THE DEBT PROBLEM

By Martin Hattersley

It is hardly necessary for me to dwell in depth on the extent of the world's debt problem. Internationally, and particularly as it affects the nations of the third and fourth worlds, it appears as a crushing burden. On the one hand, it imposes poverty and austerity on the already low living standards of the world's poorest nations. On the other, it threatens the stability of the developed world's moneylending institutions, faced with possible write offs of loans to nations such as Mexico, Brazil or Peru, that they presently carry as assets on their balance sheets.

Nationally, we see it in the inability of leaders of nations such as the United States and Canada, elected on specific platforms of reduction of the national debt, to carry out their promises. On the one hand, the burden of national debt interest consumes an ever increasing proportion of tax revenues - Canada now pays more in interest on her National Debt each year, than was the total amount of that debt less than twenty years ago in 1968. On the other hand, political ruin and economic devastation face the government that has the courage to try and bring a growing deficit under control: the price is the unpopular one of reduced government programs, higher taxes, and a slowdown in the economy that can itself make deficit reduction counter-productive, as tax revenues fall.

At the business level, the burden of debt is expressed in unsound debt-equity ratios, followed often enough by failure. Businesses cannot afford to pay a fixed return on borrowed capital in the ups and downs of profit in a fluctuating market. The farm debt crisis is an extreme example: default not only leads to loss of a family investment and way of life, with all the heartache that this involves, but it is a threat also to the lending institution. Foreclosure makes property values plunge, and with them, the security of all other loans based on real estate. Coming as I do from Alberta, where prosperity has met a sudden reversal with the collapse of the oil boom, my own experience has been of a Province where we have had the first two bank collapses in Canada since 1923, two other banks have been taken over by foreign interests to prevent collapse, one third of the Province's Credit Unions have been placed under trusteeship, the four major second mortgage lending institutions have gone out of business, and the amalgamations and terminations of trust companies come so frequently that it is impossible to keep up - all in a Province of only just over 2 million population. This without mention of the danger caused to Canada's Big Five Banks - among the hundred largest in the world - gravely threatened by the billions owed by Dome Petroleum Ltd., as well as some very shaky overseas investments, which may never be repaid.

At the personal level, and speaking now as a lawyer with a practice that involves a considerable amount of looking into the actual budgets of citizens of my Province, the aspect that concerns me most is the increasing degree to which the budget of the typical wage earner has been spent even before it is earned. Money is earmarked for payments on the house, on the car, on the furniture, on credit cards: furniture is sold on the promise of `no payments and no interest until next year.' A month's unemployment - the disability or pregnancy of the second breadwinner of the family - and the whole ramshackle structure of personal finance buckles like a house of cards. Again, the personal and social costs, and the costs in suicide, broken families and badly cared for children, are enormous.

Indeed, from the macro to the micro ends of the economic spectrum, from great nations to the ordinary citizen, nothing seems more flimsy, more likely to collapse, nothing is the cause of more unease, than this system of debts piled one on top of another, that threaten to tumble down from the wall like Humpty Dumpty, and

"All the King's horses and all the King's men
Couldn't put Humpty Dumpty together again."

THE CAUSE

There is no particular difficulty in identifying the cause of the incredible permeation of debt through all levels of the economy. It is the direct result of the almost universal adoption of bank credit as the exchange medium of the civilized world.

The history of the United States contains so much material on monetary issues - the issue of paper money by the Colonies before the War of Independence: the Constitutional Power given Congress to `coin money and regulate the value thereof': the fight of Andrew Jackson to prevent the renewal of the charter of the Bank of the United States: Lincoln's issue of Greenbacks to finance the North in the Civil War: Bryan's campaign on the monetization of silver, and in 1913, the adoption of the Federal Reserve system - that it is surprising that this issue is so little discussed at a time when the performance of the monetary system leaves so much to be desired.

Banking is essentially a way of making a small volume of gold, or other `official' money, do the work of a much larger quantity, which depositors assume to exist to be withdrawn on demand, but in fact does not exist at all. This causes an increase in the effective amount of the circulating medium in an economy. A bank holds a small reserve of `official' money, of whatever variety it may be, with which to back the likely demands for cash of those who have made deposits with it. The balance of its deposits are lent out - the promises to repay cash of those who have taken credit at interest from the bank cover the liability of the Bank to its depositors, who have the right to demand cash in exchange for their deposit balances. In this way, perhaps five cents of gold or state issued money can be the basis on which a whole dollar of new bank credit is created. Money, which once consisted of precious metal, or at least, tokens issued by government authority, has now become information in the Bank's computer, with no solid existence at all. The bulk of the nation's money supply is no longer coined by Congress, or any monetary authority: it is created when governments, investors, businesses or consumers apply to the Banks for credit, and this credit is granted in exchange for the borrower's promise to repay.

There are two particular results from this technique of money creation. The first, is instability in the economy. Gross National Product - the value of all the production in an economy - is closely related to the total credit supply. Even a small increase in the credit supply, therefore, leads to `boom' conditions of high demand, high profit, and rising prices: the very conditions that make a fine scenario for even more bank lending, and even more demand, profit and inflation. The reverse is also true - even a small decrease in credit supply will lead to business conditions where profit disappears, output is restricted to keep up prices, and employment and standards of living decline. Such a downturn in the business cycle makes bank lending unsafe and unattractive. It therefore accentuates the very problem caused by the credit contraction in the first place.

The second problem arises from the first. A bank loan is in theory the advance of some depositor's money. Since the bank has no authority to print new money, it must always cover its promise to pay cash on demand - its deposit liabilities - with the promise of some other party to pay cash to itself. It is therefore impossible to expand the money supply of an economy through the banking process, without the simultaneous expansion of debt.

Put these two factors together, and the world is in a `Catch 22' situation. If we strive to reduce debt, we can only do it by repaying bank credit. To repay bank credit causes a shrinkage in the economy's overall money supply. A shrinkage in the economy's overall money supply leads to falling prices, an even greater fall in profits, business failure, a smaller Gross National Product, unemployment, stagnation and poverty. Not to repay bank credit leads to an ever increasing debt and interest load, and the danger of runaway inflation, with loss of the value of savings and of the monetary unit. Around the world, we see nations struggling with a choice of fate similar to that of being hanged or boiled in oil. Wretched borrowers that they are - who shall deliver them from an economy headed to destruction either way?

THE UNRECORDED ASSET

At this point in my argument, it would be very easy either

1. To launch into a tirade against an alleged international conspiracy of Bankers, planning to become the alternate government of the world, or
2. To enter into a passionate plea for a return to the Gold standard.

I promise to do neither. My experience of bankers is that the best of them are cautious and worried men, eternally treading the line between their overhead, the return they pay on their customers' deposits, and the interest they can earn on what they lend, with side concerns on the subject of bad loans that may have to be written off the balance sheet, the needs of their shareholders for dividends, and the danger of a run on their cash if they lose public confidence. Such a balancing act is not a guaranteed way to make a fortune, as our own local failures show. There is no secret way whereby, through pegged interest rates, compulsory loans, or other devices, the business of Banking can be transformed into a cure all for the economy. Similarly, a return to gold is simply archaic. The deflation that it would involve, the effect it would have in limiting the ability of the economy to run at full potential, and the undeserved rewards it would give to speculators, make such a reform a completely unattractive backward step.

What is possible, at this stage in the twentieth century, is to develop a better understanding of the nature of money, and furnish the world with a system, or systems, which will provide an economy with a sufficient supply of a medium of exchange, without at the same time creating debt, and with a mechanism that controls quantity in order to make the money supply balance the ability of the economy to produce, without creating inflation.

Let's go back to some very basic concepts on the nature and working of money. The reason for money is to facilitate exchange. The need for exchange comes because people have different skills, interests and abilities, and can contribute a greater input, both in quality and quantity, into the world's store of wealth by providing a large quantity of specialized production, rather than looking after themselves with small quantities of a very large number of items. A good system of exchange means that we can all put the products of our special talents `into the pot' - or `onto the market' - and take out of the pot the products of the special skills of others, that we could not match ourselves. To facilitate this, those of us who contribute land, labour or capital to the productive process are also used to contributing real wealth quite some time before our reward, in the form of a pay, dividend or rent check, is received by us. We are also used, once such checks have been received, to holding the money they represent for some time more before we spend it, so that we don't run out of money before our next pay check arrives.

It takes between four and seven months, in fact, for the average dollar that we receive in our pay packet to be spent by us, and go through all the processes of the economy to appear in a pay packet once again. Contributors to the economy, therefore, advance a permanent `float' of real wealth onto the market of some six months value of the nation's total production. Their entitlement to draw on this float is contained in their employers' liability for unpaid wages, and the money tokens they themselves hold which give the right to buy real wealth with them by spending them. The total value of all the real wealth that people contribute to the economy at any time, in exchange for forms of monetary credit rather than products having `real' value, is therefore approximately six months Gross National Product, and this is the value of the Public Credit, which gives value to the total money supply of the economy in the same amount. It is in effect a loan of real wealth by producers to the community as a whole, in exchange for the value of tokens held by those producers which help them get what they really want and need when spent in the process of exchange.

The United States has had a long tradition of making use of State fiat money to provide its monetary units, but this has fallen into disuse in recent years. One reason, no doubt, has been the difficulty of preventing abuse by the State, which has sometimes printed excessive quantities of scrip, so that the dollar became, in the words of history, "not worth a Continental". Another, certainly, has been the difficulty of controlling the manufacture of credit based on the State fiat money by the Banking system, which would make any restraint by the State in credit issue impotent to prevent inflation through further credit creation by Banks.

SOLUTIONS

The technique that I suggest be adopted to deal with these problems is the following:

1. Establish the amount of the Public Credit as a statistical figure, certified on a monthly basis by a National Statistical Office to the Treasury.
2. Any deposit taking institution which promises to pay its depositors on demand sums totalling in excess of its actual holdings of legal tender money shall be deemed to have borrowed the difference from the Treasury, and shall be charged interest, payable to the Treasury, on the amount of this excess. Promising to pay money on demand to the public without this coverage would be deemed an act of bankruptcy by the institution, and a criminal offence.
3. The Treasury shall be authorized to issue notes against the remainder of the Public Credit - a primary use of which, of course, could be the repurchase for cancellation of large quantities of the public debt.

CONCLUSIONS

The great enemy of sanity in monetary policy is what one U.S. President lucidly referred to as "downright ignorance of the nature of coin, currency and credit." Essentially, we today base the backing for our economy's credit supply not on the Public Credit, but on the mortgaging of all kinds of assets, including not least the nation's power to tax, so as to make it possible for a bank to repay money it has not got if ever there were to be a run on its deposits. If we put the asset of the Public Credit on the economy's balance sheet to balance our money supply, this mortgage of other assets can be discharged.

No longer will we need to be a nation buying everything "on time". Armed with paid for homes, cars and furnishings, with lower taxes, and hopefully with investments and savings as well, the individual citizen will have economic power as never before. One interesting consequence of reform will be that, with the load of debt, and taxation to pay debt, removed from the citizen's monthly budget, wage rates could very easily fall, to be competitive with those nations whose cheap wages are such a threat to our employment and our prosperity at the present time. The real standard of living of the average citizen, however, helped by more investment income and less debt, will still likely be higher.

The time has come for reform and change: it is already starting to take place, whether we are ready for it or not. In my part of the world, the `underground economy' is setting up "Local Exchange Trading Systems". People invent "green dollars" with which they run their own local credit systems, under which credit can be obtained at no interest cost from participating members. The home computer and the telephone answering machine put such techniques within the reach of millions. Non banking institutions, such as American Express, Trust Companies and Credit Unions, are all getting into the checking business, and creating credit in the same manner as do Banks. Islamic `sharia' banking provides a deposit taking machinery where risk is assumed by the depositor, making in theory at any rate, a failure proof bank. In many ways indeed, our current banking system is facing competition which will force it to rethink its position. The fictions on which our current banking system is based no longer are credible. The possibilities of a global banking failure are serious enough to make it worth while on everyone's part finding out how to devise a stable, debt free and failure proof alternate system.

We should also be concerned at a danger in all these experimental approaches. It is that they are subject to no central credit controlling authority with power to limit the number of monetary tokens issued on the strength of the public credit. The consequence is the threat of dilution of the value of the dollar, and exploitation of the public which has put its faith in new and questionable monetary tokens. We have to guard against a new kind of counterfeiting taking all value from our dollar. That is why I suggest that a statistical and objective enquiry into new monetary techniques is an urgent necessity.

The present world payments system, both internally and externally, is going to become more and more unstable until a radical underpinning of its foundations is achieved. What I have suggested here is one possible solution. Our debts are the result of the way we keep our books. There is no particular reason why we have to keep them the way we do. As we get nearer and nearer to the twenty first century, and as the information processing tools we can use become of higher and higher quality, the time has come for originality and creativity. Let's allow them to break through!