The Uneasy Relationship Between Debt, Democracy and Capitalism

There is an uneasy relationship among debt, democracy and capitalism, as a new FT column ably makes clear. Here are some excerpts, starting with why debt in the U.S. has passed the levels of the Depression:

The answer is capitalism’s dirty little secret: excessive lending was the only way to maintain the living standards of the vast bulk of the population at a time when wealth was being concentrated in the hands of an elite.

The amount by which the elite has benefited is startling, and illustrates the problem with lightly regulated free markets: the rich get much richer while the rest do not get richer at all. According to Société Générale economists, the inflation-adjusted income of the highest-paid fifth of US earners has risen by 60 per cent since 1970, while it has fallen by more than 10 per cent for the rest. As was recently pointed out in the New York Review of Books, the Walton family, of Wal-Mart fame, is wealthier than the bottom third of the US population put together – about 100m people. These are staggering statistics, confirmed by measures such as the US and UK’s ever-rising Gini coefficients, which estimate income disparity. Another way of putting this is that the share of profits in gross domestic product is at a 100-year high, or was until very recently.

The preceding is such an important point. We became indebted, in large part, because of a structural imbalance in society, one that skewed incomes, redirected wealth, and encouraged companies and individuals to lever up instead of seeking out and earning higher incomes. At the same time, our unwillingness to say no to great society programs, without raising taxes to pay for them, meant that we became beholden to the bond market for funding ongoing operations, this creating an elevated base of required income to service our rising debt.

The solution is messy, multi-part and painful, but he closes on two notes with which I agree strongly:

…we should all come to terms with the fact that these are structural issues needing structural solutions; they need to be enforced over a longer time period than any one government’s term. So we need a new political consensus, one aimed at reducing overall debt levels while reducing inequality by encouraging education, entrepreneurship and investment in innovation.

Read the whole thing here.

Comments

[Neil459:]

Structural problems, yeah, its called taxes, CAFE standards and other regulations, and welfare.

1. Taxes on business are near the highest in the world, so successful businesses are operating in other parts of the world.

2. Government regulation has become oppressive and now all manufacturing is done in other countries. My grandfather taught me that wealth comes from growing something, digging up something, or converting something into more value (agriculture, mining/oil, and manufacturing)

Two of the three are now prohibited by regulations. So now people work at McDonnalds or are on welfare instead of higher paying manufacturing jobs.

3. With welfare, there is no incentive to work so guess what? People at the low end of the income scale are not working! Why does that surprise anyone?

Well, it does not surprise anyone that cares to look at cause and effect.

Jul 01 12:44 PM

[derryl:]

Ben Funnell, author of the FT article that Paul has quoted, wrote, "The net worth of US households, including their houses and after counting debt, was $50,000bn in March, according to the Fed. Not a bad tally for 306m people: $165,000 each."

This is misleading because a huge number of Americans have zero or negative net worth while a small percentage at the top have 10s and hundreds of millions of net worth. The 'average' implies that pretty much every American has a net worth of $165,000.

This income disparity is the structural problem that needs to be addressed if the US economy is ever going to recover. Right now almost all of the spendable money is owned by the investor class who cannot possibly spend a fraction of their money on consumption which will spur production which will get the economy going. Most Americans are in deep debt so they can't spur consumption/production either. Unless 100s of millions of Americans have spendable incomes in their pockets the economy cannot recover.

Michael Hudson thinks the US is in the terminal stage of a debt/compound interest cycle from which there is no escape by conventional means of earning more and spending less. Read, "Why the miracle of compound interest leads to financial crises"

www.michael-hudson.com/

Compound interest is an exponential function that will ultimately increase numerical debt to infinity. The economy is a physical system with real-world limits to its growth. The economy cannot service exponentially growing debts. In other words, Hudson is saying that the economy cannot repay the debts it already has and taxpayers certainly cannot repay the new debt that Obama is piling onto America's public indebtedness.

With interest, and especially compound interest where one year's interest is added onto next year's principal, the simple arithmetic fact is that there must always be more debt in the system than there is money to pay the debt.

In our monetary system money begins its existence as bank loans. If I take out a 1 year $1000 demand loan at 6% interest the bank will create a $1000 deposit in my account which I can spend as I see fit. So the bank has created $1000 of money which I circulate into the economy, thereby increasing the circulating money supply by $1000.

But at the same time as me and my banker added $1000 to the money supply, we added an additional $60 interest charge to the system. We added $1000 of money but at the same time we added $1060 of debt into the economy. The money to pay the interest was not created at the time the $1000 principal was created. In this very simple way there is always more new debt than new money added into our system.

I know it is difficult to believe that we can have been operating an arithmetically flawed monetary system all these decades without anyone ever coming up with a way to add enough 'free' new money into the system in order for the total amount of debt and money to balance, which would make all debts + interest at least arithmetically payable.

But even then we get to the income and net worth disparity problem where the people who own all the money are not the people who owe all the debts. So even if in aggregate there is enough money in the system to clear all debts, the debts cannot be cleared unless the people who have the money give it freely to the people who owe the debts.

This is something like the ancient Hebrew practice of Jubilee, which was instituted for the same reason: some people are really good at acquiring ownership of everything, while most people are really good at getting themselves into debt. Eventually the economy ceases functioning because a few people own everything and everybody else has no money. If we're going to address the structural problems with our economic and monetary systems, we must eventually address this issue of arithmetically unpayable compounding debt.

PS: New loans create new money that borrowers can collect to pay the interest on old loans, but this is how Hudson's terminal debt cycle happens. So we can't 'grow' our way out of debt by creating new loans. Debt can be written off as loan defaults, which helps bring the total amount of debt in the system closer to the total amount of money in the system. In the past few decades (i.e. since 1913) this is how total debts have been kept to a manageable level. Today, 10s of millions of mortgage defaults with bank debt writedowns would reduce the total debts by quite a bit. But is this really how we want to fix the unpayable compound interest problem?

Jul 01 01:45 PM

[drpaul1139:]

“The Uneasy Relationship Between Debt, Democracy and Capitalism” is an excellent start in the right direct. But because of too many unqualified experts we do not define the problems correctly.

First we need to know exactly what capital, and capitalism is. When we do know then we know that credit, debt, interest, and unemployment are not parts of capitalism.

This is not an Uneasy relationship this is an undefined relationship.

Please read “Why the Capitalist Theory is no longer fundamentally flawed”

www.productequityvalue...

Here you will find the correct definition of capital, and capitalism, you will find the absolute replacement for credit, debt, interest, and unemployment now and not some far off ill-defined future…

My biggest problem with these posts is that people are sitting on their assets and taking unqualified snipes at reality! Find the solution and then join it! Do something when you find the right solution! Jump on it with both feet!

We all win with the precise prescription!

Jul 01 01:52 PM

[conceptwizard:]

The modern dynamics of saving – and the increasingly top-heavy indebtedness in which savings are invested – are quite different from (and worse than) what Keynes explained. Most financial savings are lent out, not plowed into tangible capital formation and industry. Most new investment in tangible capital goods and buildings comes from retained business earnings, not from savings that pass through financial intermediaries. Under these conditions, higher personal saving rates are reflected in higher indebtedness. That is why the saving rate has fallen to a zero or “wash” level. A rising proportion of savings find their counterpart more in other peoples’ debts rather than being used to finance new direct investment.

Each business recovery since World War II has started with a higher debt ratio. Saving is indeed interfering with consumption, but it is not the result of rising incomes and prosperity. A rising savings rate merely reflects the degree to which the economy is working off its debt overhead. It is “saving” in the form of debt repayment in a shrinking economy. The result is financial dystopia, not the technological utopia that seemed so attainable back in 1945, just sixty-five years ago. Instead of a consumer-friendly leisure economy, we have debt peonage.

To get an idea of how oppressive the debt burden really is, I should note that the 6.9% savings rate does not even reflect the 16% of the economy that the NIPA report for interest payments to carry this debt, or the penalty fees that now yield as much as interest yields to credit-card companies – or the trillions of dollars of government bailouts to try and keep this unsustainable system afloat. How an economy can hope to compete in global markets as an industrial producer with so high a financial overhead factored into the cost of living and doing business is beyond scope.

Jul 01 02:03 PM

[mplaut:]

Actually, the author of the FT article closes with 5 points, and at least one of those left out in this review of that article is, in my opinion, worth quoting:

"Second, we have to learn to live within our means. This means spending less than we earn, perhaps doing without the BMWs, flat-screen television sets and leather sofas."

Jul 01 02:48 PM

[rosey99:]

First of all, when the author of the FT article says ". . .we must all learn to live within our means." The "we" really means "you." Furthermore, this is not just a UK or US problem, globally the distribution of wealth is entirely skewed toward the few. Google it if you are interested. I suppose you could call it an unintended consequence, if you're feeling charitable, of the wonderful counter-revolution that started (in the US) with Saint Ronnie Reagan.

He is correct in pointing out that the situation is "a political time bomb." His solution? "Innovation" and the "creation of new markets." Best of luck chum.

I don't know what the answers are, but if current conditions persist for just a few more months, I see a real risk that the wheels will come off that great gravy train that is globalization. Where the political systems are adaptable, you're likely to see substantial policy changes, changes that the FT article's author will probably disapprove of.

Where political systems are less flexible and open, you're liable to see more of what we have recently seen in Iran and Honduras. I think China may prove to be an especially interesting case over the next year. We'll see.

Thanks for the interesting post. I get a strong sense that we are, sooner than later, going to find out just what we are made of. Some really interesting, and some really awful ideas will be trotted out. Unless the pace of decline in living standards can be moderated to the degree that enough people don't really notice what's going on, real change (for better or worse) is probably on it's way.

Jul 01 05:18 PM

[Neil459:]

On Jul 01 05:18 PM rosey99 wrote:
> First of all, when the author of the FT article says ". . .we must
> all learn to live within our means." The "we" really means "you."
> Furthermore, this is not just a UK or US problem, globally the distribution
> of wealth is entirely skewed toward the few.

We have a system where people on welfare can make more money and get better benefits than working, so guess what? They do not work. Does not surprise me. Liberalism has been fighting the war on poverty since 1930, that was what, 85 years ago and we still have impoverished people. Most would evaluate that and say it does not work. Eliminate welfare and people would get back to work and move from lower income welfare status to middle class. But wait we moved all of the jobs offshore because of the stupid overreaching socialist regulations.

Now, in the US we had one of the best distributions, look at the size of the middle class without any of the government adjustments and you will see that most of your google search is propaganda. But we are quickly giving away what equity we have because most people don't understand that businesses create wealth for everyone. Businesses also do not create power. Politician's want power for themselves, not wealth for everyone.

Until people wise up, we will continue down this spiral started in 1930.

Jul 01 05:50 PM

[jstratt:]

Just want to thank Paul for his opinion which I think is right on the money.

It should be added that the management of most large corporations has gotten so greedy and been able to control the B of Ds. The result is that management has paid themselves most of any long term gain. For shareholders it means we are left holding an empty bag.

Jul 01 07:14 PM

[THofler:]

I detest this type of journalism where the author refers to the "wealth" of 100M people in one sentence (define wealth please), and the income of people in the next sentence. So "wealth" is income right?? Hah!

Of course the Walton family has a net worth greater than a very large number of people who live paycheck to paycheck. However the agregate income of those 100M people is vastly greater than that of the entire Walton family.

Imagine what those 100M could accomplish if they fired up their determination and saved a little money. Too bad no one in their schools thought it was a good idea to teach them the vice of debt and the virtue of saving. But that would be moralizing and we can't talk about morality in public schools.

Jul 01 08:56 PM

[Jet:]

These kinds of articles and discussions are important and will help define the problem - which is first step toward solutions which actually work.

Derryl. Your observation of how compound interest works is not correct I think. Yes - The $1000 is created out of thin air and spent into circulation where those funds become part of the money supply. As those funds are repaid, the principal disappears back into that same thin air. The Interest paid does not disappear. The Interest is the lender's "gross profit" out of which he pays his labor, other overhead, and absorbs losses on any unpaid loans. The amount of money spent into circulation is exactly canceled out by the repayment process. The amount of money in circulation at any moment is the cumulative sum of all new loans minus the total principal repayments. I believe the system does work mathematically and it is not evil for that reason.... But Derryl this is a common mis perception about lending so you are not alone. In fact there are other but more subtle problems with compound interest and lending. I agree that extreme concentration of wealth in a few hands serves no useful purpose - not even for those who have it. Lending practices and poor use of borrowed funds is a very big problem.

Seems to me that the FT article says the system was in fact pretty well stable and sustainable. I can provide another number which draws a similar conclusion. The US has about $12 Trillion in Home mortgages at 6% would cost around $700 B / yr in interest. That is out of total US wages of well over $7 Trillion. 10% of wages for mortgages seems reasonable.

Also I figure most of that money is owed to retirement funds of some kind. Which means we owe most of it to ourselves....

The job of investment manager is to take retirement funds and try to find something useful to do with all that money. They ran out of ideas years ago.

None of these things are the fundamental problem with the world economy. The underlying problem is we ran out of oil. Price of oil spiked at $150 in July of 2008 after a decade of fairly gradual price increases. The world just could not supply the demand for oil. If we do manage to stop the economic free fall and get world gdp increasing again, we will just run out of oil again. prices will spike again and crash the economy again. Does not mater how well structured the finances are. Weak points will be found and it will fail again and again and again - until we find an alternative to oil which can be produced cheaply and in large quantity.

If we can not replace oil, our civilization is doomed. I give it good odds oil can be replaced with a combination of solar and biofuels.

Jul 01 10:29 PM

[Neil459:]

What a load of crap. Nobody that looks past politics believes this. You sir are just a political hack.

On Jul 01 10:29 PM Jet wrote:
> The underlying problem is we ran out of oil.

Jul 02 07:51 AM

[Gregman2:]

It's the inverted yield curve.;-) That's why all the money trickled to the top. Kevin Phllips wrote about this years ago in "Wealth and Democracy."

Jul 02 04:02 PM

[TinyTim:]

I think Derryl is referring to the fundamental origination of debt in a fractional reserve banking system. It's an inherent, unavoidable part of the system.

Before jumping to conclusions, I would like to see more demographics on who the elite are that are benefiting from the debt of "the common man". I suspect as this economy has turned from manufacturing to finance, the bankers are accumulating generational wealth. Also, corporate executives seem to be doing the same at the expense of the shareholders. Generational wealth implies "unearned income" in IRS terms, so income comparisons are invalid.

That being said, I disagree that excessive debt by the vast bulk was required, even as camouflage, for continued concentration of wealth by the elite. The true elite typically know better than to conspicuously flaunt their wealth. The excessive debt didn't just maintain the standard of living of the masses, it inflated it in a huge bubble. What we are seeing now is a painful return to the norm.

Regarding the old issue of wealth / income disparity in democratic capitalism (with or without excessive debt), I have no doubt that this economic structure causes monopolistic results. This is in apparent conflict with the law of large numbers (normal distribution) and more aligned with the Pareto Principle. Since I also think a lot of individual extreme wealth is due more to luck, timing and networks than individual merit, I have no problem with attempts to "adjust" the structure for the future. Redistribution of existing wealth should be handled a lot more gently, if at all, since a lot of it gets dissipated on its own.

Many economic historians seem to feel that the solution to general decline is encouraging education, entrepreneurship and investment in innovation. These are certainly key, but more emphasis on manufacturing and less on finance and government, plus gradual conversion to other energy sources are also important.

My favorite quote regarding wealth disparity:
"it is my hypothesis that the utility of concentrated wealth is often diminished compared to distributed wealth. A thousand millionaires have much more economic potential than one billionaire."
J. Lounsbury

Jul 02 04:20 PM

[H. T. Love:]

Interesting videos here about an underlying cause of much of what we see.

www.youtube.com/watch?...
www.youtube.com/watch?...
www.youtube.com/watch?...
www.opencongress.org/b...

HardToLove

Jul 03 02:05 PM