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 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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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.

The economics of empire are fairly well understood. Persia for example, conquered the surrounding people, because it meant those people paid tribute to Persia. The cost of conquest was covered by the initial booty, at least in theory. Tribute was calculated on the ability to pay and the cost of defending the new land. While ego certainly played a major role in empire building, the economics were also a factor. In agrarian society, land was the store of wealth, so acquiring new lands was how a people got rich.

This is the reason empires preferred to negotiate with potential new vassals, rather than just invade. It made the math predictable. The initial conquests were all about the warrior spirit or maybe old grudges, but as an empire matured, it was about economics. If a city-state on the Aegean, for example, was willing to submit to Persia without a fight, the cost of conquest was easy to calculate. Not only that, it lowered the cost of maintaining the relationship, as the new vassal would be cooperative.

This has been the rule of empire since the first empire. The Romans conquered the Italian peninsula because of age old conflicts with the neighboring people. They conquered the Mediterranean because it made them rich. The British Empire was a purely financial empire, as were all of the colonial empires. There were rivalries between the European powers, for sure, but their main motivation was economic. Conquering the New World and Africa was all about enriching the conquerors.

There has always been another element to the economics of empire and that is the nature of rule. Empires have always been defined by personal rule. A ruling family or maybe a ruling tribe, sat atop the system. They owned lands themselves and treated their conquests as personal property, even if they were not defined so legally. When new lands were acquired, the emperor or king got his cut first. Then the rest was distributed to his lieutenants and supporters down to the soldiers themselves.

Personal rule means personal responsibility. Darius, the Persian emperor, had a personal stake in the welfare of his vassals. To simply loot them would be like a shepherd skinning his flock, rather than shearing them. The economics of empire have always been the same as the economics of monarchy. The people at the top must treat their vassal states as they would treat their own property, which means they have a stake in their prosperity and therefore a motivation to preserve the value of the conquest.

America is the first democratic empire. The British Empire had democratic elements, like a parliament and limited suffrage, but it was a long way from liberal democracy, as we currently define it. By the time liberal democracy swept the West in the first half of the last century, the British Empire was in steep decline. That process was the result of America rising to dominate the West and eventually become the global hegemon. America elected to conquer the world in order to spread democracy.

Democracy, of course, turns the ruling class of a country into renters. Unlike an owner, a monarch for example, the office holders in a democracy are in it for short term profit. The next election could find them back in the dreaded private sector. In order to hedge against that eventuality, they must convert as much private property into public property, in order to distribute it to friends of government. Democracy is just a formalized version of tragedy of the commons, that always ends in it murdering itself.

The question then is how a democratic empire can survive, when the ruling elite of that empire are motivated to loot the empire. In the Cold War, this was not a consideration, because the other side was a similar empire build around communism, which is just the material implementation of democracy. The natural inclination of both systems to loot themselves was checked by the very real threat of nuclear annihilation. The commies invested in territorial integrity, while the West invested in their economies.

The collapse of the Soviet Empire is something that gets little attention, as it is just assume to have been inevitable. Communism, however, shares something with liberal democracy. The people at the top have no incentive to invest in society. The Soviets did not develop their social and human capital. Instead, it ruthlessly exploited it, along with the natural resources of the territory. The Soviet system was like a renter using the furniture for firewood. When the energy markets collapsed, the Soviets collapsed.

Liberal democratic empire, rather than strip mine natural resources from the land, monetizes social capital through cost shifting. For example, business brings in foreign workers to suppress wages, but then dumps those workers into the surrounding community. Their cost of support consumes the social capital of that community through corruption of local institutions, increases in crime and social alienation. In other words, the cost of cheap goods is the loss of community and local control.

Another aspect of the exploitative economics of liberal democratic empire is how America strip mines foreign lands of their human capital. Silicon Valley, for example, is majority non-white. The best minds from around the world are recruited to the economic centers of the empire. Spend time around the Imperial Capital and it is not only a foreign country, it is an alien country. It is nothing like the rest of the empire. That’s because it is a collection point for foreign elites serving the empire.

What collapsed the Soviet system was the same as with any economic enterprise. The cost of maintaining it exceeded the benefits of maintaining it. The Soviets ran out of cash to pay their bills and went bankrupt. The Soviets had to subsidize the vassal states in order for the local elites to remain in power. They also had to spend on security forces to keep those local elites from getting any ideas. The cost of doing those things eventually exceeded the proceeds of natural resource extraction.

In the American empire, a different crisis is brewing. The destruction of social capital has reached a point where the middle class is collapsing. Inequality has never been higher, but it promises to soar as the Baby Boom generation ages off and their assets are consumed by the state. The proliferation of private debt to provide the illusion of prosperity and mask the loss of social capital, has beggared the young. The next generation is guaranteed to have a lower standard of living than their parents.

The collapse of social capital is surely one cause of the decline in entrepreneurship. To start a business is to take a risk. Having social support not only mitigates the cost of failure, it encourages risk taking. As capital, social and human, has been collected into the control of an increasingly narrow elite, entrepreneurship has declined while overall leverage has grown. The rentier system of liberal democracy, has turned the ruling elites into renters, using up resources without replacing them.

The Russian implementation of democratic communism in an empire became unstable when the proceeds from energy sales could not cover the cost of empire. Like a business with a negative cash flow, it simply ran out of money and collapsed. It’s tempting to think something similar happens in America. After all, government debt at all levels is staggering and is accelerating. That’s a mistake, however, as the state is no longer in control of the empire. Control now rests in private hands.

Proof of that is the inability of the empire to control the borders. Across the West, the voters want to sharply reduce legal immigration and end all illegal migration. Yet, supposedly sovereign governments are unable to do it. In America, the President is stymied at every turn by a system largely controlled by forces that exist outside the government. The reason there can be no border wall is the managerial elite that benefits from and is in charge of the empire, will never permit it.

The more likely source of instability will come from the cannibalization of social capital that has been the fuel of the “new economy” for decades. The loss of social capital has reduced social trust, which in turn has resulted in a decline in trust of national civic institutions. Why would people put faith in their institutions when it is clear that their office holders are powerless? That is a lesson rocketing around Europe. It explains the “yellow vest” protests and the rise of right-wing populism.

In America, only a fool believes the ruling class. People are becoming increasingly alarmed by what’s happening in the administrative state and its private partners in the technology and financial class. This loss in trust will inevitably lead people to look for alternative sources of legitimacy, authority and collective security. Identity politics is just a preview. As America becomes majority-minority, politics becomes a winner take all proposition, which will foster a rise of tribal politics.

The traditional empire always stagnated when it stopped expanding. What followed was a long period of decline. In a democratic empire, the economics that naturally flow from democracy hollow out the empire, by converting its social capital into power and status of a detached ruling elite. The global rulers of today see themselves as detached from those over whom they rule. Their subjects are just resources to be utilized and discarded.

The question to be answered is what happens to the American empire when the social capital is gone? Is it possible for a tiny alien elite to maintain control of a continent-wide population entirely dependent on the system for order and stability? Can the culture of the penitentiary scale up in such a way that the inmates still believe they are in charge of the institution? No one knows, because there has never been a democratic empire, but that is the task facing the ruling class of the American empire.