The Debt-Dollar Discipline: Part II - Conservation & Release

      Part I in this series introduced Michel Foucault's theory of disciplinary society, laid out in his book Discipline and Punish, and the application of this analysis to the "debt-dollar discipline" formally imposed on global society by the Bretton Woods Agreement of 1945 (establishing the dollar as the global reserve currency). It should come as no surprise that this global financial discipline is currently in the process of being revoked.

     This revocation is not carried out by the political or financial leaders of the world, but by the system itself. Part II will explore both the technical and practical aspects of disciplinary collapse, primarily in the context of complexity theory. Part III, to be released shortly, will conclude with some general thoughts on the potential forms of organization that could emerge from the ashes of debt-dollar discipline.

The Adaptive Cycle

     Foucault did not say much about the future he envisioned for disciplinary society in his book, as it was geared towards promoting understanding rather than inspiring rebellion. He did, however, retain some hope that a better form of society could develop. [1]. Although he correctly identified the evolution of societal discipline with the evolution of economic structures, he was not in the business of predicting future economic developments.

     Foucault's disciplinary system was a complex set of interacting networks, in which each central hub (households, schools, factories, prisons, etc.) served a necessary function. Although he described individuals moving from institution to institution in a somewhat linear path, he recognized that each institution was highly analogous to and reinforced the others. A system of such organization follows a natural evolutionary path. The debt-dollar discipline represents the tail end of this path, and the implications for disciplinary society at every level are extreme.

     Most complex evolutionary systems, such as the global financial system, can be viewed in the framework of Buzz Holling's adaptive cycle, consisting of growth (exploitation), conservation, release and reorganization. An excellent primer on this topic and its relation to Robert Prechter's socionomics and Joseph Tainter's ideas on complex societies undergoing collapse can be found at The Automatic Earth [Fractal Adaptive Cycles in Natural and Human Systems].

    The debt-dollar disciplinary system has been in a phase of extraordinary growth for the last few decades, exploiting markets and resources to increase inter-dependencies, systemic diversity and overall wealth. However, the high levels of growth and specialization also led the system into a phase of conservation, in which opportunities for novel exploitation diminished and systemic structures became rigid.



      Increasing amounts of energy and resources were directed towards maintaining the existing system, rather than growth, and this maintenance was primarily achieved by core structures extracting large amounts of wealth from the periphery. The complex inter-dependencies, which previously functioned to generate wealth, became a major liability for the system, as it was less resilient to external or internal shocks. At this stage, Holling described the complex system as "an accident waiting to happen".

Financial Conservation

     Foucault focused on the modern penal system, in part, to make it clear how the disciplinary society was able to maintain its power structures over time. It did not seek to eliminate undisciplined behavior, but simply manage such behavior on its own terms. In the wake of the industrial revolution and increasing wealth inequality, it was the property crimes committed by peasants that were most threatening to the staus quo structures. These "popular illegalities" were ultimately what drove seemingly "humanitarian" goals of "prison reform".

     By identifying, labeling, detaining and controlling lower class "delinquents" in a confined space, the state could also control the general socioeconomic conflicts that were increasingly common within industrial capitalist society. The lower segments of this society, who were absolutely necessary for the state's economic functioning, were coerced to self-discipline and fear the potential that they, too, may become a part of the largely invisible, yet detested "delinquent class". To maintain a high level of discipline, then, societal elements of popular dissent must be carefully managed, which presents an inherent conundrum for a financial system under debt-dollar discipline.

     This system, unlike its strictly industrial predecessor, is endogenously prone to over-extension in the short-term. The large economic rents extracted by speculative financiers lead to severe debt deflations, which then leave significant segments of the underlying population in economic despair, including the industrial capitalists. The rapid growth enabled by financial discipline sparks a crisis of legitimacy, in which previously self-disciplined financial consumers begin to question the wisdom of their shackles. For the most part, this questioning is simply a result of there being no other option, as financial expectations and promises have evaporated as quickly as they were formed.

     Before the global financial crisis of 2008, debt-dollar discipline was maintained by re-directing credit growth whenever a debt-induced recession occurred. Essentially, financial consumers would be disciplined (by the system and themselves) to leverage their stagnant real wealth into various different assets for temporary returns. There are currently no asset classes or greater fools left to pick up credit growth where it left off, save for government leaders around the world, who will stop at no lengths to preserve the debt-dollar discipline keeping them in power.

     However, these governments are currently or will soon face sovereign debt crises, as a function of their own enslavement to the financial disciplinary system. They, too, must borrow money from private banks and pay interest on that debt, which becomes increasingly difficult as economic growth stagnates and tax revenues plummet. The "delinquent class" has now become too massive and visible for the existing power structures to effectively control, but that does not prevent the disciplinarians from trying.

     Many of their attempts to reinstate debt-dollar discipline are failing because of the financial system's rigid structures themselves. As a function of conservation, these structures have become extremely inflexible and a liability for those seeking to maintain the status quo. The U.S. Federal Reserve has created trillions of debt-dollars through discounted loans and quantitative easing, in the alleged hopes that this "liquidity" will find its way to financial consumers and inflate the prices of assets and goods.

     Their attempts are futile because economic actors worldwide had previously been disciplined to take on dollar-denominated debt, and as those massive liabilities come due, the demand for dollars will spike along with their value. It may seem counter-intuitive that a collapse in debt-dollar discipline will cause dollars to increase in value, but the disciplinary system has actually relied on a suppressed dollar to carry out its purpose. Without inflated asset prices relative to the dollar, debts cannot be repaid and financiers go broke.

     Other attempts involve governments incurring fiscal deficits to provide subsidies, backstops and general support for the financiers. The U.S. policies of TARP, ARRA and Fannie/Freddie housing intervention are great examples of such attempts. It is hoped that financial discipline can be restored by propping up the institutions most responsible for implementing and reinforcing it. Once again, the reason this plan will not succeed is due to the financial system's original disciplinary purpose.

     It had evolved to establish a global class of financial consumers who will continuously take on debt and repay most of those debts, in the form of debt-dollars or hard assets. The system has now limited its own ability to extract future wealth, as financial consumers have very limited capacity to repay existing debts, let alone incur new obligations. Much of the collateral secured by existing debts, or that could potentially be secured by future debt, has lost significant value, cannot be reached or is already encumbered.

     These fiscal deficits will eventually lead the U.S., the purveyor of debt-dollar discipline, into a sovereign debt crisis. Attempts to decrease the national debt have been rendered useless by the financial disciplinary system, as it requires private or public credit growth for economic health. Without the underlying private growth, cuts in public spending will most likely make deficits worse and debt servicing costs greater (the current Euro zone crisis is an ongoing example of this dynamic).

     President Obama's laughable plan to double U.S. exports in five years will not even come close to fruition, because debt-dollar discipline has come at the expense of the country's manufacturing sector, and the ability to suppress the dollar's value as explained earlier. The complex disciplinary system has also rendered the political apparatus inflexible, which is why many Democrats, claiming to be against tax cuts for the rich, and Republicans, claiming to be against public deficits, have both agreed to extend Bush's tax cuts (which will cost taxpayers $5T over ten years [2]). It is truly a predicament, an inherent contradiction of the system itself, and can only be resolved by a wholesale simplification of the structures within global disciplinary society.

Comprehensive Release

     For reasons stated above and others, the financial disciplinary system has entered a phase of irreversible release. The sub-prime housing crisis in the U.S. was the triggering event for this global release, in which the complex power structures supporting debt-dollar discipline will be rapidly and chaotically dismantled. Without pervasive access to affordable credit, the vast networks of discipline around the world cannot be coherently maintained (i.e. international trade heavily dependent on "letters of credit"). This credit had become the lubricant enabling Foucault's disciplinary machine to operate smoothly, and without it, the machine will grind to a screeching halt.
    
     In Part I of this series, the financial disciplinary system was referred to as a parasite, which attaches itself to all other disciplinary institutions of society and feeds off of their established functions. In turn, the disciplines legitimizing these institutions become hopelessly intertwined with the debt-dollar discipline, as the latter has come to define the relative "success" of a society. Systems of education, healthcare, industrial production (including agribusiness) and law enforcement have become mal-adapted to prolonged periods of economic deleveraging and contraction. These foundational systems will be unable to perform their disciplinary functions when they lack sufficient resources, price their customers out and are perceived as being irretrievably damaged.

      For example, 41 percent of American adults reported that they "had medical debt or trouble paying medical bills" in 2007 [3], and debt owed by American students graduating from a public college has increased more than 100% over the last decade. [4]. It was reported that the Illinois State Police was planning on laying off more than 460 troopers and closing five regional headquarters by Fall 2010 [5], which is an ongoing trend in many U.S. and European localities.

      The U.S. passed a $26 billion spending bill in August 2010 to prevent about 160,000 teacher layoffs [6], but teachers continue to lose their jobs and the ones saved will surely disappear as soon as the money runs out [7]. Disciplinary institutions are classically "caught between a rock and a hard place", leaving them with almost no options to preserve their current functions. Perhaps the institution most visibly affected by disciplinary collapse has been the political apparatus of the U.S., which has lost much of its legitimacy in recent years.

    The emergence of the "Tea Party" movement in America is an obvious example of the government's disciplinary policies being popularly rebuked. However, this movement has arguably been co-opted by the mainstream power structures (Republican Party) and, in the spirit of Foucauldian punishment, many elements of the movement are labeled as "extremist" or "racist" by politicians and the corporate media. Whether there is any truth to those claims is irrelevant, as long as they serve to marginalize the rebellious ideas lurking within. Nevertheless, the disciplinarians are having a difficult time containing the popularity of the subversive concepts represented by the Tea Party movement.

     Another recent, existential threat to disciplinary society is the WikiLeaks organization, co-founded by Julian Assange. For many years, the various disciplines (especially debt-dollar discipline) have greatly benefited from advances in electronic communications technology, and have evolved right alongside them. Now, this technology increasingly serves as a means of communicating outside the panoptic gaze of disciplinary society.

     WikiLeaks has released numerous electronic documents given to it by informants within the heart of the system, exposing some inconvenient truths about those directing foreign and domestic policies. [8]. These documents are especially threatening to disciplinarians because they are "raw dumps" of data and communications, at least before they are "vetted" and deceptively reported on by the mainstream corporate media. The leaks provide the disciplined public a rare glimpse into the "dark side" of the modern "democratic" state and its complex power structures.

     Governments and many parts of the corporate media have obviously responded by attempting to marginalize the effects of such leaks, primarily by labeling Assange a "child molester", cyber-attacking the WikiLeaks website, restricting its access to funding and threatening criminal prosecution. Perhaps more importantly, they have attempted to frame the narrative surrounding WikiLeaks as one involving unpatriotic acts of disclosure, which may actually harm the lives of American citizens. If the truth becomes known, then we will be more susceptible to external threats and less secure.

      This is a recurring narrative that has been heavily used by the disciplinarians to marginalize political threats (i.e. Daniel Ellsburg - released Pentagon Papers during Vietnam War) and reinforce discipline (i.e. Patriot Act), especially since the attacks on 9/11. However, the momentum of release, fueled by a break down in financial discipline, is currently overwhelming their suppressive efforts. International hacker groups have recently launched web attacks against PayPal, MasterCard and Visa in response to these companies cutting their payment services to WikiLeaks. [9], [10]. The WikiLeaks organization itself has released an "insurance file" into cyberspace containing many more revealing documents, which can be decrypted and exposed should it be deemed necessary, and rest assured it will be soon enough.

    A claim circulating in the blogosphere that deserves a quick mention is that WikiLeaks is actually a covert psychological operation by the U.S. government to further reinforce discipline, primarily with regards to the "war on terror". [11]. It is claimed that much of the leaked information does not really criticize the overall justifications and motives of U.S. foreign policy (or economic policy), and rather focuses more on the corruption and deceit of other "hostile" countries. For example, the leaked diplomatic cables simply present slightly embarrassing, but well-known facts about U.S. policies, while providing the disciplinarians even more justifications to engage in military operations against Iran (diplomats alleging it has nuclear weapons).

    I tend to disagree with this viewpoint and see much of the WikiLeaks activity as being more than "slightly embarrassing" to U.S. power structures (especially given their responses), but instead of sidetracking into that debate, I will simply quote an excellent article written by Andrew Gavin Marshall on the Global Research website:

"If Wikileaks is a psy-op, it is either the stupidest or most intelligent psychological operation ever undertaken. But one thing is for sure: systems and structures of power are in the process of being exposed to a much wider audience than ever before. The question for the alternative media and critical researchers, alike, is what will they do with this information and this opportunity?" [12]

     The financial structures of power are also under attack by some of the financial consumers themselves, who have decided not to buy into the fabled narratives espoused by their politicians and pundits. Europe had an obviously unofficial "bank run holiday" on December 7th, in which large numbers of people withdrew their deposits. This episode arguably led to a temporary crash in the ATM systems of the Bank of Ireland, the country's largest financial institution. [13].

     Max Keiser and Mike Krieger also recently launched an operation to decapitalize J.P. Morgan by encouraging consumers around the world to buy an ounce of physical silver, forcing the institution to cover massive losses on its silver short positions. November saw record sales of silver American Eagle coins from the U.S. Mint, and this surge could very well have been influenced by the operation. [14]. The immediate success or failure of these "attacks" is largely irrelevant at this point, because it is literally the thought that counts.

     The U.S. disciplinary order has also lost legitimacy in the eyes of many other nations, who previously were coerced to support the system. It was mentioned above that the value of the dollar will most likely increase in the short-term, precluding the disciplinarian's attempts at restarting credit inflation, but this process is by no means a vote of confidence in the dollar as a long-term store of wealth. It is a necessary function of global deleveraging, as the dollar still provides the best means of eliminating debts and transforming paper wealth into hard assets, but this window of opportunity is rapidly narrowing. Many countries have made clear that they are no longer willing or able to submit to debt-dollar hegemony in the near future.

     The Federal Reserve's latest round of quantitative easing was ubiquitously rebuked by officials in Europe, Asia and Latin America. Brazil's finance minister has blatantly stated that "it does no good at all to just throw [debt] dollars from a helicopter". [15]. These states are simply attempting to maintain their own disciplinary mechanisms by separating out from the overarching debt-dollar discipline. They sense that structures preserving the latter are naturally collapsing, and a pre-emptive break provides their best chance to maintain a degree of national or regional order.

     Russia and China recently announced that they would stop using the dollar to settle bilateral transactions, and instead use the yuan and ruble. [16]. Germany consistently expresses its disdain for the IMF and ECB's euro zone bailout facilities, which ultimately serve to prop up financial institutions operating in Europe. [17]. Numerous countries have also been engaged in ongoing discussions with the IMF about establishing a new reserve currency, and though this is unlikely to occur, it is symbolic of the debt-dollar discipline's demise.

     Foucault perceived the disciplinary society exerting its power primarily by fixing "docile bodies" within time and space. [18]. These bodies would spend much of their lives in a highly regimented and confined existence, disciplining themselves to become "normally" functioning members of society. Debt-dollar discipline has not strictly operated through such physical requirements, but rather a pervasive psychosocial drive of consumers to extract ever-greater amounts of wealth from their environment.

     As the complex structures supporting this financial discipline deteriorate, consumers will have to confront a profound new reality, one that they previously thought to be outside the realm of possibility. They must not only confront the fact that they have been deceptively enslaved, but simultaneously impoverished as well. Part III of this series will discuss the general ways in which financial power structures and disciplined consumers may react to the new realities faced by global society, introducing the insightful thoughts of Gilles Deleuze on what he ominously termed the "control society".

The Debt-Dollar Discipline: Part I - Financial Discipline & Punish

   *The following is Part I in a two part series of articles on the relatively rapid emergence and collapse of the "debt-dollar discipline" imposed on our global society. It is being done in two installments mainly due to my current time constraints, but also for the sake of shorter length and targeted focus. This part will introduce Michel Foucault's (renowned french philosopher, 1926-1984) analysis of "discipline" and "punish" in the modern state, and apply it to the global debt-dollar reserve system. The next part will focus entirely on the ongoing collapse of this disciplinary system, as it such an important and far-reaching topic.

Introduction

      Michel Foucault's seminal work Discipline and Punish explored the extreme institutionalization of "discipline" in modern Western society, as best exemplified by the evolution of the modern penal system. He illustrated this transformation by contrasting medieval public executions with the wholly distinct system of punishment we have today. The former was a stage for the sovereign (usually a King) to exhibit physical punishment on a criminal for violating the laws of the land, which were seen as an extension of the sovereign's body, and was designed to explicitly make the public aware of the sovereign's absolute power.

      According to Foucault, this non-uniform system of public punishment eventually had the unintended consequence of creating public resentment for the sovereign, as the oppressed people would begin to identify with the suffering of the punished. This dynamic was evidenced by the violent riots that would erupt in support of prisoners during public executions. The powerful sovereign could no longer continue to maintain its domination while its political legitimacy was being undermined by such adverse reactions. These public displays may have revealed the extent of the sovereign's authority, but they were too disorderly for the modern state's purposes.

      It is no coincidence that the modern penal system evolved along with the emergence of industrial production as the dominant economic force in Western society. The latter was a system entirely focused on increasing efficiency, where students, workers and soldiers alike were trained to be more obedient, faster and stronger in every aspect of their designated functions. Modern states facilitated this process of immense wealth production by instituting high levels of order on their citizens, or what Foucault would term "discipline". It was not really a tool for the Kings and Monarchs of old, but rather was more useful for controlling the populations of emerging democratic states [emphasis mine]:

Historically, the process by which the bourgeoisie became in the course of the eighteenth century the politically dominant class was masked by the establishment of an explicit, coded and formally egalitarian juridical framework, made possible by the organization of a parliamentary, representative regime. But the development and generalization of disciplinary mechanisms constituted the other, dark side of these processes. The general juridical form that guaranteed a system of rights that were egalitarian in principle was supported by these tiny, everyday, physical mechanisms, by all those systems of micro-power that are essentially non-egalitarian and asymmetrical that we call the disciplines. [Foucault, Michel (1975). Discipline and Punish: the Birth of the Prison, New York: Random House (p.222)]

      Foucault pointed out the striking similarities of the prisons, schools, hospitals (especially "mental" institutions), military barracks, office buildings and factories that had been established in the modern state, as they were all designed around specialized functions, regimented schedules and high degrees of observation and control. These institutions even shared very similar physical architectures and were typically legitimized by an underlying "scientific" foundation, whether that be criminology, psychology, medicine or economics. It was their ultimate goal to internalize strict discipline within the individuals themselves, so they would automatically follow these societal "norms" without questioning any of their reasons or results. Anyone who strays too far from the expected behaviors are labeled as part of the "delinquent class", and are deemed to be in need of reform, rehabilitation, treatment or punishment.

      The quintessence of this institutional disciplinary structure for Foucault was Jeremy Bentham's "Panopticon", which is a prison design involving a central watchtower with heavily tinted or mirrored windows. The prison cells would be located around the periphery, and prisoners would never be able to tell whether they were being observed or not. Bentham himself described the design as allowing "a new mode of obtaining power of mind over mind, in a quantity hitherto without example." [1]. It fit in quite well with industrial society's ever-important goal of maximizing efficiency, as it allowed prisons to cut down on the number of staff needed to control the prison population.

      The Panopticon design principles have been implemented in several different prisons and even some hospitals after Bentham's time, but the general concepts can also be seen in other areas of modern life. For example, many U.S. highways have signs warning drivers that "speed limits are enforced by aircraft". It is highly unlikely that the state police department actually takes on the expense of using aircrafts for such a purpose, but that fact is largely irrelevant for the state. As long as drivers believe they are potentially being monitored from above, they will be more likely to obey the speed limits given to them. With such wide-ranging structural influence, Foucault's disciplinary society acts as an enormous, calculating machine which puts Hobbes' Leviathan to shame.

Global Financial Discipline

      Institutional discipline and order have not just been isolated practices used for limited goals, but are now a pervasive element of global society's very fabric. It may have started as a design principle of Western nations, but has quickly spread to all corners of the globe with the exponential rise in transportation and communications technology. Perhaps the most crucial element of this disciplinary expansion has been the process of "globalization", and specifically the focus on creating "free trade" between countries and establishing inter-connected markets.

      After all, the entire disciplinary transition in the Western world was arguably a response to the new economic realities of the industrial age. As the importance of financial transactions in economies around the world increased exponentially, a new form of discipline was needed for the human population. It would serve to solidify the power structures of a global financial society, usurping the previous role of the industrial class. This discipline was first imposed on the world through the Bretton Woods Agreement of 1945, in which the U.S. dollar was designated as the world's reserve currency.

      Under the original plan, the currencies of all participating countries were to be given a fixed exchange rate to the U.S. dollar and the dollar, in turn, was the sole currency that could be converted into gold by foreign governments and central banks at a fixed rate of $35/oz. Basically, the system was designed to encourage international commercial and financial transactions between countries by making the dollar a standard currency of exchange backed by gold. The "science" supporting this new monetary system was "neoliberal economics" supported by "free-market fundamentalism", and also partially influenced by Keynesian theory, and its institutional embodiment was the International Monetary Fund (IMF). 

      Participating countries and their citizens were convinced that everyone could economically benefit from dollar-denominated "free trade" and that a global IMF could manage the system's "liquidity", occasionally helping out states that encountered financial problems by issuing them "low cost" loans. Throughout the last 60 years, many countries in the developing world have been convinced to finance new "infrastructure" projects through IMF loans, and usually the debt servicing costs overwhelm their ability to repay the loans. It is this point at which these countries enter into "negotiations" with the IMF and other creditors, which typically result in the implementation of austerity measures and the auctioning off of public assets below market value.

      In 1971, the gold convertibility of the dollar was unilaterally revoked by the Nixon Administration, effectively making the dollar, as a piece of printed paper or its electronic equivalent, the sole basis for international exchange. Gold-backing of the dollar had been the one limiting factor for how much "liquidity" could be generated within the system, and so the new stand-alone reserve currency allowed for greatly increased international financial activity. It is key to understand that every U.S. dollar currently in circulation is backed by debt, meaning it was generated through the issuance of a loan and this loan created a corresponding liability. Therefore, the fact that more international corporations, governments and central banks were transacting in dollars essentially meant that they were accepting dollar-denominated debt for hard assets (most importantly oil), and all of the risks entailed by that debt.

     Of course, on the way up the debt-fueled ladder of global economic growth, there was very little risk to accepting dollar transactions. In the wake of WWII, U.S. manufacturing and exportation of goods to a world in ruins led the country into a period of great economic prosperity and established the largest economy by a significant margin. Subsequently, with the domination of the financial services market, outsourcing of production, expansion of militaristic hegemony and provision of numerous domestic entitlements, the U.S. transitioned into a powerhouse consumer economy. Americans had an insatiable appetite for the financed sales of products from other countries (especially China), which further encouraged these countries to transact in debt-dollars. A crucial instrument for managing and reinforcing the debt-dollar discipline on the world was the "letter of credit".

     For example, an issuing bank in Uzbekistan could grant a local importing business a letter of credit, which would serve as a conditional promise by the bank to pay a beneficiary in another country upon satisfaction of the letter's terms and conditions. The beneficiary may be a seller of equipment or materials in America, who must present the required documents to the issuing bank in order to draw on its payment rights. These secured transactions made it easier for international exporters/importers to do business without worrying about their legal rights in other countries, and also reduced their costs for financing transactions, since the issuing bank did not have to police the underlying sales contract.

     The global debt-dollar discipline was thoroughly institutionalized through instruments such as letters of credit and organizations such as the IMF. As the factory disciplines its workers to be more docile and efficient, the debt-dollar institutions discipline their global constituents to take on increasing amounts of debt and consume more goods and services. More importantly, they discipline the constituents to become intrinsically attached to their financed lifestyles and the overarching institutions which manage the system. It is the constant maintenance of this attachment that is the coercive goal of "punish" under Foucault's analysis.

The Role of Financial Punishment

     When Foucault wrote about modern society's need to "punish", he meant it in both the literal sense of how it is employed within penal systems and also the broad sense of how societal discipline is reinforced at every level. After all, the prison is merely an extension of the discipline continuously exerted on the individuals outside of its walls. While other critics saw the modern prison system as repeatedly failing in its goal to reform criminals, Foucault saw it as succeeding in continuously creating a state-controlled underclass of delinquents and normalizing the behaviors of those in the numerous "theatres of punishment". Although the codified laws of a society were important in maintaining order, the fundamental mechanism of ingraining discipline was ceaseless observation and "normalizing judgment" - a perpetual penalty.

      Students, workers, soldiers, patients and inmates alike must be constantly monitored to not only assess their performance, but make them aware that their behaviors are being monitored. Using these observations along with other factors, various standards of conduct can be established to define the "normal" and expected behaviors. Deviations from these standards can be quantifiably measured with grades, performance reviews, medical classifications, etc. The whole point is to methodically allow people to become self-disciplined, relying on their own self-perceptions in relation to others, without actually using any (or very little) force.

      A dual system of both rewards and penalties will coerce people to stay bounded within a range of "normal" behavior, and those who deviate will be marginalized in some manner. Penalties may take the form of negative marks, restricted activity, constraints on time or simply social stigmas, as long as they promote future discipline within the punished or among others who observe. Out of the societal group emerges an "individual unit" defined by his/her mechanistic functions and resulting hierarchical status in life, and consequently by how far he/she deviates from the "norm".

     The debt-dollar discipline imposes a degree of abstraction in modern disciplinary society, in so far as it cannot be readily identified with a specific physical institution. The IMF and other central banks are critical coordinating institutions for debt-dollar transactions, but the system's participants worldwide cannot be directly observed and trained by such institutions. It is more of a parasite which has attached itself to all of the other disciplinary institutions, which help observe and measure the behaviors of financial consumers. The standards of conduct were already deeply rooted in society through these capitalistic organizations, which primarily judged subjects according to their socioeconomic status.

      Financial consumers are pushed towards accumulating ever more material representations of their wealth, whether those be homes, cars, boats, consumer electronics, stock portfolios, etc. With modern computer technology, most of this financial activity can be easily monitored and recorded within centralized databases. The most prevalent mechanisms used to measure deviations from "normal" financial activity are credit scores for individuals and credit ratings for businesses. Although these measurements allegedly target a consumer's ability to repay debt, they typically end up reflecting the willingness of a consumer to take on debt. For individuals especially, a consumer's past level of questionable financial activity can help boost his/her scores above what they would be without any financial activity.

      These mechanisms effectively serve as carrots and sticks for the financial consumer. If you have participated adequately in debt-dollar transactions, then you may be able to participate further at a relatively low cost. With this comparative advantage over other financial consumers, you will be able to elevate your socioeconomic status and be a respected member of society. In stark contrast, those who do not participate adequately will be priced out of debt-dollar transactions and will have a very difficult time competing for a limited supply of material goods and services. They will be labeled financial "delinquents" and lose all respect from the business community or society at large. In this manner, financial consumers around the world are trapped by the panoptic gaze of governments, lending institutions, rating agencies, private corporations and their fellow consumers.

      The financial consumers in the debt-dollar disciplinary system also include sovereign states as well. These states have effectively become measured by their ability to issue debt and finance internal spending programs. Investment capital will flock to those states with the fastest growing economies and the highest-rated debt, which are typically those states carrying out the most financial activity. These states also rely on the fact that the IMF will help them out with debt-dollar "liquidity" if they run into financial difficulties on their quest to achieve relative economic superiority. Those states who do not adequately participate are treated unfavorably in all manner of other relations, including but not limited to trade negotiations, environmental agreements and diplomatic relations.

      Of course, the broader power structures involved in the debt-dollar disciplinary system have also managed systemic threats by explicit mechanisms of punishment. Since the end of WWII, the U.S. has engaged in many subversive military and political operations against "Communist" or "Socialist" groups, as they represent a potential system of organization outside of the debt-dollar discipline. Many disciplined Americans are aware of their government's wars against North Korea and North Vietnam, as these fit well  into the "fight for freedom" narrative, but not so much of their government's constant interventions in Latin America. The latter would frequently involve the subversion of democratically-elected leaders with financially protectionist tendencies, and therefore secrecy or misinformation was preferred over the traditional freedom narrative.

      Despite such exacting punishments carried out within the the debt-dollar system, some threats have continued to evade its pervasive discipline. A good example of such a threat would be insurgent groups in the Arab world who continuously resist Western domination. Their influence in Middle Eastern countries may have been negligible in the past, save for the ongoing Israeli-Palestine conflict, but it has rapidly spread to many different fronts. The current intractable military operations in Iraq, Afghanistan and Pakistan are symbolic of a disciplinary system which has over-stepped its ability to exert global control. More recently, the ongoing global financial crisis is an obvious break down in debt-dollar discipline unlike any other in the last 60 years. Part II in this series will explore the future prospects of debt-dollar discipline around the world, and more generally the entire disciplinary structure of Western society first articulated by Foucault.

*Descriptions of Foucault's analysis were largely sourced from this Spark Notes Summary and this Wikipedia article.

The Playful Musings of Illogical Optimists

     I recently came across a "discussion" between Matt Ridley, author of The Rational Optimist, and Bill Gates in John Maudlin's "E-Letter" about the nature of optimism and pessimism. Ridley generally argues that our "success" as a species up to this point has been primarily a result of our inherent ability to trade with each other, as evidenced by the very early use of rare objects far away from the sources needed to produce them. He further argues that, consequently, humans have continued to increase their collective prosperity throughout the ages, despite many dire predictions of impending doom that were being made all the while. Bill Gates has written a book review in which he quarrels with a few specific examples that Ridley had provided (problems in Africa and Climate Change), but he essentially agrees with Ridley's main point that many people are "overly concerned with potential problems", especially in "rich countries over the last several centuries".

     This so-called discussion between Ridley and Gates is, in fact, not much more than a simple back-and-forth between two people who hold self-contradictory views and know little about the topics they discuss. That statement may seem harsh, but reality can and has been harsh, a fact casually dismissed by the writers as being "too pessimistic" for their personal liking. The response by Gates is an amazing example of how human beings, those creatures who have historically been so "successful", are also plagued with many logical fallacies and cognitive biases. In fairness to Gates, these are not isolated flaws limited to the minds of a few American billionaries, but a pervasive feature of human beings in all complex societies around the world. Nicholas Nassim Taleb has deftly illustrated this point in his books The Black Swan and Fooled by Randomness, which I highly recommend.

    Anyway, I will not even dwell on Ridley and Gates' deep lack of understanding about the details of macroeconomics, climate change, environmental sustainability and whatever else they have discussed, because it would devote too much time towards arguments which can be dispelled in a much simpler fashion. I'll just quickly point out that Gates has urged us to consider "super-intelligent computers" as a major threat to humanity unfairly neglected by Ridley in his book, instead of financial meltdown, peak oil or geopolitical instability.

    Not to be outdone by another man's ignorance, Ridley responds that we are gradually transitioning away from carbon-rich coal to "hydrogen-rich fuels like oil and especially gas", so as to render climate change a greatly over-exagerrated threat. A reader can't help but get the feeling that these gentleman expect people to take their completely unsupported assertions as the gospel truth, instead of with the heavy dose of salt they so clearly deserve.

     However, since the limited discussion I read was focused mainly on the broad nature of optimism and pessimism, I will stick to the logical flaws they pepper throughout their arguments. Gates really manages to kill his logical credibility right off the bat when he refers to the following quote by John Stuart Mill:

"I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage."

     Assuming that Mill's assertion is mostly true, we are left with the point that people tend to respect purveyors of "despair" rather than those of "hope". With a logical leap of greatness, Gates then uses Marx's hugely populary theory of capitalism as an example of "excessive pessimism", since it was (is) respected by many people and also made dire predictions about the future of capitalist economies.  He effectively attempts to dispel extremely valid concerns about the sustainability of capitalism, developed over hundreds of years and now more prescient than ever, by confusing a general anecdote with the validity of a specifc scientific analysis.

    Yes, many preachers of "doom and gloom" may get significant amounts of attention and achieve large followings, but that by no means speaks to the credibility of their underlying arguments. By Gates' reasoning, any popular scientific analysis that predicts signficantly negative outcomes should automatically be treated as suspiciously pessimistic, including the widely-accepted theory of man-made Climate Change, which Gates happens to support.

     Unfortunately, the above logic will seem impeccable when measured against that contained in his next few statements. And I quote:

"Pessimism is often wrong because people assume a world where there is no change or innovation. They simply extrapolate from what is going on today, failing to recognize the new developments and insights that might alter current trends."

     Gates' point about people extrpolating past trends into the future is a valid one, but it provides no logical support for his premise that "pessimism is often wrong", because that particular cognitive bias applies just as well, if not more so, to attitudes of optimism about the future (re: constant denial by people in the developed world that economic growth has indefinitely stagnated). Between the twelve lonely economists who were predicting a housing-driven financial meltdown and the millions of people expecting housing prices to rise forever, it should be crystal clear who was in the business of extrapolating past trends. By this point in his review, Gates has established an illogical momentum which cannot be stopped. In an almost unbelievable fashion, he waits for no more than one sentence from the prior passage before dropping this bombshell:

"A lot of the rhetoric about sustainability implicitly assumes that we will exhaust our natural resources, as though there will never be any substitution of one commodity for another in the future. But there has always been such substitution."

     He has immediately employed the tactic he just criticized pessimists for incorrectly using, as if billions of dollars in net worth come at the expense of short-term memory. The suggestion is that humans have always substituted plentiful commodities for rapidly depleting ones in the past, and therefore there is no reason to expect anything different will happen in the future. Apparently, it is only wrong to project past trends into the future when those trends don't support the argument you are trying to make. Gates has completely missed the lesson of that cognitive bias, which is not that humans have always innovated their way out of historical problems, but that the specific future behaviors of complex systems are inherently unpredictable. Broad structural shifts such as energy or resource scarcity, on the other hand, are quite predictable within a range of certainty.

     Finally, the most egregious logical fallacy employed by both Ridley and Gates is that of projecting their personal definitions of "success" onto the whole of humanity, throughout all of time. They view the technological and sociopolitical developments over centuries of evolution as being clearly beneficial to all of mankind. If certain arbitrary measures have improved for specific segments of human society, such as "lifespan, nutrition, literacy, wealth", then clearly progress has been made and all of the pessimism was much ado about nothing. It is a deeply-rooted fallacy held by many people born in the developed world and living in relative stability, who tend to ignore the large historical and ongoing costs incurred to make their current lives possible. 

    They are ignoring the Earth's struggling ecosystems, the extinct biological systems, the destructive wars, the massive geopolitical instabilities formed over centuries, the lives of future generations, the tragic disconnects with nature, the deterioration of moral fabric, the structurally pervasive inequality and the very reasons why Bill Gates feels compelled to donate such large sums of money to humanitarian aid missions in the first place. All of the above and countless other things have directly occurred or will occur as a result of the human "progress" that now makes them so optimistic.

     Of course, I'm just an unknown blogger who has written no book published by a major clearing house or reviewed by an American business icon in the Wall Street Journal. If I want to engage in this discussion of optimism and pessimism with Ridley and Gates, then my best shot is in the comment section underneath the online WSJ publication. After all, what good is informed knowledge and logical consistency when it underlies a "pessismistic" world view? John Stuart Mill was wrong, in so far as anyone who makes temporal generalizations about complicated social dynamics is wrong. In modern society, pessimism about the future is largely shunned by the mainstream, because so many people are fully expecting and entirely dependent on their promised lives to materialize.

    We have been convinced by people like Bill Gates, and by our willful suspension of disbelief, that the growth story of the past will continue on indefintely into the future, and that the material gains from this growth will be fairly distributed to billions of people around the world. I say "we" because I have a hard time shaking free of this story myself, like a little child who has just learned Santa Clause doesn't exist. It takes courage and persistence to despair when others illogically scream at you to hope, so my question is this - when are we going to allow adults into this ever-important discussion? I suspect that when the next leg down of the ongoing financial crisis occurs and energy costs skyrocket, Ridley and Gates will lay low and speak with muffled voices, but still retain their optimism, because they have more than enough to survive.

*The "discussion" is sourced from here

From One Corrupt Congressman to Another

"A chain is no stronger than its weakest link, and life is after all a chain." -William James

     The House Ethics Committee has just voted to confirm there is "clear and convincing" evidence that Charlie Rangel (D-NY) has violated at least eleven different Congressional ethics rules. His violations include failing to pay taxes on his property in the Dominican Republic, illegally transforming a rent-controlled residential apartment into a campaign office and using his status as head of the Ways and Means Committee to secure funds for his public policy center. What is the punishment recommended by the Commitee for this Congressman's criminal and unethical behavior? Censure! That's right folks. Rangel will be forced to stand on the floor of the House in front of his peers, in the narrowest sense of that word, and be lectured to by its Speaker, which will either be Nancy Pelosi or John Boehner depending on the timing.

     I'm not sure exactly what the Speaker would say in this censure, which Representative Butterfield (D-NC) had the nerve to label an "extreme" punishment, but rest assured that the following is the gist of the message which will be sent:

"From one corrupt Congressman to another, congratulations on successfully fleecing the American people and abusing their trust for years, without suffering any real consequences for your actions. We could have forced you to resign from Congress, or maybe even subjected you to criminal prosecution for tax fraud, but you and everyone else here knew from day one that would never happen. Drastic measures such as those would threaten to expose the systemic corruption in this institution, and could very well subvert our entire operation!

No, not one person here wants to see that happen... but we will censure you for your actions. Take this punishment as a signal old man. You have "served" the people for decades now, during which time you siphoned off your fair share of political rents. Now, it's time for you to move over and make room for some of the new guys. After all, there's a learning curve to this here game, and plenty of eager politicians who are dying to play."

     Representative Maxine Waters (D-CA) is also up for a hearing before the Ethics Committee in a few days, on the charge that she diverted TARP funds to a financial institution in which her husband had a financial stake. What are the chances that she escapes the hearing with nothing but a slap on the wrist like her buddy Rangel did? Vegas oddsmakers would probably give you a 100 to 1 for taking the other side of that bet. I keep naively hoping that Congress will decide to dismiss the Committee's recommendations and throw the book at Rangel, Waters and all others like them. After all the bickering and rhetoric leading up to the 2010 elections, you would think that the House Republicans would at least go after corrupt Democrats with full force.

     That is, of course, until you realize that the Republicans have just as much to lose from harsh punishment as Rnagel and Waters do. They are the new face of the House, will most likely be the new face of the Senate in 2012 and perhaps even of the Presidency. These people didn't get to where they are now by ignoring the cardinal rule of American politics - accountability for one means accountability for all. The game has clearly defined rules and very strict boundaries that no one must cross. If everyone was held accountable for their "sloppy" or "stupid" actions, as Rangel described his, or for their "acts of ommission" and "failing to carry out [their] responsibilities", then who would be left to make wise policy decisions for the American people? Well, that's how the deeply embedded insitutional players think anyway.

     How many times over the past decade have we had to put up with meager settlements, petty fines, symbolic reprimands or absolutely no punishment for blatantly criminal activities? Whether it be high-level executive officials frabricating intelligence and sanctioning torture, top bank executives committing systemic fraud and laundering drug money or legislative officials accepting bribes and abusing their authority, we have seen it all spontaneously come to light and then be buried in the depths of public consciousness just as quickly. Any real puishment for these actions would lead to the end game in short order, because once they give us an inch, they know we'll quickly take a mile. Indeed, to sacrifice the weakest link is to sacrifice the entire chain.

*All facts sourced from the following CNN article

The Keynesian Vacuum Universe

"Nothing in the world is more dangerous than a sincere ignorance and conscientious stupidity"
- Martin Luther King, Jr.

     If only we existed in a Keynesian vacuum universe, then the current Administration's economic policies may have actually succeeded in fixing the ailing, debt-ridden economy! Here are some of the reasons why:

-   Swapping bad private debt for public debt would not negatively affect the sovereign bond market in any meaninful way, since all public creditors would realize that it is just a temporary measure to clean up balance sheets and restart economic growth. The prior value of that bad debt would eventually be restored, and it would be repurchased by private actors. The taxpayers would recover all of their money, or maybe even make a small profit.

-   Deficit spending would also not affect the bond market for the same reason above. It would go directly to consumers and small businesses who could pay off debt and start productive enterprises that create useful products/services, which could then be consumed. No money would be wasted on pork or in bureacratic institutions, because the government would know exactly where the money needs to go and how to get it there efficiently.

-   A "Deficit Reduction Commission" would effectively deal with any potential possibility of a public debt crisis by making small tweaks to entitlement spending and tax policy, leaving defense spending alone so all Americans can feel safe and secure. As soon as the Commission produced its report, all measures proposed would be instantly voted on by Congress and approved. The minor tweaks, of course, would not have any unintended consequences, such as stifling economic growth (and making deficit/GDP worse) or royally screwing War Veterans by cutting their health benefits.

-   Government backstops and subsidies of the housing market would not be taxpayer money wasted, because the bailed out banks and subsidized borrowers would pick up the housing bubble where it left off in 2007. As credit conditions eased, home prices stabilized and unemployment decreased, the government could draw down its market interventions and aggregate demand for homes would not plummet.

-   The Dodd-Frank Wall Street "Reform" Bill would not create any level of uncertainty or unintended consequences in financial markets, since it would extremely clear and targeted with its new measures. The new regulators would analyze the root causes of the financial crisis, propose measures to address these structural problems, implement those proposals via new regulations and enforce the regulations. All new regulators would be insulated from financial industry capture, and would work solely for the benefit of the American public.

-   Quantitative Easing by the Federal Reserve would not blow speculative bubbles in any financial markets, and even if it did, that speculation would not artificially increase the prices of commodities for consumers and productive businesses (squeezing their profit margins). Money would flow to the banks from asset purchases, and these banks would lend that money out to consumers and small businesses at affordable interest rates. Asset prices would not go parabolic again via leveraged speculation, because investors would have learned their lessons from the last credit bubble.

-   QE would also successfully devalue the dollar enough to make debt burdens more manageable and boost U.S. exports, but not so much as to cause rampant, unchecked inflation. In the Keynesian vacuum universe, other countries do not care about American monetary policy that serves to flood the entire world with dollars used for intense financial speculation.

-   Moral hazard would never be an issue. Bailouts and subsidies for banks, businesses or consumers would not affect the future decisions of these market participants, courtesy of the laws of  the vacuum universe.

     And if we really existed in a vacuum, then we would have never had a global credit bubble or financial crisis in the first place. Life would have been clean, simple and forever productive. It would always be a warm and sunny day outside, with cheerful birds chirping and the faint laughter of little children in the background. In this universe, political leaders and pundits could look their country's population in the eyes, and tell them that their economy is healthy and their country is "the greatest" with a straight face. The people would never question the wisdom of those wielding power, and their minds would always be at ease. That is, of course, until they snap back to reality and are forced to face their existence beyond the comfort of the vacuum.

Plutocracy Now!

     Every so often, Americans should stop everything they're doing for a moment, and reflect upon the nature of their country. Specifically, upon what has traditionally been this country's defining characteristic. Was it our capitalist economy? No, there are many capitalistic countries around the world and capitalism was not first formulated by Americans. What about our emphasis on personal freedom? Well, once again, many countries preach the virtues of freedom and many groups of people have fought for freedom well before America was formed. Surely it has been our diverse populace and our tolerance of all races, genders, sexual preferences... yeah, right. Personally, I would answer that it was our written Constitution and the democratic values embodied within it.

     No other country had ever codified the structures and processes of their governing institutions to such an extent in one single document. Many people focus on the Bill of Rights when speaking about the Constitution, but the first four Articles are just as important. They synthesized political ideas that were developed over hundreds of years by some of the most insightful thinkers, such as separation of federal powers, checks and balances, vertical division of powers (federalism), an independent judiciary and, of course, representative democracy. The latter emphasizes the notion that any policies enacted by the federal government must be authorized by the people, through their elected representatives who are held accountable to constituents every few years.

      So what's the state of our Constitutional democracy today? Simple, it doesn't exist. International corruption surveys typically rank the U.S. higher (less corrupt) than most other countries, but this simply proves how bad these surveys are at capturing the essence of real, hardcore corruption. We could write stacks of books on the prevalence of money in politics and the swarms of lobbyists who descend on Washington every single week, and many people have, but it's simpler to just focus on the most egregious example of corruption. The most powerful, influential economic policy-making institution in the country, the Federal Reserve ("Fed"), is an unelected body that is completely unaccountable to the people. Well, let's back up and start with the fact that this institution's very existence is most likely unconstitutional. Here's why:

     Article I, Section 8 of the Constitution states that Congress has the power to "coin money" and "regulate the value thereof". The Supreme Court has long held that Congress can delegate its legislative powers to Executive agencies as long as it provides an "intelligible principle" to guide the agencies' action. We don't even have to reach the question of whether the Federal Reserve Act sets out an "intelligible principle", however, because existing precedent states that Congress cannot delegate its powers to private institutions. Schecter Poultry (held "a delegation of its legislative authority to trade or industrial associations...would be utterly inconsistent with the constitutional prerogatives and duties of Congress). In that case, the Supreme Court struck down parts of FDR's National Industrial Recovery Act which authorized these private organizations to draft "codes of fair competition" and submit them to the President for approval.

     The Fed, by it's own admission, is an independent entity within the government "having both public purposes, and private aspects". By "private aspects", they mean the entire operation is wholly-owned by private member banks, who are paid dividends of 6% each year on their stock. Furthermore, the Fed's decisions "do not have to be ratified by the President or anyone else in the executive or legislative branch of government" and the Fed "does not receive funding appropriated by Congress". In 1982, the Ninth Circuit Court of Appeals confirmed this view when it held that "federal reserve banks are not federal instrumentalities... but are independent, privately owned and locally controlled corporations". [The Legality of the Federal Reserve System, 5]. Yet, the Fed has exclusive control over the government's ability to create money and regulate its value through the targeting of interest rates and open market operations (when the Fed buys an asset, it typically prints the purchase money out of thin air). How Congress can delegate its Consitutional powers to this independent, privately owned and unaccountable institution is beyond me.

     Still, the Constitutional issue is just the tip of the iceberg when it comes to this twisted institution's embodiment of all things undemocratic. When Congress (and the people it represents) makes a valid delegation of its powers to an executive agency, it almost always retains a level of control through its powers of appropriations, impeachment and oversight. For some not-so-strange reason, the Fed isn't appropriated any funds by Congress, and so it cannot be financially "starved" like any other agency. The members of the Fed's Board of Governors also cannot be impeached by Congress, which is especially twisted, since the President of the United States can be impeached for "high crimes and misdameanors". [The Legality of the Federal Reserve System, 8]. What about oversight? Well, a Congressional committee holds "hearings" every once in awhile to ask the Chairman a few irrelevant questions, but if this process is what passes for "oversight", then we have truly gone off the deep end.

     Speaking of committees and oversight, when Fed Chairman Ben Bernanke testified under oath to Congress in July, he said in no uncertain words, "the Federal Reserve will not monetize the [federal] debt". [1]. Fast forward to the day after mid-term elections, in which the American people clearly voted for LESS spending/printing, and the Fed announces its plan to monetize $900 billion in treasury bonds. [1]. The Chairman has proven his previous testimony before Congress to be a blatant lie, but instead of condemning the Fed's recent actions, the federal government has welcomed it with open arms. That's quite some oversight we have there. Perhaps the best way to oversee the Fed's actions would be to actually figure out what in Lloyd Blankfein's name it's been doing.

     In this country, that's easier said than done. The Government Accountability Office is not allowed to audit the Fed's transactions for or with foreign governments, central banks, nonprivate international organizations or those made under the direction of the Federal Open Market Committee ("FOMC"). It just so happens that these are the types of transactions which are most influential on global and domestic financial markets, especially the open market operations. These operations are conducted by the FOMC, who is comprised of the Board of Governors (7 members appointed by President and confirmed by Senate) and five representatives from the regional Fed Banks. Although the President appoints the Board of Governors, he must choose from a list of candidates provided by private institutions, and the other five representatives are also typically nominated by private member banks. Talk about an organization with conflicts of interest, lack of transparency and lack of accountability all tightly woven into its very fabric!

     In the last two years, the almighty Fed has printed trillions of dollars in our name to buy worthless mortgage assets from "too big to fail" banks. It has lent these banks our hard-earned money at about 0% interest, so they could lend our own money back to us at 3%+. These banks also used our free money to ramp equity and commodity markets, which mostly benefitted the top 1% of our population who owns 43% of financial wealth [2], and conveniently, also owns the Fed. The latter has kept interest rates at next to nothing to punish savers and encourage speculation, making everything less affordable for average Americans who have seen their wages stay the same, decrease or disappear. What's left standing is the perniciously powerful, highly secretive and entirely unaccountable Fed, who now epitomizes the state of American democracy.

     We have all become subject to the misguided and/or malicious whims of a few wealthy individuals operating the levers of economic policy, with no adequate means of challenging their power. Our most treasured contribution to poitical society has been reduced to a bunch of meaningless articles and amendments, containing equally meaningless words. We the people, in our pursuit of "a more perfect union", have fallen into an age-old trap. Our economic policies, currency and laws are all manufactured by our very own private dictator, who amasses a fortune from our collective exploitation and destruction. Then, this despot continues to operate like nothing ever happened. We can scream "ABOLISH THE FED" all day, non-stop to every single politician at the top of our lungs, but it will never happen.  The reality is that there is only one way back to a true democratic system now, and this path will require nothing less of us than the courage of our forefathers.

A Probabilistic Assessment of Short-Term Inflation or Deflation

*I apologize for the skewed format of this article... having some technical difficulties with blogspot

The blogosphere has been rife with debates over whether the U.S. economy will experience inflation or deflation over the next year or two. Typically, those on either side of the debate believe that, regardless of the specific outcome, it will be severe and destructive, but there are some who believe it will be a milder process. It has also become clear that those on either side of the debate are almost certain that we will experience the outcome they advocate. I am of the view that the best we can do in our complex financial economy (which is highly inter-connected to the global economy) is discuss the broad factors that make one or the other more likely to occur. It appears to me that there are at least three critical questions which should be answered to determine probabilities of outcomes in the controversial inflation/deflation debate:

1. What do the financial elites want to happen given the current economic circumstances?
2. Will the Administration (includes Congress for this discussion) and/or Federal Reserve  attempt to pursue policies that accommodate the elites' preferences?
3. If the answer is "yes" to #2, can the Administration and/or Fed be successful in achieving these goals.

After considering how much wealth is controlled by the elites (top 1% holds 43% of financial wealth) [1], and therefore how much political influence they exert, we can assume the answer to #2 will almost always be "yes". This answer is further reinforced by past political experience and a bit of common sense. That leaves us with #1 and #3, which are difficult questions to answer with high levels of certainty. However, many insightful analysts have attempted to answer these questions using facts, data, trends and experience, and have produced very plausible predictions.

          Many people may criticize the following analysis for leaving out many different factors that could potentially affect the likelihood of inflationary or deflationary outcomes. However, when too many variables are included, the analysis required to determine chances of specific outcomes grows disproportionately more difficult. This article has attempted to use broad strokes to sketch a general picture of the probabilities involved, sacrificing detailed calculations for targeted clarity. It is somewhat of a perturbation approach, where a few primary factors are used to create a “ballpark estimate”, and then this estimate can be later refined by including smaller, more detailed factors. For example, when physicists attempt to predict the motion of the Earth within the solar system and through the universe, they cannot factor into their calculations every gravitational force that acts on the Earth. Instead, they focus first on the Sun’s gravitational effect, since it is the most influential force by a large factor. After making this relatively simple calculation, they can gradually add in the effects of the next most influential bodies, but they will never arrive at an exact prediction of the Earth’s motion because the calculations eventually become too complex.

          Before delving into the discussion, I must note that it will be based on several different assumptions for the sake of simplicity. Instead of mentioning them within the discussion, I will just list them up front and let the readers decide whether they are reasonable or not:

          - The financial elites do not want severe deflation or hyperinflation, since these outcomes would
            wipe out the value of their numerous debt assets or wipe out the value of all their dollar-
            denominated holdings respectively.

          - The Administration/Fed will almost always attempt to pursue the policies that the elites want them   
             to (95% of the time for inflation; 90% for deflation)
         
          - The financial elites cannot unilaterally (without Administration/Fed) make decisions that will affect
            the probabilities of inflation or deflation (we will assume they will make self-interested lending 
            decisions).
          
          - The Administration/Fed’s attempts to inflate, if they choose that option, will not be significantly
            counter-acted by currency devaluations of other countries. They may have a temporary effect, but

            financial/militaristic incentives to work with the American power elites and threats of protectionism

            will balance this dynamic out.

          - Hyperinflation will only occur when financial elites prefer inflation, and severe deflation will only

            occur when elites prefer deflation.

          - Issues associated with peak oil/resources will not be a factor within the next few years.

The following definitions of inflation and deflation, borrowed from The Automatic Earth, will be used [1]:

• Inflation - Marginal increases in the amount and velocity of credit money relative to goods/services.
• Deflation - Marginal decreases in the amount and velocity of credit money relative to goods/services.

What do Power Elites Prefer – Policies Supporting Mild Inflation or Mild Deflation?

            Mild Inflation (25%)

The argument for power elites preferring mild inflation is perhaps the most intuitive. Inflation of the money (credit) supply to devalue the currency should lead to rising asset prices, as more money is chasing the same supply of assets. Financial elites have large investments in real estate, stocks, bonds and commodities and should therefore benefit from higher prices and interest rates. If consumer prices are also supported, then there could be a resumption of hiring by various businesses, which would certainly help restore some confidence in the economic structures of the status quo elite. In a more general sense, inflation manufactured via another credit bubble would return the economy to a state of consistent growth, allowing power elites to continue playing their cruel games. However, this argument contains the following assumption, which may simply be incorrect: that creating a modest amount of growth in the money supply, by getting debt-money to investors and consumers, will actually lead to higher prices.

The prominent blogger Charles Hugh Smith (“CHS”) has provided a very insightful argument for why the elites would not prefer mild inflation [2]. To understanding a key part of this argument, it’s important to note that the economic situation now is unlike it has ever been in the last 60-70 years and also that the elites are aware of this fact. There has been an enormous, decades-long credit bubble in the private sector (~300% Debt/GDP in 2008), and now the consumers, who make up 70% of GDP, are buried beneath a mountain of debt. Despite the Administration and Fed's programs to inject trillions into the economy via stimulus and quantitative easing, the velocity of money has remained stagnant as investors, small businesses and consumers hesitate to lend, invest or borrow. It is very plausible that a modest increase in money supply will simply lead businesses and consumers to pay down some debt and hoard any remaining cash in the face of future uncertainty. We certainly see a version of this dynamic in the stock market, where institutional investors continue pulling money out of equities despite the recent rallies [3].

For the above reasons, the economy will most likely be in a prolonged period of low growth and subdued asset price inflation despite modest amounts of further stimulus or monetary easing. Even some of the major investment banks (financial elites), such as Goldman Sachs, have predicted a negative GDP print in Q4 2010. [4]. The current dynamic for elites is much different than the one existing after the Great Depression, where losses on cash holdings from consistent devaluation of the dollar via inflation were more than offset by returns on asset investments. CHS points out that the dollar has lost more than 95% of its value since 1913, but the Dow Jones Industrial Average has actually risen at about seven times the rate of dollar depreciation over the same time period. It would be prudent to assume that the elites have learned their lesson from 1966-1981, when a period of “stagflation” (low growth coupled with high price inflation) wiped out much of the value in their stock and bond holdings. [5]. The last thing the elites would want is a period of inflation in consumer prices, which eats up the value of their debt assets, but doesn’t contribute to high returns on financial investments.

Mild Deflation (75%)

CHS explains that mild deflation, on the other hand, would increase the purchasing power of elites holding cash, money market instruments and short-term treasuries, while also increasing their returns on debt assets. When inflation is negative, the real interest rate paid on debt (= nominal IR - rate of inflation) is higher than the nominal rate. As long as the deflation doesn’t become too severe and wipe out heavily indebted consumers, businesses and governments, the financial elites can continue making decent returns while setting themselves up to buy various assets for pennies on the dollar in the future. [6]. By maintaining their wealth and political control, the elites can also ensure that any new regulations or fiscal/monetary policies continue to be in their favor (backstops of the housing market, monetization of treasury debt, higher taxes on the middle class to pay interest on public debt, welfare benefits to quell social unrest, watered down “reform”, etc.). Therefore, on whole, it seems significantly more likely that power elites would prefer a path of mild deflation above all else, but the question of whether it is even possible to maintain this Japan-style malaise still remains.

What can the Administration and/or Fed Accomplish?

            Mild Inflation (10%)

It would appear that the Administration and Fed have been completely geared towards creating inflation up to this point in time. The former attempted to re-capitalize major banks with TARP and mark-to-fantasy accounting, promote consumer spending with stimulus and stabilize housing prices through Fannie, Freddie and the Federal Housing Administration. It has also provided billions in jobless benefits and other aid to struggling citizens. The Fed has attempted to stabilize the housing market and banks’ balance sheets through asset purchases of mortgage-backed securities and zero-interest rate policy. The latter, along with the direct monetization of treasury bonds by the Fed, also serve to finance the Administration’s deficits at low interest rates (banks borrow at 0% and lend to the government at 1-4%).  

Despite all of these measures, consumer price inflation remains close to 0% (excluding energy/food) [7], unemployment remains close to 22% [8] and consumer credit continues to contract [9]. Of course, the stock and bond markets have benefitted greatly from these policies since the beginning of 2009. The former, however, has become increasingly unstable this year as retail investors continue to opt out in large numbers and robots with synchronized time horizons are left to buy and sell to each other. [10], [11]. The bond market, however, is much bigger than the stock market and its stability is significantly more crucial for the power elites and politicians. It appears at this time that, although it is in a huge bubble, the bond market will remain relatively stable due to investors’ preferences for “safe havens”, the desire of external creditors’ to support our consumer economy, and, of course, the permanent open market operations (“POMO”) of the Fed.

            Hyperinflation (30%)

Many commentators involved in the inflation/deflation debate believe that, in pursuit of inflation, the Administration/Fed will inadvertently jump start a process of hyperinflation. This argument typically follows the following logic: every time the economy renews its deflationary pressure, the politicians and central bankers will keep spending/printing money to fight it off, and eventually we will reach a tipping point of confidence in the U.S. economy and its currency as a reliable means of exchange. History certainly seems to suggest the first part of this argument is accurate, but the sociopolitical dynamics involved have significantly changed in the last few years. Both the public and politicians who pander to them have expressed much disdain for further spending or printing, and on top of that, its unclear how many trillions would even be necessary to combat the deflationary pressure. As mentioned above, the elites must maintain relative stability in the bond market to protect their holdings and the current power structure, and another $5-10 trillion in printed money would be counter-productive to this goal. For these reasons, it seems unlikely that the government will print enough money to spark hyperinflation, but that certainly does not mean we can rule it out.

A blogger named Gonzalo Lira has produced a series of articles presenting a unique perspective on how hyperinflation could occur. [12]. To summarize, he believes that a temporary spike in commodity prices (such as oil) will lead to institutional asset managers selling a portion of their large treasury holdings (paying artificially low yields) to buy into the ramp. This small sell-off will occur before a somewhat large treasury auction, and so the Fed will step in and buy to stabilize yields. Similar to what we currently see during the POMO operations, asset managers and primary dealers (“PDs”) will start unloading larger amounts of treasuries onto the Fed to turn a quick profit and reinvest proceeds into the commodity space. Asset managers will then begin to dump huge portions of their holdings, since they see the PDs selling and the Fed buying a large volume of treasuries at a time when they are already on edge about the precarious nature of the economy and bond markets. This cycle represents a classic positive feedback, where asset managers dump treasuries for liquidity, causing the Fed’s buying to stabilize yields, causing even more managers to dump while there is still a willing buyer with unlimited cash. All of this action will occur within a few hours at most, and the managers will turn to commodities as a relatively safe and perhaps quite profitable place to invest their cash.

Mr. Lira believes that physical commodities will be perceived as the only sure store of value, and will therefore shoot up between 150-250% by the end of this panicked week. Once this spike translates into significantly higher gas prices at the pump, average consumers will begin selling all of their paper assets and buying hard commodities out of fear of prices continuing to rise in the future. [13]. It is easy to see how this process will eventually translate into a self-reinforcing spiral, where almost all discretionary assets will be swapped for energy, food and other essentials, eventually leading to skyrocketing prices and hyperinflation. What’s even more frightening is that the Administration and Fed will be practically helpless to do anything about it at this point, since their limited tools will be woefully inadequate once the consumer has lost complete confidence in the currency.

Although it presents a very interesting hyperinflation scenario, the problem I see with Mr. Lira’s argument is two-fold:

(1) A large, temporary spike in oil prices is unlikely to occur or lead to a treasury-dumping spiral – The spark for a short-term spike in oil prices would have to be a major disruption of Middle East supply through a military conflict or a voluntary embargo by exporting nations. In contrast to 1973, when OPEC nations decided to place an embargo on oil exports due to Western support of Israel in the Yom Kippur War [14], the U.S. now has strategic military bases throughout the Middle East and would not allow such an embargo to even take place. [15]. Any further military conflicts that take place in this region will have the U.S. military directly involved, and it will certainly do everything it can to make sure America’s share of oil supply is not disrupted. In fact, a prerequisite for any military action would be to have a solid plan for securing production facilities in the region.

 If the supply of oil to America is disrupted by military action in the Middle East, then the Administration will most likely institute price controls on gas at the pump. Mr. Lira states that these controls would simply create a black market for goods and do nothing to reverse the underlying hyperinflation, but he is assuming these controls would only occur after there is a run on treasuries and hyperinflationary concerns reach the average consumer. It is more likely that the government will immediately cap the price of oil, perhaps through an executive order in the name of “national security”, which will destroy the incentivize for asset managers to dump large amounts of treasuries for commodities in the first place. When the potential upside gains of commodity plays can be artificially limited, it would be very risky for investors to bet against the federal government.

(2) The outstanding debt obligations of consumers/businesses are still excessive – The major reason why the U.S. economy naturally faces a deflationary depression is because there is too much private debt outstanding, and the need to destroy this debt suppresses aggregate demand for consumer goods or financial assets. Currently, when the price of oil gets significantly above $85/bbl, consumers are priced out of the market and demand destruction ensues, since demand is still relatively elastic to price changes. A temporary spike in oil prices would most likely lead asset managers to sell off stocks and commodities as well, since they are worried that consumers will heavily cut back on spending and pay off debts. This process is what the U.S. experienced in 2008 after oil hit $140+/bbl, and although the circumstances have changed since then, the underlying realities of excessive debt and artificially high consumer demand are still present. From this perspective, a temporary spike in oil prices would actually trigger a deflationary collapse rather than hyperinflation.

Mild Deflation (30%)

According to analysts such as Dr. Steve Keen, “Mish” Shedlock and Nicole Foss, the Fed is simply “pushing on a string” when it sets to generating inflation in the economy. [16], [17], [18]. Without any desire of consumers to borrow or creditors to lend at affordable rates, the trillions printed by the Fed will simply lay dormant as excess reserves or, at best, help keep the financial markets relatively stable. As for the Administration, it would have to give away a whole lot more “free money” before consumers and businesses begin spending/investing again in any meaningful manner. The best the government can do at this point is pump liquidity into asset markets and continue handing out benefits to the unemployed and poor among us. As CHS explains, the main goal here is to keep consumers paying off credit cards and mortgages, tax revenues flowing, financial markets somewhat stable and the general population placated, while economic actors continue to deleverage. [].

If the goal of power elites and the government is to manage this process of mild deflation, then perhaps the Fed is not pushing on a string at all. CHS has produced another piece which clearly shows that the government’s policies since 2008 have merely served to keep the system alive by transferring wealth from taxpayers to the top 10% of the population. Specifically, the Fed has blown more speculative bubbles in stocks, real estate and commodities, which mostly benefits the owners of financial wealth and also reduces the purchasing power of the bottom 90% through artificially high energy/food prices. Much of the toxic mortgage debt has been removed from the elites’ balance sheets and handed to the taxpayer through various government programs. [19]. This path has not been one to sustainable inflation, but rather one that keeps the power elites in business while cash flows in the general economy slowly dry up and investment capital relocates to emerging markets.

Severe Deflation (60%)

As mentioned before, however, the political capital for further deficit spending and monetary easing is drying up quickly as well. The Republicans have taken back the House of Representatives, picked up a few seats in the Senate and will certainly oppose further stimulus by the Administration. John Taylor has suggested that the Fed will also be on a much tighter leash when Congressman Ron Paul becomes head of the sub-committee overseeing its operations. [20]. Although the Fed will most likely shovel out another $500B-$2T in treasury purchases via “QE2” (waiting for the announcement as I write this), it is becoming clear that there are diminishing returns to its efforts. A QE2 package that is smaller than the initial QE program, and only targets treasury bonds, will only serve to keep interest rates low and perhaps give a small, temporary boost to equity markets. It will certainly fail to stave off further deleveraging in an economy worth ~$14 trillion that also has trillions more in unserviceable debt.

So the question becomes whether the Fed's incremental liquidity programs can at least maintain modest deflation. The best answer to this question seems to be “not too likely”. The Fed actually has little ability to counter-act the debt deflation in the consumer economy, since it cannot print money and give it directly to small businesses and consumers, and Congress will also have its hands tied after the elections. What the fiscal conservatives fail to realize is how fast the economy will unravel once government subsidies are drawn down. Dr. Keen points out that the trillions spent and printed by the government after 2008 helped to decelerate the rate of credit contraction in the private sector, and this deceleration actually reduced unemployment and projected the illusion of an economic recovery. For this deceleration to continue, the private debt to GDP ratio would soon have to begin increasing again, and this is extremely unlikely to occur in an economy with ridiculously high levels of debt. [21]. If and when housing prices begin falling again, pushed along in no small part by the “fraudclosure” crisis, we can be certain that the acceleration of debt destruction will turn positive. The excessive debt, inventory and over-capacity of American consumers, businesses and markets will reveal itself in full force, and the economy will be caught in a deflationary spiral once again.

The Guesstimated Probabilities of Each Outcome

      In the perturbation sense, the strongest influences governing inflation or deflation are the natural state of the economy, the preferences of American power elites and the policy tools of the Administration and Fed. We can express the results of the simplistic inflation/deflation analysis by translating the qualitative discussion above into percentage probabilities, based on general conclusions regarding the likelihood of each outcome. To summarize, power elites would prefer mild deflation over mild inflation at a ratio of about 3 to 1, when considering the current economic circumstances. Similarly, the Administration/Fed will be able to achieve mild deflation over mild inflation at a ratio of about 3 to 1. Hyperinflation will occur three times as often as mild inflation when power elites prefer inflation (mainly due to Mr. Lira’s scenario), and severe deflation will occur twice as often as mild deflation when elites prefer deflation. The following table lists these percentage probabilities along with the chance that the government will agree to pursue the power elites’ preferred policy, and multiplies down each column to acquire a resulting probability of each outcome.

	Mild Inflation	Hyperinflation	Mild Deflation	Severe Deflation
Preferences of PE	25%	25%	75%	75%
Government Ability	10%	30%	30%	60%
Chance of Agreement	95%	n/a	90%	n/a
Resulting Probability	3%	8%	21%	45%

 **probabilities are rounded to nearest whole number

            The resulting probabilities above add up to 77%, which leaves another 23% for outcome combinations and also further refining of the stated outcomes’ probabilities. Perhaps the initial assumptions could be modified to make the analysis more realistic. Some readers may feel that I have derived faulty probabilities from the discussion, or even that the discussion itself contains flawed logic. I encourage readers to take the framework and general discussion points that are presented in this article and generate their own probabilities for specific outcomes. The analysis could also be refined by including the next most influential factors that have been left out for purposes of simplified calculation (i.e. European sovereign debt crisis, global currency devaluations, coordination by international elites, geopolitical factors, etc.). Personally, I believe that the probabilities listed above are at least a ballpark estimate of potential outcomes over the next year or two. Of course, without extensive data-mining and the use of computer-simulated dynamic models, we may have to simply rely on time to eventually tell the tale.