Conflict between creditors and debtors is almost as old as money itself. John Taylor, an early nineteenth-century American thinker, said that the banking industry 'divides the nations into two groups, creditors and debtors, and fills each with malignity towards the other'. One can see all of economic history through this prism – a battle between those who lend money and those who borrow it. The former want to be paid back with interest in sound money; in times of crisis, the debtors cannot afford to do so.
History suggests that periods of growing economic activity are accompanied by an expansion of the money supply and a widening of the definition of money. Confidence is high because trade and incomes are growing. Businesses are happy to accept the extra money, often in the form of debt – extending credit to customers, for example. Then something happens to shatter confidence and the definition of acceptable money narrows, which means that the willingness to extend credit declines.
In the twentieth century, each successive economic cycle tended to end with more debt being added. In 1981, Ronald Reagan managed to persuade some Republican Congressmen, rather against their will, to vote in favour of an increase in the government debt ceiling beyond $1 trillion, or one with twelve zeroes after it. It was assumed that a conservative President, who referred to government as the problem, would bring the deficit down. By the end of Reagan's time in office in 1989, the debt was $2.6 trillion.
That sum inspired a property developer named Seymour Durst to set up a debt clock in New York's Times Square to highlight the growing debt burden. By 2008, the clock had to be refurbished to add an extra digit because the debt total had reached $10 trillion. Just three years later, debt reached the previously agreed ceiling of $14.3 trillion, thanks to the massive fiscal deficits that followed the 2008–09 recession. This additional debt was more than the amount that originally alarmed Seymour Durst; indeed more debt than the US had accumulated in its first 212 years of existence.
The headline totals of government debt are only part of the picture. Politicians have also made promises to fund the retirements of ageing workers, in both the private and public sectors, to meet the cost of healthcare for the elderly and to guarantee the debts of banks and other companies. Beyond the obligations of the government, debt has also been accumulated by consumers on their mortgages and credit cards, by companies seeking to expand and by banks, seeking to speculate in the financial markets.
As these debts become due, rich creditors will be pitted against poor debtors; private-sector taxpayers against public-sector workers, young workers against the retired, domestic voters against foreign bondholders. It is impossible to forecast who will win each of these battles but one thing seems certain: not all these debts will be paid in full.
The crisis has also resulted in a debate about how to control the supply of money. In the 1970s, when money lost its link with gold, the result was much higher inflation; some thought we were heading for ruin. But the period of rapid money expansion since 1971 has also been accompanied by significant economic growth and the spread of capitalism to large parts of the ex-communist world. If these two developments are related (and it is not clear that they are), people might regard this as an acceptable trade-off. After all, credit is essential to make a modern economy function. Without it, businesses would be unable to grow and create jobs. More sophisticated societies seem to develop more complex financial systems. Banks may be the subject of much public opprobrium, but without them modern life would become incredibly cumbersome. Imagine if every prospective homebuyer had to raise the finance from their friends and acquaintances, or if we had to haul bags of gold or silver every time we went on an overseas trip.
Nevertheless, the modern monetary system creates some inherent dilemmas. When does the amount of bank lending become excessive? When does the financial system become too complex for the good of the economy? It is hard to define the 'right' level but it seems clear it was breached at some point in the last twenty years.
From the book Paper Promises by Philip Coggan. Reprinted by arrangement with PublicAffairs (www.publicaffairsbooks.com), a member of the Perseus Books Group. Copyright 2012.