Value Creation in WeiDai
This is the second part in a two part article on the economics of WeiDai. The first part explained how WeiDai’s burn mechanism will eventually grow sustainably as the positive externality of burning is gradually priced in and internalized. This part will discuss the impact that thriftcoins like WeiDai and cDai will have on the health of the broader economy.
The natural size of industry
In an economy, each industry occupies a certain relative share of the entire country’s economic output. This share depends on two main factors, namely the comparative advantage of inputs and the consumer preference for outputs. Or, to use less jargon, the relative abundance of inputs and the actual products consumers desire. For instance, given that Sweden has abundant forests and that their citizens like furniture, the timber processing industry is likely to have a bigger share of the Swedish economy than in an arid country where consumers prefer plastic furniture. The natural share of an industry can change from day to day as consumer preferences alter and as new technologies render prior scarce resources abundant while directing new pressure onto once abundant resources. For instance, the advent of cars would have made transport services more abundant and rendered horses overly abundant while at the same time creating a new scarcity of liquid petroleum which was once considered an annoying waste product.
The fact that industries find their natural share in an economy implies that it’s also possible for the size of an industry to be too big or too small. This occurs when factors outside of comparative advantage and consumer preference come into play such as subsidies.
To illustrate, we can consider a fictional example by comparing two proximate economies with very different comparative advantages: Australia and New Zealand. Australia has a thriving gold industry that came about for two reasons: large gold deposits and conducive regulation. That is to say, the government in Australia didn’t try to suppress the natural resources industry as so many other nations attempt to do but instead let the natural comparative advantages in the economy play out.
Land of the Wrong Sight on Gold
New Zealand notices that the spillover benefits of a flourishing gold mining industry include a thriving supportive manufacturing industry (to assist with mining) and a seemingly endless supply of tertiary education funding directed at making mining more efficient. They also notice that the share of gold mining in the Australian economy is 7% but only 0.5% in New Zealand. Rather than focus on their own comparative advantages, New Zealand makes the mistake of thinking that a large gold mining sector is good for any economy. The government decides that it too would like to achieve the magical share of 7% and so subsidies are issued in order to reach this goal. Since gold deposits are more scarce in New Zealand, new sifting and digging machines are designed or imported to tap deeper into the crust. The added expense requires even more subsidies and to remain fiscally solvent, the government raises taxes. This is before any new gold has been dug and so the economy begins to contract under the added burden of taxes with no corresponding increase in output. To make matters worse, the now cash rich mining industry begins poaching high skilled labour from other industries or bidding up their wages and the productivity and profitability of non-mining businesses begins to suffer.
Because resources are scarce and industries need to compete for their input, subsidizing a particular industry can quickly lead to diminishing returns to scale when that industry surpasses its natural size. This can severely reduce economic output. From this we can conclude that whenever an industry is being subsidized or protected unnaturally, the economy is smaller than it otherwise would have been.
Cantillon Effect: the subsidy on finance
In modern economies, central banks issue currency by lending it into existence. Who do they lend it to? The financial industry, of course. Most central banks maintain a list of approved currency first receivers which are usually the largest banks. In return for receiving currency first, these banks are tasked with maintaining financial stability within the economy. In cryptocurrency terms, fiat currency is issued through delegated proof of stake but instead of currency holders picking the masternodes, the central bank does. Since fiat currency is inflationary, the sooner you receive it, the higher its value. Where does that value come from? The latter recipients in proportion to how late they were to receive it. The distributional implications are that the politically and financially connected receive a purchasing power subsidy financed mostly by the middle class, fixed income pension holders and the homeless. Since the first recipients of currency purchase assets, the distributional impact of money printing is felt first through an increase in asset inequality. This unequal distribution of the fruits of monetary expansion is known as the Cantillon Effect and is the biggest form of corporate welfare. To get a rough estimate of how big, consider that if the money supply were held constant, the price level in the economy would fall by the rate of economic growth on average. This means that in a fixed money economy, economic growth of 5% would imply a 5% drop in prices. A discrepancy can appear in the short run but over time, these numbers converge. To calculate a rough magnitude of the Cantillon subsidy, add the economic growth to inflation. So if the economy grew at 4% and inflation was 2% then the upstream recipients received a subsidy equal to 6% of the entire economy. That subsidy came straight out of the purchasing power of the last recipients (this is simplified since everyone upstream of the final recipient benefits at her expense, the ultimate trickle down economics).
Aside from the distributional horror, this massive subsidy on finance means that there can be no doubt that the relative share of the finance in the economy is far bigger than the natural level and as a result, the economic output and efficiency are both below what they otherwise would have been. We saw this in action leading up to the 2008 recessions when the term POW was coined (PhDs on Wall Street), as mathematicians and physicists were bid away from basic research into designing obfuscated financial instruments that ultimately contributed to the crash. Aside from recession, the employment of quants on wall street to essentially find more effective ways of packing money means that research that could have improved the economy in meaningful ways never happened. We can call these jobs created by money for money at the expense of the rest of the economy, Cantillon jobs.
Division of Labour and the Granny Redux
My grandmother who was born in the early 1920s had an incredible long term memory and in one of her stories mentioned that the prices of produce at the market she used to visit were engraved as plaques below the produce. Pause for a moment and consider the implications: retailers were so confident in price stability that they didn’t think it bizarre to go to the large expense of etching the price of an item in metal. In a world of immense price stability where money is linked to scarce gold and exchange rates between nations were agreed upon, national currencies were the ultimate stablecoins. Saving for long periods of time could be done by money-under-the-mattress methods and thrifty behaviour entered into culture as rules of thumb were handed down by wise grandmothers who mended clothing instead of rushing off to purchase new clothing with infinite credit cards.
In those days, knowledge of sophisticated financial instruments and daily monitoring of financial markets was not necessary. Contrast it with today where we require specially trained financial planners (Cantillon job?) help us understand a sea of complex financial jargon. I have found myself spending hours trying to figure out the most effective strategies and have had to devise rules of thumb to save myself from fixating on financial news just to comfortably retire. Persistent inflation has not only subsidized the financial industry through distributional effects but has received the secondary subsidy of forcing the middle class to seek refuge in the bosom of Finance in order to escape the ravages of long term inflation.
One of the main drivers for economic growth aside from technological progress is the ongoing division of labour. This is the process where jobs become increasingly specialized in order to reap increasing productivity. There are two principle reasons that dividing labour has such a profound impact on economic output. The first has to do with specialization. When I dedicate myself to a profession, I become proficient. If I had to grow my own food, write my own software, mine my own fuel etc., I’d have much less time to program and probably poorly met nutritional needs. Instead I outsource food growing to the agricultural supply chain and they outsource software production to me. It’s also important that I have a comparative advantage in software writing over food production and that the agricultural industry has a comparative advantage in food production over software design. For instance, if a farmer has a degree in computer science, a great laptop and a tiny farm and I have no training in computer science, a knack for gardening and live on a giant plot of land then perhaps we’ve got our professions backwards. So sticking to what you’re best at allows you to reap gains from trade for the exact same reason that free international trade leads to more output.
Because perpetual inflation drives citizens into finance who would otherwise have nothing to do with it, people are splitting their time between their specializations and the tax on their attention created by the Cantillon subsidy. The redirection of a person’s resources, both mental and financial, toward essentially treading water reduces the amount of resources left over for investing into their own comparative advantages. This results in lower productivity, fewer businesses started and ultimately lower economic growth than what would have taken place in a zero inflation environment.
The Corporatization of Entrepreneurship
Because of all of the above, the Cantillon subsidy has reduced private levels of savings and what pools do exist are often locked up in sophisticated instruments than can’t be accessed with ease. If individuals wish to dig into those savings, they are often contractually barred or incur large penalties for doing so. Individuals who wish to access liquidity often extend credit cards and mortgages, even though they might have the requisite savings in pension funds. Contrast this with an environment of money-under-the-mattress norms where one can reach into the piggy bank whenever the need arises. In that scenario, capital for small business financing is readily available and liquid at the community and neighbourhood level because thrifty friends and relatives can invest in ventures.
In the fiat economy, capital is mostly concentrated at the top so that the vast majority of business financing isn’t from loans and investments by family members but by large corporate entities whose agendas differ quite enormously from “helping you achieve your dreams”. The types of new businesses are therefore first vetted by the financial powers that be. Hayek taught us that whenever knowledge and information that should exist at the edges of a network are centralized, valuable parts of it are lost along the way up to the top. In less technical terms, you may have an idea that will completely revolutionize the transport dynamics in your local suburb in a way that your neighbours would love. But the investor you contacted in New York isn’t entirely enthused and wants to know how you’ll help him achieve goals you don’t value such as “what’s your exit plan?”, meaning how are you going to grow this to a scale large enough to either sell to a large corporate or list as an IPO. Although you have a sound business plan and the economics are in place, the investor takes your hesitation at this standard question to be a proxy for your general ignorance on matters of business and terminates the relationship. This is an example of how valuable information is lost as it travels up the hierarchy.
Thriftcoins —removing Nixon from the timeline
In the early 1970s, President Nixon ended the last vestiges of the gold standard, ushering in a new era of lower productivity growth and increasing income inequality as monetary policy was unleashed from the shackles that gold reserves placed on it. The Cantillon subsidy was brought to bear in all its glory where before it was a trickle, has since become a waterfall of purchasing power straight into the maws of Wall Street. It would be unfair to lay all the blame at the feet of Nixon since this banking coup was part of a long term effort by the industry that started long before the Federal Reserve even came into effect. However, this point in time had such a profound impact on the nature of the global economy going forward that it shows up in historical data (almost any economic data) as a discontinuous shift.
As the previous part of this series argued, Bitcoin is wonderful for avoiding the ravages of the Cantillon subsidy, provided your time window is long enough. For instance, if you can afford to buy bitcoin and not touch it for 5 years, then you don’t need to worry about financial market movements and can redirect your labour to what you’re good at and enjoy. If no one ever needed to access their savings in under 5 years, the Cantillon subsidy could be undone by Bitcoin alone. Unfortunately, life happens and most people need ready access to a pool of funds without risking the wild price volatility of Bitcoin. For this reason, very few people have the courage to denominate their salary in Bitcoin but would rather keep their transactional cash in a super stable fiat currency. This means that long term savings are still either contractually locked in sophisticated financial instruments or de facto locked in cold Bitcoin wallets due to risk aversion of withdrawing Bitcoin too early. This means that even in the presence of Bitcoin, the corporatization of entrepreneurship is still the dominant channel of small business financing.
If your neighbours could denominate their transactional cash in a stable, liquid currency that also grows in value then there would be no inherent volatility risk associated with using it for a rainy day or investing in family business. Thriftcoins offer this option by enjoying the stability of fiat while experiencing the upside of growth that gives the holder assurance that saving is wise both in the very short and very long run. The cultural damage incurred by the Cantillon subsidy will gradually be undone as financing of entrepreneurial activities and personal goals naturally decentralizes. This will increase the efficiency of capital allocation because less information is being lost on the way to the top of the financial hierarchy, further enhancing economic growth.
The final point worth mentioning is that the financial empowerment of the edges will lead to government backed social security and free medical care for the elderly becoming increasingly unnecessary as a new Generation Thrift begins retirement in comfort, having survived most rainy days without dipping into credit markets. Thriftcoins are ushering in a Piggy Bank era and this reduction in a need for a welfare state means that the burden of taxes and government spending can both decline, freeing up resources for more productive uses, leading to even more economic growth.
To sum up, thriftcoins will lead to a more efficient and productive economy through the channels identified above by:
- Reducing the relative size of the financial industry toward its natural size.
- Moving the division of labour toward a more optimal outcome(and promoting a general increase in happiness in those relieved to not having to fret over finance).
- Fostering the natural decentralization of business financing.
- Enabling a reduction in the need for state welfare, freeing up societal resources to be used in productive areas of the economy.