National Sovereignty in a Multipolar World

Originally sent to VIXCONTANGO subscribers on September 29th, 2022

Trade is Continental

Globalization is not only a bad geopolitical ideology, it is also a bad model to describe global trade as well as simply bad economics. In the Foreign Affairs article “Myth of the Global”, the author states that the average trip of the average globally produced product should be 5,300 miles if the world economy and its supply chains were truly global. In reality, it is only 3,000 miles. That tells you directly that the global economy in practice is not truly global. Instead, it is “regional”. Foreign Affairs prefers the term “regionalization” (as in “regionalization” vs “globalization”). I prefer to use the term “cartelization” or “continentalization” because regional commerce is predominantly a continental phenomenon, not a cross ocean phenomenon. Countries in Asia trade with each other the most. Countries in Europe trade with each other the most. Geography matters for trade. Distance matters. The presence of land borders matters. Similarities in cultures and languages matter. All of these factors accrue to commerce happening in large continental clumps. That is why the TPP (Trans Pacific Partnership) was a very bad idea and doomed from the start. The Pacific is a large ocean and trade over it is simply the worst possible way to conduct trade.

Majority of trade instead happens on the landmass of Asia, Europe and American continents. 67% of international trade in the European Union is among the countries in the European Union. 60% of international trade in Asia happens among Asian countries according to the Asian Development Bank. The biggest laggard in continental trade strength is the Americas with only 40% of international trade happening between American countries. This speaks to a tremendous deficiency of understanding of international trade inside the American government. These international trade realities mean that America is a secondary consideration on the continents of Asia and Europe. If a country in Europe and Asia had to choose between trade with its continental partners and America, it always has more to lose by choosing America. This data shows that America needs to put more effort into increasing trade and prosperity inside its own continent. Instead of catching the bird in hand, Americans always seem obsessed with chasing the 2 birds in the wild. America needs to increase its continental trade to the 60% level from the current 40% level.

Clearly globalization is a bad model to describe international trade. The USA is alone on the map with major continental trading partners Europe and Asia residing across large oceans. Perhaps that is the reason why America is the champion of globalism and why they have doggedly pursued this bad model for international trade over the past 30 years despite all factual evidence to the contrary. But Europe, Russia and China are in different parts of the global map and they fully well understand that trade is continental, not global. No matter how hard America tries to disrupt continental commerce it won’t be able to succeed because transportation needs energy and the longer the distances a good needs to be transported, the more energy it costs. The more it costs to get a finished good to its final consumers, the less profit there is for the corporations. And nobody is doing trade for free. Everybody is doing international trade to make money. That is the only reason why anybody does trade: to make money.

To put it simply: there is far more money to be made in continental commerce than there is in global commerce. And that right there is death knell of globalism. Not only is globalism a bad model for international trade, it is also a bad way to conduct trade because it assumes the highest transportation costs possible. International trade agents who trade for profit want to minimize their transportation costs and want to minimize the energy used for transportation.

The vast majority of the world’s energy reserves is not in Western hands. America is the biggest energy producer in the world but still it makes up only 10% of the world’s energy market. Globalism is inherently dependent on the collective goodwill of the biggest energy producers – United States, Russia, Saudi Arabia, Canada, Iran, Iraq, China, UAE, Brazil. If a good chunk of these countries (Russia, China and Middle East) want to put an end to American globalism, they can. And they are. Western energy powers like America, Canada and Norway alone can’t power global trade. Maybe they can power trans-Atlantic trade but that’s about it.

The establishment of a multi-polar world and regionalization/continentalization of both commerce and geopolitical power is thus inevitable. It is the most sustainable and profitable model for the global economy. The more America steps out of line with China, Russia and Middle Eastern powers, the faster its globalist dream dies due to the rising cost of transportation and the sooner we arrive at the multi-polar regionalized world order. Every time you see news on your Bloomberg terminal of rising energy costs or rising transportation costs like “Suez Canal raised its tariffs” or “Turkey raised its Bosphorous tariffs” that is yet another mortal blow to American globalism.

Debt and Sovereignty

The article “How the system was rigged” is a book review of the book “The Meddlers” by Jamie Martin which describes the history and rise of the current international global economic order. I haven’t read the book yet but I find this review particularly illuminating. Before the current international world order, you had European powers waging wars all the time and plundering each other’s treasuries to pay debts and so forth. Obviously, building militaries and destroying cities was not particularly enlightened behavior so at some point all the European powers and America decided to settle things in a more civilized way by putting rules around various national behaviors. That led to the creation of institutions such as the United Nations, World Bank and International Monetary Fund after some failed attempts after World War 1 with the League of Nations. The essence of these institutions was to replace wars with debt negotiations and those debt negotiations had the specific purpose of limiting national sovereignty and national power via austerity policies.

Obviously, international trade is a good thing and the world’s resources are located in different places. Global wealth and prosperity is thus dependent on international trade which means reducing the amount of wars being waged and increasing access to all commodities. It is an illusion that a country can be truly self-sufficient. It can’t. A country always has a dependence on other countries simply because that is where the commodities and other resources are. Thus from the get go, various countries have different levels of power inside these institutions which are related to their resource, economic and military strength. The less debt a country has, the more power it has inside the international institution. The countries that won World War 2 like US, France and England always had disproportionate power inside these institutions. 2nd and 3rd world countries were always significantly smaller players because they were indebted. Thus there is a direct linkage between national debt and national sovereignty. The less debt a country has, the more national sovereignty it has. And vice versa. Thus a country’s main geopolitical strategy then is to reduce its international debt, to become a lender if possible and then to accumulate power inside the international organizations whose only purpose in the world is to limit and constrain national sovereignty.

You can have a very simple test with which to determine the behavior of a government: do its actions reduce the international debt of the country and do they strengthen its position in international organizations? If a government increases the debt of a country, then it acts AGAINST the national interest of the country because it reduces its sovereignty and power inside international institutions. This is very clear cut determination. For example, this year’s Kiril Petkov government in Bulgaria (that was voted out with no-confidence vote earlier in the year) severed long-term contracts with Bulgaria’s Gazprom holding company and instead purchased gas for 30% markup from Romania’s Gazprom. The Petkov government increased the energy cost of every Bulgarian by 30% in pursuit of “European values” by… buying the same exact Russian gas…. from a neighboring country! The Petkov government paid 30% more for the same natural resource in order to virtue signal. It’s totally insane. How did the Bulgarian government pay for this 30% more in energy costs? By taking out debt. So you can clearly see here how Petkov acted directly against the Bulgarian national interest: he increased the national debt, removed direct access to a critical energy commodity and reduced the country’s sovereignty and power inside international instructions. It is one thing to pursue a strategy of commodity diversification, it is another to pay higher prices and remove access to commodities for ideological reasons.

Trump made a similar bad geopolitical move with his trade war in 2018. It increased dramatically the international debt of America making America more dependent on international institutions. Further, Trump removed America from some international institutions, directly surrendering power inside the WHO and other organizations. In essence, almost every action Trump took made America weaker inside international institutions and increased the debt of the country which in turn reduces the amount of its sovereignty. Between balance sheet expansion and federal debt increase Trump took on $10 trillion in debt during his 4 years, an unprecedented weakening of America’s financial and international position. Trump waged “trade war” with China using undiplomatic “art of the deal” tactics and insulted a Great Power which was then forced to deploy in retaliation a bio-economic weapon – COVID – against the American economy for which America had to go $10 trillion in debt. Numerically, Trump is the worst natural disaster to hit the American nation in history.

Right now the Liz Truss government in the UK is taking actions that directly increase Britain’s international debt and weaken its participation in international institutions. Britain will take out international loans to pay for higher energy prices. Instead of negotiating with Russia and putting to bed the Ukraine conflict and keeping energy prices low, Britain and is doubling and tripling down on bad energy policy that will directly damage Britain’s national sovereignty. It is cutting off access to a critical natural resource and is taking out debt to pay for higher prices of this natural resource which aren’t recuperable. Britain is not taking out debt to acquire assets or property, it takes on debt to simply survive another day. That makes Britain less sovereign. Brits have a right to be concerned with the drastic actions taken by the Truss government to weaken Britain’s national standing and sovereignty. It is not surprise that the British pound is in a tailspin. Just like Trump was a national disaster that hit America, so is Liz Truss. After Truss, there will be no Britain left – at least not as a nation that has a significant say in anything internationally.

A country’s participation in international institutions is inevitable due to the global distribution of world’s commodities and human resources. “Go it alone” strategy is not feasible. Isolationism is not feasible. Thus a country’s interest is best served by increasing its economic and military power, reducing international debt and increasing its sovereignty and power inside international institutions. A country has to play the cards that it has been handed well. It needs to diversify access to resources. It needs to cheapen its access to resources. It needs to allocate its resources judiciously. If it doesn’t, it goes into debt and loses sovereignty. Debt and sovereignty are directly related. The more indebted a country is, the less sovereignty and power inside international institutions it has.

Thus the national conservative objectives of a country are the following:

  1. Maximize the amount of international alliances it participates in order to increase and diversify access to commodities and other resources (such as military)
  2. Reduce its international debt to increase the power it has inside these international alliances
  3. Utilize its available resources prudently – ie have strong economy
  4. Ensure strong anti-access/area denial (A2AD) military capability which is critical to defending its territory effectively

Turkey and India are prime examples of countries executing well on a national conservative agenda. Indian Prime Minister Modi is everywhere. He is in the Shanghai Cooperation Organization (Asia’s EU), he is in European Union every other week, and he has military exercises with both America and Russia. India is in economic or military alliances with China, Russia, Europe and America. India gets access to all the world’s resources, has access to all the world’s weapons, it participates in the highest number of international organizations, uses its resources well and increases its power inside international organizations. Everybody is begging to talk to India these days. India is doing textbook national conservative strategy. Same with Erdogan and Turkey. Turkey banks are using the Russian Mir system and Western SWIFT system. Turkey has weapon contracts with both Russia and America. Turkish military has institutional knowledge of all the world’s weapons. Turkey gets gas from Russia and from Israel. It has national strategy to diversify access to critical commodities allowing it to lower its costs and ensure supply chain resilience.

Democracy as Channel of Exploitation and Needed Reform of Executive Powers

Now that you can understand better the essence of national objectives in an international context, we can better evaluate the disaster that is the American form of democracy to its national sovereignty. Democracy is simply a channel for exploitation and for plunging countries in international debt and thus reducing their national sovereignty in international institutions. The “color revolutions” that America organizes have one purpose only – to put weak national government that act directly against the national interest of the countries targeted. A prime example of that is the Kiril Petkov government in Bulgaria. Under no prior administration would Bulgaria have taken the disastrous actions undertaken by Petkov. But through a mini color revolution in Bulgaria, the Bulgarian population was fooled into electing a government comprised of saboteurs. This was an organized activity by somebody (Davos, obviously) and its result was direct reduction of Bulgarian sovereignty and plunging the country in debt. In a similar fashion, Trump’s bad policies led to the election of the Biden government which is also a saboteur of the American national interest. Biden continues to tack on debt and has pursued a policy which surrenders American access to natural resources available only on the Asian continent. Every single action Biden has taken has been bad for American national sovereignty. Biden is no better than Trump. International participation is inevitable. “Go it alone” strategy is not feasible, even for a big and powerful nation like America. In a multi-polar world, America is just like small countries like Bulgaria – it has to have a national strategy that seeks to maximize access to limited resources and secure low prices. If it doesn’t, it simply impoverishes its population through inflation and loses national sovereignty. There is a saying in China – “the emperor is far away” which in American context means if America doesn’t care about its own interest, nobody else will. And certainly not Russia, China, Europe or Davos.

The mistake of the Petkov government in Bulgaria has now been corrected through its removal, but Bulgaria remains vulnerable to the same type of exploitation in the future due to its democratic form of government. The presence of elections is a critical vulnerability. The voters can be fooled again. It is actually important to discuss the state of democracy in the world today. We no longer have “democracy”. In other words, the people don’t debate issues and elect a government that represents their choice on how to handle the issue. Instead we have governments that decide the course of action and then manipulate the electorate to vote in that course of action. That manipulation happens through direct manipulation of the vote, through voter replacement like in America and through government propaganda. The media in America doesn’t hold the government responsible for anything. Instead the media’s only task is to cover up the mistakes of the government and to direct the population about which way they should vote. Any criticism of Hunter Biden or other Biden government failures is conscientiously and religiously scrubbed from the permanent record by the media, the FBI and the CIA. The American government is engaged in 24/7 media war against its own constituents because those constituents have the power to decide who is in government. Everything in the Western democratic world is upside down. If America’s founders like George Washington woke up today, they would be horrified. The government doesn’t serve the people, it directs the people. The economy is not driven by the private sector but by the government. People who don’t follow the totalitarian ideology of the government are censored out of existence and denied employment and reduced to nothing. Criminal laws and protection of property laws aren’t applied to ideologically opposed groups. Their financial transactions are denied. In the West today, we have a form of totalitarian government never before seen in the history of the world. Even in the USSR such control was never achieved. And that is not a compliment.

Ultimately, America and the West don’t practice democracy, they practice totalitarian plutocracy. And plutocracy of the worst kind – one that doesn’t care about the national populations at all. National populations have been declared completely expendable. We went from gay marriage (which is a reasonable policy because there are gay people and normal marriage laws should apply to them at least for practical matters such as property transfer) to a Malthusian policy of mutilation of children within two years of the Biden admin. Transgender ideology and mutilation of children is the worst form of social extremism ever seen in history. Even during Mao’s social revolution there wasn’t stuff like that. Being worse than Mao is quite the accomplishment and the so called “Democratic Party” in America did it. The other sinister idea of the Biden government is the idea that whites should take a step back to blacks and people of color is reminiscent of the Soviet policy of the elimination of the Russian identity. In the Soviet Union during the Stalin era, they emphasized all national identities (Ukrainian, Belorussian, Kazak, etc) except the Russian identity. Russians were told to take a step back, take one for the team and recognize their privilege and allow other nationalities to shine. Soviet leaders were never Russian. Sound familiar? This Soviet policy, more than anything broke up the USSR in 1990. Russia itself didn’t care for the Soviet structure of government. Russia wanted the USSR gone. Much of Putin’s current policy of Russian revanchism today is a direct consequence of Soviet policies seeking to reduce Russian nationalism over the previous 80 years. Russia today feels like it needs to make up for lost time. If Russia is any bellwether, America will also have a return of a massive Anglo-Saxon nationalism in the near future.

Misuse of executive powers is abundant in the Western form of governance. There is always only one person signing off on decisions, whether that is the Prime Minister or President. The US President may be democratically elected but he is a king for 4 years. A king is still a king – a single point of failure. And king’s policies don’t necessarily align with his voters. Increasingly, the Western kings implement policies that help only their partisan interests – the people who gave the money to elect them. Instead a Co-CEO governance structure needs to be pursued to ensure national interest is not compromised. In Goldman, every account had to be signed by at least 2 people. That means every major decision is discussed with somebody else and people can’t do crazy things on their own. There is always a check on individual decisions. This is a good model to follow. Even in my personal life, I never own property by myself. There always is a second owner – my wife or kids. Single ownership and single decision making must always be avoided. Yes, you have to explain yourself but that is necessary – explaining to another person makes sure that the decision makes sense, even to yourself. A lot of thoughts that pop in someone’s brain are unorganized and illogical. Sometimes they are simply emotional reactions out of fear or love with no basis in reality. Sometimes they are actions of misperception. Only through explaining your decisions to other people can thoughts and actions be clarified.

Executive Power in the West needs to be reformed to where at least 2 people elected in separate elections should be responsible for every major executive decision related to the national interest. For example in Parliamentary Republics, for issues that directly affect the national interest such as taking on new international debt, loss of access to natural resources, participation in international institutions needs to be signed both by the Premier Minister and the President (they are usually elected in separate elections). Consultation of Prime Minister with President shouldn’t be custom as it is right now. This required collective decision making should be directly written in the Constitution. At the very minimum, a President should have a veto of what a Prime Minister does. Explicit approval is different than veto in that veto allows the Prime Minister to operate on most issues with only partial participation of President. The workload on the President is lower. But either way, major actions that can hurt the national interest should be able to be stopped. As we see recently, these norms of consultative behavior are directly exploited to weaken national sovereignty. There isn’t a norm that Trump didn’t breach while in office. Norms aren’t laws and aren’t constitutional rules. Everything needs to be explicitly listed out. It is critical for the West to move to Co-CEO model of governance. In Bulgaria, if the Bulgarian President Radev had the power to approve/veto taking on new debt or the Gazprom negotiation, the failures of the Petkov government wouldn’t have happened. If in the United States, Trump had to get sign off from the Senate on trade negotiations with China and how to perform them, the COVID disaster and the $10 trillion in debt could have been avoided. The single CEO model is dead. It clearly doesn’t work. The Co-CEO model must be established. On issues of national sovereignty, we can’t allow partisan interests that are there for only a limited amount of time to take actions that permanently reduce national sovereignty. The reign of individual politician irresponsibility in the West must end.

In addition to Executive Power reform, the West needs Electoral Reform. Elections are clearly being used to weaken national sovereignty. Thus either the electorate who is eligible to vote needs to be reduced dramatically or elections need to be scrapped altogether in favor of other methods of leadership selection and decision making on issues. Clearly the crowd is capable of madness and that madness can be exploited by shrewd international actors whenever it happens. It only takes a few failures of democracy for a country to lose its national sovereignty completely. It is not clear that the national sovereign is best served with democratic elections. Power always comes from the people, but power is usually not exercised well by the people. At the end of the day people care about doing the right thing and it is not clear democracy helps countries do the right thing. It is the exact opposite – democracies have a clear cut track record of reducing national sovereignty. As such the current election systems are NOT a viable method of leadership selection and issue resolution in the long run. And it is very likely that they will be completely reformed or scrapped as they are in East.

Sick Man America

In light of partisan interests taking opportunistic advantage and self-enriching and profiting by selling aspects of national sovereignty to international agents during their time in power, it is particularly notable that America is clearly the Sick Man of the Multi-Polar Order. Of all the Great Powers, America has the biggest problems with its national strategy. In both Russia and China, the governments and think tanks are ideologically aligned with 80% of the population. Their policies are strictly in the Overton Window of their countries. In America on the other hand, the policies of the American government are strictly OUTSIDE the Overton Window. The reason for that is simple: America doesn’t have centrist think tanks. All of America’s major think tanks exist on the ideological fringes. When Trump came to power, there was no Republican centrist think tank with which to staff a national conservative government. Trump had to source talent from Cato Institute or American Enterprise Institute or the Heritage Foundation – all distinctly libertarian or neoconservative think tanks with fringe ideologies that are unrepresentative of 95% of American population. In other words, Trump couldn’t have implemented national conservative policies even if he wanted to. There is no talent and no think tanks working on those. Similarly, Biden is staffing his government with staff from the Center of American Progress – a neo-communist institution whose Far Left ideology represents less than 20% of Americans. Before him Obama was a representative of the Black Caucus which covers less than 15% of the US population. Other Democratic institutions such as the Clinton era Third Way are also globalist and neo-communist in nature. America simply doesn’t have think tanks that can formulate policies that fall within the American Overton Window. They are either Hard Left or Hard Right. If America feels increasingly partisan, that is because it is. There is no one funding think tanks and policies that are in the national Overton Window. All the rich guys in America are weirdos and they don’t care about the country. They only care about themselves and whatever their bizarro interest is. This is a national disaster in a Multi-polar world. All other Great Powers know what they are doing except America. America is oscillating between random ideologies vast majority of the population does not believe in. That directly reduces America’s power because it can’t rally the domestic manpower behind these fringe initiatives. To the rest of the world, America looks confused, uncoordinated and reacting out of anger smashing everything along the way. There is no coherent national strategy. And that is a problem, particularly for countries in Europe that are aligned with it. The more America continues to meander confusingly the more its alliances will break. Undependability and confusion are not qualities that anybody likes in a partner. America thus not only can’t rally domestic audience for its goals, it increasingly fails to rally an international audience for its goals. America can’t even define what its goals are. America has many problems, lack of direction chief among them. It is not clear how quickly it can solve them. For as long as that is the case, America will continue to fall further down in the rankings of the international world order. America’s primary objective today is to articulate its national goals and convince the world that its domestic governance system can provide stability and coherence in pursuit of those goals over the long run. The current constitution of America does not allow it to continue to be a Great Power in the long run. Dramatic changes are needed.

Summary

International trade is continental, not global, which means the continental Multi-Polar World Order is inevitable especially when most energy resources are in the East. Western globalism is not a sustainable model for organizing the economic relationships and balance-of-power among nations and especially Great Powers. National sovereignty and debt are inversely correlated. The more misuse of economic resources is done by a nation, the lower its national sovereignty in the multi-polar world order. A national conservative strategy is to maximize participation in international alliances in order to achieve a diversified and low cost access to natural resources, utilize economic resources effectively, reduce international debt and thus increase national sovereignty and power inside international alliances and protect national capability and identity. Democracy has been a key channel to achieve reduction of national sovereignty and increase indebtedness of nations. Democratic form of government needs to reform to eliminate and reduce the power of direct elections as well as introduce a co-CEO model of governance where no individual can permanently sabotage the national sovereignty of a nation. America, in particular, does not have a coherent national strategy like China and Russia do and that is paramount weakness in the Multi-Polar world. America needs to develop think tanks and institutions that pursue Overton Window policies that define goals that Americans support in super majoritarian fashion. Absent consolidation of American goals, America’s place in the Multi-Polar World will grow weaker over time. America needs to reform its system of government to ensure that its government can’t be sabotaged by elections as it has been routinely over the past 20 years. America needs to return to a strategy that maximizes its access to world resources, reduces its international debt and increases its power in international institutions. Isolationism is not an option.

References

How the system was rigged by Branko Milanovic

The Myth of the Global by Shannon O’Neil

The Meddlers: Birth of Global Economic Governance by Jamie Martin

The Unacceptable Hegemon

Originally sent to VIXCONTANGO subscribers on September 13th, 2022

Liberalism, nationalism, federalism, imperialism and globalism are all ideologies whose purpose is to organize the co-existence of ever larger groups of people. That co-existence may or may not be peaceful. Ideally it is peaceful but most of the time peace is neither possible nor pragmatic. Peace may not be realistically achievable given the ambition of groups and the practical realities of resource and time constraints. In fact, as Kissinger observes peace is often only possible after opponents exhausts their means to fight. If co-existence can’t be peaceful then a pragmatic objective is to reduce the cost of friction.

All of those various organizational ideologies exist in the modern world and interplay with each other through the existence of various institutions. Liberalism is about the individual and his rights and the court system is what looks after those in every country in the world. Nations are ethnic groups bound by common history, struggle, language, religion and customs. National governments are the institutions that looks after their public interest. Nations are the core organizational unit in the world today as recognized first in the League of Nations and subsequently in the United Nations. Federalism is a grouping of nations bound by common values. United States is one such federation, the European Union another. Imperialism is the domination of one nation over others. The imperial nation commands and controls the resources not only of itself but of its vassals. Examples of empires are Nazi Germany or British Empire or the American empire today. Finally, globalism entails the establishment of a single world government which commands and controls all nations in the world – in essence making every nation a vassal to a hegemonic global bureaucracy and dismantling the institutions of the nation state.

Corporations are groups of people inside one or many nations dedicated to providing professional services in some industry. Shareholder capitalism is about putting profit (making money and acquiring property) above all other considerations as primary objective in the decision making of corporations. Because corporations are all about making as much money as possible, they desire to be ethnically and nationally blind – they will take the money no matter what nation it comes from. Since the end of the Cold War corporations have started to market their products to an ever more ethnically diverse set of customers and that led to the development of the new corporate religion and moral code of anti-racism or color blindness. The reality is that racism is perfectly natural. People have the right to freedom of association and can associate with whomever they want. Nations have enemies and allies. People have enemies and allies. Only corporations want to make money from everybody. But you can’t force people to be friends with whoever they don’t want to be friends with. They simply won’t participate in the interaction. People don’t want to associate with others because they smell different, look different, think different or whatever the reason may be – the reasons can be hundreds. Social behavior is not the same as selling a product but since corporations only know how to sell product, if put in charge of social behavior they put the same policies for social behavior as if they are selling a product. The classic fitting a square peg into a round hole.

The notion that “racism is bad” is a corporate moral code invented by the by world’s biggest multinational corporations in order to maximize profit.Because corporations became the world’s premier hoarder of material resources since the end of the Cold War, they can now also finance the campaigns of elected representatives in national governments around the world. Thus corporations have come to control a lot of governments and have started to influence social policy in addition to their core competency – economic policy. Because America’s business is business – in other words the American government’s policy works exclusively in favor of corporate interests, not ethnic ones – combating naturally occurring racism and other ethnic considerations has become a prime objective of the American government under both Republican and Democratic administrations. Except that this is a futile fight.

The American government is not a liberal government nor a national government. The American government is a federal government of a set of states which was expanded into an empire after WW2 with Europe and Japan as its vassals. Europe and Japan are subject to American economic and foreign policy without actually having any representative in the US Congress to discuss the impact of American policies on them. As such America often makes decisions that directly hurt the interests of both Europe and Japan. Right now Europe and Japan are becoming poorer on the directives of the American government (Yen and Euro are collapsing). Over the past 30 years, America has acquired a corporate government that tries to morph the American government into a globalist government – a one world government which directs the affairs of all other countries in the world. Japan and Europe have had to swallow this decision by America because they are vassals. Now America wants to force feed this hegemonic design to countries in the East as well. This project is directed by the World Economic Forum (WEF) – a corporate think tank based in Davos, Switzerland which seeks the establishment of an unaccountable global bureaucracy by infiltrating governments around the world. Nobody can become a leader of a major Western nation without first becoming a convert to the Davos WEF religion first. You gotta kiss the ring of the Davos mob boss Klaus Schwab. Great Power nations like China and Russia see this attempt at a global government and reject it. This is the main cause of geopolitical friction currently. America wants global unipolarity. Russia, China and Asia want sovereignty and a multi-polar world in which different Great Powers have their own spheres of influence.

The big problem for our geniuses at Davos is that the American global hegemon model simply cannot work because of what America is today. There is a fundamental deficiency in the system and that deficiency is that America is a liberal democracy. America currently has two parties and every 4 years or 8 years power changes. The policies of those 2 parties – Democrats and Republicans are radically different. Democrats want Big Government and socialist, labor friendly policies. Republicans want Small Government and capitalist, business friendly policies. In the foreign policy realm, Democrats are friendly to China, Venezuela and Iran, Republicans are friendly to Russia and Saudi Arabia. Democrats care about human rights. Republicans care about human liberties. Every time there is a power switch in America, the rest of the world sees a completely different America. One year, they hate China and Venezuela and impose sanctions on them and they pump a lot of oil and oil prices are cheap. The countries around Venezuela and China suffer from the American sanctions on their trading partners. A couple of years later when Democrats come to power America now hates Russia and Saudi Arabia and imposes sanctions on them and oil prices become high. Countries around Russia and Saudi Arabia then suffer from sanctions on their trading partners. America lifts sanctions on Venezuela, Iran and China. Small political changes in America amplify to big changes around the world.

The internal divisions in America result directly into world chaos precisely because of America hegemonic reach and ambition. It is very difficult for any government abroad to have a position that won’t be changed by America. And if governments don’t dance to Washington’s tune of the day then they are vigorously and immediately prosecuted by America for it. God forbid, you don’t do what the Americans tell you right away, God forbid you try to think, America comes down with its full power on you. No dissent on any issue is allowed at any time. It’s not just Russia today. It was Iran yesterday. Afghanistan the day before. Iraq before. Vietnam before that. Korea, Yugoslavia, Libya, Syria. The list of issues is endless. Compliance with America through all its twists and turns is a very difficult act to pull off for any politician abroad. Pro-business Republican government leaders the world that were celebrated in 2020 have been harassed and jailed by Biden government’s allies abroad this year. If you were a pro-Trump politician in Japan like Shinzo Abe, the moment Biden comes to power you get harassed and assassinated by the Hard Left in the country. In Bulgaria, the former Right Wing Prime Minister of 12 years Borisov was jailed on the orders of the Biden government by Bulgaria’s new Hard Left government. In Moldova, similar jailing of former pro-Russian President Dodon also happened. Examples like this abound around the world.

American domestic instability is world instability squared. And this ultimately is the problem with globalism. While globalism may be a good economic policy – and by now it has proven not to be – it is clearly a horrible social and foreign policy. What is good for corporations is not necessarily good for nations whose job is to preserve the well-being and sustainability of their tribes. Different nations survive in different ways. That is why there are different moral codes and religions. That is why there are different nations. A global hegemon will always be unable to deal with the totality of the world’s social conflicts effectively. There just too many things to adjudicate. America can’t be a judge to every conflict. Globalism is simply too big to manage. But the much bigger problem here is the policy volatility – every year America has a different solution to every problem. People can’t tell what America stands for anymore. A global hegemon with a democratic government will suffer from tremendous policy volatility and instability. When you amplify that volatility across big distances you get chaos. A small wave in America is a tsunami in Japan. And I am not sure what good chaos is. In its attempt to create global order, America instead created global chaos.

If America wants to be a global hegemon, it needs to stop being a democracy. It can’t be a global hegemon with this much policy volatility induced by its democratic process. Only through reduction of policy volatility can America function as a global hegemon. So America has to give up either its global hegemonic ambition or its democracy. Pick one. You can’t have both.

I think the much more pragmatic solution is National Conservatism. To do that – even inside the bloc it controls of Europe and Japan – America will need to implement constitutional changes and change most countries from Parliamentary Democracies to Presidential Republics. The Presidential Republic design is modeled after France. The President is directly elected and is in charge of military and foreign policy, while the Parliament elects the Prime Minister who is in charge of economy and domestic/social affairs. The President is elected for a longer period of time (6 years) than Parliament (4 years). 6 years is similar to a Senator in the US. The Presidency is a big deal and the country has to really pour over the Presidential candidate and elect him with a clear super majority. As such 60% vote through a runoff is needed for a win. The President then becomes a mini equivalent of the British monarch – the true head of state that unifies the nation and rises above domestic politics. With Queen Elizabeth’s death and after the hell of the past 5 years, America discovers now what it is like for a country to have a head of state that is above domestic politics. A consistent and stable head of state is very important feature for a country that aspires to be a world hegemon. Foreign policy stability in both practice and in the form of a single person is very important. It is critical for America to arrive at this way to structure governments in its sphere of influence. The Presidential Republic model will dramatically reduce foreign policy volatility in the Western hemisphere which is super important over the next few decades.

Even if America doesn’t change its constitutional model, I think many countries in Europe will adopt a variant of the French Presidential Republic model. I think there is a growing dissatisfaction with Parliamentary Democracy in Europe. Bulgaria has had 6 governments and held 3 elections over the past 2 years. Each election costs hundreds of millions of dollars to hold. Elections are being held for a tremendous cost for then to disband within a few months. Italy has had similar experience. Italy has had 66 government since 1945 (77 years). That is a new government every year. Parliamentary democracy certainly portrays chaos where there may not be one particularly in the foreign policy arena. Countries know pretty well where they stand on geopolitical issues. At the very minimum I expect Italy, Bulgaria, Poland and Hungary to officially change to Presidential Republics in the next couple of years.

This transition to the Presidential Republic model will become the institutional foundation on which National Conservatism will be built. Countries will have a stable and consistent foreign policy. That policy may change over time slowly but certainly there won’t be the crazy volatility that the democratic process produces today. That is essential for creating a more stable world and more stable geopolitical landscape. I don’t think the globalist hegemonic model is viable at all given how it amplifies domestic dissent in the hegemon. I think the world is too complex for one world government. However, a problem can always be broken down into smaller pieces and that is where National Conservatism implemented through Presidential Republics is the far better model for world governance. You will know that the world is moving towards the National Conservative model when Europe’s Parliamentary Democracies adopt the Presidential Republic model.

Fairness, not Equality, not Equity

One concerning trend since the Obama’s election in 2008 is America preoccupation with “equality” and “equity”. These are classic communist objectives no matter how you dress them up. They are bad and nobody wants them. What people want is “fairness”. “Fairness” is a different concept that both “equality” and “equity”. Let’s use the analogy of a 100 meter dash race to explain the differences. “Fairness” means giving all participants the same rules and the same distance – 100 meters and the same space in which to run. I think we can all agree that this is what people want out of this world – a fair game to play with clear rules and objective referees. “Equality of outcomes” ensures that nobody wins – everybody is forced by the ref to arrive at the destination at the same time and thus everybody is a winner. That obviously is demotivating to many – if the outcome is predetermined, why bother running? In the case of economies, nobody works. “Equality of opportunity” means that the people that are faster are being hobbled with weights (they are being “leveled down”). I am not sure how that is different than “equality of outcomes”. If everybody’s abilities are equalized by the referee, not sure how the outcomes will be different. May be the winner is the one that didn’t get hit by a thunder strike? Again this is not something that anybody wants. “Equity” is giving the slower people artificial bionic legs that make them faster (“leveling up”). Ultimately, all these approaches want to make everybody have the same abilities. So not sure how that results in anybody being motivated to race. Whatever advantage they might have is being obliterated. Ultimately, people are different and have different ways to compete. Competition is all about bringing out different ways to compete, to explore the diversity of the human population. The hare wins with speed, the turtle with tenacity. Differentiation is essential to competition. Thus “fairness” is really the objective, not “equality” or “equity”. The sooner America abandons its current neo-communist obsession with “equity”, the sooner it will be able to restore some of its standing in the world. The more Biden sinks down the hole of “equity”, the worse the geopolitical situation for America will get. If countries around the world wanted “equity”, they’d still be aligned with the Soviet Union and the Soviet Union wouldn’t have collapsed. But that is not what people around the world want. And they have never wanted it.

While America’s preoccupation with “efficiency” over the last 30 years has been bad, its current preoccupation with “equality” is also bad. America needs to be concerned with “fairness”. America needs to right-size its ambition and find the right message. That is the only way for it to move forward.

References

Quants in the Room by Jason Furman

French Fifth Republic

Principles of National Conservatism

Originally sent to VIXCONTANGO subscribers on July 10th, 2022

I have been writing lately a lot about National Conservatism and I feel like this is still a rather new, nebulous and undefined ideology in the minds of many and I want to define it as best as I can. When I refer to natcons or national conservatism, I want people to understand fairly well what it means. Liberalism in both its neo-conservative and neo-liberal forms has failed as governing ideology over the last 20 years in the West and clearly needs to be abandoned. But we can’t just take down a governing ideology just for the sake of taking it down and replace it with chaos, anarchy and entropy, we need to replace it with something better. I think National Conservatism is that ideology that provides better solutions than Liberalism in almost every respect and gives us a substantial ideological upgrade. At the very minimum, it is worth to try it out over the next decade and see if it can improve upon the failures of liberalism. Trump was elected in 2016 as a guttural scream by the American people against the failures of liberalism and over the past 6 years, national conservatism has emerged as the ideological underpinning of what the Trump election was all about. Trump himself stumbled into some of the principles, but the ideology was still ill defined while he was in power and this first attempt at national conservatism in the American government failed miserably because it devolved into a personality cult around Trump that the media correctly now calls Trumpism. Yet National Conservatism is most definitely not Trumpism. It has very solid principles that have nothing to do with Trump. The natcon movement will have a bright future with or without Trump, although it most likely will always be associated with Trump who catalyzed it and turned it into a national and international phenomenon.

Liberalism sprung up as an ideology in opposition to National Socialism and Communism. National Socialism put the nation (ie an ethnic group) above all and utilized the power of the state to control every aspect of economic and social life to expand the power of the ruling ethnic group. That was often done at the expense of other ethnic groups within the country and later at the expense of other nations. National Socialism led to frequent conflicts and wars. Ultimately, the never ending warmongering put the Nazis on the path to extinction as the world, out of self-preservation, assembled a large enough coalition to fight against it in World War 2. Communism, in its international or national versions, sought to give governing power over the means of production to the worker class which turned out wasn’t intelligent enough to run an economy well. Everybody needs a boss, especially the workers who can’t think farther than their nose. A person can either be a good professional with skills or a manager, but he can’t be both and communism’s lack of appreciation for management expertise and market price signals was its death knell. While communism excelled in pulling together national resources effectively to accomplish big tasks such as sending a man to space, maintaining a strong military or building large cities from scratch, it failed in generating sustainable and vibrant economies. Communism didn’t have a viable model for proper resource allocation and when resources aren’t allocated correctly, given that resources are limited, that quickly led to economic death and misery. Communism easily fell prey to Liberalism which offered property rights, wealth, sustainable economies, better standard of living, higher real wages, broad consumer choice and access to all of the world’s resources and products. Communism of 2nd half of 20th century was clearly an upgrade over the National Socialism of the 1st half of the 20th century and the Liberalism of the 1st half of the 21st century was clearly an upgrade over Communism.

But Liberalism wasn’t perfect. The globalization associated with liberalism resulted in some major problems. One of the major problems was economic – free trade left some parts of world that were previously successful in a national context impoverished once the economy went global (example: manufacturing in the US Midwest). Businesses and jobs were lost, incomes stagnated or went down for decades. Free trade and free markets produced long term winners and losers. Another problem with economic liberalism is that not all countries in the world practice it. Major economies like China don’t want to adopt free trade and instead seek to subvert it with geo-economic tools such as tariffs and subsidies. The problem with liberalism’s free market vision is that markets aren’t truly free. Governments always meddle. Thus liberalism is really more of a utopian global economic ideology than a real one. Liberalism can work in the West, but isn’t really a truly global ideology because neither Russia, nor China, nor India, nor Middle East, nor Africa, nor South America – home of more than half of the world’s population – subscribe to it. How can it be global when half the world doesn’t use it? As an economic model liberalism simply doesn’t describe the world economy correctly. And if the model isn’t correct, its prescriptions will surely fail and as we have seen they have failed rather spectacularly leading to poverty, inequality and political destabilization.

From a social perspective, liberalism failed as well. The diversity of new experiences and meeting all kinds of people that made liberalism attractive in the early 90s eventually morphed into a forced universal experience that was imposed by powerful public actors (multi-national corporations or the state). Liberalism morphed into a form of neo-communism/neo-nazism that suppressed alternative ideologies, nationalities and religions in favor a newly molded singular identity. That singular identity is defined by how an idealized perfect human being should behave. Thus liberalism in the West today isn’t really “liberalism” as in acceptance of atomic individuality, but instead it is “futurism” or “avant-guardism”. Westerners today may be diverse in form but certainly are uniform in thought and behavior. If somebody diverges from this idealized avant-guard persona, they are immediately cast out of the government, businesses, work place and ostracized their social circle. There really is no tolerance for different cultures in the West today, instead only the singular Western so called “liberal” culture is accepted. For example, nobody can sacrifice animals in the West today in observance of their religion because that is considered animal cruelty and the Western value of not being cruel to animals supersede religious customs (of let’s say the Muslims).  Today, you are either a “liberal” or in the dog house. In forcing people against their will to conform to this avant-guard ideal, liberalism killed freedom of association which gives rise to diversity in the first place. Liberalism as a social ideology can only thrive when nations and different types of communities already exist. Destroy the nation and the ability of people to self-define their customs and practices and liberalism loses the legs it stands on. Liberalism is in crisis today precisely because it seeks to destroy nationalism – the very foundation it is built on.

National conservatism fixes the problems of liberalism because it restores the nation at center of economic and social life both domestically and internationally while simultaneously guarding against the vast power of strong public actors such as multi-national corporations and activist governments. The word “nation” itself doesn’t just mean the government as neo-communist “liberals” interpret it but instead means the combination of public and private sectors in the country. “Conservatism” means that a set of customs and traditions get preserved through time and define a common experience for the people of the nation. National conservatism liberates society from the desire to mold everybody into a universal avant-guard persona and from the false promise of atomic individualism. It allows different cultures in the nation to co-exist while simultaneously creating a common national narrative and experience. Instead of being alone, people can proudly belong to part of a group with a shared experience. National conservatism doesn’t preclude the existence of conflict between different groups in society or seeks to protect the rights of everybody, instead it creates mechanisms at the national level to check vast concentrations of power. It allows groups to accumulate (and also lose) power but once they become big enough it works to constrain that power and create balance of power between the various groups that enables conflict to remain managed and ensures the long term sustainability of society. This national balance-of-power approach is used not only in domestic affairs but in international affairs as well.

Here is a list of specific policies that should define well what National Conservatism is. There may be more but this is what I could think of. Some of the policies listed here are borrowed from the American Compass institute which I discussed in the article “Rise of National Conservatism” late last year.

Economic Policy

  • Decouple worker benefits from employment and eliminate the single employer employment model. Reduce the power of the multi-national corporation and the single employer corporation over individuals and economic life of the country.
  • Enable the Gig Economy and the ability of individuals to work multiple jobs by making benefits portable. Allow everybody to save for retirement and have medical insurance regardless of how many jobs and how many hours they work. Labor market flexibility needs to be encourage in the private and public sector.
  • In big companies, allow for the representation of organized labor (workers) as well as gig workers in management boards so as to make sure that corporations don’t make drastic decisions that fracture the social fabric and economic vibrancy of the country
  • Implement industrial policy and protect domestic companies and workers from state-level geo-economic attacks such as subsidies and tariffs implemented by adversaries or allies. Keep geo-economic protection at broad sector or national level in order to ensure proper functioning of domestic and international capitalism and free markets. Work to preserve innovation. Avoid targeted measures that help individual companies or monopolist players. Ultimately the goal of industrial policy is to even the scales of international competition and restore market functioning when foreign government try to take advantage of free markets.
  • Protect communities and individuals from private sector collectivism (ie. woke corporations)
  • Register multi-national corporations with large stakes in adversary nations as foreign agents and make sure their voice in Congress is treated with the proper amount of suspicion as their objectives may not always align with national objectives
  • Use state power to break up or monitor very large corporations/monopolies who may use their vast capital to skew the national laws and regulations exclusively in their favor. Limit the vast power of plutocracy and make sure the economy remains vibrant and new economic actors can emerge with regularity. Over the next 20 years, we need to prevent ruthless tech giants like Facebook, Google and Apple from destroying the dynamism of the American economy as they have over the last 10.
  • Concentrations of big capital need to be checked and balanced by the national government (“tiger management”). Labor first needs to be used as a check and whenever labor measures fail, the government should take a more active stance so as to build a balance of power in the economy between the different actors.
  • Support for continental level currencies such as the US dollar, Euro or Yuan which remove the power of local politicians to devalue the currency in favor of a professional elite picked from a large continental talent pool. This helps to reduce politically induced inflation and preserve people’s savings.
  • Support non-sovereign currencies such as Bitcoin that enable people from around the world to get around sanctions and conduct commerce regardless of geo-economic barriers. In fact, core tenet of national conservatism is to eliminate or at minimum reduce greatly the use of sanctions as geo-economic tool. International economic dynamism must be preserved regardless of the political differences that nations might have. People’s economic well-being shouldn’t suffer at the altar of social differences. In addition, national conservatives need to allow people to save themselves from the bad monetary policy or economic decisions of politicians and bureaucrats by seeking safe haven in non-sovereign currency like Bitcoin.
  • Seek free trade and free markets and preserve property rights as default policy but work to fix market failures when those market failures are brought on by either large domestic actors (monopolies, oligopolies) or foreign actors (China).

Foreign Policy

  • Abandon American unipolar model and top-down globalism in favor of “balance-of-power” model that respects the spheres of influence of other major economic and geopolitical players like China, Russia, Europe, Middle East and India.
  • Use pragmatism, real-politik and federalism as guides in international affairs. While America needs to protect and project its values, its value projection can’t come at the expense of ideological purity and international peace. The goal of natcon foreign policy is to maximize market access and global economic welfare and output, not to dictate an American set of values (or some ill-conceived “universal” global set of rules). Instead seek consensus where one can be reached and allow different continental regions to compete, coexist and experiment with different economic and political choices.
  • The goal of national conservatism is to enable different approaches to social and economic problems and provide strong national siloes in which they can be credibly explored. This enables experimentation on global scale from which all can learn and improve.
  • Understand the distribution of global resources well and construct a workable framework of fruitful cooperation with the commodity producers and major manufacturing nations by putting lesser emphasis on their value system and greater emphasis on economic cooperation
  • Combat and eliminate the formation of any global bureaucracy that seeks to undermine national authorities. Nations must be sovereign and large groups of people need to be able to construct their own approaches and solutions to problems. Global harmonization of policy is not an objective. In fact, global harmonization of policy should be avoided unless it arises organically. Under no circumstance should unelected global bureaucrats be allowed to oppress the nations of the world and terrorize their citizens with bad and inappropriate policies.

Social Policy

  • Freedom of association must be preserved. Oppressive forms of government dictated social policies must be challenged and reversed.
  • Freedom of speech must be preserved. Major social media networks must be made public utilities and must utilize a national censorship code. We can’t have corporations dictate public speech in the American town square. As a general rule, at most 10% of speech should be censored. People should be able to express themselves. Freedom of speech is essential to a well-functioning society. The censorship madness and cancel culture that we have experienced over the last 5 years needs to be ended as soon as possible.
  • People should be able to use their tax dollars to pay for charter schools. Currently educational tax dollars only go to public schools where these funds get abused and people have to suffer bad education policies by rogue state and local governments. As such people have to pay both taxes and fees for private schools. Instead, a tax payer should be able to sue their tax dollars towards private school tuition where their children get the education they feel is appropriate.
  • Schools and colleges in America need to preserve and teach traditional Western morality and American culture. America wasn’t created by Asian immigrants, it was created by Europeans and its European tradition must be preserved, taught and highlighted. While various religions and identities need to be respect, there shall be no confusion about what it means to be an American and what an American identity is. The liberals and the Democratic Party must be explicitly prevented from redefining what an American is.
  • Religion and morality must be taught and emphasized. Civics must be taught again.
  • Key part to the endurance of a strong nation is a strong birth rate and government policies must be put in place that provide help for families and ensure that people have an easier time raising children. American corporatism has made child rearing very difficult over the past 40 years and that phenomenon needs to be actively counteracted by the government. The role of non-procreative individuals and Malthusian ideologies need to be sidelined completely and eliminated from the national conversation in its entirety. People need to stop being harassed with insane non-procreative ideologies. While people may make their own choices with regards to pro-creation, people that don’t procreate harm the nation and its economic vitality in the future. Child rearing families spent fortunes in both money and effort to raise the next generation and they shouldn’t be penalized in the tax code relative to non-procreative people who fail to carry their generational burden. Tax laws need to equalize somewhat the income advantage that gay and childless people get from avoiding the substantial child care expenses people with children encounter for 20 years of their lives.
  • Restrict voting rights to people who make positive contributions to the economy and don’t live off government transfer payments. People below the poverty line shouldn’t be able to vote. People that can’t handle their own finances can’t be voting on public finances. We need to reintroduce civic tests as well (the same test that immigrants take before they become citizen and obtain the right to vote). People need to understand the government and be able to read before being able to vote. Roll back the Civil Rights Act of 1965. Voter ID must be required everywhere and only US citizens should be able to vote in state, local and federal elections.
  • Make it easier to get rid of a rogue executive branch in America. In Europe, Presidents and Parliaments can easily get rid of wayward Premier Ministers (example: Boris Johnson) and rogue ministers or governments. There has been a lot of abuse of executive power in America over the past 20 years with the executive branch routinely executing hard left or hard right policy via executive orders with which 70% of the population disagrees and many times are struck down by the Supreme Court. Executive branch activism needs to be curtailed substantially and the people of the nation must be able to more effectively reign in the executive branch and make it execute policies that both make sense and align with the popular will. Constraining big government activism is a chief objective of national conservatism. The executive branch in America has far too much power.
  • Enforce the borders and end the open border non-sense. Enforce legal immigration. End illegal immigration. Start mass deportations of illegal immigrants. Increase legal immigration based on skill and education.

Rise of National Conservatism

Originally sent to VIXCONTANGO subscribers on December 2nd, 2021

The Trump election and Brexit in 2016 kicked off a new phase of American and global politics. Whether Trump was elected or not in 2016 doesn’t really matter. Even if he had lost to Hillary, the emerging National Conservative movement would have continued growing. Trump is dumb enough to think that the 2016 election was about him when it was really the emergence of a new conservative political movement that had been bubbling under the surface in America for more than 2 decades that wanted to reform conservatism and move it in a different direction on economic issues. The 2020 election was proof that the 2016 election was not about Trump. Yet many of the policy changes that Trump started remain under Biden and will remain because that is what America wants. There is a lot more work to be done and all of it will be done without Trump. Trump just happened to be an opportunist who saw an opportunity to grift off the National Conservative movement by plastering his brand all over it. But the movement has nothing to do with Trump. With or without Trump, National Conservatism was bound to emerge.  

Today we are in a period of global geopolitical and geoeconomic realignment that symbolically got kicked off in 2018 when Trump initiated his “trade war” with China. This realignment will continue for at least a decadeand will be happening on multiple fronts. Perhaps to understand better where the world is going, let’s define the broad goals of National Conservatism. I have been debating whether to call it Labor Conservatism or National Conservatism, but David Brooks of the New York Times labeled it “National Conservatism” and many already refer to these folks as “NatCons” so I will stick with that. Brooks’ attempt of course is to paint this as an ethnocentric movement and disparage it as a new form of fascism, but the reality is the movement’s focus is more on repairing the relationship between Capital and Labor. There is a new think tank called American Compass created by Oren Cass (pictured below) started in 2020 that is trying to craft this new conservative ideology. Of course to the great intraparty opposition by libertarians and neocons – the losers in this ideological conflict. The think tank is funded by moderate Republicans like Mitt Romney and its proponents are younger Gex X senators like Senator Marco Rubio of Florida and Senator Josh Hawley of Missouri. You can read the American Compass Annual Report here. Below I am going to outline my understanding of National Conservatism. Much of my views on the topic are formed from the writings in American Compass. Of course this National Conservatism ideology brand new and under development and I am sure there are various perspectives on it – this here is mine.

Rules for Limiting Market Fundamentalism

The main goal of the National Conservative movement is to come up with a framework of rules of limiting market fundamentalism.The conservative position on the economy has always been that there should be no government involvement and that there should be no rules or restrictions on private sector economic behavior. Economic liberties should never be constrained via bureaucratic regulation or taxation and the problem in the economy is always the government. Fed Chairman Alan Greenspan in the middle of the 20th century was a big fan of “counter-party surveillance” as a method for checking private sector excess but the 2008 Financial Crisis proved that this strategy does not work if every actor in the economy has incentives not to do surveillance when a rising tide lifts all boats.

Economic libertarianism or anarcho-capitalism is obviously an idiotic ideology from the very start since government is the ledger of record for property rights and the dispute resolution mechanism for contractual agreements (ie markets exists because of government not despite it). Proponents of anarcho-capitalism always point to an agreed upon private sector coalition of top business players that becomes ledger of record and I point out to them – what the hell do they think government is? Government is all the top mafia guys, Arthur’s round table of knights. Government IS a coalition of the top private sector players.

Unfortunately, anarcho-capitalist nonsense somehow got reinforcement when the Soviet Union collapsed, as if the failure of communism as an economic ideology somehow automatically validates the success of anarcho-capitalism. The question always is: why did communism exist in the first place if unregulated laissez-faire capitalism is so perfect? The answer is that it isn’t perfect. The failures of capitalism during the Robber Barron era of the late 19th century is what led to the Marxist movement to establish worker rights and later communism as government organization ideology in the 20th century. In an economy there are always economic actors who are more efficient and those who are less efficient. The more efficient will take over the less efficient. This is a process that knows no bounds and when left unchecked and unregulated, it results in a “there can be only one” economic system of monopoly or oligopoly – a state of very few winners and many, many losers. This process resulted in the Gilded Age and the Robber Barons. The winner-take-all process of unregulated capitalism sidelines many very capable people who simply aren’t the best of the best. A system that wastes its productive human capital like this simply can’t survive in the long run. A more utilitarian economic system is needed.

But communism is no answer either. Communism also failed because total collective ownership is simply not natural. When there is no generational continuity of property and knowledge, there is no incentive for individuals to build property or knowledge. Communist leaders always pose the JFK maxim to their populations “What can you do for you country?” The retort always is “What can the country do for me?” This standoff between government and its people is a quick road to nowhere. People work for themselves and then out of their property and earnings they decide how much to contribute to collective enterprise. This is not a very complicated setup but it is amazing how it gets screwed up everywhere around the world except in Anglo-Saxon nations. In communism, over long enough period of time, the lack of individual incentives ends up producing a lack of results and lack of economic activity.

Thus the ideological extremes of both individual action (laissez-faire capitalism) and collective action (communism) are both economic failures in the long run. The truth is somewhere in the middle – there should be restraints on economic actors in both the public and private sectors. But who would put those restraints? Modern day Democratic Liberalism has an easy answer – government should put restraints based on public sentiment/polling and bureaucratic expertise. Government is of the people and therefore knows best. The problem is that in practice, government policies get applied by the government bureaucracy which is a very small portion of the population. Often you end up with policy overreach – the policies are really out of step with the majority opinion. An example of this was the Trump travel bans from Muslim countries or Biden’s private sector vaccination mandates. These are policies driven by ideological extremists in the bureaucracy. The problem with government bureaucracies is that the agencies get staffed with ideological extremist who are way out of touch with the general population. All you have to do is look at the nomination of Saule Omarova to head the OCC. A government agency pick doesn’t get any more ideological and out of step with the American population than that.

But there is another issue – it’s not like the general population can be an expert in every topic. People can be really stupid on occasion due to lack of expertise. The crowd doesn’t always know best. Sometimes those publicly determined and imposed restraints result in good economic outcomes and many other times they don’t. In particular, if the government becomes overly activist and political in its economic policies, you have the emergence of black markets that end up going around the nonsensical regulations anyway. It is a mistake to think that in communist countries people didn’t believe in a command-control economic system. They did. They were simply wrong. They believed in a system that doesn’t work.

National conservatism seeks to find restraints to market fundamentalism that originate not from the government but from the citizens and workers who are also economic actors themselves. Instead of skewing government policy against workers and citizens as the conservative movement has done for the past 100+ years when in power, National Conservatism would give workers and citizens a seat at the table alongside Capital. National conservatism views Labor as the natural check of Capital. This is very different than prevailing liberal ideologies that simply want to see Capital completely excluded as a decision making factor in government policy. This is also very different than the current conservative ideologies that want to see Labor completely eliminated from policy decision making. National Conservatism seeks to find that middle between orthodox liberalism and orthodox conservatism.

Decoupling Benefits from Employment/Unbundling of Organized Labor

National Conservatism seeks to decouple Labor representation from the Labor Union movement which is viewed as being overly political. Labor Unions aren’t purely economic actors, they are also political actors that are driven by directives of Democratic Party and express opinions on social issues. The political activism of Labor Unions thus reduces their ability to be an effective economic check on market fundamentalism.

The biggest flaw in the US labor system today is that benefits are tied to an employer. Labor unions are entities that exist inside an employer and represent collective bargaining rights of employees only inside a specific employer. Labor unions actually tie employees to a given employer. This system doesn’t work because employees have to renegotiate benefits from scratch when jumping to a new employer or as is often the case – lose them altogether. That presents Americans with a massive Benefits Cliff. Labor mobility in the US economy is thus severely constrained because employees have to reckon with the Benefits Cliff. This puts all of the negotiation advantage with Capital. Also wage and benefits negotiations are bundled together in the agenda of a Labor Union. There is simultaneously bundling of negotiation items and lack of portability of benefits. It is a terrible design. All of this serves to harm employees and it is no coincidence that American labor unions have largely seized to exist. They were just malfunctioning entities from the start and were doomed to failure.

However, collective bargaining is a real force and real check to Capital and simply needs to be reconfigured and utilized in a different fashion. Benefits need to be portable from employer to employer. Moreover, a better bargain can be struck since benefits of scale can be achieved through federation. What if benefits were negotiated at the sectoral/industry level instead of the employer level (let’s say at auto industry level)? Wouldn’t that result in better and cheaper benefits? Sectoral bargaining can be done by creating a special class of non-profit organizations that deal with employee benefits. Those non-profits will have a defined mission and can only participate in a specific set of activities such as negotiating unemployment insurance benefits, health insurance benefits, paid leave benefits and so forth. Those non-profits will be prohibited from any political involvement of any kind. Their sole purpose will be to do collective bargaining on behalf of workers. Let’s call these a “Worker Benefits Organization” (I am winging it here). One WBO can represent all auto workers in the country for example. Another WBO – all graphic designers or maybe all computer workers. These will be organizations with participation in the millions to tens of millions. The larger they are the better because they can negotiate better discounts with benefit providers. WBOs will set the terms of how much burden employees carry, how much burden employers carry and how much government can subsidize a specific benefit. WBOs are thus very efficient middleman that can drastically reduce the costs of many of employer provided benefits in America. This increases both corporate profits and real worker wages at the same time. The creation of the WBOs will be massive boost to further the profitability of big corporations and will largely eliminate the cost of health insurance, unemployment insurance and other employee benefits from their balance sheets.

Since workers will be members of a WBO when they move from job to job they will no longer face the dreaded Benefits Cliff. The employer automatically accepts the WBO terms for various benefit plans and pays out benefits to each employee based on their WBO participation. For example, an employee health insurance plan won’t have to change just because they lost their job (which is really out of their control). Majority of layoffs and business failures are due to business cycle fluctuations and industry competition. In fact, economic resilience will be greatly improved because labor mobility will increase. Higher levels of labor mobility create more resilient economies since zombie firms die faster and labor capital is more efficiently relocated to better management. Thus WBOs and the portability of benefits they engender is a huge driver of economic growth inside the country and will enable a much faster reallocation of labor during periods of large economic duress like COVID.

Rise of Gig Economy/Elimination of Single Employer Employment Model

I have never been a fan of the single employer model. In fact, I have always hated being an employee. I got off the employee track as fast as I could. I incorporated an S-corp by my 5th year out of college and most of my tenure on Wall Street was actually as a contractor. I worked at Goldman for 4 years as a contractor. They offered me to be an employee after I was there for 6 months, but I declined. My Goldman boss didn’t like it at all, but I always viewed all my job as temporary assignment and I have always resented identifying myself with a particular company. But more importantly, in my own S-corp I could customize the benefits to myself and I didn’t want to deal with a different benefits setup when going from company to company. So these things I talk about here, I practiced in my life.

I have always viewed work as project based. To me a company like Goldman Sachs is not one company that does the same thing all the time. All banks go through rapid change internally. If commodities are booming, Goldman creates a commodity trading desk for the 2-3 years they are booming and when the boom ends, they close up shop. Thus Goldman is really an umbrella structure over a series of companies that exist for a limited amount of time. Goldman is just a label for a bunch of guys who are constantly sprinting from one project to another. There is a tremendous amount of turnover and creative destruction. The larger economy is similar to Goldman. Industries and practices always change due to competition and innovation. Work and skills required on projects change all the time. Therefore I have a Project Based view of the economy. You have a project to do – you gather people with the skills to do it and when the project is over, everybody goes to do something else. The grouping into corporations I view as somewhat arbitrary.

In fact, I don’t think people like their entire livelihood being tied to one employer. People don’t like being fired and in fact the single employer model leads to employees doing really stupid stuff to preserve their jobs. I am totally in favor of dismantling the single employer model. Good managers should be able to handle multiple projects and they don’t need the threat of firing to motivate workers. I think the best outcome for both employees is when they actually have 2 or 3 part-time gigs. I think this would be a tremendous improvement over the current system. If you have 2 jobs and one of them goes away for whatever reason (industry or economy sucks), the worker doesn’t lose all of his income. The income gets cut in half but that person doesn’t go to zero income and then become dependent on the government. A proper conservative movement should seek to not only decouple benefits from employers but also eliminate the single employer model and move to a Gig Economy model.

I have worked at many Wall Street companies and to me the tech teams overall are usually 4-5 core members (the VPs) and everybody else on the tech team is really a contractor who is hired for their skills which are needed for a few months. This model of having 4-5 core employees and then everybody else being a skills based contractor is really the best way to run projects, corporations and the economy overall. Too often corps hire somebody for a specific skill and then try to mold him/her to do other tasks which the employee doesn’t want. My wife had this issue at her last job. She was hired to be an accountant and she loves being an accountant. But the company started giving her other tasks like doing Human Resources work which she need to learn on the fly. She then started resenting her job. When she lost her job, we now migrated to a new model. She now has 2 jobs where she is an accountant in both, 20 hours each. If one gig ends, she has the time to find another gig without going through an existential panic of her income going to zero. She is doing what she is good at 2 places that need her. She is happy and both of her employers are happy.

Broadly speaking, a move to Gig Economy on steroids and eliminating the single employer model will result in tremendous resiliency of the US economy which will be coupled with tremendous amount of innovation. People will constantly be employed in some capacity which means their skills will remain relevant. At the same time there will be less dependence on government benefits and lower government burden. Labor capital will be more efficiently moved to what the economy needs and to those who manage it better. This is an inevitable development that will be aided by cloud and blockchain technologies. In fact, the rise of the crypto industry – which is really a pure play on a project based economy – is clearly showing us what the future economy will look like.

Board Representation for Workers

For legacy industrial companies where you have a lot of blue collar labor, National Conservatism envisions a seat the table for workers. Workers would create Worker-Management Organization (WMO) inside an employer and then elect a representative that will sit on the board of the corporation. Senator Warren’s proposal is to staff corporate boards with 40% of labor rep but NatCons view this is as too much worker representation. Currently worker representation on boards is zero. Natcons would allow for 1 seat or maximum 2 seats. The point here is that worker rights are represented (as opposed to not represented), not that worker rights become the dominant decision maker inside big business. Workers should have the option of board representation, not an automatic seat they must fill. Worker board representation should be a feature of labor law (which is federal) rather than corporate law (which is the province of state governments). The initial priority should be worker board representation for employees of the largest corporations, which employ the preponderance of the American workforce and have the most well-established corporate-governance infrastructure.

Industrial Policy/Protection from Foreign Geoeconomic Attacks

The “between the lines” promise of Trump in the 2016 election was the return industrial policy. Obviously, instead of industrial policy we got anarcho-capitalism because Trump is a liar and a fool. But with his verbal attacks on China, Americans assumed with Trump they will get a return of Nixonian industrial policy and a conservative government approach to regulating trade and commerce. Obviously they didn’t get that. They got some insane “Art of the Deal” stock market manipulation crap that permanently severed the relationship with China in the worst possible way. It made the Chinese lose complete respect for America. Trump was an absolute embarrassment.

But what American want in this case is correct: China and Europe do use industrial policy to rig trade and commerce in their favor and there is no natural “free market” response to that. The goal of industrial policy to relocate production and tax base into a country and China and Europe have been very successful at thinning out the American tax base, removing production from America and thus devaluing the US dollar, weakening the American economy and denting American geopolitical strength and prestige. They have been so successful that America today is a shell of its former geopolitical self. There is only one way to fix that and that is for America to have an industrial policy of its own.

The goal of American industrial policy, however, is not to pick winners and losers like Democrats want (for example favoring green energy) but simply to level the playing field for businesses and consumers against the industrial policy of other major geoeconomic cartels like China and Europe. Thus the industrial policy that National Conservatives propose is to be defensive in nature rather than activist. The important thing to for conservatives is to recognize here is that industrial policy must exist and must be part of the government policy toolbox. This is something that libertarian ideology has failed at for the past 40 years and as a result we have 60 million people in the American heartland without proper representation in government. This is a human tragedy. We have mass layoffs and communities that are falling apart. Your worst enemies wouldn’t pick libertarians to run the economy like conservatives have for the past 4 decades. It is a natural disaster that has befallen all those communities in America.

The goal of National Conservatism to erect protections for those communities and to give them a chance to succeed in a reconfigured world economy. And the only way to do that is to counter the industrial policy overreach of foreign governments with a defensive industrial policy of our own. Ultimately, National Conservatives see both a purely market based approach or a purely government based approach to economic policy to be both poor policy. Instead they view broad government support that leaves much to market (but not all) for key industries that are being attacked as the optimal approach for government policy.

Community Protection from Private Sector Collectivism

American communities have also another enemy that is non-governmental in nature – big businesses. International corporations are now so massive that they have power almost equal to that of governments. In fact, corporations staff the government with both politicians and bureaucrats. Unlike governments, however, businesses are completely unaccountable to the public and can pursue devastating economic policies that bring to their knees local communities around the country. While obviously businesses should be allowed to do what they want, once they get big enough to influence governments, big businesses present a private sector collectivist force that needs to be regulated, just like public sector collectivists (the government) are regulated by the American public via the US constitution. There needs to be an institutional check on big business. The US constitution writers didn’t foresee big corporations as such a big factor and didn’t set up the system to account for them.

Woke capitalism has become an escape hatch for socialists who have realized that public sector (ie government level) socialism will be always met with vigorous resistance by the conservatives US government. Instead, socialists have chosen a guerrilla approach to fight back by seeking refuge in private sector corporations because US conservatives don’t regulate the private sector. The socialist went to fight where conservatives don’t fight. As corporations grow bigger, their worker policies and more importantly customer policies become an ever bigger factor in the economy and society. Today if you want to watch a Clarence Thomas biography you are likely to do it on Google YouTube or Amazon Video. What if both Amazon and Google decide to censor Clarence Thomas biography for whatever reason? You can’t watch it. Thus big corporate censorship and other internal policies can have tremendous social and economic impact and they absolutely must be regulated by the state to ensure common access and generally accepted behavior/censorship rules. This is no different than requiring electrical companies to provide electricity to everybody in the country. At a certain size, you simply can’t allow social scoring systems to influence business behavior and allow socialists to do social engineering via the private sector.

American conservatives have always relied on the idiotism of libertarian anarcho-capitalist ideology to guide government policy and that has cost America dearly over the past 40 years. All we have as result is the hollowing out of America and reducing its gravitas in world affairs. If the goal of libertarians was to embarrass America, they certainly have succeeded. The stance of all the GOP Senators for the past 40 years was to celebrate Facebook and Google as if America is the only place in the world with big corporations. You know – never mind Samsung. The GOP of today has a totally idiotic Cold War era mentality that drowns in outdated symbolism. I mean people like Chuck Grassley couldn’t be any more fossilized. And he has the temerity to run for reelection at 82. Under the mismanagement of morons like Grassley, socialists have taken over big corporations through classic communist crowd management techniques such as backdoor committee shaming and consumer boycotts. Big corporations in America have a mandate to make money for shareholders and when threatened with loss of customers via a customer boycott they fold to the demands of social activists. Any issue can be made controversial and in the age of social media used as a weapon of corporate destruction. Thus control of business leaders through consumer boycotts is super easy. Private sector collectivism now is being used to transform America to a land of liberal idiots. No wonder why China and Europe no longer respect American conservatives like Grassley. What is there to respect? He is a complete idiot and dumb as a brick. And moreover doesn’t have the humility to retire. GOP fossils like Grassley are getting metaphorically slaughtered by socialists while they sing songs about times long past. Witness the latest $100 million Obama donation by Bezos to fund Obama’s library. The only thing missing from this picture is Bezos prostrating himself and kissing Obama’s feet.

The goal of National Conservatives is to establish procedures to protect both workers and customers from private sector collectivism gone astray. The first step is to identify big corporations that need to be designated as “common carriers” of goods and services. Then these Designated Common Carriers (DCC) have to be forced to obey generally accepted rules for doing business and be hit with big fines and cease and desist orders if they start to become activist organizations. In other words, we need to create “Common Carrier Rules Organizations” (CCRO) that will define what these rules/regulations are and then the designated big corporations through federal law need to be made to comply with these rules. CCRO rules are similar to government regulations but not entirely because the CCRO membership will consist of private sector and public sector organizations as well ordinary citizens.  Thus CCRO rules won’t be subject to political infiltration like government bureaucracy is.

Foreign Agent Registration for Big Corporation with Large Stakes in Strategic Adversary Nations

The major stakeholders of big corporations and financial organizations need to be under closer government scrutiny and be forced to register as foreign agents if they have large investments in countries which the US considers “strategic adversaries” like China and Russia. It is very important that the lobbying activity of these large corporations/Wall Street players be properly discounted in discussions of national security and national economic security. An example of this is somebody like Ray Dalio. Ray Dalio has massive investments in China and his company’s domestic lobbying behavior is heavily influenced by the Chinese government to the benefit of China and to the detriment of America. Yet Ray Dalio and Bridgewater aren’t labeled as foreign agents and thus their lobbying activity in DC is viewed as if it is purely domestic. That is wrong and something that can’t continue to happen as it results in very bad government policies for Americans. If big corporations have a big enough lobbying presence in Washington DC, it needs to be forced to register as a foreign agent of the strategic adversaries it represents. The threshold for registration is having assets north of $1 billion in a strategic adversary nation.

Conclusion

The root of this National Conservative movement is the failure of both the Bush neo-conservative and Clinton/Obama neo-liberal movements over the past 40 years to put restraints on market fundamentalism because both movements ideologically believe that markets know best. This is part ideological laziness and part political inertia. This lack of market regulation in turn got exploited by China with clever industrial policy and resulted in mass offshoring of jobs to China and disenfranchisement of 60 million Americans – a population the size of Germany. When viewing National Conservatism through historical lens, I offer this progression of general politico-economic ideology: Communism arose as a reaction to the failures of Laissez-faire Capitalism in the 1930s since the unregulated capitalist economic model resulted in a highly unequal and stagnant economy. Then in 1980s, Neo-conservatism arose as a reaction to the failures of Communism because Communism ran out of big economic development ideas and couldn’t generate economic growth after industrialization phase was completed. In 1990s, Neo-liberalism arose as reaction to Neo-conservatism because Neo-conservatism was a spent force after the collapse of the Soviet Union and large military buildups were no longer required. In 2010s, China’s State Capitalist model (allowing big corporations to flourish within the constraints of a collectivist economy) arose as a reaction to neo-liberalism because neo-liberalism refused to counter China’s geoeconomic attacks via industrial policy. Now America needs an ideological answer to China’s State Capitalism. That answer is National Conservatism.

Above I outlined 6 areas in which the National Conservative movement can improve the present economic status quo and strengthen American’s national and economic security. This list is not a comprehensive list by any means and I am sure there is a lot of other people with good ideas on what National Conservatism is, but this is a good start:

  • Decoupling Benefits from Employment/Unbundling of Organized Labor
  • Rise of Gig Economy/Elimination of Single Employer Employment Model
  • Board Representation for Workers
  • Industrial Policy/Protection from Foreign Geoeconomic Attacks
  • Community Protection from Private Sector Collectivism
  • Foreign Agent Registration for Big Corporation with Large Stakes in Strategic Adversary Nations

I think National Conservatism will be the dominant ideological force in American politics over the next 20 years and the rise of the natcons starts right here and right now with the 2022 mid-term election. By the 2024 election, the US President will be chosen from the natcon camp (I happen to think it will be Ron DeSantis). By addressing worker rights and the gig economy, Republicans will be able to successfully counteract political attacks on economic issues by progressives and Democrats will no longer be able to split Republican voters on economic issues. This political weakness of the GOP has been exploited to great effect over the past 20 years and it is time for the Republican Party to mount an effective response. That response is National Conservatism. Trump’s emergence on the political scene in 2016 was the very first and very clumsy attempt at defining this ideology. With the benefit of time, this ideology is now coming to fruition and we will see its implementation in the future.

This coming Wednesday, I will be attending the inaugural “Henry Clay Lecture in Political Economy” in Washington DC. This is a speech that will be given by Senator Marco Rubio in front of the American Compass think tank. I think this speech should put National Conservatism on the American political map and you will start to hear about it in media more often going forward.

Reference articles:

https://www.theatlantic.com/ideas/archive/2021/11/scary-future-american-right-national-conservatism-conference/620746/

Bitcoin Killer: The Narrow Bank Stablecoin

Originally sent to VIXCONTANGO subscribers on February 6th, 2022

There has been a question I have been grappling with for the past couple of months with regards to stablecoins and I am sure that same question has been vexing the Fed as well: Are stablecoins going to kill off fractional reserve banking? Fed researchers issued a paper last week called “Stablecoins: Growth Potential and Impact on Banking” that discusses this problem and I found this paper very helpful in formulating my thinking on the subject. Note that the solution I propose here is very different from what the paper recommends and what the Fed currently thinks, but I think the approach I outline ultimately will win in the end.

Currently, there are 2 major stablecoins – USDC (USD Coin) issued by Circle and USDT issued by Tether. USDT has $78 billion in AUM while USDC has $50 billion. They are both big and quite widely used in the crypto ecosystem – USDT is primarily used a trade settlement asset on digital only exchanges like Binance while USDC is used as collateral in DeFi apps like Aave and Compound. However, the two coins have very different implementations behind the scenes. USDC essentially takes US dollars, puts them in a bank account and then issues 1 USDC for each $1 in the bank. In contrast, USDT takes your $1 and with it purchases securities (ie loans and notes) with short duration such as Treasuries and commercial paper. USDT is very similar to a money market fund while USDC is very similar to your savings account at a bank. Because USDT is backed by bonds, crypto traders prefer it as a settlement asset – if the crypto market tanks, traders would buy short term bonds as a hedge and that is what USDT is. Thus when you have crypto market stress, the paper finds that USDT actually rises in value. It acts as a VIX of sorts and the reason is because traders buy bonds when risk is off (it’s like buying AGG when SPY sells off). The Fed paper calls the USDC approach “two tiered intermediation” while the USDT approach “security holdings”. The Fed paper finds that those two designs aren’t really all that different from the current banking system. Putting money in USDC is the equivalent to parking money in a commercial bank while putting money in USDT is the equivalent of buying commercial paper and Treasuries. So the answer to the question whether current stablecoins like USDC or USDT will kill off fractional reserve banking is a resounding NO. But this is not all.

The paper also introduces a 3rd theoretical stablecoin design called the “narrow bank” in which the stablecoin is backed by central bank reserves. This is very interesting and very powerful concept. There is no such narrow bank stablecoin at the moment, but Circle’s boss Jeremy Allaire is pushing very hard for regulators to turn USDC into a narrow bank stablecoin – ie for USDC to be backed by central bank reserves.

Generally speaking, the Fed is very leery of “narrow banks”. It doesn’t like them. In 2018 there was bank called “The Narrow Bank” (TNB) created by a former New York Fed Research Director James McAndrews which applied to become the first narrow bank in the US but was summarily rejected by the Fed. The purpose of The Narrow Bank was to serve non-bank financial institutions and provide them with direct access to the Fed’s central bank reserves. There is such a bank in Norway called “Safe Deposit Bank of Norway” used by high net worth individuals and institutions such as pension funds and sovereign wealth funds. Institutions want their money to be safe during market turmoil and there is nothing safer than central bank reserves in the modern banking system. Institutions know better than regular people that banks are fractional reserve institutions and lend out their deposits at minimum 8-1 ratio and therefore are risky – subject to a bank run. So if institutions put their money there, they know they aren’t guaranteed to get them back and to top it all off currently they are getting a bad rate of interest of 0%. Note that big balances at banks also aren’t FDIC insured. While retail deposits are insured, institutional deposits aren’t. So there is a whole lot of risk and no yield and institutions don’t like that setup one bit. For the non-bank financial institutions, James McAndrews was their man at trying to create this unique financial product in the USA, but it didn’t happen. Why?

Because the Fed doesn’t want to kill off fractional reserve banking. I discussed in my “Stablecoins vs CBDC” article how fractional reserve banking was Medici’s main invention and how it produced more economic growth than otherwise and the Fed isn’t about kill that banking invention/golden goose. If you have a Narrow Bank in existence, the Fed envisions that in times of economic trouble people will run to the narrow bank because central bank reserves are the ultimate safety and thus abandon commercial banks for good. All the deposits will become central bank reserves and banks will go caput. When that happens, banks obviously won’t lend and the economy will collapse. Fractional reserve banking disappears. Unlike China, in the US the Fed doesn’t believe that the central bank should become a centralized lender – that amounts to a communist takeover and central planning. There is pretty wide agreement that lending decisions need to be decentralized in order to avoid the fate of the Soviet Union. In fact, if there is one thing that people agree on unanimously in the US is that there are too few banks in the US in the aftermath of the Financial Crisis and that the big banks have grown too big and too centralized and need to be broken up. For that reason, the Fed is not going to approve a narrow bank that will compete directly with existing commercial banks (don’t forget the Fed partially represents the banks). For the same exact reason, the Fed is really leery of turning USDC into a narrow bank stablecoin and so far has resisted Jeremy Allaire’s overtures.


However, I think the Fed researchers and the Fed are thinking about this all wrong. There is critical omission here: there is already a narrow bank in existence currently and its name is CASH. Bank notes (or cash) are direct liability of the central bank – in other words they are themselves central bank reserves. So if an individual wants the ultimate safety, he can put a ton of cash in his basement. In fact, in Europe many wealth advisors have contemplated storing mountains of euro bills in bank safes as opposed to holding them as commercial bank deposits.

Still there is a critical difference between cash and central bank reserves. Cash has a permanent interest rate of 0%. Reserves on the other hand are a yield products – the Fed pays the IEOR rate on central bank reserves. Paying a positive rate on reserves is really a policy decision and different central banks have different approaches. In Japan the rate on central bank reserves is set to zero regardless of what the rate in the interbank market is (which in Europe and Japan has been mostly negative over the past decade). There is really no reason for the Fed to be paying positive IEOR rate because there is no solvency or liquidity risk for central bank reserves. They are the safest asset in the banking system. Many liberals in the US staunchly object to a positive IEOR rate and for good reason. BTW, the IEOR rate was renamed to IORB rate (interest rate on reserve balances) in 2021 and there is a new series for it at the FRED. IEOR series has been discontinued.

If the Fed simply creates a new special rate only for narrow bank reserves and sets it to zero, then a narrow bank stablecoin solution all of sudden becomes not only feasible but also desirable. Why? Because the Fed goes back in time to the pre-Financial Crisis financial system while simultaneously preserving the stability innovations introduced in its aftermath.

Before the Financial Crisis, the US had a normal financial system in which people who wanted a stable currency could put their money in cash. If they wanted to take risk, they put the money in a commercial bank deposit and would get 4-5%. They were compensated for the risk they were taking with the fractional reserve banking system and simultaneously they were not compensated for being in a safe central bank reserve instrument like cash. Everybody was happy – if people felt the economy and the banking system was in trouble, they could store cash under the mattress like Tony Soprano. If they thought the economy was doing well, they could go and take risk and put their money in a bank account and get paid 4-5%. However, our constantly virtue signaling government was not happy that drug dealers like Pablo Escobar had billions in cash and they wanted to put an end to cash and its use in money laundering and drug trafficking activity. From about 1985 on, the US government stopped printing cash. As a result, people were forced to put money in commercial banks. Commercial bank deposits vs cash ratio kept increasing from a historically normal, fairly stable 1-8 ratio to 1-10 to 1-15 and culminated at 1-20 ratio right ahead of the Financial Crisis in 2007. In other words, by refusing to print cash, the Fed massively leveraged the financial system over a period of 2 decades and the system ultimately collapsed from the accumulated leverage. Then Bernanke was forced to print cash in 2008 like a maniac but instead of printing cash, he printed central bank reserves and put them in the US banks. Obviously, the US government didn’t want to print cash that would end up in the hands of the likes of Pablo Escobar and so it printed reserves which can be very tightly controlled.

The problem with reserves though was that banks no longer wanted to lend. Bernanke himself killed the fractional reserve banking system. BTW the IEOR rate was 10 bps higher than the Fed Rate. Banks would rather keep the money at the Fed and get the IEOR rate instead of take risk and lend it in the economy. So the Fed’s worries about issuing a narrow bank stablecoin stem directly from Bernanke’s mistakes. But the Bernanke mistake wasn’t so much that he issued reserves and reduced leverage in the system, but that the IEOR rate was basically the same or higher than the Fed rate. You can’t have the commercial bank rate (Fed rate) be the same reserve rate (IEOR). IEOR has to be lower than the Fed rate in order to encourage people to take risk in the commercial banking system. It is just a fact that central bank reserves are of lower risk than commercial bank deposits and that needs to be reflected with a differential in those rates. You can’t have the difference between these two rates being 10 basis points. The spread between these rates needs to be 200 to 400 bps (2% to 4%).


If you implement USDC as a narrow bank stablecoin and set the narrow bank reserve rate to 0%, the Fed will accomplish everything that it wants to accomplish. USDC becomes the digital equivalent to cash. Institutions can go to USDC for safety and just hold it on the blockchain when they need to. But if they want to make money on their USDC and get positive interest, they need to lend it out in the economy (for example give it to Celsius or a commercial bank like Chase). The Fed can get away from the policy of Fed rate suppression that it has had over the past decade and banks can again offer 4% interest rates. If the Fed wants to stimulate the economy, it can issue new reserves in the form of USDC and have it directly distributed to retail. If retail can’t spend it and wants to save it, it puts it in a bank and the bank puts it to work. By having a differential rate between narrow bank rate and the Fed rate, the Fed will greatly incentivize an increase in commercial bank deposits. You end up with a dramatically bigger commercial banking system which is simultaneously safer than the pre-2008 system.

Censorship of any narrow bank stablecoin (like potentially USDC) has to be significantly more decentralized than a central bank digital currency. Censorship of CBDC is essentially a bureaucrat in the government. We know these bureaucrat positions go to ideologues so that is a tremendously dangerous setup and undesirable. Instead, censorship of the stablecoin has to reside with the stablecoin issuer (for example Circle) and the entities that custody your stablecoin such as banks or crypto exchanges (Coinbase). This is more similar to how the current banking system works. The Fed doesn’t censor cash or bank accounts. Banks do that. The only new addition to the censorship structure here is the narrow bank stablecoin issuer (Circle) because people can use self-custody wallets and then the only way to censor is through the stablecoin issuer. Basically the US government has to ask Circle to censor USDC while the Fed really is not involved at all because censorship decisions are inherently political and the Fed needs to stay out of that. I think this is a much more familiar and better setup. It is intuitive and people will accept it very quickly.

I completely disagree with the Fed paper conclusion that a narrow bank stablecoin will have a negative effect on commercial bank deposits. I think the exact opposite – it will increase them dramatically because it offers consumers a choice. They can pick the safety of central bank reserves for 0% yield or they can decide when to put those safe reserves to work in the economy for positive yield. On the other hand, a stablecoin like USDC which is backed by commercial bank deposits or USDT backed by securities is simply a return to the Pre-2008 financial system that led to the financial crisis. There is no cash equivalent instrument in that system and in times of trouble institutions will abandon USDC for non-sovereign safe havens like Bitcoin and Gold. The reason why Gold rose ahead of the Financial Crisis and after the Financial Crisis is because people were looking for a safe haven and there wasn’t enough cash to go around. So they were forced into Gold. If a narrow bank stablecoin is available, many people will choose that first over Gold or Bitcoin depending on their individual situation. That is why I call the narrow bank stablecoin a “Bitcoin killer”. If it was available, institutions would seek safety in central bank reserves via a narrow bank stablecoin first before they turn to non-sovereign scarce assets like Bitcoin or Gold. If the Fed wants to kill Bitcoin and put it on a downside trajectory like it did Gold in the 80s, it needs to have a narrow bank stablecoin (digital cash) in its arsenal. Commercial bank stablecoins (current USDC) or security holding stablecoins (USDT) are not going to be perceived as good safe havens in times of economic distress just like banks weren’t in 2008. It wasn’t until the Fed deleveraged the banking system in 2011 that Gold’s rise stopped. With a narrow bank stablecoin the Fed can keep the system as deleveraged as pre-Pablo Escobar.

A banking system with 0% narrow bank stablecoins and positive Fed rates is naturally self-governing. If the economy goes into recession and the deposits go from commercial bank to stablecoin, the overall rate in the economy goes down. Let’s say 10% of the money is in stablecoins earning 0% and 90% is in the commercial banking system earning 4%. The aggregate rate is 3.6%. If depositors move to 20% stablecoin/80% commercial because of recession, and the rates are unchanged the aggregate rate is now 3.2% without the Fed cutting rates. This type of system would make Fed rates far more stable and predictable and the Fed can really only reduce rates in a really big recession. By keeping commercial bank rates at 4%, institutions will be much more incentivized to keep their money in the banking system and take risk. The current system where you lower rates in the commercial bank system to 0% is simply not an acceptable proposition – investors don’t get paid for the risk that the fractional banking system poses.

If the Fed doesn’t approve of the narrow bank stablecoin design, it will face stiff competition from Europe and China. Putin and Jinping just signed a 30-year gas deal between Russia and China that will be settled in Euros worth about $120 billion. Euro stablecoins aren’t a big deal yet, but will be in the future. Europe can certainly try a narrow bank stablecoin or an equivalent CBDC type design. China already has its CBDC and I don’t know if you have noticed but China’s rates are nearly 4%. That is because its CBDC can act like safe haven for Chinese citizens and that allows the PBOC to keep rates on commercial deposits high. The Chinese know that America’s cashless financial system failed and that is why they told Hank Paulson “there is nothing you can teach us”. America’s financial system has been in decline for the past decade and the only way out is to reintroduce cash back into the system in the form of a narrow bank stablecoin. The Fed needs to allow the economy to risk manage itself. Removing cash impaired the economy natural risk management adjustments. Digital cash/narrow bank stablecoin is the solution going forward.

An introduction of narrow bank stablecoin here would enable the Fed to raise Fed rates to 4% and thus allow it to battle inflation with better credibility. Right now markets aren’t convinced the Fed can raise rates to 2.5% because it would trigger a bunch of defaults in the high yield market. But if there was a narrow bank stablecoin option for institutions, they can diversify away from Treasuries and high yield debt today, build out their portfolio with safe central bank reserve 0% yielding instrument and call it a day. Federal debt just passed $30 trillion. That means that there is about $3 trillion (10%) potential demand for a narrow bank stablecoin. The Fed can convert big portion of its central bank reserves to narrow bank stablecoins and call it a day. USDC and Circle in my view are the clear cut leaders that would profit from this type of transition. Allaire understands this whole situation and has been pushing for Circle to adopt a narrow bank design. And I think we are not far from the moment when he is going to get that charter. Watch for USDC market cap to explode in the coming year. Circle currently offers 4% yield on USDC because USDC is basically a commercial bank deposit at the moment. When it switches to a narrow bank stablecoin USDC will lose the yield but gain the world.

A transition of USDC to a narrow bank stablecoin is also key to my short Bitcoin thesis at the moment. The moment the Fed opens central bank reserves to the public via USDC, much of the safety bid in Bitcoin will disappear and Bitcoin will collapse rather dramatically. Don’t forget the Fed will be simultaneously making its reserve scarcer via QT. I don’t know how long it will take for this transition to happen but once there is consensus at the Fed to go down the narrow bank route for official USD stablecoins, these guys will move very quickly. And USDC already there, ready to capitalize.

Reference Articles

Stablecoins: Growth Potential and Impact on Banking

Fed’s CBDC Paper

The Narrow Bank

The Skinny on the Narrow Bank

Lunageddon

Originally sent to VIXCONTANGO subscribers on May 11th, 2022

The long awaited collapse (by many) of the UST algorithmic stablecoin has finally arrived. I call this event Lunageddon in reference to the 2018 Volmageddon when XIV (short VIX ETN) lost all of its value overnight. In this case, the Terra token LUNA went from about $80 at the start of May to currently trading at less than $2. Ouch. LUNA got XIVed. What happened here?

UST is an algorithmic stablecoin backed by the LUNA token. So long as LUNA has value and there is fresh new money coming in to create new UST, the code can maintain the peg. However, if there is more UST in circulation than the market cap of LUNA you could have a crisis of confidence because there is nothing backing the UST. That leads to a run on the bank ie run on the collateral. If you have a situation where people are dumping LUNA while creating new UST that would put the supply/demand dynamic of the two assets significantly out of whack. That’s exactly what is happening here. UST has been doing well over the past 2 years but they were bull market years – UST was fairly small coin and LUNA market cap was always ahead of the UST usage. This year we got the perfect storm conditions that could lead to a collapse of LUNA. The crypto bull market ended which in turn would lead people to dump LUNA. At the same time, what people do in bear markets is put money in US dollars to earn interest. That dramatically increased interest in UST this year increasing its market cap from about $8 billion to $16 billion. Terra’s Anchor lender offered the largest dollar yields out there with 20%. The yield was large enough to attract big flows. All of sudden the Terra system was awash with dollars seeking high yield. Which is fine if people were also buying the LUNA token. But because it is a bear market and interest rates are going up, big institutions were dumping LUNA. Seeing this confidence problem, Do Kwon (Terra’s creator) created a treasury which started buying Bitcoin and he committed to using the incoming dollars to buy Bitcoin which would hopefully end the run on LUNA. For a while that move worked, but then Bitcoin started crashing as well and we got a situation where all the collateral backing UST was losing value. At some point LUNA market cap dropped below the UST market cap and the peg was lost. UST trades currently at 60 cents. They have been trying to restore the peg for a couple of days to no avail. We’ll see if they recover the peg, but basically LUNA shareholders are paying for the restoration of the peg and if they run out of cash they may not be able to restore the peg. UST is being sold here as people try to get some of their money back. When UST is being burned then more LUNA is being minted (added to the market) and that is leading to massive collapse in the LUNA price as you are adding more LUNA in a seller’s market. Yesterday, a consortium led by Sam Bankman Fried and Novogratz tried to raise $1 billion to rescue the situation but it didn’t work out leading to further collapse of LUNA today.

This is by far the most high profile blowup in crypto industry history in my opinion. LUNA was a $40 billion coin at the start of April which then collapsed to a current $2 billion market cap by early May. We have a $38 billion loss here. UST itself had $16 billion market cap and now is less than $8 billion. If you add them together, we are talking about $42 billion in losses for somebody in the past couple of months. This is a blowup that is about 10 times bigger than the Long Term Capital Management (LTCM) in 1998. The bailout then was only about $3.6 billion dollars. Lunageddon is roughly equivalent to the Bear Stearns collapse. Bear Stearns had capital of about $65 billion when it collapsed in 2008. The bailout given to Bear by the Fed was about $25 billion. I know it is crazy to compare Terra with a 100-year old investment bank in Bear Stearns but there is a lot of money sloshing around in crypto these days. Crypto is the new investment banking. I think the hedge fund that is going to lose the most amount of money here is Mike Novogratz. He is a big holder of LUNA and its highest profile promoter and this collapse to $2 is painful. This, by the way, is yet another high profile blowup by Novogratz in crypto. If you remember, Novogratz previous debacle was EOS in 2018. Solunavax was a big trade in late 2021 and all those crypto hedge funds like 3 Arrows Capital and Galaxy Digital are getting killed here. Terra is at $2 (high of $120), Solana is now at $51 (high of $250), Avalanche is now $31 (high of $140). Lots of value is being destroyed here. Keep in mind that Sam Bankman-Fried has started hanging out with Bill Clinton and other former Epstein clients, financing woke Democratic candidates all over America and I am pretty sure crypto’s more conservative users don’t really want to invest in the SBF related tokens anymore – the most notable of which are Terra and Solana. Go woke, go broke.

Terra’s Bitcoin Bet to Restore Confidence in The Peg

Originally sent to VIXCONTANGO subscribers on March 14th, 2022

The biggest story in crypto right now is the Terra (LUNA) ecosystem which seems to be benefiting immensely after the sanctions on Russia. TerraUSD (UST) is the top algo stablecoin and its market cap has ballooned to close to $15 billion with $5 billion added just this year alone. At the start of 2021, UST had about $150 million in AUM so this has been an incredible rise over the past 15 months from basically nothing to a $15 billion coin and a Top 15 ranking. After the massive sanctions on Russia, UST is becoming crypto’s uncensored and unsanctioned US dollar equivalent and I guess money is flowing there because of that. I am guessing some of that money is Russian sanctioned money.

The main lender in the Terra ecosystem is the Anchor protocol (ANC) which offers 20% return on UST. My guess is this high yield is a reason for crypto natives to flock there in this bearish crypto environment where prices are getting cut in half. I have seen many of the Bitcoin guys talk about Terra lately and my guess is some of the inflows are Bitcoin whales.

In September of 2021, Terra made some changes to the protocol, the biggest of which was implementing IBC (inter-blockchain communication) and then hooking up to the Cosmos Hub (ATOM) and then becoming available on the Osmosis DEX (OSMO). That liquidity gave big boost to ATOM and OSMO and setup crypto only truly decentralized DEX system. They also made the protocol faster. But the biggest change Terraform Labs made was addressing the stability of the UST peg. UST is backed by LUNA and to address the fact that LUNA can become undesirable in a downturn and thus force UST to break the peg, the Terra foundation decided that they will add Bitcoin (BTC) as an additional reserve for UST. The original amount was $1 billion and since then Do Kwon has said that they will be buying up to $10 billion of Bitcoin to back up UST so that there is no question about the stability of the UST peg. Now UST is backed by LUNA and BTC and the Luna Foundation Group (LFB) is becoming one of the biggest buyers of Bitcoin out there. Now when people buy UST, they effectively also buy Bitcoin. That has been a very successful move and has endeared Bitcoin maxis to Terra. LUNA currently has about $35 billion in market cap and based on FDV has become the 3rd biggest coin after Bitcoin and Ethereum with almost $80 billion in FDV. Unsanctioned US dollars like UST is a big business and may become one of the biggest practical applications of crypto.

How does Anchor get its 20% return? Anchor is a decentralized lending protocol similar to AAVE. Lenders can post money there and borrowers can borrow it and pay high interest usually up to 10%. So where does the other 10% of interest come from? It comes from backing of the Anchor token (ANC) which is backed by staked LUNA and staked Ethereum (ETH). LUNA gives about 10% in staking rewards and Ethereum about 5%. So the Anchor protocol gets these staking rewards and gives it back to the users. In other words, the 20% rate is backed by both lending and staking activities. There is uncertainty about this 20% rate in Anchor and many people expect that rate to go down in the future particularly if more and more people flock to UST and Anchor and fight over a limited amount of generated rewards. Anchor has seen an explosion of TVL and is now about $13B in TVL after starting the year at around 8B. Terra’s TVL is now near its all-time high at $25B and is now the 2nd biggest chain by TVL. Incredible growth for LUNA TVL in what is a rough year for crypto. Anchor is planning to introduce staked Solana (SOL), staked Avalanche (AVAX) and staked Cosmos (ATOM) as reserve for the Anchor rewards in the future which will endear UST to SOL, AVAX and ATOM holders.

Everything so far sounds good for UST and Anchor in terms of the coin being backed by the best Layer 1 tokens in crypto and Bitcoin but I have serious problem with how centralized Terra is. The Terra foundation is in South Korea and is the holder of the reserves backing UST. So if you buy UST, you buy Bitcoin for the Terra foundation. The Terra foundation can get shut down by South Korea which at the moment is an US ally. Or Do Kwon and his partners can just walk out for whatever reason because they are threatened by somebody or just want to bolt with $10 billion in Bitcoin. I am not comfortable with how centralized the ownership of Terra is either – it is all the team and VCs. There was no community ownership at inception like most other coins like Bitcoin, Ethereum, etc. This level of ownership centralization bothers me and has prevented me from investing in LUNA. I just don’t want to be at the mercy of whales who want to dump on me. I am fine with UST being used as a trade settlement currency where you use it for short periods of time but I will not use it to park in a lender like Anchor or AAVE and make yield over the long term. I am just not comfortable with long term holding of UST. I will keep watching it but at this point I am not there yet.

Maybe the market forecasts that South Korea will not be in the US sphere of influence in the future after moves by China in the Pacific this year and thus UST really represents a US dollar with Chinese censorship rules that are outside the scope of US jurisdiction. For some people that might be exactly what they are looking for – let’s say Russian oligarchs. It seems that hedge funds are using Terra here. Terra has the highest TVL per follower of over $60,000 in TVL per follower. This stat has doubled and tripled over the past 6 months. These are big money – definitely whales or hedge funds. So big folks are using it and trusting its censorship rules. My guess if Russian oligarchs think that UST will have Chinese censorship rules they will feel comfortable parking their sanctioned money there. Certainly the spike in UST usage coincides with the Russian sanctions. Despite all of that I am not comfortable with parking money in UST and making 20% in Anchor. I’d rather still get 7% at Celsius in USDC.

On a side note, yes, the Celsius rate got lowered because there is less margin trading in crypto now that it has cooled off. Obviously, if I want to get 8% on my USD, I can do 90% in USDC at Celsius and 10% in UST at Anchor and that maybe acceptable risk to some but not to me. The Terra system is just very complicated with a lot of moving parts and dependencies and I need more time to get used to it.

The Terra Conundrum

Originally sent to VIXCONTANGO subscribers on December 6th, 2021

The hottest L1 token during this crypto drawdown has been Terra (LUNA). LUNA has gone up +30% over the past week as everything else has dropped. Terra’s TVL has grown to 14.4B during the pullback and has eclipsed both Solana and Avalanche in TVL which prior to this crypto drop were been the hottest L1s this fall. Now Terra is only 3 billion away from flipping Binance (BNB) for 2nd place behind Ethereum in TVL. These are pretty incredible developments for this Cosmos chain. In Tendermint protocols the number of validators is fixed and Ethereum degens don’t like that very much (“the chain is centralized”). Terra has 130 validators. Terra is also the only functional WASM chain out there and thus the only non-EVM chain with smart contracts. That alone is a very worthy accomplishment, but still its TVL growth has been surprising because it is clearly not Ethereum money powering it. Terra has a big backer in crypto hedge funder Mike Novogratz, but still that doesn’t explain everything that has happened recently.

Terra development is led by Do Kwon who is emerging a new top figure in crypto. Do Kwon was formerly a software engineer at Microsoft and Apple and studied computer science at Stanford University. He is South Korean and lives in Seoul. Prior to crypto he had a WiFi mesh network startup. He is about 30 years old. Do Kwon was served a subpoena by the SEC at a Messari crypto conference called Mainnet in Miami earlier in the year. Kwon has sued the SEC back for “improperly issue subpoenas” and “failure to keep confidential an investigation into the Mirror Protocol”.

Here is my conundrum with Terra: I am not surprised at all that the SEC is going hard after it. Terra’s main product is TerraUSD (UST) which is an algorithmic US dollar stablecoin backed by LUNA. UST is a synthetic dollar – it is not real. There are no dollars deposits backing UST at all. It is unlike USDT and USDC which both have backing with real dollars and real assets. Despite it being a fake US Dollar, UST has grown dramatically over the past 2-3 months from about 2-3 billion in market cap to $8 billion. This makes UST by far the biggest USD algo stablecoin. All of the TVL on Terra is from the lending protocol Anchor which basically enables lending in UST where Do Kwon is offering 20% yields on UST.

The problem that I have with Terra and that the US government has with Terra is that it is creating unauthorized liabilities for the US state. Effectively, on a very small scale Terra is printing its own counterfeit money. In addition, in the Mirror protocol Kwon is doing the same thing with synthetic stocks. He is creating unauthorized Apple shares, Tesla shares and so forth. These are shares that aren’t backed by anything other than the LUNA token. That was the reason for the SEC subpoena by the way. The US dollars Terra is printing are also backed by the token LUNA which in turn is bought with other currencies. So effectively, through code Do Kwon has been able to become an alchemist and conjure up Gold out of Lead – create US dollars out of the Korean won. Its US dollar coin UST is essentially backed by every other currency in the world via the LUNA token except the US dollar itself.

The chief attraction of the UST abroad is that it is censorship resistant. In other words, the US government can’t order a company to shut down certain addresses like it can with Circle’s USDC. For example, Iran can trade with Iraq using the UST and get the stability of the US dollar without the sanctions. In the crypto community, censorship resistance is paramount and they all want a censorship resistant US dollar. However I have always viewed that as an impossibility. It may not be a technical one but it is a legal one. A fake dollar is a fake dollar. It’s not created by the US and therefore it is not its liability. If you hold US dollars you implicitly import the censorship rules of the country that issues it. There is no such thing as censorship resistant US dollar. But Do Kwon has created one and so far he is succeeding in getting it accepted on the market. Getting $8 billion of UST in circulation out there is a big success.

I will not be surprised at all if the US government comes even harder on Kwon because of that. I am actually surprised the US government hasn’t been more involved and in particular Janet Yellen. I think one reason is that UST was fairly small this summer but in recent weeks UST has grown a lot and certainly merits closer attention. $10 billion in synthetic USD is not chump change. That is a lot of money. Mike Novogratz is a big sponsor of Do Kwon so I won’t be surprised if the US government goes after him. LUNA is not listed on any US based exchanges like Coinbase and Kraken so the US government can’t really hit it here. Trading in LUNA and UST is entirely abroad but I have a feeling that US government is going to get creative in shutting this down. I expect them to get the South Korean government involved. Crypto is fun and games, but once you start creating counterfeit US dollars, I think things get more serious. Bitcoin or Ethereum have never claimed to be something else (US dollars) but UST does.

On the other hand if the US government is unable to shut UST down, I think UST is going to become huge. Many people holding USDT will move to UST. LUNA price is a play on the popularity of UST. The bigger UST is in market cap, the higher LUNA will go. LUNA’s run maybe alluding to that. I personally am not touching LUNA with a 10 foot pole here. If the US crackdown on it fails, I will take a look, but ahead of the crackdown I am not touching it. If UST succeeds, Do Kwon is basically taking down the US treasury. America’s geopolitical enemies then effectively can devalue the US dollar by using UST. All they have to do is pour money into LUNA and they can turn their shitty currencies into US dollars and in turn devalue the US dollar. If you get more US dollars in circulation you trigger inflation in America and around the world. This whole thing can easily unleash a Pandora’s box of problems.

I honestly can’t believe this is happening. Do Kwon is playing a very dangerous game here. Don’t be surprised if you hear news about him jumping off a building in an unexplained suicide attempt. If he was messing with Putin, that probably would have happened already.

Terra (LUNA)

Originally sent to VIXCONTANGO subscribers on August 21, 2021

Terra is emerging as the 2nd largest Proof-of-Authority (POA) chain after Binance Smart Chain (BNB) with a $12 billion market cap. It has Galaxy Digital’s Novogratz as a major investor so I figured I look into it and try to understand what is happening there. I did some research last year, but I didn’t see a whole lot. Terra was one of many algorithmic stablecoin providers that were launched over the last couple of years and you know my opinion about algo stablecoins – I don’t like them. It’s also a Tendermint chain. There a lot of Tendermint chains that have gone nowhere. Everybody can spin up a Tendermint chain. That’s the whole point. What is notable is that Terra has 130 validators which is the most decentralized Tendermint chain that I know of. It also appears that Terra’s main product – the TerraUSD (UST) algo stablecoin – is taking off this year. UST has reached a $2 billion market cap and today is the 5th biggest US dollar stablecoin after Tether (USDT) 64B, USD Coin (USDC) 28B, Binance USD (BUSD) 12B and Maker’s Dai (DAI) 5B. UST started the year at less than $100 million market cap and $100 million algo stablecoins are dime a dozen. Something led to its rapid adoption over the last 6 months.

The way algo stablecoins work, they always come with 2 tokens – one token is the stablecoin and then 2nd token is the “reserve” currency. The 2nd token goes up in value if the stablecoin is used by more and more people and vice versa – if the market cap goes down then the reserve coin goes down. For example, with Frax, FRAX is the stablecoin pegged to the US dollar while Frax Shares (FXS) is the reserve coin. In Terra’s case, its own token LUNA is the reserve coin while UST is the stablecoin. The diagram below that describes the stable coin-reserve coin interactions is from Cardano’s Djed stablecoin documentation, but generally speaking all stablecoins more or less work the same way. There is a smart contract in the middle that manages the central reserve of the stablecoin and buys and sells the reserve coin to maintain the peg depending on real-time demand for the stablecoin. The reserve coins get staked and have limited supply and their value forms the base upon which the stablecoin can be pegged to $1. Reserve coins can be Ethereum (ETH), Bitcoin (BTC) or anything of value but usually it is coin of the protocol maker. Obviously one issue with all algo stablecoins is that if people lose faith in crypto markets, they dump the stablecoin, which in turn leads to a rapid decline in the price of the reserve coin and then reserve algorithm depends on whales showing up and buying the reserve coin to maintain the peg. If nobody shows up, the reserve collapses in value, the peg can’t be maintained and the stablecoin starts to trade for pennies on the dollar. There is an algo stablecoin called Basis Dollar (BSD) which trades for 2 cents to this day. It is very important for algo stablecoins that the reserve coin keeps its value. If it doesn’t, like in May and July, these things can collapse. Now that the crypto markets are going up, many of these algo stablecoins that had broken pegs in July have been able to restore their peg. But those pegs will only work while the crypto market is going up. That’s probably one reason why UST market cap is going up now as well. If crypto is in a bull market, the algo stablecoins are a safer bet. Obviously we shouldn’t ignore that the entire stablecoin market has gone up 20-30 times this year so it’s not surprising that some of the algo experiments are getting traction. Also the word on the street it is that Terra stablecoin algorithm is really good and UST has never broken the peg, even during the May selloff. That maybe a reason why now UST is becoming the stablecoin of choice for algo stablecoin fans.

Terra has also become a little bigger than just a stablecoin provider. During its latest version “Columbus” released in August, Terra gained smart contract ability using WASM. WASM is the technology that Polkadot is supporting that also Ethereum will support in ETH 2.0. WASM is short for Web Assembly and this is an open web standard supported by everybody from Microsoft to Google on down. In other words, developers can write smart contracts in Rust and Go – two new languages that are gaining popularity among application developers – compile them down to WASM and deploy them to Terra. Terra is now the 4th Layer 1 chain that can run smart contracts after Ethereum (ETH), Binance Smart Chain (BNB) and Solana (SOL). Inside the POA sector (BNB, ATOM, LUNA), Terra is clearly the most decentralized with 130 validators and has the most advanced smart contract tech with Rust and WASM. BNB at this point is last year’s version. It appears that with Terra and Solana, Rust has become the 2nd most dominant smart contract language so far after Solidity (BSC, Ethereum and Avalanche). All in all, Terra seems to be the state of the art smart contract chain in the POA sector.

Over the past month, Terra has had 2 major smart contract apps deployed on it – Mirror Protocol and Anchor. Mirror (MIR) is similar to Synthetix (SNX) in Ethereum – it provides synthetic assets such as stocks or commodities. However, like the stablecoin UST there is no actual stocks or commodities collateral backing them. They are backed by LUNA and I am guessing the algorithm used in UST is reused to peg those. You just need an oracle to provide a price for an asset and then algo will peg to the price. So long as TVL (total value locked) is growing LUNA price will grow and these synthetic assets will work. Anchor (ANC) is a lending protocol similar to AAVE. People can put UST there or LUNA and get yield. MIR has $1.7 billion TVL which is quite large. ANC has $3.5 billion which is also quite large. So it seems between UST, MIR and ANC we have a total of $7 billion TVL in the Terra ecosystem. Not a bad start.

Competitively, I don’t think the emergence of Terra changes anything for Binance Smart Chain (BNB) or any of the other top POS chains like Cardano (ADA), Solana (SOL), Polkadot (DOT), etc. Each one has their own set of users and its own target market and users aren’t going to be jumping from one ecosystem to the other. While Terra is a clearly a very nice option, it is still a POA chain and POA will be always be lower valued than POS in the long run simply because POS tech is superior and more secure. I think there is a massive amount of Wall Street money coming and chasing everything POS and POA, so I don’t think over the next year any of these competitive considerations will matter. All L1s will be going up. In Binance’s case, CZ has an amazing mouse trap (I will be writing about Binance next) and it is very unlikely that his Chinese user base goes anywhere else. Binance users will be hanging on Binance Smart Chain and won’t be going anywhere. Cardano has its own set of users. Solana its own set. It’s a big world and there is space for everybody right now. If Terra only captures the South Korean market, it will do just fine. Terra’s core developers are in South Korea. I personally don’t like the Terra product mix – all of these synthetic assets and stablecoins in my opinion aren’t scalable. Institutions would rather hold actual digital US dollars than a synthetic dollar. They would rather hold tokenized stocks and commodities than synthetic stocks and commodities. While Terra may be a month or two early to market with WASM smart contracts I don’t think that gives it any long term advantage given its product selection. Maybe that will change, but I don’t see how Terra affects anything else.

LUNA is definitely a viable bet and if you want to bet on it, I don’t think that is a place where you will lose money over the next 6 months to a year. $12 billion is still a fairly low market cap and that can clearly go up for a functional smart contract chain that has institutional fans like Mike Novogratz. However, in the long run I don’t think Terra beats out Solana, Polkadot or Cardano in total market cap. I think those will be dramatically bigger chains simply because they pack so many more features and have bigger communities. For some period of time, however, Terra could provide superior percentage returns due to its lower market cap starting point and implied reserve coin leverage. If crypto markets top out and turn down, LUNA is one of the first tokens you need to sell because everything in the ecosystem depends on it and if TVL leaves the ecosystem, LUNA as a reserve coin will lose value fast. You definitely have to keep that in mind and make sure you don’t overstay your welcome in it. LUNA can lose -80% in a matter of days given that it is the reserve coin for all of the synthetics in its system. You have to think of it as a highly leveraged play on Terra ecosystem TVL. Very small moves in TVL can have big percentage impact on LUNA. If you’ve noticed over the past year, Cardano has very low volatility compared to other chains. Why? Because it is not used as a reserve asset. With LUNA you have to expect the opposite – higher volatility compared to other chains because it is a reserve asset. The more USDC and actual collateral is used on a given L1, the lower the volatility of its token. The more the token is used as reserve for synthetics, the higher its volatility.

Putin’s Ukraine Gambit

Originally sent to VIXCONTANGO subscribers on November 13th, 2021

Putin looks back in anger at Ukraine very often. It grates on him. He feels that Russia has been wronged yet again by the West and he thinks the time is now to do something about it. I am sure the 2014 events when the Ukraine government was captured by pro-Western forces caught him completely by surprise, but in his mind this story is far from over. In a rather lengthy recent articlePutin writes his expansive thoughts on the situation in Urkaine and gives a historical background and context with which to justify the invasion of Ukraine to the Russian people. I happen to complete agree with the history presented in that article which is about as factual as it can get. Long story short, Ukraine is a land of 2 types of peoples – Eastern Orthodox Christians (Russians and Belorussians) and Catholics (Lithuanians, Poles and Germans). Ukraine borders Poland to the West and Russia to East and Belorussia to the North. Putin divides Ukraine into Russians, Belorussians and Ukranians with the “Ukranian” label encompassing native Tatars as well as people of Lithuanian, Polish and German heritage. Putin clearly puts Belorussians in the same group as Russians.

To understand the ethnic composition of Ukraine you can look through its history. In the beginning from 800 to 1200s, you had the emergence of Old Russia (Kievan Rus) and Ukraine was basically the center of that kingdom with Kiev being the capital. At some point, there was a Grand Duchy of Lithuania in 1200s which was one of the biggest countries in Europe and the Western part of Ukraine was part of that Kingdom. Russians were pushed back to Moscow. Ivan the Terrible was the king who moved the capital of Russia from Kiev to Moscow. Later, there was a big Polish kingdom in 1500s and again Ukraine was part of it. Russia fought a series of wars with the Ottoman Empire, England and France (Crimean war) and captured majority of what is modern Ukraine (even though Russia lost the Crimean war itself) in the 1800s. As is often the case with Russians, they may lose a war but win the long term geopolitical conflict and that is certainly what happened with Ukraine. Ukraine was viewed as a border region by the Russians. The name “Ukraine” in Russian literally means “outskirts”. “Ukrainians” are therefore people sent to guard the border.

To go back to the present, the Ukrainian society is fundamentally divided among these longstanding religious and ethnic lines. On one side you have Russian and Belorussians who are Eastern Orthodox Christians and on the other side you have a compilation of Lithuanians, Poles and Germans who are Catholics. In fact that group of Germanic Catholics in Ukraine was one of the worst perpetrators of the Holocaust in WW2 where they killed about 1.5 million Jews in the span of a year. To this day Ukraine is one of the most prominent countries that votes down anti-Holocaust resolutions at the UN regularly. There are a lot of neo-Nazis in Urkaine and they are the people the US government affiliates with in this conflict with Russia.

If you look at the 2010 election in Ukraine between the Putin backed Januckovich and Western backed Timoshenko, you can clearly see the ethnic delineations of the country. The south of Ukraine right next to the Black Sea is all ethnic Russians while the north of Ukraine and particularly closer to Poland is let’s call it “ethnic Ukrainians”. Obviously, the seat of the Russian Navy is in Crimea so the surrounding regions all work for the Navy and as you would guess are packed full of ethnic Russians. Crimea is the equivalent of Baltimore. It doesn’t get any more American than Baltimore and similarly with Crimea and the surrounding regions – it doesn’t get any more Russian than that. Thus the south of Ukraine is not really “Ukrainian” and Putin wants to correct that mapping wrong. In the article Putin says that geographic regions of the former USSR were not drawn along ethnic lines but along economic lines and thus when the USSR fell apart the borders of Ukraine that the USSR mapped for administrative purposes really weren’t reflective of ethnic realities. Which is true.

Further, Putin accuses the Ukrainian government of trying to convert ethnic Russians and stops them from exercising their religion or learn the Russian language. That is obviously demagoguery but the “freedom to exercise religion” doctrine should sound familiar to any student of history. Defending the rights of Christians to exercise their religion was the foreign policy doctrine of Tsarist Russia which was used to wage a series of wars against the Ottoman Empire in the 1800s which resulted in the formation of series of states in Eastern Europe – Greece, Romania, Bulgaria, Serbia, Moldova, etc. Russia also has another doctrine of strategic defense which is to put a number of Russian affiliated states between itself and the West. The sudden switch of Ukraine is a total no-no for Putin. He says that “anti-Russia” Ukraine is not an option.

It is a foregone conclusion that Putin is going to move to annex the “Donbass” – the regions of Donetsk and Luhansk – to Russia. Putin has amassed 100,000 troops on the Ukrainian border. The question is whether he will proceed further. Some people argue for a “Land Bridge to Crimea” path of invasion which will also annex the regions of Zaporizia and Kerson. Others argue for blocking off Ukraine’s access to the Black Sea completely which means annexing Odessa and Mykolaiv. And fourth option is obviously invading all of Ukraine and converting the government. Of all of these, the path of least international resistance is Donbass, but I highly doubt the West can do much about a “Land Bridge to Crimea” scenario or “Blocking off Black Sea” scenario. These are areas that are vast majority Russian that want to be back into Russia. You should have seen the lines of people getting Russian passports after the Crimea annexation in 2014. If I were to bet, I’d put the odds of “Land Bridge to Crimea” at well above 60% and “Blocking off Black Sea” at 40%. Donbass is a 90% scenario here.

It is inevitable that Putin will exploit the current American weakness on the international stage to reclaim what he feels are true Russian territories such as southern Ukraine. The American government foray into promoting gay rights and calling white people “inherently evil” has very big repercussions in Eastern Europe and Russia. There was a tug-of-war conflict between social conservatives and Western oriented Russians over the past 3-4 decades and this foray into LGBTQ rights that started under the Obama administration has handed a decisive victory to social conservatives in domestic Russian politics. Ironically, Putin is actually a Western proponent inside Russia. Putin is the most Western friendly face Russia can produce. If Putin is replaced, he will be replaced by a far bigger conservative. This is something Americans don’t really understand – Putin is the best the West can get in Russia. As you can imagine, if I say Putin wants southern Urkaine, the real Russians want all of Ukraine. However, I don’t think a full blown Ukraine invasion is in the cards. West Ukraine doesn’t want to be Russian and is not Russian. That is a battle of high cost and little reward. Russia is much more interested in the Black Sea properties and that is where they will go.

Russia’s New Weapons

Originally sent to VIXCONTANGO subscribers on March 7th, 2018

Perhaps more interesting than all these conflicts are the recent new weapon announcements that Putin made at the March 1st State of the Nation address in Russia. What are those weapons? Hold onto to your seat now:

Sarmat ICBM (intercontinental ballistic missile)

This will replace the current Voivoda ICBM system. Weighing 200 tons (same as Voivoda) it has a short boost phase which makes it difficult to intercept for missile defense systems. The Sarmat is equipped with multiple hypersonic nuclear warheads and the most modern means of evading missile defense. This missile can be used in any weather conditions. The Sarmat has no range restrictions (while Voivoda could only go 11,000 km). It can attack the US from the North and South poles. The Sarmat system can place nuclear warheads in low earth orbit and from there after orbiting for a short time they can fall on targets on earth. This system has no range limit. This system would allow Russia to attach North America from the South Pole which is the opposite direction from where the US early warning systems are oriented. A nuclear warhead falling from space from any direction is not something the US missile defense systems are capable of handling.

Voivoda (or anti-Ottoman militia captain) in 19th century Balkans. Generally known as being armed to the teeth.

Nuclear Powered Cruise Missile

Russia has been able to miniaturize a nuclear reactor (“small-scale heavy duty nuclear energy unit”) and stick it inside a Cruise Missile. That gives the cruise missile an unlimited range. Imagine being able to fire Tomahawk missiles from anywhere on Earth to anywhere on earth! This is a missile that can fly a few feet above the surface, thus it is undetectable and invincible against all existing and prospective missile defense and counter-air defense systems. These missiles can also carry nuclear cargo. The only question is how many of these missiles can Russia produce. If they can product a large number, US defenses will surely be overwhelmed.

Nuclear Powered Underwater Drone

This one is a beauty. This an underwater drone that is powered by a small nuclear reactor, it is quiet and has hardly any vulnerabilities to exploit. It can carry conventional or nuclear warheads. They can be used to engage aircraft carrier groups, coastal fortifications and infrastructure. The nuclear power unit is 100x smaller than units that power modern submarines but is more powerful and can switch into combat mode 200 times faster. This nuclear drone can carry twice the power of the “Tsar” Bomb. That makes it by far the biggest nuclear bomb ever built.

So for example, this drone can be detonated in the Atlantic Ocean to create a tsunami wave 500 meters tall (or 1500 feet) which apart from rendering massive loss of life on the Eastern seaboard would also radioactively contaminate it. This is a weapon of last resort which is intended to inflict maximum damage upon an enemy in case Russia’s land based missile arsenal is disabled by a strike. Oh and this drone can be parked in the Hudson river or somewhere off the US coast and can hang out there for years without anybody knowing that it is there.

Hypersonic Missiles & Laser weapons

Simply put these are missiles that are too fast to be intercepted. They can be fired from the ground or from the air. They fly at Mach 10 (10x faster than speed of sound), can maneuver at all phases of its flight trajectory which allows them to overcome obstacles and anti-missile defense systems. They have a range of 2000 kilometers. In addition, Putin boasts of laser weapons that are already deployed in the Russian military. In addition to all the other stuff, Russia is improving its weaponry for more conventional conflicts as well.

Conclusion

So the world is more dangerous than ever before and NATO or no NATO, Russia seems to have vaulted ahead in the military game with the development of a miniaturized nuclear reactor. This really doesn’t change the balance of power much but if the US thinks it can drone its way to military victory in the future, quite a few nuclear powered hypersonic missiles and underwater drones can change that calculus. The Ruskies always fight in ways you don’t expect and this here is no exception.

What does this mean for financial markets? Well for one, if the US has to counteract these Russian advances, it might have to spend another 1-2 trillion on military spending. If the US gets into a war either in North Korea or the Middle East, that is automatically another 1-2 trillion in military spending. If you add $3-4 trillion in the next 4-5 years to an already 20 trillion dollar US debt, we are talking an additional trillion dollars in borrowing per year. If you think rates are 3% with current fiscal situation (after tax cuts and higher spending), the moment the US gets into another armed conflict you have to up the rates by a few more percentage points (think 5-6%). There is simply more need for borrowing, less investors to buy those US bonds and thus substantially higher rates.

Unfortunately the US faces some very difficult choices – it either spends more money on defense to keep up with Russia or starts to give up geopolitical significance in the Middle East. Either of those 2 developments will be a substantial negative for the US markets in the next few years (and a positive for Russian markets). The last thing the US wants is for the petro-dollar to die. If the petro-dollar dies much of the dominance of the US dollar gets rolled back and if that happens, the DXY could hit 60s easily and general standard of living in the US will be on the decline due to hyper-inflation. China and Russia and Europe have been working tirelessly on dethroning the US dollar and Russia’s recent military advances and gold stashing is sure to be noted by financial markets at some point.

Geopolitical Risks of 2018

I haven’t spent a lot of time discussing geopolitical risks over the past couple of years (with the exception of Brexit) because I thought they would be largely irrelevant. The worst case scenario for geopolitical risk is the outbreak of a war in an oil rich country which usually results in the price of oil going up. When the price of oil goes up, consumer spending in the US suffers because US consumers spend quite a bit on gas. Discretionary budgets decline and the economy usually struggles or enters a recession. The classic example of this is the recessions of the mid-70s, but we saw this more recently in 2007-2008 and 2011.

However, an oil spike in 2016 or 2017 actually would have been a welcome financial and economic event. When Oil overshot to the downside and went down to $25 that was a very bad development for the energy industry and the financial industry. Energy companies were forced to shut down production that was operating at a loss. Their debt wasn’t going to get paid which was bad for financial companies and crews were going to get fired which was bad for the economy. Oil going from $25 to $60 was a good event because US energy companies become solvent and they didn’t have to fire crews. At the same time, US gasoline prices were in that sweet spot between $2 and $3 which US consumers can handle easily.

However, now that Oil has broken above $60, any further appreciation in oil prices will actually be felt by US consumers. When gas prices at the pump have gone from $3 to $4 that has slowed economic growth in the past. As such now, geopolitical risks will start to matter. The US economy will not handle the next oil shock without a hitch.

But there is also another big geopolitical issue that was not a problem until recently. We knew Obama would avoid going to war as much as possible. But Obama is no longer the POTUS. There is nobody to restrain the Republican war mongers. If the US goes to war again, the US budget deficit is going to explode even further. Unlike 2001, when the US had a Federal Surplus, the US is now running at a gigantic deficit. The US budget deficit was at $666 billion in 2017. The CBO projects 1 trillion deficits by 2020 after the passage of tax reform. Tax cuts have added about 250 billion to the deficit per year. Lower revenues lead to larger deficits and increases in total debt which in turn leads to debt service increases. Once you go into a debt spiral, the compounding math works against you and it gets bad quick. In addition, Debt-to-GDP ratio is now north of 100%, whereas in 2001 it was roughly at 50%, a substantially better financial position.

Initial estimates of the cost of the Iraq War in 2003 were for $50 billion. Larry Lindsey, director of the National Economic Council in 2002, was fired by the Bush administration for projecting costs as high as $200 billion. After 15 years in Iraq, the actual cost of the Iraq war is estimated to be nearly $5 trillion dollars. That is 5,000 billion or over 100 times the original projections. Since the US government was operating at a deficit over the past 15 years, the US had to borrow money to finance the war and a substantial part of the increase in debt during the Bush and Obama years is actually war spending. Most of the deficit spending during the Obama years was to finance a prolonged war started by a Republican President and a Republican Congress which lasted for a lot longer than was projected.

If the United States enters another prolonged war in North Korea or in Iran, it is very easy to see that war cost north of 2-3 trillion dollars at minimum excluding reconstruction costs. That means that the projected debt of the United States will go dramatically higher. We could be at 25 trillion debt by 2020 easily. If we add to that a normal recession, which after 9 years of expansion will be a perfectly normal event, we could be looking easily at 130% to 150% Debt to GDP ratio for the US.

Once the US reaches these Greek type debt levels, I think the US credit rating will be downgraded once again. If the US enters another war, I am certain that credit agencies will downgrade US treasury debt.

If you look at the VIX, you would think that everything is just fine in the world, but in reality, the world is a giant tinderbox waiting to burst. Geopolitical risks have never been higher with a couple of states pushing for nuclear proliferation. With the implicit backing of China, these states are trying to upend the dominance of the United States in world politics. And with Trump as President, the chances of the US entering another war haven’t been this high in a decade. Let’s look at the biggest geopolitical risks in the world today:

North Korea

The 1950-1953 Korean war caused nearly 34,000 US casualties and 1.2 million South Korean casualties. The GDP of South Korea was cut by 80%. South Korea was not the economic actor then that it is today. If Samsung and other South Korean companies were to be disrupted today, the economic impact will be substantial. A 50% fall in the South Korean GDP today will knock off a full percentage point off global GDP. The disruption of trade flows will be substantial. The war and the reconstruction will be enormous. Most expects think that US debt will increase by 30% if this war was to transpire.

Obviously North Korea is a proxy to China and if the US is fighting North Korea, it is in effect fighting China. A war between the US and China will upend the current economic order and the biggest losers out of that conflict are US multinational companies which outsource and sell to China. If you want to see earnings of the S&P500 disappear into thin air quickly ala 2008, a war with China can do that. The SPX is trading at 25 GAAP PE and that means we assume that the current benign international setup lasts for the next 25 years. I am not so sure that will be indeed the case. The old international order could start breaking if the US enters a war with North Korea and many countries in the world will find themselves in the uncomfortable position of choosing between China and the United States.

Many experts think the odds of a war with North Korea are at 50/50. Some put them even higher at 70%. Lindsey Graham, a Republican senator with expertise in foreign policy, said 2 weeks ago that there is 70% chance of war if North Korea tests a 7th nuclear missile. According to him, another nuclear test will put Trump over the edge. All I can tell you about Lindsey Graham is that every war he has advocated for over the past 30 years has come to fruition – Iran, Iraq, Syria, Lybia, Serbia, he was an advocate for intervention everywhere. The neocon wing of the GOP has put North Korea in its sights now for some reason and Obama is not there anymore to control them. I am not sure to what extent Trump will be able to resist the neocon overtures. He has been very amenable on greater military spending and has greenlighted larger US involvement in the Middle East. If North Korea is next on the neocon radar, unfortunately a war may be inevitable. The recent capture of ships that were delivering oil to North Korea could soon lead to more serious escalation of tensions. Hopefully the recent progress around the Olympics defuses tensions long term.

Middle East

Another war that is brewing under the surface is the situation in the Middle East. Now that ISIS has been defeated there is a war over the spoils. Putin is aiding Syria, the US is aiding Israel and Saudi Arabia which want to stop Iran from gaining a military foothold in Syria. Turkey is going after the Kurds who are US allies and want to establish a state that probably would have about 30 million people in it. And if it was created, it would be comparatively one of the larger countries in Europe by population. The situation in the Middle East is a complete mess and it could explode at any point. Tom Friedman ranks the Israel vs Iran situation as #2 on his global risk list. Analysis of the Middle East is not my specialty, all I know is that it is a very difficult puzzle to solve and all I can do there is just evaluate the financial involvement of the US. If the US gets involved more substantially, we are talking at least a 2-3 trillion dollar commitment.

The Little House in the Cloud

Originally sent to VIXCONTANGO subscribers on November 20th, 2015

2016 will be the year when the Cloud Economy enters the lexicon of American investors and Americans in general. While much is being made about the Gig economy as unicorn darling Uber transforms the taxi and logistical delivery businesses, a much bigger transformation is underway in the American economy.

After 20 years of employment as a software developer, I finally launched my own business this year. And I am not alone – at least 6-7 of my former colleagues have done the same. Some are launching video game streaming business, some online wine-rating business, others online lingerie stores, on and on. All of these are not unicorn startups that will change the world, but solid small businesses that provide services that thousands or tens or hundreds of thousands can use. The reason why this is happening is because we all can finally do it without breaking the bank. The empowering capabilities of the Microsoft Azure Cloud, Amazon Web Services, the Google Cloud and other open-source computing tools are something I cannot emphasize enough. VIXCONTANGO utilizes a system architecture of distributed caching, low-latency messaging and multi-layered software design that was formerly possible only inside Fortune 500 corporations who could shell out the tens of millions necessary for a global distributed cache server cluster or messaging bus or various other servers. If somebody wanted to start a company in 2010, they had to shell out millions just to buy computers. Now, it costs $100 per month on Azure to have a complete set of web and database servers, a distributed cache and a messaging bus right from the start! Pay as you go – only for what you use! The barriers to entry to creating complex online/mobile businesses have been dramatically lowered and mobile app/cloud adoption is thus in its infancy. The most recent market measures for Azure or AWS pins them at the Salesforce market cap of $60 billion. Let’s do some napkin math here. There are 35 million (17 million .Net and 18 million C/C++) Microsoft developers – if all of them spend $1000/year (less than $100/month or what most pay for cable) on Azure running a side business – that is $35 billion in annual revenue! This does not include the mass migration to the cloud of corporate America which is an avalanche that will bury corporate IT departments in 2016. Even the most bullish current estimates for the cloud businesses are wildly underestimating the size these business will have eventually. I project Microsoft Azure and Amazon Web Services to reach at least a $200 billion valuation each over the next decade.

The end result of the great migration to the Cloud Economy is a nationwide set of online and mobile savvy businesses that have very high profit margins and as result deserve higher P/E multiples both on the private and public markets. If you compare the profitability of a physical lingerie store before vs an online one now – the profit margin expansion I am talking about will become apparent.  Before you had to rent a store, remodel it, hire workers, keep moving merchandise around, all for the opportunity to sell to a limited number of people who walk through the door in that specific neighborhood. So hundreds of thousands spent on startup costs and years spent before breaking even. Eventually tiny margin. Now, you build a website, hook up to a few various service providers for tens of dollars per month– you’re up and running and the entire population of the world can be your customer. My former colleague is sitting at home, doing a mini version of an Amazon warehouse, packing, boxing, selling at 90% margin. She makes far more money than she did before, right from her Little House in the Cloud. There is a reason why Facebook is so highly valued – they have 95% margin – once they have built the basic product, money just comes through the door and costs are minuscule in comparison. While not every developer will turn a company into Facebook, there will be a proliferation of high margin small and medium sized mobile/online businesses in the years to come. Most of them be will be operated from inside people’s houses or garages. In fact, it will not be uncommon to have small 20 person companies like Snapchat reaching hundreds of millions of users and making tens of millions in revenue. Large corporations will change as well. For example, Walmart and Macy’s will de-emphasize physical locations and try to be more like online retailers like Bonobos and Banana Republic (well Banana is a real retailer but they are very web savvy). I still shop for clothes but I buy them off emails sent to me by Banana Republic and I buy entire ensembles. I don’t have to go to the store and think how to match clothes. I haven’t been to Macy’s in years. As such it is very important to disregard Macy’s and Walmart’s struggles and understand that they are part of a secular retail shopping trend towards mobile and online shopping. The end result of this mobile/online transformation in retail but not only there is an increase in profit margins across the business spectrum in the US. And higher profit margins ultimately mean higher P/E multiples. Having worked at private equity – the valuation rules are simple – the higher the margin, the more repeatable the revenue, the higher the P/E multiple. So look for the mobile/cloud economy to get bigger not because it is cool but because it is more profitable.

You can expect more of what you saw this year in technology. More migration towards the leaders of the cloud, struggles and consolidation in traditional tech companies like Intel as they lose their box customers but overall a steady increase in profitability in the sector as 5-10 companies dominate sales and earnings and valuations and make up for the carnage in the rest. I expect a 10-15% in the Nasdaq and a 20% run in the Russell 2000.

The Full Employment Limit of Broad Stimulus Effectiveness

This morning we get more non-sense from the banks yet again: they trimmed their GDP forecasts for 2022 by -100bps (-1%) because of the demise of the BBB bill. In their Keynesian thinking, if you remove stimulus spending, the economy will go down. This is wrong, it is very superficial and simplistic thinking. Here is what they get wrong:

When you have a recession, you need to stimulate the economy with broad stimulus. The decline is broad-based and affects every sector the economy and therefore the stimulus needs to be broad. You need to leave it to the Private Sector to reallocate capital to the new industries from the old industries during the recession. This is what Larry Summers screwed up in 2009: instead of giving broad stimulus in a recession, Larry Summers gave targeted stimulus. If you give targeted stimulus in recession, some parts of the economy will never recover because they aren’t stimulated by government and the private sector doesn’t have the money/savings to recover them either. That is how we got into a state of permanently lower growth after 2008. You need to give broad stimulus and give the private sector the money and ability to reallocate funds to sectors in need. In 2021, Ron Klain did it correctly by pushing through broad stimulus with the American Rescue Plan (ARP) and that is why today the economy is in top shape.

However, when the economy recovers fully and the labor market has no more workers in it (the output gap is closed), further broad based stimulus increases inflation without increasing the productive capacity of the economy. If you pour more money on an economy whose output is fixed, you simply get a higher price level. That in turn obliterates the savings that have been accumulated. When you obliterate savings, you reduce the private sector’s incentive to work and save. When people don’t want to work anymore, you reduce the aggregate capacity of the economy. Thus broad stimulus in an expanding economy is counterproductive – it reduces the productive capacity of the economy through the inflation channel.

That is why communism doesn’t work – forever broad stimulus to everybody doesn’t work in the long run. Broad stimulus only works in recessions. It doesn’t work in economies operating at their full capacity. I will use the following analogy: pouring gasoline on a fire only makes the fire bigger. You can’t do that when the fire is already big. While pouring gasoline on embers helps the embers turn into a fire that heats you in your fireplace, pouring more gasoline on an already big fire enlarges the fire beyond the fireplace and burns down the house. Long story short: you can’t overdo broad stimulus.

Therefore, once the economy gets to expansionary phase the government has to move from a policy of Broad Stimulus to a policy of Targeted Stimulus – only stimulate the parts of the economy that are hurting and be very careful not to disrupt what is already working. The inflation we are seeing today is because the government continues to apply broad stimulus (Childcare Tax Credit or CTC) to an economy that is already at full capacity by many measures (unemployment rate is 4%). Continuing that broad stimulus policy next year and beyond will further impoverish the population without achieving higher output. Broad stimulus needs to be scrapped here and that is what Manchin is doing by killing the BBB. What Manchin was trying to get the idiots in Progressive Caucus to understand for the last 6 months is that you need to start targeting stimulus once the economy has recovered. But the Progressives are ideologues, they simply don’t understand the practical limitations of broad stimulus policy. Progressives think because it worked it in 2021, it will work in 2022. That’s not how it works, comrade. And that is why we have this negotiation debacle.

Another thing that Goldman gets wrong here is a little more subtle: the labor market is at full capacity today only because of universal basic income (UBI). The CTC is UBI. If you remove UBI, there will be new entrants into the labor force because these people will need to replace their income. There is clearly 5 million people who are still out of work today. At least 50% of those (2.5 million people) can be brought back to work with the right policies – which is removing their subsidy. Thus removing UBI here actually EXPANDS the productive capacity of the economy by expanding the labor pool. If you expand the labor pool and thus the economy’s productive capacity, GDP will go up, not down. You simultaneously lower inflation and increase output. Thus killing BBB here is actually the right policy for the economy and good for GDP. I know Goldmanites aren’t really experts in MMT and they are learning it real time, but no worries, it is simply time for yet another lesson. 2021 taught Goldman one lesson (broad stimulus works in recession really well) and 2022 will teach it another (removing UBI expands GDP when economy is in expansion). Instead of lowering their 2022 GDP projection by -1%, Goldman should be raising it by +0.5%.