I am aware that this is a difficult idea to grasp, but it is nevertheless the case. The first way in which the individual is spending borrowed money is that they are not actually paying the correct level of taxes to support government expenditure. In simple terms, if the government was not borrowing, but still providing the same services, the tax rate would be far higher. As it is, the government borrowing is the borrowing of the individual, as that individual will, at some future point in time, have to pay higher taxes than they would otherwise have done. This means that, as they make each purchase, a proportion of that purchase is paid for by money the individual is indirectly borrowing through too low taxation.
The second way in which the person is spending borrowed money is somewhat more complicated. For the sake of ease, we will just look at government borrowing, but a similar situation applies for private borrowing. If we return to our individual paying cash, and imagine that he is buying a car, part of his payment comes from borrowed money indirectly derived from government borrowing. When the car dealership accepts the money from the individual, they will have increased revenue, and that revenue will pay for many other things, such as their staff salaries. A proportion of the money indirectly borrowed by the individual making the purchase then ends up in the hands of the staff of the car dealership. The dealership staff will then go on to spend the borrowed proportion of the money, and that will then be used by whichever organisation is in receipt of the money from the staff.
In other words, the money that was originally borrowed by the government percolates through the economy, and it becomes ever more difficult to separate the borrowed money from the money earned as 'real' income. As the borrowings of the government are transmitted through the economy, it becomes apparent that what appear to be 'cash' sales actually are always utilising borrowed money.
As I have said, it is a difficult idea. You may wish to see my first post on the subject, 'The Cigarette Lighter Problem' as I was just starting to grasp at the concept, and it may therefore help in understanding the ideas behind it. The reason for my return to this subject is the curious case of Greece. This is a commentary on the subject:
Since 2000, Greek unit labour costs have risen by almost 40pc. Meanwhile, German unit labour costs have barely risen. This loss of competitiveness by the southern countries is central to their current poor economic performance and their lack of viable prospects for the future.
If governments are obliged to cut back and consumers and/or companies are lumbered with excessive debts, it is to exports that these countries must look for salvation. For the eurozone as a whole to achieve prosperity and economic success, accompanied by stability and sustainability, will require the solution of both these problems. But are they simultaneously soluble within the current financial framework?
If the southern members – "Club Med" – are to regain competitiveness within the euro, the only way is for their costs and prices to increase more slowly than costs and prices in the remainder of the eurozone, led by Germany. (Let us call these countries Germany.) If costs and prices in Germany are barely rising at all, then Club Med must regain competiveness by deflating – ie. costs and prices actually falling.
The answer is that there was a mass of borrowed money percolating through the economy, pushing up activity, wages and employment, as well as providing employment for a larger workforce. This is an example of how an economy might become distorted as it becomes structured around deficit spending.
This is why the only real solution for Greece is to lower wages and costs throughout the economy. When the borrowed money disappears, the Greek economy is left with a structure in which wages are too high, and that is because the borrowed money created wage inflation. Everyone in the whole economy were laying their hands on borrowed money, even if they were apparently spending cash earned from income. In essence, it is the reality of the 'Cigarette Lighter Problem' with a harsh spotlight shining on it.
What we see in the case of Greece is the illusion of wealth appearing over all of the statistics, and this is partly why Greece managed to appear to be in a sustainable position for so long. Many of the statistics appeared to be positive, but they were only positive because they were not accounting for the borrowed money that every individual in Greece included in their spending. The borrowed money allowed the rapid wage inflation that is reported in the article. And the lesson from the case of Greece and the Cigaretter Lighter Problem - I will let you draw your own conclusions.