It has been a busy past few weeks, I am a little behind on my writing. Yesterday afternoon I cracked open Ray Kurzweil’s new book “How to Create a Mind.” As expected, it is full of absolutely brilliant and well articulated writing. A blog post for that book is upcoming, so I wanted to clear this long overdue one out of my brain first.
About Borrowing
Debt — it is the ability to consume, at once, something that should take an individual a far greater time period to reach the ability to consume. Debt can be assumed by transferring another individual’s wealth or through thin air, aka fractional reserve lending (functionally we should consider fractional reserve lending as involuntary lending on behalf of all participants in a specified monetary system.)
Because of the nature of debt, and the ability to spend something one really does not have, it creates some very unique economic behaviors. Namely, it allows for over consumption.
Value Inflation
This has a very direct impact on online advertising. As an example, a consumer whose liquid purchasing power may be $75 suddenly jumps to $25,000. What does that mean? The baseline value of what should be marginal inventory suddenly moves up to a more premium level. In some instances, that premium level exceeds the value of a well off consumer.
The specific market I am thinking of here is for profit education leads. A consumer with almost nothing to their name suddenly is capable of purchasing a product worth tens of thousands of dollars.
Wipe the drool off your face, as the market based nature of the online advertising (and the relationship requirements with the schools) doesn’t leave much low hanging fruit. However, web site publishers in general benefit from advertisers targeting $100+ CPAs from their otherwise “broke” visitors.
Market Distortions
There is a big downside to this. A consumer’s ability to take on this debt saps their ability to spend in the future. The nature of interest means they will have less than they borrowed to spend in the future. Disturbingly, many consumers don’t understand this. When taking in to account interest, late payments, and penalties, $10,000 of debt can easily triple or quadruple. That means a consumer who purchases something expensive today will be purchasing much, much less in the future.
Before for profit education, online mortgage leads filled a similar niche. Consumers were buying something very expensive. Much like for profit education, it was in hopes that they would make even more money in the future. Unlike for profit education, mortgage incurred debt may be discharged in bankruptcy.
Whether it is content farms or complex incentivized offer schemes, debt driven consumption adds fuel to online advertising growth. While this increases revenues in the short term, as consumers are drained, in the long term it should reduce revenue from that segment.
Shouldn’t the money just flow right back?
One of the assumptions in government policy that both allows and encourages reckless borrowing is the belief that the money simply flows in a virtuous circle.
During the cycle of spending, the $10,000 a consumer borrowed went to multiple people. A big chunk went to an ad network — say Google, some went to a lead aggregator, a big chunk went to the for profit school, another chunk went to the faculty, some to vendors, and so on.
This money should simply just flow back through the economy. In practice, it does, but not “simply.” In a global economy it could take a very long time for $1 you spent in the United States to return back to you.
However, there is a bigger problem:
Debt Distortions Create Waste
Economic activity is generally divided in to three areas – consumption and investment and savings. If I consume, I use something. If I invest, I “consume” resources in such a way that should return its value to me, and more, in the future. If I save, I sit on the money, or assets, preventing anyone from consuming them.
These words are tossed around loosely. I believe that many things that are being classified as savings and investment are in fact consumption. That is, they are the destruction of value rather than the creation of it.
If I, a saver, “invest” my money by lending it to a borrower with minimal income who purchases a vastly overpriced home, and that borrower goes bankrupt, did I really invest my money, or did I simply transfer it for consumption?
As money “saved” in a bank account is “invested” by the bank, we must question the nature of “savings” as well.
What if I knew with certainty that the borrower is simply consuming what I give them, immediately, and their ability to pay me back is based on borrowing more money from other people?
The nature of fractional reserve lending allows debt-driven consumption beneficiaries to use debt on their own to leverage themselves in to a larger market position. Competitive capitalism often means if a company doesn’t use large amounts of debt they can not even become a meaningful market participant.
This was demonstrated spectacularly when the mortgage market went bust. Investment banks in particular used huge amounts of leverage to magnify their profits. Without that leverage, they would have been a fraction of the size.
As such, debt impacts all participants. Investors allocate assets, owned or borrowed. Employees redirect their careers and skill sets. Web site publishers shift their resources to emphasize areas that the debt driven cash flows to. Then, when the bubble deflates, many participants find they have over-allocated themselves to an area worth much less. In some cases, participants whose leverage demanded continued market growth simply go bankrupt.
Proceed With Caution
By treating debt as gasoline, market participants can use it to extract value for themselves without risking their own solvency.
When one market or another ends, it creates new pockets of opportunity online. When a group of strong inventory bidders exit, suddenly a different business model suddenly may become profitable for that particular segment or channel.
As such, I do not view boom or bust cycles as “all in” or “out.” Rather, they provide opportunities to re-calibrate or pivot your existing businesses.
The nature of excessive debt is certainly not a virtue. Perhaps much of the most brazen, and possibly irreversible, damage to the earth’s ecosystem can be attributed to rapid and consequently careless industrialization driven by government subsidized debt. From this party of gluttons little but trash heaps will remain. Without the fuel of debt, industrialization would occur in a slower manner, allowing for more thoughtful planning both by the builder and environmental regulators. (Anyone who has lived in a condominium or home built during the last real estate boom can attest to the shoddy craftsmanship which occurred, though it was not universal.)
As cautious participants, we should view debt driven markets as a tool to re-allocate wealth to that which create long term value. The hyper deflationary nature of information technology leads me to believe that a future of sustainable consumption, which does not require destructive debt, is very possible.
