Archives for posts with tag: inequality

“we are able to catch a first glimpse of the way in which changes in the quantity of money work their way into the economic system. If, however, we are tempted to assert that money is the drink which stimulates the system to activity, we must remind ourselves that there may be several slips between the cup and the lip. For whilst an increase in the quantity of money may be expected, cet. par., to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money; and whilst a decline in the rate of interest may be expected, cet. par., to increase the volume of investment, this will not happen if the schedule of the marginal efficiency of capital is falling more rapidly than the rate of interest; and whilst an increase in the volume of investment may be expected, cet. par., to increase employment, this may not happen if the propensity to consume is falling off. ” J.M.Keynes 1936

This is my second post about quantitative easing (QE). This subject may seem arcane but I think it is crucial to the general theme of this blog. As I discussed in that previous post, QE is being held out as a painless solution for a stagnant economy. As such, any other policies to sort out our economy get put to one side in favour of giving QE more of a chance. Meanwhile QE seems to have somewhat mysterious effects on asset prices and those impact on inequality and capital flows between countries and so effect us all.

I think it is important to make a clear distinction between simply using QE to bring risk free interest rates down and using excess QE, above and beyond that, in an attempt to satiate any preference the public may have to hold wealth in the form of zero yielding cash rather than as other asset classes such as stocks or bonds. In WWII and its immediate aftermath, the US and UK governments both used QE to peg low interest rates for both short term and longer term government bonds so as to facilitate massive deficit spending. That is a straightforward policy and keeping such low interest rates could be a permanent arrangement much as it has been in Japan for the past couple of decades. However we now have QE being used not so much to facilitate government spending but as an alternative to that as a way to try and stimulate the economy.

In my previous post I tried to rationalize the effects of further QE (once risk free interest rates were at the lower bound) in terms of how it could place a ceiling, for a period, on the extent to which the central bank could subsequently raise interest rates. Nick Edmonds has expressed skepticism as to whether such a constraint would actually come to bear on a central bank that wished to hike interest rates. His point is that, one way or another, a fix would be found.

Nick Edmonds models QE  in terms of how purchases of assets such as government bonds (by the central bank, from the public) induce price changes in all other asset classes, domestic and foreign, as the public rebalances  holdings of those various asset classes. This also tallies with how the Bank of England explains QE effects. To me this raises the crucial issue of why “the public” chooses to exchange other liquid assets for cash* even when cash is a zero yielding asset and the assets they sell do have an appreciable yield. In principle in the simplest model, a liquid asset with ANY yield would be preferable to zero yielding cash that was in excess of what was needed as a medium of exchange. Such a view however overlooks the crucial attribute of cash as the ideal stable store of value over the short and medium term  (1). Perhaps the clearest description I have seen for this is from an interview with Warren Buffett’s biographer Alice Schroeder:-

“”He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.” It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing. Suddenly, an investor’s asset allocation decisions are not simply between earning nothing in cash and earning something in bonds or stocks. The key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it? “There’s a perception that Buffett just likes cash and lets cash build up, but that optionality is actually pretty mathematically based, even if he does the math in his head, which he almost always does,””

Asset managers selling assets to the central bank obviously must value the cash they receive just as much as the assets they sell. This undermines the popular narrative about QE causing a “hot potato effect” as asset managers try to offload zero yielding cash. More generally whenever anyone sells an asset to anyone, it is because they value that amount of cash as much as that asset. That, after all, is what sets the market price for assets. So every asset is valued as that amount of “call option …with no expiration date… on every asset class, with no strike price” to use Alice Schroeder’s description of cash in its asset class guise.

Every asset also has its price set by what it itself is likely to earn. Peters and Adamou make the case that asset prices and price volatility find levels at which borrowing money to purchase more of an asset won’t increase gains. Buying more of an asset using borrowed money will amplify any short term gains but also any losses whenever the asset price falls and those losses will outweigh the increased gains overall. This stems from the phenomenon of “volatility decay”. A 25% fall in price requires a 33% rise to get back even,whilst a 50% fall requires a 100% rise. This effect would cap any durable upward repricing of assets unless price volatility also reduced and/or earnings increased.

Obviously, just as cash can be used to “scoop up a bargain when it becomes available“, so any other liquid asset can potentially be sold to fund such a purchase. The asset manager’s ideal would be to have holdings of diverse asset classes that had prices that could be relied upon to move in opposite directions such that bargains in one asset class could be bought when the other asset holdings had boosted available funds. The asset value of cash relies on the unreliability of such negative correlations between the price movements of various assets. I suppose this is making the same general point as J.M.Keynes’s statement :-

“It might be thought that, in the same way, an individual, who believed that the prospective yield of investments will be below what the market is expecting, will have a sufficient reason for holding liquid cash. But this is not the case. He has a sufficient reason for holding cash or debts in preference to equities; but the purchase of debts will be a preferable alternative to holding cash, unless he also believes that the future rate of interest will prove to be higher than the market is supposing.” In this context J.M.Keynes means future interest rates on long term debt or in other words, bond prices.

Of course cash doesn’t simply serve as an asset class; its value is also anchored in the real economy in terms of how much goods and services it can buy. Cash in the hands of asset managers has little influence on the prices of real economy goods and services. Asset managers simply work to transport value through time and use wealth to gather more wealth by buying and selling securities. The cash they control is restricted to that use and so does not generally take part in bidding for goods and services.

So basically the financial system is dealt exogenous constraints from the real economy. Cash has its real economy value and the firms and property underlying assets can only supply asset holders with gains limited by real economic activity. The financial system then juggles that around amongst itself. For everything to still tally up, the extra cash held by the public due to QE must shift the return characteristics of the market to justify the continued exchange of yielding assets for yet more cash. The Peters and Adamou study indicates that increasing levels of cash are unlikely to durably push up asset values. Those selling assets to the central bank also clearly have that perception or presumably they wouldn’t sell. It seems to me that something has to give and perhaps the most likely effect is to synchronize the price movements of the various asset classes. Perhaps that unfolding scenario is the only reason why the public continues to choose to part with assets in exchange for zero yielding cash.

All the cash provided by QE has to be held by someone at all times as with all other issued securities until they are withdrawn. Prior to all of the QE, an upward revaluation of say mining stocks might have entailed a sell off of say long term treasury bonds so as to provide the funds. The last participant to sell his treasury bonds would not have got much money for them and would not have been able to buy many shares of the mining stocks. By contrast, in a post-QE world, the mining stocks could be bid up by buyers who did not need to sell off anything else because they had ample cash reserves to draw upon. Consequently all assets now can be bid up in unison and likewise they can all fall in unison. The more that effect takes hold, the more valuable cash becomes as an asset class. In June 2013 there was a modest drop in asset prices that nevertheless was widely remarked upon because it seemed perfectly synchronized across all major asset classes; all classes of stocks, bonds and commodities, across the globe, seemed to suddenly revalue downwards in terms of the US dollar or Sterling.

Its worth asking whether this is a problem or not. If asset managers now hold more cash and need to hold more cash, then perhaps that is a fairly neutral non-effect. However, at the very least, it makes me very much doubt that we can sort out our economic problems simply by doing more QE.  To me the main downside to QE looks to be a further dislocation between the financial system and the real economy. In an ideal world, asset markets would serve the real economy by coordinating allocation of real resources towards where they could best serve the real economy. I worry that QE might only serve to make asset markets yet more stochastic, disruptive and capricious in their effects on the real economy. Perhaps the starvation that came for many people as a result of the seemingly stochastic spikes in grain prices in 2008 should serve as a warning of the potential real damage irrational financial markets can cause.


*I’m using “cash” here in the sense of any “cash equivalent” such as risk free bank deposits, very short term treasury bills, and, for banks, bank reserves.

(1) I think Keynes was alluding this when he described the “liquidity-preference due to the speculative motive”. For me however, Keynes’s terminology is unfortunate because this is all about the price stability of cash, not the fact that cash can readily be exchanged for other assets as the adjective “liquidity” is often used to mean.

Related Previous Posts:

Monetary policy, the 1930s and now

Larry Summers at least sees the problem

Related stuff on the web:

Money creation in the modern economy -Bank of England (link added 19march2014 ht JKH)

For Warren Buffett, the cash option is priceless -The Globe and Mail

Chapter 13. The General Theory of the Rate of Interest -J.M.Keynes 1936

Stochastic Market Efficienc-Ole Peters and Alexander Adamou

The Case Against Monetary Stimulus via Asset Purchases -Ashwin Parameswaran

What the *&%! Just Happened -Ben Inker -GMO

Leash the Dogma -John P. Hussman

Investing Like the Harvard and Yale Endowment Funds -Frontier

A Value Investor’s Perspective on Tail Risk Protection: An Ode to the Joy of Cash -James Montier -GMO

Thanks to Dan Kervick and Mark A Sadowski for prompting my thoughts about QE with their astute comments on Steve R Waldman’s Interfluidity blog (obviously if this post is stupid, that’s not their fault 🙂 ).

Larry Summers gave an IMF speech on Nov 8th where he acknowledged that since the 2008 crisis, the USA has had a “jobless recovery” and that the economy is still floundering well below potential. I’m glad that he is drawing attention to all of that. What I disagree with is his suggestion that we need encouragement of asset bubbles as a way to cope with this reality.

It is as well to note exactly what Larry Summers said:

“Then, conventional macroeconomic thinking leaves us in a very serious problem; because we all seem to agree that, whereas you can keep the Federal funds rate at a low level forever, it’s much harder to do extraordinary measures beyond that forever — but the underlying problem may be there forever. It’s much more difficult to say, well, we only needed deficits during the short interval of the crisis if aggregate demand, if equilibrium interest rates, can’t be achieved given the prevailing rate of inflation.

And most of what would be done under the auspices — if this view is at all correct — would be done under the aegis of preventing a future crisis would be counterproductive, because it would in one way or other raise the cost of financial intermediation, and therefore operate to lower the equilibrium interest rate that was necessary. Now this may all be madness, and I may not have this right at all; but it does seem to me that four years after the successful combating of crisis, with really no evidence of growth that is restoring equilibrium, one has to be concerned about a policy agenda that is doing less with monetary policy than has been done before, doing less with fiscal policy than has been done before, and taking steps whose basic purpose is to cause there to be less lending, borrowing and inflated asset prices than there was before. So my lesson from this crisis is — and my overarching lesson, which I have to say I think the world has under-internalized — is that it is not over until it is over; and that is surely not right now, and cannot be judged relative to the extent of financial panic; and that we may well need, in the years ahead, to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential.”

Throughout this blog I’ve being trying to explore ideas for a reconstruction of our economic system  both to address exactly the “secular stagnation” issue that Larry Summers recognizes AND avoid asset bubble induced financial crises. To me the key is to replace the current tax system with a tax on gross assets.

Furthermore I suspect that asset bubbles actually worsen the underlying root cause of secular stagnation. Over the long term, the only way that bubbles offer relief is by forcing fiscal stimulus in the form of bailouts to clear up the mess after the bubble bursts. As the bubble builds, the private sector appears to be creating prosperity by itself. Once the burst happens, the damage could more than make up for that except government deficits induced by bailouts mitigate the crunch. It may be politically more acceptable to have such “disaster relief” than to have everyday fiscal stimulus but it is exceptionally regressive and wasteful. The private sector becomes distorted into becoming a bailout harvesting machine.

It might be argued that bubbles act as a sort of asset tax in that they cause wealth to be moved out of safety and splurged on malinvestments -creating jobs in the process. People become employed building ghost estates of unwanted houses or making patent applications for pretend biotech innovations or whatever. However I suspect that the people who predominantly get fleeced by such bubbles are minor savers saving for retirement. Retirees who’s pension savings went towards buying insanely overvalued stock in 2000 are now cutting back consumption as a consequence of having lost those savings. The major players  profited not only at the expense of the real economy but also at the expense of all those “dumb money” savers who bought high and sold low. In that way bubbles actually worsen the wealth inequality that is at the root of the whole problem.

Related stuff on the web:

No, Larry Summers, We Don’t Need More Bubbles -Clive Crook, Bloomberg

Secular Stagnation, Progress in Economics -JW Mason (link added 27nov2013)

The Onion Revealed As Mystery Source Of Larry Summers’ And Paul Krugman’s Economic Insight -ZeroHedge

Secular Stagnation, Coalmines, Bubbles, and Larry Summers -Paul Krugman

The Economy almost certainly needs Bubbles -Michael Sankowski

Why Do the Rich Save So Much -Christopher Carrol

Innovation, Stagnation and Unemployment -Ashwin Parameswaran (link added  30nov2013)

Tapping the Brakes: Are Less Active Markets Safer and Better for the Economy -Stiglitz (link added 21April2014)

appendix (this is an excerpt from the pdf that I started this blog off with)

A zero interest rate policy does not reduce the financial overhead

It is sometimes celebrated that the current ultra-low interest rate regime supposedly reduces the “unearned increment” taken by “rentiers”. Some politicians effuse about the exceptionally low “cost of capital” enabled by the current financial climate. Interest free credit for the financial system means boundless financial leverage. Financial leverage powers the ability of the finance industry to feed off of financial instability and also creates and amplifies such instability.

The current zero-interest rate policy was brought about in Japan to save the Japanese banks after their stock market and real estate price collapse of 1990 and then in the USA and UK after the global asset bubble burst in 2008. Reducing interest rates tends to boost asset prices. Ultra-low interest rates also enable banks to “earn their way out of insolvency” by conducting interest rate arbitrage especially across national boundaries to regions with much higher interest rates. In fact just such a “carry trade” between Japan and the rest of the world provided some of the impetus for the bubble in the lead up to 2008. The impact of zero interest rates runs much deeper than such effects however. Understanding how interest free credit benefits the finance industry requires an understanding of how financial markets extract cash flows via price volatility. Potentially a fluctuating price can be harvested to provide a cash flow. If a security maintains roughly the same price over the long term then that means any 20% drop in price eventually being matched by a 25% rise (4/5×5/4=1), any 50% drop being matched by a 100% rise (1/2×2=1) and any 90% drop being matched by a 1000% rise (1/10×10=1). Obviously, simply holding such a security would provide no benefit as the price would simply bob up and down with no overall gain. However a 50% drop from $100 is a $50 loss whilst a 100% gain from $100 is a $100 gain. The fluctuations in the price are geometric but money is money. The fact that financial holdings can be bought and sold allows that geometric to linear inconsistency to be harvested. Simply periodically rebalancing such a holding against a holding of cash would extract financial gains. Rebalancing across a portfolio of securities with independently fluctuating prices optimises that process.

Rebalancing between financial holdings bids up the prices of whatever is cheap and bids down the prices of whatever is expensive. Such trading moderates the price fluctuations that it depends upon. However, such ‘liquidity providing’ speculation is accompanied by extensive ‘liquidity taking’ speculation that amplifies price fluctuations. If a trader envisions that prices are due to rise (or fall) then she can take advantage of such anticipated price changes.  In an idealised market where no participant had ‘an edge’ such ‘liquidity taking’ speculation would not make sense -the market as a whole would have already priced in any predictable price movement. However in the real world, market-moving levels of finance are controlled by traders who do have ‘an edge’ over the market as a whole. Liquidity panics occur when traders risk losing everything due to the market moving against their leveraged positions. Consequently, increases in the volume of trading activity typically increase rather than decrease price volatility.

Security trading is a zero sum game. For every participant who buys low and sells high someone else has to have sold to them and bought from them. Certain financial securities are firmly linked to the real economy. Commodity futures set the prices for essentials such as crude oil, grains and industrial metals. Producers and processors of such commodities have real world considerations when they decide whether to sell or buy. The real economy provides the “chump” who ends up buying high or selling low so as to provide the trading gains for financiers. Previously, the borrowing cost for the funds used for trading limited such financial extraction. Interest free credit removes that constraint.

The dream of “popular capitalism” was for everyone to own stocks and align with capitalistic interests to benefit from corporate profitability and efficiency. Various government schemes endeavoured to induce households to buy stocks. However a shift in the capital structure of many companies allows much of the potential benefits to slip past “mom and pop” type stock holders. In principle, the stock market provides a mechanism for distributing corporate profits amongst the shareholders. However, companies can decide to take on debt such that much of the cash flow services the debt instead of going to profits. Low interest rates favour such corporate leverage. Corporate debt is encouraged by the current severe taxes on corporate profits. Debt servicing costs are fixed ahead of time whilst the corporate cash flow varies according to the varying fortunes of the company. Once a fixed block of cash flow is pledged to creditors, any variation becomes proportionately much more dramatic for the remaining profits. The consequence is amplified share price volatility. Management payment in the form of stock options especially encourages a capital structure orientated towards inducing share price volatility.

A highly indebted company needs to nimbly keep the debt burden serviceable by either paying off debt if tough times are envisioned or expanding the debt and buying back stock when times are good. In effect the company itself acts as “the chump” using profits for share buybacks and aquisitions -bidding up oscillations in its own share price. Those shareholders who know what they are doing are able to harvest that volatility by buying and selling at opportune times. The benefits entirely pass by the other shareholders who simply hold the stock as the price bobs up and down. All of the gains pass on through to be captured by those who trade astutely. Some shareholdings last for less than a second in an effort to harvest wiggles in the price on a microsecond timescale.

When financial leverage goes wrong, the assets bought on credit may fall in value to become worth less than the money owed. Historically, bankruptcy laws were extremely harsh on debtors and so financial leverage was feared. Without limited liability laws, company owners were personally on the hook for every debt. Nowadays, however, debts can be taken on such that there is an amplification of any gain (which is pocketed) or an amplification of any loss (which becomes un-payable and so is apologized for). The bank bailouts since 2008 have taken this asymmetry to another dimension. The government stepped in and said that it would pay for all of the losses so that none would be suffered by the creditors (predominately also banks and financial institutions in a reciprocal web of lending). Richard Bookstaber summarised the strategy ,

“Innovative products are used to create return distributions that give a high likelihood of having positive returns at the expense of having a higher risk of catastrophic returns. Strategies that lead to a ‘make a little, make a little, make a little, …, lose a lot’ pattern of returns. If things go well for a while, the ‘lose a lot’ not yet being realized, the strategy gets levered up to become ‘make a lot, make a lot, make a lot,…, lose more than everything’, and viola, at some point the taxpayer is left holding the bag.”

Currently, high finance is an extremely complex business. It requires a colossal technological and human effort. The most advanced and expensive computers are dedicated to high frequency trading (HFT). The best and brightest are educated at elite universities to prepare them for the intense battle of mathematical genius that financial trading has become.  Traders pay exorbitant rents so as to have their computers next to those of the major exchanges to avoid even the slightest time delay. A private fibre optic cable has been laid directly between New York and Chicago so as to gain a microsecond advantage for comparisons between the futures and stock markets. It is easy to become beguiled by the sheer complexity and effort of it all. People marvel at superlative feats of human endeavour and the financial markets are the Great Pyramids of our time. That is not to say that it is not counter-productive and essentially moronic.

The vast sums skimmed off from the economy by the vastly expensive finance system could mostly be avoided if money used for financial leverage had a cost such as would be the case under an asset tax system. The useful functions of price discovery and exchange would be better served by pedestrianized financial markets in which all participants interacted on a level playing field. Advanced computers would be rendered pointless if transactions were conducted with a time resolution of minutes rather than microseconds. Such a time buffer would end the vastly expensive arms race in computer technology between elite traders. The current ultra-low-latency trading environment often provides a perfectly continuous price variation down to a microsecond resolution. That much applauded attribute is only of any relevance for ultra-low-latency traders in their quest to out manoeuvre other participants. Whilst advanced technology normally creates such (superfluous) pricing precision it occasionally runs amok creating gross mispricing events such as the “flash crash” of May 2010 and the Knight Capital fiasco of August 2012. A genuinely efficient financial market is one that allows prices to be formed that genuinely reflect supply and demand and does so at minimal cost. Excessive opportunities to “make money” from trading are an indication of a dysfunctional market. However, the current market structure is entirely a concoction for just that purpose. The failure of current financial markets to serve their original purpose is apparent from withdrawals.  Farmers are now making less use of futures to hedge their prospective crop yields. There has been a transfer of stock ownership from households and pension funds to financial institutions.

The Shleifer Russia fiasco fascinates me. It seems to reveal more than a simple case of weak willed people succumbing to temptation. Rather it suggests that some of the world’s most powerful people and institutions consider use of political privilege for personal financial gain as their guiding ideal, the centre piece of the system they are endeavouring to bring about. Now Shleifer’s key mentor and protector, Larry Summers, is front runner to head the Fed.

This sorry saga started in the early 1990s after the Soviet Union collapsed. The end of the soviet era left Russia lacking the institutional arrangements needed for a modern capitalist nation. Russia did have tremendous potential; it had an extremely well educated population, abundant natural resources and extensive capital equipment and infrastructure. In principle Russia could have been expected to spring into becoming a global font of technological innovation. Russia was bounded on either side by the prosperous nations of Finland and Japan. However, instead of realizing that potential, the Russian economy collapsed; leaving a husk limited to extracting and exporting raw mineral resources whilst squandering the talents of the Russian people.

The Russian experience stands in stark contrast to what happened to Japan and Germany after WWII. In the late 1940s, the USA took on the task of setting up institutional frameworks to ensure that West Germany and Japan were able to prosper for the benefit of all their people. In both cases it was a herculean task. The USA conducted that responsibility admirably and those countries became beacons of progress and widespread prosperity. That transformation entailed dramatic redistributions of wealth and power amongst the Japanese and German people. In Japan, farmers were able to buy their farmland at an affordable price after the traditional large-scale land-owners were ordered to sell up. In Germany, the Nazi era debts were voided leaving a clean sheet.

The USA clearly had a very noble history of turning around the fortunes of former enemy states –creating affluent allies in the process, with everyone benefiting. As such, the USA was the natural place for Russia to seek advice on the massive challenge it faced. However what Russia received was very different from the earlier treatment of Germany and Japan. The USA deployed academic economists from Harvard University to guide Russia’s reconfiguration as a capitalist state. Those advisers are the people who now are looked to by western leaders when considering the future direction of western nations. Does Russia reflect what they wish for all of us?

Post WWII reconfiguring of Germany and Japan was orchestrated by US military Generals* who took a pragmatic approach. They were guided by experience of the war-time US economy and the presumption that widespread prosperity was a prerequisite for creating a nation that would serve the USA as a valuable ally rather than fester as a source of future conflict. The spectre of communism helped to focus attention on ensuring that a version of capitalism was installed that would trounce communism at every level for every sector of society. By contrast, after the Soviet Union collapsed, communism no longer posed any form of competition and so there was no longer that concern. What was set in place in Russia may reflect an unfettered political ideal of the most powerful western policy makers.

The post-war US military authorities took the common sense view that the economy needed to be crafted into a framework that aligned financial interests with what benefited the wider population. It was fully recognised that an economy might instead fall down a malign path where financial interests led instead to waste and conflict. By contrast, the Harvard team in Russia had such unqualified faith in the constructive properties of avarice that they seemed to be guided by the principle that their role was merely to sweep aside any impediments that hindered money from doing what it wilt. The Harvard ideology boiled down to the belief that personal wealth gathering would always generate benefits for the wider economy. It was deemed inappropriate meddling to be concerned about wealth distribution. Having ownership concentrated to a tiny segment of the population was not viewed as a problem because their ideology was that owners would always maximise the utility of everything they owned.

There is a certain irony to all of this. The soviet system clearly failed to make optimal use of the resources it had. The classic explanation is that, without the profit motive, resources were misallocated and disaffected workers let things slip. To my mind much of the problem with a soviet style of economy is simply that economic power is overly concentrated. A few central planners are tasked with sensing what everyone else is capable of contributing and wants to consume and co-ordinating all of that. By contrast a capitalist system with widely distributed economic power, channels the combined parallel decisions of everyone. That capability breaks down once economic power becomes overly concentrated. An oligarch is faced with just the same impossible task as a soviet central planner. They have no way of knowing what all the “little people” are up to contributing or want. So oligarchs flunk at the challenge of mobilizing human resources and an oligarchic economy atrophies down to leave just the natural resource extracting industries. Haiti provides a classic example of where oligarchy leads.

The Harvard role in the Russian privatizations took its most bizarre twist when the academic economists themselves started joining in with the asset grabs to carve out fortunes for themselves. They became entirely pre-occupied with grubbing around to gather personal fortunes and neglected (and were conflicted with) the epoch making challenge of setting up the institutional framework to enable a constructive form of capitalism for Russia. That astonishing behaviour has to be viewed in the context of their wider ideological view point as to the economic role of wealth and wealth distribution. They seem to believe that the optimal solution is for ownership to accrue to whoever is cunning enough to grab it; if that happens to be themselves, then so be it. Deploying political privilege as part of that cunning is all fair game. Following this logic, if the ultimate endgame is to deploy political power to configure the economy into a form that hands over financial power to those with political power, then those winners are the rightful victors.  Under such an ideology there is a particular imperative for believers to gather a vast personal fortune. The old adage, “if you’re smart, then why aren’t you rich?” takes on a reality in which not being immensely rich becomes a mark of failure. By contrast, my guess is that General McArthur would never have contemplated using his position for personal financial gain. Prestige came from doing the job well as evidenced by the future course of the Japanese nation. Personal enrichment from exploiting political power would have been seen as shameful and little minded.

What strikes me most about the Shleifer Russia affair is how Summers’ Harvard stood up for the protaganists and nurtured their careers whilst paying tens of millions of dollars in damages and legal fees brought on by fraud charges from the US government over the affair. Clearly Summers’ view is that the Russia privatization team did not act disgracefully and bring shame on Harvard as an institution. Schleifer has never acknowledged any wrong doing and has been backed to the hilt by Harvard.

Political power now seems to be shifting towards the kleptocratic viewpoint. The 2008 bank bail-outs were an awesome display of the political system being commandeered to appropriate immense financial power and Larry Summers was in the thick of it. If Larry Summers does get appointed as Fed chairman then that will be a crowning of the conquest.

*It is obviously important to also credit German and Japanese participants. Ludwig Erhard deserves much of the credit for the Wirtschaftswunder but ultimately it was the US who chose to put such admirable people in the driving seat in the crucial period before the first elections.

Related stuff on the web:

How Harvard lost Russia -David McClintick

‘Tawdry Schleifer Affair’ Stokes Faculty Anger Towards Summers – The Harvard Crimson

Did an Expose Help Sink Harvard’s President -NYT

Theft of the Century Privatization and the Looting of Russia – Paul Klebnikov

Who Lost Russia – George Soros

Russian Ripoff -Michael Hudson

Why Wall Street Wants Larry Summers (and Why the Rest of Us Should Not) -Kotlikoff and Sachs

Larry Summers will destroy the economy (again)– Salon

Anyone But Larry Summers – Barry Ritholtz

Larry Summers’ Take on Efficient Markets and Regulators – William K Black

Why Janet Yellen, not Larry Summers, should lead the Fed – Stiglitz (link added 14Sep2013)

Max Keiser and Greg Palast on Larry Summers and the Financial Crisis – Jesse cafe Americain (link added 18Sep2013)

Larry Summers: Goldman Sacked – Greg Palast (link added 18Sep2013)

My previous post was linked (thanks !) as “a skeptical take of Open Borders”. I had blundered into the subject and I’m embarrassed to admit I wasn’t even aware of the Open Borders campaign. After checking it out, I’m just as skeptical as ever. Open Borders hopes to address the fact that people in poor countries earn massively less than people in rich countries. Supposedly the answer is for an epic migration of billions of people from the poor countries to the rich countries where they supposedly will then be “more productive” and so poverty will be eliminated.  

It’s so important that we unpick what is meant by terms such as “more productive”. Imagine someone selling street food in Dhaka Bangladesh. It’s delicious, nutritious food, produced extremely efficiently and is sold on a large scale to an appreciative market of consumers with nothing wasted. To my mind it is grossly insulting to describe that as “less productive” than working in yet another New York restaurant where insufficient custom means the food largely ends up down the sluice. Yet, in terms of how much the workers earn, it is “less productive”. It is all down to the fact that diners in New York have massively more money to spend than diners in Dhaka.

To my mind what we really need to face up to is why customers in Dhaka don’t have enough money to spend and so those running a thriving eatery in Dhaka cannot support an affluent lifestyle. That issue is basically what much of this blog is about (see here, here, here). Redirecting flows of money entails no more real disruption than the effort of clicking a computer mouse. And yet Open Borders advocates such as Michael Clements claim that it is preferable have billions of people move to where the money is rather than looking at why the money isn’t going to where the people are.

In principle I share the libertarian ideal of everyone being able to live wherever in the world they fancy. I think the way to go about realising that aim is to first address the issues that create the disparities between rich and poor countries. Once that is (even if only partially) achieved, then the vast bulk of people would no longer have any desire to migrate. A few people would because of personal reasons and for exchange of specialist expertise. However opening borders would then not be opening the floodgates to a torrent of people driven by macroeconomic forces. It is only the prospect of such a torrent that keeps the borders closed now. My total disagreement with the Open Borders campaign is that they advocate opening the borders to a torrent of migration as a first-line response to the disparities between rich and poor countries.

It could be argued that those in the rich world have little capacity to eliminate poverty in foreign countries and so have a greater chance of benefiting the lives of poor people by opening borders to immigration. That argument hinges on the idea that poverty is due to bad governance abroad and that the only answer is for the population to vote with their feet and emigrate. Firstly, I don’t think it is actually true that the rich world is a mere passive observer of poverty abroad. From what I can see, much of the blame for that poverty lies with active policies conducted by the developed world. Furthermore, over the longer term, those malign policies only benefit a minority even in the developed world. We need fair tradereform of the international monetary system away from “US dollar hegemony” towards a more equitable and less distorting system and a realignment of economic policy away from blowing asset bubbles that enrich the rich by enticing in capital flows from the poor world.

Much of the Open Borders logic seems to stem from the idea that market finance already has an inbuilt characteristic that would always lead towards an optimal solution for the world’s problems if only meddling governments were to stand aside. It’s vital that we keep our eyes open to situations where financial forces instead pull into calamitous vicious cycles. Property prices in London, New York or Tokyo would get pushed ever higher if borders were open for mass immigration. That would entice in ever more capital flight from the developing world, exacerbating the impetus for migration. I’m struck by how Michael Clemens seems fully aware of at least one side of this feedback loop as he writes that an expected consequence of epic migration to rich regions would be that “returns to capital rise in the rich region and fall in the poor region”. I’m left wondering whether Michael Clemens does not appreciate that capital flight from poor countries to rich countries does much to generate the disparities that drive the desire for migration in the first place. Perhaps he and other Open Border economists welcome such bubble blowing feedback loops. Financial sector lobbyists, and those in their thrall, aim for financial instability because the gains from expansion can be harvested whilst the losses from crashes get socialized.

It is also not clear to me that open borders would necessarily encourage a beneficial competition between countries to entice and retain their populations. It is vital to recognise that sometimes bad governments will actually seek to usher out the population. Natural resources may be exploited even from a depopulated country. The Scottish Highland Clearances are a classic example of how a country was brutally depopulated to facilitate natural resource exploitation.

related previous posts:

Demographics, migration and fiscal sustainability

Isn’t a financialized economy the goose that lays our golden eggs?

Globalization, Triffin’s dilemma and demurrage crypto currency

Rich people could benefit if everyone else were also rich

related stuff on the web:

A reply to”Direct Economic Democracy” – Paul Crider, Open Borders (added 09Aug2013)

If people could immigrate anywhere, would poverty be eliminated? -Atlantic

Economics and Emigration: Trillion-Dollar Bills on the Sidewalk -Michael A. Clemens

Open Borders

Addressing development’s black hole: Regulating capital flight

Open borders: A morality play by the 1% -macrobusiness (added 26 Feb 2014)

The UK Office for Budget Responsibility (OBR) has made a pronouncement that we need to have mass migration into the UK as a way to reduce future government debt to GDP ratios. They claim that the “dependency ratio” between people of working age and retirees will become “unsustainable” as the baby boomer generation retires unless millions of migrants of working age join the UK workforce. This pronouncement has been hailed for supposedly dashing aside xenophobic objections to mass immigration with impeccable economic logic.

Immigration is an extremely thorny issue. I think we have a responsibility to really examine those issues rather than blustering with glib “economic arguments”. The OBR “economic argument” for migration seems to me to be entirely fatuous. It is not as if there is any shortage of unemployed or underemployed people in the UK who would willingly do the work required to care well for our aging population. Increases in mechanisation mean that our real needs can be met with less man-power. That potentially leaves plenty of people free to provide nursing care etc. The whole OBR argument is about finance and not about real resources such as human labour, buildings or equipment.

The OBR argument is entirely based on the presumption that taxes are levied on employment. Thus, so their argument goes, when a demographic bulge leaves fewer people of working age, tax revenue falls and government indebtedness tips over into unsustainability where interest repayments cause a snowballing debt crisis. There are two bogus assumptions at the heart of this argument:

-Firstly taxes need not necessarily be levied on employment. Imagine if the government relied instead on inheritance tax – then tax revenue would INCREASE as the baby boomers reached their twilight years. I’ve argued that the most sustainable form of taxation would be an asset tax. Revenue from such an asset tax would not be swung about by demographic shifts in the “dependency ratio”.

-Secondly deficit spending to fund elder care during a “demographic bulge” certainly need not precipitate a debt crisis. Currently, as fast as deficit spending adds to the UK’s stock of government debt, that debt is purchased by the Bank of England under the various QE programs. Consequently the increased interest payments by the UK treasury simply get passed back to the UK treasury from the Bank of England. There is no prospect of a snowballing of interest payment obligations. There are issues about the political consequences of endless deficit spending but it is simply not true that spanning a demographic bulge with deficits would precipitate a government debt crisis.

We need to be very wary of the extent to which “economic arguments” about demographics are not really about providing sufficient supply of needed goods and services but instead about asset prices. An increasing population gives asset prices a Ponzi effect impetus. For those currently in the “owning class”, the increasing scarcity that comes from an increasing population inflates their financial power. By contrast a shrinking population would mean that land, natural resources and capital equipment became less scarce. That would benefit those wanting to buy into ownership and those saving for future pensions but diminish the relative financial power of the current owners. I think it is very misguided to aim for asset price inflation as a target for economic policy but sadly that seems to be what is behind standard economic advice.

That gets us back to the thorny real issues around migration. It is vital to draw a distinction between on the one hand the entirely beneficial phenomenon of people working abroad as a way to exchange expertise and on the other hand mass net migration driven by macroeconomic forces. Furthermore my skepticism about the merits of mass migration is not due to any issue with multiculturalism. I view the multicultural character of the UK as a positive attribute to be celebrated. I’m struck by how the serious sectarian conflict that we do have within the UK is in Northern Ireland and is between people who share a local ancestry going back centuries. And let’s be clear that conflict is about tribalism not religion. Also in the last century the UK suffered the crippling effects of social class divisions. That is a sectarian division concocted out of thin air without a whiff of ethnic pretext. Sectarian conflict is an ever present peril that every society and individual has a responsibility to continuously dispel irrespective of how seemingly homogeneous or diverse their community is.

The libertarian ideal is that everyone should be free to live and work wherever they fancy and government has no place imposing restrictions on migration. Many migrants do experience culture shock in their adoptive country. This is starkly illustrated by the fact that a personal or family history of migration is an important risk factor for schizophrenia. Libertarians argue that any difficulties with living in a foreign culture are a private matter to be weighed up by each individual in deciding whether or not to migrate. Obviously some individuals have family or personal reasons for moving to a new country. To me however the reality of mass economic migration seems very murky. Clearly imposing restrictions on whether people LEAVE a country is a hallmark of desperate “prison states” such as the former East Germany. It also seems shocking to hear of restrictions on where individuals are allowed to live within their own countries. I would be appalled to have our government dictating which part of the UK I was allowed to live in.  However I worry that it would be calamitous to eliminate immigration restrictions.

The plight of indentured labourers working in Dubai starkly illustrates the potential cruel reality of economic migration. Desperate, illiterate, people in countries such as Pakistan, India and Bangladesh get bamboozled into taking on un-repayable debts to pay for passage to Dubai where they work and live in appalling conditions. Their situation amounts to effective slavery – about as far from a Libertarian ideal as is conceivable. Clearly this is an extreme example but it underlines a wider phenomenon of migrant workers being in a less assertive position to ensure that they receive a fair level of pay.

Much economic migration appears somewhat deranged. Migration is inevitably towards where the money is rather than where there really is a genuine greater need for work. Recruitment of migrants to meet “labour shortages” often appears to actually be a symptom of a deeper conflict over what share gets taken by workers as wages rather than accruing to employers as profits. Perhaps it would be much better if that key issue was instead dealt with head on by facilitating employee ownership such as with the John Lewis partnership.

In the 1950s mass migration to the UK was encouraged supposedly to meet a labour shortage. At the same time labour unions endeavoured to safeguard jobs and wage levels by insisting on ineffective working practices and over-manning. Unions tried to ensure that labour was scarce and valued; migration was a way to undermine that artificially exacerbated scarcity. Ironically migration was away from countries that had a vastly greater real need for work that the UK did. The West Indies, Bangladesh and Pakistan had a real need for infrastructure development, water and power supplies etc. etc. Arguments that the West Indies had an excess population as a legacy of the declining sugar industry don’t make sense to me. People anywhere have the potential to themselves be the engine of economic vitality and job creation if only allowed the necessary economic environment. Singapore after all supposedly has had a multi-decade labour shortage and yet Singapore is also a tropical island with no source of employment prospects other than those created by its own population.

The more recent mass migration from Poland to Western Europe seems to me no less deranged. Poland seemed in great need of skilled, motivated, Polish people to re-build their nation after decades of communist era floundering. Instead the 2004-2008 housing bubble in Western Europe provided such a lucrative draw, that engineers and school teachers left Poland to take unskilled labouring jobs, constructing ghost estates in Ireland and never to be used shopping centres in the UK. Perhaps if it hadn’t have been for an endless supply of migrant labour, labour shortages might have brought sanity to the housing bubble. The proceeds of the bubble might also have been distributed in a less inequitable fashion if labour shortages had pushed up construction workers’ wages.

The reality is that if all people were free to migrate around the world willy-nilly then, all too often, we would end up having to do so in an entirely wasteful and pointless fashion. Momentum chasing “hot money” flows from country to country in a largely stochastic fashion at the whim of automated trading algorithms driving the gyrations of the financial markets. Families would end up having to up-root and follow the money, further fuelling such bubbles and busts.

When considering the UK situation it is helpful to make a comparison with the extreme cases of Singapore and Japan. Both those countries have a more dramatic demographic issue than the UK does. Japan seems to be successfully ensuring that the dramatically aging Japanese population is very well looked after with no recourse to mass immigration into Japan. As elsewhere, there is no genuine constraint of labour shortage in Japan. Singapore on the other hand is fully embracing the mass immigration option. That is despite Singapore being on a tiny, densely populated, island.

Singapore has the peculiar characteristic that over a third of the people living there are not actually Singaporean citizens. Such guest workers have to leave as and when the job market dictates and in many cases their families are not permitted to live with them in Singapore. The Singapore government has set its sights on both increasing permanent immigration to increase the number of full Singaporean citizens and also increasing the ratio of guest workers to Singaporean citizens. They have set the ideal that Singaporean citizens should be predominantly managers whilst less senior jobs should be taken by guest workers. This is simply a starker and more forthright example of the mind-set also exhibited by our last “New Labour” government here in the UK. Then we were told that mass net immigration into the UK ensured career opportunities for existing UK citizens as managers of all of the new immigrants.  Personally I think this reflects a misguided view that undervalues front line workers. To my mind it is better to cherish and properly reward all required work.

See previous post:

Isn’t a financialized economy the goose that lays our golden eggs? -Rather than saying that people should migrate to where money is flowing, shouldn’t we instead stop fostering capital flight from the poor world (where the money is genuinely needed) to asset bubbles in the rich world?

Related stuff elsewhere on the web:

A rely to”Direct Economic Democracy” – Paul Crider, Open Borders (added 09Aug2013)

Fiscal Sustainability Report July 2013 – Office for Budget Responsibility

A Sustainable Population for a Dynamic Singapore

Charlie Rose: Jeremy Grantham on Our Debt Solution -Bloomberg video

Migration Matters Trust

Open Borders (added 31July2013)

Japanese nurses blocking skilled help from overseas -Japan Times

Nursing Leadership in a Rapidly Aging Society: Implications of “The Future of Nursing” Report in Japan -Nursing Research and Practice

Sunder Katwala on immigration from the West Indies -BBC

Economics and Emigration: Trillion-Dollar Bills on the Sidewalk? -Michael A. Clemens (added 31July2013)

If People Could Immigrate Anywhere, Would Poverty Be Eliminated? -Atlantic (added 01July2013)

North of the Border – Krugman NYT (added 02Aug2013)

Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist. –Kenneth E. Boulding

Our world today seems full of contradictions. We seemingly need to work longer hours to secure our jobs when there aren’t enough jobs to go around. It appears necessary to bombard us with advertising to persuade us to buy stuff we don’t really want because that is the only way to ensure enough employment for people to afford what they need. Apparently much of this is in aid of economic growth and economic growth is important because without it we won’t be able to service our debt burden.

It is easy to come to the conclusion that debt and economic growth are at the root of our problems and so we should eliminate both. There is a campaign organisation advocating just that – the “Center for the Advancement of the Steady State Economy” (CASSE). Nevertheless, it is also easy to dream up imaginary fables where both debt and economic growth are entirely beneficial:

Imagine an economy where people relied on camel herding to provide food and fire wood for power. They had intermittent famines whenever droughts occurred and spent all day every day scouring the desert for fire wood, water and camel forage. Life was hard and getting harder due to desertification from camel overgrazing and tree loss.

To avoid the looming crisis they constructed solar powered desalination plants to provide fresh water from the sea and grew seaweed on floating farms to convert into aviation fuel, plastic materials and animal fodder. The waste from the seaweed was used as a soil improver and so plenty of camels could be kept on good pasture for use as family pets and recreational riding. Solar powered, robot staffed, factories provided everything everyone wanted. The land that had been overgrazed recovered and wild animals that had been rare became numerous again. Materials were recycled and the cornucopia of consumer goods and capital equipment entirely came from organizing existing materials using human ingenuity and renewable energy.

All the economic development was funded using debts drawn up between the people. The revenue from providing goods and services to each other provided an ample revenue stream for all the debts to be serviced. Everyone was both a creditor and a debtor. People used the revenue from their debt holdings to help pay their debts to each other. There was initially a debate as to whether to use a monetary system based on bills of exchange drawn up between the populace or whether to allow banks. It was decided that banks would add convenience and fortunately the excess interest charged by banks got spent back into the economy by the bank workers and owners. There initially was nothing much in the way of government but it was decided that so long as government workers spent what was received in taxes back into the economy, a mixed public sector private sector economy might be conducive to overall prosperity.

There was no inflation either of consumer prices or of assets. The price of a camel stayed exactly the same as did the prices of the buildings that predated the economic transition. However whilst previously the camels and few permanent buildings constituted essentially all of the asset stock in the economy; they became a tiny proportion of a vastly wealthier economy with masses of incredibly valuable high tech capital equipment. The stock of debt grew in proportion to the size of the economy; as the economy grew so did the revenue streams available to service the debts with. There seemed no end in sight to the economic growth. People owned more and more sophisticated machines that enabled them to do less and less drudgery. At no point was economic growth sort after as a way to service the debts. It was simply a by-product of people doing things better. If for whatever reason economic growth had stalled, the debts would have remained serviceable because all of the repayments were spent – returning the means of payment back to the debtors.

I think it is instructive to unpick how this imaginary scenario diverges from our real life situation that has led people to found the “Center for the Advancement of the Steady State Economy”. I think it boils down to the imaginary situation being based on money and debt being entirely used to direct current investment and consumption (I’m not using the word “investment” in its financial meaning as exchange of money for another asset but rather in its economic meaning as spending on new machinery etc.). In the imaginary situation the money and debt are simply a form of communication that enables people to organize and rearrange the resources they have. They are analogous to the pheromones used by insect colonies that enable a colony of insects to work together in harmony for the greater good of each other. My impression is that our real life problems stem from money and debt being instead used to concentrate power and control rather than to direct activity. Often money is lent not so as to obtain a revenue stream to spend on goods and services produced from the investment; but rather so as to gather more wealth to keep as an insurance in case in future there is competition for scarce resources.

It is perfectly rational to want to insure against an uncertain future. The problem is that collectively our ability to provide for each other depends on our real productive capacity not our paper wealth. If bees or ants saved up their pheromones, instead of using them to direct each other for gathering nectar, the colony would collapse. When the hive was in disrepair with no stocks of honey, it would be too late and the amassed stock of pheromones would be seen for the foolishness it was.  It is exactly the same with money and debt for us. I think we need to think rationally about the glitch in the nature of finance that enables claims to be accumulated without an accompanying ability to honour those claims. When we talk about debt being unsustainable, what we are really meaning is that the debt has become disconnected from the real economy and money is being used to gather money rather than to build productive capacity. I think replacing our current tax system with a tax on assets could ensure that all wealth remains continuously grounded in the productive capacity required both to pay such a tax and so prevent that potential glitch in the nature of finance.

We also need to be extremely wary of exhortations for economic growth where what is actually meant is growth of debt disconnected from productive capacity. That is simply a demand for increased wealth inequality. Debts based on lending to fund consumption to paper over inequalities have to be recognised as reckless lending that provides no basis for real wealth and need to be left to default with no backstop for the creditors. It is wealth inequality that leads to disconnected debt being the most financially prudent form of saving. In my opinion, tackling wealth inequality is crucial if we are to have a sustainable prosperous economy.

The “Center for the Advancement of the Steady State Economy (CASSE)” have a “myth and reality” section. Two of the “myths” they refute are “We can grow the economy continuously because we can decouple growth from resource use and waste production” and “technological progress will allow unlimited economic growth”. Refuting those “myths” seems to me to be saying that people will stop learning from experience. I don’t believe that that would be desirable. I think it is vital never to conflate environmental conservation with eschewing knowledge and technology. A blind grasping for economic growth for the sake of sustaining non-productive debts may be leading us to neglect environmental concerns but in principle efforts directed at protecting our environment may actually lead to economic growth. Goods might become exquisitely designed with a view towards reuse and recycling. Potentially materials could just be remoulded again and again with no waste and no natural resource consumption. Humans have been doing exactly that with gold and gemstones for thousands of years. We will simply need to treat other mineral resources in the same way.

The sun provides our planet with an immense power source that renders the “thermodynamic” objections posed by CASSE complete nonsense. Do CASSE believe that evolution by natural selection will cease? Isn’t evolution simply a honing of the fitness of living things -the natural world’s equivalent of economic growth? I don’t consider that there is any more reason to evoke a “thermodynamic” objection to economic growth than there is against evolution. Of course humans are perfectly capable of screwing up and making each other’s lives miserable. The history of Easter Island illustrates that perfectly. That is very different from saying that we can’t behave differently.

Also see posts:

Rich people could benefit if everyone else were also rich

Chance, luck, risk and economic democracy

Related stuff on the web:

Is sustainable growth an oxymoron -John Fullerton

Growth isn’t possible- nef

The End of Growth Wouldn’t Be the End of Capitalism -The Atlantic

On the Road to Zero Growth -Jeremy Grantham

Murphy’s Law? or, Follies of a Finite Physicist- Noah Smith

I think the greatest threat to our environment is human poverty. This may seem counter-intuitive since in general each rich person consumes and pollutes far more than each poor person. It has been estimated that it would take five Earths to provide all seven billion of us with a current US lifestyle. An astonishingly low environmental impact is achieved by the poorest . On the face of it, if everyone managed to lift themselves out of poverty, increases in pollution and environmental degradation might be expected to cause an environmental calamity. However if having all seven billion of us living an affluent lifestyle poses an environmental challenge, a more serious environmental challenge is posed by having ten billion people sharing the planet even if two billion of those don’t pollute or degrade the environment much due to poverty. To my mind population growth is the crucial environmental issue and population growth comes from poverty.

Hans Rosling makes a very compelling case that the poorest two billion people are the source of global population growth. People from utterly different cultures all over the world on average have large families when child mortality rates are high and small families when they are low. Over the past few decades there has not been an explosion in the number of poor people because thankfully many poor people do manage to escape poverty. But enough remain poor to maintain a steady source of global population growth. The poorest two billion people today are just as poor as the poorest two billion a few decades ago and just as likely to see their children die and just as likely to have large families. Poor people  are the progenitors of the increased future population of better off people who eat meat, drive cars and water their lawns. If you believe that the world can only support a limited number of affluent people then the answer is to ensure that everyone is affluent.

Obviously if each of us who has the good fortune to be comfortably well off chooses to consume in a way that minimises environmental problems; then that is great. We can spend our money on say dance classes for our children rather than new hardwood flooring or whatever –reduce, reuse, recycle. Environmental concerns do also feed into politics though. Many people want the political system to steer other people towards behaviour that protects the environment.  I think it is crucial that people living in the rich world channel the politics of environmental concern towards ameliorating the extent to which the rich world impoverishes the world’s poorest. I don’t think policy makers in the rich world intentionally impoverish the world’s poorest. It comes as a by-product of efforts to ensure prosperity in the rich world or to protect special interest groups in the rich world. Agricultural tariffs and subsidies are a classic example. They lead to what otherwise would be uneconomic intensification of agriculture in the developed world so as to dump food at a loss in the poor world. There is consequent destitution of people who could otherwise be involved in commercial agriculture in the developing world both for local consumption and for export. In the 1800s the case was successfully made that repealing the English “corn laws” would benefit almost everyone with the exception of those wanting increased rents and mortgages from English farmland. I think the same arguments hold today.

In the USA in particular there is much popular support for protectionist tariffs and subsidies*. The USA is such a large country that it can cope relatively well even if global trade gets shut down. I think it is crucial that we unpick the motivation behind such protectionist views. Much of it seems to stem from the conflict between “labour” and “capital”. The owning class has the most to gain from globalization. The owning class can own whichever companies are most profitable where ever they are based. They can lend money to whoever in the world provides the highest return. Workers on the other hand lose bargaining power. Jobs become outsourced to where ever in the world has the lowest wages for a given level of competency. As I see it the answer is to ensure that everyone belongs to the owning class. Replacing all current taxes with an asset tax and paying a citizens’ dividend would have that effect. If the increased profits that came from offshoring jobs went to everyone rather than just a select owning class then much of the current resentment would evaporate.

What the world needs are advances in efficiency and technology. We need to be able to do more with less. To my mind it makes much more sense for people to be freed up to push new technologies in the developed world. A compelling case can be made that developing countries benefit from “learning by doing”. If a basic manufacturing process can be done well in a developing country then it makes sense for it to be done there, providing jobs there. Hopefully the experience gained will raise capabilities so that all of the world can be at the forefront.  People like working not simply because they want money but because they find it satisfying to create and provide, to master skills and innovate. To truly satisfy that motivation, people need to be doing work where they are really making a difference for the better. The duplication and waste that comes from trade barriers runs counter to that.

Even more than trade barriers, I think policies aimed at encouraging capital flows from the developing world to the developed world have been the overriding influence on world poverty. I’ve examined this in the previous post “Isn’t a financialized economy the goose that lays our golden eggs”. People in the UK are not callously minded towards people in the developing world. I’m sure that the decimation of the real value of the median wage across the developing world that occurred during the 1980-2000 “great moderation” period is not connected in most people’s minds  with the apparently miraculous affordability for global commodities that came in that period for those in the developed world. Ignorance is no excuse though. We need to get real and face up to the consequences of the policies we vote for. Making the UK a perfect piggy bank for capital flight from developing countries does far more damage than can be put right by some charitable donations.

It is striking that the popular sympathy for protectionism as a way to “keep jobs here” is at odds with nurturing capital flight from poorer countries as a way to gain prosperity by sleight of hand. If money were staying in poor countries, causing those countries to develop a prosperous economy of their own, then that would raise wages there. That would avoid the issue of jobs being offshored from the rich world to lower wage countries. Furthermore if the whole world were prosperous, then countries that are currently poor would become potential importers of products made by workers here.

The cost of natural resources does however increase if the whole world can afford them. If what we really want are more jobs in the rich world, then perhaps we should be more sanguine about that. There are lots of potential job opportunities in renewable energy and recycling. To my mind it makes no sense to at the same time put up trade barriers so as to “keep jobs at home” and yet entice capital flight so that we can get all the world’s natural resources and put off the day when we need to recycle and use renewables.

*As an aside, I think protectionism also is a very bad idea because it provides a compelling motivation for imperialism. In the absence of world trade, a country needs to have a large internal market and that means that countries need to be as large as possible.

see also posts:

We choose for renewable energy to make no financial sense.

Rich people could benefit if everyone else were also rich.

Globalization, Triffin’s dilemma and demurrage crypto currency.

Isn’t a financialized economy the goose that lays our golden eggs?

Related stuff on the web:

People and the planet -Royal Society

Stop blaming the poor. Its the wally yatchers who are burning the planet – George Monbiot

The mother of invention – Interfluidity

A system of governance needs to follow widely held principles of justice and “fairness” if it is to have any hope of being happily adopted. It is equally true that views as to what constitutes justice and “fairness” change dramatically between different eras and places. We currently have a cottage industry of economists and “think tanks” funded to persuade us all that handing over everything to their funding sources (largely the finance industry) constitutes the ultimate manifestation of liberty and freedom.

Perhaps one of the most startling examples I’ve seen of shifting viewpoints is an 1807 election poster from the campaign to abolish British participation in the slave trade. Bizarrely the abolitionists gave prominence to the point that the slave trade was advocated  for and conducted by self-made entrepreneurs whilst abolition had the supposed superiority of being backed by the landed aristocracy. From a modern perspective the inhumanity of the slave trade is ample argument itself and we now consider being a self-made entrepreneur to be a reason for pride whilst inherited aristocratic wealth is a shameful political liability. I was similarly struck by how the recent tearful resignation of the UK’s first police youth commissioner was forced as much by revelations of homophobic tweets as by her boasts about drugs. Only a generation ago homophobia was the respectable standard view point.

My views put forward in this blog are simply what seems fair to me now. I totally appreciate that most people will take a different view. I’m just trying to explain how I’ve come to the conclusions I have. This blog is largely based around the idea that our economy could be transformed for the better by replacing the entire current tax system with an asset tax (see bottom of this post for details). This idea typically does not go down well. A lot of the objections raised revolve around issues of “fairness” and so “fairness” is the focus of this post.

A major role for the state is enforcing property law; that enables property owners to benefit from the property they own as well as creating an orderly and prosperous economy for everyone. To a large extent the financial benefits from that state service accrue to each citizen in proportion to how much property she or he owns. Warren Buffett gains billions of dollars each year from the $53Bn worth of assets he owns. All of that is entirely dependent on the state enforcing law and order. The many people who don’t own anything much gain far less from that state enforcement. To me it seems fair that tax should therefore be paid in proportion to how much we each own. Even if we own something that does not provide an income, unrealized capital gains typically build in relation to the overall economy.  A valuable painting will increase in value each year due to increases in other forms of wealth providing potential purchasers with the means to bid more for it if it were sold. All the while that increasing value for the painting will be entirely dependent on the extremely costly maintenance of law and order by the state. Unrealized capital gains account for a large proportion of wealth increases.

A widely held view is that simply owning something has no economic impact and so should not be taxed. A painting or an unused plot of land may be rapidly increasing in value but that is merely a potential benefit for the owner if and when it is sold. As such, so it is argued, tax should only be paid if and when the asset is sold. This blog largely boils down to a refutation of that view. As I see it the critical factor is possession of financial power. The mainstream view would make more sense to me IF there was an overriding economic bottleneck due to insufficient potential for productive capacity in the economy. If all possible machines had been made and were whirring away 24/7, all production was sold without diversion of resources towards marketing and there was no involuntary unemployment –THEN a good case could be made that holding wealth simply meant deferring consumption – letting a limited supply pass on to other people; so it would seem unfair to constantly tax those assets. In the real world, that economic condition was actually approached during WWII. In peace time however, there is a HUGE gulf between what gets done and what could get done.

Most potential productive capacity is kept constantly untapped because there isn’t sufficient demand for it. Having the financial power to choose whether or not potential productive capacity is kept untapped or is made use of –that to me is the critical economic responsibility distributed amongst us all. Obviously productive capacity can be expanded tremendously by technological and organisational improvements BUT financial power is something totally different from that. What I am referring to is economic influence relative to everyone else. Clearly if productive capacity (or wished for leisure) is untapped and so goes to waste (or gets used wisely or unwisely) that is a consequence of people’s choices. Wealth amounts to having command over whether other people do sensible stuff, do stupid stuff or are left sitting on the side lines. That isn’t a power someone who acquires wealth necessarily wants or has any means of sensibly executing but nevertheless that is what it is. An asset tax is a tax on that responsibility to ensure that it is fully appreciated, wisely used and doesn’t just passively accumulate as money gathers more money.

In my view an asset tax is simply causing wealth to reflect the reality that every unused hour of machine time or human labour is permanently lost. To me a fair financial system is a financial system that mirrors reality such that doing best by money reflects what would be best if money were not considered.

Economists in the Modern Monetary Theory (MMT) tradition contest the idea that stocks of government debt (which constitute much wealth and underpin more) have much bearing on the economy. As MMT believers attest, extra resources are mobilised only if and when such stocks get drawn down and spent and in practice they  simply build up decade after decade (except for rare occasions when the entire monetary system is replaced). MMT economists such as Bill Mitchell claim that as the public fails to spend enough; government deficits can seamlessly remedy any consequent deficit in aggregate demand. The idea is that as humans we (or at least some of us) want to safely squirrel away purchasing power. It doesn’t matter what level of productive capacity there is relative to all those claims because in aggregate we will always want to squirrel away wealth more than we will want to invest or consume. Supposedly the best approach is to accept and accommodate that squirreling instinct by simply printing off government debt as fast as it gets squirreled away regardless of whether that results in a stock of paper wealth that amounts to a greater and greater multiple of everything real there is to buy.

That MMT approach is in my view extremely misguided. It might work if we were amnesic squirrels but we aren’t. Large accumulations of wealth accrue to those who have been most focussed in accumulating them. Guardians of such wealth do look at their account statements and take great consideration of what purchasing capacity they represent. A large stock of saved up government debt securities warrants a major effort and expense in political lobbying to maximise its value. Maximising the value of that paper wealth massively distorts the economy and the political process (see post Political consequences of risk free financial assets). From what I can see government deficits merely offer a short term palliative whilst the underlying issue of the distribution of financial power gets more out of hand. The distinction between the MMT and economic democracy views on taxation can be summed up as MMT viewing the proper role of taxation to be moderating consumer price inflation whilst economic democracy views the proper role of taxation to be ensuring dispersed financial power. The MMT view of taxation is actually somewhat aligned to the “Reaganomics” of Art Laffer since reducing the tax burden on the wealthy can actually reduce inflation by enticing inward capital flows (for a while anyway).

Another objection to asset taxes is that owning an asset does not necessarily mean that someone has funds immediately to hand to pay an on-going tax with. This issue could be particularly acute in the case of an elderly person living in a large house in an expensive district. They could be asset rich but income poor. In the case of personal residences, I’d be in favour of allowing an asset tax to be paid for by transferring partial ownership of the residence over to the state in lieu of the tax. The proportion of the house that was state owned would then be rented by the resident. Potentially the entire value of the house could become state owned whilst the resident kept uninterrupted occupation for their entire life. Of course the resident would be free to alternatively enter into a private equity release scheme to convert their home equity into liquid funds as many people now do. Overall I think an asset tax would actually help people to own their own homes because it would cause houses to be cheaper.

Another particular thorny issue is with small individually owned businesses. Such enterprises account for a large part of the economy of most countries. I’m not convinced that it would actually be much of a problem if much of the intangible value of such businesses slipped past taxation. If taxation were due on the sellable value of tangible assets of the business such as buildings, inventory and equipment and on debt taken on, then that would probably account for enough. If the value were disputed, then I think it would be reasonable to have a public auction of the assets where the current owner would not need to stump up the purchase price but would simply bid on the basis of what taxable value she was willing to pay the tax on.

Appendix -detail of the suggested asset tax (this is an excerpt from the pdf that I started this blog off with)

The most crucial reform would be to abolish all current taxes and replace the current tax burden with a single tax applied equally to all gross assets. Very roughly, the UK population has gross assets of about £10T. This amounts to about £160k per person but obviously is very unevenly distributed. Total annual government spending is currently about £700B or £11k per person, which is about 7% of that asset value per year.  In addition to such assets owned by households, other financial assets and liabilities are owed between financial institutions. For instance, if two banks each owe each other £100B, then that £200B of gross assets will net out and so not be overtly apparent as an asset for households owning shares of those banks. There is about £10T of such debt between UK financial institutions. There are also cross holdings of financial derivatives. The proposed gross asset tax would apply to assets before any such netting out.

A key purpose of the asset tax would be to ensure that paper assets are not concocted unless they can pay their way. Presumably a gross asset tax would lead to financial sector deleveraging (eg by loan write-downs) and that would reset the tax base to a lower level. The true purpose of taxation, however, is not to “raise revenue” but rather to maintain the true value of money. The aim is to re-align the economy towards providing true utility and away from monetary schenanigans.

The UK economy is integrated with the global economy. Assets in the UK are owned by foreigners and UK citizens and institutions own foreign assets. Multinational companies have operations in the UK and in other countries. That allows a beneficial global pooling of expertise. This situation nevertheless creates complexity for the current tax system and would also be a challenge for an asset tax system.

GBP cash and government bonds would need to have the asset tax deducted at source. Crucially the asset tax would have to apply to GBP financial assets owned by foreigners as well as those owned domestically. A key purpose of the asset tax is to avoid long term sink holes for net financial flows. Hoarding of GBP financial assets by foreigners is just such a distortion. Discouraging such foreign use of GBP financial assets as a store of value would allow exchange rates to properly reflect and correct trade imbalances.  Holdings of any other sort of debt security by UK citizens would also need to be subject to the asset tax.

Real estate on UK territory would need to be directly subject to an asset tax whoever owned it. You cannot hide real estate and so direct taxation of real estate would provide an entirely inescapable core for the asset tax. Even foreign owned UK real estate would need to be taxed. If foreign owners were able to avoid paying, then all UK real estate would simply become foreign owned. If someone owned a £200k house with a £150k mortgage, that homeowner would still need to be liable for the full tax on the £200k asset. To a large extent such leveraged ownership amounts to a duplication of financial wealth (both the house and the mortgage are assets). Taxing the gross asset value is appropriate since a doubling of house prices would benefit the homeowner in proportion to the gross asset value irrespective of the mortgage.

Entirely overseas assets owned by UK citizens would be taxed at the level of the owner. So if a UK citizen owned £10k worth of shares in say a Brazilian mining company (or foreign currency or foreign real estate), then that citizen would pay the tax based on that value. Entirely UK based companies would be taxed at the company level.  So shareholders of an entirely UK based company would not pay any asset tax directly on that shareholding. As already stated, any UK real estate or GBP owned by that company would be taxed directly. The remaining value of the company would be taxed on the basis of the market capitalization plus debt liability with a deduction for any real estate holdings (that already would have been taxed). Including debt in the corporate asset tax liability means that a UK citizen would be (indirectly) paying more asset tax when holding shares of an indebted UK company than of an indebted foreign company. However since the foreign company would be paying the foreign country’s corporation taxes, there would probably be no overall tax advantage for ownership of foreign versus UK company shares.

A multinational company with operations in the UK would pay UK tax at the company level based on those UK operations. A real risk would be companies playing the system and so making use of the lack of corporation, sales and income taxes here whilst minimising asset tax liability here. As already stated, any UK real estate or GBP owned by that company would be taxed directly. Harder to pin down would be the tax liability from, for instance, having a large research and development program in the UK. Possibly the best approach would be to divide the tax liability on the basis of the proportion of cash flow attributable to the UK operations. So if a company had 25% of its cash flow from UK operations, then the asset tax due would be based on 25% of the corporate debt owed plus total company market capitalization with the tax already paid on UK real estate deducted. UK shareholders of multinational companies would have to pay the tax for the remaining “foreign” portion of the company that was not taxed at the company level.

Currently the UK hosts banks that hold colossal webs of financial derivatives. London provides a global centre of expertise for such activity and has a buccaneering, free-wheeling regulatory system that facilitates innovative financial engineering. Of the $707T USD notional value of outstanding financial derivatives held worldwide, $417T come from London. To put that in context, global GDP is about $70T USD. An asset tax system would be incompatible with hosting such activity. Obviously such derivative contracts could never hope to earn enough to pay an asset tax imposed on their notional value. Those banks would need to relocate to other countries and cease UK operations. In terms of loss of well-paid jobs it would be painful. Goldman Sachs is an archetypal example of such an institution. They hold $44T USD of financial derivatives. They have 5500 London based employees and pay each employee an average of £336k per year. To some extent having firms such as Goldman Sachs in London can be seen as a pure gain for the UK economy. The US government has spent tens of billions of dollars bailing them out, they extract money from the entire global economy and yet a good portion of what they extract and get bailed out with goes to UK based employees. Such considerations, however, have a corrosive, warping effect on governance of the economy. The role of our monetary system should be to facilitate the activity that everyone would want if money were not a consideration. A monetary system designed so as to facilitate gaming of the system is a bottomless pit leading towards ultimate system failure. Another consideration is whether such firms actually constitute a “brain drain”. People currently employed as elite financial engineers would presumably also be doing complex, ground-breaking, work if they were otherwise engaged.

Currently trivial asset classes such as collectables would also need to be covered. Doing so would ensure that they did not become significant speculative stores of value. Legal ownership of anything would be dependent on being up to date with the asset tax.

Trusts are currently used to hold assets for collective pension saving schemes, charitable endowments, and some households and institutions.  Assets held under trusts under UK jurisdiction could be subject to the same asset tax as if they were held directly by a UK citizen. So taxation would be at the level of the trust and administered by the trustee. Ownership of UK assets by foreign trusts could be subject to the same taxation as ownership by a foreign citizen. UK citizens owning shares in a foreign investment trust could pay tax just as if they were shares in an entirely foreign company. That would lead to tax inefficiency for foreigners owning shares in UK trusts and for UK citizens owning foreign trusts that held UK assets but minimal economic disruption would result. A UK citizen transferring assets out of UK jurisdiction by transferring them over to an offshore trust could be subject to a one off “expatriation of assets” tax of say 50%.

Regulatory restrictions on land use etc would reduce the asset value and so the tax liability. If some land was a nature reserve with a public right of access, then it would have a minimal asset value and so the tax would be affordable for community groups, ancestral owners etc. Asset prices would reset to being whatever people who wanted to own an asset were willing to support through exposing themselves to the tax. For “consumer assets” such as houses, cars, paintings, leisure boats etc that price would be a function of what people felt able to afford as personal consumption. For “working assets” such as company shares, debt securities, farmland or commercial property, the price would set to a level where yield justified the asset tax exposure.

Currently, asset values are assessed for inheritance tax purposes. The same process would need to be applied universally for an asset tax system. It would be burdensome, however the same is true for the current myriad of different taxes that it would replace. If someone disputed the valuation set for taxation, then they could put the asset up for auction. If they could buy it back for a lower price, then that would be the taxable value.

People often choose to live and work in different countries at different times of their lives. It is important not to impede mobility but also important not to induce counterproductive tax avoidance migrations. That provides a challenge for taxation systems. The USA, for instance, currently has a complex expatriation tax system and taxation is based on US citizenship not simply US residency. Under an asset tax system, tourists and short term (eg two month) working visitors could be tax exempt. Perhaps foreign citizens resident long term in the UK could be largely subject to the same tax system as UK citizens whilst they were resident here. Any assets already owned before the UK residency could be tax exempt. An exemption on the asset tax could also extend up to the value of the citizens’ dividend (which they would not receive). Upon leaving the UK, a foreign citizen could choose to either continue to pay the asset tax, for any assets obtained whilst resident, or to pay a one off exit charge (much like current US expatriation taxes) of say 50%. UK citizens would need to be subject to the asset tax irrespective of where they lived. However, UK citizens living abroad could be exempt from the asset tax up to the value of the citizens’ dividend (which they would not receive). A UK citizen choosing to revoke citizenship could choose either to continue paying the asset tax on the assets they had obtained up to that point or to pay an exit charge of say 50%.

Related stuff on the web:

To Reduce Inequality, Tax Wealth, Not Income -New York Times

The Conservative Case for a 3% Annual wealth Tax -Ronald McKinnon

Want a Flat Tax? I got a flat tax for you -Steve Roth

A Theory of Commodity, Income and Capital Taxation -Michal Kalecki 1937

Tax on wealth is true to Tory principles -FT

Goldman’s Top Economist Explains The Worlds’s Most Important Chart -Business Insider

Briefly Revisting S=I+(S-I) -JKH

Now they want to tax jewellery: New Lib Dem wealth plan to target ALL assets – including buy-to-let homes -Daily Mail

The Three Ways ‘Old Money’ Holds on to its Riches -James Rickards

Modern Monetary Theory Means We Shouldn’t Have A Progressive Tax System – Forbes (link added 23May2013)

On the Phenomenon of Bullshit Jobs -David Graeber (link added 22Aug2013)

Taxing Times -IMF (link added 12Oct2013)

MMT stabilization policy -some comments and critiques -Interfluidity (link added 24Nov2013)

This post is an excerpt from the pdf that I started this blog off with. I’ve posted it because I hope it also makes sense as a stand alone post.

When Margaret Thatcher made her economic policy changes in the 1980s many economists predicted that the UK would be plunged into a vortex of impoverishment. In fact although the deindustrialization they predicted took place it coincided with increased prosperity by many measures. The resulting economic transformation was viewed as such a success that a broad political consensus was formed supporting those “neoliberal” economic policies. The Labour Party became New Labour and embraced financial deregulation and a transfer of taxation away from property and onto consumption. Wealth boomed for the wealthiest and everyone else was swept into greater prosperity along with them. Similar measures were taken in the USA and had similar results.

When reading recollections of those involved in the instigation of the Thatcher economic policies it is clear that the key aim and result was to shift from an economy where wage inflation out-paced asset price inflation to the opposite. The resulting benefit to those who already were wealthy before the transition is obvious. What needs to be understood however is how the country overall became richer on a wave of asset price inflation. How were we able to afford imported goods so much more easily than before? Seemingly by simply bidding up the price of pre-existing (or even purely paper) assets we were able to pay foreigners to do our manufacturing and provide us with natural resources that much of the rest of the world couldn’t afford.

The answer becomes apparent when the financial connections with the rest of the World are drawn into the picture. The UK became the piggy bank of the world. Foreigners were able to join in and further inflate the stock market, bond market and real estate bubble. Across the developing world, the immensely rich elite of those countries sought secure and lucrative ways to hold their wealth. The UK became a repository of choice for this “capital flight” from the developing world. When the UK bought imported goods, the money paid for them was returned back to the UK to bid up the value of our asset markets. In effect, trade became a flow of real goods (and migrant workers) to the UK in return for account statements. All that the UK needed to produce were electronic or paper documents.

To kick off this wave of financial inflow, interest rates were raised significantly above the (high) rate of inflation. This offered a potential bonanza to those buying UK treasury bonds especially if the consumer price inflation rate could be reduced. Limits on bank lending were relaxed and tax breaks were offered to those taking on debt. The government curbed labour union powers and disengaged from efforts to limit unemployment. This quashed wage inflation and so the inflationary impetus of credit expansion was channelled into asset price inflation.

The flip side of this flow of funds to the financialized developed economies was painfully manifested across the “developing” world. In fact, it made a mockery of the term “developing”. From the time of independence in 1960, Nigerian GDP increased 135% during the 1960s and then 283% during the 1970s. By contrast it shrank by 66% in the 1980s. The Nigerian Naira / USD exchange rate went from 0.78 in 1980 to 2.83 in 1985 to 8.94 in 1990 to 102.24 in 2000. With economies drained by capital flight, the developing world was no longer as able to afford global commodities such as oil, coffee, metal ores etc. That caused a slump in commodity prices and consequent further slumps in the economies of commodity exporters and so yet more incentive for capital flight.

Economic depression in the developing world was further fuelled by USD  denominated loans made by UK and US banks to third world governments. A sovereign government has no need for borrowing in a currency other than its own. Any public services such as school teaching, road building or construction of sewerage systems etc. could have been provided using local currency issued by the government to pay local people to do the work with taxes payable in the local currency ensuring the value of the local currency. Countries such as Nigeria had trade surpluses. That provided an ample potential immediate source of foreign currency to fund any imports for government use (such as weapons). The only role for USD denominated loans was for adding to capital flight. Meanwhile the western banks profited from the interest payments on the government debt. Political power in third world countries rested on being able to win over powerful cronies with the prospect of facilitated capital flight and so the dire arrangement became further entrenched.

Since 2000 however the developing world has in many cases resumed development. Hundreds of millions of people in the developing world have escaped poverty over the last decade. This has been applauded as evidence that neo-liberal economic policies have extended their benefits to everyone. Perhaps a more accurate view would be that a stage in the process of financialization has now been fully wrung out and so the choke hold over the developing world’s economies is slipping. In order to attract financial in-flows, the ideal monetary arrangement is to have high interest rates above the rate of consumer price inflation and an expectation that both inflation and interest rates will subsequently fall. The market price of any asset that provides a long term cash flow will tend to rise if interest rates fall. If an asset costing $10 yields $1 per year when interest rates are 10% then (very crudely) a drop in interest rates to 5% will tend to reset the asset price to $20. Bringing interest rates down from >10% to <1% provides a phenomenal impetus to asset markets as has occurred since 1980. However, once it is done, it is done and so wealth managers will start looking elsewhere.

A whole raft of other such policies also harvested a one off boost for asset prices. Curtailing labour union power, shifting taxation from property onto consumption, encouraging private pension saving and facilitating private sector credit expansion all added to the performance of asset holdings. What provides a real bonanza for asset holders is when there is a transition from an unfavourable financial climate to a favourable one. Once that transition has been fully priced in, much of the gain has already occurred -especially when asset values are elevated and so assets don’t provide much of an income stream. Once everything has been done to make an economy as hospitable as possible for global “hot money”, the market will price in that favour and then global “hot money” will look for a new home where the next price rises are going to occur.  This makes attracting capital flows an inherently one off rather than a sustainable way to achieve prosperity. Capital flows may unfold over decades and that may give the impression that they have provided a timeless prosperous equilibrium but ultimately sustainable prosperity depends on the real economy.

It is vital to appreciate that macroeconomic malign effects don’t require any malign intent on anyone’s part. En-mass, people simply endeavouring to manage their finances as best as possible can inadvertently cause massive waste and destruction whilst all the while being entirely oblivious of it. It is analogous to tragic incidents when people get crushed to death in large crowds. No one person is to blame, the crowd surges and crushes without any person in the crowd acting reprehensibly. That is not to say that there is not a responsibility to take crowd control seriously – quite the opposite. Some of the politicians and technocrats at that vanguard of neo-liberalism actually aimed to alleviate poverty. Their reasoning was that if money is pampered then it will spring forth rewards that can be dispensed to good causes. In their view, capital flight supposedly means that global money is continuously being deployed wherever it can earn the most. That is taken to mean that overall global wealth is maximised and so there is more to go round. The key mistake in this is that it conflates claims over real tangible sources of wealth with the underlying real tangible sources of wealth themselves. Whenever that mistake is made, policy makers inevitably fall into the trap of simply facilitating an expansion in the paper claims over wealth whilst losing sight of the underlying reality required to back-up those claims with the real economy. The true responsibility for policy makers is to ensure that the monetary framework is constructed so as to align with the real economy such that what is best for money becomes what is best for the real economy. If left to its own devices, the financial system will wander away from that ideal.  A financial system built by the financial system will direct resources towards expanding the financial overhead borne by the real economy.

We all know the Samuel Goldwyn quote, “the harder I work the luckier I get”; as a personal maxim it has some considerable advantages over, “what will be, will be.” Capitalism revolves around the idea that control amasses to those who have done well. To some extent that ensures that the economy is governed by the competent. However it would be irresponsible and delusional to deny that the effects of personal effort are overlaid on a canvas of stochastic dumb luck. Serendipity is the backdrop to many a success and many losers are potential future winners. If we want our economy to best provide for all of us and make best use of every ones‘ talents, then we need to face up to this randomness.

Ole Peters has posted a fantastic video lecture about the nature of chance (bear with him past the grasshopper stuff). He describes a simple game where a coin flip decides whether the player gains 50% or loses 40%. Clearly winning  gains more than losing loses BUT a subsequent win does not make up for a preceding loss and a subsequent loss loses more than was gained by a preceding win (1.5×0.6=0.9<1); that is the “magic” of compounding.  This simple set up means that a large enough population of players will, in aggregate, steadily gain from playing the game but all of the winnings will randomly accrue to an ever smaller minority of players whilst almost everyone loses almost everything. Ole Peters points out that from an individual’s perspective playing such a game appears highly unattractive. A critical point to emphasize is that it is just as unattractive for a winner to continue with the game as it is for anyone else. A winning or losing streak does not influence the future. A rational winner would choose to stop and keep the winnings.  If wins and losses are pooled and rebalanced across many players, then the game becomes universally attractive.

Perhaps this simple game has more similarity to real life than we care to admit. Starting an enterprise entails financial risks and from an individual’s perspective the financially prudent course of action is typically to hold back. However, if we do that, nothing gets done and we are all poorer.  Perhaps much of the regulatory and legal framework of our financial system is an attempt to entice participation in the perils of enterprise risk so as to add to the overall greater good of society. Whatever lies behind how our financial system has come to be the way it is; I think it has lost its way. Limited liability and bankruptcy laws protect owners from the full financial consequences of bankruptcy. Winnings are kept but losses can be transferred to creditors. Ultimately the state subsidises credit provision to socialise losses whilst leaving profits with owners. This would all be very well if the only sort of risk being subsidised were true enterprise risk from potentially productive endeavours. We all need people to be making valiant attempts to create the next technological breakthrough or provide services in a more effective manner or whatever. The problem is that blindly subsidising financial credit and risk also encourages concoction of synthetic financial risk through use of financial leverage*.

The incredibly complicated to manage and idiosyncratic world of creative innovation or micro-enterprise is not an easy zone to park a vast fortune into. A vast fortune can however prosper very well in circumstances where enterprise risk is avoided and instead exposure is taken to the stochastic fluctuations of global asset and commodity prices. Then economies of scale favour the biggest players –it becomes more affordable to have market beating ultra-low-latency trading systems and to employ the best of the best to develop and operate them. Wealth deployed in that way however is not providing for the future; it is merely gathering money from other people in a zero sum redistribution towards the richest. Unfortunately leveraged speculation also exacerbates price volatility and that can have tragic real world consequences such as the starvation that occurred from the 2009 spike in grain prices.

In principle financial intermediation might be hoped to distribute risk and so create a situation where enterprise risk is readily taken on. The problem is that true enterprise risk is massively dependent on the details of what is being done. That is something that can only be assessed and managed by those intimately involved in each specific project. It is utterly unsuited for pooling across the whole economy. Large corporations have a tendency to only engage in cutting edge developments after it becomes clear that the most risky, initial stages are in the bag. When broader pools of funding for investment are available, it is all too often the case that genuine attempts at innovation become displaced by those cynically attempting to tap into a gravy train. There are plenty of ghastly anecdotes from the 1990’s tech bubble. One scientist told me about how a financier in the 1990’s tried to persuade him to start a biotech company. The financier was triumphantly boasting that none of the many companies he had started had any prospect of commercial viability and all investors had been conned. Even within large companies, it is very hard to keep cutting edge innovation on an effective focussed footing. All too often projects flounder in a way that wouldn’t happen if those involved all saw the project as theirs rather than the companies.

The mainstream view seems to be that innovation would best be fostered by facilitating concentration of wealth. I wonder whether the opposite might not be true. A universal citizens’ dividend could provide a necessary small measure of financial freedom that would help anyone who fancied to have a go at developing some innovation perhaps together with other like-minded people. The history of the 19th century industrial revolution is full of examples of very small groups of individuals tinkering away and making ground-breaking technological advances. Jean-Pierre Garnier then head of GSK has stated that, “The basic philosophy for modern R&D should be to morph big into small in recognition of the fact that critical mass in fundamental research is the size of one human brain.” To my mind that is an argument for ensuring that much financial power is also at the scale of each and every human. The key thing is that people having a go at developing an innovation whilst being partly supported by a citizens’ dividend would have a lot of skin in the game. Their time and money would be theirs and so they would be so much less likely to simply “go through the motions” in the way they might if they were simply following orders.

I also think the same principle applies to provision of everyday goods and services and not just to cutting edge innovations.  In some circumstances it may be most efficient to supply say groceries through a huge supermarket chain but there are also certain efficiencies in having a dispersed small scale system. Currently, holders of outdoor market stalls selling food may be displaced by a supermarket not because they are less efficient or convenient but simply because a supermarket chain is more suitable for accommodating large scale impersonal financial investment. It might be argued that bank lending provides finance to small scale enterprises such as market stalls. However as Ole Peters so clearly demonstrates in his lecture, an enterprise financed in that way becomes dramatically more risky. The repayments are fixed but the revenue stream is subject to the variances of real life. That is why in the UK and USA the (relatively predictable and secured) purchase of pre-existing housing stock accounts for 80% of bank lending and banks are so wary of business lending. An asset tax and citizens’ dividend system might cause the economy to be conducted at whatever scale was most effective rather than having the current bias towards ever greater scale (this pdf describes such a possible economic arrangement).

*This subject is explored in further detail in the section “A zero interest rate policy does not reduce the financial overhead” on page 18 of this pdf.

Related material on the web:

Opaque and stinky logorrhea- Interfluidity and the many many links therein

We Love Banks – Monetary Realism

Cutting Edge Capital Raising for Small Business – katovich (I added this link 11May 2013)

VC for the people -Interfluidity (link added 17April2014)