Debunking the Tulip Bubble

Debunking the Tulip Bubble

What asset price bubbles are is fairly uncontroversial, even if a fast and hard definition is elusive. At their most basic, bubbles are said to exist when a sharp upward departure in the price of an asset, from its historic or otherwise reasonably expected value, occurs over a relatively brief period of time, however defined. These dramatic, often parabolic, rises can be driven by rushes into new sectors, like dotcoms, new tech, or cryptocurrencies—while some economists consider their occurrence completely random.

Whatever the case, it almost invariably happens that when talking of bubbles in this or that asset class someone brings up the Dutch tulip bubble. Despite its predictable regularity, a closer look at what occurred in Holland around the mid-1630s casts serious doubt on the comparison, for, as will be outlined, the sudden brief spike in the prices of certain tulips wasn’t due to any change in the underlying assets, emergence of new assets, or the preferences of buyers, but rather innovations in how tulips were briefly bought and sold.

By the seventeenth century Holland was the most advanced economy in Europe, with a recognizable and relatively sophisticated stock market. In 1602, for example, the Dutch East India Company was founded as a joint stock company, generally recognized as the first of its kind. As for tulips, they had begun to make their way to Europe via trade with the Ottoman Empire a century prior. As it happened, women’s fashion by the early seventeenth century had come to incorporate flowers, tulips specifically. Even more specifically, certain tulips, called “broken bulbs,” were highly sought after and came to command hundreds, even thousands of guilders each from European elites.1

The tulip market in 1630s Holland, then, was multitiered, with select broken bulbs being traded for many hundreds, even thousands, of times the value of ordinary tulip bulbs—until, that is, the two months spanning late 1636 and early 1637, which saw twenty- to thirtyfold increases in the price of standard tulips, which had traded weeks before at the equivalent of tenths of a cent per handful.

Let’s take a closer look at the mechanics that caused this to happen, and see why there is little to nothing to be gained by comparing what happened during “tulipmania” to asset price bubbles in the modern context.

As already stated, the Dutch stock market was the most sophisticated in Europe in the mid-seventeenth century, and already had a brisk futures trade. Similar to today’s futures trading, most Dutch traders at the time weren’t actually interested in owning the underlying asset. Rather, it was a simple bet on the future price of the asset. If the price went down, the seller got paid the difference, and vice versa for the buyer of the future if the prices went up.

Importantly, because of moral strictures much of this futures trading was done informally—contracting to sell something you didn’t yet own seeming an activity close to, if not indistinguishable from, gambling. And it was in late 1636 that informal futures markets for standard tulips began sprouting up. Because it was outside the existing market framework, these informal markets had their own rules but no real means of enforcing them; and it is here, in the structure and rules governing these emerging tulip futures markets, that we find the origins of the actual bubble of tulipmania.

First, everyone involved had to bid on every lot of tulips; second, new buyers were prohibited from immediately selling; third, all buying was fractional, with only one-fortieth of the price of the contract due down; fourth, there was a maximum cap of three guilders down, no matter how large the contract; and finally, while social exclusion would follow for anyone who reneged on what they owed, the contracts were technically unenforceable in Holland’s courts.

Reading over these conditions, it isn’t difficult to imagine how a bunch of bored Dutch traders with little else to do in the middle of a northern European winter, blew up and then popped an enormous bubble in the lower-tiered tulip market in just a few weeks: contracts were cheap; you might make some money; and if things somehow got out of hand, the contracts weren’t enforceable, anyway. Of course, no one wanted to have their name come under opprobrium, which is why virtually no one apparently reneged—at least at first. It also helps to explain why the bubble burst so quickly after forming. A lot of standard tulip bulbs worth only a guilder or two per bucketful quickly rose to hundreds of guilders in value. This was a huge sum, and no one wanted to risk being on the end of it.

Recognizing the mess they’d gotten themselves in, virtually everyone involved agreed to rip up the contracts and walk away. No damage was done to the Dutch economy, the price of ordinary tulips almost immediately returned to what it had been, and the value of high-tier broken bulbs, like the Semper Augusta continued to steadily appreciate.2

In short, the Dutch tulip bubble, or tulipmania, had virtually nothing in common with modern bubbles, though it is an interesting episode of economic history to be sure.

  • 1. Unlike ordinary tulips, which are a single color—typically red, yellow, or pink—broken bulbs produce a range of multicolored, distinctly patterned petals. Smaller, slower-growing, and rare, botanists now know the flowers were actually infected with a mosaic virus, which stunted their growth and caused the erratic coloring.
  • 2. And this is a key part of the story, for while the tulip bubble is generally said to have occurred between 1633 and 1637, this claim is contradicted by both Peter Gerber and Connel Fullenkamp, economists who have gone back and searched for tulip sales made in the years preceding and following that period. Their research and writings reveal that broken bulbs had been seeing a steady, almost 10 percent rise in value for at least a decade prior. To take just one example, as early as 1626 a single broken bulb had sold for just over two thousand guilders (the equivalent of around a half million dollars priced in today’s dollars). And while 10 percent is certainly brisk growth, it’s nowhere near today’s bubble level—except perhaps in housing, though this bubble is of the Fed’s creation. Lastly, as Kindleberger points out in his Manias, Panics, and Crashes this steady appreciation in high-tier tulip bulbs was happening within the context of broader asset price inflation following the economic hard times during and after the War of Spanish Succession.
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Inflation Celebration

10/14/2021Robert Aro

As reported by Reuters on Wednesday:

Yes, inflation is back, and you should probably be relieved if not outright happy.

It seems strange to start a news article with the above sentence. When they talk of inflation, they’re talking about price increases as measured through various inflation calculations. For a news source, supposedly unbiased, they seem unaware of or purposely ignore the loss of dollar purchasing power and currency debasement. What they’re celebrating is an increase in the cost of living for everyone, hurting those at the lowest level of the income bracket the most.

As one of the most trusted news sources in the world explains:

That is the verdict of the world's top central banks, who hope they have hit the sweetspot where healthy economies see prices gently rising—but not spiralling out of control.

Notice the use of euphemism or vague term sweet spot that the marriage between mainstream media and mainstream economics uses to explain concepts that cannot be conveyed. It happens frequently:

Backed by vast government spending, central bankers unleashed unprecedented monetary firepower in recent years to get this result. Indeed, anything less would suggest the biggest experiment in central banking in the modern era had failed. 

A large part of this government spending was thanks to central banks, while the monetary firepower just means expansion of the money supply, also called inflation, coupled with historically low interest rates. The word experiment is often used; this is unfortunate because those in charge of this experiment are among the richest and most powerful people in the world. It’s easy for them to experiment because they will never suffer the consequences of failure, unlike the rest of society, who do.

The possibility of repeating 1970s stagflation was dismissed as quickly as it was mentioned:

The current inflation rise is not without risk, of course, but comparisons with 1970s style stagflation—a period of high inflation and unemployment combined with little to no growth—appear unfounded.

Despite noting that:

On first look, current inflation rates do indeed look troubling. Price growth is already over 5% in the United States … well above policy targets and at levels not seen in well over a decade.

But according to the author the price increases we’re seeing are only temporary and due to the reopening of the economy, acceptable because an expert from the European Central Banks is quoted as having said:

The current inflationary spike can be compared to a sneeze: the economy’s reaction to dust being kicked up in the wake of the pandemic and the ensuing recovery.

Over half a dozen other central bankers are said to be relieved that "price pressures are finally building and policy normalisation, a taboo subject for years, is back on the agenda," while one policymaker who asked to be left nameless said that "[i]f inflation doesn't rise now, it never will…. These are the perfect conditions, this is what we worked for."

For all the meetings, planning, review of data, and deliberation, at last central bankers of the world are rejoicing over what they have done with our money. Debt levels, money supply, interest rates, and prices are in territories some thought were unimaginable. The theory or model behind any of this is still not explained by our planners.

Where some see victory, others see a time bomb. It would have been nice if Reuters had mentioned some of the problems associated with inflationism as economic policy. But who wants to put a damper on things? For now, it’s a celebration of central planners and how they brought their long sought after inflation back to the West, with the hope that the years that follow will similarly go according to plan, lest they’re forced to intervene again.

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Does the Fed Need More Progressives?

10/11/2021Robert Aro

The Federal Reserve System will need people to fill the gap left by the retirement of the regional presidents for Dallas and Boston, both stepping down after public disclosure of trading activities. Fed vice chair Richard Clarida is also under scrutiny over several millions of dollars' worth of trades. The Fed could be hiring, or promoting people, in the not-too-distant future.

If past experience is an indication of future outcomes, then someone who doesn’t ask too many questions, yet has an interest in climate change, could be a good candidate. The name that keeps coming up in news headlines looks to be Fed governor Lael Brainard. CNBC reports:

Federal Reserve Governor Lael Brainard's increased influence ahead likely means substantial changes and challenges for the nation’s banking system.

Considered a progressive who favors tighter reins on financial institutions, particularly the Wall Street powerhouses …

Progressive. Much like someone calling themselves a liberal, or socialist, a progressive is one of those self-identifiers that can include a long range of beliefs, many or most of them requiring the threat of violence, theft, or coercion.

The article supports the idea of a Federal Reserve looking for such traits. Ed Yardeni from the research firm which bears his name speaks of Brainard as someone who can move up even higher in the ranks at the Fed:

Everybody can see that the Fed has been moving toward a more progressive stance, and it wouldn’t be a big shock to see that she gets more power either as Fed chair or as vice chair for regulation.

Since it’s not enough to set a nation’s monetary policy, the Fed also monitors and directs the entire US banking system. As Yardeni explains:

To the extent that the Fed’s always more focused on monetary policy than regulation, now one of its new mandates from the progressives is to pay more attention to regulating the banks.

All this talk about being progressive, yet no one has explained where these ideas come from nor where they lead. They might sound progressive to voters and the public at large, but very rarely is it explained how this ideology is beneficial.

Here’s an example of this in action. A few days ago Lael Brainard gave a speech on climate change. She noted that:

Current voluntary climate-related disclosures are an important first step in closing data gaps, but they are prone to inconsistent quality and incompleteness. 

Sounds reasonable. Should a financial institution or any other company voluntarily wish to partake in climate-related disclosures or calculations, there’s certainly nothing wrong with this.

But now, let’s see the progressive in action. Notice the key word as she continues:

Consistent, comparable, and, ultimately, mandatory disclosures are likely to be vital to enable market participants to measure, monitor, and manage climate risks on a consistent basis across firms.

Mandatory. This is the tool of the progressive, the socialist, the liberal, and many of those considered to be on the left or right; the state can impose actions which are mandatory, or forced on whomever it pleases.

The affairs at the Fed have yet to be sorted. But one thing is clear. No matter the name of the ideology, it will limit individual freedom and support the collective, operating under the pretense that it is for the greater good, but in reality is beneficial for only those at the top. From the Fed chair on down, this is the way of the state.

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Wisdom from Piketty

10/11/2021David Gordon

The famous French socialist economist Thomas Piketty thinks we aren't  moving toward equality fast enough.  In his Long Live Socialism!, he says this to illustrate how much work remains to be done: "The poorest 50% of the world's population is still the poorest 50% of the world's population" (p.13 of the Amazon Kindle edition).

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Canada’s 2021 Election: Trudeau’s Miscalculation

10/11/2021Lee Friday

Justin Trudeau was widely criticized for calling an election during a pandemic, but he thought that his oppressive covid policies would play well with the voting public, which would then reward his minority Liberal government with enough additional seats to give them majority status. He was wrong. The Liberals won the election, but they did not achieve majority status. So much for reading the minds of the voters.

The Conservative (in name only) Party repeated their 2019 performance by winning the popular vote and finishing in second place. Which brings us to the surprise of the election: the People’s Party of Canada (PPC).

In 2017, Maxime Bernier narrowly lost the Conservative Party leadership convention—or it was stolen from him—because of his opposition to Canada’s socialistic supply management system that forces consumers to pay artificially high prices for eggs, dairy, and poultry products. In 2018, Bernier left the Conservative Party and founded the PPC because of his dissatisfaction with the Conservative Party platform, which he described as “intellectually and morally corrupt.”

In the 2019 election, the PPC, which has a distinct libertarian flavor, received 1.6 percent of the popular vote. In contrast, it took the Green Party twenty years and six elections to garner 1.6 percent of the popular vote. In the September 20, 2021, election, the PPC did not win any seats, but they increased their share of the popular vote to 5 percent (the Greens got 2.3 percent), which is a remarkable and unexpected achievement for a party that is barely three years old.

The PPC distinguished themselves with a platform that stood in stark contrast to the platforms of the Liberals and Conservatives. More importantly for this particular election, it is likely that the PPC’s opposition to authoritarian pandemic policies was the primary catalyst for their impressive performance.

So Trudeau’s decision to call an election backfired on him because he did not get the majority control that he wanted. But it also backfired on him because it gave many people an opportunity to express their dissatisfaction with his authoritarian pandemic policies by voting for the PPC. Thus, his failed attempt to secure a majority government has strengthened the profile of the PPC. Bernier should send Trudeau a thank-you note.

None of this is to suggest that the PPC is a white knight for freedom-loving Canadians. When it comes to politics, a healthy dose of skepticism is always advisable. Political parties come and go, and are often co-opted. Would Bernier keep his promises if he won an election? We don’t know.

What we do know is that Canada’s three main national political parties (Liberals, Conservatives, and the New Democratic Party [NDP]), all leftist, are concerned that the three-year-old PPC increased its share of the popular vote by more than threefold in just twenty-three months. They should be concerned. A rising PPC on the right may not bode well for Canada’s bipartisan leftist politics, because Bernier, who is not a rookie, is well versed in libertarianism.

In a recent interview with Jordan Peterson, Bernier provided a few examples of his libertarian leanings. He decries the woke culture. He opposes business subsidies and favors free market incentives. He acknowledges the contributions of Mises, Rothbard, and Hayek as he blames the central bank for the business cycle. He wants to reduce the Bank of Canada’s inflation target from 2 percent to 0 percent. He understands that consumers’ purchasing power is reduced by the inflation tax. Thus, he opposes fiat currency, and supports the gold standard. He likes cryptocurrency because he favors money competition. He favors radical decentralization at the federal level, thereby increasing the level of provincial autonomy, which brings government closer to the people in the various regions. This includes healthcare, where he wants to eliminate the federal government’s role.

Trudeau gift wrapped a higher public profile to the PPC, but it remains to be seen whether Bernier seizes this opportunity to explain the PPC’s libertarian ideas to many more Canadians before Trudeau—or his replacement—announces the next election. More to the point, if he wins an election, will Bernier stay true to his libertarian principles, or will his name be added to Canada’s long list of political sellouts? Only time will tell.

However, the Liberals and Conservatives—for whom integrity has no meaning—are worried that Bernier will actually stick to his principles, and use his extensive libertarian knowledge to explain to Canadians the myriad ways in which big brother government is detrimental to their well-being.

We don’t know if the PPC is the real deal, but for now, politicians on the left are rightfully nervous. At the very least, after a year and a half of pandemic lockdowns and restrictions, a healthy dose of entertainment is a welcome relief—and it’s always fun to watch politicians squirm.

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The Magic of the Keynesian Multiplier

10/10/2021Frank Shostak

By popular thinking, the key driver of economic growth is increases in the total demand for goods and services. It is also held that the overall economy’s output increases by a multiple of the change in expenditure by government, consumers and businesses. The popularizer of this way of thinking John Maynard Keynes, wrote,

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course by tendering for leases of the note-bearing territory), there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.1

An example will illustrate how an initial spending increase raises the overall output by a multiple of this increase. Let us assume that out of an additional dollar received individuals spend $0.9 and save $0.1. Also, let us assume that consumers have increased their expenditure by $100 million. Because of this, retailers' revenue rises by $100 million. Retailers in response to the increase in their income consume 90 percent of the $100 million, i.e., they raise expenditure on goods and services by $90 million. The recipients of these $90 million in turn spend 90 percent of the $90 million, i.e., $81 million. Then the recipients of the $81 million spend 90 percent of this sum, which is $72.9 million and so on. Note that the key in this way of thinking is that expenditure by one person becomes the income of another person.

At each stage in the spending chain, people spend 90 percent of the additional income they receive. This process eventually ends, so it is held, with total output higher by $1 billion (10*$100 million) than it was before consumers had increased their initial expenditure by $100 million.

Observe that the more that is being spent from each dollar, the greater the multiplier is and therefore the impact of the initial spending on overall output will be larger. For instance, if people change their habits and spend 95 percent from each dollar the multiplier will become 20. Conversely, if they decide to spend only 80 percent and save 20 percent then the multiplier will be 5. All this means that the less that is being saved the larger is the impact of an increase in overall demand on overall output. Note that on this way of thinking an increase in savings weakens the pace of economic activity. Following this way of thinking it is not surprising that most economists today are of the view that by means of fiscal and monetary stimulus it is possible to prevent the US economy falling into a recession.

Is the multiplier a real thing?

Are increases in savings bad for the economy, as the multiplier model indicates? Take for instance Bob the farmer who has produced twenty tomatoes and consumes five tomatoes. What is left at his disposal is fifteen saved tomatoes, which are his savings. With the help of the saved fifteen tomatoes, Bob can now secure various other goods. For instance, he secures one loaf of bread from John the baker by paying for the loaf of bread with five tomatoes. Bob also buys a pair of shoes from Paul the shoemaker by paying for the shoes with ten tomatoes. Note that savings at his disposal limit the amount of consumer goods that Bob can secure for himself. Bob’s purchasing power is constrained by the amount of savings i.e. tomatoes at his disposal, all other things being equal. Now, if John the baker produced ten loaves of bread and consumed two loaves his savings are eight loaves of bread. Equally, if out of the production of two pair of shoes Paul uses one pair for himself then his saving is one pair of shoes.

When Bob the farmer exercises his demand for one loaf of bread and one pair of shoes he is transferring five tomatoes to John the baker and ten tomatoes to Paul the shoemaker. Bob's saved tomatoes maintain and enhance the life and wellbeing of the baker and the shoemaker. Likewise, the saved loaf of bread and the saved pair of shoes maintain the life and wellbeing of Bob the farmer. Note that it is saved final consumer goods, which sustain the baker, the farmer and the shoemaker, that makes it possible to keep the flow of production going. Now, the owners of final consumer goods, rather than exchanging them for other consumer goods, could decide to use them to secure better tools and machinery. With better tools and machinery, a greater output and a better quality of consumer goods can be produced some time in the future.

Note that by exchanging a portion of their saved consumer goods for tools and machinery the owners of consumer goods are in fact transferring their savings to individuals that specialize in making these tools and machinery. Savings sustain these individuals whilst they are busy making these tools and machinery. Once these tools and machinery are built this permits an increase in the production of consumer goods. As the flow of production expands this permits more savings all other things being equal, which in turn permits a further increase in the production of tools and machinery. This in turn makes it possible to lift further the production of consumer goods. So contrary to popular thinking, more savings actually expands and not contracts the production flow of consumer goods.

Can an increase in the demand for consumer goods lead to an increase in the overall output by the multiple of the increase in demand? To be able to accommodate the increase in his demand for goods the baker must have means of payment i.e. bread to pay for goods and services that he desires. Note again that the baker secures five tomatoes by paying for them with a loaf of bread. Likewise, the shoemaker supports his demand for ten tomatoes with a pair of shoes. The tomato farmer supports his demand for bread and shoes with his saved fifteen tomatoes. The baker’s increase in the production of bread permits him to increase demand for other goods. In this sense, the increase in the production of goods gives rise to demand for goods. People are engaged in production in order to be able to exercise demand for goods to maintain their life and wellbeing.

Note that what enables the expansion in the supply of final consumer goods is the increase in capital goods or tools and machinery. Savings in turn enables the increase in tools and machinery. We can thus infer that the increase in consumption must be in line with the increase in production. From this, we can also deduce that consumption does not cause the production to increase by a multiple of the increase in consumption. The increase in production is in accordance with what the pool of savings permits and is not constrained by consumers’ demand as such. Production cannot expand without the support from the pool of savings i.e. something cannot emerge out of nothing.

Let us examine the effect of an increase in the government's demand on an economy's overall output. In an economy, which is comprised of a baker, a shoemaker and a tomato grower, another individual enters the scene. This individual is an enforcer who is exercising his demand for goods by means of force. Can such demand give rise to more output as the popular thinking has it? On the contrary, it will impoverish the producers. The baker, the shoemaker, and the farmer will be forced to part with their product in an exchange for nothing and this in turn will weaken the flow of production of final consumer goods. Not only does the increase in government outlays not raise overall output by a positive multiple, but on the contrary this leads to the weakening in the process of wealth generation in general. According to Mises,

[T]here is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.

Murray Rothbard in his Man, Economy, and State discussed the absurdity of the Keynesian multiplier.

The theory of the “investment multiplier” runs somewhat as follows:

Social Income = Consumption + Investment

Consumption is a stable function of income, as revealed by statistical correlation, etc. Let us say, for the sake of simplicity, that

Consumption will always be .80 (Income).

In that case, Income = .80 (Income) + Investment.

.20 (Income) = Investment;

 or Income = 5 (Investment).

The “5” is the “investment multiplier.” It is then obvious that all we need to increase social money income by a desired amount is to increase investment by 1/5 of that amount; and the multiplier magic will do the rest….

The following is offered as a far more potent “multiplier,” on Keynesian grounds even more potent and effective than the investment multiplier, and on Keynesian grounds there can be no objection to it. It is a reductio ad absurdum, but it is not simply a parody, for it is in keeping with the Keynesian method.

Social Income = Income of (insert name of any person, say the reader) + Income of everyone else. Let us use symbols:

Social income = Y

Income of the Reader = R

Income of everyone else = V

Let us say the equation arrived at is: V = .99999 Y

Then, Y = .99999 Y + R

.00001 Y = R

Y = 100,000 R

This is the reader’s own personal multiplier, a far more powerful one than the investment multiplier. To increase social income and thereby cure depression and unemployment, it is only necessary for the government to print a certain number of dollars and give them to the reader of these lines. The reader’s spending will prime the pump of a 100,000-fold increase in the national income.

Does the introduction of money make the multiplier possible?

The introduction of money does not alter our conclusions. Money only helps to facilitate trade among producers— it does not generate any real stuff. Paraphrasing Jean Baptiste Say Mises wrote that,

Commodities, says Say, are ultimately paid for not by money, but by other commodities. Money is merely the commonly used medium of exchange; it plays only an intermediary role. What the seller wants ultimately to receive in exchange for the commodities sold is other commodities.2

When an individual increases his spending by $100 all it means is that he has lowered his demand for money by $100. The seller of goods has now acquired $100, which he can employ when deemed necessary. We can also say that the seller's demand for money has increased by $100. Likewise, if the seller will now spend 90 percent of $100 all that we will have here is a situation wherein his demand for money has fallen by $90 whilst somebody else's demand for money has now risen by $90. In addition, all other things being equal, if individuals have increased their expenditure on some goods then they will be forced to spend less on other goods. This means that the overall spending in an economy remains unchanged. Only if the amount of money in the economy increases, all other things being equal, spending in money terms will follow suit. However, also in this case the increase is not because of some multiplier but because of the increase in money supply. The increase in monetary expenditure because of an increase in money supply cannot however produce the expansion in real output as the popular story has it.

All that it will generate is a reshuffling of the existent pool of savings. It will enrich the early receivers of the new money at the expense of last receivers or no receivers at all. Obviously then, a loose monetary policy which is aimed at boosting consumers' demand cannot boost real output by a multiple of the initial increase in consumer demand. Not only will loose money policy not lift production, but on the contrary it will impoverish wealth generators in exactly the same way as the enforcer in our previous example.

Summary and Conclusion

John Maynard Keynes's writings remain as influential today as they were eighty-five years ago. His ideas remain the driving force of economic policy makers at the Fed and Government institutions. These ideas permeate the thinking and writings of the most influential economists on Wall Street and in academia. The heart of the Keynesian philosophy is that what drives the economy is demand for goods. Economic recessions are predominantly the result of insufficient demand. In the Keynesian framework, an increase in demand not only lifts overall output but that output increases by a multiple of the initial increase in demand. Within this framework, something can be created out of nothing.

  • 1. J.M. Keynes, The General Theory of Employment, Interest and Money (London: Macmillan, 1964), p. 129.
  • 2. Ludwig von Mises, "Lord Keynes and Say's Law," in The Critics of Keynesian Economics, edited by Henry Hazlitt (Irvington-on-Hudson, NY: Foundation for Economic Education, 1995), p. 316.
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Change for a Trillion

10/07/2021Robert Aro

Could a $1 trillion platinum coin be the answer to our problems? Or is this just another bad idea on the never-ending list of bad economic takes?

If history is any indication of the past, then everyone knows how the debt ceiling debate ends. As the deadline approaches, government officials will come together, extend the ceiling, more money will be printed, and, as we’ve been told, calamity will be averted.

A trillion-dollar coin sounds absurd from the outset. But consider its implications first. Pass judgement after. ABC News explains:

Legislation enacted in 2001 allows the treasury to mint platinum coins of any value without congressional approval. Under that law, the coin's value could be anything, but it would have to be platinum, not gold or silver, nickel, bronze or copper, which are under Congress' control.

Per the Constitution, only Congress has the power to “coin money.” But should this money be backed by a platinum coin, it allows the president to bypass Congress. As for the Federal Reserve, they are not mentioned in the Constitution … 

Giving money creation powers to a president can be dangerous; however, the law can be amended to include congressional approval. And there’s a more important aspect here:

President Joe Biden could order Treasury Secretary Janet Yellen to have a coin with the value of $1 trillion be minted and deposited into the Treasury.

Money creation with an ironic twist may bode well for the free market. But think about the central bankers: Where does this leave the Federal Reserve? Have they not been cut out as the intermediary?

Understand, the Federal Reserve does not physically print money. That is the job of the US Treasury. Unintentionally, the very essence of the trillion-dollar coin calls into question the role of the Federal Reserve and should make people wonder why their bills are marked Federal Reserve Notes. Through bypassing the Fed and existing without debt creation, the trillion-dollar coin has the propensity to make the Fed obsolete.

Choose one of the two (simplified) scenarios, where $1 trillion is being physically printed:

The Treasury mints a platinum coin granting them the authority to print $1 trillion and deposit it in the USA’s bank account; this is money creation without a debt burden and without the Fed.

Or we maintain the status quo. The Treasury prints $1 trillion and gives it to the Federal Reserve. The Fed literally does nothing except send the money back to the Treasury, which then deposits it in the USA’s bank account; same money creation as the previous scenario, except now the money is owned by the Fed.

The difference is clear, as the Fed provides no value-added activity in the money creation process. Under free enterprise, there is no market for the Federal Reserve. It only exists due to a government-granted monopoly on the US dollar.

It leads us to consider whether money should even carry an unpayable debt. Gold, or bitcoin for example, carry no debt. But when the Fed is involved, our money is debt based and the benefit to society can scarcely be defended.

Watch carefully to see what inflationists and the debt-doesn’t-matter crowd have to say. Janet Yellen exposes many errors:

The platinum coin is equivalent to asking the Federal Reserve to print money to cover deficits that Congress is unwilling to cover by issuing debt, it compromises the independence of the Fed conflating monetary and fiscal policy, and instead of showing that Congress and the administration can be trusted to pay, to pay the country’s bills, it really does the opposite.

Someone should inform Yellen that the government's deficits are already covered by money printing. While Fed independence is a red herring, monetary/fiscal policy was compromised long ago.

More analysis is required. But with absolute certainty, $1 trillion will be printed by the Treasury in the not-too-distant future. This process does not require the Federal Reserve. The question for now is whether or not we want the Fed to get their cut. Or should we strive to live in a country not shackled down by central banking?

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The Evolution of Bank Runs

They can start with as little as a rumor; whether fact or fiction, some new information emerges that spooks depositors or investors, or otherwise convinces them that the institution to which they have entrusted their money isn’t going to be able to cover its debts or obligations. Predictably, those who had deposited or invested their money at the institution in question lose confidence, and this loss of confidence sparks a run on the bank.

The image that comes immediately to mind probably looks something like this: long lines of anxious depositors queued down the block, more frantically hustling from their jobs to join; inside, tellers issue bills at a plodding pace, counting out notes to those lucky depositors who got to the bank at the first news of trouble, while in back the bank manager paces and frets as the bank’s reserves run lower and lower. 

This scene, familiar to anyone who has seen the 1946 Frank Capra classic It’s a Wonderful Life or is otherwise familiar with the black-and-white photos in economic history textbooks, has virtually no bearing whatsoever on modern bank runs—Northern Rock standing as a notable exception. 

For one thing, in the case of most depositors the entirety of their bank balance is ensured by the Federal Deposit Insurance Corporation (FDIC); that is, whether the bank goes bust or not, they stand to get all the money they lost paid back to them by the government. Second, most money has been digitized; by the time Tom, Dick, and Harry get the news and start running for their cars to get downtown, it’s all over. Third, and most important for understanding systemic risk in modern finance and banking, is the short-term funding mechanisms institutions use to fund their balance sheets.

To highlight and examine the mechanics behind a modern bank run, the climax of the global financial crisis in the autumn of 2008 provides a textbook example, because it was precisely this third facet of modern bank runs that caused Lehman Brothers to collapse so abruptly. 

Banks borrow short to lend long; this is the basic premise of all modern banking, whether commercial, investment, or so-called shadow lending. In the classic case, and even, to an extent, under the early fractional reserve banking of the Federal Reserve System, banks’ biggest stock of capital came from their depositors. These depositors placed their money in the bank, thereby enabling it to make loans, open new locations, or branch out into other product services. The spread, the difference between the lower rate paid to depositors and the higher rate it charged borrowers, formed the basis of the bank’s profits.

This period of so-called 3–6–3 lending, borrow at 3 percent, lend at 6 percent, and be on the golf course by 3 o’clock, was primarily driven to extinction by the onset of high and persistent inflation caused by government overspending. Beginning in the late 1960s, and worsening in the following decade, the hitherto safe and stable banking system operating under the monetary auspices of the Bretton Woods system broke down. The high inflation rates ate away the bankers’ spread, making their former business of taking deposits and lending for thirty-year mortgages a money-losing venture.

So began thirty years of rapid financial innovation. One of these innovations, the repo (repurchase) market, is at the heart of modern bank runs.

Simply put, the repo market is a short-term funding mechanism allowing borrowers to access liquidity from willing lenders. This is done by way of repurchase agreements: contracts that allow a borrower to exchange a securitized asset for cash in exchange for a small premium, or implicit interest rate, to be repaid upon repurchase. These contracts can range as long as a month or three months but typically span just a single day. In the context of modern bank runs, then, it is best to think of these as short-term deposits: losing confidence in the institution into which they are “depositing” money daily, repo lenders pull back, refusing to renew the repo: the following day, shut out of short-term credit markets, the borrowing institution faces an immediate liquidity crisis.

Take the example of Bear Stearns, on the eve of the financial crisis one of the most profitable investment banks on Wall Street. It was regularly financing $70 billion each day through the repo market. This was far from ordinary. Bear Stearns just happened to be the first major Wall Street firm to get shut out of the repo market because of word that it was in trouble due to its exposure to subprime collateralized debt obligations (CDOs) and mortgage-backed securities (MBS). The same thing would happen to Lehman Brothers a week later.

Like deposit-based fractional reserve banks, these financial institutions don’t keep enough assets on hand to cover their obligations. When access to cheap credit dries up, or the value of the assets backing the commercial paper they issue drops suddenly, their hitherto profitable loan book becomes unserviceable. An attempt to sell assets by an institution facing such a sudden liquidity crisis can drastically drop the prices of a wide range of assets, thereby endangering the short-term financed balance sheets of similar institutions. This is why the Fed, following Lehman’s collapse, took the approach that any single failure could mean systemic failure.

Though the profits to be made by leveraging investments using short-term credit instruments were and are enormous, it is almost certain banks would think twice about engaging in such risky behavior were it not for the moral hazard built into the modern US financial system. Beginning in the late 1980s major institutions came to expect that if they got themselves into trouble the Fed or Treasury would bail them out—either directly or by forcing a deal on another bank to absorb their own failing enterprise.

It is a straight line from the savings and loan (S&L) bailout to Long-Term Capital Management to Bear Stearns.

But moral hazard in modern banking is another topic entirely. 

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The Link between Knowledge and Economic Growth

10/06/2021Ryan McMaken

In a thoughtful and thorough article at the Australian publication Quadrant, economist Wolfgang Kasper writes on the Austrian contribution to the role knowledge plays in global economic growth.

Specifically, Kasper provides some helpful observations on the decentralized and specialized nature of knowledge. Unfortunately, though, Kasper veers off course in assigning an excessively exalted role for knowledge in creating economic growth.

It is not knowledge that is the X factor in paving the way for economic growth. Rather, capital accumulation, low time preference, and entrepreneurship are the crucial factors.

Let’s look at the details.

Kasper begins with an informative description of what knowledge is and the Austrian school’s role in understanding this:

I was fortunate in that I came into personal contact with the great economist-philosopher Friedrich Hayek (1899–1992), as well as his friends Fritz Machlup (1902–83), Gottfried Haberler (1900–95) and Karl Popper (1902–94). These Viennese scholars clarified for me what the abstract and many-sided concept of “knowledge” is and what a crucial role it plays in cultural and economic development.

“Knowledge”, I learnt, consists of tested, useful ideas—useful for realising the diverse, changing and complex aspirations of millions of different people. Bits of new information are gradually integrated by rational thought and practical testing into systems of related ideas which constitute knowledge. The information must be based on observed facts. Knowledge may need to be adjusted when circumstances change. An important point is that most knowledge is held in the brains of numerous individuals. Some is made accessible to others when recorded in textbooks, research reports, technical manuals, statistics, legislative and practical publications, or YouTube tutorials. Much valuable knowledge is also incorporated in capital goods.

Two additional key factors in understanding knowledge are the decentralized nature of knowledge and the importance of exchange. Kasper continues:

One of the key points that the Austrians made is that dispersed, specialised knowledge can normally be exploited best by the voluntary co-operation of individuals. This depends on trust and trust-enhancing rules (institutions), such as the rule of law and free markets in which individual property rights can be exchanged. I learnt from my inspiring “Austrian” teachers that knowledge is a production factor, just like physical capital, natural resources and labour.

Moreover, knowledge—in the form of so-called human capital—can be deployed with factors of production, such as capital and land, to improve production:

In combination with other production factors, knowledge (or "human capital") can overcome situations of scarcity. Indeed, the long history of the human race can be seen as a sequence of more and more knowledge creating better physical capital, tapping into more natural resources, empowering labour and overcoming or at least alleviating the deleterious side effects of economic growth.

Kasper starts to run into trouble, however, when concluding:

Thus, knowledge has been the main driving force behind the unprecedented growth of the global economy since 1945. Land has been opened and crops have been made more productive by new knowledge (think of the Green Revolution); new inventions have tapped new natural resources and improved the effectiveness of energy resources and capital goods; labour has become more skilful …

But was knowledge really the key factor in these cases?

Many Austrians would argue it is not.

In Man, Economy, and State, Rothbard writes:

It has often been assumed that production is limited by the “state of the arts”—by technological knowledge—and therefore that any improvement in technology will immediately show itself in production. Technology does, of course, set a limit on production; no production process could be used at all without the technological knowledge of how to put it into operation. But while knowledge is a limit, capital is a narrower limit. It is logically obvious that while capital cannot engage in production beyond the limits of existing available knowledge, knowledge can and does exist without the capital necessary to put it to use. Technology and its improvement, therefore, play no direct role in the investment and production process; technology, while important, must always work through an investment of capital. As was stated above, even the most dramatic capital-saving invention, such as oil-drilling, can be put to use only by saving and investing capital.

Specifically, we might note that many societies have valued “knowledge” in various forms. But, as Rothbard explains:

What is lacking in (underdeveloped countries) is not knowledge of Western technological methods (“know how”); that is learned easily enough. The service of imparting knowledge, in person or in book form, can be paid for readily. What is lacking is the supply of saved capital needed to put the advanced methods into effect.”

That is, saving and investment are the key factors, not knowledge. As Rothbard notes, time preference is more essential here:

A businessman's new investment in a longer and more physically productive process will therefore be made from a sheaf of processes previously known but unusable because of the time-preference limitation. A lowering of time preferences and of the pure interest rate will signify an expansion of saved capital at the disposal of investors and therefore an expansion of the longer processes, the time limitation on investment having been weakened.

It's also important here to note that “time” is a crucial factor—and one that Kasper doesn’t mention. It takes time to build up savings and capital, and it takes time to develop the technological tools that are the fruits of innovation and knowledge.

An additional important variable in this equation is entrepreneurship. Kasper does hint at this in a few places, noting:

The stock of knowledge, which a community owns, grows when people are driven by curiosity or self-interest to risk exploring new ideas and concepts, individually or in co-operation with others. A social climate that favours individualism, enterprise, risk-taking, trust, independence and rivalry (competition) has always been conducive to the growth of knowledge.

But it is not the stock of knowledge in this case which produces the growth. It is the mechanism by which economic growth actually occurs. Randall Holcombe explains:

Research and development, and the production of human capital, can be systematic ways of producing additional opportunities, and of finding those that already exist. That specific knowledge of time and place that Hayek emphasized can play a role in revealing entrepreneurial opportunities. However, if one focuses exclusively on investment in human capital and technological advance, the mechanism by which innovation occurs is left out of the picture entirely. Such investments can produce a more fertile environment within which to search for entrepreneurial opportunities, but it is the entrepreneurial act of seizing those opportunities that produces the engine for economic growth, and that lays the foundation for more entrepreneurial discoveries.

Put another way, it’s not simply “knowledge” that is the critical input here, but a combination of capital—made possible by savings and low time preference—and entrepreneurship which deploys resources in a productive way. Merely pursuing “knowledge” gains us little. Rather, it is a specific type of market-based knowledge that matters.

This also provides additional insights into the fact that economic growth has historically not been dependent on the existence of a technologically sophisticated workforce. Although Kasper warns that "poorly educated" immigrants lessen the quality of the workforce, Lipton Matthews has recently noted that  empirical studies suggest there is not a clear connection between a schooled workforce and economic growth

And then there is the issue of the "knowledge" gap often touted during the old Cold War, and increasingly during the new "cold war" between the US and China. Kasper correctly notes that the "West still has a scientific and technological lead over China," but appears to stick with the premise that with enough devotion to a knowledge-based economy, China will take over the West in economic growth and dynamism. This conclusion is only possible if we ignore the realities of time, low time preference, and saving in economic growth. 

As noted by China researcher Michael Beckley, China is nowhere near overtaking the United States in this regard—which suggests the West overall has an edge as well. Even if China is currently saving more than Americans, or has a society-wide time preference lower than that of Americans, the American economy sits on an enormous store of wealth built up over many decades. Beckley shows time is a key factor here, and even at higher growth rates, it will take the Chinese many decades to build up capital that even rivals that of the US. Moreover, the state-dominated Chinese economy has nothing rivaling the entrepreneurial activity experienced in the US. Unfortunately for the Chinese regime, knowledge is never a substitute for time, savings, or entrepreneurship. 

None of this means a knowledgeable population is of no importance. Moreover, a society that is knowledgeable about the importance of saving, investment, and private property is more likely to ultimately produce more capital. But without actual saving and low time preference, knowledge of their advantages is of little use.  

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Backdraft: Evacuate the Military, Stat

10/06/2021Jason Morgan

For as long as I can remember, my family and I have greeted men and women in military uniform with a “Thank you for your service.” Like many other average Americans, when we see people in fatigues at a local restaurant we sometimes pick up their tab when we pay our own.

My father, grandfather, and great-grandfather served in the United States Navy (my grandfather was in the thick of some of the worst Pacific battles of World War II). Another Morgan, John, was in a Virginia militia during the Revolution. So part of the respect we have shown to soldiers, sailors, and Marines has been in recognition of others engaged in the old family business.

But there is another element to our having thanked so many service members over the years. This element is deeper and much more mysterious, even atavistic. In some way I have long been in awe of people in the military because I believed they were, somehow, sacrificial offerings.

When we laud men and women in uniform with the words, “They keep us safe,” most of us surely mean that by standing on the “front lines of freedom,” by being the “tip of the spear,” the people in the ranks guard us, hold the perimeter beyond which bay the madmen who would kill us in our sleep. This much is on the level. It is common sense to thank the watchman for the service of security in life and property he provides.

But on a much darker level I believe I have long seen the military as a kind of stand-in for myself. Like a strange double in a Conrad novel, the man or woman in the camouflage or the dress blues has, now that I think about it, embodied the wild, primitive non-category of sacrifice, of the blood-price, the one who dies so the rest might live. Thanking military members has been, for me at least, not just an expression of gratitude, but also an acknowledgement of some ineffable connection across the buried cables of the psyche, a recognition that the logic of the world in some way demands that one go down while another remains among the living.

This quasi-religious superstition was shattered in 2021. This past year I have dug up those buried cables of the psyche and cut them in half. I no longer see the military as a guardian or a half-holy avatar. I see people in fatigues now as a threat, the single greatest threat to American liberty.

The first blow to my respect for the military was the deployment of the National Guard to the nation’s capital to protect the political class from the peons who get screwed so that the swamp can prosper. You all remember the scene. People with flags and attitudes busted into the “sacred ground of democracy,” the Capitol in Washington, DC, on January 6, 2021. The “sacred ground of democracy” is reserved for grifting by the “elected” elite, but somehow the peons didn’t get the message. On that January day the political class called in the troops to protect what the politicos rightly called a bigger threat to “American democracy” than 9/11, because nothing will undo the current corrupt order like a populace which takes seriously the last president’s campaign slogan of “No More Bullshit.” Never mind that the only casualty was Ashli Babbitt, murdered by the Deep State. Somehow the National Guard was necessary to protect “sacred democracy” from the demos.

It wasn’t just that this selfish inversion of the selflessness of soldierly sacrifice turned me off to the military-industrial complex forever. I had long believed that the buck privates and hapless petty officers in the rank and file were conceptually separable from the blood-for-money business and full-bore statism by means of which the brass and handlers of the military-industrial complex stuff their bank accounts. I always thought that Lance Corporal Potatopeeler was just along for the ride, taking orders but generally clueless about what goes on above his pay grade.

But when I saw the Guard take the field against fellow Americans I understood that Lance Corporal Potatopeeler was no friend of mine after all. He knows what’s up, and still racks the slide. He could have refused the order to deploy against his countrymen. To my knowledge, not a single Guard member took that high road. Every single one suited up and fell into line. Makes sense when you think about it, though. The military is just another government job—nobody is going to risk his or her pension for something as silly as patriotism or honor. The Guardsmen would have pulled the trigger against Trump voters on January 6. They would pull the trigger against vax skeptics today. Paychecks over patria. Blow number one to the pro aris et focis pieties of the nation-state.

Blow number two was the downfall of the American imperial satrapy in Afghanistan. The “they keep us safe” logic still hung together while the Potomac jihadis held the field in Central Asia. As the puppet government collapsed, though, and the Biden regime’s lies about the situation mounted, a domino effect toppled, in the minds of many Americans, more than just our beliefs about the war or the White House.

The hard truth is that the people fighting in Afghanistan with an American flag on their shoulder did not fight for us. I never cottoned to 9/11 Truther theories, but I am forced to admit that it doesn’t make a difference anymore what really brought the Towers down. The military-industrial complex got everything they wanted out of 9/11, regardless of what really happened that day. Afghanistan, like Iraq, was a phony war. Whether one believes the Truther line or not, the evidence for Pakistani and Saudi implication in anti-American terrorism is overwhelming. But attacking either of those places would have jeopardized the retirement plans of the Joint Chiefs. So the military-industrial complex sent young Americans to die in the Khyber Pass for twenty years in a bloody one-act political theater performance, same routine every day. Go out of FOB, get blown to smithereens, send new recruit out tomorrow on same mission. Pull plug at twenty-year mark, make solemn faces for the lapdog media for a day or two, and then uncork champagne and enjoy retirement package and outstanding dental coverage enjoyed by all Potomac jihadis. Wave a little flag on 9/11 to remember the “sacrifice” of the troops who got ground up in your phony war.

Now that it is clear that the military-industrial complex is the enemy of mankind (is there an official count of the number of war crimes which Washington has committed since it lurched onto the low road of empire in 1861?), and also clear that the military is going to be—already has been—used against Americans, it is time for a “backdraft.” If you are in the military, draft yourself out. If you love your country, do not take the king’s shilling to kill your own countrymen. De-enlist, break ranks, go AWOL, disappear. When the armed forces become domestic MPs, then there are no more patriots in uniform.

USMC Lieutenant Colonel Stuart Scheller called out the military-industrial complex for Afghanistan and is now sitting in the brig on four counts of violating the Uniform Code of Military Justice. United States Army Lieutenant Colonel Paul Douglas Hague resigned his commission over the immoral vaccine mandate and the “Marxist takeover of the military.”  If you are in the military to protect Americans, then you are also living the military-industrial complex’s big lie. Your next assignment will be to enforce a Biden diktat in Florida or Texas, or to corral people demonstrating against utterly unconstitutional COVID lockdowns in New York. Your oath to “support and defend the Constitution of the United States against all enemies, foreign and domestic” is violated de facto by your ongoing cooperation with what has effectively become the military-industrial complex’s Praetorian Guard. You don’t work for America or for Americans. You work for Washington.

If you are still in uniform then ask yourself where your priorities lie. The government, or your country and fellow countrymen? It is time to wake up and “backdraft,” soldiers and sailors and Marines, to get the hell out of the military and join the fight for liberty raging all around you.

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Turkey’s Inflation Problem

10/05/2021Robert Aro

Imagine living in a country where the annual price increase of food is 30% a year. Many in the west are not very familiar with hyperinflation or a currency collapse. But when looking at a historical or present-day worldview, it’s actually not that rare.

On the other side of the globe, the Hurriyet Daily News of Turkey, reported that President Erdogan ordered Agricultural Credit Cooperatives to open:

…1,000 new markets across the country to provide “suitable” prices for consumer goods.

Not only did the government order the opening of stores, but announced the size of the stores at “500 square meters each.” Construction is expected to start soon to provide “cheap and high-quality goods,” said their President. And that:

“Such a move will help “balance the market.”

If it’s difficult to believe that a President could instruct business owners to open stores, it gets stranger:

Turkey sees annual food inflation of nearly 30 percent… Fresh fruit and vegetable prices increased 40 percent in August from the same month of 2020.

While prices increase for countless reasons, it’s a good question to ask: What, if anything, has the government or central bank done to cause these price increases?

The article provides further clues as to what might be afoot:

In early 2019, the government opened its own markets to sell cheap vegetables and fruits directly, cutting out retailers it accused at the time of jacking up prices.

It’s possible the government’s intervention created problems with price signals and the production process, which now manifests through higher prices and/or supply shortages, unless one believes governments can effectively sell fresh fruit and vegetables at more effective and lower costs to the public than the free market.

Even today, the Turkish government maintains a watchful eye:

Recently authorities have tightened inspections over alleged excessive price increases at supermarkets and marketplaces.

As for central bank intervention, less than two weeks ago Reuters announced:

Turkey's central bank unexpectedly cut its policy rate by 100 basis points to 18% on Thursday, delivering stimulus long sought by President Tayyip Erdogan despite high inflation, and sending the lira to near a record low.

Yet under the current mainstream narrative, hiking interest rates is what must be done to fight price increases. Despite high food prices in Turkey, its Central Bank explains the rationale for cutting rates by 1%:

The central bank's policy committee said a rate cut was needed because of the lower core price measures - which strip out food and some other goods - as well as shocks to supply in the wake of pandemic measures.

Meaning inflation was a little low per their measure (which excludes food). Even more surprisingly, is their belief that:

The recent rises in inflation "are due to transitory factors."

If you look at other countries around the world, government and monetary policies tend to mimic each other.

The lessons from other countries become invaluable. In Turkey, the government competes in the marketplace, opening (and possibly closing) stores at will. They also monitor “excessive price increases” in certain industries. The central bank currently holds rates at 18%, continues to offer stimulus, and claims inflation is transitory. After all this manipulation, the Turkish Lira continues to tumble on world markets and prices climb at a pace still incomprehensible to the west.

Putting it all together, Turkey’s national policies and actions of the State do not sound terribly different than what happens in America. Either economics work differently in Turkey and market distortions will never get that bad here. Or, we are being offered a glimpse into the future where the State controls every facet of the market, and the only thing certain becomes capital destruction.

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