The Downside of Debt

Cristina Fernandez de Kirchner, president of Argentina, will never be remembered as a great economist. Nor will she win any awards for ‘accuracy in government reporting.’ Au contraire, under her leadership, the numbers used by government economists in Argentina have parted company with the facts completely. They are not even on speaking terms. Still, Ms. Fernandez deserves credit. At least she is honest about it.






GDP growth itself is adjusted by the inflation number. If output increases by 10%…yet, the CPI is also going up at a 10% rate…real, after inflation, output flattens out. Pensions, taxes, some forms of insurance — the CPI number is used to correct distortions caused by inflation. But if the CPI number is itself distorted, then the whole shebang gets twisted.


The number crunchers do not necessarily deny the truth; they merely redefine it. First, they make ‘seasonal adjustments’ in order to keep the strawberries out of the March shopping basket. Second, they make substitutions; when one thing becomes expensive, shoppers switch to other things. The quants insist that they substitute other items of the same quality, just to keep the measurement straight. But that introduces a new wrinkle.

Let us say you need to buy a new computer. You go to the store. You find that the computer on offer is about the same price as the one you bought last year. No CPI increase there! But you look more closely and you find that this computer is twice as powerful. Hmmm. Now you are getting twice as much computer for the same price. You don’t really need twice as much computer power. But you can’t buy half the computer. So, you reach in your pocket and pay as much as last year.


This reasoning does not seem altogether unreasonable. But a $1,000 computer is a substantial part of most household budgets. And this “hedonic” adjustment of prices exerts a large pull downward on the measurement of consumer prices, even though the typical household lays out exactly as much this year as it did the last. The typical family’s cost of living remains unchanged, but the BLS maintains that it is spending less.

You can see how this approach might work for other things. An automobile, for example. If the auto companies began making their autos twice as fast…and doubling the prices…the statisticians would have to ignore the sticker prices and conclude that prices had not changed.




The nuances of the “inflation” number go far beyond just statistical legerdemain. What is inflation? Does the word refer only to the rise in consumer prices? Or to the increase in the supply of money? The distinction has huge consequences. Because, in the years following the ’08-’09 crisis, it was the absence of the former that permitted central banks to add so much to the latter. In other words, their measurement of ‘inflation’ not only had far ranging consequences for bondholders, investors, retirees and so forth, it also created a huge distortion in the entire planet’s monetary system. As long as consumer price inflation didn’t manifest itself in a disagreeable way, central bankers felt they could create as much monetary inflation as they wanted. Increases to the world’s monetary footings — monetary inflation of the most basic sort — caused stocks, bonds and commodities to rise. On the whole, this was a fairly agreeable form of inflation. Central bankers wished to continue inflating as long as they were able.


But a low consumer price inflation figure also allows central banks to continue inflating the world’s money supply. They’ve added trillions of dollars to the banking system directly, and trillions more to asset prices, and to the world’s debt. Rising CPI inflation would have scared lenders. Instead, low price increases reassured them so completely they buy more and more US bonds at higher and higher prices.


“Rise in household debt might be sign of a strengthening recovery.”

After reducing debt for 14 quarters, households finally had enough. They stepped up to the checkout counter…credit cards in hand…and did their patriotic duty. They bought stuff. They went deeper into debt. Once again, they were buying stuff they didn’t really need with money they didn’t really have.

Economists celebrated the event dumbly, like a turkey looking forward to Thanksgiving dinner. It was as if they thought debt was not subject to the law of diminishing returns…as if there were no downside to it.

Numbers help us define…detail…precise…measure and test reality. But we understand it, not with digits but analogs. We say “this is just like…” or “it reminds me of…” Literature…philosophy…history and economics help us to make sense of the phenomena around us. We need stories with plots, heroes, villains and adversity. And stories with a moral.

The old economists knew this. The ‘two Scottish Adams’ — Adam Smith and Adam Ferguson — who were the founders of economics as we know it, did not even call themselves economists. If they had had business cards to hand out, they probably would have listed their profession as ‘moral philosophers.’ They studied the data…the case histories…the evidence…not for the numbers, but for the moral of the story.

In a sense, the real problem in the 21st century was that economists had picked the wrong analogy…or the wrong story. They thought they were scientists. They thought economics could be treated as though it were a branch of science, where bounded problems could be reduced to numbers and then manipulated and solved. Of course, it was no such thing. There were no controlled experiments; initial conditions were always different. There were no reproducible results…and no hypotheses that could ever be disproven. That’s why many of the worst ideas in economics never go away, even though they have had disastrous results every time they’ve been applied.

We’ve already seen how quickly this analogy to science breaks down. The planners, fixers and improvers really can’t measure what they think they can measure. More than that, they can never know whether they are coming or going, doing good or bad.

But we’re going to keep an open mind. While it is definitely true in the abstract that economists can’t even know what the exact unemployment rate is…or can’t really tell whether increasing GDP would make people better or worse off…perhaps it is nevertheless true that their good intentions (if that’s what they are) somehow triumph over their own clumsy incompetence. Perhaps like prayer, there may be no understanding of how it works, but if you believe in it…perhaps it helps.

Besides, assuming as we do for the moment that they are headed in the right direction, shouldn’t they keep going? Isn’t striving to make the world a better place a good thing in itself? Where’s the downside?

Ah, you’ll have to tune in tomorrow…


Bill Bonner
for The Daily Reckoning

The Daily Reckoning