Inter-Generational Borrowing

Nick Rowe addresses the problem of inter-generational borrowing at:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/debt-is-too-a-burden-on-our-children-unless-you-believe-in-ricardian-equivalence.html

The issue is brought up again by Dean Baker: http://www.cepr.net/index.php/blogs/beat-the-press/children-and-grandchilden-do-not-pay-for-budget-deficits-they-get-interest-on-the-bonds

If I read Nick Rowe right, he assumes (using a toy economy based on apples,) that A: Apples don’t last.  And concludes:  B:  Each generation, in borrowing apples from their children,  consumes an increasing share of the apples produced by their children.  That is, each generation consumes more than they themselves produced, taking from the production of their children. (The second generation gives to the first, but borrows even more from the third, etc.) I think this is correct, and is Nick’s point: Inter-generational borrowing is not neutral. Succeeding generations end up short. And Dean Baker, who claims that there is no transfer of wealth with inter-generational borrowing, is wrong.

If I read this right, then the only moral position is to grow the economy at a rate greater than the increase in (real) inter-generational borrowing. ( Of course, this eventually comes up against physical limitations.) That is, plant apple trees at an increasing rate, greater than the increase in inter-generational borrowing. But this requires (it seems to me) that the present generation consumes less than they would if they hadn’t borrowed in the first place.  That is, the present generation must invest more than they borrow.   

But in terms of the present, real value, this just means the present generation should consume less than they produce, and invest the rest. The borrowing of money is irrelevant, except where it affects this. 

In fact, the borrowing of money is rather inverted, because the younger generation is forced to borrow money from the older, established, wealthier generation, pay that older generation back with interest, and thus end up with a diminished share of the  real pie. 

So this is what the government is doing.  It is the younger generation borrowing from the older, who refuse to pay their taxes, and instead consume more than they produce.   Social Security and Medicare notwithstanding,  (Who, after all, will be cheated, if Social Security and Medicare are not adequately funded in the future?) the government, in principle, represents the interests of the young. Its proper purpose is to invest in the future, which is more the younger generation's than the older.

But the government has been co-opted by the older generation, who, instead of holding it in trust, exploit it to their own profit. 

The Republicans’ stated goal, then, and that of Austerians in general, the shrinking of government, (especially those parts of government that pertain to investment,) is to cheat the young out of their interests.   This is what we are seeing in youth unemployment across the globe, so much being taken away that the younger generation is even being decapitalized.  Here in the US, it is seen as higher costs of college, and lower investment in primary education, the neglect of infrastructure, etc.  (Infrastructure is of greater benefit to  the young, since they can expect to use it longer.)

So not only is it the 1% vs the 99%, but it is the old vs the young.  

The problem for the old, of course, is that by decapitalizing the young, they are decapitalizing themselves.  Because it is on the backs of the young the old hope to take their ease.  

 Running a trade deficit is also borrowing from future generations, and is thus also immoral, unless it is done for investment.

Progressive Taxation Encourages Investment

Progressive taxation can be an important tool in conserving natural resources, since it increases the relative present value of future returns, by reducing the returns to immediate exploitation of the resource.  Consider an example:  A capital good, a wood lot, say, provides an income stream of $100,000 in perpetuity.  Now, if the tax is flat, and the resource can be cashed out, for $2,000,000, and invested at interest for 5%, then the owner would be indifferent to exploiting or conserving the resource.  On the other hand suppose, with a progressive tax, the $100,000 was taxed at a miniscule rate, and the $2,000,000 at 50%.  Then the owner would have to be able to invest the $1,000,000 that remained after taxes at a 10% rate in order to be indifferent to preserving or exploiting the resource.  If this rate were unavailable, he would be more interested in conserving, rather than exploiting, this resource.

Indeed, progressive taxation increases the relative present value of any future income stream, and so encourages investment in the future.

Links to Mansoor Khan

Here are active links to the articles Mansoor Khan refers to in his comment to Debt, Total Debt and by Sector. I encourage the reader to check them out. First:

http://seekingalpha.com/article/209386-modern-monetary-system-there-is-another-way

In Modern Monetary Theory, (as far as I understand it.) the government creates money by printing it, politically easy, once established, preventing inflation, and destroys it through taxation, countering inflation, politically hard. A government of reasonable virtue and principle would be required. A certain amount of inflation is more likely. Indeed, since debtors tend to be numerous, and creditors relatively few, a certain amount of inflation, which favors debtors, might counter natural tendencies toward the concentration of wealth. Compare this to what we see: Creditors have seized control of the government, and seeking to retain what are essentially ill gotten gains, are directing the government toward our common ruin.

(For a nice exposition of the problems with the current system, see:

Money as Debt:

http://www.youtube.com/watch?v=Dc3sKwwAaCU&feature=related

Or:

http://video.google.com/videoplay?docid=-2550156453790090544

And:

Money as Debt II:

http://www.youtube.com/watch?v=rCu3fpg83TY )

Next from Mansoor Khan:

http://aquinums-razor.blogspot.com/2011/08/what-is-relationship-of-money-to.html

And:
http://aquinums-razor.blogspot.com/2010/07/why-is-deflation-and-depression.html

http://seekingalpha.com/article/210346-should-newly-created-money-be-a-private-or-a-public-asset

Good. Helicopter money to every citizen. Give citizenship a tangible benefit, rather than the burden implied by the national debt. Negative taxation, which is precisely what the government should do when demand is depressed. And/Or it could guarantee employment, which would work as an automatic stabilizer.

http://seekingalpha.com/article/192375-cause-of-today-s-economic-crises-too-much-thrift

http://seekingalpha.com/article/160269-a-radical-solution-for-america-s-insolvent-financial-system

An orderly bankruptcy of the financial system, with the government as receiver.

http://seekingalpha.com/article/-great-banking-confusion-is-there-a-better-way

Mansoor's proposal for 100% non-lendable equity accounts seems doable. They would carry essentially negative nominal interest. The magnitude of this interest would be minimized by interbank competition for deposits.

Savings and Investment

There is some illusion about people saving, for retirement, for example. People do not save for retirement. They may think they do. But the reality is society invests to support its people, of whom the retired are (will be) a part.

What do we mean? We mean that it is only in the present that society supports its members. It doesn’t ‘save up’ present production to support them in the future. It doesn’t take past production to support them in the present. In terms of what is being produced, it only has what is currently being produced, to support its economy. Yes it has inventories, but usually these are at most a few months. Society doesn’t accumulate (save) a 20 year supply of dishwashers, so it will have them when they are needed ‘down the road.’ Society doesn’t do this with anything.

The closest society does to this is invest in its productive structure. Roads, structures and machinery last a fair length of time. It builds these things in the present, so it will have their productive capacity in the future. It has built these things in the past, so that we have them now. This is physical capital. A society builds capital in the present, so it will have the productive facilities to support its people in the future. In order to do this, it takes away some of its current production from direct consumption, and invests it.

Now the more society builds these things in the present, the more productive capacity we will have in the future. The more productive capacity we will have in the future, the better off, materially, we will be. Assuming, of course, we have the energy to power it. And the labor to direct it.

In particular, the greater comfort we will be able to support our retirees, and the rest of the idle class. And of course, everyone else. And everything else. Because production must also be supported.

Now the way we decide how to divvy up this production is with money. Those who spend the most money get the most goods and services. Those who spend the most, in the long run, are those who have the most. So if you save money in the present, in the future you will have more money to spend.

Now the theory is that the banks will take this money and loan it to someone who will invest it. That is, take current production, and use it to build more productive capacity, so there will be more goods and services to divvy up in the future. This isn’t the only money that does this. Corporations make profits, which they may spend to increase their productive capacity. Some of government spending may go to increase productive capacity, as with some of the ’stimulus.‘

So what happens instead when the banks take your money and squirrel it away?
Well, you’re still saving, but society is not investing in its future. Its capital is not expanding. So the pie is not growing any bigger. So down the road, when you retire and spend your savings, you may have a bigger share of the pie. But since the pie will not be any bigger, everyone else will, on the average, have a smaller share. This includes other retirees, say those on social security, and those who still work, who are supporting you with their labor. It also includes those other things, the productive facilities which must be supported to maintain present production and expand production in the future. So your individual savings, when you spend it in the future, takes away from everything else, including supporting the production on which it depends.

Now, if this were just you, this would not be very significant. But if there is a substantial share of savers, and the banks are not investing the money, (or investing it badly, say in housing or commercial real estate) then all the other people will have a significantly smaller share. And so will production.

What does this mean? Well, under these circumstances, savings is deflationary in the present, and inflationary in the future. In the present, money is being taken out of the economy, and since it is not being invested, (spent on capital) and put back in the economy, there is continually less money, chasing a constant supply of goods. And since the money was not invested, but merely saved, productive capacity is not expanded, so the quantity of goods will not increase.

So when in the future the money is taken out of savings and spent, along with the money that was there before, we will have inflation. Over time, these two effects could be expected to cancel out. What won’t cancel out is a big increase in money supply caused by deficit spending. If this is invested to expand the pie, well and good. If squandered, so the pie still does not expand, much the worse for inflation. What also won’t cancel out is the contraction caused by the deflation, which is that the decreasing amount of money chases a quantity of goods which is also decreasing., though not as fast., which does tend to mitigate the deflation, at the expense of the destruction of productive capacity. The pie actually shrinks.

So this is what is caused by the financial industry doing its retrenchment thing. Now we have already pointed out that the financial ‘industry’ is much too big, so its hoarding of money (rather than investing it in real industry) can be expected to go on for a while. To the detriment of the rest of the economy, since it means that the money supply in the rest of the economy can be expected to decrease, thus robbing productive industries of their nominal profits. Since these industries are losing money, they are not investing, they are cutting back. Still. (Add to this the contraction brought about by the trade imbalance! See: April 2010 The Effects of Unbalanced Trade)

The problem, of course, is that as long as these banks are in business, they’re going to be sucking the money out of the economy, so destroying the economy on which they depend. The government with its stimulus tried to counteract this action. It didn’t, much. It can’t. The banks are sucking too much, too fast.

So. In Economics, savings and investment are equal. At equilibrium. But not in the economy we are experiencing, where savings and investment are not equal.

Just by the way, elementary Keynesian theory predicts a reduction in a nation’s income with an increase in its ‘thrift.’ It assumes savings increases with income, but investment is relatively independent of income, or flat. How to explain the Chinese, though, eh? Next time.