“The Lord giveth increase, but man devised credit.” — Garet Garrett
Addressing the Debt Crisis with Credit
In the aftermath of the First World War, Europe found itself in a state of devastation, with economies in ruins and governments heavily indebted to the United States. Germany, in particular, struggled under the weight of reparation payments mandated by the Treaty of Versailles.
One possible avenue for relief was for European nations to default on their debts. Although this choice would likely have caused significant upheaval, it would have allowed for a fresh start in rebuilding robust economies. Instead of choosing that path, Europe opted to tackle its colossal debt burden by relying on credit.
While the U.S. government was reluctant to fund European reconstruction, private American investors were eager to channel their surplus capital overseas. Wall Street, full of optimism, believed that America could resolve Europe’s debt issues through the expansion of credit. Similar to how China has recently lent the U.S. money to facilitate American consumption of Chinese goods, the U.S. extended loans to Europe to encourage buying American products.
The Destination of Capital: An Ignored Inquiry
Wall Street exhibited little interest in where the extended credit was actually allocated. Unsurprisingly, this led to misappropriation of funds towards unproductive ventures. Garet Garrett, in his 1932 book, A Bubble that Broke the World, encapsulates the absurdity of this approach:
“Focused on the idea of maintaining a surplus of goods and credit that we needed to unload, we overlooked the urgent requirement for affordable housing for low-income individuals in our cities. Simultaneously, we permitted our credit to flow freely to other nations, particularly Germany, to address their needs.”
“Capital borrowed for public projects to replace dilapidated housing may not be exceedingly profitable, but investing in such initiatives means we create tangible benefits. If we utilize our resources to construct grand projects, at least we have something to show for it; conversely, when credit is misallocated to foreign projects that fail, we lose both the funds and the potential benefit.”
“Where is the State of Minas Geraes? Many would not readily know. We extended $16 million (approximately $218 million today) of American credit to Minas Geraes, yet the only information we have is that its bonds are in default. If Amarillo, Texas, had experienced a similar loss, we would at least know where to search for the impact.”
The Cycle of Credit and Debt: Reflecting on Historical Lessons
Today, the United States has transitioned from being the world’s leading creditor to a significant debtor nation. Over the years, the country has managed its debt challenges through additional borrowing, resulting in a gross federal debt increase of approximately $7 trillion since the 2008 financial crisis, all while the economy has stagnated.
For the first time in six decades, the correlation between increased credit and economic growth has dissolved; instead, we see greater debt without corresponding growth. The heavy burden of debt complicates efforts to stimulate economic progress. What’s the underlying issue?
The U.S. economy, along with many Western nations, has reached a point of total debt saturation. This reality explains why significant fiscal stimulus and monetary easing have failed to yield meaningful economic recovery over the past four years. Adding more debt has merely exacerbated the situation, pushing the economy beyond its capacity to absorb it.
During the previous great unraveling, a monumental depression and a subsequent global conflict were necessary to untangle the consequences of the First World War and the credit misconceptions of the 1920s. As credit falters in the years to come, governments may ultimately face the necessity of defaulting or renouncing their debts. Consequently, living standards will likely drop, as will entitlements, prompting public outrage.
In the interim, as Garet so aptly noted, the prevailing strategy remains “more credit, more debt.” Regrettably, this ongoing approach is exactly what creates the problem.
Sincerely,
MN Gordon
for Economic Prism
Return from More Credit, More Debt: Lessons from the Last Great Unraveling to Economic Prism
