Aggregate debt

From: Michael Vilkin (mikevilkin_at_mail.com)
Date: 06/12/04 

Date: 12 Jun 2004 16:18:39 -0700

This article is extremely important to understand the roots of
instability of our economy. We are still studying gold coins, but
basic concepts are exactly the same for all kinds of money, is that
gold coins, paper money or just electronic bits on your credit card.
In this article we will discuss how borrowers accumulate and repay
their debt. For the sake of simplicity we assume that borrowers pay
their debt as a single payment at the end of the lending period.
        Suppose, our moneylender has a total of 300 gold coins to lend at 10%
interest. Person A borrowed 100 gold coins for one year, and he has to
pay back 110 gold coins one year later. Person B borrowed 100 coins
for 2 years, and he has to pay back 120 coins two years later. Person
C borrowed 100 coins for three years, and he has to pay back 130 coins
three years later.
        300 gold coins are circulating in the country, but the three
borrowers have to pay back total

 (110+120+130) = 360 gold coins.

        Total amount of debt is bigger than amount of money in circulation.
Can the three borrowers earn and pay back 360 gold coins if there are
only 300 gold coins circulating in the country?
        Total debt outstanding equals (360:300)=1.2=120%
of the amount of gold coins in circulation. Let's see how the three
borrowers will pay off their debt.
         In one year person A earned and paid back 110 gold coins, and he is
out of the game. Now (300-110)=190 gold coins are circulating in the
economy. Persons B and C still have to pay (120+130)=250 gold coins.
Can they earn 250 gold coins if there are only 190 gold coins
circulating in the country?
        Our moneylender now has 110 gold coins to lend, and he made a new
loan to person D, who borrowed 110 coins for 3 years. Person D is
supposed to pay back 110 coins plus 30% interest. His debt equals (110
multiply by 1.3) = 143 coins.
        Now again (190+110)=300 gold coins are circulating in the country.
Persons B, C and D have to pay back
        
        120+130+143=393 gold coins.
        (393:300)=1.31=131%.

        Total debt increased to 131% of the amount of gold coins in
circulation.
        Two years later person B paid back 120 gold coins, and he is out of
the game. Now (300-120)=180 gold coins are circulating in the country
economy. Persons C and D still have to pay 130+143=273 gold coins.
        Now our moneylender has 120 gold coins to lend, and he made a new
loan to person E, who borrowed 120 gold coins for 3 years. Person E
has to pay back 120 coins plus 30% interest. His debt equals (120
multiply by 1.3) = 156 gold coins.
        Now again (180+120)=300 gold coins are circulating in the economy.
Persons C, D and E have to pay back
        
        130+143+156=429 gold coins.
        429 : 300=1.43=143%.
        
        Total debt increased to 143% of the amount of gold coins in
circulation.
        Person C earned and paid back 130 gold coins, and he is out of the
game. Now there is (300-130)=170 gold coins in circulation. Persons D
and E still have to pay (143+156)=299 coins.
        
        As we see, persons A, B and C have paid their debt. But they were
able to pay off their debt only because our moneylender was making new
loans, only because persons D and E borrowed money. Had persons D and
E not borrowed money from our moneylender, persons A, B and C would
not be able to pay 360 gold coins.
        As we continue to play this game, two things will happen.
        First, our moneylender will earn more and more interest. Second,
total amount of debt will grow bigger and bigger. It means that our
moneylender will own a bigger and bigger part of our little country.
        If our moneylender stops making new loans, the game is over.
Borrowers will not be able to pay their debt. More and more people
will find themselves in bankruptcy.
        This example illustrates the most fundamental principle of our
banking system. It's impossible to pay accumulated debt unless the
banking system continuously makes new loans.
         We should note, however, that when our moneylender spends money that
he earned as interest, that money is returned to the economy.
        The worst thing to happen is if and when aggregate debt is many times
bigger than the amount of money in circulation, and bankers slow down
creation of money.
That is a recipe for economic depression.

M3 is $9 Trillion, but aggregate debt is more than $20 Trillion,
without interest. With interest, it should be roughly twice that.
        Can we pay $40 Trillion of debt, if amount of money in circulation is
4 times less?

--Michael Vilkin

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