Mark Spitznagel: At What Price Safety?

Mark Spitznagel: At What Price Safety?

07/27/2021Mark Spitznagel

Editor's note: Mark Spitznagel is President and Chief Investment Officer for Universa Investments. He has written about risk mitigation and "tail hedging" in his books The Dao of Capital and Safe HavenHe is a well-read student of Austrian economics, and has applied the insights of Mises and others to his professional work. This editorial, originally published July 20 in the Financial Times here, provides compelling insights into Mr. Spiztnagel's view of "risk mitigation irony": as politicians and investors attempt to mitigate risk, they miss the "unseen," which Frédéric Bastiat admonished us to consider. For Spitznagel, both politicians and investors fail to understand the true (i.e., full) costs of their risk mitigation strategies—the former overcorrect for covid dangers, the latter overcorrect for crashes. For those interested in the distinction between uncertainty and risk in economics, see Frank Knight's Risk, Uncertainty, and Profit and Mises's Human Action, chap. 6.

From public policy to private investing, it is the central question of our time: how high a price should we pay to keep ourselves safe from harm?

And this begs even more fundamental questions: should risk mitigation come at a cost at all, or should it rather come with rewards? That is, shouldn’t risk mitigation be “cost-effective”? And if not, what is it good for? 

Think of your life like an archer releasing just one single arrow at a target. Naturally, you want to make your one shot at life a good one—to hit your bullseye—and this is why you mitigate your risks: to improve your precision (or the tightness of the grouping of your potential arrows) as well as your accuracy (or the closeness of that potential grouping to your bullseye). We often lose sight of this: safety is instead perceived as improving precision (removing our bad potential arrows) at the expense of accuracy.

The fact is, safety from risk can be exceedingly costly. As a cure, it is often worse than the disease. And what’s worse, the costs are often hidden; they are errors of omission (the great shots that could have been), even as they mitigate errors of commission (the bad shots). The latter are the errors we easily notice; ignoring the former for the latter is a costly fallacy.

Of course, we expect politicians to commit this risk mitigation irony. Ours is the great age of government interventionism—from corporate bailouts to extraordinary levels of debt-fueled fiscal spending and central bank market manipulations. Fallaciously ignoring errors of omission to avoid errors of commission essentially is the job of politics, as every government programme involves hidden opportunity costs, with winners and losers on each side.

More surprising, even investors engage in risk mitigation irony as well. They strive to do something—anything—to mitigate risk, even if it impairs their portfolios and defeats the purpose. The vast majority of presumed risk mitigation strategies leave errors of omission in their wake (i.e. underperformance), all in the name of avoiding losses from falling markets.

Modern finance’s dogma of diversification is built around this very idea. Consider diversifying “haven” investments such as bonds or, God forbid, hedge funds. Over time, they exact a net cost on portfolios’ real wealth by lowering compound growth rates in the name of lower risk. They have thus done more harm than good.

The problem is, such safe havens simply do not provide very much (if any) portfolio protection when it matters; therefore, the only way for them to ever provide meaningful protection is by representing a very large allocation within a portfolio. This very large allocation will naturally create a cost burden, or drag, when times are good—or most of the time—and ultimately on average. Over time, your wealth would have been safer with no haven at all.

An overallocation to bonds and other risk mitigation strategies is the principal reason why public pensions remain underfunded today—an average funding ratio in the US of around 75 per cent—despite the greatest stock market bull run in history.

For instance, a simple 60/40 stocks/bonds portfolio underperformed the S&P 500 alone by over 250 per cent cumulatively over the past 25 years. What was the point of those bonds again? Cassandras typically and ironically lose more in their safety interventions than they would have lost to that which they seek safety from.

Most investor interventionism against looming market crashes ultimately leads to lower compound returns than those crashes would have cost them. Markets have scared us far more than they have harmed us.

While Cassandras may make great career politicians and market commentators, they have proven very costly in public policy and in investing. We know that times are fraught with uncertainty, and the financial markets have perhaps never been more vulnerable to a crash. But should we seek safety such that we are worse off regardless of what happens?

We should aim our arrows such that we mitigate our bad potential shots and, as a direct result, raise our chance of hitting our bullseye. Our risk mitigation must be cost-effective. This is far easier said than done. But by the simple act of recognizing the problem of the deceptive, long-term costs of risk mitigation, we can make headway. If history is any guide, this might just be the most valuable and profitable thing that any investor can focus on.

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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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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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Government Spending Cannot "Stimulate" the Economy

10/05/2021Patrick Barron

Government economic policy is completely backwards. We are told that massive deficit spending, interest rates driven to zero, and now higher taxes on the "rich" will bring the American economy out of the doldrums or whatever fake malady seems to be popular. It is hard to imagine an economy in the doldrums when unemployment, the scourge of mankind for decades, is so low that businesses cannot attract enough workers. That's number one; i.e., is the US economy really so bad? I admit that it always could be better, but we are not in the Great Depression of the 1930s, in which one-fourth of those seeking work could not find a job. At least not yet. Stay tuned, though.

Stimulus Spending and the Cantillon Effect

But let's get back to the main point: Whether or not the US economy is underperforming, can government spending help? That has been the mantra since Keynesianism swept the economic and then government hallways shortly after World War II. So, we may ask ourselves, just how does government stimulus spending work? Well, from what I can conclude, the government sells its debt to the Fed (called monetizing the debt, which increases the monetary base), spends it on all kinds of programs, some (but not all) of us get more money in our pockets and spend it. So, we can see that, from government's perspective, spending is the key. More spending MUST mean that the economy is doing better. Keynesian economists call this increasing aggregate demand, just a fancy name for more spending.

The implied mechanism is that more spending via money created out of thin air somehow draws more goods out of hiding. Why these goods were hiding is not quite clear, except that aggregate demand was deemed to be too low. On the face of it, it appears logical. Let's say that you are the surprise inheritor of a great deal of money from a distant relative. Your personal lifestyle certainly will be stimulated. But let's consider the source of this windfall—your distant relative. He certainly did not print buckets of money that he left you in his will. Either he earned the money himself or inherited it from someone who did. In other words, the source of your newfound wealth was previous production. You are the new owner of that wealth. Whether you produced it or someone else, you are the new owner of what Professor Frank Shostak calls "something for something." This is in contrast to receiving stimulus dollars printed by the government. Now you have received "something for nothing." It is pure monetary inflation without any previous production in exchange. Therefore, any stimulus in the form of increased spending is pure smoke and mirrors, masking capital decumulation. The result is rising prices, at a minimum, and possibly hyperinflation if carried too far.

But let me give you two thought experiments. For the first one, let's assume that you and some others are marooned on an uncharted island, similar to the plot of the hit TV comedy Gilligan's Island. The only resources you have are whatever washed ashore when your ship sank, whatever natural resources are at hand, and whatever survival skills you possess. Now let's suppose that some large boxes wash ashore later. You rush to open them and find that they contain millions and millions of dollars in paper Federal Reserve notes. Not knowing when, or even if, you will be found, what good are these millions to you and your fellows? Do you all cheer, because now you all are rich? Since your most urgently desired goods certainly are not paper dollars, I doubt it. You all are left with the original resources—natural resources at hand, whatever goods washed ashore earlier, and your survival skills. But, you may say, I do not live on an uncharted island. I certainly can spend the millions and enrich my life. OK, now let's assume that in the middle of the night Federal Reserve chairman Jerome Powell wakes you and slides a suitcase with a million dollars in Federal Reserve notes under your bed. Wow! What would you do? You might spend a little time thinking how to spend the money, but sooner or later you will take your suitcase of money and start to spend. Then you are shocked to find out that Mr. Powell, like a magical Santa Claus, visited every one of America's 300 million-plus citizens and gave everyone of them a suitcase with a million dollars in Federal Reserve notes, too. You find that all the luxury cars are gone from dealers' lots. When you enquire about ordering one, you find that the price has skyrocketed. When government engages in stimulus spending, the same thing happens, only on a smaller scale. A fortunate few, mostly bankers and bond dealers, get the newly printed money first. They buy current goods at current prices. Good for them! But subsequent receivers of the new money find that prices have gone up and their newly acquired money really doesn't do them that much good. Then people much further down the line as recipients of the new money find that prices have gone up and their incomes haven't gone up nearly as much or not at all (think of retirees on fixed pensions). Rather than enticing production out of hiding, government stimulus spending has caused a transfer of wealth from the later receivers of new money to the earlier receivers of new money. This is known in economic circles as the Cantillon effect.

A Four-Point Plan from Forty Years Ago

So, what can government do, if anything, to aid the economy? I have four main points, all from the Republican platform of 1980. (These four points were articulated by vice presidential candidate George Herbert Walker Bush on the steps of the capitol building in Springfield, Illinois, in the summer of 1980. I was in attendance.)

  1. Return to sound money by freezing the money supply. That requires two reforms. First, do not increase the monetary base by selling government debt to the central bank. Government must spend only what it raises in taxes or obtains through honest borrowing in the bond market. Secondly, forbid the ability of banks to engage in credit expansion through fractional reserve banking, whereby banks themselves create money out of thin air when they increase lending.
  2. Cut government spending. Of course, this is exactly opposite of what government does today, but government spending is parasitical on the real economy. Government does not create goods and services itself. It can only hand out what it has taken from others. It is the private economy that brings people what they most urgently want, not what government thinks they want or what government wants them to have.
  3. Number three, reduce regulations. The free market economy and the legal system are all that is needed to bring people what they most urgently want . Disputes are best resolved in the commercial and criminal justice systems.
  4. Number four, once the budget is balanced, finally goes into surplus, and the debt is slowly being reduced, government can begin to cut taxes. Tax reductions will take money from the destructive power of government spending and increase the capital accumulation power of the private sector. Since the money supply has remained the same, increased production will result in a slow and steady fall in prices, benefiting all levels of society. The cost of living will fall and the standard of living will rise.

The American people need to be told the truth. Government can help the economy only by protecting you and your property. A free market economy, limited government, and the rule of law are the keys to prosperity and peace.

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A Natural Rights and Logic Approach to Guiding Pandemic Policy

10/04/2021Patrick Barron

Government officials at all levels—federal, state, and local—feel impelled to adopt some sort of pandemic policy, from outright lockdowns to mandates for wearing masks under certain circumstances. It all seems quite arbitrary, because it is! I contend that defending natural human rights and using logic can guide us to adopting a proper pandemic policy, even if that policy is to do nothing at all.

First of all, one must accept that the foundation of natural rights is the right to our own bodies. Many people reading this short article may agree with me at this point but will disagree with me as to where this leads via logic. Number one, if we own our own bodies, then no can tell us what to put in our bodies or, conversely, what NOT to put in our bodies. Many may agree that if we own our own bodies, then no one can force us to "take the jab." OK. Now let's expand that to agreeing that no one can prevent us from putting whatever we want into our bodies, including addictive drugs. I'm sure I lost a few supporters after this statement, but it is undeniable from the standpoint of the "we own our own bodies" principle.

Most objections to this hands-off policy fall into two categories. One, that drug addicts will cause harm to others, and, two, that drug addicts will cause our taxes to rise in order to support those who harm themselves and now must be "taken care of." I do not deny that drug addicts may cause harm to others, but they should be prosecuted for the harms they cause, just as we prosecute those who drive while intoxicated and cause harm to others. Being under the influence of a mind-altering substance, whether alcohol or drugs, does not absolve anyone from paying society's prescribed penalty for the harm that one causes. Secondly, society should be under no obligation to provide drug and alcohol rehabilitation programs or to support those who now cannot care for themselves due to their self-inflicted harms. Sounds rather severe, doesn't it? But notice that I said that society should be under no obligation to provide such serves. I did not say that private individuals should not provide them voluntarily. But, you may counter, what if private individuals do not provide these services voluntarily? What now? Well, you have just answered your own question. If we will not provide a service voluntarily, what right does government have to force us to provide it? Who decides what government may force us to provide? If government is our servant and not our master, then it has no natural right to force us to provide for others against our will for any reason, whether it is from self-harm due to drug addiction or because we must support some European-style aristocratic class.

Now let us return to natural rights and the pandemic. Does government have a right to force businesses to close against their will and against the will of their customers? Of course not! The business owners and their patrons have internalized the risk and have chosen either to continue to patronize these businesses or not. But, you may say, doing so may cause the pandemic to spread. That may or may not be true, but it makes no difference. Avoiding patronizing businesses is your right, but you have no right to prohibit others from doing so, either from a logic or natural rights approach. If others internalize the risk and continue to patronize businesses, they do not harm those who do not continue to patronize businesses. How can they? If someone wants to reduce his own risk of infection, all he has to do is protect himself by staying home. He may not force others to do the same, because they cannot harm him if he stays home. This logic becomes even stronger, but is not necessarily required, if a vaccine become available. Now those who feared infection and now are vaccinated can patronize businesses and mingle with others without fear. The fact that others may not want to get vaccinated is no one else's business. We may look upon people who refused to be vaccinated, came down with covid, and perhaps died as having exercised poor judgment, but that is their right. The argument that the unvaccinated spread the disease is of no relevancy either, because they spread it only to like-minded, unvaccinated people.

The bottom line is this: take whatever action you may think is suitable to your own circumstances and leave others to do the same. Let natural rights and logic guide your actions. Those fearful of mingling with others may stay home. Remember the wise words of my favorite philosopher, Yogi Berra: "If people don't want to go to the ballpark, no one's going to stop them."

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Warren v. Powell / The Pot v. The Kettle

10/01/2021Robert Aro

The testimony Federal Reserve Chair and U.S. Secretary Janet Yellen gave this week was one for the ages. Yellen’s duty to please hit new heights and still remains quite beyond belief. Luckily the transcript confirmed her views on the spending bill. When asked:

Secretary Yellen, do you believe that President Biden’s Reconciliation Package proposal, the one with the $3.5 trillion in total spending, will cost zero and be fully paid for?

She replied:

Yes, I do. We have a full program that the President is proposed to raise revenue that would cover the cost of the program.

If true then everyone, especially the rich should prepare for fairly substantial tax hikes in the future. As to how the next bill, and the one thereafter will be funded has yet to be seen.

While amusing, it was Senator Elizabeth Warren (D-MA) who pulled out some big punches, as CNBC reports, saying Chair Powell:

Your record gives me grave concerns. Over and over, you have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed, and it’s why I will oppose your renomination.

Nonetheless, a Powell lambaste from Warren doesn’t seem honest. To be clear, this is the same Senator who vehemently opposed Judy Shelton’s nomination, tweeting:

These fringe economic theories haven’t been named. It’s well understood Shelton made some remarks regarding the gold standard, government manipulation of exchange rates and the Fed’s independence. But what’s the point of economics as a study, if economists can’t discuss such thought provoking topics?

Much could be said about Senator Warren. She’s credited with the creation of the Consumer Financial Protection Bureau (CFPB), an organization which might be even more opaque than the Fed itself, headed by a director who can only be fired by the President for “just cause.”

Per Congressional Research Service Report:

The CFPB is funded through the earnings of the Fed, not through appropriations. The CFPB requests monetary transfers from the Fed to the extent needed to fund its operations, subject to a cap based on a statutory formula.

$517 million was transferred from the Fed to the Bureau of Consumer Financial Protection in 2020! This is impressive as normally we think of the U.S Treasury and the Fed’s stockholders as the entities who receive payment directly from the Federal Reserve.

But let’s humor Warren:

If Judy Shelton is not good because she asks too many questions, and if Powell is not worthy of his job, despite being one of the most accommodative Fed Presidents of all time, then who would Senator Warren want to helm the nation’s central bank?

She doesn’t say, but we can infer from another tweet she made:

Yikes!

It seems she’d want someone more accommodative who will be keen on expanding the money supply and national debt.

On a very serious note, it’s called the Austrian causal-realist approach because Austrian economists concern themselves with the cause and effects of human action; realist because the concern is only for what takes place in the real-world economy. This is very different, if not the opposite, from other schools which concern themselves with purely theoretical ideas that have little to no basis or relevance in reality.

Certainly, we can raise the minimum wage to $15, or even to $25.

And of course, all student loans can be cancelled. More money can go into social security and the government can fund universal child care for everyone in the nation. Nothing is stopping the government from doing this. The question we must ask is: at what cost?

As the tax burden on some doubles or triples, maybe more forms of asset forfeiture would be developed. The national debt would surely skyrocket and the money supply would balloon to unimaginable levels. Even if our central planners were fine with this, there would be some adverse effects to consider.

What happens to all prices, price discovery, savings, production, interest rates, the strength of the dollar… not to mention the infringement on liberty and freedom these policies require?

Someone like Judy Shelton, many laypeople, and any student of the Austrian school would ask these questions, looking for the effects of the action to consider if these are good ideas. Someone like Senator Warren does not. But many powerful people cling to the idea that we can live in a society where debt doesn’t matter and money creation is a public good which carries no consequence.

 

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America Is Not Meant to Recover

09/27/2021Robert Aro

It’s been said that the war is not meant to be won; but what about America’s recovery from COVID-19? Hearing Fed Chair Jerome Powell speak last week as he held interest rates steady and continued with monthly billion-dollar asset purchases didn’t offer any assurances that victory is on the horizon.

The way he uses the word recovery, a word he uses six times in his speech, should cause the public to wonder what exactly is going on. Pay attention to the message he conveys through his various quotes below, starting with some justification of easy money policies:

These measures, along with our strong guidance on interest rates and on our balance sheet, will ensure that monetary policy will continue to support the economy until the recovery is complete.

Meaning, if the recovery never happens, then monetary accommodation will never stop. He continues:

Progress on vaccinations and unprecedented fiscal policy actions are also providing strong support to the recovery… Real GDP rose at a robust 6.4 percent… The sectors most adversely affected by the pandemic have improved in recent months, but the rise in COVID-19 cases has slowed their recovery.

Per above, he cites vaccinations and fiscal response being the reason for a rise in GDP. There exists this bizarre negative feedback loop, because GDP includes government spending. Ergo, the greater the fiscal response (i.e., government spending), the greater the increase to GDP. However, the more the government spends, the worse off society becomes. Yet the worse off society becomes, the more society becomes reliant on the government...

The path of the economy continues to depend on the course of the virus… The Delta variant has led to significant increases in COVID-19 cases, resulting in significant hardship and loss, and slowing the economic recovery.

According to Powell, economic recovery depends on the virus. This is unfortunate as the new Delta variant is taking a real toll on the country.

Luckily, the Fed Committee members closely monitor for signs of the recovery. He speaks of the upcoming asset tapering:

While no decisions were made, participants generally view that, so long as the recovery remains on track, a gradual tapering process that concludes around the middle of next year is likely to be appropriate.

The key phrase being: so long as, meaning the tapering will begin so long as the recovery continues to stay on track. Also notice how he doesn’t mention the start date but believes the end date will be next year, probably June/July.

At last, the speech concludes, but not before reminding us:

Everything we do is in service to our public mission. We at the Fed will do everything we can to support the economy for as long as it takes to complete the recovery.

Something just doesn’t add up. If the Fed will only stop once the recovery is finally complete, then one thing becomes certain: The Fed will never stop helping.

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The Rise of the Digital Hand and The Emerging Class of Digitalpreneurs

09/27/2021Raushan Gross

In An Inquiry Into the Nature and Causes of the Wealth of Nations, Adam Smith described what he called the Invisible Hand - a metaphor to describe the mechanism of the market and the social benefit that individuals who participate in the market in self-interested ways intentionally and unintentionally serve others. The invisible hand guides individuals entrepreneurially to improve their own circumstances, and they unintentionally or unconsciously create social benefits for everyone by serving the ultimate purpose of creating markets, economic growth, trade and prosperity. The invisible hand guides individuals’ purposes to the most needed ends – the benefit that customers value most highly - and they express these purposes by using their skills and resources in market pursuits that benefit the larger society, intended or otherwise.

Alfred Chandler, on the contrary, took the opposite approach and described the visible hand, which he said was a managerial revolution. The visible hand guided the managerial class of large enterprises and replaced the spontaneous order of the invisible Hand with the visible hand of experts managing production, focusing on mass manufacturing and distribution. Alfred Chandler said, "Such internalization permitted the Visible Hand of administrative coordination to make more intensive use of resources invested in these processes of production and distribution than could the Invisible Hand of market coordination." Chandler sought to replace the implicit guidance of the invisible hand with the explicit control of an elite management class and the tools of organizational structure, command-and-control methods and tightly constructed processes.

We are seeing the results of the visible hand today, in the rigid structures of established businesses that struggle to respond to fast-paced change and rapid innovation, and also in the rejection of business by younger generations who see it as elitist and exploitative.

Happily, the visible hand is losing its grip. Today, what I see emerging is the Digital Hand.

Table 1: Descriptions and Characteristics of The Market Hands

 

As Table 1indicates, the digital hand is the enablement of a broad and deep population of new entrepreneurs who have easy access to infrastructure and resources available via the internet and who can connect to every available source of knowledge, expertise and support. The digital hand opens economic opportunities for everyday people who can participate as entrepreneurs in today's economic marketspaces. Ecommerce and digital marketspaces are giving rise to digitalpreneurs, both nationally and globally. Chandler's visible hand has made significant improvements in the production of economic goods and mass service offerings, no doubt. However, never in human history has there been a digital hand guiding individuals who offer services, products, and entertainment, with the power of prosperity except in this current time of mass accessibility of eCommerce platforms.

Recent data suggests that social e-platforms, digital stores, and online marketspaces are a $200 billion industry. The cause of this boon is the result of human action and not of human design; the effect is the opportunity for regular people – not Chandler’s elite - to be guided to economic success by the digital hand. Now brick-and-mortar business models can be offered through a digital marketspace or a hybrid of both click-and-mortar. One person startups or small teams or small and medium sized businesses can harness the virtually unlimited resources of the digitally interconnected global economy and serve its digitally interconnected markets.

Is the entrepreneurial participation of everyday people using digital platforms via the digital hand the final, irreversible shift to free and unhampered markets? Is the level of ease for the average person to be involved in the market process the great breakthrough for individual economic freedom, even though their investment in entrepreneurial endeavors is not as consequential as an investment of a high-profile millionaire or billionaire? In the short run, we see more real people – you, your neighbor, and your friend – profitably exercising their talents, serving consumers, using the digital hand. In the long run, an entire emergent class of individuals can realize their positive impact on society using the digital hand.

With a tremendous uptick in digital businesses opportunities within the past decade, there is anticipation that more digitalpreneurs will arise in the future, thereby expanding this class of entrepreneurs. Facebook's Marketplace has grown to millions of sellers across many countries, providing real people with enormous entrepreneurial and innovative opportunities within just a few years of its formation in the digital space. No matter the division of labor one represents in the eCommerce sphere, there are sufficient and inexpensive marketspaces to enable the expression of entrepreneurship. Poshmark, eBay, Etsy, Shopify, Volusion, and other eCommerce marketspaces have built-in buyer networks serving millions of people. These e-platforms remove arbitrary barriers to the advancement of everyday people who wish to participate in the marketspace. Digitalpreneurs, newcomers, or entrepreneurs transitioning to digital platforms develop entrepreneurial skills and can profit from them.

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