Financialization and the low burden of public debt

Financialization is a fuzzy concept. There are many definitions, and none is clear cut, at least to characterize the changes of the last 40 years or so, which is the period most authors associate with financialization. I'm not suggesting it's not a useful concept though.* In some sense, financialization refers to the last phase in the capitalist system (even if there are ways in which one might argue that capitalism was always financialized).

At any rate, going to the point I wanted to make, the financial burden of public debt went down in the 2000s, but that is not necessarily a good sign. I was trying to check the financial burden of public debt (i.e. the total spending on interests, out of total current spending) in the United States. The figure above shows that the financialization (ha, another possible definition) of the budget started with the Volcker shock, and ended more or less with the collapse of the dot-com bubble in the early 2000s.

The hike in interest rates in the late 1970s increased the financial burden of public debt, and with the lower output growth -- associated not just to higher interest rates and its effects on consumption, but also higher unemployment and lower wages which additionally impacted private demand -- debt dynamics was on the unstable side of the Domar rule (r > g) and public debt increased significantly in a peaceful period that was for the most part prosperous.

Public debt normally increased in periods of crises or of external threats (wars). In other words, public debt was an instrument for the preservation of society for the most part. There was also an agreement that public debt was a necessary instrument for the accumulation of capital, and it provided a secure asset for the functioning of the financial system. Btw, that was a point that was contentious, and not everybody accepted the Hamiltonian notion that public debt could be, to some degree, a blessing. Think of Andrew Jackson's payment of debt, and the various modern Cassandras afraid about the debt burden on future generations.

The rise of public debt since the 1980s (with the minor decrease in the late 90s) has served a very different purpose. While part of it can be seen as the reaffirmation of American Hegemony, with the increased military spending of the Reagan years (still low if compared to the heights of war, hot or cold), much of it was the result of lower taxes for the wealthy. The accumulation of debt was, like the hike in interest, necessary to discipline the labor class and control inflation.

In part, the result of that perverse use of public debt accumulation is that private agents have ramped up private debt in order to compensate for income stagnation. Think about college kids accumulating more debt to compensate the reduced public support for public universities. That of course goes hand in hand with the fact that most booms now are associated with some bubble (stock market, dot-com, housing, etc), or in the absence of a bubble we end up with a moderate lack luster recovery (the last decade), and what is confusedly described as 'secular stagnation.' The flip side is that the low burden of debt on this side of the 2000s, is not benign like the one from the 1950s to the 1970s, which was closer to what Keynes' notion of the euthanasia of the rentier.

It reflects the needs of the economy to maintain private debt under control in a relatively unstable economy. Something that is still necessary to the extent that labor is still very much being disciplined by macro and micro policies that keep wages under control.

* For a relatively recent discussion of the meaning of financialization and its relevance see Epstein (2015) here, and for an older discussion see Palley (2007) here.

Vultures, bottom feeders and the debt collection business

John Oliver's story on debt collection is very instructive. It looks only at the domestic practices, but these are essentially the same as the ones used by Vulture Funds in international financial markets.

So respectable businessmen like Paul Singer, a top GPO contributor that owns the Elliot Vulture Fund that buys debt of developing countries and sues them in New York courts, or the international organizations like the IMF that impose conditionality on poor indebted countries are not much different from the bottom feeders described by Oliver.

Kalecki's Fable

By Jan Toporowski (Full paper published by ROKE here)

Following the death, in 1935, of the Polish military dictator Józef Piłsudski, his regime continued under a group of his military cronies, known as the ‘colonels’, who increasingly modeled their regime on that of Mussolini in Italy. One of the colonels, who was responsible for economic development, wanted to understand the economic principles behind government stabilization. He called in Kalecki's colleague from the Institute for the Study of Business Cycles and Prices (Instytut Badań Konjunktur Gospodarczych i Cen), Ludwik Landau, to explain the principles behind the ‘new economics’. Landau had just been fired from the Institute and was now working at the national statistical office, Główny Urząd Statystyczny (see Kalecki 1964 [1997]; Landau 1957).

Landau explained at length the principles of effective demand and credit cycles underlying levels of output and employment at any one time. The colonel had evident difficulty in grasping this. So, finally, Landau explained by telling the following story:

In an impoverished Jewish shtetl in Eastern Poland, whose residents were mired in debt and living on credit, a wealthy and pious Jew arrived one day and checked into the local inn, taking care to pay his hotel bill in advance. On Friday, to avoid breaking the Sabbath injunction against carrying money, he handed over to the inn-keeper for safe-keeping a $100 note. Early on Sunday, the wealthy and pious Jew left the inn before the inn-keeper had had a chance to return the banknote.

After a few days, the inn-keeper decided that the wealthy Jew was not going to return. So he took the $100 note and used it to clear his debt with the local butcher. The butcher was delighted and gave the note for safe-keeping to his wife. She used it to clear her debts with a local seamstress who made up dresses for her. The seamstress was delighted, and took the money to repay her rent arrears with her landlord. The landlord was pleased to get his rent at last and gave the money to pay his mistress, who had been giving him her favours without any return for far too long. The mistress was pleased because she could now use the note to clear off her debt at the local inn where she occasionally rented rooms.

So it was that the bank-note finally returned to the inn-keeper. Although no new trade or production had occurred, nor any income been created, the debts in the shtetl had been cleared, and everyone looked forward to the future with renewed optimism.

A couple of weeks later, the wealthy and pious Jew returned to the inn, and the inn-keeper was able to return to him his $100 note. To his amazement and dismay, the wealthy Jew took the note, set fire to it, and used it to light his cigarette. On seeing the inn-keeper's dismay the wealthy Jew laughed and told him that the banknote was forged anyway.

Landau finished his story and waited for understanding to seize the colonel. Beads of sweat appeared on the colonel's forehead, from the intellectual effort at comprehension. Finally, as if he had stumbled on the explanation, the colonel exclaimed: ‘Ah, I knew from the very beginning that there was something wrong with that Jew. Of course, the money was forged!’

Kalecki's conclusion from this was that unfortunately too many people think like the colonel, and very few people understand the story as we do.

References:

M. Kalecki, '‘Ludwik Landau – Economist and Statistician’', in J. Osiatyński , Collected Works of Michał Kalecki Volume VII, Studies in Applied Economics 1940–1967, Miscellanea, (The Clarendon Press, Oxford (1964 [1997])) 325-329.

L. Landau, Wybór Pism, (Państwowe Wydawnictwo Naukowe, Warszawa 1957).

Eileen Appelbaum on the Argentine Technical Default

By Eileen Appelbaum There is no way to construe as fair the United States court ruling that Argentina cannot pay 93 percent of its creditors, unless it first pays a small group of hedge funds. It's not fair to the 93 percent of bondholders who negotiated a restructuring of Argentina’s debt in 2005 and 2010 with reduced payments. What gives Judge Thomas Griesa the right to take them hostage in order to force payment to the "vulture funds" that still demand full payment? It's not fair to the government of Argentina, which cannot pay the vulture funds without facing demands from other creditors to be paid in full, a move which would open the country up to many billions of dollars of claims that it cannot possibly pay. Although the news media reports that Argentina has defaulted to the restructured bondholders, this is not clear. The government did make the latest $539 million payment to these bondholders, but Judge Griesa is not allowing the New York bank that received this money to pay the bondholders. Griesa is defaulting, not Argentina. This is unprecedented and wrong. Read rest here. For all the entries in the NYTimes debate go here, including the entry by Alan Cibils.

*For other NK posts on the situation, see here, here, here, here, here, here, & here.

Per S&P & Bloomberg, Argentina Defaults... So What Now?

From a matter of fact point of view, even though Argentina has made the payments to bondholders, Judge Griesa's decision precludes them (the bondholders) from receiving payment, and so Argentina is technically in default (Argentine Finance Minister, Kicillof called it: "default Griesa. Griefault." This is NOT like in 2002 the result of lack of funds, but direct consequence from a judicial decision backed by the US Supreme Court. From Bloomberg:

Standard & Poor’s declared Argentina in default after the government missed a deadline for paying interest on $13 billion of restructured bonds. The South American country failed to get the $539 million payment to bondholders after a U.S. judge ruled that the money couldn’t be distributed unless a group of hedge funds holding defaulted debt also got paid. Argentina, in default for the second time in 13 years, has about $200 billion in foreign-currency debt, including $30 billion of restructured bonds, according to S&P. Argentina and the hedge funds, led by billionaire Paul Singer’s Elliott Management Corp., failed to reach agreement in talks today in New York, according to the court-appointed mediator in the case, Daniel Pollack. In a press conference after the talks ended, Argentine Economy Minister Axel Kicillof described the group of creditors as “vulture funds” and said the country wouldn’t sign an accord under “extortion.”

Read rest here.

And for recent NK posts on the situation, see here, here, here, here, here, and here.

Mark Weisbrot - The Debt Vultures' Fell Swoop

By Mark Weisbrot

Last week, the United States Supreme Court decided not to review a ruling in the Second Circuit Court of Appeals whose effect is that Argentina must pay “holdout” creditors who refused to participate in debt restructuring agreements that Argentina reached with the majority of bondholders following the 2001 default on its sovereign debt. Argentina’s lawyers warned that the court’s decision created “a serious and imminent risk” that the country would again be forced to default. But the ruling also has profound and disturbing implications for the functioning of the international financial system, and even the United States would most likely be adversely affected. Parties as diverse as the International Monetary Fund and leading religious organizations wanted the Supreme Court to overturn the decision, and briefs supporting this position were filed by the governments of France, Brazil and Mexico, as well as by the Nobel Prize-winning economist Joseph E. Stiglitz. The I.M.F. — which has had mostly sour relations with Argentina since its involvement in that country’s 1998-2002 recession — was also planning to file a brief on Argentina’s side to the Supreme Court, but was blocked by the American government from doing so. This action may have influenced the court’s decision not to hear the case.

Read rest here, and for recent posts on the topic by Matías, see here & here

The Paris Club, Vulture Funds and global debt restructuring

Argentina has finalized a deal with the Paris Club two weeks ago. And tomorrow, if I'm not wrong, the case against the Vulture Funds will be finally decided by the Supreme Court. On the first one, Argentina signed an agreement with the Paris Club that implies the country will pay around US$9.7 billions in the next 5 years.

There is an interesting twist in the agreement with the Paris Club. The agreement was reached without accepting an IMF program, which have traditionally been part of all such negotiations. The Club and the IMF used to be joined at the hip. Two Paris Club chairmen, Jacques de Larosière and Michel Camdessus, became later managing directors of the IMF. So in a sense, the idea was that austerity at home was essential for repayment abroad. Here it is important to note a traditional confusion in the conventional view about the role of austerity.

Note that fiscal austerity can only have an indirect impact on repayment of a debt in foreign currency. You don't need more revenue in pesos (from taxes) to pay interest on foreign denominated bonds, but external revenue from exports, or capital inflows, or accumulated reserves. So austerity helps if it leads to reduced demand for imported goods and services, and more dollars left for repayment.

In all fairness, not having an IMF program is good, but it is NOT a sufficient condition to guarantee that austerity measures will be discarded altogether. I had discussed this before here, but it is far from clear that the Argentinean government will continue to promote a fiscal strategy associated with expansion, which more or less characterized the 2003-2008 boom, and the fast recovery from the 2009 crisis. And while the agreement is also good from the point of view of closing the mess caused by the 2002 default, the problem will not be completely resolved until the Vulture Fund issue is sorted out.

The dangers associated with the Supreme Court's decision are difficult to exaggerate. The Supreme Court may lead Argentina to a new default, not so much because the country can't pay, but because it will not pay (correctly so, in my view). At any rate, worth remembering that creditors have a Club and negotiate from a position of strength, while debtors negotiate one at a time, without the force of collective power. Perhaps the time has come for a Club of Debtors; the Club of Athens might be an appropriate name.

Not even the IMF believes in Reinhart and Rogoff debt limits

From the intro to a new paper by two economists from the research department at the IMF:

"Influential papers such as Reinhart and Rogoff (2010) and Reinhart, Reinhart, and Rogoff (2012) argue that there is a threshold effect: when debt in advanced economies exceeds 90 percent of GDP there is an associated dramatic worsening of growth outcomes. Others dispute the notion that there is such a clear threshold and suggest that it is weak growth that causes high debt rather than high debt that causes weak growth (Panizza and Presbitero, 2012; Herndon, Ash, and Pollin, 2013). Using a new approach we found little evidence that there is any particular debt ratio above which growth falls sharply."

Not that there was much of a debate at this point. 

Dean Baker: Bond Bubbles? Silly Season at the Fed

By Dean Baker

Throughout this [so-called] 'recovery' there have been a number of economists and policy types expressing concern about a “bond bubble.” This is the idea that bonds are overpriced and could take a sudden tumble giving financial markets and the economy the same sort of hits we saw from the collapse of the housing and stock bubbles. This is seriously misguided thinking from any conceivable perspective. At the most basic level the concern is misplaced because there is nowhere near as much money at stake. Former Fed economist Andrew Flowers put the amount of money at stake in the bond market as $40 trillion in a recent FiveThirtyEight column. This compares to a stock market valued at around $28 trillion and housing market at a bit over $20 trillion. While that may make the bond market seem more important, the $40 trillion number is hugely misleading. The $40 trillion figure refers to total debt, much of which is short-term. This is important because short-term debt doesn’t lose much value when interest rates rise. If we restrict our focus to debt that stands to lose substantial value when interest rates rise – remaining duration of five years or more – the volume of debt would be well under $20 trillion.

Read rest here.

Living Paycheck to Paycheck: Nearly 44% of Americans Have Less Than 3 Months' Worth of Savings

 

The 2014 Assets & Opportunity Scorecard finds that liquid asset poverty rates have barely budged. The percentage of households in the US who lack the savings needed to weather a financial storm like a job loss or medical emergency is holding tight at 44%, suggesting that almost half of Americans are on the brink of financial calamity. The Scorecard also found that problems like growing student loan debt and high rates of consumers with sub-prime credit—especially among households of color—are to blame for Americans’ lingering inability to get ahead and build a more secure financial future for themselves and their families.

Highly Educated, Highly Indebted: The Lives of Millenials

From The Atlantc:

What's are today's young adults really like? For those who've spent too much time gazing into the dark recesses of Thought Catalog or obsessing over "Girls," the Department of Education has a new report that offers up some enlightening answers. In the spring of 2002, the government's researchers began tracking a group of roughly 15,000 high school sophomores—most of whom would be roughly age 27 today—with the intention of following them through early adulthood. Like myself, many of those students graduated college in 2008, just in time to grab a front-row seat for the collapse of Lehman Brothers and the economic gore fest that ensued. In 2012, the government’s researchers handed their subjects an enormous survey about their lives in the real world. Here, I've pulled together the most interesting findings.

Read rest here

Detroit, Greece and debt crises

The big news this week is that Detroit filed, or tried to, for bankruptcy. Some have compared the Motor City crisis to the European, and in particular Greek, crisis. And in the essential that is fine. Detroit is, like Greece has become, a sub-unit of a larger entity and does not control monetary policy. But the analogy does not help much in understanding the difficulties in Detroit.

There is an important difference that has always been part of the discussion of the European crisis, and that is that if you are unemployed in Michigan you get Federal unemployment insurance, and a series of other federal funds support the less privileged. Fiscal transfers are relatively large, and certainly larger than intra-European transfers. According to the Tax Foundation in 2011, federal aid corresponded to 36.4% of the Michigan revenues [not the highest, by the way, which was Mississippi with 49%].

So, if it is far from clear that the European crisis [and in my view that includes the Greek crisis] was a fiscal crisis, then there is even less straightforward that the Detroit crisis is a fiscal one. In general debt crises are not fiscal, with the ones in countries for the most part being related to balance of payments problems [which can be aggravated by monetary arrangements, as in the case of the monetary union in Europe, or like Convertibility in Argentina back in 2001/2] or in the case of cities having demographic causes and the changing structure of production [Krugman noted this here, and I dealt with the case of Detroit before here].

In this sense, the deep causes of debt crises are associated to the patterns of productive specialization, which imply that they don't have enough resources to pay for essential imports (countries) and to provide for indispensable social services (cities). The important thing to note is that often there is a political objective that drives the debt crises. In the case of the Latin American debt crises of the 1980s was the push to open up the markets and force the so-called Washington Consensus policies.

In the case of Detroit there might be good reasons to think that austerians want to use the need to cut Detroit's employee pensions as an example for a future cut in benefits and privatization of Social Security. As much as the New York crisis of the mid-1970s was a harbinger of the conservative assault on the New Deal institutions brought by Reagan the Conservative Revolution, the Detroit crisis might signal things to come.

Debt and the deep sources of inequality

In a previous post I noted that economists (particularly mainstream ones, like Brad DeLong) could actually learn quite a bit from anthropologists like David Graeber. One thing that they (anthropologists, not mainstream economists) seem to understand is that debt is a social relation that evolved with the creation of inequality. Debt servitude or slavery being quite old, as a result. As noted by Flannery and Marcus, in their The Creation of Inequality:

"The first step in such a process is to loan food and valuables to impoverished neighbors. The second step is to foreclose on the loan. Families who accept food and shelter from wealthy neighbors are in a poor position to deny the latter’s claims to luxury items and hereditary privileges."

As much as historians (noted here and here before), anthropologists do work with the concept of surplus. For that reason they note that societies in which there is a significant surplus have more opportunities for inequality. The basis of Flannery and Marcus' explanation for the deep causes on inequality are associated to the work of another anthropologist, Irving Goldman, who suggested three causes for inequality, namely: a religious life force associated to a leader, a particular kind of expertise, and physical and military prowess. Often a combination of three were necessary.

So you can think of early agricultural societies as ones in which certain social groups were capable of extracting surplus from other groups, as a result of their technical expertise, and a combination of religious and military power. And as much as societies have changed throughout the millennia, it is still essentially true that it is the ability of one group to extract surplus from another that determines income distribution.

Mechanisms have changed, so weakening trade unions, maintaining higher average unemployment through macroeconomic policies, using trade and tax policies to weaken labor and strengthening corporations and so on are a few of the instruments used now to create inequality. And yes, debt still is a way of subjugating particular classes and countries.

PS: By the way, Flannery and Marcus say that: "the worst inequality results not from the granting of new privileges to the people on top but from the removal of existing privileges from the people on the bottom." And this is based on historical and archeological records, not the current right-wing strategy of eliminating the protections of the Welfare State.

More on David Graeber’s Debt

Indebted? No problem we have a (minimum wage) job!

David (Fields) posted a link to Geoff Ingham’s review of Graeber’s book. Graeber is an anthropologist, recently hired by the London School of Economics, and that has often been associated with the Occupy Wall Street movement. Note that several mainstream economists have posted recently on the topic, and have been, as is often the case, barking at the wrong tree. Two mainstream takes on Graeber that are typical are from Noah Smith and Brad DeLong.

Noah wrote a post, a while ago, on David Graeber's views on debt. According to him Graeber is "a sort-of-leftish guy with a tendency to fight with other people on the left." Noah would be, by the same token, a sort of neoclassical-liberalish (in the American sense of progressive) economist fighting other people within neoclassical economics. And here lies the problem, because mainstream (neoclassical) notions about debt are really problematic, and there is quite a bit that could be learned by the profession from anthropologists like Graeber (or sociologists like Ingham; see for example this book).

Noah's complaint seems to be that David is confusing or confused or both. In his words: “his [Graber’s] pronouncements on the subject are vague or seemingly contradictory on all of the questions listed above.” In all fairness, Debt is a very long book, which deals both with one might call a Chartalist view of money, and (in my reading) a vaguely Marxist (certainly non-neoclassical) view of the functioning of the economy, but discussing the evolution of debt and economic development more or less since the beginning of Civilization.

But the basics are not difficult to get. Money does not appear as the efficient mechanism to reduce transaction costs (avoid the double coincidence of wants) in barter economies, but is the result of certain social groups ability in imposing a unit of account. As Keynes put it in his Treatise on Money: “money-of-account, namely that in which debts and price and general purchasing power are expressed is the primary concept of a theory of money.” And what is behind money of account is the power to determine what is the unit to be used, or as Keynes says, the power “to enforce the dictionary but also to write the dictionary.” Further, the classical political economy (and Marxist) approach, is not about market efficiency (not even for Adam Smith by the way, but that’s for another post) of individuals making uncoordinated decisions, but about capital accumulation in particular historical conditions, which involve class relations.

So debt is not bad per se, or good (Noah thinks that David’s point is that debt is bad, or something, as he says). Debt is an instrument that can be used by a social group to extract surplus from other social groups, from the elites in early civilizations that could command work from peasants and determine the means by which they were going to be compensated for their work, to countries that need to pay their debts in a foreign currency (normally dollars, which became the dominant currency after the victory in World War-II). Debt is then a way to force social groups and countries into situations of dependency (Noah himself is probably still paying student loans, with interests that he does not control, since he was told this is the respectable path to a happy life; yes he had a choice, but what are the choices for middle class kids with no money for college? Working for Taco Bell?).

Mind you, not all debt is bad. For example, the increase in debt to pay for unemployment insurance during this crisis is good, and in fact, too small to do any good (yes we need more spending and more debt). But not the kind of private, unsustainable debt that shackles workers to badly paid, unrewarding jobs, or that forces countries into economic arrangements that are contrary to their national interests (it was the debt crisis of the 1980s that forced most Latin American countries to accept the Washington Consensus policies).

Brad's complaint is more complicated to describe, and he is angrier it seems, but it appears to be associated to the fact that he believes David is not open to criticism, while his book contains too many factual mistakes. And yes there are some controversial points in David’s book, unavoidable in a book that is this ambitious and inter-disciplinary on top, including in chapter 12 (not sure why Brad was specially picky with that chapter). I do have also some disagreements on minor issues, but overall the framework of analysis seems to correctly point out the relevant social conflicts that arise from debtor/creditor relations, which have been absent in the mainstream analysis. At any rate, my two cents on the issue.

PS: The idea of Chartal or Cartal money is defended by 'serious' mainstream authors, and central bankers like Charles Goodhart, by the way (here). Not that it makes it more relevant. Authority has (or should have) little relevance when it comes to scientific evidence.

O sacred hunger of pernicious gold! What bands of faith can impious lucre hold?

Sociologist Geoffrey Ingham has written a review of David Graeber's Debt: The First 5,000 Years, which can be viewed here (subscription required). According to Ingham, while Graeber's monumental inquiry is much to be admired, there is quite a bit of room for critical refutation, specifically with respect to the exact nature of money, and its essence as a moral base for economic life.