flow of funds data (which start in 1952) and the earlier, not quite comparable, data from Millennial Historical Statistics. Here’s what I think is a key chart; it shows nonfinancial private-sector debt as as percentage of GDP:

One thing that jumps out is the surge in the debt ratio during 1929-33, which is due to a plunge in GDP rather than a rise in debt — call it Irving Fisher’s revenge. Another is the fall in the debt ratio during World War II, reflecting a combination of income growth, low borrowing, and some very helpful inflation; I’d argue that this debt reduction played a key role in the economy’s ability to avoid a relapse into depression.

But a broader point is the U-shaped trajectory over time. This matches up with a lot of things. Gary Gorton’s “quiet period” of freedom from financial crisis probably has a lot to do with low debt, as well as deposit insurance. The trajectory also matches long-term trends in income inequality and political polarization.

More on this eventually; for now, I think the data are really interesting.

Krugman points out "the fall in the debt ratio during World War II" which, he says, "played a key role in the economy’s ability to avoid a relapse into depression." Well, sure. But beyond that, the debt reduction played a key role -- the key role -- in creating the economic vigor of the post-WWII period by permitting demand to expand more rapidly than income, as debt was again able to increase from a low level.

Arthurian, December 18, 2009

Clarity

The problem is debt. We need to reduce debt.


We need tax incentives that get us to pay off debt faster than we do now. That will reduce debt. That will reduce the debt problem.

Accelerated repayment of debt also fights inflation. And it makes the financial system stronger.

All the pieces of the puzzle fit.

I offer an idea that needs to be taken seriously by people who know more than I do. Two years later, Krugman is pointing out the obvious, and Rowe is looking to start thinking about debt.
I wonder what ever happened with Krugman's long-term project, and what ever happened to his focus on private debt, and Rowe's.

Gross & Net Interest Cost (a first look)

Gross (red) and Net (blue) Interest Costs

The obvious reply to a complaint about the cost of interest is to point out that interest cost is exactly equal to interest income. The underlying assumption is that we should be happy to receive the interest income, happy enough not to complain about the interest cost.

All well and good. But interest income is not a payment to productive activity. It is a payment to financial activity. Interest cost and interest income move money out of the productive sector and into the financial sector. Financial cost hinders production and consumption. Financial cost hinders supply and demand. Financial cost hinders the economy.

Fact-checking FactCheck.org on the Inaugural Address

For the record, I am completely apolitical.


I was gathering my thoughts in order to write a response to Paul Krugman about the proposed "border adjustment" tax. I wanted to phrase something in a way that was reminiscent of the recent inaugural address, so I looked that up. The Google hit for FactCheck.org said

President Donald Trump was no different in that regard. But in his inaugural address, Trump portrayed the United States as a nation in decline, ...

That caught my eye, because yeah. Because analyzing the problem and fixing the economy is my life.

The Long-Term Decline of Real GDP Growth

So I clicked the FactCheck link. Here's what I got:

Presidents typically avoid facts and figures when delivering inaugural addresses, serving up a blend of broad platitudes and generalities to lay out a vision. President Donald Trump was no different in that regard.

But in his inaugural address, Trump portrayed the United States as a nation in decline, using rhetoric that did not always match reality:

• Trump portrayed the U.S. as crime-ridden and promised to stop the “American carnage.” But the U.S. violent crime rate in 2015 was less than half what it was at its peak in 1991.
• Trump promised to “bring back our jobs.” Manufacturing jobs have been on the decline for decades, but Trump inherits an overall economy that has gained jobs for a record 75 straight months and has an unemployment rate well below the historical norm.
• He said he would “get our people off of welfare and back to work.” But the welfare rolls have declined under President Obama, and they have dropped precipitously since President Clinton signed legislation in 1996 instituting work requirements and time limits.
• Trump promised to “bring back our borders,” blaming past politicians for “refusing to defend our” border. But the U.S. Border Patrol budget has tripled since 2001, and the number of border patrol agents has doubled. Southwest border apprehensions have dropped 75 percent from the peak in fiscal 2000.

The highlighting is mine. And I'm sorry about those stupid flowers where there should be bullet points. I still have not figured out how to change that.

Crime

Using the FactCheck.org link to the inaugural address, I find exactly one occurrence of the word "carnage" in Trump's speech. And one use of the word "crime". If we judge by the FactCheck response, Trump used the word carnage specifically to describe the effects of crime. The FactCheck response is incorrect.

In the paragraph immediately before the "carnage" sentence, Trump points to "poverty in our inner cities" and "factories scattered like tombstones across the landscape" and "an education system" that isn't working, and "the crime and the gangs and the drugs". In the paragraph immediately before that one, he says

Americans want great schools for their children, safe neighborhoods for their families, and good jobs for themselves. These are just and reasonable demands...

FactCheck takes this powerful imagery and these reasonable demands, and reduces it all to "crime". The FactCheck response is incorrect.

Jobs

FactCheck objects to Trump's "bring back our jobs" statement, noting that the economy "has gained jobs for a record 75 straight months". Well yeah, and that's good. But don't forget, we almost had a Great Depression there, that our previous President inherited. Getting over it occupied all of his eight years in office, and things are not yet back to normal. I was saying last summer that I expect vigor within the next few years because things are finally getting ready to get back to normal. And I was very clear, saying "the changes which will create the good years to come happened mostly during the Obama years." But this does not mean that our economy is in good shape today. FactCheck implies that our economy is in good shape, and that Trump's focus on jobs is off base. The FactCheck response is clearly incorrect.

They also point out that we have "an unemployment rate well below the historical norm". Oh. My. God. Yeah, okay, maybe so. But it is a claim made in ignorance. First of all, the unemployment rate went down because things got so bad. Unemployment got so high that people gave up looking for work. People who give up don't get counted in the pool of available labor. And that pushes the unemployment rate down. It's like when we can no longer afford prime rib so we eat beans instead, and then they stop counting prime rib and start counting beans when they figure inflation, and that brings the inflation rate down. Are prices really down? No.

Is most everybody working that wants to work? No. But like FactCheck says, the unemployment rate is down.

Actually, they say the rate is "well below the historical norm". Today the rate is 4.7%. They do not say what years they used to determine their historical norm. But if you go back before 1970 and look between the recessions you find the unemployment rate at four percent, below four percent, and at three percent. And if you look at recessions, in the years before 1970 the highest that unemployment every got was six or seven or eight percent. If you look at the years after 1970 you get highs of 6 and 8 and 9 and 10 and 11 percent. The lows are higher, too, after 1970. So the "norm" in the years after 1970 is higher than the "norm" in the years before 1970. That's the thing that troubles me: the long-term decline of the U.S. economy. So you've got that on the one hand. On the other you've got FactCheck saying unemployment is "below the norm".

The FactCheck response is insane. The norm is too high.

Welfare

When my son Aaron was six or seven years old, he and I were talking about the U.S Constitution. We got to the "promote the general Welfare" part and I asked him what he thought it meant. "We should give everybody welfare," he said.

No, I told him. It means they should do things to improve everybody's chances of doing well. Or, they should do things to improve the economic environment, as I prefer to say.

Well, FactCheck uses the word "welfare" like a six year old:

But the welfare rolls have declined under President Obama, and they have dropped precipitously since President Clinton signed legislation in 1996 instituting work requirements and time limits.

You're kidding me, right?

And what was it Trump said in his inaugural?

We will build new roads and highways and bridges and airports and tunnels and railways all across our wonderful nation. We will get our people off of welfare and back to work, rebuilding our country with American hands and American labor. We will follow two simple rules: buy American and hire American.

President Trump's focus was clearly not "the Welfare State" that Newt Gingrich wrote about in To Renew America (1995). Trump's focus was jobs. Not on making it so that people who get welfare have to take jobs, like Gingrich and Clinton, but rather on making more and better jobs available.

Whether he can do it is immaterial. The FactCheck response is incorrect.

Borders

"The U.S. Border Patrol budget has tripled since 2001" FactCheck says, and "border apprehensions have dropped". I'm not going to defend The Wall. But I will point out that if there are fewer apprehensions, if the trend of border crossings has been fewer people coming into the U.S. and more people leaving, it is primarily because the U.S. economy was so bad that even Mexicans couldn't get work.

Sorry to have to say it that way.


I am all in favor of telling the truth. That's my number one rule of writing. But the rule doesn't only apply to other people. It also applies to critics of other people.

If FactCheck.org is going to criticize the President, they should do it carefully and well. They should be damn sure they are right, twice as sure as the guy they are criticizing. Otherwise, we'll need fact-checkers to check the fact-checkers -- and where will it end?

Fact-checkers have to be more than honest. They also have to be willing to interpret their victim's words generously. It's a rare word that has but one meaning. It is easy to read things incorrectly.

In particular, if a fact-checker's political preferences differ from those of his victim, the fact-checker must go out of his way to interpret generously. And I don't see that in the FactCheck.org review of the Trump inaugural.

FactCheck tells us that inaugurals usually serve up "broad platitudes and generalities". So we should expect the wording of the Trump inaugural to be broad and general. But FactCheck takes great schools, safe neighborhoods, and good jobs, filters them through the word "carnage", and gives us only "crime". FactCheck takes a focus on jobs and flushes it down the toilet by suggesting that we have all the jobs we need. And FactCheck takes a focus on improving our economy and reduces it to "welfare".

The FactCheck response is incorrect.


For the record, I am completely apolitical.

Things change

Interest expenses of domestic financial corporations:

It used to be that interest paid on deposits was 3½ times the size of interest paid on other liabilities of domestic financial corporations.

Today, interest paid on other liabilities is 12½ times the size of interest paid on deposits.

"The drastic Republican border-tax package"

The title of the article is Jack Mintz: Why the drastic Republican border-tax package probably won’t happen. At the Financial Post.

Jack Mintz strikes me as just like all the other guys saying President Trump's economic policies won't work. I'll take advantage of this opportunity to say the people criticising Trump-o-nomics are probably the same people who didn't see the crisis coming, and who have not much changed their thinking in the years since. Just a guess, but that is how it strikes me.

So I'm not going to quote any part of Mintz's article except this:

The proposal has three major elements. First, the federal corporate tax rate would be reduced from 35 to 20 per cent. Second, comes the cash-flow tax, which would allow companies to expense investments, but they could no longer deduct the interest they pay on debt. Third comes the border-adjustment tax, where companies would pay no corporate income tax on all export revenues, but would also no longer be allowed to deduct the cost of imported inputs from their taxable profits.

There are things in there that I don't care for, and things in there that I don't care about. And there is this:

They could no longer deduct the interest they pay on debt.

Of all the things that must be done, this is right up at the top.

// Update:

For more on the tax proposal see Border Adjustments, Tariffs, VAT, and the Corporate Income Tax the Conversable Economist.

You don't just show a graph and assume that the trend it shows will continue forever

Menzie Chinn takes a look at President Trump's goal:

Boost growth to 3.5 percent per year on average, with the potential to reach a 4 percent growth rate.

(From the Trump-Pence website)

Professor Chinn shows a graph of Potential GDP which suggests that Trump's target is out of reach. This FRED graph shows the problem: Basically, Potential GDP would have to reach twice the level projected by the CBO. That ain't nothin.

As you may remember, though, I have been predicting economic vigor since last March. So you know where I'm coming from. Before any Trump anything, I was expecting vigor in GDP growth. And now we have Trump.

The vigor that I expect, arising from changes in monetary balances, will add to whatever vigor President Trump can get from his policies, so that economic growth might exceed the President's growth target. And wouldn't that be something.

But this is not a post about economic vigor or Donald Trump. This post is about Menzie Chinn's evaluation of a growth target.


Professor Chinn's Figure 1 strongly suggests that Trump's target is out of reach. His Figure 2 shows RGDP from the late 1940s to the present, with Trump's growth targets appended, to "place into historical context what a 3.5% or 4% growth rate looks like":

Econbrowser Figure 2: RGDP and Trump Targets

Chinn follows the graph with this observation:

... it seems unlikely to have acceleration of growth to the indicated rates...

The post was later updated. But the above observation was Menzie Chinn's conclusion at the time that I offered this reply:

The purpose of Figure 2 seems to be to show that the 4% claim is ridiculous. The RGDP growth rate for 1996-2000 was over 4% if my eyeball is working right. It wasn’t ridiculous then.

Another commenter, Bruce Hall, had a reaction similar to mine:

With the exception of the last decade and the “oil shock”, Trump’s target doesn’t seem quite so absurd.

Let me try again to express my reaction: You can't just show a graph of the economy not doing well for most of the last fifty years and use it as evidence that the economy will continue to do poorly. The graph shows evidence of what happened, not of what's going to happen.

I look at graphs all the time. I always want to know what happened, and why, and what was going on with monetary balances in the meanwhile. Then I try to read the tea leaves the economic forces and see what those forces might imply about the future.

You don't just show a graph and assume that the trend it shows will continue forever.


Am I reading too much into Chinn's post? I don't think so. I think he is using innuendo to make his point; innuendo demands that the reader put words in the writer's mouth. Bruce Hall and I put similar words in Professor Chinn's mouth.

But let me check my work. Figure 1 in the post shows the "contributions to annual Potential GDP growth" -- contributions from "labor force" and "labor productivity". I think this approach is called "growth accounting". I found it fascinating.

Following Figure 1, Menzie Chinn notes the large growth gap that must be made up if Trump is to hit his targets. Then he says:

For more on the growth accounting approach, see Dan Sichel’s EconoFact memo on this subject.

So I followed Menzie's link to Sichel's EconoFact memo. In the first paragraph, this:

Some of Trump's policy proposals, such as tax cuts and infrastructure spending, indeed could boost growth over the next couple of years. Such a boost would lift living standards and be a welcome change for all Americans. But ongoing growth, not just a short spurt, is required to continue raising living standards. The arithmetic of growth, and the experience of the past half-century, suggest it unlikely that sustained growth of this magnitude is possible.

The experience of the past half-century suggests it unlikely that sustained growth of this magnitude is possible.

You don't just show a graph and assume that the trend it shows will continue forever.

It's "Productivity and Cost", not "Productivity and Labor Cost"

Last week I suggested that we can improve productivity by reducing costs: in particular, by reducing the cost of finance.

Usually I try to avoid making claims like that, because I don't see cost in the calculation of productivity. Productivity is output per hour of labor. The units for "hours of labor" are time. The units for "output" are ... output, I guess. Things. Stuff. There is no cost number in the "things produced per hour" calculation. So until now I have tried to avoid talking about the connection between productivity and cost.

Of course, I have pointed out the increase in productivity that arose in the 1990s, just after Household Debt Service (a financial cost) went low:

Graph #1: Debt Service (blue) and Labor Productivity (red), and Forecast

(The graph also shows that I expect productivity to rise again soon.)

And I have pointed out that productivity always goes high as we're coming out of recession:

Graph #2: Productivity (Percent Change from Year Ago)

Recessions are times when costs are reduced. High productivity follows, every time.

And I have pointed out that productivity reliably goes high after financial costs go low: for two decades after the Second World War, and again for most of a decade after 1995. When productivity goes high again, over the next few years, it will confirm my hypothesis (though Donald Trump may get all the credit).

Even though the relation between productivity and financial cost is right there on the graphs, I have always avoided talking about the connection between productivity and cost because there is no cost number in the "things produced per hour" calculation.

That's about to change. I noticed that FRED lists productivity and costs together. And BLS puts productivity and costs together. And I thought about it.

Labor is not the only cost of doing business. It is generally the biggest, but not the only cost. If nothing else changes, a change in business financial costs will certainly affect business costs. Likewise, a change in household financial costs will affect consumer spending, and the resulting change in demand will affect business activity, output produced, labor hours consumed, and productivity.

Cost influences productivity, even though cost is not in the productivity calculation.

A "tacit understanding" is an assumption

Rated L for Language

Scott Sumner:

In 1981, 364 British economists signed a petition warning that Thatcher's polices would fail. But, by the 1990s, there was a sort of tacit understanding among policy-oriented economists that when countries get into trouble, market reforms are the only real option.

... there was a sort of tacit understanding among policy-oriented economists ...

"Tacit" means unstated. A "tacit understanding" is not the same as a well-developed theory. It is more like a well-developed assumption.

Note that a well-developed assumption is not necessarily correct.

According to Sumner, the idea that market reforms solve all problems is based not on economic theory but on a tacit understanding: This is what we did and it seemed to work. And by the 1990s, those rudderless economists were sitting around the "market reforms" campfire, building on each other's stories. But there was from the start a lack of clearness and of generality in the premisses.

The tacit understanding, the assumption of which Sumner writes, is nothing but an observation of outcome: Things turned out well. Set aside objectionables like the "great" recession, peak inequality, and the massive Federal debt, and things turned out well. "My view here is obviously somewhat subjective," Sumner says... Things turned out well.

There's no fuckin theory. It's all bullshit. They don't have a clue. They complicate their stories with numbers (364 economists on the head of a pin in 1981). They make shit up.

"The neoliberal policy revolution ... began in the late 1970s," Sumner says, and it "might be the most important recent event in world history." Singing songs 'round the campfire, and patting selves on back.

Where is the analysis of the problem? This whole neoliberal neoplasm that Sumner tirelessly, tiresomely celebrates is nothing but an observation of outcome: GDP continued to grow, so we must have done something right. But they are changing everything. And nothing they do solves the problem.

They deny it, of course. But they've been fixing things for forty years now. And they're still fixing things, because they still have not fixed the right thing. They still have not solved the problem of excessive private debt.

They say only that private debt doesn't matter. What they mean is, they're not even going to think about it. And then you get people like Sumner telling you forget about debt:

Forget about debt and focus on NGDP. It’s NGDP instability that creates problems, not debt surges.

Economics by proclamation: Forget about debt. It’s NGDP instability that creates problems, says Sumner, not debt.

Well, maybe. But it's debt that creates NGDP instability:

Excessive Private Debt --> NGDP Instability --> Problems

Dick.

What is debt?

Debt is the money on which we pay interest.