At 9:21 AM 1/22/95, Michael Perelman wrote: >In response to my earlier question about why real interest rates grew during >the 1980s, Doug shocked me by suggesting the conventional growing government >debt explanation. I suspect that rising business debt provides a better >explanation. So I repeat a variant of my original question: did falling >profits encourage business to take on more debt to create alternative profit >rates? Normally, we are led to expect that profit rates and interest rates >move together. > >My shock from Doug's response reflected my expectation of an unconventional >answer from him. Ha, caught being conventional. How embarrassing. All other things being equal, why shouldn't a rise in gov't credit demand push up interest rates? Loan demand is loan demand. How should it be any different from business credit demand? Both government and business (& households too) spend the money they borrow, which should goose demand and make the debt at least partly self-financing in the macro sense, but individual units are still left with debts to service. As the ratio of interest paid to income rose for all three sectors (hh gov biz), much of the new indebteness was the rolling over of interest. Unless the central bank is run by La Cicciolina, don't rising rates seem inevitable? The question is why everyone went so deeply into debt (and why the household sector at least is doing it again)? Gov't - fiscal crisis of the state plus an idiotic fiscal policy. (Interest began eating up most of the deficit stimulus by the late 1980s). Households - as Bob Pollin has demonstrated, households at the low end and the middle borrowed to maintain living standards; those at the high end borrowed to speculate and accumulate toys. And biz - business borrowed mainly to do M&A and defensive restructurings. Real productive investment continued to be financed overwhelmingly by retained earnings. You could certainly argue that the M&A/restructuring thing was driven by low profitability; the point of everything was to boost returns to stockholders. Research in The Deal Decade (ed. Margaret Blair; Brookings 1994) shows that there was something to Jensen's free cash flow argument: firms in mature industries had ample cash flow but few profitable investment outlets; the point of the financial maneuvering was to grab the free cash by loading up firms with debt and shipping big interest checks to Wall Street. Debt was supposed to be a discipline on management, but it was also supposed to be a way to redeploy capital. Wall Street, being the wise, disinterested, and frictionless arbiter of capital allocation decisions for all society, would assure that these funds would be profitably redeployed. Instead, they were used to finance more restructurings. Doug Henwood [[EMAIL PROTECTED]] Left Business Observer 250 W 85 St New York NY 10024-3217 USA 212-874-4020 voice 212-874-3137 fax
