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Thu, Sept. 19

Letter: DEBT!

In Debt We Trust

In Debt We Trust


It's a scary word to many people, especially these days when there is so much of it around. Most older folks grew up with the idea that borrowing was wrong. Immoral. The road to damnation and ruin.

When debt was necessary - such as for business or a mortgage - interest above a low single digit rate - two or three percent -- was usury and punishable by the whip, jail or being hung back in medieval times. Islam for instance, had a strong prohibition against any form of interest but over time they learned to get past that by simply calling the vig a rental fee. So Muslims don't borrow and pay interest. They simply rent the money instead. A simple and effective semantic finesse.

The advent of capitalism in the late Nineteenth Century allowed borrowing and higher interest rates to become more acceptable. This progress continued until finally, in 1971, the developed world switched from a gold-based currency to a fiat currency. The reasoning was that there was only so much gold in the world and the global economy was growing faster than the supply of yellow metal would allow.

Capitalism simply had the potential for creating far more wealth than gold could represent. Thus the world - or at least that part of it advanced in the capitalistic pleasures of manufacturing and consumption - decided to free their currencies from the bonds of gold. They chose instead to value their currency based on the value of the goods and services they could produce.

This created the famed GDP or gross domestic product: The value of the goods and services a nation could produce in a given period of time, generally a year. It made sense and also allowed the economy to explode. In less than a generation the total wealth of the developed world quintupled.

This explosion of wealth created a vast middle class that earned good wages and used them to create and fulfill the "American Dream." With the promise of forty or so good working years, people went in debt to enjoy life now. They bought a home, a car - maybe two, sent their kids to college, took yearly vacations and a few of the smart ones even planned for their retirement with investments. The rest of us leaned heavily on government retirement in the form of Social Security or a union negotiated private pension.

It was a good life and enthralled with it all we created a few bubbles - mostly in real estate - where borrowing to make a profit on rapidly rising prices became almost passe. Of course it didn't take long for such indulgence to get out of hand and prices rose far above the real value of the property. This self-indulgence carried further into the financial realm where people borrowed to invest in this or that new stock or bond issue until they too became over-extended.

We were borrowing to make a profit that was in reality, heady thin air until finally the over-inflated value of land and investments crashed. Thrown into the mix were complicated and at times fantastical schemes to hedge those bets until the over-extension - that amount we borrowed over and above the actual value of the item - was unsustainable and the house came tumbling down.

For the last three years we have been suffering the hangover from that extravagant over-indulgence while things get back to normal. No big deal, actually. We just got greedy as a society and it's no surprise. Larceny has always been in our blood, lying thinly under the surface, sometimes emerging in an almost violent rush of getting while the getting was good.

The sum of all those fears added up to banks that were flat broke and owed tremendous sums to investors, depositors and borrowers who couldn't pay. There were industries in the same shape. GM is a prime example. No one ever considered that GM was too big to fail, yet between those they directly employed and were indirectly responsible for via their suppliers, accounted for a couple of million workers.

If the depositor, commercial and investment banks had not been bailed out with government money, and if GM and other industries similarly situated had not been equally bailed out, we'd have been faced with absolute ruin. Instead of 9.6% unemployment we'd have likely had 25% to 30% unemployment which like a cancer would have eaten the heart out of the nation.

Even Bush pushed for a chicken in every pot and a home mortgage in everyone's safe deposit box whether or not the people could afford them. He pushed this dream in the face of declining values in the market place, in wages and a growing debt because on paper it all looked like easy profits.

So this is where we are now - slowly working our way back out of a huge red hole we put ourselves in - and it's going to hurt a bit. We got fat and lazy and now we've got to slim down. Lean ourselves back out of that gross opulence. This is what recessions do best. They shake the rotten apples out of the tree. We emerge from the financial fires of a recession leaner and meaner, ready to take the next step in this new wonder called free market capitalism, hopefully wiser and more mature.

But the subject was debt. One of the shocking results of our greedy indulgence is the largest debt we've ever seen. There's all sort of rabid rumors running about. We're burdening our children and grandchildren with this debt. We're leaving our progeny in worse shape then we are. The future is doomed to drudgery and failure. Bah. Humbug.

Let me put this as simply as I can before I indulge in a deeper explanation. We have a fiat economy - i.e., we have a fictional economy. And like any fiction, we can write it any way we choose. Our money is worth what we say it is via the market and the perceived value of our products and services. Given this fictional nature of our currency, does it not then follow that our debt is just as fictional?

Of course there are two type of debt: Fiscal debt such as the kind incurred by governments, banks and businesses, and consumer debt such as the kind we incur on our credit cards, bank loans and mortgages. In a fiat economy both types of debt have numerous ways and means of being dealt with.

For consumers there is debt consolidation, debt reduction via negotiation and the bankruptcy courts. Bankruptcy no longer has the bane of being immoral. It is a business and personal tool used to excuse a portion or all of accumulated debt. I've seen people with five or six bankruptcies going on simultaneously under different business entities. I've known a man who has filed numerous times serially. He'll get head over heels in credit card debt, file bankruptcy, and in a couple of years re-establish credit and do the same thing all over again. Mind you, I'm not saying it's right or wrong. I'm just saying it is.

Businesses have even more means available to deal with debt. Businesses can file bankruptcy, of course. There are many businesses which view the bankruptcy courts as a business tool. Debt can also be rolled over until more profitable times come along, making it easier to pay off. Debt can be traded for equity. For instance, Acme Inc. owes its bondholders $20 million and can't pay it due to any number of reasons. So they trade the bondholders $20 million in debt for $30 million in equity in the company. They can also float an IPO to raise money to pay the debt.

Governments have all the above and even more ways and means of dealing with debt that do not include higher taxes or burdening future generations. Debt can be rolled over. Debt can be forgiven. They can simply print more money. Trade balances can minimize debt down to zero. As a nations currency value fluctuates in the open market, its debt fluctuates indirectly and proportionally.

So debt is not a frightening thing. Sure, it can get out of hand. It can be a bother and a worry, but it can never destroy a nation or a society, especially in a fiat economy.

The sum of the fears about debt equal the ability to pump sufficient money into an economy to create enough jobs to generate enough profit and wealth to pay the debt and increase wealth. This is not the time to be chincy about it. Money can be printed or borrowed but it must be had one way or the other in order to prime the business pump into hiring people, producing more goods and services, and generating wealth.

Give the rich their tax breaks. It's only another $800 billion. Look at it this way too. Our total debt at the moment is somewhere between $10 trillion and $12 trillion. Our gross domestic product, even in the midst of this receding recession, is still around $14 trillion. That means we create $14 trillion in wealth each and every year and our total debt is only $12 trillion. If you owed a total of $50,000 and were making $75,000 a year, would you be worried? Likely not. Neither should we be worried about a national debt of $12 trillion. We have what it takes to pay that off and still take an annual vacation.

The absolute beauty of a free-market capitalist economy is that we have unlimited potential for creating wealth.

Ed Tomchin

Golden Valley

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