A Society Living on Credit Creates Inflation and Financial Crises

While Europe is at war and mobilizing enormous sums for arms deliveries, the banking sector and the financial markets are starting to crack. We are not referring to the Credit Suisse debacle, which at best has only an indirect connection with a new financial crisis that is on the horizon. Rather, the collapse of Silicon Valley Bank is a frightening flash in the pan: The financial markets have not only become accustomed to cheap money, but because of decades of low interest rate policy they have now accumulated risks that can unload at any time.

After the last financial crisis in 2008, people were bailed out and regulated for all they were worth. However, the false security created primarily by quantitative easing created precisely the incentives that preprogrammed the next disaster. Regulations can also create cluster risks, because now everyone is doing the same thing and thus going blind in the same eye. People think they have learned from the past but false security creates the same mistakes in a new guise.

One cluster risk is the government bonds that dominate the financial system—securities, in other words, that are nothing more than government debt assumed by the banking system. They are the fruit of monetary state financing on a gigantic scale under the leadership of the central banks. Debt that has been taken on by politicians since 2008 for bank bailouts, euro bailouts, pandemic reconstruction funds, the Green Deal, and more.

A Monetary System that Is Up in the Air

On the balance sheets of commercial banks, but above all of central banks, these debt instruments appear as seemingly safe assets. This may be true in nominal terms, but these securities are not what they are cracked up to be.

Above all, the rising interest rates are leading to their devaluation. And that means that the values with which currencies like the dollar and the euro are collateralized—government debt on the balance sheets of central banks—do not exist at all. They decrease the more interest rates rise and governments, that is, the debtors, get into trouble because of rising interest rates.

Hanging in the air is our monetary system, which is largely based on credit money, that is, money in the form of debt. As soon as the markets—ultimately the population—lose confidence in the creditworthiness of debtors, there will come the crash of currencies like the dollar and euro, which are backed primarily by sovereign debt.

Something analogous happened in 2008, but to a much lower degree, when the international banking system was infected with mortgage-backed securities of miserable quality. After the bursting of the government-fueled real estate bubble in the U.S., the banking system also came to the brink of the abyss. With new regulations and even more money at zero cost, they now tried to be smarter than the supposedly irrational market. However, if every cleanup is prevented and postponed, the regulating forces of the market will eventually come fighting back all the more aggressively.

The process of erosion of our money is now additionally accelerated in the short term as a result of inflation and its opposition in the—in itself salutary—increase in key interest rates. Of course, inflation is the consequence of the very policy that was intended to do so much good. The tragedy is that it is precisely the fight against inflation that is likely to bring the banking system back to the brink of the abyss, that is, to bring about precisely what inflationary monetary policy was intended to prevent.

An Early Warning of Inflation already in the Middle Ages

In the end, the timing of which no one knows, there will come what has always come at the end: debt haircuts or monetary reform to attempt a new start in monetary policy. However, if this is not combined with drastic economic reforms, it will only lead to the expropriation of citizens in favor of debt relief for the states. As we know from history, the political risks and distortions of these anti-market—and extremely anti-social—policies are incalculable.

It should be clear at least by now that this is not a topic for economists alone, but one for enlightened citizens in general. As early as the 14th century, the French bishop Nicholas of Oresme said in his treatise De mutatione monetarum that devaluation of money was a fraud on the citizens, because money was the fruit of their labor and their property, not that of the princes—that is, the state.

The devaluation of money at that time was carried out through coin debasement with the purpose of expanding the money supply for the financing of political projects. This was, according to Oresme, nothing more than a hidden and particularly perfidious tax, because the citizens could not defend themselves against it.

The same thing was recognized centuries later by John Maynard Keynes, a Briton regarded as one of the greatest economists of the 20th century—but this time it was not to fight inflation, but to extol it as a particularly effective means of stimulating the economy. Keynes’s ideas have substantially inspired the cheap money policy of recent years. However, it is unworthy of a liberal, constitutional and democratically constituted society and is more typical of ancient and medieval despots.

Capitalism as the Scapegoat and the Demographic Trap

However, society, the citizens of the Western industrialized nations, are happily playing along with this game: “As long as the host keeps on borrowing, they are happy and unconcerned,” says Goethe’s Mephistopheles in Auerbach’s cellar, adding maliciously: “The little people will never feel the devil, even if he had them by the collar.” The problems of our financial system are ultimately the problem of a society that lives on credit, does so willingly and refuses to accept responsibility for the consequences. When things go wrong, they like to blame it on capitalism.

Admittedly, capitalism is a driver of welfare and consumption. But living on credit, the debt-making of the public sector—as well as the private sector—and living beyond one’s means…the sense of entitlement, receiving social benefits while lying in a hammock, with debt-financed rescue packages everywhere just to avoid painful corrections: none of this is capitalist and it cannot work in the long run.

In addition, there is now the demographic trap: the productive population of our rich Western industrial nations is shrinking. Immigration cannot make up for this, because among the immigrants there are too many who cost society, especially the social systems, more than they contribute. This is particularly true of our pension systems, for they are largely based on the pay-as-you-go principle, which contains an internal contradiction.

Retiring Baby Boomers: A Time Bomb Pay-as-You-Go System

As a report published in 2005 by the then German Federal Ministry of Economics and Labor (BMWA) shows, in this system “you already acquire a pension entitlement if you finance your parents’ generation by paying contributions. The fact that one has children oneself is not important. Without children, however, the pay-as-you-go system collapses.”

The current system has to be kept alive with tax money or debt. Now the baby boomers are also retiring, but they did not make provisions for this. Because they had too few children—the increasing shortage of skilled workers is just one of the consequences. They financed not only their own prosperity on credit, but also their future—their pensions. Now the next generation is being asked to pay for this. The redistribution from young to old in our social system has already begun. At the same time, life is becoming more expensive—another consequence of an overly generous and inflationary welfare state.

Of course, the baby boomer generation also worked hard and created the prosperity that future generations can now enjoy. Nevertheless, their lifestyles were neither sustainable nor future-oriented. Please note that I mean this in purely economic terms, not in a moralizing way.

Affluent Society on a Collision Course

Those who criticized “consumerism” in that generation that lived on credit saw the problem, of course, in capitalism. In reality, the opposite is true. For capitalism is based on productive work and saving, which is primarily nothing other than investing private property at one’s own risk—with the hope of profit through value creation that makes everyone better off. But this is the opposite of living on credit.

Calls to rethink things will go unheeded. Because our affluent societies are like giant steamships on a collision course, where course corrections come too late. Many things cannot be changed overnight. Moreover, many people in the engine room and on the bridge do not see the problems, nor do they want to see them.

Politicians are helped by the climate hysterics, the prophets of the end time, the despisers of the free market, and the many forms of capitalism bashing. For they legitimize politicians to keep setting up new aid, new rescue plans and sustainability programs, and to continue with debt-financed state charity. Maybe good prospects for politicians who want to be re-elected, but bad for the citizenry as a whole.

This article originally appeared in the Neue Zürcher Zeitung of 13. 4. 2023, p. 31, under the title “Das vergnügte Leben ist vorbei” and online at nzz.ch under the title “Eine neue Finanzkrise droht – doch nicht der Kapitalismus, sondern die Gesellschaft auf Kredit trägt die Verantwortung.”