Can you ‘spark’ a crisis?

As the US Administration and Congress grapple with the budget and debt ceiling impasse, repeated claims are made that further brinkmanship will “spark a global financial crisis”, especially if the US is forced to default on some of its obligations – even briefly. While enough has been said on the US budget process, it’s interesting to see what “sparking a crisis” actually means.

So let’s take this hypothetical event – the US stops paying its bills for a brief period – and first ask ourselves: is it really a “spark” – in itself an inconsequential event, but one which triggers a destructive sequence – or a real, objective catastrophe? And once we know that, what does it teach us about the global financial system and its current state?

I would claim that those who talked about “sparking a crisis” have unwittingly used a correct metaphor – a brief US default is really a spark, and not a catastrophe.

To see it clearly, it helps to abstract ourselves from the complexities of today’s financial system, with its markets, securities, bonds, derivatives, interests, treasuries, liquidity and other financial terms. Important as these things are, they only exist with one, and only one purpose: to help us move real, physical resources around, in a more efficient way. If at any point, some process cannot be understood or evaluated except in complicated financial terms, we must be doing something wrong.

For example, you can say there was a “liquidity crisis” in certain country at some point in time. You can also say, “it was very hard to get a loan” instead. But even more basically, you can say, “there was not enough resources to start new projects, so resources had to be pulled from existing ones”. This will describe the situation just as well, and will be true even if there were no money at all and people used barter economy.

So first thing to note about this potential US default is that no physical wealth is destroyed. Some people indeed do not get paid, and this is bad, but it does not destroy wealth in general, it just transfers it – in this case, from people who should have been paid to those who should have paid them.

Wealth is generally hard to destroy – whatever you may hear from a TV screen every time the market crashes. Wealth is the things we have – cars, roads, buildings, technology, land, resources. An example of wealth being destroyed is the Fukushima disaster in Japan. It took a tsunami to do this scale of damage, and even from that the country and the world have recovered.

There is no way that changes to distribution of green pieces of paper or numbers inside really big computers can (or should) result in “wealth destruction”, or “cost the economy billions” or other such things. They can ruin many people financially, while making some other people rich. They can create huge injustices and imbalances. They can draw resources from one sector to another, and make resource use less efficient. But they cannot magically “break” the economy.

Unless, of course, that economy is already broken, and the changes in question are just… a spark.

This distinction is crucial. Whether we see the US default as a spark or a real problem will dictate what we do about it. If it is a real problem, we should avoid it at all costs. If it is just a spark, we should deal with the powder keg it can potentially set off. Because even if we deal with this potential “spark”, there will be another spark, and another, until it finally blows up.

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