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Why Concentrated Wealth Breaks Markets

Hollow, bankrupt states and crisis of capitalism is not a “dystopian future”

It is actually happening now — with almost hourly updates.

Back in 2007, I coined the term, “hollow state.”  Here’s what it means:

The modern nation-state is in a secular decline, made inevitable by the rise of a global market system.  Even developed nations, like the US, are not immune to this process.  The decline is at first gradual and then accelerates until it reaches a final end-point: a hollow state. The hollow state has the trappings of a modern nation-state (“leaders”, membership in international organizations, regulations, laws, and a bureaucracy) but it lacks any of the legitimacy, services, and control of its historical counter-part. It is merely a shell that has some influence over the spoils of the economy. The real power rests in the hands of corporations and criminal/guerrilla groups that vie with each other for control of sectors of wealth production. For the individual living within this state, life goes on, but it is debased in a myriad of ways. The shift from a marginally functional nation-state in manageable decline to a hollow state often comes suddenly, through a financial crisis.

This early analysis was right on.  Seven years later, the “hollowing out” of the developed countries is well underway.  Nearly every nation in the developed world is in a debt crisis, cutting services, and losing legitimacy.

This hollowing out process goes beyond the failure of bureaucratic decision making (a topic we dove into last week) to deliver meaningful results.   It’s also increasingly clear that market-based decision making is breaking down too.

The markets we relied upon to do everything from allocate economic resources to selecting our political leadership aren’t providing us with value anymore.  Instead, we careen from market meltdown to political crisis and back again with no end in sight.

Why is market-based decision making failing?  There are three reasons:

  1. Centralized decision making.
  2. Easily disrupted.
  3. Incompatible design.

Let’s look at all three.

First, extreme wealth concentration has centralized our market-based decision making process.   Too few people have too much control over the decision making process.  As a result, we’ve seen a misallocation of economic resources on a scale only rivaled by the Soviet nomenklatura at its worst.

In practical terms, a very small number of very wealth decision makers allocate the bulk of the investments in our global economy.  They decide where the big money goes, and what gets funded.  These investments, collectively, determine our economic future.

Centralized decision making is a bad way to allocate investments even in a world that is relatively simple and predictable. However, in a world that is filled with technological dynamism and granular complexity, it’s a recipe for collapse.

And that’s what we are seeing. Specifically, our financial elites are grossly mismanaging our economic system.  For example, they’ve built ziggurats of derivative financial complexity that falsely promise rewards and stability not possible in the real world.  Investments so fantastically bad, they can be counted as one of the worst examples of capital misallocation in human history.  A profound squandering of our society’s economic surplus on financial vapor.

Of course, this misallocation is the underlying reason the 2008 crisis almost caused a complete meltdown of the financial system and since it is still going on, why we will experience another crisis like that in the near future.  Worse, this gambling in financial vapor has displaced investments that we need to succeed in the future and why conditions will continue to worse until this decision making process is fixed.

NOTE:  I’ll cover disruption and design flaws of market-based decision making tomorrow.

JR

SUMMARY:  Centralized economic decision making + a world of rapidly increasing dynamism and complexity = economic disaster.

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Discussion — 4 Responses

  • Bob Lynch January 27, 2014 on 7:18 pm

    Can’t wait until the next segment! I rather think that the BANKING and INSURANCE sectors have worked the hardest to abstract their historic and pragmatic purpose in society, largely hand-in-hand. Both expect the gullible to believe that a dormant checking account should incur $35/mo fees (for nothing, not even a statement), and 75% commission structures in the insurance world. With money so uselessly employed, it is a wonder that conventional manufacturing and product design research is working at all.

    Reply
    • John Robb Bob Lynch January 28, 2014 on 10:55 am

      Bob,

      Thanks. You are right, but that’s only the tip of the iceberg. Finance is overhead. It’s nonproductive, yet it continues to grow in influence due to wealth concentration. It is a HUGE burden on the entire economic system.

      JR

      Reply
  • Burgundy January 28, 2014 on 8:37 am

    John says: “…As a result, we’ve seen a misallocation of economic resources on a scale only rivaled by the Soviet nomenklatura at its worst…”

    From our human centric viewpoint absolutely. But during this massive economic misallocation of resources, technology has been advancing exponentially. Even as the people’s Economy (ie. main street) has been left for dead in the gutter and the Nation State has been hollowed out.

    We can of course put it down to bad people causing the problems, the banksters, the elite, the politicos, the rich, the CEOs, etc. But they don’t pile all their ill gotten gains under the bed and their actual spending is usually insignificant in relation to their fortunes. No, they put all their wealth back into the financial system. They’re only a stepping stone, a way point, for the money on its trip to eventual misallocation. They’re just left holding IOUs like the rest of us.

    So where is it all going? Even the global financial system is bankrupt and needs life support from the central bank printing presses.

    Reply
    • John Robb Burgundy January 28, 2014 on 10:59 am

      B,

      Exactly. Wall Street. Main Street. 1600 Penn ave. They are all legacy systems in decline. Technology is obsoleting them.

      The problem is that many people know this in their gut, but they don’t accept it at a rational level yet.

      JR

      Reply