Politics of unproductive debt
Debt is now everywhere and large debt burdens have become an increasingly normalized scenario for many. Now we have an increasingly large number of people, governments and companies who have increasingly large amounts of debt, which incentivizes them to support kicking the can down the road instead of dealing with the underlying debt crisis that's brewing. It wasn't always like this. I started writing this post in September 2020 when it became clear to me that many parts of the world were entering into rather severe monetary system crisis conditions and since then the debt situation just hasn't let up.
Now the 2020 federal budget has been released in Australia I can't help but realize that attitudes towards government spending and especially government debt have undergone an enormous change in the last few decades.
I think to understand the great proliferation of debt that has spread everywhere it is important to start by looking at personal debt. While personal debt is a small percentage in dollar terms of the overall amount of debt that exists in the world the proliferation of personal debt has normalized the notion of carrying debt for many people. Because it's so widespread now personal debt has shape opinions and cultural attitudes towards debt. On top of this more of the electorate carries some form of personal debt compared to before which impacts the policy directions taken.
Last year I remember clearly talking to a lot of people younger than myself who were carrying absolutely huge credit card balances. I knew of people who had incomes of $60000 AUD a year in 2020 dollars 1 who had $30000 credit card balances and were effectively pushing a huge proportion of their incomes into just paying off the absurdly high credit card interest payments. I also knew some people over in the states who were doing the credit card juggling game where they have multiple credit cards and are using lines of credit to pay other debts, debts on top of other debts. Thoughts of the NINJA loans that propping up in record numbers during the sub prime mortgage crisis immediately came to mind. A "NINJA loan" is a loan where there's No Income No Job No Assets, a clear sign of very lax lending standards. Lax standards were part of what created the massive subprime mortgage crisis in the American housing market a bit over 10 years ago looms heavily. Do people ever learn?
One reason people don't learn is because they think about money less often than they used to. Specifically people don't think as much about what money itself is. The pandemic of mindless cashless payments where people just tap some plastic without thinking about what they are spending at all is pretty crazy. I've spent a bit of time observing peoples habits around payments and I'm shocked at how little thought people engage in with payments now. There's research that shows there's a difference in psychology when buying on credit vs cash. The thought to question just isn't even coming up with a lot of people, but what if it did? What's getting in the way of people learning more about how money works and how finance really works?
Part of why people, including policy makers, don't seem to learn is because most people2 don't actually have a good idea of what money and debt are on a conceptual level. There's a great book called "Debt: the first 5000" years that goes into a lot more depth about the nature of debt and the connection this has with money. This isn't just a consumer matter, the entire system is increasingly designed around the assumption of ever growing amounts of debt everywhere. There's a great article on Epsilon Theory called "What do we need to be true?" that discusses the assumptions that have become built into the financial systems in which we operate in. Put simply a growing number of powerful interests are getting a lot more enmeshed in debt based arrangements of various kinds. There's been a noticeable increase in instances where where organizational survival is starting to hinge on access to debt, so systems are starting to assume that a high level of indebtedness is the normal and are ossifying around assumptions of cheap debt being available. If you want to understand why a lot of the political discussions around debt have changed it's critical to understand how money itself works in the current system. We have a debt based monetary system where the vast majority of the "money" that's now in existence was created by the issuance of loans. Perhaps the most sneaky thing about such a debt based monetary system is that debt and money are treated far too much the same in such a system than they really should be.
On top of this we have an entire industry that hires extremely talented people to set up programs to sell debt to everyone. It's hard to resist the temptation to leverage up when everyone is telling you do to so. It's even harder when the people selling the debt use the cutting edge developments in psychology and advertising technology to manipulate you into taking on more debt than you should.
Attitudes towards government debt and credit have changed substantially in the last few decades. When I was younger there was a moment in the campaign for the 1996 Australian federal election where in September of 1995 John Howard drove around a truck with a billboard showing the amount of foreign debt. This political stunt was to be known as the "debt truck":
At the time the amount of government debt was seen as an important political issue, the government had $7 billion in foreign debt and to some this was seen as being far too high. Interestingly the political response from Mr Beazely at the time was to call the stunt "the fully imported lorry of lies", a reference to the truck being manufactured and imported from Japan rather than made locally.
What a difference a quarter of a century makes! Fast forward to 2020 and there's no cars being manufactured in Australia since the local automotive industry has mostly been destroyed and the amount of government debt is larger than any politician from any party decades ago would have ever publicly supported. The debate now seems to revolve around how much debt to add rather than questioning if expanding government debt is a good thing to do. We saw this "how much debt?" debate play out spectacularly in the USA with the deadlock over direct government stimulus payments in 2020, most of the parties are arguing over "how much" rather than if the contents of the stimulus program is a good idea at all. In Australia we see similar debates about the JobSeeker and JobKeeper programs, debates about government debt tend to be around "how much" rather than if the programs should be changed. The whole world has an enormous amount of public debt now, as this highly informative world debt clock shows. Along with huge amounts of money being created absurd "pork barrelling" was attached to many of these pieces of legislation. People who called this into question were easily shut down by strawman claims that being against stimulus was to be against people in need or to be an "enemy of the people". Many of the arguments made by those supporting the stimulus were a form of a Motte-and-bailey argument. While the frenzy of spending was at its height detailed discussions of fiscal prudence seemed to slip outside the Overton Window entirely at some points. Even expressing well reasoned Austrian Economics viewpoints started to get dangerous.
The reason this political stunt with the truck struck me while I was researching for this article is that it's just so clearly from a different era. Both sides of politics involved in this stunt reference an Australia that no longer exists. If you understand debt and international finance it's somewhat intuitive to realize that running a dual deficit (simultaneous government deficits with foreign deficits) creates substantial risks to currency stability, especially if the currency doesn't have any capital controls. It's clear that attitudes on a lot of things have changed, the criticism of a political figure driving a vehicle not manufactured in Australia is an obvious sign of how Australia has changed. The destruction of local manufacturing in Australia is anything but subtle, but the change in attitudes towards debt and how the government is to manage money are far more subtle (these monetary policy considerations are a large factor in why local manufacturing collapsed in the first place, but are rarely talked about). Recently we are seeing debates regarding if Australia should manufacture more things on shore again after a somewhat long stint in the shadows where the topic rarely came up. Discussions on debt are less tangible and the electorate doesn't have as good a grasp on this so there is far less political pressure for politicians to talk about it.
Back in the 1990s consumer debt just wasn't as big a deal and the subsequent change to a greatly indebted populace has really big political implications. Against a backdrop of decades of steadily declining wages in real terms people increasingly started to borrow money to support their standard of living. But during the election campaign in 1995 the electorate hadn't come to see holding massive amounts of debt as "normal" and didn't expect their elected officials to take on large amounts of debt either. This political debate was in an era before deficit spending became widespread and politically normalized. The whole rules of the game so to speak were that the budget should balance, this had seemed to be the convention in the aftermath of the Whitlam Government Dismissal, an Australian constitutional crisis that came about in large part because of poorly managed government budgets, when the supply bill wouldn't be passed the government looked to get financing from other sources. The subsequent Loans affair where the government didn't go through the proper channels in its efforts to acquire a $4 billion loan were scandalous. If you adjust for inflation such a loan would be at least $20 billion AUD when priced in 2021 dollars but the size of the loan that sparked a constitutional crisis in the 1970s seems small compared to the current day government debt.
Speaking of Whitlam's era, many in my parents generation had free university degrees courtesy of the Whitlam governments policy directly paying upfront and in full all tuition costs. Now we have the Higher Education Contribution Scheme (commonly referred to by the acronym HECS which always reminds me of the word "hex"), which is just yet another acronym that represents another form of debt that the younger people in the country are carrying. With student loans not only do we see another example where debt has become normalized but a growing debt burden is also becoming common. Student loans are often large loans to people who are completely un-creditworthy which is normalizing unproductive debt even if the debt happens to be worth it for some degrees. We also increasingly see a system where a degree is becoming a requirement for entry into jobs, even if those jobs have no real need for a degree. We indoctrinate kids in high school that they must go to to university and get a degree in order to get a good career (which really is bullshit and threatens the very foundations of the prosperity of the nation but this is a topic for another post). The system promises that going to university will make you more money while simultaneously avoiding putting the finance skills on the curriculum that would allow students to make an informed calculation themselves of whether all the undischeargeable debt they are about to take on will actually be worth it. We tell kids that they must take on large amounts of debt but we don't teach them what debt is and how the financial system in which they are about to be indebted to works. The fact that student loans in many parts of the world cannot be discharged via bankruptcy has some very interesting parallels to debt peonage, something that people just don't talk about anywhere near enough. Frankly the whole concept isn't something we should be normalizing but yet we push our youngest through this system.
At a larger scale when you loan huge amounts of money to people who are not creditworthy you have a situation where most of the loans would end up delinquent or in default.
But people are now starting to question this system of indebtedness, especially when they reflect on the fact that student loans are frequently non-dischargeable debt, the sort of debt that continues to burden people even if they are bankrupt. Even the education system now loads people up on debt while at the same time mostly avoids teaching students anything about the financial system and the debt they are taking on, even though that now has such a large impact on people's lives. One thing I very much agree with Ivan Illich about is that the solution to the educational system issues we have right now isn't just a matter of "more money" and that less money in the system could lead to significant improvement. The idea that less money might make an improvement is simply unthinkable for many. The framing of this might seem very off but I think this comes from the current establishment mindset that debt is money, so in less money in the educational system in such a framework is actually equivalent to less debt in the educational system.
Unfortunately students who are loaded up on debt are finding that the jobs that they were promised at the beginning don't actually exist (and maybe never existed) are now increasingly asking questions that threaten the entire debt-education industry. The lies they have been fed just can't be sustained in the face of high youth unemployment, since employment is now the main carrot used to entice students into the increasingly expensive higher education system. I think the problems being created for these students wouldn't be as bad were it not for the huge amount of debt they will now be burdened with.
A different system for funding higher education could solve a lot of these problems, the current situation of having large amounts of undischeargable debt is distorting the incentives of the system in such a huge manner that it's causing the higher education system to internally implode. It needn't be this way.
There's a lot more to the state of education than can be covered in this post, and it would be a substantial diversion from talking about debt, I hope to write about this more soon.
There's been an absolute explosion in the amount of corporate debt in the last few years. This has also coincided with, and indeed directly created, a pandemic of zombie companies.
A zombie company is defined as one that can only continue to exist by taking on more debt. Such a company is only ever paying off debt, not getting ahead, at least by traditional metrics of getting ahead. But then again we now have companies like Uber that consistently lose a billion dollars each and every quarter so what constitutes getting ahead may be changing somewhat? A promise of direct central bank purchases of corporate debt as a buyer of last resort was a policy change that massively expanded the corporate debt bubble in 2020.
In a free market if a company has crappy creditworthiness then people just won't want to give that company loans. When you have a group that can create money arbitrarily decide to issue loans to companies with freshly printed cash without good fundamentals and at lower interest rates than any rational free market participant would choose to do you create a tremendous number of warped incentives.
Systematic changes are starting to assume high debt levels are inevitable
If you want to understand the real fundamental reasons behind the current state of debt you really need to understand the monetary system and how it has changed. In the past the monetary system tended to be based on ownership claims people had against valuable items such as property, precious metals or other scarce items. Over time this has subtly morphed into a system whereby most "money" is really just claims on debts. While debts and loans have always featured in monetary systems the change is that the monetary system now revolves far more around debt than assets, a system where most of the "money" that is now in "existence" was and is created as the result of loans. I really ought to write an article about this at some point because I think it's so crucial to understanding recent economic events, but much material already exists on this topic so I'd recommend doing some research into it if you are interested. The insight needed is that in this current system debt is regarded as far closer to money than people typically think. In this system creating new debt creates new money. Because creating new debt creates new money if you can create debt you can create money in such a system. Given this incentive we see debt increasingly seeping into more areas of commerce and society. One example is the rise in retail debt with new buy-now-pay-later schemes such as Afterpay/Zip/etc being recent example of people figuring out innovative ways to create even more debt because by doing so they get to create "money", but more about the rise of this business model later.
Many political figures spin a narrative that a larger GDP in nominal terms represents economic health. Naively aiming at a larger nominal GDP is not a good thing because GDP only measures the amount of economic activity and not the quality of that economic activity. Seeking to maximize GDP at any costs seems to be a case of Goodhart's law at best and actively harmful at worst because the easiest ways to increase economic activity are rarely the most valuable choices. When increasing economic activity becomes the goal instead of creating value then strong perverse incentives are created that shift valuable economic output into less valuable but "bigger" projects (where bigger just means bigger in nominal cost terms).
The number of businesses that lack fundamentals but are propped up by debt is turning into a crisis, with huge numbers of zombie companies and VC backed dumpster fires including some that consistently lose billions of dollars each and every quarter being disturbingly common. These companies will add to the GDP despite being a huge net negative for the real economy. One of the ways these companies harm the real economy is because it's extremely hard to compete (or impossible in some cases) with companies that can continue to operate with consistent quarterly losses due to external debt and money consistently rolling in without also turning to these same instruments yourself. Imagine you are a productive person who just wants to run a say pizza restaurant that just wants to provide an honest service by cooking good ethical food for the community at a reasonable price. These are the sorts of sustainable businesses that we really want to have, but how can a business like this compete with a debt based funded company that uses debt to fund promotions that literally give away pizzas for free. Or do you deal with a multinational delivery company that lists your own menu items for delivery for less than you charge without you even knowing about it? Maybe you want to deliver your pizzas but how can you do this when the competitors you face in this space consistently lose huge amounts of money each and every year but yet somehow remain in business? These corporate debt distortions really badly hurt the people who just want to run honest businesses with reasonable sustainable growth.
A crucial backdrop to the debates around current government expenditure is the growing amount of unproductive debt that's popping up almost everywhere. Unproductive debt is getting disturbingly normalized on many levels and organizations that would previously never have carried debt have increasingly been lured into taking on loans with low interest rates since this financing was cheaper than selling equity. As time has gone on some of these organizations now have such crippling debt loads that they will never be able to pay their debts off. This isn't some small number of companies either, the zombie companies were already a major issue in 2019 and have got far worse as a result of the pandemic where stimulus has been used to continue propping up the zombies instead of letting them finally fail while creating a fresh new batch of newly zombified companies.
We have this uncomfortable political situation now where so many businesses have so much debt that raising interest rates would immediately put a lot of companies out of business, so the easy way out politically is to just kick the can down the road and keep servicing the debt. The other slightly more painful way to deal with things is to monetize the debt which reduces the debt load by destroying the purchasing power of the fiat currency in which the debt is being monetized. The way this works is that the burden of some amount of debt denominated in dollars is only as much as what that amount can buy, so if you destroy the amount that can be bought you also reduce the real burden of that amount of debt too. While many people don't understand debt monetization this plan carries substantial political risks because a debased currency usually leads to political instability. One interesting change is that with more accessible communications people might realize what's going on, though it appears most people just don't care until the currency problems are at a crisis level and are too late to be easily solved. Once again the easy temptation is to just kick the can down the road and try to delay things enough so that the problem has to be dealt with by someone else in the future. With a delaying strategy various issues like systematic insolvencies of companies is not "on your watch" and you can leave the economic problems to the next person/generation and if you get lucky it will be their reputation that takes the hit. But eventually this reaches a breaking point where the debt load is unsustainable even in the short term. This is the point we were already starting to reach in many places in 2019, long before the COVID pandemic ever started.
The electorate themselves is also getting more indebted too and this causes them to also be incentivised to kick the debt can down the road on debt related problems. If the electorate has enough voters who are indebted then they might elect those who promise to keep interest rates suppressed. For example the absolute explosion of the bubble of prices for real estate assets has led to a much higher proportion of debt as a percentage of the asset values. Many people who own real estate with high leverage will be very underwater very quickly if rates were to rise. With calls to allow real estate to be purchased with ever smaller amounts of equity the overall economic systems ability to respond to any drop in prices is also reduced. When I was younger for example many people didn't have credit cards, I now regularly hear of people in their 20s with fully maxed out cards where their card limits are more than half a years worth of wages. So we also have this uncomfortable political situation in personal debt too, any increase in interest rates will send a lot of people bankrupt. With increased debt substituting for actual wage growth in the last couple of decades these people are becoming an increasingly large voting block.
That said the swing towards tightening credit has kicked in now, the other day I wanted to apply for a $400 limit credit card so I could do some online shopping but I was turned down by the bank. That same major Australian bank is on the brink of insolvency (or might already be insolvent) since any drop in real estate asset prices will now utterly devastate them. This is a factor in why they are tightening their lending standards, any rise in loan delinquencies and they are in big trouble. The banker who turned down my application was confused when I said I'd prefer to see higher interest rates, and I was confused that he didn't realize that low interest rates are likely going to cause him to lose his job soon (the shrinking of the number of commercial banks is a global trend). Things took a bit of an awkward turn so I tried to strike up some conversational points about Austrian economics but I realized that he didn't understand some of the concepts I was talking about which was deeply unsettling, needless to say the awkwardness got worse. But the reason I might personally like to see higher rates is because it would perhaps represent a society that's in less debt. What I'd really like to see is a completely different monetary system, I'm working on writing about this at the moment. I any case in a higher rate environment it might make sense for the bank to extend credit to me and I might actually leave some savings in the bank if they offered me a better interest rate. As it currently stands there's no incentive whatsoever for me to have anything more than the barest of minimum involvement in the traditional banking sector. I'm just thankful I don't work at a retail bank, on top of everything else COVID has accelerated the closure of branches.
One of the areas that's taking away market share from the banks is the so called shadow banking system. In the aftermath of the market crash in early 2020 some of the biggest stock gains in the Australian market have been in the shadow banking sector that is offering credit. I'm talking here about the buy-now-pay-later companies like Zip and Afterpay.
If the bank won't give me credit then these companies might. When I was younger I remember lay-buys being a thing, but these are different arrangements where the customer pays in installments and receives the item only after all payments are made. In any case debt based financing for small purchases certainly wasn't the juggernaut that Afterpay has turned into. Debt again is everywhere and is increasingly normalized, you can unthinkingly tap your credit card at the store and create debt without even having to spend a second thinking about it, and many people don't spend that second thinking about it either. The attitude that's being aggressively manipulated and pushed on to people is that you can buy things now and pay some other time later. Financing is no longer seen as something just for items that you couldn't afford to buy upfront, like housing or works with large upfront capital expenditure requirements, but now has expanded into items that people could have afforded to buy without financing at all.
What's allowed all this to happen is low interest rates. Over the last decade or so interest rates have dropped as a result of natural economic changes and have been artificially pushed downwards from there. As long as the banks think there is little risk of them not getting the principle on loans repaid they will be happy to loan a lot of money to people and over the last decade this has led to a flooding of cheap debt all over the place. If you have sufficiently good collateral it was fairly easy to get a loan, but any sort of downgrade to collateral quality will cause serious problems now, as happened in the Repo Market Crisis of 2019. As long as asset prices keep inflating into bigger and bigger bubbles the banks know that they are going to get paid back their principle on any loan. As long as the monetary creation outpaces inflation and the risk of defaults those loans will continue to be made. The downside is that the banks are now completely fucked in the case of any sort of market shock that pops these asset bubbles as a large percentage of their balance sheet is in big trouble if a deflationary shock happens that triggers defaults.
Unfortunately the response to this growing risk of the asset bubbles to the overall banking sector has just been to keep adding more and more fuel to the asset bubble situation in an effort to make it not pop. For a number of years interest rates were low, but they are now hitting the zero lower bound as monetary policy efforts to prop up asset prices despite deflationary trends continue. But the market rate for interest rates is a bit of a different story, and this is the story that I suspect will matter in 2021 at some point. Low rates doesn't actually incentivize people to loan money in any situation not secured by an asset that has reliably appreciating value over time, because if you have 0% interest you also have zero reward to offset against the risks of loaning to someone. If a central bank or other entity with money creating power is offering loans the situation is different because they aren't actually risking money like any other entity would be in order to offer a loan. This is the main mechanism behind which they can put pressure on interest rates at the margins. The only reason rates have managed to get this low so far is a general policy trend to massively support the creditors over the debtors. Again if interest rates are to be low people will only loan money on the free market if they think there's minimal risk of default. A regulatory framework and policies that make defaults harder reduces the risk to those offering loans and allows loans to be issued that would otherwise be entirely imprudent, like almost every student loan ever issued for example.
Policy makers are completely culpable in this growing asset bubble crisis because of an insistence that interest rates be set low by fiat by unelected bureaucrats. And the unfortunate part about this is that the debt is now so large across so many sectors that people are starting to apply political pressure to keep interest rates even lower than what the free market wants because this reduces the pain of the debt burden on them. After the events of 2020 we have seen governments engaging in massive deficit spending to deal with the pandemic and the fallout from it. Much of this has been funded by debts. So the government has obligations to meet and keeping interest rates low (while inflation is high) is much easier than defaulting in the event of any troubles in servicing that debt. (And yes governments DO default on debt denominated in their own currencies, there's a lot of reasons why this might be expedient, but more about that in another article)
The absolute bipartisan support of more debt is terrifying because it means interest rates must be kept low at all costs or else the debts are not serviceable. Because everyone is in so much debt and new debts are issued in a system of fractional reserve banking many debts can be created on top of an original debt. So if the government, or any other major player defaults on debts the whole system can rapidly collapse due to defaulting on debts causing a contagion. Such a catastrophic cascade of defaults would be highly destabilizing so many of the established interests would like to avoid this happening. Recent discussions seem to be not be questioning if there should be more interference in the markets but rather are asking how much?. Taken to its extreme we start seeing suggestions of negative nominal interest rates, a truly absurd proposition, absurd enough that significant resources of state coercion are required for such a policy to have any chance of being implemented at all. Again if keeping a system of high debt load in place is seen as an existential problem people will try all sorts of absurd contortions of policy to keep kicking the can down the road as much as possible. After all people will not want to have to pay to loan money to other people, they will have to be forced to do so by some means or another3.
The main reason this is an issue is because we are seeing an economic situation that goes far beyond a liquidity crisis and is now really a solvency crisis. The more debt we create the more zombie companies and zombie organizations we spawn that aren't ever able to pay down the interest on their debts. The solution here is not to load up ever more debt, as tempting as that may be as a short term political "fix". Turning the entire entire economy into a Ponzi Scheme powered by debt isn't a sustainable plan let alone one that would actually maximize happiness and utility. These unproductive companies add to the solvency crisis in a very insidious way, the economic drag from having these non productive companies undermines any sort of real economic effort that may be able to pay off the debts and feeds into the debt cycle trap. On a broader scale this is disastrous, doubly so if these companies get bailed out by the creation of -- you guessed it -- even more debt.
Eventually when these cycles play out we see an eventual questioning of "who really owes who what? And how did this come about?". The only thing that is seemingly for sure is that if this debt problem is not resolved democracy will be dead.
I hope to write more about the counter-party risk bubble we now see in a future article.
I'm getting in the habit of putting in the year and currency in my articles because inflation is becoming an increasingly large problem for the average person. Sure there may be a deflationary bust in the future but that also makes putting the date in the article important too. Future readers may wish to convert these figures to whatever their current purchasing power adjusted currency is for comparisons. ↩
A surprisingly large number of people who work in the financial and banking sectors also are clueless as to way in which the monetary system really works. As long as the paychecks keep rolling in a lot of people don't care at all, including a lot of people who are currently working in the banking sector who are at huge risk of losing their jobs in what's increasingly looking like an upcoming banking crisis. Ignorance is bliss for some people though. ↩
One way that is suggested to enforce negative nominal interest rates is to remove physical cash from the system and force people to only have their money in bank accounts that have a negative interest rate. Even though the majority of transactions in many countries are cashless the presence of cash is important in the way in which it creates a floor on the interest rate at zero. Cash always yields zero percent and you'll start to see more people take out physical cash when the interest rates in bank accounts are close to zero. This is what we saw empirically in Australia in 2020 when interest rates hit zero or perhaps slightly negative in nominal effective terms due to fees. ↩
This post is part 3 of the "MonetaryPolicy" series:
- Finally getting around to publishing some monetary policy articles
- Fast things happen slowly then quickly
- Politics of unproductive debt *
- Futures markets lower prices, both in good and bad ways
- Why do stable coins matter
- Why is so much financial advice bullshit
- Bank bail ins
- Where is money created
- Bastiat on legal systems and morality
- Transitory inflation means permanent purchasing power reduction
- Problems with Celsius
- Crypto's Lehman moment
- Crypto crash update May 2022
- The myth of the unbalanced government budget
- The 2006 debasement of NZ coinage
- Demand destruction anecdotes
- Central bank interventions and price discovery
- Luna a modern case of hyperinflation
- Collateral crisis psychology
- The death of full employment