Solving the world’s debt problem dominated the discussion in the Rick’s Picks forum over the weekend, with the final word going to “Jill,” who congratulated the group for “putting on their thinking caps and devising some kind of solution rather than just abandoning all hope.”  From where we’re sitting, however, it is only those who have abandoned hope who truly understand the problem.  For in fact, there is no more a “solution” to the world’s debt problem than there is a perpetual motion machine or cold fusion generator to remedy the world’s energy problem. In the end, to restate C.V. Myers’ dictum, every penny of every debt must be paid – if not by the borrower, then by the lender. It’s as simple as that. And much as we’d like to believe that some financial genius will come up with a way to spare us the pain of a Second Great Depression, it ain’t gonna happen. Because the world’s debts total in the many hundreds of trillions of dollars, there is simply no discharging those debts without ultimately ruining the financial lives of most creditors, debtors, or more likely, both.

However the unpayable sums are dealt with, as long as contracts are strictly enforced, deflation will continue to attend the process. Under the circumstances, the bankruptcy courts -- as opposed to a political system that may well eventually succumb to an anti-bank, populist tide -- will remain responsible for sorting out which creditors get paid, and how much.  By and large, such a process would visit pain on borrowers and creditors roughly commensurate with their respective sins of greed, stupidity and recklessness.

A Wacky Idea

In the forum over the weekend, the wackiest-sounding solution for the debt problem would have the U.S. Government print “debt-free money” that would be distributed to all Americans. Here is what the Treasury Department supposedly would have to do, according to the idea’s author, “F. Beard”:  “1) Calculate how much bank credit is in the system;  2) send every American adult (borrowers and savers) an equal [share, based on] total bank credit; and, 3) borrowers could pay off their mortgages, and savers would be compensated for years of suppressed interest rates.  In the end, says Beard, “we end up with a debt-free population, 100% reserve banking and no inflationary spiral, since the counterfeiting cartel, the banks, would not longer be able to create money (credit). A one-time shot of inflation? Maybe, but why? M1 would not change, it would simply become real money instead of credit.” wacky

We’ll leave it to readers to parse the logic of this modest plan, and to write letters to newspaper editors if they wish to see it promoted. However, as far as we’re concerned, it is dead-on-arrival as soon as we calculate “how much bank credit is in the system.”  For in fact, bank credit is non-existent once the banking system’s very real liabilities are subtracted from its mostly fictitious assets. For one, there’s the banks’ counter-party exposure to a derivatives bubble with a notional value estimated as high as a quadrillion (i.e., a thousand trillions) dollars.  And for two, there is all that bad mortgage paper being warehoused at the Fed, which traded Treasury paper for it. The Fed may be able to pretend that, for one, GM is going to repay its bailout loans, but the illusion that the nation’s lowest-quality mortgages have returned from the dead will be far more difficult to concoct as long as an estimated half of the nation’s 75 million homeowners remain underwater.

…and a Wackier One

Whether you screw the lenders or stretch borrowers on a rack to get them to pay, the financial loss in macroeconomic terms will be the same. If the politicians want to try something truly radical, they should consider a Federal income tax moratorium in 2011.  Although this would “cost” the U.S. about $2.5 trillion in lost revenues, that’s not a whole lot more than some of the high-end estimates for the looming QEII.  Granted, it would be hugely inflationary. But the spectacular stimulus it would provide to capitalists, entrepreneurs and workers could conceivably reinvigorate the economy sufficiently to leave everyone better off. You could also argue that because the dollar is already fundamentally worthless, there is no better time than now – when some still believe the dollar has value – to try such a crazy scheme.  Considering that the alternative is a deflationary depression, what have we got to lose? It would be great to see everyone working his or her tail off for a year, and for the economy to be breathtakingly productive. And at the very least, it would probably further postpone the Second Great Depression that seems all but inevitable otherwise.

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-- Posted Monday, 1 November 2010 | Digg This Article