Debt is the Problem

If you had to sum up what is wrong with the world economy in a single word, that word is debt. Excessive debt is the number one problem in both the U.S. and Europe.

The nature of debt is such that there are only two ways to deal with it.

The first way is to pay it back. Money is borrowed for a specific period of time. When the time elapses, the loan is paid back with interest and the debt disappears.

Secondly, the debt can be defaulted on. At the end of the loan period, the debtor admits that they can’t pay back the money and declares bankruptcy. A judge will authorize the debtors assets to be seized and sold. Proceeds will go to the creditors in order offset part of the debt owed to them. If insufficient money can be raised to satisfy the entire debt, the creditor will have to take a loss.

Debt can be used for production or it can be used for consumption.

When a debtor borrows to produce, the chances are much higher that the loan will be repaid. There will be something to show for the debt; something that can be used to generate revenue. It’s not a sure thing though. The debtor must produce in a way that is profitable enough to pay back the loan and interest. He must produce in such a way that he meets consumer demand.

If debt is used for consumption, it is much less likely that the debt will be paid back. When a person goes into debt to take vacations or eat at fancy restaurants, the person has nothing to show for the money spent. Nothing was produced that could help raise enough funds to pay back the money they borrowed.

People borrow money and governments borrow money.

When a person borrows money, they have to repay the loan with their own resources. Before loaning money to a person, a bank or credit card company must determine the person’s creditworthiness. If it seems like a risky loan, the lender will charge a higher interest rate. If the rate is too high, the borrower might decide that the loan isn’t worth it.

When a government borrows money, they pay back the money and interest with taxes. Governments have no money of their own. They do have guns and printing presses though. This gives lenders a lot of confidence that governments can pay back debt. As a result, governments tend to pay lower interest rates. Lower interest rates encourage even more borrowing. Of course the ability to spend other people’s money stimulates the borrowing as well.

For a very long time, governments and central banks around the world have been pursuing an easy money policy. They’re aim has been to keep interest rates low in order to make borrowing easy; both for themselves and private citizens.

They’ve encouraged private citizens to go out and consume. Take a trip on the credit card. Borrow against the house. Finance a new car.

Higher interest rates would have put the kibosh on a lot of these activities. However, the operating theory has been that consumption is what drives economies. Lowering interests rates facilitates consumption. But we already know that borrowing to consume is a recipe for either bankruptcy or austerity later on down the line.

At the same time, governments have been taking advantage of low interest rates for their own purposes. Easy money makes financing social programs much easier. Politicians were able to promise tremendous benefits to everybody under the sun. Old age protection. Free food. Free medical care. Free education. Free houses. They fought war after war on credit.

All of this was borrowing to consume as well. When you borrow money and build a war drone and the drone gets shot down, you just consumed a drone. When you borrow money and spend it on an old person, that is consumption. If the kids you are educating aren’t able to produce more than you’ve spent on education them, resources are being consumed.

Well, some day the bills are going to come due. That is just the way it works. Remember, there are only two ways to deal with debt. You can pay it back, or you can stiff the creditor.

Paying it back means limiting your consumption for the time being. You have to put something aside. You have to run a surplus. After running surpluses for a while and paying down the debt, you can start to consume more again. This implies austerity. Consuming is fun, running surpluses is a sacrifice. That is they lesson. Borrowing to consume requires a future sacrifice.

The other option is to renege on the agreement. No matter what you do, you can’t run enough surpluses to pay back the debt. It’s impossible. You give the creditor all you’ve got and you go to court and declare bankruptcy. No more debt for you. The downside is that you can’t borrow money anymore because you’re a bad credit risk. You’re only able to consume exactly as much as you can produce, no more.

Let us not forget about the agency that loaned the money. They are forced by the circumstances to sacrifice. Instead of enjoying the present and consuming all they had produced, they loaned some of their production to you. You aren’t able to pay it back. Now they’ve got nothing. They’re going down with you.

Alas, this gives us the key insight about whats happening in the U.S. and Europe. Governments around the world have borrowed a lot of money and they want to keep borrowing more money. However, lenders are growing weary of governments’ ability to run future surpluses and pay back the money. It’s getting riskier to loan money to politicians. Interest rates are rising on that risk.

Who has loaned money to the governments of the world? Big banks. What happens if the governments renege? The big banks go down with them. The big banks don’t want to go down. They are pushing their debtors, the governments of the world to come up with money from somewhere. Of course, governments can only get money from one place: the people.

Let us not forget, there are only two ways to deal with debt: pay it back or default on it. Paying it back requires sacrifice on the part of the people so that we can pay back the money that governments borrowed from big banks. If we default, the government and the banks will go down together.

Seeing as how I disapprove of the government programs that the debt finances, I say let them all go down together. The wars have been murderous and wasteful. The social programs have created generations of uneducated, unmotivated people. The politicians have been living high off the hog on the backs of the working man.

The great thing about default is that we’re back to even. No more sacrifice. The economy gets a fresh start. As an added bonus the governments of the world would no longer be able to borrow money. What more can you ask for?

 

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