The Breaking Point

by James Dale Davidson

  Lord Rees-Mogg was fond of saying, “Trees don’t grow to the heavens.” No one with a basic grasp of reality expects a tree that has grown fifty feet high to continue growing until it stretches fifty miles into the sky. We formulated “megapolitics” as a framework for understanding some of the basic factors that counteract and reverse apparently well-established trends. To help specify those factors, we turned to a lost 211-year-old treasure trove of investment secrets: An Inquiry into the Permanent Causes of the Decline and Fall of Powerful and Wealthy Nations by William Playfair. Ironically, Playfair was the genius who invented the trend line, the pie chart, the bar graph, and the other familiar formats for the representation of statistical information. But Playfair did not stop there. He was a technological visionary and assistant to James Watt, inventor of the steam engine. Playfair understood that technology changes power relations and thereby changes societies. Playfair wrote:

  The invention of gunpowder . . . changed the art of war, not only in its manner, but in its effect . . . While human force was the power by which men were annoyed, in cases of hostility, bodily strength laid the foundation for the greatness of individual men, as well as of whole nations. So long as this was the case, it was impossible for any nation to cultivate the arts of peace, (as at the present time.) without becoming much inferior in physical force to nations that preferred hunting and made war their study; or to such as preferred exercising the body, as rude nations do, to gratifying the appetites as practised in wealthy ones. To be wealthy and powerful was then impossible . . .

  Those discoveries, then, by altering the physical powers of men, by changing their relations and their connections, as well as by opening new fields for commerce, and new channels for carrying it on, form a very distinct epoch in the history of wealth and power.1

  The theory of megapolitics, as developed here, is an attempt to identify and decipher the boundary forces that inform life’s games. Roughly speaking, there are three such games you must understand:

  1. There is the economic game in which people attempt to prosper within the rules. By and large, this is the realm of the free market.

  2. Above that is the political game in which individuals and groups attempt to prosper by changing the rules. This is the realm of the “antimarket,” dominated by corporatist “crony capitalists” who rent the power of government to pick your pocket.

  3. And finally, we come to the largest game of them all, “nonconstitutional politics.” “The highest and biggest game of all is nonconstitutional . . . politics,” as Jack Hirshliefer put it in Economic Behavior in Adversity. “This biggest game of social interaction is subject only to the laws of nature. There are no property rights, and the ultimate arbiter is the physical force of individuals or the coalitions they can form.” This is the realm of the pickpocket, warlords, the Mafia, terrorists, and other predators.

  Far more than we tend to understand, the direction of social evolution, and the outcomes of life’s games, is determined by megapolitics and the shifts in these boundary forces that determine the costs and rewards of violence.

  About “The Laws of Nature”

  The famed Franco-Brazilian historian Fernand Braudel, who helped found the University of São Paulo, characterized the upper layer of the antimarket in The Wheels of Commerce as the zone “where the great predators roam and the law of the jungle operates.”2 In our era, these predators are primarily active in the realm of constitutional politics, including the lobbyists, lawyers, and legislators who negotiate the advance sale of stolen goods appropriated through politics.

  Even though the law of the jungle seems to generally favor “the great predators,” measured in terms of size, this need not necessarily be so. After many centuries in which the characteristics of technology supported the exercise of power at an ever-larger scale, culminating in the industrial nation-state—the biggest, most expensive government the world has ever seen—I suspect that we are now entering an era of the devolution of power. This will lead to an outcome that may now seem most unlikely: a new era of economic freedom.

  How could this be? This book aims to explain that mystery. The answer may not be obvious, considering that the world has probably never been so unfree. But only the most oblivious could miss the mounting evidence that the status quo is faltering.

  The Breaking Point Is Nearer than We Suppose

  We used to amuse ourselves with the fantasy that we could postpone the day of reckoning by spending ever-larger sums of money out of an empty pocket. Of course, this required that we expunge even rudimentary principles of accounting from our consciousness. And it also necessitated that we ignore the prudential warnings from one of the few economists who could foresee long ago the “inevitable crisis” we now face in the Breaking Point. F. A. Hayek warned that all our efforts “to postpone the inevitable crisis by a new inflationary push, may temporarily succeed and make the eventual breakdown even worse.”3 That is wisdom that is too sublime for our time.

  We can’t even come to grips with the fact that funny money entails double ledger bookkeeping. Not even digital credits conjured out of thin air are truly free.

  While we have been settling in to enjoy quantitative easing to infinity, if need be, the unwelcome consequences have been piling up. As reported by Bloomberg in November of 2015, according to Michael Hartnett, Bank of America’s chief investment strategist, “Zero rates and asset purchases of central banks have, thus far, proved much more favorable to Wall Street, capitalists, shadow banks, ‘unicorns,’ and so on than it has for Main Street, workers, savers, banks and the jobs market . . . For every job created in the US this decade, companies spent $296,000 buying back their stocks.”4

  We expected to encounter such tribulations only in “the long run.”

  Feeling as we do, that the “long run” is far away, we may even feel a twinge of guilt for bequeathing a bankrupt world to our children and grandchildren. If so, we have been wildly optimistic. The “long run”—a.k.a., the Breaking Point—is much nearer than we thought. Evidence that the antiquated system no longer pays its way is there for all to see in the gaping budget deficits that are common to almost all advanced economies. In Europe, North America, and Japan, government revenues fall far short of paying for generous welfare provision, especially Social Security retirement pensions and medical entitlements. The inability of the mature nation-state to pay its way not only explains the prevalence of corporatist fiat money systems that grant banks the extravagant power to create money—much of which is devoted to financing the state’s yawning deficits—but also hints at bigger truths. The whole jerry-rigged system could implode at almost any time. Watch out below.

  Given that the United States has been the hegemonic power in the world system, part of this analysis places the US decline in the context of previous hegemonic transitions.

  It goes without saying that neither Lord Rees-Mogg, Peter Thiel, nor any other brave soul whose contributions I acknowledge share any responsibility for the views put forward in this book or any mistakes that may have crept in.

  That said, if he were still living, I am confident that Lord Rees-Mogg would be in accord with the thesis of this book. He agreed that “anything that can’t go on forever” will come to an end. And he already suggested that the US imperium will indeed go the way of the late Soviet Union.

  While we have a pretty good idea of what is coming, no one can be sure when it will happen.

  The mysteries about timing are all the more acute because the conventions of citizenship discourage open discussion of the make-believe view that the modern nation-state will endure forever, as King Arthur’s Court could not.

  “A Political Economy of Illusions”

  You cannot depend on normal information channels to orient you as the Breaking Point approaches. The message of the mainstream media is that high stock prices trump swarms of other indicators that all is not well, such as declining median income and dwindling energy uptake and capacity utilization. Where income is con
cerned, the evidence is bleak. According to Frank Hollenbeck’s 2015 article “Our Current Illusion of Prosperity,” from the peak of the last expansion in 2007 through 2014, real wages declined 4.9 percent for workers with a high school education, fell 2.5 percent for workers with a college degree, and rose a pitiful 0.2 percent for workers with an advanced degree. Overall, real wages have flat-lined or declined for decades.5

  A more recent calculation by the Pew Charitable Trust concluded that real median income fell by 13 percent from 2004 through 2014, while necessary expenditures for housing, food, and health care have soared by 14 percent over the same period, meaning that median net disposable income after expenses has plunged.6

  The upside of falling wages is that it implies higher operating profits for companies. In some fields, like food and beverage, labor costs can account for 40 percent or more of revenues. So with wage bills falling, profits should have risen. And they did. But much of the hype in the stock market has been leveraged from the creation of trillions of fiat dollars out of thin air. Note that corporate revenue growth since 2009 is 30 percent, while earnings per share have surged by 250 percent due to massive share buybacks financed by cheap debt. In February 2015 alone, authorized share buybacks soared to a record $118.32 billion, as reported by Robert Wiedemer in The Aftershock Investor Report.7

  Don’t believe official statistics that portray an accelerating rebound. They are a current version of what economist Peter Boettke dubbed “the malpractice of economic measurement” in Why Perestroika Failed, his study of Soviet economic collapse.8

  Today, the personalities are different, and the alphabet is Latin rather than Cyrillic, but the dedication to fabricating a fake prosperity is the same. In spite of the fact that the total number of US business closures exceeded the total number of businesses being created during every year of Barack Obama’s presidency, you are told that the economy is recovering. There is supposed to be a robust recovery in real GDP under way. Don’t believe it. Forget the headline GDP reports. You are far better advised to gauge the strength of the economy, or lack thereof, on the basis of reported nominal GDP growth. That series is not distorted by the government’s phony deflator calculations. On a nominal basis, GDP has flat-lined since 2010. Or worse.

  Consider that nominal GDP over the past three business cycles shows a strong secular trend toward slowing. During the recovery from the Savings and Loan Crisis (S&L Crisis) in the 1990s, nominal GDP grew at a 5.6 percent annual rate. After the dot-com bubble burst, nominal GDP grew at 5.3 percent during the recovery into the subprime bubble after 2001. After that bubble collapsed into the Great Recession of 2008–9, nominal GDP grew at a rate of 4 percent during the first three years of “recovery after the bottom.” Since Q2 of 2012, nominal GDP growth has been steadily decelerating. In looking at Q3 of 2015, we saw a sad 2.9 percent GDP growth over the prior year, further proving that the US economy was continuing to stall.

  Of course, the rate of nominal growth is crucial to determining how heavily the deflationary burden of debt weighs on the economy. Servicing $62.1 trillion in credit market debt outstanding—an amount equal to about 350 percent of reported GDP—obviously grows more difficult the further the rate of nominal GDP growth sinks below the carry cost of debt.

  Bureaucrats in the TsSU, the Central Statistical Agency of the Soviet Union, issued glowing economic reports portraying what was evidently fake prosperity right up until the Soviet state collapsed. They were reporting a comfortable 3 percent national income growth, higher than the reported average US real GDP growth of 2.37 percent since 2009. Meanwhile, however, dissident statistician G. I. Khanin, who disclosed that official statistics overstated the growth of Soviet national income from 1928 through 1985 by thirteenfold, saw a sharp compound decline in the Soviet economy beginning in the late ’80s. History has shown who was right.

  Remember, as well, that fabricated growth and “make believe well-being” reported by Soviet statisticians seem to have hoaxed Western experts, as well as the mainstream news media. As late as May 1988, The RAND Corporation was reporting that “the Soviet Union [had] transformed itself from an undeveloped economy into a modern industrial state with a GNP second only to that of the United States.”9

  More amazing, as late as 1989, Nobel Prize–winning economist Paul Samuelson declared in the thirteenth edition of his textbook that “the Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive.”10 Shows how little they knew.

  It also hints at the common ground that corporatist, welfare state capitalism shared with the “state capitalist” (Lenin’s term) system known popularly as Communism. Both systems were varieties of crony capitalism in different guises. Both involved the hoarding of antimarket privileges created at the expense of the general public. Both were all about rewarding the insiders, a.k.a. the nomenklatura. This similarity was veiled by the very different political theater in Washington and Moscow. But appearances aside, both systems shared common roots in what Sir John Hicks called “the modern phase of fixed industrial capitalism.”11 The more monopolistic and brittle of the two—the Soviet “state capitalist”/“Communist” system—collapsed first.

  Remember that by his own account, Lenin aspired to a utopia “organized on the lines of a state capitalist monopoly.” He declared his ambition “to organize the whole national economy on the lines of the postal service” and said “that the technicians, foreman, bookkeepers, as well as all officials, shall receive salaries no higher than ‘a workman’s wage,’ all under the control and leadership of the armed proletariat—this is our immediate aim.”12

  Boettke well described the Soviet system: “Throughout its history the defining characteristic of the mature model of Soviet-style socialism was political and economic monopoly. The vast system of interlocked monopolies, and the nomenklatura system, worked to provide perquisites to those in positions of power and controlled access to these positions. The Soviet system created a loyal caste of bureaucrats who benefited directly from maintaining the system.”13 But while Western economists were celebrating the imaginary economic success of the Soviet Union, promises of future abundance rang hollow to the Russian masses. They saw that the Soviet economy was imploding.

  By the final days of the Soviet Union, in the words of economic historian Mark Harrison, “the scale of the downturn in the Soviet economy had already substantially exceeded that of Western market economies in the slump of 1929–1932, but with the difference that there was no prospect of recovery.”14 Today, the bureaucrats who report on US economic performance are just as enthusiastic about their fake statistics as were their Soviet counterparts.

  The danger of economic lies and exaggerations, as illustrated by the Soviet collapse, is that they “blanked out the true picture.”15 A realistic understanding of the challenges you face is a prerequisite for getting the better of the bureaucrats. You will be hard-pressed to make the necessary adjustments to prosper in a rapidly changing world if you are complacently swaddled in official lies.

  “Things Fall Apart”

  The age of big government is over, not just in the Soviet Union, but throughout the globe. The nation-state endures as a not-so-colorful, well-surveyed abstraction, but it has lost its vitality and is now a dysfunctional legacy institution trading on past glories. In the years since the collapse of the subprime bubble almost brought down the world financial system, it has been kept on life support with trillions of dollars created out of thin air by central banks and more trillions spent from an empty treasury by bankrupt central states.

  Popularly known as “kicking the can down the road,” this game of “extend and pretend” has not resolved the fundamental structural problems. To the contrary, it has made them worse. The phony remedies to past crises only increase the amplitude of the terminal crisis to come that will eventually bring the tottering system to the Breaking Point.

  From Pastels to Earth Tones

  In this
sense, it is appropriate that the latest edition of the National Geographic map of the world depicts nations in somber earth tones rather than the bright pastels I remember from the maps of my mid-twentieth-century childhood. Somalia appears as a flat stretch of ochre, bordering the Indian Ocean. Syria along the Mediterranean is the same color. Iraq and Yemen are represented to scale, more or less, in burnt umber; Argentina is a purplish gray, while Pakistan is brown; and Libya, Afghanistan, and Nigeria appear in an unlovely shade of green that I believe interior designers call “olive drab.” The colors offer no clue to distinguish failed and failing states from apparently more stable jurisdictions at the core that share similar tones and hues elsewhere on the map. But that doesn’t change the reality that the collapse of the nation-state that began on the periphery is working its way toward the center.

  A group like ISIS (the Islamic State of Iraq and the Levant, or “Daesh,” after its Arabic abbreviation [al-Dawla al-Islamiya al-Iraq al-Sham]) is both a catalyst and consequence of the breakdown of nation-states, as the poet foresaw almost a century ago:

  Things fall apart; the centre cannot hold;

  Mere anarchy is loosed upon the world,

  The blood-dimmed tide is loosed, and everywhere

  The ceremony of innocence is drowned;