Using an analogy with ancient Babylonia as its leading motive, this Viewpoint argues that the credit crisis is the symptom of an underlying problem. Fuelled by government policies, unprecedented debt levels were run up in industrialized countries over the last quarter century. Present policies of financial sector bailouts are not only unwise use of taxpayer’s money. They maintain economic structures opposed to what Classical liberals such as JS Mill envisaged as a free market economy.credit crisis; debt; Babylonia; Mill; Liberalism

Bezemer, Dirk J

English

Research Papers in Economics

  1 
 
Economic Viewpoint 
 
 This is not a credit crisis - it is a debt crisis* 
 
Dirk J Bezemer 
 
 
ABSTRACT 
Using an analogy with ancient Babylonia as its leading motive, this Viewpoint argues that 
the credit crisis is the symptom of an underlying problem. Fuelled by government policies, 
unprecedented  debt  levels  were  run  up  in  industrialized  countries  over  the  last  quarter 
century. Present policies of financial sector bailouts are not only unwise use of taxpayer’s 
money. They maintain economic structures opposed to what Classical liberals such as JS 
Mill envisaged as a free market economy. 
 
Key words: credit crisis, debt, Babylonia, Mill, Liberalism 
 
 
What Babylonians Knew 
When he took office as leader of the most powerful nation on earth, his first act was to 
legislate a debt workout for the beleagured economy. Under his predecessors, the public 
financial  system  had  produced  a  bad  debt  problem  that  now  threatened  to  crush  the 
economy. Many of his citizens had to pledge their incomes in debt servicing and financial 
fees.  Others  lost  their  homes  and  land  as  foreclosures  were  rampant.  His  people  were 
looking to him for change and for relief. 
No, this is not about Obama. The year was 1792 BC, the nation was ancient Babylonia 
and the leader was king Hammurabi. The workout was in fact a plain debt cancelation, or 
‘Clean  Slate’  -  a  social  mechanism  that  allowed  ancient  civilizations  to  prevent  their 
financial sectors from ruining the real economy and family livelihoods.  
Recent  archaeological  finds  of  shubati  clay  tablets  (ancient  ledgers)  indicate  that 
Babylonia developed an extensive public financial sector. Its administrators had mastered 
the  mathematics  of  exponentiation  and  applied  compound  interest  rules.  They  used  a 
precursor to modern double-entry bookkeeping and grasped its fundamental tenet that for   2 
 
every asset there is a liability, and for every credit a debit. Their economic thinkers realized 
that financial sector expansion would bring exponential debt growth, inevitably beyond the 
economy’s ability to pay. Their system of financial regulation was for rulers to periodically 
declare a Clean Slate. This applied to debt denominated in barley (the household staple) 
which families owed to the temple-state public financial system. Households had typically 
run  up  such  debts  as  liabilities  for  crop-sharing  rents  and  water  fees.  In  contrast, 
commercial  debts  by  traders  and  denominated  in  silver  were  not  forgiven.  Ancient 
Babylonians recognized the difference between the consequences of commercial risk taking 
which traders could carry, and the consequences of financial liabilities created by public 
sector policy, which threatened households’ livelihoods (see Wray, 2002; Hudson & Van 
de Mieroop, 2002; Hudson & Wunsch, 2004). 
You could be forgiven for mistaking the US (or the UK, for that matter) for a debt-ridden 
Babylonia  on  the  eve  of  a  Clean  Slate.  Though  3,801  years  apart,  the  similarities  are 
striking. But at least the Babylonians had learnt how to deal with debt before it crushed 
them. At the moment, we haven’t. It is the elephant in the room that no one talks about. 
 
Credit Boom, Debt Growth 
From the mid-1980s, most industrialized economies implemented financial policies that 
stimulated  a  credit  boom  without  debt  management  provisions.  As  any  Babylonian 
economist could have predicted, the debt overhead imposed on their real sectors has since 
grown  unchecked  and  exponentially.  Stimulated  by  public  policies  of  generous  credit 
facilities and artificially low interest rates, banks moved away from their traditional role of 
deposit takers and credit providers to households and business, and engaged in merchant 
banking and securities trading. In creating and trading in financial innovations such as the 
now-infamous collateralized debt obligations (CDOs) and similar instruments, they created 
serial bubbles in dotcom stocks, real estate, and currency trade. All this happened not only 
with the tacit approval of government, but with its active support via monetary policy. Now 
that the grapes turn sour, this support continues in the form of bank bailouts at the costs of 
real-sector  employment,  profit,  jobs  and  even  homes  -  a  perversion  of  the  Clean  Slate 
philosophy. Our real problem is not that credit flows have dried up. It is that we have not 
even started to recognise what was central to Babylonian financial management. Debt is the 
problem, lack of credit is a symptom. 
The size of the debt had grown out of control well before the credit crisis broke. Total 
liabilities from the US real economy to its financial sector amounted to only 1.5 times its   3 
 
GDP in 1980, but the multiple rose to 2 (1985), 3 (1996), 4 (2003) and then 4.7 (2007) 
(BEA,  2009).  Growing  ‘investment’  in  financial  assets  came  at  the  price  of  diverting 
finance from investment in US manufacturing structures from 5.5% of its GDP in the 1970s, 
down  to  4%  (1980s),  3%  (1990s)  and  then  below  2%  (2000s)  (BEA  2009).  It  also 
diminished demand for real output. US households in 2007 paid over a fifth of their after-
tax, disposable income to the financial sector in debt servicing and financial fees. The US 
had become an economy trying to drive with the brakes on. 
Debt growth can be understood by herding behaviour, falling costs of credit during the 
recent boom, and since with compound interest, each loan requires additional debt creation 
for loan servicing. So in a number of ways, loans beget loans and without regulation, debt 
growth is self-propelled. With active government encouragement, it is a swelling tide. We 
tried to ride that wave for two decades, but it is now time to build a dike. The flood is such 
that no one will keep dry feet. But at least the real economy of households and businesses 
should be saved from drowning. 
The current debt burden was obscured for a time by the illusion of wealth during the long 
asset price boom-turned-bubble of the last quarter century. Thanks to rising prices of real 
estate and its derivative instruments, US households’ ‘net worth’ increased from 4.7 times 
disposable household income in the 1980s and 1990s to a multiple of 5.9 in 2000 and 6.1 in 
2007. The inevitable end to the asset price rally came with the turnaround in the US real 
estate market in the summer of 2006. Sudden net negative equity impaired households’ 
ability to keep borrowing against asset values to keep paying for a growing debt. Bank 
lending came to a standstill, but not debt repayment. 
 
The Misplaced Sanctity of Debt  
And yet it is unwise to try and pay off this debt, and so to favour banks as creditors over 
households and firms, their debtors. This policy relies on the image of banks as passively 
supplying loans demanded by the public, which must therefore now face the consequences 
of its choices. This image stands in stark contrast to reality. The debt was run up recklessly 
in  a  lending  spree  where  commercial  banks  and  Central  Banks  (foremost,  the  Federal 
Reserve and the Bank of England) worked together to keep credit flowing. There is no 
moral imperative for debtors in the real economy to shoulder the bulk of the costs now that 
the boom has turned into crisis. Neither is that feasible. The debt represents a burden far 
beyond what the real economy can pay off, even if it keeps trying (as it now does) for 
decades to come. The current attempt is futile and harmful. It drains resources away from   4 
 
real demand and investment and absorbs any government package intended to stimulate the 
real economy. This is worse than driving with the brakes on - it is like trying to start up 
with the brakes on. It cannot be done. 
What is true for the US is true for the global economic system. Outstanding derivatives 
have reportedly reached USD 1.14 quadrillion worldwide (BIS 2009). But policymakers do 
not seem to realize what was plain to your proverbial Babylonian economist. The credit 
crisis is the symptom, the debt is the cause. Without a debt workout, recovery is beyond the 
horizon no matter how many bank bailouts. Present policies of financial sector support are 
the inverse of a Clean Slate – they artificially maintain debt claims by keeping so many 
creditors in business to pursue their debtors. For all our economic sophistication, ancient 
Babylonians would be stunned by our lack of perception. 
 
Classical Liberalism’s View of Rentier Incomes 
As with all bad debts, rescheduling will be inevitable. The choice is to do it now or to do it 
later, after subjecting the real economy to a prolonged drain of liquidity, employment and 
income. So why don’t we face the music? 
The reason is that a debt workout will one way or another hurt financial institutions 
living on debt servicing income. The current consensus is that this must be avoided since it 
will harm the real economy as well. But for a sizeable chunk of the merchant banking and 
securities management segments within the wider financial sector, this assumption does not 
hold  water.  Their  business  plan  was  simply  to  manipulate  asset  prices.  Their  role  in 
supporting real-sector investment was negligible or negative and the knock-on effects of 
their demise on the real economy may be limited or even positive. Their relation to it was 
more parasitic than symbiotic anyway. Today’s economists shy away from the inevitable as 
they are trained to think of the financial sector in toto as indispensable to the real economy. 
It  needs  to  be  protected,  with  no  distinction  between  its  productive  and  unproductive 
investments. 
Classical  liberalism  had  a  very  different  view.  Its  vision  of  a  free  market  included 
freedom from the burden of rentier income (as, for instance, enjoyed by land owners). 
Liberalism’s  intellectual  giant  John  Stuart  Mill  made  an  important  distinction  between 
capital  used  productively  and  capital  kept  idle  by  government  taxation  and  by  rentier 
claims. Payment for such privileged asset ownership, Mill (1848) wrote, “is not one of the 
expenses of production; and the necessity of making the payment out of capital makes it 
requisite that there should be a greater capital ... than is naturally necessary, or than is   5 
 
needed  …in  a  different  system.  This  extra  capital,  though  intended  by  its  owners  for 
production, is in reality employed unproductively.” 
Banks today operate under a state-given privilege to create and trade financial assets. If 
managed well, these assets help the real economy to save, to invest, to smooth consumption 
and to diversify risk. But just like the landed gentry in Mill’s days, the financial sector has 
the power to inflate asset prices, reaping windfall gains which simultaneously raise the 
costs of production to the real economy, so smothering its progress. When this dynamic is 
set  in  motion,  those  parts  of  the  financial  sector  specialising  in  windfall  gains  expand 
rapidly and the real sector (where most jobs and profit are generated) stagnates, as has 
happened in the US and UK since the 1980s. In this constellation, there is not synergy but 
conflict of interest between the financial sector and the real economy. 
Monetary policy and the public debate have neglected this reality since the 1980s. The 
constructive role of finance in economic growth was widely publicized during the credit 
boom in textbook lore, academic research and business journalism. Its potential for draining 
the real economy of liquidity - the lifeblood of economic transacting - in a boom-gone-bust 
was underreported, but has recently become painfully clear by demonstration. Of course, it 
really is age-old. 
Mill (1844) already warned that “the inclination to borrow has no fixed or necessary 
limit”… and that a banker responding to this by ”issuing paper which is inconvertible, 
levies a tax on every person who has money in his hands or due to him. He so appropriates 
to himself a portion of the capital of other people, and a portion of their revenue.” Mill the 
moral philosopher is also clear that he considers this an “iniquity”. His problem with taxes 
was  that  it  ”…  limits  unnecessarily  the  industry  of  the  country:  a  portion  of  the  fund 
destined  by  its  owners  for  production  being  diverted  from  its  purpose,  and  kept  in  a 
constant state of advance…" (Mill, 1848). Today, a fifth of the disposable income that 
Americans could spent in support of the productive economy is kept “in a constant state of 
advance” to the financial sector, with active government support. This implicit tax is the 
iniquity to be redressed. 
 
A New Policy 
The drain of liquidity from the real economy to the financial sector must be decreased for a 
recovery to start. The important point is that it is, in Mill’s words, not “naturally necessary”. 
We can do without much of those financial claims, and the firms that live off them. Really, 
we can. This comes as a shock to economists, policy makers and the public who have been   6 
 
told for decades that the financial sector is to be nurtured, and now to be saved. But this 
view ignored the productive and unproductive roles that the financial sector can play, a 
distinction central to classical liberal economics and its social policy. A shrinking of the 
financial sector - its most speculative part, preferably – by allowing bankruptcies would 
proportionally force it to relinquish its stifling debt claim on the real economy. That part 
has only loose links to real-sector investment if any at all, and the collateral damage will be 
limited, certainly less than today’s alarmist scenarios prompting us to pour more money 
into speculator’s pockets. In contrast, shrinking would improve rather than impair the now 
bloated financial sector’s ability to serve the real economy. Not all that long ago, the US 
economy did well with a financial sector only a third of its present size. Do we really need 
all of the other two thirds? 
We should move away from supporting finance in toto. The new policy should be limit 
support  to  banks  that  serve  the  real  economy.  If  some  of  the  other  financial  firms 
specializing in asset price manipulation go bust, this will not the end of the world. This, 
after all, is what bankruptcy is for. It is a legally acknowledged and orderly debt workout 
mechanism and the natural consequence of commercial overexposure. Inevitably, there will 
be collateral damage to investors among firms, households and pension funds. To the extent 
that  this  has  real-sector  repercussion  via  falling  demand  and  incomes  there  should  be 
provisions  to  compensate.  This  may  be  financed  out  of  the  liquidity  withdrawn  from 
today’s blanket bank support, so it need not come at an extra cost. Most importantly in the 
longer  term,  this  policy  will  allow  the  debt  overhead  -  and  the  speculative  part  of  the 
financial sector - to shrink back to more normal levels. This latter objective is important 
and is not achieved under present policies. 
So let market forces work to effect a solution to the debt problem that underlies the 
credit crisis. As soon as a debt workout is put in place, recovery can start - but not earlier. 
Learn from Babylonia. 
 
Dr Dirk J Bezemer is a Fellow at the Research School of the Economic and Business 
Department, University of Groningen in the Netherlands. His research is in comparative 
economic systems. Contact: d.j.bezemer@rug.nl 
 
 
   7 
 
* I thank Michael Hudson and Michael Ellman for helpful comments on an earlier version 
of this paper and Arno Daastoel for help with locating data. 
 
BEA (2009) Data from the Bureau of Economic Analysis at http://www.bea.gov. Accessed 
March 2009 
BIS  (2009)  Data  from  the  Bank  for  International  Settlements  at  http://www.bis.org. 
Accessed Marc h 2009 
Hudson, M and M vd Mieroop, eds.  (2002) Debt and Economic Renewal in the Ancient 
Near East. Baltimore: CDL Press 
Hudson, M and C Wunsch, eds. (2004) Creating Economic Order: Record-Keeping, 
Standardizations, and  the Development of Accounting in the Ancient Near East. Baltimore: 
CDL Press 
Mill, JS (1844), Essays On Some Unsettled Questions of Political Economy, Essay IV: On 
Profits, and Interest.  At http://www.econlib.org/library/Mill/mlUQP.html 
Mill, JS (1848), The Principles Of Political Economy: With Some Of Their Applications 
To Social Philosophy, Book I, Chapter 4: Of Capital. At 
http://www.econlib.org/library/Mill/mlP4.html#Bk.I,Ch.IV 
Wray (2004) (ed.) Credit and Sate Theories of Money: the Contributions of Michael Innes 
Cheltenham UK: Edward Elgar 
 

This is not a credit crisis

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