Debt and saving


in Economics, Politics

The issue of debt has come up here a fair number of times before – for instance, when when discussing a recent Margaret Atwood book. In the United States, one of the things driving the Tea Party movement seems to be anxiety about the deficit. People rightly worry about burdening future generations with debt that cannot be managed.

That being said, it does seem to me that there is a mathematical reality that is sometimes ignored, when discussing debt. Namely, that it is the unavoidable arithmatic counterpart to saving. If we think it is laudable to save for the future, we must accept that when we save we are lending to others, and thus making them indebted. The world as a whole cannot be a net saver or a net debtor.

I think the critical distinction between good debt and bad debt is whether the purpose being served is sustainable or not. One minor example is avoiding short-term cash crunches. Having access to credit makes it easier for people to avoid situations where they are basically solvent, but desperately short on liquid funds for a brief span of time. Much more importantly, debt can be used to make productive investments.

The most virtuous arrangement is one where people who need money in the future (say, for retirement) lend it temporarily to those who can make good use of it now (say, by expanding businesses that serve human needs). There is the caveat – of course – that externalities like climate change need to be taken into consideration. That said, I believe that human welfare can continue to increase even as our biophysical impact on the planet shrinks. We just need to invest in clever ways, such as in mechanisms to improve efficiency and in zero-carbon and renewable ways of producing energy.

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{ 30 comments… read them below or add one }

oleh November 11, 2010 at 2:11 pm

I appreciated your explanation that for there to be savers (creditors) there must be borrowers (debtors). You particularly point out that “The most virtuous arrangement is one where people who need money in the future (say, for retirement) lend it temporarily to those who can make good use of it now (say, by expanding businesses that serve human needs).”

At age 53, I more likely am thinking of saving for a future when I am not earning income. I am also the son of two DP’s (displaced persons or refugees from the Second World War). Saving is second nature to me. I am very adverse to incurring debt. Your explanation makes a lot of sense to me.

I am also wondering what are the views of people in their 20’s to both personal debt and to public debt. With public debt being on a such a large scale, does that contribute to the willingness to have personal debt?

Byron Smith November 11, 2010 at 5:43 pm

Actually, creditors are not universally (nor even primarily) savers.

Most creditors worldwide are banks, who loan money into existence. They loan far more money than they actually “save” from others (usually the ratio is about ten units loaned for each unit deposited, but in many places it is quite a bit higher).

It is crazy (and I admit I’m no expert on this stuff), but apparently this is how our system “works”. Here are some videos explaining the concept: here and here (and you might want to follow on to the next few videos – they are each fairly short).

Milan November 11, 2010 at 5:56 pm

I think you may be misrepresenting reserve ratios.

Banks need to keep some cash on hand, because people might need it immediately. Most of their reserves, however, get lent out. For instance, a bank might lend 90% of what is in all its savings accounts to businesses and consumers. Some of that borrowed money may also end up deposited in the bank, and 90% of it would then be re-loaned.

Byron Smith November 11, 2010 at 8:58 pm

I may well be getting it wrong. Did you watch the videos (esp the second one)?

Milan November 12, 2010 at 9:10 am

I think it may be a matter of interpretation.

If I lend you $100 and you give me an IOU for $100, there is a sense in which we have ‘created’ money. There is now $100 in cash out there, along with a promissory note worth $100.

That’s something that happens whenever anyone lends money in exchange for a promise. It isn’t just something banks do.

Byron Smith November 12, 2010 at 12:36 pm

Sure, I said that most creditors are banks (at least in terms of volume of money loaned).

(One of) The problem(s) with debt-based economies is found more in the second video where interest is introduced – namely, the necessity of endless growth to keep the system moving. It’s a bit like a Formula 1 racing car – very good at going fast, but if it gets too slow, the engine seizes up and the brakes don’t work and the car no longer sticks to the road and you have an expensive mess.

Milan November 12, 2010 at 1:18 pm

Tristan has a post on BuryCoal asking what zero- or negative-growth capitalism would look like.

Personally, I think growth is still possible; it just needs to be based on improving the quality of goods and services, while reducing humanity’s total biophysical impact on the planet.

Tristan November 14, 2010 at 5:43 pm

To say economic growth is still possible, is this not the same as to say that the further accumulation of debt is sustainable? Is there a limit to the amount of debt we can accumulate? In the history of Europe, we see cycles of debt accumulating and being declared invalid.

I agree with Milan that the quality of goods and services can continue to improve. But I disagree that this is incompatible with zero growth or negative growth economy. Some things that improve quality of life actually contribute to a decline of growth, i.e. a transition from vehicle transit to bicycle transit. Or, when an innovation allows a product to be produced more efficiently – each unit consumed of that product now counts as a smaller portion of GDP, so if consumption doesn’t go up to compensate, it will be a force towards negative-growth.

Furthermore, I think if we’re serious about human welfare, I think we’ll quickly conclude that the current inequality is a massively inefficient distribution of wealth – much less wealth could produce a much greater benefit if more equally distributed. For instance, for the same 70$ loss which might lead a wealthy person to buy a 30$ bottle of wine rather than a 100$ bottle, a person on welfare can eat better for a week. It’s criminal to stand idly by when such injustices exist.

Milan November 14, 2010 at 6:49 pm

This is why economic growth can continue:

We can get better at building everything, using fewer raw materials and generating less waste.

Milan November 14, 2010 at 6:56 pm

Is there a limit to the amount of debt we can accumulate?

As described in the above post, every debt owed by Person X is a credit owned by Person Y. As long as people are willing to lend to one another, debt can continue to increase. If people don’t have the money to pay back their debts (or get freed of the obligation to do so), then the people who lent them money lose out.

The world as a whole has no debt. Of course, the distribution of debt between individuals is significant in many economic, social, political, and ethical ways.

Byron Smith November 15, 2010 at 7:32 am

As described in the above post, every debt owed by Person X is a credit owned by Person Y.
Only if we allow corporations as people, which I deny, despite the legal history of this equation. But in any case, the fact that every debt has two sides doesn’t mean that any level of debt is sustainable. Imagine a situation in which many of the debts in the world were so large that they could not possibly be paid back and they were growing faster than the very rosiest estimates of economic growth and in system that requires debts to grow faster than the ability to repay them grows and in a world where there have been a history of such debt bubbles growing and popping with disastrous consequences. Then open your eyes and welcome to the world we live in.

If our hopes for endless economic growth are based on decoupling growth from resource depletion, then (a) at best we push back the problem a few years and (b) that best is a long way from where we are now, which is that no major economy has achieved a significant level of decoupling when international travel and imported goods are considered. See here for some interesting stats and here for a fascinating talk with even more stats, including some jaw-dropping points about 2-3 minutes in concerning the level of improvement required to decarbonise the economy to the level required with continued economic growth over the next few decades.

And that is just carbon. Climate change is but one of a range of interlocking problems where we are systematically destroying the future, undermining the possibility of future human flourishing: soil depletion, biodiversity decline, fresh water stress, depletion of cheap liquid fuels,* deforestation, ocean acidification, overfishing, pollution and so on.

* I realise you believe peak oil will be solved by the market. If it is, then the market’s “solution” is going to be non-conventional fossil fuels, and even then, might not be enough to avoid serious economic downturn.

Prosperity is not measured by GDP. Growth is not the goal.

Tristan November 15, 2010 at 12:48 pm

“If people don’t have the money to pay back their debts (or get freed of the obligation to do so), then the people who lent them money lose out.”

If that were true, we would have let the banks fail.

Tristan November 15, 2010 at 4:52 pm

Concerning the very expensive (and very impressive if you take off your “look at this kooky old stuff” glasses) Hard-drive pictured above – I don’t understand why the fact computers get faster, better, cheaper is a reason economic growth can continue. If anything, that’s a reason it will decline: if computers start costing less, people may spend less on computers. If people spend less on computers, that contributes to an economic contraction. What drives economic growth is not that things get better, but that things get more expensive – the bundle of goods bought by the average person gets bigger in terms of net dollars spent. That’s what economic growth is – not getting more for your money, but spending more money. “Economic growth” doesn’t care what you get for your money.

Furthermore – it’s easy to make fun of a ten megabyte hard-drive now. But when they came out it was a big deal. My father worked at Kokums-Cancar at the time – and it made a big difference to how productive the programmers could be. Such breakthroughs enable economic growth, at least in the short term, because they allow the same number of man hours to produce more wealth, more product. (Of course, this means they also need less programmers to do the same amount of work – that’s called job-destruction).

Breakthroughs as big as the 10 megabyte hard disk are much more difficult to come by now – what was the last product which radically improved worker productivity? The increase which I’m sure we’ll see in the next few years from 1 terabyte drives to 100 terabytes drives is not in any way a difference of comparable importance than floppy to 10 megabyte drives. Heck, you could probably run the internet on a google-os machine with 512 meg of ram and a 1 gig harddrive, and be as productive as someone with a 2500 macbook.

Another thing, while I don’t deny we have gotten “better” at making these things, it’s still not clear that we could produce them if the people producing them lived lives comparable to middle class north americans. Could you look a foxconn employee in the eye and say you have no problem with their working conditions – that they deserve less opportunities than you had because of to whom and where they were born? Or, do you think their conditions are fine and the worker protest suicides are not something that keeps you up at night?

Tristan November 15, 2010 at 4:56 pm

“That’s what economic growth is – not getting more for your money, but spending more money.”

Keep in mind, you can only spend more money if you make more money. And you can only make more money if you are more productive or if you work more hours. Or, instead of making more money you could just borrow more and more from your future self. But for economic growth to continue, some vector of these three factors must continue to increase – either you (on average, of course) must continue to be more productive, work more hours, or borrow more.

Do we work more hours, on average, than in 1980? Do we borrow more from our future selves than in 1980? If yes, that would suggest that some amount of the growth we’ve experienced is not simply due to increased productivity.

Milan November 16, 2010 at 12:16 am

If that were true, we would have let the banks fail.

It’s true that it introduces major problems into the financial system (and many others) when you create incentives for people to behave recklessly. Reducing moral hazard is an important undertaking.

Byron Smith November 16, 2010 at 11:55 am

If anything, that’s a reason it will decline: if computers start costing less, people may spend less on computers.
Or spend the same amount, buying more computers, which would not contribute to economic growth, but would undercut any gains in efficiency, which is what generally actually happens. Efficiency gains (in terms of ratio of product per resource) are swallowed by the increase in demand generated by the lower price that the efficiency enabled.

Tristan November 16, 2010 at 3:18 pm

I think the belief in the possibility of indefinite economic growth is best understood as a kind of religious belief.

Byron Smith November 16, 2010 at 6:17 pm

Sure. I’d call it an idolatrous belief, since it is a false alternative that holds out the promise of life only to snatch it away and be revealed as a path of self-destruction.

Byron Smith November 16, 2010 at 7:20 pm

Here is the case for the impossibility of sustained growth put briefly and eloquently. It is also a case for taking climate change as one of a series of interconnected issues. I would give it a more prominent place than Heinberg (who gives pride of place to peak oil), but the basic mix and outlook I’d agree with (economy, energy and ecology leading to the end of economic growth (traditionally understood) between now and 2050).

Milan November 16, 2010 at 10:00 pm

Nominal economic growth doesn’t matter. What I am saying is that human welfare can continue to increase, even as humanity’s environmental impact falls, if we set the right incentives.

The question of investment is more complicated. It seems like it would be pretty problematic if people with excess capital simply couldn’t put it toward productive purposes. They would lose out, since it would make it harder to save for any future purposes, and those with good ideas would lose out, since they couldn’t access the capital to fund them.

When it comes to ideas like improved forms of renewable energy, the efficient (and profitable) deployment of capital could be a major driver toward greater sustainability.

Tristan November 17, 2010 at 10:09 am

“Nominal economic growth doesn’t matter.” I was never talking about nominal growth, I’m talking about net, or real growth. None of my comments have anything to do with “nominal” growth, which can easily be simulated by inflation. I did comment on this idea, however, in a post on on the idea of negative-growth capitalism.

” It seems like it would be pretty problematic if people with excess capital simply couldn’t put it toward productive purposes.” I agree. If on average investments do not grow, of course people would be free to put excess capital towards productive purposes, but they would lose, on average, the incentive. This would lead to a drastic reduction in the efficient allocation of capital. And you’d have to think seriously about what other ways we might allocate capital.

And you know, that might not be so bad. Sure it’s easy to make fun of the USSR. But did the USSR ever spend 40% of its product on researching efficient allocation and distribution? If 40% of the US economy is finance, then that would be the fair comparison.

“When it comes to ideas like improved forms of renewable energy, the efficient (and profitable) deployment of capital could be a major driver toward greater sustainability.”

It could be? Well sure, it could be, but only if those forms of renewable energy are the most profitable investments. And hopefully they will be – but that depends on the conditions which the political sphere sets for the market. Currently, states are encouraging investors to put their excess capital into oil extraction by subsidizing oil, coal and tar sands production both through tax breaks, and also through ignoring the externalized environmental costs – which are the state’s role to include.

It’s kind of weird for you think the market should be the large force in building renewable energy, considering the renewable energy that’s been built over the last 100 years has been build largely by states. Again, this suggests to me that faith in the market is a form of religion it HAS to be true!

Byron Smith November 17, 2010 at 10:49 am

Nominal economic growth doesn’t matter.
Except to economists, bankers and politicians (and those who pay attention to them). Otherwise, irrelevant.

Tristan November 17, 2010 at 2:17 pm

Economists are concerned with net growth – that’s why they use baseline years when they express currencies. For instance, Canada’s GDP growth year on year might be expressed in 1999 dollars. That’s not nominal.

Bankers might care a bit more about nominal growth, but they will still get awfully worried when nominal growth is eclipsed by inflation – because that causes people to run to hard commodities. If you want evidence, look at the spike in gold prices.

The reason why nominal economic growth “doesn’t matter” is because nominal economic growth is not distinguishable from inflation. Weimar Germany likely had the highest nominal growth on record ever, of any country. Is that impressive? Did that lead to improvements in welfare, or to efficient distributions of capital? Of course not.

Byron Smith November 18, 2010 at 11:17 am

You’re right. I was being facetious.

Byron Smith December 3, 2010 at 1:23 pm
. January 8, 2011 at 6:41 pm

Getting real
The savings glut was really an investment dearth

NEWS bulletins feature the stockmarket’s daily movements or the rise and fall of European government-bond yields. But they very rarely mention an important economic measure; the very low level of real interest rates (ie, after allowing for inflation). In October America even managed to issue an inflation-linked bond with a negative real yield.

Low real rates have propped up asset markets this year as investors have been forced into riskier assets like equities, corporate bonds and even commodities in search of higher returns. But a new report* from the McKinsey Global Institute argues that real rates are bound to rise in the coming years. That is because an investment boom is taking place in developing countries, which will place a strain on global savings.

It is an economic truism that savings must equal investment. However, desired savings can be greater or less than desired investment: the two are equalised via the level of interest rates.

Ben Bernanke, the chairman of the Federal Reserve, has explained the low levels of real rates over the last decade in terms of an Asian savings glut, with central banks recycling their foreign-exchange reserves into government-bond markets. But McKinsey argues that the explanation lies in a downturn in investment, which dropped from 26.1% of global GDP in the mid-1970s to a low of 20.8% in 2002. Between 1980 and 2008 global investment was some $700 billion a year less than it would have been had the trend of the 1970s persisted. The investment decline was caused, according to the McKinsey study, by the end of the post-war rebuilding programme in Europe and Japan and a decline in the economic growth rate, which reduced the need for more capital expenditure.

But global investment started to pick up in 2003 as Asian countries ploughed more money into infrastructure. This investment surge was halted, probably temporarily, by the recession. On average, developing countries spend twice as much on infrastructure (as a proportion of GDP) as developed countries do. As the weight of emerging markets in global output increases, the report forecasts that investment will hit 25% of GDP by 2030. In constant prices, that will be an increase from $11 trillion today to $24 trillion by 2030.

. April 4, 2011 at 5:34 pm

That points to another distortion, which is generational. A large number of welfare payments and social transfers are now aimed at the elderly. The huge baby-boom generation that is just about to retire will make these even more expensive. In Christopher Buckley’s political satire, “Boomsday”, America’s young eventually start bribing their self-indulgent parents to end their lives early. In his interesting book “The Pinch”, David Willetts eschews that solution for Britain’s baby-boom generation, but calculates that it will take out nearly 20% more from the system than it has put in. The first budget of the new Tory government, in which Mr Willetts is a minister, still directed money disproportionately towards the old.

. April 23, 2011 at 5:56 pm

70 or bust!
Current plans to raise the retirement age are not bold enough

PUT aside the cruise brochures and let the garden retain that natural look for a few more years. Demography and declining investment returns are conspiring to keep you at your desk far longer than you ever expected.

This painful truth is no longer news in the rich world, and many governments have started to deal with the ageing problem. They have announced increases in the official retirement age that attempt to hold down the costs of state pensions while encouraging workers to stay in their jobs or get on their bikes and look for new ones.

Unfortunately, the boldest plans look inadequate. Older people are going to have to stay economically active longer than governments currently envisage; and that is going to require not just governments, but also employers and workers, to behave differently.

. April 23, 2011 at 6:01 pm

A special report on pensions
State of war
Taxpayers versus public-sector workers

AMERICANS ARE USED to debates on the financial health of their Social Security system at the national level, but many will have been caught unawares by a pensions crisis in their state and municipal governments. Already one small city—Prichard, Alabama—is unable to pay its pensioners. The crisis has exposed the potential conflict between public-sector workers who still enjoy DB pensions and private-sector workers who get less generous DC pensions—and at the same time have to fund the benefits being paid in the public sector through their taxes. Years of underfunding mean that more contributions to public-sector plans are needed, and soon. But since most states have balanced-budget requirements, such contributions can come only from higher taxes or cuts in services.

Reform of public-sector pensions is inherently difficult. The biggest liability is promises made to existing employees. Court decisions have suggested that these promises cannot be withdrawn; states may not even be able to limit the future accrual of pension rights by existing workers. In California the Little Hoover commission, which in February reported to Jerry Brown, the state’s governor, concluded that courts had protected employees’ pension rights “as structured on their first day of work”.

It seems odd that private-sector employers can restructure their pension plans and public-sector employers cannot. The best that local governments can do is change the system for new employees, a process that will take decades to bear significant fruit, or to increase employees’ contributions. Even that amounts to a pay cut, creating the potential for dispute with the unions. In Wisconsin unions have swallowed higher contributions but balked at attempts to restrict their bargaining rights.

. April 23, 2011 at 6:02 pm

Will such money ever be paid or will taxpayers revolt? “What I tell the folks in the unions is that these pension promises are a mirage. The money isn’t going to be there,” says Mr Quigley. So the stage may be set for a legal and constitutional battle in which the authorities try to reduce the pension bill and the unions challenge them in court.

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