My view on macroeconomy

Or: Why there's no inflation and things are weird.

TL;DR: Global economy is much closer to a game of Monopoly than most people realize. We're at this phase when it's clear who owns all the hotels, and the only thing that allows other players to keep playing is taking on more and more debt. This big Monopoly game always ends up like this, and is being restarted. That's the economic “supercycle”.

All models are wrong, but some are useful

I really enjoy simplifying complex system into useful mental models. This is a short compilation of what and how I think about the macroeconomy. I'm not saying it's right, but it's mine and I wanted to share it. I'll be happy to hear where it is inaccurate or simply wrong. Also, I'm aware that what I say here is probably not very novel.

Assets & capital

What are Assets? Assets are things that can produce more things of value. The value here is a tricky but very important part, because it's subjective, changes with time and circumstances. A very efficient sand factory is not an asset on Sahara desert, because there's already a lot of sand nearby, so more of it is not valuable at all.

What is capital? It's just another word for assets. Assets in the aggregate make the capital.

Here is the important thing to realize: The proportion of the world's capital that you own determines how much of the world's total economic output belongs to you. What can you do with that economic output? Consume, or exchange.

the Haves and the Have-nots

Why there is no (little) price inflation? Because of economic inequality.

For our simplified model, we will divide people into two groups: “Haves” and “Have nots”. In the real world, people fall on the spectrum between these two, but for our model, it's sufficient to think everyone is one or the other. These two have completely different economic behavior.

The Have-nots have very little capital of rather poor quality: usually their own time and work. Because of that, they have to consume most of the economic output from their capital. Even if they have any excess, it difficult for them to get a lot of return on it, and they tend to make pure investments anyway. We can also call these group the Labor.

The Haves own excess of the capital of good quality. They get a lot of economic output and are often unable to consume it if they really wanted. They typically invest a big proportion of it: which means buying and building more capital. That's why they are the Haves in the first place, right? We can call these group the Capital.

Obviously, there's plenty of exceptions and people move between these groups (dynamic inequality), or even belong to both groups at the same etc. But for our model, it's not very relevant.

The “problem” with the Capital is that it tends to grow exponentially and scales much better than the Labor. Imagine two people. On has to consume around 1000USD a month to live and owns starting capital producing 1100USD a month. Lives frugally and reinvests everything above what he needs to spend. Another consumes 10000USD a month but has a starting capital that makes 20000USD a month. Unless the first one gets really lucky, or the second one does something really stupid, with the compounding rate of the return, the second one will quickly be magnitudes richer than the first. Also, what makes the matter worse is that the inflation that richer one creates is hitting the first one proportionally much harder. Eventually the rich person has everything, and the poor (comparatively) nothing.

And that's just how economic inequality builds. No one has to be evil, or stupid or unproductive. Capital produces more capital. The increased economic output makes people able to consume more. Ha. It makes people have to consume more! Cars get better, but also more expensive. The rich get richer, and the poor get comparatively poorer. Important part: Everyone's quality of life is improving, which is awesome. But the capital tends to accumulate in the hands of fewer people that are good at turning it into more capital. The fact that governments usually tax income at a much higher rate than capital income is definitely not helping.

And here is the explanation of lack of price inflation. What causes price inflation? A lot of money chasing not enough goods. In a normal, reasonably balanced economy where the capital is spread somewhat evenly, any increase in productivity is spread more evenly between the Haves and the Have-nots. Raising consumption causes the prices of goods to go up, which causes inflation, which keeps everything somewhat stable. For a while.

Eventually, the Haves become few and very rich and the Have-nots large and relatively poor.

It is very much like a game of Monopoly. Some people play the economic game better than the others, and eventually one player owns all the hotels. The main difference is that it's much higher scale, number of players change dynamically, and the board is not fixed, but can actually grow as technology and investments enlarge the economy. But the general mechanism is still in place: if you're winning you'll most probably keep winning even more.

Very rich Mr. Buffet

There is a twist to all that though. Basically: the capital that rich people own is only as valuable, as other people can pay for what it produces.

Let's use my favorite modeling tool: taking stuff to an extreme, to see what happens when the economic game is nearing the end, and wealth inequality becomes too high.

Imagine a world in which Warren Buffet owns everything except maybe the people themselves. I mean everything. All the factories, houses, natural resources and so on. (I have nothing against Mr. Buffer, BTW. He just fits because he's really rich, really good with money and well know.)

It seems really great for Warren Buffet. He can produce millions of cars per week. All belong to him. But ... what for? What is he going to do with them? He can't ride them all at the same time. And he has no one to sell them to because no one has any capital, so no productive capacity, so no money or anything else to offer.

And here is the rub. What is the value of an asset that produces something that you can't use or sell? Zero. Warren Buffet owning everything is actually making Warren Buffer's assets rather worthless. There is only so much Coca-Cola cans he can drink a day, right?

So what are Warren Buffet's options? One is to fully automate everything, build his private Ellisium and let everybody starve as he has no more use of them. I guess it kind of works, but what is the point of winning a game which no one else is playing anymore?

Another approach is to just to give everybody else loans, so they can keep purchasing and consuming. But this only delays the inevitable. If everyone weren't able to keep up with Mr. Buffer in the first place, why would it change if they were carrying a load of debt on their shoulders? Eventually, everything reverses to a place when Warren Buffer owns everything, and everyone else has nothing, plus owes a lot of money to Mr. Buffer.

A different approach is to invest more! Building more factories, hiring a lot of people, which lets them consume, which lets them spend, which gives jobs and purchasing power to even more people. The problem is that is still ultimately just increasing the capital of the person that owns the investment. Mr. Buffer will just own millions of factories more. This approach can work and I guess actually quite often works, but only if there is something worthwhile to invest in within the current technology level and resource constraints. And it looks like recently we've out of amazing technical advancements like electricity or the Internet, and we're running thin on natural resources too. The best we were able to come up with recently is... Social Networking? ;) And even when this works, it only delays the moment in which Mr Buffet owns everything again! (Remember, he's only a metaphor for the Capitalist winners – but without the negative connotations).

No inflation? Asset inflation!

These two last approaches are what I think have been practiced both in the USA and globally. Give everyone a lot of loans, and keep investing. And I don't think it works. The game is still running because central banks keep increasing liquidity in more extreme ways. QEs, negative interests rates and so on. It's just a desperate attempt of letting everyone borrow more money and increase the rate of investments, to keep the game running. But like most games ... it can only really continue if there results are not certain. Otherwise – what's the point of playing?

Any monetary stimulus flows to the Haves one way or another. And what do Haves do with it? They buy assets! That's why they are the Haves in the first place. Bonds, stocks, real estate, old cars. Anything that seems like an asset sees price inflation. And that makes buying assets even more lucrative, at least in the short term! Everyone owning assets is making a profit and getting richer. And all the additional liquidity lowers the interest rates, which allow Have-nots to go deeper in debt and consume more. They can consume, but not enough to create price inflation of goods. The GDP is barely growing, but the value of assets and the amount of debt are sky-rocketing. All this makes central banks think that there's not enough inflation, so to conquer that they need to provide more liquidity... to the Haves. It's a positive feedback loop! And positive feedback loops always mean one thing: explosion.

So, how does it end?

It's hard to tell exactly. A lot of this depends on the behavior of the Haves, and central banks/governments, and also the Have-nots. It is really akin to a late-stage Monopoly game, when everyone are just scrapping by, one player already owns all the hotels, and things got really not-fun. Who is the first to say “I don't want to play anymore”, and how exactly? What if someone gets upset and just flips the table? (╯°□°)╯︵ ┻━┻

I think as long as the Haves don't blink, and keep buying assets while central banks are providing liquidity, the Haves will be content with the illusion of getting richer. Illusion, because while on paper these assets are valuable, there's no way to get that much value out of them, because people that produce the goods produced by them can't pay back in near, medium, long or even any future.

During the time when there's not enough liquidity produced to keep the assets going up, or the Have-notes consuming, the Haves will get scared sometimes and there will be moments of panic, followed by central banks providing the liquidity again.

How I see the different end-game options:

So what is Ms. Buffet to do?

Well, he has to stop focusing on winning the economic output accumulation game. It's great to be good at something, but if you're so much better then no one else can keep competing – the game is broken.

When playing a game like Go, it's natural for the better player to give a handicap to a weaker opponent. To keep the Capitalism game running we probably have to introduce something like capital taxes. Don't read it wrong: Not capital income taxes. Total capital taxes! Like 1% of all your net worth is taxed every year. It can't be just capital income tax, because such taxes are not only trivial to avoid, but also don't really change the fact that incomes do not grow as exponentially as capital does, so while the Capital is beneficial for everyone its is just totally OP. At very least we definitely have to abolish income taxes! People that are relying on personal income, are the Have-nots. Otherwise, they would just be spending their time looking for good capital investments.

Final words

I have mixed feelings about all this. First, I'm not so sure if my remedy ideas would even work in the first place. Second, I am actually deeply pro-market etc. But I just can't hide the fact that the economical game seems to behave like a big game of Monopoly where eventually the game has to end either because the Have-not-players went bankrupt and stopped playing or someone thew a big fit and ruined the game. I just have to write it down, and maybe someone will tell me how am I wrong, and I will stand corrected.