Is Credit Leading to the Downfall of Society

Depending on who you’re talking to, credit can be the worst thing in the world, or the best. Not surprisingly, both positions are correct – in part.

The key to understanding this paradox is that there is “good credit” and “bad credit.” This is because the thing we know as “credit” is simply a promise to deliver a specific amount of wealth at some future date and time to a specific person, and there can be both “good promises” and “bad promises.” The serious danger in which our society finds itself – our entire civilization, in fact – is due in significant measure to the wrong use of credit, that is, the widespread use of “bad credit.”

While these terms are rather broad (and there are, as you might expect, exceptions in all cases), we will define “bad credit” as credit extended for something that does not generate its own repayment. Into this category we can put all credit cards for personal use, consumer credit for “non-durables,” government borrowing, school loans – anything that does not, by its own nature, generate cash income that can be used to repay the loan.

(Yes, school loans enable you to go to school and qualify you for a better job at a higher wage – but there is not direct correlation between attending school and getting paid for it. School loans are therefore “bad credit,” however contradictory that sounds. Similarly, borrowing to purchase food enables you to live so that you can go out and work for a wage, but very few people get paid for eating! An exception may be made for something like home mortgages – assuming that the dwelling purchased is bought at its real value, not an artificially inflated one – because a dwelling is a “durable,” and you are simply spreading out the purchase over the years of use … and paying a high price for the privilege of spreading out the payments. A house, unless it is rented, does not, however, generate a stream of cash income, and therefore borrowing to buy a home must be a very carefully weighed decision, and constitute a “semi bad” use of credit.)

We will define “good credit” as credit extended for something that DOES generate its own repayment. Into this category we can put the purchase of investments that generate enough profits to allow the investor to repay the loan used to acquire the investment, the purchase of plant and equipment by businesses, the purchase of agricultural land, and so on.

An important exception to this is the purchase of debt and equity instruments (i.e., stocks and bonds) on credit (a “margin purchase”) in the hope that the value of the instrument itself will increase, and then can be sold to pay off the loan and make a profit. This is “speculation,” not investment. The thing purchased is not expected to generate sufficient interest or dividends to repay the purchase price, and thus buying shares or bonds “on the margin” constitutes “bad credit.”

Unfortunately, given both government’s and citizens’ reliance on bad credit, society is in serious danger. The problem is made much worse because politicians and retailers continue to promote bad credit in the hope of realizing a short term profit that sacrifices the long term health of society. Virtually everyone can get consumer credit. Some groups have even promoted the idea that access to bad credit is a civil right, while politicians, fearful of being cut off from the “free money” (i.e., funding to which they are not accountable to the taxpayer), promote the idea that the economy cannot function without a public debt!

The solution is obvious once we realize and understand the difference between good credit and bad credit. Those who promote credit as a civil right have the right idea – all they need to do is reorient themselves away from consumer credit and start pushing capital credit, that is, credit used to purchase assets that will pay for themselves, and afterwards generate an adequate and secure income for their owners. If everyone had democratic access to capital credit, instead of consumer credit to make up for inadequate wage and dividend incomes, the danger to society would be over – at least from that quarter.

A proposal that would replace the bad use of credit with the good use of credit is called “capital homesteading for every citizen,” from the book of the same title. It bears investigating, especially at this time when the financial and securities markets are floundering for an answer that is right in front of their noses.