Deutsche Bank: The Market's Current "Metastability" Will Lead To "Cataclysmic Events"

With the VIX slammed at the close of trading on "quad-witch" Friday, sending it just shy of single-digits once again and pushing stocks back in the green in the last seconds of trading, the much discussed topic of (near) record low volatility simply refuses to go away, which means even more attempts to i) explain it, ii) predict what ends the current regime of "endemic complacency" and iii) forecast the "catastrophic" damage to markets when it does finally end as JPM"s Kolanovic did earlier this week, when he set the bogey on a modest increase in the VIX from 10 to just 15.

Overnight, applying his typical James Joycean, stream-of-consciousness approach to capital markets, Deutche Bank"s derivatives analyst Aleksandar Kocic penned his latest metaphysical essay on this topic, which covered most of the above bases, and which postulates that far from "stable" the current market equilibrium is one which can be described as "metastable", the result of widespread complacency, and which he compares to an avalanche:"a totally innocuous event can trigger a cataclysmic event (e.g. a skier’s scream, or simply continued snowfall until the snow cover is so massive that its own weight triggers an avalanche."

He also inverts the conventionally accepted paradigm that lack of volatility means lack of uncertainty, and writes that to the contrary, it is the ubiquitous prevalence of uncertainty that has allowed vol to plunge to its recent all time lows, keeping markets "metastable."

How does the regime change from the current "metastable" regime to an "unstable" one? To Kocic the transition will take place when uncertainty, for whatever reason, is eliminated: "Big changes threaten to explode not when uncertainty begins to rise, but when it is withdrawn." He also points out that while there is punishment for those who seek to defect from a "complacent regime"...

Complacency encourages bad behavior and penalizing dissent – there is a negative carry for not joining the crowd, which further reinforces bad behavior. This is the source of the positive feedback that triggers occasional anxiety attacks, which, although episodic, have the potential to create liquidity problems. Complacency arises either when everyone agrees with everyone else or when no one agrees with anyone. In these situations, which capture the two modes of recent market trading, current and the QE period, the markets become calm and volatility selling and carry strategies define the trading landscape. But, calm makes us worry, and persistent worrying causes fear, and fear tends to be reinforcing.

... such "metastability" is in itself unstable: "Persistence of low volatility causes misallocation of capital. This is how complacency leads to buildup of risk – it is the avalanche waiting to happen."

Unlike Kolanovic who quantifies the "metastable" regime"s thresholds in terms of VIX (warning of catastrophic losses for vol sellers once VIX rises above 15), Kocic instead merely qualifies the factors that build up in the final phase of the "metastable" regime, eventually spilling over (as shown in the chart above), forcing its end in a violent burst of volatility (and a market crash):

Endemic complacency, which continues to take hold of the markets, is likely to play an increasingly adverse role the longer markets continue to operate as they recently have. However, although volatility remains depressed, the risk continues to be pushed to the tails. This is a buildup of metastablity. The longer the stick remains still, the more surely it will fall.

The simplest analogy to "Austrians" like Mark Spitznagel, is the lack of controlled "forest fires" to eliminate old trees (i.e., systemic excess and "zombie corporations" from central bank intervention and record liquidity), ultimately resulting in a catastrophic conflagration of epic proportions -  a lack of "creative destruction" sowing the seeds of the system"s collapse, as Schumpeter would put it:

In the financial forests of our own making, suppression is particularly problematic — and even deadly. Excess and malinvestment thrive for a time, only to be destroyed by ravages caused by their own vulnerability. Yet, as we will see, even such high-intensity "fires" (of the forest and financial varieties) will has up and redistribute resources; in the case of the market, it releases capital to areas previously avoided the to the myopic distortions of monetary intervention. (The Austrian School naturally understood this well, as explained by the Austrian Business Cycle Theory.)

To Kocic, the natural equivalent is an avalanche. Whether one uses a raging inferno, however, or an avalanche as the analogy of what will eventually happen to the market, the message is clear - every passing day that the market remains "metastable" adds to the violent whiplash that will be unleashed once markets inevitable revert back to their "unstable" disequilibirum in the near future.

* * *

Below we excerpt select sections from Kocic"s full essay:

Metastability

Big changes threaten to explode not when uncertainty begins to rise, but when it is withdrawn. Excessive determinism is almost always the biggest enemy of stability. This seeming contradiction is behind the concept of metastability which captures the mode of market functioning in the last years.

Imagine you have to balance a long stick on your finger. By placing it vertically on your fingertip, the stick could fall either left or right from its initial position because standing upright is unstable. However, in trying to keep the stick vertical, you instinctively (and randomly) wiggle your finger. The added randomness (noise) acts as a stabilizer of an otherwise unstable equilibrium. So long as the noise is administered carefully, the stick remains vertical, or metastable. The withdrawal of noise becomes destabilizing.

In general, there are three types of equilibria to distinguish: stable, unstable and metastable. The bottom of the valley is stable; top of the hill is unstable; a dimple at the top of the hill is metastable (Fig). Metastability is what seems stable, but is not -- a stable waiting for something to happen. Avalanche is a good example of metastability to keep in mind -- a totally innocuous event can trigger a cataclysmic event (e.g. a skier’s scream, or simply continued snowfall until the snow cover is so massive that its own weight triggers an avalanche).

Complacency is a source of metastability. It has a moral hazard inscribed into it. Complacency encourages bad behavior and penalizing dissent – there is a negative carry for not joining the crowd, which  further reinforces bad behavior. This is the source of the positive feedback that triggers occasional anxiety attacks, which, although episodic, have the potential to create liquidity problems. Complacency arises either when everyone agrees with everyone else or when no one agrees with anyone. In these situations, which capture the two modes of recent market trading, current and the QE period, the markets become calm and volatility selling and carry strategies define the trading landscape. But, calm makes us worry, and persistent worrying causes fear, and fear tends to be reinforcing.

Persistence of low volatility causes misallocation of capital. This is how complacency leads to buildup of risk – it is the avalanche waiting to happen. For a given level of uncertainty, on the risk/reward curve investors settle at a point that corresponds to their risk limits. This position is determined by the volatility cone on the risk frontier, its width commensurate with volatility.

As volatility declines, the cone shrinks and returns decline. This compels investors to move across the frontier towards higher risk in order to enjoy the same return.

Endemic complacency, which continues to take hold of the markets, is likely to play an increasingly adverse role the longer markets continue to operate as they recently have. However, although volatility remains depressed, the risk continues to be pushed to the tails. This is a buildup of metastablity. The longer the stick remains still, the more surely it will fall.

In the past, (in rates market) we did not have to worry about this issue (until it became too late): Mortgages are negatively convex and that risk was transmitted from homeowners to capital markets through MBS hedging. As a consequence, rates market was negatively convex which maintained support for gamma and provided residual volatility. Mortgage convexity hedging practically disappeared after 2008 with convexity risk moving to the Fed’s balance sheet. The transmission mechanism between homeowners and capital markets was severed. This extinguished realized volatility and encouraged further volatility selling. Any attempt to own volatility was penalized by negative carry.

This change caused the major refunctioning of the rates derivatives market, from an extension of the MBS to an insurance market, and with this the action moved from at-the-money to out-of-the money. This was another blow to realized volatility (a 25bp decline of the mean, from 105bp to 80bp) which dragged down implieds as well.

How Will The 'GREAT DEFLATION' Impact Gold & The Dollar?

By the SRSrocco Report,

The coming GREAT DEFLATION will impact the value of Gold and the Dollar much differently than what most analysts are forecasting.  Unfortunately, most analysts do not understand the true underlying value of gold or the U.S. Dollar, because they base their forecasts on information that is inaccurate, flawed or imprecise.

This is due to two faulty theories:

monetary science
supply-demand market forces

While some aspects of monetary science and supply and demand forces do impact the prices of goods and services (on a short-term basis), the most important factor, ENERGY, is totally overlooked.  You will never hear Peter Schiff include energy when he talks about the Federal Reserve, Commercial Banks, money printing or debt.  Schiff, like most analysts, is stuck on studying superficial monetary data that does not get to the ROOT OF THE PROBLEM.

Furthermore, the majority of folks who believe in the Austrian School of economics, also fail to incorporate ENERGY into their analysis.  For some strange reason, most analysts believe the world is run by the ENERGY TOOTH FAIRY (term by Louis Arnoux).  Without cheap and abundant energy, monetary science and supply-demand forces are worthless.

That being said, as the debate on whether the world will experience, inflation, hyperinflation or deflation will continue to go on and on, I guarantee we are going to experience the MOTHER of all DEFLATIONS.  Again, this will be due to the disintegrating energy sector and its inability to provide sufficent profitable net energy to the market.

The falling net energy and declining EROI - Energy Returned On Investment, are totally gutting the entire market.  This can be seen quite clearly as the U.S. added $4 of debt for each $1 of GDP growth in 2016.  According to the Zerohedge article, It Took $4 In New Debt To Create $1 In GDP:

As a reminder, according to the latest BEA revision, nominal 2016 GDP was $18.86 trillion, an increase of $632 billion from 2015; the question is how much credit had to be created to generate this growth. Well, according to the Z.1, total credit rose to a new record high $66.1 trillion. This was an increase of $2.511 trillion in the past year. It means that in 2016, it "cost" $4 in new debt to generate just $1 in new economic growth!

As we can see, adding $4 of debt to create $1 of artificially inflated GDP is not a long-term sustainable business model.  I get a laugh hearing "Conspiracy Theorists" explain how the ELITE have been planning this take-over all along and have the markets totally under control.  While conspiracies do indeed take place, the ELITE have been SHOOTING FROM THE HIP and WINGING IT just to keep the entire market from imploding.

For those who believe that the elite want to crush the market to buy assets for pennies on the Dollar, I am here to tell you...  it CHAIN"T gonna happen.  When the Ancient Roman Metropolis collapsed from a population of one million people down to 12,000, I can assure you, the majority of the ELITE were wiped out.... KAPUT.

Real Estate values and revenue streams in Ancient Rome evaporated into thin air.  There was no "RECOVERY" or "PLAN B."  Death had come to the once great Roman Empire... for good.

Regardless, the coming GREAT DEFLATION will destroy the value of most assets shown in the chart below:

Of the $369 trillion in global asset values (2015), gold and silver accounted for $3.1 trillion or 0.8%.  That"s correct, not even 1% of total global assets.  Savills Research, who put together the data shown in the chart above, recently published figures on Global Real Estate Investment:

Now, this chart does not represent total Real Estate values, but rather shows how much money is being invested in the Global Real Estate Market (minus China).  Interestingly, global real estate investment has never regained its previous peak set back in 2008.  Furthermore, the data shows that global real estate investment has rolled over and declined since the first quarter of 2016.  This is not a good sign.

This means, deflationary forces may already be taking place in the global real estate market.

How The "GREAT DEFLATION" Will Impact Gold & The Dollar

To understand how the coming GREAT DEFLATION will impact gold and the U.S. Dollar, we must throw out the window all preconceived notions about economics and money.  Any individual who continues to believe in the standard orthodox economic theory, you might as well also accept that the EARTH IS FLAT and infite GROWTH on a finite planet is possible.

Unfortunately, the U.S. educational system and alternative media continue to misinform the public about the role of MONEY.  So, the blind continue to lead the blind as Rome burns... so to speak.

The GREAT DEFLATION is coming due to the disintegration of the U.S. and global oil industry.  As I mentioned in a precious article, the top three U.S. oil companies slashed their Q1 2017 capital expenditures (CAPEX) by 40%, versus the same period last year.  Furthermore, the world only found 2.4 billion barrels of new oil in 2016 while it consumed 25 billion barrels:

I hate to be a broken record, but precious metals investors better WAKE UP.  How many new barrels of oil do you think the global oil industry will find in 2017 as they continue to slash their CAPEX spending even greater than last year??

Regardless, the Fed and Central Banks are propping up the market with more money printing and asset purchases than ever.  This will not solve our financial and economic problems, however it is a last ditch effort to postpone the inevitable.

To truly understand what will happen with the value of Gold and the U.S. Dollar, we have to grasp the data shown in the chart below:

To produce an ounce of gold in 2016 (top two gold miners - Barrick & Newmont), it took $1,113.  Thus, the top two gold miner"s total production cost was 89% of the gold market price ($1,251).  This is why gold stores wealth.  Stored wealth has always been "STORED ECONOMIC ENERGY."  Gold has been the King Monetary Metal because of its rarity in the earth"s crust and its ability not to corrode or tarnish like many other metals.

On the other hand, the U.S. Treasury Department of Engraving and Printing produced a new $100 bill for a mere 13.4 cents.  Thus, the U.S. Treasury"s $100 bill cost of production was 0.13% of its face value, versus 89% for an ounce of gold.

The production cost figures for the U.S. Federal Reserve Notes came from the U.S. Treasury Department of Engraving and Printing, shown in the table below:

It cost the U.S. Treasury $134.14 per thousand of $100 bill"s printed.  While the U.S. Treasury spent more money to produce the lower denomination bills versus their total face value, 71% of the $213 billion of Federal Reserves Notes printed in 2016 were $100 bills.

If we are able to understand the information presented above and are able to do some "CRITICAL THINKING", then it is easy to understand that the U.S. Dollar will suffer signficantlyu during the GREAT DEFLATION..... not gold.

We also must remember, a "NOTE", as in the "Federal Reserve Note", means an "OBLIGATION" or "DEBT."  Money is not supposed to be an obligation or debt.  Money is supposed to be a store of value and medium of exchange.

Thus, when the GREAT DEFLATION arrives, the value of the U.S. Dollar has a much farther way to fall versus gold.  Why?  Because the value of most things, always reverts back to their COST OF PRODUCTION.  The innate value of a $100 bill is a mere 13.4 cents.... so, its value still has room to fall 99%+.

Again... the innate value of most things are based upon their cost of production, not supply and demand.  What"s the use of being in the business of producing goods at a loss????

Here is one last example.  In 2016, total global gold mine supply was worth $103.6 billion.  This figure was based on the of 3,222 metric tons of gold mine supply (GFMS 2017 World Gold Survey), multiplied by the average spot price of $1,251.  The estimated cost to produce this gold was $92.2 billion:

Here we can see that the gold market price, was based on its cost of production.  On the other hand, the U.S. Treasury was able to print $151.7 billion in $100 bills for the total cost of $235 million ($0.235 billion).  Which means, the U.S. Treasury"s production cost was only 0.13% for the $151.7 billion of new currency (fake money) it issued last year.

People need to realize the U.S. Dollar"s value is backed by U.S. debt, which is being propped up by burning energy.  Thus, ENERGY = MONEY.  The huge increase in U.S. and Global Debt means the quality of energy that runs everything is rapidly declining.  Which means, the more debt that is added, the lower interest rates have to go.  It is a one way street.

Analysts who think interest rates need to normalize to a much higher level, have no idea about ENERGY.... ZIP, NADDA, ZILCH.  They look at the markets as if the ENERGY TOOTH FAIRIES run everything.  There are only a small handful of analysts who understand the energy dynamics.  The rest are the blind leading the blind.

The coming GREAT DEFLATION will destroy the value of most STOCKS, BONDS, REAL ESTATE and PAPER CURRENCIES.  The reason Real Estate prices will plummet below their cost of production is due to their 20-30 year financing and their inability to function during the disintegrating energy environment.  The same will be for automobiles and many other assets and items.

Investors need to understand how ENERGY and the FALLING EROI- Energy Returned On Investment, will impact the value of most assets going forward.  Most assets will collapse in value, while a few will hold or gain in value.  Gold and silver will be two of the few that will hold or gain in value during the GREAT DEFLATION.

Lastly, if you haven"t checked out our new PRECIOUS METALS INVESTING section or our new LOWEST COST PRECIOUS METALS STORAGE page, I highly recommend you do.

Check back for new articles and updates at the SRSrocco Report.

What Nassim Taleb Can Teach Us

Authored by Jeff Deist via The Mises Institute,

Nassim Nicholas Taleb does not suffer fools gladly. Author of several books including The Black Swan and Antifragile, Taleb is known for his incendiary personality almost as much as his brilliant work in probability theory. Readers of his very active Medium page will experience a formidable mind with no patience for trendy groupthink, a mind that takes special pleasure in lambasting elites with no “skin in the game.”

“Skin in the game” is a central (and welcome) tenet of Taleb’s worldview: that we are increasingly ruled by an intellectual, political, economic, and cultural elite that does not bear the consequences of the decisions it makes on our (unwitting) behalf. In this sense Taleb is thoroughly populist, and in fact he correctly identified trends behind the Crash of ’08, Brexit, and Trump’s election. He understands that globalism is not liberalism, that identity and culture matter, and most of all that elites don’t understand how randomness and uncertainty threaten the inevitability of a global order. 

Thus Taleb argues the intelligentsia are not only haughty when they plan our future, they are also clueless: fragility abounds, and threatens to crash the Party of Davos. Hubris results from unearned wealth and prominence, coupled with a blindness to the Black Swans lying in wait.   

Born in Lebanon to a prominent family, educated at the University of Paris and Wharton, Taleb was poised to become part of the cognitive aristocracy he mocks. But he was never one of them. His hard-nosed persona, enhanced by a dedication to rigorous deadlift workouts, is quickly evident in his notorious interviews and very public Twitter brawls. His willingness to delve into history and and religion sets him apart from the neoliberals who hope to wish them both away. Taleb writes for the intelligent everyman, and this blue-collar approach also extends to his description of himself as a “private intellectual, not a public one.”

Austro-libertarians will find much to admire in his brilliant takedowns of the “pseudo-experts” he identifies in academia, journalism, politics, and science. But Taleb is no Austrian. While he holds a decidedly jaundiced view of most economists—calling for the Nobel in economics to be cancelled— he does not denounce economics as a field of study per se. Nor does he claim heterodox or reactionary inclinations:

“I am as orthodox neoclassical economist as they make them, not a fringe heterodox or something. I just do not like unreliable models that use some math like regression and miss a layer of stochasticity, and get wrong results, and I hate sloppy mechanistic reliance on bad statistical methods. I do not like models that fragilize. I do not like models that work on someone"s computer but not in reality. This is standard economics.”

While he is not averse to using mathematics and statistics in economics, Austrians share his perspective that both are tools for economists. Statistical models are mostly bunk that provide no value to economic forecasters or investors, despite the highly paid Ivy League quants who produce them. In fact, models often have harmful effect of creating a false sense of relative certainty where none exists. It"s refreshing to see Taleb make this claim so effectively from outside the Austrian paradigm of praxeology. But if his view of economics is mainline, his tone is Rothbard meets Hayek:

I"m in favour of religion as a tamer of arrogance. For a Greek Orthodox, the idea of God as creator outside the human is not God in God"s terms. My God isn"t the God of George Bush.

We know from chaos theory that even if you had a perfect model of the world, you"d need infinite precision in order to predict future events. With sociopolitical or economic phenomena, we don"t have anything like that.

Taleb does see a role for government, and supports consumer protection laws against predatory lending as one example. But he also purportedly supported Ron Paul in the 2012 presidential election, and has indeed mentioned Hayek as an influence regarding the dispersal of knowledge in society. He’s also applied special venom to several worthy targets in professional economics, including Paul Krugman, Joseph Stiglitz, and Paul Samuelson. Taleb labels as “Stiglitz Syndrome” the process whereby public intellectuals suffer no financial or career consequences for being spectacularly wrong in their predictions.

This is especially galling to a man who correctly called (and in fact became wealthy as a result of) economic crises in 1987 and 2008. In both instances, Taleb had “skin in the game” as a market trader. His own money and reputation were on the line, unlike the court economists in the New York Times.

For an excellent (albeit indirect) analysis of how Austrians and libertarians can advance their cause from a minority position, Taleb’s recent article The Most Intolerant Wins: The Dictatorship of the Small Minority is a must-read. He reminds us that a small minority with courage—the most important form of skin in the game— can prevail over the slumbering masses. And he also reminds us that courageous individual actors, not 51% mass movements, drive real changes in every society:

The entire growth of society, whether economic or moral, comes from a small number of people. So we close this chapter with a remark about the role of skin in the game in the condition of society. Society doesn’t evolve by consensus, voting, majority, committees, verbose meeting, academic conferences, and polling; only a few people suffice to disproportionately move the needle. All one needs is an asymmetric rule somewhere. And asymmetry is present in about everything.

Economics is lost, mired in a quicksand of predictive models that fail to predict and macro-analysis that fails to analyze.

Democratic politics is lost, ruined by bad actors with perverse incentives to burn capital rather than accumulate it.

And academia is lost, still stuck in a centuries-old model run by hopelessly sheltered PhDs.

Taleb gets all of this, and does an admirable job of explaining it. Austro-libertarians would be wise to see him as a valuable ally and voice in the ongoing fight against states, central banks, and planners of all stripes.

Bernier’s radical bid to stabilize consumer prices (and make the CAD good as gold)

Submitted by Sprott Money News

Original available: HERE

Conservatives in Canada are rarely regarded as champions of the little guy. However last month, leadership candidate Maxime Bernier made a radical proposal to cut inflation, which would provide enormous relief to ordinary Canadians.

"Inflation is like a tax," said Bernier, who cites Ludwig von Mises, Friedrich Hayek and the Austrian School as his key economic influences. "(It) eats away at our purchasing power, revenues and savings."

Inflation at 2% (the BOC"s current target) may seem small, but it means prices double every 35 years. Bernier"s commitment to ask the Bank of Canada to study the benefits of adopting a 0% inflation target, has attracted surprisingly little attention. But if enacted, it would make the loony a store of value almost as good as gold.

A stable dollar would also make essentials like food, housing and consumer products more affordable to ordinary Canadians.

The higher interest rates needed to implement such a policy, would also boost savings and help to stabilize pension plans, which are increasingly underfunded, due to their inability to generate returns on their fixed income investments.

A hidden "Poloz Tax?"
Bernier"s approach flies in the face of almost all conventional economic thinking. Led by Paul Krugman, governments, tenured university professors and the big banks almost all agree , that GDP growth is best generated though a mix of increased spending financed by rising taxes, borrowing, and most recently central bank financing.

Bernier, who cut his teeth at the free market-oriented Montreal Economic Institute , prior to entering politics, will have none of it.

"You cannot create and grow wealth simply by printing more money and encouraging people to borrow and spend," says Bernier. "The only way to create wealth is by investing more, working more and producing more."

Bernier is a particularly strong critic of the Bank of Canada, which, under Stephen Poloz"s leadership (and others before him), has sharply increased the cost of living for ordinary Canadians.  

For example the average cost of buying an existing home has shot up by 34% since 2013, the year that Poloz took office, according to the Canadian Real Estate Association.
 
"Prices don"t increase because businesses are greedy," says Bernier. Ultimately only the central bank is responsible for creating the conditions that cause inflation."

Benier isn"t alone in his assessment of current central bank rising prices policies; which here in Canada we might call the "Poloz Tax," for lack of a better term.

Ben Bernanke, a former Chairman of the US Federal Reserve, has made similar observations. Bernier is particularly critical about the Bank of Canada"s approach because its effects are hidden to ordinary Canadians.

As John Maynard Keynes himself noted, such measures are hard even for professionals to understand, although the late economist was clear about their effect.

"By a continuing process of inflation, governments can confiscate secretly the wealth of their citizens," Keynes famously wrote. "The process does it in a manner which not one man in a million is able to diagnose." 

Harder work, lower taxes and deregulation 
Bernier balances his sound money stance with a wide variety of proposals targeted to generate organic economic growth, based on demands created in the real economy.

These include for example measures that would encourage business investment, to better enable Canadian companies to compete on the international stage.

Bernier believes that when businesses invest in plant, equipment, software and other productivity-enhancing items, - measures which create or protect jobs and generate spin-off activity, - they should benefit from accelerated tax write-offs.

Bernier is also a strong proponent of deregulation. For example while Canada has long negotiated free trade deals internationally, domestic free trade between provinces continues to be hampered by a variety of protectionist rmeasures.

At first glance, Bernier"s sound money policies appear to be common sense.

However in "tax, borrow, print and spend" Ottawa, they amount to heresy. So much so, that whether Bernier can muster public support against the entrenched interest groups remains an open question.

The fate of the Canadian economy hangs in the balance.

Size Matters - No Country Should Be Bigger Than This

From the perspective of the state, one of the benefits of growing larger geographically is that bigness makes it more difficult for residents to emigrate or cross over borders to escape taxes. 

In his writings on the origins of the "European miracle" that led to the continent"s economic success, Ralph Raico has noted the importance of small states in Europe and the ability to easily emigrate from one political jurisdiction to another. This free movement has been essential in forming a free and open economy and society. Raico contrasts Europe with Imperial China where the state was more easily able to monopolize both natural and human resources through its large size. 

In an earlier article at mises.org, we also explored how the creation of a larger number of (necessarily smaller) states creates more options for residents of the existing states, and thus increases the potential for fruitful migration and escape from overweening state power. 

Larger states, geographically speaking, work in the opposite direction of this, limiting options for relocation, and placing greater barriers in the way of residents who might be looking to change the the conditions under which they live. 

In the case of the United States, for example, the sheer size of the United States requires a potential emigrant to move hundreds of miles from friends and family simply to live under a different national government. Even worse for the potential immigrant is that, in the case of the US, there are only two bordering states. This means, unless the emigrant can gain entry into one of those two neighboring states, he may potentially need to move thousands of miles from friends and family. 

The magnitude of such a move means that an emigrant, in order to visit family members, or conduct business in his or her community of origin, must endure great expense in terms of travel costs and time. 

On top of this, given that 80 percent of the world"s native English-speakers live in the United States, any potential emigrant is also likely to need to learn a new language, which is no small affair. 

This, of course, helps illustrate the absurdity of claims by nationalists that any critic of the local state should simply "love it or leave it" and move somewhere else. Even if that person can gain entry into another state — something that is by no means guaranteed — he would then need to separate himself from friends and family by hundreds or thousands of miles, learn a new language, and be prepared to potentially spend thousands of dollars and take time off from work simply to visit a sick relative. 

Not surprisingly, then, virtually no one emigrates based on political views alone because the quality of daily human life depends largely on a countless number of connections to family, social networks, and business associations that tend to depend on physical proximity to others. Leaving these social and economic networks can come at a great personal cost, and the further one must move from them, the greater the cost may be. 

Thus, the more a state can make cross-border travel expensive, tedious, or time consuming, the more that state can easily impose a wide variety of disincentives to emigration. 

For these reasons, among others, advocates for greater freedom in the movement of goods, persons, and capital, should seek to limit and shrink the size of states. Given that states, by their very nature, rely on extending a monopoly on coercion over a specific area, one can say that smaller states are less state-like. Larger states, by contrast, act more like the quintessential state since they are able to effect greater consolidation of monopoly power. 

Mises"s View of State and Society

Ludwig von Mises believed that states, in theory, could be reduced in size to a single household. That is, he was theoretically an anarchist. However, Mises also recognized that, for practical reasons, individual political jurisdictions were likely to be larger than a single person or household. Writing in liberalism, Mises concludes: 

If it were in any way possible to grant this right of self-determination [via secession] to every individual person, it would have to be done. This is impracticable only because of compelling technical considerations, which make it necessary that a region be governed as a single administrative unit and that the right of self-determination be restricted to the will of the majority of the inhabitants of areas large enough to count as territorial units in the administration of the country.

But what does Mises mean by "compelling technical considerations?"

To get insight into what Mises may mean here, we can extrapolate from Mises"s view of how and why human civic institutions are formed in the first place. 

For Mises, individuals associate with each other voluntarily in order to take advantage of the division of labor. Writing in Human Action, Mises notes:

Every step by which an individual substitutes concerted action for isolated action results in an immediate and recognizable improvement in his conditions. The advantages derived from peaceful cooperation and division of labor are universal. They immediately benefit every generation, and not only Iater descendants. For what the individual must sacrifice for the sake of society he is amply compensated by greater advantages. His sacrifice is only apparent and temporary; he foregoes a smaller gain in order to reap a greater one later. 

Mises continues: 

[H]uman action itself tends toward cooperation and association; man becomes a social being not in sacrificing his own concerns for the sake of a mythical Moloch, society, but in aiming at an improvement in his own welfare. 

In Mises"s view, these efforts to enhance trade and cooperation among human beings lead to the creation of cities and other population centers. 

Moreover, for Mises, the state — properly limited to the function of protecting private property — can potentially assist in creating conditions that facilitate the cooperative behavior he envisioned. Thus, it is the cost of acting as an administrator of law that leads Mises to conclude that certain "compelling technical considerations" are are likely to keep states above a certain minimum size.  

A problem arises, however, when we recognize that this vision of the state exists in tension with the fact that — as illustrated by Raico — the physical and geographical growth of states tends to facilitate the expansion of state power well beyond the role imagined by Mises. 

When contained at a municipal or metropolitan level, state power is one thing. Relocation to a neighboring metropolitan area remains relatively easy. Once states begin to take control of sizable frontiers and multiple municipal areas, however, the situation becomes far different, and states begin to limit and regulate trade and free movement, rather than facilitate it. 

Thus, even if we accept Mises"s idea that there is some level at which economies of scale for state administration may be beneficial, those assumed benefits are increasingly threatened the larger a state becomes.

A Modest Proposal for States on a More-Human Scale

The answer lies in limiting state size to a human scale in which human beings can still associate, travel, and trade across jurisdictional boundaries without incurring a great cost. The standard for "great cost" is subjective, of course, and over time has changed substantially. The cost of traveling 50 miles in the 16th century, for example, is significantly different form the cost of traveling the same distance today. 

There are ongoing attempts by geographers, however, to determine the "natural" size of a region that encompasses a population"s economic, political, and social institutions. In a recent study, for example, Garret Dash Nelson and Alasdair Rae attempted to identify regions that "have been substantively tied together by the forces of urban development, telecommunications, the frictionless circulation of capital, and the consolidation of both public and private institutions." 

Basing their standard of scale on tolerance for commute times, the geographers selected 50-mile commutes as an indicator of how closely tied together is a specific region. The end result was this:

Full methodology and explanation available here. 

The authors then create a suggested map of political units based on the scale of megaregions: 

What are the implications of this analysis? 

Analysis of regions such as these are significant because, even if we accept many of the arguments claiming that states are necessary to facilitate basic infrastructure and services, this analysis suggests there is no need to have states any larger than the so-called megaregion. After all, if one takes the view that states are necessary to streamline legal relations within certain economic regions — as Mises suggested — then this can easily be accomplished at the level of the megaregion. There is no reason, for example, why a single megaregion could not fund its own infrastructure and welfare state through the usual redistributive means. I do not advocate for this sort of redistribution, but am merely recognizing that geographically expansive states are simply not necessary to provide the sorts of state interventions put forward by modern-date social democrats. 

Indeed, many welfare states we find around the world to this day are scarcely more than singular megaregions themselves, as in the case of Finland or Norway. Both states are little more than small handfuls of metropolitan areas surrounded by sparsely populated frontiers. 

Moreover, even military needs, as dictated by geopolitical realities need not require a geographically large state. Historically, these issues have been successfully addressed by membership-based confederations such as the Hanseatic League and the early United States (especially during the 1770s and 80s). In both cases, these groups composed of independent city states or small states successfully addressed outside military threats. In the case of the Hanseatic League, which had no central government at all, this continued for nearly two centuries. 

To this day, of course, small independent states continue to enter into agreements for the purposes of defense and do not require consolidation of domestic power into a central state. 

These realities, however, are unlikely to lead to any re-arrangement of the United States — or any other state — along the lines of smaller megaregions. Even if advocates for interventionism recognized that the "services" for which they advocate could be provided at a much smaller scale, they would be likely to recognize that state power would tend to be more limited by a large number of smaller states than in a world of fewer large states. 

After all, when kept to a size such as that of the megaregions listed here (to use just one example), the persons who live within them could for more easily leave one jurisdiction to do business in another, even on a daily basis. Political jurisdictions seeking to raise taxes and regulatory burdens would be limited by the relative ease of moving one"s business or family to a neighboring jurisdiction. Even worse — from the state"s perspective — those expatriates would still be able to visit friends and family "back home" with relative ease. And, those jurisdictions that sought to engage in various types of prohibition such as those on marijuana, would find it far more difficult to prevent their citizens from easily traveling over jurisdictional lines to spend their money in neighboring areas — thus robbing the prohibitionist states of further tax revenue.

With States, Size Matters

Many advocates for limited government or even laissez-faire government continue to debate the proper extent of state power, or whether states should exist at all. What should be apparent, however, is that even for those who want states to provide certain amenities, many modern states are far, far greater in size and scope that what is even necessary to provide those amenities in the first place. Unfortunately, the primary effect of bigness in these states is to enhance the power of the state and limit the ability of citizens to escape the state"s taxes and impoverishing regulations.