Credit Is Not Wealth: The “Christmas Club” Edition

Amongst other things, Paul Krugman worries that we cannot grow the economy without credit as a stimulus for aggregate demand. It’s a reasonable worry given that people are just financially tapped out. To show my theory of just how tapped out people are, I ran FRED formula showing ratio of Personal Savings to GDP versus the ratio of Revolving Debt to GDP. It’s stark!

savings to debt

And here’s the personal savings rate history unfettered by Algebra.

Savings Rate

Credit is not wealth; something that Wall Street, the Government, and the Central Bank keep forgetting. People were “wealthy” in history when they had actual wealth (a.k.a. cash) sitting in banks.

I remember the days of the “Christmas Club.” It was a special savings account that people used to set aside money throughout the year for Christmas. People would spend that money, instead of running credit card debt for Christmas items. The days of the Christmas Club went out with the advent of Money Market Mutual Funds and Ronal Regan; in other words, a long time ago.

On larger investment savings scale, Krugman argues that the IS-LM is so skewed at the Zero Lower Bound that it looks something like this:

092513krugman5-blog480

What Krugman doesn’t say is that in lieu of running massive federal stimulus debt for a very long time, the only other answer in moving the IS line is devaluing the dollar, and accepting some deflation (seen as a horrible and gruesome death for the economy!).

Considering that real income is significantly lower now than pre-2008 (or even pre-1980), is devaluation and deflation really that bad? Of course Potential GDP is going to be lower when so many people are working for $8 per hour on 20-hour weeks (the new normal). The IS line (savings) has to be moved, and according to Krugman’s ZLB model, the only way to do that after 5 years of nothing else working, is to reduce potential output. That would bring the “natural” rate above zero, and move the IS line in back to where it should be.

Sure Wall Street would loose a lot of money, and it would probably cause a double-dip recession, but I think it’s been proven beyond a reasonable doubt that the “recession” for most people has never ended.

By lowering the GDP potential (through deflation or devaluation, or both) which actually accurately describes the real world, you effectively solve the problem of the liquidity trap.

Maybe we’ll even see “Christmas Clubs” come back.

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