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Business Bytes

Polonius erred; a borrower, please be

First the modern world eliminated debtors’ prison, making prison more a state of mind.  But with any number of people coming to collect and settle debts, prison might have been kinder: serving time in lieu of searching desperately under the mattress ad infinitum.

The drama of financial crises and fiscal cliffs has obscured a defining fact of modern life: debt is valuable.  Once we understand such a concept, the usual thinking about savings and borrowing seems more based on conservative rhetoric and Shakespearean one-liners (neither a borrower nor a lender be) than empirical reasoning.

Let’s begin with the most timely of topics: government debt.  The United States has been in substantial debt before and will be in substantial debt again.  Throughout the years, about the 1770’s to the present day, other people, mostly other governments, have loaned the United States money.  This practice stands in sharp contrast to the zero-sum mercantilist system, which based a country’s wealth on it store of gold.  This system motivated governments to keep gold within country borders thereby minimizing trade and stymieing finance.  If you won’t even give up your gold for a guaranteed good today it’s unlikely you’ll give up gold for the potential to get it back (plus a little more) on some future date.

It would be tempting to think that a post-mercantilist world is a kinder, gentler place to be.  Hardly.  People give up money because they expect to benefit from an exchange, the difference is the understanding that both parties can benefit.  France loaned the United States money to fund a revolution to weaken British interests.  Fast forward to the past several years, with the Treasury issuing what some have termed “massive” amounts of debt and people saying things like, “this can’t go on; we can’t keep living beyond our means.”  They would be correct if people stopped buying US debt.

So why do people buy our debt? Is it leftover colonial strategizing? Certainly not because the United States offers a great return, with interest rates at historical lows. But because in this time of elevated uncertainty people want a safe place to put their money; US debt is considered a safe place.  This means that people want to buy US debt and so the US can continue to supply debt on its own, very favorable terms.

The American consumer is hardly as reliable as the American government at paying bills.  Why then are there so many institutions willing to loan people money to the consumer on such a cheap basis?  Before we jump to the obvious MBS (mortgage-backed securities), consider the humble credit card.  Credit cards function as short-term consumer loans: a much more secure , efficient way of, as they said in the old days of the general store “buying on credit.”  Allowing people to go into debt, on however long a basis, is profitable for multiple players:merchants can make a sale they might otherwise lose and the simple fact that the credit card industry has several major and minor players and is a multi-billion dollar industry suggests substantial value ready for extraction. Then, for the really big things like cars, an education, a home, there are any number of loans, which people find value in by bundling the loans together and labeling them as an asset or selling them to others who value them.

This is not to say that saving has no value or that people should not save.  Rather that the simple act of saving does not stand up to the assumption that it is always a virtue.  Really, saving and loaning money are two sides of the same identity: loans come from a supply of money.  Just as you miss 100% of the shots you don’t take,in macroeconomic terms, money means nothing if it doesn’t move.  Indefinite or infinite saving may provide peace of mind, but most people not suffering from a Scrooge mentality save to spend later

Most people save not to supply the macroeconomy with funds for investment but for their own retirement or due to a reactive fear of the future.  The former is highly sensible if a person does not wish to work until death.  The latter, though, is inconsistent with past history.  While no one knows the future, “path dependence” is a standard term for good reason: once behaviors and institutions are established they tend to stick around for a while.  It seems highly unlikely that current modes of lending will simply disappear and all anyone can spend will depend on what they make or what they saved.  There is simply too much value to be had.

In a way, those investors seeking value are indebted to the country’s debtors.



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