"I fully agree with the important point he [Mr. Robertson] makes (pp. 180-183) that the increased demand for money resulting from an increase in activity has a backwash which tends to raise the rate of interest; and this is, indeed, a significant element in my theory of why booms carry within them the seeds of their own destruction."- J.M. Keynes in The Quarterly Journal of Economics, February 1937
Yeah.
Um, yeah.
The conclusion of my previous post was that financial corporate business (FCB) is less than 40% as productive as nonfinancial corporate business (NCB). That conclusion, however, rests on the assumption that everything counted in Gross Value Added (GVA) is output.
The assumption is not well-founded. Dirk Bezemer and Michael Hudson, in Finance is Not the Economy, wrote
National accounts have been recast since the 1980s to present the financial and real estate sectors as “productive” (Christophers 2011).
The
calculation of GVA has been "recast": It has been changed in ways that increase what counts as
output. The more the output, the more productive a business is -- or
the more productive it is reported to be, depending on whether the new
inclusions are output in fact, or only in the calculation.
As for myself, I like to say "nonfinancial" businesses are the ones that produce the goods and services we buy, and "financial" businesses are the ones that produce the money we use to buy those goods and services. That's a bit of a simplification, but it provides clarity. It also invokes the image of financial business as entirely non-productive.
I have not
concluded that financial business is entirely non-productive. Nor have
I concluded that it isn't. Thus I asked the question in the title of
the previous post: How productive is finance? But my answer depends on
the size of output as given by the GVA of finance. If the output of
finance has been increased by changing what's counted to make output
look bigger, then GVA overstates the output of finance, and my previous
post overstates the productivity of finance.
It seems Bezemer and Hudson's "recast since the 1980s" remark is a simplified version of the story. In Financial Output as Economic Input: Resolving the Inconsistent Treatment of Financial Services in the National Accounts, Jacob Assa provides a brief history of the changes to the accounting of finance in the System of National Accounts (SNA):
At a first stage in the history of this question (SNA 53 and before), all financial intermediation activities were excluded from calculations of national output based on the value-added approach, since they were considered to be mere transfers of funds (similar to social security payments) and hence unproductive. An intermediate approach followed with the SNA 68, where the output of the financial sector was considered to be an input to a notional (i.e. imaginary) industry which has no output....
Finally, with the 1993 SNA, financial intermediation became an explicitly productive activity, for which value added is imputed based on the net interest received by financial institutions (the FISIM approach).
Assa points out that these additions to the GVA of finance are subtracted
from other components of GVA: They are treated as costs to the industries using those financial
services, "thus affecting only the relative size of the financial
sector rather than the total GDP".
So, if I have it right, they are not using these accounting revisions to double-count finance and boost the reported size of GDP. But they do count financial costs as part of output, by including them in the Gross Value Added of finance. In this context, it is important to remember that with "SNA 53 and before ... all financial intermediation activities were excluded ... since they were considered to be ... unproductive."
The end result of this "recasting" of the national accounts has been to include more financial cost as financial industry output and to count it as part of the Gross Value Added of finance.
The Bezemer and Hudson article and the Jacob Assa paper both reference Brett Christophers's 2011 paper Making finance productive. In the Abstract of that paper, Christophers writes:
His statement clearly describes the redistricting of data that increased the output attributed to financial business. In brief, then, Bezemer and Hudson were exactly on point: the national accounts have been "recast" to present finance as productive.By placing different activities on different sides of a pivotal ‘production boundary’, national income statisticians effectively dictate what counts as productive – as adding value to the economy – and what does not.
Calling something productive doesn't mean it is productive. Sure, we may be able to buy more cars because of finance. And we may be able to manufacture more cars because of finance. But finance didn't make the cars. It only made the money available.
It made the money available, and sent us the bill. And yes, that may be fair. But "fair" is not the same as "productive".
How much output does finance create, really? Not much; this is clear from the graphs of the previous post. But those graphs use the "recast" Gross Value Added as the measure of financial output. The true measure of financial output is less than the graphs show. And that means the productivity of finance is less than those graphs show.
How much output does finance create, really?
Michael Sandel teaches political philosophy at Harvard University. In an interview with Sam Harris of Making Sense, Sandel said
It's been estimated by folks who know more about it than I do, that only about 15% of financial activity consists in investment in new productive assets for the economy. 85% consists of simply bidding up the price or betting on the future prices of already existing assets or, increasingly, synthetically created derivatives and other fancy financial instruments that have precious little to do with making the economy more productive.
The productivity of finance is about fifteen percent.
In an article at LinkedIn, Rana Foroohar wrote
Market capitalism, as envisioned by Adam Smith, was supposed to funnel our collective savings into productive investment, via the banking system. But today, deep academic research shows that only around 15% of the money flowing from financial institutions actually makes its way into business investment. The rest gets moved around a closed financial loop, via the buying and selling of existing assets, like real estate, stocks, and bonds.
The productivity of finance is about fifteen percent.
Sandel and Foroohar agree on the number. Neither one documents it: no references, no links, no quotes, no sources, not even any detail. So I cannot accept the number. Sure, it's probably right, I will say that. But as presented, it is no better than a rumor.
But how much output does finance create, really?
Using my calculation, GVA per dollar of profit as a measure of industry productivity, corporate finance is less than 40% as productive as the standard set by nonfinancial corporate business. On average, 37.9%. But if GVA overstates the output of finance, then 37.9% overstates the productivity of finance.
I'm not the guy who can determine what is
and what isn't financial output. Mine is only a hobbyist's eye. To my
eye, finance produces no output, only cost. I could guess that finance
is only half as productive as the "Gross Value Added" says. I think it must be much less than half, but I certainly don't know. So to be fair (yeah, that
again) fifty-fifty is the only guess I can make.
If half the
GVA of finance can legitimately be considered output, then, on average,
half of our 37.9% number is the answer. That brings the productivity of
finance down below 20%, meaning finance is less than 20% as productive
as nonfinancial business, per dollar of profit. More accurately, less
than 19%.
That is not far at all from the 15% number of Sandel and Foroohar.
But then, again, if "output per dollar of profit" is a valid way to figure the productivity of industry, and if it was not used in figuring the 15% number, then we should want to use it and apply the "less than 40%" rule, reducing the 15% to less than six percent.
And if we are now saying that finance reaches less than 6 percent of the productivity achieved by nonfinancial corporate business, well, we are almost back down to zero. Nonfinancial businesses are the ones that produce the goods and services we buy, and financial businesses are the ones that produce the money we use to buy those goods and services. The narrative is clear: Finance is entirely nonproductive.
Labor productivity measures how much output workers produce per hour. It is the ratio of output to employee time. But employees are paid for their time, often at an hourly rate. Saying output per hour is not far removed from saying "output per dollar of labor cost".
To figure the labor productivity for our economy, we divide GDP by a cost factor, the hours of labor required to
produce GDP. We want to do something similar when we ask how productive
finance is.
But when we ask "How productive is finance?" we do not mean to ask how much the employees produce. We mean to ask how much the industry produces. The appropriate unit of cost is not the wage, but the profit. The appropriate ratio is not output-per-hour, but output-per-dollar-of-profit.
You could figure the productivity of an industry like finance by using components of GDP, if GDP was reported by industry. GDP isn't reported that way, but "Gross Value Added" (GVA) is. To figure the productivity of finance, you can use the GVA of financial corporate business, divided by the profit of financial corporate business.
Today's graphs present an example.
This graph, which we saw the other day, uses GVA as a measure of output. The graph shows profit per dollar of output:
 |
| Graph #1: Corporate Profits as Percent of GVA (output) for Financial (red) and Nonfinancial (blue) Corporate Business |
Finance runs high.
If
we take that ratio and turn it upside down, we'll be looking at output per
dollar of profit. We will get to see how much output is produced (and how
much income is created) per dollar of reward to some bunch of corporations. Now, that is a measure of industry productivity!
Profit-per-dollar-of-output measures the benefit to the business that generated the profit. Output-per-dollar-of-profit measures the benefit to the economy that generated the output.
Profit-per-dollar-of-output has micro-economic significance. Output-per-dollar-of-profit has macroeconomic significance.
//
This graph, then, shows the macro view:
 |
| Graph #2: GVA (output) as Percent of Corporate Profits for Financial (red) and Nonfinancial (blue) Corporate Business |
Here
finance (red) runs low. Red is approximately half,
maybe less than half the blue. Output per dollar of profit, for financial
corporations, is half or less than half the output per dollar of nonfinancial
corporate profit. Per dollar of profit, the benefit to the economy produced
by finance is half or less than half the benefit produced by
nonfinancial corporate business.
How productive is finance? Half or less than half as productive as nonfinancial business.
//
Less than half. The nonfinancial measure of "output per dollar of profit" runs consistently higher than the financial measure. The nonfinancial measure sets the standard. How does finance compare? The next graph shows the financial measure as a percent of the nonfinancial:
 |
| Graph #3: GVA-to-Profit for FCB as a Percent of GVA-to-Profit for NCB |
40 percent, about. Less than half. Give or take, the financial measure is about 40 percent of the standard set by the nonfinancial measure of output per dollar of profit.
The average, for all the quarterly (Q4 1951 to Q3 2021) data shown on the graph is 37.9%. Less than 40% of the nonfinancial measure, on average.
If
output per dollar of profit is a measure of how productive business is,
financial business is less than forty percent as productive as
nonfinancial business. That's based on corporate "Gross Value Added"
data and corporate profits. I'm not making it up.
//
Now... The
calculation of Gross Value Added has been tinkered with, to make GVA of Finance bigger. There is evidently some disagreement about
which parts of financial business activity should count as "productive" and which parts shouldn't. We'll review the history of this tinkering tomorrow.
For now, suffice it to say
that when we count every dollar of GVA reported for corporate finance, and count it all as productive, financial corporate business is still only
37.9% as productive as nonfinancial corporate business. If we undo the tinkering and take out the changes that made the GVA of finance bigger, we make it smaller again. If we do that, finance
will be less than 37.9% as productive as nonfinancial corporate business.
This all is based on output per dollar of profit, which makes good sense to me as a measure of industry productivity.
 |
| Graph #1: A Gross Value Added comparison: GVA FCB as a percent of GVA NCB |
Financial Corporate Business (FCB) starts the graph at about 4% the size of Nonfinancial Corporate Business (NCB), and ends up at, oh, call it 16%.
There was a fourfold increase in the size of finance, relative to the productive (nonfinancial) corporate sector. That fourfold increase occupied the whole second half of the 20th century. The effect on the economy was nothing like the fourfold increase in the price of oil in three or four months of 1973.
Nothing
like it. In the 1970s, for a while people almost stopped blaming wages
for inflation, blaming oil instead. But in the whole second half of the
twentieth century, far as I know, no one ever blamed the cost of finance
for causing inflation. Finance was the magic bullet, all good, with
zero harmful effects.
Zero harmful effects? Nah, I don't buy that.
|
| Graph #1: Corporate Profits as Percent of GVA for Financial (red) and Nonfinancial (blue) Corporate Business |
"Financialization is the result of a shift away from low-profit activities in the real economy."- Chris Dillow in The trouble with capitalism
I
think so, too. These days, or "since the 1980s" maybe, financialization
is a shift away from the low-profit activity of the nonfinancial economy.
But I also think the activity in the nonfinancial economy became low-profit activity because of the growth of finance in the years before 1980. When you add this afterthought to Dillow's statement, things start to make sense.
Outside the financial sector, finance is a cost.
Dillow's topic is the decline of profits:
Many of the faults Martin [Wolf] discusses have their origin in a declining rate of profit – a decline which became acute in the 1970s but which was never wholly reversed.
The causes of this decline, causes that Dillow touches on, go back to the 1960s.
So do the causes that he doesn't touch on -- the growth of finance, the growth of financial cost, and the fact that finance is At Least Largely (ALL) nonproductive.
(That's my idea of funny, that "(ALL)" there at the end.)
"The capitalist who is solicited for a loan by a needy Finance Minister, considers, first and chiefly, how soon and on what terms he will be able to sell his rights to it."- Francis William Newman, in On the constitutional and moral
right or wrong of our National Debt, published in 1849.
On the constitutional and moral right or wrong of our National Debt by Francis William Newman (1849), a Google Book, via Google Ngrams and Search.
I should say first, so far I have only read the Introduction.
Francis
William Newman, philosopher, does not argue in the Introduction for or against paying down
the national debt. He does not argue for or against expanding that debt.
The argument he lays out is in opposition to the unimpeded progress of financialization and, I suggest, to financialization itself.
Those who traffic in the Public Debt of a country have, in one important respect, an interest directly the opposite to the fixed creditor; just as the speculators in Railway Stock have an opposite interest from the shareholders in general.The next excerpt opens by saying most people who hold government debt think of it as "a permanent investment". This may not be true today; surely it is at least somewhat less true today than it was in 1849. Do not dismiss what Newman says on the grounds that it is no longer valid. Think of it instead as something that became no longer valid through a gradual process that is today called "financialization". If you make it past the first half of the sentence, you will see why I say this:
Now, inasmuch as the great mass of the English funded debt is held either by trustees or by persons who have selected it as a permanent investment, these have nothing to gain, but in prospect something to lose, by concealment and by inflated hopes: while, on the contrary, it is unfortunate that the useful class of men who from month to month buy and sell largely in the Funded Debt, have a direct and powerful temptation to deprecate all inquiry into its history, its theory, and its prospects.
He reminds me of Adam Smith. Maybe it's the "philosopher" thing. Anyway, regarding that "useful class of men":
Now, since it is this very class of persons, the great money-dealers, who most affect the action of the Government, the opinion of the aristocracy and the utterances of journalists ... it is not surprising, that to direct the public mind at all to the subject, is regarded as mischievous, and that whoever ventures to unsettle the prevalent notions concerning it, is called reckless and destructive.
Newman says that these "useful" men, these rentiers, are the influencers of government, of other wealth holders, and of the media, and they don't want anyone to challenge their dominance. Then, clearly arguing against financialization, Newman writes:
To the permanent holders of public guarantees, it is of first importance that doctrines which utterly disavow their rights should not advance, unopposed, because ignored.
To the many (who think of their holdings of government debt as a "permanent" investment) it is highly important, Newman says, that the few with "an opposite interest" do not win the argument by suppressing argument.
How much data would it take to convince you?
 |
| Debt-to-GDP, 1834-2020. Debt data from Steve Keen, FRED. GDP data from Measuringworth. |
... those basic economic tendencies ... proceeded steadily ever since long before the Civil War, and continued down to the latest moment ...
Why does it matter? Because the cycle of civilization is just a big business cycle. And because when we say "the economy changes" we are talking about that big cycle.
And because we can continue on, to the rapidly-approaching Dark Age, or we can prevent that outcome. The choice is ours. "Civilizations die by suicide".
Excessive preoccupation with finance and tolerance of debt are apparently typical of great economic powers in their late stages.- Kevin Phillips, quoted by Giovanni Arrighi
I get up in the morning -- this morning, around 1:30 -- turn the computer on, and see where it takes me. I always find something to write about. Lately, the topics are bigger than I can satisfyingly write in a day. A lot of that writing is left unfinished, forgotten when the next morning comes.
So it goes.
This morning I was going to resume yesterday's efforts on financialization as the latest stage in the evolution of finance. But then I thought Oh, you know, let's see the ngrams.
Apparently nothing
until the 1980s. Skyrocket since the early 2000s. I clicked the
link to view the associated Google-books and picked the "full view"
option. It didn't take long, and I was off to the races again.
Modern Economic Tendencies by Sidney A. Reeve. Copyright 1921 by E.P. Dutton & Co.
The Expansion of Financialization. -- Indeed, the birth and growth of this practice, with its variations, has so revolutionalized our national methods of organizing industry, during the last quarter-century, that a business man of 1890 would find himself at sea to-day. The whole aspect of our more prominent engineering houses has been transformed, to meet this modern condition, from that of shops or designing-offices pure and simple into concerns more or less completely financial in character and function...
I read a little more, then jumped to the start of the book. The Preface opens with these words:
In a work portraying economic evolution from a time generations in the past down to the latest practicable moment ...
Economic evolution. I have to read more.
From the Preface:
In essential, the structure of the book remains that of a history of American economic evolution from early in the nineteenth century down to the entrance of this country into the Great War of 1914. As to the huge economic changes wrought by the war itself, then not only unfinished but regarded by many as hanging precariously in balance, barely an attempt at their inclusion has been made. The still more significant changes which have occurred since the armistice of November, 1918, are represented only as sheer predictions ...
So far as these latest changes have proceeded they corroborate not only the predictions made in the book, but the principle on which those predictions were made, namely, history's repetition of itself. The results of the Great War in matters economic have been a close parallel with those resultant from the Civil War, and from the Spanish War of 1898, except that all scales of magnitude have been increased. But, just as those basic economic tendencies which this book reveals as having proceeded steadily ever since long before the Civil War, and continued down to the latest moment, with a scarcely perceptible waver in deference to either that war or the war of 1898 -- with acceleration, indeed, by each of those wars -- so it is only natural to remark now how slightly this path of social evolution has been altered by even the Great War of 1914, except in its acceleration thereby.
And briefly, from Chapter X: Interest and Dividends
There is no other topic of such supreme import to modern society as the nature of interest. There is no other one feature of the social organism which handles anything like the current volume of wealth as this, nor which guides toward happiness or unhappiness so many lives.
...
For the present, the minor differences between interest on bonds, commercial paper or personal loans, as contrasted with dividends on stock, will be overlooked. The same remark applies to some so-called profits, which include wrongly sums which are in reality interest. Whatever the name, the essential character of interest is that it is money paid by the Ultimate Consumer (and not by the borrower) ...
"Excessive
preoccupation with finance and tolerance of debt are apparently typical
of great economic powers in their late stages. They foreshadow economic
decline."
- From Kevin Phillips in Boiling Point: Republicans, Democrats, and the Decline of Middle-class Prosperity (1993), quoted by Giovanni Arrighi.
 |
| Graph #1: Net Interest on a Log Scale |
Financialization is sometimes said to have begun around 1980. But there was financialization from the start. What began around 1980 was a power struggle,
"... a power struggle between rentiers and industrial capitalists that is eventually being resolved at the expense of workers."- The Impact of Financialisation, p. 10
For the economy as a whole, interest paid equals interest received.
When
you break it up by sector, there's no guarantee that things remain equal.
For any one sector of the economy, as for any one person, there is no
assurance that interest paid will equal interest received. It is like "sectoral balance" analysis, where some totals are above zero and
others are below. But if you count everything and double-count nothing,
the sector totals will still add up to zero.
I didn't do that.
I didn't count all the sectors, just the interesting ones: government,
business, and people. And I did do some double-counting: I counted not
only domestic business but also the part of it called domestic corporate
business, and again two components of corporate business: financial and
nonfinancial.
So the lines on my graph won't total up to zero. But there still are above-zero and below-zero values all over the graph, and you get the feel for how they would add up to zero if I did it right.
 |
| Graph #1: Net Interest for Various Sectors of the US Economy |
I made the graph taller than usual because all that text at the top crowded the plot area.
From lowest to highest in the most recent years:
The orange (financial corporate business) data is double-counted in the purple (corporate business) and the green (total US business) lines. To eliminate the double-counting, imagine that the green and purple lines disappear. That leaves financial corporate data by itself, high on the graph, while nonfinancial corporate runs low (below zero) with the household and federal net interest data.
Household net interest did run above zero until the early 1990s, but has been below zero since then. Oh, and net interest "above zero" means you have more interest income than cost. "Below zero" means you have more interest cost than income.
So
basically, finance makes a lot of money by interest -- which keeps
banks in business -- and everyone else loses money by it. Our loss is
their gain.
From Measuring Labor’s Share of Income (PDF, 11 pages) by Paul Gomme and Peter Rupert:
[T]he terms “capital’s share” and “profit share” are often used interchangeably, ignoring the fact that capital income derives from more sources than just (corporate) profits.
From Finance is Not the Economy (2016) by Dirk Bezemer and Michael Hudson:
Immoderate debt creation was behind that “Great Moderation”. That is what made this economy the “Great Polarization” between creditors and debtors. This financial expansion took the form more of rent extraction than of profits on production — a fact missed in most analyses today.
Reminds me of what is said of the Debt-to-GDP graph: Flat before 1980, then rising.
Much of the existing economic literature on credit and banking, when it turns to the kind of larger historical questions treated in this book, strikes me as little more than special pleading. True, earlier figures like Adam Smith and David Ricardo were suspicious of credit systems, but already by the mid-nineteenth century, economists who concerned themselves with such matters were largely in the business of trying to demonstrate that, despite appearances, the banking system really was profoundly democratic...
If things went bad in the mid-nineteenth century, it wasn't because of J.S. Mill and economists of his caliber. More likely it should be attributed to a business ethic; to a view shared by people who thought they would make money by promoting that view; by bankers and other lenders.
Perhaps it should be attributed in part also to our natural willingness to use credit. But it is difficult to say, because our natural willingness has been enhanced by people who promote the use of credit and, even more, by economic policies that promote the use of credit.
Debt dominates David Graeber's thinking in the book, just as it dominates mine here on the blog, and just as it dominates all our lives, almost all our lives, out in the world. Graeber promotes a "choose not to pay your debt" view. I found that a terribly disappointing end to his book. He thinks we should take a moral stand and say debt is wrong, debt is somehow wrong, we object to debt, and we refuse to pay:
And the first step in that journey, in turn, is to accept that in the largest scheme of things, just as no one has the right to tell us our true value, no one has the right to tell us what we truly owe.
That is his concluding thought: No one has the right to tell us what we owe!
He is indeed an anarchist. And apparently he doesn't care if the economy falls apart. You can't have an economy where people run up debt and then don't pay it. That cannot work. And for sure it won't work if you take government out of the picture.
The trick is to not run up debt in the first place. But we cannot defy policy. We have to change it.
Hey,
Graeber says we need "debt amnesty" or a "biblical Jubilee". I think
something like that is a good idea -- but only because we have an
economy where we ran up debt until we couldn't afford to pay it. Debt
jubilee isn't a solution. It's a temporary fix. The problem is that we
have an economy that thrives on running up debt until we can't afford to
pay it. That is the problem. That has to change. Just
forgiving debt doesn't do it.
Graeber, chapter 3
If one were looking for the ethos for an individualistic society such as our own, one way to do it might well be to say: we all owe an infinite debt to humanity, society, nature, or the cosmos (however one prefers to frame it), but no one else could possibly tell us how we are to pay it.
By definition, an infinite debt cannot be repaid. Even if you could pay half of it, the unpaid debt would still be infinite.
Graeber, chapter 3:
One could in fact interpret this list as a subtle way of saying that the only way of "freeing oneself" from the debt was not literally repaying debts, but rather showing that these debts do not exist because one is not in fact separate to begin with, and hence that the very notion of canceling the debt, and achieving a separate, autonomous existence, was ridiculous from the start. Or even that the very presumption of positing oneself as separate from humanity or the cosmos, so much so that one can enter into one-to-one dealings with it, is itself the crime that can be answered only by death. Our guilt is not due to the fact that we cannot repay our debt to the universe. Our guilt is our presumption in thinking of ourselves as being in any sense an equivalent to Everything Else that Exists or Has Ever Existed, so as to be able to conceive of such a debt in the first place.
Graeber, chapter 3:
If you start from the barter theory of money, you have to resolve the problem of how and why you would come to select one commodity to measure just how much you want each of the other ones.
David Graeber, from chapter 3:
Why were cattle so often used as money ? The German historian Bernard Laum long ago pointed out that in Homer, when people measure the value of a ship or suit of armor, they always measure it in oxen-even though when they actually exchange things, they never pay for anything in oxen . It is hard to escape the conclusion that this was because an ox was what one offered the gods in sacrifice. Hence they represented absolute value. From Sumer to Classical Greece, silver and gold were dedicated as offerings in temples. Everywhere, money seems to have emerged from the thing most appropriate for giving to the gods.It is strangely fascinating, but it is not economics.
On 4 January I said
I'm thinking of new-use-of-credit as extra money spent into the economy. And I'm thinking of cost-of-interest as a reduction of money available for current spending.
Scott Sumner would say it is not true that the cost-of-interest is a reduction of money available for current spending. I remember an exchange of comments at his blog Money Illusion. Here, Sumner's reply to an earlier comment by Woj:
Woj, You said;
“As the aggregate amount of debt and interest rises, the percentage of income used to pay interest costs or pay down debt also rises, lowering the amount available for consumption/investment.”
This is simply factually wrong. Every debt payment is money received by someone else.
Even if what Sumner said is true, it still misses the point.
If I use a dollar of income to pay a debt, I can't use that dollar to buy something else. And as the aggregate amount of debt and interest rises, there are more and more dollars that can't be used to buy something else.
Meanwhile, the dollars used for debt and interest payments are money received by someone in finance. As debt and interest costs rise, money moves increasingly out of the general economy and into the financial sector. And money in finance tends to stay in finance.
Oh, you can borrow it, maybe, but you'll have to return it. And you'll have to pay a little something extra. As debt and interest costs rise, and even just as time passes, money moves more and more into finance. As it does so, it moves out of the "nonfinancial" economy where people live and where goods and services (other than monetary services) are created.
As money moves out of the nonfinancial economy, we are forced to increase our reliance on credit. As our reliance on credit increases, money increasingly moves out of the nonfinancial economy. This is the new "circular flow".
If it continues, civilization will not.
You've seen the GDP equation Y = C + I + G + NX where
C and I and G represent the three major domestic sectors of the economy, and NX covers trade with other nations.
Okay,
I want to look at interest cost, not GDP. But I want to look at
interest cost in our whole economy. So again there are the three major
domestic sectors. In place of Net Exports we could have interest paid by
"rest of the world" but I don't want to count that: I want to count the
interest paid by us -- by US households and businesses and governments.
And I want to count that interest, no matter who received the payment.
So I have C and I and G but I don't need Net Exports.
To count all of G it is necessary to count two parts: the federal component, and the state-and-local component. So to count all interest cost, I count interest paid by C + I + F + SL.
I could use FRED's "Monetary Interest Paid" dataset, but that only goes back to 1960. C and I and SL go back to 1946, and F goes back to 1929. Evidently, FRED doesn't combine those datasets, probably because they are incompatible.
I'm going to combine them anyway, to get a rough idea of what the interest cost might have looked like all the way back to 1946.
Here is the combined data:
 |
| Graph #1: The orange data continues out to 2020. This graph stops at 1975. |
The blue line is my estimate of interest paid during the 1946-1959 period. It includes payments by households, businesses, the federal government, and state and local governments.
The orange line begins in 1960 and shows the FRED data for the total Monetary Interest Paid.
That was more work than I expected, considering the simple thing I want to do with the resulting data: I just want to compare the cost of interest to the new use of credit each year.
I'm thinking of new-use-of-credit as extra money spent into the economy. And I'm thinking of cost-of-interest as a reduction of money available for current spending. I think the "extra money" will have to be greater than the "reduction of money", or the economy will get no boost from the use of credit.
My purpose in this post is to evaluate the flow of credit into the economy, and the flow of payment-for-that-credit out of the economy, or (more precisely) out of the producing-and-consuming sector and into the financial accumulation sector. My task is an attempt to see how useful credit is as a tool for expanding aggregate demand in the producing-and-consuming sector.
My gut says it is no longer useful, because the accumulation of debt is so big that the interest we pay -- even at low rates -- is more than our new uses of credit. I figure it is the financial accumulation sector that benefits most by our use of credit.
The graph below shows for
each year the total amount borrowed by all sectors of the US economy,
minus the amount we paid as interest on our debt. Where the plotted line
is above zero, it shows a boost to the economy from our borrowing and
spending. Where the line is below zero, it indicates a drag on the
economy arising from interest costs that exceed the amount of our
borrowing. Where the line is at zero, there is no boost and no drag.
Note: The values shown on the graph are annual, not cumulative:
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| Graph #2: That tall spike on the right is the covid-related borrowing of 2020 |
Until around 1978, the plotted line runs near zero. It says there was no net gain from our use of credit, but no net loss either.
After 1978 the plotted line is almost entirely below zero. Net loss almost all the time, except in the financial accumulation sector. This could explain the relatively poor performance of our economy for the last 40 years and more.
Below is a close-up of the early years, from 1946 to 1982:
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| Graph #3 |
It runs at or slightly above the zero level until around 1966; then at or increasingly below the zero level. In other words, there was a very slight boost to the economy from credit use, early on. But after 1966 the use of credit did more harm than good, as the interest cost was generally more than the boost we got from credit use.
That drag on the economy continued after 1982, as graph #2 shows. That graph can explain the slowing of the US economy since 1966. Thus one argument -- the growth of finance -- explains the long-term slowing of economic growth.
The Excel file at DropBox: Monetary Interest Paid datasets 3 Jan 2022 ArtS.xls
