Doc's Daily Commentary
Mind Of Mav
The Coming Deflationary Era
You may have noticed that the news isn’t all that fun to watch lately.
And yet, underpinning every unexpected hardship we’ve encountered this year, there is this lingering feeling that something is fundamentally wrong with our system.
Sure, we could look at 100’s of graphs or listen to countless experts, but they often point to symptoms of the problem, rather than address the root issue. So, what is that root issue?
Technology is deflationary. What that means is that as technology advances, we can do more with less. Less capital and labor needed to create more value.
And because technology underpins more and more of the world around us, it means that we are entering into an age of deflation unlike any the world has ever seen.
So why is this the root cause of our struggles? Our economic systems were not built for a world driven by technology where prices keep falling.
They were built for a pre-technology era when labor and capital were inextricably linked, an era that counted on growth and inflation, an era where we made money from scarcity and inefficiency. That era is over. But we keep on pretending that those economic systems still work. Rather than let the new system driven by technology take its course, institutions like the Fed have instead stepped in.
Because of their race-to-the-bottom monetary policy, the only thing driving growth in the world today is easy credit, which is being created at a pace that is hard to comprehend.
The rise of that credit and corresponding debt is keeping us locked into a system where we try to artificially drive an economic system built for the past, but we are creating more than just economic trouble. On our current path, our world will become profoundly more polarized and unsafe.
Just look around at all the recent events driven by discontent.
While seemingly random, they are all connected to a loss in hope for a better future for large portions of the population. Underlying this loss of hope is a new economic reality where it’s not just the poor who are missing out on economic gains.
To recap, technology is deflationary, but our institutions have locked us into an inflationary system that is doomed to fail.
Let’s run down some reasons why our current system is heading for a cliff at an alarming speed.
- The global economy’s cost structure has been fatally distorted by central bank policies of inflating asset bubbles and reducing interest rates to near-zero. It should be extremely telling that additional stimulus matters more to Wall Street than news of a vaccine.
- Earnings from labor have stagnated or eroded since the era of globalization / financialization took off around 2000.
- Everything costs too much, i.e. is no longer affordable from earnings alone, so the only way to maintain the current costly lifestyle is to borrow money and use it to pay current expenses. This is true for every sector: household, corporate, and government.
- As a result, everyone now needs every dollar of income just to pay their expenses, including interest and principal on their rising debts. There is no slack (buffers) in the system at all.
- This can be visualized as a row of dominoes. Once the first domino falls, every domino will be toppled.
The dominoes falling trigger a reverse wealth effect. This is important because the wealth effect–the psychological state of euphoria created when one’s assets steadily rise in value– has been a core driver of consumption since the Federal Reserve transformed the economy into a Bubble-Based Economy in the late 1990s.
When we feel wealthier because our assets are rising, we’re increasingly likely to tap that newfound wealth by borrowing money to fulfill our desires for inessential goods and services. Since the Fed has suppressed interest rates, the cost of borrowing against one’s house or buying a new car seemed remarkably affordable, especially compared to the big increases in wealth generated by rising assets.
Unfortunately, while the wealth effect can reverse, debts have to be paid regardless. Debt payments are forever while the wealth effect is fleeting.
The current mass delusion is that the Fed can bail everyone out with cost-free cash, which explains the stock market hitting all-time highs repeatedly.
If it takes ever-increasing credit growth to achieve economic growth, how are our economies any different from a Ponzi scheme? A Ponzi scheme creates an illusion of profits because it pays early investors with investments from later investors. Even though the scheme is a fraud, it can look like a good business in that early investors talk about how great their returns are. Because it requires more and more capital to pay out investors, it continues until new investors at the bottom of the pyramid slow down enough to stop paying out earlier investors, which brings the entire system down. At what point does debt slow enough to bring the entire system down? When does the future stop paying off the past?
To keep the system running, monetary policy all around the world has target inflation rates. From a debt perspective, this makes sense: inflation makes debt easier to pay back because you’re paying yesterday, when dollars cost more, with money from tomorrow, when dollars are worthless.
For those unable to access debt, though, and put it into assets that rose in value, the inflation has been punishing because their dollars do not go as far as they used to. And since inflation makes your currency worthless over time, we need to start asking: Isn’t currency founded on trust in the value of that currency? And doesn’t that mean that by setting inflation target rates, governments have a stated goal of eroding that trust?
What if the natural order of things was permitted? What if, instead of trying to stop deflation at all costs, we embrace it? As technology spreads, deflation happens at the rate it should. Deflation becomes something celebrated because it means that we are getting more for less. We allow ourselves to accept abundance. Along that continuum, as technology removes jobs and fewer overall jobs are needed, prices will keep falling, allowing those who lose jobs a way to share in the benefit of technology abundance without massive transfers of wealth.
If technology-driven price declines continue to the point of something becoming free, we let that happen, too. People will no longer have to be on an endless treadmill to pay for things that are constantly rising in price. As hard as that might be for us to accept, because it is such a radical change to the way things are today, it seems to me that it is the only real choice we have.
It is hard to imagine this because we have grown up in a world where these choices did not exist. Where technology deflation was only in isolated pockets of our economies instead of throughout. Where we could count on training people into new jobs and industries not impacted by the changes and continue on the same path that drove prosperity at a different time. That same path is impossible to imagine going forward, with technology soon underpinning almost everything we do. It is easy to dismiss it out of hand, because we are trapped in a system where we don’t know what we would do with ourselves if we didn’t have jobs.
Our careers are far more important to us than just the income that they bring. Our careers become part of the story of who we are—with our relationships and social status (our “us”) often coming from our jobs. For that reason, even if the facts are inescapable, that most of these jobs will be better done by technology, we bury our heads in the sand. The fear of a future without those jobs and self-worth that they bring stops us from imagining a better world in which they might not even be required. Consider this alternative: allowing abundance without the jobs might actually open an entirely new enlightenment era where we have time to enjoy the benefits that technology brings.
A true capitalist system could work well in that environment because there would still be an incentive to work harder and innovate. Prices of all things would fall, yes, but those creating value would be paid for their value creation—at a rate that matched the new realities of supply and demand and our digital world. We still line up for the newest iPhone even while our service providers let us have older models for free, after all. But those who lose out in our societies would be less at risk. As an entire infrastructure needed to support more jobs to support price inflation resulting from monetary easing is removed, the cost of entitlement programs is removed with it. It becomes much cheaper to live, and thus the burden to those working drops.
While I am sure that governments will not voluntarily give up control of their currencies, if there is not a coordinated international effort on a Bretton Woods type of framework that establishes rules around currency exchange rates, it will happen regardless—just in a different way.
Remember, a currency only holds value because of the deemed trust we have in it. That trust is just an agreed-upon exchange of value and that government will keep its promises. That trust is compromised if governments do not keep their promises—even if they pretend to by changing the value of the paper the promise is written on. The more that trust is eroded, the more likely that an alternative currency becomes a more trusted mechanism. That alternative—whether Bitcoin or something different—could emerge quickly. The digital and distributed nature of digital currencies such as bitcoin allows them to benefit from a network effect with each additional user enhancing its value.
As more users trust the system, more trust accretes to the system. Although it is hard to imagine it surpassing any of the main currencies, that reality could easily change tomorrow as more currencies come under pressure; the by-product of that pressure increases the value of Bitcoin or any blockchain network. In other words, what starts as a way for citizens in Venezuela and other regions of the world to escape crushing currency devaluation could jump from country to country and easily build to a point where it becomes the de facto standard of trust.
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