Coming to Terms with Debt

If American conservatism can come to terms with the meaning of debt, it will represent a nearly unprecedented intellectual triumph.[1]

Given the extent of economic misunderstanding among vast swathes of the populace – both professional and lay – this introduction to investment has first dealt with basic economic principles.  This is because such a lack of understanding must first be rectified before proper decision-making can even begin to take place.

Nevertheless, a feeling of unease may remain, at least if one accepts the framework of understanding I have laid out in this book. It rubs against the grain of human understanding that our entire economic system is built upon what many consider sand – credit and debt – rather than bedrock – pay-as-you-go solvency. It seems to fly in the face of sound economics that so much economic activity depends precisely upon the willingness to incur debt and to obligate oneself to others. This kind of voluntary dependence, while ubiquitous in our society, nevertheless seems to us to partake of the character of a necessary evil. It is not how we would choose to live if we could. The ideal seems to be financial independence in the sense of no debt, no obligation, <98> no commitment to meet any requirement laid upon us by another, voluntarily or no.

But, if we think more clearly on the subject, it becomes clear that such an ideal is unattainable, or if attainable, only so at the cost of social life. It is an autarkic ideal that the debtless life embodies, self-sufficient, yet self-absorbed, “idiotic” in the literal sense of the word.[2]

The discussion above has made clear that credit/debt relations are the warp and woof of a pluralistic associationalist society, the society of freedom. Mutual obligation is what credit and debt embody; the capacity to engage in credit/debt relations is what enables freedom.

Thus, the society of freedom is one in which credit and debt has shed the stigma it has in solidary, communitarian societies. This capitalist form of social order distinguishes itself from other forms of social order precisely in its attitude towards debt, as Stadermann highlights:

In other forms of organization, indebtedness came in question only as a result of economic failure; it was quite likely that with the thus reduced resources of the debtor, a happy ending was only seldom the outcome. Rather, indebtedness was a signal of decline, and the threat of bonded labor or slavery was the more likely consequence than proper debt relief. It was, so to speak, the first step toward the loss of economic independence. In the money economy, debt normally does not serve to <99> stave off an acute emergency situation such as a failed harvest: the necessitous demander of credit typically cannot get any. Credit for investment serves as the foundation of economic growth. Interest is to be generated from its proceeds and not paid out of the substance. Credit for consumption processes likewise ought to have as its foundation a sufficient growth of the income of the credit demander in future, from which then the interest obligation in the normal case can be paid.[3]

This is a fundamental reorientation of social life. Behind it is the shift in the kind of debt obligation the society is based upon: the unreleasable versus the releasable debt (see p. 18 above). Debt is an inescapable phenomenon in society. The question is: shall it serve to enslave the debtor, or to empower him? Steuart’s pithy summation can best serve to illuminate the difference: “From these principles it appears, that slavery in former times had the same effect in peopling the world that trade and industry have now. Men were then forced to labour because they were slaves to others; men are now forced to labour because they are slaves to their own wants.”[4] Being slaves to their own wants is the same as being free with respect to others. One’s own wants are not the imperious master that another person is. At least there is the hope of taming them, but one has nothing to say to him.

It is by such an understanding that time becomes integrated into economic theory. Economics has hitherto been such a failure to guide practice because it has refused to recognize that the addition of time to its calculations entails the recognition of <100> the pivotal role of credit and debt relations. Not wishing to recognize this, it has had recourse to timeless abstractions that do nothing to guide decision-making.

In the prologue I spoke of a lonely Peace Corps volunteer living in his hut in Paraguay, pondering the vagaries of development and economics. One of the books which then fired my imagination was George Gilder’s Wealth and Poverty. I bought my copy, a translation in Spanish – Riqueza y Pobreza – at a market in Asunción – testimony to the already burgeoning demand for grassroots free-market alternatives in the developing world. I realized how important Gilder’s arguments were, but there was something in them that I could not come to terms with, and that was his defense of inflation and deficit spending. I was one of those conservatives who needed to come to terms with the meaning of debt. Gilder did not accomplish that, but the job has since been done, at least to my satisfaction, as witness common-law economics.

I have since returned to that book, and can now appreciate the argument all the more. Gilder did not fully grasp the nature and origin of money. What economist has? But that does not lessen the achievement the book constitutes. In fact, when one realizes that his argument is fundamentally sound despite this crippling shortcoming, one becomes even more impressed by the “imperatives of growth” he so eloquently urged.[5]

Gilder highlights Jane Jacobs’ dictum that the “crucial and definitive conflict” in every economy

is not the split between capitalists and workers, technocrats and humanists, government and business, liberals <101> and conservatives, or rich and poor. All these divisions are partial and distorted reflections of the deeper conflict: the struggle between past and future, between the existing configuration of industries and the industries that will someday replace them. It is a conflict between established factories, technologies, formations of capital, and the ventures that may soon make them worthless – ventures that today may not even exist; that today may flicker only as ideas, or tiny companies, or obscure research projects, or fierce but penniless ambitions; that today are unidentifiable and incalculable from above, but which, in time, in a progresing [sic] economy, must rise up if growth is to occur (p. 249).

It is a conflict with regard to time, to the future, to uncertainty. The role of government, seen from this perspective, too often becomes that of protecting vested interests against the threat of the competition of new ideas, processes, ways of doing business or pleasure. What planning accomplishes is not planning, but restriction to what already exists and the redistribution thereof. “Socialist and totalitarian governments are doomed to support the past. Because creativity is unpredictable, it is also uncontrollable. If the politicians want to have central planning and command, they cannot have dynamism and life. A managed economy is almost by definition a barren one, which can progress only by borrowing or stealing from abroad” (p. 251). And what regulation accomplishes (too often) is the protection of those companies, already well-established in their fields, who are <102>thereby insured against being displaced, the regulatory regime being geared to their requirements.

Detailed systems of regulation understandably tend to favor the products and patterns of behavior that have been adjusted to the rules – the “good” companies that can be easily understood and supervised by the existing expertise of the incumbent regulators. Innovation always has unpredictable and possibly dangerous results. In early stages, it is always uncertain, inefficient, and if it is based on new scientific findings, even inscrutable. Any fail-safe system of regulation to prevent environmental damage, work-place hazards, and every possible peril to consumers would never have permitted the launching of an airplane, let alone an industrial revolution. Regulators must always rely on existing knowledge, commanded by existing scientific disciplines and their leading proponents (p. 252).

Hence, “excessive regulation to save us from risks will create the greatest danger of all: a stagnant society in a changing world. The choice is not between comfortable equilibrium and reckless progress. It is between random deterioration by time and change and creative destruction by human genius. Our current regulatory apparatus is in danger of becoming an enemy of creative destruction” (pp. 252-253).

Economic theory is the bastion of the existing versus the potential, of the past versus the future. Because the past is measurable and the future is not, economics lives in the past. Time cannot be captured in its formulas, and therefore is abstracted from the equation.

In their preoccupation with inflation and deflation, the monetarists and Keynesians joined forces even as they fought. Pulling at the two ends of the quantity theory equation, MV = PT (money × velocity = prices × <103> transactions), they imagined that they were in an intellectual tug of minds in the central arena of economic thought. The monetarists clung to the money supply side (MV), while the Keynesians cleaved to aggregate demand (PT), but both schools were leaning on the same rope for analytic support, the same key formula of aggregates. For all the heat of their conflict, they were inexorably linked within the equation itself, and few noticed that the equation was peripheral to the most crucial matters of economics.

For Gilder, supply-side economics provided the way out of this impasse. For even though it lacked the quantitative prowess of existing economic theory, it recognized the qualitative factors that rendered quantitative measures nugatory.

The supply-side movement… by focusing on the processes of production and innovation, turns the equation inside out. Rather than stressing aggregate demand for goods and services, they stress the dynamic supply of new ones. Rather than emphasizing control over the supply of money, they emphasize the generation of demand for money through the production of goods: the supplies that create the need for a store of value and a medium of exchange. Rather than dwelling on the quantity of money, they stress the quality of it: its anticpated [sic] worth in goods and services, or in gold.

Thus, supply-side economics recognized the dynamic element of production and entrepreneurship, thus the connection of future expectations and money,  in creating economic growth. By contrast, conventional economics focuses on the optimal distri <104> bution of that which already exists, using quantitative measures such as aggregate demand and money supply.

But money is not so much a measure of that which exists but rather that which will come into existence. It is, as we noticed (see p. 15 above), an instrument by which time is made calculable.

The desirability of holding money, after all, depends most fundamentally on acts of savings and investment that will provide new objects for purchase in the future. No monetary policy can stop people from bidding up the real prices of a declining store of goods in an economy that is running down or that has lost its faith in the future.

The long-run answer to the Keynesian concern with aggregate demand is not a concern with the money supply, which is merely another facet of aggregate demand. The answer is an unremitting cultivation of the supply of new goods – the sources of creativity and expectation that create the demand for money. The key equation of economics is between long-run innovation and growth and long-run monetary quality.

The focus on inflation, especially in the 1970s, at the tail-end of which Wealth and Poverty was originally written, led many to embrace the monetarist prescription of clamping down on money supply growth. But Gilder correctly noted that it was not inflation per se which was the problem, but what accompanied it, what in a sense induced it. Inflation in its late-1970s form was merely a symptom.

The fundamental problem of the U.S. economy is not inflation. It is collapsing productivity caused by de <105> clines in innovation and research, by a diversion of resources to real estate and collectibles, by steady expan- sion of the burden of government on every productive worker, by stagnant and misdirected business investment, by a booming tax-free underground economy of little long-run ability to generate technical progress, by the increasing age and obsolescence of plant and equipment, and by a 40 percent slowdown since 1973 in the rate of growth of capital stock per unit of labor. All these problems are either caused or made much worse by a perverse and destructive pattern of taxation.

Inflation at current levels is significant chiefly as it reflects and intensifies the burden of government spending on productivity. It is only when productivity is flat – when new wealth is not being created – that taxes cut ever more deeply into the incomes of the people. It is only then that the normal struggles of citizens for advancement result in an inflationary spiral of claims on a stagnant pool of goods and services. What matters, once again, is the supply side – expanding and improving the pool of products by promoting new opportunities, rather than propping up old auto companies and hyping the market for existing land and housing (pp. 231-232).

The corollary to the misunderstanding of inflation is the misunderstanding of debt. Gilder cites at length Thomas Babington Macauley’s History of England with regard to the growth of England’s public debt – something which, it had been confidently predicted, would lead to national bankruptcy, but which, with every prediction of gloom, had nevertheless been accompanied by ever-expanding wealth and progress. Which leads Gilder to make the revolutionary (yet rather mundane when one gets down to it) claim that debt in itself is not a bad thing – <106> rather, it is the purpose for which debt is incurred that determines whether it is a bad thing.

Debt that is wantonly monetized or accompanied by chaos, as during the French revolutionary era, or debt that is prodigally incurred in order to destroy the unit of account of other debt, as in Weimar Germany, can bring ruin. Debt such as that in America, which is piled up to finance programs paying people not to work, combined with penalties on business for being profitable, can destroy an economy. But debt that is incurred for capital projects of benefit to citizens and their productivity, or debt that is incurred to avoid inflicting destructive taxes on growing firms – such liabilities can become vital assets of growth and progress. The worst economic disaster is to blight the future by suppressing the catalytic ventures on the economic frontier (pp. 243-244).

The point of incurring debt in a capitalist economy is to make more of a profit than one will have to pay in interest. This is the universal underlying motive force that capitalism establishes (see p. 98 above). It is the transformation of time into wealth.

In an expanding economy money available now for investment is many times more valuable than money paid later in interest or payments diffused through the economy in higher prices. To the enterprising capitalist the future always promises more abundance than today. Only in a static, uncreative economy does it pay to pay as you go. Only within the cramped horizons of zero-sum budgeting (where every gain for one man must mean a loss for another) and linear or homogeneous time (where money does not grow in value as it moves toward the <107> present), only in an abstract mathematical world can the burdens of debt seem crushing.

Budgeting in a growing capitalist economy is not zero-sum, and time is not linear. Money to be paid beyond a certain future point dissolves almost entirely; even in accounting, an annual payment of a hundred dollars forever has nearly the same value as a payment of a hundred dollars for twenty years. Time is capital in a growing system and dwarfs all debt (p. 244).

In the money economy, commercial debt is incurred to finance investment in order to make a profit in excess of interest payments. Otherwise it would not be incurred. And consumer debt is incurred because interest payments can be paid out of an income which is derived from the differential between profit and interest.

This is well-said and worth hearing. It is part of Gilder’s attempt to bring about that nearly unprecedented intellectual triumph, as he puts it, of having conservatism come to terms with debt. But supply-side economics lacked the proper foundations to pull off this feat. Witness Jude Wanniski, one of its founding theorists, who pleaded for a return to the gold standard.

Investment has to be investment in the future, in production, in opportunity, in improvement of life. Gilder’s admonitions that wealth creation is in the mind, and that the expansion of wealth is the expansion of opportunity, culture, and civilization, qualitatively at least as much as quantitatively, are nothing else than the further elucidation of the common-law order. This order is a product of the human spirit, an artifact, and not anything natural per se. It is not corporeal but incorporeal, not tangible but intangible, not bare goods and services but commitments on the basis of surety, the buying and selling of promises backed by physi <108> cal goods and services. These institutions are what make for a dynamic economy. Where they are combined with a self-reliant citizenry, there is where investment will yield an abundant return. And where these do not exist, investment is a barren exercise in preserving that which one has already obtained, a sordid attempt to hold at bay the forces of enervation and decay.

[From Investing in the New Normalch. 7]


[1]George Gilder, Wealth and Poverty (San Francisco: ICS Press, 1993 [1981]), pp. 241-242.

[2]This would seem to be to what Marx was referring when in the Communist Manifesto he spoke of dem Idiotismus des Landlebens (the idiocy of rural life). The word “idiot” derives from the Greek idios, meaning that which is private, one’s own, implying self-absorbed isolation.

[3]Stadermann, Nominalökonomik, pp. 93-94.

[4]Steuart, Book I, ch. VII.

[5]“The Imperatives of Growth,” ch. 18 of Wealth and Poverty.