Brainteasers, Bill Gross

A recent Internet blog posed the predicament of many medium/long-term relationships: At some point couples run out of historical stories or even topical things to say. After all, there are only so many Trump tweets you can talk about, and you’ve long since agreed to disagree about the meaning of life. The blog suggested inventing some new philosophical brainteasers to keep the conversation alive. Having written Investment Outlooks for over 30 years now, I thought it apropos to follow the same approach, so here are my twisters and summary comments following each. Spoiler alert: please think of your answer before reading the “comments”.

1) If forced to choose between killing your favorite pet or an anonymous human being, what would you do?

Comment: In a USA TODAY survey from a decade ago, the majority of responses seemed to favor killing the person and saving the pet!

2) Would you rather be “interested” or “interesting”?

Comment: Most say “interested”, (as would I), but it’s a close vote.

3) If you were offered one year of quality life in addition to how long you would have lived anyway, would you give up your cellphone for it?

Comment: This one creates the most controversy. Young people do not give up their phones. Older people jump at the chance for that additional year. They don’t know how to use a cellphone anyway!

4) If you were stranded on an island with a totally repugnant looking and abusive human being, would you entertain romance with him (her)?

Personal Comment: Maybe at 22, not 72!

5) If offered the certainty of a second life after your current one, but it would be a life of misery with no moments of happiness, would you take it?

Comment: A few actually say yes, suggesting that their misery might in some way lead to happiness for others.

6) Is there an emotional distinction between saying “Luv you” and “I love you”?

Comment: Almost certainly. Inserting the “I” signifies a much stronger – and riskier – personal commitment.


Can the Trump Agenda recreate 3% growth?

Well, now, that is the investment question of the hour/day/decade and its conclusion, unlike romance on a desert island, will determine the level of asset prices across the investment spectrum. 3% growth leads to a levered rate of corporate revenue/profit increases and a significantly higher P/E ratio, all else equal. 3% growth also sends a green light/all clear signal to high yield bonds and other risk assets that are leveraged and growth dependent. It may also, although not necessarily, lead to higher real interest rates and a future bond bear market. So what’s the answer?

Northwestern’s Robert Gordon has long argued that lower productivity may now be a function of having picked all of the “low hanging fruit” such as electrification and other gains from 20th century technology.

Well, growth is productivity dependent, and the experts are in a tizzy trying to explain why productivity in the last five years has averaged only .5% versus a prior pre-Lehman “old normal” of 2%+. Fed Chair Janet Yellen, speaking on April 10th, said that no one really knows the answer, which was her way of saying that the past five years’ experience has been three standard deviations outside of the Fed’s model. But others, such as Northwestern University economist Robert Gordon, have long argued that lower productivity may now be a function of having picked all of the “low hanging fruit” such as electrification and other gains from 20th century technology. Then there is the obvious connection between recent years’ low levels of private sector investment, which perhaps begs another as to why that is so low. Optimists claim that the future benefit of smartphones and medical technology have yet to have an impact and that eventually – much like the introduction of the automobile – they will lead to a resumption of historical trends.

But in a detailed report by the IMF, their economists argue that the current trend is an offspring of the financial crisis. Slowing business investment/trade and an ongoing level of low to negative interest rates have resulted in a misallocation of capital to low risk projects and a slowdown in small business creation. Longer term secular demographic factors such as an aging population also play a significant part since older consumers consume less of almost everything except health care. So Chair Yellen may just be sticking to her old models and her educated but “common sense” deficient staff that claims that no one really knows the answer. She may need to “tease” her brain that is so focused on historical but dated economic models. There may be answers and solutions that other organizations are coming to grips with.

The same IMF study suggests that unless there is an unforeseen technological breakthrough, productivity growth is unlikely to return to the higher rates of the 1990’s for advanced economics or the early 2000’s for emerging economics. In other words, their warning speaks to a global productivity slowdown, not just a U.S. based phenomena. They warn that increasing tariffs and developing restrictions on immigration will only exacerbate the slowdown. Global growth, and of course U.S. growth, will be lower than average, they forecast.

High rates of growth, and the productivity that drives it, are likely distant memories from a bygone era.

And if so, what are the investment conclusions? Well here’s where a two handed economist might fall back on the conclusion of my six original brainteasers: There is no right or wrong answer. But since I have two hands but have frequently been accused (praised) of not being an economist, I’ll post my own comment. Equity markets are priced for too much hope, high yield bond markets for too much growth, and all asset prices elevated to artificial levels that only a model driven, historically biased investor would believe could lead to returns resembling the past six years, or the decades predating Lehman. High rates of growth, and the productivity that drives it, are likely distant memories from a bygone era. If you’re “interested” in investment performance, hopefully you’ll find these conclusions somewhat “interesting”. Now pick up your cellphone and know that the only real way to have one more year of extended life is to feast on blueberries instead of Oreo cookies and to exercise daily instead of heading for your couch and widescreen.

Happiness Runs – Janus, By Bill Gross

 Happiness is wanting what you have

And not wanting what you don’t have.

Shakyamuni Buddha, 500 B.C.


The three grand essentials of happiness are: something 

to do, someone to love, and something to hope for.

Alexander Chalmers

Happiness runs in a circular motion…

happiness runs, happiness runs.

Donovan, 1969


I think a lot about happiness – what makes a person happy, whether or not happiness should even be a life’s priority – things like that. A good high school friend stunned me at the early age of 17 by suggesting we should not necessarily try to be happy. Sacrifice, service, devotion to a cause were higher orders, he felt, although presumably, since those were choices, their pursuit could secondarily lead to happiness.

Through the years I’ve accumulated a short list of quotes that express a personal view of what makes people happy. You, I’m sure, have your own candidates, but most of them probably resemble some of the ones listed above: Stay busy doing something you enjoy; be mindful of other people and the world in, around, and above you; don’t let your reach exceed your grasp; find someone to share your happiness with. My favorite of all of these is the one above by Donovan – that somewhat kooky “love generation” folk singer of the late 1960s. “Happiness runs in a circular motion…happiness runs, happiness runs.” There may be more to this refrain, however, than appears at first glance, the entirety of which I’ve tried to encapsulate artistically in my open-ended smiley face that wasn’t ever-popular when Donovan crooned the tune. For years I thought that the gist of Donovan’s phrase was the obvious – the “pay it forward” allusion that suggests what goes around, comes around – and it undoubtedly is. But there are hidden nuances, at least to me. The “running in a circular motion” also connotes a self-contained, inward-looking, self-satisfaction that equates happiness to being content with yourself as a person. And the last phrase – “happiness runs, happiness runs” may speak to the Buddhist philosophy of impermanence and the priority of the moment. Donovan might not rank up there with Kant and Spinoza, but his little song packs a powerful message. Rock on, flower child, wherever you are.

And while happiness may run in a circular motion, it seems history may too – or at least it may rhyme, as Mark Twain once said. Pictured below are two of my notes written not recently, but in 2003. They are as relevant today as they were then. “Financial repression” runs…in a circular motion, it seems. In 2003, though, central bankers had rarely contemplated the monetary policy instruments that could lower and then artificially cap interest rates. Although my notes correctly allude to “all means including ‘ceilings’ ” to keep the cost of financing low, the expansion of central bank balance sheets from perhaps $2 trillion in 2003 to a now gargantuan $12 trillion at the end of 2016 is remarkable. Not only did central banks buy $10 trillion of bonds, but they lowered policy rates to near 0% and in some cases, negative yields. All of this took place to save our “finance-based economy” and to raise asset prices upon which that model depends. As any investor would admit, these now ongoing policy panaceas have done just that – promoted higher asset prices and engendered a modicum of real growth. In the process however, as I have frequently written, capitalism has been distorted: savings/investment has been discouraged by yields/returns too low to replicate historic productivity gains; zombie corporations have been kept alive in contrast to Schumpeter’s “creative destruction”; debt has continued to rise relative to GDP; the financial system has not been cleansed and restored to a balance where risk and reward are on a level plane; disequilibrium has replaced equilibrium, although it is difficult to recognize this economic phantom as long as volatility is contained.



But in order to control volatility, and keep a floor under asset prices, central bankers may be trapped in a QE-forever cycle, (in order to keep the global system functioning). Withdrawal of stimulus, as has happened with the Fed in the past few years, seemingly must be replaced by an increased flow of asset purchases (bonds and stocks) from other central banks, as shown in Chart I. A client asked me recently when the Fed or other central banks would ever be able to sell their assets back into the market. My answer was “NEVER”. A $12 trillion global central bank balance sheet is PERMANENT – and growing at over $1 trillion a year, thanks to the ECB and the BOJ.

Central Bank Balance Sheet (US$)


Source: Bank of England website “Following Bank of England money market reform on 18 May 2006 the Bank of England ‘Bank Return’ was changed. This series forms part of the new Bank Return, with data starting on 24 May 2006.”


An investor must know that it is this money that now keeps the system functioning. Without it, even 0% policy rates are like methadone – cancelling the craving but not overcoming the addiction. The relevant point of all this for today’s financial markets? A 2.45%, 10-year U.S.Treasury rests at 2.45% because the ECB and BOJ are buying $150 billion a month of their own bonds and much of that money then flows from 10 basis points JGB’s and 45 basis point Bunds into 2.45% U.S. Treasuries. Without that financial methadone, both bond and stock markets worldwide would sink and produce a tantrum of significant proportions. I would venture a guess that without QE from the ECB and BOJ that 10-year U.S. Treasuries would rather quickly rise to 3.5% and the U.S. economy would sink into recession.

So what’s wrong with financial methadone? What’s wrong with a continuing program of QE’s or even a rejuvenated U.S. QE if needed? Well conceptually at first blush, not much. The interest earned on the $12 trillion is already being flushed from central banks back to government fiscal authorities. One hand is paying the other. But the transfer in essence means that monetary and fiscal policies have joined hands and that the government, not the private sector, is financing its own spending. At an expanding margin, this allows the private sector to finance its own spending and fails to discriminate between risk and reward. $600 billion in the U.S. for instance goes into the repurchase of company stock, whereas before, investment in the real economy might have been a more lucrative choice. In addition, individual savers, pension funds, and insurance companies are now robbed of the ability to earn rates of return necessary to maintain long-term solvency. Financial Armageddon is postponed as consumption is brought forward and savings suppressed and deferred.

For now, investors must go with, indeed embrace this financial methadone QE fix. Quantitative easing will continue even though the dose may be reduced in future years. But while a methadone habit is far better than a heroin fix, it has created and will continue to create an unhealthy capitalistic equilibrium that one day must be reckoned with. Yields will likely gradually rise (watch 2.60% on the 10-year Treasury), yet they will stay artificially low due to the kindness of foreign central bank quantitative easing policies. But that is not a good thing. Happiness runs…Happiness runs, and so one day, will asset markets, artificially supported by quantitative easing.

“Stagflation On The Horizon” By Paul Brodsky

Stagflation on the Horizon

Logic and current trends suggest that declining output growth accompanied by higher prices will begin hitting economies and facing policy makers in the coming years. Markets should begin sniffing out this stagflationary macroeconomic setup this year.


We have published data showing global output growth is in decline and have argued this trend will continue. Indeed, a long term graph of US Real GDP growth implies a change in complexion since 1999, from credit-induced boom-bust economic cycles to a secular trajectory of decline (red lines on graph 1).

Graph 1: US Real Gross Domestic Product: Percent change from preceding period is in secular decline

This trend is especially troublesome following the debt-induced wash-out recession in 2008/2009, subsequently offset by zero-bound interest rates and central bank asset purchases. Since then, real GDP growth, characterized by middling output and low consumer inflation, has languished on a low plane, bouncing between 2.5 percent and 1.6 percent (shaded box on graph 1).

The US Bureau of Economic Analysis will not release its initial GDP estimate for Q1 2017 until April 28, but credible high frequency reports suggest real US output growth is in the process of falling below its low plane. The Atlanta Fed’s GDP now forecasts growth of only 1.3 percent in the first quarter. Among the factors weighing on the updated outlook are softer projections for household spending and non-household capital expenditures. Even more ominous is that this estimated slow growth included a month (February) in which the average temperature was ten degrees above normal – the hottest in sixty years.

Weak output growth is a far cry from the Fed’s official 3.1 percent forecast based on broad econometric models. This more optimistic forecast has more influence over the Federal Open Market Committee, which establishes and executes monetary policy. Accordingly, the Fed has communicated it will hike rates today and hinted it will again two or three more times in 2017.

Declining secular growth stems from the downside of pervasive debt assumption, which retards capex and consumer spending. Unperturbed, policy makers are doubling down. GaveKal Capital published the following two graphs showing how critical Treasury debt issuance has become to US growth. The first shows how debt assumption is increasing far more than GDP ($1.05 trillion of federal debt vs. $632 billion of GDP in the latest quarter). Clearly, it takes a lot of government debt assumption to drive output growth.

Graph 2: Diminishing Impact of Federal Debt on Nominal GDP: 2007 – 2016

To prove its point, GaveKal notes a close correlation: “In the first three quarters of 2015, debt growth was held in check by the debt ceiling and fiscal conservatives in Congress. Notice the negative effect on GDP growth in this period as growth slowed each quarter. Then in the fourth quarter of 2015, the debt ceiling was suspended and the flood of federal debt began again. Predictably, growth picked up too.”

GaveKal then extended the same graph back 35 years and expressed the time series annually. We can see from Graph 3 below that output growth regularly outpaced debt assumption when a dollar of debt produced more than a dollar of output; which is to say when the US economy functioned properly. This was real economic growth – growth that was not borrowed and that was expected to be repaid someday.


Graph 3: Diminishing Impact of Federal Debt on Nominal GDP: 1980 – 2016

 As always, Treasury must service its debt by issuing new debt, and raising the debt ceiling has been a constant source of conflict among US legislators. Last week, Treasury Secretary Mnuchin asked Speaker Ryan to persuade the House to raise the ceiling as soon as possible. If Congress does not raise it above $20 trillion, experts say Treasury would default on its debt by late summer or early fall 2017.

We are of the view that Congress will once again raise the debt ceiling, but that it will come at a significant cost. One of the major sources of the recent rally in equities and higher Treasury yields has been enthusiasm over Donald Trump’s economic initiatives. If raising the debt ceiling is delayed or tied to legislation that triggers future debt retirement, then expectations for future US growth would decline, as would US equities and Treasury yields.

Even if raising the debt ceiling goes smoothly, we think global output will continue to drop. Using debt to promote output growth is playing out across the world. Despite massive debt growth, output is static or declining in Europe…



…and even India:

Where is the global driver of output growth? Which geography or segment of society has a balance sheet large enough and un-levered enough to support a return to a debt-fueled boom-bust economic cycle?

Are we to believe that changes in US fiscal, regulatory, immigration and trade policies would have the power to persuade businesses and consumers around the world to reverse course – to not care about the exchange value of their currencies – so that they produce and consume for the benefit of American output and labor? Even if President Trump succeeds at raising US GDP to 3 percent, which would be no easy feat, how sustainable would that be and would it even matter for US multinationals that must grow abroad?

Investors should take note of what should logically be one of the highest-frequency leading indicators for the onset of a recession – retail spending. S&P retail sector stocks, as expressed in the XRT ETF, have declined 13 percent over the last six months in spite of a very strong stock market, and for good reason. Table 1 shows that in the last two quarters profit margins in the retail sector have crashed:

Table 1: Leading Indicator of Recession: Retail Sector Profit Margins are crashing

Watching US market ebullience in the face of a tiring, highly-indebted US economy that lacks an obvious new outlet for credit growth is like watching a slow motion car crash. We expect continued disappointing consumption, corporate profits and real growth rates to continue in 2017, in the US and around the world, and expect it to be followed by declining global trade and economic malaise.


We expect rising inflation to accompany falling output, and to understand why we offer a wonky but practical discussion of inflation.

Classic economics suggests demand and inflation should track each other higher and lower. Such a correlation, however, is not as tight in real life as it is conceptually. Super-economic factors associated with the exogenous management of global trade and credit greatly affect supply in ways often unintended by policy makers. From time to time supply shortages arise independent of the economics of production and demand. This creates significant economic dis-equilibria, leading to substantial inflation.

The last time this occurred was in the 1970s. OPEC oil exporters, bothered by the unknown future purchasing power of the new fiat dollars they were being forced to receive in exchange for their crude, limited its supply and drove up its price. Since energy was needed for manufacturing and transporting goods and services, the general price level rose across economies, even as demand and the need for labor fell. So, policy-induced supply disruptions led to slowing output and rising prices – stagflation.

Since then a global monetary regime that prices oil and most other trade goods in fiat dollars has been in force. US policy makers have maintained a generally stable dollar and, as importantly, strong dollar-denominated assets, which have provided global suppliers with an attractive destination for their wealth.

A stable dollar and generally rising US financial assets have created a fairly stable level of perceived wealth creation across the world. Were the dollar’s exchange rate or capital markets to fall, then US dollar and asset holders (foreign and domestic) would have great incentive to liquidate their holdings. Thus, the perception of the US as the global hegemon is the key to stability in the global economy.

What would cause capital flight out of the US? The obvious answer is the general perception that the dollar and the US economy will weaken more than those of other major economies.

This does not seem to be the case today, at least in relative terms. Following the financial crisis, the Fed acted aggressively to de-leverage the US banking system and was then first to taper and stop quantitative easing. US dollars and capital markets attracted global wealth. More recently, the Fed was also the first among major central banks to begin raising benchmark interest rates, which has further boosted the exchange value of the dollar vis-à-vis other major currencies. The recent enthusiasm over President Trump’s economic initiatives has provided a further boost to US corporate equity. All seems copacetic presently for dollar and US asset holders around the world.

Graph 4: DXY Index: a strong US dollar

Imminent Problem: A Scarcity of Dollars

Not so fast. Relative strength in the dollar stems from positive interest rate differentials and the natural demand for dollars to service, rollover and repay dollar denominated debt. Total US credit market debt totaled over $60 trillion (before the Fed stopped publishing it last quarter), which is five times M2 and fifteen times base money – the amount of deliverable dollars available to repay it. (The $60 trillion figure does not include off balance sheet obligations like Social Security, which would boost the multiple further.)

Graph 5: US dollar Leverage

There is also a scarcity of dollars held in foreign hands relative to the scale of the global economy. This will lead to a decline in dollar reserves held abroad. Recall that global trade volume is mostly based in dollars. A decline of dollars held in reserve limits global trade, pushing global output down. This, in turn, speeds incentives to raise the status of other major currencies to compete with the dollar.

To date, US bond issuers have had an easy time servicing their obligations because the dollar has been strong and they have produced sufficient revenues in dollars. The more pressing problem may arise from non-US issuers of dollar credit, which has doubled over the last ten years to $10 trillion. This credit also has to be serviced, rolled over and repaid in dollars. We anticipate increasing pressure among non-US dollar creditors to obtain dollars as the Fed hikes US interest rates, strengthening the dollar further.

The most pressure will be felt by emerging market sovereigns, banks and other companies that have issued about $3.2 trillion in dollar bonds. While further dollar strength would increase exporters’ profit margins, it would also reduce gross trade volume. Top line output of EM economies would suffer and they would likely raise consumer prices to maintain nominal growth rates. Inflation.

A discussion of the US dollar and dollar assets (including US real estate) without a discussion of dollar denominated liabilities is like trying to clap with one hand. Depending on how one counts, 25 to 95 percent of US dollars have liabilities attached to them. To service or repay these liabilities, more dollars have to be created. Simply liquidating assets to service or repay them will not work because for every liquidation there must be a buyer and the buyer must have dollars (that do not exist) to settle the trade.

Interest rates attached to liabilities ensure that the gross amount of liabilities will grow at a compounding rate, and higher interest rates ensures liabilities will grow faster. This, in turn, puts further pressure on assets to generate returns in excess of the negative return from liabilities. Eventually, this pressures policy makers to make sure asset prices rise more than the compounding rate of liability growth.

Ultimately, helping to maintain the appearance of rational asset valuations and decent commercial fundamentals becomes secondary to policy making institutions principally charged with protecting the dollar-centric global monetary system. We are currently far along on this spectrum.

We argue the US economy, US assets, the Fed and US fiscal policy makers are displaying obvious signs of late-stage fatigue associated with protecting the current global regime at all costs. As in the 1970s, the triggers for goods and service inflation within a slowing global economy will be currency related and a dearth of supply flowing through the trade channel, but rather than oil, this time the world will lack an adequate supply of increasingly scarce dollars needed for debt service.


The Political Solution: Dollar Inflation

Milton Friedman famously noted “inflation is always and everywhere a monetary phenomenon”. In the post-Bretton Woods monetary system, the pricing and supply of money and credit are not determined by production, but rather by monetary and currency exchange policies. Central banks and treasury ministries manufacture inflation through policy administration.

This is easy to see in extremis. During the financial crisis central banks were able manipulate the general price level higher to counteract the onset of deflation. We learned from the 2008/2009 experience, however, that central banks cannot determine where new money and credit mostly flow – to production or to assets. Central banks can directly manipulate only bank balance sheets, and banks, in turn, tend to lend more to issuers and buyers of assets when the organic need for production is not increasing.

The organic need for more production in the US (and everywhere else) is falling, as evidenced by declining global output growth. The only lever US policy makers will soon have left to pull, if they want to maintain the USD-centric global system, will be coordinated currency dilution (i.e., devaluation).

Oil is still very important to manufacturing and transportation, but oil exporting countries no longer have the same influence over global pricing, thanks to Russia’s ability to compete in global trade and the more recent fracking revolution in the US. The exogenous influence that would produce global economic dis-equilibrium and bring about stagflation today would be money itself, specifically US dollars.

To produce consumer inflation coincident with declining or contracting output, there must be an exogenous influence over prices outside the reach of central banks. We believe that influence is actually – and ironically – contracting production. The less production in an economy, the less influential that economy’s factors of production are in the global economy, and the less influence its central bank has over the global supply of goods and services.

The Fed has already recognized, and communicated to the public in its statements over the last two years, that its monetary policies also consider the strength of the dollar, trade and the global economy. We think it will have to soon recognize declining global output growth and the impact a strong dollar has on it. Our guess is that the Fed would like to hike rates as much and quickly as possible over the next two years so that it can then reduce them – to weaken the dollar – as global output sinks deeper.

In the end, the Fed will not be able to protect unilateral US dollar hegemony. Officials at the Fed and other major central banks, working bilaterally and with the BIS, IMF and WTO, would have to try to bring the purchasing power value of all currencies down together in relation to the real value of global production. Doing so successfully would be a monumental bureaucratic undertaking. We imagine it will be messy from social, political, economic and, especially, financial perspectives.

The Fed will have to turn on the spigots and create dollars for US and foreign creditors and, if they are lucky, debtors too. Stagflation will appear. The markets should begin getting a whiff of this soon.


Cuándo Trump olvidó a Ricardo y a Keynes. Comentario de Ignacio Diez. CS Gestion SGIIC

La Fed reiteró su intención de subir tipos gradualmente a medida que el mercado laboral siga mejorando. El primer meeting del año de la Reserva Federal sonó ligeramente más optimista, ya que reconoció una mejora de la confianza del consumidor y de las empresas, así como del mercado inmobiliario. Los inversores se centrarán ahora en el dato de empleo del viernes para tomar posiciones tras la incertidumbre creada tras la investidura de Donald Trump en sus dos primeras semanas de mandato.

La Fed no hizo mención alguna a planes de reducción de balance. Continuamos pensando que habrá posiblemente dos subidas de tipos este año. La primera podría llegar más de cara al tercer trimestre, salvo que haya un repunte de la inflación por encima de lo esperado en el primer semestre. No obstante, estaremos muy atentos a las noticias en referencia al plan de estímulo fiscal anunciado por Trump.

La reacción del mercado a la decisión de la Reserva Federal se concentró principalmente en su divisa que se depreció contra el euro hasta niveles próximos al 1,08. La curva de tipos apenas se movió, ya que no hubo sorpresas.

“Simplicity does not precede complexity, but follows it.”

– Alan Perlis

“Stop trying to change reality by attempting to eliminate complexity.”

– David Whyte

Esta semana vamos a reflexionar sobre el acierto o no de los aranceles a la importación y la política fiscal expansiva . Vamos a tratar de ver las consecuencias de la política económica que es posible que acometa Trump.

Nos  gustaría desarrollar una falsa idea que corre por los medios basada en el cálculo del PIB por la vía de la demanda y como no  se puede incidir en él de forma aislada interviniendo un componente como las importaciones . El PIB, es la suma de la Demanda Interna de un país (Consumo Privado, la Inversión Bruta y el Gasto Público más la Demanda Externa (Exportaciones de bienes y servicios menos las Importaciones de bienes y servicios). Debido a que el PIB sólo calcula los productos producidos en el país, se deben restar las importaciones. Las exportaciones deben añadirse, porque una vez que abandonen el país, no se añadirán a través de gasto de los consumidores. Para tener en cuenta la importación y exportación, toma el valor total de las exportaciones y resta el valor total de las importaciones. A continuación, agrega este resultado en la ecuación. Si las importaciones de un país tienen un valor superior a sus exportaciones, este número será negativo. Si el número es negativo, resta en lugar de agregar. Aquí es donde nos gustaría centrarnos. El déficit de la balanza por cuenta corriente de bienes y servicios se compensan con la balanza de capital. Si se pretende por parte de la Administración Trump que una caída de las importaciones genere un superávit en la balanza por cuenta corriente no se da cuenta que el PIB caerá ya que producir en USA hará que los productos sean más caros, la inflación elevará los tipos de interés y se contraerá el Consumo y la Inversión.

Tipos más altos atraerían capitales y el dólar se apreciaría agudizando la caída de las exportaciones.  El mundo es global y no es posible revertir esta tendencia. Ya se intentó en los años 80 con el sector de autos y todos sabemos cómo acabó la industria en Estados Unidos.

Con el fin de no incurrir en errores, es importante saber que en el pasado a la hora de presentar los datos de balanza de pagos de los distintos países, y en la mayor parte de los libros de macroeconomía todavía en la actualidad, cuando se hace referencia a la balanza por cuenta corriente ésta incluye las transferencias de capital que en la actualidad se suelen presentar en una cuenta independiente.

Sin embargo; siguiendo la metodología recomendada en la actualidad por el FMI y seguida por la mayor parte de los países, la capacidad o necesidad de financiación vendrá determinada por la agregación de los saldos de la balanza por cuenta corriente y de la cuenta de capital.

Un desequilibrio por cuenta corriente no es en sí ni bueno ni malo, de modo que en ocasiones puede ser interpretado como beneficioso para el país en cuestión, mientras que en otras ocasiones se considerará perjudicial, dependiendo de las circunstancias económicas concretas del país.

Existe una identidad contable básica en economía internacional según la cual, la balanza por cuenta corriente a nivel mundial debe estar equilibrada, o lo que es lo mismo, deberá cumplirse que la suma de los saldos en cuenta corriente del conjunto de países debe ser cero. Por tanto, el saldo por cuenta corriente de los países superavitarios (que determina la capacidad de financiación a nivel mundial) deberá coincidir con la suma de los saldos en cuenta corriente de los países deficitarios (que determina la necesidad de financiación a nivel mundial).

Así, la contrapartida al aumento del déficit por cuenta corriente de Estados Unidos y al consiguiente aumento en las necesidades mundiales de financiación ha sido la expansión de los superávit en otros países.

David Ricardo (Londres, 18 de abril de 1772 – 11 de septiembre de 1823) fue un economista inglés de origen judío sefardí-portugués, miembro de la corriente de pensamiento clásico económico, y uno de los más influyentes junto a Adam Smith y Thomas Malthus. Es considerado uno de los pioneros de la macroeconomía moderna por su análisis de la relación entre beneficios y salarios, uno de los iniciadores del razonamiento que daría lugar a la ley de los rendimientos decrecientes y uno de los principales fundadores de la teoría cuantitativa del dinero. También fue un hombre de negocios, especulador exitoso, agente de cambio y diputado; logrando amasar una considerable fortuna.

El modelo de la ventaja comparativa es uno de los conceptos básicos que fundamenta la teoría del comercio internacional y demuestra que los países tienden a especializarse en la producción y exportación de aquellos bienes que fabrican con un coste relativamente más bajo respecto al resto del mundo, en los que son comparativamente más eficientes que los demás y que tenderán a importar los bienes en los que son más ineficaces y que por tanto producen con unos costes comparativamente más altos que el resto del mundo.

Esta teoría fue desarrollada por David Ricardo a principios del siglo XIX, y su postulado básico es que, aunque un país no tenga ventaja absoluta en la producción de ningún bien, es decir aunque fabrique todos sus productos de forma más cara que en el resto del mundo, le convendrá especializarse en aquellas mercancías para las que su ventaja sea comparativamente mayor o su desventaja comparativamente menor. Esta teoría supone una evolución respecto a la teoría de Adam Smith. Para Ricardo, lo decisivo en el comercio internacional no serían los costes absolutos de producción en cada país, sino los costes relativos.

De la teoría ricardiana sobre el comercio exterior solamente la teoría sobre los costes comparativos fue introducido en los libros de texto. La teoría de los costes comparativos sostiene que el comercio entre dos países es beneficioso para los dos países incluso en el caso que un país es más eficaz que otro en la producción de todos los productos.

El comercio internacional es beneficioso para todos ya que conduce a una mejor asignación de los recursos y una especialización orientada a mejorar el PIB per capita de cada economía. Trump debería darse cuenta que el PIB en Estados Unidos ha crecido gracias a la tecnología, biotecnología, shale oil y shale gas y otros sectores más productivos que ha hecho que en sectores con menos rentabilidad se haya trasladado el empleo a otros países. El comercio es el componente del PIB que más pesa en USA y este se ha disparado gracias a una mayor renta disponible como consecuencia de la bajada de precios de muchos de los bienes importados.

David Ricardo:

“En un sistema de comercio perfectamente libre, cada país, dedica su capital y trabajo a los empleos que le son más beneficiosos, utiliza más eficazmente las facultades peculiares y distribuye el trabajo más eficaz y económicamente. Con esto difunde el beneficio general, une por medio de los lazos del interés y el intercambio, la sociedad universal de las naciones, ya que es más fácil importar aquellas cosas que cuestan más producir y exportar aquellas que podemos producir más cómodamente (más beneficioso aplicar todo el capital a aquello en lo que somos buenos produciendo, que a aquello que nos cuesta más).”

En On the principles of Political Economy and Taxation David Ricardo explica esta teoría en media página de 350 páginas. Se puede decir igualmente que menciona este aspecto, sin darle gran importancia. Es otro ejemplo más para un fenómeno que podemos ver muy a menudo. Algo bastante irrelevante en la obra original llega a ser la afirmación central y aspectos mucho más importantes caen en el olvido. Es algo parecido a como se está desvirtuando a Keynes. Su política de expansión fiscal iba dirigida a períodos de contracción, no de picos de ciclo. No tiene sentido argumentar que la actual política económica estadounidense es keynesiana.

Ricardo es recordado por su profundidad intelectual y la forma excepcionalmente moderna con la que abordaba los problemas económicos, con un elevado y riguroso nivel de abstracción a pesar de que carecía de formación universitaria reglada. Igualmente todavía hoy Keynes, sigue siendo un economista ‘muy actual’, con reflexiones que aún hoy siguen haciéndonos reflexionar mucho sobre el ahorro y la política económica.

El keynesianismo es una teoría económica propuesta por John Maynard Keynes, plasmada en su obra Teoría general del empleo, el interés y el dinero, publicada en 1936 como respuesta a la Gran Depresión de 1929. Está basada en el estímulo de la economía en épocas de crisis.

Este control se ejercía mediante el gasto presupuestario del Estado, política que se llamó política fiscal. La justificación económica para actuar de esta manera parte, sobre todo, del efecto multiplicador que, según Keynes, se produce ante un incremento en la demanda agregada.

Las escuelas monetarista y austríaca han intentado refutar el keynesianismo, sin embargo, éste sigue aplicándose en la mayor parte del mundo, y cierta parte de los economistas más influyentes del mundo son reconocidos keynesianos, como Paul Krugman y Joseph Stiglitz.

Al igual que establecer aranceles como hemos podido explicar es un error y lejos de crear empleo lo va a destruir, hacer una política fiscal expansiva en la parte final de uno de los ciclos más largos, es un error mayor que desembocará en un fuerte incremento de tipos, una recesión más profunda y un ajuste mucho mayor. Lo crea o no Trump el mundo sigue siendo Global, Digital y Renovable.

“Con un proceso continuo de inflación, los gobiernos pueden confiscar, secreta e inadvertidamente, una parte importante de la riqueza de sus conciudadanos (…) Pero cuando los fenómenos son tan complejos, los pronósticos no pueden señalar nunca un solo camino, y se puede incurrir en el error de esperar consecuencias demasiado rápidas e inevitables de causas que acaso no son todas las aplicables al problema.”

J.M. Keynes

“Economics in general has a problem. It wants to be seen as a true science, on the level of physics or biology or chemistry, rather than one of the soft sciences like sociology or history. At various times, economics has been called “political economy” or “philosophical economy.” Political economy was, in the words of Adam Smith, “an inquiry into the nature and causes of the wealth of nations,” and in particular “a branch of the science of a statesman or legislator [with the twofold objectives of providing] a plentiful revenue or subsistence for the people… and to supply the state or Commonwealth with a revenue sufficient for the publick services.”

John Mauldin

Inequality vs Inequality. NASSIM N TALEB

There is inequality and inequality.

The first is the inequality people tolerate, such as one’s understanding compared to that of people deemed heroes, say Einstein, Michelangelo, or the recluse mathematician Grisha Perelman, in comparison to whom one has no difficulty acknowledging a large surplus. This applies to entrepreneurs, artists, soldiers, heroes, the singer Bob Dylan, Socrates, the current local celebrity chef, some Roman Emperor of good repute, say Marcus Aurelius; in short those for whom one can naturally be a “fan”. You may like to imitate them, you may aspire to be like them; but you don’t resent them.

The second is the inequality people find intolerable because the subject appears to be just a person like you, except that he has been playing the system, and getting himself into rent seeking, acquiring privileges that are not warranted –and although he has something you would not mind having (which may include his Russian girlfriend), he is exactly the type of whom you cannot possibly become a fan. The latter category includes bankers, bureaucrats who get rich, former senators shilling for the evil firm Monsanto, clean-shaven chief executives who wear ties, and talking heads on television making outsized bonuses. You don’t just envy them; you take umbrage at their fame, and the sight of their expensive or even semi-expensive car trigger some feeling of bitterness. They make you feel smaller.

There may be something dissonant in the spectacle of a rich slave.

The author Joan Williams, in an insightful article, explains that the working class is impressed by the rich, as role models. Michèle Lamont, the author of The Dignity of Working Men, whom she cites, did a systematic interview of blue collar Americans and found present a resentment of professionals but, unexpectedly, not of the rich.

It is safe to accept that the American public –actually all public –despise people who make a lot of money on a salary, or, rather, salarymen who make a lot of money. This is indeed generalized to other countries: a few years ago the Swiss, of all people almost voted a law capping salaries of managers . But the same Swiss hold rich entrepreneurs, and people who have derived their celebrity by other means, in some respect.[ii]

Further, in countries where wealth comes from rent seeking, political patronage, or what is called regulatory capture (by which the powerful uses regulation to scam the public, or red tape to slow down competition), wealth is seen as zero-sum. What Peter gets is extracted from Paul. Someone getting rich is doing so at other people’s expense. In countries such as the U.S. where wealth can come from destruction, people can easily see that someone getting rich is not taking dollars from your pocket; perhaps even putting some in yours. On the other hand, inequality, by definition, is zero sum.

In this chapter I will propose that effectively what people resent –or should resent –is the person at the top who has no skin in the game, that is, because he doesn’t bear his allotted risk, is immune to the possibility of falling from his pedestal, exiting the income or wealth bracket, and getting to the soup kitchen. Again, on that account, the detractors of Donald Trump, when he was a candidate, failed to realize that, by advertising his episode of bankruptcy and his personal losses of close to a billion dollars, they removed the resentment (the second type of inequality) one may have towards him. There is something respectable in losing a billion dollars, provided it is your own money.

In addition, someone without skin in the game –say a corporate executive with upside and no financial downside (the type to speak clearly in meetings) –is paid according to some metrics that do not necessarily reflect the health of the company; these (as we saw in Chapter x) he can manipulate, hide risks, get the bonus, then retire (or go to another company) and blame his successor for the subsequent results.

We will also, in the process, redefine inequality and put the notion on more rigorous grounds. But we first need to introduce the difference between two types of approaches, the static and the dynamic, as skin in the game can transform one type of inequality into another.

Take also the two following remarks:

True equality is equality in probability


Skin in the game prevents systems from rotting

The Static and the Dynamic

Visibly, a problem with economists (particularly those who never really worked in the real world) is that they have mental difficulties with things that move and are unable to consider that things that move have different attributes from things that don’t –it may be trivial but reread Chapter [3] on IYIs if you are not convinced. That’s the reason complexity theory and fat tails are foreign to most of them; they also have (severe) difficulties with the mathematical and conceptual intuitions required for deeper probability theory. Blindness to ergodicity which we will define a few paragraphs down, is indeed in my opinion the best marker separating a genuine scholar who understands something about the world, from an academic hack who partakes of a ritualistic paper writing.

Let us make a few definitions:

Static inequality is a snapshot view of inequality; it does not reflect what will happen to you in the course of your life

Consider that about ten percent of Americans will spend at least a year in the top one percent and more than half of all Americans will spent a year in the top ten percent[1]. This is visibly not the same for the more static –but nominally more equal –Europe. For instance, only ten percent of the wealthiest five hundred American people or dynasties were so thirty years ago; more than sixty percent of those on the French list were heirs and a third of the richest Europeans were the richest centuries ago. In Florence, it was just revealed that things are really even worse: the same handful of families have kept the wealth for five centuries.[iii]

Dynamic (ergodic) inequality takes into account the entire future and past life

You do not create dynamic equality just by raising the level of those at the bottom, but rather by making the rich rotate –or by forcing people to incur the possibility of creating an opening.

The way to make society more equal is by forcing (through skin in the game) the rich to be subjected to the risk of exiting from the one percent

Or, more mathematically

Dynamic equality assumes Markov chain with no absorbing states

Our condition here is stronger than mere income mobility. Mobility means that someone can become rich. The no absorbing barrier condition means that someone who is rich should never be certain to stay rich.

Now, even more mathematically

Dynamic equality is what restores ergodicity, making time and ensemble probabilities substitutable

Let me explain ergodicity –something that we said is foreign to the intelligentsia; we will devote an entire section as we will see it cancels most crucial psychological experiments related to probability and rationality. Take a cross sectional picture of the U.S. population. You have, say, a minority of millionaires in the one percent, some overweight, some tall, some humorous. You also have a high majority of people in the lower middle class, school yoga instructors, baking experts, gardening consultants, spreadsheet theoreticians, dancing advisors, and piano repairpersons. Take the percentages of each income or wealth bracket (note that income inequality is flatter than that of wealth). Perfect ergodicity means that each one of us, should he live forever, would spend the proportion of time in the economic conditions of segments of that entire cross-section: out of, say, a century, an average of sixty years in the lower middle class, ten years in the upper middle class, twenty years in the blue collar class, and perhaps one single year in the one percent. (Technical comment: what we can call here imperfect ergodicity means that each one of us has long term, ergodic probabilities that have some variation among individuals: your probability of ending in the one percent may be higher than mine; nevertheless no state will have a probability of zero for me and no state will have a transition probability of one for you).

The exact opposite of perfect ergodicity is an absorbing state. The term absorption is derived from particles that, when they hit an obstacle, get absorbed or stick to it. An absorbing barrier is like a trap, once in, you can’t get out, good or bad. A person gets rich by some process, then having arrived, as they say, he stays rich. And if someone enters the lower middle class (from above); he will never have the chance to exit from it and become rich should he want to, of course –hence will be justified to resent the rich. You will notice that where the state is large, people at the top tend to have little downward mobility –in such places as France, the state is chummy with large corporations and protects their executives and shareholders from experiencing such descent; it even encourages their ascent.

And no downside for some means no upside for the rest.

Take for now that an absorbing state –staying rich –causes path dependence, the topic of Part X.

Pikketism and the Revolt of the Mandarin Class

There is a class often called the Mandarins, after the fictional memoirs of the French author Simone de Beauvoir, named after the scholars of the Ming dynasty that gave their name to the high Chinese language. I have always been aware of its existence, but its salient –and pernicious –attribute came to me while observing the reactions to the works by the French economist Thomas Pikkety.

Pikkety followed Karl Marx by writing an ambitious book on Capital. I received the book as a gift when it was still in French (and unknown outside France) because I found it commendable that people publish their original, nonmathematical work in social science in book format. The book, Capital in the 21st Century, made aggressive claims about the alarming rise of inequality, added to a theory of why capital tended to command too much return in relation to labor and how absence of redistribution and dispossession would make the world collapse. The theory about the increase in the return of capital in relation to labor was patently wrong, as anyone who has witnessed the rise of what is called the “knowledge economy” (or anyone who has had investments in general) knows. But there was something far, far more severe than a scholar being wrong.

Soon, I discovered that the methods he used were flawed: Picketty’s tools did not show what he purported about the rise in inequality. I soon wrote two articles, one in collaboration with Raphael Douady that we published in Physica A: Statistical Mechanics and Applications, about the measure of inequality that consists in taking the ownership of, say the top 1% and monitoring its variations. The flaw is that if you take the inequality thus measured in Europe as a whole, you will find it is higher than the average inequality across component countries; the bias increases in severity with extreme processes. The same defect applied to the way inequality researchers used a measure called Gini coefficient, and I wrote another paper on that. All in all, the papers had enough theorems and proofs, to make them about as ironclad a piece of work one can have in science; I insisted on putting the results in theorem form because someone cannot contest a formally proved theorem without putting in question his own understanding of mathematics.

The reason these errors were not known was because economists who worked with inequality were not familiar with… inequality. Inequality is the disproportion of the role of the tail –rich people were in the tails of the distribution.[2] The more inequality in the system, the more the winner-take-all effect, the more we depart from the methods of tin-tailed Mediocristan in which economists were trained. Recall that the wealth process is dominated by winner-take-all effects, the type described in The Black Swan. Any form of control of the wealth process –typically instigated by bureaucrats –tended to lock people with privileges in their state of entitlement. So the solution was to allow the system to destroy the strong, something that worked best in the United States.

The problem is never the problem; it is how people handle it. What was worse than the Piketty flaws was the discovery of how that Mandarin class operates. They got so excited by the rise of inequality that their actions were like fake news. Economists got so excited they praised Piketty for his “erudition” from his discussing Balzac and Jane Austen, the equivalent to hailing as a weightlifter someone seen carrying a briefcase. And they completely ignored my results –and when they didn’t, it was to declare that I was “arrogant” (recall that the strategy of using theorems is that they can’t say I was wrong, so they resorted to “arrogant” which is a form of scientific compliment). Even Paul Krugman who had written “if you think you’ve found an obvious hole, empirical or logical, in Piketty, you’re very probably wrong. He’s done his homework!”[iv], when I pointed out the flaw to him, when I met him in person, evaded it –not necessarily by meanness but most likely because probability and combinatorics eluded him, by his own admission.

Now consider that the likes of Krugman and Piketty have no downside in their existence –lowering inequality brings them up in the ladder of life. Unless the university system or the French state go bust, they will continue receiving their paycheck. Donald Trump is exposed to the risk of ending having his meals in a soup kitchen; not them.

Cobbler Envies Cobbler

Envy does not travel long distance, or across so many social classes. The envy-driven feelings that usually –as we saw in the works of Williams and Lamont –do not originate from the impoverished classes, concerned with the betterment of their condition, but with that of the clerical class. Simply, it looks like it is the university professors (who have arrived) and people who have permanent stability of income, in the form of tenure, governmental or academic, who bought heavily in the argument. From the conversations, I became convinced that these people who counterfactual upwards (i.e. compare themselves to those richer) wanted to actively dispossess the rich. As will all communist movements, it is often the bourgeois or clerical classes that buy first into the argument.[1]

Aristotle, in his Rhetoric postulated that envy is something you are more likely to encounter in your own kin: lower classes are more likely to experience envy towards their cousins or the middle class than towards the very rich. The expression Nobody is a prophet in his own land making envy a geographical thing (mistakenly thought to originate with Jesusουδείς προφήτης στον τόπο του in Luke and a similar expression in Mark) originates with that passage in the Rhetoric. Aristotle himself was building on Hesiod’s: cobbler envies cobbler, carpenter envies carpenter. Later, La Bruyere wrote jealousy is found within the same art, talent and condition.

So I doubt Piketty bothered to ask blue-collar Frenchmen what they want, as Lamont did. I am certain that they would ask for a new dishwasher, or faster train for their commute, not to bring down some rich businessman invisible to them. But, again, people can frame questions and portray enrichment as theft, as it was before the French Revolution, in which case the blue-collar class would ask, once again, for heads to roll.[2]

[1] “τὸ συγγενὲς γὰρ καὶ φθονεῖν ἐπίσταται.”, Rhetoric 1388a, citing originally from Aeschylus, frag. 304.

[2] La Bruyere: L’émulation et la jalousie ne se rencontrent guère que dans les personnes du même art, de même talent et de même condition.

Data, Shmata

Another lesson from Piketty’s ambitious volume: it was loaded with charts and tables. But what we learn from professionals in the real world is that data is not necessarily rigor. One reason I –as a probability professional –left data out of The Black Swan (except for illustrative purposes) is that it seems to me that people flood their story with numbers and graphs in the absence of logical argument. Further, people mistake empiricism with flood of data. Just a little bit of significant data is needed when one is right, particularly when it is disconfirmatory empiricism, or counterexamples for rules: only one point is sufficient to show that Black Swans exist.

Probability, statistics, and data science are principally logic fed by observations –and absence of observations. For many environments, the relevant data points are those in the extremes; these are rare by definition; and it suffices to focus on those few but big to get an idea of the story. If you want to show that a person is richer than, say $10 million, all you need is show the $50 mil in his brokerage account, not, in addition, list every piece of furniture in his house, including the $500 painting he has in his study and a count of the silver spoons in his pantry. So I’ve discovered, with experience, that when you buy a thick book with tons of graphs and tables used to prove a point, something is alarmingly suspicious. It means something didn’t distil right! But for the general public and those untrained in statistics, such tables appear convincing –another way to substitute the true with the complicated. For instance, the science journalist Steven Pinker did that with his book, The Better Angels of Our Nature, concerning the decline of violence in modern human history. My collaborator Pasquale Cirillo and I, when we put his “data” under scrutiny, found out that that either he didn’t understand his own numbers (actually, he didn’t), or he had a story in mind and kept adding charts not realizing that statistics isn’t about data but distillation, rigor and avoiding being fooled by randomness –but no matter, the general public of IYI colleagues found it impressive for a while.

Ethics of Civil Service

People who like bureaucracies and the state have trouble understanding that having rich people in a public office is very different from having public people become rich –again it is the dynamics, the sequence that matters. Rich people in public office have shown some evidence of lack of total incompetence –success may come from randomness, of course, but we at least have a hint of some skill in the real world, some evidence that the person has dealt with reality. This is of course conditional of the person having had skin in the game –and it is better if the person felt a blowup, has experienced at least once the loss part of his or her fortune and the angst associated with it.

A good rule for society is to oblige those who start in public office to pledge never subsequently to earn from the private sector more than a set amount; the rest should go to the taxpayer. This will ensure sincerity in, literally, “service” — where employees are supposedly underpaid because of their emotional reward from serving society. It would prove that they are not in the public sector as an investment strategy: you do not become a Jesuit priest because it may help you get hired by Goldman Sachs later, after your eventual defrocking –given the erudition and the masterly control of casuistry generally associated with the Society of Jesus.

Currently, most civil servants tend to stay in civil service –except for those in delicate areas that industry controls: the agro-alimentary segment, finance, aerospace, anything related to Saudi Arabia…

Currently, a civil servant can make rules that are friendly to an industry such as banking — and then go off to J.P. Morgan and recoup a multiple of the difference between his or her current salary and the market rate. (Regulators, you may recall, have an incentive to make rules as complex as possible so their expertise can later be hired at a higher price.)

So there is an implicit bribe in civil service: you act as a servant to industry, say Monsanto, and they take care of you later on. They do not do it out of a sense of honor: simply, it is necessary to keep such a system going and encourage the next guy to play by the rules. The IYI cum scumbag Tim Geithner–with whom I share a Calabrese barber –was overtly rewarded by the industry he helped bail out.

Watch former heads of state such as Bill Clinton or Tony Blair use the fame that the general public gave them to make hundreds of million in speaking fees –indeed for these two sleek fellows, public service was the most effective step towards enrichment. The difference between a salesman and a charlatan is that the latter doesn’t deliver what he claims to be selling. Ironically the pair Clinton-Blair appeared less greedy than the typical ego-driven businessman who seeks elections.


[1] 39% of Americans will spend a year in the top 5 % of the income distribution, 56 % will find themselves in the top 10%, and 73% percent will spend a year in the top 20 %.

[2] The type of distributions –called fat tails –associated with it made the analyses more delicate, far more delicate and it had become my mathematical specialty. In Mediocristan changes over time are the result of the collective contributions of the center, the middle. In Extremistan these changes come from the tails. Sorry, if you don’t like it but that is purely mathematical.

David Gordon on Mervyn King: Central Bankers are Losing Faith in their own Alchemy. Cobden

Mervyn King is the British Ben Bernanke. An eminent academic economist, who now teaches both at New York University and the London School of Economics, King was from 2003 to 2013 Governor of the Bank of England. In short, he is a very big deal. Remarkably, in The End of Alchemy he frequently sounds like Murray Rothbard.

King identifies a basic problem in the banking system that has again and again led to financial crisis.

“The idea that paper money could replace intrinsically valuable gold and precious metals, and that banks could take secure short-term deposits and transform them into long-term risky investments came into its own with the Industrial Revolution in the eighteenth century. It was both revolutionary and immensely seductive. It was in fact financial alchemy — the creation of extraordinary financial powers that defy reality and common sense. Pursuit of this monetary elixir has brought a series of economic disasters — from hyperinflation to banking collapses.”

How exactly is this alchemy supposed to work?

“People believed in alchemy because, so it was argued, depositors would never all choose to withdraw their money at the same time. If depositors’ requirements to make payments or obtain liquidity were, when averaged over a large number of depositors, a predictable flow, then deposits could provide a reliable source of long-term funding. But if a sizable group of depositors were to withdraw funds at the same time, the bank would be forced either to demand immediate repayment of the loans it had made, … or to default on the claims of depositors.”

Readers of Rothbard’s What Has Government Done to Our Money? will recognize a familiar theme.

Many have sought to salvage the alchemy of banking by resorting to a central bank. By acting as a lender of last resort, a central bank can bail out banks in need of funds to satisfy anxious depositors and thus avert the danger of a bank run. The alchemy of transforming deposits into investments can now proceed.

Though he was one of the world’s leading central bankers, King finds fault with this “solution.” A local bank can be rescued by getting money from the central bank, but the process generates new problems. Thomas Hankey, a nineteenth-century Governor of the Bank of England, pointed out some of these in response to Walter Bagehot, the classic defender of the central bank as the lender of last resort:

[i]f banks came to rely on the Bank of England to bail them out when in difficulty, then they would take excessive risks and abandon “sound principles of banking.” They would run down their liquid assets, relying instead on cheap central bank insurance — and that is exactly what happened before the recent [2008] crisis. The provision of insurance without a proper charge is an incentive to take excessive risks — in modern jargon, it creates “moral hazard.”

Given the dangers of financial alchemy, what should we do about it? Again, King strikes a Rothbardian note. He writes with great sympathy for one hundred percent reserve banking.

Even though the degree of alchemy of the banking system was much less fifty or more years ago than it is today, it is interesting that many of the most distinguished  economists of the first half of the twentieth century believed in forcing banks to hold sufficient liquid assets to back 100 percent of their deposits. They recommended ending the system of “fractional reserve banking,” under which banks create deposits to finance risky lending and so have insufficient safe cash reserves to back their deposits.

Like Rothbard, King calls attention to the insights of the nineteenth-century Jacksonian William Leggett. King cites an article of 1834 in which Leggett said:

Let the [current] law be repealed; let a law be substituted, requiring simply that any person entering into banking business shall be required to lodge with some officer designated in the law, real estate, or other approved security, to the full amount of the notes which he might desire to issue.

King may to an extent resemble Rothbard; but unfortunately he is not Rothbard; and alert readers will have caught an important difference between King’s idea of one hundred percent reserve banking and Rothbard’s. King’s notion, unlike Rothbard’s, still allows banks to expand the money supply. The “liquid assets” need not be identical with the deposits: they need only be easily convertible into money should the need arise to do so.

King’s own plan to “end the alchemy” allows for substantial monetary expansion. He calls his idea the “pawnbroker for all seasons (PFAS)” approach. This is a form of “liquidity” insurance. Banks would have to put up in advance as collateral with the central bank some of their assets. This would act as a “form of mandatory insurance so that in the event of a crisis a central bank would be free to lend on terms already agreed.” So long as the insurance had been paid, though, the central bank would still bail the bank out in a crisis by giving it more money. Contrast this with the plan suggested in the quotation from Leggett, in which if a bank could not redeem its notes, depositors could proceed directly against the bank’s assets. This allows no monetary expansion; and Rothbard’s plan is of course more restrictive still.

Having come so close to Rothbard, why does King shrink from the final step? Why does he still allow room for monetary expansion? He fears deflation.

Sharp changes in the balance between the demand for and supply of liquidity can cause havoc in the economy. The key advantage of man-made money is that its supply can be increased or decreased rapidly in response to a sudden change in demand. Such an ability is a virtue, not a vice, of paper or electronic money. … The ability to expand the supply of money in times of crisis is essential to avoid a depression.

But if the demand for liquidity suddenly increases, when the monetary stock is constant, cannot falling prices for goods satisfy the demand? King, here following Keynes, is skeptical. “Wage and price flexibility does help to coordinate plans when all the markets relevant to future decisions exist. But in practice they do not, and in those circumstances cuts in wages and prices may lower incomes without stimulating current demand.” Prices may keep falling indefinitely.

Other possibilities of coordination failure also trouble King, and underlying them is an important argument. Following Frank Knight, he distinguishes between risk and uncertainty.

Risk concerns events, like your house catching fire, where it is possible to define precisely the nature of that future outcome and to assign a probability to the occurrence of the event based on past experience. … Uncertainty, by contrast, concerns events where it is not possible to define, or even imagine, all possible future outcomes, and to which probabilities cannot therefore be assigned.

We live in a world of radical uncertainty, and thus we cannot be sure that relying on market prices to adjust to changes in the demand to hold money suffices to avert catastrophe. It is for this reason that resort to monetary expansion sometimes is needed.

This argument moves altogether too fast. It does not follow from the fact that Knightian uncertainty prevails widely that one must take seriously the possibility that prices and wages would fall indefinitely. In a situation of uncertainty, we cannot, by hypothesis, calculate probabilities; but this does not require that we take outlandish possibilities as likely occurrences that must be averted by the government. Some reason needs to be given for supposing that prices will continue to fall indefinitely. Why would entrepreneurs not be able to correct the situation, without resorting to monetary expansion? We are not faced with a dichotomy between exact mathematical calculation, in the style of an Arrow-Debreu equilibrium, and blind groping in the dark.

King himself acknowledges that in the American depression of 1920 to 1921, no resort to the government was needed.

The striking fact is that throughout the episode there was no active stabilization policy by the government or central bank, and prices moved in a violent fashion. It was, in the words of James Grant, the Wall Street financial journalist and writer, “the depression that cured itself.”

It is encouraging that King cites the Austrian economist James Grant, but he draws from his work an insufficient message. “The key lesson from the experience of 1920–21 is that it is a mistake to think of all recessions as having similar causes and requiring similar remedies.” In view of the manifold invidious consequences, fully acknowledged by King, of government intervention, should we not rather emphasize the need to rely on the unhampered market? King nevertheless merits praise for coming close, in his own way, to many Austrian insights.

Why Fixing Trade Deficits Is Essential Barron´s by FRANK BERLAGE

 Trade and budget deficits will eventually catch up with us, and the effect on the dollar won’t be pretty.

In 1965, when we imported less, manufacturing employed 24% of the U.S. workforce. By 2015, substantial portions of our manufacturing base had moved overseas, and domestic manufacturing had shrunk to just 9% of employment.

The U.S. has now run a trade deficit for 40 years, and at present levels our annual current-account deficit of $400 billion to $500 billion will aggregate additional deficits of $4 trillion to $5 trillion in only 10 years. However, despite the largest cumulative current-account deficit in world history and a plunge in manufacturing as a share of our economy, the U.S. seemingly persevered without a definitive penalty.

So, do trade and balance-of-payments deficits really matter?

Not according to U.S. Sen. Ron Johnson, Congressman Ron Beyer, and many other U.S. politicians. However, history will attest that no country has incurred perennial trade deficits, imported and borrowed more than it exported or lent, and seen its currency live to tell about it.

Much of the demand for U.S. dollars is derived from its reserve-currency status, since the U.S. dollar is commonly held as a means of exchange and lending between independent third parties and not as much for claims on actual U.S. production. Therefore, Americans get the benefit of a higher value for their dollar, and this results in an ability to borrow capital and buy foreign products at lower prices, thus incurring trade deficits. Because reserve-currency status can prevail only alongside confidence in our dollar, the longer U.S. trade deficits go on, the greater the crisis when they cease, voluntarily or involuntarily. Consequences of imprudence often occur when least expected. The 2008 housing crisis is a case in point.

The approaching danger is that in one year or five, we will experience one $40 billion monthly current-account deficit too many, resulting in a decline in the dollar that extends in greater duration and magnitude than the economic climate might dictate. Economists will be mystified, but we will be catching up and paying penance for long decades of trade and budget deficits. On that day, nothing will save the dollar, not the corporate profits offshore, not more Japanese purchases of U.S. Treasuries, not presidential jawboning. Nothing.

At the outset, the degree of upward pricing in imports will overwhelm even the best of optimists. The Toyota, once closely priced to the Chevy, will double, and the U.S. consumer will rapidly devour all outstanding inventories of Chevys. However, enhanced foreign purchasing power will then bid up for domestic U.S. production, and the U.S. buyer will be priced out. Foreign investors will also buy up U.S. farmland, mines, and other industries on the cheap.

Understandably, it is hard to imagine such a scenario in today’s disinflationary economy. Nevertheless, unable to afford imported goods, Americans will seek to buy shoes, only to find they aren’t made in America. They will search for televisions, only to find they aren’t made in America. They will ruefully realize that the same applies to Rawlings baseballs, Gerber baby food, Etch A Sketches, Converse sneakers, stainless-steel rebar, Mattel toys, minivans, vending machines, Levi jeans, Radio Flyer wagons, cellphones, railroad turnouts, Dell computers, canned sardines, knives, forks, spoons, and lightbulbs.

Americans will wistfully wonder where their manufacturing base went and how they lost more than 63,000 factories just since the year 2000. 

The U.S. urgently needs a plan that will mitigate future long-term trade and budget deficits, an overall blueprint where everyone is better off, including our trading partners. Therefore, I propose that when the U.S. runs a trade deficit with any country for five years, an automatic import limit comes into play in the sixth year, mandating a reduction in the trade deficit with that specific country by 20%. A 10% increase in U.S. exports and a 10% decrease in imports relative to that country would fit the bill, but either way, an additional 20% annually mandated reduction in the trade deficit would continue for four more years until trade is balanced. Then, the law would go into hibernation for five years, allowing free trade with that country to resume. No tariffs, just a country-specific trade-deficit limit to act as a current-account safety mechanism to reduce the dangers of de-industrialization.

This gradualist method would also ensure that our trading partners’ interests would be aligned with ours, providing them with a strong incentive to buy more U.S. products. As a result, they would bring to bear innovative solutions on how to import more of our products so that they could export more of theirs. Ultimately, this would be a much firmer foundation for world trade.

However, modifications in our trade policy aren’t the only changes required for the U.S. economy to improve. We need a return to fundamentals that mandate significant reductions in corporate and personal income taxes, as well as government spending and entitlements. A flat tax of 22% at the federal level with a maximum combined state and local income tax of 4% would revive U.S. fortunes better than any single factor. It is no coincidence that Hong Kong, with a maximum 16% income-tax rate, has over the long term been one of the world’s best-performing economies. These fundamental changes would result in greater prosperity by increasing aggregate savings, investment, and demand.

If we fail to mitigate our long-term trade deficits alongside our cumulative budget deficits, we will eventually destroy many of our remaining industries, as well as our military.

Forty years of trade deficits might lead one to agree with what we are told; that trade deficits, like budget deficits, don’t really matter. However, as international economist Rudiger Dornbusch warned, “In economics, things take longer to happen than you think they will, and then they happen much faster than you thought they could.”

FRANK BERLAGE is the CEO of Multilateral Partners Global Advisory Group, a private-equity firm based in La Jolla, Calif.