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Introduction to wealth, liabilities, assets, debt

by on 26/07/2018

Introduction to wealth, liabilities, assets, debt

Wealth is financial savings, represented also as liabilities of entities accumulating assets of the same value expressed by universal scalar, MONEY, equivalent to the financial assets of the savers. So savings are equivalent to investments. If an incorporated business invested in tangible asset and if financed it by equity (Capital), lent by the entity owner, and/or by bank as a loan, by definition all this has to be balance between debt translated to liabilities and asset. If the asset price will go up, it will be a profit translated to additional equity, registered as a liability, that in future will be paid as dividend to the equity holder, vice versus. The difference between equity finance and loan is that the first doesn’t pays interest but dividends, and in case of liquidation of the entity for whatever reason, the lender gets paid first. Also equity financier holds the ownership share and managing power of the entity it finances, while the bank loan or different kind of securities financiers (bonds, debentures) have no ownership rights.

By definition liabilities of borrowers are assets of the lender. The economic world is divided between the lenders and borrowers, while in between stands the financial institutions, mainly the commercial banks.

  1. Liabilities are either of public institutions empowered to collect taxes (federal government, states, and municipalities) or private. The private entities are either, foreigners (foreign governments or foreign private entities), private households or corporate and non corporate businesses.
  2. According to the above mentioned definition, assets = liabilities are either public or private. Private assets and liabilities can be either of private households or of incorporated business entities, that have different level of ownership distribution.
  3. Assets can be tangible or claims against others, that are debts of others than the assets holders. The debts of the public institutions, are in form of cash money or securities issued by public entities. Then loans to private entities, or from other borrowers in form of future receivables.
  4. If government increases its debt by deficit, it will become debtor to either foreign country,  private households, or businesses, but to the lender it will be part of their assets.
  5. Quantitative easing is a process of transferring liability of government from government bonds and securities, obliged to pay interest, to cash money, usually deposited in commercial bank accounts, free of interest payments from the government or other public entity. These deposits are either lent to borrowers by commercial banks, or deposited as reserves in Federal Reserve bank, that according to new policy introduced after the 2008 crisis, pays interests on this deposits.
  6. If the foreign debtor wants to reduce the level of loans it gave in the past, it has to sell the debts on the free market. By selling the debts, that will be usually either government or corporate securities, it will reduce the market price of the debt, it means the debt value will be reduced. Lower government bond prices means also increase of interest rate in the borrowing country, that can cause economic depression. To prevent interest rate increase the government (central bank) or the corporation has to buy back its debts, (Quantitative Easement). Government bonds buyback would mean changing public debt from liability paying interests to promissory notes without interest charges and without expire date, (Money). But if a private corporation buys back its bonds they will become assets in its balance sheet, in exchange against bank deposits of cash money. Against it will stand the debt itself in liabilities. If offsetted against each other the liabilities and assets will be decreased accordingly.  

While government purchases its debts, the financial liquidity in the economy increases, while when business corporation is doing so, its financial liquidity decreases.

Does such an increase in financial liquidity in economy and consequent increase of money circulation have limits? Most probably yes, when more value of money will circulate in the economy than real production capacity. Is US economy close to it? It is hard to estimate,  because limits of production capacity are not all the production items used to produce, (usually what is watched is level of employment), but any substantial item,that has no supplementary alternative, can become that limiting item of the production capacity, and its essentiality is discovered usually when it is out of shelf. Still, most of the money in economy is supplied by the banks and not by the government. But to much Quantitative easing, generates cash money in businesses and other private entities, that are alternative to the bank loans, and reduces demand for bank loans. Since the 2008 economic breakdown, the volume of commercial banks credit is limited by the volume of business opportunities the banks can enter to. Other limited factors of the banking system as minimum reserve requirement and/or minimum equity requirements are becoming less and less limiting, with increased cash in the economic system.

Too much cash in the monetary system, means too much money in bank deposits. Public deficit financed by new government securities, increases demand for money deposited in financial savings, meaning causes increased interest rate, repurchase of these securities by the central banks or Federal Reserve, increases the security price and so decreases the interest rate.

Too much cash will cause less debt in private sector and will make the economy financially more stable. At first, the publicly traded corporations, if no better investment opportunities appear, will repay their debts. Then they will purchase from the public their own shares, and increase share prices.

As to the public sector, its repurchased debts will be changed to form of promissory notes, without interest charges and without expire date, (Money).

If quantitative easing policy of central banks, results reduced debt levels of public and private sector, what’s the problem? Why not to use it more often,  or even always?

  1. The lenders, mainly those who hold most of their assets in money, be it cash, deposits or savings, will lose their asset value compared to those, who hold their assets in non financial form, due to low interest rates and increasing non financial asset prices caused by increased liquidity. This means, pensioners, wage employees, low income part of the society will be the one to pay the price.
  2. The banking sector has its own problem? On one hand it will have also more deposits in form of cash in their balance sheet, much above the reserves demanded by the Federal Reserve, that makes them much more stable. On the other hand, less demand from potential credit worth borrowers, will shrink the share of bank credit in the economy. Because of enormous political influence of the banks, such a policy is opposed by political system. This situation may cause more loose risk taking approaches of the banks.
  3. The central banks and F.R. have to be very careful not to become too addicted to Quantitative easing, and not to purchase other than government public debts. Otherwise while not democratically elected, the central banks will be involved in resource allocation policy of the democratically elected government, from one sector to other sector, creating unwillingly price distortion between the sectors. The central banks has to have, as much as possible, a neutral policy as to resource allocation between the different sectors of the economy

Does Quantitative easing causes limitations on economic intervention in the future, in cases inflation or deflation overtakes the economy?

In case of deflation, if there are no more public sector securities on the market, it may be a problem, unless the government will increase its deficit, and create new debts. It may do it by tax reduction, that can be fast, or/and increasing public sector investments and consumption. The problem is political opposition to such a policy, and investments in public infrastructure may take time, until it will have effect on the economy.

In case of inflation, assuming the government can’t reduce its deficit, it will have to squeeze the bank credit to balance the deficit. The bank regulator has enough tools to do it. Again the banking sector will have to be squeezed as result of such a policy. The share of the private sector compared to public sector in the economy will decrease as a result of deficit financing of public activities. But the public sector is financing it’s activities by tax collected from the private sector. Squeezed private sector means less taxes and even more deficit. This scissor effect has its limitation too.

Still it looks the Quantitative easing has huge positive impact on the economy, why such an opposition to it, and why it was never implemented before 2008?

If we neglect the consumers society phenomenon of consumers credit, the loans are supplementary to equity capital needed to invest in new business venture, or existing enterprises. The lenders are those with excess financial capital deposited in the banks, while they don’t have the capacity it fully utilise efficiently themselves. The borrowers are usually the entrepreneurs, with need for supplementary loans, to invest into the new or existing enterprises. Policy of Quantitative easing has to degrade the relative value of the financial capital, unless it is actively invested. Active investment is about higher risk taking, compared to investments in bank deposits.

Conclusion:

As said above, from economic point of view the society is divided to lenders and borrowers of financial capital, while the banks are the usual go between. Since money value is imaginary,  and is based on faith, this process of lending – borrowing is filled with emotions, mythologies, misunderstanding.

Quantitative easing means increasing the money in the economic system on account of the loans. With more cash money in the system, more money is to lend, and less money is needed by the entrepreneurs for investments. The demand for money is infinite, yet its price is negatively sensitive to level of cash money abundance. Who will lose from abundance of money? The lenders and the financial system, as the go between. The actual gainer of this process will be the borrower, who is culturally seen as the sinner, the bad guy of the game, while the lenders are traditionally seen as the noble ones, who need to be protected.

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