Debt: An Inescapable Concept Part 6: Conclusion

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.

Your financial 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.

Most advisors 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.

Credit/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 not exist.

Extending trust 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.

Sometimes the 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 status.


55—61: $69,00062—64: $55,00065—69: $44,00070—74: $37,00075—79: $30,00080+: $28,000


55—61: $24,00062—64: $19,00065—69: $16,00070—74: $14,00075—79: $14,000|80+: $13,000

Singles start 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.

The reason 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.

Debt taken 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.


Consumer 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.

When someone 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 asset.

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.

Government 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.

Because government 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.

Government 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.


Debt/credit 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.

Rhetoric against 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.

Something similar 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.

Debt/credit 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.

May19, 2007

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 19-volume series, An Economic Commentary on the Bible.

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