Monday, November 22, 2010

Can You Borrow Your Way Out Of A Recession?

As a matter of fact, it’s the economic orthodoxy. The insight that eludes critics of debt-financed government spending as a policy tool, is that they fall into the trap of the fallacy of composition – just because saving is good for an individual in times of uncertainty, doesn’t mean it’s good for society in aggregate.

Similarly, if individuals and companies are averse to spending, doesn’t mean it’s good for the economy if the government doesn’t do it too. Of course, making sure that government spending is effective and supports nominal spending and economic recovery remains a thorny issue, as is the level of sustainable debt that a country can bear over the long term. On that basis, a reliance on monetary policy is generally preferred – but that’s hard to do near the zero interest rate boundary.

But often, the debate shouldn’t even have to go that far – I’ve always been of the opinion that it’s relative debt (relative to income and wealth), and not absolute debt that matters. And you really shouldn’t talk about debt without talking about its inverse, wealth and income.

So this article just about pushes all the wrong buttons for me:

All those IOUs stashed under America’s carpet
Andy Mukherjee

NOV 22 — The most accurate depiction of the way United States policy makers have dealt with the unsustainable, unserviceable debt that caused the financial crisis of 2008 has to be this: “Bury that putrid stuff under a carpet of cash and hope that no one notices.” …

…Some numbers first. Two years after the crisis, whose after-effects have kept the world’s biggest economy stuck in a low-growth, high-unemployment, low-interest-rate bind, here is a snapshot view of America’s indebtedness:

…In other words, there has been no deleveraging by US companies. Household debt has roughly dropped by US$400 billion since December 2008, partly the result of foreclosures on mortgages from which homeowners have walked away.

…The result is a US economy where non-financial domestic economic actors are, in aggregate, servicing US$35.45 trillion in obligations today. That is almost US$2 trillion more than the debt they had when the crisis struck.

The logical question to ask is: How are these IOUs going to be paid? With almost 10 per cent unemployment, how soon can consumers hope to have the cash flows to service their loans?

When will non-financial companies have enough revenue to make a dent into their mountain of debt? When will the federal, state and local governments have tax receipts that are adequate to the task? …

…How does more debt help solve a crisis that was created by a debt binge? That is a question Hussman and other critics of US monetary and fiscal policies have repeatedly asked in bafflement. It is when Mr Market starts asking the same question as Mr Bernanke that he will have to come up with a credible answer. If he fails, the smell of all that debt stashed under the carpet will start wafting up. — Today

The article presents absolute debt as the problem – but that gives a highly misleading picture.

Mukherjee notes that corporate debt hasn’t fallen, and the corporate deleveraging process hasn’t begun – but fails to mention that 2010 is looking to be a banner year for corporate profits. 2Q 2010 profits are up 37% on the year, and 6.9% over 2007 and 27.8% over 2008.

He says household debt is US$400 billion less than before, and partly attributes this to US homeowners walking away from underwater mortgages – but fails to mention that personal disposable income has fully recovered in 2010 and is also growing (+2.2% in 2Q 2010 y-o-y, and 8.8% higher than in 2007). Nor is the fact that the personal savings rate (5.9% in 2Q 2010) is now triple the 2007 level (2.1%).

So in those terms, for private agents in the US economy, the amount of relative debt has actually fallen.

Not mentioned also is that the US government bailout of financial (and auto) institutions amounts to the socialisation of debt from institutions that aren’t seen as solvent, to the ultimate financial safe haven i.e. the US taxpayer. And that this helped the recovery process in financial markets, such that asset prices have returned to their pre-crisis level and thus bolstering household balance sheets. So in fact, you can borrow your way out of a recession, even one created by a debt binge, if you’re the government and your debt replaces less trustworthy private debt.

That Mukherjee talks about government spending as if it is actually bounded by the ability to tax suggests he buys into the fallacy that sovereign governments face a hard budget constraint defined by revenues, and not a more realistic soft constraint defined by inflation, productive capacity, and public trust.

I don’t even have to mention the issue of higher money demand leading to soft private spending – because it’s no longer really relevant now. The essential economic problem that needs to be tackled isn’t debt but unemployment, and all that it entails.

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