Saturday, August 06, 2011

Why is debt breaking the world economy?

Even the most complex problems have simplicity at their heart.

The world economy looks as if it is about to collapse under its weight of debt.

193 out of 198 countries are in debt.  (Source - CIA)
Here is the same list on Wikipedia, kindly arranged so you can play around with the list per capita and as % of GDP.

From this, we learn that the debt is not owed by one country to another (otherwise it would be 50/50, wouldn't it?). The debt is owed by 193/198 countries to the banksters.

This is all down to the way money is created. Make no mistake, money is being created. World money supply is increasing. It had a doubling time of 10 years in the last decade of the 20th century. Which means that someone is creating new money. That someone is the banks, who make the vast majority of new money. (Governments get to make a tiny amount of new money as notes and coins: in the UK that is 3% of the total).
Banks create money by issuing loans, in the following way:
    1. They issue money to the borrower's account, and sets up an equal and opposite sum in their own accounts.
    2. The borrower goes away and earns (in the real economy) money to pay off first the interest on her loan, and then the original capital sum. 
    3. When the capital sum is finally paid off, the two accounts cancel each other out.
    4. In this process, the bank has acquired an extra amount of money, the interest, which varies with the terms of the loan. For example, a straight loan of $10,000 at 5% over 10 years will earn interest of $2,728.
    5. That $2,728 has gone from the real economy into the bank.
    6. Either the real economy has lost $2,728 to the bank, or other people have borrowed it from banks, creating more debt. 
    7. If it had been withdrawn from the economy, it would be deflating, which it isn't (generally). Therefore it is being borrowed, repeating the whole cycle.
    8. Therefore all money in the economy has its origins in debt - the capital sums borrowed (which will be annihilated when repaid) and the interest, which represents other monies borrowed into existence.
    9. Therefore debt increases inexorably in the system, until a critical point is reached when it is realised that debt becomes unpayable.
    The whole economic system is based on debt. We are in a vicious circle, working to pay off debt. If money is growing, debt must grow. Money has grown, debt has grown, and now it is crunch time.

    Clearly, this is a vast oversimplification. There are a multitude of other factors at work, but this is the logical and necessary core of the problem, despite all the obfuscation that will no doubt ensue in the comments below.

    I hope that helps. 

    My advice: dig up your lawn and plant vegetables. 


    David Cox said...

    There is of course another way of ‘creating money’ - the Swiss created an alternative currency to keep small companies afloat during the 1930s recession, is still thriving as three-quarters of a centaury later. The WIR (WIR derived from the word "wirtschaftsring", or "economic circle". Wir is also the German word for "we", signifying togetherness and solidarity) was launched in Zurich in October 1934 as thousands of small and medium-sized enterprises (SMEs) struggled to cope with the consequences of the great global depression. Cash was hard to come by as stock markets crashed, banks collapsed and people with money hoarded their reserves. The WIR bank is a not for profit bank. It serves the interest of the clients, not the bank itself. It is a very stable system, not prone to failure as the current banking system is. It remains fully operational even in times of general economic crisis. WIR may have contributed to the remarkable stability of the Swiss economy, as it dampens downturns in the business cycle.

    Vince Cable is calling for more quantive easing, if this were done this through a WIR type bank it could help the UK weather the storm and fund the green transformation of our energy generation and economy - which is now not just an environmental imperative, but a strategic and economic necessity.

    faeraemae said...

    Sounds like a plan David, per'aps you could 'suggest' this to Vince.

    I, myself, although rather bereft of funds, just for devilment, loaned a small amount to a company that lends it to someone else and I share the interest. I don't know if this is the same sort of thing as the WIR?

    I, too, am looking forward to the 'Green Revolution'!

    Stuart Jeffery said...

    Hi Richard, I think you might be better off looking at balance of payments rather than just debt.

    DocRichard said...

    Hi David ((or should that be Your Mayoralness?)

    Good to hear from you again, and delighted to learn that you too understand that there is more than one way to generate money.

    Hmm. What zacly would we be asking Vince to do? WIR was a collective, with no scrip. I'm open to suggestions, but given the glutinous slowness of the speed at which Govt can move, would it not be better to press him to a more modest goal, like requiring that QE2 should be passed (mainly) though the Green Investment Bank?

    Welcome! Thanks for following. I had no idea. I suspect that you are doing WIR, in essence. Though since we are discussing finance, another might come along and say the opposite.

    Hi Stuart
    Long time no see.
    I know. Balance of payments (ratio of imports and exports) in UK is not good. We import too much. Which is one of the unsung virtues of the Green New Deal - by cutting imported energy. Though I may be wrong there, because gas is needed to back up renewables, sadly.

    This is the thing about economics - it is such a huge system. I cannot believe there are not computer models available for economics, as there are for climate science.

    Anyway, I didn't look at balance of payments because I am trying to explain how increase in debt is inextricably intertwined with increase in money supply.

    David Cox said...

    Yes Doc, I'd agree QE should go into the Green Investment Bank - the conventional banking sector will simply horde the money. You might be interested in this from the NEF’s David Boyle.