“How unlimited interest rates destroyed the economy”

I strongly recommend reading this:  ‘How unlimited interest rates destroyed the economy“, Thomas Geoghegan, Harper’s Magazine, April 2009.It is subscription only.  Here is a brief excerpt.  The article is worth the price of  picking up a copy at your local store.Amidst all the writings about the financial crisis — both nonsense and expert insights — this describes an important and overlooked aspect of the problem.  Perhaps the most important aspect.  While the conservative media frets about the increase in government liabilities from $65 trillion to $70 trillion, tens of millions of American households groan under loads of debt from which they can never escape.  Other than through bankruptcy.  Here lies the potential for serious social unrest.  Radicalism, perhaps even violence.

Opening

The number of collection and foreclosure cases in this one county {of Chicago} — 174,000 — is equal to the total number of people in three entire Chicago wards: every man, woman, and child. I stress “child” in particular, since the banks give out credit cards like candy. Yes, 174,000 cases — and that was before the economy tanked. These are not old-fashioned collection cases either. Typically, the banks are enforcing arbitration awards handed down by “private arbitrators” who more or less work full time for the banks. So the banks can sue anyone anywhere in any court in America without having to provide a witness or prove a case.

The pain of all this may get much worse. If deflation comes (even in a mild form), it means each dollar of debt will be harder to repay. That’s why populists in the 1890s took up their pitchforks: deflation made it increasingly difficult to pay off the principal on their loans. But at least in the time of William Jennings Bryan, they were only paying back at 5 percent. While we deflate, credit card holders will be paying off at rates of 20% to 35% , and 1890s-type deflation would make the rate feel more like 35% to 50%.

What’s the worst of all the legal changes that fill up collection courts? There are so many, but I’d pick the legalization of usury. It’s the form of deregulation that not only drove us into debt but also sped up the loss of the manufacturing jobs that created our middle class — that, in short, brought about our current Time of Troubles.

Conclusion

Finally, we should think about ways to “inject equity” directly into the accounts of working people rather than into banks. The best way to do this is to announce a plan to raise the gross replacement rate of Social Security from 44 percent to something closer to 65 percent, which is still short of the rate in many European social democracies. We can afford this as much as or more than they can.

We could aim to reach that goal gradually, over the next twenty years, but even announcing the goal encourages future-oriented thinking. It would encourage people to believe that they could invest in real things again, instead of pinning their hopes on the false and predatory promise of a big, Vegas style payout. The promise of a real public pension that people can live on would lead fewer of us to chase bubbles in good times, even as it gave all of us the confidence to keep spending when times were bad.

Schumpeter feared that this kind of countercyclical thinking by people on the left would lead to a stagnating form of socialism, or even the end of capitalism, But socialism, in the state run form he anticipated, is not inevitable, or even desirable. Social democracy, European style, which Schumpeter did not expect, is desirable. Sure, I’d like the European governments to run up a bit of public debt to pump up demand over there—I don’t think that’s so immoral. What’s immoral is to pump up demand, as we have, by handing out easy money at high interest and driving people into debt.

Even in Babylon they spared people that kind of captivity. We now have to ensure our own country does the same.

Afterword

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To read other articles about these things, see the FM reference page on the right side menu bar.  Of esp interest are:

Posts about America’s debt:

  1. Death of the post-WWII geopolitical regime – death by debt, 8 January 2008 – Origins of the 1982 – 2006 economic expansion; why the down cycle will be so severe.
  2. A picture of the post-WWII debt supercycle, 26 September 2008
  3. Debt – the core problem of this financial crisis, which also explains how we got in this mess, 22 October 2008

Originally published at Fabius Maximus and reproduced here with the author’s permission.