Too Much Principal and Not Enough Principle

Wisdom is knowing what to do next; virtue is doing it.

~David Star Jordan

It’s funny how rather complex issues can sometimes become a little more clear by accident. One of the spelling riddles I sometimes come across when I’m writing is the difference between principal and principle. Unlike other words like favourite and favorite, this is not simply a matter of unique international spelling conventions. Principal and principle actually have completely different meanings.

Principal vs. Principle: What’s the Difference?

According to my trusty dictionary, principal can refer to:

1. a school administrator
2. something or someone of first rank or importance
3. capital bearing interest

Principle, on the other hand, is:

1. a fundamental truth, or doctrine on which others are based
2. rules of conduct or ethical behaviour

Who Cares?

I’m sure some of you can already see where I’m going with this. It’s not about spelling trivia. It’s about the global economic pickle we seem to have landed in. The markets have reflected the uncertainties we face by alternately surging and plunging. The last few trading sessions have obviously leaned pretty heavily toward the plunging side. Even the precious metals complex, considered by some to be a safe haven, has been hammered. At one point on Friday gold was down over $100.

These manic-depressive tendencies reflect the uncertainties surrounding the mountains of debt that have been piling up in the Eurozone, the United States, and even China. While China’s massive stimulus programs helped us out of the 2008 economic ditch, there’s growing concern that they may have inadvertently thrown themselves into it along with us. So it seems China may not be able to come to our rescue again.

The recent market gyrations are simply a continuation of the financial crisis that began in 2008. I’ve written quite often about the idea that the root causes of the crisis were never addressed. I am by no means the originator of that assessment. The measures taken in 2008 and 2009 only served to rescue the financial sector with taxpayer money. Now taxpayers are tapped out, governments are tapped out, and we have even more debt on global balance sheets than we did in 2008.

While the problems facing us seem quite complex at times, we can probably boil it all down to 6 simple words: too much principal; not enough principle.

Too Much Principal

Obviously, we are dealing with an unmanageable quantity of “capital bearing interest” worldwide. We are very close to the terminal stages where the interest owing alone is causing many debtors to incur more debt just to pay the interest charges. Forget about the principal. No one seems to be able to comprehend making a ding in that at all. We have put ourselves into survival mode where we are just trying to tread water, buying time (on credit of course) and hoping for a miracle solution.

Creditors do not want to acknowledge that the debt will probably not be repaid, but they don’t want to take the haircuts that go with that reality. It’s time to face the music. It’s unfortunate that we didn’t do it sooner.

One of the major reasons governments and creditors have been reluctant to allow debtors to default is the exponential effects of credit default swaps. If a large financial institution or sovereign nation were to default on its debt, bondholders would suffer, but so would anyone who wrote CDS on those bonds. It’s widely acknowledged that the amount of CDS out there vastly outnumbers the capital in the financial system. In other words, the folks who insured the debt can’t pay up.

We’ve had a few years to figure out a solution to the CDS conundrum. How can we allow failed institutions to default without bringing down the global financial system? Instead of taking a serious stab at curtailing the size and influence of the financial sector, we gave them more money. Exposure to derivatives has reached new highs.  Now the rescuers need rescuing.

Not Enough Principle

It’s not hard to look at the global leadership vacuum and see that one of the major problems confronting us is a lack of principle. I don’t know a single soul who isn’t completely exhausted and/or disgusted by watching the political brinkmanship play out across the globe with progressively poorer results. We seem to be getting better at calling each other names, but worse at addressing the mounting problems that confront all of us.

A second major problem might be a pervasive failure to recognize the fact that some of the principles we’ve embraced over the past few decades may not have been of the highest calibre. Consumerism, growth at any price and short-termism have undermined our economy. We’ve listened to Alan Greenspan, Henry Paulson, and a host of others who are either revered or reviled depending on whom you ask. They have been the alleged champions of free market capitalism.

Now I’m a big fan of capitalism. But the last time I checked, capitalism is supposed to allow for failure. That’s one of the things that makes it great.

We can have a great idea about how to solve a problem or provide a service. We can develop and bring that idea to market. If our idea takes off, we will likely reap financial rewards commensurate with that success. If it doesn’t, we close up shop and go back to the drawing board, hopefully richer in experience, if poorer in cash.

Failure is an essential component of capitalism. It can’t work without it. Unfortunately, the version of capitalism under which we are currently operating is more like Gore Vidal’s idea of “socialism for the rich and capitalism for the poor.”

Who would have thought that a simple spelling puzzle could help define the financial crisis? I realize that defining the problem does not automatically lead to a solution, but it strikes me that reducing principal and redefining principles might be a good place to start.

What do you think?