Article : why debt growth must exceed interest payments

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

How do I pay you 10 $GNK$ on a wage of 1 $GNK$, or did you really loan me 10 $GNK$ instead of 100? Inquiring minds want to know.

The first ten payments of 10 $GNK$ each were paid by returning one-tenth of the 100 $GNK$ principal each week. The eleventh and final 10 $GNK$ payment returned the first ten weeks wages of 1 $GNK$ each.

[gnk]

Re: Article : why debt growth must exceed interest payments

My explanation -- we're toast. That debt will default. I'm trying to figure out how I can continue to feed my ample-sized carcass, once my Social Security check will no longer feed my cat, much less myself.

I'm not disagreeing that we're toast. I'm just legalistically quibbling over the word "mathematics." You'll have to pardon me.

Well, we both agree on something.

I'm going to reread your earliier example and get back to you. As I said before, I am far from being an expert and mostly self taught. When I see complex formulas on economics, I admit, my eyes glaze over until the 5th re-read.

I see a lot of people viewed this thread - any other opinions out there? The issue, as I see it, is can the current system function sustainably without corruption, or was it always inherently flawed and the corruption is merely a by product of that flawed design?

[oddlots]

Re: Article : why debt growth must exceed interest payments

Like Sishya, I found the Stephen La Chance article very rewarding. There was an earlier discussion of it in this thread:

http://www.itulip.com/forums/showthr...00555#poststop

... where PC also brought up his sports car. (He must really miss that car!)

PC also brought up some good limiting factors on the usefulness (or lack thereof) of the notion of self-liquidating debt. His points are well taken: you cannot know that something will indeed prove to be "productive" (self-liquidating debt) beforehand and in some ways it is, therefore, a useless concept. A good, topical example: the government might have so skewed incentives in the system that investment in pursuit of productivity gains in, say, manufacturing is sort-of crowded out by the superior returns in financing (think of the relationship between GE the industrial conglomerate and its financing arm. Or Pandit's "as long as the music plays we've got to keep dancing.")

Likewise, I think PC has a good point regarding the apparent "mathematical" certainty of the outcome. If it's true, it's not because of a mathematical certainty.

Basically, what I learned from this discussion is that La Chance overstates his case and so, in the end, discredits it. I think that's kind of unfortunate because the notion of self-liquidating versus non-self-liquidating debt is a useful concept, if only as a heuristic device to demonstrate why the wealth caused by asset price inflation is largely illusory. (For instance why, in aggregate, we can't get rich selling each other our houses.)

[gnk]

Re: Article : why debt growth must exceed interest payments

Like Sishya, I found the Stephen La Chance article very rewarding. There was an earlier discussion of it in this thread:

http://www.itulip.com/forums/showthr...00555#poststop

... where PC also brought up his sports car. (He must really miss that car!)

PC also brought up some good limiting factors on the usefulness (or lack thereof) of the notion of self-liquidating debt. His points are well taken: you cannot know that something will indeed prove to be "productive" (self-liquidating debt) beforehand and in some ways it is, therefore, a useless concept. A good, topical example: the government might have so skewed incentives in the system that investment in pursuit of productivity gains in, say, manufacturing is sort-of crowded out by the superior returns in financing (think of the relationship between GE the industrial conglomerate and its financing arm. Or Pandit's "as long as the music plays we've got to keep dancing.")

Likewise, I think PC has a good point regarding the apparent "mathematical" certainty of the outcome. If it's true, it's not because of a mathematical certainty.

Basically, what I learned from this discussion is that La Chance overstates his case and so, in the end, discredits it. I think that's kind of unfortunate because the notion of self-liquidating versus non-self-liquidating debt is a useful concept, if only as a heuristic device to demonstrate why the wealth caused by asset price inflation is largely illusory. (For instance why, in aggregate, we can't get rich selling each other our houses.)

I agree that PC has a good point. Earlier in this thread I alluded to the velocity of money being high for his scenario to play out. And keep in mind, if velocity of money accelerates to keep up with all debtors' ability to pay off debt - that is, they have ready access to money to make payments, then what of a corresponding rise to inflation due to velocity, which in turn, affects interest rates, which in turn requires even more money to retire debt?

It's mind numbing to me.

But also keep in mind, as I said before, that all money is born of debt. That is, even if you are a lender, you are being paid back in debt - what Austrians call "iredeemable currency." As Prof. Antal Fekete says, only gold is the true extinguisher of debt; it has no counterparty.

Good reads:

http://www.professorfekete.com/artic...eathThroes.pdf

http://www.professorfekete.com/artic...vityOfDebt.pdf

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

... where PC also brought up his sports car. (He must really miss that car!)

Those BMW six cylinder engines are fine!

I think that's kind of unfortunate because the notion of self-liquidating versus non-self-liquidating debt is a useful concept, if only as a heuristic device to demonstrate why the wealth caused by asset price inflation is largely illusory. (For instance why, in aggregate, we can't get rich selling each other our houses.)

Yes, unfortunate.

The essential concern of debt, in my view, is how burdensome the payoff becomes. Usually that means that self-liquidating debt has an advantage over debt incurred for non-productive purposes (that flat screen TV or cruise in the Bahamas or a BMW 530!) because self-liquidating debt more likely has within it the means to enable payback without undue stress. However debt always involves some risk, as it trades present value for future value, and sometimes the future doesn't turn out as we expected.

The degree to which debt appears in an economy is roughly proportional to that economy's surplus capacity. When everyone is struggling to eat, there is no excess present capacity to fund with anticipated future earnings. I doubt that the ordinary citizens of North Korea have a debt problem. When on the other hand, there is enormous overcapacity (starting in our present situation with the immense supply of very low cost and quite convenient energy provided by oil this last century) then debt grows enormously, as a way to fund more consumption. On that backside of that peak, if that overcapacity declines, then as they say "payback is a bitch."

[ggirod]

Re: Article : why debt growth must exceed interest payments

The first ten payments of 10 $GNK$ each were paid by returning one-tenth of the 100 $GNK$ principal each week. The eleventh and final 10 $GNK$ payment returned the first ten weeks wages of 1 $GNK$ each.

So, the guy paid 10 $GNK$ a week from a 1 $GNK$ wage a week?

Sign me ....

Befuddled

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

So, the guy paid 10 $GNK$ a week from a 1 $GNK$ wage a week?

No -- he paid 10 $GNK$ a week out of the 100 $GNK$ he borrowed (except for the 11th week, when he paid that final 10 $GNK$ out of his saved wages of 1 $GNK$ per week for the prior 10 weeks.)

My example was made about as simple as possible, so as to make the point but not lose the reader. Guess I failed.

A more realistic example would involve actually passing that borrowed money back and forth between other economic participants, before sending it back to the lender as payments.

My purpose in this example however was not to teach useful economics, but to provide a sufficient counter-example to disprove the claim that it was mathematically impossible for a debt-based monetary system to be perpetually stable. Mathematics, like law, sometimes appears to be more relevant to our real lives than it actually is.

[aaron]

Re: Article : why debt growth must exceed interest payments

For what it is worth, PC, I agree with you too.

This topic comes up on iTulip and elsewhere on the web because of misinformation being spread.
"This is a debt based system. When you create money, that money + interest must be repaid. Therefore, the system is designed to fail and a certain number of people MUST default because it is impossible to pay a debt of $110 dollars when only $100 dollars have been created." --> this is just wrong as you explained so well.

[gnk]

Re: Article : why debt growth must exceed interest payments

It is not mathematically unsustainable. By mathematics I refer to that body of proofs, definitions and theorems derived from some specified set theory such as Zermelo-Fraenkel following the rules of a second order predicate calculus.

Here's a (very very very brief) sketch of a proof by counter-example: I believe I could code a simulation of say 100 automatons operating in a stimulated "perfect" economic system, funded by a single issuance of debt-based money, such that that economic system was stable and sustainable forever, during and following the payback of that one initial debt, where the initial principle amount of money issued in the single loan funding the system remains forever and always exactly the amount of money available to the system.

The original lender in this simulated system must spend some of (*) the loan payments (P+I) he receives back into the system for goods and services. The original borrower works, providing some service and receiving a cash flow income from which those loan payments can be made. Actually the other 98 automatons are inessential to this "proof"; they're just there to make this simulation more "realistic."

A quite simple example. Let's say you hire me as a servant. You lend me 100 $GNK$ (100 pieces of paper you scribbled your initials on.) I work for a wage of 1 $GNK$ per week, and I pay you back 10 $GNK$ principle plus interest for 11 weeks to extinguish the debt. Beginning the 12th week, I begin paying you 1 $GNK$ for rent of the shack I built the first 11 weeks for you on the back of your property, in which you now let me live. You continue to pay me 1 $GNK$ wages. My job is now to guard and maintain that precious ;) shack.

Each week thereafter, in perptuity, I give you 1 $GNK$ (rent) and you give me 1 $GNK$ (wages.) You keep the other 99 $BNK$ locked up in your safe, for you are a wealthy man.

My best guess is that the word "mathematics" has different meaning for me than it does for yourself and most other people. I still treasure my volume one of Nicolas Bourbaki's Elements of Mathematics and my first edition of Set Theory and its Logic by Willard Van Orman Quine. My early edition of Quine's Mathematical Logic fell apart and was apparently discarded in some move I made in the past.

(*) "some of" -- meaning sufficient to provide the cash flow required to fund future loan repayments.

Quick question.

The inital 100 $BNK$ that I keep 99 of in the safe... where did it come from? Who issued it? If money is created thru debt, doesn't someone somewhere need some of that 99 $BNK$ to cover their debt?

[Rajiv]

Re: Article : why debt growth must exceed interest payments

PC,

Please read Hudson's - The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview

Part - I
Part - II

Both parts should be read completely.

You should also perhaps revisit "The Crash Course"

From Hudson's Part - I

“Whoever enters here must know mathematics.” That was the motto of Plato’s Academy. Emphasizing such abstract ratios as the Pythagorean proportions of musical temperament and the calendrical regularities of the sun, moon and planets, its philosophy used the mathematics of nature to reveal an underlying harmony and order in the universe and hence, in an ideal society. But there was little quantitative analysis of economic relations. Although the Greek and Roman economies were increasingly wracked by debt, there was no measurement of this phenomenon, or of overall production, distribution and other macroeconomic measures.

The education of modern economists still consists largely of higher mathematics whose use remains more metaphysical than empirically measuring the most important trends. Over a century ago John Shield Nicholson (1893:122) remarked that “The traditional method of English political economy was more recently attacked, or rather warped,” by pushing

the hypothetical or deductive side . . . to an extreme by the adoption of mathematical devices. . . . less able mathematicians have had less restraint and less insight; they have mistaken form for substance, and the expansion of a series of hypotheses for the linking together of a series of facts. This appears to me to be especially true of the mathematical theory of utility. I venture to think that a large part of it will have to be abandoned. It savors too much of the domestic hearth and the desert island.

To contemporary economists, mathematics has become the badge of scientific method. But are the right things being mathematized? Do today’s models correlate the appropriate phenomena, or do they confuse cause and effect while omitting key dynamics? Is the use of mathematics scientific ipso facto, regardless of how it is applied?

The preferred method of mathematical economics is general equilibrium analysis in an environment in which only small marginal disturbances are envisioned, not major structural problems or legal changes in the economic environment. Marginal analysis avoids dealing with quantum leaps. It selects and correlates a rather narrow set of phenomena (supply, labor and materials costs, the interest rate, income and the pattern of demand) to produce models that show how economies might settle at an equilibrium point if left free from outside political interference.

Many economists are trained in calculus and higher mathematics without feeling much need to test their theories quantitatively. They tend to use mathematics less as an empirical measuring tool than as an expository language or simply as a decoration to give a seemingly scientific veneer to their policy prescriptions. Mathematical economics rarely is used to statistically analyze the inherent tendencies at work to polarize wealth and income.

In fact, the mathematical “badge of science” has distracted attention from the tendency for economies to veer out of balance.[1] The problem is that to achieve a single determinate, stable solution to any given problem (always posed as a “disturbance” to a pre-existing balance), general equilibrium theorists are driven to assume diminishing returns and diminishing marginal utility in order to “close the system.” A narrow set of variables is selected that all but ignore the economy’s growing debt overhead relative to its assets, and the associated flow of interest.

Economies change their shape as they grow. This shape is distorted by the inherent tendency for financial claims – bonds, bank loans and other financial securities – to grow more rapidly than the economy’s ability to carry them, much less to pay them off. The volume of such claims tends to grow by purely mathematical principles of self-expansion, independently from underlying economic trends in wealth and income, and hence from the ability of debtors to pay.

The task of economic regulation is reduced to setting an appropriate interest rate to keep all the economy’s moving parts in equilibrium. This interest rate is supposed to be controlled by the money supply. An array of measures is selected from the overall credit supply (or what is the same thing, debt securities) to represent “money.” This measure then is correlated with changes in goods and service prices, but not with prices for capital assets – bonds, stocks and real estate. Indeed, no adequate statistics presently exist to trace the value of land and other real estate.

The resulting economic models foster an illusion that economies can carry any given volume of debt without having to change their structure, e.g., their pattern of wealth ownership. Self-equilibrating shifts in incomes and prices are assumed to enable a debt overhead of any given size to be paid. This approach reduces the debt problem to one of the degree to which taxes must be raised to carry the national debt, and to which businesses and consumers must cut back their investment and consumption to service their own debts and to pay these taxes.

Excluded from the analysis is the finding that many debts are not repayable except by transferring ownership to creditors. This transfer changes the shape of the economy’s legal and political environment, as creditors act as rentiers to subordinate labor and capital to the economy’s financial dynamics.
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[gnk]

Re: Article : why debt growth must exceed interest payments

Great finds Rajiv. This is a very important topic, and I appreciate the different views expressed here - including PC's... To me, these theories are difficult to absorb without understanding competing views.


I particularly liked this conclusion regarding debt "transferrence"

Excluded from the analysis is the finding that many debts are not repayable except by transferring ownership to creditors. This transfer changes the shape of the economy’s legal and political environment, as creditors act as rentiers to subordinate labor and capital to the economy’s financial dynamics.

I'll post yet again another Prof. Fekete article relevant to the above quote:

That the world has lost the facility to reduce its total indebtedness short of default or monetary depreciation becomes clear if we consider the fact that a debt of $1,000 once contracted cannot be liquidated. If it is paid off by a check, the debt is merely transferred to the bank on which the check is drawn. The situation is no better if it is paid off by tendering $1,000 in Federal Reserve notes, ostensibly the ultimate liquidator of debt. In this case the debt is transferred to the U.S. Treasury, the guarantor of the liabilities of the Federal Reserve banks (since it is clear that the latter have neither the intention nor the resources to meet these obligations). However, substituting one debtor for another is not the same as liquidating debt. The very notion of 'debt maturity' has lost all reasonable meaning previously attached to it. At maturity the creditor is coerced into extending his original credit plus accrued interest in the form of new credits, usually on inferior terms. It is true that the option to consume his capital represented by the credit is open to him. But is it not a strange monetary system, to say the least, which forces savers to eat the seed corn whenever they are dissatisfied with the quality of available debt instruments, or with the terms on which they are offered?

Monetary Growth Must Exceed the Rate of Interest

This argument also shows that the stock of money must increase at least at the rate marked by the rate of interest. Every year monetary authorities must create at least as much new money as needed to service outstanding debt, in order to keep the game of musical chairs going. No monetary policy can be implemented that would cut the rate of
monetary growth below the rate of interest on a net basis. So much for Milton Friedman's clever horse that he said he would train to tread out new money at the treadmill. Poor horsey will be confused mightily when the rate of interest goes to 16 percent, as it did in 1980.

Governments have lost not only their option to reduce indebtedness but, more ominously, the option to balance their budgets. There is a new item in the budget that is never named, that is well-hidden, but that is increasing by leaps and bounds year after year: that part of government borrowing that is needed to provide cover for the increase of the monetary base. In other words, the budget deficit has become an autonomous, non-discretionary item in the budget that has nothing to do with financing operations, or with husbanding resources. It has become indispensable without which there is no way to inject new money into the economy, and without which the dogs of deflation would be unleashed. From a narcotic drug with all its negative side effects the budget deficit has become a standard prescription drug routinely provided for the stimulus to which society has become addicted. It is remarkable that this change in the character of the budget deficit had to be made clandestinely. The utterances of politicians about their resolve to eliminate the budget deficit is disingenuous - it cannot be done under the prevailing monetary regime on a net basis. This raises grave questions about the stability and durability of the regime. Governments are busy constructing an enormous Tower of Babel to reach to high heaven, the bricks of which are made of public debt - without giving the slightest thought to the wisdom or safety of their construction.

source: http://www.professorfekete.com/artic...01Lecture4.pdf

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Quick question.

The inital 100 $BNK$ that I keep 99 of in the safe... where did it come from? Who issued it? If money is created thru debt, doesn't someone somewhere need some of that 99 $BNK$ to cover their debt?

Initially you created it, by scribbling your signature on 100 scraps of paper. You then gave me those 100 scraps of paper in exchange for a note that I signed, saying that I'd pay you back 10 such scraps per week, for 11 weeks.

We both ascertained that I could perform that repayment, given that we also had an agreement that you would pay me 1 scrap per week for my labor. I thus had sufficient assets and income to handle the debt repayments.

In the real world, I exchanged my labor in building, securing and maintaining a shack on your property for a license to live there so long as I wanted and you allowed. You get to keep the shack when I leave.

This debt-based money and corresponding loan note realized that relationship in the monetary world. The lease agreement I signed with you realized that agreement in the legal world, spelling out who had what rights to property and under what obligations and the terms of termination.

[Glenn Black]

Re: Article : why debt growth must exceed interest payments

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

[/SIZE][/SIZE]HOW DEBT MONEY GOES BROKE
by Steven Lachance
December 12, 2005

A couple of issues. You say only businesses have producing loans. People & governments don't.

I disagree. For example, Gov. can invest in paying bureaucrats to search high & low for new things to tax that will not cause a revolt amongst the sheeple. They borrow, they pay for research, they legislate, they collect, hopefully repaying their debt. If not this time, then we all have to pay by even higher taxes on their subsequent attempts, until they get it right.

Based on a job offer letter, people can borrow money to get a car so they can get to their new job, using some of their income to pay off the loan; all of which is better than sitting at home watching TV because you can't get to where the jobs are.

Banks do the same on the spread between loans & deposits. If they take in counterfeit money, or get duped, or they have bad loans, they make up their losses on the backs of subsequent depositors & borrowers. Due to the fractional reserve system, small loan losses can be tolerated, but there is a brutal tipping point beyond which there is no recovery due to market forces. Too low a deposit rate or too high a loan rate (so as to recover excessive losses previously incurred), and people will vote with their feet and their dollars, vacate the bank even though they have banked there for generations, even though it is inconvenient to go across town to bank elsewhere, creating a run on the bank, and its collapse.

Mal-investment, like we had in the dot com and for the last 20 years, can only be tolerated so long. A tipping point is reached, where the cumulative losses have exceeded the economic alternatives currently available. Once this turning point has been passed, they are on borrowed time, Eventually the inconvenience, inertia, and apathy are overcome by awareness & assertiveness. What was previously accepted and tolerated will be shunned, changing overnight via herd behaviour.

Exponential growth is the root cause of all these issues of debt and servicing costs. See this wonderful video on arithmetic, growth, & energy http://www.youtube.com/watch?v=F-QA2rkpBSY 8 parts, approx. 1 hr. total time, well worth it.

For example, there was virtually zero inflation for many decades in the US history, always destroyed by government's folly of excessive money printing. The Civil War ended one period of zero inflation due to excessive printing.

Exponential growth, whether inflation, debt, population, or something else, is what is unsustainable, and this is what gives us mathematical certainty of destruction.

I live on Manitoulin Island, the world's largest freshwater island. In 2010, we had virtually the same population as was here in 1900, 110 years previously. Manitoulin is known for no economic booms, and no busts, just steady living. It is the only region I know of with a 100-year sustainable population. Steady population is the first tenant of sustainability. However, we have yet to conquer the inflation problem. Solve that, and we have paradise.

[Rajiv]

Re: Article : why debt growth must exceed interest payments

I live on Manitoulin Island, the world's largest freshwater island. In 2010, we had virtually the same population as was here in 1900, 110 years previously. Manitoulin is known for no economic booms, and no busts, just steady living. It is the only region I know of with a 100-year sustainable population. Steady population is the first tenant of sustainability. However, we have yet to conquer the inflation problem. Solve that, and we have paradise.

That is primarily because it is not an economic or environmental island -- maybe close, but not quite. So FIRE will have its effects unless the residents choose to isolate themselves from the rest of Canada's economy.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Exponential growth is the root cause of all these issues of debt and servicing costs.

"Exponential", another word like "mathematical" used to glaze over the listener's mind, so as to cover up an insufficient precision of thought with an imposing layer of language.

If tomorrow I go out and sign a mortgage for a $3 million dollar McMansion, with monthly payments of perhaps 200% of my income, that's not exponential growth in my debt load. Presently I have zero debt and quite modest income. Signing that note would be financial suicide, taken all in a single step function. Nothing exponential about it.

On the other hand, if the rent on my trailer lot increases by 1% per-annum forever, I'll easily be able to handle that increase on my current quite modest income, even if my income remains exactly fixed. I doubt I'll be here more than another 30 or so years, during which time a 1%/yr increase, compounded annually, totals out to just a 35% increase. No problem.

Debt becomes a problem to the debtor when the repayments exceed the cash flow available for repayment. Debt becomes a problem for the lender when the debtor defaults. When that happens depends on future events which cannot be entirely predicted, and which certainly cannot be computed using some particular form mathematical equation.

If SAC accidentally drops a live nuke on Denton, Texas tomorrow morning then even a $1 debt at zero interest that I might owe someone defaults .. is vaporized ... instantly.