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How to lower debt ratios

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A lot is being written on debt ratio’s. Financial news is full of articles and charts showing how debt to GDP is rising everywhere. A high or increasing Debt to GDP ratio (either in private or public hands, or both) is, apparently, a very bad thing.

However, I am wondering how an economy can actually decrease its debt ratio. I have trouble visualizing the mechanics behind such a process.

Because if the economy is booming, many people and companies go to banks and take out even more loans. So, more debt.

Is a debt ratio declining only if the velocity of money (ie spending) increases?

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Posted by Matthijs
Posted on 08/16/2017 11:32 AM
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Starting in the early 1930s, the US reduced its debt / GDP. This continued until the early 1950s. See figure from Rogoff.

One problem with a high debt level is that more resources go to servicing the debt rather than productive outcomes. This results in less investment– hence lower GDP growth (something we’ve seen play out recently).

Another problem is that debt doesn’t necessarily go away even if the ability to pay it is reduced. When it does go away — through default or restructuring (a form of default), it means that the assets of somebody else — who was counting on those assets, e.g., to pay pensions — are reduced.

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    Posted by DeltaV
    Answered on 08/16/2017 12:14 PM
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      High DeltaV: correct, those debt ratio’s go up and down. But how, exactly? How do they go down?

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      Posted by Matthijs
      Answered on 08/16/2017 1:45 PM
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        Generally going down coincides with debt restructuring / default. It is also possible to “grow your way out” by getting the economy going faster while accruing debt at a lower rate. There is also money printing, which is intended to get the economy going faster, but the worked examples of that aren’t entirely successful — the QE experiment in the US is still ongoing, but in Japan (which started at least 10 years earlier) debt has grown faster than the economy.

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        Posted by DeltaV
        Answered on 08/16/2017 2:46 PM
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          Higher velocity of money would do it, so would less compounded credit chains. For example when a bank funds a loan to a customer by borrowing from another bank, that is recorded as two instances debt for one instance of bank customer credit. Another example , coordination of the sequence of production and sales with less debt. More Equity financing less debt financing, with that caveat that equity is a liability.
          Etc.

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          Posted by Dinero
          Answered on 08/17/2017 8:50 AM
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            High Dinero, not everything you say is entirely clear. The way I see it: when you have an economy with 10 people, in which there are 2 business people taking out loans for their business, 5 people taking out a mortgadge and the rest just earning a wage. In that cases there’s for example 10 million of debt/money in the system at point X in time. GDP is the amount of money being spend per unit time. 10 people making 1 million each and spending it all, gives a GDP of 10 million per month.

            The debt/GDP ratio goes down if people spend their money faster. But if you assume no new loans (no extra debt), there is a mathematical limit to how fast people can spend. You can not spend more than your income. So how to grow GDP?

            This shouldn’t be so complex but I’m missing something obvious here.

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            Posted by Matthijs
            Answered on 08/17/2017 10:40 AM
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              As you say, its not complex.

              For a fixed amount of debt and no other changes in how transactions are accomplished then the Growth in GDP would be accompanied with greater velocity of money.

              But a growth in GDP can be achieved with a fixed or lower amount of debt and a fixed velocity by the examples I gave and others.

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              Posted by Dinero
              Answered on 08/17/2017 11:26 AM
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                The sale of cars is included in GDP.
                A vendor can borrow $1Million to create an inventory stock of cars. Or they can sell a car and use the proceeds to buy the next car for resale and so on.
                Same GDP as before no debt.

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                Posted by Dinero
                Answered on 08/17/2017 11:33 AM
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                  ie. there is no debt in the second case and the GDP is the same.

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                  Posted by Dinero
                  Answered on 08/17/2017 11:36 AM
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                    These ratios are silly to be honest. It’s just one half of the balance sheet. Here’s the total net wealth trends. They’re also rising. So, the assets are rising even faster than the liabilities are.

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                      Cullen Roche Posted by Cullen Roche
                      Answered on 08/17/2017 11:42 AM
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                        Sorry Dinero, it’s not clear what you explain.

                        If I have an income of 1000 dollar/month and all 10 other people in my economy have the same income, how can we spend more than 1000/month? It’s not possible without new debt. I make 1000/month and can spend 1000/month.

                        The car dealer is the same story: he earns 1000 by selling a car and he spends 1000. Whether on buying a new car for resale or spending it on consumption in a restaurant doesn’t matter.

                        @Cullen: I know the assets rise as well. You have written about that a lot. I’m just trying to get my head around how debt/gdp would/could fall in a simple example.

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                        Posted by Matthijs
                        Answered on 08/17/2017 11:52 AM
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                          You ask “How can a country decrease its debt ratio”

                          Well the car dealer example would achieve that.

                          It is clear there is the no debt and the same GDP.

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                          Posted by Dinero
                          Answered on 08/17/2017 12:06 PM
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                            Hi Dinero, it doesn’t make sense: if someone (car dealer or not) earns 1000/month and spends 1000/month, how can he increase his spending without new debt, without getting a new loan from a bank? It’s mathematically impossible.

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                            Posted by Matthijs
                            Answered on 08/17/2017 12:21 PM
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                              Why do debt ratios have to come down? If I borrow $1,000 and bury it in a hole then debt ratios go up. In fact, this is a lot of what’s happening. People borrow money and don’t spend all of it. I don’t see the big deal here? As long as we can service that debt then it’s all good and debt service ratios have been declining for the last decade….

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                              Cullen Roche Posted by Cullen Roche
                              Answered on 08/17/2017 12:32 PM
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                                If GDP is rising then earning and spending must be rising.
                                The amount of sales, GDP, can increase without debt by selling before buying and the same money circulating.

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                                Posted by Dinero
                                Answered on 08/17/2017 12:50 PM
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                                  Hi Cullen, thanks for your response. You are correct that what matters is servicing debts. As long as people or companies are able to to that, it’s fine.

                                  To be clear: I’m not coming to this question from a “help we’re drowing in debt!” perspective.

                                  It’s just that I want a clearer picture in my head of how the mechanics of debt, spending and debt ratios work.

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                                  Posted by Matthijs
                                  Answered on 08/17/2017 12:53 PM
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                                    I think I made the point in a similar thread that many commentators, who write about debt and debt ratios, completely ignore the fact that one person’s debt is another person’s savings. Those that come from the ‘we’re all drowning in debt’ school (and I appreciate that you aren’t one) who call for lower levels of household, corporate and government debt and lower debt/GDP ratios, don’t tend to realise that they are also saying that we are ‘drowning in a sea of savings’ and are calling for lower savings levels. I’ve even had discussions with people who believe that we should all move away from buying anything on credit and should prudently save up by putting a little bit of our monthly pay aside before buying anything like a car, or a holiday (they always seem to think that borrowing to purchase a property is absolutely fine, though). They simply don’t understand that it’s impossible for everyone to be a saver.

                                    Whilst these people would never agree that too much savings is a problem, I am firmly of the view that the ‘debt problem’ (if it is indeed a problem) is genuinely a ‘savings problem’ and the cause is baby boomers who are preparing for or have just entered retirement. It is the boomers saving that is causing the indebtedness of younger households. Now, I don’t necessarily see this as a problem – as the boomers move through retirement and start spending those savings, they will be spending on goods and services provided by the younger generation, who will have the option of using the funds received to repay their debts (in fact it is likely they will have no choice but to repay those debts, unless there is another group that emerges with a similar desire to save that the boomers had). When this spending is unleashed, not only will GDP be enhanced, but absolute debt levels will likely fall, resulting in a dramatic fall in debt/GDP ratios. At the same time, you will likely see a move higher in interest rates that those savers think are somehow ‘artificially low’.

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                                    Posted by Robert Pearson
                                    Answered on 08/18/2017 3:50 AM
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                                      Robert, thanks for your elaborate answer. Appreciated as always.

                                      You are correct that saying “too much debt” also, by definition means one is saying “too many savings”.

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                                      Posted by Matthijs
                                      Answered on 08/18/2017 4:22 AM
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                                        Just this week read an article by a journalist writing that he has started saving more than 50-60% of his income, in order to save 750k and be able to retire very early in life. This after reading about it on some financial guru blog online. Nothing wrong with that maybe, from a personal point of view. But he also advised everyboday to follow that example, claiming we all should start saving two thirds of our income to all be able to retire early. If people invest their savings wisely, it should yield enough returns to grow into a large enough sum of money, the claim was.

                                        Trying to explain that it’s mathematically impossible to all save 65% of our income because you also lower someone else’s income by 65% and because it will completely crash the economy since ther will be hardly any spending left, was impossible to explain.

                                        Money is a hard concept to understand.

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                                        Posted by Matthijs
                                        Answered on 08/18/2017 4:50 AM
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                                          You can have saving without a corresponding debt , when the saving is in something that is a commodity.

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                                          Posted by Dinero
                                          Answered on 08/18/2017 9:13 AM
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                                            Dinero, your are correct. Saving in coconuts, a nice house (without mortgadge), solar panels, etc are all ways to save without debt. But that’s not what the author was talking about I’m afraid.

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                                            Posted by Matthijs
                                            Answered on 08/18/2017 9:36 AM
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                                              yeah, I tend to refer to something that is a commodity as a commodity, not savings.

                                              Many people try to tell me that if they are living on a desert island and they need 10 coconuts a day to survive and they collect 12 a day, they build up savings – which if they were truly living in a subsistence economy might well be the case. But as we all live in a highly developed financial economy, it makes sense to talk about savings in terms of financial assets – given that we all tend to get paid in financial instruments and spend financial instruments and therefore any surplus or deficit will be in financial instruments.

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                                              Posted by Robert Pearson
                                              Answered on 08/18/2017 9:46 AM
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                                                Matthijs – you beat me to it about the coconuts!
                                                Dinero – even if you regard non-financial assets, such as cars, houses, jewellery etc as ‘savings’, it doesn’t change the fact that somebody’s debt will always be somebody else’s savings.

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                                                Posted by Robert Pearson
                                                Answered on 08/18/2017 9:51 AM
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                                                  Robert – lol, coconuts seem to be an important savings vehicle. Buying more coconut stock now 🙂

                                                  You are right about the financial instruments. Those (outside actual deposit money) are also non-debt savings in a sense. But at the same time, both “real” money and any other financial instrument (bond or stock) are in the end claims on someone’s real production. So there will still be a limit to what everybody can save in those financial instruments.

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                                                  Posted by Matthijs
                                                  Answered on 08/18/2017 10:10 AM
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                                                    I was not thinking of a commodity saved for later use I was thinking of commodity held that the saver is planning on selling in the future. Its not a debt of someone else, but it does require that there is a demand for it in the future.

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                                                    Posted by Dinero
                                                    Answered on 08/18/2017 10:38 AM
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