Short-selling and the Self-fulfilling Prophecy

The lesson of GameStop brought home

The GameStop affair is instructive because it reveals how financial markets work. It reveals something of what these markets are, and what they are not.

What they are not: instruments of accurate valuation.

Take the stock market. Supposedly, the stock market provides us accurate valuations of businesses: what they are worth as a function of their economic contribution to the real economy. In actuality, stock market valuations have only the most tenuous relation to individual company performance. Far more important to those valuations is the amount of total liquidity on the market. A rising tide lifts all boats. At this time there is a massive amount of liquidity circulating on the stock (and other financial) markets, not least because of the Federal Reserve and other central banks, which with their bond purchases have pumped trillions of adventitious funds into the financial market. Price/earnings ratios bear little relation to valuations because the general abundance of liquidity – too much money chasing too few goods – swamps individual choices regarding relative performance. Everything goes up and down in terms of the overall amount of liquidity, not so much individual performance. Additionally, the only direct connection between a company’s individual performance and stock ownership is the dividend payout, and many companies eschew such payments, most investors being far more interested in capital gains than what they consider to be piddling dividend payouts. This only exacerbates the disconnect.

Historically, the stock market along with the real estate market are two major locations where financial bubbles form. In “boom” times they inflate, attracting inordinate amounts of funds seeking a return, only to burst when the unforeseeable threshold is passed and everyone starts to pull their money out at the same time. The stampede leaves many trampled underfoot.

So what is their function? That is a difficult question. Bond markets exist for companies, governments, and other entities to borrow money. Stock markets exist for private owners of companies to cash out in an initial public offering (IPO). The now-public company continues with a managerial existence, whereby in theory shareholders call the tune. That is the theory; the actual practice I will leave to one side, as well as the question of the broader economic function these markets play. The fact of the matter is, they exist and we have to take things as they are.

The financial market makes possible such things as short selling. Short selling is done when people decide the valuation of a particular company or other financial entity (e.g., a bond, a currency) is too high and is set to go down. At that point, they conduct a strategy by which to profit from that downturn. In the case of shares, they borrow a block from someone else who owns them, with the promise of returning those shares after a set period of time, together with an interest payment. They then turn around and sell the shares at the current price. After the shares drop, they buy them back at the lower price, and return them to the original owner. The differential between the sale price and the purchase price is their gain (or loss, if the share gains in price rather than loses).

The question then becomes, is that downturn something that comes about apart from this action, or is it something precipitated by this action? Because when shares are sold, the sale has a signaling effect on the market. Every sale signals a drop in price, just as every purchase signals a rise in price. If sales or purchases occur at sufficient volumes, these signals become very loud. If a large investment fund suddenly “dumps” its shareholdings in this or that company, it is interpreted as a vote of no-confidence in that company, and others will follow suit. The share price drops accordingly, sometimes precipitously.

Now then, suppose the same thing happens with short-selling a company. If enough shares are sold at one time – which is precisely what happens in short selling – this can have the quality of a self-fulfilling prophecy. The market receives a strong sell signal, and shareholders in that particular company all begin selling off their particular holdings. As a result, the share price drops like a rock, the original short sellers buy the shares back at this lower price, and pocket the difference.

This is what George Soros did to the British pound in 1992. He engaged in a massive dump, “amassing a short position of more than $10 billion worth of Pound Sterling,” which prompted the British Treasury to spend massive amounts trying to keep the pound from falling. Soros’s “timely and brave (!) bet against the Bank of England in 1992” cost the Bank of England £3.3 billion while netting Soros some $1 billion. The taxpayers’ loss is the hedge fund billionaire’s gain.

Timely and brave or not, it was a self-fulfilling prophecy, made possible by the British government’s stated goal to maintain the pound’s valuation at a certain level. This gave speculators like Soros a target to shoot at, and they did not miss.

With GameStop, the story is different, as there was no targeted valuation. In fact, the hunter this time became the hunted. Hedge funds targeted GameStop as a vulnerable prey, “overvalued” in their view and thus primed for a short-sell attack. (Which begs the question: Who decides what is overvalued? Isn’t that just another self-fulfilling prophecy?) But after having staked out these positions, investors on Reddit took notice, decided to pool together, and mounted a counterattack. In this case, instead of taking the market signal as a signal to sell, they took it as a signal to buy. This meant, of course, that hedge funds would end up having to buy back the shares they sold at much higher rather than much lower prices. At one point, the losses they were facing were calculated at $70 billion.

What is the lesson to learn? Simply this, these market signals work both ways. If the market appears to be signaling a selloff, it could simply mean that a market player or players are setting up another self-fulfilling prophecy, hoping to profit with a short-sell structure. But market players are free actors and can just as well buy as sell in such a situation. Short-circuiting their ability to act in the manner they see fit, as when platforms began disallowing purchases of GameStop, is to rig the game in certain players’ favor against others. Self-fulfilling prophecies are okay, but acting counter to them is not okay. Really? That isn’t wrong? Of course it is. If the market is allowed to exist, it also must be allowed to function on the same terms for everyone. If short-selling is allowed, counterbuying should also be allowed.

And that is what is causing so much commotion now. Time and again, people are witness to the insidious phenomenon of certain favored, privileged, connected groups receiving special treatment while others are treated differently, either less leniently, or overlooked when it’s time for a bailout, or deprived of justice altogether. One of the things that makes America or any country great is the equal application of the laws without respect to persons. The differential application of laws or rules in order to benefit or privilege certain groups is something everyone ought to acknowledge as being wrong. Otherwise, there is no rule of law. There is, as Aristotle called it, the rule of men rather than laws. Shamefully, it is yet another sign of the decline of a once-great country.

How to Understand Capitalism and Socialism

A burning topic, figuratively and literally.

Those of us who experienced the Cold War can be excused for thinking that this argument was dead and buried, but that has proven not to be case. Nor could it be, if the analysis given here is correct. For socialism, unlike capitalism, is a matter of the heart.

For many moderns, socialism is indeed the ideal. As I wrote 20 years ago, 

Even at its triumph, capitalism remained deeply unpopular, even shameful. The people’s hearts were elsewhere. They longed for a return to lost community, a caring society, a giving society, for commitment, for compassion. Though the Marxist reality was rejected, its ideal remained living and vibrant. Something deep inside compelled people to seek a social order fundamentally different from the one in which they lived. The moral high ground was held by those proclaiming agendas fundamentally at odds with the liberal order.[1]

These moderns function within a capitalist system; what’s more, many professed socialists make quite a good living within it. On the face of it, this seems utter hypocrisy. But it isn’t if one understands one basic datum: capitalism and socialism are not two stand-alone systems. No indeed. Capitalism is a system that can be harnessed; and socialism is one method of harnessing it – or at least attempts to do so.

Capitalism is structure, socialism is direction

How is that, you may ask? To make this clear, we need to introduce the distinction between structure and direction. Structure has to do with the way things are, the way they are built. It also includes the way in which they develop. As with a tree: its structure is branches, roots, a trunk; and the seed will of itself develop into a such an object with these characteristics. Direction, on the other hand, is the way such structures are put to use. A tree can be used in various ways, to provide shade, to provide fruits in season, to provide beauty, shelter for wildlife, or even be cut down and used for saw-timber or firewood. The plan and purpose for a tree is imposed upon it, it is the direction to which the tree is subjected.

The distinction is straightforward enough, but it is neglected, when not completely ignored. Language can be equivocal and as such confusing, leading to false conclusions. This is the case for the subject at hand. For the first thesis to be proposed is perhaps the most controversial: capitalism is in fact structure, while socialism is direction.

This means that the usual method of dealing with these two “isms” is faulty. As if they were two competing entities, each complete in itself. Nothing could be further from the truth. Capitalism is indeed a stand-alone entity, but one which can take on many guises, depending on the various directions imposed upon it. Socialism is not a stand-alone entity; it is, in fact, one of these many directions.

Capitalism is the form in which an economy develops

Capitalism is not the structure of all economies, but it is the structure into which all economies develop if given the opportunity. That is because it is based on realities implicit in the human social order.

If we look at undeveloped versus developed economies, we see certain characteristics. The most obvious is undifferentiation versus differentiation. An undeveloped economy is an undifferentiated economy: it lacks complexity, it lacks a variegated division of labor, and it also lacks organizational complexity. It is based on a simple social structure, the family writ large, thus the clan or tribe. Society itself is an organization. All relations are internal, the law pertains only to these relations; outside relations are ex lex (outside the law = outlaw), hostis (enemy), presumptively hostile or at least suspect, lacking governance in terms of an overarching law.

In the process of the development of a social order, the monolithic social structure with its sharply defined internal (domestic) versus external (foreign) relations, begins to break up, re-forming into a multiplicity of lesser associations with shifting memberships and coordinated interaction.

This process is especially visible in the development of the legal system. On the one hand, there is the formation of one specialized institution, the state, an institution/organization among many, charged with the sovereign promulgation and execution of law. On the other is the development of private law.

Essentially, private law is external law. It is external to all the organizations and associations of which the society comes to be made up, including the state. Public law, by contrast, is the law internal to the state organization. But the state is only one association among many; and these other associations likewise have internal laws. What coordinates them all with each other? It is private law. As such, private law enables the generation of the pluralist associationalism of a differentiated social order.

Now then, this private law is characterized by certain specific institutions. These come up always and everywhere, and they did so paradigmatically in Roman law, which is why that law has served as the framework for all legal science. These are property, contract, and pledge; these revolve around the citizen; they are enforced by means of courts in terms of the due process of law.

This is why Roman law speaks of the law of persons, of things, and of actions; these three sets of law correspond to those three categories.

Furthermore, private law has an economic dimension; in fact, this is perhaps its most significant dimension. For property, contract, and pledge, all determine economic relations. Together, they provide for the generation of credit and debt, and thus money. They are thus the basis for capitalism, which is an economy in which these institutions take their place. As such, every economy which develops, does so along these lines, and capitalism becomes more or less a part of everyday life, depending on the degree to which one becomes a participant in the process. The alternative is to remain a subordinate member of a group, enjoying only group-internal rights and privileges, eschewing exposure to the outside world. This is manorialism, which may coexist within capitalism as an outpost of the previous undifferentiated economy.

Upshot: The institutions of private law are the institutions of capitalism.

Socialism tells us how an economy ought to be arranged

Therefore, capitalism is a set of institutions that arises through the differentiation of society from monolithic to pluralistic conditions. It is a structure; it is the structure of a developed economy. Socialism, on the other hand, is a set of ideas about how such an economy ought to be arranged. It thus arrives on the scene once capitalism has been established.

In fact, it arrives on the scene only when a specific form of capitalism is established. This would be the form of capitalism which generated the Industrial Revolution – essentially, a combination of financial innovation and technological application, leading to the explosion of productivity characteristic of capitalism since the 19th century. This superabundant productivity, in turn, led to the divorce of production and consumption which has had momentous effects on all aspects of life.

One of these effects has been precisely socialism. For what is it that inspires socialism, this vision of how things ought to be? The spectacle of maldistribution of the exorbitant wealth suddenly made available to mankind. Not only do the “capitalists” benefit from this new process of production by amassing enormous fortunes, money which, in this view, has been misappropriated, as it rightly belongs to the workers. But production itself is disproportionately distributed. Seemingly it goes to those who already have, leaving those lacking the means to participate in the capitalist system to “go without.”

We could argue that this is not the proper way to look at this phenomenon. After all, the actual conditions of the working class have improved on a consistent basis, albeit through periods of depression which likewise can be explained quite adequately without issuing a blanket condemnation of the capitalist system. The standard of living for all people in post-Industrial Revolution (“industrialized”) societies has improved dramatically over the years. Citizens of countries which have not been industrialized attempt, on a monumental scale, to migrate to nations which have been, which does not argue for a deterioration in conditions.

In this sense, post-Industrial Revolution capitalism has been its own worst enemy. It has created the means to generate enormous productivity. But this has only awakened a spirit of resentment regarding the ends to which that productivity is directed.

Because it creates conditions of inequality, or better, does not alleviate inequality, it also creates resentment, even though the baseline condition of everyone is improved. Spurred on by the concurrent development of rights-oriented ideologies, it has engendered a spirit of entitlement to the fruits of the production of the capitalist engine.

This fundamental change in mentality is something which has not received sufficient comment. Prior to the Industrial Revolution, this entitlement mentality did not exist. No one dreamed of claiming a right to food, housing, work, health care, education, etc., the way citizens of industrialized nations do. This is because there was not yet any divorce of production from consumption. For the most part, the production/consumption loop was closed in local or regional contexts. But since the advent of the Industrial Revolution, production has become a problem.[2] The connection between production and the consumption of that production has been lost. The division of labor has lost its self-evidence. The “cog in the machine” experience, itself the product of a complex division of labor, supply chain logistics, and the like, has created conditions of uncertainty with regard to one’s position and purpose in society.

One of the first harbingers of the new state of affairs was the controversy over the possibility of gluts, waged in the early 19th century between Thomas Malthus and Thomas Chalmers on the one hand, and Jean-Baptiste Say on the other. It was this controversy which inspired Say to develop what has since become known as Say’s Law: supply creates its own demand. In other words, production and consumption are bound together in an iron loop. As such, Say argued, there can be no possibility of gluts.

But reality proved otherwise. Say’s Law could be better formulated as supply ought to create its own demand. When it doesn’t, something is wrong. This is what fired the socialist mentality. The production/consumption mismatch led to gluts on the one hand and shortfalls on the other. The mismatch might have been repaired by reforming the system. One of the major elements of that system was an unfair financial and monetary system – commodity-based reserve banking – that generated boom-bust business cycles with an intrinsic deflationary bias, and so consistently benefited the creditor over against the debtor.[3]

Instead, visions were spun of order and justice establishing real, absolute equality in the here and now – visions, be it said, totally dependent on and reliant upon the underlying economic reality.

In this sense, socialism is a production of the “revolt of the masses,” Ortega y Gasset’s summation of the change in mentality brought on by the Industrial Revolution. Ortega pointed out that modern man has a new attitude, one of expectancy combined with ignorance. All the fruits of progress are taken for granted, while the process by which they all are generated is not only not understood, but dismissed as irrelevant. Dangerous, this kind of enlightened unenlightenment. And that is what socialism does: it takes for granted the ongoing existence of productivity, and expects to direct the flow in new directions.

So socialism views the “means of production” and the concurrent systems of logistics, transportation, legal order, etc., as pre-existing realities that are just there.[4] All it takes is to remove the group that is atop the system and replace that group with an enlightened one, one with the right set of values, who will take that massive superabundant productivity and put it to good use, and so provide for everyone’s needs and wants while also saving the planet from greed, corruption, pollution, and other ills.

But socialism undermines the structure it is attempting to harness

But this is to beg the question. Certainly, capitalism is structure, but it cannot be harnessed to socialist goals, because to do so would require that we dial back the institutions characteristic of a developed economy, all of which revolve around private law with its institutions of property, contract, and pledge. As such, it would cast society back into the condition of an undifferentiated monolith. For one thing, this would reduce carrying capacity logarithmically (i.e., reverse exponentially). The result would be mass starvation.

Capitalism is structure, but it requires a certain spiritual infrastructure to operate. It developed in the West, because of the peculiar confluence of factors in the West, particularly Roman law and Christianity. One of the fruits was the abolition of slavery, something which hitherto had only been contemplated as a far-fetched possibility, which only obtained in a bygone Golden Age. As with everything else, our age views this, not as an achievement, but as something to be expected as a matter of course, requiring no thought as to how it came about, but only vilification for the fact that it took so long.

Ortega’s motif of a revolt of the masses explains this perplexing bias against the hand that feeds. The capitalist order, the order of private law, is not only institutions but customs, mores, habits. The three loci of private law as listed above are persons, things, and actions. Actions can be summed up as due process of law: no one can be deprived of life, liberty, or property without a fair trial, without being able to defend oneself before a neutral arbitrator. Things can be summed up as the laws, including property, contract, pledge, credit and debt. These are the rules enabling free and equal individuals to pursue their own ends in freedom and for mutual benefit.

Thirdly, persons are citizens. This is the subjective side, over against law, the objective side. Laws do not exist in a vacuum; constitutions do not enforce themselves. Persons, citizens, give direction to the structure that these provide. They either use these tools advantageously, or misuse them to their own great disadvantage. The goal, as Aristotle said, is reciprocity.

There are two different orientations citizens can adopt when faced with this framework. One is that of a virtue orientation. The virtuous citizen pursues self-reliance through an ethic of work and saving. He follows the Apostle Paul’s injunction: “He who steals must steal no longer; but rather he must labor, performing with his own hands what is good, so that he will have something to share with one who has need” (Ephesians 4:28).

The other is an entitlement orientation. The entitled citizen goes through life being owed things, demanding rights which, when analyzed, begin to look a lot more like privileges. Politicians pander precisely to the citizen harboring this mentality. Such citizens are who Ortega had in mind with his mass-man, his “Señorito Satisfecho.” Production is just there; or even worse, mass-man’s wealth has been confiscated, somehow, although how precisely he finds it difficult to pin down. We resort to generalities, demonizing capitalists, or “kulaks,” or various ethnic groups. There have been many such groups demonized throughout history. The Jews are just one. Who are today’s Jews?

A structure exists to be harnessed to one direction or another. Here as well, nature abhors a vacuum. Contemporary capitalism is certainly being subjected to a certain “vision of the good.” Perhaps it would be better to say that it is being subjected to two competing such visions. The question is, which one will win out.

Further reading:

[1] A Common Law, p. 6 (2nd ed.: p. 8).

[2] See “Consumers of the World, Unite!

[3] This is the true basis for Marx’s critique of the “capitalist” – see “The Social Question Unravelled.”

[4] “Civilisation is not ‘just there,’ it is not self-supporting. It is artificial and requires the artist or the artisan. If you want to make use of the advantages of civilisation, but are not prepared to concern yourself with the upholding of civilization – you are done. In a trice you find yourself left without civilisation. Just a slip, and when you look around everything has vanished into air.” Revolt of the Masses, p. 88.

Understanding the yield curve

Of late there has been a lot of chatter about the so-called yield curve, usually to complain about its incomprehensibility. This lends an aura of mystery to it, which coupled with lore about its alleged capacity to predict recessions, turns it into a modern-day Urim and Thummim.

But in actuality, there is nothing so mysterious about it. So let’s break it down.

First, what is a “yield”? Before we can understand that, we have to understand what a bond is, because a yield refers to bonds. So what is a bond? Quite simply, it is a loan that can be bought and sold.

Now a bond, like all loans, has two elements, principal and interest, to be paid back over a set term – 5 years, 10 years, what have you. The principal is the sum borrowed, interest is the money above and beyond the principal that is to be paid back to the lender. Interest is expressed as a percentage of the principal, payable on an annual basis – 2%, 3%, 4% interest rates indicate that 2, 3, or 4 percent of the principal have to be paid back each year the loan is outstanding.

All of this is referred to as nominal, because it is denominated on paper by the lender. When the bonds are actually sold, deviations crop up which reflect what buyers actually think of those nominal amounts. Is the interest rate too high or too low? Is there a chance that the borrower will not be able to pay back the loan? Not only do such considerations lead to various ratings being attached to the bond — AAA, AA, etc. — but they generate a new set of criteria: the bond price, and — drum roll — the yield.

If buyers think that the interest rate on the bond is too low, and are not worried about either the interest or the principal being paid back, then the bond will trade at a price higher than its nominal value — at a premium. And vice versa, if it trades at a lower price, it is trading at a discount.

Now then, the yield is a kind of derivative interest rate. It is derived from this market valuation of the bond. It is the quotient — result — of the annual interest payment (referred to as the coupon payment) and the bond price, like this:

Current yield = Coupon payment ÷ current bond price

In actuality, then, the yield is equivalent to the current interest rate as determined by the market, as opposed to the nominal interest rate as originally set by the lender. And of course, it fluctuates. For instance, here is a graph of the yield of the 10-year bond issued by the U.S. Treasury, as of August 23rd, 2019:

The formula for calculating the yield shows us that it is inversely related to the bond price. Which means that when yields go up, the price is going down, and bond is being discounted. Vice versa, when yields go down, the bond is being traded at a premium. Lower yields generally indicate less inflation and a better business and investment climate. Higher yields may be a danger sign of the opposite.

We are now in a position to talk about the yield curve. Again, it is not a hard thing to understand. Essentially, it is a map of all the yields on the money (short-term) and capital (long-term) markets, plotting them according to their maturities (how long before they are paid back). The x-axis will show the various maturities, the y-axis the corresponding yields, like this:

From Kevin Drum, ” The Great Yield Curve Inversion of 2019.”

This graph actually shows two yield curves, one from January 2nd, 2019, the other from August 14th, 2019.

Normally, the yield curve will increase from the short-term to the long-term end of the scale. That is because short-term interest rates tend to be lower than long-term ones.

What, then, are we to think of the inverted yield curve? In this case, yields at the short-term end are actually higher than at the long-term end. For example, the yield curve for August 14th in the graph above shows higher short-term than long-term rates. As such, the graph is inverted as compared with the normal shape of the curve, as exemplified (more or less) in the graph for January 2nd.

The usual explanation is that the market is signalling a recession. This generates lots of gloom-and-doom headlines. Just run a Google search for “inverted yield curve” and you’ll see them in abundance.

Why is that? Well, normally short-term rates are lower than long-term rates, so the markets are acting really weird, which must mean that bad things are going to happen, and, well, recessions have often been preceded by inverted yield curves.

Is that what is happening? Not quite. The inverted yield curve is not a function of the market, but of central-bank intervention in the market. This is because the Federal Reserve controls short-term rates via its Federal Funds Rate. As Anthony Crescenzi writes:

One of the biggest influences on the yield curve is the Federal Reserve. The Fed affects the yield curve largely though its control of short-term interest rates. When the Federal Reserve raises or lowers the federal funds rate, yields on short-term maturities tend to follow…. As a result, the yield curve tends to get steeper when the Fed lowers interest rates, as yields on short-term maturities fall faster than do those on long-term maturities. Yields on long-term maturities respond more slowly to the Fed’s interest rate moves because they are affected by a wide variety of other factors, including speculative trading activity, technical factors, and inflation expectations (The Strategic Bond Investor, 2nd edition [2010], p. 158).

What this means is that it is not the market but the Federal Reserve that is pushing interest rates upward, contrary to what the market otherwise would reflect. In other words, the Fed knows better than the market what interest rates to ask; rather than let supply and demand determine the going rate of money, it intervenes to make it artificially more difficult to borrow.

This is one reason for President Trump’s repeated criticisms of Fed policy. In his mind, the Fed is actively precipitating a recession precisely by making it harder for businesses and consumers to borrow, even though the inflation climate is so moderate. In this sense, the inverted yield curve is not so much a predictor of a recession but an indication that the Federal Reserve is actively pursuing one.

And given the current climate of electoral politics, is such a conclusion so far-fetched?

WSJ: Trump is losing the trade war with China

If so, it isn’t because of this

So the Wall Street Journal published an article about how Donald Trump is losing the trade war with China. A serious matter, if true. Yet whether it’s true or not, this article doesn’t make the case, even though written by Jason Furman, chairman of the White House Council of Economic Advisers under President Obama. In fact, it only bolsters the impression that trade policy under previous administrations truly was disastrous.

Let’s run through some of the more “interesting” statements:

Today China is more integrated with the rest of the world while the U.S. is more isolated.

This is already a sign of a flawed argument. Logically the sentence says nothing, because without referents, “more integrated” and “more isolated” have no meaning. I’m guessing that the meaning is, the U.S. is more isolated than China from the rest of the world. But what do “more” or “less” even mean? With reference to what?

According to Eurostat, the U.S. accounted for 14% of world exports and 18% of world imports in 2016, while China accounted for 17% and 12%, respectively. So if the U.S. accounts for a greater share of world trade than China, as these percentages show, how is it more isolated than China? Is that what it means to be more isolated? Who knows.

Tariffs on China have caused clear harm to the U.S. economy in the short run. In the second quarter of this year they contributed to the decline in business fixed investment ….

And business fixed investment bounced (is bouncing) right back in the third quarter (see here). How could this be if tariffs in fact “contributed to the decline” in the second quarter? At the very least, tariffs encourage domestic investment, whatever other deleterious effect they might have.

The decline [in equity markets] after the president announced a new round of tariffs Aug. 1 indicates that, in present value, the strategy is a negative.

No, it indicates that the strategy does not benefit multinational corporations, which predominate on equity markets. The real economy is something else entirely (see my tutorial on The Two Markets).

China’s growth has also slowed, but much of the downturn can’t be credited to U.S. trade actions. Instead, the slowdown largely reflects the limits of Beijing’s tendency to prop up growth through short-term investment and state-owned enterprises, even as its demography worsens and productivity growth slows.

So those limits only are just now being bumped up against? Beijing’s structural problem has been evidenced for years. Sheer coincidence that it is manifesting itself in slowing growth only now, right?

Market movements have also blunted some of the impact that tariffs might have had, reducing U.S. leverage in the trade war. The yuan has weakened, which offsets the tariffs by making Chinese exports cheaper.

More coincidence. The yuan just happens to weaken at the same time as the tariffs are imposed. Wow! Nothing to do with Chinese economic and foreign exchange policy, right?

This is the inevitable result of Mr. Trump’s de facto strong-dollar policy, driven by larger budget deficits that have increased foreign demand for U.S. dollars as well as tariffs on China that have reduced U.S. demand for the yuan.

Wow again! So Trump just started generating larger budget deficits. We never had those before. They’re the reason for the weaker yuan.

Before the latest round of the tariff war, China was helping bring about Mr. Trump’s desired weak dollar by intervening in currency markets to keep the yuan strong. Yet when Beijing gave markets more latitude, the administration branded China a currency manipulator.

The fact of the matter is, China was forced to relax its weak yuan policy or face the consequences. The natural tendency of a country running a massive trade surplus is for the currency to appreciate. That it had not done so was precisely due to various Chinese economic and foreign exchange policies. By relaxing these, the currency naturally rises. By reimposing them, the currency falls again. China’s policies do not give the markets “more latitude,” it gives them less. Double-talk and reversing the order of cause and effect are the order of the day in this mode of thinking.

In January 2018 China had average tariffs of 8% on imports from the U.S. and the rest of the world. In response to U.S. actions it raised its average tariffs on the U.S. to 20.7% by this June while cutting its tariffs on the rest of the world to 6.7%…. China has cut its imports from the U.S. but increased its imports from elsewhere. China’s exports to the rest of the world are also growing.

No wonder China isn’t in a hurry to make the major concessions Mr. Trump has demanded. 

Let’s see. The U.S. purchases 19% of all Chinese exports, far and away the largest amount of any single country, and equal to Europe as a whole (see here). But China purchases only 7.3% of U.S. exports (see here). As a result, the U.S. ran a $419 billion goods trade deficit with China in 2018.

The upshot: the U.S. is far and away China’s most important export market. China needs the U.S. market far more than the U.S. needs China’s market.

No wonder Mr. Trump isn’t in a hurry to make the major concessions China has demanded.

The administration needs to change its strategy radically. The first step should be to work with, rather than against, U.S. allies. That means shelving Mr. Trump’s threatened trade wars against close partners, such as across-the-board tariffs on Mexico or tariffs on car imports from Europe. The U.S. should deepen ties with partners, including by re-entering the Trans-Pacific Partnership, which doesn’t include China.

These “allies” have similarly been running massive trade surpluses with the U.S., while conducting export-friendly policies that rig the global marketplace in their favor. Michael Pettis’s seminal book The Great Rebalancing provides the details. This counsel is nothing but a continuation of the ruinous policy of previous administrations that led to massive deficits, massive amounts of debt, and massive job losses. Thanks, Furman.

And we haven’t even begun to deal with China’s trade espionage and thefts, its spy networks and insidious infiltration of foreign institutions. At least Mr. Furman acknowledges that these are serious issues to be addressed.

Is Mr. Trump losing the trade war with China? You wouldn’t know it from this article, that’s for sure.

Socialism as a Rival of Organized Christianity


Modern Protestantism is woefully ignorant of its most formid­able rival. The Catholic Church has been painfully awakened in France, Belgium and Italy. Protestantism awaits its awakening. There is now no country of economic importance without a grow­ing party raising the banner of Marxian Socialism.[1] To under­stand this sweep, it must be steadily remembered that Socialism is not simply a political economy, nor yet even a philosophy of society, nor a scheme of reform. Socialism is a religious faith, and is being embodied in a religious organization. Hence it hap­pens that no calm academic discussion has any more effect on its fortunes than the sneers of Pagan philosophers had upon the activities of fanatic monks in the second century. It is not a science but a dogma; it is not a belief but a profound trust. True it is that it is based upon a political economy far from con­temptible; it also involves a philosophy of life, cruder indeed relatively than its political economy, and it catches up and uses the phrases and conceptions of modern science more thoroughly, if not more intelligently, than does modern Christianity.

It is, moreover, in Socialism that organized Christianity has its most serious and most determined rival. Christian Science, the Salvation Army, Zionism and a hundred other supposed rivals are not really more than temporary phases of religious variation with which Christianity as  organization has always had to contend. In Socialism, a new hope and a new faith have found definite expression. In view of such possible rivalry, it is highly suggestive that the economic world-conditions to-day reproduce, in many ways, those which so greatly farthered the spread of an organized and dogmatic Christianity. Now, as in the days of Rome, the world is physically united, as it has not been since the fall of the Empire. Since then, not until the last century was travel as safe and as frequent as in the days of Roman domination. Now, as then, the world is intellectually under the dominion of a com­mon stock of ideas and methods. What Greece did for the Roman world, experimental science does for us. Now, as then, three tongues give any teacher the ears of the world’s real leaders, and the wide extent of the world’s dominion gives a freedom of utter­ance which the smaller conditions of life made impossible before, and which reminds the student of the really astonishing liberty of speech permitted by Rome. Moreover, now, as in the days of the Empire, the land open to exploitation is rapidly passing into a few hands, and the urban population increases at the expense of the country as it did in the days of Nero, and equally to the alarm of the responsible power-possessing class.

The economic factors that shaped so largely the fortunes of early Christianity have never been fully dwelt upon. But the modern historian is beginning more and more to recognize the fact that the Old Catholic Church rose to power because, under existing economic conditions, it was the only organization with sufficient strength among the proletariat to reorganize the bank­rupt world.[2] Moreover, the whole history of organized Christi­anity is to a great degree dominated by that inherited responsi­bility. It is noteworthy that the strain and tension of that day Hatch finds reproduced in our own. Not, indeed, that Christi­anity was the only organization among the proletariat:

The Roman world was overspread with religious societies. There was no longer any fixed religion, but there were religions in plenty. …. There were none, especially among the lower classes of the people, who did not belong to some union of the kind. . . . The members of the societies were even formed into a sort of general brotherhood.[3]

In fact, the Christian Church fell heir to a mass of proletariat organizations in a manner only comparable to the way in which to-day Socialism is falling heir to trades-unions and reform agencies of even middle-class origin.[4]

Something, however, had happened in the religious world of lower-class Rome. As Sohm says: “their heaven had been emptied of its gods.” Just that has happened in the home of Marxian Socialism. In Germany, the narrow dogmatism of a formal and middle-class State Church has left the working-man to his fate. And into the breach Socialism has rushed. The day in which the Socialist lecture-hall is taking the place of the church begins to alarm even the dull leaders of a decaying orthodoxy.[5] Says Mr. Austin Lewis, one of the most thoughtful and sane Socialist writers:

In Berlin to-day, five out of six people who are to be seen on the streets going to some meeting or other, are going, not to church, but to hear addresses from the platforms of the Social Democrats upon the rights and duties of the working classes. When their children have acquired the habit of substituting the lecture-hall for the church, the latter will no longer confront a careless proletariat with no religion, but a sturdy proletariat with a very definite, if materialistic, substitute for a religion, with an organization, with speakers who are at least as able as the theological colleges can produce, and without any doubt as to their working-class sympathies.[6]

What has gone so far in Berlin is going on all over the con­tinent of Europe, and is beginning rapidly to take place in the United States. Indeed, the student of church history who wonders feebly over his books what was the power exercised by the early wandering prophet and the ecstatic dreamer of dreams, would do well to visit a Socialist meeting, stirred to enthusiasm by a visit­ing “ comrade ” whose reputation as a speaker has preceded him. The burden of testimony at such a meeting is a more or less in­telligent repetition of the catch-phrases of Marxianism; and, with that as a basis, ringing and confident assurances of a world con-quest; and faces worn with toil light up with the radiance of as­sured victory and final world-peace.

Here begin some of the strange and striking analogies that should make every student of primitive Christianity an earnest student of Socialism. For the dogmatisms and the dreams of the two organizations, in spite, of course, of serious and many differ­ences, deserve the most careful psychological comparison and analysis.

What gives Socialism an incalculable advantage over all trades- unionism and independent societies is its tremendous organizing faith in a final world-conquest. Going out of the close and often sordid air of trades-union squabbles into the atmosphere of Social­ist idealism, even the calm and hostile critic must feel the force of this faith in the great unseen dream of an ultimate and complete victory. This uplifting vision was what marked the message of early Christianity, as over against even the most effect­ive and most democratic of the other religious unions. These offered, indeed, temporary refuges, promising to every member some warmth and shelter while he lived and a decent burial when he died. The Christian guild was profitable both for this life and the life to come, and stirred men’s blood by the promise that soon, no man could tell how soon, the meek, the oppressed, the poor and the slave would inherit the earth, and would reign triumphant, where they were now suffering seemingly final defeat in life’s battle.

The Socialist hymn-book rings with the joy of just such certain success:

Still brave deeds and kind are needed,
Noble thoughts and feelings fair;
Ye, too, must be strong and suffer,
Ye, too, have to do and dare.
Onward, Brothers, march still onward;
March still onward hand in hand;
Till ye see at last Man’s Kingdom,
Till ye reach the Promised Land.[7]

What are an eight-hour day and a doubtful ten-per-cent, in­crease in wage, compared with a hope like that? The Socialist dream fills out, in the somewhat starved imagination of the proletariat working class, just the place the prophetic dream of a reign of God filled out in the enhungered fantasy of the early Church.

Moreover, this hope, like the hope of primitive Christianity,[8] was in its origin just as catastrophic in its character. Paul ex­pected the triumph to come at any time. This age was to pass away with dramatic judgments, and one of the early struggles was over the modifications of this view occasioned by recurring cycles of disappointed expectation. The primitive view has never been overcome, and to-day, at each requickening of Christian zeal, the old premillenarian type of hope at once reasserts itself. So, also, Karl Marx and all early Socialist prophets hailed already the day of proletariat triumph, and fondly expected in their own time the catastrophic change which economic conditions were automatically to produce. Even now, the old leaders, like Bebel, scoff at the weakness of faith that demands present reform as an earnest of completer triumph, and the constant debate is about the character of the “revolution.” Marx, Engels, Liebknecht, Bebel, Ferri and all the old-line leaders maintained that it was the grossest heresy to try and substitute “evolution,” in the sense of political compromise even of a temporary character, for “revolution,” complete and final.[9] A saner feeling has taken possession of the working Socialism of to-day. Karl Kautsky,[10] in the Socialist International Congress, held in Paris in 1900, carried substantially the following resolution:

In a modern democratic state the conquest of the public powers by the proletariat cannot be the result of a coup de main; it must be the result of a long and painful work of proletariat organization on the economic and political fields, of the physical and moral regeneracy of the laboring class, and of the gradual conquest of municipalities and legislative assemblies.

This has caused ever since heated discussion, and was carried by about twenty-nine affirmative against nine negative voices. It corresponds to the change that took place in the eschatology of the early Church between the dates of the first and second letters to the Thessalonians. Nor will the earlier Socialist teaching die easily. As the Christian Church settled down to a more comfort­able acquiescence in the existing order, men like Tertullian were filled with just the rage and contempt which now stir Bebel when he discusses Vollmar, Bernstein and Jules Faures, and from much the same instinct. For here again a striking analogy between dogmatic Socialism and early Christianity comes to light. Both are redolent of the scents of a class battle. In the canonical Scriptures, apart from the famous “ Sermon on the Mount,”[11] we have only to consult James ii: 1-7. And far down the history of Christian triumph, this note is still sounded, as in Tertullian. Not that the proletarian then, any more than now, lacked edu­cated leaders. Indeed, the account of Ambrose’s work in Milan, or of Tertullian’s in North Africa, show abundant evidence of how fruitful a field for propagandist activity was the educated proletariat. The most astonishing growth of orders of monks pledged to poverty was the emphatic recognition, far down the Middle Ages, of this class character—a survival of the conception that only a poor and obedient man could have his part and lot in proletariat deliverance. And at each quickening of the religious life of the Middle Age Church, there was a strong revival of this conception.

No one can thoughtfully read the Gospel of Luke without see­ing how primitive and strongly entrenched, in the very centre of early Christianity, this possessionless character of the movement was.

Out of this proletarian character, so strongly marked in the early Church, came another peculiarity which also is noteworthy in Marxian Socialism. A possessionless class is not only a rela­tively unstable population, but one in which national feeling is weak. The Christian or Socialist group is bound to become cosmopolitan in sympathy. The group is no longer based on geographical considerations; the organizing conception is a com­mon discontent and a common hope. The proletariat of the days of Jesus, like the proletariat of to-day, felt itself cut off from national ambitions, and class feeling became stronger than all national feeling. The common burden of economic inferiority acted powerfully in detaching the various possessionless classes from the old group lines, and bringing them together in a new solidarity of common interest. This could not happen without a struggle in the days of Jesus. Paul’s principal battle was for just such a new solidarity on the basis of a common faith. He felt, and rightly felt, that the future of Christianity was staked on that issue.

In precisely the same way, the National Socialist Party of Germany, now decently buried, was an attempted protest against the cosmopolitan character of the Social Democracy. It was an utterly vain attempt, and died an ignominious death.

The National Socialist Party failed to take into account an entirely new standard of valuation, produced by the very condi­tions of the proletariat life and hope.

The conditions of the proletariat struggle are reproducing to­day, in another particular, the history of early Christianity. The power-possessing class press sees in the internal struggles of Socialism a sure indication of inherent weakness; and there is scarcely any exaggeration possible of the bitterness of these dis­sensions. Yet it must be remembered that they have never reached the heights and depths of the contests waged by the parties in the early Church. The whole Empire was shaken by the fierce feuds of warring monks, who fought in the streets and poisoned rival superiors, and used all the arts of blandishments, intrigues, bribes and threats to secure the banishment or death of hated rivals. It is intense fanatical faith that makes such quarrels possible, and without that faith Socialism would be no danger to the existing order. Should a political Socialist party in the near future reach power, such contentions would be as se­rious a menace to the stability of society as were the desperate con­flicts between Arian and Orthodox parties in the old Roman world.

If the reality of these analogies (amid, of course, many differ­ences) is recognized, we are in a position to study and understand the important question of the rise and the significance of dogma. The usefulness of a dogma does not depend upon its truthfulness. What is essential is the unity of the fighting organization upon some dogma.[12] The new organizing enthusiasm must not only have expression, but must find an outward unity in that expression. This is the real explanation of the tenacity of dogma. It be­comes the symbol of the fighting organization, the banner of an army.

Christianity as a personal religion may not need dogma; as an organization, really fighting for the reconstruction of society, it has never been able to dispense with dogma.

To-day, Socialism, as an enthusiasm fighting a desperate battle for a reconstruction of society, is doing just what the Old Catholic Church did; it is hardening into a dogmatism, and doing that under our eyes.

It has its trinity of essentials. These are: the Marxian surplus value theory; the doctrine of a class struggle; and the economic interpretation of history. In 1900, a careful ex­amination of some forty Socialist papers, having a total circu­lation of over a million, showed an extraordinary uniformity of statement along all these lines.[13]

The political economy of Karl Marx is too elaborate for the comprehension of the unintelligent; but it is, at least, as well understood as was the fundamental theology of Paul (cf. II. Peter iii; 15-16), and furnishes a basis for the hope of a future society amply provided with the material means of existence. The economic interpretation of history, as a dogma, plays just the part that the doctrine of predestination has nearly always played when the Church was really struggling. To a weak, small and economically inferior group, faith in the great unseen forces of the universe, as working and fighting with them and for them, is an incalculable source of aid and comfort. Hence, in the dark and stormy days of Christianity, a doctrine of pre­destination, not to be sharply distinguished from fatalism, has always played its part.

The same role falls now to an “ economic and material inter­pretation of history.”[14] It was from Roman Stoicism that early Christianity borrowed the form of its teaching, and the German phenomenalism of Feuerbach seems to be the primal source for Socialism.

But the origin is almost immaterial.

The real significance of the dogma is the support it gives to a profound faith in a new-coming order, inevitable in spite of all apparent weaknesses.

And, as in the days of the Old Catholic Church, so to-day, dogma furnishes weapons with which to fight half-hearted oppor­tunists. The struggle began for Christianity with Gnosticism. The marks of the conflict she bears with her yet. Her efficiency as a fighting organization depended upon her escaping the influ­ences of corroding intellectual analysis, just as to – day, the claims of Vollmar and Bernstein for the liberty of “self-ex­amination and criticism” excite the fury of responsible leaders, and are only permitted within the express limits of a dogmatical confession of faith.

The same struggle between a dogmatic faith and political opportunism is going on in Italy and France, as well as in the United States. The real struggle now, as in the fourth century of Christian history, is not for intellectual exact­ness, but for an uncompromising unity as the basis for a fight­ing organization. The main interest of Athanasius was not a correct metaphysics, but a platform on which the Church could stand and struggle for the conquest of the world. The same is the real interest of the leaders of Socialism. If only Bern­stein will act with them now, he can do all the thinking he wants to after the world-conquest and reorganization have been attained.

In both movements, the sweep and scope of this world ambition dominate all minor interests; and both may be seen historically choosing, with unerring instinct, the weapons near­est at hand for their militant purpose. As fighting organi­zations, both restrict themselves deliberately to men who dis­tinctly do their thinking within prescribed lines. This position the Roman Communion still maintains;[15] and in a feeble way heresy trials within Protestantism still remind us in how small a measure Catholicism has been intelligently rejected by Reform bodies.

Exactly the same instinct that made the embryo Old Catholic Church refuse the flattering overtures of an attractive, specula­tive Gnosticism, with its distracting and disintegrating intel­lectual processes, leads fighting Socialism to repel even the ad­vances of the “ Socialism of the Chair/’ if that is to imply the introduction of all ranges of academic doubt. The immediate purpose in hand is the possession of the producing tools of society.

After that purpose shall have been achieved, formulation of a correct philosophy will not be a great difficulty. So think and even preach those who are the responsible leaders of militant Marxian Socialism. Such dogmatism is strength, of course, but it is also profound weakness.

Dogmatism rendered the triumphs of the Old Catholic Church, and the power of Imperial Romanism, vain bulwarks against the rising tide of a sceptic, Pagan renaissance. The world was, in­deed, conquered—not, however, by truth for truth, but by an organization, worthy of much praise, but yet fatally defective for the permanent purpose of establishing even its own ideals, and much less the more splendid dreams of a reign of a Father- God.

The real strength of Socialism is not its dogmas, but its faith in a supersensuous reality, a profound faith in a coming reign of its ideals of righteousness. These ideals are class ideals, often as bare and unattractive to a power-possessing class as was the Christian dream to a hypercritical and sensuous Paganism. But just because Socialism has formulated those proletariat ideals, it has faith in itself and succeeds in arousing unbounded en­thusiasm among its adherents. The paternalistic and essen­tially feudal and aristocratic communion of Rome is rapidly losing touch with the producing classes, so far as she has ever controlled them. Individualistic Protestantism is linking its life and its fortunes more and more with the present power-­possessing and privilege-possessing class. The producing class has begun to find in militant Socialism its religious expression— “a little materialistic” though not much more so than some Jewish dreams of a land flowing with milk and honey, or some Christian hopes bound up with a new Jerusalem with streets of gold.

There are also just such dangers attendant upon this trans­ference of interest as accompanied the rise of Christian dogma­tism.

The struggles of proletarian Christianity seem often to have hardened and even embittered it. The Apocalypse repre­sents, among the canonical writings, some of these tendencies.[16] The class-struggle doctrine of the modern Socialist will, all too easily, become a doctrine of class hate, and a dream of justice be transformed into a vision of judgment upon “the crime of capitalism.”

Thus, in all attempts to understand the rapidly swelling tide of Socialist enthusiasm, it must be steadily remembered with what we are dealing. No intellectual defeat of the political economy of Karl Marx will have any more effect upon Socialism than the philosophic sneers of ancient Rome at the miracle stories of early Christianity. No appeals to national values will affect a cosmopolitanism even more logical and far-reaching than that of the early Church. The spirit of a fighting patriotism has been transferred to a group organized on a different basis. No persecution will do more than quicken the zeal of earnest fol­lowers and harden the dogmatism of the Socialist faith. The silent graves of the so-called Anarchists[17] in Chicago form already a place of sacred pilgrimage. The existing order is not chal­lenged by a theory of political economy, nor by an academic philosophy of life; it has to deal with a religious faith, a new standard of values, a fighting ideal and a militant enthusiasm rapidly hardening into an aggressive dogmatism. The Roman Empire gave way to the Old Catholic Church because it was rot­ten economically. For genuine Christianity this was a grave mis­fortune, however dramatic the victory may seem to have been. Christianity was dogmatized and formalized and organized into a new Paganism. The really vital question before the existing order to-day is: How far is it ready to meet the tremendous strain of changing economic conditions, or how far is it really as rotten as Socialist enthusiasm proclaims it to be ? If the Socialists are right, and to them fall the responsibilities of reorganizing a weary and outgrown civilization, then it is to be devoutly wished that they may become accurate students of the rise of the Old Catholic Church, and that they would more carefully guard them­selves against the dangers that beset it in the hour of its victory. If the existing order is to maintain itself, then it must find some more zeal-inspiring dream than any yet on the horizon of either feudal Romanism or individualistic Protestantism. Perhaps we, too, might do well to learn again the lessons of success and failure written in the pages of the gradual transformation of primitive Christianity into the Old Catholic Church, as securus judicavit orbis terrarum.

Originally published in The North American Review, Vol. 178, No. 571 (Jun., 1904), pp. 915–926.

[1] The Social Democracy of Germany has now over three million votes, and is the largest party in the Empire. In Austria, the voting power is nearly a million. In the United States, it is now probably about a quarter of a million. In France, it is over a million and a half. And the party is strongly entrenched in Norway, Sweden, Denmark, Holland, Italy, and even now in Spain.

[2] See Hatch’s Organization of the Early Christian Churches, 1880, pages 32–36 and 141–151. Consult also opening chapters of Ritschl’s Entstehung der Alt-Katolischen Kirche, 1857.

[3] Rudolph Sohm: Outlines of Church History.

[4] Such as the Nationalist clubs founded by Bellamy.

[5] For abundant evidence at first hand the reader need only consult the Reports of the Christlich-Sociale Partei for the last three years.

[6] The International Socialist Review, February 1, 1903, Vol. III., No. 3.

[7] Havelock Ellis in Socialist Songs, with Tunes.

[8] For best discussion, consult Johannes Weiss’s Die Predigt Jesu vom Reich Gottes 1900.

[9] Compare also James T. van Rensselaer in The International Socialist Review, July 1, 1903.

[10] Karl Kautsky himself believes, however, in a final “Revolution,” and has written an interesting work thereon.

[11] Of course, incorrectly so called. It is a collection of scattered poems and sayings of Jesus, gathered by Matthew, about the Kingdom concep­tion. See the writer’s “ Messages of Jesus,” pages 110–125.

[12] Consult for another view, Harnack’s Dogmengeschichte, Vol. I., pages 17-19.

[13] Compare Chapters X. and XI. of the Socialist Campaign Book for 1900.

[14] Consult Professor Seligman’s careful estimate, in his Economic Interpretation of History.

[15] See the suggestive encyclical of the present Pope.

[16] Compare also II. Thessalonians i: 4–10, a writing probably not Pauline, and after 72 A.D.

[17] As a matter of fact it should be remembered that the men who were hung were really Socialists, Socialists at that time not being distin­guished from Anarchists.

The Paradox of Unthrift Waiting for another – doubtless very different – Keynes

The cornerstone of John Maynard Keynes’ General Theory of Employment, Interest and Money is the rejection of one of the pillars of classical economics, and indeed of virtue itself classically understood. That pillar is saving. In that classical world, saving is a fundamentally important action, crucial to economic survival and growth. From it flows the wherewithal to outlast economic downturns – “saving for a rainy day” – and from it flows capital which is then available for investment, either by the saver or by someone else, to whom the saver either lends or extends, in the form of venture capital. This was orthodoxy, not only for economists, but for everyone living during the age of scarcity, prior to the Industrial Revolution.

Keynes turned this economic orthodoxy on its head, when he popularized the notion of the paradox of thrift. In this understanding, saving actually is harmful to the economy because it withdraws money from circulation that otherwise would go toward consumption. In other words, saving breaks the link between production and consumption which is basic to the circular flow of the economy. Speaking of the individual saver, Keynes wrote, “For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself” (General Theory, p. 84).

Keynes wrote during the time of the Great Depression, when economists (and everyone else) were knocking their heads trying to explain the utter collapse of economies around the world. The conviction of many was that classical economics had not predicted the collapse and could not explain it. They came to these conclusions: At bottom, the problem was a collapse in demand; this was caused by, among other things, saving; demand needed to be restored in order for supply, and thus labor, to be restored. So everyone followed Keynes’ advice and turned to government to make up the shortfall through deficit spending.

What was missing in Keynes’ analysis and indeed in the solutions put forward to deal with the Great Depression was an understanding of the drastic change that had taken place in the economy as a whole which had been wrought by the Industrial Revolution. It was a change pointed out, on a different level, by José Ortega y Gasset in his book, The Revolt of the Masses, published in 1930.[1]

Hitherto the economy had run in terms of the circular flow of production and consumption at the level of the household. These two had to be in basic alignment, with the balance tipping in favor of production, or the household would not survive. Mr. Micawber put it succinctly in Charles Dickens’ novel David Copperfield: “Annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

But the Industrial Revolution brought in its train the fabulous capacity to produce, far beyond anything previously imaginable. This production in turn generated wealth for the masses beyond anything that had gone before, which Mr. Ortega y Gasset brings into clear relief. But it also upset the balance of production and consumption, of the circular flow, by enabling the divorce of production from consumption: rather than being producers first, people became consumers first, and all generations since then have been characterized, not by what role they play in production, but by the fact that they are all consumers.

This consumption without regard to production has been advancing ever since the late 19th century, and it has done so through the political process and universal suffrage. Whatever else it did, the Great Depression, and indeed the Second World War, generated an exponential increase in the number and volume of programs and entitlements enabling precisely consumption without regard to production.

The Industrial Revolution did not create this divorce, but it did facilitate it, by virtue of the exponential increase in productivity it engendered.

Keynes took advantage of this possibility by 1) blaming saving, thus classical economics, for the divorce, 2) rather than restoring this balance, working on the basis of it, and 3) proposing an alternative: demand-side economics, which is deficit spending so as to facilitate consumption and in this manner generate production.

So the Keynesian Revolution hijacked the Industrial Revolution, in doing so solidifying the divorce. But the idea that demand can create supply is only an illusion made possible by the great productivity enabled by the Industrial Revolution. For that capacity to produce, seemingly as if by magic, does not nullify the fact that individual and household production still precedes consumption and enables it. All the factory systems and automation and whatever else is involved in the modern production process does not change a simple reality: it is still aggregates of networked households that do the production, and consume the results of the production. Supply still creates its own demand.[2]

Which is why we are waiting for a new – doubtless very different – Keynes. The divorce between production and consumption has to be resolved; the two need to be brought in balance again, because the alternative is nothing other than ever-increasing debt. For where does the vaunted Keynesian multiplier-inducing pump priming come from, other than deficit spending, i.e., government indebtedness? Mountains of it. And by the same token, the global-supply-chain-structured world economy[3] has broken the circular flow of national economies and turned the world into regions of production and consumption, whereby the link between the two is consciously severed, for the gain of those occupying the nexuses of the transnational framework, in the process generating massive trade deficits, all of which are “financed” by – that’s right – more indebtedness.

All Keynes did was acknowledge the reality of what was already transpiring but had yet to receive any theoretical justification from economists. Our – doubtless very different – St. Benedict will need to provide an economics that recognizes this reality and instead shows how to redress the imbalance wrought by politics and indeed by changed social mores. That will not be easy, for it will require the complete overhaul of our system of values. But who was St. Benedict, other than someone who enabled the conservation and transmission of civilization itself? Nothing less is needed.

(for more, see also The Problem of Saving)

[1] For this and the following, see the previous article.

[2] This will continue to hold true even in the new age of automation ahead of us, in which robotics will play the leading role – Blade Runner notwithstanding.

[3] Paraphrasing Rousseau, I would say that “Man was born free but everywhere is in global supply chains.”

Consumers of the World, Unite! A Dissection of Contemporary Mass-Man

There is something different, something new and unprecedented, about the generations of the 20th and 21st centuries as compared with all  those that went before them. This was already noted in 1930 by the great Spanish journalist and philosopher José Ortega y Gasset, when he unveiled[1] the phenomenon of el hombre-masa, the mass-man, otherwise known as señorito satisfecho (the self-satisfied little man). This curious figure (he couldn’t be me – could he?) was spawned and nourished in his millions by the Industrial Revolution, with its exponential increase in material production. He enjoyed a standard of living previously unknown to the wealthiest royalty, yet he was completely oblivious to the basis of that productivity. He was the product of universal education and literacy, yet entirely cut off from the spiritual and cultural roots of his own civilization. He was the “vertical barbarian,” unable to appreciate the centuries of labor required to pass from barbarism to civilization, the civilization to which he was heir, which he, as a result, would have a difficult time sustaining.

All of this strikes a deep chord: Ortega y Gasset was certainly on to something. But usually that something is misunderstood. Usually when people read his book they think of the “common man” as opposed to the educated man. Why, those of us with college degrees, we’re special and we understand what it is that separates us from “this crowd which does not know the law” (John 7: 49).

Actually, that’s not at all correct, at least by Ortega y Gasset’s own measure. For he specifically says that it is not a specific social class – the working class – that he has in mind when he talks of el hombre-masa. Certainly, in quantitative terms that is the most numerous and hence the most obvious candidate for “mass-man.” But that is the quantitative meaning. There is also the qualitative, “pejorative” meaning: “a kind of man to be found to-day in all social classes, who consequently represents our age, in which he is the predominant, ruling power.” Lo and behold, it is the man of science who is the “prototype” mass-man: “because science itself – the root of our civilisation – automatically converts him into mass-man, makes of him a primitive, a modern barbarian.” Ortega is referring here to the “barbarism of ‘specialisation’” which only knows its own little area of expertise and is ignorant of the rest.

A powerful thesis, this, which goes a long way to explain the degeneration of the university into the multiversity. And indeed, the dictionary definition of “multiversity” unwittingly bears witness to the phenomenon. Merriam-Webster defines multiversity as “a very large university with many component schools, colleges, or divisions and widely diverse functions.” Nothing about the fact that the “uni” is gone and only the “multi” is left. No unifying factor, just diversity, great diversity, specialization upon specialization with quantity alone left to qualify the association. Nominalism with a vengeance.

What, then, is the cement that holds this together? This is where I think I can add something to Ortega y Gasset’s masterly exposition. I would do so by pointing out the seemingly innocuous phenomenon of the consumer. Innocuous only until you start thinking about it. For then you come to the realization that only the generations beginning in the 20th century are made up of consumers. No generations prior to these have been. They are the first.

Of course, this does not mean that we are the first to consume. Everyone in every age must consume to live, obviously. What it means is that consumption defines us. Consumption for us is a given. We consume regardless of whether we produce, and that is the key point. Consumption for us has been divorced from production. Everyone consumes, regardless of what they produce.

Of course, there have been many in previous centuries who have lived in a similar situation. In societies with slaves or servants, there are always the wealthy who own or employ these menials, who in turn free them up from having to work themselves. They consume without producing. It goes without saying that the menials were not consumers, but producers: their consumption was paid for, and then some, by their production.

Likewise, those who worked for themselves first produced, and only then consumed. Consumption was tied to production and proceeded from it. There was no divorce of production from consumption.

And this was true from an early age. One had early on to work for a living, first in a simpler way, later on in a full-fledged occupation. Child labor was a given. No one ate without working, unless there was good reason. The Apostle Paul’s rule was universal: “if anyone is not willing to work, then he is not to eat, either” (2 Thessalonians 3: 10).

Everyone understood this: there is no consumption without production. And so people were not consumers, but producers who also consumed, whose consumption derived from their production: Say’s Law in practice. Consumption did not define the man, production did.

But all of this changed with the Industrial Revolution and the subsequent rise of the welfare state. The fabulous productivity of the machine age enabled a redistribution of the fruits of its production without a necessary connection to the production thereof.

Each generation since then has seen this gap between production and consumption widen. The Great Depression, while it saw widespread poverty and misery, also saw the exponential growth of the capacity to provide for those unable to provide for themselves. The miseries of the Second World War were followed by a postwar boom and flowering of a redistributionist system of wealth the likes of which the world had never seen. Every generation since then – in the West, the center of this transformation – has grown up with the proverbial silver spoon in its mouth.

Which is why what previously would never have entered into anyone’s head, is today a matter of course – to demand as a right the consumption goods which this form of civilization has made possible.

This is true not only of the citizens of the countries in which this productivity takes place, but also of the citizens of countries which do not experience, and never have experienced, such a level of productivity. They have tasted enough of the world of consumer goods to demand it for themselves, and if they cannot obtain it in their own countries, they will go where those goods are available, and do whatever it takes to get there and stay there.

Consumerism is, as Leslie Sklair noted, the most successful ideology of all time. “The practical ‘politics’ of [global capitalist] hegemony is the everyday life of consumer society and the promise that it is a global reality for most of the world’s peoples. This is certainly the most persistent image projected by television and the mass media in general. In one sense, therefore, shopping is the most successful social movement, product advertising in its many forms the most successful message, consumerism the most successful ideology of all time.”[2]

Sklair was writing in the 1990s, when the Internet was in its infancy and smartphones were not even in anyone’s dreams. Since then, the global reach of, and inundation in, consumerism has advanced exponentially.

All of this dovetails nicely with our reigning political and judicial ideology, centered in the notion of human rights and embodied in the mechanism which conflates subjective right and sovereignty, issuing forth in the sovereign individual. For according to this mechanism, everyone is entitled, not to what he or she produces, but simply to what is available, in accordance with the principle of equality and equal distribution. There should be no boundaries to the spread of wealth because the connection between production and consumption has been severed. I have pointed out elsewhere that the divorce of production and consumption is behind the massive trade imbalances our world is running, and the massive debt load these imbalances are generating. But beyond this lies the ideology of human rights, which is essentially an ideology of structural imbalance: everyone is entitled to consumption, regardless of what they produce.

Can the balance be restored? Not until the underlying philosophy, politics, culture, is transformed. Unless and until we restore the link between production and consumption – at every level. Until then, the conflicts and miseries we are now experiencing, especially in terms of migration, will only get worse. For the mechanism is inexorable.

Consumers of the world, forget the barricades. First, get on the wagon and restore, in your own lives, this most precarious balance. Governments won’t solve this, people will; only then can the people hold governments accountable. For people need to hold themselves accountable first.

[1] La Rebelión de las Masas, 1930; English translation: The Revolt of the Masses (New York: W.W. Norton & Company, 1932).

[2] Leslie Sklair, “Social movements for global capitalism: the transnational capitalist class in action,” Review of International Political Economy, Vol. 4 No. 3, 1997, p. 531.

Immigration, Migration, and Imbalances

The current fracas with regard to immigration through the southern border of the United States will die down in time, and another issue will replace it in the headlines, in breaking news announcements, in round-table discussions. There will not be a resolution any time soon. But what is important is to understand the underlying issues involved. The context is what we need to get a better idea of how to judge necessarily ephemeral events.

The first thing to understand is that at bottom, the motivation for these people movements is economic. For this reason, we can start our analysis by eliminating the category of refugees seeking asylum. The latter is not a function of economics but of justice and compassion. While this is important, it is dwarfed by the scale of economics-inspired movement.

We also need to distinguish immigration and migration. In the sense I intend, immigration concerns people going to the country of destination with the mindset of assimilating into that country. For example, hitherto when immigrants moved to the United States, they moved with the intention of becoming Americans, of leaving their home countries behind and entering into the civic compact that has defined the United States from its inception. Migration, on the other hand, is no so much concerned with assimilation, but rather with the maintenance of the original culture and religion in the midst of the new environment – the establishment of enclaves within a foreign culture, that while engaged, is not entirely received, and indeed is held at arm’s length. In this sense, migration is a form of colonialism. And indeed, contemporary migrations are looked upon, approvingly or otherwise, as a form of retribution for the centuries of colonial relations the West imposed upon the rest of the world: these foreign peoples are now returning the favor, colonizing, and extracting wealth from, the host nations.

In the current climate, and in this analysis, it is migration with which we are concerned.

Some economic principles to guide the discussion

Migration, then, is an aspect of a global confluence of factors mainly economic in character.

Certain basic economic concepts have to be grasped in order to get a proper view of this phenomenon.

First: the economy, whether viewed locally, nationally, or globally, is a circular flow of the production and consumption of goods and services. This is a reflection of Say’s Law: supply creates its own demand. Say’s Law, which was most effectively employed in the work of Joseph Schumpeter, from whom the phrase “circular flow” comes, helps us understand how economies function.

The circular flow of goods and services concerns is the so-called real economy.

Second: not only is there a circular flow of goods and services, there is also a circular flow of payment, credit and debt, which is generated together with the other circular flow. It is both the result of that flow, and affects that flow. This is the so-called financial economy.

The two impinge on each other and determine each other. They cannot be viewed in isolation but as two parts of the same coin. The trouble with much of modern economics is that it does not do that, but treats them in abstract separation.

These circular flows are firstly local, comprising a local economy. A larger economy is a composite of smaller economies, and so comprises a confluence of circular flows. For this reason the economy, especially in other languages like French, is also called the conjuncture. The broader economy is a conjuncture of smaller economies operating more or less in sync with each other.

The component sub-economies do not move in lockstep. Rather, they develop at varying paces, some experiencing boom periods, others bust periods, others more or less stagnating.

What happens, then, is that factors of production flow towards areas of greater productivity: that is where the jobs are, that is, where capital receives a better return.

Borders and exchange rates

Within a political unit, these flows can occur unhindered. Between political units, they are obstructed by borders. These borders are the product of law. Laws set up obstructions to the crossing of boundaries. Furthermore, currencies, which are the product of law, form hidden barriers. Because they fluctuate, they make it more difficult to judge relative values, such as wages, keeping investors and workers from making the move, especially if the move looks to be from a more valuable to a less valuable currency. But beyond all of this, language and culture form boundaries, so that even in the absence of legal or monetary hindrances, people are hindered from moving because of the difficulty in adapting to foreign conditions.

So how do adjustments occur between economies separated by boundaries? By adjustments in the exchange rate of the countries’ currencies, so that areas with expanding economic activity see their currencies appreciate, while those with relatively contracting activity see their currencies depreciate. This is reflected in the current account, which is the sum of a country’s economic activity as far as production of goods and services is concerned, as it relates to other countries. The current account is in surplus when exports exceed imports, and vice versa. And a current account surplus should result in an appreciating currency.

In a perfect world, this mechanism would proceed unhindered, and the balance between nations would be maintained, with current account surpluses and deficits continually issuing forth into currency shifts that automatically lead to their reversals. Outperforming countries would have more money to buy foreign goods and services, and underperforming countries would have relatively cheaper goods and services to offer. This would result in a reversal of flows, with the more expensive countries importing more (and producing less) and the less expensive countries exporting more (and consuming less). Wages would increase in step with the currency, allowing them to import more. This is not a static condition. Currency exchange rates would continue to shift, balancing flows through the fluctuations and reversals of economic conditions over time.

Short-circuiting the feedback mechanism

But here is where problems arise. Particular interests are favored at any particular time, on both sides of the equation. On the side of the exporting country, there is the interest of the export industry, while on the side of the importing country there is the interest of consumers. Or at least, consumers can be led to believe that it is in their interest to have cheap goods available, although there is a hidden cost to this, which we will discuss shortly.

This is the situation in our current regime of globalism. Cheap-production countries are looking to lock themselves into exchange-rate and regulatory conditions favorable to their continued exports, even though such a regime is unfavorable to their own domestic economies. In those countries, domestic consumers face high prices on imports and production geared to foreign markets; workers see their wages artificially suppressed, rather than automatically rising vis-à-vis foreign competitors, as they would if currency exchange rates moved in step.

The gainers in such a situation are mainly multinational corporations which have relocated to low-wage countries and use their former home markets as dumping grounds for cheaper production. Other gainers are governments in the exporting countries, which book revenues from those corporations and their exports. Controlling elites on both sides of the equation benefit financially and politically.

The result in the importing countries is cheaper imports, but likewise a drain of production capacity, leading to an economy heavy on service-sector jobs.

Is such an economy – one lacking in production capacity – sustainable? It would seem that, given the demands and requirements of modern welfare states and the generation of revenues they require, that such an economy is not sustainable – for ultimately it is production capacity that generates wealth, while services only redistribute pre-existing wealth. Not to mention the utterly redistributionist nature of entitlement and benefit payments, which generate no wealth whatsoever, and in fact entail a form of friction which erodes wealth.

The stubborn expansion of imbalances

In the event, such a regime generates what have come to be known as imbalances. And a lot of effort is expended to counter those imbalances without resolving them. For to resolve them would lead to favored parties – e.g., multinational corporations, exporting countries – losing their lucrative advantages.

One of the important consequences is reflected in money and banking. The regime of fixed or pegged exchange rates is realized by keeping currency exchange from taking place. Normally, cross-border trade is paralleled by currency exchange, which leads to shifts in exchange rates. But to keep those exchange rates stable, currency exchange has to be headed off at the pass, as it were. This is accomplished through what is known as “sterilization.” Central banks act to keep foreign currency earnings from being released into the domestic economy. This holds down purchasing power and so eases pressure on the domestic currency to appreciate against the foreign currency. But this also leads to bloat in the currency of the importing country. Under our current regime, in which the US dollar serves as the reserve currency for international trade – and in which the US, not coincidentally, serves as the “consumer of last resort”—this has led to the buildup of massive amounts of liquidity which circulate aimlessly on financial markets without touching ground in real markets. This leads to bubbles in markets that traditionally serve as havens for excess liquidity, such as real estate markets and stock markets. Such asset “bubbles,” when they burst, lead to massive failures in the banking system, as occurred in 2008–2009.

Migration as a rectification of imbalances

This is one way in which imbalances are generated, and how they, by hook or by crook, get resolved. But capital flows comprise only one of the factors that resolve cross-border imbalances. The other mobile factor of production – labor – will likewise be drawn by the magnetic attraction of richer countries, especially where 1) those economies are lopsided toward service jobs, which cannot be exported and therefore draw low-wage labor to them rather than going to where low-wage labor is, like manufacturing capacity can; and 2) those economies maintain more or less lavish welfare and benefit regimes which ipso facto exert an attraction on citizens of less prosperous countries.

Therefore, in a world of fixed or pegged exchange rates – or especially, in the case of the European Union, a single currency – imbalances are rectified globally in the same way they are internally within a domestic economy. For the effect of the current globalist regime is to turn the entire world economy into a single domestic economy.

It would seem that this is a driving force behind current policy decisions being taken by Western nations, both in North America and in Europe. In the United States, border control lapsed and the government introduced a range of measures to accommodate inward migration, rather than making an attempt to stifle it. This is a tacit acknowledgement that a regime of floating exchange rates, the counterpart of nations able exert to effective sovereignty, has been set aside for all practical purposes, and that the great dream of cosmopolitan liberals everywhere is at hand: a global regime of universal jurisdiction, of a police rather than a military force, of a global welfare state in which ostensibly universal human rights move from the category of “ostensible” to “actual,” and the entire globe is harnessed to a redistributionist regime in which equal rights for all becomes a reality, regardless of cost.

In the meantime, what this regime of more-or-less fixed exchange rates and open borders spells is mass migration. For able-bodied labor will move if it can move, and given the technical transportational possibilities that increasingly have become available to low-wage populations everywhere, this movement will only accelerate. This is even more the case where populations are stuck not only in low-wage situations but in crime-ridden or even war-ridden, dysfunctional countries. Muslim populations in particular seem to be caught inordinately in such situations. Not surprisingly, Muslim populations are on the move.

The problem with this solution

But this points up the profound danger involved in these movements, and the misgivings they give rise to among “receiving” populations. For we are not dealing here with interchangeable parts; we are dealing with human beings, with cultures, mores, religions, in addition to whatever wealth or lack of it, health or lack of it, they may already have. Add to this the migration-orientation as opposed to immigration-orientation of these peoples, and the problem becomes all too apparent.

With migration, nationhood itself becomes problematic; instead of these groups being encouraged to assimilate, they become treated as victims of nationalistic jingoism, and encouraged to become integral parts of the grievance coalition. Patriotism really does come to be seen as the last refuge of the scoundrel, at least for the idealist. Cosmopolitanism becomes de rigueur.

But that cosmopolitanism is only a façade covering over deep divisions. For example, to what degree is Islam compatible with liberal democracy? If Muslims ever were to become a majority, would they maintain Western liberal institutions, or would they impose the institutions peculiar to Islamic countries, such as Sharia law? These are questions that not only are interesting academic exercises, but which practice will answer unequivocally, sooner or later, and of which real people will feel the effects.

Another such question: to what degree can countries like the United States sustain influxes of low-wage labor for service jobs that already are under pressure from unemployed or underemployed citizens? How can revenues be generated to counter the massive amount of pressure being put on the health, education, and welfare systems these countries have built up over the years, especially given their aging populations? Is it not a form of collective suicide to allow these migrations to take place in the hope that the gravy train will continue to flow? For looked at purely in terms of economics, these flows look to be unsustainable.

The end game?

Perhaps that is what our contemporary global elites are after. The very destabilization of nations, the undermining of national sovereignty, only plays into the hands of those desiring to establish a global regime to replace, or at least gain dominance over, sovereign nations. Nationhood itself is at stake. Politicians seem to have placed the dream of universal jurisdiction and the realization of every human being’s inalienable rights to food, accommodation, livelihood, education, health care, and the rest of it, above the exigencies of national survival. Apparently, they will pick up the pieces left in the aftermath of conclusive national failure.

Indeed, this would seem to be end game of national leaders favoring and preferring foreign interests to those of their own nations (e.g., Barack Obama, Angela Merkel). They seem to be auditioning for leadership in the regime which is yet to come, a regime to supplement or even replace our current framework of internationalist institutions such as the United Nations. Will it ever come to that? Yet another of those questions that practice will answer. But it is looking increasingly likely.

But there is an alternative. The venerable tradition of national sovereignty, of laws and currencies which are the expression of that sovereignty, of national populations that determine their own destinies rather than having them determined by unaccountable elites at transnational levels – the infrastructure for this is still there. And the top priority to this end, quite simply, is floating exchange rates and maintenance of the institutions protective of national sovereignty. This is not rocket science. It is a simple choice. Nationhood, or globalism?

Border-Adjustment Sleight of Hand? Sense and Nonsense on the Border Adjustment Tax

The trickle of articles discussing the proposed Border Adjustment Tax (BAT) has turned into a veritable flood. Not surprisingly, the lion’s share of these articles oppose the idea of border adjustment. It would be tedious to run through them all; suffice it to say that the primary argument is that such a tax would raise the price of consumer goods.

That of course is true. But that would not be such a bad thing. For, what is the point of cheap consumer goods if the purchasing power required to buy those goods has been shipped overseas, in the form of productive labor, otherwise known as jobs?

Is this not the Achilles’ Heel of the current structure of the division of labor? We have divided up the world into rich consumption-oriented regions and poor production-oriented regions, and have allocated production capacity accordingly. The problem with this arrangement is, it has divorced production from consumption: production does not finance consumption, as it should in a healthy economy.

What should happen in such an arrangement is that the low-wage, producer countries should be seeing a steady accretion in purchasing power, reflected both in higher wages and appreciating exchange rates, which would serve to bring trade relations into balance by allowing them to consume more and so import more. The rich consuming countries would constitute the flip side of this: they would produce more and so export more.

That would be a healthy arrangement for international trade. But the current system does not allow for that. It keeps low-wage producer countries at the low-wage end, and obstructs their consumption; conversely it keeps rich consumer countries consuming at the same levels, whether through asset-bubble-financed consumption (which led to the housing crisis of 2007-2008) or simply by lavish wealth redistribution schemes, which in effect redistribute wealth from the future to the present, because they are financed in increasing degree by deficit spending, otherwise known as debt.

So the gap between production and consumption is being bridged by indebtedness. Which is one of the reasons why the world has generated such a massive debt overhang. And no matter how much one hears politicians crow about “the crisis being over” and “the future looks bright,” the debt overhang only gets more overhangy: In 2016 global debt continued its unsustainably onward and upward course.

We owe it to ourselves? Let’s not kid ourselves. Borrowing is not a shuffling of money from one drawer to another, or, as the Dutch say, “broekzak-vestzak” (pants pocket-shirt pocket). No, borrowing is receiving money in exchange for a promise to pay at some future date. In other words, it is not that we owe it to ourselves; rather, we owe it to the future – to future generations, who are on the hook for what we, collectively, borrow in the present.

The idea behind all sound borrowing is that it goes toward investment, not consumption. (Borrowing for consumption can only be permitted if sufficient reliable future income stands over against it – hence, a form of cash flow management.) Borrowing should be done in order to finance future, reliable, income – a return on investment.

Our present global trading system fosters irresponsible borrowing – borrowing for consumption without heed to the capacity to repay. In fact, it is built upon such borrowing. Which explains its unsustainability. Global indebtedness continues to burgeon, as we just pointed out. And fueling this indebtedness is the production/consumption divorce, which is reflected in trade imbalances. These imbalances are simply measures of indebtedness, for all trade deficits are “financed.” Which is another way of saying, paid for by debt rather than by a reciprocal performance.

We have gone over this many times in previous posts. The funny thing is, you won’t hear a word about it in the discussions regarding the BAT. At least, not on the part of its opponents. For them, all that matters is that it raises prices on consumer goods.

As far as popular treatments go, one of the most adept criticisms of BAT was published on April 16 in the Wall Street Journal: “The Border-Adjustment Sleight of Hand,” by Veronique de Rugy and Daniel J. Mitchell.

For starters, de Rugy and Mitchell go after one of the main arguments pushed by the pro-BAT forces, that the tax will cause the dollar’s exchange rate to rise, and so neutralize the effect on imports. Hence, any rise in prices of consumer goods will be wiped out by the rise in the dollar’s exchange rate, which has the effect of lowering prices of imported goods. De Rugy and Mitchell throw cold water on this notion. The data, they say, argue against any such compensating effect taking place, especially in the short term.

I thank the authors for making this argument. Because if the BAT has no effect on trade relations, then – to paraphrase Flannery O’Connor – “to h/*& with it.” What is needed is precisely an arrangement that will do something about trade imbalances, and if the BAT won’t, then let’s get something that will.

But de Rugy and Mitchell go on to argue that the BAT will not do anything to affect trade relations anyway. They do so by pointing to the effect Value-Added Tax (VAT), another kind of border-adjusted tax, has had on trade. In their view, VAT has done nothing to skew trade relations one way or the other.

Here’s the nub of their argument:

The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds horribly unfair, right? Don’t be fooled. Like magicians, those making this argument are distracting the unwary, hoping that nobody will notice the trick.

Here’s the real story: What matters from a competitive perspective is whether the playing field is level—and it is. When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

While this argument sounds convincing, it overlooks some essential information. In fact, it focuses on one effect only and totally overlooks another. So it’s not sleight of hand that’s the problem, it’s short-sightedness. Granted, in this example there is a level playing field in America, and an equally level playing field in Germany. But that’s the problem – there are two playing fields. On the American playing field, you have no VAT, but on the German one, you do. The question is not so much whether individual German products are advantaged or disadvantaged vis-à-vis their American counterparts, but whether Germany is shifting its entire playing field to the advantage of producers – both German and American – and disadvantage of consumers – both German and American. And that is what’s happening. Germany, and other countries that employ VAT, have made it more difficult to consume in their countries. Therefore, they end up overproducing, and shipping their excess production to foreign countries, mainly the United States. It is this that leads to the trade imbalances we have been harping on and will continue to harp on.

Here is an overview of US trade imbalances with key trading partners in 2014, taken from the Wikipedia article, “List of the largest trading partners of the United States.” Firstly, notice that the overall US trade balance is in deficit by a $734 billion. That’s an additional $734 billion in debt, rung up in just one year. Add that to the federal deficit and you really do have a twin-deficits problem.

But notice also that all the major bilateral trade deficits are with countries that have a VAT.

Rank Country/District Exports Imports Total Trade Trade Balance
World 1,454,624 2,188,940 3,643,564 -734,316
1  China 115,775 462,813 578,588 -347,038
 European Union[3] 270,325 416,666 686,991 -146,340
4  Japan 63,264 132,202 195,466 -68,938
5  Germany 49,362 114,227 163,589 -64,865
3  Mexico 230,959 294,151 525,110 -63,192
15  Ireland 9,556 45,504 55,060 -35,948
16  Vietnam 10,151 42,109 52,260 -31,958
11  Italy 16,754 45,210 61,964 -28,456
6  South Korea 42,266 69,932 112,198 -27,666
18  Malaysia 11,867 36,687 48,554 -24,820
9  India 21,689 45,998 67,687 -24,309
21  Thailand 10,573 29,493 40,066 -18,920
8  France 30,941 46,765 77,706 -15,824
12   Switzerland 22,701 36,374 59,075 -13,673
10  Taiwan 26,045 39,313 65,358 -13,268
27  Indonesia 6,037 19,203 25,240 -13,166
2  Canada 266,827 278,067 544,894 -11,240

Is that coincidence? We think not. Of course, VAT is not the only factor involved in trade deficits. There is also the infamous currency manipulation, as well as factors such as forced savings. I have gone over these in previous posts, and the reader would do well to apprise him- or herself of them.

The fact of the matter is, the BAT – or something like it – is direly needed to offset these ongoing trade deficits. Of course, there will be a price to pay, in the form of higher prices for consumer goods. That is why representatives of industries ranging from retail sales to the Koch Brothers to “big oil” oppose it. But higher prices for consumer goods will of  necessity reduce consumption vis-à-vis production and help bring that relationship more in line with trading partners, thus helping rebalance trade. Granted, it would be better if those other countries would eliminate their border-adjusted tax regimes, but that is not in the offing. Something has to be done, and this is better than nothing.


A Monetary Solution to Trade Imbalances? Gilder and the Gold Standard

The wait continues regarding the tax reform proposal to come out of the White House and be taken up by Congress. Despite the headlines dominated by more peripheral matters, tax reform is shaping up to be one of the cruxes to the success of the new administration. It is not simply a matter of reducing tax rates, or eliminating loopholes, or otherwise rendering the tax code more transparent and equitable, as important as those things might be. It turns out that tax reform is also crucial to combat the out-of-kilter trade arrangements that not only are strangling the US economy but also are perpetuating inequitable and exploitative terms of trade, at both ends of the trade relation, for both developed and developing countries.

How is tax reform relevant to this question? By virtue of one of the key proposals now being discussed: the border adjustment tax. We discussed this, and its importance in terms of trade relations, in a previous post.  As of this writing, the prospect of its being incorporated into the tax reform proposal taken up by Congress is up in the air. One report even speaks of it being on “life support.” If it, or something like it, does not come along, something else, most likely more draconian, will probably take its place. Something more like traditional protectionism.

But there are other proposals being floated likewise intended to counteract the cockeyed trade regime with which the world is now saddled. Conservative icon George Gilder has one for us that merits consideration. Gilder’s focus of late has been money, as evidenced by his 2016 book The Scandal of Money: Why Wall Street Recovers but the Economy Never Does. The burden of the argument is that floating exchange rates are the bane of the modern economy; our economic issues can only be rectified by a return to the gold standard. Floating exchange rates, in this version, are the product of government-controlled money, and as the Friedrich Hayek-authored epigraph has it, “The source and root of all monetary evil [is] the government monopoly on the issue and control of money.”

In his book, one of the claims Gilder makes is that the accusation against China as being a currency manipulator, is specious. Quoting John Mauldin, Gilder asserts that “Trump and all those who prattle on about Chinese currency manipulation have the economic comprehension of a parakeet” (p. 40). But Gilder, at least on this score, has had a change of heart. Writing in The Federalist, Gilder confesses “I was wrong.” Trump’s economic comprehension, apparently, does exceed that of a parakeet. In fact, he is on to something – though he does not quite know what. “World trade is no longer expanding for a reason, and Trump has put his finger on it. That reason is a combination of crazy quilt trade pacts, disguising wild and wooly monetary manipulation.”

So Gilder puts his finger on what Trump already put his finger, refining what he implies is a wooly argument. It is not the “crazy quilt trade pacts” that are the problem, so much as the “wild and wooly monetary manipulation” that they ostensibly conceal. Gilder’s vision is of a world in which speculators in the currency trade generate deranged exchange rates, wild swings that make a mockery of economic fundamentals. “Currency trading is a speculative orgy that fails to correspond at all with relative productivities of workers, or comparative advantages between countries, or purchasing power parities between different markets.”

For example, US workers have lost their jobs – because the Japanese yen went from 80 to the dollar to 300 to the dollar and back, and because the euro has fluctuated 20% vis-a-vis the dollar: “A worker who lost a job because of the global economy might as well have been hit by lightning. No rhyme or reason explained it. What we call a crisis of trade is really a scandal of money.” NAFTA was a big mistake, not because of the specifics of the deal, but because it led to Mexican peso devaluation: “No entrepreneurial creativity or worker efficiency or technological virtuosity could dent the overwhelming impact of the drastic relentless change in the unit of account. It emitted—as Ross Perot put it—a ‘giant sucking sound’ symbolizing a major reorganization of North American manufacturing. Yet the entire costly and tempestuous change was mostly an effect of monetary speculation.”

Hence, the global trade imbalances which have precipitated the mass transfer of production and capacity and thus jobs have been caused by floating exchange rates. The solution, as one might surmise from such a diagnosis, is to eliminate them. “So long as central banks possess the power to change currency values virtually at will, free trade cannot be either fair or efficient.”

Let us take note at this point, that we have added a person of interest to the list of currency malefactors. To the currency traders, the “10 international banks that do 77 percent of the exchanges,” Gilder has added central bankers. But this does not yet exhaust Gilder’s list. Where are the politicians? Here they are: “With money controlled by politicians in the guise of central bankers, it cannot serve as an objective measuring stick of commerce.” So central bankers are really politicians – essentially giving us three categories of malefactors. Which is why Gilder endorses Hayek’s assertion that it is government-run money that we are dealing with.

Gilder’s solution: “We Need A New Bretton Woods Agreement. ” Let’s take a look at that. Bretton Woods was the post-World War II monetary arrangement whereby the dollar, tethered to gold, served as the reserve currency for the countries of the world’s various domestic currencies. We will be exploring the concept of a reserve currency more fully in a future blog post (for now, these posts will suffice). The idea of a reserve currency is to function as “real” money in the banking system, so that monetary issue is limited to some multiple of reserve currency holdings. In other words, in the Bretton Woods framework, domestic currency issues were restricted by the amount of dollars held by the banking system, mainly the central bank. The amount of dollars, in turn, was restricted by the requirement of gold redeemability, with the price of gold fixed at $35 per ounce.

This would eliminate both inflation and deflation: “The best way to obviate both inflation and deflation is a global agreement to tie currencies to gold in the spirit of Bretton Woods.”

For all the respect I have for Mr. Gilder’s work – and it is a lot: his Wealth and Poverty made a permanent impression on my thinking, back when I was a wet-behind-the-ears Peace Corps volunteer – I think he claims too much here. The problem is that he posits precisely what he needs to demonstrate: that a commodity money standard, such as the gold standard, brings with it price stability. Certainly, tying domestic currencies to gold would eliminate their fluctuations vis-à-vis one another, but that is not the same thing as saying that prices would cease fluctuating. Quite the contrary.

During its heyday in the 19th century, the gold standard operated in terms of the so-called “automatic mechanism,” with gold flows settling imbalances between trading regions. Not between countries per se, but regions – because in the framework of the gold standard, borders vanish and the participating countries become locked into a single economic unit. At least, theoretically; practice was different, as we shall see.

So then, where countries tied their currencies to gold, and gold flows were allowed to occur without hindrance, and where corresponding trade flows of goods, services, labor, likewise were allowed to occur without hindrance, there you had the properly functioning automatic mechanism. And within this mechanism, gold flows are triggered by interest rates. Where interest rates are high, there gold flows. What leads to shifts in interest rates? Economic performance. Interest rates are raised where economic performance is lagging, and reduced were economic performance is buoyant.

What was the result of such actions? It has everything to do with the reserve function of gold in this system. The money supply is tied to gold; the more gold held by banks, the more money could be issued (a healthy multiple was considered to be two to three times the amount of gold reserves). Gold inflows allowed for monetary expansion, hence increased lending and thus increased investment and expenditure, while gold outflows reduced the money supply, tightened lending conditions, and throttled economic growth. In this way, economic regions were kept in balance: where growth was occurring it would automatically be restrained, and where contraction was occurring, the economy would automatically be stimulated.

Trade imbalances could not arise under such a system, but there was a price to pay: inflation and deflation. Where the money supply was allowed to expand, there you had inflation; and where the money supply was forced to contract, there you had deflation. Inflation and deflation was built into the gold standard with its automatic mechanism. Mr. Gilder’s assertion that a gold standard eliminates price fluctuations is totally mistaken. A gold standard functions precisely by triggering inflation and deflation.

There is more. The broader economy, in this system, is tied to the amount of gold held in reserve. In other words, economic growth, population growth, and attendant phenomena depended upon the vagaries of gold mining production as to whether they could even occur or not.

But of course, the 19th century was also the age of the social question, the silver question, the labor question, the suffrage question. All of these questions were tied to the gold standard with the restriction it inherently placed upon economic growth. The labor movement arose in response to that restriction, as did expansion of suffrage: for politicians realized that much hay was to be made by appealing to that ever-expanding voting bloc of disgruntled workers subjected to the whims of gold flows and gold reserves.

In response to incessant social and political agitation, there came the institution of central banking, the goal of which was to mediate between these social forces, on the one hand, and the dictates of the automatic mechanism, on the other. Increasingly, the pound sterling was considered to function as a substitute for gold, enabling money supplies to expand accordingly. But like the post-WW2 dollar standard, this made the world dependent upon sterling, and countries like Germany chafed under that dependency. The sterling standard gave the UK an “exorbitant privilege,” as they say, and provoked rivalry with Germany that ultimately led to the First World War.

Things got even worse in the aftermath, as war reparations along with the devastations of war led to the ascendancy of the US, which, in accordance with the dictates of the day, received in payment mountains of gold. But despite copious amounts of lip service, the automatic mechanism was not allowed to reassert itself. Instead, it was during the 1920s that the entire ideology of “price stability” and “full employment” began to be developed and implemented by central bankers, and the key to this was to keep all that gold from entering the financial system, provoking an unsustainable boom, or, even worse, allowing it to flow back to the countries from whence it came, as those countries tried to export their way to prosperity. The US, of course, had always practiced protectionism and now continued to do so, essentially consigning countries like Germany to relative penury and sowing the seeds for the Second World War.

What needs to be realized is that any system of currency which short-circuits the feedback mechanism (Jane Jacobs’ term) of currencies vis-à-vis one another, like the gold standard did, only substitutes another feedback mechanism. If one does not wish for fluctuating exchange rates, one should welcome the inflation-deflation whipsaw, because that is the alternative means for rectifying imbalances. And where such a whipsaw mechanism is politically unfeasible, as in any developed democracy it will be unfeasible, then the alternative is stagnation, as imbalances are allowed to build up on bank balance sheets in the form of unredeemed debt.

These are our alternatives. There are no others. The dream of a return to the gold standard should be laid to rest. Besides, the likelihood that such apparitions from the grave will be given new life is probably zero. Let’s spend our time talking about feasible alternatives.

More on the gold standard can be found in these posts and in these excerpts from my book Follow the Money: The Money Trail Through History. More on floating exchange rates can be found in these posts.