Thursday, February 4, 2010

A Minor Point

That last bit from Andrew Haldane once again:

Debt operates rather like a tax. Debt servicing costs, like a tax, reduce the disposable income of the borrower. Too much debt means a higher debt “tax” and a greater drag on activity – lower lending by banks and spending by households and companies.

The cost of debt is like a tax, because it is a "factor" cost.

My favorite part of The Wealth of Nations is the part where Adam Smith identified the factors of production. Smith looked at the world around him. He saw the land-owning aristocracy, a rising business class, and the commonfolk.

Smith realized that each of these groups received income from economic activity. He knew that these incomes were the costs of production. Today we call those groups "factors" of production, and the costs "factor costs." The well-worn phrase land, labor, and capital identifies Smith's factors; rents, wages, and profits are the costs.

When I look at the world I see one more factor: money. And its factor cost: interest.

The "debt tax" that Andrew Haldane describes is interest, the cost of using other people's money. When you start to look at interest as a factor cost, you start to see the source of our economic problems.

The cost of using money to make a product is included in the price of the product, just as labor costs and resource costs and profits are included. The more the cost of using money embeds itself in prices -- the greater the factor cost of money -- the greater is its effect on life as we know it. And the more we rely on credit, in the economy as a whole, the greater the factor cost of money.

Debt? Debt is simply the evidence of our reliance on credit.

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