Economic Theory

Point 1:
I was going to say that this is a “known fact”, and then it occurred to me that like common sense this knowledge might be surprisingly rare.


In a free market prices are set by the interplay between supply and demand. The demand portion actually has two components; desire and ability. desiring a product or service without the ability to pay for it does not translate into demand. Conversely; nobody is going to buy something they don’t want regardless of whether or not they can afford it.


Inflation and deflation are caused by an imbalance between supply and demand and this imbalance occurs on a natural and cyclical basis. Economies expand and contract in a manner which, if plotted it on a graph, would be very close to a sine wave; assuming you are talking about a true free market economy.


This is something that all rational people whose subjective viewpoint of reality is closely correlated with objective reality can agree with.


Point 2:
There are only three things that have true inherent value; air, water and food. Literally everything else, including precious metals, have value only because we value them.

Paper currency has value because of faith. When we accept payment for a good or service in the form of paper currency; we do so because we have faith that someone else will accept that same paper currency from ours at a substantially similar value to what it had when we accepted it to begin with.


Point 3:
There is a phenomenon known as hyper-inflation; which is distinct from normal inflation, even very bad normal inflation.

So-called “normal“ inflation is nothing more than an imbalance between supply and demand. It doesn’t really matter if the imbalance is caused by the natural interplay of supply and demand or by poor decision making. This is still something that is eventually self correcting if it is allowed to correct itself.

Hyperinflation on the other hand has nothing to do with that imbalance. It is a phenomenon where people no longer wish to accept a particular currency as a store of value.

Essentially, it is a loss of faith. If we are asked to accept a currency, whether paper or hard, we will only accept it if we have faith that someone else will accept it from us at a substantially similar value.

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It is within this context I have come to believe that sovereign debt doesn’t matter in an economy that is using Fiat currency; providing that the sovereign entity is able to service the debt. By servicing the debt, I mean that the sovereign entity is able to continue paying interest on the debt.

This doesn’t mean that accumulating excessive debt is a good idea.

The overvaluation of mortgage backed securities a decade and a half ago was effectively an accumulation of debt on the promise that when it came time to redeem the debt we would be able to do so. By we, I mean people and corporations who invested in those securities.

That market collapsed when it did essentially for no other reason then enough people became aware of the growing problem that when one individual corporation decided to dump all of its mortgage-backed securities, it set off a chain reaction.

This could just as easily have played out differently if the owners of these securities backed out of the market in a slower, less panicked manner. This is of course a moot point.


When that happened the federal government stepped in with a bailout package. Whether this was a good idea and whether or not it was done poorly is no longer relevant. What’s done is done and there is no going back to make different choices with the benefit of hindsight.

Recently the idea was broached that states which have accumulated a substantial pile of unfunded obligations and are now financially stressed by the Covid crisis should get a federal bail out.

As a counterpoint, the idea of state level bankruptcies was brought up; would enable states to break contracts with public service employee unions and renegotiate them, as well as to be able to walk away from other structural death problems that were accumulated as a result of poor decisions based on political convenience.

Whether or not this is legal, a good idea or even possible are all valid questions; but that is a subject for a separate discussion.


We have already seen the size of the bail out needed to rescue major banks and insurance companies. We’ve also seen the size of the rescue package for the current “crisis”, which is still an ongoing issue and quite likely not yet finished.

Weather or not what is happening now is a good idea is also a separate discussion.


Our national debt, at least the part that we talk about, is in the mid $20 trillion range. A bail out of California Illinois and New York i’ll buy them selves is likely to push that debt to the level of $30 trillion and beyond.


As a postulated earlier, in a very real sense this debt no longer matters as long as we are able to continue servicing it by paying the interest.


All of this begs the question…

At what point is it no longer possible to service the debt?

Eventually printing more money is no longer effective as we have seen in late 18th century America, early 20th century Germany and currently in Venezuela.

It becomes a problem because at a certain point the pace of inflation destroys the faith of the population in the currency that is being inflated.

Indefinite, unending inflation is generally not an issue and for evidence I point to millennia of human history.

However, let that inflation happen rapidly enough and people will no longer want to except your currency.

I suspect that if you were somehow able to graph this unspoken public opinion you would have a parabolic arc.

This is not like a calculus limit where the ark can continue to approach the X or Y axis forever. Eventually there will be a sudden shift in the attitude of the population towards a currency and while I cannot say that it will be unexpected because people have always seen these things coming; I can say that it will still take most of us by surprise if and when it happens.


So…
Where is that point, and how close are we to it?

When it happens, who bails out the whole country?

Comments

  • Fact

    When rapper "50 cent" visited Zimbabwe, he was addressd as "100 billion dollars".
  • "Where is that point, and how close are we to it?"

    No idea. That's a question of psychology, and it's the psychology of an entire people, not an individual. I think most people still want to believe in the idea of America, and included in that is the idea of our exceptionalism, strength, and ability to overcome damn near anything. I bet the faith in our currency could get pushed pretty far, as long as people's daily lifestyles aren't disrupted.

    "When it happens, who bails out the whole country?"

    Creditors who think of us as "too big to fail", I think. China? But what does a Chinese bailout of the US look like? Takeovers of vast swaths of public land? Warrants against future resource extraction? Scary prospect.
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