Debt is that which is owed. People or organisations often enter into agreements to borrow something. Both parties must agree on some standard of deferred payment, most usually a sum of money denominated as units of a currency, but sometimes a like good. For instance, one may borrow shares, in which case, one may pay for them later with the shares, plus a premium for the borrowing privelege, or the sum of money required to buy them in the market at that time.
There are numerous types of debt obligations. They include loans, bondss, mortgages, promisary notes, and debentures. It is very common to borrow large sums for major purchases, such as a mortgage, and pay it back with an agreed premium interest rate over time, or all at once at a later date. The amount of money outstanding is usually called a debt. The debt will increase through time if it is not repaid faster than it grows. In some systems of economics this is usury, in others, this refers only to the excessive rate of interest, in excess of a reasonable profit for the risk accepted.
As noted above, debt is normally denominated in a particular monetary currency, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation, so it can happen even though the borrower and the lender are using the same currency. Thus it is important to agree on standards of deferred payment in advance, so that a degree of fluctuation will also be agreed as acceptable. It is for instance common to agree to "US dollar denominated" debt.
The form of debt involved in banking gives rise to a large proportion of the money in most industrialised nations (see money and credit money for a discussion of this). There is therefore a complex relationship between inflation, deflation, the money supply, and debt. The store of value represented by the entire economy of the industrialized nation itself, and the state's ability to levy tax on it, acts to the foreign holder of debt as a guarantee of repayment, since industrial goods are in high demand in many places worldwide.
Lendings to stable financial entities such as large companies or governments are often termed "risk free" or "low risk" and made at a so-called "risk free interest rate". This is because the debt and interest are highly likely to be repaid. However, if the value of a currency has changed in the meantime, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to "risk free" or "low risk" lendings, even though in terms of the amount of a currency that will be returned there may not be. The Bank for International Settlements is an entity that sets rules to define what loans qualify as "risk free" or not. It is a very powerful institution, formed by the Bretton Woods agreements, which has had a pivotal position in central banking since 1947 when it opened.
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2 Bonds 3 Inflation Indexed Debt 4 Nonstandard Approaches to Debt 5 Arguments against debt 6 Debt forgiveness 7 Type of debts 8 See also |
Debt allows people and organisations to do things that they otherwise wouldn't be able or allowed to. Commonly people in industrialised nations use it to purchase houses, cars and many other things too expensive to buy with cash on hand. Companies also use debt in many ways to leverage the investment made in their private equity.
The properties of debt have been blamed for exacerbating economic problems. For example, during the onset of the Great Depression there was deflation, which effectively made debt throughout society grow. This resulted in a contraction of consumption since the borrowers were on average people who had to consume less due to the increased proportion of their earnings going towards repayments while the lenders were on average people who would invest their extra purchasing power. The reduction in consumtion reduced business activity and caused further unemployment. Also in a direct sense, more bankruptcies occurred due to increased effective debt than otherwise might have been the case.
Large organisations can break their debt into many small units of debt. These small units of debt are known as bonds. Each bond entitles the holder to the remaining repayments on that unit of debt. Bonds can be traded during the repayment period, and so ownership of the debt is seen as a form of investment.
Because bonds are traded on a regular basis, they have a fluctuating price. This implies that the overall debt represented by the total number of any particular type of bond also has a fluctuating price.
Borrowing and repayment arrangements linked to inflation indexed units of account are possible and are used in some countries. For example, the US government issues two types of inflation indexed bond - TIPs and I-bonds. These are one of the safest forms of investment available, since the only major source of risk - that of inflation - is eliminated. A number of other governments issue similar bonds, and some did so for many years before the US government.
In countries with concistently high inflation, ordinary borrowings at banks may be inflation indexed also.
It is possible for some organisations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the lender hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The "repayments" are therefore proportional to what the borrower earns and so can not in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.
Similar arrangements could exist for individuals in that they could agree to repay a percentage of their earnings for a set amount of time in return for a sum of borrowed money. The lender would need to evaluate the future earning capacity of the borrower (this is possible and is often done anyway when lending), but more difficult would be the necessity to track how much they do in fact earn during the "repayment period". Typically, only governments can track earnings of individuals in such a way, and so such arrangements are only currently of use to governments. It is possible to view a portion of taxes as such a form of repayment in return for the cost of government services previously "lent" to citizens, for example education when the citizen was young or government paid maternity leave for the citizen's mother to look after them. Such views occasionally form part of justifications and structuring of some taxation. Some taxes in some countries are only collected from individuals that have received particular services, such as university education. Such an arrangement provides an incentive for the government to make the education useful, since they are sharing in the proceeds from it.
There are many arguments against debt as an instrument and institution, on a personal, family, social, corporate and governmental level. Usually these refer to conditions under which debt should not be used as a solution, e.g. to fund consumption for survival. Consumer debt and public debt deal with some of these issues.
Some theories of economics argue that debt is itself a problem, and should not be the foundation on which contracts are made between persons, organizations and nation-states. Those theories that hold it as wholly undesirable are often called creditary economics, and are also often related to theories of economics that look more basically at fundamental scarcities: clean air, clean water, safe food, shelter:
Islamic economics, concerned with the equity of distribution of these things and the potential for unrest if simple luck is permitted to cause some to starve while others prosper, simply for having held a safer debt asset through a catastrophe, has alternative instruments that do not obligate repayment in the sense of debt but instead act as a joint venture type instrument. The justification for this is a hadith which states as a rule of trade: "nothing present for that which is absent". This avoids the problems of the devaluted asset or bad debt becoming a source of unrest later on, should it be devalued or defaulted through no fault of the borrower. Since Allah intends the misfortune to fall on all those involved, the argument goes, to leave the debtor obligated and the creditor with recourse to the state for collection, is to defy God. Christian philosophy is also often concerned with these very issues.
Feminist economics is more concerned with the ultimately coercive nature of debt and the circumstances into which it is entered, and the consequences of having to liquidate one's resources, or even one's body (slavery, prostitution) directly, to repay debt undertaken for consumption - or mere survival. Unequal distributions of force required to collect debt, unequal vulnerabilities to coercive pressures of a society in general, are seen as hopelessly slanted against the female, who is a perpetual debtor, versus the male, who is a perpetual creditor, given the relative masteries of deadly force, and the vulnerability of mothers and the children to which they are closely bonded: debt bondage accrues more to women than men, and may even require the sale of children - often for sexual uses by men. Thus, debt simply reflects patriarchy, and even such female-friendly schemes as Grameen Bank are suspect because they are ultimately seeking to get women to "perform" in an economic system that is defined by, and for, men, for male desire.
Green economics makes an argument from ecology: the ecological yield of natural capital is quite limited by current solar income and other factors, such as water, topsoil, shade, nutrients and pollination. Nature's services only restore the capital so fast. Any interest rate greater than this nature rate of restoration necessarily obligates debtors to deplete the capital reserves of nature, and thus the services themselves, simply to repay the cash debt. This race to the bottom is exacerbated by competition - thus the slowest-recovering systems are forced to depletion even faster by "need" to compete with faster-recovering ones which have a higher yield and thus likely receive more attention from the exploiter. Even an interest rate less than the rate of depletion, charged on the land or rights of access, can lead to disaster if there is a high capital cost and thus equipment depreciation to repay. A particularly cogent example is fishery and forestry which are increasingly dependent on high-tech machines, creating fewer jobs, but depleting more fish stocks and forests, simply to repay the debts on equipment, which is ever more sophisticated. Thus, debt-financed infrastructural capital is analogous in this view to weapons: their only service is to compete, threaten and ultimately destroy all value in the long run. They do not "produce" on any kind of sustainable basis. The availability of debt itself to finance these machines and technologies is a problem, and not just of economics.
Short of bankruptcy, very often debts are wholly or partially forgiven. Traditions in some cultures demand that this be done on a regular (often annual) basis, in order to prevent systemic inequities between groups in society, or anyone becoming a specialist in holding debt and coercing repayment.
Global debt has reached the scale that many economists are convinced that forgiveness is the only way to restore any global equity in relations for the developing nations who, as predicted by green economics, are often despoiled simply to repay it. This movement has very broad support but predictably, not among most bankers.
Effects of Debt
Bonds
Inflation Indexed Debt
Nonstandard Approaches to Debt
Arguments against debt
Debt forgiveness
Type of debts
See also
