Deflation Made Simple (Part II)

The Story of Real Money (Entry 114)

Beginning with Image 101 we temporarily abandoned our discussion of The Estates’ budget in favor of a more theoretical discussion about the nature of the state, debt, taxation, and state citizenship. During this discussion we examined several ways in which a state can form, and noted, in particular, how a state that arises from the voluntary good-will of its citizens can quickly turn into a state of contempt and tolerated imposition.

Further, we examined an additional form of money-in-use and the coercive side of money-in-alms — namely, money-ad-prodigo (money-in-use spent on money-generating government debt) and, of course, money-per-vim (taxation), respectively. Money-in-alms and money-per-vim have been with us ever since real money became a popular way of conducting trade, and the church and state have been dominant forms of insuring social order among citizens of diverse cultures dominated by a single ruling entity.

Additionally, we distinguished between money-generating financial instruments that are financed with money-ad-prodigo and wealth-generating financial instruments that are financed with money-in-use in the spirit of Jean Calvin. Further, we showed how the holders of these instruments grow disproportionately wealthier than those who do not hold them, and that, irrespective of the rate-of-return (ROR) and risk associated with each instrument, investors may or may not be indifferent to their origin. Moreover, we showed that money-generating debt instruments tend to be wealth-destructive, and that wealth-generating debt instruments, as their name well suggests, are in most cases wealth-generative.

Finally, we showed how money-ad-prodigo shifts the burden of money-per-vim from the holders of money-generating debt instruments to non-holders. In other words, the burden of the state is shifted from the wealthy — those who can afford to purchase the instruments — to those who cannot — namely, the poor.

There is one more important conceptual relationship that we should consider before returning to the facts on the ground that gave rise to the above, more theoretical concepts — namely, entrapment. This occurs when the creditor becomes trapped by the debtor for his own material well-being.

Lent money is, generally speaking, money in search of best-use. From the point of view of the lender best-use is generally defined as invested money that brings the greatest return for the least amount of risk to its lender. From the point of view of the borrower best-use can mean whatever the borrower wants it to mean so long as the borrower can meet his debt obligations — namely, regularly scheduled interest payments and payment of the principal when the debt instrument reaches maturity. This difference in perspective can explain, in part, how we have learned to confound money-generating from wealth-generating investments.

What happens, however, when the debtor can no longer meet his payments schedule? The crisis is not a one-way street; rather the burden of responsibility for the outstanding contracted amount is shifted from the debtor to the creditor, who must now decide whether to prosecute the debtor for non-payment or help the debtor to meet his payments.

In the case of wealth-generating debt instruments prosecution by the creditor for non-payment on the part of the debtor will not be immediate. For, after all, finding good debtors who make regular payments is a somewhat costly task, and why kill the goose that was laying the golden eggs, if the goose were only sick and could readily recover? Even the best companies cannot be prepared for every vagary in the market place, and even under the best of market conditions good companies can over-invest.

So, the debtor and the creditor sit down and discuss various ways in which the debtor might meet his interest obligations moving forward. If the debtor is unable to convince his creditor that the current problem can be resolved in a timely manner, the creditor will be compelled to take the debtor to court, whereupon the debtor will declare bankruptcy, and the court will do its best to insure that the company’s creditors are paid and the company is rendered solvent, if indeed, solvency is even possible. Once again, being solvent means being able to take on debt and meet one’s payments.

In order to meet its obligations the court will generally force the debtor to sell off its assets in whatever amount is necessary to meet the debtor’s obligations to the creditor. If the debt is very large, and the assets of the company are small, the creditor — or, as is often the case, creditors — could lose the difference and the company would be dissolved. If the debt is small relative to the firm’s assets, and it appears that the company can once again be made solvent, the creditor will work with the debtor under the supervision of the court to restore a positive net income flow so that the debtor can once again meet its interest payments and pay back the outstanding principal of its future debt. A promise kept is a promise met.

In the case of money-generating debt instruments — money-ad-prodigo that is lent to the state — the situation is very different. For, unless the state owns wealth-generating assets — what is generally not the case — the state’s only recourse is to tax its citizenry additionally or cut its own spending. For, after all, what creditor would want to continue to lend to a government that cannot meet its payments?

Unfortunately, this is often what happens. Creditors — even the same to whom the state already owes what it cannot pay — lend even more! And, why? Because it is believed that the iron will of the state can eventually force its citizenry to pay whatever is necessary until the solvency of the state is finally restored (Entry 110). In such a scenario, lenders will take into consideration the amount of debt-outstanding, the ability of the state to make good on its promise of increased taxation, the willingness of the state to reduce spending, and the possibility that the state will simply default.

Once again, recall that we are still dealing with an economy in which real money is the basis for all transaction. Matters become far more complex and rapacious once counterfeit currency is introduced.

In liberty, or not at all,
Roddy A. Stegemann, First Hill, Seattle 98104