"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Wednesday, January 11, 2012

Deleveraging , Debts and Distribution

Most economists are already convinced that years of massive stimulus spilled on the economy yielded just minor economic results: In any case far from what can be regarded as “Recovery”. Why? Many are the obstacles the economy is facing, though it is widely acknowledged that the private sector heavy indebtedness and its "Deleveraging" .....
( Debt reduction) process subtracts a substantial consumption power from the American and global economy.

As can be seen from the following graph, the above description is not a mere perception ( DEBT/ GDP )

So the "deleveraging2 process has begun but the return to the long run averages ( Debt) is still far away. True, the current low interest rates policy helps Debtors but since Principal is not recycled, the outcome is an absolute subtraction from purchasing power. Such pro cyclical behavior of credit is nothing new to economics.

However, the above narrative is just PART of the story, or may I say exactly 50%. How can I be so accurate? Well, the “Debtor” tale is the other coin of the “Creditor” Tale, as each cent of Debt is a cent of Credit (Asset) at somebody´s else account. Therefore, while some are experiencing a “deleveraging” process, others are just getting back their money. So if on the aggregate balance (creditor + debtor) we get a zero sum game from a purchasing power perspective, how it comes that the deleveraging process affects overall consumption? Is there something else that the pundits are missing? Or maybe I am missing something?

Well, the deleveraging tale and its link to consumption is consistent as long as we introduce other (hidden) hypothesis. In our case, the additional assumption we should bring in is that Debtors tend to spend more than Creditors out of their available cash. Lets analyze that point.

That hidden hypothesis is straightforward: The Debtor attained its “infamous” status for spending more than his actual income (that´s how she became Debtor….) due to a personal attitude or a need. On the other hand, the Creditor is someone who, regardless her personal attitudes is also ABLE to save the resources to be funneled through the financial system. So, the Debtor is usually a low medium income citizen ( who “needs” more) and the Creditor a wealthier citizen ( “able” to save).

So the conclusion which is consistent with the above TALE is that the deleveraging process affects the economy since the Debt returned to its wealthy citizen generates less consumption than the same USD in the hands of its modest compatriot.

The important question is why analysts tend to ignore that point and confine the debate just to the deleveraging itself. The reason is very simple: If the above logic concerning the Dollar value in different hands is applied beyond “debt” to a wider arena of income and distribution, the conclusion could be that the best way to deal with the crisis is to improve the income distribution.

Let me explain that point : We agreed that a USD ( debt or income ) let’s say, distributed at a 50%-50% mode is more effective (in spending and economic growth terms) than let’s say 90%-10%. So the conclusion could be that the crisis could be treated by a more fair distribution of income, wealth and so on. That is a major conclusion that many establishment experts or spokespersons are not willing or able to accept for their own reasons .Too radical? I am not that sure. Remember H. Ford words about his workers´ salaries …."One's own employees ought to be one's own best customers... "Paying high wages," he concluded, "is behind the prosperity of this country.")

As far as it concerns to me, I am more than convinced that the only way out of the crisis is the restoration of a more fair income distribution on national and global scale. I guess that the deleveraging debate just sheds another light on such perspective.

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