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A Venetian Tale
Once upon a time a poor gondolier of Venice, having done a favor to the gnomes of the Piazza, was given a magic
pepper mill that would grind out anything at a word. The gondolier, a modest
man, used it only to keep flour and sugar in supply. But his brother, a
wealthy salt merchant, upon learning of the mill, cajoled its secret word
from the gondolier, stole the mill by night, and set out to sea for the
markets in the Levant.
Eager to try his prize and fill his sacks he uttered
the word, and the mill began to grind out salt. The vessel's holds were soon
filled and salt began to cover the deck. The merchant now tried to stop the
mill, but alas, he had forgotten to learn the other secret word. The ship
began to settle, and finally sank, carrying with it the avaricious merchant
along with the mill, where it still rests, at the bottom of the sea, grinding
out salt.
And that, the tale concludes, is the reason why the
sea is salty.
Debt mill on the Potomac
Most observers worry about the inordinate growth of
the money supply. But the growth of the money supply is merely a symptom,
concealing a far more serious condition: the uncontrollable growth of
dollar-denominated debt. The magic mill of the Venetian gondolier has
been commandeered by the masters of the Federal Reserve System. They uttered
the word, and enjoyed the sight of the uninhibited outpourings of cheap
credit. But the obverse of credit is debt, and the mill on the Potomac River started flooding the country with bad
debt that can never be repaid. The new masters of the mill would like to stop
it, but alas, they have forgotten to learn the other word. The nation's
economy, overburdened with bad debt, has started sinking.
In praise of debt
Debt is not bad per se. Debt embodies the
symbiosis between the three progressive classes of people in the economy: the
savers, the producers, and the inventors. Debt is the instrument facilitating
the exchange of the wealth of the savers for income. Debt is the instrument
facilitating the acquisition of state-of-the-art technology by the producers,
in order that they may get the highest output per input of labor and capital for the benefit of everybody. Debt is
the instrument facilitating the exchange of the future wealth of inventors
for present income in support of research and development. Debt alone can
make possible the extension of division of labor to
generations that are far removed in time. Debt alone makes the emancipation
of savings possible: saving is no longer anti-social as it was when the
saving of a gold coin perforce meant a contraction of demand, prices, and
output. Through debt as catalyst, saving is more beneficial than spending:
the present wealth and income of savers find their way to the producers and
inventors, and to the socially most beneficial applications.
The danger of a debt meltdown
Debt, however, is not without its dangers. It is not
unlike nuclear energy. It can be enormously beneficial if properly harnessed
and constrained - but it can also be equally destructive if the harness and
constraint are removed. Bad debt is like fissionable matter. It can keep
accumulating unobtrusively and without any apparent bad effects up to a
point. But once this critical point is reached, a meltdown occurs. Proper
safeguards in debt creation are therefore imperative.
The distinction between good and bad debt is not
subjective or arbitrary. The quality of debt can be gauged by its
productivity. This is the ratio of the net gain in GNP (gross national
product) to the gain in debt. (The net gain in GNP is the excess of
additional GNP over additional debt.) If this ratio is positive, then the new
debt can be serviced out of current income, and the greater the ratio, the
higher is the quality of debt. If the productivity of debt is allowed to
decline significantly or, worse still, to become negative, then the debt can
no longer be serviced out of income, and new debts have to be incurred to
meet the maturing debt. The negative ratio is a clear signal that bad debt is
now breeding more bad debt. A feedback is in effect,
short-circuiting the economic process. The debt-tower is growing out of
control, and in due course it will self-destruct.
Debt accumulation versus capital accumulation
The Principle of Productivity of Debt asserts that
the ratio of net gain in GNP to the gain in debt must never be allowed to
become negative. If this principle is observed, then debt is properly
harnessed and constrained, and is socially beneficial, It makes a positive
contribution to economic growth and public welfare.
We have long since passed the point when debt had a
positive productivity in this country. Before 1960 it took less than one
dollar of new debt to produce $1 gain in GNP But in the 1960's, on average,
it took $2. in the 1970's it took $5, and in the
1980's so far. It's taken $3.50 of new debt to produce the same $1 gain in
GNP. The growth of bad debt is accelerating.
It should be clear that this trend cannot continue
indefinitely. The new debt has no economic justification. It does not produce
the income to amortize itself, let alone a spendable
income. Sooner or later the fantastic debt tower will topple, and bury the
economy that prefers debt accumulation to capital accumulation.
We owe it to ourselves
There are those economists who maintain that the
public debt is just the other side of public investment and therefore its
growth, far from alarming, is actually beneficial. The public debt need never
be repaid. "We owe it to ourselves", they say pointing out that if
a family goes bankrupt, it is never on account of internal family debts, but
on account of debt owing to outsiders.
There has never been a more vicious
misrepresentation of economic fact, The public debt is being serviced at the
expense of the taxpayers, and if it will never be retired, then taxation can
only grow worse. Moreover, the credit worthiness of the government can
suddenly evaporate, if creditors lose all faith in the ability of the
government to consolidate and eventually to retire the public debt.
Debt in the United States is presently (1985)
increasing at the annual rate of 14%. Most of this inordinate increase can be
accounted for by the high rate of interest, far in excess of the productivity
of labor and capital. Interest payable on the debt
must be created out of nothing, to keep the game of musical chairs moving. But
the merry-go-round must stop sooner or later. The solution to the problem of
debt is to bring down the rate of interest at once to the level of the productivity
of labor and capital in this country. That part of
the debt that can be serviced at the lower interest rate will be
consolidated; the rest must be written off. Then creditors in the future will
think twice before they lend to the government and businesses which bank on
new credits to meet interest payments on old debts.
Antal E. Fekete
September, 2005
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