EC HH Why The Bezzle Matters To The Economy

burning banknotes

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The bezzle, a word coined in the 1950s by a Canadian-American economist, is the temporary gap between the perceived value of a portfolio of assets and its long-term economic value. Economies at times systematically create bezzle, unleashing substantial economic consequences that economists have rarely understood or discussed.

In a famous passage from his book The Great Crash 1929, John Kenneth Galbraith introduced the term bezzle, an important concept that should be far better known among economists than it is. The word is derived from embezzlement, which Galbraith called “the most interesting of crimes.” As he observed:

Alone among the various forms of larceny [embezzlement] has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in—or more precisely not in—the country’s business and banks.

Certain periods, Galbraith further noted, are conducive to the creation of bezzle, and at particular times this inflated sense of value is more likely to be unleashed, giving it a systematic quality:

This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times, people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances, the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression, all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.

Galbraith recognized, in other words, that there could be a temporary difference between the actual economic value of a portfolio of assets and its reported market value, especially during periods of irrational exuberance. When that happens, Galbraith pointed out, “there is a net increase in psychic wealth.” Why? Because the embezzler feels (and is) wealthier, while the original owners of the portfolio do not realize that they are less wealthy. Think, for instance, of the many investors duped out of their retirement savings by Ponzi schemes like that orchestrated by Bernie Madoff.

In such situations, because the collective perceived wealth of the conman and the assets’ original owners exceeds their collective real wealth, for a while the world appears to be a happier (and wealthier) place. As British economist John Kay later explained, “The joy of the bezzle is that two people—each ignorant of the other’s existence and role—can enjoy the same wealth.”

In this sense, the bezzle is created not just by Ponzi schemers, like Madoff, but also in the form of companies—like Enron, for example, or WorldCom—whose accounting frauds result in overvalued assets and excessively high stock valuations. Until the accounting frauds are uncovered, there is a collective increase in psychic wealth as the value of the bezzle rises.

Unfortunately, the bezzle is temporary, Galbraith goes on to observe, and at some point, investors realize that they have been conned and thus are less wealthy than they had assumed. When this happens, perceived wealth decreases until it once again approximates real wealth. The effect of the bezzle, then, is to push total recorded wealth up temporarily before knocking it down to or below its original level. The bezzle collectively feels great at first and can set off higher-than-usual spending until reality sets in, after which it feels terrible and can cause spending to crash.


By itself, this was quite a useful concept, but in the 1990s, the vice-chair of Berkshire Hathaway, Charles Munger, developed it into a far more important and subtle concept. The bezzle doesn’t need embezzlement to work, he pointed out. Anytime the reported market value of an asset or portfolio temporarily exceeds its real economic value (by which he meant the value of future returns on that asset), the economy goes through the same increase in psychic wealth followed by a decrease. As he explained in a 2000 speech,

Galbraith coined the “bezzle” word because he saw that undisclosed embezzlement, per dollar, had a very powerful stimulating effect on spending. After all, the embezzler spends more because he has more income, and his employer spends as before because he doesn’t know any of his assets are gone. But Galbraith did not push his insight on. He was content to stop with being a stimulating gadfly. So I will now try to push Galbraith’s “bezzle” concept on to the next logical level.

Munger went on to illustrate how rising asset prices when they rise faster than rises in the underlying long-term economic value, can contribute to what he now renamed the febezzle—a clumsy word that has never stuck. Munger’s insight was that rising stock or real estate prices can generate income and wealth effects whether or not these rising prices reflect real increases in the earning capacity of these assets, that is to say in their real fundamental values. When they do reflect real increases in wealth, the increase in the investor’s wealth is matched by an increase in the real productive capacity of the economy. There is no false or distorted sense of wealth.

But when asset prices increase for reasons other than real increases in their productive capacity, something very different happens. The overall economy is no better off because there will be no corresponding increase in the productive capacity of that economy. The owner of such assets, however, feels richer—although only temporarily—because over the long term, asset prices eventually converge to a value that represents their real contribution to the production of goods and services.

When the perceived value of assets outpaces their actual economic utility, the psychic wealth of the economy once again rises, and because this rise is not associated with any corresponding rise in real wealth, it is only temporary (though, as Munger noted, this temporary phase can go on for a very long time). The point is that financial markets can create temporary impressions of false wealth very similar to those of Ponzi schemes without any need for an embezzler—a notion, by the way, that economist Hyman Minsky would have quickly recognized as a restatement of the third, Ponzi, stage of his Financial Instability Hypothesis.

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