Jun 282013

Much talk about Bitcoin centers on the claim that it represents some kind of existential threat to the US dollar (USD) specifically, fiat currency generally, and maybe even the nation-state as a social institution and organizational structure. Considering that the total value of Bitcoin in circulation today, in June 2013, is approximately USD 1.25 billion, or 2% of Carlos Slim’s personal portfolio, one might easily conclude that Bitcoin fanboys are drunk on their own fumes and perhaps getting just a little bit ahead of themselves.

Deflating Inflation Fears

As I have pointed out before:

In general, and all other things held constant (or, as we say in the business, ceteris paribus), prices can rise for three reasons: demand increases (e.g., an auction or a popular restaurant), supply decreases (e.g., lower efficiency, war, or natural disaster), or the number of units of currency increases faster than the rate of increase of goods and services (inflation).”

If it fulfills even some of its potential, then Bitcoin could mitigate USD inflation, by increasing the economically relevant supply of available goods and services via the reduction of transactional friction, especially across borders and among the unbanked.

As things stand, a consumer in Suburbia is restricted to local merchants who will accept fiat cash and equivalents, stored-value cards, or cards tied to the banking system, on the one hand, and to online merchants who will accept stored-value cards, or cards and online derivative services tied to the banking system, on the other hand. That’s pretty much it.

Many of the payment systems that are tied to the banking system are either expensive or impossible to use across borders. This means that the supply of goods and services available to the Suburbian consumer is constrained by legacy and political inefficiencies in the international banking system.

The World’s Second-Largest Economy

With virtual currencies generally and Bitcoin specifically, consumers in Suburbia can buy goods and services from suppliers in Outland that hitherto have been out of reach, meaning that they effectively do not exist from the Suburbian perspective. While this might seem trivial to a Suburbian whose entire economic life is spent, as it were, in Suburbia, it is a daily headache for Outlandish suppliers and consumers, who comprise a rather significant economic force.

G’won… Click on the video!

For example, it is very difficult for local hotel operators in much of Latin America and the Caribbean to accept credit card payments directly from foreign guests as deposits prior to travel. This means that the foreign guests will tend to stay at hotels run by large international chains, putting the local hotels at a severe disadvantage. If a hotel operator in Latin America or the Caribbean accepted Bitcoin, even if only for the initial deposit, then anyone in the world could make reservations easily, and the effective worldwide supply of hotel rooms would increase.

This same story can be told for as many goods and services as one can imagine: coffee from small-scale roasters in Central America, small-label hot sauces from sub-Saharan Africa, local distilled spirits from the Caribbean, textiles from Southeast Asia, crafts from pretty much everywhere, personal services, software development, graphic design, world music, etc.

Before one dismisses the total value of small-scale global trade, one should consider that during the 2012 presidential campaign, Pres. Obama raised tens of millions of dollars in small-sized contributions, and that 83% of the world’s population lives outside the OECD. This same e pluribus magnum power of large quantities of small transactions is the driving force behind crowdfunding, which also can be facilitated globally much more easily with Bitcoin than with legacy options.

In the video above, Robert Neuwirth refers to the worldwide informal economy as the world’s second-largest economy. And, they don’t have bank accounts, credit cards, or access to capital markets, but they do have mobile phones, many of which can run Kipochi, even if they do not have smartphones that can run a Bitcoin wallet.

Ponder that for a moment, before reading further.

Somewhere in Nairobi, some street vendors are carrying more powerful financial technology in their pockets than 90% of the Suburbians reading this have in their whole houses.

Fear, Uncertainty, and Doubt

Bitcoin could essentially conjure into existence for Suburbians the goods and services produced by 5.75 billion potential trading partners in Outland that currently might as well be in some parallel universe. In so doing, the USD/stuff ratio (i.e., price level) could fall, even if the numerator (USD money supply) continued to grow at historically unprecedented rates, so long as the denominator (cool stuff from Outland) were allowed to grow even faster.

That’s right, widespread Bitcoin adoption could mitigate inflation! Those who claim the opposite assume that Bitcoin will supplant the USD for existing transactions, and that the two payment media will vie for shares of a fixed-sized pie, like two dogs fighting over a bone, which is silly. Chinese refinery operators are not going to buy Saudi Arabian oil with Bitcoin any time soon, as the percentage savings would be less than trivial. The USD will continue to function where legacy systems work well, and Bitcoin could open markets that have never existed before, if allowed to.

One concern that one comes across with distressing frequency is that tax collection might be made more difficult, if large numbers of Suburbians started transacting in Bitcoin, but there are alternatives to income taxes that can be as progressive as policy makers want them to be, including a national land tax based on assessed value, luxury goods taxes, automobile taxes based on sale price, etc., and tax collectors still can demand that all taxes be paid in local fiat and charge a conversion tax on Bitcion exchanges into the local currency. These suggestions should not be mistaken for a paean to the social welfare state, but merely as evidence that the taxation critique of virtual currencies is a red herring. Similarly, concerns about money laundering and terrorist financing are overblown, especially given the existence of Bitcoin’s publicly available blockchain, which records every Bitcoin transaction that has every been cleared and every Bitcoin user—including law enforcement and taxation agents— has access to.

Setting aside the red herrings, straw men, and other knee-jerk overreactions from luddites, the real issue is how Bitcoin can grease the wheels of small-scale global commerce, thereby removing the vast amount of friction from transactions across borders… which could ease inflationary pressure on the USD.

There’s Nothing to Fear but Fear, Itself

Should bankers be afraid of Bitcoin? Absolutely not! They can earn from the exchange into and out of Bitcoin, serve as escrow agents for Bitcoin users who prefer not to keep their holdings under a proverbial mattress, they can facilitate Bitcoin loans, use Bitcoin as a reserve asset, etc.

Should regulators be afraid of Bitcoin? No more so than any other commodity. In fact, perhaps even less so, seeing as how commodity markets are largely unregulated; it is the commodity derivatives markets that are regulated, and Bitcoin is a commodity, like gold, oil, or wheat, and not a derivative, like an option or a future. Now, if people start issuing options and futures contracts on Bitcoin, the of course regulators will have quite a lot to say.

Should law enforcement agents be afraid of Bitcoin? Hardly! The blockchain that memorializes every Bitcoin transaction for posterity can be read into a database and sifted every way imaginable using Big Data techniques. Also, it is remarkably easy to set up a sting operation with Bitcoin, which already seems to be happening.

Should tax collectors be afraid of Bitcoin? Perhaps, if their goal is to tax Bitcoin-denominated transactions that do not intersect with the banking system. However, anything that touches the banking system directly is recorded in accordance with banking regulations, and anything that touches the banking system indirectly is likely to drag the tax evader’s fingerprints through the blockchain, which is available to all without a subpoena.

Welcome to the 21st Century

Bitcoin is part of a larger transition away from the capital/labor economy to the service/knowledge economy. Welcome to the Age of Decadence, where disruptive innovations in engineering, entrepreneurship, and entertainment are announced with mind-boggling frequency. If government legislators and regulators clamp down on the work of frighteningly intelligent and disobedient young men and women, then that work will go to where it is tolerated, even if not embraced, per se, thereby impoverishing the populations that the governments are supposed to serve, protect, and represent.

Skype and Twitter are making a joke of national telephone monopolies. Remote collaboration tools are making a joke of immigration restrictions, and thus labor regulations. Free and open source software and hardware development tools are making a joke of patent and copyright regimes. The only way to stop or even slow this process would be to disconnect your country from the Internet, and, seriously, do you really want to do that?

Some legislators and regulators will try to shovel back the tide, and their people will be held back, as were the people of the USSR, Ghaddafi’s Libya, the military dictatorships that once reigned in Latin America, and Burma, Cuba, and North Korea today. Other legislators and regulators either will embrace or at least tolerate the inevitable change, and their people should fare well. Yet others will strike some middle path, with varying results.

What US officials in the Federal Reserve, the US Treasury, the Department of Homeland Security, the Internal Revenue Service, etc. do is anyone’s guess. It is obvious from my comments here what my hope is, and I continue to live in the USA.

If there are any Hortons in Congress… yop.

Invest accordingly.

Prof. Evans

May 062013

As Mark Knopfler of Dire Straits put it in “Telegraph Road“, after the homesteaders settle, then come the churches, then come the schools, then come the lawyers, then come the rules. And, as Danny Elfman of Oingo Boingo put it in “No Spill Blood“:

Who makes the the rules?
Someone else.”

So, what are we to make of this latest announcement that US regulators at the Commodities & Futures Trading Commission (CFTC)—the people allegedly responsible for the demise of Intrade—are not going to sit passively by and watch Bitcoin, that furry woodland creature that is giving status quo dinosaurs the fits, rise in prominence?

Bear with me, while I do that glass-half-full thing that I have done so well, to the great irritation of doom-&-gloomers, for more than a quarter-century.

This is FANTASTIC news! [Gads, how I miss the <blink> tag right now!]

If the CFTC regulated Bitcoin, or more likely Bitcoin derivatives, then this would officially legitimize Bitcoin and maybe even make it possible to buy it through a licensed derivatives broker, like OptionsXpress.

Yes, pipsqueak mom-&-pop operations would not be able to experiment with disruptive financial innovations, but Bitcoin is not the only unbacked token out there. Go experiment with something that is still off regulators’ radar.

Yes, the US financial system is run by and for the benefit of plutocratic oligarchs. Go live in Chile or Panama, if that sort of thing bothers you.

The point is that people with real money to spend have shown keen interest in Bitcoin, and regulators are lining up at the front of the parade and pretending like they are in charge, rather than trying to shut it down. As long as Americans continue to elect rulers who see their role as the wielding of power over everyone else, these are the only two realistic options.

The world would be a wonderful place, if it were governed by the principle, “No Victim, No Crime,” but until that day arrives count your blessings, however meager they might be.

What would CFTC regulation mean in practical terms? No one knows, and anyone who prophesies the future is a fool, a liar, or both. The main thing to bear in mind here is that, just as there is a cost for every benefit, there also is a benefit hiding within every cost.

That, and the market always wins.

Invest accordingly.

Prof. Evans

Feb 232013

Some many years ago, I interviewed for a job in Vienna. The individual whom I was to replace was an Englishman bedecked in an aura of weariness that Englishmen wear so well, like a comfortably wrinkled suit. He told me that he had come to admire the Austrians for their marketing genius, what with having convinced the world that Beethoven was Austrian and Hitler was German.

I was reminded of this recently, in a discussion about socialism, during which it stuck me that socialists exhibit a similar genius.

It is much less inflammatory to call someone a socialist than it is to call someone a terrorist, a racist, or even a statist, even though tens of millions of humans have died in the name of various brands of socialism, whereas the victims of terrorism number in, perhaps, the tens of thousands.

This is not to excuse any brand of collectivism—be it tribalism, nationalism, ethnocentrism, or boosterism—but it should be unexceptional to declare it worse to kill 20 million than to kill 3,000.

To put this to the test, utter the name Pinochet and then the name Lenin during an argument over politics and note the differences in reactions. Pinochet is credited with killing about 3,000 individuals; Lenin, millions. And yet, university students can write term papers on Lenin that are generally supportive of Bolshevism, whereas the same—mutatis mutandis—is not true of Pinochet.

Better yet, socialists have convinced a great number of individuals that some salient difference exists between ‘right-wing’ national socialism and fascism and ‘left-wing’ international socialism and communism. Both Hitler and Stalin engaged in systematic genocide; so, that does not distinguish them. Nor do secret police, purges, the suspension of fundamental human rights, etc.

About the only policy difference between ‘right-wing’ and ‘left-wing’ socialism is that under ‘right-wing’ socialism individuals retain title to property, and under ‘left-wing’ socialism private property is abolished, and everything belongs to the state. Under both systems, the disposition of property is dictated by the central authority’s agents.

Under fascism in Mussolini’s Italy, the farmer owned the cow, and an agent of the state dictated whether the cow was to be milked or slaughtered, and how the resulting products were to be distributed; under communism in Castro’s Cuba, the state owns the cow, and an agent of the state dictates whether the cow is to be milked or slaughtered, and how the resulting products are to be distributed.

And yet, here we are, surrounded by individuals who are emboldened to speak of Marx, Lenin, and Castro with a warmness that one would be surprised by, if the subject were Hitler, Mussolini, or any 20th Century Latin American military dictator.

This is relevant today, because this false distinction is used to silence critics of statist policies.

For example, on the one hand, critics of ObamaCare who decry it as socialistic—meaning, implicitly, left-wing socialism—can be shown to be incorrect, because The Mandate that requires US residents to transact with commercial insurance firms under penalty of a ‘tax’, the non-payment of which would be a felony, is not the same thing as nationalization. No nationalization, no socialism; QED.

On the other hand, if someone correctly describes ObamaCare as fascistic—not totalitarian, racist, or genocidal, but in the sense of a government policy that puts the needs of the nation above individual rights, as determined by a very few individuals who wield supreme power—as Whole Foods CEO, John Mackey has done, the backlash is swift.

Check, and mate. It isn’t socialism. You cannot call it fascism.

Rather than address the substance of the criticism, the message of the backlash is more akin to whipping the little boy who dares to point out that the emperor is wearing no clothes or the dog that exposes the scare little man behind the curtain pretending to be a wizard.

This obsession with trivial distinctions between ‘right-wing’ and ‘left-wing’ collectivism that statists use to distract the conversation from substantive issues puts individualists at a rhetorical disadvantage.

Call a statist a statist, and one is perceived as shrill; call an individualist an individualist, and it comes across as meaning something benign, like not keeping up with fashion trends or maybe listening to unpopular music.

Call a socialist a socialist, and one might inspire a discourse on the moral superiority of the proletariat over the plutocracy. Call a fascist a fascist, and the knee-jerk assumption is that one means that the other party is a murderous racist.

We are left with relatively unfamiliar terms, like ‘corporatism’ or the ungainly neologism ‘crony capitalism’, neither of which captures the essence of being compelled to dispose of one’s property according to the dictates of individuals who do not bear personal cost for their decisions.

Little is to be done about this situation, other than to be aware of it, to recognize it when it happens, and to avoid being distracted by activists’ misdirection.

Invest accordingly.

Prof. Evans

Feb 132013

The graph below is the standard, textbook depiction of the effects of a minimum wage on the labor market.

Hardly anyone ever states explicitly what is meant by the quantity of labor, and the tacit assumption is that it refers to hours worked. Considering that the labor theory of value was abandoned except by Marxists and other cranks nearly a century-and-a-half ago, this is a dubious assumption.

However, the graph above is fine for general, broad-brush discussions.

Think of quantity as the number of employees, the number of hours worked for hourly wages, or whatever.

The dotted line in the middle that rises from L* is the market-clearing quantity of labor. This means that the number that choose to work equals the number that employers want to hire at the wage indicated. At any wage below the market wage, fewer choose to supply labor than employers choose to hire (labor shortage); and any wage above the market wage, more choose to supply labor than employers choose to hire (labor surplus, aka unemployment).

Offer 10¢ per hour, and hardly anyone will show up for work. Offer $10,000 per hour, and surgeons, nuclear physicists, and talk show hosts will quit their jobs to come work for you.

If one set the minimum wage at $10,000 per hour, then not only those willing to work for the market wage would be closed out of the labor market, but those willing to work for $9,500 per hour would be closed out.

This process is multiplied by automation.

A half-century ago, about half of the working population in the USA was involved in manufacturing and distribution; today it is a bit less than 10%, and the total value of goods manufactured in the USA continues to exceed the total value of goods manufactured in China.

American factories no longer need an army of proletarian meat-that-talks, when robots are more accurate, don’t organize labor unions, and do not demand insurance and retirement benefits.

It is such a shame that we have so few political rulers who understand basic corporate finance. Instead of increasing employers’ cost of labor, policy makers should be doing everything they can to decrease employers’ cost of labor, if their goal is to reduce unemployment.

If one wants to institute populist policies—and I am not saying that one should, only if—then one would do better to focus on the lower end of the income statement than on the upper end.

Income Statement
+ Gross Sales
- Variable Costs (supplies and materials)
- Fixed Costs (rent, payroll, insurance)
- Depreciation or Mark-to-Market Adjustment
- Interest
= Earnings Before Tax (taxable profit)
- Tax (some percentage of taxable profit)
= Net Income (after-tax profit)

If one raises the minimum wage, one increases Fixed Costs, thereby reducing Earnings Before Tax, and potentially making it negative. In such a situation, the natural response for managers is to reduce the scope of the firm, to automate, or both, and lay off as many workers as is feasible.

Better to let the market determine the appropriate wage rate and to increase the corporate income tax—since it is paid on before-tax profit—and use the additional proceeds to fund transfers to workers. That way, the firms’ executives would have an incentive to increase the scope of the firm, in order to increase Net Income to its previous levels before the tax increase.

Granted, this would create an incentive for firms to relocate to lower-tax jurisdictions, but that’s the sort of thing that one must accept, if one insists on instituting populist policies.

At the very least, the effects of the corporate tax would be known and predictable—X% of taxable profit—rather than hit-or-miss increases in payroll costs caused by the arbitrary political fiat of a minimum wage.

Invest accordingly.

Prof. Evans

Nov 152012

3 November 2012, Clayton Christensen, whose earlier works I have found inspirational and illuminating, published an article in the New York Times—”A Capitalist’s Dilemma, Whoever Wins on Tuesday“—that starts with a reasonable premise, and veers hopelessly off course.

To Wit: “Whatever happens on Election Day, Americans will keep asking the same question: When will this economy get better?”

Fair enough. That is a very reasonable question, and it is a very reasonable expectation that Americans will keep asking it.

So far, so good.

Then, we get this:

“The Fed has been injecting more and more capital into the economy…”


The Fed has been pumping more and more money into the economy. The value of money is measured by the ratio of units in circulation to the value of stuff. If the number of units in circulation increases faster than the quantity, value, or both of stuff, then prices rise.

Capital is the long-term means of production: drill presses, trucks, robots, etc.. The Fed doesn’t have any of that, and Fed governors are not in a position to command others to make such things available.

The Fed lends money to the US Treasury, buys toxic assets from commercial banks, and regulates banks. It isn’t a hardware store.

Now, if one is sitting on a lot of money that one can convert into capital assets, then one might adopt the financier’s habit of referring to that money as capital, but one should avoid conflating fiat inflation with the means of production.

“And yet cash hoards in the billions are sitting unused on the pristine balance sheets of Fortune 500 corporations.”

Firms are supposed to keep pools of cash as a kind of self-insurance policy against slow economic times. We call this ‘working capital’. When the future is even scarier than normal, the prudent thing to do is to hold more cash. The ‘Fiscal Cliff’, Pres. Obama’s political rhetoric expressing open disdain for those who are wealthier than he, the unknowable effects of Obamacare, the ongoing transition away from a capital/labor economy toward a service/knowledge economy, and the specter of another decade of ‘Bush’s war’ are enough to render all expectations of the future little more than random bets and wild guesses.

And, no one gets fired for playing it safe. So, until things settle down, executives play it safe.

“Billions in capital is also sitting inert and uninvested at private equity funds.”

Does Prof. Christensen believe that fund managers have piles of big, canvas sacks with dollar signs on them, filled with cash… like Scrooge McDuck or the dapper little fellow from the Monopoly™ game?!?

The money is invested somewhere, most likely US Treasury debt, because the US Treasury has a reputation of always paying its debts… even if it has to print more money to do so. In these highly uncertain times, the safest bet is the safest bet.

“Empowering innovations create jobs, because they require more and more people who can build, distribute, sell[,] and service these products.”

Sadly… no, no, no, and no.

Build: Factories are increasingly automated, and when meat-that-talks is needed, one hires labor where it is cheap; i.e. Latin America, Southeast Asia, and increasingly Sub-Saharan Africa.

Distribute: DHL, FedEx, UPS, already have that pretty well covered.

Sell: Amazon.com.

Service: What is that? Throw it away and buy a new one.

“[T]he Toyota Prius hybrid is a marvelous product.”

Except that [o]nly 35 percent of hybrid car owners bought a hybrid again when they purchased a new vehicle in 2011.

“‘[E]fficiency’ innovations… almost always reduce the net number of jobs…”

This one is spot-on. It is unfortunate that Christensen did not make it the centerpiece of his analysis.

“The economic machine is out of balance and losing its horsepower. But why?”

Peter Drucker answered this question in Post-Capitalist Society, which was written nearly twenty years ago, and reads today like a play-by-play account of what happened in the 1990s and 2000s.

[Reread the sentence above, click on the link, and buy the book. You can thank me later.]

Also, the total value of goods manufactured in the USA continues to exceed the value of goods manufactured in China.

The scorpion’s sting is in the tail. Toward the end of the article, Christensen states, “We can use capital with abandon now, because it’s abundant and cheap. But we can no longer waste education, subsidizing it in fields that offer few jobs.”

No one knows where the ‘jobs’ of the future will be. Social engineering always fails. In the 1960s, it was plastics; in the 1980s, software development; in the 1990s, Dot.Com… No one knows what it will be next decade.

“[T]he [capital gains tax] rate should be reduced the longer the investment is held — so that, for example, tax rates on investments held for five years might be zero — and rates on investments held for eight years might be negative.”

It might have made sense a century ago, when technology changed slowly, to make it costly to change plans quickly in response to new information, but Christensen’s advice in a highly dynamic—even chaotic—integrated global economy would create an incentive to keep sub-optimal plans running beyond their use-by dates.

“Federal tax receipts from capital gains comprise only a tiny percentage of all United States tax revenue.”

This suffers from two fatal flaws. 1) The universe does not end at the US border. 2) If capital gains represent a trivial portion of the federal budget, then eliminate the cost of collecting and enforcing them and call for their repeal. Leave the money in the owners’ hands, rather than seize it at gunpoint, if it is hardly worth collecting.

“It’s true that some of the richest Americans have been making money with money — investing in efficiency innovations rather than investing to create jobs. They are doing what their professors taught them to do, but times have changed.”

Indeed, times have changed, but that does not mean that this time is different, as Christensen seems to assume. We are in the latter stages of a transition as profound as the 18th Century Industrial Revolution, from a capital/labor division—in which semi-literate proletarians drive industrial machines—to a knowledge/service division, in which skilled workers are the ‘capital’ and are not interchangeable.

However, the wealthy will invest where they expect the greatest opportunities are, as has been the case since the Renaissance a half millennium ago. When princes, presidents, and parliamentarians create uncertainty, the wealthy will hunker down and wait until circumstances stabilize.

Christensen started with the premise that the president and the Fed do not have the power to fix things, and then concluded that the IRS does have such power.

This conclusion is counterintuitive. An alternative would be for presidents, princes, and parliamentarians to enforce transparency, and otherwise to mind their knitting, rather than concern themselves with affairs that are beyond their abilities.

Invest accordingly.

Prof. Evans

Nov 042012

When I was a child, I had a book of jokes that contained the story—if memory, after nearly a half-century, serves*—of Little Mable Moneybags. This story reminds me of the attitudes of many vocal activists—both libertarian and social welfarist—who live in North America and Western Europe.

Little Mable Moneybags was a very lucky little girl, who had been born into a very lucky family. One day in school, her teacher asked her to write a story about a poor family. This is what she wrote:

Once upon a time, there was a frightfully poor family. They were all frightfully, frightfully poor.

The mommy was poor, and the daddy was poor. The little girl was poor, and her teddy bears were all poor. The kitty was poor, and the puppy was poor.

The chauffeur was poor, and the chef was poor. The butler was poor, and the upstairs and the downstairs maids were poor.

The groundskeeper was poor, and security guards were poor.

They were all frightfully, frightfully poor.

Whenever I get mail with the smiling face of a celebrity or millionaire on the letterhead, extolling the virtues of and asking me to send money to a lobbying group or ‘non-partisan public policy research institute’ that is dedicated to reducing regulation and taxes or increasing regulation and taxes, I think of Little Mable Moneybags, and wonder why so many libertarians and social welfarists seem to be oblivious to the poor in any meaningful way. They all want me to donate my money and time to lobby for tax-cuts that benefit only those who actually pay taxes or tax-increases that ultimately go to government employees.

While I recognize that everyone who pays taxes benefits directly from tax cuts, everyone—individual and multinational firm, alike— who receives government subsidies benefits from tax increases, and everyone benefits indirectly an optimal level of regulation, those who benefit the most almost never are among those least able to protect their own interests.

If I am going to expend an effort to promote liberty, minimal government, and individual responsibility, I am going to be much more interested in helping the poor extricate themselves from the social welfare bureaucracy than in promoting the pet causes of individuals who earn more than I do.

If I am going to expend an effort to help the poor, I am going to be much more interested in helping the poor extricate themselves from the social welfare bureaucracy than in expanding it and perpetuating the cycle of dependency.

And, in particular, if am going to expend an effort to promote liberty, minimal government, individual responsibility among the poor, I am going to focus my attention on the 5.5 billion who live outside the OECD who are really poor.

In the meantime, the mailers go straight into the recycling bin.

Invest accordingly.

Prof. Evans

* If you are a copyright holder who feels that this, in any way, violates your rights, contact me immediately to provide proof of ownership, and to let me know your intentions.

Nov 042012

We examine the effect of securities laws on stock market development in 49 countries. We find little evidence that public enforcement benefits stock markets, but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets.”
(La Porta, Lopez-de-Silanes & Shleifer 2006)

In general—and vastly oversimplified—regulatory regimes fall into three categories: Authoritarianism, Anarchism, and Transparency.

The term authoritarianism here refers to what one might think of as over-regulation, as when entrepreneurs in a particular country must seek permission—perhaps even an act of parliament or specific permission from the ruling junta—before being allowed to register a new firm.

The term anarchism here refers to a de facto, even if not a de jure lack of government oversight, where regulations either do not exist or exist but are not enforced.

The term transparency here refers to a regime, in which individuals are more or less free to do as they want, but must make public disclosures of actions or decisions of material importance.

Markets that could be described as ‘authoritarian’ tend not to attract much capital from investors outside those jurisdictions, and investors within those jurisdiction—particularly those who are not politically connected—often tend to prefer to invest abroad. This is in large measure, because they are highly constrained in how they can respond to new information, changing supply conditions for inputs, and evolving demand conditions among consumers.

For example, if one were required to declare the precise nature of one’s enterprise as a condition of registration and permission to operate, and one were forbidden to deviate in the future from this stated purpose in response to changing expectations, regulatory inflexibility might create an incentive for one to take one’s business to a jurisdiction less plagued by bureaucratic micro-management.

At the other extreme, ‘anarchic’ markets tend not attract much capital from outside those jurisdictions, and investors within those jurisdictions—particularly those who are not politically connected—often tend to prefer to invest abroad. This is in large measure, because they have little recourse to dispassionate enforcement institutions, like unbiased judges, neutral regulators, and incorrupt police.

For example, if one were subject to routine breach of contract, expropriation of property, or threat of violence, regulatory apathy might create an incentive for one to take one’s business to a jurisdiction less plagued by uncertainty.

Between these two extremes are ‘transparent’ markets, which one tends to find in English-speaking countries and non-English-speaking countries where the legal systems have been based on or even borrowed from England or the USA (and possibly the commercial code from Germany). In these countries, one has a relatively free hand to organize one’s affairs as one sees fit and to change plans as needed.

For example, in Australia, Canada, the UK, the USA, etc., one can incorporate, regardless of one’s standing in the community, family membership, political affiliation, or even criminal background. One does not need to declare the specific purpose of one’s firm—the boilerplate ‘purpose’ being “to engage in any lawful activity”—seek sponsorship or permission to incorporate, or submit to a background check. One submits articles of incorporation, pays a fee, and stays current with one’s filing requirements.

The executives of privately held firms must communicate all decisions and actions that have a material impact on the firm to their shareholders, or risk civil or even criminal complaint. The executives of publicly traded firms must file public disclosures for seemingly trivial matters, or risk regulatory penalties.

Jurisdictions where transparency is the order of the day tend to attract both domestic and global investment, have efficient and liquid markets, and recover from crises robustly.

The optimal level of regulation lies somewhere between authoritarianism and anarchism, in which executives are free to form expectations, make plans, take action, and to modify their plans in light of new information—including rumor, superstition, and noise—changing supply conditions for inputs, and evolving demand conditions among consumers.

Invest accordingly.

Prof. Evans

La Porta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer, 2006. “What Works In Securities Laws?” Journal of Finance 61(1), 1-32.

[possibly available at: http://works.bepress.com/cgi/viewcontent.cgi?article=1000&context=florencio_lopez_de_silanes]

[2003 Working Paper available at: http://www.nber.org/papers/w9882]

Jan 032012

While responding to a Facebook post, about these final stages of the transition from a hodge-podge of nation-based Capital vs Labor economies to an integrated global Knowledge vs Service economy, it occurred to me that lovers of classical liberalism might be dismayed to see capitalism actually end up being its own undoing, as leftists have predicted… but not as leftists have predicted.

That is, not for economic reasons, but for political reasons.

In other words, the one perfect jewel that classical liberals hold so dear might perform precisely as advertised, but be surrounded by unappreciative drones who are two paychecks from reverting to savagery and outnumber the enlightened 99:1 by many accounts.

I exaggerate, but only for effect.

Imagine for a moment that an economy is going through a massive transition, such that:

  • A century ago, about 40% of the US workforce was engaged in agriculture. Today, it is a bit less than 2%.
  • A half-century ago, about 40-50% of the US workforce was engaged in manufacturing and distribution. Today, it is somewhere around 10% and falling.
  • A lot of white collar occupations are being taken over by software, including bookkeeping, accounting, paralegal, inventory control, etc.
  • Throw in about 10% working in various levels of government, and that leaves around 75-80% looking for something useful to do. In general, the choice is between a) high-end knowledge work, like entrepreneurship, industrial design, etc., and b) locally delivered personal services like pepper spraying peaceful protestors, automobile maintenance, etc.

That leaves a lot of idle hands.

Now, imagine that those hands get to vote.

All the eloquent arguments, apodictic truths, and hermetic logic in the world will not sway an electorate in thrall to populist demagogues, be their shirts red, brown, or black.

If my one, tiny voice mattered, I’d do what I could to get the humanitarians to stop hanging out with left-wing populists, and to get the classical liberals to stop hanging out with right-wing populists.

The false dichotomy of Eat the Rich vs Eat the Poor is a loser’s game.

The most charitable act that one can undertake to help the poor is to start a business and hire them. The most selfish act that one can undertake to keep the poor from storming the Bastille is to make sure that they have enough bread and circuses.

Invest accordingly.

Prof. Evans

Dec 092011

The Third Way

Wilhelm Röpke (1899-1966) is credited by many as one of the architects of the post-WWII German Economic Miracle, driven by the implementation of the Social Market Economy that is advocated by adherents of ORDO Liberalism, and associated with the Freiburg School of political economy.

(The term ORDO refers to an academic journal established in 1948 by the founders of the Social Market Economy movement in Europe following WWII.)

ORDO Liberals see a distinction between laissez-faire and Classical Liberalism that is very similar to what Karl Polanyi (1886-1964) describes in his book, The Great Transformation.

Essentially, laissez-faire is about means and Classical Liberalism is about ends, and there is no guarantee that laissez-faire will lead to Classical Liberalism. Evidence includes cartels, ‘old boy’ networks, cronyism, Unconscionable Contract, etc., all of which can exist under laissez-faire, but are very different from the ends that Classical Liberals advocate.

Some of the most repressive societies are those that have evolved in remote tribal villages, so far removed from formal government that it essentially does not exist.

On the other hand, the opposite of laissez-faire, statism, has led to unfathomable horrors including the twin extremes of National (‘right-wing’) Socialism and International (‘left-wing’) Socialism, the Khmer Rouge, and numerous Middle Eastern dictatorships, along with watered-down versions of in Cuba, Myanmar (Burma), Venezuela, Zimbabwe, et al., ad nauseam.

Statists see this not so much as a distinction between laissez-faire and Classical Liberalism, but as an inevitable consequence of laissez-faire, and they argue that government regulators and enforcers should achieve desired ends by whatever means are deemed acceptable.

In post-WWII Germany, the heavy hand of government was used to create a social safety net for the socioeconomic bottom-most while allowing market participants to allocate resources. So long as individuals employed means and achieved ends that were acceptable to government regulators, they were left to do as they wished. When someone in power determined that either the means or the ends were unacceptable, government agents stepped in to redirect the resources.

For the decade after the War, politicians and regulators steered the German economy down this middle way with some success, avoiding the excesses of command-&-control socialism at one extreme and the kind of anarchic chaos seen later in Russia following the fall of the Soviet Union at the other extreme. China’s rulers appear to be attempting to follow a similar path today.

If politicians and regulators are united in their belief that Classical Liberalism is the ultimate end, and that the constrained laissez-faire of the market is the most efficient means to achieve that end, with occasional intervention, then an ORDO Liberal policy regime can work.

There is, of course, no guarantee that subsequent generations of politicians and regulators will not err on the side of command-&-control, as happened in Germany in the last quarter of the 20th Century. Where individuals wield power, the danger always exists that they will use it in pursuit of personal agendas, even at the expense of the community as a whole.

Sovereignty without Sovereigns

Today, as we transition from capital/labor national economies to an integrated knowledge/service global economy, we face an altogether different set of challenges. The question today is not, “Will statutes and regulations be overly burdensome?” but “How can transnational firms and networks be hindered in forming cartels in the absence of a global statutory and regulatory authority?

In other words, the danger today is not that the agents of a national government might tax or regulate a firm or industry out of existence, but that the executives of transnational firms and networks will enter into contractual arrangements that create artificial monopolies or otherwise exploit their positions to the detriment of consumers.

Granted, Dominium is less of a concern than Imperium, but it is a concern, when it results in higher costs for those least able to afford them. At the extreme, executives gain a kind of sovereignty by being beyond the reach of any particular government other than the ones that they happen to be standing in.

An example of this is illustrated in a recent Bloomberg story, “U.S. Studies Derivatives That ‘Game’ Tax Rules” that describes some of the difficulties that US legislators and regulators are facing in their quest to control the executives of financial firms and the participants in derivatives markets.

A major part of the problem is the fact that all financial assets are either contracts or titles that derive their existence from individual agreements and social institutions. They can be transferred quasi-instantaneously; encoded, shredded, and stored transnationally; and accessed, reassembled, and decoded from any jurisdiction.

The only things preventing the establishment of a peer-to-peer asset exchange that exists purely on the Internet are inertia and convenience. The tools and designs have existed for more than a decade. As long as the cost of the status quo remains less than the benefit, individuals will resort to status quo organizations, but if legislators and regulators raise the cost of doing business conventionally much more, then transitioning to something else becomes a viable alternative.

Even in the absence of overt blundering, the relative benefits of technological innovations are growing at exponential rates, and the tipping over into a new order that is out of the reach of any national government probably will come no matter what politicians do in any particular jurisdiction.

In such a world, the idea of a Third Way becomes untenable, as no national regulator or enforcer will be strong enough to compel laissez-faire to lead to Classical Liberalism.

Where things will lead, like all else in the future, is unknowable, but it is not unimaginable. I will explore some possibilities in Part 2 of this essay.

Invest accordingly.

Prof. Evans

Dec 072011

Röpke on Imperium & Dominium

In addition to advocating the Social Market Economy, for which he is most famous, Wilhelm Röpke (1899-1966) distinguished between two types of colonialism that are of immense relevance to understanding the world today, as we transition from multiple capital/labor national economies to an integrated knowledge/service global economy.

Röpke referred to these as Imperium and Dominium. [warning: PDF] Imperium refers to political sovereignty, and it is projected at the point of a gun. Dominium refers to economic sovereignty, and it is projected at the point of a pen used to sign a contract.

Röpke recognized that both Imperium and Dominium are forms of domination, and that Imperium is by far the more violent of the two. In other words, if one were going to be dominated by a foreign power, one would be better off if that power were Nike and not the CIA. Still, one would be dominated, and one might be expected to chafe at that.

Historically, Imperium has been more potent than Dominium, e.g. the Roman, Ottoman, Spanish, British, etc. Empires. It was not until the 20th Century and the birth of the multinational corporation that Dominium began to emerge as a potent political force. As borders become increasingly meaningless today, corporate Dominium is supplanting government Imperium as the predominant means for projecting influence and power worldwide.

While agents of the US military drop bombs, executives of Chinese firms are buying controlling interests in the Panama Canal, Freeport (Bahamas), and other Western Hemisphere commercial infrastructure. In the long run, US taxpayers will tire of paying for adventures in nation building on their behalf, while one expects that the demand for global transportation will continue for the foreseeable future.

(And, make no mistake of it, the Americans might be flat-footed and incompetent imperialists, but they are master dominialists!)

As we have seen in the Middle East in 2011, when enough individuals realize that the real power is in transnational commerce, and that politicians and regulators govern at the pleasure of the people, their relationships with their rulers can change radically.


This is not to say that that future will be all roses, ice cream, and singing unicorns. Quite the contrary, colonialism and other forms of domination will persist, but in different forms from before.

One of the distinguishing characteristics of a colony is that it is a jurisdiction that exports raw materials and imports finished goods from the jurisdiction to which the raw materials were exported.

For example, historically, British weavers imported cotton and silk from India and exported finished cloth and apparel to India. In this way, the weavers were able to acquire raw materials at commodity prices and sell their output at significantly higher monopoly (one producer) or oligopoly (a small number of producers) prices.

Independence from British weavers was such an issue for Gandhi that he wove his own cloth as a sign of protest, and the spinning wheel became such an important symbol of Indian independence that it adorns the national flag of India.

Over the past century, the economic center of gravity has shifted away from agriculture to manufacturing to knowledge, and the nature of colonialism has changed.

Today, China, India, and Russia export large numbers of students and entrepreneurs — the raw materials of a knowledge economy — to North America and Western Europe, where they conduct research and produce commercial goods that find their way into textbooks, software, and other information goods that are then exported back to their homelands.

From this perspective, one can argue that colonialism never went away; it just changed industries. The raw material today is not fiber, grain, or rubber, but human capital.

As Röpke pointed out, today’s colonialism is not based on the imperialism of the past, which was imposed at the point of a gun in the employ of an East India Company; it is based on ‘dominialism’, which originates in commercial transactions.

While such distinctions have merit, and they appeal to academics and public intellectuals, from the perspective of the student in Shanghai, Bangalore, or Lahore… or São Paulo, or St. Petersburg, or Kiev, or La Paz, or pretty much anywhere outside of the G7 countries, such distinctions might ring hollow. Technically, it is true that one chooses to engage in transactions, but when those transactions relate to food, shelter, clothing, textbooks, and entertainment, the balance of economic power is tilted toward the supplier of the finished goods and away from the individual consumer.

Fading Power

The seat of global power is shifting from parliaments to boardrooms as corporations supplant governments, and today’s colonial masters of the people of the middle-income countries of the world are not France, the UK, or the USA, but Microsoft, Sony, and Wiley & Sons.

Whether this is ‘good’ or ‘bad’ or ‘right’ or ‘wrong’ is irrelevant. The fact is that the individuals in the middle-income countries outnumber the individuals in the G7 countries nearly 10:1, and they bear the brunt of Dominium. There was a time in India, when the British Empire seemed impervious… till Gandhi came along.

Today, Microsoft, Sony, and Wiley & Sons might seem impervious, but they enjoy their monopoly positions only so long as the people in the Middle Income countries do not realize that nothing stops them from being home to BookBoon, Khan Academy, or any of a multitude of other information services that requires effectively no capital investment.

As there is a cost for every benefit, and there’s no such thing as a free lunch, there is a benefit lurking with every cost, and chaos equals opportunity. The real game is not political but commercial. Currently, is being played in Silicon Valley, Manhattan, Mexico City, Miami, Shanghai, Singapore, and Bangalore.

Nothing stops it from being played in Accra, Addis Ababa, Dhaka, Kingston, Jakarta, Lahore, Montevideo, Tegucigalpa, or anywhere else.

Invest accordingly.

Prof. Evans