Who are the Financiers? Part 2: the Relationship of Debt System and Taxation

Let's briefly summarize Part 1. Part 1 demonstrates that in a debt-based system, over time wealth and power tend to be concentrated in the hands of a few, at the expense of many. Note that the society described in Part 1 is very basic. It did not assume the existence of a central banker, it did not assume fractional reserve lending. However, it assumed that the money supply is constant, something that may be the case when a unit of money corresponds to a unit of gold, for example. Hence, Part 1 demonstrates that even when money is backed by gold, even when there is no central bank, and even when there is no fractional reserve lending, a debt-based money system may lead to the concentration of wealth and power in a few hands. (This point is largely missed by many of gold-back currency proponents)

A neat little story posted by Bill Gross (the famous mutual fund manager at Pimco) gives a vivid example of Part 1's main observation. The quote is taken from Bill Gross' June 2010 Investment Outlook:

"Debt will get you in trouble – on both sides of the dollar bill as Shakespeare wisely counseled long ago: Neither a lender nor a borrower be. That probably seems like a strange admonition coming from a guy who helps to lend $1 trillion of it – and I suppose it is. But there was a time back in 1968 when lending got me in lots of trouble – deep doo-doo, to tell you the truth – and I’ve regretted it ever since. I was a Naval officer back then, sailing between the Mekong Delta and Manila Bay. Strangely enough, it was in the Philippines, not Vietnam, where I lost my moral compass and ran aground. I started a shipboard replica of a “payday” lending company operating under the principle of “two will get you three.” Sailors in port were always short of cash and yours truly – engaged to be married and operating under a self-imposed one-beer, nine-o’clock curfew – was more than willing to extend them a hand. The “two gets you three” scheme sounded harmless enough, because, heck, what’s a buck between friends when you’re about to hit the beach and party hearty! Still, as the “payday” characterization connotes, the money was due only a few weeks down the road when we were back at sea and receivables could easily be collected. And the annualized yield, as most of us investor types can easily calculate, was well in excess of 1,000% annualized. Well, there’s usury and there’s grand larceny, and my payday-hayday scheme was clearly in the latter category. The amounts were small – paychecks were only a few hundred dollars – but 200 compounded into 300, which turned into 450, 675, 1,000 – well, you get the picture. It didn’t take too many ports of call before Uncle Sam’s next payday became the property of Uncle Bill, and I became the financial godfather of the USS Wish I’d Never Enlisted. Oh but loose lips sink ships, and it wasn’t too long before the authentic godfather – El Capitan – got wind of Ensign Gross’s growing fortune. Rather than cut himself in on the scheme, he did what every good captain would do. He made me give it all back and confined me to the ship for the rest of my tour. No beer, no sightseeing in Tokyo on the way back home. No nothing. Two got me three for awhile, but it eventually got me into a heap of trouble. Well deserved, I’d say, and I’ve learned my lesson. Never made a 1,000% loan since!"

The above example illustrates what can go wrong over time in a debt-based system. In a relatively short amount of time, Bill accumulated much of the wealth of his colleagues. His captain stepped in and pushed the "reset" button, requiring him to return all the wealth that he had been accumulating. The reset mechanism has proven crucial in breaking the concentration of wealth and power in the hands of a few in this case.

I want to address another issue. Quite a few people pointed out that in capitalism, if you lend your money, you risk not getting paid back. For example, the borrower may run away with the money, the borrower may use the loan to purchase a cattle that later dies, purchase a home that later is blown away by hurricane, etc. There are many scenarios in which the borrower will not be able to pay back the loan. Since you risk your capital, you should be compensated for it. For example, if on average 1 in 10 loans is completely not paid back, to get back $100 that you lend, you need to charge an interest in the amount of ($100-$90)/$90 = 11.1%. However, charging 11.1% only gives your money back, it does not increase it. So what incentive do you have to loan it in the first place? Why not just keep the money and enjoy it? Hence, you would like to charge an interest rate that is higher than 11.1%. Of course, sometimes you will not be able to precisely calculate your risk, hence you may ask for additional interest rate just in case the risk is higher than your estimate. For example, in the above example, you may charge 14% instead of 11.1%.

I completely agree that if you lend your money, you take the risk of not getting paid, so you need to be properly compensated by charging interest on the loan. In fact, such a system is the essence or soul of capitalism: if you take risk with your capital, you get rewarded, provided that you estimate the risk correctly. You will lend the money to a group of people at higher interest rates if they have a higher risk of not paying back the loan, and at lower interest rates if they have a lower risk of not paying back the loan. This forces all lenders to constantly evaluating risks, and capital is lent out to people with the best economic prospect (those who use the loan to produce an income stream that enables paying back the loan) and best behavior (those who truly intend to pay back the loan). This ensures allocation of capital that maximizes income growth and rewards prudent borrowers as well as prudent lenders. Therefore, charging interests on loans by properly accounting for default risk is fundamentally essential to an efficient allocation of capital and to maximizing economic growth.

However, note carefully that that does not change the fact that over time, a prudent lender (who calculates his risk well) still accumulates power and wealth. The problem of wealth and power concentration can and will still occur as described in Part 1. Therefore, we should conclude that capitalism is by its own insufficient in addressing wealth and power disparity between lenders and borrowers. Capitalism must then be paired with a reset mechanism, such as one beautifully illustrated in Bill Gross' writing.

What is the best reset mechanism? I have no clue. But let me offer a list of examples that can help slowing the concentration of wealth and power:

1. Progressive taxation system. Increasing the percentage of income that is taxed as the income increases reduces the speed (but does not eliminate the eventual possibility) of concentration of wealth in the hands of the few.
2. Taxation distinction between earned income vs. unearned income. Since interest income rides on the labor of the borrower (estimating risks is not labor!), we can distinguish the laborer's income as earned income, and lenders' interest income as unearned income, and can tax unearned income at a higher rate.
3. Taxing the wealth accumulation at certain events such as death. This taxation is very potent if used correctly, as it can reset the concentration of wealth completely. For example, anybody can accumulate wealth in his lifetime through charging interests on loan (ensuring efficient allocation of capital), but at death, some fraction of his wealth (e.g. 50%) or all wealth above a certain limit is taxed.

Note that in the US, these taxation systems are already employed to some extent. However, the system is quite flawed. Financiers are able to go around them easily. For example, while it is true that there is progressive taxation on salaries, capital gains, which are the main source of income for financiers, are taxed at a lower rate (e.g. Warren Buffet famously said that his tax rate is lower than his employees' tax rates). Unearned income tax rate should be higher than earned income tax rate, but instead is lower. Estate tax, which taxes wealth at the time of death, has been attacked heavily by many rich people on the ground that it places tax on income that was already taxed.

Note that these taxes are crucial in providing the reset mechanism to a debt-based system, or any capitalistic system. Taxation is a means to redistribute wealth, and it is a healthy thing to avoid super-concentration of wealth in the hands of a few. Taxation is not equal to big government or government embarking in a spending binge. In fact, big government itself helps concentrating power in the hands of a few. Thus, tax revenues should be used only for essential public spending, and the rest distributed back to taxpayers in the form of lower tax rate (skewing the distribution toward people with earned income and fewer assets), rather than being used by the government for pet projects.

Who are the Financiers? [Part 1]

In my last post, I talked about the "financiers" and their role in enslaving the public through bubbles in asset prices and through inducing the public to take debt purchasing bubble-priced assets. In this post, I will talk about who the financiers are.

Have you ever gone to a get-rich quick seminar? I have. Typically, there will be one charismatic speaker making a presentation to an audience. The speaker has a slogan that sounds really nice and appealing such as "The secret to wealth is to transform from working hard for money, to letting your money work hard for you". Isn't "money working hard for you" an interesting term? How can money work for you? Money is a dead object, by definition a dead object cannot work, let alone work hard.

The way money can work for someone is if it is lent out with interest. This is called "debt". For example, if A has $100 and lend out the money to B with a 10% interest for 1 year, then B agrees to pay A back his original money ($100) plus the interest ($10) for a total of $110. Let us assume that in the world where A and B live, there is a constant amount of money in circulation. In order for B to get the $10 that he didn't have before, he has work hard to make sellable goods or services so that others are willing to pay him $10 or more in exchange for B's labor. Using this money, B returns $110 to A after one year. Therefore, A's money has grown because of the labor of some one else, in this case B. Thus, it is inaccurate to say that money can work hard for some one. It is more accurate to say that money can buy labor of some one else.

Now imagine that A is the only lender in the world. The total money in the system is, say, $1000. Initially, A owns $100, and the rest ($900) is owned by others. A lends out $100 to the world at 10% interest for one year, and gets back $110. In the second year, A lends out all his money $110 to the world, and gets back $121 ($110 principal + $11 interest). And so on. Here is what happens with A's wealth:

Year 0: A has $100, world has $900

Year 1: A has $110, world has $890

Year 2: A has $121, world has $879

Year 3: A has $133, world has $867

...

Year 10: A has $259, world has $741

...

Year 20: A has $672, world has $327

...

Year 24: A has $985, world has $15

In just 24 years, A has accumulated almost all the money in the world, leaving the whole world to own just $15! As I mentioned before, A has accumulated all the money. Since money is essentially a claim on other people's labor, A has a claim on the rest of the world's labor. In other words, A has become a king, controlling what the rest of the world's wealth and labor.

Going back to the original question, A is the financier, while B and the rest of the world are the public.

We can make one interesting observation: any system that relies on debt is bound to be unstable at some point, as over time, wealth gets concentrated in the hands of the few, at the expense of many.

In addition, once wealth is concentrated in the hands of a few, loan cannot be paid back, since there is no longer enough money in the world to pay back debts. In the example above, if A lends out all his money in Year 25, nobody will be able to pay back the debt because to pay back the debt, the world needs $1,083.50. It simply does not have that much money! So what will happen is that the world defaults their debt, and A takes possession of the collateral of the debt. What collaterals? Whatever the world pledge to secure their debt. It could be their land, their daughters, their obedience, etc. Therefore, the second observation is that a debt-based world, over time, becomes incompatible with democracy as it leads to the concentration of power in the hands of the few.

Take time to digest the two observations that we just made. The observations are very basic but are powerful in helping us to understand the monetary system in the world today.

What does the Bible say about debt?

God recognized the danger of a debt-based system, and the concentration of wealth and power in the hands of the few. This is His word in Leviticus 25:37-43:

³⁷ You must not lend him money at interest or sell him food at a profit. ³⁸ I am the LORD your God, who brought you out of Egypt to give you the land of Canaan and to be your God.

³⁹ " 'If one of your countrymen becomes poor among you and sells himself to you, do not make him work as a slave. ⁴⁰ He is to be treated as a hired worker or a temporary resident among you; he is to work for you until the Year of Jubilee. ⁴¹Then he and his children are to be released, and he will go back to his own clan and to the property of his forefathers. ⁴²Because the Israelites are my servants, whom I brought out of Egypt, they must not be sold as slaves. ⁴³ Do not rule over them ruthlessly, but fear your God.

A few important observations:

1. Verse 37 speaks against lending money at interest, which is a statement against using a debt-based system.

2. Verse 40 describes a reset mechanism. In the year of Jubilee, basically every 50th year, the debt system is annulled, and wealth and power re-distributed to the original state. Every person, even if he has already become slave, due to his/her inability to pay back his/her debt, can go back to own the land that his/her ancestor once owned, and wipe out his/her debt.

3. Verse 42 predicts that a debt-based system leads to slavery.

Financiers vs. Public

http://www.capitalvue.com/home/CE-news/inset/@10063/post/1185337 According the above article (link), Beijing home prices plunge 31.4% (May 11) vs. a month ago. Suppose the median household wage in Beijing is USD 12,000 per year. With a healthy house-to-income ratio of 3:1, the average household can purchase a USD 36,000 home. Even after 30% drop, the price per square foot of Beijing home is 16,898/6.8/10.76 = USD 231. That means an average household can afford a home of 155 sq ft in size. Well, much better than before the drop, when they could only afford 109 sq ft home. Looking it differently, if an average home is 1000 sq ft in size, it takes 19.25 years of labor to pay for it (without interests). In the power play game between the financiers (banks and government) vs. the public, the public has lost. Don't measure the affordability of things in terms of money. Instead, measure it as the number of hours of labor for an average person needs to put in to pay for a home. When the financiers are able to create a bubble, and they convince the public to commit more and more of their labor to them. On top of that, they win in another way: by charging interests. Make no mistake, this power play game is global, not just in China. Don't participate in this game, unless you want to be the servant of the financiers for the rest of your life. Action items: 1. Refuse to buy overpriced assets 2. Refuse to buy overpriced assets with debt In the context of Christian living: The financiers' god is Mamon. Jesus said that one cannot serve two masters. He/she either serves God, or Mamon. "No one can serve two masters. Either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve both God and Money" - Matthew 6:24.

Peak Oil Theory: Gross vs. Net Hubbert Curve

Oil crisis due to peak oil will come sooner than most people have thought and when it comes, it will be more severe than people have thought. The reason is that the argument put forward by some analysts relies on Hubbert's curve, which shows a bell shaped amount of oil production. Hubbert's curve on itself is already damning, that is oil production declines quickly after it reaches peak. However, what matters is not the amount of that can be produced. Rather, the amount of oil that can be consumed, which is equivalent to the amount of oil that can be produced minus the amount of oil needed for extraction, refinement, and transportation. As an oil field is depleted, it takes more and more energy to extract/refine it. The latter, called net Hubbert curve, shows a drop off that comes sooner and the angle of the drop off is steeper.

Here is the curve. The blue one is Hubbert curve, and the grey one is Net Hubbert curve

Action Items:

1. Conserve energy whenever you can

2. Demand our politicians to come up with policy to conserve energy

What Caused the Collapse of Easter Island Civilization

I am reading the book "Collapse" by Jared Diamond. The story of how the Easter Island civilization evaporating is interesting. When Polynesians arrived in about 600 AD, they found an island with giant palm trees, diversed jungle that host abundant wildlife. They settled and multiplied, given abundant natural resources. Then they started cutting down the trees in order to build canoes and boats, and tools and means to transport huge rocks from quarry to valleys. They erected the rocks, carved them in the shapes of human, spending enormous manpower and natural resources for them. These activities were enabled by the abundant natural resources and easy to get food.

When the Europeans landed on the island in 1722, all they saw were giant statues all over the low areas, but the land was barren. No tree was taller than 10 feet tall. The Polynesians have completely deforested the island, and now lived in poverty and subsistence. The population size had collapsed to only about 10% of the peak.

The mistake of the Polynesians in Easter Island was that they took the abundant natural resources for granted, using them up without thinking about sustainability, and wasting them for useless ego-worship activities of erecting and carving stone statues.

Aren't we making the same mistake today with oil and mining? We take them for granted. Only few care about sustainability, and we use a lot of them for useless ego-worship huge houses and huge cars. We are not even taking major steps yet toward sustainability. We have not encouraged or required conservation in the amount of resources we use. Are we going to doom our future the same way Easter Islanders did? We are as vulnerable as they were in the sense that as Easter Island was isolated and could get no help from neighboring islands, our earth is isolated in the galaxy and we cannot get help from other civilizations if we ruin the earth.

As Christians, shouldn't we be a good steward of the natural resources that God gave?