Monday, October 29, 2018

Beyond Our Means: Debt as a Cultural Sign

The CBC recently reported that Canadians have a debt problem.  You can find the story here. This is not news. In one way or another key financial institutions (central banks, economists, chartered banks) have been warning of debt issues for some time. There is a certain measure of hypocrisy to these warnings: the very institutions that, in one way or another, create debt or make their money from it, on the one hand, seem to warning about it, on the other.  That is of some significance and it is a point to which I will return later.   What causes this debt? How does it relate to the history of the Canadian economy? Is it a problem?

Debt is an economic issue, but its development is the product of a series of changes in values (culture) and the way financial institutions function. It is closely tied to consumerism and the expansion of consumerism (in terms of the both depth and breadth) over the last generation. Debt has always been with us. Histories of banking and the social elite, as well as governments, show that there have -- as best as we can tell -- been institutions and networks that carried debt for a very long period of time. Heck, the OId Testament has rules against usury. Today, debt has become a normal feature of life. Most of us expect to be in debt for extended periods of our working life. We don't necessarily call this debt "debt" because we don't like the term so instead we use terms like "student loans," "mortgages." "personal lines of credit," or "credit cards," among others. In short, there has been a dramatic expansion of the ways in which we can accumulate debt, label it, manage it, and pay it back. What I'd like to do in this blog and some others is to explore debt from a cultural and historical perspective. I hasten to add that I am not necessarily faulting debt -- although, to tip my hand, I think there is a lot to fault -- but attempting to understand and address the questions I asked above.

Debt occurs when you spend more money than you have. That is simple and relatively straight forward. I'm not telling you something you do not already know, but just to keep everyone on the same wavelength, let's give an example. Imagine I want to buy a car. I don't have the money so I ask the car seller person for a loan. They give the loan. Overtime I pay it back with a small extra charge. That extra change is, of course, called interest and it is compensation that I give the car seller people for getting to use their money. Because I pay interest, this means that overtime, I end up paying back more than the price of the car.  Moreover this interest is compounded. That is, you are, in effect, paying interest on interest. You can find a discussion of this here if you need a refresher. But, for our purposes, what it means is that you end up paying back more on your loan than a straight calculation of interest might suggest. For instance, imagine that I buy a car for $100. Over a three year period, the compounded interest I would pay on my $100, if the interest rate were 5%, is $116.15. For our purposes, what this means is that the car that I bought for $100 ended up actually costing me $116.15.

You can find a nifty site that allows you to calculate compound interest here.

You can think of interest rates as the cost of money. This is confusing because we often think of money as the way of address costs. But, in an economic sense, this is not strictly true. Money is a means of transaction and a symbol of wealth at the same time. When I get a loan, what I am actually doing is buying money. Why would I buy money? On one level the idea of buying money seems to make no sense at all. Well ... as I have already intimated, we buy money (get loans, that is accumulate debt) for all kinds of reasons so that we can take that money and use it to buy something else (a car, a house, an education, etc.). But, because we had to buy the money in the first place, our purchase of the car or house or education is mediated. We are not directly buying that thing that we want. And, for the moment, let us assume that the thing we want to buy is legitimate. After all, as I have been blogging, there is nothing wrong with education. And, I own a house and a car. I'm not shooting anyone down for buying such things. The point that is important to note is that the purchase is now mediated by a series of financial institutions -- I bought my car from a car seller but secured my car loan (bought money to give to the car seller which made the cost of the thing I wanted to buy go up) from my bank. My example is pretty silly and small but run the compound interest on a 25 or 30 mortgage at even a low interest rate over time and see what happens.  You might be surprised.

It is also important to note that not all interest rates are created equal. I'm middle class and because of that I have access to relatively easy credit at relatively low interest rates. In fact, my bank offers to sell me money all the time. They don't call it that. Like I said, they call it credit cards (increasing your credit limit) and lines of credit and "catch up" loans (remember those!).

It does not take a lot of see why excessive debt can become a problem. Bankruptcy (which can also be called a number of things) can be the product of a range of contributing factors, but it occurs when you owe more money than you can reasonably -- or, perhaps even possibly -- pay back over time. This is a product of the expansion of debt and credit (that is, the amount of money people are willing to sell you). I started thinking about this blog because of comments made on FB by a friend who has some serious crushing debt issues. He is about my age and has large student loans. His repayments on these loans are significant and, like many others, he is having a hard time finding full time employment. That is, he works in the precarious employment market, which guarantees neither regular work nor necessarily good wages. His quick calculations have led him to find himself in a situation that he finds really angering and I cannot say that I blame him (a subject I will get to as time goes by).

Let's play out an example to illustrate this point. If I have a salary of $100.00 per month and I owe $20 of that in rent and $15 of that for groceries and $5 for heat and $5 for utilities and $5 for renters insurance and $5 for a phone ... you can see how my regular bills start adding up really quickly. I have now spent over half my income and I've not paid my car loan or my car insurance or my student loan or the loan for my furniture nor gotten Christmas presents for family or gotten any clothes. Debts can mount for all kinds of reasons because there are so many ways to get credit. In addition to my car loan, I suspect most people have a credit card loan they have accumulated somewhere (they may even have more than one), a line of credit payment; they may need to buy school supplies. If you are a parent, you have a whole bunch of other costs. Furniture loans ... etc.

Debt serving charges (interest = the price we paid to buy that money in the first place that we now have to pay back) in this context starts to become a problem. Thus, in one situation debt is manageable. If I can keep my debt low (say, a mortgage and a car loan), I will be OK and can manage that debt from my income. I might not have a lot to spare at the end of the month but I can keep making payments and, over a long time, the amount I owe will slowly decrease. It becomes a problem when one cannot make payments, that is, one defaults, on loans. On a broader social and economic level, this is manageable if it happens on a modest level. In fact, defaulting on loans happens all the time. Money lending people know this and have it built into their calculations. A certain percentage of people to whom I loan money will not be able to pay me back. As long as it is not too many, the interest the others pay covers over that loss and things go well.

When it occurs on a large scale ... then that is where problems begin.  This is what happened in the US (again, there were a variety of contributing factors) in 2008. A whole bunch of people could not pay the loans on their houses (or, mortgages). Because of this, banks suddenly did not have a lot of money left in the till (and insurance companies that had insured those loans took a huge hit). In effect, the amount of capital (money) in the economy shrunk.

Again, I recognize that sounds odd. How does money disappear. Imagine this situation: I owe the Bank of Sackville $100 at 5% interest over three years, compounded that means that I will pay back just over $116. The bank uses that $116 for a bunch of things but let's assume we have a nice bank and say it is paying its employees with that money. Then I cannot make a loan payment because, say,  I lost my job or I was over-extended and had a bunch of other loans. I am starting to have to make choices between paying my loan and buying groceries for my kids. So, I don't pay loan (I default). But, I took the $100 and gave it to the car company. The bank cannot come and get back that money because I no longer have it. It can come and take my car, but I've now had the car for a bit, it has lost value, and so even if they take,  reselling it will not pay back the money that I borrowed (my debt), let alone the interest that is needed to pay employees. And, what if they can't sell it? Here is how money disappears), the bank had on its books my loan and interest as assets. Assets are the money I (or, you, or the bank) have. While the money was not actually there, because they assumed I would pay it back, it was counted as an asset: we have X amount of money coming in.

Again, this is not rocket science and you have all heard of this and perhaps even done it yourself.  You may have said something like "I don't have the money to buy X now but I get paid on Thursday and so I'll buy it then." When you do that you are counting a future earning (money you have not yet received) as an asset. What happens if you are not paid on Thursday?  That asset vanishes. The same thing occurs with the bank. The money that was on the books (because they lent it to me and I promised to pay them back with interest) was a fiction. The money did not actually exist. I was counting my future earnings as an asset that I would use to pay the bank and the bank was counting my payments as an asset to pay employees, give dividends to stock holders, etc. My insolvency -- my default on my loan -- makes it impossible for me to pay it back and the fiction of its existence is exposed. The money is actually not there. Thus, I guess it does not disappear per se but is shown to not exist.

This is what these warnings are all about. In effect, what the CBC expert is noting and what some financial institutions are saying is that there is too much debt in the Canadian economy, our rates of repayment cannot be sustained, this means people will default and defaults on a mass scale hurt the economy. In my example, what happens to the Bank of Sackville if I default on my loan and they cannot pay their employees?

How does all this relate to culture? What interests me is a couple of things and it is to these matters I will turn in future blogs. How did we think it was good to get into this situation in the first place? Why do we accumulate debt when, on one level, it does not make a lot of sense. How does debt relate to consumerism?

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