Wednesday, November 19, 2008

Economic Capacitance

Of late, the flavor of financial news has shifted. Much less is there a focus on the shenanigans of Washington and Wall Street, and much more we see reports of job loses, downsizing, and lowered expectations in the retail and manufacturing sector. The collapse of Circuit City, and the pleas by the big three automakers for bailout money, are recent examples that come to mind.

This blog attends to the supply of base money and credit, trends in general prices, and the relationship between the three. The strife that comes of failing financial policy I’ll leave to other sources. But personal case examples I see have started to accumulate over the past month or two.

So, the subject brings up a concept I’d like to introduce: "economic capacitance." Capacitors I know from the physics of electrical circuits—where stores of electricity build between two parallel plates, such that when the energy supply is turned off the capacitor will discharge and continue to power the circuit until exhausted. Economic capacitance behaves similarly, and refers to stored wealth, like savings accounts. In coming posts I will use it to conceptualize the timing of deflationary downtrends.

Prices are, and should be, whatever the seller decides to charge. If underpriced, then inventory will fly off the shelves and be consumed or resold at a profit. If overpriced, inventory will move slowly and accumulate. To reduce prices of a given investment below what was paid, the asset holder must concede a loss. The other option is to cling to an unprofitable business or investment practice hoping for a turnaround.

Economic capacitance will refer to the ability of an economy— personal, government, business, or otherwise—to persist under adverse financial circumstances before collapsing in bankruptcy and foreclosure. It is the ability to withstand negative cash flows and relates to the amount of savings one has, assets one can sell, and the amount of credit they can borrow. It reflects the duration one can persevere with a negative cash flow.

There has been a tendency over the past few years to put a positive spin on one’s financial status—until overnight suddenly a business is bankrupt. It began with the fall of Enron, and we saw it with Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, AIG, Washington Mutual, and Wachovia. The factors that comprise economic capacitance are all private matters that nobody wants to share. Capacitance allows an unprofitable system to appear well until the point of total collapse.

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