Dear Evan,

You asked whether I had anything in writing to point you to about the history of the great international debtors' revolt of the 20th century, more commonly called the World Wars. I didn't, and I have had some trouble figuring out what the best approach is, in part because it's not clear who my audience is or which feedback if any is trying to learn something new rather than condition me to say more familiar things. Without an idea of someone who might understand me, there is no such thing as an attempt to communicate. The epistolary format has worked well for me recently, so I am going to try to explain what I know to you, personally, and publish at least my original email, and any back-and-forth you're willing to share.

I want to start by explaining the importance of this history. If I tell you that the old world has been overthrown by a class of debtor-aristocrats, and society converted en masse into a debtor aristocracy, you might think of exemplary cavaliers such as Thomas Jefferson and get the wrong idea. Instead, I'll start with an anecdote about the sort of person I mean, so you can see the relationship between membership in a debtor class, shame, class privilege (including "racial" privilege), and opposition to language. Next I will talk a little bit about the mechanism by which the debtor aristocracy propagates itself. Then I'll go into the chronology of the Money Wars. Along the way I will try to clearly signpost standard search terms, related bodies of recorded knowledge, and particular books or essays that might be relevant, but there are a lot, and I will try to write this in a way that at least potentially stands alone - please do err on the side of asking me questions (or trying to restate things in your own words to check whether you understand) rather than assuming you should do your own research first, because that will help me create a canonical summary I can point others to, and I expect that you are better informed than the typical person I need to explain this to.

The New Regime

Ann: A Case Study in Debtor Privilege

Near the beginning of the pandemic my friends and I arranged a small distribution of masks into prisons. After some signal-boosting by Madonna and Oprah, Jack Dorsey donated $10M, enough to solve the problem nationally. We tried to follow up with distributions of vitamin D and nHales. In both cases we were blocked, and couldn't even get any information from our strategic partner with prison connections about what sort of resistance he was facing. I redacted his name from the published version of this because I'm saying something negative about him here, and he's playing a coalitional game.

In the course of this work, we met Shawanna Vaughn, an African-American advocate for mental health care for incarcerated people. Shawanna is not constrained in her ability to talk by playing coalitional games. Because of this, she was able to tell us clearly where and how she was blocked on distributing vitamin D to prisoners - and also that one Michigan prison responded by jacking up the price of vitamin D in the commissary and telling the prisoners there was a shortage in the outside world. I am looking for a lawyer willing to file a class-action suit on Michigan prisoners' behalf. Asking around among the lawyers I know hasn't led to any positive results yet.

When we were beginning to work with Shawanna, she introduced us to her friend "Ann" (not her real name), a white woman with over a decade of experience in credit unions. Ann was working on a project to expand access to credit for formerly incarcerated people. Afterwards, Shawanna told us that she had introduced us because she couldn't get Ann to listen to her. She guessed Ann wouldn't listen to her because she was black, and hoped maybe we would be able to speak for her, though I didn't have this context when I met Ann.

As Ann described her project to me, she was planning to expand access to credit by making special exceptions, creating special credit scores for formerly incarcerated people that would give them a bonus for taking patronizing classes in financial literacy. These special exceptions would allow them to build the kind of credit history that might eventually give them a good enough credit score to qualify them for more mainstream credit. This isn't an unreasonable thing to do, but it works by validating the underlying system of privilege currently excluding formerly incarcerated people. It's not systemic change; it's a special favor.

I wasn't particularly interested in helping someone extend charity to a class I'm not a member of, but I am interested in justice, so I asked Ann whether she had considered designing an alternative system of credit on a for-profit basis - in other words, lending to formerly incarcerated people not because they are in need, but because they might be creditworthy. She didn't recognize that as an option, responded as though I had said she should not underwrite based on "risk" at all, and asserted without argument the moral superiority of credit unions over for-profit banks.

I decided to break the problem down into parts. I pointed out that right now, credit scores are self-fulfilling prophecies about people's ability to roll over their debts based on future access to credit. I explained the difference between lending on this basis, and underwriting loans based on the kinds of fundamentals a bank might use before the existence of empiricist credit scores. She responded by pretending such ignorance about lending that I found myself trying to explain that you might lend some grain to a farmer, so they could plant it to grow more, pay you back with interest, and still have some grain left over. If this farmer did not yet have a grain repayment history, you might investigate other things like whether they had access to the land they said they did, whether they had a reputation among friends and neighbors for meaning what they said, and whether they had the knowledge and equipment to plant and harvest grain. She said this was too "abstract" a "metaphor" for her to understand.

That night, Ann called Shawanna, drunk and crying, complaining that I'd been mean to her and called her racist and that she never drinks so she was embarrassed to have gone to a liquor store to drown her sorrows in response, and that she isn't racist.

Ann's theory of lending implied that disprivileged people are inherently uncreditworthy and can only be lent to via special favors like a special, charitably rigged credit score. But Ann's class performance rendered her in need of coddling, mentally incompetent to handle criticism. Ann almost certainly has a higher credit score than Shawanna, the black woman she conspicuously performed dependency on by demanding hours of emotional support. The class performance that gets Ann superior access to capital and jobs is a costly signal of unaccountability. On any naive microeconomic explanation of the financial sector, this should be puzzling.

Robert Jackall's excellent book Moral Mazes, an ethnographic study of American middle managers, demonstrates that Ann's case is far from unique, but is typical of the professional-managerial class, and these habits generalize far beyond this particular case of racial inequity. I was able to explain to Shawanna - and demonstrate by my failed attempt to have a conversation with Ann - that Ann can't listen to Shawanna, not because Shawanna is black, but because Ann can't listen to anything that might hold her accountable. She understands it well enough to feel threatened, though. You don't occupy a high position in the professional-managerial world without skill at something.

Let's be more precise. The process generating Ann's feelings and decisions understood what I was saying well enough to feel threatened. This process is committed to preventing the self-model Ann identifies with from ever understanding such things, warding off the self-knowledge that would break her act of charity. For a brief review of the acculturation processes that produce this kind of split, see The Order of the Soul, and The Trauma Coup.

The Keynesian revolution systematically reallocates resources away from objectively creditworthy people to create jobs for people like Ann. Mechanically, how does this happen?

Notes, Treasury and Suicide

The television series Thirteen Reasons Why is a story told within the frame of a high school student's audiocasette suicide note, which describes an experience of high school that was not preparing her to serve any useful function in society, or to understand her rights and duties as a citizen of a republic, but instead, to acculturate her into the world of social threat and betrayal described in its mature form by Robert Jackall's Moral Mazes and Doris Lessing's The Golden Notebook, and analyzed as a developmental process in Ayn Rand's essay on Progressive educational ideology, The Comprachicos (a). The suicide note offers thirteen case studies to explain why she would rather die than adjust to her circumstances. Enough young people who watched the show or read the eponymous book on which it was based were persuaded by the implied argument that some state authorities have acted to suppress dissemination of the text. For this reason, as well as the corroboration of Jackall's and Rand's account, I regard the text as sociologically credible. I have more hope for the future, but while I was blind to the sort of aggression the series describes, I did independently notice (and articulately state) that my high school was not preparing me to serve any useful function in society, and my mother was sufficiently concerned by the resulting depressive episode to send me to a psychiatrist.

While most of the Thirteen Reasons come from inside the hell the suicidal narrator objects to, one sheds some light on its origin. Her father is an independent pharmacist being driven out of business by a large, corporate pharmacy chain. His daughter sees that her father's way of life is financially unsustainable, and also sees herself as only a financial burden to him, not a potentially productive asset.

The small business owner driven out of business by a large corporation is a common trope in the last few decades - You've Got Mail being an obvious but shallow example, and Six Feet Under exploring the situation in substantially more detail. But it's worth examining both how this happens and its implications for society.

A century ago, a typical pharmacist would have needed not only the pharmacological knowledge and credentials to perform their specialty, but the ability to perform basic business accounting, keeping track of revenues and expenditures in order to run a small business profitably and make sure they could pay their debts. Now, a typical pharmacist has a corporate job, with a pharmacy chain or hospital. In the old regime, they were accountable. In the new regime, they are instead asked to obey and conform, i.e. pass the Milgram and Asch tests respectively.

Microeconomic ideology generally claims that this is because large corporations are more productive due to economies of scale. This may be true in some cases, but it is not generally the case. A local entrepreneur I know tells me that a well-run coffee shop in a well-chosen location can pay for itself (recoup the initial investment) within a year, while an investor in the stock market is doing well if they double their money in nine years. Another entrepreneur I know is planning to buy privately owned laundromats, package them into a publicly traded company, and sell it at 10-50 times the purchase price. So it is most likely that when a large corporate pharmacy is driving its competition out of business, this is not on account of its superior profitability and efficiency. Instead, publicly traded corporations are able to pay more than private competitors for leases and talent and charge consumers less because they have access to cheap capital, and are optimizing not for profits, but for growth. In other words, their interest in expanding their business is not to increase total profits, but to increase total expenditures.

I am going to try to describe the mechanism by which we found ourselves in this situation, but first, I want to try to describe the transition the West underwent, from a creditor-led finitist society to a debtor-led infinitist one, in generalized terms.

Solvency vs Growth

Under solvency norms, commitments are to be resolved promptly. In other words, if someone takes on debt, the normal outcome is that at some point in the near future they pay off the debt, so that the normal state is a debt-free one. The total amount of outstanding debt is kept well below the maximum level that can be explicitly evaluated. One can quibble about whether this is optimal, but it's a state of affairs that was thought both desirable and achievable by Calvinists, Puritans, and Quakers. While man's debt to God might be infinite, man's formal debt to man could be minimized.

In a solvency-oriented society, enterprises grow by earning cash profits, which - in competitive conditions - are a good proxy for superior objective resource management and information processing capacity. Good stewards increase the total productive capacity under their care, and thus become more influential over time. According to Albion's Seed, the Puritans not only divided productive land among many small households (thus making most people stakeholders and ensuring a densely competitive market), but preferentially settled rocky land in need of a lot of work, so that householders could become wealthier by using intelligent diligent labor to improve their existing property, not just by expanding the amount of territory under their control. It seems as though there was also a serious attempt to discourage people from exploiting pricing power to become wealthier, which would have created an incentive to form monopolies. Raising prices due to underlying product scarcity outside of one's own control (described as the hand of God acting on the market, cf. "invisible hand") was explicitly permitted, and raising prices due to market power was explicitly prohibited, and people who did it were censured by the clergy.

It is obvious under such circumstances why someone would have a prosocial profit motive, and the bourgeois virtues would be adaptive; over time, people with those attributes have more resources to take care of children, so they become a larger share of the population over time. The relevant principle here is the Iron Law of Wages; life strategies that earn more than enough to reproduce themselves make more copies in the next generation, and ones that earn less than enough to reproduce themselves make fewer.

Microeconomics tacitly assumes we live in a solvency-oriented society - that people want to maximize monetary profits on their business ventures, net of the cost of capital. But academic finance of the kind used to price options assumes, to the contrary, that every economic agent has the ability to borrow arbitrary amounts for arbitrary lengths of time at a fixed rate of interest, and assumes without justification that there is a profit motive. What is there instead?

A growth oriented society does not expect debts to be paid off completely. A significant reduction in the total amount of debt outstanding is called deleveraging, and is generally considered a crisis to be avoided. Instead, people - and more importantly in the long run, legally immortal corporations - are expected to roll over their debts indefinitely. As debt increases over time, more resources are allocated on the basis not of cash profits, but of access to capital, i.e. ability to borrow (or issue stock) at low effective rates of interest. Therefore, the Iron Law of Wages favors whatever behavior causes someone to have discretion over more resource flows, whether or not they are making a nominal profit or increasing the productive capacity of the real resources they are responsible for.

If such debtor elites control a central bank, especially one with a fiat currency, they can arbitrarily decouple resource allocation from underlying profitability, though the greater the decoupling, the larger the reduction of money's purchasing power. A high level of decoupling allows clubby patronage networks to seize increasing shares of resources over time, at the expense of the kinds of people who would try to increase the productive capacity of the system by applying apolitical standards. With access to arbitrary credit, debtor elites can also subsidize their favored ventures to make them financially profitable on paper when they otherwise would not be, by granting them cheaper access to capital.

We would expect such debtor elites to feel the kind of dread at the prospect of a final reckoning or enforcement of standards, characteristic of the kind of Christianity I describe in Judgment, Punishment, and the Information Suppression Field, Blackmailers are Privateers in the war on hypocrisy, and my review of Malcolm X's autobiography. More on this later, including an analysis of transitional states between these extremes.

How does the debtor-elite regime work in practice?

The Money Supply

I am going to sketch out a picture of what pass for normative resource flows in our society. There are extremely important exceptions, but they are exceptions, much more important materially than they are financially.

How does an American live well enough to reproduce? You have to get food and pay rent somehow. If you are able to demonstrate dependency via unemployability, then you can access housing and food subsidies that are probably enough to live decently on if you are diligent and clever, though in practice bureaucrats might threaten you with withdrawal of those resources if you don't demonstrate a level of shame incompatible with economic prudence. You can participate in illegal cash commerce as well, though the authorities keep trying to make this more difficult. Neoliberal technocratic types approve of India's attempt to eliminate cash, "drug dealing" and other informal trade is frowned on, and online commerce requires formal financial intermediation.

Suppose you instead want to work for a living. Well, you can get a job, but unless you have a very unusually marketable skill, any savings you acquire are extremely precarious; if you're not on Medicaid, hospital care can be financially ruinous unless you have a "good job," which will usually be the kind of job one holds due not to competence but to class privilege, what David Graeber would call a Bullshit Job. Programming jobs used to be different, but everyone I know who had mental integrity and worked at Google until recently has left due to the politicization of the workplace. The normal path by which people trying to work for a living are encouraged to improve their prospects is by borrowing a lot of money to attend a finishing school that teaches them little or nothing in the way of productive capacity (see Bryan Caplan's The Case Against Education), but inculcates a sense of class loyalty to other people like them, and of entitlement to good jobs.

As a worker your main expense is housing, the nominal price of which has been inflated by rationing of the supply of housing in high-income areas, combined with state-subsidized mortgage financing, which allows people on a given income to pay more for a house. Let's work through a simple example. Forgetting about down payments, suppose the effective rate of interest on a house is 20%. Then someone with a housing budget of $10,000 per year can afford a house priced at up to $50,000. But if the rate of interest goes down to 5%, then that person's leveraged purchasing power goes up to $200,000. Thus, as mortgage rates declined over time along with Treasury rates, the value of real estate increased over time. This is a target of government policy; economic decisionmakers close to central banks talk openly about the desirability of increased house prices, for the benefit of homeowners. This is part of the mechanism by which savers in state-favored assets are rewarded in the absence of high real return on productive investments. This sort of financial "wealth creation" also involves increasing the market value of a good by rationing it, decreasing the amount of real consumption. In other words, increasing the value of homeowners' assets necessarily means making it more expensive for new entrants to pay for a home - and the less access to credit they have, the more their effective cost of housing has increased over time.

Housing is an informal part of what economists would call the money supply. Home equity is an important component of savings, and mortgage-backed securities are an important asset class held by banks, pensions, and other key financial institutions. In 2007, a reduction in the price of housing caused what is called a liquidity crisis, as mortgage debt started to exceed the value of the houses that secured it. The state responded by lowering interest rates, often by directly purchasing this debt, until the market stabilized, at the expense of anyone who had displayed a more old-fashioned sort of economic prudence, and anyone who was renting.

Since landlords generally profit from their situations, we should expect homeowners to pay less for housing than renters living in comparable housing. This isn't an equilibrium solution under free market assumptions, so if landlords keep making money, the supply of credit must be rationed somehow. And it is! I won't get into the mechanism by which the total amount of credit extended is limited yet, since I want to work through an example first. It is easier to get a mortgage on favorable terms if you have a good credit score, which you get by regularly borrowing, and using your history of timely debt service to access more credit on more favorable terms. It is also easier if you have a stable income well in excess of your mortgage payments, which is easier if you have a "good job."

Where do good jobs come from? Mostly from large publicly traded corporations, another sort of structural debtor with privileged access to credit.

Consider my friend with the business plan to buy up laundromats. Let's say an illiquid, privately held laundromat makes a 25% return on invested capital. Suppose the stock market demands a 10% return for a small-cap company. So $100 million of privately held laundromats would generate $25 million in annual income, worth $250 million on the stock market, 2.5 times the initial investment. But if the laundromat company can finance 75% of the deal at 10% interest, then the cash cost of acquisition is $25 million. The cash flow profits of $25 million are reduced by $7.5 million in interest payments, for a net annual profit of $17.5 million. This company could sell for $175 million on the stock market, seven times the initial cash outlay. For this reason, orthodox financial theory recommends that companies borrow as much as they can get away with and roll over the debt perpetually, to maximize return on equity. (For a simpler worked example on these kinds of multipliers, see the section on credit rationing mechanisms.)

This sort of opportunity would not exist if there were an adequate supply of potential entrepreneurs with access to capital.

In the long run this subsidy to large purchasers should inflate the market price of inputs for the laundromat industry, simultaneously increasing the market price and reducing the profitability of existing businesses, creating increasing pressure to sell out. Note that by the same logic as above, the laundromat company would profit from creating new laundromats with an ROI above 10% but well below the 25% earned by existing businesses. This creates the dynamics observed in Thirteen Reasons Why; the pharmacist father can't keep his business going, but would have profited financially by selling it, converting from a small business owner into a member of the stock-owning class. In the long run, the return on investment in such assets in the aggregate has been driven by reductions in interest rates.

This would locally at least seem to benefit consumers and wage-earners; if pharmacies or laundromats are run with lower margins, prices will go down and salaries will go up. But the greater financial efficiency of corporations with privileged access to credit does not correspond to any savings in the use of real resources like time, materials, and labor. Instead, the implied subsidy to large publicly traded businesses comes at the expense of more competitive sectors, so capital has to become comparatively more scarce elsewhere, leading to higher prices and lower wages in those parts of the economy. For example, debt-financed corporate laundromats might bid up rents in an area, increasing the costs of all other local businesses (and households!). Some businesses can cope by lowering wages or raising prices (which also lowers real wages). Others simply lose their leases and go out of business, reducing the range of goods and services available for purchase, a real reduction in the purchasing capacity of money. This also leads to the creation of large conglomerates with local oligopoly and oligopsony power, which can increase their paper profitability yet again without any improvement in the efficiency of real resource usage.

Agents with access to cheaper more reliable credit can sometimes even drive less privileged competitors into insolvency. US railroads were built on massive credit, often competed unprofitably to try to drive the competition out of business, and only became profitable when JP Morgan organized cartelistic price-fixing. Boeing drove all but one other state-backed competitor out of business, is now Too Big To Fail, and doesn't even have to be profitable. Uber may be a more brazen instance of the same thing - it's selected for by an expectation of future access to credit, not by a clear model of how its future profits can cover its current debts, and that can be enough to wipe out competitors that don't behave that way.

There's a strong structural analogy between this and Moral Mazes style coalitional strategies that favor nihilistic confidence and malleability of narrative over the sorts of things that actually make money for a company. This is almost certainly also the mechanism by which Boeing was hollowed out by the managerial class at McDonnell Douglas. This is why even capital allocation within a given credit privilege class may not correspond to any underlying fundamental profitability; pyramid schemes are not good at making accounting profits, but they are excellent job creation schemes.

You might expect that a bank willing to lend to politically disadvantaged individuals and companies might be able to do a lot of profitable business. This is what I was trying to suggest to Ann, and her response implies that the financial industry strongly selects for people who can't recognize that opportunity, and conditions people working for it to become increasingly unable to recognize it. I've had difficulty finding anyone with the initiative to try to exploit this opportunity, but if you know anyone who might be a good fit, I would love to help them and have monied friends who would be excited to investing in such a venture.

But the clubbishness of bank culture didn't come from nowhere. Banks are heavily regulated, and the amount of credit they can extend is also rationed by the government. The zero-sum coalitional strategies described above have the greatest advantage when competing over fixed rent streams, or at least in environments where profit-and-loss feedback is slow relative to the speed of corporate politics. And orthodox macroeconomic policy is in fact a cybernetic system designed to maximize the long-run growth of correlated pyramid schemes. I'll describe the advantages of correlated pyramid schemes first, and then the mechanics of the cybernetic system.

Benefits Accruing to Participants in Correlated Pyramid Schemes - or, The Power of Positive Thinking

Large or highly correlated and politically connected businesses can borrow more cheaply, not only because their nominal rates of interest are lower, but because they can get away with systematically inflated accounting profits. In the long run, politically unprotected businesses that fail to model tail risk or are unprofitable when tail risk is taken into account are selected out of the economy; they fail. But if enough enterprises are exposed to the same risk, it would be economically disruptive to allow them all to fail, so the government prevents them from failing. Therefore, excessive optimism is not selected against, when it is correlated with the optimism of others. Critically, this is also true of the banks lending to businesses, so the banks that grow the most in the long run are the ones that can offer more favorable credit terms by being too optimistic, not the ones that protect themselves adequately against tail-risk events, which in turn incentivizes borrowers to be optimistic. This adverse selection problem is the main point of Nassim Taleb's recent book Skin in the Game, and his idea of the Intellectual Yet Idiot is a pointer at the kind of person selected for.

A bit more detail: Since corporate debt is effectively part of the money supply - banks can hold it as an asset corresponding to deposits - a large enough reduction in its value would lead to a liquidity crisis, as banks would have to sell off such assets to cover liabilities, leading to a further decline in those asset values, and eventually precipitating a wave of defaults, runs on the bank, etc. To prevent this, while most individual corporations might be allowed to fail, any group of corporations large enough to be systemically important will be bailed out with more loans at better-than-market terms if they are in danger of failing.

Enterprises can be systemically important simply because they account for a large enough share of outstanding debt. In the 2008 financial crisis, when financial institutions and mortgage backed assets were in danger of a correlated default, the US government intervened by inflating the price of "troubled assets" and lending to banks on favorable terms. This meant that as long as a loan was profitable under "normal" conditions, it was long-run sustainable for a large bank to make that loan, even if in the absence of central bank intervention the tail risk would have made it badly unprofitable.

Systemic importance can also come from employing a lot of people, or doing business with a lot of companies that depend on you. For this reason, in the 2008 financial crisis, the Big Three automakers were bailed out, even though there were plenty of more efficiently run foreign companies happy to sell cars to Americans.

This selects for the behavior patterns of taking on correlated risk while denying it exists, and hiring a lot of people. The incentives it creates reinforce well-known patterns of intracorporate conflict, in which factions that inflate nominal profitability, and leaders who manage to hire more people, gain in size and influence at the expense of ones that don't.

Here is how I summarized this pattern on Twitter:

In 2008 we worried that:

- It might become cheaper to live in a home.

- Wall Street might shrink as a share of the economy.

- The corrupt Big 3 automakers might get out of the way of well-run companies like Hyundai and Tesla

The Fed made more money to prevent this good outcome.

Startups are also part of this extended ecosystem. While people in the scene pretend that they are a continuation of Calvinist-style capitalism, they are optimized to produce smoothly climbing growth metrics decoupled from actual profitability, in order to raise a series of funding rounds as part of a self-validating system of inflated expectations culminating - for the winners of this tournament - in an IPO where they formally enter part of the informal money supply and - if they manage to form or join a systemically important coalition - can expect to get bailed out by the Fed when they fail. (In the 2020 crisis, the Federal Reserve lent to major corporations directly, not just to prevent defaults, but to keep stock prices from crashing. This effectively recognized equities as an informal part of the money supply expected to gradually appreciate relative to the dollar, much like real estate, thus subsidizing people passively relying on stocks as part of the informal money supply, at the expense of people trying to invest based on rational expectations of underlying profitability.)

So I've described the ecosystem cultivated by a cybernetic process of credit rationing. But how does the cybernetic system actually work?

Credit Rationing Mechanisms

Microeconomic ideology says that changes in treasury bond yield affect the availability of credit via opportunity cost. But mechanically, changes in treasury bond yields affect the availability of credit via the market value of banks' capital reserves.

Let's consider a simple bond: an IOU for $10 in a year. If I buy it for $8 now, then it's as though it will go up in value by 25% in a year, so the effective yield is 25%, the same as if I bought an $8 bond paying 25% interest.

Market Price Yield

Market PriceYield

What's the opportunity cost story? Banks have investment portfolios consisting of treasury assets and other investments such as loans. A bank would take a net loss making any investment with a risk-adjusted yield below that of treasuries. So the marginal loan should have the same risk-adjusted yield as a treasury bond. On this account, when treasury yields go down (i.e. treasury bonds get more expensive), banks sell treasury bonds and make loans until the marginal yields match at equilibrium, and when treasury yields go up (and prices go down) banks make fewer loans and buy more treasury bonds.

In practice, I think there's a very different mechanism whereby higher/lower treasury bond yields lead to reduced/increased lending: capital reserve requirements. Banks have to hold some minimum percentage of their deposits as "safe" assets like treasuries. When the Fed buys treasury bonds it raises their market price through normal supply-and-demand mechanisms, and thus lowers their yield. When it sells bonds, it does the opposite. This changes the amount of safe reserves banks are considered to hold!

Let's say a bank has $100 in deposits, and has to hold 20% of this, or $20, in treasuries, no matter how good the other lending opportunities are. Obviously this is consistent with a situation where the return on the marginal loan is a lot higher than the return on treasuries. The Fed buys some treasuries, raising their market price by 5%. The bank, holding the same bonds, now has $21 in safe assets. It can sell the extra $1 of treasury bonds, and use that to make profitable loans.

It works the same way in the opposite direction - if the Fed sells treasury bonds, their market price goes down - so the bank now has to buy more treasury bonds to keep its capital reserves at the required level.

This is a totally different mechanism from the "opportunity cost" story, and implies very different structural features of the financial economy, but makes the same predictions about the marginal effect of Federal Reserve actions on retail credit. Specifically, in the opportunity cost story there is a single credit market, securities like treasury bonds are one end of a spectrum along which capital flows efficiently, and towards the other end of which are things like credit card debt and payday loans. In the regulatory-mechanisms story there are many markets, within which market yields may represent an efficient capital allocation based on the risk of the underlying investment, but between which interest rates differ for structural reasons like the one mentioned above.

Under classical Ricardian microeconomics, we would expect the profitability of ventures to go down over time as a result of competitive pressures, reducing the market value of business enterprises. Thus, as society becomes wealthier and experiences more leisure, less labor is purchased, and the financial economy deflates. But conventional macroeconomic policy is explicitly opposed to this outcome, and acts to reinflate the financial economy, targeting enough growth to keep everyone busy, but not enough growth to inflate the nominal prices of goods and services fast enough to break the illusion that money has a fixed value. This is what it means to balance the goals of low unemployment and low inflation, which is the Federal Reserve Bank's explicit mandate. Thus, if goods and services become too cheap, the Fed buys bonds, to encourage banks to lend to more pyramid schemes to buy up productive enterprises and parasitize them, and if prices start rising too fast, the Fed sells bonds, to limit the growth of pyramid schemes.

Sometimes a genuinely competitive company like Amazon slips through the cracks, of course, but that's an anomaly.

To summarize the mechanism: The job of the US Federal Reserve Bank is to regulate how busy people are. When people are not busy enough, the Fed manipulates the market to increase the amount of credit available for existing state-backed pyramid schemes to expand, and new pyramid schemes to become more official.

The Money Wars

When I was young, I read advice in favor of thrift from wisdom literature such as the Bible's Proverbs, and The Autobiography of Benjamin Franklin. But the idea of growing rich through saving money didn't seem to match the environment I lived in. The interest paid on bonds or bank accounts was negligible, especially compared with the rate at which the nominal cost of living was increasing. Some personal finance advice suggested shopping around for accounts that paid higher rates of interest but the increased interest income was equivalent to maybe an hour's work by an adult, at the hourly rate implied by normal middle-class salaries.

Low interest rates had two related implications that seemed hard to reconcile with the concrete details of my environment. Low interest rates imply low time preference, so I should have expected to see an ethos of good custodianship, and building things to last. But a lot of the physical infrastructure was poorly maintained, new construction was widely regarded as less sturdy than "prewar" construction, software was being crudely hacked together, and agricultural land was farmed extractively, in ways that implied that resources were still being mobilized for some sort of emergency. Low interest rates also imply a well-capitalized society with easy availability of cheap credit, and while there were some areas where the effects of cheap credit were in evidence (car loans, mortgages, the dot-com bubble), it didn't seem like labor was correspondingly scarce and well-rewarded. While books from as late as the 1970s described an environment where someone willing to work could easily trade their time for enough money to live thriftily but decently on, in the '90s the vibe was that upper-middle-class people midway through their careers were anxious about maintaining their positions, and starting in 2008 their successors graduating college found a job market where good jobs were scarce.

Clearly there was some sort of rationing going on, rationing that was concealed by neoliberal economic ideology. In the previous email I described some of the ways in which credit could be nominally cheap at the top of the pyramid, but expensive at the bottom. Now I'm ready to describe how we got there.

The Antediluvian World Order

After the world wars, Stefan Zweig wrote his autobiography, The World of Yesterday, which begins in prewar Austria.

Zweig came from a bourgeois Jewish family which was careful to spend less than its income and accumulate savings in the form of government bonds. They expected to steadily grow richer through this process, because they expected the state to honor its commitments - and its debt was ultimately backed by a commitment to deliver a certain quantity of specific precious metals to the bearer of paper currency. For an independent summary of this economic process, which alludes to the periodic crises that disrupt it, see Thomas Piketty's Capital in the Twenty-First Century.

By the time Zweig was in school, his family's economic position seemed secure enough that he felt free to compete in the arts. Specifically, he became a famous writer. He describes Vienna, the capital of the Austro-Hungarian empire, as practically worshipping art and artists, so it seemed like he was doing well at the most highly regarded tournament available. But at the same time, it was new for Jews like him to be allowed to compete in Vienna's art scene on equal terms - and young Christian elites were shifting their attention to more military pursuits, like forming aristocratic dueling gangs. He'd arrived - but ominously, they'd departed.

After Stefan Zweig's The World of Yesterday alerted me to the existence of a lost prewar world with a texture of life radically different from the postwar world we live in, I read Tooze's The Deluge and Wages of Destruction to try to understand what happened. It appears that states (or more precisely, the kinds of elites who staff executive bureaucracies) started a giant war in order to borrow a lot of money from the creditor-bourgeoisie to hire vast armies of dependent political clients. This created a large urban class dependent on continued state spending, which created a political majority (heavily concentrated in the urban areas where central decisionmaking happened) opposed to the post-war deleveraging that would have been necessary for debts to be repaid. This allowed the executive class to expropriate all the wealth of the creditor class by transitioning to state-controlled economies. In Russia this happened through explicit seizure of assets; in the West, through monetary policy.

While the World Wars were the most important such crisis, I want to start a bit earlier.

State Paper and the Aristocratic Ethos

Using paper debt as an alternative form of currency is not much younger than paper itself; Marco Polo described China using stamped mulberry bark to represent gold and silver. Italian bankers, especially from Florence, were instrumental in its adoption across Europe, but it's older than that. Basically, if you have a functioning reputation network, you can sell to a buyer at point A in exchange for a letter entitling you to some of the buyer's account held at point B. I found a couple of Patrick Wyman's podcast episodes helpful in setting context here. He has a book out called The Verge which may contain much of the relevant content, I'm not sure.

These informal systems of reputation were perfectly adequate for credit to private individuals, but bankers also lent to sovereigns. Kings might have seemed very creditworthy, with large future tax incomes to borrow against, and highly respected. But an important problem with kings - and aristocrats in general - is that they can command respect, i.e. threaten people with violence for questioning their honor. The practice of commanding respect can compromise reputation systems of credit, which rely on freedom of criticism; the aristocratic sense of honor parasitizes mercantile notions of creditworthiness. The Compagnia dei Bardi of 14th Century Florence was ruined in part by partially repudiated loans to King Edward III of England.

Eventually, Italian merchant republics like Venice and Genoa achieved enough local interest alignment to engage in regular, sustained debt finance of state military ventures, and with the Spanish "Reconquista" these tools were applied by a major kingdom. How did the aristocratic Genoese entrepreneur Christopher Columbus get an audience with the King and Queen of Spain, to pitch them on being the lead investors in his mercantile venture? The Spanish crown relied on the expertise and networks of Genoese merchant-bankers. By the 17th Century France was also issuing large amounts of debt to finance something approaching a modern centralized state.

Barry Lyndon illustrates the resulting dynamics - and alternative systems worth comparing it with - very well in their mature 18th Century form. The eponymous protagonist begins in Ireland under British rule, where money is precious metals and duelling is for love and honor. He joins the English army, in which a combination of thrift and career advancement could significantly improve a soldier's economic position, but there's also ritualized fighting in the form of boxing where skillful participation affirms your status as someone not to be lightly offended. The English use financial incentives to recruit people into an army where most of what is expected of them is to precisely obey commands to walk towards danger while holding formation. Such armies compete for right of way over the territory (tax base) used to constitute the armies, so despite not being productive in themselves a successful army can offer a positive financial rate of return.

David Graeber's Debt describes the origin of a hard currency economy in similar terms; to avoid the extreme administrative difficulties of explicit central planning, kings instead use their military capacity to extract taxes in coin, and then offer coins in exchange for the goods and services their armies need, thus allowing locals to self-organize into efficient market-driven supply chains.

Barry next serves with the Prussian army, which seems to have run out of slack to recruit resources through a currency economy, and instead resorts to direct violence, harshly beating soldiers for poor discipline and kidnapping teenagers for new soldiers.

The next scene Barry finds himself in is the French aristocracy, where he teams up with an Irish gambler, who plays against aristocrats on credit and cheats to win. Barry's role, as a competent duelist, is to extract payment from debtor aristocrats by challenging them to duels. The norm seems to be that an aristocrat's word cannot be challenged except by someone willing to back up the challenge with (somewhat ritualized and contained) physical violence in the form of a duel. Everyone else is treated as a sucker who need not be repaid because they cannot command respect.

Through skillful courtship, Barry marries Lady Lyndon, coming into possession of the Lyndon estate in England. He then borrows heavily against this estate to try to obtain a peerage. This effort fails when his stepson baits him into a public altercation, which marks him as too low-class to be ennobled; he has impulsively revealed a conflict, instead of using a combination of self-control and nascent class privilege to prosecute the conflict covertly. In response to this, the estate's creditors demand payment and threaten to seek legal remedy.

The Anglo-French nobility thus occupy a sort of parallel economy to the cash economy used by the English state. They can issue debt, which - as long as they've held onto their social status - might even recirculate as a sort of secondary currency. Since they are competing for position using resources that must be paid for (e.g. decorators' and caterers' bills), they are in an arms race that selects for people willing to accumulate debts. They are also selecting for social behaviors that conceal rather than revealing conflict. The privileges of the aristocracy in such a system are inexplicit; while there are some institutions they have explicitly exclusive access to, in large part their privilege consists of the justified expectation that others will feel compelled to look away from and cover for things that would be inconvenient for an aristocrat in good standing. Because of this, a failed attempt to buy into the aristocracy can be catastrophic, as one accumulates debts in the process that are unsustainable without such covering.

Naively it feels to me like Barry Lyndon's decision to try to buy into the aristocratic class is a poor choice, when by simply not doing that, he could have been rich and comfortable and had many well-cared-for children. But like Zweig's, my bourgeois attitude misses important parts of the picture.

Lorenzo de Medici inherited a profitable bank and trading company; financial wealth can buy goods and services, but is vulnerable to expropriation by political actors. While the bank began its financial decline in his lifetime, Lorenzo the Magnificent spent a lot of that money on patronage, which eventually resulted in the Medici family becoming dukes of Tuscany. To me this seems like Lorenzo was losing - the company lost money! But very obviously a family might expect a more secure future as hereditary Grand Dukes of Tuscany than operating a profitable business in an extremely competitive field. While Barry Lyndon failed to buy into an aristocracy, the Medicis succeeded - and acquired an army and tax base to hold onto their winnings.

My idea that the wealth that matters is net worth is profoundly idealistic. It embeds the assumption that we live under a stable regime with civil law where accounts are being kept. Capitalism is sometimes described as "whoever dies with the most toys, wins," but even debtor aristocrats who never acquire an independent duchy may very well actually possess more toys than thrifty capitalists with bourgeois virtue with a similar magnitude of assets under management.

Veblen's idea of conspicuous consumption (developed in Theory of the Leisure Class) makes much more sense if you don't start from the assumption that accounting representations are bound to reality; you show your capacity to recruit resources by actually recruiting those resources. This is at least as old as kings commissioning the carving of throne guardian statues; the powerful winged beasts beneath the throne represent the productive capacity of the skilled labor recruited to sculpt them, and are therefore a costly signal of a king's ability to defend himself against enemies without comparable resources to recruit. Prosperous Dutch merchants accumulating art objects were doing the same. Prior to the 20th century, rich people wearing elaborate watches were specifically signaling that they could mobilize the labor of the kinds of skilled mechanics critical to modern war machines.

One might better describe the capitalist idea of acquisitiveness as, "whoever has the largest legally enforceable claims against the future productive capacity of others wins." Jews in particular have been making this mistake since biblical Joseph reduced Egypt to debt-slavery. Legally enforceable claims are threats, and if you're threatening a lot of people then you have a lot of enemies, which is dangerous. This is especially dangerous if you grow rich by working for violent gangs (Talents). The Hávamál, Norse wisdom literature, contrasts instructively with Proverbs; it's a guide for how to have a nice life and not get stabbed out of envy. Ecclesiastes seems to occupy a middle ground. (Financial investment is just a symbolic representation of investment projected onto a low-dimensional space inside a control system run by the US government.)

Even if earned enmity were not a problem, Barry Lyndon is only making an obvious mistake under the assumption that a high number recorded on a bank ledger implies correspondingly large control over real resources. A skeptical empiricist might prefer to trust what they actually see people doing and getting, rather than some numbers on a page with a complicated and potentially dubious connection to concrete reality. On this more empirical attitude, the way to tell whether it's better to be an aristocrat isn't by checking the account books, but by looking at what their lives are like. Charles Dickens was no stranger to the potential downsides of debt. His father was sent to a debtors' prison. And yet, in his story A Christmas Carol, the wealthy miser Scrooge's life gets a lot better when he transitions from an acquisitive life strategy to one that allows money to pass through him, and in principle racking up debts could make things even nicer for him, especially if he faces competition.

But the leveraged version of this strategy only works in the medium run if debtors collude to behave as though they intend to repay their debts. Debtor elites have to be ashamed of their debts, i.e. feel a shared compulsion to cover them up. This is why Barry Lyndon's impulsive violence against his stepson renders him unfit tor the aristocracy; such matters are handled covertly, behind closed doors, so a veneer of respectability can be maintained.

Correlated leverage strategies give each participant less freedom of action, but are better at mass mobilization, which gives them an advantage at the beginning of conflicts. The beginning of Graeber's Debt describes the situation of the famous conquistador Cortés, doing monstrous violence to people far from home, for profit. He was deeply in debt, and any compunctions against this unjust violence were outweighed by his shame as a debtor.

To generalize, correlated debt-shame builds up as a sense of resentment against one's creditor-persecutors, until the pressure becomes intolerable and the debtors attack their creditors in an wave of correlated violence, often catching their creditors (who are not tuned into the same shame coordination mechanism) by surprise. Pogroms and world wars work on roughly this principle.

The 1995 film Rob Roy, set about half a century before Barry Lyndon, paints a more balanced (fictional) picture of the relative strengths of leveraged and unleveraged players. It sets up an opposition between the Marquis of Montrose, a refined English lord and a political operator who lives in a world of deceit, and the Duke of Argyll, a very Scottish lord who is stuck playing defense politically because he doesn't know what's going on, but is capable of entertaining the hypothesis that someone might be sincere. When they first meet, they bet on a duel between Cunningham, an effeminate fop who is staying with Montrose, and a skilled Scottish swordsman working for Argyll. Cunningham turns out to be an expert duellist, and wins for Montrose.

Rob Roy MacGregor is the hero, a vassal of Montrose. He is portrayed as economically prudent, plain-spoken, skilled at violence and willing to raid opportunistically, but true to his word, caring for the people and property in his custody. The people on his land are poor, so to help them, he arranges to borrow a thousand pounds from Montrose to finance a profitable cattle trade. MacGregor, his wife, and his children speak frankly to one another, and there is open mutual sexual attraction between him and his wife

The duellist Cunningham is MacGregor's opposite. He speaks and acts ironically in most social situations, and accumulates debts he cannot pay. He irritates Montrose by purchasing clothing at a local tailor on credit by claiming that he's a member of Montrose's household (and therefore making Montrose liable). He has sex with a servant in Montrose's household, whom he relates to with something approaching real vulnerability, telling her that he is ashamed and resentful of his mother because he is a bastard and doesn't even know who his father was. She is dismissed from the household because she has become pregnant, and tells him that she loves him, will follow him anywhere, and has nowhere else to go. He responds by telling her "love is a dunghill, Betty, and I am but a cock that climbs upon it to crow," he doesn't care where she goes, and at least her son will know his father's name. She hangs herself from shame.

Cunningham, who has annoyed his patron by taking on debt in his name at a local tailor, attempts to fix the problem through stealing the money Montrose plans to lend MacGregor. Cunningham conspires with another of Montrose's servants to manipulate MacGregor's agent into accepting easily stealable cash rather than the sort of promissory note mentioned in the beginning of this section, and then ambushes MacGregor's agent in the forest, killing him and stealing the money.

Montrose confronts MacGregor, who frankly confesses that the money was stolen. Montrose offers to renegotiate the debt if MacGregor will testify that Argyll is treasonous. MacGregor refuses, which astonishes Montrose, but MacGregor maintains that he only owes Montrose a finite monetary debt, not arbitrary crimes on his behalf. Montrose interprets debts as part of a blackmail industry; MacGregor interprets them as specific commitments that are either honored or broken, with specific public consequences. MacGregor evades imprisonment by Montrose, but Montrose launches a campaign of harassment against his property and family, led by Cunningham, who finds glory in his new red coat and mission of violence on behalf of a higher power. Like Cortés, he discharges his shame in a bout of correlated violence against people living outside his system of double binds.

Montrose gradually begins to suspect that something funny has happened - Cunningham seems to have suddenly come into a lot of money, at the same time MacGregor lost his - but he's unable to see any opportunity in reconciling accounts. He can only see how to seek adversarial advantage, so he ends up in a very unprofitable conflict with MacGregor's whole village, who damage Montrose's property in retaliation.

Eventually, MacGregor's wife appeals to Argyll for help, and tells him how MacGregor refused to falsely accuse Argyll of treason. Argyll asks some appropriately skeptical questions, but is eventually satisfied that she's telling the truth. Argyll offers their family sanctuary, arranges a duel to the death between MacGregor and Cunningham, and bets on it with Montrose, staking a thousand pounds of his own money against Montrose's cancellation of MacGregor's debt. Cunningham out-duels MacGregor, but at the last moment MacGregor grabs the blade of Cunningham's fencing sword to stop it, and takes advantage of the surprise to kill Cunningham on the spot. MacGregor is out of trouble and goes home.

This film depicts two things clearly in conjunction. First, MacGregor is better off on account of his integrity. He has real, warm relationships with other human beings, and as far as we can tell is more reproductively successful than Cunningham. But also, the power animating Cunningham is clearly advancing, winning against people like Rob Roy and Argyll, able to marshall whole armies to crush people who stand in its way. Argyll is depicted as a sort of holdover from a dying era, as is MacGregor himself. Power isn't good for its substrate, but it's even less good for everyone else, so it spreads in a population through something like Hamiltonian spite. Rob Roy gives us a fine-grained picture of this process, with a sympathetic picture of both sides. It shows us an older type of aristocrat compatible with bourgeois ethics, being edged out by a new type compatible with the high finance of the modern state.

Tocqueville's The Old Regime and Patrick Wyman's podcast series both describe the world before the emergence of the centralized state as one in which power was balanced between many different kinds of institutions, each asserting and defending (sometimes by force) their own particular rights. The Church, the Towns, and Feudal Lords all had to compete with each other, and someone persecuted by one could seek refuge with another. The centralizing state leveled these protections. While this was sometimes a liberalizing force in the short run, in the long run it meant that no one could safely stand against the arbitrary will of the executive.

In A Man for All Seasons Robert Bolt also describes this problem, in the contest of Sir Thomas More's opposition to the subjugation of the English Church to the English State. More explains that he won't respond to bad faith behavior by escalating in kind, because it would set a bad precedent:

William Roper: So, now you give the Devil the benefit of law!

Sir Thomas More: Yes! What would you do? Cut a great road through the law to get after the Devil?

William Roper: Yes, I'd cut down every law in England to do that!

Sir Thomas More: Oh? And when the last law was down, and the Devil turned 'round on you, where would you hide, Roper, the laws all being flat? This country is planted thick with laws, from coast to coast, Man's laws, not God's! And if you cut them down, and you're just the man to do it, do you really think you could stand upright in the winds that would blow then? Yes, I'd give the Devil benefit of law, for my own safety's sake!

Early Centralization of American Monetary Policy Before the World Wars

In a war fought from 1776 until 1783, local elites succesfully seized control of the British Empire's thirteen American colonies. In the process, the thirteen new confederated states, as well as their common government, issued debt.

Since these thirteen states were jealous of their autonomy, the common government was constituted to be a weak one without the ability to levy taxes to pay its debts. This weak central government made interstate relations difficult, and was also judged potentially inadequate to defend the united states' interests against foreign powers. On this basis, in 1788, some of these elites persuaded the people of all thirteen colonies to agree to a new, more strongly constituted central government, with a constitution formally defined in writing, and the power to levy taxes of its own.

In 1790, Alexander Hamilton, Secretary of the Treasury, persuaded the new government to assume the states' war debts. This was controversial partly because it necessitated new methods of federal taxation, justifying increased centralization of power, and partly because only some states had significant outstanding war debts. The bonds of these debtor states had come to trade at a significant discount to face value, as the original lenders accepted that they'd gotten stiffed and sold for whatever the speculative market would bear. In effect, the states which had already paid off their own debts now had to subsidize the debtor states.

Hamilton explicitly argued that an adequately funded national debt was beneficial to the new government, because it would align its creditors' interests with its own. (If you owe the bank a million dollars, you've got a problem. If you owe the bank a billion dollars, the bank's got a problem.)

The newly centralized nation quickly divided politically into two parties: a "Federalist" party predominantly from the northern debtor states, which advocated a stronger central ("federal") government with a national, centrally subsidized bank, and a "Democratic-Republican" party predominantly from the southern creditor states, which advocated a minimal central government and opposed central state-backed financial infrastructure.

For details, see the Federalist papers and Ron Chernow's biographies of American founders, especially Alexander Hamilton.

The conflict between these two parties, under various names, continued until the US civil war of 1860, during and after which JP Morgan rose to prominence as an unofficial central banker. The Morgan family was already a significant international banking family in the prior, familial system of international finance, similar to the Rothschilds and others, with family members operating banks in New York, London, and Paris. Morgan gradually became central to US finance through a combination of audacity (e.g. offering to handle an entire bond issuance for the federal government when he'd have been expected to bid for a small percentage of it alongside other banks) and business acumen (e.g. acting like a private equity firm, taking over troubled businesses he'd invested in and restructuring them to restore profitability, which gained him a favorable reputation for investors, and thus market power; a Morgan investment made your business more worth buying into.)

Railroads were a major new venture in the post-Civil-war period. Competing railroads would drive prices down to the marginal cost of running routes. Since railroads also had to finance large fixed costs, this led to a series of bankruptcies. Eventually, Morgan managed to use his financial position as leverage to broker a consolidation agreement between different railroads, reducing the level of competition by dividing up territory, allowing them to run profitably. Morgan's financial position eventually became large enough to coordinate important bailout efforts during the periodic financial crises of the rapidly financializing US economy, including bailouts of important New York banks, and important railroads. President Theodore Roosevelt's "antitrust" agenda was in large part a response to this concentration of power in private hands. In 1907 Morgan bailed out the federal government itself. In 1913, under President Woodrow Wilson, the Federal government responded by creating a new nationally chartered banking system called the Federal Reserve System. Soon after came the first World War, and a massive expansion of Federal spending and national debt finance.

For details of Morgan's career, see Ron Chernow's The House of Morgan.

The World Wars

In the early stages of the World Wars, the Allied powers were about an equal match for the Central powers, in terms of the number of fighting men they could levy and supply with the tools and supplies to fight. The Allies - especially the Western Allies, Britain and France - tried to additionally mobilize the productive resources of the US, by issuing debt to pay for war supplies.

Just as in the Austria of Zweig's childhood, so also in Britain, France, and the United States of America - and the other major belligerent powers - states' ability to fight large wars involving expenditures in excess of tax revenues depended directly on their ability to borrow from private individuals, foreign or domestic. Money meant gold, and nations borrowed from individuals. Even though states were privileged borrowers, a state defaulting on its debt was a possible, meaningful, and discrete event.

Previously, this had limited the level of war mobilization possible, since there was only so much money, and if it seemed like you were going to lose the war, lenders would want to cut their losses. But with the increasing centralization of state power over the colonial period of the 19th century, this situation become increasingly fragile.

In The Deluge, Adam Tooze describes American president Woodrow Wilson as seriously concerned with the correlation of default risk. If Americans held to much British and French debt, then Britain and France would be Too Big To Fail and the American government would come under pressure by American creditors to intervene if the Allies seemed in danger of losing the war; American taxpayers would ultimately pay the bill. Wilson eventually went as far as to actively discourage major US bankers like JP Morgan from helping the British and French governments sell more bonds to Americans.

Wilson's intervention was not sufficient to keep the US out of the war; the otherwise warm relationship between the US, Britain, and France led the German high command to decide that the US would inevitably enter the war on the other side. Germany got caught trying to persuade Mexico to invade the US in the hope that this would distract the US from the war in Europe, and also used its submarine fleet to sink US merchant vessels. Eventually German paranoia became self-fulfilling and the US joined the Allied Powers as a co-belligerent, with an interest in bailing them out. The US began extending international (i.e. state-to-state) credit to the other Allied powers.

America's bailout of the Allies replaced the bourgeois system of privately held debts with a system of international debt, i.e. debts owed by one state to another. America, still a basically conservative liberal power, insisted on full repayment of war debts. The British and French tried to pass this along to the Germans, who they also maintained owed them compensation for destructive German behavior during the war. The total amount Germany ended up owing simply could not be paid in full without further American lending to Germany, so that the whole system gradually came to resemble a centrally planned economy, planned by an ostensibly reluctant America.

The higher level of wartime spending on credit led to higher prices, as states bid up the cost of goods and services, and a lot of people found livelihoods meeting this new demand - staffing militaries and wartime bureaucracies, building weapons, and selling newly scarce ordinary commodities like food and raw materials. After the war, to pay off their debts, the belligerents had to reverse the process and take in more in taxes than they spent, leading to severe deflation. Tooze focuses on the effect this had on debtors and people with jobs, and ignores the effect on the creditor class. Here is how I interpret the situation, filling in the gaps in his perspective:

War has often been a strategy by which a warrior class can expropriate from other classes, on the premise that they're being protected from the other side's warriors.

World War I gave the aristocratic debtor class the opportunity to mobilize a lot of people at the expense of the creditor bourgeoisie, who delayed gratification and lent to belligerent states on the assumption that after the war, they would be paid back what they were contractually owed. But wartime mobilization created a large urban population of dependents. These were the abstract equivalent of a Roman politician's clients. A Roman patron could count on his clients to support his political agenda by voting the way he wanted or sometimes even engaging in street violence. In exchange, the patron used his political power and connections to help clients access more centrally controlled resources. Likewise, the class of clients dependent on the support of aristocrats' state programs could and would vote or riot to prevent this support from being withdrawn. So deflation was not an economic problem, but a political one, i.e. a proxy military conflict between a creditor bourgeoisie and a debtor aristocracy.

The bourgeoisie do not seem to have discovered that they were in a conflict.

States ultimately decided to covertly resolve this conflict by abandoning the gold standard. This allowed them to claim that nominal contracts were being honored by changing the legal meaning of their terms. Contracts that referred to money, which used to mean gold, now referred to paper that could be printed freely by the state. This reduced the value of war debts, effectively transferring financial wealth from creditor bourgeoisie and business entrepreneurs, who expected to be taken care of through the enforcement of contract and property law, to people who expected to be taken care of as members of a politically relevant client class, and to the kinds of political entrepreneurs who staff the Office of Emergency Wartime Economic Planning (or whatever they actually call it). By the Great Depression, only America was still on the gold standard - but not for long.

Centralization of American Monetary Policy After the World Wars

For a while after the first World War, Americans were apparently greatly enriched. Much of the war's expenses had been incurred by European powers, which now owed America money, to be financed in part by reparations from Germany. However, much of the apparent financial gain seems to have been the result of concealing insolvency, since in 1929 a huge deleveraging began, as banks tried to sell assets to cover their positions.

This resulted in mass unemployment (i.e. many disappointed clients all at once), which led to the election of US president Franklin Delano Roosevelt, who embarked upon a massive campaign of centralization of power, bringing large swathes of economic activity under federal regulation and in some cases directly subsidized large jobs programs. This also included regulation and implicit subsidization of publicly traded corporations, so that much economic activity that was still in name private enterprise was de facto a government program.

In 1933, Roosevelt used the prospect of bank failures as a justification to close and seize control of all banks in the US. The federal government banned the possession of large quantities of gold, requiring holders to exchange their gold for an equivalent number of US dollars. The banks were reopened under state supervision, and the state declared that all contracts previously denominated in old dollars, i.e. gold, now legally referred to the new dollars. New dollars still notionally corresponded to gold, but this no longer represented a real option to convert one's dollars to gold which might carry value elsewhere regardless of the credit of the US government. Thus, anyone who had previously held truly portable hard currency now held an asset the value of which was determined by the policies of the US government.

In 1944, after the second World War, the postwar powers agreed to the Bretton Woods system in which, while different state currencies could not be compared by reference to a shared basis in gold, the participants agreed to fix the exchanged rates between their currencies by fiat, so that e.g. a "dollar" would always buy the same number of "francs" and vice versa, thus simulating the convenience of a gold standard for international commerce without a corresponding return to states being accountable to borrowers in real terms.

By 1971, the US had borrowed so much that it was having difficulty keeping exchange rates fixed, so US president Nixon unilaterally exited the agreement and formally abolished the convertibility of dollars into gold.

In the 1970s, '80s, and '90s, financial deregulation led to a sudden increase in the rate at which corporations were financialized, consolidated, and made more responsive to short-run incentives. Barbarians at the Gate: The Fall of RJR Nabisco by Bryan Burrough and John Helyar, and Liar's Poker by Michael Lewis, explain the mechanisms by which this happened.

In short: Businesses had large excess cash reserves, or very strong cash-flow profits. People like Michael Milken figured out how to market high-yield high-risk bonds to the general public. This enabled financial entrepreneurs to extract cash from such companies through leveraged buyouts, in three steps:

  1. The investors issue a lot of high-yield debt to buy control of a target company.
  2. Have the acquired company borrow as much as it can, and use the money to pay out dividends to cover the investors' debts.
  3. Sell the now deeply indebted company, for more than the difference between the special dividends and the original purchase price.

After the brief explosion of such deals in the 1980s, this sort of private equity transaction became part of the background incentives within which US corporations function. Rare exceptions like Apple can hold onto large cash reserves; for the most part, a company that isn't already lean enough to need to roll over its debts constantly is a target for extraction. And a company that is so lean is totally dependent on the continued exception-making of the too-big-to-fail financial system and the state decisionmakers who oversee it.

For a clear case study of the kind of unprofitable behavior subsidized by the new regime, see Ranjan Roy's Doordash and Pizza Arbitrage and ZIRP explains the world.

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I'm sympathetic to a lot of your complaints and find your overall narrative interesting (albeit not something I fully understand or buy). But most if not all of the pathologies you describe seem explainable under mainstream microeconomics (mainly using the concept of principle-agent problem), so I think I'd be more receptive to a version of this post where you didn't claim otherwise.

I found myself trying to explain that you might lend some grain to a farmer, so they could plant it to grow more, pay you back with interest, and still have some grain left over. If this farmer did not yet have a grain repayment history, you might investigate other things like whether they had access to the land they said they did, whether they had a reputation among friends and neighbors for meaning what they said, and whether they had the knowledge and equipment to plant and harvest grain.

If you were an owner or investor of a bank, should you really prefer that lending decisions be based on the subjective judgement of loan officers? What if they decide to base their decisions in part on what maximizes their values instead of yours? E.g., demand kickbacks, make loans to their friends or allies, bias their decisions with political ideology, or just slack off when they're supposed to be interviewing the farmer's friends and neighbors.

Or consider the leveraged buyout example. A standard principle-agent problem in corporate governance is managers who prefer to hoard cash instead of returning profits to investors, with the investors not trusting the managers to use that cash in their interests (instead of the managers' own interests) in the future. (That's probably why the shares of such a company are trading at such a low multiple to its earnings that you can afford to buy them by issuing debt.) Leveraged buyout can be viewed as a solution to this problem.

From my perspective, the solutions to these problems offered by mainstream finance have their own serious downsides, but that's exactly what you'd expect from a second best solution, as these solutions have to be.

Microeconomic ideology generally claims that this is because large corporations are more productive due to economies of scale. This may be true in some cases, but it is not generally the case. A local entrepreneur I know tells me that a well-run coffee shop in a well-chosen location can pay for itself (recoup the initial investment) within a year, while an investor in the stock market is doing well if they double their money in nine years. Another entrepreneur I know is planning to buy privately owned laundromats, package them into a publicly traded company, and sell it at 10-50 times the purchase price.

These are examples of publicly traded companies being valued at higher multiples than small businesses. This phenomenon is so well known or frequent that there's a name for what the second entrepreneur is doing, "multiple arbitrage". But again you don't have to go outside of mainstream microeconomics to find explanations for this. Liquidity premium is one (relatively mundane) explanation, and I suspect principle-agent problem again applies here, perhaps because it's easier (less costly) for a shareholder to monitor one big company for misalignment, and for the company to institute governance measures to try to ensure alignment, than the equivalent for n smaller companies.

But again you don't have to go outside of mainstream microeconomics to find explanations for this. Liquidity premium is one (relatively mundane) explanation, and I suspect principle-agent problem again applies here, perhaps because it's easier (less costly) for a shareholder to monitor one big company for misalignment, and for the company to institute governance measures to try to ensure alignment, than the equivalent for n smaller companies.

I would expect a liquidity premium to exist but I'd expect it to be much smaller than the size of opportunity I'm seeing - why do you expect to see one so large?

I don't think the principal-agent problem explains anything here because large publicly traded corporations frequently have governance, financial structures, and operations that aren't intelligible at all to casual investors. For example, I've taken courses in finance, accounting, and economics, and worked in financial services, and I have no idea how to evaluate Markopolos's criticisms of GE, & compare this with their financial statements, because the latter are so vague. (Do you?) Nor was there a trusted intermediary whose evaluation methods I understood. (Can you recommend one?) In practice when I did own stocks I was relying on correlation with other investors - the government would try not to let us all fail at once - rather than any ability to meaningfully exercise oversight over centralized management.

The parenthetical questions are meant seriously, they're not just rhetorical flourishes.

A standard principle-agent problem in corporate governance is managers who prefer to hoard cash instead of returning profits to investors, with the investors not trusting the managers to use that cash in their interests (instead of the managers' own interests) in the future. (That's probably why the shares of such a company are trading at such a low multiple to its earnings that you can afford to buy them by issuing debt.) Leveraged buyout can be viewed as a solution to this problem.

I understand this argument, it would be a perfectly logical reason for some leveraged buyouts to happen in some circumstances, but in practice many leveraged buyouts are a way to offload risk onto counterparties with less legible high-trust relationships with management, such as employees - e.g. in the airline bankruptcies - or consumers, who can't use brand quality as much as they used to be able to because corporate decisions are made based on short-term numbers, and turnover means that the cost of eroded brand loyalty will be correlated across many companies and distributed across many people, and since the state won't let large corporations in general fail all at once, we end up with bailouts. I recommended a book on the subject because I really can't cover everything in the blog post, it's long enough already and this sort of thing is very well documented elsewhere.

If you were an owner or investor of a bank, should you really prefer that lending decisions be based on the subjective judgement of loan officers? What if they decide to base their decisions in part on what maximizes their values instead of yours? E.g., demand kickbacks, make loans to their friends or allies, bias their decisions with political ideology, or just slack off when they're supposed to be interviewing the farmer's friends and neighbors.

I'd rather people investing on my behalf use objective profit-maximizing criteria, ideally with skin in the game, and that's why it's surprising that access to capital depends so much on the kinds of subjective factors you mention (checking whether someone has already been extended credit, whether they're vibing the right way with VCs or bankers, whether they look like a normal borrower, and in the case I described, whether they took a class prescribed by the credit union) relative to economic considerations.

I have a close friend who was had a business bank account closed for avowedly discretionary reasons after a conversation with a banker where as far as I can tell the banker got spooked because he seemed like he had specific, creative plans that didn't look normal. (Nothing illegal was discussed; they were thinking about something that might have attracted regulatory scrutiny, but they'd have been happy to negotiate or just look for a different counterparty for those transactions.)

An important case study here is Abacus Bank, the only bank to be prosecuted in relation to the 2008 financial crisis, as far as I can tell simply because they're culturally decorrelated from other banks (small, ethnically Chinese, privately held). The prosecution didn't work out, because Abacus hadn't done any crimes.