Tuesday 21 June 2011

America's debt, the role of the State and the fight for survival

I'm going to look at the contention that State debt is the real villain and all we need to do is cut taxes and social benefits, and let business have its head. I don't feel it's quite as simple as that, but please do put me right wherever you see the need. This is an exploratory essay so I'd welcome correction, and further information and ideas.

First, let's agree that somehow or other, the State has to balance its books (over some cycle of time, to allow for recessions), because ever-increasing debt ultimately leads to ruin. That seems intuitively obvious.

So, how bad are the government's debts? Here's a graph of the official annual figures for the 58 years ending last December:

That looks dramatic, though the very steep slope in the last couple of years is atypical because of attempts to deal with the post-credit crunch economic crisis. Now let's see it in the wider context of GDP:

For the Federal government's "real" (GDP-adjusted) debt, the lowest point is in 1974, then a few years later, starting around 1980, the debt begins to rise significantly, doubling from its low by the early 90s. After that there's the boom of the later 90s, the bust of the 2000s disguised/mitigated/deferred by monetary easing, and the reckoning of 2008 onwards. (The final slope looks much as it did in the previous graph, since the economy has stalled.)

We end the sequence actually not far above where we started in 1952, but this time against the background of a greatly changed economy and society. To understand this we need to widen the lens to include the panorama of Total Credit Market Debt Outstanding:

This doesn't fit conveniently into the conventional narrative. All those whirring government-debt-counting widgets on blogs, yet 2007 was an historic low point? Something's funny here; time to look at what else was going on in the credit market. Let's begin with the "domestic" elements:

Proportionally, households up from 19% to 25%, nonfarm up from 3% to 7%, others generally stable or declining. The domestic sector as a whole shrank from 95% of TCMD to 69%.

So what was responsible for most of the rest? The financial sector:

Four subsets account for most of the financial sector:

As you see, it's now mostly mortgage-related. The graph above takes us to 2008, and below you see the first decade of the new Millennium, including the bailout of mortgage pools:

This demonstrates the government's recent effort to maintain the status quo. Personally, I feel that criticising them for this is like stoning the firefighters when they come to the blaze. My gripe is about how the fire started, which was the attempt to support homebuying and then to shore up home prices.

Take a look at what happens when we include the above three mortgage-based elements in the category of household debt - I rename the aggregate as "house and home":

So it's not general government overspending that's the biggest problem; at least, not directly. And then, when the home lending cracks up, the government rides to the rescue:

Oddly, from 1974 on, home and government debt are almost mirror images:

But it wasn't so before, when the two lines ran almost parallel. Perhaps there was some postwar golden age when money was going not into the spendthrift government, not into illiquid and non-income producing homes, but instead boosting American business? It seems so, if we look at the other subsectors of the "domestic" heading:

Having partially re-categorised the debt in a way that I hope you won't think too unfair, here's the simplified big picture showing how things changed over those 58 years:

To me, this seems illustrative of developing malinvestment. We have been buying and even speculating on houses, and filling them with foreign-made TVs, computers, iphones etc; but we've had much of our consumption on credit and indirectly (via the Treasury), quite a bit of that from abroad. (I say "we" because my brother is now an American, and aso because Britain is America's mini-me in terms of its economic problems.)

Imagine if that money had gone into business ventures, instead of illiquid and non-income-producing housing assets. What if successive governments had reined-in credit and consumer spending, and encouraged the reinvestment of profits into industry and research, rather than the unreally-rewarded financial sector?

Far from over-regulating, it would seem that government has failed to regulate sufficiently. Laissez-faire economics may work okay when the quantity of money is limited, but fiat currency (and debt, which forms part of it) entails the duty to supervise and intervene when necessary.

Was debt ever good? I speculated earlier that there might have been a postwar golden age of beneficial credit, when business borrowing accounted for a third of all debt. Yet when we relate the credit market with GDP, here's the result:

It seems as though debt never fully pays for itself, and the faster the debt accumulates, the worse it gets. Coincidentally, Karl Denninger has just made the same point. Last year, Nathan Martin's "Chart of the century" purported to show that beyond a certain point, additional debt results not just in lesser growth, but actually reduces GDP. Are we all wrong, or is "sound money" a (maybe the) precondition of a sustainable economy? (And how do we square this with the fact that many individual businesses borrow and prosper - is it that leverage gets you market share but tends to shrinks the market overall?)

The size of the debt is unimaginable, though still calculable. Four years ago I was reading Michael Panzner reporting on comptroller-general David M. Walker's mission to warn the nation, Cassandra-like, of the scale of unfunded State healthcare obligations. Even then, the latter was talking about figures exceeding $50 trillion. Well, we've breached that ceiling right now, even without factoring-in the notional capitalized value of benefit programs. Here we are:

Some say we're approaching (and some others say we're past) the point where it becomes mathematically impossible for the economy even to service the interest on our obligations, let alone reduce the amount outstanding. I'm not sure I agree, though the challenge is certainly daunting. Here is the total credit market debt expressed as a percentage of GDP:

If we have to be deeply in hock, perhaps it's better to have the government take care of some of the burden, for three reasons:

1. The debt doesn't have to end, as for example a mortgage does. Loans may need to be rolled-over, but the nation as a whole doesn't retire, so it can borrow forever.

2. Government debt is more secure, in the sense that more fiat money can be created to make the payments. How can you run out of nothing, which is where the money comes from? (Or rather, it comes from diluting the value of other people's stock of the money.)

3. The interest rates are, accordingly, lower than for most private and corporate borrowing. The average for all Treasury interest-bearing debt is currently 3%, whereas fixed-rate mortgages (if you can get one) are running at 4% - 5%, and credit cards are now averaging over 16%.

So, by all means let the government play little Dutch boy, plugging the holes in the dam. The total interest on the national debt for fiscal year 2010 was $414 billion, a vast sum but still an effective interest rate of around 3%. What average rate is being paid on the other $38 trillion or so that's burdening the economy (not to mention capital repayments)? Imagine if that debt was on terms similar to the government's...

Maybe it's not the banks that should be bailed out, but businesses and consumers. How would things look if more debt was transferred to government and slowly retired and paid for by various forms of taxation? Could this help distressed consumers and businesses keep going for long enough to get back on their own feet? Or must we go the let-'em-fail way demanded by free-market Puritans? (In which case, can we also get puritanical about the money supply and who is allowed to supply it, please?)

Bailing out is a good thing to do when the ship is sinking, but we have to do much more than that. So much has to go right that it's no wonder Dr Marc Faber (aka "Doctor Doom"), away in his Thai retreat, reckons it's hopeless and predicts a complete economic "re-set" (including the death of the dollar) and war. I hope he's wrong for once, otherwise I'm wasting my time here.

Survival begins in the head: you have to believe you'll get through, so you can condition your mind to look for tools and opportunities. Can we work on the assumption that there is a way?

One way was suggested in 1993 by the far-seeing billionaire Sir James Goldsmith, who recognised the threat that GATT posed to Western economic and social stability. Sadly, the man is no longer with us, but his book, "The Trap", is still available and highly relevant, even more so now that Goldsmith's predictions are coming true.

Globalisation has tipped the balance of power so decisively in favour of capital and against labour that American - and European - society is beginning to tear itself apart. Sir James advocated a system of economic trading areas to protect against completely unbeatable competition from extremely low-cost labour forces.

Either capitalism - which, theoretically, creates work and wealth by allocating capital efficiently - must have some bounds set for it so that it nurtures the society that gave rise to it - or, as Marx predicted, its contradictions will destroy itself. If we don't want an Ayn Rand dystopia, we have to make it possible for our people to work and prosper.

We are presently trading away not merely our income but the jobs that earn it, and the capital and physical means that create the jobs, and the knowhow that utilises the means in productive projects, and the intellectual property rights that safeguard the knowhow. As for the development of fresh, potentially wealth-creating knowledge, I understand that businesses have been cutting their R&D and even the universities favour their MBA schools over maths and science.

We need a plan. It will call for visionary leadership, skilled and patient management, the most careful international diplomacy, and the co-operation of politicians, voters, workers, industrialists and financiers.

In the meantime, emergency measures may be necessary, and they may not be the ones the econo-fundamentalists want. Austerity could be the worst possible solution at this stage - it is the exact opposite of Keynesianism to let rip when times are good and starve the economy further when there's already a recession on, and others are making this point already, e.g. "Rortybomb" and Australian economist Bill Mitchell. And there are those who say that taxation is nothing like as onerous as many people believe.

Or do you go with "Doctor Doom"? If so, maybe you shouldn't be planning to be rich in your own country, but preparing to move far away from the consequences of the coming collapse.

If you think that is irresponsible doom-talk, consider the President's Executive Order of a couple of weeks ago. I don't read the establishment of a White House Rural Council as mere quasi-socialist interfering; I sense the beginning of a national plan to survive and feed the nation in disrupted times. If it isn't such a plan, then there should be one.

For it's about more than just money, now.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.


Jim said...

The issue is this - in order for there to be more investment in the West in productive capacity, rather than in the Far East (broadly put, making iPods and plasma TVs in the USA not China), then the cheap imports must be curtailed. The only reason 'stuff' is made in the Far East is not only that they pay the labour a lot less than the West, but their standards of business are far lower. They have no health and safety laws, no environmental laws, workers rights are low.

Broadly put the West has exported its pollution and exploitation of labour to China, and reaps the rewards (cheap stuff) without having to pay the immediate consequences - polluted environment and people living in poverty.

I have always said the West is trying to have it both ways - it wants the good environment and worker protection, but it also wants cheap stuff. Something has to give. You either allow the cheap imports, in which case the home based industries die, and you end up where we are now, or you prevent stuff coming in that is not produced under the same rules as apply at home, in which case you pay more for goods, and we in the West have lower (but perhaps more stable) standard of living.

The Arthurian said...

Hi, Sackerson. Great graphs!! Definitely, private-sector debt must not be ignored.

You refer to "fiat currency (and debt, which forms part of it)". And you ask: "is 'sound money' a (maybe the) precondition of a sustainable economy?"

Q: What is "sound" money in a fiat system?

A: In FRED, look at TCMDO/M1SL ... total credit market debt owed, relative to the quantity of spending money in circulation
(MZM is a debt-laden version of M1; there is no sense to compare MZM to TCMDO.)

Use the Historical Statistics to carry the relation back to 1916.

You will see that Debt-per-dollar (DPD) increases continuously, except:
1. during the entire presidency of FDR
2. just before the late 1990s boom.
3. after 2007.

A high level of DPD creates problems; reducing DPD solves problems.

For a fiat money system to be sound requires a fairly low and fairly stable ratio of debt to circulating money.

Sackerson said...

Jim - yes.

Arthurian - thanks for the lead.

And thanks for your comments, both!

Paddington said...

It's not hard to see what happened, at least in the US.

Since 1980, we reduced tax rates on the wealthy (mostly in the financial sector), and the average wage stayed constant, adjusting for inflation. Most blue collar wages have not even grown with inflation.

The only way to get ahead was either to have two working adults per house, or max our your credit, including mortgages. The interest then went to, guess who? It also severely hurt tax receipts. What would they be if all wages had grown with inflation?

Jazzbumpa said...

Sackerson -

Facts, data, rational conclusions! Is this the internet, or have I wandered into an alternate reality?

I followed Art's link over. (Does that make this an Art link-letter?) This is a really good post.

One correction, and a comment.

The correction:
Oddly, from 1974 on, home and government debt are almost mirror images: . . . But it wasn't so before, when the two lines ran almost parallel.

Your eyes have deceived you. The two lines display contrary motion almost all of the time, even at a detail level. It's the combined line that roughly parallels total gov't before '74, because the down slope of gov't was so large.

The comment:

First, off, I totally agree with you about misallocation of resources, though I don't think of it as any kind of investment.
Having partially re-categorized the debt in a way that I hope you won't think too unfair,

It's fair enough, perhaps, but there is a point that gets lost in this grouping, and that is the 6-fold (or so) increase in the percentage of finance sector debt.

This, is think, is more significant than household debt, per se, since it is a key enabler for the rent-seeking behavior of Goldman-Sachs, frex, and the (totally useless, IMHO) derivative market that dwarfs the the total output of world economies - also by a factor of about 6.

The fact that it's largely mortgage related isn't trivial, but it isn't the key.

In short, I think house and home, rather than financial tail-chasing, is a sub-optimal focus.

Lots of other nutritious thought food here, but this comment is already over-long.


Sackerson said...

Hi, JB. By mirror image I did mean opposite, though it's not exactly so, but I take your point about the enormous expansion of the financial sector. Now what, eh?

Thank you very much for visiting.

The Arthurian said...

I am concerned about your third graph here, which shows the federal debt reaching an "historic low" of around 10% of total debt. I think the graph understates the problem. (Also, I could not find your Treasury data source.)

Quickview: If the $14 trillion federal debt is 10% of total debt, then total debt must be around $140T. But that number does not stand up. Michael Hodges reports total debt at $57 trillion. FRED TCMDO (whicih comes from the Z.1 Flow of Funds) reports it at $52603.83 billion, $52.6 trillion. $14 trillion (if that number is right) is about a quarter of the Hodges and FRED numbers, not ten percent. Again, I don't know what the Treasury numbers show.

In my own work, I have misread the breakdown of debt presented by the Z.1 tables.

Gene Hayward first brought this discrepancy to my attention here.

Using different source numbers, my graph #7 here shows the federal debt reaching a low around 20% of total debt.


Sackerson said...

Hi Arthurian

The data source is/was the Z1 Flow of Funds info at http://www.federalreserve.gov/releases/z1/current/accessible/l1.htm

I downloaded to Excel and got the system to convert to % of total credit outstanding and that's what I got, but the "low" is at 2007. That graph also splits Fed debt from State/local government debt, so it's Fed-only at 10% of TCMDO.

Have just checked on that Fed site again, in case I'd made some spreadsheet error, but for 2007 we see TCMDO "All sectors" at $50043.2 bn and Fed liablity at $5122.3 bn which works out at 10.24% of the total.

I haven't included GSEs etc but deal with those elsewhere in the graphing, because I see those as part of my "house and home" category.

Have I misunderstood / misread?

Sackerson said...

P.S. My title for that graph may have misled, as it referred to total public debt yet gave Fed and State/local separately. Combined they look to be about 15% of total at end 2007.

The Arthurian said...

Thanks for the link to your source.

I can see your reason for leaving out the GSEs. I see your internal consistency. As long as you are aware of it. (When I did a similar thing it was a mistake, but that was from my own lack of knowledge.)

I am all in favor of showing that the federal debt is low compared with private-sector debt. And I think there are great lessons to be discovered by looking at the history of the public/private debt ratio in the context of economic performance. But I do not think it productive to understate the federal debt number.

You refer to All those whirring government-debt-counting widgets on blogs. Everybody knows the federal debt is $14T+. To be effective, I think a debt graph has to deal with it.

I don't mean to be critical of your work. I'm thankful for the opportunity to talk about these things. And I am thrilled to see I am not the only one working through them.

The Arthurian said...

I'm examining debt again, thanks to you. I have two thoughts on your post, above.

1. You are right: there was a significant, historic low in 2007. I had completely missed it. Kinda makes the point, doesn't it?

2. I have been thinking about your approach, excluding (some) federal financial debt from the federal numbers. I see this makes a lot of sense. But for me, the trouble is there are many ways to break total debt down into pieces, and one needs more technical education than I have, to do it well.

Greg said...

Very nice post. I must confess to skimming some of it but I totally get your point here and agree.

One thing that I think needs to be done is a language change. Calling govt debt "debt" and private debt "debt:" is extremely misleading to most everyone. We need to pick one reference point (us) and stick with it. In relation to US private debt is debt (something I OWE) while govt debt is an asset or investment (something I can collect interest payments from). For the many who are confused on this I have a standing offer:If you think the two are equal you can take my $100,000 mortgage and Ill take your $100,000 T Bill. I havent found any takers yet.

Now this is not to say that our public debt can never be too high but it is saying that simply looking at a number, like 12 trillion , is insufficient. It must be looked at in relation to other factors like, average wages, unemployment levels, taxation levels, productive capacity going un utilized etc etc.

Sackerson said...

Art: the way I separated it out was because the encouragement of housebuying seems different to me from job creation or the provision of socially useful services. But you're right, there must be many other ways to do it.

Greg: it's all interest-earning, isn't it? Except the interest paid on private debt is higher, and the debt much more likely to be defaulted.

I'm considering buying Stev Keen's new book when it comes out in September (Debunking Economics II), because he has focused for a long time on the role of debt in economics and this is what led him to predict the present crisis.

The Arthurian said...

Hey, Greg. Your standing offer cracks me up... But, no thanks!

Sackerson, yes, that's what I was thinking, encouragement of housebuying is different. Sort of a "desperate expedient," perhaps, but qualitatively different.

And RE your reply to Greg,
"it's all interest-earning, isn't it? Except the interest paid on private debt is higher, and the debt much more likely to be defaulted."
I don't know if there is more to it than that or not. But I'm writing about "debt relatives" -- federal debt relative to non-federal, and the inverse -- and these are highly significant ratios without doubt. You see it yourself, with "U.S. public debt as % of Total Credit Market Debt" turning up an "historic low" point... Changing the denominator to "the rest" of the debt (rather than *all* of it) emplasizes such differences.

Keen is wonderful.

Greg said...

Its not all interest earning to US. I pay interest on my mortgage and receive it on my T Bill, as do over 90% of Americans. Banks receive interest from both but not the average Joe. Banks are NOT private institutions, they are public/private hybrids so its false to look at their interest earnings on loans as being strictly within the private sector.

Yes, if loans were operationally the same as you and ten of your friends lending me money, my interest payments would be income to you, but loans are not operationally that way.

Yes you are correct that private debt is much more likely to default, in fact public debt (in the US) cannot default, at least in terms of "inability to pay", it might default from "unwillingness to pay" but thats different.

Sackerson said...

Greg, for me the significant thing about debt is how a load of it depresses demand, either because we have either to pay more taxes to the government or more interest (and repay capital) to the banks, so there's less available for purchase of each others' goods and services. I take your point about who gets the interest, though foreigners and the Fed also get a lot of money on US public debt these days.

Greg said...

I dont see how govt debt depresses demand though.
Govt debt is a private sector interest bearing asset. It results in income to the private sector and therefore potentially increases demand, unless the income is just saved. It can never decrease demand however.

Now, there are obviously distributional issues. Most of the owners of govt dbet are very rich and they likely save their interest payments, but if domestically held govt debt was sent out to each American equally it would be about 250$/month per person. A significant number of people would spend ALL that 250 and it would result in quite a stimulus.