Bitcoin can repair the broken incentive systems created by finance and low interest rates that lead to unsustainable practices.
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This article is part of a series of adapted excerpts from “Bitcoin Is Venice” by Allen Farrington and Sacha Meyers, which is available for purchase in Bitcoin Magazine’s store now.
You can find the other articles in the series here.
“The concentration of the farmland into larger and larger holdings and fewer and fewer hands — with the consequent increase of overhead, debt, and dependence on machines — is thus a matter of complex significance, and its agricultural significance cannot be disentangled from its cultural significance. It forces a profound revolution in the farmer’s mind: once his investment in land and machines is large enough, he must forsake the values of husbandry and assume those of finance and technology.
“Thenceforth his thinking is not determined by agricultural responsibility, but by financial accountability and the capacity of his machines. Where his money comes from becomes less important to him than where it is going. He is caught up in the drift of energy and interest away from the land. Production begins to override maintenance. The economy of money has infiltrated and subverted the economies of nature, energy, and the human spirit. The man himself has become a consumptive machine.” — Wendell Berry, “The Unsettling of America”
The reader may understandably have been put off by our treatment so far in the past few sections of “the environment” as if a purely financial matter.[i] While we rather have little choice, given we are committed to discussing the relationship between stocks of capital — the environment, in this case, finance and communications infrastructure above — and capitalism, we do appreciate the inherent crassness of the approach, necessary or not.
The perception of crassness is not merely aesthetic: Humans respond to economic incentives whether they want to or not. If our treatment of “the environment” has been crass, that is because human interaction with the environment under degenerate fiat “capitalism” is crass. We would certainly like our discussion to be humbler and more reverential, but that would require a compelling reason to believe that contemporary capitalism itself can adopt a suitable reverence and humility. To zoom out even further, then, the thesis of “Bitcoin Is Venice” is that it can: Bitcoin fixes this.
But we can be much more specific about why this is the case, rather than outsourcing our analysis to the connotations alone of words like “local,” “reverent,” “humble,” and so on and so forth. We can once again adopt the terminology of time preference, and we can even quantify our analysis in the simple terms of discount rates. Tarek El Diwany provides precisely such an analysis in “The Problem with Interest,” writing,
“Imagine a farmer who wishes to buy a plot of land and farm it. His purchase and operating costs are to be financed entirely on borrowed funds. The land is capable of supporting a highly intensive technique which is forecast to produce £150 per year of net profit for fifteen years, and which results in the land’s desertification. An alternative production technique produces only £100 per year of net profit but allows the land to regenerate and maintain its productive potential indefinitely.
“Discounted cash flow analysis allows the modern farmer to compare these two sets of cash-flows and select the most profitable […] it is the farming approach that provides the highest total present value that is then recommended […] With interest rates at 5% the highest present value (£2,000) resides in the low intensity farming approach, whilst with rates at 10% the highest present value (£1,140.91) resides in the high intensity option.
“The incentive towards intensive farming, and thus desertification, increases as the interest rate increases. This unfortunate result is entirely due to the familiar way in which the discounting process progressively reduces the present value of the land’s output in future years toward zero. £100 of net profit earned in year fifty has a present value of approximately £0.85 if the interest rate is 10% per year.
“No wonder then that the analyst who relies on discounted cash-flow analysis has little care for what the land can produce in year fifty. Whether the land at that time is desertified or not is of little relevance, since its contribution to present value is negligible.”
Lest we confuse the reader, we recycle a warning featured in Chapter Five of “Bitcoin Is Venice,”
“Of course, we must not confuse the nominal interest rates forced upon economic actors by artificial debt creation with real time preference. A low rate on a manipulated market reflects neither an abundance of available funds for investment nor creates that which it is pretending to be. Or, perhaps more provocatively: An interest rate should be a discount rate; it should reflect the balance of time and opportunity cost. But high time preference incentives create high discount rates, which viciously recreate high time preference incentives in the form of short-term investment horizons. Low interest rates do not solve what is essentially a character flaw, and in fact they exacerbate it by providing the unknowingly flawed not only with no negative feedback that might be of character-building value, but also with an abundance of artificially cheap capital to waste on their high time preference nonsense.”
El Diwany has just shown us such a vicious circle: If a farmer starts off with a short-term outlook for any reason at all, he will likely finance and operate his farm in such a way that his high time preference infects everything his operation touches — even non-economic factors such as his own ethics, psychology, and philosophy of life.
That El Diwany does not make this precise distinction[ii] gives us an opportunity to explain precisely why dictating artificially low interest rates does not solve this problem and in fact exacerbates it. It is not the number that matters but the attitude the number reflects and from which it emerges: that of a high time preference, or, as cheekily alluded to above, a character flaw.
Artificially low interest rates will catalyze artificially-high debt financing, which creates exactly the same problem, albeit for slightly different reasons. The levered farmer may well need to produce £150 of profit per year because the interest on his debt financing has squeezed his operation past the point at which £100 of pre-interest earnings is sustainable. This rhetorical slight ought to be lingered on for longer because it captures a profoundly tragic irony:
Fiat money so perverts incentives that it makes the sustainable unsustainable.
“Local,” “reverent,” and “humble” are not just buzzwords under such a degenerate financial regime. The farmer who needs to produce now because of a globally-decreed artificially-low interest rate is already eschewing the local and will have a hard time revering nature, the environment, his stock of natural capital, or however else we might be minded to characterize such things. This is no mere hypothetical, as the following extract from “The Future of the Great Plains” — the report of the Great Plains Committee of the U.S. House of Representatives in 1936 following the ecological disaster of the dust bowl — makes painfully clear,
“The First World War and the following inflation pushed the price of wheat to new levels and caused a remarkable extension of the area planted to this crop. When the price collapsed during the post-war period Great Plains farmers continued to plant large wheat acreages in a desperate endeavor to get money with which to pay debt charges, taxes, and other unavoidable expenses. They had no choice in the matter. Without money they could not remain solvent or continue to farm. Yet to get money they were obliged to extend farming practices which were collectively ruinous.”
Furthermore, consider an abstract definition of “leverage” as “induced vulnerability to shocks in exchange for a magnified gain in their absence”: This implies a lack of humility. In the real world, outside the models of degenerate fiat economists, there are always shocks. Leaving money on the table by foregoing leverage and maintaining an equity buffer to absorb an unforeseeable shock is a form of humility. Maximizing one’s long-term vulnerability in exchange for magnified short-term gains is usually either arrogant, stupid, or both.
Such a choice also limits or even removes the ability to acquire knowledge and competence. Knowledge and competence are arguably the theoretical and practical sides of the same coin: the hard-won product of experience and discovery. Contrary to high-modernist arrogance, in any practical setting in which they are worthwhile in the first place, they cannot be deduced or made to pop out of a model, but must be arrived at by experimentation — at least originally. And once arrived at, they exist as a form of capital we would do well to at least nurture, if not eventually replenish with education and grow by more experimentation.
Entrepreneurship is one such form of experimentation, but it is one kind among many.[iii] Experimentation requires room for failure, since the nature of a worthwhile experiment is that we cannot know its outcome, or else we wouldn’t bother running it in the first place.[iv] Leverage eliminates room for failure, meaning it removes the opportunity to experiment and, in turn, the possibility of incrementally acquiring knowledge and competence. Leverage and short-termism literally make us stupid.
The inverse is also true. We wouldn’t go as far as to say that equity finance and long-term thinking is itself necessary and sufficient for achieving reverence, humility, applied intelligence, and personal nirvana. But removing potentially overwhelming incentives towards irreverence and arrogance certainly doesn’t hurt the cause.
Furthermore, ensuring that such irreverent, arrogant stupidity is forced to reckon with its own inevitable consequences rather than enjoy the coerced charity of socialized losses and involuntarily-taxed bailouts won’t hurt either. This hints at what is likely the simplest practical path to “localism”: not some elaborate social scheme, just the removal of artificial disincentives towards a state that would otherwise be natural, and the removal of artificial incentives towards its unnatural antipode.
This is more or less the argument of Roger Scruton in positioning environmentalism as a deservedly (politically) conservative cause. He writes in “Green Philosophy,”
“For the conservative, politics concerns the maintenance and repair of homeostatic systems — systems that correct themselves in response to destabilizing change. Markets are homeostatic systems; so too are traditions, customs and the common law; so too are families, and the ‘civil associations’ that make up the stuff of a free society. Conservatives are interested in markets, and prefer market forces to government action wherever the two are rivals. But this is not because of some quasi-religious belief in the market as the ideal form of social order or the sole solution to social and political problems; still less is it because of some cut of homo economicus and the ‘rational self-interest’ that supposedly governs him. It is rather because conservatives look to markets as self-correcting social systems, which can confront and overcome shocks from outside, and in normal cases adjust to the needs and motives of their members.”
Later in the same chapter, however, Scruton helpfully walks back this position to one of admirable nuance:
“This is not to say that the big NGOs [non-governmental agencies] are always wrong in their campaigns or that multinational companies always behave responsibly. On the contrary, Greenpeace and Friends of the Earth have drawn attention to real abuses, and used their high profile to good effect in educating the public. As companies get bigger, developing the capacity to move from jurisdiction to jurisdiction, evading their liabilities in each, so does their accountability dwindle. Shareholders rarely ask questions, and certainly not about the environmental consequences of actions that are bringing them a return on their investment. It is one of the weaknesses in the conservative position, as this has expressed itself in America, that its reasonable enthusiasm for free enterprise is seldom tempered by any recognition that free enterprise among citizens of a single nation state is very different from free enterprise conducted by a multinational company, in places to which the company and its shareholders have no civic tie. It is this carelessness towards ‘other places’ that underlies environmental catastrophes like BP’s oil-rig spill in the Gulf of Mexico, or the ‘slash and burn’ cropping by multinational agribusinesses in the Amazon rainforest.”
Precisely the environmental damage Scruton highlights evidences that the incentives in question are far from abstract, and the drive to reckless extraction unrelenting. El Diwany’s farmer may have been hypothetical but exactly the mechanics of incentives for nurture versus extraction described, rooted ultimately in time preference but distorted by finance, has caused nothing short of an ecological disaster in the past fifty to sixty years or so in the form of widespread soil erosion (to be discussed in next week’s extract).
[i] We actually went back and forth on the terminology we even wanted to adopt. On the one hand, “the environment” conveys an unfortunate arrogance with respect to our total inability to manage such a system. But on the other hand, “natural resources” — meaning something like, that tiny subset of the environment that is economically relevant — sounds exploitative in precisely the manner we are trying to avoid. If the reader could do us a favor and coin a new expression that has the benefits of both and the drawbacks of neither, that would be grand.
[ii] Just in this extract, to be clear. Later in “The Problem with Interest,” El Diwany provides a thorough debunking of the lunacy of fiat money and banking.
[iii] It is the kind that is relevant to the capital stock of capital! Or, to be less cute, financial and production capital, as opposed to the more abstract and intangible varieties discussed in this extract and some that follow.
[iv] There are conceptual reflections here of comments made in “Wrestling with the Truth”: Why simulate the entire universe when the universe will happily simulate itself? We run experiments precisely because we cannot just deduce or model the answer. Note also, experiments require upfront costs and take time. This is much more than just an analogy or a metaphor; it is literally true: Entrepreneurship is experimentation.
This is a guest post by Allen Farrington and Sacha Meyers. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.