Saturday, July 16, 2011

Debtocracy and global bankruptcy

Watching the European Union member countries demanding hundreds of billions of Euros to get through another quarter (Greece will go broke again in September), and the United States government arguing over increasing the national debt another couple trillion dollars to get through another year, and most states, cities, towns, and even school districts calculating the magnitude of their insolvency, we wonder how all this will end up.

We think there is a battle between  two major economic forces in the global economy. The first, well-known to most people, is the power of market forces where the best products (most efficient, most inexpensive, etc.) win. The second economic force is the rise of debtocracy, when a community or country takes on debt by voting for it, creating debt by democracy rather than by the market economy.  In school districts, residents and teachers and staff voted for new buildings, higher pay, and long-term benefits and committed their communities to long term debt as a result. States, countries and cities did the same thing. Since public employee contracts are not driven by market forces, like costs and employee wages are in private industry, there is nothing to correct the overpayment like a company going bankrupt. Debtocracy funded national social programs as well; their debt was also voted by elected officials keeping their commitments to their constituents.  In contrast to how the market price of oil drives the amount investors are willing to risk to drill for new oil, the huge local and national debt is not driven by risk and reward or any market forces at all.

The question is, what will the net affect be of the conflict between market economic forces and debtocracy? Here are some of our thoughts on the struggle and potential outcomes.

Those benefiting from the debtocracy will continue to use every means possible to maintain their income and the guarantee of long term benefits. They will get promises and money from anyone and anywhere to keep the insolvency from being revealed and maintain their lifestyle. We see this in Greece where both the government and the banks are doing whatever they can to extend the debt and the debt payments while ignoring the suffering of the people and the future of Greece. Debtocracy has allowed those with position and power to create debt for their nations without any possible way to pay it back.  

As the global debtocracy grows, it is driving away the real market economy. No organization or person living in the real market economy can afford to live in a debtocracy; it is too costly and too stressful. Local economies become warped as some things operate based on market economy while others are based on the massive debt voted into existence by local communities and congress.  In Hawaii for example, we see condos in the same community for dramatically different prices; some being offered by the government for low prices with no money down (actually Fannie Mae gives you 3.5% at closing) and federally subsidized interest rates and payments while others are being sold by their owners. Individual owners have to pay a real estate agent and their buyers must deal with loans at market interest rates and new stringent requirements. During this worst economic downturn of the century, many American workers are unemployed or working multiple jobs to earn a portion of the salaries and benefits they earned before the crash in 2008 whereas local and federal government employees are paid based on contracts signed by elected officials rather than based on the value of the tax base in their communities.

Debtocracy is causing secondary collateral damage by distorting the value of things. People can’t figure out how much they need to live on, what their houses are worth, or how much they can afford to borrow. In a local economy where some are able to obtain low interest subsidized loans while others are paying exorbitant interest rates, the amount you can afford to borrow varies greatly. Things that would normally be easy get really hard when you cannot distinguish what is real.

The debtocracy system is destroying the infrastructures of cities, counties, states and federal governments because the focus is on keeping the money flowing rather than cutting the spending back to a level consistent with what the communities and countries can afford. Debts are mounting to cover the shortages and push the problems into the future, making insolvency  and the complete collapse of the services offered more likely.  More and more cities may take the bankruptcy route to address their debts, like Vallejo, California did.

Two scenarios seem likely to us, one the federal government steps in to pay off the huge debts by printing more currency, or everything goes into default and the cities, counties and other entities collapse.  If the Fed creates a flood of currency to cover the debts, it will cause hyper-inflation and devalue money so much that it will not be a viable exchange medium. People will be forced to use gold, silver and bags of apples to buy things. If everything goes into default, then pensions will not paid, government employees will be laid off, and all the muni-bonds bought by the wealthy will become worthless making money scarce. Everyone being broke will cause hyper-deflation and people will forced to use gold, silver and bags of apples to buy things. 

In either scenario, a world where no one has any money or a world where money has no value, value will be in real assets and capabilities instead of currency.  Fresh air, clean water, non-radioactive land, nutritious food, and good health will be real wealth instead of a suitcase of paper currency or a promissory note for a pension.   From a personal perspective, we think one’s economic value will be what you know, what skills you have, and what you are able to accomplish for yourself, others and your community.   


Matt said...

I've been enjoying your blog so far, but this post is a vast oversimplification. If teachers are paid too much their salaries should be adjusted. Getting their salaries from debt or from a reserve of cash doesnt change the value that we should place on their services. I guess you could argue that since we pay interest on the debt then we should reduce their salaries to account for the interest, but then you would be recruiting some 2nd tier teachers. Also it would seem like this same logic would need to be applied to all government paid positions. If we started reducing soldier salaries and pensions based on the amount of their pay which was funded by debt there would be a serious backlash.

Thinking of this simply as debt vs no debt is an oversimplification. I'd propose looking at the efficacy of programs and finding ways to cut money from failures and support good ones (good being defined as programs which provide more dollars in benefit back to society than they cost). At the same time as this we should also call on legislators to be better fiduciaries. Selling your statehouse for a one time windfall (but ensuring a future of rent payments) is a foolish endeavor, counting some of next years revenue as part of this years to make budget is also shortsighted. Americans need to support their legislators in paying for programs the most rational way (through immediate taxation). This is the only way constituents will feel the cost of what they are voting for. Locking down taxes and thinking that politicians won't find some stupid way (like bonds or the accounting shenanigans I mentioned) to pay for the programs is a fools errand.

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