One man’s debt is another man’s savings. Every dollar borrowed is a dollar lent. If a debtor has a problem, then a saver has a problem. If there are doubts about whether debts will ever be paid back, then there should be equal doubts about whether savings are safe.

Whose savings are we talking about? Total US credit market debt is above 350% of GDP, which amounts to more than 50 trillion USD. Total reserves of China are slightly above 2 trillion, i.e. just 4% of outstanding US debt. Throwing in a few more trillion from other Asian and oil-exporting countries does not change that picture – the West is not indebted to Asia, it is indebted to itself. The largest creditors are our own pension funds.

The debt and consumption spree of the past 15 years happened mainly at the expense of our own old age and not at the expense of Asia. Money which was supposed to be invested was in fact not invested, but spent for consumption. Therefore, in the aggregate, not enough capital was invested, and out of the capital that was invested, much of it was malinvested, for example in housing. As there is not enough capital backing the outstanding debt, there is no source of income to service that debt, let alone to pay it back.

Note that social security systems can either be funded by savings (via capital transfers across time) or by taxes (via transfers across demographic segments of the population, from the working to the retired). Adding insult to injury, not only will the transfers via time turn out to be much smaller than planned, but also the redistribution from a shrinking working force to a growing amount of pensioners will become more and more difficult. If we indeed should be worried about debt, then we should be equally worried about our social security systems. 

We are currently in uncharted territory concerning the consequences of the huge monetary and fiscal stimuli applied to counter the financial crisis and the economic downturn. Consequently, we are confronted with an elevated potential for surprises and black swans. However, nothing has been learnt from the abject failure to predict the financial market crisis. Although some analysts may indeed be concerned about “extreme” outcomes (2-3 sigma events), the true black swan events (4+ sigma events) are probably not given enough consideration, and hedges against them are probably underpriced by financial markets.

There are, by definition, no black swan “seers” – a black swan is, by definition, unexpected. Therefore, don’t rely on the cranks-turned-celebrities who warned of the financial market crisis to warn you of the next black swan, because the signs on the wall will be written in a different language. Those few who were able to read these signs two years ago won’t be able to read them next time, and those who warned of the crisis, but were right only by chance, won’t be able to read them either. It will be different cranks and different lucky analysts who will turn out right next time.

I think we are already inmidst serious inflation. Although consumer prices are falling in many countries, this does not imply we are experiencing deflation. Inflation is not defined as rising consumer prices, inflation is defined as a fall in the value of money because of an excessive increase in the quantity of money. Consumer prices are one (out of several) indicators of inflation. Because consumer prices are sticky, i.e. consumer goods are not traded on liquid markets, consumer prices are a lagging indicator of inflation. Most real-time indicators of inflation point to rather high inflation: growth rates of monetary aggregates around the world are massive, and the purchasing power of the US dollar has been falling on almost every liquid market for several months now (foreign currency, commodities, stocks). Consumer prices will probably follow other prices in due time.

This sounds logical, but it is not. In particular, some things are badly mixed up. Actually, inflation could probably result with government support being much smaller than wealth losses.

First, real estate, stock, and risky credit were overpriced at the onset of the financial market crisis – their valuations were not backed by an equivalent stream of future production. Note that wealth is nothing else than a claim on future production. Therefore, pre-crisis levels of asset prices did not reflect actual wealth – in fact, there was no chance that these overpriced assets could ever have been converted into future production at prevailing prices. Expectations reflected in asset prices were exaggerated. In order to balance future aggregate demand and supply of goods and services, either consumer prices would have had to rise, or asset prices would have had to fall. The latter happened.

Enter the government. By reinflating prices of worthless assets above their intrinsic value, false wealth is restored. Furthermore, by backing AIG and honouring bets which were not honourable from the beginning, even more false wealth is created. Trying to restore exaggerated expectations is probably a bad idea and could turn out very inflationary.

The second flaw in the introductory reasoning is that apples are compared to oranges. A dollar in wealth (losses) is not the same as a dollar in money supply, which is not the same as a dollar actually spent for goods or services. In particular, wealth and money supply are stock variables, while spending is a flow variable. Simply aggregating the headline amount of government measures and comparing them to estimated wealth losses is therefore useless at best, if not misleading, in order to assess future inflationary tendencies.