Monday, January 11, 2016

The Opium of Public Debt

After last week’s stock market gyrations caused — according to the experts — by events in China and alleged events in North Korea, other experts are predicting that 2016 will be “A Year of Sovereign Defaults.”  According to Carmen Reinhart, Professor of the International Financial System at Harvard University's Kennedy School of Government, “As 2016 begins, there are clear signs of serious debt/default squalls on the horizon. We can already see the first white-capped waves.”

A collage perfesser.
For once, the experts may be right.  The world is not only burdened with sovereign debt — a fancy word for debt issued by governments that have managed to kid the people into thinking that the politicians are in control of things and know what the heck they are doing — it is brainwashed by academic economists into thinking that having governments go into debt is the only way to have an adequate money supply.

That depends on how you define “adequate,” of course.

For thousands of years — and we do mean thousands — people managed to carry on commerce and even finance new productive ventures without any kind of government debt at all.  None.  Zero.  Zip.  Zilch.  And we just ran out of “Z” words for “nada.”

Money is anything that can be accepted in settlement of a debt.
What did people use?  The same thing we use today; as the Bible says, “Nothing new under the sun.”  They used something called “money.”

What is “money”?  It’s something so simple that most people have trouble grasping it.  Money is anything that can be accepted in settlement of a debt; as the lawyers say, “All things transferred in commerce.”

Every time — and that’s every single time — someone traded one thing for another, money was created when the agreement was made, and cancelled when the agreement was kept.

That’s because all money is a contract and (in a sense) all contracts are money.  Every single contract consists of three things or “elements.”  These are 1) Offer.  2) Acceptance.  3) Consideration.

If the word “consideration” gives you trouble, it’s actually quite simple.  A lawyer would say that “consideration” is “the inducement to enter into a contract.”  In English that means “why you are making an agreement” — the things of value the parties to the agreement expect to end up with.

All trade and commerce involves money.
For example, your neighbor says, “If I give you an apple today, will you give me an orange next week?”  You say, “Yes.”  A contract — money — has been created.  Your neighbor gives you an apple.  A week later, you hand over an orange.  She says, “Thanks.”  A contract has been completed and the money cancelled.

It’s test time.  Identify the three elements of a contract in the above example.  1) Offer: An apple today for an orange next week.  2) Acceptance: You agree or “accept the offer.”  3) Consideration: the apple and the orange — the things of value being exchanged.

Believe it or not, that’s pretty much how people carried on commerce for thousands of years before what most people today think of as “money” appeared.  Not to disillusion most people today, but “money” is as old as human society, even when people were (allegedly) living in caves and having two-mammoth lunches.

The vast bulk of documents that survive from the ancient world consist of various forms of money — contracts.  These have different names depending on what they were intended to do and the type of transaction, but they are (or were) all forms of money: mortgages, bills of exchange, letters of credit, promissory notes, bills of lading, and so on (and on, and on, and on) — anything by means of which people exchanged marketable goods and services.

Now, what has this got to do with the sovereign debt crisis?

Central banks were invented as banks for banks, not government.
With the invention of central banking, governments thought they had latched on to a money machine.  That’s not why central banks were invented, of course.  Central banks were invented as a way of making certain that commercial and mercantile banks — banks that create money by accepting contracts — could always be sure of “accommodation,” that is, of sufficient liquidity to carry on business for the private sector, not government.

Unfortunately, due to a series of crises and coincidences, governments found that they could monetize their own debt using the central bank, letting the private sector that produces the wealth go begging for credit.  Governments began shifting from taxation to debt to finance operations . . . and, voila!  The sovereign debt crisis was born.

This makes sense, for if a government raises taxes, everybody complains even before the taxes are levied.  If a government goes into debt, nobody complains until it’s time to retire the debt — if then.  After all, the government can just refinance by floating more debt and borrowing more money, can’t it?  And keep paying out more and more money for everything . . . just like Greece!

All sarcasm aside, almost the worst thing a government can do is finance on debt as a usual thing.  This puts the government in the power of whoever lent it the money.

Henry C. Adama: Public debt endangers sovereignty.
The worst thing a government can do?  Create money by monetizing its own debt.  Borrowing existing savings is bad enough, because it gives creditors power over government that should be independent of everything except its own citizens — but at least the supply of existing savings is limited.  Once it’s been borrowed and spent, no more can be borrowed.

Once a government starts monetizing its own deficits, however, the sky is the limit.  Debt that can be turned into money seems like the politician’s dream: you get rich by spending.

Except that, every dollar of debt that is turned into money decreases the value of all other currency.  The price level rises, and to be able to continue operating, governments are forced to monetize more deficits . . . creating a vicious circle in which the deeper in debt the government goes, the less money it has in real terms.

At some point, the currency becomes worthless, and hyperinflation — the condition in which the price level rises faster than the money supply can be increased — kicks in.

So, yes, with virtually every government on the face of the earth in debt up to their collective eyebrows, the moment the public realizes that the only thing behind the money supply is a stack of promises that governments can’t keep will set up a domino effect of sovereign debt defaults as creditors line up to grab what they can before the bottom drops out.


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