Strictly speaking, it’s impossible for the world to be in debt. All borrowing nets out somewhere in the world, since we don’t borrow money from people on other planets.
But does this mean the entire world can’t be wildly leveraged? No, quite the contrary.
Imagine an entire world in which we devoted the bare minimum of our physical and human resources to things like oil exploration, food growing, bridge repair, drug discovery and building maintenance. We’d be highly leveraged in the sense that any unplanned event (e.g. a tornado, an earthquake, or a new strain of flu) would be devastating.
Conversely, the world could “save” a lot by devoting resources to such contingencies: so, we’d keep more grain in grain elevators, and we’d always have people performing infrastructure maintenance, so that they could survive natural disasters.
But again, in both the scenarios — the highly leveraged one, and the one in which we’re saving a lot — our net debt = $0. Neither scenario would show up in any recognisable, financial balance sheet.
Now this is precisely the opposite of what happens on the individual level. If I live a life only focusing on the short term, by consuming as much as I can right in this instant, and doing very little to plan for the future, then my personal balance sheet will likely reflect significant leverage.
And if you are a paragon of thrift, always delaying gratification for a later debt, while working two jobs diligently, you’re bank account is likely to be heavily padded.
So financial leverage and lifestyle align nicely on the individual level, but the correlation falls apart on the macro scale — no matter how humanity lives as a whole, the balance sheet will always look the same.
It’s almost like physics, whereby the rules that govern us on the molecular level don’t actually apply when it comes to astrophysics — hence the search for a unified theory.
This paradox becomes important if we’re trying to understand what it means when a country like the US is in so much debt. Our tendency is to think of the US as a badly-in-debt person (like Michael Jackson) and to think of the Chinese as a big saver. But is it right to think of the US as an individual with a debt, or is it somewhere else on the continuum.
When we’re confronted by charts like the one above, which shows an explosion of federal debt (seemingly taken on just to pay off past debt), it’s easy to think that we’re totally screwed. On the other hand, despite the amazing amount of debt we’re issuing, it doesn’t appear, as J. Brad Delong notes, that we’re having any trouble selling it at all. It all seems to be balancing out, shockingly.
The problem gets thornier when we try to think of what it really means to borrow money from the Chinese. For example, it’s often said that Chinese savers helped us fund our housing bomb by snapping up boatloads of agency debt. But is it really true that if the Chinese weren’t saving their money — say, if the Chinese citizens spent more on clothes, movies and education — that we wouldn’t have been able to build up all those homes out West with the help of migrant workers? The answer to that isn’t instantly obvious.
The point here isn’t to offer an explanation, but to just poke some holes into easy thinking on debt and leverage, and how these concepts change in definition when you go from the individual scale, to the nation scale and to the world scale. Given the extreme focus on debt right now (cause we have so dang much of it), this is definitely a worthy area for re-examination.
Any thoughts or pointers to discussions/books/papers along these lines are very much appreciated.
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