Is the world determined to live beyond its means?

I am troubled by the view of debt expressed in "Rome's Fall Reconsidered", the essay by Vladimir Simkhovitch that I've been dwelling on for some six weeks now.

Simkhovitch had some line of reasoning about how exhaustion of the soil reduced farm output and farm income in ancient Rome. Since Rome had an agricultural economy, almost everyone's income was hurt by it. So a lot of people started borrowing more to get by. And because farm output didn't improve a year or so later, people got trapped in a cycle of rising debt. I may be embellishing Simkhovitch's story a little.

But anyway, either he said or I imagined he said the debt became a problem as it grew. I hear economists say the same thing these days. It drives me nuts. If debt is a problem, it's a problem. If it grows, it's still a problem, only bigger. They act like debt is benign until it is a problem. That's incorrect.

So anyway I was looking up "benign debt". What turned up and caught my eye was something totally different than I expected. What turned up in the "People also ask questions" was the question

What is natural debt?

and this answer:

In the case of natural debt, economies borrow the assimilative capacity of the environment by releasing waste gases faster than they can be removed naturally. This natural debt is similar to the financial debt of a nation, because it is a loan from nature taken to grow faster and at lower costs.

I think I understand that. And I think I'm going to like the site.

The page is Count the natural debt, too, and the site is downtoearth.org. So I went.

The article, by Sunita Narain, is dated 15 December 2011. Here is the first sentence:

Now that Europe’s debt crisis is unfolding all around us, shouldn’t we question why the world is determined to live beyond its means and not worry how it sabotages our common future?

I like very much that we have similar concerns. Highly important concerns. But it is not true that we have all the debt because "the world is determined to live beyond its means". It is not true. We have all the debt because of how our monetary system works. The Federal Reserve will tell ya:

The Federal Reserve Act of 1913 established the Federal Reserve System as the central bank of the United States to provide the nation with a safer, more flexible, and more stable monetary and financial system.

Key on the word flexible. Sometimes the economy needs more money. Sometimes it needs less. The Federal Reserve was created to handle our changing need for money. That is the "flexible" part.

Here's the catch: When we need more money, we borrow it. It's not like we have more because they print it up for us. We have more because we borrow it. 

When we go to the bank because we need more money, they don't print it and give it to us. They lend it to us. And they don't put the money in our hands. They put it in our account. Only when we want to take the money out of our account to we need money that has been printed.

Almost all the money in our economy was created when it was borrowed from a bank.

 

When we need more money, we borrow it. When we don't need it anymore we repay it. This makes our monetary system "flexible".

But here's the thing. When we borrow, we have "more" money. We have money to spend. It's a good feeling. When we repay the loan, we have "less" money. We have less to spend. It is not such a good feeling. So our natural inclination, perhaps, is to borrow more but repay less. If we do that, our debt increases. If we do it for a lifetime, our debt may increase for a lifetime. In a lifetime, a person can accumulate a lot of debt.

In a lifetime, a society can accumulate a lot of debt.

A lot of economists say debt is not a problem. I think they are wrong, but that's what they say. There is a tendency, among economists, not to worry much about debt.

When people borrow, they spend. The extra spending can help the economy grow. Policymakers want the economy to grow. So policymakers make policy that makes credit more readily available. And policymakers make policy that encourages people to use credit -- I mean, encourages people to borrow the money and spend it.

So it is not only that people might naturally tend to borrow money faster than they pay it back. That's not the only reason we end up with a lot of debt in our economy. We also have policy that encourages us to borrow. So we borrow more that we normally would. We borrow excessively. Policy makes it happen.

Policy makes it happen.  The problem is not that we are "determined to live beyond our means". No. That's not it. The problem is policy. Policy encourages us to borrow more than we otherwise would.

The problem is not our natural inclination to borrow money. Anyway, you can't change human nature. The problem is policy. Policy, really, should be a mild sedative that inhibits our natural inclination to borrow more than we repay. Instead, policy gets us borrowing even more, but does nothing to get us repaying debt faster.

So naturally, debt accumulates until it starts to hinder economic growth. You know what happens then? Policymakers see economic growth slowing down, and in response they create more and stronger policies to increase our borrowing. Because they think borrowing money is good for economic growth, and they think the accumulated debt is not a problem.

One question remains: Why is it a problem when we accumulate too much debt?

The cost of debt service takes money out of the nonfinancial sector and moves that money into the financial sector. The nonfinancial sector is where goods and services are produced and purchased. The financial sector is where money is produced. But the money flowing into the financial sector is coming out of the productive sector. That's why it is a problem if we accumulate too much debt or if the financial sector gets too big.

When we pay down our debts, the money goes out of the goods-and-services economy. That money is no longer available to pay for goods and services, because it went to pay the cost of financing. Because of this, the financial sector grows while the goods-and-services sector slows. That's why it's a problem when we accumulate too much debt.