oftwominds-Charles Hugh Smith: 4/1/24

Monday, April 29, 2024

China and the U.S.: What Matters That's Overlooked

Parsing geopolitics is fun but our attention is better directed to the limits and second-order effects of legacy systems in each of the rival states.

Geopolitics, like any conflict, is dramatic: rivals jostle for hegemony on a 3-D chessboard, war threatens, etc. The focus of this drama is on the leaders' calculations and the pieces being moved around the board in the complex battle for hearts, minds, resources and the high ground.

This is the conventional context of history, and so accounts of the rivalry between the Roman Empire and the Persian Empire read like contemporary accounts of the rivalry between China and the U.S.: the actors and scenery changes, but the dramatic plot remains the same.

A less dramatic but closer reading of history tells a different story: imperial decline stems not from external rivalries but from internal limitations. Externalities--plague, drought, invasion--are not causes so much as events which reveal the limits of the empire's internal legacy institutions.

These rigidities can be structural--economic or political--or cultural / social. There are two dynamics in play here:

1. Once solutions are institutionalized, they become legacy systems that focus not on flexibly solving problems but on sustaining and defending the interests of the institution and its insiders. The solution becomes the problem.

2. Whatever is viewed as a solution generates unanticipated second-order effects which the system is ill-equipped to resolve.

There are many examples of these dynamics in both China and the U.S., and indeed, in every nation / polity.

Consider the goal of increasing homeownership, a laudable ideal that the U.S. pursued after World War II by institutionalizing the heretofore unavailable innovation of 30-year fixed-rate mortgages and government-agency backed mortgages (Veteran Administration-backed mortgages for veterans, FHA, etc.).

Once the institutions promoting homeownership became self-sustaining legacy systems, they changed from "solution" to "problem." As homeownership rates reached 65% of American households, the institutional drive to increase homeownership led to the development of subprime mortgages designed for households that did not qualify for conventional mortgages.

To grease the skids, lending standards were stripped to the point of irrelevance, liar loans took center stage and ratings agencies rubber-stamped risky mortgages as low-risk.

The net result of this institutional self-serving inertia was the collapse of subprime securities and the near-collapse of the global financial system as the dominoes of default and obscured risk started falling.

Turning to China, consider this chart of what happens when a one child per family state policy is enforced for three generations:

The policy was institutionalized with a sensible goal of limiting population growth to increase living standards, but without consideration of the second-order effects down the road.

In three generations, there are four grandparents and two parents who are all single children without siblings, uncles or aunts, and a single child who could be tasked not just with caring for two aging parents but four even older grandparents, should they live beyond the ability of their own aging offspring to care for them.

China has acquired the markers of a great power--missions to the moon and Mars, a mighty military and global economic influence--but it lacks a state-funded universal social welfare system that provides a substantial pension and medical care for every retiree regardless of their employment or earnings. This leaves much of the care of China's rapidly aging generations on the shoulders of the third generation of single offspring.

As in other nations, China's birthrate has declined precipitously as the financial pressures on parents mount, especially on young mothers who desire career opportunities equal to those available to young men.

Social welfare programs become increasingly costly and burdensome as populations age. Any state-funded solution will require diverting enormous sums currently spent elsewhere to the care of a large aging cohort.

The sources of brittleness and failure that are overlooked are internal, not external. Parsing geopolitics is fun but our attention is better directed to the limits and second-order effects of legacy systems in each of the rival states.

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Thursday, April 25, 2024

The Ghetto-ization of American Life

Behind the facade of normalization, even high-income lifestyles have been ghetto-ized.

Consider the defining characteristics of a ghetto:

1. The residents can't afford to live elsewhere.

2. Everything is a rip-off because options are limited and retailers / service providers know residents have no other choice or must go to extraordinary effort to get better quality or a lower price.

3. Nothing works correctly or efficiently. Things break down and aren't fixed properly. Maintenance is poor to non-existent. Any service requires standing in line or being on hold.

4. Local governance is corrupt and/or incompetent. Residents are viewed as a reliable "vote farm" for the incumbents, even though whatever little they accomplish for the residents doesn't reduce the sources of immiseration.

5. The locale is unsafe. Cars are routinely broken into, there are security bars over windows and gates to entrances, everything not chained down is stolen--and even what is chained down is stolen.

6. There are few viable businesses and numerous empty storefronts.

7. The built environment is ugly: strip malls, used car lots, etc. There are few safe public spaces or parks that are well maintained and inviting.

8. Most of the commerce is corporate-owned outlets; the money doesn't stay in the community.

9. Public transport is minimal and constantly being degraded.

10. They get you coming and going: whatever is available is double in cost, effort and time. Very little is convenient or easy. Services are far away.

11. Residents pay high rates of interest on debt.

12. There are few sources of healthy real food. The residents are unhealthy and self-medicate with a panoply of addictions to alcohol, meds, painkillers, gambling, social media, gaming, celebrity worship, etc.

13. Nobody in authority really cares what the residents experience, as they know the residents are atomized and ground down, incapable of cooperating in an organized fashion, and therefore powerless.

I submit that these defining characteristics of ghettos apply to wide swaths of American life. Ghettos are not limited to urban zones; suburbs and rural locales can qualify as well. The defining zeitgeist of a ghetto is the residents are effectively held hostage by limited options and high costs: public and private-sector monopolies that provide poor quality at high prices.

Daily life is a grind of long waits / commutes, low-quality goods and services, shadow work (work we have to do that we're not paid for that was once done as part of the service we pay for) and unhealthy addictions to distractions and whatever offers a temporary escape from the grind.

We've habituated to being corralled into the immiseration of limited options and high costs; the immiseration and sordid degradation have been normalized into "everyday life." We've lost track of what's been lost to erosion and decay. We sense what's been lost but feel powerless to reverse it. This is the essence of the ghetto-ization of daily life.

Behind the facade of normalization, even high-income lifestyles have been ghetto-ized. But saying this is anathema: either be upbeat, optimistic and positive or remain silent.

What's worse, the ghetto-ization or our inability to recognize it and discuss it openly?

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Tuesday, April 23, 2024

Cities' "Doom Loops" Are Even Worse Than You Imagined

This is why those who understand these dynamics are getting out, even though the city was their home.

A correspondent who prefers to remain anonymous sent me this account of the "doom loop" that is playing out in many American cities. The correspondent makes the case that the Doom Loop is not limited to specific cities, but is a universal dynamic in all US cities due to the core causes of the Doom Loop: financialization and the multi-decade decay of cities' core industrial-economic purpose / mission.

I have edited the text slightly, with the correspondent's approval.

The context of the Doom Loop is the process and politics of this decay are the second-order results of central bank easy money (free fiat). That led to financialization becoming the city's core function and the subsequent loss of the city's previous mission. The people living in cities just haven't gotten the message yet.

As such, there is no reversing the process until the centralization of capital itself is reversed.

The typical media articles on metropolitan "doom loops" make it seem like not every city is headed down the path. Now that financialization does not require a physical presence, every city above a certain size will share the same experience. There will be local variations which impact the trend, such as a potential utility as a large pool of voters (i.e. a vote farm), but the decline is part and parcel of financial 'virtualization.'

It is inevitable.

Even hosting one of the twelve central reserve banks won't save you.

The process when a city loses its purpose but persists due to inertia follows this basic pattern:

1. Corporate consolidation costs the city its financial base as Fortune 100 corporations are sold to conglomerates closer to the centers of finance.

This is one more second-order effect of easy money: global corporations can easily finance the acquisition of multi-billion dollar companies.

2. In the past, cities received huge government subsidies for re-development, but none for ongoing maintenance. All the redevelopment projects looked great at first, but with little funding for maintenance, they've gone downhill and many are now dangerous.

Today, the only redevelopment is done by the billionaire class who make most of their money from (surprise) finance. Once the billionaire loses interest, it's gone, too.

I would rather find myself in a developing-world city than an American downtown, at least there would be people around. Many American downtowns are literally apocalyptic.

3. Major league sports are increasingly an exercise in force protection. It's like going inside a forward firebase in Iraq. People still get shot in the stands from guns fired outside the bubble. Unsurprisingly, some major league teams are exploring space outside the cities despite their stadiums being only 20 years old.

4. When federal agencies build new facilities, they're essentially fortresses with direct entrance/egress from the highway. They add little to nothing to the surrounding economy.

5. Real estate, sales and personal property taxes in cities are typically the highest within the state. As tax revenues decline, cities' political leaders increase business taxes and start floating ideas such as taxing non-profit organizations: a financial death spiral indeed. Should taxes increase, organizations and companies have said they will leave.

6. In the industrial economy, the core purposes of cities were derived from advantageous locations and key transportation assets (first water, then rail, then roads, and later aviation). In the information age, those benefits are diminished or gone. As a result of their transportation advantages, cities became manufacturing and warehousing hubs. Those too are diminished or gone.

7. Cities have lost their core economic purpose and are choking on their high legacy costs. The proposed substitute purposes--entertainment and bourgeois lifestyles--are not true substitutes. Fine dining and secure condos with delivery do not replace actual economic functions.

8. Making matters worse, the upper-middle class doesn't want affordable housing in their enclaves, as it lowers property values. So the workers needed to keep the city functioning can no longer afford to live there. Yes In My Backyard (YIMBY) movements to promote affordable housing are not enough.

9. Much of the politics the media focuses on are a consequence of decline, not a cause, and the net result of all the in-fighting is some version of stasis: all sorts of solutions are proposed, but since none address the core sources of decline or the cities' high legacy costs, they boil down to rearranging deck chairs on the Titanic.

This is why those who understand these dynamics are getting out, even though the city was their home.

Of related interest:: The Real Estate Nightmare Unfolding in Downtown St. Louis: The office district is empty, with boarded up towers, copper thieves and failing retail--even the Panera outlet shut down. The city is desperately trying to reverse the 'doom loop.'

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Monday, April 22, 2024

Is the 'Housing Shortage' the Result of Housing-Hoarding by the Wealthy?

Those seeking to buy a house as shelter for their household can't compete with the wealthy seeking assets to snap up and hoard for appreciation.

Longtime readers know I've been addressing housing issues from the start of the blog in 2005. Let's start with the general context of housing in the US, courtesy of the US Census Bureau, which tracks occupancy and the number of housing units nationally: Quarterly Residential Vacancies and Homeownership, 4th Quarter 2023

All housing units 145,967,000

Occupied 131,206,000
Owner 86,220,000 59%
Renter 44,985,000 31%

Vacant 14,761,000 10%

Non-seasonal (i.e. not second homes owned by the wealthy for their recreational use) 11,177,000

Units vacant because they're in the process of being rented or sold:
For rent 3,224,000
For sale only 757,000
Rented or Sold 783,000

Held off Market (occasional use, temporarily occupied, other) 6,414,000

Seasonal (i.e. second homes owned by the wealthy for their recreational use) 3,583,000

TOTAL Held off Market and Seasonal / Recreational: 9,997,000

In summary: there are 14.7 million vacant dwellings in the US, of which 10 million are not available for year-round rentals or sale. Those 10 million dwellings are comparable to the total number of dwellings in entire nations, for example, Australia (11 million housing units, population of 27 million).

There are many complexities not specified or included in these statistics. For example, vacant dwellings located in rural locales with few jobs might be empty because there is little demand due to a declining population. Other dwellings may no longer be habitable without renovation or repair.

On the other side of the equation, non-permitted dwellings (granny flats, etc.) may also be uncounted as those answering Census Bureau questionnaires might hesitate to report units added without official approval. This can include everything from RVs parked alongside homes to converted garages to living rooms partitioned off and rented out as quasi-bedrooms.

The vagarities of self-reported data are potentially major factors in counting short-term vacation rentals, a.k.a. AirBnB / VRBO-type rentals. Data remains sketchy on exactly how many housing units are being "held off the market" as short-term vacation rentals. As of 2023, there were 2,459,260 available vacation rental listings in the U.S., but this may not include informal rentals, rentals listed outside of the major platforms, etc.

The Census Bureau offers several estimates of seasonal units: 3.6 million in the above link, and 4.3 million vacant seasonal units in this post: See a Vacant Home? It May Not be For Sale or Rent. These are traditionally second or third homes of wealthy households. but many such properties are now being offered as short-term vacation rentals for periods when the owners aren't using the property.

What these statistics don't tell us is how many housing units have been snapped up by wealthy households as investments, nominally as "second homes" but solely as safe places to park excess capital / credit, not for recreational use. The wealthy may have joined the rush to cash in on the short-term vacation rentals boom, but they don't need positive cash flow to afford the costs of ownership; the Airbnb rental income was mostly to defray the costs of ownership.

Too Many Rich People Bought Airbnbs. Now They're Sitting Empty

In other words, one factor in the "housing shortage" is the pressure on the wealthiest households to find places to park their excess capital and exploit their low-cost lines of credit. This can be understood as a second-order effect of the Federal Reserve's policy of inflating asset bubbles in which 90% of the gains flowed to the top 10% households. This new wealth could then be tapped to buy real estate, a long-favored asset class of the wealthy that has risen to new heights as the wealthy compete with other wealthy households to snap up housing.

There's not much in the pockets of the bottom 50% to compete with the top 5% for housing: we can expand this to say there isn't enough in the pockets of the bottom 90% to compete with the top 10% who collected 90% of the gains of the Fed's credit-asset bubbles:

We can see how much rental and sales prices have risen in the past few years: charts are courtesy of the US Census Bureau.

Median asking rent for vacant rental units, nationally:

Median asking sales price for vacant for sale units, nationally:

Meanwhile, housing units per capita is hitting record highs. This doesn't support the claim that there aren't enough housing units; it supports the idea that housing has been hoarded as an asset class, concentrated in the hands of those seeking vacation rental profits or appreciation on housing left purposefully vacant because renting it out is a hassle.

Would a couple million housing units entering the year-round rental market relieve some of the pressure pushing rents into orbit? Basic supply-and-demand suggests the answer is yes.

What happens when central bank manipulations of credit and interest rates reward the few with 90% of the gains generated by policies seeking to goose "the wealth effect"? The entire economy becomes distorted by the speculative frenzy to snap up assets that will appreciate as the Fed's bubbles continue expanding.

Those seeking to buy a house as shelter for their household can't compete with the wealthy seeking assets to snap up and hoard for appreciation. Those seeking to rent a dwelling are up against corporate hoarders of homes such as Blackrock, which owns 7% of all rentals in the US, and wealthy households pulling dwellings out of the year-round rental market to feast on the profits generated by revenge-spending vacationers.

Would a deep recession incentivize an increase in the number of occupants per dwelling and a corresponding decline in demand for rentals? Would a collapse of The Everything Bubble prompt some selling of hoarded housing? As painful as these might be, these dynamics would correct the destabilizing distortions wrought by the Fed's easy-money bubble blowing and concentration of wealth in the hands of the few at the expense of the many.

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Friday, April 19, 2024

Living on Uneasy Street

It's nice to anticipate sunny weather, but it's a good idea to carry an umbrella just in case the forecasts prove overly optimistic.

Yes, the market will rally if World War III didn't start last night. The market will also rally if World War III does start, because the Federal Reserve will surely lower interest rates.

We chuckle uneasily at gallows humor here on Uneasy Street because we're still required to maintain an upbeat veneer of endlessly cheerful optimism even as we sense that the forces currently in play are beyond the control of individuals or groups, no matter how powerful they may be, and that these forces will follow a course to an end no one can predict with any degree of upbeat confidence.

Back when we lived on Easy Street, things were getting better for everyone in varying degrees and the ladder of social mobility was available to all: anyone could improve their prospects by putting in the effort.

Fortunes were being minted, lists of reasons to be optimistic proliferated like overfed rabbits and spots of bother ran off the road on their own, requiring nothing of us.

Life on Uneasy Street is, well, different. The lists of reasons to be optimistic are still everywhere, but they now ring hollow, as those conjuring the lists sound increasingly frantic: come on, people, get with the program, it's all gonna be wunnerful, AI, AI, AI, Roaring 20s, blah blah blah.

The only true believers are those paid to shill the optimism by those seeking to maximize their profits via selling the sizzle rather than the actual steak. The entire exercise of trying to convince us that we still live on Easy Street is simply more evidence that Easy Street is a figment of imagination.

Now that various forces have been unleashed, gravity and the lay of the land will dictate the course of history. Yes, yes, our technological powers are god-like, we're going to Mars, there's a new (and immensely profitable, of course) technological solution to every problem, so just buy, buy, buy the latest gadget or med: imagine that, you can talk to your refrigerator! Wow. That solves a ton of pressing problems.

Too bad the fridge fails in a few years and has to be replaced, the med must be taken forever or your ill health returns, the side effects require a couple more meds, each of which has their own side effects, and going to Mars has no causal connection to actually solving problems here on Earth with some new technology.

Cycles play out despite our cheerleading inspirational rah-rah. Humans respond the same old way to the tightening of various screws: they start hoarding what's scarce, start seeing conquest and war as the go-to solutions to scarcities and rivalries, reasons to cooperate wither under the relentless sun of crisis while reasons to disagree proliferate most disagreeably like noxious weeds.

Just like all the other creatures on the planet, humans expand their consumption and numbers in times of plenty and are unprepared for the inevitable asymmetries of supply (stagnant or declining) and demand--forever rising, as growth is the one essential for the status quo, regardless of ideological type or label.

As supplies no longer exceed demand, inflation (loss of purchasing power of wages) eats the bottom 90% alive, while the rise of debt that so wondrously expanded the asset wealth of the top 10% starts eating its own tail, as interest rises faster than wages or actual production.

Various grandiose solutions are promoted that claim to fix the pressing problems. Some are absurd techno-fantasies (huge mirrors to deflect solar radiation--never mind the increasingly untenable cloud of space junk orbiting Earth), and some sound appealing but are not as painless as advertised, for example, the clearing away of all debt with a jubilee in which all debts are instantly forgiven.

A debt jubilee is certainly appealing to debtors and those who see the cliff ahead, but recall that all debt is an asset that is holding up an asset class far larger than the debt itself: mortgage debt is what props up the entire global real estate market, and what happens to valuations when debt ceases to exist?

Those who see jubilee as a solution also tend to ignore that all this debt is an asset of which 90% is owned by the wealthy class who run the status quo. Every bond, every mortgage-backed security and every bundled student loan / auto loan is an asset owned by someone or some entity who depends on that asset and its income stream for their wealth and thus their political power.

To hazard a guess based on human history, the wealthy / powerful will probably not be too keen to surrender the vast majority of their wealth and thus their power in the laudable pursuit of eliminating all debt and starting over.

Again based on the usual human responses to decay, decline, scarcities and threats to "what's mine," we can anticipate the elite's preference for a messy, chaotic form of jubilee in which various borrowers default and the underlying assets that provided collateral for the loan will be liquidated.

The elite hope that this messy, chaotic form of jubilee will reduce the debt so gradually that the system that benefits them will continue on its merry way. This hope is misplaced, however, for when collateral gets auctioned off at bargain prices, the value of all other similar assets drops accordingly.

And since nobody wants to catch the falling knife of crashing valuations, buyers are scarce, so the selling begets more selling and prices are pressured lower. Those who reckoned they were "buying the bottom" are wiped out, increasing the reluctance of survivors to take the risk of buying assets which could get much cheaper.

Soaring defaults tend to self-reinforce via feedback as the herd gets skittish and the appetite for risk vanishes like early morning mist in Death Valley. As buyers of crashing assets are carried out on stretchers, those who still own the sinking assets are watching their treasured wealth disappear, so they sell--at first with high expectations, and eventually in pure panic.

The future looks cloudy here on Uneasy Street, and everyone's still hoping for sunny days rather than a deluge. It's nice to anticipate sunny weather, but it's a good idea to carry an umbrella just in case the forecasts prove overly optimistic.

Here are three snapshots of what we're told is Easy Street: global debt skyrocketing:

Federal debt skyrocketing:

Financial wealth of the bottom 50% plummeting:

But think of the opportunities pre-cliff-dive:

As assets are liquidated, look for "likes" and upbeat Yelp reviews:

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Wednesday, April 17, 2024

The Spear in AI's Back

That real harm will result from the use of AI tools is a given.

AI is like the powerful character in an action movie who looks invincible until they turn around, revealing a fatal spear embedded in their back. The spear in AI's back is the American legal system, which has been issuing free passes to tech companies and platforms for decades on the idea that limiting innovation will hurt economic growth, so we'd best let tech companies run with few restrictions.

The issuance of free passes to Tech monopolies / cartels and platforms may be ending. Letting Big Tech run with few restrictions has led to the smothering of innovation as tech monopolies do what every monopoly excels at, which is buy up potential competitors, suppress competition, pursue regulatory capture via lobbying and spend freely on deceptive PR.

Now anti-trust regulators are finally looking at the uncompetitive wastelands created by Big Tech and recognizing the union-busting tactics of quasi-monopolies like Starbucks and Amazon. The bloom might be off the Big Tech / Monopoly rose.

Enter AI, which offers the thrilling prospect of trillions of dollars in additional profits for purveyors of AI and all those companies which use their AI tools.

The American legal system deals with new technologies much as a reptile digests a meal--slowly. I get email from readers about defending the Constitution, something we all support. I am not an attorney, but my impression of Constitutional law is that it is a tediously complex thicket of case law that must be carefully picked through before we can even begin to understand exactly what we're defending: every issue anyone might be concerned about has already accumulated an immense load of rulings and arguments.

This is American jurisprudence: advocacy goes to trial and ruling are issued, some as rulings that will pertain to all future cases and some that will not. The law advances in new fields such as AI as positions are argued before judges / juries and then reviewed by higher courts as losers appeal judgments / rulings.

A great many things we might think are novel have long been settled. Isn't the Selective Service Act a form of involuntary servitude? Nope, that's been settled long ago. The government's right to draft you to fight in a war of choice is unquestionably the law of the land.

AI has certain novel features which have yet to be decided by the processes of advocacy, rulings and appeals. In general, corporations selling / giving away AI tools are claiming these tools incur no liability to the issuers of the tools because they're akin to software that, for example, adds HTML coding to plain text: a tool that performs a process.

This strikes me as incomplete. It seems to me that AI, by its very name and nature, is making implicit claims of utility far beyond mere processing of data or text: AI is called AI because it is adding intellectual value to data or text.

All the disclaimers in the world cannot dissolve this implicit claim of utility that adds value. Since I'm not an attorney, I'm not able to put this in proper legal terms; I am using the terminology of philosophy. But the law is a system based on philosophic principles, and so the language of philosophy plays a key role in broadly applicable legal rulings.

Now let's consider a real-world example. A patient receives a mid-diagnosis and suffers as a direct result of the mis-diagnosis. In our system of law, somebody or some entity is liable for the consequences of the error, and must pay restitution to those harmed by the error.

As fact-finding proceeds, it turns out an AI tool was used in the initial scanning of the patient's data. The company that created the AI tool will naturally claim that the tool was intended only to be used under the supervision of a human professional, and there were no claims made as to the accuracy of the AI tool's output.

This is a specious argument, as the clear intent of the AI tool is to replace human expertise as a means of lowering the costs of diagnosis by accelerating the process and increasing the accuracy of the diagnosis.

Clearly, the tool was designed for exactly this purpose, and therefore deficiencies in its performance that contributed to the mis-diagnosis--for example, the fact that the AI tool rated the diagnostic result with a high probability of accuracy--are the responsibility of the company that issued the AI tool.

Should the court find the AI company 1% liable for the misdiagnosis, the principle of joint and several liability means the monetary settlement falls on whichever parties can pay the settlement. Should the other parties found liable be unable to pay a $10 million settlement, then the AI company might end up paying $9 million of the $10 million settlement, despite their apparently limited liability.

Off the top of my head, I can foresee dozens of similar examples in which an AI tool can be found partially liable for misrepresentations, errors of omission, unauthorized use of confidential intellectual property, and so on, in what can easily become an endless profusion of liability claims.

If the bloom is off the rose of Big Tech, the likelihood of a court assigning liability to those issuing AI tools increases proportionately. If the ruling is upheld by an appeals court, it will generally enter case law and become the basis for similar lawsuits assigning liability to those entities issuing AI tools.

That real harm will result from the use of AI tools is a given. The idea that those issuing these tools should be given a free pass because "we really didn't mean that you could use the tools to reduce human labor and increase accuracy" does not pass the sniff test, nor will it negate advocacy claiming that these tools implicitly make claims about utility that incur liability.

Use an AI tool, get sued. The Wild West of AI's claims of zero liability will soon enter the meat grinder of jurisprudence, and implicit claims of utility will be more than enough to incur liability in a court of law--as they should.

The legal spear in AI's back could prove fatal. A 1% error rate and 1% liability will add up fast.

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Monday, April 15, 2024

Financial Forecast 2025-2032: Please Don't Be Naive

Rather than attempt to evade Caesar's reach, a better strategy might be to 'go gray': blend in, appear average.

Let's start by stipulating that I don't "like" this forecast. I'm not "talking my book" (for example, promoting nuclear power because I own shares in a uranium mine) or issuing this forecast because I favor it. I simply see it as the most likely trajectory of the global financial system, based on history and the dynamics of human systems. "Liking" it or not liking it has nothing to do with it: the opinions of Titanic passengers who didn't "like" that the ship was sinking didn't affect the outcome.

You already know the global financial system is untenable. In a nutshell, the expansion of production and consumption has been funded by the expansion of credit--money borrowed from future resources and income. The rate of expanding debt far surpasses the anemic rates of expanding production, and this rapidly expanding mountain of debt is perched precariously on the phantom collateral generated by The Everything Bubble, the astounding expansion of asset prices as those with the lowest cost access to credit have bid up every asset class, from real estate to gold to bitcoin to stocks to fine art.

All these assets are phantom collateral because they were bid up on the wings of cheap, abundant credit. History is rather decisive: all credit-asset bubbles pop, and the price of the assets round-trips back to pre-bubble valuations. As the bubble pops, credit shifts from being abundant and near-zero in cost to being scarce and dear.

The commercial real estate sector (CRE) is a real-time example of this dynamic. Half-empty buildings are being dumped at a fraction of their peak valuations, and then sold again for even less or abandoned to default and liquidation. This is how all bubbles pop; there is no other template supported by history. Humans cling to magical thinking and grasp at straws rather than face the unwelcome reality that the cycle has turned and there is no happy ending for those who believe the "real value" of an asset is the peak price at the top of the bubble.

Now that we understand the impossibility of keeping The Everything Bubble forever inflated, let's shift our attention to those tasked with keeping the system from collapsing. In my view, the closest analogy is police officers tasked with protecting the often ungrateful and undeserving while being plagued by do-gooders and naysayers who are safely isolated from the wretchedness they demand the cops deal with in a manner that meets with their refined approval.

In other words, us and them: only those who share the responsibility for protecting the often ungrateful and undeserving while being plagued by do-gooders and naysayers can understand. Outsiders know little of the realities and are often naive, basing their convictions on what they think "should happen" rather than the limitations of real life.

This will be the mindset of the authorities tasked with "saving" the system we all depend on--especially the wealthiest who have benefited the most. These is of course the class that feels most entitled to advocate for special treatment: we're rich and important, so you should listen to us and do what works for us.

In other words, like the do-gooders, naysayers and whiners telling the cops how to do their jobs. Those tasked with saving a system sliding toward an inevitable crisis will have little patience for obstructionists, however well-meaning. The attitude of those carrying the responsibility for saving the system will be: do your part, get out of the way, stop whining and be grateful we're saving the system for your benefit.

Let's now shift to a very common belief of "investors": foreseeing this crisis, we've piled up "hard money" assets that are safely hidden from the grubby, illegitimate grasp of authorities. When the crisis sweeps away the bubble, we'll still be rich, and we'll then scoop up all the bargain-priced assets, making ourselves even richer.

It gives me no pleasure to say the obvious: please don't be naive. Those who will be trying to save the system from collapse understand that every asset is only richly valued now because of the credit bubble. From their point of view, "investors" who are planning to preserve the bubble-valuation of their assets and then emerge to snap up everything for pennies on the dollar are, well, the enemy.

Another widespread belief holds that the hyper-wealthy always sneak through the wormhole and emerge with all their goodies intact. This fosters the idea that if they can do it, so can I. History offers examples on both sides: the great estates of the wealthiest Romans did not survive intact when the empire crumbled (or put another way, when control of the shards shifted to a new elite).

As the bottom 99.5% feel the squeeze, their rage at those at the top not paying their fair share will rise exponentially, and the political pressure on authorities to go after the hyper-wealthy will become too intense to ignore. Many of those trying to save the system will have already had enough of coddled billionaires, bankers and financier grifters.

Another conviction that will be revealed as naive is the faith that the rules will stay unchanged, allowing us to hoard our stash and emerge unscathed to scoop up the bargains offered by the less prescient. History is again rather definitive: the rules will change overnight, and continue changing, as needed. One "emergency measure" after another will be imposed and become normalized.

It's important to put ourselves in the shoes of those struggling with the impossible responsibility of keeping the system from collapsing. From their point of view, everyone trying to evade the wealth taxes, windfall taxes, special assessments, etc. are ungrateful whiners, as what will anyone have if the system collapses? We're doing you all a favor, taking only 10% in a wealth tax to preserve the 90% that remains yours.

Another point of naivete is what happens to obstructionists in a full-spectrum surveillance Corporate-state. China has shown other nation-states how to do it properly: every digital communication and transaction is monitored, and while VPNs and other gimmicks offer a few wormholes, the fundamental reality is: it takes an awful lot of effort to not leave a trail of crumbs, and at some point, is it worth all the effort? It's much easier to just pay the wealth tax, the windfall tax, grumble about it, and move on to enjoy life as best we can.

In China, the local authorities politely invite transgressors to tea, and offer a suggestion to mend your ways and keep your nose clean. Those who insist on mucking up the works after the kindly advice will be neutered one way or another.

The naivete also extends to ways to evade surveillance. We're all going to get by on barter. Really? Have you actually tried to exchange stuff with anonymous others? Like many encounters in online boards, people don't show up, they flake out or decide not to make the deal. It's tediously time-consuming and frustrating unless you already have a network of trusted contacts who do this kind of thing all the time.

In my experience, reciprocity with other trustworthy productive people works better than barter. Instead of haggling over price/value, just give stuff away. In a trusted network, whomever gets the free stuff will scrounge up something to give you for free in return. These networks tend to have a "node," an outgoing, friendly, trustworthy person who can find a welcoming home for whatever is being freely distributed, and pass around what's being given to those who gave freely of their surplus.

Another point of naivete is the belief that as an asset soars in value, the authorities will magically restrain themselves from noticing this juicy target. If we factor in history and human nature, we will conclude the opposite is more likely: the authorities will redouble their efforts to track and collect that which is Caesar's from those trying to evade the collection of everyone's "fair share."

Given the resources of the NSA et al., how plausible is it to think little old me is going to leave no digital crumbs as I go on my merry way? Thanks to automation of data scraping, it's going to get easier and cheaper to scrape data looking for miscreants trying to avoid paying "their fair share."

The whole idea of a wealth tax is it's a tax on all wealth, held anywhere in the world. So burying assets offshore only works as long as the authorities turn a blind eye to tax havens. As pressures mount, trusting the eyes to remain blind might not be as "sure-thing" as many seem to believe.

As specific assets soar in value, a "windfall tax" will become politically appealing. Since all this soaring wealth is unearned, shouldn't the fortunate owners pay a bit more due to the windfall nature of their unearned wealth? Of course they should.

The key point to understand is the system will have to grab enough collateral to fund itself while collateral evaporates in the deflation of the Everything Bubble. This will truly be a case of TINA--there is no alternative. Desperation will drive policy extremes few think of as possible, much less inevitable.

Something else that may be revealed as naive is the faith that moving to another nation-state will offer secure respite from those demanding we render unto Caesar that which is Caesar's. This faith overlooks the global reach of these dynamics: rampant inflation, the debasement of currency, the increasingly desperate need for collateral and revenue to keep the system from imploding, the rising cost of risk and credit, the scarcity of collateral, and so on. How will the nation-state we're moving to respond to these financial crises? What are the odds that they will magically escape the crisis, or come up with a painless solution that doesn't demand any sacrifices of residents? How secure will the rule of law and the wealth of foreigners be once push comes to shove?

In summary: to understand the next 8 to 10 years, start by having some sympathy for the fox and not just for the hare. Here we are, trying to save the system that everyone depends on, taking a modest 10% wealth tax, and the ungrateful wretches are whining and trying to evade paying their fair share.

Rather than attempt to evade Caesar's reach, a better strategy might be to go gray: blend in, look average: post photos of kittens and puppies, complain about the cost of groceries, drive a look-alike vehicle, live in an unremarkable house, render unto Caesar that which is Caesar's, forget about emerging as one of the rich who evaded Caesar and get on with enjoying one's private life focused on well-being, and as difficult as it may be, work up a little gratitude for those carrying the responsibility for keeping the system from collapsing. A system that degrades but coheres is a far better place to live than a system that completely collapses.

It gives me no joy to suggest please don't be naive, but a realistic appraisal of what happens when things unravel suggests there are few limits on "emergency measures" anywhere on the planet and it's best to plan accordingly and focus on what we can control rather than what we can't control.

For more on this approach, here are free excerpts of my book on self-reliance.

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Thursday, April 11, 2024

Sound Money Vs. Fiat Currency: Trade and Credit Are the Wild Cards

We need to start thinking outside the current system, which has no solutions.

Our convictions about money are quasi-religious: heretics are burned at the stake. I'm not sure which stake I'll be tied to, because all the conventional choices--fiat currency, sound money (gold, Bitcoin) or debt-free currency (a.k.a. MMT)--are all fatally flawed.

To understand why, consider the wild cards in any monetary system: global trade and credit. Let's start with credit, which as David Graeber explained in his book Debt: The First 5,000 Years, has been an integral component of monetary arrangements since the dawn of civilization.

Taxes must be paid and seed purchased for the next crop, and so credit in some form--notched sticks, bills of sale, purchase orders, loans--is the lifeblood of commerce and state revenues. Credit naturally divides into short-term commercial credit--credit extended until the goods or payment are delivered--and longer term credit secured by collateral.

In traditional economies in which gold and silver are money, credit was generally limited to commerce, as credit based on loaning surpluses of gold and silver was limited by the scarcity of those metals. But the demand for credit did not diminish; rather, it increased, which is why small banks (that often went bust) emerged in the 1820s in America to meet the demand from small enterprises for credit to expand.

In an economy in which gold is the only money, credit is limited to a percentage of gold held in reserves, as much of the reserves must be held to fund customer redemptions / withdrawals. This limits the availability of credit.

In a fractional reserve banking system such as ours, one ounce of gold held in reserve is sufficient collateral for a loan 10 times the value of the reserve: $2,300 in gold enables the issuance of $23,000 in new money, i.e. a loan of $23,000, as every loan is new money created by the act of issuance.

What happens to "gold-backed money" when credit expands the supply of money expands 10-fold? The gold reserves are now spread over a much larger sum of money. The actual value of the gold backing each unit of money declines to a fraction of its initial value.

In other words, if credit is allowed to create money, then the "gold-backed" valuation of each unit is massively diluted. If credit is limited to surplus gold/silver loaned at interest, the sum of credit is a tiny fraction of all money in circulation.

Ancient Rome offers an example of a system in which only gold-silver were money. When the empire's silver mines in Spain were depleted, the supply of new money dried up and scarcity forced authorities to shave the actual silver content of coinage, the older higher-value coinage was quickly hoarded and left circulation: this is Gresham's law, that bad money drives good money out of circulation.

Rome also offers an example of trade's impact on money. Rome's wealthy--who naturally ended up with most of the empire's "sound money" wealth--spent freely on luxuries from foreign trade with Africa, India and distant China: silks, incense, gemstones, etc. This trade drained the empire of gold and silver, which was transferred overseas to buy the luxuries.

In other words, trade imbalances drain importers of their gold/silver. President Nixon didn't end the convertibility of the US dollar to gold on a whim; due to rising US trade deficits, America's gold would have been drained to zero in a few years. That's what happens to "sound money" when trade deficits cannot be controlled: those running the trade deficits run out of gold-silver and cease importing goods.

Nixon's hand was forced by the requirements of a global reserve currency, the US dollar. What is often overlooked in discussions of money is the necessity for reserve currencies to be "exported" to the global economy at scale so there's enough units floating around to fund commerce and credit.

If there is insufficient currency available in the global system, the currency cannot function as a reserve currency due to its scarcity. As the global economy increased in size, the sums of US dollars required also increased, requiring permanent trade deficits as the means to "export" the currency into the global financial system.

Many feel that getting rid of the USD's reserve status would be a plus, but those mercantilist nations exporting to the US would disagree, as once trade dries up their gravy train ends. Also unsaid is the reality that many nations must import food and energy, and their trade deficits are thus unavoidable.

A global economy with severely limited credit and trade will be a very different economy than the one we have now, undoubtedly better in terms of reduced consumption but this may not be entirely welcome or usher in an era of stability. The ideal system would be one that enables a transition to a new global economy that doesn't impoverish the bottom 90%.

Interestingly, convertibility to gold didn't restrain the ravages of inflation. Look at the chart of the USD's purchasing power since 1900 and note the value dropped from $25 to $5 during the period that the USD was convertible to gold.

The influx of New World gold and silver via Spain in the 1500s and 1600s also deflated the value of precious metals in Europe.

The larger point is the purchasing power and price of everything is set by global markets: the relative value of precious metals, currencies, commodities, labor, risk, credit--all are set by global markets. Any nation-state which presumes to anchor a price that suits its policy makers only creates a black market for whatever they are attempting to control.

Fiat currencies arose to escape the limitations of "sound money" generated by credit and trade. The problems of fiat currencies are well-known: the temptation to create more currency is irresistible. If currency is simply printed, per Modern Monetary Theory (MMT), a.k.a. debt-free currency, we end up with billion-dollar bills because the increase of currency above and beyond the increase in production of goods and services reduces the value of each unit of currency.

Borrowing money into existence by selling Treasury bonds serves to limit the collapse of currencies, but it imposes interest payments (mostly paid to the wealthy who own 90% of the nation's financial wealth) which drain the economy of vitality, leading to stagflation / decline.

We need to start thinking outside the current system, which has no solutions: debt-free money leads to billion-dollar bills, "sound money" (gold or bitcoin, it doesn't matter) ends up in the hands of the wealthy and borrowing money into existence leads to stagnation as soaring interest sucks the economy dry.

I have explored money in two books:

Money and Work Unchained and

A Radically Beneficial World, which proposes a system that creates new money at the bottom of the wealth-power pyramid rather than at the top. Yes, I understand this is wildly impractical in the current zeitgeist, but all conventional monetary systems run aground on their intrinsic limits / flaws, we'll have to start somewhere other than the status quo.

New podcast: Tommy Carrigan and I discuss the Fourth Turning

New podcast: Self Reliance & The Importance of Choice (24 min), Part 2 in a three-part exploration of self-reliance.

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