Why Isn't the Market Listening?

You've probably seen the Disney film, Fantasia, in the segment called The Sorcerer's Apprentice. Mickey Mouse is the apprentice, and he decides to use some of the sorcerer's magic while the boss is away. The experience is glorious, until he realizes that he can't control it any more and he finds himself drowning in a self-created flood.


[Thanks to Wikipedia.org for the illustration by S. Barth.]

Jean-Claude Trichet, the European Central Bank president, must see the market as a kind of sorcerer who is on his way home to save the day. As the Financial Times tells us (here and here), Mr. Trichet has called on financial markets to "help policymakers rebuild the levels of confidence in the banking system required to kick-start economic growth around the world." He "gave a stark warning to financial markets yesterday to stop putting pressure on banks to hold more capital."

But the market is not the sorcerer. It is the water--neither good nor bad, just flowing, or flooding, or drying up, doing what water does.

Trichet's jawboning reveals that politicians and their appointees, the quasi-government officials, are not part of the solution; they're part of the problem. They are Mickey.

It should be no surprise, then, that Mickey decided in 1913 to take over the powers of the sorcerer by turning a market-suggested financial-market-system convenience--the Federal Reserve clearing house set-up--into a powerful and politically expedient government-like macromanager of our money supply. Nor should it be a surprise when he ends up destroying our economy in the process. (See my article on the Fed, Page 1, Page 2, and Page 3 for more.) He's got the broom now, and things are getting out of hand. Mickey can call on every power he possesses, the water will never heed him.

We shouldn't be disappointed when ordinary humans fail at sorcery. It's not really their fault. Our government agents are themselves part of a bigger "market," in a sense. When we go to the polls and vote for more government intervention in our life, we are expressing our political "market" preference for government sorcery.

In our current crisis, here's an example that shows the pickle their in. This article in the FT says:

"Amid the recrimination and hand-wringing over the causes and consequences of the financial crisis, bankers and policymakers at the World Economic Forum in Davos have identified a new threat to global prosperity: the rise of financial protectionism. The huge state-backed bank bail-outs in Europe and the US, while necessary to prevent a collapse of confidence in the financial system, have forced banks to withdraw from overseas markets in order to concentrate their limited resources at home. ... The sharp reversal of capital flows appears at least partly due to political pressure on banks, especially those that have received large doses of state support, to sacrifice international operations in favour of maintaining lending to domestic consumers and companies. For governments attempting to explain their decision to commit hundreds of billions of taxpayers' money, this is an understandable response."

Likewise, when our factory workers start to hurt, the government becomes protectionist on that front as well. In 1930, Roosevelt's Congress, in response to public pressure to "do something," forced the market to "buy American" by passing the Smoot-Hawley Tariff Act. This Tariff turned out to be one of the main reasons the country didn't recover from the Great Depression until a decade later.

Here's more evidence of the public's growing protectionist spirit in the form of restrictions on purchases of steel with the stimulus package. (At press time, Obama seems to be rethinking this, but he will have to disappoint his base to do anything about it.)

Another example of forthcoming problems for the Sorcerer's Apprentice: The stimulus package won't work the way it's intended. You can't force banks to lend by throwing money at them, because as one banker put it, paraphrased by the Financial Times, "it is difficult to make loans to companies and individuals as most new lending would be loss-making and end up burdening their balance sheets with further writedowns." (FT Article.)

You can't buck the market. Nor can you force home buyers to buy when they know darn well prices will go down even more. Furthermore, when the government borrows money to spend on its own projects, it takes it away from the very people it is trying to help: capital-starved small businesses.

If we step back for a better perspective, clearly we are confronted with a culturo-political phenomenon: People have turned to government to cure a problem of government's own making. That's like asking Apprentice Mickey to solve the water problem.

There is one natural market phenomenon that will get Mickey back onto dry land in the longer run. It is a return to some form of a gold standard. This standard evolved in the marketplaces of the world over the centuries, and it would exist today if government agents had not decided to force their citizens to abandon it by declaring paper money to be our only legitimate legal tender.

Reality Check: The Government Stimulus and Bail-Out Plan

Today is a cartoon about the government stimulus and bail-out packages. I think it's self-explanatory. (Click on the image for a larger version.)

Italy Suggests Global "Legal Standard": A Viable Financial Measuring Stick?

In today's Financial Times, we find an article by Guy Dinmore entitled "Italy calls for 'legal standard' on world finance."

Italy's finance minister Giulio Tremonte thinks he can persuade the G7 to adopt a new global financial standard--"just as once there was a gold standard"--to discipline world financial markets. He thinks he has the support of France's Sarkozy and Germany's Merkel.

The idea is to bring "tighter financial regulation" through a "legal standard" that would be "the minimum basic set of rules on propriety of international activities and transparency which the whole international community is expected to respect."

Hm. Nice idea. But...

My first reminiscence was about the UN, an optimistic creation that came about in another time of abject pessimism. The second was the Bank of International Settlements, intended to regulate foreign exchange after it became apparent that the world was abandoning the gold standard. My third was the Doha round of talks, meant to free trade relations as the international community struggles with the seeming impossibility of applying free-market theory to the real world.

I stopped there. No point in prolonging the agony: These three international cooperative efforts--but not only these three--have been failures. I wonder where Italy's finance minister gets the courage to attempt another such unrealistic idea.

According to the article, he thinks that the trading nations of this world would abide by "a mix of voluntary and binding codes" that "would be closely monitored with a wide range of tools, including peer review, naming and shaming, indicators and 'black listing ... for "rogue" economies.'"

OOooooooo. These sound ree-e-e-e-eally scary (not).

The Organization for Economic Cooperation and Development is helping work out the details. They will suggest "an anti-bribery convention, principles on corporate governance including state-owned enterprises, guidelines on multinational enterprises, standards of transparency and cooperation on tax, principles on disclosure of financial information, existing G7 task force recommendations on money laundering, and standards on international property rights."

Remember, every nation would have to participate to make it work. I wonder how many legislators of participating G20 countries would tremble at the thought of being named and shamed--places like China, Russia, Argentina, ... why, even Europe and the US.

As recently as yesterday, the USA--the supposed bastion of the free market--raised the (already existent) import tariffs on French Roquefort goat cheese. (See this article in the French newspaper Le Monde.)


"What?!? Qu'est-ce que tu dis?!?"

[Thanks to Lepetitcochin.fr for this picture of their cute little French goats, admittedly from Poitou and not Roquefort.]

Did you know Americans already pay a 100% import duty on Roquefort cheese, and that it will now go up to 300%? And that you will now have to pay 100% duty on French "meat, fruits and vegetables, mushrooms, cereals, chewing gum, chocolate, chestnuts, fruit juices, mineral waters, and fat products"?

Of course, this will spark a lawsuit by the European authorities at the World Trade Organization (WTO) against the US. Their statement (my translation): "It is clear that this decision of the American administration signifies that we will have no other choice but to begin preparations to bring this matter to the WTO. Important efforts have been made to find a set of rules that could be accepted by the various parties in the current conflict. This task has now been rendered more difficult."

Oh, I forgot to tell you that the EU had previously banned US beef on the (unsubstantiated) grounds that the hormones in it are dangerous.

Just like a couple of five-year-olds.

Does Mr. Tremonti really think a "legal standard" will do the trick? I doubt it. His ideas are in a huge bag labeled "Wishful Thinking," especially when you consider that the supposedly most capitalist countries of them all can't even stop bickering about beef and cheese (never mind get rid of subsidies of American sugar, rice, et al., or agree to abide by some vague and relative international financial "legal standard").

The irony is that the international community is passing by the very thing that has any chance in hell of carrying some weight: The gold standard itself, or some modern form of it designed to avoid the pitfalls that caused its demise in 1971.

The gold standard, as contrasted to a "legal standard," is tangible, physical, and precise. It is literally measurable, not just approximate. It is based upon something with a specific density, weight, and chemical composition, whereas a legal standard is based upon morality; and everyone knows that morality is relative when it comes to politics.

That the world might obey such a solid, modernized gold standard is perhaps also a pipe dream. I'm not saying that it would not need legal backing; quite the contrary. It will indeed need sharp judicial teeth. But those teeth would at least have a solid-gold jawbone as a foundation, and not just international good will, which would be a standard with about as many rotten holes as Roquefort cheese.

Government Bonds: The Latest Bubble, but Probably Not the Last

These days US Treasuries can do no wrong. No matter how much interest dips, they're just the hottest thing in town. The bird in the hand theory of finance, I suppose. But is this bird really in hand, and for how long?

One would think that the bond market has already factored in the upcoming big-spending stimuli planned by a number of G20 players; but, even though the printing presses have already begun their magic in earnest, the amounts that have already been distributed have yet to have an impact on the economic outlook. Recession and deflation seem to be what are on everyone's mind.

But for how long? We know that markets are fickle. And supple. They can turn on a dime.


Thanks to Tfdclowns.com for this picture of Huffy turning on dime.]

Once the presses get churning at billions a minute, and whether or not deflationary pricing stops, what will the markets do? Could they turn this bond boom into another burst bubble?

The world has been awash in credit and in the chimera of purchasing power the sheer mass of it seemed to engender. It flowed into the real estate bubble until 2006, then to the stock market bubble in 2007, then to commodities in 2008. Each one came rushing down like something at Magic Mountain, only to see the remaining cash hop on again for another loop with bonds.

Government bonds are the last safe haven before ... there's only one thing left after government bonds: Gold. But that would mean a flight from paper currencies altogether. Are we that far gone?

We'll soon find out. Foreign bonds will have a tremendous amount of competition soon, once the US and other debtor nations begin to borrow to the max. Cash may still flow into these government bonds for a while, but as stated in this editorial in Friday's Financial Times, "finance ministers must make plain how they intend to keep paying creditors without resorting to debasing their currencies. Those who have not already credibly done so are living on borrowed time."

And just which have done so in a credible fashion? I'm hard-pressed to name one.

So I'm betting that gold will be our next, and perhaps last, bubble, at least for this time around. (Disclosure: Yes, I do own some gold-related assets. I'd be a hypocrite if I didn't.)

In case you haven't seen my mantra, I'll repeat it for you:

"You can take the gold out of the standard, but you can't take the standard out of gold."

We have a Republic, not a Democracy

This little film (click on the link at "little film," not on the picture below) explains very nicely why what we need is less government, more freedom; less democracy, more republic.


[Thanks to Wimp.com for the still image I captured.]

If you've ever searched for a short visual to explain the essence of the US Constitution, this is it. I wish I could find out more about the people who made it. The Wimp.com website is very succinct, to say the least.

We need more of this.

Wait! There is more!

Find out about it on the Moving Picture Institute's website. I'm trying to get Netflix to acquire some of their products. The Institute screens their films in scheduled sessions around the country, and some have been distributed on a grand scale. The movies are excellent.

Film is a fantastic medium for the transmittal of ideas, good or bad; and Big-Government exponents are good at exploiting it. We need to sharpen up our drama skills to take advantage of this medium (and get a sense of humor while we're at it).

Economics used to be called "political economy," and for good reason. You can't have economics without politics, and you can't have politics without economics. They go hand in hand, sometimes to our detriment if we don't watch out.

Inflation Target: Getting it Right

In today's context of financial disarray, verbal clarity is vital. Many financial commentators, and even some serious economists, make grave errors that sprout from the misuse of terminology.

One of the most mangled of these terms is "inflation." This word has come to mean two different things over the last century, both in the understanding of the public and in the mind of otherwise highly erudite scientific economists. Some speakers and writers mix the two variations within the same paragraph.

Here are the two distinct meanings that they often confuse:

1. [Price] Inflation: The degree of increase in the CPI and other price indices. More and more, this is the meaning used by some of the most influential people in the world today, among them even most of the Federal Reserve Board members, legislators, and former and future presidents. It's the one we all understand when we see the word "inflation" in the news media.

However, there is another, in fact more precise, economic meaning of the term:

2. [Monetary] Inflation: The rise in money supply, i.e. of money and credit, over and above what the market requires, leading always to eventual price distortions. These distortions may manifest themselves in CPI increases, or they may not. They may appear instead as speculative bubbles such as the real estate bubble of 2006. Such bubbles reduce consumer purchasing power, relative to what it would be if there were no bubbles, through the siphoning off of corporate wealth to speculative activity, rather than towards increasing worker wages and funding solid new capital ventures.

This may come as a surprise to you, but this second meaning is the one in Webster's New World College Dictionary, 4th ed., as I noted in my May 2007 post. Here is the exact Webster's quote:

"inflation ... 2a) an increase in the amount of money and credit in relation to the supply of goods and services b) an increase in the general price level, resulting from this, specif., an excessive or persistent increase, causing a decline in purchasing power. [emphasis added]."

How amazing to find that Webster's is more precise and on point than most economists today, including the research staff and board of the Federal Reserve, the very people harnessed with the responsibility for controlling the same phenomenon that they cannot define or use correctly in their research--with dire consequences.

In a recent article by Krishna Guha of the Financial Times, we learn that the US Federal Reserve is moving "to establish a de facto inflation target in order to shore up inflation expectations and reduce the risk of deflation." This "inflation target" would be based on a measurement of the "personal consumption expenditure deflator on average over the medium term." The "personal consumption expenditure deflator" [PCECTPI] is the measuring stick used by the Fed to calculation the "rate of inflation."


[Thanks to Joe-ks.com for the image.]

Admittedly, the Federal Reserve has an impossibly fuzzy mandate. (See my Los Angeles Business Journal article, Page 1, Page 2, and Page 3.) They are supposed to (1) maintain full employment, and (2) control "inflation." But which one? The text of the law is unclear.

My cursory study of a number of the Federal Reserve's research papers, including this one written by Ben Bernanke, allows us to draw the conclusion that the Fed believes they can best fulfill their dual mission by maintaining "price stability," and that they see a clear cause-and-effect relationship between "zero inflation" and "price stability."

It would seem, then, that the Fed does not see any other way of measuring the appropriate amount of money and credit the system needs other than by trying to interpret the effects of their monetary adjustments on general prices, as seen in their version of the CPI, the above-mentioned PCECTPI.

Is that the way to measure the efficacy of their monetary interventions? I don't think so.

For example, I can think of a number of situations that would show zero inflation on the PCECTPI statistics, i.e. perfect "price stability" according to the Fed, but where the public would be the victim of monetary theft through reduction of purchasing power (which is mentioned in the text of law, if my memory serves). Here's one:

Imagine a new technology that cuts the cost of production of all manufactured things in half. (Over a period of a few decades, such advances have done exactly that, if not more.) Imagine that the Fed, by targeting "price stability," allows the money supply to reach a point where it causes the price index to read zero, or perfect price stability. (They currently are not aiming at zero, but rather 2 percent annual increase.) Isn't it clear that, over time, at price stabilization, their actions would be forcing us all to pay at least twice as much as our products are worth?

This sounds like an exaggeration, and I realize that it doesn't take into account the increases in our wages. But this is essentially what the Federal Reserve has done. And have our wages truly kept pace with price inflation? Certainly not in the last few years.

But where has monetary excess gone if it isn't in general prices? It has gone into the hands of our more playful producers and speculators, to create the dot-com boom and the more recent real estate and Wall Street bubbles. Why work for a living when you can make more money so much more easily by playing poker?

The Fed's major booboo in economic analysis stems from--well, first of all from their lack of humility, but also from their underlying confusion of the difference between Price Inflation and Monetary Inflation.

What the Fed needs to fight is "inflation" as defined in Webster's dictionary, i.e. excessive money and credit creation; and targeting price stability will just not do the trick.

However, they are bankers, not supermen. We may have given them an impossible task. And if they can't find a modern tool to do a better job, they should reinstate one that has functioned pretty well for centuries, a monetary measuring stick (gold has worked pretty well), so that the market can find money-and-credit equilibrium itself.

Keynes vs. Von Mises

In this weekend's Financial Times, we find yet another article dismissing the Austrian economists as a bunch of moralistic nitwits and praising John Maynard Keynes for his "great insights."


[Thanks to TheAdvocates.org and Wikipedia.org for the images.]

In Is your recession really necessary? the FT editors demonstrate their misunderstanding both of the errors in Keynes's delusions, and of the true value of the only economic analysis of business cycles that actually gets it right.

Keynes's idea, according to the article, is that "[g]overnments must respond [to signs of recession] by supporting demand with loosened monetary and fiscal policy. These weapons are slow-acting blunderbusses; they do not allow for rapid responses or fine-tuning. ... It is not possible to liquidate the malinvestment without risking allowing unemployment to spiral out of control and demand to fall with it. ... [G]overnments must work together, internationally, to sustain demand. They must not sit idly by."

On the other side of the issue, the article quotes the Austrian Ludwig von Mises as disagreeing:

"[P]olicy that aimed to 'bolster up undertakings that would otherwise have succumbed to the crisis, and on the other hand to give an artificial stimulus to economic life by public works schemes ... eliminated just those forces which in previous times of depression have ... paved the way for recovery'."

The editorial critics dismiss the Austrians as "liquidationists," gloom-and-doomers who believe in the Biblical dictum that you reap what you sow. Economists like von Mises and von Hayek, they think, are no more than repressed social conservatives who confuse science with religion.

But the editors have misjudged two things: (1) the solidity of the Keynesian formula, and (2) the thrust of the Austrian argument.

The Keynesian formula advises attempting to "restore demand," something the Austrians think is futile, to wit impossible, and counterproductive. Sure, they say, you can find holes to fill and keep workers busy; but ultimately government spending drains the financial markets of the very capital that private enterprises will need in order to do a better and quicker job of recovery.

Too many factors influenced the confluence of events following the 1929 crash to enable either side to prove their argument. No one (except Ben Bernanke) pretends that he fully understands what happened. Who really knows how long the Great Depression would have lasted had legislators not imposed the Smoot-Hawley tariffs in 1930, or had Roosevelt not imposed the Keynesian-inspired New Deal in 1933?

But what is certain is that the effects of both the tariffs and the New Deal have been long-lasting and distinctly harmful. To be specific, the New Deal brought us (among other things):

- The Federal Deposit Insurance Corporation (FDIC), backed now by our tax dollars, i.e. bailed out;

- The Federal Housing Administration (FHA), bailed out;

- The Tennessee Valley Authority (TVA), a government-owned power company that could have been privately created and owned just as well and with a lot less controversy;

- The public Social Security System, an unsound pay-as-you-go arrangement that is ready to go bankrupt within a few years;

- The Securities and Exchange Commission (SEC), the one that didn't catch Madoff (or much else for that matter) and that in fact lends Madoff and his ilk an aura of "Certified Okay by the US Government";

- Fannie Mae, that lead to Freddie Mac, Ginnie Mae, and Sallie Mae, all bankrupt;

- An acceptance of the corrupting, embezzling, wealth-redistributing influence (in the wrong direction) of chronic inflation on our economy and, by extension, on the stability of our society;

- An expansion of the role of central bankers to the monetary and political power-brokers they are today; and last but not least,

- The abandonment of the gold standard, the most long-standing, underestimated, and maligned financial tool the world has ever known.

What positive things do we have to say about these entities and notions, about the results of their implementation, and about the place they occupy in our nation's economy? Of course, no one objects to the ideas behind them. After all, the purpose of each is laudable. Even Milton Friedman, the man behind the theory of a chronic two- to five-percent inflation rate, had good intentions, as did Keynes with his flippant relegation of the gold standard to the trash bin of outmoded relics.

But it's the format that is defective in each case. None of these implementations has gone through the refinement process that competition brings. And look where they have gotten us today.

The Austrians do not prescribe a bitter pill of unemployment and depression; they merely state the fact that recovery comes through liquidation of excess, and that this liquidation will take place no matter what the legislators and government agents do. Recovery will occur, not through a fiction of temporary occupational busywork, but through the natural cyclical nature of the business cycle. Government usurpation of the wherewithal to finance it will just slow it down.

Von Mises's understanding is not moralistic; it is simply realistic. And no amount of hysterical government grandstanding will change reality--although it can change people's perception of it, which is what the politicians want.

Our dear friend Keynes, consciously or not, played right into the hands of the big-government legislators who are always on the lookout for a new gimmick to impress the electorate. His formula for state spending is only a stopgap measure, something to keep our mind off our problems, while the system clears itself of past misallocations of resources and the politicians insure their own future.

And this time, it's state spending on a grand scale. The new administration plans to allocate almost a trillion debt-inflating-dollars to spend our way back to prosperity; and that's over and above the $700 billion already allocated by Congress, plus the additional billions created by the Federal Reserve to lend to financial institutions, to buy Ginnie's mortgages, and to purchase Treasuries. To put that into perspective, just the $700 billion we have already allocated for bailouts represents a check for $71,000 for each unemployed person in the nation.

If this latest business cycle goes the way of the 1930s, Keynes's ideas will survive this rebirth and reach their culmination in another flight from paper currency, just as they did in the 1970s. Then when prices and/or bubbles begin to rise again and the central banks find they cannot control them, the Austrians will find favor once more--or so one hopes. This time, however, I doubt it will take 40 years.

Mulally Calls for Government Thugs to Beat Up Taxpayers

I complained in this post about "the American businessman's apparent dearth of guts in the face of cumbersome big government, about their lack of idealism and economic philosophy when the going gets tough. 'If we can't beat 'em, we'll just have to join 'em,' they seem to mumble as they sidle up to the nearest legislator, checkbook in hand, instead of taking the more honorable and idealistic high road of public political debate."

Ford's CEO Alan Mulally has just confirmed my low impression of such businessmen's philosophico-moral compass by "urging US politicians to consider the hitherto taboo idea of raising petrol taxes as a way of encouraging fuel conservation." (Quote from an article by Bernard Simon in today's Financial Times.)

So the automakers are environmentally conscientious fuel conservationists? I don't think so.

What Mulally really wants is for the Washington politicians to imposed a tax on gasoline to entice--oh, let's just say it: strong-arm car purchasers into buying government-mandated hybrids, thus preserving Mulally's job.

What prostitutes many large corporate managers have become. Instead of protecting the future of business in America by fighting government mismanagement with a little courage and a handful of sound convictions, they choose to put their self-respect aside, along with their moral common sense, and jump into the orgiastic Big-Government fray.

Now, for those social liberals who hesitate to cast moralistic stones at prostitutes, you must acknowledge that the idea of selling access to one's body for money evokes some discomfort, at least in most of us; and we should also admit to the existence of culturally ingrained and/or biologically instigated emotional ties inhibiting the freedom of our physical relationships to a subjective degree. To deny this and defend absolute licentiousness would be to deny the observable, esteemed human pair-bonding behavior and the family solidarity it engenders.

A similar malaise should stem from this kind of corporate libertine behavior; and yet as soon as a government gets too big for its britches, all too many in positions of corporate leadership put shame aside and start to lower their own.


[Thanks to Pantsoffroad.co.uk for the image.]

What a pity. The cabal of entities trying at present to to feed at the taxpayer trough could instead be so much more effective (never mind be able to look at themselves in the mirror) if they would band together, keep their pants on, and take the high road.

And who knows? From within this more noble ilk might we elect our next small-government president.