QOTW: Debt and Delusion
By Barry Ritholtz - July 22nd, 2011, 1:30PM
In yesterday’s afternoon reads, I linked to Bob Shiller’s article Debt and Delusion. The same paragraph (below) was emailed back to me so many times, I had to make it our quote of the week:
“Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidity – or, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories.”
hat tip many many emailers
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July 22nd, 2011 at 2:41 pm
You might add “and investors’ inflated opinion of their abilities.
July 22nd, 2011 at 3:25 pm
Nooooo. Rational expectation works. Just look at the markets.
Oil broke $100 a couple of minutes ago. This is clear and convincing evidence of an economy that is growing faster than pimples on a new teenager with raging hormones. We are booming!!! Warp speed now, Scotty.
July 22nd, 2011 at 3:34 pm
PS Re: oil
I think $110 is the new $147.
July 22nd, 2011 at 3:53 pm
The other main point of Shiller’s article is also worth mentioning. The division of debt/GDP into 4 arbitrary categories and then correlating without consideration for confounding factors is problematic. Maybe the correlation simply show that when you have a bad economy you are more likely to build up national debt and get slow growth in the following years.
I would add that it would have been nice with a detailed plausible model of causation. Yes you may increase the amount of money spend on interest, and that rent-seeking money is a lot less productive than invested money (whether private of public investment). But if that is your model then the relevant parameter is not the debt/GDP rate but the “interest payment” as a % of GDP (interest burden on the national economy). That interest burden is currently only about 1.6% of GDP for the US, compared to about 3.0% from the last years of Reagan and half way into the Clinton presidency.
It is sort of interesting how our corporate media back in the Clinton years focused on the size of national debt interest payments and the % of total federal expenditures used just to pay the interest on the debt. During Bush II the focus was on national debt numbers but without including the debt to social security. After Obama got into office they started including the debt to trust funds and used % of one years GDP with number ominously close to 100% (as in the credit card is 100% maxed out). Yet there are still some lunatics out there who call the corporate media liberal???
July 22nd, 2011 at 4:30 pm
An excellent one via the Curious Capitalist –
“The only way to truly get the U.S. economy back on track is to end this myopic focus on what to cut and start focusing on what to grow,” says Foroohar.
July 22nd, 2011 at 4:56 pm
Not to mention fear, euphoria, hope, and herding behavior.
July 22nd, 2011 at 7:03 pm
Quote of the week? That should be written in stone and placed by the front doors of every economics school in the land!
July 22nd, 2011 at 8:45 pm
What Foroohar said.
Focusing on what to cut is what they did in the UK, Ireland, et al and what they are doing in the European Union generally, and the outcome has been and will be the same all around: Downhill economically with lots of pain and months (or years) of lost productivity to try and catch up with those nations who didn’t cut.
National macroeconomics is not a morality play and you get docked points for purging on the field: If you want to play to win you have to grow something above and beyond puke and mouths to feed.
July 22nd, 2011 at 9:29 pm
he forgot one: a “wicked sense of humor.” the fact of the matter is there is no such thing as a “rational purchasing decision” when dealing with any financial instrument. shall we pick an irrational place from which to start our analysis however? hmmm…where to begin, where to begin…
http://www.youtube.com/watch?feature=player_detailpage&v=Lyg7IJ-_0F4
July 22nd, 2011 at 9:47 pm
market?
invisible hand?
voodoo?
Never mind!
Better to follow Kabir and be “Bairagi avowed”!
July 22nd, 2011 at 11:56 pm
or just plain ole fraud, the name Angelo Mozillo comes to mind…
July 23rd, 2011 at 8:47 am
DeDude:
But the burden on the national income doesn’t depend only on the interest rate itself, it also increases with the total amount of debt, on which the interest payment has to be made, relative to GDP. So, the better choice of a measure would be interest rate*dept/GDP.
BTW: Shiller claims in his article that the number for the debt to GDP ratio depends on the choice of the time period for the GDP. I don’t agree with him here. It only appears in this way, since Shiller uses the wrong unit for the dept to GDP ratio. He uses % as unit. The correct unit for GDP is $/[time unit], though. Thus, the correct unit for the debt to GDP ratio is [time unit]. If one uses the correct unit for the GDP, one always get the same debt to GDP ratio, whether it’s the quarterly, annual, or decadal GDP (assuming the GDP increases linearly in time). The debt to GDP ratio is an approximate measure for how long it would take to pay off the debt for a given GDP, if the interest rate was Zero.
July 23rd, 2011 at 10:51 am
rootless;
I am talking about interest payment and burden in $ amounts (relative to GDP). So during the early year of Clinton we all talked about interest on the national debt being $ 2-400 billion, and that was a sizable chunk of both the national budget and the GDP. In contrast to individuals, who eventually have to pay all their loans back, the country does not care if the interest expense is on a higher principal paying lower rates or a lower principal paying higher rates. It would actually be a disaster for the worlds reserve country on a fiat currency to pay its debt down in any substantial amount.
So during the Clinton years when unemployment was moderately low (3%/year) and the national debt interest payment burden was high (>3%GDP), it made a lot of sense to reduce the deficit (and the % of our GDP used to non-productive rent payments on national debt). Paying down the debt $1000 takes $1000 of productive money and exterminate it, in return for a slight current reduction on the rate of converting productive money into non-productive rent-seeking money (at a rate of $40-60 per year). So paying down debt (or reducing deficits) is a very very long-term investment, but because it is so destructive for the economy it should only be done when the economy is very robust. In the current negotiations Obama appears to be betting that the recovery will be robust enough in 1-2 years to be able to handle the destructive cuts the GOPsters insist on. The administration was too optimistic in their predictions when they did the stimulus, and I think they are again. The much better solution would be to take rent-seeking money from the rich (taxing them) and use it to exterminate rent-costing national debt, that way they could reduce the national debt without hurting the flow of productive money.
July 23rd, 2011 at 10:59 am
Sorry error should have said:
…unemployment was moderately low (<7%) growth was robust (3%/year) and the national debt interest….
July 23rd, 2011 at 11:11 am
dead hobo – why does Oil have to follow supply & demand therory as you state it .. some things you gotta have at all costs – or reshape your entire life in its absence – you do get that .. like money – one of those things you just gotta have at all costs – or reshape your entire life in its absence – you do get that .. thats why you Trade / correct?
July 23rd, 2011 at 11:29 am
bloggers above “the national debt being $ 2-400 billion (early Clinton) and that was a sizable chunk of both the national budget and the GDP” .. “would actually be a disaster for the worlds reserve country on a fiat currency to pay its debt down in any substantial amount”
.. ummm .. no one ever seems to high5 me with the Clinton era high times from “setting up factories on foreign shores” (ok) ..
Americans are the worlds innovator draft horses .. and the eartern countries are the worlds assembler work horses (ok) .. capital needs an incentive – doesn’t it (ok)
July 24th, 2011 at 7:48 am
I agree that “free and fair” trade mantra was a huge mistake, probably one of Clinton’s biggest. Like Obama, Clinton was not great at the economy and did not select a very good economic team for his administration (and allowed the worst to “win” over the best).
The only people who in the long run benefit from removal of tariffs are the investor class. The consumer class may get slightly lower prices on things, but the loss of jobs and associated pressure on wages makes the overall deal a loss for them. We should have a 20% tariff on all imported goods and services. That makes the production of things here a more attractive proposition. Furthermore, when companies try to keep profits abroad by selling things produced abroad at inflated prices, that price excess at least gets hit with a 20% tax. I know some of the bubble heads claims that tariffs made the depression worse, but that claim is not supported by facts. Tariffs did not help because everybody did it to each other. It may also have reduced efficiency if workers in one country were more “efficient” at producing something, but with double-digit unemployment you don’t want more “efficiency”.