BBMillions throws down the gauntlet

Capitalists* beware! The burning fire of my unstoppable logic shall reduce your palaces to small yet tasteful townhouses and your foot soldiers to part-time mall security guards. This is no dead letter, but an UNdead letter, who unnatural power and longevity are wholly bent on the destruction of your economic engine of doom. Tremble--yes, tremble! The fear you feel from this preamble is nothing compared to the bone-melting terror that will seize you when my rhetorical drumbeat reaches its bloody crescendo. Capital flight cannot save you; tariff walls cannot hide you; angel investors cannot protect you. Kiss your shibboleths goodbye because they'll be nothing but shi't when I'm done with them.

Now then, where was I?

Some months back, I tried to grapple intellectually with my discovery that private banks literally have a license to print money. (This contributes to inflation, exacerbates boom-bust cycles, and enriches well-placed individuals at the expense of the rest of us.) Lately I came across an author who developed this line of thinking more clearly and fully (Herman Daly, Beyond Growth, ch.12). He points out that traditional lenders charged interest in exchange for temporarily giving up the use of their cash. However, modern banks sacrifice nothing when they lend because they create cash out of thin air when they draft the loan (and destroy an equal amount when the loan is repaid). There is no longer any economic justification for charging interest on loans beyond the tiny bookkeeping cost.

I also discussed that, to prevent inflation, the money supply needs to keep up the with the uneven growth of the "goods and services" supply. I said banks are useful for that because they create money case-by-case for those who intend to spend on new goods or services. I realize now that that is wrong: the net money created is equal to the interest charged by the banks not the capital, so there will still be a mismatch between the growth of goods and services and the money supply. Daly has a different proposal: banks should only lend money which they actually have, and the size of the money supply is controlled directly by the state through the issue or redemtion of government debt. It would be controlled to keep purchasing power constant, ie to average zero inflation on a certain basket of goods. Something else to consider.

This monetary skimming is irksome, but it's far from the most important economic problem. The worldwide ecological damage is related only to the total physical throughput of the economy, not the amount or distribution of human currency. By throughput I mean the rate of input (trees cut per year, fish caught per year, oil pumped per year) and output (CO2 emitted per year, garbage landfilled per year, wastewater discharged per year). Daly combines neoclassical economics with the second law of thermodynamics (irreversibility) to develop a crude but useable economic model. (In contrast, mainstream economics is like mechanical engineering without heat loss, corrosion, plastic deformation, or any other irreversible behaviour.) Needless to say, his new economic model leads to very different economic policies than the pervasive perpetual-growth paradigm. He was a World Bank economist, and in more enlightened times he might have sparked a transformation there, but as it is this book is essentially an extended letter of resignation.

I don't have space to reproduce his arguments here, but his central postulate is that manmade capital (industrial machinery, buildings, consumer goods) requires not only labour and capital but also high-value material and energy from nature (coal, sunlight, soil nutrients) and that such "natural capital" is non-infinite. Sounds reasonable to me, but that heresy was enough to get him stonewalled at the World Bank.

I'll mention one last thing, which Daly doesn't address but which follows from his argument. There can only be environmental macroeconomics not microeconomics because it is unfeasible for citizens and firms acting independently to keep resource consumption and pollution within safe limits. To make a rational economic choice, they would need to know all the material and energy that goes into each item they could buy and how close each type of input and output is to its safe limit. In other words, microeconomics must be a subset of the human economy, whether or not macroeconomic planning incorporates environmental limits.


*Defined herein as those who live well by creating and/or exploiting flaws in the monetary/financial system rather than through their manual or intellectual labour. This includes bank senior executives, speculators, and most economists but not bank clerks or other salaried financial workers.

Immetric (part II)

A sketch of the real economy, drawn from here. See also "The Story of Stuff" here.

A previous post criticized our current economic system (method of resource allocation) on several fronts. That begs the question--if this one isn't working, what should we replace it with?

Whenever we design something, there are certain steps to follow. First, we need to decide what we want the economy to do. I offer the following:

An economy should reliably provide subsistence to all.

That is, all humans should have access to enough healthful water, food, and shelter to contribute fully to society. Any resource use beyond that is a cultural or political matter and should be decided by the people not by economists. The reliability condition means that the system must be robust and flexible enough to function amid the normal disruptions of life, and it implicitly forbids any irreversible or unpredictable degradation of the planet. There is already enough food, water, and goods produced to satisfy the needs of everyone on the planet--it's just a matter of allocating it more intelligently.

Second, we need to understand the "universe" we're working with. That sets the limits on the economy. How big can it be? How much resource consumption and pollution can the biosphere tolerate? The classical view of economics as a tension between supply and demand is woefully inadequate here because it ignores limits entirely.

That was fine when the economy was far from its limits, but these days, such a view is dangerously simplistic. A better picture of the economy is shown at the top of this post. The limits are the supply of energy and raw materials, the capacity of the biosphere to absorb waste products, and the physical dimensions of the Earth. The sectors or aspects of the economy can be tweaked to improve the operation of the overall economy.

Third, we need to sit down and design the structure of the economy. We don't need to re-invent the wheel: there have been many economic systems throughout history, and we can learn from their successes or failures. I can't go much further without getting into specifics; there is a body of work already out there describing possible economic models and how to get there. Personally, I favour ecological economics, which is based on steady-state use of materials and energy rather than perpetual growth.

Immetric

illustration by the Beehive Collective

Over the past few months, to escape my unwilling idleness, I've occasionally written here about the unfolding economic mess. It's certainly causing a lot of suffering, yet the official explanations and remedies are so confounding and counterintuitive that I can't make sense of them. I suppose it's the engineer in me: I discover an unfamiliar, half-broken machine and ask myself, "what does this button do? how well does it run on a cold day? what happens if the power is interrupted? can I fix this myself?"

Unfortunately, the machine analogy is too apt by half: capitalism* is like an engine that only runs in one direction. Since 1991, we've witnessed the triumph of capitalism worldwide, and look at the results--increasingly rapid and irreversible ecological damage, overproduction of armaments and disposable consumer goods, endemic poverty in most of the world, unpredictable crashes in wealthy countries, distortions in democratic political systems, and an irrational and opaque mechanism. Some criticize it for more intangible reasons: robbing people of their individuality, elevating the seven deadly sins to virtues, reducing beauty to a commodity, and subordinating free will to a dollar-maximizing imperative. For my purposes, the flaws I listed above are more than enough reason to discard that economic model.

Others have written at length about these problems, but I'll just clarify what I mean:

♦Ecological damage. Capitalism only assigns value to things which can be commodified. A new computer is $1000; clean air has no value. Since capitalism maximizes financial wealth, society will have many computers and little clean air. (See also "overproduction" below.) Nearly all components of a healthy ecosystem are assigned zero value, so they are routinely despoiled to retrieve those components which are considered valuable. Government intervention can counteract this, but as long as there is economic incentive to pollute, regulation and enforcement will always be a step behind.

This lacuna has far-reaching consequences. Scientists tell us that our best weapon against global warming is our forests because they consume CO2, stabilize climate, moderate floods and droughts, and require no upkeep. But in a capitalist system, lumber has value while a living tree has none. A modified climate, of course, also has no value; the wealth destruction due to freak weather is written off as an act of god. So the world's forests continue to be clearcut while we devise expensive and unproven carbon-capture-and-storage devices.

♦Overproduction. Let's call it the iPhone syndrome. We already have ways of cheaply storing and listening to music; playing games; organizing our affairs; and talking to our loved ones. It would be hard to argue that having one device which combines all those functions would improve our quality of life. Yet millions of iPhones are sold, which consume finite resources and quickly become waste. Financial wealth accumulation is all credit and no debit; a brand-new iPhone adds $500 to the wealth of society, but a discarded iPhone a year later subtracts nothing (in fact, there is a small credit because the garbage man is paid to drive it to the landfill). The engine of capitalism will blindly keep polluting and consuming oil and industrial metals to make iPhones until a new gadget replaces it or the raw materials are exhausted.

Some argue that consumers (species Homo capitalis) demand these products, so their rapid development, production, and distribution is a sign that capitalism works. That's simply not true. After a new consumer good is developed, billions are spent to market it, that is, to create demand for it. I propose an experiment: stop all advertising worldwide for one year, and let consumers decide for themselves what they want.

The arms trade is a privileged niche market of consumer goods. Instead of waiting a few years for the product to break down and be replaced, the manufacturer creates products which are designed to be destroyed in a matter of weeks (bullets, missiles, bombs) or which require a large number of fragile components (stealth bombers, drones, Missile Defense System). Human life doesn't appear on Lockheed Martin's balance sheets.

♦Global poverty. Tent cities, sweatshops, lawlessness, famine, poor sanitation, no medicine, no education. Warlords (state or non-state) displace subsistence farmers to grow cash crops for export and use the money to buy guns from our factories. The sea, which fed the poor since the dawn of mankind, is denuded of fish by industrial fishing fleets. Any useful minerals are "owned" by the rich before they even leave the ground. From a capitalist perspective, all this is considered positive. In this world, if you have no cash, you don't count. The business community is unapologetic: capitalism is all the logic they need. They use their knowledge and resources to mercilessly extract wealth from the poor. Even if foreign aid met the UN target of 0.7% of rich countries' GDP, nearly 100% would still be devoted to this cold and mechanical exploitation. What's worse, the industrialized world has consumed so much of the world's resources that it's now mathematically impossible for the rest of the world to ever live as well as we do--there just isn't enough oil and minerals left.

The global trade imbalance is repeated in microcosm within capitalist countries. The Dow Jones industrial average was above 10 000 for almost ten years, so in theory there was more wealth than ever before; but even then, millions of Americans had inadequate food, shelter, and social services. I'll be charitable and assume that the government is interested in solving those problems; but even so, there are millions of businessmen who can benefit by exploiting the poor who have speed, scope, and flexibility the government can never match.

♦Booms and busts. This is what everyone's talking about, but I never hear any systemic critique or any mention of the dozens of times it has happened before. Because of the imaginary nature of financial wealth, it can be created or destroyed in an instant. In case real-world experience was not enough, stability analysis (a mathematical tool) shows that the financial system is prone to large and erratic oscillations in paper wealth. Although it is supposedly the most effective wealth-creation system, capitalism destroys wealth seemingly at random. From the perspective of a real person, this makes it impossible to confidently plan for the future because assets and employment depend on the emotional state of distant financiers. Only sound monetary policy and financial regulation can avert this, neither of which exist in pure capitalism.

♦Political distortion. In a society with strict property rights and high financial inequality, it is logical that rich individuals who wish to do so can become politically powerful. Prime Ministers and Presidents are almost uniformly millionaires. Elections often become a money-spending contest, which favours the party whose members have the most financial wealth. Many important issues are ignored because they don't interest the rich power brokers. The more purely capitalist an economy is, the more it suffers from such a nation/state disconnect.

♦Opaque mechanics. Although "ideal" free-market capitalism assumes perfect access to economic information by many independent actors, the reality is very different. Most activity is performed by large private companies which have an interest in secrecy. Even with publicly available information, only large organizations can afford to gather extensive data. Some companies falsify internal or public bookkeeping, especially right before a market crash. This makes it difficult to fix systemic problems; when the economy crashes, decision makers' only source of information is public data... which is bit like trying to fix a car engine with your eyes closed. Last year the US government nationalized several bankrupt banks with no idea of their true financial situation. Without transparency, there is no hope of fixing or even understanding modern capitalism.

Academia, which in theory should investigate the behaviour and problems of capitalism, is unfortunately mostly useless. Because so much money is involved, there is a strong incentive for economists to justify the status quo or decisions which the powerful have already taken. For instance, Reagan's tax cuts for the rich led to "trickle-down economics", which even now has some believers. Such theoretical systems are only self-consistent insofar as they ignore contradicting factors. Without well-funded research, it is more difficult to identify solutions for many problems of capitalism.


Unlike me, those we elected to fix the EconoMess still consider the economy a machine to be fixed. They're no fools: most of them benefit directly from the "wealth output" of that machine. But what we really need is not economic "engineers" or "mechanics" but doctors: someone who understands that feeding a hungry man is no use if the man's lungs are collapsing. Even in good times, capitalism simply doesn't work. Let's address the real needs of real people and then worry about the theoretical details.


*My working definition of capitalism is a system of resource distribution characterized by many independent actors, each of whom act to maximize their financial wealth (ie net worth in dollars, euros, etc.). Labour, capital, and goods are bought and sold in a free market. The demand for value-added products will distribute resources so as to maximize the total creation of wealth. All goods and services are produced privately and all wealth is privately owned, that is, individuals have no right to property except through paid labour, capital gains and interest, or gifts and inheritance. Pure capitalism has never occured because it assumes the absence of corporations, labour unions, states, and other collective institutions.

Bust'd

I ran across an obscure 1975 book by JK Galbraith, Money, a brief and entertaining history of currency and banking. In recent times, that consists of capitalism's great booms and busts (interspersed with central planning during major wars). With respect to the US, he sketches out the crashes of 1778, 1819, 1837, 1857, 1873, 1884, 1893, 1907, 1921, and 1929 (to which we could perhaps add 1973, 1980, 1987, 2000, and 2008). The root of the problem is always someone's "new" way of creating money out of thin air; if investors and legislators go along with it, it becomes a financial bubble which wreaks havoc when it bursts. Afterwards, remorseful legislators impose restrictions to prevent a recurrence... and a few years later those restrictions are quietly removed.

He illuminates some patterns. For one thing, financial bubbles are often the consequence of military overreach. A clear example is the US War of Independence, which could not conceivably be financed by taxation (there was no state apparatus yet) or loans (creditors were not convinced the fledgling state would survive). So the American rebels printed money (see image above) with a certain (inadequate) amount of gold to back it up. True, the money devalued almost to zero after the war, but by then the state was secure. If you think that's ancient history, just look at The Three Trillion Dollar War. The event that bursts the bubble is usually in the civilian real estate or stock markets, but the original bubble came from the monetary policy of the state.

He also points out:

"During the last century and until 1907, the United States had panics, and that, unabashedly, is what they were called. But, by 1907, language was becoming, like so much else, the servant of economic interest. To minimize the shock to confidence, businessmen and bankers had started to explain that any current economic setback was not really a panic, but a crisis. [...] By the 1920's, however, the word crisis had also acquired the fearsome connotation of the event it described. Accordingly, men offered reassurance by explaining that it was not a crisis, only a depression. A very soft word. Then the Great Depression associated the most frightful of economic misfortunes with that term, and economic semanticists now explained that no depression was in prospect, at most only a recession. In the 1950's, when there was a modest setback, economists and public officials were united in denying that it was a recession--only a sidewise movement or a rolling readjustment. Mr Herbert Stein, the amiable man whose difficult honor it was to serve as the economic voice of Richard Nixon, would have referred to the panic of 1893 as a growth correction." (103)

Alas, all too true. With each burst bubble, a legion of teleconomists appears with new mushmouth words for it: "market correction", "slowdown", and most recently "credit crisis". We need macroeconomists who actually study the real economy, draw conclusions, and make reasonable predictions and recommendations--people with intellectual integrity and a memory longer than 6 months--not the glorified grief counselors we have now. Joseph Stiglitz, are you listening?

Galbraith touches on many other topics as well. Here is a good passage about the de facto adoption of cigarettes as the currency of 1945 Germany:

"This was the equivalent, in all respects, of a well-considered coinage. The single cigarette was excellent small change; the package of twenty and the carton of two hundred were convenient multiples for large or major transactions. The decimal form was modified but not to the point of mathematical difficulty. Few forms of money in history have been more difficult to counterfeit. None had within it such an excellent tendency to self-regulation of its value. If the exchange value of cigarettes had a tendency to fall, i.e., if supply was too great and the price of products in exchange for cigarettes too high, there was a tendency for the holder of this coin to smoke it up or offer it to his addicted friends rather than pass it on. This had the effect of reducing supply, maintaining value." (251)

Ergo failure

My limited knowledge and incomplete logic doesn't tell me whether the trillion-dollar bailouts will lead to hyperinflation. I just don't know the details of how it is financed and distributed. I find it hard to believe that a government with $10 trillion in debt could find creditors willing to lend another trillion... but without raising taxes or cutting spending, where will that money come from?

I think I've wasted too much time already trying to make sense of our dysfunctional economic system and its handmaidens. When I have a nonzero income, I'll be able to make financial/economic choices, but for now I'll stick with my employment, language, and technical projects.

Out of touch, anyone?

President Obama announced yesterday that any senior executives who receive a federal bailout will have their pay capped at
$500 000/year. Expense accounts, stock options, and other benefits don't count, so they can still earn millions. Wow. Even for a symbolic gesture, that's unbelievably timid. Let's review the score: failing corporation X will get a billion dollars in free money, and in return the senior management needs to tighten their belts down to a million dollars a year. Does the president realize that hundreds of thousands of non-incompetent Americans lost their jobs and savings and can't pay for food and rent?

I shouldn't have to point this out, but there are real problems with their economy which brought us this pass. Among other things:

1. Out-of-control deficit spending by some individuals, corporations, and governments caused a massive debt bubble, an economic house built on sand. We still don’t know how much of their apparent wealth is bad debt. They need transparency and lending reform before the bubble bursts.

2. A lack of oversight of the financial system led to billions of dollars of fraud. This isn't new, but it gets worse every year.

3. Creation of credit is entirely in private hands, so when bankers panic en masse as they did last fall, they cause major economic damage (”credit crunch”). Capitalism has a gun to our head. There should be a public body which can also lend money and keep commerce running smoothly in such situations.

4. North America's productive economy is linked to an unproductive and volatile speculative economy and an equally unproductive war industry. We should invest more in things which are durable and improve quality of life.

5. There is deep and persistent wealth inequality, which distorts political decisions and causes unnecessary suffering for "the rest of us". For a start, billionaires need to start paying taxes so we can fix our health care, EI, and pension systems.

I don’t want to see anyone punished “as an example”--I want to see financial criminals put on trial and systemic reform so this doesn’t happen again.

Ergo inflation

I was still wondering how these mind-boggling bailouts will affect the value of money. So to find out more, I picked up a 10-year-old book called Paper Boom, a critique of the Canadian financial system. The author makes some interesting points*, but there is something he mentions in passing that really caught my eye.

When talking about the value of money, we're really talking about inflation. In theory, inflation occurs when the money supply expands faster than the amount of real goods and services (or shrinks more slowly). With more dollars in circulation for the same number of goods, the price per good goes up. Nobody wants that** because it means the purchasing power of our salaries and savings shrinks every year. We can't just keep the money supply artificially low because then there is a shortage of currency, which leads to an inefficient barter economy. Since we can't easily control the total amount of goods and services, we control the money supply to avoid inflation.

I thought that the government controlled the money supply by minting, physically or electronically, any money used in commercial transactions. Loans or bonds wouldn't change the total money supply since they are simply a transfer from one person to another. In fact, that's quite false. Only about 5% of wealth created is issued by the government. The rest comes from a special power that banks have called "creation of credit". By law, banks can lend more money than they actually have. So if they have $1 million in liquid assets, they can lend $10 million and thereby increase the total money supply. That sounds like a bad thing--I have visions of 1929 bank runs--but as I explained above, the money supply does need to expand*** in order to keep up with the increase in goods and services, and bank loans are an efficient way of doing that. It would be difficult for a central planner to accurately match monetary and economic expansion, but since banks lend (newly created) money to purchase newly created goods, there is a close match. That being said, there is a logical consequence: the interest charged on this created credit leads inevitably to inflation. I'll illustrate what I mean below.

Suppose a community produces 100 units per year of real goods and services at $1 apiece, say food and music, and that increases by 5 units per year. That's the real economy. We'll neglect government wealth creation by assuming old currency wears out as quickly as new coins are minted. Each year, citizens take out loans (since the money doesn't exist yet) to buy the additional goods. The economy expands by 5 units/year and the money supply expands by $5/year; therefore the goods will still cost 1 $/unit the next year and there is zero inflation. However, banks don't lend for free: they will charge interest on the $5 loan. This extra dollar or partial dollar means that the money supply is now larger than the real economy, so there must be inflation to compensate. Ergo, any interest charged on bank loans causes inflation.

The next question is, how much does this contribute to real-world inflation? Canada's real economy was valued at $1150 billion in 2007 with yearly economic growth of about 1.5% and 2.5% inflation. Interest on bank loans was about 5%. So inflation from bank lending is

(economic growth)x(loan interest rate)/(size of economy)=(1.5%x$1150 billion)x(5%)/($1150 billion)=0.075%

Which is only a tiny fraction of the actual inflation. So I guess it isn't a major factor.


I realize that there are several important factors I've neglected in this analysis--I was just so astonished that banks create wealth that I had to write this down. For the sake of brevity, I'll just mention one of them. We know that human industry and commerce are damaging our planet's life support system and depleting natural resources. Expansion of goods and services, which mainstream economists take as their goal, is a central cause of this degradation. Therefore it would be preferable to halt inflation by freezing economic growth and minting a constant amount of currency. That is, to invest in reduced waste rather than growth for its own sake. I don't know the best way to achieve that, but there will need to be public analysis and control of resource exploitation and pollution rates to safeguard our environment's life-support capabilities and allow continued prosperity.


*Author Jim Stanford mostly tells us what we already know--our financial system is hyperactive, mostly pointless, heavily subsidized, unfair, detached from reality, and prone to catastrophic crashes--but he goes into depth and lucidly explains how and why this is so. A few things he said were surprising:
First, although theoretically its whole purpose is to channel savings into productive investments, the financial sector only handles about 3% of real investment. The rest is performed via retained earnings by companies, individuals, or governments. That productive investment accounts for about 5% of financial activity, and the rest is entirely casino capitalism.
Second, most successful companies in Canada are insulated from the destructiveness of the stock market through majority ownership by a family or individual.
Third, mutual funds are for suckers: they nearly always underperform the stock market as a whole. Mutual fund brokers do so well because they spend hundreds of millions of dollars on advertising and because they get large subsidies through the RRSP system.

**Some argue that inflation is really only a problem for those who are already wealthy. In Canada, the poorest 30% (family income < $30 000) have such a low income that they never accumulate any savings. The middle 60% ($30 000-$250 000) usually invest any surplus income in paying off their mortgage, so as long as their wage keeps pace, they actually benefit from inflation. The richest 10% (family income > $250 000), whose assets and real estate are paid-for, invest their surplus income in the financial system, and that is where inflation is a big problem. So for 90% of Canadians, high employment and wages is much more important for their financial well-being than low inflation. I agree with that under normal conditions, but what I'm worried about is hyperinflation, which is very harmful to the poorest 90%.

***For commerce to function, the money supply needs to keep pace with the expansion of the real economy. However, banks are given the power to create wealth but not a mandate to do so. This can lead to serious problems when, for one reason or another, banks refuse to create wealth (ie lend money). That's exactly what happened last fall; bankers panicked over the collapse of the stock market and caused a paralyzing "credit crunch" until they were bribed to lend money again.

Market magic

I promise this will be my last post on economics. It's not something I enjoy thinking about--the Invisible Hand is so HP Lovecraft--but with financial fire-and-brimstone all over the news, I start to feel as though it could be important. The trouble is, media "experts" have a vested interest in the status quo, so I can't get an accurate picture or explanation of the carnage. Some things just sound wrong to me...


I know what real investment and assets look like: 1000 people get together and spend $1 million on a cracker factory, and it makes them $100 000 a year of profits for 50 years. All things being equal, you could even say that investment is beneficial for society by efficiently supplying a cracker-hungry nation. Inflation, depreciation, debt, and fluctuations in the price of labour and raw materials muddy the situation, but that's the basic idea. Combine a million factories and other productive assets, and you get macroeconomics. (That classical picture ignores social and physical limits, but I'll let that slide for now.) But it's the financial crisis that's in all the papers, and that's rooted in the speculative side of the economy.

First, let me just say that derivatives trading is the stupidest thing I've ever heard. People have been "investing" by betting whether a numerical value will go up or down. That's the same as betting on a horse race, and it has just as much to do with the real economy. Let them gamble if they want to, but the rest of us shouldn't bail them out when they have a losing streak. Worse still, it exaggerates the upswings and downswings of the market, which is making the current collapse even worse. (Warren Buffet himself called derivatives "financial weapons of mass destruction" in 2002.) From what little I understand of the other opaque 21st-century "financial instruments," the same is true for them.

But let's get back to that old august gambling house, the stock market. It's supposedly been the motor of economic growth for centuries. It's true that IPO's lead to real investment, ie mobilize unproductive wealth and labour. (Often it's more effective when the state mobilizes resources itself, but I digress.) But the currency, stock, futures, real estate, etc. speculation that occupy 95% of trading have nothing to do with real investment. It's a series of side bets. If Microsoft shares go up or down, that doesn't change its working capital, only the wealth of those who happen to buy or sell that day. And unlike the cracker factory, that value is entirely imaginary: just like tulips or baseball cards, shares only have value if someone else believes they do and is willing to pay. Elsewhere we call that a pyramid scheme. (Some shares give dividends, inside information, or voting privileges, which gives them some real value, but they are still grossly overvalued.) So why do we have billions of dollars tied up in the stock market? Why have we bet the entire global economy on "irrational exuberance"? It's true that small investors are often ignorant, emotional, and short-sighted, but the large investors who control most of the stock market have professional, expert staff, and they should know better. Maybe the Marxists are right--the whole thing is a shell game designed to transfer wealth from the working class to the rich, and whenever there is financial collapse, that's the biggest transfer of all.

It's been proven many times that the more stocks you own, the more you tend to make from them. The irrational cycles of the market punish small investors and reward large ones because large investors have more information, expertise, and control and can predict or orchestrate downturns. The speculative economy also impoverishes the working class by making small investors feel more rich than they are. If you bought $100 of my stock yesterday and now own $500 worth (on paper), you'll feel like celebrating, and you'll go ahead and spend some of your non-speculative money. Studies show a 3-4 cent increase in spending for every dollar of stock increase. You can see how that can lead to disaster: when your stock goes back to $100, or to zero, you just bought things you can't afford. Many people end up going into debt rather than sell their stocks, on the assumption that the value of their stocks will always go up faster than their debt. When stock prices finally do fall, the hardship is multiplied immensely because people have more debt and smaller savings.

I have one last rant, so bear with me. Lately, I've often heard TV talking heads say that global markets lost a trillion dollars overnight. That is, the total face value of global stocks went way down. What a catastrophe, right? But here's the problem: the listed stock price is its marginal price not its value. Let's say my company issued 1000 shares at $1. So $1000 of real money is invested. Then the next day people learn my grandfather is John Lennon, so 100 stocks are sold to Beatles fans for $5. Now $1500 is "invested" in my stock, $1000 in the company itself and $500 in the pockets traders. But the media would say the value of my stock is 1000x$5=$5000! If some investors change their minds the next day and sell for $2.50, economists go ballistic because the stock "crashed" from $5000 to $2500, even though there is still only $1250 or so invested. That's why trillions of dollars can be created and destroyed in the blink of an eye; it's a mathematical fiction. The true value of a stock would be something like this: the total cash raised if all stocks were sold one by one. It would be above $1000 since the marginal price is high, but it wouldn't be much above it.

If I have the time and the patience, I'll read up more and see what I can figure out. So I may come back and post an update. In the meantime, my advice is to ignore anything economists say and get on with your life.

Meanwhile, on Wall Street (Part II)

Part I here.

In response to the debt crisis on Wall Street, Washington itself has been going into debt like there's no tomorrow. (For the world's pre-eminent nuclear and military power, that phrase takes a whole new meaning.) Now Bush is ready to write a blank cheque to prop up the debt bubble and delay financial collapse until after his term. Although they disagree on the details, senior US decision-makers agree that this bailout needs to go ahead. But they simply don't have the wealth to back up all the dollars they're throwing around. (Maybe it's time to sell Louisiana territory back to France!)

It would be pointless for me to discuss solutions to this crisis. They are obvious, and it's up to the US public to demand them. I'm more interested in what the ripple effect will be for me and mine if the bailout does go ahead. I readily admit that I don't understand macroeconomics, but here's the situation as I see it.

In the short term, since the government is offering no support to individual debtors, hundreds of thousands of families will lose their homes and become New-Orleans-style internally displaced persons. Although this will cause widespread misery, it will not affect the economic or political systems much because those Americans are already disenfranchised. In the medium term, the most likely outcome is hyperinflation. By all appearances, the government intends to keep running a deficit, but sooner or later creditors will no longer be willing to buy US securities (public debt). To stay solvent, the government will need to either default on its debt payments or print a lot more money*. When this happens, US dollars and US securities will devalue, international investors will dump them, and the value of the currency will crash. The end result would be that financial wealth (dollar bills, bank accounts, shares) quickly becomes worthless while real wealth (real estate, factories, goods) becomes much more valuable. Wages couldn't keep up with inflation, so those in debt would go bankrupt. Nearly all of the debt-free real wealth is held by the richest 1%, so in practice, hyperinflation quickly leads to deep and widespread poverty. What happens next depends on many things, but there would certainly be a humanitarian crisis.

The financial industry protects itself with opaque or absent record-keeping, so very few really know what's going on. It's impossible to predict with any certainty what will happen in the US, let alone in Canada. Export-oriented industries will certainly suffer from a loss of American spending power, and if Canadian financiers get spooked, our own debt bubble could burst. Individuals can insulate themselves somewhat by reducing their debt load, but the only real defence is to work collectively to create an economy which is insulated from speculative bubbles.


*The fundamental value of a US dollar has been very murky since they stopped using the gold standard in 1971. The dollar has been anchored by the global oil trade--Washington (backed up by the Pentagon) insists all oil must be traded in US dollars. In other words, any time the US wants $20 worth of oil they can simply print another $20 and get the oil. In fact, any country that wants to buy oil must first buy dollars from the US at face value. Most countries also use US dollar reserves to anchor their own currencies. So if the US dollar has hyperinflation, it would trigger hyperinflation around the world. Theoretically a country could protect itself by starting to sell its US bonds and dollar reserves, but no-one is willing to do so because such a public "lack of faith" would trigger a mass sell-off of dollars which would wipe out their own currency.

Meanwhile, on Wall Street

Americans are so fucked. But first, these messages...

Until recently, there was a major housing bubble in the US: normal working-class houses would sell for a million dollars or more. Banks offered subprime mortgages, multiple mortgages, and interest-only mortgages with minimal credit check, which encouraged many Americans to buy houses they couldn't afford. Some call it NINJA financing: "No Income, No Job: Approved!" As long as the price of houses kept rising, they were solvent because they could theoretically sell the house and make a profit. Investment banks like Bear Sterns began trading mortgages, insurance on mortgages, and other pieces of paper as if the housing industry were a stock market, and this kept driving up the price of homes. Homeowners acquired more and more debt to avoid losing their houses, so superficially the money supply kept growing. At some point, though, too many people started missing mortgage payments, and all those pieces of paper became worthless overnight ("loss of investor confidence"). At the end of the day, a few dozen people on Wall Street became billionaires and many Americans lost their life savings. To add insult to injury, the US government bailed out Bear Stearns but not homeowners, so the fraudsters got another $2 billion windfall. Fast-forward to this week: the US government just stepped in and nationalized the $5 trillon mortgage giants Fannie Mae and Freddie Mac. If their assets are made of air like those of Bear Stearns, the US public debt will double overnight, and all that money will go to the people who are responsible for the crisis in the first place.

The subprime mortgage crisis is not the end of the story; there is a similar crisis looming with consumer debt (credit cards, installment debt, etc). We all know people with several maxed-out credit cards they'll never pay off. Sooner or later, a critical mass of creditors will call in their debts, credit card holders will go bankrupt, and the apparent wealth of the nation will evaporate. Obama's VP Joe Biden has deep connections to the credit card industry, so a government shakedown is very unlikely.

I won't waste my breath highlighting the massive injustice of all this. It's clear that those responsible deserve to work in a rice paddy the rest of their natural lives. The point I'm trying to make is this: the US government itself is very shaky financially, and soon it won't be able to backstop the "failures" of the economy any more.

For 200 years, the fastest way to get rich in the US has been to take over an essential service, run it into the ground, and wait for a government bailout (cf railways, Lockheed Aircraft, Chrysler, Savings & Loan, Enron, Bear Sterns). When the industry becomes profitable again, it gets sold back to the private sector for cheap because a profitable government agency is "socialism". The stakes are bigger than ever now because of all the corporate mergers. But now, the government itself is broke due to decades of corporate handouts (especially via the pentagon) and tax cuts. It has stayed solvent by taking on more private and foreign debt--an additional $2 trillion or so since 2000. A leftwing administration could redistribute money back from Wall Street to the public purse, but there is no American Left to speak of. Besides, there needs to be serious, longterm investment in education and infrastructure before the US can become economically self-sufficient again.

So where will it end? What happens when an essential service fails and Japan and China aren't willing to underwrite a bailout any more? Will we discover that all the non-imaginary wealth in the US is owned by a few hundred thousand people, like 1929? And what will happen to the rest of us?


September 20 update: Since I wrote this post, the US government has pledged another 800 billion dollars of bailouts for Wall Street. No word yet on where all that cash will come from. This raises the US debt ceiling to 11.3 trillion dollars, $32 000 for every man, woman, and child in the US.

I wonder when this will start to qualify as odious debt.

Don't stop! Give it all you got!

Modern capitalism is truly astounding. It’s the absolute pinnacle of dysfunction. Its only purpose is to allocate limited resources efficiently, yet it requires an enormous number of managers; allocates wealth inequitably and irrationally; wastes resources on useless or harmful things; has unpredictable and damaging boom/bust cycles; and fuels internecine and international warfare. Its underlying theory is absurd and its implementation criminal, but somehow its evangelists have convinced the general population that this is the best possible system. I won’t belabour the point, but I’d like to share a minor epiphany I had.

I’ve tried to live in opposition to this warped system, but I realized lately that I fell into one of its traps. One of its intellectual pillars is the notion that progress comes from a Protestant work ethic. If we all work harder, we can build a better society with the fruits of our labours. Politics is then relegated to the decision of how to spend the wealth generated via capitalism—roads, weapons, schools, solar panels. This apparent flexibility explains why ideologues of all stripes support capitalism. This logic can be extended to any group or individual. There is no problem that cannot be solved through hard work.

Historically, this was largely correct: when there wasn’t enough food or clothing or firewood, someone needed to work to produce more. But with 20^th-century mechanization, our material needs were met long ago, and we have become so productive that extra work actually reduces our quality of life. These days, half of the work done is to create the demand for more work: in order to create jobs in an SUV factory, workers in marketing and sales need to create the demand for SUV’s. Overall, people work longer hours, consume more, and produce more waste, but they are not happier. This system favours disposable consumer goods or military hardware because the shorter its useful life, the more people who can work to extract, assemble, sell, and dispose of the product. This aggravates social and environmental problems beyond what the government can deal with, despite increased tax revenue.

One symptom of this perverse work ethic is that the more lucrative the work, the more damage it causes—corporate senior managers, arms dealers, or financial speculators are handsomely paid while students, parents, and artists often have no income at all. Any work that raises productivity is rewarded, yet this extra productivity causes environmental damage, invasive advertising, and curtailed leisure time without providing any lasting benefit for the citizen.

It sounds ridiculous to suggest that we can solve problems without working, but that’s just because the notion is so deeply rooted. Of course, it is not possible or desirable for everyone to stop working. We just need to sort out which work improves our quality of life and which is pointless or harmful. In fact, it isn’t difficult: if a job seems futile and soulless, it probably is. The lucrative jobs I named earlier are generally high-profile, so they are also easy to spot. Failing that, we can be proactive and enumerate which work does provide benefits.

But what can we actually do? There is no way to stop someone from working a certain job. First we can stop treating paid work as a virtue in and of itself. If there is less status associated with a job, perhaps people will be more mindful of whether the work brings them wellbeing and fulfillment. Collectively, we should provide a living wage to the unemployed and limit very high incomes in order to deter those who enter destructive careers for the money.

I don’t claim to understand the cause and effect of this yet, but it’s something I’ll keep an eye on now that I’ve noticed it.