Behavior And Incentives
Part VIII of the Bitgenstein Serialization
“It is harder to ignore the enormous increase in indebtedness and overhead that has accompanied the enlargement of farm technology. Mr Billard quotes an Iowa banker: “In 1920 … $5,000 was a big loan, and people hesitated to borrow. Now a $40,000 loan is commonplace, and having mortgage after mortgage is an accepted thing. I occasionally wonder whether the average farmer will ever get out of debt.” …
… The Iowa banker’s statement, doubtful as it may seem out of context, is made in praise of credit. Nowhere is there a question of the advisability of basing so large on enterprise on credit, or of the influence of routine indebtedness on a people’s character. Nowhere is there a suspicion that there might be any worth in the old rural values of solvency and thrift.”
- Wendell Berry
What really matters in all of this — what the financial terminology ought to elucidate but can just as easily obscure — is what is happening to the incentives individuals face to devote their time and energy to economically useful behavior. Are they incentivized to grow the capital stock or not? I can think of four obvious changes in relative incentives, although I’m sure there are countless more.
First, there will be an incentive to find some asset other than money to save with. Likely candidates are real estate and equity and bond indices. Inflation in these asset classes will march upwards with the threat of inflation in general, distorting the price information they otherwise both create and rely on and further misdirecting capital to ends that are only as sustainable as the inflationary regime. Anybody who wants these assets for their actual economic function — somewhere to live, stable cash flows, whatever — ends up at the mercy of this regime: unable to own anything unless they lever up too, which of course just exacerbates the problem.
Second, those who hold return-seeking capital assets but who do not lever up are comparatively disadvantaged if their competitors do. And if they don’t get politically preferential access to the front of the queue for new loans, they may have to sell to those who do. The oldest company in the world, Kongō Gumi, was run by 50 generations of the same Japanese family before selling out to conglomerate Takamatsu in 2006, when it “succumbed to excess debt,” according to Bloomberg.
Third, this constant and pointless demand for financialization will create political and business opportunities to better facilitate it. Financial capital will increasingly be directed towards the very business of financialization at the expense of creating real productive capital. Those in on such schemes will do very well indeed, but this is clearly not economically useful. Here, Matt Stoller describes this process in equal parts entertainingly and depressingly, as industries as odd and diverse as portable toilets, prison phones, and dentistry are financialized to absolutely nobody’s benefit other than those orchestrating, “a form of legalized fraud shifting money from the pockets of investors and workers to the pockets of financiers.”
Fourth, this artificially expanded opportunity will favor general bigness and concentration in finance itself. Berry’s insight of the optimal organization of agriculture I think once again transcends his domain and is a valuable commentary on credit and capital:
“In a highly centralized and industrialized food-supply system there can be no small disaster. Whether it be a production “error” or a corn blight, the disaster is not foreseen until it exists; it is not recognized until it is widespread. By contrast, a highly diversified, small-farm agriculture combined with local marketing is literally crisscrossed with margins, and these margins work both to allow and encourage care and to contain damage.”
In other words, the financial system will tend towards a structure that makes crises all the more devastating when they inevitably occur.
And finally, an obvious consequence of all four is accelerating inequality between those who do and do not own capital, who are and are not able to get to front of the queue for artificial finance, and who do and do not malinvest in their own human capital on false price signals. Given the focus of this essay is to elucidate the dynamics of the capital stock, I will leave the connection at the following musing: if the popular reaction to such spiraling inequality and unaccountable overseeing of proliferating crises is to whip up anti-capitalist sentiment and/or demand compensatory money printing, will the incentives to channel time and energy towards growing the capital stock get better or worse?
The Uncapitalizing of America
Does it ever end? If so, where? When? How?
It is likely impossible to say because the impetus is politically variable, and there will always be the countervailing force of successful experiments propping the whole thing up. We can interpret their significance from multiple angles. By definition, they add to the capital stock and may or may not offset its natural rate of depletion. They contribute to deflation which may or may not offset the inflation caused by the perversity of the monetary regime. Most critically, they offer a means of natural deleveraging — even within the ideological obsession with consumption — because the lower later consumption that balances their financialization will be relatively less impactful.
But that that opportunity to deleverage exists does not mean it will be taken. Successful investment and capital creation may not pull hard enough and may only delay the inevitable. The never-ending march to greater and greater leverage will meet its final boss at the zero lower bound of interest. It is difficult to overstate the importance of appreciating the ZLB from first principles.
If you are offered a negative interest loan, what this means is that you can spend it on an investment project that loses money, and still make money yourself. This financialization allows you to crystallize future value that will never come to exist. In other words, it encourages not even the relative waste of capital, but its direct consumption. Imposing negative interest rates is strip-mining the capital stock. It is eating the seeds rather than planting them. It is utter insanity, but it is an insanity with no alternative if we can’t deleverage and yet we must consume.
Berry’s analysis of the tragic logic of the accelerating pillaging of the agricultural stock I think translates practically word for word. It may even be more accurate to say that it generalizes, as the agricultural stock is but one form of accumulated capital — the original:
“It is no doubt impossible to live without thought of the future; hope and vision can live nowhere else. But the only possible guarantee of the future is responsible behavior in the present. When supposed future needs are used to justify misbehavior in the present, as is the tendency with us, then we are both perverting the present and diminishing the future. But the most prolific source of justifications of exploitative behavior has been the future. The future is a time that cannot conceivably be reached except by industrial progress and economic growth. The future, so full of material blessings, is nevertheless threatened with dire shortages of food, energy, and security unless we exploit the earth even more “freely,” with greater speed and less caution. The obvious paradoxes involved in this — that we are using up future necessities in order to make a more abundant future; that final loss has been made a calculated strategy of annual gain — have so far been understood to no great effect. The great convenience of the future as a context of behavior is that nobody knows anything about it. No rational person can see how using up the topsoil or the fossil fuels as quickly as possible can provide greater security for the future, but if enough wealth and power can conjure up the audacity to say it can, then sheer fantasy is given the force of truth; the future becomes reckonable as even the past has never been.”
To say this sheer fantasy “ends” here is likely presumptuous. It gets abjectly worse here, but nobody knows when it ends. When all capital has been consumed? When leverage is infinite?
What about if or when savers revolt against the tax on their savings that negative rates require? Inflation may be a stealth tax that is unavoidable as far as they are concerned, but surely this obnoxiously direct tax can be avoided by removing deposits? Unfortunately, this will do little more than trigger a liquidity crisis that will have to be patched by long-term inflationary reserve creation, from which yet more short-term inflationary leverage will predictably metastasize. And if you think about it, this nuisance would be rather solved by simply banning cash such that fungible pan-bank liabilities are not liabilities against anything in particular, besides the loans that created them. It would be jolly good for banking stability to protect it from the animal spirits of the rabble. I wonder if anybody has considered this …
In Parts I through IV, I stressed that money is useful not because it fits some or other semantic scheme that holds up if and only if nothing in real life changes, but because real life does change, and money provides certainty in an uncertain world. But this is not to say that uncertainty is harmful. Capital formation is by necessity highly uncertain, but greatly beneficial. Money provides a means of socially scaling the embrace of this uncertainty, provided it gives us certainty in the first place. The more capital we create, the more complex the economic environment gets, and the more valuable the certainty of money becomes. Money emerges from uncertainty, capital emerges from money, and uncertainty emerges from capital.
This progression towards order and complexity can be reversed if perturbed with enough economic misinformation. If the value of money becomes increasingly uncertain, it will create increasingly worthless capital, which will mean money is less valuable anyway. If you break money, you break capital, and if you break capital, you break money. If you break money badly enough, you have to start strip mining capital to reclaim enough certainty to function at the level of civilizational complexity achieved to that point. But as this complexity depends on this capital, this is clearly not a sustainable proposition.
If we believe, or merely suspect, we are heading towards this outcome, can it be stopped? Can we opt out? Does anything …
… fix this?
What would it seem like if it did seem like we could fix this?
continue to Part IX:
or go back to Part VII:
n.b. This is a serialization of my previous trilogy on Bitcoin, economics, and capital markets: Wittgenstein’s Money, The Capital Strip Mine, and, Bitcoin is Venice.
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