Posted on 10/01/2014 4:29:08 PM PDT by Kaslin
Reader Mike wonders how interest can ever be repaid in a credit-based economy.
Hi Mish,Exponential Math
I wonder if you would be able to comment on this from Bill Gross in For Wonks Only:
"A credit-based financial economy (as opposed to pure cash) depends on an ever-expanding outstanding level of credit for its survival. Without additional credit, interest on previously issued liabilities cannot be paid absent the sale of existing assets, which in turn would lead to a vicious cycle of debt deflation, recession and ultimately depression.
Put simply, if credit needs to expand at 4.5% per year, then the private and public sectors in combination must create approximately $2.5 trillion of additional debt per year to pay for outstanding interest."
This seems to correlate to reality 100% but the implications are stunning. It means that assets must increase in value at the rate of the original loan plus all interest payments ever made. It also means there will be a very major reversal at some point as there will be a moment when the last loan that someone will actually pay gets written and the system will not be able to expand. I always assumed that debt levels would just reach a very high plateau and stay there but Gross is saying that is not possible.
If the system we have requires the interest to be created every year (in the form of new loans) to survive that seems like the very definition of a ponzi scheme.
Do you know the mechanical reason why the interest payments need to be created by issuing new debt? It is possible, of course, that you disagree with Bill Gross but he probably knows more about how debt works than any man alive so my assumption is that you agree with his viewpoint.
I'm sure you get endless requests for articles but this is such a fundamental question I would be extremely grateful (as I'm sure would many other people) if you are able to write a reply as an article.
Mike
Interest is basically nothing but the discount of future goods vs. present goods. At its root, interest is actually a non-monetary phenomenon. In the modern-day fractionally reserved fiat money system, it has become possible to expand money and credit at immense rates. The reason why the debtberg was able to grow to such immense proportions is that interest rates fell for over 30 years. But now we have arrived at a critical juncture, because interest rates can no longer go any lower. The possibility to refinance existing debt again and again to lower its cost has come to an end.On the Edge of a Cliff
The size of a debt is immaterial if the debt has been used for productive purposes and is so to speak 'self-liquidating'. Imagine you are a company that borrows $200 million at 3%. If you employ this money to produce goods that have a net profit margin of 6%, the repayment of the debt plus interest poses no problem.
But a lot of debt in the system today is a "dead weight" that will produce nothing. All extant government debt is only a reflection of past spending, and the funds have been 100% consumed. The same obviously holds for consumer debt, but consumers at least have an income based on production (i.e., their work will create value in the future). The government's income relies on the production of others, which is coercively appropriated.
In the realm of corporate debt, which may be considered productive in principle, there is the problem that many of the investments that have been undertaken are really malinvestments, as economic calculation has been falsified by monetary pumping. Debt that has funded capital malinvestment is a dead weight as well, although this may only become obvious at a later stage.
So the situation is now this: debt service will now grow with every new addition to existing debt, as interest rates have arrived at their absolute lows. Given total credit market debt of $60 trillion in the US alone, it will become more and more difficult to actually produce the added value required to service this debt. There is indeed an incentive for many to play a kind of Ponzi scheme that is very similar to the government debt Ponzi. Many companies, especially the junk credits, can only survive by rolling over their debt when it comes due.
Nevertheless, Gross' calculation may be a bit too simplistic. After all, if you are a creditor and get paid interest and principal, money is only moving from A to B. It is still there, only its ownership has changed hands. The problem is that central banks believe in inflating debt away and keeping prices "stable".
In a free market economy, prices would not be stable, they would in fact decline. Thus, interest would be quite low to begin with, and every dollar would be doing more work over time (i.e., could be exchanged for more real wealth/goods/services as time passes).
So we currently have a systemic bias toward more and more debt expansion. Obviously, debt service costs in this system are slated to rise, while an offsetting creation of wealth is no longer guaranteed. You can see this from the fact that more and more new debt is added per dollar of GDP growth. So Gross is quite correct that there is a problem - the problem is the ongoing bubble. Such a bubble does indeed require a constant acceleration in debt and money supply to keep going.
Seems to me that it is a system that is coming ever closer to a cliff.
As long as it is fiat... NOPE
Not everybody borrows money in order to repay debt.
In fact — most people don’t.
So much of our economy is based on debt, and I don’t just mean credit cards. Automobiles and homes are often financed with it, and we are watching the consequences today of a whole generation of people opting out of the latter. Without the Ponzi scheme growth (in population, for the new lowest tier on the scheme), whole regions are collapsing; the government’s response (injecting trafficked foreigners into those areas to stabilize housing, businesses, and keep the education industry - one of our largest - afloat), don’t help much because they aren’t bringing wealth with them, and aren’t creating any. Transferring money from a dwindling American population to their replacements isn’t working because the pie is continually shrinking.
Bump!
Most people don’t but this is talking about governments.
The gov’t doesn’t intend to pay back the money it has borrowed. The trouble is they are going to have to borrow money to pay ever-growing unfunded liabilities like SS and Medicare and the interest on their debt.
I have an idea - just bring in millions of illegal aliens. They must have tons of money! /s
The pie would be a lot larger if the government would stop taking an ever larger portion - to give to the ever increasing poor illegals.
The word is Ponzi.
The trouble is they are going to have to borrow money to pay ever-growing unfunded liabilities like SS and Medicare and the interest on their debt.
Before they make significant cuts they will just tax your entire pay check no matter the amount. When they do that SS will be around another 200 years. That is what the Democrats are planning.
Yep. They can just supply everyone with public housing and transportation and you won’t need any disposable income at all!
Interest in a Debt Based monetary system can only be paid for, by the Blood and Sweat of Labor, The Principle can NEVER BE PAID or even Paid down. It must forever increase til it blows up or instant depression.
The illegals are trafficked here to keep the government worker pie from shrinking (while the private sector withers & dies).
True enough, but many of the "once-middle-class" are borrowing money on top of money for necessities.
I don't know or care about the macros of the credit deal - we use our credit cards for convenience and write one check each month to pay them off. I would like to say we don't pay any interest, but these days everyone pays interest because stores mark up their goods to cover the "vig" that the credit card companies get. If all stores would offer a discounted price for cash, I would gladly stash my card.
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