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August 10, 2012 3:36 PM Will Reducing the National Debt Inflate More Bubbles?

By Ryan Cooper

That’s the thesis of Karl Smith, who makes a very convincing case for a slightly different idea. He says that bubbles are driven by too much savings sloshing around the world:

Large inflows of savings create - necessarily I would argue - bubbles…Usually when people buy a product the price goes up. It then becomes harder for other folks to buy the same product and so the number of buyers stabilizes.
Yet, with capital goes the opposite can happen…the cost of a capital good is the cost of carry, and that includes, in large part, how easy it is to unload the capital in a pinch. The more buyers a capital good has the easier it is to unload. This can actually make capital goods more affordable as demand increases and the market price rises.

This relates to the US budget deficit because as the world gets older and richer, especially outside the traditionally stable market democracies, people will save a lot more. All that savings will be looking for a safe investment, and there’s none safer than US debt. But if we were to pay off the national debt then there would be an enormous excess of savings with nowhere to go, and…

The result is a world with an ever increasing propensity towards bubbles. Indeed, if things simply continue along their current path and the US decides to cut the deficit then we should expect bubbles far greater than the ones we have experienced in the past.
We can see already that the next bubble will probably have something to do with either alternative energy, smartphones or social networking. Indeed, its possible that it could contain all three.

The obvious quibble with this is that people managed to inflate a titanic bubble back in the 2000s, when George Bush was still running up huge deficits. Also, it doesn’t seem possible that the world could get older at an ever-increasing pace. Wouldn’t deaths have to equal things out after a generation or so?

But more broadly, it seems like the problem could be equally stated as there being just too much income concentration. We used to have economic growth driven by wage-led consumption, where recessions were caused by the Fed tamping down inflation. Now what little growth we have is driven by asset bubbles, and recession are caused by enormous debt overhangs. If we could get that money out distributed more broadly, then the bubble tendency would be correspondingly diminished.

The politics of that seem utterly impossible, what with the one percenters capturing 93 percent of income gains in 2010, but the way this has happened in the past is that increasing income concentration leads to ever-larger bubbles which leads to a huge crisis and eventually systemic collapse. The Great Depression paved the way for a lot of stuff that severely restricted income concentration in the US, so it’s not impossible to imagine something similar happening to China and India.

It could be that this aging-wealthier trend is just a force of nature, and we’re doomed forever to quick spurts of insane growth in between crushing depressions. But it seems worth trying to avoid.

Follow Ryan on Twitter and his website; follow the magazine @washmonthly.

Ryan Cooper is a National Correspondent at The Week, and a former web editor of the Washington Monthly. Find him on Twitter: @ryanlcooper

Comments

  • SadOldVet on August 10, 2012 4:45 PM:

    WTF Cooper...

    You are on a roll today with your agism and war on the elderly, aren't you?

  • T2 on August 10, 2012 4:51 PM:

    there is a campaign going on...remember?
    Romney is calling for Obama to stop asking Romney questions about, well, about anything. It's been a rough day for Mitt. I'm not sure if Mormon's are allowed to sweat, but he might just be doing a little. Polls are very bad for him today and that nasty Harry Reid just won't let him alone. Don't they understand that he is a real wealthy guy who is not supposed to answer any questions he doesn't like? He's running for president, for pete's sake.

  • emjayay on August 10, 2012 5:08 PM:

    Karl Smith's thesis is interesting but needs someone with more econ than my BS to analyse it. The most interesting parts to me were actually the birthrate trend charts, showing India and Iran going down over the years - Iran down to less than replacement. I thought women there had to stay home and have as many babies as possible. I guess they are all catching on to some factors of the modern world like even a little modern medicine greatly increasing child survival.

  • Mikhail on August 10, 2012 5:17 PM:

    Nice work, Mr. Cooper. Please keep it up! And yes, what usually ends up happening is something horribly unpleasant as the situation just gets worse and worse. Hopefully this can be avoided, though hope is a dying commodity.

    Capcha: Which Rotitin -- which is a good question.

  • DAY on August 10, 2012 5:32 PM:

    Speaking of "bubbles", let me mention South Seas, Tulip Mania, and Beanie Babies. Of course, those were for the little people; the sophisticated big guys went with Bernie Maddof and mortgage derivatives.

    Warren Buffett got rich by only buying things he could understand. but, of course, he is "old".

  • Ron Byers on August 10, 2012 5:53 PM:

    Ryan

    I have to say I have really enjoyed your posts the last couple of days. You have us old geezers thinking. That is a good thing.

  • Tom Marney on August 10, 2012 10:25 PM:

    Deficits don't even matter all that much compared to the extreme trend toward concentration of wealth in the hands of the rich. Remember, under Clinton, we were running $200 billion surpluses and there was still enough excess capital left to give us the Dotcom Bubble.

    Inequality isn't primarily a moral issue-- it's a practical one. Capitalism works fine as long as democratic institutions keep it from going off the rails. But there's been an overabundance of capital for fifteen years or more, and the situation is only getting worse.

    The reason to raise taxes on the rich isn't to balance the budget. It's to transform excess capital into something more benign.

  • golack on August 11, 2012 1:49 PM:

    Nature had a news and views write up recently on researchers using the tools from ecology and applying them to history. So instead of flowing the rise and fall of prey-predator communities, it looks at the rise and fall of societies. They say they can pull out generational cycles (riots roughly every 50 years) as well as the growth and collapses of societies--from baseline starting point of everyone about the same (economically) to increased concentration of wealth and ultimately the fall of the top heavy societies.
    http://www.nature.com/news/human-cycles-history-as-science-1.11078