Most Economists Don’t Pay Any Attention to Debt
As I noted in 2009:
Paul Krugman [believes] that debt is a “phantom menace”. But this is not because Krugman is a liberal. Government economists in the Reagan, Bush and Obama administrations have all believed pretty much the same thing: deficits don’t matter.
Indeed, as Steve Keen documents in his must-read book, Debunking Economics: The Naked Emperor Dethroned, mainstream (i.e. neo-classical) economists don’t even take debt into consideration in their models of what makes for healthy economies.
As Keen noted in September:
The vast majority of economists were taken completely by surprise by this crisis—including not just … the ubiquitous “market economists” that pepper the evening news, but the big fish of academic, professional and regulatory economics as well.
Why did conventional economists not see this crisis coming, while I and a handful of non-orthodox economists did [?] Because we focus upon the role of private debt, while they, for three main reasons, ignore it:
They believed that the level of private debt—and therefore also its rate of change—had no major macroeconomic significance:
Finally, the most remarkable reason of all is that debt, money and the financial system itself play no role in conventional neoclassical economic models. Many non-economists expect economists to be experts on money, but the belief that money is merely a “veil over barter”—and that therefore the economy can be modeled without taking into account money and how it is created—is fundamental to neoclassical economics. Only economic dissidents from other schools of thought, like Post Keynesians and Austrians, take money seriously, and only a handful of them—including myself (Steve Keen, 2010; http://www.economics-ejournal.org/economics/journalarticles/2010-31)—formally model money creation in their macroeconomics.
Even the most “avant-garde” of neoclassical economists, like Paul Krugman, have only just begun to consider the role that debt might play in the economy:
Given both the prominence of debt in popular discussion of our current economic difficulties and the long tradition of invoking debt as a key factor in major economic contractions, one might have expected debt to be at the heart of most mainstream macroeconomic models—especially the analysis of monetary and fiscal policy. Perhaps somewhat surprisingly, however, it is quite common to abstract altogether from this feature of the economy. (Paul Krugman and Gauti B. Eggertsson, 2010, p. 2)
Even when he attempted to break from this mould, Krugman did so from the same point of view as Bernanke above—that the level of debt doesn’t matter, only its distribution, and that one can abstract completely from how money is created:
Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person’s liability is another person’s asset ….
So most economists think that debt – and our money system – don’t matter.
Debt is the Essence of Our Money System
But as the following two quotes show, debt is the very essence of our current money system:
That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.
- Chairman of the Federal Reserve Mariner S. Eccles, September 30, 1941 hearing before the House Committee on Banking and Currency
If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.
-Robert H. Hemphill, FORMER Credit Manager of the Federal Reserve Bank of Atlanta
(This must-see 47 minute video provides details).
Greenspan Worried that We’d Pay Off Debt … So He Suggested Cutting Taxes on the Wealthy, to Increase the Debt
Indeed, despite the harms that too much debt can cause, some in government have worried that paying off our debt would be harmful for our country.
As NPR reported last month:
[NPR] has obtained a secret government report outlining what once looked like a potential crisis: The possibility that the U.S. government might pay off its entire debt.
It sounds ridiculous today. But not so long ago, the prospect of a debt-free U.S. was seen as a real possibility with the potential to upset the global financial system.
We recently obtained the report through a Freedom of Information Act Request. You can read the whole thing here. (It’s a PDF.)
If the U.S. paid off its debt there would be no more U.S. Treasury bonds in the world.
The U.S. borrows money by selling bonds. So the end of debt would mean the end of Treasury bonds.
But the U.S. has been issuing bonds for so long, and the bonds are seen as so safe, that much of the world has come to depend on them. The U.S. Treasury bond is a pillar of the global economy.
Banks buy hundreds of billions of dollars’ worth, because they’re a safe place to park money.
Mortgage rates are tied to the interest rate on U.S. treasury bonds.
The Federal Reserve — our central bank — buys and sells Treasury bonds all the time, in an effort to keep the economy on track.
If Treasury bonds disappeared, would the world unravel? Would it adjust somehow?
What do you do with the money that comes out of people’s paychecks for Social Security? Now, a lot of that money gets invested in –- you guessed it — Treasury bonds. If there are no Treasury bonds, what do you invest it in? Stocks? Which stocks? Who picks?
The danger that we would pay off our debt by 2012 has clearly passed. There are plenty of Treasury bonds around these days. U.S. debt held by the public is now over $10 trillion.
And in talk last a week and a half ago before the United Nations, Nobel prize winning economist Joseph Stiglitz said that -10 years ago, when the U.S. had a surplus – Federal Reserve chairman Alan Greenspan was worried that if we didn’t do something, we would end up paying down all of our debt, and then the Fed “wouldn’t be able to conduct monetary policy”.
So Greenspan pushed for a tax break for the wealthy, to increase the debt.
Debt In the Real World
In the real world – and not even taking into account the debt downgrades to the U.S. – economists have shown that too much debt creates a drag on the economy which stifles growth.
Nouriel Roubini points out:
Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won’t solve the debt overhang problem (Dr. Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn).
Steve Keen says:
[We’ll have] a never-ending depression unless we repudiate the debt, which never should have been extended in the first place.
As I noted in July:
PhD economist Michael Hudson says (starting around 4:00 into video):
If the problem that is grinding the economy to a halt is too much debt, and if no one in the government – in either party – is looking at solving the debt problem, then … we’re going to go into a depression as far as the eye can see.
As PhD economist Dean Baker points out, the IMF is cracking down on the once-proud America like a naughty third world developing country. (As I’ve repeatedly noted, the IMF performed a complete audit of the whole US financial system during Bush’s last term in office – something which they have only previously done to broke third world nations.)
Indeed, economics professor and former Senior Economist for the President’s Council of Economic Advisers Laurence Kotlikoff wrote yesterday:
Let’s get real. The U.S. is bankrupt.
Last month, the International Monetary Fund released its annual review of U.S. economic policy…. The IMF has effectively pronounced the U.S. bankrupt.
Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt.
This is what happens when you run a massive Ponzi scheme for six decades straight….
Bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.
On the other hand, as I also pointed out last month, the government isn’t even stimulating in an effective way:
“Deficit doves” – i.e. Keynesians like Paul Krugman – say that unless we spend much more on stimulus, we’ll slide into a depression. And yet the government isn’t spending money on the types of stimulus that will have the most bang for the buck: like giving money to the states, extending unemployment benefits or buying more food stamps – let alone rebuilding America’s manufacturing base. See this, this and this.
(Yes, Congress has just thrown twenty billion dollars at jobs and the states, but it is a tiny drop in the bucket compared to the many tens of trillions of dollars in handouts to the giant banks.)
Keynes implemented his policies in an era of much less debt than we have today. We’re now bankrupt, with debt levels so high that they are dragging down the economy.
Even if Keynesian stimulus could help in our climate of all-pervading debt, Washington has already shot America’s wad in propping up the big banks and other oligarchs.
More important still, Keynes implemented his New Deal stimulus at the same time that Glass-Steagall and many other measures were implemented to plug the holes in a corrupt financial system. The gaming of the financial system was decreased somewhat, the amount of funny business which the powers-that-be could engage in was reined in to some extent.
As such, the economy had a chance to recover (even with the massive stimulus of World War II, unless some basic level of trust had been restored in the economy, the economy would not have recovered).
Today, however, [politicians] haven’t fixed any of the major structural defects in the economy [update]. So even if Keynesianism were the answer, it cannot work without the implementation of structural reforms to the financial system.