Category Archives: Synthetic Economy

The Kevlar Bubble

 “Deficits don’t matter,” we were told in the 1980s, as the Reagan Administration started running what seemed at the time to be huge budget deficits ($200 billion!) to defeat the Russians.  We had seen much smaller deficits associated with price inflation in the 1970s (‘too much money chasing the same goods’), but were told not to worry.

Remarkably, it seemed to work.  The Russians were defeated (although, in fairness, the Reagan defense buildup had relatively little to do with it), the economy generally prospered, and prices for consumer goods remained stable.  The Federal deficit moderated, and even came close to running a surplus in the late 1990s.

But since the turn of the century, the government has been running larger and larger deficits.  Under the Bush (43) administration, deficits ran around a half-trillion dollars per year, and the Obama administration introduced the trillion-dollar deficit.  President Trump campaigned that he would not only eliminate the deficit, but would retire the entire debt in eight years.  (In fairness, that was one campaign promise I didn’t take very seriously.)  In fact, deficits under Trump have gone back into trillion-dollar territory.

And yet price inflation has been moderate.  Yes, the government figures understate the case.  But while today’s Federal deficits, as a percentage of GDP, are at least twice what they were in the 1970s, real price inflation has been less severe.  What happened?

One of the most basic equations of economics is:

MV=PQ

where:

  • M is the quantity of money in the system
  • V is the velocity with which money changes hands
  • P is a price index
  • Q is the value of goods and services transacted (in some unit of measure unaffected by transient price changes)

So, since about 2000, M has gone way, way up; Q has stagnated, rising very slowly; P has gone up moderately.  V, in consequence, has dropped like a rock.  Money doesn’t change hands like it used to.  It disappears out of the economy almost as fast as it’s created.  How does that happen?

For starters, every year, there are roughly $700 billion in imports that have no corresponding export.  Once one of those dollars leaves the country, it isn’t coming back.  That, in itself, will make a big dent in the effects of a trillion-dollar Federal budget deficit.

Perhaps a bigger factor is the inequality that has overtaken the American economy since 2000.  Another place the money can go to have no further effect for ordinary people is into the pockets of the very, very rich. The rich have relatively little need for consumer goods (how many Lamborghinis can one drive at once?) but will seek to invest their new-found gains to at least preserve their value.  So the stock market rises, independent of the productive values of the corporations on it, and real estate goes up, which causes some incidental problems for ordinary people who want to live in places like New York and San Francisco, but nothing major.

Yes, it’s a bubble.  Bubbles usually pop when people realize that the object of the bubble isn’t returning value and they want their money back.  But the essential difference this time is that the money won’t stop.  As long as there are huge new debts, the money has to go somewhere.  This bubble is made of Kevlar, and so far, is puncture-proof.

About 30 years ago, I read The Great Depression of 1990 by Ravi Batra.  At the time, its essential premise seemed ludicrous: that the very rich would suck all the money out of the economy and impoverish the rest of us.  Yet that’s exactly what’s happening now.  The vast Federal deficits, nominally intended to help the people, are in fact helping the very rich become even richer.

Yet it works, for now.  The Federal government borrows money that doesn’t exist; the money passes through ordinary people, but doesn’t really circulate very much before it ends up in the hands of a big bank and its owners, who effectively sequester it so it can’t do any further damage in terms of price inflation, or the money simply leaves the country, never to return.

It’s a delicate balance.  If you cut budget deficits, suddenly banks and big corporations would have to work for a living, and the stock market would plummet.  If people became more prosperous and traded among themselves, rather than buying imports, money wouldn’t be flushed out, and prices would rise.  And if, as some of the Democratic candidates for President imagine, you mobilize millions of people and pay them union wages to go out and fix climate change, they will find that their new paychecks won’t actually buy very much.

A while back, I entertained in these pages the notion that the economy we experienced was a simulation of sorts that had become divorced from the economy of the stock market and the Federal government.  No, it’s not quite a simulation, but it’s pretty close.

Synthetic Politicians

The politicians who know about the Synthetic Economy know that the only way forward is to maintain the status quo.  Big deficits are OK, as long as the excess doesn’t slosh around in the Little People’s economy and cause inflation.  And the politicians, and their friends in the Big People’s economy, get richer and richer because the same dollars circulate in both economies.

But even the politicians who aren’t in on the secret are constrained to follow the status quo, as well.

  • If you believe in increasing spending, you run headlong into the Little People’s notion that money is finite. (It isn’t necessarily true anymore in the Big People’s economy, but it’s still universally understood, and useful as a bludgeon.)  “We’re eighteen trillion dollars in debt!  How dare you contemplate another half-trillion to fix the roads!”  The real reason—that an extra half-trillion loosed into the Little People’s economy would be inflationary—need not be mentioned.
  • If you believe in reducing spending, you quickly find out that every dollar of spending has a constituency, who will argue that the world will come to an end if even one dollar is cut from their program. A while back, the Federal government convened a ‘blue-ribbon commission’ to investigate spending and identify things that could be readily cut.  They could identify less than 1% of spending that fit in that category.  And Federal, State, and local governments all have commitments enshrined in law that cannot be readily unwound.

While state and local governments can’t print their own money, they are nevertheless subject to the same constraints, with the same results.  Occasionally a governor or mayor can turn back the tide in his own state or city, reducing taxes and encouraging development, but it’s a drop in the bucket, and the gains in one state or city are almost always balanced out by losses elsewhere in the US.

So what does this mean for our politicians?

  • A politician’s positions don’t matter. We’ve always know that most of what politicians say when campaigning is motivated by ambition, and bears scant resemblance to what the politician will actually do if elected.  But now, with the Synthetic Economy, politicians really can’t do very much different.
  • Political parties don’t matter. At least, not at the Federal level.  The rhetoric and the emphasis may differ, but both parties are pulling in the same direction and seeking the same ends.
  • Elections become beauty contests. In the 2000 Presidential election, much was made about how George Bush was ‘more likable’ than Al Gore.  At the time, I thought it was ludicrous: we’re electing a President, not hiring a bartender!  But the pattern has been set for every Presidential election since then, as well as most of the others I’m aware of: the most telegenic candidate wins.
  • Incumbents rule. And if you’re not telegenic, but you’re the incumbent, you still have it made.  You have the name recognition and, perhaps more important, the connections for campaign funding.  Just don’t do anything stupid that would land you in prison.

For us ordinary citizens, it’s all very disappointing.  In general, there isn’t much point in supporting one politician over another.  And the notion that an ordinary person might run for office and win, once one of the basic tenets of our republic, is now a pipe dream.

And the keepers of the Synthetic Economy prefer it that way.

Synthetic Economics: Directions for Government

The Synthetic Economy enables the Federal government to continue to run vast deficits every year without having to worry about the usual consequence of price inflation.  But as wonderful as that is for the government, it’s paradoxically even better for the banks.  For they have made trillions in loans to foreign countries and others that, as a practical matter, can never be repaid.  Some of these came up as an issue in the 1980s, but through the magic of ‘extend and pretend,’ and some ‘aid’ from the Federal government, the banks have managed to sweep them under the rug.  The banks would like to very much go on sweeping, as the politicians would very much like to go on spending.

Under the Synthetic Economy, the government and the banks (the Big People’s economy) work to balance the amount of money going into the Synthetic Economy that the vast majority of us live in.  Too little, and people get angry, and there are riots and other civil disturbances.  Too much, and there is widespread price inflation, which could ultimately lead to riots and other civil disturbances.  Meanwhile, in the Big People’s economy, inflation is, indeed, out of control.  But since the inflation manifests itself in the stock market and the price of real estate (at least in the places useful to the Big People’s economy), people think of it as prosperity, rather than runaway inflation.

So what does the government have to do as its part of the deal?

  • As I noted earlier, the first rule of the Synthetic Economy is that we do not speak of the Synthetic Economy. So no politician can say that this is how we solved the deficit problem.  (On the other hand, the former cliffhanger drama of the debt ceiling has become tiresome, so we can quietly ditch that.  Never mind that the debt ceiling was the practical implementation of the Constitutional requirement for Congress to authorize Federal borrowing.)
  • We also don’t want to tell the Little People that money isn’t finite anymore: first, because it is contrary to the experience of their lifetimes, and second, once they came to understand it, they would demand a piece of the action, and they vastly outnumber you. No politician will propose a vast new spending plan, to be paid for by borrowing.  Instead, the propose ‘taxing the rich.’  And their plan goes off to die, because nobody likes tax increases.  (And in any event, a 5% or 10% tax increase won’t change the overall situation.)
  • But perhaps the most important thing is that the government needs to maintain policies that discourage money from circulating in the Synthetic Economy. This isn’t to say that money doesn’t circulate at all: it does.  But we want the money paid into the Synthetic Economy (government spending, wages paid by Big Economy players, payments for exported goods and services) to come out (through taxes, payments to Big Economy players—like one’s mortgage payment—and the purchase of imported goods) as quickly as practicable.  When someone buys a domestic manufactured item, they pay the factory owner, who pays his employees, who go out and buy the things that they want and need.  This used to be the virtuous cycle of capitalism.  It’s now bad news, because it can’t be readily controlled.  We must stop it, as much as we can.
  • A corollary of discouraging circulation is that saving and investing need to be curtailed, as well. If the denizens of the Synthetic Economy have their own productive assets, they can function independently of the Big People’s direction, and that’s bad.  And if people do have assets, and can be encouraged to liquidate them, so much the better.  (Anyone for a home equity loan?)

What happens when the politicians carry out these tasks?  What about effects on the politicians themselves, or the political system?  Tune in next week….

Synthetic Economy: Interest Rates

For as long as mankind has known money, we’ve known that a dollar (or pound, or shekel, or whatever) in hand today is worth more than a dollar in hand next month, or next year.  And if we want to borrow someone else’s dollar so that we can use it today, then it’s appropriate to pay him something—interest—for the temporary use of his asset.

Historically, interest rates varied with the state of the economy, and served to regulate economic activity.  If an economy gets ahead of itself, interest rates rise, borrowing becomes difficult, and the economy brings itself back into balance.  At least, that’s what happened in the past.

For almost the last decade, the Federal Reserve and the banking system have worked to keep interest rates low.  For the Big People economy overrun by debt that can never be legitimately paid off, it’s a survival mechanism.  By keeping the cost of debt service low, debts can be kept current, and life goes on.  And if there were a way to make interest rates negative, debt could be unwound.

Of course, the Synthetic Economy doesn’t share in the benefit.  For the little people, money has to remain scarce, and interest rates—at least for debts—have to remain positive.  So we still pay 20% on our credit cards.  And while rates for mortgages have remained low, they’ve become more difficult to get since the 2008 implosion.  The banks, we’re told, want to stay away from risky investments.

So, what happens as a result?

  • The big banks get bigger, and the little banks get bought out. It is very difficult for a bank to exist as a creature within the Synthetic Economy, because it can’t compete with the big banks that can freely synthesize money out of nothing.
  • Saving becomes pointless. When I was growing up, in the 1960s and 1970s, banks paid 5% on ordinary savings accounts, and higher rates for time deposits.  While, in most cases, that didn’t keep up with inflation, at least, you felt you were accomplishing something as you watched your savings increase.  But if the bank is paying 0.1%—a dime for $100 for a year—why bother?
  • The stock market becomes the only game in town. If you want to do better than a fraction of a percent, and remain liquid, your most practical choice is the stock market, outside the Synthetic Economy.  This is true not only for individuals, but for pension funds entrusted with securing retirement for the little people.  Yes: if you watch the market and are careful, you might be able to secure a decent return.  But the days when you could pick a solid corporation, buy its stock, and come back twenty years later expecting a meaningful return are long gone.  And the market could always burp and take half your investment with it.

At this point, the Federal Reserve has hit the wall.  For now, interest rates can’t really go negative, because even if the banks charged rather than paid interest on savings, one could simply hold cash.  But even that may change.  Chase has told its safe-deposit customers that they may not store cash in their safe-deposit boxes.  And now, technology has gotten to the point where electronic transfers are cost-competitive with cash for all but the very smallest businesses.  (We may not think of it that way, but processing cash costs money for businesses: it has to be counted, tracked, transported to and from the bank, and secured.)  In 1969, the Treasury stopped issuing US currency in denominations larger than $100, to discourage drug trafficking.  (Alas, we know how that turned out.)  It wouldn’t be much of a stretch, particularly in response to some real or imagined crisis, to go further.

Synthetic Economics: Money is Crap Anyway

The raison d’être of the Synthetic Economy is to enable both the government and the banks to manage the condition under which the banks had lent trillions of dollars, not only to the Federal government, but states, localities, and even foreign countries, which, as a practical matter, cannot be repaid.

The traditional approach, for a national government, is to ‘monetize the debt’ by printing money to pay it.  Of course, new money, with nothing to back it, will simply lead to price inflation.  Many times in our history, governments and banking systems have collapsed as a result, as the money was quickly recognized as worthless by the public.  In the United States, and modern states with central banks, the process is a little more complicated: the government issues debt, which is bought by the central bank.  The bank creates money on the spot to buy the debt, which the government can then spend.  But the result is the same: money is effectively created out of nothing, with nothing to back it.

The Synthetic Economy addresses this concern by managing what most of us experience as ‘the economy’ (i.e. the Synthetic Economy) so that what most of us experience as ‘money’ maintains a relatively stable value.  This is done by balancing whatever new money is introduced into the Synthetic Economy by money taken out, either through taxes, repayment of ordinary people’s debts, or purchases of imported goods.  (Once a dollar goes to China, the Synthetic Economy will likely never see it again!)  As a consequence, very little of the new money migrates into the Synthetic Economy, so prices remain stable.  In fact, to combat price inflation, the Synthetic Economy is run in a slightly deflationary mode.  This further stabilizes prices, but also depresses wages.

For national governments, big banks, and multinational corporations (the players in the ‘Big People’ non-synthetic economy) this means that money is no longer a scarce good.  Spend all you want: we’ll make more!  But don’t spend it on higher wages for your employees, or new infrastructure or benefits for your citizens.  If too much of this money gets into the Synthetic Economy, it will wreck the balance.

For years, politicians have told us that they can ‘fix the economy’ through government spending.  Alas, it doesn’t work.  One of President Obama’s first efforts was ‘the stimulus:’ a package of some $787 billion in spending meant to get the economy restarted.  It accomplished almost precisely nothing.

Actually, that’s not quite true.  The dislocations of 2008 primarily hit the Big People economy, but did have an effect on the Synthetic Economy as well.  Many ordinary people lost their savings and pensions, or became unemployed.  It was a case where too much money had been bled out of the Synthetic Economy, and we had to put some back to maintain the balance.  However:

  • Much of the stimulus was aid to states and local governments to fund their ongoing operations. This did nothing but spare state and local politicians the necessity of making difficult choices.
  • Some of the stimulus went for infrastructure, but then again, the government is constantly spending on infrastructure (although perhaps not enough to overcome the ongoing decay). So at least some of the infrastructure spending in the stimulus was brought over from programs that would have been enacted in its stead.
  • The stimulus did nothing to help individuals who had lost out in the 2008 dislocations. The banks and other too-big-to-fail firms had previously received bailouts, but individuals were left out.  In fairness, that wasn’t its purpose, and it’s a fair question whether the government should be responsible for making good on individuals’ bad financial decisions.

So the stimulus served to reinforce the status quo, as well as the notion that it’s dangerous for Little People to play in the Big People’s economy.  It didn’t change the economy overall, and did not result in the fount of new jobs that its proponents claimed for it.

In fact, because of the need to maintain balance, we haven’t seen, and are unlikely to see:

  • Meaningful public or private investment in infrastructure. At best, there will be continuing public spending to keep things from falling down, but little more.  On the private-sector side, companies that earn their living through their infrastructure will spend to maintain it, but in the absence of new markets for their products and services, there’s little incentive to build more.
  • Private-sector mobilization to create jobs and do more. For a long time, I have believed that the private sector, rather than the government, has the keys to a real recovery.  The government can’t force businesses to expand or hire people, but if businesses did it for themselves, they could drive a new, real, recovery.  But they won’t, not only because consumers are pretty much spent out, but because introducing new spending into the Synthetic Economy will upset the balance.
  • Significant efforts to redistribute income through taxation. Paul Krugman is a big believer in deficit spending to increase demand, but doing so would be inflationary, and the Synthetic Economy is being run in a deflationary mode for price stability.
  • Meaningful tax cuts… or tax increases. The rates might be tweaked up or down because of political pressure, but the overall regime, and the role of taxation in keeping the Synthetic Economy in balance, will not change.

Years ago, one of my engineering-school professors remarked that ‘money is shit anyway.’  And now it has come true.  It’s certainly true in the Big People economy, where money can be synthesized at will, out of literally nothing.

For now, with the Synthetic Economy, the rest of us have been slow to catch on.

The Synthetic Economy

When I was growing up in the 1970s, I was aware of inflation.  My mother sent me to the supermarket since I was about eight, and I remember seeing the prices of things like milk tick up over the weeks and months.

In high school, and from the newspaper, I learned that inflation (in terms of rising prices for ordinary goods) was a consequence of deficit spending, primarily by the Federal government.  The money went into the economy, chasing after the same set of goods, so prices went up.  And in the late 1970s, under the Carter administration, the Federal government deficit per year was around $50 billion.  It seemed serious at the time.

And then came President Reagan, and deficits skyrocketed.  We were going to whip the Russians.  (Indeed, we did, but the USSR was on its last legs anyway.)  But curiously, the big deficits did not lead to very much consumer-price inflation.  Instead, the stock market and real estate went up.  Apparently, when the price of bread and milk go up, that’s inflation, and that’s bad, but when stocks and land go up, it’s prosperity.

For the last decade, we have been running deficits, under both Bush and Obama, that would have made the politicians of the 1980s run for cover.  And while the government has finagled the statistics to make things look better than they really are, price inflation (the kind I observed back in the supermarket in the 1970s) has really been moderate, considering the vast deficits we now run.

100 years ago, we all inhabited the same economy.  Some people were very, very rich, but they became that way by building vast productive enterprises that hired, collectively, millions of people, and brought forth products and services that an earlier generation could hardly have imagined.

Not any more.  I believe that the vast majority of us (‘the 99%’ is a fair approximation) have been transplanted into a ‘little people’s’ synthetic economy.  The economy that we used to all inhabit together has now been left to the ‘big people:’ the Federal government, the banks, the big corporations, and the very, very wealthy.

The ‘little people’ synthetic economy is run by the ‘big people’ economy, rather like a hothouse.  And within it, things work pretty much as they always have: money is a scarce good, so you either have to earn it, or subsist as a ward of the state.  And money has value, in that it can be readily traded for goods and services, and that value is relatively stable.

Meanwhile, in the ‘big people’ economy, money is not scarce.  After all, it can be created out of nothing, and it exists in such vast quantities that a $18 trillion national debt that can’t be paid off is actually of little consequence.

So almost all of the currency debasement that went everywhere in the 1970s is now very effectively constrained to the ‘big people’ economy.  The stock market continues to rise, even through there is no productive activity to support it.  And the very rich get richer, and the rest of us are hung out to dry.

There are three very basic rules:

  1. The first rule of the synthetic economy is that we do not speak of the synthetic economy.
  2. The synthetic economy is to be kept isolated from the ‘big people’ economy, and kept in balance, with stable prices, if nothing else.  (After all, nobody wants food riots!)
  3. A dollar in the synthetic economy is the same as a dollar in the ‘big people’ economy.  Individual dollars in the hands of individuals may freely cross between the two.  (However, collectively, the flow of money between the two economies is in fact effectively managed.)

When I look at the economy this way, many of the weirdnesses that seem to afflict us become simple and straightforward.  I’ll write about some of the applications of this theory in future posts.  But the synthetic economy (and the things the ‘big people’ to do maintain it) explains things like:

  • Why nobody fusses over the Federal budget deficit anymore.
  • Why party politics doesn’t matter.
  • Why all our politicians seem to favor open borders.
  • Why Islam is cool and Christianity isn’t.

More to follow in future posts.