What Good Are The 99%?

Yeah, that includes me.

Two disruptive technologies have changed the world forever. The one that most people think of is the Internet, but that is not the most disruptive, nor the first. Container Shipping has done more to shrink the world than any technology since the steam engine. Even a massive spike in fuel prices would have little effect. Boats are really efficient and they have huge numbers of power options. The Internet doesn't use that much electricity and while India and China invest in 21st century infrastructure, the US is fighting 100 year old monkey trials and 50 years of keeping the government out of the bedroom.

So I ask the question "If India can do the programming and China can do the manufacturing, and a dozen guys in California can do the design funded by a handful of guys in New York, what use are the rest of us?"

A new way to bank

What if you could get direct deposit to your local post office? It's not so crazy and has huge benefits.

Instead of guaranteeing deposits in an institution the government has no control over and then regulating that institution as a way of saying "please don't make me cover all your crap!" Let's just have a national bank modeled on Credit Unions. We expand the Post Office to act as branches for the federal bank, but leave the banking to a revised FED. One that the depositors own, not the banks. There are many benefits to this model and few, if any, problems.

Deposits would give much more direct monetary control to the FED. If consumers are driving inflation, increase the interest paid to savings accounts. In a slump, lower the rate. The same can be done with loans. The FED can then create a balanced portfolio of mortgages, treasuries, business loans, and other assets as the needs of the economy require. Since no group of executives or investors will excessively profit from this, it will be as stable as the credit unions were through this crises.

During times of real economic collapse, these banks can be the means of direct consumer injection of stimulus. This provides for interesting opportunities. If all accounts are limited to $250k, then all account holders could be treated the same. While Warren Buffet may have an account and get some stimulus money he doesn't need, so will a person who pays no taxes because they are too poor. And there are far more of the former than the later.

Finally, imagine how much easier it becomes to distribute social security, unemployment, tax returns. The accounts can be limited to one per US citizen and thus be a great help to enforce immigration law.

The large banks would still function much as they do now. It is a fallacy that banks lend depositors money so others can buy a house. They create the debt out of thin air. If the bank is leveraged at 10:1, and require 10% down, it simply invents the other 90%. The down payment now becomes the banks reserve rather than depositors accounts.

We will never get such a system, but the idea does encourage new ways to think about things that we think we know. Maybe the biggest question this asks is who owns our economy? Is it the banks, or the government? Shouldn't means and responsibility reside with one group rather than risk goes to one while reward goes to the other?

A Tunisian Fruit Vendor - Another Perspective

The story of a Tunisian fruit vendor lighting himself on fire and starting the Arab spring is tragic and inspiring. We all know the story. Police corruption as an arm of a brutal dictator pushed a man too far. But that corruption is no different than here in Hyderabad. The fruit vendor is no different. The loan shark is no different. The fruit itself was no different. So why there and not here?

OWS, Arab Spring, a fruit vendor, what are they all protesting? The creeping leverage of rent in every aspect of our lives making us poorer, weaker, and more afraid. Were the police wrong? Of course, but why did that man have to borrow money to sell his fruit? If he had saved his money he could have kept both the profit and the rent. But how can he get that money in the first place? The loan shark knows to lend enough to get through a day, but at a rate to ensure the vendor has nothing left to save. The corruption is just enough to take any savings the man may have had and ensure he must always come to the loan shark. The police work in the interest of the loan sharks. If they take too much, there is no fruit to buy and nobody to shake down. This leaves all the profit in the hands, not of the entrepreneurs, but the rentiers in the guise of the loan shark and the police.

And what is lost? A man who knows his neighborhood. Who knows the seasons. Who knows how much of what kinds of fruit to stock up on. Where to be when kids get out of school. In short we lose the knowledge that makes a market efficient.

And yes I am making the connection that the banks are the loan sharks and our government is the corrupt policemen.

Government is not the problem. Government protects the problem.

Truthy Economics

The presidents speech was an envy driven socialist rant against the job creators and wealth generators of Wall Street. Steve Jobs created more jobs (in China) than the failed stimulus program, which didn't create a single (Chinese) job. We know this stimulus stuff doesn't work because highly paid opinion columnists tell us so every Sunday in very stern and serious voices.

Look. The stimulus program works like this. You dip a bucket into a lake on one end and then on the other, in front of a bunch of cameras you pour it back in. Of course this has no effect because the water at the opposite end of the lake rises instantly. Anyone who took physics in High School knows this and is the reason swimming is impossible. Any effort to displace water in one place only gets replaced immediately from the rest because, just like markets, fluids are perfect. Any comparison now between so called "viscosity" and "price stickiness" would imply that the world, created by God, is not perfect and, by extension, God is not perfect. Since God is perfect, so are his markets. Irrefutable!

We also know that all this stimulus, which we just proved has no effect on the market, will cause bond markets to raise inflation rates through the roof due to all the government borrowing. See it works like this. In order to take the water out of the south end of the lake to dump into the north end, the government had to "borrow" water from the east side of the lake and put it into the west side of the lake. Now the west side of the lake has the water displaced by taking the south end of the lake's water. But this water must be paid back with extra water. If this goes on too long, the east side water will see there is a giant hole and a tsunami will destroy the entire lake. If you don't think this is possible just ask Thailand if tsunamis exist. If tsunamis didn't exist then Zimbabwe could have kept printing money just like the FEDs. If you don't understand why water going east to west makes a difference, but water going north to south doesn't, pray more. Seriously, cause I don't understand it but it is clearly his will.

Finally, we are going to end up like Greece. For whatever reason at the time, Obama borrowed all the stimulus money in Drachmas. I guess he figured since the Greeks weren't using them anymore he could get a bargain. But here's the real problem. We owe more Drachmas than exist! Greece refuses to print more and we can't print more Drachmas that would be counterfeiting! What are we going to do? If we can't get more Drachmas we'll end up defaulting on our debt and humanity will come to an end.

There! Humanity will end from a tsunami caused by a hole in the lake formed by pouring water into the lake and the Greeks refusing to print water proof Drachmas. See? It makes perfect sense!

Externalities (or how to create a better tax structure)

Market Externalities are very likely the key to solving all our national problems. But, what are externalities? Externalities are costs or benefits to a person or to people who are not part of the market transaction. Pollution is a common example. In fact, in many ways, you can think of all of our problems as externalities. Problems that aren't externalities are often due to poor or non-existent incentives. Incentives that are often effected by externalities themselves.

People often say that unregulated markets are the most efficient system we can create for distributing goods and services. That is largely true, except in a few key areas. The first I'll be writing about here is externalities. I'll write about the inefficiencies of efficiency later.

Two farmers live next to a lake. One farmer loves to fish in his spare time, the other loves to sacrifice woodland creatures to Cthulhu. The second farmer realizes that if he plows his land right to the very edge of the lake he gets the best soil and the best yield. This also puts excess silt in the water killing the plants the fish feed on and the first farmer gets pretty upset by this. Not only that, the extra food the second farmer is growing has lowered the price for food and now the first farmer can't pay his mortgage. In desperation he also plants next to the lake. His farm is saved and he takes up mud wrestling as a hobby as there are no more fish.

Normally the solution is to pass a law that says you can't plow near the lake, but this has several problems. First, what if the first farmer figures out how to farm near the lake without any mud getting in the lake. The town is deprived of food that could be grown because the law did not anticipate this. Second, the second farmer discovers a part of his property that has all the same benefits of growing near the lake, and it is far enough away by law to plant. Unfortunately this land still washes mud into the lake even though it is farther away. Finally, the two farmers start working together to modify the law so that no new farms can be built unless they can prove that they will not put mud in the lake. Now the two farmers can raise the price of food knowing no third farmer will come in because they made it too tough to get past regulation.

Many economic libertarians believe there should be no public land. If the lake were owned, the owner would demand compensation for the mud in the lake and there would be no need for regulation. This is correct except it means that the local kids can't swim unless they pay this guy and since he is the only one with a lake, he can gouge people.

Can we get the same benefits from the libertarian idea and still keep the lake public?

Sure. We demand the same compensation as any private owner would want. How much do we want food versus how much do we want to swim? How much do we want fish? These all determine how much we charge the farmers.

Borrowing another bad idea often put into practice, why don't we impose a lake front tax? For however much lake front you have you pay X amount. That money will be used to filter the lake. This suffers from many of the same regulation problems. It doesn't encourage anything other than weaseling around the law.

So what is the solution that has near universal economist support? Tax the externality. Imagine if instead of the other solutions we charge the farmers based on the quantity of mud they individually put in the lake. The first farmer discovers how to avoid the tax by using new technologies to not get mud in the lake in the first place. The second farmer decides it's worth the extra cost to plow that area that puts mud in the lake. The first farmer realizes he could license his technology to the first farmer for a price just less than the externality tax. Clean lake, new technology, plenty of food.

The system uses the market forces in a positive way rather than a negative. The desire to save money encourages technology. The lack of regulation means the farmers can respond to market demands with well understood trade offs.

What can go wrong?

What if the tax isn't the right amount? This is easy. Just nudge the numbers around a bit to get to the desired outcome. If food is scarce and the people think the lake doesn't have to be that clean, lower the tax. If the lake is still too muddy, raise the tax. Determining a start point to the tax is not very difficult. It's simply a matter of calculating all the positive and negative externalities and adding that as a modifier into the market. What if one farmer tries to cheat the system? The other farmer has an economic incentive to catch him. If there is no other source of mud, it must be the two farmers. If one farm jiggers the numbers, the cost is borne by the other. The two farmers are in the best position to watch each other. What if they claim X amount comes from nature? This will be quickly absorbed in the pricing of the tax as will the lakes natural ability to absorb some silt. If the number is too high, it will be reflected in the outcome, the lake.

These externality taxes give us a simple way to determine what is more valuable to us. When food is scarce, we give up a cleaner lake. When food is plentiful we want a clean lake. The clean lake gives us better fish at a cheaper price. Our kids get healthier through exercise. We may feel this is worth the extra cost on food.

This is already pretty long so I'll write another post on the many ways both positive and negative externalities can be used to create desired outcomes. 

The Destructive Power Of Rent

There are three basic kinds of income in economics. These are rent, profit, and wages. Of these three, the most destructive is rent. First thing to understand is that in economics words don't mean what you think they mean. Rent is more than what is commonly known as rent, for example, and wealth means less than is what is commonly thought of.

Rent is income derived in such a way no wealth is created. To understand wealth, it's best to use some examples. If I print $1 million, I have not created very much wealth. Other than the cost of printing and the paper and my lovely art skills, I did not make anything that adds to the value of the country. If I build a free game engine that is then used to make free games and everybody loves playing these free games, I have created a lot of wealth, but it is difficult to identify how much.

In the first case, money is made with no creation of wealth, and in the second wealth is created without the use of money. It's important to know that money is not wealth. Nor is it capital as is so often claimed. If that were the case then we could create more wealth with the flip of a switch, but that is not what the FED does.

Why is rent destructive?

A Tale Of Two Coffee Shops
It was the best of grinds, it was the worst of grinds....

One of these coffee shops is right in front of a subway station and the other is on the other side of a busy highway. The one in front of the coffee shop can charge much more because who wants to cross a highway to save a buck? You would think that that coffee shop earns more in profits than the other and you'd be wrong. It earns more in rent.

Let's consider the two shops renting the space they are in. Each has a landlord. Do the landlords charge the same rent to each shop? Of course not. So how much do they charge? Exactly the value difference of the location. If, due to location, one shop earns $1000 more per month, the rent will be $1000 a month more. So who gets the extra value for the location? The landlord.

Why does this make rent destructive?

If the extra money went to wages because baristas were in tight supply, more people would want to become baristas and wages would come down and more coffee could be produced at a lower cost to the customer. The wealth of the country would be increased by having more coffee produced by more baristas. If profits were high, somebody would open a new shop next door and profits would go down. Again this would cause more coffee to be produced at a lower price. This would also require hiring more baristas so wages would go up, but of course that would be temporary since more people would become baristas. If the landlord has a lock on the location, there is no encouragement to adjust the marketplace for a more beneficial distribution of effort. People just pay more and no market forces can alleviate the imbalance.

Now, the guy across the street thinks that if he can lick this highway problem then he could make bank! So he creates an elaborate crane to deliver coffee across the highway. His profits start to rise. So do you think the guy with the shop at the subway is going to get a lower rent? No. The guy with the crane is going to have his rent raised to the same level as the first shop minus the operational cost of the crane. Once again the landlord wins and the entrepreneur loses.

This is what is so destructive. The cost goes up and squeezes the consumer, so they buy less coffee. Since some of those people are employees of the coffee industry, some lose their job. This then makes them not buy coffee, so more are laid off.

"The layoffs will continue until demand improves" to paraphrase an equally ludicrous observation.

Here is where it turns from a problem to a crisis.

What happens when those landlords need people to count all that money for them? They hire them. So the financial industry gets bigger and creates new ways for landlords to make even more money without creating corresponding wealth. And more people get hired away from factories and into financial services. Finally you end up with the only things being made are products designed to suck all the money out of the economy and leave the country broke, derelict, and ignorant.

Economics is supposed to match limited resources to unlimited demand as efficiently as possible. One way to do that is by introducing money. When money is the dominant product of a society, it is effectively producing effluvium. There is no difference between the wasted resources of a gold rush or the wasted resources of a housing bubble. Desired products are not being created so that the ephemeral can be.

Thoughts On A Digital Economy

We are living in a world on the brink of massive change. The powerful institutions will fight with everything they have to prevent that change and perhaps they will succeed. Here is my world if they fail.

The cafe was more crowded than normal, but Jayden had a regular booth. The flame wars had begun again. Such a waste of time. He ordered a beer.

"Hey, you exchanging reps tonight?"

"I got plenty," replied the bartender.

"Then make it a cheep beer, " replied Jayden.

Reputation was the only thing of value in a digital world. Jayden worked alone and avoided most flame wars. He earned less, but lost less as well. In front GlobalHell launched an attack. Most do it for rep but Jayden knew this was cover for a "log run." A digital attack on the analog world. Jayden waited and sipped his beer. He watched his favorite tube and chated with some friends about the show. Ella broadcast her latest episode. Jayden's rep gets him into the live chat.

A ping came from his sniffer. The log run had finished. Jayden walked over to Caleb.

"I'm lookin to sell a few reps," confides Jayden.

"Sorry, man I need the cheese."

Caleb saw Jayden's disappointment.

"Hey look. You've always been solid with me. I gotta cheese head lookin to score some rep. I'll put you in."

Cheese heads are the analog businessmen and financiers. They make their money in the digits, but they make analog money. A cheese head needing to impress will pay good money for rep. It would destroy the value of rep if it weren't for the fact they are largely spoiled rich guys used to getting whatever they want. They don't understand the new world and lose reputation faster than they can buy it. When someone is suspected of paying for rep someone will ask aren't you Aubrey or some other cheese derived name.

"Yeah that would be great." replied Jayden.

"Saw your tut on back end UIKit. That was fresh. You know I could always use more digits."

"Thanks, " Jayden beamed.

Rep is more than a way to keep score, it is its own reward. The beards in the lecture halls don't understand it so they pretend it doesn't exist.

"but I'm OK alone," he continued.

"You're never alone. Just remember that."

Caleb turned to his gang and Jayden went back to his booth to wait for the suit. Jayden prefered making his cash picking up gigs on the net, but his latest vid took more time than expected. Jayden hoped this suit wasn't 5-0. Nobody has yet figured out what the crime is, but the government and the corporations can't get a piece of it so it must be illegal. They trump up charges and try to flake a digizen. Luckily Digizens United is very good at making evidence disappear.

$200 haircut and a Movado on his wrist. The cheese head wasn't fooling anybody.

"Time to make some cash." thought Jayden.

Finance Is Not A Free Market

If we look at Financial institutions the constant claim is that they are private companies and should not be heavily regulated. But this is simply wrong.

We can argue till we are blue in the face that regulating is good for the economy, but this is irrelevant. We are ignoring the role of the Federal Reserve. If the economy heats up, the Fed raises interest rates and when it slows down, it lowers them. When there is a rise in the value of a currency, the treasury prints more money. But why do this if the market is always right? Because financial institutions are not private corporations. They are publicly funded private/public partnerships. The way it works is like this.

Banks try to make obscene amounts of money any way they can. When they make too much, the Feds come in to modify the economy in some fashion to slow runaway growth. When they make too much, the Feds give them money for free.

OK. Here's one example of how this works, or I should say doesn't work. The economy slows down and the Feds lower the rate for BANKS. Not for everybody, only banks. This means that banks can make more money if they loan more money. But then there is a wall. What happens if the Feds cut rates as much as they can and it still is not enough? Liquidity trap. Banks borrow money at almost no interest or even zero interest. But if the economy is so bad there is no point in lending for profit, banks look for old debt that paid more and they buy that.

A bank gets free money so it can lend to an economy that is desperate for investments. But it says instead...

You know all those bonds that were issued in the days of high interest rates? Let's buy those instead of lending to new companies. We'll make a fortune!

This old value over new is not new. During Reagan, art auctions for antiques went into record breaking levels. Bush as well. The housing bubble is the same thing. Don't invest in new things, invest in things that are valuable only if the rate of interest is zero. These things are rarely innovative.

The flip side is what happens when the economy is going incredibly? We have the same problem. I have $100B and I want to invest. Well, so do a lot of people. So should I invest in long term progress to build a greater nation, or should I invest in what I know is overvalued commodities that are rising 10X the rate of everything else? If you can get out at the right time, go for the bubble! If you don't, you lost your corner office to the guy that did. Oh and the multi-billion dollar bonus as well.

Finance is a strange beast that should not push the bounds of the market because it serves as a fundamental arm of government. Just like the Army should not try to make a profit (Shudder and think of that outcome), banks should be limited in what they can do to make a profit.

Where's The Wheat?

All over the world food prices are rising causing riots and starvation. The weather is certainly partly responsible, but that is not the real story. It used to be that the rule in commodities was simple, Supply and Demand. Another way to look at this is the stock to consumption ratio. That ratio is not really very high right now. There is enough food and it is getting from where it is grown to where it is eaten, so what gives?

Does it seem to be a recurring theme that wherever the majority of people are suffering, a small part of the population is getting stinking rich from that pain? At a very simple level what is happening right now is that those people that made a fortune in mortgages and then begged for a bailout are now buying up all the food and oil. After all, we all have to eat and these days that also means we all need food shipped to us. So by holding part of the food and part of the oil out of circulation, the price goes up for you and I. It's like there's a millionaire welfare tax on everything.

You might think that these people holding all this up must be spending a fortune on storage costs and losing money on food spoiling. Not really. Food and oil are necessities in the modern world. If the price of food goes up, consumers will pay. If consumers can't pay then governments will subsidize. Speculators know that when it comes time to schedule a ship or a train, the owners will pay any price for the futures. Those owners know they can sell the high priced wheat to the distributor who knows he can pass it on to the stores who pass it on to the customer. The kind of food eaten will change, but not the total calories. (no wheat was harmed in the making of this explanation)

They have also packed these futures into securities that speculators can then buy insurance on. Is this starting to sound familiar? It should, it's the housing market all over again.

Now for the REALLY scary part. There is more money in the world than everything in the world is worth. And, speculators can make more whenever they want. So in theory, speculators can buy everything, wait until our last breath and charge us every penny we have. At that point we are of no value to them and we die. That theory might seem a little harsh and unlikely unless you are a poor family in Bangladesh starving to death because you can't afford the price of food doubling. Then that theoretical life becomes your true reality.

How can this happen? In 2000, at the end of Clinton's presidency, he passed a whole lot of deregulation laws that led to the housing crises we have now. These also deregulated commodities and a whole lot of other things. And who can we thank for this deregulation? The same people who invented many of these new financial instruments, The Koch Brothers!

Yeah, but how does it work? OK, first we have the whole food spoiling thing and the storage. What if what you own is not a pile of wheat, but instead a certificate saying that some wheat is yours somewhere. As long as the wheat keeps moving, but a pile is reserved for you then that wheat will keep getting freshened up with new coming in and old going out. So it is with futures. As the wheat is about to be delivered you sell it and buy another future. Since the original futures traders, the farmers, shippers, and retailers still need the system you will always find a buyer. If the farmers decide to grow more food than is needed and the retailers have a decrease in demand the speculators dump everything and move to another bubble. They lose money, but nothing compared to what they made. The commodities market now has no idea what the real price is or the real supply and demand. It is in chaos and people die.

But this brings up the biggest question. Why do we let this happen? We've conflated capitalism with democracy. All this ranting and raving about "Free Markets" makes us think that our democratic freedom is in danger if we regulate markets. But this is stupid! We have a democracy and yet we have laws. Having laws that reflect our values as a people is what democracies are all about. Pure freedom is called Anarchy. Once we see that we function best when we agree to laws that benefit the majority over the powerful, we return to traditional democracy and the great economic gains that brought us.

Little Pieces Of Paper

I have been troubled by an aspect of this economic crises that seems to be overlooked. Our tool has become our master.

I'm specifically talking about money here. We have become slaves to little pieces of paper that are so useless they can't be eaten, or worn, or keep you dry, but are so valuable you would never even blow your nose with one. This is insane!

As best as I can figure out, this is what happened and why we are here. The US, once upon a time, made things that kept you warm and dry and grew food to eat. But then we realized that other people could do that cheaper, but not better. So we gave them our little pieces of paper so they would do this for us. But with others making all those things, what should we do? After all, sitting around and doing nothing wouldn't get us any more of those little pieces of paper. Then it hit us! All those people buying all that stuff made elsewhere needed little pieces of paper, so we would make that. But, you can't just print up your own copies of little pieces of paper, that would be illegal. And we can't have the government do it, We wouldn't get any profits! And besides, we all know what happened to Germany when they printed little pieces of paper. Inflation went crazy, the cost of everything went through the roof, and the economy collapsed.

But what can we do? What if we create new pieces of paper and sold them? And since nobody with any common sense would give up official little pieces of paper for ones we invent, we'll offer little pieces of paper insurance! This is fool proof! Of course this little piece of paper is worth something. I have another little piece of paper that says it is. Now go out and spend.

So we stopped making stuff and started making little pieces of paper and we were so proud of ourselves we even invented a new name for how clever we had become. We have shifted to a “Service Economy.” And the primary service we provided was lending official pieces of paper in exchange for our home made little pieces of paper and we even, for an additional $19.95, offered a completely different piece of paper telling you how good our invented paper is.

This is where it gets a little funny. Everybody started making just as much stuff as we used to and even more. All so they could have our little pieces of paper. But, once they had all that they didn't know what they should do with them all. Clearly they are too valuable to blow your nose, and they don't keep you warm, and I don't really want to buy those crappy Salad Shooters Americans seem to love. I'll buy those new little pieces of paper! They are all the rage! And so everybody was happy.

Until.

Somebody looked up one day and realized that there was far more homemade little pieces of paper than there were official pieces of paper. But that's OK because I have this other piece of paper saying everything is fine. But it wasn't. The second piece of paper was just as imaginary as the first. So suddenly everybody wanted official pieces of paper so they could pretend these homemade pieces of paper never existed. If I could dump all this worthless paper for some of that official paper then I can pretend I had no part in this Ponzi scheme. But everybody wanted to do the same thing and nobody was accepting these pieces of paper anymore and as useless as official pieces of paper are, these are even more useless. And yet they are still too valuable to use as tissue.

So this new “Service Economy” is playing tug of war with all the official pieces of paper and refusing to let any of it out of their sight. Meanwhile, the suckers in the old “Making Stuff Economy” are demanding little pieces of paper so they can make stuff. See, the financial geniuses convinced everybody that rather than save up or raise money to buy auto parts so you can build a car, they should borrow the money. After all, they'll sell the car in a matter of weeks anyway, so why sit on all that cash when you could be accepting these new homemade pieces of paper. And we will give these pieces of paper to your customers so they can buy that car without saving up either.

So the bankers printed money and speculation went through the roof, and the economy collapsed. All because of a little piece of paper.

Why High Taxes Are Good

...or the invisible hand is senile old drunk.

If you don't know what the invisible hand is, go check wikipedia and I'll wait here.

Done? Good.

I have a friend who has a robot vacuum cleaner. Without his controlling the thing at all, it vacuums his entire living room. How does it work? Some secret AI doing advanced pathing? Careful memory mapping of the room? Stochastic dimensional area-ization formulas? It bounces into a wall and randomly turns. It's dumber than a staggering drunk. And so is the invisible hand. 

Now, if I ran that vacuum long enough, it would vacuum every corner and every square inch of carpet. However, a person could do it with less waste. So how efficient is it? Well, it depends on what is to be measured. If I measure the effort I must put in, the robot is more efficient. If I measure the energy and time used, I am more efficient. If I measure the cost of electricity and what I would have to do to earn that electricity, well, that would depend on my job and wage. 

So, if you love the idea that government does no work and should do no work, then by all means, let the invisible hand vacuum your floor and watch it painfully bouncing into the same wall and turning only to bounce off the same wall again. If you think maximizing time and resources is the most important, then have the workers control the means of production and watch the incredibly efficient production of stuff nobody wants. But, if you are like most of us who really just want the biggest bang for the buck, then it depends on what else could be done with that time and effort.

I'm going to turn things on their heads for a minute and apply economics to the schools of economics. Economics is all about making choices when faced with limited resources. Economics is "the science which studies human behavior as a relationship between ends and scarce means which have alternative uses." 

So economic philosophies attempt to decide what is the “right” way to use scarce resources. Marx believed that profits and rent were improper wastes of scarce resources and only labor should be rewarded. Libertarians think that only the market can decide value and only through complete privatization can a correct value be placed on anything. Others believe that the most efficient method to get goods and services from those who can provide them to those who want them by any means necessary. Keynesian economics believes that markets can only run at peak efficiency through government intervention.  

So now we see the variables at play. Government intervention; Market Freedom; Productive Capacity; Profit; Labor; Rent;

So, if I were a libertarian, I would measure the government intervention and declare success regardless of productive capacity. If I were a Marxist, I would declare victory when rent and profit were zero regardless of productive capacity. If I wanted the most stuff for the least effort, I would declare victory when productive capacity were as high as possible. 

I know some will complain that this is not fair. Both Marxists and Libertarians believe their philosophy does maximize productive capacity. But, my counter argument is that they should then put that at the beginning of the equation and let the rest just happen. But they don't. They have decided an outcome and want to prove they are right. Some solutions favor free markets, some favor communism. Most are both and neither.

Here are some interesting things to think about. They are macroeconomic principles:
There is infinite work to be done.
There is infinite demand for goods and services
There is an infinite potential for productive capacity

If there is infinite work how could there be unemployment? Because the invisible hand is a dottering old fool that wanders around like a robot vacuum only sometimes looking smart and the rest of the time we anthropomorphise the thing to the point we cease to see its flaws. Same answer for questions on the other subjects.

Markets attempt to reach equilibrium. Ok, fine, but they don't do it very well. If I asked you to drive straight down a road then you would drive straight down a road. If the invisible hand drove the car, it would drive straight until it started to swerve off the road and then over correct only to bounce off a passing car in the other lane. Or put another way, economics, like water, always seeks its own level. But, Tsunamis and hurricanes still cause massive disasters. And floods don't go away overnight. 

Does anyone doubt building an interstate highway system would increase a country's productive capacity? How about a court system that protected contracts? How about an energy grid or a rail system? We know that these raise the productive capacity of a country, but the market rarely builds these. Why? Because they benefit the competitor as much as it does them and if they didn't we would have 50 different roads between Chicago and St. Lois. They also require massive spending and in many cases, no clear way to collect money after. Toll roads reduce the benefit of having the road in the first place by forcing drivers to slow down and fumble for change. A partial destruction of the benefit is necessary for the profitability of that road. Now, imagine driving to work where every road is owned by somebody else. They may be in competition with you and simply refuse to allow you to buy passage on their road. 

We have a unique advantage in a democracy that other forms of government do not have. We can collectively decide what should be done and though it is flawed, we often make better decisions this way. If we look at the things we spend our government money on, it goes to what we want it to go to. I know I'd like to see a shuffling of priorities, but the point isn't that I get exactly what I want, but rather I get roughly what I want. I can't afford a tank let alone an Army. I can't send a man to Mars. I can't cure AIDS, but I can vote for my tax dollars to do that. And, the budget becomes a compromise of our collective values. As long as we get rid of this idiotic notion that we will get a better mix in the private sector, we can all be pretty happy with a 10-20% increase in government spending. 

So I can't afford everything that I think will make the country a better place. And neither can Bill Gates, or Warren Buffet, or anyone.

Bill Gates is doing an admirable thing by taking his money and spending it on Africa. That's great, but I think it's a waste of time and money. Africa is a political problem, not a monetary one. Maybe I'm wrong, maybe I'm right, but if it were government money we would debate the merits and then act. By deciding that only the wealthy can decide is to say that only the wealthy know the best course of action, or are not being self serving. If Gates is wrong in Africa, I can't fire him, but if Obama is then I can.

This has always been the downfall of other collectives. Monarchies rely on one person to be really smart. Communism almost guaranteed failure by turning the economy into a committee meeting. Free markets rely on the drunk old invisible hand to bounce perfectly into the right oncoming car and squeak through the right decision. Needless to say this almost never happens.  

When we had high taxation on the wealthy we built dams, roads, nuclear bombs, won a world war, went to the moon, built an interstate highway system, electrified the nation, built a national phone system, built a national trail system.

Now that we have decided that you can spend your money better than the government can we have collapsing bridges, deteriorating rail system, not a single new mile of trails though wilderness usage is way up, no national fiber optic system, an outdated electrical system, a decrepit space program, and a productive capacity that can only sell houses to ourselves using money borrowed from China.

This is not a useful investment in our nations future. This is not the way to be the leader of the free world. This is not the way to be a major player in future technologies. We became a manufacturing superpower by following Alexander Hamilton's “Report on Manufacturers” which advocated strong government involvement in building infrastructure and funding young industries. We created canals and railroads making us the most powerful industrial economy in the world. Despite a devastating Civil War. We then became a military power through massive government seizure of production during WWII. That became a massive technology investment making us the inventor of the new economy. 

Now after 200+ years we have decided that all that stuff government did to get us where we are was no good and we shouldn't pay for it. Government has no role in the market and the market can do this all by itself. But ask this. What has a pharmaceutical company ever cured? Oh sure, they are great at managing a disease for the rest of your life, but a cure? Why do that? How about a space station? Surely there's a market for that? So why isn't there one that is privately funded? How about a weather service? Everyone complains how the weathermen are so bad. There's a clear demand for better weather forecasting and yet all those weathermen get the same data from the same government. How about a super-collider? Or a unifying theory? How about doing the human genome project itself rather than combing data provided by the government.

The truth is the market sucks at pure research. Markets suck at infrastructure. Markets suck at science. Markets suck at exploration. What they are very good at is exploiting what governments pave the way for. Governments paid to discover a trade route to India. The East India Trading Company brilliantly exploited that discovery, but didn't discover anything on its own.

Here's a big one. What do we have that is fundamentally different than we had in 1958? What major, life disrupting invention have we come up with in the last 50 years? Sure, we've made computers better, jets better, rockets better, cooler TVs, better ways to distribute movies. Now, compare that to 1908 - 1958. We got the Airplane to the jet airplane to rockets. Steam engines to diesel electric. Rural electrification. Sewage systems. Water systems. End of the horse as primary transportation. Nationwide phone system. Helicopters. A cure for Polio. Blood typing. We went from the world of Malthus to the world of Galbraith. A world of barely surviving to a world a affluence. 

This was done with government money spent on things that we the people thought reflected our values and desires for the future. 

It's said that there are three ways to order and organize the means of production, and I'm not talking Marx just because I use that term. 
Central Planning
Free Markets
Mix The Two.

Well, I don't think I have to convince anyone that Central Planning has problems. In a way I am trying to show that might not actually be the case, but let me continue. Free markets? Well, I think they suck, but similar to Democracy, it's the worst except for all the others. But what about a mix?

The problem with central planning takes root in another notion of economics. It's the question of value. If I want something really badly that costs $100 and I buy it. It may be worth $1000 in my happiness. A $20 life jacket is worth every amount of money to a drowning man. But, a glass of water is worthless. And that's what happens with Central planning. Too often the life jackets, or Louisiana's amphibious vehicles, go to the desert and the water goes to the flood victims. This is when we all laugh at government and say what a lousy job government does.

OK, so the free market would never do something so stupid. It would never sell dog food or lumber over the Internet. It would never overvalue homes to offer bad loans at the height of a housing bubble. Nor would it ever use heavily leveraged mortgage money to jack up the price of oil futures. I think you get my point.

Here's where Democracy makes a big difference. Political pressure made Brownie lose his job. The same is not happening on Wall Street. When a Democracy does something stupid, the voters get a chance to correct it. If the government does not respond to our values, then we vote for those who do. We don't get to vote on Wal-mart building a new highway to the massive store they just built. They expect us to build it for them. And that's fine, because then we get to decide if that's the best thing for our town. Maybe we want Wal-mart to be a little difficult to get to. Maybe we don't, but that's a debate we get to have.

But what about voting with your dollars? Well, that means Paris Hilton gets more votes than you, but her vote can have a massive impact on you. Let's say she wants to build a perfume factory next door to your house. Well, if you don't like it, don't buy her perfume! That will show her!

The point of all of this is look at what government can do and has done. Look at our values and compare it to the values of our government. If you don't like those values, try to change them. But, government spending is not the enemy. People telling you it's the enemy while they spend like crazy on things that don't reflect our values are the enemy. They want us to debate low taxes and evil government spending rather than looking at what they do with our money. And my favorite is when we catch them doing it, they say “see! Government spending is evil! I just proved it!”

Tell the Europeans the Marshal Plan was evil.

Spoon Full of Sugar

With a collapse of the financial market, why on earth would I care a fig about inflation? After all, aren't we in a period of massive deflation? 

Yes, we are. But as I posted earlier, deflation is easy to fix. And it can be fun. Inflation is like stopping a boom. It's unpleasant and nobody will be your friend after it's done. Just ask Carter. 

Here's a proposal. 

In order to end deflation, we have to print and spend a lot of money. We will get schools, roads, bridges, parks, all the great stuff that came out of the depression. But, we may end up with too much money and that would require a massive hike in interest rates, the very rates that are near zero now and not doing anybody any good. Unless Germany and Japan can kindly go to war with us again so we can soak up that extra cash and capacity, we will face a very painful time as we return to normal economic policies. 

I know I said there was a proposal, but hear this all out first. Why not just not print that much money in the first place? Well, the problem here is that you need to actually cause inflation and it has to be believed by everyone, especially bankers. If I have $1000 at 0% interest and pay back $1000 at the end of the year, the lender has made no money. If I borrow at 10% interest then the bank makes $100. But, if inflation is at 10%, the bank has the same equivalence of money as before. So, why should a bank want inflation? Because the bank can leverage that to a better advantage. If the bank borrows at 0% and you borrow at 5% then you pay back $50 more than you borrowed. The bank is sure you will pay it back because money in the future will be easier, not harder to get. The bank pays back $1000 and gets to keep its risk free $50. The bank is borrowing at -10% interest and you are borrowing at -5%. In other words, the Feds are paying you to borrow money. 

Now the bank only needs $100 to lend you $1000. I know, it's called fractional reserve banking and it's very weird and I personally think it is the basis for most of our economic problems throughout the last two centuries, but that is how it works. Anyway, They are in effect making 50% profit from that 5% loan. The reason they won't make the loan now is that the expectation is that deflation is running about 5% now. That means that $1000 loan that needs to be paid back at $1100 is going to cost the borrower $1155 in todays dollars. For many, that is just too much and the bank has to foreclose and cough up that money itself. So a bank loans $1000 on $100 and makes $100 or loans $1000 on $100 and loses $1155. That's an upside of +100% or a downside of -1,155% or more than 10 times the loss as there is for the gain. So the banker has to know that there will be inflation and the borrower will be able to repay the loan or at the very least, the house will be worth more in the future. 

Plus, the bank has to fold deflation into the loan so the interest rate is out of reach for many people. If I borrow $1000 at 0% and hold on for a year at -5% inflation, then I made $50 for doing nothing. If I put that in a T-bill at 2% then I make 7%. That's a nice amount of money for doing nothing! If I loan it, I'd need 12-15% to make that kind of risk/return. 

Really, the proposal

So here's the idea. What if we raise interest rates to about 5% over the next year while at the same time print lots of money? I know it sounds like it's self defeating, but here's the beauty of the idea. The hard times come during the good times and all that is needed when we are recovered is to ease off the good times. It's like deciding ahead of time who will be the designated driver. In this case, it will be the banks. Yes, those same people who got us into this in the first place. But here we are asking them to do what they are good at. They are good at being party-poopers. In fact, they are so good at it that they are preventing us from having a party right now which is why the Feds have to throw us a party instead. 

So, the Feds become the bank while the banks wring their hands and worry about their balance sheets. Eventually they will see that with inflation making loans less risky and the negative numbers on the balance sheet start looking smaller due to inflation and the T-bills starting to look less and less desirable, they will start to loan money again. 

When the designated driver looks ready to have a drink, we know it's time to end the party and go home. The banks take over more and more of their proper role in the economy and the feds do less and less. The rate is now in a position that it functions again both directions and we can return to our normal insanity. 

I believe this will prolong the time the government has to stimulate the economy, but I don't think it will prolong the overall time the Feds will have to intervene in drastic ways. I just think it will let them intervene completely on the stimulus side, and not at all on the politically disastrous kill the party side. So no politician has to face the issue of do the right thing, but commit political suicide. There is a big implication of trade and flight from the dollar, but I may mull those over in a future posts.

Every thing's Just Fine

This current economic mess is a pretty simple problem to get out of. There is no chance we will do the right thing to fix it though because too many people have the wrong idea about why we have an economy at all, or even money. Understanding that is the key to understanding or current mess and the obvious solutions.

Some Basics

OK, so the first thing to realize is that we did not get invaded or bombed or hit peak oil or had a catastrophic ecological disaster, yet. So our problem is a wholly man made problem and, as opposed to an oil spill or industrial accident, wholly one in a fictitious world. 

Let me back up a minute to say something that will shock many people. Economics is no more real than the rules to baseball or Texas Holdem. I know, I know. The economy is how our world functions, the “Invisible Hand,” communism doesn't work, blah, blah, blah. The “The Tortoise And The Hare” is also fiction. It doesn't mean it's not useful, it just means that it's fictional. There is no theory of gravity equivalent in economics just like there is no formula for winning a football game. And there lies the solution to this whole mess.

Just go with me for a while that economics is just a bunch of made up rules to a game we all agree to play. First, what is real in this game? In soccer, the players are real, the ball is real, the field is real, but the rules are fantasy. In economics, production capacity is real, workers are real, consumer goods are real. What is not real? Money, loans, bonds, stocks, inflation, these are all by-products of the game. Just like offsides, holding, pass interference are by-products of the rules to American Football. 

Why Won't We Fix This?

So, like I said earlier. Nothing fundamentally has changed. Everything is still there. Factories are still there. Workers are still alive. Consumers still want stuff. So what's the big deal? The big deal is money. Who has it, who can get it, and who controls it. This is the focus everyone is so fixated on. The real question is what do we want and how do we get it. Money is only a tool to facilitate the production and distribution of goods and services. Money itself is pointless. You can't eat it. You can't drive it to work. You can't wear it, though I know someone who would try. So it's just pointless pieces of paper. It used to represent gold, but that's even dumber. Suddenly finding a ton of gold does not increase production and so does nothing to actual wealth. Losing a ton of gold does not reduce the production. Right now we have lost a ton of gold and have shut down the economy while we all scramble around looking for it. It's the most insane thing I could imagine doing. The house is on fire and we are throwing money on the fire thinking that since money can buy water it's the same as throwing water on the fire!

We are so afraid of inflation and debt we are letting real things stop making real things. My dad has bought into one of the right wing talking points, and I don't blame him. It goes like this. We are in this mess because U.S. consumers went too deep into debt to try to fund a lifestyle beyond their means. OK, but my response is this, It couldn't have been beyond their means because we could make the stuff. So, forget about money for a minute. If we have the productive capacity to make all this stuff, then it is not beyond anyones means to have it. Imagine this, because it really happened during the Great Depression. Farmers have fields full of produce and people are starving in the city because of lack of money. Does this scenario make any sense? It does if the prime importance is a little slip of paper, but it's nonsense if it is your child dieing in your arms. To say that the parents are to blame for having kids they could not feed is not only callous, but incredibly stupid. The food is there. The work was done. Somebodies idiotic fiscal policy drove all the slips of paper away. That is why the child is starving to death.

So Where Did All The Money Go?

Here's the biggest secret to this whole mess. The money that disappeared never existed in the first place. When you ask the bank for a loan, it hands you a check to go against whatever you are going to buy. That check, if you or I wrote it, would bounce higher than the moon. It is written on nothing! As our productive capacity increases, and our population, we need more and more money to keep the economy running. The US in its infinite stupidity decided that the best place to get money is for everyone to borrow it. The more money borrowed, the more money in circulation, the more goods and services produced, and consumed, and workers get paid not quite enough to pay for all this. Through the brilliance of trickle down economics, the workers go deeper into debt to those who don't need any more money, but who's money rests solely on the workers being able to borrow and spend more every year. It's just an elaborate version of the old sharecropper scheme. 

When the consumer can no longer borrow more or repay what they have borrowed, they get punished even though the economy rested on this very thing happening. If the consumer had gotten wise and been more prudent, this same scenario would have played out, but the complaint would have been consumer hording, which is exactly what happened and exactly the accusation hurled in Japan. The problem in both is the same and the solution in both is the same.

One more point about trickle down economics. In my previous post I pointed out that a boom is too many investment dollars chasing too few investment opportunities, the investment equivalent of inflation. When the wealth is concentrated so much as it is now, it is inevitable that we will have a huge series of bubbles. One bubble just replaces another as stocks of the 90s became housing became oil futures until everything collapses and that string of clever deals unravels and nothing was based on nothing was based on nothing. Now we are in a crises, not because of the plight of the workers, but because of the plight of the wealthy. 

So, Einstein, How Do We Fix It?

Print more money!

Every year we grow our production capacity. Every year we grow in population. Every year we need more money. Our national debt grows to cover projects that are getting done and work we think is important. Our trade deficit grows for all the new demand of goods and services that are being done. It's time to see money for what it really is, a tool. If we need more of it, just print the stuff. We did this with colonial script and with the green back. The LETS system is a variant of the idea. Take the idea of borrowing out of the monetary surplus equation. 

But we can't do that! After all, this system has been around for about 100 years and we've only had one, and now maybe two, great depressions, recessions every half dozen years, bank failures, S&L failures, wall street failures, booms, busts, stagflation, inflation, gold speculation, and it's working just fine. Printing money would be just like Weimar Germany!

No it wouldn't. Weimar Germany printed money to get out of the obligations of the treaty of Versailles. It was not done as a gesture of being a good steward of the economy. Spain endured inflations and recessions after the new gold and silver from the new world ravaged their economy. Rome experienced booms and busts based on foreign conquests. Britain rose and fell through colonial exploitation and the economic upheavals caused by that. Every banking disaster of the last and this century has occurred at the end of low taxes for the wealthy producing a housing bubble. Being helpless in the face of a nations monetary base hasn't worked. It is time for us to take direct control of our monetary reserves. Trickle down economics is much more like Weimar Germany than taking our own control of the monetary base. Trickle down economics allows the printing of free money by those with the power to do so. Issuing new stocks, new lines of credit, new mortgages, are all methods of printing more money, and more money is clearly needed. That is how we grow. However, this form of creating currency comes at too high a cost. We are in effect renting our circulating capital from private enterprises. 

Our economy was doing OK, though pretty lethargic at previous levels of money. Let's print what we lost and call it even.

When a Dollar is not a Dollar

We often think a dollar is a dollar. This concept gets us into trouble when we try to understand the economy or economic troubles. If we instead think of two different dollars, financial issues become clear and even Stagflation can be understood. I'll call the first of these two dollars Consumer Dollars to represent money used to pay workers and to purchase consumer goods. It is money that circulates quickly and has a very high velocity. These are the dollars most of us think of when we think of dollars. The second I'll call “Investment Dollars” and represent money used for long term investment purposes. This is money held as stocks, bonds, loans, etc. It has a low velocity. 

Adam Smith, perhaps unwittingly, referred to this when discussing bank notes. He explains the effective difference between “fixed capital” and “circulating capital”. He opposed small bank notes believing that money should only be borrowed in order to procure materials necessary to produce goods. He believed borrowing money to purchase consumption goods was so insane no person or government would ever do it.

Recession and Inflation

Inflation occurs when too much money chases too few goods. The normal response to this is to constrict the money supply by printing fewer dollars or raising interest rates. Recessions occur when too many people are trying to horde too few dollars. The normal response here is to print more money or lower interest rates. When either of these become severe, as in the US in the 70s and in Japan in the 90s, the solutions must become more drastic. They remain the same solution, but become politically more difficult as the remedy becomes more and more drastic. However, these measures only work on the right problem and because there are still many who, for political or ideological reasons, dismiss Keynes, the most effective methods are often vehemently opposed. 

Regardless of the method used to combat recession and inflation, in this context, inflation and recessions are consumer dollar problems.

Booms and Busts

To differentiate Fiscal problems from consumption problems, I will refer to booms and busts as the fiscal equivalents of inflation and recession. A boom is too many investment dollars chasing too few investment opportunities. A bust is too many people trying to horde too many investment dollars. Keep in mind that this behavior can occur regardless of what is happening on the consumption side. Though, this is often clouded with statements like “Wall street is nervous about the new consumer confidence numbers coming out today.”

The solution to a boom is usually pretty simple, but politically almost impossible. Who wants to be the one who ended the party. Unfortunately, not ending the party will result in a horrible hangover. This hangover is much more expensive to fix than stopping the party. I will delve deeper into this in my next post.

Stagflation

So, how does this explain stagflation? In the 70s, we had rising inflation and rising unemployment. Remember that inflation is too many dollars chasing too few goods. The solutions to inflation almost always focus on the too many dollars part. This is what the policy of the 70s did. However, the rising unemployment should have pointed to too few goods as the real culprit, and the fiscal policy of the 70s is also the policy needed to end a boom party. The problem here is there was no party to end. Instead we had a little bit of a headache. When interest rates rose, investment dollars disappeared.

If a factory owner wants to make more money, and demand is high, he can expand production or raise the price. If he raises the price too much another entrepreneur will think “Hmmm, I could make a killing too if I made that.” So he goes to the bank and borrows some money. More likely he would go to an investor, but for reasons I won't go into, the end result is the same and the bank makes things much clearer. Now, if he borrows at 5%, he obviously needs to make more than that to pay his loan back, so if we assume the normal profit rate is 5%, then he needs to sell his goods with a 10% mark up to cover these costs. 

If banks raise the interest rate to 18%, as happened in the 70s, the prospective factory owner would require a 23% markup to cover these costs. The original factory owner can also charge 23% even though his costs are only the 5% normal profit rate. The 18% his competitor must pay becomes, to him, all pure profit. At some point consumers will cease buying the good and those who borrowed the money to fund a factory will go under first. But, unless something significant changes, like a massive recession or a sudden availability of cheap investment dollars, the situation will remain where it is. 

When the Fed turned its policy against consumer dollars instead of in favor of investment dollars, it also hurt the real problem of the economy which was supply and not demand. This has been taken up as the neo-con mantra of economics. However, the trickle down crowd has learned the wrong lesson from this supply crisis. Just as a sudden influx of dollars can un-stick a recession, supply side policies can un-stick a bust. But, an influx of dollars is not an appropriate long term solution to a robust economy any more than trickle down economics is a long term solution. 

This does not completely explain stagflation, how it started, how it ended, and what should have been done. I hope, however, this makes understanding the debate much clearer and helps illuminate the insanity of some “analyses”, especially given our current situation. I wanted to explain how I am thinking about the macro economy before I delved into my understanding of our current mess. 

Living Life Behind The Power Curve

I wrote this a while ago and shared it with friends. I think it's worth saving some place.

You are flying the final leg down to the runway and you realize you're too low. You add power and pull back, but you're still going down. Give it full power and you're barely holding altitude. What's going on? This is called flying behind the power curve. This phenomenon happens because there is so much drag on the airplane it can't climb no matter how much power is added. The trick is to push the nose down, get some speed, and gently begin the climb again.

How often do we do the same thing in our life? We are so focused on climbing and we give it everything we've got, but we still aren't climbing or worse, we're going down. This is living life behind the power curve. All we need to do is back off, get our mind and body into a healthier condition and we can climb almost without effort if we so choose, or glide along where we know our position is our choice, not our limitation. This all seems so simple until faced with a real situation. Imagine we are in the airplane again and in front of us is a row of trees, power lines, or buildings. It takes an awful lot of faith, training, or both to be willing to point the plane straight at disaster in the hopes of recovering later.

When will the plane begin to climb again? Could I make it if I keep doing what I'm doing? Looking back at our own lives, the trees become bills, power lines are credit card payments, and buildings represent a mortgage. Can we risk easing off in our attempts to climb with those looming threats?

We often know we cannot continue as we are, but are afraid of what happens if we stop. If I don't deliver this project on time, will I get passed over for a raise I badly need? Will I get fired or laid off? If I ease off now I know I will crash and I do seem to be climbing ever so slightly. So we continue like this and just barely miss the trees. We look out in front of us and are relieved to see there are no more immediate obstacles. Now is the time to nose down and get out of this situation, right? Of course not. We cleared the trees meaning this must obviously be working for us. In fact, things are going so well, I'm going to fly over to the other side of the mountains; and so we buy a new car or take a vacation on our credit cards or buy the latest new gotta have gadget or learn to fly.

Thumbs Out, Thumbs In – Off With Their Thumbs!

The wealthy, powerful, and connected sit on high watching the masses struggle and fight in the arena. They place their wagers on the outcome as simple people strive for nothing more than a life of food, water, and shelter. The betting becomes intense as the outcome becomes more and more certain. All wagers shift to the obvious winner and as the house has predicted this years ago, it is only too happy to oblige. The fight slows. The fighters worn out. The outcome becomes questionable. The gamblers begin to panic as the fighters refuse to give a satisfying outcome. The house suspends all bets and the gamblers cry out in fury! This is not fair! We are ruined! The drones did not behave correctly! It is our right to exact justice!

The wealthy retire to their private jets and sky boxes to await the just decision of the referee. As the masses have failed the gentleman gamblers, let the masses pay the losses!

Understanding The Meltdown

The more I read about explanations for why we are in a financial crisis, the more I realize Occam was right. But in this case the simplest explanation is not how do we understand the problem, but rather where are we looking. We blame bankers for making illogical loans and gambling trillions of dollars. We blame middle America for wanting to own a home. We blame deregulation for allowing financial institutions to put the national economy at risk. Finally, we blame the overseers for not overseeing. All of those explanations are only symptoms of a very simple and fundamental flaw in our economy and, indeed, our entire national understanding of economics.

Let me walk through a simple thought experiment:

Imagine there are ten people and each has $100. This creates a society with $1000 worth of currency. One is given the exclusive privilege to lend money at a fraction of what he actually has. So, five of the people decide to borrow $1000 each in order to build a home. We now have $6000 in our society. The borrowers agree to pay back $1200 at the end of the year, but since they are not banks they must return the money in real dollars, not as bank credits. All five cannot repay the loans because it would require there to be more money in existence than actually exists. Even if, through the “invisible hand” of the market each of the five could get back all the credits outstanding and pay them back to the bank, the return would be short $500. These five must somehow get the remaining $500 that society has and turn that over to the bank as well.

But! I can already hear the objection. The bank would be issuing other loans and so there would be more currency out there than just the $6000. The five would have built something of value and so could borrow again with that newly built value.

In our world, in order to pay the original loan, the first five sell the houses to the other five for $1100 who take loans from the bank. Since the bank now has a supposed $5000 in loans it can cover these loans and even buy a house itself without any money. They make enough profit to borrow again and build themselves a home. Now the original five borrow $1000 to build homes. We now have $10400 in circulation. But, it must all be paid back to the bank. In fact more has to be repaid than exists in the world and so can never be repaid. So, the bank starts taking homes and can't sell them because either someone has a home or cannot borrow to get a home. 

This is the scenario we find ourselves in. But really, this just goes back to who is wrong? Is it the system? The borrower? The Bank?

Well, here is where we start looking elsewhere for the problem. As long as the system keeps expanding and the amount of money keeps increasing, we have no problem. As long as the population increases and technology increases we have no problem. And, as long we always have demand for that new production, we have no problem.

But, we have a problem. In our world there is a pretty straight connection between the money borrowed and the value of the product now owned. In other words, there is no profit takers. The bank makes money by its unique ability to create new currency and to hold dominance over that currency. Each builder makes a profit, but it largely goes back to the bank for more loans. And as long as this cycle continues, the system works fine.

Now before I am accused of being anti-profit, the point here is not pro or anti, rather it is to be considered.

In this world of ours, one of the ten becomes an entrepreneur Through some mechanism he ends up with a little more money or credit than his other citizens and he builds a factory with borrowed money and the other eight work for him. They get paid for building value and he gets profit for his (and here you will have to insert your own justification as I have not yet concluded in my own mind what he is exactly contributing. So insert any economics 101 regurgitation here as that will suffice for these purposes). The entrepreneur issues stocks and the workers buy some and the owner gets the rest and his factory is worth $10000 based on his workers buying shares with money they borrow based on loans from the increased value of their house and generous contributions in the form of 401k and option plans. The system actually continues to function. The workers work, and repay loans. The factory owner gets his profits, and repays his loans. Everything stays in balance.

Now I have really taxed the patience of the reader. I promised a simple explanation for what has happened and all I have done is given a long winded thought experiment justifying the status quo. I am almost to the point and I apologize it takes this long. I want to cover as many initial objections as possible before revealing the point. I hope that I have created a world that all can agree is a reasonable simplification of our economy at work. True, we have only one bank, one factory, and everybody works at the same place and we haven't even discussed the issues of monopolies, unionizing, taxes, government enforcement, oversight, banking regulations, pollution, raw materials, etc. All these are extraneous to the conversation and if we simply agree those issues are balanced by other forces in a larger, more complicated market, then we can continue the experiment.

For some reason, whether it be the forces we have not included or some unforeseen new opportunity such as expanded trading opportunities, our Entrepreneur begins accumulating wealth at a higher rate than he had before. This upsets the societal balance. The money must come from somewhere. Let's say he discovers he can make due with one less worker because he has optimized his operation. There is now an unemployed worker who is skilled at the job required. So, our entrepreneur cuts wages. After all, if they don't like it, the out of work worker will gladly take the job for less money. Unemployed or under-employed, the workers begin defaulting on loans. The entrepreneur and the banker begins accumulating the wealth in our fictitious village. The workers attempt to offer solutions to the two powerful men such as renegotiated loans and the banker and entrepreneur agree. The wages are cut further and the loans extended longer. At each stage, the workers ask for new terms and they are given. At each stage the accumulation of wealth increases deepening the already difficult economic situation. Finally, the two own all the real cash and there is none left to repay outstanding loans. The fictitious money collapses under its own devaluation. The banker finds himself once worth $10400 now worth only $500. The entrepreneur is in a similar situation. He has only $500 left and nobody will buy his products. The economy has collapsed and the two can only think back to when they were so rich.

The problem we face today is nothing more or less than proof trickle down economics does not work. All it does is concentrate the currency into the hands of a few people who leverage that currency into larger quantities of fictitious money whether they be stocks or mortgages. This money then, as Gresham's Law points out, drives out the good money where it is horded or moved overseas to purchase oil or finance federal debt. Since these institutions are not bound to take this fictitious money as legal currency, and in fact are forbidden, the bad money must be converted to good money in order to pay off another instrument of bad money, the mortgage. This transaction debases the bad money further and begins a downward spiral. Though the value of the fictitious money held by the bank is diminishing through this policy, the obligation of the borrower remains the same. His increasingly valuable real currency must be exchanged for a decreasingly valuable debt. The result is hording by the banks of the valuable real currency and an expulsion of the bad and decreasingly valuable fictitious money.

How can I make a statement as bold as this is proof trickle down economics does not work? Because we have seen an increasing accumulation of wealth and an increasing burden of debt to everyone but the wealthy. If money truly did trickle down, we would see the distribution of wealth remain relatively consistent and the economy rising evenly across all income levels. What we have seen instead is a greater and greater concentration of wealth resulting in a Gini coefficient at its highest since the great depression. This wealth is then leveraged into fictitious money and is considered to be at parity with real currency. And indeed, if one were to sell 100 shares of Microsoft, you would get parity. You would get what the market says it is worth. However, if Bill Gates sold all of his shares in Microsoft, he would not get parity, but rather some fraction of the current assumed worth. If everybody tried to sell Microsoft, the stock would be worthless and the parity percent would be zero.

Our assumptions that fictitious money and real currency have equal parity misdirects our economic efforts. For example, we point to the GDP and say, “Look at our prosperity!” But, this prosperity is largely fictitious money. As we pass legislation increasing the dominance of fictitious money through low capital gains taxes and IRA plans, we in turn devalue the fictitious money. Our parity percent becomes lower and lower with each increase of fictitious valuation. When we turn our economy from real goods and services to the management and creation of fictitious money, we balance our economy delicately on the pinnacle of a house of cards. Each move in this direction decreases the parity percent and the difference between our true worth and our perceived worth becomes increasingly larger until it can no longer be sustained and it all comes crashing down.