4---Public and private debt essentially trade off one for one – you’d rather have public

Start with public debt deleveraging, since it is the type of debt that garners the most attention. Economists and politicians often cite the post-World War II period as a triumph of government debt deleveraging. In the 30 years from 1951, a point just beyond the wind-down of World War II, to 1980, the beginning of the Reagan era, federal debt to GDP declined from 73 percent to 32 percent (it is now back to 105 percent). What these experts generally either don’t notice or neglect to mention is that private debt increased dramatically during this period, from 54 percent to 101 percent, entirely offsetting the decline in government debt. It was that offsetting leveraging that allowed the public debt ratio to come down. Otherwise we would have had massive GDP contraction just like in the Great Depression. From 1951 to 1980, a huge $2.7 trillion increase in private debt powered a $2.5 trillion increase in GDP, such that even though public debt grew by $653 billion, it declined in ratio to GDP. But total debt increased in ratio to GDP. The GDP growth resulting from that private debt growth is what allowed the federal debt ratio to decline without causing a contraction in GDP. In fact, offsetting private leveraging is usually the mechanism that enables the ratio of public debt to come down. So, for example, we may find that a given country’s GDP grew by $30 billion, but public debt grew by only $10 billion, thereby improving that country’s public debt ratio. When we examine countries comprehensively, what we will generally find in a situation like this is that private debt will have increased by $20 billion or more in the same period, filling the “gap” left by slower public debt growth. In this example, it took a full $30 billion in total debt growth—$10 billion public and $20 billion private—to obtain this $30 billion in GDP growth. The exceptions to this are when there is very high inflation or a large net export position. To understand this more fully, I examined a database that includes available data from 1945 onward for 47 of the largest 71 countries, including the 20 largest. (Historical private debt data is missing for certain countries, underscoring the lack of attention to this subject.) These countries together constitute 91 percent of world GDP. For these countries, since World War II, there have been a total of 42 cases where public debt to GDP (and not also private debt) has declined by at least 10 percentage points in a five-year period. By my reckoning, in 33 of these cases, this deleveraging was due largely or wholly to increasing private debt leverage—not the most desirable way to achieve that end. Stated differently, on a ratio basis, private debt increased as much or more than public debt decreased, and therefore overall debt stayed high. In the next eight cases, the deleveraging was due to high inflation. Inflation does work, but it is a painful path to deleveraging. In the one remaining case, Saudi Arabia from 1999 to 2014, the deleveraging was due to massive positive net oil exports. In no case was the deleveraging accomplished without one of these three factors—rapid private debt leveraging (which in many cases led to a financial crisis), high inflation, or a very large net export position. None. Both private debt leveraging and high inflation are steep prices to pay for public deleveraging. A high net export level is a better path, but it is the very thing that contributes to the global imbalances that economists have so heavily criticized. It generally only occurs in smaller countries, and is very difficult for larger countries to sustain without political repercussions, as with China in the 2000s or Germany in the current, contentious EU. In any event, in its entire history, the United States has never had a sustained export surplus of the size required for meaningful public debt deleveraging. The story is similar for private debt. Private debt deleveraging has usually only been possible because of offsetting public debt increases. Japan’s private debt ratio reached a whopping 221 percent in the lead up to its 1990s crisis. But luckily for Japan, its public debt ratio at that time was only 86 percent. In the two decades following Japan’s crisis, private debt has deleveraged from 221 percent to 170 percent (which is still too high), but that deleveraging was enabled by a massive increase in the public debt ratio from 86 percent to 246 percent. Private debt declined by ¥260 trillion, but public debt grew by ¥810 trillion, and the combined impact of this debt increase was growth of zero in nominal GDP. Again, just one example, but I have surveyed all the available data for these same 47 countries, and since World War II, there have been a total of 40 cases in which private debt to GDP (and not also public debt) has declined by at least 10 percentage points in a five-year period. By my reckoning, in 24 of these cases, the deleveraging was due largely or wholly to increased public debt leverage. In eight more cases, the deleveraging was due to high inflation. In the eight remaining cases, the deleveraging was due to a large, positive net export position. In no case was the deleveraging accomplished without one of these three factors—rapid public debt leveraging, high inflation, or a very large net export advantage. There are only ten cases since World War II in which both public and private debt deleveraged by 10 percentage points or more in a five-year period. Six of these were due to high inflation. Four of these were in large measure due to a high export surplus position, or more broadly speaking, a high current account surplus. One of these, Israel in 2003, comes the closest of any case I examined to deleveraging through growth, but even there, total debt outgrew GDP. Deleveraging is difficult. Absent the methods described above, if the total debt ratio were to be meaningfully reduced, either through an absolute decline in debt outstanding, or through a decline in the ratio, it would force significant, damaging downward pressure on GDP. The Great Depression saw such a deleveraging, and that’s why those years were so tremendously painful. By contrast, in the years after 2008, the U.S. government and the Federal Reserve acted to prevent deleveraging. We were saved from another Great Depression, but we were left with a massive pile of debt.