The Great Consolidation

One of the more important trends in post-Cold War America is the great consolidation that is going on all areas of life. This past Christmas shopping season, for example, was great for a small number of giant retailers. Amazon certainly had a good shopping season, as well as some giant operators like Walmart. For the small local retailers, Black Friday was not the start of their boom time, but a continuation of a decline that started in the 1990’s and continues unabated.

An adult in 1985 would probably have done business with a dozen different retailers during the season, in order to get the gifts and supplies he needed. He would have gone off to a mall to walk through dozens of shops. He would have hit the bigger retailers, of which there were many. That mall would have had two or three big stores, in addition to many small retail chains. Most people had access to two or three malls, in addition to small retailers operating in older strip malls.

This past Christmas, many people will have done all of their shopping on-line and some of those will have done their business with just one company. You can buy just about everything you want from Amazon. If they are not the direct seller, they are operating as a fulfillment company for others. They also operate storefronts for those who just a few years ago would have had their own web store. Amazon and Walmart are close to owning the entire on-line marketplace in the United States.

Consolidation is, of course, a feature of capitalism. An important thing libertarians always miss is that markets naturally seek to consolidate. No matter what set of rules are agreed upon in the market initially, dominant players will emerge and seek to consolidate their grip on the market. Eventually you end up with a few players that control the supply side of the market, thus turning the market into the modern version of the Bronze Age palace economies.

This tendency toward consolidation is not just turning up in the retail side of the American economy. It is occurring in the wholesale side as well. The industrial supply sector has seen a great consolidation in this age. Regional players have been backed by investment bankers toting unlimited credit money, so they can buy-up the smaller players. The supply chain has also seen a similar consolidation, where local operators are displaced by global operators.

The relentless drive toward consolidation is not just an economic trend but a cultural and political one as well. For the first time in a very long time, the children of middle-class Americans can expect a lower standard of living than their parents. One reason for that is the consolidation in the professional ranks. That great consolidation in the economy has meant relatively fewer jobs in the middle and upper management ranks of American business and in the professions.

That’s something that has gone completely unnoticed. In the 1980’s, going to a top-25 law school meant an upper-middle class life, even for the slacker. If you could not cut it at one of the elite firms, you were going to land in regional or local firm, where you could expect a comfortable life. There is a now a great consolidation in the law that will accelerate in this decade. Not only will the number of spots in the elite get smaller, but the next levels down will disappear entirely.

Another area where this will happen is higher education. In a way, higher education has been a relief valve for the children of the top-10%. Those unable to get into elite law schools or cut it in the law of finance, could land a comfortable life in a university either as an administrator or professor. The number of tenured professors and senior administrative staff continues to shrink relative to overall staffing. Of course, the college finance system is about shrink the whole system.

What we are seeing is something no one worried much over in the 20th century and that is the collapse of the upper-middle class. The focus was always on the working class and the great solid middle. While the working class has been obliterated as a social unit, the middle-class has struggled on. Where there is a crisis is in the upper middle, the class of people who served as the staff for the ruling class of American society in business, the professions and politics.

The great consolidation at the very top, is going to mean a great consolidation in the class that serves the top. In a world of ten thousand local guys like Jeff Bezos, there was demand for ten thousand top assistants. In a world of one Jeff Bezos, there is only one aid and maybe a support staff for that top man. That’s a bit of an exaggeration, but it reveals just how much damage consolidation at the top does to the next strata of society that exists to serve the elite.

There is another consequence to this great consolidation. The children of professionals, who are unable to find a spot in their class, tumble into the next class. This changes the that class. The radicalization of the white middle-class we see happening is due, in part, to this consolidation. All over in dissident politics are men who would have been in management tracks, partner tracks and tenure tracks. Instead they are working outside that system and exercising their minds in dissident politics.

This will have consequences. One way of viewing the revolutions set off by the Enlightenment is that they were the result of idle smart people. The American Revolution and the French Revolution were led by smart fractions. In a world of global oligarchs, where the smart fraction is coalescing outside the ruling fraction, the result will be increasing social unrest. The great populist revolt of the past decade is probably just an appetizer for what lies ahead in the new world order.


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Repo Men

There used to be a time when the mass media covered the Federal Reserve as if it was Hollywood or a professional sports league. Whenever the Fed acted or the Fed chairman made a statement, it was big news. That has not been the case for a long time, mostly due to the mortgage meltdown. Worshiping the money men was no longer good copy after they came close to blowing up the world. Halfway through the Trump tenure, the media barely mentions the Fed or Fed policy.

Still, the central banks remain the most important government institutions on earth and this is particularly true of the Federal Reserve. They control the global economy, because they control the supply of money and credit. This is why the massive intervention into the credit markets by the Federal Reserve recently should be front page news. Something very big is happening and no one seems to know why, but the Fed is responding to it with $500 billion in new money.

Now, they are not just printing up cash and throwing it out the window. Instead, they are intervening in the repo market to head-off a market crash. For those who don’t know, the repo market is not where repossessed items are sold. The word “repo” is slang for repurchase agreement¹. A repurchase agreement is a short-term funding mechanism where one party needing cash, sells an asset to a party for cash, with an agreement to repurchase the asset at an agreed upon price.

A repurchase agreement functions in effect as a short-term, collateral-backed, interest-bearing loan. Much of what happens in the world of investment banks is reliant on the repo market. In order for these entitles to function, there has to be enough cash available in the system for these transactions to occur. Otherwise, borrowing rates go up, which means the cost of doing business goes up. Taken to the extreme, no cash available means the credit markets lock up.

Since the financial system is like a watch with gears interlocking with gears, one gear seizing up has the potential to seize up all the other gears. A frozen repo market could result in a cash crunch for banks, which locks up business and retail lending. That locks up the Main Street economy and we’re looking at bread lines. The economy, as we understand it, relies on a steady supply of money and credit freely flowing through the system according to the rules established by central banks.

As an aside, if the repo market probably sounds a lot like a pawnshop to you. A pawn shop offers short-term, collateral based loans. You take the family silver into the pawnshop and they give you cash. You agree to come back with the cash, plus interest, to get the family silver out of hock. If you blow the cash on a sure thing and are unable to pay the pawnshop, they take ownership of your item and sell it for cash. So yes, the financial system is built on the logic of the pawnshop.

Now, this move by the Fed is very curious. Clearly, something has caused this problem in the repo market, but no one seems to know the cause. It’s serious enough that the Fed’s balance sheet, currently at $4.1 trillion, will surpass its all-time high of $4.5 trillion. For several years now the Fed has made clear its intent to shrink its balance sheet. Therefore, this problem is serious enough to cause the Federal Reserve to change course and blow up its balance sheet.

The question is, what’s going on?

One possible answer is bad rule making over the last decade that has rewarded banks for hoarding cash. Instead of lending to one another, they are sitting on cash reserves. The risk-reward is better than short term lending. This could be due to a combination of market factors created by Fed policy and regulations on banks regarding their cash reserves. In other words, the government has created a distorted short-term lending market, through regulation and Fed policy that discourages short-term lending.

Another, more worrisome cause is that central banks have built a low-interest rate trap for themselves that they cannot escape. In lowering rates and intervening so aggressively in the market to stave off collapse a decade ago, they have created a system that cannot exist without low rates and aggressive intervention. Efforts to restore rates to historic norms or attempts to shrink the balance sheets of central banks threatens the very existence of the global financial system.

In such a scenario, the system controlled by the central banks becomes increasing complex with every intervention. Currently, the Fed does not know why the repo market is broken. They are simply reacting to the short-term effects. Their actions, however, will be part of the problem to be solved, a problem they don’t fully grasp. By the time they do understand the issue, they may have been forced to make additional interventions that further change the complexity of the problem.

Of course, a world of permanently low interest rates and unlimited intervention by the central bank is not a world controlled by the central bank. Rather, the central bank is now controlled by the system it created. The main weapons the central bank has used in the past to address systemic failure are no longer available. Taken to its logical conclusion, the financial system is a run-a-way train. The Feds do what they can to keep it on the tracks, but eventually, the inevitable happens.

In the long run, the story of credit money may be that it is simply a complex way to pull forward the benefits of economic activity, for the benefit of a few. Eventually, all of the pain avoidance with low interest rates and central bank intervention consume all of the economy to pull forward. Those accrued costs are reversed out all at once and system collapse in the result. The resulting political fallout then topples over the liberal democratic order and we enter an entirely new age.

That may sound overly apocalyptic, but consider how political institutions must weather a crisis. The people must not only want to preserve those institutions, they must trust the people running them. A great systemic collapse of the economic order would need a lot of trust in the political order to avoid revolts. At no time in the West has the current political order be less trusted. It needs the good economy to survive. That sound a lot like a house of cards waiting for the wrong decision.

¹Short primer on repurchase agreements.


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The China Questions

The trade war with China is heating up, so the usual suspects are now turning up in the media to pronounce on the issue. There is the sense that many of the pundits are relieved to take a break from discussing the culture war that surrounds the Trump presidency and the Progressive response to it. Talking about trade and global economics feels like old times. Here is a longish post from David Goldman, the man behind Spengler of the Asia Times, addressing the trade war.

As is always the case in these matters, the Michael Crichton observation about the media should be kept in mind. The growing rift between China and the United States is a complicated matter by itself. The impact it will have on global trade, the US economy and geopolitics is even more complex. Even people paid to risk real money in these areas don’t have a firm grasp of all the moving pieces. The people posting in the media know even less. Often they know nothing at all.

That does not mean there is nothing we can know. The first question, in any heated trade dispute between two countries, is “who is buying and who is selling?” and the related question is, “What is being traded?” In this regard, trade disputes are not a lot different from disputes between customers and vendors. How they proceed and how the end is entirely controlled by the relationship and the products in question. That determines who has the most leverage in the dispute.

In this case, the relationship is easy to sort. U.S. imports from China totaled $539.5 billion in 2018. U.S. exports were $179.3 billion. That export total is about 7% of all U.S. exports for 2018. Put another way, the U.S. market is about 5% of the Chinese economy, assuming the fake Chinese economic numbers are even close to reality, which is surely not the case. The Chinese market is less than one percent of the U.S. economy in 2018. Imports are about 3% of the U.S. economy.

Right away, the relationship between China is the U.S. is not an equal one, in terms of dollars, but also in terms of impact. Then there is the nature of trade between the two countries. Almost all of the U.S. exports to China in 2018 were aircraft parts, electronic components and car parts. In many cases, these are either high precision items the Chinese cannot produce or they have intellectual property that the Chinese will try to steal, so they are made in the U. S. and sent to China.

This is why Trump is playing hardball. He believes he has far less to lose than the Chinese in a trade war. Even if all trade with China comes to an end, the cost to the U.S. economy is not going to be devastating. In fact, it will be hardly noticed. Much of that trade will be replaced with other cheap labor countries, as it is not really trade in the conventional sense. America’s economic relationship with China is about off-shoring manufacturing to dodge labor, tax and environmental laws.

This is a point that cannot be made enough. When American producers sell good to Canada, and Canadian producers sell good to America, that’s trade. When American producers move manufacturing to Mexico, then bring those goods back home under a tariff free regime, that’s not trade. China is not selling the world anything the world does not have or cannot make. What China is selling is a safe haven to avoid the labor, tax and environmental laws that exist in the West.

That does not mean there can be no impact. That’s the other set of questions that can be examined from the outside. China can play a long game, as the Chinese leaders are not facing annual elections and endless media scrutiny. The West, particularly Trump, are in an endless election cycle. Any little blip in the economy is magnified by the media and then fed into the political calculus. While this trade war will inflict more pain on China, they have a much higher pain threshold than Trump.

That’s the theory. It is not all that clear just how much pain Trump will suffer from this standoff with China. The timing actually works in his favor. The slow buildup not only gives American business time to adjust, it gives the political class time to cast it as the typical good guy versus bad guy story. Xi Jinping is not exactly a lovable Jackie Chan type of guy, so casting him as a villain will be easy. In other words, Trump may be trading a little economic capital for a lot of political capital.

Then there is the question of just how much pain China can take and for how long. It is just assumed by Western analysts that the Chinese can absorb any amount of suffering for as long as it takes. After all, China weathered the Cultural Revolution without a mass revolt by the people. Mao had to die before the party moved to end the madness. Why would the Chinese people revolt over a slight down turn in the economy? Why would the party move against Xi Jinping, if the trade war contracts her economy?

No one can know this, but we do know that wealthy people are far more sensitive to small changes in the economy than poor people. We see this in the West. A small down turn has the middle class turning against their party, but a generation long depression in coal country has not caused a revolt. That same reality may be true in China. There are a lot of people living bourgeois lifestyles along the Chinese coast, all financed by one-sided trade with the United States and her allies.

While all of this economic 4-D chess will occupy the pundits, there may be a simple answer to what is going on with China. It could simply be that China has become a liability to the West. The benefits of moving manufacturing to China has been consumed at this point. What’s left is the liability, which is currency manipulation, IP theft, espionage and financial shenanigans. China is running out of friends in Western capitals. The appetite for tolerating this stuff may be waning.


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The Uncertainty Of Money

Imagine a world in which governments do business with one another only in gold, as in physical gold. They can issue promissory notes to one another, but it has to be backed by verified stores of gold. Governments, however, do not use gold for paying employees or contracting work with private business. In the case of employees, government pays in script, the value of which is set by the government. The vendors, on the other hand, are paid with silver, as in real silver coin or silver notes.

The first part of this thought experiment is not a big leap, as governments still hoard gold and will on occasion pay one another in gold. In our imaginary world, gold would be the exclusive currency of government, so regular people would hold very little of it, other than for novelty. This is not much different from today, as gold is not legal tender in most of the world. It is treated, in the law, as a commodity, like diamonds, barrels of oil, bales of hay, and so on. Gold is a product, not money.

The rest of the thought experiment gets a little weird, as companies do business in the tender of their home country. If they did business with one another in silver, then one of two things would happen. Either the price of silver would be pegged at the value of the legal tender or it would be pegged at the price of gold. Since government would always be willing to buy gold in silver or tender, from anyone holding gold as a store of value, the most likely result is all three would be related in value.

The result of this arrangement would be a world where the credit worthiness of governments would be pegged to their gold reserves, but also the gold reserves of their native companies and populations. A government that could quickly buy up gold from its people would have more flexibility than a government so distrusted that its own people would resist selling its gold to the state. Something similar would apply to the credit ratings of businesses, with regards to the supply of silver.

A well run country with a high trust population and a responsible government would find that the flow of gold and silver would be high, as there would be no reason to hoard them. Similarly, the value of the paper script used for retail transactions would have a steady value, relative to the currency of business and government. This would not just be an internal trust. Outsiders would see it too. In contrast, corrupt states with corrupt people would have low trust and lots of hoarding of gold and silver.

Now, this thought experiment is useful in understanding what is happening with the screaming headlines about negative bond yields. The media hypes these events as if they are the sign of the end times. Most likely, they are triggered by the word “negative” and just assume it is bad news. In reality, what the market is saying is that the German bonds are so safe, the holder is willing to pay for the privilege of holding them. Lenders are literally paying the German state for the privilege of lending to it.

Now, it is tempting for a certain sort of person (libertarians) to say it is ridiculous to compare government debt to gold, as in this analogy. They are right. Government debt is actually more secure. The reason is this. Tomorrow, the government can ban the private ownership of gold. Executive Order 6102 is a United States presidential executive order signed on April 5, 1933, by President Franklin D. Roosevelt that effectively banned the private ownership of gold in the United States.

On the other hand, no government anywhere could ban the private ownership of government debt. In fact, no government could risk the hint of not paying its outstanding debts, as that would make all debt worthless. Since, in the case of Western countries, those government bonds are the basis of the financial system, public trust in the credit worthiness of government is vital. That’s why people are literally willing to trade gold at a loss for the privilege of holding German bonds right now.

Now, that does not mean negative rates are all puppies and sunshine. Going back to our analogy, a world where everyone trusts government, but is not willing to trust companies, would result in a disequilibrium in the relationship between gold, silver and the paper script used in retail. The “price” in terms of script for silver would collapse, while the price of gold would soar. After all, why hold silver when business is bad, when you can hold gold or even cash, which has a higher value?

In our age, government debt is the gold in the analogy, but corporate debt is the equivalent of the silver. Modern business works off debt, as it is the currency of the modern age. In prior ages, government debt and corporate debt was captive to the supply of gold and silver. Today, the relationship between sovereign debt, municipal debt, corporate debt and legal tender is enabled and managed by central banks, primarily the Federal Reserve and the European Central Bank.

This is why borrowing rates across the West remain at historic lows. The whole point of this arrangement was to prevent the ups and downs, the booms and busts that plagued industrial economies since the steam engine. The trouble is, the system also allows for the easy manipulation of the economy through the money supply. Inevitably, that worked one way and we are now in a place where no one is willing to pay the price of getting things back to something close to historic norms.

This system has also been based on certain assumptions about America that are starting to unravel. One is that America would continue to operate like a giant shopping mall, willing to buy on unfavorable terms. Both Europe and China based their economic models on this assumption. Trump has abandoned that and that’s why we see problems in China and now economic uncertainty in the heart of Europe. The uncertainty of world political arrangements is now showing up in the money.

It also suggests the markets are slowly coming to terms with the fact that the Trump economic model is the new normal. The election is fourteen months away, so if his loss in 2020 was the safe bet, the markets would be responding now. Instead, the global economy seems to be slowly coming around to the fact that either Trump wins in 2020 or his polices will be carried on no matter what happens. America as problem solver for the world’s money problems may be coming to an end.


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House of Cards

One of the things that was revealed in the 2008 mortgage crisis was the fragility of the global financial system. The system that was born of the Louvre Accords was supposed to be robust and resilient, unlike the previous arrangements. The masters of finance would be able to keep a steady hand on the tiller, guiding the world economy through each storm, rather than have a free-for-all ever time there was a little turmoil. Up until 2008, everyone knew something like the mortgage crisis was impossible.

A credit based financial system was supposed to get around the problem of currency devaluation to solve political problems. That’s been a problem since the advent of coinage. When the state gets in trouble, the easiest ways to solve it is to spend money on the public. Whether it was debasing the coinage or printing paper money, the solution to spending money that did not exist was the create it. That always created new and bigger problems for the society down the line.

One way of looking at the mortgage crisis is as a form of currency devaluation. The global financial system is based in credit. That’s the base unit of value. Government debt and to a slightly lesser degree, corporate debt, is the foundation of the global financial system. Government issues debt, which increases the supply of money in the system, as that debt is used as collateral in the system. Central banks can buy and sell debt to control the supply of money in the system.

What no one thought much about, it seems, is how players in the system could devalue credit, in the same way governments devalued currency. That’s exactly what the mortgage brokers were doing. By lowering credit standards for borrowing, they were debasing a fundamental unit of currency in the system. This went unnoticed for a long time until everyone started noticing at the same time. The panic to unload the debased currency – those bad mortgages – set off the mortgage crisis of 2008.

That’s something to keep in mind as the next crisis appears on the horizon. The Wall Street Journal ran a story on General Electric’s financial issues. It’s based on a report by independent watchdog Harry Markopolos, who got famous sounding the alarm over Bernie Madoff’s scheme. For those familiar with global corporate finance, it is an interesting read, as GE is the exemplar of corporate legerdemain. It is not unreasonable to say that GE exists to exploit gaps in the regulatory system.

General Electric is one of those companies that looks like one thing, but in reality is just a financial scheme masquerading as a legitimate business. For example, their stunning growth in the 1990’s was not due to great manufacturing innovation. It was the result of GE Capital, a banking arm of the company. This arm not only financed their clients, who bought GE products, it financed GE’s expansion through acquisition. Without GE Capital as its credit creation vehicle, there would be no General Electric.

When you dig through the report, there are the familiar signs from the 2008 crisis. The allegation is GE is exaggerating one side of the balance sheet and minimizing the other, in order to make its liquidity appear much higher than reality. The whole point of this is to maintain a credit rating that allows it to borrow at competitive rates. Those lenders are not all that interested in the facts behind those numbers, as they have no incentive to examine the credit worthiness of General Electric.

Now, GE is one firm and maybe this is both exaggerated and isolated. That’s not the way to bet though. One of the ignored aspects of global business is that even tech oligopolies rely on a financing arm to exist. Apple, for example, is really a hedge fund that makes phones. Braeburn Capital is a wholly owned asset management company based in Reno, Nevada. Other tech giants are far less transparent, but every bit as wedded to the credit system to maintain their positions.

In theory, having global corporations as nodes in the global credit system is not a bad thing, because it makes them easier to regulate. In reality, as we saw with the mortgage crisis and now with General Electric, it also encourages everyone to overstate their credit worthiness. It also encourages opacity. The more complex and opaque the financial statement, the more costly the audit. Again as we saw with the credit agencies in 2008, the simple answer it to take the statements at face value.

That was the other thing revealed in the mortgage crisis. The system was a black box, even to the people inside it. The decisions makers in the big banks were unaware of what was happening upstream to pollute their asset pools. Of course, they had no incentive to care, so they never looked. Those people upstream had no way of knowing what they were creating downstream, but they had no reason to care. Regulators, of course, had no skill to examine the system and they did not care either.

Global debt, which includes government, corporate and household, is now 50% higher than it was at the time of the 2008 financial crisis. Due to the massive expansion of government debt, the stated quality of the overall debt is higher than in 2008, but this assumes government never runs out of money. Given that government solvency is tied to corporate and household solvency, that’s not an indisputable assumption. All anyone can really know is the world is awash in debt at all levels.

One read of the 2008 crisis was that it was a proof of concept. Instead of the system collapsing the world into depression and war, it withstood a huge blow and slowly eased the world out of the crises. The other read is that it was a warning about the internal logic of the system. A credit based economy is a house of cards. If the wrong card falls, the whole system collapses. It could be that the warning over GE is like the warning over mortgage lending. A warning to the house of cards.


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The Cheap Credit Trap

The Federal Reserve is making noises about cutting interest rates for the first time in several years. The reason is the trade dispute with China and now Mexico is potentially having an impact on the global economy. Even though it is only a signal of an intention, markets rallied on the news. Global investors and their robot traders love cheap credit from the Federal Reserve, so anytime there is the promise of more cheap credit, there is a rush into equities. It is a reminder of what actually drives stock indices.

It used to be that recessions were seen as a correctives for the system, as they eliminated unproductive and parasitic elements from the economy. In good times, all sorts of inefficiencies are tolerated, as everyone is making money. When times get tight, everyone gets serious again. Inefficient businesses and industries fail, thus putting those resources into more productive areas. The recession was the economy’s way of policing itself, so it was considered a necessary, if unpleasant, feature.

No one thinks like that today. Any sign of a downturn produces panic, especially among office holders. Part of it is no one has any respect for office holders, so voters will look for any reason to throw the bums out. For people who live off the public, losing an election is worse than death. Another part of it seems to be the sense among the ruling classes that they have only a tenuous grip on power. This is a bread and circus world now and they better make sure both are in ample supply.

That’s all speculation, of course, but it’s also a reminder of the long running problem that no one can figure out how to remedy. That is the interest rate trap. Lowering rates to address a slowing economy or a financial crisis is easy. Raising the rates back up again appears to be impossible. It has been over a decade since the mortgage crisis and the Federal Reserve is still trying to unwind its position and bring rates back up to historic norms. This news suggests they will never pull it off.

One reason the Federal Reserve is trapped in a world of ultra-low interest rates is the world economy is based on credit. The foundation of the credit system is U.S. treasuries. When the government borrows money, it is also creating an asset to be used in the financial system. Stable and predictable interest rates make treasuries valuable collateral, as their value will never decline. In fact, the market has an insatiable appetite for American sovereign debt. Those super-low rates are a big part of it.

Of course, the flip side of this is the U.S. government can only exists as it does with super-low borrowing rates. Current debt stands at $22 trillion and goes up by a trillion per year, give or take. Even if the so-called fiscal conservatives got all the items on their wish list, the cost of the great Baby Boomer retirement guarantees massive borrowing for the next several decades. That is only possible in a world of cheap credit, so both sides of the debt transaction need super-low interest rates.

Then there is the retail side. Whole industries have become hooked on super-low borrowing rates. Imagine what happens to housing if mortgage rates return to historic norms, in terms of interest rates and terms. Imagine what happens to the car business when car makers cannot offer 84-month terms and low interest rates. The answer is these industries shrink considerably and take the economy into a depression from which it would unlikely recover. These industries need low rates to survive now.

Now, there is an argument that borrowing rates are normal for a highly efficient modern economy. Historic averages are not useful, as the world where men paid debts with gold coin, or mortgages were processed by hand, is nothing like today’s world of automation and complex financial instruments. There is a lot of truth to this. Automation has not just made transaction processing faster, it has made it more reliable, thus reducing systemic risk and friction. Cheap rates are a reflection of cheaper costs in the system.

There’s also the fact that central banks have greater control of the global economy than at any time in human history. The microprocessor has had no greater impact on the world than in the financial system. Not only do central banks have more information about the state of the economy, they have tools that allow them to see trends before they get going, thus allowing them to anticipate problems before they reach crisis level. It’s not perfect, but managed capitalism is more efficient and predictable.

That said, the main tool central banks have in fighting a financial crisis is lowering borrowing rates. The reason they could soften the blow of the mortgage crisis is they could spread the cost of remedying it across the following decades. In the simplest terms, the Federal Reserve used a payment plan to cover the cost of fixing the mortgage crisis in 2008. That was only possible with the room to lower rates and borrow heavily from the private economy to soak up bad debt and warehouse it at the Fed.

Inevitably, this topic leads to questions about whether the current credit based economy is sustainable in the long run. The old joke about “in the long run, we’re all dead” is true here as well. The current monetary system has been in place since the Louvre Accords in the 1980’s. While there have been recessions, there have been no depressions that threaten the political order. The ability to borrow has never been stronger, which means the West should be able to manage the great demographic change over.

Still, there is that haunting sense that this credit regime is a slow-motion bust-out where social capital is turned into cash and used to perpetuate the current order. At some point, when the West is nothing but a shopping mall full of strangers, with no connection to one another, what happens then? The West is haunted by the sense that the true cost of cheap credit makes the credit based economy unsustainable. In the end, the cultural capital will have been exhausted and there will be nothing left to borrow.

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The Bandit Economy

There is an old parable about business ethics, where a young ambitious man is hired to run a pickle factory. Being ambitious, he comes up with a brilliant idea to increase productivity. He reduces the number of pickles in each jar by one. The result is the cost per jar falls and the number of jars produced goes up. His bosses are suitably impressed and he is quickly promoted. The firm hires another young hotshot to take his place, he quickly figures out the scheme and repeats the process.

The lesson of the story is that such an approach is not really about increasing efficiency or cutting costs. It is about fraud and the limits of fraud. If this process is carried out a few more times, customers will notice that the jars have a lot less product. Taken to its logic end, the company will eventually be sending empty jars to the market. Of course, once the public catches onto the fraud, the good name of the company is ruined and all of those savings they gained on the front end are lost on the back end, plus interest.

It is a useful parable when trying to understand what has happened to America over the last three decades. Free of the threat of nuclear annihilation, the ruling class has abandoned ethics and morality. One result is we live in a bandit economy, where things like shrinkflation are features rather than exceptions. This post over at Zero Hedge details how the gas you put in your car has been systematically watered down over the last quarter century, coincidentally starting at the end of the Cold War.

Of course, a trip through the supermarket will find plenty of examples of this phenomenon, some of which border on the absurd. The classic pint of ice cream is now fourteen ounces and shrinking. It won’t be long before they will quietly change the definition of quarter to be 2.5 pints. Only conspiracy theorists will notice the change. It used to be that a pint was a pound the world around, but you can’t even buy a pint of beer without a heroic capitalist pulling shenanigans on you. It’s becoming a game with them.

The libertarian line about the market simply being a place where buyers meets sellers sounds good in the hothouse, but in the real world, left unattended, it becomes a grifters alley, where the honest are preyed upon by the unscrupulous. Just as there is never a cop around when you need one, there is no longer anyone policing the practices of our capitalist overlords. If you want to know why people at the end of the Industrial Revolution were open to the call of communism, stand in the chip aisle of your market.

If you are the sort who likes a sandwich and some chips for his lunch, the one thing you can’t help but notice is the bags of chips have grown larger and more expensive. What used to be fifty cents is now a buck-fifty. The bag is also twice the old size, but inside are fewer chips than in the past. It’s already reached the point where the bag is 80% air and 20% product. If this continues on much longer, the lunch time snack will be a dirigible sent to your office containing one chip. That will be your drone delivery.

What the West is experiencing is something people figured out at the end of the industrial revolution. That is, market capitalism is great, except for the market capitalists. Left unsupervised, they quickly turn into bandits in business attire, coming up with clever ways to rob the public. Another feature of this age is the declining number of independent suppliers. It turns out that a feature of unrestrained market capitalism is the strangling of the market by a handful of powerful suppliers, who exercise hegemonic power.

Of course, what is happening here, in a million little daily transactions, is the monetization of public trust. The office workers grabbing lunch trusted that the participants at their local deli were playing fair. Meanwhile, those clever MBA-toting business men and their brilliant ideas about removing just one more pickle from the jar, are exploiting this trust and skimming a few more pennies from the unwitting customer. This sort of practice is modern coin-clipping, which used to be a capital offense.

At some point, when the rubes notice their sandwich can fit in the palm of their hand and the bag of chips is the size of a hot-air balloon, they lose their naiveté and privately realize they are being scammed. We live in a cynical age, because privately, people are coming to believe nothing is on the level and no grift is too small. That has the effect of codifying deceit as a feature of the market and of society. We are rapidly reaching a point where only a sucker trusts anyone other than his friends and family.

This is why unfettered market capitalism is a cancer on society. It turns morality on its head, justifying the unwillingness of the elite to enforce public morality. It’s why your kid’s phone is full of hardcore pornography. The market has spoken and you’re not against the market, are you? Eventually, there is the “A-HA!” moment, when people discover that their private loathing of the daily grift is shared by a large portion of the population. The preference cascade sets the world on fire and morality returns with a vengeance.

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The Black Poodle

There have always been certain issues that function as litmus tests, in that there is a factually correct position and many factually incorrect positions. Those wrong position, however, tell us things about the person holding them. Gun control is the best example. The right position is based on a mountain of data collected over generations. The wrong positions range from uninformed to the mendacious. As a result, the gun issues is a good litmus test. A person wrong on guns is telling us things about themselves.

The universal basic income is shaping up to be another one of those litmus test issues, where the self-righteous and fashionable use it to advertise their virtue and edginess, but also tell us about their ignorance. The other day, the leader of America’s hipster intellectuals, Claire Lehmann dramatically announced she is now on board with the universal basic income. In fact, Andrew Yang’s goofy Asian hipster populism platform is starting to become the cool thing among our edgy trend setters.

The giveaway at this point, with this issue, is in that linked Quillette post. “There are reasonable arguments to be leveled in good faith against the UBI platform, which Yang has dubbed “The Freedom Dividend,” but what was once considered a utopian pipe-dream is beginning to sound more plausible in light of the unfolding tectonic economic and technological shifts.” Are there reasonable arguments made in bad faith? That line makes clear that one side is virtue signaling, hoping the other side plays the role of skeptic.

What’s shaping up is the UBI is going to be the hipster beard for the politically active millennials, who dream of living as the Eloi. As was brilliantly explained before, it can’t possibly work as expected, but that is part of the attraction. That’s always part of the appeal to utopianism. The believers are emotionally wedded to the idea because the Promised Land always feels just out of reach. The world without work, where everyone is free to self-actualize and get a gold star from teacher is the millennial dream.

The math of UBI is really not worth discussing, however, as the people excited by it are incapable of grasping it anyway. They are simply using the issue to stake out what they think is the moral high ground. Yang is a very smart guy, who grew up studying the people now flocking to these sorts of ideas. The alt-right thinks they meme’d him into existence, but Yang looks a lot like an East Asian Obama. That is, he is the sort of minority who flatters upper-middle class white Progressives just be existing.

The real problem with the UBI is it is part of the larger trend of infantilizing people, turning them into wards of the custodial state. A society where everyone is watched, where everyone has their speech monitored, where everyone is on an allowance, is called a prison. That’s how prisons work. Given the tender sensibilities of the next generation, this world is evolving into a daycare center. Ideas like UBI are not about economics. They are about normalizing the custodial state. UBI is Faust’s poodle.

The problems that UBI are supposed to address are real and concerning. Automation is replacing labor at an alarming rate. Sure, the robot future is wildly exaggerated, mostly by people who have no experience in the real world. Most people reading this, for example, will not live to see robot trucks roaming the highways. Still automation is a serious issue facing the West. The consequences are frightening, not for material reasons, but because they will force the West to face up to the reality of culture and social organization.

You’ll note that in the linked Quillette article, there is no mention of immigration. The latest data show that Trump’s alleged jobs boom is mostly just a boom in migrants finding work in America. End immigration and automation suddenly is a different issue. In fact, it becomes a tolerable issue, because a society willing and able to put its own interest ahead of strangers is able to rationally address the sorts of welfare schemes required to support friends and neighbors. That’s the fear that truly haunts our ruling class.

In fact, the fear of facing up to the basic questions every society must address is what is behind the fear of automation and technology. When Tucker Carlson told Ben Shapiro that he would happily ban certain forms of automation, Shapiro nearly burst into tears because he lives in fear of ever having to face the questions Carlson raised. When you face the questions “Who are we and what sort of society do we want?”, things like automation and social welfare become less frightening. UBI is a way to avoid facing those questions.

Litmus tests like gun control or now UBI offer an opportunity to introduce the subjects that our betters would prefer not to discuss. UBI is a door that opens to a debate about who we are and what kind of society we want. That inevitably leads to the question of who gets to decide and why. That debate is always a part of what defines a society. For the modern West, it is a part that has no conscious place in our political life. Talking about the details may not be a lot of fun, but even a deal with the devil has opportunities.

Zero Marginal Culture

A long running gag in popular culture is one where the adults complain about the fads popular with the younger generation. Adults supposedly have been complaining about the kid’s music since the birth of pop culture in the 20th century. The same is true of clothing styles and haircuts. Of course, part of that is the marketing of popular culture. The people peddling this stuff try to feed on the normal youthful rebellion, so an ideal result, if you’re in the business, is for the adults to really hate it. Then the kids will love it.

The assumption underlying this gag is that there is no objective difference in quality between pop culture trends. The perceived quality is relative. From the perspective of a teenager, the new thing is useful because it translates to status within their peer group or allows them access to a desirable youth subculture. For adults, these new trends have no social value. There may be some small value in hating it, but since all adults are tuned to not like teenage fads, the value in not liking it is minimal.

The makers of pop culture made up for this lack of qualitative difference in fads by maintaining a monopoly on the supply. Hollywood was controlled by a small clique from the start and remained a family business of sorts until recent. Music was similarly controlled by a relatively small number of record companies. Read the book The Wrecking Crew and you see how this used to work. This bottleneck on the supply side allowed the makers to keep down costs and therefore maintain a profit margin.

Technology has made it much more difficult for the people controlling the supply side to maintain this bottleneck. That’s mostly because technology has lowered the barrier to entry into pop culture. A great example of this happening in front of our eyes. Talk radio became a thing in the 1980’s. Conservative Inc. controlled middlebrow conservative opinion by controlling the radio networks. If you wanted to talk politics on the Right, you had to play ball with the people controlling the talk radio industry.

Today, some of the most influential voices on the Right are podcasters and live streamers. If you’re under the age of fifty, you’re probably close to abandoning the old radio model entirely, maybe listening to some of the old guys on-line. The audience for Rush Limbaugh is half of its peak now. Most talkers have seen their audience shrink and they are now seeing competition from below. People like Stephan Molyneux can produce high quality, professional content, from their home and reach a broad audience on-line.

The thing is though, supply does not create demand. Just because you can now produce your own music from a home studio, it does not follow that you become a pop star. That old assumption about there being no qualitative difference in trends works in the macro sense, but talent still counts. The fact that young people may prefer pop music from their grandparent’s generation suggests there is a qualitative difference in this area. To these young ears, that music is better, so they prefer it over what the style makers produce.

Alternatively, another way of looking at this phenomenon is that like the consumer electronics business, pop music is now fully commoditized. There’s little or no value added to the music from the producers and creators, so the only thing that matters in the music market is price. Since streaming is the platform of the future, producing new music makes less sense, when there is this vast library of existing music. The kids have not heard these old songs, so selling them the old stuff is possible.

Another aspect to this is the cultural one. Pop music had a peak in the 1970’s and has been in decline ever since. This tracks with the overall decline in the culture. This turns up in per capita music consumption. The aberration was the introduction of the CD, which had everyone re-buying their catalog of music. Otherwise, Americans have listening to less music than fifty years ago. Young people may simply prefer that which was created in peak America over that which is produced in post-America.

Putting aside the cultural angle, which is not unimportant, the economic issue raised by trends in popular culture is how does a market economy work when everything is a commodity? If technology makes it impossible to create bottlenecks and control artificial monopolies on supply, how can concepts like entrepreneurship and market competition still exist? After all, business is about creating scarcity and exploiting it. What happens when the Peter Theil model is no longer possible?

It sounds fanciful, and maybe it is, but it is worth thinking about, as the people who rule over us are thinking about it. The author of this book on the subject is an adviser to the European Union and is read by the western political elite. They are not worried about a world of zero marginal cost. They want to create it. The world of zero marginal cost is also a world of zero marginal culture. More precisely, it is post-culture world, in which things like pop music are simply things supplied by the system on-demand.

Jelly Bean Economics

Imagine you find yourself in one of those underground malls, where they design it such that you never have to go above ground. Now, instead of just the mall, your living and working space is also underground. It is an underground community that is like a small town, except everyone is stuck there, unable to leave the mole utopia. You know, however, that there is a world outside and that people live above ground. It’s a not prison, just a system that is complete, so you have no reason to leave the mole utopia.

In your world, everything works like it does in the world of today. People have jobs, socialize, conduct commerce, and have families, all the stuff we associate with normal human society. The one difference between the mole utopia and this world is their economy is based on jelly beans, the little candies given to kids at Easter. Each color has a different value and people treat them in the same way you would treat coins or bills. When you get paid, it is in jelly beans. When you buy stuff, it is in jelly beans.

No one knows where the beans come from or who is responsible for making sure the supply of beans is correct. There’s some vague notion of a jelly bean consortium and people who spend their days keeping track of all beans in circulation. There are people, who police the bakers to make sure they are not making fake jelly beans. Otherwise, the beans are just the thing that is there, taken for granted by everyone. The jelly beans used in commerce are as much a part of reality as the air people breathe.

Now, there are people in charge and they do control the supply of beans. At first, when they set the system up, they figured the goal was to keep the supply of beans constant, as beans are fragile and people will tend to eat them. The best bean counters in mole utopia were recruited to keep track of the flow of beans in order to determine the overall supply and rate of bean decay. They would order up new beans to be introduced into the supply to keep the supply of beans steady, so there could never be a shortage.

At first they would just have people hand out beans under the guise of charity, but before long the people doing that started cheating. They would keep the beans or only give them to friends and family. The next scheme was to have the government of mole utopia disperse the new beans, by hiring people and buying stuff. This worked pretty well until government started cheating and ordered up beans whenever it needed to buy votes or reward friends of the government. This caused people to lose faith in the jelly beans.

Finally, the bean counters landed on a scheme where they would lend the new beans to banks at extremely low interest. The bean banks, flush with new beans, would then lend beans to people at very low rates. This got the beans into the economy, without anyone stealing them or using the supply to corrupt the system. The one flaw is the bankers got rich from the scheme, but bankers are always rich, so no one really noticed much of a change. It also made the bankers dependent on the bean counters.

The bankers could lend to anyone, including the government. Since rates were so low, the government could borrow vastly more than under the prior arrangements. That meant they could spend vastly more than in the past. The bankers were never worried about the government repaying, because ultimately they controlled the supply of beans, so they could always order more beans. That meant it was the safest type of loan, because the government would always make its payments and make them in full.

The only constraint on the government spending was how fast they could increase spending. Too fast an increase and too many beans would enter the economy of mole utopia, lowering the value of each bean. This could distort markets in unpredictable ways, by increasing demand unexpectedly in some areas, but not in others. This would also raise prices and force lending rates to increase. Therefore, inflation became the only check on spending. As long as inflation remained low, spending was unlimited.

This description of mole utopia may sound simple and ridiculous, but it is how the modern American economy is run by the Federal Reserve. Modern Monetary Theory is the economic argument that government spending is only constrained by inflation, as long as the government has control of the money supply. Here is a short video lecture on the topic from Professor Stephanie Kelton of Stony Brook University. Here is a much shorter version in the form of a post that appeared on Zero Hedge last week.

The basic argument of the MMT people is that as long as there are resources not being utilized by the private sector, the state has a duty to step in and put those resources to use through government spending. That’s a moral argument, not an economic argument or a factual observation. The economic argument is that spending and debt is meaningless, as long as the state is not crowding out the private sector and the spending is not driving up retail inflation. Otherwise, the government can spend as much as necessary.

To many people, this sounds like a version of the old joke about the stranger who comes to a small town looking for a room. He plops down a few hundred dollars and the inn keeper tells him to wait while his room is prepared. In the meantime, the innkeeper rushes out to pay his vendors, who then rush out to pay their vendors. Eventually, that new money reaches the town’s prostitutes, who use the inn for their clients, renting rooms on credit. They rush in with the new money and pay the innkeeper what they owe.

In that old gag, the stranger changes his mind about a room, takes his money back and leaves town, but everyone that was owed money is now paid. That’s the joke. The lesson, of course, is that as long as everyone is getting paid, especially the prostitutes, the system keeps spinning and everyone is happy. That’s the moral theory of MMT in a nutshell. As long as productive resources are being utilized and everyone is getting paid, the system keeps spinning. Just as important, the society remains stable.

The critics will instinctively shoot back that this sort of economics is inherently unstable and the apparent stability is short lived. In the long run, the accumulation of debt becomes untenable and the system collapses. The response to that is no one, especially government, lives in the long run. More important, MMT answers the question as to how government should respond to automation. As robots eliminate jobs, more people become idle. How does the state address the problem of fewer jobs for a growing population?

There’s another way to look at this. The custodial state runs on the same premise as a prison. The first job of the warden is to maintain control of the prison. He does that by making sure the prisoners are always kept busy in ways that work toward his goal of maintaining control of the prison. One mechanism for doing that is controlling the supply of goods and services in circulation in the prison. Prisons have an economy based on items from the commissary and that commissary is controlled by the warden.

What MMT seeks to do is make the sovereign state, by which is meant the issuer of currency, the commissary of the American economy. By controlling the supply of goods and services, via currency manipulation, spending and debt, the state can keep an increasingly useless population busy. It can always reward activities that enhance control of the system and punish activity that creates disorder. Inevitably, the communications companies, banks and technology firms become the prison guards of the system.