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Debt - Crash Course Chapter 13

There's just too damn much of it
Friday, September 12, 2014, 8:04 PM

Chapter 13 of the Crash Course is now publicly available and ready for watching below.

The fundamental failing of today's global economy can be summarized simply: Too Much Debt

We have taken too much of it on, too fast, in too many markets around the world, to have any hope of making good on it. Not only does the math not work out, but also on a moral level, we are placing a tremendous obligation on future generations that will unfairly limit the prosperity they can enjoy tomorrow in order to finance our consumption today.

In the US alone, total credit market debt stands at over $57 trillion and is doing its damnedest to continue expanding exponentially. Since simple math shows us that this debt level cannot be supported, the key questions to ask at this stage are:

Will the unsupportable debt disappear via default, or inflation?

And very important:

When these debts do disappear, who will take the losses?

For the best viewing experience, watch the above video in hi-definition (HD) and in expanded screen mode

Coming next Friday: Chapter 14: Assets & Liabilities

For those who simply don't want to wait until the end of the year to view the entire new series, you can indulge your binge-watching craving by enrolling to PeakProsperity.com. The entire full new series, all 27 chapters of it, is available -- now-- to our enrolled users.

The full suite of chapters in this new Crash Course series can be found at www.peakprosperity.com/crashcourse

And for those who have yet to view it, be sure to watch the 'Accelerated' Crash Course -- the under-1-hour condensation of the new 4.5-hour series. It's a great vehicle for introducing new eyes to this material.

Transcript: 

With the background you’ve received to this point covering money creation, exponential growth, and the immensity of trillions, we are now ready to go into the first big "E": the Economy, in greater depth

It’s the data in these next few chapters that leads me to conclude that the next twenty years are going to be completely unlike the last twenty years.  So we begin our economic inquiry with “debt”.  

Our debt-based money system has a fundamental shortcoming: it requires infinite growth to remain functional and infinite growth forever is simply not possible. 

So studying debt gives us clues to the size of the predicament in which we are in, and perhaps hints at the timing of when things might unfold.

Let's begin with a few definitions.  A financial debt is a contractual obligation to repay a specified amount of money at some point in the future. 

The concept of debt is thoroughly characterized within the legal system so we can say that a debt is a legal contract providing money today in exchange for repayment in the future….with interest, of course.

Debts come in many forms:  auto loans and mortgage debt are known as “secured” debts because there is a recoverable asset attached to the debt.  Credit Card debt is known as ‘unsecured’ because no specific asset can be directly seized in the event of a default.

For you and I there are only two ways to settle a debt. Pay it off or default on it.  But if you have a printing press like the government does, a third option exists; printing money to pay for the debt. 

This method is a poorly disguised form of taxation since it forcefully removes value from all existing money and transfers that value to the debt holders.  I view it as a form of default but one that preferentially punishes savers and those least able to bear the impact of inflation.

The pure debt obligations of the US government as of December 2013 stand at more than $17 trillion, dollars.  This is only the debt.  Once we add in the liabilities of the US government, chiefly Medicare and Social Security, we get a number 5 to 8 times larger than this.  We’ll be discussing these liabilities in the next chapter so that’s all I’m going to say about them now.  Right now we are focused simply on debt and it’s enough to know that debt is only part of the whole story.

OK. Next, this is a chart of total US debt – that’s federal, state, municipal, corporate and private debts in the red line, compared against total national income in the yellow line.  The total debt in the US at the end of 2013 stood at over $57 trillion.  That’s 57 stacks of thousand dollar bills each of which is 67.9 miles high.

If we adjust these debt levels for both population and inflation over time so we’re comparing apples to apples, we find that in 1952 there was the equivalent of $76,000 of total debt per person and that today the number is $183,000.  At $183,000 per head, this means that today the average family of four in America is associated with roughly $735,000 of debt. 

This is now more than twice as high as back when a single income was sufficient to sustain an average family.

This is a useful way to look at debt because it doesn’t really matter if the debt is owed by a government agency a corporation or an individual because these are really the debts of our country and all debts get paid through the actions of people. 

So examining the debts on a per capita, or household basis, gives us a sense of the situation.    

Can debts forever grow faster than the incomes that service them?  Can the average household earning a bit more than $50,000 realistically pay back nearly three quarters of a million dollars in debt?   

The answer to both of these questions is no, and almost certainly not, respectively.

Am I saying that all debt is “bad”?  No, not at all.  Time for another definition.  

Debt that can best be described as ‘investment debt’ provides the opportunity to pay itself back.  An example would be a college loan offering the opportunity to earn a higher wage in the future. 

Another would be a loan to expand the seating at a successful restaurant.  In the parlance of bankers, these are examples of  “self-liquidating debt”, meaning that the loans boost future revenues and have a means of paying themselves back.

But what about loans that are merely consumptive in nature such as those taken out for a fancier car, or for vacations, or for more war materiel

These are called  “non-self-liquidating debts” because they do not generate any additional future revenue.  So not ALL debts are bad, only too much unproductive borrowing is bad.

Between 2000 and 2010 total credit market debt in the US full doubled from $26 trillion to over $53 trillion. And a very large proportion of that has been of the non-self-liquidating variety. 

This has profound implications for the future.     

So what is debt really?  Well, debt provides us money to spend today.   Perhaps we buy a nicer car and we enjoy that car today. 

But in the future the loan payments represent money that we do not have then to spend on other items or to save. 

So we can say that debt represents future consumption taken today.  As long as it is my decision to go into debt and the repayment is my responsibility, then everything is cool.

However, once we consider that our current levels of debt will require the efforts and incomes of future generations to pay them back, we start to trend into the moral aspect of this story. 

Is it really proper for one generation to consume well beyond its means and expect the following generations to forego their consumption to pay it all back?  That is precisely our current situation and these charts say as much.

This is our legacy moment - we are piling up debts that we ourselves cannot pay back, and much of that borrowed money is simply being used to support consumption, not grand infrastructure investments that future taxpayers will benefit from.

Is this fair?  Is it moral?

Now, we learned earlier in the Crash Course that money can be viewed as a claim on human labor, and we just learned that debt is really just a claim on future money, so we can put these statements together and arrive at a new Key Concept:  Debt is a claim on future human labor

When we get to the section on baby boomers and the demographic challenge our country faces, I’ll be recalling this important concept.

When viewed historically, and compared to gross domestic product, the current levels of debt are without precedent, and the chart even suggests that we are living in the mother of all credit bubbles.  Current total credit market debt stands at more than 350% of total Gross Domestic Product. 

As we can see on this chart, the last time debts got even remotely close to current levels was back in the 1930’s and that bears a bit of explanation   The easy credit policies of the Fed gave us the “roaring twenties” and then a burst credit bubble which was followed by 11 years of economic contraction and hardship which we now refer to the Great Depression. 

Note that the debt to GDP ratio didn’t start to climb until after 1929.  What’s the explanation for this?  Were more loans being made?  No, the chart climbs here because the while the debts remained the economy fell away from under them creating this spike. 

In the absence of the Great Depression anomaly our country always held less than 180% of our GDP in debt.  It is only since the mid -1980’s that that relationship was violated so we can say that our current experiment with these levels of debt is only three decades in the making and therefore an historically brief phenomenon.  

And it is THIS chart, more than any other, that leads me to conclude that the next twenty years are going to be completely unlike the last twenty years.  I just cannot see how we can pull off another twenty just like the one highlighted here.

But what if we did?  What would be required if we wanted - or expected or even required - debts to grow at the same pace between 2014 and 2044 as they did between 1984 and 2014?

Because debt grew by an average of 8% per year over the prior thirty years, it means that debt was doubling every 9 years. 

If we somehow managed to continue that 8% rate of growth over the next thirty years we discover that total US credit market debt would stand at more than 570 trillion dollars, or 520 trillion dollars higher than today. 

What would we borrow that much money for?  Total student borrowing is only a trillion.  All credit cards 2 to 3 trillion. 

The entire residential real estate mortgage market is in the vicinity of ten trillion.   Put those all together and you don't even come up with the twenty in the number 520. 

Okay, back to this chart (debt to GDP). Based on the shape of this chart, our entire financial universe has made a rather substantial and collective assumption about the future.

Because a debt is a claim on the future each incremental expansion of the level of debt is an implicit assumption that the future will be larger than today

Which means there is a very profound assumption baked right into this debt chart.  And that is, “the future will be larger than the present”.  Here’s what I mean.

A debt is always paid off in the future and loans are made with the expectation that they’ll be paid back, with interest.

If more credit is extended this year than last, then that means there’s an expectation, an assumption, that the ability exists to pay those loans back in the future. 

Given that our debts are now over 350% of GDP there is an explicit assumption here that the future GDP is going to be larger than today’s. 

Much larger.  More cars sold, more resources consumed, more money earned, more houses built – all of it – must be larger than today just to offer the chance of paying back the loans we’ve ALREADY taken out. 

But each quarter we see that new debts are being made at a rate 5 times to 6 times faster than growth in the underlying economy, which means that we're still piling up the assumption that the future will be bigger than the present.

Even with a fairly optimistic assessment of future growth, this trajectory is unsustainable.   

Our banks, pension funds, governmental structure and everything else tied to the continued expansion of debt has an enormous stake in its perpetual growth.  And so here we come to our next key concept of The Crash Course.  

Our debt markets assume that the future will be (much) larger than the present

But what happens if that’s not true?  What if the means to repay all those claims does not arrive in the future?  Well, broadly speaking if that comes to pass there’s only one result with two different means of making it happen. 

The result is that the claims – the debts- must be diminished somehow, if not destroyed, and the means by which that could happen involves either a process of debt defaults or by inflation.

The defaults are easy to explain, the debts don’t get repaid and the holders of that debt don’t get their money back.  Boom.  The claims get destroyed.  . 

Inflation is the means to diminish the current and future claims.  The inflation route can be confusing so think of it this way  – what if you sold your house to someone and elected to hold a note for  $500,000.  The terms call for the note to be repaid all at once in ten years as a single payment of $650,000. 

Well, what if in tens years you get paid your $650,000 right on time but time has reduced the purchasing power of those dollars so much that $650,000 will only buy this house? 

You got paid all right, but your claim on the future was vastly diminished by inflation.  

In the default scenario your money is still worth something but you don’t get it back.  In the inflation scenario you get it back but it hardly buys anything.  In both cases your future earning power was destroyed so the impact is very nearly the same but the means of achieving it are wildly different. 

So the questions you need to ponder for yourself are; have too many claims been made on the future?  And if so, will we face inflation, or defaults as the means of squaring things up? 

You will arrive at wildly different life decisions depending on whether you answer “YES” or “NO” to the first question and “inflation” or “Defaults” for the second question.  So they are worth pondering.

All right. Here’s what we’ve learned:

  1. Debt is a claim on future human labor.
  2. Second, Per capita debt has never been higher.  We are in truly unprecedented territory in this country.
  3. Debt has increased by $26 trillion in the first decade of the millennium, and most of it was consumptive debt.  .
  4. And finally,, our debt markets assume that the future will be much larger than the present.

This last insight plays in two critical areas that are coming up in future chapters of the Crash Course.

Our entire economic system, and by extension our way of life, is founded on debt. And debt is founded on the assumption that the future will always be bigger than the past.

Therefore it is utterly vital that we examine this assumption closely, because if this assumption is false, so are a lot of other things we may be taking for granted.

With our understanding of Exponential Growth, Money and Debt we can now put these three important concepts together to clearly see how our current economic system MUST continue expanding in order to function.

What will happen if it can’t?  Please join me for the next Chapter: A National Failure to Save

Thank you for listening.

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13 Comments

Time2help's picture
Time2help
Status: Diamond Member (Offline)
Joined: Jun 9 2011
Posts: 2768
Gimme a break!

Can't we all just declare collective bankruptcy?  Yeesh.

james_knight_chaucer's picture
james_knight_chaucer
Status: Silver Member (Offline)
Joined: Feb 21 2009
Posts: 160
Can't we all just declare

Can't we all just declare collective bankruptcy?

Unfortunately, if governments defaulted on loans, anyone that had bought government debt, (banks, insurance firms, pension firms, etc) would also go bankrupt in fairly short order. Thus any money that anyone had in the bank/ pension/ insurance policy would also disappear in a puff of smoke.

(I'm sure you knew that.) smiley

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
The Purpose of Debt.

 Thus any money that anyone had in the bank/ pension/ insurance policy would also disappear in a puff of smoke.

Not at all James. What would disappear would be digits on a computer. What would disappear would be the representation of wealth. The real wealth, the farms, tools, skills and people would still exist.

This argument of yours is what got us into this mess. The purpose of debt is to enslave. This little illusion will work until people recognise it for what it is. An illusion.

Too Big to Fail. To Big to Jail. We can do what we want and pay ourselves as we see fit. But you must bail us out or your world will end. And by the way don’t think any of the bond holders is going to pay. No that’s for you little people to pick up the tab and then make the cut-backs in services we insist are necessary.

 

Today our masters are busy negotiating behind closed doors the TTIP (US and EU) , TPP (US and Pacific countries)  and potentially the most dangerous of them all, TISA (global financial corporations and their ‘rights’) trade agreements. If they are passed then corporations will have the right to sue all our nations (in private closed hearings) for any laws we might make or alter that they feel infringe unfairly on their profits. This will include environmental, food safety and labelling, labour and even tax decisions. Cattle indeed.

Source

In a nutshell James, the cattle are revolting.

james_knight_chaucer's picture
james_knight_chaucer
Status: Silver Member (Offline)
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Posts: 160
Oh, I agree with everything

Oh, I agree with everything you've said Arthur. Just that (selfishly) I'd quite like to keep my computer digits which I worked for.

cmartenson's picture
cmartenson
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Posts: 5570
A debt jubilee = a wealth transfer
james_knight_chaucer wrote:

Oh, I agree with everything you've said Arthur. Just that (selfishly) I'd quite like to keep my computer digits which I worked for.

While the idea of a debt jubilee is appealing on the surface, the deeper reality is that it would be nothing more than massive losses for the holders of the debt being written off.

Yes, that fantasy 'wealth' would go 'poof' and simply disappear, but every retiree, endowment, individual and sovereign and corporate entity holding that debt at that time would suddenly be a lot poorer.

Many would be wiped out.  In the cascade that followed many others would be dragged down.  Colleges would close, banks would fail, nations would crumble, wars would erupt, and political careers ruined.

Other than that , everything would be ok.

But, as Arthur says, before during and after the debt jubilee destroys everyone's perceived sense of 'wealth' the same number of arable acres, houses, factories and other expressions of true wealth still exist.  But people's claims on those assets has been canceled.  In this construct "canceled" is a synonym for "transferred."

The alternative to a debt jubilee is to have the central banks buy that debt from the holders and then have the makers of fantasy money take the fantasy losses.  That at least eliminates the pain of immediate destruction of the holders of the debt.

However, that path merely transfers the losses to all the current holders of the currency involved.  That is, the wealth that everyone has gets transferred to other parties.

Either way, the final outcome of too much debt is a vast wealth transfer.

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
Real wealth preservation.

Aside from the loss of many natural resources (Oil springs to mind) if the real wealth is still intact, then there are no problems. We can still feed, cloth and house our people.

However this destruction of digits will have to be done with care. There has been a massive destruction of wealth in Detroit due to careless handling of the situation. Here are images of houses for $1 in Detroit.

This destruction of wealth was either a symptom of mishandling of the situation or a sinister scheme similar to the Highland Clearances.

The trick will be to preserve the real wealth during the transition. For instance people should have never been evicted from their homes due to the banks re-selling toxic bundled mortgage tranches, so that the chain of ownership is broken.

The law should explicitly say that if the chain of ownership is broken then the resident owns the property, thus ensuring someone lives in it and preserves its value. This would be an example of how to handle the economy to minimise wealth destruction.

This by no means exhausts the list of options.

If the US can spend trillions of borrowed money in failed wars then I am sure that they can feed everyone. This has always been the promise of automation, remember? Man hours worked inevitably come down with greater automation. Calvinistic guilt has to be replaced with Calvinistic compassion.

There is nothing wrong with being bone idle if your labour is just not required. There is a lot wrong with depriving people of wealth through greed.

The real problem is Future Shock. We are still living with the moral certainties of the Victorian era and the instincts of the Savannah Ape. They no longer apply.

Hotrod's picture
Hotrod
Status: Silver Member (Offline)
Joined: Apr 20 2009
Posts: 177
Feeding the populace

Arthur,

Unfortunately, modern industrialized agriculture can only function with massive infusions of annual credit, otherwise known as operating loans, to purchase seed, fuel, chemicals, and pay for land rental, etc. An interuption in credit availability would shut down the majority of food production here in the US.  Most modern farmers have lost the knowledge base required to reduce or eliminate these inputs.  In addition, during the 30's, many farmers who could feed themselves and otherwise survive lost their farms from the inability to generate enough earnings to pay their property taxes.

I thoroughly enjoy your posts. 

climber99's picture
climber99
Status: Silver Member (Offline)
Joined: Mar 12 2013
Posts: 176
Who will pay our debts back?

 

Who will pay our debts back? Ans. Savers, bank bond holders and owners of physical assets; and quite right too.  These are the people who have benefited the most during our energy boom years. 

Savers will pay the price by virtue of too much money being created compared to the resource base and hence having the effect of reducing their purchasing power over time.  Pension fund holders will pay the price if loans get defaulted on because they are substantial bank bond holders.  The government could bail out the banks like they did following the 2007 financial crash of course but this doesn't repay debts but just transfers them from the private to the public sector. Governments could rise taxes to pay back their debts. The people who can most afford this are those who own physical assets (primary wealth).

On our energy descent, we are all going to use less energy i.e. less stuff, less traveling etc. Just the way it is unless we can steal some resources from someone else on the planet.  Russia?

climber99's picture
climber99
Status: Silver Member (Offline)
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Posts: 176
Ah yes, the promise of

Ah yes, the promise of automation. Humanity chose to increase it's population rather than decrease hours worked.   We are preprogrammed in our genes to breed like rabbits.

On another subject, I read Future Shock by Alvin Toffler 20 years or so ago. Wonder how the books have aged over the years?

Cornelius999's picture
Cornelius999
Status: Gold Member (Offline)
Joined: Oct 17 2008
Posts: 373
Having being a

Having being a lightly practicing tai chi adept for years, recent changes in the energy flows in my body, ( they  have gone deeper and opened up long compacted areas of tissue)  encouraged  me to read Robert Tangora's seminal book on Cloud Hands. It's discussion and elucidation of how we can rewire the body's energy flows, for health, martial arts, and sheer exploration of barely known body and mind powers, as many taoist practioners have done for generations, blew my mind. So I've invested hundreds of dollars in his Tai Chi DVDs. I figure if I practice even a fraction of what he shows, it will be worth it. And I'm doing my bit to preserve priceless skills for those in the future, who may have more time to practice.

Arthur Robey's picture
Arthur Robey
Status: Diamond Member (Offline)
Joined: Feb 4 2010
Posts: 3936
Lessons from Adolph.

Unfortunately, modern industrialized agriculture can only function with massive infusions of annual credit, otherwise known as operating loans, to purchase seed, fuel, chemicals, and pay for land rental, etc. An interuption in credit availability would shut down the majority of food production here in the US

Adolph Hitler seemed to breeze right past that problem Hotrod. I wonder how he did it? (I realize that he is not flavour of the month- but let us play the ball, not the man.)

You are again talking about a virtual problem protruding into the Real world. Credit is a virtual problem. Access to diesel, fertilizer and the other farming inputs are the real problem.

Again this is an example of having to manage the destruction of debt.

Ah yes, the promise of automation. Humanity chose to increase it's population rather than decrease hours worked.   We are preprogrammed in our genes to breed like rabbits.

Climber I have to get to work, but the role of our genes has been misinterpreted from the beginning. They are nothing but the templates for amino acids. Our cells are controlled by their environment. It is a fractal thing. Everything is self-similar. Our cells are self similar to our bodies and our bodies are controlled by their environment too.

Whether we breed or not is also controlled by our environment. I do however agree that ovulation should be an act of volition and subject to legal sanction. That will require some tinkering to get right. Do not lose hope in the progress of science. Besides, Ebola might do a splendid job. There are many factors at play.

Mark_BC's picture
Mark_BC
Status: Gold Member (Offline)
Joined: Apr 30 2010
Posts: 429
I would tend to agree with

I would tend to agree with Arthur on the issue of debt jubilee. A lot of the perceived casualties from wiping out debt would actually be a good riddance -- the whole financial sector produces nothing tangible of value and is merely the hiding place for the otherwise enormous masses of unemployed due to the twin impacts of manufacturing automation and overseas outsourcing.

I disagree that farming would cease, or become problematic, due to its current dependence on cheap credit -- it would simply be done in a different manner, one which is dependent on true supply and demand forces. Will there be a demand for food? Yes. Will there be natural gas around to make the fertilizers? For sure. Will there be oil around to power the equipment. Yes, but less of it. Therefore, farming will continue on just fine, until oil and gas run out (or water). Food will be more expensive because gas and oil will be too, but it will continue.

Yes, many savers will be wiped out. Its very unfortunate that the people who supposedly did the right thing will get hurt but I see no way to avoid it. However, its no secret that the US is bankrupt and has been for a long time so I dont see why the rest of society should bend over backwards to maintain the savings of investors who wilfully ignored the most obvious market anomaly in history. Isnt that what market forces are supposed to do? Wipe out bad investments?

And arent most debt holders other nations? Am I supposed to feel bad for China for losing the value on all its trillions of Treasuries? Not for a second. Firstly, they were the other half of the coin in creating this mess. The US dollar fiasco could not have been pulled off if China hadnt been manipulating its own currency down. Secondly, they know and have always known very well that the Treasuries are worthless and will never be paid back. Thats why they have been instead receiving payment in artificially cheap physical gold.

The thing is, in a debt jubilee (and presumably a return to some form of an asset-based currency) the government would again be able to provide old age pensions for everyone since it wouldnt be burdened with crushing debt anymore. I disagree that we as a society cannot care for the elderly via pensions because supposedly our resources are declining and because everyone is aging. The fact that everyone is aging falls perfectly in line with automation throwing people out of work and increasing per-hour labour productivity many fold. We still have enough resources to pay for basic energy and food to keep old people alive. Furthermore, there are tons of houses out there so there is no reason why the old people couldnt live there. The whole real estate system is just screwed up in this bankers paradise.

So those are the two problems we face with our current debt: 1) the tax base has been destroyed as wealth accumulates at the top of the pyramid into the hands of a very few (not to mention that the true wealth of the nation has decreased due to manufacturing outsourcing and oil decline). Those wealthy elites rig the rules in order to evade taxes. 2) there wont be enough people working, for reasons discussed above, for an income tax to be sufficient to provide revenue to the government to fund pensions for everyone, unless we reduce the work week to spread out the remaining income wealth more equitably.

However, I think everything I have said above isnt really totally relevant because I highly doubt we are going to get a debt jubilee. I fully expect that after the dollar is devalued and government and corporate debt is wiped clean, the average person will be slapped with a new repriced version of their previous debts -- say half in real terms? It would have to be reduced significantly because there is no way everyone can manage their debt loads, so it would be a partial debt jubilee.

Merle2's picture
Merle2
Status: Bronze Member (Offline)
Joined: May 4 2014
Posts: 34
Ah, but in the 80s they said...

All of this takes me back to the 80s when I was beginning my career and the company was informing me that pensions were not needed, for we had exponential growth to take care of your future. And we all were shown the charts: If you put 5% of your income in an IRA for 40 years, well, gee whiz, you will be rich when you retire. Just look at the charts! What they didn't mention is paying off that debt requires more people, more steel, more land, more water, more oil, more everything. And where was all that going to come from? In the 80s we didn't think about that. Now we do (or at least some of us do).

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