The Unit of Account Problem

 (5700 words) 

Intro

Here I go again, making new friends. Since this is a sensitive subject, I’d like to overemphasize two points: 

1. I have nothing against Bitcoin as a trading vehicle to make money. I hope it goes to a million so everyone’s dreams come true.  I would buy it on a breakout to new highs as a trade with defined risk, but I’d prefer to buy it after a deflationary collapse causes the QE liquidity machine to resume. My thinking in this arena has always been an exploration of ideas to solve our monetary problem, which Bitcoin is incapable of doing. 

2. In the Michael Saylor section, I’m not being critical of him as a person, I’m being critical of the things he says about Bitcoin. 

The Unit of Account Problem

The chart that shows Bitcoin adoption going from the lower left to the upper right is misleading because there has been almost zero adoption of Bitcoin in its 15 years, and there’s a very good reason. What that chart actually shows is the adoption of people who are speculating on its adoption. Real adoption would be people using Bitcoin in everyday transactions as money, but that isn’t happening in any meaningful way because it doesn’t work on any level for anyone, and anyone that tries will quickly realize its limitations. Proponents who say the developing world needs Bitcoin to protect their savings from devaluation when a stablecoin would serve the same purpose without the volatility reeks of a conflict of interest. 

Money satisfies three functions: a store of value; a medium of exchange; and a unit of account (what goods and services are priced in). This world doesn’t have money. Fiat currencies are the medium of exchange and the unit of account, but they aren’t a store of value. Gold is a store of value, but it’s not the medium of exchange or unit of account. Bitcoin is none of them. A store of value doesn’t have periodic 80% drawdowns - speculative assets do. It's easy to conflate price going up with value.

  

There are 3 main economic entities: consumers, businesses, and the government. Together their transactions create our economy, so expecting any of them to use a form of money that is not the unit of account brings foreign currency risk into every transaction.

Consumers get paid in the unit of account because no business is going to add the complexity of paying their employees with a foreign currency; however, a consumer could immediately transfer their paycheck into Bitcoin every week and simulate the same outcome. Since everything they buy is priced in the unit of account of their domestic fiat currency, they would be introducing foreign currency risk into all their transactions. When Bitcoin is up, all their expenses would be discounted as they transfer it back to fiat to pay their bills, but when Bitcoin is down, they’d be paying a premium, so there would be no escape from the discount/premium dynamic of when to buy anything. When do you buy the new car? Bitcoin is up 20% this month, but let’s wait till next month in case it goes higher, oops, now it’s down 30% as the discount becomes a premium. This is foreign currency risk, and if you think consumer sentiment is finicky now, try introducing that additional stress into every transaction. 

From the point of view of the business, accepting a form of money that isn’t the unit of account creates a level of complexity no one has the time or willingness to deal with. Why not ask every mom and pop hair salon, restaurant, and car mechanic to accept Yuan or shares of NVDA as payment? Since all their expenses are priced in the unit of account of their domestic fiat currency, the only way to avoid a world of headaches is if their revenue is priced in the same unit of measurement. And no one is going to risk their profit margins accepting a form of payment that isn’t the unit of account, especially one as volatile as Bitcoin. 

It doesn’t work for lending either. Imagine taking out a home mortgage in a currency you’re not paid in. Let’s say Bitcoin is $100k and you borrow 3 Bitcoins for a $300k mortgage at 6% over 30 years and during that time Bitcoin rises by 10x to $1M per Bitcoin. Since you’re getting paid in US dollars because no one wants to deal with a foreign currency, you now need to earn $3M USD to pay back your 3 Bitcoin loan. On the flip side, if Bitcoin lost 90% of its value during that time and traded at $10k per Bitcoin, you’d only have to earn $30k in USD to pay off the mortgage of 3 Bitcoins. Banks aren’t going to take this risk and neither are consumers. Taking out a loan in Bitcoin would bankrupt you if it keeps rising; it’s the same as being short Bitcoin.

Clearly, the government isn’t going to accept foreign currency risk in its tax revenue collection either.

This is the reason Bitcoin isn’t being adopted. It doesn’t solve the unit of account problem, not to mention it also incurs a capital gains tax every time you spend it. Once you realize Bitcoin doesn’t have the characteristics to function as money, all that’s left is its utility as a payment network.

The novel invention of Bitcoin is how it solved the double spend problem with a proof-of-work protocol that allows it to operate without a central authority. It’s a decentralized Paypal that has a native token it forces everyone to use to facilitate the transfer. The fact that it’s decentralized causes people to create all kinds of beliefs about its native token as money because it taps into a very deep mistrust of centralized authority ingrained in our DNA, but if a decentralized Paypal had its own token with a capped supply that it forced everyone to use to transfer value would anyone be saying one day PPAL is going to be a global currency adopted as a settlement layer by central banks? Would anyone be calling it a “monetary system with rules?” If PPAL existed, it would have the same unit of account problem getting adopted outside its payment network as Bitcoin. Solving the double spend problem doesn’t make it suitable to function as money. It makes it suitable to function as a decentralized payment network with all the trade-offs that come with it. 

Since Bitcoin can’t be money due to its inability to overcome the unit of account problem, let’s return to our central premise of life: all that exists are viable business models and the commodities they use. There’s mature businesses with discounted cash flows and there's speculative growth businesses hoping to become mature businesses with discounted cash flows. If Bitcoin was a viable business model it would be designed so the miners distributed their profits to the token holders like a dividend. The miners would subtract their energy bills, rent, labor, and other expenses from the rewards they receive for validating blocks, and the cash flow generated from providing this service would be discounted to derive a value per Bitcoin, which would be grounded in the operation and viability of its utility against competing centralized payment networks and other cheaper-to-run decentralized proof-of-stake protocols to determine if proof-of-work deserves a premium or discount. 

The Bitcoin Maxis creatively rationalize why using so much energy is necessary, but there’s no proof that it’s true; it’s just another sales pitch to recruit new adoption. Both of the main types of protocols can centralize over time if they aren’t designed with limitations to prevent it. Whether it’s consolidating mining pools centralizing around really expensive hardware that acts as a high barrier to entry and therefore prevents a more levelized distribution of block validation, or the consolidation of funds in ever increasing stake pool sizes, there needs to be a limitation built-in or there will always be the possibility of collusion, which might be unlikely, but a global monetary system can’t be built upon “unlikely”.

Eventually, the incentive to keep holding any investment is being the recipient of a sustainable cash flow generated from consumers of its product or service, which Bitcoin lacks, so what’s the plan when everyone who wants to own Bitcoin, owns it? A lending business to generate yield won’t work due to the unit of account problem, and most of the yield in crypto is self-referential, unsustainable, and doesn’t come from consuming the crypto as a commodity, product, or service anyway. A true yield comes from profit margins.

Bitcoiners like to say its volatility will decrease as it becomes a more mature asset, but age is not the reason investments become less volatile, and there’s no evidence Bitcoin will be an exception. The reason deeply established businesses with products or services embedded in our lives become less volatile is because there’s little to no growth left to speculate on, so the revenue projections are fairly well known and efficiently priced as profits get distributed in the form of a dividend, which incentivizes investors to stay invested. Since Bitcoin can’t become embedded in our lives due to the unit of account problem, and it has no cash flow as a yield from its block validation, all that’s left is the price appreciation game, so even if it becomes less volatile one day, is everyone supposed to hodl as a self-sacrifice to support the network and ignore better risk/reward returns of other investment options elsewhere, particularly as we move toward an exciting era of AI potential? This is certainly a long-term concern but it reveals the model isn’t viable because it violates investor incentives.

Bitcoin isn’t art; it isn't a collectible (which are also subjective price appreciation games); and it can’t be adopted as a currency. For Bitcoin to have value it needs to either evolve into the model of a cash flowing business, or become a commodity used by one; otherwise, it’s just a price based on beliefs with no objective value. It’s like a growth company with wild projections of future cash flow that can never materialize. Real assets derive their value from being grounded in economic activity and relationships with other assets grounded in economic activity. That’s what gives them the value to function as collateral. Narratives, false beliefs, and greed can disconnect price from value for a long time, especially in manias, but they inevitably reconcile. Bitcoin is just people trying to get rich, which is fine, go for it, I am with you, but if there’s nothing grounding an investment in objective economic reality based on observable metrics, how do you distinguish it from Tulips? The greatest enemy an investor or trader faces is their own beliefs. “It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. “ – Mark Twain

What I’m describing are investment principles like physics that govern this world. They can be bent by psychology but not broken. The problem with investments based on belief is beliefs change. I don’t need to believe in the utility of my iphone. It would take a new invention of communication, or a nuclear battery that lasts a lifetime, to hurt its value for Apple and the cash flow it generates. Even then, viable business models have to continually adapt to changing markets as price fluctuates wildly around value based on sentiment and evolving economic conditions. Nearly all businesses one day don’t keep up with changing technology and fail. 

The higher Bitcoin goes in price, and the longer it takes, the closer we come to the emergence of the next monetary system, so eventually the risk/reward will skew negative as a critical mass of people realize most of the price appreciation gains are gone and there’s better returns elsewhere. That’s when Bitcoin will be forced to seek its intrinsic value based on the utility it provides with its unique value proposition among competing payment networks as beliefs and narratives about its role as money evaporate into the reality of economic and investor incentives. The exact price where the risk/reward shifts permanently downward is anyone’s guess - it does not seem imminent at the moment. It might be caused by a series of long-term well-known hodlers all deciding to move on in short succession.

Let’s address a few of Michael Saylor’s claims in his No Second Best presentation because at this point he might as well tattoo the Bitcoin logo on his face. The first thing to notice is how Bitcoin Maxis are forced to believe proof-of-work is necessary to run a decentralized payment network. The reason is because it’s the only differentiating quality that makes Bitcoin unique. Yes, there are other proof-of-work cryptos, and yes there are others with limited supply, and yes you could create an infinite number of them, which is why the limited supply of Bitcoin is disingenuous. What it really boils down to is adoption and brand, so the Maxis have to constantly make their case to attract new money by attacking other approaches because it’s not a sustainable business model producing cash flows that self-fuels its own organic adoption by providing a better product or service to incentivize migration away from legacy systems.

Instead, its adoption is facilitated by an army of economic actors pursuing their own self-interest like the promotion mechanism of a multi level marketing machine. The evangelists include: miners profiting from validating blocks; exchanges and brokers profiting from transaction fees; newsletter writers and Youtube channels profiting from subscribers; venture capitalists and other hodlers; advertisers from ancillary services like swaps, lending, hedging etc etc... It’s a whole ecosystem based on a technology that has not yet proven itself to be viable, which I choose to view, positively, through the lens of helping to awaken the general public to the problems with our monetary system that people can feel but can’t articulate. At some point, though, we need actual viable solutions and not a payment network masquerading as one.

The only non-replicable feature Bitcoin has is its first mover advantage, so the strategy of Bitcoin Maxis is to proselytize the case that proof-of-work is necessary because what you’re buying when you buy Bitcoin is the proof-of-work protocol. The problem is we don’t have to speculate on this - other protocols like proof-of-stake already exist and they’re working perfectly well. To think Bitcoin is not a security and the rest of them are is the epitome of conflict of interest, especially when all kinds of layer two applications are being built upon Bitcoin too. There’s nothing that can be done on the Bitcoin network that can’t be done on others, but there’s plenty that can be done on others that can’t be done on Bitcoin because it wasn’t designed to be built upon from the ground up.

One of the more bizarre rationalizations of using so much energy on proof-of-work is how Bitcoin miners are incentivized to seek the lowest cost energy in remote places, which they call “stranded energy.” Since Bitcoin can’t integrate into our lives due to the unit of account problem, and it’s not designed to scale as the host of thousands of Dapps, this “stranded energy” argument is no different than going to the Arctic and setting up power generators that don’t connect to anything. They just burn energy for no purpose.  

You might ask why anyone would do that? Because the people buying the generators (the miners) who are paying for the low cost “stranded energy” to run them are receiving even larger amounts of money (block rewards) from the people who are speculating that one day this particular inefficient network will connect to some kind of sustainable economic activity, but there’s two problems with that: once a critical number of Bitcoin is mined, the miners will need to earn their rewards from transaction fees in excess of their operational costs (which grounds us back in the reality of competing payment networks); and the hodlers of the Bitcoin token need to receive a yield from the operation of that network (even higher transaction fees) that exceeds risk-free yields and/or the dividends of other investment options with better price appreciation and total return potential. Without high enough transaction fees to satisfy both investors and miners there’s no incentive to validate blocks or tie up money holding Bitcoin. This is the inevitable realization of a model based on unproven economics. What prevents the Maxis from seeing this is a misguided belief that the native token has value outside its network without any of the characteristics or functionality that would give it value, so they have to invent narratives to keep new money coming in, and they point to the price as validation of their perspective, but price doesn’t validate a thesis. 

Say Say calls Bitcoin “digital energy,” which is his best attempt at defining Bitcoin as a commodity (if you missed my Taylor Swift reference, shame on YOU). He does get credit for creativity, and he’s been very clear on his story. Microstrategy was in decline and faced the choice of pivoting or dying. He pivoted to Bitcoin, which thus far has worked out quite well, but since he’s all-in on the Bitcoin, he has no choice but to conjure up arguments why a token with no value outside its network has value outside its network. He’s kinda like a defense attorney who’s forced to defend a serial killer caught on video who shows up to court with blood on his shirt and a knife falls out of his pocket. Calling Bitcoin a commodity is problematic mostly because it’s not a raw material used by any business, which is kinda the definition of a commodity. If “digital energy” was a commodity there would be businesses whose operations were fueled by it, so they would constantly need to buy Bitcoin to run their business, and they would hedge their future digital energy needs like the players in oil, copper, and other commodity markets. Or consumers would need “digital energy” to power their computers or houses. The fact that Bitcoin requires energy doesn’t mean it’s backed by energy if that energy doesn’t have a real world use like powering everyday products or services. When a currency is “backed by” something it means it can be redeemed for it. (To be fair, I’ve said the US dollar is backed by the US military, our system of governance, and our assets, which is also not accurate.)  

Say Say then compares Bitcoin to “land” or “property,” which is a much better argument because what will give cryptocurrencies actual value and utility are Dapps built upon them that get utilized in our everyday life, so if this is the new Bitcoin thesis, which is exactly what the Maxis criticized about “shit coins” for years, there’s far superior technology that was designed for this purpose from the ground up to scale better than Bitcoin. 

Micro Saylor calls Bitcoin an entirely new asset class, which is an attempt to rationalize the investor incentive problems I’m pointing out as not pertinent to the Bitcoin, but even new inventions don’t supersede the laws of economics and the incentives of investors who will only stay as long as there aren’t better returns available elsewhere. This same problem applies to all cryptocurrencies no matter what proof-of protocol they use. The only way they are sustainable in the long-term is if they eventually provide a yield generated from the utility they provide, which means the staking reward in proof-of-stake can’t come from existing supply, or even new supply created for that purpose. The yield must come from the consumption of its utility, or it would be like Palantir deciding to get into the oil business so it can distribute a dividend. I recently saw someone proposing that Bitcoin could be used as collateral to earn staking rewards in the proof-of-stake systems, which is just more evidence that Bitcoin has no utility on its own. This is the entire point. Value comes from consumers using the product or service, which generates its own self-sustaining yield from the profit margin, not people speculating on its price and conjuring up schemes to manufacture a yield.

The way a crypto network could work as more than a casino game is if thousands of Dapps were built upon it, and each one generated transaction fees or subscriptions from its users that were distributed to the holders of the layer one token who would be participating in the cash flow of the network’s operation. If this causes a problem with security laws, then security laws need to change because this is the only path to real world sustainability. Each Dapp would have to be a better mousetrap than existing non-decentralized apps that perform the same function, otherwise why would people adopt them? If it’s a payment network Dapp, then it needs to be cheaper, safer, and faster than Paypal, Zelle, Chime, Cash app, Venmo, Apple Pay, Google Pay, etc., but in order to be adopted by actual users, this new “feature” of decentralization needs to solve an existing problem in a way that incentives migration away from the centralized legacy apps. 

Are there so many people getting ripped off by Paypal and Apple Pay that we can’t trust a third party to handle our payment transfers anymore? Is there such an intense and widespread urgent need for instant settlement that it’s not worth waiting a little longer for the security of an accountable publicly owned business to ensure the transfer happens without fraud? The huge trade-off using a decentralized service is the lack of recourse if anything goes wrong, whether it’s user error, or theft, so if we expect a mass migration of users to adopt cryptocurrencies for the only utility they currently provide, the “better mousetrap” nature of it needs to be so much better that actual users (not speculators) overcome the learning curve to adopt it, and use it, which requires everyone to stay on the cutting edge of wallet security or risk getting hacked and losing all your funds, so carpe diem grandma. I’m sure Nancy Pelosi and The Regulators (a blues band from Detroit) won’t mind the rampant fraud that would ensue since they probably have Bitcoin wallets in Belize accepting anonymous donations from big hodlers to look the other way, but that won’t last long because if Bitcoin ever got adopted for actual use the political pressure to regulate the theft will turn them into the legacy system we have now. Isn’t that a depressing thought. 

The sole value of the invention of Bitcoin is the decentralized payment protocol. All the additional value people ascribe to its native token to facilitate the transfer is the Tulip part of the equation because it lacks the characteristics to function as money outside the network, so all the value projected onto it is the groupthink of a mania. If you’re part of the Bitcoin religion and want to see how those of us who are more pragmatically minded view your beliefs, listen to the Michael Saylor presentation again, but every time he says the word Bitcoin replace it in your mind with Tulip. It’s quite amusing, and, no, it’s not a fair comparison because the Bitcoin protocol is an actual invention that solves the double spending problem, so that part has objective value (and there's always hope it can evolve as a host of Dapps).

Essentially, Crypto is just a new way to crowdfund ideas. The token is not much different than a stock certificate, so Bitcoin is a non-dividend paying stock certificate of the novel invention of a decentralized payment network that must compete for market share like any other invention, or be driven by fanciful beliefs that will one day run into reality - unless it evolves. The Bitcoiners will say I don’t understand, Bitcoin is______. And Michael Saylor proves you can insert anything in that blank, but eventually the rubber meets the road and an invention is what it does, and what Bitcoin does is transfer value, so the economics of the transaction fees will need to work for investors and miners based on that in the context of competition. The thesis that Bitcoin is an escape from dollar devaluation in an era of ever increasing liquidity certainly makes sense, but without any meaningful external adoption as money, or any objective cash flowing utility as a payment network, that’s a greater fool price appreciation game. 

 

There are currently over twenty thousand global commercial banks and 180 currencies recognized as legal tender in 195 countries (per Chat GPT). In the US, our banks spend billions every year on security measures for customer protection. We also have FDIC insurance. Our credit card processors also spend enormous sums to protect their networks and the businesses and customers who use them, which includes an arbitration process for chargebacks and fraud for both businesses and consumers. Their processes have evolved to the point of automated texts or calls if there’s suspicious activity on your account, and if you get hacked they refund the fraudulent charge. Every single economic actor of the legacy system is a point of failure that could individually disappear without taking down the entire system, although, to be fair, our largest banks are still too big to fail. 

In comparison, crypto has zero consumer protections, and worse, if we moved the entire financial system onto a proof-of-work or proof-of-stake protocol and it somehow failed it would cause an unprecedented human catastrophe because the entire financial system would go down. The only way crypto could work as a financial system is if it was coded to be mathematically impossible to hack the system, the owners of the system received a yield, and comparable (if not better) protections for consumers and businesses existed, oh, and there needs to be a way for a higher authority to reverse transactions and make changes to wallets. In other words, the whole premise of crypto is incompatible to function as the foundation of a financial system or as money. People who don’t see this are being blinded by a desire to get rich or rebel against the status quo and not objectively analyzing how the system would function in everyday transactions amid a world of fraud. I recently saw someone comment about criticisms of crypto: “who cares if everything crashes in 5 years, I’ll be rich by then!” Again, I’m not against people trying to get rich, but I care. I’m trying to solve the problem, not leave behind a burning inferno as I lay in the sun on the beach. Layer ones do not have the characteristics to function as money, but they can be the decentralized base layer a more thoughtfully designed monetary system can be built upon. 

Here’s what would change my mind on Bitcoin becoming money and having value beyond its payment network utility: if that chart showing Bitcoin adoption going from the lower left to the upper right was businesses and consumers choosing to transact in Bitcoin, I would be among the most fanatic advocates out there. But it’s not, and I just listed half a dozen reasons why it’s not only improbable, but most likely impossible to occur because the characteristics of money and the basis of a monetary system are way more complex than solving the double spend problem with a limited supply of an immutable chain. 

One of the weakest arguments to promote Bitcoin is an attempt to compare it to gold by saying it’s a store of value and pointing out how the price of gold is also based on belief because only a small percentage of it is used industrially or as jewelry. And while there’s some truth to that, it’s not the same. Essentially, gold is just a yellow rock. The reason it has value is because its innate properties made it the best choice to function as money for thousands of years, so it was adopted by businesses and consumers to transact and save in. Bitcoin is attempting to mimic this value creation through brute force of will, but a group of people can’t decide something has value and then try to convince businesses and consumers to adopt it as money so they can get rich. That’s backwards. Value comes from adoption by businesses and consumers first. Without that, there is no value to store; it’s just narratives and beliefs. 

Ever since gold has been demonetized it has maintained a relationship with the dollar and/or real rates from its long history functioning as money, so over long periods of time it accounts for money supply expansions. It’s lagged over the last decade because the dollar bottomed in May of 2011 (the same month silver topped) (and 3 months before gold)), so it’s actually done quite well for battling such long-term dollar strength, particularly through the recent rise in real rates. This is how assets grounded in actual economic relationships behave. The proper way to think about gold is the value of its purchasing power never changes because it rises with nominal prices, unlike fiat currencies that devalue over time.

During the secular devaluation of fiat currencies we’re currently living through, gold will certainly race too far ahead at times as well, fueled by sentiment, and undergo wicked periods of correction because that’s how markets work, but its function as an accounting mechanism for monetary expansions makes its repricing higher much more likely to stick with the permanently rising nominal prices of Slowflation. I don’t see why Bitcoin won’t continue to benefit from these flows as well because all the flaws I’m pointing out have existed from the beginning and continue to be overridden by FOMO, greed, and a genuine misunderstanding of a complex topic, but the bottom line is best expressed by a famous investment axiom: the voting machine of price is adoption by speculators; the weighing machine of value is adoption by the marketplace. Gold is an investment; Bitcoin is a trade. 

When I get invited to speak at the Bitcoin conference (besides promising to wear all white with blue suede Pumas), I will close my presentation with two questions for the Bitcoiners: 1. By show of hands, how many of you use your Bitcoin to buy everyday goods and services?  2. If the most Bitcoin-educated people on Earth aren’t using it as money, how will it ever get adopted? 

This is the unit of account problem.  

Revisiting The Universal Stablecoin

The exciting promise of blockchain, of course, is its potential to develop a decentralized financial system outside credit card processors and the Swift network, and beyond the reach of politicians, but it needs to seamlessly integrate with the legacy system in a way that solves the unit of account problem, or it will forever remain a separate island created on a foundation of beliefs not grounded in everyday economic activity. A truly independent monetary system doesn’t mean it can’t involve sovereign fiat currencies, in fact, it must involve them or it’s dead on arrival. The inevitable monetary Dapp that runs on a layer one network doesn’t need to be decentralized if it runs on a decentralized network and has built-in protections to prevent the abuse by a higher authority that motivated the creation of decentralization in the first place. 

The idea is to resurrect the three functions of money by restoring its store of value while retaining the current unit of account and medium exchange status of sovereigns in a way that allows consumers and businesses to seamlessly use them in everyday transactions, but without the perpetual erosion of purchasing power. This would be a much safer check on government spending than MMT, and it would transfer power back to the people where it belongs. 

Two years ago, I proposed a universal stablecoin structured as a version of the SDR based on weightings of the world’s sovereign currencies (plus gold), designed to maintain a stable value through a mechanism that countered one component going up (USD) with an offsetting component going down (EUR, etc.) so the currency unit (Unis) as a whole always equalled one, which would reinstate a store of value to our money. The addition of gold was to offset all sovereign currencies going down together against real assets. 

Since then, I’ve had new insights that revealed a flaw, but also a solution. If the currency units (Unis) were issued for use in everyday transactions they would have the same unit of account problem as any other foreign currency like Bitcoin or gold, so I had a new epiphany and rethought it, and in the process I realized every cryptocurrency is approaching the problem the same way. I can’t say what that is without revealing too much of the idea, but there’s a good chance the government would not be able to stop this, nor would they want to. I am mindful of the possibility that I’m missing something critical, so what this needs is a group of people to beat the idea with a stick, then test it inside an algo simulated environment. If there isn’t a flaw, this could be the programmable money that functions as a layer two application because it resolves all of the objections I’ve expressed above. 

Since we’re still very early in the penetration of blockchain into our lives, this idea likely requires migration of certain parts of our current system onto decentralized platforms before it could be implemented in a way that’s beyond the reach of the government, but it’s the most promising idea I’ve ever come across. And to be honest, there is no functional monetary system the government, or even Big Tech, couldn’t stop, so this isn’t a war; it’s a cooperative partnership. As enticing as a truly decentralized system sounds, how could it ever be implemented without the permission of Apple and Google to operate on their hardware at the point of sale, or the permission of the government for businesses to accept the payment as legal tender? No one is going to add another device to their life for this purpose, so it will have to run on phones, and businesses will need an auditable trail for tax purposes and accounting. Fortunately, the monetary incentive will be enormous, but running on phones is still a central point of failure if the government wants to prevent it. With that said, think about how transformative it would be if we had a completely independent monetary system that ran parallel with fiat currencies but integrated with them seamlessly in everyday transactions.

 “And that’s all I have to say about that.” - Forrest Gump 

In three weeks, we’ll explore a path of how it could happen in The Proposal, but first let’s get a little provocative with The Flaw of Humans next week. 

The Surprising Superiority of Modern Monetary Theory

( 3200 words)

The Surprising Superiority of Modern Monetary Theory

If we ran the experiment of Earth a million times, the same major problems we face today would happen every single time because they’re driven by individuals pursuing their own self-interest without any attempt to balance it with society as a whole because any attempt at doing so creates a vulnerability to be outcompeted by those with a singular focus on their own benefit. Essentially, our cultural problems are amplified by the very foundations of capitalism and the incentives it creates. 

It does not matter how many people recognize and adapt to this truth, if some of the major participants are still playing to a philosophy of kill or be killed, extracting every penny they can from others with little to no regard to the consequences, they could dominate the majority and nothing would change. It’s not enough to enact laws to incentivize a more holistic approach because laws can always revert back in the future. It’s only technology and the structure it creates that can manifest a balance unable to be overrun by the selfish desires of humans. In algos, we trust. 

People who don’t want to believe the problem is human selfishness at the heart of capitalism prefer to blame “crony capitalism” or “regulatory capture” etc., but there isn’t one without the other. Crony capitalism IS capitalism. Others like to blame the crux of our problems on a lack of sound money, and if only we could bring back the gold standard, or implement a Bitcoin standard, all will be fixed, but the monetary system isn’t the problem. You have to dig deeper and look at the incentives. The fatal flaw of a free market (indirect) democracy is elected politicians make the laws, so it forces them to constantly appease the voters, and therefore incentivizes policies like the creation of a central bank, fractional reserve lending, and globalization in the name of free trade as a win-win for all, etc… There is no monetary solution that can overcome this (that currently exists). And a dictatorship that isn’t beholden to the voter would be worse. The only thing worse than Capitalism is all the other choices. The essence of the problem is humans, and despite what many idealists want to believe, the government chooses our money, so even the perfect monetary system will inevitably be corrupted to benefit the people in power, unless… (let’s return to this in The Unit Of Account Problem next week). 

Imagine a group of young politicians came to power and adopted a Bitcoin standard, which harkens back to the innocent days when gold restrained politicians 100 years ago. How long do you think it would take for these idealist young politicians to create a derivative layer on top of Bitcoin to adopt as money instead so they could return to manipulating the money supply to increase their chances of staying in power? The betting line would be an hour and I would take the under. Do you see the problem? We don’t need a monetary solution. We need a political one that solves human nature, and there isn’t one that wouldn’t devolve into the Slowflation devaluation and perpetual can kicking we have now because that’s what benefits everyone in power the most. The realization of this truth has staggering implications.

Gold would have the same result. There is no solution politicians can’t overcome with a derivative layer (like fiat currencies) that allows them to create money without limits. If gold worked to restrain the money supply we would still be on the gold standard. If Libertarianism was a viable system we would still operate with those principles. Ultimately, Libertarianism lacks sufficient regulations, which causes people to get hurt and lawyers to get involved until the people literally demand to be regulated. Self-custody sounds great until you get hacked and lose your life savings with no recourse. Have you met humans? I met humans. Thumbs down. I’m an intelligent person, but I can’t keep track of my car keys, so I do not want the responsibility of staying on the cutting edge of wallet security and the latest tricks hackers use to steal not just a credit card, but my entire life savings, and 90% of the population would fare worse. Self-custody works great in cold storage to protect your assets from a bank bail-in, but it’s dead on arrival for everyday transactions when your wallet is continually exposed to buy products and services if there’s no way for a higher authority to prevent fraud or reverse transactions. 

Our interventionist foreign policy creates an ever growing and unsustainable military budget to proactively tamp down the spread of dictatorships and communism so they don’t threaten our way of life. Imagine an alternative history where the US stayed neutral like Switzerland and communism spread across the rest of the world as China/Russia/Iran grew as powerful as the US and had military bases in Canada and Mexico. How would we feel about the presence of another set of values pointing a nuke at us? 

Since we can’t know a counterfactual, we can’t know such a threat would arise in our absence overseas, but if a war was truly necessary to defend our way of life, do we not trust the populace to fund the budget with war bonds, so we can restrain politicians and their war machine when their spending is not truly in our self-interest? Trump might be a blow-hard clown-boy man-child but he’s correct that an international military effort should be funded equally by the international countries it benefits. Otherwise, we’re vulnerable to the military industrial complex Eisenhower warned about 60 years ago calling the shots to capitalize on the profits it would generate, which is the epitome of Capitalism run amok by humans with no restraint, and results in the endless (proxy) wars we live with today.

This is all a preamble for why Modern Monetary Theory is a superior system to the one we have for one fundamental reason: it would very ironically create a check and balance on government spending we don’t currently have (I intended to caveat that with “I don’t think we should do it,” but I’m starting to wonder). 

People throw around the term MMT when they describe deficit spending, but that’s not accurate. MMT is the complete elimination of the treasury market. The government would not need to borrow money from anyone. On the surface this sounds insane. If the unaccountability of our political spending is one of the main sources of our monetary problems, how would eliminating the last vestige of restraint in the form of spiking interest rates (aka the bond vigilantes) be superior? 

The reason is because the inflationary mechanism of our system is not understood by the general public, so it appears to them like the nominal wage price spiral of Slowflation fueled by an ever increasing money supply is the normal evolution of a growing economy. What was the minimum wage when you were a teenager and what is it now? That’s not from a growing, evolving economy, it’s from the debasement of the dollar. Since the Fed (and therefore the banking system) is able to create unlimited amounts of money, we will never have a sovereign debt crisis. What we will have is a currency crisis because the Fed can buy the entire bond market, so it’s a plunging currency that ultimately restrains the Fed, but the currency is a relative measure against the equally warped European Union and other sovereign nations, and it competes with the disinflationary effects of our productivity for its overall inflationary effect, so the actual value of the currency doesn't reflect the continual loss of its purchasing power. Since the populace doesn’t feel the consequences of our current policies in real-time, there’s no check and balance on politicians, so the people don’t realize why they’re perpetually stressed, and frustrated, and can never get ahead. Collectively, we shake our fist at whoever’s in office and then vote in the other team for their turn at yet another failed attempt at fixing our problems.

In contrast, MMT has no central bank monetary policy because it allows politicians to spend at will until inflation forces them to raise taxes to withdraw liquidity. Ironically, this total lack of restraint creates an actual restraint because the populace will feel the effects in real-time and will only tolerate inflation for so long until they literally demand the politicians raise someone else’s taxes to combat it, which surprisingly creates a very transparent self-correcting system of continuously allowing small brush fires to keep the forest safe. Of course, if you think our country is divisive now, wait until there’s real-time consequences for our spending and a fight over whose taxes will pay for it. In other words, the total failure of MMT-like policies and their inflationary effects from the Covid stimulus programs illuminates how effective it would be as a self-correcting restraint on politicians. (I’m pretty sure that‘s not how the MMT crowd is trying to sell their idea.) 

In our current system, the people in power mask the effects of currency dilution with a Fed and Treasury “put” that prevents periodic deflationary collapses and therefore allows the brush to accumulate until it one day ends in a grand wildfire currency destruction because there is no check on the process along the way. You might (correctly) point out that if the politicians could spend without the restraint of issuing interest bearing debt to investors, why wouldn’t they print endless amounts of money and buy overseas assets? And they could, but even this would be restrained by the Forex market repricing the dollar lower, which could cause commodity prices to rise and lead to higher consumer prices. If consumers didn’t receive an offsetting raise because it’s not a true monetary expansion onshore since the printed money was circulating overseas instead it would have the typical supply side inflationary impact of causing a recession to stop it. Markets are self-correcting mechanisms. The madness of MMT eliminates the ability of politicians to override market forces with their deficit spending and restores a self-correction mechanism to the inflationary consequences of their spending. 

The system we have with a central bank capable of printing endless amounts of money to indirectly finance the Treasury (and one day outright monetize it) would have occurred in 100% of Earth simulations because it’s driven by humans pursuing their own self-interest above that of the whole. Once you realize this, the unfortunate conclusion is we have no check and balance on the inevitable slow destruction of the currency, and there is no monetary system that can’t be manipulated by politicians unless it created real-time consequences that forced the populace to elect politicians who promise to reduce inflation by restraining their spending. 

Instead of trying to revert backwards to a system of tighter, sounder money with austerity and fiscal discipline that has no chance of happening, and no chance of being maintained throughout time, and will inevitably result in manipulation that masks the currency dilution of inflation, why isn’t the surprising superiority of MMT a better system than what we have due to its transparency and real-time effects? The money supply would live at the max amount relative to the productivity.

My original criticism of MMT was focused on the misaligned incentives and lack of accountability if we allowed politicians to spend at will, as well as the interference of free market price discovery, but once you realize there is no monetary system politicians can’t break (that currently exists), maybe the better trade-off is a check on government spending via the real-time inflation it would cause and the vulnerability politicians have to get elected, rather than a system that can be manipulated beyond public awareness that enslaves the lower half of earners who don’t own enough assets to offset it. 

Before we fire up the printing presses and make it rain hundos on America, let’s pump the brakes and see if there’s a better solution in The Unit Of Account Problem next week. There has to be a way to solve this problem without risking hyperinflation and civil war. 

The Subsidized Deglobalization Illusion 

Globalization is irreversible because the incentive of seeking the lowest cost labor and least regulations to maximize profits for shareholders is the foundation of the economy. People who think deglobalization is even possible, let alone happening, are curve fitting a narrative to fit their inflationary or investment bias. All you have to do is watch Apple and Nike. There’s no two companies on the planet who would benefit more from “deglobalization,” so if the process was organically driven by self-fueling incentives, why isn’t there a bidding war for Iowa farmland to construct all the new manufacturing facilities? The reason is because the thought of moving back here only occurs to them in nightmares. The US would be the last place on Earth any sensible business person would look to relocate manufacturing because we are a hostile place to do business.

Other people calling for deglobalization are just not being precise with their terminology. If by deglobalization you mean an exodus out of China, then call it deChinafication, or Reglobalization. Some see the uptick in US manufacturing caused by government subsidies and falsely believe it’s deglobalization, or a reshoring renaissance, but if subsidies were an economically viable strategy, why don’t we offer all our global companies the same deal? 

Here’s the offer: if you would like to relocate out of China, but find the economics of the move discouraging, simply put together a proposal of the expense differentials between relocating to Vietnam, Africa, India, Mexico, and the US, and we will subsidize the difference. We’ll need to see the cost to construct the facility, and the increases in utilities, labor, insurance, regulatory, and shipping costs - both for the materials and final products, etc.. Then the US taxpayer will subsidize the difference between the lowest cost location on Earth and moving back here. Bingo Bango Bongo, world solved. Easy peasy. What do we solve next? Human flight?

Before I start gluing feathers to my arms, let’s follow the money to see if a parade is in order. The subsidies would come from increases the taxes on the profits of our domestically constrained businesses so we can give money to our reshoring global companies (and also increasing their taxes) to reduce the prices of their final goods so they compete with products produced at the lowest cost locations in the world. For this to work, the companies moving back here would need to generate the amount of the subsidies in new taxes from their additional profits so the whole thing pays for itself in a virtuous circle, otherwise, it’s a net loss and a permanent bill (as it currently is); therefore, the expansion of their market share would have to occur outside the US or it’s just taking money from Peter the taxpayer to pay Paul the manufacturer to save Peter a lesser amount in product prices than we took from him in taxes. “We were promised a perpetual motion machine, but all we got was a fat kid in Baltimore generating power on a bicycle who gets tired and takes a nap.” This is not a self-sustaining viable business model. 

Here’s the ultimate Litmus test for an idea like this: if a little works, why not more? Why not increase the subsidies even more so the products these “reshoring” companies produce are the least expensive in the whole world by a long shot? Certainly our companies would grow their global market share and be able to pay back the subsidies with profits from a massive trade surplus, so it’s a win-win for our taxpayers, the companies, the newly employed workers, and a boom for our local economies. In fact, this could generate so much revenue, the additional taxes it would generate could start paying down the national debt. If all our global companies moved back onshore we could control the standards of the products, the conditions for employees, etc., and now that we embraced MMT why not save the taxpayer money and fund it with our new monetary spigot?  

If the market share for these companies truly grew globally, and they generated the substantial subsidy it would require in additional taxes, it would work - if we lived in a vacuum. The problem is the rest of the world wouldn’t sit idly by and watch us take over their lives. Global trade laws are designed to prevent this from happening. Such a policy would be a race to the bottom as countries competed to subsidize the cheapest products to gain the largest market share, which would result in a trade war, a kinetic war, or both. If subsidized “deglobalization” is as fraudulent as a perpetual motion machine, why are we doing it at all? Because we want to control certain vital sectors for geopolitical reasons. It’s not a self-fueling reshoring renaissance - it’s a net economic loss for a strategic geopolitical gain. 

Globalization is irreversible because it violates the law of incentives. Our US global companies currently in China don’t want to lose access to the billion customers they have, so it’s not an easy decision to even Reglobalize somewhere else. And what a logistical nightmare. China doesn’t want them to leave either, so the barriers to deglobalization are enormous because it’s not in the best interest of the companies, or China, or the consumer, but the more China acts like a clown boy Tootsie Roll maker, the more our manufacturing base will Reglobalize somewhere else. 

The fact is globalization will deepen as companies are forced to continue seeking the lowest expenses possible, which will keep putting downward pressure on prices because as they relocate to other countries they will build new manufacturing facilities with the latest automation, so their prices will go down as more of the process is automated. Manufacturing will relocate back to the US when automation makes it cheaper than the lowest cost location in the world, but even that would depend on many factors. An A.I. program could be developed for a company like Apple to upload all its sales data, raw materials locations, shipping costs, etc., then the A.I. could analyze every possible location in the world to determine the most efficient one based on long-term trends in customer acquisition cross-referenced with geopolitical, regulatory, and tax burdens, among other complex factors. The future of our global supply chains will be organized by artificial intelligence.

Globalization is irreversible, and the chasm in the American middle class bifurcating upward or downward will continue to worsen until technology flattens everything as we approach the end of Capitalism (more on this in two weeks). Globalization creates a nonviable economic condition where monetary and fiscal authorities must continually debase the currency with fire hoses of liquidity to prevent collapse by perpetuating Slowflation to neutralize the burden of debt. Meanwhile, non sovereign technology continues spreading across cultural borders, constructing a network that integrates developing world citizens who have limited access to credit with sources of funding, but since there’s foreign currency risk in transacting across borders, what the world needs is a global currency capable of penetrating organically into everyday commerce as developed and developing worlds integrate through technology and the world becomes a giant interconnected, self-organizing, self-fueling, smart system computer. 

In The Unit of Account Problem next week, we’ll explore why it won’t be Bitcoin. 

The Nominal Game We Play

Intro

I have not heard one argument from the Inflationists that isn't tainted by concepts blinding them to the pragmatic reality of how inflation actually works.

(5400 words)

The Nominal Game We Play

The reason a wage price spiral is not a cause of runaway inflation is because wages are not a cause of rising prices; they are a price, and all prices are an effect of the money supply, which expands the balance sheets of consumers and businesses (depending on how it's distributed). This is not something that has to line up perfectly on a chart because there can be lags shaped by things like velocity and confidence, particularly when influenced by pre and post globalization effects, among other variables, but without a broad increase in the money supply, where does the money come from to pay for general rising prices? If you say “wages,” you are engaging in a self-referential loop that requires funding to fuel it. The flawed thinking goes like this: “prices go up, which pressures wages up, which pressures prices up in a self-fueling spiral....” But this assumes an infinite balance sheet when in reality rising prices cause consumer and business discretionary income to shrink because it’s not simultaneous and it's unevenly distributed. 

Let’s assume the money supply stays constant and the federal government forces a 10% increase in all wages so it happens simultaneously to all businesses. This would cause a 10% loss to all businesses via increased payroll, so let’s also assume every business decides to raise their prices by 10% to offset it. Let’s further assume everyone spends the 10% increase in wages proportionally across every business so they all initially lose 10% in higher expenses but it’s replaced with 10% of higher revenue. What is the result? Wages and prices go up but there’s no real economic gain. All that happens is the level of debt remains constant while the nominal wages and prices to repay it increases. This is the process of inflating away debt. 

There is not a self-fueling inflationary mechanism here unless the forced simultaneous wage increases happen consistently every year, and there’s a boatload of assumptions I made to illustrate how unfounded fearing a wage/price spiral actually is. In reality, the money doesn’t get spent evenly, so some businesses receive a disproportionate amount of the benefit while others receive less or none. Also, not every business can raise their prices without hurting their revenue in lost volume. A business would likely respond to forced higher wages by cutting hours and making the remaining employees work harder, which is another reason why a wage/price spiral cannot fuel itself without continual funding. The same reason high prices cure high prices, inflation cures inflation, except during hyperinflations which typically involve an ever increasing flow of money to broad consumers from a noneconomic actor like the government. Free market competition prevents runaway inflation. You will only find sustained inflation in sectors or countries where monopolies exist, or government intervention overrides free market mechanisms broadly.

Here’s another flawed concept: inflation expectations cause rising prices. There isn’t a single merchant on the planet who will take my inflation expectations as payment for their goods and services. They insist on money, which is a prerequisite for inflation expectations, so if the monetary expansion stops, inflation expectations will follow, and demand will weaken, ending the inflation as discretionary income and profit margins get squeezed and cause a slowdown or recession. A caveat to this is how idiosyncratic it can be. A growing business could see all of its input prices go up and yet its free cash flow still increases because its market share is growing. Likewise, an individual who gets a raise that exceeds their increases in expenses is not affected by inflation in real-time. Naturally, the percentage change in wage growth for those making less money doesn’t increase the absolute dollar amount of their discretionary income nearly as much as those making higher income, so the economic effect from the same percentage increase in wage growth varies dramatically across the income spectrum for the universal goods and services everyone consumes, which makes inflation a very regressive tax that hurts the poor the most. A statistic that would express this is showing the percent of disposable income consumed by each category of CPI across each of the income quintiles. If that statistic existed there would be far less conceptualizing about inflation.

If you think prices can sustainably rise without being fueled by the expansion of the money supply into the hands of broad consumers, prove it to me by drawing a flow chart of 5 consumers and 5 businesses as pyramids with the largest base layer as income, a smaller middle layer as expenses, and the smallest top layer as discretionary spending. What is causing prices to rise? Is it a supply side phenomenon or is the money supply increasing? If it’s a supply side problem, the middle expense layers of the pyramids expand (overall) but the bottom income layer doesn’t, so the top discretionary spending layer must shrink. This is what happens when energy costs, interest rates, or commodity prices, rise, which forces a reallocation of budgets away from discretionary items towards mandatory spending on staples and utilities. 

If there’s an increase in the money supply, the bottom income layer expands, which allows the top two layers to expand as well because there’s more money available to spend. You cannot expand the expense layer in the middle without shrinking the discretionary layer at the top unless the income layer rises, but the income layer can’t rise universally for everyone unless the money supply increases broadly through wide scale borrowing or redistribution stimulus programs. Increases in prices caused by the supply side induce recessions that self-correct the supply imbalance because consumers and businesses don’t have the money to pay the higher prices, so demand wanes. If the productive output of an economy increases while the money supply remains the same, prices go down. This is a welcome deflation and the natural mechanism of the free market because it reduces the middle layer of expenses and therefore increases the discretionary layer without requiring the income layer to increase.

A runaway wage price spiral is impossible, but a slow moving one is the basis of our economy. In fact, a system of fractional reserve banking and deficit spending requires a wage price spiral; it’s the lubricant that allows the engine to run, so it’s peculiar to hear people worry about a wage price spiral when it’s the desirable outcome. Without a wage price spiral the whole system implodes. How else are people going to pay for the higher prices? Prices don’t come down; wages go up. Our system requires a continual expansion of the money supply to fund a continual wage price spiral to prevent it from collapsing. It’s surprising how many people didn’t take the time to figure out the difference between a rate of change and a price level of inflation. There are still people who believe prices have to come down for inflation to subside when it’s wages going up over time that makes it work. What usually deflates following, or alongside, an inflation, is asset prices, not consumer goods, although sometimes asset price deflation is so dramatic it deflates consumer prices as well - until the money supply reinflates everything again, which is the pattern we’ve been in for a hundred years.

If we had sound banking, and sound money, wages and prices wouldn’t have changed much from 100 years ago. The median house would still be a multiple or two of around $6,000 and the median salary would still be a multiple or two of around $2,000. Prices don’t rise over time because the economy grows. In fact, the scale and efficiency of free market competition causes prices to fall over time. Prices rise from the money supply increasing, diluting purchasing power, which then requires more dollars to buy the same stuff, so it’s not prices that are rising, it’s the purchasing power of the dollar going down. Central bank critics blame this on the Fed when most of the money supply is created by banks. It does not matter that banks are funding what should be viable economic activity; what matters is the supply of money per capita vs the productivity. In theory, the money supply could expand and prices could still go down if the overall productivity was increasing faster. In comparison to a system of hard money like gold, the money created by banks could not exist. It is future economic activity brought forward into the present by a printing press. This is why demographics play such a huge economic role and why the Boomers distort everything they touch. 

This is the nominal game we play, and there’s no stopping it because in a debt-based system the value of the collateral supporting it can never deflate or it would destabilize the centralized creators of credit with contagious counterparty risk, which would force the Fed to bail them out. Some like to argue letting the system fail would be akin to the sharp quick depression of 1920, but in a globalized world we don’t have the base layer of manufacturing to lean on, so bailing out the system is not a choice, it's mandatory. Restructuring the debt is also not an option because it would be a massive deflation of the value of collateral. The only choice is the continual debasement of the currency through money supply expansion with the hope that increases in productivity from A.I. eventually outpaces it, or there will be a loss of faith in the currency, which is the ultimate expression and failure of the institutions comprising our system.

To illustrate the point, in 1913, an approximation of M2 was 29.7 billion, and the population was 97 million, which is $306 per capita. In 1959, the first year of officially tracked M2, we had 177 million people and an M2 of 298 billion, or $1,678 per person. In 2023, M2 was 21.1 trillion and the population was 339 million, which is $62,223 per capita, which is 203x the amount from 1913. M2 might be a flawed statistic but you get the point: if M2 was distributed evenly Jeff Bezos would have to sell the yacht. In a gold backed system, the money supply tends to naturally increase in proportion to population growth and improvements in technology as more people are available to mine the gold, and the equipment becomes more efficient. If the money supply per capita stayed relatively the same over the last century we would still have an imbalance of wealth but it wouldn’t be so extreme, and the evolution of technology would have been glacially slow, so there would have been pressure from foreign competitors who were increasing their money supply and reaping the benefits of faster technological improvements in the same way athletes got tempted into steroids to keep up with competition. The predicament we find ourselves in may have been the inevitable result no matter what choices were made along the way, but that doesn’t mean we can’t course correct voluntarily, or be forced to course correct by technology in the future.

One of the main benefits of an incrementally expanding money supply as the cause of incrementally rising prices and wages is best demonstrated with housing. When someone takes out a 30-year loan for $300k at 6%, they end up paying $347k in interest. If the house is $360k at the time of purchase and it appreciates at 4.59% (which is what Google just told me was the average from 1992-2023), after 30 years the house will gain $495k in value and be worth $855k. The average inflation rate was 2.48% during that time. The average annual wage growth since 1992 was 5.15% (according to Google citing SSA). So this Slowflation creates $150k in nominal purchasing power (not counting any refinancing at lower rates over time), which comes from the dilution of the currency causing house prices to rise more than the total interest cost, which is a transfer of wealth from those who hold the currency but don’t own a house, and it’s yet another contributor to the wealth imbalance as those who don’t own assets fall further and further behind. 

Slowflation benefits bankers in nominal terms (but since the money is created out of thin air, the interest received is a net gain even though the purchasing power of the principal they loaned gets diluted over time); it benefits homeowners in real terms (since their house and wages appreciate more than the interest and inflation (overall)); it benefits the government in nominal terms because the debt issued 30 years ago is diluted by rising tax revenue); and it benefits businesses in real terms as they raise prices and become more valuable as assets. The people it hurts are those who don’t own assets, savers in cash, and owners of debt (unless you create it out of thin air like a bank, or if the price of the debt rises like a treasury bond bull market for 40 years so the total return offsets the loss in purchasing power when the principal is repaid). 

One of the more misleading charts is the 99% loss of purchasing power of the dollar over the last 100 years because it doesn’t show the rise in wages that offset it. Chat GPT says inflation since 1913 has averaged 3.1% but real wage growth was still 2% until 1979 and then just below 1% ever since. While money sitting under a mattress decays over time, money earned to pay living expenses has outpaced inflation, so the question is: why haven’t real wages for the lower half kept up with the upper half as seen here, and the answer is globalization. If you owned assets AND got real wage growth during this time you’ve done quite well as “number go up.” This outperformance of higher wage earners in real terms is more evidence of the insidious effects of globalization and the wealth imbalance it causes.

One of the better arguments for a trend change from structural disinflation to structural inflation is the shift from monetary to fiscal dominance. And while I agree this shift is happening and will continue to happen, I don’t agree that it has to cause consumer prices to accelerate any faster than they have in the previous century of Slowflation. Fiscal dominance does not necessarily mean a runaway train of inflation - it means the effect of the responses to deflationary collapses will be more dominated by fiscal policies than monetary policies, but that doesn’t change the order of operations requiring a deflationary collapse first, which then causes an inflationary response that will now likely be dominated by fiscal effects, but typical deficit spending doesn’t cause “general rising prices” in the same way it causes rising prices in specific sectors. 

If we follow the money, government spending flows to the military, transfer payments, healthcare, retirees, infrastructure, etc., which creates artificial demand for the businesses in those sectors and ends up on the balance sheet of banks, but banks aren’t short on capital, so this increase in lending capacity still requires creditworthy borrowers with collateral and viable loans. Neither the Fed nor the Treasury can print creditworthy borrows. To use the pyramid analogy, deficit spending is not a broad based increase in the income layer of the overall population because it’s narrowly distributed to select recipients and businesses. If the government passed a UBI policy, or the Fed started pinning the curve, then I would agree it would be a structural change (which is likely coming if AI takes too long), but that is a really high bar to pass Congress and would only happen as a response to a deflationary collapse. 

If you believe deficit spending causes broad consumer prices to rise, prove it to me with a flow chart showing where the money comes from, and who receives it, then explain how the price of milk and beef and cars will rise if 80% (?) of the population doesn’t receive the money to increase the demand for those products. Prices can only rise if there is an imbalance of supply and demand, so if supply remains constant then where does the sudden increase in demand come from? Some of the inflationists have the right understanding; they’re just saying it wrong. Deflation is the problem; inflation is what they do to prevent the problem from occurring. Some of the deflationists have the order of operations right but they underestimate the response: the only certainty in life is the Fed will be diluting the purchasing power of existing bond principal to pay for future government obligations.

To think inflation is the problem is like saying alcohol is the problem for the alcoholic when it’s the underlying condition of pain causing them to drink. This is not just semantics. If inflation was the problem you’d want to be long the dollar and short everything else because the Fed would be forced to keep increasing overnight rates ever higher attempting to contain it. Since deflation is the problem, you want to be long assets that benefit from Slowflation as nominal prices continually increase over time from monetary and fiscal policies forced to prevent a deflationary collapse, which occurs at times along the volatile way. 

The 1970s inflation was largely caused by simultaneous demand for credit by a freak demographic boom all hitting their peak borrowing years at once over an entire decade (amplified by oil, of course). The 1940s inflation had elements of a locked down economy, and a simultaneous release of consumers when soldiers returned, all hitting a restrained supply chain since so many manufacturers switched to producing munitions, so a sudden increase in demand hit a reduced supply. (Among other factors in both decades, of course.) To whatever weak extent companies are reshoring due to subsidies, that is a supply side force because it’s not increasing the money supply. And Treasury deficit spending financed by the private market isn’t inflation; it’s just redistributing money and crowding out private investment that could have happened elsewhere. Foreign buying of treasuries is outside money like the Fed, which is additive, but you’d have to follow the money to determine who is receiving it to figure out which consumer prices are likely to sustainably rise from it, not to mention where it came from, which is our trade deficits. In other words, unless there’s a fiscal program that broadly distributes the money, it’s not possible for demand to outpace supply and cause a general rising of consumer prices, so there is no chance of a resurgence in inflation like we saw during Covid. When the Fed inevitably starts cutting rates it is very unlikely to cause enough borrowing to spur inflation like the 70s’ freak demographic boom - largely due to the loss of secure incomes in the lower half caused by globalization. There is a huge difference between general rising prices and the rising prices of specific sectors caused by government interference in the free market. And there is a huge difference between rising prices caused by the supply side vs rising prices caused by an increase in the money supply. The former causes a temporary economic boom while the latter causes a recession, so a new word should be coined to express the difference because the effect on assets prices is dramatically different. 

My experience of the Covid inflation will force the “supply shock only” theorists to soften their views. When I bought my business in 2018, if I call the numbers I bought into 1x, I expected the changes I implemented to increase both the top and bottom lines by 50% in 2019, which is exactly what happened. I thought maybe another 25% increase would happen in 2020, but that would max out this business without getting into a world of headaches I had no intention of getting into. But then Covid hit in 2020 and both the top and bottom lines increased 3.5x and stayed there for two years. I was not affected by a supply problem at all, not even a little bit. My suppliers all raised their prices by 50-100%, which forced me to raise my prices the same, but that was in response to the insane demand, not a supply shortage. In July 2022, when everyone started the summer of endless vacations, my numbers reverted all the way back down to 2019 (a 70% drop). I am neither that good nor that bad at running this business, and while there is some degree of consumer preference changes for sure, nearly all of what happened was caused by the one-off stimulus money. I agree a supply shock was the cause of some degree of the price hikes for a lot of global companies, but if the inflation wasn’t driven by money, then how did the top and bottom lines for so many companies increase so much?  I would argue 75% of the CPI increases were caused by the distributed money and 25% was a supply shock. This is a better explanation why it’s taking so long for the last mile as the money works its way through the system, which has been extended by the Inflation Amplification Act. 

To put inflation in the most concrete terms possible, put yourself at a sales counter of our newly established business. In front of you is our cash drawer, a credit card terminal, and a computer with financing options. On the other side of the counter are 5 customers representing each of the 5 income quintiles. The person in the lowest 20% income bracket is not a factor in determining our cash flow. In fact, in the business of their life they are losing money since their income is being subsidized by transfer payments from us. Most of the people in the 20-40% bracket feel like they’re in the bottom bracket and don’t have much discretionary income. The top 80-100% bracket also doesn’t matter because there’s not enough of them to move the needle broadly and they don’t have to change their consumption even as the world ends in an apocalypse. It’s the 40-80% and most specifically the 60-80% bracket that will move the needle on economic numbers the most. This is the group with the highest number of people with the most discretionary income to spend. 

Now a genuine inflationary impulse happens like the Covid stimulus. First of all, businesses don’t control their prices; they are set by demand relative to the supply in context of the competition. A functioning business does not want to raise its prices; in fact, it’s scared to raise its prices because it could lose customers and hurt its top and bottom lines from less volume. When inflation causes all its expenses to go up, a business is forced to raise its prices and look for efficiencies anyway it can. The idea of pricing power is also exaggerated because it too has limitations. If Coke and Pepsi raise their prices too much they will discover their loyal customers will choose to get their diabetes from the local generic brand. 

Once the intensity of the inflationary demand subsidies, the hangover begins. The business has higher expenses, the employees have higher expenses, the customers have higher expenses, and wages haven’t kept up for enough of the population because they’re unevenly distributed. So the business has to get lean, eliminate unnecessary spending, and figure out how to reduce payroll by giving the most critical employees a raise, but also more duties so hours can be cut overall to keep the expense the same (if necessary). This is why a wage/price spiral is so impossible. It’s not how it works at all. The thought process of a business owner morphs into: how can I maintain (or even increase) productivity with the same payroll? 

If you apply this dynamic to every business on the planet, some businesses (like mega cap tech) are growing their markets because they have products and services continually in need and expanding throughout the globe, so they aren’t as impacted, but the vast majority of small businesses feel an economic contraction much more intensely, so their ability to raise prices to offset their expenses is limited, which is why it’s not a self-fueling phenomenon unless the flow of money to the broad consumer base that is causing the supply/demand imbalance is perpetual. Imagine being behind the sales counter of every business in existence. Follow the money of deficit spending. How many dollars are reaching the customers standing before you and which income quintile do they belong to, and what sector is the business in?  Imagine an extended oil price shock, or a weaker dollar causing commodity prices to rise, or any supply side shock like higher interest rates or higher prices from “deglobalization.” Our prices are going to rise but the consumer's discretionary income is shrinking, so they have less to spend. Now compare the supply side causes with stimulus checks sent directly into the hands of our customers, bidding up our prices. The supply side causes a contraction; the demand side causes an expansion, then a contraction. This is at the crux of the difference between cyclical and structural forces. 

A structural force is grounded in the incentives of the participants, making it perpetually self-sustaining unless something changes to alter the incentives. Structural disinflationary forces are caused by: downward pressure of free market competition eroding profit margins; improvements in output from the efficiency of technology; cost savings from CEOs seeking the lowest cost labor and expenses in the world; the saturation of debt devouring consumer discretionary income; and the demographics of the baby boomers entering their non productive years.

The argument that we entered a new inflationary regime rests on forces like remote work, higher energy costs, fiscal dominance, and deglobalization, but remote work is likely disinflationary, if not deflationary because it will cause serious write-downs of commercial office real estate debt on bank balance sheets with unknown consequences. Remote work is like globalization for digital services, and, really, it’s just changing office locations - it doesn’t add or subtract economic activity. When workers don’t want to come to the office, it opens the potential workforce to the entire world. I recently needed some web work done, so I put an ad on Upwork and received so many replies I had to shut it down. My choices were Dan from Denver for $150/hr, or Monika from Mumbai for $35/hr. One thing you discover about the Monikas from Mumbai is they don’t always represent their fluency in English accurately. And I’m sure some US jobs require a cultural knowledge that can only be acquired through decades of living here, but there is an enormous amount of work the Monikas from Mumbai can do if our workforce doesn’t want it. She did a fantastic job. The point is there’s no economic gain or inflationary impulse if you relocate workers from a downtown office to their houses.

I won’t spend much time on energy because it would be a supply side issue, not an inflation problem, so by definition that’s cyclical as the market will seek a high enough price to self-correct the imbalance, which will drive up prices without an increase in money to pay for it, so it will cause a recession. I agree with Doomberg that Peak Oil is a myth. According to Worldometers the globe has 47 years of proven reserves at current consumption. And if a supply shortage one day becomes an issue, we already have existing technology to solve the problem, even if all the budding new approaches fail: we can convert to natural gas; we can build modern nuclear plants and make our own hydrogen or ammonia; and/or upgrade the grid to power sodium/lithium or lithium/iron batteries, among dozens of other possibilities. The necessity of data centers incentivizes the creation of cheap, efficient energy. I won’t be surprised if A.I. solves fusion or aliens come out of the closet with advanced energy technology. 

Why we don’t incentivize EV hybrids as an interim solution to slow down oil use and grant more time to develop the tech is beyond me. This does not mean we won’t cause our own energy crisis from political incompetence, but that is a political argument, not an energy scarcity one. The abundance and efficiency of energy will go UP over time, dramatically. I expect the next 150 years will have an even greater, cleaner, and cheaper energy impact than the last 150 years, but humans do all the wrong things first until they finally get it right. (Again, I’m not talking about the price of oil spiking if we sabotage ourselves. I’m talking about energy scarcity or abundance and whether we need to worry about the future existence of our civilization.) We already discussed fiscal dominance as a reactionary function and limited in scope unless the money is broadly distributed. We’ll explore the illusion of deglobalization next week. 

The Fallacy of Real Yields and Universal Inflation 

There’s a huge difference between a universal system of standardized measurement like the Metric System, or the US Customary System, and a relative system seeking an average statistic to calculate things like CPI, which varies immensely per individual. Since there is no universal measurement of inflation, there is no universal real yield. It’s a meaningless number akin to the weather channel saying the global temperature is 48 degrees (Farenheit). It depends entirely on where an individual lives, and in the case of CPI, what they spend their money on, what they own, how much income they earn, and their net worth. 

The way to calculate a meaningful real yield would be a spreadsheet where an individual can enter their income and how much they spend per CPI category to derive an individualized CPI, which would have to be compared to their local prices over time. Unlike a house, rising auto prices have a much different effect since they lose value for everyone, but the percentage loss against incomes and its psychological effect vary immensely. Increases in services depend how much you spend on them. Once you input your income, assets, and spending in the proper CPI categories, you can calculate an exact inflation rate against any rise in your income. If you own a house it’s likely keeping up with overall shelter percentage increases but it will of course vary by region and locality and the value of your home. If your wage increase is higher than your personal inflation rate then you’re not being affected by the real-time inflation, even as the purchasing power of the dollar is going down. Technically, the real yield on your excess savings can’t be determined until the money is spent. In the future, when every dollar can be embedded with the ability to track CPI and asset returns across time, it will be possible to calculate the real yield of each dollar from the time it was acquired until the time it was spent, which is the only accurate way to do it. 

If you have money in treasuries collecting 5% in an investment account that you’ll never spend in your lifetime, it’s more appropriate to measure the real yield in terms of alternative investments. Even though it’s apples to oranges, that money could be invested in the S&P, or if you think a market cap weighted stock index to bonds is an unfair comparison, you could use low beta dividend etfs, or more duration, or credit risk, or asset diversification strategies etc... When making a real yield calculation across long periods of time, comparing the yield against alternative investments is just as relevant as CPI to determine the loss of purchasing power. But the final real yield isn’t complete until it’s compared with the price increases in the categories of how the money is spent. Otherwise, it’s just an average global temperature, which may be all we have, but it’s wildly inaccurate.

SUMMARY

Rising prices caused by an increase in the money supply into the hands of broad consumers creates a temporary economic boom that lifts the top and bottom lines of businesses and their equity prices, but much like a drug, it is not self-sustaining and only lasts as long as the money is flowing. Rising prices caused by any other reason shrinks margins and disposable income, which results in the lower equity prices of a recession to reflect the self-correction of the supply imbalance through demand destruction. Sustained inflation can’t exist unless a monopoly like the government overrides free market competition, but even then it’s important to follow the money to determine if it’s a general rise in prices or it’s contained to narrow industries and therefore a relative rise in specific prices like education or health care. The Fed inflates asset bubbles; the Treasury inflates consumer prices wherever the money flows. These two forces, combined with fractional reserve banking, inflated an Everything Bubble via a 203x increase in M2 per capita over the last century. Since the Fed and Treasury have chosen to prevent the deflationary pressure of globalization upon our economy with liquidity (as seen in their balance sheets), but most of our treasuries are privately owned, inevitably there comes a point when the interest to service the debt consumes the entire budget so the Fed will have to outright monetize the debt and pin the curve. A productivity miracle from artificial intelligence can save the day, but will it arrive in time? The mystery and suspense is like living in a movie. 

Next week in The Surprising Superiority of Modern Monetary Theory, we’ll find out if a long-term sound money advocate has changed his mind.