Debt Folly

David Gracey

"Debt is the disease... and you don't cure it by freeing up banks to issue more of the stuff to consumers who can't afford what they already owe" (The Globe and Mail, September 27).

Truer words were never spoken. At $2.58 trillion, US consumer debt is staggering. Canadians aren't much better off, with consumer debt now exceeding 130% of per capita disposable income. The US national debt is approaching $10 trillion and will rise by over a trillion in the coming year. US consumers now spend 14% of their income on debt service. If interest on the national debt paid through taxes is included, the figure approaches 25%.

Such debt levels are unsustainable, hence the current financial meltdown in the US. We in Canada are not immune, despite the media cheerleading about our secure banking sector. Our banks have had to be bailed out before and they probably will again.

There is outrage, as there should be. There is anger at the financial executives who extracted millions from companies which are now bankrupt. There is anger at the president and legislators who took millions from Wall Street to deregulate the financial sector. It has become apparent that, despite all the rhetoric about free markets, what we actually have is capitalism on the way up (at least for the rich) and socialism on the way down. Hopefully this anger will result in some badly needed reforms.

But the basic problem will remain, because there is no public understanding and no political will to solve it. The real problem is that the US economy and ours run on debt and, unless we make fundamental changes in our monetary system, they will continue to do so. Almost all of our money supply is debt, i.e., money borrowed at interest. Only a tiny fraction less than 5% of our money supply is debt-free legal tender issued by the government. If the credit system is impaired by bad loans, loss of capital, or loss of confidence, the money supply sinks and the economy shrinks.

As the credit becomes harder to get, consumers and businesses retrench or go bankrupt, spending falls, and jobs are lost. This is our current predicament.

Notice that in the US nothing is being done for the overextended consumer or mortgage holder. Wall Street is totally opposed to such action. Instead, hundreds of billions of dollars has already been committed to various financial firms. The $700 billion "rescue" package passed by Congress will buy up much of the toxic paper held by the financial sector.

The financial experts tell us repeatedly that this bailout is essential. Without it confidence would he lost, credit would dry up, and a financial meltdown would ensue. They are right. We are totally dependent on the credit system to supply us with money. Unless confidence is restored people will not borrow enough and banks will not lend enough. If the bailout works, we will experience a painful recession, but the money will start to flow again and the economy will recover.

But the price of recovery, and we cannot escape this, will be more debt. Since we deregulated the financial sector, allowing for an explosion of credit, it has become apparent that, for the economy to grow, indebtedness must grow even faster. The chief, indeed the only, beneficiary has been the financial sector, which lobbied for deregulation in the first place. The financial sector has got bigger and fatter, but there are no concomitant gains for the "real" economy. We can restore "confidence" and get the credit engine working again, but it is certain that debt will increase and that this debacle will recur in a decade.

Instead of a bandaid (some bandaid!) we must change the monetary system. The financial markets must be tightly regulated as they were for several decades after the Great Depression. A Tobin tax to reduce speculation would be highly desirable. But most important, we must reduce our dependence on credit. A much greater percentage of our money supply must be debt and interest-free. It can be done.

David Gracey

from Economic Reform November 2008