Article Analysis: China “Primes the Pump” in Order to Continue Economic Miracle Story

Reference article: https://www.marketwatch.com/story/chinas-central-bank-frees-up-nearly-175-billion-to-jump-start-economy-2018-10-07

Is the Chinese economy truly a miracle story?  To a large degree, yes, but the story has taken a turn in direction in recent years.  Speculation is now widespread in the country of 1.3 billion people.  You can see physical evidence of this in one of dozens of Chinese “ghost cities,” where the grandiose boulevards, elaborate monuments, skyscrapers, and suburban blocs of town homes that line the landscape are also completely empty – effectively it is all productive capacity devoted to the expectation of infinitely-growing future demand.  In a recent move, the Chinese government also reduced reserve requirements, signaling a desire to create even more lending in the face of a stalling economy.

In the United States, which existed without a central bank for many years, private banks could and did collapse from poor speculation, which was especially common with collapses related to railroad speculation in the 1800’s.  Economic recessions were more frequent and sometimes quite sharp, but always short-lived and localized, as lending practices were far more stringent than by today’s standards.  As a result, American real economic growth in the 1800’s was unprecedented, with little to no long-term inflation and extremely rapid rises in living standard.

Central economic planning, designed to “tame” economic crises, effectively eliminates the moral hazard that exists when lenders face the consequences of lending too many reserves in the expectation of future demand.  China now has well over a 300% debt to GDP ratio.  Chi Lo wrote an interesting piece in Barron’s entitled “China’s Debt Bubble: Why the Bears Are Wrong,” in which he downplays the risk of a debt bubble in China, due to banks using deceptively complex credit accounting (although the direction of debt-to-GDP is what matters), but correctly points to private bank lending as the culprit behind rising debt levels.  I also think he misses the additional step further to examine why the blame needs to go towards central planners, who have made countless decisions to remove the moral hazard that keeps lending practices rigid and localized.

Despite the complexity in credit accounting, Chinese debt levels are rising quickly and American tariffs have evidently taken a hit on the Chinese economy.  Chinese officials moving to “prime” lending by reducing reserve requirements, slashing interest rates, pegging their currency and even bailing out the stock market are some of many poor decisions the central government has taken in order to keep Chinese growth on an rapid upward trajectory.  In our often blind praise of the Chinese economic growth story, we often forget that it is still very much a Communist regime.  Of course, the Chinese are extremely hard-working and industrious, which is why they would be better off with a slower, more stable growth strategy that revolves around manufacturing for their own citizens.  They would be better off forgoing the additional production that is devoted to fulfilling the IOU’s of American consumers…

-Adam

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Settling the Debate Over Public Debt

The national public debt is a well-publicized figure in political debates.  I think nearly everyone knows by now that we have a $20 trillion national debt and it’s well on its way towards $21 trillion.  As I discussed in a previous article, private debt is a more vicious and immediate problem than public debt, but that doesn’t mean public debt isn’t a drain on the economy.  Here, however, we will discuss the actual problems associated with public debt, namely potential inflation and opportunity cost.

The graphic below shows how the government’s annual operating budget, around $4.09 trillion, is only 89% funded through tax revenues.  The shortfall, known as the annual deficit, is tacked onto the total national debt, which must be funded by treasury or bond holders.

Public Debt.PNG

The list of bondholders, to the right, shows who is primarily responsible for upholding the US government’s profligate spending habit, and whom the government has to entice with an interest rate for risk in order to get buy-in.  Astoundingly, foreign nations service nearly 30% of the national debt, the largest being China, Japan, and the UK.  However, the largest component still consists of individuals and institutions such as pension funds and mutual funds.  Notice the “social security trust fund.”  The government branch that manages social security payments still operates in a surplus (separate from this graphic).  They use that surplus to purchase US treasuries in order to add some interest to the fund and keep up with PCE inflation.  In approximately 2020, social security expenses are estimated to exceed revenue inflows, thus leading to a shortfall in funding.

Why Is Public Debt Bad?

Now that you understand the inflows and outflows, it’s important to take a step back and fundamentally question public debt and the opportunity cost it creates.  Very simply, the government diverts 17% (see the $3.64 trillion in tax revenues) of all gross domestic product in order to fund the public projects it sees necessary for a high standard of living in the United States.  I would argue here that the diversion of this 17% of all income is an inefficient allocation of capital.  The opportunity cost is the ability of individuals and firms to save and invest this money in projects that create deflationary growth through competition between firms.  What I just said is a concept shared almost solely by Austrian school economic scholars, because they understand that standard of living is a product of deflationary growth and innovation.  This occurs when the basket of products we purchase are able to deflate in price due to innovations.  This obviously leads to higher savings and further investment opportunity for Americans over time.  If Americans had greater savings and wealth, I can guarantee we wouldn’t even need social security to function with a high standard of living as wealth and investment would carry over well into old age.

In terms of inflationary risk, we need to take a deep dive to understand how, if any, inflation is created through public debt.  As it stands, bondholders are basically depositing their savings into a bank account that is being used to fund consumption.    Take, for example, the military budget, which is a large component of government budget spending.  The government accepts bondholder savings in order to fund the production of weapons, aircraft, armored vehicles, etc., the vast majority of which sit idly on military bases and provide no deflationary benefit for Americans and their basket of consumption goods.  Austrians would likely call this a ‘malinvestment’ of capital.  Bondholders require a risk premium for allowing the government to spend their money along a spread of different timelines; however, this risk premium is not actually leading to any sort of return on investment as it would in the hands of a business.  The concept of an investor requiring a risk premium in order to upgrade missiles and fund your someone’s grocery bill is flawed in the sense that there is no profit-making initiative here.  It is the exchange of interest-bearing dollars for the purpose of consumption.  A central tenant of Modern Monetary Theory or the “MMT School” is the belief that government debts should bear no interest.  On a technical level, that would work, but it seems like a Catch-22 for the government because no one would ever loan money for up to thirty years without an interest rate for risk.

How do we know this is actually creating inflation?  Here’s another twist in the story: interest payments are actually part of the annual budget, in the “other” category highlighted above.  While 89% of the interest payment is essentially a net neutral redistribution from taxpayers to interest-earners, the remaining 11% is unfunded.  So we can try to understand this: the government taxes us in order to fund spending, part of which is the interest payment to bondholders who are actually funding the excess spending.  This means that the interest payments are underfunded (because only 89% of government spending is funded) and bondholders are removing savings from the economy in order to finance interest expenses paid out for the purpose of consumption! Exactly how much of the annual budget is inflationary?  Assuming the annual interest on the national debt in 2017 of $266 billion becomes part of the annual budget, 11% of that is unfunded on average, meaning approximately $30 billion in savings must be diverted from additional bond investors in order to pay for remaining interest on government spending used for consumption.  Assuming an M2 money stock of $13.8 trillion in 2017, $30 billion is removed from the money supply annually to pay for interest on that consumption, which equates to roughly .2% annual inflation. 

If interest rates rise; however, the story can change significantly.  If interest rates on issued treasuries rise due to fears about economy, budget, etc., the interest burden becomes larger.  If a situation occurs where government spending swells way above tax revenues, that $30 billion recycled interest expense can grow much larger and suddenly inflation becomes very real.

Conclusions

While the current inflation created through public debt looks to be quite minor compared to private debt, that doesn’t mean public debt isn’t a massive drain on the economy.  Inflation can certainly occur if rising interest rates on bonds swell out of proportion and remain underfunded.  Is it any wonder why the Federal Reserve has been buying up trillions in treasuries in order to keep rates low?  I’d also like to remind people that 17% of the annual GDP is removed from circulation to fund the government’s budget.  This is $3.65 trillion that could be used to invest in new businesses and not just consumption-based spending.  This the definition of “opportunity cost” from day 1 of Economics 101.

Fractional Reserve Banking: Separating the Truths from the Untruths

Within the subject of economics, there is likely no other topic so nebulous, confusing, and weird as fractional reserve banking.  The simple reason is that the millions of loans  issued by banks on a daily basis, all the way from large commercial loans down to credit card loans, involve so many transactions that it’s almost impossible to scrutinize them as a single entity that can be observed in a sort of flow diagram.  I think the best way to understand F.R.B. is to have an examination of some total economy metrics that are easily accessible, as well as examine some regulations that impact banking and some truths and untruths that surround F.R.B.  I should note that this is an educated opinion based on research.  It is simply the position I take at the moment, in which I’ve examined as much of the information I currently have at my disposal.

For the purpose of brevity, fractional reserve banking is the way banking is conducted in modern market economies.  As opposed to a full reserve banking system where banks must back up all demand deposits with a 100% reserve of monetary units, fractional reserve banking allows banks to vault only 10% of the demand deposit while making a loan with the other 90%.  The theory of why banks do this relates roughly to an analogy about bicycles.  Suppose a individual, X, owns 1,000 bicycles.  In all likelihood, the vast majority of those bicycles will not be sold all at once.  Instead of putting those bikes in a warehouse and selling them one by one over time to secure funds, X decides to loan many of them out, along varying time tables and according to how he sees fit so that bicycles are returned at various times.  This analogy shows the concept of why banks decide to loan your deposit out: on average you will simply not need the vast majority of your deposit at once.  Keep in mind this simplistic analogy is only appropriate in the sense that it teaches the concept of time-based necessity for funds.  The actual flow diagram as it relates to monetary units is obviously quite different.

Chicken vs. Egg: How Are Loans Created?

Now that we’ve addressed the concept of why banks loan out deposits, let’s examine the depth of a banking operation.  Most importantly: what is the origin of a loan?  The classic money multiplier model taught in economics textbooks presents the notion that loans are created AFTER a deposit is received.  This suggests that banks are ready to fire off a loan the moment they receive a deposit, which would result in a money multiplier effect.  Once the loan is issued, the borrower takes most of the loan to the same bank or another bank where the deposit is once again turned into a loan.  This process continues down the line until the marginal loan created equals/is close to $0.  The multiplier is the inverse of the reserve requirement.  Thus if a bank set a reserve requirement at 10%, the monetary amplification/inflation would be equal to 10x in the case of extreme abuse of the system.  At a reserve requirement of 20%, it would be 5x, etc.

This is false.

Of course the consequences of this would be catastrophic.  A major buildup of artificial wealth would be created, leading to exponential inflation and loan interest payments would completely cease all economic activity until a serious debt deflation or write-off took place.  In reality, loans are created prior to the receipt of a deposit, which completely flips the idea of the money multiplier on it’s head.  However, the research that disproved the money multiplier model was not always known.  As Frank Shostak of the Mises Institute so eloquently writes:

“Indeed, economists from the post-Keynesian school of economics (PK) have expressed doubt about the validity of the popular framework.

It is argued that the key source of money expansion is the demand for loans together with the willingness of banks to lend.

The supply of loans, in this way of thinking, is never independent of demand — banks supply loans only because someone is willing to borrow bank money by issuing an IOU to a bank.

Accordingly, the driving force of bank credit expansion and thus money supply expansion is the increase in the demand for loans and neither the money multiplier nor the central bank. Bank lending is not constrained here by reserves that are injected by the central bank, but by the demand for loans.”

In short, we can rest assured that the money multiplier is a myth in that banks respond to the aggregate demand for loans and must have a willingness to lend based on their view of the creditworthiness of the borrower.

This does not mean that fractional reserve banking does not create problems.

Where Banking Can Suffer

The easiest way to observe the illness that results from fractional reserve banking is to keep an eye out for private debt levels at all times.  When private debt levels are too high, it signifies the overextending of credit to the point of exhaustion to the economy.  Currently the US consumer and corporations are overloaded with debt.  Low interest rates and Q.E. primarily created a moral hazard whereby credit was too cheap at a time when prices needed a serious deleveraging following the housing bubble that grew until 2008.  Deleveraging would have allowed prices to drop and created a more advantageous environment for the American consumer to build savings once again.  While a serious pullback in loan creation would throw the economy into a deflationary illness, debt needs to be deleveraged in order to drive production and economic value creation.

How Fractional Reserve Can Lead to Inflation

With our revised knowledge surrounding the fractional reserve system, we now know that loans are created based on the aggregate demand for loans in the economy and that the money multiplier effect is a myth.  However, fractional reserve banking still has the capacity, without question, to inflate the money supply.  The creation of a loan of say $50 for X at a rate of interest to purchase bulldozers with the assumption that his housing business will expand now results in X spending against a demand deposit from the loan.  Let’s say Adam then deposits $100 in his checking account from working with a company that has produced a widget that consumers have purchased due to the fact that it’s cost is cheaper than previous widgets in the market by 40%.  The bank considers this a deposit that will balance it’s loan portfolio.  The $100 produced through economic value added is now being spent by Adam while X is spending monetary units against the $50 created through a bank loan out of thin air.  Here is the part that ties it all together: the mere fact that two sources are spending while only one has created the economic value added means that this is inflationary by nature, unless risk is allowed to take its course and liquidate bad loans while rewarding loans that result in E.V.A.  In a full reserve banking system, Adam could have risked $50 of his own $100 to loan to X; however, with the explicit risk in mind that his $50 could be lost.  Adam also gives up $50 in present goods so that the loan can be made.  If the business proposition fails, he is only capable of spending the $50; however, the money supply remains steady in the process.

While the banking institution can engage in making loans with the express consent happily given by the depositor, the creation of loans prior to balancing with deposits makes this a bad business model.  That being said, nothing a bank does that we’ve just discussed is truly illegal.  Banks do offer safety deposit boxes, which should be in far greater demand than savings accounts.  One revision that should be made: the depositor should be advised of the interest rate risk of each loan the bank is attempting to make.  Considering this stipulation, depositors would surely demand a far higher rate of interest than is currently set by the Federal Reserve system.  The “prime lending rate” is around 3-4%, but how do we know that is an appropriate rate of interest?  After all, the FDIC moral hazard and notorious failures of the centralized interest rate Politburo known as “the Federal Reserve Bank” almost guarantee that whatever rate has been set for prime lending… it is probably the wrong one.  If depositors knew infinite information, they might, in reality, demand 15-20% from those so-called prime borrowers.  Surely depositors would require 30-40% for the most risky loans.  This alone would drastically decrease the economy’s reliance on loans and only the most prime projects would be funded through loan issuance.

Considering the fact that depositors do not possess infinite information at their disposal, it seems logical that banks should primarily be in the business of safeguarding money.  A select percentage of depositors can feel free to take risk; however, the vast majority simply want a safe-guarded storage of present monetary units.  This would also open up the possibility for depositors to make their own investments and loans as they see fit coming from real savings.  Thus the depositor can feel free to charge his own rate of interest: 20, 30, 40, 50%… whatever he sees fit for a risky project that might result in a loss of money.

Private Debt and How to Manage Risk in the Financial System

The issue of debt is not well-understood in this country, or in many others for that matter.  The total burden of financial debts in the world outweighs the amount of savings that citizens have, and this is an extremely concerning issue.  Many economists will tell you that debt fuels economic growth.  In the words of Paul Krugman: “your debt is my income and my debt is your income.”  The problem with this very simplistic analysis is that debts lead to production that aren’t matched by an equivalent reserve held anywhere in the bank and those debts accumulate interest liabilities.  A consumer with a mortgage, car loan, and likely some student loans and credit card debt, becomes a slave to interest.  Whatever savings are accumulated are immediately diverted towards simply paying back interest on the loan.  Anyone with a friend that has significant debts is well-aware of their difficulties in simply making a dent in the principal payment.

Private Debt

Private debt is a liability owed by consumers and businesses while public debt is a liability owed by the government.  While many citizens are well-aware of the infamous $20 trillion public debt figure, it is often completely unknown how large the swelling private debt has become.  By 2016 private household debt had risen to $12.6 trillion, just barely below 2008 recessionary levels.  The exact composition of that debt has changed slightly since the peak of the housing bubble, with growing consumer burdens on student loans and car loans taking up the slight drop in mortgage debt; however the total figure is nearly the same.  Among the countries with the largest private debt burdens are Australia, Switzerland, Canada, and the United States.

 

How is private debt different from public debt?

Public liabilities owed by the government have swelled to almost twice the level of 2008.  This massive liability is surely a problem, but the reason it hasn’t created an instant recession is due to the fact that the government has it’s own metaphorical printing press, thus allowing any accumulating debts to be printed up.  While social security and Federal Reserve liabilities have contributed massively to the $20 trillion in public debt, the Federal government almost always prints up payment for its liabilities and has only chosen default on very few occasions in recent history.  Public debt contributes to declining purchasing power by inflating away savings accounts; however, recent maneuvers such as the Fed’s Q.E. program are leveraging government printing power to keep the financial system afloat by injecting much-needed liquidity into the banking system and allowing it to continue lending practices.  While public debt isn’t the same as private debt, it is being used as a catalyst to prop up the financial lending system and contributes to inflation in the meantime.

How do we solve the private debt crisis?

The private debt crisis arises from a complicated mechanism tied into our banking system.  Historically, private debt begins to swell when the economy is deemed to be in a state of irrational exuberance.  Some consumers, such as the Japanese, have actually continued the deleveraging process despite low unemployment rates.  This is quite indicative of the fact that cultural views on fiscal responsibility contribute heavily to the nature of household debt.  The Japanese are historically a very fiscally-responsible society.  At the end of the day no one is forcing consumers to take on loans, thus the values embedded in our collective psyche determine how we respond to superficial signs of economic recovery.  Ideally the deleveraging process would continue unabated following a recession.  Consumers would deleverage and bubbles would deflate, thus allowing prices to return to healthy levels.  In the case of Japan, the government has stepped in as a massive institutional buyer and virtually negated any attempts on behalf of the populace to deflate prices.

Setting aside the fiscal morals of consumers, there are several schools of thought on how to dismantle the mechanisms that lead to private debt accumulation; however, if we examine the issue from it’s core, I think we can arrive at the conclusion that central banking and misalignment of government-dictated incentives are the direct culprit of this issue.  This is not simply my conclusion, but the conclusion of the entire Austrian School of Economics, first developed by Friedrich Hayek and expanded upon by Ludwig von Mises, Murray Rothbard, and academics at current institutions such as CATO and Mises.  The issue of loose bank credit can be, for the sake of simplicity, boiled down to two culprits: central bank interest rates and the FDIC mandate.

Central banks have formally orchestrated the funnel of credit to the economy for nearly 400 years, beginning with the Bank of Amsterdam, established in 1609.  For centuries central banks have acted as the metaphorical “maestros” of the economy, setting one interest rate that dictates the flow of credit.  However, Austrian economists understood that one, centrally-planned interest rate cannot efficiently price the risk of lending to all borrowers.  Undeniably the interest rate is an incredibly complex mechanism that needs to be personalized for each borrower, based on his or her financial standing.  Doing away with centrally-led interest rates would certainly make the financial system more accountable for setting interest rates properly in a way that properly prices risk for each borrower.

Taking into account the existence of centrally-planned interest rates, we can see other culprits that have loosened the grip on financial accountability.  Many economists are well-aware of the moral hazard posed by the FDIC mandate, in particular John Allison, former CEO of CATO Institute who did extensive research on the moral hazard posed by FDIC insurance.  The FDIC mandate says that each bank account shall be insured by the government for up to $250,000.  The moral hazard this creates should be clear and visible to any rational person.  It wipes away almost all accountability by financial institutions to engage in safe lending practices that insure each customer’s savings will be protected in the face of financial lending practices.  Without this mandate, financial institutions would actually be scrutinized by prospective depositors and this would be an extremely positive risk management mechanism for the financial system.

The act of separating commercial and investment banking in accordance with Glass-Steagall does not, by nature, decrease this risk in the financial system.  Many politicians are in favor of implementing Glass-Steagall while breaking up the banks.  Only when financial institutions are fully accountable for their own risks will private debt bubbles be solved and return to normal levels in accordance with true capitalism.

 

Why gold is the best wealth insurance

Gold investing is not for the faint of heart.  It’s a physical currency that sits in your house and collects dust.  Often people choose to store it in safety deposit boxes meaning a yearly rental fee eats away at your asset when it’s sitting in storage and the stock market is moving upwards.  It doesn’t generate a return and it doesn’t generate a dividend.  By all investing standards it absolutely sucks.  And there’s no reason an investor should look at gold as a normal investment vehicle.

However, that’s not why we hold gold.  Gold is a currency and it’s the best one out there.  I’ll spare the chemistry of it, but by the miracle of science, gold has been blessed with the best characteristics for use as a currency.  It’s impossible to replicate, doesn’t tarnish, and doesn’t erode.  Not to mention it’s shiny and beautiful and rich people buy lots of it.

Gold is a currency, but that doesn’t mean we can’t make a profit off of it at certain times.  The reason that most people hate gold during certain eras is very often the best reason to own it at that time.  See, gold gets battered when people have faith in the official US paper dollar currency system and the overall economy in general.  Money flows out of gold when stock markets are booming from a debt and credit-fueled economic bubble that creates inflation, then as soon as the market crashes investors pile into gold at a disproportionately higher rate than any other asset.  This is the definition of undervaluation, which is the best way to extract value from the rise of an asset.  An asset is undervalued when people don’t price it at it’s true value.

Gold typically only occupies .25-.50 of a percent of the overall investment matrix in the United States.  In the scenario of a recession, if a mere 20% of investors allocate a new 5% of their assets towards gold holdings, that will increase the overall share of gold in the investment matrix to 1.25-1.5%.  That massive inflow of demand for gold would absolutely skyrocket the price of the precious metal.

Ideally we would return to the gold standard unless we can reverse losses in the value of the US dollar.  The media pundits tell you it’s a relic of the past but that’s absolutely unfounded.  So many misconceptions surround gold standard and it’s stability as a store of value helped ensure the advancement of the United States economy to unprecedented heights unseen by any other economy in history.  If we were to return to gold standard, it would obviously need to be set at the proper price given the amount of gold available and the increase in currency over time.  That price would be anywhere between 10,000 to 50,000 per ounce of gold depending upon which monetary supply level you choose.  100% gold-backing would set a price of 50,000 dollars per ounce.  Unfortunately (and fortunately for gold investors), it doesn’t look like we’re anywhere near reversing the dollar’s decline.  As dollar liabilities increase each year with our growing national debt, accelerated by the Fed’s Q.E. binge, inflation has run rampant.  As the Fed attempts to increase interest rates, interest payments will only increase on national debt, not to mention the challenge of unwinding the Fed’s 4.5 billion in bond holdings.  The future is bright for gold and it’s only a matter of time before it’s value is appreciated once again by savers and working Americans in general.

Trump must pop the debt bubble

It is imperative for Trump to pop this toxic economic bubble once and for all.  Our cultural discourse is at a critical cliff at the present.  Nearly half of the country feels that socialism is the best direction for this country and it has been driven by Keynesian academics that GDP growth requires inflation and interventionist forces:

-more government spending

-more tax increases to ease our growing national debt and unfunded liabilities

– more low interest rate policy that will eventually end in a Japan-like scenario where negative interest rates are used to pay off the national debt.

This is simply catastrophic.

Austrian economics is unparalleled in its consistency.  It is the only school of economic thought in which price signals are truly understood.  Prices simply adapt to new environments.  Natural deflation is consistent with capitalism itself and always makes living affordable for human beings.  Wages should never have to rise to keep up with inflation because inflation is an interventionist policy that results in an unsustainable system.  This is directly at odds with our move towards automation.  When automation is implemented properly it should result in far greater productive efficiency.  However, when paired with an inflationary environment automation is catastrophic as it creates competition with increasing wages due to inflationary pressure.

Trump is far from an Austrian economist but he understands principles that are essential to a surviving capitalist system.  He understands that growing national debt is catastrophic and creates inflation.  It is now up to him to connect the puzzle pieces and recover this system once and for all.

Automation Isn’t Wrecking the Economy, Federal Monetary Incompetence Is…

Recently I’ve been reading a number of articles surrounding technology and the impending takeover of our jobs by machines.  It’s a concept that has existed for many years and is a natural fear for many humans.

Fortunately (and also unfortunately), the concept is just not true.  I can’t even begin to think of what it would take to replace many of our jobs.  Any job involving strategic insight, engineering, and satisfying customers requires significant human input.  Enhancing machine capabilities still requires the human input while improving what can be extracted from information.  Okay, so let’s take another, more basic career: steel worker.  China employs almost 12 million people in the coal and steel manufacturing sectors alone.  At the height of the 2000’s economic bull market in America (2006-2008) a mere 2.5 million people were employed simply in the manufacturing industry in the entirety of the United States.  Now, China IS making a push to cut steel jobs, but this is due to an overcapacity or glut of steel, not automation.  The point I’m trying to make is that automation is not something we should be worried about.

-Our fears should be focused on the absolute chaos and ineptitude that has taken over the global financial system, not technology and automation-

Automation has been happening since the beginning of time, which is probably the reason people still had jobs once things like the printing press were invented to replace scribes and automobiles were invented to replace horse-drawn carriages.  The misconception that automation is stealing our jobs avoids the all-too-important topics of monetary inflation and outsourcing due to excessive government regulation, both of which have caused the plight of a hollowed-out middle class and rusty, empty factories in the United States.

I’m not alone in this educated belief.  Peter Thiel, noted Silicon Valley investor and entrepreneur, believes the same thing.  Government is the cause of our woes.  Dollar inflation has turned healthy economic theories on their back and led us to vilify capitalism as workers chug along trying to afford increasing prices in real estate, food, stocks, and college tuition.  The Federal Reserve and US government selfishly print money and run up the national debt, respectively, that flood the global market with dollar-denominated liabilities to pay for increased consumer spending.  The government believes it can prevent recessions from ever occurring by forcing US consumers to spend money.  The funny thing is that government actually creates these recessions in the first place through over-speculation and spending!  As a farmer prods his sheep to move, so does the US government prod it’s citizens into spending and avoiding savings.  This is not only happening in America, but in nearly every nation around the world.

-Innovative deflation made us kings-

Innovative deflation is the core and essence of capitalism.  The period of growth in America from the late 1790’s to about 1913 was the most successful and wealthy era in modern history.  During this era, goods were cheap, wages were high, and there was no monetary inflation.  There was no income tax and virtually no regulation on businesses (although we now realize that some regulations are healthy).  A little known fact is that Standard Oil was so successful in providing cheap oil to consumers, that it was making competitors angry at the lack of potential business.  Thus, out of jealousy and spite, crony capitalism and lobbied monopolies were born.

Entrepreneurs find ways to make goods cheaper for consumers while increasing profits that allow for more entrepreneurial investment.  This is the beautiful cycle of capitalism that has been nearly thrown in the trashcan by global central bankers.  If this is not true, tell me why computers have become so affordable that they cost less nowadays than many driver’s license registrations?  Computers and electronic technology have managed to avoid inflationary pressure because of the fact that companies have been so effective at reducing prices in spite of inflation.  The idea of capitalism is to make life easier to the point where work is more productive than ever, less laborious than ever, and goods are cheaper than ever.

-How should we react to technological changes?-

While technological changes don’t evaporate the need for human labor, they will shift human labor.  Look back to history when people were employed in positions that are utterly useless nowadays.  When was the last time you saw someone employed as a carriage wheel manufacturer?  Aside from your local Amish family or Queen Elizabeth’s carriage manufacturer, this career is utterly unnecessary.  We train people to be flexible with changes in technology.  This is a constant throughout human history.

 

The illusion of prosperity under central banking

Robert Murphy, Hans Hermann Hoppe, Ron and Rand Paul, Peter Schiff, Harry Dent, Michael Burry, David Stockman, Jim Rickards, etc.: these are just some of the influential Austrian economics-educated figures who have vehemently protested the past decade-plus of economic policies in America.  Their voices have been drowned out by the droves rooting for Obama and fixated on the “change” and “hope” platitudes that have been tossed around in his many speeches.  Little do they know that the central banking policies propped up under the Obama presidency have created nothing more than a band aid on a growing tumor.

What’s happening with employment and debt? If you’ve been inquisitive enough to question national unemployment numbers I’m proud enough of your performance to give you one gold star sticker, which is worth about as much as the money printed by the Federal Reserve…  Real unemployment is measured by the U-6 and probably shows an even bigger picture through the “labor force participation rate.”  While official unemployment statistics are shown to be around 4.9%, the U-6 is around 9.9% and the labor force participation rate even worse, showing only 63% of working age adults somehow involved in work.  That means 37% are no longer even pursuing work.  This figure has decreased steadily since 2007 from 67%, while the unemployment figures that are reported by the Fed and the Obama Administration have shown the complete opposite…  The ruse is up.  Our lower and middle classes are saddled in debt while lacking any gainful employment

What’s happening with the Fed and Banks? The Federal Reserve’s primary goal since 2008 has been to create a spending-rich environment through low interest rates which would then be balanced out by an eventual rise in interest rates (higher interest on bank accounts means more consumer savings).  So what actually happened?  The Fed launched two measures that were supposed to boost spending: 1) lowering interest rates by lowering the rate at which banks could lend each other money (usually overnight) and 2) quantitative easing: the mass purchase of treasuries and other securities by the Federal Reserve with a stream of yearly cash flows by means of creating money out of thin air.  It sounds ridiculous because it is ridiculous.  By purchasing massive amounts of bonds through QE and lowering interest rates, would-be bond buyers had few options are were forced to accept miserable yields.  Consequentially, wealthy investors looked to park their investments in higher yielding speculations such as stocks.  The years from 2009 to 2014 marked one of the most odd, consistent increases in stock prices in history.  If it looks too good to be true it’s because it is.  Price-to-earnings ratios are through the roof in some industries where investors have over-speculated.

Where it’s headed from here:  The lower classes have remained financially weak since the crisis because little value has been created in terms of actual production and manufacturing jobs.  The following analysis is my own assessment, and I would appreciate criticism of these assumptions: The stimulus package worked the way any Austrian economist would have told you it worked: it created finite value by means of taking other peoples money.  A road construction job only lasts so long.  Krugman argued the stimulus should have been larger, which makes sense, but I am confident the vast majority of these government stimulus programs create very little value.  Wind energy?  Cash for clunkers?  Road construction?  I mean how many of these jobs can you reasonably expect to sustain the lower classes of the U.S. economy?  Krugman thinks these stimulus jobs initiate a healthy pattern of spending but it obviously fell short: banks aren’t making loans to consumers anymore because their stimulus jobs and part-time work as Starbucks cashiers aren’t creating any spending opportunities. Because consumers aren’t spending the stock market has stalled.  Quantitative easing has stopped, which means speculation on the stock market has to stop.  Loans to consumers have stopped because they don’t actually have any money.  The entire system has just… stalled.  People aren’t spending money anymore and this has terrible consequences.  Paul Krugman seems to believe infrastructure spending is a panacea, whereas real, intrinsic value is created through a healthy manufacturing sector, or at the very least, companies that keep their operations on American soil.

A lack of supply-side economics: Peter Schiff characterized it so well when he said Americans are getting China to buy our treasuries so that we can go and spend money on goods made in China.  The overall hollowing out of the manufacturing economy in America has made us a nation of spenders who don’t actually produce anything.  We have intellectual capital and lots of land, but where is our manufacturing economy?  Where are the great steel factories that line the Great Lakes?  Over the years, manufacturing has been steadily outsourced due to excessive regulations, union presence, and ridiculous rates of taxation.  This talking point has been misconstrued for years with Democrats claiming we simply can’t compete with third-world labor rates.  The truth of the matter is that once you take into account significant decrease in quality, setting up shop, and extra transport costs, the benefit of manufacturing overseas is not that much greater than the cost.  Just lowering corporate tax rates alone would prevent so many corporate inversions that have happened in recent years.  Is it any coincidence that the strongest manufacturing centers in America are in Tennessee, Mississippi and Georgia where unions are the weakest and tax rates are some of the lowest?

So what’s the international consequence of our excessive spending and lack of productive capability?  China will look towards slowing US treasury purchases while anchoring their currency around a gold standard.  They clearly realize this is in their own best interests because it provides an intrinsic value to their currency that won’t inflate.

The smartest idiot in the room?: The American economy is partially held together by the fact that we are one of the least screwed-up countries in the world.  Where else will investors put their money?  Russia?  Argentina?  France?   It’s true that we are one of the smartest idiots in the room, but that can’t change the fact that we have serious internal structural issues.  Our lower and middle classes are hollowed out, plain and simple.  At some point the Federal Reserve will come clean and reveal their hand.  It’s going to show poor job growth and low economic output.  We have to revamp the entire system if this is to work properly.  Food for thought: the last president to pay off America’s debt in it’s entirely was Andrew Jackson, the guy who was removed from the 20 dollar bill last week.  Is this symbolic or what?

A Libertarian Response to Pollution, Pt. 2

I was watching a video last night on Vice TV, which is the YouTube channel of the media outlet known as Vice Media.  The video had something to do with a “petcoke” plant in Chicago where people were protesting over the massive mountains of petcoke soot building up in the area.  Understandably they were pissed as hell.  Apparently this stuff has the consistency of fine dirt but is sticky at the same time, meaning it blows all over the place and seriously disturbs surrounding communities.

It brought me to thinking a great deal about Milton Friedman.  Friedman acknowledges the handful of scenarios where a governing body is necessary, among them is the need for an environmental agency that simply administers cap and trade permits.  The reason this is necessary is because the environmental externality associated with certain forms of pollution is often too difficult to pinpoint to any one, particular firm.  While class-action lawsuits have traditionally been used to handle such matters, we are familiar with just how difficult it can be to fight a team of corporate lawyers.  The burden of proof is on the victims and they must prove that XYZ company is directly responsible for so-and-so’s lung cancer.  Despite this, we all know that certain pollutants cause major health issues and can also damage private property value.  This creates the distinct need for an active market of cap and trade permits under a government body.

Cap and trade permits can be used for virtually anything because they simply determine the acceptable limit of pollutants that can be released into the air, water, or earth.  The government body simply sets the limit for the year and firms go about trading permits with one another and creating a supply and demand market for releasing pollutants.  It may also be useful to create a limit on the amount of permits that any particular firm can purchase.  This way the most powerful company in the region can’t simply buy out all of the permits for the year.  Cap and trade could easily be administered for carbon dioxide and methane emissions, waste water, biological hazards, and would also take care of this petcoke issue in Chicago.  Clearly the firm found it most useful and cheap to simply dock their petcoke in Chicago, but a permit limit for Chicago would have prevented this from happening on the scale that it did.  The firm can then find the most cost-effective way to work around that issue, but no matter where they look they will have to purchase pollutant permits along the way.

Automation vs. Artificial Intelligence

Did Adam Smith ever take into account the possibility of artificial intelligence?  How would he have reacted to this development?  What are we supposed to do about the rising intelligence of computing power and the possibility of independently-learning computers?

First of all, we MUST make the distinction between automation and artificial intelligence.  Automation is a net positive for society.  It allows us to make quicker decisions and complete processes much quicker than in previous years.  Why is this positive?  Well automation has changed occupations but hasn’t actually decreased anyone’s employment.  There are countless professors and researchers who have studied this topic only to find that automation simply creates new jobs where old ones are retired.  The beauty of this system is that certain processes may remain in place as long as we are content with them.  Microsoft Excel and it’s various add-in automation solver components, for example, has been useful for over 20 years now.  The essence of Excel has barely changed yet has been useful for increasing the efficiency of various other industries.  This blank-slate program has made it easier to create strategic business decisions and has probably improved our overall quality of life as a society.  Excel has opened up an opportunity for an expansion of careers involving Excel.  The better we get at using it, the more we realize we can use this tool to do some incredible stuff.  Nowadays if you are very proficient at Excel, you can land a job quite easily, in my opinion.

Artificial intelligence, on the other hand, is a far greater challenge to actually achieve.  The concept of AI was first really brought into the public light by Alan Turing in 1950 when he asked if computers could think independently and grow without human input.  Both of those stipulations, in my opinion, are impossible to achieve.  Human input will always be involved.  The random synapses in our brains combined with our organic composition make us incredibly incredibly unique.  Organic beings have limitations, no doubt, but we also possess a randomness that makes us so creative and unique.  Machines will always be our tools, in my opinion.  We, as humans, program them and tell them to do things.  Maybe they will end up beating Gary Kasparov in chess or winning Jeopardy, but does that mean they are actually artificial?  No.  Artificial intelligence strives to emulate human beings, albeit at a faster rate of learning than human beings.  If human beings are also evolving organically, we should instead marvel at human intelligence, not artificial intelligence.

As machinery becomes more and more complex, we must understand that it is all simply automation.  Humans have very basic desires and needs and computers are merely here to serve our needs in a simpler process.