Is this a bubble within the crash?

[Jay]

Re: Is this a bubble within the crash?

I think what you've all got a hold of here is the distinction between self-liquidating and non-self-liquidating debt. It's also the distinction between productive and non-productive investment. The upshot is that some debt (the non-productive kind) requires asset price inflation to be sustainable, even on the short term. In other words, its ability to pay the principal and the interest is purely dependent on ever increasing credit supply and so rising asset prices. This does indeed follow the iron law that it is - over the long term - impossible to pay both interest and principle.

Contrast this with investment that increases productivity. Here the interest is paid through profitability and its antecedent: falling costs.

The problem is that both appear to be genuine profit. In fact, due to the magic of leverage (on the way up at least) offered by finance that cannot be nearly duplicated in the "real" economy, the non-productive investment is far more profitable in the short run, especially if it has a grip on the imagination of politicians: short term boom, especially for their campaign contributors. This is doubly important: the more illusory the profits are (in terms of the liquidating / non-self-liquidating dichotomy) the greater the power of politicians to enhance them through gutting regulation. Almost infinite leverage through writing CDS anyone?

My point is that the notion that no debt is payable with interest unless one assumes increasing aggregate credit is false. The 19th century actually had deflationary booms. (I credit Marc Faber for hammering away on this point.) In fact it seems to me that this is the only healthy kind of boom: real investment is rewarded and hard won. The currency is stable enough to reveal purely inflation-dependent ponzi-schemes to be shams. (Contrast today where the hand of government dead-weights the scales in the favour of the most non-productive, inflation dependent endeavours as a matter of course.)

I credit Stephan LaChance with the basic insight into debt-based monetary systems which I've parotted above. This is a short, great read:

http://www.financialsense.com/fsu/ed...005/1212b.html

Wouldn't the debt monetary collapse be true only if the banks don't reinfuse their profits from interest payments back into the economy?

[ThePythonicCow]

Re: Is this a bubble within the crash?

I think what you've all got a hold of here is the distinction between self-liquidating and non-self-liquidating debt.

The key questions are "what is good debt?" and "what is bad debt?"

The answer offered in this article is that "self-liquidating" debt is "good debt":

Debt is self-liquidating when used to generate future income, from which interest is serviced and principal repaid.

At other times I've seen it written that "bad debt" is any debt that charges interest, or any debt that charges "too much" interest, or any debt that is not repaid, or any debt extended to someone who is at significant risk of not repaying or any debt extended for "bad" purposes, or any debt extended without solid collateral, or debt extended using a fractional reserve system, or debt created by printing new money or debt created from thin air as new bookkeeping entries, or ...

Just after I got an advanced degree in Computer Science and started a good job at Bell Labs (at the time, essentially zero risk of being laid off), I borrowed what amounted to my entire annual salary to purchase a sports car. That surely was not a self-liquidating debt. I could easily have acquired the transportation I required for a tenth the money. But I was still living comfortably on less than half my new income, and easily paid off that car debt in two years.

That debt was not "self-liquidating." It did not generate any future income. The future income was already in the works.

Another aspect - one cannot know the future. It is possible that some catastrophe awaits us next week causing a massive drop in the productivity of human civilization, such that almost no debt whatsoever currently outstanding can be paid off. Thus defining "good debt" as self-liquidating debt is a somewhat useless definition, because one cannot know whether any particular extension of debt will self-liquidate.

I would suggest that "good debt" is not any of the forms suggested above.

Rather "good debt" is debt which almost certainly is less than future productivity gains.

Those future productivity gains need not have been directly by that debt (as in my sports car example.) There is always some risk with debt, because the future is never certain. Good debt can fund non-productive expenses, it can incur high interest charges, it can be created with printing press money, it can be lent to those unable to pay back (essentially a gift),... What matters is that the productivity increases of the economic community exceed the monetary expansion due to the costs of the debt.

Well, actually that's not even the key factor. A society can endure stable inflation of the monetary base forever. What kills you is unpredictable volatility. When there is "too much debt", this increases the fragility of the system and hence makes future economic circumstances less predictable. One should usually avoid extending debt with too high an interest rate, or to someone with inadequate income or prospects of income to repay, or without adequate collateral because these circumstances usually incur higher risk of default and hence such debt increases the fragility and consequent unpredictable volatility of the system.