Is my thought process reasonable, or am I mixing too many different things? I feel like I am in a ball of yarn pulling on strings and trying to form an opinion on what will move and how.

The “bang for the buck” was dramatically larger when given to the debtors, and there’s a simple dynamic reason as to why: the rate of flow of money out of debtor’s accounts is much higher than that out of bank reserves during a credit crunch! So if you’re going to throw money around as a government in the hope of stimulating economic activity, you’re best to throw it at the debtors and not the creditors. On this basis, quantitative easing and the like by Bernanke et al are relatively ineffective, while handing money out via “cash for clunkers” and “tax rebate” measures a la Obama and Rudd are relatively effective.

Whether such a concept works in a dynamic setting–i.e., the real world–is a moot point. There is one way this is true in my monetary framework: the spending acts as an addition to the money supply which then turns over at the same rate as money does in general–which is why an addition to private debt of $100 can cause say $400 of economic activity for a multiplier of 4.

In this sense any injection of money into the system, or deduction from it, has the same multiplier.

However in a dynamic setting the non-”ceteris paribus” nature of the real world comes into play, and a government injection might cause changes in other processes, or have to counteract an opposite action by the private sector.

That’s why in general I don’t work with a multiplier concept, but instead look at the scale of injections into and deductions from the active money supply. On that basis, since Australia’s starting with a debt to GDP ratio of 165%, and our historic rate of deleveraging appears to be between 3% and 8%, the deductions from aggregate demand caused by debt deleveraging will start at between 5% and 12% of GDP.

The government’s stimulus has been on the up side of the world average of 18% of GDP over 3 years, according to Rudd’s essay–so say a 7-8% injection equivalent. That’s enough to mask private deleveraging for a while (and there’s also been successful encouragement of the private sector to continue increasing debt via all the housing market manipulations), but it has to be maintained indefinitely to keep aggregate demand from falling.

I have yet to work all this through fully, but this in brief and in part is why I disagree with some of my Post Keynesian colleagues–such as Randy Wray, Warren Mosler and Bill Mitchell–on the sustainability of a government-deficit-driven economic recovery from a private financial crisis. I won’t get into that debate until I have time to work through the issues in my dynamic-modelling manner, but my gut feeling is as stated above.

On your questions:

1. Part of why you could pay that debt level in our current society is that someone with initially no debt would buy whatever asset you’ve purchased with your own debt level and take over its servicing. If that person couldn’t be found, then you’d need to finance it solely out of your own income stream, and even with a good income level that can be problematic. Many people in society don’t earn enough to be able to consider taking on debt and purchasing an asset in the first place: they dilute the feasible debt load at the national level. There is no “right” level, but looking at times of economic tranquility (1948-65 for Australia) it seems that a debt level at the national scale of 25-40% is sustainable. Any more than that and the dynamics of debt growth dominate economic activity–leading to the Ponzi bubble we’re now in. That really is the danger–not so much the debt level per se as the reason it’s taken on. When it’s to finance speculation, by definition its a net sum loss for society as a whole, and the burden of supporting that can bring the economy down.

2. The trouble with an individual approach to deleveraging is that it undermines the income stream on which that deleveraging is based. In our demand-driven economy, with demand as the sum of GDP plus the change in debt, deleveraging reduces aggregate demand and the economy tends to shrink–which counteracts the attempt to reduce debt at both the individual and social level. It may well be what ends up happening, and it does eventually work, but it involves a long, drawn out economic decline.

1. What is a sustainable level of debt expressed as a percentage of GDP? It may be a bit simplistic but as an individual I certainly wouldn’t be overly concerned about a debt level of say twice or even three times my earnings. However this seems to be a problem at the national level – I wonder why?
2. Even if there is too much debt couldn’t de-leveraging occur in an easier -‘family unit’ basis. By that I mean that my parents could assist me with reducing debts and in turn I could help my children. Of course not everyone has family or assets that could be used in that way but even grown children moving back home could be a way of reducing their expenses and thus leaving the way open for them to spend more on consumer goods. This coupled with a bit more domestic demand from China, India and others could mean consumer spending globally is close to existing levels. Not that this is necessarily a good thing of course and eventually the house of cards may fall – however it is the timing which most people would be interested in. Another bubble – however created – that goes on for 6 or 7 years is a different proposition to a bubble that bursts in a few months. The implication from Steve’s lecture is that this will happen soon – however I am not sure why.

Anyway thanks again Steve for a good lecture and your web site is a revelation.

eric janzen of itulip.com argues that capital exporting nations will not experience infaltion in debt deflation, there’s quite a lot of room for the country to increase public debt to make up the balance and keep rates low. The US on the other hand who needs to funds current account deficits will need to raise rates if it is to attract foreign capital and this will cause inflation, why this hasn’t happened yet is because of the US’s special status as reserve currency issuer. Australia seems to fit Eric’s criterea well for inflation, perhaps our special case is that we’ve got a crap load of resources to back the currency and that’s why we haven’t had to raise rates.

I understand that bond sales are for interest support to manipulate the yield curve but the toxic pile of debt is a by-product of the policy. Just like carbon dioxide is a by-product of burning coal. My point is that it is equally unsustainable in the long run.

The exchange rate is affected by the availability of currencies and this is how central banks intervene on the markets – by selling or buying currencies. The exchange rate would collapse because speculators (investors) don’t care about the full employment policy but they want short-term returns. So if there is an excess of USD due to the trade deficit its exchange rate must fall – when overseas investors stop buying bonds. The excess of USD on the markets will happen sooner or later (probably in a few years time) if the current policy continues. This aspect of reality is ignored in the explanations how the modern monetary system works.

If all the bonds were issued to domestic investors things would look a bit better but strong USD kept to stimulate consumption is correlated with the trade deficit. They are cornering themselves leaving smaller and smaller space to make any adjustments.

The time scale of a currency collapse could be in days (depending on the behaviour of exchanges – they will most likely halt trading in such a case, the response time of automated trading systems is around or below a millisecond).

The time scale to rebuild the productive economy in the US (bearing in mind how much they depend on oil) when petrol costs there several times more than now could be in years.

Of course collapsing the USD is a mutual-destruction scenario for China and it can be only used to blackmail. But the collapse of currencies can also be triggered by short-sellers. They don’t care and they did it in the past (G. Soros).

I understand that without simulating we don’t know what will happen in 20 years if the current trends continue but I am sure that if the US debt keeps growing the system must be extremely unstable.

1. mitchell agrees, i think. but his preference is for fiscal policy, anyway. even if monetary policy has perverse effects (massive spending on debt service when rates rise), fiscal policy can still be used, in his view.

2. mitchell/wray/mosler, etc. argue that bond sales are not for finance, but for interest support. so they reject your point here outright. this point is too complex to treat completely here, so i’ll leave it at that and just refer to mitchell and mosler blogs. on another note, though, if fiscal policy keeps the economy at full employment even if foreign investors sell bonds, why would the exchange rate collapse? wouldn’t you want to invest in a country at full employment? worst case scenario is that the currency falls as you said and exports rise, which is what us politicians want, anyway. sidenote: note how schizophrenic us policy toward china is; that is, “please buy our bonds and keep our currency strong” while at the same time “stop manipulating your currency by buying our bonds and instead let our currency weaken.”

3. again, they would disagree as long as the debt is issued in the domestic currency that the government itself creates. and, yet again, bond issuance not necessary in the first place in their view.