2011 May 15 Sunday
Hernando de Soto: The Destruction of Economic Facts

Noted Peruvian economist Hernando de Soto argues in a Businessweek piece that the financial markets went so awry because there is no longer enough publicly available knowledge about financial firms to enable the markets to operate efficiently.

To prevent the breakdown of industrial and commercial progress, hundreds of creative reformers concluded that the world needed a shared set of facts. Knowledge had to be gathered, organized, standardized, recorded, continually updated, and easily accessible—so that all players in the world's widening markets could, in the words of France's free-banking champion Charles Coquelin, "pick up the thousands of filaments that businesses are creating between themselves."

The result was the invention of the first massive "public memory systems" to record and classify—in rule-bound, certified, and publicly accessible registries, titles, balance sheets, and statements of account—all the relevant knowledge available, whether intangible (stocks, commercial paper, deeds, ledgers, contracts, patents, companies, and promissory notes), or tangible (land, buildings, boats, machines, etc.). Knowing who owned and owed, and fixing that information in public records, made it possible for investors to infer value, take risks, and track results. The final product was a revolutionary form of knowledge: "economic facts."

Changes in financial regulations (along with a large amount of enabling computing power) enabled financial firms to create private markets with repos, credit default swaps, and other instruments that leave regulatory agencies (along with buyers and sellers of shares in financial firms) unable to figure out the financial condition of banks, insurance firms, and other financial firms.

Over the past 20 years, Americans and Europeans have quietly gone about destroying these facts. The very systems that could have provided markets and governments with the means to understand the global financial crisis—and to prevent another one—are being eroded. Governments have allowed shadow markets to develop and reach a size beyond comprehension. Mortgages have been granted and recorded with such inattention that homeowners and banks often don't know and can't prove who owns their homes. In a few short decades the West undercut 150 years of legal reforms that made the global economy possible.

While de Soto does not mention it, resource shortages and other factors are undermining the ability of governments, firms, and workers to grow their incomes enough to service their debts. The enormous house of cards built with debt instruments stands at risk of an even greater crisis than we saw in late 2008.

The financial problem posed by rising resource prices and limits to growth has been driven home to me as I read Chris Martenson's The Crash Course: The Unsustainable Future Of Our Economy, Energy, And Environment. Our system of debt assumes growth. Take away growth and the amount of unaffordable debt quickly scales up into the trillions of dollars.

Looking at the Congressional Budget Office Analysis Of The President's 2011 Budget a link to economic projections of the CBO shows the CBO is assuming 4.2% annual GDP growth for 2012-2014 and then 2.4% annual growth for 2015-2020. They expect this to yield a 31% real growth in the US economy. Well, what if that does not happen? What if commodity price spikes keep kicking the US economy (along with the other OECD developed countries) back into recession? The effect on debt service would (will?) be catastrophic. More people would demand stuff from government (e.g. people would retire earlier due to lack of jobs) and they would pay far less in taxes.

While greater transparency would help (e.g. to help people learn they need to start growing gardens and cancel vacations) if economic growth stops then no amount of transparency will help us avoid inflation as some of the developed country governments try to inflate away their unaffordable debts. The Western countries and Japan aren't the only ones heavily dependent on growth to manage their debts. China's increasingly debt-driven growth puts its economy at substantial risk of a huge correction. A depression there is not out of the question. So many houses of cards.

Share |      By Randall Parker at 2011 May 15 04:59 PM  Economics Credit

REN said at May 16, 2011 6:06 AM:

Here are four statements regarding money that distill historical learning: The media of exchange needs these desirable qualities:
1) They are to be paid into circulation (this means NOT loaned credit money as in today).
2) They are to be redeemable for goods or services or as payment of taxes.
3) When demand deposits (your money at you local bank) are used as a media of exchange, they are to have 100% cash reserves on deposit at the bank.
4) All are to be issued in good faith.

Our current system has all money loaned into circulation, and hence it is a debt based system. All new money comes into existence as debt, either from a new loan at the bank, or at the the government level. Both government money (base money) and credit money (from your loan at the your bank) mix together in the money supply. This causes all kinds of distortions, which we see today. Additionally, hedgers and counter-parties gamble with each other, and when they loose or win, new loan money has to come into existence to settle the debt.

In other words, virtually evey economist in one form or another, is trying to get a handle on credit money. Credit money can bubble up due to easy leveraging. For example, insurance companies like AIG backing up house mortgages, where said credit "looks" good, but really isn't. The handle the economists want on credit money is more LAW, or more transparency, or more something. BUT, they never look at what money is, and hence miss the essentials. They cannot see the forest for the trees.

If all money is money and not credit, then you don't have the distortions. With all money issued by a central authority and based in the law, then that ONE source can be watched and controlled. With private banks being forced to only issued money that already exists by using 100% reserves, then all financial dealings are inherently understood, as it is money and not credit.

This is the game the bankers and plutocrats and rent seekers play on the population. They make you think you need their credit mechanisms in order to have the money you need to do trade and exchange your output. But it is a lie overturned by many examples throughout history. Englands Tally Stick system lasted for 600 years. Benjamin Franklins colony operated on real money until it was overturned by the British. Salons reforms in Greece. Brief experiments in Canada and Australia. Germany's MEFO bills got them out of hyperinflation, and law based money paid for WW2. Its a crazy world, and we were not taught real history or the real effect of our money system in our Government schools.

By the way, much of China's money circulating was issued debt free. Most of the cities they have built have no debt attached, so many economists get the analysis on China wrong too. In other words, China has free standing infrastructure that exists as a wealth increase with no long term debt attached. They can also easily drain the supply by increasing reserve requirements or increasing taxes, which they have shown they can do.

Lou Pagnucco said at May 16, 2011 8:51 AM:

And, the creation of opaque, private equity/commodity exchanges ("dark pools") enable plutocrats to manipulate prices in ways that were formerly illegal, e.g., wash sales, pump-dump, front running, ....

See - "Are Dark Pools Destined to be the Next Financial Black Hole?"

Until all such transactions are forced to be public, and a small transaction tax is instituted, my bet is that we have a global financial quake to look forward to - and, of course, an ever growing wealth chasm between Main Street and Wall Street.

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