Wednesday, February 21, 2007

Heinlein Ahead of His Times

For Halcyon Tempest

Heinlein’s “For Us, The Living” provides an interesting analysis of a number of different social quirks of the early 20th Century. His analysis of the economic institutions and structure is, naturally, of particular interest to me. Before I begin a discussion of the viability of the economic system proposed by Heinlein in the thin guise of science fiction, it is important to lay out a little bit about where he’s coming from.

The original manuscript was written in 1939. WWII was just beginning, and the US was far from entering the war. The US was still in the process of recovering from the single largest recorded economic disaster in its history. The Great Depression strongly informs Heinlein’s perspective on the structure of an economy. There are two key elements of the depression that Heinlein correctly identifies in his writing. First, the relatively large scale failure of the American banking system. During the Depression, deliberate efforts were made by both monetary authorities of the US and the private banks to maintain interest rates at relatively high levels. This was done by contracting the money supply. Contracting the money supply typically makes an economy contract - oops. Heinlein’s economist overstates the control of the American money supply on the part of the banks and completely ignores the role of interest rates, though his arguments are largely correct given his frame of reference. Second, Heinlein is correct in identifying weak aggregate demand for goods and services as a major part of the problem. It seems clear that Heinlein had either read or knew of John Maynard Keynes’ “General Theory of Employment, Interest, and Money” published in 1936. Most governments now automatically stimulate aggregate demand in a recession.

There appear to two be key elements to Heinlein’s proposed economic system. The first is the system of “heritage”. Under this system every individual in the society receives credit (effectively cash or purchasing power) to spend as they see fit. The individual is then able to work for extra funds if they so choose. Any extra funds are subject to some level of taxation. This is an idea that’s been around for a number of years under a variety of names. I’m most familiar with as either a negative income tax program or a guaranteed annual income program. The idea is almost exactly the same. All people receive a transfer of funds from some level of government. This transfer is not subject to taxation. The individual is free to work in the paid labour force for additional funds if they so choose. Any additional income earned is subject to taxation, commonly at a relatively low and constant rate. These proposals were really popular during the 1970. In Canada there was even a field trial of one; the Canadian Basic Annual Income Experiment, or Mincome Manitoba, conducted between 1975-78. The results found there was only a minuscule impact on work effort. So this part of Heinlein’s proposal would likely work on a national scale. The savings in terms of program delivery costs would be phenomenal. More money would actually reach people who needed it. These types of programs have generally been resisted political by conservatives due to the incentive to work effects – which Heinlein actually addresses. Other groups resist for more selfish reasons. Punch Line: economically feasible – politically...?

The second key element of the economic system described in “For Us, The Living” involves the funding of the “heritage” or negative income tax system. The process suggested by Heinlein is only workable under very specific circumstances. It requires that all individuals believe that prices will remain stable. Not a problem when Heinlein was writing, prices were stable and in some cases even dropping. It requires that there be significant unemployment already in the economy, as there was when he was writing. Excess productive capacity must already exist. If you consider Heinlein’s chess piece economy, the workers were unemployed until the arrival of Perry’s factory. If the workers were already employed, the result could only be inflation.

The easiest way to explain is with a small amount of economic theory. PY = MV. That’s it! It’s the quantity theory of money, currently out of favour in most economics texts – it’s too old and too simple to learn. Here’s the deal. P is the price level (CPI = 2 in Heinlein’s example), Y is the real output of the economy (63 Playing Cards), M is the money supply (100 poker chips), and V is the velocity of money (slightly more than 1). The velocity of money is the number of times a unit of currency changes hands in the purchase of goods – generally fixed by banking technology. Assume, as Heinlein’s economist does, that the price level is fixed at 2. Assume also that the velocity of money is fixed at just over 1 but less than 1.26, again as in the example in the book. It’s pretty clear now that the two sides of the equation don’t balance. The solution to this problem, if prices and velocity of money can’t change, is either to reduce production (throwing more people out of work) or increasing the money supply.

The supply of money must always increase if the economy is growing or else prices will have to fall. Deflation is almost never observed. Virtually all countries in the world have money supplies that grow at some pre-determined rate. Here’s the catch, if you’ve already balanced the PY = MV equation, adding more money can only lead to inflation. If we were to attempt to fund a cost of living “heritage” and other public goods solely out of money supply growth, we’d suffer from hyperinflation, like interwar Germany, or more recently Brazil, and a number of African nations. Hyper-inflation destroys economies.

That’s my two cents worth on Heinlein’s economic theory. He’s not entirely out to lunch. The monetary policy needs to be approached with a lot of caution, but the “heritage” system is totally workable.

Interesting Aside: The earliest reference I can find to a negative income tax plan is Juliet Rhys-Williams in the 1940’s. It seems Heinlein was once again a head of his times.

Tuesday, February 20, 2007

Weapons of Economic Warfare II

Weapons of Economic Warfare II (Targeting the Banking System)

By disabling the banking system an economy can be largely handicapped. There are methods with which an unfriendly power may be able to effectively attack the banking system of a country. The attack may come through one of two spheres, electronic or public opinion. An electronic attack has already received a lot of attention. An increasing portion of modern banking is done via computer. Even cheque clearing is now done via computers. The majority of a bank’s record keeping is done electronically. There are a number of different methods in which an attack on these records could bring down the system. The simplest attack would be to simply destroy the bank’s records of deposits and loans. A slightly different electronic attack would simply modify a portion of the records. This would likely cause banks to shut down while the records are either recovered from backup or verified. How well would a population like Canada’s do with no access to their banking system. Think about how much cash you have on hand right now. How long could you survive with just that amount of cash? If the banking system was sufficiently shut down for longer than that, what would you do? Think of the ensuing panic that would result from the inaccessibility of cash. This would definitely do some serious damage to the economy of the nation in question. In this strategy the objective would not be profit but chaos.

The other method of assaulting a banking structure would be attempt to initiate a bank run. Most countries now use some form of fractional reserve banking. This means that the majority of the deposits in a bank are not held within the bank. Instead most of these deposits are used to finance loans. If you wanted to make a substantial withdraw from your accounts, the bank would give you money that was deposited by somebody else. This normally isn’t a problem as its unlike that a large number of people would all decide to make substantial withdraws at the same time. If for some reason a large number of people all decide to make large withdraws at the same time a bank may not be able to satisfy the demands of its clientele and thus shut down. The modern system of electronic banking and direct electronic transactions (interac) actually limit the possibility of a bank run. In this system electronic markers are transferred, not physical markers of value. The system is protected from a bank run by the simple fact that the bank can create electronic markers on demand. The scarcity of these markers is limited by the banks’ own actions.

Banks defenses against attacks have currently focused on actions by individuals or groups of individuals attempting to make profits. These defenses may also reasonable against a group attempting economic warfare. The failing of banks may be in a combination of an electronic attack and a public opinion attack, or in the fact that an electronic attack may trigger a more traditional bank run. Maybe all banks should be equipped with a Jimmy Stewart impersonator.

Friday, February 16, 2007

Weapons of Economic Warfare I (Money Supply Target)

What started out as a simple musing has become something much more. This may require some actual academic study and writing.

Now that I think I’ve identified most of the potential targets in an economic war, I can begin to discuss the “weapons’ that might be used to “neutralize” those targets. Having identified the weapons, defensive strategies can be developed. I’ll take the targets one at a time and identify some of the possible methods of neutralizing that specific target.

The first target is the monetary system. Without a well functioning monetary system a market economy is reduced to barter. This clearly limits the opportunities for specialization. It also increases the demand for foreign currencies to act as a hard currency, decreasing the cost to a foreign power of purchasing a specific resource or commodity. There are essentially two basic ways in which a monetary system can fail, general non-acceptance or hyper-inflation. One weapon with the potential for both impacts is counterfeiting. Countries have different laws governing responsibility for passing fake bills, so this may not have the same impact everywhere. For the sake of the argument, assume that once an individual has accepted a counterfeit bill, they are responsible for the loss. The greater expected loss due to counterfeit bills, the lower the likelihood an individual is to accept payment with that bill. It is now common to see many signs stating that denominations greater than $20 will not be accepted as payment. This is due, in large part, to the high number of counterfeit bills being passed. If this were to extend to include smaller denomination bills, a situation in which the currency falls out of acceptance may occur. Thus counterfeiting is a potential weapon of economic warfare. For this weapon to be effective, there are two key requirements. First, the attacking power must have the ability to create passable currency. In most modern economies a number of security features have been introduced to prevent or limit counterfeiting. Second, a method of injecting large quantities the counterfeit currency into circulation is required. The larger the monetary base under attack, the larger the required injection. For most modern economies, the required injection of counterfeit currency would be staggering. The likelihood of being able to inject such a quantity of currency without detection is small.

Many of the defenses against such an attack are already in place. Most currencies have built in security features. Currency unions increase the size of the counterfeiting operation required to have a strong negative impact. Virtually all economies have agencies charged with the responsibility of tracking down counterfeiters.

There is another method of attacking the monetary system of a country. This involves attacking the (electronic) records of the banking system. In a country using fractional reserve banking, a fictitious increase in a deposit will be multiplied through the banking system. In a banking system with a required reserve ratio of 10% an increase in deposits of $100 will lead to a $1000 increase in the money supply, with a reserve ratio of 1% the small deposit increases money supply be $10,000. Thus a relatively small number of falsified deposits can radically increase the supply of high powered money and thus cause inflation or even hyper-inflation. This multiplier effect is due to the increased loans made with the excess deposits. This attack could take place at one of number of sites. The records of the banks and near banks are an obvious target and many have taken steps to ensure the security of their record keeping. This security is far from perfect as the recent Winners/Home Sense security breach shows. The records of the central bank are also a possible target. Again these records tend to be defended against manipulation. There is some cause for concern about both of these sets of records. Generally, they are defended against manipulation for personal or corporate profit, rather than malicious attack.

Counterfeiting will have a similar impact on the supply of high powered money, though likely on a smaller scale due to monetary leakages and the fact that most monies first deposited at banks are checked against the passing of counterfeit bills.

Another vector for attacking a country’s monetary system is through international exchange markets. A number of countries have experienced currency crises or exchange rate attacks. An organized and well funded organization has the potential to initiate a run on most currencies. In such an attack, the value of the currency being attacked is greatly reduced relative to other currencies. This will have two impacts. First, it will make the cost of vital imports much higher for the victim. Countries which are extremely dependent on imports are particularly vulnerable to this type of weapon as the increase in input prices will lead to increased inflationary pressures. Japan comes to mind as a particularly susceptible. Second, by reduce the value of the domestic currency a campaign of asset acquisition by an unfriendly power will become much more feasible.
This attack will also serve to reduce the cost of exports from the country being attacked.

These weapons are designed to a limit a country’s ability to defend against unfriendly powers acquiring its assets or to resist a political. These weapons achieve this by destabilizing the monetary system of the economy. An economy with an unstable monetary system hardly able to coordinate the most basic of activities, let alone a defense.

Tuesday, February 13, 2007

Targets of Economic Warfare II

The remaining targets apply to both countries and non-state groups. Again, bare in mind the objective is to eliminate the group’s ability to resist. In many cases, these tools can be rather “selectively” targeted.

In any modern economy very few big ticket items are saved for and then purchased. Instead these items are financed. Most corporations and governments are even more reliant on financing for day to day operations. By eliminating a group’s access to financing the ability to resist an economic take over or political agenda is greatly reduced. This has been one of the major tools in mergers and acquisition in the corporate world over the years. By creating cash-flow problems and preventing financing as a solution, many major corporations have successfully conquered. Access to financing as a target need not be limited to corporations. Any group can be economic handicapped by removing their access to financing including governments.

The means of production or the sources of income are another key target that relate to both countries and groups. Without a source of income very few groups can survive for an extended period of time. The siege was one of the first forms of economic warfare. This can be as complex as an embargo or a boycott, or as simple as shutting down a single key stage in a production or distribution chain. With no income, the group will eventually have to capitulate or die. This method has been employed by a number of groups throughout recent history with varying degrees of success. Most intriguingly against a variety of leftist groups against major corporations with only marginal success, unions with a great deal more success.

Saturday, February 10, 2007

Targets of Economic Warfare

I started writing on potential weapons of economic warfare and it kind of got away from me. I kept having to go back and add new ideas and details. I had pages and pages of stuff and I wasn’t even half done. So what I’m going to do instead is post little bits as I get them done. Here’s the first part.

Before I can begin an intelligent discussion of the potential weapons of economic warfare, it is necessary to consider the goals of such a conflict. The common objective of any conflict is to eliminate an opponent’s ability to resist. This is also true of any economic conflict. This may mean eliminating an opponent’s ability to prevent your acquisition of essential resources or means of production. It may also mean eliminating an opponent’s ability to resist a political agenda. How can these objectives be accomplished? Essentially, the economy of the target country or group must be disabled.

This brings about the next question, how is an economy disabled? The answer depends on whether the target is a nation or a non-nation group. Start with a nation. One of the common elements of nationhood today is the printing and circulation of money, almost exclusively a non-commodity backed money. Very few, if any, countries still directly link their paper currency to a real commodity. By and large, the modern monetary system employed in all countries involves an act of faith on the part of the citizenry. This means the monetary system of the country may be vulnerable to attack by unfriendly powers. By destroying the faith in the monetary system, one destroys the many of the possibilities for specialization, thus effectively knee-caps the economy in question. Here is the first potential target.

The second target is the banking system. Many economies in the world now use fractional reserve banking, and in many cases the level of reserves is not mandated by the government. Fractional reserve banking simply means the majority (usually over 90%, and as much as possible if the banking industry is not regulated) of the money deposited in a bank does not remain in the bank. Most of it is lent out again. In short, the bank does not have your money any more. Factional reserve banking systems create a large portion of the wealth in developed economies by allowing banks to serve as financial intermediaries and finance investment opportunities at a relatively low cost. However, a breakdown in the banking system or a loss of faith in the banking system on the part of the populous would bring even the most robust economy to a screeching halt. This is the second potential target.

Expectations play a key role in the demand side of the economy. Consumer purchases are heavily influenced by what people expect future incomes and prices to be. If consumers believe the future will be difficult, the tendency will be to delay purchases and hoard money. This was seen in North America during the 1930’s depression, and helped prolong the depression. Consumer confidence is the third potential target of economic warfare.

Tuesday, February 6, 2007

Economic Warfare

There has been a lot of talk about the nature of the next big conflict in the world. (Why now, when we’re still dealing with one, I’m not sure.) Major thrust of most of the speculation is armed conflict between countries is largely over. We’re unlikely to see another war with the US on one side and another well define state on the other. This is exactly what we’re seeing in Afghanistan and Iraq. Well defined countries are fighting against opponents that are hard to find and identify.

An extension to this speculation is that we’re likely to see hostilities between states move to the realm of electronic information. I don’t think this is likely. Here’s the problem. The electronic information that most of these analysts and pundits are talking about has to do with military matters. This information only has value if the potential for armed conflict exists. If you have no intent of attacking the US what difference does it make if you the deployment of its troops. This could only be of value to those non-state groups engaged in armed conflict.

There has been a lot of writing in science fiction which attempts to motivate armed conflict between corporations instead of states. This again is unlikely. Corporations don’t do battle in terms of guns and bombs. They do it with lawyers. Granted, given the nature of reality television these days, lawyers arguing their cases with guns and bombs might get great ratings, but it’s unlikely to happen.

So what are we left with for the extension of political aims by other means? Economic Policy. The two main reasons to go to war are; to capture wealth/resources or to impose a political will or system on another group of people. Both of these aims have been achieved in the past through the use of economic policy. Capturing wealth and resources is fairly easy in a country in which private property is entrenched. You simply buy it up. This is a lot cheaper than trying to take it by force. We’ve seen this throughout the last half of the 20th Century with people of different nationalities and groups buying up large chunks of real estate and other assets for the use of the nation or group. The Chinese have proven particularly able in this regard.

There are three interesting things about this approach. First, it tends to be less destructive than other methods of accomplishing the same goal. Second, it is a lot more subtle than taking something by force. It’s possible to take over something or somewhere before anybody really knows what’s going on. Explosions and gun fire are a lot more noticeable than a real estate deal. Finally, this type of maneuver doesn’t require a nation state. Like guerrilla warfare it any small group with the right resources can engage in this type of campaign. This approach has been exploited by multinational corporations as well as countries.

The use of economic policy to impose a political will on another group has been one of the main tools of the United Nations down through the years. The biggest success came against South African apartheid. Economic sanctions caused the government to collapse to overturn some of its racist policies. The US has done this to Canada on a number of occasions. This is the pursuit of political objectives by economic means.

Potential Economic Weapons of Economic Warfare? Next time.

Sunday, February 4, 2007

In the corner to my right...

Education vs Training

I did a newspaper interview on Friday. I actually still get a kick out of working with the media. There are some interesting questions being asked. The radio is the most fun as they give you a relatively uninterrupted block of time. Newspapers and TV have their own perks too. The interview was mostly about the decline in job quality in Atlantic Canada as measured by CIBC world markets research. An interest fact that ties into some of the other things I’ve said here.

On of the things that came up was the issue of training versus education. New Brunswick is in the middle of a review of post secondary education. This, of course, makes everybody in the post secondary game really nervous, particularly those in the community colleges. Though this time around, the universities are worried too. Being nervous brings out the arguments in favour of training instead of education - a not too subtle poke at universities by community colleges.

Here’s the problem as I see it. Training is the process by which specific skills for defined tasks are acquired. Training is what keeps us from having to re-invent the wheel every time. Training is essential in trades. I don’t want to hire a plumber or a carpenter with no training, it wouldn’t end well. Training is what lets you know which screw or fitting to use. The key is you know what but you don’t have to know why. Training is increasingly common in the business world. “This is the way you do it – I don’t know why - it just is.”

Education, on the other hand, is the honing of creativity and critical thinking skills. This could be thought of making sure someone knows there are basic machines, how they work (pulley, inclined plane, lever, etc) and then turning them loose to try and solve a series of problems using these ideas. It is possible to figure out specific knowledge from the general principles, but you may re-invent the wheel along the way. It is also possible to come up with new solutions and new ideas from education. These new solutions and ideas are basic to economic growth. The key to education is you may not know what, but once you’re told you know why.

The Atlantic Provinces’ “education systems” have actually been about training rather than education, even after the removal of shop classes (I always liked shop by the way). The question is always, “What job can I get with this degree or diploma?” That’s not education, that’s training. There is damned little education going on. It shows in our economic performance.

The point I’m trying to make is really simple. Training is essential for keeping things going as they are. Education is essential for growth and improvement. We need to make sure that both are available and both are of high quality. In short we need some real education.