Debt, Deflation, and Debacle: Of Private Debt Write-Down and Public Recovery
KeywordsPrivate debt overhang
Financial asset price bubble
Banking and Finance Law
Law and Economics
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AbstractMost public discussion of the world’s continuing financial and macroeconomic troubles focuses rightly on debt. It focuses wrongly, however, on public debt. The real source of our ills is global-trade-related private debt overhang among millions of households below the top of the wealth distribution in the “developed” world. That is the provenance of both (a) the asset price bubbles and busts in whose aftermath we still struggle, and (b) the fact that we’re still struggling. Public sector debt growth in the developed world since 2009 is merely a symptom – the product of thus far failed treatment – of this fundamental condition. In sum, then, we are now living with over three decades’ postponed secular stagnation on the part of the global middle class and the economies whose growth they once fueled, the destructive consequences of which we simply put off to, and accordingly concentrated into, the present moment. This is why times are so tough and so volatile. What then to do? Relative to the state of the public discussion, the answer is lamentably obvious. In the immediate term, private debt must be massively restructured and largely forgiven on a scale commensurate with those asset price plummets that were the crash. In the longer term, the structural conditions that render us debt-dependent have to be radically, even if incrementally, altered, while financial regulation for its part must become forthrightly macroprudential in character. This is the only sustainable way to eliminate our now crippling private debt overhang and prevent a recurrence. The only alternatives are intolerable: (a) continuing slump, with all of the waste and continuing tragedy it entails; or (b) further asset price bubbles and busts, of the sort in which all efforts to pare overhang artificially from the asset side of the balance sheet alone – e.g., through non-supplemented monetary policy – ultimately issue. This paper aims to head-off these intolerable alternatives. It begins by elaborating more fully on the role played by inequality and private debt in fomenting financial crisis and then underwriting post-crisis slump, first modeling the mechanism through which this occurs, then empirically corroborating the presence and operation of this mechanism in the nation’s most devastating bubbles, busts, and ensuing deflations. The paper then documents the magnitude of that post-bubble private debt overhang with which we now struggle. It shows that this overhang is by far the most salient cause of our ongoing troubles. The paper then turns to elaborating a full menu of shorter and longer term policy actions that must be taken to eliminate private debt overhang and restore healthy growth to the macroeconomy. These include carefully integrated debt write-down, capital-ownership-spreading, finance-regulatory, and global currency reform measures.