The Theory of Problematic Debt

A response to "Do entrepreneurs constitute a class?"

This post is a response to one at In Defense of Anagorism:
https://astoundingteam.com/wordpress/2014/01/28/do-entrepreneurs-constitute-a-class/

 

In The Wealth of Nations, Book One, Chapter Six, Adam Smith considers "the component parts of the price of commodities": land, labor, and capital. I always want to add finance to that list. And the landed aristocracy has become less important, so maybe we can drop "land" from Smith's list. Then I get what you get:

"I identify three distinct classes that are actively involved in production. I call these (from top to bottom) financiers, proprietors and wage-earners."

But I wouldn't say financiers are "actively involved in production". That's the trouble with finance: it adds to the cost of production (and consumption) without actually adding output. So it is always a source of cost-push pressure. Maybe finance is passively involved in production?

https://www.econlib.org/library/Smith/smWN.html?chapter_num=9#book-reader

Six moments

First, this summary of an observation made in 1850, from the Liberty Fund:

Frédéric Bastiat, while pondering the nature of war, concluded that society had always been divided into two classes - those who engaged in productive work and those who lived off their backs (1850)

For Bastiat, the two classes were those who owned everything, and those who did the work.

 

Next, from an 1895 book by Brooks Adams, grandson of John Quincy Adams:

The Latins had little economic versatility; they lacked the instinct of the Greeks for commerce, or of the Syrians and Hindoos for manufactures. They were essentially land-owners, and, when endowed with the acquisitive faculty, usurers. The latter early developed into a distinct species, at once more subtle of intellect and more tenacious of life than the farmers, and on the disparity between these two types of men, the fate of all subsequent civilization has hinged.

For Adams, the two classes were farmers and usurers. Note that ancient Rome was an agricultural society, so that when Adams says "farmers" he means basically everyone, usurers aside.

From a 1916 essay by Vladimir Simkhovitch:

Because of this peculiar character of credit in certain historical periods, money lending was not a savory occupation. The gentleman, therefore, who in our industrial and mercantile life is a pillar of society and a respectable financier, is known by a different name under agricultural conditions. His name is Usurer.

Again, farmers and usurers in ancient Rome.

In the 1921 book Modern Economic Tendencies by Sidney A. Reeve, under the heading The Expansion of Financialization:

Indeed, the birth and growth of this practice, with its variations, has so revolutionalized our national methods of organizing industry, during the last quarter-century, that a business man of 1890 would find himself at sea to-day. The whole aspect of our more prominent engineering houses has been transformed, to meet this modern condition, from that of shops or designing-offices pure and simple into concerns more or less completely financial in character and function...

Reeve does not specifically identify the classes, but notes the clear advance of finance that had taken place, now more than 100 years ago.

From the abridged 1960 edition of Toynbee's A Study of History:

... the horizontal schism of a society along lines of class is not only peculiar to civilizations but is also a phenomenon which appears at the moment of their breakdowns and which is a distinctive mark of the periods of breakdown and disintegration, by contrast with its absence during the phases of genesis and growth.

Toynbee does not identify the classes, but does find momentous significance in the historical moment when the difference between classes becomes a "schism".

At Amazon, Michael Hudson's 2022 book The Destiny of Civilization is described:

A narrow rentier class has gained control and become the new central planner, using its power to drain income from increasingly indebted and high-cost labor and industry. The American disease of de-industrialization has resulted from the costs of industrial production being inflated by the economic rents extracted by this class under the system of financialized monopoly capitalism that now prevails throughout the West.

The costs of industrial production have increased, Hudson says, because of increasing financial costs to employer and employee alike in our increasingly indebted world. I agree.

Hudson's "rentier" is the same as the "usurer" of Simkhovitch and Adams. Myself, I just refer to the growth of debt or the growth of finance, and sometimes just to interest cost.

 

The graph below does not show the cost of interest payments, or any cost. It shows how often the phrase "interest payments" arises in Google Books books.

Some but not all of the works quoted above are from Google Books.

Most of the quoted authors probably used the phrase "interest payments" at one time or another, but I didn't quote any of them using that phrase.

So what's the graph for? It shows general interest in the phrase "interest payments" among writers who perhaps saw increasing interest cost as a problem, or perhaps saw it as not a problem, or who happened to use the phrase for other reasons. I'm using the Ngrams image as a white noise background. In the foreground I added the names of the six authors quoted above, and the dates of the writing.

I think the rising background noise adds urgency to the quotes. So does the grand decline in use of the phrase since 1988, which stands as an indication of the (hopefully not yet final) final victory of the rentier class as described by Michael Hudson.

Notice also that in 1850, when Bastiat wrote, use of the phrase "interest payments" had not yet begun to percolate.

(Click Image for a Bigger View)

Arthurian debt policy

Our anti-inflation policy is all wrong.

 

I understand the "raising interest rates" method of fighting inflation: It reduces the money flowing into the economy from borrowing. Less money means less inflation. I get it. But it is not a good plan.

Less money means less spending, and less spending means less inflation. But less spending also means less economic growth. That is why inflation-fighting often leads to recession. 

But recessions are not the big problem. They are only evidence of it. The big problem is that this anti-inflation policy, applied consistently, results in the consistent slowing of economic growth.

To maintain a policy where inflation is limited to two percent, as we did for many years, is to maintain a policy of low economic growth.

Economists ask: "Why is economic growth slow?" Growth is slow because of our anti-inflation policy.

Demand-pull inflation arises from too much demand, too much spending, too much money in the economy. By definition, in a slow economy there is not too much demand. Our inflation is not demand-pull.

Cost-push inflation arises from too much cost. Our inflation is cost-push. Some people say cost-push inflation is rare, but they are wrong.

Cost-push inflation is common because there is too much cost in our economy. Too much financial cost. In response to the financial crisis of 2007-2008, policymakers pushed interest rates down as low as they could go. That response was an admission that financial cost was too high.

The problem is not interest rates. The problem is debt. We have so much debt that reducing interest rates does not solve the cost problem, even when interest rates are as low as they can go.

We think of finance as the solution to all our economic problems. But that thinking has created another problem. That thinking has created the high cost of finance.

We have many policies that make credit more available. And we have many policies that encourage the use of credit. Therefore, credit use grows rapidly. But we have no policies designed to accelerate the repayment of debt. Therefore, debt grows to extremely high levels.

The personal income tax provides a deduction for mortgage interest. So we don't have to pay income tax on the money we use to pay the mortgage interest. In effect, this makes mortgage interest less costly for the taxpayer. That makes it less costly to have a mortgage. 

The policy makes it less costly for us to be in debt. It encourages people to be in debt.

That policy also reduces the tax revenue the government receives. But even if the cost to government was exactly the same, it would be better to have policy that encourages taxpayers to get out of debt.

Instead of getting a tax deduction for the interest we pay, we should be getting a tax deduction for paying down our debt ahead of schedule. This policy would help us get out of debt. It would reduce debt. It would reduce financial cost. It would reduce cost-push inflation. It would reduce the need to raise interest rates. It would reduce the policy-induced slowing of economic growth. And by reducing the cost of finance, it would bring some vigor back to our economy.

It has been a long time since people talked about economic vigor.

Friends and family

Happy holidays!

The "nubs" of finance

This one didn't go where I thought it would.

See for yourself the persistent growth of finance:

Graph #1: The Persistence of  Memory  Finance

The growth of finance doesn't plot out as straight as the trend line, but the plot is not far off. Based on the graph we can say that Financial Corporate Business has been growing by two percent of GDP every 25 years. But don't forget: GDP was growing over all that time. Finance was gaining on that gain. Finance was growing faster than the economy. 

As if we didn't have enough finance already.

Maybe you are thinking 2% in 25 years isn't much. But, well, the change in GDP growth was half as much -- It was only 1%, period-to-period. For the first 25-year period, the average of quarterly Real GDP growth rates was 4.1 percent. For the second 25-year period, the average was 3.1 percent. For the third 25-year period, the average growth rate was 2.3%. Economic growth was great in the first period, not so good in the second, terrible in the third. And finance was gaining twice as fast as economic growth was declining.

Economists predict even slower growth in the future. McKinsey says global economic growth will fall by half in the next fifty years. That would put us in the neighborhood of 1% growth -- probably in half the time McKinsey says, and right on schedule. And finance will be 10% of GDP by then.

While we're waiting, take a look at the history shown on the graph:

• In the first 25-year period, 1947 thru 1972, when RGDP growth was great, the growth of finance was running on the high side of its trend line. But around 1963 something changed: the blue line shows the growth of finance running below the trend line until the early 1980s. What happened between those low-side dates? The Great Inflation happened. Inflation is related to the Quantity of Money; the Q of M is related to the borrowing we do; an increase in borrowing is related to an increase in the size of finance. There is a connection between inflation and the size of finance.
  
  
• In the second 25-year period (1972-1997), after 1975 or so the blue line shows finance creeping back up to trend. The line runs above-trend from the early 1980s to around 1987, the Reagan years. But then the line goes low again, indicating a slowdown in the growth of finance from 1987 to around 1997. This slowdown was a consequence of the Savings and Loan crisis. Wikipedia puts that crisis between 1986 and 1995. And the graph does show the blue line creeping back up to trend again after 1995.
  
  
• In the third 25-year period (1997-2022) the growth of finance runs high from around 1998 thru 2006. The growth of finance this time is greater than in the previous above-trend episodes; the gap between red and blue lines is greater. But then suddenly we had a "financial crisis". You can identify it by the sharp low between 2007 and 2011 on the graph. Coming out of the crisis, finance grew below-trend for five or six years, and then things got back to normal -- for finance. For the rest of us, not so much.

Here's an interesting bit: Just at the end of the 1998-2006 high in the growth of finance, there is a little nub. I don't know what else to call it (nub: "a small lump or protruberance" according to Oxford Languages). Immediately after the little nub, finance fell into crisis.

That's not the interesting part. The interesting part is the second nub, the one we see in the last two years on the graph. It is similar in shape to the first nub, and similarly higher than the five or six years leading up to it. But this second nub is bigger and more ominous. Plus, the Federal Reserve is busy right now raising rates and creating the next recession, just like they did before the 2008 crisis. Does this mean that after the new nub we get a new financial crisis?

Oh, I don't know. I'm no good at predicting things. I'm always wrong. 

So that's good, right? It means we don't get another financial crisis in 2023, right?

Oh, I don't know. I'm no good at predicting things...

Happy holidays, anyway.

The words 'interest payments' in Google Books, 1800-1935

... and the awakening to financialization:

(It does go up more after 1935.)