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Who the Heck Consumes His Capital?!
by Keith Weiner
I have been writing about consumption of capital, using the example of a farmer who sells off his farm to buy groceries. It’s a striking story, because people don’t normally act like this. Of course, there are self-destructive people in every society, but, not many. Most people know not to spend themselves into poverty.
To make people hurt themselves, we need to add the essential element: a perverse incentive. Consider a parlor game called Shubik’s Dollar Auction. You auction off a dollar bill, but there’s one extra rule. The second highest bidder has to pay his bid, getting nothing in return. This game works best with a large crowd, so that several people bid before they think too much about it. Then the participants become ensnared. There is always an incentive to raise the bid by a penny. Would you rather pay $1.01 to buy a dollar, or lose $1.00 and get nothing? The same incentive works at $2.01, $3.01, and so on. There is no limit to how high the bidding will go, until someone gives up in disgust (and anger at whoever ran the game).
This game can make people overpay to win a dollar. How perverse is that?
It’s easy to see through this simple game, and many people will refuse to play. There’s only one way to push everyone into such a scheme: force. Let’s look at monetary policy in this light. When the Federal Reserve dictates interest near zero, everyone has to play under that rule. It causes some perverse outcomes.
Those with access to the Fed’s dirt-cheap credit can borrow to buy bonds, mortgages, or other assets. The result is rising assets and falling yields. With every increase in bond prices, there is falling yield purchasing power. This makes it impossible to live on the interest, forcing retirees to liquidate capital to buy groceries.
Let’s consider this from a different angle. Suppose you own a home. If you mortgage it, does that make you richer? Would you spend the borrowed funds like you would spend income? Of course not. What if someone else borrows money to buy the house from you, at a higher price than you originally paid? “Aha,” you say, “that’s different!”
Is it? At first, it may look like a capital gain. However, your gain is possible only because the next guy borrows more. Why is he doing that? With a lower interest rate, the same monthly payment covers a larger loan.
Suppose the rate keeps falling. One person after another buys the house, handing a profit to each seller. Each seller is given the incentive to spend some of his gain. However, nothing has been produced though this entire series of transactions. If nothing is produced, then what are these successive sellers consuming? They consume something that was previously produced. It’s otherwise known as capital.
This is a perverse incentive in action. Outside Shubik’s game, a dollar does not sell for $5. Outside central banking, capital is not destroyed en masse. While any fool can dissipate his inheritance and any farmer can sell his farm to fund his drug habit, farms are not destroyed. They are transferred intact, to more rational neighbors. Once back in responsible hands, they quickly return to productive use. A free market has no mechanism to cause all capital to be destroyed simultaneously.
The Fed does. We should call its game Shubik’s Wealth Effect.
This article is from Keith Weiner’s weekly column, called The Gold Standard, at the Swiss National Bank and Swiss Franc Blog SNBCHF.com.
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ZIRP is THE way to camouflage inflation. In normal circumstances, you gain 50.000 US$ of interest each year if you have 1 million US$ at a 5% interest rate. Now, with say 0.25% interest rate, you need 20 million US$ for that same 50.000 US$ interest. This means your US$ is worth 20 times less, or otherwise stated : effective inflation of your savings was 1900%.
"Who the Heck Consumes His Capital?!"
That is why I continue to harp on the fifth-column colonization, Zion, that is plundering and exploiting the American country. They are plundering us, AND our "seed corn."
This is most evident at the stores where little is found to be made in our still shrinking manufacturing base. This is because Zion, and their grifting banksters, destroyed our manufacturing base so as to keep their schemes and plundering going on as long as possible with cheap importations.
Zion is stealing our current wealth, and our "seed corn" to replant with.
Zion is a scheme, not an ethnicity.
“Zion is stealing our current wealth, and “seed corn”…”
Well, someone is doing the stealing… and it’s not Zion; they are taking the blame that should be laid on Orthodox, Reform and Conservative Judeo-Bolsheviks.
The telling difference between the last 3 and Zion is that the former are INTERNATIONAL collectivists while the latter are NATIONAL collectivists.
What is being done today by Judeo-Bolsheviks requires an organization at least a thousand years in the making (with international connections, a tribe that can murder without remorse and keep its mouth shut; and that can be trusted to manage stolen farms and factories with absolute loyalty to a central authority (that is, the Judeo-Bolshevik triumvirate: Scholars, rabbis, and notables).
There was no such thing as a Zionist until the middle of the 19th century. All they want is a national homeland for Judeo-Bolsheviks; beyond that, nothing.
This is why the Orthodox, Reform and Conservative JB’s of the Soviet Union persecuted Zionists, who only wanted to escape to Palestine. There “brothers” wanted them to stay and help plunder Russia.
You’ll need a copy of the Old Testament beside you while you read the above link; otherwise you won’t believe what you read.
Yes, very interesting, indeed.
It is quite obvious that people on fixed incomes, composed in part of interest and dividends, will have to spend down their capital once their investment income declines due to ZIRP, and asset sales become the only way to maintain their living standards. The author makes a fine case for the proposition that asset bubbles created by successive transfers of assets at increasing prices also result in erosion of capital on a macro basis over time. This erosion will occur only when the purchasers take on debt to make the purchases, but that will be the case, I would think, most of the time, whether it be mortgage debt for real estate or margin debt for securities, or loans for share buybacks, in a ZIRP environment.
The gradual erosion of capital is hidden throughout most of the bubble process because the person spending the capital gain is not the person taking on the new debt. But what happens when the bubble bursts? All of a sudden we learn that over time most of the owners of these overvalued assets have become highly leveraged due to the availability of low interest loans needed to pay the high asset price. The thin veneer of their apparent prosperity is stripped away overnight, unless, of course, they can still borrow more easy money to maintain the illusion of wealth after their balance sheet goes negative.
In the end, the continuation of easy money becomes a necessity for the highly levered monied class which also controls the political system. Also, accounting rules must be changed to prohibit mark-to-market for assets, lest it become publicly known just how bad a credit risk you have become, making your receipt of more free money seem ridiculous to anybody paying attention. It would also help if some governmental entity came along and purchased a lot of your bad assets at face value to plug the holes in your balance sheet.
For society as a whole, bubble pricing across all asset classes creates an illusion of gaudy wealth which overlays the increasing squalor underneath the surface.
The central banks are actually playing Shubik’s game with each other. They've all continually bid one increment lower -- historically low rates became zirp, and then nirp, and then printing and devaluing.
Fiat and fractional reserve have always been a ponzi. They can't help themselves.
Our rulers aren't wearing clothes...
interesting article
good article............
If Subiks dollar auction really works than why aren't the streets full of con men making money on it?
It has never been tried in real life because PEOPLE ARE NOT THAT STUPID.
Ever hear of Wall St.? Or do you think Amazon is actually worth its valuation?
When you're at the poker table and can't tell who the mark is - it's probably you.
That's what he says, that's where force came in. Pay attention.