On the demonisation of debt

Congratulations to Ben Dyson, self-professed “money and banking specialist” for finally discovering, err, money. Or, how money works.

In a column in the Guardian on Tuesday, Dyson recounts in grand revelatory style how the solution to the system’s current ails is nothing other than recognition of the fact that “money has been privatised”. Shock, horror!

Apparently banks manufacture digits out of thin air to fuel bubbles in pursuit of their own evil agenda. How sinister.

To quote Dyson’s website:

A bank doesn’t have to have any real money to make a loan.

If we tried not to go into debt, then the banks would be unable to create money and economy would grind to a halt.

This is no conspiracy, we’ve gone through 500 documents from the Bank of England to make absolutely sure this is how the system works.

FT Alphaville readers (or anyone who has ever read Niall Ferguson or nearly every other economic historian, or taken even a passing interest in the unit of exchange they use on a daily basis) will, of course, know that that little revelation was probably last considered to be breaking news in 1913.

Having staggered upon this amazing factoid Dyson nevertheless (with some amazing financial credentials to boot) has decided to start his own monetary initiative entitled “Positive Money” — a move which, as far as we can see, plans to end evil debt everywhere by forcing banks to only lend what they’ve got. Or more specifically by banning banks and nationalising banking. His big idea is that the Bank of England becomes responsible for all bank accounts and loans everywhere.


If only it was that easy.

Naturally, we understand that Dyson’s proclamation is the result of central banking and financial operations capturing the hearts and minds of the population on account of the current financial crisis. That is definitely to be commended. Even applauded. Everyone should take an interest in how our system works.

We just think it’s sad that it’s taken this long for people to start recognising what’s been staring them in the face for so long. More so, that upon finally stumbling on this amazing treasure chest of knowledge regarding how central banks work, people somehow think that the most obvious solution is the best one, without considering the fact that some of the greatest minds (who did bother to take an interest when everyone was more busy watching X Factor) have likely already considered, if not dismissed, such concepts.

FT Alphaville is a good example of a relatively nerdy yet lay blog trying hard to get to grips with complex developments, systems and even the basic foundations of the financial system itself. If there’s one thing we know, it’s that it is not simple. Via our day-to-day operations, we encounter a multitude of varying opinions, views and theories. We struggle to communicate and make sense of them all. Sometimes we get things right. Other times we make mistakes. But most of the time we recognise that the system is complex, and even with our team’s collective specialist experience to fall back on, there isn’t a day where we don’t learn something new when reporting on the current crisis.

The reason we can’t find a clear consensus on the debt crisis, is because the most obvious solution is clearly not a workable one. At least not without a huge material impact on the quality of life of every living soul in Europe (or further afield). Something everyone is trying to avoid. The challenge thus comes in finding a solution which is palatable, above all.

That’s not to say the solutions to the crisis won’t necessarily be simple. They could very well be. But that’s not our point here.

Our point is that we’ve all been lax. The media especially. We’ve failed to communicate the message correctly. The message should not be that all debt is bad. Rather that, some debt (and here’s a wacky idea), some debt, is actually good. Without debt, after all, you can’t have money. Without money you can’t have dynamic trade. You go back to barter. Society regresses.

To understand it properly, we propose to look at it from an anthropologist’s viewpoint. Take this interview with David Graeber, which we found particularly enlightening.

As he noted, history tells us that debt comes before money, not the other way around:

So really, rather than the standard story – first there’s barter, then money, then finally credit comes out of that – if anything its precisely the other way around. Credit and debt comes first, then coinage emerges thousands of years later and then, when you do find “I’ll give you twenty chickens for that cow” type of barter systems, it’s usually when there used to be cash markets, but for some reason – as in Russia, for example, in 1998 – the currency collapses or disappears.

And as Graeber goes on, it’s not necessarily debt that is bad — since debt actually allows you to risk-manage your life. Amongst other things, it’s essential for consumption smoothing. By borrowing from the future anyone’s life experience can be a better one. You’re borrowing from other people who can afford to lend today, because you could very well be in a position to lend to them when they need your help. More specifically, the point is to smooth over the seven years of plenty over the seven years of famine, usually found in the earlier part of life. Debt is thus a hugely efficient wealth distribution mechanism.

The debt obligations (money) which come about through this process are just the IOUs allowing us to cash-in early on the total productivity of our lives. Before they’re extinguished via payment for goods (or via the payment of tax in return for spending done on your behalf by the government) they stand as a useful means of exchange, which has facilitated trade and barter and progressed our lives as a whole.

But the system depends on a) matching those with something to give with those who have something to give back in exchange and b) determining how many units represent your likely productivity (or what you can realistically borrow). A job which has conventionally been done by banks, and one which they have conventionally been compensated for with interest payments.

Thus, banks’ key mandate is to evaluate the risk, and quantify just how much anyone (including corporates) can borrow from their own future. And this is where the root of our crisis lies. Banks failed to manage that risk effectively, and thought they could lend more than what they should. Or, as we would argue, became misguided because international surpluses skewed the price of debt availability, making it far too cheap and easily distributed.

The pricing of the debt, after all, determines everything — particularly how much risk banks take.

And interestingly on that front, Graeber notes:

Interest-bearing loans, in turn, probably originated in deals between the administrators and merchants who carried, say, the woollen goods produced in temple factories (which in the very earliest period were at least partly charitable enterprises, homes for orphans, refugees or disabled people for instance) and traded them to faraway lands for metal, timber, or lapis lazuli. The first markets form on the fringes of these complexes and appear to operate largely on credit, using the temples’ units of account.

But this gave the merchants and temple administrators and other well-off types the opportunity to make consumer loans to farmers, and then, if say the harvest was bad, everybody would start falling into debt-traps. This was the great social evil of antiquity – families would have to start pawning off their flocks, fields and before long, their wives and children would be taken off into debt peonage.

Often people would start abandoning the cities entirely, joining semi-nomadic bands, threatening to come back in force and overturn the existing order entirely. Rulers would regularly conclude the only way to prevent complete social breakdown was to declare a clean slate or ‘washing of the tablets,’ they’d cancel all consumer debt and just start over. In fact, the first recorded word for ‘freedom’ in any human language is the Sumerian amargi, a word for debt-freedom, and by extension freedom more generally, which literally means ‘return to mother,’ since when they declared a clean slate, all the debt peons would get to go home.

Thus, evaluate risk incorrectly, extend too much debt (beyond the means of likely return) and the system crumbles. Historically, pawning will ensue.

And it seems very little has changed on that front even today. Except that now pawning is called repo. But whether you call it repo or pawning what it represents is a return to collateralised lending. Something which is happening now on a major scale.

And, we would argue, it’s also how the system is fixing itself.

Money cannot be extended out of thin air if every new obligation has to be matched by existing collateral. Instead, the current trend towards collateralised lending — just like the one which gripped markets post the Great Depression – ensures that for every working loan there is an equivalent collateral base already in existence.

Debt continues. It just becomes collateralised until we once again discover how to price it effectively.

Of course, if the crisis itself is the result of a wider paradigm shift — say, on the scale of the industrial revolution or some such — then it’s possible that the way we come to price it in the future will be very different indeed.

For example, in this technological era which has brought us eBay, PayPal, Kickstart, social networking does it even make sense to count on banks as credit intermediaries?

Could we as a population do a better job at matching borrowers and lenders, and evaluating the risk in doing so?

That may indeed be so.

What Ben Dyson misunderstands is that no matter where the paradigm shift eventually takes us, it will never rule out debt completely. Or, for that matter, centralise its distribution at one focal point.

To do so would be going backwards not forwards in terms of civilisation.

Related links:
Better the quality collateral you know?
- FT Alphaville
Negative interest in cash, or goodbye banknotes
- FT AlphavilleThe power of the dark inventory – FT Alphaville
Avoiding the monetary road to serfdom
- FT Alphaville

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