Credit, Debt, Government, And Krugman

If there is one economist, that is, an individual who has earned a PhD in Economics, who is excessively stupid in my estimation, that individual is none other that Paul Krugman, winner of the Nobel Prize in Economics because he more or less stated the obvious.  For that they gave a prize.  And all this time I thought it was because he created the consumer confidence fairy carrying a cat in its arms and giving hope to people with his magic wand.  He has been one of the loudest cheerleaders for increasing government debt which, by his reasoning, will cure all ills in the economy.  Well, he was trained in the methods of Keynes and not Mises, so we should expect such nonsense.  He recently wrote:

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.[emphasis added]

The major problem with economic theory is that the keynesian school of thought wealth magically appears out of nowhere.  If one makes a bunch of stuff others will always buy it.  By that reasoning the Ford Edsel should have been a winner, outselling the competition.  History shows that after all the focus groups and marketing research what the public said it wanted was different from what they would buy.  That, by the way, was during the heyday of Ford’s whiz kids led by Robert Mcnamara, future Secretary of Defense under Kennedy and Johnson.

Main stream economic thinking has not grasped the basic idea that economies are closed systems.  But we tend to mistake the idea that our economy in America is linked to the economies of the world and that we are, to some degree, interdependent upon each other.  We never factor in all the costs.  If a country was completely self sufficient to the point that it needed no imports nor exports, then it would serve as the ideal model of an economy.  So consider that perfect model for a moment.  How might it operate?  It may have a centrally planned economy which might work.  And everyone could be an employee of the state, including children.  The children would be paid to simply be children and go to school.  So everyone has a job and has an income.  Of course if the economy is centrally planned, then there is no need for money.  All necessities would be provided.  If one has all the plain toothpaste and a chicken in the pot, what more do you need?  Transportation would be by public conveyance.  All farming could be done with machines and whatever fertilizer that was needed.  All the central planners need to know is how much of each item to make.  They could take a basic census the first year and then rely on the birth and death records to keep the census current.  Each year the individuals could fill out their necessities requests so that production could be planned and output properly distributed.  By this way the central planners can anticipate increased demand through an increase population.  Unless, of course, the population is only replacing itself and not increasing.  Economic growth comes from an increase in demand that means more consumers since all economies are consumer led.  It all sounds easy.  But this would be a subsistence style life.  You’ll never be fired, you won’t have to work hard, there is no need to learn much about the world, perfect boredom.  But then the funny things start to happen, human nature being what it is.  You dull little hovel needs to be brighten up, so what do you do?  Perhaps you find a way to use the common pigments in the ground to create a thin paint and thus paint your hovel, inside and out.  Now you are the envy of friends and neighbors.  Now they want to paint their houses.  So you pass along your idea and methods to the central planners who take note and quickly execute yo for causing dissatisfaction in the populace.  One, it wasn’t their idea and two it is more work for them.  A paint factory must be build and the processes approved with the few colors that will be provided.  But the problem is, as they correctly foretold, people won’t want just the basic colors but custom colors and means they can’t control that process.  Individuals who possess a sense of color will find part time work mixing custom paint color.  But there is no money, no currency to use as a medium of exchange.  Ah, the introduction of credit and debt.  I mix the color and you owe me something.  We will need a bartering system to make all this work.

So we introduce the idea of credit or debt.  Credit is what is extended, debt is what is taken when credit is extended.  On my credit cards, since I have been a good customer and have a high credit rating, which means I pay my bills on time, including my credit card charges, I am now empowered to borrow as much as $25,000 on one card.  I have that much credit or possible debt power.  If I borrow $25,000 then I am in debt for that much money and no longer have any usable credit.  That is a simple transaction.  I have my yearly income and could cash my checks and take the cash, but why bother when we have an electronic system.  If I spend no more than I receive in income then I am at a breakeven point in the economy.  If I withhold some of my income then the economy does not receive as much as it had before.  So let’s say that I save a thousand dollars a year, easy enough to do if you keep your expenses down.  And suppose there are ten million others like myself who save a thousand dollars a year.  That is a billion dollars ever year that is not consumed in the economy.  On the other hand, that saving represents capital, and capital can be used to provide the means of increasing production.  In this way I and ten million others are creating credit based on real funds, a one to one dollar relationship.  I am lending a dollar and you are borrowing a dollar.  Now we have not created any more money in the money supply.  But suppose I leverage that money.  I have a bank and I lend you one thousand dollars.  You now deposit that thousand into your account at my bank and I proceed, based on the theory that you will never use more than 10 percent our your account at one time and that I have a great number of accounts from which I can make money available, I now lend 90% or $900 dollars to another person.  And suppose that I do the same again with their nine hundred dollars.  Now I am leveraging that original amount some tens times.  Well, you do the math.  I have now increase in an artificial way the money supply.  By doing this I create inflation because more consumption will occur.  Unfortunately inflation is a nasty tax on the poor, the rich never notice it.  If Bill Gates $100 cigar goes up ten dollars do you think he cares or switches to a cheaper brand?

Now let us take the case of government, and yes, we have to.  Government does not manufacture anything but hot air.  Yes, it does provide a few necessary services such as national defence and a judicial system that answers questions of tort and criminal behavior.  It is not really needed to provide educational services as long as there are libraries and individuals willing to teach their children.  Schools use to be controlled by the local residents, that is no longer the case.  Yes, it does provide old age benefits but the individuals should have been saving for their retirement.  Yes, there are some group insurance plans but those could have been met by private corporations.  In reality, if one measures what government provides versus what we only need from them, it is a very wasteful spender of our tax dollars.  Like savings, tax dollars are withdrawn from the economy.  And yes, they are spent in the economy.  But the consumption effect is different.  Not too many taxpayers can afford to buy their own billion dollar tank or fighter aircraft.  So this tax money is taken away from the normal consumer spending.  Yes, it does come bank in terms of military contracts for defense items and for social services, but these are largely unproductive measure in an economy.  Unfortunately when the government increases its spending and exceeds the taxes collected, then it must issue instruments of debt.  Everyone honors the government’s credit card and no one writes nasty letters threatening collect.  Where does this extra money come from and why does it matter?  It comes from those people who save their money, who in effect create capital.  Perhaps I would rather lend the money at a decent rate of return that is lower than I could get from a corporation because I want the safety of an assured repayment of my principle.  Thus government debt crowds out the credit market, that one that allows the allocation of capital for productive purposes  It is true as Mr Krugman asserts that our federal government has not paid off the debts incurred it fighting World War Two, or the Korean War, the Vietnam War, the NASA programs, the war of poverty, the war on drugs, the Iraq War, or any other wars, military actions, military assistance, economic assistance, social security…..well, you get the picture.  Our tax money and future tax money, because it is through future taxes that we will keep paying for all that our government spends now and in the future until it can’t.  But the MMT people say that a government can’t run out of money.  What happened to Argentina and Venezuela?  Doesn’t their government own printing pressed with which to print more money?

Well, if you recall one or tow of my past articles I go through the problems of currency and how, when it is a fiat currency it is the belief that it has worth and when fewer people believe that it has worth then it becomes less acceptable as a medium of transaction.  But surely that can’t happen to America?  Yes, those are the famous last words, aren’t they, “It can’t happen here.”  As long as we have PhDs who don’t understand the system they are paid to teach and are given honors for greatly misunderstanding that system it will happen here.  The problems is very simple.  Credit given will spend like money, so when you extend credit you are making more money available to individuals, corporations, and governments.  Once credit is spent it becomes debt and debt matters.  It matters because it is a claim on future earning, future income.  And debt has a bad habit among some of becoming unrepayable, and that includes governments.  What did you think the problems of Greece were about?  As that government tries to extract taxes from corporations and individuals while cutting transfers of wealth payments it reduces the money that circulates in the economy and reduced consumption.  So government spending is down, private spending is reduced, tax collections are reduced and the ability to repay government debt is reduced to the point of default.  It Greece weren’t part of the European Monetary Union it could always print more Drachmas and hope the creditors would accept them.  But their debt is repayable only in Euros and Drachmas would, at any rate (pun intended) has to be exchanged for what other countries and individuals thought they were worth.  Yes, the MMT people say I haven’t done the math.  But I have done the math and 2 + 2 does not equal 5 or 6 or 8 or 2,319,726.  There is no money tree in the government’s back yard.  Debt has consequences, for it must be serviced and that takes income.  Ask the Japanese what would happen if they had to borrow government funding at one or two percent.  The government would fall, the economy crash.  Why?  Because they already spend 25% of their tax revenue of debt service or interest payments.  And most of their government bonds are held in the country.  Raise the rates for all future bonds, for they must continue to roll over their existing debt, and that debt service will consume every last tax dollar, there will be no money to run the government.  Failure to pay that service constitutes a default and no one will lend them a single yen.  That’s why debt matters.  It can destroy a nation.  Louis the XVI lost his head because he had bankrupted France, a process that had been going on since Louis the X.

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