Debt is Not Wealth

Here’s the status quo:


These figures are staggering; the advanced nations typically have between three and ten times as much total debt as they have economic activity. In the United Kingdom — the worst example — if one year’s economic activity was devoted entirely to paying down debt (impossible — people need to eat and drink and pay rent, and of course the United Kingdom continues to add debt) it would take ten years for the debt to be wiped clean.

But the real question is why? Why are both debtors and creditors willing to build a status quo of massive unprecedented debt?


From the side of the creditors, I think the answer is the misconception that debt is wealth. Debt can be used as collateral, or can be securitised and traded on exchanges (which itself can become a form of shadow intermediation, allowing for a form banking outside the accepted regulatory norms). To keep the value of debt high, and thus keep the debt illusion rolling along (treasury yields keep falling) central banks have been willing to swap out bad debt for good money. But debt is not wealth; it is just a promise, and in today’s world carries huge counter-party risk. Until you convert your debt-based promissory assets into real-world tangible assets they are not wealth.

From the side of the debtors, I think the answer is that debt is easy. Why work for your consumption when instead you can take out a home equity loan or get a credit card? Why buy the one car that you can afford when instead you can buy two with debt?

But there is another side in this world: the side of the central planners. Since the time of Keynes and Fisher there has been an economic revolution:

Deflation has effectively been abolished by central banking.  And so we get to where we are today: the huge and historically unprecedented outgrowth of debt. Deleveraging necessitates economic contraction, which produces the old Keynesian-Fisherian bugbear of debt-deflation, which the central planners abhor. So they print. Where once deflation often made debts unrepayable, and resulted in mass defaults, liquidation and structural transformation, today — thanks to money printing — debtors get their easy lunch of cheap debt, and creditors get their pound of flesh, albeit devalued by the inflation of the monetary base. It has been a superficially good compromise for both creditors and debtors. Everyone has got some of what they want. But is it sustainable?

The endless post-Keynesian outgrowth of debt suggests not. In fact, what is ultimately suggested is that the abolition of small-scale deflationary liquidations has just primed the system for a much, much larger liquidation later on. Bad companies, business models and practices that might otherwise not have survived under previous economic systems today live thanks to bailouts and money-printing. This moral hazard has grown legs and evolved into a kind of systemic hazard. Unhealthy levels of leverage and interconnection that once might have necessitated failure (e.g. Martingale trading strategies) flourish today under this new regime and its role as counter-party-of-last-resort. With every rogue-trader, every derivatives or shadow banking blowup, every Corzine, every Adoboli, every Iksil, comes more confirmation that the entire financial system is being zombified as foolish and dangerous practices are saved and sanctified by bailouts.

With every zombie blowup comes the necessity of more money-printing, and with more money-printing to save broken industries seems to come more moral hazard and zombification. Is that sustainable?

Already, central bankers are having to be clever with their money printing, colluding with financiers and sovereign governments to hide newly-printed money in excess reserves and FX reserves, and colluding with government statisticians to hide inflation beneath a forest of statistical manipulation. It is no surprise that by the BLS’ previous inflation-measuring methodology inflation is running at a much higher rate than the new:

Worse, in the modern financial world, we see an unprecedented level of interconnection. The impending Euro-implosion will have ramifications to everyone with exposure to it, and everyone with exposure to those with exposure to it. Not only will the inflation-averse Europeans have to print up a huge quantity of new money to bail out their financial system (the European financial system is roughly three times the size of the American one bailed out in 2008), but should they fail to do so central banks around the globe will have to print huge quantities of money to bail out systemically-important financial institutions with exposure to falling masonry. This is shaping up to be a true test of their prowess in hiding monetary inflation, and a true test of the “wisdom” behind endless-monetary-growth fiat economics.

Central bankers have shirked the historical growth cycle consisting both of periods of growth and expansion, as well as periods of contraction and liquidation. They have certainly had a good run. Those warning of impending hyperinflation following 2008 were proven wrong; deflationary forces offset the inflationary impact of bailouts and monetary expansion, even as food prices hit records, and revolutions spread throughout emerging markets. And Japan — the prototypical unliquidated zombie economy — has been stuck in a depressive rut for most of the last twenty years. These interventions, it seems, have pernicious negative side-effects.

Those twin delusions central bankers have sought to cater to — for creditors, that debt is wealth and should never be liquidated, and for debtors that debt is an easy or free lunch — have been smashed by the juggernaut of history many times before. While we cannot know exactly when, or exactly how — and in spite of the best efforts of central bankers — I think they will soon be smashed again.

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Bread & Circuses & Antiprosperity

If I was a mathematical economist — and I have very, very good reason not to be — I would try to create a formal model for what I call antiprosperity.

What is antiprosperity? It is a strange effect. I hypothesise thus: as nations (and to a lesser extent, people) become more prosperous, they tend toward greater fragility. In other words, fat times create weakness. This is not a universal law, because there are some exceptions. It is more of a tendency. The children of the strong, the hard-working or the wealthy often grow up lazy and stupid and conceited. People who keep winning don’t learn about their weaknesses, and without being aware of their weaknesses their weaknesses can fester and develop into glaring cracks.

An example of antiprosperity is the global system of derivatives. By creating a system of side bets, market participants could “hedge” against any undesired eventualities (for example, shopping chains dependent upon high consumer turnout could create an option on weather — if the weather was poor, and thus their sales were down, the option would payoff, mitigating their losses). By 2008, over $1 quadrillion of derivatives had been created to hedge against inflation, rate spikes, weather, price changes, defaults on debt, climate change, and almost anything imaginable. The problem was that if a counter-party with a large amount of derivatives on their balance sheet fails, then those “assets” become worthless. Any liabilities go unpaid, and so other companies who have agreed to contracts with the bust counter-party may themselves become illiquid due to their losses with the bust counter-party. This can quickly cascade into systemic meltdown. So, to recap, a system designed to “stabilise” global markets — and, let us not forget, was once prophesied as the end to systemic risk — ends up destroying them through unprecedented systemic risk..

I am still trying to understand what causes this mechanism. I think human life tends to be characterised by a steady process of building and breaking. As we learn skills we face setbacks, and failures, we learn from our mistakes and we fix our weaknesses. Humans once had no choice but to work for their food.  Taking away this gradual process — say, by creating a system that guarantees a constant and steady stream of food that requires no work to fulfil — creates a weakness, because the skills necessary to fulfil the pre-existing need become rusty. Western civilisation has become so good at feeding itself that it creates huge surpluses of goods and food. People don’t need to learn to feed themselves. Many people — who take the welfare route to “prosperity” (left-wing readers — yes, this includes bankers, defence contractors, and other corporate welfare recipients) — don’t even need to learn to work. They just suck up the handout and go on their merry way.

This tidal wave of prosperity hides a sickness inside, and we are seeing the first symptoms: overflowing bellies. Why learn the skills necessary to survive in the wilderness when it is easier to sit on your ass, stuffing your face with junk food? After, all the global resource infrastructure that pulls oil out of the ground in the middle east, refines it, ships it in oil tankers to America, and creates petrochemical-based fertilisers that are used to grow crops, produce (what can loosely be described as) food and transport that food to the consumer will always exist, won’t it? Readers are advised to know where their next meal is coming from — and their next meal for six months or a year — if the global system of trade were to break down.

To become stronger we must seek volatility, and to some extent, failure. When I was learning to play the guitar, I didn’t get better by playing pieces I could already play. I got better by seeking out failure by trying to play pieces and measures that were too difficult for me. Failure is beneficial and useful, because we can learn from it. Weakness is beneficial and useful, because we can learn from it.

How can governments and businesses learn the lesson of antiprosperity? Well, Steve Jobs seemed to know a thing or two about it. He was famed for his management style, whereby he lashed employed with vicious criticism to keep them on their toes. Failure and weakness built strength.

Governments should learn to keep welfare nets — both corporate and social — to a minimum. While the vulnerable (e.g. children, the aged, and the severely disabled) should under no circumstances be abandoned, welfare should never become a gold-plated ticket for an easy life. Governments should also peel back barriers to entry and overregulation so that the poor and unemployed can easily become self-employed without having to pass futile certifications, and pay thousands of dollars for licensing.

If we humans cannot avoid the excesses of prosperity, nature is a cruel mistress. What is the punishment for gluttonous obesity? It can become difficult or impossible to find a mate, thus making it difficult or impossible to pass our genes onto the next generation. The obese die younger, and thus turn back into dust sooner than their thinner counterparts.

And so too do societies enamoured with bread, circuses and free lunches. Rome was sacked, and its empire crumbled. Ming China collapsed under the weight of its traditionalism and technophobia. We here in the West — fed fat by the free lunch of petrodollar supremacy, the beauty of globalisation, the power and simplicity of a carbon-driven economy, and the largesse of the state — should heed those warnings. It is estimated that 99.9% of all species that have ever existed are now extinct