The Whole World is Practically Insolvent

The people and all the countries of the world are collectively close to insolvency because their collective financial assets are only marginally greater than their collective financial liabilities. Also, although the world could never actually be technically insolvent (to owe more than it is owed), it could become insolvent in practical terms. Indeed, it might already be so.

There are two definitions of insolvency. One is when liabilities exceed assets. However, this state covers many individuals and businesses who are not normally regarded as insolvent because they have an income which exceeds their expenditure, including payments towards their liabilities. The second definition of insolvency is when expenditure exceeds income.

Bankruptcy
Bankruptcy normally only occurs when there is both an excess of liabilities over assets and of expenditure over income, for example, when the interest due on debts exceeds income, or when the excess of expenditure over income requires assets to be sold, until liabilities exceed assets.

All these quantities - assets, liabilities, income and expenditure - are measured in monetary terms, or what is called 'liquidity'. Non-liquid assets only have value if they can be sold for money. An asset that cannot be sold, no matter what price was paid for it, or what it might be considered to be 'worth', effectively has no value. Solvency is thus a matter of liquidity, which is to say, of having enough money.

To whom is the world in debt?
The question must thus arise as to whom is all the world's debt owed? What 'extra-terrestrials' are in credit with all the world's debtors?

The major creditors in the world are the commercial banks, the 'High St' clearing banks with which most people have accounts, and of which many were helped out during the initial stages of the credit crunch.

The banks themselves are also major debtors. Their debts form the world's money supply. Banks' debts are what most people regard as their 'money in the bank'. The banks have very little cash to back their liabilities, but they do have enormous financial assets. These are their customers' debts, which far exceed the banks' liabilities. By convention, a debt owed by a bank to a customer, which the customer can spend, is called money, whereas a debt owed by a customer to a bank, which the bank cannot spend, is not.

The UK money supply
The UK economy will serve as a microcosm of the whole world. In March 2011, the total UK stock of liquid assets was £2,165 billion, being the total UK money supply (M4). Of this total, £57 billion consisted of notes and coins, of which some £50 billion was held by the banks. The remaining £2,110 billion or so of the money supply consisted of £920 billion owed by one commercial bank to another (inter-bank lending) and the £1,190 billion owed by the commercial banks to their non-bank customers – individuals, businesses and government bodies - being their deposits with these banks.

Set against the liquid assets (money) of the non-banking part of the British economy, are our collective nett liabilities, which are the banks' assets. This consists of £1,450 billion of personal debt, mostly mortgages, some £500 billion of corporate debt, and about £550 billion of Government debt (out of a total Government or National Debt of £900 billion).

Total UK debt
The total amount of debt owed to the banks is more than twice the amount on deposit from their customers. The banks' ratio of assets to liabilities is about £2,500 billion against £1,190 billion (excluding inter-bank debt). This might seem to give the banks good financial security, but it does not.

There is a saying that if you owe the bank £1,000, you have a problem, but if you owe the bank £1 million, then the bank has a problem, and never was this fact more applicable than now. The banks' nett assets are almost entirely non-liquid. The banks continued viability depends upon the financial viability of their debtors, be they business borrowers or householders with mortgages. Unfortunately, many businesses and households are struggling financially because they are so heavily indebted to their bank.

In recent years, commercial property has fallen in value so much that the approach of the banks to commercial mortgages has become known as 'pretend and extend'. They pretend that the property has retained its value and have extended the period of their mortgages in order to maintain the fiction of the nominal value of their assets. In similar vein, they have become more reluctant to repossess homes, as doing so on a large scale would reduce house prices even more than the current rate of decline.

Economic growth needs more debt
Economic growth would end this log-jam, but growth requires an injection of more money into the economy, which in turn requires more people to borrow more money into existence. This is unlikely to happen given that so many people are so heavily indebted already, and given the fact that banks are already too nervous about the value of their existing assets to want to increase their liabilities (the money supply) against further assets (new loans) that could also go 'toxic'.

Debt repayment without growth
The only way that the country's myriad debts could be reduced without growth (and a necessary increase in debt) would be for everyone with any money to spend it in such a way as those with the debts could earn it and use it to pay off their debts. This in turn would reduce the banks' liabilities as the amount of money on deposit with them would fall to the same extent.

The problem with this approach is that if everyone did spend all of their savings, they would risk financial disaster themselves. There would be many more bankruptcies, both household and commercial, if fewer people had the financial cushion of some savings.

The eradication of the nation's bank accounts would see the money supply almost totally disappear, causing a complete collapse in the economy. We would still collectively owe at least £1,300 billion, with no means of paying it off. Possibly it would be soon be written off, but having returned to a sort of mediaeval pre-monetary economy, few people would care.

However, we would have a small collective nett positive liquidity (the £57 billion in notes and coins) for the first time since 1985 (Result!). We would not actually be collectively insolvent, but would be practically so.

All around the world
One can apply the same scenario across the world, not only within a country, but across borders. The Germans might complain that they are lending too much to the Irish and the Greeks, but what do they think that their money consists of? Their credit has to be someone else's debt. That is how the modern money system works. Very little money, of any currency, consists of purely positive money, such as notes and coins.

All around the world, one person's credit is another's debt, and the only way that the debtors can reduce or eradicate their debt is if the creditors spend their money with them. If the creditors refuse to spend their money with the debtors, but insist on selling them more stuff, lending them the money to buy it, they cannot in all honesty then complain when their debtors' debts continue to increase.

A zero-sum game
Debt-based money is a zero-sum game. The only way for no one to be below zero is for everyone to have zero. The only way that debtors can avoid bankruptcy is for creditors to spend so much of their money that they themselves risk bankruptcy. In practical terms this not likely, but given that creditors' credit is dependent upon the financial viability of their debtors, it is ultimately the only way that they can secure their credit.Debt-free money as a proportion of the whole

The money supply is not entirely a zero-sum game. In Britain, out of a total money supply of £2,165 billion (March 2011), £57 billion is not based on debt. This amounts to 2.6% of the total. In 1946, when the Bank of England was nationalised, notes and coins, the debt-free element within the money supply, was 46% of the total.In the following decades, both in Britain and around the world, this wholly positive, debt-free element of the money supply has steadily fallen, and as it has fallen, so the capacity for widespread solvency has also fallen.

It might seem impossible for the proportion to fall further, but it can, as less and less cash is used by people who increasingly prefer the convenience and security of various types of plastic. It is possible to envisage a world without cash, where there is no longer any margin between collective solvency and collective insolvency.

The solution
The solution to our economic problems is staggeringly simple. Ban the facility whereby commercial banks can create credit based on their borrowers' debts. Require all bank loans to be backed by the banks holding some form of positive, publicly-issued and government sanctioned money, whether as cash or as credits with the Bank of England, and then issue enough of such money to enable the economy to function without having to have people, businesses or the government itself massively in debt.