Government Debt and Deficits Are Not the Problem. Private Debt Is.

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Originally posted on March 13, 2012 at the New Economic Perspectives blog.

(Remarks by Prof. Michael Hudson at The Atlantic’s Economy Summit, Washington DC, Wednesday, March 13, 2013)

There are two quite different perspectives in the set of speeches at this conference. Many on our morning panels – Steve Keen, William Greider, and earlier Yves Smith and Robert Kuttner – have warned about the economy being strapped by debt. The debt we are talking about is private-sector debt. But most officials this afternoon focus on government debt and budget deficits as the problem – especially social spending such as Social Security, not bailouts to the banks and Federal Reserve credit to re-inflate prices for real estate, stocks and bonds.

To us this morning, government deficit spending into the economy is the solution. The problem is private debt. And in contrast to Federal Reserve and Treasury bailout policy, we view the problem not as real estate prices too low to cover bank reserves. The problem is the carrying charges on this private debt, and the fact that debt service is eating into personal income – and also business income – to deflate the economy.

Mortgage debt that is still leading to foreclosures, evictions, and is depressing the real estate market for most buyers except for all-cash hedge funds;

We have been urging a write-down of mortgage debt in line with the debtor’s ability to pay, or to bring debt service in line with current market prices. The administration has bailed out the banks for their bad loans, but has kept the debts in place for most of the population. Its promise of debt write-downs has been empty.

Student loan debt, now the second largest debt in the US at around $1 trillion, is the one kind of debt that has been growing since 2008. It is depriving new graduates of the ability to start families and buy new homes. This debt is partly a byproduct of cutbacks in federal and local aid to the universities, and partly of turning them into profit centers – financializing education to squeeze out an economic surplus to invest in real estate and financial holdings, to  pay much higher salaries to upper management (but not to professors, who are being replaced by part-time, un-tenured help), and especially to create a thriving high-profit, zero-risk, government guaranteed loan business for banks.

This is not really “socializing” student loans. Its social effects are regressive and negative. It is a bank-friendly giveaway that is helping polarize the economy.

The character of the stock market has been turned upside down. Instead of raising equity capital to reduce corporate debt ratios, corporate takeovers are being financed with debt.

Business debt service is still crowding out the use of corporate cash flow for new tangible investment and hiring. This is especially the case for companies bought in leveraged buyouts for corporate or management takeovers. Shareholder activism is forcing industrial companies to yield financial returns, such as using earnings for stock buy-backs to bid up stock market prices (and thereby increase the value of management stock options). We thus are seeing a buildup of financial capital, not of industrial capital.

The result of the private-sector debt overhang is a self-feeding spiral of debt deflation. Revenue earmarked to pay bankers is not available to spend on goods and services. Lower consumer spending is a major reason why firms are not investing in tangible capital to produce more output. Markets shrink, shopping malls close down, and empty stores are appearing for rent on major shopping streets from New York City to London.

Slowing employment is causing a state and local budget squeeze. Something has to give – and it is largely pension plans, infrastructure spending and social programs.

However, the one kind of debt we are not worried about is government debt. That’s because governments have little problem paying it. They do not need to balance their budget with tax revenue, because their central bank can simply print the money. On balance, the overall public debt rarely needs to be paid down. As Adam Smith noted in The Wealth of Nations, no government in history ever has paid off its public debt.

Today, governments do not even have to pay interest on money their central banks create. (Think of the Civil War greenbacks.) Even for borrowing from bondholders, Treasury borrowing costs are now the lowest in history. As for the monetary effect of governments running budget deficits, there is little threat of commodity-price inflation. Price rises are concentrated where special interests are able to indulge in monopoly pricing and rent extraction.

Yet most of the speeches you will hear this afternoon will warn about the rising government debt, not private-sector debt. The press follows this hand wringing, urging governments to balance the budget to restore “fiscal responsibility.”

The problem is that “fiscal responsibility” is economically irresponsible, as far as full employment and economic recovery are concerned, less government spending shrinks the circular flow between the private sector’s producers and consumers. That is the essence of Modern Monetary Theory (MMT) that Steve Keen here, and Yves Smith in the earlier panel, have been writing about in our blogs.

So, I needn’t elaborate here on how the United States should look at Greece, Spain, and other Eurozone disaster areas, that lack a central bank to monetize deficit spending into the economy to restore growth. “Fiscal responsibility” and “smart investment policy” are mutually exclusive. What really is responsible is for the government to spend enough money into the economy to keep employment and production thriving.

Instead, the government is creating new debt mainly to bail out the banks and keep the existing debt overhead in place – instead of writing down the debts.

So, governments from the United States to Europe face a choice: to save the economy, or to save the banks and bondholders from taking a loss by keeping the debt overhead in place and re-inflating real estate prices to a level high enough to cover the debts attached to the property whose underwater mortgages are weighing down the banking system.

The problem is rising housing prices increase the cost of living, and hence of employing labor. When I started to work on Wall Street fifty years ago, banks had a basic rule in lending mortgage money: mortgage debt service should not exceed 25% of family income. A year ago, Sheila Bair recommended limiting mortgage lending to 32% of income. Washington’s most recent rules for providing housing loan guarantees raised the ratio to 43%.

When it comes to analyzing comparative advantage among nations, the key no longer is food or prices for other goods and services. Financial charges and taxes are the key. The typical blue-collar family budget provides the explanation for why the United States is losing its industrial advantage.

Housing (rent or home ownership)40%
Other bank debt10 to 15%
FICA wage withholding13%
Other taxes15%

Only 20 to 25% of the family’s budget is free to buy the commodities being produced. This means that Say’s Law – the circular flow of income and spending between employers and their work force – is diverted to pay debt service, and also to pay including Social Security and Medicare taxes as a user fee instead of these services being paid for out of the general fiscal budget by progressive taxation falling mainly on what Adam SmithJohn Stuart Mill, and their Progressive Era followers urged: land rent, natural resource rent, monopoly rent, and luxuries.

A Keynesian economist would point to excess saving as the problem. But debt repayment has changed the character of saving in today’s debt-ridden economies. In the 1930s, Keynes pointed to savings being a leakage from the economy’s circular flow. What he meant by “saving” was mainly non-spending – keeping income in bank accounts or other liquid or illiquid financial investment.

But savings rates have risen since 2008 for quite a different reason. America’s recovery of savings rate from zero in 2007 is not a result of people building up saving for a rainy day. What the National Income and Product accounts report as “saving” is actually paying down debt. It is a negation of a negation.

This is what debt deflation means. The antidote should be more government spending and larger deficits – as well as debt forgiveness.

Bank lobbyists are urging just the opposite set of policies. They have implanted a false memory and a false economic theory blaming hyperinflation on deficit spending. The reality is that every hyperinflation in history has come from paying foreign debts, not domestic debts.

Germany’s Weimar inflation resulted from the Reichsbank having to pay reparations to the Allied Powers. It sold German currency on the foreign exchange markets for sterling, francs and dollars – far beyond Germany’s ability to obtain foreign exchange by exporting. Germany had been stripped of its coal and steel production capacity and its ability to export was limited. So, the currency plunged.

Declining exchange rates caused import prices to rise. The general price level followed suit behind the umbrella effect of higher import prices. More money had to be printed to pay for transactions purposes at the higher price level. Every serious study of the German hyperinflation – and also those of France and, later, of Chile – shows the same sequence of causation from foreign debt payment to currency depreciation, rising domestic prices, and, finally, to new money creation.

The German economy suffered from austerity imposed by over-indebtedness. The same was true of debt-strapped Third World economies from the 1960s onward under IMF austerity programs, and it is true of eurozone countries today. Austerity and lower government spending did not make these economies more competitive. It worsened their balance of payments and made their distribution of wealth and income more unequal as economies polarized between creditors and debtors.

The policy lesson for today is that to avoid debt deflation, falling markets, and unemployment, the economy needs to be revived. The way to do this is what was called for and, indeed, promised four years ago: a write-down of debts in keeping with the ability to pay.

Once this debt overhead is addressed, tax reform is needed to prevent a debt bubble from recurring. A tax system, that favors debt financing rather than equity, and that favors asset-price “capital” gains and windfall gains over wages and industrial profits earned by producing tangible output, has been largely to blame. Also needing reform is tax favoritism for the offshore fictitious accounting, that has become increasingly unrealistic in recent years.

Unless government fiscal policy addresses these issues, the U.S. economy will face the same kind of debt-deflation pressures and fiscal austerity, that is now tearing the eurozone apart.

There is something striking about the arrangement of talks for later this afternoon. In contrast to the majority on this panel (Steve Keen and William Greider), we saw the crisis coming and warned publicly about it. Steve’s printed bio for this conference gives the Financial Times article, that acknowledged this and reproduced my flow chart of the economy. Second, on that flow chart, you will see that for every half a trillion in federal deficit spending since the 2008 crisis, the Federal Reserve and Treasury have spent twice as much – $1 trillion – in providing new credit to the banks.

President Obama announced that he hoped the banks would lend it out. So, the solution by his advisors, including some here today, is for the economy to “borrow its way out of debt.” The aim of the Fed and Treasury subsidies of the commercial banks is to re-inflate housing prices, stock and bond prices – on credit –  that means on debt.

This, obviously, will make matters worse. But what will make them worse of all is the demand that the government “cure” the public-sector deficit by spending less, generally, and, specifically, by cutting Social Security and Medicare. As in the case of the recent FICA withholding, ostensibly to fund Social Security, the effect of less public spending into the economy is to force the private sector more deeply into debt.

I find there to be something hypocritical about this. Instead of writing down debts of the 99% to keep their financial heads above water, the government is trying to save the banks and the 1% – at public expense. Why do they call for governments to balance the budget by pushing the economy at large deeper into debt, while trying to save the banks from taking a loss?

The ultimate question to be posed is, thus, whether the economy really needs Wall Street and the banks to be made whole on credit, that has been created largely to inflate asset prices (the Bubble Economy) and to gamble on derivatives and computer programs (Casino Capitalism), without really interfacing with the industrial sector and employment – except to provide takeover credit for leveraged buyouts, that load down companies further with debt?

Placed in this context, the financial problem, thus, turns into a structural social problem.


  1. Pingback: Government Debt and Deficits Are Not the Problem. Private Debt Is | Fifth Estate

  2. joe bongiovanni | March 13, 2013 at 7:19 am |Thanks to Dr. Hudson for this great posit of the private debt problem, it being causal to the public debt solution. But I don’t really see any connection being made to the root cause for all the private debt in the first place.
    It is unfortunately not simply an ill-advised tax structure and an un-balanced reward system in the financial sector. These are symptoms of the failure of the money-finance system, but not the cause.
    The cause has been previously identified by Dr. Hudson quite specifically.
    It is compounding interest on a debt-based system of money.
    Each credit/debt bubble is predicated on its predecessor debt bubble.
    Debt bubbles occur in finance for two axiomatic causes – because they have to and because they can; because compounding interest does not lie and does not get cured without debt-deflation.
    That’s what Fisher’s Debt-deflation Theory was all about.
    Financial and monetary chaos is the natural outcome of a debt-based system of money, which is also the cause for wealth concentration through upward flows of income to the debt-asset creators.
    You can embrace a debt-jubilee of sorts to achieve some semblance of social equity, and financial reforms of all genre, but unless you eliminate the root cause, compounding interest on debt-based money, the grandkids will be right back here doing this all over again.Please see:
    (Seems to only work by copy/paste in browser address)
    The Deeper Roots of the Global Financial Crisis
    Dr. Bernd Senf, Pr.Emer., The Berlin School of Economics.

    • justaluckyfool | March 14, 2013 at 10:59 am |*WHAT IF THE …The Fed Reserve were to become the CENTRAL BANK WORKING FOR THE PEOPLE (CBWFTP) instead of working for the Private For Profit Banks (PFPB) .The government can not win against ‘compound interest’ on debt for that can be infinite in amount. IF ‘compound interest were eliminated then there would be no “systemic failure”. Or better yet; take that most powerful weapon, use it for the people .
      Let’s try this game: Substitute the words “Central Bank Working For The People” (CBWFTP) where ever” Private For Profit Banks” (PFPB) appears.****PFPB (read CBWFTP) have $100 trillion in assets as mortgages on residential and commercial real property (RE) loans. The average compound interest rate is 4% for a term of 36 years. The PFPB (read CBWFTP) would have created that $100 trillion ‘out of thin air’ (Horizontal Money)(read Vertical Money) which would have an attachment that would require $400 trillion to be paid to the PFPB (read CBWFTP). YES, take away the smoke and mirrors, this is a fact-the Rule of 72. Now we must replace (reduce to zero ) the Horizontal Money by subtracting $100 trillion leaving a profit,income,taxation from ‘somewhere else’ of $300 trillion. This amount goes as profits to the PFPB.(read CBWFTP) Revenue they may use for their own selfish purposes. That’s not the bad news-what the bad news is :That $300 trillion is real money, real currency, sucked up by the PFPB, (CBWFTP) yes Vertical Money !!
      Why would you not want prosperity for yourselves and your children? Why would you not want $300 trillion THAT MUST BE PLACED BACK INTO THE ECONOMY IN ORDER TO PREVENT DEFLATION !
      Maybe,just perhaps you might read and improve : “Justaluckyfool” that Adair Turner is suggesting Quantitative Easing for the People not for banks. Copying @ProfSteveKeen?
      Adair Turner recommends Quantitative Easing for the People
      A breakthrough speech on Monetary policy by journalist and financial economist Anatole Kaletsky was published by
      READ “QE 4 The People”
      Read “QE 4 Disaster Relief”
      Discover a path to

    • UMKC Economics Undergrad | March 17, 2013 at 10:16 pm |Thanks for citing Fisher’s Debt-deflation Theory. I’ve listened to Dr. Michael Hudson’s interviews on Pacifica/KPFA’s Guns and Butter (and transcribed and posted some on as well). And I recall interviews wherein host Bonnie Faulkner has asked Dr. Hudson for clarification of the concept of debt deflation.I hear Marxist-leaning thinkers often say it’s simply “capitalism,” which always yields ‘financial and monetary chaos.’ I’m told capitalism cannot be ‘saved.’ But when I ask for the key factors differentiating their proposed socialist model from the existing capitalist model they usually shrug. And clarifying the causality of the boom-bust cycles seems key to socioeconomic equity. But, certainly, we can all agree compounding interest is all bad, as is the de facto two-party dictatorship, which always sides with the ruling-class and is now building legal barriers to entry to alternative political parties, such as California’s Top Two Primary.

  3. Frank | March 13, 2013 at 8:17 am |Margrit Kennedy also points out the problem of compound interest growing exponentially, which impacts every part of a country’s economy. payments and Interest:
    Gains show large disparities:
    80% of the population pays twice as much as they gain.
    10% gain more than twice as much as they pay.Her analysis his spot on, but her suggested solutions are too complicated in my view. She seems to exclude the idea of a government creating its own debt and interest free money.

  4. Tyler Healey | March 13, 2013 at 8:33 am |Great speech, Michael!Low interest rates seem to encourage people to go into debt, while also starving the economy of interest income. I think they should be saved for when there is an inflation problem, which is certainly not now.

  5. RobertM | March 13, 2013 at 8:47 am |Brilliant explanation of the problems we face in terms layman can understand.In regards to compound interest:
    I believe it was Dr. Hudson who previously said ‘Debt that cannot be paid back won’t be paid back’.
    “The greatest shortcoming of the human race is our inability to understand the exponential function.”- BartlettOur government has chosen the banks over the people. Sadly, they do not understand the above quotes.

    • UMKC Economics Undergrad | March 17, 2013 at 10:29 pm |The “laity” is the most important audience, as we are the most numerous. And I think Dr. Michael Hudson is one of the strongest public figures bringing some hard-hitting heat. Of course, we gotta give it up for Dr. William K. Black, Dr. L. Randall Wray, Dr. Stephanie Kelton, and UMKC heterodox economics.Yeah, that’s a great quote from Dr. Hudson:“The basic premise underlying my analysis is that a debt that can’t be paid won’t be. All of the Wall Street analysts I know realise the debts can’t be paid. The political question is how won’t they be paid. Will they not be paid by letting the banks foreclose? One quarter of all American real estate today owes more money on the mortgage than it actually is worth. That means one quarter of homeowners—almost ten million people—could walk away from their property and come out ahead on their balance sheet. Donald Trump would walk away. Certainly, Goldman Sachs walks away from bad investments. But individuals are told that their debt should be paid, that only the debts of the rich don’t have to be paid. Only the debts of the 99% to the rich have to be paid. And there’s a shift in the understanding of how the economy works.” OR

  6. Giselle | March 13, 2013 at 10:04 am |Student loan debt is the same as cost of war on drugs. Not counted expenses on prisons, court costs, built up police state, deaths and human tragedy. Legalization of drugs as Portugal did in 2001 could save $ 15 bilions annualy

  7. Giselle | March 13, 2013 at 12:01 pm |Silvio Gesell and Gottfried Feder were from the same platform as M. Kennedy. On Gesell’s theory work indenpendent currency in Swiss called Wir which support barter business with over 1 bilion SF equivalent annualy. I see problem in centralization, monopolization and corrupted political monoculture. I see this as roost and cause all above. Look at decentralized Swiss. They decided in referendum to limit “golden bonuses” for outgoing oligarch since this is actually out af pocket of small investors . I always smile from those libertarians, tea party, reps, dems and so on. Any ideas have dead end in political monoculture in DC which is deaf, blind and mute. It is worthless to spend time to create ideas and throwing them as dust into air.
    Look at healthcare reform. Main issue in US is employers out of benefits as healthcare etc. All must be done on indenpendent basis and alternatives in public cooperatives. The best health insurance in Brasil is public cooperative. It is not necessery to change system just alternate monopoly. Those monopolies will sooner or later go out of business by itself. Doing this need to change tax system- it needs to be changed no matter what, and rapidly rise minimum wages as we take benefits from employers they need to add money on paychex. See minimum wages in Scandinavia, Benelux, Austria or Canada on wikipedia.
    Student loan debt? No other country on this world has this problem as they have decentralized and demonopolized systems. Money for education comes from income, sales, fuel taxes not property tax. This package is split by number of stdents. When parents asign kid to school this school get the money no matter if public or private. If is cost more than that, mostly private, parents pay extra money. But keep kids in school as prisoners of district is nasty monopoly.

  8. Giselle | March 13, 2013 at 12:16 pm |Another thing is efectivnes of schools. In Europe after 8 elementary yers students have 3 ways depend on score: school of trades, specializing on trades high school, and similar to college which prepare for universities. What they get? They do not mix bad with good students. They got great tradesmans from schools of trade who are lifetime certified without money out of pocket, high school prepares nurses, teachers- limited, technicians- they also get certificate for trade but usually they do lower management as foremans etc. And those from 3rd level- school elites at age 18 goes to universities. So they eliminated 4 years bubble of expenses syntetically created by Board of education created by Rockefeller’s monopoly. And output is exactly as they wanted to- debt prison.

  9. Robert Avila | March 14, 2013 at 8:07 am |“Student loan debt, now the second largest debt in the US at around $1 trillion” and yet no one ever asks what was this debt used to finance? I did a study in the 1980s of US College and University budgets which found that over the previous twenty years per student College and University spending on educational services as compared had remained flat in constant dollars while administration and overhead spending grew year after year. That was before the rise of adjunct instructors, and university ancillary business operations. Over the past 25 years University and College administration is one of the few sectors of the economy where work processes have not been systematically automated and outsourced. Corporate headquarters are far smaller and leaner than they were in the 1970s and 1980s, while the bloat in higher education continues rise driving up “costs”. It is the student loan program that has turned the administration of higher education into a money making business for administrators. It has not increased the quality or the quantity of higher education.Historically most loans have required collateral that can be foreclosed on in the event of default. The two great exceptions are sovereign debt and student loans. Student loans, being against future earnings, are a form of indentured servitude and thus of questionable legality. When viewed in the light of the vast administrative bureaucracies these loans subsidize, their morality is even more dubious.

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