This week we do some review on a very important topic, the velocity of money. If we don’t understand the basics, it is hard to make sense of the hash that our world economy is in, much less understand where we are headed.

The Velocity of Money

The Federal Reserve and central banks in general are running a grand experiment on the economic body, without the benefit of anesthesia. They are testing the theories of Irving Fisher (representing the classical economists), John Keynes (the Keynesian school) Ludwig von Mises (the Austrian school), and Milton Friedman (the monetarist school). For the most part, the central banks are Keynesian, with a dollop of monetarist thrown in here and there.

Over the next few years, we will get to see who is right about debt and stimulus, the velocity of money, and other arcane topics, as we come to the End Game of the Debt Super Cycle, the decades-long cycle during which debt has grown. I have very smart friends who argue that the cycle is nowhere near an end, as governments are clearly increasing debt. My rejoinder is that it is nearing an end, and we need to think hard about what that end will look like. It will not be pretty for a period of time. The chart below shows the growth in debt, both public and private.

But the end of this debt cycle involves more than just debt reduction.  There are a number of ideas we have to get our heads around, including the velocity of money. Basically, when we talk about the velocity of money, we are speaking of the average frequency with which a unit of money is spent. To give you a very rough understanding, let’s assume a very small economy of just you and me, which has a money supply of $100. I have the $100 and spend it to buy $100 of flowers from you. You in turn spend $100 to buy books from me. We have created $200 of our “gross domestic product” from a money supply of just $100. If we do that transaction every month, we will have $2400 of annual “GDP” from our $100 monetary base.

So, what that means is that gross domestic product is a function of not just the money supply but how fast that money moves through the economy. Stated as an equation, it is P=MV, where P is the nominal gross domestic product (not inflation-adjusted here), M is the money supply, and V is the velocity of money. You can solve for V by dividing P by M. By the way, this is known as an identity equation. It is true at all times and all places, whether in Greece or the US.

Our Little Island World

Now, let’s complicate our illustration a bit, but not too much at first. This is very basic, and for those of you who will complain that I am being too simple, wait a few pages, please. Let’s assume an island economy with 10 businesses and a money supply of $1,000,000. If each business does approximately $100,000 of business a quarter, then the gross domestic product for the island is $4,000,000 (4 times the $1,000,000 quarterly production). The velocity of money in that economy is 4.

But what if our businesses get more productive? We introduce all sorts of interesting financial instruments, banking, new production capacity, computers, etc., and now everyone is doing $100,000 per month. Now our GDP is $12,000,000 and the velocity of money is 12. But we have not increased the money supply. Again, we assume that all businesses are static. They buy and sell the same amount every month. There are no winners and losers yet.

Now let’s complicate matters. Two of the kids of the owners of the businesses decide to go into business for themselves. Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP rises to $14,000,000. In order for everyone to stay at the same level of gross income, though, the velocity of money must increase to 14.

Now, this is important. If the velocity of money does not increase, that means that (in our simple island world) on average each business is now going to buy and sell less each month. Remember, nominal GDP is money supply times velocity. If velocity does not increase, GDP will stay the same. The average business (there are now 12) goes from doing $1,200,000 a year down to $1,000,000. The prices of products fall.

Each business now is doing around $80,000 per month. Overall production is the same, but divided up among more businesses. For each of the businesses, it feels like a recession. They have fewer dollars, so they buy less and prices fall. So, in that world, the local central bank recognizes that the money supply needs to grow at some rate in order to make the demand for money “neutral.”

It’s basic supply and demand. If the demand for corn increases, the price will go up. If Congress decides to remove the ethanol subsidy, the demand for corn will go down, as will the price.

If Island Central Bank increases the money supply too much, you will have too much money chasing too few goods and inflation will rear its ugly head. (Remember, this is a very simplistic example. We assume static production from each business, running at full capacity.)

Let’s say the central bank doubles the money supply to $2,000,000. If the velocity of money is still 12, then the GDP will grow to $24,000,000. That will be a good thing, won’t it?

No, because with the two new businesses only 20% more goods are produced. There is a relationship between production and price. Each business will now sell $200,000 per month, or double their previous sales, which they will spend on goods and services, which only grew by 20%. They will start to bid up the price of the goods they want, and inflation sets in. Think of the 1970s.

So, our mythical bank decides to boost the money supply by only 20%, which allows the economy to grow and prices to stay the same. Smart. And if only it were that simple.

Let’s assume 10 million businesses, from the size of Exxon down to the local dry cleaners, and a population that grows by 1% a year. Hundreds of thousands of new businesses are being started every month and another hundred thousand fail. Productivity over time increases, so that we are producing more “stuff” with fewer costly resources.

Now, there is no exact way to determine the right size of the money supply. It definitely needs to grow each year by at least the growth in the size of the economy, the population, and productivity, or deflation will appear. But if money supply grows too much then you have inflation.

And what about the velocity of money? Friedman assumed the velocity of money was constant, and therefore he stated that inflation is always and everywhere a function of the supply of money. And it was, from about 1950 until 1978 when he was doing his seminal work. But then things changed.

Note that nothing Friedman says contradicts the equation MV=PT, if you assume constant velocity. Almost by definition you get inflation if the money supply grows too fast.

Let’s look at two charts sent to me by Dr. Lacy Hunt of Hoisington Investment Management in Austin (and one of my favorite economists). First, let’s look at the velocity of money for the last 108 years.

Notice that the velocity of money fell during the Great Depression. And from 1953 to 1980 the velocity of money was almost exactly the average of the last 100 years. Also, Lacy pointed out in a conversation that helped me immensely in writing this letter, that the velocity of money is mean reverting over long periods of time. That means one would expect the velocity of money to fall over time back to the mean or average. Some would make the argument that we should use the mean from more modern times, since World War II; but even then, mean reversion would result in a slowing of the velocity of money (V), and mean reversion implies that V would go below (overcorrect) the mean. However you look at it, the clear implication is that V is going to drop. In a few paragraphs, we will see why that is the case from a practical standpoint. But let’s look at the first chart.

Now, let’s look at the same chart since 1959 but with shaded gray areas that show us the times the economy was in recession. Note that (with one exception in the 1970s) velocity drops during a recession. What is the Fed response? An offsetting increase in the money supply to try and overcome the effects of the business cycle and the recession. P=MV. If velocity falls then money supply must rise for nominal GDP to grow. The Fed attempts to jump-start the economy back into growth by increasing the money supply.

In this chart from Hoisington, the recessions are in gray. If you can’t read the print at the bottom of the chart, he assumes that GDP is $14.5 trillion, M2 is $8.2 trillion, and therefore velocity is 1.7, down from almost 1.97 just a few years ago. If velocity is to revert to or below the mean, it could easily drop 10% from here. We will explore why this could happen in a minute.

P=MV

But let’s go back to our equation, P=MV. If velocity does slow by another 10%, then money supply (M) would have to rise by 10% just to maintain a static economy. But if we assume 1% population growth, 2% (or thereabouts) productivity growth, and a target inflation of 2%, then M (money supply) actually needs to grow about 5% a year, even if V is constant. And that is not particularly stimulative, given that we are in recession.

Bottom line? Expect money-supply growth well north of 7% annually for the next few years, or at least the attempt. Is that enough? Too much? About right? We won’t know for a long time. This will allow armchair economists (and that is most of us) to sit back and Monday-morning quarterback for many years.

A Slowdown in Velocity

Now, why is the velocity of money slowing down? Notice the real rise in V from 1990 through about 1997. Growth in M2 (see the above chart) was falling during most of that period, yet the economy was growing. That means that velocity had to rise faster than normal. Why? Primarily because of the financial innovations introduced in the early ’90s, like securitizations, CDOs, etc. It is financial innovation that spurs above-trend growth in velocity.

And now we are watching the Great Unwind of financial innovations, as they were pursued to excess and caused a credit crisis. In principle, a CDO or subprime asset-backed security should be a good thing. And in the beginning they were. But then standards got loose, greed kicked in, and Wall Street began to game the system. End of game.

The financial innovation that drove velocity to new highs is no longer part of the equation. Its absence is slowing things down. If the money supply hadn’t risen significantly to offset that slowdown in velocity, the economy would have been in a much deeper recession, if not a depression. While the Fed does not have control over M2, when they lower interest rates it is supposed to make us want to take on more risk, borrow money, and boost the economy. So they have an indirect influence.

And now we come to the policy conundrum for the Fed. They have pumped a great deal of money (liquidity) into the economy. Normally, banks would take that money and multiply it by lending it out (through fractional reserve banking at a potential 9-times factor), increasing velocity and the overall money supply. In the past, the more the Fed increased the money supply, the more banks lent.

But today bank lending is still falling at an average of 15% annually, so far this year. But what if that trend stops?

Corporations in the US have more money on hand than ever in the last 54 years. They are more productive. Their debt-to-equity ratio has been dropping by about 25% for the last 3 quarters, as they repair balance sheets. Capital spending jumped 18% annually in the last quarter. If we are not at an inflection point of rising employment, we are close to it (although we do need at least 100,000 new jobs a month to make up for increased population). And thus are the stock market bulls inspired, and we hit new trend highs weekly.

While growth this quarter will not be as robust as last, it will be fairly good for an economy with 10% unemployment. If you are a Fed governor, you have to be worried that things could turn around quicker than now seems plausible. What if corporations decided to take their cash and start investing in growth?

The last chart showed a small uptick in velocity at the end of last year. What if that is for real? What if we have turned the corner? Then the Fed will have to start taking back the money they have put into the economy, unless they want to see inflation. And indeed, that is what some Fed governors are arguing. They want to raise rates now, or at least signal that they will begin to do so soon. Note there have been a number of speeches by Fed officials of late assuring the bond market that they are aware of the problem, and that they have all the tools they need to keep inflation (and higher interest rates) at bay.

But then again, while there are signs that the economy may be picking up, it is a strange type of recovery. It is what I call a statistical recovery. Let’s look at this litany from my friend David Rosenberg of Gluskin Sheff. He notes that there are measures of economic health other than the stock market and GDP. To wit:

– More than five million homeowners are behind on their mortgages.

– There are over six million Americans who have been unemployed for at least six months, a record 40% of the ranks of the jobless.

– The private capital stock is growing at its slowest rate in nearly two decades.

– Roughly 30% of manufacturing capacity is sitting idle.

– Nearly 19 million residential housing units, or about 15% of the stock, is vacant.

– One in six Americans is either unemployed or underemployed.

– Commercial real estate values are down 30% over the past year.

– The average American worker has seen his/her level of wealth plunge $100,000 over the last two years, even with the recovery in equity markets this past year.

– Bank credit is contracting at an unprecedented 15% annual rate so far this year as lenders sit on a record $1.3 trillion of cash.

– Unit labor costs are down an unprecedented 4.7% over the past year, and what has replenished household coffers has been the federal government, as transfer payments from Uncle Sam now make up a record 18% of personal income (and the Senate just passed yet another jobless benefit extension bill!).”

Wow. 18% of personal income in the US is now from the US government (also known as taxpayers, current and future).

If you take away the punchbowl too soon, you risk strangling a very shaky recovery that is significantly dependent on stimulus spending, which is going to rapidly go away the second half of this year. Further, the Fed situation is complicated by the fact that taxes are highly likely to go up in 2011 (maybe the largest tax increase ever), which will put a serious strain on the economy.

I think the Fed is on hold throughout 2010 and well into 2011, as they see what effect the tax hikes, coupled with decreased stimulus, bring. Next week we will explore the potential effects of the tax hike on the 2011 economy. Stay tuned.

Let me ask for a little bit of help. I am trying to find data on the potential tax increases, and what I am finding is all over the board. In fact, I had intended to write about that topic this week, but simply don’t trust the numbers I am reading. If you have a source or RECENT paper, I would love to see it. Thanks.

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com.

Disclaimer
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

“Masked youths…attacked the head of Greece’s largest trade union, who was addressing the crowd, and hurled stones at the police. GSEE union boss Yiannis Panagopoulos traded blows with the rioters before being whisked away, bloodied and with torn clothes.”

The Daily Mail account put the blame for these disturbances on Germany’s finance minister, who warned the Greeks that “the German government does not intend to give a cent.” At least Bild, a popular German newspaper, was trying to be helpful. It suggested that Greece sell Corfu…and that Greeks get up earlier and work harder.

Meanwhile, from Iceland comes news that every voter with an IQ above air temperature has cast his ballot against a bailout plan. The Icelanders were slated to make good $5.3 billion in bank losses. But why shackle common voters to the banks’ losses? The plan was so outrageous and so unpopular that Iceland’s normally compliant Prime Minister called for a referendum. Given a chance to vote on it, 93% said no. The other 7% probably read it wrong.

Insurrection is in the air. In England, government employees are preparing the biggest strike since the ’80s. In America, dissatisfaction with Congress is at record highs; four out of five of those polled say, “Nothing can be accomplished in Washington.”

Herewith, an attempt to deconstruct the rebel yell. By way of preview, it’s not the principle of the thing, we conclude; it’s the money.

There are more clowns in economics than in the circus. They invented an economic model that has been very popular for more than 50 years – particularly in the US and Britain. It began with a bogus insight; John Maynard Keynes thought consumer spending was the key to prosperity; he saw savings as a threat. He had it backwards. Consumer spending is made possible by savings, investment and hard work – not the other way around. Then, William Phillips thought he saw a cause and effect relationship between inflation and employment; increase prices and you increase employment too, he said.

Jacques Rueff had already explained that the Phillips Curve was just a flimflam. Inflation surreptitiously reduced wages. It was lower wages that made it easier to hire people, not enlightened central bank management. But the scam proved attractive. The economy has been biased towards inflation ever since.

Economists enjoyed the illusion of competence; they could hold their heads up at cocktail parties and pretend to know what they were talking about. Now they were movers and shakers, not just observers. The new theories seemed to give everyone what they most wanted. Politicians could spend even more money that didn’t belong to them. Consumers could enjoy a standard of living they couldn’t afford. And the financial industry could earn huge fees by selling debt to people who couldn’t pay it back.

Never before had so many people been so happily engaged in acts of reckless larceny and legerdemain. But as the system aged, its promises increased. Beginning in the ’30s, the government took it upon itself to guarantee the essentials in life – retirement, employment, and to some extent, health care. These were expanded over the years to include minimum salary levels, unemployment compensation, disability payments, free drugs, food stamps and so forth. Households no longer needed to save.

As time wore on, more and more people lived at someone else’s expense. Lobbying and lawyering became lucrative professions. Bucket shops and banks neared respectability. Every imperfection was a call for legislation. Every traffic accident was an opportunity for wealth redistribution. And every trend was fully leveraged.

If there was anyone still solvent in America or Britain in the 21st century, it was not the fault of the banks. They invented subprime loans and securitizations to profit from segments of the market that had theretofore been spared. By 2005 even jobless people could get themselves into debt. Then, the bankers found ways to hide debt…and ways to allow the public sector to borrow more heavily. Goldman Sachs did for Greece essentially what it had done for the subprime borrowers in the private sector – it helped them to go broke.

As long as people thought they were getting something for nothing, this economic model enjoyed wide support. But now that they are getting nothing for something, the masses are unhappy. Half the US states are insolvent. Nearly all of them are preparing to increase taxes. In europe too, taxes are going up. Services are going down. And taxpayers are being asked to pay for the banks’ losses…and pay interest on money spent years ago. Until now, they were borrowing money that would have to be repaid sometime in the future. But today is the tomorrow they didn’t worry about yesterday. So, the patsies are in revolt.

Several countries are already past the point of no return. Even if America taxed 100% of all household wealth, it would not be enough to put its balance sheet in the black. And Professors Rogoff and Reinhart show that when external debt passes 73% of GDP or 239% of exports, the result is default, hyperinflation, or both. IMF data show the US already too far gone on both scores, with external debt at 96% of GDP and 748% of exports.

The rioters can go home, in other words. The system will collapse on its own.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.

Yesterday marked the one-year anniversary of the rally. The Dow rose a piddly 11 points. Gold sold off $1.

This rally has gone on for so long most people think it is not a rally at all, but a new bull market. Worldwide, it has taken equities up some 73%…making it one of the greatest rallies ever.

What are we to think? Are we alone in thinking it’s still a trap? What happened to the problems that led to the crisis of ’07-’09?

If you don’t think about it too much you might think everything is fine. Stocks are up. Business profits are up. GDP is up. Housing and unemployment seem to be stabilized. What’s not to like?

The recovery is a done deal as far as most people see it. The rescue efforts, initiated by the feds, were a big success…or so they believe. It has been 12 months since the bottom…and the world still has not ended. Everything is back to normal…isn’t it?

The problem in ’07-’09 was that too many people owed too much money.

And what has happened to change that? The net level of indebtedness in the US has actually gone up since ’07!

Huh? How’s that? We’re in a de-leveraging phase, aren’t we?

Well…yes…but only in the private sector. The feds are still adding debt.

Let’s look at the private sector first. There, we find unemployment still around 10%. Adult males in their prime working years, however, have fewer jobs than ever before. One figure we saw shows that only 4 out of 5 of them are working.

That is just the beginning of the problem for these fellows. They’re getting fewer college degrees, compared to women, than ever before. They’re earning less money too – again, compared to women. Fewer are the chief breadwinners in their households. And fewer are even in a household at all – more are alone.

Let’s not get distracted by the suffering of the masculine part of the population…

…we’re looking at what is going on in the broader economy. Is it healthy and growing? Or is the stock market just a honey trap…a bear market trap for the unwary investor?

The private sector is de-leveraging. Not only is the unemployment rate high, the typical family also lost a lot of money when its house went down in price. And since the typical householder is also in his 40s or 50s, he has to consider his retirement and how he’s going to fund it.

Stocks? While they’ve bounced back nicely, the stock market is still well below its highs…and still in a losing position over the last ten years. A 73% gain sounds nice, but it would take a 100% gain to recover the losses of the ’07-’09 bear market.

Houses? One out of four mortgaged houses is still underwater. In some new developments, the figure is as high as one out of two. And there is little likelihood that the owners will be high and dry anytime soon. People no longer expect to retire on the gains from their houses.

This leaves the middle-aged householder without much choice. He has to save money. Remember, the boom of the 2003-2007 period was caused by dis-saving. Now, a higher savings rate will mean less spending for many, many years. This is a fundamental and important change of direction for the economy. It will restrict business growth and restrain profit growth too.

So, is it possible to slough off the crisis and return to business as usual? Nope. Not possible. You can pretend that things are back to normal. You can act as if they are back to normal. You can invest as though they are back to normal. But you can also lose your money.

But they’re not normal at all. They’re different. The 1982 to 2007 period was…mostly…a boom time, caused by rapid increases in debt, asset prices, and consumer spending. The next period is…mostly…a bust time – when asset prices, private debt, and consumer spending go down.

Sooner or later, but probably sooner, the stock market will realize it. Our Crash Alert flag – tattered and faded – is still flying.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.

As we’ve pointed out before, there are two parts to a political system. One part is shrewd, calculating and corrupt. The other is stupid, senseless, and earnest. The first is surprisingly predictable. The second is predictably surprising.

Like the two sides of the brain, people use politics both ways. On the right side, they use it to do something that is completely preposterous…and often completely at odds with their own interests.

Start a war, for example. National pride. Sentiment. Anger. Humiliation. There’s no telling exactly what emotion will stir up the mob. And there’s no telling what mischief it will get up to when it’s been properly stirred and shaken. India was the site of the biggest political demonstration of all time. What was it about? Killing cattle. The Hindu population was against it…

Meanwhile, from Nigeria comes news that the Christians and Muslims are killing each other. And in europe, just a century ago, people tried to kill each other for 4 long years…

But the right side of politics is beyond our scope for today. We’re concerned with the left side…the rational…goal seeking…angle playing side…where people use politics like a burglar uses a crowbar – to get something that isn’t theirs.

For example, a report in USA Today tells us that government employees have used politics to get more money. The paper said that 8 out of 10 professions are better paid by the government than by the private sector.

Lobbyists use the government to get money for their employers. If we read the item in The Wall Street Journal correctly, there were 10,000 “earmarks” in the latest budget bill.

What’s an ‘earmark?’ It’s a special little provision that gives a contract – or other favor – to a specific company, industry, or locality. A congressman might insert a little provision awarding a $100,000 contract, for example, to one of his constituent companies. Directly or indirectly, the company may have contributed $50,000 to the congressman’s re-election campaign…or may be ready to hire him if he is booted out of office…or may have hired his son or daughter. The amount is so small that the rest of the Congress is not going to pay much attention to it. Besides, other members of Congress are doing the same thing. Ten thousand earmarks…that’s more than 20 apiece.

Giving out money to friends and supporters is not exactly what Congress was set up to do. A Congressional Ethics panel was organized to investigate. Its report just came in this week. What did it find? That there was no impropriety; it was just business as usual!

Even the Ethics Committee has been corrupted by the left side of politics – the rational side. Everybody is looking out for Number One. Even the Ethics Committee.

Very predictable. And no harm in that. Everyone does it.

But as the political system matures, it supports more and more people who are looking out for Numero Uno and don’t much care what happens to Numero Duo. And as the host weakens, the parasites become bolder.

Even the right side of politics is corrupted. Instead of going to war for purely absurd reasons, lobbyists for pentagon contractors urge the nation to war for practical ones…specifically, to add to their own profits…and generally to boost employment.

Eventually, between the left side and the right side, the nation runs out of juice. Or worse. When the politicians have squeezed all they can out of existing taxpayers they go to work on those who aren’t even born yet. The debt rises and rises…until it is too heavy to carry. Then, all Hell breaks loose.

A few days ago, the Congressional Budget Office reported that the Obama administration’s deficit forecasts were a little on the low side – $1.2 trillion short over the next 10 years.

How reliable are those CBO forecasts? Not very… The deficits are likely to be a lot higher than either the administration or the CBO now imagine.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.

We are in an era of accelerating change, moving toward a future that will be profoundly different from the past we grew up in. But what will the nature of that change be? What will the future look like? For the last 7 days I have been in an executive program designed by Singularity University ( www.singularityu.org) to give some insight into that complex question. We looked at a number of technological fields, lectured by experts assembled to give us some idea as to where current research is and to where it is going. We visited some of the cutting-edge companies here in Silicon Valley.

Just as interesting, I got to visit with 44 of my fellow information seekers from 15 countries and extremely diverse backgrounds, along with a dozen college students, as well as the faculty. The group ranged from very successful entrepreneurs to academics to relatively high-level government workers to starry-eyed young people just starting out. There were a lot more applicants than could be accommodated, and the staff did a good job of choosing a group of people who all “brought something to the table” besides their entry fee of $15,000. The days were typically 14-15 hours, and there was a lot of discussion amongst us on the topics of the day.

This week we depart from my usual letter on finance and economics so I can report on a few of the ideas I came across. Some truly grabbed my interest, some confirmed my thinking, and others quite frankly either disappointed or alarmed me. This will not be my normal narrative, but rather short observations cribbed from my notes and thoughts. As I am on (yet again) a plane to San Antonio for a speech tomorrow morning, there will not be the usual links; and in some cases I must confess I made notes without writing down the name of the speaker. Mea culpa. So, sit back and let me share what has been a great week. (And I suspect that a few of you will be happy that we are ignoring Greece for at least one week!)

I, Robot

I think the positive surprise takeaway (for me at least) was how far we have advanced in artificial intelligence and especially robotics. Artificial intelligence has been promised to us for decades, and has been a disappointment for so long that I have consigned it to the dustbin of my research. Ditto for robots. I mean, seriously, if the Roomba (a glorified vacuum cleaner) is the best we can do after decades of work, how are AI and robots going to change the world? This is hardly the world that I grew up reading about in Isaac Asimov’s brilliant I, Robot sci-fi series some 40 years ago.

It is all well and good for a single-purpose robot to be designed to make a spot weld on a car, but a general-purpose robot seemed a long way off. As far as AI goes, I am reminded of the old joke about a young geek who specializes in AI sitting at a bar, and this gorgeous blond comes up to him and they begin to talk. One thing leads to another and they end up in her room, where he proceeds to spend the entire night telling her how good things are going to be. AI has been a lot of talk for decades, and as with our geek, not much more.

The robotic sessions were led by Dan Barry, a three-time astronaut and veteran of many space station adventures (as well as appearing on Survivor!). What I saw onscreen and heard about has made me rethink my doubts about robotics. There are significant strides being made in mobility and utility in robotics. I saw robots walking on four feet through very difficult terrain, on ice, and up stairs. Robot “hands” are a lot further along than I had thought. Mobile robots on wheels, and walking balanced on two feet, are working today.

The ability of robots to recognize their surroundings, to differentiate between a table and a glass on the table (which is a very difficult thing to program), to pick up the glass, etc. is advancing at a fairly good pace. Dan is an enthusiastic advocate, and it was easy to get infected with his vision, but I can see a robotics industry in the 2020s actually having some significance in the US and world economy. We explored all manner of potential uses for robots, some with more economic potential than others. I am often asked where the jobs of the future will come from. It may be in robotics.

I was particularly drawn to the personal assistant robot. It is actually plausible to design a robot to be the “maid” in a home, to be able to purchase groceries, to assist the elderly, etc. These are the repeatable types of tasks that can be programmed and learned. We may only be ten years away from a nascent and powerful new industry. Now, this is not the robot of I, Robot. It will not have intellectual conversations with you. But it will respond to voice commands and clean up, put away toys, etc. Cooking, however, other than microwave foods, is a LOT harder. You will have to make your own omelets for a few decades.

The Mauldin Test

When (if ever) do we get computers that are self-aware? Alan Turing proposed in 1950 what has become known as the Turing Test of a machine’s ability to demonstrate intelligence. It proceeds as follows: a human judge engages in a natural-language conversation with one human and one machine, each of which tries to appear human. All participants are placed in isolated locations. If the judge cannot reliably tell the machine from the human, the machine is said to have passed the test.

One participant suggested that in the future, as we get closer to true AI, computers should be tasked with designing the next generation of AI and computers. I pointed at that if we were to do so, then the Turing Test might not be the best way to determine if we had true artificial intelligence rather than just extremely sophisticated programs. I proposed the Mauldin Test. When a computer tells us that it no longer wishes to program a smarter computer, we will have arrived at the point of self-awareness and survival instinct. I suggest that is true AI. Just a thought.

Who Stole My Nanotech?

Ralph Merkle regaled us with the promise of nanotechnology to make anything and everything. Very tiny molecular machines would assemble all manner of things, from roads and homes to furniture to computers. The problem is that this was pretty much the same speech he was giving ten years ago. Not much progress has been made in the ensuing decade. This was perhaps the most disappointing note at the conference for me.

Let me differentiate between nanotech and nanoscale. Nanotech is the ability of very small machines to build useful objects one atom and molecule at a time. Nanoscale is the technology that creates very small objects to do useful things. An example would be carbon nanotubes, which are proving to have all sorts of useful properties.

There is very little money being put into actual nanotech research. We are at least two decades and hundreds of billions away from Merkle’s (and Freitas’ and others’) vision, if even then. It is still in the arena of pure research, far from any potential commercial application. And there does not seem to be a lot of research in the field.

Nanoscale, however, is a different story. Batteries made from carbon nanotubes hold tremendous promise for better storage (by 400 times less weight per watt output). Filtering of seawater to produce fresh water, increased computer speed and power - there is a long and rapidly growing list of nanoscale advances.

If we ever do get actual molecular nanotech, it may look more like biotech, as we slip in on nanotech from the side. After all, combine a few cells and you eventually get a human being. For some, this is the path to robust nanotech.

Water, Water Everywhere, Nor Any Drop to Drink

And speaking of water (above), I was hoping to hear that we were further along with the cheap purification of water. I queried several venture capitalists, who see literally thousands and thousands of business proposals. While lots of people are working on it, they are aware of nothing on the near horizon. Water may be my #1 concern about the future. It is an intractable problem and one that must be solved. There is Microsoft- or Google-type wealth awaiting the team that creates an inexpensive way to purify water. Water management will be a major issue in the future. There are those who think we will go to war over oil or energy in the future. I rather doubt it. Water rights are going to be the issue that will divide nations and peoples unless we can find new technologies to create cheap supplies of fresh water and move it to where it is needed.

The Promise of Biotech

Ok, I am on record of late with my view that biotech is going to be a bubble in the latter part of this decade. I am actually starting to invest in smaller-cap biotech companies that hold what I think is significant potential intellectual property. In conversations with my fellow attendees, I think the consensus is that biotech holds the most immediate promise for transforming our lives.

A little background. The human genome project was launched in 1990. It cost $3 billion. At the time, detractors said it was a waste of time, as it would take a thousand years - and they were right, if you assumed then-current technology. It actually took only 11 years (to 2001), as new technologies were constantly invented. Craig Venter started Celera in 1998 and finished in a dead heat with the government for a fraction of the cost, at around $300 million.

Where are we now? Ray McCauley of Illumina told us of a machine they make that can do the entire human genome in one week. The cost of the machine is $750,000. He predicts that by 2013 the cost of doing your personal genome will be around $100, and in the future the cost will be as little as $1.

A prize has been offered for the first team to sequence 100 human genomes for $10,000 each in ten days or less. The $10 million USD prize, donated by diamond prospector Steward Blusson, will be claimable until the deadline of 4 October 2013. Many scientists around the world think it is highly likely the prize will be claimed before the deadline, probably substantially before.

Moore’s Law says computing power is doubling every few years? That’s so slow and old hat by biotech standards. Genome “power” is doubling every six months. It will be routine for you to get your own human template in a few years.

Those expensive toys that do your genome? Jun Wang (for some firm) in China bought 128 of them. That is the equivalent of being able to process the entire NCBI genome databank every 15 minutes. Although Ray would not say, I got the impression the Chinese simply opened their checkbook and said “How many will you sell us?”

Put this into context. Arguably one of the true US experts on stem cells, Mike West of Biotime, is also going to China to do a joint venture with the leading stem cell researcher there. They will be in human trials soon. (It’s the same story with International Stem Cell Research, which is going to Russia.) Mike lamented to me over dinner that he could not get the trial speed he needs here in the US. There are a lot of other areas of research that are going offshore, too. Biotech is an area where the US has a clear lead today. We are in danger of losing that. Someone at the FDA needs to start a program that can keep up with the warp speed of change in the biotech world, or watch our lead go to the rest of the world, which is quite willing to leapfrog us. For all the talk about jobs, you would think someone would pay attention here.

DIY-Bio

I don’t know how I feel about this next one. It has possibilities for both good and evil. Do It Yourself Biotech (DIY-Bio) is becoming a real movement, akin to the movement created by computer nerds in 1975, looking to build their own personal computers. But the real difference now is that this time they are connected by the internet.

The movement is just what it sounds like. The equipment and technology to do genetic experiments is getting cheaper and easier to access. Literally, some people do it in their closets. Want to drop a duck gene into a pig cell? That could be fun. Do you get a pig that can fly? But you can also test the water ecology around you and do other quite socially useful things, and even have a chance to stumble on a real advance. One teen group in New York recently bought a lot of fish from various restaurants and stores. Their genetic testing determined that 35% of what was sold as a particular type of fish was something else. Just cover it up with sauce and who can tell?

I like the idea of ten thousand people randomly working on solutions to real problems. But, and this is a big but, playing with genes seems a little problematic to me in a non-lab setting. The presenter pointed out that there are all types of really bad bugs out there, and the human race has survived, but somehow that did not allay my concerns.

The next presentation was from Special Agent Edward You of the FBI, who told us that the FBI is paying attention. That made me feel better, until he basically said they were not sure what to do. We can’t dial back the clock, but some self-policing mechanism needs to be set up. As one person pointed out, we require all sorts of licenses for people who want to dive into the ocean. Increased complexity (diving into caves, for instance) requires additional licenses.

I am generally your basic libertarian. Let people do what they want to do - but I think I draw the line here. Access to equipment, materials, etc. ought to require some sort of license and some awareness training. Call me old-fashioned, but just as we don’t let kids randomly experiment with uranium, maybe we should think about how we go about playing God. Don’t get me wrong, I want people experimenting and pushing the edges. I just want someone supervising the sandbox.

Random Takeaways

OK, the next few pages are going to be short paragraphs from my notes, with no real connections among them. Very stream of consciousness. Take a deep breath and dive in.

The major cost of biotech is people. China has cheap people, and that may give them an advantage.

In regards to the DIY-Bio movement, one of attendees behind me said, “OK, does this mean in the future we buy 99-cent bio apps for our iBiophone?” Think about that for a second. Just a few years ago, the thought of 100,000 iPhone apps for a few bucks or even pennies or free seemed ridiculous. Now it is commonplace. By the way, I met a young kid from India. He has an app to turn my letter into a very easy iPhone app and is also programming for the rest of the phone world. Watch for me on your phone in a few months. It is indeed a brave new world.

The theme of the conference was accelerating technology. Things are going faster and faster. I had a thought. Our bodies can take only so much acceleration before we pass out. Will an increasingly fast world have the same effect on our minds? Is there a limit to how much change we can adapt to? Just a question; not sure of the answer.

Greg Papadopoulos, who is the Chief Technology Officer of Sun Microsystems, gave us his thoughts on the breakthroughs that are likely to happen and will change the world as we know it. New approaches to energy efficiency are on the horizon in 5-10 years. We will see a major breakthrough in memory, which will make the ability to remember (store) things really cheap. He speculated that there will be a new energy technology that will come out of left field to completely change the energy equation. By the way, this prediction showed up several times, from a variety of speakers. (I must admit that is also my personal prediction as well.) Greg thinks we will have silicon photonics by 2020 (think faster, more powerful computers). Quantum computing is way out there, but biocomputing may be here in the mid to late 2020s.

Steve Jurvetson, the #1 most influential geek (according to Wired, I think) simply blew us away. I would like to tie him to a chair for five hours and find out why he invested the billions of dollars in the scores of companies he has helped launch. He is focusing on clean tech, as is a lot of Silicon Valley. He sees 5,000 business plans a year. He talks about how we are soon in for Perpetual Future Shock. There are 6 x 10 to the 21st microbes in the ocean. There are microbes that only exist in certain parts of the ocean. We have only begun to explore the world. It is going to take a long time to switch to renewables. Maybe by 2030. He is blown away by how many incredible ideas there are. This is a guy who did his EE major at Stanford in 2.5 years and was #1 in his class. Intimidatingly smart.

As an aside, someone mentioned that at the TED Talks a few weeks ago, Bill Gates made a major commitment to nuclear energy. Did you know that the nuclear waste we already have could power the US for centuries? The technology exists to use it, as France has done for a long time. If someone truly thinks the US should be energy independent from foreign oil, this is the path. And it is green! Why not government-guaranteed loans for nuclear power and a requirement that every state or locality find a place to put a nuclear plant in their area. Pick a locale. If you choose not to put one “in your backyard” then you pay double for your power, which makes the power for the areas that choose to have nuclear plants free! That would attract some voters for nuclear plants. We need to stop sending money to the rest of the world for oil. Now that is stimulus you can believe in! (OK, off my soapbox.)

Another speaker saw potential game changers in low-cost photovoltaics and a smart grid. (Let’s hope he’s right!) He also speculated and laid out the technology to use CO2 as a source for fuel. Basically, you take CO2-emitting sources and use them to feed biofuel farms. Seems plausible.

Christopher deCharms, CEO of Omneuron, blew me away. Seems they can recognize patterns in your brain when you see certain (simple) objects. And they are teaching patients to control certain regions of their brains that have to do with pain. They are having some success, although he stressed that it was early and the tests were rudimentary. That aside, that we are even potentially in that world is amazing.

Jason Bobe from the Personal Genome Project at the Harvard Medical School talked about how they intend to first publish (publicly) 100 personal genomes and then go on to 100,000 in order to create a database for researchers to use to find correlations between certain genes and diseases. I plan to volunteer to be part of that initial 100, if they will take me. I really don’t care who knows my genome, and if it will help move the science forward I am more than ready.

They are also moving beyond the human genome. They can now “sample” your blood to see what kind of exposure to certain diseases, metals, cancers, etc. you have had and then relate that to your genes. That is going to produce some very powerful and controversial results. But what we learn is going to give us clues to how to fight all sorts of diseases.

Jason noted that people who participate have no guarantee of being anonymous. It seems some young man a few years ago, upon hearing that he was the offspring of an anonymous sperm donor, did some research and found out who his father was. “Surprise! I’m your anonymous son!”

In the future, the world will get turned on its head. Instead of 15 minutes of fame, you will only get 15 minutes of anonymity.

The day before something is seen as a breakthrough, it is a crazy idea.

One guy was asking for dollar bills and other small foreign currency. They are doing DNA samples to see where and how many people have touched a particular dollar bill. In the not too distant future, you’d better be careful who you pay with cash if you don’t want to be traced.

Dr. James Canton gave a very interesting talk on the future of the internet. He predicts that within 3-5 years we will live in a blended reality. Everything will be connected. The internet will become self-assembling. In the near future, information will find you rather than the other way around. Future networks will mimic living ecosystems. Web 3.0 will be the Collaborative Web. Not human to human, but human to machine to avatar to network. I am not sure what that means exactly, but he was quite convincing.

Information that finds you? Will there even be a need for me in the future? He too thought the really big surprise in the future would be a new source of energy, not to mention a new search topology with more predictive analytic search. There is a lot more, and if I can get a link to his speech I will.

We are now landing in San Antonio, so I need to call a halt and get ready to hit the send button. What a week!

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. Contact John at John@FrontlineThoughts.com.

Disclaimer
John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Miserable cities…ghost towns…angry voters…

Market flash:

The Dow was flat yesterday. Gold rose $2. And Greece said it was making progress towards cutting its deficit.

Yesterday we looked at America’s most miserable cities. Today, let’s take a gander at its new “ghost towns.”

There are many towns and cities that are losing population…losing key industries…and probably on the verge of extinction. USA Today mentioned some of them in a cover story this Tuesday.

Ravenswood, W. Va., for example. It has 4,000 people and one major business. It’s a one-horse town, in other words, and the nag is leaving. The aluminum works are partly shuttered already, says USA Today; the rest is for sale.

What’s going to happen to Ravenswood? It could become a ghost town.

There are already dozens of towns in West Virginia that are inhabited mostly by ghosts. They’re relics of the booms and busts of the past. Mining, logging, railroads – each one created it own towns. Then, the profitable industries of the 19th and 20th century became unprofitable somewhere along the line. People left. Those who remain live among the shades.

The booms and busts of our time are simply claiming more victims. Cleveland is losing population. So is Baltimore. So are dozens of US cities.

“In the America where things are made the recession has a depression,” continues the report. “According to a new Northeastern University study, one in every six blue-collar industrial jobs have disappeared since 2007.”

And one in five adult males of prime working age is out of work. There are fewer and fewer factory towns in the US…and fewer and fewer jobs for people who work in them. And now comes word that auto sales in February fell nearly 4%. And early estimates suggest that the job report coming tomorrow will be depressing.

“Industrial workers are dinosaurs,” says one laid-off worker, now retraining to be a traveling nurse.

Hmmm… Let’s see. How does this work? No one makes anything anymore. We all become service industry workers…looking out for one another. I give you $5 for cutting my lawn. You give me $5 for cutting your hair. Neither of us has a penny more. How then do we afford to buy anything?

“An industrial town makes products that bring wealth into a community; a post-industrial ghost town as a zero-sum economy – people in marginal jobs ‘serving and paying each other,’” says USA Today.

Services don’t make people wealthier. They may make them more comfortable. But real prosperity requires real stuff – food, cars, tables, light bulbs, iPads.

Of course, you could offer services to people who make these things. A small nation, such as Singapore, for example, could earn a living by offering financial services. A Caribbean island could offer vacations. But what can a great nation like the US offer? It can’t get by on services. And it can’t support half its population on welfare, unemployment and food stamps. It needs manufacturing…it needs to make things…and sell them.

Why doesn’t it do that already? How come so many people are out of work? How come men can find jobs?

Ooh la la…too many questions. But when was the last time you heard a mother proudly announce that her son was going into manufacturing? Or that he was learning to be a machinist? When was the last time you saw a major factory under construction? When was the last time you picked up something in a shop, turned it over and found “Made in America” stamped on the underside?

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.