Thursday, May 3, 2012

The Global Debt Crisis, I: What is the Problem?

The world is awash in debt — credit extended for which there is no reasonable hope of repayment. Gross government debt as a share of GDP is uncomfortably (read "terrifyingly") over 100% for Greece and Italy. It is galloping toward that percentage for France, Germany and the United States. Governments are falling all over Europe as outraged government employees and public pensioners riot to protest cuts in spending. Spain's debt crisis is (in the words of one report from a socialist) "pushing [the] global economy to the brink." There are "renewed fears" of a European debt crisis. The global economy seems ready to implode.

According to conventional Keynesian thinking, none of this should be happening. In conformity with the principles of Georg Knapp's "chartalism" (more widely known today under the euphemistic label, "Modern Monetary Theory"), the State should be able to emit all the money (bills of credit) it needs without any problem. More money in circulation means more money for investment, more effective demand to stimulate that investment, more education that will foster creativity and growth, and so on, so forth.

Theoretical support for a large public debt is rooted in the fixed belief that an expanding debt is essential for prosperity. That being the case, the larger the debt is, the better off we are. As Dr. Harold G. Moulton analyzed this Keynesian doctrine in his short book, The New Philosophy of Public Debt (1943), the perceived necessity for a large public debt is due to three factors:

• The Mature Economy Thesis,

• The Phenomenon of "Excess Savings," and

• Corporate Independence of the Capital Markets.

The Mature Economy Thesis
In response to the decline in the rate of population growth during the Great Depression of the 1930s, Keynesian economists believed that there would be insufficient demand to keep the economy going. There would simply be not enough people to consume all that the economy was capable of producing. As Moulton summarized this argument,

"The argument that the United States has recently reached economic maturity and that in consequence further growth (under private capitalism) must be very slow starts with an assumption — namely that economic progress is primarily dependent on rapid growth in population and the opening of new productive areas. Conversely, it is held that a declining rate of population growth and the disappearance of frontiers will check economic growth." (Harold G. Moulton, The New Philosophy of Public Debt. Washington, DC: The Brookings Institution, 1943, 21-22.)

The Phenomenon of "Excess Savings"

In The Formation of Capital (1935), Moulton analyzed the "economic dilemma." That is, assuming that the only way to finance new capital formation is to cut consumption and accumulate cash, there is no justification for new capital investment.

No rational investor will purchase new capital if there is no existing or reasonably anticipated increase in effective demand to justify additional marketable goods and services. If savings increase, in fact, even existing capital becomes redundant as consumption declines. The "dilemma" an investor faces, then, is that if consumption is reduced to finance new capital formation, there is no reason to finance new capital formation.

Increasing public debt allegedly solves this problem. As Moulton explained,

"The phenomenon of money savings in excess of investment outlets is related in one way to the mature economy conception. If, because of the disappearance of frontiers and an arrested rate of population growth, further private capital expansion were impossible, then obviously we would have no private investment outlets for the current money savings of the people. But independently of a mature economy, it might still be possible that the volume of current money savings had become greater than could be absorbed in productive capital investment. It is contended that the evidence supports the thesis that henceforth money savings are always likely to exceed productive outlets in private enterprise; hence public flotations must fill the breach." (The New Philosophy of Public Debt, op. cit., 30.)

Corporate Independence of Capital Markets

The experts continually remind us how important Wall Street is for the allocation of credit. Wall Street, however, is supposed to be the private sector. The Federal Reserve seems to be in the business of handling government debt, although that was not the original intention. This is endemic throughout the world, as central banks have shifted away from private sector financing and gotten into financing government.

The Keynesian argument during the Great Depression, however, was that, because business corporations presumably had no need of raising funds in the financial markets, there were insufficient new issues to absorb people's savings. At the same time, business corporations simply weren't financing new capital. As Moulton explained,

"The investigations of the Temporary National Economic Committee endeavored to show that in recent times business corporations have largely freed themselves from the necessity of raising funds in the financial markets, the bulk of the investment funds required now being obtained from their own internal resources. Accordingly, even if private business enterprise were reasonably thriving, it would still be necessary for the government to provide outlets for current money savings of the people through continuing flotations of government bonds. This conclusion has been widely accepted in government circles." (Ibid., 35.)

Despite these theories, the crisis continues to mount, yet at the same time demands become more strident to increase the level of government spending to stimulate economic recovery. Even the socialists and laissez faire capitalists are in agreement on this one. As one capitalist source put it, "[T]he IMF says that the United States and Japan have no plan to ever stem their deficits and record borrowing, creating 'latent risks include disruption in global bond and currency markets as a result of high budget deficits and debt in Japan and the United States'." ("Global Government Debt Crisis Emerging" New American)

When the John Birch Society and the Socialist Party can agree on condemning something, somebody ought to be reconsidering just how well the program is working.

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