How Do You Tackle a Big Idea?
It has long been believed that Capitalism is the last economic system. It has triumphed over its rivals, socialism and communism, and has now come to define modern society. Many believe that the religion of Adam Smith was the culmination of all of our economic experiments. To many, not only is Capitalism the best economic system that humanity has ever devised, it is the best that it will ever devise.
About five years ago, I decided to challenge that premise. An idea had occurred to me which ultimately germinated into a system. For two years, I let the idea gestate, examined it from every angle which I could conceive. Finally, in 2014, I was able to bring the concept to fruition. In May, 2014, I published an 14,500-word essay titled The Currency Paradox, a work of economic philosophy. But, more significantly, it presented a concept of incredible audacity…
An economic system that could viably replace Capitalism.
I published it thinking it had the potential to open up a new way of thinking about economics, that it might spur new approaches that would lead to improved economic equality. I shared it with economists of all stripes and political leanings, hoping to create a dialogue. I was interested to know what they thought about my essay and, more importantly, if and how it might influence their thinking on economic matters.
However, a strange thing happened: silence.
Though many read the essay, the small bit of criticism I received was entirely ideological. No one assailed its basic premise and the viability of the economic system presented in it went completely unchallenged. Though I knew better, it was as if my essay didn’t exist. Despite making repeated attempts, the Econ community refused to engage. Economists have refused to tackle the ideas presented in The Currency Paradox.
Some may think that it was probably because the ideas in The Currency Paradox were unworthy of debate. Maybe, but I doubt that absolutely no economist over a three-year period would not have taken the opportunity to “educate” a layman on the error of his concept. Economists are known for many things but humility isn’t one of them. However, more saliently, the concepts presented in The Currency Paradox, once only recognized and examined marginally, have gone mainstream: globalization, economic inequality, student debt, the value of work… all of these topics, which now occupy the mindshare of the Econ community, were addressed in my essay. Solutions like Universal Basic Income (UBI) and Universal Job Guarantee (UJG) have become far more popular topics of debate though the economic innovation in The Currency Paradox elegantly encompasses and surpasses both. The Econ community has become more aware of the pathologies in the Capitalist system but have refused to even examine a possible cure.
In every sense of the word, The Currency Paradox has proven to be “anti-fragile”; it is an idea that has only grown stronger as time has passed. Indeed, much of it has been confirmed through independent research; for instance, my observations regarding the changes in global economic inequality were independently substantiated by economist Branko Milanovich with his now-famous “Elephant Chart.” You’ll now get a chance to decide for yourself. The following is my essay, with only mild edits relative to the original. As with my original essay, we’ll start with my initial thoughts on Bitcoin; keep in mind that this was written in 2014, when the trajectory of it was still very much in doubt. My thinking on the technology hasn’t changed; rather, it has been confirmed. Though I’ve been proven correct regarding its viability as a common money, some people still consider it “the future.” I still think it is a way-station on the road to a better idea.
There’s been a lot of press recently about Bitcoin. What exactly is it? The simple answer is that it is a virtual currency. However, what makes it unique is that it is also an astounding innovation in computer protocols, akin to HTTP, SMTP, and other core Internet technologies. The Bitcoin protocol eliminates the need for a trusted third party when performing electronic payment transfers. Rather than entrusting (and paying) a third party to handle a payment transaction between two parties, Bitcoin allows two parties to transmit money, in the form of bitcoin, to each other near instantaneously and at very little costs.
What is exciting about Bitcoin is its speed, security, and low costs associated with payment. Its infrastructure maintains a perfect record of all transactions and has proven to be impervious to any malicious electronic attack. Proponents are excited by its potential to financially empower billions of people without access to banking resources or for whom money transfer is expensive.
While a tremendous achievement in a technological sense, Bitcoin is highly unlikely to be effective as a currency. For the most part, the important qualities of a currency are efficiency, elasticity, and its ability to store value. How does Bitcoin measure up?
For practical purposes, consider “efficiency” to mean the ease with which money is used for payment or transferred. Is Bitcoin solving a problem related to the efficiency of modern money? Not really. Granted, transferring Bitcoin is extremely fast, inexpensive, and secure, but it lacks the comprehensive infrastructure of today’s fiat money. Literally trillions of dollars are transferred between parties for payment and foreign exchange using the current system, which is mostly electronic and largely frictionless. In this respect, Bitcoin and other so-called “crypto-currencies” aren’t solving a problem. As it relates to efficiency, the fiat money system as it exists is “good enough.”
In regards to “elasticity,” fiat currencies are very flexible relative to the needs of the market; the money supply can be expanded or contracted as needed by governments or central banks. “Elastic money” allows a central authority to address excessive inflation, deflation, recession, or other distortions in a Capitalist economy [or at least try to]. Is Bitcoin more “elastic” than today’s fiat currencies? Absolutely not.
Indeed, Bitcoin suffers from many of the same problems that make gold impractical for modern use as money. Similar to gold, Bitcoin is “mined,” but through the use of algorithms; as more are created, the computational resources required to mine them increases. The net effect is that relatively few bitcoin are produced. This condition causes Bitcoin to more closely resemble commodity money, mirroring the same deficiencies. The fact that the total supply of Bitcoin is always a known absolute quantity and that new ones are slow and resource-intensive to produce encourages price volatility that actually greatly exceeds gold.
However, the most damning aspect of Bitcoin is the fact that only 21 million units will ever be produced; whatever beneficial qualities they have will paradoxically encourage them to be hoarded, artificially limiting supply. Right now, over 60% of bitcoin have never been transferred or exchanged. As the absolute limit of its supply is reached, Bitcoin transactions could potentially slow to a crawl. Demand could exceed supply so greatly that it will become obsolete; losing whatever perceived value it has as a common money as people flee to a less scarce, more flexible currency.
Some make the argument that Bitcoin is infinitely divisible, making the elasticity issue moot. However, the likelihood is that dividing bitcoin will create the problem of “infinite denominations,” producing a substantial amount of complexity in matters of accounting. Also, dividing a currency does not truly address circumstances in which actual expansion of the money supply is necessary. It is the equivalent of stating that a bucket of water can be stretched by using an eye-dropper for distribution rather than a cup. No amount of rationing from one bucket of water will solve the problem of needing another bucket of water.
Finally, currency should be a relatively good “store of value.” In other words, a particular currency should be generally accepted as having a certain level of worth in current circumstances and a relatively high chance of having a certain level of worth in future circumstances. Not only is this criteria very difficult to meet with today’s fiat currency but it is a difficult standard to practically meet with any currency. However, the “store of value” problem is circumvented in a pretty interesting way with fiat currency… its value is more or less imposed by force. Governments make the determination of what the common money will be and then use force, implied or actual, to ensure the money’s stability. This creates an interesting correlation between a country’s money and the power of its armed resources relative to its population. It’s likely not a coincidence that the world’s most powerful country militarily also has the dominant money. The bottom line is that the government of the United States of America has the legal apparatus and force of arms to ensure and reinforce the acceptance of the dollar as legal tender for resolving debt among its citizens. More importantly, U.S. dollars are the only form of money accepted by the U.S. government for taxation. The act of taxation provides strong validation for fiat currencies and ensures their value; this concept is historically referred to as “chartalism.”
Is Bitcoin an effective “store of value”? It is a largely unregulated, pseudo-commodity created completely electronically, controlled and validated by no central authority. Its value is determined entirely by the market. So it is worth something as long as people think it is worth something. The main problem with Bitcoin is that it has no real-world analog with which to reference. They have no intrinsic value of which to speak and not even the benefit of force of arms with which to impose their value. They are created from thin air and the very equipment used to create them can only be purchased with government-backed fiat currency. There is nothing to indicate that Bitcoin is an effective store of value.
Some claim that Bitcoin’s intrinsic value lays in the protocol that enables it. This is reasonable thinking if there were no possible substitutes and Bitcoin had evolved as the sole means of making payments or transferring money electronically. However, the global currency market can and likely will continue to evolve without the Bitcoin protocol. An object, system, or protocol must not only be essential but also unable to be practically substituted or duplicated for it to be credibly claimed to have high “intrinsic” value. For instance, what effective substitute can there be for indoor plumbing? Bitcoin does not meet that criteria. The global currency system already processes trillions of dollars in payments and exchanges and will likely continue to do so indefinitely without it.
Whatever its technological merits, Bitcoin fails utterly to meet the basic criteria of a currency. It is possible that other crypto-currencies will solve the problems of efficiency and elasticity, but it is highly unlikely that any crypto-currency will solve the problem of being an effective store of value. While the technology underlying crypto-currencies will surely make an indelible mark on the overall technological landscape, it is doubtful that Bitcoin or its copycats/derivatives will succeed in the long-term as currencies.
The Paradox of Fiat Currency
There are a lot of fancy definitions for money, but I prefer to think of it as the “blood” of an economy. Much like blood transports oxygen and nutrients to the cells in a human body, money flows in an economy to transport goods and services from the people who provide them to the people who need them.
However, fiat currencies themselves are only placeholders for real goods and services. Without the backing of central authorities, they have no real value. Fiat currencies are a paradox, being inherently worthless yet able to be traded for things of actual worth. This is a fundamental flaw in the Capitalist system. Let’s examine this in detail:
Does money have an exact or even near exact correlation to the amount of goods and services available at any given moment? Those who believe in the efficiency of markets will generally say “yes,” but it is highly unlikely. To illustrate: one person may be willing to pay $100 for a cow, one may be willing to pay $1,000 for it, however, does the cow itself alter in any way if someone pays more for it? Does the same cow become a better cow if someone pays more for it or a worse one if someone pays less for it?
The belief is that “markets” are self-correcting; that, in the end, fair value for that cow is established as an aggregate of what the market is willing to pay for it. But, under any conditions, market pricing is highly arbitrary. It is actually an aggregate of what many people with many different levels of understanding and/or need related to price and value are willing to pay. In many circumstances, people may pay radically different amounts for the same item or service. On top of that, items can be (and often are) priced by their supplier (businesses) to appeal only to a limited segment of the population, placing it beyond the financial means of a majority of people who may actually desire that particular item or service. Luxury items are notable examples. Quality is often stratified by means; higher quality items are reserved for those who can afford them. In this manner, quality of life itself is stratified. In the situation of the cow, it is unlikely that the person who can only pay $100 dollars for the cow has similar financial circumstances relative to the person who can pay $1,000 for it. Also, it doesn’t matter how many cows are offered for sale, the person who can only offer $100 will likely always lose to the person who can offer $1,000 for the cow. Targeted pricing by suppliers and variations in the knowledge and the means of the population creates pricing distortions in which items and services that may be very similar intrinsically have radically different values as measured in money.
A more significant problem exists when it comes to financial and speculative markets, such as commodities. To illustrate: soccer is a universal game and millions around the world play it … but what are the odds that a group of moderately-skilled players will be able to defeat a team of professionals?The pros are separated from the moderately-skilled players by a number of factors such as talent, ambition, long hours of practice, and a love or understanding of the game that gives them insights that less-skilled players do not possess. The professional soccer player has an advantage over the moderately-skilled player that is substantial in the short-term and practically insurmountable over the long-term. It is possible that some of the moderately-skilled players could achieve a high level of proficiency at the game with intense practice, but the actuality of that is highly unlikely. The reality is that, among the millions of people who play and enjoy soccer, only a relative handful has the unique combination necessary to become truly elite players. Those players will always have an advantage against lesser-skilled opposition.
The same can be said of financial markets as well. There is a relatively small group of “professional Capitalists” with the particular combinations of talent, experience, insider knowledge and circumstances to have distinct advantages over others who participate in those markets. These circumstances create distortions that are similar to professional soccer players playing against lesser players. Rather than both teams winning an equal amount of times over the long-term as statistics would generally dictate in situations with 50/50 odds, the professional team will defeat the team of lesser players the overwhelming majority of the time. Many markets are likewise skewed, with the people possessing expert skills and/or insider knowledge having an indelible advantage over those who do not.
These conditions make economics as a discipline an inexact practice. As a result of naturally occurring distortions in market dynamics, it is practically impossible to know the value of money in an economy – as an accurate measure of goods, services, and productivity – at any given time. The reason for that is because market economics guarantees that nothing can ever have an absolute, permanently-fixed value defined in money. Indeed, there are substantial advantages for professional Capitalists that such conditions exist.
This brings us to the matter of money supply. In theory, central banks or governments can create an unlimited amount of it. Fiat currency is an artificially-created commodity which, by the very fact that it can be produced practically without limit with relatively little effort, is worthless. Yet, every unit of fiat currency can be exchanged for real goods and services. In other words, something that is inherently worthless can be exchanged for things of actual worth. Central authorities get around this by letting markets determine what currency is worth in any given circumstance but, as shown, this is a symbolic exercise. Does believing that money is worth something actually make it so? Also, what actual choice do markets really have? Fiat currencies are standards codified by laws which are then protected with implied or actual force. It is impossible to live in a modern society without having to use fiat currency, especially considering its use for taxation purposes. As a result, people who control the production and lending of money wield an incredible amount of power and have a ridiculously unfair advantage over those who do not.
From a syllogistic standpoint, the following conclusion can be drawn: without a way to precisely correlate fiat currency to actual goods and services, the fiat currency system is very similar to theft. As previously stated, fiat currency is inherently worthless, yet can be exchanged for actual goods and services the moment it is created. Those responsible for producing and lending it benefit from legal monopolies that are protected by force. On top of that, even in an economic environment in which markets set its value, the constant production of fiat currency slowly erodes its purchasing power to zero. This in itself would not be as much of an issue if the decrease in money’s purchasing power was offset by relative increases in the amount of money people earned as a result of providing their services in the form of work. However, that is not the case. Globalization and technological advancements have deprecated the overall value of work by shifting labor costs from more expensive, highly-developed labor markets to less-expensive, developing labor markets. In other words, the earned incomes of workers in highly-developed regions are stagnant or falling as a result of their being displaced by technology as well as workers in developing regions, whose incomes are commensurately rising. The net effect is the leveling of most incomes across all regions to a common lower baseline. The improvement in the standard of living for some is coming at the expense of the standard of living for others.
This can be seen in the growing glut of labor supply in highly-developed regions taking the forms of high unemployment and underemployment. Because people, for the most part, cannot opt-out of the fiat currency system, the bargaining power of most workers is severely compromised. As the overwhelming bulk of necessary work doesn’t require advanced skills, there is always a ready pool of people willing to take the lowest level of compensation offered in order to survive. Efforts to destroy, severely hamper, or suppress collective bargaining in many developed regions has also greatly contributed to stagnant or falling earned income. The net effect is a system in which workers must compete individually against not only each other, but also a massive network of corporations and institutions that control the overwhelming bulk of the planet’s wealth and resources through the fiat currency system.
This condition could be offset if people could retreat to an alternative economic system outside of the fiat currency system. But such a system does not exist in a practical manner. There is not a practical alternative economic system in the world ready to claim the billions of people currently being economically exploited or neglected by the current system.
Massive unemployment and underemployment, widespread poverty, and escalating income inequality are the clearest evidence that the fiat currency system is a sophisticated form of theft; by correlating real work to an inherently worthless commodity and then deprecating the purchasing power of that commodity over time, the fiat currency system isn’t just an extremely efficient system of theft of goods and property, but one for theft of something far, far more important … time.
The Debt-Driven Economy
In order to get into the heart of the current economic system, it’s best to start with a simple question: why does the fiat currency system exist?
Some conspiracy theorists think that its purpose is global enslavement, that a cabal of the super-wealthy and powerful has created it to control the world. If there is indeed a conspiracy controlling the financial system, then:
1) it has beaten all odds by keeping such a thing relatively secret for presumably decades to hundreds of years;
2) Even still, the odds are very much against such a group maintaining this type of secrecy indefinitely;
3) Even if everything goes more or less exactly as this cabal plans, something completely unexpected will occur that will tip the apple cart. A perfect crime may indeed be possible, but not an ongoing one that lasts hundreds of years.
A simpler explanation is that the fiat currency system exists because it is practical and, for the most part, it has worked. It has been exceedingly effective as a mechanism for the advancement of the human species.
The fiat currency system is complex in its intricacies, but simple conceptually. It is actually similar to a game of “hot potato.” Basically, when money is created, it is immediately loaned to a person or entity with the expectation that the borrower will pay it back with interest. In many instances, the money initially borrowed is loaned out again at a higher interest rate to another party. The initial loan can change hands several times or not very much at all but, ultimately, a borrower without the means or inclination to pass the debt must invest time and effort to produce the goods or services that can be exchanged for the money to repay the debt. In this manner, value is actually created. It can be stated that this is the engine on which civilization runs.
However, there are signs that the system has reached the limit of its utility. The likelihood is that debt has exceeded the total capacity for human production so much that it can no longer drive real growth; debt has simply accumulated far beyond the practical ability for it to be repaid with productive effort.
Since fiat currency is created by central banks in massive quantities, it can be loaned very cheaply; this is normally accomplished when they buy assets or securities from governments or large financial institutions, often ones native to the region in which the currency is produced. In some instances, such as China, the government itself acts as the central bank. When central banks or governments purchase securities from large banks, the funds are added to the institutions’ reserves and then used as the basis for what is known as “fractional-reserve banking,” a practice in which the bank is able to lend a greater amount than what it retains in actual monetary reserves. Critics of the fractional-reserve model claim that it creates money “out of thin air” and they are, for the most part, correct. However, the problem isn’t necessarily the money created through fractional-reserve banking, but the debt obligations created by the demand for interest on the money that is loaned.
To account for potential defaults and to make profit, banks charge interest on their loans, the rates of which are generally inversely related to the amounts loaned. In other words, money is cheap to borrow in large quantities and becomes progressively more expensive to borrow as the loan amounts decrease. This condition is mostly circumstantial; banks lend money based on the assessment of risk for default. Institutions and individuals that already control massive amounts of capital are seen as better risks when lending large sums of money. The less capital that is controlled by an individual or institution, the more it is perceived as a risk for default relative to the amount to be loaned. Even those with an excellent repayment history will be limited to how much they can borrow simply based on their capital levels. The greater the perceived risk for default, the higher the amount of interest that is charged for a loan. This creates the paradoxical situation in which the entities with the least amount of resources to repay loans have greater debt obligations in relation to those resources when they borrow money.
The likelihood is that debt creation has outpaced the practical ability for it to be repaid with work. Estimates place total world debt at roughly $224 trillion USD; split evenly among the roughly 7.13 billion people on the planet, that places the estimated debt burden of everyone at about $31,417 USD. A considerable figure, but maybe not as intimidating as some would think. However, consider the following:
Using the average world salary in Purchasing Power Parity (PPP) dollars of about $18,000 annual (the equivalent in USD), it would take every individual about two years to pay off their share of the debt. However, this can only be done if nobody pays for anything else, such as food, water, shelter, or clothing. If you assume that everyone will have a relatively generous 15% left over as disposable income after paying for necessities, this leaves about $2,700 per year per person to address the debt issue. Based on that number, it would take over eleven years for each person pay off their share of the debt. For many, that still may not seem like a particularly excessive burden until you take these other factors into account:
That debt burden is for everyone: man, woman, and child, from newborns to those only seconds away from death, not exclusively working-age adults. Labor force Participation in the U.S. is roughly a third of the population; applying that proportion worldwide, the debt load for each working-age person is $94,118 USD. It would take a bit over five years for each person to pay off their share of the debt provided they paid no other expenses. Using the disposable income figure of $2,700 per year, it would take each person about thirty-five years to pay off their share of the debt.
Over two billion of the 7.13 billion people on the planet live on less than $2 PPP per day. Multiplying their daily income ($2) by the number of U.S. standard business days in a year (260) yields an annual income figure of $520. At that annual income, it would take over sixty years for the members in this group of two billion to pay off their $31,417 share of the debt while not paying any other expenses. At 15% disposable income, it would take each of them over four hundred (400) years to settle their portion of the debt.
However, this assumes a complete workforce of 7.13 billion people. If we confine the debt to a labor force participation rate of roughly 1/3 the size of the total population, it would take about one hundred eighty (180) years for each person in this group to pay off their share of the debt provided they pay for nothing else. At 15% disposable income, it would take each of them over twelve hundred (1,200) years to pay off their share of the debt.
These figures assume a static debt. However, the debt is actually growing at a rapid pace. Almost every new unit of fiat currency created carries a debt burden (there are exceptions, U.S. minted coins being a notable one). Debt creation is not standing still.
However, things aren’t all bad … global wealth is estimated to be about $241 trillion. Operating under the premise that one dollar of wealth destroys one dollar of debt, subtracting total global debt from total global wealth leaves the world with $17 trillion net wealth. Not too bad, right? But …
Using the current distribution of wealth, the top 1% of the population will control 46% of what’s left while the top 10% will control 85%. Of the $17 trillion left, the top 1% will control about $7.82 trillion or about $109,677 per “1 Percenter.” The next 9% would control about $6.6 trillion or about $10,285 per person, rounding out the top 10%. This leaves $2.55 trillion dollars for the remaining 90% of the world, a little over 6.4 billion people. That equals about $397 per person or slightly over $1 per day over the course of a year.
While this is definitely a simplification of the debt situation, it should provide a pretty accurate sense of its scale. It takes real effort in the form of man-hours to pay off debt and the scale of the debt created by the fiat currency system is staggering. The debt situation facilitates tremendous financial inequality, as those with the knowledge, skills and connections starve the fiat currency system of money by accumulating it in huge quantities through profit and capital gains and using it to control massive amounts of natural resources.
The net effect is that fiat currency has likely outlived its usefulness as a practical means for managing an economy. In other words, the fiat currency system has simply become too expensive. For instance, even with massive advancements in technology, debt and inflation have made funding large- to massive-scale efforts such as actually returning to the moon or sending a manned mission to Mars economically unfeasible. Some may think that such efforts are unimportant, but, as I will explain later, the very survival of the human species relies on our ability to fund projects of those magnitudes.
Next: Part 2