Shut Down Shoddy Debt - Keith Weiner

by Keith Weiner, Sprott Money:

We have been discussing the consumption of capital. We again must say:

“We see people eating more of the seed corn.”

Right now as we write this on Saturday afternoon, the US government has “shut down”, due to a political impasse on the legislation to fund its continuing operations. Government funding is a mix of taxing and borrowing. Government borrowing provides a segue into another mechanism of capital consumption.

Legitimate credit requires that the lender both know and approve. Do holders of dollars—which are often called “base money”—realize that they are extending credit to the Fed, and hence to the government to spend on its welfare state?

Most worry about the quantity of dollars, not the quality. This worry comes of the belief that one is not a creditor, but that by holding money, one owns a pro rata shares of the goods and services produced. In this view, if the government increases the quantity, it dilutes that share to a smaller fraction. This view is not correct, popular though it may be.

Legitimate credit has two other requirements. The borrower must have the means and intent to repay. And this leads us to the crux of the problem. The government this year—and every year for many decades—cannot even pay its present expenses. It must borrow to make payroll. The conclusion cannot be avoided, squirm though we might: the government has no means to repay what it borrows. Repayment would mean taking in more tax revenues than expenses. Instead of spending it on welfare, it would repay creditors. So far as we are aware, not even the most mean spirited fiscal conservative is proposing this now, or ever. The most radical wants to increase the debt, at a slower rate.

If the president, Treasury Secretary, and Congress borrow without means of repaying then this borrowing is in bad faith. They clearly lack any intent to repay.

Instead of worrying about dilution, which is a concept from the quantity theory, they should worry about the quality of the credit. And this brings us back to the consumption of capital.

What happens when a borrower takes your money and, with an oily smirk, gives you a piece of paper that is a promise to repay? He cannot repay. He knows it (and you know it too), but everyone goes through the motions, and there is a liquid market for this bad debt paper.

Two things happen. The first is in the nature of all borrowing transactions. The borrower is enabled to consume today what he would otherwise have to wait to produce. He is consuming the capital of the lender. In legitimate lending, of course, the borrower has a plan to increase his production in excess of what he consumes, and so to repay the lender with interest. But that’s not the case with borrowing to fund the welfare state. The lender’s capital is gone, replaced by a piece of paper.

This would be bad enough if everyone understood what happened. The lender is made poorer, and being poorer should reduce his own consumption. However, the nature of this particular fraud is that he is made to feel that the government’s bad debt paper is good money. Not only that, but that it’s going up! Falling interest is the flip side of rising bond prices. They are a strict mathematical inverse, like a see saw. Interest has been falling since 1981, and hence bond prices have been rising since 1981.

The richer the bond holder feels—which happens the more the price rises—the more he may feel free to spend. Think about this. The government first consumes his capital, calling it a “loan” despite that it will never be repaid. And on top of that, it deceives him into believing himself richer. Which offers him the means to spend more to consume more.

We will close with two quotes. The first is from Keynes, and we will excerpt just a brief part:

“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation [which we define as the counterfeiting of credit], governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.”

The other is from Ludwig von Mises:

“…Keynes did not teach us how to perform the ‘miracle … of turning a stone into bread,’ but the not at all miraculous procedure of eating the seed corn.”

The principle virtue of the gold standard is not that the total quantity of gold cannot be increased, and thus gold owners cannot be diluted. It is that it helps keep borrowers honest. It does not enable endless borrowing without means or intent to repay, as we have today. Also, it does not enable 37 year bond bull markets such as our (notwithstanding passive aggressive talk of hiking rates).

The dollar strengthen a little bit this week. No, we don’t measure it in terms of its derivatives such as euro and yuan. We measure it in the objective unit of measure of economic values, gold.

In ordinary terms (that is, backwards) gold went down from 1337 to 1331, or a six buck drop. Silver fell 20 cents, to $17. Among many other reasons, we don’t like this view because it turns money into just another colored chip for betting in the dollar casinos. We say the dollar went up, even if the whole world says that gold went down.

We note that Copernicus said the Earth revolved around the sun even though the whole world (no pun intended) said the sun revolved around Earth. He knew that a true idea had to win in the end, and in his day there was not a free market for ideas. We stand in awe of him, as he knew that men had been killed for lesser heresies than his own.

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