January 15, 2015

Growing debt is bad, but shrinking debt is worse

Comment on New Arthurian on 'The first of the great powers to reduce private debt will be the world's next hegemon'


Your blog is about the perils of debt. On the face of it, you are right: there are problems and they are as old as economics.

“Adam Smith, when he wrote his Wealth of Nations, and Burke, when he produced his famous speech on economic reform, understood by political economy a branch of the science of the statesman or legislator, a theory of practice, the science of the prudent management of the public finances. The growth of the huge debts which weighed on the great military nations would end in proving their ruin. This was especially true of England, which had become immensely in debt through the conquest of her colonial Empire.” (Halévy, 1960, pp. 104-105)

The core problem with debt is that economists do not understand the relationship between household sector deficit and business sector profit. In other words, the profit theory is false since Adam Smith.

In a short working paper titled Debunking squared (2013) I have demonstrated this for Steve Keen's profit theory. What holds for Keen holds for the rest of Heterodoxy  and, of course, for the New Arthurian.

First important point: both Orthodoxy and Heterodoxy lack the true theory. That is bad in several respects: “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

The true theory says that  in the simplest of all possible cases  profit/loss is exactly equal to dissaving/saving or in other words to growing/shrinking household sector debt. For the formally correct derivation of this fundamental relationship (in fact, the live formula of the market economy) see (2014). The relationship becomes a bit more complex when profit distribution, investment, government, and foreign trade are included.

Condensed to a slogan, the true theory says for the world economy as a whole: a growing debt of private households and/or government is the essential condition for the stability of the market economy.

In other words, the true theory predicts (for a closed economy): As soon as private/public households pay off their debt the economy breaks down.

Egmont Kakarot-Handtke

Halévy, E. (1960). The Growth of Philosophic Radicalism. Boston: Beacon Press.
Kakarot-Handtke, E. (2013). Debunking Squared. SSRN Working Paper Series, 2357902: 1–5. URL
Kakarot-Handtke, E. (2014). Mathematical Proof of the Breakdown of Capitalism. SSRN Working Paper Series, 2375578: 1–21. URL
Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic Method in Economics and Econometrics. Cambridge: MIT Press.