Value in our 21st Century

So what is real money, real value? It is the holding of anti-fragile assets. Anti-fragile assets benefit from time, stress, and the rare, but not truly unpredictable, extreme ups and downs, rather than being destroyed over time and through stress and chaos. If the sum of weighted holdings outperforms in its wins and doesn't underperform, or at least survives, in its losses, it is anti-fragile. Life is anti-fragile, because it is strengthened under (moderate) stresses. A company with smart, honest management, uninterruptible cashflows, and plenty of discretionary capital available is anti-fragile since it can adjust its options quickly under changing circumstances and will capture unpredictable wins as well as survive unpredicted disasters. Fragility: inflexible management, or lack of a cushion for both survival and opportunities in future rare events or destructive circumstances, which can drop your asset to zero, and it's hard to bounce up from zero. Anti-fragility is a mixed portfolio which doesn't have to predict the future to succeed, because your hedging bets on big wins can be cheap, and your safe bets to maintain value across economic chasms and disasters should be plentiful. Then ignorance, honestly recognized and allowed for, can beat any genius whose timed bets will on average reliably lose (cf Newton's bets).

Financial forces: Hydraulic Flow versus Smarts

First, smart money: Let's assume there are counter-betting populations of smart investors with plenty of backup investment options. They can pull their money out if they want; they have some idea of the value of things; they can and do notice if a price is below its value and if so they buy according to their confidence and size of their wallets until the price is bid up to the value, within epsilon. Epsilon is the error of this model, equal to the transaction cost plus perhaps some amount related to the other investment options available (if your other options are marginally better, you won't throw money at this asset which hasn't enough margin of value-price in comparison with your alternatives).

A second model is hydraulic, being a matter of simple forced flows. It is a balance-of-flows model, where the bidding up or down in price of some asset is related to the flow in and flow out of the asset. It's not necessarily based on some independently-derived sense of value of the asset, but simply, without knowledge of value, the flows into the asset. I have in mind that if a society of workers is all working all their careers to put some retirement money away, plus companies matching, and most of them are forced to put this money somewhere, and so they essentially throw their money wherever their financial advisers recommend, that is to say they lock in the hose connector to pipe their contributions into a diversified portfolio of stocks, bonds, and ETFs, such that, irrespective of the true value of such portfolio's underlying assets, these flows will automatically flow and continue to bid them up by the amount of their retirement contributions every month. Forced flows.

This flow model can work in the context of ignorant investors guided by self-interested advisers who make money on the churn in the investors' portfolios. Since there is not much churn in real estate, such advisers don't advise going there sufficiently. And given the indexing argument that you should invest in everything in proportion to all the relative asset values, investment can be carried out in complete ignorance of true underlying valuations, and even Warren Buffet tells people to follow that advice (cf his public million dollar bet against active managers versus the S&P index, which was lost by the opposite bettor). The indexing bet takes no knowledge, yet is far better than a bet on the average actively managed fund. Thus we discover not only that the stupidest bet is a great bet (based on the indexing argument) and further that the entire world of mutual funds and following the advice of the financial advice industry is even stupider than that stupidest bet, and yet huge cashflows are continually going into the stock market based on those paths, the paths of minimum and negative total intelligence. Huge, huge cashflows, because everyone is putting money algorithmically away for retirement.

How can we confidently bet?

Here's an anecdote, a tiny example of my own, only for illustration. I felt I knew all those elements recently, to a small degree of confidence, and I made a Covid-19 bet on Gilead (GILD).

It was thrashing up and down with the whole market at the time Covid was coming into wider awareness, after many months in the range of about 60-64, now it was in a range from 64-84, mostly based on fluctuating news of studies of its drug, remdesivir. I heard through personal contacts that the first US Covid-19 patient had used remdesivir and his fever has dropped from dire to no big deal in 24 hours after administering it. To me that's not perfect information but it's a valid and direct signal from the underlying reality which is quite suggestive: it's probabilistic knowledge, even from a single data point. Obviously others would be finding this out too, and during a time of fear, froth, and volatility, people are going to bid it up, but not too much because even if it cures Covid-19 it won't necessarily make Gilead double their already enormous (44B) company valuation. And I had a floor, because it is a big pharma company with plenty of value outside its remdesivir position, not much below its then-current trading price, so it probably wouldn't tank completely at least not soon.

So I thought in advance, next time they go down below 70 I'm buying, and I'm sure it'll pop over 80 some time, it'll be a fine bet and I'll sell then. Not that I had infinite confidence in this, but I had enough to bet $7000 to buy 100 shares. So I did, and it did, and when I sold them for $8000 a couple days later I made $1000, a tidy profit but a small fraction of the market-wide losses I more than shared in at that time in my own S&P index fund investments.

Now two months later it's still trading around 76, having spent maybe a day in the interim trading above 80. So I feel good, and indeed it has the hard-to-acquire joint prerequisites of a good bet. There was a good floor. There was a sense of the impact on its potential value as being far from a doubling. There was a sense of the timing of investor sentiment, based on the visible wave of exponential growth and universality of the Covid pandemic infection and death curves coming at us, which were not widely acknowledged but obviously were going to wash over the US and therefore over the mass of market participants. I could feel the timing of a tidal wave of investor sentiment coming, which I expected could waffle with good and bad news but that yes they would rush in with some good news some time, and their interest would be scaled by the derivative of the investor need for that news (greater panic would mean higher price). Given my own experience of Covid panic when I had realized Oh God this is Real, I could see the spreading sense of panic around me at about the time of the initial shutdown, when the country started finally thinking this is real, it was hitting home, that investor sentiment trajectory was quite visible in the news and the numbers, and the moment of maximum distribution of the O My God sentiment was my time to sell. Perfect.

Except despite my thesis I didn't have the confidence to bet heavily on it. What a turkey!

The Turkey, The Butcher, and the Antifragile Investor

So maybe there's a lot of turkeys out there, pecking their feed and waiting for slaughtering day. Listening to Nassim Taleb, one draws the lesson that having a great forecast or model is actually not even the point; instead, acknowledge your ignorance and create a portfolio of options that jointly make you a winner irrespective of whether the outcome is good or bad. If you can buy some cheap options to cover the extreme conditions, then you're all set irrespective of unpredictability. Whereas if you don't do that, then when rare, unpredicted, unpredictable events carry most of the value, if you don't get them right, you lose everything. An anti-fragile approach gets stronger under volatility. Thus, mortgage bankers play an anti-fragile game. If employment drops, etc., someone has unpredictable hiccups, they lose their mortgage, no problem, from the banker's perspective. Volatility is the banker's friend. The bank gets the lowest-risk part of the homeowner's income, who has to give every last dollar if their income drops to barely sustaining the mortgage, to the bank. Anti-fragile. So much for mortgages, which are a good idea in good times.

The Making of Money

So suddenly there's a lot of money in the world, because everybody is borrowing money from their bank, and the bank just invents it by using this method.

Could this trick be available outside banking? For example, could credit also be issued by property developers to their home-buying customers? Or, could GM Financial do the same with cars? If they were receive an agreement to pay in exchange for something that costs them nothing to produce and deliver, or that in aggregate they don't have to deliver at all, then Maybe. But the account balance the customers receive is the car itself, and they drive it away. So No, it wasn't just a double-entry account-balancing event, largely left in the bank's customer account or the bank accounts of the aggregate of customers. Sure, yes, to some degree there is profit in the sale, and that percentage of the money seems to be invented, I think, but it's also kept in the seller's account rather than the customer's. So the answer seems to be No: I don't see how to do this without being a bank.

Historically the betting game of poker provided a way to do this. A winner would receive a note from a loser who had bet away more than he or she had, an amount without any limit in principle. From a broken bank beforehand, the bet transaction now essentially produces an IOU, a security with non-zero repayment value, held by the winner, and an obligation to pay it, on the head of the loser. The winner could then direct future favors, such as a portion of the loser's labor, or a tax on their outside income or property, so as to gradually reduce and eliminate the debt amount.

Thus in an environment of limited cash, new and in principle unlimited additional value is created from thin air, in the form of the debt security on the winner's side and the debt obligation on the loser's side. It is kept track of between the parties themselves without government or institutional interference, so long as the participants play honorably. In a cash-scarce economic environment in which everyone is largely cash-broke, these debt-creation events, out of thin air, produce an unlimited capital cushion in the form of directable surplus labor. The participants, we may hope, don't starve each other, yet now their labors above the level required to maintain mere survival can now be accumulated and directed. Poker is a simple game, barely more complex than "War", but it rewards the aggressive, calculating, socially-observant, proactive individual, and punishes with (generally) bearably severe financial consequences. It accumulates from-thin-air wealth into the hands of its aficionadoes. A wonder, but not a coincidence, that it arose in the burgeoning (but cash-poor) capitalism of the indusrtrializing American Midwest. A fascinating talk on this history is the MIT Poker Economics lecture on youtube.

So, in this way the banks actually create most of the money in the economy. But the scandal is not this, it's the next bit.

I coach pingpong, and when I bring students to the point of discovery of the power of heavy top-spin, I say, Young one, you have discovered you have a super power. You must now face two questions. First, will you use it for good, or for evil? Second, will you learn to control it?

Since money can be invented arbitrarily by a bank when it makes a loan, that seems like a super power. So, Shall we use it for good, or for evil? Banks differ importantly, in size, strategy, and public benefit. This correlation is Werner's point:

• Big banks: mostly make enormous loans to enormous clients who make few jobs with their loan proceeds, lead to asset bubbles and general economic fragility; whereas,

• Small banks: make a lot more small loans to smaller companies, which create a lot more jobs per dollar which also leads to more increases in economic production as distinct from asset price appreciation.

To reiterate, in normal operations as well as banking crises, banks, and especially central banks, can simply create assets in the same way, by creating a loan/repayment accounting double entry, with the asset column being a repayment agreement with whoever, let's say X, and the liability column being an invented amount of money theoretically used by X as X's money on deposit. There can be no crisis if a bank in crisis can simply make a giant loan and thereby have a huge additional asset on its books, as Werner documents in a case study was done by Barclays in the great recession. Thus banking crises don't have to be a crisis, ever, and if they occur it would seem to be they are more an opportunity for central banks and large banks to manipulate the system for more power than they are a true difficulty without a safe manageable resolution within the normal operations of banks. In short, says Werner, support your local, small banks, and support the role of banks in supporting productive economic activity (loans to manufacturers not homeowners).

In our present environment of central banks running everything and making lots of loans for (non-production-enhancing) financial asset transactions, like buybacks and real estate purchases, it is clear enough that when the government prints a few trillion dollars, the prices in the whole stock and real estate markets would go up. With a lot of spare money floating around, it has to go somewhere, it might as well go to float the whole stock market up because that's as good as Warren Buffet's advice. Then, all us turkeys, we all advise our advisers to follow their advice and direct the flow there, and algorithmically up it goes, pushed with the pump of our pension contributions. Maybe there's no inflation in consumer goods, but there's huge inflation in investment asset pricing. This seems to be approximately accurate as to what is going on in the world today.

Tech Deflation

Andrew Yang reports that, according to the head of the Service Employees International Union, the future of work is no work. The call center jobs go away to Spoken, and retail jobs go away to Amazon, and future transportation and logistics jobs go away to robot cars and trucks. Future construction jobs will go away to scaled up 3D printing. Even a simple plumber has plenty of ideas for robotic plumbers. This sh*t is coming, and it WILL hit the fan.

From a money perspective the basic trend from technology in general is deflationary: A farmer with a hoe feeds a family, but a farmer with a tractor feeds a village. So the labor cost of food goes down as technology develops. Not just food, but everything with a labor component in it, consumer goods, business goods, indeed employment itself all goes toward zero. And this is a good thing from one perspective because it moves towards a post-scarcity consumption society, in which the labor cost of plenty for everyone becomes less and less. But the other side of the transaction, the supply side, looks much scarier.

The central fact is that one software program written and debugged one time can do the work of unlimited workers over unlimited time. John Henry, Everyman, will certainly die in a race against this more modern kind of steam shovel. Will John Henry have a replacement job when the improvements in technology change their character from aiding humans in doing more and better work to replacing humans entirely? The talk is about AI, but to me it's when rich sensors become part of the technology, that the playing field tips from humans toward tech.

The old Luddite argument, that technology is taking our jobs, was certainly temporarily wrong during the massive expansion of the manufacturing economy since 1816, when if one kind of work went down another came up. But the old Luddites will certainly be ultimately proved correct since obviously the robots are coming. It says, Hey, most of you, your labor isn't worth anything now. What are you going to do about it, eh, when your income is your labor exchanged for money, and nobody wants your labor??

Let's think about it. Technology is deflationary. In comes tech, down goes the labor cost of production, down eventually (if there is competition!)go the prices, down down. And yes it's good because life should be easier for everyone when things are more affordable, but no it's also bad because no-one can afford anything when they aren't working for good money.

Two Arms of Value

Nassim Taleb on this point: "People have a fear of inflation. There are two inflations. There is goods and services. Buying your morning coffee at Starbucks. Or sorry, buying your bad morning coffee at Starbucks; I had a bad experience today, okay? And then there's the other thing is the assets, okay? The second category is enormous --- The best hedge I think that you may have, if you are not equipped to do tail hedges, is in being in cash when there's fear of [overblown, about-to-unwind] inflation, because assets are the ones to go first. See, so, simple, and clear." (Youtube, Nassim Nicholas Taleb: Why Correlation is Unreliable, from the Greenwich Economic Forum, March 22, 2022, 15:08-15:57).

• Technological progress cannot increase the quantity of scarce assets.

• However,
  • As technology reduces the labor cost of those products and services that have a labor component (that is, those for which production can be increased!),

  • As the community of fiat currency issuers print money like crazy to fund endless government borrowing thrown mainly at the enrichment of the bankers and corporate bond issuers,

  • As any valid underlying measure of true value (V) remains constant,

• Then,
  • Deflation in terms of V applies to all the consumer non-scarce products and services that can be produced and served,

  • But inflation also applies to them

  • and the effects cancel, so the deflation is invisible because the devalued fiat pricing of them produces a flat result,

  • And,

  • Inflation in terms of fiat currencies applies to all the scarce assets such as real estate bitcoin and investment-worthy stocks.

At the same time, technology cannot reduce the cost of the scarce assets like real estate, bitcoin, or investment-worthy stocks, so currency inflation is visible in the apparent price increases in scarce assets.

In this way we resolve the mystery. Here we are in the middle, a strong rope tied to each Arm, pulled opposite directions by two unstoppable forces, technology deflation and the governmental spending juggernaut of inflation. The mystery is, which direction will we be pulled? And the answer is, Both. We assert that Scarce and Non-Scarce are two separate Arms of value, and technology deflation applies only in the Non-Scarce Arm, and the government spending juggernaut cancels out the technology deflation in Non-Scarce products and services to create a semblance of consumer price stability, while in the Scarce Arm, deflation does not apply, so inflation becomes visible.

It's certainly a strange, perhaps an ugly picture, if not a bloody one. Our Gumby arms are stretched indefinitely in opposite directions in reality; whereas, in the central-bank fictional world one arm is held unmoving and only the other arm is stretching away into the unaffordable distance. Eventually, or perhaps already, only the 1% will be able to hold meaningfully-valuable assets, which poses an "Exit, Voice and Loyalty" conundrum, where "exit" corresponds to movement into bitcoin, "voice" corresponds to revolution or, unlikely, political change, and loyalty is increasingly clearly only for those with no long-term view or ambition or hope. Bitcoin seems the likeliest path.

The truth at present is that the scarce assets are NOT appreciating in (true) value despite (apparent) rises in fiat pricing; those rises are a measure of the loss of true value V in which fiat currencies are measured by the market. If a fiat dollar inflates/devalues by half, then everyone should realize that their real estate didn't double in value V, but only followed the loss of fiat currency value by staying the same in V but double in dollars. So yes we wonder why real estate even in backwater markets is going up so much, but no it's not real estate that's going up but the dollar that's going down. Even if the peso goes down at the same time relative to V, exchange rates peso/dollar remain unchanged yet all the scarce assets in the peso and dollar world are all going up because all the fiat issuers are printing away at the same time.

Real Value

Here in America we might not be planning to let the working class go off in the forest and die. Therefore, working people will certainly be paying rent somewhere, so some multiple of headcount times C class residential rents in today's money, tomorrow's money, any imaginable time's money, should pretty much keep you in mac-and-cheese if you can get that many houses paid off in your portfolio. Yes, I'm saying I actually don't believe in money and I don't care what happens to money, because I have my couple of houses, and you can go ahead and pump your trillions of printed money into the economy and I should still be good.

Except if ...

Except if America says, F*** the formerly working classes, they have no value in our new high tech new software economy, let them go into the forest and forage or starve, and with our robo-cops we don't even need a few suck-ups to man the gates against the starveling masses any more, we'll live happy on our robot-mowed estates, it's fine, let's let the population just drift downward.

In that repulsive, revolution-worthy future, my houses may be worthless indeed. Especially as the population crashes from 2050 forward, the real estate asset bubble sags, the remaining tenants all move upscale and the crappy houses get bulldozed.

I'd rather bet on the working class though, myself.

Okay, what to do, how to think about money and value, when money is a-printing (for the rich), but services and goods are a-cheapening (for the poor). Andrew Yang is certainly right, the Freedom Dividend, UBI, Universal Basic Income, will be necessary sooner or later, if people are to remain consumers despite having no jobs. For if the consumption economy society sags, then the riches of the rich, which also exist in consumer-product company stock and C class rents, will also sag. Even UBI's generosity of spirit only solves a national problem when it's actually a global problem. What about the poor countries when robot designers target even the low-value jobs of Bangladeshi textile workers and Zimbabwean miners? Let them starve? Even if the US and Switzerland can print money for a universal basic income and remain financially stable, can Pakistan also print money for its own UBI, while remaining stable? It's very unclear, and maybe, probably, not. Which predicts a lot of emaciated bodies in the forest. And soon.

What to do, what to do? Public policy, private policy.

If the cost of consumer goods goes to zero, then an income of nearly zero would still pay to live comfortably. It's like that math question, what is X/Y when X and Y approach zero? We are facing a problem in the limit.

I notice that a generous UBI costs a lot less in a world where consumer prices are substantially deflated. Let's agree then, that a UBI is necessary wherever affordable. That would be nice.

Can we at least differentiate between the labor cost of goods and the natural resource cost of goods? Marx said Capital is just saved up Labor, which is true enough, except for the large fraction of all Money that is just invented bank-account balances (yes: see step 4, footnote, paragraph 3, here). In this asset-inflation game the asset-holders and the printed-money beneficiaries win, while the moving costs in the economy drift downward where based on software-replaced labor, but float perhaps more slowly down where based on limited natural resources independent of labor. Like, certain kinds of mine-owners might do well over time. Gold, bitcoin, ugh. This is ugh-ly.

And natural monopolies may do well, if monetizeable. Open source software, Nope. Netflix, Yep.

Actually this forces me again back toward real estate, but I have to say now, Quality real estate. Location location location is what it's all about, and location is an intrinsically limited asset.

Okay that's an economic model of price discovery, a re-envisioning of money itself, an investment philosophy, a future trend assessment and a public policy prescription. Fair enough? Fair enough.

Epilogue

Yours,

Tom