A Debt Jubilee Is Unavoidable

Mariano Torras Economic Theory, Finance, Future, General, History, Macroeconomics, Politics, Public policy/Wellbeing Leave a Comment

April 11, 2021

I am truly sorry not to be teaching my macroeconomics principles class this semester. Debt is invariably an under-remarked topic in such classes, never mind a debt jubilee (or debt forgiveness). Yet everything recently happening both in the markets and politics offers a “real-time” tutorial. So, here I will try to explain why, in my view, a debt jubilee is unavoidable – sooner or later.

“Debt” may be an abstract and confusing concept to many. Largely it is because we really are talking about several different things. National governments, for example, are increasingly indebted, mostly though not entirely to the capitalist class and the private sector. Developing country governments are increasingly indebted to industrialized country governments. And households are increasingly indebted to capitalists via mortgages, credit cards, and student loans. We can classify these and other similar relationships as “debt.”

The massive rise in total debt levels since 1970 (see Chart) have greatly increased inequality – social, international, and intergenerational. It is what Thomas Piketty, of Capital in the 21st Century fame, means when he addresses the growing gap between “r” and “g.” To Piketty, r stands for the average return on private assets and g for the GDP growth rate. As debt levels grow, creditors gain more interest income (part of r), which does not contribute to g. So, inequality worsens. Piketty envisions a future where, major absent policy remedies, the trend continues indefinitely.

I do not harbor any illusions that debts are, in aggregate, ever paid off. And history bears this out, as argued by the late David Graeber in his tour de force on the subject. Yet in my principles class my students learn that price inflation is one mechanism of natural redistribution. 

Inflation, for example, hurts recipients of retirement annuities, since the purchasing power of their monthly payments diminishes over time. But inflation helps people paying off mortgages since it (mostly) increases their incomes but not their monthly payments. So, it is generally the case that inflation redistributes income from creditors (usually richer) to debtors (disproportionately poor).

It is why discussions about the so-called unemployment-inflation tradeoff are always mired in controversy. The rich could happily live with marginally higher unemployment, if it means low inflation and minimal erosion of their asset values. It explains perfectly why, until only a month ago, the Federal Reserve has long prioritized inflation targeting. The poor and the middle class, who possess a minimal share of the country’s assets, understandably consider their employment chances more important.

And the good news for them, if expert opinion is to be believed, is that inflation is coming. If consumer spending were to “take off,” as expected with pandemic fears subsiding, inflation could be significant. 

To understand why, we need to look at both the supply and demand sides of the economy. The pandemic-induced shrinkage experienced by the supply side of the economy will surely take some time to correct. New facilities need to be built, machinery purchased, etc., and this takes time. And it only happens once businesses have regained enough confidence in the future. Rapidly increased demand against slowly increasing supply is a recipe for inflation, since scarcity would prevail for at least the short to medium term.

As argued by Pascal Blanqué, such an outcome, if not Panglossian, would surely be better than the alternative of continued stagnation. An inflationary period would offer an opportunity to unwind the massive existing debt in an orderly fashion. In a way, it would be akin to a debt jubilee, even if not a complete one (since debts would not be canceled, only reduced). The wealthy might not like it, but the alternative would be decidedly worse. Continued stagnation would only make the global economy even more reliant on debt, with the future reckoning that much greater whenever it comes.

Yet prevailing inflation forecasts presume robust growth leading to economic recovery. The presumption is critical. Absent a meaningful recovery, unemployment and stagnation would persist along with inflation, meaning that our economy would continue to be reliant on debt. With debt levels already teetering on the threshold of unsustainability, it is not a stretch to suggest that any inflationary “escape” from economic crisis must be accompanied by growth. 

And therein lies the rub. Expert opinion aside, an imminent emergence from pandemic darkness is hardly guaranteed, or at least not in the immediate term. And even if it were in the cards, I wonder how many Americans would actually engage in a wholesale spending spree. There is no good reason for households to halt their recent savings behavior. Saving, after all, tends to trend upward in uncertain times. And make no mistake: Uncertain they remain.

For this reason, I am perhaps more circumspect than most about inflation in the near term. Decades of shifting from real and relatively prudent productive investment to debt-fueled speculative financial investment has created unprecedented economic inertia. Despite the sound logic behind the argument for its inevitability, it is difficult for me to imagine appreciable inflation in the near term. Although conceivable, continued stagnation, if not deflation, is at least as likely.

The many in the investor class who understand the above problems hope for a “soft” landing that concedes some asset erosion. It is a major reason, for example, that there has not been more opposition to Biden’s stimulus plans. But there is a greedier subgroup that will stop at nothing to prevent redistribution, however ill-begotten their earlier gains.

Here is where the main tension rests. How it is resolved will ultimately determine whether the unavoidable debt jubilee, whenever it comes, will be passive and orderly or active and potentially chaotic. There is also a third alternative, as noted by Michael Hudson. But let us here at least avoid the topic of economic depression.

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