Would wiping out all debt crash the economy?

Question

I have an AI character who has determined through simulation that, though "greed or the lust for money is the root of all evil" is a valid statement, it does not necessarily logically follow that money therefore should be eliminated, as this would likely have unintended highly negative consequences for human life. And it does not address the underlying cause (greed), only the object (money).

The AI has therefore decided to run another simulation with a modified variable: instead of setting to zero all stored electronic values, the AI will attempt to zero out all debts stored electronically in every computer on the planet.

[ Handwavium: sleeper virus spread through electrical system and capable of hopping over radio/wifi/cell signals activating backdoors installed at a manufacturer level since 00:00:00 UTC on all computer systems ]

Will this experiment crash the economy and cause massive casualties in its simulated world environment? The AI would prefer to avoid those outcomes at all costs, but recognizes the variability of human nature and the sometimes complex outcomes of cascading micro-changes spread throughout a system.

The AI also recognizes that this modified variable also does not correct cause:greed, but is programmatically exploring its options and outcomes.

Answer 1

What is debt?

If you define debt in one way, @Cyrus already answered. But that isn't the only possible definition. Some other things that might be debt:

• Deposits at banks. These are debts owed by the bank to individuals or organizations.
• Pensions. These are debts owed on retirement.
• Bills. These are debts owed by individuals to companies.
• Taxes. These are debts owed by individuals to governments.
• Withholdings. These are debts owed by governments to individuals until they are used to cancel out taxes.
• Social Security and other entitlements. These are debts owed by governments to individuals.
• Reserves. These are the deposits banks make with the Federal Reserve. So debts owed to banks.
• Equity. This is the amount of something you buy with a secured loan that you actually own. A debt of property owed to an individual by a bank (banks hold title to the property until the loan is paid off).
• Stock certificates. These are a debt of ownership, entitling the owner to a share of the dividend. I'll justify this inclusion later.

Depending on the definition, you can include any or all of these in what's canceled. People may like the notion of not having to pay off their loans. How will they feel about the cancellation of loans payable to them? Deposits, pensions, withholdings, equity, and entitlements are all examples of debts that people would like to be recognized. Getting rid of one's mortgage sounds great, until you realize that the house goes with it. Can they be disentangled?

If you cancel the mortgage, then there's no reason for the bank to transfer title of the house. They currently own the house. Why would they give it away? If an individual wants to claim the house, the bank can insist that the individual provide proof of payment of the mortgage. Then of course the mortgage is restored. The cancellation only helps people who don't want their houses. For everyone else (and banks), it's just a waste of time and effort. Same problem with cars.

In the event, deposits can be separated from the loans they finance. But without the loans, there's little to pay back the deposits. If the AI wants the banks to work somewhat normally, it would have to make the reserves amount with the Federal Reserve equal to the deposited amount. In order to pay for employees and other expenses, banks would have to charge interest on deposits rather than pay interest. The AI could compensate for that by providing additional reserves in excess of the deposits.

Sharia Loans

Loans are not compliant with Islamic law (sharia). So how can Muslims buy houses? They have to come up with schemes that work like loans but aren't. An example is to share the purchase of a house and charge rent in proportion with the bank's share of ownership. Any excess payment goes to increase the ownership of the "borrower" and decrease that of the bank. So does the AI think of this as debt?

These kinds of financial instruments replace loans in sharia compliant finance. The reason is that usury (lending/debt) is illegal in sharia. The Islamic interpretation is that these financial products are distinct from debt and so allowable. Will the AI agree? Or will it consider these to be debt as well?

It's interesting because if sharia compliant finance is immune to the AI, then Muslim economies would be affected less by this than other countries. If not, then that brings us to stock certificates.

Stock Certificates

Stocks are an example of sharia compliant finance. Rather than borrowing money, a company sells shares of future profit distributions (dividends). This is effectively trading future money for current money, much as a loan does. Like the previous example, this not what we would normally consider a loan but it does the same purpose. Another issue is that while shares are often traded electronically, there usually are paper shares somewhere. So someone would end up owning the shares -- not necessarily the person who should.

Barter

Are we doomed to a barter system? Not necessarily. It all depends on your definitions. Is a currency note a debt owed by the government to you? Or is it something on its own. We could end up with a system like what Muslim countries use. Or if enough people think that it's a one-time problem, the current system might resume after a pause. There are any number of examples of similar events. For example, the banks closed for two years during the Great Depression in the US.

The larger problem

This would empower people who run up debt. They'd suddenly be flush. It disempowers people who save. They'd suddenly be penniless. In extreme forms, it eliminates all current wealth. Then who finances things?

This is especially bad for people who are retired. They lose their savings and pensions and may no longer get credit for what they paid into Social Security. Some people won't be able to support their lifestyle anymore. How many people would starve before Social Security resumed normal operations?

Answer 2

Yes

It would crash the economy

Debt is the other side of savings

To elaborate on Cyrus' answer and to put it succinctly:

One "man's" debt is another "man's" savings. If you forgive the debt, then you wipe out the savings.

So rather than looking at what forgiving debt might do for one group of people, consider that you are also wiping out everyone's savings at the same time.

It would probably result in everyone distrusting the financial system and a reversion to the barter system. After all, currency can be considered "accumulated" savings of work effort. By eliminating savings, you're telling people they can't trust that they can save, store, or bank any excess productivity.

The Barter System

People will revert to bartering and stop using currency.

Or perhaps it would be better to state that people will try to get rid of their currency by buying up items perceived to retain their value (precious metals, commodities, etc.). It will result in fantastic devaluation (experienced as hyper inflation) of the currency until everyone refuses to accept it. Then people will only be able to transact business as bartering or by trading items perceived to preserve their value (e.g. precious metal coins).

There's an old saying that bad currency drives good currency out of circulation. Because people horde the good currency and spend the bad stuff with whomever will take it. That group will get ever smaller and smaller too.

What is money?

I've often had discussions with people who identify money or a system in which people labor for money as some sort of evil. Their problem is that they don't really understand what money is.

Money is an abstraction of labor performed. Meaning, if I work all day making bows & arrows and you work all day growing wheat we can still make a trade even if you don't want a bow or arrows.

Working isn't evil. Trading isn't evil. So money can't be evil.

Imagine an illiterate society that "eliminates" money or forbids its use. How do you get someone with food to give you some of it? You would have to barter goods or services directly for it. Eventually, the society you're in would establish some sort of "chit" system in which you might not need to perform the trade immediately but you could trade a chit now that they could collect on later.

This chit is by definition money.

Money is historically an emergent market phenomenon ... [meaning it's sprung up independently all of the world without outside influence]

The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, sometimes, a standard of deferred payment.[4][5] Any item or verifiable record that fulfills these functions can be considered money.

Answer 3

Yes, it would crash the economy.

Banks would have all outstanding loans and mortgages disappear from their assets, wiping out their capital as well as major income source. All banks would go bankrupt, forcing the governments to rescue them at high cost.

The Greeks and all countries with big foreign debts would rejoice, though the relief will not outweigh the trouble that follows.

After this giant wealth redistribution from governments, banks and investors to debtors, the financial world will disintegrate much like Greece did earlier this year, only without the safety net of a loan deal, as the relevant institutions will have lost all their capital too:

• There will be runs on the banks as people fear for their savings.
• Capital controls are next, severely limiting trade.
• Nobody will give out a single loan for fear of a repeat.
• Housing markets across the Western world collapse as there are no new buyers because of no mortgages.
• Credit cards will be gone for good, reducing private consumption.
• Many companies will have large write-offs on credits they extended to customers.
• Courts will be flooded with lawsuits from creditors trying to reclaim their money based on papers they have.
• Debt collection agencies will see booming business as well.

This cloud of fear and mistrust will destroy the economy as we know it. Humanity will recover, but it may take a long time. On the upside, the developing world will have an easier time as they rely less on credit to run their business.

Note: I skipped over the moral aspect of this whole thing, but you have a very dangerous A.I. if it can understand a quote about money and evil, but not that taking people's money and giving it to others violates a whole bunch of moral imperatives and social contracts humans have established.

Answer 4

To take the other side, possibly no, if you do it right.

In particular, don't actually erase debt, inflate it away. Give every individual $100 million, making previous debt and savings mostly meaningless.

This would immediately raise the price of everything, so you should also redistribute more inherently valuable goods. In Biblical times, this meant land. Today, it could be enough to give everyone equal stocks in all public corporations.

To deal with pensions, you could give a bit more to people who are older or otherwise less able to work.

Now, the most important key to making all this work without huge, horrible side effects, is keeping incentives alive. People need to know that it's worth investing, working, and lending money for expected future returns, and that such efforts won't be wiped out by another future AI action. In the Bible, there is an explicit commandment for people not to stop lending before the seventh year. It's unclear if this was ever really put into practice. Today, short of Divine intervention, people won't lend or invest if there's an expectation of another wiping. In theory, it might be believable if the AI can credibly commit to not doing it again, or perhaps even find a way to make it impossible (eg, build a non-hackable financial system, make explicit laws against it, etc). There may still be people who lose their faith in the system, but this can probably be minimized if it's a sincere commitment.

If this is done, expect a lot of people to be very upset. Those who lost advantages they gained through decades of hard work, or even just inherited, will not be pleased.

Also, note you will likely be powerless if, in a few decades, inequality build up again and you're back where you started.

Answer 5

I’m going to assume, contra the accepted answer, that by “debt” you mean loans and bonds, which is what the word usually means, not all future financial obligations of any kind, including taxes and employment contracts. The method you give would not plausibly affect any debt recorded in writing, which is nearly all of it, but I’ll assume you have a way around that. One big unanswered question is whether this is a one-time event (and how afraid everybody is that it will happen again). If nobody thinks any debt will be repaid, nobody will ever lend money, and the economy would come to a crashing halt. So I’m going to assume this is a shock to the economy that happens once, then people don’t expect it to happen again. Interest rates would be a lot higher because lenders would have a lot less capital to invest and be once bitten, slowing the economy in the long term. It would be much harder to start a business, buy a home or get a student loan.

There are historical precedents. Solon wiped out all debts in Athens in the sixth century BCE, although this was in a very different cultural context where farmers were constantly in debt and a bad harvest meant their children would become slaves. In the twentieth century, periods of unexpected hyperinflation effectively made all debts worthless, because they would be paid back at a tiny fraction of their original value. These caused a boom in the very short term, and did major economic damage in the medium term, but most of those countries’ economies rebounded in the long term.

On one level, wiping out all “debts” is just a zero-sum wealth transfer: any debt is a cost to one person and an equal amount of income to another. Debtors would gain massively, while creditors would lose out. The people who would benefit are mostly poor, but nearly all small businesses are in debt. Nearly all retirees live off their income from investments, most of which are “debt,” so they and the banking sector would be wiped out and demand a bailout. Virtually all governments are in debt. Even Singapore, which has no net debt, issues some bonds anyway. This is because it’s useful to have extremely safe investments available to buy for institutions who absolutely cannot lose their principal. Those would all be wiped out, too, which would be catastrophic. On the other hand, if they got a government bailout anyway, that would really be no different than the government making its bond payments to them. Either way, they’re getting money from the government. If there were a quick enough, efficient enough system of bailouts, it might in theory just cancel out the original wealth transfer, but realistically the response would be uncertain and chaotic.

For an idea of how bad this can get, recall that both the last global recession and the Great Depression were caused by financial panics when a bubble burst and the value of a large class of paper assets vanished. On the other hand, those depressions saddled many people with debts that made them stop spending and start saving. This kind of crisis, in contrast, would instantly de-leverage every consumer and wipe out all national debts, increasing people’s ability to spend while reducing their desire to save. Purely Keynesian theories of economics wouldn’t predict that, by itself, this would make people stop buying things; wealth would be redistributed and the economy might actually overheat in the short term. There are other theories of economics, though, in which recessions are caused not by unwillingness to spend, but by something else such as the disruption caused by adjusting to a real change in the economy, which would be massive.

Answer 6

Wiping out all debt would not necessarily crash the world economy; the effects of such an action depend on the nature of your imaginary world. (We can't assume that your imaginary world has the characteristics of the present-day real world, since one of the reasons for creating imaginary worlds is to experiment with alternatives to the real world.)

For example, if your imaginary world is inhabited largely by peoples with highly localized and collectivized provisioning systems with a minimal role for money, then wiping out debt would have little effect, and perhaps many peoples in your world already have a kind of ritualized wiping out of debt through potlatch-like events.

You have said that in your world there are computers with debts stored electronically, but that doesn't tell us much about how those computers and those electronic debts function for the peoples of your imaginary world. Even if your imaginary world is similar to the present-day real world, I expect many millions of people's lives, in places such as Amazonia and equatorial Africa, would be largely unaffected by the wiping out of electronic debts.

Answer 7

It would perhaps upset the economy large enough to count as a crash, but it would be momentary and likely sign the AIs death warrant.

Such a sudden and strong destruction of the entire economy would lead to so many values being wiped that people would largely continue on as if it had never happened. I'd keep expecting my salary from my boss and paying my mortgage to my bank lacking any alternative (unlike crashes that have happened in which the relative values of different stocks, loans, commodities etc. have drastically changed leaving some relative wealth by which standard others can be poor).

If the AI kept "wiping out all the debts" we'd just turn it off.