Judging the Whole By the Sum of its Parts


I’m going to suggest that, as educated observers, we move away from the tendency to discuss economic health entirely in terms of broad aggregates such GDP growth, change in CPI, or (worst of all) the level of the Dow Jones.

Equating economic health with the Dow Jones is bad for a lot of reasons, but the primary one is:  It is a nominal number!  It is very sensitive to expected inflation.  The Dow could be at 100,000 in fifteen years, with the county in absolutely abysmal shape.  As a former prof of mine used to say, “I can multiply all of your grades by 1000 if you want.  Would you like that?”

There are currently some signs of encouragement if one is focusing on broad economic aggregates.   But what if one instead takes a “sum of its parts” approach and says that the economy is only as healthy as the sum of all individual balance sheets, considered at once.   There is some reason for optimism — some people are very, very rich.  But on the whole, when I look around, I see a lot of people and businesses who are broke — how can an economy consisting of all broke people be anything but broke?

The answer, of course, is that it can’t.  We have an economy consisting of many, many broke people, and a thin slice of wealthy people, most of whom could leave or transfer assets tomorrow.   When I say “thin slice”, I do mean thin slice.  It’s very, very difficult to find broad net worth statistics — the best source is probably the Survey of Consumer Finances.   What you find is the bottom 75% have no assets to speak of.  One statistic I quote in my book is:  “Sixty-five percent of the elderly have assets of less than the value of one year of nursing facility costs.” (footnote below)

Are individual balance sheets going to improve in real terms over the next few years?  Clearly not!  Since most Americans don’t own anything and now can’t borrow money to buy things like real estate and stocks, the only way to improve their balance sheets is to earn more than they spend.  There will be no random upticks in wealth anymore, only random downticks.  As a best case, we will see stable real household net worth over the next few years, but that is only if one considers deficit-finance government transfers as true “income”.

So how does one, as it were, square the circle, and explain how formerly the world’s richest country would find itself in a situation where it consists of mostly broke people and was, therefore, as a nation, mostly broke?

The short answer is that the macroeconomics of credit destruction are much more severe than most people realize.  When an economy increases its overall debt stock, it grows faster than it otherwise would.  If it wants to decrease its debt stock to the former level in a later period, it has to grow slower than it otherwise would.  If the debt grows and grows and isn’t paid down, then when one looks at individuals’ balance sheets, one sees that much of the assets on these balance sheets consist of IOUs from other people.  Note that bank accounts are IOUs from the bank, which it can pay only if the people who owe the bank make good on their IOUs.

When a large fraction of debts in the economy default or look like they will soon default, what effectively happens is a massive destruction of wealth.  One can move from an environment of many, many rich individuals to one of all broke individuals very quickly when credit destruction comes into play.   Moving the other way, from all broke individuals from many, many rich individuals is a much more difficult trick, but in an environment with a lot of debt that MIGHT be paid, it’s a trick that at least has some chance of working.  In the US, we are going to give it our best try.

Note regarding previous blog…..

I wrote a blog recently about Mosler Economics (www.moslereconomics.com) and I should have mentioned that some of the articles on that site weren’t written by Warren (most were).

Two especially good papers that I mention in the post were not solely authored by Warren…. The  paper “Tax-Driven Money”” is by Matthew Forstater and ““The Natural Rate of Interest is Zero” was co-authored by Warren and Matthew Forstater.

.[1] Barbara Lyons, et.al., “The Distribution of Assets in the Elderly Population Living in the Community,” The Kaiser Commission on Medicaid and the Uninsured, http://www.kff.org/medicaid/loader.cfm?url=/commonspot/security/getfile.cfm&PageID=53591 (accessed June 22, 2009).



One Response to “Judging the Whole By the Sum of its Parts”

  1. 1 BillG

    Bravo my boy…as always insightful,educational & stimulating fodder for cogitation!
    Well done, actually rare in this medium!

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