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A Simple Guide to the Most Important Subject You Never Learned In School, What Our Money Is, Its History, and an Analysis of a Failing System.

Debt Taken On By Fools

Debt Taken On By Fools

NEVER A ZERO SUM GAME

 
It is often touted that total debt carried by a government or total debt in general does not matter because debt is one person’s liability and another's asset thus a zero sum game.  This is plugged most loudly by Paul Krugman in an attempt to explain why the enormous debts of nations such as the United States and Japan do not matter.  Nothing could be further from the truth. 
 
For example consider a productive farmer and an adjacent town full of people.  The townspeople accept the farmers’ food but do not repay the farmer using money earned by providing production and services; they pay him back with IOU’s also known as debt.
 
The farmer is happy to accept this debt because he has big plans for his future.  He has been working hard and accepting these IOU’s for 35 years and is nearing retirement.  He and his son love to hunt on his land and after retiring he is planning on letting his land grow over, all the better for hunting he concludes.  He never teaches his son to farm, he would rather his son spend time doing what he loves and hunt with his father in his old age.  The farmer believes he has plenty of IOU’s to maintain his family’s lifestyle in retirement.
 
Unfortunately, the townspeople have never had to grow their own food and have not taken the time to consider how they are going to pay back the farmer.  When the farmer attempts to collect on the debt it is possible they could then take the time to learn how work the land and try to pay the old man back, but there is no incentive to work hard if they are not going to enjoy the fruits of their labor.  In addition, farming skills would take time to develop, not to mention they don’t have any land to work even if they wanted to.  
 
In this light we can understand that looking at debt as a zero sum game without considering the ability of the debtor to pay that debt in what the creditor will need in the future is a fallacy.  In our example above someone is going to lose.  The farmer will either realize he does not have an asset in those IOU’s or the townspeople will have to work without present compensation.
 
Many may think the answer to this problem is for the townspeople to figure out how to farm and properly repay their debt.  This sounds fair to me as well until you consider that the townspeople that wrote the IOU’s are old like the farmer and could not be productive on a farm anyway.  The burden would have to fall to their children who didn’t even know the IOU’s were being written.
 
In this example it is clear that the town’s ability to create money to pay the debt back will not provide the services the farmer needs in retirement, thus is no solution.
 
This is the situation that has come about in most developed economies, particularly Japan, but since most readers will be from the United States I will stick with using the US as an example since we are not far behind the Japanese.  There are plenty of creditors and debtors in our system but to draw parallels to our above example, the baby boom generation is similar to the old farmer, the government is the older townspeople and their children are Gen Xers and Millennials. 
 
As with the farmer the baby boomers collected IOU’s in the form of government bonds in their pensions, 401k’s and the SS trust fund, as well as promises made such as Medicare.  The benefit for the government came in the form of paychecks to government employees or entitlements paid for using borrowed money as well as wars and putting a man on the moon.  Elected officials also gained power by distributing those payments.  The younger generations, X and Millennials, are the ones who will be expected to make good on those incurred debts.   
 
The tug of war over the next 15 years will be between who will lose in how these debts will be rectified.   There are two choices; the baby boom generation will have to accept default on the IOU’s they own and live a life at a much lower (possibly dangerous) standard of living, or the younger generations will have to work without compensation in the form of goods and services.  This is truly a battle between juggernauts, the baby boom generation is the largest voting block and controls the majority of the wealth, and capitalism does not function without proper compensation for production.  It will be fought in the financial markets, particularly the debt markets, around the table of the Federal Reserve, and in the ballot box.  The outcome of this battle cannot be known, but it is fair to say there will be pain on both sides and the turmoil in financial markets will be immense.
 
This pain and turmoil brings us back to why large debt loads will not end up being a zero sum game.  The reason is the debts create an illusion that warps the participant’s preparation.  In the above examples the debtors or those who depend on the debtors, the townspeople, government employees, or entitlement recipients believe they will be always be maintained by the creditor, and this is all they know.  The creditor, the farmer or the baby boom generation is under the illusion that the loans they have made throughout their life will support them just when they will need the support the most. 
 
These debt illusions dictate how both groups prepare for the future; this causes misallocation of resources/piss poor planning, and emotional pain when the illusion disappears.   The disruptions triggered to a complex society take years or decades to repair.
 
Another misconception used by Krugman to bolster his zero sum game theory is the idea that we owe the money to ourselves.  Much of this concept is dispelled in the arguments above but it also assumes ‘ourselves’ is one entity.  Thinking of ‘ourselves’ as one entity allows the thought that if one portion of that entity is benefiting and one is suffering it all equals out.  But in the case of debt this is not the case.  If nonproductive retirees benefit to the detriment of the productive working generations the disincentive to produce eventually negatively affects the whole society.  
 
The inevitable enormous debts that occur with any debt based monetary system are far from a zero sum game due to the fact that debt is one person’s asset while another’s liability.  How the likes of Paul Krugman can spout such nonsense is beyond comprehension. 
 
Quote from the Movie Dumb and Dumber (1995)

Nicholas Andre What is this? What is this? Where's all the money? 
Lloyd Christmas:  That's as good as money, sir. Those are I.O.U.'s. Go ahead and add it up, every cent's accounted for. Look, see this? That's a car. 275 thou. Might wanna hang onto that one.

Confused?  I suggest reading my first post History and Introduction to understand where we started.  http://www.debtcrash.report/entry/history-and-introduction
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I Bought What?!

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Comments 9

 
Guest - Hunt4Steve on Thursday, 26 February 2015 13:07

I've been telling my family for years the stock market only provides them with paper assets that "tell" them they have so much value in some account, somewhere. They are literally banking on using those accounts in later years to support themselves. In fact, some of my relatives are retired and have gone out and purchased larges homes based upon their retirement savings, which of course are tied up in the Stock Market. When said Market takes a dump, and they have nothing left to pay the note on the house....what will they do? The bank that loaned them the money to purchase the house will certainly want their I.O.U in some form or fashion, but since the market ate up their retirement savings, and they have no job prospects..... Seems like diversification of skills and hard tangible assets may be the way to get through this coming crises...... Maybe.

0
I've been telling my family for years the stock market only provides them with paper assets that "tell" them they have so much value in some account, somewhere. They are literally banking on using those accounts in later years to support themselves. In fact, some of my relatives are retired and have gone out and purchased larges homes based upon their retirement savings, which of course are tied up in the Stock Market. When said Market takes a dump, and they have nothing left to pay the note on the house....what will they do? The bank that loaned them the money to purchase the house will certainly want their I.O.U in some form or fashion, but since the market ate up their retirement savings, and they have no job prospects..... Seems like diversification of skills and hard tangible assets may be the way to get through this coming crises...... Maybe.
CaptDebtCrash on Thursday, 26 February 2015 13:41

@Hunt4Steve. I'm going to be making another post you may want to show to you family in a few days. Thanks for the reply.

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@Hunt4Steve. I'm going to be making another post you may want to show to you family in a few days. Thanks for the reply.
Guest - Debt Crash on Sunday, 08 March 2015 07:31
Here's the new post http://www.debtcrash.report/entry/i-bought-what
CaptDebtCrash on Wednesday, 11 March 2015 16:33

This is pretty simplistic, no? The farmer has just blithely accepted the townspeople's promises? They have produced nothing in return for the farmer? They haven't manufactured any equipment, turned any of that wheat into bread, or provided the farmer with entertaining TV shows? Nothing? And if that's the case that they produce nothing of value to the farmer, then why did he continue to accept IOUs when he had years of experience that the townspeople had nothing of value to exchange with him?

The other problem with your parable is that the farmer is perfectly happy to close his farm, and thus make productive capital completely unproductive. Since there are better places to hunt than abandoned farm land, this part makes no sense. Why doesn't he just sell the farm?

It's pretty clear that going into debt to pay for current consumption is a bad idea, but not all debt is created equal. Had the townspeople borrowed money to build factories that returned a higher profit than the cost of the debt, all would be better off.

This is the problem with this topic. At the end of the day it's not simple at all. Debt can have very productive uses, but current consumption funded by a completely unsophisticated creditor is not one of them.

0
This is pretty simplistic, no? The farmer has just blithely accepted the townspeople's promises? They have produced nothing in return for the farmer? They haven't manufactured any equipment, turned any of that wheat into bread, or provided the farmer with entertaining TV shows? Nothing? And if that's the case that they produce nothing of value to the farmer, then why did he continue to accept IOUs when he had years of experience that the townspeople had nothing of value to exchange with him? The other problem with your parable is that the farmer is perfectly happy to close his farm, and thus make productive capital completely unproductive. Since there are better places to hunt than abandoned farm land, this part makes no sense. Why doesn't he just sell the farm? It's pretty clear that going into debt to pay for current consumption is a bad idea, but not all debt is created equal. Had the townspeople borrowed money to build factories that returned a higher profit than the cost of the debt, all would be better off. This is the problem with this topic. At the end of the day it's not simple at all. Debt can have very productive uses, but current consumption funded by a completely unsophisticated creditor is not one of them.
Guest - Debtcrash on Wednesday, 11 March 2015 17:20

Kim,

Yes my example is much simpler than the real world, but I believe the dynamics and outcomes will be similar. It is my viewpoint and I want it to be judged by the events of the future but certainly don't mind your judgment as well.

Your question as to why he doesn't just sell the farm is a good one and shows that when a creditor loans money to an unworthy borrower with the expectation of getting paid back in full his quality of life will be lower than he/she expects.

The farmer had to sell an asset he wanted to use in a certain way and from his point of view this will cause a reduction in his standard of living that could be an emotional shock. In the case of the baby boomer as a creditor they too will have to sell assets like stocks and homes to pay for their medical expenses, food and other retirement expenses. They may be depending on direct bond holdings, pensions holding bonds, or SS (which also holds govt bonds in its trust fund) to pay for these general retirement expenses. If those IOU’s end up not paying out, they will have to use their stocks, homes and other assets to pay for the necessities and have to forgo the vacations, dining out, and spoiling grandchildren they were planning on using them for, aka reduction in their expected standard of living. And those assets may not even cover the necessities making the adjustment and emotional shock that much worse.

Again use your best judgment when reading my posts and tests them with the events that actually occur. I’m looking forward to finding out if my thoughts on the future come to fruition.

Thanks for your comment and I hope you come back again.

0
Kim, Yes my example is much simpler than the real world, but I believe the dynamics and outcomes will be similar. It is my viewpoint and I want it to be judged by the events of the future but certainly don't mind your judgment as well. Your question as to why he doesn't just sell the farm is a good one and shows that when a creditor loans money to an unworthy borrower with the expectation of getting paid back in full his quality of life will be lower than he/she expects. The farmer had to sell an asset he wanted to use in a certain way and from his point of view this will cause a reduction in his standard of living that could be an emotional shock. In the case of the baby boomer as a creditor they too will have to sell assets like stocks and homes to pay for their medical expenses, food and other retirement expenses. They may be depending on direct bond holdings, pensions holding bonds, or SS (which also holds govt bonds in its trust fund) to pay for these general retirement expenses. If those IOU’s end up not paying out, they will have to use their stocks, homes and other assets to pay for the necessities and have to forgo the vacations, dining out, and spoiling grandchildren they were planning on using them for, aka reduction in their expected standard of living. And those assets may not even cover the necessities making the adjustment and emotional shock that much worse. Again use your best judgment when reading my posts and tests them with the events that actually occur. I’m looking forward to finding out if my thoughts on the future come to fruition. Thanks for your comment and I hope you come back again.
Guest - Kim G on Thursday, 12 March 2015 19:24

Thanks for the very gracious reply. If nothing else, it's pretty clear that today there's a lot of debt around the world that will only be partially (at best) repaid. Here in the USA, everyone is focused on the cash deficit and concomitant debt. However, in my view, the unfunded liabilities of Medicare, Social Security, and other benefits programs are the truly frightening figures. I'm sure you are familiar with the work of Laurence Kotlikoff, who wrote a paper in 1996 laying out quite clearly that the USA was then bankrupt. As we know, things are far worse now, all the more so for not having done anything to remedy the problem before it becomes critical.

As an aside, Japan is a case study in how long a society can muddle along with an unsupportable debt. Even now that it's pretty clear that the JCB intends to monitize a big chunk of the debt, there has been no panic selloff in JGBs.

We live in interesting times.

0
Thanks for the very gracious reply. If nothing else, it's pretty clear that today there's a lot of debt around the world that will only be partially (at best) repaid. Here in the USA, everyone is focused on the cash deficit and concomitant debt. However, in my view, the unfunded liabilities of Medicare, Social Security, and other benefits programs are the truly frightening figures. I'm sure you are familiar with the work of Laurence Kotlikoff, who wrote a paper in 1996 laying out quite clearly that the USA was then bankrupt. As we know, things are far worse now, all the more so for not having done anything to remedy the problem before it becomes critical. As an aside, Japan is a case study in how long a society can muddle along with an unsupportable debt. Even now that it's pretty clear that the JCB intends to monitize a big chunk of the debt, there has been no panic selloff in JGBs. We live in interesting times.
Guest - Debt Crash on Friday, 13 March 2015 17:53

Kim,

I agree with pretty much everything you have said. I discuss unfunded liabilities and GAAP in my first post History and Intro. They are a major problem but are yet another example of an IOU that the baby boom generation is depending on.

I am amazed at how long Japan has lasted as well and believe normalcy bias as well as their culture has allowed it to go on much longer than anyone in the west would have expected. That said I think they are in the end game and it will fold in the next 5 years, but who knows. My question is when a developed economy such as Japan folds because of its debt load how will other developed economies and governments react? Will it scare them into action, or will they give the long list of reasons why their nation 'is not Japan'. I think it will be the latter, but one of my smartest guy in the room candidates, Kyle Bass believes it may be an effective wake up call.

We certainly do live in interesting times and I am thankful I get to live through them. Your comments have been insightful and well informed. I hope you will continue to visit my blog and test my analysis. I would love your take on my first post History and Introduction though I have some interesting updates to follow

http://debtcrash.report/entry/history-and-introduction

0
Kim, I agree with pretty much everything you have said. I discuss unfunded liabilities and GAAP in my first post History and Intro. They are a major problem but are yet another example of an IOU that the baby boom generation is depending on. I am amazed at how long Japan has lasted as well and believe normalcy bias as well as their culture has allowed it to go on much longer than anyone in the west would have expected. That said I think they are in the end game and it will fold in the next 5 years, but who knows. My question is when a developed economy such as Japan folds because of its debt load how will other developed economies and governments react? Will it scare them into action, or will they give the long list of reasons why their nation 'is not Japan'. I think it will be the latter, but one of my smartest guy in the room candidates, Kyle Bass believes it may be an effective wake up call. We certainly do live in interesting times and I am thankful I get to live through them. Your comments have been insightful and well informed. I hope you will continue to visit my blog and test my analysis. I would love your take on my first post History and Introduction though I have some interesting updates to follow http://debtcrash.report/entry/history-and-introduction
Guest - JethroBoden on Saturday, 22 August 2015 11:17
I Call B.S.

Oh yeah, the hardworking baby boom generation toiling in the field and collecting IOUs - except that's total B.S.. The Baby Boom generation is the townspeople, writing freaking IOUs at an increasing clip for decades. Wracking up TRILLIONS of dollars of debt, benefiting from a government that provided services without collecting enough taxes to pay for those services. Same shit continues to this day. CHINA and other DNs are the farmer - working their assess off to support the debtor countries.

0
Oh yeah, the hardworking baby boom generation toiling in the field and collecting IOUs - except that's total B.S.. The Baby Boom generation is the [u]townspeople[/u], writing freaking IOUs at an increasing clip for decades. Wracking up TRILLIONS of dollars of debt, benefiting from a government that provided services without collecting enough taxes to pay for those services. Same shit continues to this day. CHINA and other DNs are the farmer - working their assess off to support the debtor countries.
CaptDebtCrash on Saturday, 22 August 2015 12:18
Jethro Your Preaching to the Choir

Jethro, no question the baby boomers have been, up until this point, the largest beneficiaries of this Ponzi system we have going. They have enjoyed credit created bubbles in real estate, stocks and bonds for most of their lives. They have enjoyed and continue to enjoy payments from the government, while that government pretends those systems, such as SS and medicare, are solvent. But that is to this point, and does not see the story through to its conclusion. There is no question that if a single generation should take blame for where we are it would be the baby-boomers, but it has been a team effort and they did inherit much of the mess. That said there are many in that generation that I care about and it will be hard to watch the chickens come home to roost, so to speak, when they are least able to deal with the repercussions.

0
Jethro, no question the baby boomers have been, up until this point, the largest beneficiaries of this Ponzi system we have going. They have enjoyed credit created bubbles in real estate, stocks and bonds for most of their lives. They have enjoyed and continue to enjoy payments from the government, while that government pretends those systems, such as SS and medicare, are solvent. But that is to this point, and does not see the story through to its conclusion. There is no question that if a single generation should take blame for where we are it would be the baby-boomers, but it has been a team effort and they did inherit much of the mess. That said there are many in that generation that I care about and it will be hard to watch the chickens come home to roost, so to speak, when they are least able to deal with the repercussions.

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