Tuesday, June 13, 2023

Moneylending, in Shakspeare's Play (3)

"In mathematics, the Pythagorean theorem or Pythagoras' theorem is a fundamental relation in Euclidean geometry between the three sides of a right triangle. It states that the area of the square whose side is the hypotenuse (the side opposite the right angle) is equal to the sum of the areas of the squares on the other two sides.
Maybe it could be likened to this, there were three medieval kingdoms on the shores of a lake that shaped rectangled triangle. There was an island in the middle of the lake, over which the kingdoms had been fighting for years. Finally, the three kings decided that they would send their knights out to do battle, and the winner would take the island.
The night before the battle, the knights and their squires pitched camp and readied themselves for the fight.
The first kingdom, was very rich, had 12 knights, and each knight had 5 squires, all of whom were busily polishing armor, brushing horses, and cooking food.
The second kingdom, even richer, had 20 knights, and each knight had 10 squires. Everyone at that camp was also busy preparing for battle, all of them were busily polishing armor, brushing horses, and cooking food.
At the camp of the third kingdom, because they were destitute, there was only one knight, with his squire. This squire took a large pot and hung it from a looped rope in a tall tree. He busied himself preparing the meal, while the knight polished his own armor. Both of them could relax, ete and got enough sleep, to prepare the battle.
When the hour of the battle came, the three kingdoms sent their squires out to fight (this was too trivial a matter for the knights to join in). The battle raged, and when the dust had cleared, the only person left was the lone squire from the third kingdom, having defeated the squires from the other two kingdoms. Thus proving that the squire of the high pot and noose is equal to the sum of the squires of the other two sides."

The moon continued by saying, "Actually, the remarkable thing about the statement 'one has to pay one’s debts' is that even according to standard economic theory, it isn’t true, says Graeber. A lender is supposed to accept a certain degree of risk. If all loans, no matter how idiotic, were still retrievable—if there were no bankruptcy laws, for instance—the results would be disastrous. All modern nation-states are built on deficit spending. Debt has come to be the central issue of international politics. But nobody seems to know exactly what it is, or how to think about it.
The very fact that we don’t know what debt is, the very flexibility of the concept, is the basis of its power.
What is the difference between a mere obligation, a sense that one ought to behave in a certain way, or even that one owes something to someone, and a debt, properly speaking? The answer is simple: money. The difference between a debt and an obligation is that a debt can be precisely quantified. This requires money.
When we study the history of debt, then, is thus necessarily a history of money—and the easiest way to understand the role that debt has played in human society is simply to follow the forms that money has taken, and the way money has been used, across the centuries—and the arguments that inevitably ensued about what all this means. Still, this is necessarily a very different history of money than we are used to. When economists speak of the origins of money, for example, debt is always something of an afterthought. First comes barter, then money; credit only develops later.
Not only is it money that makes debt possible: money and debt appear on the scene at exactly the same time. Some of the very first written documents that have come down to us are Mesopotamian tablets recording credits and debits, rations issued by temples, money owed for rent of temple lands, the value of each precisely specified in grain and silver.

We've been looking at the debt from a historical perspective, but it's a good idea to look at it from another perspective. Ray Dalio begins it with credit, which is the giving of buying power. This buying power is granted in exchange for a promise to pay it back, which is debt. Clearly, giving the ability to make purchases by providing credit is, in and of itself, a good thing, and not providing the power to buy and do good things can be a bad thing. For example, if there is very little credit provided for development, then there is very little development, which is a bad thing. The problem with debt arises when there is an inability to pay it back. Said differently, the question of whether rapid credit/debt growth is a good or bad thing hinges on what that credit produces and how the debt is repaid (i.e., how the debt is serviced).
Almost by definition, financially responsible people don't like having much debt. In Dalio's perspective—even though he bought some assets, or when he built Bridgewater, without debt—he identifies that that’s not necessarily true, especially for society as a whole (as distinct from individuals), because those who make policy for society have controls that individuals don’t. He learned that too little credit/debt growth can create as bad or worse economic problems as having too much, with the costs coming in the form of foregone opportunities.
Generally speaking, says Dalio, because credit creates both spending power and debt, whether or not more credit is desirable depends on whether the borrowed money is used productively enough to generate sufficient income to service the debt. If that occurs, the resources will have been well allocated and both the lender and the borrower will benefit economically. If that doesn’t occur, the borrowers and the lenders won’t be satisfied and there’s a good chance that the resources were poorly allocated.
In assessing this for society as a whole, one should consider the secondary/indirect economics as well as the more primary/direct economics. For example, sometimes not enough money/credit is provided for such obviously cost-effective things as educating our children well (which would make them more productive, while reducing crime and the costs of incarceration), or replacing inefficient infrastructure, because of a fiscal conservativism that insists that borrowing to do such things is bad for society, which is not true.
Credit/debt that produces enough economic benefit to pay for itself, in Dalio's view, is a good thing. But sometimes, the trade-offs are harder to see. If lending standards are so tight that they require a near certainty of being paid back, that may lead to fewer debt problems but too little development. If the lending standards are looser, that could lead to more development but could also create serious debt problems down the road that erase the benefits.

Suppose that you, as a policy maker, choose to build a subway system that costs $1 billion. You finance it with debt that you expect to be paid back from revenue, but the economics turn out to be so much worse than you expected that only half of the expected revenues come in. The debt has to be written down by 50 percent. Does that mean you shouldn’t have built the subway?
Rephrased, the question is whether the subway system is worth $500 million more than what was initially budgeted, or, on an annual basis, whether it is worth about 2 percent more per year than budgeted, supposing the subway system has a 25-year lifespan. Looked at this way, you may well assess that having the subway system at that cost is a lot better than not having the subway system.
To give you an idea of what that might mean for an economy as a whole, really bad debt losses have been when roughly 40 percent of a loan’s value couldn’t be paid back. Those bad loans amount to about 20 percent of all the outstanding loans, so the losses are equal to about 8 percent of total debt. That total debt, in turn, is equal to about 200 percent of income (e.g., GDP), so the shortfall is roughly equal to 16 percent of GDP. If that cost is “socialized” (i.e., borne by the society as a whole via fiscal and/or monetary policies) and spread over 15 years, it would amount to about 1 percent per year, which is tolerable. Of course, if not spread out, the costs would be intolerable.
For that reason, says Dalio, that the downside risks of having a significant amount of debt depends a lot on the willingness and the ability of policy makers to spread out the losses arising from bad debts. Whether policy makers can do this depends on two factors: 1) whether the debt is denominated in the currency that they control and 2) whether they have influence over how creditors and debtors behave with each other.

By studying the global monetary system ('Bretton Woods') in 1966–1971, the inflation bubble of the 1970s and its bursting in 1978–82, the Latin American inflationary depression of the 1980s, the Japanese bubble of the late 1980s and its bursting in 1988–1991, the global debt bubbles that led to the 'tech bubble' bursting in 2000, and the Great Deleveraging of 2008, the collapse of the Roman Empire in the fifth century, the United States debt restructuring in 1789, Germany’s Weimar Republic in the 1920s, the global Great Depression and war that engulfed many countries in the 1930–45 period, and many other crises, Dalios sees that each case of a certain type of disease unfolding as 'another one of those.'
Throughout history, only a few well-disciplined countries have avoided debt crises. That’s because lending is never done perfectly and is often done badly due to how the cycle affects people’s psychology to produce bubbles and busts. While policy makers generally try to get it right, more often than not they err on the side of being too loose with credit because the near-term rewards (faster growth) seem to justify it. It is also politically easier to allow easy credit (e.g., by providing guarantees, easing monetary policies) than to have tight credit. That is the main reason we see big debt cycles. Debt crises are inevitable, and, according to Dalio, come in cycles. You create a cycle virtually, anytime you borrow money. Buying something you can’t afford means spending more than you make. You’re not just borrowing from your lender; you are borrowing from your future self. Essentially, you are creating a time in the future in which you will need to spend less than you make so you can pay it back. The pattern of borrowing, spending more than you make, and then having to spend less than you make very quickly resembles a cycle. This is as true for a national economy as it is for an individual. Borrowing money sets a mechanical, predictable series of events into motion. Economies whose growth is significantly supported by debt-financed building of fixed investments, real estate, and infrastructure are particularly susceptible to large cyclical swings because the fast rates of building those long-lived assets are not sustainable. 
Economists generally speak of three functions of money: medium of exchange, unit of account, and store of value. The story of money for economists always begins with a fantasy world of barter. The Myth of Barter cannot go away, because it is central to the entire discourse of economics.
Once economics had been established as a discipline, the theological arguments no longer seemed necessary or important. People continue to argue about whether an unfettered free market really will produce the results that Adam Smith said it would; but no one questions whether 'the market' naturally exists. The underlying assumptions that derive from this came to be seen as common sense—so much so that, we simply assume that when valuable objects do change hands, it will normally be because two individuals have both decided they would gain a material advantage by swapping them.
Recall here what Adam Smith was trying to do when he wrote The Wealth of Nations. Above all, the book was an attempt to establish the newfound discipline of economics as a science. This meant that not only did economics have its own peculiar domain of study—what we now call “the economy,” though the idea that there even was something called an “economy” was very new in Smith’s day—but that this economy operated according to laws of much the same sort as Sir Isaac Newton had so recently identified as governing the physical world. Newton had represented God as a cosmic Watchmaker Who had created the physical machinery of the universe in such a way that it would operate for the ultimate benefit of humans, and then let it run on its own. Smith was trying to make a similar, Newtonian argument. God—or Divine Providence, as he put it—had arranged matters in such a way that our pursuit of self-interest would nonetheless, given an unfettered market, be guided 'as if by an invisible hand' to promote the general welfare. Smith’s famous invisible hand was, as he says in his Theory of Moral Sentiments, the agent of Divine Providence. It was literally the hand of God. And Allah knows best."

The roosters had woken up, and were preparing to take a breath, to sound the dawn call. The moon retreated while chanting,

I was just guessing at numbers and figures
Pulling the puzzles apart
Questions of science, science and progress *)
Citations & References:
- M. Lindsay Kaplan (ed.), The Merchant of Venice: Texts and Contexts. 2002, Palgrave
- Jay L. Halio, Understanding The merchant of Venice: a Student Casebook to Issues, Sources, and Historical Documents, 2000, Greenwood Press
- David Graeber, Debt: The First 5,000 Years, 2014, Meliville
- Ray Dalio, A Template for Understanding Big Debt Crises, 2018, Bridgewater
*) "The Scientist" written by Jonathan Mark Buckland, Guy Berryman Rupert, William Champion & Christopher Anthony John Martin
[Session 2]
[Session 1]