The Importance of Writing
Some thoughts on thinking
If one day I find that there’s some fundamental flaw with the One Lesson which I hadn’t considered, I’ll see if there’s a way to recover something valuable from the wreckage, but like Edison being content when he discovered yet another new way not to make an electric light bulb, I’ll be content that I’ve learned a new way not to do economics.
Having said that, after years of thinking this way, I’m confident of the approach. It’s just a simple description of how balance sheets change in response to people’s actions (and natural events e.g. an apple rotting). Part of what gives me that confidence is that I constantly test it when I hear an opposing argument, learn something new, or get involved in a discussion. For example, I used it to help me to understand the excellent book An Accounting Model of the UK Exchequer – 2nd edition — a topic I knew very little about before, but which was easy to understand when I translated what I was reading about government finances into changes in different people’s raw net worths1. Interestingly, the One Lesson led me to some different conclusions from the book.
Writing this substack is another way of testing my understanding. When you write, you have to try to order your thoughts in a way which lets you communicate ideas which aren’t completely structured, and that can sometimes show you that you haven’t understood something quite as well as you thought. Or perhaps just that you need to rethink how to express something. Jordan Peterson, a Canadian clinical psychologist and author2, often says that writing is an important part of thinking, and from my experience with this substack, I have to agree.
(Raw) net worth
When I first tried to write a book about the One Lesson, a few years ago, I didn’t have as good a way to talk about debts. For someone who isn’t owed anything and doesn’t owe anything, I thought of what they own as a bucket of tangible assets. But once they start owing debts, I thought I had to switch to giving everything a money value, because it hadn’t occurred to me that I could just subtract one type of thing from another.
I’m not quite sure why it didn’t occur to me at the time. It’s a relatively simple idea from maths: vector arithmetic. But it didn’t, and I had to come up with explanations which I wasn’t happy with, such as why a pen might suddenly become “worth” more because it had been owned by a celebrity.
Once I thought of the idea of adding and subtracting different types of thing, I didn’t have to make the same sorts of assumption. If Alice has a pen, and sells it to Henry Cavill, it’s still the same pen, even though Bob might be prepared to pay more for it now that it’s belonged to Superman.
I still used the term “net worth” for assets minus liabilities. But a couple of years ago, I realised that everyone assumed I meant the money value of the assets minus the money value of the liabilities. That’s when I added the word “raw”, to show I meant adding and subtracting the assets and liabilities themselves, rather than some money value which someone had assigned to them. It’s a bit of a clumsy term, but on balance I think it’s better to signal to readers that I mean something slightly different from what they’re used to.
Saving
At the moment, I’m trying to explain saving, and that’s forcing me to think harder about it. The main idea I’m trying to explore is what actually counts as someone’s savings. If you keep a spare lightbulb at home, so that you can immediately replace one which breaks, it makes sense to count that as part of your savings. If you have an IOU for a bulb from a shop, it’s also reasonable to count that as part of your savings — as long as the shop has enough bulbs of the right kind to pay all of the IOUs it’s written, just in case everyone’s bulbs break at the same time.
There are lots of other things which look like savings. But it seems to me that there’s a big difference between an IOU where the debtor has a stock of everything they owe, and an IOU where the debtor has no assets at all. Between those two extremes is where the debtor has enough stock for the number of IOUs which might be brought in for payment, or where it has something which the creditor might accept instead of what they were promised.
If Bob has an apple, and has written Frank an IOU for a banana, does Frank have savings of one apple or one banana? Do we need two different terms e.g. savings-in-theory and savings-in-practice?
Rather than putting ideas which aren’t quite fixed yet into writing, I think for now I’ll move on to another subject, and come back to savings later, once I’ve had some time to think about it more.
Thanks for reading! As always, if there are any topics you’d like me to address, please let me know in the comments.
Someone’s raw net worth (RNW) is what they own plus what they’re owed minus what they owe. It is a “heterogeneous” sum/difference, which just means that things of different types are added and subtracted, not monetary “values” which have been assigned to them.
I tend to spend most of my time on Substack reading Tomas Pueyo's Uncharted Territories. We recently had a conversation about how writing helps thinking: you have to clarify and organise your thoughts to get them into written form. This means you can see them as another person might and gives you a different perspective. If you take a further step and try to teach someone about your writing, then that forces you to translate your thinking into simpler language and again makes your brain think about the issue in a different way. I think for various reasons economic concepts are made to sound very complicated when in fact they are not.
FWIW I will give you my thoughts on value, IOUs and savings*. The financial value of things changes all the time depending on supply and demand. I would argue that in an economic discussion, as Noah also argues, the only true value is the current market value i.e what someone else is prepared to pay at that particular point in time. Any other value is merely a notional value (what we would like to believe something is worth!). The value of a famous pen is higher simply because someone (logically or emotionally) will pay more for it than a standard pen. Ten minutes later it might be posted on social media that the famous person has been charged with rape and demand for (and thus financial value of) the famous pen evaporates. Some people understand this constant change in the value of things through concepts such as wealth creation and wealth destruction.
An IOU is a debt. If I have an IOU for a bulb from a shop then that is an asset, but it is not worth the same as an actual bulb in my possession because of credit risk. In the example you give, the credit risk is probably very low but not zero. If you call in the loan, what are the chances you will get 100% of what you are owed? Credit risk is simply a quantification of trust. Thinking clearly about this exposes a major flaw in our financial system’s balance sheets that has been exposed time and again by reality: if you account for an IOU as an asset, then in theory it should be discounted by some percentage due to credit risk.
If Bob has written Frank an IOU for a banana then clearly he is a debtor and this should appear as a liability on his balance sheet. It should appear on Frank’s balance sheet as an asset, but ideally discounted according to credit risk. I don’t think there is any practical advantage in using the word savings, I would just stick to the concept of assets and liabilities. The word savings implies an accumulation of assets over time, but there is no difference in theory between cash, gold, money in the bank or any other asset such as a pen or a light bulb. They all have advantages and disadvantages as a vehicle for saving that depend on the circumstances at the time. In a realistic world, assets would also be discounted by their loss risk: anything that you legally own can be taken away from you. It is only because we have lived in an age of peace and respect for property rights that some assets seem less risky than they actually are.
Thanks for making me think!
* This will of course help me clarify my thoughts and expose them to challenge. If there is an error of logic pointed out then I can learn from that and adjust my model of reality accordingly (i.e. learn and improve)