The debt dilemma

11 May by Michael Roberts


(CC - Pixabay : Tumisu)

I have mentioned many times on this blog that rising global debt reduces the ability of capitalist economies to avoid slumps and find quick way to recover (and see ‘Debt Matters’ in my book, The Long Depression and also in World in Crisis).

As Marx explained, credit is a necessary component in oiling the wheels of capitalist accumulation, by making it possible for investment in longer and larger projects to be financed when recycled profits are not sufficient; and in more efficiently circulating capital for investment and production. But credit becomes debt and, while it can help expand capital accumulation, if profits do not materialise sufficiently to service that debt (ie pay it back with interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. to the lenders), the debt becomes a burden that eats into the profits and ability of capital to expand.

Moreover, two other things happen. In order to meet the obligations of existing debt, weaker companies are forced into borrowing more to cover debt servicing, and so debt spirals upwards. Also, the return over risk on lending for creditors can now appear to be higher than investing in productive capital, especially if the borrower is the government, a much safer debtor. So speculation in financial assets in the form of bonds and other debt instruments increases. But if there is a crisis in production and investment, perhaps partly caused by excessive debt servicing costs, then the ability of capitalist corporations to recover and start a new boom is weakened because of the debt burden.

In the current coronacrisis, the slump is accompanied by high global debt, both public, corporate and household. The Institute of International Finance, a trade body, estimates that global debt, both public and private, topped $255tn at the end of 2019. That is $87tn higher than at the onset of the 2008 crisis and it is undoubtedly going to be very much higher as a result of the pandemic. As Robert Armstrong of the FT put it: “the pandemic poses especially big economic hazards to companies with highly leveraged balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheets, a group that now includes much of the corporate world. Yet the only viable short-term solution is to borrow more, to survive until the crisis passes. The result: companies will hit the next crisis with even more precarious debt piles.”

As Armstrong points out, “in the US, non-financial corporate debt was about $10tn at the start of the crisis. At 47 per cent of gross domestic product GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
, it has never been greater. Under normal conditions this would not be a problem, because record-low interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
have made debt easier to bear. Corporate bosses, by levering up, have only followed the incentives presented to them. Debt is cheap and tax deductible so using more of it boosts earnings. But in a crisis, whatever its price, debt turns radioactive. As revenues plummet, interest payments loom large. Debt maturities become mortal threats. The chance of contagious defaults rises, and the system creaks.”

He goes on,“this is happening now and, as they always do, companies are reaching for more debt to stay afloat. US companies sold $32bn in junk-rated debt in April, the biggest month in three years.” Armstrong is at a loss to know what to do. “Containing corporate debt by regulating lenders is also unlikely to work. After the financial crisis, bank capital requirements were made stiffer. The leverage Leverage This is the ratio between funds borrowed for investment and the personal funds or equity that backs them up. A company may have borrowed much more than its capitalized value, in which case it is said to be ’highly leveraged’. The more highly a company is leveraged, the higher the risk associated with lending to the company; but higher also are the possible profits that it may realise as compared with its own value. merely slithered off of bank balance sheets and re-emerged in the shadow banking system. A more promising step would be to end the tax deductibility of interest. Privileging one set of capital providers (lenders) over another (shareholders) never made sense and it encourages debt.”

Martin Wolf, the FT’s economics guru, reckons he has an answer. You see, the problem is that there is too much saving in the world and not enough spending. And this ‘savings glut’ means that debtors can borrow at very low interest rates in a never-ending spiral upwards. Wolf bases his analysis on the work of mainstream economists, Atif Mian and Amir Sufi. Mian and Sufi wrote a book a few years ago entitled House of Debt, which I reviewed at the time. It was considered by Keynesian guru, Larry Summers as “the best book this century”!

For the authors, debt is the main problem of capitalist economies, so all we have to do is sort it. What is odd about their argument is that, while they recognise that public sector debt was not the cause of the Great Recession as neoliberal austerity economists try to claim, they put the blame for the Great Recession not on corporate debt nor on financial panic, but on rising household debt. They claim that “both the Great Recession and Great Depression were preceded by a large run-up in household debt… And these depressions both started with a large drop in household spending.” Mian and Sufi show with a range of empirical studies that the bigger the debt rises in an economy, the harder the fall in consumer spending in the slump. But they fail to note that it is a fall in business investment that presages crises in capitalist production, not a fall in household spending. I and others have provided much empirical evidence on this.

In their original book, Mian and Sufi do not address the reason for the inexorable rise in debt, corporate and household, from the early 1980s onwards. Now in new studies, cited by Martin Wolf, Mian and Sufi offer a reason. The spiral of (household) debt was caused by the rich getting richer and saving more, while the bottom of the income ladder got less and so saved less. The rich did not invest their extra riches in productive investment but hoarded it, or put it into financial speculation, or lent it back to the poor through mortgages. So household debt spiralled because a “savings glut” of the rich.

The rich got richer and saved more, while investment in productive assets slipped away.

So the ‘savings glut’ of the rich is the cause of the low investment and productivity growth of major capitalist economies.

Mian and Sufi argue in their second paper that because poorer households borrowed more, forced by low incomes and encouraged by low interest rates made possible by the savings glut of the rich, household debt spiralled to the point that it reduced ‘aggregate demand’ and slowed down economic growth in a form of ‘secular stagnation’. This theory of ‘indebted demand’ is when “demand is sufficiently indebted, the economy gets stuck in a debt-driven liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. trap, or debt trap”. This is how much debt servicing would have cost if interest rates had not dropped after the 1980s.

Wolf cites another version of the same argument that too much debt is caused by too much saving and is the cause of crises in capitalism. This comes from the post-Keynesian Minsky school. David Levy, head of the Jerome Levy Forecasting Center argues in a paper, Bubble or Nothing, that “aggregate debt grew faster than aggregate income” so “making financial activity increasingly hazardous and compelling riskier behavior.” Levy sees the risk not in the size of the debt so much as its increasing fragility, as Minsky argued.

Unlike Mian and Sufi however, Levy correctly points to the importance of rising corporate debt, not household debt. The nonfinancial corporate sector’s debt-to-gross-value-added ratio is near a new all-time high.

“Moreover, if one excludes the largest 5% of listed corporations, the corporate leverage picture is more extreme and worrisome (chart 45). One indication of the risk associated with this increased corporate leverage is the profound rise in the proportion of companies with ratings just above junk levels in the past 10 years.”

Again Levy shows that “since the mid-1980s, the U.S. economy has been swept up in a series of increasingly balance-sheet-dominated cycles, each cycle involving to some degree reckless borrowing and asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). speculation leading to financial crisis, deflationary pressures, and prolonged economic weakness.” In other words, rather than invest in productive assets, corporations switched to mergers and financial speculation so that much of their profits increasingly came from capital gains rather than profits from production.

Profitability relative to the stock market value of companies fell sharply – or more precisely, the stock market value of companies rocketed compared with annual earnings from production.

Levy concludes that “without balance sheet expansion (ie buying financial assets), it is exceedingly difficult to achieve the profits necessary for the economy to function. Moreover, once those profits are achieved, it is also exceedingly difficult to stop households and businesses from responding by borrowing and investing, thus reaccelerating balance sheet expansion and defeating the entire purpose. Bubble or nothing.”

What do we really learn from all this? Mian and Sufi emphasise rising inequality from the 1980s, a shift in income from the poorer to the top 1%, leading to a rise in household debt and a savings glut. But they do not explain why there was rising inequality from the early 1980s and they ignore the rise in corporate debt which is surely more relevant to capital accumulation and the capitalist economy. Household debt rose because of mortgage Mortgage A loan made against property collateral. There are two sorts of mortgages:
1) the most common form where the property that the loan is used to purchase is used as the collateral;
2) a broader use of property to guarantee any loan: it is sufficient that the borrower possesses and engages the property as collateral.
lending at cheaper rates, but in my view that was the result of the change in nature of capitalist accumulation from the 1980s, not the cause.

And actually Mian and Sufi hint at this. They note that the rise in inequality from the early 1980s “reflected shifts in technology and globalization that began in the 1980s.” Exactly. What happened in the early 1980s? The profitability of productive capital had reached a new low in most major capitalist economies (the evidence for this overwhelming – see World in Crisis).

The deep slump of 1980-2 decimated manufacturing sectors in the global north and weakened labour unions for a generation. The basis was set for so-called neoliberal policies to try and raise the profitability of capital through a rise in the rate of exploitation. And it was the basis for a switch of capital out of productive sectors in the ‘global north’ to the ‘global south’ and into the fictitious capital of the financial sector. Ploughing profits and borrowed money into bonds and equities drove down interest rates and drove up capital gains and stock prices. Companies launched a never-ending programme of buying back their own shares to boost stock prices and borrowing to do so.

But this did not reduce ‘aggregate demand’; on the contrary, household consumption rose to new highs. What ended this speculative credit boom was the turning down in the profitability of capital from the end of the 1990s, leading to the mild ‘hi-tech’ bubble burst of 2001 and eventually to the financial crash and Great Recession of 2008. A ‘savings glut’ is really one side of an ‘investment dearth’. Low profitability in productive assets became a debt-fuelled speculative bubble Speculative bubble An economic, financial or speculative bubble is formed when the level of trading-prices on a market (financial assets market, currency-exchange market, property market, raw materials market, etc.) settles well above the intrinsic (or fundamental) financial value of the goods or assets being exchanged. In such a situation, prices diverge from the usual economic valuation under the influence of buyers’ beliefs. in fictitious assets. Crises are not the result of an ‘indebted demand’ deficit; but are caused by a profitability deficit.

But how does capitalism get out of this debt trap? This is the debt dilemma.

Wolf and Mian and Sufi reckon that it is through the redistribution of income. Wolf cites Marriner Eccles, head of the US Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/
in the Great Depression of the 1930s. In 1933, Eccles told Congress, “It is for the interests of the well to do . . . that we should take from them a sufficient amount of their surplus to enable consumers to consume and business to operate at a profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. .” So you see, it is in the interests of the rich to let the government take some of their money to help the poor to boost consumption.

Mian and Sufi say: “Escaping a debt trap requires consideration of less standard macroeconomic policies, such as those focused on redistribution or those reducing the structural sources of high inequality.” So we need to reduce the high inequality by addressing “structural sources”. In my view, that means addressing structural features like the rising concentration and centralisation of the means of production and finance, not just a rising inequality of income.

Indeed, Wolf appears to take a more radical view: “we have a huge opportunity now to replace government lending to companies in the Covid-19 crisis with equity Equity The capital put into an enterprise by the shareholders. Not to be confused with ’hard capital’ or ’unsecured debt’. purchases. Indeed, at current ultra-low interest rates, governments could create instantaneous sovereign wealth funds very cheap!” So the state should intervene and buy up the shares of those companies with large debts that they cannot service. But in effect, this would mean governments buying weak companies that are already ‘zombies’, while the powerful and profitable corporations remain untouched. This is government aiming to save capitalism, not replace it. Here Wolf follows closely the line of the FT itself that “Free markets must be protected through the pandemic, with sensible and targeted state intervention that can help capitalism to thrive post-crisis.”

In contrast, Levy is pessimistic that there is any solution that avoids slumps: “there is neither a realistic set of federal policies to painlessly solve the Big Balance Sheet Economy dilemma nor even a blueprint of what the optimal policies should be.” Marx would agree that the only way out of this slump is through the slump. Former IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
chief, the (infamous) Dominic Strauss Kahn reckons that the strategists of capital must just allow the liquidation of the zombies and unemployment to rise because then “the economic crisis, by destroying capital, can provide a way out. The investment opportunities created by the collapse of part of the production apparatus, like the effect on prices of support measures, can revive the process of creative destruction described by Schumpeter.”

To end the spiral of debt and fictitious capital will require much more than taxing the rich more or buying up weaker companies with government debt Government debt The total outstanding debt of the State, local authorities, publicly owned companies and organs of social security. . As Wolf says: “We will have to adopt more radical alternatives. A crisis is a superb a time to change course. Let us start right now.” Of course, he means to save capitalism, not replace it.




Michael Roberts

has worked in the City of London for over 30 years as an economist. He is author of several books on the world economy: The Great Recession, The Long Depression and World in Crisis. He blogs at thenextrecession.wordpress.com

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