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Debt Is Optional

It is no secret that debt-based economic solutions do not work. If they worked they would not need debt and would not produce debt. The rise of debt is a perfect barometer of irrational exuberence.

The main difference between economists is the reason they give for why economics as a discipline fails to produce predictable results. It does not matter which theory is used. Regardless of whether it is monetary policy, fiscal policy, Keynesianism, Communism, Socialism, Cooperatives or Capitalism the success record of economics in producing viable answers is as dismal as the discipline itself is said to be. But there is no need to peruse reams of financial printouts or develop complex mathematical models to discern why the financial projections of economists are so often wrong.

The simple answer is that not one economist has produced a theory that understands and rejects debt. Cash based accounting is not thought a viable option. Capitalism is built on three ideas: the Free Market, Private Enterprise and debt.

Economic activity that is based on or dependent on the use of conventional forms of money has to produce debt. Even when goods and services are paid for with cash the money supply must increase to cover interest payments because even cash money represents someones debt and the decision to buy goods and services is made at the expense of a decision to eliminate debt.

However, if repaying debt appears to be impractical it is for all intents and purposes it is. If debt is paid down the money supply decreases. This is especially true now that most money represents bank debt. Modern markets are in the curious position of having to create more debt simply to stay solvent. Interest payments inflate the Money Supply. This inflation must be mirrored by an increase in the actual supply. This at least partially explains why the economy exhibits cyclic behavior. As more and more money is inputed into the economy debt grows until it consumes such a large portion of the consumers dollar that he or she can no longer borrow. Borrowers must then pay down debt. The expansion of the money supply to reflect its decline in value on the basis of interests rates can be slowed down and moderated to some extent but it can never be stablized.

Of course when businesses borrow money they create jobs and this we assume creates more wealth or what is called economic development. Borrowing is thought to be justified when it generates sufficient income to pay the debt carrying costs. However, this misrepresents the true picture. Debt creates inflation and inflation destroys the value of money. Borrowing gives the borrower more money but it decreases the value of the money other people have by that amount, plus the interest that is added to the amount borrowed. Inflation eats away the value of of money so the borrower penalizes those who do not have any debt by causing the value of their dollars to decline.

From this we can deduce the reasons why monetary policy, fiscal policy and Keynesianism or what is referred to as deficit spending, fail.

For the sake of brevity and clarity we will simplify the present methods of creating economic activity.

Monetary policy increases or decreases the amount of money circulating in the economy.

Fiscal policy increases or decrease the amount of taxes we pay.

Deficit policy is when government borrows funds to spend on capital projects to stimulate economic activity.

Money is created primarily by banks lending money to individuals and businesses. The more money businesses borrow the more they can invest to capitalize business activity. The more money individuals borrow the more business activity they generate as a consumer. If a business borrows money to invest in money-creating enterprises the investment is expected to generate more in revenues than the debt consumes in interest payments. The debt is paid off by the earnings generated. If all businesses paid down the money they borrowed the money supply would decrease. As the money supply decreases prices would also have to decrease and workers would be forced to accept lower wages. Which of course would make it extremely difficult for private borrowers to pay off their debt.

The State prefers some inflation because it eats away the value of the debt they owe. Inflation is also required to keep the money supply constant, otherwise interest payments would decrease the actual amount of money in circulation.

The State through the Central Bank however reduces interest rates at times when debt is high and they wish to stimulate more economic activity (which generally requires more borrowing). Lowered interest rates encourage people to roll over high interest payments into lower interest debt. Increasing the ability of people and businesses to borrow creates an economic stimulus. People borrow more and create more debt and interest payments or pay off their debt even faster worsening the economic decline. But interest rates can only be lowered so far before banks can no longer afford to lend money.

If money is borrowed to purchase consumables, rather than capital goods, then the debt is less easy to pay off. However the borrowing does create jobs so long as the borrowing to spend continues. Debt continues to increase until the risk becomes too great. The banks may decide to expose themselves to the increased risk, in hopes of a larger payback. In this case they will continue to lend money even when the ability of their borrowers to pay it back is suspect. However, this trajectory is generally reflected in an increase in interest rates that reflect the higher risk - which incidentally increases the risk of default. 

The State may utilize what is called fiscal policy and reduce taxes. Reducing taxes may result in substantial savings when you consider half our income goes towards tax payments. Lower taxes means the consumer has more money to spend on consumption though this also means that the government must increase its own debt to cover the shortfall. The end result is that the government transfers a portion of our debt onto its own books, or defers the time when we the taxpayer must pay the debt.

The total debt of course does not decrease it merely moves from our books to the books of the State.

Assuming this debt transferred to the State does not increase economic wealth (assets) and the debt is not invested in a manner that covers its repayment costs there is a point where even nations hit a debt ceiling. If a government can always borrow there is a point where the cost of borrowing is not feasible in that repayments at some point begin to consume too large a share of the nations GNP.

At some point interest rates are as low as they can go and the state has lowered taxes so far its ability to provide services is compromised. At this point it can possibly reduce its expenses but this means laying off civil servants or reducing the services it provides. Both these options tend to depresses economic activity further. The other alternative is to run a deficit. When services have been cut as much as possible and the bureaucracy has been pared down to the bone governments have to borrow. Deficits give the economy time to recover and provide a degree of stimulus but if the tax revenues do not start to climb as a result the government soon is faced with the reality of having its credit rating downgraded or imposing tax increases.

A lower rating makes it harder to run deficits because fewer institutions are willing to purchase Treasury Certificates and higher interest rates mean more money goes into servicing the debt.

The weakness of modern economic solutions is that debt is not without risk and every option, monetary policy, fiscal policy and deficit spending all increase debt. They differ only in the kind of debt produced. When businesses, individuals and the state are deep in debt and facing an uncertain economic future further borrowing becomes problematical if not impossible. Even if the interest rate is dropped to zero and the government lowers taxes people will at some point not be able to borrow more money or think twice about adding to an already impossible debt load. When people become adamantly determined to pay down debt the economy collapses.

To respond rationally to debt is from the perspective of the Free Market the worst response one can make. Debt repayment decreases economic activity, creates unemployment and business bankruptcies and turns recession into depression.

When businesses and individuals refuse to do the insane thing governments must step in. The world was in this type of situation in 1929. John Maynard Keynes argued for increased government spending in these times, an option named after him. When the private sector is unwilling to borrow and spend the State must do so. This can be restated as when business views the acquisition of debt to be irrational governments borrow in their stead. The community and future generations pay the interest.

Luckily for the Status Quo the economy is a large and complex entity and can lurch and stagger from one collapse to the other and yet not actually collapse to the point where it cannot stagger onto its feet again. But when every segment of the economy has borrowed all it can, when government revenues are largely consumed by debt repayment and deficits continue to grow, when workers income are stagnant and businesses are deep in debt and owners are uncertain sales will increase regardless of any investment made; when interest rates are at all time low and still no headway can be made in paying down debt and when people have borrowed all they can on the strength of their assets what is the next step?

The situation can be summed up as M4 = D(g+p+c). Or all forms of money (M4) is the total of all forms of debt (D), government, personal and commercial.



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