Wednesday, May 22, 2019

China's Insurmountable Global Weakness: Its Currency

If China wants superpower status, it will have to issue its currency in size and let the global FX market discover its price.
Quick history quiz: in all of recorded history, how many superpowers pegged their currency to the currency of a rival superpower? Put another way: how many superpowers have made their own currency dependent on another superpower's currency?
Only one: China. China pegs its currency, the yuan (RMB) to the U.S. dollar. It adjusts the peg a bit here and there, but the yuan's value is set by the Chinese state, not by the market of buyers and sellers.
(Yes, various nations have used gold coins minted by rival powers (Spanish pieces of eight were money everywhere, for example) but we're talking about fiat currencies, backed by nothing but supply and demand, not intrinsically valuable gold coins.)
Second question: is pegging your currency to a rival power's currency a sign of strength? The obvious answer is no. It's a sign of weakness. A real financial power issues its own currency and let's the global FX (foreign exchange) market discover the relative price / value of the currency. The financial power trusts the market to discover the value / price of its currency, and it responds by raising or lowering the yields on its government bonds and other pricing inputs.
If the issuing nation won't allow users and owners of its currency price discovery, few will want the currency because they can't trust the state's arbitrary, non-market price. This reality is reflected in the chart below of global currencies' relative share in global payments, loans and reserves. China's currency, the yuan (RMB) is basically signal noise: its global role in payments, loans and reserves is near-zero.
Why does China cling to state control of its currency's valuation? The obvious answer is that China's economy and global role are too fragile to absorb a major revaluation of its currency up or down: a major loss in purchasing power would raise the cost of energy and other imports, while a major strengthening of the yuan would crush the global competitiveness of China's goods and services.
As for the idea that China will unpeg its currency when it backs it with gold, recall that "backed by gold" means "convertible to gold." If the yuan weakens and other nation-state owners of the currency decide gold is the safer bet, China will have to exchange yuan for gold if it wants to make good on its claim to be backing its currency with gold.
If the currency isn't convertible to gold, it isn't backed by gold at all; it's just another fiat currency backed by nothing.
If China wants superpower status, it will have to issue its currency in size and let the global FX market discover its price. Anything less leaves China dependent on the U.S. and its currency, the dollar.
If China is so powerful, why doesn't it let its currency float on the FX market like other trading nations? Until its currency floats freely like other currencies and the yuan's price is discovered by supply and demand, China's global role in currency payments, loans and reserves will remain near-zero. That is a weakness that appears to be insurmountable.
My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format.


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Tuesday, May 21, 2019

Technology Is Not Just Disruptive, It's Disastrously Deflationary

Deflation eats credit-dependent, mass-consumption economies alive from the inside.
While AI (artificial intelligence) garners the headlines, the next wave of disruptive technologies extend far beyond AI: as the chart of technologies rapidly being adopted shows, this wave includes new materials and processes as well as the "usual suspects" of machine learning, natural language processing, data mining and so on.
While many voices seek to assure us these technologies won't displace human workers, the reality is cutting labor inputs is the core driver. What few pundits seem to understand (perhaps because they've never experienced a truly competitive market?) is that the rush to incorporate these technologies into existing enterprises is deflationary not just to prices but to profits.
Reducing labor inputs and improving productivity of capital and the remaining labor force is not going to generate profits if competitors can access the same tools and processes. The race isn't to maximize profits, it's to survive the inevitable deflationary spiral in prices as competitors are forced to pass along cost savings to customers to retain market share.
Pundits glorying in tech profits only consider monopolies or quasi-monopolies like Apple, Facebook and Google or monopolies / cartels enforced by government regulations and policies. Markets open to competition do not enable pricing power beyond a temporary advantage for one or two product cycles. (Please see Two Intertwined Dynamics Are Transforming the Economy: Technology and Financialization)
As the race to improve technologies speeds up, "good enough" open source software and cheap previous-generation hardware is good enough for most applications. (We can surmise that the Pareto Distribution is active: technology that is 20% of the cost of the newest product can do 80% of what the new product can do, and tech that costs a mere 4% of the latest tech can do 64% of what the latest product can do.)
Everyone counting on trillions in tech profits is overlooking the inconvenient reality of the S-Curve for cheap credit, cheap energy and cheap labor--the three drivers of global expansion. Once credit dries up or becomes more expensive, once cheap energy is only a memory (or future fantasy) and once employment sags under the pressure to reduce labor inputs, the ranks of those with the earnings or credit to buy, buy, buy will be thinned.
Stagnant wages can only be supplemented with borrowed money until the costs of servicing the debt (interest) eats the borrower's budget. At that point, lenders will have to face the unpalatable truth that any additional loan will end in default, a process that will also collapse the entire unsustainable mountain of debt the household is struggling to service.
As many others have pointed out, energy can be abundant but it only drives expansion if it's affordable to low-wage workers. If it's only affordable to the top 20%, every economy based on mass consumption implodes.
One of the factors in the U.S.-China trade dispute that few seem to notice is labor costs are spiraling higher in China, reducing its competitiveness at a critical juncture as global trade, demographics, energy costs and the risk of credit bubbles bursting all form a self-reinforcing confluence of negative dynamics.
China still needs the jobs while its customers (including but not limited to the U.S.) are seeking lower-cost alternatives to Made in China. Even Chinese companies are looking to establish lower-labor cost manufacturing hubs overseas.
Strip away the happy talk about technology creating jobs and we're left with real-world enterprises desperate to lower cost inputs in any way they can: and the go-to "solution" to reducing cost inputs is reducing labor inputs by reducing wages via global wage arbitrage (a.k.a. offshoring jobs) and/or replacing human labor with software and robotics.
Sure, there will be jobs for those installing and maintaining the software and robots, but remember: enterprises don't have profits, they only have costs, and the pressure to eliminate entire layers of managerial costs as well as production costs will only increase.
Who will be willing and able to pay a premium for any technology, product or service if cheaper alternatives are available? As debt service costs rise and wages continue to stagnate, the "solution" of borrowing more reaches an endgame of credit contraction and soaring defaults.
That leaves government-enforced monopolies as the only dependably profitable corporations, and the citizenry will soon tire of enriching tech oligarchs who bought political cover and regulatory moats. Deflation eats credit-dependent, mass-consumption economies alive from the inside.
Adapt or die boils down to strip out costs or die.
My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format.


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Two Intertwined Dynamics Are Transforming the Economy: Technology and Financialization

If you want to understand how the economy is being transformed, look at the intersection of Big Tech, financialization and the central state.
The two dynamics transforming the economy--technology and financialization--are intertwined yet widely viewed as unrelated. Critics and proponents of each largely ignore the other dynamic: critics of institutionalized fraud and other manifestations of financialization implicitly assume the economy will return to some golden age if we get rid of financialization's skims and scams.
They are largely blind to the reality that the speed with which technology is transforming the economy is increasing: there is no golden era to return to. The economy they long for (strong unions, full employment, rising wages, declining inequality, political bipartisanship, financial stability and security, etc.) has already slid into the dustbin of history.
They are equally blind to the reality that the central state they revere as the "solution" to financialization is itself the source of wealth/power asymmetry and the enforcer of Big Tech and Big Finance domination.
Proponents of technology implicitly assume that financialization's skims and scams have no impact on technology's golden promise of glorious advances which both enrich the few who own the technology and free the many to enjoy robots doing their work and endless entertainment (for a modest monthly fee, of course).
They are largely blind to the inconvenient reality that replacing tens of millions of workers with robots and software means there is no longer a mass-consumption economy for all the technological wonders, as the supposed solution--Universal Basic Income (UBI)--can't provide either paid work or enough income for the millions who will be receiving UBI subsistence to borrow or spend enough to keep the consumer economy afloat.
Financialization's solution--creating more credit / debt-- simply insures that the UBI recipients will be devoting much of their subsistence income to debt service rather than tech toys.
In reality, both dynamics reinforce the disruptive effects of the other on non-elites. Financialization concentrates wealth and political power in the hands of those closest to the sources of cheap credit--central banks and private-sector banks.
Financialization enables tech companies to borrow billions on the cheap and use the money to buy back their own shares, increasing the value and further concentrating ownership of the most profitable tech companies.
With billions in profits and credit (via selling low-yield bonds), giant tech corporations have the wherewithal to invest in bleeding-edge technologies--and pay the top researchers sums that cannot be matched by lesser firms.
Companies are faced with Andy Grove's famous summary of technological change: adapt or die. As the chart below illustrates, companies in virtually every sector are being forced to adopt technologies that reduce human labor while increasing productivity. Those who fail to do so effectively enough and soon enough will be outpaced by global competitors.
Unless of course the corporations have enough capital to purchase political power: once a corporation is powerful enough to buy regulatory moats and other forms of political cover, they reap the monopolistic benefits of what analyst Simons Chase calls the negative network effect: they "lock in" their monopoly via regulatory capture and the enforcement of the state.
Consider network effects, the popular economic construct applied to market concentration and increasing returns for strategies pursued by some leading tech companies. This dynamic economic agent is also known as demand side economies of scale.
W. Brian Arthur, the economist credited with first developing the theory, described the condition of increasing returns as a game of strategic positioning and building up a user base to the point where "lock in" of dominant players occurs. Companies able to tap network effects have been rewarded with huge valuations and highly defensible businesses.
But what about negative network effects? What if the same dynamic applies to the U.S.’s pay-to-play political industry where the government promotes or approves of something through a policy, subsidy or financial guarantee due to private sector influence. Benefits accrue only to the purchaser of the network effects, and consumers, induced by the false signal of large network size, ultimately suffer from asymmetric risk and experience what I’m calling a loss of intangible net worth for each additional member after the "bandwagon" wears off.
If this were the case, then you would see companies experience rapid revenue growth (out of line with traditional asset leverage models), executives accumulating huge fortunes and political campaign coffers swelling.
But the most striking feature would be the anti-social outcomes, the ones not available without the instant critical mass of government-supported network effects, the ones that, at scale, monetize a society’s intangible net worth.
In effect, the negative network effect generated by America's pay-to-play political structure creates a winner take most economy in the tech sector that mirrors the the winner take most dynamic of financialization.
Non-elites already live in a winner take most economy--a reflection of asymmetrical concentrations of wealth and power in tech and financial corporations. The commoditization of credit and institutionalized fraud such as corporate buybacks have served to strengthen the negative network effect that arise from the unholy alliance of Big Tech and the central state.
If you want to understand how the economy is being transformed, look at the intersection of Big Tech, financialization and the central state.
My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format.


If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. New benefit for subscribers/patrons: a monthly Q&A where I respond to your questions/topics.

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Friday, May 17, 2019

The Normalization and Institutionalization of Fraud

Normalizing and institutionalizing fraud undermines the foundations of the economy and the financial system.
I am indebted to Manoj Samanta (twitter: @flation_debate) for the insightful concept the commoditization of fraud. The first step in the commoditization of fraud is to normalize fraud as Business as Usual (BAU) to the point that it's no longer viewed as "wrong," destructive or an aberration of evil-doers but as an accepted way to maximize gain and offload risk onto others.
The last step in the process is to institutionalize fraud within central banking and government policies.
How is selling shares in a money-losing corporation at outlandish valuations not the commoditization of fraud? The fraud has been normalized into a game of hoping that greater fools will be so enamored of the normalized fraud that they'll take the IPO shares off your hands at ever-higher valuations until the fraud breaks down.
But by then, the instigators of the fraud--the IPO--have escaped with billions in gains and zero liability.
How is private equity loading companies up with debt as a means of paying outlandish dividends to themselves not commoditized fraud? How is paying dividends with debt rather than earnings not fraud? The net result of this fraud is the debt-burdened company eventually defaults on its debt, defrauding the investors who were suckered into the scam.
But once again, the instigators of the fraud--private equity--have escaped with billions in gains and zero liability.
How is understating inflation so Social Security retirees get near-zero cost of living adjustments as real-world inflation pushes 7% not normalized, institutionalized fraud? We all understand the motivation for this institutionalized fraud: to limit the increasing cost of Social Security and mask the erosion of household income's purchasing power.
While the Social Security recipient and the minimum wage worker are getting squeezed, those getting nearly free money from the Federal Reserve to plow into stocks are piling up trillions of dollars in gains. How is the Fed's fee money for financiers not commoditized, institutionalized fraud? Those who can borrow outlandishly large sums at a discount are in effect being given the tools to defraud the financial system and all the other players who aren't as close to the money spigot of the central bank.
How is charging 20% interest on a credit card balance while financiers pay 2% not commoditized, institutionalized fraud? The cover for this fraud is particularly rich: the high credit risk of the credit card holder demands a high rate of return, while the "low-risk" financier gets 2% financing to blow up the entire financial system and get bailed out by the taxpayer.
Normalizing and institutionalizing fraud undermines the foundations of the economy and the financial system. Calling these commoditized frauds business as usual doesn't mean they won't destroy the system from the inside.
My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format.


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Thursday, May 16, 2019

Downward Mobility Creates "Deplorables"

The real heresy here is the American economy is now rigged for downward mobility.
In the conventional narrative, one's economic class is overshadowed by one's political belief structure: liberal, conservative, libertarian, etc. In terms of economic class, the conventional narrative divides people into their ideological beliefs about economic ideologies: free market capitalism, socialism, etc.
Economic class is one of the few remaining heresies in America: in the conventional narrative, it doesn't exist or is meaningless due to the tremendous social mobility of the American populace: the working class stiff is one wise decision way from middle class status, and the middle class worker is one wise investment away from becoming wealthy.
What the conventional narrative purposefully ignores is the potential for downward mobility, in which one bad decision or investment triggers a drop in economic class and future financial prospects. I've been writing for years about the diminishing number of slots in America's upper middle class, and the realities of diminishing social mobility has been documented by research.
As the recent college admissions scandal has highlighted, those already in the upper middle class have privileges such as alumni preference denied the lower classes. Those who already own assets have profited immensely from the credit-bubble economy while those without assets have been priced out and squeezed by relentless increases in rent, healthcare, childcare etc.
The heresy I'm proposing here is one's economic class matters more than one's purported ideological or political beliefs. The second half of my heretical proposal is that one's political leanings divide very neatly along a single fault line:
Are your economic-financial prospects brightening or diminishing? Put another way: are you more likely to experience downward mobility (the reality for most in the bottom 90% and even many in the top 10%) or the conventionally expected upward mobility?
Those who recognize their precarious hold on their current economic class and the increasing risks of downward mobility are the infamous "deplorables", those who are voting for non-mainstream candidates left and right, voting for national interests over globalization and so on.
The slippery slope from upper middle class to lower middle class is greased by the neoliberal boom-bust nature of the global economy: buy at the top and be forced to liquidate at the bottom and the entire household's wealth can be wiped out.
When a two-earner household that counts on two high incomes is downsized to one good income and one precariat income--low wage, unpredictable hours, no benefits-- the sharp decline in income triggers a cascading decline of security.
In a credit-bubble boom-bust economy, everyone must become a brilliant, savvy trader/gambler or they risk losing it all. This is true not just of investment decisions but of career decisions, decisions to buy or sell a home, decisions to move to another region, decisions to have a child and so on.
As a general rule, the top 20% support the status quo because the status quo works well for them: they own assets, they feel secure in their jobs, and they feel they are upwardly mobile.
Interestingly, wealth and income don't matter as much as we suppose. Those with high incomes and substantial wealth who feel vulnerable to downward mobility are much more critical of the status quo and more likely to vote along "deplorable" lines for outsider candidates.
The real heresy here is the American economy is now rigged for downward mobility, which fuels the rise of the "deplorables" who recognize downward mobility is the real new normal. Only the protected class with secure jobs support the status quo without question, but as the recession takes hold and deepens, and the credit-bubble bursts and assets decline rather than loft ever higher, the percentage of the populace who awaken to the precariousness of their economic class status will soar.
The greatest sin in America is to recognize downward mobility is now like gravity: the upper-middle class household that loses a high-paying job and places the wrong bet in the credit-bubble casino is one slippery step from becoming a "deplorable."
This dissolution of conventional ideological loyalties terrifies the ruling elites, for it threatens to dissolve their control of the masses. When the SillyCon Valley engineer gets laid off and loses the illusion of upward mobility, when the government worker who was promised a generous pension and bennies discovers that the bankrupt local government can no longer pay what was promised, the ranks of the "deplorables" will swell with self-reinforcing momentum.
My book Money and Work Unchained is now $6.95 for the Kindle ebook and $15 for the print edition. Read the first section for free in PDF format.


If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. New benefit for subscribers/patrons: a monthly Q&A where I respond to your questions/topics.

NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.
Thank you, Richard P. ($50), for your marvelously generous contribution to this site-- I am greatly honored by your steadfast support and readership.

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