My last two blog entries received withering criticism from my daughter and I was given a list of required reading to gain a better foothold for my implicit critique of the neo-marxist theories. Rather than follow this path I will resort to a standard academic trick - I will unveil my own theory and let neo-marxists try to poke a hole in it! My theory can be described easily in a few paragraphs. It explains recent past, correctly predicts the future and it is endowed with great simplicity coming from combining logic with Bayesian reasoning. Unveiling is the right word, the theory is too good to be false, and in fact it was created many years ago and it took a great deal of effort of politicians, bankers and regulators to implement it. I simply reverse engineered it from life experiences of myself and my colleagues.
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From the early 90's US economy developed a three-currency system described below.
Green money
Green money is the usual currency used for everyday needs. Average citizen has always very little of it, usually in form of loose change or small bills, and if popular culture is a good indicator, large quantities of green money are usually connected with criminal activity. Green money is used to buy food and other necessities and steady inflow of green money is synonymous with having a job.
Red money.
This is a special kind of money that buys only one thing - your house. Banks will give you practically any amount of red money while retaining ownership of your property and the right to kick you out. You are constantly converting green money into fees associated with having red money but you also have the ability to use red money for your economic activity. Having red money is critical to passing through the transition points in your life: starting a family, sending children to college, providing medical care during the sunset years, etc.
Yellow money
This is the money that represents your entitlements. Throughout your life you accumulate yellow money in form of Social Security, 401k, and other retirement schemes. Technically you are converting a part of your green income but in reality those contributions are not voluntary. You have no access to your yellow money until you are very old and even then you do not control it. Yellow money is a major source of economic activity for others.
This three color scheme is an abstraction whose sole purpose is to explain the connections between different components. In the end, the theory will posit that green money does not have practical value, red money is a mechanism that allows you to send your kids to college, and yellow money is an IOU that allows fund managers to have private jets and billion dollar bonuses.
The theory described below presents economy as interactions between two types of players: small and big ones, and the main focus is on you - a small player. A small player is a member of the middle class but I prefer a modern term: a precarian.
Total wealth formula
Your total wealth is W=G+R+Y or more generally W(p,t) = G(p,t)+R(p,t)+Y(p,t), where the variable p represents a person and t is time.
As an instantiation of the variable p you may think that the red portion of your wealth represents a debt so it should be subtracted rather than added. Not quite, as you will soon see.
The value of W(p,t) can be computed for different values of t but such computations will be only approximations. This is really a technicality and to remove statistical variations, big players use tranches of the form W_P(t)=sum_{p in P} W(p,t) (sum of the values of W(p,t) over all the p's in the population P). The value of such tranche can be computed with arbitrary accuracy at any time t with error that depends only on the size of the population P.
We continue with basic axioms of the system.
Axiom 1
G(p,t) equals approximately 0 for almost all (p,t). In other words, almost everybody is almost always broke i.e. does not have any green money.
Note that this axiom does not contradict the existence of millionaires but of course the number of them must be a measure zero set. Main consequence of Axiom 1 is that the green money is not a significant source of economic activity for anybody, at least directly.
To introduce axioms 2 and 3 we need one more parameter. Recall that the red money R =R(p,t) was used to acquire your property. Let V(p,t) represents its value.
Axiom 2
R(p,t) equals approximately V(p,t) for almost all (p,t) or equivalently that for almost everybody and most of the time the amount of red money in your possession is approximately equal to the value of your property.
Axiom 3
lim_{t --> infinity} V(p,t)=infinity for almost all p, that is that for most people the value of their property goes to infinity.
These axioms are the cornerstones of the theory so let me explain their consequences.
A bank that owns your property charges you monthly rent (called interest) which is a percentage of its value. What makes this transaction special and unique is that in addition it provides you with the full value of the property paid in red money (called mortgage). This trick allows you to use the term "my house" with a minimum amount of credibility. With an ordinary act of sale you would attempt to buy down red money to zero and complete the purchase. However, Axiom 3 indicates that buying a house is not an ordinary sale since the value of the property goes up with time. Consequently, your behavior is described in Axiom 2. As the value of property increases you increase your red money holdings by taking out the difference V(p,t)-R(p,t) in green money. The technical term used for this procedure is called extraction of equity and it produces a temporary windfall of green money. But wait, does it not violate Axiom 1? No, it does not - the green money that you obtain this way is immediately used for necessities other than food. These were already mentioned: sending kids to college or fixing up your house in order to extract more green money out of it.
This points to Axiom 3 as the enabler of this scheme. Is this axiom true? Abstractly, the value of your property is a small fraction of the value of the entire planet and we know where this is going. Economically however, the value of your property is determined by willingness of others to try to buy it, and this in turn is determined by the supply of red money. As this source appears bottomless Axiom 3 is certainly valid.
This describes how you can live and prosper in this economic systems, and that is the micro-economic scale of things. Now we look at the big players or the macro-economic game. As I indicated already they deal with tranches to compensate for the stochastic aspects of the axioms. So do not feel that this is all about you and that somebody is out to get you. This type of thinking will only get you into the looney bin... The source of profits for the big players is the yellow portion of your wealth portfolio. You and your employer are continuously increasing this amount by their involuntary contributions and this gigantic pool of wealth is open to modern financial wizardry while nobody is watching. So in practice the only growth of this portfolio is represented by your contributions while the profits from investing it, turning it into stocks, futures or other obligations go the the owners, that is the banking industry. Since the end-value of your yellow portfolio is an order of magnitude bigger than your red portfolio and the average time that it is out of your reach is about 20 to 30 years the big players can extract tremendous amount of wealth from it without making it obvious that they are robbing you blind.
Early capitalists were after your ability to work and deliver surplus value. In this new scheme your entire life - present and future - is in the hands of a twenty-something hedge fund manager with quick mind and fingers whose formative years were spent playing Grand Theft Auto.
There is a version of Axiom 3 (due to Alan Greenspan) which assumes in addition that the derivative dV(p,t)/dt is greater than zero, that is that the value of your property is always increasing in time. This version of the axiom greatly simplifies economic calculations but unfortunately it turned out to be false. In 2008 the property values went down on a set of positive measure and many precarians become proletarians. The current version of Axiom 3 allows temporary reversals.
In summary - the presented theory demonstrates how of two people spending 8 hours in the office one can make many thousands times more money than the other. It describes a layer of economy where great deal of action is taking place while nothing is ever being produced or consumed. And finally, it describes optimal strategies for small and big players.
In the presented system, everybody benefits (although not equally), and a significant portion of the society gets a sliver of the american dream. For this to work well however it is best if they remain asleep.
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