Tuesday, March 17, 2009

Bad debt: capitalism's vampire

I have been noodling over the role of bad debt in monetary frameworks. Here is where I currently am at.

Out of nothing comes debt and cash. A bank starts with zero, lends you 100, you owe 100, the 100 will be destroyed when the debt is repaid.

Forget for a moment that banks charge interest out of this phantom money (5%/year) and that this right there is proof positive of the endogenous creation of money.

In case the debt is defaulted on (bad debt) then several interesting things happen
1/ money in circulation, keeps in circulation, it is not taken back from the system. You sort of have this build up of monetary gunk in the system. That money has an inflationary contribution
2/ Senior debt to capital. In case of bad debt at a company, creditors are senior to equity holders. So those that provided debt coming out of nothing will be able to raid equity and have seniority on cash flows over equity capital.

It is the second bit that I find really really disturbing. Fake money, or credit money, not backed by real deposit but by the endogenous creation of money by the banks (meaning it never existed) ceases to be an innocuous presence when it goes bad. By senior status of debt in the capital structure, it start "vampiring" real capital.

Fake money will start devouring real money in case of bad debt by senior status.

I am turning rapidly marxist on these monetary topics. Marx was not anti-capital, he was anti-debt. Banks are vampires of capital. Debtism kills capitalism.

1 comment:

tom said...

Interesting... if I read this often enough it eventually starts to make sense to me.

and here I agree with you - debt is eating real real capital. Nothing burns my butt more than to think of stock holders being wiped out - while the nincompoop managers (and creditors) live to eat salad another day.

And after digesting this blog post it heats me up even more!

I'm curious though. I don't think it was set up this way just because it's "the natural order of things". I don't recall any Adam Smith thoughts on this structure.

but it was set up this way. some how, some time, some where. right?

I wonder what the history of that looks like. Any idea where I could go to look at that? Is it simply a document or an operating manual or is it, in fact and after all... "just the way it is"?

and thanks for your blog. I'm learning about and thinking about things I didn't know existed.