Debt Deflation: What's the Solution?

Nice presentation on the unfolding of debt deflation from David Meier that, however, does not cut to the core problem that causes debt deflation and that makes the reflationist “solution” risible: we have too much debt. It’s the debt, stupid!

Prudent lenders have always helped their borrowers by examining the cash flows of applicants and making sure that the credit extended isn’t going to put the borrower underwater. On the other hand, if you’re writing trash loans that you’re going to unload into a big Wall Street securitization that is going to get a triple-A credit rating from a rating agency paid by the investment bank floating the Structured Investment Vehicle (and possibly taking a short position in it at the same time…), then… well let’s just say that isn’t banking, that’s fraud. And everyone loses except the Wall Street sharpies who invented the shell game and sold it to those bankers greedy enough to go for it (with full knowledge of what they were doing, in my humble opinion—committing fraud to get obscenely rich quick). The borrower who also falls for the ruse then loses his or her house.

What is the solution to debt deflation? Restore honesty and transparency to the financial statements. Write off bad debts, get society back a level of indebtedness that it can handle. Provide a livable dole, health insurance and education to the people. Stop imperial overextension, stupid wars, excessive and corrupt government spending. Get real, in other words, about our fiscal position. America was the world’s greatest creditor in 1933; today America is the world’s greatest debtor. Reflation won’t work because any increase in interest rates given our debt load will cause interest payments to balloon to unmanageable levels faster than incomes can catch up.

Note that those who keep their jobs and houses don’t much get hurt in a debt deflation (see the comment from a friend of Jesse’s in Japan regarding their “lost decade”; turns out it wasn’t bad at all). The lucky employed can refinance at lower rates, and get more for their money at the market. Those who become collaterally unemployed through no fault of their own require social support, if our society believes we share a responsibility to care for one another. Seems to be an open question among those on the right; while the question I have about those on the left is whether they, like the Wall Street grifters, will pile too much debt on the American people.

Debt Deflation October 2009

Comments

[John Galt:]

> Provide a livable dole, health insurance and education to the people.

I agree with 99% of your article except this statement. Where in the Constitution does it say we (tax payers) have to give free education, health care, and a livable dole to the people? Is America the land of handout prosperity or the land of opportunity?

Nov 02 01:34 PM

[User 435211:]

Exactly right. Half the country already doesn't pay income tax. It's easy for them to vote themselves benefits, paid for by others.


On Nov 02 01:34 PM John Galt wrote:

> > Provide a livable dole, health insurance and education to the people.
>
>
> I agree with 99% of your article except this statement. Where in
> the Constitution does it say we (tax payers) have to give free education,
> health care, and a livable dole to the people? Is America the land
> of handout prosperity or the land of opportunity?

Nov 02 01:55 PM

[Gary A:]

The fastest way to get your family out of debt is to walk away from it. When you realize that much of the debt you carry was a result of a ponzi housing scheme that was fraudulent and when you realize that credit card interest rates should be dropping to reflect the lower borrowing costs of banks, you can see that there is only one means of escape if you are trapped by credit.

If the banks were moral, and interested in your well being, then perhaps a "moral" response would be warranted. But when the banks are immoral, and not interested in your well being, in these times of extreme necessity to just survive, the moral act is to fight these banks and walk away from fraud loans.

It is more important, morally, to support your family and pay your rent and light bill than it is to pay debt to a bunch of legal loan sharks.

You would think that banks would only loan to people who have increasing wages, yet they loan to a continually declining consumer, as if they want to beat you when you are down. This predatory behavior is against the interests of the United States as a sovereign nation. It is destructive of families, of trust in financial institutions and of faith in America.

Nov 02 01:56 PM

[The Geoffster:]

"Those who become collaterally unemployed through no fault of their own require social support, if our society believes we share a responsibility to care for one another. Seems to be an open question among those on the right; while the question I have about those on the left is whether they, like the Wall Street grifters, will pile too much debt on the American people."

Why not write an article justifying your sense of social responsibility and how you can achieve it without piling too much debt on the American people. Your sense of compassion has already indebted generations yet unborn.

Nov 02 03:06 PM

[Angel Martin:]

From the article: "Provide a livable dole, health insurance and education to the people. "

The Federal gov't is already running annual deficits in excess of 10% of GDP.

Since the problem is too much debt, how does expanding the dole, education and health care by going further into debt help with this problem?

Nov 02 08:39 PM

[PastTense:]

Welfare for the poor is a small fraction of welfare for the middle class and rich in this country (starting with the bankers, continuing to the house buyers buying Mcmansions, the overpaid auto workers, the farmers...). So if one cuts benefits for the latter while improving the safety net for the disadvantaged, the result is a much improved situation regarding too much debt.

Nov 02 09:46 PM

[bob adamson:]

Your objectives are laudable Mr. Brodwicz. Important questions of timing and sequence of steps to achieve these objectives go unmentioned however.

While those who see fiscal and monetary stimulus alone to be the solution to the current crisis make a critical mistake as you suggest. That said, we are faced with a paradox for massive stimulus was a necessary tool to stabilize the economy and set the stage for further steps along the road to a sound recovery.

When the international investment banking crisis came to a head in 2008 and threatened to metastasize in very short order into cascading general financial and deflationary crises the first order of business was to stabilize the banking sector and pump monetary and fiscal stimulus into the economy across the G8 to stabilize the credit system and the economy generally. The paradox is that these vary measures mirror the excesses that generated the US trade deficit, over-emphasis on the consumer sector of the US economy, US government deficits and personal, corporate and government debt accumulation all of which together helped inflate the bubble that set the stage for the aforesaid crisis in the first place. Further, measures to correct the lending practices that fuelled the accumulation of debt and to put a break on shady financial institution practices that generated excessive creation of secularized debt and derivative instruments, a large portion of which having little value, were downplayed in practice by governments so as to not further confuse and destabilize the investment banking sector at the height of the crisis. In short, the first step was not to attack the underlying causes leading to the crisis but rather to stabilize the situation even though this entailed continuing and even increasing for a short term the bad policies and practices to some degree of the recent past.

While paradoxical this was the right thing to do provided it was seen as only the first short stage of a many stage long term process to place the economy on a sounder footing. It would be interesting, Mr. Brodwicz, to read your suggestions for the sequence of steps and the measures to be taken at each step to rebuild the sound economy you describe in a practical way. This can not be a one step Hail Mary Pass that somehow telescopes steps, measures and time into one instant.

Nov 02 11:07 PM

[Benign Brod...:]

Disclosure: I have been an independent for a long, long time.

PastTense gets it right. The American government provides trillions of dollars of welfare to the rich, and very little to the poor. Anyone who denies this truth after the events of the past year is ignorant indeed.

The solution is to reverse that pattern. Also, to quit stupid wars and "nation-building" (destroying) efforts abroad while our own nation is falling apart.

It is my hope that the "screw thy neighbor" attitudes expressed here will become so socially unacceptable within a few years that people mouthing them will be shunned as if they had the plague.

Nov 03 10:53 AM

[Gregman2:]

"Those who become collaterally unemployed through no fault of their own..." I'm not sure the press has really examined fully the nature of current unemployment and the decline in real wages. Are you suggesting it's time for an industrial policy?

Nov 03 07:50 PM

[Benign Brod...:]

Of course we always have an industrial policy through our tax and tariff laws. I am suggesting that fiscal "stimulus" should be targeted at supporting the welfare of the people directly, not in more pork for the well-connected, or more war.

Nov 04 08:51 AM