Charles Hugh Smith may not call himself a socialist. But I’ve always found this altruist, collectivist, populist undertone to his writing. Let’s see what he wrote today.
He has an 8-point plan to fix the economy. The first thing I’ll note is that he does not address the punitively low rate of interest set by our expert central planners at the Fed. There cannot be a fix to anything if we leave central planning of money, credit, interest, and discount under the control of an economic dictator. And there cannot be a recovery without savings, which certainly is discouraged by Zero Interest Rate Policy.
Anyways, 6 out of the 8 points are about marking various asset categories to market value, punishing fraud in this marking, and putting banks into receivership if they are insolvent under the new rules. It sounds good, upon superficial examination. But upon deeper thought, he’s missing something important here.The purpose of financial statements is to present a conservative and realistic view of a business, not a speculative view of how good things could be. One must consider assets and liabilities slightly differently. Assets should be kept on the books at the *lower* of either: (a) acquisition price or (b) current market value. If an asset’s price goes up, it is not normally appropriate for a business to mark it up. Liabilities, on the other hand, should be kept at the higher of either: (a) acquisition value or (b) market value. If the liquidation value of a bond goes up, the debtor must show that as a loss of capital. Otherwise, the balance sheet does not show the true picture. If this rule were implemented, then the devastating effect of falling interest rates would be obvious. Those “free” capital gains won by bond speculators come from somewhere: the capital accounts of bond issuers. It’s hard to fault Smith for not understanding this. Hardly anyone does.
But two of his points are something else altogether. One of them proposes to give a free house to anyone whose lender committed any kind of fraud–even if they misrepresented risk to their investors. This is arbitrary, capricious, and will have massive consequences.The other was to allow bankruptcy to discharge student loan debt. I think Smith is motivated by the idea of “soaking the rich bankers” and giving a freebie to people. I would agree for a different reason. We need to get rid of the special cases and special exceptions in our legal code, and return to the rule of law. Either it is fair and proper and moral for people to be able to erase debt through personal bankruptcy, or not. Either way, student loan debt hardly merits its own special treatment under law.
I have been following your work for some time and have decided to read all your posts from the beginning. Please help me understand the following example:
I lend the government a $100 with the understanding that they give me back $110 in a year. Later today you buy this claim from me for $105. Surely the government (debtor) did not loose anything in the process as it will only be liable to pay you $110 in a year.
Thanks for your time.
Think of issuing a bond as begin short the bond. Even if you know you will have to pay $100 at maturity, the bond has a $105 liquidation value today. This is an “overhang”, a weight increasing the burden of that debt.
I’ve written other pieces that look at the burden of debt rising as interest falls in more depth.