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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Is Marxism Coming Back?

It is true that as the financial and economic crises roll on, as more and more disasters accumulate, as more people are thrown into unemployment and suffering that more and more of us will question the fundamentals of our economic system. It is inevitable that many will be drawn to some of the criticisms of capitalism, including Marxism.

The Guardian today published a salutary overview of this revival:

In his introduction to a new edition of The Communist Manifesto, Professor Eric Hobsbawm suggests that Marx was right to argue that the “contradictions of a market system based on no other nexus between man and man than naked self-interest, than callous ‘cash payment’, a system of exploitation and of ‘endless accumulation’ can never be overcome: that at some point in a series of transformations and restructurings the development of this essentially destabilising system will lead to a state of affairs that can no longer be described as capitalism”.

That is post-capitalist society as dreamed of by Marxists. But what would it be like?It is extremely unlikely that such a ‘post-capitalist society’ would respond to the traditional models of socialism and still less to the ‘really existing’ socialisms of the Soviet era,” argues Hobsbawm, adding that it will, however, necessarily involve a shift from private appropriation to social management on a global scale. “What forms it might take and how far it would embody the humanist values of Marx’s and Engels’s communism, would depend on the political action through which this change came about.”

Marxism is a strange thing; it provides a clean and straightforward narrative of history, one that irons out detail and complication. It provides a simplistic “us versus them” narrative of the present. And it provides a relatively utopian narrative of the future; that the working classes united will overthrow capitalism and establish a state run by and for the working classes.

Trouble is, history is vastly more complicated than the teleological narrative provided by dialectical materialism. The economic and social reality of the present is vastly more complicated than Marx’s linear and binary classifications. And the future that Marx predicted never came to fruit; his 19th Century ideas turned into a 20th Century reality of mass starvation, failed central planning experiments, and millions of deaths.

Certainly, the system we have today is unsustainable. The state-supported financial institutions, and the corporations that have grown up around them do not live because of their own genius, their own productivity or innovation. They exist on state largesse — money printing, subsidies, limited liability, favourable regulation, barriers to entry. Every blowup and scandal — from the LIBOR-rigging, to the London Whale, to the bungled trades that destroyed MF Global — illustrates the incompetence and failure that that dependency has allowed to flourish.

The chief problem that Marxists face is their misidentification of the present economic system as free market capitalism. How can we meaningfully call a system where the price of money is controlled by the state a free market? How can we meaningfully call a system where financial institutions are routinely bailed out a free market? How can we meaningfully call a system where upwards of 40% of GDP is spent by the state a free market? How can we call a system where the market trades the possibility of state intervention rather than underlying fundamentals a free market?

Today we do not have a market economy; we have a corporate economy.

As Saifedean Ammous and Edmund Phelps note:

The term “capitalism” used to mean an economic system in which capital was privately owned and traded; owners of capital got to judge how best to use it, and could draw on the foresight and creative ideas of entrepreneurs and innovative thinkers. This system of individual freedom and individual responsibility gave little scope for government to influence economic decision-making: success meant profits; failure meant losses. Corporations could exist only as long as free individuals willingly purchased their goods – and would go out of business quickly otherwise.

Capitalism became a world-beater in the 1800’s, when it developed capabilities for endemic innovation. Societies that adopted the capitalist system gained unrivaled prosperity, enjoyed widespread job satisfaction, obtained productivity growth that was the marvel of the world and ended mass privation.

Now the capitalist system has been corrupted. The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system, however, is not capitalism, but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

The system of corporatism we have today has far more akin with Marxism and “social management” than Marxists might like to admit. Both corporatism and Marxism are forms of central economic control; the only difference is that under Marxism, the allocation of capital is controlled by the state bureaucracy-technocracy, while under corporatism the allocation of capital is undertaken by the state apparatus in concert with large financial and corporate interests. The corporations accumulate power from the legal protections afforded to them by the state (limited liability, corporate subsidies, bailouts), and politicians can win re-election showered by corporate money.

The fundamental choice that we face today is between economic freedom and central economic planning. The first offers individuals, nations and the world a complex, multi-dimensional allocation of resources, labour and capital undertaken as the sum of human preferences expressed voluntarily through the market mechanism. The second offers allocation of resources, labour and capital by the elite — bureaucrats, technocrats and special interests. The first is not without corruption and fallout, but its various imperfect incarnations have created boundless prosperity, productivity and growth. Incarnations of the second have led to the deaths by starvation of millions first in Soviet Russia, then in Maoist China.

Marxists like to pretend that the bureaucratic-technocratic allocation of capital, labour and resources is somehow more democratic, and somehow more attuned to the interests of society than the market. But what can be more democratic and expressive than a market system that allows each and every individual to allocate his or her capital, labour, resources and productivity based on his or her own internal preferences? And what can be less democratic than the organisation of society and the allocation of capital undertaken through the mechanisms of distant bureaucracy and forced planning? What is less democratic than telling the broad population that rather than living their lives according to their own will, their own traditions and their own economic interests that they should instead follow the inclinations and orders of a distant bureaucratic-technocratic elite?

I’m not sure that Marxists have ever understood capitalism; Das Kapital is a mammoth work concentrating on many facets of 19th Century industrial and economic development, but it tends to focus in on obscure minutiae without ever really considering the coherent whole. If Marxists had ever come close to grasping the broader mechanisms of capitalism — and if they truly cared about democracy — they would have been far less likely to promulgate a system based on dictatorial central planning.

Nonetheless, as the financial system and the financial oligarchy continue to blunder from crisis to crisis, more and more people will surely become entangled in the seductive narratives of Marxism. More and more people may come to blame markets and freedom for the problems of corporatism and statism. This is deeply ironic — the Marxist tendency toward central planning and control exerts a far greater influence on the policymakers of today than the Hayekian or Smithian tendency toward decentralisation and economic freedom.