We are embarking on interesting economic times. I don’t mean that facetiously as a comment on the self-inflicted wounds by our leaders. Instead, I refer to an economic territory uncharted since the recession of 1979-81. We learned a lesson in the 1970s that we perhaps had forgotten in the halcyon days since the Great Depression. As comforting was the notion of a self-healing economic system kept always in equilibrium by the Invisible Hand, we discovered that a macroeconomic equilibrium can occur at whatever level we want it to be. Now, this sounds a bit flaky, so let me explain. The father of macroeconomics did not study much economics at Cambridge. Instead, like his philosopher father, he was interested in how humans can create our own realities. He discerned between the subjective realities of the hard sciences and the more objective realities of humans. The probability that it will rain is not influenced by whether we all decide to carry an umbrella today, but the probability of a recession is very much dependent on whether we think there will be one. In other words, our expectations often dictate human outcomes. And, now, expectations are sinking to very low numbers. They will get worse next week when people see their quarterly 401K statements and realize they lost 5-10% of their retirement wealth since January. Our collective moods are a pretty good indicator of the state of affairs of the economy, and definitely dictate our short to medium term economic future. Already, before the gloom ahead, people have been worried about global trade wars, electricity and potash shortages, and a pretty dramatic downturn of the U-6 unemployment rate that measures not just unemployed but also underemployed and discouraged workers. We now see on today’s graph that the inflation rate is ticking up pretty robustly. In fact, if you look at the quarterly trends that I calculate and publish in this blog series, you see that three month averages have been ticking up since the election and are now well above the level that the Federal Reserve deems tolerable. Worst yet is not the new levels, approaching and exceeding 3%, but the upward trend that seems destined to take inflation higher. In fact, in the most recent University of Michigan Survey of Consumer Sentiment, 66% of people surveyed expect higher unemployment in this year, compared to just 51% a month earlier. That’s the highest level of pessimism since the Great Recession in 2009. Our sentiment has dropped 28 points and our expectations are down 32 points in the last year, mostly in the last couple of months. This increasing gloom has not been seen since the depths of the Great Recession, and only a handful of times since the Michigan survey was first created in the 1940s. The ramping up of inflation, barely a year since some tough Federal Reserve policy seemed to have had it licked, is a big reason for the doom and gloom households feel. People are buying less, especially big ticket items that economists call consumer durables. We are getting nervous about spending as economic uncertainty steps in. Where consumers tread, investors soon follow. If we aren’t buying big ticket items, they will stop making them. That means layoffs, which increases unemployment still further and forces the economy to ration the reduced output to only those willing to pay the most for it. Depressing sentiment combined with the self-fulfilling expectation that prices will rise, and the simultaneous retrenchment of private production is precisely what central bankers fear. You see, they can deal with inflation by slowing down the economy through increases in the interest rate. Or, they can deal with unemployment by stimulating the economy with lower interest rates. Either of these policy prescriptions are made more difficult when our gloom train has already left the station. But formulating an optimal policy becomes nearly impossible when we have both unemployment and inflation at the same time. This stagflation problem is vexing indeed. This is really a job for a central banker as our leader. Fortunately, for Canada, it appears that Mark Carney, who ran both the central bank in Canada and the counterpart in the United Kingdom, seems destined to take the helm of Canada’s economy. Unfortunately, the leading economy of the world does not have that insightful leadership, and indeed may now subscribe to mercantilist economic theories that were buried with the creation of economics two and a half centuries ago. There are, of course, things we can do to reverse this malaise. We discuss many such ideas in these pages. I’ll prompt your memory, though. They aren’t what we are doing now. Trade wars and alienating economic allies are not paths to mutual success. Nor is mandating the return to these shores of manufacturing of cheap goods. When nations produce things of low value, our wages drop accordingly because a wage has two components - how much we produce using labor, and how valuable is the stuff we produce. Manufacturing left our shores, for the most part, because we’d prefer to buy the cheap things low wage countries can afford to make rather than earn the low wages and face the higher prices by producing them ourselves. No, we are better off as a beacon of innovation in high tech, rocketry, aeronautics, sustainable energy, medicine, education, AI, and chip manufacturing. In each of these enterprises, only some of which are manufacturing, and all of which are high tech, we need to cultivate a culture of the best and the brightest, and invite people from around the world to be part of our innovation economy or, at least, buy the products and concepts we produce. This is what makes America and Canada great, not trade wars, artificially expensive and depressingly uninnovative automobile manufacturing, or a reliance on a fossil fuel economy that would make us all better off if it just sailed into the sunset, replaced by cheap and plentiful sustainable energy. As I noted from the start, we live in interesting times. But, while my concerns for the economy may make me lose some hours of sleep, the situation is far more dire for Jerome Powell and the Federal Reserve as they try to figure out what to do with stagflation when there is really no good policy possibility. Don’t worry, though, Jerome. You will probably be joining the growing unemployment line as well by about this time next year.

In 1944 a brilliant polymath named John von Neumann collaborated with Oskar Morgenstern to produce a book called The Theory of Games and Economic Behavior. At the time, Neumann was engrossed in developing the first large digital computer and the prototype to programming languages that run computers ever since, participating as perhaps the smartest person among the Manhattan Project physicists, revolutionizing modern meteorology and atmospheric science and even predicting global warming, formulating the modern theory of nuclear deterrence, and his brief foray into game theory. His brilliance astounded his colleagues at Princeton’s Institute of Advanced Studies, including Albert Einstein, and his contribution to economics has tried and proven true to my discipline. The Theory of Games is perhaps the most understated title of all times. After all, when we think of games, we imagine such innocuous activities as checkers or chess. They are non-cooperative in that one person wins only if another loses. They are what Neumann would also call zero-sum since one person’s loss is the other’s gain. Neumann recognized that games may also be cooperative and positive-sum in that we can work together to enhance value for both or even a large number of sides. Nor did he restrict his analysis to idle games of chance that last a few minutes or a few hours before we flit off to another idle activity. In fact, Neumann was deadly serious. He anticipated that the rational analysis of competitive endeavors could apply equally well to Cold War strategies. Such games that superpowers play are certainly inherently adversarial, but are also played out over generations, and with dire consequences if we get them wrong or peace dividends and the potential for cooperation if we instead redirect our military efforts into higher aspirations such as enhanced global awareness, sharing of cures for poverty and disease, sustainability, liberty, and self-determination. Such activities is not a game, but the Theory of Games offers insights. If we first acknowledge that perhaps only idle activities have no important stakes or long term implications, then we can discard the miniscule subset of his theory that applies only to zero-sum games. Even market transactions are not zero-sum. Yes, with every transaction, currency and property are swapped, but value is created. If both sides of a transaction did not benefit from the transaction, there is no transaction. This is where economics differs from politics. In economics, our interactions are always mutually beneficial, but in politics and many other interactions, the parties view each other adversarially, with “winners” of elections, and “opponents” in the other party. The second important aspect of game theory is that, in the real world, our interactions are not “one-shot” but are instead often repeated over and over with the same partners. How we interact in one round will affect how we are regarded in subsequent rounds. Finally, games have rules that define how the game ought to proceed. Figure skating is a highly structured Olympic game designed to tease the best out of its participants. That is why we were aghast when people associated with Tonya Harding harmed Nancy Kerrigan’s knees to prevent her from competing. They used tools from outside of the game to win. We call such transgressions cheating. These understandings of how to follow the rules to meet our needs in games of life or when lives are at stake create the sober rationality not because the stakes are so low but because they are high. This notion of repeated games in which trust becomes paramount, positive sums so that we all gain from our interactions, and a need to play by the rules and not use threats or extortion to tip the playing field one’s way is the very nature of our agreements, in our community or our international interactions. The sport of pugilism may be violent, but one prevails only by following the rules. This sport differs from no-holds-barred wrestling in which people bash others over the head with chairs and much of the ridiculous spectacle is outside the ring. It is silly, unrealistic, and perhaps even troubling in its folly, and few argue it is the serious activity of serious people. Likewise, we could view the world as a series of completely isolated real estate transactions. Sure, you can hit the other side upside the head with a chair in a real estate transaction. You might even knock their opponent out by using tactics of threats, violence, or even extortion, but that opponent will never want to deal with you again. It might appear rational, if perhaps unethical or immoral, to view the world in such a zero-sum game way if you never plan to deal with this person again and there are plenty of other deals to be had. But the world is not one big real estate play. We aspire for mutual benefit, we must build trust if we hope players will participate with us in the future, and, if we don’t follow the rules, we are taking the equivalent of baseball bats to the knees of those we suddenly view as opponents instead of allies. Life is not a game but Neumann’s Theory of Games gives homo economicus (economic man) all the tools necessary to enhance the value for all concerned by fully embracing the rules of the game and our need to build trust so that the game can continue into the future. Eighty years after Neumann’s theory, economists still hold dear the principle of rational negotiations that follow a set of rules upon which we all agree and which provide a sound and desirable blueprint for all of our future interactions. In this approach that is now well-understood by economists, we can enjoy mutually beneficial relationships and transactions. But, alas, that does not seem to be the world of politics. Now, I know we can look at the spectacle of human folly and the games that are played, and chuckle to avoid a tear. Unfortunately, life is not a game. We will prosper better together if we don't aspire to a worldview that is vengeful and negative-sum. Let us not view the world as the World Wrestling Federation.

Last week we discussed how the dramatic increase of federal deficits under President Trump’s first term has been crowding out the ability of the private sector to borrow and invest in new capacity. This doubling-down of tax cuts for the wealthy has affected us all not through higher output and efficiency but through higher interest rates and prices instead. Normally, the Federal Reserve would deal with the increasing inflation rate through further increases in interest rates, even though these rates never really came down once the Fed took their foot off the brake last year. The reason is that government borrowing has kept demand high for loanable funds, and the market sees that. The Fed now has a competing problem, though. Unemployment is on the rise, and underemployment is increasing perilously, 7.5% in January to 8.0% since the inauguration. These figures are yet to include the massive layoffs arising from Elon Musk’s DOGE chainsaw approach to discretionary spending. There is one predominant formula for the determination of a recession, although it is not a hard-and-fast rule. Two consecutive quarters of real economic decline usually results in a determination of a recession by the umpires of such things, a group of economists called the National Bureau of Economic Research (NBER). We had a couple such quarters of a fall in the production of goods and services, adjusted for inflation, a couple of years ago that did not result in the declaration of a recession. Then the reason was that the unemployment rate remained low. That candidate for a recession may have been more because of the subtleties of inflation on our adjustment of Gross Domestic Product figures. We won’t likely be so lucky this time around, though. Inflation is picking up in this second Trump administration when viewed on a more relevant and recent quarterly basis rather than stale data embodied in the traditional annual inflation calculation. Nonetheless, inflation is nowhere near what it had been at the end of the previous Trump administration and beginning of the Biden administration. The early indications of a first quarter of economic decline should then catch our attention, especially since the current data still does not yet measure the flood of fired federal workers that are beginning to flood unemployment lines. Economic uncertainty is also accelerating and may well become the hallmark of the second quarter. If so, we may well find ourselves in the first recession in more than a decade. In addition to the troubling effect of increased unemployment, market retrenchment may be an equally contributing factor. The economy critically depends on the confidence of the investment sector. Real and relevant investment is based on the belief that the market will properly value what the private sector offers. Entrepreneurs can take the risk to produce a new product but they are not prepared to hazard guesses about the vagaries of financial markets. Such market volatility is measured by an index called the VIX, also known as the “fear index.” This index is now at the highest point since the Great Recession. This VIX usually hovers around 15. The onset of COVID caused it to spike at over 30, but, before that very unusual point in time in March of 2020, the only other time the index has flirted with 30 was surrounding and immediately following the Great Recession of 2008. This time around, the heightened fear index that is terrifying financial markets is completely self-inflicted. There is a certain school of thought among some politicians that great nations must rattle sabres to get the attention of what they view as lesser nations. This time around, such saber rattling is not in the positioning of aircraft carriers off distant shores but in the imposition, removal, reimposition, doubling, and retaliating to responses to trade tariffs. As economists are aghast, investors run for cover concerned what the heck might happen next. A combination of an acceleration of inflation, a dramatic increase in the number of discouraged and underemployed workers, and rattled financial markets all bear poorly in our hopes of avoiding an imminent recession. Fear of those who are unemployed, underemployed, or facing firings, of financiers fearful of global trade wars, and of economists watching a resurgence of inflation is now impinging on perhaps the most significant measure of them all. Consumer sentiment is falling like a rock. Granted these have been a tough few years for consumer confidence as our economy recovered from the great COVID shock. But, over the last few months, fewer people believe the economy is good and more people feel the economy is bad, as today’s graph shows. It is hard to imagine how our economy can avoid a recession when trade wars are erupting absolutely unnecessarily, investors are running for the hills, unemployment and underemployment is rising fast, inflation is reappearing after many many months of steady decline, and, now, consumers are becoming as surly as voters. Of course, we don’t know for sure we are in a recession until the seventh month after it started, which, by then the recession actually abates. We’ll see this time. I can tell you that the combination of apprehension and unnecessary self-infliction of economic wounds is almost unprecedented. If there is such a thing as an economic purgatory, we seem to have found it - a stagnant or declining economy that suffers simultaneously from inflation that may well worsen as a result of impending tariffs. Now, we haven’t seen that combination of economic pessimism for almost half a century. Now that’s history, but not the good kind.

As an economist, I am worried. As someone who researches and teaches sustainability, I’m shocked. Now, as a proud grandfather, I’m concerned. My concern is the bill we are leaving for our children and grandchildren. The tab is getting bigger, and with no end in sight. I’m not referring today about the inflationary effects of troubling trade wars looming on the horizon and how the first shots have already been taken. Beyond the generational mistrust they will engender, their more immediate effects will be transitory once we come to our senses that nobody gains from weaponizing trade. Instead, I am referring to the inflationary effects of massive government debt. Today’s graph shows how the US federal government has been spending beyond its means for decades. The gap has become much worse since the tax reduction act of 2017 and is soon expected to gobble up a 6.1% share of our Gross Domestic Product. That’s money ultimately taken from investing in our private sector supply chain, and from our children’s pockets. And it will assuredly cause perennial inflation. In the United States, Congress is on the verge of formulating a budget that is expected to add about $2 trillion annually to the national debt for the foreseeable future. In fact, we have been adding such debt by consistently running $2 trillion deficits ever since the deep tax cuts passed in President Trump’s first term. In a handful of years this nation has doubled what it owes and may well double the debt again by around 2040, or worse. Interest on the debt is already the federal government's third biggest program, after social security and Medicare/Medicaid. In a decade or two, interest payment for past spending folly will be our second biggest program, if social security survives. If not, interest will be what government does most. What do we have to show for it? And, why does that matter? After all, by mid-century, many readers will be long gone. It matters because of what such debt does to our current economy, even if some discount how it hampers opportunities for our grandchildren. Two or three trillion only amounts to perhaps 7% to 10% of the US economy. Why would such a relatively small federal government deficit make such a difference? Well, our economy is made up of a few sectors that depend on borrowing. In combination, we call this the loanable funds market. Some save, and others borrow, to buy a home or a car, pay for an education, build a new factory, maybe even repair a road or upgrade a new municipal water system. All of us compete for the savings of some to fund these important activities that benefit all. Private investment, to fund new homes, factories, etc. sums about $2 trillion per year in the U.S. In other words, the total amount of investment made in the private sector each year is about the same size as the total deficit the US federal government now runs each year. Also competing for these funds is borrowing for our homes, student and car loans, increases in our credit card balances, but to a much smaller degree compared to commercial and governmental borrowing. We can quickly see how the increasing share of debt commanded by the government can translate into inflation and recession. Let me explain. Our financial markets have traditionally mobilized savings to match private investment. But, over the last eight years, government borrowing has become the biggest drain on loanable funds. Fortunately, the US has also run a foreign trade deficit totalling $1.2 trillion each year. The greater sums we send abroad, to purchase goods and services from other nations compared to what returns to purchase US goods and services, does not somehow disappear. Nor is it by any definition a subsidy, as some would claim. Instead, that trade deficit returns to the U.S. in what is called foreign direct investment. Repatriated dollars may help build our factories or our homes, but now much is lent to the government to cover part of its deficit. We have now assembled the pieces to show why the massive and unrelenting debt causes inflation. The first effect is through disproportionate spending itself by government. If government spends without the inconvenience of having to take money out of taxpayers’ pockets to do so, then overall spending rises, and this imbalance between spending and income is inflationary. As an example, recall the spending induced by Presidents Trump and Biden as they sent check after check to Covid households. Spurring spending without enabling production added fuel to the Covid fire. Economists predicted that inflation would be inevitable. Surprise. Government spending in excess of tax revenue is also far more inflationary than private sector spending. When the private sector produces more stuff, it generates additional income for those who help produce it. That income and production is met with an equal amount of purchasing power and spending. Everything remains in balance. But, if government spends from borrowing, there is no commensurate additional production to match the spending. Prices rise. Inflation takes off. The second effect of government spending in excess of production is through the effect of excessive borrowing on interest rates. We saw above that the huge deficits the government is inducing are funded not out of taxes but out of competition for loanable funds. While the imbalance this creates has been partially ameliorated by the trade deficit and the related repatriation of US dollars through foreign capital inflows that can fund runaway fiscal deficits, foreigners don’t make up the entire difference. Instead, the greater demand for borrowing economy-wide forces up interest rates and deprives the private sector of purchases of new equipment and facilities, households of new homes, students of an education, as loanable funds must be rationed to the highest bidder. Nobody can outbid government which borrows without any regard for the interest rate. Private sector investment designed to ultimately improve production is left out in the cold. As private sector production diminishes with increased government borrowing and spending, our supply chain tightens, and prices rise. In economics we call this the crowding-out effect that arises when government borrowing usurps private investment. We are seeing that happen already. The Federal Reserve had, until recently, declared an end to the great inflation generated by Trump I and Biden. They lowered their interest rates to more typical levels, and yet broader interest rates such as the mortgage rate or commercial loans just did not come down. The reason is that government continues to borrow massively. Unfortunately, the huge tax reduction, mostly for the wealthy, in 2017 set us up for spending beyond our means. The dubious economic theory of free money by simply borrowing and then passing to our children the responsibility of paying for our debt has set us on a path by which inflation will be difficult to control. We thought we learned our lesson when we saw governments of South American countries make the same mistake by spending profligately without a commensurate increase in production. Hyperinflation resulted, naturally enough. We scolded them for their poor economic policies then, but we repeat variations of those same policies now and somehow expect different results. Historians will look back at the bungling of the Great Recession of 2008 and the decade of low interest rates that followed, the ridiculous and patronizing tax cuts of 2017, our response not to Covid but our unnecessary responses even once Covid came under control, and our trade wars and other policies since and will declare this a generation of economic dysfunction. Let's see whether Congress continues this week to perpetuate the mismatch between revenue and expenses that portends to economic hardship in the future. The problem is that economists are already expressing these concerns in real time. But let’s not let the obvious economic dysfunction get in the way of some good ole political fun. After all, it's all just a game, isn’t it? Except for our grandchildren who are left picking up the pieces. I’m currently teaching a couple of sections of macroeconomics. I had a student come up to me at the end of a lecture on Thursday quite troubled. He said he is losing hope and is wondering why people in power are creating such a mess that will be left for his generation to clean up. I had to agree. Meanwhile, let the trade wars erupt between the two best trading partners and strongest allies in the world. As President Trump says, “it will make good TV.” Don't our grandchildren deserve better from us than good TV?

I remember when I was a kid and Leave It To Beaver was on the television. Mr. Cleaver and his family could afford to live in a nice house in the suburbs all with the income of one parent, usually the father in those days. If Mr. Cleaver got transferred, no problem. They knew they could start anew in another community, maybe even another state or province. The move would not be too expensive, and the real estate commission rate was lower than it is today. In 1950, the median home price was $2,990 and the median household income was $7,354. It took about 40% of an annual salary to buy a home. If a family moved, little was lost - about 5% real estate commission of a home worth 40% of one’s income, or a mere one-month’s salary as the major cost to relocate. Those were the days when people could consider opportunities for a better life elsewhere. The American nation was mobile. This is great for entrepreneurship, for economic development, and also for tolerance. When people are willing to move to new regions and experience new neighbors and new ideas, we develop a healthy tolerance for each other. We live less insular lives, and we are exposed to new ideas, many which perhaps we do not agree, but all of which we tolerate. The 1960s saw a great expansion of the labor force as laws prevented the discrimination against women and minorities that kept women in the home and minorities in separate communities. Reproductive freedom also afforded women greater options in life. This dramatic expansion of the labor force created opportunity and economic growth, but much of that growth was capitalized into higher housing costs. By the 1980s, median household incomes had risen dramatically, but housing costs rose far higher. A household with a single income earners did not stand a chance of buying a home. Even most young two-income households consider homeownership out of reach in many metro areas in the US and Canada. A median home in the US has risen from the 40% of household income in the 1950s to 110%. In current dollars, family income in the 1950s was about $40,000 then, and is now upwards of $100,000 now. Household incomes have risen dramatically, but home costs have risen far faster. Too many have given up on the dream of homeownership. This is significant because even those who can save enough to purchase today cannot afford to move. The cost of selling a home and buying elsewhere has risen from about one month’s salary in the 1950s to about four months of salary today. Meanwhile, mortgages must be renegotiated, and typically the monthly payments rise. At one time, most everyone could move to seek a better life. Now, few can. Today’s graph shows that the average person had about a 22.5% chance of moving in a given year back in the 1950s. Now, people move at a third that rate. This 60-70% drop in the rate we move is a symptom of a less dynamic and entrepreneurial economy, with new opportunities that abound. Instead, it is an economy in which people feel stuck, afraid to move, priced out of housing markets, and terrified with the lack of health care should they be forced to change jobs. Last week we saw that unemployment is rising but rising faster yet is the U6 underemployment rate. When people feel stuck and are laid off from, say, a federal job, they could end up driving an Uber, despite their master's degrees. Lack of mobility matters, and it damages the economy. What concerns me more is the sense of being stuck. Certainly someone who lost their job when the local steel plant closed could not relocate to a new location and a new high tech job that replaced the steel sector. Perhaps like no other time since the beginning of the Gilded Age have Americans felt so stuck. Certainly higher income households can afford to be mobile, in jobs and in geography. Many, especially lower income, households are immobile, which is why we move a third as often as when our economy was growing much faster. This breeds some of the social malaise we sense today. People feel threatened, economically and by new ideas. People are resentful that they do not have access to better jobs because they can’t afford to move to a faster growing community with higher housing prices. They can’t afford to pay to convert themselves from a steelworker to a computer technician. And when people are stuck, they feel threatened and disheartened. It is human to blame others, which further depreciates our social capital. We become more entrenched as we converse with smaller and smaller circles of people who are often facing the same economic plight. This results in economic segregation and frustration. It manifests itself as an angry electorate that feels little optimism about the future. When we cannot balance the risk and uncertainty of an evolving and dynamic economy with the comfort and confidence we can share in increased economic bounty, we tend toward conserving what we have as we lose faith in what could be. Retrenchment has replaced the pollination of ideas, cultures, and ways of life. The world has become a zero (or perhaps negative) sum game. Gone by the wayside is tolerance and optimism. Instead we revert to beggar-thy-neighbor, glass-half-empty thinking rather than a confidence that a rising tide lifts all boats. It should then be no surprise to find ourselves in the plight we do, with a declining sense of national cohesiveness and with divided and dysfunctional government. We seem to have forgotten that it is opportunity which paves the way for economic dynamism. The great bounties can and do flow to the wealthiest among us, but as the income gap between the wealthiest and the rest widens, what was once considered an attainable American Dream disappears for many. That should trouble us all.

Every month or so I offer a summary of the current state of the economy and a comment on what may lay ahead. This month the horizon appears unusually cloudy. Economic data is not a cause but is rather a symptom. Let’s look at the symptoms and then try to glean the cause. Our graph of the week shows a return of inflation. Since the middle of last year our inflation rate had been hovering just above the magical sweet spot of 2%. It allowed the Federal Reserve to lower interest rates as they sensed a steadying glide path toward a healthy, resilient, and optimistic economy. Since then inflation has begun to ratchet up and is now in the 3-5% range by some measures. That is not reason to conclude the sky is falling in itself, but it occurs at times of other bad news. Monthly surveys of consumer sentiment have taken a dramatic turn downward. The U-6 unemployment rate, a far better measure of well-being because it includes those who are forced to be underemployed (a former administrator driving for Uber, for instance), has risen precipitously. And the level of inflation for those goods and services most purchased by low income households is far worse than the inflation many readers of this blog sense. Meanwhile, growth has slowed to the second lowest rate in three years, and we appear to be on the verge of global trade wars that can only result in higher prices, higher unemployment, and slower growth most optimistically, and far worse than that pessimistically. A few data points may not be significant, even if the trend is consistently in one direction. However, the strength of our modern global economy is fueled by optimism and destroyed by pessimism. We might then combine economic data with some political trends. Nations are bracing for conflict and are forced to make guns instead of butter as alliances that have shared defense resources and hence deterred hostilities are at their lowest points since the War to End All Wars followed by World War II. The notion of the new world order forged after World War II to prevent hostilities by integrating all nations economically has all but completely broken down. To put the dark economic clouds in perspective, let me offer up a bit of economic history. The period that forged the nation of the United States was one of colonialism that induced foreign powers to search for new lands from which they could strip resources to feed the factories back home. The colonial political model was the result of a theory of economics that predated the formal study of economics itself. Proponents of that theory, called Mercantilism, believed that the power of one’s nation was proportional to the vastness of its trade surpluses. It is not hard to see how they drew that naive conclusion. After all, nations’ leaders are invariably politicians or warriors. They view the world in a way dramatically different from the universal view of economists. To some presidents and generals, the world is a zero sum game. If you are a hammer, all you see is nails. They only win if someone else loses. Their cup is always half empty and they wish to fill it up by plundering, outsmarting, tricking, invading, cajoling, or even killing someone else. Some will do so at almost any cost. We see that playing out today. Some have set their eyes on Ukraine, Moldova, and the former Soviet republic of Georgia, Taiwan, Greenland, the Gaza Strip, the Panama Canal, and even Canada. Elsewhere, but under the radar screen of many of us are conflicts such as the cobalt war in the Democratic Republic of Congo. Some of these conflicts are in search of territory, some for rare earth metals, some for minerals, some for human capital and manufacturing capabilities, and of course, many in the last few decades were over oil. There are battles too over ideology or hatred. When we think of wars, we often focus on these more obvious human motivations, even if the resulting genocide is sometimes a pretext for mere empire-building conquest. In this new mercantilist world where one’s power is proportional to one’s stock of minerals, oil, or trade surpluses, and where might makes right, peaceful resource-rich nations have become easy targets. If even Canada is now threatened by an economic war over resources, there is now no safe haven. This attitude of “I win only if you lose” and the logically false premise that every nation should run a trade surplus did not survive the 18th Century. In 1776, the United States threw off the shackles of an increasingly controlling Britain by first revolting over onerous taxes on tea and then in a war of independence. That same year Adam Smith, considered to be the founder of economics, produced a book called The Wealth of Nations that exposed the logical inconsistency of mercantilism. Smith was no rabid capitalist. In fact, he held a professorship in theology. But, he did believe in the generosity of the human spirit that is rewarded not when each of us does well but when we all succeed. He believed it was intrinsic in human nature to want what was best for us all, and if that were truly the motivation inside of us, the pursuit of self-interest becomes a noble cause. To Smith, self interest was not greed. In fact, it was motivated partially be benevolence and partially with the human desire to invent the better mousetrap or replace human toil and suffering with the efficiency of machines. You can understand why such an optimistic approach would have its detractors among authoritarians. For instance, Smith viewed government not as oppressive but as a provider of some goods or services (public education for example) that free markets could not or would not produce in sufficient quantity. Smith implicitly believed we could be governed with a light hand because we all want the same thing - life, liberty, and the pursuit of happiness, which of course was forged indelibly into the U.S. Declaration of Independence. Smith’s optimistic approach that we trade for mutual advantage and that my success also contributes to yours, and vice versa, is not a universally shared ideal. A real estate developer may be more transactional than synergistic. Such a transactional approach implies the art of the deal is not to find a point where both sides prosper but rather where every bit of economic surplus, and maybe a little bit more, is extracted by the more powerful, cunning, or ruthless side of the transaction. World War One (then simply called the Great War) was fought over nationalism, imperialism, oppression, and resentments that were catalyzed by an assassination. It came to an end with the defeat of Germany followed by a series of oppressive conditions on the loser of the war that would fester for decades more. At the time an economist named John Maynard Keynes warned that economic oppression will not turn out well for either the oppressed or the oppressors. He was right. World War II ensued. As the end of World War II was in sight, Keynes inspired and led the British delegation to bring world leaders together in the small picturesque place named Bretton Woods, New Hampshire, with a spectacular view of Mount Washington. Keynes was no mercantilist. He believed that it would be in the interest of countries that ran surpluses to help nations with deficits develop so that markets could be expanded and prosperity shared. In other words, both sides gain from trade and prosperity by the very nature of what humans realize implicitly but nations now forget. I don’t expect the local supermarket to buy something from me if I benefit from buying something from it. By encouraging trade and not sweating the childish details of who benefits more than another, we produce a mutually beneficial world that recognizes and avoids the folly of aggression. To aid in such economic integration and ward off World War III, institutions such as the World Bank and the International Monetary Fund were formed at the United Nations Monetary and Financial Conference in Bretton Woods to strengthen economies and promote mutually beneficial trade and economic development, while the United Nations was strengthened to promote peace and prevent poverty. Today, concepts such as the United Nations, the virtue of sovereignty and self determination, and even the advantages of established alliances such as the North Atlantic Treaty Organization (NATO) are viewed with disdain by some because they serve their intended purpose to deter war and conflict. After a quarter millennium of experimentation with free markets, some wish to repeal modern economics and roll us back to the days of mercantilism and colonialism. Now, I am not always a huge fan of unbridled capitalism. But, to paraphrase Winston Churchill, the free market system is a terrible one, until you compare it to the alternatives. World superpowers now seem quite willing to throw out the notion of sovereignty and free markets and replace them with economic or military wars. The increasing volatility in global stock markets, the upward trend in prices, the plunge in consumer sentiment, and the dramatic ratcheting up of uncertainty are symptoms of a new world order that is a throwback to one we thought we left in the dustbin of history centuries ago. I guess what’s old is new again. May the spirit above transport us mortals from the dangers of our worst instincts and the folly of our ways. Where is the theologian Adam Smith when we need him the most? Has economics forsaken us? I leave you with two sentences from John F. Kennedy’s inaugural speech on January 20, 1961. You recognize the first, but perhaps we need to reflect on the second: “And so, my fellow Americans: ask not what your country can do for you--ask what you can do for your country. My fellow citizens of the world: ask not what America will do for you, but what together we can do for the freedom of man.”

(from https://www.economist.com/graphic-detail/2021/05/14/as-the-price-of-bitcoin-has-climbed-so-has-its-environmental-cost) Last week we described the potentially destabilizing effects of cryptocurrencies which provide a new way to transact, but also force us to forfeit some major levers in the management of our economy. We also documented that, while an efficiency-enhancing business case for cryptocurrencies may someday develop, virtually no (legal) advantages exist today for cryptocurrencies and exchanges, while there are a significant and growing range of risks to the economy. These risks go well beyond the profiteering that so benefited our new president, and our lovely Hawk Tuah lady, both of whom benefited by shilling crypto memes, but at a cost of hundreds of millions of dollars to their naive believers. The wreckage of crypto lies strewn on its path, if only regulators dare to look. Perhaps there will someday be a legitimate business case for crypto beyond the speculation, money laundering, and international sanction-busting that plagues this infant industry. Coins newer than their granddaddy, bitcoin, permit features that could someday aid in commerce. But, bitcoin’s design is not amenable to innovation. And, a concern all Americans should have is not whether to embrace crypto, but instead how to deal with the detrimental effects of bitcoin mining on the pocketbook of electricity ratepayers and on the environment. It is the issue of this creation of new bitcoins that few Americans understand, and for which our country is ill-prepared. The real world impacts from cryptomining, completely distinct from the financial instruments called cryptocurrency, are completely, go almost entirely unregulated at the federal level. Leaders have been silenced and have become complicit by accepting huge crypto campaign contributions that represented a plurality of all monies donated in the recent election cycle. As a result, there has been little national attention on the harmful impacts of the most widely employed type of cryptomining. The bitcoin protocol uses a particularly harmful and wasteful method to record transactions that virtually every other cryptocurrency has avoided or long since abandoned. Our leaders must step up and protect our residents at the state and local levels from such “proof-of-work” cryptomining before our energy supply is placed at even greater jeopardy. Recent figures from hashrateindex.com reported that the tens of millions of mining machines used to encode bitcoin transactions consume, on average, about 26.5 Joules of electricity for every trillion calculations used to encode bitcoin transactions. Today the entire bitcoin mining network processes about 881 exahashes (million trillion such calculations) every second to record a mere 13,000 transactions per hour, and, in doing so, requires an astonishing 23.4 gigawatts of power, each and every second. Encoding of transactions and minting of new bitcoin consumes enough electricity to power more than 2.2 million American homes, 24 hours a day, 7 days a week, 365 days a year. The U.S. share of electricity used in mining, mostly from two bitcoin mining companies, Foundry USA and MARA Pool, is equivalent to the power used by 2.1% of U.S. electricity usage, not including peripheral energy necessary to support such bitcoin farms and remove the intense heat generated by bitcoin mining. To place this industry in perspective, U.S. bitcoin electricity consumption alone exceeds the electricity usage of a top-40 electricity-consuming nation such as Colombia, while worldwide mining approaches the electricity usage of Spain, a top-20 electricity consumer. Over a few short years, accelerated by China’s ban on crypto mining, proof-of-work cryptomining in the U.S. has led to energy shortages and rolling blackouts across the country. And while a small handful of early adopters or institutional investors are making millions and billions off of proof-of-work crypto mining, the rest of us are left holding the bag. Some estimate that the resulting increased energy bills cost ratepayers $1 billion more each year. Nationwide, the average American is doling out more in energy bills for an enterprise that does not benefit the rest of us and which generates almost no long-term jobs. At a moment when the calling cards of politicians are “affordability and job creation,” cryptomining is robbing our pocketbooks every month. Even a large crypto mining operation creates fewer jobs than a typical McDonalds restaurant. Proof-of-work cryptomining is also incredibly carbon-intensive. Every hour 18.75 new bitcoins are created as a reward to incentivize cryptominers who compete in a race to encode about 12,900 new transactions, a mere hundredth the number of hourly transactions processed by our ubiquitous ATM network. However, the retail electricity cost for each bitcoin transaction is about $231, far more than the pennies it costs to keep an ATM transaction secure. I document in my recent book "The Bitcoin Dilemma" that such exorbitant transaction costs are not paid by the transactors themselves. Instead, they are spread across all bitcoin owners by issuing new bitcoin as a reward to miners and hence diluting the digital currency. Nor do the fees cover the environmental damage that occurs with our increasing reliance on fossil fuels to generate the increasing need for more power, or the costs arising from sanction-busting or illegal activities arising from anonymous bitcoin transactions. Finally, miners pay far lower electricity rates than the average American, and hence all ratepayers must subsidize their industry through our higher electricity rates. Just compare your electricity costs now and a few years ago before the dramatic runup in bitcoin prices and mining. Perhaps most alarming is that each bitcoin transaction uses about 1.8 megawatt-hours of energy. At 250 watts per mile for an efficient EV, that is enough energy for an electric car to drive 7279 miles, from Halifax, Nova Scotia to San Diego, California - and back. Just imagine almost a fleet of 13,000 cars embarking on a cross-continental round trip every hour, just to support the maintenance of a crypto coin the vast majority of Americans have never even used. Is this the industry we wish to showcase our global leadership? A recent report by the London School of Economics determined that the United States is responsible for 46% of all global emissions from cryptomining. Since fossil fuels remain the main source of electricity generation in the U.S., every bitcoin transaction contributes more than two tons of carbon dioxide emissions, if powered by coal generation plants, or almost 1,800 pounds from natural gas electricity generating plants. Even if bitcoin mining mandates more power from the cleanest form of fossil fuel power generation, that’s an additional 100 million tons of carbon dioxide emitted into the atmosphere every year, just to support bitcoin transactions that could be encoded in a far more efficient way. Unnecessary crypto mining is undermining national and state climate goals across the country and the world. The tragedy is that these emissions are entirely unnecessary. The successful encoding of almost every other crypto coin demonstrates that cryptocurrency doesn’t need proof-of-work cryptomining to survive. Crypto verifies transactions using complex algorithms, but there are far more efficient ways. For instance, t he alternative Proof-of-Stake alternative is 99.69% more energy efficient. The crypto coin Ethereum, aware of the negative intergenerational impacts, recently transitioned from proof-of-work to “proof-of-stake.” But Bitcoin refuses to adopt this far more efficient method because their voting members wish to preserve the profits arising from their particularly wasteful form of cryptomining. The bitcoin mining industry opposes an alternative mining method that could put money back into the pocketbooks of ratepayers and prevent harm to communities and future generations. Meanwhile, c ommunities across the country and around the world are suffering other ill effects of self-serving bitcoin mining. Local energy bills are skyrocketing as utilities clamor to quickly bring online some of the most expensive and damaging electricity generation technologies. Grids are failing and our atmosphere is threatened unnecessarily. States and nations have all but abandoned their greenhouse gas goals. Often, rural communities least able to fend off opportunism have become the most vulnerable. Virtually every other cryptocurrency has demonstrated that digital currencies can coexist with climate stewardship. As a new administration promises that the U.S. shall lead the world in cryptocurrency, come what may, could we not figure out a way to protect the vast majority of Americans just to profit a meager slice of the crypto industry that vies for lucrative profits at the expense of us all? There is a better way. If indeed crypto must be the new bête noire, we need not throw the baby out with its polluted bathwater. We know how to do better than that.

(from https://www.ecommercetimes.com/story/ftc-reports-huge-jump-in-cryptocurrency-scams-87137.html) It has already started out to be a pretty disruptive year so far in the U.S., and around the world. Let’s not leave crypto out of the mix. This week I shall describe the immediate and medium term future for crypto. Next week I will update a discussion we’ve had in the past on the environmental issues raised not by crypto in general but rather by the method to record transactions in just one digital currency, bitcoin. We should not be at all surprised with recent events that will soon define cryptocurrencies. After all, while in 2019 President Trump stated “I am not a fan of Bitcoin and other Cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air,” just two years later he was inviting some deep pocket bitcoin miners to Mar-a-Lago as he began to raise money for his upcoming election. He changed his refrain quickly, and the crypto industry rewarded his change of heart by declaring him the crypto President. When combined with donations from Elon Musk and other venture capitalists whose offices occupy Sand Hill Road in Silicon Valley, our relatively low tech president quickly became the biggest recipient of crypto and AI money in the history of our nation. The pilgrimage of deep pockets to Mar-a-Lago has even induced some to call the path blazed outside the president’s residence as Sand Hill Road East. Of course, these donors are not trying to purchase democracy. Rather, their hopes are on a regulatory environment that charges full speed ahead in crypto and bitcoin mining, in artificial intelligence with few strings attached, in an increasingly unregulated and unself-censored social media world from the mold of X, and for rules that allow those who will benefit from these new technologies to keep the hundreds of billions they expect to earn. Access and accommodation comes with a price that I don’t believe surprises any readers. It is not clear whether the economy will be more efficient in the end, but we can hope. We know that the pie will be carved up differently, though. We’ve discussed some of the benefits but also some substantial risks of Artificial Intelligence on the overall economy. What is far less discussed is the risk to the commercial banking industry as a consequence of a regulatory framework that is determined to shatter principles and institutions that are a century old. Now, I am no Luddite. I love technology. I wrote a book on bitcoin that celebrated some of the spirit of the founder of that digital currency seventeen years ago. I am keenly interested in the role of banking in our economy and I have been teaching money and banking for almost 40 years. So, when Satoshi Nakamoto proposed a new digital currency called bitcoin back in 2008 as a way to democratize transactions through almost instant peer-to-peer transactions, I took note. Nakamoto was frustrated then by the meltdown of financial markets in the leadup to the 2008 recession it triggered. Nakamoto’s concept was a way to bring banking to the unbanked who could not afford all the fees banks were tacking on to small account holders. The idea is that if we could exchange a digital currency on our laptops and smartphones, we could avoid a banking system that Satoshi felt was wrought with self-dealing and risk. Satoshi’s creation succeeded in what turned out to be Frankenstein proportions. His (or her) dream was for the value of bitcoin to perhaps reach a dollar, and hence reward about $50 every ten minutes to one of the handful of hobbyists that were paying electricity to run a special program that would indelibly record each transaction between bitcoin account holders who could remain anonymous. Satoshi even designed into the program a feature in which this compensation would eventually dwindle for the lottery of which hobbyist could first succeed in recording transactions in a particular way. When Satoshi saw that her simple system was perhaps simplistic and which would eventually demand a sizeable swathe of our nations’ electricity, he or she disappeared from the scene, never to appear again. We’ll discuss in startling terms more about this electricity dimension next week. But, if that innovation of what we call bitcoin (or Proof-of-Work) mining became an environmental Frankenstein, so too was Satoshi’s hope of bringing banking to the unbanked. Stablecoins are a response to the problem of a digital asset such as bitcoin that fluctuates in value by the second and often by 10% or more in a day. Satoshi and others since have recognized that people don’t want to bank with a currency that is highly volatile. When rent is due at the end of the month, we want to know our account has not decline by 20% over the weekend. Stablecoins were supposed to solve that problem. By backing a coin’s value with some sort of harder asset, we’d have confidence that there is nothing behind a digital coin “but thin air” as President Trump described it. His administration is now working very quickly to pass legislation that will do just that. It will permit people to invent new digital currencies but also require them to have some sort of backing of more stable assets, kind of like how gold once backed the U.S. dollar. The problem is that, if a sponsor of a stablecoin fully backs every coin issued 100% with some hard asset that will retain its value, there is no return for the sponsor. This is what has imperiled hundreds of thousands of people who mistakenly believed that a stablecoin was truly stable in value. They weren’t back with the hard assets their sponsors promised, and when 23 such companies failed, people who had full faith and credit in those coins lost their shirt. Some perhaps couldn’t then pay their rent. When something is represented as a financial security, the Securities and Exchange Commission is obligated to regulate such instruments. The first thing President Trump had to do was get rid of the regulator, first by engineering a new SEC chair and second by supporting a move of crypto regulation to the lightest touch regulators around, the Commodity Futures Trading Commission. This is the group that regulates such things as a fall delivery of wheat or next week’s delivery of fuel oil as promised. Such contracts on hard commodity assets don’t need much regulation because contractors and contractees are in the business of working with each other and living up to their promises. This is not the case in the oxymoronic world of stablecoins. The wild and wooly buyer beware world of stablecoins and crypto just got a whole lot unsafe. But so will banking. The great innovations following the failure of 50% of US banks during the Great Depression were the Federal Depository Insurance Corporation and a Federal Reserve with teeth. They recognize how banking works. A bank takes deposits and uses most of those deposits to make loans in its community. Those loans will perhaps pay contractors to build homes or factories, which results in further deposits made by those who receive payments from such commerce. The bank again lends out most of these new deposits to create even more loans and more deposits. For every dollar of initial deposits, another eight or nine dollars of deposits can be created through loans. The difference between what a bank charges on a loan and pays in interest to a depositor is what keeps this mechanism going. In turn, banks scrutinize borrowers to be sure they are not creating unnecessary risk to the bank, its depositors, and the entire banking and financial system. Meanwhile, regulators constantly scrutinize bank actions to ensure they have sufficient assets of sufficient liquidity to meet the needs of their depositors. Now, I admit Satoshi was exasperated with such a banking system once we saw the excessive risks banks will take when they become “too big to fail.” Satoshi though bitcoin was a solution but soon realized it could not be once the digital coin was viewed as a speculative instrument to bet for or against rather than as a currency for the unbanked. I don’t know if Satoshi ever considered the danger, though, of a parallel and essentially underground financial system. Imagine if the masses could simply avoid traditional financial markets. The underground economy has been using a stablecoin to avoid detection for decades. It’s called the 100-dollar bill, the universal currency of crime, at least until bitcoin came along. In such a nebulous network, profits are made, but they are not plowed back into the economy. Instead, proceeds are reinvested into more criminal ventures. Similar problems could result from stablecoin legislation. The legislative rationale is to give people an alternative to traditional checking accounts. That is merely a statement to decimate the deposit base of banks and hence all the local lending they would normally do with our deposits. I am certain that the purveyors of stablecoins will figure out some way to make our deposits work for them. But, they won’t have the tools or the tolerance for local lending. Instead, if they are permitted to back stablecoins out with loans that earn them a profit, much of those loans will probably be sequestered in the crypto family. I can’t see a day when your stablecoin savings will fund my purchase of a home. Such a diversion of deposits away from traditional banking will have profound implications on the banking industry and will be expensive for all of us in ways we cannot fathom. In addition, while peeling back layers of regulation is music to the ears of every libertarian, it is those regulators that have kept our financial system safe and the envy of the world for almost a hundred years. They prevent fraud and hence they encourage retail savers like you and me to invest in markets. And, by holding the puppet strings of the banking industry, the Federal Reserve can act as the only responsible party left to limit inflation and encourage growth. A skepticism of all regulation just because one may not like some regulation is not a sound rationale for gutting the financial regulatory system that has mobilized and protected the retirement savings of generations of Americans. There is likely also little tolerance for a hands-off regulatory approach that merely trusts a new breed of crypto bros too big to fail to act most prudently on behalf of depositors rather than their own stashed wealth. Knee jerk shock and awe deregulation may appeal to some, but, when it comes to people’s life savings, “let the buyer beware” is discomforting. The President and our pro-crypto legislators want us to embrace this brave new world that they hope will soon dominate deposits, lending, transactions, and commerce, without the protections of the Federal Reserve, Securities and Exchange Commission, or the Federal Depository Insurance Commission. It is fine, many might say, to unshackle the reins of our monetary system built on “full faith and credit.” Okay, I say, but tell me, how exactly do you think stablecoins work? If you don’t have a great answer to that question, maybe your “full faith and credit” in Pollyanna finances might become dystopian surprisingly quickly. Well, I guess we get the regulation we deserve, or the deregulation some can purchase. It is ironic that we have the protections to uphold the integrity of the monetary system precisely because banks begged to be regulated following the bank panic of 1907. Now, in the wake of accelerating crypto failures, crypto bros are demanding and purchasing reduced regulation. I'm confident we will eventually find a balance. But a lot of people may get hurt as the regulatory pendulum shifts so violently.

Well, the absurd has occurred. There is no point employing objective economic policy to better understand the pique of irrationality that tears at the fabric of international trade. So, let’s leave discussion of trade policy to some time in the future when cooler heads can prevail. Suffice it to say that we have seen in one day more long run economic carnage than the two closest allies and trading partners in the world have experienced in a lifetime. As a signatory to an open letter from economists across this country, I merely refer you to the statement by Larry Summers and Phil Gramm entitled: A Letter on Tariffs from Economists to Trump. It is almost baffling to decide just what policies to analyze this week. Shock and Awe has come to the White House. But, I will pick off some low hanging fruit. Tax cuts for the wealthy are again on the planning table. I’m going to make the case for “no cuts necessary” for the super wealthy. The reason is simple. They don’t play any income taxes anyway. It's not that they shouldn't pay at least the same rate as you and me. It's just that they don't - and far from it. Let’s explain why and how. The ultrabillionaires of the country, Musk, Bezos, Zuckerberg, Ellison, Altman, and myriad others have all amassed fortunes, mostly in the value of their own companies. Their wealth has increased phenomenally, perhaps by a billion dollars a day, of late. And yet they often employ a technique to avoid paying any taxes at all while they live like royalty. Their secret is “buy, borrow, die”, a strategy described three decades ago by Prof. Ed. McCaffery, a tax law professor at the University of Southern California. To understand the strategy he described, let us first describe an aspect of the U.S. tax code. People like you and me who receive a wage, salary, or pension every two weeks are considered for tax purposes to have realized income. We receive a tax form from our employers or providers, and we must then tally our income, net of some allowable deductions, on our tax filings due in a couple of months. We then pay a share of that taxable income based on our average and marginal tax rates. People like Musk have amassed unimaginable wealth which rises every year. This rising value is in the increasing price of the stock they own in their own companies or perhaps the stock they’ve bought in other companies. That’s the “Buy” part of buy, borrow, die. A quirk of the tax system in the U.S. and Canada is that any gains in the value of the stock one owns is not considered income until the stock is sold. Let’s say someone named Muskee tells his board he will forgo any salary and will instead let his efforts increase the value of his stock in SpaceXee, Teslaee, The Boring Companyee, and others. The problem with this strategy is how will poor Mr. Muskee afford to live in the style to which he has grown accustomed if he has no income? No worries. Here’s the trick of McCaffery’s strategy. Mr. Muskee need only find a friendly investment banker that will lend him money at a very low interest rate consistent with good collateral. Let’s say Muskee needs $10 million to live. He can pledge a lien on $10 million of his stock to secure a $10 million loan. Knowing that the pledged stock will continue to rise in value at, say, an average return of the stock market of about 10%, the investment banker knows the value of the collateral actually increases over time. The going lending rate for such an inside deal is around 4-5%, which is more than covered by the increasing value of the stock. The investment banker has to agree with Mr. Muskee that this is a long-term relationship, perhaps even until death, and that Mr. Muskee can borrow a similar amount every year and increase the total number of shares pledged to always ensure that there is more than enough stock to cover the loan. In fact, if the stock price rises faster than the loan rate they agree upon, Muskee may even need to pledge less and less new stock every year to keep those loans coming. In effect, Muskee can then live on his $10 million, or whatever, a year to cover expenses not paid for by his company. In doing so, Muskee has completely avoided taxes since he reports no realized income, even as his wealth rises by billions every year. Not only does he avoid paying any taxes on his annual increase in wealth, but he also pays no taxes on the money he borrows. He has gone tax-free. The last step is the death part of “Buy, Borrow, Die.” When time comes to pass a lifetime of wealth net of borrowing to his dozen children, he can do so in a few ways. Before he does anything, any amount owing to the investment bankers that funded his lifestyle must be paid back. If Muskee must pledge $10 million more in stock to this scheme every year, and that stock rises faster than the very low interest rate he could negotiate for an essentially risk-free plan, there will be way more than enough set aside in the end to pay the investment banker back fully, with interest, and still return any remaining collateral to Muskee’s estate. Muskee’s estate can then cash in all these assets, but the heirs would be better off simply taking ownership of these various stocks at what the IRS calls a stepped-up basis. If Muskee were to sell the stock before he died, he would be responsible for a capital gains tax bill that is the difference in what the stocks are worth and what they were worth when he first acquired them. But, his Muskeeteers could instead take advantage of the stepped-up-basis tax loophole and inherit these assets with a new cost basis equal to their current value, not their original value. Then, his heirs can impose their own “buy, borrow, die” strategy to avoid taxes going forward just as their father had. In the end, an immense wealth is created, any sort of imaginable lifestyle can be supported based on the unrealized income the portfolio generated, and no taxes are ever paid. Instead of a tax bill of $100 billion for 40% tax rate paid on about $250 billion of wealth created, there are no taxes paid at all. Now, I know that this financial instrument sounds unusual, but it is actually very common. The instrument is called an annuity, which is a payment of a certain fixed amount for a specified number of years for either a payment up front or, for a future annuity, a payment at the end. To earn a very low interest rate, the investment banker funding these payments would need to receive some stock collateral up front. Actually, if this risk-free interest rate is low compared to the growth of the collateral, the amount of collateral put up actually falls as the annuity lengthens. This is because the collateral is becoming more valuable over time. And, of course, since an annuity is a loan, no income taxes are paid on the regular income received, and, if this financial instrument can be rolled over to the Muskeeteers, capital gains taxes can be perpetually deferred as well. Not a bad gig, if you can get it. This scheme sounds like a tax evader must find a friendly banker willing to hold these assets until the billionaire’s death, and also be willing to offer an interest rate lower than the average return of the stock portfolio held in collateral. That is not too difficult, though, for a couple of reasons. There are likely many investment banking firms who are clamoring for Muskee’s business, so such a modest side deal for $10 million of lending each year is a drop in the bucket. The second reason is that this arrangement is essentially a securitized loan, with well-defined terms and a heck of a lot of collateral. If one investment banker wants to cash out of the deal, that financial security can be purchased by another. Any other investment banker who has an interest in the stocks in the portfolio would be happy to participate. In fact, they may be able to expense some of their costs of borrowing to send the annual checks to Muskee, while they defer their income from the arrangement to the point where they cash in. And while this scheme is equivalent to an annuity that would have tax implications for you and me, we don't have the room full of tax lawyers that investment bankers employ to take care of their wealthiest clients. This is good for everybody, except of course the taxpayers who must send more to the IRS to support the spending to which our legislatures commit but without the ultrawealthy paying their fair share.