Power & Market

It's time to reprogram the conditions of the economy to serve the many rather than the few.

Star Trek's Kobayashi Maru training exercise tests officer candidates' response to a no-win scenario: any attempt to rescue the crippled ship's crew results in the destruction of the candidate's ship, while standing by and taking no action results in the loss of the Kobayashi Maru's crew.

Captain Kirk famously defeated this no-win scenario by reprogramming the simulation to "change the conditions of the test." This can be viewed as either cheating or as creative problem-solving via "thinking outside the box."

The Kobayashi Maru is a very apt description of both the U.S. and the global economies, which are currently running a real-world no-win scenario called "Profits, Infinite Growth, Low Inflation, Full Employment." (PIGLIFE). To win in the PIGLIFE scenario, you need permanent expansion of GDP, consumption, profits and employment and a permanently low limit on inflation. Anything less and you lose.

Central banks and political leaders have managed to "win" the PIGLIFE scenario for decades, but at a cost that can no longer be cloaked by happy-happy statistics. The economy has been fatally hollowed out into a fragile shell of monopolies and cartels profiting from hyper-financialization and hyper-globalization, a system in which the only possible outcome is hyper-inequality and hyper-self-exploitation as the immense profits enable the purchase / capture of political and regulatory power.

Now that the PIGLIFE economy has stripmined all the easy-to-exploit resources and workforces, scarcities are pushing inflation far above the "winning" low level. Oops, you lose. Now the real teeth in the Kobayashi Maru scenario are bared: if Central banks and political leaders close the spigots of "free money" that's been expanding GDP, consumption, profits and employment for decades, then all those slide from expansion into contraction.

But if they keep the spigots of "free money" wide open, inflation threatens to feed back in a self-reinforcing loop of expectations of higher inflation that push inflation higher, which then justifies the expectations which then push prices, wages, etc. higher.

Meanwhile, the two engines of the PIGLIFE expansion, hyper-financialization and hyper-globalization, have dived off the cliff of diminishing returns. Boosting debt, leverage and globalized supply chains aren't generating expansion, they're actively undermining whatever "growth" is still sluicing through the PIGLIFE economy.

So sorry, Central banks and political leaders, you lose. The way you've rigged the system, it goes into self-reinforcing contraction if you close the spigots of "free money" even modestly. But if you don't, the Klingon ships of inflation destroy you. The more you push hyper-financialization and hyper-globalization as "solutions," the greater the destruction.

Clearly, we need a new set of conditions for prosperity and well-being that do not rely solely on expanding GDP, profits, consumption and employment. Many economists, for example, Joseph Stiglitz, have proposed retiring GDP as a measure of prosperity and well-being and using more accurate and sustainable measures of well-being to inform policies.

If we've learned anything, we've learned that enriching the already super-rich so they have even greater means to distort democracy to serve their private interests undermines the prosperity of the many rather than increases it. It's time to reprogram the conditions of the economy to serve the many rather than the few, and enable a truly winnable scenario of sustainable prosperity and well-being by tossing the "waste is growth / Landfill Economy" PIGLIFE model into the toxic waste dump of failed, no-win scenarios.

Inflation is created by governments, so the solution to inflation is political. Governments and cronies falsely claim that inflation is good or even necessary, when it’s neither. It’s just best for elites. Deflation, on the other hand, comes naturally when customers are in control, and this customer-driven deflation brings sustainable investment and increased productivity. This is best for everyone.

Government-Created Inflation

Price “stability” (stagnation) or price inflation is caused by inflation of the quantity of government money by government people and cronies.

When money is created by government people, they borrow by creating Treasury bonds. The value that the Treasury people borrow this way is taken and spent right away by politicians to favor cronies. In return, cronies contribute to politicians’ campaigns and get their favored politicians elected.

The interest on the Treasury bonds is paid by taxpayers. The principal of the Treasury bonds keeps getting rolled over into new Treasury bonds and never gets paid back. The value of this principal, along with the value of all other holdings that are denominated in dollars, eventually gets driven to near zero by inflating endlessly. The resulting inflation losses are borne by everyone who uses dollars.

When money is created by government-crony banks, they simultaneously create loan money and loan liabilities, and they loan the money to producers and customers. The fact that loans are easily available sends a false signal to producers that customers have saved money and will spend it later if producers build better processes and products, so producers make investments.

As producers and other borrowers pay back the principal on their loans, the crony banks need to eliminate their liability for this money they created, so as this created money gets repaid, the crony banks destroy it. When producers’ investments come to fruition and the resulting better products are offered for sale, the savings that customers would use to buy these products aren’t there. Such savings never were there. Because of this, some portion of producers’ investments turns out to have been malinvestment. Malinvestment compounds until some producers no longer generate the required interest payments and no longer get propped up by further government-granted privileges or bailouts.

Through money creation these producers’ plants were created, and through money destruction these producers are destroyed. Through this destruction, malinvestment generates crises. In crises as of late, cronies create even-more inflation, which is crisis inflation.

Government-Created Deflation

In crises in earlier times—which also were initiated by inflation of the quantity of money by government people and cronies—crisis deflation of prices has resulted from further actions by government people and cronies.

In exercising their government-granted money-creation privileges, crony banks have circulated money without holding enough reserves to cover all deposits they promise to produce on demand and to cover all bad loans. This system design is not only unconstitutional but also unstable.

Borrowers are subject to competition, and they make mistakes, and they suffer disasters. Borrowers haven’t been able to insure against every problem. Some loans have failed.

In times of such failures, depositors have understandably not trusted that crony banks have had enough reserves to stay open. Some depositors have tried to withdraw their money, creating runs on these banks. Some banks have gone bankrupt. When they have, all the assets they have listed on paper but haven’t backed by reserves have been suddenly destroyed.

This destruction of paper wealth has deflated the total quantity of money. For products to sell, producers have then needed to reduce their prices. This has deflated product prices. When product prices have been deflated, either labor prices (wages) have had to be deflated or jobs have been destroyed. With fewer dollars being used to buy and sell the same products at the same rates, each dollar has become worth more.

In general, the falling nominal wages have ended up sufficient to cover the falling product prices. But for borrowers who have had existing loans, their falling nominal wages haven’t ended up sufficient to cover their unchanged nominal loan payments and principal.

For borrowers, this midstream change in the real values of their loan payments and principal has been a substantial hardship that they didn’t create. For cronies, this change has been a substantial windfall that they, empowered by the government people, did create.

The government people, though, despite having been the root cause of this crisis deflation, haven’t required their cronies to discount the nominal loan payments and principal to make the real values match the real values that both parties had contracted to exchange.

Every borrower who hasn’t been relieved by bankers acting on their own and who hasn’t been relieved by government people restoring the original real terms has been squeezed hard. Some, and oftentimes many, have failed. These failures have left more banks with unanticipated losses, leading depositors to make unanticipated withdrawals, leaving more banks destroyed, multiplying losses much-more widely.

Crisis deflation has enabled government people to greatly ratchet up government. The 2.5-year panic of October 1839 through March 1842 ended the initially small-government Democrats’ plan to systematically greatly-limit government using three presidents over 24 years, destroying that plan after just 12 years. The 1.4‑year recession of January 1893 through June 1894 eliminated the last small-government major party by transforming the Democrats into a big-government party.

Customer-Driven Deflation

Deflation of prices can instead be achieved by keeping the quantity of money constant and leaving individual producers free to increase their productivity. Productivity increases come naturally when savers, investors, producers, and customers act freely.

Savers store up past value-added to be spent later. Saving makes investments sustainable, because when better products are produced by this investment and these loans are paid back, this earned-and-saved money will be available to spend on these products. Saving also increases the sustainable investment and learning and innovation that increase productivity, so the same quantity of money buys more and better products.

Changing over from the current inflationary regime will be simple. All that’s needed is to stop granting crony banks the unconstitutional privilege to use fractional reserves, and to transform crony fractional-reserve banks into value-adding full-reserve banks, with a few simple actions:

• Repeal banks’ privilege to hold fractional reserves.
• Create and transfer to banks the quantity of money needed to back all current deposits with full reserves.
• Transfer ownership of all bank assets to mutual funds. (Transferring ownership from the current owners is appropriate because the current owners are cronies who are accepting the banks’ crony privileges.)
• Distribute the same fraction of shares in these mutual funds to every citizen. (Some people have had much value taken from them. Other people have been stopped from adding much or any value in the first place. This dispensation provides a simple, reasonable path forward.)

Repeal won’t require government people to administer new scope by promulgating new programs. After these one-time transfers of money and ownership, government people will be required to do nothing.

The Fed was government-spawned to address government-caused panics. But once banks are required to hold in reserve all the money they’re required to pay out on demand, these panics will be fully prevented with no added controls and no accompanying variation, error, and risk.

Savers, investors, producers, and customers will no longer have to readjust their choices in response to the Fed’s every move, in addition to readjusting their choices in response to all the other, smaller changes around them. Savers’, investors’, producers’, and customers’ choices will be more accurate and optimal.

Customers, Freely-Competing Producers, and Voters Unite!

So why haven’t we gotten the government people to make these simple changes before? When the government people make these changes, all the built-up malinvestment won’t be sustainable and must fail.

For the entrenched government people and cronies, such a transition has been a genuine fight to the death of their longstanding way of life. Their unearned advantages over us would end. The cronies’ malinvestments would fail and the failed businesses would be destroyed. To block such change, these elites have constantly pushed out their narratives using every channel they control: academia, most media, and supermajorities of politicians.

But now we know what’s wrong and we know what to do about it. This time when the built-up malinvestment fails, people will again do what people usually do in uncertain times: they will start saving more. This time, though, their savings won’t be undercut by government and crony money-creation that unsustainably lowers interest rates, so this time people will keep saving more. Producers will sustainably create new jobs. Workers will choose those jobs.

What will determine the duration of this initial transition will be the durations of these overlapping initial changes to saving more, creating new jobs, and moving to new jobs. These initial new jobs can be created and filled surprisingly quickly, once enough producers start working to use this transition to their best advantage.

All recoveries’ delays and rates are determined by producers’ choices. In this recovery, producers won’t be awash in inflated money, but producers will be keenly aware of the dawning of a free, new regime. Once government actions are changed for the better, this brings good results that are politically popular, and this popularity helps hold these changes in place.

Opportunities will be everywhere; first-mover advantages will beckon. Like producers did after World War II, producers will move fast. Ongoing development of still-better jobs will proceed at a furious pace.

Price stagnation or price inflation is evidence that governments and cronies are grabbing advantages over us. Crisis deflation in years past was evidence that governments and cronies were taking advantage of us. Customer-driven deflation has been, and will be, evidence that the playing field is level and that customers are in control.

Customer-driven deflation is the economic way that we live better. The best time to get started at living better is always right now.

János Kornai was born in 1928, in a century of bloody and tragic twists and turns. His homeland, Hungary, was especially a dangerous place during the 20th century. Among other things, it fell under both totalitarian regimes: Nazism and Communism.

Kornai’s personal life was also shaped by that century. His father became a victim of the Holocaust. He was assigned to a special labour-service corps of the Hungarian Army, into which Jews were drafted as a supplementary force destined to perish. Kornai, however, was fortunate enough to survive the war. For him the arrival of Soviet troops literally meant liberation. No wonder that the young Kornai, who had been destined to perish, became a Communist. His turn towards Communism was heavily influenced by the reading Das Kapital in 1947. He became a journalist of the central newspaper of the Hungarian Communist party. However, one of the show trials of the Stalinist era opened his eyes and changed his life-trajectory. Kornai, the formerly devoted communist journalist, increasingly distanced himself from the regime. He became a supporter of reforms and opted for an academic career as economist in 1955. He participated in the 1956 revolt, and after the bloody re-imposition of communism by Russian troops, he abandoned his Marxist beliefs.

Nonetheless, the reinstalled regime, led by János Kádár, had increasingly distanced itself from the openly repressive practices of the Stalinist period. In this new era, Kornai could return to follow his academic work.

At the beginning of his research career, he criticized the over-centralization of state planning and argued for a more decentralized market-mimicking socialist economy. In the reform-era of the Kádár-regime, from the late fifties to the early sixties and onwards, his academic work also contributed to the regime’s cautious, limited and selective marketization and liberalization reforms. The so-called goulash socialism brought prosperity compared to the high Stalinist period in Hungary. However, Kornai was keenly aware of the internal contradictions and deep-seated problems of the so-called happiest barracks of the Soviet camp. In the eighties, he became one of the most important modern critics of the then existing socialism. His ground-breaking work, The Economics of Shortage, argued that there are deep-seated internal reasons for the inevitable and unsolvable problems of the socialist system. His analyses of the systemic malfunctions of socialism are a staple for those who really want to know why Marx's socialist utopia is inoperable and anti human. His theoretical constructs, such as deficit and surplus economy, soft and hard budget constraint, which he developed for the analysis and comparison of the ideal systems of socialism and capitalism provided an important starting point and theoretical framework for further research.

During his long academic career Kornai had arrived at a vision close to the position of Austrian School of Economics. This was primarily based on his experience in a functioning socialist system. At the same time, he became one of the greatest pro-market thinkers of our time. Despite the shared vision, he never considered himself as belonging to the Austria School, although he admitted his intellectual debt to Mises, Hayek, Kirzner and especially to Schumpeter.

The reason for the shared vision is that key figures of the Austrian School, like Eugen von Böhm-Bawerk and Ludwig von Mises at the turn of the century and in the early twenties took on the challenge of criticising Marxism and the Marxist utopia of socialism. They showed that the "scientific" work of Marx had insurmountable contradictions and socialism bound to lead to failure. Also, the members of the Austrian School contrasted the benefits of a market economy with the inbuilt problems of the utopian Marxian vision of socialism. They argued most forcefully among the economic schools that capitalism is a dynamic economic system, and this dynamism is the key to human progress. Also, the Austrians were eminent among those who argued that the cause of the dynamism of capitalism is private property, entrepreneurship and competition.

One of the last important books of Kornai’s life is Dynamism, Rivalry and the Surplus Economy. The main theme of the book is the comparison of socialism (state planned economy) and capitalism (market economy). Comparison of the economic system of the shortages with the system of the surpluses.

Socialism produces shortage, capitalism produces surplus. The basic reason for this difference, according to Kornai, is that there is no opportunity and space for innovation in socialism unless it is considered important by the centralized planning state for some political purpose. Therefore, there is no room for entrepreneurs, whose function is to apply inventions in an innovative way. In contrast, the most important feature of capitalism is that it gives the entrepreneur freedom to realize inventions and satisfy consumer demand.

Kornai’s argument is by and large the same as the position of the Austrian School of Economics. One of the major differences is the method of inquiry between the Austrians and Kornai. Menger, the founding father of Austrian school, first established that the goal of economic theory is to discover cause and effect linkages in economic life.

 Kornai, using the contemporary language of positivist economic thinking, arrived at the same position that of Menger and Mises, who used a theoretical language, which is now considered outmoded by the mainstream literature. Kornai first discovers the economic facts, then analyses them and finally seeks to identify causal relationships. At the end, he arrives at basically the same positions as Menger: economic life is dynamic, the engine of dynamism is human invention and entrepreneurship, and there are cause and effect linkages, which shape human behaviour.

He would have deserved the Nobel Prize in Economics. What a pity that, with his death, he deprived the Nobel Prize Committee of the opportunity to recognize Kornai’s enormous significance not only in building economic theory, but also in undermining the scientific legitimacy of the Marxist vision of socialism and state planning.

It is even more painful that with his death he was deprived of the opportunity to educate us: interested lay readers, his fellow scholars, and last but not least, politicians. It is a pity, because the average citizens, scholars and politicians of our time are not acknowledging the benefits of capitalism but support economic policies furthering state interventionism. It is a bitter situation, as he learned through his own experiences, that state planning is a non-workable system. He forcefully argued that only a capitalist economic system can dramatically improve people’s lives and quality of life. He also believed that capitalism is also a necessary condition of democracy, and of avoiding totalitarian regimes, which were so abundant in the last century.

Many years ago, I had a lunatic roommate who would remove people's clothes from the laundry machines midcycle, throw temper tantrums like a child, and set the thermostat to crazy temps, among other things.

One workaround that one of my sane roommates and I designed for the thermostat problem was to go out and buy a second thermostat. We connected it to the HVAC system and disconnected the existing one but left it on the wall.

The new one was hidden behind the wall, but still accessible through a vented panel. The one on the wall was still powered—it beeped and displayed temps normally. It just was not connected to the system so it would not actually control the heat/air. It was a decoy.

The crazy roommate never figured out that the thermostat did not do anything. The belief of control was maintained, but control was secretly removed. I don't have many practical examples of how to do this, but we should do this to the government.

Give politicians, activists, and corporate media "fake thermostats" to adjust to their hearts' content, so they can exercise their tyrannical dreams without turning our lives into nightmares.

They probably won't figure it out, because they will be too busy celebrating their victories and patting themselves on the back to check the outcomes of their "policy." Even if they did check, they would probably succumb to confirmation bias and attribute the healthy, free society and good economic outcomes to their own tinkering with the fake thermostats. Our response should be to pat them on the head and say "Good job!" like we would to a child pretending to steer the car from the back seat while the adult drives.