Consumer Debt: Not an American Monopoly

The sheer scale of consumer debt has made millions of households extremely vulnerable to shocks in the economy, both from fiscal mismanagement and external factors such as oil price rises, acts of terrorism and wars. A downturn in the economy would create serious economic and social problems for the fifteen million people who struggle with debt repayments. Debt is a time-bomb which could be triggered by any number of shocks to the economy, at any time.

~ Griffiths Commission on Personal Debt (March 21, 2005)

In a story released to the press on March 21 and published on Yahoo and in English-speaking outlets around the world, the Conservative Party warned of rising consumer debt in Great Britain. What caught my eye was the author: Lord Brian Griffiths. Before he became a peer, Dr. Griffiths was Dean of the Business School at the City University of London until 1985, the year he became the head of Mrs. Thatcher’s policy unit.

I remember this all too well. I was sitting in his office on the day he got the offer. That cost me an important taped interview that I had flown to London to conduct. One day earlier, and I would have recorded a classic — "the one that got away." From that day on, he became too famous to give interviews as explicit as the one I would have conducted. He had to turn me down. I saw him again in the late 1980s. My parting words were, "Let me know when you’re a nobody again. I still want that interview." So far, he’s still a somebody. No interview.

UK faces consumer debt "time bomb"

The UK faces a potential consumer debt time bomb that could be triggered by an external "shock" such as rising oil prices or from rising interest rates, a report from the UK’s Conservative Party said.

Britain’s consumer borrowing has reached the 1 trillion pound mark and a sudden shock could impact on 15 million people, the report said.

The report, compiled by Goldman Sachs International vice-chairman and Conservative Brian Griffiths, said credit in the UK has been "too easily available and marketed far too aggressively."

Griffiths called for the voluntary Banking Code to be replaced with a statutory "customers charter" to help tackle the spiraling household debt problem. This would outlaw aggressive marketing practices and increase transparency of credit card charges.

"There is a real need to improve the quality of information made available to borrowers (who) need better support once they get into financial difficulties and independent advice to restore their financial stability," Griffiths said.

He told a news conference that the sheer scale of consumer debt has made millions of households vulnerable to external economic shocks such as rising oil prices, wars and terrorism.

He also criticized the Bank of England for being "too sanguine" about the level of debt, adding that as the debt-to-income ratio had gone from just under 100pc to 140pc in recent years it had become a "time-bomb which could be triggered by any number of shocks to the economy at any time."

Griffiths is not just an academic economist. He oversaw much of Mrs. Thatcher’s de-regulation program, which transferred many of the state-run monopolies to the private sector. She made him a life peer in 1990.

He then became Vice-Chairman of Goldman Sachs International. This is one of the major investment banking houses in the world. In the United States, Goldman Sachs is considered one of the Establishment investment banking firms.

That is why I regard his authorship of the report as important. This is not simply a policy paper issued by a party out of power that may be facing an election in May, if Blair calls one, as is expected. Griffiths is putting his reputation on the line: academically and professionally.

Unlike most economists, Griffiths brings an explicitly moral perspective to his economic analyses. He is the author of two books, Morality and the Market Place and The Creation of Wealth: A Christian’s Case for Capitalism. It was these that I had hoped to interview him about. He told me at the time that my 1973 book, An Introduction to Christian Economics, was the first one he had read on the topic.

Having followed his career from a distance for over two decades, I conclude that he is not raising a false alarm for publicity’s sake. The threat of a debt crisis is real.


Under a gold coin standard, there is negative feedback on the expansion of credit. If bankers create too much money, depositors will come down and demand gold coins for their checks or banknotes. A bank that cannot redeem these notes is declared bankrupt.

Without a commodity standard with redemption on demand, the monetary system moves into positive feedback. Here is an example. During the French Revolution, the government confiscated the church’s lands. Then it issued paper money against the value of these lands. The bills were called assignats. No one could redeem assignats for a specified piece of land. But the government promised to restrict the issue of assignats by the value of the land.

This created a positive feedback condition. The price of land was measured in assignats. The more assignats the government issued, the higher the price of the land went. But the higher the price of the land went, the more assignats this authorized the government to issue. Within two years, all prices were soaring. The economy went to barter or black marketing. The currency was ultimately destroyed. The story of this disaster was written almost a century ago by Cornell University’s Andrew Dickson White, "Fiat Money Inflation in France." You can get in free online.

When the dollar was removed from the citizen’s gold standard in 1933, abolishing citizens’ right to own gold, and again in 1971, when convertibility on demand at $35/oz was abolished for central banks, the interest rate, especially in the bond markets, became the only major limiting factor on the Federal Reserve System’s ability to inflate the money supply. Fear of interest rate increases, meaning fear of falling bond prices, became the restraining factor. This fear kept Bill Clinton’s spending plans tightly in check — a fact he learned in his first few days as President.

In the housing market, there is a positive feedback condition. The size of the loan is limited by the appraised value of the house. But if mortgage interest rates drop, then a borrower can afford to borrow more money and still make his monthly mortgage payments. More borrowers show up for loans because more people become eligible at the entry level.

They start bidding against each other. Up go home prices. Appraisers tell lenders that prices are up. Lenders are then willing to loan more money to buy these more expensive houses. The spiral begins.

Now there is evidence that some appraisers have committed fraud, reporting higher than market prices to lenders, so that lenders could extend even more credit to home buyers and re-financing owners. This has placed lenders and borrowers at risk during an economic recession.

How high can it go? The median price of a home in California is $465,000. Incomes did not rise to keep pace with these prices. Marginal buyers are driving up the price of those few homes that are offered for sale. The high price received by these marginal homes is imputed to all homes by the appraisers. All home prices go up, not just those offered for sale.

The two negative factors are these: (1) the number of people who can afford to buy an entry-level home; (2) interest rates, which affect #1. Until these kick in, a region can experience a housing boom. It can become a mania.

In the United States, housing on the two coasts have been bid up beyond the ability of most entry-level couples to buy. Florida housing is also appreciating fast. A man I know has equity profits of well over half a million dollars in three years. He is taking his money and running. He will move to Kerrville, the hill country of Texas, which was cheap a decade ago, but not now.

People not in these boom areas are locked out from them. They cannot afford to move in. Population will flow out, especially among younger workers. Businesses will locate in the heartland, where housing prices are lower. They will be able to hire talent cheaper.

But in high-priced areas, housing prices will not fall back to what they were a decade ago unless mortgage interest rates soar. The ratchet will have its effect.


We know what a ratchet is: a geared cog with teeth that are designed to be locked in place by a lever. A spring is attached to the cog. The tighter the spring, the more tension is on the cog. As you turn the cog against the spring, it gets more resistant. Raise the lever above the teeth, or else let go of the cog’s crank handle before you lock in the next tooth, and the cog will whirl in the opposite direction. Woe unto whatever is on the pulley that is attached to the cog. The higher it is up the pulley, the farther its fall to the earth.

The commercial banking system is the cog. The central bank keeps cranking this cog: buying T-bills.

As with any ratchet, there are two ultimate limits: the tension on the spring and the resistance of the spring’s metal. At some point, the spring snaps. In monetary affairs, this is mass inflation. Ludwig von Mises called this the crack-up boom, when money dies. The other limit is tension — in the case, interest rates. At some point, the spring can’t be cranked any tighter without driving short-term rates up and causing recession.

Move the cog up one more notch, and the lever may break loose mid-lock. The cog will spin backward like a propeller. That’s called depression/deflation. That’s what happened 1929—33.

Short of a gridlocked banking system, where leveraged debts cannot be paid off, the greater risk today is inflation. The FED keeps cranking the cog. Debts keep getting agreed to at ever-higher prices.


Most people have entered into multiple debt agreements. They think that prices will not fall. If prices do fall, owners’ equity will disappear. The appraisers will then have to report lower prices, which will lower the loan value of property.

The entire economy today is way up the pulley. Contracts are made at one level up the pulley, and then it rises higher. What if this process reverses? It did in Tokyo real estate, 1990—2005.

The FED has created a boom by expanding the money supply. Now it is trying to unwind the boom’s low-interest foundations without jeopardizing the boom. It is slowing the creation of money. But it does not want to create an unsprung ratchet.

The FED is tightening money. A handy way to follow this is to go to a newly created blog site, created by one of my readers. This blog site serves as a good model. It is run for free on

He offers several handy links on the right-hand side. Click MZM, money of zero maturity. MZM is down at an annual rate of almost 3% since mid-January. Since early June, 2004, it is up 0.9%.

Using the Median CPI figure, price inflation is up 2.4% for the last 12 months.

There is a ratchet. Prices do not fall. But by slowing the creation of money by restricting its purchases of T-bills, the FED has restricted this upward ratchet move.

But remember: this ratchet never falls here. When it threatens to fall, the FED inflates money. Look at the adjusted monetary base since late January. It is now in the 10% range, despite some backing off over the last few weeks. (Adj. Monetary Base 2) Over the last four years, the move is relentlessly upward. (Adj. Monetary Base #1)


Consumers have bid up the prices of goods with fiat money. Then they go into further debt to buy more of these goodies. This is a ratchet phenomenon. The restraining factor is upward interest rates. This process has begun in the short-term debt markets in the United States, but it has not yet affected consumers’ desire to buy more goodies by going into more debt.

The decisions of millions of consumers, all over the world, to raise their level of debt has created what the Griffiths Committee calls time-bomb conditions. England is not alone. Consider this report from Canada.

Some finance experts are warning Canadians must wean themselves off debt, otherwise they face a major shock if interest rates rise.

"It could be catastrophic in terms of the whole economy," says financial counselor Allen MacLeod.

Interest rates have been quite low in Canada for the past several years.

But Canadian paycheques have grown very slowly. To prop up their standard of living, many Canadians have resorted to cheap credit and stopped saving money.

Lines of credit have grown at a record pace in Canada, up 30 per in 2004 alone.

Holly McIntosh and Frank Lestage’s bank offered them a line of credit a few years ago.

"They just give you the money and people spend and spend," Lestage said. "It doesn’t take long to get it under control, but you have to realize what you’re doing and that takes a while. You have to get in trouble to realize what’s going on." . . .

"I think as things have gotten more expensive, we’ve (become) a need-to-have-now generation," says Cindy Cassidy.

And that’s part of the problem, says consumer advocate Mel Fruitman: "Consumer debt as a whole in Canada exceeds consumer assets. That means we’re on the brink."

MacLeod says personal bankruptcies are up more than 10 per cent since January.

The article goes on to say that TD bank says there is no problem. Obviously, not many bankers are going to sound the alarm.


Consumers worldwide are being lured into more and more debt. They will have to reduce spending. This has not happened yet. But as the FED tightens money, allowing short-term demand for loans to push up rates, the traditional response is a falling stock market.

I think we’re there.

March 31, 2005

Gary North [send him mail] is the author of Mises on Money. Visit

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