The above book isn't too clever. It consists mainly of emotive weeping and wailing about the allegedly horrific effects of debt.
The title of the book is misleading: the book does not actually advocate the abolition of debts, i.e. it does not advocate a debt jubilee. Instead it advocates replacing a significant proportion of existing debts with zero interest loans. As for who pays for that largesse, savers and commercial banks pay, which (unbeknown to the author) would ruin most banks.
As for the author’s claim that debtors are worse off now that ten years ago, the author does not take into account the fact that the fall in interest rates (by a factor of about three) is much more than the rise in debts in real terms. Thus mortgagors (who account for about three quarters of household debt) far from being worse off now than they were 20 years ago, as claimed by the author, are now in a significant number of cases better off!!
However, the criticisms of the book set out here are not to suggest that nothing needs to be done about inequalities, which are a significant cause of debt among the less well off. But those inequalities are best dealt with via higher taxes on the rich, a better social security system and so on.
The only reason I read the book was that Steve Keen and Ann Pettifor are giving it a “book launch” on 2nd May. I’m mystified as to why. Though part of the explanation is probably that Steve Keen has long favoured debt jubilees, though it’s doubtful, far as I can see, whether he understands the basic flaw in debt jubilees.
I set out the basic flaw and dealt with Keen’s failure to understand the flaw here. See also here.
Montgomerie’s book basically consists of a lot of weeping, wailing over the allegedly excessive level of household debt, plus it sets out a scheme for cutting interest on that debt. The weeping and wailing will of course be an emotional thrill for the large proportion of the population who are influenced by emotion rather than logic.
And there is certainly a huge amount of mileage to be got out of the emotional overtones of the word “debt”: the Tories won the last two general elections in the UK to a significant extent by repeating ad nausiam that Labour’s allegedly profligate spending in the past and it’s plans for more spending in the future would increase “the debt” (i.e. the national debt). Republicans in the US played the same wholly dishonest trick.
Also the book contains a number of new terms like “financial melancholia” (a term introduced on pages 1-2) which are unnecessary given that standard economics already has suitable words and phrases.
Are household debts excessive?
The author tries to substantiate her claim that debts are excessive in Ch1, page 29-30 where she says “In both the United States and the United Kingdom, the total stock of household debt grew as a proportion of GDP from 69% and 62% respectively, in 2000 . . . . to 79% in the United States and 86% in the United Kingdom.” (The latter figures are for 2014).
What she fails to mention in connection with the latter “horrendous” increase in household debts (about a 20% increase) is that there was a huge fall in the rate of interest paid by the typical mortgagor between 2000 and 2014: the rate paid on a typical variable rate mortgage in the UK fell from 8% to 2.5% between those two years, according to this source. (Mortgages account for about three quarters of household debt in both countries.)
Of course the rise in house prices in real terms between the above two dates can’t be ignored: a rise in house prices makes life for mortgagors and house buyers in general more difficult. In the UK, the price of the average house rose from £136,00 to 210,000 between those two year according to this source. So to summarise, interest rates fell to a third of their previous level, while house prices have nowhere near even doubled. That means that mortgagors on interest only mortgages (or relatively long term mortgages) have done very nicely. And most mortgages in the South East of England are interest only.
Of course that’s not to say that mortgagors are taking no risks at all: it’s always possible there’s a steep rise in interest rates. But basically mortgagors have “played safe”: that is, their reaction to the collapse of interest rates to a third their earlier level has certainly not been to run out and borrow three times as much or anywhere near that much.
Thus far from mortgagors being in more trouble now than in 2,000 as claimed by Montgomerie, it’s arguably the other way round: they were in a more precarious position in 2000 than now. And note that the big potential problem with a mortgage lies with interest rates, not the capital sum: if I borrow a trillion with the interest on the debt fixed over the long term at a zero rate of interest, where’s the problem for me?
Repaying debts is deflationary?
As for why debt and its repayment should be a problem, one reason given by Montgomerie is thus. “Currently most households keep up their debt repayments. However, by doing so they are robbing the economy of its vitality by regularly remitting a growing proportion of their present day income to repay debts that have fuelled past economic activity: these payments are thousands of pinpricks that bleed the economy….”
Well it’s certainly true that borrowing and spending is stimulatory, while the opposite, i.e. repaying debts is “anti-stimulatory”, i.e. deflationary. However, the total amount of new lending every year is approximately equal to the total amount debt repayment, thus on balance there is little stimulatory or deflationary effect in an average year.
To be more accurate, the total amount of lending over the last twenty years or so has actually exceeded the total amount of debt repayment, as Montgomerie rightly points out, thus the net effect of the “borrow and repay” process as a whole has been stimulatory!!
And finally, even if total repayments did exceed total new loans for a few years, the deflationary effect could easily be countered via standard government / central bank stimulatory measures.
As for interest on debt, that does not “bleed” the economy, any more than paying for beer, cabbages or smart phones bleeds the economy. That is, interest payments to banks simply fund the salaries of bank staff and pays for the vast number of other expenses involved in running a bank, like maintaining bank offices. Plus some of the money funds interest paid to depositors and bond holders and dividends for bank share-holders and so on. In short, interest payments to banks are simply part of the non stop circular flow of money that an economy consists of, just like paying for cabbages funds the income of farmers and supermarket checkout staff. None of those payments “bleed the economy”.
So all in all, Montgomerie’s ideas about the deflationary effects of debt repayment are not too clever.
How interest on debts is to be cut.
Montgomerie’s introduces her system on her p.45. It’s not entirely clear to me how her system works, and that’s not because I’m stupid: if you skim thru the thousand or so articles on this blog over the last ten years you’ll see that I have no difficulty understanding what economists are saying about 95% of the time. Rather the explanation is that Montgomerie’s explanation is not at all clear. So don’t take my description of her system as necessarily being totally accurate: you’ll have to read the book yourself if you want a better idea.
Anyway, her p.45 says:
“My modest proposal is to create a household debt cancellation fund that starts with half of the declared value of cash outlays and the full value of credit guarantees offered to the financial sector ten years ago: approximately £500bn in cash and £2 trillion in guarantees and $8 trillion in guarantees in the USD. Taking half the amount of bailout required for the financial sector and applying it as bailout of the household sector will I argue generate more uplift in the economy than the 2008 bailout in a shorter period; and crucially it will begin to unwind the Anglo-American economies’ dependence on debt to generate growth. Next a comprehensive package of household-level debt cancellations that targets key loci of indebtedness must be developed in ensure maximum benefit to households, and by extension to the economy and to society.”
Well now, if your jaw hasn’t dropped, it should have: the “household debt cancellation fund” for the UK totals a sum that approaches UK GDP!!! That’s the above mentioned £500bn in cash and £2tr in guarantees.
As for “modest”, I wouldn’t call refinancing debts of an amount approaching UK GDP modest. But never mind.
Her scheme is, so she claims, funded by a “Long Term Refinancing Operation” (LTRO). That is, existing debts, or at least a sizeable proportion of them, are cancelled, which in turn means relevant savers, investors and banks are robbed of a trillion or two. But the latter robbery is made good by having the state lend savers and banks a trillion or two of freshly created money at a zero or near zero rate of interest, which in turn is loaned to debtors at a zero rate of interest.
Now there’s an obvious nag there, which is that under the existing system banks make a living by charging borrowers more than the rate they pay depositors, bond-holders etc. And that’s for a very good reason, namely that (to repeat) there are significant costs involved in doing what banks do, i.e. accept deposits, lend money, and so on: e.g. the cost of bad debts, the cost of paying bank employees and so on.
Montgomerie however seems to be unaware of these costs. At least on her p.86, she says that the dramatic fall in the rate of interest paid by banks to obtain funds gives “banks and other financial institutions considerable room to make profit by exploiting the preferential rate of interest offered by the central bank and the market rate they charge for loans especially the very high rates that retail credit offers households.”
Well firstly, the fall in the rate of interest paid by banks to obtain funds has not translated directly into increased profits for banks because (to repeat) there was a dramatic fall in the rate of interest charged by banks to mortgagors over the same period. Thus roughly speaking, the fall in rates paid to and paid by banks will have had little effect on bank profits.
Second, and as regards the “preferential rate of interest offered by the central bank”, Montgomerie is referring to the relatively small amount of money offered by the Bank of England to commercial banks at an artificially low rate of interest recently with a view to boosting lending by commercial banks. That actual amount was around £100bn if memory serves, which is small compared for example to the £2.5trillion of debt re-financing that Montgomerie proposes. It is also small compared to total UK bank assets or liabilities.
Moreover, two blacks don’t make a white, as the saying goes. That is, Montgomerie is right to disapprove of the loans made by central banks to commercial banks at sweetheart rates of interest. That is, if stimulus is needed, it should be channelled into the economy via Main St not Wall St. But the fact that sweetheart loans were offered to commercial banks by central banks is not an excuse for central banks to offer sweetheart loans to anyone else.
If the state is going to create money and dish it out, it should be dished out to a very wide range of actors and entities. I.e. as Keynes said in the early 1930s, the cure for a recession is to simply have the state create or borrow money and spend it. That spending should not be concentrated on just one or two lucky recipients: banks, mortgagors or whoever. The money is best distributed as far as possible over the economy as a whole.
Also, and as regards Montgomerie’s claim that it is specifically “Anglo-American” economies that are hooked on household debt, that is not true: household debt to GDP ratios in the US and UK are very much in line with other advanced countries. See here.
Saving not needed to fund mortgages?
On her p.58 Montgomerie tries to rebut the idea that savers are hurt when debts are wiped out or debtors are relieved of the need to pay interest on their debt. She says, “This argument against debt cancellation claims that savers and pensioners are the biggest losers when debts are cancelled or borrowers default. This is a clever sleight of hand. Banks are not intermediaries which means they do not require savings in order to lend.” So Montgomerie seems to saying that when banks expand their loans by £Y there is no additional £Y of savings to match that.
Well it’s perfectly true that when a bank lends, it can produce the relevant money from thin air and lend that to borrowers. Unfortunately that does not mean that no saving takes place to match that borrowing. Reason is that when borrowers spend the money they’ve borrowed, that money inevitably ends up in the bank accounts of others. I.e. for every £X of extra loans, there is an extra £X of deposits or “savings”.
In short, and as common sense suggests, for every £X borrowed from a bank, there is £X saved by someone somewhere. Indeed, bank balance sheets would not balance if their assets (i.e. loans) were not matched by liabilities (i.e. sums owed to depositors, bond holders etc).
To summarise, I’ve dealt mainly with the first half of the book. That’s enough for now. There are plenty more flaws in the second half which I may deal with at a later date if Montgomerie’s idea looks like becoming popular.