GDP plus Change in Debt—and the US Flow of Funds
on September 7th, 2010 at 4:06 pm
My recent post “What Bernanke doesn’t understand about deflation” has hit a chord, with a number of sites around the world reproducing it—including John Mauldin’s Outside the Box column. But it has raised a couple of queries in people’s minds too:
- Does my definition that “aggregate demand equals GDP plus the change in debt” involve double-counting?
- My figures for the USA are difficult to reconcile with the published US Flow of Funds data.
On the second point first, I produce an aggregate level of private sector debt in the USA from Table L1 of the Flow of Funds (on page 60 of the June 2010 PDF, and in ltab1d.prn in the ltabs.zip data archive) by adding together debt data for the following sectors:
- Household
- Non-financial corporations
- Nonfarm non-corporate
- Farm
- Financial Corporations
This omits some of the debt included in the aggregate debt level in the same table—notably government debt and debt owed by the “rest of the world”. In the interests of making it easier to reconcile my table with the data in the Flow of Funds, here’s the same exercise applied simply to the very first row in Table L1 (and the first column in ltab1d), “Total credit market debt owed by:”
US Flow of Funds Table L1, row 1 (column 1 in the file ltabs1d.prn)
| 200504 |
41267079 |
| 200601 |
42343298 |
| 200602 |
43337326 |
| 200603 |
44258861 |
| 200604 |
45329493 |
| 200701 |
46504304 |
| 200702 |
47528151 |
| 200703 |
48860628 |
| 200704 |
50044489 |
| 200801 |
50812625 |
| 200802 |
51272735 |
| 200803 |
52082473 |
| 200804 |
52524931 |
| 200901 |
52882693 |
| 200902 |
52686684 |
| 200903 |
52549072 |
| 200904 |
52416676 |
| 201001 |
52126900 |
I also transform the data to monthly by interpolation, and the way my data is stored the figure I give for 2006 corresponds to the figure stored for the end of the quarter 200504 by the Fed. I’ve highlighted these numbers in the two tables here to make that more obvious.
Change in debt and aggregate demand
| Variable\Year | 2006 | 2007 | 2008 | 2009 | 2010 |
| GDP | 12,915,600 | 13,611,500 | 14,291,300 | 14,191,200 | 14,277,300 |
| Change in Nominal GDP % | 6.3% | 5.4% | 5.0% | -0.7% | 0.6% |
| Change in Real GDP % | 2.7% | 2.4% | 2.3% | -2.8% | 0.2% |
| Inflation Rate % | 4.0% | 2.1% | 4.3% | 0.0% | 2.6% |
| Total Debt | 41,267,079 | 45,329,493 | 50,044,489 | 52,524,931 | 52,416,676 |
| Debt Growth Rate % | 9.2% | 9.8% | 10.4% | 5.0% | -0.2% |
| Change in Debt | 3,468,111 | 4,062,414 | 4,714,996 | 2,480,442 | -108,255 |
| GDP + Change in Debt | 16,383,711 | 17,673,914 | 19,006,296 | 16,671,642 | 14,169,045 |
| Change in Aggregate Demand % | 0.0% | 7.9% | 7.5% | -12.3% | -15.0% |
On the first point, since I consider that aggregate demand is spent on both goods & services (which are counted in GDP) and the net sum expended purchasing existing assets (which is not counted in GDP), then there is no double counting. A standard textbook aggregate demand figure is the sum spent buying goods and services (for the expenditure definition), which omits of course the sum spent buying existing assets as well. That would be all well and good if we lived in a world without asset sale—which of course we don’t.
Another reason people see a potential error here is that they think that a loan simply represents the transfer of spending power from a saver to a borrower, so that overall there’s no change in spending power because of a loan: money is simply transferred from one group that will therefore spend less (creditors), to another that will therefore spend more (debtors). This is clearly the thinking that Bernanke applied when he, in common with most all neoclassical economists, dismissed Fisher’s “debt deflation” explanation for the Great Depression:
“Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macroeconomic effects. ” (Bernanke 2000, p. 24)
This is not the case in the real world, for two reasons:
- Credit Money is created by banks “out of nothing” by the act of giving a borrower purchasing power (a loan of money) in return for recording a liability by that borrower to the bank (a bank debt). This creates new spending power “ab initio” without removing it from other agents. For the mechanics of this process, see my “Roving Cavaliers of Credit” blog entry (click here for the PDF).
-
As Schumpeter argues cogently, the endogenous creation of money by the banking sector lending to entrepreneurs is an essential reason that capitalism can grow, and it creates spending power that does not originate in the existing “circular flow of commodities”:
“From this it follows, therefore, that in real life total credit must be greater than it could be if there were only fully covered credit. The credit structure projects not only beyond the existing gold basis, but also beyond the existing commodity basis.”
“[T]he entrepreneur needs credit … [T]his purchasing power does not flow towards him automatically, as to the producer in the circular flow, by the sale of what he produced in preceding periods. If he does not happen to possess it … he must borrow it… He can only become an entrepreneur by previously becoming a debtor… his becoming a debtor arises from the necessity of the case and is not something abnormal, an accidental event to be explained by particular circumstances. What he first wants is credit. Before he requires any goods whatever, he requires purchasing power. He is the typical debtor in capitalist society.” (Schumpeter 1934, pp. 101-102)
So there is no double-counting in “aggregate demand equals GDP plus the change in debt”: the rise in debt adds new demand to that generated by the sale of commodities alone (and is a good thing here because it finances a large part of investment); and the increase in debt is spent financing part of investment and consumption (an overlap that could give rise to double-counting) and also on purchases of existing assets (where no overlap is possible).
Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.
Schumpeter, J. A. (1934). The theory of economic development : an inquiry into profits, capital, credit, interest and the business cycle. Cambridge, Massachusetts, Harvard University Press.
Marco,
I believe that aggregate demand must be equal to aggregate supply all the time but this doesn’t tell us about the value of C and I. Both demand or supply are dMoney/dt (flows).
Change in debt is still dimensioned as dMoney/dt let’s call it dD/dt
change in GDP would be d2M/dt2 (the second derivative) so we cannot write that d2M/dt2 = k * dD/dt unless k is dimensional.
Debt will contribute to GDP = COE + GOS + GMI + TP
We can say that DP = COE + GOS + GMI + TP + debt_loading
Debt loading will shift the dynamic equilibrium. Dependant parameters are C(t) and I(t) (and probably more)
Please look at how Kalecki tackled the changes of the parameters in time using exactly the difference equation approach you mentioned:
http://homepage.newschool.edu/het//essays/multacc/kalecyc.htm
Unfortunately I haven’t worked everything yet and this will take me long time to complete but I believe that Kalecki what the one who got the framework right.
He only did not include the change in debt. But I found verbal descriptions of such a model.
… We can say that GDP = COE + GOS + GMI + TP + debt_loading
You know its a small world when I saw Maudlin’s piece with a description of economics that said it had “rules” “like physics” on Ritholz’s blog, told him he needed to read Debunking Economics and understand the difference between static and dynamic models, and two hours later he guest posted your piece on Bernanke’s most recent failing.
Keep up the good work, Steve.
Many thanks favjr–you may well have been the catalyst for him checking this blog. Traffic has grown substantially since then, with over 60 new members signing up each day now.
Haven’t seen it Romeo–a link would be appreciated. A similar confidence has been expressed by every lender prior to a near death experience, as you implicitly note.
Hi Steve
Link Below
http://www.commbank.com.au/about-us/shareholders/pdfs/2010-asx/Australian_Residential_Housing_media_release_9_September_2010.pdf
Cheers
Romeo
Sorry that link was a dud.
http://www.asx.com.au/asx/statistics/announcements.do?by=asxCode&asxCode=cba&timeframe=D&period=W
Cheers
Romeo
Hi Romeo,
Good link to the CBA presentation. Thanks.
Pretty superficial….but I guess when you have to present to the un-informed (ie: global hedge funds) you have to keep it simple.
Could have done more, for instance
- Cost of production versus asset values (CBA would have good data on this)
- The +8% increae in residential rents per annum (underlying structural supply problems)
- No change in household costs / income for 15 years
To top it off, they could show the price of a litre of petrol in Australia (US$1.30 per litre) and compared it to the price of “gas” in the US ($2.70 per gallon, or US$0.71 per litre). They could suggest that GMO would conclude we have a petrol bubble! Quick…short Caltex…..
http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_home_page.html
Dean Baker’s view on stable house price vs income ratios over 80 years-
http://www.cepr.net/index.php/blogs/beat-the-press/house-prices-and-income?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+beat_the_press+%28Beat+the+Press%29
Noah cross,
I read this link which suggests house prices have not kept pace with income growth (ie: house prices have underperformed incomes after adjusting for the fact we have better quality stock).
With regards to observations that Bernanke does not understand. Bernanke, like a handful of other government minions and some bankers, does understand but cannot admit the reality.
By deliberately and unilaterally adopting a fiat monetary system, the authorities cannot admit that the system is inherently limited mathematically. A politician may not understand this, but Bernanke like Greenspan before him, most certainly does. Other than empirical evidence of the diminishing marginal efficiency of debt borne out by various data series such as the charts at the link below:
http://guidoromero.wordpress.com/2009/11/07/the-utility-of-a-fiat-monetary-system/
there is also factual evidence that upon joining government Greenspan underwent a radical change of heart with regards to the long term viability of a fiat monetary system:
http://www.321gold.com/fed/greenspan/1966.html
Government must always and everywhere maintain that a fiat monetary system can be expanded at will. Failure to maintain this position guarantees sovereign bankruptcy once the mathematical limit of the marginal efficiency of debt is reached.
@AK (#55)
You know much more than me about these things, ak, so I may be missing your point, in which case I apologize.
However, if you look at equation (3), reproduced below, you notice that, after reconsidering my argument as applying to consecutive periods, the first finite difference of GDP is Change_in_debt (i.e. “first derivative of GDP w.r.t. time”):
GDP(t) = GDP(t-1) + Change_in_debt(t-1).
Now, just substitute equation (2):
GDP(t-1) = COE(t-1) + GOS(t-1) + GMI(t-1) + TP(t-1)
for T = t-1 (unlike what I was considering in my first post), into equation (3). And we get
GDP(t) = COE(t-1) + GOS(t-1) + GMI(t-1) + TP(t-1) + Change_in_debt(t-1).
Isn’t that what you were getting at when you said (errata on comment #55):
“We can say that GDP = COE + GOS + GMI + TP + debt_loading”?
Unless I’m missing some subtlety, I believe is the same thing. What do you think?
Marco,
The point Steve was trying to make was that:
GDP(t) – GDP(t-1) = k * (Change_in_debt(t) – Change_in_debt(t-1))
or
GDP(t) = GDP(t-1) + k * Change(Change_in_debt(t), Change_in_debt(t-1))
(I would insist on adding a scaling coefficient k)
The difference equation language can be very confusing here and I think that Steve may be right in promoting using the differential equations language instead.
The SECOND (not the first) derivative of the stock of debt impacts the FIRST derivative of the GDP (which is the SECOND derivative of the monetary stock).
The second derivative of the stock of debt is the first derivative of the rate of borrowing. If you replace Change_in_debt(t) by Change_in_borrowing(t)
you’ll get
GDP(t) – GDP(t-1) = k * (Change_in_borrowing(t-1))
what is probably much closer to the reality
I would argue that the actual transmission mechanism is not trivial. I am not entirely convinced that dDebt/dt is an independent variable.
GDP can be compared to electric current which is a derivative of charge (not a change in time but an amount crossing a surface)
http://en.wikipedia.org/wiki/Electric_current
i = dq/dt
C = dMonetary_value_of_consumption/dt
I = dMonetary_value_of_investment/dt
…
However the change in debt results in the change in amount of money generating a flow.
A debt-induced flow like a current charging/discharging a capacitor while the normal flow of money is like a current generated in a coil by a changing magnetic flux.
To make it even more convoluted – I believe that borrowing and paying back the debt are separate sometimes independent processes. It is borrowing and spending what actually stimulates the economy but debt repayment can divert a monetary flow from consumption or investment towards /dev/null .
Anyway I may be wrong and I need to build a more formal model.
First of all, this site is a necessary read for me. I am an unknown guy with a finance degree who posted quite a bit over the past decade about this approaching disaster, as I understood debt would eventually consume itself and would become more than can be paid off. I read stuff about consumption and GDP, but consumption has nothing to do with GDP, other than how you add it up. If it did, they would call it Gross Domestic Consumption, not Gross Domestic Product.
In any case, what Steve presents as aggregate demand explains bull and bear stock markets and bubbles better than anything I have read and I will file that idea away in my mind for objective reasoning in the future.
Few can see what is going on in the US asset market. For one, people aren’t paying their mortgages and continuing to spend instead. Rather than mark this debt down, banks and other intermediaries are making believe the debt is good. They are hiding real estate off the market, thus supporting a price that cannot be supported permanently and allowing for funds to continue to flow to a massively over priced stock market. We will see both these props end soon.
When debt is written off, it is in some fashion paid. That money cannot be reloaned to continue to float markets and its holder becomes less rich. Banks can create money out of thin air, but not without sufficient capital reserves. The reserves must be capital, not Federal Funds, which merely allow banks to write checks to each other in overnight clearing or give their customers cash in return for a reduction in the liabilities to the customer. The impending losses and the losses already taken is why banks can’t lend.
If Steves assumption for aggregate demand is correct, we are headed for a sudden crash, as there is an air pocket developing as we read. Denninger, at market ticker posted a new bullish opinion that since people are taking money out of mutual funds, that is a bullish sign. They are clearly missing the point that the capacity to support the aggregate demand for secondary market assets is deflating and this is part of the process. It isn’t the people taking money out that are wrong, but the people who put the money in to buy their stock that are wrong. Same holds true for those that rushed in to buy houses, either for rental or for occupancy. The home market and the stock market probably combine for about $25 trillion in value, down from nearly $40 trillion and these AD figures Steve has produced explain this. There will be another several trillion disappear next year as well. People will keep eating, keep paying rent, and buying a reduced number of cars, as they become luxuries in replacement of a necessity already possessed. There are going to be some ruined retirment plans when this is done.
“By deliberately and unilaterally adopting a fiat monetary system, the authorities cannot admit that the system is inherently limited mathematically. A politician may not understand this, but Bernanke like Greenspan before him, most certainly does. Other than empirical evidence of the diminishing marginal efficiency of debt borne out by various data series such as the charts at the link below”
Come on guy. Do we need another Bryan sticking is arms out at a Democratic convention? Here is a better idea:
(1) The Federal Reserve Act of 1913 effectively ceded the sovereign power to create Money delegated to Congress by the Constitution to the private financial industry.
(2) This cession of Constitutional power has resulted in a multitude of monetary and financial afflictions, including an uncontrollable national debt, excessive taxation of citizens, inflation of the currency, drastic increases in the cost of public infrastructure investments, excessive un- and under-employment, and erosion of the ability of Congress to exercise its Constitutional responsibilities to provide for the common defense and general welfare.
The Secretary of the Treasury, following targets established by a 9 member Monetary Authority appointed by the President with the advice and consent of the Senate, shall directly issue all money, called United States Money, the nominal unit being the U.S. Dollar. This money shall be legal tender, backed by the full faith and credit of the United States.
The Act stops the creation of money by private banks. Fractionalized Reserve Banking is prohibited and banks can loan only the United States Money they actually have on deposit.
The Federal Reserve System (but not the local banks) is nationalized as a Bureau within the U.S. Treasury.
The United States would no longer borrow money. The Secretary of the Treasury shall issue United States Money as needed in lieu of public borrowing.
All existing money shall be exchanged for United States Money.
U.S. Money can be loaned to local banks which can continue to loan United States Money but with maximum charges not to exceed 8%. Banks can loan only U.S. Money.
The U.S. shall pay off the principal and interest of the national debt as they came due with directly issued United States Money.
The U.S. would use directly issued United States Money to rebuild the nation’s infrastructure.
The United States could loan United States Money interest free to states and local governments.
It is contemplated that in the future United States Money would be issued to finance Universal Health Care and an Education Funding Program that would at least put the United States on par with other developed nations.
CONCLUSION
President Obama and his economic advisors can be encouraged by the fact that famous and influential economist Milton Friedman supports the idea of abolishing the Fed. For at least 300 years, the private banks have used their wealth and power to persuade governments to allow them exclusive control over money. They have relentlessly and vigorously battled every single effort of governments to create currency. The author Ellen Brown does not expressly claim that banks have resorted to actual assassination, but she does note the strange sudden deaths of many of the reformers such as President James Garfield who urged public creation of currency. The political power of Wall Street banks is currently illustrated by their ability promptly to get billions of dollars of bailout money with no serious debate. The banks due to their own greed and ineptitude are now near bankruptcy and collapse. They are more vulnerable now to nationalization than they ever have been. They have brought all of us to the brink of economic disaster. This is a strategic political time for the U.S. to create our money. The awesome political power of private banks driven by the quest for huge profits would be curbed. Public control of the money supply would unleash the government to meet our legitimate human needs as it has done in the past in our own history. If the private banks can create money out of thin air, there is no reason why the government could not do it. We would all escape our excessive debt and tax burdens due to the interest owed to private banks. If interest must be charged, let it go into the public treasury.
Steve Keen: Who is the Marx of the post-keynesians fwiw?
@ John Prentice
Apologies. My contention that government deliberately opted for fiat money should in fact be reformulated as government having ceded the power to choose a fiat monetary system. Nonetheless, whichever way you turn it, it was a political decision to allow private interest to encroach upon something that should be purely in the hands of the public.
@ak,
You are probably right ak, although, frankly, I don’t quite understand why this should be and I certainly don’t have the slightest idea what you are talking about with the electrical engineering example.
I wouldn’t know what a capacitor is, if it bit me in the bum, but I take your word for it.
I revisited Steve’s numerical example in “DebtWatch 43: Declaring victory at half time” and indeed, it says that Aggregate Demand (not GDP!) is GDP + increased debt. Back to basics for me, then.
I was sure my interpretation was not only faithful to Steve’s own, but that my reasoning on my second post proved his theses right. Oh well.
Let’s see what thomasalan has to say.
Cheers!
Have you given a thought to what Depression would actually look like, given the increases in productivity since 1930?
We have robotized production lines, wheat harvesters, women in the workforce, computer design, GE, internet, 3rd world labour, blah blah….
The monetary system has to get pretty bad before we will look like 1930. The experience of Japan shows that you can have a meaningless monetary system and things can tick along just fine.
Another thing I’d like to mention is that Ravi Batra predicted the downfall of the US economy in 1990. I think it’s time we got over this paradigm that sensible monetary system is somehow necessary for life to exist. Just like mathematicians can use square roots of negative numbers to produce meaningful results, and the Japanese could test negative interest rates, I think it’s time for economists to embrace a more imaginary monetary theory: one with pretty pink ribbons and clown hats.
Quid, no problem. You have to understand though, as alot of people don’t,the Gold Standard was LOVED by the Wall Street bankers at one time. Anyone that tried to mess with it and that included internationally, was going to get ripped.
When FDR tried to “nationalize” the FED and permanantly go off gold, JP Morgan threatened a coup and a fascist dictatorship. Alot of “goldbugs” generally don’t like bringing this up, because it threatens their worldview. Much like they don’t like admitting the great depression was made by the FED basically pushing for a old fashioned liquidation as they raised rates in 1931 like many are calling for now. Instead they try to say the government “intervened” in the depression.
The sellout by Wilson and the Democrats passing that garbage instead of bringing back Lincoln’s greenbacks is no doubt one of the greatest crimes of the 20th century especially after Democrats had been screwed by the monied elite of the Northeast for years.
FDR hated Wilson and REALLY hated him by the time his poor war management was shown in WWI when he was navy sec. It set the stage however, for the FED to at least give the US money without debt restraining transactions to fight WWII. Without FDR’s aristicratic background, I doubt the terms would have been so good.
Overtime, the gold standard was replaced slowly by the “dollar standard” which isn’t quite the pure “fiat” people think it is.
“The Federal Reserve System (but not the local banks) is nationalized as a Bureau within the U.S. Treasury”
see where your going with this john prentiss(jp)
so does the fed still manage and underwrite the liquidity in the payments system, and do we still have reserve requirments under this scenario?
or for that matter interest rate targeting
because if we do , we have some problems to sort out.
lets not forget the fed acts defensively when it comes to managing interbank liquidity under a interest rate targeting framework
“If the private banks can create money out of thin air, there is no reason why the government could not do it. We would all escape our excessive debt and tax burdens due to the interest owed to private banks. If interest must be charged, let it go into the public treasury”
amen to this,
250 years of american banking history is against you though,
im not sure we can get rid of the fed completely, i mean the whole reason the fed was set up, was that robber barons like jp morgan got sick of reaching into their own pockets to prop up the system like in 1907.
and surprise surprise, its happened again, but this time they had bag man benanke
removing the tax burden relies upon getting rid of the gcb(government budgetary constraint) paradime
i have turned a deeper shade of purple trying to explain to politicians and their advisors, why gbc is a total crock of shyte, to very little avail.
i think we are going to have to run this show into a very deep ditch, before we get movement at the front.
Mahaish,
Whether the system is a crock of shyte or not depends on who you are.
If you are a primary dealer and, particularly, if you are the top dog of the primary dealers, this monetary system is the best you could ever hope for in any given universe.
#74 astrayan
“The monetary system has to get pretty bad before we will look like 1930. The experience of Japan shows that you can have a meaningless monetary system and things can tick along just fine.”
I say a similar thing to what guidoamm says at #78…
When your neighbour loses his job and his house it feels like a recession. When YOU lose your job and YOUR house it feels like a depression.
(I just used blocks for emphasis – I am not shouting).
I believe that there are 20 million houses in the USA that are stood empty. This is just one more sign of a monetary system that has failed – but even that point of view depends upon “who you are”?
I would further add that we often think no further than our own doorstep. If you look further than that and “span the waters” you would find the deeper depression our (unjust) monetary system has caused – and I am not just talking about how many DVD players a person might have.
Sirius,
How profound. I believe that the depression that we are facing or already in, is personal (very) and I mean that in a financial way. (Recession for the neighbour V Depression for Oneself is not new it was touted in the 70′s)
It will affect everyone in a different way or by different degrees, some much more than others. Debt will be the overiding factor as to how much it affects certain people IF and maybe when their income falls.
Some people will come through with less pain than others. The have’s and have not’s will polarise. However, everything financially,reverts to the “true” owner. Most people in extreme debt need to realise that they only have temporary use of their material possessions and that they don’t own it,-the lender does.
The reality is depression, financially and in a clinical sense for people really believe they actually “owned” these possesions and their sense of loss when it occurs is real.
Yes, it will happen, not necessarily in one line in the sand for all, which I think the “World” is expecting a definitive line to be drawn, so that they can relate to, no I think it will be individual and gradual over a long, long time. This will probably lead to a rather more rational life, not one as hyped and so self centred as the individual and society as a whole has become with debt explosion. It will revert to productivity in the true sense of the word and above all respect for others and humbleness will be normal every day behaviour rather than it being propaganda political “speak”
I copped out of debt because it gives me freedom.
“Freedom is nothing left to Lose”- Kris Kristofferson.