What do we owe whom? What exactly do we owe? When is it due? How is payment made?
These four questions form the basis of all relationships between a giver and a recipient. Before I get into what debt represents in a historical and economic context, let’s just stop for a moment and discuss the act of giving and receiving in our daily lives.
Are we freeloaders who abuse the generosity of others? Are we people who simply take and do not give when it’s time to return the favour? And lastly, are we individuals who take and return considerably less than what we have received?
I don’t know a single person in this world who likes to be characterised by these traits, but unfortunately, these are commonly-known behaviour patterns that exist in human nature. If any of the above sounds like you, be warned—you might have an old friend in your karmic bank balance named Debt.
The Transaction of Exchange
The act of exchange—giving and receiving—is characterised and interpreted differently across the world. Money—and any form of energy exchange—functions universally as an instrument to settle debts and garner future favours. Each and every single one of us takes on debts—both social and financial—and are obligated to honour them.
The Vaniya seafarers of the 18th and 19th centuries followed the lunar Naroj calendar—a maritime schedule that guided their planning in navigation and sailing across the ocean. The calendar is derived from the Iranian New Year and served as a standard method for seafarers to mark the passage of time while crossing the Indian Ocean. It also served an important function in marking the beginning and the end of a new accounting year and was indispensable in establishing dates for the settlement of debts throughout the annual trading season.
Debt is the cornerstone of the modern economy. In our current monetary system, money and debt are twins. We may choose to view debt and money as two separate financial instruments, but they share the same womb. Without debt, there is no money creation, no growth and no initiative to place our faith in a future that does not exist.
Society as a whole benefits enormously when the banking system operates efficiently. Economic growth and development are stunted when promising investment opportunities remain under-utilised because entrepreneurs, individuals and corporations are not able to get the financing they need to fully harness those opportunities.
A poorly structured or undeveloped financial system is an impediment to growth and economic prosperity–especially when money is allocated on a non-meritocratic basis.
The Twins of Debt and Money
Debt has existed as long as money has existed. Throughout history, debt and property ownership have been intertwined. Debt is inherently risky, but it is not dangerous–not till it reaches a certain level.
Part of the difficulty in ‘remembering’ a pre-money world lies in the fact that currency as a medium of exchange has been around for so long. Scottish philosopher Adam Smith who founded modern economic theory popularised the idea that barter was a precursor to money. He believed that the earliest humans had neither cash nor credit. They bartered–trading goods or services for mutual benefit–so the story goes. Any sort of transaction requires a measure of value or a medium of exchange–and even back in the day, there was simply no free lunch.
However, it is interesting to note that some scholars have proposed that the existence of debt predates the existence of money. Debt–the creation of obligations in cash or kind–has existed at all levels of society throughout the ancient world. The earliest-known money-lending activities have been identified in ancient civilisations that include Assyria, India and Sumer.
Interest-bearing loans first appeared in Mesopotamia, thousands of years before the first coins were minted in Lydia. In Mesopotamia, individuals who worked in temples, palaces and prominent households calculated loans based on commodity prices.
While trade indisputably occurred in non-monetary societies, it did not take place among fellow villagers or familial groups, but rather, was used almost exclusively with strangers, or even enemies. The idea is that to barter with someone suggests a deficit of trust. To do a deal on credit requires trust and confidence–in a future outcome or situation that does not yet exist.
The Reciprocity Between The Twins
It takes two to tango in any debt arrangement.
For a transaction to occur between two parties, it’s important to first understand what is exchangeable and for what. For instance, if I were to invite you over for dinner; a reciprocal exchange would (or perhaps should) be something of equivalent value. This sort of gratitude-induced obligation is timeless.
On the other hand, if I were to borrow a sum of money from a bank to finance my home or business, a transaction such as this one would take place in a commercial context, usually with a representative of a bank who is a complete stranger. This is a legal and contractual obligation–where both parties make a formal promise.
In both cases, we have an obligation to repay.
The relationship with the bank is highly formal; whereas the relationship I have to reciprocate for dinner is highly informal. Nevertheless, any and all relationships characterised by the notion of ‘debt’ are not mutually exclusive. Transactions between two people form a relationship between them. And with that comes the spoken or unspoken expectation that the relationship will continue on–be it among friends and family; or between a business and its customer. Someday, the recipient will have to return the favour.
In the case of investors and banks, these obligations shift the balance of power away from the recipient and towards the lender. In informal situations, the lender risks his own reputation if he treats a debtor without contrition. In the market economy, creditors have and can resort to punitive measures to restore order.
Which is why too much debt is inherently risky for both the debtor and the creditor. If the balance of power tilts too heavily in the favour of the lender, a whole society can collapse. Debt imprisonment was a common practise in ancient times has endured a long, bloody and revolting history. The practise may have started in ancient Mesopotamia, but it wasn’t till 1869 that the British Parliament banned debt prisons.
The Role of Banks
Interest-bearing loans started with the advent of agriculture. It is how farmers borrowed money now to repay in the future through the surplus they earned from their harvests. This endeavour was fraught with risk as gains on agricultural produce was uncertain due to unpredictable weather patterns.
From loans for seed money; to the lending of small sums and household objects as well as borrowing to cope with unforeseen crises–debts have characterised society since civilisation came into being. Loans even existed to allow the wealthy to support an élite lifestyle. Debt touches everyone–the destitute and the wealthy.
In today’s financial terms, debt refers to an amount of money borrowed by one party from another. Regardless of the sum involved, a debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, typically with interest.
People take on debts to pay for things that they can’t afford based on their income. It is how money that does not have a tangible existence is created and circulated within the economy. If the sale is the beating heart of a business, then consumer debt is the lifeblood of our modern economies.
Banks ordinarily raise funds from depositors, investors and their own shareholders. On the bank’s balance sheet, these funds are classified as liabilities because they impose an obligation on the bank to service the funds it has borrowed. It also imposes an obligation on the bank to repay these funds at some point in the future.
Banks, in turn, apply or invest the funds that they have raised from depositors, investors and shareholders by building a portfolio of assets that generate profits for shareholders. Typically, a percentage will be held in liquid forms such as cash or cash equivalents. For a bank to remain solvent, the value of its assets must always exceed the value of its liabilities.
Money for Nothing, But Not For Free
The sense that we ‘owe’ someone something is rooted in the notion that we have taken something that we didn’t have in exchange for nothing at all. Lenders assume a certain level of risk when they give out loans. But lenders cannot assume all the risk. The expectation is that a surplus return in the future is part of the contractual obligation of taking something in exchange for nothing.
For consumers, the habit of taking up loans for purchases that one cannot feasibly afford is how a person’s financial standing grows exponentially weaker as time goes on. The nature of debt is to accrue interest over time and this causes temporary financial gain, which is followed by financial burdens later on. The cost of the debt places a premium–known as interest–for giving something in exchange for nothing.
Interest rates can be both fixed and flexible. For instance, balloon payments have lower initial payments. They are ideal for companies or borrowers who might be facing cash crunch in the short term, but expect the liquidity to improve in the future.
To the average consumer, the banking system seems to have grown into a highly complex and intricate beast with colossal strength. But at the heart of the banking system is a vulnerability in the form of exposure to risk.
When borrowers borrow and lenders lend, it is with the view of a fixed stake of both time and money. The best way to avoid debt is not to borrow more than you can foreseeably repay. On the side of the creditor, they have to protect themselves against giving out loans that can foreseeably lead to bad debts and defaults.
The key role of banks in the financial system and the vulnerability of banks to sudden collapse; can lead to a total loss in the confidence of the entire banking system. Financial crises have occurred repeatedly throughout the cyclical course of history.
When lenders can no longer lend and debtors can no longer repay, there is quite simply not much that a civilisation can do to continue creating money. We would have to subsist on what nature provides in tangible terms with little opportunity to plan or create a future.
Which brings me back to the questions I asked at the very start: What do we owe who? What exactly do we owe? When is it due? How is payment made?
These are questions for both lenders and debtors to answer. Lenders should never give out more than they can foreseeably give. And debtors should never accept more than they can foreseeably repay.
If we stick to the rules of the game, we can cushion ourselves from the collapse that ensues when the balance becomes skewed beyond repair.
Our old friend Debt has been around for a long time and by the looks of things, he’s going nowhere. Best we realise that we are indebted to him and do our best to make our repayments responsibly.