Category Archives: economics

Great Problems: The Rent-seeking Economy

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In a healthy society, people acquire wealth by making stuff people want. Farmers till a plots to provide for their nutritional wants. Workers assemble motorcycles for consumers who pay money because they find the motor bikes valuable. Perhaps the worker serves a philanthropic organization and earns a salary by serving the official goal of the organization. Or perhaps the worker earns money by creating crafts that others in the community value.

A society structured as the above has two great benefits. First, incentives are aligned to produce more output. A person can only acquire wealth by producing wealth. Thus the production of wealth is encouraged, as man’s natural greed is channeled towards productive ends. Second, humans are innately goal seeking creatures. It makes us fundamentally happy to strive towards a goal – whether that goal be winning a football game, learning a new song on the piano, leveling up in Warcraft, or producing a product that people want.

In a dysfunctional society, people acquire wealth via corruption, rent-seeking, and theft. Perhaps they steal it at the point of a sword. Perhaps they acquire wealth through outright corruption. Perhaps they acquire wealth through holding a position in a completely dysfunctional management structure that requires internal politicking and Kabuki make work rather than actual performance.

As Adam Smith wrote, “there is a great deal of ruin in a nation” Corruption has always existed in America. But in the past decades it seems as if the dominant paradigm has shifted, so now more and more income comes via dysfunctional rent-seeking rather the net creation of new wealth. 1

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The Four Economic Classes and their Respective Plights

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This is the third essay in a series on the great problems of our age. See part 1 and part 2.

To understand American economic conditions, it is helpful to generalize Americans into four economic classes:

  • The Underclass Those scraping by at the fringes of economy, often subsisting on crime or welfare.
  • The Plebs The interchangeable parts in the machinery of the economy. Because plebs are so easy to replace, they earn low wages and have little job security.
  • The Rat-racers Those who have found a career track that offers leverage and rewards inside knowledge. The inside knowledge makes it harder to replace the rat-racer, thus earning them higher salaries. But they must grind out long work hours to maintain their competitive edge.
  • The Rentiers Those who have achieved complete economic security. They no longer need to work to live, instead they work for personal fulfillment.

Please note that the above classes are economic classes, not social classes. A hipster coffee shop barista and a high school dropout janitor both belong in the same pleb economic class, but they are in very different social classes.

Let’s examine each class in detail.

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Why GDP and CPI numbers are psuedoscience (Work in progress)

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Many have pointed out the flaws in the GDP and CPI. But yet the numbers are still the primary economic metrics used across academica and the media. This essay comes not to criticize but to destroy. The GDP and CPI numbers are not just imperfect, but they are off by so much, and in so many different directions, that they should be tossed out entirely. For every purpose that GDP may be used, a better measure exists. We’ll start this essay by decimating GDP, and then I’ll present the alternatives.

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Top 10 Articles About the Financial Crisis

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Of the many articles I’ve read about the financial crisis, the following ten have been the most informative.  Read them all, and I think you will have a very solid understanding of what is going on.

1)  The Financialization of America A broad overview of how 1) insanely profitable Wall St. became in the past two decades and 2)  this profitability was due to implicit government subsidization of risk.  This includes the “too big to fail policy” and the “Greenspan put”.

2)  The Global Pool of Money [MP3] – An hour long podcast from NPR about the selling of subprime mortgages.  Hear the story of hustlers, smooth talking sales guys, fast cars, and big money.  It’s like something out of a movie.

3)  Triple-A Failure: The Ratings Game by Roger Lowenstein of the NYTimes.  You may ask, who was buying these securities that were so obviously shoddy?  Government regulations mandated that certain investors – mutual funds,  insurance companies, pension funds – could only buy bonds rated as investment grade by one of the three official rating agencies – Fitch, Moody’s or S&P.   But these rating agencies were for-profit companies that earned more money by giving banks higher ratings.  This conflict of interest resulted in systematically underestimating risk.

4)  How regulation breeds complex financial products and Why Lax Regulation Did Not Cause the Crisis by Mindles Dreck.  The author works in the investment banking industry.  He relates how the industry had actually seen a dramatic increase in regulation as a result of Enron and the Patriot Act.  But the effect of regulation was not to make finance less risky, but rather regulations encouraged the creation of more complex financial products that outsmarted the regulators and gamed the system.

5)  Fannie Mae’s Golden Goose – A Lesson in Moral Hazard – The author, Bill Burnham, has worked as a Wall St analyst, venture capitalist and hedge fund manager.  In the mid-90′s he consulted with Fannie Mae for a year.  He tells the story of how Fannie Mae abused its implicit government backing to make very risky loans at low interest rates.

6) Commodity Hysteria – An Overview by Nick Szabo, a former programmer, now a law school academic.  He explains how the simultaneous rise in price of dozens of diverse commodities is best explained by rising inflation expectations due to the financial crisis.  As inflation increases, more people buy ETF’s and commodity index funds. Additionally, producers have no incentive to pump more oil, as oil in the ground is worth more than a dollars in the pocket.

7)  Record Central Bank Financing Continues by Brad Setser, an academic economist.  Setser notes that foreign central banks are buying up massive amounts of American debt. Foreign countries have deemed the U.S. government too big to fail: “Sometimes I think the US should drop the façade of auctioning off Treasuries and just negotiate private placements with the People’s Bank of China and the Saudi Monetary Agency.”

8)  How Stocks are like Baseball Cards by Mark Cuban.  Mark Cuban is famous for selling Broadcast.com for billions during the dot com bubble.  He explains how the decline of dividends has turned stocks into purely speculative collectibles, rather than ownership shares that earn the investor money.

9)  How the Fed lowered the reserve ratio and caused a decade of inflation and asset booms – In 1995 the Federal reserve created special exemptions allowing banks to keep 0% reserves in many cases.  This lead to an explosion of the broad money supply, and successive bubbles in the stock market and housing market.

10) Maturity transformation considered harmful: an unauthorized biography of the bank crisis by Mencius Moldbug, a semi-retired software engineer who’s spent the past two years studying history and economics full-time. He traces the roots of the financial crisis to a fundamental flaw in our banking system that has been around for 300 years. He proposes a solution to fix things up and prevent these crises from ever happening again.