“There is simply too much debt in the world today.”
Jaime Caruana, General Manager, Bank for International Settlements
June 27, 2014
One year ago, when total global debt had reached its highest level in human history both in absolute terms ($199 trillion) and as percent of global output (286%), the Bank for International Settlements (BIS – the global economy’s central bank of central banks) concluded that “there is simply too much debt in the world today,” warning that the global economy is more vulnerable to collapse now than it was prior to the 2008 failure of Lehman Brothers.
Remarkably, the BIS had also warned as early as 2003 that the global debt of financial institutions and households was becoming “too much”, predicting that if not curbed it would lead to financial crisis. When BIS warnings went unheeded and the predicted crisis finally arrived in 2008, a complete meltdown of the global economy was barely avoided through massive new debt issuance when governments borrowed trillions to bail out private financial institutions.
The result has been that the original debt crisis of 2008 has grown to be a much greater menace to the world economy today. The size of the crisis has reduced the world’s private financial industry to an impotent dependent on government subsidies, as these taxpayer-funded subsidies to private financial institutions resulted in an explosion of government debt from $33 trillion in the beginning of 2008 to nearly $60 trillion today.
The world responded to the private debt crisis of 2008 with a tsunami of government indebtedness that has nearly doubled global sovereign debt, leaving governments enfeebled by over- indebtedness and weakened revenue raising capacity, unable to generate effective policies, and running out of time, money and legitimacy.
The colossal size of global debt makes today’s debt crisis a crisis of civilization. It is a crisis that can neither be understood nor addressed effectively without a comprehensive inquiry into the links between debt and civilization as these have unfolded from the dawn of history.
Civilization is a mode of understanding reality and conferring meaning upon human existence that emerged when cities – civitates in Latin – became the primary organizing hubs of human life and interaction. What made cities both possible and necessary was a certain threshold of division of labor whereby the levels of agricultural productivities required to support a certain population size depended not only on farm labor but also on specialized, full-time tool-making and administrative skills.
This level of division of labor requires transactions that can only be effected by means of payment advances via promissory notes, i.e., credit, and therefore debt. Debt and civilization have been tightly interwoven from the dawn of recorded history. In fact, the very first written historical records are the cuneiform debt instruments of Mesopotamia where civilization (and actual cities) first emerged.
Debt – i.e., promises to pay in the future – existed thousands of years before coined money was invented. Debt is much more ancient than money. Archaeologists have found thousands of debt instruments in clay tablet form that had been in existence in Mesopotamia dating back to the 3rd millennium BC, at least 2,000 years before the invention of coined money. These debt instruments record receivables akin to modern commercial paper and other intertemporal transactions that financed exchanges among rural food producers, urban tool makers and administrators (temple priests or royal officials acting as intermediaries) and long-distance traders. In fact, the art of writing was stimulated by the need to have recorded debt contracts, while the art of temple or palace administration consisted mostly of enforcing such contracts either via temple-enforced “sanctity” of contracts or through royal justice.
The interlinked blend of all these – division of labor, promissory notes, payment advances, writing and the religious or royal administrative centers to regulate them – is what we call urban life and civilization and they appear to have come into existence simultaneously.
Just as debt arose simultaneously with civilization, so did the problem of “too much debt.” Throughout history every time debt became “too much” momentous events followed that reset the course of human civilization. If the BIS assessment is accurate, beginning with the 2008 financial crisis humanity entered another momentous reset of its civilization.
The first-ever recorded instance of “too much debt” was in 2402 BC when, according to the royal inscription of King Enmetena of the Sumerian city-state of Lagash, the king of neighboring city-state of Umma owed him half a trillion liters of barley. As a consequence of his claim, King Enmetena went to war and conquered Umma. With the proceeds of his victory, Enmetena was then able to afford the cancellation of the debts owed to him by his own subjects.
Enmetena’s example of debt cancellation was formalized as a general practice seven centuries later in the Code of Hammurabi and formed the legal precedent of the biblical tradition of the Jubilee Year. Two grand traditions were thus established at the dawn of recorded history: war and debt forgiveness as alternate ways of dealing with the problem of “too much debt.”
More recent instances of “too much debt” prior to the current crisis include:
- The German war reparations debt imposed on Germany by the Versailles Treaty of 1919, whose consequence was the World War II – a seminal event in the history of human conflict.
- The debt incurred by the British government in the Seven Years’ War that led directly to the 1776 American Revolution – also a seminal event that launched a radically new political order in human affairs.
- The debt accumulated by the French monarchy that led directly to the 1789 French Revolution – a further seminal event.
- The debt of the Renaissance Popes (e.g. Medici Pope Leo X) to the Medici and Fugger banks, which inspired the sale of papal indulgences (collected by the creditor Medici and Fugger banks) and thus led directly to the Protestant Reformation of the 16th century – the pivotal cultural event that launched modernity.
- The Imperial Habsburg debt incurred by the social conflicts and wars of the Protestant Reformation, which led to the tax revolt in the Netherlands and the subsequent revolutionary financial innovations in Amsterdam and London – the formative event of economic resource organization that launched modern capitalism.
I believe that this thematic pair of “too much debt”/“seminal historic events” is a suitable conceptual framework for reflecting on the present condition of over indebtedness in which the global economy finds itself and about which the BIS has been warning.
But the question is: Just how much debt is too much?
The answer to this has varied throughout history as human civilization evolved. The faster the technology-dependent advances in the division of labor, the higher the yardstick of “too much debt.”
For example, French sovereign debt at 40% of GDP in 1789 was “too much” and led to the French revolution; but American revolutionary debt of 45% of GDP in 1790 was not “too much” and was used to finance the spectacular growth of the young American republic. Again, German war reparations debt at 55% of GDP in 1918 was “too much” and led to Nazism and the Second World War; but Great Britain’s sovereign debt at 200% of GDP at the end of the Napoleonic wars was not “too much” and in fact formed the financial basis for the global industrial revolution that followed. US federal debt at 118% of GDP at the end of the Second World War was not “too much” and provided the financial foundation for the astonishing postwar scientific and technological advances that ushered the post-industrial revolution.
This historical experience, whereby a debt burden of 40% or 55% of GDP is considered “too much” but a burden of 45% or 118% or 200% is not, clashes with the standard definition of “too much debt” espoused by the Bank for International Settlement.
According to the BIS, whether debt is “too much” or not depends on the type of debt and whether it serves economically beneficial purposes. In this view, the three main types of debt, i.e., household, government and corporate debt, result in economic benefit when
- Household debt is used for income smoothing, whereby young householders borrow to buy a house or finance their education while their income is low and pay back their debt as they grow older and have higher incomes.
- Government debt is used to smooth the fluctuations of economic conditions by increasing debt during times of hardship and reducing it during times of prosperity.
- Corporate debt is used to finance investment when investment opportunities outpace the growth rate of internal corporate funds.
When debt is used for purposes other than those listed above, as is the case today, then in the view of the BIS we have “too much debt.” This may be a reasonable definition of “too much debt” but it is useless for finding ways out of “too much debt” crises of the scale the world faces today. For this, considerations of social structure and the impact of technology and division of labor on the social structure must be added to the cited BIS definition.
The series of posting that will follow this introductory overview will pursue the following working hypothesis:
“Too much debt” is “too much” relative to what the economy’s socio-political structure is willing to bear. When it becomes “too much”, then processes emerge that alter the socio-political structure: either destructive political revolutions that alter the power relations between classes (as in the case of the French Revolution or the Nazi rise to power) or constructive technological revolution (as in the case of the British-led industrial revolution and the US-led post-industrial information technology revolution).
But these turbulent ways of dealing with crises of “too much debt” are phenomena of modern history. For most of recorded history a third method of dealing with these crises dominated: periodic debt forgiveness. This began with Mesopotamian royal acts such as that of King Enmetena, mentioned above, that were later codified and written into both government law (Hammurabi) and religious decree (Biblical Jubilee debt forgiveness).
Ancient Greek and Roman approaches to the problem of “too much debt” stand somewhere between the debt forgiveness approach of the far more ancient Middle East and the turbulent and transformational approach of modernity.
The foundational act of lawmaking in Western civilization is the celebrated legislation of the Athenian Solon in 594-593 BCE, which defused the first-ever recorded “too much debt” crisis of the Western world that was just beginning to emerge from under the shadow of the great Middle Eastern civilizations. The gist of Solon’s reforms was not a mere debt restructuring, as is often misrepresented. It was a comprehensive structural economic and monetary reform designed to convert the traditional, inward-looking agricultural subsistence economy of Athens into an export-oriented maritime and trading power: incentives to switch away from cultivation of grains for domestic consumption to olive oil and wine for export; incentives for the development of shipbuilding and pottery for the transportation and packaging of these liquid goods, and a monetary and banking system to facilitate and finance overseas trade.
The combination of prudent, limited debt restructuring and far reaching structural reforms resulted in new wealth creation modes that enabled the Athenian debtors to repay their debts and in the process build a mighty maritime and commercial empire within one hundred years.
The early Roman Republic used “too much debt” (if tax farming contracts are understood to function as public debt instruments, as will be argued in future postings) to expand its writ and reorganize the entire ancient world of the Mediterranean littoral into a single, integrated market. But when the geographical limits of that wholesale global restructuring of socio-political power relations were reached with the conquest of Egypt in 31 BCE, the Roman Republic attempted to deal with over indebtedness by transforming itself into the Roman Empire. The Empire abolished tax farming (public debt contracts in disguise) and embarked on a protracted era of balanced budgets whose annual execution depended on ever more onerous taxes and state regulation.
Eventually, the Roman Empire disintegrated because its overtaxed subjects first lost the capacity to generate taxable value and subsequently transferred their loyalties to less taxing overlords: the invading Germanic tribes in the Western Empire and, a few centuries later, expanding Seljuk and Ottoman emirates in the Eastern Empire. The conquerors in both the Western and Eastern halves of the Roman Empire contributed nothing to the solution of the problem of over indebtedness. Economic decline and stagnation continued unabated, until revolutionary innovations in debt management and finance erupted in the maritime city-states of Genoa and Venice in the 13th century – and were imitated and improved upon by Amsterdam and London in the 16th and 17th centuries.
This overview begins a series of reports that will argue that debt is good and not evil, as a growing number of modern critics contend, and that it is essential for supporting the cooperative division of labor on which all civilized life depends: technological advances give rise to more complex divisions of labor; more complex divisions of labor require both larger debts and larger populations. Technologically stagnant societies deal with excessive debt through government regulated periodic debt write-offs. Technologically dynamic societies deal with excessive debt either by tolerating market failure (creative destruction) or by resorting to violence (revolution, war – i.e., “uncreative” destruction) or, in more rare but more felicitous occasions, by steering a successful course of structural reforms that give rise to spectacular advances of civilization, as in the case of Solon’s solution to the Athenian debt problem of the 6th century BC, the British post-Napoleonic war debt of the 19th century and the US post-WWII debt in the 20th century.