I just started watching Mr Robot on my Amazon Prime (Try Amazon Prime 30-Day Free Trial) because I wanted something to watch on the plane.
If you haven’t seen it, there are going to be some minor spoilers. But the show is a couple years old already, so if spoilers bother you then you need to get cracking on your tv viewing!
So after the first episode it looks like the over-arching plot (at least for season 1) is trying to create a debt jubilee by wiping out the credit records at a huge conglomerate, Evil Corp. For the moment, let’s set aside how that would never happen for both technological, legal, and logistical reasons.
What would wiping out debt do?
Would that be a net positive or a net negative for the world?
At first glance, I’m inclined to say it’s a bad idea.
What is debt?
Borrowers want more money than they have. Lenders are willing to give it to them in exchange for a promise to pay over time with interest. Fundamentally, it’s the exchange between people with high time preference (borrowers who want money now) and people with low time preference (lenders who want more money later). And that’s OK.
Who are borrowers?
In the show they talk about personal borrowers. People who use credit cards, student loans, mortgages, car loans, personal loans, and so on. Of course there are corporate and government borrowers as well, but I want to focus on personal for now.
Who are lenders?
Banks, financial institutions, insurance companies, retirees, investors, central banks, anyone who holds a bond or a bond fund.
Why do people want to wipe out debts?
Unsurprisingly, the people who want to wipe out the debts are those that owe them. So if their debt were wiped out, the stuff they bought on their credit cards would still be in the living room, but the payments would disappear. The house would still be there, but free and clear. Those looming student loan payments would disappear. The cars might drive a little better without a car note weighing them down. The motivation is pretty obvious.
But what about the other side?
Banks would be obliterated. The debt is a liability to the borrower but an asset to the bank. Without those assets, the “solvency” of a bank is annihilated. Oh and by the way, your bank account balance is a bank’s liability. If the bank doesn’t have any assets to pay for its liabilities, your bank accounts goes poof along with the debt.
The financial institutions like your car lenders would have spent all the money to enable the (former) borrowers to buy the cars, but the revenue coming back in would disappear. Then the lines of credit between the financial institutions and the commercial banks would also be gone, so the financial companies would close up shop.
Insurance companies keep most of their assets in relatively safe loan instruments, so their capital to payout on claims would disappear.
Retirees and individual investors that hold bonds and bond funds would be lose their streams of income.
So sure, the borrowers would love it, but the all the people who work for those institutions would be out of a job (along with all those ripple effects), the people who are depending on bond income to live would be eating cat food, and anybody who had a car accident or a house burn down would be completely shit out of luck since the insurance companies are wiped out.
But what about the debt jubilees in the bible?
I see this argument from time to time that since there was a rolling debt wipeouts every 50 years or so. Since it was in the bible we should do the same thing. Outside of a religious argument, this doesn’t make much sense. The ENORMOUS difference between those debts and our modern debts was the inheritance of debt. Those debt jubilees did perform a service in that children would eventually be relieved of debts inherited from their parents. After all, 50 years was probably beyond the life expectancy of most peasants in ancient Judea.
In our society, children do not inherit debts from their parents. If your parents die, and their estate is not enough to pay off any creditors, then those creditors are out of luck. And that’s a good thing. The risk of loss is what forces lenders to be conservative in their underwriting.
Still, I understand the motivation.
Everyone hates banks. I do, everyone I know does, and you probably do too. And if you understand how fractional reserve banking works, it’s easy to understand why.
Joe gets a paycheck from Acme Corp (customer of the month: Wile E. Coyote). He deposits his paycheck in EvilFractionalBank. He’s happy that he has a nice account balance of $10,000. EvilFractionalBank uses that deposit to lend out $100,000 (simplifying the ins and outs and cumulative effect of multiple bank transactions). It could be car loans, credit cards, mortgages, whatever. EvilFractionalBank tells Joe that his money is there and ready to withdraw whenever Joe wants and just relies on the fact that Joe usually wants to keep his money in his checking account because it’s easier to operate his life that way rather than withdrawing cash all the time and paying for things in cash. And besides, his mortgage to EvilFractionalBank has to be paid be electronic payment rather than in cash.
So on net, Joe lends EvilFractionalBank $10,000 so he can borrow $100,000 for his house, car, whatever. EvilFractionalBank doesn’t actually provide anything to Joe. It’s all accounting fiction! It’s easy to see why this is infuriating.
If fractional reserve banking were not a thing supported by the government then this whole arrangement would collapse under its own weight as the banks borrow short duration (on demand payment for you checking account balance) and lend long duration (car loans, mortgages, etc). The duration mismatch will eventually be called out by market forces and a run on the bank will cause a bankruptcy. But this cleansing process can’t happen when every bank does the same thing and is supported by the central bank and the government. So the people who run the banks (those evil rich) keep siphoning off interest and fees while doing pretty much nothing in real terms. It’s a ridiculous system and one I fully support getting rid of.
But wholesale wiping out the debts is not the answer because it’s not just the banks that are getting those payments. It’s also the elderly who are clipping those bond coupons and personal investors who are building their wealth by letting others use it.
And besides, what about the day after?
So let’s imagine this utopia where all the debts are wiped out, somehow civilization hasn’t been wiped out. What happens tomorrow? Will those people who wanted to borrow money suddenly not need to borrow money?
Somehow I doubt it. People with high time preference tend to stay that way. And those with low time preference tend to stay that way. It is built into the human condition to want more. More money, more stuff, more power (a whole other topic). So hitting a giant reset button on debt will give a windfall to borrowers, but we’ll be right back in the same position before long. After all, look at people that get discharged from bankruptcy with all their debts gone. Does it give them a new lease on life? Temporarily. For most, they are back in debt pretty much as soon as people are willing to lend to them again.
So how do we really fix our lives?
We know that in real life there isn’t going to be a magic debt fairy. How do we get control of our money and not be debt slaves?
It all comes down to money management.
Step 1, get control over your finances. You have to create a personal surplus. Whether that means cutting expenses, increasing income, or both (preferable) is up to you. Your life is individual. So how you create a surplus will be individual as well.
Step 2, get out of banks. Bank accounts are fantastic for providing transactional ability. They are total shit for storing value though. Every dollar you keep in a bank increases the money supply and keeps inflation going. So personally, I don’t use banks for building up dollar balances. I keep enough to pay my bills, but that’s about it. Get your savings working for you. There are lots of ways to do this. Personally I use an Infinite Banking Concept life insurance policy as my ‘money home.’ Then from there it will go into investments and such. You’ll see a lot of people argue against cash value life insurance as an investment. And I more or less agree with them. It’s not a great investment. It does make a great stand-in for cash though. But my point is not to argue for insurance, but merely to point out that there are alternatives to holding your savings in a bank account.
Step 3a, pay down your debts.
Step 3b, build up your emergency funds. Everyone needs a buffer. When you have those unusual expenses, you need to be liquid enough to cover them. Otherwise you end up right back in debt.
Step 4, build cash flow. Once you have your financial life under control, you can start building your wealth. There is real magic in becoming financially independent – that point where your passive income covers your bills.