The Modern Day Debt Jubilee

The economic impact from the Coronavirus will be one for the ages. The International Monetary Fund expects the global economy to shrink 3% this year, far worse than its 0.1% dip in the Great Recession year of 2009. Some estimates are pointing towards a $10 trillion hit to economic output, that’s more than the economies of Germany and Japan combined. The obvious reaction from policy makers has been to spend. Governments across the globe have already committed $8 trillion in spending to help patch the hole in the sinking ship. And that number will be much higher when all is said and done. In order to support government spending, central banks have put their foot on the accelerator. Global Quantitative Easing (QE) asset purchases are likely to reach USD $6 trillion in 2020 alone, Fitch Ratings says. That’s in addition to the $17 trillion of existing assets The ECB, Fed and Bank of Japan have accumulated over the years. There are many sane and rational pundits arguing against government action, on the basis that it will cause hyperinflation, and/or give our children an unsustainable burden of government debt to carry in the future. However, as the eloquent professor Steve Keen has articulated, forget inflation, it’s all about debt deflation. For those who are unfamiliar with professor Keen, his work on articulating the fallacies of mainstream economists and their failure to understand the modern banking system and credit creation have become popular reading. Today, Keen argues, in the absence of government rescue, the likely outcome of this crisis is serious deflation. This will be caused by a mechanism called “Fisher’s Paradox”, in honour of Irving Fisher, who first identified it as the primary cause of the Great Depression. Fisher argued that the Great Depression was caused by the twin coincidence of too high a level of private debt, and too low a level of inflation. In this situation, debtors resorted to distress selling, cutting their prices in order to attract a cash flow to themselves rather than their competitors. But because everyone was doing it, prices fell across the board, taking GDP down with it. Debts therefore fell less than GDP, and the private debt ratio actually rose. Fisher’s Paradox was ignored by mainstream economics, because they subscribe to the fantasy model of banking known as “Loanable Funds”, in which banks are simply intermediaries between savers and borrowers. As Fisher argued, the fall in the price level amplified the impact of the decline in real output. Falling prices combined with falling output to mean that the fall in nominal GDP was actually bigger than the fall in real (inflation-adjusted) GDP. Since debts are also measured in nominal terms, the fall in the price level made the rise in the private debt ratio worse: “the more debtors pay, the more they owe”. This is why reflation, by Roosevelt’s New Deal (and also his “Bank Holidays”, which allowed insolvent banks to be wound up and their depositors funds transferred to solvent ones), was so important. If the injection of new money by the government hadn’t happened, this private sector chain reaction of liquidation leading to falling prices and an ever-rising debt level could have continued unabated. What’s the relevance of this historical story to today’s situation? It is that the Coronavirus crisis has hit when we still haven’t addressed the run-up of private debt that caused the Great Recession in 2007. Private debt today is higher than it was at the peak of the Great Depression. With the Coronavirus smashing both wages and profits in the US and global economies, the last thing we need is for workers that can’t pay their rents and mortgages, and firms that can’t pay their rents and service their corporate debts, to go bankrupt now. Inflation, which is already low, will turn negative, and the private debt ratio will explode once more, as it did in 1930-1933. Bankruptcies would cause a chain reaction of further failures, taking the banks down as well as the debtors. The solution? Keen believes a modern debt jubilee is necessary. He continues… We there­fore need a way to short-cir­cuit the process of debt-delever­ag­ing, while not destroy­ing the assets of both the bank­ing sec­tor and the mem­bers of the non-bank­ing pub­lic who pur­chased ABS (Asset backed securities). One fea­si­ble means to do this is a “Mod­ern Jubilee”, which could also be described as “Quan­ti­ta­tive Eas­ing for the pub­lic”. The current form of Quan­ti­ta­tive Eas­ing was under­taken in the false belief that this would “kick start” the econ­omy by spurring bank lend­ing. Instead, its main effect was to dra­mat­i­cally increase the idle reserves of the bank­ing sec­tor while the broad money sup­ply stag­nated or fell, for the obvi­ous rea­sons that there is already too much pri­vate sec­tor debt, and nei­ther lenders nor the pub­lic want to take on more debt. A Mod­ern Jubilee would cre­ate fiat money in the same way as with Quan­ti­ta­tive Eas­ing, but would direct that money to the bank accounts of the pub­lic with the require­ment that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injec­tion would have their debt reduced but not elim­i­nated, while at the other extreme, recip­i­ents with no debt would receive a cash injec­tion into their deposit accounts. The broad effects of a Mod­ern Jubilee would be:

1. Debtors would have their debt level reduced;
2. Non-debtors would receive a cash injec­tion;
3. The value of bank assets would remain con­stant, but the dis­tri­b­u­tion would alter with debt-instru­ments declin­ing in value and cash assets ris­ing;
4. Bank income would fall, since debt is an income-earn­ing asset for a bank while cash reserves are not;
5. The income flows to asset-backed secu­ri­ties would fall, since a sub­stan­tial pro­por­tion of the debt back­ing such secu­ri­ties would be paid off; and
6. Mem­bers of the pub­lic (both indi­vid­u­als and cor­po­ra­tions) who owned asset-backed-secu­ri­ties would have increased cash hold­ings out of which they could spend in lieu of the income stream from ABS’s on which they were pre­vi­ously depen­dent.

Sure these concepts are controversial and unlikely to be implemented as policy makers despite change. However, they should absolutely be on the table for further debate. Again, our current debts will never be repaid, and suggestions of further taxation to pay off the debt will only cause further damage to consumer spending and economic growth. After all, you can not borrow your way to prosperity, nor can you tax your way to prosperity. As it stands today, policy makers are doing everything they can to keep the monetary system on life support. But the current solution of curing a debt problem with more debt will only prolong the inevitable overdose and eventual death.

Three Things I’m Watching:

1. America’ private debt to GDP ratio rose between 1929 and 1933 while the level of private debt was actually falling. 2. Here’s what happens when you shut down the global economy. 3. Remember the Great Depression. Deflation came first with the massive shock. Then came the policy-induced inflation with a lag.