The Debt Jubilee – “There ain’t no such thing as a free lunch”

By September 3, 2018Economics, Finance
The Hutch Report

It should be no surprise to anybody who has been reasonably informed about what has gone on in the last 15 or so years that debt is becoming a burden. This has become an issue not only in the US but pretty much everywhere all over the world. The debt has come in many forms such as student loan debt, credit card debt, medical debts, personal loans, and on a national scale you have the national debt, underfunded pension liabilities, medicare etc. 

The big issue is how to manage it. A few are talking about it but only in the form of a warning, “someday soon we will have to deal with it.” They keep pushing it off. However the longer you push off a problem like the one we face, the more pressing the problem becomes and that tends to eliminate the bulk of your options to deal with it when it really comes due. 

There has been a potential solution that has been bantered about for the past few years. However, it has been presented as the only solution that will be left when it becomes too late to entertain any others. The solution is known as the “Debt Jubilee,” or debt forgiveness. It means what its name implies, that if someone owes you money you just forgive the debt. The debtor is no longer required to pay back the money he/she owes.

This idea has in fact been around for a long time. Historians have counted around thirty episodes of general debt cancellations from 2400 to 1400 BC, noting they were occasions of great festivity which often involved the physical destruction of the tablets on which liabilities were recorded. One of the most famous episodes of debt forgiveness comes from ancient Babylon (modern-day Iraq). In 1792 BC, the self-proclaimed King Hammurabi of Babylon forgave all citizens’ debts owed to the government, high-ranking officials, and dignitaries (read more from our post about Hammurabi here). The Code of Hammurabi, which currently sits in the Louvre in Paris, declared:

“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” 

The main thing to remember is that at that time the main creditor in most cases was the King himself, and/or institutions closely aligned with the monarch. It was relatively easy for the King to abolish debts owed directly to himself or the royal institutions, or even to a substantial proportion of wealthy creditors.

Debt forgiveness was also practiced during the time of the Old Testament. In Jewish Mosaic Law, every seventh Sabbath year saw the wiping away of all debts, where creditors cancelled all the obligations of their fellow Israelites. Every 49th year (seven Sabbath years) was the ‘Year of the Jubilee’ when freedom from all debt and servitude was proclaimed throughout the land.

This practice of debt forgiveness was not purely altruistic on the part of the creditors and ruling class. History has shown that if debtors become too enslaved to their creditors and ruling class, too disenfranchised, it opens the door for opposers or competing rulers to recruit the debtors in revolts to overthrow the ruling class. In current times, protests such as those led by the Occupy Movement show that these issues are still prevalent today and are never too far from boiling over.

At the end of World War I, Europe emerged mired in debt and in a depression. By the mid-1930s, many countries began to abandon the Gold Standard in an attempt to reflate their economies without the burden of an exchange-rate system. As part of this process, most of Europe’s governments had a significant portion of their liabilities written-off for good.

As recent as World War II the practice of debt forgiveness has been exercised. Following the end of WWII, the London Debt Agreement of 1953 saw the abolition of all of Germany’s external debt. The total forgiveness amounted to around 280% of GDP from 1947-53. This last episode is important because it is central to why a debt jubilee may not be the panacea that many believe. 

Michael Hudson highlighted why jubilee, debt cancellations, cannot now be replicated exactly:

“……the main credit/debt transactions initially were undertaken directly between the (ultimate) creditor and (ultimate) debtor. The largest credit relationship was between the government and taxpayers. Nowadays a very large proportion of all financial transactions are intermediated via financial institutions. Any attempt to cancel some category of debt, say government debt or personal mortgages, would immediately drive those financial intermediaries holding such assets, e.g. banks, pension funds, investment trusts, into insolvency.”

There are many economic and ethical problems with the debt jubilee concept. It would essentially amount to the government stealing wealth from all lenders and giving it to all borrowers. The more nefarious or corrupt you were prior to the jubilee, the more you would make out like a bandit as a result of the jubilee. A debt jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. In an era of secu­ri­tized finance, the own­er­ship of debt is engrained in society in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend. Debt forgiveness would eventually destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders. 

As we mentioned earlier, the example of Germany’s debt foregiveness after World War II is an important one. LSE Professor of Economic History Albrecht Ritschl conducted research into how Germany was able to pay off its debts after the two World Wars:

“In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II.”

When polled whether or not Greece should be the recipient of some form of debt cancellation from the eurozone, only 16% of polled Germans agreed. The irony may have been lost on some.

The world’s financial system is more interconnected than ever. Debt forgiveness would take on an unimaginable complexity. There are a large number of counter-party risks as shown by the Deutsche Bank example below:

The Hutch Report

This would no longer be a one to one abolishment of debt as in the days of Hammurabi. Any debt forgiveness of one party would affect a number of other parties. As free market economist Milton Friedman once said, “There ain’t no such thing as a free lunch.” It may be time to devise another plan, and quickly.