It is time to stop quivering in our boots in pointless fear of the future and just roll up our sleeves and build it.
- Ray Pierrehumbert

Friday, September 30, 2011

Is Debt Conserved?

Arthur Smith makes an interesting argument.
I don't understand what a global overall "borrowing from the future" could mean in any physical sense. Maybe you have something specific in mind?

With monetary debt every loan has two sides: the borrower and the lender. There is a promise that the borrower will pay back the loan - with interest, so that's a promise of future exchange, a commitment by the borrower to redirect some of his future income to the lender. But there is no physical constraint involved: it is merely a contractual obligation between borrower and lender, and can be broken under various conditions without any fundamental damage to the world.
Clearly every time a dollar is borrowed, a dollar is owed. The transaction of borrowing money does not create or destroy total wealth in itself; one party owes a dollar, another is owed a dollar, so in the aggregate nothing happens.

After acknowledging that this is absolutely algorithmically true, I note that it is not what my conventional Keynesian macroeconomic prof taught me in Econ A01 at Northwestern in 1973 or so. (Wish I could remember his name, Robert something I think, he was an adviser to McGovern's campaign shortly thereafter.) He did not teach Keynesianism as a theory. He taught it as established fact. We would never ever have another depression because Keynes.

According to professor Bob, "public debt is OK, because we are borrowing from our future selves".

So did we borrow from our future selves (thus committing to growth) or did we borrow from the Chinese (thus giving them an asset to balance our deficit).

Well, the crucial thing to understand is that the bank and the government can lend money that they don't actually have. This has always been the secret of banking, and why, ordinarily, having a bank is the best possible business, with the possible exception of evangelism. In fact, when you put money on deposit at the bank, the bank gets permission to lend out some multiple, larger than 1, of that money as loans. This quantity is controlled by government fiat in some way.

I believe something very much like this is true in every non-Islamic country, by the way, except maybe the very weirdest pseudosocialist autocracies like Myanmar and North Korea. It includes contemporary Russia and China, though perhaps not their communist predecessors a generation ago.

So the point is, something did happen in the aggregate. The total of assets and liabilities remains zero, of course, by the fundamental theorem of accounting ledgers. But the absolute quantities of liabilities increased.

Now, why is the bank lending you money? After all, a bird in the hand is worth two in the bush, right? Well, because you agree to pay back the loan, plus inflation, plus coverage for the bank's risk, plus a profit for the bank. As we all experience with mortgages, in the end this is a significant penalty. It does not show as part of your or the bank's credits or debits (if you win the lottery tomorrow, you can settle your mortgage account with the bank next week, after all) but is something you implicitly owe the bank in addition to the amount you borrowed.

This is the engine of capitalism and it runs on optimism. The bank has some confidence that you (or your insurance company) will repay, or find someone else who can repay to buy the house from you, or in the worst case, that it can resell the house after repossessing it. In any case, the likelihood of losing most of the value of the house (or business) is small enough that it can be placed in a statistical category on which a profit can be made.

When you take out a mortgage, you are borrowing from the bank. But you are also committing your household to a specific level of economic function, such that you expect to be able to pay off the house and all the financial overhead associated with the loan. So although you are borrowing from the bank, you are also borrowing from yourself. You are saying, in order to have the pleasure of living in a house before I have paid for it, I promise to work hard enough to have enough surplus to pay for the house and the financial overhead.

You are borrowing from your own future earnings. If you expected to lose your income, you would not take out such a loan. If the bank expected that, they would not give it to you. At least, that was the idea until recently, but let's leave aside how the pattern failed.

The point is that when China buys US bonds, China is assuming that the US will pay them off.

If Tea Partiers come in and break the US economic system because they are too stupid to learn how the system works before taking hold of it...

Well, it could break in a number of ways that my Keynesian prof would have found absurdly unlikely, let's just leave it at that.

But in the aggregate, every loan that isn't disguised charity is an optimistic bet on the future of the debtor. And pretty much all the money comes into its strange ghostlike existence through such loans. So every dollar in circulation represents most of a dollar bet on the future. It's a "promissory note" that no longer promises gold or silver. It simply represents somebody's promises to gladly pay the bank on Tuesday for a hamburger today.

And as for Treasury bills, they are a special debt that is explicitly incurred by the nation as a whole, so its implicit problem is for the future prosperity of the nation. Without growth, the debt payments gradually become insurmountable. Without growth, that is, borrowing from your future self is destructive.

And that is why I think Krugman is not entirely right. We can't necessarily take up as much public debt as is needed to go back to "full employment", never mind expect the private sector to pick up the slack when "demand" goes back to baseline.

At this point future growth is not a sure thing. At some point, it becomes a sure not-thing. And whatever that point is, it's not clear we should be carrying debt at that time.

Fortunately there is an immense amount of wealth in the US and the wealthy are hugely undertaxed, so if anybody were making any sense there would be no reason to take on any debt.

But eventually, debt does matter.

What happens when the optimism is misplaced? Well, we are seeing exactly that now. The sudden disappearance of "wealth" and widespread increases in various stresses and demands, even though little or no physical damage was incurred!

This is bad for the debtor and bad for the creditor. It is no zero-sum move for the creditor to write off the loan and the debtor to lose access to credit. And this bad thing happens when growth is less than foreseen. And a worse thing happens when zero growth is foreseen.


Nothing happens. Zero growth, basically zero credit. And since we have arranged things so that we can only feed ourselves when something happens economically, well, everything goes to hell in a hurry.

So we'll have to change that. But the holders of debt will not like any prospect of growth stopping. Not one bit.

Zorg: I hate warriors, too narrow-minded. I'll tell you what I do like though: a killer, a dyed-in-the-wool killer. Cold blooded, clean, methodical and thorough. Now a real killer, when he picked up the ZF-1, would've immediately asked about the little red button on the bottom of the gun.


Greg said...

I think you're being a little too absolutist about what a sustainable economy has to look like. Even within a sustainable economy you will have people and companies with brighter-than-average prospects who therefore make an attractive investment opportunity. As those opportunities won't be as common as during the era of growth, interest rates charged will be lower.

As for Krugman, he's looking at the well-being of people right now and the next ten years. The end of growth is further off than that. (Think how much economic activity will be required to deploy the clean energy infrastructure of that future steady-state economy.)

I agree with your statement that we could fund the necessary programs without borrowing, by reclaiming some wealth from those who've made out like bandits from the last decade or three of US policy. But technically we don't have to do that right now. If the US borrows to fund its way to the steady-state future, and then finds itself unable to pay off that debt in that zero overall growth environment, it will either default, costing the bondholders, or will appropriate such wealth a necessary to pay them. In either case, the cost will fall on the wealthy (as it should). Yes, it would be cleaner to approach that future state with intelligent levels of taxation and more-or-less balanced budgets than to arrive there with a debt crisis. But if that is not politically possible, then it's better we get to that future by borrowing than we don't really get there at all.

Greg said...

Oh, I forgot. Serious kudos on the 5th Element reference. I had it just from the picture. :-)

Phil said...

Even though the balance sheet averages out to zero, creation of debt increases the amount of money potentially in circulation. When a deflationary crunch hits, like now, money which could be being spent on all those planet-destroying goods and services tends to be directed to paying off debt. Which increases the deflationary pressures. Nice positive feedback loop there.

Hank Roberts said...

We got yer wealth, right here, it's under this little walnut shell. Keep your eye on it, the shells move around fast but the value is always under one of them. Keep watching .....


Auditing in the News: $7.6 billion missing
"Steven J. Greenwald"
Mon, 26 Sep 2011 21:55:01 -0400 (EDT)

ALL of the "Big Four" accounting firms listed in the attached article do the same thing: send soi disant "auditors" around who .... work from stale checklists. And don't know what the hell they do (and never will). But they wear expensive clothing.

I have seen the look of amazing ignorance and stupidity on the faces of these "auditors" so many times ...

The article:

Kevin Gray, Deloitte sued for $7.6 billion, accused of missing fraud (Reuters)

"... the world's largest accounting and consulting firm, was accused on Monday of failing to detect fraud during its audits of one of the biggest private mortgage firms to collapse during the U.S. housing crash....
... facing accusations about their auditing standards by investors who collectively seek to recoup billions of dollars lost in the
financial meltdown."

rustneversleeps said...

The Mind Reels

The mind reels - they are just starting to think about how to include debt in their models now?

From Stephen Cecchetti's paper at the Jackson Hole conference.:

For a macroeconomist working to construct a theoretical structure for understanding the economy as a whole, debt is either trivial or intractable. Trivial because (in a closed economy) it is net zero – the liabilities of all borrowers always exactly match the assets of all lenders. Intractable because a full understanding of debt means grappling with a world in which the choice between debt and equity matters in some fundamental way. That means confronting, among other things, the intrinsic differences between borrowers and lenders; non-linearities, discontinuities, and constraints in which bankruptcy and limits on borrowing are key; taxes, where interest paid to lenders is treated differently from dividends paid to shareholders; differences between types of borrowers, so household, corporate and government debt are treated separately; and externalities, since there are times when financial actors do not bear (or are able to avoid) the full costs of their actions.

As modern macroeconomics developed over the last half-century, most people either ignored or finessed the issue of debt. With few exceptions, the focus was on a real economic system in which nominal variables – prices or wages, and sometimes both – were costly to adjust. The result, brought together brilliantly by Michael Woodford in his 2003 book, is a logical framework where economic welfare depends on the ability of a central bank to stabilise inflation using its short-term nominal interest rate tool. Money, both in the form of the monetary base controlled by the central bank and as the liabilities of the banking system, is a passive by-product. With no active role for money, integrating credit in the mainstream framework has proven to be difficult.

Yet, as the mainstream was building and embracing the New Keynesian orthodoxy, there was a nagging concern that something had been missing. On the fringe were theoretical papers in which debt played a key role, and empirical papers concluding that the quantity of debt makes a difference.

The latest crisis has revealed the deficiencies of the mainstream approach and the value of joining those once seen as inhabiting the margin.

Michael Tobis said...

Greg, sustainability may not literally mean zero growth. And zero growth, surely, does not mean no enterprise at all is creditworthy.

But a sustainable society will presumably be much closer to zero growth than we are used to, and there would be dramatically less credit extended in a zero growth society.

So "nothing" is perhaps overly dramatic as a prediction. But presumably debt will be much less common.

Note how, as soon as the assumption of ever-rising real-estate prices vanishes, it became much more difficult to get a loan, even for a credit-worthy person. This is because in the past, the bank could not only rely on your cohort's creditworthiness, but also on the increasing value of their liens on their respective properties.

andrew adams said...

Well, the crucial thing to understand is that the bank and the government can lend money they doesn't actually have. This has always been the secret of banking, and why, ordinarily, having a bank is the best possible business, with the possible exception of evangelism. In fact, when you put money on deposit at the bank, the bank gets permission to lend out some multiple, larger than 1, of that money as loans. This quantity is controlled by government fiat in some way.

Banks (with the exception of central banks) can't lend money they don't actually have - it has to come from somewhere, either from depositors, the bank's own capital, or borrowed from other banks. In the latter case that is money which is already in the banking system and ultimately must have come from one of the former sources. When money is deposited with a bank it has to keep a proportion (I think it is 10% in the US) in "reserve" to maintain liquidity and is able to lend the rest - obviously this means that there is more money in circulation than if they just held the entire amount in reserve, in which case they would find it very hard to make money and it would be bad for those of us who need mortgages and the like, but no new money is actually created.

Michael Tobis said...

Andrew is sort of right and I am sort of right. In more detail, quoth Wikipedia on "Fractional Reserve Banking":

"The relending model begins when an initial $100 deposit of central bank money is made into Bank A. Bank A takes 20 percent of it, or $20, and sets it aside as reserves, and then loans out the remaining 80 percent, or $80. At this point, the money supply actually totals $180, not $100, because the bank has loaned out $80 of the central bank money, kept $20 of central bank money in reserve (not part of the money supply), and substituted a newly created $100 IOU claim for the depositor that acts equivalently to and can be implicitly redeemed for central bank money (the depositor can transfer it to another account, write a check on it, demand his cash back, etc.). These claims by depositors on banks are termed demand deposits or commercial bank money and are simply recorded in a bank's accounts as a liability (specifically, an IOU to the depositor). From a depositor's perspective, commercial bank money is equivalent to central bank money – it is impossible to tell the two forms of money apart unless a bank run occurs (at which time everyone wants central bank money).[2]

At this point in the relending model, Bank A now only has $20 of central bank money on its books. The loan recipient is holding $80 in central bank money, but he soon spends the $80. The receiver of that $80 then deposits it into Bank B. Bank B is now in the same situation as Bank A started with, except it has a deposit of $80 of central bank money instead of $100. Similar to Bank A, Bank B sets aside 20 percent of that $80, or $16, as reserves and lends out the remaining $64, increasing money supply by $64. As the process continues, more commercial bank money is created.
When the reserve rate is 20%, as in the example above, the maximum amount of total deposits that can be created is $500 and the maximum increase in the money supply is $400."

Ron Broberg said...

My introduction to this topic is through Chris Martenson's Crash Course

Kooiti Masuda said...

It sounds like Frederick Soddy's "Wealth, Virtual Wealth, and Debt".
Herman Daly discussed Soddy's economic thoughts in a chapter of his book "Beyond Growth".
It motivated me so much that I should read Soddy's original book, so I have got a copy, but I have not read it yet.

Nick Palmer said...

When considering these ideas it is helpful to remember that conventional economic growth (more energy, more materials, more products) should be reclassified as uneconomic growth as we now cannot afford it any longer.

Economic development, which creates the same goods and services using the same or less energy and materials is the way to go.

All the talk from the pundits at the moment is about restoring growth, which is madness, whereas we should be focussed on restoring (or achieving for the first time) economic health.

David B. Benson said...

Zero net growth still leaves room for borrowing and lending. Think of it as a redistribution of energy from the sun.

Contemplate the history of Europe before industrialization set in, bringing excess energy derived from coal.

Eric L said...

To the extent that growth affects our ability to repay our existing debt, it is nominal growth that matters, not real growth. There are no limits to that. And even in a no growth economy borrowing money to attend college makes sense, borrowing to open a business makes sense.

Right now interest rates are below inflation, and so long as that's true every pothole you put off filling, every necessary bit of infrastructure that gets delayed until there is money for it places a bigger burden on future generations than deficit financing them now would.

By the way, most treasury bonds are privately held, not owned by foreign governments. So personally I wonder if there is much difference between borrowing money and taxing the rich -- the money will mostly come from the same people, but in one case you take it and in the other you convince them to give it to you and promise to pay them back, which will almost certainly require raising taxes later anyway.

Eric L said...

It occurrs to me that even borrowing money to buy a house can make sense in a no-growth world. The alternative is paying rent, indefinitely, so what you're really doing is paying a little more than it would cost to rent for 30 years so you can pay nothing after that.

Also keep in mind that wages can grow over time individually even if they don't in aggregate -- if employees become more valuable as they gain experience then they should expect their wages to grow, and this doesn't require total wages payed by the employer to grow over time because they keep hiring new employees at the starting wage while much higher paid employees retire.

John Mashey said...

"If Tea Partiers come in and break the US economic system because they are too stupid to learn how the system works before taking hold of it..."

Do the Koch brothers (i.e., who sparked the Tea Party via Americans for Prosperity and Freedom Works) have the *slightest* interest in a nonbroken US economy over the next few years?

They've invested over 20-30 years to get something like the Tea Party, they are very rich and they run a private company, so no worry about quarterly results.

They might well think a worldwide depression woudl be a good idea if it permanently wrecks the Federal govenments sop it sops bothering them with taxes and environmental rules. They certainly don't want the Federal govenment investing in science, education, alternate energy technologies, or even energy efficiency. [See voting records of Tea Party]. A good depression could get rid of much of that. Of coruse, the Tea party folks would be wrecked, too, but why would the Kochs care?

Nick Palmer said...

Eric L said...
It occurs to me that even borrowing money to buy a house can make sense in a no-growth world. The alternative is paying rent, indefinitely, so what you're really doing is paying a little more than it would cost to rent for 30 years so you can pay nothing after that

If the house is designed to last 2-300 years (easily possible), and we have stabilised the population, then, after a generation, the next generation not only does not need to expend more energy and materials to build further housing but also they would not need to work to fund that major part of most people's expenditure, which is that for the mortgage. The footprint of the economy could instantly become much smaller with no reduction in living standards

Pangolin said...

The majority of "economics" as I understand it has great gaping holes explained by fancy sounding postulates that amount to: "and than a miracle occurs". This idea quickly breaks down if we track transactions with bags of blue sand instead of fiat currency. Banks get to lend more than they have in deposits; they get to lend money that they don't actually have and then charge us interest on it. And then pocket the interest.

Which is a neat trick the bankers pull to keep farmers giving them stuff for free. it works really well too as long as next year the society as a whole harvests more energy next year than it does this year so that the actual increase in resources covers the increase in money.


In agricultural societies that have to live on the variable, but limited, income from the interaction from sunlight and plants lending money for interest is always regarded as a barely tolerable evil just a hair above slavery. For good reason since debtors are frequently enslaved along with their children when loans couldn't be repaid.

The modern banking system and related economics is inseparable from colonization and rapine resource extraction. It (the IMF actually) demands that forests be clear cut, fisheries over-harvested, rivers dammed, soil exhausted, mountains removed for fractional coal harvests and aquifers be drained in order to repay loans made by elites. The people whose lives depended upon sustainable yields from those forests, fisheries, rivers and farmlands; they end up in favelas, barrios, slums, shanty-towns and what have you.

With any luck other countries will follow Iceland's example and issue a giant _ck you to the bankers demands of repayment. Why be a slave?

Eric L said...


"Banks get to lend more than they have in deposits"

This is not true. They keep a fraction of deposits on reserve and lend the rest. They lend less than they have in deposits; however the fact that they have lent the money that someone else still sees they have on deposit results in the creation of money. It doesn't result in the creation of more and more money over time, though.

Nick Palmer,

"they would not need to work to fund that major part of most people's expenditure, which is that for the mortgage"

Are you assuming everyone is living in inherited proprty? Seems to me a lot of people would still buy.

Eric L said...

Okay, one more thing that's bugging me:

"So although you are borrowing from the bank, you are also borrowing from yourself. You are saying, [...] I promise to work hard enough to have enough surplus to pay for the house and the financial overhead."

But on the other side of this transaction, isn't there someone who is doing the opposite, who wants the freedom tomorrow to have the option of working less hard and living off accumulated savings plus interest? You borrow from someone else; you can think of yourself as borrowing from your future self but it is only made possible by the fact that someone else is saving for their future self; the economy as a whole cannot borrow from its future self. So I'm not sure there is any commitment to growth assumed here; some of debtor A's future income is being committed to be transferred to lender B, but where is the commitment to increase the total between them?

I also get the impression that many people (and I don't necessarily mean in this comment thread) believe not only that it is possible through debt for the economy to borrow from the future, but that we did exactly that and are paying it back now, as though we must produce today the stuff we consumed yesterday. Consumer debt is certainly a problem but this isn't really a reasonable way to think about it.

Pangolin said...
This comment has been removed by the author.
Pangolin said...

Eric L_ The problem with the hypothesis that banks can only lend a fraction of what is deposited is that virtually all modern banks are associated with some form of central bank that has the authority to generate fiat currency.

In short, should all the depositors walk up to the window and demand their full assets the bank in turn is permitted to go to the the reserve bank and request a loan at "special" interest rates. That money, is indeed, whistled up from thin air.

Simply increasing the number of recursive loops that happen before the money appears in the bankers pocket doesn't change the ultimate outcome. The money is not generated as gold, grain or kilowatt hours, it simply appears.

As I said before, you couldn't replicate modern banking practices if you used bags of sand and were never allowed to use symbology where the sand didn't exist. At some point somebody holds his empty hand up and declares that he's holding a bag of sand and expects others to believe it.

Pangolin said...

But on the other side of this transaction, isn't there someone who is doing the opposite, who wants the freedom tomorrow to have the option of working less hard and living off accumulated savings plus interest?_Eric

It's the phrase "plus interest" that causes all the problems. The actual income of the Earth has not changed. Each sq. meter of surface receives ~1kw hour of energy per hour of sunlight.

So somebody who farms 5 acres and has accumulated a surplus to lend now gets the income from his 5 acres plus a portion of his neighbors creating a further surplus to him. This he lends to a third neighbor creating a further surplus that he lends to a fourth. Before long the first farmer owns 15 acres and has four people working for about 1 acres income each to pay off their debts; which they can never repay.

If this doesn't sound familiar it should because this is exactly what happens in India, some African nations and anyplace else where debt peonage isn't forbidden.

This cycle has only been broken by revolution, strict usury laws or fossil fuel economies. But we're losing the fossil fuel economy and we have notoriously lax usury laws. People with student loan debts in the U.S. are effectively in debt peonage. There is no discharge short of death for those unable to find sufficient employment. And the bankers encourage employers to refuse employment to those with undischarged debts.

Ultimately debts repayable for interest will have to be strictly regulated in any sustainable society.

Ron Broberg said...

Benson: Contemplate the history of Europe before industrialization set in, bringing excess energy derived from coal.

Should we be contemplating the deforestation of Western Europe(and subsequent import of timber from the Baltics and Americas?) Or further back in time, and the deforestation of Southern Europe and Northern Africa during the Roman times? Or the deforestation of the Near East even earlier?

Alexander Ac said...

Everybody who really wants to understand the role of debt in economics SHOULD read Steeve Keen.

Eric L said...

It's the phrase "plus interest" that causes all the problems. The actual income of the Earth has not changed.

Interest doesn't change my point. It's just a little more income the debtor is committing to, and that much less income the lender is committing to. There isn't any requirement for overall growth, and as I've noted already it can be quite reasonable for individuals to expect higher future earnings in a world of no growth.

I agree that finance plays a role in wealth concentration, as does any sort of return to capital, and I believe that the financial sector has gotten to be too large of a fraction of the economy (though I think this is as much a symptom of wealth inequality as it is a driver -- a large financial sector means the people who have money don't need it and the people who need money don't have it.) But I'm unconvinced of the growth connection here; the financial sector will have this effect with or without growth.

should all the depositors walk up to the window and demand their full assets the bank in turn is permitted to go to the the reserve bank and request a loan at "special" interest rates.

True, but this doesn't happen very often, and as you note if at all possible it comes in the form of loans that are expected to be paid back. Most TARP money has been paid back. We are not now in a situation where there is more debt than deposits.

Arthur said...

Thanks for the interesting discussion - I appreciate MT's attempt to be more specific what he means on the subject but I find myself largely in agreement with Eric L's very coherent commentary here.

A number of people have pointed out central bank ability to create money as a problem - but to me it seems this is while troubling (money implies power, this gives the central bank a lot of it) hardly unique. That is, the issue isn't an increase in coins or currency but rather the obligations between various participants in the economy. But those contractual obligations can be entered into without any participation by central banks at all. The explosion of "swaps" and derivatives a few years ago vastly expanded the total quantity of "assets" lying around - each asset matched to a liability - while doing essentially nothing for the economy as a whole.

The real power of central banks is controlling the value of money or debt relative to goods - the rate of inflation. If money is created too freely, prices will rise and that's the main real consequence. Different central bank strategies will certainly have real impacts on the distribution of wealth between debtors and creditors, rich and poor. But you could have much ofnthe same effect through taxation as well,

So I still don't see any real fundamental meaning in the world as a whole borrowing from the future. Redistributing between generations, between rich and poor, between nations, yes that can happen. But from the future to the present?

Michael Tobis said...

It is clear to me that confusing the formal zero sum of accounting with the question of growth in economics is wrong. But this raises the question at a fairly fundamental level: what is it that is growing.

Suppose in the extreme case that you lend me your last $100 at 10%/year. Then you change your mind and borrow it back, but I can squeeze you for 15%/year.

Then no money has changed hands at all except for a brief while, but you owe me $5 a year until you pay me back the money that I owe you!

If we are the only two people in the economy, the extra $5 has to be made out of something...

What does that say? I'm not sure.

One thing I am sure about is that double entry accounting will tell us nothing. The total accounting equity in the universe is zero.

But that doesn't mean our behavior is the same in the presence or absence of debt.

We can collectively have more or less debt, and the amount of debt seems clearly to be related to a prediction about the future.

If my house is paid off, I will be less concerned about my ability to earn money than if I am carrying a mortgage, and the bank will be less concerned as well. If I have a mortgage, the debit cancels the credit, but we both want the loan to stay in good standing and we both want my prospects to be good. If I have no mortgage, I care less and the bank cares not at all.

Hank Roberts said...

"... The 2007-2008 financial crisis is very much a case in point, at least as I understand from my recent reading of Michael Lewis' account, "The Big Short: Inside the Doomsday Machine". A number of people became enormously wealthy while bankrupting their own companies, their customers, or large swathes of the general public. The ways in which they managed this was through exploitation of a handful of real "bugs" in US and international systems of finance. Some of these bugs have been addressed; some I'm less confident will be, exhibiting further bugs in our political and media systems...."

Hank Roberts said...

What we need is economic models that assume the players behave like they actually behave, for as long as they can get away with it, and profit.

Where are the models that handle kleptocracies?

David B. Benson said...

Ron Broberg --- Yes, deforestation is and was a form of energy and materials extraction. However, farming practices changed almost not at all from a nominal date of 410 CE (for the fall of the western Roman empire) to 1440 CE (the invention of the printing press). [I'm sure of this because the farming tools on display in the British Museum dating from about 410 CE are exactly the same in form and materials as those used by my grandfather on his 40 acres.] During that thousand plus years the number of books in Europe declined and possibly transportation became more difficult. The first sign of positive(?) change was in about 1140 CE with the construction of the first Gothic Cathederal. Of course some stone fortresses in Europe are probably older, but the lack of timber helped spur the use of stone around then.

I suggested contemplating this interval because a fair amount is known about it, despite the decline in books, and it is as close to steady state as I know about. [I know almost nothing about history in Asia.] Of course the steady state ended with printed books and literacy.

What was the role of debt (and maybe even banks) during this time?

Ron Broberg said...

A couple of quick thoughts:

1) Sustainable does not mean steady-state. Neither human-beings in their own self nor their societies nor the species as a whole exists in a steady-state.

2) Americans, even post-911, take security for granted. Security is a prerequisite for production. If your crops are raided, your churches and storage looted, and your factories and libraries burned, the economy is set back. If small in scale, the society might be able to absorb them. If the raids increase in frequency or scale, the economy is lost.

3) We tend to think of history as the expansion and contraction of political entities and the wars between them. Economic history is just as important if not more so. I've been toying on the edge of it.

What was the role of debt (and maybe even banks) during this time?

Speculatively, I will point towards the payment of taxes in some combination of cash, labor, crops, or animals. So debt would likely be structured as 'future obligations.'

Marlowe Johnson said...


Given your choice of graphics, I'm surprised you didn't end your post with a quote from Gary Oldman's character in the Fifth whit:

"You see, Father, by creating a little destruction, I'm actually encouraging life. In reality, you and I are in the same business. Cheers."

Michael Tobis said...

But that IS a quote from Oldman's character, which explains the image...

Marlowe Johnson said...

hmmm i see what you mean....can you make the font smaller next time? Still, I think my quote is more apropos the subject of this post, but whatever. Far be it from me to criticize anyone from your generation who has the geek chops to quote the Fifth Element. Bravo sir.

guthrie said...

David B benson - this is a bit of an essay, but I see no need to apologise because your post re. the middle ages is rather in error.

For starters, farming practises changed a fair amount across western europe from around the 9th cnetury AD onwards, with the introduction of the 3 field system and improved ploughs, not to mention changes in breeding such that sheep became better wool producers enabling a better more modern wool industry. Clearance of forests came and went of course, but the simple fact is that that to compare the thousand years to as near a steady state as possible is wrong. Perhaps you could take the 400 years or so after the fall of Rome and during the rise of feudalism as being the steadiest period, at least with regards to technological and social development.

Now, more specific points to back up the mere 400 years of slow change - the use of stone was almost certainly spurred by foreign examples, its greater utility for defensive and show off purposes, and so on, not because of lack of timber. Especially in England, where lack of timber can be seen in houses seveeral hundred years after they began building stone castles. In all this sort of thing, the limiting factor is not so much raw materials, as people who know how to manipulate them and a ready market for their products that is not already filled, hence the general rarity of glassblowers in England before the 16th century.

The number of books in Europe probably did decline in the 400 years or so after Rome fell, but with feudalism being established and the spread of monasteries in the 9/10th centuries, with their scriptoria, many more books were produced. Literacy as well spread amongst the more educated and mercantile parts of the community, such that by the 15th century books of instruction were being produced for more normal people on everyday things, let alone books of secrets and suchlike.

The 13th century in particular sees the invention of the mechanical clock, and spectacles, both with their attendant social changes. It is also the first great period of pan-western european trade, with the invention of a variety of new bookkeeping methods, and of course the introduction of lost knowledge from the east through Spain, although a lot of that stuff began in the 12th century.

guthrie said...

My comment, continued:
Transportation, at least in the ex-empire, was probably actually better in the earlier part of the medieval period. The records we have suggest, especially in places such as England, that merchants etc found it easier to travel in the 12-14th centuries than later, because Roman roads and such still existed, but as traffic increased they became increasingly worn out and there wasn't a central authority to keep them up in the old style.

The style of drawing a line in the sand and saying "this is the decisive point" is very old and not very accurate. In the case of the developments of medieval europe, it is totally inappropriate. For instance, the type used for printing involved a special alloy with antimony in it. 3 centuries before, people weren't even very sure exactly what antimony was, but the developments over that time isolated it and meant that skilled craftsment knew what it was and what it was good for.

Now, the role of banks in the high and late medieval period was basically to lend money and get it back. They often went bankrupt due to bad debts. It was a comparatively simple system, but by the 13th century we had paper drafts on banks, and a network of couriers taking important information from Italy to the low countries and into Germany and France and Spain. Or was that the early 14th? I can't recall right now.
Anyway, the other part of the story about the high and late medieval periods is the increasing use of money - at least in England, a great many more peasants were involved in the money economy in the 13thC than people give credit for; the pure feudalism was pretty much dead. So you had a lot of silver in circulation, and some gold, but it was more directly under the control of the Kings, rather than private institutions. If inflation occured, it was likely because the king was adulterating the coinage, not because banks were lending as much money as they could to all and sundry.

AK said...

Wow! I go away for a while and MT is digging into economics. Well, IIRC he said he was going to.

@guthrie & David B benson...

There were many changes between the end of the Empire and the invention of the printing press, but the most important wasn't on guthrie's list: the rigid horse collar, which allows a horse to do around twice as much work with the same amount of food. Traditionally, an ox and a horse ate five times as much as a man, and could do five times the work. With the introduction of the rigid horse collar the horse could do twice the work while still eating five times as much as a man. AFAIK the rigid horse collar spread throughout the Carolingian Empire, along with improved plows that depended on it, starting around 800CE.


The ultimate basis of money is confidence. If nobody believes in anything but gold, then the amount of gold present in the economy is the amount of money. If you (or the king, or a central bank) start writing notes that people have confidence in, so that they don't come back to you for gold, then the notes you write represent an expansion of the total money supply. Every time somebody signed a mortgage, that's what happened.

The mess we're in now was fueled (IMO) by two problems: a housing bubble meant that more money was being created as housing prices increased, while the value of these high LTV loans was being increased too far due to unrealistic confidence: anybody who couldn't pay could always resell for more.

The other problem was that with 2nd derivatives those loans were being treated as worth more than even the Fed knew, so the money supply had gotten out from under their control.

When the bubble stopped growing, defaults started growing, risk was re-assessed, and the whole house of cards came tumbling down, causing a massive shrinking of the money supply.

David B. Benson said...

guthrie & AK --- Thank you. I'll point out that the books on the history of libraries I read were quite clear on the point of the decline in the number of books. According to those sources the monks did not copy as fast as books disappeared. But I had forgotten about the advances in agriculture; indeed my grandfather's mule wore a rigid collar when pulling a moldboard style metel plow. [But a #2 spade has been a #2 spade and a nail hammer a nail hammer for at least 1600 years.]

Other things took a long time to recover, at least in the decorative arts.

Peter T said...

The two schools of "lets pretend the economy runs on barter" and the Austrian "banks create money, this is wrong, lets go back to gold" have just about everyone confused. All it would take is a short course in ancient history - credit, interest and most of the other apparatus of finance appear well before there was gold or silver coinage or even a standard unit of account (actually, some thousands of years before). It is, as MT notes, all about time.

Money is a debt, differing from private debt only in that it is a "debt" on the general community rather than on some particular person or institution. Anyone can create debt, just by promising to pay at some future time and having that promise accepted. Private debts are translated into money all the time, and vice versa (I create a company, issue share - ie promises to pay some fraction of future earnings; shareholders use the shares as collateral with a bank - voila, money. Or I simply use my credit card - my private debt has become card company money or general money (all denominated in the same unit).

As MT notes, in a low growth or steady state economy, it's difficult to issue as much debt. Part of the path to such a state involves writing off much present debt. But this is no different in principle from writing off private debts, just larger scale and much more disruptive.

Marlowe Johnson said...

On second thought Michael, this scene is probably more germane to the discussion...

Michael Tobis said...

Peter T., thanks enormously!

It is always both reassuring and frustrating to have one's original thoughts validated. Reassuring, because one knows that he has not gone completely round the bend, and frustrating because one knows he will not get credit for breaking new ground.

If there is one person who sees it the way I do, might there be more? What economists should I be reading to validate and build upon this point of view? In particular, do any of them accept long-term limits to growth?

AK said...

@David B. Benson...

You're welcome. One of my fantasies is to get enough time (&energy) to create a history of the Industrial Revolution. My current thinking carries the deepest root back to the Carolingian Empire.

Something else to consider: the growth of wind and water power, which by the 15th century was very widespread. From Wiki:

The development of water mills from its ancient origins was impressive, and extended from agriculture to sawmills both for timber and stone. By the time of the Domesday Book, most large villages had turnable mills, around 6,500 in England alone.[3] Water-power was also widely used in mining for raising ore from shafts, crushing ore, and even powering bellows.

David B. Benson said...

AK --- Thanks again. After checking a bit regarding the horse collar, I would now propose 410 CE to 1066 CE as relatively unchanged in Europe. Not only does your comment about windmills tend to put paid to that, but my European history course over 50 years ago began with the latter date. So I haven't the slightest how matters of debts were treated over that interval [which might be termed Early Midieval?]

guthrie said...

David - another comment I'm afraid!
Surely you would be more accurate to say "relatively unchanged technologically", since there was a great deal of political upheaval, with the invasions, tribal movements, rise of the feudal system etc. Probably more than during the last 4 centuries of the Roman empire anyway.

Technological change was certainly much lower in the period, and often consisted of rediscovering or re-importing older stuff, such as the manufacture of brass, which the Romans did but it died out and was rediscovered in the 800's or so in Germany. Pattern welded Viking swords were also around, but that sort of thing fell out of use over time.
History of technology is a very interesting subject. Why did something get invented at a certain time, how come it fell out of use at other times, etc.

My personal understanding (from reading books, academic papers etc) is that in western Europe, material culture and trade etc didn't quite reach the capabilities or volume of the busiest Roman period until the 15th century, but at that time it was already surpassing the Romans in dissemination of technical knowledge, complexity and depth of knowledge and technical skill.

rustneversleeps said...

@ mt: "What economists should I be reading to validate and build upon this point of view? In particular, do any of them accept long-term limits to growth?"

As another commenter suggested, I think you should take a look at Steve Keen.

Here is a good intro/primer video (not well: this lecture was made well prior to the Lehman collapse.)

Maybe this short 3-part series as well.

I think he gets a little too cute when he describes credit as driving deposits, but generally good.

I the comment I made above about the paper presented at Jackson Hole, the concluding quote was "On the fringe were theoretical papers in which debt played a key role, and empirical papers concluding that the quantity of debt makes a difference... The latest crisis has revealed the deficiencies of the mainstream approach and the value of joining those once seen as inhabiting the margin."

As far as I can tell, that refers to "people like Steve Keen."

As to the current discussion, the key takeaway is not that there should be no debt, but that the current economic/financial system is biased towareds creating "too much" debt, and has done so.

I am not sure where he stands on absolute physical limits to growth. He does reference climate change and peak oil in one of those presentations, but it is more in the context of those constraints having a mitigating effect on deflationary pressures, which he sees as a consequence of the inevitable deleveraging.

Speaking of which (deleveraging), here is another economist video that is tangentially related.

I must say that these two seem to make a scary amount of sense. Which leaves me a little uneasy. How can so many other experts see things so differently? What am I/are they missing?

rustneversleeps said...

Hmmm, coincidentally, I just bumped into another Keen video at the Energy Bulletin.

I am just noting it, and giving a listen. It looks interesting from first bit.

David B. Benson said...

guthrie --- I agree. But the political changes didn't stop in 1066 CE nor did people's lot much improve until a somewhat arbitrary date of 1440 CE. Nonetheless one suspects there was some level of borrowing against the future even during the "dark ages" from 410 CE to 1066 CE. For example, the mount of Chinon was first fortified as a stronghold by Theobald I, Count of Blois in the year 954 from
How did Theobald I finance that? Out of pocket seems unlikely.

EliRabett said...

Dollars are bosons

Kooiti Masuda said...

I have started reading Soddy (1926) "Wealth, Virtual Wealth and Debt", but I am not sure when I finish.

Its epigraph is interesting.

"That which seems to be wealth may in verity be only the gilded index of far-reaching ruin; a wrecker's handful of coin gleaned from the beach to which he has beguiled an argosy; a camp-follower's bundle of rags unwrapped from the breasts of goodly soldiers dead; the purchase-pieces of potter's field, wherein shall be buried together the citizen and the stranger."
-- John Ruskin, Unto this Last, 1862.

By the way, Ruskin was also a member of the Meteorological Society and he wrote something there as shown here. Hence the title of Paul Edwards' book (2010) "A Vast Machine".

Kooiti Masuda said...


guthrie said...

Umm, anyone saying "it seems unlikely" has already given up any hope of reaching a sensible conclusion.
For example, the Chinon fortifications may well at first have been made of wood, cut and carried by locals under the command of the big bloke sitting on a horse. Or by the soldiers themselves. Thus very little finance is needed at all, just the right by feudal obligation or force of arms to compel people to work for you.
Stone fortifications could have come later, financed by saving up taxes, theft, grants from the king
I am sure that borrowing did occur in that period, but it would have been between the very richest people in the top of society.

David B. Benson said...

guthrie --- Mere speculation. I've been to Chinon.