What We’re Reading (Week Ending 17 July 2022) - 17 Jul 2022
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 17 July 2022):
1. The first CRISPR gene-editing drug is coming—possibly as soon as next year – Sy Mukherjee
Until recently, CRISPR—the gene-editing technology that won scientists Jennifer Doudna and Emmanuelle Charpentier the 2020 Nobel Prize in chemistry—sounded more like science fiction than medicine; lab-created molecular scissors are used to snip out problematic DNA sections in a patient’s cells to cure them of disease. But soon we could see regulators approve the very first treatment using this gene-editing technology in an effort to combat rare inherited blood disorders that affect millions across the globe.
In a $900 million collaboration, rare disease specialist Vertex and CRISPR Therapeutics developed the therapy, dubbed exa-cel (short for exagamglogene autotemcel). It has already amassed promising evidence that it can help patients with beta thalassemia and sickle cell disease (SCD), both of which are genetic blood diseases that are relatively rare in the U.S. but somewhat more common inherited conditions globally…
…The latest exa-cel clinical data, unveiled during the 2022 European Hematology Association Congress in Switzerland, found that all 75 patients with either beta thalassemia or SCD given the gene-editing therapy showed zero or a greatly reduced need for blood transfusions (in the case of beta thalassemia) or incidences of life-threatening blockages (in the case of SCD). All but 2 of the 44 patients with thalassemia hadn’t needed a single blood transfusion in the 1 to 37 months of follow-up after the treatment’s administration, and the remaining 2 had 75% and 89% reduction in how much blood they needed transfused.
Similarly impressive, all 31 patients with a severe and life-threatening form of SCD experienced no vaso-occlusive crises (the life-threatening incidents in which healthy blood is blocked from moving freely) in anywhere from 2 to 32 months of posttreatment follow-up. Those same patients usually experienced, on average, nearly four of these crises per year for the two years before they received exa-cel…
…CRISPR isn’t the only type of gene therapy that’s made waves in just the past few weeks. Earlier in June, a group of advisers to the Food and Drug Administration (FDA) gave unanimous recommendations for a pair of non-CRISPR-based gene therapies from Bluebird Bio. The treatments target genes associated with beta thalassemia and a rare disorder afflicting children called cerebral adrenoleukodystrophy (CALD). The latter is a disease that eats away at white brain matter in children as young as 4, has few treatments, and usually leads to death within 5 to 10 years.
Bluebird’s eli-cel therapy has faced clinical setbacks because of its association with higher risk of a type of cancer, but the independent advisers decided its benefits still outweighed the risks for some patients with few other options. The FDA doesn’t have to follow the recommendations of its advisory panels, but typically does.
2. Stock Market Experiment Suggests Inevitability Of Booms and Busts – Jerry E. Bishop
Vernon L. Smith knows why the stock market crashed. He ought to. He’s seen dozens of “bubbles” — booms followed by sudden crashes — in the past three years.
Almost every time, Mr. Smith says, the bubble occurred because inexperienced traders dominated the market. In fact, traders had to go through at least two booms and crashes before they collectively learned to avoid these bubbles.
Mr. Smith is one of a new breed of economists who test economic theories by setting up laboratory experiments. For the past few years he and his associate at the University of Arizona in Tucson, Gerry L. Suchanek, and Arlington W. Williams at Indiana University in Bloomington have been running experimental stock markets in their labs…
…In these experimental markets a dozen or so volunteers, usually economics students, are given a set number of “shares” of stock, along with some working capital. All the volunteers are connected by terminals to a computer, which is set up to duplicate trading on the stock-market floor. A trading “day” lasts about four minutes during which the traders may have entered two or three dozen bids and offers resulting in anywhere from five to a dozen trades. A typical experiment during an afternoon or evening runs 15 days.
The booms and crashes occurred in a recent series of 60 experiments aimed at testing an aspect of one of the most basic of all stock-market theories — rational expectations. This theory says a stock’s price is determined by investors’ expectations of what dividend the share will pay. If investors are rational in their expectations, they all place the same value on the stock and it will trade at a price reflecting its true dividend value. The price will change only when new information comes along that changes the dividend expectations.
Mr. Smith and his colleagues assumed, however, that even if investors had the same information, their dividend expectations would differ and they would value the stock differently. Price speculation would then be possible. But, they hypothesized, investors would soon realize that speculative profits are uncertain and unsustainable and they would begin changing their dividend expectations until, at some point, they all came to a common and rational expectation. The stock would then trade at its dividend value.
To find out how long this learning process would take, they set up a laboratory market in which all traders began with the same information about dividend prospects. Traders were told a payout would be declared after each trading day. The amount would be determined randomly from four possibilities — zero, eight, 28 or 60 cents. The average daily payout would be 24 cents. Thus, a share’s dividend value on the first trading day in a 15-day experiment was $3.60 (24 cents times 15 days). As the days passed and dividends were paid, the dividend value would drop.
One typical experiment involved nine students. On the first four-minute “day,” trading opened when a student’s offer to sell a share for $1.50 was quickly accepted. A moment later a bid to buy a share for $1.30 was snapped up. Such bargain prices triggered a flurry of rising bids, and a boom quickly developed. By the middle of the fourth trading day the price topped $5.50 even though the stock’s dividend value had dropped to $3.
But at such high prices offers to sell began to outnumber bids to buy. A crash began and by day 11 prices were below the stock’s $1 dividend value. Only on the last two trading days prices settle at or near the dividend value.
Some of the more astute traders were able to post gains of as much as $50 in dividends and trading profits while others ended up with as little as $5, Mr. Smith says. If the stock had consistently traded at or near its dividend value, all nine students could have had a profit of $16.
Such market bubbles occurred repeatedly. “We find that inexperienced traders never trade consistently near fundamental value, and most commonly generate a boom followed by a crash in stock prices,” Mr. Smith says. Moreover, traders who have experienced one crash “continue to bubble and crash, but at reduced volume,” he says. But, he adds, “Groups brought back for a third trading session tend to trade near fundamental dividend value.”
To counter any criticism that the boom and crash reflected students’ naivete, the researchers used Tucson businessmen who had “real world” experience. They generated the biggest bubble of all and, like the students, had to go through two booms and crashes before settling down to trade at a mutually profitable dividend value.
3. Lifestyles – Morgan Housel
Anyone alone at sea for nine months will start to lose their mind, and there’s evidence both Crowhurst and Moitessier were in poor mental states when their decisions were made. Crowhurst’s last diary entries were incoherent ramblings about submitting your soul to the universe; Moitessier wrote about his long conversations with birds and dolphins.
But their outcomes seemed to center on the fact that Crowhurst was addicted to what other people thought of his accomplishments, while Moitessier was disgusted by them. One lived for external benchmarks, the other only cared about internal measures of happiness.
They are the most extreme examples you can imagine. But their stories are important because ordinary people so often struggle to find balance between external and internal measures of success.
I have no idea how to find the perfect balance between internal and external benchmarks. But I know there’s a strong social pull toward external measures – chasing a path someone else set, whether you enjoy it or not. Social media makes it ten times more powerful. But I also know there’s a strong natural desire for internal measures – being independent, following your quirky habits, and doing what you want, when you want, with whom you want. That’s what people actually want.
4. The Biggest Problem With Remote Work – Derek Thompson
But if the work-from-anywhere movement has been successful for veteran employees in defined roles with trusted colleagues, for certain people and for certain objectives, remote or hybrid work remains a problem to be solved.
First, remote work is worse for new workers. Many inexperienced employees joining a virtual company realize that they haven’t joined much of a company at all. They’ve logged into a virtual room that calls itself a company but is basically a group chat. It’s hard to promote a wholesome company culture in normal times, and harder still to do so one misunderstood group Slack message and problematic fire emoji at a time. “Small talk, passing conversations, even just observing your manager’s pathways through the office may seem trivial, but in the aggregate they’re far more valuable than any form of company handbook,” write Anne Helen Petersen and Charlie Warzel, the authors of the book Out of Office. Many of the perks of flexible work—like owning your own schedule and getting away from office gossip—can “work against younger employees” in companies that don’t have intentional structured mentorship programs, they argued.
Second, remote is worse at building new teams to take on new tasks. In 2020, Microsoft tapped researchers from UC Berkeley to study how the pandemic changed its work culture. Researchers combed through 60,000 employees’ anonymized messages and chats. They found that the number of messages sent within teams grew significantly, as workers tried to keep up with their colleagues. But information sharing between groups plummeted. Remote work made people more likely to hunker down with their preexisting teams and less likely to have serendipitous conversations that could lead to knowledge sharing. Though employees could accomplish the “hard work” of emailing and making PowerPoints from anywhere, the Microsoft-Berkeley study suggested that the most important job of the office is “soft work”—the sort of banter that allows for long-term trust and innovation…
…Third, and relatedly, remote work is worse at generating disruptive new ideas. A paper published in Nature by Melanie Brucks, at Columbia Business School, and Jonathan Levav, at the Stanford Graduate School of Business, analyzed whether virtual teams could brainstorm as creatively as in-person teams. In one study, they recruited about 1,500 engineers to work in pairs and randomly assigned them to brainstorm either face-to-face or over videoconference. After the pairs generated product ideas for an hour, they selected and submitted one to a panel of judges. Engineers who worked virtually generated fewer total ideas and external raters graded their ideas significantly less creative than those of the in-person teams…
…The work-from-anywhere revolution has something of a kick-starter problem: It’s harder for new workers, new groups, and new ideas to get revved up.
So how do we fix this? One school of thought says face-to-face interactions are too precious to be replaced. I disagree. I’m an optimist who believes the corporate world can solve these problems, because I know that other industries already have.
Modern scientific research is a team sport, with groups spanning many universities and countries. Groups working without face-to-face interaction have historically been less innovative, according to a new paper on remote work in science. For decades, teams split among several countries were five times less likely to produce “breakthrough” science that replaced the corpus of research that came before it. But in the past decade, the innovation gap between on-site and remote teams suddenly reversed. Today, the teams divided by the greatest distance are producing the most significant and innovative work.
I asked one of the co-authors of the paper, the Oxford University economist Carl Benedikt Frey, to explain this flip. He said the explosion of remote-work tools such as Zoom and Slack was essential. But the most important factor is that remote scientists have figured out how to be better hybrid workers. After decades of trial and error, they’ve learned to combine their local networks, which are developed through years of in-person encounters, and their virtual networks, to build a kind of global collective brain.
If scientists can make remote work work, companies can do it too. But they might just have to create an entirely new position—a middle manager for the post-pandemic era.
In the middle of the 19th century, the railroads and the telegraph allowed goods and information to move faster than ever. In 1800, traveling from Manhattan to Chicago took, on average, four weeks. In 1857, it took two days. Firms headquartered in major cities could suddenly track prices from Los Angeles to Miami and ship goods across the country at then-record-high speeds.
To conduct this full orchestra of operations, mid-1800s companies had to invent an entirely new system of organizing work. They needed a new layer of decision makers who could steer local production and distribution businesses. A new species of employee was born: the “middle manager.”
“As late as 1840, there were no middle managers in the United States,” Alfred Chandler observed in The Visible Hand, his classic history of the rise of America’s managerial revolution. In the early 1800s, all managers were owners, and all owners were managers; it was unheard of for somebody to direct employees without being a partner in the company. But once ownership and management were unbundled, new kinds of American companies were made possible, such as the department store, the mail-order house, and the national oil and steel behemoths…
…The synchronizer—or, for large companies, a team of synchronizers—would be responsible for solving the new-worker, new-group, and new-idea problems. Synchronizers would help new workers by ensuring that their managers, mentors, and colleagues are with them at the office during an early onboarding period. They would plan in-person time for new teammates to get to know one another as actual people and not just abstracted online personalities. They would coordinate the formation of new groups to tackle new project ideas, the same way that modern teams in science pull together the right researchers from around the world to co-author new papers. They would plan frequent retreats and reunions across the company, even for workers who never have to be together, with the understanding that the best new ideas—whether in science, consulting, or media—often come from the surprising hybridization of disparate expertise.
5. The Trillion-Dollar Vision of Dee Hock – M. Mitchell Waldrop
This is one of Dee Hock’s favorite tricks to play on an audience. “How many of you recognize this?” he asks, holding out his own Visa card.
Every hand in the room goes up.
“Now,” Hock says, “how many of you can tell me who owns it, where it’s headquartered, how it’s governed, or where to buy shares?”
Confused silence. No one has the slightest idea, because no one has ever thought about it.
And that, says Hock, is exactly how it ought to be. “The better an organization is, the less obvious it is,” he says. “In Visa, we tried to create an invisible organization and keep it that way. It’s the results, not the structure or management that should be apparent.” Today the Visa organization that Hock founded is not only performing brilliantly, it is also almost mythic, one of only two examples that experts regularly cite to illustrate how the dynamic principles of chaos theory can be applied to business.
It all started back in the late 1960s, when the credit card industry was on the brink of disaster. The forerunner of the Visa system — the very first credit card — was BankAmericard, which had originated a decade earlier as a statewide service of the San Francisco-based Bank of America. The card got off to a rocky start, then became reasonably profitable — until 1966, when five other California banks jointly issued a competing product they called MasterCharge.
Bank of America promptly responded, franchising BankAmericard nationwide. (In those days, banks were forbidden to have their own out-of-state branches.) Other large banks quickly responded with their own proprietary cards and franchise systems. A credit card orgy ensued: banks mass-mailed preapproved cards to any list they could find. Children were getting cards. Pets were getting cards. Convicted felons were getting cards. Fraud was rampant, and the banks were hemorrhaging red ink.
By 1968, the industry had become so self-destructive that Bank of America called its licensees to a meeting in Columbus, Ohio to find a solution. The meeting promptly dissolved into angry finger-pointing.
Enter Dee Hock, then a 38-year-old vice president at a licensee bank in Seattle. When the meeting was at its most acrimonious, he got up and suggested that the group find a method to study the issues more systematically. The thankful participants immediately formed a committee, named Hock chairman, and went home.
It was the chance Hock had been waiting for. Even then, he was a man who thought Big Thoughts. Born in 1929, the youngest child of a utility lineman in the mountain town of North Ogden, Utah, he was a loner, an iconoclast, a self-educated mountain boy with a deeply ingrained respect for the individual and a hard-won sense of self-worth. And he stubbornly refused to accept orthodox ideas: before he’d started with the Seattle bank he’d already walked away from fast-track jobs at three separate financial companies, each time raging that the hierarchical, rule-following, control-everything organizations were stifling creativity and initiative at the grass roots — and in the process, making the company too rigid to respond to new challenges and opportunities.
He’d been a passionate reader since before he could remember, even though his formal schooling ended after two years at a community college. He read history, economics, politics, science, philosophy, poetry — anything and everything, without paying the slightest attention to disciplinary boundaries.
What he read convinced him that the command-and-control model of organization that had grown up to support the industrial revolution had gotten out of hand. It simply didn’t work. Command-and-control organizations, Hock says, “were not only archaic and increasingly irrelevant. They were becoming a public menace, antithetical to the human spirit and destructive of the biosphere. I was convinced we were on the brink of an epidemic of institutional failure.”
He also had a deep conviction that if he ever got to create an organization, things would be different. He would try to conceive it based on biological concepts and metaphors.
Now he had that chance. In June 1970, after nearly two years of brainstorming, planning, arguing, and consensus building, control of the BankAmericard system passed to a new, independent entity called National BankAmericard, Inc. (later renamed Visa International). And its CEO was one Dee W. Hock.
The new organization was indeed different — a nonstock, for-profit membership corporation with ownership in the form of nontransferable rights of participation. Hock designed the organization according to his philosophy: highly decentralized and highly collaborative. Authority, initiative, decision making, wealth — everything possible is pushed out to the periphery of the organization, to the members. This design resulted from the need to reconcile a fundamental tension. On the one hand, the member financial institutions are fierce competitors: they — not Visa — issue the cards, which means they are constantly going after each other’s customers. On the other hand, the members also have to cooperate with each other: for the system to work, participating merchants must be able to take any Visa card issued by any bank, anywhere.
That means that the banks abide by certain standards on issues such as card layout. Even more important, they participate in a common clearinghouse operation, the system that reconciles all the accounts and makes sure merchants get paid for each purchase, the transactions are cleared between banks, and customers get billed.
To reconcile that tension, Hock and his colleagues employed a combination of Lao Tse, Adam Smith, and Thomas Jefferson. For example, instead of trying to enforce cooperation by restricting what the members can do, the Visa bylaws encourage them to compete and innovate as much as possible. “Members are free to create, price, market, and service their own products under the Visa name,” he says. “At the same time, in a narrow band of activity essential to the success of the whole, they engage in the most intense cooperation.” This harmonious blend of cooperation and competition is what allowed the system to expand worldwide in the face of different currencies, languages, legal codes, customs, cultures, and political philosophies.
No one way of doing business, dictated from headquarters, could possibly have worked. “It was beyond the power of reason to design an organization to deal with such complexity,” says Hock, “and beyond the reach of the imagination to perceive all the conditions it would encounter.” Instead, he says, “the organization had to be based on biological concepts to evolve, in effect, to invent and organize itself.”
Visa has been called “a corporation whose product is coordination.” Hock calls it “an enabling organization.” He also sees it as living proof that a large organization can be effective without being centralized and coercive. “Visa has elements of Jeffersonian democracy, it has elements of the free market, of government franchising — almost every kind of organization you can think about,” he says. “But it’s none of them. Like the body, the brain, and the biosphere, it’s largely self-organizing.”
It also works. Visa grew phenomenally during the 1970s, from a few hundred members to tens of thousands. And it did so more or less smoothly, without dissolving into fiefdoms and turf wars. By the early 1980s, in fact, the Visa system had surpassed MasterCard as the largest in the world. It had begun to fulfill Hock’s vision of a universal currency, transcending national boundaries. And Dee Hock was seen as the system’s essential man.
“Utter nonsense,” Hock says. “It’s the organizational concepts and ideas that were essential. I merely came to symbolize them. Such organizations should be management-proof.”
In May 1984, at 55, Hock put his beliefs to the test. He resigned from Visa and three months later, with his successor in place, dropped completely from sight. Six years later, in an acceptance speech as a laureate of the Business Hall of Fame, Hock put it this way: “Through the years, I have greatly feared and sought to keep at bay the four beasts that inevitably devour their keeper — Ego, Envy, Avarice, and Ambition. In 1984, I severed all connections with business for a life of isolation and anonymity, convinced I was making a great bargain by trading money for time, position for liberty, and ego for contentment — that the beasts were securely caged.”
Visa never missed a beat.
6. America’s freight railroads are incredibly chaotic right now – Rachel Premack
A railroad engineer or conductor typically earns a six-figure salary, retires with a pension and enjoys union benefits. They don’t need a college degree; the monthslong training is provided on the job. It’s the kind of career that ought to be popular — but Doering said trainees and longtimers alike are getting burned out. It used to be a job with eight- or nine-hour shifts and plenty of time at home. Now, Doering says railroading demands too much time away from one’s family and workdays that last up to 19 hours, combining 12-hour shifts with hours of waiting around for transportation or relief crews.
Union Pacific is struggling to find railroad crews after years of slashing headcounts. The $22 billion railroader had 30,100 employees during the first three months of 2022, according to its latest earnings report. Five years prior, the company had nearly 12,000 more workers. (A representative from Union Pacific declined to provide a comment for this article, as the company is reporting its second-quarter earnings later this month. The rep did share a company blog on the importance of supply chain fluidity and cooperation.)
This employment issue isn’t unique to Union Pacific. America’s railways are in an unusually chaotic state as Class I lines struggle to find employees. That’s led to congestion that analysts say is even worse than 2021, which saw some of the biggest rail traffic in history. Now, a strike of 115,000 rail workers could happen as soon as next week.
“We’re spending more time at home-away terminals than we are at home,” Doering said. Doering is also the Nevada legislative director for SMART Transportation Division, a labor union of train, airline and other transportation workers. “So the attitudes out here, I think, are warranted. Morale is at an all-time low.” …
…So, while you may not have been keeping up to date with rail congestion, industrial bigwigs and lawmakers alike are furious. The coal industry is slamming rail for the “meltdown” in service capacity and grain shippers said they had to spend $100 million more in shipping costs to get their product moved amid poor rail service. The Port of Los Angeles is taking to the press to demand rail move those gosh darn containers away, saying that railroaders could cause a “nationwide logjam” with the unmoved containers sitting around. Members of the federal government’s Surface Transportation Board recently demanded answers from railroad executives in a May two-day hearing, but tensions seemed to have only worsened since then.
Even more exhausted are the rail workers themselves. Rail unions have been negotiating with their employers since January 2020, with a “dead end” in negotiations reported two years later. Now, President Joe Biden is being charged with appointing a “Presidential Emergency Board” to nail down a new contract. If he doesn’t do so by Monday, railroad crews could legally have their first nationwide strike since 1992. Such a strike, according to the U.S. Chamber of Commerce, would be “disastrous.”…
…Let me tell you the hottest rail trend of the 2010s: precision-scheduled railroading. As The Wall Street Journal’s Paul Ziobro explained in a 2019 story, PSR means that railroads have set times for when they pick up cargo from their customers, not unlike a commercial airline. Before, railroads would wait for the cargo.
There are endless implications that come from this system, some of which my colleague Mike Baudendistel delved into in this 2020 article. PSR allowed railroads to reduce capital budgets, slash headcount and merge internal operations with glee. But its biggest boon to the railroaders was how much it boosted their cred on Wall Street, creating billions in shareholder value.
“The railroad stocks have greatly outperformed the broader market in the past 15 years, which took place despite the major deterioration of coal volume, the railroads’ historical business,” Baudendistel wrote.
There are serious service issues with PSR, though. When the tactic was first implemented at CSX Transportation, dwell time at some terminals increased by as much as 26 hours, according to another 2019 WSJ piece by Ziobro. Trips that would take a few days stretched out to more than two weeks — a struggle for customers that relied on just-in-time supply chains…
…Rail giants, as you could guess, struggled during the early months of COVID. In April 2020, for example, rail carloads saw their biggest year-over-year drop since 1989 and intermodal loadings saw a decline not experienced since 2009.
Railroads were shedding employees from April until July 2020, when my colleague Joanna Marsh reported that crew headcount had finally begun to increase again. Still, there were 25% fewer crews than in 2019 and 28% fewer than 2018, according to data from the Surface Transportation Board.
The financial status of these firms was in question, which motivated them to furlough workers. “At least one Class I railroad held meetings to decide whether they had enough cash through the summer, if they had enough cash to pay the bills and could they stay in business,” Hatch said. “When they began to lay people off, much to the consternation today of the regulators and whatnot, you need some understanding that they did not know how long this would last.”
Railroaders struggled to re-hire those crews they furloughed. Many of them found work in construction or manufacturing, industries that allow workers to spend evenings and weekends at home, Tranausky said.
Unlike its siblings in trucking or ocean shipping, the railroad industry didn’t have a bonkers 2021 — but it survived. 2021 saw healthier volumes from the year before. They were still below 2019’s levels…
…Some issues are completely out of the railroads’ control. Most kinds of employers across the country are still struggling to find workers. Even finding shuttle drivers to take railroad crews to their terminal has been a struggle, from Doering’s observations. Recently, Union Pacific has put him in a taxi to go from Las Vegas to inland California. “We’re watching the little ticker up there in the cab go up to $400 or $500 for a trip,” Doering said.
Even in the best of times, it’s hard to find someone to sign up to be a railroad crew member. They have a similar lifestyle to, say, airline pilots, who must be away from their families for days at a time, living in hotels and manning massive, potentially dangerous pieces of equipment. Railroad crews are on call even during their home time.
They require months of training and after that need years or decades on the job to become truly masters of the rail. “There’s a learning curve,” Tranausky said. “[New crews are] not as efficient, not as productive as those higher-seniority crews.”
While Tranausky and Hatch said labor is the main driver of today’s congestion, one factor is totally outside the control of railroads. Unlike 2021, many warehouses are packed with inventory. Some insiders told FreightWaves that shippers are essentially using railcars as storage rather than moving the cargo into their own warehouse. That’s causing a shortage of chassis and increasing congestion — particularly in rail yards like Chicago.
7. TIP462: What Is Money? w/ Lyn Alden – Stig Brodersen and Lyn Alden
Stig Brodersen (01:11):
To kick this episode off, perhaps you can tell this story of the ancient Greek democracy in sixth century b.c. that used partial jewelry as a solution to avoid a catastrophic class conflict and how that relates to where we are in the debt cycle today.
Lyn Alden (01:28):
You have something that builds up decade to decade, even generation to generation, two or three generations, and it doesn’t self-correct enough, right? So, there’s basically the structural issues in society where things build up and get worse and worse. Basically, things have a tendency to concentrate, especially the way we structure things. And so, you have a given society where let’s say farmers, they harvest crops. They have a big harvest every year, but of course, they have to pay for things throughout the year. So, they might, for example, use debt with the promise to pay them back once their harvest comes in. That might work for 10 years in a row, but on the 11th year, they have a crop failure and suddenly, they find themselves in massive debt that they can’t pay.
Lyn Alden (02:13):
And back then, you could become a debt slave. There are all sorts of ways to deal with that in society. Problem is that over time, you have things build up where wealth consolidates and then it also feeds on itself. So, once you’re wealthy, you’re able to influence politics more, right? You have the ear of the king. Or if it’s a republic, you might have more voting power. Back then especially, only rich people could really vote anyway in societies that were republics. So, you can further make the rules in your favor and you get this tendency to consolidate one way or another. Societies had to deal with that in different ways and we have records going back to ancient Sumeria, Babylon, and Greece.
Lyn Alden (02:56):
And the one I used in this piece was Plutarch wrote about the ancient King Solon in Greece and this was an excerpt from Lessons of History by Will and Ariel Durant. I’ll just read it because it’s actually a really good paragraph. And in the Athens of 594 b.c., the poor finding their status worsened with each year, the government in the hands of their masters and the corrupt courts deriving every issue against them, began to talk a violent revolt. The rich, angry at the challenge to their property, prepared to defend themselves by force. Good sense prevailed, moderate element secured the election of Solon, a businessman of aristocratic lineage to the supreme archonship. He devalued the currency thereby easing the burden of all debtors, although he himself was a creditor.
Lyn Alden (03:43):
He reduced all personal debts and ended imprisonment for debt. He canceled arrears for taxes and mortgage interest. He established a graduated income tax that made the rich pay at a rate 12 times that required of the poor. He reorganized the courts on a more popular basis. He arranged that the sons of those who had died in war for Athens should be brought up and educated at the government’s expense. The rich protested that these measures were outright confiscation and then the radicals on the other side complained that he had not redivided the land. But within a generation, almost all had agreed that his reforms had saved Athens from revolution.
Lyn Alden (04:21):
And so, basically, when we talk about this multi-decade, multi-generational compoundings, usually, what you have is these sharp events at some point where either people revolt, right? Everyone’s a debt slave now. So, they say, “Wait a second. We outnumber these guys 100 to 1. Let’s just go burn their house down.” So, there’s that. Or they through politics basically say, “Okay, this is not sustainable. The courts are corrupt. We have so entrenched cronyism and the policy is not good. Let’s sharply reverse some of this without going too far.” And so, this was an example where they managed to moderate it. Most examples are not that successful.
Lyn Alden (05:00):
And so, this shows over time that when you have massive debts and wealth concentration built up in a society, there’s usually some release valve that in various ways, it’s painful for various groups. And then depending on how it goes, it could be extraordinarily painful for everyone if you have a collapse or a revolution of some sort…
…Lyn Alden (11:47):
The best money isn’t always the absolute hardest. There’s other attributes like the ease of transaction, the divisibility, the speed with which you could move it around. And that’s why I would argue for example that for the past 150 years, paper currencies have really outpaced gold, because even though gold’s harder, in practical terms, it has trouble keeping up. So, for thousands of years, commerce and money moved at about the same speed, which is the speed of humans, right? So, we go around on horses and chips and on foot and we transact with each other with gold, silver, copper pieces, or even our ledgers. Even if we started keeping ledgers, those physical ledgers could still only move at the speed of humans.
Lyn Alden (12:29):
We had to really bring them somewhere if you want to give them to another city. But with the introduction of telecommunications equipment in the 1800s, first with the telegraph and then the telephone, we lay these undersea cables under the Atlantic, starting in the 1800s. And so, by the time you got to late 1800s, institutions around the world could talk to each other almost instantly. And so, you could update ledgers and perform certain types of transactions on multi-continent basis far faster than physical goods, including physical money, could settle. And so, gold was no longer able to keep up with the speed of human commerce, and that really further, I think, led to the need for abstraction.
Lyn Alden (13:12):
So, historically, gold was abstracted, because it had limits on its visibility. Whereas now, we also had the even more important thing where we had limits to its speed relative to the speed we wanted transact. So, we had to abstract it more and that eventually opened up the divide between gold and paper currencies. And then eventually, they could be separated. Whereas, in some other world, if there was an element like gold that we could just mentally teleport to each other, it would’ve been much harder to ever introduce paper currencies, because it would’ve been seen right away as an inferior product, but because gold had those limitations and there was an advantage to using paper claims for gold, it was able to lead to that separation.
Lyn Alden (13:53):
So, in many ways, even though dollars are less hard than gold, they have other advantages over the past 150 years or so that has allowed them to at least keep up with gold and that more people use dollars than use gold, even though gold is a better store of value. So, gold as its hardness is better retained its store of value property, but it lost the medium of exchange and unit of account aspects to what is basically better technology. When you look at pure commodity monies, the stock to flow ratio is pretty paramount. There’s actually a really good example in the early American colonies. There was almost an accelerated version of why most monies fail.
Lyn Alden (14:39):
And basically, in pre-American before the revolution, you had these Southern colonies in the 1600s and they started using tobacco as money. They grew tobacco. It was a high value crop. It was reasonably liquid and fungible. And so, they started using tobacco as money. They even made it legal tender in some colonies like Virginia, where you could pay your taxes, you could pay all debts in tobacco. And so, it became money. Problem is that when you put on a monetary premium to something, you basically give everyone an incentive to make more of it. And so, tobacco’s not very resistant to debasement, so anyone could go and plant more tobacco. And so, they started to inflate the value of tobacco away.
Lyn Alden (15:22):
Basically, the prices of things as dominant to tobacco began to increase. And then so the government imposed restrictions. They said certain class of people couldn’t grow tobacco or there’s only so much tobacco that can be grown a year. They’re trying to artificially increase the stock to flow ratios. Then you had another problem where unlike gold, tobacco is not very fungible, right? So, there’s higher quality tobacco, there’s lower quality tobacco. And so, there’s an incentive to pay your debts in this marginal tobacco, the worst tobacco, and then to say, sell the good tobacco overseas or smoke that or whatever you want to do. Use that for better purposes. Give other people the worst ones.
Lyn Alden (16:00):
You basically have Gresham’s law in play, where the weak money dries out the good money. So, everyone’s trading around the bad tobacco. Then they had to say, “Okay, well, we need external auditors to come in and check the quality of tobacco.” So, they put tobacco in warehouses, grade it, and then trade paper claims for that tobacco. So, they basically had to try to increase the fungibility. And then eventually, they abandoned the whole situation, because it was untenable. And so, that’s an accelerated version of why any commodity that’s not resistant to debasement, meaning it can’t maintain a high stock to flow ratio given our level of technology, ultimately fails as money.
Lyn Alden (16:41):
When you look at the broad spectrum, all the different commodities of history, that’s one reason why gold keeps reemerging, because no matter how good our technology is, we’re not really good at making more gold. So, in the 1970s, for example, when the price of gold went up more than tenfold, if you look at the gold production, it barely changes at all, because we just literally don’t have the capability to make a ton of new gold in a short period of time.
Stig Brodersen (17:08):
I’m holding this amazing blog post. It’s another one of Lyn’s great blog post. The title is, “What is Money, Anyway?” I’ll make sure to link to that in show notes and you tell different stories about commodity money. I love all of them. One of them is about African beads, which is amazing itself and really the illustration of what you’re saying there about new technology coming in. I don’t know if I could ask you to share that story with the audience.
Lyn Alden (17:31):
Yeah. So, the African bead story, that’s probably the most tragic one, one of the most tragic examples in that piece. So, basically, for a long period of time, you had different groups in West Africa using beads as money. So, again, that goes back to the idea that money is technology. So, what is rare, liquid, fungible, desirable in an area could be different in other area. So, in that region, they didn’t have glass-making technology. And so, glass beads were very rare and desirable. And then also you had a pastoral society. So, you might have your herd of animals, shepherd. You’re moving around. So, you want to be able to bring your money with you. So, you could literally wear your beads. You could wear your wealth. And so, that was a useful type of money.
Lyn Alden (18:17):
They also used things like fine fabrics and things like that and certain herbs. These were money-like instruments, but beads were a key one for them. And the tragedy was that Europeans who at the time had glass-making technology when they were traveling around, they would identify and say, “These people like to use beads as money and so we can use that to our advantage. It’s cheap for us to make fancy glass beads and then we can start trading it for things of actual value. We can buy their animals. We can buy their resources.” And then sadly, there was a slave trade. So, you could buy slaves with these beads that you could make for almost free. So, they became known as slave beads in some circles. But then of course, the Africans had resistances against this.
Lyn Alden (19:06):
So, if the Europeans flooded everything with these say clear glass beads, they would start to say, “Okay, these clear glass ones are… No, they’re not good money. We want the purple kind.” But then of course, over time, the Europeans would adapt and say, “Okay, well, they want the purple kind now.” So, there was this cat and mouse game where beads were not fully fungible. There were different types and so there were different taste preferences. And then there were different reactions to the perceived scarcity of different types of beads. But eventually, that money became untenable for obvious reasons that there was a technology asymmetry between the cultures and then over time, that technology spread everywhere.
Lyn Alden (19:46):
And so, glass beads are in the long arc of time not good money. And it also that shows that if you don’t have hard money and if your money is not hard and if you’re using something as money that another culture or that some other group within your society can produce more of, then you’re at a disadvantage. So, that’s one of the tragic examples of why money is so critical, especially when different groups interact with each other…
…Stig Brodersen (33:52):
Yeah. And on that note, I would like to talk about the private to public de-leveraging. Usually, that is a process that’s inflationary and then we look at a country like Japan. They mainly stood for decades without almost any price inflation and with very low monetary inflation, but still many macro analysts look at this and they assume that “Well, if this is what’s happening to Japan, it’s going to happen to the US, to the rest of the world perhaps even.” You think that they’re wrong, why is that?
Lyn Alden (34:24):
Two main reasons. One, they own a lot more foreign assets than the collective foreign sector owns of Japanese assets. So, they actually have over trillion dollars, trillions of dollars of claims basically, that they can draw in to pay obligations as needed, right? So, they have this large investment base relative to the size of their GDP. So, that gives them one advantage that many countries now don’t have, especially United States. Number two is that that whole massive private de-leveraging and public leveraging happened primarily during the 2010s decade, which was a very disinflationary decade in terms of commodity market. So, there’s roughly this 10- to 15- to 20-year commodity cycle that happens worldwide where prices are low.
Lyn Alden (35:15):
So, nobody invests in commodities. They don’t build new production. Eventually, that causes a shortage. So, lots of money rushes in for a decade and builds all sorts of new commodity production. And eventually, we oversupply the world with commodities and then that breaks the price. And we start this cycle anew and that takes quite a while. That takes maybe 10 years of building and then 10 years working it out and 10 years of building and 10 years of working it out. Most countries are not big enough to really affect that cycle. United States and China are, but if you’re a country that’s a small percentage of GDP, you don’t really affect that on a global scale.
Lyn Alden (35:51):
And so, Japan happened to do this de-leveraging during a time of substantial commodity disinflation or actually outright deflation. Commodities were literally going down in price while they were doing this. And so, they basically had all the commodity needs available to them at low prices and you weren’t getting this scarcity and undersupply of commodities. That is a much harder thing to do if you’re not at the right part of the commodity cycle or if you’re big enough to affect the commodity cycle. And so, I would argue that Japan represents an almost perfect example of doing this with the right conditions and at the right time that we shouldn’t then just look at that and say, “Well, when all the other countries go through a similar process, it’s going to be just like Japan.”
Lyn Alden (36:41):
Actually, third factor I would say is that unlike most countries in the developed world, Japan has very little political polarization or rising populism intentions in the country. And part of that’s you have a rather homogeneous society and they’ve governed pretty well domestically. They don’t spend a lot of money on military, things like that. And so, a lot of the money just goes back to the people. You have a rather harmonious society. That doesn’t mean it’s perfect. There are obviously disagreements in society, but when you look at just quantitative ways of measuring political polarization, the United States and most European countries are in a much tougher spot there, whereas Japan has a rather harmonious society rather low levels of wealth concentration.
Lyn Alden (37:30):
And so, that gives them a deeper tool chest, I would say, to handle those storms. But of course, their main disadvantages right now are that they are a commodity importer, which now is becoming relevant. And then they also do have now a ton of public debt. And so, they have less ability to raise rates or otherwise protect the value of their currency because they can’t really service that debt otherwise. And so, I think, people over extrapolate the Japanese example by not realizing a lot of the nuances around the timing and the details for how they’re able to do that without it being inflationary.
Stig Brodersen (38:07):
So, let’s talk more about that. It’s very hard to talk about Japan macroeconomic terms without looking that huge debt burden they have. And we started out this interview by talking about forgiveness of debt restructuring. And so, keeping that in mind, the listener might be sitting out there thinking, “Well, we do know that a lot of money is being printed and that’s on the Bank of Japan’s balance sheet. Can’t they just forgive the government debt that they hold and thereby bringing down the debt burden?” I know that’s a question that you have asked yourself. What’s the answer to that?
Lyn Alden (38:44):
The answer is mostly no, but it is a good question, right? So, people think, “Okay, so if the central bank buys a lot of the government bonds and the central bank is more or less the government, why can’t they just forgive the debt that they more or less owe to themselves?” So, if the Bank of Japan ends up owning 75% of Japanese government debt, why can’t they just wipe that off their ledger and then they’ve lowered Japanese government debt by 75% and they start fresh? The problem is that the whole crux of this fiat currency system runs on the premise that a central bank and the government have some degree of independence from each other, right?
Lyn Alden (39:27):
Because if you have a dictator with absolute power over the money, that money’s going to get debased a lot quicker, just the way human nature works. Even if say there’s some philosopher king running a country, as soon as he dies, the next one’s going to be worse and he’s going to miss it, right? So, if you have centralized power, you’re more quickly going to debase the money. Whereas if you have all these checks and balances to make it hard to create more money, so you have to have Congress approve it, then you have to have the central bank finance it, you have to have the president not veto it, so you have to have all these different groups agree to create a lot more money, that really slows down the money creation.
Lyn Alden (40:08):
And that’s why countries with strong institutions and independent institutions generally have a much longer track record of maintaining a reasonably successful fiat currency compared to smaller countries with less histories of institutions and then the institutions get co-opted by some more authoritarian type of ruler. And so, going back to the premise, central banks are at least in theory supposed to be independent. Obviously, in times of war and things like that, that independence get seriously threatened, but it’s still not the president or a head of a country can just go and tell the central bank head to do exactly what he wants. If they do, they’re more like a banana republic. They’re more like that authoritarian model.
Lyn Alden (40:52):
And so, even though they might appoint the central bank chief, that central bank chief now has a term that can potentially persist through multiple administrations and that has checks and balances for how they can be removed, how a new one can be added, right? And so, there’s some degree of separation there. So, a president can’t just do something like cut interest rates three months before the election, make everyone happy, and then go back to having higher rates, right? So, they don’t have that fine control over interest rates, because it’s in someone else’s hands. It’s supposed to be independent.
Lyn Alden (41:24):
And part of maintaining central bank independence is that they can’t be insolvent, that they have to have assets that are equal or higher than their liabilities, because otherwise, they’re reliant on financing from the government and that they’re entirely reliant on that government. And therefore, they no longer have any credible independence. And so, the way central bank balance sheets work is that the currency is their liability. So, physical currency is their liability and bank reserves of commercial banks that are assets for them are liabilities of the central bank. So, those are their primary liabilities. And on the other side of that ledger, their assets are things like primarily their government debt that they own. That’s their key asset.
Lyn Alden (42:10):
And then depending on the different central banks, some of them have mortgage-backed securities. Some of them even have equities, but the core of their assets is that government debt. And so, if they were to erase that government debt and say, “Look, you don’t owe us anymore. Let’s just start fresh,” well, now, that central bank has a multitrillion dollar hole on the asset side of its ledger but still has all those liabilities. And so, they are now technically insolvent organization. They have no independence. They’re entirely reliant on government financing. And so, that whole model of some degree of credible decentralization goes away, credible independence.
Lyn Alden (42:51):
And so, while you might not have any overnight effect from just say, wiping away central bank owned government debt, it’s not like you wake up tomorrow and the currency hyperinflated. But going forward, that central bank is now 100% captured by the government more or less. And so, the long term ability to do that degrades and that’s why most of them have laws in place to prevent that from happening, that the central bank can’t just wipe it away. Now, there are other tricks that they can do, right? So, you could, for example, make the government could issue a special bond that is 100-year bond that doesn’t pay interest.
Lyn Alden (43:30):
Now, you have this bond that’s different from the other government debt that doesn’t pay interest. And so, basically, there are things that they can do like that and there are other tricks they can do to keep the ledger, the asset side, and the liability side technically solvent, but merely deleting the asset side is generally untenable at least the way that we’ve structured the system now for a century or more in many countries.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Microsoft and Visa. Holdings are subject to change at any time.
