7 ms·

We can only cut debt by borrowing

27 points by chrismealy 16y ago

anigbrowl 16y ago
I strongly agree with Wolf's remarks. In a nutshell, he is pointing out that the major cause of the current economic stagnation is a lack of cash flow. Deficits can not be increased forever, but absent cash flow then GDP will continue to shrink, increasing the relative size of a nation's debt. Boosting GDP (ideally through sensibly targeted investments in infrastructure) makes debt more manageable, not least because infrastructural investments tend to pay off over the long term. With a little imagination and selectivity, a situation like this can be a good opportunity to reduce transfer payments and endorse productivity in both the social and industrial sectors.
- lzw 16y ago
  This is standard neo Keynesianism (neo because nowadays governments just roll over the debt while Keynes advocated repayment in full at the end of the recession.) The counter argument to it is very simple: this spending is spending money that comes out of the economy, and taking money out of the economy hurts economic growth. Further, many argue that the spending produces less froth than the money destroys when taken out- lower profits at the personal or corporate level mean less investment in growth via consumer spending or business expansion. Further we have just witnessed a perfect implementation of this theory- after the dot com crash, government lowered interest rates below inflation, making free money and spent massively running up record deficits. It managed to spark a housing boom and a lot of consumer spending... But the situation we find ourselves in now is simply the hangover from that party. If we get drunk again, it isn't going to banish hangovers and each time we do it, it gets worse while the body gets closer to death.
  - dasil003 16y ago
    Medical analogies for financial markets are pretty tenuous, but I find myself in agreement. A big issue from my perspective is that everyone is ringing their hands about home values and trying to prop up the deflating bubble. As someone with aspirations to own a home, this is infuriating. I can't afford a home, and neither could all the people who bought them. They need to let the prices fall to where people can actually afford them instead of trying to save the speculative value which we already know was based on hot air.
    - walkon 16y ago
      That was (and is) the ironic thing about all the government sponsored home ownership programs and legislation. They pumped up demand at an unreasonable rate, causing ever increasing prices, which made it harder to afford a house, which prompted further government stimulation...an endless loop, at least until the fiat charade ends.
      - anigbrowl 16y ago
        So why didn't the banks try to throttle the supply? It's funny, I don't recall any CEOs complaining about the economy being driven off a cliff in the runup to the bust. On the contrary, I was astonished at their readiness to give money away. Don't you recall the endless stream of refinancing commercials on TV? shows like 'flip that house'? The way everyone and their dog suddenly seemed eager to have a realtor's license? The guy at my local pizza shop had his realtor business cards on the counter next to the delivery menus. Edit: I see the truth is uncomfortable for some people. But the fact is that government promotion of home ownership is one thing, and instant approval of jumbo loans with 0% down are quite another. I got burned in a property boom when I was about 20 and this time I decided to stay out of the market.
    - matwood 16y ago
      The second option, and the one the gov. appears to be attempting, is to keep home prices steady and eventually let inflation catch up. This stinks for people who want to buy because they have to wait, but looks good for the gov. in charge. I'm with you and think they should just let prices fall. I can't find the video right now, but at one point President Bush was asked why he wasn't doing anything to prop up home prices. He responded that it's giving people who were priced out the opportunity to buy so he didn't see the need to do anything. His statement was early on in the recession and eventually he was pressed to do something though.
      - anigbrowl 16y ago
        The government hasn't been propping up prices, and the homebuyer's tax credit expired last April. If you talk to people in the real estate biz (I too have been looking for a house), you'll find that banks have about twice as many properties sitting empty as they do out in the market, and they are trickling them out because if they put them all on the market at once prices would crater (which would incidentally trigger another wave of repossessions). According to the banks, this is the tgovernment's fault, because the government is not throwing any money at them to invest in the future value of homes: http://www.housingwire.com/2010/09/27/bofa-analysts-call-for-ppip-2-0-to-reduce-shadow-inventory http://www.housingwire.com/2010/09/27/bofa-analysts-call-for... If it's the government propping up house prices, kidly explain why prices are stable when there are ~300,000 homes in various stages of foreclosure: http://www.realtytrac.com/content/press-releases/foreclosure-activity-increases-4-percent-in-august-6041 http://www.realtytrac.com/content/press-releases/foreclosure... Seriously, what information are you basing these conclusions on?
  - anigbrowl 16y ago
    We agree on the basic economics, ie repayment in full (which is also what Wolf advocates). Further we have just witnessed a perfect implementation of this theory- after the dot com crash, government lowered interest rates below inflation, making free money and spent massively running up record deficits. Ah...see I have a problem with this - with luck we can disagree without falling into partisan bickering. 'Government' is not this indifferent entity that does whatever it wants, it's people implementing policies, and I think you're glossing over the details. So we had a small notional surplus at the end of the last decade, and in 2000 we got a change of administration. We agree (I hope) that the seeds of the dot-com bust were already rooted; I don't blame any political figures in particular for that. Greenspan warned about 'irrational exuberance' etc., and pretty much everyone I knew told him to shut and stop being a party pooper. Sometimes people just have to learn the hard way. But the new administration came in and gave people a tax cut, on the principle that if the treasury was running a surplus then it should be giving the American people's money to them (the same tax cuts which are supposed to be expiring soon). Just so we're on the same page, when I refer to EGGTRA I'm talking about the 2001 tax cut and by JGGTRA I mean the 2003 (post dot-com bust) one: http://en.wikipedia.org/wiki/Economic_Growth_and_Tax_Relief_Reconciliation_Act_of_2001 http://en.wikipedia.org/wiki/Economic_Growth_and_Tax_Relief_... http://en.wikipedia.org/wiki/Jobs_and_Growth_Tax_Relief_Reconciliation_Act_of_2003 http://en.wikipedia.org/wiki/Jobs_and_Growth_Tax_Relief_Reco... Now, I say you're 'glossing over' things with your analysis, because while there are policy justifications for both cutting taxes to stimulate growth and paying off debt (less lovely cash in your pocket, but less long-term interest accruing while you sleep), it seems rather disingenuous to complain about government failing to pay off the debt and ignore the fact that the administration of the day opted to cut taxes and make up any shortfall with borrowing. Even the budget director at the time, Paul O'Neil, thought this was a dreadful idea, and by 2002 was expressing his alarm at the ballooning deficit, allegedly causing VP Cheney to respond with the argument that "Reagan proved deficits don't matter." O'Neil departed the White House by the end of that year. Now, several people have argued that the Clinton 'surplus' was no such thing, and amounted to little more than an accounting trick (for example http://www.craigsteiner.us/articles/16 http://www.craigsteiner.us/articles/16). There is some merit to this argument, but it is not disputed the the rate of increase in the national debt slowed down during that period, nor that it was ~$5.8t when the White House changed hands in early 2001. After that, deficits ballooned and the debt swelled considerably. A lot of people (like me) expressed the belief that cutting taxes like this was a terrible idea - a justifiable war of the kind the US undertook after 9/11 is one of the few occasions where you can persuade people to tolerate higher taxes, because a situation of genuine military necessity exists. It would have been better (in my view) to either use available revenue to slow the rate of deficit growth, or at least to pay for the Afghan war. Come 2003, and the administration launched a second war and another tax cut. At the time, objections to this were generally dismissed as loony leftism or sour grapes or lack of patriotism. I don't want to rehash all of those political issues, but from an economic point of view war is expensive and I haven't seen evidence to suggest that the tax cuts significantly boosted revenue - in fact, I agree with you that low, low interest rates had more to do with the asset bubble which followed. Now those tax cuts are set to expire, and because one party has suggested that perhaps it would be sensible to extend them for the great majority of people who earn under $250k/year (and that the increase on those making above would still leave them paying less than in Reagan era), the other party has taken its ball and gone home - rather than roll them back partially for now and fully later, they've instead committed to making them permanent, which means a ~$4t hole in projected revenues, right around the time we are entering a demographic retirement bulge, and a good deal of our infrastructure is in very poor shape. It's all very well to wag the finger and say it's time to lay off the fiscal moonshine, but I find it really hard to take seriously lectures about debt which blithely a policy of repeatedly substituting borrowing for revenue.
- deleted 16y ago
  [deleted]
ctdonath 16y ago
Absurd. Upshot is a continuation of what got us into this mess: denial of risk. He starts with the misguided notion that net debt is zero. The point of interest-bearing debt is that the debtor might NOT be able to pay the debt off. He then proposes ways to reduce risk to zero, with lenders suffering no consequences of risky loans - a furtherance of policies which got us where we are, determined to take risks then legislate away the consequences. The system is vibrant because of the willingness to accept risk. To enforce a risk-averse system is to destroy the benefits of risk. Isn't risk the core of ycombinator's purpose? to take risks, and to manage them better than others? The system cannot be cleaned up until the buck stops somewhere, until the music stops and those without chairs leave the game. Borrowing, in a fractional-reserve system, means that for every real dollar there are tens or hundreds of claims on that dollar. You can't pay everyone off because there isn't enough money - unless the government opts for hyperinflation, achieving the same basic ends thru redistribution of abject losses.
gvb 16y ago
I'm having a hard time swallowing the whole of the article, based on assertion [A]t the global level, debt cancels out: net debt is zero. So, in paying down debt, one is also reducing credit by an equal amount. I agree that (credit - debt) = zero. The problem is that credit is not a fixed amount due to the fact that it is leveraged... see fractional reserve banking. http://en.wikipedia.org/wiki/Fractional-reserve_banking http://en.wikipedia.org/wiki/Fractional-reserve_banking The leverage formula is (1 / reserve) where reserve is a fraction tending to zero. This is a non-linear relationship and we all know that the lim x -> 0 (1/x) = infinity. If lenders (e.g. banks) hold a 20% reserve, they will "expand" the money supply by 1/0.2 or 5x. If they hold a 10% reserve, they will "expand" the money supply by 1/0.1 or 10x. If they hold a 1% reserve, they will "expand" the money supply by 100x. As the reserve fraction goes to zero, the effective credit part of Martin Wolf's equation goes to infinity. A lot of exactly that type of lending was being practiced during the "bubble", especially in the housing market where mortgage underwriters were loaning more money than the houses were worth. This was happening before the housing crash - mortgage originators were advertising "we will loan you 100% the value of your house" (sometimes more than 100%).
- jonhendry 16y ago
  I'm not sure you're thinking globally.
- anigbrowl 16y ago
  I'm unsure why you think the reserve fraction must inevitably tend towards zero. You seem oblivious to the fact that current proposals (known as Basel III, after the city in Switzerland) requires banks to raise their tier 1 capital ratios, ie reduce their capacity for leverage. Currently central banks are acting as lenders of last resort, but once healthy growth resumes they will gradually sterilize that funding. That will be a limiting factor on growth, but one that seems preferable to a total credit freeze. http://www.bloomberg.com/news/2010-09-23/ubs-credit-suisse-may-face-12-capital-ratio-analysts-say.html http://www.bloomberg.com/news/2010-09-23/ubs-credit-suisse-m...
  - lzw 16y ago
mkramlich 16y ago
Whether the author's plan would work or not, what bothers me about it is that it seems that the 2 major actors within the US government that would have to carry out this plan, namely Congress and the Executive branch, appear in recent times to the lack the ability and/or willpower to carry out any long-running fiscal-scale mission in a consistent way. I'm in my thirties and from what I've observed so far in life it is extremely hard/rare for them to carry out any single plan regarding Federal spending consistently for more than 2 years or so, before making significant changes, adding loopholes, gutting it, making exceptions, making a total 180 degree turn in direction, etc. To give just one example, if you follow US Congressional news you'll periodically hear about something called a "debt ceiling" that supposedly Congress has to follow, which puts a limit on how much debt/deficit is allowed to exist at the Federal budget level. The problem is that they also periodically raise this "ceiling", whenever it is convenient. Whenever there is some supposedly exceptional or temporary state. And these exceptional cases and temporary conditions keep happening. Therefore the Federal debt just keeps going up and up (mostly: except during part of the Clinton presidency.) Memo to Congress, I don't think the word "ceiling" means what you think it means! The crack baby treatment of NASA is another example. "Give us a big plan to return to the Moon and Mars and we'll fund it. Okay, thanks, great plan, we'll start funding it." Few years go by. "Oops, sorry, we changed our mind, uh, could you repurpose that into a cute little station escape pod for us? k thx bye."
- lzw 16y ago
  If you look at history, this has been the case ever since the founding of the Federal Reserve. This is not a failure of will, this is the way the system is designed. The system is designed to fail, because this maximizes profits for the bankers in the long run and for politicians in the short term. When the system fails, most of the politicians who propagated the bad policies will be out of power. The federal reserve put us on a boom-bust business cycle, and those who understand the cycle profit from it. The fed drives up the boom, as they did with housing, and everybody who is smart makes money, then they raise rates and trigger a bust, and when that happens to the point where serious damage is going on, everybody buys up assets really cheap. The politicians profit from this as well- during the boom they say "look at this boom I created!" and get reelected. During the bust they say "look at this bust the other guy created, give me more power!" and they get more power. The ultimate boom, of course, is in the value of the dollar which is actually nothing more than a debt instrument itself. When it crashes there will be huge political opportunity to remake the country, including constitutional amendments or even a new constitutional convention. People will suffer, but there's nothing like a good crisis for the politicians.
sridharvembu 16y ago
This article ignores the other possibility, which I believe to be the only real solution: default on the debt, wiping out shareholders where appropriate, convert debt to equity, thereby reducing systemic debt. Bondholders will have to take a haircut, and the sooner the better. This would result in a sharp GDP contraction for a relatively short period, a sharp hike in unemployment, but then growth would resume fairly quickly, once the realization sinks in that we are not dead after all. Government can do two things to make this process faster: 1) make the justice system work faster in resolving the various disputes that will inevitably arise in imposing hair-cuts on bondholders 2) Make sure no one starves, and no one freezes. These things it can do. The present course of cutting-debt-by-borrowing has a clear destination: zombiehood without an exit strategy. Look at Japan for the best illustration of this. It is becoming increasingly clear that Japan is not going to resolve its problems without a major crisis. It should have taken that sharp GDP contraction in 1991 instead.
- mkramlich 16y ago
  Defaulting on the Federal debt to China could have a wee bit of a repercussion.
  - anamax 16y ago
    > Defaulting on the Federal debt to China could have a wee bit of a repercussion. They'd seize every US or American-owned asset that they could get their hands on and stop sending us stuff on credit. The former is much smaller than the debt that they hold (so we could compensate private holders and still end up ahead) and the latter is arguably a good thing.
    - anigbrowl 16y ago
      And then they would just forget about it and let bygones be bygones, I suppose.
      - anamax 16y ago
        > And then they would just forget about it and let bygones be bygones, I suppose. Not at all. They'd remember and never loan us money again. Given our spending habits, that would be a good thing. Or maybe they would loan money in the future if they decided that was in their best interests. Remember, other countries have defaulted and gotten loans later, some more than once. Why would this be any different?
cjlars 16y ago
"While the highly indebted and the newly “asset-poor” have good reason to spend less than before the crisis, creditor households have no reason to spend more. Indeed, the collapse in interest rates in a slump lowers their incomes and so is quite likely to make them want to cut back on their spending, too. The aggregate effect of these changes in behaviour is, of course, a rise in the desired household rate and so the desired financial surplus of the household sector." Read this carefully, because I'm fairly certain the author is trying to disguise something. His argument is this: Households cut spending and drive down rates, therefore creditors have less income and cut spending, therefore, creditors demand higher rate and more household debt. You can see the sleight of hand, creditors desiring a higher rate does not force a higher rate. In fact, as he already admitted, debtor payments have pushed down the rate. What the author fails to admit is that rates stay low AND debtors pay down their balances. Debtors do not need to somehow 'outsave' their creditors in order to pay down their debt. They simply pay down their debt. There may be arguments for stimulus packages and other counter-cyclical govt spending, but the author doesn't make a fair point for them. I certainly don't see why it would be necessary for govt borrowing to offset an increase in the private savings rate.
danbmil99 16y ago
what about good old fashioned inflation? That seems the obvious, if odious, way out of this bubble.

27 points by chrismealy 16y ago

I strongly agree with Wolf's remarks. In a nutshell, he is pointing out that the major cause of the current economic stagnation is a lack of cash flow. Deficits can not be increased forever, but absent cash flow then GDP will continue to shrink, increasing the relative size of a nation's debt. Boosting GDP (ideally through sensibly targeted investments in infrastructure) makes debt more manageable, not least because infrastructural investments tend to pay off over the long term. With a little imagination and selectivity, a situation like this can be a good opportunity to reduce transfer payments and endorse productivity in both the social and industrial sectors.

lzw 16y ago
This is standard neo Keynesianism (neo because nowadays governments just roll over the debt while Keynes advocated repayment in full at the end of the recession.) The counter argument to it is very simple: this spending is spending money that comes out of the economy, and taking money out of the economy hurts economic growth. Further, many argue that the spending produces less froth than the money destroys when taken out- lower profits at the personal or corporate level mean less investment in growth via consumer spending or business expansion. Further we have just witnessed a perfect implementation of this theory- after the dot com crash, government lowered interest rates below inflation, making free money and spent massively running up record deficits. It managed to spark a housing boom and a lot of consumer spending... But the situation we find ourselves in now is simply the hangover from that party. If we get drunk again, it isn't going to banish hangovers and each time we do it, it gets worse while the body gets closer to death.
- dasil003 16y ago
  Medical analogies for financial markets are pretty tenuous, but I find myself in agreement. A big issue from my perspective is that everyone is ringing their hands about home values and trying to prop up the deflating bubble. As someone with aspirations to own a home, this is infuriating. I can't afford a home, and neither could all the people who bought them. They need to let the prices fall to where people can actually afford them instead of trying to save the speculative value which we already know was based on hot air.
  - walkon 16y ago
    That was (and is) the ironic thing about all the government sponsored home ownership programs and legislation. They pumped up demand at an unreasonable rate, causing ever increasing prices, which made it harder to afford a house, which prompted further government stimulation...an endless loop, at least until the fiat charade ends.
    - anigbrowl 16y ago
      So why didn't the banks try to throttle the supply? It's funny, I don't recall any CEOs complaining about the economy being driven off a cliff in the runup to the bust. On the contrary, I was astonished at their readiness to give money away. Don't you recall the endless stream of refinancing commercials on TV? shows like 'flip that house'? The way everyone and their dog suddenly seemed eager to have a realtor's license? The guy at my local pizza shop had his realtor business cards on the counter next to the delivery menus. Edit: I see the truth is uncomfortable for some people. But the fact is that government promotion of home ownership is one thing, and instant approval of jumbo loans with 0% down are quite another. I got burned in a property boom when I was about 20 and this time I decided to stay out of the market.
  - matwood 16y ago
    The second option, and the one the gov. appears to be attempting, is to keep home prices steady and eventually let inflation catch up. This stinks for people who want to buy because they have to wait, but looks good for the gov. in charge. I'm with you and think they should just let prices fall. I can't find the video right now, but at one point President Bush was asked why he wasn't doing anything to prop up home prices. He responded that it's giving people who were priced out the opportunity to buy so he didn't see the need to do anything. His statement was early on in the recession and eventually he was pressed to do something though.
    - anigbrowl 16y ago
      The government hasn't been propping up prices, and the homebuyer's tax credit expired last April. If you talk to people in the real estate biz (I too have been looking for a house), you'll find that banks have about twice as many properties sitting empty as they do out in the market, and they are trickling them out because if they put them all on the market at once prices would crater (which would incidentally trigger another wave of repossessions). According to the banks, this is the tgovernment's fault, because the government is not throwing any money at them to invest in the future value of homes: http://www.housingwire.com/2010/09/27/bofa-analysts-call-for-ppip-2-0-to-reduce-shadow-inventory http://www.housingwire.com/2010/09/27/bofa-analysts-call-for... If it's the government propping up house prices, kidly explain why prices are stable when there are ~300,000 homes in various stages of foreclosure: http://www.realtytrac.com/content/press-releases/foreclosure-activity-increases-4-percent-in-august-6041 http://www.realtytrac.com/content/press-releases/foreclosure... Seriously, what information are you basing these conclusions on?
- anigbrowl 16y ago
  We agree on the basic economics, ie repayment in full (which is also what Wolf advocates). Further we have just witnessed a perfect implementation of this theory- after the dot com crash, government lowered interest rates below inflation, making free money and spent massively running up record deficits. Ah...see I have a problem with this - with luck we can disagree without falling into partisan bickering. 'Government' is not this indifferent entity that does whatever it wants, it's people implementing policies, and I think you're glossing over the details. So we had a small notional surplus at the end of the last decade, and in 2000 we got a change of administration. We agree (I hope) that the seeds of the dot-com bust were already rooted; I don't blame any political figures in particular for that. Greenspan warned about 'irrational exuberance' etc., and pretty much everyone I knew told him to shut and stop being a party pooper. Sometimes people just have to learn the hard way. But the new administration came in and gave people a tax cut, on the principle that if the treasury was running a surplus then it should be giving the American people's money to them (the same tax cuts which are supposed to be expiring soon). Just so we're on the same page, when I refer to EGGTRA I'm talking about the 2001 tax cut and by JGGTRA I mean the 2003 (post dot-com bust) one: http://en.wikipedia.org/wiki/Economic_Growth_and_Tax_Relief_Reconciliation_Act_of_2001 http://en.wikipedia.org/wiki/Economic_Growth_and_Tax_Relief_... http://en.wikipedia.org/wiki/Jobs_and_Growth_Tax_Relief_Reconciliation_Act_of_2003 http://en.wikipedia.org/wiki/Jobs_and_Growth_Tax_Relief_Reco... Now, I say you're 'glossing over' things with your analysis, because while there are policy justifications for both cutting taxes to stimulate growth and paying off debt (less lovely cash in your pocket, but less long-term interest accruing while you sleep), it seems rather disingenuous to complain about government failing to pay off the debt and ignore the fact that the administration of the day opted to cut taxes and make up any shortfall with borrowing. Even the budget director at the time, Paul O'Neil, thought this was a dreadful idea, and by 2002 was expressing his alarm at the ballooning deficit, allegedly causing VP Cheney to respond with the argument that "Reagan proved deficits don't matter." O'Neil departed the White House by the end of that year. Now, several people have argued that the Clinton 'surplus' was no such thing, and amounted to little more than an accounting trick (for example http://www.craigsteiner.us/articles/16 http://www.craigsteiner.us/articles/16). There is some merit to this argument, but it is not disputed the the rate of increase in the national debt slowed down during that period, nor that it was ~$5.8t when the White House changed hands in early 2001. After that, deficits ballooned and the debt swelled considerably. A lot of people (like me) expressed the belief that cutting taxes like this was a terrible idea - a justifiable war of the kind the US undertook after 9/11 is one of the few occasions where you can persuade people to tolerate higher taxes, because a situation of genuine military necessity exists. It would have been better (in my view) to either use available revenue to slow the rate of deficit growth, or at least to pay for the Afghan war. Come 2003, and the administration launched a second war and another tax cut. At the time, objections to this were generally dismissed as loony leftism or sour grapes or lack of patriotism. I don't want to rehash all of those political issues, but from an economic point of view war is expensive and I haven't seen evidence to suggest that the tax cuts significantly boosted revenue - in fact, I agree with you that low, low interest rates had more to do with the asset bubble which followed. Now those tax cuts are set to expire, and because one party has suggested that perhaps it would be sensible to extend them for the great majority of people who earn under $250k/year (and that the increase on those making above would still leave them paying less than in Reagan era), the other party has taken its ball and gone home - rather than roll them back partially for now and fully later, they've instead committed to making them permanent, which means a ~$4t hole in projected revenues, right around the time we are entering a demographic retirement bulge, and a good deal of our infrastructure is in very poor shape. It's all very well to wag the finger and say it's time to lay off the fiscal moonshine, but I find it really hard to take seriously lectures about debt which blithely a policy of repeatedly substituting borrowing for revenue.
deleted 16y ago
[deleted]

ctdonath 16y ago

Absurd. Upshot is a continuation of what got us into this mess: denial of risk. He starts with the misguided notion that net debt is zero. The point of interest-bearing debt is that the debtor might NOT be able to pay the debt off. He then proposes ways to reduce risk to zero, with lenders suffering no consequences of risky loans - a furtherance of policies which got us where we are, determined to take risks then legislate away the consequences. The system is vibrant because of the willingness to accept risk. To enforce a risk-averse system is to destroy the benefits of risk. Isn't risk the core of ycombinator's purpose? to take risks, and to manage them better than others? The system cannot be cleaned up until the buck stops somewhere, until the music stops and those without chairs leave the game. Borrowing, in a fractional-reserve system, means that for every real dollar there are tens or hundreds of claims on that dollar. You can't pay everyone off because there isn't enough money - unless the government opts for hyperinflation, achieving the same basic ends thru redistribution of abject losses.

gvb 16y ago

I'm having a hard time swallowing the whole of the article, based on assertion [A]t the global level, debt cancels out: net debt is zero. So, in paying down debt, one is also reducing credit by an equal amount. I agree that (credit - debt) = zero. The problem is that credit is not a fixed amount due to the fact that it is leveraged... see fractional reserve banking. http://en.wikipedia.org/wiki/Fractional-reserve_banking http://en.wikipedia.org/wiki/Fractional-reserve_banking The leverage formula is (1 / reserve) where reserve is a fraction tending to zero. This is a non-linear relationship and we all know that the lim x -> 0 (1/x) = infinity. If lenders (e.g. banks) hold a 20% reserve, they will "expand" the money supply by 1/0.2 or 5x. If they hold a 10% reserve, they will "expand" the money supply by 1/0.1 or 10x. If they hold a 1% reserve, they will "expand" the money supply by 100x. As the reserve fraction goes to zero, the effective credit part of Martin Wolf's equation goes to infinity. A lot of exactly that type of lending was being practiced during the "bubble", especially in the housing market where mortgage underwriters were loaning more money than the houses were worth. This was happening before the housing crash - mortgage originators were advertising "we will loan you 100% the value of your house" (sometimes more than 100%).

jonhendry 16y ago
I'm not sure you're thinking globally.
anigbrowl 16y ago
I'm unsure why you think the reserve fraction must inevitably tend towards zero. You seem oblivious to the fact that current proposals (known as Basel III, after the city in Switzerland) requires banks to raise their tier 1 capital ratios, ie reduce their capacity for leverage. Currently central banks are acting as lenders of last resort, but once healthy growth resumes they will gradually sterilize that funding. That will be a limiting factor on growth, but one that seems preferable to a total credit freeze. http://www.bloomberg.com/news/2010-09-23/ubs-credit-suisse-may-face-12-capital-ratio-analysts-say.html http://www.bloomberg.com/news/2010-09-23/ubs-credit-suisse-m...
- lzw 16y ago

mkramlich 16y ago

Whether the author's plan would work or not, what bothers me about it is that it seems that the 2 major actors within the US government that would have to carry out this plan, namely Congress and the Executive branch, appear in recent times to the lack the ability and/or willpower to carry out any long-running fiscal-scale mission in a consistent way. I'm in my thirties and from what I've observed so far in life it is extremely hard/rare for them to carry out any single plan regarding Federal spending consistently for more than 2 years or so, before making significant changes, adding loopholes, gutting it, making exceptions, making a total 180 degree turn in direction, etc. To give just one example, if you follow US Congressional news you'll periodically hear about something called a "debt ceiling" that supposedly Congress has to follow, which puts a limit on how much debt/deficit is allowed to exist at the Federal budget level. The problem is that they also periodically raise this "ceiling", whenever it is convenient. Whenever there is some supposedly exceptional or temporary state. And these exceptional cases and temporary conditions keep happening. Therefore the Federal debt just keeps going up and up (mostly: except during part of the Clinton presidency.) Memo to Congress, I don't think the word "ceiling" means what you think it means! The crack baby treatment of NASA is another example. "Give us a big plan to return to the Moon and Mars and we'll fund it. Okay, thanks, great plan, we'll start funding it." Few years go by. "Oops, sorry, we changed our mind, uh, could you repurpose that into a cute little station escape pod for us? k thx bye."

lzw 16y ago
If you look at history, this has been the case ever since the founding of the Federal Reserve. This is not a failure of will, this is the way the system is designed. The system is designed to fail, because this maximizes profits for the bankers in the long run and for politicians in the short term. When the system fails, most of the politicians who propagated the bad policies will be out of power. The federal reserve put us on a boom-bust business cycle, and those who understand the cycle profit from it. The fed drives up the boom, as they did with housing, and everybody who is smart makes money, then they raise rates and trigger a bust, and when that happens to the point where serious damage is going on, everybody buys up assets really cheap. The politicians profit from this as well- during the boom they say "look at this boom I created!" and get reelected. During the bust they say "look at this bust the other guy created, give me more power!" and they get more power. The ultimate boom, of course, is in the value of the dollar which is actually nothing more than a debt instrument itself. When it crashes there will be huge political opportunity to remake the country, including constitutional amendments or even a new constitutional convention. People will suffer, but there's nothing like a good crisis for the politicians.

sridharvembu 16y ago

This article ignores the other possibility, which I believe to be the only real solution: default on the debt, wiping out shareholders where appropriate, convert debt to equity, thereby reducing systemic debt. Bondholders will have to take a haircut, and the sooner the better. This would result in a sharp GDP contraction for a relatively short period, a sharp hike in unemployment, but then growth would resume fairly quickly, once the realization sinks in that we are not dead after all. Government can do two things to make this process faster: 1) make the justice system work faster in resolving the various disputes that will inevitably arise in imposing hair-cuts on bondholders 2) Make sure no one starves, and no one freezes. These things it can do. The present course of cutting-debt-by-borrowing has a clear destination: zombiehood without an exit strategy. Look at Japan for the best illustration of this. It is becoming increasingly clear that Japan is not going to resolve its problems without a major crisis. It should have taken that sharp GDP contraction in 1991 instead.

mkramlich 16y ago
Defaulting on the Federal debt to China could have a wee bit of a repercussion.
- anamax 16y ago
  > Defaulting on the Federal debt to China could have a wee bit of a repercussion. They'd seize every US or American-owned asset that they could get their hands on and stop sending us stuff on credit. The former is much smaller than the debt that they hold (so we could compensate private holders and still end up ahead) and the latter is arguably a good thing.
  - anigbrowl 16y ago
    And then they would just forget about it and let bygones be bygones, I suppose.
    - anamax 16y ago
      > And then they would just forget about it and let bygones be bygones, I suppose. Not at all. They'd remember and never loan us money again. Given our spending habits, that would be a good thing. Or maybe they would loan money in the future if they decided that was in their best interests. Remember, other countries have defaulted and gotten loans later, some more than once. Why would this be any different?

cjlars 16y ago

"While the highly indebted and the newly “asset-poor” have good reason to spend less than before the crisis, creditor households have no reason to spend more. Indeed, the collapse in interest rates in a slump lowers their incomes and so is quite likely to make them want to cut back on their spending, too. The aggregate effect of these changes in behaviour is, of course, a rise in the desired household rate and so the desired financial surplus of the household sector." Read this carefully, because I'm fairly certain the author is trying to disguise something. His argument is this: Households cut spending and drive down rates, therefore creditors have less income and cut spending, therefore, creditors demand higher rate and more household debt. You can see the sleight of hand, creditors desiring a higher rate does not force a higher rate. In fact, as he already admitted, debtor payments have pushed down the rate. What the author fails to admit is that rates stay low AND debtors pay down their balances. Debtors do not need to somehow 'outsave' their creditors in order to pay down their debt. They simply pay down their debt. There may be arguments for stimulus packages and other counter-cyclical govt spending, but the author doesn't make a fair point for them. I certainly don't see why it would be necessary for govt borrowing to offset an increase in the private savings rate.

danbmil99 16y ago

what about good old fashioned inflation? That seems the obvious, if odious, way out of this bubble.