Friday, October 10, 2008

The Nature of Money

Changing the Nature of the Economy from Scarcity to Abundance

I strongly recommend Stirling's article on Open Left.

Ian Welsh and Stirling Newberry are writing brilliantly about the crisis.

I've been writing on the now arrived crisis for over a year. Including...

Again, I strongly urge you to start by jumping to Stirling's article before continuing.

My takeaway from Stirling is, THE NATURE OF MONEY IS BROKEN.

Obama screwed up in backing the bailout. Once he's in office -- maybe before if the market doesn't stop crashing -- we (Obama) need to change the very nature of money.

This has happened before.

Back in the days before the Great Depression, money was Gold based. Then it became Asset based, that is, money is now based on how much "stuff" you have, how many buildings, how many factories, cars, computers, and real estate. This is the "book value" of what you own. Some of it appreciates. Some of it depreciates. Put together everything you've got at "book value", take away everything you owe, and that is your net worth.

Before the Great Depression the key to all of this was Gold and other minerals, dug out of the ground. Now it is how much "stuff" a nation (or you) can make/create. Ultimately, because we take stuff from where it doesn't cost much, and ship it to where it costs a lot, where we then make it into something else, this manufacturing economy I will say -- Newberry doesn't precisely say this -- is an economy of scarcity. There is a limit on how much stuff we can make. There is a limit on how much real estate there is. There is a limit on how many cars people need. There is a limit on how much oil we can drill out of the earth. Because we've reached those limits, just as roughly 80 years ago -- a lifetime ago -- we reached the limits of Gold, we now have to change.

In more ways than one, that is why this election, we have a candidate of change. This is a generational candidate, the kind we see roughly every 22 years between generations. The wipeout of LBJ over Goldwater with 44 states + DC and 61% of the vote showing the rise of the GI Generation, and the switch the other way in 1984 with Reagan winning every state but one plus D.C. with 58.8%. This is FDR wiping out Hoover 42 states to 6 with 57% of the vote in 1932, (that's 32 years after FDR... the wartime leaders really hung in there for a while before the generational POP.)

But Obama is more than the generational change candidate that falls between generations, in this case between the Boomers and the Xers. He is the candidate who comes once a life-time, at the start of a crisis. He will not still be president when the crisis ends, some 20-25 years from now, as FDR was, as Lincoln was. But he is here at the start of the crisis and how he sets us up will determine our options in large part for the next 80 years, the next lifetime. Just as we are now living out the options which FDR set us up with in 1933 with the New Deal as he came to power.

The old money is broken, Newberry tells us. As Gold was in the Great Depression.

WE MUST CHANGE THE FUNDAMENTAL NATURE OF THE ECONOMY, FROM SCARCITY TO ABUNDANCE. (I do not mean this in some woo-woo California airy-fairy way.)

FDR took people's Gold away, shifting the economy from Gold to oil/dollar/scarcity-assets.

"If you build it, they will come" and your book value will increase.

That was appropriate then.

We'd reached the limit of how much Gold could be dug from the ground in order to keep the world moving forward, and here was all this OIL, much of it in great big reserves under the United States.

Now, we've reached the limits of all this OIL, as well as real estate (more or less), so we need to shift the fundamental nature of money once again.

The new economy -- since the old one was SCARCE OIL/ELECTRICITY -- will likely be based on ABUNDANT GREEN ENERGY, although it could be based on other stuff (but it won't. Pay attention. School's in session.)

ABUNDANT X, where X is something which can be monetized throughout the world, but still (because the U.S. will be setting the standard, as we control the dollar and the rest of the world owns gad-Zillons of dollars) gives the U.S. an edge. Thus X will be technological in nature, in a field where X is something the
  • U.S. truly needs, and the
  • entire world is going to need.
By creating the fundamental market and tech on X, we will lead the world for another century as we do in
  • software
  • music, movies, and
  • high-speed pizza delivery.
(Yeah, I stole the line. Want to make something of it?)

Also X must have inherent war-making potential, i.e.: the energies must be HUGE.

The point is, it has been roughly 80 years since the Great Depression started, and almost that long since the world switched from Gold to Oil, as Stirling explains.
Open Left

What is to be done? The answer is not found in the equations of macro-economics. Economics can optimize for the problems we set it, but it cannot decide them. What is necessary is to recapitalize the financial system. This means not an infusion of money, but expanding the basis of what money is. It is simplest to argue by analogy.

In the late 19th century the global financial system came to be based on gold. Gold worked because it was easy enough to transport between distant places, and the amount of gold was organically related to the basic activities that drove the economy. It was not money itself, but it was a good proxy for the things that people did that created capital concentrations. However, with the internal combustion engine, this proxy nature was broken. Capital could produce more than gold could value, and the scramble for resources, which gold encouraged, was at it's limits.

What replaced gold based money was asset based money. Banks could lend if they could show that there were good assets, the "book" value of what they were lending for, involved. A mortgage, a business loan. The assets, such as factories and houses, were what the economy could produce. This encouraged people to make assets, such as houses and factories. As the pool of assets expanded, so could the amount of money.

However, in the present hard assets are failing in a number of ways. First, they do not address the basic scarcity. Just as gold encouraged state actors to invade, and private actors to concentrate capital and dig for resources, at a time when there were no more Africas to conquer, and wealth was no longer mined, asset money encourages people to burn oil, at the very moment when the limits of oil are being reached. Second, the hard assets we can create are increasingly not making people in the developed world happy. We have reached the point of diminishing returns on what internal combustion engines can do for our lives, as much as the coal economy reached the point where ships could not be built larger economically. It is possible to add any number of other points, but they amount to the same thing: macroƫconomics is about how fast or slow to run the engine that converts scarcity into goods that make people happy. However, if that engine is already running as hot as it can, running it faster does not help.

To recapitalize is to convert asset money into some other kind. Since both the scarcity part, and the happiness part are, empirically, broken, it also means that we need to look at the engine itself. That engine is the analog petroleum-electrical economy, and running that engine faster or slower does not fix either the scarcity of energy, or the fact that people don't need more internal combustion engines in their lives.

This means that the future must reset on the creation of other kinds of basic capital, to change what is scarce, to change what is produced, and to change the engine that converts them.

The temporary step has always been to replace the old basis with fiat. The government promises that it can tax, grants itself powers over the economy to change the shape of output, and then guarantees that money will be worth something on the other side. Then it must produce the actual proxy, silver, gold, assets or whatever else. The challenge for the present it is to get rid of the function of derivatives, that is stabilizing the rates of return, and replace it with a government based insurance and regulation regime, as was done during the New Deal, and in fact during the Civil War in the US, and, to reach back to a different place, the Napoleonic Wars in Great Britain.

What we have now is paper money, whose objective, as in 1925, is to allow the global economy to be suspended in the air, and hope that time will allow an eventual collection of debts in the form contracted. To ignore that there isn't enough housing asset base now to collect in the event of default, and but keep mortgage debts at the inflated numbers so as to collect back the money loaned. With interest. Real above inflation interest.

The alternative is not just a different policy regime, but to announce that the objective of the temporary suspension of the asset base is not to reassert the old one, but to establish a new one. Once this is done, and the immediate crisis stabilized, the new basis for revenues can be asserted, and a new banking system built on the ashes of the old. The manifest failure of the bail out, politically and economically, means this moment will come soon. The political landscape indicates that there will be a very brief tide for the Democratic party to be the instrument of this change.

There's more...
Again, I strongly urge you to read the entire article if you have not done so already. Stirling and Ian Welsh have been doing amazing work.

Ian points out the historical basis for the DOW under these circumstances could be as low as 6,000. Ouch.

On January 23, 2008 I wrote this. (Bold added):
Group News Blog

Stocks Continue Fall; Bonds Rise.

In Europe, the Central Banks refused to join the Fed in cutting rates, and markets continue to fall.
AP News via MyWay

NEW YORK (AP) - Stocks fell in another rocky opening Wednesday, with investors uneasy about the health of the economy and corporate earnings after disappointing reports from big names like Apple Inc. (AAPL) and Motorola Inc. (MOT) In the first minutes of trading, the Dow Jones industrial average fell 261.10, or 2.18 percent, to 11,710.09.

Broader stock indicators also declined. The Standard & Poor's 500 index fell 28.97, or 2.21 percent, to 1,281.53, and the Nasdaq composite index slid 53.19, or 2.32 percent, to 2,239.08.
I'm fully out of the market, as of the end of trading yesterday.

Everything is liquid, cash, money-market accounts, certificates of deposit. All backed up with the full faith and force of the U.S. Government. Could I get hurt? Yeah. Inflation could hurt. I might move 10-15% to physical gold, but I should have done that two years ago. I knew it then too, when I saw this coming. I just didn't have the cash then to buy gold in any real volume. I still don't, actually.

Here's what I predict. TAKE THIS AT YOUR OWN RISK. I am not a broker or a licensed professional of any kind. It's your money, not mine.

Oh... and if you are going to read one person, read this guy, The Bonddad Blog, who not only has his own blog but publishes at Huffington Post as well. Bonddad isn't saying what I am saying. (I am responsible for my analysis.) But I like his thinking.

I believe China is way over-extended. They have been keeping their economy over-heated and will try to keep it up and looking good through the Olympics. At some point, for sure after the Summer 2008 Olympic games, possibly before, China's economy is going to melt down. When that happens, they won't be positioned to keep loaning the United States $2 billion dollars a day in the bond market.

China will go into their equivalent of the U.S. Great Depression, and take the rest of the world with it, including the U.S. I believe this will happen about mid-2009, roughly 18 months from now. Lots of people will be out of work, everywhere. Could it happen sooner? Sure. Later? Yep. Could I be wrong? You bet.

Do I think I'm wrong? No. And I'm putting my money and actions behind what I'm telling you. But take my analysis at YOUR OWN RISK. I don't back anything I'm telling you up with a damn thing. It's all on you to check this out for yourself, and make up your own mind what to do.

The most important thing will be to have a six-month supply of food and clean water (or better, a good water filter) stocked up. I'm not kidding. Then have gold and silver, which have real value which will hold, even as paper money inflates away. Physical tools of good value. A good bicycle you can get to work on. An adequate supply of medicines. If your home mortgage is underwater, make sure you've sold it before spring a year from now. Hard times are a-coming. Prepare for them. If you're going to ride things out where you're currently living, a wood stove to heat the place wouldn't be a bad idea, and make sure it had enough room on top for you to cook, maybe even including an oven.

Do I know this is going to happen. Of course not. No one knows the future to a certainty. But just as we can be sure that earthquakes will happen along known fault-lines at some point in the future, I look at what the Fed is doing, the over-heated economy in China, the defaulting mortgages all across the land, and even someone as ignorant about money as I am, can say, hard times they are a coming. We've been living in a bubble for a while, and it's going to burst in a big way.

If I'm wrong, well, you'll miss out on some upside appreciation in the market. Oh well. If I'm right, you just saved yourself possibly losing a third or more of your life savings which you have in the market, plus made sure your family has enough to eat, tools to make a living with, and a warm house during the cold months, a year or two from now when it gets tough.

That's what I'm doing. And that's what I'm advising those close to me to do.
I wrote the above last January. The day after I pulled all my money out of the market.

If you are still in the market, well, I have different recommendations today.

I recommend you go to The Bonddad Blog and pay attention. There will be buying opportunities on the way down. And obviously you want to dump your crap as the market unwinds. If it's true crap, dump it now. Don't wait, just go. You're going to take a loss so take it.

You're in the U.S. probably, so take advantage of that. You can see opportunites folks not here won't.

Energy stocks are going to be worth a lot, especially green energy. What will be the winners? Can't tell you. But ten years from now, we're going to be off foreign oil. Energy is going to be huge. So is infrastructure and supporting components for energy. All the way down to some small bio-tech thingy that lets us move from silicon to biogel and go faster and better. Comes the revolution it will overthrow lots of stuff. GREEN doesn't just mean tech. It means bio as well.


Our money right now is OIL DOLLARS or PETRO DOLLARS. If our money ten years from now is Solar dollars, Wind dollars, Hydro dollars, Tidal dollars, and Carbon-offset dollars, then we have an ABUNDANT GREEN ENERGY ECONOMY. With the United States having invented and controlling the key patents behind the new dollar, and having relegated the entire Arab world to third-world status overnight.

Oil will mean... NOTHING. Think about THAT. Oh, it will still be used in some industrial processes as a lubricant, and it may still be used as fertilizer, but with enough energy, we can convert other goods to fertilizer and to hell with oil. It gets us out of the Arab world and won't that be nice for national security?

In fact, people in many parts of the world may be FINED for using oil for fuel because of the damage burning carbon does to the environment. Which leads me to...

The WAR at the end of this crisis -- 2025-2030 -- will likely be fought between THIRD WORLD and FIRST WORLD nations over enforcement of environmental laws. We will insist they stop using oil and oil-based pollution and convert to the new green tech. They will say they can't afford the upgrade. Instead of fighting a war in 20th century style, the new President will simply shower their countries with free cars running on free energy from the sun, and unlimited free energy, medicines, crops. This will destroy their Third World governments and the old ways of doing things.

Near the end of this coming ten years oil will reverse course and be worth less and less, as fuel replacements are put into place, and abundant endless, NEXT TO FREE ENERGY comes into play.

Think about this....

Every economy, every unit of exchange -- dollar, yen, yuan, pound, euro, Gold, Salt, pelts -- the world has ever known, has been based on there being a fixed, limited supply which the Government can control.

What happens to the Economy (Capital E "Economy") when a ten year old girl can set up a solar panel and a windmill with her brother in their backyard, and make ENERGY, which they sell into the GRID? Enough energy to pay for all of their basic cost of living and I do mean ALL. And then some.

This coming economy is an economy of ABUNDANCE... unless folks artificially cap it in order to control it for the benefit of the Owning Class.

How about them apples?