Bitcoin: The opportunity costs of mining for money

Everything we do and every choice we make has an opportunity cost. In a world of scarce time and resources each choice necessarily means rejecting many other possible opportunities. One of the best illustrations of this concept was made by President Eisenhower in a 1953 speech. Eisenhower criticized the use of scarce resources for military purposes because of the opportunity cost:

The cost of one modern heavy bomber is this: A modern brick school in more than 30 cities. It is two electric power plants, each serving a town of 60,000 population. It is two fine, fully equipped hospitals. It is some fifty miles of concrete pavement. We pay for a single fighter with a half-million bushels of wheat. We pay for a single destroyer with new homes that could have housed more than 8,000 people. [The Chance For Peace]

These kinds of choices are just as difficult as they were for Eisenhower in 1953. How much time, resources, and effort should be dedicated to military activities? It’s still a contentious argument, and opinions greatly differ.



How saving endangers the economy — and what to do about it

An impressive video featuring former Treasury Secretary Larry Summers has been making the rounds.

Summers makes the case that the United States and other Western nations may have reached a state of permanent stagnation in growth and employment. In Japan, per capita incomes grew strongly until the 1990s, and since then they have been growing very weakly and intermittently. Summers cites Japan as an early example of what might occur elsewhere.

Japan’s stagnation is shocking — today, the Japanese economy is only half the size economists in the 1990s predicted it would be if it had continued on its pre-1990s growth trend. As Summers notes, in the U.S., growth is also well below its pre-crisis trend, and unemployment remains persistently high. More than 12 million people who want work and are actively looking cannot find it. That’s a very ugly situation.

Under normal conditions, central banks can lower interest rates on lending to banks as a way to encourage activity and fight unemployment. Lower rates make business projects easier to afford, and more business projects should mean more jobs. If an economic shock pushes the unemployment rate up, central banks can lower lending rates to ease conditions. And conversely, if economic conditions are overheating and inflation is pushing up above the Federal Reserve’s target of 2 percent, interest rates can be hiked to encourage saving and discourage spending.

Yet in the current slump, unemployment has remained elevated even while interest rates have been at close to zero for four years while inflation has remained contained. This suggests that the interest rate level required to bring employment down significantly is actually below zero. Summers agrees:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative 2 percent or negative 3 percent sometime in the middle of the last decade.

But central banks can’t lower interest rates below zero percent because people can just hold cash instead. Why invest if you’re going to lose money doing so?


On Depressions, the Structure of Production & Fiscal Policy

I came into economics and finance blogging in 2011 a very different economic thinker than I am today. I was convinced (and remain convinced) that we were going through a once-in a generation economic transformation, or more accurately an industrial revolution the shape of which remained uncertain. These ongoing industrial revolutions, of course, cause great upheavals. As Joseph Stiglitz has noted, the Great Depression of the 1930s can be seen as a great displacement of labour in agriculture thanks to technological improvement. Stiglitz, like myself, sees a parallel between today’s slump and that of the 1930s; in the 1930s we were transitioning out of agriculture. We are also in a transitional period today. Since the advent of globalisation, and the growth in automation in the 1970s and 1980s society had begun suffering from falling real wages, and had had to lever up on debt in order to sustain lifestyles and spending habits. The financial sector had taken advantage of this, offering cheapish debt and — morally hazardously — securitising these debts and selling it a greater fool. This was a bomb waiting to explode — because lenders did not have to take responsibility for the fruits of their lending, they could lend to any NINJA, pay the credit rating agencies to grade highly speculative debt as AAA-grade, and sell it to another bank, or a pension fund, or a hedge fund. When the financial crisis blew up, I desired very, very strongly to see the entire corrupt market liquidated. This was an entirely Darwinian wish; financial firms had acted irresponsibly, creating a monstrous system that nobody really understood and they should pay the consequences for their irresponsibility. In liquidation, people would learn a harsh lesson and the economy would be forced to adapt to the new reality. In Hayekian terms, I thought that the structure of production ought to be left alone to adjust.

So I was furious to see the financial sector bailed out and rescued, and I strongly suspected that such medicine would have very harsh negative side effects as the speculators had been rescued instead of learning their lesson the hard way. Maybe the bankers and financiers who got bailed out — and the regulators who were found to be asleep at the wheel — have not learned a lesson. We shall see. Yet, when push came to shove, governments and central banks chose to save the system instead of watching it burn to the ground and given the complexity of the system, and the danger of good businesses being destroyed alongside the speculators and shysters, that is an entirely understandable decision. Certainly, it was also a morally questionable decision — after all, while bankers and financiers get bailed out in an emergency, help for the much poorer fringes of society is much less forthcoming. Yet this is the world in which we live in.

Of course, the world goes on. Banks may not have been disciplined, but the structure of production still must adjust to the new world, albeit in a less brutal and immediate fashion. This has been far from simple. Even though the financial system was saved, economies around the world remained in a depression. In fact, I would define an economic depression in these terms — a depression as opposed to a transitory recession, which relatively quickly self-corrects is a situation in which the structure of production cannot adjust itself back into a pattern of growth, and economic activity becomes permanently lowered. In Britain and the Eurozone we are so far behind our pre-crisis trend that we still as of October 2013 have not grown our way out of the trough yet, let alone caught up with the long term trend line:


The causes of this are multiple and complex. We are in an the midst of an ongoing industrial revolution, a great whirling flourish of creative destruction in which both foreign labour and automation are displacing both manufacturing and increasingly service industries. This creates real ongoing instability. Furthermore there remains the fallout from the crisis — confidence in new job-creating and growth-creating business ventures may have become inherently depressed, as economic expectations drift lower and lower in the context of low growth. Then there is the ongoing trend of government austerity, taking money and jobs out of the economy. Energy prices remain relatively high by historical standards, as we rely on old and increasingly expensive oil-based infrastructure (although I expect energy costs to begin to fall as we transition to newer energy architectures). The private sectors in most Western countries remain in deleveraging mode from a very large private debt overhang from before the crisis, limiting their consumption and investment and paying down debt. These are just some of the possible causes of depressed growth and elevated unemployment that we see.

Governments particularly in Britain and the Eurozone have attempted to fight depressed growth using austerity policies (in the context of expansionary monetary policy). The proponents of austerity theorise that by promising to bring down taxes and spending, they will unleash private sector spending by reducing future expectations of taxes. To me, this has always seemed like a boneheaded and Rube Goldberg-style approach. Simply, the issue of depressed private economic activity is far more complex than future taxation expectations. And aggressive monetary policy has not succeeded in reversing the depression(even if it has probably made the depression less severe). So it has been entirely unsurprising to me to see this approach largely failing. I approach the problem in a far more direct manner. The solution to lowered growth and elevated (and involuntary) unemployment is relatively simple. Eventually someone will start using up the idle resources. This will either be the private sector once it independently gets over its slump in animal spirits, or it will be the government. With such huge volumes of idle capital, interest rates will remain very low until stronger appetite for credit re-emerges. In equilibrium theory, the low cost of credit will by itself start to re-energise borrowing appetite by making more projects potentially profitable. Of course, interest rates are far from the only factor that borrowers take into account when seeking credit, and so it is perfectly plausible that the economy — as it has done — can remain depressed even with very low rates due to deleveraging pressures, low expectations and low confidence, etc. So if the market is ill-suited to taking up the idle resources any time soon — lying as it is in a depressive, irrational strop — the only agent that can do so is the state. The fact of low interest rates allows this to kill two birds with one stone — the state can borrow money (utilising idle capital) to create jobs (utilising idle labour), raising interest rates and bringing down the unemployment rate. And this approach does not require anyone to make accurate predictions about the future. It simply requires a market economy, and a state willing to employ idle resources when they are idle, and to ease off using idle resources when unemployment becomes low and interest rates start to rise.

Many — including probably Hayek himself — would argue that using up idle resources in such a manner will not allow the structure of production to adjust to the new economic reality. The state, Hayek would argue is a poor allocator of capital because it lacks the informational efficiency of the market. I would mostly agree with Hayek’s objection, and note that I favour a predominantly market-based economy. Government interventions should be kept to a necessary minimum. Yet, in a depressionary environment, the structure of production deteriorates as resources lie idle. Unemployed workers lose skills, lose competitive edge and spend and invest less, further depressing the economy. Capital — factories, buildings, amenities, ideas, etc — deteriorates. Young workers may enter the labour force but never find a job. Crime rises, and shady fringe businesses like loan sharks thrive as the unemployed struggle to pay the bills. The social costs of mass unemployment are exceedingly high. The adjustment occurring in a depression is more like a rot. And it is absurd to rot your way to growth. Instead, by lowering unemployment and using up idle capital (preferably in a mix of state-run infrastructure and technology projects, and lending to new businesses) more businesses can be born into existence. Potentially successful new ideas can be tried out, and may find success in the marketplace. The formerly unemployed get to develop skills, habits and ideas, instead of sitting at home all day doing nothing, or hunting for jobs in a scarce and depressed marketplace. And money will go into people’s pockets, spurring investment and consumption, fomenting more new business growth. This, in my view, is the best shot at getting a depressed and rotten structure of production out of the doldrums and back toward strong organic growth. Sooner or later, of course, the private sector will come back and begin to use up resources. But that could be a very, very, very long way away. If we want the structure of production to adjust to the new world and to continue adjusting as the world continues to change, letting huge quantities of resources sitting idle seems like a bad way to do it. Targeted fiscal policy can change that.

On the Possibility of Hyperdeflation


Even given the failure of hyperinflation to pass since a variety of pop-Austrian TV finance pundits predicted it since 2008 in the wake of the various quantitative easing programs, the world at large continues to talk of the possibility of hyperinflation in the future. The value and purchasing power of money is a significant topic for the entirety of society — savers, debtors, large and small businesses, workers, welfare recipients, pensioners, etc — so it is no surprise that people fixate upon historical events in which the purchasing power of money has gone to zero. Yet this previously-known and widely talked about phenomenon may not occur in the future for most countries. Instead, a previously unknown phenomenon that I now tentatively coin hyperdeflation may be far more common.

Hyperinflation is an interesting phenomenon. As I have noted in the past, it seems to be predominantly associated with collapses in agriculture, infrastructure and transport, the loss of a war or natural disasters. Faced with dire economic breakdown and spiralling prices and wages (as plentiful paper money chases after increasingly scarce and limited goods) monetary policymakers are forced to print in an attempt to keep a broken economy going. In a functional economy like present day Japan, Britain or America with no mass breakdown of institutions, transport or infrastructure (and thus with with freely available food, energy and resources) printing (or digitally multiplying) money does not lead to huge, soaring inflation. But in an economy already disrupted — like the many countries on this list that experienced hyperinflation — the inflationary impact of new base money just continues to spiral, and all the extra paper dumped into the system is simply abandoned and rejected by the public as its purchasing power gravitates toward zero.

And in the modern world, some countries and places may have become more susceptible to the kinds of economic breakdowns that could lead to hyperinflation given a bad-enough shock. In an increasingly interconnective and trade-dependent world, natural disasters or wars can shut off the supply of important products or components that countries or regions do not and cannot manufacture. That makes this a particularly fragile phase of history, even if it does not seem so given the huge and widespread affluence not just in the West, but also increasingly in the developing world.

Yet beyond this phase of history, stretching out into the long run, the opposite may become true. Society is shaped by its technological capacities — this has been true since the days of the spear, the wheel, the bow, etc — and our technological evolution continues at ever rapider rates. The internet has already provided a channel for mass cultural interconnectivity, and the effective decentralisation of media. I have written at length on the possibility of superabundant decentralised energy from falling solar and alternative energy costs, combined with the possibility of mass decentralised molecular manufacturing. Simply, if every house has an advanced 3-D printer that can transform soil and waste into food, consumer electronics, or tools (etc), and a superabundant energy source from high-efficiency solar panels (or artificial fossil fuels, or even micro-nuclear reactors) then the era of material scarcity is effectively over, and humanity can concentrate its energies on other matters (cultural, religious, philosophical, space colonisation, etc). Now, we are still a while away from a single house having such capacities, but the implications of the beginning of that era will be profound.

My supposition is that the era of superabundance will be characterised by very strong deflation as the supply of goods and energy becomes increasingly superabundant. This trend has already begun in the West, where inflation and interest rates have — in the context of cheap Eastern labour, computerisation and automation — been falling for the last 20 years. Even strong quantitative easing by central banks has not reignited strong inflation. My guess is that unless we experience some huge shock that dramatically shakes the foundations of society — like a megatsunami, or a nuclear war, or a mass pandemic that wipes out half the population — it will be hard for strong inflation to ever return no matter how much money central banks print. Central bankers may be able to keep inflation close to zero with strong activist monetary policy, but even that may be challenging especially as the age of superabundance draws onward.

Of course, in a world of material superabundance, trade and business will not end. While everyone may have a molecular factory in their house that can build anything from a huge library of open-sourced 3-D designs downloadable from the internet, people will still have to design things and create things. Although at some stage the machines may become sentient and creative, this appears to be at least a very, very long way away. So all the 3-D printers, robots and unlimited energy in the world won’t for the foreseeable future invent things, or write a Hamlet or a Breaking Bad, or a Dark Side of the Moon or an Emperor Concerto, leaving humans an important niche as designers, empathisers and imagineers. While with superabundant energy and goods, people will have all the resources necessary to devote themselves to such pursuits, people as they have done throughout history will still choose to co-ordinate and collaborate, so they will still need some currency. Whether this will take the form of state fiat money, or private currencies like Bitcoins, Facebook and Youtube likes, or Whuffies, or a mixture of the above remains to be seen.

Another possibility, of course, is that there will still be scarcities even in the era of superabundance. While every house may be able to manufacture an unlimited quantity of food, household goods and gadgets, some highly-desired technologies and goods like interstellar spacecraft or particle accelerators or exotic matter may remain far beyond the reach of a typical household or community either on technological grounds or on the grounds that they are contraband (it is quite easy to imagine that manufacturing of certain goods — weaponry in particular — may be made illegal by states, who may create increasingly sophisticated and Orwellian surveillance structures to prevent the distribution of illegal materials). These post-superabundance scarcities may form the basis of new widespread media of exchange and units of account, especially if state fiat money hyperdeflates its way to irrelevance.

(And yes — in an age of superabundant energy, gold will in all likelihood lose its scarcity, as with enough energy it is possible to transmute lead into gold in a particle accelerator. This means it is quite possible that gold’s all-time high of $1917 in September 2011 may be the highest dollar-denominated price gold ever trades at).

Why Savers Should Put Up Or Shut Up

There is an idea popular in certain circles that low interest rate policies are stealing from savers. When the economy went into freefall in 2008, central bank interest rates were lowered to the zero bound. And rates for savers and investors in both government and corporate debt have certainly fallen since then:


Critics of low interest rate policies actually have the wrong end of the stick. It is not central banks that set interest rates for the market. Central banks set lending rates into the banking system. The interest rates in the market remain a function of the demand for savings. Demand for savings (shown as a percentage of GDP, to show the real level of demand for savings relative to economic activity) has absolutely soared since 2008:

fredgraph (22)

How can savers expect a positive real return on their savings when the demand for savings has gone so high even in the context of lower interest rates in general? Central bank policy is designed to discourage saving and encourage investment and consumption. That’s the point — but even with interest rates close to zero, the growth in savings has not been stanched. All else being equal, had central banks not cut rates, demand for savings would be even higher. And with higher demand for savings, that would have just depressed interest rates to the levels we see now irrespective of central bank policy.

The great irony here, of course, is that there are still high rates of return for those with capital if they look for it. Payday loans companies continue to charge companies interest rates in the thousands of percent lending to people with poor credit histories or who may have lost their jobs in the context of the bad economy. Access to capital is not universal or even widespread. Real incomes are flat on where they were five years ago, which has led many individuals and families into borrowing to meet their bills. The fact that the financial industry is lending to some at huge interest rates and denying credit to many businesses while simultaneously paying smaller interest rates to savers is not symptomatic of theft from savers — it’s symptomatic of financial industry dysfunction, and a failed transmission mechanism.

For savers, positive real return on capital is not a right, and it should not be an expectation especially in a depressed economy. If businesses aren’t mostly expanding and taking on new workers, where is the positive real return going to come from? If wages aren’t rising, where is the positive real return going to come from? If the economy isn’t growing where is the positive real return going to come from? The answer is that with a pie that isn’t growing, those who get a bigger slice will be dispossessing others. Simply, high real rates of interest in the context of a depressed economy are rents, and demanding them — and especially demanding that the government enforce their existence — is rent seeking. This is ultimately why a low-growth environment is naturally and in the long run unavoidably a low interest rate environment. It is not central bank theft. It is the inevitable outcome of a depressed economy.

Savers looking for a larger rate of return should know damn well what to do — take their money out of low interest savings accounts and out of the failed financial intermediation industry and invest it into quality economic projects that create jobs and growth. This could involve buying the stock or debt of large companies that wish to expand, or it could involve starting your own business, or investing in a startup or a mixture of these things. The easiest way to return to growth — and thus higher interest rates, and higher returns for things like pension funds — is for today’s savers complaining about low interest rates to turn into tomorrow’s investors seeking out and pouring money into quality projects that increase incomes, create jobs and create products that people desire and want to use. Sitting on cash in a bank account in the dysfunctional financial system and whining about a low return is incoherent nonsense.

Minsky, the Lucas Critique, & the Great Moderation

Last week, I noted that the post-2008 world had provided an astonishingly good test for Milton Friedman’s notion that stabilising M2 growth was an effective antidote for economic depressions. Bernanke stabilised M2 growth, yet the depressive effects such as elevated unemployment, elevated long-term unemployment, and depressed growth still appeared, although not to such a great extent as was experienced in the 1930s. Friedman-style macro-stabilisation may have succeeded in reducing the damage, but in terms of preventing the onset of a depression Friedman’s ideas failed.

Of course, the onset of the post-2008 era was in many ways also a failure of the previous regime, and its so-called Great Moderation. Ben Bernanke in 2004 famously noted that “one of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility”.  Bernanke saw successful monetary policy as a significant reason for this stabilisation:

The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. As Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002). Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.

Bernanke’s presumptive successor, Janet Yellen explained in 2009 that from a Minskian perspective, this drop in visible volatility was itself symptomatic of underlying troubles beneath the surface:

One of the critical features of Minsky’s world view is that borrowers, lenders, and regulators are lulled into complacency as asset prices rise.It was not so long ago — though it seems like a lifetime — that many of us were trying to figure out why investors were demanding so little compensation for risk. For example, long-term interest rates were well below what appeared consistent with the expected future path of short-term rates. This phenomenon, which ended abruptly in mid-2007, was famously characterized by then-Chairman Greenspan as a “conundrum.” Credit spreads too were razor thin. But for Minsky, this behavior of interest rates and loan pricing might not have been so puzzling. He might have pointed out that such a sense of safety on the part of investors is characteristic of financial booms. The incaution that reigned by the middle of this decade had been fed by roughly twenty years of the so-called “great moderation,” when most industrialized economies experienced steady growth and low and stable inflation.

Minsky’s financial instability hypothesis can be thought of as an instance of the Lucas Critique applied to macro-stabilisation. Lucas’ contribution — earlier stated by Keynes — is that agents alter their behaviour and expectations in response to policy.  By enacting stabilisation policies, policy makers change the expectations and behaviour of economic agents. In the Minskian world, the promise and application of macro-stabilisation policies can lead to economic agents engaging in increasingly risky behaviour. A moderation is calm on the surface — strong growth, low inflation — but turbulent in the ocean deep where economic agents believing the hype of the moderation take risks they would otherwise not. In a Minskian world, these two things are not separate facts but deeply and intimately interconnected. Whichever way monetary policy swings, there will still be a business cycle. Only fiscal policy — direct spending on job creation that is not dependent on market mood swings — can bring down unemployment in such a context while the market recovers its lost panache.

The march of monetarists — following the lead of Scott Sumner — toward nominal GDP targeting, under which the central bank would target a level of nominal GDP, is a symptom of Friedman’s and the Great Moderation’s failure. If stabilising M2 growth had worked, nobody would be calling for stabilising other monetary aggregates like M4 growth, or stabilising the nominal level of economic activity in the economy. Sumner believes by definition, I think, that the policies enacted by Bernanke following 2008 were “too tight”, and that much more was needed.

Of course, what the NGDP targeters seem to believe is that they can have their Great Moderation after all if only they are targeting the right variable. This view is shared by other groups, with varying clinical pathways. Followers of von Mises’ business cycle theory believe that an uninhibited market will not exhibit a business cycle, as they believe that the business cycle is a product of government artificially suppressing interest rates. Minsky’s financial instability hypothesis and its notion that stability is destabilising is a slap in the face to all such moderation hypotheses. The more successful the moderation, the more economic agents will gradually change their behaviour to engage in increasingly risky activities, and the more bubbles will form, eventually destabilising the system once again. Markets are inherently tempestuous.

Or at least that is the theory. It would be nice to see empirical confirmation that the moderation produced by Sumnerian NGDP targeting is just as fragile and breakable as the Great Moderation. Which, of course, requires some monetary regimes somewhere to practice NGDP targeting.

The “Unemployment Is Voluntary” Myth

Loyd S. Pettegrew and Carol A. Vance of the Ludwig von Mises Institute ask and answer a question:

Why does a large portion of the population choose not to work when there are many jobs available? The answer is simple. If you can receive 2-3 times as much money from unemployment, disability, and/or welfare benefits (subsidized housing, food stamps, free cellphones, etc.) as you can from a temporary or part-time job, and live a life of leisure, why work? In 2011, the U.S. government spent over $800 billion on this “welfare,” exceeding expenditures on Social Security or Medicare.

So, is it true? Is the reason why unemployment is elevated that millions of Americans are choosing not to work because of cushy government welfare provisions?

After all, welfare payments as a percentage of GDP and unemployment have risen in tandem:


However, in this case it is clear that correlation is not causation. Why?

Well, if labour was truly slacking off then we would expect to see a shortage of labour. But instead we see an elevated level of applicants per job openings:


This means that there are not enough job openings in the economy even for the number of current jobseekers, let alone the discouraged workers and disabled individuals who are claiming welfare. If the Federal government were to throw them all off welfare, the number of jobseekers per opening — already elevated — would soar. This means that the issue causing unemployment is not individuals dropping out of the labour force, but an economy that isn’t creating jobs very rapidly. So welfare is not acting as a disincentive to work, in this case. It is acting as supplementary income for those who cannot otherwise find an opening in the economy due to factors like job migration and automation reducing the level of labour desired by employers.

Under other conditions, it is possible that welfare payments could act as a disincentive to work. If there were a low number of applicants per opening, then welfare that paid better than the lowest-paid jobs available could be seen as a disincentive to work. But now, with job openings at a very low level? Don’t be ridiculous.