A trifling debt makes a man your debtor; a large one makes him an enemy.
-Seneca the Younger
Yesterday, the, dare I say, always-worth-reading Paul Krugman wrote on the on the hazards of deliberating in “Nobody Understands Debt”: “Why is deleveraging a problem? Because my spending is your income, and your spending is my income, so if everyone slashes spending at the same time, incomes go down around the world.” Mr. Krugman provides the orthodox Keynesian diagnosis of deleveraging in terms of aggregate demand and it doing so reveals the flaws of the aggregate-demand approach: It ignores the ecological qualities of the markets.
To really understand whether people’s spending reflects the wealth of the nation, we have to understand the context in which people are trucking, bartering and exchanging. The economy is a coordination problem where profits are to be had by bringing people’s future plans into greater coordination with each other. Wealth, in turn, is fit order that correctly anticipates people’s future appetites and is thereby coordinated with them.
Any process of deleveraging therefore needs to be understood in a coordination perspective. Such a process, however painful, can be necessary if there is widespread mal-coordination within the economy. In a 2010 study, “Debt and Deleveraging: The global credit bubble and its economic consequences,” the authors, Roxburg et al., addressed such mistaken activity when it wrote about how the level of debt in most mature countries aggressively expanded after 2000 due to “unusually low interest rates and risk spreads…” (Roxburgh et al. 2010: 10). Later in the study, Roxburgh et al. specifically point to the leverage of households as being an economic problem post-2008:
Taking a more granular view of leverage within sectors of the economy, we find that households increased their borrowing substantially, particularly through home mortgages. Rising housing prices meant that the ratio of household debt to assets appeared stable in the years prior to the crisis. But household debt compared with disposable income increased significantly, which should have raised a red flag long before the crisis. (Ibid)
Leverage just isn’t a data point; rather, it’s the manifestation of economic life. Whether it’s a manifestation that adequately corresponds with the demands of life is another matter. The markets can and do lead to situations where the patterns of specialization and trade that have hitherto evolved are, for one reason for another, unsuited to the demands of life. Roxburgh et al. write of a credit bubble that led to households holding an unsustainable level of debt, compared to their income, once economic reality reasserted itself.
Mr. Krugman is correct in asserting that debt per se is nothing, “it does not directly make the economy poorer (and paying it off doesn’t make us richer)” What makes us poorer or richer is how our economic life, the patterns of specialization and The moment that people realize the departure of the two is, like most sudden revelations, a moment of crisis—the crash of the housing market was certainly devastating for those who had based their economic life on it.
Once such bubbles have burst, spending needs to go down so that people can figure out the most profitable ways of doing business with one another. Deleveraging can be a necessary part of that natural process. The way forward isn’t to deny that people borrowed too much, it’s to accept that people have to adapt themselves to the demands of economic life and deleveraging, as described by Roxburgh et al., can be a necessary part of that process. Economic life, after all, is a coordination problem. Even if that coordination problem may be somewhat of a mass hallucination, it is still a mass hallucination that people have to adapt to if they desire to flourishing.
Insofar as deleveraging reflects the aftermath of the extinction of unprofitable patterns of specialization and trade, it reflects an event that enhances the wealth of the nation by bringing people’s economic decisions into better coordination with one another. It is bad when it doesn’t it doesn’t enhance that coordination, which can be the case when there are monetary disturbances—but that’s a topic for another day. The connections created between people through business are complex and ecological, not simple and hydraulic.
Mr. Krugman’s repetition of the tired line that “We owe debt to ourselves” encapsulates the latter perspective. People don’t owe money to themselves; rather, different people in their own distinct stations of life owe money to different people. There’s a politically pertinent reason for not wanting to look at loans in such simplistic terms: The adage that he who holds the purse holds the power is all too true.
The fall of Prime Minister Silvio Berlusconi’s government in Italy following pressure from the bond markets on his government’s finances in 2011 and the rise of Mario Monti’s government of unelected technocrats, just a week after Monti had been appointed a senator for life by President Giorgio Napolitano, should be a lesson in the power of the bond markets as a faction. A modern government cannot operate without access to well-functioning bond markets, which means that bond-holders are a potential faction that can override an otherwise democratic government’s wishes. As long as people have different appetites and different ways of life, then the slogan “We owe it to ourselves” is a delusion. There is no ‘us.’ There’s only a heterogenous population of different people all with their own ends in life, and only a fool bets that people will be publicly spirited when crisis is around the corner.