Capitalism – Gennadi Kneper

The Origins of Wealth and Opportunity Gaps, and a Possible Way Out

Posted on October 28, 2022October 30, 2022 by gennadi.kneper

1) If you grew up in late 1980s and early 1990s like me, you certainly remember ALF—the furry irreverent extraterrestrial featured in the NBC sitcom of the same name. At the beginning of the show, ALF crash-lands in the garage of the suburban middle-class Tanner family, who lives in the San Fernando Valley and gives him shelter for the next four years.

One of the most interesting things about the sitcom, apart from its lighthearted humor and hilarious gags, is the way in which it shows American suburbia. Coming from another planet, ALF soon learns to appreciate the charm of the late eighties consumer society, where almost everything can be ordered on the phone and delivered right away.

Even more important, the series allowed an unusual glimpse of the everyday life of the American middle-class that was increasingly getting squeezed during the Reagan and Bush Senior years.

There was less money and less security, and when ALF accumulated $6000 gambling debt, the Tanners had to struggle quite a bit to pay it off. In the series, loss of social status didn’t come across as a real danger, but it was looming on the horizon. Thirty years later the horizon has been reached.

2) Wealth and opportunity gaps in the present-day world is a real issue. In his book about the changing world order, Ray Dalio, like many other astute observers, argues that large differences in wealth distribution tend to lead to internal political divisions, oftentimes causing major social and political conflicts.

On a very general level, there’s little you can object to that. Unfortunately, Ray Dalio remains pretty vague on this subject. As opposed to the analysis of money and debt cycle and the factors responsible for the success of great powers he refers to the wealth and opportunity gap rather fleetingly (though it’s true that he has written somewhere else about why and how capitalism needs to be reformed).

At any rate, social policy and equal opportunity seem to be important enough to have a closer look at it.

3) When talking about wealth, opportunity and values, Ray Dalio contrasts what happened in the US and the UK during the 1930s with what was going on in Germany and Japan at the same time. However, he largely fails to do the same for the time after 1945.

If you want to understand what is happening now, a close comparative look at the last thirty years of the 20^th century might be helpful. This period is widely referred to as the Age of Neoliberalism. The history of the idea itself is extremely insightful, but for our purposes here we’ll focus on how it found its way into politics and what kind of impact it made there.

To cut the long story short: in the 1970s, when many Western countries were in deep economic distress, several free-market scholars suggested that the socially-minded economic policies applied for forty years in the wake of Roosevelt’s New Deal were responsible for the problems governments were increasingly facing. They also offered a solution, which basically consisted in deregulation and tax cuts.

Whether their analysis and the measures proposed were accurate is debatable. The point is that these guys had a clear idea about what to do, and were successful in convincing politicians to listen to them.

But here comes the surprise: in some countries neoliberal politics were extreme, in others they were moderate. Sure enough, the outcomes were not the same.

4) While Ronald Reagan in the US and Margaret Thatcher in the UK interpreted neoliberal prescriptions in a radical manner, politicians in capitalist West Germany made rather careful adjustments that allowed to refloat the economy without compromising social security, union power and domestic manufacturing.

Present-day debates about the legacy of Reagonomics and Thatcherism tend to be lopsided. While Marxist-inspired scholars like David Harvey consider economic egoism fostered by neoliberalism as absolutely pernicious for public interest, free-market radicals from organizations like the Cato Institute and Mercatus Center praise this policy highly for creating economic growth.

If you look at it in a less passionate manner, you’ll realize that it’s difficult to come to a definite conclusion about the value of neoliberal prescriptions. The comparison between the UK and West Germany suggests, however, that many decisions made by Margaret Thatcher were not predicated on their economic effectiveness, but rather ideologically motivated.

5) The same goes for the politics of the Reagan administration. Now, it is true that in the face of the Soviet Union, which seemed still very powerful in the early 1980s, the US had to come up with an effective solution for its economic problems. It is also true that neoliberalism allowed to reach this goal and to shoulder significant increases in military spending, which arguably contributed to the demise of the Soviet Union.

In other words, reinforcing an economic and social climate where moneymaking was easy and laudable might have been justified at that point. You could see it as the price that had to be paid for winning the Cold War.

But once this goal had been accomplished, nobody thought about rebalancing the economy and society. And why should they? After all, communism was gone. The unravelling of the Soviet Union seemed to prove the case for an approach in which profit seeking was considered the single most important factor in human relations, and everything else was thought to be a derivative of it.

6) In the long run, the hidden costs of that approach have proven to be immense. A part of them is six feet two inches (188 cm) tall and is called Donald Trump. The rise of populism is, as the economic historian Barry Eichengreen has argued, a pretty common political response to economic hardship and social turmoil.

It is then no wonder that in an increasingly chaotic world with growing wealth and opportunity gaps, populist leaders have been winning elections and putting their ideas into practice. Their political activity spans the globe, and is unlikely to come to an end any time soon, even though occasional electoral defeats show that the populist surge isn’t invincible.

Ray Dalio is well aware of this particular dynamic. But the way he puts it, you might think that economic policies swing between different extremes in a cyclical and basically uncontrollable manner, like “the width of ties and the lengths of skirts.” It is, however, difficult to argue that there are apparel companies, designers and trendsetters who have a strong influence on what becomes fashionable, even though they don’t control it fully. This is also true for large-scale economic and social policies.

Neoliberalism was not a coincidence or a cyclical phenomenon, but a conscious choice of policymakers, which means that they are at least partially responsible for the rift in wealth distribution, political polarization and the lack of equal opportunity.

The huge debt the US government incurred in the 1980s, its massive tax cuts and loosening control over financial markets are elements of a deliberate policy that put up with paying a high price to achieve its goals.

To be sure, deregulation started before Reagan was elected, and went on long after he was out of office. A part of Ray Dalio’s success as an investor is closely connected to this lax legislation. And while it would be too easy to decry unrestrained speculation with financial assets as the root of all evil, it makes sense to ask to what extent the current wealth and opportunity gaps result from calculated decisions to leave the markets largely unregulated.

7) Add to that the digital revolution, the lack of a rival communist superpower that would make you pay more attention to your poor, and the increasing competition from the developing countries where people are willing to work hard for little money—and you’ve got the perfect storm.

Smart observers have long realized the self-destructive potential of unrestrained markets. The problem is that there’s no quick fix for the wealth, opportunity, value and political gaps of the last years. Neither is there an easy solution for reducing the immense load of public and private liabilities accumulated over decades. Unlike ALF, the US government has no spaceship it can lease to a set decorator of a science-fiction movie in order to repay its debt.

As a shipwrecked entrepreneur, you have of course the option to move to your Mom’s basement, eat rice and beans, and work your way back to sound economic condition. But what would happen to a country that would have to do exactly that?

The dollar - still a global reserve currency

Money, Debt, Cycles, and the Historical Reasons for the Upcoming Dollar Erosion

Posted on July 7, 2022July 7, 2022 by gennadi.kneper

1) Remember Gordon Gekko? Right, the outrageous, unrestrained, insatiable corporate-finance shark from Oliver Stone’s 1987 movie Wall Street. This guy, played by Michael Douglas, was manipulative, greedy and tough, enough so as to get up before sunrise and call up his young would-be partner to remind him that “money never sleeps.”

While immoral in his financial behavior, Gekko was one hundred percent right about how money works. It never rests, it always flows, from one place to another. Like the blood in the human body it ensures that the world economic system receives its “oxygen.” Like it or not, money makes exchange easy and offers a handy way to store wealth.

2) In his recent analysis of the changing world order, Ray Dalio has reflected on money, debt, and capital market cycles throughout history. From his point of view, cyclical development is typical of most areas of life. In other words, things that happened in the past will probably occur again in the future. Speaking of economy, this means that we can learn about the crises to come by studying the disasters of the past.

Ray Dalio is of course not the first to notice that there is such a thing as economic cycles. Though he doesn’t mention any economist in particular, it’s very likely that his ideas are based not only on his vast experience as an investor, but also draw on research carried out by scholars such as Irving Fisher, John Maynard Keynes, and Joseph Schumpeter, who studied the dynamics of debt, economic growth, and technological innovation.

What makes Ray Dalio’s outlook so special is the fact that he is not a scholar, but a hedge fund manager who analyzes long-term money and debt cycles in order to come to practical conclusions that could help him with his investments.

3) The examples Ray Dalio uses are related to the development of capitalism in the North Atlantic area beginning in the 17^th century. One of his main concerns is the fate of three major reserve currencies, the Dutch guilder, the British pound, and the US dollar.

Looking at what happened to the guilder and the pound, which used to be widely accepted around the world for transactions and savings, and then lost their importance, he comes to the conclusion that the US dollar might be going the same way in the future—with profound implications for global capital markets.

Another of his historical comparisons has to do with the dramatic changes in monetary policy of the Federal Reserve that occurred in March 1933 under Franklin D. Roosevelt and in August 1971 under Richard Nixon. By defaulting on the government’s promise that people could turn in their money for gold, both presidents were able to ease the pressure on the US economy. As a consequence, the dollar lost part of its value, while the stock market soared.

Looking at these examples, Ray Dalio suggests that the recession of 2008 (and possibly that of 2020) has essentially obeyed the same mechanics. But is he right?

4) As you might have figured, the answer is yes and no at the same time. Ray Dalio certainly has a point when he talks about similarities in short-term consequences of the dollar devaluation. If the value of money is decreasing, people tend to look for other assets, be it securities or real estate. It’s also true that the discussed decisions of the US government had some positive effect on economic growth.

What Ray Dalio’s analysis fails to take into account are the differences between the situations he reflects upon. There are quite a lot of them. Here are just a few examples.

– As opposed to 1971 and 2008, the US dollar was not a global reserve currency in 1933.

– Roosevelt had to face the challenge of more than three years of harsh economic depression and aimed to fight deflation. Nixon, on the other hand, wanted to counter inflation, and secure America’s exorbitant privilege of controlling the world’s major reserve currency.

– In 2008 governments throughout the world acted very quickly to prevent the Great Depression scenario. The measures taken to provide cheap money and credit and support the economy seemed to help in the short run. But what about further consequences?

5) This is a point where Ray Dalio’s analysis doesn’t go far enough. If you look at the medium-term repercussions of government policies in 1933, 1971 and 2008, you’ll see that they were not the same.

In 1933, the government-induced dollar devaluation was part of a much bigger package of measures that created a whole new framework for the US economy, several parts of which are still effective. Even more important, six years later World War II started, the economy changed even stronger, and in 1945, after the war ended, the world economic system underwent a radical change.

The so-called Nixon shock in 1971 was a good deal for the president, who was re-elected with a vast majority one year later. But economically speaking, the 1970s are remembered as a time of high unemployment and uncontrolled inflation, partially caused by the 1973 oil crisis. Then Paul Volcker became the Federal Reserve chairman and raised the interest rates to 20 percent to curb inflation. And at some point in the 1980s Reagonomics began.

Finally, in 2008 the Federal Reserve, the European Central Bank, and the Bank of Japan drove interest rates under any imaginable threshold and kept buying government debt until they were up to their ears in it. It seemed to work. For more than a decade the economy was growing, start-ups run by 20-year-old college dropouts were raising cheap money, Donald Trump was about to be re-elected. Then the COVID-19 pandemic came along and all went down the drain.

6) In other words, the medium-term implications of government policies applied in 1933, 1971, and 2008 don’t have much in common. As I mentioned in a previous post, the number of factors that influence the outcome of any given historical situation is very high. And so, there’s little wonder that the results were different.

Ray Dalio’s point is that the long-term analysis of money and debt cycles enables him to anticipate the direction in which the economy will go. He actually claims that this perspective allowed his company to weather the storm in 2008.

If you look at their numbers, he must be right (though it worked much less for them during the pandemic). My point, however, is that knowing the overall direction might not be enough. Neither is focusing on money and debt. In our current economy capital markets are probably the single most important driver. But you also have to look at manufacturing cycles, disruptive technology, the environment, the demographics, the pandemics and, yes, the big politics.

To be sure, I’m not in the least as knowledgeable in financial investments as Ray Dalio. I suppose that even though his analysis of long-term economic patterns isn’t 100 percent accurate, it’s fair enough for a good bet on the stock market or wherever else he decides to put his money into. After all, that’s what a hedge fund manager is supposed to know how to do.

Ray Dalio’s recipe for these turbulent times is diversification. I guess he’s right, though history can always surprise us.

7) Last but not least, there is his prediction about the impending demise of the US dollar as the world’s most important reserve currency. In this case, the question is not whether it will happen, but rather how and when. Some people at the International Monetary Fund suggest that a “stealth erosion of dollar dominance” has already started.

In the 17^th century, the Dutch guilder was pushed aside after a series of lost wars. The British won both World Wars in the 20^th century, but were too depleted to hold up the pound’s paramount position in the global capital market. What will it take to keep the US dollar where it is after all the upheaval in international politics in 2022?

While you muse on it, you might be interested to have a look at what one of the “Founding Fathers” of the long-term economic analysis Nikolai Kondratiev had to say about cycles.

And don’t forget: Money never sleeps, pal.

All You Should Know about the Changing World Order

Posted on May 29, 2022 by gennadi.kneper

The Changing World Order

May you live in interesting times

(an allegedly Chinese saying, in fact not Chinese at all)

1) We live in extremely interesting times. The world order around us is changing quickly and profoundly. The COVID-19 pandemic and the recent Ukraine crisis are just two most talked-about elements of larger transformations that are taking place on our planet.

These transformations are both fascinating and full of risk. Understanding them is therefore the first step to riding the wave without drowning in the stormy sea.

2) Recently, the hedge-fund manager Ray Dalio has published a highly insightful take on the changes that are occurring in the world, as a book and as a Youtube video. From his vantage point as the proverbial Yankee up in capitalist Connecticut, he has suggested a framework that can help understand why great powers rise and fall, and what can be done to stop the decline.

While these ideas are not nearly as humorous as Mark Twain’s novel, they can compete with the ingenuity of its approach. There is no doubt, that Ray Dalio has a point. However, there are also parts of his reasoning that are not quite exact.

What do I mean by that?

3) At the beginning of his book, Ray Dalio suggests that you can’t focus on the details to see the big picture. He is of course right, but also wrong on that account – because the devil is in the detail. And while his model is sound on the whole, there are several aspects of it that deserve a closer look.

As an experienced investor, actually one of the best of his kind, Ray Dalio approaches problems from the economic perspective and tries to elaborate general models that will work under all circumstances. There’s nothing particularly wrong about this approach, but just like any angle it has its limitations.

4) Unlike economic models, history is full of exceptions and irregularity. The sheer amount of actors and factors is so big that it makes any accurate prediction extremely difficult. The comparisons Ray Dalio draws between different historical situations that are similar to our own are striking. But what about the differences?

I’m confident that they are at least as important as the features these situations have in common. If we want to get the right picture, we should pay at least some attention to them.

According to Ray Dalio, there are three big cycles (money and debt; internal order; international order) and eighteen key drivers that explain the rise and fall of great powers.

5) In the following weeks I will have a closer look at these cycles and key drivers. I will stress test them against historical evidence and other perspectives in order to see where Ray Dalio is right and where he is wrong.

History doesn’t repeat itself, but it rhymes. Even though Mark Twain actually never said that, it certainly makes good sense. Given that, it might be worth learning how to rhyme elegantly.

Next week we’ll be starting with the money and debt cycle. In the meantime, you might be interested in taking a look at this.

What NFTs Teach Us about Humans, Art and Capitalism

Posted on December 17, 2021December 18, 2021 by gennadi.kneper

1) Before I start, let me tell you a quick personal story. Some years ago, when I just finished my PhD project and wasn’t sure where to go next, I decided to try myself as a community manager for a medium-sized company. The offer they made wasn’t very well-paying, but I was short of money, and also curious to learn how the media environment I had studied as an undergrad has changed in the meantime. And so I said yes.

It turned out, that I had to catch up quite a bit. Mobile communication and web 2.0 were not the kind of species I knew how to deal with. This meant that I needed to learn quickly, and that was the moment when I came across Gary Vaynerchuk (aka garyvee). I read a couple of his books and watched his Youtube videos to get steeped in the new digital lingo. It worked quite well: from what I can tell, my bosses were satisfied with my performance, and when I left back for academia two years later, I was much more knowledgeable about the disruptive digital world.

2) Why am I telling you this? Reason number one: Gary Vaynerchuk is one of few people in the social media circus who reminds you constantly that a significant part of his success stems from studying history. Reason number two: recently, he has moved heavily into NFTs. And while no-one knows if and how this technology will change our way to live on this planet, it seems to be an interesting case of study to understand how lifestyles, production, and consumption evolve over time.

Just in case you don’t know what NFTs are: the acronym stands for “non-fungible token,” which is basically an (almost) unhackable computer code you can attach to a piece of art, music, film, or any other item that exists in the digital world. By connecting an NFT to a digital product, you create a proof of its authenticity and uniqueness. This is great news for all digital artists out there. Now it doesn’t matter how often people copy the meme or the video game you created. If you own the corresponding NFTs, you’re considered as their author and can sell the rights for your idea to whoever you want.

This is copyright’s Second Coming, but NFTs are actually much more than that. They create a new contractual infrastructure, which can be used for any kind of agreements between people and organizations. Since our today’s lives are already extremely connected to digital experiences, it is very likely that digital technologies like NFTs will be in high demand in the future.

3) In other words, it looks like the rules of the game are about to be rewritten again. In the first quarter of 2021, NFTs accounted for about 10 percent of worldwide art market revenue. If you think that most of the digital items sold are worth nothing, you’re probably right. But this might also be true for 99 percent of the art purchased at Christie’s and Sotheby’s, no matter if conventional or digital. After all, the value of a piece of art lies, more than anything else, in the eye of the beholder – and the community he or she belongs to.

This is by the way nothing new. Back in the 1930s, few years before he lost his life while fleeing from the Nazis, the German philosopher Walter Benjamin wrote an essay about The Work of Art in the Age of Mechanical Reproduction. One of his key ideas was that in modern times art is not what it used to be in the Ancient world or in the Middle Ages. Back then it was all about uniqueness, restricted access, and physical experience, which created a special aura and cult value.

The invention of photography and cinema made technological reproduction of a work of art easy and inexpensive. Cult and aura vanished, and instead of them the exhibition value became the main criterion to establish the significance of a piece of art. The number of people who watch a movie is an indicator of its cultural importance, even though it doesn’t necessarily mean that it’s a high-quality product.

4) In the digital age, the effects of low-cost mass reproduction have become even more pervasive. Copying, remixing, sampling – you name it – are so simple that anyone can do it at almost zero cost. Moreover, you have the opportunity to spread your creations easily among the people, even though large-scale distribution is more difficult to pull off and still requires considerable resources.

For the last decade, we’ve been flooded with other people’s creative output on the internet: funny and sad, subtle and tasteless, but most frequently trivial and irrelevant. Here’s where NFTs come in. By re-establishing the notion of uniqueness they allow us to bring some order into the chaotic world of digital interactions. And if there’s something we’ve learned from history, than it’s the idea that humans need order to get things done.

It’s all about social agreements. Sure, you can copy a JPEG, print it out in high quality, and enjoy looking at it at home. But if there are enough people who think that only the JPEG with an NFT attached is the real thing, then your JPEG doesn’t carry the same meaning, which is to say: you won’t get from your JPEG what you’d get from the NFT-connected JPEG.

Since NFTs can be owned collectively, people who hold a share on an NFT become something like an exclusive club. If it sounds too stuck-up for you, think of urban tribes of rockers, skaters, punks – they are exclusive, too. No matter if upper-class or subcultural, communities are about belonging and shared experiences that are inaccessible for outsiders.

5) In a way, NFTs bring us back to the pre-modern world of artistic experience Walter Benjamin was talking about. The mystical aura might have gone forever, but the restricted access to, and the physical experience of, something unique still matter. At the same time, NFTs reinforce the tendency of considering culture as an economic asset.

In many respects, this is a consequence of us living in a largely capitalistic society. Societies that value co-operation over competition are less prone to think about protecting intellectual property (aka great ideas) and creating artificial scarcity.

The financialization of culture, which is what NFTs could possibly be doing over the next thirty years, is just another piece of human existence in the age of surveillance capitalism. Don’t be misguided: big corporations will have big say in how NFTs will evolve. But you might have an opportunity, too.

It would be a mistake to forget that humans haven’t changed much in the last couple of hundred years. Technologically, we’re in the skies with diamonds, but deep inside we still seem to think in terms of the Stone Age. No matter how abundant our world has become recently for many, it’s hard to believe that it won’t go away some day. And so, NFTs make perfect sense for the time being.

However, as Walter Benjamin remarked, human perception is “determined not only by Nature, but by historical circumstances, as well,” which is to say: it’s up to us to decide where we go from here. Just make your bets, and let them be long-term.