The absurdity of Krugman's stance on debt...

Feb 10, 2015

- By Bill Bonner

Bill Bonner
Sao Paulo, Brazil

Dear Diary,

Last week, McKinsey Global Institute reported that world debt levels were actually twice what we thought -- $200 trillion, or about three times the total planet's output.

What a relief it was to discover...only a few hours later...that there was nothing whatever to worry about. Our concern was totally misplaced. It was nothing but a colossal misunderstanding, or as Nobel Prize winning economist Paul Krugman put it, a 'bad analogy.'

So now, we can go back to our Portuguese lessons without a care.

Are you curious about how much progress we are making in Portuguese? We didn't think so. But we'll tell you anyway.

We pride ourselves in our ability to learn local idioms quickly. Put us down in any city in the world; after three days of intensive language lessons we'll be able to walk into any bar in the city and order a beer. With confidence.

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So it is in Sao Paulo. We can't conjugate the verb 'conhecer' yet. We can't pronounce it either. But we have mastered the essentials --'please, 'thank you' and 'debt bomb.'

Only now there's no further need to think about debt. Especially not here in Brazil. Even after 13 years of socialist government, public debt is only 60% of GDP. As for private debt, we haven't been able to get a number yet. We suspect it is low. The credit industry is fairly new, and cautious, here.

In 1980, a hamburger that cost 4 cruzeiros at the beginning of the year, cost 5 trillion cruzeiros by Christmas 1997. Brazil had to bring in a new currency and a new government to set things right. That's not the kind of thing you forget overnight. It makes lenders reluctant to lend long and stymies the growth of credit.

Especially when there is a whiff of inflation in the air. Prices are already rising in Brazil at a 7% rate - far beyond the government target.

But why bother to think about it? "Deficits don't matter," said Dick Cheney. "Debt doesn't matter either," says Paul Krugman.

What a pity. All these years, we've been laboring under the illusion that these things did matter. Thank goodness Krugman has finally clarified things (in the New York Times):

    You can see that misunderstanding at work every time someone rails against deficits with slogans like "Stop stealing from our kids." It sounds right, if you don't think about it: Families who run up debts make themselves poorer, so isn't that true when we look at overall national debt?

    No, it isn't. An indebted family owes money to other people; the world economy as a whole owes money to itself. ..

    ... debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn't make us richer).

Let's see. Debt doesn't make us poorer. So we don't need to worry about it. But does it make us richer? Ah, there's the question...for if it makes us neither poorer nor richer, why bother with it at all?

What's that you say, Paul, it CAN make us richer, if it is used intelligently? Isn't that the whole point of lowering interest rates? Aren't the lower rates supposed to encourage borrowing, spending...and greater wealth? So, there is something about debt that can have a real effect on the bottom line, isn't there? Debt, invested properly in wealth producing assets, can make both borrower and lender richer.

And if that is so, isn't it also likely -- by no means proven, of course - that debt CAN also make us poorer? Don't we all know that that is true too? You borrow money, you squander it...and you're worse off. And so is the person to whom you owe the money. You can't pay. He can't collect. You both lose. It doesn't matter whether you are a family or a whole nation. You're all worse off. Debt does matter, after all.

According to the McKinsey report, debt has grown by $57 trillion since the beginning of the crisis in 2007.

That, not real economic growth, explains why US stocks are so expensive. It is also why there is a house for sale in Florida for $139 million. And it's why a single painting - which was worth almost nothing when put on the market in the late 19th century - is now valued at $300 million.

This new data shows the absurdity of Krugman's "debt doesn't matter" position...and the futility of central bank policies since 2007. The financial crisis that began in 2007 came as a result of too much bad debt in the US housing and financial sectors. American households couldn't pay. They had to put on the brakes. Suddenly, all those billions of dollars' worth of mortgage backed assets proved to be worthless; every bank on Wall Street was threatened with bankruptcy. So how did the central banks respond? They stepped on the gas!

Government debt alone grew by $25 trillion in the last 7 years, according to the McKinsey report . Plus, eight out of ten households (mostly out of the US) have more debt than they did in 2007. And China has quadrupled its debt, from $7 trillion in 2007 to $28 trillion last year. China's debt - approaching 300% of GDP - is greater than the US or Germany. And half of it is collateralized by real estate.

Yes, dear reader, we live in an Age of Wonders. We wonder what will happen to $200 trillion worth of world debt when the collateral gives way. We wonder why anyone would pay $300 million for a single painting by a dead Frenchman. We wonder when the Nobel Committee will reconsider.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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