December 1, 2012

Debt or Go Away Closer – Take 2

We first published the blog note,“Debt or Go Away Closer” in December 2010, when the Greek debt crisis seemed to have peeked. Yet two years later, Greece is still drowning in debt and nothing more than patch work has been done that “kicks the can” and prolongs the agony.

In the United States, the debt situation is quite different from the situation in Greece. The U.S. also has a lot of debt but the U.S. can “print money.” This reduces the value of the dollar but also reduces the value of debt that is in dollars. “Printing money,”or what is popularly known as "quantitative easing" (QE) is actually a procedure that involves the federal reserve buying debt, thereby putting more liquidity into the system. The fed buys the national debt through buying treasuries. The fed can also buy mortgage backed securities.

With “printing money” the debt becomes less onerous. On the face of it, this would appear to be a no-brainer solution to the problem of excessive debt, but not so fast – there is a down-side to "printing money":

By increasing the volume of money in the system, “printing money” actually causes money to become less and less valuable. Savings accounts become worth less and less over time. Fixed income becomes worth less and less. In turn, basic goods and services cost more and more, because the money used to buy them has become worth less and less. Eventually, as a result of “printing money” all commodities will theoretically rise in value including food, supplies, oil and gas, gold, and – real estate! But these rising costs, also known as “inflation,” could backfire and cause demand for goods and services to contract.

If we really look at debt for what it is, debt is simply a means of distributing goods and services to greater numbers of people. It may not be the best means and certainly is not a utopian means but it is a means. If a car or a home or even a big screen HDTV could only be purchased for cash, imagine how few people would have these things? Without debt, travel, education and recreation would be much less readily available for the average American. While admittedly the debt system is the greatest instrument of global oppression, at the same time the debt system has served to broaden and expand the human experience.

The debt system works as long as demand for consumption continually expands. But when the demand for goods and services contracts, which in turn causes production to be cut back, prices to be reduced, and employment and associated wages curtailed, the debt system implodes on itself. And when the debt system implodes, we are in a financial crisis. The financial crisis that began in 2008 was a debt crisis.

The kicker is that money itself is actually debt. Every dollar is actually a promise to pay. And to pay with what? With another promise that is greater in size because the new promise includes the interest owed on the first promise. The debt system can’t exist in equilibrium. It incorporates the inherent requirement, not only that consumption of goods and services increases ad infinitum, but also that the supply of money increases accordingly. Until… until… ???

Solutions to over-extended debt are not easy to come by. “Printing money” may backfire and actually reduce demand if it causes costs of goods and services to rise too much. “Austerity,” the remedy frequently proposed in Europe, entails spending cuts that contract the economy resulting in less and less demand. This will not solve a debt crisis that can only be solved by increased demand.

In 2010, we concluded the following and today it still rings true, “There is really only one solution to global debt issues, and there is a term for it. Some would say it is a religious term and it may be that. But I think this is a term for what the human experience in this world is really all about, a term for something that solves a lot of problems and sets a lot of things straight. It is “forgiveness”and it is long past due."

Many analysts say the real estate market in the U.S. has healed and that we’re heading “up” from here. Each short sale or foreclosure along the way has been a form of debt forgiveness. And yet the banks are still making loans. The debt system hasn’t imploded just because of a little forgiveness. Go ahead and write down the Greek debt, and don’t worry, the bond holders will be back for another round.