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Translating Bill Gross: The Debt Trap

Bill Gross
Scott Eells | Bloomberg | Getty Images
Bill Gross

Brad Delong, the Berkley economics professor and blogger, simply cannot comprehend what PIMCO's Bill Gross is saying in his latest letter.

“And I know that William H. Gross of PIMCO is very smart, and very good at this. But I cannot figure out what his model of how the world works is,” Delong writes, in a post titled “Department of ‘Huh?!’: What Is Bill Gross Saying? Edition.”

Here’s what Gross writes:

My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth…. The Rogoff/Reinhart biblical parallel of seven years of fat followed by seven years of lean is not likely to be disproven in this cycle. The only missing input to the equation would seem to be how many years of fat did we actually experience? More than seven, I would suggest…

This really isn’t all that hard to figure out. Gross is defending the "debt trap" thesis that I have explained at length here and here. And here I explained it very briefly.

For some reason, economists like Delong have a really hard time even thinking about the debt trap. It is literally unthinkable to them—perhaps because they too often busy themselves with building complex models that they believe explain or describe the world—but all too often rule out empirical evidence.

There are a number of studies that show that something weird begins to happen when levels of debt become too high relative to the size of the economy. Growth is stymied, probably because very high levels of indebtedness act as a signal that something has gone wrong, and people react to this signal with “belt-tightening.”

In short, the debt trap is a theory about reflexivity. A society that worries about its debt level is different from one that doesn’t. And when debt crosses a certain level—perhaps with the exception of times of war—there doesn’t seem to be much to do to control the fear—and contraction—caused by debt.

In other words, we may have nothing to fear but fear itself. But we do indeed have to fear fear.

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