One last time:
Private debt is an inescapable concept. It is never a question of
debt or no debt. It is always a question of which kind of debt,
owed to whom, when.
You are from
birth either a creditor or a debtor. As an adult, you are probably
both. Workers are creditors in their capacity as pension owners.
Workers are debtors in their capacity as home owners carrying a
mortgage. There is a balance between household debt and credit.
future depends on your ability to understand debt and credit and
then apply what you know to your situation.
There are advocates
of maximizing debt for investment leverage. Virtually all of the
modern economy is based on leverage. The derivatives market is estimated
at $300 trillion of promises to pay. It is entirely leveraged and
highly leveraged. The modern world economy rests on a gigantic system
of promises to pay — promises that are never met. These promises
are rolled over when they come due — replaced by new promises. The
same is true of the commodity futures markets.
There are also
advocates of zero personal debt. They tell people to cut up their
credit cards. Some say people should not borrow even to buy a home.
They recommend renting until you can afford to pay cash for a home.
Problem: A rental contract is a promise to pay. So, there is no
escape from debt/credit.
fall somewhere in between. They advocate buying a home with a mortgage.
They recommend using credit cards, but paying the debt off every
month. They recommend setting aside money monthly to buy a car.
They recommend a combination of thrift and debt.
is a system for allocating different kinds of risk. Some people
would rather risk paying a mortgage than risk being evicted at the
end of a house-rental period. There are creditors who would rather
risk lending money to home-buyers money than lend to other kinds
of debtors. The credit markets allow people to exchange the kinds
of risks they do not want to bear for the kinds of risks they are
willing to bear.
Debt is the
other side of credit. Debt and credit are inescapable in a world
of imperfect knowledge about the future. Time and imperfect knowledge
of the future together mandate trust. Without trust, society could
is a way to extend credit. We rely on others’ cooperation. We make
plans. We seek the cooperation of others in the future. We can ask
for cooperation, but when we offer a benefit for extending cooperation,
we present a more compelling case.
We should think
of the debt/credit relationship as a way to increase the likelihood
that others will cooperate with us when we seek our goals. When
we pay someone in advance to show up on time and perform a specific
task, we become creditors. Conversely, when someone shows up on
time and performs a specified task in exchange for a promise of
future payment, he becomes a creditor. In each case, there is an
inescapable aspect of credit and debt.
task to be performed is a matter of tradition, as in a family. Sometimes
it is a matter of a voluntary contract which is enforceable by civil
law. Sometimes it is a matter of legislation. But there is always
risk that one of the two parties will not perform the task or perform
it at a level below expectations. There can be defaults in this
world. When they take place, those who had relied on the other party
to perform according to one set of standards suffer a loss.
As you grow
older, you should owe less money than when you are starting out.
You should be in the creditor category. This is because of your
earning ability. Usually, it drops as you get older than age 55,
unless you own your own business or unless you are a senior manager.
A May, 2006
study published by the Social Security Administration, "Income
of the Population 55 or Older, 2004," indicated the
following decline in median income by age group and by marital
at a much lower level of income, but the decline is less sharp.
Couples who do not factor in this decline after age 65 are probably
making a big mistake.
why people need to be creditors as they age is because they move
into capital consumption mode. They lack the income-producing strength
and opportunities as salaried workers. So, they must build up capital
in their years of productivity.
This is no
longer being done in the United States. Personal saving has disappeared
in the population at large. But dreams of a comfortable retirement
have not faded. There is a looming disconnect.
Debt that increases
a person’s ability to produce is productive debt. He takes on debt
because he expects to be able to repay this debt with money to spare
— money that he could not generate apart from the debt.
The same is
true of business debt. Debt that is used to increase future productivity
can be a wise decision. It may allow a faster response to increased
market demand than by accumulating retained earnings or issuing
new shares of stock.
on at the beginning of an economic boom can benefit buyers of capital
equipment, land, or other assets. Of course, the opposite is true
at the end of a boom.
It takes entrepreneurial
foresight to assess such matters.
Not all people
who think they possess this ability really do. They can be whipsawed
by the business cycle. They take on debt late in the cycle. They
suffer falling revenues in the contraction phase, yet the debt meter
keeps ticking. But the fact that some debtors are ineffective entrepreneurs
is not an argument against all forms of debt.
lets us buy now, pay later. There are emergency periods in which
such debt is wise. A car’s breakdown on the road or an illness requiring
hospitalization are such times of crisis. But these events are rare.
borrows to finance the purchase of depreciating assets, which most
consumer goods are, he decides to fund present consumption at the
expense of even greater future consumption, which he will not enjoy.
He allows his innate present-orientation manifest itself at present
interest rates. He obligates himself to pay future money for a depreciating
The West has
long placed a moral premium on future-orientation. This is one of
the causes of economic growth. This was especially true of monasteries
during the Middle Ages. Men who had taken vows of poverty were put
to hard work. The result was an increase in retained earnings. The
first great examples in the West of long-term economic growth —
compound growth — were the monastic orders. Every few centuries,
the church called for moral reform of the monastic orders, which
had accumulated property in the name of poverty.
People in a
free market are allowed to purchase the kind of future they prefer.
Creditors purchase streams of future income. Debtors purchase goods
and services now in exchange for payments in the future. The market
lets debtors and creditors negotiate the exchange of complementary
futures over time.
Here is where
the quest for security finances the creation of great insecurity.
Investors trust politicians’ promises. So do voters. The result
is dependence on a system which ends in default. Why does it end
in default? Because state financing substitutes coercion for voluntarism,
unfunded promises for funded promises.
debt finances the growth plans of agencies that by nature are not
run by people who must satisfy consumers. They must satisfy voters.
Voters in turn
expect to pass on their expenses to the government. So, they vote
for grand schemes of wealth redistribution because, one by one,
each expects to do better than the average taxpayer or recipient
of extracted wealth. It is the triumph of hope over statistical
reality. It is tooth fairy economics, except that this fairy knocks
out every tooth it collects. Resting their heads on tens of millions
of pillows, slumbering voters expect something for nothing in the
morning. Most of them will wake up with fewer teeth than they had
when their slumber began.
debt is unspecific with respect to the sources of its future funding,
yet broad in the scope of its promises, there is a fundamental disconnect
between promises and liabilities. In this gap stands the central
bank. It is in a position to write checks to meet liabilities, but
only nominally. Under mass inflation, liabilities exceed funding,
for liabilities are real, while their funding is digital.
debt is transacted in promises that can be revoked at will, unlike
insurance contracts. The promising agency sets the terms of repayment.
The words may stay the same — "dollar," "a moral
obligation of the government" — but their substance does not.
and trust/time necessarily go hand in hand. To abolish the use of
debt/credit relationships would be to abolish trust/time relationships.
This could not be done without destroying the division of labor
and therefore society.
debt is often misused. The critics of debt too often do not understand
the trust/credit aspect of the division of labor. They do not acknowledge
that risk is inescapable in life, and that credit markets allow
people to exchange one kind of risk for another kind. In short,
they have not thought through the implications of their position.
can be said of defenders of government debt, which also rests on
the trust/time relationship. Civil governments have repeatedly violated
those who have trusted them. This especially includes creditors.
Creditors hope that with each new extension of credit to the state,
"this time, it’s different." It rarely is.
is as legitimate as trust/time. You are wise to select carefully
that agency you will trust over time, either as a debtor or as a
creditor. When it comes to the state, you are both: a creditor (taxpayer
today) and a debtor (dependent ward of the state later). In the
latter position, you should make plans on the assumption that you
will receive less than has been officially promised.