Are you older than debt relative to GDP?

I am.

On bringing down the debt-to-GDP ratio

 I quoted this recently. It is still on my mind:

... provided fiscal space remains ample, countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.

Countries should let economic growth "bring down debt-to-GDP ratios organically."

By "organically" I think they mean "naturally". Here's what I think they mean: Economic growth is the natural way to bring down the debt-to-GDP ratio, and that's what countries should do.

Two guys from the International Monetary Fund (IMF) wrote the thing I quoted. They must know what they are talking about, right? You'd think. 

But when has economic growth ever been rapid enough to bring down the debt-to-GDP ratio, and when has debt growth ever been slow enough to allow it?

Once, for about three years, beginning in 2009, something like that.

Benjamin Friedman (1986), page 21:

Indeed, a sufficient period of sustained rapid economic growth could readily shrink the economy's overall debt ratio back to its historical range, not by reducing the numerator but by enlarging the denominator.

Indeed, it could. But it doesn't. When are we gonna learn?

 

PS: Economic policy encourages the accumulation of debt. Maybe if we turn that around ...

I know, it's like sacrilege

Just a minor change of wording:

... let it be, let it be, let it be
Whisper words of wisdom, let it be

And when the broke and hungry people living in the world agree
There will be an answer, let it be
For though they may be parted, there is still a chance that they will see
There will be an answer, let it be

Let it be, let it be, let it be ...

 

Just a minor change. Otherwise, let it be.

 

 

Happy holidays

Economics by reflex

Out of context, from The risks of high public debt despite a low interest rate environment:

After the 2008 Global Crisis, the interest rate-growth differential (r-g) has turned negative in several economies and interest rates have remained low ever since (Teulings and Baldwin 2014). These two conditions offer strong arguments to pursue fiscal expansions to spur growth, as a negative long-run r-g implies a more sustainable public debt, and countercyclical fiscal policy is arguably more effective in a low rate environment (Blanchard 2019, Eggertsson and Summers 2016, Ubide 2016).

The article warns of problems with the view they express, which I refer to as "reflex".

Blanchard, Eggertsson, Summers, and Ubide could surely back up their reflex view.

My problem with it is that there must be something wrong with the thinking behind that view, because that same thinking has been getting us in trouble since, oh, since the 70s. 

Look at the two "strong arguments" that are presented:

• a negative long-run r-g implies a more sustainable public debt, and 
• countercyclical fiscal policy is arguably more effective in a low rate environment

Both of these are based on the assumption that "fiscal expansions to spur growth" are "effective". They are not.

After the financial crisis of 2007-08, economists paused to reflect and evaluate their thinking. That's nice. 

It seems they decided there was nothing wrong with their thinking. That's a problem. 

Their revaluation became an opportunity for them to reafffirm their views, take more entrenched positions, and expand the political divide that stretches between those positions.

If a disaster like 2007-08 doesn't cause more of a change in economic thinking than we have seen, there is little hope for improvement. And by the way, we are on the downhill slope. We need more than just a little improvement if we want any actual improvement.
 

Out of context, from  A Future with High Public Debt: Low-for-Long Is Not Low Forever:

... provided fiscal space remains ample, countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.

Yeah, absolutely, of course, sure. Except that plan no longer works. We don't get growth enough to bring down debt-to-GDP ratios. Fiscal expansion to spur growth is not effective.

Graph #1

The red line is an exponential curve -- a growth curve -- based on data for the years 1946 to 1974. The red line after 1974 shows how big the Federal debt would have been if the debt kept growing at that rate.

The blue line shows how big the Federal debt actually got. 2019 is the last year shown. The debt is even bigger now.

The plan was working in the 1950s and 60s and the early 70s.  But by the mid-70s we needed more and more and more debt. The plan became ineffective.

Graph #2

The red line on the second graph is also an exponential curve. It is based on Real GDP data for the years 1946 to 1974, same period as the first graph. The red line since 1975 shows how big Real GDP would have been if it kept growing at the rapid pace of 1946-1974. But it didn't keep up that pace. Economic growth fell behind.

The blue line shows how big Real GDP actually got. It falls behind the trend in the mid-70s. And it keeps falling farther and farther behind all the while the federal debt (shown on graph #1) is gaining on its 1946-1974 trend.

Now, Republicans tell you that the debt increase shown on graph #1 is the reason Real GDP keeps falling behind the trend. That's just bullshit. They don't know the reason. And their argument is that they could fix the problem but the other guys won't let them. That's pathetic.

And the other guys tell you that the debt increase shown on graph #1 was insufficient, and that we need the government to spend "whatever it takes" more to boost the economy. Bullshit. That plan no longer works. And they don't know the reason, either.

In fact, neither side is even looking for a reason. They're just going with what they think they know. A phrase comes to mind: When the facts change, I change my mind. I hear that phrase repeated too often. But nobody says it from the heart. They all want the "I" who changes his mind to be the other guy.

 
I'm not going to say I know, because I've not been to the future. I've not seen my plan enacted and successful. Instead of saying that, let me just say this:

Some of them think the problem is too much government debt. The rest of them think the problem is too little government debt. Between them, they consider only one thing: government debt.

The problem, however, is excessive private debt.

One more on Krippner

From the Harvard University Press, in their page on Krippner's 2012 book Capitalizing on Crisis:

In Capitalizing on Crisis, Greta Krippner traces the longer-term historical evolution that made the rise of finance possible, arguing that this development rested on a broader transformation of the U.S. economy than is suggested by the current preoccupation with financial speculation.

Krippner argues that state policies that created conditions conducive to financialization allowed the state to avoid a series of economic, social, and political dilemmas that confronted policymakers as postwar prosperity stalled beginning in the late 1960s and 1970s. In this regard, the financialization of the economy was not a deliberate outcome sought by policymakers, but rather an inadvertent result of the state’s attempts to solve other problems.

 

• "a broader transformation" -- Yes. So de-financialization will require more reversals of policy that anyone recognizes.
  
  
• "beginning in the late 1960s and 1970s" -- Sounds right to me. Except I think the slowing of prosperity in the late 1960s was itself a result of the expansion of finance in the 1950s and early '60s (and maybe since the Civil War, though I'm not ready to make that argument).
  
  
• "not a deliberate outcome sought by policymakers" -- I've not read the book, but I agree with this conclusion. These days everybody thinks of government as the bad guy. God, that's tiresome. What I think is that policy was  not effective (and had unintended consequences, per Krippner) because policymakers misunderstood (and continue to misunderstand) the problem. Vested interests interfere with understanding, and skew outcomes in unsustainable directions.
  

Krippner's Figure 6

Source: The financialization of the American economy by Greta R. Krippner

"Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits."

One more time, just quickly.

According to JW Mason, Krippner "mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses."

So my question is: Does it look to you like the rise -- and the fall -- of interest rates explains the change in activities of nonfinancial business shown in blue on this graph?

Graph #1: Interest Received as a % of Interest Paid (NCB)
and the 10-year Treasury Rate

My answer: Hell no!

Krippner, Mason, and Nonfinancial Corporate Business

In Corporate cashflows, 1960-2016 JW Mason writes:

It is simply not the case that nonfinancial corporations in the aggregate have turned themselves into hedge funds – have replaced profits from operations with income from financial assets. The Greta Krippner article that seems to be the most influential version of this claim is a perfect example of the dangers of focusing on one piece of the cashflow picture in isolation. She looks at financial income received by corporations but ignores financial payments made by corporations (mostly interest in both cases). So as shown in Figure 3, she mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses.

Figure 3. Because she focuses on the heavy black segment in isolation,
Krippner mistakes a period of high interest rates for a reorientation
of nonfinancial corporations to financial profits.

Mason rejects the view that nonfinancial corporations "replaced profits from operations with income from financial assets". It troubles me that he does not address the slowdown of output growth that would result from such a change. It irks me that he ignores the economic slowdown that occurred in the 1970s. However, my purpose here, like his, is to consider the financial side of the economy.

Mason shows a graph comparing interest flows to interest rates and declares that Krippner "mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits."

That is not only a challenge to Krippner. It challenges the whole focus of my thinking. So I looked at interest income relative to interest cost. For nonfinancial business, if the ratio increases, that's financialization.

Graph #1: Interest Received as a Percent of Interest Paid
for Nonfinancial Corporate Business

The ratio runs flat in the 1950s and shows just a little increase in the '60s. In the 1970s there is a massive increase of interest income, relative to interest cost. After the 1970s slow increase again, to 2006. This graph shows increasing financialization.

And let me suggest that the financial crisis was the economy's way of trying to solve the problem of excessive financialization.

 

Interest rates trended downhill since 1981. Neither my graph nor Mason's supports his view that "a general rise [and fall] in interest rates" explains the flows of interest in the nonfinancial corporate business sector. 

In a follow-up post, Mason says

it’s true there is a rise in interest income from the 1960s through the 1980s. But, as discussed in the previous post, this is outweighed by a rise in interest payments ...

His Figure 3 shows interest income and payments, but does not show the one in comparison to the other. The FRED graph shows the comparison. The FRED graph shows that the rise in interest payments did not "outweigh" the rise in interest income. It shows the opposite. It shows that from 1970 to the financial crisis, the increase of interest income far outweighed the increase in interest payments. The FRED graph shows financialization.

After 2006, the coincidentally financial crisis creates a sharp decline on both graphs. On the FRED graph, the decline continues till 2016. After 2017 the ratio rises for two years and rises sharply -- even more sharply than in the 1970s. I take this rapid increase to be financialization's recovery from the financial crisis, a recovery interrupted by the pandemic of 2020.

I do not explain the increase of the 1970s, except to say it was not caused by rising interest rates. My guess would be that there was a change in the tax code or some other policy, perhaps in the late '60s, which caused the increase. The readiness of the ratio to increase after 2017 suggests that this policy was still in effect. The decline after 2006, due to the financial crisis, was temporary. As I interpret it, that 10-year decline was not a change in trend. The decline was a reaction to the crisis, and a temporary departure from the trend. Mason seems to see the comparable decline on Figure 3 as the natural result of downtrending interest rates. But the financial crisis was not a natural event. It was the result of decades of bad policy.

Mason references the Integrated Macroeconomic Accounts in his post. I went with FRED. I'll try it his way, using the IMA "all tables in XLSX format" file. Table S.5.a shows the Nonfinancial Corporate Business data at annual frequency, in millions, 1960 to 2020:

Graph #2: Data Comparison, IMA and FRED Data

Funny how the two lines follow each other so closely except before 1970.

Funny how the IMA data shows nothing before 1960.

Funny how FRED shows the increase from near the 25% level to near 50%: roughly a doubling in a decade. IMA, though it runs a good deal higher, shows only about half a doubling during that decade.

Funny that the IMA link brings you to BEA, which is also the source of the FRED data. Ha ha.

Mason says "Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits." He is saying the increase that looks like financialization is really due to the increase of interest rates. He apparently assumes that the interest cost increase and the interest income increase are similar in size. They are not.

Both FRED and the IMA show definite increase of interest income relative to interest cost in the 1970s and after. This difference between income and cost has little or nothing to do with the change of interest rates, far as I can see.

The FRED data makes it easy to see the financialization of nonfinancial corporate business. It is not as easy to see that the IMA ratio shows it, because the data starts late and goes downhill. But there is the increase of the 1970s, and the increase of the 1990s, and the increase leading up to the financial crisis. Each increase peaks at a higher level than the one before, and all of them are higher than IMA's 1960 data point. That's financialization.

For both datasets, interest income increased relative to interest cost from 1970 to the financial crisis. And for both, financialization resumed with vigor after 2017. Increase of interest income relative to interest cost is a measure of financialization. I have to accept Krippner's view on this, not Mason's.

"The big problem is not cost-push inflation, but cost-push decline."

 

Why the cost of finance must be reduced

I think maybe I had too many graphs in Wednesday's post. Today, I repeat the thoughts I couldn't put into words until those graphs were done.

First, allow me to remind you that the cost of finance is driven by two factors: the rate of interest, and the size of debt on which interest is paid.

 
The growing cost of finance was the prime mover, the initial cause that set in motion not only the wage-price spiral of the 1960s and '70s, but also our subsequent decline.

 

The cost of finance can create cost pressure and cost-push inflation as surely as OPEC can. People still today talk about OPEC as a source of inflation, and wages as a source of inflation. But nobody ever points the finger at finance and says here is the cost that drives cost-push. But it is. Finance is the root of the problem. Excessive finance.

It is all well and good to say business has to raise prices because wages have gone up, and to say labor needs an increase because prices have gone up. But the question that must be asked is "Which came first?" We have accepted the story of the wage-price spiral for half a century and more, without ever insisting that there must have been a first cause.

There must have been a first cause. But it cannot be wage hikes and it cannot be price hikes, because in the accepted story each of these is caused by the other. There must be some other cause, some initial cost increase that set the price spiral in motion.

That initial cost was the cost of finance.

The rising cost of finance in the years after the second World War contributed to the "creeping" inflation of 1955-57, the inflation that troubled Samuelson and Solow (1960). The cost of finance continued to increase, creating the cost pressure that led to rising wage demands in the latter half of the 1960s.

Finance is our primary growth industry. The growing cost of finance is endless. But the growing cost of finance is a source of cost-push pressure. It drives prices up and economic growth down.

Inflation is not the worst part of this problem. The cost pressure is the worst part. The cost push. Cost-push slows economic growth. The big problem is not cost-push inflation, but cost-push decline. And since the growing cost of finance is endless, the result is long-term economic decline. 

Long-term economic decline is indistinguishable from the decline of civilization.

The study of credit and economic growth

Graph #1: Slide the ScrollBar Right to See More, or just Click the Graph

 

 

 

 

 

It has to go up, or everything I thought I knew about the economy is wrong.

Here I develop an example of financial cost after World War II and consider the growth of that cost in subsequent years. The growing cost of finance is a source of cost-push pressure. It drives prices up and economic growth down. Moreover, the growing cost of finance is endless, because finance is our primary growth industry.

The growing cost of finance was the prime mover, the initial cause that set in motion not only the wage-price spiral of the 1960s and '70s, but also our subsequent decline.

 
For manufacturing, the FRED data on Average Hourly Earnings goes back to 1939. For the private sector in total, it goes back only to 1964.

Graph #1: Average Hourly Earnings before 1980

Where they overlap, the two data series run close. (Less close after 1980, but still close.) I will take the manufacturing data as an estimate of the average "Total Private" wage before 1964.

The FRED data for interest paid by the household sector starts in 1946. It's a big number -- billions, not dollars per hour. But I only want to see how fast it goes up, compared to hourly earnings. So dollars vs billions is not a problem.

Graph #2: Average Hourly (blue, red) and Interest Cost (green) Comparison

I added interest cost (green) to the graph. If I take the green line and multiply it by 0.86 and divide it by 1.735, green and blue will be exactly equal in 1946. I'll do that, I'll make them both 0.86 in '46. Plus I'll zoom in by cutting off the years after 1965:

Graph #3: Interest Cost (green) and the Average Hourly (blue, red)

Interest cost goes up a lot faster than the average wage in these early years. But in 1946, when the average hourly earnings amounted to 86 cents, people didn't spend their whole paycheck just to pay interest. There wasn't that much debt in those days, for one thing, and interest rates were low.

I should make the green line less. Household debt amounted to 20 percent of personal income in 1946. And the mortgage rate was, say, 4%.

So I can picture my dad's 86-cent hourly wage, and figure his debt was 20% of that, 17 cents of every dollar he earned in 1946. And the interest on the mortgage was 4% of 17 cents, or two-thirds of a penny. So now I want to divide the green line by something to make the 1946 value equal to two-thirds of a penny. That's what Dad paid for interest, out of every dollar he earned.

On graph #3, both lines have the value of 86 cents in 1946. If I divide 86 by 0.67 (which is two-thirds of a penny) I get 128.36. So I want to go the other way and divide the green line by 128.36 to reduce the 1946 value to two-thirds of a penny:

Graph #4: Household Interest Cost per Dollar of the Average Wage

It worked! The green line, now low on the graph, has a value of $0.00670 in 1946: two thirds of a penny.

The interest cost doesn't look like a big number, does it, on graph #4.

Let me look at it another way: interest cost as a percent of average hourly earnings. It will go up. It has to go up, or everything I thought I knew about the economy is wrong.

Graph #5: Household Interest Cost per Dollar of the Average Wage, Percent

Household Interest Cost
as a Percent of
Average Hourly Income

The green line goes up, as expected. It goes up faster than the average wage. It had to, if finance is the true source of the cost-push pressure. It had to.

So now I can say that the rising cost of finance in the years after the second World War contributed to the "creeping" inflation of 1955-57, the inflation that troubled Samuelson and Solow back in 1960. I can say also that in the years after the second World War, the rising cost of finance created cost pressure that led to rising wage demands in the latter half of the 1960s.

"Wage-push inflation" they called it. Labor got the blame. Nobody looked into it enough to notice that the rising cost of finance was putting pressure on wages. Nobody had our back. Nobody looked out for consumers. Nobody. 

Eh, that was all a long time ago. I remember, and I resented the "wage-push" nonsense because it meant they were blaming me and people like me for the inflation, people just scraping by. But I don't hold a grudge. That's not what this essay is about.

This essay is about the cost of finance -- a cost that can create cost pressure and cost-push inflation as surely as OPEC can. But people still talk about OPEC as a source of inflation -- and wages as a source of inflation -- and nobody, far as I can tell, nobody ever points the finger at finance and says here is the cost that drives cost-push. But it is. Finance is at the root of the inflation problem. Excessive finance.

It is all well and good to say business has to raise prices because wages have gone up, and to say labor needs a wage hike because prices have gone up. But the real question is "Which came first?" We have accepted the story of the wage-price spiral for half a century and more, without ever insisting that there must have been a first cause.

There must have been a first cause. But it cannot be wage hikes and it cannot be price hikes, because in the accepted story each is caused by the other. There must be some other cause, some initial cost increase that set the price spiral in motion.

That initial cost was the cost of finance.

Inflation is not the worst of the problem. Worst is the cost pressure, the cost push. Cost-push slows economic growth. The real problem is not cost-push inflation, but cost-push decline. And the problem is not once upon a time long ago. The problem is long-term decline, driven by the long-term growth of finance now and for the past 60 years.

Interest as cost

Total interest paid is equal to total interest received. Some people will tell you it doesn't matter how much we pay as interest, because we receive exactly the same amount of interest. But who is this "we"? Unless net interest is zero for every one of us, there is a redistribution of income. So it does have an effect. It does matter.

And even if it was net zero in every instance, it can still have an effect on the economy: 

• If 2% of our income is interest and 98% is income from productive activity, we got a lot of output with little financial cost.
  
• But if half our income is interest and half is income from productive activity, then we didn't produce much, and we had to pay a lot for it to cover the financial cost.
  

Between individuals, incomes vary. But for the economy as a whole, if interest is a high percentage of our income, then the nation's output will be inexplicably low. Inexplicably, because we choose not to see the high level of interest as a problem. Low, because interest is not a payment for the creation of output.

"Adversity"

CBS has a self-promotional TV commercial they play during the Army football game. The theme is adversity. They make it sound like losing a football game is the height of adversity.

That's not it. That's a bad day. Adversity is more like this:

"An essential feature of the law of motion" of the rise and fall of civilizations

Or, the fall anyway.

Financialization in a Long-Run Perspective: An Evolutionary Approach, by Alessandro Vercelli

On the view of Marx:

What we call financialization is nothing but the process through which exchange value becomes independent from and gains predominance over use value. In this sense, financialization is not just a symptom of the basic contradictions of capitalism but is an essential feature of the law of motion of capitalism.

Even a "long" century is short, compared to a Dark Age

Giovanni Arrighi: The Long Twentieth Century

From the Preface:

With the advent of the Reagan era, the "financialization" of capital, which had been one of several features of the world economic crisis of the 1970s, became the absolutely predominant feature of the crisis. As had happened eighty years earlier in the course of the demise of the British system, observers and scholars began once more hailing "finance capital" as the latest and highest stage of world capitalism.

Arrighi based his book on Fernand Braudel's interpretive scheme:

In this interpretive scheme, finance capital is not a particular stage of world capitalism, let alone its latest and highest stage. Rather, it is a recurrent phenomenon which has marked the capitalist era from its earliest beginnings in late medieval and early modern Europe. Throughout the capitalist era financial expansions have signalled the transition from one regime of accumulation on a world scale to another. They are integral aspects of the recurrent destruction of "old" regimes and the simultaneous creation of "new" ones.

Arrighi mentions "Braudel's notion of financial expansions as closing phases of major capitalist developments", and refers to

the current financial expansion, in the course of which the structures of the now "old" US regime are being destroyed and those of a "new" regime are presumably being created.

Presumably, he says. In the Epilogue, Arrighi considers "three possible outcomes":

• the old centers may succeed in halting the course of capitalist history
• the old guard may fail to stop the course of capitalist history
• capitalist history would ... come to an end ... by reverting permanently to the systemic chaos from which it began ...

Permanent systemic chaos, of course, is the Dark Age.

The other part of the debt problem

I came upon a site called Business Writing Services. The site offers to write an essay or term paper or research paper for me. It has a "Live Chat" option and two "Order Now" buttons. Needless to say, it is not my kind of place.

https://www.businesswritingservices.org/business-finance/372-factors-that-influence-the-cost-of-finance

But there is this, under the heading "Factors that Influence the Cost of Finance":

Effects of taxation – Debt finance is cheaper by the amount equal to tax on interest and this means that debt finance will entail a saving in cost of finance equivalent to tax on interest.

It describes the precise amount that debt financing can be less costly than some other methods of paying for things. They're talking about reducing your tax by taking advantage of the tax deduction. Anymore, this applies mostly to business.

"Debt finance is cheaper by the amount equal to tax on interest". That's the line that struck me. You borrow, you pay interest, you deduct the interest from your taxable income, and the tax you pay is less as a result.

See, you couldn't do that if you stole the money, or printed it yourself. You also couldn't do it if you worked to earn that money or issued more stock in your company. The tax advantage arises because you borrowed the money.

The tax code creates economic behavior which increases the use of credit and the growth of debt.

Felix Salmon says 

Just as America’s obesity problem is largely a function of the ubiquity of cheap high-fat food, America’s debt problem is a result of the ubiquity of cheap easy-access credit.

Salmon should know better. "Cheap easy-access credit" is only part of the debt problem. The other part is that policy encourages both the use of credit and the ubiquity of access to it.

This is from memory, but I think consumers could deduct all their interest costs from taxable income until around 1990. After that, only home mortgage interest was deductible. And according to Wikipedia, as of 2018 interest on home equity loans is no longer deductible.

Most of the interest deductions for consumers are gone now. The increase of debt got a boost because of those deductions but, unfortunately, the debt didn't go back down again when they took the deductions away. And now things are so bad that it's almost impossible to avoid going deeper in debt.

Most of the interest deductions for business still exist. Business still gets a tax break for using borrowed money. Again, this encourages the growth of finance and the growth of debt.

If you have economic policies that encourage borrowing, but you don't also have economic policies that encourage the repayment of debt, then debt will grow unnaturally fast and will reach an unnaturally high level. Even now, by the way, debt is still going up.

When policymakers eliminate tax breaks that encourage borrowing, rather than replacing them with tax breaks that accelerate the repayment of debt, they are not fixing the problem.

They raise and lower interest rates all the time. But debt just goes up

So I said "As long as debt grows faster than GDP, the cost of finance increases." Then I acknowledged that "interest rates also play a role in the cost of finance."

But how big a role? How much of interest cost is due to interest rates? And how much to the level of outstanding debt? Sure, as interest rates rise, more of the cost is due to interest rates. As rates fall, less of the cost is due to interest rates. As the accumulation of debt increases, more of the cost is due to the size of the debt. And as the accumulation falls in size -- Oh! Does that ever happen?

Not since 1937:

Graph #1: Percent Change in Domestic Nonfinancial Sector Debt (Annual Data)

The Excel sheet shows a -0.03% change between 1936 and 1937: For every $100 of debt in 1936, there was three cents less debt in 1937.

There has been no decrease in Domestic Nonfinancial Sector debt since that time.

As long as debt grows faster than GDP, the cost of finance increases.

As long as debt grows faster than GDP, the cost of finance increases.

Debt-to-GDP, 1834-2020

I make a statement too general to be supported, in order to draw your attention to a less general statement that may demand more of your time and attention. Obviously, interest rates also play a role in the cost of finance.

Arthurian theory in brief: Financial cost-push

As a rule, the cost of finance is always rising.

To the extent that finance is nonproductive, it increases the cost but not the volume of output.

This creates cost-push inflation or, if inflation is prevented, cost-push pressure that must find relief by some other means.

Cost-push pressure which cannot be relieved by inflation is relieved by slowing growth.

To the extent that finance is nonproductive, it slows economic growth.

Long-term growth of finance creates long-term slowing of economic growth.

Long-term slowing of economic growth is indistinguishable from the decline of civilization.

The Extents of Finance

Finance creates cost.

To the extent that finance is non-productive it creates cost-push pressure.

To the extent that finance is productive at the micro level by the extraction of rent, it creates cost-push pressure.

To the extent that finance is 100% productive, the growth of finance beyond its economies of scale creates cost-push pressure.

And to the extent that financial income comes from the nonfinancial sector, it creates cost-push pressure. 

Cost-push pressure slows economic growth.

One and one

From mine of 1 November:

Rising interest rates are not the only avenue by which the costs of leverage increase. As long as credit grows faster than output, the growth of credit itself increases that cost, even when interest rates remain unchanged.

 

From 6 November:

Debt-to-GDP, 1834-2020

The graph shows the size of nonfinancial debt as a multiple of the size of GDP since the 1800s:

• 1883: Debt about half the size of GDP
• 1928: Debt about equal to GDP
• 2002: Debt about twice the size of GDP
• 2020: Debt about three times the size of GDP
  

As long as debt grows faster than GDP, the growth of debt increases the cost of finance (unless interest rates fall enough to offset that increase).

Rules of thumb: Debt always grows faster than GDP. And the cost of finance is always rising.

The Problem with S1 E2

The Problem with Jon Stewart: I watch because it's Jon Stewart. I watched episode two a second time to take some notes. Second time, I noticed how good that episode is. The guests are great.

Not sure who said it. One of the guests:

"There is a slow erosion of the principles of democracy"

Not slow enough. And you won't agree, but the reason for the erosion, specifically, is that the economy is so bad. People can live with many things, but they can't live with unlivable living conditions. So when a guy comes along with Trump's skillset, they jump on his bandwagon. We think things get worse. They know things have been getting worse for a long time and they are anxious, some of them desperate, for a solution. Trump provides a clear alternative to the status quo. Thus the attraction. 

If you want to beat Trump, you also must provide an alternative to the status quo. The same old policy is not an alternative. Nor is more of the same. Not even if you add the comedic twist.

The voters who supported Trump (and even those who didn't) lived through the covid recession, most of them; not ten years before that, we had the financial crisis and that whole economic disaster from which we never recovered; farther back in time, there was the inflation of the 1970s -- and general economic deterioration since that time.

If you have money for cigarettes, you cannot understand the situation of a co-worker who doesn't have money for cigarettes. He's not likely to sit down and explain it to you, either. But there is a limit to how much he can take. Your best option is to be sympathetic, because you may be the next one to find yourself without cigarette money. Ours is a continuing economic decline. Nomadland.

Jon Stewart: "Everybody wants to ban shit that they don't agree with. And how do you square that?"

You square it, Jon, by fixing the economy. People will think you're going off-topic. But the economy is the root of the problem. Everything else is consequences. Fix the economy so that the government can recede, "a distant ship, smoke on the horizon". 

When people can afford their own medical insurance, the government doesn't have to make arrangements. Isn't that what people really want? When living standards are rising, the "socialist" social spending becomes less and less necessary. That spending can recede. As it recedes, it becomes less objectionable to those who object to it. That is how you bring polarized people together: by fixing the economy.

We have to solve the problem, not the consequences. To wait until we're starting to have insurrections, and then say insurrections are the problem, no Jon, that's not right. Not even close.

31 minutes into the episode, Bassem Youssef says

"The death of democracy in America could only be summarized in one word: money."

That's what I said, except I called it the economy.

Maria Ressa jumps in after Bassem and expands the thought:

"Look, it is about power and money, all across the board. Power and money. So think of -- the pieces are this, right:

• Someone seeds a meta-narrative that is kind of half true.
  
• It becomes a virus of lies and infects real people.
• Then those real people spread it. 

That is a diseased system. And that is what we are living in."

You picked up on that, Jon, and brought it back to money:

"It's like we're fighting two pandemics, two viral things. And it's interesting. I originally said oh this is like the fable of the three bears. It's really scarface. It's: first you get the money, then you get the power."

"First you get the money, then you get the power." There's a word for that, Jon: financialization. Economist Thomas Palley writes:

In effect, there is a politics of financialization that goes hand-in-hand with the economics.

It's all tied together. 

When we fix the economy, we change the flows of money and power. We just have to be sure we fix it right. Neither Democrats nor Republicans have the right plan.

A year ago, a month ago -- Same difference? No.

CPI and PCE -- Same difference? Yes.

Download as PDF

The first graph shows CPI, the well-known measure of inflation.
The second graph shows PCE, the inflation measure preferred by the Fed.
(Both graphs show the same difference: Blue is high, Red is low.)

The blue line shows the change in prices from a year ago.
The red line shows the change in prices from a month ago.
(Both are figured every month.)

Note: Blue and Red are the default colors,  not a political statement.

CPI Inflation since June 2019:

Graph #1: https://fred.stlouisfed.org/graph/?g=ICPC

 

 

PCE Inflation since June 2019:

Graph #2: https://fred.stlouisfed.org/graph/?g=ICPF

 

 

 

The change in prices a year ago was important a year ago.
What's important now is the change in prices now.

Debt to GDP 1834-2020

This you know:

Graph #1: Debt-to-GDP, 1946-2020

Dunno about you, but I want to know two things: What happens next? 

And what happened before.

I can't answer the first question. I can tell you that my guide to understanding what's going to happen is the cycle of civilization: "Civilizations die by suicide" and all that.

This post addresses the second question.

The debt data comes from A neverending debt trap by Steve Keen, from 2013. I looked at it some years back, and even some years before that. But it took me till now to look at it as debt-to-GDP.

The GDP data is from Measuringworth.

Graph #2: Debt-to-GDP, 1834-2020

One could ask: When did financialization start? The 1980s? The '70s? The '60s? I don't think so. The Civil War? Maybe.

One could quote Benjamin Friedman from 1986:

One of the most striking features of the U.S. financial system during the post-World War II era -- but not since 1980 -- has been the stable relationship between debt and economic activity... Moreover, except for the depression of the 1930's, the debt ratio was also fairly stable, and trendless, during the pre-war period extending as far back into the nineteenth century as available data permit.

Stable and "trendless" before 1980? No. Before the Great Inflation of the 1960s and '70s, there is a persistent upward trend going back almost to the start of the graph.

Friedman's assertion is backed up by the supporting evidence of this footnote:

See Friedman (1980, 1982) and Goldsmith (1985).

Evidence? References are not evidence. References only create the appearance of evidence. Eh, but I looked. In the first of those three references, Friedman writes:

Throughout their history, but more so during the twentieth century and especially in the years since World War II, the American financial markets have undergone a shift away from direct transactions between nonfinancial borrowers and lenders toward the intervention of financial intermediaries.

That sounds to me like an example of increasingly greater financialization. Friedman says this was occurring throughout the history of American financial markets. Since the beginning.

I do not see that the statement from Friedman (1980) supports the view that financialization and/or the debt ratio were "trendless". There was persistent increase in all aspects of finance, at least since the Civil War, and no doubt since the inception of the financial markets.

On top of all the other cost of finance...

At CFO: Metric of the Month: Total Cost of the Finance Function (May 11, 2015) by Mary C. Driscoll:

... CFOs are still expected to do more with less, however. In other words, automate on the cheap, move more work into shared services centers, cut headcount wherever possible, and drive down the cost of financial operations.

Yet gauged in terms of Total Cost of the Finance Function as a Percentage of Revenue, the first APQC Metric of the Month (an ongoing CFO feature),  many organizations are, sadly, still wasting hundreds of thousands or even millions of revenue dollars on inefficient finance operations (Figure 1).

This data reflects the relative cost profiles of 543 organizations that completed an APQC benchmarking assessment for the finance organization as a whole. Total cost includes personnel, systems, overhead, and any other costs necessary for day-to-day operation of the finance organization. The data shown in Figure 1 are calculated as follows: total finance cost divided by total business entity revenue, which is then (for display purposes) multiplied by 100.

I'm thinking these financial cost figures apply to nonfinancial businesses. So, at the median, the cost of overhead attributable to financial operations comes to 1.2% of revenue. These are internal costs, as opposed to the external cost of interest on a bank loan, for example. Hey, you have to have finance people in the company, to deal with the finance people you're doing business with.

So if I were to figure the total cost of finance, I'd start with the financial sector, add to it the financial dealings of the nonfinancial business sector, and then on top of all that cost add this 1.2% of nonfinancial business sector revenue, to cover the cost of the finance organizations within the nonfinancial businesses.

I don't think I'm double-counting anything.

Inflation: The "Percent Change from Year Ago" Lag

The red line measures price change from a month ago. The blue measures price change from a year ago. These are the default colors. Nothing to do with politics.

The high red peak in 1974 is not near 10%. The red line is measured by the numbers on the right side of the graph. That red peak shows prices increased a little over 1% from the month before.

The blue peak shows prices increased a little over 10% from the year before.

Graph #1: From-Month-Ago (red, right scale) vs From-Year-Ago (blue, left scale)

That red peak occurred in June, 1974. The blue peak appears eight months later, in February 1975. After June of 1974, inflation was falling. The red line shows a definite down-trend, and the line is not even very jiggy until it approaches a bottom in the latter half of 1975.

The blue line runs downhill parallel to the red but several months later. The "percent change from year ago" numbers lag the monthly changes shown in red.

Notice that later on the graph, where the blue line peaks at the end of 1980, the blue line again lags the red. That's the way the "from year ago" calculation works.

I expect it to work the same way now, lag and all.

Recent numbers show that from-year-ago inflation increased from 1.5 in February 2021 to 3.5 in May, and 3.6 since June. You should note, however, that some of this increase was due to deflation dropping out of the from-year-ago calculation in March and April 2021. That deflation came with the covid recession of March and April 2020. The deflation, by dropping out of the calculation, contributed to the from-year-ago inflation in the Spring of 2021.

Those below-normal monthly numbers were replaced by the above-normal numbers of March and April 2021. These higher numbers also contributed to the increase this past Spring.

Since April 2021, when the monthly inflation number peaked, the monthly increase in prices has been getting smaller. As of September 2021, monthly inflation is back in the normal range -- or close to it, depending on how you define "normal" inflation. The important point is that the current, month-to-month rate of inflation has been falling for five months, and prices are now rising at an unremarkable rate. 

Unfortunately, the from-year-ago calculation shows inflation to be much higher than recent monthly numbers show. The same thing happened during the inflation of the 1970s and 1980s. Also, as we saw at that time, the from-year-ago inflation develops a lag when the monthly inflation rate trends downhill. It takes a year to get all the old, high numbers out of the from-year-ago calculation. If the lag turns out to be 8 months again this time, the from-year-ago number will run high until December 2021, even if the monthly numbers continue to fall. Expect the media to make the most of it.

The Primary Principle of Policy

The ideas that credit use is good for growth and that interest rates can be used to manage growth, which together form the primary principle of policy, are undermined by the fact that the effects of accumulating debt are nonlinear.

"increased demand for credit can drive up interest rates"

Noah Williams, Financial Instability via Adaptive Learning, 2015

I have to take something out of context. 

In his PDF, Williams sets the stage by giving a brief summary of Minsky’s financial instability hypothesis. I skip to the point where he writes

the growth of credit expands

He then follows up, saying

Eventually, the growth of demand for credit leads to highly levered positions which can be difficult to sustain if there is an increase in the cost of debt service.

Well said. The funds that go to service debt are largely a transfer of income from the nonfinancial sector to the financial sector. This transfer of income hinders economic growth.

Williams attaches a footnote to that last quoted sentence, footnote 1:

Minsky emphasized how increased demand for credit can drive up interest rates and so increase the costs of high leverage. In this paper interest rates are constant, so this channel is shut down...

 In three bullet points we find a tidy endogenous package:

• "the growth of credit expands"
• "increased demand for credit can drive up interest rates and so increase the costs of high leverage"
• "highly levered positions ... can be difficult to sustain if there is an increase in the cost of debt service"

I accept this as a given. But rising interest rates are not the only avenue by which the costs of leverage increase. As long as credit grows faster than output, the growth of credit itself increases that cost, even when interest rates remain unchanged. The three bullet points can therefore be reduced to one:

• "the growth of demand for credit leads to highly levered positions which can be difficult to sustain"

Everyone on the internet points out the effect of rising interest rates. None of them point out that the same effect is created by the increase of outstanding credit.

"Fed's inflation measure holds at record annual pace for fourth straight month"

A record annual pace? Maybe I'm missing something here, but inflation now is nowhere close to the double-digit inflation of the 1970s.
 

• Link to the article at Fox Business
• Image of the article at Fox Business

I'm not finding a date for the article, but in the HTML it says

<meta data-n-head="ssr" data-hid="dc.date" name="dc.date" content="2021-10-29">

so 29 October, the same day I'm making these notes. Okay, yeah, and the "Updated" field on the FRED Graph page says "7:43 AM CDT" -- the same day, or  else there would be a date there. 

Just checking.

The article's opening statement:

The core personal consumption expenditures index, the Federal Reserve’s preferred inflation measure, continued to climb at the fastest annual pace on record in September.

The fastest annual pace on record? I don't think so.

Looking for info on "the Federal Reserve’s preferred inflation measure", I come across this item from Fox Business dated August 27, 2021; presumably the July 2021 inflation:

Inflation "soars by most in 30 years". That I can believe. I already looked at this graph, showing "Percent Change from Year Ago" inflation:

Graph #1 (Click the graph to see it bigger)

At the extreme right of the graph, inflation shoots up to 3.6 percent. Then if you look 30 years earlier, around 1990 (near the middle of the graph), there's a label pointing to March 1991 when inflation was 3.65 percent. Inflation now is the highest since then, but not a record.

I still don't know what they're talking about when they say inflation is presently at "a record annual pace". What record? If you look back a little farther in time on the graph you can see inflation peaking in 1975 and again in 1981, both near 10% annual. Looks to me like the January 1975 inflation rate is the record.

I don't find anything telling me which one of FRED's 816,000 datasets is "the Federal Reserve’s preferred inflation measure". I'm on my own here. The Fox Business article mentions the "core personal consumption expenditures index". (That's the PCE index, not the CPI.)

They also say "Core PCE ... excludes food and energy prices". (I think "core" is a keyword the Fed uses to mean "excludes food and energy prices".)

I looked up core pce at FRED and went with the first one they turned up: Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index). The numbers are right. On graph #2, in the upper-left of the graph area an information box shows 3.5% inflation for May and 3.6% for June, July, August, and September.

Graph #2 (click to enlarge)

The dots are months. The rightmost dot is September. Fox Business gives the same numbers FRED gives, 3.6% for the last four months:

Core PCE, which excludes food and energy prices, last month rose 3.6% year over year, according to the Bureau of Economic Analysis. Core prices have accelerated by that amount for four straight months.

They omit May. But the other numbers match. We're looking at the same graph Fox Biz is looking at.

They make the inflation sound pretty nasty, don't they? "Core prices have accelerated by that amount for four straight months." The Sunday morning talk shows that I mentioned on the 20th, in Inflation show-and-tell, also made the inflation sound pretty nasty.

I'm not too concerned about the inflation we've been getting. I'm more concerned about the inflation the media may be creating out of ignorance. The inflation numbers we're looking at measure "percent change from year ago". Inflation didn't go up 3.6% between August and September. It went up 3.6% between September of 2020 and September of 2021. Inflation's not as bad as they make it sound.

This next graph shows both the from-year-ago change and the from-last-month change:

Graph #3 (click to enlarge)

The red line shows percent change from one month ago; the blue line shows percent change from 12 months ago. So you would expect the blue line to be higher, and sure enough it is.

It's hard to see without making the graph bigger, but the big increase in the blue line runs from the low in February 2021, to the high in April. After that it runs almost flat, with the 3.5% in May and then June thru September at 3.6%.

You can see a similar increase in the red change-from-one-month-ago line: There's a low in February 2021 and a high in April. After April, the month-to-month numbers actually go down. Since May, the price increases have been getting smaller. That's why I say I'm not too concerned about the inflation we've been getting.

As I said before, if you get one month of high inflation, that high number stays in the "percent change from year ago" calculation for a whole year. It makes inflation look persistent when it is not. That's why it's important to look at the red line, the month-to-month numbers.

Graph #4 (click to enlarge)

The red line on Graph #3 is shown in blue on #4. The from-year-ago graph is gone.

Graph #4 shows a lot more months than #3. Don't let that confuse you. What I want you to see is the low of April 2020 and the high of April 2021.

When they figured from-year-ago inflation for March 2021, the low of April 2020 was still in the calculation. But when they figured the from-year-ago for April 2021, the old data (April 2020) came out of the calculation. It was replaced by the monthly high of April 2021. 

Replacing the low monthly number with a high one -- burning the candle at both ends, so to speak -- made the from-year-ago inflation increase look unusually big and threatening. That's why on Graph #3 the March-to-April 2021 increase is disproportionately bigger in the blue line than in the red. That's why the gap between red and blue opens up so much with the April number.

The April 2021 increase was big, but not as big as the from-year-ago number makes it seem. It seems big because the unusual low came out of the calculation. This kind of figuring is the reason Graph #3 shows the blue line stubbornly high, even though the red line is already back down in the normal range of inflation. And this kind of figuring will happen again next month and the month after.

About halfway between April 2020 and April 2021 on Graph #4, the blue line shows two months in a row at the zero level. No inflation. Those two months are October and November of 2020. The October 2021 from-year-ago inflation will have this month of no inflation dropping out of the calculation. Any inflation will be high by comparison, making the from-year-ago number look big.

And then a month later, the zero inflation of November 2020 will come out of the November 2021 report. This mathematical chicanery will again make the from-year-ago inflation number seem worrisome.

There'll be inflation, but it won't be as bad as the news will make it sound. To get a feel for what's happening with prices, pay a lot of attention to the month-to-month numbers, and not so much to the from-year-ago numbers.

One more graph to look at: index values. The index values are like the price level, as opposed to the "change-in" numbers we've been looking at.

On Graph #5 the line goes up just as prices go up.

Graph #5 (click to enlarge)

The flatter the line, the less the rise of prices. The steeper the line, the more the rise of prices.

On this graph we can see prices going up more quickly after February 2021 than before. And after May 2021 we can see the line flattening and a slowing of inflation. That's what you need to know. You can see it here, and you can see it in the red line on Graph #3.