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Debt Distraction

September 12, 2011

It’s time for some perspective on all the talk about too much debt and the need to balance budgets that seems to have gripped our political discourse recently.  Debt was not always the pariah that it has become, and for good reason.  Most of us often need some way to  time-shift our spending and earning, which is the ultimate purpose of debt.  If you remove all of the institutional layers that have grown up around lending, you can get back to that loan that parents make to their kids so they can buy their first house. The parents with more years of wage-earning behind them have accumulated cash, and the young adult children, poised with potential, have no material wealth with which to provide themselves housing.  Loan pay-back is entwined with family dynamics and responsibilities.

At one time, banks merely played the role of super-parents.  The deposits of the cadre of successful earners went toward the lending needs of myriad young families.  Banks had another important role as well,  to make loans even if they didn’t have deposits to cover them.  They could lend money into existence. After all, there were many more young people poised with potential than there were elderly savers, and as long as the borrowers made good on their loans – all was well.  The Federal Reserve would allow the banks to create money this way only until it bumped into a “reserve requirement” that was there to ensure that banks had sufficient resources so that loan delinquencies could be met by the bank without making it insolvent.  The reserve requirement is only a few percent of the loan value, so practically, most of the banks assets are “lent into existence.”

The fact that almost all the money in the economy is produced by way of a loan is sometimes hard to fathom, but it’s nonetheless  true.  When thinking about debt, its a good idea to remember that there are always two sides to the transaction.  There is the person with the mortgage, and there is the investor that holds the IOU.  The other thing to realize is the enormous class differences between lenders and borrowers – precisely because the needs to time shift spending is strongest for young working-class families.  Investors can be older professionals and wage earners, or more frequently, they make up  the upper 1% “ownership” class by themselves.

If there is too much debt out there, then there also must be too many loans held by investors.  Or, to put it another way, the investor class has too much money!   We’ve gotten into this “too much debt” problem, to a large degree because of pressure from investors looking for a lucrative place to park their “too many assets”.  It all comes back to the age-old problem of distribution of resources.

In the chart above, I wanted to give an idea of the size of these private debt totals, compared to the federal government debt (purple line).  The private debt market dwarfs government borrowing.  To get at the class aspect of debt, notice that the debt owed by households was growing much faster than the debt held by households in the decade before the 2008.  If households are not holding more debt, then it is businesses and financial institutions to which households are indebted that is increasing during this time.  You can also see the small uptick in federal debt as the feds try to make up for the stagnation in the private credit markets.

The lassie-fair (libertarian) solution to the distribution problem – do nothing – results in 19th century boom and bust cycles where the disruptions of the busts prevent the investor class from obtaining unlimited wealth.  The busts are often precursors to wars and revolution that generally destroys wealth.  Furthermore, those that have nothing, have nothing to lose, while those with wealth have much to lose during a bust.

The Federal Reserve was created to help deal with the problems of boom bust cycles, and following WWII it has been doing a reasonable job of it.  Other New Deal reforms coming out of the last Great Depression also provided for automatic economic stabilizers that naturally countered the boom-bust business cycle.  Social safety net programs continue to provide income to people in down turns.  Highly progressive tax rates prevented the great accumulations of wealth that are always in search of “debt income”.

Conservative policies, spearheaded under Reagan, have had the consistent goal of preserving the wealth of the wealthy above all else.  Such policies have been so successful that the plutocracy has been the only consistent growth segment of the economy for decades.  Concentration of wealth has brought with it a need for investments in the form a wide variety of debt.

This increasing class separation has been in progress for years, and all went well until the debtor class could no longer service their loans.  The process that has now started is for that giant pool of money, owned by the investor class,  to  combined with the giant pool of debt owned by the borrower class until it all cancels out.  There are many ways to effect this wealth transfer – none of them popular with the plutocracy.

The least painful solution is general inflation.  True inflation, with wage as well as price increases, helps borrowers pay back loans with less valuable money while investors lose money in constant dollars on their loans.  Restoring New Deal reforms that were enacted after the last Great Depression and have been eroded ever since, would improve the situation.  Progressive tax rates like those from the Eisenhower era would help as well.  But we will hear none of this from our politicians until civil unrest spreads far and wide.  We are living in a precarious time.

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5 Comments leave one →
  1. September 14, 2011 8:35 pm

    We outsourced 50% of our manufacturing jobs, textiles-electronics.

    Thats the entire issue with our decline.

  2. Thom Thumb permalink
    September 15, 2011 3:48 am

    And if you look at 1970 houses were at honest actual value not fake BS make believe value to make simpletons think they are rich (even though they owe 90% or 100% to a bank and have nothing.) In 1970 $150,000 bought a magnificent house in a good city, and you lived in it long term. Consider THAT one for a minute. This entire issue is self-created and I don’t feel for the masses who went in deep hoping for that free buck – it backfired now pay the piper.

  3. Doug Hess permalink
    September 15, 2011 4:22 am

    Politicians get re-elected by spending the country’s money regardless of whether it benifits the country. This is a system that is bound to eventually fail, and it has.

  4. Colin permalink
    September 15, 2011 7:56 am

    1. Speaking of inflation…if you adjust the U.S. Debt totals graph for inflation, I think you’ll find the debt total from 1970 to 2000 is fairly flat. It would be interesting to see the same against GDP over that period. We obviously added huge amounts of debt in nominal terms, but what about real, and as a percentage of the nation’s income (GDP)?

    2. It’s interesting to think of debt as a movement of resources from the future to today. If you think of it that way, and these obligations are not meaningfully modified or nullified (be it through principal reductions, strategic or non-strategic default or inflation) we, as a nation, will be paying off these burdens for a long time to come. If we don’t want to end up like Japan, we have to get rid of this debt one way or another.

  5. Russ Wetherill permalink
    September 15, 2011 8:16 am

    Have you considered that more lenders chasing fewer borrowers results in lower interest rates? This balances the wealth between the so-called lower and upper classes. If everyone were rich, then there would be no yield to be had for lending money out. The few productive borrowers could borrow to expand their business at low rates.

    As your article implies, the fact of the matter is that the wealthy and the poor are codependent — the rich need the interest, the poor need the capital. What matters most is that the capital is put to productive use (decreasing costs or increasing revenue). Instead, poor borrowers have gone into massive debt to purchase an income draining liability instead of an income producing asset.

    Had we instead invested the ten trillion in mortgage debt to lower healthcare costs by curing terminal an chronic diseases, worker lost sick time would decrease and productivity would increase. Furthermore, career lengths would increase resulting in better job-specific knowledge with its inherent efficiencies.

    Wealth is not a zero-sum game, as Barry Ritholtz would have you believe. Wealth is the product of productive effort. Those who work harder and smarter produce more, and therefore, in any just society, deserve more.

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