Here's What Could Cause the Next Financial Crisis

There’s no dispute that America’s gross domestic product cannot grow without government and private debt.

But paying down spiraling private debt broadly brings economic contraction: a recession or depression, argues Richard Vague, co-founder of two credit card companies and secretary of banking and securities for the Commonwealth of Pennsylvania 2020-2023, in an interview with ThinkAdvisor.

“The only way to remove [private-sector debt] without destroying the economy is through some type of debt amnesty,” contends Vague, who has been dubbed a contrarian economist.

Total U.S. household debt reached $17.06 trillion on Aug. 8, according to the Federal Reserve Bank of New York. 

Indeed, consumer credit card balances hit a record high this spring of more than $1 trillion, a $45 billion increase from March 31 to June 30.

What is not widely understood is that excessive private debt has been a prelude to nearly every modern financial crisis, including the global 2008 meltdown, as Vogue writes in “A Brief History of Doom: 200 Years of Financial Crises” (2019).

In his just-published book, “The Paradox of Debt: A New Path to Prosperity Without Crisis” (University of Pennsylvania Press-July 2023), he explains, among a wide range of iconoclastic ideas, how financial crises can be foreseen and prevented with modern-day “debt jubilees.”

This form of debt forgiveness dates back to ancient Israel. Earlier versions were used by kings of Assyria and Babylon, among other countries. Debt jubilees would bring “increased financial health to households” Vague maintains.

In the interview, he says: “We need modern-day debt jubilees to reduce accumulated debt and do it without destroying the economy.”

 “Small debt jubilees” are in fact frequently held, he notes.

Vague is calling for the Federal Reserve to pay considerably more attention to private-sector debt growth. “Usually, he says in the interview, “when we see a disaster, there are plenty of signals along the way.”

His background is largely in banking: He was co-founder and CEO of two credit card companies, one sold to Bank One, the other to Barclays. He also co-founded Energy Plus, a supplier of electricity and natural gas, which was sold to NRG Energy.

ThinkAdvisor recently interviewed Vague, who was speaking by phone from his base in Philadelphia.

In our conversation — which also covered inflation and “a highly controversial” remedy for growth without debt involving the Treasury and the Fed — a  sidebar exchange had Vague campaigning for the term “printing money” to be removed from the “economics lexicon.” This “misleading anachronism” is “bad shorthand,” he insists.

Here are highlights of our interview:

THINKADVISOR: What’s paradoxical about debt?

RICHARD VAGUE: Debt is both the creator and the destroyer. Economies can’t grow without an increase in debt.

When a company wants to build a factory or an individual wants to build a new home, they usually have to employ debt to do so.

What’s the “destroyer” aspect?

Debt can bring a great financial calamity, as in the 2008 financial crisis. 

And as debt accumulates, it weighs down an economy because individuals have to spend proportionately more and more on servicing debt than they would otherwise spend on carrying the economy forward.

You write that a crisis can be foreseen and prevented once attention is paid to what’s “at the heart of a crisis: excessive lending and debt.” Why aren’t the authorities paying attention?

One of the astonishing things is that the Federal Reserve’s economic forecasting model, widely used, doesn’t have debt as a factor. 

That’s because there’s the false notion that the real economy is separate and apart from the financial economy.

That’s why the Fed was completely blind to the massive build-up that brought the 2008 crisis.

How widespread is that “false notion”?

[It’s held by] most economists and is front and center in orthodox macroeconomics.

As wealth grows, so too must debt, you write. Then you say, “Ever-growing debt stultifies economic growth, exacerbates inequality and brings risk of financial crisis.” Is there a way to grow without debt?

In the way our economy is structured today, there isn’t. This is a very important fact.

The economy can’t grow without growth in debt. In fact, debt for spending and debt for growth and the GDP correlate almost exactly with each other for that very reason. 

That’s why debt always grows as fast or faster than GDP. It’s dependent on debt growth.

Seems like a catch-22, doesn’t it?

Yes. The only way to remove debt without bringing a contraction of the economy is with some forms of debt jubilees.

What’s a debt jubilee?

Here’s a short history: Debt accumulation was a problem from the very beginning of civilization — in Assyria, Babylon, Egypt, [Ancient] Israel and China.

Debt pervaded those societies, and kings over-used their prerogatives to broadly forgive debt.

How did that become a debt jubilee?

The people of Israel took this [forgiveness] out of the realm of a king’s whim and regularized and calendarized it in what was called a “jubilee”: the year after [seven periods of seven-year Sabbatical cycles] was a jubilee year.

Trumpets blared, debt was forgiven, and rejoicing resounded throughout the land.

Can you, then, bring the debt jubilee concept full circle to the modern day?

We borrowed the term very loosely from the Old Testament and used it to apply to the much more pragmatic programs that we have today.

We borrowed the term jubilee as a kind of catch-all for anything you do to try to bring earlier relief of debt to households.