Do Creditors Exploit Debtors, or Vice Versa?

I’m asking this question because I think a proper understanding of the answer is a giant leap toward grasping the geopolitical realities of the relationship between America and China.

This discussion was triggered by Noah Smith’s discussion of David Graeber’s ideas on debt, and particularly his idea that debt is a means to “extract wealth” out of others.

Noah Smith on David Graeber:

“Debt,” says Graeber, “is how the rich extract wealth from the rest of us.” But sometimes he seems to claim that creditors are extracting wealth from debtors, and sometimes he seems to claim that debtors extract wealth from creditors.

For example, in the Nation article, Graeber tells that The 1% are creditors. We, the people, have had our wealth extracted from us by the lenders. But in his book, Graeber writes that empires extract tribute from less powerful nations by forcing them to lend the empires money. In the last chapter of Debt, Graeber gives the example of the U.S. and China, and claims that the vast sums owed to China by America are, in fact, China’s wealth being extracted as tribute. And in this Businessweek article, Graeber explains that “throughout history, debt has served as a way for states to control their subjects and extract resources from them (usually to finance wars).”

But in both of these latter cases, the “extractor” is the debtor, not the creditor. Governments do not lend to finance wars; they borrow. And the U.S. does not lend to China; we borrow.

So is debt a means by which creditors extract wealth from debtors? Or a means by which debtors extract wealth from creditors? (Can it be both? Does it depend? If so, what does it depend on? How do we look at a debtor-creditor-relationship and decide who extracted wealth from whom?) Graeber seems to view the debtor/creditor relationship as clearly, obviously skewed toward the lender in some sentences, and then clearly, obviously skewed toward the borrower in other sentences.

But these can’t both be clear and obvious.

What Graeber means by “extracting wealth” in the context of a relationship between, say a mortgager and a mortgagee seems to mean the net transfer of interest. It is certainly true on the surface that there is a transfer of wealth from the debtor to the creditor (or from the creditor to the debtor if the debtor defaults).

However, between nations Graeber sees the relationship reversed — that China is being heavily and forcefully encouraged to reinvest its newly-amassed wealth in American debt (something that some Chinese government sources have suggested to be true). But if the flow of interest payments — i.e. from America to China — is the same debtor-to-creditor direction as between any creditor and debtor, then is the relationship really reversed? If China is being forced to amass American debt by the American government, is America effectively forcing China into “extracting its wealth”?

The thing Graeber seems to miss is that the transfer of interest is the payment for a service. That is, the money upfront, with the risk of non-repayment, the risk that the borrower will run off with the money. That risk has existed for eternity. In this context, the debtor-creditor relationship is a double-edged sword. Potentially, a debtor-creditor relationship could be a vehicle for both parties to get something that benefits them — in the case of the debtor, access to capital, and in the case of the creditor, a return on capital.

In the case of China and America, America may choose to pay off the debt in massively devalued currency, or repudiate the debt outright. That’s the risk China takes for the interest payments. (And the counter-risk of course being that if America chooses to repudiate its debt, it risks a war, which could be called the interstate equivalent of debtors’ prison).

Of course, the early signs are that China’s lending will be worth it. Why? Because sustained American demand provided by Chinese liquidity has allowed China to grow into the world’s greatest industrial base, and the world’s biggest trading nation. And it can’t be said that these benefits are not trickling down to the Chinese working class — China’s industrial strength has fuelled serious wage growth in the last few years. Yes — the Chinese central bank is worried about their American dollar holdings being devalued. But I think an inevitable devaluation of their dollar-denominated assets is a small price for the Chinese to pay for becoming a global trading hub, and the world’s greatest industrial base. Similarly, if American firms and governments use cheap Chinese liquidity to strengthen America, for example funding a transition to energy independence, then the cost of interest payments to China are probably worth it. And that is a principle that extends to other debtors — if the credit funds something productive that otherwise could not have been funded, then that is hardly “wealth extraction”. There is the potential for both parties to benefit from the relationship, and the opportunity costs of a world without debt-based funding would seem to be massive.

But what if tensions over debt lead to conflict? It would be foolish to rule out those kinds of possibilities, given the superficial similarities in the relationship between China-America and that of Britain-Germany prior to World War I. It is more than possible for an international creditor-debtor relationship to lead to conflict, perhaps beginning with a trade war, and escalating —  in fact, it has happened multiple times in history.

It is certainly true that devious creditors and debtors can extract wealth from each other, but so can any devious economic agent — used car salesmen, stockbrokers, etc. The actual danger of creditor-debtor relationships, is not so much wealth extraction as it is conflict arising from the competition inherent to a creditor-debtor relationship. Creditors want their pound of flesh plus interest. Debtors often prefer to be able to shirk their debts, and monetary sovereign debtors have the ability to subtly shirk their debts via the printing press. That is potentially a recipe for instability and conflict.

There is also the problem of counter-party risk. The more interconnected different parties become financially, the greater the systemic risks from a default. As we saw in 2008 following the breakdown of Lehman Brothers, systemic interconnectivity can potentially lead to default cascades. In that case, debt can be seen as a mutual incendiary device. 

So the debtor-creditor relationship is very much a double-edged sword. On the one hand, if all parties act honestly and responsibly debt can be beneficial, allowing debtors access to capital, and allowing creditors a return on capital — a mutual benefit. In the real world things are often a lot messier than that.

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27 thoughts on “Do Creditors Exploit Debtors, or Vice Versa?

  1. It seems there are two big winner out of the globalization game: China and the USA. Ok, add one more: Germany. China had resurrected from a dirty poor nothingness country now becoming almost the #2 of the world so even if they forgive the US debt they still came out a winner. Without the help of Americans, they could not have done it. In fact the Chinese elites or the leading class are already aware of that they most likely will not see those money in the T Bills ever again. Instead they see it as an ace card they hold over the USA. The US on the other hand also profited greatly from globalization because the dollar is still the #1 world reserved currency. As long as they know how print, surely rest of the world will take it and give the Americans real goods.

    The debts issue is not difficult to find the solution. China and the USA are both holding Ace cards in the play. It’s not about the fiat money but all about the chess game of geopolitical power play. The visionaries look far beyond now. Great goals are all planned. It’s a G2 (China and the US) world for the short term but Germany will most likely to lead the EU emerging to become the G3 later on if they can come out of their crisis in one piece.

    So there will be a new Three Kingdoms《三国演义》history rewritten. Instead of one superpower, there will be 3, China leading Asia, Germany leading Europe, and USA of the rest.

    Three Kingdoms《三国演义》

  2. David Graeber’s “Debt”, is a good book. I recommend it to all for a history of debt.

    But, while reading the book, I couldn’t help but notice that it lacked a somewhat contemporary voice.

    The book would have been more relevent had it been printed in 1970, or so.

    Today’s blogs do a much better job the at explaining the issues surrounding debt.

  3. One thing I found interesting was the (new for me) idea that becoming indebted to a powerful person/entity could have the beneficial side effect of safety.

    If you owe the cheif a million seashells, nobody is going to mess with you because then they would have to answer to the cheif.

  4. Who’s extracting wealth from who? There’s a very simple answer: just look at the real or inflation adjusted rate of interest being paid.

    E.g. if the creditor gets 2%, but inflation is 4%, then the debtor is extracting 4-2=2% from the creditor to the tune of 2%p.a.

    • Yeah, I suppose to some degree we should look at the real-interest rate adjusted transfer payment, but at the same time inflation affects everyone differently, so I prefer the absolute transfer as a fee for cash upfront analysis… Projections of future real interest rates are important in making that decision, though.

    • Yes this was the point I made in the book. T-bonds pay under the inflation rate. Holders don’t make anything on the interest payments, they lose money on the deal (pp.366-67) – continually, since the bonds generally aren’t ever cashed in but just rolled over. It’s amazing that supposedly professional economists like NS don’t understand these basic facts, didn’t notice it in the book, or maybe pretend not to. Whatever. This is why I don’t even bother trying to argue with them.

        • For most of the 80s and 90s there was a huge spread, bigger than the spread claimed by Shadowstats, etc. Right now, there is a lot of deflation in certain sectors, and a lot of inflation in others. Obviously, this isn’t taken into consideration by a CPI or PCE generalisation, but it is a general starting point.

          Additionally, everyone experiences a different rate of inflation based on their initial portfolio and spending preferences. As a guess, I’d tend to say that monetary sovereigns sitting on a huge pile of treasuries like the PBOC experience a lower rate than American workers who have to spend a much higher proportion of their income on inflation-sensitive commodities like food and fuel.

      • Unreserved creditors (e.g. banks) extract wealth.

        Fully-reserved creditors (e.g. unlevered bondholders) are systematic prey.

        Debtors are sometimes winners, sometimes losers.

        Ergo, one can deduce that unreserved lenders extract wealth from reserved lenders?

  5. It might help the analysis to note that in a given community, especially a state, there is a ruling or leading class and the people-in-general, or PIG (and perhaps other classes, castes, or groups) who have different interests and different powers at different times. For example, the ruling class of the U.S. can cause the government to borrow heavily from themselves (the r.c.) or foreigners and then force the PIG to pay off the debt, or to suffer severe inflation to avoid paying off the debt. The debt relations created and maintained in the last few decades between the U.S. and China seem to have been of great advantage to the U.S. and Chinese ruling classes, and to the PIG of China, but not generally to the PIG of the U.S.

    In general, the advantages and disadvantages of debt as we know it in the modern world, like most every other relation in liberalism-capitalism, depend heavily on the power, knowledge, and connections of the engaged parties.

  6. Debt is the most efficient method of stealing another’s future income.

    Institutions NEVER worry about debt, as they could care less whether they pay it back or not. If they can, fine, if not, so what? You declare bankruptcy and move on to the next debt-scam.

    Banking [debt/interest] is THEFT, something people figured out thousands of years ago. Even in the horribly virulent form contemporary banking has taken, people still buy into notion that you must not only invite this grotesque parasite into your home, but, additionally, you must additionally offer your own body, and those of your wife, son[s] and daughter[s] to be financially raped and mutilated by these sociopaths.

    Bankers are not your friends.

  7. Aziz says: “But I think an inevitable devaluation of their dollar-denominated assets is a small price for the Chinese to pay for becoming a global trading hub, and the world’s greatest industrial base. Similarly, if American firms and governments use cheap Chinese liquidity to strengthen America, for example funding a transition to energy independence, then the cost of interest payments to China are probably worth it.”

    This the delicate game being played!

    Let us hope emotional politics does not excite the masses too much!

  8. I’m more interested in the Chinese trade relationship with the US than for now with Noah P’s view on David Graeber on the contradictions of indebtedness (I like reading DG btw). I’m working through both Bill Mitchell (@billy_blog) and Michael Pettis’s thoughts on trade and on capital and external sector imballances. Bill makes the valid point (amongst many) that a country that exports forgoes the benefits of consumption at home of those exported goods or services. Another MMTer Randall Wray, points out that what China gets in return for its exports, is to ‘hold’ US$s in its account at the Fed. The US offers bonds in return for $$$ and pays interest. That’s clearly no big deal for China as you’d understand below. And the US does not need to borrow from China in order to spend – the US as MMTers know, does not need to fund its deficit. This problem is political.

    Note there is not much room here for hubris on the part of China – about China revelling in the knowledge that it’s the World’s biggest trader. Why? Because China has suffered a loss to the well being of its own people. It has allocated (read also e.g. Michael Pettis on capital misallocation) capital to producing goods for the benefit of the people living in the US. Why does it do this? The most convincing reason I have heard is from Michael Hudson. Michael Hudson stated recently that China chose an economic path of development that saved it from the fate of the USSR. China wanted technology and it knew that Russia was starved of this and suffered the eventual consequences. Hence China is not interested in a mercantilist fantasy. It’s not really interested in following the beggar thy neighbour headlong rush to export that afflicts the developed world – like Germany (read both Mitchell, and Pettis recently on Germany and Spain). China wanted technology and escaped the economic isolation inflicted on the USSR by exporting at the scale in which it has. It has problems because of this, but the fate of the USSR does not seem to be one of them.

    So debt? It’s obviously structural and historical – that’s where it’s nuances, contradictions and political interpretations come from. And as history marches on, the US may lose its captive producers in China and have to sort out producing its own cheap domestic consumption goods. China may rebalance. Germany has penurised the PIIGS. It may lose its captive market and suffer painfully itself. I’m waiting to learn more. I’m not sure at the moment though, what inflation particularly has to do with this.

    • I read an old newspaper from 1987 2 months before the October crash. it mentioned how the USSR was opening up the economy to designer brands, manufactured in the USSR. The brands were intended to be exported.

      The USSR was THIS close to being the equivalent to China today.

      China’s accession to the WTO had a lot to do with its success. Russia is yet to get WTO membership.

      Too bad Yeltsin screwed it up and the Oligarchs picked the USSR’s bones. Maybe Yeltsin planned it. Whoever backed him made a fortune.

      • Jo Stiglitz maybe holds one of the handles on this economic coffin as far as understanding goes? And of course the usual criminals including advice from the IMF’s economic digester unit.

  9. Sounds like this has more to do with power differentials than anything else. The party that’s likely to be “exploiting” (ie getting better terms than the other party would otherwise prefer) is the one that wields the most political, military, or economic power.

    Just how that might play out within the context of modern western society is, aha, left as an exercise for the reader.

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