Can I steal from myself? Of course not. Further, I cannot hold too much of my own stolen property. My future plans to dispose of my stolen property cannot be constrained by the possibility that I will have to restore it to its rightful owner, since I will have to restore it to myself.
Similarly, the world cannot steal from itself and the world economy cannot be deprived of its assets. In the absence of expropriation from Mars or Venus, the claim that “the world economy has too much swag” is a misunderstanding. The growth of demand in 2011, 2012 and later cannot be held back by allegedly excessive “global theft”.
These remarks are surely obvious. Nevertheless, a common argument since the meltdown is that an overhang of excessive booty will hold back acquisition and lead to a prolonged period of weak demand.
Substitute “debt” for “theft”, and this is the opening of Tim Congdon’s latest Marketplace column for Standpoint magazine, arguing that debt is no burden on the economy, since there is always a credit to match the debit. The logic is as true for theft as for debt. For every victim who has lost an asset there is a criminal who has gained an asset. And yet it is obvious that an economy in which theft was rampant would be less well off than an economy in which people acquired property only by voluntary exchange.
Tim is treating the economy as a zero-sum game, and assuming that the value of assets remains proportional to the money that was exchanged for them. In reality, wealth can be created or destroyed through changing ownership and use of property. The pie shrinks or expands accordingly.
In the case of theft, wealth is usually destroyed, because the stolen good is worth less to the criminal than it was to its rightful owner. In the case of voluntary exchange, wealth is usually created, because each participant obtains a good that they value more highly than the good that they exchanged (otherwise they would not have agreed to exchange). In the case of debt, whether wealth is created or destroyed depends on the use to which the borrowed money is put.
I lend money to a borrower on the basis that they are able to make better use of it in the short term than I am. If I am right, they repay me with interest gleaned from the profitable use to which the money was put. We are better off. Wealth has been increased. But I might be wrong. In that case, I will not be paid the full amount due. We are worse off. Wealth has been destroyed.
It is little consolation that, until the point of default, the debit and credit remain in full on our respective books. Nor does it help if we distort monetary values and demand through monetary policy, so that the debt is able to be repaid in full in nominal terms. It is not real. If the money has been badly invested, wealth has been destroyed, and nothing can change that.
As an amateur, I hesitate to criticise one of our leading professional economists and defenders of the free market. But Tim seems to me in this article to have crystallized the monetarist philosophy into a form so pure that the underlying errors can be seen clearly through the cubic zirconium intellectual construct.
What Bruno Prior says above is true, but I don’t think he addresses Congon’s basic claim.
The PIMCO/El Erian argument according to Congdon is that excessive debt leads to reduced aggregate demand (AD0. Congdon answers this by claiming that “Any reduction in spending by net borrowers can be offset by an increase in spending by net lenders.”
Well obviously reduced spending by borrowers CAN be offset by increased spending by lenders. But the $64k question is whether the offset actually works.
In particular, where lots of debtors suddenly see the value of their houses fall dramatically relative to what they owe (more or less what has happened in the last two years), they are likely to cut their spending, i.e. deleverage (exactly what they’ve done). Meanwhile, there is no particular reason for creditors to INCREASE their spending to compensate, far as I can see. (Certainly there is no reason why reduced spending by debtors should EXACTLY equal increased spending by creditors.) Net result: reduced AD. Indeed, feeble AD is exactly what we have!
Bruno Prior says he “hesitates to criticise one of our leading professional economists and defenders of the free market” (i.e. Tim Congdon). I’ve never had any such hesitation. Congdon has long been fixated on monetary aggregates, with not regard, far as I can see, for WHO holds any addition to the money supply (e.g. there is HUGE different between feeding money into the pockets of ordinary consumers and feeding it into the pockets of those who are “quantitatively eased” (i.e. the wealthy)). Indeed, Bruno Prior more or less makes the latter point in his last sentence.
There is another Standpoint “article” which consists of a debate between Robert Skidelsky and Tim Congdon. Here again, Congdon is fixated on monetary aggregates, and (as Skidelsky rightly points out), Congdon fails to take into account the RATE at which additions to the money supply are spent. See:
http://www.standpointmag.co.uk/dialogue-december-09-tim-congdon-robert-skidelsky-john-maynard-keynes-recession?page=0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C0%2C8
I think that if Tim Congdon were to read Bruno and Ralph’s remarks here about debt he would agree and he’d be shouting “that’s not what I mean”.
Congdon’s point is that it’s not debt per se that is ever a problem. The performance of assets, whether they have been appropriately allocated this is a problem. In the short run of the crisis all that debt relations do is to apportion particular assets and liabilities to particular people. If the distribution were different then the resulting “aggregate demand” may be slightly different as Ralph says because some people may spend more than others.
If previous debt contracts have produced bad investments then that will lead to lower production later. But, it is not the debt contracts themselves that cause it but rather the bad investments.
Ralph writes:
“In particular, where lots of debtors suddenly see the value of their houses fall dramatically relative to what they owe (more or less what has happened in the last two years), they are likely to cut their spending, i.e. deleverage (exactly what they’ve done). Meanwhile, there is no particular reason for creditors to INCREASE their spending to compensate, far as I can see.”
Certainly this is true, but the cause of the situation is the fall in the price of houses!
It’s not the falling that kills you, it’s the ground. But it is nevertheless more practical to try to reduce the risk of falling in the first place, than to climb ever higher and nearer the edge of the cliff as the ground crumbles around you, immune to fear because falling is not harmful in its own right.
To isolate the fall in the price of houses as the cause of the situation begs more questions than it answers. It is unrealistic to take the debt out of that equation. If the falling house prices were not matched to vast amounts of debt, there would be little harm; in fact, a lot of good in my opinion. And without the debt, they wouldn’t have got to the levels where a correction was inevitable.
People can make their own judgments whether Tim was making the argument that Current suggests. I don’t think so. Having re-read the article, it still seems to me that Tim was saying that everything is fine because (a) there are credits out there to match the original debts, and (b) we can print money until the money supply is growing sufficiently again. There is no recognition in the article that there may have been bad investments and that they may have a negative impact on the economy. There is no suggestion that the promotion of consumption and risk and the punishment of saving and prudence through extraordinarily loose monetary policy may have harmful effects. There is no consideration of whether reinflation and the favouring of imprudence is a desirable objective to pursue – it is simply assumed that it must be preferable to allowing a proper correction and rewarding prudence. The recession was merely a question of monetary aggregates, apparently, and the economy will be fine once enough money is pumped in.
But if Tim were making the more nuanced argument that Current adduces, he’d still be wrong. The debt matters. We might be able to reduce for a while its effect on some people by imposing its cost on others through currency debasesement. But the cost is disguised not reduced, and the effects of those countermeasures are harmful.
> To isolate the fall in the price of houses as the cause of the
> situation begs more questions than it answers. It is unrealistic to
> take the debt out of that equation. If the falling house prices were
> not matched to vast amounts of debt, there would be little harm; in
> fact, a lot of good in my opinion. And without the debt, they
> wouldn’t have got to the levels where a correction was inevitable.
I’m not trying to remove debt from the equation. I’m trying to emphasis the “reflective” nature of debt. I don’t think that we could have got into the situation of seeing a large fall in the price of houses without debt.
You write: “If the falling house prices were not matched to vast amounts of debt, there would be little harm; in fact, a lot of good in my opinion.”
I don’t believe that this is true. The “vast amount of debt” you mention is matched by a “vast amount of credit”. If Jim owns his house fully and it’s value goes down then he suffers from that loss of wealth. If Terry has borrowed from Neil to buy his house then certainly both parties suffer. There are knowledge problems associated with debt, such as the banks having to find out the financial situation of their borrowers. However, the principle point is that in the short-run debt only spreads the loss of wealth. Any exacerbation of it is caused by the knowledge problems only.
I agree that Tim isn’t taking an Austrian line and recognizing the causes of malinvestment. However, I think he would recognize that bad investments have been made.