Wednesday, April 1, 2015

A deluge of delusions

The world is now confronting the grim prospect of being engulfed by a global-wide deflation. Still, only a few renowned economists believe that the world is marching in lockstep into a depression, even though the coming one will be more severe than anything ever experienced. The denial state continues with more delusionary statements spewed out, revealing the hollow thoughts of the commentators.

To avoid being trapped in the delusionary thinking of self-proclaimed economic experts, we need to conceive new definitions for both deflation and depression. The conventional definition — using definitions from Investopedia.com — for deflation is a general decline in prices, often caused by a reduction in the supply of money or credit, while that for depression is a severe and prolonged downturn in economic activity, or to be more precise, an extreme recession that lasts two or more years. Though helpful, these definitions don't allude to the risk of the deflation morphing into a depression.

We need new definitions that instead of being descriptive, identify cause and effect. Deflation and depression are always caused by changes in supply and demand, not of goods or services but money, or to be exact, credit supply. Deflation then, under this new definition, is a steady shrinking of credit while depression is a drastic plunge in credit. Credit is like water; you can hold it back but only for a while. When credit wants to contract, it will do so even if you create tons and tons of new credit.

Deflation will inevitably lead to depression despite whatever measures taken to prevent depression. Like the Monopoly board game, the real life economic game under the current Wave 4 of the Kondratieff Wave will end because wealth circulation is seizing up. We've seen how policymakers are throwing everything to stave off deflation. The ECB and the BOJ are back with the same QE stuff, an attempt that's no better than throwing the kitchen sink. Einstein would've deemed it insanity: expecting different results by doing the same thing over and over again.

With the recent spate of plane crashes involving major loss of life, it's best that we choose a different analogy as a pattern to understanding deflation and depression. The water dam, another human creation that has led to major loss of life when disaster struck would be an appropriate substitute. Hopefully, mankind has learned enough from past dam failures to avoid repeating one in the future. But for economics, mankind is still in the dark ages, condemned to suffer calamity after calamity.

A dam's structure is made of concrete, that is, a mixture of cement, sand, water and aggregate. A chemical reaction that emits heat ensues when water is mixed with limestone in the cement. Because of the dam's massive structure, the huge amount of concrete cannot cool evenly. Unless a special cooling method is contrived, the uneven cooling would result in a cracked structure. Over time, the weakened dam would give in and burst.

Similarly, in economics, the capitalism structure has a major fault. It has no room for compassion. Capitalism, like the Monopoly game, is a game in which the players compete at a very intense level. With that kind of emotion, you don't have a feeling of compassion for your fellow competitors who have lost out. The winner's aim is to decisively trounce the losers, with no quarter given. What the winning players don't understand is it's just a game. You finish off your competitors at the expense of the game being stopped. "The goal is to win, but it is the goal that is important, not the winning," said Reiner Knizia, the German board game designer. To keep on winning, the game cannot end. You must give away your winnings to keep the game in perpetual motion.

Each Kondratieff Wave is like a water dam. Mankind has built four Kondratieff dams so far. Three have crumbled with the fourth soon to fall apart. Only one more dam, probably a small one replacing the current one, is left to be built. Because of the dam's structural fault, it keeps on failing, each failure inflicting major economic disaster on people's lives. Unlike a water dam's disaster, you can't see the rushing water that lays waste to anything that lies in its path. It's not a water deluge but a deluge of vanishing money or credit. That's why economists can't still get a handle on economic depression because they can't see something that disappears.

With this dam analogy, we can now understand the danger of deflation. Deflation, using the dam analogy, means that the reservoir water level is dropping because the dam has started to crack and spring leaks. The right thing to do is to release water from the reservoir to ease the pressure on the cracked dam. But the penstocks, the pipes that channel water for irrigation or electrical generation, are faulty. The valves or the sluice gates that allow water to pass through the penstocks are stuck because the cracked dam has misaligned them. The act of releasing water is analogous in economics to the winners voluntarily cancelling the debts owed by the losers. If the winners refuse to write off, the debts will still disappear but the manner in which they disappear is steeped in antagonistic feeling that, carried to extremes, can result in blood-letting.

Policymakers and economists fear deflation because when prices fall, they believe that people will withhold spending hoping that things can be bought cheaply later. This is a crock of bull which assumes people have foresight as to future prices. The recent falls in oil prices have resulted in onshore oil tanks and offshore tankers being filled to the brim because the speculators believe that oil prices will start rising again. People's expectations are always rational, that is, from their own perspectives.

No, deflation is dangerous not because people withhold spending but because it signals that credit supply has begun its relentless slide towards a much bigger plunge, that is, the point when the dam bursts. People stop buying simply because they don't have money to buy. But the public loves deflation because it sees only lower prices; if it knows that lower prices come at the expense of losing jobs, it will clamour for inflation. Democracy thrives on the voters being continually deluded.

Credit disappears when wealth flows increasingly to the 1%. With disappearing incomes and wealth, the 99% can no longer repay their debts. That's why debt is dangerous in a deflation; delusionary economists however argue differently: in a deflation, the debt burden increases because debt maintains its value while prices of goods and service fall. If that's the case, borrowers can still cope by cutting other costs. One prominent economist, Paul Krugman, as usual with his specious argument, contended that we shouldn't worry over the high debt level because we owed it to ourselves. Of course, debt is not owed between people and animals but substitute 99% for 'we' and 1% for 'ourselves' and you'll get the drift of where events are leading up to.

Debts must be written off but it takes time for lenders to admit their losses. They would prop up their borrowers with more loans little realising that at the end stage of a Kondratieff Wave borrowers are losers who can never repay. The rise of big governments further complicates the issue. Imagine that in the Monopoly game the winner lends money to the bank to on-lend to the losers to keep the game going. The winner wouldn't lend directly to the losers because he knows that it won't be repaid. In real life, the government plays the same role as the bank in the Monopoly game. By taking on more debt from the 1% and dishing it out as incomes and welfare payments to the 99%, the government merely acts as a shock absorber to delay the inevitable reckoning. The effect is to make the crunch more catastrophic.

It's as if the dam operators upon seeing that the water level has dropped, remain oblivious to the cracked structure. They worry about the falling water level, not the cause of the fall. They carry out cloud seeding to increase rainfall to replace the leaked water. To assuage worries about the cracked structure, they make surface patching — that's what their QEs do — while underneath the cracks continue to build up. Western economic thought is like its medical counterpart: it treats symptoms rather than root causes.

As the water level keeps rising, the dam can no longer bear the pressure and eventually bursts. This is the trigger that marks the beginning of the depression. The gushing out of water and sudden great drop in the reservoir level is synonymous with the drastic falls in credit supply and goods and services prices as lenders are caught with loans that self-destruct. Money or credit suddenly vanishes. Prices are cheap simply because there's no money to be had.

That essentially is how an economic depression will unfold. Using the dam analogy, we can explain two issues: one, the events that are now playing out, and, the other, the plunge that is looming. This post deals with the first while the plunge will follow in the next post.

Now that oil prices have finally been devoured by the deflation monster, some commentators have welcomed the price falls as a boost to global economic growth while others fear the deflationary impact of lower oil prices. If you believed the former, you'd been disappointed by now as there are still no signs of robust growth after more than six months of prices falling from peaks of more than US$100 per barrel. On the other hand, if you worry about the latter, you can always offer to buy oil at US$100 from the Saudis. Alternatively, you can heed the equally crass advice of a former Harvard president to impose carbon tax on fuel. Mind you, the depression delusions don't spare those of high intellect.

These commentators are speculating on the consequences of the price falls. The mere thought of that betrays their delusionary thinking. If they can't grasp the cause of the price falls, their take on the consequences would surely be wide of the mark. A hint of the cause can be seen in the systemic nature of the price falls, affecting not only oil but practically all commodities. Commodity supply and demand being inelastic in the short term couldn't have risen or fallen so dramatically. Such vertiginous and expansive price movements within a short time span could only be caused by something that could easily expand and contract. The only thing that fits this bill is credit, a virtual object that can be created or erased at the stroke of a pen or a press of the key.

Although credit is the culprit for short term price gyrations, long-term price movements on the other hand are subject to technological advances. If we look at the long-term real prices of commodities (see chart below from The Economist), the trend is downwards. Eventually with new materials based on advances in nanotechnology, we will no longer have a need to move earth to exploit the minerals except gold and silver, which will remain in demand for their precious content. Most others will remain soundly buried.


We can also view the prices of the various industrial commodities (chart below from The Financial Times), this one from 2000 to 2014. Iron ore prices show more significant gyrations than the other industrial commodities but the trend is obvious: prices are plummeting across the board. Surely to understand this odd phenomenon, we can't be focusing solely on oil. The role of China in stockpiling certain commodities, especially iron ore and copper for its overbuilt cities, and the whole world for hoarding precious metals, i.e., gold and silver, may have accounted for the short-term differences in price movements but over the long-term convergence can be discerned.


Let's zoom our focus on oil, using the chart below from chartsbin.com. We have both real (constant) 2013 prices and nominal (current) prices of oil from 1861 to 2013. Notice over more than 100 years of oil being in use, its nominal prices had never exceeded US$10 per barrel. Only after the 1973 oil embargo did prices breached US$10 and only recently US$100. We are still in Wave 4 of the Kondratieff Wave that began in 1960 and will end by 2020. The second half of that period (1990-2020) should've been characterised by falling prices as winners begin grabbing wealth, preventing it from circulating through the economy. But that didn't happen although early signs did emerge with the puncturing of the Japanese property and asset bubbles. Abenomics is just the latest yet already failing attempt, after a slew of past equally failed measures, to break free from deflation.


If we exclude Japan, why have other countries not succumbed to deflation back then? If there were only two categories of economic players, that is, winners (1%) and losers (99%), the deflationary impact would've been felt much earlier. As explained earlier, the government, has been absorbing the blows inflicted by the winners, effectively delaying the onset of deflation. The wealth continues to circulate with the winners lending to the government who will in turn distribute to the losers. The chart below extracted from the McKinsey Global Institute report titled 'Debt and (not much) deleveraging' reveals how the public or government sector has been buttressing the global economy by taking on more debt after the 2008 Great Recession.


This arrangement works on the dubious assumption that the government will exist indefinitely. In the long span of history, much bigger empires came and went. Most of the developing nations now were created during Wave 3 (1900-1960) and the early part of Wave 4. But before Wave 4 even ends, many are starting to collapse with every passing month. Next in line beginning in Wave 5 (2020-2080) will be the developed nations as new technologies that favour pluralism start kicking in.

To see the impact of the above government debt or spending, we have the following deflation chart from The Economist that covers the same period as the second commodity chart and the debt chart above. Notice how deflation was discernable as far back as the beginning of the new millennium but the increased private debt that peaked in 2008 had rescued these high-income countries from the grip of deflation. The Great Recession wiped so much debt that deflation came back with a vengeance in 2009. The ballooning government debt managed to subdue the deflation but only for a couple of years. Now both the public and private sectors have overindulged on debt that they have been rendered powerless in the face of the deflation comeback. Also notice that the commodity prices in the second commodity chart were greatly influenced by the debt level.


Another bunch of high profile delusionary economists are the central bankers. They have been given undeserved credit for their supposed role in rescuing the global economy from depression. What they have done is only a sleight of hand trick which they themselves still are unaware. Now everybody is scared that they might raise interest rates which might scupper the so-called nascent recovery. The reality is the secular trend of the global economy won't be much affected even with the absence of the central bankers. The disappearance of credit won't be swayed by the tweaking of interest rates. Instead interest rates fall because money demand reduces as borrowers cannot afford to take on debt. They rise when investment opportunities abound during an economic expansion in the early half of a Kondratieff Wave.

Some economists have even joined the political fray, the most prominent being Yanis Varoufakis, the Greece finance minister whose specialty is in game theory. Well, his game theory is leading Greece into the abyss. The latest is he's planning to use Bitcoin, a currency that's as bad a choice as the Euro. He would understand money better if he had mastered the theory of the Monopoly board game. In the first place, when nation-states are fracturing, why does Greece want to remain in a confederation of nation-states which has passed its sell-by date? A state which has no control over its money has no control over its politics. Greece might as well offer to become Germany's 17th state. With one stroke, that would solve its war reparation claims and its cash crunch problem. What Hitler couldn't deliver, the Greece politicians are willingly proffering to the Germans. The Greeks must revive the drachma and exit the Euro which together with the EU are already in self-destruct mode.

When our metaphorical dam bursts, you will observe the economists will be the ones swimming naked. It takes an economic depression to make them realise that all along they've been wearing no clothes.

Wednesday, October 29, 2014

Stall, stall, stall

In times of falling incomes, the last thing you'd expect is for the stock markets to keep breaking new records and home prices continuing their upward surge. Even the unemployment rate has continued to improve albeit at a snail's pace lately. Surely a bit of positive news can give a glimmer of hope in a climate of widespread gloominess. Some hope.

Are we in a 2-speed economy, one in which the 1% are reaping the rewards at the expense of the 99% who are seeing their wealth stagnating, if not falling? No, the economy still operates on one speed, which, right now, is snail speed moving on to stall speed. If you use the analogy of the car, the economy will soon stop moving but it's an incorrect analogy because, no matter what, the economy cannot stand still, it must move.

The more appropriate analogy is obviously the plane and we all know, in the hands of an inexperienced pilot, like that of Air France Flight 447 which plunged into the Atlantic Ocean in June 2009, a simple mistake — his was simply trying to keep the plane's nose up in the middle of a stall — could crash a plane. The economy is now losing speed, yet the policymakers look on blithely as wealth continues to move in the direction of the 1%. The only way to gain speed is to quickly reverse the direction of wealth movement just as a plane pilot should point the plane's nose down to avert a stall. But the demise of communism has convinced all economists of the superiority of free market economics that they let the market run its course even when a crash is imminent.

Why should we compare the economy to a tragic plane crash? No, it's not meant to be disrespectful to the victims but to show that those tasked with the management of many countries' national economies are equally confused in the face of a major crisis which has yet to pass. However there is a crucial difference. The pilots of the plane could have averted the crash but the political leaders and policymakers have no means of steering the economies to their own liking. They are there to give a semblance of control wherein fact they have no control. They can tweak the movements slightly but the national economies and, by extension, the global economy have their own set course, that is, going downhill. By the way things are progressing, it looks like a crash rather than a smooth descent.

However, if our political leaders and economic policymakers can understand issues, forget about coming up with solutions which are anyway beyond their ken, they can at least refrain from making decisions that lead to more aggravations. For example, had they known that the inclination of nation-states was towards fracturing, they wouldn't have instigated the downfall of autocratic Arab regimes. Instead, they wasted money to topple those regimes and, now, realising their colossal blunder, they are throwing more money to prevent the rise of the jihadis.

It's obvious that Western leaders lack imagination in both economics and politics. Once the forces of fracturing have been unleashed, you cannot set it back. The only way forward is to legitimise the borders of the new partitioned states in a manner that is consistent with ethnic homogeneity. The price for maintaining ethnic diversity entails much economic wealth, a commodity that is fast disappearing as the economic depression takes hold.

Much has been said or written about the growing US economy in the midst of a retrenching global economy. How things have changed. At one time, China was thought to be the growth engine. Now it's switched position with the US. There's no better depiction of the state of the major economies than the HSBC/Markit Manufacturing Purchasing Managers' Index (at left, from The Economist). It may be argued that manufacturing is a minor component of a modern economy but still it provides an advance indication of economic conditions since months before the products are consumed, orders for raw materials would have to be placed. The purchasing managers therefore would've had advance knowledge from their sales teams about future consumer demand.

A reading of more than 50 on the PMI indicates that the industry is expanding. Since we're using the plane analogy, we can imagine that the PMI movements as the changing altitudes of the various planes. Since the beginning of this year, the Euro economy has been going all the way downhill. The major Asian economies of Japan, China and India appear to have attempted a climb lately but they're destined to fail. They all have new leaders, the longest at the helm having been in office for less than 2 years but a change of guards is not going to make much difference to the economy which is autopilot driven anyway.

The UK economy which has been praised for not being in the Eurozone is starting to lose speed. This has been reflected in its house prices which have started to fall in most places, even in London, one of the most price bullish places for houses. Now we know what has been fuelling the UK economy: easy credit for house purchases. The difference between the UK and the Eurozone is that in the latter you can't easily boost credit growth. The ultimate outcome matters little because the UK now has a deeper hole to get out of. Which explains why the UKIP is gaining strength. And had the Scottish referendum be deferred to next year, Scotland might have got its independence.

It's also been claimed that the growing US economy is corroborated by the falling US unemployment rate. The Fed is foolishly buying into this story. To counter this, we have an interesting chart at left from The Economist which shows a decadal line-of-best-fits scattergraph of the US unemployment and its labour force participation rate. In past recoveries, falling unemployment was accompanied by rising LFPR. Now as unemployment rate falls, the LFPR falls along in lockstep. If we imagine this as a plane with its nose at the higher end of the incline, we can see the US labour market is attempting the impossible. Instead of pointing its nose down, the plane is trying to fly upside down. The US economy or even its labour market is huge, like a lumbering commercial airliner. It is not designed to fly upside down because there's no lift to keep the plane afloat. You should know what comes next.

The seeming growth in the US economy in times of falling growth elsewhere can only be explained if we look closely at its credit growth. Under current conditions when wealth circulation is about to seize up, you can have growth only if you juice up credit growth. This does not tackle the crucial problem of failing wealth circulation, it just lets the problem fester much longer at the risk of more serious consequences later. If we look at the US 2nd quarter 2014 GDP, we can see it perked up, only slightly. We should not use the widely reported 4.6% quarter on quarter growth compounded 4 times, because the true measure is the 2.6% year on year growth. You can see that credit did move up and so did GDP but overall the movement was insipid. Next we need to know which credit component caused the slight uptick in credit.











The chart on the left panel above shows the absolute growth in dollars while the right panel the year-on-year growth. Only two components really drove credit growth: government and non-financial businesses. The rate for government credit growth however has been slowing down since the beginning of the recession. It's only business credit that has been growing on both absolute and relative measures. We now need to follow the trail where this credit growth is being channelled into.

The chart at left from The Financial Times reveals that the corporations have been buying their own shares using borrowed money as evidenced by the falling earnings retention ratio. This explains the recent record notching feats of the equity indices. The share buybacks have slowed down lately which accounts for the sluggish indices.

The corporations only began investing in the 2nd quarter of 2014 providing support to the seemingly strong GDP showing (see left chart). But this happened at a time the consumers were retrenching their investment in properties. The government also has been cutting down real spending since 2010 but it still has to borrow as its revenue has never been enough to cover its spending. As long as wealth accumulation flows unidirectionally, the business corporations are more likely to be disappointed with the returns on their investment and we can expect further retrenchment of business investment.

Absent business investment, what drivers are there left to boost GDP growth? Certainly not personal consumption expenditure because without  household credit growth, PCE cannot autonomously grow. It has to rely on goverment or business credit growth which then funnels the money to consumers for their final consumption. If you look at the household debt chart at left, the most glaring information that you'll glean is that mortgage debt has always been the main driver of household debt growth. How do you reconcile the falling mortgage debt with the increased residential investment which grew from 2012 to 2013? The only conclusion that you can infer is that while consumers took on more mortgage debts, a bigger amount of old debts were being written off or repaid; between the two, the impact on money supply is still the same: negative credit growth.

Wait, there's an uptick towards the end of the chart above. Again, it's a blip. Now in the 2nd quarter of 2014, the growth rate of residential investment fell off the cliff and the Case-Shiller monthly rate of home price increases though positive have been declining four months in a row (May-Aug 2014). If we project the trend further, September 2014 will see a negative growth. Where will the needed credit growth come from?

In the plane cockpit, whenever the plane enters a stall, a human voice synthesiser will call out, "Stall, stall, stall", and the pilot must take corrective action. An economy doesn't have that luxury but we can read the crucial gauges that warn us of a stall. The US economy is alone that's still aloft but it's already in stall mode. Its political leaders think Islamic State is the real threat. Yes it is a threat to all nation-states but it is because all nation-states have been weakened by the coming Grand Depression. No, the real threat is internal; as the economy stalls, the glue that holds nation-states together will start unravelling.

Tuesday, July 22, 2014

Be wary of high GDP growth and the central bank

Once again the looming depression is beginning to rear its ugly head while the world is buoyed by positive news of various economic indicators, such as the global manufacturing PMI, the stock indices and the unemployment rate. Such positive news are at odds with the economic conditions experienced by the common man. Even the Bank for International Settlements in its latest annual report is puzzled by the disconnect between financial markets' buoyancy and the global underlying economic developments.

Some emerging market (EM) countries are still reporting strong GDP growth, exceeding 5% on an annual basis. Economists would approve of such commendable economic performance in the belief that the EM would shore up the global economy. Under normal conditions, that would be the logical thing but during the closing phase of the Kondratieff Wave, the EM is courting disaster. This does not mean that countries should aim for low GDP growth either. It's just that unless countries address the extreme wealth disparity, whatever choice made is irrelevant. The outcome is between later more awful misery and immediate slow death, a choice opted by France.

In the Monopoly board game, when the game is winding down, most of the players have dropped out. You can continue playing provided the winner doesn't bankrupt the losers but accept IOUs from them instead. Before that happens, the bank, which in the real world is represented by the government, would have issued IOUs to the players as the Monopoly money is never enough to last till the end. That's why in the real world, credit, not gold, bitcoin or hard cash, is the real money.

A country's GDP can also be compared to the revenue of a business. When economic conditions have taken a turn for the worse, sales will inevitably stagnate, if not fall. You can only increase sales if you make credit sales to customers with poor credit history. Of course, you'll never see your money but by then you'd have flogged the business to suckers to deal with the receivables mess.

The political leaders of countries that are taking a similar course are tempting fate, only that in this case they themselves will end up being suckers. Towards the end of a Kondratieff Wave, government is the only economic sector that can spend using borrowed money. Government borrowings never decrease in absolute terms; they do so only in relative terms, that is, as a percentage of GDP. So the GDP growth must outpace government debt growth but at the end of the Kondratieff Wave, this possibility is closed given the dwindling economic activity. This means that the government must double down its spending just to keep the economy on an even keel. Like in the Monopoly game, the bank, even if it pays $1,000 to the losers upon passing Go, may find it not enough to keep the game going because every time the losers traverse round the board, the punishing rents will suck more than what they earn from the bank .

A snapshot of a country's finances and its revenue can be seen from the movements in its debt and GDP. The chart at left shows that after the 2009 recession, the US economic growth outpaced the debt growth but that ended in late 2012. Since then, it's been the reverse and the further ahead we project into the future, the greater will be the divergence unless Obama plans to set himself up for impeachment. You'd also notice in the chart that the GDP growth for the 1st quarter 2014 is a positive 1.5% using the more meaningful YoY computation instead of the widely reported negative 2.9% annualised QoQ number.

Delving into the GDP components would give us a better picture of the GDP sluggishness. For this, you don't have to rely on the personal consumption expenditures (PCE) despite its 69% contribution to the GDP numbers. It's not only because of the lopsided weight attached to it but also the PCE, which has been growing consistently around 2% YoY since mid 2011, doesn't carry much predictive ability.

Instead, the more critical components of the GDP are investment and government spending. The investment spending reflects business and household confidence in the future prospects of the economy. If business prospects are sanguine, businesses will invest in plants and machinery. Likewise, households will invest their money in homes if they expect their incomes to rise. Still, government spending as explained earlier is the most consequential. Unlike other components, government has the power to create money — by this, I mean deficit spending, not money printing which has confused most economists — but excessive deficit spending has weakened government so much that the edifice of nation-state is beginning to crumble.

Now, the Q1 2014 US economic reality is shown on the GDP chart at left. Residential investment growth YoY has plunged to 2.7% while business investment growth has been sluggish since early 2013 snaking between 2.4% and 3.5%. The slowing investment is in accord with the Monopoly game pattern at the ending when with the losers all gone, it's pointless to put up new buildings. Meanwhile, government spending has been crimped since mid-2010.

Next, look at the credit charts below. The left panel shows the movement in absolute amount while the right panel is the relative YoY growth. You'll notice only two debt components that are still growing, to wit, government and non-financial businesses. Though the growth rate for government debt is on the decline, it's still higher than the GDP growth rate.



How do you reconcile government spending in the GDP which is decreasing and the government debt which is still growing? It simply means that even though government has been cutting spending, its revenue is still insufficient to cover the reduced spending. The more pertinent question is what is really driving GDP growth: the household PCE spending or the government debt that fuelled that spending. The GDP chart wouldn't give the credit to the government but the debt chart would.

When the game is drawing to a close, spending falls as most players fall by the wayside. The issue is not failing to generate economic output but a failure to consume goods or services produced by the winner because of the losers' falling incomes. The only income that the losers can earn is the $200 salary paid by the bank upon passing Go. Similarly, in real life, the government is the final mainstay of income support to the losers. The fall in residential investment growth is related to the slowing growth in government deficits. The only way for the losers to maintain their PCE is by slashing their home investments. So it's not the losing households' PCE but the government deficits that ultimately drive GDP growth. The deficits fund the households who in turn prop the PCE.

With this, we can also clear the confusion surrounding the central banks' quantitative easing (QE). The Monopoly game has only one banker but our modern day bureaucracy has grown unwieldy in that the same role is taken up by two agencies: the Treasury and the Fed, both equally ignorant of money creation. Only the Treasury can create money through deficit spending. The Fed's role should've been restricted to regulating the financial institutions to ensure that they don't lend more than they can absorb in losses.

When the Fed is tasked to conduct the nation's monetary policy, a task which it is incapable of fulfilling, it rises to the level of its utmost incompetence. Picture its role in the Monopoly game. At the end stage of the game, there'll be a lot of IOUs owed by the bank (in the real world, bonds issued by the Treasury) to the winner. Enter the Fed. It swaps the Treasury IOUs (bonds) with its own IOUs (deposits placed with it). The winner still owns the same amount of IOUs. It makes no difference to the winner who the counter party to the IOUs is.

How has the Fed managed to convey the impression that its QE did stimulate the economy? The claim is nothing more than an illusion. Coinciding with the Fed's QE, the US government continued its deficit spending, that is, it kept throwing IOUs into the game, so to speak. So in the Monopoly game, it's like the bank continuing to pay the $200 to the players to enable continued play. The Fed's bluff should have been called with the slowing growth in government deficits but the non-financial businesses have thrown the spanner in the works when they started ramping up their borrowings. Where the money from their borrowings has gone to will be addressed in the next post.

A case frequently cited for supporting the Fed intervention is that it'll lead to a reduction in interest rates. This is a delusion that needs to be disabused of. The Fed has set the Fed Funds Rate to almost zero since December 2008. Now, look at the yield at left of 10-year T-bonds. If the Fed Funds Rate had a bearing on the interest rates of other financial instruments, then the T-bond yields wouldn't have fluctuated within the 1.5% to 4% band. Effectively the Fed has no say in the determination of interest rates.

It's the market that decides the prices of money, that is, the interest rates. The prices reflect the market expectations of inflation or deflation. Low prices signal low inflation or, possibly, deflation which arises when most consumers are suffering from stagnating incomes, the conditions that prevail at the closing phase of the Kondratieff Wave. Because the Kondratieff Wave is a global phenomenon, you'll find that falling interest rates are predominant throughout the world as depicted in the left chart.

Calls have been made by economic eggheads that the Fed should increase the interest rate so as to encourage investment. The received wisdom is that higher interest will encourage savings and as savings equal investment, higher investment will soon follow. This logic is flawed because it assumes savings will drive investment.

The decision to invest is made when there are opportunities to earn returns that more than compensate the cost of funds. At the end of the Kondratieff, even at zero cost, there are no returns to be had because the market has disappeared with the falling incomes. If investment is infeasible even with funds at zero cost, how can increasing the cost make it viable?

The interest rate decisions of Sweden's central bank since the 2009 recession reveals the futility of trying to control interest rates. Because of the fiscal deficits sustained by many governments following the 2009 recession, there was a temporary spurt in consumer prices. In order to stem the mild inflation, the central bank raised its policy rates but notice that the central bank actions always lagged the consumer price movements. As demand disappeared, consumer prices dipped. As for the central bank, it had to eat crow by retracting its earlier actions. Had it not manipulated the policy rates, the consumer prices would have ended in the same place it is now.

Finally, the last delusion that we need to counter is the argument that China's continuing growth is sustainable because of its current low urbanisation rate (see left chart from The Financial Times). A comparable developing country rate is 60% while that of the developed world is 80%. A 10% increase in China's urbanisation rate would translate into a migration of 130 million people to the cities. Therefore, large scale investment spending is still needed to cater for the mass migration of its rural population to urban areas.

In reality, China is already late to the Kondratieff Wave party. The world can no longer consume more than what China is currently exporting because all over the world the number of losers dropping out of the game are increasing. Following their dwindling incomes, the productive capacity now available far exceeds the consumption ability. What about China's own internal market which exceeds 1 billion people? That's all the more reason to worry because you now have more than 1 billion problems of falling incomes.

By giving in to globalisation and economic liberalisation, mankind has unleashed unseen forces that are too powerful for it to subdue. With those in power remaining oblivious to the dangers, the biggest risk to us is not knowing how the future will turn out.

Tuesday, June 17, 2014

Making communism work

With no solution in sight to the ever worsening economic crisis, the talking heads with a leftist bent have suggested Marxism or communism as the answer to the unfolding crisis fostered by the widening income inequality gap. But communism has been discredited in many former communist countries and anything that has failed deserves to be banished for good. If we go by Karl Marx's vision of a true communist society, actually there have been no communist states; most that once claimed to be communist states were really an extreme form of socialism.

To Marx, a communist state will evolve from a socialist state. Under socialism, the role of the state is central since the state owns the means of production and direct economic activities. As the socialist state transforms into Marx's utopia of classless communist society, the means of production will transfer from state to society. As the state disappears, power from above is replaced by universal cooperation. However as cooperation is predicated on mutual trust, it can only be possible if society is small, that is, not more than Dunbar's number of 150. I guess for a tribe this would count adults only, so a tribe membership could double this.

Dunbar's number is the maximum number of people that each of us can maintain stable social relationships with. That limit is imposed by the size of our brain neocortex. If the society members exceed 150, a new group will form and split off from the original group. That's why communism cannot work in a modern state with population numbering in the millions; it's only suited to small groups.

There's also a reason why so-called communist countries stopped evolving into real communism once they reached the stage of the extreme socialist state. In a socialist state, power is heavily concentrated with the state because economic wealth and means of production are owned by the state. Once the state governing class has tasted vast power, power becomes addictive and impossible to let go of. The state has reached utopia, for the ruling class, that is. Actually this conforms to Marx's own authoritarian disposition that brook no dissenting opinion.

So-called communist states have foundered but real communist societies still survive. It's insightful to understand the factors that contribute to the survival of communist societies. We can glean them by observing societies that truly practise communism. For this, you can find no better example than the !Kung San Bushmen, aka Khoisan, or zhun/twasi, who live in the Kalahari Desert. Of course, no such tribes would claim that they are communists simply because they predate communism.

Marx's thoughts seemed profound in the context of the industrial slums of 19th century Britain; had the intellectuals and philosophers of his day been aware of life of the hunter-gatherers or foragers in the Kalahari Desert, his ideas wouldn't have been thought provoking. All those mathematical formulas he wrote to prove that his thesis would've worked would've been meaningless. Quantitative analysis is ill-suited to modelling human social behaviours as such behaviours do not lend themselves to being quantified except if the time frame is short or the geographical space is localised.

The zhun/twasi who survive in an environment of scrub forests and open plains provide important lessons in making communism sustainable. To understand the basis for their survival, we will rely on our usual 4Cs of Capacity, Consumption, Communication and Currency/Credit but this time we have to ignore the 2Cs of Communication and Currency. Communication in terms of physical transport is not needed because a forager society lives off the land; in hunting for food, the men only walk or run which means they do not stray far from their camp. As for information communication, it is mainly oral typically manifested when they gather around a nightly campfire and relate stories of hunting experiences, spiritual beliefs, daily going-ons, legends and music and dance. The other ignorable C, Currency, has no relevance when there is no surplus to be exchanged.

Even the 2Cs that are relevant, i.e., Capacity and Consumption, have to be tempered because of the sparse environment in which the Bushmen live. In a wealth accumulating society, the object of capacity is to intensify production, not only to cater for own consumption but also to produce a surplus that can be exchanged with others. That is true for both agrarian and industrial societies. As they put much effort in intensifying production, they need to have ownership or usage rights to the factors, such as land, labour or other resources, that contribute to the increased production. In contrast, a forager society has no permanent claim to assets, not even land — they need to move around as the availability of food sources and watering holes depend on whether the season is dry or rainy.

It is precisely this reason that communism failed in both the former USSR and China. Marx believed society must be industrialised before communism could take root while Mao thought Chinese agrarian peasantry would be sufficient for the transformation to communism. Reality has proven that without ownership rights, neither the industrial working class nor the agrarian peasants have the incentives to produce. Even if they produce, the output is not what the consumers demand. The Bushmen do not face these problems: whatever they hunt or gather, they will always consume and not hoard for the future.

In the dying days of communism, Gorbachev and Deng Xiaoping each was faced with a government that was almost broke. The USSR split up yet Russia the supposed successor to the USSR remains dependent on natural resources as did the USSR despite the transformation from communism to capitalism. Its oil dependency has made the other sectors uncompetitive making it politically as shaky as the old USSR. Now that oil and gas prices could no longer move up given the coming excess supply, another turmoil is in the cards. Its revanchist policy is a cover to suppress its internal weakness — Putin's approval ratings dropped to a low point in 2013 — much as Hitler invaded Poland to cover for Germany's weakening economy and politics which were being threatened by the strain of ever increasing fiscal deficits.

The Chinese has taken to capitalism like a duck to water. However, capitalism provides only a temporary fix. Yes China has grown rich but it has now produced more than the world can consume and it does not know how to get out of this conundrum other than to keep on producing. We are witnessing a massive disappearance of this surplus wealth. Its predicament is however different from that of Russia.

In Russia, for now, the state is strong because the wealth is from oil and gas, which flows to the state. In China, the wealth is owned by many economic players, so power has dissipated beyond the grasp of the central government. Social harmony can only be maintained with non-stop economic growth, which under current conditions can only be had with runaway credit growth. Like Russia, the Chinese government is whipping up nationalist furies to divert the anger that not only may bring down the ruling class but also fracture the state once economic turmoil sets in.

The Bushmen have no such worries of the ruled class overthrowing the ruling class because there's no formal leader of a camp. Decisions are reached by consensus. It's truly classless. There's only a core of older people for which greater respect is accorded. A camp consists of between 20 and 30 people who are related by blood or marriage. If tempers get frayed, some of the members may leave to join other camps. Moving between camps is not a problem because they love visiting other camps which fosters relationship ties. Revolt therefore is pre-empted.

A classless society doesn't come naturally. Humans are natural wealth accumulators, and it takes tremendous effort to wean them off this unyielding piece of their nature. The Bushmen have to constantly cultivate the sense of egalitarianism into the camp members. They deliberately belittle one another's hunting achievements so as to prevent such feats from going to their heads. Expressing gratitude for gifts is avoided because to do so would create a feeling of indebtedness to the bestower of gifts. Mocking others is systematic in the Bushmen society that even Andrew Zimmern of Bizarre Foods fame was on the receiving end of a parody as can be observed in the video clip below. You can also see their egalitarian way as displayed in the sharing of the meat of a 5-ounce bird among 12 people, each one getting a morsel of bird meat.


To fulfil their economic capacity, the Bushmen employ two methods of food production: hunting and gathering. For long term sustainability, their rate of food production cannot exceed the natural rate of animal and plant reproduction. The surprising thing is they do not work harder than the average person. Their average workweek is about 42 hours per person and that includes toolmaking and housework. The rest of the time is spent on leisure, in relaxing, playing with children, telling stories, and participating in ceremonial activities. Their diet, rich in protein and without any starchy staples, surpasses internationally recommended levels of nutrients.

The Bushmen have exceptional tracking skills. Based on the spoor of animals, they can identify the number of animals, their travel direction, how long ago the animals passed by, how tired they are, whether there is a wounded animal among the herd which they will use to follow. They also can reconstruct the events that actually transpired based on the track marks. In tracking game animals, they rely on the cactus-like plant, Hoodia Gordonii, to suppress their appetites and thirst for up to 24 hours. Big game animals are not a usual treat, the more usual fare is the giant porcupine and the springhare. In the four days that Andrew Zimmern spent with the Bushmen, they managed to catch only one 60 kg porcupine.

While the men from the camp hunt, the women's task is to gather wild food plants. In fact, more than half of their diet comes from gathering. The protein-rich mongongo nut is a common food resource.

To be able to enjoy the luxury of working at a moderate pace, their population density is kept relatively low. The Bushmen rely on physiological means to control their population growth rate. By extending the number of years in which the mother nurses her infant, she delays the onset of her menstruation cycle. A woman needs around 20-25 percent of her body weight consisting of fat before she starts menstruating. The high protein and low carbohydrate diet also contributes to the delay in getting pregnant which can be more than four years after each birth.

For an egalitarian society, like the Bushmen, despite appearing to live in harmony with nature, it is vulnerable when coming into conflict with any wealth accumulating society. Even though the Kalahari scrubland is ill-suited for intensive agriculture, it still can support cattle herding, an activity carried out by the Bushmen neighbours, the Herero, a member of the Bantu people. The Bushmen used to be hunted down by the Herero and the Dutch Boer. Likewise, communism, if put head-to-head with capitalism will falter much earlier because it is weak in intensifying wealth generation. Capitalism's failure comes much later when its wealth distribution comes unstuck.

A comedy film, The Gods Must Be Crazy, is an excellent parody of how an eligatarian society is almost threatened upon being exposed to capitalism. It tells the story of Xi, a Bushman, who chances upon a Coca-Cola bottle thrown out of an aeroplane. The Bushmen have many uses for it but since there is only bottle, it is a cause of friction and much unhappiness among the camp members. It has introduced a sense of ownership in a society where there are no ownership rights. Despite the bottle providing some economic benefits, Xi takes the trouble to return the bottle to the Gods in order to bring back harmony to the camp. The same goes for capitalism. If the massive wealth has become a cause of many troubles now plaguing the world, shouldn't the world destroy the wealth to restore harmony?

Wednesday, May 7, 2014

An economy for times of no growth

How do you run an economy in times of low growth? Do you keep on creating debts to artificially sustain the economy? The answer unfortunately can't be found by delving into the workings of modern economies. No, we don't have to go back far in time but just to industrial times though not in an industrial society. The time is 19th century and the society is the Kwakiutl tribes. To be sure, the Kwakiutl political and economic system is not perfect because we still have to contend with the human frailties of greed and self interest.

Politics and economics are intertwined. If only the anthropologists realised that economics is actually a study of human behaviours, they would have appropriated the university economics department as a sub-department within anthropology. Only then will economics be stripped of its pointless quantitative analysis that has blinkered economists for generations. Economics would also benefit from an interdisciplinary approach, avoiding the dangerous parochial mentality that ignores economics' inextricable links with other social science disciplines.

The narrative about the Kwakiutl that I'll recount in this post is nothing new. My sources are comprised of Daniel Gross's book, Discovering Anthropology, Eric Wolf's Envisioning Power: Ideologies of Dominance and Crisis and also several books by the late anthropologist, Marvin Harris. Some of the information can also be scoured from the web but knowing much is not important. The key is as Albert Einstein once said, "Any fool can know. The point is to understand." Admittedly, in the current crisis we've come across many charlatan economists proferring their quack remedies. To avoid becoming a fool, we will rely on our 4C framework to piece together the underpinnings of the Kwakiutl's social cohesion and economic well-being in the 19th century.

My previous post described how the Kwakiutl tribes — there were about 30 tribes, each in turn made up of clans or septs, all with their own chiefs — had managed to sustain their societal bond through their exhibitive wealth destruction as characterised by the potlatch ceremony. However there's more to it than just wealth destruction. More so with the crumbling of nation-states, when only those who organise themselves into tribes will stand a good chance of surviving the carnage that comes with the absence of a strong central authority — it's unravelling right now with the US retreating from global leadership just as one country after another descends into a fracturing mess.

Capitalism hastens this march towards disintegration as it falls over like a slowing bike when the economy is stuck in low gear. This low or zero growth prevails during the ending phase of a Kondratieff wave except that the current wave is significantly worse off than past waves. From the first to the third Kondratieff Waves, the ending phases were in the midst of increasing population growth rates. Although prices were dropping, the drops were compensated by increased consumption. But in the current fourth Kondratieff Wave, price drops take place in situations of slowing population growth rates, and in some countries, declining population numbers. The world in modern times has never encountered this phenomenon but the Kwakiutl did — because of western epidemics, their population plunged from 23,000 in 1836 to 2,000 in 1886, this being a major setback which they weren't able to recover from. Economists who have observed the beneficial price deflation of past Kondratieff waves fail to appreciate that, given this population reversal, the past experiences of the western economies are a misleading guide to the future.

The Kwakiutl narrative is about economy, money and wealth — its accumulation, circulation and destruction. What stood the Kwakiutl apart is that they managed to accumulate wealth without creating the extreme inequality that afflicts modern capitalism. Of course, like those of most traditional societies, their economic system was not capitalism; theirs was more of a gift or reciprocity economics.

The environment in which they lived played a major role in how they organised their lives. That environment, the Pacific Northwest coast (see Wikipedia map below) of Northern America, was a rich source of food, chiefly attributable to the genial climate and the conducive physical geography. How they adapted to that environment is the crucial point.



From the map, you will notice that the coastline is rugged and studded with islands and intersected by many river and stream inlets. The communication leg of the 4C is evinced by the numerous waterways linking the land. Physically, the natural nook and crannies of the landscape are ideal grounds for the proliferation of many species of fish and shellfish while the dense forests provide timber and various game animals; this being the capacity leg of our 4C. Now, if we flatten the land and straighten the coastline, that would correspond to globalisation in the economic sense. It would destroy all those niches in the name of economic efficiency. The outcome is immediate bounty enjoyed only by the top predators followed by long-term paucity as species diminish with fatal consequences to the predators themselves.

The Pacific Ocean to the east is warmed by the Alaska current, which flows northward. This warming moderates the cold climate and generates heavy year-round rainfall which contributes to the thick forests. The Kwakiutl's canoes and houses were built from the red cedar timber while their clothing from its bark. They also gathered various types of berries and roots from the forests and kelp and seaweeds along the shore. Their primary occupancy was however fishing. From the sea, they caught seals, seal lions, codfish and halibut while from the rivers, salmon. The salmon runs were so heavy that a person could catch enough fish to last one year just by fishing for a few days. As food was seasonal, the Kwakiutl would fillet and dry or smoke the fish for later consumption.

Every Kwakiutl clan had its own fishing spots, hunting grounds and berry-picking grounds. These sites were under the custodianship of the clan's chief. That was how order was maintained among tribe members. When the economy can't expand, you have to stop competing and start cooperating. Moreover, although the land was bountiful, the Kwakiutl could at times be exposed to starvation as food resources were not constant from year to year. The potlatch was the means to redistribute the sometimes unequal harvests. The potlatch didn't interfere with their economic activities as it was held in winter. In fact it spurred them to work harder to accumulate in spring and summer what had been destroyed in winter.

We can observe in modern times that the surplus production of resources would lead to wealth accumulation but, as we all know, whenever wealth is allowed to accumulate, wealth distribution will inevitably be unbalanced. The lopsided wealth accumulation usually favours those who are born of the right lineage. Meritocracy has conveniently been used by the haves to reinforce their status difference, feigning ignorance to the fact that not only status privileges confer head-start benefits upon birth, such benefits also swell with the progress of time, eventually reaching extreme proportions.

Even in Ancient Rome during its golden age under Emperor Augustus, members of the upper classes which controlled most of the agricultural land made up only 1 percent of the population. This is no different from the current politics in the US where leaders from both sides of the political divide are beholden to the 1 percent. The 1 percent is always successful throughout the ages because, to quote Joseph Brodsky's observation, "life is a game with many rules but no referee." Those who win don't consult the rules to see what's right or wrong. Instead they watch others play to see what works. Often they inherit substantial wealth which they use not only to leverage their competitive positions but also to write or bend the rules.

That explains why countries which have sought to transfer wealth through redistribution in order to achieve social harmony, have achieved disappointing results. The gap between the haves and the have-nots continue to widen as wealth eventually ends up with the haves. Often, ethnicity is the dividing line. It's not at all surprising that WEB Du Bois, the late African-American sociologist once lamented, "To be a poor man is hard, but to be a poor race in a land of dollars is the very bottom of hardships." It's not easy to escape the clutches of a weak culture when stacked against it is a more competitive culture that keeps on outpacing it. The competition is not between individuals but between cultures, with the stronger culture buttressed by its closely knit network.

To the politicians, this is their biggest dilemma: To redistribute wealth creates social rifts but not to do so threatens a social collapse. It becomes more problematic with the onset of globalisation as wealth redistribution would make a country's economy inefficient relative to that of another with no such programme. But in the early phase of globalisation, everybody benefits as even those who lose out can resort to credit to buy cheap goods. It's in its later phase that the dark reality sinks in. Now the horrendous cost of globalisation is mounting as one country after another plunges into social turmoil with seemingly no end. Economics, not the voters, is the real lever behind politics as politicians take turns at being elected and booted out. Both politicians and voters are confounded by this turn of events. Blaming globalisation is out of the question as this goes against received wisdom.

The tenacious reluctance of wealth to redistribute itself has been given further credence by a recent op-ed piece 'Your Ancestors, Your Fate' in The New York Times which estimates that 50 to 60 percent of variation in overall status is determined by your ancestors. Worse, it takes 300 to 450 years for the fortunes to significantly change. This gives the lie to the popular maxim that "all men are created equal." A recent book titled Capital in the Twenty-First Century by Thomas Piketty, a French economist, also claims that wealth inequality rises exponentially. Actually, you don't have to carry out deep research to make such a claim; a round of the Monopoly game would leave you convinced. Recognising pattern is a quick way to understanding events and issues.

If social mobility moves at a glacial pace, we might as well embrace the Kwakiutl's customs of institutionalising status difference through ranking. At least life is more stable and predictable as this obviates the need to individually outdo others. In pack animals that have a number of both males and females, such as wolves, only the leaders, the alpha male and female, have elevated levels of cortisol, a stress hormone, a consequence of always needing to be on guard against a leadership challenge by the pretenders, the beta male or female. A lower ranking member has no reason to go for the leadership of the tribe as he/she will not be accepted as a legitimate leader by the tribe members.

While we may think that our own life experiences belie this, bear in mind that most of us have benefited from the industrialisation advances of the 1st to the 3rd Kondratieff Waves and these are being undone by the intellectualisation advances of the 4th to 5th Kondratieff Waves which are dumbing down jobs. The wealth from industrialisation has led to the demise of the extended family and the proliferation of nuclear family that is detached from near relatives. The same wealth has allowed the state to provide the bond that glues together a modern society.

However, this situation is unravelling as the middle class is being hollowed out by advances in computing and artificial intelligence that have eliminated jobs even in fields previously considered unthinkable, such as research analysis and writing. Jobs exist only in the lowly paid service sector. Now even those who find it below their dignity to depend on the state would readily accept state handouts. The state will weaken and eventually die out with the disappearance of the middle class.

The European Dark Ages (AD 300 to AD 700) that followed the fall of the western Roman Empire coincided with the Little Ice Age in which agricultural yields fell, wiping out the surplus that had been used to support urban life. Likewise with the coming end of the Kondratieff Waves, the security of law and order provided by the state will vanish. Banding together into tribes is the only means of coping with future troubles. Troubles will not only come from other tribes but more dangerously from individuals who will be increasingly empowered as a destructive force by advances in computing, nanotechnology and biotechnology.

Tribes are structured differently in different societies but since we mostly come from wealth accumulating societies, the Kwakiutl structure may be insightful. A Kwakiutl society had four rankings: chief, noble, commoner and slave. Slaves were mainly war captives, captured through night raids on rival tribes or villages, but they could also be traded. Although slavery seems morally repulsive, we must remember that slavery was prevalent in ancient societies. The main reason we can live without slaves is because technological advances have replaced the biological muscles of slaves. Soon technology will enslave us as we will be in thrall to those who possess vastly superior technology.

Owning slaves was not only a means of flaunting a family's wealth but slaves also reinforced the Kwakiutl's wealth differences as slaves enabled the Kwakiutl chiefs to possess more productive capacity in a society with no draught animals and labour saving technology. Both flaunting wealth and increasing wealth disparity are, in fact, common features shared by all societies in which wealth accumulation is the norm.

Wealth accumulation entails money or, more specifically, credit. Within a tribe, there was no need for money in the absence of market exchange among themselves since the members were all producing the same goods. It is said that barter was used when trading with other tribes or with European settlers. However, it is more likely that the Kwakiutl and other North American tribes used physical objects as money to conduct trade with outsiders.

The money used was initially dentalia, that is sea shells of a mollusk species that were harvested on the coast of Vancouver Island. Later, the Hudson's Bay wool blankets replaced dentalia as currency. Dentalia and wool blankets could serve as money because they fulfilled two key requirements: credibility and liquidity. Credibility because both had intrinsic value: dentalia as jewellery and ornaments, and wool blankets as robes for the loinclothed or breechclothed Indians. Wool blankets could hold heat even when wet. Liquidity means that the supply of both currencies could increase but not too fast so as to easily lose their value.

Sometimes, credibility comes from general acceptance by members of the tribe on the historical value of the chosen money even though it has no inherent value. The Yap islanders in Micronesia at one time used doughnut-shaped stone discs as money. Because the discs are heavy, ownership might change without any physical movement of the discs. This is possible only in small traditional societies because of the high trust, fostered by blood relationships, among members.

Confused observers have treated the exchanges carried out using physical objects as barter. So they have assumed that before the advent of money, man resorted to barter. They couldn't have been further from the truth. A look at the trade involving dentalia would reveal that barter cannot substitute for money. In trading with the Kwakiutl, the white settlers would keep dentalia that they had received in exchange for guns and copper plates. The dentalia would then be used to buy otter pelts or other tradeable goods from other tribes. The exchange was not between pelts and guns but between dentalia and other goods.

And most important, when trade was between tribes, current account deficits or surpluses, the bane of a country' economy, did not arise; all trades were settled in full. You don't extend credit to other tribes when you can't enforce repayment. When the global economy is growing, it's normal for some economies to suffer deficits and others to accrue surpluses but when growth is flat, all countries must square accounts among themselves. Otherwise extreme deficits will crush a country's economy and with it, its political stability.

Our modern paper or fiat money, like the Yap stone money, also has no intrinsic value but depends on the strength of the state for credibility. It is said that value can be imputed to fiat money by the state imposing tax, payable in fiat money, on its citizens. However there are states with zero taxation yet having its own fiat money. Usually the state relies on exports of high value natural resources for income. So the credibility of fiat money doesn't come from taxation but from the economic and political strength of the state. The moment the state fractures, the value of its fiat money disappears along with it. That's why in the future, we can expect fiat money to vanish.

The more important money however is credit because without credit, you can't accumulate wealth on a big scale though you still need physical object or paper money in which to reckon credit. Credit also needs written accounting records and a strong written rule of law. However for tribes, an oral record made known to all tribe members is the custom. The potlatch serves this purpose because most members of the competing tribes would witness the debt. The purpose of the record, written or oral, is to ensure that the debtors honour their debts or risk dishonour.

Credit is the easiest money to create but it's preconditioned on the existence of trust. Although trust within a tribe is huge, internal market exchanges that give rise to credit are rare. So how did credit emerge in Kwakiutl tribes? Their potlatch ceremonies created a need for debts because the organisers had to amass goods to be given away. They did this by forcing loans on the tribe members to induce them to contribute. Also, the potlatch gifts that were made to a chief were expected to be repaid with an interest payment. But repayment is not an obligation; if you couldn't repay, there was no debt slavery, you just suffered shame. Some potlatch goods were not even given away but destroyed just to show that repayment was not desired. This need to cancel debts and let debtors off would have been of great benefit to modern society in times of low growth as it would check the rapidly rising inequality.

Before 1849, the potlatch ceremonies were small scale and the gifts were of low value. The change post-1849 came about after some of the tribes merged into a bigger coalition. Warfare and slave raiding diminished and to make up for that, the potlatch ceremonies took on a grander scale. Slaves as a source of wealth no longer mattered as the Kwakiutl had access to the money economy of the Europeans. Because ranking remained highly esteemed in tribes, the potlatch now took on the role previously elicited by warfare, that is, a means of projecting a tribe's status over other tribes. If a chief could outdo others in giving away more wealth, then his status and that of his tribe would rise.

As the potlatch grew in scale, the social hierarchy of the Kwakiutl was being insidiously threatened by the money economy. Each Kwakiutl tribe used to have its own subsistence area and seasonal sites under the control of the hereditary chief. By controlling the means of economic production, the tribe chief gained submission over his followers. But with more economic opportunities available outside from employment in the money economy, the chief's economic hold over his followers began to weaken. Once exposed to the money economy, the fortunes of the Kwakiutl tribes would rise and fall along with that of the general economic cycle.

Although the Canadian government outlawed potlatch in 1884, the decline in potlatch ceremonies could have been precipitated by the great decline in the Kwakiutl population. By then the potlatch was not only a means for giving away goods but also a contest for destroying great amounts of property. Destroying money, burning blankets and canoes, breaking and throwing copper shields into the sea, and burning fish oil in which the fire would reach to the roof were carried out not only to demonstrate great wealth but also as a sign of a society demoralised by the dwindling population. It could also reflect that the goods were surplus to the needs of the reduced population and thus had to be destroyed.

The eventual cause of the cessation of the potlatch was the the Great Depression of the 1930s. As more Kwakiutls got caught in the money economy, their fortunes flowed and ebbed with that of the economy. As the Great Depression struck, many couldn't afford to pay off their debts and accumulate enough wealth to redistribute. Nowadays, the potlatch is still held but more for their symbol of a native identity and tradition.