I can't escape the feeling that you have left out one element of liquidity that is important in market design. Maybe I have misunderstood, but a big part of liquidity is the assurance that you will actually be able to move an asset quickly. "Noise traders" at Goldman probably aren't going to be encouraged by what you are calling "genuine" liquidity. If I understand correctly, variance actually gives them a larger opening to make a buck. Lots of money sloshing around doesn't seem to quite explain this part of the liquidity puzzle either, or at least it explains it in a very circular way. Obviously *some* things you won't buy just because you can... ripe mangos, for example. Ripe mangos have a certain value, but it declines so quickly that money isn't just going to slosh itself into the market for ripe mangos. Why isn't the same thing true of the stocks that noise traders take? "Genuine liquidity" is out, and the noise traders *are* the sloshing money, so I think we need a third aspect of liquidity to explain why sloshing money is willing (or unwilling) to slosh its way into securities markets.

The biggest areas for speculation (surely) are not long lived assets like equities but shorter lived assets like futures contracts and options. And I've always presumed that the main trade (and gain from it) is not between fools and privileged parties, but between those who are betting to hedge (in which case they're after insurance and are prepared to pay for it) and those who speculate to pick up the money the hedgers leave lying around on the pavement.

(Though I agree there is also the transfer of money from fools to the privileged - particularly in equities - by way of insider trading (of various degrees of legality and ethics)

Thanks Randy,

I'm not really disagreeing with you. I am sympathetic to the argument, but that's why I think it needs to be put very scrupulously. I agree that too many traders can destabilise and threaten the efficiency of a capital market. But I'm sceptical of the language you use. You speak of deliberate 'manipulation' of the markets and of 'noise traders' somehow introducing a volatility to exploit it. Doesn't that call for awfully big traders or collusion between them? My impression is that there are a whole lot of noise trading programs out there all betting against each other and against the hedgers. This can be destabilising and so can reduce efficiency, but the picture of the privileged and the fools I think could be quite misleading.

Yeah, "the privileged and the fools" is overstatement and exaggeration, and perhaps unwise, since it invites marginalization.

The main article, before the comments, tries to make a much more technical argument, that easy money may cause the appearance of liquidity (reduced spreads, less price impact to large trades) without actually serving the one of the main purposes of liquidity — more accurate pricing of assets, and the ability to actually trade at fair prices. To the degree that easy money induces volatility not related to a fair valuation of underlying assets, easy money increases the likelihood of misallocations of real-economy capital. "Noise-traders" in the main article are not necessarily manipulators or fools, just anyone who transacts in an asset market without valuing the underlying asset, on the (self-fulfilling) expectation that price fluctuations are loosely if at all coupled to any "fundamental value" of an asset. This is a less loaded, although still very controversial, sort of argument to make.

That said, I think people underestimate the degree to which even very large capital markets are manipulable for short periods of time. Games really are played. Capital markets have never been and are not now the efficient calculators of academic theory. Those theories shold be regarded as prescriptive rather than descriptive — we should strive to modify market institutions to make them efficient, not simply presume that they naturally are efficient. The usual stories, that any mispricing will be quickly arbitraged away, have been very well debunked by an entire literature on "limits to arbitrage", and by any practical investor's experience. Lots of short tech investors were 100% correct on fundamentals in the late 1990s. It didn't prevent any of them from going bankrupt.

Capital market manipulation is not a conspiracy theory. A single hedge fund manager can purposefully alter security and index prices for a short period of time, if she is willing to risk direct costs on the hope of indirect gains. (The famous screaming Cramer recently admitted to having done so as a fund manager, and argued that managers who refuse to do so when it is arguably legal aren't really doing their jobs.) "Momentum trading" amounts to a kind of collective, loosely coordinated form of market manipulation, in which traders rely on one another to contribute to the mispricing of an asset, while they compete with one another in a game of chicken to profit as much as possible from the mounting distortion but escape the inevitable but unpredictable correction. And in this game, there are more and less privileged players. Ones ability to be wrong in timing and still eventually profit is directly related to ones level of capitalization and ability to take on leverage with minimal risk. Some entities that make markets, provide credit, and trade on their own account have access to a lot of information that other players do not have and may, despite firewalls and whatnot, improve their timing in these games by virtue of that information.

One can easily overstate this sort of case. But most mainstream writing and financial theory very much understates the real-world liability of markets to mispricing and manipulation. Near absolute faith in markets that frequently generate erroneous signals invites consequential errors in the organization of the real economy. (That invitation has already been accepted, in my opinion.)

To Nick -- the reason I made my original point to Steve is that I have a relative who was indirectly involved in, well, let's call it market design. I took Steve's basic position; noise traders (or to use our preferred metonym, Goldman) were not actually adding a great deal to the market. My relative defended a position that he couldn't really deviate from, because it was his employer's position; even if Goldman does zero research on fundamentals, introduces unnecessary volatility to the market, and diminishes the gains to research into fundamentals, they still are essential to the market because they provide liquidity for the people who do trade on fundamentals.

So in short, Nick, if Steve and I are correct, the fact that markets are intentionally designed to attract noise traders is a serious problem. If my relative and his employer are correct, noise traders are adding a great deal of value to the market via a mechanism that is difficult to theorize articulately, and markets are designed quite well.

Let me be slightly clearer about relating my definition to yours:

You relate the folk definition of "liquidity" (an increasing money supply, largely in claims of nonzero maturity) to the "genuine" or classical "liquidness" of an asset or asset claim, that is, the clarity of its price. Then you suggest that an increase in "folk liquidity" may in fact simulate "genuine liquidity" - do I have this right?

My little response above is attempting to pin down the "folk liquidity" side a little better. It says nothing about "genuine liquidity."

However, it's worth noting that the activities of a lender of last resort introduce an enormous amount of gamable uncertainty into the market. Consider the change in dollar asset prices if the Fed "broke its plates." Consider the change if it ran the printers full out. The power of this political signal is essentially infinite.

Moldbug — Okay. I find very little in your comments to disagree with, so that might leave this a bit of a dull response. The headline essay here is a rough draft of a rough draft. I'd like to spell out more mathematically what I mean by "genuine" liquidity. If I were to do so, as you say, it would not be a simple scalar, like "the money supply is 10-gazillion dollars". As both you and Nicholas have pointed out, liquidity needs to have a time dimension. But I think we are emphasizing different things. The most "liquid money" is zero maturity money, but to me it is a definitional question, "liquid in terms of what currency or commodity?", and I'd be willing to consider liquidity in terms of some "broad money", to the degree that can be defined. But the notion of nonzero maturity money, as you suggest, implies credit risk. And fiat money implies dilution risk. One way of thinking about "pseudoliquidity", a false appearance of liquidity (low spreads at high volumes that suggest a degree of certainty in valuation that is inaccurate), is that it represents a market failure whereby agents underestimate the endogenous volatility of a currency, where despite increasing expected future volatility due to overprinting or extension of credit, agents value assets as though the "plates" had been broken already. MZM has dilution risk, but not credit risk. Liquidity defined in terms of broad money, which has both risks, is more likely to be compromised by currency volatility. But, paradoxically, since there is always many times more broad money than base money, to the degree market participants consider the two both interchangable and stable, broad money-based liquidity will seem greater than cash money liquidity. If broad money is not stable, this apparent liquidity is an illusion.

I like your B <-> A <-> Fed picture, and agree with your point that A would be insolvent by definition without the Fed behind them. I also agree that what people mean by "folk liquidity" is that certain kinds of claims or financial assets are being generated, though I don't think that maturity is the only criteria that matters. Sure, a 6 month note is always more money-like than a 30yr T-Bond, but I think it's the depth, spread, and speed of the market between an asset and cash, rather than simple maturity, that defines how money-like, or "folk-liquidity-producing" a new claim is. I agree that there's a stark qualitative difference between true cash and future claims on money, and that this difference creates the danger that much apparent liquidity will simply disappear someday, but still, the folk consider their eurodollar deposits to be liquidity, and will do so until those deposits can no longer be redeemed.

Our confusions here are a good example of why I dislike the word "liquidity."

Liquidity in the "genuine" sense of the word - "low bid-ask spreads at high volumes" - has more or less been abandoned to the "pseudoliquidity" sense of the supply of credit. This is very analogous to the way "inflation" has come to mean "aggregate quality-adjusted consumer price appreciation" instead of "monetary dilution."

I fundamentally do not think these words are rescuable. I think they have become tref and need to be buried in the dirt for at least a few years. It is some effort to invent new words, but I think it is easier than fixing "liquidity" and "inflation."

There definitely needs to be a word for the cost, defined in terms of Y, of exchanging X for Y and back to X again. Would you agree that this is what you are trying to get at with your definition of "liquidity"?

If so, perhaps a metaphor can be drawn from physics, in terms of friction, thermodynamic efficiency, electrical resistance, etc, etc. The concept is more or less the same as Menger's "saleability" or Mises' "marketability," but neither of these words sounds right to me now.

Back to the money supply sense: yes, MZM is broad money, not base money. But in practice, which is after all what counts, the difference between broad and base money is not a matter of credit risk. It is an implementation detail of our bank regulatory system, it is not related to any fundamental concept at all. (Mutual exclusion is a fundamental concept - lock files are an implementation detail.)

To anyone who is not a bank, broad money is the same as base money, because the Fed says so. Fiat bux. Anything the Fed is willing to exchange for one of their pretty little notes is a dollar.

What Austrians who define money supply as MZM miss is that the power of fiat applies not only to money of zero maturity. If you redefined checking accounts, for example, as time deposits that were rolled over every day, every hour, or nanosecond, or whatever, their economics would change only by this epsilon. Imposing a qualitative distinction at zero is bad praxeology.

In other words, it is the power of fiat itself that has a time dimension. The Fed can "print" money not only at t=0, but at t=whatever.

And it does this in the same way for t=0 and t=whatever: by implicitly insuring nominally private liabilities. Checking deposits - broad money - are actually supposedly "insured," in the actual actuarial sense of the word, by the FDIC. But of course a bank run is not an insurable risk, so the real insurer is the Fed. (I'm really not sure what the people at the FDIC do, though I'm sure if you tried to take away their staplers they would have some kind of a story.)

By implicitly insuring claims of nontrivial maturity - the canonical example, of course, is T-bills, but agency bonds apply as well - the Fed's fiat power is responsible for a significant fraction of the market price of these instruments. If you imagine the price of any of these assets if "the plates were broken" - of course, this cannot actually be measured without actually doing it - you see how much of it is fiat. This is dilution without printing - a sort of quantum tunneling, if you will. And none, or at least hardly any, of it appears in MZM.

Not even when it reaches maturity. Because it never needs to reach maturity. Claims on Fed-insured entities can be, and typically are, rolled over and exchanged for new debt. This is another fiat-world practice that would not exist in a hard-money economy. A disinterested creditor in an efficiently enforced free market should never roll over a loan. If the loan cannot be paid, liquidation is his best option. If it can be paid, and he wants to lend the money again, he should claim it and lend it to someone else.

This phenomenon - fiat dilution in the market for immature claims to fiat money - is of crucial importance when we look at monetary reconstruction. If you are willing to look in any serious way at reconstructing the monetary system, the language that has to be used is the language of liquidation, which is fundamentally an exchange of claims for equity. My assertion is that many claims which are not, legally, claims against the Fed, have fiat dilution introduced by Fed insurance as a substantial part of their market price. If you disregard this form of fiat when you reconstruct, you introduce considerable disparities in the treatment of creditors, which obviously is to be avoided. Rothbard, for example, makes this mistake in his plan for returning to gold.

Another way to say what I'm saying is that if you have a plan for monetary reconstruction, the first step in that plan needs to be nationalization of all banks, futures exchanges, and agencies, because in practice the market treats their liabilities as Federal liabilities, which makes them de facto parts of the state. Nationalizing them, and including their monetary liabilities in the book of fiat notes, is simply a formalization of reality.

The reason I say this is that you seem to hint above that you have some kind of idea of what a stable monetary system might look like, and you seem to hint that your plan is not based on the usual tawdry metals. Hm. As it happens I also have some ideas in this department. I'll show you mine if you'll show me yours...

Re liquidity, yes. It is interesting to observe the economic path by which the surface of exchange you describe is affected by dilution of the money supply, and the linguistic path by which the two became confused. But I still wish you luck in disentangling them!

I think our main distinction on dilution is that I don't think of the dilution as risk at all. I think of it as something that has already happened, a fait accompli.

These are two equally valid ways of looking at the same problem. I just think that mine is simpler.

The question is: why is a "broad dollar" worth exactly as much (to non-banks) as a "base dollar"?

The answer in your sense is that the probability of a bank run and the probability of a dilution event (ie, the dilution risk - but "risk" is a slightly curious word, as this event of course is positive for the holder of said broad dollar, though it may not be desired by others who are using their dollars to compete for the same goods and services) are exactly, or almost exactly, equal.

The answer in my sense is that the fact that these probabilities balance is not a coincidence, but a matter of policy. A political decision, enforced by the power of the state.

Which is exactly the same power that stands behind the dollar. The US government creates considerable demand for dollars by demanding said instruments from us every April 15. It is just as happy to accept a broad dollar as a base dollar.

My views may occasionally sound libertarian, but I am not a libertarian at all. I think of law as a practical rather than an ethical instrument. Property rights, to me, are just a way to keep people from fighting over property. If a better way could be devised - some drug, for example, that we could take, that would all make us love each other, and wouldn't wear off the way MDMA does - I'd be first in line for the injection.

The problem with a system in which a large part of the value of assets is provided by "winks and nods" - informal promises, such the Greenspan put - is that, in the terminology of de Jouvenel, it represents a step away from Law and toward Power. Goldman Sachs can make $20 billion a year or whatever off FICC because it is in the business of translating its informal proximity to this informal information into trading advantage. This is plunder.

In my view, the way to fix such a system is not to dismantle the Greenspan put, but to formalize it. Confiscating the proceeds of crime is an ineffective and counterproductive way to restore law. All the real estate on earth, for example, has been alienated by violence many times over. You have to look at who has what now and give them a formal title to it.

To me this equals formal dilution: replacing the informal value created by the Greenspan put with formal and accountable currency. Every claim on an implicitly insured financial institution (bank, agency, futures exchange) has two components of value: the value of the instrument and the value of the insurance. Since these cannot be separated without actually precipitating a market collapse, the correct formalist way to rectify the situation is to cancel them all and replace them with new dollars at the present market price.

If you want to take the money that is returned to you in this flag-day closeout and buy a derivative from an uninsured actor, of course you should be free to do so. But my guess is that this business would be much smaller. Ideally it would involve the matching of equal and opposite risks, as in the purchase of a future by an industrial commodity user from an industrial producer.

Back to money. Your views are actually in some ways more Austrian than mine. (The best Austrian primer, in my opinion, is the original - Mises' _Theory of Money and Credit_. Full text is online.)

I believe a star topology, as you put it, is unavoidable in monetary systems. Let me explain why. (This is all in this paper I'm writing, in my, um, copious spare time. NB: if you ever decide to design a new programming language and a revised theory of money, try not to do them in parallel. The only thing that saves me is that I have neither a job nor a blog.)

Menger and Mises, like you, emphasize transaction efficiency (your "liquidity") in the appearance of a monetary standard. Their view is that the most efficiently exchangeable good ("saleable" in Menger's terms, "marketable" in Mises') tends to become more efficiently exchangeable, creating, as you say, a star topology.

This view appears very reasonable in the historical context in which money arose, which was hardly marked by sophisticated markets. In fact, today's markets, as you point out, are lousy. (We don't have a computerized financial system - we have a paper financial system that's been ported to computers. Most people who do computerized finance seem to learn this system in much the way one might learn, say, VMS, or the Win32 API - in a practical context, that is, in which its lousiness is utterly irrelevant to their own personal objectives, and therefore need not be understood as such.)

One way to forget this is to imagine the problem not in the context of real markets today, but in the context of a virtual world (MMORPG) such as Second Life or World of Warcraft. As you probably know, many of these systems have thriving economies which seem to obey all the same principles as the real ones. And they should, because they are also based on the axioms of human action in an environment of scarce resources.

Of course, these worlds have implementation details of their own. But it somehow feels more grounded to construct an abstract virtual world than to construct an abstract real world. The planet has seen enough of the latter.

So our gedankenexperiment will be to construct a premonetary equilibrium - your mesh topology, in which no asset has a central position in exchange valuation - in such an abstract world. Then, we will try and break the equilibrium in various interesting ways, and see what happens.

My belief is that the following system is a premonetary equilibrium: a virtual world in which there are a fixed number of assets of every class (magic swords, etc), in which an asset can be teleported from any player to any other player at any time, in which there is no storage cost for inventory, and in which a central Walrasian auctioneer, limit-order book, bot, etc, provides automated exchange services.

As an owner of assets, you could simply declare the goods that you were willing to exchange any of your goods for, set them as object annotations so to speak, and the exchange would happen automatically at any point at which it was demanded. (You might want to mark up your sword for a few minutes if you happen to be in the middle of fighting some orcs or whatever.)

This design eliminates, I believe, the issue of "saleability," "marketability," "liquidity," etc. The central auctioneer can discover and execute multipoint exchanges of arbitrary complexity. No numeraire is demanded. Clearly, this is a silly and impractical design not only in the real world, but in any reasonable virtual world. But this is beside the point.

So what would break this equilibrium and create a monetary standard?

The reason I have tried to eliminate transaction efficiency from this gedankenexperiment is that I do not believe transaction efficiency is the main cause of monetary standardization. In the presence of asymmetrical transaction inefficiency and self-reinforcing efficiency, and the absence of all other causes, the logic of Menger and Mises is correct - the cause is sufficient. But I don't think it is necessary, and I think other causes are much more powerful.

Recall the problem we are trying to solve. The problem is the superficially anomalous appearance of the demand for money. Whether it is little pieces of paper or discs of shiny, attractively colored metal, money would appear to command far more in exchange than its actual practical usefulness to anyone. Why do we trade real goods and services for this apparently useless junk? What's up with that? What is the source of demand for money?

Now review the nature of a monetary transaction. You have some good A which you exchange, in exchange E1 at time t1, for some good X. Then in exchange E2 at time t2, you exchange X for some other good B.

This is a monetary transaction because you have a direct use for B, but no direct use for X. Therefore you have no concern for the quantity or nature of X. Your goal is only to maximize the quantity (or quality, or whatever), of B that you receive for your A.

The interesting question is: what is the duration (t2 - t1)? Of course it is a continuum. But if this duration is short, we can characterize the purpose of the exchange as "trade." If it is long, we can call it "hoarding." (Some would say "saving," but this word has the same kind of problem as "liquidity.")

If we look at the aggregate societal demand for goods of exchange (X), it is fairly easy to see that, in any normal human society where the world is not likely to end tomorrow, most of this demand will come from hoarders.

From the perspective of the prospective hoarder, the choice of X is less likely to be controlled by the overhead of the exchanges E1 and E2. It is more likely to be controlled by the cost of storing X over a hoarding (eg, multiyear) timeframe, combined with the expected change over that timeframe of the exchange rate X:B.

Back to our virtual world. Let's introduce some reality.

Consider Sven, a fisherman. He sails the virtual sea, he fishes the virtual fish. These fish are goods - perhaps you feed them to your pet orcs or whatever. But they are fish, so they do not keep. Sven cannot store his virtual fish in a pile in his virtual backyard.

Therefore, if Sven wishes to hoard for his virtual retirement, the trivial option of X = A is not available to him.

Here is our source of anomalous demand. Sven must choose some X to hoard, which is not a good that he would ordinarily demand. He has to sell his fish and exchange them for something. How does he choose that something? What is his strategy?

Remember, he wants to maximize the exchange rate A:X:B, where A is fish. And - more crucially - he is not operating in a vacuum. He is not the only fisherman, or the only producer of nonstorable goods. He is operating in a world of many Svens. This must factor into his price projections.

This is getting long. But my view is that if you look at this problem, you see four things.

One is that Sven's goal is best served by choosing the same X as everyone else. Otherwise, he is bidding up the price of an asset that is already fairly priced. If Sven and a few other Svens choose some X1, but the rest of the world chooses X2, X1 will appear to be an overpriced asset and its increase in price will not be sustainable. The mass exodus from X1 will become a self-fulfilling prophecy. There can be only one. (Bimetallic standards, for instance, are inherently unstable.)

Two is that if society has not already made a clear choice of X, Sven should look for a storable good whose supply is rigid, or whose cost of production at least increases with the quantity already produced - because it is these goods whose buying power is most likely to be increased by an influx of hoarders, and thus will be favored in the Highlander-style competition.

Three is that once X is chosen, it naturally becomes the basis for all monetary computation in this world. For example, the natural interest rate is defined in X.

Four is that if some upstart Y intends to dethrone X, it can do so only by being a harder currency than X - by projecting a scenario in which the exchange rate X:Y will move sustainably over time in favor of Y. Once this consensus reaches a critical point, Y will become the new monetary standard and X will be valued solely on the basis of its utility. This transition is self-reinforcing and may be extremely turbulent.

I'm making unsubstantiated assertions here, so I should stop. But I'd be curious to hear what your first reaction to this hypothesis might be - especially since it directly contradicts your assertion that the problem of preventing a star topology is manageable.

Steve,

It is a pleasure to see the perspective of 20th-century economics so elegantly and fairly stated.

My feeling, however, is that this particular period of history was the most destructive since the aforementioned entactogenesis, and the fondness it still enjoys in our minds is a product of personal reminiscence and political propaganda, both of which can produce intense emotion but are not noted for secular constancy. And of course the impressive economic successes that occurred on this century's watch can be attributed entirely to its technical prosperity, which did much to compensate for its monstrous crimes, but can scarcely be counted as an argument for or against it. 20th-century science and engineering was simply a continuation of the 19th century's work, and there is very little factual basis for anyone to estimate how well this work would have proceeded had the aristocratic legal, political, and economic structures of the 19th century remained intact. Their destruction at the hands of an alliance of Gracchist politicians and moralizing intellectuals cannot be measured as either gain or loss by any objective method, though it is perhaps illustrative that the most successful states of the early 21st century, at least measured by standard indicators of government customer-service quality such as tax and crime rates, such as Dubai, Hong Kong, Switzerland, Andorra, Singapore, and so on, look a bit like "living fossils" of the 19th.

In other words, I am not sure you have applied adequate consideration to the possibility that, contrary to the consensus perspective imparted I'm sure in your education, that the grass actually was greener.

Because of my heterodox opinion of this period, I don't consider the 20th century a good source of historical analogies, especially for anyone who means to praise some design feature that changed from the 19th to the 20th. It's like saying that segmented addressing is great, because it worked so well on the 80286.

Of course, there are certainly nontechnological aspects of 20th-century society that I think any reasonable person would conclude were improvements on the 19th. But to regard the general course of legal, economic, and political change over the last century as one of advance, even nonmonotonic advance, is a proposition with which it would be almost impossible to find any intellectual figure of 1907 to concur.

Or suppose an alien mothership somehow could introduce 20th-century science and engineering into 1907. Pick up the contents of a university library and send them back in time. What do you think the result would be? Sure, there would be some dislocation, but I think it would be very difficult to argue for any result but an enormous economic boom.

Now suppose 2007 society was reduced by some disaster to 1907 technology. Not only would we see a tremendous adjustment shock, there is simply no way that the world of 1907 could create and support the official-sector structures of 2007. Any political system in the world today, perhaps excluding the "living fossils" mentioned earlier, would be too heavyweight to function. Kind of like running Windows XP on a 286, in fact.

I realize that this is not a point of view one hears a lot. Nor do I feel that this fact is entirely coincidental, although this is not by anyone's direct or personal design. I think it is just a consequence of evolutionary selection in an extremely successful system.

Three books I have read that have helped clarify my views on this subject are _Three New Deals_ by Wolfgang Schivelbusch, _As We Go Marching_ by John T. Flynn, and _On Power_ by Bertrand de Jouvenel - especially the last.

So I think the large-picture perspective that it is difficult to see in the current political order of the world is that it is, as so many people with unfashionable prejudices have said, a system in secular decline.

In other words, I am tempted to say, in a surely politically incorrect phrase, "who is this we?"

I recently read a rather interesting book, Theodore H. White's _Making of the President 1960_. This as it happens was written, in fact, in 1961, in other words before JFK's assassination. It tells a story of the New Frontier that is the same in some ways as the one I grew up with, but not in others. And one thing that struck me in it, particularly, was White's description of the Kennedy men as - I forget the exact words - basically, jaded and worn-out.

Wow! I mean, this is the New Frontier we're talking about, this according to NPR is the golden age of youthful brilliant energy. The Harvard faculty is seemingly descending en masse on the city by the river. Or at least this is what I was taught. But, when you read a contemporary description, it is actually cynical and disillusioned. What up wid dat?

What's up with it is that the real zenith of the American mandarin class - which is simply my definition of the kind of people who went to Brown with me - was actually around 1937. If that. The really essential documents are Bellamy's _Looking Backward_ (1888) and House's _Philip Dru_ (1912). But, since the window of personal memory only goes back so far, the aureate glow advances. Right now it is the civil rights movement and the resistance to Vietnam, a war which looks like it can be refought on an indefinite periodic basis with only minor variation.

So here is my answer: at this point in the cycle, I do not believe that designing new solutions which are not stable is a useful exercise. Deck chairs, Titanic, etc. Since you know your approach is unstable I feel no need to elaborate on it.

Another way to say this is that your answer sounds like an answer to the problem posed by John Rawls, of which I'm sure you are aware. This exercise is very useful in principle, but Rawls himself makes the mistake, which as one might expect has been generally copied by his disciples, of omitting that the most important and difficult aspect of the veil-of-ignorance problem is that of selecting, not from all possible organizations of society, but all possible organizations that can be formed and maintain themselves indefinitely without divine intervention.

In other words, Rawls' problem frequently serves as a surreptitious mechanism by which to reinject a God, and a strangely Christian God at that, into the problem of constituting legal systems. Which is no surprise, because the tradition which gave us Rawls, John Dewey, and similar thinkers, is a thoroughly Christian tradition. It traces back to the Unitarianism of John Adams and William Ellery Channing, forward from them to Emerson and the transcendentalist statism of Lincoln and the Bellamies, and of course earlier back to Jonathan Edwards, Oliver Cromwell, and Jean Calvin, and it is today epitomized by such influential and well-established institutions as Harvard, the United Church of Christ, Greenpeace, National Public Radio, etc, etc, etc.

(Not that we didn't already have a constitution. But strangely, I don't recall it mentioning Mr. Rawls. Or the Federal Reserve, for that matter.)

The fact that, on the basis of what any nontheistic person can only consider a minor doctrinal detail, this tradition no longer calls itself Christian, is most simply explained as a parasitic mutation strategy in order to evade the separation of church and state, and establish itself as the official creed of a monotonically expanding civil service and educational system. Historical precedents for such a strategy are nothing if not abundant.

Hopefully all of this won't someday leave me wondering what, exactly, I'm doing in an adult education facility in Alaska. But if you're wondering why I start from different premises than you, well, this is why.

And to be even still more pragmatic:

You mention civil strife as a consequence of "unfairly" distributed resources.

The case is exactly the converse. Civil strife is the consequence of the inability of a legal system in which property rights are defined as a function of "fairness," rather than as formalized artifacts of history, to prevent violent disputes. This is ensured by the fact that there is no way to construct any standardized definition of "fair" property rights, on which all can agree and none can, cloaking himself in apparent and usually quite real sincerity, adopt the tools of physical or political violence to dispute. Or at least no such definition has been seen in the wild as far as I am aware, and it has not been for lack of attempts. This is especially compelling considering as exactly this concept of egalitarian distribution has been readily apparent in the religion which the West has followed for most of the last two millennia.

Gracchism has always been, and always will be, presented as the cure for civil strife. Pay off the mob and it will quiet itself. If you apply this approach to the problem of impecunious and underprivileged youth at one's adolescent educational institution, who at least in my experience can be quite insistent on the injustice of the structure of wealth in society, you will find yourself embarked on a course of consistent prandial asceticism, not to mention daily humiliation, that can be quite difficult to reverse. Or indeed so it proved for Rome, and it is hard to see how any different lesson should apply for us.

In other words, civil strife is not the result of the rich denying their goods to the poor. It is the result of some of the rich offering some of their goods to some of the poor, in order to shape them into a political weapon. Gracchism, or Caesarism, or welfare economics, or whatever you want to call it, is a perfect iatrogenic therapy. It may not be necessary, but it is quite sufficient, to cause the disease it purports to cure. This keeps the doctor coming back, though of course he cannot and will never put it to himself in this way.

Am I getting through here, or am I just belaboring a point which you have already considered and rejected? The effort does seem worthwhile to me, but perhaps I'd better stop here.

MB — Oops! Just posted after seeing only the first of your series of comments! I guess I'll read the rest now...

Steve,

While it is always a pleasure to assault on a broad front and meet with determined resistance along its full length, rather than the typical complaint that any system of thought which is both unconventional and general violates some intellectual Geneva Convention which requires us all to be either pragmatists, specialists, or preferably both, please be assured that any damage to either your keyboard or your marriage is the farthest thing from my mind. I speak as one who has actually worn holes into more than one keycap, and as for the tolerance of my girlfriend, sometimes it simply passeth understanding.

I am afraid I have probably mischaracterized some of your opinions by identifying them with the closest conventional equivalent, a tactic that drives me into a white-hot rage of keyboard-destroying fury when it's used on me, and I apologize for this as well. Please be assured that any such offense is unintended. You have clarified a bit and I will try to fill in the gaps.

To start with, let's look at your "quasimarxist" claim that something about the legal, social, or political nature of 19th-century Manchester liberalism was inherently unstable. An instability which you compare to the point, on which we agree, that the moneyless economy you propose is unstable.

Well, clearly something about the system of the 19th century was unstable, because it did, in fact, collapse. Moreover, its collapse was predicted by numerous 19th-century writers whose worst fears were realized to an almost eerie precision, including Tocqueville, Burckhardt, Spencer, Acton, etc. So historical determinism aside, there is clearly some pattern in these events.

This is not in any sense a scientific question. It cannot be settled by the presentation of evidence. It is a matter of perspective. You see one pattern, I see another.

My interpretation of these events generally follows, as I've said, Bertrand de Jouvenel, though you can get much the same story from Erik von Kuehnelt-Leddihn, Albert Jay Nock, (later) James Burnham, etc. But Jouvenel attacks the problem in an extremely systematic and effective way without a trace of romanticism or Hegelian mystery, and I like his presentation the best.

The tragedy of the 20th century, per Jouvenel, is a fragment of a trend that is continuous and almost, if not entirely, monotonic: the decline of law and the rise of Power. (Jouvenel generally capitalizes the word "Power," which is a little Continental for my taste, but can be clarifying, so I will follow his usage.)

All the centralist and demotist tendencies of the 20th can be seen, if you adjust your spectacles along the law-Power axis, not only in the 19th century, but also in the preceding four or five.

To Jouvenel, for instance, the French Revolution was not the overthrow of the absolutist state created by Louis XIV, but its natural culmination. The First Empire was not a perverse and ironic reversal of the ideals of 1789, but their logical consequence.

Huh? How does this make any sense at all? What is the difference between law and Power? Surely law, after all, is not self-enforcing? Surely it depends on Power? Aren't they just the same thing?

This is probably not the way Jouvenel would put it, but you can think of law as a special case of Power. Law is the subset of Power which is simple and well-defined. When law becomes ambiguous, it becomes indistinguishable from Power. And beyond a certain threshold, complexity is ambiguity.

Simplicity is the cure for violence. For example, if we postulate an imaginary oracle that could predict the outcome of any battle, we could eliminate war. The predicted loser would have no incentive but to concede to the demands of the predicted winner. But since there is no such oracle, the only way to avert violence is to define an algorithm simple enough for both sides and an independent third party to execute with minimal chance of disagreement, and endow that third party with whatever Power it needs to enforce that result - and, ideally, no more.

The word "violence" demands clarification. Violence does not always involve bloodshed. The point of violence is for side A to use "any means necessary" to convince side B that resisting some outcome is counterproductive. Thus we consider robbery a violent crime, even if no one is hurt.

Similarly, a battle may be resolved by agreeing to fight not with real guns but with paintball guns, and respecting the outcome. Or by setting rules that reduce but do not eliminate the physical damage of battle, and have no significant effect on the result. Symbolic and restricted violence of this sort is common in primitive humans, and indeed is the general rule in the animal kingdom. In general the goal of symbolic violence is to figure out who would win in an unrestricted fight to the death. As long as the results of these processes are identical, there is no incentive for either party to deviate from the symbolic convention. And even if they are not quite identical, the parallel may be good enough.

Another symbolic way to resolve a battle, for instance, might be to simply count the number of soldiers who show up on each side. We see here the roots of democracy, which once factions emerge - as, the Federalists notwithstanding, they always do - is a sort of regularized, symbolic civil war. It is no surprise that when you try to impose democracy on a country in which some faction believes that a real civil war will produce better results, the symbolic restraints tend to evaporate.

Therefore, when we define Power as ambiguity and ambiguity as complexity, we can consider the decline from the elaborate precision of medieval law, with its principle of rex sub lege, to 20th-century democracy and Holmesian "legal realism," as a self-reinforcing complexity collapse - a process surely not unfamiliar to any programmer.

The interesting question, the "quasimarxist" claim you raise, is: what was the cause of this collapse? And did it have anything to do with hard money, laissez-faire, etc, etc?

We can certainly identify the currents of demotist faith behind the disaster. I have done a little of this above. I would argue that demotism (ie, leftism) is an essential part of Christianity, maybe even its most important element. To me leftists seem if anything much more Christian than the traditionalists who call themselves by that name today.

But this doesn't really answer the question, because it doesn't tell us why this ideology became so popular at this time. Certainly, as the history of Catholicism shows, Christian fervor is also quite compatible with extremely aristocratic and hieratic institutions.

I have spent far too much time around leftists to doubt their sincerity. However, human psychology is very good at rationalizing its interests. It cannot be denied, for example, that the giant flocks of young aristocrats who have decided that NGO work is the capstone of their pyramid of needs tend to be deeply sincere about the causes they have chosen. But it also cannot be denied that these institutions of public service are the most obvious path to status and Power in today's world, much as the Jesuits or Dominicans might have been in another century, and the pattern of a society in which young aristocrats put most of their non-hedonic energies not into producing goods and services, but into scheming for Power, is quite familiar from history.

In other words, Gracchism attracted ambitious aristos because this strategy seemed likely to succeed, as indeed it did. If it had been clear that the assault on law would not succeed, it might not have happened at all. Certainly the Roman Republic had seen many a year before the Gracchi.

This is a classic description of a feedback loop. Power, in my view, behaves much the way that bad code behaves in a software system. The "Big Ball of Mud" pattern is always out there. There are many ways to the top of this mountain. And the only way to prevent it is to be absolutely vigilant, even paranoid, in rooting out complexity - Power - wherever it is found.

For an example, let's look at leftism a little more closely. As I have said, once you replace "justice" with "social justice," Power's nose is in the tent. There is no precise definition of "fairness" or "equality," and that is what kills you.

My contention is that once private charity becomes official policy, the battle is lost. There is no point of principle on which the decay of law into Power can be resisted, because you have already accepted the principle that whatever the People can extract, they will come to feel they deserve. (Spencer in _The Man Versus The State_ is particularly good on this.)

Can this process be reversed? Let's imagine restoring law to a welfare state.

My position, as I've said, is Jouvenel's: that the natural course of power is growth. When we aim to not only check but actually reverse this growth, we are trying to solve a very difficult problem. And beggars cannot be choosers - no pun intended.

Therefore, when we try to formalize ambiguous power dynamics and return to a state of law, it is a very bad idea to try at the same time to redistribute scarce goods in a way that strikes us as superior for some abstract reason. Rather, we should take the approach that is most likely to succeed. Which is clearly an approach that confirms the ownership of everyone to whatever goods he or she has, in the period of violence, managed to lay his hands on.

So the way to reformalize a welfare state is not to end welfare, and not to end the taxation that funds it. It is to consider that the welfare recipient has, by the use of power, acquired a claim on the state. If we try to cancel that claim, said recipient, and (more importantly) his or her political patrons, become our enemies, and we make the establishment of law more difficult. Which is not a problem we need to have.

The state, freed of its mystical trappings, be they theistic, demotistic, or whatever, is simply a large corporation. So the welfare recipient gets a share in that corporation, or possibly a bond issued by it.

What assets does the corporation own in order to make this claim valuable? Well, national forests, gold reserves, and so on, of course. But its most valuable assets are its claims on its citizens, who are simply corporate serfs. (You are a serf if someone else has a permanent lien on your income. For example, in the 19th century before the liberation, an effective enforcement apparatus allowed Russian landlords to let their serfs move to the cities, while still receiving a predefined fraction of the proceeds of their labor.)

From this we see my own personal preferred path for the dissolution of the post-1945 system of government, which is not to destroy the existing states, but to demystify them, and migrate their ownership and management toward well-understood models of agent-principal separation. They can then be expected to dismantle and decentralize themselves simply for efficiency.

I think the most efficient size of a government is a single city, and I think a global system of privately owned cities, competing on the basis of the usual customer service criteria, would be extremely stable and provide very good service.

Especially if your citizens are mobile and can skedaddle, aggressive violence is unlikely to be profitable for any firm as a whole. My view is that aggression is common in state actors because states historically have not enjoyed a clean separation between agent and principal. Instead, they have been run for the benefit of their employees, invariably resulting on competition between employees for the unformalized distribution of the profits (something you can see all the time on "The Sopranos"), and aggressive war certainly brings glory and power to those employees who specialize in it. For the state as profit-making company, in theory there may be some paths by which aggression could increase the dividend rate, but in practice this is likely to be a very dubious business plan. (This is also why Europe in the age of monarchy, in which the state was to some extent a family-owned corporation, tended to be less violent - Hans-Hermann Hoppe is very good on this point.)

Defensive and deterrent violence, however, is a necessity for corporate survival. And preventing either the corporation's employees or its customers from seizing its assets and redirecting their profits away from the legitimate owners is a sine qua non, and hence a core competence, of the profitable state. The sort of salami tactics that we saw in the democratic degringolade are unlikely to be tolerated - Power will not gain its deadly foothold.

I hope this answers your question as to why the 19th-century system of government was unstable and collapsed, and how a restoration of law can be made stable and effective.

(I can't tell whether or not you are expressing agreement with the conventional view that hard-money finance collapsed - ie, in 1929 - as a result of its own intrinsic instabilities. If so, I recommend Rothbard's _America's Great Depression_. Short summary: it didn't jump, it was pushed. 1920s economics were an intermediate point between prewar economics and what we have today, and the failure to restore the Victorian financial system was exactly that, a failure. Indeed, 19th century American and British finance was itself constantly battling with fractional-reserve dilution, and this period should by no means be regarded as a paradise of hard money. If you want a hard target to practice on, the Bank of Amsterdam is the most recent clearing system with zero dilution.)

Now when we turn to your monetary proposal, we see, I think, an entirely different form of instability.

As I've explained, even completely eliminating transaction costs does not by any means eliminate the pressure for a star topology, which is primarily the result of the fact that humans want to save and not all goods are saveable.

Intuitively, especially if you know something about investment, you would expect this "monetary energy" to distribute itself evenly across all assets, increasing the price of each by the same percentage. But when you look at the game theory of it, this is simply not how it works. Instead, the only equilibrium strategy is for all savers to pile into a single scarce good.

Preventing this involves an enormous game of Whack-A-Mole. This game is being played as we speak, and it involves financial tricks, legal discrimination, and the management of public opinion. My view is that the first and the third are not very sustainable, and probably reliance on the second will have to increase. But in any case, here is Power aplenty and in all directions. Lower the bar and throw your citizens in the slammer if they keep gold, and watch them stock up on, say, palladium. (Or, more to the point, real estate.)

Even today financial authorities are constantly trying to suppress asset bubbles. And this is with an existing fiat monetary system, that even though it happens to be diluting at 10 or 15% a year, still basically kind of works. It strikes me as very implausible that money - that is, a single overvalued asset - can be prevented from emerging in a moneyless society. Even with all the Power you are ready to apply to the task.

And what is the end of this? The reason I assumed you favor dilution is that you seem so clearly opposed to saving. This is how the 20th century state funded itself - by confiscating savings, typically through dilution. If your goal is not to do so, what is the source of your opposition?

"Distorts rather than contributes to the efficiency of production." This is perhaps the center of your argument, if I may be so bold, and it is certainly familiar from the logic of many who have found money to be the root of evil.

If there is anything I've learned from Austrian economics, it is that here, perhaps, is one place that the hackneyed analogy of Einsteinian relativity is actually useful. I believe that the central fallacy of 20th-century economics, really most due to Fisher, is that since monetary effects on pricing are unpredictable, since the aggregate demand for savings affects all prices, there must be some other scale that is more reliable (eg, Fisher's price indexes).

The history of 20th-century fiat economics is the history of the search for this fixed reference frame, this luminiferous ether. It simply does not exist. The only way to compute profitability is in terms of money itself. Any system that attempts to compensate for changes in the demand for savings, which is the demand for money, has no objective basis for calculation, and simply introduces additional sources of distortion into the signal. The composition of price indexes, for example, is arbitrary and meaningless information. It is little wonder that there was never any significant demand for price-indexed contracts.

Money can always be priced precisely in terms of itself, and it does not appreciate. Defining a holder of money as a receiver of rents is a distortion of the concept of rent. Nor are declining prices, a normal phenomenon in the presence of increasing productivity, any impediment to moneylending. Money will be lent if it can be used to generate a positive risk-adjusted return. If it can't, society clearly has no use for capital, which is surely not impossible in theory - maybe we really all can become Zen monks.

So if you conclude that money is necessary, and that it must be restricted, you are left with two choices. You can use a commodity that is restricted by natural forces, or you can use one that is restricted by political forces - that is, Power.

I favor the former because of my belief in the tendency of Power to expand itself. Because it can do so, and so easily, by shirking its duty to prevent creation of new money, it cannot be trusted with this duty.

It is remarkable that there is a book which almost every Western intellectual has read - Tolkien's _Lord of the Rings_ - whose core theme is precisely this. What is the Ring, but the Power of monetary dilution? Of course, I'm sure Tolkien had no such specific analogy in mind, but that is the greatness of great fiction. Or at least it is supposed to be. Yet the lesson of Boromir strikes me as if anything less understood than ever. (Maybe it's just because the movies sucked so much.)

Anyway. You ask: if not precious metals, then what?

Well, in practice, I do think it will be precious metals. But, as I said, I do have some other ideas in this direction. However, I would like to keep them off port 80 for at least the present time. If you're still interested, we can take this to port 25...