Monday, 13 October 2008

How Do We Get Out of Debt?

It's easy for an individual to work out a strategy to get out of debt. Spend less than you earn and sooner or later your balance will get back in the black. It might be easier to say than to do, but it doesn't present any big intellectual problem.

But weaning society off debt is a bigger problem, and one that throws up all sorts of difficulties. The debtor might feel isolated and alone with his problem, but the fact is that there are a whole set of interested parties. For example, the bank will be keenly interested in how a bank loan gets paid off. If the loan goes according to plan and is paid off according to the agreement when the debt is going t be cleared. When it is the bank has lost its income from the loan and needs to either sell the same guy some more debt, or find a new customer. When the debt is paid off the debtor now has a choice. He can spend his new income on other goods, he can start saving or can raise another loan. What he decides will affect people around him. This all might seem a bit obvious - but it is worth thinking through just how big a difference this one person's decision can be.

Suppose he saves the money. If he puts in his bank he has now compounded their marketing problem. Not only have they lost him as a net contributor to their profits, but now they have to find the means to pay him interest on the money he has deposited with them. If everyone does the same the bank becomes a very dull business indeed. They won't run out of cash. In fact they have plenty of the stuff. But they are not going to be very profitable.

But if he doesn't save it he might decide to take out a huge mortgage to buy a bigger house. In this case the bank are laughing, just so long as they have the money to lend him.

But the chain of events doesn't stop there. If he uses his new big mortgage to buy a house at a higher price than has previously been paid on the street, he might increase the value of the whole road. All his new neighbours suddenly feel a lot richer. If the banker has a really lucky day a lot of them will be down raising new loans against the increased wealth in their houses.

This is all a bit simplistic but I think it shows that people's behaviour with their money is something that has a big impact not only on themselves but on those around them. No man is an island. Certainly no man is a financial island.

As I write this article governments around the world are ploughing huge sums of taxpayers' money into their banking systems. They have had to do this because there is a real risk that without this support the entire financial system will collapse. Even with this support there are some people who think that it might still go pop. The quantities involved are staggering and it is hard to see how this intervention isn't going to end up costing us dearly for years and even decades to come.

The thing that has surprised most people is the speed with which it has all blown up. But when you look at how big an effect the different options open to us as to what to do with our money, it is perhaps not that surprising that events can move so quickly.

But we need to get out of this situation. We need to escape our dependence on debt as a society and as individuals. And we need to do it gradually. There are many risks ahead, and one of them is that we all start saving all our money. If we all horde cash we will crash our economy even quicker than the credit crunch has managed so far. But we can't carry on living on tick either. We need to develop some social responsibility. Taking out a huge mortgage and paying out huge sums for a house is an anti-social act. But we need to come up with creative ways to allow people who need finance for projects of genuine value to be able to borrow the money they need too. Creative ideas are needed.

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