October 17, 2016
Yes, what else is new? Today’s column highlights the growth in debt-to-GDP ratios in both the public and private sectors in the last decade. There are three points worth making on this issue.
The first one is that Samuelson’s concern, as noted in the headline, is that the growth of debt will leave us open to another financial crisis. The problem here is that it goes along with the myth that the financial crisis was something that sneaked up on us that no one could detect. In fact, the financial crisis, was a crisis because a bubble was moving the real economy. The housing bubble was driving well over $1 trillion in demand through its impact on residential construction (which was a record high as a share of GDP) and consumption, as people spent based on bubble generated housing equity.
The surge in both areas was easy to see for anyone who looks at the data. It was an astounding failure of policy makers (think Alan Greenspan and the Fed) that they somehow either didn’t see the bubble or didn’t realize the importance of its collapse to the economy.
This matters because it is wrong to imagine that a potential economy wrecking bubble can grow without any sentient beings seeing it. The policymakers and economists who totally missed the housing bubble have a stake in pretending that it was all very difficult, but their story is not true. It was simple, they just chose not to look at the data and think for themselves.
The second point, which we have been through before, is that the ratio of government debt to GDP means almost nothing. The ratio of debt service payments to GDP does mean something (Samuelson quotes economist William Cline making this point). However, the ratio of interest payments to GDP is near a post-war low at 0.8 percent of GDP. This compares to more than 3.0 percent of GDP in the early and mid-1990s.
Furthermore, if interest rates rose (the deficit scolds horror story) we can buy back long-term bonds at serious discounts, reducing our debt-to-GDP ratio at zero cost. This exercise would be utterly pointless, but it should humor the people concerned about debt-to-GDP ratios.
We should also insist on some honesty in these discussions. Formal debt is just one way in which the government makes commitments for taxpayers in the future. Grants of patent and copyright monopolies also commit taxpayers to make large payments compared to free market prices. These are effectively taxes that the government allows corporations to collect in exchange for doing innovation or creative work. This sum comes to close to $400 billion a year (@ 2 percent of GDP or 10 percent of government revenue) in the case of prescription drugs alone.
Finally, Samuelson is correct to note there has been a large rise in private, primarily corporate, debt around the world, although mostly not in the United States. There are two points to note on this issue.
First, it is now very cheap for corporations to borrow in most countries. In this context, it is not surprising that they would choose to borrow a great deal. Again, if we focus on debt service, payments are likely not to be very large in most cases, although there are undoubtedly exceptions.
The other point is that debt can often be fairly easily eliminated by exchanging it for equity. Suppose GE has $20 billion in debt. If it decides that its debt burden is too high, it can issue more shares of stock and buy back some of its debt. The debt is now gone and Robert Samuelson is happy. Not every company can just issue shares like GE, but even for companies in relatively weak financial condition it will typically be possible to replace debt with equity. The United States does this very well, in other countries the process can be more difficult.
Anyhow, the long and short is that debt can be a problem in cases where it is pushing unsustainable growth patterns. This is likely the case with housing in China and almost certainly was the case with the growth of manufacturing there. But debt by itself is not necessarily a cause for concern.
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