Category Archives: Economics

The China Questions

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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

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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.

For sites like this to exist, it requires people like you chipping in a few bucks a month to keep the lights on and the people fed. It turns out that you can’t live on clicks and compliments. Five bucks a month is not a lot to ask. If you don’t want to commit to a subscription, make a one time donation. Or, you can send money to: Z Media LLC P.O. Box 432 Cockeysville, MD 21030-0432. You can also use PayPal to send a few bucks, rather than have that latte at Starbucks. Thank you for your support!

House of Cards

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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.

For sites like this to exist, it requires people like you chipping in a few bucks a month to keep the lights on and the people fed. It turns out that you can’t live on clicks and compliments. Five bucks a month is not a lot to ask. If you don’t want to commit to a subscription, make a one time donation. Or, you can send money to: Z Media LLC P.O. Box 432 Cockeysville, MD 21030-0432. You can also use PayPal to send a few bucks, rather than have that latte at Starbucks. Thank you for your support!

The Cheap Credit Trap

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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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The Bandit Economy

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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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Zero Marginal Culture

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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 kids’ 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 are 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 recently. 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 is 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 are under the age of fifty, you are 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 his home and reach a broad audience on-line.

The thing is supply does not create demand. Just because you can now produce your own music from a home studio, it does not mean 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 is 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.

Jellybean Economics

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Imagine you find yourself in one of those underground malls, where they design it in such that you never have to go above ground. Now, instead of just the mall, you are 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 is 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 jellybeans, 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 jellybeans. When you buy stuff, it is in jellybeans.

No one knows where the beans come from or who is responsible for making sure the supply of beans is correct. There is some vague notion of a jellybean 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 jellybeans. Otherwise, the beans are just the thing that is there, taken for granted by everyone. The jellybeans 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 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 jellybeans.

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 is a moral argument, not an economic argument or a factual observation. The economic argument is that spending and debt are 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 is 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 is 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 that no one, especially government, lives in the long run. More importantly, 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 is 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.

Old And Busted

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Way back in the before times, at the dawn of the interwebs, I had some dealings with a small niche publisher. He had a few small newspapers he sold that focused on narrow subjects. Before the internet, there were a lot of these publications. Some were in the magazine format, while others were like a small newspaper. The model was to charge a relatively high subscription fee to a small audience. They could not sell ads, so the only way they could survive was on high subscription rates to loyal fans.

One day, this publisher starts telling me about his plans to abandon the old model and move to the internet. That way he could cut his production and postage costs, which were the biggest part of his operation. I asked him how he was going to handle the revenue side, as this was before firewalls and on-line payment processing, He said he was going to make up the difference with clicks. After some back and forth, I told him banks do not take clicks, so he better come up with a way to make money, rather than clicks.

The guy thought I was just ignorant about the way the future would work, so he dismissed my skepticism. He was not alone. In the 1990’s, everyone was given a disk and then a CD that allowed them to get on-line and feel like they were on the cutting edge of technology. They were in the new economy, with clicks and traffic, not the old economy with money and expenses. It was a good lesson in human nature. Take people out of their natural environment and you suddenly see their raw cognitive ability.

That story comes to mind whenever there are layoffs in media and the media start analyzing what went wrong. This story at Wired is better than most, but the fact that it needs to be written at this late date says a lot about the people in the media. By now, everyone should know that the newspaper model was never about the news. It was about the distribution system. The newspaper brought ads and marketing material to the people at a cost and efficiency no one could match. That was always their business.

The news part was the marketing expense. People would buy the paper because of gossip or the sports pages. The news was only interesting when something interesting was happening. Otherwise, the so-called hard news side was a sinkhole. When the internet robbed these operations of their distribution hegemony, the logic of their business went with it. When the internet robbed them of gossip and sports, they were left with hard news, which has a tiny market, but huge expense.

This was obvious by the middle of the Bush years. Yet people in the news business have never noticed. Today, in a world where most everyone knows most of the news is fake, just made up by desperate losers looking for attention, the point should be impossible to ignore, but here we are anyway. After Vice, Huffington Post and Buzzfeed cut staff in what will be a long journey into insolvency, the media was full of handwringing about the state of journalism. It suggests the people in the media are not terribly bright.

That still leaves open the question as to why no one can find a model for news that is sustainable, without rigging the market or relying on the charity of billionaires. The on-line advertising model was always a bit of sham and that is becoming increasingly clear as Google and Facebook monopolize the space. Even there, the viewership of the ads is declining, as people employ counter measures. The result is more people are exposed to ads, but fewer people are watching them. At some point, that becomes a problem.

What may be true of the news business is that without monopoly or oligopoly power, it cannot exist beyond some scale. That is, a form of Brook’s Law comes into play. The more journalists that are added to a news enterprise, beyond some optimal number, the faster the enterprise descends into insolvency. A single journalist can create enough content for a theoretical maximum of consumers. Two journalists, however, can produce something less than the sum of those theoretical maximums.

This would explain why local papers somehow manage to bugger on, despite what is happening to city broadsheets and even tabloids. It is not that the local paper fills a niche, which is certainly true. It is that it never grows beyond a certain size and that size is well below the failure point. The people working in it do not see themselves as a secular clerisy and instead take a practical view of their job. As a result, the cultural dynamic inside the organization is like you see inside any small local business.

Another point worth mentioning is that it has always been assumed a new economy would evolve to take advantage of the new efficiency brought on by technology, particularly the free flow of information on-line. What is going on with mass media suggests maybe there is another option. Technology eliminates large chunks of economic activity, not through automation, but by making it impossible to maintain barriers to entry. That is, when the price of something fully reflects all available information, the price drops to zero.

The Economics Of Democratic Empire

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The economics of empire are 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, 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, but it also 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 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 land 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 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. To hedge against that eventuality, they must convert as much private property into public property, 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 built 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 assumed 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, but also an alien country. It is nothing like the rest of the empire. That is 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 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, but it also 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 is tempting to think something similar happens in America. After all, government debt at all levels is staggering and is accelerating. That is 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 oversees 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 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 is happening in the administrative state and its private partners in the technology and financial class. This loss of 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 oversee 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.

The Coming Crisis

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In a crisis, people either turn to their institutions or they turn to their leaders to provide a path forward through the emergency. This is especially true when the path forward is waiting out the emergency. People respect action, so they must have faith in their leaders if the right course is patience. Alternatively, if the leaders and institutions are not up to the task, then the people turn on each other. The French Revolution is the perfect example of what happens when leaders and institutions fail in a crisis.

It has been a long time since American faced a real crisis. The closest we came to anything major was the financial crisis a decade ago. For people foolish enough to take on the crazy mortgages, it was a very real emergency, but for most people it was more of an abstraction than a real crisis. Unemployment ticked up and the stock market took a header, but it was not the Great Depression. There was a concern, for sure, that the wheels were about to come off the cart, but it never materialized.

Of course, one could say that the leaders and institutions stepped in and guided the country through the crisis. People tend not to think of the Federal Reserve as an essential institution, but it is probably the most important part of government now. The head of the central bank is every bit as important as the President. In fact, he may be more important, as we saw with Greenspan and George Bush. An overly tight monetary policy led to a slight downturn in the economy at just the right time to sink the Bush election bid.

In 2008, the world was lucky to have a Fed chairman, who had prepared his whole life for such an event, and a very weak political class. Bush was near the end of his reign, and no one thought much of him anyway. Congress has not had much credibility in decades, so they could not cause too much trouble. Bernake was given the room to do what had to be done to stabilize the financial system. People can argue about the solution and various alternatives, but the Fed did provide a peaceful path forward.

The world was lucky in another way. The public was still confident in the system, even though they may not have liked many of the people in it. George Bush was down in the polls, because of the Iraq war, but people still trusted he was a good guy. The restoration of public trust during the Reagan years still cast a shadow over the Bush years. Even though Clinton had been a degenerate and Bush was an incompetent, people still thought the system was fine. They could trust the system.

That brings us to the present. Half the country voted for Trump and increasingly blames the system for blocking his efforts. The other half voted against him and increasingly suspects he is punishment for a broken system. The political class is at war with itself, as it grapples with the fact it no longer commands respect. Then there is the hidden war between the semi-permanent administrative state and the reformers in the White House and Congress. Right now, the people and institutions are not very stable.

That is what makes the rumblings from the financial system ominous. Wall Street is not Main Street, so a yearlong bear market should not be overstated. The old line about the markets being predictive is nonsense. If people could see the future, there would be no stock market. The US markets went on a crazy upward run and may simply be going through a correction. Still, the housing market is heading into a recession and the economy is showing signs of a slowdown, if not a recession.

None of this is cause for alarm, but what if the long-prophesied collapse of the credit system is a lot closer than we know? A lot of smart people said that 2008 was one of those tremors that precedes a major earthquake. Maybe what we have been experiencing is something like the Long Depression, which ran in fits and starts for two decades. The last few years have simply been a respite, and we are about to have another serious downturn or even a panic. Will the leaders and institutions hold up?

In other words, the economic pendulum swings back and forth. That is the lesson of economic history. The salient question is whether the political institutions and the leaders can hold up as the pendulum swings. In the 19th century, Europe was convulsed with civil unrest and war as the Industrial revolution blasted through traditional institutions. In the US, the post-Civil War period was relatively calm, even though the same forces were at work. The institutions and leaders held up.

Again, we really do not know if the current system and the people in it could hold up under a real crisis. Maybe the 2008 crisis can be read as proof that the system is better than the people in it. Maybe the lessons learned from it have made the system even stronger. On the other hand, maybe the system held up because of residual stability that has now dissipated. That is increasingly obvious with regards to public trust. It is much lower today than it was a decade ago. Maybe the same is true of the internal stability.

The thing is though, there are a lot of signs that the people at the very top of the global system are slowly rearranging the board. For a long time, America could count on the dollar as the world reserve currency and, more important, a hungry market for US Treasuries. The system built by the American empire relies on credit to operate and the reserve credit of the world is US debt. If there is even a hint of that changing, the great crisis will be upon us. Will those institutions and people hold up?