But not a happy accident

Òscar Jordà, Moritz Schularick, Alan M. Taylor in Macrofinancial History and the New Business Cycle Facts (2016):

In the age of credit, monetary aggregates come a distant second when it comes to the association with macroeconomic variables. Real changes in M2 were more closely associated with cyclical fluctuations in real variables than credit before WW2. This is no longer true in the postwar era. As Table 10 demonstrates, in recent times changes in real credit are generally much more tightly aligned with real fluctuations than those of money.

and

The growing correlation between credit and inflation rates is noteworthy. In the pre-WW2 data, the correlation between loan growth and inflation was positive but relatively low. In the post-WW2 era, correlation coefficients rose and are of a similar magnitude to those of money and inflation.

Yeah, and it's good that they point these things out. But really, what else would you expect??? Probably half of our economic policies are dedicated in one way or another to expanding the use of credit, or the availability of credit, or both.^[1]  So of course we use credit. So of course credit has come to replace money as the transaction medium of choice. So of course the things that used to be associated with money are now associated with credit-use. So of course we find J.W. Mason saying

I don't think the idea of "money" as something that has a quantity applies to the credit-money world of today

and

I don’t think a “quantity of money” has been an important part of orthodox macroeconomics or any major heterodox school for many, many years.

and

Basically, once you say “the central bank sets the interest rate”, M disappears from the analysis.

Of course: Mason has a very good understanding of the way the economy works. But I wonder if he ever thought about how and why our world changed from a “quantity of money” world to a "credit-money world". And now I'm thinkin maybe more than half our economic policies serve to expand the use or availability of credit, or both.


As if confirming our transition from a world of money to a world of credit, and the findings of Jordà, Schularick, and Taylor, Christina D. Romer writes

Monetary policy, in particular, appears to have played a crucial role in causing business cycles in the United States since World War II... The role of money in causing business cycles is even stronger if one considers the era before World War II.

Well, now we know.
The role of money was stronger before World War II; the role of credit is stronger since.^[2]  Oddly, though, the word "credit" doesn't even appear in Romer's article. And I don't ever see economists saying the transition to credit was the result of economic policy. It was an accidental result, in my view, but this does not relieve policy and policymakers of responsibility.

Come to think of it, when I said credit is our "transaction medium of choice", I didn't really mean we "chose" it. It's more like we were tricked and trapped and encouraged and induced into using credit, by the design of policy. But I still say our transition to credit was an unintended consequence of policy that had been created for the purpose of boosting economic growth.


James Hamilton pointed out that Jordà, Schularick, and Taylor

also find that the skewness of GDP has become more negative– big movements up have become more subdued relative to downturns.

Seems to me this should count as a cost, not a benefit, when we're tallying up the costs and benefits of our accidental transition to cashlessness.



Notes
1. For example, the debt of the government-created agencies Fannie Mae and Freddie Mac was "equal to 46 percent of the current national debt" -- almost half -- and that was back in 2003. Good thing it's not counted in the Federal debt, huh? Too bad our mortgages are counted in our debt!

2. Credit-use became dominant (and money of secondary importance) in the early 1960s. See The Sweet Spot on my old blog.

An "optimum level of credit use"? Yeah!

Back in 2014, Steven Hansen asked Is Credit Fueling Economic Growth?  He quoted Noah Smith:

Maybe credit really does drive growth. Maybe excess credit really does force a boom to turn into a bust. But no one has yet come up with a really compelling, testable explanation for how that happens.

Sure they have, Noah, though perhaps not expressed in the particular model you require. Cost. The explanation is cost: the rise of financial cost. Cost, Noah.

Need I repeat myself?

Down the page a bit, Hansen writes:

Also there is little question that consumer credit is becoming a larger and larger element in the economy - but:

• prior to 1980 it seems there was a positive correlation between consumer credit to gdp ratio and GDP growth;

• since 1980, consumer credit to gdp ratio has had an inverse correlation to GDP growth.

Could it be true that at some point of growth, consumer credit growth works against GDP growth?

Yes, Hansen, but it's tough to untangle. A lot was going on around 1980: deregulation, supply-side economics, you name it. Credit use was only one part of it all (and credit use was enhanced by some of it). And consumer credit was only one part of credit.

Further yet down the page:

My opinion is that too much consumer credit outstanding constrains economic growth, and too little consumer credit outstanding constrains economic growth. The optimum consumer credit levels are likely a sliding scale based on a slew of dynamics - and I suspect one of the larger dynamics is rate of inflation (the higher the rate of inflation, the higher the optimum level of credit).

Glad to see I'm not the only one who says there must be an optimum level of credit. But, fuck, it's not only "credit outstanding" you have to think about. There are also the new uses of credit, the ones that add to credit outstanding, just like deficits add to the Federal debt.

New uses of credit put money into the economy when the money is spent. The borrower is left with a debt (or "credit outstanding" as Hansen says). Then, when the monthly payments begin, money starts coming back out of the economy. The new use of credit, the borrowing and spending, increases economic activity. Repayment of the debt reduces it.

So...

1. The amount of credit we have in use use is called debt. Putting new credit to use adds to that debt. 
2. A new use of credit provides boost to the economy. Paying down the resulting debt creates a more or less "equal and opposite" drag on the economy. And
3. Debt, oddly, is not the problem; repayment is. But you can't have one without the other.

Super simple stuff.

"the level of debt doesn’t matter"

Steve Keen:

I couldn’t convince several of the academics in the audience of the importance of private debt: they kept coming back to “one person’s debt is another person’s asset, therefore the level of debt doesn’t matter”.

Yeah, I think I get what the academics were sayin...

The Level of U.S. Private Debt

Why would it be a problem? Cost, maybe?

No, no, I see their point: It's probably better just to adamantly refuse even to think about it. Cough cough.

How did we get so much private debt, and why was nothing done to prevent it?

How we got all that debt is simple: Policy didn't prevent it. In fact, policy encouraged it. But what's done is done. There is a better question: Why? Why was nothing done to prevent it?

Cecchetti, Mohanty, and Zampolli:

"For a macroeconomist working to construct a theoretical structure for understanding the economy as a whole, debt is either trivial or intractable. Trivial because (in a closed economy) it is net zero—the liabilities of all borrowers always exactly match the assets of all lenders."

I'm leaving out the part about "intractable" because they've already answered my question: "net zero". It comes to nothing.

Steve Keen:

"conventional economists ... ignore private debt as just a “pure redistribution”, to quote Ben Bernanke."

Pure redistribution: For every dollar my debt costs me, somebody else earns a dollar. It's the net-zero thing again.

Paul Krugman:

This is how you want to think about debt: it’s not a burden on the nation’s resources, because it’s mainly money we owe to ourselves, and it’s a problem not because we have to tighten our belt but because debt is currently leading to spending that’s less than we need to maintain full employment.

Krugman at least acknowledges that excessive debt reduces aggregate demand. But really, he's only changing the subject.

Debt's "not a burden," he says, "because it’s mainly money we owe to ourselves". Again, the net-zero thing. He enhanced the story, but he can't let go of net-zero.


Asymptosis summarized such explanations with exceptional clarity:

"Economists will tell you that gross debt levels don’t matter because one person’s debt is another’s holdings. (Net: zero.) They ignore it."

Yeah, I know: Net zero. But isn't it a weak argument? I mean, really. That's the whole story? Are we doing economics here, or are we just jerking off?

The "net-zero" argument is absurd. It's like balancing your checkbook (remember those days?), getting the errors to zero out, and then saying the zero means you didn't spend any money last month.

There's gotta be a better explanation. I need a better explanation.

I kept an eye open for a long time, and finally found a different story, from Patrizio Lainà:

"Interestingly, mainstream economists have given warnings about the public debt to GDP ratio (see e.g. Sargent & Wallace 1981), but at the same time they have almost completely neglected the private debt to GDP ratio. This might be due to Fama's (1965 & 1970) widely used efficient market hypothesis, which simply implies that private debt does not matter because it is always on the “right” level and no economic imbalances, such as bubbles, should occur. This, in turn, indicates that there is no need to study private or total debt."

The efficient market hypothesis. At least it's not net-zero again. And if the EMH has been debunked, that's good: It just means the "private debt does not matter" argument has no solid foundation.

Beyond that, something finally clicked for me, and now I have my own explanation, apart from net-zero and the efficient markets thing. My explanation is simple: As long as economists think credit-use is good for growth, they cannot see private debt as a problem.

I think mine is the strongest argument.

An oldie but goodie

From Finance Is Not the Economy, by Dirk Bezemer and Michael Hudson (2016):

The financial sector does not produce goods or even “real” wealth. And to the extent that it produces services, much of this serves to redirect revenues to rentiers, not to generate wages and profits.

Credit: A very vicious circle

Using credit boosts the economy because it leads to additional spending. But using credit also creates debt, and paying off debt reduces spending.

If we start off with only a little debt, the use of credit creates a good boost to spending, and debt service only reduces spending a little.

But credit-use creates debt, so our little debt gradually becomes big. And debt service on a big debt reduces spending a lot. When that happens, to get a boost by the use of credit, our use of credit must be large and growing. But using credit creates debt ...

Economics over Politics, always. Why?

If you need to ask why, I suppose you need an answer. Here's a good answer, from Chapter 1 of The Moral Consequences of Economic Growth by Benjamin M. Friedman:

Economic growth -- meaning a rising standard of living for the clear majority of citizens -- more often than not fosters greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy...

But when living standards stagnate or decline, most societies make little if any progress toward any of these goals, and in all too many instances they plainly retrogress...

And as we shall see from our own experience as well as that of other countries, merely being rich is no bar to a society's retreat into rigidity and intolerance once enough of its citizens lose their sense that they are getting ahead.

Try it sometime

J.W. Mason from 2013:

I don't think the idea of "money" as something that has a quantity applies to the credit-money world of today

The implicit assumption underlying Mason's statement is that "the credit-money world of today" is just as viable as the quantity-of-money world was in its day.

I think that's an incorrect assumption.

J.W. Mason, more recently:

I don’t think a “quantity of money” has been an important part of orthodox macroeconomics or any major heterodox school for many, many years.

Here, Mason's not talking about the economy. He's talking about economics, or schools of economic thought. I think he's right. Economists no longer think of the “quantity of money” as an important part of macroeconomics.


Maybe they don't think in terms of the quantity of money because we live in a credit-money world today.

As for myself, I think in terms of the quantity of credit-money relative to the quantity of non-credit money. Try it sometime.

Terminology

When you borrow money and spend it, you are using credit. But the person that you pay receives money, not credit. (They don't have to pay interest on it; you do.) And after you spend it, you don't have that money anymore; you owe it. You have the debt.

"breakdown"

From The Disintegrations of Civilizations (chapter 5 in A Study of History):

... [T]he horizontal schism ["between geographically intermingled but socially segregated classes"] of a society along lines of class is not only peculiar to civilizations [as opposed to primitive societies] but is also a phenomenon which appears at the moment of their breakdowns ...

From How Do I Stop My Garden Hose From Leaking? at Backyard Boss:

Occasionally a leaky hose might be as simple as a loose connection at the faucet that is easily remedied with a quick turn of the joint. But more often than not, once something begins to leak, if a tightening of the hose connection at the spigot head doesn’t solve the problem, or if the leak is found elsewhere, there is a good chance it will get worse. The most common reason for joint or spout leakage is due to a breakdown of the connection ...

So maybe, if you're fiddling with your hose and suddenly it starts to leak, maybe you caused the breakdown of the connection by fiddling.

And maybe, if you're fiddling with economic policy and it doesn't reduce or eliminate the schism along lines of class, maybe you didn't fix the problem.

Evolution: An accumulation of changes

Following Wikipedia's histories of HUD and Fannie Mae we have:

• 1938: Fannie Mae is created "to provide local banks with federal money to finance home loans in an attempt to raise levels of home ownership and the availability of affordable housing"
• 1942: The National Housing Agency is established by Executive Order 9070
• 1947: "The Housing and Home Finance Agency is established through Reorganization Plan Number 3"
• 1950: Fannie Mae is acquired by the Housing and Home Finance Agency from the Federal Loan Agency
• 1954: Fannie Mae becomes a "'mixed-ownership corporation', meaning that federal government held the preferred stock while private investors held the common stock"
• 1959: "The Housing Act of 1959 allows funds for elderly housing"
• 1964: "The Housing Act of 1964 allows rehabilitation loans for homeowners"
• 1968: Fannie Mae becomes a privately held corporation "to remove its activity and debt from the federal budget." [Note that as of 2003, the "combined debt [[of Fannie Mae and Freddie Mac]] is equal to 46 percent of the current national debt."]
• 1968: Ginnie Mae split off from Fannie Mae
• 1968: Ginnie Mae guarantees "the first mortgage passthrough security"
• 1970: Fannie Mae is authorized to purchase conventional loans
• 1970: Freddie Mac created, "to compete with Fannie Mae"
• 1971: "Freddie Mac issued its first mortgage passthrough"
• 1981: "Fannie Mae issued its first mortgage passthrough and called it a mortgage-backed security."
• 1992: Fannie Mae and Freddie Mac "have an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families"
• 1999: Fannie Mae "under pressure from the Clinton administration to expand mortgage loans to low and moderate income borrowers"
• 2003: "in 2003–2004, the subprime mortgage crisis began"

Policymakers went out of their way to make sure credit was available in the economy, and to encourage people to use it. The result? An unprecedented increase of debt, public and private.

Fannie Mae is only one example of such policies.

The Difference Between Recessions and Depressions

GDP goes up and down. It goes down during recessions, and otherwise up. The behavior of debt is similar but more severe: Debt goes down during depressions, and otherwise up.

You can look at the changes in accumulated debt to determine whether a slowdown is a recession or a depression. During recessions, GDP goes down while debt continues to go up (though more slowly than usual). During depressions, GDP and debt both go down.

The units on the graphs below are "change in billions". On these two graphs, the lines always go up and down. But GDP is going down only when the lines are below zero. This occurs at the gray bars that indicate recessions:

Graph #1: Quarterly Change in Real GDP

Debt is also going down only when the lines are below zero, but this only occurs at the rightmost gray bar. Other than that, debt is always going up -- faster or slower, but always up:

Graph #2: Quarterly Change in All Sectors Debt

It's not the easiest thing to see, but debt goes up more slowly near the gray bars than elsewhere; perhaps not in every case, but often.

On the first graph, GDP, the lines go below zero at the gray bars or very near them. On both graphs, the upward trend seems to slow before the gray bars, often well before. The "up slower" starts before the recessions because the central bank is increasing interest rates before recessions, in order to slow the economy.


I notice that in a recent post, David Glasner refers to the Great Recession as the "Little Depression". He's right.

Incomplete transactions

Again, from the Boston Fed's The Evolution of Consumer Credit in America (PDF):

During the early years of the 20th century, a few hotels issued credit cards to favored guests, but the cards were mainly a gimmick — status symbols that distinguished the cardholders from the masses of cash-paying customers. Retail stores and oil companies were issuing credit cards during the 1920s, but they were single-party cards issued by merchants who saw them as a way to sell more goods and services...

Credit cards as we know them today didn’t take off until the 1960s, when financial innovation, improved technology, and changing consumer attitudes all converged. Financial innovation came in the form of a concept pioneered by Diners Club in 1949: the dual-party card. Dual-party cards represented a major breakthrough because the card issuer wasn’t actually providing the goods or services being purchased. Diners Club was not a restaurant chain or a food service company. It simply signed up hotels and restaurants to participate in its credit card plan, and it then issued cards to creditworthy people who were willing to pay a yearly fee for the convenience (and status) of having a card — no need to handle cash or fumble with a checkbook. When a cardholder charged a meal, the restaurant sent the bill to Diners Club, and Diners Club then paid the price of the meal, minus a small commission, directly to the restaurant’s bank. Finally, Diners Club sent the cardholder a monthly statement (bill), and the cardholder sent Diners Club a check.

But Diners Club was only a first step. The innovation that ultimately put dual-party credit cards into so many wallets was the bank card — a general-purpose card that consumers could use in a wide variety of situations. Franklin National Bank (Franklin Square, New York) introduced the first bank card program in 1951. A few years later, Bank of America launched BankAmericard (now Visa), and Chase Manhattan Bank followed with MasterCharge (now MasterCard).

Terminology: "single-party" and "dual-party". Apart from the customer, a single-party card involved only the merchant. The merchant provided both the item purchased and the credit needed to buy it. By contrast, a dual-party card involved not only the merchant but also a bank; and it was the bank that provided the credit.

With the single-party card, it was buy now and pay later. With the dual-party card it was buy now and pay someone else later.

For the single-party card, the picture is a little fuzzy in my mind. Those cards were before my time. But for the dual-party card the situation is clear. With the dual-party card there are two transactions for every purchase.

1. You buy from the merchant and pay with a credit card.
2. You pay the credit card bill.

Now the nomenclature makes sense to me: single-party, one transaction ... dual-party, two transactions. The "parties" are the ones who get paid. That's why the customer doesn't count as a "party". The fuzziness fades.

Anyway, today's credit cards are two-party cards. Every credit card purchase requires two transactions. Whenever you buy something with a credit card, the purchase is not complete until the credit card bill is paid.

Likewise, if you take a bank loan, buy something, and pay the merchant using the borrowed money, your transaction with the merchant is complete but your transaction with the bank is not.

Looking at it this way, debt is a measure of incomplete transactions.

The argument leaves something out

From the Boston Fed: Credit History / The Evolution of Consumer Credit in America (PDF):

Nineteenth century Americans had more than their share of financial pressures, and they weren’t opposed to borrowing. It’s just that they rarely went into debt for things that were fun or frivolous...

But the definition of “luxury” or “nonessential” has a way of changing from one generation to the next. In 1980 most Americans still thought home computers were frills or expensive toys; color televisions were luxury items in 1960; second bathrooms were a relative luxury in 1940; ditto for cars, refrigerators, and washing machines in 1920. Yet by 21st century standards, using credit to acquire any one of these things is neither extravagant nor extraordinary.

Okay. Sure. We use credit more now than we did years back. No shit. But the analysis always stops there and, explicitly or implicitly, we are told that the character of the American people has declined. We're just not as good as people used to be.

Well, I don't like that argument too much. Maybe it's true that our character has declined. I couldn't say. But the argument, the argument leaves something out.

Every time policymakers decide they need to boost economic growth, they come up with a plan to expand the availability and use of credit. It's not something that happened once. It seems to happen in every decade and under every President.

That long-term focus on boosting the use of credit surely contributed much to the change in our credit habits. That part of the story is always left out.


If you happen to think that our "character" has declined or our "moral fiber" has declined, and our use of credit is evidence of this, then you can go F yourself. On the other hand, if you think that policies promoting the use of credit are the big part of the problem, then I'm with you.

And if you think that the gradual, long-term increase in our use of credit increased the financial costs embedded in the cost of living and in the cost of things we buy and sell, then you and I have something in common: You and I can see what's wrong with the economy.

What I could live with

In his links of 8/23/2019 Mark Thoma quotes Summers and Stansbury:

In an environment of secular stagnation in the developed economies, central bankers’ ingenuity in loosening monetary policy is exactly what is not needed. What is needed are admissions of impotence, in order to spur efforts by governments to promote demand through fiscal policies and other means.

Thoma doesn't say that he agrees with the statement, but I figure he does.

I don't. Sure, "admissions of impotence" wouldn't hurt. But the rest of that sentence bothers me: "in order to spur efforts by governments to promote demand through fiscal policies and other means." It suggests that the authors know what policies are needed.

Figuring you know what policies are needed is a good way to create problems. Especially after the problem our policies created a decade ago, economists ought to be very hesitant to jump into anything. Especially if they want to jump into the same policies we had before, or the ones we had before that.

If the quote said that admissions of impotence are needed in order to spur efforts to question everything we think we know about the economy, I could live with that.

As is, no way.