thegreatdivide
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Proving a government's surplus is the private sector's deficit.
(by Prof. Steve Keen)
Triggering Crises by Reducing Government Debt
What Musk thinks will revive the economy is more likely to trigger a serious recession.
(note: 'credit money' refers to bank-created money; 'fiat money' refers to state created money.)
The beliefs that the State faces a fiscal crisis if its debt gets too high, and that it is prudent for the government to reduce its debt by running surpluses rather than deficits, have existed since the dawn of the Republic. The empirical record of such attempts is definitive, and runs contrary to the expectations of governments at those times. A serious crisis, triggered by a private debt bubble and crash, has followed every sustained attempt to reduce government debt. This can be seen by comparing data on government and private debt back to 1834.
Figure 17: Private and Government Debt, Credit and Fiat Money Creation 1790-2023. See footnote 15 on page 27 for the data sources
Note: graphs not shown here, you can access them by subscribing and supporting Keen's work, on Patreon).
Sharp and sustained downturns in credit-based money creation—with credit turning strongly negative and staying so for years—occurred in 1837-1844, 1930-37 and 2007-2010. These are known respectively as the “Panic of 1837”, the Great Depression, and the Global Financial Crisis. All three crises were preceded by periods during which the government either succeeded in reducing its debt by running surpluses (the Panic of 1837 and the Great Depression), or attempted to, but was waylaid by other factors (such as the “War on Terror” which derailed the attempts by Clinton and G.W. Bush to run surpluses in the late 90s and early 2000s).
During the 1920s, President Coolidge deliberately reduced government spending each year, with the surplus averaging of 1% of GDP across the decade. His final State of the Union Address, 68F[1] on December 4th, 1928, lauded these surpluses as both the cause of the 1920s boom, and as a guarantee of continued prosperity.
Ten months later, the Great Crash occurred, ushering in the Great Depression. While Coolidge had focused on reducing government debt, private debt, which was ignored by policy makers, rose substantially. Government surpluses of 1% of GDP, which reduced the money supply, had been offset by credit of roughly 5% of GDP, which increased it. Then credit turned strongly negative after the Great Crash, with the fall in private debt exceeding 10% of GDP in magnitude between 1930 and 1933. Despite this, the private debt to GDP ratio rose, because the fall in real output was amplified by deflation of 10% p.a., so that the fall in nominal GDP far exceeded the fall in private debt.
Irving Fisher argued that the crisis was caused by private sector deleveraging from a position of excessive private debt, coupled with deflation:
<<deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes.
In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast, as it increases the value of each dollar owed. Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. {Fisher, 1933 #152`, p. 344}>>
Fisher was well aware of the importance of bank-created money in fueling both booms when it is rising, and slumps when it is falling:
<<A man-to-man debt may be paid without affecting the volume of outstanding currency, for whatever currency is paid by one, whether it be legal tender or deposit currency transferred by check, is received by the other, and is still outstanding. But when a debt to a commercial bank is paid by check out of a deposit balance, that amount of deposit currency simply disappears. {Fisher, 1932 #4878`, p. 15}>>
Unfortunately, Fisher’s analysis was ignored by mainstream economists like Ben Bernanke on the basis of the model of Loanable Funds, in which lending is a “pure redistribution” that does not change the quantity of money:
<<The idea of debt-deflation goes back to Irving Fisher… Fisher's idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. {Bernanke, 2000 #1098`, p. 24}>>
Bernanke’s characterization of private debt as “pure redistributions” shows that he was thinking in terms of the false Loanable Funds model. The data shown in Figure 18 contradicts the claim that changes in private debt “should have no significant macroeconomic effects”, and it was available when Bernanke wrote those words.[2] In practice, only mavericks like Hyman Minsky {Minsky, 1982 #35} took Fisher seriously, and developed an approach to macroeconomics in which private debt had a significant role.
(cont.)
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