Apr

20

I'm writing this only because I think it might clarify some sloppiness in how people frame the U.S. debt problem. Thanks for the great site and the consistent advocacy for substantive discourse.

The Hydraulics of Debt are quite simple. It is impossible to lend without someone borrowing. When I buy shares in the stock market, someone is selling the shares. The marginal price at which this transaction takes place becomes a means of savings only in a roundabout way. At the end of the period we look back and say, well society earned $15 in money income, how was it spent? Some of it was consumed; some of it was held over against the future periods either in the form of additions to the capital stock or in the accumulation of inventory. Theoretically, the transactions that establish the price of the existing stock of assets (via the marginal buyers and sellers trading in continuous price discovery) also proscribe the amount of real investment that firms do . This happens both by encouraging existing firms to add or remove capital from their existing stock and also by incentivizing new entrants to produce capital of greater market value than production cost. No one saves by putting money in the stock market.

That's it, market prices effect our collective prosperity only through this roundabout and tenuous manner. Why is this relevant to the debt question? To understand the debt question, we have to first understand how tenuous savings is. Society as a whole cannot save by everyone putting money in the bank. Society is not better off if all its companies are profitable. If every company in society returned cash to its claimants (profits less capital expenditure), then society would be getting progressively poorer. We would be consuming our capital stock and suffering a real diminishment of wealth. We might care that companies are profitable because it means that their stock prices will be high, but the truth of this proposition rests on the further observation that these high prices for the stock of wealth induce creation of new wealth. High stock prices can be useful in accommodating demanded savings by serving as the basis for investment.

There are many reasons why our psychological demand to save might differ wildly from our psychological demand to invest. Most of us experience this radical difference every day. We accommodate our pessimism about the future by saving. We accommodate our optimism about the future by borrowing (investing). We are able to divorce these two things by an institutional sleight of hand. I need not intermediate my own saving demand and my own investment demand. Rather the market will intermediate all such savings and investment schedules. How this is accomplished is too long a story to go into. At the end of the period, the fact that savings and investment will be equal to each other is an identity of accounting that gives no flavor for the the great search in time that renders this identity true when looking backward. This is the fundamental insight of economic modeling. Things that are both identically true from one perspective and radically undetermined from another constitute the economic field.

All of this as a long prelude to an identity which should be hammered into every college students head. The borrowing by foreigners, businesses, households and governments has to be exactly equal as an identity to the money lent by foreigners, businesses, households and governments. It is nothing more than an identity to say that if foreigners, businesses, and households are all net savers then by definition the government must be a net borrower. But it is a deeper truth to say that the government borrowing is the means by which this savings is even possible.

So far we're on solid ground. Most observers understand intuitively that the motives causing businesses to fail to invest all their net proceeds are not related to current government policy (this has been a longstanding trend based on the increasing power of the tautology that a business is worth only the sum of its discounted future cash flows). Some observers still claim a mythical means by which government is causing this gap between funds received and funds spent. A concise refutation of this idea is that the hydraulics of debt necessitate companies lend this difference to the government. "We have no faith in our government, but we'll lend them trillions".

Most observers think it is right for households to become net savers, although the people who work building houses might disagree. But again, as a class, you cant be a net saver without someone else being a net borrower. We have already seen that businesses also refuse to be this class of borrower.

Most observers, other than the foreign governments themselves, believe that America should increase its foreign savings (by decreasing its borrowing from foreigners). We're trying, but we've also been trying for many years.

And so we're right back where we began. But now, instead of the government borrowing being an identity, we've suggested that much of this borrowing in involuntary in the sense that it has been driven by the collective desire to hold excess savings. The people's pessimism is driving their government's borrowing at least as much as their government's borrowing is driving the people's pessimism.

This has gone on way too long, for which I apologize. Ill just end by making a quick allusion to the "unfunded liability problem". Be wary of false identities. If we have a 200 trillion unfunded liability we also have a 200 trillion unrecorded asset. If those benefits were ultimately paid out they would flow through the economic system and redound to who? You guessed it, us! So what is the true fear about this unfunded liability? Ill leave that for another time. Maybe we should run around screaming, "those doctors and nurses are about to make off with our unfunded 200 trillion asset, to the barricades!"

Thanks,

Tyler.


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