Ponzi Planet
The Danger Debt Poses to the Western World
A work by the graffiti artist Banksy in London.
Lutz Goebel is used to borrowing money. The 56-year-old businessman is the managing partner of the Henkelhausen Group, a German mid-sized company that specializes in motors in the western German city of Krefeld, with 240 employees and €65 million in annual sales. The debt Goebel incurs is of a completely different nature than the country's debt.
Five years ago, Goebel had the opportunity to buy another company's gas-engine service division. Goebel was convinced that it was a worthwhile investment, and that the resulting net revenues would ultimately exceed the €1.5 million he had to borrow to pursue the deal. "It paid off," he says today.
As president of the German Association of Family-owned Businesses, Goebel represents the interests of 5,000 companies throughout the country. The owners of these businesses usually borrow funds only when they intend to make significant changes or build something new. For them, debt is a necessary part of developing their companies.
There are undoubtedly good reasons to go into debt. Companies use debt to finance investments. Private citizens use it to pay for major acquisitions, like automobiles or real estate. Most are aware that they have to economize as long as they are using current revenues to pay off the principal and interest on their debt.
It can also make perfectly good sense for governments to go into debt, such as when a government seeks to stabilize its economy with additional spending to ward off a recession. It particularly makes sense when governments borrow money to pay for real assets that will also benefit future generations, like a bridge or a kindergarten.
Everyone Benefits
Finance experts call this form of the solidarity principle "pay as you use," in which future generations are expected to pay for the rest. In addition to leaving the assets -- bridges, kindergartens and the like -- to its children and grandchildren, the current generation also leaves a portion of the financing up to future generations, and everyone benefits from it.
The only problem is that countries hardly ever use this instrument in such a productive and far-sighted manner. Nowadays, governments usually borrow money to finance their daily expenditures, like paying the salaries of government employees or servicing existing debt.
Of course, there are also people who live unrestrained financial lives. Readily available credit at every bank makes it more likely than ever that they will be tempted to abuse it. Living on credit used to be considered somewhat disreputable, but not anymore. In the third quarter of 2011, Americans had $700 billion in outstanding credit card debt. There are likewise undoubtedly many companies with lax payment policies. The number of major corporations with excellent credit ratings has been consistently declining for years.
Nevertheless, there is still a difference between private and public debt. Citizens and companies usually have real assets to serve as collateral against their debt. The value of a government, on the other hand, is -- with the exception of a few companies, properties and land -- primarily virtual, namely, that it enjoys the priceless privilege of being able to issue bonds. It borrows money from citizens who, in return, receive a bond that promises repayment of the principal plus interest.
In the 14th century, northern Italian rulers applied this principle for the first time. The British historian Niall Ferguson sees the invention of the government bond as "the second great revolution" in the economic world, following the introduction of credit by banks. It served as the foundation for the ascent of money, according to Ferguson.
No Incentive for Responsibility
Since then, the state has been able to constantly print new securities, which it uses to replace the old ones. Debts are not repaid but "refinanced." In other words, they are passed on to future generations. This trick seduces governments into treating their finances with less solemnity, and it deprives them of any incentive to live within their means.
They have also provided the securities with a special advantage: Banks, savings banks and insurance companies, the main purchasers of European sovereign bonds, are not required to back the bonds with equity capital, unlike with loans to private citizens or companies. The bonds have been treated as "especially safe" -- at least until now.
Everyone benefits from this system. Through the bonds, the banks acquire from the issuing governments apparent security on their balance sheets, fictitious assets. And, for governments, the banks serve as constant new buyers for their securities.
The state creates the illusion of freedom from risk to satisfy its self-indulgence, at least until the Ponzi moment arrives: when the last shred of confidence has been gambled away and no one buys bonds anymore.
Were a business owner to run a business in the same way, he or she would soon be forced to declare bankruptcy. "Family business owners borrow money to invest it. Usually the government borrows money to consume today," says German business leader Goebel. And, he adds, "while a businessman takes on the risk and liability for his company, in the case of countries, it is almost always the next generation that suffers."
Debt is thus a double-edged sword. When used prudently and in moderation, it enhances prosperity. "But, when it is used imprudently and in excess, the result can be disaster," the BIS economists warn in their study. Today's world has become a Ponzi planet.
