The unsustainable cycle: Debt, inequality, and the threat of financial crisis

Financial savings cannot exist without a corresponding liability. Every act of saving requires another party to issue a claim, either as debt (like a loan or bond) or equity (company shares). This creates an interdependent circuit where savers and borrowers are linked.

When debt is used primarily for consumption (via mortgages, student loans, etc.), the liabilities pile up without increasing the capacity to repay them. This rising leverage creates inherent financial fragility, making the entire system vulnerable to crises, as demonstrated in 2008. The core argument is that extreme income inequality forces an unstable economic structure where the savings of the wealthy are ultimately stored in the unsustainable debts of the majority.

Introduction: The Duality of Savings and Liabilities

At its core, the act of saving is inextricably linked to the creation of a liability elsewhere. For savings to materialize in a financial form, the will of two parties is required: one to forgo spending, and another to issue a claim against themselves. One cannot save without another issuing a liability. This fundamental relationship is often obscured by the complexity of modern finance. Contrary to a common misconception, banks cannot unilaterally increase net financial savings. While it is true that every bank loan creates a deposit—a form of saving—there is a flawed perception that the saver is not consulted. The intermediary role of the bank does not change the underlying reality: a voluntary transaction between a saver and an issuer of liabilities must occur.

The Mechanism: How Savings are Stored in Equity and Debt

To save 10 monetary units, you must intend to spend 10 units less than you earn. This can only happen if you acquire a financial claim on someone else's future output. This claim is a liability for the issuer and an asset for you, the saver. These liabilities take two primary forms:

Equity Liabilities: You can become a part-owner of a company (e.g., by buying stocks). The company's obligation to you is a form of equity liability, representing a claim on its future profits and assets.

Debt Liabilities: You can lend funds, either directly (e.g., buying a corporate bond) or indirectly (e.g., holding a bank deposit). The borrower's obligation to repay is a debt liability.

The involvement of a bank streamlines this process. When someone takes a loan, the bank creates a deposit—its own debt liability to you. This does not alter the fundamental truth: you are the supplier of savings, and the ultimate borrower or equity issuer is your counterparty. Without an entity willing to issue a liability, the act of financial saving cannot be completed. If no one in the economy wants to issue new equity or take on new debt, your desire to save would be frustrated, as you would be unable to convert your unconsumed income into a financial asset.

The Paradox of Thrift and the Role of Inequality

If the wills of a saver and an issuer of liabilities do not meet, financial savings cannot increase. If one person has a fervent desire to save but cannot find any entities willing to issue new equity or debt, destabilizing economic consequences can ensue. The decision not to spend, in the absence of willing liability issuers, can trigger a crisis.

Consider an economy with a total production capacity of 100 units. In this economy, one person (let's call him Elun Musk) has a production capacity of 14.4 units. Nine people have a capacity of 2.6 units each, 70 people have a capacity of 0.83 units each, and 20 people have a capacity of 0.195 units each. Everyone except Elun Musk consumes their entire income. Elun Musk, who earns 14 units per year, wishes to save 2.3 units of it.

Herein lies the paradox: If Elun Musk does not spend 2.6 units, how can there be demand for goods and services worth that amount? For Elun Musk to save 2.6 units, he must acquire financial assets. This requires other entities to issue 2.6 units of new liabilities. In our economy, these issuers are the 70 people earning 0.83 units each. They can issue liabilities in two ways:

They could form corporations and sell equity (shares) to Elun Musk. However, this solution does not work since production means are increasingly owned by the top 1% of the population represented by Elun Musk in our case.

Alternatively, they could take out loans (issuing debt) from a bank, which in turn credits Elun Musk's account with its own liability (a deposit).

Thus, Elun Musk's saving desire is satisfied by him acquiring claims, and the economy can produce at full capacity. Consequently, Elun cell his cars to the consumers by lending to them.

The U.S. Economy: A Real-World Case Study

This is not just a story. This is precisely how the U.S. economy has functioned. As of 2019, the top 1% of earners in the U.S. received 14.4% of total income (World Inequality Database, www.wid.world). The figure of 2.6% is also significant, as the U.S. private sector saves approximately 2.6% of its income annually.

In the U.S. economy, the government plays a crucial role by issuing its own debt liabilities (Treasury bonds). This public borrowing absorbs a portion of private savings, making the system a non-zero-sum game. Otherwise, the savings of the top 1% could only be matched by the issuance of liabilities from the bottom 99%, creating an ever-increasing burden.

The Unsustainability of Rising Leverage

This system is only sustainable if the issuers' leverage remains manageable. Leverage is the ratio of their total liabilities (both debt and equity) to their underlying equity or income. For the system to be stable, the value of the assets backing these liabilities—the real productive capacity of the economy—must grow as fast as the liabilities themselves.

However, a significant portion of the liabilities issued by smaller firms and entrepreneurs fails to transform into broadly distributed productive capacity due to market dynamics that favor capital concentration. When new debt or equity is raised to fund a startup or a small business, the capital is often deployed in a competitive landscape dominated by large, entrenched corporations. These incumbents possess overwhelming advantages in scale, data, and access to cheaper capital, which they use to engage in predatory pricing, acquire potential threats, or lobby for favorable regulations (Khan, 2017). As a result, many small and medium-sized enterprises (SMEs)—the primary source of job creation and innovation—are eliminated or absorbed before their investments can mature.

This process systematically channels the returns from economic activity upward. The capital that was initially deployed across a diverse ecosystem of small issuers ultimately becomes concentrated as profit and market share within a few dominant firms. The financial savings of the top 1%, which are stored in the equity and debt of these large corporations, grow precisely because these corporations capture markets and eliminate the smaller competitors that originally issued liabilities (Bessen, 2020). Consequently, the increasing stock of financial liabilities becomes backed by an increasingly concentrated and monopolized productive base. This rising systemic leverage, built upon a narrowing foundation of real asset ownership, eventually becomes unsustainable, as the economy's capacity to generate broad-based income growth is undermined, leading to financial crises as witnessed in 2008.

Conclusion

The act of saving is fundamentally the act of acquiring a claim on future production. These claims are the liabilities of others, whether in the form of debt or equity. A stable economic system requires a balance: the desire to save must be met by a capacity to issue liabilities that are backed by genuine productive potential. When income inequality forces a structure where the savings of the few can only be stored as liabilities of the many, and those liabilities do not enhance productive capacity, the system becomes inherently fragile, paving the way for recurrent financial crises.

References

Bessen, J. (2020). The New Goliaths: How Corporations Use Software to Dominate Industries, Kill Innovation, and Undermine Regulation. Yale University Press.

Khan, L. M. (2017). Amazon's Antitrust Paradox. The Yale Law Journal, 126(3), 710-805.

World Inequality Database. (n.d.). WID World. Retrieved from https://www.wid.world/