The Price of Capitalism

As a followup to my previous Ticker ("There Is No Unicorn That Craps Skittles") I wish to address the myriad people who have written over the years about the "E-Viles" of debt-based monetary systems, which inherently ends up in a call to bar the imposition (or payment) of interest, or at least a ban on private collection of interest.

The problem with this folks is that it won't work.

Let's first define what INTEREST is.

It is the price that you pay to use someone else's capital for a given amount of time and purpose.

That's all.

The riskier that venture is, the more INTEREST you will be charged.

When I set up MCSNet back in the 1990s I shopped for money.  Banks had no desire to deal with me - what I was doing was quite high risk, starting up a new company.  I had some capital, but not enough to do it all on my own - at least I didn't think I did.

So among other people I went to were a handful of what are frequently called "Angel Investors" - that is, people who have a lot of wealth and might be willing to loan you some of it.

All legal, all above-board.

I took each of these people an non-disclosure agreement and a full business plan.  They signed the first and got a copy of the second.

Discussions only got somewhat-serious with one of these people.  He wanted what amounted to the ability to ultimately take control of the company if things didn't go as the business plan projected (and he liked) - a demand that is quite common among people who are solicited in this fashion.

I decided not to go forward with that transaction.

But let there be no mistake - what he proposed to "charge me" was in fact INTEREST, never mind that it wasn't in the form of "8% per year"; it came in the form of an equity position and the right to more if the company "screwed up".

Now what happens if you bar the imposition of interest?

If that ban cannot be worked around (with something similar to what that "Angel Investor" proposed there is an instantaneous shutdown of all lending of capital.

See, the people who have that kind of capital (and believe me, he had - and I presume still does have - a LOT of it) have absolutely no need whatsoever to let any of it out of their control.  They can instead choose to buy a new Maserati every three months for the rest of their life, fly around the world in their LearJet, give the finger to literally everyone and still die rich.  If you try to steal their capital they will just leave the US - people with this kind of money could give a good damn about your idea of "wealth redistribution" - at the point they figure what you're doing is unfair to them, in their sole judgment, they simply pack up and leave.

So either such a plan is a lie or it immediately results in the law making it impossible for people to borrow capital to engage in some transaction that might come with risk of loss.

To counter this problem (that of private capital instantly being withdrawn from where they would formerly lend it) most of these proposals either "redirect" interest into the government as a "citizens dividend" or in some other way put it in control of government.

That's even worse, because you have now put CONTROL of capital into the sole hands of the government.

Once control of capital has passed to government you have IN EFFECT created Communism because control of capital is in fact control of ALL LEGAL COMMERCE.

So let's stop right here and dispose of all such claimed "solutions" and "plans" as what they are - the work of Satan in the name of Karl Marx.

If you trade or invest in the markets in any form you cannot support such a plan - no matter how it is couched.  It is absolutely antithetical to the premise of capitalism - no matter what sort of shroud (more succinctly - fraud) someone couches it in.

As such I am simply not going to entertain such garbage on my forum no matter what sort of fishpaper it is wrapped in, because Tickerforum (and The Market Ticker) is expressly a place where we talk about The Capital Markets in a Capitalist economic system within a Representative Republican Government.

If that isn't your thing, then neither The Market Ticker or Tickerforum is appropriate as a place to discuss whatever it is you're trying to sell (and make no mistake, that's exactly you're trying to do!)

With that having been dispensed with, we can now determine the price of Capitalism that we must endure in order to have:

1. Private property rights, including the right to own and control capital that you acquired through lawful means, including loaning it to other people on terms as you may determine in your sole authority.
2. The inevitable fact that in such a system credit is always issued at interest, and that any attempt to not do so violates #1 and thus is antithetical to free-market capitalism.
3. The fact that debt (and thus interest) is inherently an exponential function, yet we live in a linear world where resources are finite.
4. The fact that all people who engage in commerce (whether its lending capital, making something, or consuming) do so with a profit motive - that is, to better their life.

Let's look at what happens as a natural and inescapable outcome of these four basic foundational facts in a Capitalist system:

Remember, everyone seeks a profit.  Therefore, those who loan capital out will demand some price above the "risk free" return that can be obtained by simply sitting in the economy and lapping up the growth.

Nobody will take an intentional loss as long as there are alternatives, and unless you steal people's property, there are!

Therefore, there will always be a "spread". 

But look at what happens.  In the first year, the "spread" between the two - the difference between the economic outcome and the lending price - is 3%.  But by the fifth year that spread has grown to 21% and is accelerating rapidly - 21% is much higher than 3 x 5, or 15%.

In 10 years the spread is much worse - 63% instead of the "expected" 30%, and in 20 years its horrifying - 286%!

Why?

Because both functions are exponents (compound functions) and so long as people seek a profit it will always cost more to borrow capital than the rate of growth in the economy, as you must induce them to take a risk.

Left alone the overhang of debt will always "run away" and destroy the economic and monetary systems.

Therefore if we are to avoid a complete collapse of the economic and monetary systems there must be times when the "overhang" of bad debt defaults, lest it grow so much that nobody can make the payments and the economy is choked off.

That is exactly what has happened because our government intentionally prevented the defaults that were NECESSARY in 2000-2003 to restore balance between these two functions.

Now the pain is worse, and as you can see above, the longer you try to put it off the worse it gets.  It's bad now (about 10 years in); if we try to "kick the can" for another 10 years it will be catastrophic.

This is the fallacy of those who say we "must prevent foreclosures", "increase lending", and "have a soft landing", including all of the idiots in Washington DC and on CNBC.

Baloney!  If you've got bad debt out there you want to default it and you want to do it now, because the longer you wait - the more you kick the can - the worse the economic pain will be.  The math guarantees this will be the case and there is absolutely nothing you can do to prevent or change it.

The bottom line is that you must accept that from time to time "liquidation events" - that is, the forcing of excess credit, which will always happen, into the open where it must default, bankrupting both creditors and debtors, are an inherent and necessary part of all capitalist economic systems.

Put in one sentence without explanation it reads:

“There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig von Mises

Mr. Mises didn't explain why, nor did he explain why such liquidation events are not only expected but are necessary in any capitalist system.  He should have, but perhaps he assumed that his readers understood mathematics.

He gave our leaders, and the public, too much credit.

In fact, we need resort to nothing other than the fundamental truth regarding exponential functions when operating within the boundaries of a fixed system. 

It is not possible to have a boom without a bust, and the bust must not fall under attempts to contain or avoid it, but rather allowed to run its course, or it is inevitable that it will become a bigger and more painful bust.

This is a fundamental truth that is a part of all capitalist economic systems where private ownership of property (which inherently includes capital) is recognized.

This not only cannot be avoided it must not be tampered with, because the mathematical facts of exponents (go look at that table up above again) means that each and every time one tries to interfere with these "liquidation events" by bailing out either the borrowers or lenders the time under which compounding of the damage occurs increases and thus the total damage to the economy must and does expand at this very same exponential rate. 

It simply cannot be otherwise.

To restate this in simpler terms:

1. The fact that debt and interest are exponential functions means that when a business failure occurs the sooner we force its recognition the less damage the economy takes overall.  Only liquidation of bad debt stops it from accruing damage to both the borrower and lender, and thus the economy.
2. Because all businesspeople in a capitalist system seek a profit, those who lend capital will always charge more than they believe will be the risk-free (that is, the aggregate GDP growth) rate of return.
3. GDP growth is also exponential (that is, compounded.)
4. The spread between aggregate output and debt overhang will, over time, always widen due to the inherent exponential nature of both interest and growth, and as it does it places pressure on all businesses as the "debt overhang" presses on the economy at a rapidly-increasing rate; this cycle is only interrupted by liquidating the bad debt.

Because of 1-4 delaying the liquidation of bad debt is ALWAYS the wrong thing to do in each and every case because the math guarantees that the damage you take today is always less than the damage you will take tomorrow by kicking the can down the road.

This is mathematics folks, not politics.  The mathematical facts do not care if you're Republican, Democrat or Martian.  Anywhere and everywhere there is a capitalist economic system where people have recognized the right to own, control and direct the use of private property with the intention of making a profit such a cycle is inevitable and interference with liquidation of "bad bets" always results in more severe economic damage to the system as a whole.

We must stop bailing people out, rescind the existing bailouts, and force the bad debt - all of it - into the open where it will default, because the damage we take from doing so today is less than that which INEVITABLY will occur if we continue to try to avoid or delay the liquidation events.

Oh, and if you think its bad with all the private business and banks going "boom", consider what happens if we transfer all of the bad debt to The Federal Reserve and then it defaults there as the inevitable reality of exponents comes home to roost in the center of our monetary system!

PS: Whoever wrote The Old Testament (whether you believe it was God or man) understood this, which is why "Jubilee" - that is, the wiping of all debt by decree on specified intervals - was written into the Torah.  They understood that only such an act halted the exponential "runaway" in the economy and thus prevented the ruin of the economy and the people.  Is it not amusing that we claim to be "so advanced" and yet not one person in 100 in this country seems to understand that which an ancient people, living in a time before electricity, automobiles, The Internet and even running water had figured out exponents - but the huge majority of our citizens haven't?  And you wonder why I rant and rave about our so-called "education" system and "teachers"?