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- Stephen Roach warns of a crash in the dollar by as much as 35%.
- “Money is no longer scarce,” will lead to money no longer having value.
- Scarcity and value go hand in hand & vice versa.
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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Redefining Money, or, “If Wishes Were Horses…”
October 7, 2020
Kevin: Many of our listeners know that on Monday nights we meet, you smoke a cigar when you’re not training, and I drink a little bit of a Talisker, and we talk about things. One of the things that we’ve been puzzled by, Dave, is this amazing amount of money that’s been created, this sea of money, and we’re just wondering where velocity went, which is how many times a dollar changes hands. Velocity has been falling now for about a decade, really.
As we were talking about it, because we knew you had committed last week to talking about velocity, in particular, of money this week, it hit us both. We’re not talking about velocity of money. We’re talking about scarcity. Is there even scarcity anymore? Money used to be something that was scarce. That gave it value. Is there scarcity? And is that the direction we should look at today?
David: Yes, and scarcity is our subject. Does scarcity have value or is abundance to be preferred? The answer seems obvious. If a little is good, a lot must be better. So abundance is, I think, where we end up landing.
Kevin: Even how we measure money has changed over the last 100 years.
David: Yes, even our theories of money. The quantity theory of money is being left behind because it depended on an old definition of money. We’ve been redefining money for the past 100 years in different ways, in different iterations, beginning in 1922 at the conference of Genoa when we shifted to the Gold Exchange standard, a subtle difference. But then a hard shift in 1933 when we made gold illegal domestically, but still maintained legitimacy with our foreign creditors by keeping the exchangeability of gold with foreign creditors.
That followed up at Bretton Woods in 1944 when we defined the World Monetary System according to the U.S. dollar based on our massive gold reserve assets and a stable economy. And then, of course, more recently, when we left the Bretton Woods system and unhinged the dollar from any tangible backing in the 1970s. That final move allowed us to shift from a narrow definition of money to a very broad one, including credit, in the new definition of money.
Kevin: And that’s something you and I can’t do. To me, that’s the defining line. You and I can count what we have in our bank account as an asset. We really can’t count what we could go charge on our credit card as an asset. Yet what you’re talking about is, that’s how money works. If you think about debt, and we’re going to talk quite a bit about that today, I think of the old saying, “If wishes were horses, all beggars would ride.” Now, if you think about that, debt is a wish brought from the future into the present. And there’s still a cost.
David: So you redefine money and the benefits then accrue to those segments of the financial universe that are closest, both to the creation of money, as it was and as it is, and its flow. So now you have securities, you have money-like instruments, and credit, primarily, is what we’re talking about. And so who’s the primary beneficiary? Wall Street and your major financial firms have, really, since the 1970s and more rapidly since the 1990s, displaced even commercial banks as the handlers of money, as the creators of and the distributors of, this new form of money. So even as deposits and currency in circulation have become a smaller part of what today constitutes money, Wall Street has had a bit of a haven.
Kevin: So the question becomes, how then do you count velocity? If old money, which really is what we consider currency, is just the old way of counting, how do you count velocity, the changing of hands, the movement of this energy storage form called money?
David: Yes, so velocity should not just count the old money but also account for tradable debt instruments and the money-like securities as well, and account for the trading that occurs on a very high-frequency basis. We said we would talk about the Q2 [second quarter] Z-1 report [Financial Accounts of the United States, formerly known as the Flow of Funds accounts], and so we shall. It was Richard Duncan’s contention in sort of an offline conversation, and then he just did a Macro Watch video series also, that velocity is irrelevant, and velocity tells us nothing about inflation. And I agree, but I would add that if you’re going to change and broaden the definition of money, it’s not fair to keep the old narrow definition of velocity. So get them to match up and the indicator is as relevant as ever.
Kevin: So if we’re counting debt now, just like we would count the creation of money, call it M2 and M3, how do we then count the creation of debt? I mean, how much has that increased?
David: That’s where the Z-1 shines a light on the various segments, whether it’s household debt or non-financial debt, government debt, all those segments are broken out and accounted for. There in the Z-1 we find debt securities have increased $5.9 trillion in the past year, 3.36 of that increase in the second quarter alone.
David: Never before has that kind of growth occurred in such a short timeframe, to a new high to a new high.
If you’re looking at the cumulative number now, a new high of 51.69 trillion. That is 265% of GDP, complemented by equity securities, which came in at 51.95 trillion, 267% of GDP. So if you look at total securities, they increased by 12.48 trillion dollars in the second quarter to a brand new total for total securities, a new high, 103.65 – 103.65 trillion dollars, which as a percentage of our gross domestic product is 532%.
Kevin: That’s a list of an awful lot of numbers with a “t” after it – trillion. But the bottom line is debt is exploding at this point, and we’re calling it money.
David: Yes. Can we ignore the securities market and the expanded footprint of credit? Again, this goes back to, if you’re measuring old velocity but you’ve got a new form of money you’re really not talking apples to apples. So perhaps the old definition of velocity is dead or irrelevant, which is why I think it’s important for the conversation to include an expansion of credit and credit instruments.
So if you look at banking assets, as I mentioned earlier, they’re fading in terms of their significance, and that’s in line with what used to be money. Banks are not the only originator of loans today. Banking assets compared to the $103 trillion that are in the total securities markets, bank assets are at 22.78 trillion, a fraction of the total in the securities market, and the securities markets are treated more and more as money-like assets.
Kevin: So for the person who says, “Wait a second, you’re expanding all this debt and you’re calling it money, I protest.” The people who are creating the debt would say, “Oh, no, no, you’ve participated.” You asked the question, would we prefer to have scarcity or would we prefer to have abundance? They would tell you that your household debt has skyrocketed. You should just be happy and shut up.
David: But assets have, too, so your net worth figure is improved. It doesn’t matter that household debt has increased, assets have, too, so your net worth figure is 118 trillion. That includes your real estate holdings. At 118 trillion, household net worth at all-time highs is topping 610% of GDP, previous peaks.
Kevin: Aren’t we saying the same thing? I accidentally said household debt. I meant household net worth (laughs). But no, let’s stop for a second. That is actually what we’re saying. Debt is an asset at this point. Debt is money. It is net worth.
David: It’s the new form of money because it allows you to spend what you want to spend on what you want to spend, when you want to spend it, regardless of whether you have it or not.
Kevin: So if wishes were horses…
David: Beggars would ride. And these beggars are riding high, to the tune of $118 trillion. Again, just for comparison, your previous peaks for net worth where 2000 and 2007. I guess that wouldn’t come as a surprise. But again, relative to the size of the economy, 446% of GDP and 492% of GDP, respectively. So, sitting at 610 we’re in a new era of either success or excess. Again, we come back to this issue of abundance (laughs). Nobody’s complaining, right? So is there value in scarcity? How do you value something without scarcity?
Kevin: That’s what I’m wondering. I mean, if you can just create out of thin air any form of money whatsoever and they say, “Well, that’s abundance because household net worth is just skyrocketing,” then what is valuable anymore? That’s the question. Even when people call and say, “Tell me about cryptocurrency. Why does it have value?” Or, “Tell me about gold? Why does it have value?” Well, tell me about debt, Dave. Why does it have value?
David: I would come back to this sort of dirt versus diamonds – where is or what is value without scarcity? That was the question at the dinner table last night. A dump truck full of dirt versus a handful of diamonds – does scarcity matter? The fact that you can find dirt just about anywhere, the fact that you can’t find diamonds just about anywhere, there’s a scarcity differential there.
Kevin: What did your kids say?
David: To the six-year-old it was kind of like, “What are we talking about here?” But to everybody else, down to the nine-year-old, the answer was an obvious yes. Of course there is a difference between diamonds and dirt.
Kevin: So is Duncan right that if we measure velocity the old way, it’s really not meaningful at all as far as a measure of inflation?
David: Right. What does velocity signify when the system has moved on from the old version of money? Since we have changed the quality of money by more broadly defining it is credit plus money in circulation, deposits in the banks, as well, we have also redefined its functions. Money was once the domain of exchange transactions. “I’ll give you this amount of dollars for that amount of eggs, groceries, gasoline, water,” what have you. There was an exchange transaction. It was also a representation of a store of wealth. Essentially, money has been, through the millennia, energy, or labor stored for future use.
Kevin: You have different forms of money, even in your office, Dave. I know on certain islands they had big, round, heavy stones that were considered money. Why? Because there aren’t that many big, round, heavy stones. And so there was an element of scarcity, which means when a person would say, “Yes, I’ll accept that in trade” because it has a certain amount of scarcity, then it became a store of energy and productivity.
David: And now, money, when you include credit, in particular credit, is not used exclusively for the exchange of goods and services. But there’s this financing component, and it is a derivative, a representation, more than a representation of labor and energy, it’s kind of a derivative form of labor and energy, a form that’s easily used for speculation. So the new function of money, when more broadly defined as credit, is to promote growth in the present on terms that include a future cost. There’s this repayment of principal and interest. And that’s a key wrinkle.
Kevin: So if we were to simplify what we’re talking about, nothing’s changed. When you go into debt, you are stealing from the future for the present.
David: Yes, and that has some opportunities and sometimes necessity. You have to do that in periods of real crisis. So we counted the velocity of money on the old definition of money as the number of times a dollar circulates through the system. Now, circulation of those dollars has shrunk, even as the total quantity of what we call money, that is the old and particularly the new money, in combination is an even bigger number. Again, the circulation of money – I’m talking about the old money – represents a small part of the function of money, which is now beyond spending, beyond bank deposits. Again, new money equals new functionality.
Kevin: So are you talking about the bond market? That’s what represents debt is bond market, right?
David: And it’s a work-around for the banking industry as a whole. This is one of the reasons why commercial banks are under pressure, even while Wall Street and bond traders are not so much under pressure. Using the bond market, harnessing the power of credit, we can transport future growth into the present. We can shift future consumption into the present. And this is the key benefit of credit as money. And of course, there are attendant risks, but that is the key benefit, that you can move the future into the present and end up goosing your growth figures and growth statistics.
Kevin: So when we took economics in school, wasn’t economics being economical with something scarce? Has that changed?
David: Economics is the social science that has the most to say about the future. They don’t have to be right about the future, but they’re the ones who are prognosticating, predicting, anticipating, measuring behavior, telling us what the results are from the behavior that they have accounted for, measured, observed.
Kevin: But there’s an element of uncertainty. That’s why you study economics because you’re trying to figure out how to embrace uncertainty going forward.
David: What the redefinition of money allows is for economics to consider the best ways, not only to anticipate the future, but to guarantee future results.
Kevin: There’s a change. No longer is an economics. At that point, it’s just control.
David: Right, because credit is a facilitator of desired economic outcomes. So if I have the ability to change the terms of credit and so influence the incentives, someone has to either consume more or less in the present, again, you find expensive credit is restrictive, cheap credit makes economic activity more accessible, and if you start playing with these levers, what you’re doing by redefining money is that you’re empowering economists to not only predict the future, but to directly, or maybe it’s more fair to say, indirectly influence outcomes and create the future.
Kevin: Do you remember when you interviewed Thomas Sedlacek, who wrote the economics of good and evil? He said, “If you look at the creation of money or the central banking community, they are almost like the new religion, and the central bankers are the high priests of that religion.” Dave, one of the things that I’m interested in is astronomy. I’ve studied a lot of Babylonian astronomy and just looked at how the control was kept on being able to predict ahead of time the movement of the planets, and you would have families that generation after generation would guard these secrets very, very carefully, the movement of Jupiter amongst the Zodiac or the movement of Saturn or Mars.
What they would do is they would direct the future by making predictions of something that other people thought were random events. But see, they actually had figured out a way of controlling. Now, in a way, what you’re saying is, if an economist or if a central banker can create money and then choose where it goes, they can influence the future events to their direction. Isn’t that just like a high priesthood?
David: Yes, and I think what you’re in some sense talking about, when it comes to Babylonian astronomy, is informational arbitrage. These are men, families, who had information that no one else did, and they were able to use that to their advantage. And that kept them safe. It ensured their survivability through multiple kingdoms, through multiple regimes.
Kevin: Yes. Babylon, Mead, Persia, Greece, Rome. These families existed all through those different changes of power.
David: Right. And then they were necessary because they had this informational advantage. They kept it very tight. So yes, Tomas Sedlacek describes the relationship between time and money, and says that, like energy, it can be moved around in space and time. And he says that, as a form of energy, money can travel in three dimensions. Vertically, those who have capital to lend to those who do not. And again, this comes back to this fascinating idea, Kevin, of having capital. Ordinarily, we think of that as savings, and so if you’ve saved, you have the opportunity to lend. But now we’re talking about capital created out of nothing, and that’s an interesting twist, as well, from this old version of lending.
Kevin: Well, that’s alchemy. That is magic or alchemy, and usually that has to do with trickery.
David: So, he says, three dimensions. One, you can move it vertically. Those who have capital to lend to those who do not have capital. And horizontally, which is speed and freedom in horizontal or geographic motion, and that has become the byproduct or driving force of globalization. But money, as opposed to people, can also travel through time, and this time travel of money is possible precisely because of interest, one of the fascinating points that he’s talking about.
Kevin: Yes, borrowing from the future. There is a charge to borrowing from the future unless you also take away all the interest charge, which the central bankers have done.
David: “Because money is an abstract construct,” he says, “it is not bound by matter, space, or even time. All you need is a word, possibly written, or even a verbal promise. Due to this characteristic, we can energy strip the future to the benefit of the present.”
Kevin: Say that one more time. You’re stripping energy from the future.
David: I think this is a critical.
Kevin: This is a quote, right?
David: Yes. Due to the characteristic, and again, this is the interest component. Think about these two things. “The time travel of money is possible precisely because of interest. Due to this characteristic we can energy strip the future to the benefit of the present. Debt can transfer energy from the future to the present. On the other hand, savings can accumulate energy from the past and send it to the present.”
Kevin: That sounds a little healthier in the long run, doesn’t it?
David: Yes, so he ends by saying, “Fiscal and monetary policy is no different than managing this energy.” I ask the question, are the monetary and fiscal policy initiatives of the present period driven off of wise reflection of future needs, of optimal intergenerational investment? Or instead, is our fiscal policy and monetary initiatives driven off of pragmatism? Is it driven off of essentially generational selfishness?
Kevin: High inflation hit Greece about 700 years before the time of Christ, and there was a collapse in their currency. They made a new law that basically said anyone who took the Greek currency off the silver standard would suffer the death penalty. They had a death penalty because they had learned that they never wanted to experience that again. I’m wondering, what do we learn from history about this new definition of money?
David: Yes, because it’s actually just like we talk about Modern Monetary Theory, which is not modern in any sense of the word, the new definition of money is not really that new, either, because we’ve had people wrestling with these ideas for a long time. And Sedlacek, I highly recommend the book, Economics of Good and Evil, because he chronicles the early Greek and Jewish concerns over the rapacious nature of debt and of interest. And he balances out the benefits with the temptations of shifting energy from the future to the present. And that is for personal, that is for generational, benefit. But you kind of leave the next generation holding the bag.
Kevin: And debt can be fine when you use it temporarily when you need to bail something out or what have you. But it’s become a permanent fixture to the point where we’re actually calling it our money.
David: Right. It has always been a tool helpful to fill gaps. It allows for family continuity, business continuity. It’s a financial bridge of sorts. Its use today is very interesting. This is where I think Duncan has a fascinating insight when he describes creditism versus capitalism. Now, debt is used in the context of abundance. It’s not just a gap filler, but it’s used as an enhancement for the comforts of life.
It’s not a safety net. It’s not as a means of investment in future productivity. It just means that instead of eating a little, we eat a lot. Instead of traveling a little, we travel a lot. Instead of living a little, we live a lot. In fact, most debt is unproductive. It shows no positive return on investment. There’s no future cash flow generated from it. It’s just an accumulation of an obligation, and it really is that sense of sucking energy from the future into the present.
Kevin: You had asked about dirt versus diamonds, but if there’s something that’s not scarce, ultimately it becomes relatively worthless. So is money no longer scarce?
David: (laughs) Money is no longer scarce. Money is no longer simply a representation of labor and stored energy. Again, a store of value, a medium of exchange – that’s how we used to define money. Credit as money transforms the old functions into new possibilities. And with those new possibilities, there are also perhaps temptations. And this is where economists have in recent decades become like the philosopher kings of old, the central planners, influencing outcomes and creating a future they deem to be ideal.
Kevin: We talked about economics being a way of trying to counter uncertainty going into the future. But do you eliminate uncertainty for a period of time if you can create money?
David: Both at the level of a household and at that of a nation, you take away uncertainty, typically by a countercyclical choice. For instance, you and I might say, “Look, in a tough time, we have a rainy day fund. This is why we have a six month reserve of cash.”
Kevin: Why would you save for a rainy day if you could just print it as you need it?
David: Exactly, because now, with money defined by credit, you can always move resources through time. You can move resources and re-allocate from the future to the present moment of need. So why save at all? We have truly redefined the nature of capital in capitalism through the redefinition of money.
Kevin: So we can be sloppy with the way we spend because it just doesn’t matter.
David: Yes. Tapping credit lines, if you don’t use wise management, you can see these things get out of control. And herein is the problem. Credit is not just someone else’s capital being redeployed as a loan. Today, credit goes well beyond the redeployment of savings, where you are matching up someone who has too much and someone who has too little. This is the old banking version of financial intermediation. We’ve gone beyond that. Credit is now facilitating more than just that intermediation process.
Kevin: So are we reaching John Maynard Keynes’ dream, which is very low savings and high velocity as far as just spending continually? But the velocity isn’t in money, per se, it’s just continually deployed assets. I don’t know, I’m trying to figure out, because Keynes really did not believe in savings even though he himself was able to make millions and lose it multiple times. In his economic formula savings wasn’t really a big part of it.
David: I don’t know that this is Keynes’s dream. It may end up being something of a nightmare as we’ve had intervention after intervention, which in the context of crisis, certainly is Keynesian. But when it becomes normalized behavior…
Kevin: So this is normalized Keynesianism.
David: Yes, so I don’t know that neo-Keynesianism is exactly the same thing, and we certainly have normalized that interventionism today.
Kevin: At this point, if this continues to work, savings is not even worth it.
David: Because you can count on the appreciation of assets. You can count on the inflation of assets. As you continue to increase the quantity of money in the system, lo and behold, you have an inflation of something. If it’s not of consumer goods, it’s of things, it’s of real estate and stocks and bonds, and what have you. And so, yes, to some degree credit makes the concept of savings seem anachronistic. If you always have access to liquidity via the debt markets and if you have an inflation of asset prices, why would you limit what you’re spending today? Why reserve – why store energy indefinitely?
Think about the creation of trillions of dollars in credit this year. Where did it come from? Whose resources were they first? Was it an existing capital pool, which was then turned into individual loans or bonds, or are we back to this idea of creation out of nothing – creation ex nihilo? No, what we’re talking about is the writing of IOUs, the purchase of IOUs by the central bank in a way that pumps liquidity into the financial markets. If you look at current measures of velocity, they don’t capture this growth in financial instrument liquidity. If you just look at the old definition of velocity, it does not capture that growth in financial instrument liquidity and how it circulates within the financial ecosystem.
Kevin: So Duncan may be right.
David: In that sense, Duncan’s right. Old velocity of money measures old quantities of money. Credit has to be accounted for as the larger part of total money in existence, and so does its circulation. Then consider, if you would, the amount of credit that is in the system as it’s turned over.
So we’re back to this issue of circulation. Some people buy these investments and hold them. Debt instruments are sometimes held to term, to maturity. And oftentimes they’re traded and used as instruments to speculate on interest rates, to speculate on foreign exchange rates, to speculate on credit dynamics. And so the excess actually stimulates a different kind of behavior. It’s not necessarily productive investment to create more in terms of goods and services. It’s just, “We’ve got this stuff, and maybe the price is going to move, and maybe I can make a penny and leverage the penny on the move.
Kevin: If there is nothing new under the sun, like Solomon says, we can go back to the old clay tablets, talking about Babylonian astronomy, and it’s fascinating. I know for many people it sounds dry.
David: But everybody studies it.
Kevin: (laughs) It’s fascinating, but the only reason we know what they thought was because they wrote it down on something that’s probably one of the most permanent record keeping devices out there, far better than our digital media at this point. You put it on a clay tablet, you bake that in stone and you see it. So this trading of IOUs is not new. These clay tablets not only kept records of the stars and the movements of the planets, but they also kept record of the prices of commodities, and they also kept record of who owes who how much, and with the belief system that they would actually get repaid.
David: That’s right. So again, is this idea of credit as money a new concept? Not exactly, it’s just changed in terms of the scale that credit is used. But it’s not as if credit as money is new. The clay tablets in ancient Mesopotamia allowed for the transference of debt, credit, from one party to another. It was a tradable instrument then.
Kevin: Yes, but that’s not what’s changed. You had to have the belief that you were going to get repaid. That has to be factored in for debt to have any value at all.
David: Sure. So just keep in mind that credit comes from the word credo, meaning, I believe. What is your creed? These are the things that I believe. So you’re right, belief is tied to credit. And it’s this belief that either I will pay or I believe I will be repaid. And these are not new ideas. Credo is the root word. What is novel in the modern world is the displacement of money in circulation as the primary form of money. Now, it is predominantly an “I believe” system, predominantly a credit system, where confidence is tied to the future repayment of obligations. And sadly, this is, I think, a subtle shift, but an important one, the parties responsible for paying the obligations may not even be born yet. So it’s not really, I” believe I will be paid back by the party who borrowed.” It’s rather, “I believe in the power of future extraction via taxation, inflation and financial repression. And I believe in the enforcement of these contracts and obligations on whomever’s head they do fall.”
Kevin: So I believe, after this conversation, that you have no intention of repayment, if you’re the guy talking about what you just now said.
David: No. It doesn’t matter. That’s why you can go from 9 trillion to 18 trillion to 27 trillion, and it doesn’t matter anymore because no one has the intention of paying it off. Someone may say to themselves, “That’s a scam, that’s a lie.”
Kevin: That’s the new meaning of the word confidence. Remember, confidence can either be used for a con game, a confidence game, or confidence can be that you’re going to actually repay and have integrity.
David: I sat with a gentleman who was giving a loan on a fairly substantial property. He said, “I’ve been in the community for 30 years. The bank is giving me a jumbo loan on my house for 30 years fixed at less than 2.85%.” And I thought, “That’s just amazing deal.” And obviously, because it’s a jumbo loan, it’s nonconforming, it’s not going to be sold off to Fannie Mae and Freddie Mac. That is a banker who knows you and knows your ability to pay. He knows your honesty and integrity and that you are good for it.
Kevin: That’s the good meaning of the word confidence.
David: Right. And so it’s there on a one-to-one basis. Confidence is no longer based on a one-to-one relationship, but on structural power. And in the near future, today’s debtors will be dead and gone, and they will have captured the benefits of debt in the present moment, leaving the obligations to linger for those that did not reap the benefits. Now, we’re assuming that most debts are unproductive in nature, I think that’s fair to say.
Kevin: You and I were talking about who would say no to this system. It offers abundance. And then it hit me. Any German over the age of 70 or 75 would scream and say, “Don’t you see what you’re doing?” I remembered Klaus Buecher. He was a money manager that we used back in the 1990s for international bonds. I remember he sat me down, I was in New York on 42nd Street, I think it was, in an office in a high-rise building. I thought he was going to talk to me about his bond fund. Instead he said, our family had to pay for its house three times in the last century. He said right after World War I the inflation felt abundant at the time, and then we ended up losing everything, World War II.
And then finally they had to pay off their third mortgage. He said they had just finished paying off their third mortgage, but what he was saying was their family literally had a cellar full of vodka that they didn’t drink, that they traded as money when their money completely collapsed. Germans, even now in the European Union, Dave, the old Germans would say, “What you’re doing is going to be something you will highly regret later.”
David: Again, back to this issue of unproductive debt, because it’s not as if all debt is bad. But this year’s increase in government debt – 500 billion in the first quarter, 2.8 trillion in the second quarter. So the second quarter filled a gap left by consumers. You’ve got the pandemic. But this gap – think of this. Government spending was four times more than the previous record set in the fourth quarter in 2008. So $3.3 trillion in the first half of the year to keep the recession from being worse. But, number one, that obligation has to be paid back. So this is a debt, this is not a grant. It’s a debt. And number two, it’s gone. There’s nothing in terms of future growth or income to show for it. That’s the working definition of non-productive debt. So no one bothers with the problems of abundance.
Kevin: Not at the time.
David: That’s what the Fed wants to create. It wants to create abundance. We’re not critics of having too much, and I suppose you could be a critic – if you have a hangover you might be a temporary critic of abundance. But the only lasting critics of abundance are like the Klaus Buechers, as you have described, those who have lived through a full cycle to appreciate the downside of abundance. I know that sounds weird, but who wants constraints on a system? Actually, it’s only those who have lived through a cycle of excess and know that there are consequences, many of which are unintended, but painful nonetheless.
Kevin: Do you remember when Polverini said, “If you are getting something for free, you’re the product?” When my wife and I were at a carnival right after our daughter had been born and she was in the stroller. And I love to throw darts, Dave. I love playing darts. And there were, of course, darts and balloons, you know, the typical carnival thing. This guy said, “Hey, do you want to throw one for free?” It’s a dart. Why wouldn’t I throw one for free? Of course, I popped the balloon, no big deal. And he said, “Wow! Do you want to throw another one for free?” And I’m thinking, “Yeah!” Well, that was the last time he said for free. He kept handing me darts, and I thought they were free.
David: Okay, now this has got to be five bucks, right?
Kevin: Oh, no, it was more than five bucks. I just kept popping balloons. No, I was the idiot in the equation. He demanded the payment of the money, and I thought I was just living for free. I kept getting bigger and bigger prizes. I should have known. I’m not the sharpest knife in the drawer. But are we doing that? Are we throwing darts right now at balloons and getting prizes and thinking that we’re not paying for them?
David: I think this is an issue. The Fed is being graded on providing abundance, which again is tough to criticize. We like having more, rather than less, of everything. It is somewhat like a Rorschach test. More or less money? More. More or less power? More. More or less sex? More. More or less food? More. We’re going to vote for more, and that provision of abundance, at every turn.
Kevin: Sure. Here’s a dart.
David: Yes. Here’s less. And you think, “No, who wants that?” We’ve already defined austerity as evil, scarcity as bad. What is adequate, though? What is adequate? What is enough? We’re living in an age of abundance, and without answering those two questions of what is adequate, what is enough, we tend toward excess, certainly not scarcity.
Kevin: So is there any value without scarcity? That’s the question.
David: Value without scarcity, but I think there’s also value in scarcity. Arguably, there’s only value because of scarcity, because without scarcity values are largely driven by how we see and equate what something is worth. It’s driven by an impression. It’s driven by a trend. So the value of a house, if you’re talking about just time and materials, might be worth $500,000, but in the market it might sell for 750,000, it might sell for 800,000, it might sell for 1.2 million. So what is the value? The trend is up, and it’s continuing up, but that is based on impressions and can be quite fickle.
Do you remember Robert Jervis? He was a Commentary guest, maybe just a year ago. He is at Colombia and he teaches International Relations. One of his other books is System Effects, in which he says that, “Like the crucial qualities of credibility and reputation, confidence is inferred by observers who know that the actor is vitally concerned with the inferences they draw.”
Kevin: So, integrity.
David: “Acts which at first glance show confidence are likely to be taken only when the situation is desperate.” He goes on to talk about the Continental Illinois failure. The failure of that bank was accelerated by the announcement of a $4.5 billion credit package.
Kevin: “We’ll just borrow more.”
David: And the support of the bank actually weakened the situation, and the bank run accelerated as this sort of overt government effort was interpreted as a sign of things being, yes, just that bad (laughs). So again, it’s like, “No, no, we’ve solved all the problems. Here’s $4.5 billion, everything is going to be fine.” Poof! Continental Illinois is gone. And the intervention was not what was necessary.
The same kind of market response, again, coming back to this idea of credibility and reputation and confidence, happened with the 1987 Louvre Accord. And it also happened in 1973 where you had a market response, a direct intervention, and that intervention was taken as a signal of grave currency problems, more than the solutions they were intended to be seen as, and the dollar in both of those cases tanked. 1973 was terrible. And in the case of the Louvre accord, the dollar corrected to below pre-accord levels, which was not the intended effect.
Kevin: So when you say the dollar tanked, that’s another way of saying devaluation, right? Because ultimately you either pay your debt or it’s one of the two “Ds.” You default or you devalue.
David: Value and scarcity is something that I think cross-applies to many things. Information is also something that we have in abundance. The question is, is it the ease of access, or is it the quantity of information, that causes us to take information for granted?
Kevin: You can Google anything but that doesn’t show that you have wisdom as to what you find.
Davie: And just because you can access the information doesn’t mean that you have the information. You don’t own it. You don’t possess it. Does that make sense?
Kevin: Oh, absolutely.
David: We are fairly reliant on things like Google for finding our way around the world, using Google maps, or finding our way through the world of information. In the midst of abundance of information, there has never been more confusion, whether we’re talking about fake news or the inability to discern wisdom from falling.
Kevin: Try to get somebody below the age of 30 to actually read a book. A book used to be a place where you had condensed information that you could mark – you and I mark them up. You could go back and you could say, “Hey, I see the markings. I now have re-gathered the information, I’ve gained the wisdom, hopefully, that the author is trying to convey.”
David: For me, this is a beautiful world. Books have been devalued (laughs). And in essence, what is that? The distilled ideas of an author, the nuggets that they’ve mined, the ideas which they have refined into a concentrated value – they’ve never been cheaper. You can build a library today for the cost of one year’s college education. We’re talking about more books than you can read in a lifetime for the cost of one year’s college education.
So it’s ironic that when you have informational abundance there’s a qualitative aspect which is lost in terms of education and learning. Information scarcity causes a different interaction with, and a different valuation of, the limited information which is accessible.
Kevin: So we were going to talk about velocity today. We actually talked about the value, the true value of scarcity.
David: Yes, there is a value to scarcity, and it would seem that there is still a line between abundance and devaluation. You can get to the point where abundance, something that you enjoy and no one would argue against, all of a sudden slips into, “I guess we have too much.” And so it’s cheapened.
Can you have too much money to the point where it’s cheapened and you just throw it around? Can you have too much of power to the point where you abuse it and change relationships? Can you have too much of food or sex or anything else under the sun? And you say to yourself, maybe not, but actually, the answer is yes. There is this line between abundance and devaluation, and when we step over it, we only recognize it in retrospect.
Our favorite economist from Morgan Stanley – he was formerly with Morgan Stanley Asia, chief economist for them, and now he’s a teacher at Yale. He has warned twice, on the 23rd of last month and on the fifth of this month, so twice in about two weeks, that a crash in the dollar by as much as 35% is imminent. This is Stephen Roach.
Kevin: What’s his timeframe?
David: By the end of 2021? And the reason, he tells the Financial Times most recently, is that there is a lethal interplay between a collapse in domestic savings and a gaping current account deficit. This is where you see a correction occur, and it can happen in one of two places. It can happen in the world of interest rates with a spike in interest rates, or it can happen through currency devaluation. And basically he makes the case that the Fed has a new inflation target and will fight a market adjustment in interest rates. So the adjustment must come through devaluation.
Kevin: That’s the “d.” And so with debt, which is a “d” word, you can either default or you can devalue.
David: And the funny thing is, of course, we don’t care about defaulted value. We feel like we’re living in abundance. That’s the thing. We’ve scuttled the notion of scarcity. We’ve said we have what we want, $118 trillion in net worth. It’s all we could ever ask for. It’s actually not.
Kevin: It’s never been better for you. As an American, it’s never been better.
David: And it’s never enough.
Kevin: We saw this movie back in the eighties by Jim Henson of the Muppets. He created something that was a little bit more serious called Dark Crystal. There were these characters, these big bird-like creatures that seemed to never grow old. It turns out as you watch the movie, what they’re actually doing is capturing other beings and draining them of their essence, what they called “the essence.” You would see it dripping into the jar, and that’s the only thing that kept them young.
In a way, that’s what’s occurring because we have devaluation. We talked about the redefinition of money, but Dave, I still have to use dollars when we go to the store. A loaf of bread that was six cents 100 years ago, that was 85 cents back in 1987, that is $5 or $6 today, we are still having to pay for in the old form of money. Call me old-fashioned, but I’m not paying for it in this new form of credit money, I’m paying for it in dollars, and my essence is being dripped away as that bread costs more and more and more. I hate to sound depressing, but what we have to do, Dave, to stop the drip is invest in things that are scarce.
David: On the bright side, since we’ve redefined money as credit, since credit is money, Roach is talking about a significant relief from the long-term burden attached to our new money. If you’re talking about a 35% reduction in the value of the dollar (laughs)…
Kevin: That means bread is going to go up, by the way.
David: But isn’t that also a 35% reduction in the burden of debt?
Kevin: For the government, yes.
David: Assuming those who have lots of it, almost a jubilee of sorts. Now for those that see no benefit and only a cost to a 35% devaluation, then might I suggest a variety of hard assets as an alternative to the once mighty dollar.