Debt Is A Zero Sum Game

Are bonds an asset class? I bet that if I ran a poll amongst financial professionals, 99% of them would instantly answer yes. They would be wrong, however, because the correct answer is concurrently yes and no, meaning that the question itself is incorrect. Blame it all on the double-entry accounting system, so ingrained in peoples' minds ever since it was invented by Luca Pacioli, in 1494. More on that later.

Debt is a zero sum game: one person's liability is another's asset - it all depends on your circumstance, your point of view. If you own debt you consider it an asset, whereas if you owe it you consider it a liability. On an overall net basis, debt cancels out - it cannot exist by itself. The only "real" assets are real estate and ownership of means of production, i.e. equities. Thus, ultimately debt is based on consensual fiduciary trust, backed by ownership of land, stocks and human capital.

What's the use of debt, then? Because it is not equally spread amongst people, debt can be used to selectively leverage ownership and thus the temporary monetary value of real assets. Debt can never exceed the value of real assets, of course, but the rate at which it expands or contracts vs. the value of assets, can. When we expand debt faster than the value of assets we create temporary credit bubbles, which ultimately pop to restore balance.

For the past 15 years, total debt in the United States has been rising significantly faster than the value of stocks or real estate, pointing to the creation of incipient bubble conditions, at least on a localized basis. Globalization has spread out the boundaries of asset ownership and thus the effects of debt, but I for one am not ready to view the global financial system as homogeneously efficient and impartial. There is no global society as of yet, despite pronouncements that The World is Flat.

Data: World Federation of Exchanges, FRB

To close, let's go back to Luca Pacioli, the "father of modern accounting". Why did it take human beings so long to come up with the double-entry system? After all, it was nothing more than a simple logical arithmetic process, and people had been trading goods and keeping accounts for thousands of years before him. Why didn't the Greeks with their superb mathematical skills come up with double-entry - or at least the Romans, with their meticulous bureaucracy?

The answer is simple: they didn't need it - but the Venetians, Milanese, Genovese and Sienese did. By the 15th century the city-states of Italy had become trading giants whose merchants' debts (mostly bills of trade) could be traded as "money" - asset and liability at once. Not surpisingly, then, the oldest bank in the world is Banca Monte dei Paschi di Siena, founded in 1472. We've been wondering about "what is money" ever since, but I think the Sienese bankers had it all figured out a long time ago. They became rich enough to make their city one of the most beautiful in the world.

Santa Maria dei Servi, Siena