Re: [CrashList] Economics of Debt

[perry arnett]

from one who's been there: this is a very clear and accurate statement;
which gets to the heart or the core of why this 'slowdown' is not going away
very quickly....

thanks, Henry!  this is a keeper

Perry

----- Original Message -----
From: Henry C.K. Liu <[EMAIL PROTECTED]>
To: <[EMAIL PROTECTED]>; <[EMAIL PROTECTED]>
Sent: Friday, February 02, 2001 21:58
Subject: [CrashList] Economics of Debt


> One of the shortcomings of economics is that inadequate attention has
> been paid to economics as a behavioral science.  The problem can be
> traced to the concept of the economic man who is supposed to act
> rationally in his own interest which is generally defined rather
> simplistically as financial gain.  Modern economics of course deal with
> the problem of human behavior with more sophistication, albeit always
> through the back door, and always equating self interest with pricing. A
> market economy is coordinated
> through the price system based on the principle of declining marginal
> utility. Economists construct indifference curves to show a consumer's
> preferences. A good whose consumption goes down instead of up when its
> price goes down is called a Giffen good.  An inferior good is a good
> that you buy less of when your income goes up. A Giffen good must be an
> inferior good, but most inferior goods are not Giffen goods. The effect
> on consumption of a pure change in price is shown in an
> income-compensated demand curve (also known as a Hicksian demand curve
> after economist John Hicks). A Marshallian demand curve is based on
> marginal utility. Utility is observed only in choices. The problem of
> consumption is simply the problem of choosing the bundle of goods that
> maximizes your utility, subject to the income constraint--the
> requirement that the bundle you choose costs no more than your income.
> The so-called Presidential
> Elecion Cycle Theory of stock prices held by some investment analysts
> suggests that major stock market moves can be predicted based on the
> four-year presidential election cycle. The pattern is as follows: stocks
> decline soon after a president is elected, as the new leader, incumbent
> or not, takes harsh mearsures and unpolular steps necessary to bring
> inflation, government spending and deficits under control.  During the
> following two years or so after an election, taxes may be raised and the
> economy may slip into a recession. At about the mid way of the four year
> term, stocks should start to rise in anticipastion of the economic
> recevery that the incubent president wants to be roaring at full steam
> by
> election day.  The cycles is supposed to repeat itself every four years.
>
> The above is a select sample of theories hat makes sense generally only
> if they fit specific defining conditions.
>
> The purpose of this post is to suggest that human behavior is complex
> beyond the measurment of price and that price alone is not sufficient to
> influence market behavior.  Marx dealt with the concept of fetish as a
> factor in demand.  Education is another factor.  Economics literature
> has never dealt saitisfactoerily with eduction, being unable to clearly
> define it as consumption or investment or both. Similarly with health
> care and environmeantal preservation.  If it is both, there should be a
> limitless supply/demand relationship.  One could not possibly have an
> over-educated society or an over clean environment.
>
> With debt, it is quite obvious that debt changes human behavior.  A
> little debt reinforces responsibility. The American value system is
> built on the notion that home owners with a life long mortgage are
> better citizens than renters.  People tend to take better care of their
> "homes" if they "own" it, even though 90% of the purchase value is in
> debt. On the other hand, it is clear that excessive debt encourages
> irresponsibility.  The borrower may develop an irresistable incentive to
> walk away from his debt if he perceives that debt to be beyond his
> ability to repay, or the cost of the debt exceed its benefits.  The
> American bankruptcy regime is designed to give such debtor a fresh start
> from debt.  Unlike European predecents, no one in the US can be put in
> jail for failing to pay his debt, unless fraud is involved.  In fact,
> there is the legal concept of lender liability, based on which a
> distressed debtor can sue the lender for damages for lending money
> irresponsibly that leads the debtor into financial trouble.  Debt
> bascially is unearned money with a promise to repay it with
> optimistically estimated earned money in the future, that for example,
> the borrower will not become unemployed through no fault of his own.
>
> On the corporate level, debt also alters management behavior. Leverage
> increases profit margin on successful business plans.  But debt also
> exaggerate losses when business plans fail. And in the US system,
> bankruptcy is always a legal if not painless way to refute debt.  The
> comfort to the lenders is that equity investors are wiped out first
> becuase the lenders' variously collaterized positions.  Banks used to be
>
> the sole intermediaries of debt.  For this reason, a Central Bank is
> formed to supervise and provide liquidity tio the banking system.  Thus
> central banks came into existence on the asumption that the existence
> and health of the banking system is in the national interest.  And to
> protect that interest the cnetral bank is allowed to act a lender of
> last resort to the nation's banking system with public money, or more
> accuracy through the government authority to create fiat money.  Thus
> regulation on banks
> is a fair quid pro quo social contract.  Bank deregulation without
> corresponding raising of the standard for central bank bailout is a
> direct breach of this soical contract.  If banks cannot be allowed to
> fail, they
> should also not be allowwed to deregulate.  More ominous,  the US credit
> system has broken through the banking system, the bulk of debts now is
> intermediated through the unregulated credit markets through
> securitization of debts.  Over this market the government is generally
> only an interested bystander, so far quite unwilling to regulate even
> derivative trading by banks.
> There is ample evident to suggest that the level of interest rate does
> not influence the level of debt in an economy.  When interest rate is
> high, it often merely reflects the credit unworthiness of the borrower
> or the high risk for the lender.  High interest rates in fact creates
> more incentive to take higher risk by offering more compensation to the
> lender. As the Willaim Zechendorf, the bankrupt real estate tycoon once
> said: "I 's rather be alive al 30% interest than be dead at 3%." It is
> not clear that debt, unlike equity capital, actually puts money to work
> for the highest and best use, or where it is most needed and where it
> does the most good.  Debt tends to be most productive at the highest
> risk level which destabilizes the economy.  Debt securitization actually
> lowers the credit quality systemically by socializing the risk across
> the whole system rather than concentrating on the singular defaulter.
> Debt also discourages ecnomic democracy, since the poor generally find
> it much harder to obtain credit.  There is much truth is the saying that
> it is not how much you own, it is how much you owe that measures how
> rich you
> are. Debt also encourages carelessness with money, since the lender
> implies faith in the borrowers ability to repay in the future.  People
> tend to be more careful with money hey earned in the past in the form of
> savings because they remember how hard they had to work for it.  In
> comparison, debt is based on future earnings, which is deemed easier
> money by the exisence of the debt itself. The problem with debt is that
> it needs to be serviced regularly (except zero coupons which cost more),
> and a debt-propelled economy will reach a point where its ability to
> service the growing debt is exceeded, unless inflation is ahead of
> interest charges. Thus runaway systemic debt always leads to
> hyperinflation.  Bankruptcy only relieves the debtor, but not the
> economy.  If, as Minsky claims, money is created when credit is
> extended, then the erasure of debt destroys money and shrinks the
> economy.
>
> But the most fundamental aspect of a debt economy is that it cannot
> sustain a slow down, even a soft landing.  If Greenspan were better
> versed in debt economics, he would have inderstood that a debt bubble,
> unlike the conventional business cycle, cannot survive the slightest
> deflation.  His attempt to engineer a soft landing by raising interest
> rates only accelerated the debt bubble's burst. His only option was to
> prevent the debt bubble from forming by tightening credit quality years
> ago, but he chose to rely on the "market" to exercise its discipline.
> Instaed of discipline, the market gave him an insatiable apetite for
> destructive debt.  Once the bubble is on its way, Greenspan is on top of
> the debt tiger that he cannot get off without being devoured by the
> beast.  It was not the New economy, it was not the new productivity that
> gave the US its decade long boom.  It was debt.  Withoput debt, there
> would have been no New Economy, no dot com industry, no structured
> finance, no budget surplus and no current account deficit or its flip
> side capital account surplus.
> The 1990s was the debt decade. Much of the technology was invented prior
> to the beginning of the decade and became widely applied through debt in
> the form of vendor finance.  The communication revolution was built on
> debt that had been accumulated in the last decade.  The greatest
> invention
> of the 90s was more and more sophisticated debt instruments.
>
> Henry C.K. Liu
>
>
>
>
>
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