Leverage

Addiction and Economic Decision Making

Again, this may seem too much like an economics blog, but I’ll get back to addiction by the end, I promise. I said I’d write more about leverage, the process that seems to pave the way to loss of integrity so I’ll do that. It may seem a bit of a winding road to get where I’m going, but stick with me. To start I have to start at the beginning.

Economics (and recovery) start with the individual. The individual we’re going to think about is named Sam. Sam lives alone on a island and spends his days hunting and gathering to get enough food to live. That’s it; that’s all he does. It gets kind of boring, but it does keep him alive. Being human, Sam gets an idea. What if he builds a trap that will catch animals to eat while he’s out gathering? That will give him some free time and he’s always wanted some free time. So Sam decides to build a trap and he thinks about what he’ll need. He figures it will take him two days to gather the materials and build, two days while he won’t be able to gather or hunt for food. For two days he won’t be able to eat.

Sam would really rather eat during those two days as hunger will actually make his work harder and endanger the whole project. He decides to set some food aside every day to build up a stockpile, enough to last him two days. During the time he will build the stockpile he eats a little less than usual, making a SACRIFICE today so that he can have some set aside. That’s called SAVING, an important idea. Well, you pretty much know what happens then. He successfully saves enough food to eat while he’s working on the trap, builds the trap and saves himself half the day. So Sam used his savings to purchase an INVESTMENT, something that will pay him in the future. That’s the way it works, you use less sacrificing something you want today, save for the future and use the savings to invest in something that makes things easier, better, faster, or cheaper.

Skipping ahead several millenia, Sam found a Samantha, they had lots of little children, learned to build boats and colonized the world. They’ve repeated Sam’s formula over and over millions of times until what they have is a flowering civilization that’s so complex that the savings and investment now include things such as buying other people’s time so they can build you something. Some people become very successful at this SACRIFICING, SAVING, and INVESTING that their investments start to actually pay them more than they need. They create excess saving which we’ll call, for lack of a better term, CAPITAL.

Capital is an interesting thing. It’s actually no good unless it’s doing something. If your capital is a bushel of wheat and you just put it in your hut for a few years saving until you need it, it will be gone or ruined by the time you do. But the more complex the society becomes, the larger amounts of capital someone needs to get the projects done. That’s because the projects get bigger and more expensive. It costs more to build a bridge than to build Sam’s trap. So there has to be some way to store capital and there is. It’s called MONEY. The people with excess capital in terms of goods can sell those goods to the people who need them now in return for money that is more durable than the goods themselves. Many things have been tried as money, but for the last 5000 years or so of human history the best money has been GOLD.

But gold is pretty heavy and it’s hard to carry it around. There has to be a place to put it so Sam’s descendants invented the BANK. The first banks weren’t banks at all. They were goldsmiths and silversmiths that were used to holding metal and agreed to hold other people’s metal as well for a fee. They wrote out receipts for these deposits and people were able to trade these rather than the gold itself, thus the first paper money in Europe came about. This actually produces no problem. It’s an easier and cleaner way to do business that couldn’t be done if you had to carry around bushels of wheat to trade or even a lot of gold. The only problem was that the “bankers” forgot that economics started with Sam. Sam was so far back in pre-history to them that he didn’t even count. In fact no individual counted, only groups. They figured that most people never came to get the gold and so the bankers never actually had to have it all the time. So they invented something called FRACTIONAL RESERVE BANKING, where the bank only has to have a fraction of the reserve it says it has to back all the paper money it’s created. That’s a simple form of leverage. So if they have 100 ozs of gold they can actually print money that represents more than 100oz of gold.

If the bankers had remembered Sam, they would have wondered what he thought about his hard earned gold backing more paper money than it represented. What if more people than the bank expected came for the gold and then when Sam came they told him they’d given it to someone else? Wouldn’t he be upset? That’s happened many times in our past; it’s called a BANK RUN, and it’s pretty destructive to society.

That actually was the kind of money we had in America, but the bank runs bothered people. The solution was to get rid of gold backing of the money. We still have fractional reserve banking but instead of gold, banks have to hold deposits in their accounts. They can actually loan out about 10 times the money they actually have on the books. This is a more complex form of leverage because the underlying unit (capital) isn’t even there anymore; it’s been replaced by paper, and later, an entry in a computer. This paper is called a derivative; it’s a derivative because it derives from the underlying asset (capital). This supposedly got rid of bank runs. If more people wanted their money than the bank had, they could just get more from the printer (or make more up on the computer) to get past the crunch. Later when people put their money back in the bank, the bank would destroy it.

But leveraging against derivatives is like having a tree in the backyard that grows money. Even better, it’s like having a legal printing press in the basement that prints money.How’d we think this was an okay way to store capital? We forgot Sam. We forgot his saving. We forgot his sacrifice. Capital became so plentiful that it seemed to come from no where and have no source. It seemed so plentiful that it would always be there and could be safely taken for granted.

This backing money with nothing really did cut down on bank runs. Since the money wasn’t backed by gold anymore there was nothing to go to the bank to get. If you turned in your bills you’d just get more bills; what’s the point? But this way of getting rid of bank runs caused another problem. It led to our forgetting the source of the capital. Because we forgot the source of capital (savings and sacrifice), we started treating it cavalierly. Since it wasn’t hard to come by we risked it pretty freely. Why bother to protect it? We’ll just go over to the capital tree and get some more if we lose this. This led to bigger problems. More leverage from large holders of capital in a more complex system. Derivatives of derivatives until no one understood what was going on. Instead of bank runs we had sudden threatened collapses of “too big to fail” institutions and resulting bailouts. Instead of having to know your bank was solid before depositing your gold there, we had a system so complex no one had any way to know who was going to be next to collapse.

You’re probably saying, “When is he going to get back to addiction?” Well, now. This economic mess we’ve gotten ourselves into has been called “addiction to credit” in the media and they aren’t that far off. There are parallels. In addiction we have forgotten the source of what we have. We are running from fix to fix trying to keep a faulty system afloat. Rewards are derivatives of the underlying source rather than being the source themselves. We never know when or where the next collapse will be. And what is recovery in this metaphor? Recovery is getting back to basics. It’s remembering that the capital of life is built on sacrifice and saving. It’s a simplification where the overly complex machinations and rationalizations of the mind are put to rest and the body lives in harmony with the universe the way it is. There’s one other way that economics and addiction are alike.

When people talk about going back to gold, those who protect the current system say that it would be a disaster. They say it would cause deflation, a decrease in leverage. Recovery has been talked about in terms of “ego deflation at depth.” It’s a system reset where the imagined greatness of the imaginer is set aside in favor of the reality of the world the way it is. And it’s scary as hell. So when the US Treasury and the US Fed act as if they are scared of getting back to basics, scared to let go of a system so complex that no one understands it and no one can contradict them when they say they do understand it, they are just like the active addict who is hearing a suggestion to stop using and get into recovery. But they’re like a rich addict, one who had enough resources to keep going, one who has enough money to keep buying new friends even when all the old ones are gone. We all hope the addict gets into recovery before he loses everything, but this is not as common an occurrence as we hope.

We all know people with addiction who have caused harm to others, but in this instance, where the complexity invades every fiber of our society, it isn’t a few who will be harmed. And if you think the crisis is over, think again. The too big to fail banks of 2009 are bigger, the leverage on Wall St is bigger, the debt of the country both government and private is bigger. We had a geographic cure, but we didn’t actually manage to get rid of the problem. It came with us. We’ll have another chance soon. I hope we don’t blow it.

Author: AddictionDoctor

Share This Post On

Submit a Comment

Your email address will not be published. Required fields are marked *