Everything anyone consumes has to be made by someone. Every good, every service; cornflakes, iPhones, math lessons, homes, condoms, physiotherapy sessions, belts, hats, cheese sandwiches – even 3B pencils. Every. Single. Thing.
It may be that you think of this as not a particularly profound observation. ‘Well, obviously!’ – you mutter to yourself.
Judging by collective human behavior, it does not seem to be quite so obvious. Take any boom and bust cycle. The expansionary part of such a cycle is intuitive. There is stuff. There are humans. Humans want the stuff. They take the stuff. Simple.
Of course, it does not quite end there. After a while, the stuff starts running out. Humans still want the stuff. Uh-oh. So what do they do? The first response is rationing. Restricting consumption of stuff works in the sense that on paper, consuming less stuff makes the stuff run out less quickly. Naturally it does not solve the problem that humans still want the stuff. In fact, some perverse dynamics may lead humans to covet the stuff even more, now that it is hard to get. They start tampering with the rules. Some humans end up getting a lot of the stuff – more than they need even – and others less. In other words, a social hierarchy emerges around the distribution of stuff.
Hierarchy, however, creates incentive for conflict. After all, why should that guy (let us call him Larry) get so much stuff if I, Livius, do not get enough stuff to sate my own desires? Maybe if I demonstrate that I deserve the stuff more than Larry, I can just… take more of the stuff. There are several ways that this can play out.
Postponement
Livius: “Larry, I have meditated deeply on this matter and I think I deserve more of the stuff. You have stuff. Give me your – I mean, my – stuff.”
Larry: “No.”
Livius: “Hm, o.k.”
Livius and Larry ignore the conversation ever happened and try to go their separate ways in the future. They may quarrel again later – perhaps with entirely different parties.
Violence
Livius: “Larry, I have meditated deeply on this matter and I think I deserve more of the stuff. You have stuff. Give me your – I mean, my – stuff.”
Larry: “No.”
Livius: “Hm, o.k.”
*Livius whacks Larry over the head with a pointy rock and takes the stuff anyway*
Actually, rock-mediated conflict resolution has very much gone out of fashion with the emergence of complicated and deep hierarchies that have evolved ‘sophisticated’ organs and structures to reduce friction costs from conflict. While the idea of violence may conjure up images of youths in partner look carrying projectile accelerators, the vast majority of conflict in society is settled through non-physical and indirect (and in aggregate cheaper forms of) violence: politics, laws, prison systems, social norms, intimidation and so forth.
Alignment
Livius: “Larry, I have meditated deeply on this matter and I think I deserve more of the stuff. You have stuff. Give me your – I mean, my – stuff.”
Larry: “No.”
Livius: “Hm, o.k.”
Larry: “How about we team up instead and take the stuff from someone else and then divide it amongst ourselves?”
Livius: “Eh, sounds good to me.”
Livius and Larry begin co-operating and pooling resources, potentially making them more competitive and improving their access to stuff.
No matter which scenario(s) plays out, these are the basic options available to humans when it comes to the distribution of resou- I mean, stuff. All agent interaction in one way or another follows one or a combination of these dynamics.
But what about the supply side? So far, we have been laboring under the assumption that the number of units of stuff available for consumption is fixed. That is not quite right. So back to the drawing board.
There is stuff. Humans take the stuff. The stuff runs out. Humans make more stuff. And they lived happily ever after.
The crux is the mis-match between the rate at which humans generate stuff and the rate at which humans would like to consume it. Though theoretically human capacity for the production of goods and services in absolute terms trends toward infinity, over any finite period of time, the amount of stuff produced remains finite itself. A variable yet constrained supply of stuff and the ability of humans to generate it in limited quantities over time (yet always desiring higher present consumption than present production), however, allows for the emergence of something very interesting indeed: credit.
Credit allows for the expedition of consumption (i.e. bringing it forward into an earlier period) relative to what would otherwise be possible under the constraint of having to provide equivalent productive output in exchange at the moment of acquisition of a good or service. In other words: Magic!
In an idealized world where future output of individuals is known, credit/lending would be an essentially risk-free affair that would not command significant fees. In reality however, credit is of course risky because future repayment is not assured and therefore lending demands compensation. But that is not the only difference that arises from uncertainty about future production. Inflation, of course, is a significant concern – as is financial repression. Yet these are ultimately manifestations of a different underlying problem. Because lending always involves a creditor and a debtor, both of whom have opposed interests in a narrow sense (if they truly had completely opposite goals, lending would not occur at all which would be disastrous for mankind), unproductive loans (that is to say the additional productive output generated as a result of the spending enabled by the loan is less than the principal plus interest charged) represent a miscalculation – a shortfall – in coordinating present consumption with future production which has to be covered out of the pocket of either one or both the parties involved.
This fact – that borrowing may not always be paid for completely out of the borrower’s pocket – leads to (unproductive) credit becoming a tool for wealth redistribution. But not just to the detriment of future humans to the benefit of present humans, even across socioeconomic and geopolitical divides. Credit is an extremely potent instrument that can – in the (right? wrong?) hands – reshuffle social hierarchy or maintain an existing order. Furthermore, credit is inherently non-democratic and intellectually opaque even to the so-called experts. At least when a nuclear warhead hits a city, most people can establish who executed the sequence of actions that has led to the destruction (and most of them also intuitively grasp the cost of having leveled a city and killed large numbers of productive civilians). Not necessarily so with the redistribution of wealth resulting from the use of credit.
Just picture our previous exchange between Livius and Larry in an environment where credit is an established social institution.
Livius: “Larry, I have meditated deeply on this matter and I think I deserve more of the stuff. You have stuff. Give me your – I mean, my – stuff.”
Larry: “Certainly. Please just sign here, here and here. Interest payable semi-annually.”
Livius: “Hm, o.k.”
Now, dear reader, tell me: Who is the winner in this situation? Is it Livius, because he received purchasing power he did not have before this exchange? Is it Larry, because he will in the end receive satisfactory return on his principal? Is it both, because the loan is invested productively and leads to a sustainable increase in output attributable to Livius who uses some of it to cover the debt? Is it neither, because the purchasing power is spent unproductively and Larry is not compensated?
Go on.
.
..
…
Don’t look at me – I have no clue either.
The true nature of the transaction depends entirely on its terms and ultimate repayment. But without fully knowing – or understanding – the terms, much less knowing the future, we cannot know how or in what direction wealth was redistributed. Nevertheless, redistribution has been and is occurring. At scale.
Indeed, even if credit were not such an enormous system spanning all of human civilization and you only had a small amount of lending going on, the dynamics of causality (investors affectionately call this compounding) must transform the course of history completely, given time. If there is the possibility of capital accumulation and there are flows of credit, even if every agent begins with exactly the same amount of capital, uncertainty and randomness will make some of them wealthy and powerful and some of them poor and weak. This issue is exacerbated by the fact that wealthy individuals have easier and cheaper access to credit and may indeed end up being (the) creditors themselves.
This is the beauty of humanity: Be confronted with a harsh physical reality dictated by the universe, create a sophisticated buzzing perpetuum mobile of social organs that allow prolonged ignoring of reality to the point of complete delusion about fundamental physical truth, have the miracle-machine break down eventually and be thrown into despair, all the while crying out: “Woe is us, how could anyone have seen it coming that one cannot in aggregate consume more than one produces for a prolonged period of time?”. Who needs children in order to witness true surprise and wonder at a new discovery when we have the financial industry and credit cycles?
At this point we could get into government intervention into lending, central banks or the looming contraction of global credit but each is a world unto its own of such magnitude that I shall address them in a separate piece.
Hopefully this has been of interest to you
Tom
The Financial Flâneur 