Thursday, January 23, 2014

Winterspoke


From Winterspeak:

A married, mid-career professional couple will find themselves making over $250,000, comfortable by any standard and likely in the 1% or close, but such a "prudent clean and sober" couple is not driving inequality in the US. That's being driven by the Finance industry, which is growing primarily on debt and derivatives. The latter can be outlawed, and the former can be more accurately priced by banning securitization and forcing sound credit management by requiring debt to be held on the issuer's books to maturity.

I like that, and I was gonna let it stand on its own. But Winter tacked on one more sentence --

Manage resulting credit contraction through fiscal action.

-- and I have to look at it. I cannot imagine a "fiscal action", an increase in government spending, large enough to compensate for the credit contraction our economy requires. We need to cut debt at least by half, and that means a credit contraction of at least $29 trillion, or close to TWO TIMES GDP.

Nobody wants that much government spending.

What we have to do is prune back the incentives that encourage borrowing and lending, and create new incentives that encourage the repayment of debt. We can have a nice, gradual decompression, but that's not really the right word. We can have a gentle change from excessive reliance on credit, to reliance on the dollar. And all the while that change is taking place, things will be getting better, and people will notice that things are getting better.

If we borrow less, if we prune back finance, then the central bank will be able -- willing and able, I'm sure -- to increase the quantity of actual money we have in the economy. And this is exactly what needs to happen. But it cannot happen as long as Congress and the Fed continue to think that we need more incentives for lending and for borrowing.

Granted, since the crisis it may be more difficult to do it my way. But then, since the crisis, everything is more difficult.

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Related remarks: The One-Page Guide

7 comments:

Jazzbumpa said...

Help me understand where you get a value close to $60 trillion for debt.

The Arthurian said...

From FRED of course.

geerussell said...

Fiscal injections don't need to replace private debt $ for $. Fiscal injections provide equity on the private sector's balance sheet and it's the ratio of equity:debt, or leverage, that really tells how stable, how burdensome that private debt is.

Which brings me back to one of my favorite charts.

It doesn't take that drastic of a fiscal injection combined with private debt contraction to bring the amount of leverage down to less precarious levels.

The Arthurian said...

"It doesn't take that drastic of a fiscal injection combined with private debt contraction to bring the amount of leverage down to less precarious levels."

Yeah I think you are right, G, but I have to think about it in the morning, not at the end of the day.

On a slightly different topic, while we have your graph handy...

From 1981 to 1995 there was a significant increase in Federal debt relative to GDP. This was a fiscal injection also, yes?

Look what happened. For most of the 1980s your private/public ratio (black line) ran flat. In other words, private debt used up every last bit of the fiscal injection. There was no real relief until the late '80s when the black line actually fell.

Private debt growth slowed from the mid-1980s to the early 1990s. I think this was a result of changes in the tax code: elimination of the tax deduction for interest expense and possibly other things.

My point: In order for a fiscal injection to actually fix the problem, it must be "combined with private debt contraction" as you say. Otherwise, the injection is simply frittered away.

Coldly put: This is the purpose a Depression serves -- it forces a contraction in private debt. Policy these days can circumvent a major contraction, but provides no alternative means of forcing the contraction.

The Arthurian said...

Oops.

Policy these days can circumvent a major depression, but provides no alternative means of forcing the contraction of debt.

Jazzbumpa said...

From FRED of course.

Which data series, please.

The Arthurian said...

Geerussell: "Fiscal injections don't need to replace private debt $ for $. Fiscal injections provide equity on the private sector's balance sheet and it's the ratio of equity:debt, or leverage, that really tells how stable, how burdensome that private debt is."

I know accounting lingo is all the rage these days, but it is like using a foreign language. Rather than using le mot juste, I prefer to speak simply.

"Government spending doesn't need to replace private debt dollar for dollar."

Private debt has two parts: the stock of existing debt, and the flow of new additions to that debt. Consider them separately.

New additions to debt provide an increase in current spending and a boost to aggregate demand. Each dollar less of new private debt is a dollar less demand. If government spending is to offset a reduction of private debt growth, there has to be dollar-for-dollar increase in government spending.

The stock of existing debt creates a drag on aggregate demand because the money we pay as interest is money we do not spend on other things. (It is true that the recipients of that money might spend it on other things. But that spending is delayed until after the interest transaction takes place; this delay itself is a drag on aggregate demand. Delay aside, if the interest payment is seen as a transfer of money from spender to saver, it is clear that the recipient of the interest payment is less likely to spend that money than the debtor would have been. This also is a drag on aggregate demand.)

In addition to the interest on existing debt, repayment of principal is also a drag on aggregate demand. Given a personal saving rate of 5%, we can say 95% of every private dollar is spent. So for every extra dollar that is used to pay down debt, there is a 95-cent reduction of spending. If government spending is to replace existing private debt and maintain aggregate demand, it will take 95 cents of extra government spending per dollar of private debt reduction. That may not be exactly dollar-for-dollar, but it is damn close.

Government spending DOES need to replace private debt dollar for dollar, if that is the approach we are to take.