Debt and Declining Future Capital
Jan 30, 2011

Debt and Declining Future Capital

We often use the words capital and money interchangeably. There is of course a distinction and it is in this distinction that we can relate issues of indebtedness, cheap energy depletion, global warming and the like.

Capital refers to the production factors of an economy - basic resources, human labour, organization, etc. Money is a medium of exchange that represents as a proxy the value of these underlining resources. It is such a good proxy and used so ubiquitously that we drop the distinction and use the two words synonymously.

While our accounting for debt in society has nominal values in money, it can be cast in terms of capital as receiving a large amount of capital now in exchange for return of capital in the future. That we will be able to, as an aggregate, have a steady stream of capital capable of paying the nominal values is the basic assumption we operate on when agreeing to debts.

When we experience resource depletion - such as declining cheap oil supplies - this is equivalent to a lowered future supply of real capital. Oil is arguably the most important production factor in our economy and so its decline will be a significant lowering of future capital. The range of possible outcomes is still uncertain but future capital supplies are likely to be lowered from global warming as well either for the long term (an agriculture region now receives less rainfall and so produces less goods, for example) or the medium term (declining production during transitions such as people moving out of coastal Bangladesh).

The problem with our societal debt is based on our estimates of future ability to pay. The current numerical value of our debts is such that all else being even we will have significantly more capital in the future than we do now to pay them back. This has been a reasonable assumption for a long time and with technological advancement and increased population it is possible, but seems unlikely. However, we know that baring technological breakthroughs the future capital is likely to decline due to peak oil and global warming. So our estimates of future ability to provide capital is likely wrong. Actually, it is likely overestimate even if these future declines did not occur. Our social ordering is reflected in debt levels which represent a stable continuation of the status quo. Changes to the debt levels and composition are equivalent to changes in the social ordering.

Smoothed out over time, our economy will continue and reflect the real capital at our disposal. As that capital changes, so too will the economy with it - even if that is a decline from the current scale of economic complexity. Our knowledge of future capital flows will continually update and with it will come the level of monetary debts we will undertake.

The problem is that our public realization that we have erred in our judgement about how indebted we ought to be historically doesn't come smoothly but in fits and starts. A smooth increase in debt followed by a crash that sheds enormous amounts of debt over a short portion. We see this both at the scale of individual companies going bankrupt and having to dramatically reassess their worth in bankruptcy proceedings and we see it in financial crises like the last one with systemic deleveraging. That future capital will be depressed because of these crises is a reality, but we can exacerbate that reality by misjudging our debt load. The insecurity and instability that comes with rapid realigning of debt with genuine capital is what causes the most short term damage, not the change in capital itself.

What we need to do is consistently test to see if our current social ordering - as reflected in debt levels - is truly sustainable. Where we find that it isn't, perhaps due to future capital declines due to peak oil and global warming, we must make a gradual process now to realign with that capital reality to avoid the consequences of instability and sudden crashes that comes with rapid realignment. 

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