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“In the Beginning…Was the Unit of Account” – Twelve Myths About Money

November 19th, 2017 29 comments

Jan Kregel presented a great dinner speech at the recent Modern Monetary Theory Conference, touching on some of the fundamental ways we think about money and economics. (Sorry, no recording or transcript available.) I had a brief conversation with him afterwards, and we followed up with a few emails.

The quotation in the title of this post is condensed from the final line of one of his emails — a line that made me laugh out loud:

“So I guess we start from that — in the beginning was the word, and the word was the unit of account?”

Okay, yes: money-dweeb humor. But the implications are kind of profound.

The Word. LogosIndeed. I’ve written about this before — how writing in its earliest forms emerged from tally sheets, accounting. Even, that its emergence was the first step on the road to outsourcing our memory onto iPhones, maybe even (only somewhat tongue in cheek) causing human brains to shrink over millennia.

Jan’s great line, and our conversations, prompt me to set down some thoughts on this ever-vexed subject. Herewith, twelve widespread usages and conceptions that, in my experience, tie our money discussions in knots. Please assume that anything you don’t like here is mine, not Jan’s, and apologies to those who have heard some of this from me before.

(A proleptic response to an inevitable digression: I’m assuming a closed national or world economy for simplicity. The “rest of world” sector, and the exchange rate with Martian currency, are not considered.)

#1. Money was invented around 700 BCE. No. That’s when coins were invented — handy physical tokens making it easy to transfer assets from one person’s (implicit) balance sheet to another’s. Money existed on something like balance sheets — tallies of who owns what and who owes what — long before that; those tallies go back thousands or tens of thousands of years. Mentions of monetary values in written documents — designated in staters, drachms, whatever — were widespread long before anyone thought of using coins for asset transfers.

The earliest coins, by the way, may well have been badges of honors and offices issued by religious authorities. Somehow people started exchanging them, and voila: physical currency. This had little or nothing to do with butchers and bakers or convenient time-shifting of purchases. That’s a made-up armchair myth (though the convenience benefit is real). Wampum, likewise, wasn’t used for trade exchange until Europeans captured that “money” system and transformed it.

#2. Money is a “medium of account.” (Whatever “medium” means in that phrase…) Money was invented when some clever tally-keeper, totting up cows and horses and bags of grain, invented the arbitrary unit of account — a unit that allows those heterogenous goods to be tallied on a single sheet, in a common unit of value. We find price lists of assorted goods on some of the earliest Sumerian tablets, for instance, and price lists can’t exist without a unit of account. It’s hard to know, but it seems like this clever technology might have been invented multiple times over the millennia.

If this historical tale holds water, the earliest forms of money were just…the value of tallied (balance-sheet) assets, with the value designated, denominated, in a unit of account. In the beginning…

By this thinking, an “asset” is a labeled balance-sheet entry, designating the value of an ownership claim — again, designated in a unit of account. These “asset” things only exist on balance sheets. The claims themselves may be informal — you own the apple on your kitchen counter by norm, convention, and common law. Or they may be formal, inscribed in one or more legal instruments and a supporting body of law and norms. The forms and terms of these ownership-claim instruments are myriad and diverse.

Money in this sense is the UofA-designated value of an ownership claim (perhaps formally recorded in an asset entry).

Ask a real-estate zillionaire, “how much money do you have”? The answer has nothing to do with physical dollars in wallets, or any particular class of ownership claims/assets that are tallied up in “monetary aggregates.” It’s about total assets or net worth — necessarily, designated in a unit of account.

The problem arises when we confute these two common meanings of the word. Start watching: you’ll often see it happen even within a single sentence. This ubiquitous muddle — trying to talk about two different things using the same word — has engendered unending confusion.

Both uses of the word are perfectly valid and useful; they just mean completely different things.

#3. There is such a thing as non-fiat money. Nope. (A better description is “consensus” money. The consensus is usually enforced by the fiat powers of a government, temple authorities, etc.) The consensus exchange or “face” value of precious-metal coins must always be higher than the market value of the metal substrate. If the reverse were true, people would just melt them down. Outside the fiat/consensus purview of the issuer, those coins many only retain their substrate value. So they’re still valuable for far-flung trade, or if authority breaks down, because the commodity may still retain consensus value. (That security in itself can contribute to holding up their consensus face value.)

Ditto cigarettes in POW camps. There are physical things called cigarettes, but there’s also this conceptual thing that emerges when people start using them in general trade: a cigarette.” Or “the cigarette.” It’s a unit that can be used to designate the value of other things.

The consensus value of coins and currency is based on the stability of the unit of account. (See: Brazil.) The coins are just physical tokens representing a unit of exchange — an asset that can be transferred, and that’s designated in the unit of account. In the beginning…

#4. Money “is” debt. Or, “you are paying with liabilities.” Money, by any definition, is always and everywhere an asset of the holder. The $5 bill in your pocket or the five dollars in your checking account are assets on your balance sheet. Paying, spending, is transferring assets to someone else — from the lefthand side of your balance sheet to the lefthand side of theirs.

Now of  course money issuance is often associated with the creation of new balance-sheet liability entries — think government deficit spending — but those liabilities are posted to the money issuer’s balance sheet. The recipient gets an asset: the credit half of the tally stick. That’s what gets passed around in spending and payments. The debt side is generally held on the balance sheet of large, powerful creditors or institutional authorities.

This isn’t just true of “cash”; government bondholders are obviously holding assets. The debt is on the government balance sheet. “Holding debt” is a handy shorthand for finance types, but considered even briefly, it makes no literal sense at all. How could you hold or own something you owe?

Ditto “paying with liabilities.” If you transfer a liability from the righthand side of your balance sheet to the righthand side of another’s, you are unlikely to receive much thanks, or any value in return.

These usages can be useful, stylized ways of referring to particular economic, financial, and accounting relationships. Which is fine as long as users are perfectly clear on how the thinking is stylized. But on their face they don’t make sense, and they engender great confusion. Money is always an asset of the holder.

#5. People “spend out of income.” Spending, payments, always come from asset balances. That’s what payments are — asset transfers. When you write a check, you withdraw from your checking-account balance. When you buy a bag of Doritos at 7-11, the money’s coming out of your wallet. It’s impossible to “spend out of” the instantaneous event of somebody handing you a five-dollar bill. Once it’s in your hand, once it’s an asset you own, you can spend it.

“Spending out of income” is another of those common usages — a useful shorthand way to talk about spending more or less than you receive over a period. It’s an unconsidered commonplace that deeply confuses our conversations about money.

#6. There’s a difference between “inside” and “outside” money. After new money is issued, its origin is immaterial in the particular. Where did the $100 in your checking account “come from,” originally? Say I borrowed it, or got it in a tax refund, or whatever, then paid it to you. It’s impossible to say, and it doesn’t matter, where it came from.

New assets appear in account balances from 1. government deficit spending, 2. bank lending, and 3. holding gains. Then people swap them for other assets, or transfer them to pay for newly produced goods and services. Whether the money came from “inside” or “outside” sources (or holding gains), once it’s circulating among accounts, it’s just…money. As we all know, money is fungible.

Certainly, newly created liability entries associated with money issuance can be economically significant. And some particular financial instruments retain a meaningful and influential financial or economic (ultimately institutional) relationship to particular liability entries. But in the big picture once the money’s out there, it’s disconnected from its “inside” or “outside” origins.

#7. Monetary aggregates tell us how much “money” we have. The various monetary aggregates so beloved of monetarists (M0, M1, MZM…) share a common, unstated definition of “money”: financial instruments whose prices are institutionally pegged to the unit of account — physical coins and currency, checking account and money-market deposits, etc. Remember the 2008 headlines: “Money Market Fund ‘Breaks the Buck.’” The institutional powers and practices of pegging are diverse, and institutional pegging can fail.

This particular subset of assets — fixed-price, UofA-pegged financial instruments — comprise only about 9% of U. S. households’ $111 trillion in assets. They play a particular role in individual and aggregate portfolio allocation (more below), and they’re quite handy for buying new goods. But their stock quantity is swamped by even the price-driven change in other assets; capital gains on variable-priced instruments added $7 trillion to household balance sheets in 2013 alone. Monetarists’ fetishization of these “currency-like” financial instruments, and their aggregates, is…misplaced.

#8. If people save more money, there is more money (or “savings,” or “loanable funds”). Obviously, if you save (spend less than your income over a period), you have more money. But we don’t. Just, the money’s in your account. If you spent it instead of saving it, it would be in somebody else’s account.

Spending — even spending on consumption goods that you’ll devour within the period — is not consumption. The money isn’t, can’t be, “consumed” by spending. It’s created and destroyed by other, financial, mechanisms. If you eat less corn, we have more corn. If you spend less money, we have no more money.

#9. Saving “funds” investment. Investment spending, like all spending, comes from asset balances. “Funding” from flows is harder to nail down: If a firm this year has $1M in undistributed profits (saving) and borrows $1M, spends $1M on wages and buys $1M in drill presses, which inflow “funded” which outflow? Firms borrow to make payroll all the time. (Don’t even get me started on stock repurchases.)

I can’t resist quoting one of the best financial and economic thinkers out there (read the whole thread):

Individual money-saving isn’t even really a flow; it’s a non-flow — not-spending — just an accounting residual of income minus expenditures. (Though of course it’s a flow measure: tallied over a period of time, not at a moment in time.)

#10. Portfolio allocations — and spending — are determined by “demand for money.” The relatively small stock of monetarists’ “money” — instruments whose prices are pegged to the unit of account — is sort of a fulcrum around which portfolio preferences and total asset value (wealth) adjusts. But the vague gesture toward the unmeasurable and dimensionless notion of “demand” is not illuminating. Here in more concrete terms:

Suppose government deficit-spends $1 trillion into private-sector checking accounts. The market’s portfolio is overweight cash (assuming portfolio allocation preferences are unchanged). But the market can’t get rid of those fixed-price instruments — certainly not by spending, which just transfers them — or change their aggregate value (their price is fixed, pegged to the unit of account).

So people buy variable-priced instruments — stocks, bonds, titles to real estate, etc. — bidding up their values competitively until the desired portfolio allocation is achieved. (This, by the way, is exactly how things work in the more advanced Godley/Lavoie-style, “stock-flow consistent” or SFC models.)

The economic implications of this: A trillion-dollar deficit-spend results in $1T more in private-sector assets (the “cash”), plus any asset-value runups from portfolio adjustments triggered by that cash infusion. (This is before even considering any effects on new-goods spending — the so-called “multiplier” — or the proportion of spending devoted to investment — Keynes’s particular fixation.)

Sure, if wealthholders are feeling nervous — more concerned with return of their wealth than returns on their wealth — they may prefer instruments that by their very nature guarantee stability, non-decline relative to the unit of account. They’ll sell variable-priced instruments, running down their prices until the market reaches its preferred portfolio allocation. “Liquidity preference” is one rather strained way to refer to this straightforward idea of portfolio allocation preferences.

Likewise, “demand for money” is a cute conceptual and verbal jiu-jitsu, flipping straightforward understandings of portfolio preferences on their heads. Demand is supposed to influence price and/or quantity. But it can’t influence the “price of money” or the aggregate stock of fixed-price instruments — only the prices, hence aggregate total, of variable-priced instruments. This notion does far more to confuse than to enlighten.

Takeaway: holding gains and losses — which are almost universally ignored in economic theory even though they’re the overwhelmingly dominant means of wealth accumulation — are the very mechanism of aggregate portfolio allocation. If you’re only considering “income”-related measures (which ignore cap gains), there’s no way to think coherently about how economies work.

#11. The interest rate is the “price of money.” This is like saying a car-rental fee is the price of a car. The price of a dollar (a unit of exchange) is always one, as designated in the dollar (the unit of account). The cost of borrowing is something else entirely. Like “demand for money,”  “the price of money” is just verbal and conceptual gymnastics, inverting the very meaning of the word “price,” and trying to shoehorn money-thinking into a somewhat inchoate notion of supply and demand (that’s constantly refuted by evidence). It’s not helping.

#12. Central bank asset purchases are “money printing.” Not. Sure, the Fed magically “prints” a zillion dollars in reserves to purchase bonds. But then it just swaps those reserves for bonds, which are “retired” from the private sector onto the Fed’s balance sheet. Private-sector assets/net worth are unchanged; the private sector just has a different portfolio mix: more reserves, less bonds.

Ditto when the Fed sells the bonds back (as it’s now doing and promising to do, a bit); it re-absorbs the private sector’s reserve holdings and releases bonds in return, disappearing the reserves back into its magic hole in the ground. (As Milton Friedman observed, banks have both printing presses and furnaces.) Again: no accounting effect on private-sector assets or net worth.

QE and LSAPs do have some asset-price, hence balance-sheet, effect, at least while they’re happening; the central bank has to beat market prices by a smidge to play the whale and buy all those bonds. Bond prices go up and yields go down. Which will push investors’ portfolio allocations more into equities and other “risk assets,” driving up their prices some. But the first-order accounting effect is just to change private-sector portfolio allocations.

So there: twelve conceptions about money that have made it difficult or impossible for me, at least, to think coherently about the subject. Here’s hoping these thoughts are useful to others as well.

=============

I’d like to end this post with the same question for my gentle readers that I went to Jan with. Units of account are very odd conceptual constructs indeed. They’re not like other units of measurement — inches, degrees centigrade, etc. — which generally have some physical objective correlative: “length” or “warmth” or suchlike. Units of account tally “value,” which basically means value to humans, a function of human desire. And human desires, of course (“preferences”), vary.

So my question: what’s a good metaphorical or figurative comparison to help us understand and explain this strange conceptual thingamabob? Is money an invention like algebra? Are there other conceptual constructs that are similar to units of account, comparable mental entities that can help us think about what these things are? I can’t think of any good analogies. It’s vexing.

Extra points question: what is “the bitcoin”?

Yes: In the beginning was the word. Words are one of the main things, maybe the main thing, that we use to think together. All thanks to my gentle readers for any help in doing that.

The Giant Logical Hole in Monetarist Thinking: So-Called “Spending”

May 3rd, 2017 4 comments

Ralph Musgrave, who knows a thing or two about modern economic thinking, perfectly articulates the giant logical hole in monetarist thinking in a recent comment (emphasis mine):

If the private sector’s stock of saving is what it wants at current rates of interest, then additional public spending will push savings above the latter desired level, which will result in the private sector trying to spend the surplus away (hot potato effect).

Really? People/households say to themselves, “Wow, I’ve got too many assets, too much net worth. I’d better spend more to get rid of it.”

Here’s the verbal and logical sleight of hand that monetarists pull to hide this obviously inane assertion, and that Ralph doesn’t seem to have spotted: they game the word “spending.”

When government deficit-spends, it deposits (helicopter-drops) new assets, created ab nihilo, onto private-sector balance sheets. And since that deficit spending doesn’t create new private-sector liabilities, voila: there’s more private-sector net worth.

Those new assets hit balance sheets in the form of “cash”: checking-account deposits, money-market fund balances, etc. So people might end with a higher proportion of cash in their portfolios than they would like.

But they don’t try to “spend it away” to get rid of it. They rebalance their portfolios by buying riskier/higher-return financial instruments — bonds, equities, titles to real estate. This drives up the prices of those instruments.

These market runups create new balance-sheet assets (and net worth) — while leaving the collective stock of fixed-price “cash” unchanged. (That’s pretty much the definition of “cash”: financial instruments whose price is pegged to the unit of account — the instruments that monetary aggregates try to tally up.)

With a larger percentage of bonds, stocks, etc in their portfolios, and the same amount of cash, people have the portfolio mixes they want. Full stop. No hot potato. Likewise this is no game of musical chairs; market runups create more chairs. This is how “liquidity preferences” play out in the markets.

Those purchases of riskier financial instruments are not “spending.” People aren’t “spending down” their balances on newly produced goods and services. They’re just asset swaps — cash for Apple stock (and the reverse), or whatever. Through the magic of market-makers’ bid/offer order books, these asset swaps create new assets, collectively achieving investors’ preferred or “desired” portfolio mixes.

(Note: investors could also adjust their portfolios by paying off debt, simply shrinking their individual, and the collective private sector’s, balance sheets by disappearing both assets and liabilities into a hole in the ground. As Milton Friedman said, banks have both printing presses and furnaces.)

Now you might suggest: when people bid up Apple stock, that “causes” there to be more investment spending, spending to create more long-lived goods. I’m hoping I don’t have to explain all the logical flaws in that thinking, or point out the empirical disproofs. (It’s basically a freshman error: confusing “investment” with investment.)

Sure: when people buy into IPOs and new private bond issues, or buy titles to new (spec-built?) houses, there’s a quite plausible causal link between those asset swaps and actual increased investment spending. An excess proportion of cash in investors’ portfolios could certainly drive this economic effect.

But: 1. These purchases of newly issued financial instruments constitute a tiny proportion of the portfolio rebalancing we’re talking about; the magnitude of holding gains on existing instruments swamps these measures, and 2. It has nothing to do with investors trying to “spend down” and get rid of their balances, cash or otherwise. That notion is individually implausible, and collectively incoherent.

 

Liberals Getting It Wrong on the Job Guarantee

February 25th, 2017 4 comments

I’ve been quite troubled lately by voices I’ve been hearing from my compatriots on the Left discussing the Job Guarantee — especially in relation to an alternative, Universal Basic Income. A new Jacobin article by  displays several of the aspects that make me uncomfortable.

Get the Math Right. Right off the bat, I’m troubled by the article’s flawed arithmetic — not what I would like to be seeing from left economists who need to be scrupulous in their role as authoritative voices for the left.

…we argue for a FJG that would pay a minimum annual wage of at least $23,000 (the poverty line for a family of four), rising to a mean of $32,500. … In comparison, many of the UBI proposals promise around $10,000 annually to every citizen…half the rate that would be available under the FJG.

$10K per citizen versus $23K per worker is not “half the rate.”

How do the two policies actually compare? I have no idea. This is exactly the kind of difficult calculation that we need economists to do for us (it’s way beyond our abilities), so we can evaluate different policies. Absent analysis with clearly stated parameters (Who counts as a citizen? Children? Etc.) this kind of statement carries no import or information value.

These analyses have been done by economists. I’ve seen them around. But I don’t have them to hand; they’re exactly what I’d like this article to point me to. Are these authors unaware of this work, or did they just not bother to look at it, draw on it, or cite/link to it in this article?

Perhaps most important: this kind of slipshod analysis delivers live and loaded rhetorical ammunition to the enemy. It’s an invitation to (very effective) hippie-punching.

Get outside economists’ fetishistic obsession with short-term business cycles, and with the automation versus globalization debate. We’re facing decades-long campaigns to get any JG or UBI implemented, and decades- or centuries-long technological and job-market trends. If Ray Kurzweil’s exponential productivity growth is even somewhat valid (choose your exponent), we’re facing at a world where Star Trek-style replicators can turn a pile of dirt into a skyscraper or a thousand Thanksgiving dinners — and potentially, where a small handful of people own all those replicators.

In this world, nobody would ever pay a human to produce goods. It would be stupid. Will service work deliver the kind of jobs and wages that let a worker share the fruits of that spectacular prosperity? It doesn’t seem likely. Will the highest-paying service jobs themselves be automated? It seems likely.

That’s an extreme vision, but it embodies the long-term issues these policy discussions need to address. Instead we get from the authors:

The dangers of imminent full automation are overstated…. No doubt, stable and high-paid employment opportunities are dwindling, but we shouldn’t blame the robots. Workers aren’t being replaced by automatons; they are being replaced with other workers — ones lower-paid and more precariously employed.

They’re pooh-poohing the technological future — continuing centuries of Luddite-bashing — because (quoting Dean Baker):

In the last decade, however, productivity growth has risen at a sluggish 1.4 percent annual rate. In the last two years it has limped along at a pace of less than 1 percent annually.

Issues here, in very short form: 1. Productivity and “economic capacity” measures are wildly problematic, both theoretically and empirically. The econ on this is a mess. 2. A decade, much less two years, is not even close to a trend. 3. The automation vs offshoring debate is specious; they’re inextricably intertwined, like nature and nurture. 4. They’re (I think unconsciously) buying into the whole economic worldview and conceptual infrastructure (think: “factors of production”) that delivered us unto these times.

The authors are certainly correct that:

…the balance of forces over the last few decades has been skewed so dramatically in the favor of capital. … It’s time to get the rules right

But this fairly muddled (and hidebound) depiction of the issues at hand does little or nothing to suggest what the new rules should be. We need left economists to unpack these long-term secular forces and trends far more cogently — and radically. They need to be examining the very foundations of their economic thinking and beliefs.

The “Dignity of Work.” It actually makes me squirm in discomfort to hear liberals with very cool, interesting, high-paying jobs going on about the dignity of work. I’m just like, “how dare you?” That kind of supercilious presumption arguably explains why liberals have been losing elections for decades — especially the latest one.

Here’s the full passage on this:

Conventional wisdom holds that people dislike work. Introductory economics classes will explain the disutility of labor, which is a direct trade-off with leisure. Granted, employment isn’t always fun, and many forms of employment are dangerous and exploitative. But the UBI misses the way in which employment structurally empowers workers at the point of production and has by its own merits positive dimensions.

This touches on a heated debate on the Left. But for now, there is no doubt that people want jobs, but they want good jobs that provide flexibility and opportunity. They want to contribute, to have a purpose, to participate in the economy and, most importantly, in society. Nevertheless, the private sector continues to leave millions without work, even during supposed “strong” economic times.

The workplace is social, a place where we spend a great deal of our time interacting with others. In addition to the stress associated with limited resources, the loneliness that plagues many unemployed workers can exacerbate mental health problems. Employment — especially employment that provides added social benefits like communal coffee breaks — adds to workers’ well-being and productivity. A federal job guarantee can provide workers with socially beneficial employment — providing the dignity of a job to all that seek it.

The variations on the “dignity” thing are endless. Our authors here give us:

employment structurally empowers workers at the point of production

This is clearly something that working-class workers and voters are clamoring for.

by its own merits positive dimensions

Sure: in our current system where only wage/salary work provides “dignified” income, you’re gonna see positive second- and third-order effects from employment. Does a program where government provides the income (in most implementations, channeled through private-sector employers) change that pernicious social environment?

But wait: workers get communal coffee breaks!

The whole thing actually, rather remarkably, turns Marx on his head. The alienation that he imputes to working-for-the-man, wage labor is here transformed into the sole, primary, or at least necessary source of human dignity and self-worth. It’s the only way for the working class “to contribute, to have a purpose, to participate in the economy and, most importantly, in society.” Contra David Graeber, if there’s not a money transaction involved, it’s not “valuable” or worthy.

This before even considering the freedom to innovate and thrive that arises when you don’t have to go to work. (Every startup I’ve ever been involved in — many — began with endless hours of hanging out and drinking beer with friends.)

Like so much so-called left thinking over the last half century (think: The Washington Consensus), this thinking unquestioningly, even blindly, unconsciously, adopts and is entrapped by one of conservatism’s core economic mantras: “incentives to work.”

Why in the hell do we want people to work more? We know why conservatives do: because it allows rich people to profit from that labor and grab a bigger piece of a bigger pie. But isn’t the whole point of increasing productivity (or a/the main point) to work less while having a comfortable and secure life?

What the authors dismiss as “conventional wisdom” is in fact largely correct: Most people don’t want to go to work. Or they don’t want to work nearly as much as they do. They can manage their “relationships” and social well-being just fine, thank you. Sure, they enjoy the social interaction at work, to the extent that… But they go to work because they want and need the money. Full stop.

In 1930 Keynes predicted a future of 15-hour work weeks. Sounds idyllic to me. Does anyone think workers would object? Or do we have a better handle on their wants and needs than they do?

We haven’t even come close to that future. Two-earner households are now the necessary norm, and hours worked per worker has been flat since — surprise — 1980, after a very nice decline postwar. Here’s annual hours worked per household, even as households have gotten steadily smaller:

A job guarantee as I understand it does nothing to advance that Keynesian bright future. Given the pro-work rhetoric we hear from JG enthusiasts, it might just further entrench what you see above.

So three takeaways here:

• Get the math right. Do the careful, difficult analysis for us so we can make informed judgments. Or point us to the work that’s already been done.

• Look to your theoretical and empirical fundamentals. They’re often inherited, often unconsciously. They’ve been indoctrinated and inscribed into economists’ invisible System 1 thinking. Many of them are not conceptually coherent, or morally valid.

• Just stop talking about the “dignity of work.” It’s a huge own-goal — both the policy results (more work for workers), and the electoral results of that presumption.

If we want that Keynesian utopia — comfortable, secure lives with not a lot of work required — UBI seems like a far more direct path to getting there. If you want to give people comfort, security, dignity, well-being, power, the opportunity to thrive on their own terms, and economic security…give them money.

 

My Letter to the Fed: Stop Misrepresenting the National Debt

February 14th, 2017 Comments off

The Fed data portal, Fred, just posted a blog item that I take exception to, “suggested” by Christian Zimmermann, Assistant Vice President of Research Information Services. Here’s my response.

Dear Mr. Zimmerman:

I’m pleased to see that this post focuses on the interest burden of the federal debt. It’s an important measure that doesn’t get enough attention in discussions of the subject.

But still I’m shocked by how many things are poorly represented in the post. I have no doubt you know all of this, but:

1. Public Debt is not Debt Held by the Public. (“The Public” here meaning the private sector.) Public debt includes money owed by government to itself (SS trust fund, etc.).

Almost every economist agrees that Debt Held by the Public, not “Gross Debt,” is the economically significant measure. Highlighting gross debt is not useful in educating the public on this subject. Quite the contrary.

This measure of course paints a very different (and less dire) picture:

2. This of course impacts the interest burden, and also paints a very different picture.

3. Even for Debt Held by the Public: Federal Reserve Banks are included in “the public” for this measure — even though their balance sheets and profits/losses redound to Treasury, IOW government, not “the public.”

Here’s actual Debt Held by The actual Public — only 60% of GDP:

One can discuss whether the Fed will ever shrink its balance sheet, and how it would do so, but this is the current condition.

4. Again, the interest burden: Treasury’s interest payments to Fed banks on their bond holdings cycle directly back to Treasury. So true, total government out-of-pocket interest payments:

Less than 1% of GDP.

5. Circa 50% of those interest payments are to the U.S. domestic private sector, so are in no way a drain on the U.S. domestic sector.

Interest payments to foreign entities come to less than .5% of GDP.

Probably unintentionally, this Fred post contributes to the widespread “scare tactics” that result in such economically destructive fiscal decisions by our legislators.

Thanks for listening,

Steve Roth
Publisher, Evonomics

What’s All Our Stuff Worth? Tobin’s Q for America

December 7th, 2016 5 comments

In recent posts on the Integrated Macroeconomic Accounts, I’ve highlighted that we have two market estimates of what America’s “capital” is worth — the cumulative sum of net investment (roughly, “book value”), and total household wealth (“market value”). I got curious: how to they compare over the decades? What’s America’s market-to-book ratio, or Tobin’s Q?

Here are two pictures depicting that:

screen-shot-2016-12-07-at-10-01-07-am

screen-shot-2016-12-07-at-9-59-47-am

And here’s how I calculated them based on the IMA’s table S.2.a, plus BEA inflation measures (spreadsheet here):

Start with the IMA’s estimate of total household net worth in 1960 (expressed in 1960 dollars), as the asset markets’ best estimate of what all America’s stuff (“capital”) was worth at that moment.

Inflation-adjust that value to show it in 2015 dollars. (Choose your deflator; I tried a few, but settled on simple old CPI.)

Add net capital formation (net of capital consumption) for 1960, again expressed in 2015 dollars. This is the value of stuff added to our stock. That gives you book value of our stuff in 1961 (the 1960 stock of stuff, plus new stuff added).

Repeat for each ensuing year, ending in 2015 with a cumulative sum of all those years’ net capital formation. This is the 2015 “book value” of that accumulated stuff, expressed in 2015 dollars. (See: Perpetual Inventory Method.)

Now for comparison, look at the IMAs’ annual estimates of household net worth, with each year converted to 2015 dollars. These are the asset-markets’ year-by-year estimates of the value of all our stuff. (Alternatively you could use “U.S. Net Wealth” from Table B.1, which excludes the value of land and nonproduced nonfinancial assets.)

Is this interesting or significant? Do these pictures tell us anything useful?

The main takeaway, I think: since the mid 90s, the measures of capital formation have been having a lot of trouble capturing the value of…new capital formation. Hard-to-measure intellectual, human, and social capital have increasingly dominated our economy. The existing-asset markets incorporate that new “capital” into their estimate of our total worth, but measures of sales in the new-goods markets have trouble doing so. (This even after the 2013 GDP revisions, which added much “intangible” value to its measures, notably intellectual property and even “brand value.”)

For example, how valuable are the services from Facebook, Twitter, and Google? Nobody pays anything for them. And the advertising spending that supports them (in case you were wondering) is not counted as part of GDP. Advertising is considered an “intermediate good,” an “input to production,” so is excluded from the “value added” that is GDP. (For reference, U.S. advertising spending is about $150 billion a year — 0.8% of GDP.) The stock market knows (thinks) those firms have value, but how much “capital formation” do they do? It’s a pretty dicey question.

Apply the same kind of thinking to even harder-to-measure human intangibles like knowledge and skills, developed through education and training, and you probably have a pretty good explanation of the divergence between the book and market lines over recent decades.

 

No: Money Is Not Debt

August 27th, 2016 19 comments

A quick note in response to recent twitter thread, and to a widespread usage that I find to be deeply problematic.

You constantly hear very smart thinkers about money saying that money is debt. I strongly disagree. It’s not a useful way to think about money. Quite the contrary.

Balance-sheet assets designating the value of claims may have offsetting liabilities/debts on other balance sheets. (Not all do; that’s why, for instance, U.S. households have positive net worth — assets minus liabilities, credit minus debt — of $88 trillion.) But in any case, the asset being “held” is credit, not debt. A holder of a Target gift card is holding Target credit, not debt — the “claim” side of the tally stick.

“Holding debt” is handy and ubiquitous (Wall Street) shorthand, but it’s conceptually incoherent. You can’t own an obligation; it’s not an asset. Money is not “debt.” Exactly the opposite.

I think this “money is debt” confution cripples our our conversations, our collective thinking, and our collective understanding.

Semi-aside: a dollar-bill is best thought of as a handy, exchangeable physical token representing a balance-sheet asset. Sure, that asset has an offsetting nominal “liability” on the government balance sheet (which we devoutly hope will never be “paid off”). That’s immaterial; the dollar bill represents credit, an asset. It’s incoherent to suggest that when you have a dollar bill in your pocket, you are holding “debt.”

Even if the asset you’re holding will someday be redeemed by the original issuer, the thing you’re holding holding is an asset, which you can transfer to someone else’s balance sheet in exchange for work, or real stuff or…some other financial instrument, be it a Euro bill a bond, a title to land, or whatever (which is also a credit, or asset). They’re all financial instruments (with various rights designated). Claims. Credits.

Economists Agree: Democratic Presidents are Better at Making Us Rich. Eight Reasons Why.

August 13th, 2016 Comments off

In 2013, economists Alan Blinder and Mark Watson — no wild-eyed liberals, they — asked a very important question: Why has the U.S. economy performed better under Democratic than Republican presidents, “almost regardless of how one measures performance”?

Start with their “performed better” assertion: it’s uncontestable. While you can easily cherry-pick brief periods and economic measures that show superior economic performance under Republicans, over any lengthy comparison period (say, 25 years more), by pretty much any economic measure, Democrats have outperformed Republicans for a century. Even Tyler Cowen, director of the Koch-brothers-funded libertarian/conservative Mercatus Center, stipulates to that fact without demur.

Here’s just one bald picture of that relative performance, showing a very basic measure, GDP growth:

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The difference is big. At those rates, over thirty years your $50,000 income compounds up to $105,000 under Republicans, $182,000 under Democrats — 73% higher. (And this is all before even considering distribution — whether the growing prosperity is widely enjoyed, or narrowly concentrated.)

Hundreds of similar pictures are easily assembled — different time periods, different measures, aggregate and per-capita, inflation-adjusted or not — all telling the same general story. No amount of hand-waving, smoke-blowing, and definition-quibbling will alter that reality. (If you feel you must try to debunk Blinder, Watson, and Cowen: be aware that you almost certainly don’t have an original argument. Read the paper, and follow the footnotes. You’ll also find more hereherehereherehere, and here.)

So what explains that superior performance? Blinder and Watson’s regression model basically says, “we dunno.” Their model, for whatever it’s worth, rules out a whole slew of possibilities — only finding a significant correlation with oil price shocks (uh…okay…) and Total Factor Productivity (the black-box residual economic measure that’s left when the other growth factors economists can think of are accounted for in their models).

Standing empty-handed after all their work, Blinder and Watson punt. They attribute Democrats’ consistently superior performance to…luck. Yes, really.

On its face, the bare fact of Democrats’ consistent outperformance suggests a straightforward explanation: Democrat policies and priorities, in their myriad interacting forms, expressions, and implementations, directly cause faster growth, more progress, greater and more widespread prosperity. (Blinder and Watson pooh-pooh this idea, simply because they don’t find short-term correlation with the rather bare measure of fiscal balances.)

So the question remains: what could it be about the Democratic economic policy mix that delivers superior performance? Here are eight possibilities:

1. Wisdom of the Crowds. Democrats’ dispersed government spending — education, health care, infrastructure, social support — puts money (hence power) in the hands of individuals, instead of delivering concentrated streams to big entities like defense, finance, and business. Those individuals’ free choices on where to spend the money allocate resources where they’re most valuable — to truly productive industries that deliver goods that humans actually want.

2. Preventing Government “Capture.” Money that goes to millions of individuals is much harder for powerful players to “capture,” so it is much less likely to be used to then “capture” government via political donations, sweetheart deals, and crony capitalism.

3. Labor Market Flexibility. When people feel confident that they and their families won’t end up on the streets — they know that their children will have health care, a good education, and a decent safety net if the worst happens — they feel free to move to a different job that better fits their talents — better allocating labor resources. “Labor market flexibility” often suggests the employers’ freedom to hire and (especially) fire, but the freedom of hundreds of millions of employees is far more profound, economically.

4. Freedom to Innovate. Individuals who are standing on that social springboard that Democratic policies provide — who have that stable platform of economic security beneath them — can do more than just shift jobs. They have the freedom to strike out on their own and develop the kind of innovative, entrepreneurial ventures that drive long-term growth and prosperity (and personal freedom and satisfaction) — without worrying that their children will suffer if the risk goes wrong. Give ten, twenty, or thirty million more Americans a place to stand, and they’ll move the world.

5. Profitable Investments in Long-Term Growth. From education to infrastructure to scientific research, Democratic priorities deliver money to projects that free market don’t support on their own, and that have been thoroughly demonstrated to pay off many times over in widespread public prosperity.

6. Power to the Producers. The dispersal of income and wealth under Democratic policies provides the widespread demand (read: sales) that producers need to succeed, to expand, and to take risks on innovative new ventures. Rather than assuming that government knows best and giving money directly to businesses (or cutting their taxes), Democratic policies trust the markets to direct that money to the most productive producers.

7. Fiscal Prudence. True conservatives pay their bills. From the 35 years of declining debt after World War II (until 1982), to the years of budget surpluses and declining debt under Bill Clinton, to the radical shrinking of the budget deficit under Obama, Democratic policies demonstrate which party merits the name “fiscal conservatives.”

8. Labor and Trade Efficiencies. The social support programs that Democrats champion — if they truly provide an adequate level of support and income — give policy makers much more freedom to put in place what are otherwise draconian, but arguably efficient, trade and labor policies. If everyone can confidently rely on a decent income, we have less need for the sometimes economically constricting effects of unions and trade protectionism.

To go back to Blinder and Watson’s “luck” explanation: A non-economist might suggest that “to a great extent, you make your own luck.” And: “hire the lucky.”

Cross-posted at Evonomics.

Noahpinion: What Causes Recessions? Debt Runups or Wealth Declines?

June 7th, 2016 Comments off

Noah Smith asks what seems to be an interesting question in a recent post: “what leads to big recessions: wealth or debt”?

But I’d like to suggest that it’s actually a confused question. Like: is it the heat or the (relative) humidity that makes you feel so hot? Is it the voltage or the amperage that gives you a shock, or drives an electric motor? The answer in all these cases is obviously “Yes. Both.”

The question’s confused because wealth and debt are inextricably intertwined. “Wealth” is household net worth — household assets (including the market value of all firms’ equity shares) minus household sector debt. Debt is part (the negative part) of wealth.

Still, it’s interesting to look at time series for household-sector assets, debt, and net worth, and see how they behave in the lead-ins to recessions.

I’ve pointed out repeatedly that year-over-year declines in real (inflation-adjusted) household net worth are great predictors of recessions. Over the last 65 years, (almost) every time real household net worth declined, we were just into or about to be into a recession (click for interactive version):

Update 6/8: This was mistakenly showing the assets version (see next image); it’s now correctly showing the net worth version.

This measure is eight-for-seven in predicting recessions since the late sixties. (The exception is Q4 2011 — false positive.) It makes sense: when households have less money, they spend less, and recession ensues.

But now here’s what interesting: YOY change in real household assets is an equally good predictor:

Adding the liability side of the household-sector balance sheet (by using net worth instead of assets) doesn’t seem to improve this predictor one bit. This perhaps shouldn’t be surprising. Household-sector liabilities, at about $14 trillion, are pretty small relative to assets ($101 trillion). Even if levels of household debt make big percentage moves (see the next graph), the actual dollar volume of change isn’t all that great compared to asset-market price runups and drawdowns. Asset levels make much bigger moves than debt levels.

It’s also interesting to look at changes in real household-sector assets (or net worth) compared to changes in real household-sector liabilities:

As we get closer to recessions, the household sector takes on debt progressively more slowly, with that shift happening over multiple years. (2000 is the exception here.) That speaks to a very different dynamic than the sudden plunges in real assets and net worth at the beginning of the last seven recessions. Perhaps: household’s portfolios are growing in these halcyon days between recessions, so they have steadily less need to borrow. And as those days continue, they start to sniff the next recession coming, so they slow down their borrowing.

My impressionistic take, unsupported by the data shown here: Higher levels of debt increase the odds that market drawdowns will go south of the border, driving the economy into recession. And they increase the likely depth of the drawdown, as lots of players (households and others) frantically need to shrink and deleverage their balance sheets, driving a downward spiral.

If the humidity’s high, and it gets hotter, you’re really gonna notice the change.

My obstreperous, categorical take, cadging from the past master of same:

Recession is always and everywhere a financial phenomenon.

Cross-posted at Angry Bear.

How Perfect Markets Concentrate Wealth and Strangle Growth and Prosperity

June 5th, 2016 5 comments

Capitalism concentrates wealth. Ridicule Marx and his latter-day disciples all you like (I’ll help); he definitely got that right.

But capitalism is a big word with lots of meanings, and enough ideological baggage to fill a Lear Jet. Let’s talk about something more precise: perfect markets, with ownership, in which individuals compete with others to produce stuff, and store up savings. You can see this kind of perfect world in agent-based simulations like Sugarscape. Start with a bunch of sugar farmers trying to accumulate sugar in an artificial world, hit Go, and watch what happens.

Here’s what happens to wealth concentration (number of poorer farmers on the left, richer on the right):

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Wealth is pretty evenly distributed at the beginning (top). That doesn’t last long. You can see the same effect in another Sugarscape run, here compared to real-world wealth distributions:

Screen Shot 2016-06-04 at 7.28.09 AM

That’s the Gini coefficient for wealth. Zero equals perfect equality; everyone has equal wealth. 1.0 equals perfect inequality; one person has all the wealth.

Perfect markets concentrate wealth. It’s their nature. But at some point, market-generated wealth concentration strangles those very markets (compared to markets with broader distributions of wealth). If a handful of people have all the wealth, how many iPhones will Apple sell? If only a few have the wealth to buy cars, automakers will produce a handful of million-dollar Bugattis, instead of forty handfuls of $25,000 Toyotas. Sounding familiar?

But wealth concentration doesn’t just strangle the flows of spending, production, and income. It throttles the accumulation of wealth itself. Another simple simulation of an expanding economy (details here) explains this:

Screen Shot 2016-06-04 at 10.49.29 AM

The dynamics are straightforward here: poorer people spend a larger percentage of their income than richer people. So if less money is transferred to richer people (or more to poorer people), there’s more spending — so producers produce more (incentives matter), there’s more surplus from production, more income, more wealth…rinse and repeat.

This picture says nothing about how the wealth transfers happen (favored tax rates on ownership income, transfers to poorer and older folks, free public schools, Wall Street predation, the list is endless). It just shows the results: As wealth is transferred up to the rich, on the left, and wealth concentration increases, our total wealth increases more slowly. When that transfer is extreme, even in this growing economy the poorer people end up with less wealth. (Note how the curves get steeper on the left.) As wealth concentration declines on the right, our total wealth increases faster, and poorer people’s wealth increases much faster. Note that richer people still get richer in most scenarios — it’s a growing economy, always delivering a surplus from production, and increasing wealth — just more slowly.

And that’s just talking dollars. If we start thinking about our collective “utility,” or well-being — the total of everybody’s well-being, all summed up — the effects of wealth concentration are even more profound. Because poorer people getting more does a lot more for their well-being than richer people getting more. (Likewise, even if the richer people actually lose some of their wealth, they’re not losing as much utility.)

Because: Declining marginal utility of wealth (or consumption, or whatever). This is one of those Econ 101 psychological truisms that seems to actually be true. The fourth ice-cream cone (or Bugatti, or iPhone) just doesn’t deliver as much utility as the first one. Plus, a Bugatti in one person’s hands doesn’t deliver as much utility as forty Toyotas in forty people’s hands. (Prattle on all you want about relative and revealed preferences; you won’t alter this reality.)

So if we were to re-work the chart above showing utility instead of dollars, you’d see far greater increases in utility on the right side, especially for poorer people. Widespread prosperity both causes and is greater prosperity.

Why, then, aren’t we spending our lives on the right side of this chart? It’s a total win-win, right? The answer is not far to find. Nassim Taleb shows with some impressive math (PDF) what’s also easy to see with some arithmetic on the back of an envelope: if a few richer people (who dominate our government, financial system, and economy) have the choice between making our collective pie bigger or just grabbing a bigger slice, grabbing the bigger slice is the hands-down winner.

That’s why decades of Innovative Financial Engineering has served, mostly, not to efficiently allocate resources to efficient producers, improve productivity, or increase production. Rather, these fiendishly clever entrepreneurial inventions control who gets the income from production. You can guess who wins that game. Top wealth-holders would be nuts to play it any other way (if you go with economists’ definition of rationality…).

But for the rest of us, it’s a loser’s game — at least compared to the world we could be living in. If household incomes had increased along with GDP, productivity, and other economic-growth measures for the last two or four decades, a typical household would have tens of thousands of dollars more to spend each year — and much bigger stores of wealth to draw on. If you think that sounds like a thriving, prosperous society…you’re right.

To summarize: perfect markets, left to their own devices, concentrate wealth. Concentrated wealth results in less wealth, and far less collective well-being. (You’ll notice that I haven’t even mentioned fairness. It matters. But I’ll leave that to my gentle readers.)

This all leads one to wonder: how could we move ourselves into that happy world of rapidly increasing wealth and well-being on the right side of the graph? Hmmmm….

Cross-posted at Evonomics.

You Don’t Own That! The Evolution of Property

April 24th, 2016 4 comments

Get off my lawn.

In a recent post on the “evolution of money,” which concentrated heavily on the idea of (balance-sheet) assets, I promised to come back to the fundamental idea behind “assets”: ownership. Herewith, fulfilling that promise.

There are a large handful of things that make humans uniquely different from animals. In many other areas — language, abstract reasoning, music-making, conceptions of self and fairness, large-scale cooperation, etc. — humans and animals vary (hugely) in degree and kind. But they still share those phenotypic behavioral traits.

I’d like to explore one of those unique differences: ownership of property. Animals don’t own property. Ever. They can and do possess and control goods and territories (possession and control are importantly distinct), but they never “own” things. Ownership is a uniquely human construct.

To understand this, imagine a group of tribes living around a common water source. A spring, say. There’s ample water for all the tribes, and all draw from it freely. Nobody “owns” it. Then one day a tribe decides to take possession of the spring, take control of it. They set up camp surrounding it, and prevent other tribes from accessing it. They force the other tribes to give them goods, labor, or other concessions in return for access to water.

The other tribes might object, but if the controlling tribe can enforce their claim, there’s not much the other tribes can do about it. And after some time, maybe some generations, the other tribes may come to accept that status quo as the natural order of things. By eventual consensus (however vexed), that one tribe “owns” the spring. Other tribes even come to honor and respect that ownership, and those who claim and enforce it.

That consensus and agreement is what makes ownership ownership. Absent that, it’s just possession and control.

It’s not hard to see the crucial fact in this little fable: property rights are ultimately based, purely, on coercion and violence. If the controlling tribe can’t enforce its claim through violence, their “ownership” is meaningless. And those claimed rights are not just inclusionary (the one tribe can use the water). Property rights are primarily or even purely exclusionary. Owners can prevent others from doing anything with the owners’ property. Get off my lawn!

When push comes to shove (literally), when brass tacks meet the rubber on the road (sorry, couldn’t resist), ownership and property rights are based purely on violence and the threat of violence. Full stop, drop the mic.

In the modern world we’ve largely outsourced the execution of that violence, the monopoly on violence, to government. If a family sets up a picnic on “your” lawn, you can call the police and they’ll remove that family — by force if necessary. And we’ve multiplied the institutional and legal mechanics and machinery of ownership a zillionfold. The whole world’s financial machinery — the immensely complex web of claims, claims on claims, and claims on claims on claims, endlessly and densely iterated and interwoven — all comes down to (the threat of) physical force.

There are obviously many understandings and implications to this reality (e.g. Where did your ownership claim originate? Who got excluded, originally?), which I’ll leave to my gentle readers. But I’d like to close the loop on the the comparatively rather desiccated ideas of balance-sheet assets, and money, explored in my previous post.

When the one tribe takes control of the spring, they add that spring as an asset on lefthand side of their (implicit) balance sheet. Voila, they’ve got net worth on the righthand side! In standard modern terminology, the spring is a “real” asset — a direct claim on a real good, as opposed to a financial asset, which (by definition) has an offsetting liability on some other balance sheet — is a claim on that other balance sheet’s assets, is a “claim on claims.” The tribe’s asset — its claim to the spring and the output from the spring (capitalized using some arbitrary discount rate) — has no offsetting liability on other balance sheets. It’s a purely inclusionary claim. Right?

Wrong. It’s an exclusionary claim. Which means there is a liability, or negative net worth, on others’ balance sheet(s) — at least compared to a counterfactual fable in which all the tribes have free access to the spring. “Real” assets — balance-sheet entries representing direct claims on real goods (even your claim to the apple sitting on your kitchen counter) — have offsetting entries on the righthand side of the “everyone else” or “world” balance sheet. A truly comprehensive and coherent accounting would require first assembling such a pre-human or pan-human world balance sheet. Practically, that’s utterly quixotic. Conceptually, it’s utterly essential.

So while the distinction between real and financial assets can have conceptual and analytic value, it’s important to realize that the claims behind real and financial assets are far more similar than they are different. A deed to land — the legal instrument encoding an exclusionary claim — is quite reasonably viewed as a financial asset. There is an offsetting balance-sheet entry elsewhere, if only implicit. Donald Trump certainly views the deeds he “owns” as financial instruments, fundamentally similar to his stocks and bonds. Just: the legal terms of those financial instruments — the inclusionary and exclusionary rights they impart — vary in myriad ways. (Aside: economists really need a biology-like taxonomy of financial instruments, categorized across multiple dimensions. Where’s our Linnaeus?)

Balance sheets, accounting, and their associated concepts (assets, liabilities, net worth, equity and equity shares) are the technology humans have developed to manage, control, and allocate our (violence-enforced) ownership claims, a crucial portion of our social relationships. At first the balance sheets were only implicit — when the tribe first laid claim to the spring. But humans started writing them down and formalizing them, tallying those ownership and obligation relationships, thousands or tens of thousands of years ago. (Coins weren’t invented till about 800 BC.)

When some clever talliers started using arbitrary units of account to tally the value of diverse “assets,” and those units were adopted by consensus, we got another invention: the thing we call money. Like ownership rights, the unit of account’s value is maintained by consensus and common usage among owners and owers. But like ownership, its value is ultimately enforced by…force.

Balance sheets. All is balance sheets…

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I find it distressing that this kind of deep and fundamentally necessary thinking about ownership and property rights is absent from introductory (and ensuing) economics courses — both textbooks and coursework. Likewise concepts like value, utility (carefully interrogated), and yes: money (ditto). I don’t think you can think coherently about economics if you haven’t carefully considered these issues and ideas. It’s that kind of deep and broad, ultimately philosophical, thinking, in the context of a broadly-based liberal-arts education, that makes American universities — somewhat surprisingly to me — the envy of the world.

Before leaving, I have to give full props here to Matt Bruenig, who delivered this clear and coherent Aha! understanding of ownership for me after I’d struggled with it for decades. It seems so simple and obvious now; others have certainly explained it before. I feel like a dullard for taking so long.

Cross-posted at Evonomics.