First published in the Telegraph on 14 January 2010
A few decades ago, archaelogists digging in modern-day Iraq made a remarkable discovery: the world’s first-known legal contract. The inscription was carved, 4,400 years ago, in Cuneiform text on the bricks of a temple in ancient Lagash, somewhere between Baghdad and Basra. To their surprise, it laid out not the punishments for thievery or murder, or some other formal commandment, but the terms of a cancellation of debt.
The more we have discovered about ancient Babylonian law, the clearer it has become that debt cancellation was a routine part of life. Indeed, according to the economic historian Michael Hudson, ancient states would regularly cancel the obligations of stricken debtors, who would otherwise be forced to sell their wives or mothers into slavery to appease their creditors. Even the Bible ordains that there should be a jubilee every 50 years, when debts will be forgiven.
Such policies were less down to over-indulgent rulers than to a pragmatic recognition: when debt mounts to a certain level, it becomes so destructive that creditors are better served cutting their losses than demanding it all back. The problem is that debt – whether money borrowed directly from a bank, or bonds sold on the market – obliges the borrower to repay a certain amount each month, or year. As anyone who has missed a few credit-card bills knows, falling short of your payments for even a couple of months will sharply increase your total debt, which in turn inflates the cost of those instalments. In the long run, a family – or a country – faces debtor’s prison, or its modern equivalent of bankruptcy, unless it can generate cash at a faster rate than the payments are racking up.
If we had briefly forgotten this ancient lesson, the past couple of years have been a painful reminder. The financial crisis itself may well be over, but an enormous burden of debt still hangs over the economy. Vast numbers of businesses and households are trapped in the debt spirals as are a growing number of governments. Just as for families, there is a point of no return for nations: once annual interest payments pass a certain level, the debt becomes effectively inescapable. Britain teeters somewhere near the brink of this situation, as do Japan, the US and several major states.
It is all the more bizarre, then, that in spite of the obvious dangers, governments sought to encourage indebtedness in recent decades. Indeed, the tax system in the UK (and other developed nations) promotes the raising of money through debt, rather than other, less risky methods.
At some point in the coming years, governments will have to face up to the fact that if they and their citizens intend to pay off their debts in full, it will consign them to a long and painful period of stagnation. So why not follow in our ancient ancestors’ footsteps and go the whole hog with a grand jubilee for modern debt?
It is an enticing prospect: wiping the slate clean could liberate so many people from the constraints of those monthly instalments that it would trigger a momentous economic recovery. But while such a move has the virtue of simplicity, it is hardly practical. For one thing, ancient kingdoms tended to be creditors, and so could forgive as much debt as they fancied. Western governments today are largely debtors. Moreover, a wholesale debt jubilee would so scare investors that in the future they would demand excessively high interest rates in exchange for loans, causing a lack of credit which would endanger our whole economic system.
And yet, beneath the radar, we are already witnessing a small-scale version of the jubilee. In some cases, debt is being cancelled for moral reasons. Late last year, an American judge voided one home-owner’s mortgage after concluding that the lender behaved in a manner “completely devoid of good faith”. Some expect a stream of similar legal decisions.
It is also happening in business. Since the onset of the crisis, banks have exchanged loans to stricken companies worth billions of pounds for shares in the firms themselves. The company is freed from the debt trap, but hands over partial control to the banks. Stephen Hester, the chief executive of the Royal Bank of Scotland, told the Commons Treasury Committee this week that because of such debt-for-equity swaps, his bank now effectively owns more than 1,000 companies.
And there may even be a jubilee for countries. Iceland looks likely to refuse to pay some of the debts it owes the British taxpayer, pleading an inability to do so. Whether we allow that remains to be seen, but it sets an important precedent: some of the most troubled countries will have to hammer out informal deals with their creditors when it dawns on them that paying back their debts is nigh-on impossible.
Should Britain follow suit, and try to make a clean start? It’s tempting – but painful as the process is, we are best advised to pay back our debts, rather than abandoning them. The time will come for us to reconsider our perverse relationship with debt. But in the meantime, we should not forget that the countries, and people, who come out of this crisis with a reputation for honest dealing and prompt repayment are the ones that will have easier credit, and a greater chance of prosperity, in the coming decades.