Dear Winnipeg

Dear Winnipeg,

I’ve been meaning to write about this ever since I read a really interesting article this summer by author/journalist Cory Doctorow about Uber’s financial statements, predicting the eventual inevitable demise of the company, because, as the author states, “every bezzle ends”. It had me asking myself the obvious question, what the heck is a bezzle?

Although it sounds like a pizza seasoning, bezzle is actually a word coined by Canadian-American economist John Kenneth Gailbraith in his 1955 book about the 1929 stock market crash. It’s derived from the word embezzlement, which he thought was “the most interesting of crimes”.

You see, with embezzlement, unlike most other types of theft, there’s a delay between the time the crime takes place, and the time the victim discovers the crime. Because of this, there’s a period of time where the total amount of money thought to exist, what Gailbraith calls “psychic wealth”, is higher than the total amount of money that actually exists (“real wealth”).

For example, let’s say you have $100, and a fraudster has none. There is a total of $100 of real wealth in the system. Once the fraudster has stolen your money, but before you discover it’s gone, the fraudster now has $100 (and knows it), and you still think you have $100. So both of you are going about your lives thinking, and acting, like you each have $100. The total amount of money thought to exist, the total “psychic wealth” is now $200, even though the actual “real wealth” is still $100.

That extra $100 is called bezzle. Fake money that is thought to exist, but actually doesn’t. Because eventually, every bezzle ends. Eventually, you discover the fraud, you realize that you actually don’t have the $100 anymore, and the psychic wealth returns to match the $100 of real wealth. But of course, money (fake or real) can’t just disappear without someone feeling the pain of it… in this case, you. This is important to remember: when bezzle ends, someone always pays.

So what does this have to do with city finances?

Well, hold on to your shizzle my dizzle, because this is where it gets interesting.

While Gailbraith invented the concept of bezzle to describe fraudulent activities, like embezzlement and Ponzi schemes, it wasn’t until the 1990s that Charlie Munger, aka Warren Buffett’s business partner at Berkshire Hathaway, expanded the concept to apply to stock markets and the wider economy. He explained that fraud wasn’t even necessary to create bezzle, that it could be created in the wider economy whenever asset prices rose higher than the real earning capacity of those assets. In other words, whenever stock or real estate prices rise higher than what they’re really “worth”, bezzle is created. We call these stock bubbles, or real estate bubbles, or asset bubbles, but in all cases, it has the same effect: people feel richer temporarily, so they spend and borrow as though they actually are richer. But because every bubble bursts, every bezzle ends, eventually someone gets stuck with the bill, driving home the realization that the added perceived wealth wasn’t real at all.

But it goes even further than that. Because all that bezzle-fuelled additional spending tends to boost GDP, the artificially bezzle-boosted GDP can lead to the creation of more bezzle, which pushes GDP up even further, continuing up in a self-reinforcing cycle.

But every bezzle ends. Sometimes quickly, in a blazing financial crisis that forces individual asset owners to take huge losses personally, stuck with high levels of debt and no assets to cover them. Sometimes slowly, like with government bailouts of large banks, where the loss is amortized slowly over many years and paid for by taxpayers, directly through taxes, or indirectly through inflation, recession and unemployment. Sounding familiar? Someone always pays, and usually, it’s us.

As Michael Pettis puts it:

“Unfortunately, the history of bezzle suggests that, while ordinary households and workers absorb few of the benefits from the creation of bezzle, they tend to absorb most of the costs of its reversal: it is probably not just a coincidence that periods in which large amounts of bezzle are created and then destroyed seem almost always to experience rising income inequality.”

— Michael Pettis, Professor of finance at Guanghua School of Management at Peking University in Beijing

How does this apply to cities? Patience, we’re getting there.

We’ve seen how bezzle applies to fraud, and we’ve seen how it applies to asset bubbles. But Michael Pettis goes on to describe a third variation on bezzle, which he says “in some cases can be by far the largest source of bezzle in an economy”. And he calls that source “Bridges to Nowhere”.

Examples he cites are Japan’s literal bridges to nowhere, as well as China’s economy, which he claims as much as half the GDP growth in recent years may be due to bezzle creation. As he explains it, any time a government builds any kind of infrastructure, from roads to bridges to factories, that doesn’t have enough real economic growth to support it, then you have created bezzle. And every bezzle ends.

It doesn’t take a huge leap to see how that applies to cities in North America, but let’s connect that final dot:

“Most American cities find themselves caught in the Growth Ponzi Scheme. We experience a modest, short-term illusion of wealth in exchange for enormous, long-term liabilities. We deprive our communities of prosperity, overload our families with debt, and become trapped in a spiral of decline.”

— Charles Marohn, Strong Towns

“Ponzi scheme”, “illusion of wealth”, “spiral of decline”. Chuck Marohn is describing the prevailing North American development pattern since WWII, but these words also describe exactly the stages of bezzle creation, of temporary increases in psychic wealth, and the end of that bezzle.

And every bezzle ends. Always.

Unfortunately, most people, including politicians and media, are not accountants and economists. That may seem obvious, but here’s why it’s important. Most people intuitively understand the City’s operating budget (or income statement)… revenue minus expenses equals net surplus. Easy. It’s why the focus of most city finance discussions is around the operating budget.

But bezzle isn’t created in the operating budget. It’s created in the capital budget (or balance sheet) by our infrastructure choices. And ours have been akin to a Ponzi scheme, our own version of “bridges to nowhere”.

I’ve written about it before, but it’s critical for all of us to understand that the money for capital budgets comes from operating budgets from other years, and that every capital dollar spent, or given by the Province or the Feds, or donated by developers in kind, commits the City to spending additional operating dollars in the future. It’s important so we can see whether we’re creating real wealth over time, or just bezzle. Because when bezzle ends, we are the ones who pay.

It’s why business investors look for a “healthy balance sheet”, and not a “healthy income statement”. You can have decades of consecutive balanced/surplus operating budgets, and still get poorer, if you’ve been creating bezzle instead of creating real wealth.

And it’s obvious by our own City’s balance sheet which one we’ve been doing.

It’s also why what we’re facing today, and what we’ll face in the future, is already baked in from our past infrastructure choices. Today is just yesterday’s future. We can’t undo those choices, but the sooner we adopt a more productive way forward, the better off we’ll be. As always with bezzle, the larger the bubble gets, the harsher it will feel when it pops.

We can ask ourselves, why is there no money to fix the potholes, maintain our rec centres, keep libraries open, invest in transit, care for trees? Where did it all go? The answer is, while we could have been creating real wealth over the past several decades, instead we’ve just been creating bezzle.

And every bezzle ends. The only thing left to see is how harsh we let the correction be.

Love,

Elmwood Guy