Sunday, April 18, 2010

The Civilization Bubble

There have been many financial and real estate bubbles during the past few hundred years, and there have been empire bubbles, but never before has there been the global civilization bubble in which we are now in. The bubble will collapse within a few decades. It will be the end of civilization, and will result in world-wide violence, deaths, and chaos.
Empire bubbles can last several hundred years, as for example the Mayan civilization or the Roman Empire. What brings down empires is invasion, bad economic policy, environmental exhaustion, or weakened tyranny. The Soviet Union, for example, was a statist bubble that was brought down by economic decay and weakened tyranny.
Most of the world is now in a global civilization. There are two enemies of this global order. One enemy is terrorist pseudo-religious supremacists. They could bring down the global civilization with electromagnetic bombs that would wipe out the storage and transmission of data that the world’s economy depends on. Very little is being done to protect the global electronic infrastructure from attack, thus the bubble.
The other threat to global civilization is internal, or as scientists say, endogenous. Global civilization is rushing towards an environmental collapse. There are hints of this in the plastic contamination of the oceans, the depletion of fresh water, the destruction of fish and corals, the eradication of forests, and possibly accelerated climate change. What will most likely bring down global civilization is the plundering and poisoning of the natural infrastructure of the earth.
The global civilization bubble began with the industrial revolution of the 1700s. The model that was adopted world wide was the extraction of material natural resources, processing them into products, and spewing the waste and pollution into the air, water, and soil, with no compensation for this trespass. The old English common law concept of nuisance was swept aside by government in order to subsidize industrialization. Witness developing countries following that same model today.
The economic policy that would avoid environmental destruction is to charge polluters the social cost of their use and abuse of the environment. Sustainable public finance includes public revenue from the natural rent of land, from the rental generated by public services, and from the dumping of pollutants into the environment. Sustainable public finance would also abolish the taxation of labor, capital, and trade, as these taxes create economic and therefore also environmental waste. Compensation for use and damage would minimize the harm, as the payments would shift production towards less damaging products and methods.
Interestingly, the beginning of the industrial revolution was accompanied by the development of the theory of efficient, equitable, and sustainable public finance by the first organized school of economics, the Physiocrats of France. Adam Smith was influenced by their theory of free trade and the single tax on the surplus that is land rent. Classical theory culminated in the works of Henry George during the last decades of the 1800s, as George integrated moral philosophy with economics in a policy of free trade and public revenue from rent.
The environmental aspect was nailed down in the early 1900s by the economist Arthur Cecil Pigou, who theorized on what came to be called the Pigovian policy of charging for significant externalities such as pollution. Complementary to pollution charges and land value taxation is marginal-cost pricing, which was thoroughly analyzed by the Nobel-prize winning economist William Vickrey. Pigovian policy should not just be applied to pollution, but also to the exhaustion of natural resources such as fresh water as well as to traffic and parking congestion.
The political question is why governments world-wide are allowing industrialists to unsustainably pollute the planet and not enacting the solutions provided by economics. For that, we turn to political science and the economic theory called ”public choice.” The model of voting that evolved in the United Kingdom and is now spread world wide is that of mass democracy, of masses of individuals voting for candidates about whom they know next to nothing. Voter ignorance and the inherent demand for campaign funds provides an incentive to rent-seeking special interest such as the polluters to provide support to government chiefs in exchange for privileges.
The model of democracy that would remedy special interest subsidies and plunder was developed interestingly enough by anti-statist anarchists. Their vision was small voluntary communities which would elect representatives to higher-level associations for mutual aid. Bolshevik communists adopted this plan, and proposed a union of “soviets,” which means “councils” in Russian. Their slogan was “all power to the soviets!” But when the revolution came, power in the Soviet Union instead became concentrated in the Communist Party, and the anarchist model of small-group bottom-up democracy was lost to global civilization.
Global civilization is therefore now like an ancient Greek tragedy, as it moves inevitably towards a tragic collapse of its environmental foundation. Although many people are aware of the impending doom, their warnings and calls for reform are futile, because mass democracy prevents any significant change. Almost nobody is calling for a reform of democracy, and so we are like boats in a fast-running river headed towards a waterfall of global environmental collapse with no way to stop the boats or get off.
What may save humanity is the existence of a few small primal societies in the jungles of the Amazon or Africa or pockets of Asia which are not yet in the global civilization. As the rest of the world dies in starvation and conflict, these remnants would survive, but the earth will after that never be same jewel of natural richness that humanity enjoyed before the rise of agriculture.

Sunday, April 04, 2010

Credit Booms Gone Wrong

Recent research by economists Moritz Schularick and Alan M. Taylor have confirmed the theory that economic booms are fueled by an excessive growth of credit. They have written a paper titled “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870–2008" (, published by the National Bureau of Economic Research.
A major cause of the Great Depression was a credit boom, as analyzed by Barry Eichengreen and Kris Mitchener in their paper, “The Great Depression as a credit boom gone wrong” (BIS Working Paper No. 137, Eichengreen and Mitchener cite Henry George’s Progress and Poverty as providing an early theory of booms and busts based on land speculation. They also credit the Austrian school of economic thought, which in the works of Friedrich Hayek and Ludwig von Mises, had developed a theory of the business cycle in which credit booms play a central role. Henry George’s theory of the business cycle is complementary to the Austrian theory, as George identified the rise in land values as the key role in causing depressions.
An expansion of money and credit reduces interest rates and induces a greater production and purchase of long-duration capital goods and land. The most important investment and speculation affected is real estate. Much of investment consists of buildings and the durable goods that go into buildings as well as the infrastructure that services real estate. Much of the gains from an economic expansion go to higher land rent and land value, so speculators jump in to profit from leveraged speculation. This creates an unsustainable rise in land value that makes real estate too expensive for actual uses, so as interest rates and real estate costs rise, investment slows down and then declines. The subsequent fall in land values and investment reduces total output, generates unemployment, and then crashes the financial system.
We can ask whether this theory is consistent with historical evidence. One strand of evidence is the history of the real estate cycle, which has been investigated by the works of Homer Hoyt, Fred Harrison, and my own writings. Another strand is the history of credit booms, as shown by Schularick and Taylor, who assembled a large data set on money and credit for 12 developed economies 1870 to 2008. They show how credit expansions have been related to money expansions, and how financial innovations have greatly increased credit. Because economic booms are fueled by credit expansion, Schularick and Taylor note that credit booms can be used to forecast the coming downturn.
Followers of Henry George have focused on the real estate aspect of the boom and bust, while the Austrian school has focused on credit, interest rates, and capital goods. A complete explanation requires a synthesis of the theories of both schools, but these recent works on credit booms have not recognized the geo-Austrian synthesis. In order to eliminate the boom-bust cycle, both the real side (real estate) and the financial side (money and credit) need to be confronted.
Current Austrian-school economists such as Larry White and George Selgin have investigated the theory and history of free banking, the truly free-market policy of abolishing the central bank as well as restrictions on banking such as limiting branches and controlling interest rates. In pure free banking, there would be a base of real money such as gold or a fixed amount of government currency. Banks would issue their own private notes convertible into base money at a fixed rate. The convertibility and the competitive banking structure would provide a flexible supply of money along with price stability. The banks would associate to provide one another with loans when a bank faces a temporary need for more base money, or a lender of last resort.
Both the members of the Austrian school and the economists who have studied credit booms have not understood the need to prevent the land-value bubble by taxing most of the value of land. That would stop land speculation and eliminate the demand for credit by land buyers.
But the credit-bubble theorists have not understood that financial regulation and rules for central banks cannot solve the financial side of credit bubbles. Credit booms always go wrong. As the Austrians have pointed out, there is no scientific way to know the correct amount of money or the optimal rates of interest. Only the market can discover the rate of interest that balances savings and borrowing, and only the market can balance money supply with money demand.
Thus the remedy for the boom-bust cycle is both land value taxation and free banking. Land speculation would not be as bad without a credit boom, but will still take place as land values capture economic gains and land speculators suck credit away from productive uses. But also, a credit boom with land-value taxation will still result in excessive construction and the waste of resources in fixed capital goods, reducing the circulating capital need to generate output and employment, as Mason Gaffney has written about. Economic bliss requires both the public collection of rent and a free market in money.