Contents
Of the utmost importance here is to understand that the incentives do not self-correct the imbalances they create. Fiat is “Paretian.” They only make the imbalances greater over time, and the price required to disincentivize such behavior is something to which no participant would voluntarily agree. The optimal strategy for any adversary whose opponent’s biggest weakness is their own structure of operation, is patience and persistence. This in turn incentivizes everyone operating in such a society to play the same game so as not be left in the dust. Everyone must maximize their debt accumulation, and thus a credit-based fiat economy can only go in one direction. Excess saving leads to specialization, allowing for innovation and productivity gain, in turn generating additional savings.
As our centralized debt trap expands in circumference, the risk-free rate must also trend toward zero, as has been the case over the past 40 years. Over time, the consequence of this could even be the elimination of the need for a private sector. As is often the case with disruptive technology, its usage preceded an appropriate infrastructure to handle it.
But there is another reason why the above scenario is likely inevitable. While the cost of carrying our imbalances is high, it is not yet sufficiently high enough to reverse the stubborn inertia of the system to recalibrate. Unfortunately, the imbalances laid out in this essay are likely to only rise from here. I have discussed the path dependency of this conclusion by way of analyzing the options available to us, and solving for the path of least resistance. We have no appreciation for durability over time. Therefore, we do not particularly value persistence because its main attribute is indeed durability over time.
We are heading in this direction as a product of false choices that have cornered us into an inexorable debt trap. In my professional life, I have been honored to have learned firsthand from some great mentors, including Wall Street veteran Marty Zweig. Beyond his status as a pioneering and legendary macro investor, he also coined the phrase “don’t fight the Fed,” a simple axiom that adheres to the notion of following the path of least resistance. Compound interest is one of the most impressive growth formulas experienced in the natural and economic worlds, and its most efficient avenue for success is antifragility. On one axis, you have a quantity and variety of stressors, but on the other you also have a quantity and variety of reactions, responses and results.
Their successes eventually become their weaknesses. Efficiency helps fuel dominance in a world that values power as a function of resources, but it leads to dangerous deficits in resiliency that inevitably make them easy to destroy. This is also why empires are often built over long periods of gradual ascent, but often fall precipitously. A centralizing power depends on vulnerability to validate its own existence. As the costs of centralization mount, is becomes existentially vital for an authority to lay claim on the sole ability to medicate the very ailments it fabricates, so as to traverse unstable times unscathed. Passive or indexed investing vehicles such as exchange-traded funds are yet another example of this shift toward a “mass investor class.” While such a trend may seem innocuous, it is cultivating the seeds of enormous societal change.
It helps an increasingly interconnected economy divide labor beyond its current stalemate. Given that volatility is a natural phenomenon of any free system, suppressing it requires external and artificial forces. It requires a central authority to manage the system and to solve for low volatility. Our central bank policy of monetizing moral hazard is evidence of this. Moral hazard from this prism is simply a function that solves for low volatility, at all costs. Instead, such rules generalize the flow of investment, compensating those market participants best suited to game such a system.
Volatility, on the other hand, is a natural characteristic of all complex systems. This is because the greater the number of variables, the greater the number of possible outcomes. Stressors lead to adaptation and growth, which leads to survival, which builds resilience, which lays the foundation for more resilience and growth.
Conversely, centralization craves more uniformity. Otherwise, there become too many outliers in the herd to corral, and the system becomes unmanageable. As networks proliferate, governments increasingly are driven existentially to ramp up the use of power and coercion against this natural force.
As we kick the proverbial can, we are in essence just reallocating costs out into the future. The costs do not actually move out into the future as if transported in some time machine. They persist in the present, but are obfuscated by a mask of financial engineering, giddiness at the prospect of overnight wealth, and the immense power of narrative.
As such, the nature of bitcoin’s decentralized structure will be at the core of part two of this series. Money, a human social technology of value and communication, is perhaps one of the few practical instances we can witness of a limitless power law function, as it stores labor over time. In a power law equation where time itself is the variable to which the function is raised, this creates a powerful compounding effect. That is, as long as the calculated value can persist over time.
Resilient to deleveraging elsewhere, resilient to market volatility, resilient to dollar shortages, and even resilient to cyclical inflation. A move from 20% to 14.5% may not sound significant, but this is a nearly 30% decline in average volatility. The positive effect of such a shift has on underlying asset prices cannot be overstated.
Nonetheless, the pace of change and data dumping has inspired us to overly romanticize and revere data accumulation, prediction, and data modeling techniques. American openness toward socialism, and a commensurate disdain for capitalist ideals, has increased dramatically over the last four generations. This has been well documented with recent generations, particularly millennials, but it is important to recall that such a trend has been consistent well before that, even with the Swing Trading boomer generation relative to their parents and grandparents. One could argue that some changes would certainly make these aims easier to administer, like augmenting the Federal Reserve Act of 1913 and expanding the powers of the U.S. However, the key point here is that such change is not required. If the reader finds this too far fetched, I would recommend listening to the taped conversations between ex-President Richard Nixon, and then-Federal Reserve Chairman Arthur Burns.
If this equation is disrupted then this virtuous progression collapses. An absolutely scarce money accrues its interest as the residual incremental productivity gained from marginal output. New productive labor can only scale if work can be continually divided and specialized. Such scaling, in turn, can only occur if there is adequate savings of excess production. Volatility is the mathematical expression of what biologists and evolutionary scientists might call a “stressor.” Biological organisms crave stasis.
This group has become the “landlord class” of the internet, and the vast majority of value proffered by the internet and its myriad innovations of social communication has been funneled through this layer. The consequence, of course, has been more inequality, more surveillance and control, and more concentration of power. Further, we’ve witnessed a trend toward a reduction of quality of information. There is a diffusion of responsibility that engulfs the internet when ownership is so opaque and ephemeral.
Survive like our palm tree and you get to keep compounding. As long as the other variables in the equation do not change materially, time will do the heavy lifting. This speaks to an important point on the importance of resilience when it comes to financial assets, as consistency through time is what leads to such tremendous abundance. What has historically given treasuries their stature of primacy for so many years was the dollar’s reserve currency role.
Given that resilience is vague and incandescent, a decline can seem harmless until it suddenly breaks completely. This means that the relationship between efficiency and resilience is non-linear. There is always a point on the curve where the benefit of efficiency gains become precipitously overwhelmed by the cumulative trade-offs. Thus, rates must go down, so volatility must go down. However, there are other problems to consider from this evolution of behavior as well.
This is especially obvious when one simply looks at the below chart, or even at the hiring behavior on Capitol Hill, like the large representation of Blackrock alumni acquiring key roles in the current White House administration. Blackrock is the number-one manufacturer of passive investment vehicles in the world, with over $1.8 trillion in assets under management (followed by Vanguard in second place at $1.2 trillion). As discussed by Inigo Fraser-Jenkins, a highly-regarded maverick quantitative equity strategist at Wall Street firm Bernstein, passive investing can be compared to Marxism.
This has unfolded by way of a windy half-century road of best intentions gone awry. A road pock-marked with asset bubbles, moral hazard, slippery-sloped tributaries flowing into busted dams, cascading into tipping points, wpf dynamic table and catapulted further downstream by the gravity of inertial political malaise. Unless we can find a plausible, new and imaginative path to fully decentralize the economy, it will end up fully centralized instead.
The decision-making process becomes tied much more to government policy goals, cronyism and bribery, and other characteristics very similar to those of communist systems trading 212 account types of governance. The corporation and the entrepreneur lose their utility in this world. Any marginal gain in efficiency requires a marginal loss of resilience.
A more frictionless pathway would be the mechanism outlined above, whereby social welfare can be extolled circuitously. The brilliance of such a policy approach is that it would not require any incremental pieces of legislation, and no constitutional alterations to property rights. This implies that our current institutions have the power to accomplish such social welfare goals today.
