Sustainability of Debt

death scythe

For economies with fractional reserve-generated fiat money, balancing the budget is characterized by an exponential growth D(t) ≈ D0(1 + r)t of any initial debt D0 subjected to interest r as a function of time t due to the compound interest; a fact known since antiquity. At the same time, besides default, this increasing debt can only be reduced by the following five mostly linear, measures:

(i) more income or revenue I (in the case of sovereign debt: higher taxation or higher tax base);

(ii) less spending S;

(iii) increase of borrowing L;

(iv) acquisition of external resources, and

(v) inflation; that is, devaluation of money.

Whereas (i), (ii) and (iv) without inflation are essentially measures contributing linearly (or polynomially) to the acquisition or compensation of debt, inflation also grows exponentially with time t at some (supposedly constant) rate f ≥ 1; that is, the value of an initial debt D0, without interest (r = 0), in terms of the initial values, gets reduced to F(t) = D0/ft. Conversely, the capacity of an economy to compensate debt will increase with compound inflation: for instance, the initial income or revenue I will, through adaptions, usually increase exponentially with time in an inflationary regime by Ift.

Because these are the only possibilities, we can consider such economies as closed systems (with respect to money flows), characterized by the (continuity) equation

Ift + S + L ≈ D0(1+r)t, or

L ≈ D0(1 + r)t − Ift − S.

Let us concentrate on sovereign debt and briefly discuss the fiscal, social and political options. With regards to the five ways to compensate debt the following assumptions will be made: First, in non-despotic forms of governments (e.g., representative democracies and constitutional monarchies), increases of taxation, related to (i), as well as spending cuts, related to (ii), are very unpopular, and can thus be enforced only in very limited, that is polynomial, forms.

Second, the acquisition of external resources, related to (iv), are often blocked for various obvious reasons; including military strategy limitations, and lack of opportunities. We shall therefore disregard the acquisition of external resources entirely and set A = 0.

As a consequence, without inflation (i.e., for f = 1), the increase of debt

L ≈ D0(1 + r)t − I − S

grows exponentially. This is only “felt” after trespassing a quasi-linear region for which, due to a Taylor expansion around t = 0, D(t) = D0(1 + r)t ≈ D0 + D0rt.

So, under the political and social assumptions made, compound debt without inflation is unsustainable. Furthermore, inflation, with all its inconvenient consequences and re-appropriation, seems inevitable for the continuous existence of economies based on fractional reserve generated fiat money; at least in the long run.

Austrian Economics. Some Further Ruminations. Part 2.

There are two Austrian theories of capital, at least surfacially with two completely different objectives. The first one concentrates on the physical activities roundabout, time-consuming production processes which are common to all economic systems, and it defines capital as a parameter of production. This theory is considered to be universal and ahistorical, and the present connotation of Austrian Theory of Capital falls congruent with this view. This is often denoted by physical capital and consists of concrete and heterogenous capital goods, which is nothing but an alternative expression for production goods. The second and relatively lesser known theory is the beginning point for a historically specific theory, and shies away with the production process and falls in tune with the economic system called capitalism. Capital isn’t anymore dealing with the production processes, but exclusively with the amount of money invested in a business venture. It is regarded as the central tool of economic calculations by profit-oriented enterprises, and rests on the social role of financial accounting. This historically specific theory of capital is termed business capital and is in a sense simply money invested in business assets.

A deeper analysis, however, projects that these divisions are unnecessary, and that physical capital is not a theory of physical capital at all. Its tacit but implicit research object is always the specific framework of the market economy where production is exercised nearly exclusively by profit-oriented enterprises calculating in monetary terms. Austrian capital theory is used as an element of the Austrian theory of the business cycle. This business cycle theory, if expounded consistently, deals with the way the monetary calculations of enterprises are distorted by changes in the rate of interest, not with the production process as such. In a long and rather unnoticed essay on the theory of capital, Menger (German, 1888) recanted what he had said in his Principles about the role of capital theory in economics. He criticized his fellow economists for creating artificial definitions of capital only because it dovetailed into their personal vision of the task of economics. In respect of the Austrian theory of capital as expounded by himself in his Principles and elaborated on by Böhm-Bawerk, he declared that the division of goods into production goods and consumption goods, important as it may be, cannot serve as a basis for the definition of capital and therefore cannot be used as a foundation of a theory of capital. As for entrepreneurs and lawyers, according to Menger, only sums of money dedicated to the acquisition of income are denoted by this word. Of course, Menger’s real-life oriented notion of capital does not only comprise concrete pieces of money but

all assets of a business, of whichever technical nature they may be, in so far as their monetary value is the object of our economic calculations, i.e., when they calculatorily constitute sums of money for us that are dedicated to the acquisition of income.

An analysis of capital presupposes the historically specific framework of capitalism, characterized by profit-oriented enterprises.

Some economists concluded therefrom that “capital” is a category of all human production, that it is present in every thinkable system of the conduct of production processes—i.e., no less in Robinson Crusoe’s involuntary hermitage than in a socialist society—and that it does not depend upon the practice of monetary calculation. This is, however, a confusion (Mises).

Capital, for Mises, is a device that stems from and belongs to financial accounting of businesses under conditions of capitalism. For him, the term “capital” does not signify anything peculiar to the production process as such. It belongs to the sphere of acquisition, not to the sphere of production.  Accordingly, there is no theory of physical capital as an element or factor in the production process. There is rather a theory of capitalism. For him, the existence of financial accounting on the basis of (business) capital invested in an enterprise is the defining characteristic of this economic system. Capital is “the fundamental notion of economic calculation” which is the foremost mental tool used in the conduct of affairs in the market economy. A more elaborate historically specific theory of capital that expands upon Mises’s thoughts would analyze the function of economic calculation based on business capital in the coordination of plans and the allocation of resources in capitalism. It would not deal with the production process as such but, generally, would concern itself with the allocation and distribution of goods and resources by a system of profit-oriented enterprises.