Finance – Gambling vs. Productive Input

I’m reading “Killing the Host” by Michael Hudson and feel compelled to share two excerpts from the book.

Saint-Simon, a French political economist, proposed that lending to businesses be done in exchange for equity not interest payments.

Saint-Simon’s key reform was to replace debt financing with equity ownership shares. If loan proceeds are invested to produce a profit, he argued, the borrower can pay interest out of the venture’s proceeds, as dividends from its earnings. Dividends on equity capital – literally, an ownership share – can be cut when profits decline. But bank loans and bonds bear interest that must be paid regardless of the fortunes of the debtor. Missing a debt payment may lead to default and forfeiture of assets when creditors foreclose. Saint-Simon laid out the logic for banks to take ownership shares in their customers rather than making straight loans.

This is what differentiates doing business from conventional banking.

The requirement to take an equity stake and assuming some of the risk of doing business (that your investment will end up being “lost”) is what prevents finance from holding the economy hostage and absorbing part of the output (which is also the income by definition). The economy does not become a “zombie economy” where further increases in output, i.e. growth, are absorbed into making the interest payments. This is what a debt deflation is and is what the world is currently experiencing (the current low growth can be blamed on more than a single reason, debt deflation and growing inequality are, according to me, the biggest culprits).

It is basic mathematics that the interest payments required from debt grow exponentially while growth happens roughly linearly. There are times when an economy suffers from slowdowns, even negative growth, that is never faced by interest payments. Interest payments display secular growth while economic growth is cyclical. Leaving the debt, and the interest owed, in place holds future economic growth ransom to the debt of a previous business cycle.

Modern finance has worsened the effect. Debt grows at rapid rates in modern finance thanks to two things – the introduction of virtual finance and leveraging. Leveraging was present in the past as well but the introduction of information technology allowed financial firms to grow debt at much more rapid rates as the information about contracts and cash flows became updated nearly instantaneously. If you are now thinking it is the introduction of IT to finance that is the source of problems, I should point it out that there used to periodic debt forgiveness events in ancient times that would erase all debt and interest owed to begin a clean slate for the people and the economy. The introduction of IT has merely led to the debt overhead being created at immensely quicker rates.

Charging interest on debt also exacerbates economic inequality as those already possessing wealth can simply choose to get a definite return on their wealth instead of risking their business input.

The sooner the economy is decoupled from interest-charging debt, the healthier will economic growth be.

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