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Why can't we just cancel all debt?

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During this time of global crisis, I have been talking to an unusual number of people about finance and the economy. Unfortunately, people tend to take interest in these topics a lot more when everything is collapsing than when things are going well. That’s just human nature, I guess.

During one of these conversations, a friend asked an obvious question that perhaps all of us should be considering: why can’t we just cancel all the debts and start over? It does seem like an obvious solution: cancel the monumental debt burdens that countries are racking up trying to save their citizens from the impact of the financial crisis, and the debts of individuals unable to pay their bills because of it, and everyone will be better off, right?

Central banks have essentially been doing just that in response to the global financial crisis of 2008. Quantitative easing (QE) is basically the cancellation of government debt. A central bank prints money and uses it to buy government bonds, which means the government owns that bond and its debt burden is reduced.

So why, then, can’t we just erase all the debt altogether and live happily ever after? Well, unfortunately, that’s not how our complex financial system works.

The truth of the matter is that all debt, whether it be government or household, is owned by someone. Often, this ‘someone’ is a pension fund that invests the savings of thousands or millions of people.

Some of these people will be young and stay in the pension fund for a long time before they retire. Usually, their money tends to be invested in more risky things, like company shares (equities). The price of these can fluctuate quite a lot, but the returns are also likely to be higher over the long term.

However, there will be a lot of people invested in the funds that are nearing retirement, and their money is often invested in less risky options. Traditionally, this has meant investing in debt rather than equities, because it is considered to be less volatile, meaning its value goes up and down less. This is usually the debt of companies or governments. But a significant amount of money worldwide is also invested in household debts such as mortgages (yes, the ones that caused the financial crisis).

If we suddenly cancel all these debts, then a huge proportion of investments globally will become worthless. By the first half of 2019, the total amount of debt globally surged to $250 trillion! This is an unimaginable amount to most of us. Cancelling all this debt would plunge the world into a crisis that would make the current one fade by comparison.

But isn’t a financial system that relies on debt to such a great extent extremely flawed, you ask? You would be forgiven for thinking so, and there is a growing school of thought which agrees that our financial system needs to change.

The global crisis we are in now is making more and more people speak up about how necessary this change really is. For example, I read an article in the Irish Times the other day which suggests we will need a new global reserve currency that could put a “worldwide value” on all debts and assets. But at this stage, we are still far from seeing what a new financial system would look like and how many changes we will need to implement to adapt to the post-pandemic environment. Let’s just hope those in power are worrying about these questions as much as us mere mortals!