What happens to debt when there’s too much of it?

Photo: Dodgerton Skillhouse

The short answer is, we pay it – one way or another. I remember a time when our family was struggling. I was responsible to pay the bills, and it got harder and harder. Finally, I couldn’t pay off the entire credit card balance for the month, and I had to tell my wife that we needed to have a conversation.

Usually, debtors knuckle down and organize their finances. The steps are clear: establish an emergency fund; pay down your credit cards; pay down your other debts, and save for retirement. Some things that aren’t on the list: a new car, a fancy vacation, beginning an expensive hobby. Excess debt makes us focus on the fundamentals. That’s what we had to do at home.

The same thing applies to businesses. Management wants to keep their jobs, above almost everything else. When they’re in over their head, they cut back on marketing, cut back on new projects, maybe even cut back on staff. Because the day they tell the bank that you can’t service their loan, the bank is in charge, not them. I’ve sat in on some of those meetings. No one comes out happy – not the bank, not the business owners, and certainly not the managers.

What happens to a country when there’s too much debt?

The short answer is, it depends. When a government doesn’t issue its own currency, it’s kind of like a big company. States and countries in the Eurozone and some other countries are in this boat. They have to bear down and manage their debts. But if a country issues its own currency, like the US and Canada and China and Switzerland, it can just print more. There are consequences to this. It’s called debasement. When a country issues more currency to pay its debts, the currency becomes less valuable. Ancient Rome did this when they added base metals to the Roman gold and silver coins. And when a currency is debased, the debt doesn’t disappear. It’s just transformed.

Roman Aureus. Source: Wikipedia

Excessive debt gets in the way when you want to do other things. Recent college graduates with big student loans find that they can’t buy a house. Municipalities that borrowed to build big school buildings or incinerators or convention centers that aren’t filled up find that they have a hard time meeting their other budget obligations. Debt is a useful servant, but a poor master. It lets individuals, businesses, and governments build productive capacity in hopes of higher future revenues. But when the borrowings are wasted, we have to knuckle down.

What will happen to all the Coronavirus borrowings?

Conventional wisdom says it will all be all right, that consumers and businesses will use the proceeds as a bridge to a coronavirus-free future. But if the money is wasted – on speculation, frivolous items, or something else – it still needs to be paid back. And all that debt will get in the way.

It’s possible that the massive corporate and government borrowings of the last three months will be used in the best possible manner, that the managers and bureaucrats in charge of the trillions in debt will shepherd it appropriately, and our economy will emerge from the crisis stronger than ever. It’s possible that the PPP Loans will be forgiven on schedule, that people will pay their rent to the landlords, who pay their mortgages to the banks, who deposit their excess reserves with the Fed, and the excess debt is retired. It’s possible.

Whether it’s likely is a different question.