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The Tragedy of the Commons

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Last week, in a Minyan Mailbag post, we described the idea that "nothing is free" in relation to the Fed's monetary policies. The 2 year-old easy money policy that the Fed has pursued has real costs: to senior citizens, to laborers, to savers, and, eventually, to everyone via price inflation and a devalued dollar.

I wanted to expand on the concept because it is an economic point that is little understood and has vast and important ramifications: for the economy, for the markets, for Minyans.

In 1968, bioethicist Garrett James Hardin coined the term "tragedy of the commons" to describe the abuse and degradation of "common", or public, property. This abuse results when the property rights of that good are either ill-defined or entirely undefined. As a result, the benefits of that good are separated from the costs of it: the very definition of "free lunch".

To explain the concept of the "tragedy", Hardin famously posited a communal pasture where there are no private property rights to the pasture land. Under this structure, shepherds, because they are interested in maximizing the value of their flock, add more and more of their sheep to the land to graze. Ignoring the detrimental effects of their individual actions on the grass, other shepherds, and the long term value of the land, the shepherds inevitably destroy the pasture, leaving a barren land capable of nourishing none of their sheep.

Hardin sums up what has happened: "Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit-in a world that is limited."

The key economic aspects of the tragedy of the commons are these: ill-defined property rights and a separation of the costs and benefits of an asset. PJ O'Rourke has famously used the public toilet as the perfect example of this: when something becomes free, expect it to be abused, and once that abuse carries to its logical end, expect the productive value of that good to go to zero. Almost no one would choose to use a public toilet over a private one.

The same economic principles apply to credit.

Greenspan has made credit "free" (on a relative basis, of course, though the carry trade is by definition, "free" money). Consumers and businesses are abusing that credit (via the carry-trade, ARMS, mortgage cash-outs, the 1.2 billion revolving credit cards U.S. consumers own, etc.). The "value" of that credit will be decimated.

In a regime of fiat money in the U.S., there is, literally, no "cost" to the creation of money. Fed Governor Bernanke has publicly boasted (11/2002) that the Fed's "printing press" could easily be used as a salvation to any nascent deflationary pressures in the economy. The two key aspects of the tragedy of the commons, the separation of the costs and benefits of a good and the ill-defined property rights, are manifest in the credit creation process. Fiat money costs nothing to create, a minority benefit from it (the spendthrift, mortgage brokers, home sellers, capital equipment suppliers, etc.), while everyone in the economy, in the end, bears the costs via goods price inflation and the declining value of the dollar.

The tragedy of the commons applies to money and credit just as much as it applies to Hardin's contrived grazing land. And a compelling case can be made that credit is, indeed, being abused. The only question that remains, frankly, is when the grass runs out.
No positions in stocks mentioned.

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