Analysis by Keith Rankin.
I recently encountered the concept “pay it forward”, with reference to a debt. While it was in a personal context that I came across this concept, on reflection I am wondering why – as a follower of news media – I have never heard the concept in any current affairs discussion. There is so much hand-wringing about debt – especially government debt – yet so little useful commentary.
In its most simple sense, paying a debt forward is to repay a debt to a third party, and not to the original creditor. In a particularly important sense, however, it is the idea of paying to the future rather than paying back to extinguish a past contract. Thus a generation, raised by its previous two generations, in turn raises the next two generations. We are in debt to our parents (and grandparents) – our specific parents and our parents’ generation – and we pay that debt forward by raising our children and our children’s generation. We also service that debt by enabling our parents’ generation to enjoy the latter part of their lives free from the requirement to be in paid work until they die; and our children service their debt to us in the same way.
By thinking of our existence as a form of debt, we find ourselves under some obligation to lead good lives; good lives which can be understood as including both debt servicing and paying our existential debt forward by reproducing ourselves.
Further, we can extend that thinking back in time to our ‘origin myths’ – eg Adam and Eve, or Ranginui and Papatūānuku. And back further, to the beginning of the universe. ‘God’ becomes the original creditor. (See my Existential Concerns.) Human existence (and other life) is a perpetual process of paying debts forward, until a critical mass of people reneges on that demographic contract.
Personal Debt versus Existential Debt
We can think of debts as sitting on a spectrum, with life-creating existential debts at one end, and simple personal debts at the other end. In the middle are bank debts.
The best example that I can make of a simple personal debt is the situation where two colleagues each want to buy a car, but each only has $10,000 and a car has a $20,000 price tag. So, one friend (Jan) lends $10,000 to the other (May), who goes ahead and buys a car. Each expects to save $11,000 in the next five years. They make a contract that, in five years time, May will pay Jan $11,000, and Jan will use the $11,000 plus her savings to buy a $22,000 car. Each of Jan and May gets something (a car) and gives up something. May gives up the opportunity to buy a better car, and Jan has to wait to buy her car. In the contract, Jan is the creditor and May is the debtor. May services her debt ($1,000 interest) and pays back the debt ($10,000 principal). There is no question that there is a debt contract which involves ‘paying back the debt’, and the whole matter is settled – ie extinguished – once the debt is repaid and both Jan and May have their cars. In this example, there is a clear and unambiguous relationship between creditor and debtor; and the debt contract is terminated by the creditor making her delayed purchase.
Most of the financial debts that most of us participate in involve financial intermediaries, with ‘banks’ being the most familiar and important type of intermediary. Thus, a person who makes a bank deposit is a creditor, and a person who takes out a bank loan (which could be a credit card purchase) is a debtor. Further banks create new debts, through double-entry bookkeeping, enabling their collective balance sheets to expand. These new debts become new deposits, which, when spent, continue to be deposits – albeit deposits owned by someone else. The depositors are creditors of the banks, and the borrowers are debtors of the banks. Debts are assets of the banks. A person who becomes a net creditor runs a financial surplus, and a person who becomes a net debtor runs a deficit. (A person paying back debt is also running a surplus, and a person withdrawing deposits is also running a deficit.) The sum of all surpluses must equal the sum of all deficits; that’s called an ‘accounting identity’. Public deficits necessarily mean private surpluses, and vice versa.
When a person (say, debtor A) repays a debt to a bank, to debtor A it’s a personal debt paid back; but to the bank, that debt is existential. Banks’ responsibility to their shareholders is to maintain or preferably expand their balance sheets; not to allow them to contract or extinguish. Thus, the last thing that banks want is for their assets to disappear. Too much contraction of a bank’s balance sheet would mean the end of the bank’s’ existence.
So, when a loan is repaid by debtor A, a bank must find a new debtor (debtor B) to replace debtor A. The net effect is that the debt of A is paid forward to B; and then B will pay their debt, via the bank, to debtor C; and so on. In this sense, the bank acts as a facilitator in the paying forward process. This is a good process so long as that chain of forward debt contributes to the economy, and does not feed into a process of speculation in financial or property assets.
The banks – necessarily – expand their balance sheets by creating new debts, and prevent their balance sheets from contracting by facilitating the paying forward of existing debts that, from the point of view of borrowers, are being paid back.
The Reserve Bank and Government Debt
The Reserve Bank is essentially the banks’ bank; it can also be the government’s bank. The key assets of the Reserve Bank are the existential debts that constitute a country’s monetary system; thus the Reserve Bank acts to make sure that the banking system is creating new debts – including government debts – at a sufficient pace to support an equitable and sustainable economy.
The Reserve Bank is officially indifferent as to whether bank debt supports private sector business investment spending, government spending, or household spending on newly produced goods and services. Each of these forms of spending constitutes the economy. In times of recession – or near recession – the Reserve bank understands the accentuated need to support government spending and household spending as means to raise business confidence. In non-recessionary times, when business confidence is high, then the Reserve Bank expects banks to be lending in large part to private sector businesses in the economy.
In the years from 2010 to 2016, the New Zealand economy was for the most part in near recessionary conditions. In 2020 it has been in recession. Thus, in the eight mentioned years, the focus should have been for the banking system to expand government debt and consumer debt, with consumer debt including mortgages to support the building and upgrading of houses. Instead, what we found for these years is far too much debt going to the wrong places; in particular into the speculative purchase of existing assets, with the residential land market and the sharemarket being the most obvious examples of this misallocated debt.
In the years from 2011 to 2014, the government – by its own misguided choice – borrowed and spent far too little, meaning that far too much bank lending was deflected into the wrong places. In the years from 2015 to 2017, the government repaid debt – debt that was subsequently paid forward into the property market – while it should have been borrowing more and addressing the issues of inequality and poverty. From 2018 to 2019, while the New Zealand was close to full employment, interest rates had to stay low to maintain this; the government could have taken better advantage of these low rates. The governments – whether National-led or Labour-led – saw themselves as equivalent to personal debtors, having to pay back debt in the same way that May had to pay back the debt she incurred to buy her car. Governments are notoriously insensitive to interest rates; for them, low debt is a misplaced moral imperative.
So the governments repaid debt, and the banks paid that debt forward into the residential land market and into the sharemarket. The net effect was that – by repaying its ‘personal’ debt rather than addressing the problems that governments are expected to address – the government paid much of its debt forward into speculative markets.
In 2020 this unintentional funnelling of debt into secondary (speculative) markets is very clear. The Reserve Bank is injecting massive new amounts of existential debt into the banking system in order to support the Covid19 recessionary economy. The absolute priority is that this new money gets into the hands of governments, and needy households. As Keynes showed in the 1930s, by far the most effective means of getting new money where it is needed is through large deficits in governments’ Budget.
If the newly created debt does not get into the right hands, then it gets into the wrong hands. That’s double jeopardy. Not only are the needy missing out, but the greedy are getting it instead, and speculating with it, on residential land and shares. By not taking on as much debt as it should, the government is fast-tracking the paying forward of debt into the property market.
Monetary policy is not just about the quantity of existential debt required to support the economy; it is also about the service price – the interest rate – on that debt. Thus, in the ‘raining’ 2020 environment, in order to have the amount of existential debt that economies need, existential debt is available at record-low interest rates. New spending is induced by cheap consumer debt, and by discouraging people from holding money in term deposits and savings accounts; to spend their erstwhile ‘rainy day’ money on goods and services. We see this in a number of ways, ranging from home improvements, domestic travel, and such things as laser eye surgery. Monetary policy is about induced spending. Governments, unlike rational households and businesses, are unresponsive to monetary policy; they confuse personal debt with existential debt.
Three Rooms – Three Doors
We can imagine this situation. The Reserve Bank creates new existential debt. That debt can flow into any of three ‘rooms’: government; business; financial speculation (the financial ‘casino’, if you will).
A recessionary environment is an environment of private economic caution. Thus, the ‘business confidence’ door to the business room is at best ajar in a recession. A recessionary environment is when the government door should be wide open to compensate for the ajar business door; instead, the government door is also ajar and with tight springs holding it in that nearly closed position. The result is that the debt being pushed towards the business and government doors is deflected towards the third speculative door, into financial and property assets.
The solution is conceptually simple. In a recessionary environment, the government should open its door, both because of the unmet needs that can be easily resourced, and in order to keep that debt from flooding into the financial markets. The government should not pretend that its debt is equivalent to personal debt. It should understand that, from a wider economy point of view, it is dealing with existential debt. If governments do not spend the Reserve Bank’s existential debt, then that debt will circulate elsewhere – eg raising house prices and house rents to increasingly unaffordable levels – or it will become inert, creating economic inertia or collapse.
The Banks have to push to avoid this inertia, especially the Reserve Bank. Governments need to open their doors, so that the debts created by the banks’ flow into where they are needed, and do not flow to where they are not needed. The consequences of governments committing financial suicide – by not spending what they are required to spend – are dystopic.
Some say that the Reserve Banks try too hard because they err in favour of doing too much rather than too little, to get their countries’ economies moving. Maybe. But they shouldn’t have to push so hard against obstinate governments.
Human Sacrifice
In ancient times, people understood that they were in debt to the Gods. When things went wrong, they performed sacrificial rituals to pay back some of that debt. Some societies practiced sacrifices routinely, as insurance against things going wrong. These practices didn’t work, though – through coincidental timing – they sometimes appeared to work. This approach to debt led to perpetual underachievement.
We still have human sacrifices today, albeit the sacrifices of neglect and bureaucracy. We see far too many people, in New Zealand, subject to oral health disasters because of the ‘financial risk’ of addressing these issues. We see people with untreated cancer (and delayed treatment) and other life-threatening and painful conditions because of the ‘financial costs’ of timely diagnosis and treatment. We have become familiar with seeing people unnecessarily living in appalling housing conditions, or homeless, due to government perceptions that it is financially inconvenient to address these problems. We would rather have another ‘great depression’ and/or rows of near-empty million-plus dollar residential properties, than address these problems. If that’s not human sacrifice, I do not know what is.
Paying the Debt Forward
There are two ways that governments can pay their debts.
They can pay back their debts to the banking system, obliging the banking system to pay forward these debts, either into the private economy (a good thing in principle, though not always in practice) or into the speculative markets (a bad thing). In the latter case, the lives of future generations are undermined, as diminishing numbers of people gain control over the world’s resources. This is what happens, but should not.
Or governments can take a more worldly view, by understanding that our economies are underpinned by existential debt. Thus governments can choose to spend that debt, by investing in their countries’ futures; that’s what paying forward is really about, in spirit. We invest in the future by spending the debt – not extinguishing it – and we service existential debt by leading good lives (and paying the interest!). Public debt should be perpetually rolled forward, growing in recessionary times.
Rolling back the banking system debt – or governments refusing to participate in an economically rational way – is one route to existential disaster. Existential financial debt underpins our economic existence. To sustain future generations, we pay existential debt forward, not back.
