Capitalism—A New Idea

by Jeff Thomas

Capitalism, whether praised or derided, is an economic system and ideology based on private ownership of the means of production and operation for profit.

Classical economics recognises capitalism as the most effective means by which an economy can thrive. Certainly, in 1776, Adam Smith made one of the best cases for capitalism in his book, An Inquiry Into the Nature and Causes of the Wealth of Nations (known more commonly as The Wealth of Nations). But the term “capitalism” actually was first used to deride the ideology, by Karl Marx and Friedrich Engels, in The Communist Manifesto, in 1848.

Of course, whether Mister Marx was correct in his criticisms or not, he lived in an age when capitalism and a free market were essentially one and the same. Today, this is not the case. The capitalist system has been under attack for roughly 100 years, particularly in North America and the EU.

A tenet of capitalism is that, if it’s left alone, it will sort itself out and will serve virtually everyone well. Conversely, every effort to make the free market less free diminishes the very existence of capitalism, making it less able to function.

Today, we’re continually reminded that we live under a capitalist system and that it hasn’t worked.

The middle class is disappearing, and the cost of goods has become too high to be affordable.

There are far more losers than winners, and the greed of big business is destroying the economy.

This is what we repeatedly hear from left-leaning people and, in fact, they are correct. They then go on to label these troubles as byproducts of capitalism and use this assumption to argue that capitalism should give way to socialism.

In this, however, they are decidedly wrong. These are the byproducts of an increasing level of collectivism and fascism in the economy. In actual fact, few, if any, of these people have ever lived in a capitalist (free-market) society, as it has been legislated out of existence in the former “free” world over the last century.

So, let’s have a look at those primary sore spots that are raised by suggesting that collectivism will correct the “evils” of capitalism.

Prices Are Driven From the Top Down

This is unquestionably the case in the aforementioned countries, however, it is not so under capitalism. Under capitalism, each producer tries to get as much as he can for his product, but, as others are also creating the same product, those with the lowest price are the ones who will succeed.

Therefore, the consumers effectively set the prices, based upon what they’re willing to pay.

But in any country where cronyism exists between big business and government, regulations can squeeze out the competition, allowing a monopoly for a given product. The definition of this marriage between business and government is “fascism.” The government makes it increasingly difficult, through regulation, for the small producer to compete with the larger producer (who gives kickbacks to the government).

Capitalism Only Benefits Those at the Top

Capitalism benefits those who produce the most, but it also benefits all others, as they have a free choice to purchase whatever products they wish, at a price they’re prepared to pay. If the producer demands too high a price, consumers instead buy his competitor’s product, putting him out of business. The consumer is therefore in charge of the price of goods. A producer only rises to the top if he produces the most affordable product (as did Henry Ford, 100 years ago, with his Model T. Through the free market, he lowered his price repeatedly and, in so doing, put America on wheels).

Capitalism Impoverishes the Masses

The free market offers more goods to more people at lower prices, which enriches the lives of all consumers, no matter how rich or poor. In so doing, it raises up the masses over time, providing them with more and better goods, education, health care, etc., enabling them to rise out of poverty. By contrast, overregulation and entitlements enslave those same people to poverty.

Capitalism Can Only Work if It’s Heavily Regulated

The whole idea of the free market is that it’s free from interference by others—most importantly, governments. If left alone, the free market will produce the goods the public are most willing to pay for, which results in an ever-self-levelling of products and prices. As soon as regulation enters the picture, the free market is compromised. What exists today is not a free market, as Adam Smith would have recognised it, but a bloated, dysfunctional socialist/fascist/capitalist mongrel of a system.

Of course it doesn’t work.

Fascism is capitalism in decay.

—Vladimir Lenin

Quite so. Regulation is a cancer that slowly eats capitalism until it morphs into fascism.

Do not their leaders deprive the rich of their estates and distribute them among the people; at the same time taking care to preserve the larger part for themselves?

—Socrates to Adeimantus

What was true ca. 400 BC in Athens is true today. Fascism (or corporatist cronyism) results in 99% of the population coming under the diktat of the 1%, which is made up of government leaders and corporate leaders, working in concert, to the exclusion of all others. This is, in fact, the opposite of a free market.

The creation of new wealth is the only functional weapon against poverty.

—Doug Casey

New wealth comes from the bottom up—it’s as simple as someone building a better mousetrap, or building the old one more cheaply. In such a market, both the producer and the consumer benefit.

In a fascist system, the wealth gravitates to the top, eventually choking out the middle class and expanding the poorer class, and that’s just what we’re witnessing today. The solution is not to go further in this direction, but rather to try something new… or at least new to anyone living under the fascist system. Although it still retains some capitalist overtones, it is unquestionably not capitalism.

A last word—capitalism does exist today, but it lives in select countries that have not yet given in to overregulation. In those countries, the average person thrives and has opportunities far beyond what’s allowed in the former “free” world. Should the reader conclude that his present country is unlikely to go in the direction of capitalism, he may choose to vote with his feet in order to prosper the way his ancestors did 100 years ago.

Skepticism of Experts and the End of Libor

By Xander Snyder

For decades, the public generally placed its trust in technocrats, the people perceived to be skillful and knowledgeable managers of economically and politically important institutions (including banks). The thinking was that aspects of the economy and politics had become too complex for ordinary citizens to understand and that the best way to handle this complexity was to allow the experts to take over. The events of 2008–09 shattered that belief.

Its demise has swept away some of the old ways, and the next casualty is Libor, the London Interbank Offer Rate. This is the benchmark interest rate that many of the largest banks in the world charge one another for loans. It underlies an estimated $350 trillion in debt and debt-related derivatives worldwide, including everything from mortgages to corporate loans to student debt.

In July, the Financial Conduct Authority, which regulates Libor, announced that the rate would be phased out over the next four years, ending in 2021. It’s unclear what will replace it, but whatever it is won’t be as easy for bankers to manipulate.

Nearly a decade later, the 2008–09 financial crisis is still reverberating through the system, demanding the attention of regulators and affecting the global political environment. It is for this reason that the true impact of the crisis can’t be understood in purely economic terms.

Rise and Fall

The British Bankers’ Association introduced Libor in 1986 as a measure of wholesale interbank lending rates. Similar traditions existed before that point in London (where the rate originated) for syndicated loans (those that are large enough that many banks participate) whereby large banks would submit funding costs to the syndicate. Many of these banks began borrowing against this reference rate, however, which gave them incentive to underreport the cost. So the BBA began formalizing the data collection process for the interbank rate, which became Libor.

Libor is essentially set by “expert judgment.” Each day, a panel of banks submits its estimated cost of lending to another bank for various time periods to ICE Benchmark Administration (formerly the British Bankers’ Association), the administrator of the rate. What this means in practice is that only some of the bank submissions are based on real underlying transactions, and the rest are left up to traders’ estimates. In 2015, for example, about 70% of the submissions were experts’ guesses.

Two developments since the crisis of 2008–09 motivated the Financial Conduct Authority to end Libor. The first was a scandal in 2014 in which traders at several large banks were found to be conspiring to manipulate Libor rates to benefit their own trading positions… and therefore, their bonuses. The second is the decline in wholesale interbank lending in the post-crisis years.

Andrew Bailey, the chief executive of the FCA, has perhaps unsurprisingly focused on the second cause in his explanation of why Libor must be abandoned.

According to the FCA, with fewer real transactions on which to base the benchmark rate, Libor becomes more and more dependent on expert guidance—that is, submissions by bank managers—which isn’t sustainable in the long run. With increased regulation following the 2014 scandal, there is a risk that banks that currently submit Libor rates will choose to leave the panel, making the benchmark rate more dependent on the estimates of fewer financial entities.

There’s some uncertainty about what will replace Libor, since several potential alternative rates have been proposed. In the United States, a panel of 15 banks voted in July to support a rate based on overnight secured lending against US Treasurys. The idea is that this new rate would be based on real transactions between banks and other private entities, not the guesswork of traders trying to bump their annual bonuses. But Libor is a rate for unsecured lending, which means that the new rate would likely be lower than Libor. For loans that are based on Libor or comparable indexes, this presents a problem for the banks: If they decide to switch to this new secured rate for existing contracts, their loans will become less profitable.

This is just one possible replacement, but the inverse could also become true—costs could go up for borrowers of all types, from homeowners to students to businesses.

What’s Next?

The financial concerns about Libor are legitimate, but still, it’s unlikely that this sort of reform would have occurred were it not for the scandal and fines levied against banks. And these scandals would not have come to light were it not for the investigation into bank lending and trading practices that began after the 2008–09 financial crisis, when public confidence in the financial system evaporated.

The crisis abolished the idea that “experts” can manage the complex systems with which they have been entrusted. This is about more than the financial system. There is growing skepticism that experts of all kinds know what they’re doing. And if they don’t, will the public continue to tolerate the degree of complexity that has developed in public and financial institutions that justifies the experts’ existence?

The demise of Libor is just one example of the consequences stemming from this lack of faith.

And though the FCA didn’t make its decision based on the will of the people, it’s hard to imagine that the unsustainability of this interest rate would have become as apparent as it has were it not for the investigations demanded by those who have lost confidence in the managers of the financial system.

A split has formed between people who generally trust the counsel of technocrats and those who question their intent… or at least their competency. That split is becoming increasingly visible in the West. Skepticism of experts has motivated opponents of the status quo, often materializing as nationalist parties that reject governing elites, who are unaccustomed to challenges to their authority. In Europe, this has taken the form of distrust of EU policies and national politicians who advocate them. In the US, it has pitted those with enduring confidence in elites against those suspicious of them—the divide taking the rough form (in a general sense) of the interior versus the coasts, and urban versus rural.

Divisions will only get worse as governing institutions fall victim to their own complexities and fail to provide the services their constituents want them to. There will be more financial (and other) reforms that try to respond to this growing unease. But as with most reforms, there will be winners and losers.

For now, these reforms are still being managed by those who know best how to profit from the complexity in the system. It’s unlikely that the public will be satisfied with reforms guided by technocrats in whom the public is losing confidence. Even proposed solutions that could turn out effective will be distrusted if they are introduced by what many see as a growing class that doesn’t have the public’s best interests in mind.

This is the dynamic behind popular division in Europe and the United States, and there’s no reason to believe that it will be halted within the next several years.

Hidden Forces of Economics, Gold & Silver Report

By: Keith Weiner

We have noticed a proliferation of pundits, newsletter hawkers, and even mainstream market analysts focusing on one aspect of the bitcoin market. Big money, institutional money, public markets money, is soon to flood into bitcoin. Or so they say.

We will not offer our guess as to whether this is true. Instead, we want to point out something that should be self-evident. If big money is soon to come in, and presumably drive the price up to whatever new height—perhaps even the magic $1,000,000—what comes after?

In the restless churn that has overgrown our capital markets, investors speculators are always seeking to get into whatever asset is bubbling up. Big money leaving will follow big money entering, as surely as a rock thrown into the air will fall back down.

In last week’s Supply and Demand Report, we excerpted a quote from economist John Maynard Keynes. He cited Vladimir Lenin discussing how to destroy Western civilization. Here is the full quote (from The Economic Consequences of the Peace):

“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Keynes is talking about printing currency, which causes rising prices. He went on to note that businesses who buy and sell goods get rich. There is always a price increase between when they buy and sell. And when they borrow to invest in property and plant, they profit again.

He is describing the American economy in the 1960’s and 1970’s (except the Fed does not print, it borrows). It does not describe the present environment (see also Keith’s article The Lazy 1970’s vs. the Frenetic 2000’s).

Today, prices are not rising, but falling. Crude oil, for example, has not merely fallen a little. It has been an epic collapse (which is likely not over). Commodities show monetary effects most clearly (and skyrocketing healthcare costs are not the effect of monetary policy, but regulatory and fiscal policy).

Yet, Lenin’s debauchery is still occurring. The hidden forces of economics are still in operation.

The undermining of civilization is still the effect. And it’s still true that not one in a million can diagnose it.

Let’s focus on something else Keynes said, that the value of the currency fluctuates wildly. That means in both directions (we don’t have a graph of the value of the German mark, but this page by University of California Santa Barbara Professor Harold Marcuse shows it in a table).

The US dollar certainly fluctuates wildly in both directions. Look at this graph of the price of the dollar. The dollar goes up from 80mg gold to 120mg, then down to 16mg then up to 29.27mg on Dec 3, 2015. Since then, it’s been choppy.

The price of the dollar is not the only thing that fluctuates wildly. The interest rate also fluctuates wildly. In the same period, the interest rate on the benchmark 10-year Treasury has fluctuated from 7% to 1.4%.

This is important because the net present value of a long-term loan or bond fluctuates (inversely) with the interest rate. As the rate falls, the net present value rises. This is an example of “permanent relations between debtors and creditors … becom[ing] so utterly disordered as to be almost meaningless”.

We refer to the capital gains that go to bond speculators, and corresponding capital losses that go to bond issuers (though conventional accounting does not recognize it).  Keynes described this perfectly too, “this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth”.

When bond prices rise and bond yields fall, then by a process of arbitrage stock prices rise and stock yields fall. And the same for real estate. When bonds, stocks, and real estate are rising then all assets experience upward pressure.

And how do most people feel about this? Keynes nailed this too. “Those to whom the system brings windfalls … are the object of the hatred of the bourgeoisie, … not less than of the proletariat.” On the one hand, wages are under downward pressure and jobs are being replaced with capital assets. On the other hand, a few get richer such asset owners and those whose income is tied to asset prices such as CEOs and brokers. This partly explains the rise of Trump.

And it brings us back to bitcoin. Bitcoin’s fluctuations are so wild, that by comparison the value of the dollar looks like a flatline. And its arbitrary enrichment of a few is correspondingly greater (the impoverishment of others will not be obvious until the price collapses).

We have seen some comments from readers and in bitcoin discussions elsewhere, that strike us as pugnacious. A chip-on-the-shoulder pseudo-pride, that practically sneers “I got mine, suckaaah!”

Most bitcoin millionaires aren’t like this. And we do not begrudge anyone his trading gain. One should not hate the player, but the gamemaster who forces us to play. The Fed.

However, this is an important phenomenon. We bring it up as the flip side of the “hatred of the bourgeoisie and the proletariat”. Both sides know that something is screwy.

Everyone knows that money does not grow on trees. You do not normally get rich quick by betting on some Internet scheme. Yet, bitcoin seems to say, “Oh yes it does! Oh yes you do!”

We offer this insight: speculation converts one person’s wealth into another’s income. No one wants to spend his wealth. But they are happy to spend other people’s wealth—when it comes to them in the form of income.

Andy Appleton buys $10,000 worth of bitcoin. Later, he sells it for $20,000 to Bill Baker. Andy takes his original capital back plus 10%, or $11,000. That leaves him $9,000 of Bill’s wealth to spend, to consume. Bill of course bought it, hoping it would go up. And indeed it does. He sells it for $40,000 to Charlie Chilton. He reserves $22,000 of capital, leaving $18,000 of Charlie’s life savings to spend.

Charlie forked it over to Bill, in the hopes of spending $36,000 of David Dalton’s wealth. And so on. Until the scheme hits the wall.

Bitcoin is a promoted as an alternative to fiat currency. However, it “engages all the hidden forces of economic law on the side of destruction” the same as the dollar. At an even faster rate.

And this is promoted as a feature, not a bug.

The gold standard does not provide a mechanism to convert your wealth to someone else's income. In our view, this is a feature, not a bug.

The price of gold dropped two bucks, and silver two cents. However, it was a pretty wild ride around the time when some information came out from our monetary masters at their annual boondoggle at Jackson Hole. We will show some charts of Friday’s intraday action, below.

As always, the question is which moves are driven by fundamentals, and which by speculation? We will show graphs of the basis, the true measure of the fundamentals.

But first, here are the charts of the prices of gold and silver, and the gold-silver ratio.

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio.

The ratio barely budged.

In this graph, we show both bid and offer prices for the gold-silver ratio. If you were to sell gold on the bid and buy silver at the ask, that is the lower bid price. Conversely, if you sold silver on the bid and bought gold at the offer, that is the higher offer price.

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph.

The price didn’t move much, and neither did the basis.

So our calculated gold fundamental price was up $5, to $1,330.

More interestingly, let’s look at the basis action when the price was gyrating on Friday.

The correlation between basis and price is uncanny, isn’t it? And it works in both directions.

Manipulators speculators were buying paper gold from around 13:15 GMT (which is 14:15 BST or 9:15 NY time). Then these same manipulators speculators—or was it a different group, who overpowered the first, hm?—started selling at around 13:40. Then buying resumed at 14:00.

We are joking about the manipulation, of course. In our view, superstition thrives where people struggle to explain what they see without a scientific theory. Once upon a time, they saw thunder and lightning and thought the gods were having battle, or perhaps expressing anger at some sin of man. Such mythology could not survive the advent of the field meteorology (if even that long).

The manipulation myth similarly does belong in a world where there is an arbitrage theory of markets, and daily pictures of the basis and cobasis.

Note also the rise in price at 15:00, without a rise in basis. That is likely some buying of physical metal.

Now let’s look at silver.

The basis fell and the coabsis rose. Not a lot, but it did lift our calculated silver fundamental price $0.20 to $17.18.

Here is the intraday price and basis graph for silver during Friday’s rollercoaster.

As with gold, the basis tracks the price. The moves in both directions were speculative.

America and China’s Codependency Trap

Stephen S. Roach
. Skyscraper in Beijin

NEW HAVEN – Seemingly at odds with the world, US President Donald Trump has once again raised the possibility of a trade conflict with China. On August 14, he instructed the US Trade Representative to commence investigating Chinese infringement of intellectual property rights.

By framing this effort under Section 301 of the US Trade Act of 1974, the Trump administration could impose high and widespread tariffs on Chinese imports.
This is hardly an inconsequential development. While there may well be merit to the allegations, as documented in the latest “USTR Report to Congress on China’s WTO Compliance,” punitive action would have serious consequences for US businesses and consumers. Like it or not, that is an inevitable result of the deeply entrenched codependent relationship between the world’s two largest economies.
In a codependent human relationship, when one party alters the terms of engagement, the other feels scorned and invariably responds in kind. The same can be expected of economies and their leaders.
That means in a trade conflict, it is important to think about reciprocity – specifically, China’s response to an American action. In fact, that was precisely the point made by China’s Ministry of Commerce in its official response to Trump’s gambit. China, the ministry vowed, would “take all appropriate measures to resolutely safeguard its legitimate rights.”
Caught up in the bluster of the US accusations being leveled at China, little attention is being paid to the potential consequences of Chinese retaliation. Three economic consequences stand out.
First, imposing tariffs on imports of Chinese goods and services would be the functional equivalent of a tax hike on American consumers. Chinese producers’ unit labor costs are less than one fifth those of America’s other major foreign suppliers. By diverting US demand away from Chinese trade, the costs of imported goods would undoubtedly rise sharply. The possibility of higher import prices and potential spillover effects on underlying inflation would hit middle-class US workers, who have faced more than three decades of real wage stagnation, especially hard.
Second, trade actions against China could lead to higher US interest rates. Foreigners currently own about 30% of all US Treasury securities, with the latest official data putting Chinese ownership at $1.15 trillion in June 2017 – fully 19% of total foreign holdings and slightly higher than Japan’s $1.09 trillion.
In the event of new US tariffs, it seems reasonable to expect China to respond by reducing such purchases, reinforcing a strategy of asset diversification away from US dollar-based assets that has been under way for the past three years. In an era of still-large US budget deficits – likely to go even higher in the aftermath of Trump administration tax cuts and spending initiatives – the lack of demand for Treasuries by the largest foreign owner could well put upward pressure on borrowing costs.
Third, with growth in US domestic demand still depressed, American companies need to rely more on external demand. Yet the Trump administration seems all but oblivious to this component of the growth calculus. It is threatening trade sanctions not only against China – America’s third-largest and fastest-growing major export market – but also against NAFTA partners Canada and Mexico (America’s largest and second-largest export markets, respectively). As the reactive pathology of codependency would suggest, none of these countries can be expected to acquiesce to such measures without curtailing US access to their markets – a counter-response that could severely undermine the manufacturing revival that seems so central to the Trump presidency’s promise to “Make America Great Again.”
In the end, China’s economic leverage over America is largely the result of low US domestic saving.
In the first quarter of 2017, the so-called net national saving rate – the combined depreciation-adjusted saving of businesses, households, and the government sector – stood at just 1.9% of national income, well below the longer-term average of 6.3% that prevailed over the final three decades of the twentieth century. Lacking in saving and wanting to consume and grow, the US must import surplus saving from abroad to close the gap, forcing it to run massive current-account and trade deficits with countries like China to attract the foreign capital.
It is sheer political chicanery to single out China, America’s NAFTA partners, or even Germany as the culprit in a saving-short US economy. Fostering policies that encourage an economy to squander its saving and live beyond its means makes trade deficits a given – as are the seemingly unfair trading practices that may come with this Faustian bargain for foreign capital.
The US ran trade deficits with 101 countries in 2016 – a multilateral external imbalance rooted in America’s chronic domestic saving problem. The fix for this problem cannot be made in China. Ironically, with the Trump administration’s policies likely to lead to larger budget deficits that put national saving under additional downward pressure, the need for Chinese and other foreign capital will actually intensify and the codependency trap will only close more tightly.
America does not hold the trump card in its economic relationship with China. The Trump administration can certainly put pressure on China, and, on one level, there may well be good reason to do so. But deep questions concerning the consequences of such pressure have been all but ignored.
Getting tough on China while ignoring those consequences could be a blunder of epic proportions.