Bootstrapping


Baron Munchausen. Fantasist. Bootstrapper. Could walk into most senior economic jobs.

Me again.

The same battle of economic ideas is playing out this week as we've seen for the past few years. On one side we have conventional economists, and most politicians, saying that economies run in smooth self-correcting cycles, so the financial scare in the past year or so is now correcting and it will soon be back to business as usual.

On the other side are those who think money and more specifically debt are central to how economies work, and that economies don't self-adjust or run in smooth cycles but are like every other system in the world, in that they sometimes don't follow any sort of regular pattern at all. For these (to me hugely more realistic) thinkers, we're still sitting on the same time bomb of debt.

See for example the figures the Reserve Bank of Australia have released, described very nicely here. Australians now have more personal debt than the entire economy earns in a year. More than $50,000 for every man, woman and child in the country. More than 1 trillion dollars of debt. You don't hear private debt mentioned much at all, because the first group of people above use an economic theory that says (and yes, they really do say this) that individuals always make rational decisions. They are 'the market'. And the market is never wrong. Now I'm definitely not always rational, and I doubt anybody is, so I think any theory that uses that as its basis is obviously absurd. And yet that's what passes for common sense in economic thinking.

The same group of market thinkers also say the current level of debt isn't a great problem because we're all just richer than we used to be, so we can afford to service these big debts. The value of our assets, particularly our houses, has grown so much in recent years that we're now all much better off. (And the article linked to above shows that, with about 90% of that more than 1 trillion dollars of debt being tied up in mortgages.)

The other side here would remind people of something called 'bootstrapping'. Literally derived from the idea that if you fall into a swamp or a bog you can survive by yanking on your own boot laces to pull yourself out. Utterly ridiculous and the stuff of fantasy books for kids, which is where the phrase came from in the first place. Our apparent huge increase in wealth, over such a short time, with exponential growth in housing prices in particular, is simply bootstrapping. What's driven the value of houses sky high is one simple thing - debt. The value of the houses themselves, the materials they're made of, hasn't grown exponentially - how could they? We're not suddenly lining our homes with gold. So the very thing the first group claim is what makes the debt sustainable i.e. our magical increase in wealth, is itself produced by the debt.

It's perfectly easy to understand how it all works. Houses, and the parts of the economy they flow through to (the building industry, materials, the other investments we make based on the 'equity' we have in our fabulously increased home values, etc. etc.) have no intrinsic value beyond the bricks and plaster and windows and other materials they're made of and the land they sit on. Now have these materials suddenly become exponentially more expensive to make and provide? Not at all. It's true there may be less land available, but it's not anywhere near enough of a shortage to explain the HUGE increase in house prices over the past 10-15 years.

The huge increase in house prices has been based purely upon what we all call 'the market'. Or in other words, based purely upon what people are prepared to pay, funded by debt. House prices have been the engine room of the recent apparent boom in Australia and many other countries, the huge money people have made from buying and selling real estate is what has then fed the rest of the (apparently) booming economy. But you can see how it's all make-believe. Because what generated these huge price increases wasn't anything tangible at all, it was simply people taking on more debt. So using our apparent wealth to explain why we can handle so much more debt is bootstrapping of the highest order, because it's the debt that created the apparent wealth. It's having your cake and eating it too.

Before the 1980s people seemed to use more common sense in economic questions. If you had huge debts it was obvious to everybody that you were in trouble. It was the great Thatcher and Reagan revolutions that threw all of that out of the window and replaced it with magic pudding economics, where enormous wealth appears out of thin air, for no work. Entire economies became casinos, what has passed for economic activity since that time has been largely speculation.

The next few years will show which of the above camps turns out to be right. My money is (literally) with the second lot.



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