Financial capital is a fleeting thing

A friend of mine swears up and down that financial capital cannot be destroyed. Moved around, yes: I can lose, you can win. But not destroyed.

I disagree profoundly with that.

Money is debt, debt is money

We live in a world of fiat money. All that means is that “it’s money because we say so”.

Change what we say is money, and the old “money” is suddenly without value. Drop into a café in Cannes with a 20F note and order a café-au-lait and a pain-au-chocolat and you’ll see that it’s unlikely to be accepted a decade after the euro replaced it. This despite the fact that the franc note can be turned in for exchange, and that its value remains fixed relative to the euro from the day of conversion.

Walk into a bar in Prague with old communist-era Czechoslovak notes and order a beer. Unacceptable. Waste paper.

Most of our money, of course, is not physical. Only about 3% of the total money supply actually exists as notes and coins. The balance is numbers in databases.

The last time you took out a loan, did the bank move money from one shelf to another in a vault, so that you would have it and the depositors who had locked it in for lending now did not? Don’t be daft.

The bank merely credited your account by adding some numbers to it. Your loan is debt money. Yes, there are rules about how much of this can be done, what sort of loss reserves must be held back, how many times a deposit can be multiplied (including the deposit just made as the loan is issued). That doesn’t change the fact that that money was created from debt.

Of course, governments selling bills, notes and bonds do precisely the same thing. Only the instruments change.

What happens if you declare bankruptcy? Your trustee calls your creditors together and says “here’s what’s owed; here’s the assets; here’s the proposed division”. The bank gets, say, ten cents back on every dollar it lent to you. What happens to the missing ninety cents?

That money — that debt — is destroyed.

It’s the same for a corporation, and for a government. Financial assets can be destroyed: currency holdings, bond holdings, stock holdings, derivative instruments.

The prudent and the profligate both suffer

Our banks, our governments, have both been broken in the past few years. We’ve done everything — quantitative easing, near zero interest rate policies, troubled asset purchases, bailouts of corporations, massive deficits, both stimulative spending and austerity budgets — to try and bridge the gap and allow them to heal. To grow our way out of this, so that we can take the losses without having to admit that the structure itself is broken.

But it’s not happening, is it?

Individuals and families recognise the difficulties, know people out of work, worry about the future. They’re trying to pare back and pay down debt, not take more on (which is what “growth” is in a debt economy).

Corporations are sitting on cash, unwilling to invest it. They fear “the system” breaking under the strain; they are preparing for that day. They know how close their demise was the day Lehman Brothers went under: Lehman was the primary dealer in corporate paper, the short term debt used for everything from payrolls, to purchasing of supplies, to bridging the gaps between shipping products or providing services and actually being paid for them. That market seized up: many had no cash on hand for short term needs. Now they do.

At the same time, they are wrestling down their own debt piles, just as are families.

There are only so many costs that can be cut, so many corners to trim. Profits and dividends have been paid from these, for the most part, while investment has stalled. Those days are now ending, too.

What sustains a share price, but the expectations of more tomorrow? What sustains an index, but the pool of expectations? The prices being charged for shares is merely a reflection of those expectations, both short and longer term. Take away the prospect of more earnings, and the price falls: it must fall simply to retain the current ratio of prices to earnings.

When the “market cap”, which is just available shares multiplied by the current price, falls because the price falls, where did those assets go? Into the ether, mostly. Yes, the short seller can profit, but only to the extent of their position and the price change. Most of the market cap that evaporates simply disappears.

Promises that can’t be kept

We have two kinds of promises circulating now. Neither can be kept to the extent that has been promised — not even close.

The first is the promise of investment solving problems. People love to talk about how fracking technology gets at so much oil and gas that we’ll all be awash in the stuff, energy exporters, able to put off anything. There are other technologies: this is the hot one.

Alas, every well requires capital — lots of it. If the site fails to pay off, that capital is consumed, without a return. Of course, if a massively productive and extremely long-lived well is the result, it’s a wonderful investment that pays off for years and years.

Most of the new technologies create wells that, if they produce at all, don’t produce much for long, relative to conventional wells from, say, fifty or more years ago (or relative to the big producers still around today, like the Ghawar field in Saudi Arabia, although even there there’s a lot of new drilling going on to extract less and less oil). This material isn’t here to be exploited today simply because of a technological breakthrough, or a suite of new discoveries never before obvious to geologists.

They’re being exploited because there aren’t many other options left.

But they’re not — by historical standards — great returns on investment. More capital is destroyed or never fully pays back than previously. The cross-over between “being worth doing” and “not worth the risk” is close.

Cross it, and no sensible person would use their capital in this way — no matter how much might be there.

The other big promise that’s failing is the various programmes promised citizens.

These are all, in their way, promises to pay.

Destroy employment — jobs or businesses — and there is less to pay in, more to pay out.

Promise ever more — more medical services, more drug coverage, more this, more that — there is more to pay out.

Watch the demographics shift, and who is collecting (say, retirement benefits) shifts relative to who is paying in (say, those working for pay).

It is not that these programmes are wrong. Nor are the other things our governments do — fund infrastructure ahead of economic need, or repair that which exists — wrong.

But what is wrong is risking them all by failing to figure out how to pay for them.

As the Spanish proverb goes, “take what you want, and pay for it”.

Running deficits is running out on the cheque. It says “thanks, we’ll take that now, and someone else can pay the bill”.

There is no better definition of a ponzi scheme (one where earlier “investors” are paid from the contributions made by later “investors”, with the last ones in receiving nothing) than that.

The prudent expect their capital, painstakingly put aside, to hold its value. They expect the forms it takes — currency funds, bonds, stocks and real property — to hold their value, not to be destroyed.

The profligate expect that their demands will always be met, kicking the problem down the road for later. They believe that debt can be piled up forever — or at least until after they’re gone.

What to do

The reality is that both the prudent and the profligate are about to be deeply disappointed. The game of holding the system together is getting harder and harder to play. It only takes one wrong step to set off a cascade failure, given the degree of interrelationships involved in the institutions and instruments in play.

Steve Keen, an economist, has made one good suggestion. Instead of printing up more debt — more money — to keep the institutions afloat, governments should have one last massive debt spree, but hand the money directly to individuals.

If you owe, you must first use it to retire all your debt. This clears the household balance sheet.

Once you don’t owe, you may keep the rest. This is your nest egg.

Now let the institutions go. With it will go most of the financial capital — but individuals will not be impoverished, and they will hold some assets to start building again with.

Accept that the pension funds will mostly be destroyed with this as well (that’s why you gave money directly to people).

Governments would, after this point, have to run without deficits. There would have to be choices made: what promises, how much, who gets, what don’t we do.

In its own way, it’s the same idea as simply defaulting on the government’s debt and declaring a debt jubilee.

That’s a world where we probably would do less pipe-dreaming about endless supplies of this and that, and more community building, putting our assets where we live and labour.

That is an idea that’s slowly starting: people pulling assets out of the financial system and investing them directly in their own communities. Funding upgrades to, for instance, the school, which pay back out of the operating savings: keeping their money working locally (where they can keep an eye on it).

It’s like the idea Senator Hugh Segal has promoted for decades: kill off all the other programmes, and have one “guaranteed income” administered through the tax system. It replaces pensions, old age supplements, disability payments, welfare, child benefits, the lot. Set a high personal deduction — top up if earnings didn’t reach the deduction — pay tax on anything above it.

This certainly makes the cap on funds required clear — it makes the cost of delivery much lower — and it empowers people, since the risk of not having a job just went down. Just as a national single-payer universal health care system makes it easier to take the risk of leaving employer health coverage behind, this would make it easier to chart your own course in the world.

One way or the other, we’ll be seeing financial capital decline in importance, and size. As it goes, pipe dreams about endless this and that go with it.

Worth thinking about. Meanwhile the time left in which we can do something other than react to others’ collapses is ticking down.


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