Debt

Debt is an obligation to deliver goods or money in the future, incurred in return for goods or money received now. Its price is interest.

Austrians treat debt as a case of exchange across time rather than as a distinct financial phenomenon. A lender gives up present goods and receives a claim on future goods; the premium he gets is the market expression of time preference, the general fact that a good available now is valued above the same good available later. Interest is therefore not the price of money and not a charge invented by lenders. It would exist in a barter economy and cannot be legislated away, only disguised.

Productive and consumptive debt

The useful distinction is between debt that finances the acquisition of capital and debt that finances consumption. It is a distinction of purpose and effect, not of legal form, and the two are often hard to tell apart in practice.

Debt incurred for a commercial or industrial investment designed to earn a future income can cover its own interest cost and yield a profit besides. A second mortgage taken out to buy a holiday home, a car or a cruise may be called productive by the borrower, but it builds no shop or factory and adds nothing to the productivity of labour. Hans Sennholz argued that such borrowing may actively consume capital and so depress living standards, while presenting itself in the statistics as economic activity.

Credit expansion is not saving

The Austrian claim that distinguishes this treatment from most others is that it matters enormously where the loanable funds came from.

When lending is funded by genuine savings, someone has abstained from consumption and released real resources. When it is funded by newly created bank credit, no one has abstained and no resources have been released, but the interest rate falls anyway. Entrepreneurs read the lower rate as a signal that people have become more willing to wait, and start long-dated projects for which the means do not exist. The projects cannot all be completed, and the discovery that they cannot is the bust. This is Austrian Business Cycle Theory, and on this account a debt boom is not merely a risk factor for a crisis but its mechanism.

Public debt

Government borrowing raises questions private borrowing does not, because the borrower is not the party who will repay.

The classical treatment is David Ricardo's. Examining Walpole's sinking fund, which was established in the 1720s to retire England's public debt, Ricardo observed that its revenues were repeatedly diverted to war and then to ordinary spending, so that the fund which was supposed to extinguish the debt served mainly to make borrowing easier and the debt larger.

Austrians add two points. The first is that public debt is a claim on future taxpayers who were never asked and cannot decline, which makes it a transfer between generations rather than an ordinary contract. The second is that a government which also controls the currency has a third option besides repaying and defaulting: it can inflate, which is a default carried out on the holders of money instead of the holders of bonds.

Murray N. Rothbard drew the conclusion most economists resist, arguing that repudiation of public debt is the honest course, since the obligation was contracted by people spending money they had taken from others and is owed by people who never consented. The position follows from his ethics rather than from any technical claim, and most Austrians who accept the analysis stop short of the conclusion.

See also

• Interest
• Time preference
• Public debt
• Austrian Business Cycle Theory
• Inflation
• Bankruptcy

Links

• Deep in Debt by Hans F. Sennholz, January 2004
• Debt at Wikipedia