A Zero Sum Game?

Rule #1: Consumption cannot exceed production in the aggregate (outlined last week)
Rule #2: It can at the individual level and this is called debt.
(We are using the term consumption loosely to represent spending – monetary or barter.)

1. Debt is essentially pre-spending, and
2. Debt is spending on behalf of someone else.

Remember: this is only possible if someone reduces her own consumption by at least the equivalent of your “over-consumption”. If no one wants to do such a thing, you can’t incur debt. Period. Just not possible.

In a world with zero interest rates (you get wagon in period “today” and you return a wagon plus a wheel in period “tomorrow”), 3 scenarios:

1. Your Income Today and Tomorrow is the Same: You have just shifted the timing of your consumption. You consume more than you produce now and you consume exactly that much less tomorrow. Good for the impatient types.
2. Your Income is Higher Tomorrow: You won’t need to reduce consumption by as much. In fact, if growth is strong enough you might not need to reduce consumption at all. Yippee!
3. Your Income is Lower Tomorrow: Repayment hurts. Bah humbug.

If spending more than you can afford now means you have more income tomorrow (education, medical care, shelter, etc.), debt can be a great thing. Otherwise, it’s not.

Furthermore, in a zero interest rate world potential savers have no good reason to let you spend on their behalf unless they simply don’t mind helping you smooth your consumption and they feel pretty damn confident you’re going to make good in the end. Even if the borrower is using the funds for all sort of admirable self-investment, the debtor gets no material benefit out of the arrangement and still bears the risk that they may never recoup their foregone consumption. This is especially pertinent if odds are that the borrower will be in a constant or shrinking income world during repayment time.

In a world where interest rates are greater than zero:

1. Constant income: You are worse off since now have to come up with the extra wheel to repay in addition to the original wagon that you borrowed.
2. Growing income: Unless your income grows by at least the equivalent of a wheel you are worse off.
3. Shrinking income: You are definitely worse off.

Now there is a material incentive for a saver to let you spend on their behalf but again the interest rate must make up for the risk that you won’t make good on your obligation.

So what does it all mean? (aside from being the world’s most boring blog post ever?)

• Debt for non-productivity enhancing activities is dubious. (That may even include housing, the American holy dream – more on that later.)
• Debt for productivity enhancing activities must be proportionate. (Absurdly expensive educations are of dubious value – for-profit colleges, certain private colleges, etc. More on that later.)
• No savers = no debtors. It’s a symbiotic relationship and the saver has to get something out of the arrangement.
• Interest rates matter! Savers gain only if there are enough debtors out there who are doing useful things that make them willing/able to repay debt + interest and/or who don’t mind forsaking equivalent or greater consumption in the future to pay for extra Gucci shoes now. Otherwise, savers get no or negative returns for their sacrifice. THERE IS NO REASON SAVERS SHOULD COUNT ON POSITIVE RETURNS OF ANY PARTICULAR LEVEL. EVER. It matters what that borrower is doing with your savings.