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.