Toxic Money v. Toxic Assets

Our economy is going through a lot of turmoil right now and there is a push to find the bastards to blame. But if we concentrate too much energy on those at fault and too little energy on correcting what went wrong then we will be equally culpable when we go through this again.

So let’s get a handle on this by going back to the beginning.

Economies grew out of society’s attempt to take advantage of human strengths: different special and valuable skills in different people. Some people were better at hunting and some were better at making hunting tools. If the hunter kept all of his kills then the toolmaker would have to hunt too instead of making it easier to catch prey and the hunter would be using sub-par equipment. If they share the kill then both can concentrate on what they do best with the net result of more to share for everyone. This led to the development of money so that all specialties could share in the wealth of the community. Take special note. Money is NOT wealth. Wealth is the accumulated value of an individual’s, or society’s, production. Money is merely the unit of measure for the production. A key part of what has gone wrong in today’s economy is that money is sought after for itself.

When the wealth of an economy is measured we use the term Gross National Product (GNP) to describe it. We express GNP in terms of dollars. So we already know about money being an increment. As a matter of fact, we have diagnosed a cancerous blight on an economy that has too much money for its production: Inflation. In spite of this there is a faction in our investment community that practice the generation of money without any increase in production. They rely on transactional calculations that take advantage of some investors not being as savvy as others. This is sometimes called arbitrage. An economy can withstand a certain amount of these transactional proceeds. A small amount may even help the investment markets run smoother.

But there is an end to this limit before it becomes obnoxious and ultimately devastating. This end is hard to define and will change according to what is going on in the production and employment levels in our society so we need to watch it and keep it at workable levels. But our recent past has had notable lapses in watchfulness.

Let’s start with the egregious events of Spring 2001 when an industry stole billions of dollars from the citizens of California. Without increasing production, power-trading companies “sold” electricity to each other ticking the price up at every “sale” before finally releasing the energy to the grid. No new dams, no new plants, just ink on paper, or LCD displays on computer screens. One of those companies, ENRON, was ultimately caught trying to hide this ill-gotten booty under Caribbean mattresses until the you-know-what hit the you-know-what.

As a result thousands lost millions.

More recently it was mortgages. The scam here was to bundle high-risk mortgages together into one tradable security with the idea that someone else can have the risk while I get the money. This bundling led to more bundling of even more risky mortgages. Buyers of bundles then bundled them with other bundles and sold the new bundles to other bundlers, and so on. A most perverted pollution of the sound investment strategy called diversification. So when a higher than expected percentage of increased risky mortgages started to default bundles started to become devalued. Since individual bundles had been rewrapped into other bundles this house of cards came tumbling down. Banks did not know what their assets were worth. (They couldn’t see how much wealth they had buried under all that money.) Since they can only lend a percentage of their assets they had to stop giving customers credit. Grind and crunch and all lending came to a halt. Since there is a time gap between producing something and selling it the inability to borrow interrupted production. Layoffs followed. More mortgages defaulted blowing up more and more bundles. The ability of banks to evaluate their wealth got murkier and their ability to lend got worse.

And millions lost billions as a result.

In view of this I have deep suspicions about any public figures who still insist our country is better off with an unregulated economy. Our economy has a toxic virus of toxic money (not toxic assets as they are popularly called) that cannot be wholly cured. A small strain may help investing run smoother but if it is allowed to run rampant the results are catastrophic. Among other responsibilities, our elected government officials are entrusted to secure the health of our futures in the economic theater. They are the people who must step up to the plate to look beyond culprits and implement controls to keep transactional proceeds at a healthy level.

For if they don’t, the next time billions may lose trillions – I don’t think there is enough production on Earth to handle that.