Paul Krugman recent wrote again about how austerity is bad (both lack of government spending and lack of debt forgiveness, which is just government spending directed at bad borrowers), or to flip it around, how virtue is killing the world economy. And when he says “virtue,” what he means is, “Austerity when economies needed stimulus, paranoia about inflation when the real risk is deflation, and so on.” In addition, he specified a need for debt forgiveness. I agree with him on some of the basics:
A simplified but broadly correct account of what went wrong goes like this: In the years leading up to the Great Recession, we had an explosion of credit (mainly to the private sector). Old notions of prudence, for both lenders and borrowers, were cast aside; debt levels that would once have been considered deeply unsound became the norm.
Then the music stopped, the money stopped flowing, and everyone began trying to “deleverage,” to reduce the level of debt. For each individual, this was prudent. But my spending is your income and your spending is my income, so when everyone tries to pay down debt at the same time, you get a depressed economy.
This graph compares GDP to the total public plus private debt, starting in 1982:
It would appear that for the last 20 years or so, the rate of borrowing was increasing faster than the GDP was growing. Or to put it another way, some part of GDP growth has been financed by borrowing. I think that’s pretty widely recognized.
But then he adds:
So what can be done? Historically, the solution to high levels of debt has often involved writing off and forgiving much of that debt. Sometimes this happens explicitly: In the 1930s F.D.R. helped borrowers refinance with much cheaper mortgages, while in this crisis Iceland is outright canceling a significant part of the debt households ran up during the bubble years. More often, debt relief takes place implicitly, through “financial repression”: government policies hold interest rates down, while inflation erodes the real value of debt.
Well, that strikes me as just plain wrong. I guess he’s forced to refer to those opposed to these tactics as being believers in virtue because, well, we are. Savers are already feeling the brunt of the financial repression, which is certainly happening, just in slow motion. That is, rates are 0, and inflation is 2%, instead of rates at 2% and inflation at 6%, which is probably more what the K man has in mind. But hey, why not dig that knife in a little deeper to savers, by adding their neighbors’ bad loans to their overall government debt burden? That really is infuriating.
And really, we already have done some debt forgiveness, but only for the banks through direclty through the bailouts and QE, as well as indirectly the accounting changes (FASB 157). If Krugman wants to see bad debt written down, he should start with the owners of the bad debt acknowledging it as such. But then the Fed would not be able to buy it at “full” value. This makes QE a stealth debt forgiveness program, but only the inside big guys get the forgiveness.
One man’s debt is another man’s asset, so someone will have to take the loss. God forbid that it should be a SI bank. What should happen is rule of law. If you don’t pay, you default. You lose your credit rating and your collateral, and the bank loses whatever skin it had in the game. If you are a bank and you become insolvent, then the FDIC does its thing. Seems pretty straightforward. But it is really not what happened at all, and it is still failing to happen. The bad debt has not gone away.
As Krugman noted, borrowers have really not reduced their balance sheets by much. He likes % of GDP measurements, but I prefer real dollars. Here’s what private borrowing, government borrowing, and the sum of the two look like historically. These are real 1982 dollars:
And here’s what they look like over just the past few years, again in 1982 dollars (to be consistent). Sorry about the annual data on this, and thank you to Arthurian for helping direct me to the correct data series:
So public debt (people and corporations) has gone down about 15% but is flattening out now. And as it went down, public debt went up to compensate, so that overall debt really didn’t change much.
Another reason that the debt load has not gone down more is that banks are simply not foreclosing. Look at the overhang, shown on this chart from Calculated Risk:
It seems like what Krugman really wants is not so much for bad debt to be erased as private debt to be replaced by public debt. That’s moral hazard, even more of it than we already have. My vote for the cause of economic sluggishness still goes to moral hazard. We all know that when it happens again, the same guys are still going to get paid. Literally. The same EXACT guys.
Well, this is a very poorly written post, but I don’t have time to work on it any more today. Maybe I will edit it another day.
Right on time, as I was considering this post, Cliff Asness included this gem of a paragraph in his recent letter:
Focusing my attention, as was predestined, Paul Krugman lived up to his lifelong motto of “stay classy” with a piece on the subject entitled Knaves, Fools, and Quantitative Easing. Some lesser lights of the Keynesian firmament have also jumped in (collectivists, of course, excel at sharing a meme). Responding to Krugman is as productive as smacking a skunk with a tennis racket. But, sometimes, like many unpleasant tasks, it’s necessary. I will, at least partially, make that error here, while mostly trying to deal with the original issue separate from Paul’s screeds (though one wonders if CPI inflation had risen in the last four years if Paul would be admitting his entire economic framework was wrong – ok, one doesn’t really wonder – and those things never happen to Paul anyway, just ask him).
Asness then goes on to describe why he was wrong about inflation with regard to the obscene level of money printing (answer: he didn’t think velocity of money would disappear even more quickly than new money was printed), and what he thinks might happen next (not known, because the money is still out there). Krugman fires right back, with a post that essentially says, “I’m right because I’m smart, you still don’t understand this stuff, and you should leave it to us smart guys.” I’m sure Asness is flattered to get that personal attention from the Great and Powerful Paul.
Greg Mankiw does a much better job of explaining exactly why inflation didn’t occur, but, like Krugman, he still is not getting the point of those who feared inflation. Mankiw writes:
…it is very clear to Paul Krugman and to his back-up singers that quantitative easing’s effects are small unless it is taken as a credible signal of a régime change and thus generates a significant shift in expectations of inflation. It wasn’t. So it didn’t. That it had at best small effects is an intellectual win for the Keynesian side here.
Everybody who has done their homework recognizes that.
Cliff Asness appears to believe that Paul Krugman’s beliefs are in some sense the flip side of his–that while Asness believed that QE would produce high inflation, instead Krugman believed that QE would produce a real economic boom:
The Fed clearly wanted this money lent by banks and spent…. They didn’t get that, and we didn’t get the inflation we feared…. How this is a victory for one side of the debate or another is beyond me….
It is as if Asness never bothered to read things like this:
Not so easing (wonkish) – NYTimes.com: “Goldman Sachs report (no link) suggest[s] that the Fed’s policy of ‘unconventional easing’…
…isn’t very effective… that it would take between $1 trillion and $1.6 trillion of unconventional easing to accomplish as much as the Fed can achieve, in normal times, by cutting the Fed funds rate by 1 percentage point…. Bernanke and the Fed… have been gaming out what they would do if ‘it’ happened here for years. And a key element of the strategy was altering the composition of the Fed’s balance sheet–that is, unconventional easing. But that tool isn’t proving very potent.
This is an interesting argument, but it is not the one that Asness is making. By the way, if they didn’t think that QE was going to lead to an improved economy, why did they do it? Was it really just to make rich people richer, right on its face? This seems to have been the only large measurable effect to this point. I digress. The point Asness makes, quite directly, is that inflation is certainly still possible. All that new money is still out there, albeit parked in equities and real estate and excess reserves. But until it gets bought back again by the Fed, the Keynesians really cannot honestly declare victory. It will be great if that happens, and there is no horrible inflation, and we all get to keep on keeping on. But we are not there yet.