The Paradox of Debt (eBook)

INTRODUCTION

In 2020, during the darkest hours of the global coronavirus pandemic, the US government spent $3 trillion to help rescue the country’s – and, to some extent, the world’s – economy. This infusion of cash increased US government debt and thus reduced US government wealth by almost the entirety of that frighteningly large amount – the largest drop in US government wealth since the nation’s founding. Surely something this unfavorable to the government’s ‘balance sheet’ would have broad, adverse financial consequences.

So what happened to household wealth during that same year? It rose. And it improved by not just the $3 trillion injected into the economy by the government but by a whopping $14.5 trillion, the largest recorded increase in household wealth in history. As a whole, the wealth of the country – its households, businesses, and the government added together – increased by $11 trillion, so this improvement in wealth was contained largely to households.

How and why did such an extraordinary increase occur?

To understand this paradox, we need to seek answers to some of the most fundamental questions in economics: What is money? What is debt? What brings about increases in wealth? Often the most basic questions can be the most challenging to answer. They appear deceptively simple but they are complex and vitally important.

To address these questions, in this book I share a new approach to analyzing US economic data. I then set this data in the context of total global money and debt, comparing the US to the six other largest economies in the world: the UK, China, France, Germany, India, and Japan. This provides crucial insights into how the US economy operates while also offering a generalized model of how most economies work, even as some details vary from country to country. In so doing, we learn not only what precipitated the increase in household wealth in 2020 but also build a much deeper understanding of global economic trends and their policy implications.

THE STATE OF DEBT TODAY

Even the casual observer is likely to be aware that debt has grown rapidly in the US and other major, developed countries over the past half century. This is true of both government debt, which has been closely studied by a broad range of economists and policymakers, and private sector debt, which has been analyzed to a lesser degree but is integral to the growth and health of an economy. Private sector debt includes everything from secured real estate debt, such as home mortgages and commercial real estate loans, to personal debt such as credit card balances, student loans, and healthcare expenses being paid off over time.

Nor is the trend of debt growth unique to the US. From 2001 to 2021, when global gross domestic product (GDP) more than doubled, global debt tripled, to $230 trillion. Of that total, more than 60 percent – $145 trillion – was private sector debt, while $85 trillion was government debt.

In fact, over the past fifty years, the quantity of total debt as a percentage of GDP has grown substantially in every one of the world’s seven largest economies. Together, these seven countries represent 62 percent, or nearly two thirds, of global GDP and 75 percent of global debt. For convenience, I refer to them as the Big 7.

Figure 0.1 shows the ratio of total debt to GDP for the Big 7 from 1970 to 2021. GDP is national income and spending, so the ratio of debt to GDP is, in effect, the ratio of a country’s debt to its income. Just as a high ratio of debt to income would be concerning to a household, a high ratio of debt to GDP, especially of private sector debt to GDP, is concerning for an economy. The striking feature of the past fifty years is the inexorable rise in debt in relation to the GDP of all of the Big 7 economies.

Global debt is concentrated in just two countries: the US and China. The private sector portion of that debt is largely comprised of real estate debt. Figure 0.2 shows the relative amounts of total debt among the Big 7, along with the relative types of debt – that is, government debt as compared to the key private sector categories of business and household debt.1

These economic trends are clearly significant, but most economists – and the most prominent books explaining economics – pay little attention to total debt. Politicians and the financial media also give total debt short shrift. Either the role of debt in the economy is set to the side in favor of focusing on spending and growth, or the discussion of debt is directed more narrowly on government debt alone, ignoring both the size and the weight of private sector debt. Yet there is far more private debt than government debt, and so private debt should be of much greater economic concern. Studying government debt without understanding private debt is like studying the heart without understanding the circulatory system: it is helpful for fixing problems with the heart, but if there are wider problems of circulation, it will not heal the patient, or help them to survive.

A RECKONING FOR DEBT

In this book, I look at the causes and consequences of increases in total debt – public debt integrated and analyzed in tandem with private debt – and likewise combine the study of liabilities with the study of assets, which are largely comprised of debt, both what is owing and what is owed. This involves applying basic financial and business accounting rules to the Big 7 economies. While such an approach is uncommon in the field of economics, it yields powerful insights into the complex interactions underlying an economy.

In the business world, debt numbers are important, but they are only one set of numbers in a company’s statement of condition, a financial report that is usually, and more casually, referred to as the ‘balance sheet’.2 The statement of condition compiles the business’s assets and liabilities to show net worth or wealth; to gain a full picture of financial standing, assets and debt must be weighed against each other. In this context it is perhaps not surprising that money and debt have grown at a stratospheric pace in recent decades, with the global money supply of $16 trillion in 2001 rising to $82 trillion in 2021. Wealth has generally grown faster than both money and debt over the same period.

The balance sheet is accompanied by an equally important financial report called the income statement, which records the income and expenses of the business for a given time period. Income statements and balance sheets are typically published at least annually and are connected, given that increased net income adds to wealth.

I have taken economic data3 for the US in the form of income statements and balance sheets and analyzed them for the US economy as a whole and for each of its major subsets or ‘macrosectors’ – namely, households, non-financial businesses, financial institutions, governments, and that sector of the economy that represents financial transactions with the ‘rest of the world’, or ROW.

The economic statistics of a country are, in essence, simply all the financial information of the country’s individuals, businesses, and institutions added together. Since those entities manage their records, formally or informally, as income statements and balance sheets, it follows that considering these number in the aggregate is an appropriate and straightforward way to analyze the economic status of countries and the world as a whole. Some of the data we seek is easy to obtain and other data not so much, partly due to more limited interest in documenting phenomena related to private sector debt. Nevertheless, I’m grateful for the data that is available. It is due to the considerable efforts of the US Federal Reserve Bank, the World Bank, the Organisation for Economic Cooperation and Development (OECD), the Bank of International Settlements (BIS), and others that my colleagues and I have been able to undertake the analysis in this book, which would have been painstaking if not impossible a generation ago.

As we take this unique economic journey together, it will become clear that debt, especially private debt, represents an overlooked and misunderstood but powerful economic force – so much so that the methods and analysis in this book might be considered the debut of a new discipline, debt economics, that could help us to better manage economies in the future. As we as a society come to better understand debt, it will become possible to more accurately forecast economic trends, predict financial crises, shape policy decisions, and understand how national wealth grows, and thus how to address inequality.

A NEW UNDERSTANDING OF DEBT

When you set aside the specialized tools of economists and instead use the conventional and familiar methods of financial analysts and accountants, several things come into view: