Wednesday, December 16, 2009

Debt Does Not Exist

...Debt does not exist, except as a measure of credit in use.


Debt is an accounting of the use of credit. If you borrow a dollar, you put credit to use. If you borrow a dollar and spend it, the credit remains in use until you repay what you borrowed. Debt is just a measure of money borrowed. The only way to reduce debt is to reduce credit-in-use.


Nothing else need be said. But here, read it again:

Debt is the measure of credit in use. If you borrow a dollar and spend it, the dollar is gone. But the credit stays in use. The credit stays in use until you pay back what you borrowed.

It's pretty simple, and pretty obvious. But it is ignored by policy-makers.

When the economy is growing and things are going well, people are borrowing money and accumulating debt. The quantity of credit-in-use is growing. The "quantity of money" is growing.

And the Federal Reserve starts to get concerned that the growing quantity of money will cause inflation. So the Fed raises interest rates to discourage borrowing. And the Fed takes money out of circulation by selling assets. And, sometimes, the Fed causes a recession. All in the name of fighting inflation.

And then after a while the economy is growing again and things are going well, and people are borrowing money again. Debt is accumulating again. The quantity of credit-in-use is growing again. And before you know it, inflation becomes a concern again. The cycle repeats.

What's wrong with this picture? One step is missing. Where is the part when we pay back what we've borrowed? We don't. We just accumulate debt, to the bitter end.

Here's what should happen: When inflation becomes a concern, tax incentives should kick in. Tax incentives that encourage people to pay off more debt. This would take money out of circulation as surely as the use of credit puts money in to circulation. This would fight inflation. It would also reduce the level of debt. That would be good.

2 comments:

Gene Hayward said...

""Here's what should happen: When inflation becomes a concern, tax incentives should kick in. Tax incentives that encourage people to pay off more debt. This would take money out of circulation as surely as the use of credit puts money in to circulation. This would fight inflation. It would also reduce the level of debt. That would be good.""

When I teach Fiscal Policy and the role of Congress in fighting recession and inflation, the students easily see how recessions can be addressed using Keynesian policies--decreasing taxes and increasing spending. There are LOTS of constituencies to please with these policies. But when it comes to fiscal policy addressing inflation, even High School students see IMMEDIATELY that politicians dont have the will to increase taxes/decrease spending with the same zeal to tame inflation. I tell them that is why the Fed is supposed to be the "adult" in the room and conduct contractionary monetary policy. As you so plainly put it, this at best is neutralized by bad Fiscal policy ...This post was very helpful...Thanks!

The Arthurian said...

I think about setting up a "standing" tax policy. I hesitate to put numbers on it, and this is just an example. But say you recently bought a house and now your total debt is 4 times your income. The tax policy will make your tax rate higher than someone with debt 2 or 3 times their income... BUT you can reduce your tax rate (or your effective tax rate or whatever) by making extra mortgage payments in that tax year. In other words, you bring your taxes down by bringing your debt down.

It is a policy that people will see as helpful to them in their daily lives.

The concept is to make taxes do for the individual (and for the business) what interest rates are supposed to do for the economy as a whole: Influence future additions to borrowing and debt.

As a "standing" tax policy, it would not be tweaked by Congress at every opportunity. Granted, it would have to be set up better than I can describe, and it would have to be tweaked to get it working smoothly, but then those tax rates would be known and predictable. Car dealers and Real Estate agents would be able to sit down with you and show you how your taxes would be affected, and they might say things like, "...and if you make two extra mortgage payments this year, your income tax will be less than it was last year."

The essential idea here is that by using the tax code to do what has heretofore been done with interest rates, we have the opportunity to eliminate the "boom and bust" effect that interest rates have on our economy. It would then be possible to achieve the stable Quasi-boom.

This idea is big, Gene.