The key to a good economy lies in maintaining the affordability of debt

Originally posted 20 Feb 2013 on my old blog. Streamlined, updated, and re-titled. And this time, I finish the thought.

Ours is a world that relies on credit to grow the economy, yet somehow we think private debt can never be a problem.

What's that? "Not we," you say? Good. I'm with you.

The good economic growth of the 1950s and '60s was fostered by the growth of private debt. In the early 1960s, private debt was still relatively low, and not much of a problem. But by 1970, debt had accumulated enough that the rising cost of debt service engendered a great inflation.

Despite the inflation -- or because of it, maybe -- economic growth was vigorous in the 1970s. But the inflation was unacceptable. The fight against inflation created a series of recessions and reduced the decade average growth rate. Today, people think growth was slow in the 1970s.

In the 1980s, monetary accommodation by the Federal Reserve went out the window. In its place we saw increased Federal spending and bigger deficits. The economic growth of the 1980s was fostered by rapid increase of the Federal debt. Then we had two decades of growth fostered by excessive private debt, and a day of reckoning in 2008.

Because we use credit for growth, the key to a good economy lies in maintaining the affordability of debt. When debt was relatively low it was affordable. While inflation was high, erosion of debt kept the growing debt relatively low and affordable. When Federal debt growth was rapid, the Federal spending provided funds to make the growing private debt affordable. But when it came down to depending on private debt growth to make private debt affordable, it was a suicide mission.

Today debt is high, inflation is low, and Federal debt growth is seen as a problem. No method remains to make private debt affordable. And our economy cannot grow.


We use credit for growth. I think we have to use credit for growth. But using credit creates debt, and debt eventually becomes a problem. What's the solution? Obviously the solution is not to pretend that the accumulation of debt can never be a problem!

The solution is to pay debt down faster than we do: Pay down private debt faster, so that it doesn't accumulate enough to hinder economic growth in the private sector.

To accelerate debt repayment, we could change the tax code to make the tax rate go up for someone with a lot of debt, with a provision that the tax rate comes back down for people who make extra payments on their debt during the tax year. Also, since debt is already at a problem level for the economy, we should have tax credits that are equal in value to the extra payments we make. Just until debt gets down to a workable level and the economy starts humming.

One other thing: Money should come more from government and less from the banks -- and let's be sure it is money, not credit. You can tell the difference, because if you have to pay it back with interest, it's credit. If you have to pay it back at all, it's credit.

The alternative to borrowing money, of course, is earning it. So what I'm saying, really, is that we need less borrowing, and higher wages. Higher wages raise business costs and push prices up. But they don't have to. We got into this problem in the first place because growing financial costs crowded out wages:

Corporate compensation of employees fell by 5 percentage points between 1948 and 1975
while corporate interest costs increased by nearly the same amount.
Source: The New Arthurian Economics

The solution is to reverse the 1948-1981 trend, and let wages crowd out financial cost.

The goal behind these thoughts is to keep financial cost down in the private sector, so that the private sector is able to grow with vigor. That's really what we want, isn't it? Some people badmouth the idea of better growth. But "economic growth" means "income growth", and everybody wants more income.