Good Debt, Bad Debt

Is using debt to create money a bad idea? It depends on where the money goes.
Pile of Debt, photo by Andres Rueda

Debt isn't necessarily a bad thing—but it needs to be backed by real assets to work properly.

Photo by Andres Rueda.

This is the sixth of a series of blogs based on excerpts adapted from the 2nd edition of Agenda for a New Economy: From Phantom Wealth to Real Wealth. I wrote Agenda to spur a national conversation on economic policy issues and options that are otherwise largely ignored. This blog series is intended to contribute to that conversation. —DK

It appears that we are a nation addicted to debt. In 2009, U.S. public and private debt totaled $57 trillion. Of this total, $42.5 trillion is private household/business/financial sector debt and $14.7 trillion is federal/state/local government debt. Of the private debt, $13.5 trillion is household debt, accounting for 122.5 percent of annual disposable income. Of the total U.S. debt, $14 trillion is owed to foreigners. Current U.S. GDP is $14.3 trillion.

So is this a problem?

Most of the money in circulation is created as credit when a bank issues a loan. By the nature of this system, no debt means no money. Now that would be a really big problem in an economy that cannot function without money.

More important than the size of the debt is the question of whether it is good debt or bad debt. So what’s the difference?

Let’s start with good debt. The underlying logic of a debt-based money system rests on the assumption that the money banks create by issuing loans is invested in ways that expand society’s productive capacity and thereby the available pool of real goods and services.

The problem facing the United States is that most of our outstanding debt is bad debt—it isn't backed by real assets.

It further assumes that the benefits produced are shared equitably among all who contribute. The savers and investors who defer their consumption to build the bank’s capital reserves receive a fair share as interest. The bank employees receive a fair share as salary and benefits. The governments that provide the legal, social, and physical infrastructure required to do business receive a fair share as taxes.

The problem facing the United States is that most of our outstanding debt is bad debt. It was issued to fund consumption and phantom wealth speculation and in aggregate cannot be repaid, because it is not backed by real assets.

This didn’t just happen. It is the result of bad public policies and can be corrected only by better policy choices. Let’s take a look at four examples.

  1. Gambling Debt: Borrowing at interest to gamble on asset bubbles and loan pyramids can inflate financial asset statements, but produces nothing of real value and the assets can deflate in a heartbeat, leaving the loans unsecured and unpayable. This is a direct consequence of the financial deregulation that allowed Wall Street players to take control of the money and banking system and reorient it from financing investment in the real-wealth economy to financing speculation in the bubble economy.
  2. Private Consumer Debt: Borrowing at interest to support current consumption beyond one’s income is a dead end. At issue here are policies relating to trade, unions, wages, employment, public services, and taxes that suppress the incomes of working people relative to the cost of living—while inflating the incomes of the investing class. This forces the majority of households to borrow from the investing class to cover basic consumption expenses.
  3. Public Consumer Debt: Much of the current debate about debt centers on public debt. Borrowing by governments to invest in things like education, research, infrastructure, and even temporary economic stimulus directed to creating jobs in the real economy builds the nation’s future productive capacity and is logical and sensible. Borrowing to fund war, tax breaks for the rich, and current government operations is neither. Tragically, most of our public borrowing has been for the latter.
    Arguments focused on the size of the U.S. public debt will get us no place, unless we address the failed economic theories and policies that have mired us in all four of the major varieties of bad debt.
  4. Foreign Debt: Perhaps the most dangerous of all bad debt is that owed to foreign countries to pay for current consumption beyond what we produce for ourselves domestically. Our foreign debt is largely a result of unsound trade policies that lead to outsourcing jobs in manufacturing, research, and technology and increase our dependence on imports of manufactured goods, agricultural products, and services. These policies also play a major role in driving down domestic wages and forcing households to borrow against their credit cards and home equity to meet basic consumption needs. They place our children in a position of potentially permanent debt slavery to the children of other nations—a very bad idea indeed.

Arguments focused on the size of the U.S. public debt will get us no place, unless we address the failed economic theories and policies that have mired us in all four of the major varieties of bad debt. To get out of this mess, we need policies that favor productive investment over speculation, living wages and quality public services over consumer debt, public investment in education, research and infrastructure over war and tax breaks for the rich, and domestic production over outsourcing and imports.

[Next: A Real Market Alternative]

The ideas presented here are developed in greater detail in Agenda for a New Economy available from the YES! Magazine web store.