Letters To Krugman: Math Rage

Math Rage:

In a normal economy, large investment losses are typically accompanied by bankruptcy, where by bad debts are cleared and the remaining assets are liquidated at market.

It follows that the correct way to eliminate the bad debt is not to print money, but to wipe out the debt through bankruptcy. This would allow new entrepreneurs the opportunity to purchase the assets of their bankrupt competitors at pennies on the dollar. This is how losses are normally realized in a market economy.

The public debt of the bailouts should not be paid back; it should be wiped out by forcing the private banks to accept the losses they managed to shove on to the tax payer. The GSEs should be wiped out in bankruptcy court. The commercial banks should be wiped out in bankruptcy court.

New commercial banks run by new entrepreneurs could then step in with extremely low overhead, unencumbered by bad debts. The public debt would not be expanded, it would be reduced.

Debt is a function of time preference. Entrepreneurs give up future earnings to acquire material capital in the present in order to engage in productive capital building enterprises that raise the overall standard of living in the future by increasing the productive output of the economy.

The use of debt is not a zero sum game if the borrowed capital is put into activities that expand future productivity. In a stable monetary system where the money supply neither decreases or increases, this would lead to deflation (a good thing) since the monetary base would remain unchanged but the productive capacity of the economy would be constantly expanding.

We would naturally see a decrease in the amount of debt businesses need to expand operations because the money should be gaining in value as productivity is expanded. Thus, less nominal debt would be necessary for a business to acquire the same amount of capital goods in the future. If this is the case (which it is) then this leaves more available monies for spending on the paying down of existing debt.

The market naturally limits debt to productive enterprises because investors demand payment of interest on their investment dollars. In a sane and rational economy, interest rates prohibit reckless wasting of capital on non-productive enterprises and coordinate the structure of production between lower (consumer goods) and higher (producer capital goods used to make consumer goods) stages of production.

During all of this, if investors do make bad business decisions, they will ultimately go bankrupt, thereby freeing up capital goods and eliminating debt so that others who are more talented at meeting consumers needs can acquire those resources cheaply.