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January 28, 2013

Public Debt and Private Debt

Our brother Greg is doubtless correct (1) that the public debt must at some point be trimmed, (2) that not to trim it would involve our passing down weighty obligations incurred by ourselves to our political descendants, and (3) that doing that in turn would constitute poor stewardship.  Few, if any, would seem to disagree with this chain of observations.  Where there is disagreement is on how best to do the job, and over what time horizon. 

One thing that it is critical to bear in mind as we consider these two questions is the source of the public debt, for sources of debt typically also are sources of debt-liquidation.  President Obama of course inherited the lion's share of the current public debt from the administration that preceeded his -- an administration that told us that 'Reagan showed that deficits don't matter' as it proceeded to slash public revenue and balloon public spending.  At least as important, however, is the economy that the President inherited not only from the administration that preceeded his, but also from administrations dating back to the 1970s.

Dating back to the 1970s?  Yes.  This is particularly important to recognize in view of the frequency with which one encounters observations to the effect that President Clinton's administration put the federal government into surplus and even began paying down the national debt.  While those observations concerning the Clinton years are true, they overlook an underlying weakness that was at work during the Clinton years and the earlier Bush, Reagan, and Carter years to boot.  This is a weakness that made of the Reagan and Clinton 'prosperity' something of a mirage.  It is also that weakness that ultimately brought us the crash we experienced in 2006-09 and, therefore, the growing of the public debt even beyond the unprecedented ballooning that the Bush II administration  brought.  

The weakness to which I refer is our failure as a nation to keep real incomes among those beneath the top one percent of the national income distribution from growing with productivity.  That is in turn partly a function of trade policy, partly a function of education policy, and partly a function of tax policy, among other things.  Irrespective of causes, however, the pertinent upshot is that consumer and mortgage debt steadily came to substitute for real income growth among most Americans as a support for growth- and employment-sustaining consumer expenditure.  That growing reliance on private debt, in turn, layed the predicate for a classic debt-fueled asset price bubble.  Once the credit ran out, of course, the bubble burst.  For literally scores of millions of Americans, that meant that variable equity value dropped below fixed debt value.  Scores of millions, that is to say, suddenly found themselves financially 'under water,' living in the shadow of debt overhang. The macroeconomy accordingly lurched into Irving Fisher style debt deflation.

The problem with debt deflations is their 'downward-spiraling' dynamic.  Debt overhung consumers stop spending.  That raises inventories and lowers employment.  Lowered employment lowers consumer expenditure yet further, leading to more layoffs, & cet. 

This is in turn why public debt always soars during debt deflations.  Japan, for example, entered into a debt deflation of its own circa 1992 in the wake of a combined stock and real estate crash of its own much like ours.  And Japan is still there - it's 'lost decade' has doubled to two now, and its public debt to GDP ratio is well over twice that of the U.S. right now. 

But why has Japan's debt deflation persisted for so long?  The reply to that question affords guidance to those who would answer the questions with which I opened above.  Japan responded quite timidly to its crash.  It acted as many misguided politicians now urge the U.S. to do -- with premature austerity.  It's easy to see why austerity would yield the effect that it did:  again, in the absence of private consumer expenditure, public expenditure must fill in the void until growth is restored.  That's what Japan failed to do on sufficient scale, and it's what even we in the U.S. have failed to do up till now.  Our 2009 'stimulus' was anemic and too reliant on tax cuts, which debt-overhung consumers simply hoard during depressions like ours. 

Of course, neither Japan nor the U.S. -- nor any other nation, for that matter -- can substitute public expenditure for missing private expenditure indefinitely.  Hence the public expenditure must be both strategic and combined with other policy measures that can restore private purchasing power and growth.  That means significant public infrastructure spending on the one hand, and large scale private debt -- in the U.S., especially mortgage debt -- write-downs on the other hand.  In a few subsequent posts, I'll say more specifically what that means where concrete policy measures are concerned.  

For purposes of this post, however, the closing point is this:  Poorly targeted and/or premature public austerity measures will be self-defeating.  They will simply resume recession and thereby lower public revenues further, worsening the public debt in so doing.  That is perhaps the most salient entailment, right now, of the well known macroeconomic 'paradox of thrift.'

In conclusion, then, poorly targeted and/or premature public austerity would itself be the worst abuse of our stewardship in which we could engage right now.  That would deprive our political descendants of future wealth and leave them with all the more future debt.  

 

 

Posted by Robert Hockett on January 28, 2013 at 12:46 PM | Permalink

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