The Growth of Debt

This section of the discussion has been anchored in the previous description of a basic economic model in the hope that it might help to clarify some of the key processes at work, which now affects the lives of most of us. While the quality of life for many living in the more affluent economies around the world may appear to have improved considerably over the last 100 years, we may still have to question how this improvement has been ‘financed’.

The graph above shows ‘real income per person’ in England over the last 800 years or so, which appears to have remained fairly constant until the start of industrial revolution in the 18th century. However, the following quote by Gregory Clark may put this economic evolutioninto a better long-term perspective:

For the majority of the English, as late as 1813, conditions were no better than for their naked ancestors of the African savannah...even according to the broadest measures of material life, average welfare, if anything, declined from the Stone Age to 1800. The poor of 1800, those who lived by their unskilled labour alone, would have been better off if transferred to a hunter-gatherer band.

The idea of a ‘Malthusian Trap is named after the political economist Thomas Malthus, who suggested that for most of human history, income was largely stagnant because technological advances and discoveries only resulted in more people, rather than improvements in the standard of living. It was only with the onset of the agricultural revolution and the Industrial Revolution in the 18thcentury that the ‘income per person’ began to dramatically increase, but not in all countries. Writing in 1798, Malthus also described the conflict between exponential population growth against the arithmetic growth of the food supply, which he believed might only be resolved by one of two forms of ‘checks’ that would reduce the population to a more sustainable level. The first type of check he defined as ‘preventive’ and required a form of moral restraint, i.e. abstinence plus delayed and restricting marriage based on financial criteria. The second type of check he defined as ‘positive’, although the word ‘negative’ might have been more appropriate as these checks all led to premature death, e.g. disease, starvation, war.

But what has this to do with economics?

What we might all have to come to recognise in the graph above is the unsustainability of economic growth, which has to ultimately be reconciled with the finite resources of planet Earth. While the issue of finite resources will be deferred to the section entitled ‘The Limits to Growth’, we might recognise that the graph of ‘real income’ is not telling the whole story about the financial status of an average individual or the economy of the nation-state. For while ‘real income’ may have increased, so have ‘real outgoings’, which must also include debt repayment.

Country Debt
(in millions)
Population
(in millions)
Debt
per Capita
UK $2,187,500 64 $34,180
US $18,000,000 320 $56,250

As outlined in the previous ‘economic model, the debt of a nation-state results from the accumulating the year-on-year budgetary deficit of government spending, i.e. outgoings exceeds income.

Note: Household debt is defined as the amount of money that all adults in the household owe financial institutions and  is assumed to include consumer debt and mortgage loans.

In addition to the national debt, it is estimated that sum of all household debt across the population is nearly comparable to the national debt.

Country Household
Debt
(in millions)
Population
(in millions)
Debt
per Capita
UK $2,269,568 64 $35,462
US $11,987,520 320 $37,461

As such, we might make a crude estimate of the total debt per capita, as showed below. However, it is possible that the true level of ‘indebtedness’ as to be seen in terms of a typical household consisting of a family of 4:

Country Total
Debt
(in millions)
Population
(in millions)
Debt
per Capita
Debt
per Family
UK $4,457,068 64 $69,642 $278,567
US $23,975,040 320 $74,922 $299,688

While the private banks may be happy with this level of debt, as they earn interest on all loans, it is unclear that this state of affairs can be sustained, even in purely economic terms. If so, future generations may have to reconcile the idea of ‘sustainability’ in terms of both physical resources and economic growth, such that the mechanisms underpinning the current banking system may have to be radically re-evaluated:

  • The banking system uses the idea of assets and liabilities to control over 99% of all transactions, by value. Again, we might describe bank liabilities, i.e. bank credit and bank deposits, as being equivalent to money in the digit world.

  • Banks can ‘create’ bank deposits, i.e. the money in your account, when they make loans. They add liabilities to the borrower’s account, and simultaneously add an asset, i.e. the loan contract,  to their balance sheet. Again, this can all take place within the digital representation of a balance sheet within a computer system.

  • The money that banks use to pay each other, via central bank reserves, is also effectively ‘created’ out of nothing, which may only exist as an accounting entry within the central bank’s balance sheet to which all private banks are customers. The liability that the central bank ‘creates’ for use by the private bank is balanced out by the asset that the private bank posts as ‘collateral’.

However, what might not be clear in the examples given in this section of discussions, and the summary above, are the overall consequence stemming from the ability of private banks to ‘create’ money in the system. Let us consider a specific example, where the central bank (CB) injects $100 million dollars into its banking system, which we will assume ends up being deposited in some private bank (PB). Let us also assume that the bank system, as a whole, requires any private bank to retain 10% of its deposits as a contingency reserve, such that it can only use $90 million of the originate $100 million for forward loans. Now let us see how this might ‘percolate’ through the banking system:

Bank

Deposits
(Millions)
Loans
(Millions)
PB-1 100 90
PB-2 90 81
PB-3 81 72
PB-4 72 65
PB-n .. ..
Total 1000 900

So, what started out as a $100 million injection into the monetary system, ends up ‘creating’ $900 million worth of ‘credit money’ in the private bank system, which is all gaining interest. i.e. profit to the private banks, which adds more money to system, which we might assume affects the value of each $1 already in the system as possibly reflected in the following plot of the purchasing power of the US dollar over the last 100 years or so:

As such, it is difficult to understand how this system can avoid some form of inflation, and in fact may be its very source, which impoverishes everybody that is not earning interest on the money being injected into the system, e.g. like the private banks through loans.

Note: In the case of the US economy, $1 lent at 5% interest becomes $2 in 14 years, which means the money supply has to double every 14 years, just to cover the interest owed on the money existing at the beginning of this 14 year cycle. In the US, the Federal Reserve's own figures confirm that the money supply has doubled every 14 years since 1959. Based on these figures, it suggests that private banks effectively earn as much money in interest as there was in the entire economy 14 years earlier.