Public and private debt

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By FERNANDO NOGUEIRA DA COSTA*

Placing public debt securities with very high real interest rates to avoid capital flight and dollarization causes serious concentration of financial wealth

A capitalist system is defined, under given conditions of productive forces, by the hiring of labor power by money capital, being genetically a financial system. Therefore, abstracting financial institutions, as the pure theory of mainstream, does not result in adequate applied theory to make good practical decisions. So orthodox economics is not a theory of optimal decisions!

There was a binary subdivision of macrofinancial regimes. Initially, a self-financing or equity-based economy prevailed; later, an economy based on debt or with financial coverage began to predominate.

However, a third element included makes it possible to get closer to the reality of global financial capitalism, in a typology of three financial subsystems: (i) Germanic model: based on private credit; (ii) North American model: based on capital markets; (iii) rest of the world model: mixes both with public credit.

This 3rd. dimension highlights the importance of different markets in the transfer of resources between economic agents. It mixes subsystems based on capital markets and subsystems based on debt.

Another qualification refers to the way in which prices are set in these markets. These can be competitive prices, prices dominated by private institutions or prices set by the government.

In countries with late financial capitalism, to make up for the economic delay, the State assumes an active role in the financing system. A conflict of interest arises.

On the one hand, the neoliberals defend the government to give priority only to the control of monetary aggregates, the fixing of the basic interest rate or the non-interference of the government in the allocation of resources among competing users. On the other hand, social-developmentalists consider appropriate the pursuit of a growth acceleration plan with goals to be achieved by direct quantitative administration or by manipulation of market conditions. Neoliberals would opt for the inertia of the free market over this activism criticized for being a “politics of winners”.

In relation to the original English industrialization, in German late capitalism, within a financial system based on private credit, there was a dominant state institution and political negotiation in the processes of change. In late XNUMXth-century North American capitalism, the Union deployed its army to the genocide of native Indians and conquest of the West, while the federal states built the infrastructure. At the turn of the century, during the era of the robber barons (concentration in trusts and cartels), a transition based on the capital market with competitively determined prices began, due to the entrepreneurial conduct of the process.

In the other historical experiences of late capitalism, financial systems based on credit and administered prices were mixed with the state conduction of this process. States and banks played a decisive role in trying to close the historic gap.

A capitalist economy is described by Hyman Minsky as a set of interrelated balance sheets and income statements. Assets on a balance sheet are financial or real (new or used), held to generate income streams, sold when liquidity is needed, or offered as collateral for loans. Liabilities represent a prior commitment to make cash payments, on a predetermined date or when some contingency occurs.

Assets and liabilities are carried in the unit of account, that is, in the national currency. The excess of the value of assets over the value of liabilities is accounted for as nominal equity.

All economic agents, grouped into institutional subsystems such as households, non-financial corporations, banks, governments and the rest of the world, have balance sheets. They take positions in assets by issuing liabilities such as debt, providing collateral for creditor protection.

A safety margin is the excess income expected to be generated by ownership of assets over promised payment commitments, due to liabilities capable of providing greater economies of scale. This financial leverage is a “cash flow” cushion: the difference between incoming and outgoing cash flow.

For banks, inflows are interest received on loan and bond portfolios, plus bank fee income, while outflows are interest paid on liabilities plus the costs of running a bank: wages, rents, information technology, ATMs. etc. They operate with a safety margin through their Allowance for Loan Losses (PCLD) and their Shareholders' Equity (capital plus reserves).

The greater the value of assets relative to liabilities, the more equity is required as a buffer. This equity and reserves constitute an inventory “cushion”. In the event of a revenue deficit in view of its liability commitments, the bank sells assets to meet payments.

Another “cushion” is the liquidity of the position, known as the “liquidity cushion”. If liquid assets can be sold or redeemed quickly, or pledged as collateral in a refinance, the margin of safety is greater.

In reality, these three types of protections can be important in protecting any institution, be it financial, non-financial business, domestic or government. If the time duration (maturity) of assets exceeds that of liabilities, for any subsystem, positions must be continually refinanced on account of liabilities falling due before assets mature.

For example, there are real estate loans granted for amortization over thirty years recorded in assets, backed by savings deposits as collateral in liabilities, which can be withdrawn immediately. They have to be continuously picked up or “rolled”.

The dynamic of a general sell-off is to drive asset prices down in the so-called debt deflation process. The more widespread the pressure to sell, the greater the deflationary pressure on asset prices.

Hence, the “equity inventory cushion” (capable of absorbing losses) and the “liquidity cushion” (capable of postponing “urgent sales”) are important if the “cash flow cushion” is eroded. In a contagion effect, if many institutions are trying to sell the same assets, in this crisis, banks refuse to provide more refinancing.

In this case, Central Bank interventions are needed to protect systemically important banks by temporarily providing funding through loan-of-last-resort facilities. Only the government – ​​the Central Bank plus the National Treasury – can buy or lend against limitless assets, providing an elastic supply of “high-powered money”.

Banks are “special” because they operate with very high leverage ratios. Their asset positions are “refunded” charges. With a speculative stance, they issue liabilities while buying assets. These liabilities become “customer money”.

With an illiquid position, they intentionally place themselves in the position of continuous need for refinancing, that is, they specialize in funding. They require this continual refinancing on favorable terms because the interest rate they receive on their loan and bond portfolios is fixed – and they cannot easily sell assets.

In the United States, rather than commercial banks, investment banks, using the capital markets, have specialized in placing stocks or direct debt securities in their portfolios. They typically rely on income from changes in the market value of these assets rather than receiving interest as credit income.

If capital markets enter a systemic crisis, they can become trapped in assets that are impossible to sell at asking prices. Some will need access to refinance their stocks and bonds. Others will decide between holding, earning income (dividends paid on shares), or trading assets on their own for capital gains. They may also trade on behalf of clients.

Both the “capital market economy” and the “debt economy” are possible alternatives for late capitalist development, while the exclusive model of private commercial banks is related to the previous industrial transformation after the original English industrialization. The Brazilian economy has incompletely developed features of the three models of term financing: weak capital market, incipient private credit and insufficient public credit.

Placing public debt securities with very high real interest rates to avoid capital flight and dollarization to the Argentina. It causes serious concentration of financial wealth.

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP).


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