A mind-blowing machine

[FRED]

A mind-blowing machine
Jan. 28, 2008 (Paul B. Farrell - MarketWatch)

In America, land of the bubbles, the next pop will be the biggest

Actually it's the 1919 tune that launched the roaring run-up to the '29 crash and the Great Depression. Remember the lyrics: "I'm forever blowing bubbles. Pretty bubbles in the air. They fly so high, nearly reach the sky. Then like my dreams they fade and die."

And it still fits today! Listen to venture capitalist Eric Janszen's scary new paradigm in "The Next Bubble," a Harper's Magazine report: "That the Internet and the housing hyperinflations transpired within a period of 10 years, each creating trillions of fake wealth, is, I believe, only the beginning."

[snip]

Never-ending: Gross and Janszen agree on that. But they're both wrong. The biggest low in Janszen's argument: "Given the current state of our economy, the only thing worse than a new bubble is its absence."
Wrong, wrong, wrong! Remember, this new paradigm assumes that the only way the American economy can exist in the future is if Wall Street's greedy "bubble-blowing machine" keeps feeding on itself, creating an endless, accelerating succession of ever-bigger bubbles.

Folks, that's one of the dumbest economic theories ever, silly "new age" magical-thinking touted as a scientific basis for the new self-indulgent ideology of Wall Street, Washington and Corporate America.

AntiSpin: Apparently Paul B. Farrell has never read iTulip.com. EJ is an entrepreneur first, VC second. The Next Bubble argument is to turn the entrepreneur, financing, and economic machine to a constructive purpose. The alternative is a mix of 1930s USA, 1990s Japan, and 1920s Germany.

Here's where we stand.

We define the ten periods shown as compared to periods of inflation adjusted DJIA growth and decline as follows:

A. Globalization V1.0 and FIRE Economy V1.0.
B. Failure of FIRE Economy V1.0 and Globalization V1.0 (global economic depression and de-globalization).
C. World War II (drawn out and self-reinforcing global depression across elections influences political outcomes).
D. Start of Globalization V2.0 (rise of the US industrial economy).
E. Decline of US industrial economy.
F. FIRE Economy V2.0 starts in 1980 (first crisis, real estate and banking early 1990s).
G. FIRE Economy V2.0 experiences first asset hyperinflation (equity financed in tech companies).
H. FIRE Economy V2.0 second crisis (stock market crash).
I. FIRE Economy V2.0 second asset hyperinflation (debt financed in housing and businesses.).
X. FIRE Economy V2.0 final crisis (real estate market crash. "Period X" current.

Scenarios of the Real DJIA returning to the real 1.64% mean curve via rising inflation and nominal price declines are:

1. 2012 - Fast 50% real decline via very high inflation.
2. 2020 - Moderate 45% real decline via high inflation.
3. 2025 - Slow 40% real decline via very moderate inflation.

Looking out the next few years, here's how it looks.

1) Jan. 2008: We're in the early innings of the US debt deflation; think: Japan 1990.
2) Jun. 2008: The US is in recession and evidence mounts that the first true demand crisis in the US since the early 1980s is in train.
3) Jan. 2009:
- USA: Republicans blamed for the recession so a Democrat won the presidential election in Nov. Taxes are not raised. Government spending increases. Foreign lending has dropped, the dollar has continued to depreciate, import prices rise which increases inflation pressures.
- EU: Most of Europe is in recession. The ECB was slow to see the risks of deflation and worried too much about inflation, as the Japanese did in the early 1990s. Without a euro treasury department to inflate the euro through bond issuance and monetization, a deflation process takes hold and interest rates march relentlessly to the zero bound. The euro strengthens. At the same time, tension among UE members increases as recessions impact different countries in different ways. Countries such as Spain are under intense political pressure to enact stimulus that is contrary to ECB rules. Countering the euro strengthening trend are political stresses on euro zone unity.
- Asia: China's GDP growth slows to 3%. Feels to the average Chinese like a serious recession. Unemployment rises and with it political strife. The CCP clamps down hard on dissident groups. Increasing political instability feeds negatively back into financial markets and the economy. Other nations, such as Japan, that are dependents on China for demand enter deep recession and suffer political problems of their own.
4) Jun. 2009: Governments around the world cope with the first global recession since the early 1980s, with rising unemployment and political unrest. In some countries, bad ideas start to gain ground and are picked up by populist leaders looking to replace incumbents: protectionism in the US, counter-protectionism in Asia, Islamic militancy in the Middle East and parts of Europe, and so on. Initially, relationships between long standing contacts among central bank officials holds together. But as elections occur, CB officials that represented the previous administrations are placed with new faces. Soon a new regime is in place.
5) Jan. 2010: A period of heavy global election activity occurred in the 2008 to 2010 period. If these elections occurred in an environment of ongoing or increasing economic and political trouble or even chaos, then the a De-Globalization process may begin.

The outcome of the process of debt deflation and recession depends on how deep the global recession goes and how long it lasts. If it goes on long enough to impact elections around the world, then we may begin a process of De-Globalization. If the recession is short, then the system holds with no major political and economic re-alignments. The process of globalization and de-globalization is apparent in immigration trends.

Guys like Farrell may not know it but are asking for "Period X" to be another period of de-globalization like the one between 1932 and 1950. No thanks. Here's an alternative.

My philosophy is that it’s not enough for me to identify how screwed up things are and how bad things are going to get if I don’t also have any constructive solutions to offer, and that’s really what the Harper’s article is all about. As the economy and financial markets devolve over the next few years, we all going to be looking for ways to get things going again and I’m hoping we go the re-industrialization route without the global depression, de-globalization, and war that followed the collapse of the last major debt financed asset price inflation, back in the 1920s. To help readers see what I see, I ask a number of questions.

Why can’t the US have the best auto industry in the world, leading with the best next generation technology? Why not build a national high speed rail network where you can work as if you’re in your office as you head to Texas, Florida, Chicago, or California from Boston or New York? Why not build safe and simple pebble bed nukes for local electricity and hydrogen fuel production for local personal transportation and wean ourselves off imported fossil fuels? Why not install fiber to ever home to enable communication tools that vastly reduce the need for in-person contact and commuting.

These are the kinds of energy, transportation, and communications projects I have in mind, massive investments to make the US economy more efficient for private businesses. Get government out of the business of subsidizing industry directly as it does the real estate industry today. Participants are government, private industry, private equity, and Wall Street. Capital gains tax rate on private company investment? Zero. If as an entrepreneur you’re taking all the risk to compete to, say, make the best ceramics technology for the high temperature turbines for the new nukes, you and your investors should not pay any capital gain taxes if the bet wins. How to make up for the tax revenue shortfall? Shift taxes back onto the FIRE Economy, especially real estate and other non-productive assets. The economy will shift its focus from debt-financed consumption to equity financed production.

The FIRE Economy V2.0 is as good as over anyway. Farrell thinks we can go from FIRE Economy to zero cold turkey. That proves he has no idea how the economy actually works.

See also: The Big Bet


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[Rajiv]

Why can’t the US have the best auto industry in the world, leading with the best next generation technology? Why not build a national high speed rail network where you can work as if you’re in your office as you head to Texas, Florida, Chicago, or California from Boston or New York? Why not build safe and simple pebble bed nukes for local electricity and hydrogen fuel production for local personal transportation and wean ourselves off imported fossil fuels? Why not install fiber to ever home to enable communication tools that vastly reduce the need for in-person contact and commuting.

These are the kinds of energy, transportation, and communications projects I have in mind, massive investments to make the US economy more efficient for private businesses. Get government out of the business of subsidizing industry directly as it does the real estate industry today. Participants are government, private industry, private equity, and Wall Street. Capital gains tax rate on private company investment? Zero. If as an entrepreneur you’re taking all the risk to compete to, say, make the best ceramics technology for the high temperature turbines for the new nukes, you and your investors should not pay any capital gain taxes if the bet wins. How to make up for the tax revenue shortfall? Shift taxes back onto the FIRE Economy, especially real estate and other non-productive assets. The economy will shift its focus from debt-financed consumption to equity financed production.

The FIRE Economy V2.0 is as good as over anyway. Farrell thinks we can go from FIRE Economy to zero cold turkey. That proves he has no idea how the economy actually works.

I don't think this is going to work unless some of the conundrums posed by Bill Catton, Jared Diamond, Michael Hudson, Margrit Kennedy etc. are answered, and adequate solutions found - see the subthread

[WDCRob]

This was something that came up more than a year ago...

Did anyone do anything with the idea that compound interest on ever increasing levels of debt behaves like bacteria in a jar? i.e. expands exponentially right up until the point that it completely collapses?

I've dug up the original post here.

As I recall, someone subsequently posted something by Hudson which said that the collapse in the world's monetary system would occur when the FIRE economy grew to the point that the interest payments could no longer be serviced by income from the real economy.

That's in the right ballpark anyhow.

That seemed like an intriguing idea, but so far as I remember no one went any further with it, or was able to estimate where that maximum might occur.

[Jim Nickerson]

This was something that came up more than a year ago...

Did anyone do anything with the idea that compound interest on ever increasing levels of debt behaves like bacteria in a jar? i.e. expands exponentially right up until the point that it completely collapses?

I've dug up the original post here.

As I recall, someone subsequently posted something by Hudson which said that the collapse in the world's monetary system would occur when the FIRE economy grew to the point that the interest payments could no longer be serviced by income from the real economy.

That's in the right ballpark anyhow.

That seemed like an intriguing idea, but so far as I remember no one went any further with it, or was able to estimate where that maximum might occur.

Sept. 20, 2010. That's the date to watch. Sorry no time to explain how it is foreseen.

[WDCRob]

Thanks Jim! I'll sleep better tonight knowing the number of our days, and will get straight to the serious planning in the a.m.

[Rajiv]

Thank you for pointing out the thread to me -- many insightful comments there.

The solutions to the monetary crisis posited have been suggested by ecological economists like Margrit Kennedy by proposing a concept of interest and inflation free money

Others Like Tom Greco have also suggested alternatives.

Other ecological alternatives have been suggested -- for example Peter Barnes' Capitalism 3.0

A lecture by Peter Barnes can be found here

[Jim Nickerson]

Thank you for pointing out the thread to me -- many insightful comments there.

The solutions to the monetary crisis posited have been suggested by ecological economists like Margrit Kennedy by proposing a concept of interest and inflation free money

Others Like Tom Greco have also suggested alternatives.

Other ecological alternatives have been suggested -- for example Peter Barnes' Capitalism 3.0

A lecture by Peter Barnes can be found here

Rajiv, if such exists, you are a reference machine. Do you read or have your read all the stuff you put up? Assuming you have, it seems you seldom put up your thoughts about whatever conclusions you may have drawn. I would find your conclusions supported by your references perhaps more useful, but it is your time.

[WDCRob]

Interesting Rajiv.

I've just dragged Diamond's 'Collapse' down off the shelf now that you've linked his ideas to this subject, and will be playing catchup with some of the stuff you've posted previously now that I understand (in the broadest sense) how it fits together with iTulip's themes. Thanks.

I'm wondering about your thoughts here re: human nature, and the complexity of international political and economic systems as they relate to the practicality of moving from A to B?

[jk]

Did anyone do anything with the idea that compound interest on ever increasing levels of debt behaves like bacteria in a jar? i.e. expands exponentially right up until the point that it completely collapses?

I've dug up the original post here.

As I recall, someone subsequently posted something by Hudson which said that the collapse in the world's monetary system would occur when the FIRE economy grew to the point that the interest payments could no longer be serviced by income from the real economy.

That's in the right ballpark anyhow.

That seemed like an intriguing idea, but so far as I remember no one went any further with it, or was able to estimate where that maximum might occur.

seems to me that inflation compounds just like inverse interest, making your effective debt service smaller. the question is whether the inflation rate is higher or lower than the interest rate. and, of course, whether incomes grow along with inflation. [but for inflation to be maintained over a prolonged period, it seems to me that incomes must grow apace.]

[WDCRob]

I'm not sure I've got you right here, but...

Are you saying that POOM as policy gets around exactly the problem Rajiv's authors are writing about because inflation would be allowed to grow while interest rates are artificially held in check below that rate? (Fed buying further out the yield curve for example.)

[jk]

I'm not sure I've got you right here, but...

Are you saying that POOM as policy gets around exactly the problem Rajiv's authors are writing about because inflation would be allowed to grow while interest rates are artificially held in check below that rate? (Fed buying further out the yield curve for example.)

i'm not saying that specifically, since i don't know what rates to compound at- both the interest rate and the inflation rate must be specified to make the calculation. i'm just pointing out that inflation works as the inverse of compounding debt, i.e. it tends to cancel out the effect of compounding.

[Tulpen]

From Paul B. Farrell - MarketWatch:

Never-ending: Gross and Janszen agree on that. But they're both wrong. The biggest low in Janszen's argument: "Given the current state of our economy, the only thing worse than a new bubble is its absence."
Wrong, wrong, wrong! Remember, this new paradigm assumes that the only way the American economy can exist in the future is if Wall Street's greedy "bubble-blowing machine" keeps feeding on itself, creating an endless, accelerating succession of ever-bigger bubbles.

Folks, that's one of the dumbest economic theories ever, silly "new age" magical-thinking touted as a scientific basis for the new self-indulgent ideology of Wall Street, Washington and Corporate America.

Right on the money!

Setting up and selling people for a "next" bubble is the last thing this country needs.

[Rajiv]

Yes you are right that inflation acts as negative interest. But unfortunately, interest accrues to the banks - while inflation hits the population at large -- resulting in a net transfer of wealth - from the population at large to the bankers.

Have you ever thought why the Federal Reserve Act and the Income Tax (16th amendment) were passed the same year - 1913?

I believe that they both went hand in hand to allow for exactly what you are aiming for -- Allow the bankers to create money - but tax them so that balance is restored. However, the income tax got bastardized not just to include interest and investment income -- but also to wages and salaries -- thus of no use at all to prevent the transfer of wealth to the rich

Even if the income tax had been properly applied - corporate structure of th banks may still have allowed the tranfer of wealth to happen.

However, in my view, the main problem with using interest/inflation is that inflation hits everybody -- not just the lender and the debtor -- the cost is borne by the whole society -- because of the increase in money supply. Going back to a fixed money supply would address some issues -- but would result in boom bust scenarios as long as interest (and particularly compound interest) is used. This is one of the reasons I like Margrit Kennedy's and Tom Greco's ideas -- they appear to work on the small scale -- but the question is whether they can be scaled up and whether they would be accepted by the existing power structures.

[Rajiv]

Tulpen,

By agreeing with Farrell, I think you just stepped on EJ's foot!

[donalds]

Eric,

Your analysis and predictions have continued to be valuable and on the mark. One aspect you incorporate successfully is the geopolitical, often missing or understood by many mainstream economists.

However, your analysis fails to take into consideration ecological factors. Granted, your prediction of the move towards alternative technologies addresses ecological factors. But it hints at the old technological fix argument. One must take into consideration something as simple as the second law of thermodynamics. Energy transformations mean loss of energy: entropy. Societies can only depend on the exploitation of natural resources to the extent that scarcity does not pose a serious problem. For instance, building an advance auto industry requires the raw materials needed to manufacture those autos. This still requires mining, fabrication of plastics, etc., for which there are limits posed by the resources available to us. So, in reality, the problem is not so much one of scarcity but of over use and over exploitation; scarcities are not produced by nature but by humanity.

In any case, whatever baseline of natural resources exist, their limits can be overcome only so much through technological advances. At some point excess exploitation and consumption override said tech. advances.

The bottom line is that your re-industrialization thesis runs against the grain of limits inherent in any ecological system. As long as society depends on an economy that runs by the imperative of growth, then these limits will continually be confronted, and technological advances will only starve off the eventual outcome.

So, why not look at an economy that is not based on god (grow or die)? Perhaps human population levels leave one thinking that there exists no other choice. But then again, perhaps these very population levels leave us with little choice but to move towards sustainable, steady state economies.

[Jim Nickerson]

Eric,

Your analysis and predictions have continued to be valuable and on the mark. One aspect you incorporate successfully is the geopolitical, often missing or understood by many mainstream economists.

However, your analysis fails to take into consideration ecological factors. Granted, your prediction of the move towards alternative technologies addresses ecological factors. But it hints at the old technological fix argument. One must take into consideration something as simple as the second law of thermodynamics. Energy transformations mean loss of energy: entropy. Societies can only depend on the exploitation of natural resources to the extent that scarcity does not pose a serious problem. For instance, building an advance auto industry requires the raw materials needed to manufacture those autos. This still requires mining, fabrication of plastics, etc., for which there are limits posed by the resources available to us. So, in reality, the problem is not so much one of scarcity but of over use and over exploitation; scarcities are not produced by nature but by humanity.

In any case, whatever baseline of natural resources exist, their limits can be overcome only so much through technological advances. At some point excess exploitation and consumption override said tech. advances.

The bottom line is that your re-industrialization thesis runs against the grain of limits inherent in any ecological system. As long as society depends on an economy that runs by the imperative of growth, then these limits will continually be confronted, and technological advances will only starve off the eventual outcome.

So, why not look at an economy that is not based on god (grow or die)? Perhaps human population levels leave one thinking that there exists no other choice. But then again, perhaps these very population levels leave us with little choice but to move towards sustainable, steady state economies.

I'm not attempting to answer anything for EJ, but to make a point about available resources of some types. When was the last time you drove around the US? I did from 1998 to 2003, and it always boggled my mind as to the junk machinery that exists everywhere. Old cars and farm machinery are everywhere. Perhaps a lot of it is being recycled, but it seems to me there is still a gigantic junk pile in America if and when it becomes feasible to reclaim and reuse it.

If I knew anything about business and were younger, I might start a company of going to all these farms, run down homesteads, junk lots and buying the steel and whatever else is just setting there and begin to recyle it.

Also there are tons of old oil drilling equipment, tanks, pumps, pipe just lying around in the Permian basin.

[FRED]

I'm not attempting to answer anything for EJ, but to make a point about available resources of some types. When was the last time you drove around the US? I did from 1998 to 2003, and it always boggled my mind as to the junk machinery that exists everywhere. Old cars and farm machinery are everywhere. Perhaps a lot of it is being recycled, but it seems to me there is still a gigantic junk pile in America if and when it becomes feasible to reclaim and reuse it.

If I knew anything about busisnes and were younger, I might start a company of going to all these farms, run down homesteads, junk lots and buying the steel and whatever else is just setting there and begin to recyle it.

Also there are tons of old oil drilling equipment, tanks, pumps, pipe just lying around in the Permian basin.

EJ writes in:

Give capitalism a chance.

"According to the Environmental Protection Agency (EPA), more than 95 percent of all end-of-life vehicles in the U.S. are processed for recycling, irrespective of their age, make or design."

That wasn't the case 20 years ago. Markets tend to find ways to pick up thrown away money. As the price of steel increased, so did recycling. Use a floating tariff on oil to hold then gradually increase the price of oil. The economy will organize itself around the new prices: cars will get smaller, commuting will decline, demand for public transportation will increase, and so on.

As for my hope for a new transportation and energy infrastructure, it will further reduce the energy intensity of the US economy as higher oil prices have done over the past several years. As it takes energy to produce goods, the per capita ecological footprint will decline, too.

[WDCRob]

If I knew anything about busisnes and were younger, I might start a company of going to all these farms, run down homesteads, junk lots and buying the steel and whatever else is just setting there and begin to recyle it.

Too late Jim - someone has beaten you to it, and ramped it up to a scale that'd be hard to compete with now. Great article on this exact thing in the New Yorker last week. Unfortunately the whole article isn't available online, but the abstract is here.

[Jim Nickerson]

Too late Jim - someone has beaten you to it, and ramped it up to a scale that'd be hard to compete with now. Great article on this exact thing in the New Yorker last week. Unfortunately the whole article isn't available online, but the abstract is here.

Well, just eye-balling things, there is still a lot of scrap out there. Perhaps when we go to NM this summer, it will all be gone, but I doubt it.

[c1ue]

Did anyone do anything with the idea that compound interest on ever increasing levels of debt behaves like bacteria in a jar? i.e. expands exponentially right up until the point that it completely collapses?

The Economist had an article a while back while talked about how 1 penny invested at the birth of Christ would have become a mass of gold larger than the Earth by now through continuous compounding.

The reason this is not true is that there are regular episodes of wealth destruction.

The entire inflation vs. interest rate debate is stimulating, but misses the point (while Dr. Hudson also talks about): Banks may gain some liquidity/capital from low interest rates, but ultimately the power game lies in repossession of collateral.

Cheap money means those who lend are not forced to risk real assets in order to obtain loans/liens on real property; the 'big game' played by nations and classes is the loan and repossess one.

Thus the key to lenders winning is ensuring that borrowers never can repay the loans; one way is through taxes on real property (which never end) coupled with rising asset prices.

The lenders thus neither have to pay the property taxes nor are they unduly inconvenienced by liquidity issues as the lenders are the entities creating credit.