Paul Krugman wades into debt fundamentals
People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.
That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.
Just to keep each other honest. I am pretty sure I know what Paul means but the bolded line is not exactly true. Most likely there will be real resource transfer, just within the country not between countries. Such resource transfer is not frictionless, however.
This is easiest to see when the resources are transferred from taxpayers to bondholders . Even if these are the exact, exact same people the transfer itself involves taxation and thus deadweight loss. Whether it involves measurable loss of production is another issue, but its fairly clear that it involves deadweight loss.
More generally though I would like to encourage people to think of debt as promises.
One thing that I hope this can help us see is that there is no limit to the number of promises we can make between each other. I make a promise to you. You make a promise to me. Back and forth we go, and we just become ever more entwined with one another.
However, there is no real limit to how many promises we can make, thus there is no limit to how high debt levels can go.
The promises, that are our debt, allow us to co-ordinate our activities more tightly. If I know that you will be there for me when I need you I can take on certain tasks that I could not otherwise.
What’s dangerous about promises is that they may not be kept. When we depend on others and then others don’t come through for us we can be hurt. This is true in love, life and finance.
The more promises (debt) we have the more dependent we are on each other and the more it will hurt when one us – inevitably – doesn’t live up to those promises.
However, this alone is not a reason to fear a world of debt anymore than broken hearts are a reason to fear a world of love.
Now, in love and money people do shy away from commitment – explicit or otherwise. I think this is over done. You have to let other people make their choices. So long as you are upfront about what it is that you have to offer you should let your suitors fall in love with you if they wish and the bank loan you money if it wishes.
Their hearts and their money are their own.
Perhaps, if not bailouts you say? Well, more on that later.
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Wednesday ~ December 28th, 2011 at 2:49 pm
josephbohm
I am very confused. Isn’t there a difference if the debtholder is foreign vs domestic? Japan is one of the largest debtor nations but its citizens hold most of its debt. The US on the other hand owes Saudi Arabia, China etc.
“And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.”
If I understand this correctly Krugman is saying that the nation as a whole won’t be worse off b/c those obligations will be paid to other children in our nation. But that isn’t the case.
How is debt a burden we owe to ourselves?
Wednesday ~ December 28th, 2011 at 2:58 pm
andrew lainton
Where to start – was thinking Krugman was beginning to get it over debt
1) debt is nominated in nominal terms, not real terms, so when real wages fall the burden of debt can be unsustainable and lead to bankrupcy – then there is no or a marked down ‘asset’ which does not equal the liability – so creditors does not equal debtors – there is a net loss to society
2) most debts are secured by collaterol – so when collaterol is sold by debtors it drives down prices – classic debt/deflation – Richard Koo’s paradox of deleveraging – so again the value recoverable by creditors is less than than owed by debtors
3) debt creates money which expand the economy when spent on productive investment. That money is paid back by the debtor but the creditor makes a profit from interest as does the creditor from the productivity of the investment – but they need not be identical, there will be different entrepreneurial surpluses and creditor surpluses – this is quite different to the classic exchange model of producer and consumer surpluses cancelling out in perfect competition.
4) Debt, through financialialisation, can expand almost without limit, until the economy busts, which it will when the level of debt servicing is unaffordable – so the total level of debt matters
5) debt is created out of the existing unequal distribution of resources, and income derived from debt reinforces that distribution. Demand in the economy cannot be sustained by the rich getting richer and the poor getting poorer
6) debt can be used to fund purchases of assets, which if used as inputs to production or leading to rising wages because of land rent will reduce wealth to society as a whole, rising asset prices can be used as collatoral for debt so leading to a upwards debt spiral
7) when there is a risk of debt not being paid then there will be a debt overhang effect – otherwise profitable investments will not be made because the level of existing dent will require an additional risk premium – so again the overall level of debt matters as it can depress investment.
Note: 1 & 2 can drive the business cycle down, 3 up, and 5, 6 & 7 can cause the bubble to burst – so the overall level of debt doesn’t matter then!
Wednesday ~ December 28th, 2011 at 3:14 pm
Jonathan M.F. Catalán
(Just in case the other post gets deleted, I’ll just c&p my comment here.)
I think it’s misleading to make the claim (I’m not insinuating that you, in particular, are making it) that people hold a fear of debt simply out of the belief that “too much debt is bad” — even though it is oftentimes framed as such (including by politicians, such as Ron Paul [comparing national debt to household debt]). I think there is a more complicated rationale that many, although not all, hold: accumulating debt without adding to productivity is potentially harmful.
“Households” accumulate debt. The father or mother of a household may take out a loan to invest it in a new family business. This debt will be paid off by future productivity. Those who support fiscal stimulus are suggesting a similar relationship: government expenditure will directly or indirectly provide the means towards productive growth in the United States. A more productivity society will be one more capable of repaying the debt (the debt burden will fall; it will take up less of our nominal [monetary] aggregate demand).
The fear is that this narrative is not true: further government spending (and, thus, accumulation of debt — unless it is paid for by direct fiduciary expansion) will no increase productivity. Instead, our debt accumulation is akin to paying for your consumer shopping on your six different credit cards.
I’m not suggesting that this fear has any legitimate theoretical backing (although, I personally think it does). I’m just saying that the portrayal of the fear of debt by people like Krugman is not entirely accurate, and it avoids detailing the major, fundamental theoretical differences which have led to a variance in opinions on whether we should accumulate greater debt or repay what we have collected so far.
Wednesday ~ December 28th, 2011 at 4:12 pm
Mr. Violet (@EuropeanViolet)
“However, this alone is not a reason to fear a world of debt anymore than broken hearts are a reason to fear a world of love.” unfortunately this is too long to re-tweet!
Thursday ~ December 29th, 2011 at 1:04 pm
bdbd
Ah! A Lennon McCartney hand me down, World without Love, http://www.youtube.com/watch?v=v_lJPUKTchI