Ciao, Britannia!

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Published on the Economic Undertow on June 8, 2016

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Triangle of Doom 062516

Figure 1: Chart by TFC Chartz (click for big): It’s called the Triangle of Doom for a reason, carried through to the end, no outcome is possible other than demise of the automobile industry and its petroleum dependencies. Since 2000, there have been a series of petroleum price surges intended to meet the industry’s exorbitant extraction costs. Each attempt has failed as credit conditions outside the fuel markets deteriorated. As can be seen, many of the credit failures originated within the European Union. These fails, credit shocks and price retrenchments are to some degree, a product of EU structural shortcomings. Now, the British have voted to leave the EU, panic ensues: (NY Times).

‘Brexit’ Sets Off a Cascade of Aftershocks …




Maybe the future does not include flying electric cars after all.

By Steven Erlanger





Britain’s startling decision to pull out of the European Union set off a cascade of aftershocks on Friday, costing Prime Minister David Cameron his job, plunging the financial markets into turmoil and leaving the country’s future in doubt. The decisive win by the “Leave” campaign exposed deep divides: young versus old, urban versus rural, Scotland versus England. The recriminations flew fast, not least at Mr. Cameron, who had made the decision to call the referendum on membership in the bloc to manage a rebellion in his own Conservative Party, only to have it destroy his government and tarnish his legacy.




So it goes. There is a huge reaction and certainly more to come as markets digest what has happened … and what is certain to come. In the end it is very simple …

The Brexit vote was inevitable. Britain had no choice but to jump in the lifeboat and abandon the sinking EU Ponzi scheme.

Will it succeed? Probably not but it has to try. If not England it would have been another big European country, perhaps Italy as the first to abandon the scheme. The rest have to wait … but not for long. England’s alternative would be to devolve in a few short years to a petty euro protectorate like Greece or Ukraine begging Russia for fuel and Frankfurt for loans and forbearance. At issue is UK’s massive (£6+ trillion) external balance sheet, its banking liabilities vs. the dubious quality of its assets.

Brexit states unequivocally the City of London is insolvent; at the the point where it cannot finance itself any longer. This is the reason why the establishment rolled out the Brexit referendum in the first place, to save the banks. Think of Brexit as a bailout: the small will pay for the excesses of the great. The City certainly cannot finance the rest of the country and its massive and non-remunerative fleet of gas-guzzling automobiles; something has to give. There are 31.5 million cars in a country of 64 million humans, each car requires the resources of 20 persons. UK staggers under the equivalent human population of 630 millions on a small island … the bulk of those being dented, metal deadbeats. Talk about immigration, no wonder the economy struggles.

The automobiles and their need for fuel imports and infrastructure paid for w/ endless credit issue have bankrupted the entire West, not just England. In Europe: the euro = gasoline. For once — maybe not realizing exactly why and not being entirely happy about it — the British have voted against their cars.

It’s about time!

A Look to 2016

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Published on the Economic Undertow on January 4, 2016

No doubt a lot of people are happy to see 2015 in the rear view mirror: refugees, their ‘hosts’ in Europe, bond investors, frackers and Brazilians, it is likely that 2016 will bring more of the same, challenges and idiocy … and a ray of light!

— Energy deflation to take hold in 2016

Triangle of Doom 123115

Figure 1 (above): The $64 trillion dollar question: ‘Is energy deflation under way’? If it is, get ready. It will be the biggest story of 2016 and years decades to come. (TFC Charts, click for big)

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Energy deflation is similar to Irving Fisher’s debt deflation: a premium or ‘scarcity rent’ is attached to the price of crude. This manifests itself as a reduction in customer borrowing power; the price of crude cannot fall fast enough to offset the ballooning scarcity rent! In energy deflation, fuel prices are always too high for customers while the same prices are too low the drillers. The outcome is a vicious cycle: increased scarcity rent and self-compounding fuel shortages => greater scarcity rent!

If oil prices happen to rise for any reason — such as a war between Saudi Arabia and Iran — the scarcity rent doesn’t go away, the entire combined price becomes even less affordable causing the price to crash again.

America’s waste-based economic infrastructure has been built assuming endless supply of sub- $20 crude into perpetuity. The inflated prices the world has endured since the turn of the millennium have left this ‘investment’ hopelessly underwater. The prices have also done a number on the credit-worthiness of ordinary customers. This is why declining prices for crude oil have so far been unable to reboot economic growth … current lower prices are still too high to offer much in the way of (debt) relief. This means more price drops to come; more driller pain.

Right now it is hard to tell whether the current ‘action’ in crude- and other markets is a trading phenomenon or something more, but we are soon to find out one way or the other. The inevitable outcome of energy deflation is the supply of fuel shrinking to the level that can be supported by productive, remunerative use … rather than the current wasteful level supported by access to credit. Because remunerative use of our fuel supply is a (very) modest fraction of overall consumption … a modest fraction of our current fuel supply is what we will be able to afford.

— Dollar Preference emerges as an economic factor in 2016

fredgraph velocity

Figure 2: Hoarding much? M2 money velocity (chart by St. Louis Federal Reserve). While the actual supply of M2 funds is increasing, the volume of transaction taking place with those funds has been shrinking (plummeting).

A component of energy deflation is the effect of constrained energy supply on money. When priced in crude, money — particularly dollars — have real worth (money never has value, otherwise it would never be spent). It turns out a very modest (flow) constraint has an out-sized effect on money-worth. Right now, dollars are exchanged on demand for a valuable physical good millions of times every single at gas stations around the world. Because of this exchange, the dollar can be considered a quasi-hard currency … similar to the way exchanging dollars for gold rendered the buck a hard currency during the early 1930s. What keeps the dollar somewhat ‘soft’ despite exchangeability has been the flood of fuel into markets and gas stations. There is no obvious reason to prefer dollars or make an effort to gain them vs. something else; little in the way of ‘scarcity rent’ to distort the worth of dollars.

Given the appearance of a fuel supply constraint and the scarcity rent, the perceived character of money shifts: dollars cease to be near-worthless proxies for commerce, becoming instead proxies for scarce and valuable fuel. They are then hoarded out of circulation … as is starting to take place around the world right this minute!

Commerce withers as the economic activity is reduced to currency arbitrage; trading different forms of money back and forth so es to gain the fuel ‘bargain’ dollars represent … This is what ‘dollar preference’ means: the buck is preferred to all other kinds of money because of its relationship to fuel.

The only way to escape the depression that results from this preference is to break the bond between dollars and petroleum the same way the Roosevelt administration severed the connection between dollars and gold in 1933. The US must ‘go off oil’ the same way it- and the rest of the world went off gold in the middle-1930s.

fredgraph-gasoline sales

Figure 3: Along with M2 velocity, gasoline sales have been declining. (chart by St. Louis Federal Reserve). When customer are broke — or tight-fisted — they don’t buy gas. Low prices can’t fix broke.

— The Kurds will destroy the Islamic State in Syria in early 2016.

The sharp decline in fuel prices since 2014 has severely dented the Islamic State which is not possessed of the material means of support: it has no economy to speak of, no industry, finance or organic credit. It must swap goods such as stolen fuel and antiquities with donor states by way of Turkey to gain materiel. Low oil prices means less funds to be spent on war-making, medical supplies and salaries.

Just days before Christmas, with little fuss and less warning, the Kurdish military force captured a vital road crossing over the Euphrates River, putting the Kurds astride ISIS supply lines and issuing the death-sentence for the group, (DW):

Syrian Kurds take strategic dam from ‘Islamic State’






An alliance of US-backed Syrian Kurdish and Arab rebels has taken a key dam on the Euphrates River from the so-called “Islamic State.” The alliance has pushed back “IS” from large swaths of territory.

The Syrian Democratic Forces (SDF), a rebel alliance that includes the powerful YPG Kurdish militia and Arab rebel groups, wrested control of the strategic Tishreen Dam from Islamic State on Saturday after making rapid advances south earlier this week, Kurdish media reported.





Tishrin 2

Figure 4: In war — as with finance — leverage matters: Tishrin dam on the Euphrates carries the highway from Jarabulus to Manbij- to points south and east including Raqqa and Mosul in Iraq. (Washington Post/Institute for the Study of War). Taking the dam (intact) and establishing a bridgehead on the western side of the Euphrates leaves the landlocked ISIS group at the mercy of the Kurds.

The road connection with Turkey is the only way in- or out of the Islamic State caliphate with Jarabulus-Manbij as the main thoroughfare. Leaders, recruiters, wounded fighters traveling to- and through Turkey, troop replacements from the rest of the Middle East and elsewhere, all ISIS military supplies must travel through this territory; trucks carrying purloined crude travel the other direction. As of now there is no scheduled airline service to/from anywhere in the Islamic State.

The group is responding to the existential threat by adopting a lifeboat strategy: upping efforts to organize in Libya and elsewhere in Africa. Stripped of its precious caliphate heartland and its leadership dead, captured or on the run, the group will lose relevance, becoming target practice for other ‘Brand X’ militant groups and Western commandos. In our current Islamic world without pity, every sign of weakness is an invitation to murder. At the same time, ISIS ‘threat’ will be unmasked as to a large degree a US-media creation, a fashionable ‘flavor of the month’; the ‘New al-Qaeda’ (as opposed to ‘Classic’ version), a militarily inept criminal group with violent tendencies but little else; an instrument to mold US public opinion into an appropriately warlike form.


Figure 5: Syrian zones of control along with gains by Kurdish forces since November, 2015. Islamic State supply lines extend through the area claimed by Turkey as a ‘safe zone’. The weight of strategic necessity draws the Kurds toward Manbij and al-Bab. When these towns are captured the rout will be on. The only surprise will be how quickly the IS group collapses. It will be entertaining to watch the group’s ’emirs’ on YouTube in women’s clothes filter through Kurdish territories toward Turkey in small groups … and being found out; to see them jumping beardlessly into dented Toyota pickup trucks to race like rats across the countryside in every direction looking for a way out.

Fleeing to Iraq offers no hope of escape: there are Kurds in Iraq, too. They all have very long memories …

That the Kurds aim to close Manbij gap is indicated by heavy fighting between Kurds and non-ISIS militants near Azaz and US bombing in and around Manbij. The tactical cat is already out of the bag, there is nothing to gain for the Kurds by waiting … unless they hope to lure more IS fighters into the town so that they might be killed more efficiently.

Islamic State’s primary supporter is Turkey, a Nato member with all the military bells and whistles. It might be expected for the Turks defend their interests and send troops across the border to push the Kurds back. Not this time: they won’t risk stepping into Syria or attacking on the ground without air superiority, something they threw away without thinking … by shooting down a Russian aircraft that was doing them no harm.


In early November, a combined Iraqi-Syrian Kurdish offensive in Northern Iraq dislodged ISIS forces from Sinjar town in Northern Iraq, at the same time Kurdish led Syrian Democratic Force (now QSD) overran al-Hawl a few miles away across the border in Syria. This action cut the road running between Raqqa and Mosul. In December, Iraqi security forces attacked the Islamic State in Ramadi, pushing them out of the center of the city.


The patient Kurds torment the Islamic State in the east, causing them to pull in what reserves they possess, then attack in force in the west. The ISIS group is left with many widely separate places that must be held at all cost including Raqqa, Ash Shaddadi, the oil-producing region near Deir al-Zour and Manbij. This means that none of these place will be held at all.

Turkish blunder and Russian air defense means a Kurdish ‘cordon sanitaire’ along the northern Syria border connecting all the Rojava cantons. This gives Kurds an influence greater than their numbers would suggest. Their control over supply flows would constrain other rebel groups such as al-Nusra. They would be seen to ‘pick winners’, which in turn offers a potential a way out of the endless auto-destructive warfare between the irreconcilable factions. Kurds have demonstrated the ability to coexist with Syrian Arab Army, to collaborate on the ground with Sunni, Arab even Turkmen groups which are otherwise represented by extra-Syrian jihadi extremists. Kurds’ military capability and success increasingly renders Assad irrelevant regardless of Russian commitments … of all the groups involved in Syria the Kurds come across as most reasonable … grown up.

Islamic State — like Ashley Madison — has had a nice little run. Time for them to go, so also:

— Turkish strongman, Recep Erdogan, man of many blunders, to be removed from office by military coup.

The war that keeps on giving in the Middle East reaches out to touch everyone in the region. No escape for Erdogan who has lost his sense of balance. His approach to winning over Kurdish hearts and minds in Turkey is not to embrace them but to shoot. The inevitable outcome: a civil war leading to a belligerent Kurdistan carved out of southeastern Turkey, something the Turkish military — which is charged with the actual winning over part — views with alarm. Who gets the axe? 20+ million Kurds or one deluded mad man in an ill-fitting suit?

Prior to Erdogan and AK Party, the powerful military was the final political arbiter in Turkey. Prime ministers served at the pleasure of the command. If the Generals believed official policy was destructive or would lead to war there was a coup … as in 1960, 1971 and 1980. Erdogan purged the Turkish command by way of kangaroo corruption trials; the army has been a Stepin Fetchit fool-for-Erdogan ever since.

Undertow observes the Turkish military to be resentful and awaiting its chance … Turkish generals understand the army cannot defeat Kurdish militants in urban settings without destroying the country. The key is what the Kurds do over the next few months; as they defeat ISIS, they also defeat Erdogan at the same time. The emergence of ‘protection brigades’ like YPG in Kurdish areas will force the military’s hand. This is the Kurds’ moment, they will not be denied. Erdogan will be ejected and replaced with a national council until new elections can be held. The clue to this outcome is the exposure of Erdogan involvement in the smuggled oil trade with Islamic State. Corruption being the instrument by which the military is purged, corruption will also be the hammer to dismantle the Erdogan regime.

— The China economy will crash … who could have guessed?

Ho hum, who cares! Old news … Oops. The China stock market is crashing already. What took it so long? The cause is excess Chinese leverage + dollar preference, the flight of dollars from China and the stripping Chinese finance of collateral. Turns out China is not a credit provider but depends on millions of Americans borrowing from Capital One to buy stinky China-Brand Poison Dog Food and lead-painted baby toys.

Collapse of China’s economy is ironically best evidence of dollar preference! Said economy has been built on a foundation of borrowed dollars; repayment outside of China makes the dollars which remain in China that much more desirable. The bidding of dollars in China means the unbidding of everything else: China RMB depreciates, real estate stumbles, stocks are socked, the only thing certain in China is smog.

— The ‘Widowmaker Trade’ finally unravels.

Shorting Japanese bonds is called ‘the widowmaker’ because the prices never plunge … even when fundamentals such as the vast overhang of debt-relative to GDP suggest they must. The short-sellers wind up being fed to the pigs … Endless monetization and balance sheet expansion by Bank of Japan and reluctance (good sense) of Japanese themselves to spend has pushed bond prices high as possible and kept them there. (Bond yields are inverse to prices; yields decline and prices increase.) Beginning this year, dollar preference will undermine whatever worth the bonds represent as the yen will (continue to) depreciate relative to the dollar. A problem is the massive position accumulated by BoJ. Should it becomes necessary to sell some of its bonds, the Bank will find there are few buyers because they have been elbowed out of the market by the BoJ!

— Migrants will flood into the US as Puerto Rico defaults leaving millions of US citizens with no means of support.

The island has overspent and cannot retire its loans. Its ambiguous administrative status within the United States and inept leadership does not offer much hope for ordinary Puerto Ricans who will make their way in great numbers to the mainland.

— War between Iran and Saudi Arabia …

Both countries are fighting an all-out proxy war in Iraq, Syria, Yemen and elsewhere; the recent execution of a Shiite imam by the Saudis has inflamed tensions to the breaking point. Reality rules: despite the status of both countries as (wealthy) petroleum suppliers, both countries are actually too poor to afford a general war, particularly one that might adversely affect exports … or propel energy deflation.

— Economic uncertainties will cause world- industry leaders to shelve ambitious plans to combat climate change

Instead: ‘Conservation by Other MeansTM‘ … Entropy always wins, always.










Debtonomics vs Economics

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on March 31, 2015


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There was an eye-catching article in the Washington Post the other day:

Meet the 26-year-old who’s taking on Thomas Piketty’s ominous warnings about inequality,Jim TankersleyIt was 2:45 a.m. on a Thursday last April. Matthew Rognlie was still awake, like a lot of graduate students. He had just finished typing 459 words and a few equations. They totaled six paragraphs, which he posted to the comments section of a popular economics blog.Rognlie’s comment on the blog Marginal Revolution was a response to the provocative argument laid out by the French economist Thomas Piketty in his bestselling book on wealth inequality, “Capital in the Twenty-First Century.”Piketty had worried in his book that wealth inequality (surplus) could soon explode at such a velocity that it would continue to widen essentially on autopilot. Wealthy people would accumulate more capital in the form of stocks, real estate and other assets, would continue to earn high returns on them, and then would have more capital to invest. As more and more money became concentrated among the wealthy, less and less would be available to workers. The book turned Piketty into an international celebrity.Rognlie, however, wrote in his blog post that the French economist’s argument “misses a subtle but absolutely crucial point.” Piketty, he said, might have got the pattern in reverse. Instead of the returns to capital increasing in perpetuity, Rognlie said, they might be poised to decline.

This is from Rognlie’s comments on Tyler Cowen’s Marginal Revolution blog:

Krugman correctly highlights the importance of the elasticity of substitution between capital and labor, but like everyone else (including, apparently, Piketty himself) he misses a subtle but absolutely crucial point.

Elasticity of substitution measures the changing relationship between ‘production’ inputs ‘K’ (capital, in the conventional sense) and ‘L’ (labor), it is a component of neo-classical economics.

When economists discuss this elasticity, they generally do so in the context of a gross production function (NOT net of depreciation). In this setting, the elasticity of substitution gives the relationship between the capital-output ratio K/Y and the user cost of capital, which is r+∂, the sum of the relevant real rate of return and the depreciation rate. For instance, if this elasticity is 1.5 and r+∂ decreases by a factor of 2, then (moving along the demand curve) K/Y will increase by a factor of 21.5 = 2.8.Piketty, on the other hand, uses only net concepts, as they are relevant for understanding net income. When he talks about the critical importance of an elasticity of substitution greater than one, he means an elasticity of substitution in the NET production function. This is a very different concept. In particular, this elasticity gives us the relationship between the capital-output ratio K/Y and the real rate of return r, rather than the full user cost r+∂. This elasticity is lower, by a fraction of r/(r+∂), than the relevant elasticity in the gross production function.This is no mere quibble. For the US capital stock, the average depreciation rate is a little above ∂=5%. Suppose that we take Piketty’s starting point of r=5%. Then r/(r+∂) = 1/2, and the net production function elasticities that matter to Piketty’s argument are only 1/2 of the corresponding elasticities for the gross production function!

From Rognlie’s MIT paper:

Capital in the Twenty-First Century (Piketty) is a work of remarkable scope and influence, with a sweeping new view of income, wealth, and inequality. It builds on a singular trove of data assembled by Piketty and coauthors, and it is sure to be a centerpiece of the debate for years to come. Although the book is widely recognized for its empirical contributions, it also uses this data to construct a distinctive theory about the trajectory of the wealth and income distribution.

Rognlie’s criticism is similar in form to Chris Giles’ picking apart of Piketty in FT a few months previous. Despite claims to the contrary; it is also similar to criticism of Reinhart and Rogoff by Herndon, Ash and Pollin. In these other instances there are faults found with the first authors’ calculations or data. Rognlie argues Piketty substituted a net function for gross; his remarks are giving him with his fifteen minutes of fame within macroeconomic circles, it can be said he is riding on Piketty’s coattails (as Economic Undertow is right now riding on Rognlie’s).

One of the main themes in Piketty (2014) is the gap r – g between the real return r on capital and the real growth rate g of the economy. This gap, for instance, gives the rate at which a wealthy dynasty can withdraw capital income for consumption purposes with- out decreasing its wealth relative to the size of the economy. More generally, when r – g is higher, “old” accumulations of wealth become more important relative to “new” ones. Higher r – g generally implies that the power law tail of the wealth distribution has a smaller exponent … so that there is more inequality of wealth at the top, and extreme levels are more likely. Many readers take the dynamics of r – g to be the central theme of the book.One of its central themes is a story of capital accumulation. In Piketty’s framework, slower growth will produce a rise in the ratio of capital to income. This, in turn, will bring about an expansion in capital’s share of income. Meanwhile, as the growth rate g dwindles and the return on capital r holds relatively steady, the gap r – g will expand, allowing existing accumulations of wealth to grow more rapidly relative to the economy as a whole. This will aggravate inequality in the wealth distribution. In short, a key message of Capital in the Twenty-First Century is that capital’s role in the economy will grow in the twenty-first century.As Piketty readily acknowledges, diminishing returns may be problematic for this thesis. If the return on capital falls quickly enough when more capital is accumulated, capital’s share of income will fall rather than rise—so that even as the balance sheets of capital owners expand, their claim on aggregate output will shrink. Furthermore, with a sufficient decline in r (returns), as g (economic growth) falls the gap r – g will narrow as well. But Piketty argues that diminishing returns, although undoubtedly present, are unlikely to be so strong; this view is offered in additional depth in a companion journal article, Piketty and Zucman (2013).This note articulates the opposite view: most evidence suggests diminishing returns powerful enough that further capital accumulation will cause a decline in net capital in- come, rather than an expansion. If, following Piketty’s model of savings, a decline in g causes an expansion in the long-term capital stock, both the net capital share of income and r – g are likely to decline. These conclusions are not definite -— there are many obstacles to empirical certainty here —- but they do counsel skepticism about Piketty’s central outlook.In Section 2, I discuss the economic concept central to diminishing returns, the elasticity of substitution between capital and labor …When this elasticity is greater than one, a higher capital/income ratio is associated with a higher share of capital income; when the elasticity is less than one, the opposite is true. A crucial detail is whether this elasticity is defined in gross or net terms; net subtracts depreciation from income, while gross does not. Although (Piketty and Zucman) rightly affirm that net concepts are more relevant for an analysis of inequality, they do not cover the distinction between net and gross elasticities. This is problematic, because net elasticities are mechanically much lower than gross ones, and the relevant empirical literature uses gross concepts. The vast majority of estimates in this literature, in fact, imply net elasticities less than 1 … well below the levels needed by Piketty.

Piketty’s problem is not in his calculations but his “story of capital accumulation,” that, “slower growth will produce a rise in the ratio of capital to income. This, in turn, will bring about an expansion in capital’s share of income.” Maybe it will and maybe it won’t: a quick glance out the empirical window suggests the tycoons’ share of consumer excess is expanding relative to that of the labor force: Rognlie’s coattails appear to be hovering over shaky ground.

More importantly, it is unclear what exactly is being accumulated and what is being substituted for. Is capital itself being accumulated or (worthless) claims against it? Is equipment being substituted for labor or is it something else? Piketty errs when he suggests that surpluses can expand without limit. All conventional economists are in error when they suggest that the expanding money- or material claims against capital are indistinguishable from capital, itself.

Given Piketty’s assumption that K/Ynet = s/g with fixed s, it appears virtually impossible to generate a substantial increase in r – g in response to a decline in g. For empirically plausible values of the elasticity (about 1), the diminishing returns induced by higher K/Ynet cause r to drop by at least as much as g.For empirically plausible values of the elasticity (about 1), the diminishing returns induced by higher K/Ynet cause r to drop by at least as much as g … except within the Debtonomy where absolutely none of this matters! If a firm is fashionable/survivable then it borrows. Organic returns are irrelevant. What matters is the willingness of lenders to ignore system insolvency and add to the growing mountain of private- and public sector debt, to subsidize chic firms by way of their marginally-(un)employed customers.

Peak Economist

It can be said that we are now at ‘Peak Everything’: complexity, credit, water, farmland, phosphorus and other strategic minerals, fisheries … certainly peak oil. The certain evidence of peak oil is all the media babble regarding a production glut. After all, how would a peak appear except as the prospect of drowning in too much oil.

At any peak there is nowhere to go but down: Western decline comes across so far as being remarkably ordinary. No doubt, the reason for this is our willingness to do anything to avoid a recession including slowly murdering our grandchildren. What James Howard Kunstler calls ‘the Long Emergency’ turns out to be a diffuse series of quiet tragedies en miniature: business failures and jobs permanently lost, drug addiction, homes surrendered to foreclosure, towns and shopping centers abandoned, infrastructure decay, insolvency, crop failures, drought and emptying reservoirs … There is little drama to the post-modern Empire of Less we currently inhabit; it has crept upon us while we were sleeping.

US Labor Force Participation Rate

Figure 1: Elasticity of substitution in action: US labor force participation, chart by St. Louis Fed: US labor participation is unchanged since 1977 despite the massive increase in the actual US workforce occurring within that nearly- 40 year interval. Note the participation peak occurred just as computerization began to penetrate the economy, allowing the discharge of millions of clerks, materials handlers, machinists, receptionists, printers and supervisors. The outcome is a customer shortage: the inability of industry to find folks both in the US and around the world with the means to afford anything other than basic necessities. As managers reduce headcount and wage rates they are able boost businesses bottom line over the immediate term; the longer-term outcome is steady depreciation of (the worth of) labor (relative to machine output). The underemployed are forced to increase their borrowing even as fewer among them are able repay.

The ‘capital’ accumulation narrative is as old as civilization itself:

for whatsoever a man soweth, that shall he also reap,
— Galatians 6:7

An entrepreneur produces (soweths) then ‘sells’ goods and services to its customers (reaps). The firm ‘profits’ when revenue (returns from sales) exceed expenditures (costs) including those for capital (K) + labor (L). Depreciable ‘capital’ has come to mean real estate and physical infrastructure, goodwill and equipment; these things are the ‘means of production’. Given enough ‘sales’ and ‘profits’ the firm owner accumulates more of this ‘capital’; he is ‘wealthy’ in that he is possessed of less inequality than his labor force. When the firm meets its own costs by way of sales to labor, it is considered ‘productive’, it’s gains are ‘sustainable’. With time, owners obtain more profits from productive enterprises; family fortunes rise even when the overall economy slows. This is a nice story with a ‘feel good’ ending … “They profited happily ever after.”

Exit Galatians, enter industrialization: ‘sales’, ‘profits’ and ‘sustainability’ are myths emptied of any real meaning, veneers over monstrous debtonomics. Slo-mo accumulation has been relegated to the quaint micro-economy of artisans with hand tools. The shift-over occurred centuries ago: Adam Smith described the industrial process shortly after Newcomen in the mid- eighteenth century in ‘Wealth of Nations’, (from Diderot):

”One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day.”

The pin making process; yea, but not all! Smith leaves out the debt! Factory building(s), the ground (within costly metropolitan districts), the machines, prime movers, labor force training, management and all-important marketing must be bought and paid for in advance of making the first pin! Each pin machine is itself the product of its own expensive factoria and their fleets of machines, their machines and the machines’ machines’ machines … all must be paid for in advance of that first pin … which on its own costs tens of millions of pounds! Relative to the enterprise — making and handfuls of tiny pieces of pointed wire with but one purpose — the life cycle costs are stupendous. Every component offers the potential for non-trivial losses, each of which must be met with borrowed funds. So too the profits for the manufacturers and his lenders; pins cannot be sold or profits gained until they are first in hand, marketable to customers who can make use of them. Smith simply omits all of this: it’s unpleasant, it doesn’t fit his quasi-Biblical narrative; it suggests dependence upon conniving shylocks and ankle-breaking overseers: that ‘progress’ is material fraud and abuse rather than an inevitable force of provident nature and her invisible guiding hand.

Because the multiple, competitive firms vomit pins by the freight-car load, customers by necessity are also firms: mega-pin manufacturing becomes a component of much larger downstream machine processes … all of which require loans. To retire the manufacturers’ debts the end users must have the desire (demand) and means (consumption) to pay too much for pins. They must borrow more than the manufacturers in aggregate … or else. If they cannot, (or refuse) the firms are hanged by their own borrowed rope, then the creditors themselves are likewise ruined:

“Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone … ”

— Walter Bagehot

The wider-scale the processes, the greater need for (debt x borrowers). Without debt, without the infrastructure of organic credit enabling the processes in their entirety there would be only hand-drawn pins made by silversmiths’ apprentices gained by way of trade or hard currency; not much Wealth of nations Tycoons, either.

Obviously, managers, ‘investors’ and factory owners are paid up-front with borrowed funds along with the machinery. Within debtonomics, firms are not productive, they don’t have to be. Instead, they are over-priced collateral (with fanciful ‘utility’) every- and all returns are borrowed, profits are artificial (fraudulent), enterprise is sustained only as long as the firms themselves or their customers can borrow and refinance maturing debts.

Because firms are not productive, because they borrow their returns, the ℇ elasticity of substitution … the relationship between the capital-output ratio K/Y and the user cost of capital, which is r+∂ … the sum of the real rate of return plus the depreciation rate … all of these are irrelevant! What matters is access to a willing lender. In contrast to the mysterious and exotic clockwork of macro-econometrics, debtonomy is a bludgeon to the head; simple enough for a gangster, politician, banker or stock swindler to understand. The debtonomy’s functions are entirely expedient, almost magically so. All dilemmas are resolved by throwing more borrowed money at them … along with bombs and billy clubs. As long as economic agents have access to ‘fuel’: lending capacity and capital to waste, the debtonomy will expand consuming every available resource until the enterprise collapses under its own weight.

Within the debtonomy: businesses borrow because they can … they borrow very large amounts because they can. A ‘good’ businesscan borrowbecause it is fashionableand for no other reason. The businesses’ customers must borrow even larger amounts in order to retire the firm’s loans-plus-interest. In debtonomics, this is said to be a ‘firm borrowing against the accounts of its customers- or against that of the state’. There is really no difference between the two: borrowings against the state are nothing more than involuntary loans by the same customers’ children.

Instead of capital being substituted for labor, debt is substituted for returns. The real costs of capital (resource inputs + externalities) are misstated in order for firms to ‘fake’ profitability: progress turns out to be faulty accounting. Because firms are not productive, debt must increase in order for business activity to expand so as to meet debt service costs. The debtonomy collapses when sufficient marginal borrowing capacity is dedicated to debt service (Minsky Moment).

Economic activity requires material- plus energy needed to do ‘work’: to move- and transform objects, to heat and forcibly cool them. As such, all activities are subject to fundamental, thermodynamic laws: what matters on our planetary endeavors are energy- and material throughput. The economy is a component of the natural environment; the constraints of nature make accumulation of surpluses difficult and slow. Like firms, the wealthy become so by borrowing large amounts of money then compelling others by force or trickery to repay the resulting debts. Any needed work is done at its own pace after the fact of enrichment. Repayment of the rich man’s loan takes as long as necessary or never completed. The work-process becomes collateral for still more loans; the longer the repayment term the greater the yield at interest, etc.

Industrial economies intend to manage diminished returns: the ‘First Law’ of economics: that the costs associated with any surplus increase along with it until at some point the costs exceed what the surplus is worth. Surpluses, by themselves, are the product of industry; they can be any tangible thing such as pins, machines, tycoon’s money or ‘wealth’: gold, fuel, food, material even livestock, cars, coal, water, cigarettes; anything. As surpluses expand so do costs; agents shift these costs onto third parties, using them as ‘cost sinks’. As Rognlie observes, “the economic concept central to diminishing returns, the elasticity of substitution between capital and labor” is self-defeating.

Within conventional economics, tycoons are lenders (investors) who gain an incremental, residual returns on ‘profitable’ business enterprises: capital accumulation. Within debtonomics, tycoons are borrowers bent on outlasting their own firms, short-sellers offering vaporware ‘innovations’ when they aren’t front-running the stock exchanges.

Within the debtonomy, economists and policy makers are actors reading from scripts: as with all else in our culture, economists are products of fashion. In keeping with the expedient nature of debtonomics, economists obtain their speaking roles because they conform to expectations created by marketing managers and commercial artists. Conformity includes how managers look, dress, speak, where certified and whom they know; where they live and work and how they travel.

Within debtonomics, non-renewable resources are capital: the foundation of all productive activities. The factories and shops, fixtures and infrastructure that conventional economists consider as such are actually (tangible) claims against capital; money and debt are intangible claims. This is because factories, money, etc. produce absolutely nothing by themselves, they require resource capital to extract, process and transform … to send to the landfill or pump into the atmosphere as waste. Within the debtonomy, resource- wasting processes (claims) are collateral; capital itself cannot be collateral because it is destroyed by way of its ‘use’. Instead of becoming more wealthy as we toil, we steadily reduce ourselves to ruin: as we destroy our capital we are destroying our purchasing power at the same time.

Just as consumption can never exceed available supply, purchasing power can never exceed the resource capital that remains to be purchased. Industrial wealth is a spurious claim against capital: when it is exhausted we are bankrupt regardless of how much ‘wealth’- or money-claims workers or their tycoon overlords possess. In this way the decline in purchasing power is the result of resource mismanagement, it is also a cause of mismanagement: the process feeds upon itself (deflation).

Within convention, the economy is a set of interconnected abstract functions that can be ordered mathematically. Its is offered as a natural process (invisible hands) that can be parsed scientifically the same way as chemical reactions. These functions only only vaguely relate to the real economy, they are friction- and cost free assumptions and/or simplifications. There are no ‘controls’ or alternative economies that can be made use of in comparison. Economic models are built using statistics sourced from agencies that are captured by business interests or possessed of partisan political agendas. This is also self-amplifying as the partisan agendas promote increased capital extraction and waste. That these agencies routinely ‘err’ (lie) means that most analysis is without proper empirical foundation, that a lot of material factors are left out or wished away, resulting calculations are practically worthless.

Criminality is a foundational component of industrial capitalism. Economics tends to ignore this activity as it does not conform to the enterprise’ anodyne worldview. Conventional economics becomes an unwitting enabler- accessory to criminal activities on the largest scale. Whereas bilking or manipulating others to repay your obligations is theft, doing so on a world-wide scale is served up as ‘progress’.

Economists could do useful things like invent ‘money’ that is difficult to steal. Instead, economic theorizing repeatedly flops in the real world. Economists cannot predict recessions or extreme price movements, they cannot explain recessions after they occur. Greek economist/Finance Minister Yanis Varoufakis works hard to gain a motorist-friendly bailout from German banks: he’s a post-Keynesian expert but painfully ineffective in the real world. Varoufakis cannot command capital to appear, he has near- zero leverage over other European countries’ finance ministers, who are sock puppets of criminal finance … as is the Greek establishment. The Greeks can gain loans by surrendering to the criminals but not on anything approaching Varoufakis’ terms => damage to Greek government’s credibility. The next step is loss of confidence => (ongoing) bank run => EU credit freeze => Government failure => default => Varoufakis being replaced with another hapless economist.

The outcome of this process is Greece, de-industrialized. No loans = no industry. Despite what economists insist, firms cannot pay their own way; they are reductive rather than productive. That this is so is self-evident: if any firm could retire its own debts it would have done so already. There would be no debts; the firm would retire its own then those of the other firms, it would then make everyone rich. Instead, such a firm is thermodynamically impossible, a perpetual motion machine. In place of general prosperity the world is prostrate under a mountain of debts and useless junk; monuments to both industrialization and self-delusion

Economists also seem not to grasp that collapse in Greece or elsewhere is permanent. Industrialized capital extraction and waste-making leaves insufficient resources with which to recover.

Redistribution cannot solve anything because debt-surplus costs cannot eliminated only shifted. Aggregated industrial costs are greater than the worth of the entire economy, even as purchasing power evaporates. Workers cannot accumulate surpluses on their own because their consumption speeds their funds toward the bankers.

The first step away from calamity must include jettisoning the myths upon which our economic (mis)understandings are built. The economy is a criminal enterprise. Economists need to wake up and smell the coffee. There are no invisible hands or divine providence … only fraud. This is no game, there is no one or nothing to bail us out. Our economy does not pay for itself, there is no such thing as ‘capitalism’ unless that means pillaging. Our counterparty is Nature, she is much more powerful than we are … and does not have our interests.

The second step is to conserve our capital it must come under the stewardship of those who would husband it for the greatest (future) returns. We either conserve voluntarily or it is forced upon us by events.

The third step is to to render the elasticity of substitution … of debt for organic returns to zero. If nothing else it would end the tyranny of criminal bankers.

“The ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”-― John Maynard Keynes

Good News, Bad News, Deux

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on October 28, 2014


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For all you wandering billionaires looking for a place the crash, the brilliant (tall) cudgel-shaped concrete tower at 432 Park Avenue in Midtown, Manhattan has just been topped out! With the Brooklyn Bridge (temporarily) off the market, this is your second- best opportunity to own a piece of the Big Apple, (Curbed):

Today, the concrete for the Rafael Vinoly-designed tower’s highest floor will be poured, which means that it has reached its superlative 1,396-foot height, making it not only the tallest residential building in New York City, but also the entire western hemisphere. But one could argue that it’s the tallest building in the city. That title official belongs to the 1,776-foot One World Trade Center, thanks to its 408-foot-tall spire, but the roof of One World Trade Center is actually 28 feet below that of 432 Park Avenue. The tower will open next year, and more than half of its 104 condos have already sold, including the $95 million penthouse.

432 Park Avenue, NYC

The best architecture too-much money can buy turns out to be a blunt, square-ish concrete post set to bludgeon the New York skyline … how appropriate to our new age of ‘inverted totalitarianism’, perpetual war and capital constraints. Look to the right-foreground next to the ‘White Stripe’ building and pick out the graceful Sherry-Netherland Hotel from 1927, with its copper clad spire and Italian Renaissance terra-cotta/brick facades. The 38-story hotel is a large building but is dainty compared to the neo-fascist stalagmites erupting all over Midtown.

The Great Real Estate Orgy of the ‘oughts and the deflating panic of ’08- ’09 have been overtaken by an even less-restrained speculation madness. New York City has been blitzed by the international uber-rich; as a consequence, New Yorkers cannot afford to live in their own home town. At the same time, even fewer parts of the city are off-limits to developers seeking to build high-end versions of Third Reich flak towers. As in China, the bulk of the uber-apartments are to remain vacant; 432 Park is a poker chip with elevators. Apartments are to be ‘flipped’ to greater fool-billionaires in the future; there is no point to actually ‘living’ in the apartments, (Curbed):

Onto the numbers: census data from 2012 shows that “from East 56th Street to East 59th Street, between Fifth Avenue and Park Avenue, 57 percent, or 285 of 496 apartments, including co-ops and condos, are vacant at least 10 months a year.” A swath that’s a bit north of that, from East 59th to East 63rd, shows that “628 of 1,261 homes, or almost 50 percent” are pied-a-terres. All those dark windows? Not your imagination. The place is deserted but for the tourists packed into the Apple Store’s glowing cube.

A reason for emptiness: the dark windows cannot be opened, there is no way for the tycoons to empty cauldrons of boiling lead upon the masses below. Another reason is what amounts to a New York City tax subsidy: non-residents avoid city income taxes; the property rates for non-primary residences in the city are stupefyingly low:

Property taxes here are based on a complex equation related to rental values and can be very low. At One57, for example, a unit that sold for nearly $3.6 million is estimated by the city to have a market value of just $430,000 when calculating its property tax.

432 is one of a number of super-tall, super-needle towers set to rise in Midtown, all are destined to sit vacant: 157 West 57th Street, (One57), 220 Central Park South, 111 West 57th Street, the Nordstrom Tower and 53 West 53rd Street, at the Museum of Modern Art.

It isn’t just ‘dwellings’ where billionaires can squander their fortunes, (Bloomberg):

One Percenters Drop Six Figures at Long Island MallCarol HymowitzAmericana Manhasset, about 30 minutes from Manhattan, is one of several American malls that have figured out how to thrive by catering to One Percenters. Some customers spend more than $100,000 a year. Frank Castagna, owner of the mall on Long Island’s North Shore, and Danielle Merollo, manager of personal shopping, talk with Bloomberg’s Carol Hymowitz about the luxury center. (Source: Bloomberg)At Americana Manhasset, the salespeople know your closet better than you do. They call designers in Paris or Milan to find the perfect little black dress. They deliver soup when you’re ill.Situated on Long Island’s Gold Coast, about 30 minutes from Manhattan, the open-air shopping center is one of several American malls that have figured out how to thrive by catering to One Percenters.Americana Manhasset’s 60 shops sell the priciest status brands — Dior, Gucci, Hermes, Cartier, Prada. Some customers spend more than $100,000 a year and five times that if they’re planning a wedding or buying fine jewelry. Danielle Merollo, the mall’s personal shopper, recently accompanied a client to a private Prada show in New York to buy a bespoke fur cape.

… what is good for billionaires is good for America. If you are wealthy enough, your life is a floating dream of vacant apartments in the stratosphere and Prada capes that are better than all the others. The non-wealthy are muppets … who must pay for everything and do so by borrowing.

Good news! The USA is to be spared the worst ravages of something or other … (Bloomberg):

U.S. Gains From Good Deflation as Europe Faces the Bad KindRich Miller, Simon KennedyWhen it comes to deflation there’s the good — and there’s the bad and ugly.Europe faces the risk of the latter as it teeters on the edge of a recession that could trigger a debilitating dive in prices and wages. The U.S., meanwhile, may end up with the more benign version as surging oil and gas supplies push energy costs down and the economy ahead.“Bad deflation weakens growth,” Nancy Lazar, co-founder and a partner at Cornerstone Macro LP in New York, wrote in a report to clients this month. “Good deflation lifts growth.” Lazar also co-founded International Strategy & Investment Group LLC more than 20 years ago.The Trouble With Falling Prices

That’s welcome news for U.S. investors. Billionaire Paul Tudor Jones, one of the most successful hedge-fund managers, said on Oct. 20 that U.S. stocks will outperform other equity markets for the rest of the year, according to two people who heard him speak at the closed-door Robin Hood Investors conference in New York.

Hedge fund manager David Tepper, who runs the $20 billion Appaloosa Management LP, told the same conference the following day that investors should bet against the euro, two people familiar with his remarks said.

For a country that is as indebted as the US, deflation or even diminished inflation is fatal. Deflation exists when assets (capes, vacant apartments) are worth less than the debt taken on to gain them. At the same time the (borrowed) funds needed to retire the debts are worth more and increasingly difficult to find (the muppets cannot borrow). A ‘scarcity premium’ is added to the funds in real terms; this premium increases faster than debts can be reduced.

Debt repayment removes funds from circulation: this drives up the scarcity premium in a vicious cycle; the more you repay the more you owe in real terms! At some point the only way to reduce debts fast enough to keep up with the increasing scarcity premium is for lenders to fail and for debts to be repudiated! This is definitely not good news …

Fuel prices have declined because fuel customers are bankrupt … not due to any ‘glut’. Those enlisted in the repayment endeavor are the masses scurrying around the bases of the billionaires’ massive towers. If the billionaires are required to repay their own debts they obviously won’t be billionaires any more, nor will there be funds available for others to repay. The bad news is that billionaires and their personal shoppers refuse to understand how the economy works. If they did they would not borrow more than what the non-billionaires can repay by way of their labor. Excess borrowing = illusion of wealth = inevitable insolvency.

In our interconnected world with giant forex- and dollar bond markets, deflation respects no borders, its effects are not confined to one country. China deflation ships out to South America and Australia, it punctures mortgage debt bubble in Canada which in turn cuts funds needed by tar sands operators. Ultimately, deflation results in illiquid markets and credit freezes.

Good News! Petroleum prices have declined, now what?

Fuel price action reflects markets that are actually functioning as they should rather than manipulated one-way markets as with equities. Customers are making a choice between purchasing fuel or purchasing alternative goods. Even as fuel price declines spare customers at the pump/ticket counter, the drop in price reflects a loss of worker income along with an increase of unserviceable worker debt: always customers = workers. The resulting shortage of funds ricochets though retail, consumer producer- and China export sectors.
Screen Shot 2014-10-27 at 11.57.00 AM
Figure 1: Americans are burning less fuel, prices are steadily declining, supply-and-demand does work, chart by Doug Short, (click on for big).

Declining energy prices reflects both consumer choice and declining worker purchasing power. Customers adapt by not bidding for fuel. At some point customers choose to hold off purchases looking for still lower prices in the future; as funds in circulation decline the consumers are left with no choice, they cannot afford any fuel at any price no matter how low: this is ‘energy deflation’.

Customers are only able to afford big-ticket items such as cars by taking on excessive leverage. In addition to the high costs for fuel there are the increased costs for healthcare, government/military and higher education … also costs incurred by way of deteriorated infrastructure. All of these cost must be met by more customer borrowing.

Today’s customer cannot borrow enough to meet his systemic obligations. There is nothing he can afford to buy that he can borrow against, he cannot afford an apartment in a tower in Manhattan.

Lower petroleum prices aim to undermine oil driller balance sheets, (Energy Policy Information Center- EPIC):

Report Warns of Capex Crisis for Oil MajorsCrude oil prices tumbled this month on the heels of historically high U.S. oil production and a downwardly revised global energy demand outlook. The conventional economic wisdom is that the market requires high oil prices for international oil companies to break-even. High prices, after all, boost the profitability of expensive, unconventional ventures. A new report finds that, in addition, high prices impact long-term investments in unconventional projects and heighten the oil majors’ risk of stranded assets.Kepler Cheuvreux, a research organization, contends that market conditions evolve to shift supply from more expensive energy sources to less expensive ones. Over time, they say, high oil prices encourage investment in alternative energy research and development, and lead to a decline in the cost of those sources over the long term. For oil majors, this means that capital-intensive unconventional projects, like the Canadian oil sands, or deepwater and Arctic drilling, may lose profitability, and actually become financial risks.

From the Wall Street Journal, (WSJ):

Fracking Firms Get Tested by Oil’s Price DropRussell Gold, Erin AilworthTumbling oil prices are starting to frighten energy companies around the globe, especially drillers in North America, where crude is expensive to pump.Global oil prices have fallen about 8% in the past four weeks. The European oil benchmark closed Thursday at $90.05 a barrel, its lowest point in 29 months. The price of a barrel in the U.S. closed at $85.77, its lowest since December 2012.Weakening oil prices could put a crimp in the U.S. energy boom. At $90 a barrel and below, many hydraulic-fracturing projects start to become uneconomic, according to a recent report by Goldman Sachs Group Inc. While fracking costs run the gamut, producers often break even around $80 to $85.“There could be an immense amount of pain,” said energy economist Phil Verleger. “As prices fall, you will see companies slow down dramatically.”

Paul Sankey, an energy analyst with Wolfe Research LLC, said the first drillers to react to declining crude prices would be some in the least productive fringes of North Dakota’s Bakken Shale. “We’re not quite there yet,” he said, but a further drop of $4 or $5 a barrel will force companies to begin trimming their capital budgets.

The real problems are on the consumption side. Because drillers are firms, they have access to credit that is unavailable to customers who are individuals. The cost of credit scales inversely to potential borrowing capacity. A firm can borrow at less unit- cost than can a human, a government can borrow at even more cheaply. Between drillers and their customers, affordable funds are available to the drillers that cannot be had by customers. The consequence is customers are starved for funds even as they need more to meet both fuel- and non-fuel costs:
Screen Shot 2014-10-14 at 5.16.17 PM
Figure 2: How low a price? Price of historical Brent Crude illuminating longer-term downtrend since 2008, (Zero-Hedge):

Scale buys time (now) but there is a time cost to fuel; customers must retire the drillers’ loans, they must do so by borrowing because ‘using’ (destroying) the fuel does not offer any returns. When drillers purchase time they add to customers’ loan burdens. When customers are unable to borrow the drillers fail … along with both parties’ lenders!

Customers are being gutted, (Wolf Richter):

What NCR just Said about the American Retail QuagmireAn epidemic of store closings, restructurings, bankruptcies… as the American consumer runs out of options …When NCR announced its preliminary and disappointing third quarter results today, it lowered its guidance for the rest of 2014. Its stock got knocked into a breathtaking 21% plunge. While at it, NCR revealed to just what extent brick-and-mortar retailers were sinking into a quagmire …NCR, a thermometer into (the butt of) the retail industry beyond the latest sales statistics, has noticed that brick-and-mortar retailers are cutting back. And they’re not just cutting back buying point-of-sale devices; they’re cutting back, period. “Ongoing retail consolidation,” Nuti called it. And some are using bankruptcy courts to do it.

More carnage, more Wolf Richter:

What Unilever just Said About Consumers Around the World: “It’s Really Tough out There”Over the last few days, one after the other reported what are more or less unvarnished quarterly revenue and earnings debacles.At McDonald’s, global revenues fell 5% and net income plunged 30%. At Coca-Cola, international volume was up a measly 1%, but in the US, volume declined 1%. Revenues were down fractionally for the quarter and 2% year-to-date. Net income in the quarter dropped 14%. Revenues at third largest beer-giant Heineken, which brews its stuff in 70 countries, dropped 1.7%. People are scratching their heads: are consumers actually cutting back on beer? Other companies too have reported disappointing results.On Thursday it was Unilever, the Anglo-Dutch giant maker of shampoos, deodorants, laundry detergents, ice cream… that warned in its quarterly report about what it looks like “out there,” not in the stock market, but in the real economy around the world.“It is really tough out there,” said CFO Jean-Marc Huët. “We have been at pains to say that for a long period of time.” Consumers are in trouble and are cutting back across key markets, leaving the company with price pressures and crummy sales.

Still more carnage, (Retail Industry About dot com):

Retail chains, large and small, have announced a veritable epidemic of store closings in 2014. Here are the “Top 20″ announcements of store closings. For these 20 chains, the total number of stores to be closed exceeds 4,200!
400 Office Depot/Max (by 2016)
370 Family Dollar
365 Coldwater Creek
360 Dots
300 Blockbuster
300 Sears
225 Staples (through 2015)
223 Barnes & Noble (through 2023)
200 Radio Shack (through 2017)
180 Abercrombie & Fitch (by 2015)
175 Aeropostale (“over the next several years”)
170 Jones Group (by mid-2014)
155 Sbarro
150 American Eagle Outfitters (through 2017)
150 Rent-A-Center
145 Brown Shoes / Famous Footwear
128 GameStop
125 Children’s Place
125 P.S. from Aeropostale
100 Advance Auto

Online retailer Amazon makes up its ballooning losses with volume (and borrowed investor dollars); it is a Ponzi scheme, (Wall Street Journal):


View image on Twitter


Figure 3: chart of Amazon expenses, revenue, share price and operating earnings. No doubt, some online retailer somewhere is making money selling to broke people.

Retailers are on the front lines, not just within the US; look to the lenders who are underwater, (Guardian):

Twenty-four European banks fail financial stress testsEuropean Banking Authority finds €25bn black hole in finances with nine banks in Italy failing the testsJill TreanorOne in five European banks have failed crucial tests of their financial strength, leaving a €25bn (£19.6bn) capital hole in the continent’s banking system at a time of renewed fears that the five-year long eurozone crisis may be flaring up again.European banking regulators published the test results on Sunday. The findings put particular focus on Italian banks – nine of which failed and contributed €9.4bn to the overall shortfall.The tests by the EBA were imposed on 123 banks, including the UK’s bailed-out Lloyds Banking Group and Royal Bank of Scotland. They were intended to draw a line under concerns about the health of Europe’s banking system by showing if banks had enough capital to withstand a series of economic shocks, such as a rise in unemployment, a sharp fall in house prices or declining economic growth. Twenty-four banks failed the examination.

The gain the needed ‘capital’ (investment funds) the tycoon owners of the banks will borrow more and spend on shares, adding to the burdens of the customers, etc … Upward and ever upward … Those looking to the success of tycoons have to feel pretty good about our economy, those looking at the cohort charged with paying for it all as well as their lenders … they are filled with despair.

The original ‘Good News, Bad News’ article was published in January of this year.

Thoughts on Purchasing Power

Off the keyboard of Steve from Virginia

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Published on Economic Undertow on September 18, 2014


Amount of military spending in the US relative to other discretionary amounts; chart from National Priorities dot org.

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Resource-consuming infrastructure in the West and elsewhere among its imitators has been built assuming real sub-$20/barrel oil into perpetuity; infrastructure includes cars, suburbs, airlines, goods-imports, military, government, finance, insurance, freeways, retail, workplaces, etc. Any price above $20-30/barrel is too much to bear.

At the higher price, our precious ‘Empire of Junk’ is underwater, a liability rather than an asset. What makes up the ‘spread’ or difference between the modest amounts that cash flow is able to service and system costs is debt, currently hundreds of trillion$ of dollars worth …

“What is ultimately essential is, on the one hand, the quantity of them technically required for combination with a certain quantity of living labor, and, on the other, their suitability, i.e., not only good machinery, but also good raw and auxiliary materials. The rate of profit depends partly on the good quality of the raw material. Good material produces less waste. Less raw materials are then needed to absorb the same quantity of labor. Furthermore, the resistance to be overcome by the working machine is also less.”— Karl Marx; ‘Capital, Volume 3′, chapter 5;

Lately, world oil prices have been dropping, from $108/bbl to $98. USA price has fallen to near $90. Drillers need a plus-$100/barrel price to be able to afford to drill, this is the large problem that is facing both the drilling industry as well as the country as a whole.

Countries like Mexico and Russia depend almost entirely on petroleum sales so national costs are added to drilling costs, this means these countries require $120 or more per barrel to meet expenses. Ditto Saudi Arabia and Iran. The countries can (and do) sell for less and are able to drill however, other non-oil expenses are not met or the countries fall into deficit, meaning they must borrow from their overseas’ customers or do without. Other than the US and to some degree the UK, no major oil producer is a credit provider.

Since countries like Iran and Saudia don’t have any agriculture to speak of, there are grave dangers to all petroleum players, both drillers and consumers. If there is insufficient credit available to customers, there are less funds available to drillers; by way of this constraint, credit creation itself is adversely affected. Without credit, countries are unable to import agricultural goods which in turn leads to uprising and violence.

The national media promotes the viewpoint of ordinary American consumers who use cars constantly. For drivers, cheap gas is a birthright/necessity. From a system viewpoint, the entire fuel supply/consumption regime is stranded by high costs. Fuel supply is subject to ‘energy deflation’ where a scarcity premium (or ‘rent’) is added to the refinery price as a consequence of supply/demand: even as the nominal price declines, the scarcity premium increases faster so that the ‘real’ cost of fuel remains unaffordable. Currently, scarcity rent takes the form of diminished purchasing power, or rather, diminished claims against it. Diminished claims take the form of inability of customers to borrow or lenders’ unwillingness to offer loans and for wages/firm returns to decline relative to other costs. Within energy deflation, a barrel of oil might cost $5 or less … yet there are few- or any customers with money to afford it. The decline in ‘money’ (claims against purchasing power) is the increased scarcity premium!

This dynamic feeds on itself with affordability always a little out of reach even as the fuel price plummets … as customers become bankrupt so do the drillers which reduces fuel supply => renders more customers bankrupt => ruining drillers in a vicious cycle. This deflation phase is just now underway. The key is the observation that multiple wars in oil producing regions have not triggered reflexive marketplace fuel price increases, instead prices have swiftly declined. The customers both in US and elsewhere are going broke faster than reductions in fuel supply can affect marketplace dynamics, customers are bankrupted by the costs of their own cars and the wars fought to obtain for these cars the necessary inexpensive fuel.

Driving cars for the greatest part is non-remunerative, it’s simply waste for its own sake- plus the benefit of auto manufacturers. Multiply negative returns times one-billion (the number of motor vehicles in the world) and it becomes easy to see the global scale of our finance- and debt problems.

Likewise, the costs of the various US wars must be added to the cost of any fuels: the wars are in- and- of themselves futile and pointless, the only gains flow to corrupt military services provider-contractors and manufacturers. In this way the automobile segment of industrial economy is at economic odds versus its military dependency; the agenda of the one clashes with that of the other.

Keep in mind, shortages that result from fuel being unaffordable are permanent … shortages = a decrease in purchasing power, the attempt to add (money-credit) claims against purchasing power is pointless as these claims cannot increase it and are simply redundant, they add to credit costs and nothing else.

“The capitalist mode of production is generally, despite all its niggardliness, altogether too prodigal with its human material, just as, conversely, thanks to its method of distribution of products through commerce and manner of competition, it is very prodigal with its material means, and loses for society what it gains for the individual capitalist.”— Karl Marx; ‘Capital, Volume 3′, chapter 5;

Purchasing power is an economic term that can be hard to put a finger on, like ‘value’. Basically, purchasing power is the ability to gain goods in a market by exchange with other goods (or services). Going further, purchasing power is the ability to gain capital by way of exchange with the fruits of capital.

Purchasing power is therefor relationship between capital and the non-capital good(s) that are exchanged for it. Here, ‘capital’ is non-renewable resources, the basis of all production. One side of the trade is value (capital), the other is the measure of goods that are derived from capital (worth). Purchasing power is intertemporal (value is not directly interchangeable with worth) yet components are tightly bound by way of the exchange itself.

Intertemporality represents the difficulty in properly evaluating purchasing power. As the goods derived from capital are far removed from it in form and utility; there are marginal- and opportunity costs that are embedded within goods that do not exist within the capital. There is no utility, marginal or otherwise, that attaches to uranium, petroleum, topsoil, timber, fisheries, water or any other capital, only that which attaches toward their extraction and ‘use’.

The purchasing power interrelationship is always equivalent, that is, the amount and quality of the non-capital good offered is equivalent to the capital as determined by exchange. It is the exchange itself determines purchasing power and nothing else.

Where purchasing power is the first-order claim against capital, all forms of ‘money’ or secondary exchange media including specie, currency, swaps or options, private-sector money (stock shares), discountable bills, receivables, bonds and structured finance issues are derivative, surplus claims against purchasing power!

For example: when a country creates local currency against overseas (money) collateral the nominal rate of exchange is arbitrary. One unit of currency ‘A’ might be worth one unit of currency ‘B’ or five and a half units or a thousand … or vice-versa. It is purchasing power that is multiplied; that of the one currency being equivalent to that of the other at all times regardless of exchange rate. Purchasing power relationship is inelastic and tightly coupled by way of arbitrage; the simultaneous purchase or sale of common goods with both currencies, such as a third-party currency or petroleum.

It is in the interests of the trading- and investing partners to maintain exchange rate stability over time, so that nominal and real purchasing power are aligned. Countries and central banks attempt to do so by way of currency pegs, interventions or by adjusting interest rates. Purchasing power borrowed against foreign exchange is always constrained by collateral, it cannot be ‘adjusted’ by cheating because any imbalance between funds and purchasing power is exploited by arbitrageurs.

Because specie is a natural resource (gold or silver) those elements are somewhat of a special case, nevertheless, as metals are used as money specie becomes a claim against purchasing power no different from paper currency or ‘bank money’ created within a database. Specie’ liability is the cost to extract it from the ground- or separate it from its previous owner by force or otherwise and put it to the use of the state. Labor is also a derivative claim against purchasing power.

Purchasing power itself exists outside the reach of governments but derivative claims in the form of currency or binding contractual obligations exist to serve the interests of the state, the same way religion exists to serve the state. By use of these claims, authorities are able to ‘sell’ or cause to be sold ‘goods’ that cost nothing to make yet are able, due to the citizens’ evolving dependency upon them, to bring the greatest part of the public into a form of uninformed, semi-voluntary servitude/slavery.

The actions of finance and monetary authorities aim to increase claims against purchasing power; by doing so they seek to increase capital. Yet the multiplicity of claims is perverse; capital is not increased but exhausted more rapidly. As capital vanishes into furnaces and then the atmosphere, so does purchasing power: at the end of the day capital is gone, leaving behind fragments of purchasing power alongside mountains of worthless claims.

When claims cannot be perfected against (vanished) capital they are turned against other claims including labor, this extinguishes workers’ purchasing power (which takes the form of wages). The real cost is the difference between what labor would earn without the claims and what it actually earns with the claims in place. The difference aggregates toward the issuers of claims — finance — relieving at the same time the obligations of the banks’ clients — the tycoons who borrow from finance.
fredgraph dollar
Chart by St. Louis Fed (FRED): citizens wish to reclaim 1950’s purchasing power of the dollar-claim so that they might be able to purchase gasoline and other goods at 1950’s prices, not realizing that burning gasoline since the 1950s has eroded purchasing power … even as the worth of each claims against purchasing power has likewise been diluted. Even if the number of claims can be reduced, the purchasing power cannot be increased except by conserving capital, making gasoline unavailable. Purchasing power can never exceed underlying capital: think of it as the collateral component of purchasing power.

The three-way aspect of purchasing power must be kept in mind at all times:

Capital = Purchasing Power <=> Money claims against purchasing power.

Purchasing power is variable because any attempt at capital conservation, inadvertent or otherwise, increases purchasing power or at least diminishes it less quickly (which can appear as an increase). Currently, claims against purchasing power are relentlessly increasing so that conservation is offset by the effect of surplus claims.

Claims haven’t always expanded, they shrank during the 1930s Depression. Claims were in short supply due to debt-repayment mechanism (repaying debts-claims extinguishes them) as well as the unwillingness of citizens to part with their claims-in-hand (represented by currency). Purchasing power was extreme because of the quality and quantity of available (resource) capital, left untouched by diminution of demand/consumption. The Great Depression was an example of ‘conservation by other means’ ™. Because of the relative shortage of claims, America’s bulging purchasing power was not exercised or accessed: the country was both rich (excess purchasing power) and poor (absence of claims) at the same time!

In contrast, we are now poor and poorer at the same time: our mountain range of claims requires constant additions to meet service- plus surplus-management costs. Decreases in purchasing power render claims redundant, the bulk of our claims are either worthless or hopelessly diluted. At the same time, purchasing power itself is falling due to exhaustion of capital. There is little to compare the economics of the 1930s and the present time: we face the looming failure of the claims-mechanism as well as the onrushing shortage of capital.

Effective conservation would increase purchasing power but the increase in claims renders such efforts futile. Managers can regulate some of the claims but the private sector will ‘innovate’ replacements that can evade regulations. Because new claims carry the guise of virtue and salvation, there is a ready audience for them, a pool of users ready to use them to assault what remains of our capital.

Needed, a New Kind of Purchasing Power Ending the Claim Against Capital

The issue is the purchasing power relationship between capital/value and the products of it, as well as claims against that relationship. Business uses capital to leverage more claims against it: the capital-cannibalizing process becomes collateral for more claims => these become the means to extract of more capital => extraction becomes collateral for still more claims in a virtuous cycle. Fast forward to the present and more claims meets diminished capital returns, the purchasing power relationship has broken down.

Labor is the ultimate sink for nonredeemable capital claims. If capital cannot pay, then must labor do so. As a consequence, labor is bankrupted. It is far better if purchasing power becomes a claim against labor rather than the claim against capital. Not only would the exchange be more honest but claims would become real only when labor component of the purchase is properly priced. As labor produces less in quantity than industry/capital, it would be necessary to increase the price of those aspects of labor that add to the worth of goods: skill and creativity, utility. At the same time, capital claims directed against labor would be set aside: because our industrial output is the product of capital rather than labor we do not care whether labor is overburdened or not. Without the use of capital there is an incentive to make the best use of labor — rather than the least productive use of it. To do otherwise would be pointless.

Claims against labor/purchasing power would become appreciating assets; as up-skilling increases so would purchasing power. This increase would serve to extinguish obsolete capital claims over time. Even as capital diminishes, labor does not provided it is given the means to increase its ability. At the same time, labor claims would not be able to proliferate beyond the rate at which labor itself can increase. There is too much history of human labor and endeavor to expect the same kind of ‘growth’ that has been a part of the capital-destroying machine enterprise. Fewer claims would strand the tycoons, the useless rentiers and economic gate-keepers.

Americans have become so dulled-down by games, fast food, media and labor saving capital destroyers that we cannot imagine what an up-skilled citizenry would be like. As long as purchasing power is the first-order claim against fossil fuel waste we will never find out.

Interview with Steve Ludlum of Economic Undertow: Part 1

Off the microphones of Steve from Virginia, Monsta666 and RE

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Aired on the Doomstead Diner on April 28, 2014


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Fundamentals of Capital Destruction and the Waste Based Economy

After many delays and some false starts, we finally got in some Podcasts with one of my favorite Econ Bloggers, Steve (from Virginia) Ludlum of Economic Undertow.

Steve and I have been hashing out Econ topics both in Undertow and Diner commentary for a few years, not always seeing eye to eye on all topics but in general agreement on the Fundamentals.

I highly recommend Economic Undertow as a source of the best analysis you’ll find for the economic mess we find ourselves in at the moment.  His series Debt-o-nomics is a must read for all Kollapsniks.

In Part 1 we look at the basics of the Industrial Economy and the Capital Destruction ongoing for the last few hundred years.  We look at many of the misconceptions people have about the nature of Capital and the Productivity of such an Economy.

Part II is a much more free-wheeling discussion, where Steve and I go Mano-a-Mano with differing perceptions of the driving force behind the Carz economy and the construction of the Eisenhower Interstate.  Don’t miss that one, it’s a HOOT!  🙂


Debtonomics: Currency Crisis

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Published on Economic Undertow on February 15, 2014


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An argument can be made that under our present circumstances analysis of the declining economic order is not particularly relevant: it is best to look forward rather than pick over the past, to let the current regime fall apart and build something new and better on the ruins. While there is something to be said for that approach, we need to understand where we are … and to do so not just to ‘know the enemy’ or grab him by the belt. We are likely to see a post-industrial economy reassembled out of existing components; evolution as much as revolution. How things actually function is important to know, the challenge is to parse analysis from advertizing. Within economics, the truth is liberating to the extent that speaking it will likely get you fired.

Economic processes are fairly straightforward to understand piecemeal but can be much harder when taken together. Much of this is by design, some is happenstance. We are conditioned to think in terms of linear narratives with beginnings, middles and ends. We have been well-trained by television; we like simple, we like dramatic, we like violent, we like ‘happily-ever-after’.

The past 400 years offers proofs that there are no happy endings to industrialization, only varying degrees of ruin. Modernity hollows itself out, the ‘advance of progress’ within nations is like the rot of a body afflicted with gangrene. The flow of funds within economies is similar to the flow of hydraulic fluid in an automatic transmission; there are main-streams, feedback loops and pressure differentials, all offering different outcomes depending on which gear you select and what pedal you push. After some time, the transmission stops working and so does the car … nobody can figure out why.

Individual economic processes can be linear but each is a sub-component of others; narratives multiply, segue into others or intertwine to form multi-layered complex webs which are closely-coupled and brittle. Analysts specialize: they tend to focus on individual processes so as to keep their narratives intact while serving the needs of their sponsors. Life within voluntary constraints is pleasant for the economist who excludes all the bits of unhappy reality outside his specific area of expertise. Hence, the heavy emphasis on conventional econometrics, neoclassical- and DSGE analysis from the establishment: these disciplines self-edit by design.

They also self-edit for a purpose: our present regime is a debtonomy. Lenders conjure endogenous money or debt as the means to private riches for themselves and their clients; tycoons borrow immense sums for their own gain leaving others to meet the costs. This process makes up the entirety of our economic system. Debtonomics follows Fisher 1933, also Minsky 1980 and Keen 2014.

Debtonomics: an indictment as much as a description:

— All economic activity is subject to the First Law, where the costs of managing any surplus increase along with the surplus until at some point they exceed it. This is simple mean reversion applied to business activities along with conservation of energy- and matter; there can be no possible work- or goods output greater than the sum of inputs. Debt, false accounting and the use of fossil fuels have allowed us to pretend while shifting costs to others.

— On a cash-flow basis our consumption economy is continually ‘underwater’, the gap between capital cost and system return is financed with debt. When input prices are low, the amount to be financed is affordable. Scarcity reprices resource capital, at some point both capital and necessary credit become too costly. These costs cannot be shifted, the outcome is ‘demand destruction’, currently underway around the world.

— Industrial firms are loss-making enterprises, incapable of organic returns. That the industrial economy cannot afford itself is self-evident: if the enterprise was productive it would retire its own debts. A firm can be a government entity or a business; the larger the size of the firms the greater is aggregated costs and the more it or its customers need to borrow — first law.

— Borrowing represents artificial returns; firms borrow against their own accounts, against the accounts of their customers, against the state or against foreign exchange. Firms’ success has little to do with products but rather their ability to wheedle loans.

— Besides borrowing, an ‘outside’ activity of firms is converting capital — non-renewable natural resources — into waste. The shiny and glamorous wasting process is collateral for loans; the more effectively firms waste or enable it by others, the more efficiently the firm is able to borrow. Another activity is mispricing resource capital; by manipulation in markets and by purposefully refusing to identify capital as such.

— Because waste does not offer a return, the foundation of modern economic development is provision of loans. The industrial country requires its own currency; strong, well- managed and capitalized banks at all levels; an independent lender of last resort and a legal system: the rule of law including enforceable contracts and regulatory constraints on practices. Any two countries possessed of the same material advantages … of natural resources, manpower, education, transportation access, and liberal governments; where one possesses the instruments of credit and the other does not … the first country will industrialize while the second will depend upon the credit of the first and become its subject. Absence of organic credit provision is why nations are unsuccessful at modern development.

Provision of loans is why bankers are ascendent, why they hold the world hostage, why they are free from any accountability for their own crimes and excesses: banks create money by lending it into existence. If there are no banks, there are no loans, if there are no loans there is no money and no industrialization.

Firms borrow from their own bankers or from credit markets, or by issuing shares so that others borrow for the firm’s benefit. Firms borrow against the accounts of their customers whenever they take on loans to purchase the firms’ goods; as a consequence, business ‘profits’ and any retained earnings are simply the continued ability of firms’ customers to continue borrowing over time.

Firms borrow against the accounts of the state because states generally have greater borrowing capacity than firms and at lower cost. Firms position themselves to gain access to the stream of funds from the state. Access takes the form of direct (contract) payments, subsidies and tax advantages. Holding currency is a form of borrowing against the account of the state: in a debtonomy all cash currency is the unpaid debt of others. Firms borrow against foreign exchange when imported currency becomes collateral for loans in the native currency.

Visualizing flows of funds.

Currency flow diagram of a fictional economy showing how borrowing from foreign exchange works. Funds originate at the left @ ‘Country A’ and flow to the right, by way of ‘Country B’ and back to the beginning where the cycle is (hopefully) repeated. Keep in mind, flows are not static like a graphic. Future graphs of this particular model would show the same components and flows having more-or-less identical relationships, perhaps at a different overall scale.
China Sector Credit Flows 2

Figure 1: The arrows on the chart represent flows and are roughly to scale. Credit originates as bank money in country ‘A’ and is sent to country ‘B’ in exchange for goods’ exports or as foreign direct investment (FDI). These funds are aggregated at country ‘B’ central bank where they are used as collateral for loans in local currency. By this simple means the exporter doubles his purchasing power: he holds both the imported currency as well as the newly created currency which is distributed into the economy. This multiplication of purchasing power is why countries are eager to export as well as borrow overseas currencies.

Some of the country ‘A’ currency becomes foreign exchange reserves, some is swapped for gold or other resource capital while the rest is recycled back to country ‘A’ where it becomes ‘vendor financing’ for subsequent rounds of export purchases and FDI. Here, ‘currency’ means the forms of a country’s money and credit in aggregate.

FUNDING The flow of foreign exchange (black arrows)
REFUNDING Flow from the central bank to the commercial banks
DISTRIBUTION The flow from the banks into the economy

When a country creates local currency against overseas collateral the nominal rate of exchange is arbitrary. One unit of currency ‘A’ might be worth one unit of currency ‘B’ or five and a half units or a thousand … or vice-versa. It is purchasing power that is multiplied; that of the one currency being equivalent to that of the other at all times regardless of exchange rate. Purchasing power relationship is inelastic and tightly coupled by way of arbitrage; the simultaneous purchase or sale of common goods with both currencies, such as a third-party currency or petroleum. For this reason, both the black and red arrows in country ‘B’s economy are the same size, they represent purchasing power.

It is in the interests of the trading- and investing partners to maintain exchange rate stability over time, so that nominal and real purchasing power are aligned. Countries and central banks attempt to do so by way of currency pegs, interventions or by adjusting interest rates. Purchasing power borrowed against foreign exchange is always constrained by collateral, it cannot be ‘adjusted’ by cheating because any imbalance between funds and purchasing power is exploited by arbitrageurs.

Conventional analysis sees the world as a dependency of the US Federal Reserve money printing. ‘Hot money’ dollars are hustled overseas by way of carry trades, with speculators looking to exploit interest- and exchange rate differentials for short-term gains. Funds flow toward developing countries when rates favor the trades, they recoil when rates turn against speculators. Inbound flows push asset prices higher, when flows reverse assets are dumped and prices decline, including currency. To support currency prices central banks adjust short term policy rates by taking deposits, hoping to lure the speculators back.

This analysis is overly simplistic and incomplete. The Federal Reserve cannot create new money, it is collateral constrained. Its foreign exchange interventions are zero-sum affairs. Countries gain dollars by exporting petroleum or manufactured goods, borrowing against their American customers as well as by way of FDI, these flows are relatively inelastic and unaffected by borrowing costs. The scale of borrowing against foreign exchange is immense; amounting to trillions of US dollars in China alone; Forex borrowing represents the largest component of lending support for developing countries as these generally do not have organic alternatives. The uncertain potential rise of a few basis points will not affect the demand for dollar loans from overseas’ borrowers. Their choice is to borrow regardless of interest cost or miss the latest chance to develop.

Whereas lenders’ long-term returns from interest payments can be substantial, short-term returns are relatively modest. The greater gain from lending is the requirement on the part of the borrower to repay with money that is more costly to him than the loan is to the lender. Bank money costs the lender almost nothing to create as it requires only keyboard entries. The borrower must repay with circulating money; he cannot create repayment on his keyboard but must beg, steal or more likely borrow repayment- or have it borrowed by others in his name (bailout). Whereas interest cost tends to be a small fixed percentage of the principal payable over time, the expense of circulating money is determined by its availability in the marketplace, by supply and demand. When circulating money is scarce the real worth of repayment can be much greater than the nominal balance due, yet this is invariably when the demand to repay is fiercest, as during a margin call. If the loan is secured and the borrower cannot repay, he must surrender collateral along with other rights. These are always worth more than a keyboard entry.

In this sense, lending malpractice is outright theft rather than usury; with the banks offering loans that cost them nothing as the means to gain high-cost money as well as the real goods and labor that are pledged as collateral. There is also risk: when there is no collateral to seize in the place of circulating money, both borrower and lender are ruined.

When bank money changes hands it becomes circulating money. By acceptance, the recipient banks validate the ledger entries as ‘money’ as well as their worth. At the same time, the borrowers accepts their obligation to retire the loans on the lender’s terms with interest.

Inflation and deflation implications

Conventionally, inflation and deflation represent the inverse relationship between funds and purchasing power. Inflation is increase in unsecured loans, the increase of funds in circulation over time without a corresponding increase in purchasing power. This is also ‘economic growth’. Deflation is the decrease of funds relative to purchasing power. Periods of deflation follows episodes of inflation over long cycles; funds balloon and unit-purchasing power declines followed by reversion to mean.

Model of Argentina national credit flows:
Argentina Sector Credit Flows

Figure 2: This could be the chart for Brazil, South Africa, Venezuela, Ukraine, Turkey along with dozens of other developing countries. Argentina’s problem sticks out like a big, pink thumb: unsecured loans by the central bank. This is seen as the increased flow within the refunding channel, costs (losses) are directed to the commercial banks which attempt to distribute them into the economy. The resulting imbalance between funds (pesos) and purchasing power (dollars) is exploited by arbitrageurs (anyone with access to pesos) … instead of being absorbed by the economy, losses are forced back onto the commercial banks which become progressively weaker until they fail. Meanwhile, the same economy is emptied out of purchasing power as the ‘loss-pushing’ process is self-amplifying.

Argentina is poster child for long-running policy errors: the greatest being repeated efforts to industrialize which invariably end in disaster, the other being the central bank making unsecured loans. As it does so it becomes insolvent which in turn triggers bank runs.


Any two countries possessed of the same material advantages … where one possesses the instruments of credit and the other does not … the first country will industrialize while the second will depend upon the credit of the first and become its subject. Absence of organic credit provision is why nations are unsuccessful at modern development.


So it is with Argentina: without organic credit the country is dependent upon overseas loans. Hyperinflation is persistent across South America because private banks are historically weak and unable to pass costs onto others. The banks cannot provide the credit needed to meet politicians’ delusion of grandeur, partly because credit by itself is unable to provide anything real. To gain credit, countries import dollars and other foreign currencies while central banks are called upon by leadership interests to supplement the commercial banks’ unsecured lending with their own. The outcome is vanishing lenders of last resort, systemic insolvency and runs. Repeated cycles of (hyper)inflation, bank runs and crises pulverize the banks … which are able to recover somewhat with more outside loans … only to collapse when the crisis re-emerges a few years later. Latin American countries cannot free themselves from dead-money debts or develop as they wish.

Whether countries such as Argentina are suited to American-style industrial development is never examined nor are alternative approaches given consideration, only the same cycle of borrowing and failure repeated over and over.

Banks are weak because managers are cronies of government elites, other interests are ignored, or worse. Bankers simply steal depositor funds and leave the country. Unsurprisingly, citizens don’t trust the banks, they do as much of their business as possible with cash and hold savings in the form of real estate or other hard goods that cannot be easily stolen or replicated into worthlessness. Like most countries with inflation problems, Argentina has been in a frenzy to develop, to ‘get rich quick’, to become industrialized.

Argentine lenders have one foot out of the country, together they represent the transmission channel for foreign currency loans. The returns on these loans are appealing to yield-starved overseas investors while spreads are positive for lenders. The pressure to lend in dollars and other foreign currencies is unrelenting. The outcome has been foreign currency flows into Argentina followed by droughts as locals, outside speculators and the lenders themselves remove the funds out of harm’s way as fast as they can.


… the requirement on the part of the borrower to repay with money that is more costly to him than the loan is to the lender.


When dollars become scarce, Argentines cannot refinance maturing loans. Firms and citizens compete with each other to gain dollars, the contest crowds out commerce and becomes the country’s entire economy … which becomes the big reason why Argentina’s central bank makes unsecured loans:

Hyperinflation is complex and there are many historical episodes with multiple causes. The hyperinflation known as the Price Revolution occurred in Europe during the 16th century due to the flow of gold and silver into Spain after its conquest of the New World; also population increase, the decline of goods output due to wars, the introduction of new banking instruments as well as currency debasements. Hyperinflation in the US during the Revolution was amplified by British counterfeiting. Hyperinflation in Wiemar Republic was accompanied by similar outbreaks in Hungary, Poland and France. A common characteristic of all hyperinflation episodes is countries desperate to develop at any price along with weak- or non-existent private sector banks unable to distribute central bank costs onto others.

Hyperinflation = central bank losses (costs) forced onto commercial banking sector. The central bank attempts to expand purchasing power by adding to the refunding channel flow. Commercial banks attempt to distribute their loss to the economy which they cannot do because increases in the amounts being distributed have the same purchasing power as original foreign exchange funds.

Because the purchasing power of a currency is equal to that of the collateral, commercial banks borrowing from the central bank are continually underwater; a peso lent by a bank to its depositor is always worth more than the replacement they borrow from the central bank. The banks demand more pesos from the central bank to ‘make up the losses with volume’. Meanwhile, the unsecured peso refunding from the central bank is the incentive for depositors to remove funds as quickly as possible and change them for dollars. Both depositors and outside speculators become bankers in miniature, using increasing amounts of pesos to bid for diminishing amounts of ever- more costly dollars in the black markets which are then spirited out of the country. If the central bank attempts to defend a particular exchange rate the dollar arbitrage process accelerates until the country is emptied of dollars. Once the establishment abandons the official rate, depositors use pesos to strip the country of goods, leaving the currency with zero collateral and worthless as a result.

Non-bank businesses refuse to accept pesos — as every increment of time represents a loss of peso purchasing power, every good is worth more than money. Listening to pleas from the banking sector, the central bank believes the economy is running out of funds — when it is really running out of purchasing power.

Deflationary bubble
China Sector Credit Flows(1)
Figure 3: China’s loans-against-forex model is like Argentina’s and the rest because China is dependent upon dollar- and other hard currency flows as collateral for domestic loans. This contradicts conventional analysis which has China as a US creditor. China cannot create dollars or dollar credit; China ‘lends’ energy (coal) and human labor to the US in the form of manufactured goods, which cost the country very little to produce. Repayment is in the form of dollar loans which cost Wall Street almost nothing to produce.

China’s energy flows are not on this model, China’s real energy costs and externalities are not on any of China’s models.


Any two countries possessed of the same material advantages … where one possesses the instruments of credit and the other does not …


Who says the Chinese cannot innovate? The Chinese have created two parallel dollar economies within one country. Dollars flow by way of US customers and retailers to Chinese manufacturers. Some are forwarded to the Peoples Bank of China at the official exchange rate where purchasing power is replicated in the form of secured RMB loans into the Chinese economy. The balance are diverted by manufacturers into the loan shark economy where they become quasi-collateral for as many RMB loans as the market will bear. This lending is universally unsecured: when there is no collateral to seize in the place of circulating money, both borrower and lender are ruined.

In China there is no refunding channel between the central bank and shadow finance. The shadow banks are very strong and have distributed losses into the economy a long time ago, these losses have simply not been recognized. Deflation occurs when these losses are finally measured, when inflated Chinese assets are marked to market.

Dollar funds to the PBoC become foreign currency reserves, some of these are swapped for gold or other resource capital while the rest are recycled back to the US where they become vendor financing for subsequent rounds of export purchases and FDI as indicated by parenthesis. Foreign exchange dollars flowing to shadow banking are simply stolen, shipped out of the country to offshore tax havens by Chinese elites.

There is something in this for everyone: elites claim with straight faces that this system provides loans that the above-ground lenders are unwilling to offer. Within the official sector the relationship between purchasing power and exchange rate is stable; the Chinese establishment pegs the RMB to the dollar. There is organic credit provision; the central bank is careful not make unsecured loans. The official exchange rate allows Chinese officials to insist to the West that their currency is appreciating … for public-relations purposes. The unofficial rate is a de-facto RMB depreciation which continues China’s export advantage for manufacturers and provides funds for more over-development which in turn becomes part of the Chinese ‘growth narrative’ … all of which is used to wheedle more dollar loans.

Analysts suggest that Chinese forex reserves can be deployed to bailout shadow lenders however there is no refunding channel between the PBoC and shadow banks. Because shadow banking costs have already been distributed into the Chinese economy, all that remains is for these losses to be recognized, the only other alternative is kick the can down the road and pray. The central bank cannot ‘bail out’ the shadow banks as they are simply shells erected to enable the theft of forex reserves. Any redeployed reserves would be stolen as well. This would starve manufacturers of customers who would lack vendor credit with which to purchase Chinese goods. Because shadow banks are strong, any unsecured central bank lending would be distributed into the Chinese economy as more unrecognized losses. Attemting to bail out shadow banks would precipitate the deflation crisis the Chinese establishment is desperate to avoid: flight of dollar collateral => decline in RMB purchasing power => recognition of losses => bank insolvency and runs out of banks.

Credit cannot expand forever; the ‘Minsky Moment’ occurs when the cost of servicing (unsecured) debt plus the cost of running the actual economy exceeds the cash flow that can be generated by more borrowing.

Observations and remedies.

All claims and money-funds are promises to deliver some good or work in the future. During credit expansions, all promises are held in the same high regard. As results fail to measure up, some promises are held more highly than others. At the end of the cycle the promises are recognized for what they really are; lies.

— Governments are not a hyperinflationary factor where they do not directly issue currency other than to make demands of the central bank and ignore law-breaking.

— Velocity of money or rate of transactions re-using the same funds is not a hyperinflationary factor.

— Hyperinflation is a form of currency arbitrage.

— A remedy to corral inflation is to reduce system leverage by adopting a loanable funds model.

— Increase recognition of the real gains from lending. Allow debt repayment in kind: settlement of ledger ‘bank money’ loans with ledger repayments.

— Countries need to reduce borrowing from overseas lenders and dependency upon them at the same time. A way must be found to penalize overseas lenders short of (inevitable) economic collapse.

— Make use of local- regional currencies as sub-components of national currencies: increase the numbers of ‘central banks’. Increasing the diversity of participants interrupts the feedback loop necessary for inflation- or hyperinflation to take hold. Users are able to switch from an issuer’s inflated notes to alternates. Currency stability within the US during the 19th century is attributed to the gold standard but is more likely the result of free-banking and divers local currencies and issuers, along with the limited convertibility to gold. Currency worth was measured by exchange with ordinary goods and differences ironed out by discounting and arbitrage.

— Introduce peer-to-peer systems that allow users to be their own banks for the purpose of transactions.

— Adopt a scientific unit measurement for money following Le Système International d’Unités, or ‘SI’. Just as there are universally recognized kilograms, moles and amperes, there would be a standard for money that directly relates to the other standards. Prior to the use of abstract reserve funds, foreign exchange ‘money’ was metal — gold or silver — measured by weight rather than worth, and thus universal in all countries.

— Underway is a deflationary finance crisis as losses within major economies emerge, both collateral worth and loans against it are marked down to zero, banks- and credit-dependent industries fail. There is no cure for deflation just as there are no remedies for dying — only palliatives. A strategy is to voluntarily recognize losses before they emerge on their own and assign them to the malefactors who are responsible for them, Doing so will set examples and prevent future cost shifting.

— The larger remedy is to recognize the failure of industrialization and move on to some other fashion trend. Argentina’s repeated attempts to modernize have left the country with dead-money dollar debts it cannot hope to retire; it is bankrupt, it will default. It should start over with a new plan that does not include consumer products, factories or ‘progress’. China strips the world of resources endangering the life-support for all of life … so some tycoons can accumulate stolen symbols. This is insanity.

— Even after a great collapse, the world will still spin.


NOTE: Here are some terms that are used in this article:
The gain from lending Borrower must repay with money that is more costly to him than the loan is to the lender.
Funding The flow of foreign exchange
Refunding Flow from the central bank to the commercial banks
Distribution The flow from the banks into the economy
Ordinary inflation Expansion of unsecured credit, bubbles, also ‘economic growth’
Hyperinflation Central bank costs forced onto commercial banking sector
Deflation Recognition of commercial bank losses already distributed into the economy
Strong banks (First Law) Banks able to distribute their losses into the economy
Weak Banks Banks unable to manage or distribute losses

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Inside the Diner“They are dying. That’s true. It is what it is.” Trump’s Axios interview was a ...

Poor Moriarty.  So wrong, so very wrong.  RE Shale Faces Another Round Of BankruptciesBy Irina Slav - Aug 03, 2020, 6:00 PM ...

Donald Trump dumped $400 million into his clubs in Aberdeen and Turnberry. Now, lawmakers in Edinburgh want to investigate him for money laundering.In 2006, Donald Trump purchased a 1,400-acre swath of the old Menie Estate in Aberdeenshire, a r...

"I think we're doing very well. I think that we have done as well as any nation. If you really look, if you take a look at what's going on, especially now with all these flare ups and nations that they were talking about," President Trump told repor...

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Doomstead Diner Daily July 17The Diner Daily is av [...]

Doomstead Diner Daily July 16The Diner Daily is av [...]

The point being to wear down the "precariat [...]

Quote from: UnhingedBecauseLucid on March 18, 2019 [...]

CleanTechnicaSupport CleanTechnica’s work via dona [...]

QuoteThe FACT that the current incredibly STUPID e [...]

Quote from: K-Dog on February 24, 2020, 06:23:52 P [...]

I wonder how much these coins have been debased? [...]

Precious tip of the day.....Buy silver NOW  She [...]

Scientists have unlocked the power of gold atoms b [...]

Quote from: azozeo on August 14, 2019, 10:41:33 AM [...]

I am OUT of Jury Service!  I got summoned to be a [...]

Quote from: Eddie on May 16, 2020, 10:30:30 AMQuot [...]

Quote from: RE on May 16, 2020, 08:20:06 AMQuote f [...]

Quote from: RE on May 16, 2020, 08:20:06 AMQuote f [...]

Alternate Perspectives

  • Two Ice Floes
  • Jumping Jack Flash
  • From Filmers to Farmers

The Flim-Flam Men by Cognitive Dissonance   I suspect if average Joe or Jane were asked to identify [...]

The Coming War With China Re-posted from   (Have you noticed that (suddenly) Ch [...]

Papers Please! By Cognitive Dissonance     For those who may not know, Mrs. Cog and I live in the mo [...]

Lies, Damn Lies and Coronavirus Statistics By Cognitive Dissonance     “Never believe anything in po [...]

The Decline and Fall of Civil Society Chapter One By Cognitive Dissonance     From my perspective at [...]

Event Update For 2020-08-02 [...]

Event Update For 2020-08-01 [...]

2020 - JUL - Spotlight StoriesCategory: Variety Pack2020-07-01 - Hundreds of elephants mysteriously dying, mostly around waterhole [...]

In other words, treat COVID-19 like a dry-run for the upcoming "big one" [...]

However don't expect strikes and yellow vests to fix underlying problems [...]

So how many more times are we going to hear that this is our last chance to take action in order to [...]

This is definitely not a bona fide post [...]

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The Great Pause Week 20: Coronation Part I"With the number of Covid patients closing in on 20 million, epidemiologists hope the virus has [...]

"Your future is a story you were told, like Santa Claus or the Tooth Fairy."Thirty years a [...]

The Great Pause Week 18: Midwinter Down Under"Our objectives are low-tech, anti-fragile, and human-centered. By using tools of permaculture [...]

The Great Pause Week 17: Toppling Mount Rushmore"We are being schooled in the deficiencies of human neurobiology."President Cobblepot and [...]

The Great Pause Week 16: Cash Bounties for Scalps"The word “redskin” has been coined to refer to these trophies."Paris, June 15, 1756. Anti [...]

The folks at Windward have been doing great work at living sustainably for many years now.  Part of [...]

 The Daily SUN☼ Building a Better Tomorrow by Sustaining Universal Needs April 3, 2017 Powering Down [...]

Off the keyboard of Bob Montgomery Follow us on Twitter @doomstead666 Friend us on Facebook Publishe [...]

Visit SUN on Facebook Here [...]

What extinction crisis? Believe it or not, there are still climate science deniers out there. And th [...]

My new book, Abolish Oil Now, will talk about why the climate movement has failed and what we can do [...]

A new climate protest movement out of the UK has taken Europe by storm and made governments sit down [...]

The success of Apollo 11 flipped the American public from skeptics to fans. The climate movement nee [...]

Today's movement to abolish fossil fuels can learn from two different paths that the British an [...]

Top Commentariats

  • Our Finite World
  • Economic Undertow

In reply to Norman Pagett. Lydia is correct and Norman doesn't have the grace to grace her comm [...]

In reply to Duncan Idaho. As I said, you've all be ingesting, imbibing and inhaling too much ju [...]

In reply to Very Far Frank. I can smell it too. I try to hold my nose but even so the pong is disgus [...]

In reply to Erdles. Was on monument metals website last night with Silver at about $24.00 an ounce.. [...]

In reply to Harry McGibbs. Strange framing: "lose 60% of their benefit". .when it was a te [...]

Nothing to see here. Move along! Lol. [...]

Steve seeing as how this is reante's fourth in a row, lemme know if I'm posting up too muc [...]

Hey Steve what do you think if the idea that the 1K/mo digital UBI for US citizens 18 and older (plu [...]

Who was it who used to argue here years ago about how much fat could be cut from the system? Was it [...]

Independent to me means non-commercial. They may sell half or full beefs and five or ten ton of hay [...]

RE Economics

Going Cashless

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Simplifying the Final Countdown

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Bond Market Collapse and the Banning of Cash

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Do Central Bankers Recognize there is NO GROWTH?

Discuss this article @ the ECONOMICS TABLE inside the...

Singularity of the Dollar

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Kurrency Kollapse: To Print or Not To Print?

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Of Heat Sinks & Debt Sinks: A Thermodynamic View of Money

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Merry Doomy Christmas

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Peak Customers: The Final Liquidation Sale

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Collapse Fiction

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Technical Journals

This study was designed to identify trends in maximum, minimum, and average air temperatures in the [...]

Cultural sites are particularly important to Indigenous peoples, their identity, cosmology and socio [...]

Globally, subtropical circulation in the lower troposphere is characterized by anticyclones over the [...]

Numerical models are being used for the simulation of recent climate conditions as well as future pr [...]