Well the straight offhand answer of the economist is that it is money. And too much money creates inflation. But we have too much debt and we do not have appreciable inflation – and what inflation there is – is camouflaged taxes. How can that be?
Well the concept and link between debt and money is (in my view) far too primitive! The inbreed view is represented by the kindergarten relationship:
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I) Money ~ GDP
But there is a difference between the different types of debt. They carry different interest and maturity. So let’s be realistic, not all money is the same despite being cavalierly treated as such. We must take velocity into consideration: How fast is the debt paid back?
II) Money * Velocity ~ GDP
So in reality it is not:
III) Debt = Money
IV) Money * Debtservice ~ GDP.
Now we all know the expression “bad debt” – which is a euphemism for “dead and lost”. It has a velocity (or circulatory speed – debt service) of 0 times pr. Year. Between the cash in your hand (which most certainly moves away fast) and the fortunes of a deposed Russian aristocrat there is a wide variety of speeds. The real problem of relation II) and IV) is that the calculation of this speed – it is a real bitch!
- The banks books contain huge amount of lost loans; but that will never be admitted by the banks because a loss is to be deducted from equity – ugly thought – which would mean that banks are insolvent. This they are several times over – at least where we have checked due to insolvency because illiquidity has forced them to default. The rest is clenched jaw silence! No reason to assume that so called healthy banks are that much better generally , it is – just as the Vikings discovery of America – a well kept secret about an embarrassment!
- The discrepancy in service rate between the different sorts of debt is huge. The service rate on a 30 year mortgage is between a tenth and a twentieth of a year. 0.10-0.05 times per year.
Contrast that with the turnaround speed of a commercial credit which depending on the situation is between 5 and 20 times a year. Suppliers are beastly – they want their money or they don’t deliver.
We are talking a factor between 50 and 400 times from the fastest to the slowest debt service rate – and here we have only considered the money that with some justification can be called alive. Huge opportunities for obfuscation!
What is it that happens in a credit crunch? The best customers cannot get credit because as soon as their debtors pay the account is slammed shut – because the bank cannot pay their creditors due to illiquidity.
In other words the good debt and good money dies first and the rest is really distressed – deferred service and lowered interest. So the money supply is really going down, but not with very much as the good money weighs about a hundred times heavier in the money times debt service expression.
Quantities Easing is just a Central banks way of restoring some of the money that has disappeared. The problem is however that the total quantity of money now contains very dead capital. As losses are NOT taken and banks on paper remain solvent the official figures are audited by the reputable accountant firm Hans Christian Andersen.
Now turning to the nasty side of banking: Who are to bear these losses? The banks obviously can’t. New capital cannot be added, as the extremely rich and naive is an endangered species. Rich people are rarely naive and naive are never rich – for very long.
The real losers in this are the investors – pension funds f.i. – either they get a return on their capital that is negative in real terms or the money is outright lost. As we have seen in Italy and other places the pensions cannot be paid out.
I stopped saving in a pension fund in 1989, when I got a statement from the company that the modest monthly saving was prognosticated to give me a taxable income as a pensioner retiring at 65 exceeding my salary as a full time employed MBA (approx.) in my mid-thirties servicing debt on a large student loan. Totally unrealistic!