America Is Purple

With all the talk of national debt and deficit spending lately, I can’t help be reminded of the awful truth of the American economy: The economy runs on debt, or as it’s called by the savvy marketing types: credit.  If everyone were to pay off their student loans, mortgages, car loans, and credit cards the American economy would collapse.  While it is good for individuals to pay off loans quickly to be in a better financial position for the long term each dollar that you pay back on the principle of your loan shrinks the economy.  What the hell am I talking about, you ask?  Leverage.

If I went to the bank tomorrow and was granted a loan to buy a house, a mortgage, the bank would give me many thousands of dollars in bank credit to go out and purchase a house.  They are not giving me actual money that they have in the vault.  In fact, for each dollar they have in the vault they may have loaned out 10 or 20 dollars.  Our government allows banks to give out bank credit in the form of US Currency.  This means, that when I get a loan, the bank is conjuring into existence money.  It is theoretical, ephemeral money but I will pay that money to the home owner who will likely take that money and put it towards a new house.  An actual monetary transaction will have occurred but with money the bank created this morning!  And the more that banks do this, the more money is flowing in the system.  This is what was happening in the years leading up to 2008 and the crash.

Leverage is the ratio of actual money to credit that a bank has.  If a bank has one dollar and they loan out 9 dollars, they are said to be leveraged at 9:1.  If instead, they loan out 30 dollars and they have 1 dollar, the are leveraged at 30:1.  Where this becomes a problem is if someone is unable to pay back the money.  If I have $10 and give three people an IOU for $10, I’m fine until more than one of them tries to collect at a time.  If a bank has given 30 people $100,000 mortgages based on them having $100,000 on hand, they’re screwed if more than one person is unable to pay them back.  During the real estate bubble, banks thought nothing of giving nearly anyone a mortgage loan because the value of the property would likely increase and even if the borrower couldn’t pay back the loan, the bank would be able to seize the house and sell it for a profit.  Once the bubble burst and they were no longer able to sell the house at a profit, or possibly even at all, the whole house of cards came close to collapsing.  All that ephemeral bank credit in the form of US Currency went poof, and the economy contracted.  The result was less less money in the system.

Which brings us to the United States National Debt.  While deficit spending and increased national debt are a problem, having less money in the system (banks are wary of giving credit to people after getting burned) is more of a problem.  While many people liken the US Government to a family that has to tighten the belt and balance the checkbook, the US is in actuality more like a business.  Many businesses run on credit.  Many were hurt badly or were closed down when they were no longer able to get credit to make payroll.  The US Government runs on credit as well.  Aside from a brief couple years in the 1830’s when we paid it off, the nation has always been in debt.  (Oddly enough for those who think the national debt is purely evil, after Andrew Jackson paid off the national debt the country entered a huge recession.)

While skyrocketing national debt is worrisome, so long as we can afford the interest payments, debt on a national level is not as horrifying as many would have us believe.  Again, we’ve been in debt since 1836 and the country hasn’t imploded yet.  The debt allows us to add currency to the economy without as much risk of inflation.  The government could simply print more money, conjure it into existence much like the banks do, but without the value that comes from having to pay it back, it would cause the currency as a whole to drop in value, diluting the value of the dollar.  This is important because unlike the banks which have $1 to back the several dollars they loan out, the currency of the United States is backed only by the good faith of the American Government.  Comforting, I’m sure to those who have no faith in the American Government.

And to the idea of balancing the nation’s checkbook, there are two ways to reduce deficits just as there are two ways to pay off debt in your household.  You can cut your spending on everything else, subsist on Ramen and put all your money into paying off your debt.  It isn’t a pleasant way to live, but may pay off long-term.  The other way you may have little control over, but it’s to increase your income.  Get a better paying job, or a second (or third) one.  In the Government’s case, this would involve raising taxes.  Those who are hell-bent on reducing the national debt never seem to be open to this idea, for some odd reason or other.  (It also seems strange that I didn’t hear a peep out of them about the deficit spending and increased national debt during the Bush administration, but that’s another post.)  And there’s no reason you can’t do both.  Cut unimportant programs and remove tax cuts.  It’d be wildly unpopular, but if you’re truly in favor of reducing the national debt, that’d be the way to go.  Of course, in so doing  you would be removing 13 trillion dollars from the nations economy.  I imagine with money being scarce enough as it is, we may want to rethink that plan until the banks are once again in the conjuring mood.  Perhaps once we have some regulation in place to make sure they don’t go too crazy with it again.