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.

I can’t help it. I have a worldview that people are rational and nobody would misinform on purpose. I know, pretty naive. But, let’s set the record straight before February 1 when President Trump vowed to impose a 25% tariff on exports from Canada and Mexico. This is an opportunity to discuss how trade works. I don’t know if a lesson is really necessary though. You and I know how trade works. I sell my labor efforts in return for an income, which I then use to pay our bills. At the end of the year I have some left over, which allows me to save some money for retirement. It’s pretty simple. Foreign trade is not any different. In the case of Canada and the United States, Canada purchases a bunch of services and finished products from the U.S. because the U.S. can produce these goods perhaps at lower price or greater quality than could Canada. These exports from the U.S. are considered imports by Canadians. They are a great thing. Nobody complains that imports are unfair. No one has a gun to their head. Individuals and nations have consumer sovereignty to decide what they wish to purchase. That’s great for Canada that gets to buy goods and services from the U.S., and for U.S. producers who earn between $400 and $500 billion (US) annually in purchases by Canadians. Americans also purchase from Canada. If you take out oil and natural gas, the trade is about the same - between $400 and $500 billion annually. In addition, the Province of Alberta also sells around $50 billion of oil into pipelines that flow between the U.S. and Canada. It could sell those products through ports in British Columbia to nations in the Pacific Rim, but it can offer a better price to American refiners that dot the mutual pipeline, are optimized for the heavy oil that is in abundance in Alberta and some western states that also feed into the pipelines, and depend on that low cost supply to serve their markets. Energy purchases from Canada by the U.S. represent about 61% of U.S. oil imports, 98% of its natural gas imports, 93% of its electricity imports, and 28% of its uranium purchases. Other provinces, such as Ontario and Quebec also sell energy to U.S. consumers, but Alberta is the biggest player. The biggest beneficiary of those cheap exports are American consumers. Let’s for a moment take these energy exports out of the picture. If we do so, Canada and U.S. trade are essentially balanced. Now, let’s consider oil Canada sells to US markets rather than foreign markets. The US gets a better deal because inland refineries have access to less expensive oil. And Canada benefits because it does not need to absorb the additional costs of marine shipping. It can also feed existing U.S. refineries instead of having to build their own. So far, so good for everybody concerned. The question then remains. President Trump intends to impose a 25% tariff on Canada because he calls these purchases by U.S. refineries a subsidy. This is where I am confused. If I buy dinner at a local restaurant, and the local restaurant does not buy anything in return from me, does that mean I am subsidizing the restaurant? I didn’t think anybody believes this is what mutually advantageous trade means, until now. President Trump argues that the purchase of a good with cash should now be considered a subsidy. Now, let’s talk a little bit more about how international trade and exchange rates work. In countries that subscribe to what we call a floating exchange rate (and that’s most every country in the world these days), the exchange rate adjusts to be sure those who sell to other nations also purchase the same amount from other nations. What? Wait! I thought we just said the U.S. buys a bit more stuff from Canada than Canada buys from the U.S. Where are those extra American dollars flowing into Canada then going? Is there a stack of American dollars Canada is stashing somewhere? Is their government covering any budget deficit by paying Canadian workers in American dollars? If excess American dollars were really subsidizing Canada, the $200 billion that President Trump claims is subsidizing Canada would allow Canada to bring its personal income tax rate to about zero. On the other hand, President Trump argues that Canadians would love to join the U.S. as its 51st state because Canadians pay way more in taxes. Which statement is true? Does the U.S. really subsidize Canada through its willingness to sell energy to the U.S. at a lower price Americans could find elsewhere, and then use the subsidy to be sure Canadians don’t pay taxes, or do Canadians pay taxes and are not subsidized by the U.S. And, with regard to that approximately $100 billion surplus of goods, Canada then uses about half that amount to purchase American services, such as financial services, etc. So that still leaves about $50 billion. Where is that going? The solution is not really complicated. Of course, there are not stashes of extra American dollars flowing permanently into Canada and burning a hole in their pocket. Instead, those funds come back to the U.S. not in purchases of goods and services, but purchases of U.S. investment goods. Money returns to the U.S. in the form of investments - the same sort of investments President Trump lauded when he held a press conference for the notorious Saudi Crown Prince Mohammed bin Salman who promised to reinvest $600 billion of excess U.S. dollars (again, from purchases of oil, this time from Saudi Arabia) into U.S. investment projects. Canada makes such investments in the U.S. all the time, but Canadians don’t look different from Americans, and only speak a little bit differently, so their investments are not so apparent. As a consequence, President Trump can get away with claiming Canada is somehow taking advantage of the U.S. through its energy sales while Saudi Arabia does not. Let’s compare the roughly $50 billion actual trade deficit with Canada (nobody really understands how President Trump arrived at a $200 billion figure). China’s surplus with the U.S. is about $400 billion, almost ten times that with Canada. And yet, while President Trump is threatening a punishing 25% tariff on Canada, he is only proposing a 10% tariff with China. Maybe this is even worse than the mafia creed - punish your closest allies and embrace your adversaries. Now, President Trump doesn’t explain his light treatment of China, but he does claim that Canada is a poor friend. After all, less than 1% of fentanyl inbound to the U.S. is from Canada and about the same percentage of its illegal immigration. Ironically, most of that fentanyl is made with products from China, and a good share of illegal immigrants to the U.S. crossing its land borders are from China as well. Canada actually suffers along with the U.S. such illegal immigration and drug production. The two countries should be working to stop such transgressions of sovereignty at their source rather than threatening each other. Now, to be honest, it is obvious that trade is not the real issue here. Today’s graph shows that the trade deficit the U.S. has with Canada barely cracks the top ten and accounts for only around 3% of the U.S. trade deficit, despite all the rhetoric. Equally insignificant are the miniscule flow of immigrants and drugs flowing between the two countries, which are not just in one direction. Nor does Canada seek to punish the U.S. despite the unprecedented flow of illegal firearms coming into Canada from the U.S. Something else is going on, at a more personal level between Canada and President Trump. This relationship is rapidly deteriorating, and damage has been done even if President Trump backs down from the bluster on February 1. Astute Canadian observers probably sense what is really going on. But I will leave that to the politicians. As an economist, I’m far more comfortable at trying to make sense of the facts rather than make the seemingly irrational rational. In that dimension, I stand completely baffled.

It appears President-elect Trump’s proposed use of economic tariffs to punish political grudges has its first casualty even before he takes office. Canada’s Prime Minister Trudeau resigned following controversies within his cabinet on how to handle Trump’s teases, taunts, trolling, and tariff threats. Last week I spoke of the dangers associated with using broad based tariff policy to settle political scores. I argued in a long-winded way (even for me) that the tariffs President Trump is proposing do not make sound economic sense. They penalize nations for reasons unrelated to perceived trade infractions themselves, they penalize American consumers who pay a dearer price for imports unavailable domestically, they induce inflation, and they run a great risk of a global trade war. But, it is not my style to criticize without providing workable solutions. I certainly share the frustration if a rogue nation trades unfairly. I first have to acknowledge that fairness is in the eyes of the beholder. As a parent, you may tell your two year old that 8pm is time for bed. They may stomp and proclaim “that’s not fair!” but it is from the parent’s perspective. For instance, Canada and the US have disagreed on the fair treatment of softwood lumber trade. Canada is the second largest country in the world, with huge tracts of forest that have almost no opportunity value as farmland, given their latitudes. A well-managed forest that isn’t permitted to overmature and then rot can actually offer opportunities for carbon sequestration as the biomass is converted to permanent structures. Hence, not only is the value of forestland low in Canada, but prudent forestry and extraction may even be encouraged to enhance sustainability. On the other hand, forest land is in shorter supply in the U.S. The land under U.S. forests has more alternative uses, hence its opportunity values are high. The U.S. may thus have a higher land cost associated with forestry than in Canada. It is not an example of subsidization if Canadian sawmills thus pay less for wood than their American counterparts if Canada’s land is less highly valued in the marketplace. Hence, it should come as no surprise that Canadian softwoods are cheaper, in the same way that a low labor cost country has lower manufacturing costs. Canada doesn’t have much labor, but it has a lot of land and forest. Canada’s softwoods have been targeted in US trade policy for years because the US claims Canada subsidizes its timber by not charging as much for their use of land. This is an example of fairness in the eyes of the beholder. Because one nation does not have the same cost structure as another does not imply unfair competition. Heck, differing cost structures are the very basis of the 19th century politician and amateur economist David Ricardo’s notion of comparative advantage. Instead, we must measure unfair competition more objectively than that. Is pricing truly designed to force competitors into bankruptcy? Are companies permitted to conduct industrial espionage or flagrantly steal patents? Are the human rights of employees abused through child labor or servitude? Do nations refuse to incorporate into the cost of factors such negative externalities as the pollution they create? Are companies engaged in corrupt activities such as bribery? These issues can be measured objectively through fact-finding. Courts or tribunals know how to make these determinations in cases of domestic corporate malfeasance. Surely we could agree to a set of protocols at the international level as well. It may take some work to form a sufficiently strong coalition of trade allies to ensure that a group such as the World Trade Organization develops objective criteria based on sound economics and then screws up the political courage to put some best practices in place. Many of the WTO’s member states already ensure such principles to create a level playing field for trade at home. And there is experience with such tribunals to settle trade disputes within such treaties as the US Mexico Canada Agreement. We know how to do it. We only lack the political will to make it work on a broader international level, and then resist the temptation to ignore its conclusions when it does not every moment favor a nation’s preferred conclusion. Then, once a determination has been made, a nation should be required to pay appropriate compensation for any harm done, and must incur a penalty for any future damage until the transgression can be remedied. These are the principles we would use in civil law within a nation for domestic commercial disputes, so we know it can be done. By establishing international standards, we then much more highly leverage the effectiveness of our concerns because a rogue nation would feel the brunt of targeted sanctions not just from one country but by all nations who agree to the principles of the WTO. There is still the issue of political will, though. It would require nations to discontinue using tariffs as a blunt instrument with which to club nations over the head over issues perhaps entirely unrelated to trade disputes. We spoke last week about President Trump’s threat of tariffs on Canada over claims that Canada is not serious about border security, despite only 1.5% of all illegal crossing apprehensions occur at the US Northern border, or fentanyl smuggling, even though only 0.2% of forder-seized fentanyl is from Canada. These are issues entirely unrelated to trade and, in fact, not even serious complaints. Clearly there is some other unarticulated frustration Trump has with Canada, but it is impossible to have a meaningful discussion of terms of trade when trade is a red herring for something else. Nations have other levers of power. The product of a particular company or sector can be banned altogether if its products violate a nation’s standard, just as we would ban the sale of an illegal or rogue domestic product. The US blacklisted Huawei based on assertions the Chinese telecommunications firm could release confidential customer information to its government, and has legislated the sale of China-owned TikTok based on similar stated concerns. Targeted prohibitions or sanctions work. The US can magnify its potency by eliciting allies in likewise banning products or companies. Such would be a huge deterrent from pursuing unfair trade practices or outright corporate thefts. Other disputes can still rely on various levers of power, such as were employed with limited effectiveness against Russia. Privileges of membership to international monetary conventions or commercial facilities, access to international credit and investment, mutual defense, travel bans, banning of products used to support the revenue needs of rogue actors, and other soft incentives can be used to deal with non-trade-related grievances. Diplomacy and downright deal making is always employed. And, in the most dire circumstances when nations defy the sovereignty of others, a strong UN or coalition presence may be necessary to defend the weak against the mighty. There are escalating tools that can be used for various degrees of non-trade transgressions. We certainly see that some nations use every opportunity to abuse trade or conduct electronic warfare. We hear stories of Russia, China, and North Korea wrecking electronic espionage havoc, often for political, but also for commercial purposes. The US must defend itself, at great cost and with some inevitable failures, and may even have our own programs of electronic espionage. We must certainly address those threats but we don't need to do so in ways that cause so much damage to free trade. Yes, a scalpel is tedious when one can just pull out a sword. But a scalpel is much more targeted and will do much less collateral damage. The point is that we should not fight non-trade disagreements or otherwise try to gain the political upper hand against nations by making trade threats that damage global supply chains and risk trade retaliation and deterioration. Or, if our complaint is that a nation such as China does what we do, through subsidization of key industries, rather than sanction them, perhaps we should do more to enhance our own key industries. Let’s face it. A nation of comparable size does not simply bend to American wishes. With China, we are dealing with entirely different world views, and tariffs aren’t going to change that. Dealing with disputes across different countries and cultures is often difficult enough. We don’t need to make them worse by threatening nuclear options over stubbed toes when microsurgery might be more proportional and appropriate. It is best to use economic solutions for economic issues and reserve political tools for political battles. And, when the going gets tough, we should get going in the way that has always worked in the past - by building that better mousetrap rather than attacking others. By the way, I find curious soon-to-be President (again) Trump's other rationale for economic invasion is that Canada is subsidized by the U.S. because it runs a trade surplus with the US. China has twice the trade surplus, and most of the fentanyl precursors and 55,000 apprehended illegal immigrants came from China over the last 18 months (up 8000%), but Trump has not talked about China as the 52nd state (yet). I wonder why. ,

First, happy New Year! Be sure your seat belt is securely fastened and your trays are in their upright and locked position. This could be a very rough landing. In response to today’s title about when tariffs are a good idea, for those who suffer from TL;DR, the answer is almost never. Let me explain. First, let us draw a distinction between what is sound economics and what is typical politics. Economic policy follows one principle - how do we expand the economic pie to make everybody potentially better off. If we include future generations in such policies, and there is absolutely no reason from an economic standpoint that we wouldn’t, we should further qualify the economic principle to ensure that we can sustainably expand the economy through good policy. Any policy has winners and losers - else it would be called a no-brainer rather than a policy. The key to sound economic policy is that the winners gain enough to potentially compensate the losers for any setback they may suffer from the policy. In economics we call this the Pareto Principle, after the 19th Century polymath Vilfredo Pareto who formulated the concept. Note that I used the term “potentially”. A policy is still good even if compensation is not made to losers in a policy change, so long as the gains are sufficient to complete the compensation if the population deems it necessary. Another way of stating this principle is that we should not pursue any policy unless its benefits exceed its costs, and we should scale the policy to ensure that the last bit of the policy just balances the last bit of its costs. This is the “marginal” principle in economics. If we properly quantify all the costs, including the costs to those harmed by a policy change or the cost on future generations, then we should seek economic policies for which the overall benefits most exceed the costs. This is where the principle of free trade comes in. The notion dates back to Adam Smith’s 1776 Wealth of Nations and beyond. If trade is voluntary, and if all the various benefits and costs are properly considered, nobody would trade if it were not in their interest. In other words, we all gain from trade, at the personal level when one decides the compensation from work is worth sacrificing our free time, when we agree that we benefit more from purchasing a product than its price, and, in the international sense, when we agree to buy a product from another country at the price offered us. There is no gun to our head in the purchase of an import. Free trade has nothing to do with liberty. Rather, it is the notion that an economy finds efficiency if I am left to decide what I value most, and you are free to decide what you can provide most profitably that interests me. It is all about efficiency rather than freedom, which is why perhaps free trade is misunderstood and why some would try to limit our choices to meet their political ends. For instance, we now see some countries accused of artificially selling their products at too low a price. Have you ever complained to a retail store manager that the sale price of a good is too low? Export subsidies are the same thing. If a company or a country wishes to increase their sales by decreasing their price, then that is a good thing, so long as all benefits and costs are considered. There are some instances when we may claim that is unfair. A company or country could try to expand their market share through predatory pricing - a temporary and seemingly irrational price decrease that is designed to force their competition out of the market. Such a policy may work with near monopolies, and is abhorred by economists, but can rarely if ever succeed internationally. Of course, the U.S. and other nations often subsidize various forms of production in ways that has the effect of reducing prices of our exports. A recent agriculture think tank report observed that US farmers on average receive about 36% of their income from the government. That is twice the average level of Organization for Economic Cooperation and Development (OECD) nations, and more than four times the rate of emerging and developing nations. Many nations subsidize their exports of agricultural products. It’s just that the US does it on the grandest scale. The policy is apparently not designed to ensure we have oats for our breakfast. It is a political decision argued to defend family farmers in rural areas where each political party panders for their vote. However, a big bulk of this vote-buying goes to corporate farms that can’t vote, so the policy is not only bad economics, but is also bad politics. The politicians have dug their hole on this one though. Any politician who would speak the truth to such subsidies would immediately be labeled as opposed to mom and apple pie. A subsidy can be used on a very short term basis to allow a new industry to gain a toehold in the market (Airbus in Europe, chipmaking in the US, ironically enough given that the US designed the first microprocessors). This is the so-called “infant industry” argument. A subsidy is not used for predatory reasons, but rather to increase competition in the long run by allowing new competitors to enter the market. This is the very opposite of predatory pricing designed to reduce competition. Such subsidies also often fall to political pandering. For instance, the US recently engaged in the king of all industry subsidies by providing demand-side incentives to purchase US-made electric vehicles. The subsidy was well-intentioned to solve a market failure. Investors have very short term horizons. If something like a new EV or a plant to build solar panels cannot produce quick results, the investment dollars flow elsewhere. EVs in particular are high risk because few manufacturers are innovative enough at a sufficiently low price point. A more effective subsidy would be designed to remove long term risk by investing directly in research and development that does not always result in a successful outcome rather than subsidizing purchases. Tesla was a huge beneficiary of such US subsidies. But, instead of building more and better cars here, they used the profits from the subsidies to build more cars elsewhere, in China, Germany, and even with plans for Mexico. Their decision to use the subsidies to expand rather than innovate means other companies, particularly from China, are now building the better and cheaper cars Tesla perennially promises but equally perennially fails to deliver. One might also subsidize in the longer run to ensure a steady stream of a critical resource which wars (with armies or trade) may threaten. Japan is an island nation and dependent on rice production so the nation ensures a sufficient supply of rice to guard against naval blockades that occurred, for example, in the Second World War. In any regard, such subsidies often provide what some would claim to be unfair advantages to certain companies or industries based on nationalistic politics. However, they still translate into lower prices, domestically and abroad. The other accusation often leveled from our own glass house is that countries manipulate their currency to make their products artificially cheap for foreigners. Such a policy is often leveled at China. When China’s economy was much smaller, it could have tried to manipulate its currency. For the last decade or so, though, that would be infeasible. The only way China could do so would be to skim a large share of its trade surplus and devote it to buying other currencies, particularly the American dollar. That is very costly and it removes the trade surplus from productive investment in their own country. It also basically subsidizes US consumption of their goods. If anything, such a policy is ill-advised for China and good for consumers. China knows that these trade surpluses could be better spent targeting strategic investments in their own economy to build better mousetraps. China’s central bank and government economists understand that. After all, many of their top scientists and social scientists were educated in the U.S. That is unnecessary now, given China’s massive investment in their education infrastructure. International currency expert Michael Klein, who also happened to have the office next to me when I was at Clark University, noted in a 2015 article that there could then be no claim that China was manipulating its currency. That is for small developing countries to mistakenly do, but China was already then too large to afford to manipulate their currency. If you look at today’s graph, China’s currency has only strengthened since then, even compared to the US dollar, which has soared compared to other currencies. If the observation that other currencies seem to consistently lose value against the dollar since 2015 is a measure of currency manipulation, then all countries apparently do that. Instead, it is a measure of a flocking of foreign capital to US investments, which strengthens the dollar and is a good thing. To claim otherwise is a false but politically expedient narrative. Currency manipulation is a politically popular ploy that then President Trump first used in 2017. If it was already invalid then, it is even more so now, but Trump cynically believes it gives him the rationale to impose severe sanctions on China in the form of import tariffs. Tariffs are a lazy way to be economically ineffective. They appear to cost a nation nothing but benefit domestic industries. But, while politicians love gimmicks, in economics there is no free lunch. If you follow the logic of tariff desirability to its natural conclusion, there would be no global trade, and EVERYBODY will suffer from an inability to trade voluntarily to further our individual interests. They are likened to subsidies of our domestic industries, but costlessly. The no free lunch conclusion is that the domestic cost is actually very high. Consumers immediately pay more for products only made abroad - think certain natural resources or products that are so inexpensive we don’t want to devote our skilled labor to make them domestically. Even domestic industries may suffer if some of their factors of production cross borders. A tariff on Canada will significantly push up the price of a US-made Ford that relies on Canadian content. This self-imposed shot-in-the-foot under the false premise of currency manipulation or lack of border security (1.5% of all illegal immigrant arrests occurred at the Canadian border) or drug-running (an even smaller 0.2% of all border fentanyl seizures were from Canada) creates an even worse result in that other nations naturally have to stand up for their domestic industries by imposing a similar tariff on U.S. imports. The only nations that win in this escalating tit-for-tat are those who build stronger relations with economic allies willing to forgo economic foolery. And, once that policy is pursued, greater economic, political, and defence integration will likely follow. American isolationism has little chance of success in the long run. Let us debunk one final claim about any perceived long run benefits from tariff imposition. The argument states that tariffs divert spending on goods from other countries to spending domestically on goods of higher prices. This inflation will discourage consumption and instead encourage investment, or so the flawed argument goes. This argument is false on many levels. First, anticipation of inflation actually increases spending because we believe our money will be worth less in the future. We are already seeing a wave of such inflation-anticipation spending. This leaves less money available for investment, not more. Besides, how are nationalistic voters going to feel about a policy designed to reduce consumption and increase inflation? Have fun selling that to the electorate. The second more fundamental flaw in President-elect Trump’s logic is that a wave of new manufacturing will occur domestically. We have already discussed in past blogs the microeconomic revelation that more expensive goods at Walmart will not result in a wave of US manufacturing of cheap plastic goods. But, even if one could make the case that such import substitution could occur, will there actually be the investment trade distortion proponents claim? If people actually consumed less and instead invested more, does that translate into more domestic jobs? No. When consumers invest, it is in the purchase of stock, not in building new factories. A financial bubble may form, but it is unlikely we’d see a significant increase in domestic jobs. Indeed, unless the tariff policy was also accompanied by a restriction on financial capital outflows, as some desperate nations have tried and failed, smart money will just go elsewhere less prone to the upheavals from costly trade wars. This leaves us with only one explanation. Tariffs are a convenient scapegoating tool for opportunistic politicians wishing to sow the seeds of nationalism at the expense of inflation and perhaps even domestic investment. They do not improve our global competitiveness and may actually worsen it. But, boy, they sure sound great on the campaign trail. It is always comforting for people in desperate circumstances to blame others for our own plight. It might be more productive, though, to sniff out why our economy is failing and fix problems with inadequate domestic investment or innovation, distorted domestic markets, or demand incentives rather than the more sorely-needed supply incentives. We’d be better served if, instead of pointing a finger at others, we point out ways to improve competitiveness ourselves rather than reduce competitiveness through tariffs. I know you all recall the vast arc of American history in which the nation believed in the American Exceptionalism notion that nothing can suppress American competitiveness. When was that replaced by the notion that the US can succeed only be suppressing others? Let's pull up our bootstraps rather than focussing our attention on tying down theirs. Has American Exceptionalism really be replaced by American Divisionism?

I was perusing the Federal Reserve Economic Database (FRED) earlier this week, as all good nerds do, and came across a troubling conclusion. We are witnessing the decline and fall of the middle class. At the same time, Natalie and I are tripping around India, a remarkable and the world’s most populous country, in which the abject poor live alongside some of the world’s wealthiest. India has the third most billionaires of any country, including Mukesh Abmani, one of the world’s ten wealthiest one hundred billionaires. At the same time, it struggles to create enough jobs to give its children an opportunity to succeed in life. The consumption-based economy that worked so well to vault post-WWII United States into the economic envy of the world was based on a simple Keynesian premise. If we can provide consumers with a sufficient income to purchase the products they produced, an economy can grow as the population and productivity grows. Even Henry Ford realized that paying a higher wage will allow his workers to buy his cars. This notion that a good share of our productivity was paid out in wages was the cornerstone that permitted the U.S. economy to consistently grow at a rate of 3-4% for decades. So, what happened? We live in economies that subscribe to an increasingly fictitious concept of a middle-class driven national economy. In fact, they are increasingly devoting more and more of our economic pie to the wealthiest. Meanwhile, consumption and growth are faltering. Let’s get back to FRED and Keynes. John Maynard Keynes integrated various economic ideas from the early twentieth century that harkened back to French physiocrats from the 18th century. Economies work best when income is constantly recycled - income is earned, and then spent to purchase products that generate additional income from those who produce them. This virtuous cycle makes the economy go round and is the basis for the consumer-driven economy. It requires the most sizable populations to have the means to spend. This was the notion of the middle class, a potent and large economic force that creates built-in demand for the products a nation could produce. This notion of a society in which the predominant class was middle income, perhaps constituting wage-earners from the 25th to the 75th percentiles of earnings, was the juggernaut of American economic success since the Eisenhower era with “a chicken in every pot and a car in every garage.” So, what happened to that American Dream of a predominant middle class? We don’t have to look too far back. The Reagan Revolution was based on the flawed premise that we could replace a consumer-based economy with an investor-based economy if only we let investors keep more of their income and wealth. The theory held that they would invest their newly-kept income in new enterprises. Instead, they merely pumped up financial bubbles even further, which gave the false impression of financial success with little additional production. Meanwhile the reduced taxes that permitted the wealthiest to keep their income accelerated our national deficits and debt. We have stuck with the unfortunate fiction ever since. Many, particularly the wealthy, believe that reduced taxation of million and billionaires would somehow translate into economic growth. Instead, our once strong 3-4% growth rate has halved to 1-2%, and the national debt has consistently grown. A quick appeal to FRED explains why. Today’s graph shows that, in 1979, a median wage earner, defined as the point in which half of our population earn less wages per year and half earn more, received wages of about $55,000 (in today’s dollars). Fifty years ago that income represented about 56% of our national productivity per person. By 2024, this median wage for one solidly in the middle class had risen ever-so-slightly, to $61,000. The average worker is simply not getting ahead much, even over almost half a century. The self-professed economic miracles of Reagan and Clinton have turned out to be a middle class mirage. That rising tide of upper income retained wealth has sunk the middle class American Dream. Meanwhile, our productive capacity zoomed ahead. The size of the American economy, on a per-person basis, has doubled from about $102 thousand per American worker to $219 thousand over the last half century. Wages are stagnant but growth churned upward. In other words, the American worker has been left behind. Where is all that additional production going if it is not to those who labor to produce our goods and services? Owners of the non-labor factors of production own the machines and resources, and those who own our companies have captured about half of the slice of the economic pie that belonged to workers. This matters from a Keynesian perspective because the wealthy are much fewer in number and consume much less as a consequence, in the aggregate. Their larger bite at the economic pie, at the expense of the masses, is slowing down the economy. A nation just can’t grow at the customary 3-4% if people aren’t around to buy its products, either domestically or internationally. I am witnessing in India a lot of poor people, almost unparalleled wealth,, and a realization that a nation that cannot create a productive middle class cannot develop much further. There is a lot of discussion on the development of a middle class in India, so at least they are going in the correct direction as they strive to become a top-three economy within this century. On the other hand, the U.S. is going in the opposite direction. Huge shares of wealth are moving from the vast middle class and into the hands of the relatively small handful who own non-labor resources. This is a recipe for long term economic decline. Elon Musk has been anointed to carve the U.S. economy into a shape that caters to what he believes ought to be the new American Dream. It is not one of an empowered middle class that shares in the growth of a nation’s wealth. While Musk is destined to attain a trillion dollars of wealth within a decade (and that was before his newfound ability to smooth the way), he does not buy 20 million more Teslas than the middle class worker earning one twenty-millionth of his wealth. The vast wealth transfer is reducing domestic demand. This is where good economic policy formulated for sustainable growth clashes with the capitalist system designed to concentrate wealth in the hands of those who own the scarcest resources. The problem with people is that we procreate. There is nothing scarce about the American worker and hence the middle class cannot command the clout of one who owns resources or patents. And, now with billionaires dictating the outcome of elections and the loyalties of those elected, it appears we are quickly veering away from the direction that most Americans have been led to believe is their destiny. I guess we will know more in another four years. It should be an interesting experiment as we round out a half century of Reaganomics, with its upward spiraling wealth and national debt, and downward spiraling American middle class.

(data from https://www.visualcapitalist.com/cp/ranked-dead-crypto-coins-by-year/, accessed Dec. 21, 2024) Every year Time Magazine names their person of the year. Some past recipients included Hitler (1938), Stalin (twice, in 1939 and 1942), Kruschev (1957), and the Ayatollah Khomeini (1979). I labelled them recipients rather than winners as the recognition is no prize. Time notes the distinction recognizes “a person, group, idea, or object that "for better or for worse ... has done the most to influence the events of the year". I can imagine there will be a number of challengers for the more dubious “for worse: distinction next year. To that list I will add Cryptocurrencies. Before we get into the weeds, let’s note that the 2024 U.S. presidential election was fought over and bought by cryptocurrency. I know - all the discussion about the election was about disaffected minorities and males, but let’s look at another demographic. We know that the election was won (or at least the successful presidential candidate secured 49.9% of the vote) by inducing twenty-something males to come to the polling stations and vote for Donald Trump en masse. One in seven young male voters shifted Republican. Their shift was even more profound in the three swing states that, combined, determined the election of Donald Trump by a little more than 200,000 votes. The Trump hold on young males shifted more than 2 million votes his way in an election he won by about 2.3 million in the popular vote. Combine young men with other crypto bros, and you see that a new pro-Trump coalition came in surprising numbers. About half of that same demographic of twenty-something males own and “invest” in cryptocurrencies. Young males are three times more likely to own crypto than young females. And many of them were motivated by a promise to grow their crypto investment if only they vote for the new darling of the sector, Donald Trump. Trump once had it right. He had said that bitcoin was a Ponzi scheme. There is no underlying value to the digital coin - no precious metal, no quarterly dividends, no products it manufactures or services it provides. Its value rises only because more people over time wish to buy bitcoin than sell it. In other words, only by constantly convincing more (young?) people to buy bitcoin will its value continue to rise. Trump once understood that, before his pollsters convinced him that it is far more profitable for him to reverse his position and tote the crypto party line. In the recent election, he pledged to order the federal government to buy about a million bitcoin over his upcoming term, at a cost of a hundred or hundreds of billions of taxpayer dollars. The resulting cash inflows to bitcoin will surely escalate its value and contribute incredible profits for the crypto industry and those enticed to vote for President Trump based on that promise. It will also be the first time that billons of taxpayer dollars have been invested in a Ponzi scheme. As with all Ponzi schemes, because they aren't selling anything of intrinsic value, bitcoin relies on the "greater fool" theory. So long as new fools continue to flow in to buy something that has value only on paper, the paper price will rise. I guess the U.S. taxpayer will be the greater fool for the next few years. Such an adoption of bitcoin as a reserve currency for the United States Treasury is very dangerous. Obviously, it is a highly volatile security that can gain or lose almost all its value at any time since there is nothing backing it but thin air. Recall the purpose of a reserve currency. It is a device to steady currency markets and stabilize the value of the U.S. dollar. How a highly volatile asset can help stabilize a currency is a mystery to me. This pledge is simple political pandering, but it was clever, devious, and perhaps even cynical on the part of the president. I also personally witnessed a profound shift in Democrat political policy in the summer and early fall of 2024. Representatives went from deep concerns about crypto to crypto zealots almost overnight once they saw the success the crypto campaign was having in attracting 20-something males who often don’t vote. But, by the time the Dems jumped on the crypto train, that train had left the station. This all did not happen by chance, though. It was a highly orchestrated strategy developed by the crypto industry itself. In fact, crypto emerged as the largest single benefactor to election year politics. Their associations “invested” hundreds of millions of dollars to be sure crypto candidates got elected. Combine their investments with those of Elon Musk, and we are talking billions of dollars to sway an election and, especially, get young males out to vote. Well, that’s the nature of politics. In a democracy people vote by their pocketbook, not the collective pocketbook of an economy. If we must now recognize that crypto is perhaps the most powerful single force with the wealth to purchase political power, what in their own words does the industry claim regarding their contributions to the economy? The crypto industry claims they contribute in the following ways: decentralized finance (DeFi), smart contracts, asset tokenization, financial innovation, increased transparency, and the possibility for broader participation in banking and investment markets. Let us discuss these in turn. The stated purpose of bitcoin and the cryptocurrency movement was defined by their times. Bitcoin inventor Satoshi Nakamoto was upset by the role central banks and banks-too-big-to-fail had in the 2008 Global Financial Meltdown and vowed to create a way to transact that defied central control. His (her) solution (because we don’t actually know who Satoshi was or is) was to design a digital token as an alternative to cash, and a digital wallet where we could keep our coins. Authorizing a transaction would then be equivalent to writing a check, albeit completely outside of the control of banks. This was decentralized in two ways. First, it defies central control because we are transacting with each other, not through our banks. Second, a computer program administered by dozens, then thousands, and now tens of millions of small computers worldwide would record all these transactions, adjust our balances, and check to be sure nobody or no machine is cheating. This is called the blockchain. At first, personal computers did the work of recording transactions. Bitcoin is now almost the only cryptocurrency processed using millions of machines, each looking over the other’s shoulder to deter cheating, in what the industry calls Proof-of-Work. Almost every other digital coin has adopted a far more efficient way to ensure accurate recording of transactions, called Proof-of-Stake (for the most part). However, this decentralization that really only describes bitcoin, not the other cryptocurrencies, is not what Satoshi intended. Nakamoto envisioned a handful of enthusiasts performing that function. Since the reward to run PCs and use electricity a decade and a half ago was small, the blockchain network was too. But, once the price of bitcoin started to rise with its popularity to fuel mostly illegal transactions then, so did the incentive to participate in the processing network. Since the reward structure was baked into the coin design, eventually this network generated fees to miners valued at millions of dollars every hour. These revenues to process transactions is what has created the huge profits crypto used to buy elections. Hence, the notion of a small and devoted community to help the unbanked participate as an alternative to the banking system instead grew into a financial and political behemoth with clout Satoshi could never have imagined, and would have found appalling, given his/her contempt for large self-serving financial institutions. Bitcoin is no longer decentralized, in the political sense. It is controlled by a very few very deep-pocketed individuals, called “whales” in the industry. The second crypto claim is that it can permit smart contracts, which are transactions that record more than just the money changing hands. Such a transaction might also indelibly record the terms of a car loan (monthly payments, interest rates, principal, maturity, etc.) or other more complicated transactions that would normally require reams of overly complicated legal documents to enshrine. While smart contracts are one of the promises of crypto, there are very few actual examples of such utility in reality. Instead, the vast majority of transactions are for illegal activity, evasion of international sanctions, ransom payments, money laundering, and speculation. Asset tokenization is merely a fancy way of saying commodification. It is complex to invest in commodities, but exchanges do this all the time - with fuel contracts, pork belly futures, exchange rate purchases, etc. Assets have been tokenized for centuries. There is nothing new or unique here, except that crypto can avoid all the regulations that typically protect consumers from commodity-peddling charlatans. Unfortunately, we can’t read our daily news feed without hearing of some recent scam relating to such crypto tokenization, including the Hawk Tuah woman of late who made hundreds of thousands of dollars by creating a new digital coin that almost immediately failed and took with it almost half a billion of other people’s cash. Indeed, the industry talks about such financial innovation as a good thing. The argument goes that, in the absence of crypto, the financial world would be less innovative. That is probably true. There is certainly a huge amount of resources, both human and electricity, devoted to the crypto industry. In fact, their electricity needs alone are enough to fuel some major nations like Sweden or Ireland. But, human and resource energy devoted to this new type of finance is not necessarily a measure of progress. It is creative destruction of traditional means of transacting, but what it creates in its wake is not productive, even if it is destructive. The industry also brags about its transparency. It believes that banks and other financial institutions are opaque in transactions that we must take as an act of faith. It is probably a bigger leap to trust that the latest crypto craze is legitimate, or that those who will transact with you, but only through a crypto currency are reputable. We need not look farther than the bankrupted crypto dealers and coins, and the trail of tearful transactors who have lost the economy billions of dollars to wonder if this unregulated sector lives up to its promises. Today’s graph shows the number of failed coins over the short period crypto has been around. Can you name even one example of any other form of currency that has failed as thousands of sham cryptocurrencies have disappeared in just a dozen years? Finally, the industry argues that it affords us the opportunity for participation in banking and investment markets. Certainly that was the promise - to bring banking to the unbanked. However, who would want to keep their cash in an asset whose value could drop 50% tomorrow. Yes, it might be great for financial risk takers, but the unbanked want to know they have money to pay the rent tomorrow. On the other hand, there are also a number of risks. These include reliance on cryptocurrencies run by fly-by-night crypto bros out to make a buck, an unregulated sector that affords none of the consumer protections we all expect, an inability to oversee the money supply to ensure monetary targets are met, and the waste of vast amounts of human and electrical energy just so we can replace our government-sponsored currencies. Yes, I understand why some wished in 2008 to break free of large financial institutions that had lost their faith and trust. But, to replace a government-backed currency with one that is so risky, so volatile, and so prone to scams, theft, and worse, all in the interest of financial anarchy, seems like a most dubious proposition. Alas, that proposition is now on the verge of becoming the official policy of the U.S. government. We live in truly scary times when elections can be bought and sold, and currencies debased, and we are all sold a bill of goods peddled by slick advertising and political campaigns. And they called it democracy. Let’s just see how well all this works out for the twenty-something males who are buying the latest and greatest version of snake oil, and who have taken us all for a crypto fueled joyride to boot. The celebrated economist and father of macroeconomics, John Maynard Keynes, once said, "I'll change my opinion when the facts change." Likewise, if there could ever be made a legitimate economic rather than political purpose for crypto such that the benefits to society outweigh the costs by a greater margin than its alternatives, I will be the first to step on the crypto bandwagon. I can't conceive of a circumstance in which the facts may swing sufficiently, but I will keep an open mind. But I won't hold my breath.