Debt Overhang and Negative Wealth Effects

[william the wie]

A more or less consensus dealing with wealth effects and debt overhang is growing but there is a chicken and egg problem.

Increasing wealth leads to more spending and especially spending on credit.

Decreasing wealth reduces spending in an attempt to get back to even and this effect is greatest among those with more debt.

To a great degree this overturns the national income model of how things spin out of control as in 2008 and 1929

What do you think?

 

[waltky]

Granny says, "Dat's right - dem politicians is sealin' our doom...

CBO: ‘The Projected Amounts of Debt Would…Make a Fiscal Crisis More Likely’
July 15, 2016 | In its Long-Term Budget Outlook published this week, the Congressional Budget Office said that the additional debt it projects the federal government will accumulate in the coming years if it continues on its current path would make a fiscal crisis in the United States more likely.

“In particular,” the CBO said in its report, “the projected amounts of debt would: Reduce national saving and income in the long term; increase the government’s interest costs, putting more pressure on the rest of the budget; limit lawmakers’ ability to respond to unforeseen events; and make a fiscal crisis more likely.” “Federal debt held by the public ballooned in the past decade,” the report noted.

The CBO projects that the federal debt held by the public is on its way to unprecedented levels as a percentage of Gross Domestic Product: “If current laws governing taxes and spending did not change, the United States would face steadily increasing federal budget deficits and debt over the next 30 years, according to projections by the Congressional Budget Office. Federal debt held by the public, which was equal to 39 percent of gross domestic product (GDP) at the end of fiscal year 2008, has already risen to 75 percent of GDP in the wake of a financial crisis and a recession. In CBO’s projections, that debt rises to 86 percent of GDP in 2026 and to 141 percent in 2046—exceeding the historical peak of 106 percent that occurred just after World War II. The prospect of such large debt poses substantial risks for the nation and presents policymakers with significant challenges.”

The first chapter of the outlook—“The Long-Term Fiscal Imbalance”—includes a subsection titled “Greater Chance of a Fiscal Crisis,” which explains how such a crisis could unfold: “A large and continuously growing federal debt would make a fiscal crisis in the United States more likely. Specifically, investors might become less willing to finance the government’s borrowing unless they were compensated with high interest rates. As a result, interest rates on federal debt would abruptly become higher than the rates of return on other assets, dramatically increasing the cost of future government borrowing. In addition, that increase would reduce the market value of outstanding government bonds. If that happened, investors would lose money. The potential losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt might be large enough to cause some financial institutions to fail, creating a fiscal crisis. A fiscal crisis also can make private-sector borrowing more expensive because uncertainty about the government’s responses can reduce confidence in the viability of private-sector enterprises.

“Unfortunately, no one can confidently predict whether or when such a fiscal crisis might occur in the United States. In particular, the debt-to-GDP ratio has no identifiable tipping point to indicate that a crisis is likely or imminent. All else being equal, however, the larger a government’s debt, the greater the risk of a fiscal crisis. “The likelihood of such a crisis also depends on economic conditions. If investors expect continued economic growth, they are generally less concerned about the government’s debt burden; conversely, substantial debt can reinforce more generalized concern about an economy. Thus, fiscal crises around the world often have begun during recessions—and, in turn, have exacerbated them. “If a fiscal crisis occurred in the United States, policymakers would have only limited—and unattractive—options for responding. The government would need to undertake some combination of three approaches: restructure the debt (that is, seek to modify the contractual terms of existing obligations), use monetary policy to raise inflation above expectations, and adopt large and abrupt spending cuts and tax increases.”

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Judicial Watch: Obamas Spent $79.6 Million on Travel Expenses So Far
July 15, 2016 | New information obtained from the Department of Homeland Security (DHS) brings the grand total of known travel expenses of President Obama and his family to $79,630,433.93, Judicial Watch reported Wednesday.

Judicial Watch President Tom Fitton called President Obama’s travel spending a “scandal” and an “abuse of the office.” "Taxpayers should be incensed that the Secret Service’s resources [are] wasted to provide security for endless golf excursions, political fundraisers, and luxury vacations,” Fitton said.

The non-profit government watchdog organization obtained new information on Secret Service spending on hotel and travel expenses for seven presidential trips in 2014 and 2015, which were mostly for pleasure and fundraising, through a November 2015 lawsuit it filed against DHS because the agency "had failed to respond to 19 FOIA [Freedom of Information Act] requests" since July 2014.

The priciest of the seven trips - to Seattle and Los Angeles to raise money for Democratic congressional candidates in July 2014 - cost taxpayers $237,731.05 on hotels, $19,888.70 on rental cars, $1,451.40 on air and rail travel, and $2,425,085.50 on Air Force expenses, for a grand total of $2,684,156.60, according to the released records. The second most expensive trip was a $1,604,380.50 getaway to Westchester, N.Y. and Providence, R.I. that same year.

Obama’s luxury family vacation to Martha’s Vineyard last August cost taxpayers $465,420.49, according to DHS records. “The First Family’s Martha’s Vineyard vacation, their sixth in the past seven years, was spent at the lavish Blue Heron Farm in Chilmark, a seven-bedroom, nine-bath, 8,100-square-foot estate, sitting on 10 acres of farmland. The estate features 17 rooms, expansive water views of Vineyard Sound, an infinity pool, and a tennis-basketball court. It rents for $50,000 a week,” Judicial Watch reported.

Judicial Watch: Obamas Spent $79.6 Million on Travel Expenses So Far

 

[william the wie]

Negative interestrates are so far shipping momney from Europe and Japan to here but that will have to blow up eventually.

 

[oldfart]

A more or less consensus dealing with wealth effects and debt overhang is growing but there is a chicken and egg problem.

Increasing wealth leads to more spending and especially spending on credit.

Decreasing wealth reduces spending in an attempt to get back to even and this effect is greatest among those with more debt.

To a great degree this overturns the national income model of how things spin out of control as in 2008 and 1929

What do you think?

I'm having trouble following the argument here. In standard Milton Friedman consumption theory, there is a wealth effect in that consumers who find their wealth increased by some factor beyond their control ( like the stock market going up) will feel wealthier, be willing to absorb more risk, and will spend more. It's been a pretty shaky argument for the last 80 years.

The first problem is that wealth is highly concentrated, most of the wealth effect would accrue to people who already have enough money to buy everything they want. An increase in wealth for these individuals would simply give them more money to financially invest and not increase consumption. This is borne out by the micro studies of consumer behavior. They also reveal that the effect is not symmetrical; a fall in wealth (as in 2008 or in the UK following the Brexit vote) will not cause a reduction in consumption of the same size as the increase in consumption resulting from an increase in wealth of the same size. When asset prices vary widely, there is a rachet effect.

Also bear in mind that those with substantial financial assets (generally the top decile) have very little debt not associated with things like real estate investment. The bottom half of the wealth distribution have essentially zero net worth and live on current income and borrowing. This is the probable reason for the rachet effect. These families borrow to spend and cannot easily unspend in a downturn; they are stuck with the mortgage, car note, and credit card payments even if they stop all new spending.

In terms of public debt, remember that what is a liability to the government is a financial asset to someone in the private or foreign sector. Were the government to pay off a substantial amount of public debt, many investors would have to reallocate capital from government securities to other instruments, and this would likely influence asset prices.

In summary, I think the evidence is overwhelming that wealth effects are a secondary phenomena, and I see no mechanism whereby the size of the public debt would alter any such wealth effects.

 

[william the wie]

A more or less consensus dealing with wealth effects and debt overhang is growing but there is a chicken and egg problem.

Increasing wealth leads to more spending and especially spending on credit.

Decreasing wealth reduces spending in an attempt to get back to even and this effect is greatest among those with more debt.

To a great degree this overturns the national income model of how things spin out of control as in 2008 and 1929

What do you think?

I'm having trouble following the argument here. In standard Milton Friedman consumption theory, there is a wealth effect in that consumers who find their wealth increased by some factor beyond their control ( like the stock market going up) will feel wealthier, be willing to absorb more risk, and will spend more. It's been a pretty shaky argument for the last 80 years.

The first problem is that wealth is highly concentrated, most of the wealth effect would accrue to people who already have enough money to buy everything they want. An increase in wealth for these individuals would simply give them more money to financially invest and not increase consumption. This is borne out by the micro studies of consumer behavior. They also reveal that the effect is not symmetrical; a fall in wealth (as in 2008 or in the UK following the Brexit vote) will not cause a reduction in consumption of the same size as the increase in consumption resulting from an increase in wealth of the same size. When asset prices vary widely, there is a rachet effect.

Also bear in mind that those with substantial financial assets (generally the top decile) have very little debt not associated with things like real estate investment. The bottom half of the wealth distribution have essentially zero net worth and live on current income and borrowing. This is the probable reason for the rachet effect. These families borrow to spend and cannot easily unspend in a downturn; they are stuck with the mortgage, car note, and credit card payments even if they stop all new spending.

In terms of public debt, remember that what is a liability to the government is a financial asset to someone in the private or foreign sector. Were the government to pay off a substantial amount of public debt, many investors would have to reallocate capital from government securities to other instruments, and this would likely influence asset prices.

In summary, I think the evidence is overwhelming that wealth effects are a secondary phenomena, and I see no mechanism whereby the size of the public debt would alter any such wealth effects.

Good to see you again. The Fisher school managed to ignore the massive loss of capital sales to farms in the 1930-9 drought/Dust bowl. While the Cambridge school completely missed the deflationary increasing returns in the high tech of the 20s and 30s they also missed the 1930-9 collapse in investment. While there are great advances being made in accounting for weather and disease variances that hasn't worked its way into economic policy models yet. another factor is that policy does not account for kinks in information flow. For example, ROI analysis demonstrates that MIT not Harvard is the best school in greater Boston. My argument is that the standard model ignores wealth effects in establishing policy.

 

[EdwardBaiamonte]

A more or less consensus dealing with wealth effects and debt overhang is growing but there is a chicken and egg problem.

Increasing wealth leads to more spending and especially spending on credit.

Decreasing wealth reduces spending in an attempt to get back to even and this effect is greatest among those with more debt.

To a great degree this overturns the national income model of how things spin out of control as in 2008 and 1929

What do you think?

no idea what you are saying about 2008 and 1929?? and certainly not what policy changes relate to your post.