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.