Saturday, February 7, 2015

Lessons from the Great Galactic Depression

A long time ago, in a galaxy far far away, there were two planets orbiting a star, not unlike our own sun.  The inhabitants of these planets share a common ancestry but, over the years, they have developed somewhat different temperaments. 

The names of these planets are difficult to pronounce in English, but we will call them Nordus and Sudus. The name of their star is Sol.

Nordus, being further away from Sol, has a colder climate than Sudus and its inhabitants are known to be frugal and patient. The Sudusians, in contrast, live for the moment. Using the language of economics, earth people would say that the Sudusians have a higher rate of time preference. 

For many centuries, the Nordusians and the Sudusians were often at war. But in recent years, the development of a new and dangerous weapon, the Death Star, has made war infinitely more risky. Some fifty Sols ago, the political elites of the Solarian system, realizing the danger of mutual destruction, entered into an economic and monetary union. 

At the inception of the union, each planet abandoned its own monetary unit and a new Solarian Central Bank (SCB) was created; its President is a wise Solarian by the name of Obi-Mar Draghobi. Under Obi-Mar's guidance, the SCB issued a new currency, the Solo, which takes the form of little pieces of colored plastic called Solarian credits, or screds.

The Solarian social structure is composed of dynastic families who accumulate wealth and pass it down to their children. This system is fairly stable but dynasties do not last forever. Sometimes, a Solarian family produces a "bad wookie"  who squanders the family fortune. And often children quarrel with their parents and are disinherited. As a consequence, there is constant regeneration of dynasties and a dynastic wealth distribution that depends on dynastic age and dynastic time preference.

The governments of Nordus and Sudus sometimes engage in infrastructure projects that benefit not only current generations of Solarian citizens, but also generations yet to come. A good example is the investment by the Nordusians in Warp drive technology to enhance trade with neighboring star systems. 

Solarian economists are an advanced lot who agree about most things; the Solarians call them "dentists". When the Nordusian government embarked upon the Warp program, it consulted with the Solarian Association of Dentists (SAD) who recommended that Warp investment be funded not just from current taxes, but also from Nordusian government bonds. Since the benefits of the Warp drive are very long-lived, the initial investment was paid for by issuing 3% consols. These are scred-denominated claims to a flow of 3% of the principal in perpetuity.

The Sudusian government, like its Nordusian neighbors, also issues consols. But the profligacy of the Sudusians is legendary and the citizens of Solaria, both Nordusians and Sudusians, are unwilling to buy Sudusian consols at 3%. Instead, they require a 2% default premium to reflect the considerable possibility that a future Sudusian government may decide to default on its debt. Since much of the debt has been used to finance transfers to Sudusian pensioners, and, some say, star cruisers for the Sudusian political classes, the probability of default is only too real.

On setting up the Solarian Central Bank, SAD dentists were once again consulted. They pointed out that screds are costless to produce and they have value solely because of their use in exchange. Because scred creation is costless, the SCB, as the monopoly provider of screds, can create wealth. But how is that wealth to be distributed?

The founders of the Solarian union were far sighted and wise. They created a rule that distributes the benefits of scred creation back to the citizens of Nordus and Sudus in proportion to the number of citizens of each planet. Since there are approximately equal numbers of people on each planet, in practice, the Nordusian and Sudusian peoples receive equal shares of seigniorage revenues created by the SCB.

These revenues are of three kinds.  First, there was the creation of sc1 trillion at the inception of the union. Second, there is the ongoing flow from the creation of new screds to meet the need for liquidity as the Solarian economy grows. And third, there is the flow of revenues generated by the interest payments on the asset holdings of the SCB.

At its inception, the SCB needed a way to introduce screds into circulation. Following a recommendation by the Solarian Dental Council, the SCB purchased sc1 trillion of consols split equally between Nordusian and Sudusian bonds. And every twelfthsol, the SCB purchases a further basket of consols, equally weighted, between Nordus and Sudus. The exact amount purchased depends on economic conditions in the Galactic Empire; but there has not been a single twelfthsol since the inception of the SCB, when the Bank did not purchase at least some consols in the financial markets.

The Nordusian government pays 3% interest every Sol to the SCB and, under its charter of incorporation, the SCB turns around and pays those revenues right back to the Nordusian Treasury. Similarly, the Sudusian government pays 5% (3% plus the default premium) every Sol to the SCB which the SCB returns to the Sudusian Treasury.  

The situation I have described worked like a charm for more than fifty Sols, from the inception of the union in Sol MMCX through to the onset of the Great Solarian Depression in Sol MMCLX. The history of this episode is well known so I will be brief. 

During the Protracted Expansion that lasted for almost twenty five Sols, the Nordusian banks invested heavily in foreign bonds issued to fund res-pod construction at the Galactic Center. As pod prices escalated there was an unsustainable wave of new pod development that ended in disaster with the bankruptcy of the Jabba Brothers bank in Sol MMCLII. As we all know, the collapse of Jabba Brothers caused the entire galactic economy to spiral into a deep depression.

The Galactic Depression had profound effects for the Solarian economy and the Sudusian government defaulted on its debt. Much of this debt had been held by Nordusian banks. Although the default caused consternation for Nordusian shareholders, the Solarian Association of Dentists pointed out, correctly in my view, that the Nordusians should not have been too surprised. They had, after all, been earning a premium of 2% on their investments in Sudusian bonds for more than ten Sols. 

Some Sudusian dentists reminded the Nordusians that, after all, they had themselves defaulted on bonds issued to fund the last Galactic War and as one charismatic Sudusian Politician put it; "what's sauce for the hoska is sauce for the hosko".

And of course, Obi-Mar Draghobi's masterful handling of SCB affairs is by now the stuff of vidtexts. His successful negotiation with the Nordusian Chancellor, and former Princess, Queen Anga-Leia over the funding of future scred creation is widely credited with saving the Solarian union and heading off another Galactic war. 

The Nordusians argued that, since the Sudusians had defaulted on their debt, the SCB should be banned from future purchases of Sudusian consols. Obi-Mar Draghobi pointed out, that the financial markets had long since capitalized the default probability of existing bonds and that nobody should be surprised when the inevitable finally happened. Excluding Sudus from the benefits of future scred creation, that was by then running at approximately sc60 billion a twelthsol, would be an unfair penalty to Sudusian taxpayers and could easily kindle a resurgence of the rebel alliance.

Initially, Queen Anga-Leia listened to her finance minister Darth Scheudius, who argued that the Sudusian default had put the Nordusian taxpayer on the hook and the Sudusian's should be made to repay the full amount. Obi-Mar Draghobi pointed out that the purchase of Sudusian consols was a once and for all transfer and that the debt to the SCB was never expected to be repaid. 

The rest as they say, is history. The Sudusian Treasury re-entered the capital markets after a short delay and a considerable shakeup of its political elite. It is to be hoped that the new Sudusian finance minister, Hanis Soloufakis, will manage to pull off the considerable reforms that will be required if the union is to survive a potential future Galactic crisis.


  1. Obi-Mar

    Well done, Roger Lucas.

  2. But it's sci-fi. It didn't happen. Princess Anga-Leia is still revered in Nordusia for the way she stood firm to the Sudusians. Nobody blames her for the inexplicable collapse of the planetary economy. Nordusians fervently hope that with enough strong will, Nordusia will be rebuit within a few hundred sols.

  3. Fiction should be used when it makes things more understandable. This would be shorter and easier to digest as an essay with no fictitious countries, terminology, or asides, and an opening paragraph explaining what it's going to be about that would orient the reader.

    1. I think that would ruin the literary effect. If you don't understand that all of the actors correspond to real live people, nations, and institutions in Euro zone, this is not the post for you. It was clearly written for a well-informed audience.

    2. @Ben Wheeler "Step Forward Padawan. Benakin Skywheeler, by the right of the Solarian Aassociation of Dentists... By the will of the Force, dub thee I do... Jedi ... Knight of the Republic"

  4. Perhaps you should read my own epic story, before conferring jedi status on me!

  5. What a great just so story. It really explains why we live in a spiral galaxy. It dates back to the great debt spiral.

    (I'm being ingenuous here. Is there an emoticon I should be using?)


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