Unemployment benefits restored. Bondholders rejoice?

July 23, 2010

Link: Jobless benefits restored for millions

The standard Keynesian argument in favor of paying out unemployment benefits, and for stimulus programs in general, is that the money is targeted to those people with the highest marginal propensity to spend that money on consumption. Increased consumption increases money velocity, which helps put people back to work and relieves deflationary economic forces.

But I wonder if that proposition holds true in an economy suffering under huge debt burdens.

Take the US economy for example. Household debt is somewhere near 100% GDP (levels not seen since the great depression). Total debt, public and private, is something like 350% GDP (I don’t have links to support these figures at the moment. You’ll just have to take my word for it : ). Many working age citizens — those eligible to work for stimulus funds, or receive unemployment checks — are loaded with huge sums of credit card debt, car loan debt, student loan debt, and the biggest of all: mortgage debt.

Non-productive debt

Most of this debt is non-productive — meaning the debt was not accrued in exchange for capital that could be used to eventually improve the income of the indebted (student loans are an exception — education usually has a good return. Car loans might also be considered an exception (the necessity of transportation), but that’s stretching it a bit).

Non-productive debt is essentially nothing more than pulled-forward demand. And demand pulled forward will likely leave a hole in future demand. So when the bill comes due and debt is repaid (as is happening now), current demand suffers.

The paradox of thrift states that, while saving money is generally a good thing, if everyone does it at once, it becomes self-defeating and deflationary. I don’t disagree with that statement. But I would add it’s opposite: The paradox of debt is that, while going into debt to invest other people’s savings is generally a good thing, if everyone does it at once, we’re gonna have one hell of a debt-deflation problem on our hands, when the bills all come due.

Another bondholder bailout?

Back to unemployment benefits and stimulus. I suspect that many people who receive unemployment checks, or work for stimulus funds, or work at all for that matter, are more concerned with paying their mortgages and credit card bills and student loans rather than using that money on direct consumption. Bankruptcy is a psychological barrier that many people don’t wish to cross. If they’re handed a stimulus check, are they going to spend it on food and clothes and whatever other consumption to help get the economy moving again? Or will they pay their mortgage/rent, so they don’t go homeless, and their credit card bills, so the interest fees don’t spiral out of control, and their student loans, which can never be discharged in bankruptcy anyway (assuming they’re govt-backed)?

I bet most people will make their debt payments. And in that case, the money is not directed toward consumption; it’s directed toward debt-holders — i.e. bondholders.

So stimulus funds and unemployment benefits can be viewed as just another route by which the govt attempts to repair bondholders’ balance sheets. And since bondholders are already savers, and have a low marginal propensity to spend that extra money on consumption (or on new investment, given current market conditions), this doesn’t seem like an effective or efficient way to restore economic growth.

But I’m not sure what the alternative is. If we stop delivering unemployment checks, stop funding stimulus, then people will have to downsize their living expenses, write off credit card debt, declare bankruptcy, etc. Perhaps that would be a good thing, at the individual level. But cascading bankruptcies and write-downs could spiral the global economy into deflationary dust. Lots of Austrian theorists, however, claim that’s exactly what we need to do. Yes it will hurt, but the argument goes that the pain will be brief. Otherwise the economy will limp along, perhaps for a decade or more, with little or no growth, as we slowly nurse bondholders back to health, on the well-worn backs of the working class.

So in conclusion: On this matter, I am very unsure. More thought required. In the meantime, until we figure out something better, by all means: write the checks.

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One Response to “Unemployment benefits restored. Bondholders rejoice?”

  1. Jørgen Klaveness Says:

    Thanks again!


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