Wednesday, May 23, 2012

My naive and fishy view on deleveraging

I'm writing this in response to a Barron's piece about Ray Dalio. I'm writing this because I'm puzzled about the 3 strategies for deleveraging that I heard about over the years. To me, there is only one strategy. (I'm not sure if the Barron's article is behind their paywall. If so, you can also find a snipplet quoted at Frank Voisin's blog.)

* * *

In the distant land of Asgard, the currency unit was "cans of sardines". And sardine hunting was Asgard's major economical activity.

One day, an entrepreneur called Loki visited the Central Bank of Sardines. He wanted to borrow 1/2 of the nation's sardine reserve, which had been accumulated as a preparation for the next ice age. He had this grand vision. He wanted to use the proceeding to employ many engineers and scientists to create an automatic sardine harvesting machine.

Loki eventually got his loan. But on his way back to his office, he bumped into a gigantic green monster and all the sardines were lost.

Now, after this incidence, Asgard didn't have enough sardines for the nation to go through the ice age. What could they do? What were the options?

Could they "inflat" their way out? They could repackage each can with only 70% of original volume of sardines, and they could repeat doing this every year. That inflated the number of cans. But, it didn't address Asgardians' hunger... 30% less sardines was 30% stomach unfilled.

Could they go on austerity?

Well, I think austerity = hunger.

It's apparent that the only sensible option was to ramp up their sardine hunting or improve the yield (by really inventing a harvest machine!) to make up for the lost.

This means they had to grow, to improve their productivity.

Did inflation have a place? Probably. If Asgard labour and goods were cheaper, they could probably sell more stuff to other nations and thus accelerated the build up of their sardine reserve.

Did austerity have a place?  Probably. For one thing, sardines (i.e. money) should not flow through Loki's hands anymore. In other words, austerity should be applied selective at the places where waste would occur.

But, without growth, austerity and inflation were useless.

* * *

I don't have any rigorous economic theory to back up my story. I am pretty sure you can poke holes in this "analysis". I am looking forward to comments on the fallacies of my reasoning.

(Don't ask me why "Asgard" and "sardine". I just had these random thoughts in my head while I was writing this.)


  1. To inflate your way out you need to have sufficient sardine's in your economy; since inflation is effectively just transferring wealth from the rich to the poor (and since the state often has the biggest debt it's the biggest beneficiary from this wealth transfer). If you need X sardines to survive an ice age, and in the whole economy there are just X/2 inflation is not going to help. But if you do have >X sardines inflation can help if sardines need to be transferred from the rich to the poor.

    1. That's a good point, Vulture.

      If we do have only X/2, that means we need to *grow* to X. Right?

    2. I had some more thought on this.

      Does inflation necessarily transfer wealth from the rich? What if the rich hold hard assets instead of cash?

    3. Inflation does not always have to be a transfer from the rich to the poor, but on average those who have debt are 'poor' while those who have provided the money for these loans are 'rich'. But the fact that there is inflation can be a good incentive for people to do something productive with the cash; for example investing it in economic activities that do provide growth.

      But to make the story a bit more complex; in your example the main problem is a lack of resources, and that can only be fixed by increasing productivity. But this doesn't imply that spending more to realize growth is the solution; if everybody who is capable is already working in the sardine business; what can you do? You probably need a scientific breakthrough to increase the number of sardines you can catch, an economic solution cannot fix it. An economic solution can only work if there is some problem in the market that results in resources that are underutilized.

  2. I had some more thought just now. I realised I forgot about the "confidence factor". I think that is a major argument for austerity, to restore the confidence in the country.

    1. And confidence is critical if you are to prevent those Asgardians holding sardines either selling them to other countries in return for something less manipulable or simply leaving Asgard.

      On the assumption that those holding sardines tend to be better than your average sardine hunter, the lowering of the average standard of Asgardian sardine hunter is likely to exacerbate the existing problem.

  3. Sorry but I don't see the connection betweed sardines and money. One is a good and the other one is a claim on someone.