The finance-based economy.

A few weeks ago I wrote a metaphor for the present state of the world economy that I'm pretty proud of. Let me reprint it here:

The richest guy in town is on a buying spree. Every day, he wanders through the market and chooses what he likes. The merchants want to sell to him, and are willing to accept his credit notes. After all, he's the richest guy in town! Everyone knows his credit is good. Eventually, the merchants exchange these credit notes with each other, and use them to purchase assets like real estate or shares of other businesses. This makes prices for these assets go up and makes the richest man in town (who owns many of these types of assets) even richer. He goes on a shopping spree to celebrate.

I like this metaphor because it captures the absurdity of the present world economy, but also displays the dilemma we're all in. These credit notes can't be cashed because the rich man can't pay them; if we try anyway, their value will decrease rapidly -- disastrous to the village.

Another thing the metaphor shows is that the Americans (or the rich man) are borrowing without paying interest. This is essentially true; interest rates have never been lower. But because of this dependence on free credit, the village economy is dependent not only on more credit being created, but also the maintenance of the present credit terms. An increase would cause a serious drain on the rich man's finances that would end his spending spree.

Bill Gross is a powerful bond trader at PIMCO. He discusses these issues in his latest Investment Outlook essay (he's using a 'Western' metaphor):

But folks, all blame aside, I must tell you in advance that this story or movie does not have a happy ending. In terms of timing it may not be high noon, but High Noon it will be in terms of an ultimate outcome. Because in a finance-based economy that depends on more and more low cost money in order to thrive, the game ends when either the “more and more” or the “low cost” modifiers are replaced with “less” or “higher cost.”

(Emphasis in original.) He offers this chart (among others) to show how the economy has become reliant on debt:

He goes on to talk about the forces that defend this situation, and the inevitability of the whole game collapsing. Read the whole thing (and buy gold!).

Posted by Bruce Gottfred at February 4, 2004 11:25 AM | TrackBack