Ch 7 Corporate Write-downs
This brings us to banking and corporate write-downs of real estate and other financial assets. These write-downs have off-set inflation by tens of trillions of dollars. The economy is said to have lost up to $17 trillion in ‘paper value’ in this last ‘recession.’ Having the gov’t replace this is something of an off-set against what was lost. In a sense, we are replacing this same amount of lost ‘money.’ Bailouts basically replaced those losses back in the economy back to its original level. If the gov’t replaced this $17 trillion in lost paper value with $17 trillion in new debt, it would be something of ‘a wash.’
(It’s not an exact inflation off-set, but write-off against new debt has some parity that has not been accounted for by most inflation reviews. That parity depends upon where the capital was directed – debt replacement vs. spending etc, as outlined below)
The banking bailout was an example of replacing lost ‘paper value’ against new debt. Both Democrats and Republicans voted for and complained against it so they are both right and wrong depending upon which step of the process they acted.
Ch 8 Deflation Financing
There is an additional side to these financial write-downs. Refinancing old debt with new debt can have a neutral or even a deflationary impact. Much of the ‘new debt’ is often refinancing old debt. In such cases, no new money was added to the economy and so is inflation neutral. It’s like taking $100,000 home mortgage and refinancing it for that same $100,000, but at cheaper interest rate. This is true of all debt of equal value or type as explained shortly.
Short Term, for Long Term Debt
Some refinancing is deflationary. Refinancing short term debt with long term debt would be an example of this. Swapping short term for long term debt taps the ‘time value of money.’ Much of the Quantitative Easing by the Federal Reserve was often refinancing short term gov’t or Wall Street debt into long term bonds. This saved money as short term notes were converted over into long term bonds. This refinancing is deflationary as long as the interest rate is below the rate of inflation (as we have today). This has a powerful deflationary impact. This is multiplied by time. We see this of the last half decade since the crisis began. The last 5 years has stabilized a cross section of industries with each showing growing value. These returns have injected new layers of equity into all this debt and so serve as examples to the time value of money.
Every 3% interest rate hike doubles the cost of a 30 year home mortgage. This works in reverse as well. Reducing interest rates by this same 3% reduces finance charges. It cuts the over-all cost of the home by a whooping 50%. Interest rates on refinanced ‘sub-prime’ mortgages were dropped by 4% to 6% or more (ex: 9% refinanced down to 3%). This in effect reduced the cost of the home by a whole two thirds from that of the higher interest rate. The US has done this for tens of millions of homes and businesses. We are reaching the end of these gains as most short term or high interest debt has already been refinanced into ‘deflation financing.’
There is still one other value to be gained in switching from short term over to long term debt. It’s one of stability. Leaving the question who is going to refinance a bill coming due can spook markets or imploded entire economies during a financial crisis. We had the Fed stepped in and remove much of this instability by refinance trillions in new bonds. Without them, the US would have likely tanked.
Democrats were on the money in demanding a complete refinancing of home mortgages as well as small businesses and student loans. Republicans dropped the ball on this one.