debts, assets, and other confusions

They have learned nothing and forgotten nothing.
-- Talleyrand on the Bourbon Restoration

Martin Wolf has a piece in the FT that both gets to the heart of financial matters, while inadvertently showing the insolvency of our economic thinking. In the end, Mr. Wolf's piece is a defense of fiscal spending in reaction to deflation. In so doing, he makes the case, but confusedly, of the importance of understanding the difference between assets and debt. Wolf writes,

But the time has come to look at the longer-run implications. This is particularly important when one considers fiscal consolidation. On this I make a simple point: it is not just about debt; it must also be about assets.

Mr. Wolf's argument is confused because, at a financial level, debts and assets these days are in many instances the same thing, accounted for differently in separate books. Mr. Wolf attempts correctly, but not convincingly to offer a little clarification stating,

Yet governments should not sacrifice the future to the pressures of the present. What is the sense of cutting spending today if the result is a poorer country tomorrow? This point turns on its head the refrain that we should at all costs avoid burdening the future with additional debt. We should indeed avoid burdening the future with unproductive debt. Yet productive debt is not a burden, but a blessing.

The problem here, and it is a big one, is matters of finance and money are not integrated into modern economic philosophizing. That Mr. Wolf, who understands finance better than 99% of those writing on economic matters, is maybe confused, reveals how conventional thinking on such matters offers little help in extracting us from the problems the world finds itself mired.

The greatest argument for those advocating more fiscal stimulus is there is no inflation, but inflation is not the only symptom of a malfunctioning or dysfunctional financial/monetary/economic system. Insolvency is also an important measure. In a functioning market system, insolvency at the individual and business level are important mechanisms for balancing the system. However, insolvency at industry wide levels, such as banking or housing, or at a national level, are signals of much greater problems, problems not simply corrected by pouring in more money.

Mr. Wolf's piece once again ignores, as does almost all modern economic analysis, the problems of financial bubbles. They are first and foremost a problem of the financial/monetary system, and secondly, depending on their size and length, tremendously distort the underlying real physical economy. In all cases, bubbles are manifestations of unsustainable practices. They create unproductive debt. Thus, the dichotomy Mr. Wolf addresses between productive and unproductive debt is important and key to understanding our future, but more difficult to discern after large bubbles. Wolf continues, seeming to not really believe the distinction. He states,

Yet, in the short run, with demand below capacity, even borrowing that raises current consumption would be better than leaving resources idle. The fact that some residents (future taxpayers) may then have to pay a little more to other residents (bondholders) is surely a second order issue.

Much of this "demand below capacity" and "idle resources" are results of the preceding unsustainable bubbles, simply attempting to blow them back up is not only impossible, but detrimental. This is not a matter of "future taxpayers" paying more to other "resident(bondholders)", it is indenturing the future to a bankrupt past. With this statement, Mr Wolf could very well be accused of being plain disingenuous, particularly in relation to the reality of the Irish, where the Irish government, leaving aside any argument on fiscal policy, is indebting the future to pay-off the bad loans of English and German banks. But it gets worse, Mr. Wolf inadvertently revealing the true insolvency of much of our economic priesthood states,

Some insist loudly that one cannot solve a problem caused by too much debt by piling on more debt. But that is wrong. In the US and UK, net debt is close to zero: thus, debt is not a burden on society as a whole, but an obligation of some residents to others. As Nobel-laureate Paul Krugman points out, debt matters only because of who the debtors are. If, for example, debtors suffer an unexpected loss in net wealth or are forced suddenly to repay, the impact on the economy is bound to be fiercely contractionary. If the state can borrow, to offset this effect, it should do so. That would not impose an overall burden on a society, since net debt would remain close to zero. If it also raised GDP above what it would otherwise be, that would surely be a very good thing.

Phew, invoking Krugman and his Nobleness in defense shows without a doubt the lack of needed critical thinking, though it demonstrates the ahistorical thinking of our economic priesthood. First, from a current accounts balance perspective, arguing that US "net debt" is zero is incredulous -- it's accounting gimmickry -- of course something at which we do excel. Secondly, the question of solvency from a national perspective, concerning what the debt is comprised, is an important for the US, and really who cares about the British? History is littered with nations, Mr. Wolf's old Britannia for one, who continued to add to their debts, a better word being liabilities, in an attempt to sustain the unsustainable, leading eventually to national insolvency. Yet, Mr. Wolf wants to disregard these problems in lieu of the great magic elixir of our industrial capital priesthood, growth, "a raised GDP".

Mr. Wolf is right, the difference between debt and assets is key, but in a system where the accounting of debts and assets is completely confused, in fact where all debt is simply notched as someone else's asset, it is problematic. Where a financial system i completely removed from the real economy, combined with a political system that is eminently corrupt, the further wanton dumping of money into the system will only create greater distortions and future hardship. For example, all dumping of money into the US economy furthering our oil addiction, whether it's infrastructure supporting the internal combustion engine or military misadventures across the Mid-East, is not just bad debt, but destructive liabilities, though this might not seem the case to collar counties of Maryland and Virginia.

The problem is the American political economy is so distorted and so corrupt to not be able to tell the difference between good and bad debt, in fact, it favors bad debt. That is why talking about simply dumping more money into the system, without a corresponding discussion of reforming our financial, corporate, political and government systems is not simply detrimental, but destructive. We can begin a healthy discussion on the future in deciding what debt is going to be destroyed and how the losses are going to be accounted. Afterwords, we can have a better understanding what future good debt looks like. Without doing this, all the talk of throwing more money at our problems is nothing more than an a desperate attempt by a decadent and corrupt aristocracy and its servants to keep in place a failed status quo.