We are going to feature a series of posts this week on the merits of the idea of using Federal deficits to stimulate an economy in severe recession or depression. The first offering is from DoctoRx, who writes at EconBlog Review:
Part I. INTRODUCTION
Robert Rubin’s home town of Miami Beach contains any number of hotels and apartment buildings, plus a movie theater that honor the progressive Presidents Roosevelt, especially FDR.
How ironic then that Mr. Rubin would end up as such a key person in the 1999 evisceration (Gramm-Leach-Bliley) of part of Roosevelt’s first major securities law, the Glass-Steagall Act of 1933. How further ironic – and tragic- that this Beach boy would help rebuild much of the entire financial structure of the United States on sand, as if he were still in his hometown, rather than on the granite of his adopted New York.
Economists have been struggling to deal with the crisis caused by the crumbling of much of what he encouraged to be built.
Some now believe that as in FDR’s New Deal, the U. S. should increase its governmental debt even more than is currently in the works. One recent essay by Dr. Edward Harrison was of special interest in that it argued that the private sector of America is so burdened by excessive debt that the government needs to take on more and more debt in response.
While I am sympathetic to much that is in this wide-ranging article, this argument merits comment.
Part II. Discussion of “The recession is over but the depression has just begun”
Dr. Harrison believes that a chronic “depression” state is underway, regardless of any “Fake Recovery” that he believes has begun. He states:
“This is the core of our problem-debt.”
Re the title, while a chronic depression may be underway, who really knows? How would that opinion, even if widely shared, justify major changes in policy which themselves have unpredictable effects for better or for worse, given all the uncertainties?
Is debt really the core of our problem(s)?
Focusing on private debt as the core problem may be analogous to focusing one’s attention on one species of tree within a much larger stand.
How can it be that in a democracy, if the people and their companies are too heavy with debt, the solution can be that their government–which is the people in another form and whose debts are therefore the people’s debts– should take on debt which is additional to the existing debts? (It would be somewhat different if the government borrowed the money to extinguish the debt.) Is this a case of circular reasoning? Dr. Harrison implicitly says no, first saying:
1. The government plays a crucial role here because of the huge private sector indebtedness. In the U.S. and the U.K., the public sector is not nearly as indebted.
The author does not present the data he is using to support this statement. Published estimates of net existing Federal debt plus the present value of future obligations are north of $50 trillion; with current revenues around $2 T, the government has a debt:revenue ratio of 25 or worse. How many companies, individuals, or aggregate private sectors have that indebtedness ratio?
Statistics I have seen suggest that private debt is not as much above 1959 levels as one would think, but that it is Federal debt and unfunded obligations that is vastly worse than 50 years ago. For example, the Fed reports (http://www.federalreserve.gov/releases/z1/Current/z1r-5.pdf) that the household sector has $67 T of assets and $14 T of liabilities. (I do not believe that the promised Social Security benefits are counted as household assets, and assuming I am correct, either household assets are thereby understated or the Federal liabilities estimated above are overstated.) Personal income is running about $12 T. So in the aggregate, is not the household sector healthier re debt:income (and probably debt:equity) than the Federal government?
I am excluding private business debt from this sort of comparison. Business can take care of itself. The proposal that all of us should indebt ourself either to each other or foreigners because some businesses may have too much debt does not resonate with me.
2. Dr. Harrison then introduces the following argument:
So while, the private sector rebuilds its savings and reduces debt, the public sector must pick up the slack. Why do I say must? It’s because of an accounting identity which comes from the financial sector balances model. Marshall Auerback says it best in a recent post:
Here is Mr. Auerback’s wording in bold:
We’ve said it before and we’ll say it again. As a matter of national accounting, the domestic private sector cannot increase savings unless and until foreign or government sectors increase deficits. Call this the tyranny of double entry bookkeeping: the government’s deficit equals by identity the non-government’s surplus.
So, if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue. . .
DoctoRx here.
Mr. Auerback was kind enough to provide references so I could learn about this model. Without making the argument for or against any particular level of government spending or surpluses/deficits, here are comments on the general argument for more government spending, to be followed by a discussion of the model.
1. A model is just that; it is not reality. Reliance on a value-at-risk financial model initially generated at J. P. Morgan helped create the recent/ongoing financial crisis. A more basic identity than the above one is the “Accounting Identity”, which says that profit is what is left after costs are subtracted from gross income. No evidence has been presented that in a $14 T economy, the costs of running the economy exceed $14 T. If in fact the economy is net unprofitable, then kicking the can over to our doppelganger, the Federal Government that the States created, will not change the underlying economics.
2. No model, however intriguing, can change the basic facts that a profitable individual, company, State, or private sector has the potential ability to repay with interest even a heavy debt load out of true ongoing economic profits. Absent proof that the private sector debt load is crushing in the aggregate, and with a bankruptcy system that allows crushing individual debts to be extinguished,why is it both fair and beneficial all of us should borrow more funds through the special purpose vehicle of our government because some unwise or unlucky borrowers and lenders are in a jam.
3. Theory aside, how strong is the empirical evidence, or even better what is the proof that increasing government annual and aggregate deficits are good things to add to the economic mix following large increases in both private sector and governmental debt?
4. Could the government either simply let creditors work things out with borrowers, or use at least moral suasion to encourage the debt-reduction process to move along as fast and fairly as possible, and why would that not be superior to adding more credits and debits to the system?
5. There are all the standard other questions about crowding out private borrowers, worries about excessive governmental debt leading to higher interest rates on that debt, fears of continued/renewed debt monetization, etc. There are also less standard theoretical arguments to the model, such as that is is arbitrary and even political to set up government and the private sector as the two sectors to compare financial flows between. In 1858 in the U. S., for example, perhaps the more relevant comparison was between the East, which sent capital to the developing West, while the Federal government was small and had little or no net debt.
Let us discuss the financial sector balances model in detail. From a post by Rob Parenteau, courtesy of Marshall Auerback:
The financial balance of any sector in the economy is simply income minus outlays, or its equivalent, saving minus investment. A sector may net save or run a financial surplus by spending less than it earns, or it may net deficit spend as it runs a financing deficit by earning less than it spends.
Furthermore, a net saving sector can cover its own outlays and accumulate financial liabilities issued by other sectors, while a deficit spending sector requires external financing to complete its spending plans. At the end of any accounting period, the sum of the sectoral financial balances must net to zero. Sectors in the economy that are net issuing new financial liabilities are matched by sectors willingly owning new financial assets. In macro, fortunately, it all has to add up. This is not only true of the income and expenditure sides of the equation, but also the financing side, which is rarely well integrated into macro analysis. (Emph. added in bold)
So what Mr. Parenteau is explaining is that just as the income-expenditures relationship balances, so must the “financing side”. But what if the private sector simply accumulates equity, which has no debt financing characteristics? No government intervention or new debt issuance has to occur.
In addition, the financing issues may be somewhat more complicated than one might think.
After all, the private sector has to debit its bank account to send the funds to the government in order to buy the debt. All that is really happening is that the private sector had cash, and now the government has the cash with some repayment terms.
Now, if the government had a special relationship with tall aliens with big heads who arrived from another planet To Serve Man, and these aliens divulged to the government and only to the government the ways to make the deserts bloom, eliminate illness, etc., then the government would be able to have a great return on investment from the borrowed funds. But that’s sci-fi.
There is of course direct monetization of the government debt. The prospect of more of that behavior costs taxpayers directly in the form of higher interest rates. The greater the governmental debt issuance, the higher the unnecessary interest rates will go for this and other reasons.
It is thus hard to see how this model, useful though it may be (click HERE for an academic discussion), can change the facts that absent monetization of its debt, the government withdraws the same amount of funds from the private economy that it borrows. Whether this borrowing is “good” or “bad” for the economy depends on what the government does with the money versus what the private sector would have done with it had the government not traded debt for cash.
There are infinite examples of real savings that add to the net worth of the private sector and do not become anyone’s liability. Consider obtaining enough milk to meet the needs of many children from a cow that eats free grass, building a cabin from logs cut from nearby trees, or building a bridge to create an important crossing point of a river.
Please consider these simple examples as fractals with regard to the complex American economy. In these examples, government is irrelevant to private wealth creation, and the private sector may be able to eliminate its debt to zero on its own with its profitable activities.
The private sector can be profitable while the public sector is simultaneously profitable. Or, both can be unprofitable. One can be profitable and the other unprofitable. Double entry bookkeeping is a convention and is not tyrannical. It allows for wealth creation, for equity accumulation.
The world of profit and loss is in concept a single-entry world. Click HERE and scroll down for an example of a service provider’s accounts kept in single- vs. double-entry form (when all the service provider really cares about is profit, which is not even shown) and finally for a summary of the uses double-entry system.
(This discussion has for simplicity ignored imports/exports, because the thinking expressed herein would be just as valid if we were talking not about the U. S. but about the United Countries of the World, where the trade balance of each country would be just as irrelevant as the trade balance of each State of the United States.)
A follow-up post will suggest unconventional approaches to get to a healthier economy as well as a healthier America.
Copyright (C) Long Lake LLC 2009
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agree whole heartedly.
Borrowing is not income, and debt is not wealth.
If the government cannot service the debt, it would be a disaster for the most needy in our society. It will probably do the old inflation move that makes the decrease in the standard of living hard to blame on any particular action by the legislative or executive branch of government.
I’ve been reading a blog by Steve Ludlum called Economic Undertow here http://economic-undertow.blogspot.com/
He has an interesting take on this debate by treating energy/oil, as something of a ‘wild card’ that makes conventional economic formulations irrelevant.
If oil supply is more or less fixed then what we do with fiscal or monetary policy is moot because without more energy
input you can’t really grow the pie. Might be useful to invite him to comment on this whole ‘stimulus’ debate.
DoctoRX says:
After all, the private sector has to debit its bank account to send the funds to the government in order to buy the debt. All that is really happening is that the private sector had cash, and now the government has the cash with some repayment terms.
That seems like an oversimplification of what is actually going on, and it tells only half the story. For while it may explain some of what is happening—apparently Americans are net saving once again–there is another dynamic which DoctoRx omits, which is this:
The Fed buys toxic assets from the private sector with money that is 1) freshly minted or 2) borrowed from the private sector. The net effect is that the private sector is not buying government debt with funds it has “earned,” but with funds it has received from the government in exchange for worthless assets. The private sector thus converts worthless assets into government debt.
By sleight of hand the Fed’s acquisition of toxic waste is not judged to be “spending” in the same way that congress “spends,” but I for one believe that distinction to be disingenuous.
The hypocrisy arises when one argues against Congressional spending, but either by commission or omission defends the Fed’s spending.
I suppose one can make the argument that Fed spending is more beneficial to the economy than Congressional spending. However, it can never be argued that Fed spending is more democratic than Congressional spending.
I’d also like to throw in this quote from Kevin Phillips, which I think provides some much needed out-of-the-box thinking:
The Democratic presidential cycle that began in 1933 soon introduced willing use of deficitry and debtcraft, reflecting the spend-to-stimulate theories of John Maynard Keynes, whose view had become so widespread by 1970 that Richard Nixon acknowledged that “we’re all Keynesians now.” In fact, the inflation of the 1970s was about to end Keynes’s ideological reign. Yet many Republicans besides Nixon remained under partial influence. By the Reagan years, besides encompassing supply-side tax-cut theology and monetarist faith in currency expansion and shrinkage, the ranks of conservative Republicanism included tax-cut Keynesians (deficits are fine if you’re giving money back to the folks who count), military Keynesians (the Pentagon houses government’s most deserving function), pork-barrel Keynesians (more roads and projects, and then even more), and even bailout Keynesians (large or well-connected financial institutions have to be rescued). By the decade’s end, as the philosophers of debt usefulness finished lining bookshelves with their paeans to junk bonds, leveraged buyouts, “deserving deficits,” tax cuts no matter what, and the belief that current-account deficits signify only foreign hunger to invest in America, the debt fox was loose in the fiscal henhouse.
–Kevin Phillips, American Theocracy
Please correct me if I’m wrong, but you seem to be singling out pork-barrel and/or welfare Keynesians, while at the same time failing to mention all the other types of Keynesians that Phillips enumerates. And if the picture you provide is incomplete, does that not slide off into the murky waters of half-truth and propaganda?
First, it is an identity, not a model. If you accept the first line of
GDP = C + I + G + NX
then you must accept
Private Savings = Government Deficits
If you don’t accept the first line, then what do you propose in its place.
Second this:
” and with a bankruptcy system that allows crushing individual debts to be extinguished,why is it both fair and beneficial all of us should borrow more funds through the special purpose vehicle of our government because some unwise or unlucky borrowers and lenders are in a jam.”
simply misunderstands or misrepresents the nature of demand for savings.
Then in your discussion of single vs. double entry accounting, there is a basic misunderstanding of what accounting does and is. We use accounting because it can track every dollar. Once you decide to track every dollar, you cannot simply wave your hands because you do not like the results. Accounting tracks money and not value – it does not care about creating profits or losses.
This shows you do not understand the model:
“It is thus hard to see how this model, useful though it may be (click HERE for an academic discussion), can change the facts that absent monetization of its debt, the government withdraws the same amount of funds from the private economy that it borrows…
There are infinite examples of real savings that add to the net worth of the private sector and do not become anyone’s liability. Consider obtaining enough milk to meet the needs of many children from a cow that eats free grass, building a cabin from logs cut from nearby trees, or building a bridge to create an important crossing point of a river.”
None of these transactions in the second paragraph describe money at all. They describe value created. In a world without government deficits, the money paid to purchase these things of value must becomes someone elses net money deficit. Allowing the government to run this deficit is the best way of keeping score of who is creating value. Otherwise we would be throwing someone into debtors prison, no?
The government does not need to borrow money. Issuing debt sets the price of term money. Monetization helps set the price of zero-term money. Setting prices for money is useful, because it lets people know relative prices for risk.
Wealth, money, value, and equity are not the same thing. Money is used to keep track of these things, but it is not any of them.
The sooner you recognize that money is about keeping score and not a store of value, the whole idea will get much easier for you. Do they ever run out of points in a football game? Do they take away points from the other team because the other team scores?
Nice argument. Have a question, How does one add up all of the activity that is: Consumption, Investment – residential, commercial and equipment, Federal, State, County and Municipal and Exports less Imports? Where do the numbers come from? Who reports them? That has always been a puzzle.
Year in, year out, we cannot borrow more than we earn. Further, please show me a society that was able to borrow its way to prosperity.
Money has two very critical functions, it serves as a medium of exchange; and, to be viable it must also serve as a store of value. Once money, the coin of the realm is no longer seen as a store of value, the stage is set for profligate borrowing. In very large measure that is how we got to this point.
You ask “Further, please show me a society that was able to borrow its way to prosperity.” Possibly there is no such society – there is some argument about this point. I’ll expand on this.
First I assume you are referring to the traditional method governments use to boost demand: borrow and spend. I.e. I assume you are NOT referring to a private citizen borrowing from another private citizen (or other private institution).
When a government borrows and spends this is held by some economists to get an economy moving a bit quicker. Given excess unemployment this is a good thing to do, and this leads to your “prosperity”. But there is some debate as how effective “borrow and spend” really is.
I’ve got my doubts. I prefer straightforward money printing: not too much and not too little, ideally. For a very nice illustration of how money printing increases prosperity in a very simple economy, see http://www.slate.com/id/1937/
“Have a question, How does one add up all of the activity that is: Consumption, Investment – residential, commercial and equipment . . . . . “
The answer is that thousands, if not tens of thousands of people are employed by government and private research organisations round the country looking a firm’s profit and loss accounts and balance sheets, and at spending figures for the public sector: federal and local government, the military etc. They then attempt to tot up the total figure for sales, investment, etc etc.
Plus the total of all personal incomes can be totted up from Internal Revenue sources and from government departments responsible for dishing out social security payments, etc.
For more up to date information and recent changes or trends, random selections of firms (and families) are asked questions like, how much did they spent on investment last month, how much they borrowed, did they increase numbers employed, what do they intend doing next month, etc etc.
You can spend five years studying how to do this and still not know the half if it!
Hi,
Money is given its initial value from taxation.
The government will throw you in jail unless you pay them in their fiat currency. This creates a huge incentive to get that currency. If you are taxed 15% of your total value earned in a year that has to be paid in a fiat currency, you will insure that when you are paid for creating value, it will be in that currency.
It doesn’t need to be a store of value.
In the absence of government deficits, money gets more valuable whenever someone creates something of value.
Why should someone else increase their relative wealth and others increase their relative poverty simply because I created something valuable? And why should I get paid anything less than full value for my product?
This is the moral reason why governments should run deficits.
Siggy as well as fresnodan get to the heart of the case I presented. While technically currency is a debt obligation of the Govt, in the real world, it is treated as a transactional unit with the same value as that good or service which it purchases. We give it credibility just as our ancestors trusted transactional gold.
Re Siggy’s initial paragraph’s questions: good ones. In a way, they get to my points, which is to think of the real economy first, think of wealth creation, and then deal with the financing abstractions/credit-debit/debt-equity issues later. Our economy is so huge, all macro numbers are just estimates, IMO.
Re DownSouth and others: I reread the post. I don’t see any political bias against welfare etc., or even any specific criticism of larger governmental deficits. In fact, I decry what Messrs. Rubin et al have done to FDR’s legacy. My argument was theoretical, which is that there are other ways for the private sector to reduce its debt burden than more government debt, which strikes me as a hair of the dog strategy for our debt-heavy society.
Re Mike S: I agree with your moral point. My point is that society can function w/o much debt and that the U. S. today has private debtors owing private lenders. They can work things down to appropriate debt levels w/o any action from the Federal government.
The utilization of bank credit to finance real investment or govoernment deficits does not constitute a utilization of savings since bank financing is accomplished through the creation of new money. Never are the commercial banks intermediaries in the savings-investment process. Bank financing will impose a “forced” savings on the community but to imply that an equal volume of voluntary savings is derived from bank financing is to confuse net with gross money incomes.
Furthermore the economic implications of bank vs.voluntary savings financed investment or government deficits are polies apart. Bank financing is inflationary since new money is injected into the economy. Volumtary savings, on the other had, require prompt utilization if the circuit flow of funds is to be maintained and deflationary effects avoided.
By including commercial bank financing of investment and government deficits in a concept of savings, the national income accounts distort the concept of savings and blunt its usefulness as an economic tool; and by ignoring the non-uses of savings and the uses of savings which do not contribute to GDP, the nation-income approach fails to recognize the problems created by the savings practices of the public.
If all savings were spent on real investment or to finance government deficits incurred on goods and services account, as the national income approach assumes, there would be no savings problem. The problem arises from the fact that recipients of money incomes (which incomes are a cost to others) may hold savings for an inordinate period in a monetary form, or so utilize their savings as not to contribute to the effective demand for output.
The payments approach to the analysis of savings provides many useful and important policy clues. In addion to policy measures designed to promote investment (or reduce the volume of savings) and therby reduce the need for government deficit financing, higher levels of production and employment could be promoted by minimizing the non-uses of savings and those uses which do not contribute to GDP.
It is also evident from the payments approach that those uises of savings which do not contribute to GDP should be minimized. Of particular significane is the excessive use of savings in financial investment. The policy objective should, therefore, be to adopt measures which will minimize the advantages to be derived from speculative activity in land and securites…DR LELAND JAMES PRITCHARD, PHD, CHICAGO, ECONOMICS, MS, STATISTICS, SYRACUSE