Thursday, April 26, 2012

Paying off debt - the Problem

Total public and private debt, in most of the developed world, has reached heights never before seen in an financialized economy. There seems to be a general consensus that these high debt levels are "unsustainable" and a wide view that they should be paid off, as opposed to jubilee'd or inflated away. But I've never seen anybody discuss what it would require for these debts to be paid off. Some consideration of the consequences of paying off debt on a societal scale show that it can't be done by belt-tightening by the debtors, and that the only solutions will be inflation, drastic increases in taxation, or massive default (including almost all sovereign developed governments). This also raises a long-term political issue in that none of these options are currently acceptable to the governing classes of any developed nation, meaning eventually the governing classes will either have to change their minds - or be overthrown.

The problem is that debt has different meanings to a society than to an individual. For an individual, debt is an external item can be paid off, by earning more or spending less, up to some limit. We are all individuals, and we naturally think of debt in this way. But on a societal scale, debt is not external. Debt is a relationship between debtor and lender; the debtor's debt is the lender's asset. So an excess debt problem is, on a societal scale, also an excess asset problem, and the two problem are not just interlinked; they are the same thing. For debt to be paid off on a societal scale, lender assets have to be reduced at the same rate the debtor debts are reduced. Given the enormous sums involved (typically several times GDP) and the highly skewed wealth distribution, this creates a problem.

There are two basic ways for the lenders to have less assets. They can spend at the rate the debtors pay, or they can have assets taken away. Spending would require an almost unimaginable splurge by the rich. Spending by buying assets won't fix the problem, because then they'd still have assets. It has to be consumed.

In the US, almost all the debt is owned by the 1%, and most by the top 0.1%. If the combined debt is reduced from 370% to 270% over ten years, that's about 13 trillion dollars of assets of the wealthy that have to disappear. The top 0.1% own about half the wealth, so if the losses were proportionate, the 300,000 members of this group would have to spend about 20 million each. That's a lot of trips and hotel rooms, fancy cars and big parties, or for that matter, anything.

The simple fact is: the rich aren't spending like that and they're not going to. Luxury spending dropped precipitously in the 2008 crash. It has since recovered, but it's not going up by the severalfold increase needed to allow the debtors to pay things off. The economy probably couldn't support luxury spending at that level anyway. Our society relies on infrastructure, both concrete and conceptual, to produce stuff, and that infrastructure is tied to what it makes. We're not set up to produce luxury goods and services on that scale and it would be a huge project to become capable.

So since the rich can't consume all the rest of society owes them, some of their assets will have to be taken away, directly or indirectly. There are a number of ways to do this. One is for some of the debts to be cancelled. Another is high taxes on the rich. And the last is for high (but not necessarily hyper-) inflation. All approaches have been taken in the past, successfully.

Sometimes debts get cancelled. According to the bible, that's the way God requires. Every 7 years, all debt disappears. We don't have records to demonstrate this actually happened, but in pre-industrial societies land reform was often used to essentially the same effect. Poor farmers borrow for problems, landowners take the land when they can't pay, land reform returns the land to the farmers.

Higher taxes have also been used. Two examples are the US paying off its Great Depression/WWII debt, which was accomplished partly by tax rates of 91% on earned income; and Great Britain paying off its Napoleonic War debt, which was similarly accompanied by high taxes for most of the 19th century. In these case the outcome was quite good for the countries in question. Higher taxes on the middle and working classes have also been tried, but these haven't worked so well, most likely because those people don't have the assets to be taken in the first place. Higher taxes on them causes either general economic collapse or mass cheating on taxes.

Inflation has also been used many times in the past. Generally the results have been inferior to the other two methods, although I think this is effect, not cause. A government has to be strong and far-sighted to jubilee or redistribute, because those are always opposed by the wealthy classes. Weaker governments inflate, and the same weakness that forces them to use the more indirect taking of inflation makes them less able to deal with the kinds of problems that any society must deal with from time to time.

Given that one of these approaches will have to be taken, the next question is how can one of them be picked? Debt cancellation, by bankruptcy, on the requisite scale would bankrupt every bank in the world; as 2008 demonstrated governments won't tolerate that. If that happens, the government will guarantee the banks' assets an in the end will have to assume debt roughly equal to that cancelled by bankruptcy and we're back where we started, except that the debt is now owed by the government rather than by individuals. I know some people advocate letting the banks fail; but I don't want to argue that here; my point is that the current governments won't allow it.

High taxes on the rich is a possibility in some countries. Hollande of France is running on a platform of increasing taxes on the rich to 65% and he may win. I'm not sure that taxes will be raised high enough, though. Roosevelt had to raise them to 91% and the debt problem of the Great Depression was much smaller than that today. The problem with taxes is that the government normally taxes primarily flows (income and expeditures) but needs to use them to pay off an accumulation (debt). Hollande's 65% proposal would help, but I doubt it would come anywhere near fixing the problem.

So that leaves us with inflation. Normally that would be the approach expected of weaker governments, like today's, unable to implement the other solutions. But in the developed world money is controlled by independent central banks. They are without exception controlled by bankers, and their directors all seem to have a horror of inflation. We have seem them step in with large increases in the money supply to stop collapse, starting with Japan in the 90's and expanding to virtually all countries today. But, as soon as inflation even threatens to pick up a little, never mind to the relatively high levels (5-10%) needed to work off excess debt, the excess money gets pulled back. There is only one country currently willing to accept any meaningful inflation, Great Britain. I expect the usual course will be that of Japan since their bubble popped in 1991, with similar results - no growth, and ever-increasing but monetized government debt. In the end they must accept inflation, assuming none of the other approaches to excess assets among the rich get taken. But the end may be very far off, judging by how long Japan has stuck to the strategy. I'm also not sure what would be able to force the central banks to give up on their low-inflation fixation.

A combined approach might be the best we could hope for under the current regimes. Increased taxes on the rich can be used to support the rest of society as it pays of its debts. Increased taxes on capital gains in particular could induce more spending by the rich and induce them to partially consume their excess debt. A "lost-decade" money approach by the central banks could give the time for these policies to work. If the extra time is used to resolve the problem (Japan has not) then perhaps at the end a moderate inflation hiccup could finish the job. In the US, though, even this approach would be totally beyond the pale of proposed policy solutions. I don't see anything adequate except a crisis of a scale to force a change in government against the wishes of the wealthy who control most money spent on politics and the mass media, and I really don't want to live through that kind of crisis.