A Closer Look at History: Where Does Debt Come From?

This graph of American household debt relative to American Gross Domestic Product over time is licensed under Creative Commons 2.0 Share and Share Alike.

The obvious answer is this: debt comes from borrowing money.

What’s not so obvious is this: if debt is what happens when someone who doesn’t have money borrows from someone who does, how on Earth can every nation in the world be in debt?

Where is all the money being borrowed from, if nobody seems to have any to lend?

Here’s what I found…

Interest rates are how you make money off of lending money to others.

This painting of Jesus giving his Sermon on the Mount by I. Makarov is in the public domain. Jesus was not a fan of charging interest on loans.

For centuries in Europe, Christians were not allowed to be bankers. Why? Because Jesus forbid his followers from charging interest on loans. “Give, asking nothing in return,” he said. “If you lend money to any of my people with you who is poor, you shall not be like a moneylender to him, and you shall not exact interest from him.” The Bible also stated that all remaining debts should be forgiven if the borrower was unable to pay them back after seven years.

The same scriptural teaching has led to the creation of Shari’a-compliant banks in the modern world; rather than saying simply “don’t do it,” the Qu’ran allows Muslims to lend and borrow money, provided they follow strict rules about interest rates, to ensure that the amount of money paid back by the debtor is fair, and that taking out a loan does not result in a lifetime of indebtedness.

When you put it that way, it kind of makes you wish all banks were Shari’a-compliant.

The modern economic argument for high interest rates is this:

  1. Lending money is good for economic growth. If people are able to borrow money to start a business, which will “create wealth” by creating a new product or service, everybody wins. The new borrower gets to use a temporary investment of wealth to turn their time and talents into a sustainable source of income; the world gets a new product, service, or piece of infrastructure; the lender gets back what they leant, plus interest (in the case of a simple loan), or a portion of proceeds from the new business (in the case of investment).
  2. High interest rates and low capital gains taxes encourage people who already have money to spread it around through lending and investment. After all, who wouldn’t want to lend money to others if it meant you were going to get substantially more money back? Over time, lending money has itself come to be viewed as a source of profit. Step 1: Convince people to borrow money from you; Step 2: Charge high interest rates such that you end up with more of the borrower’s money than you originally lent to them; Step 3: Profit.Arguments in favor of mandating lower interest rates have often been met with concern that, if interest rates were lower, fewer people would be able or willing to lend, and overall economic development would suffer as loans became harder to come by.

    However, the present situation often involves borrowers who started out poor or middle-class paying out thousands more than they originally borrowed to people who were already wealthy to begin with.

    This explains the endless stream of credit card offers you get in the mail.

Debt can be so profitable that buying it can be seen as a good investment.

This photograph, taken from inside the members’ gallery at the New York Stock Exchange, has been generously released into the public domain by photographer Ryan Lawler. Surprisingly, debts are one of the assets traded within and between countries as potentially profitable assets.

I mentioned the practice of buying debt in my article about Greece’s financial situation.

Because debt is now thought of as a source of profit – something that you will get more money off of than you originally spent – debts are often bought and sold.

Parties who are looking to make some cash now will sell someone’s debt for less than the total expected payout; the buyer, who pays that amount of money to the original lender, will then receive all subsequent payments on the loan.

For the seller, it’s a way to make some money now instead of waiting for the loan repayment schedule; for the buyer, ownership of the debt is supposed to represent a long-term source of profit.

This is one reason why the American-spawned Great Recession hit everyone; governments of other countries, especially those in Europe, had been buying chunks of homeowner’s mortgage debt from American banks, thinking that the payments on these would fuel their own economic growth.

When many American homeowners were unable to pay their debts, all of the debt buyers were suddenly in the red.

This is also why The Rolling Jubilee has been able to eliminate $32 million worth of debt by spending only $700,000 in donations: “distressed debt” for which the original lender is currently receiving little to no payment may be sold for  fraction of the price of the original loan.

The Rolling Jubilee has been buying distressed debt for pennies on the dollar. Instead of initiating collection efforts as is common practice for the new owner of a debt, they forgive it.

Some banks were so threatened when they heard about this charity model that they refused to sell debt to The Rolling Jubilee, for fear that this kind of debt forgiveness could drain borrowers’ payments from the market if it became widespread.

Debt can be so profitable that people sometimes lend to other people instead of paying their own bills.

Although China owns over $1 trillion in U.S. debt, it owes over $17 trillion of its own debts to other parties. Using your money to buy others’ debt instead of paying off your own bills is now a commonly accepted economic practice. This image licensed by FutureofUSChinaTrade.com under Creative Commons 3.0 Share and Share Alike.

Take, for example, the strange case of the U.S. and China.

It’s a popular talking point that China owns a large amount of the U.S.’s national debt. This leads to the popular perception that the U.S. owes China money.

While this is technically true, it is also true that the Chinese government itself owes over ten times more money to various parties than the U.S. owes to China.

This suggests that, at some point along the line, the decision was made by China’s government to spend the money they had acquiring U.S. debt instead of paying their own bills in real-time.

Like the European governments prior to the Great Recession, the Chinese government was probably figuring that interest on U.S. debt would be a source of profit over time.

To be a sensible solution, they must have been betting that the interest we pay on those debts would outweigh the interest they would pay on their own debts acquired as a result of not using that money to pay bills in real-time.

All of this leads to a global sustainability problem.

Citizens block traffic to protest austerity measures in Germany. Austerity measures, referred to as “spending cuts” in the U.S., are designed to alleviate government spending – but they often hurt the economy by leaving citizens less productive and with less disposable income as a result of loss of public services. Photograph by timmy-litchbild licensed under Creative Commons 2.0 Share and Share Alike.

See the problem yet?

If all of us are betting on interest payments on loans as a source of profit, and all of us are borrowing money from each other, we’re effectively all gambling with money we don’t have.

This is what allows a crash in one region, such as the U.S. Great Recession or any number of potential natural or man-made disasters, to become a downward spiral worldwide.

Only countries with strictly regulated banking systems, often criticized for “restricting growth,” seem immune from such global calamities.

Somebody can’t pay their debts? Then the people who borrowed from them can’t pay their own debts either (indeed, the U.S. mortgage crisis was one of many contributing factors to the Greek economic crisis for that reason).

Government can’t pay its debts? It faces the choice Greece faced: either stop providing public services, or continue borrowing yet more money at yet higher interest rates from people hoping to profit off of lending to you, and pray that you somehow come up with enough economic growth to pay them off.

If you stop providing public services, you face a loss of worker productivity and a loss of economic activity, as people are spending more of their own money on basic essentials to stay alive instead of on purchasing goods and services from your businesses.

If your people stop purchasing goods and services from your businesses, your businesses have to lay people off. If your businesses lay people off, those people obviously have even less money to spend in your local businesses.

Suddenly it seems like borrowing more money at higher interest rates – which is the only way anyone will lend to you, since high interest rates balance out the probability that you won’t make be able to make your payments on time – is the only way out.

When everybody in the world is doing this, the net effect is a kafka-esque loop whereby everyone is passing around hypothetical resources that don’t currently exist, gambling on the idea that someday they will.

The effect at the end of the day is…

The top 1% is constantly siphoning money off of the bottom 99%.

This image based on controversial estimates which attempt to take into account “missing” money, such as money hidden in foreign tax shelters and otherwise not reported for tax purposes. Original source: Henry, James, “The Price of Offshore Revisted: New Estimates for Missing Global Private Wealth, Income, Inequality, and Lost Taxes”, Press Release, Tax Justice Network, July 2012, pp 5. Licensed under Creative Commons Attribution Share Alike 3.0.

This graph based on controversial estimates which attempt to take into account “hidden” money, such as money in overseas tax shelters and money not reported for taxation purposes. Original source: Henry, James, “The Price of Offshore Revisted: New Estimates for Missing Global Private Wealth, Income, Inequality, and Lost Taxes”, Press Release, Tax Justice Network, July 2012, pp 5. Licensed under Creative Commons Attribution Share Alike 3.0.

We’ve all heard of the term “trickle-down economics.” The logic was that prosperity for the wealthy would naturally lead to prosperity for all, as the wealthy would naturally invest their money in creating jobs, lending to and investing in small businesses, and passing top-bracket tax breaks along to consumers in the form of lower prices.

The problem is, in a culture where wealth is seen as a measure of your moral fiber (how many times have you heard economic success attributed to “smart decisions and hard work?”), that’s not what happens.

What happens instead is that the wealthy become devoted, primarily, to becoming wealthier. While this motivation might make sense for those at the bottom and even in the middle of the income curve, when practiced by those who already have six-figure incomes, it becomes clear that a self-sustaining feedback loop of more money = better has formed.

Moral questions aside, the numbers are clear on the fact that this happens. Since the 1970s, instead of a “trickle down” effect, the U.S. has seen a trickle-up effect; each year, the already-wealthy have gotten proportionally richer, while the wages of the lower- and middle-classes have dropped relative to the price of essential commodities.

This can be seen happening at a global level as well; and interest rates are a huge way in which this happens.

While it’s true that global prosperity is in fact rising, despite all the doom and gloom we hear in the news, and due in no small part to moneylending by the wealthy – it is also true that much of this money is lent with the ultimate intention of making a profit off of the borrower, and the net effect is that billions of dollars annually paid by national governments and private individuals on their debt are going into the pockets of those who already had enough money to go lending it around.

This is cause for serious concern, since many parties, from wealthy insiders to NASA scientists, have raised alarms about the rise of the global elite. The concern is not that these people are evil, so much as it is that they’re simply out of touch, as a consequence of wealth-is-good morality.

After all, someone who is accustomed to comfort and has practically limitless money is not likely to care tremendously about climate change; they will almost certainly care more about the numbers in their bank account, and if one locale  becomes uncomfortable, they can simply move to another.

Someone who has not had to struggle to pay bills in decades – during which the economic landscape has drastically changed – is unlikely to feel sympathy for the plight of workers struggling to pay medical or educational bills. “Just work harder,” they’ll say, “that’s what I did.”

The fact that the cost of a college education has risen by 1120% since they were in college themselves  may register as numbers on a piece of paper, but there’s no way they can know the reality of it if they haven’t experienced low or even median income firsthand in decades.

This is arguably all a product of our “wealth means you’re a good person” culture. By persistently attributing financial success to pure hard work and good ideas, we ignore the role that screwing over other people often plays in economic success. We also totally ignore the influence of luck, because it’s uncomfortable to think that such an important aspect as our income is determined to a large extent by forces we cannot control.

And yet, statistics show that it is – in the United States, for example, only a small percentage of people now manage to escape the economic class in which they were born. Generally, those lucky enough to be born rich will remain rich, and indeed get richer thanks to current economic trends; those unlucky enough to be born poor will generally remain poor due to the difficulty in affording healthcare, education, and other resources needed to become financially successful.

Statistics tell us that a thousand factors which are not chosen or earned effect our economic outcomes.

Men make much more money than women. Members of the ethnic majority make more money than minority members. IQ, a key determinant in “making smart business decisions,” is determined by a confluence of everything from genetics to education to the nutrients and toxins you ingested growing up. Children in many poor cities, for example, have been found to have high levels of lead in their blood and in the soil and water around their houses, which negatively effects neurological development and IQ.

And the strongest correlate of all is how much money you were born with: those who can afford the best private schools from day one through college will obviously be more successful than those struggling through underfunded public schools in the inner city. Studies show that even the “rich kids have better genes” argument does not explain the results we see.

In summary, debt is a dangerous game of gambling stability for the possibility of growth.

The Great Depression was spawned by excessive “buying on credit” – essentially, people borrowing and spending money they didn’t have. The interest-based economy bears a resemblance to this habit, as it also relies on money that doesn’t yet exist. This photograph is in the public domain, available through the National Archives and Records Administration.

Moral ramifications for the individual aside, the economic truth about debt is this: nearly everybody has it, and the potential to make money off of acquiring it is leading to a self-sustaining  cycle of buying other people’s debt instead of paying your own bills.

Buying other people’s debt, you see, is an investment in infinite growth. Paying your own bills is responsible – except insofar as “not making the most profitable investment” is considered irresponsible, the same way that not borrowing thousands of dollars in order to go to college is.

The cycle has to stop somewhere.

Arguably the easiest way to do that would be to follow the example of the Hebrew scriptures, the Christian gospels, the Qu’ran, and The Rolling Jubilee: if you’re going to give money to another, don’t do it because you hope to turn a profit.

If you want to lend money to help increase the world’s productivity, do it because you want to help increase the world’s productivity – not because you’ve been taught that wealth = right and lending money is a way of getting more wealth.

Changing that cultural paradigm will require an attack on the “wealth equals morality” ethos that are so deeply ingrained in the way we think.

But succeeding in changing that might just save the world.

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