Category: Economics

Blockchain for Dummies

Japan is a country that does nearly everything well, including handling luggage for trips. Traveling from New York City to Kyoto, I handed my bags over to the curbside skycap at the airport and strolled inside. By the time I checked-in to my hotel in Kyoto, the following entities had custody of my luggage: JFK airport, American Airlines, Narita airport, Yamato delivery, Japan Railway, a delivery truck, and my hotel. After a long trip my bags were waiting for me in my room.

Imagine a distant future where most cities in the world are capable of this miraculous feat. How might I check the status of my luggage? There is no central entity that can collect all this information from every airline, airport, hotel and delivery service in the world. We need a decentralized method for collecting information about luggage that does not depend on any central server.

If my luggage is damaged, who will pay for repairs? Assume the last company to have my bag is responsible, unless they can produce a picture proving the bag was already damaged when they took custody. Now every company will take a picture of my bag when they get it and when they hand it off to the next company in the chain. This picture can be attached to the status messages collected for my bag. But an unscrupulous company may try to change the picture in the status message, or change someone else’s picture to blame them for the damage. We need a secure system that prevents anyone from tampering with the data.

How will I choose the right delivery company to get my luggage to my hotel? There may be many companies that serve different areas of a city, handle different types of bags, and have different delivery schedules. I want my luggage delivered by 10pm to a ryokan on the outskirts of Kyoto for less than $10. The delivery companies should have software that dynamically bids for each bag based on the latest exchange rate between dollars and yen. I don’t care who delivers it, but I do want proof that someone has my bag. We need a smarter system that allows companies to write custom software for this data collection network.

Necessity is the mother of invention. For reasons I don’t fully understand, some people have long wanted a form of digital currency that is not controlled by governments nor corporations. No one could build such a system until a mysterious genius published a paper describing Bitcoin, the first digital currency. Today (May 2017) the total value of all Bitcoins is $25 billion! Since it’s inception in 2009 no one has been able to steal from the Bitcoin network, demonstrating the incredible security of this novel system. In 2013 Ethereum was proposed as a programmable network using Bitcoin’s core ideas. More importantly, the underlying technologies in Ethereum and Bitcoin, specifically blockchains and smart contracts, can be used to implement a luggage delivery network.

In the near term, blockchains and smart contracts are useful when there is already a decentralized network of companies who want to exchange information. This means there is no trusted central company or government that can gather all the data for the network. Currently these companies share their data in an ad-hoc way that error-prone and inefficient. This includes networks such as supply chains, health care records, financial products, housing, diamonds, and many more. Each of these is a billion to trillion dollar market vertical.

In the medium term, there are many companies and government agencies currently serving as a trusted central authority that could be replaced by blockchain and smart contract technologies. Blockchains are particularly useful in countries with corrupt or ineffective governments. Birth, marriage, and death certificates. Licenses to practice medicine, real estate, and massage therapy. Patents, land and car titles, and approvals for drugs.  In the private market, the roles currently played by Visa (credit cards), the DTCC (financial product ownership), and Experian (credit reporting) could be replaced by blockchains. Energy companies can be supplanted with rooftop solar/wind generation and a blockchain to coordinate energy distribution. These agencies and companies are a drag on profits and progress because they are a bottleneck in their respective networks.

In the long term, many different blockchains (e.g. health, finance, government) can be combined to create new services across networks. It’s difficult to imagine the possibilities, but people have come up with some wild ideas. For example, decentralized companies with just-in-time labor. Decentralized and fully automated venture capital funds (see the DAO). The craziest idea I can think of is a self-driving car that bids $20 to have the traffic lights turn green on its route to get to the airport on time. Although by then it’s likely we’ll have flying cars or jetpacks instead.

Some form of blockchain and smart contract technologies can replace many of today’s centralized systems. These are very early days in the technology. It’s really only existed for 8 years. These technologies still need to be improved in every dimension: performance, security, privacy, expressiveness, flexibility. I remember the “Internet” in the early 1980s. No one then could have imagined what we have today, nor the trillion dollar economy built on it. The only constant is the crazy people on Usenet are now on Reddit. Someday they’ll have flamewars on a blockchain.

You’re throwing money away!

I am for the first time seriously considering making a bid on a home. Coincidentally, two seemingly intelligent women chattering next to me at lunch today agreed that when renting “you are throwing money away”, whereas buying a house means you will (somehow) get that money back. It’s bizarre that most people don’t understand the true cost of owning a home.

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Employment is a lagging indicator

The newspapers and talking heads are obsessed with unemployment numbers, yet they fail to grasp that this is the last thing that will improve after a recession. More importantly, productivity has improved strongly year over year and corporate profits are up enormously. If and when people believe the economy will improve, businesses will have a stockpile of cash to spend and hire people. There are still lots of problems with the economy, but this obsession with unemployment is looking at the wrong thing.

Global Sexism

The Wall Street Journal reports that after 128 years in business, The Bank of Japan has promoted its first female branch manager. This example points clearly to the self-destructive sexism that will doom Japan to decline. Japan has a severely low birthrate which will put immense pressure on their economy as their population ages and shrinks rapidly. They need more people, yet they refuse to allow immigration. The simple, obvious solution is to make more effective use of the talents of half their population, and yet in 2010 they still haven’t managed to integrate women into the workplace. I’m going to miss Japan when it finally disappears.

The same article points to a report from the World Economic Forum on gender parity. The countries with the best gender parity are obviously the Scandinavian countries, while the US is ranked at 31. Here are some countries that rank higher than the US: South Africa, Lesotho, Sri Lanka, Mongolia, and Mozambique. How can these countries be “better” than the US for women? That’s when you have to peek behind the ranking and analyze their methodology. It’s atrociously stupid. They defined “gender parity” merely as the ratio of female over male for several metrics. For example, let’s say literacy rates for some 3rd world country is 30% for women and 25% for men. The parity score is a whopping 1.2, which exceeds a 1st world country with literacy rates of 95% (f) and 98% (m) with a ratio of just 0.96. But which country would you rather live in? Sri Lanka is ranked #6 for political empowerment largely because a woman was head of state for 23 out of 50 years (though Sri Lanka has been independent only 38 years!). But would anyone claim that Sri Lanka offers more political power to women than the US? The methodology and the metrics are completely awful, yielding a report that is worse than junk. Nevertheless, lazy, stupid reporters will repeat these rankings uncritically and shape public perception that the US is far behind other countries in gender equality. Seriously, South Africa – “Rape Capitol of the World” – is ranked #6! Didn’t anyone at the WEF raise an eyebrow at the strange rankings?

The Financial Crisis

This is an explanation of the cause of the financial crisis, though it’s too long at 17 pages. Here’s my dumbed down summary. Around the world there was a huge glut of cash, particularly in Asia. Individuals can put cash in FDIC secured savings account, but no such safe account exists for huge deposits. So where can money markets and hedge funds and Chinese banks put their money and guarantee it’s safe? They put it in the repo market.

A money market fund (MMF) has $1B in cash and no safe place to deposit it. The investment banks came up with an idea: give them $1B cash and they’ll give the MMF $1B in Aaa-rated Treasury bonds as collateral. But the MMF wants to be able to withdraw money at anytime, so the bank agrees to buy back those bonds the very next day. This is called a repurchase agreement and is the foundation of the repo market, worth over $12 trillion worldwide. From the MMF’s point of view, they earn interest on their cash and hold an equivalent amount of bonds just in case the bank fails. And they get their cash back every day, so they can withdraw what they need in the morning and sign another repo agreement for the next day. From the bank’s point of view, the repo market turns their vast holding of Aaa bonds (required for all sorts of purposes) into cash they can use to do more lucrative investments. Everyone is happy.

The problem lies in those Aaa-rated bonds. The repo market got super huge and there wasn’t enough high quality bonds to meet demand. Someone figured out how to turn consumer loans (home, credit cards, auto, school) into Aaa-rated bonds. The bank gives the MMF $1B in consumer loans, and AIG promises to make up any loss in those bonds. AIG did this because everyone agreed that consumer loans would never blow up, so they earned a small fee on every loan for doing nothing. AIG made tons of money. Everyone is happy.

In 2007 home values suddenly declined a bit for the first time ever. The MMF complains the $1B in mortgage bonds have lost value, so they want more bonds as collateral or their cash back. All the bank’s cash is tied up in other investments, so they have to sell some stuff to raise money for the MMF. But all the banks started selling the same securities, which sent prices down. The banks suffered losses and had to sell more securities to make up for their losses, which sent prices down again in a terrible cycle. This initiated the banking crisis around Sept. 2007. The global economy crumbles. Everyone is freaked out.

The paper says that this was a classic run on the bank; that is, suddenly everyone wanted their money back at the same time. FDIC insurance stopped bank runs by consumers, but the lack of insurance for large depositors means we’ll continue to have this same crisis in the near future. Somehow the banking system must be made more resilient to panics.  I don’t know if this is a complete explanation of the financial crisis, but it does help to understand all this weird “parallel banking system”.

Pigovian Tax on Meat

There is finally a growing recognition that the industrialized production of meat is bad for people and the planet. When something has a significant negative externality (e.g. pollution) a Pigovian tax is used to add the social costs to that product’s price. That’s why many economists support a tax on gasoline. The negative externalities include production of greenhouse gases and undermining our security interests by sending too much money to unfriendly countries. For meat, there are several negative externalities.

  • Grazing animals produce more greenhouse gases (belching and farting) than cars.
  • Industrial farms seriously degrade water quality because of large amounts of feces.
  • It’s an inefficient use of water and arable land, both of which are subsidized by the gov’t.
  • Over-consumption of meat leads to poor health, which adds to our total health care costs.

By adding a tax and/or removing agricultural subsidies for meat production, it raises the price to match the real total cost of a double cheeseburger. Though it is impossible to expect people to suddenly become vegetarians (I’ve struggled for 10 years), it is trivial for people to reduce the amount of meat they eat. Americans are grotesquely obese because they eat too much of everything. Reducing total food consumption means less meat consumption which leads to lower rates of obesity. Raising the cost of meat should hopefully push people to eat more fruits and vegetables. I think the biggest problem is America’s meat & potatoes food culture. People just don’t know what to do with vegetables. Incidentally, I asked Greg Mankiw, Bush’s economics advisor, about this and he agreed with a Pigovian tax on meat. (Isn’t the Internet great?) So you could likely get bourgeoisie support, but the overweight proletariat will riot to get cheap bacon. Mmmmmmm, bacon.