Sybil's Star

California's Redevelopment Agencies: Another Example of Government Run Amok

2012-01-04T11:39:00.000-08:00

California is a funny state. It is overwhelmingly Democratic, but there are old-school Republicans hidden about here and there, and the usual few Libertarians. Over the last twenty-five years, it has had both Republican and Democrat Governors, but since Reagan left the State, it has become the standard-bearer for progressive legislation.

Some years ago the legislature happily gave city bureaucrats the budgetary wherewithal to take over control of inner downtown areas through an institution called the Redevelopment Agency. The Agencies began a campaign to renovate downtown areas that had become run down due to landowner neglect.

Instead of looking for the twisted economic incentive that spurs otherwise intelligent people to allow their buildings and neighborhoods to fall apart, the politicians decided simply to override property rights by making deals with favored land developers. These professionals, backed by City Hall, proceeded to rid the city streets of the eyesores and reap huge profits in the process. The Supreme Court decision in Kelo v. the City of New London buttressed their actions.

By a strange quirk of nature, Governor Jerry Brown, who is about as progressive as they come, decided to cut the budget for the redevelopment agencies. Of course, the slighted bureaucrats howled and even took him to court. They lost.

What they don't realize is that there are other ways to combat downtown blight, as I point out in a short Letter to the Editor at the Los Angeles Daily News.

[Thanks to the Daily News.]

Quoting loosely but also filling out the shorter letter, I told them that people like Nancy Sweeney, the President of Revitalize Reseda, who defend the redevelopment agencies against Brown's budget cuts must not realize that California has come very close to bankruptcy. The agencies' pet projects may be nice on their face, but (1) they are likely to be projects that would not be completed without taxpayer subsidy, and (2) at the moment taxpayers have more important things to do with their money.

Instead, let's take away the incentive to abandon property. To avoid allowing city blocks to fall into the same blighted state again, I suggest that Californian cities and towns implement Henry George's Land-Value Taxation (LVT) scheme. According to this policy, agglomerations are, by definition, the creators of a good measure of the value of a particular central street address. Therefore they (i.e. the local taxpayers) should reap the rewards. George's taxation scheme places all the tax burden on the land and none on the improvements, while lightening or even eliminating the taxes for other things (sales tax, license fees, income tax, and oh-so-many others).

The proven results--already obtained by some communities around the country and the world--are a downtown where blight is "taxed away." Owners of valuable property cannot just sit on centrally located but deteriorating land and buildings, just to speculate in future gains. Why? Because the taxes are too high to make it worth their while. It's "either crap or get off the pot": build something useful, or sell the spot and let someone else do it.

California is special because Proposition 13 protects commercial property owners as well as residential owners from reassessments as long as they hold onto their land. They can even exchange a plot with another like landowner and retain the lower taxation rate. A change in the law for these businesspeople would force them back into a more fair taxation schedule. (After all, they are not little retired grandmas who risk losing their home in an episode of runaway inflation, like the individuals who inspired Proposition 13 in the first place.)

Then, once the LVT is in place, developers will flock downtown to buy properties from former speculators and turn valuable spaces into income sources for those who created that value, i.e. the taxpayers. To each his just desserts. And the professional developers will not install just any income source, as the redevelopment agencies tend to do (behold the restaurant over-development in Old Pasadena). These new owners have every incentive to find the ones that will be the most successful.

Although Governor Brown may not know why, he has done the right thing. Now the people of the State should take it one step further.

But for the Grace of the Almighty Dollar Go We

2011-12-07T16:22:00.000-08:00

Anyone who has been watching this European fiasco play itself out might get a kick out of this little cartoon I did today. (Click on the various images until you get the largest size you like.)

A Default By Any Other Name

2011-10-29T16:30:00.000-07:00

Isn't it wonderful how our Ruling Class can persuade itself that something isn't really what it is, simply by calling it something else.

"EU Forges Greek Bond Deal," shouts the headline on Thursday's Wall Street Journal. Aha, one thinks, they've found a solution that doesn't involve Greece going into default. They reached a "deal."

[Thanks to Bloom4ever.com for the image.]

But wait a minute. The second line reads: "Private Investors to Take 50% Haircut." What is a 50% haircut if not a default?

Let's see here. What is the definition of the word "default"? According to my handy Webster's New World College Dictionary, 4th ed., it is:

"1. failure to do something ... when required or expected; specif., (a) failure to pay money due...."

I see nothing in this definition implying that acquiescence by a defaultee changes the nature of the act of the defaulter. Let's be frank: at 50 cents on the euro, Greece is defaulting on its bonds, i.e. failing to pay money due.

Yet French President Sarkozy was ecstatic that the "drama of a Greek default" would be avoided, and that " 'the Greek debt agreement wouldn't be forced on holders of Greek bonds' ... that the leaders had reached agreement with private banks on a 'voluntary' [quotes in the original] 50% reduction of Greece's debt in the hands of private investors." (Original article.)

Angela Merkel was "very satisfied" with this arrangement. President Obama calls it "an important first step".

Apparently, the key word here is "voluntary." Oh, I see, so when a victim doesn't cry out as a knife pierces her skin, she is no longer being stabbed.

I love the logic. And the funny thing is that the market seems to be going along with the charade--for now, anyway.

My guess, however, is that the market will be quicker to wise up than our Ruling Class. More importantly, the Greek people seem not to be duped at all. A bookstore owner named George Patiniotis reacted this way:

"Who are they trying to fool?" (WSJ piece.)

Sure-Fire Solution to our Banking Woes

2011-09-01T20:11:00.000-07:00

All of the government's efforts to force the banking industry to its knees will probably backfire. I have designed a perfect solution.

[Click on the image for a larger version.]

Basically, what I'm saying is:

Go back to something like Glass-Steagall and force separation of the commercial banking function and the investment banking function, and:

COMMERCIAL BANKS

1. Allow commercial banks to accept savings for deposit, and/or offer checking accounts, and to create credit only for commercial-paper purposes, based 100% on bills of lading with maximum 90-day payoff.

2. Allow commercial banks to invest in other sound instruments and loans, but ONLY up to the amount of the savings on deposit plus bank capital and equity. No credit creation permitted.

3. Allow commercial banks to function on a 10-20% reserve requirement, whichever the system finally decides is best through trial and error.

4. Allow commercial banks to function under the FDIC's umbrella, and allow the Fed to issue money only in times of war or of serious disruption of the interbank lending system (which is unlikely to occur, because these banks are not playing Santa Claus with credit).

On the other hand:

INVESTMENT BANKS

1. Force investment banks to change their structure to a partnership, where the partners are 100% liable for losses. Change the laws so that poor investments mean personal wipe-out for the partners.

2. No FDIC, no bailouts.

3. Put a big sign on the front door that says, "Enter at your own risk."

How simple is that? Fits on one page, not 2,300 like Dodd-Frank.

I think this might go a long way to solving our problems in the future. Of course, we must eliminate all government-sponsored banking enterprises and all government participation in the banking industry.

There's nothing like failure to teach people a lesson. It's call Creative Destruction.

What To Do If There's a QE3? --or-- Is This 1933 All Over Again?

2011-08-22T14:17:00.000-07:00

Quantitative Easing is nothing but a planned inflating.

[Beautiful rabbit bubble image created by Iman Sadeghi]

To be sure that everyone understands this phrase, let's look at the definition of "inflation":

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. (Source: Webster's New World College Dictionary, 4th ed., 1999.)

In other words, Quantitative Easing is the Federal Reserve's attempt to support the economy, general prices, and asset prices (e.g., the stock market) by purchasing government bonds with nothing but its own full-faith-and-credit, backed, of course, by the full faith and credit of the U.S. taxpayers. In effect, the Fed is performing 2a) to achieve 2b). (The decline in purchasing power is just an incidental but not unattractive side-product, at least to the Fed governors' way of thinking.)

Does the Fed really know what it is doing? Let's look at history.

Back in 1933, a little known economist named Edward C. Harwood took a look at the Federal Reserve's intended "planned inflating" of the day. (Harwood later came to dislike using the word "inflation" when referring to 2a) above, and so he substituted the word "inflating," to avoid any confusion.)

Harwood was shocked to learn that anyone was actually considering a planned inflating as a stimulus to cure the Great Depression. He had observed through his statistical work that by 1933 the economy had rid itself of the causative factors behind the crisis, and that business was poised to make a comeback. Interference by government was the last thing the economy needed. Yet here came the politicians and Federal Reserve officials contemplating intervention.

In an article appearing in The Bankers Magazine of New York, Harwood wrote the following (I have substituted "inflating" for "inflation" where necessary):

"[T]here are several possibilities with respect to the scheme itself. It may work as planned and actually cause a return to the general price level of 1926, or at least a movement in that direction of substantial proportions. It may not work at all. It may prove to be unmanageable and carry on to an indefinite expansion of credit and currency which will finally render the dollar valueless. Unfortunately, the historical record suggests that the last named possibility is perhaps the most probable of the three. In any event, it is obvious that every businessman and every investor will be faced with the problem of adjusting his affairs to the new possibilities....

"It is clear that anyone who believes that the attempted inflating will be abortive and without substantial effect will not change his present course of action. However, those who anticipate a recovery and higher prices in general, as well as those who fear an indefinite expansion and ultimate collapse, will surely act with a view to taking advantage of the situation, at least to the extent of protecting themselves. Careful consideration of just what this will mean in the case of each type of individual mentioned will prove illuminating....

"The owner of equities has nothing to fear from inflating, in fact, is apt to gain thereby, [if he or she thinks the planned inflating will be successful;] but the position of the bond owner is vastly different.... [T]he obvious remedy for the situation is to sell fixed income securities and buy equities.

"If, however, the holder of bonds and mortgages fears a runaway inflation [hyperinflation], he may attempt to convert his securities into gold for the purpose of hoarding it....

"The situation of the depositor who has savings accumulated and of the man who owns life insurance policies is similar to that of the bond owner. In the first place, the value of dollars on deposit will decline, in terms of goods, during a period of inflating. It is quite obvious that it would pay depositors to withdraw their funds and buy equities or commodities of some kind. Those who feared that the dollar would go the course of the German paper mark would naturally withdraw their savings, and also their cash surrender values in the case of life insurance, in order to hoard gold.

"It follows that if the inflating is assumed to be effective, the banks will be called upon to pay out vast sums to depositors at the same time that the bond market is flooded with securities for sale. Banks and insurance companies will also be sellers in order to meet demands for cash or cash surrenders and complete demoralization of the bond market would result. It is hardly necessary to add that this would mean the closing of every bank in the country.... [This happened a few weeks later.]

"The truth of the matter is that inflating is the road to ruin. Deliberately planned inflating only makes the road so much the shorter because it points the way for even the most ignorant to see. Inflating can only 'succeed' by fooling most of the people all of the time. That anyone would be fooled concerning a measure which would be fought over in both branches of Congress and in the public press, is beyond belief....

"Those who advocate even the least degree of planned inflating are attempting to set in motion forces which will bring utter ruin, not only to their puny schemes, but to our whole economic fabric. Words are too weak to express adequate condemnation of those who, like children with a complicated toy, are willing to destroy that which they do not understand."

Today's Kitco gold chart gives us an interesting counterpart to his views:

[Kitco gold chart, 8/22/11, 4:30 p.m. EDT]

Today, I would say that the American economy is not in the same place Harwood found it to be in early 1933. We are faced today with another year and a half of "regime uncertainty", a major factor in our current stagnation. However, the market show must go on.

As a result of all the confusion, the market has multiple personalities these days (just like my Sybil). A third of it believes QE3 will be "successful," i.e. it will turn the stock market into a winner. A third believes the European problems will destroy the stock market but reinforce the U.S. Treasury market and dollar hegemony, in spite of QE3. Another third thinks we will see a flight from the dollar and maybe even a worldwide plunge into a Double Dip, just like in 1933.

What do you think?

Where is Peter Sellers When You Need Him?

2011-08-15T15:07:00.000-07:00

Remember "Dr. Strangelove"? Peter Sellers could probably do a smashing take on Paul Krugman, if one is to judge by the latter's performance on a recent CNN interview.

Then again, Krugman does a pretty good job of making a mockery of himself without any help whatsoever.

If I were to tabulate the laughs gifted to me by decades of movie-makers, I would have to list Peter Sellers at the top of the column entitled Best Comedic Actor. "Being There" is my all-time favorite, closely followed by scenes from the original Pink Panther series, and then by some of his earlier films.

I have to put the laughing aside, though, when I realize the damage this "economist" is doing. Where are the serious economic scientists when Krugman goes on these rants? Why isn't the economic community signing petitions to get this guy's Nobel Prize back? Correction; I suppose the Nobel Prize is now so ignominious that this gesture would be a waste of time. But at least they should be publicly denouncing such rubbish from the mouth of one of their kin.

I suppose there's always the possibility they don't take him seriously. But they must realize that CNN and The New York Times are contributing to the death of the Dismal Science as quickly as they can make a folk hero of this guy.

After I had watched the CNN video, just as the disgust within me was about to bust a blood vessel in my brain, I fell upon Buffett's latest "Gauche-Caviar" antics (French for "Caviar-Leftist"). Thank goodness for my brain circulation, even the ever-serious Patrick Buchanan seems to have easily found the perfect repartee to this nonsense, saving me from apoplexy.

Ah, what would we do without a little humor to carry us through the chicanery and comic posturing of the pseudo-wise-men that surround us?

French People: Hurry and Get Your Gold Before It's Too Late

2011-08-12T19:02:00.000-07:00

In France, the noose is beginning to tighten around the necks of anyone wanting to buy or sell gold anonymously through professional vendors.

[Thanks to Comptoir Change Opera at www.ccopera.com for the image.]

It used to be possible to make cash purchases or sales of gold up to an amount of 15,000 euros without declaring the purchase (although at least one company limits the sum to 3,000 euros).

As of July, however, there is a new law. It says:

"Law No. 2011-900 of July 29, 2011 of financial rectifications for 2011(1)
"Article 51
"I. - After Article 88 of the General Tax Code is inserted an Article 88A as follows:
" 'Art. 88A - All persons or corporations who regularly purchase ferrous and nonferrous metals on the retail market must submit, before January 31 of each year, to the taxation authorities of their place of residence or legal domicile, a declaration the contents of which is fixed by decree, in which shall figure the identity and address of the sellers and the total amount of the purchases made from each of these.' "

This Law also modifies another Article which now reads as follows:

"Article L.112-6
"Modified by Law No. 2011-900 of July 29, 2011 - Art. 51(V)
"I. - ... Any transaction relative to the retail purchase of ferrous and nonferrous metals is to be made by check, bank or postal transfer, or by credit or debit card, with the total amount of the transaction not to exceed a ceiling fixed by decree. The non-respect of this obligation is punishable as a misdemeanor of the fifth class...."

This punishment consists of a passage before a judge, a fine of between 1,500 and 3,000 euros, possible imprisonment with or without a suspended sentence, mention in one's criminal record, and some kind of restriction of liberty such as the confiscation of the assets involved.

- A vendor's web page on the subject

- Article L.112-6 itself, in the original French

- The new Article 51, in French

The sale of gold bars or coins to a professional vendor is currently taxed in France, unless the seller can prove he acquired the assets more than 12 years ago. If the seller can prove the date of purchase, he can calculate the tax at 31.3% minus a 10% reduction for each year of possession starting with the third year. If he cannot prove the date of purchase, he can opt to pay an 8% tax, no questions asked.

Sovereign-state politicians are too smart to allow the public to buy and sell gold free and clear, because they know that if they did permit it, the public would no longer allow the state to manipulate the currency. But even with the taxes, people are now buying gold more than ever.

Perhaps the reason for France's recent law changes has to do with political fear of the public's reactions to what politicians have done, and are continuing to do, to their national currency.

Pictures Are Worth a Trillion Words

2011-08-10T15:53:00.000-07:00

I could almost throw these at you without any explanation, but I will give the context, source, and some data details. (Please click on each image for a larger version.)

Inebriated consumers stopped partying and began some sober saving when the boom-town lights went out in 2008, according to this graph from the St. Louis Fed:

(Unfortunately, it looks like this process of deleveraging has hit a ceiling of some sort--not surprising, given that the economy has stagnated and people are struggling.)

Now for the banking sector. What about bank assets versus their liabilities? Rather than resolving and reducing troubled assets, banks still have an increasing assets portfolio (graph from the Federal Reserve):

What about the banks' investments? Here is a graph from the St. Louis Fed showing total commercial bank investments:

Of this total, much of the increase is in government securities (purportedly safe, but currently financing problematic US debt) (source):

Here is the corresponding diminishing quantity invested in "other securities" (source):

Some of these "other investments" are now held at the Fed. The Fed's assets have exploded with precarious instruments and government securities (source), to be unloaded when, to whom, and at whose expense no one really knows:

And here is a graph showing the market's evaluation of the value of the dollar versus Bernanke's "commodity," gold (source: Kitco):

Must I say more? I think not.

Trying to Get My Funny Back

2011-08-05T15:15:00.000-07:00

This wonderful piece over at TheOnion.com made me laugh out loud for the first time in months. It also made me realize that I have completely lost my sense of humor.

[Thanks to Artfire.com for the photo.]

Does anyone else notice the vitriol that is beginning to seep out from under the covers of some very good intentions? Have you, like me, begun to feel a twinge of resentment for one or more of your fellow Americans? Perhaps your neighbor, the nice one who asks you to water her flowers when she's away, recently made a nasty comment about someone or something on your political side of the fence, and for the first time ever you thought to yourself, "What an idiot"? (You can assuage your bad conscience with the likelihood that she feels the same way about you.)

Maybe you were playing tennis with the usual crowd, and someone who used to be lighthearted pipes up, all irritated, about how stupid the "socialist Democrats" are, or how scary "those crazy Tea Party Republicans" can be? Does this sound familiar, my friend?

Are you, like me, wondering why bands of youths are beginning to create havoc in public gatherings, seemingly just for the fun of it?

Well, I've noticed these changes; so I've stopped to ponder and I've found that it's no wonder that we've all gone sour:

-- Our Congress just proved to us once more that it is composed of complete nitwits (with a few exceptions) who are ready to sneak around important issues rather than face them head-on and deal with them. How did this happen? Or more appropriately, why did we entrust these professional politicians with such serious issues? The answer lies beyond my comprehension.

-- Our savings account interest is plunging lower than ever. Jokingly, I say to myself, "Maybe soon our banks will start asking fees just for stocking our cash...." Wait! They already have!

-- The stock market is crashing again, most likely due to poor economic growth and bad employment figures mixed in with serious European banking woes. It looks like we're headed for a double-dip, just like in 1933. And we thought things were bad already.

-- We've got another whole year to go before we find out who will run the country, what our tax structure will be, what the debt situation will look like, whether the euro will still exist--heck, even whether the dollar will still exist!--and whether businesses can start investing again or not.

-- News is seeping out that S&P just might downgrade the US after all. (Correction: It just did.)

This country has never been so divided since the Civil War. I have lost my sense of humor because there is little to laugh about these days. Our federal and state governments have managed to ensconce themselves into every facet of our lives and, in the process, have split this country right down the middle. Are they dividing us, the better to conquer us?

But, remember: They are only doing what comes naturally. We are the true guilty party. Politicians crave power, and somehow we let them have it. Now we must reverse this process, and it is going to be very, very painful--not a laughing matter at all.

Over the past six years, I have written thousands of words about the value of gold as a measure of the value of currencies, and I am convinced more than ever of the soundness of my analysis. Gold, at well over $1,650 an ounce, is proving to be the best thermometer of monetary mischief, even better than "the Almighty Rational Market" (the stock market, that is) that tends to be about as rational as a Las Vegas gambler.

[Aside: Oh all right, perhaps it's rational over a period of 200 years, but who lives that long? In the end, the success of the theory in any particular case depends on the prices at which you got in, and whether or not you actually reinvested those dividends like you were supposed to.]

In my book, the current gold rush has been the only rational part of today's crisis. And it was predictable (and in fact predicted) since the 1990s when the Federal Reserve began manipulating the interest rates downward and trying to tinker with the U.S. economy (again).

Even as long ago as the 1970s, a few common-sense economists warned us about the approach of the problems through which we are living today (example: Edward C. Harwood in The Money Mirage and elsewhere). Why so few people heeded them, and why even fewer are turning to their research today, is a mystery that's--well, it would be funny if it weren't so tragic.

(If you didn't click on TheOnion.com link, do so now. The chuckles'll do your sad heart some good.)

Another Inadequate Defense of a Zombie-Idea

2011-07-08T16:03:00.000-07:00

Professor Laura Tyson has given us the Nth argument for stimulus spending in her latest commentary at the Financial Times. While more humble economists are scratching their head and wondering where they went wrong, a few like the Professor are still trying to revive dead economic notions.

[Thanks to Aboutcostume.com for the zombie photo.]

Her headline:

"Only more stimulus can fix a jobless recovery."

Wasn't it Keynes who thought that "[t]he short-run challenge is inadequate demand" (Tyson's words)? This is a zombie-idea if there ever was one. A good deal of evidence invalidates it, never mind that it's especially noxious at this time of fiscal over-expansion.

Tyson isn't completely off base: she admits that "the long-run challenge calls for fiscal contraction". However, she insists that "the short-run challenge calls for fiscal support."

Her solution? Promise to do both--and then start with the stimulus first under the wisdom of the old adage: Never do today what you can put off until tomorrow.

Her idea is to "pair fiscal measures targeted at job creation during the next few years with a multiyear deficit reduction plan that kicks in once employment recovers. Pass both now as a package."

But what happens if employment doesn't recover? Isn't her suggestion what every pro-stimulus economist and their politicians have been trying to do since this whole episode began? But the Professor is unfazed by the up-to-now inefficacy of the idea. She continues:

"At the very least, the federal government should introduce additional stimulus measures to offset the substantial fiscal drag that is slated to occur this year and next when current stimulus measures expire. On the spending side, it should invest more in infrastructure maintenance and replacement. Such investment raises demand, creates jobs and increases the growth potential of the economy."

Oh it does, does it? I think what we have here is a person with no fear of the facts.

1. Which fiscal stimulus measures have been proven to increase anything other than temporary job creation or maintenance?

No one can point to evidence that stimulus measures create jobs in a cost-effective and enduring way; and, on the other hand, evidence supports the hypothesis that fiscal stimuli are ineffective and even counterproductive. Who has produced that evidence? Ironically enough, today's version of Professor Tyson's own Council of Economic Advisers has come out with a study concluding that Obama's stimulus measures have produced jobs, but at a cost of $278,000 each.

The study also points to the fact that "the 'stimulus' has been working in reverse over the past six months, causing the economy to shed jobs." (Source; also, download the full CEA report from the same page.)

May I also point out that the latest job figures include a hefty release (see chart part-way down) of government employees, and that this is a good thing? Much of the stimuli went towards the maintenance of useless federal and state jobs. We are finally shedding these, thanks to the stimuli's demise, and we're helping our state and federal budgets in the process.

Lastly, I would like to point out that road maintenance and replacement are not job growth measures; they are simply ordinary expenses, the budget for which the politicians have stolen for other items.

2. Next question: When should the stimuli stop, given that most jobs created (or not lost) are dependent upon continuing stimuli for their survival?

3. Isn't excessive boom-time spending the very stimulus-like activity that got us into this predicament in the first place? Isn't more stimulus spending the same as throwing good money after bad?

4. To finance the stimuli and infrastructure, will Congress prefer that the Treasury go deeper into debt, or will it have the wisdom to cut spending elsewhere to compensate (which would seem counterproductive to her argument)? Our current cost-cutting-minded Congress has enough on its hands just trying to reign in the wasteful, debt-producing spending we are already doing, never mind finding places for even more cuts.

On the revenue side, the Professor thinks "the government should extend some of the targeted tax measures including the payroll tax cut for employees and the capital investment expense deduction. It should go further and cut payroll taxes for employers on all new hires, including hires by new businesses. This cut should be linked to the unemployment rate and should be maintained until it falls to the 5-6 percent range."

This is the only suggestion that makes any sense. Better yet, put a torch to the whole current tax code and instigate a much more fair flat tax. And while you're at it, stop farm subsidies. Oh, and turn back the regulatory clock and cancel some very bad recent legislation. But I suppose these ideas make too much sense.

Hopefully, the stimulus zombie-idea will soon turn to dust and disappear once and for all. (But don't hang around any economic-idea cemeteries long enough to find out.)

Bernanke Clueless?

2011-06-23T18:11:00.000-07:00

He actually said:

"We don't have a precise read on why this slower pace of growth is persisting." These are his words--perhaps just an overabundance of academic caution, but a strange way, nonetheless, for the most important man in the world to phrase his thoughts.

Of course, if he had said, "Yes, we know exactly why this is happening", the reaction would have been, "Well then, do something about it!" Then he would have had to admit that he is powerless to do something about it, which is a very unbecoming admission for a world leader.

"Bernanke began speaking at 2:15, and stocks started falling at about 2:30...." Well, that makes sense. After all, when the Head Honcho admits outright (or pretends) that he's completely in the dark, the market is justified in getting a little skittish.

[Thanks to Allfancydress.com for the image.]

Then, according to this AP News article, Bernanke indulged in a little excuse fishing: "[T]he Fed blamed the worsening economic outlook in part on higher energy prices and the earthquake and tsunami in Japan, which slowed production of cars and other products."

Oh, so we have to go as far as Japan to find a culprit? Last time it was in China, with the savings glut.

Bernanke's comments seem disingenuous, as this writer suggests, especially coming as they do from one of the greatest economic intellects of our era. But just in case he's sincere, may I suggest he start looking closer to home?

Three elements possibly contributing to our current predicament come to mind:

1. The first is the phenomenon Robert Higgs describes as "Regime Uncertainty." (I did an earlier blog entry on this.) Essentially, businesses are hesitant to expand without some kind of reassurance about America's future politics. Will employers have to eliminate employees, drop health insurance, or simply join the upcoming national health system and cut profits? Will they have to pay new taxes, or consider outsourcing? Will compliance costs go up or down?

[Aside: Ignorance among academics about things happening at the ground level of business is astounding. All economics students, and come to think of it their professors too, should be required to spend one year as an apprentice in some business--any business--so that they can see how things transpire between the wheel and the road, down where the doers have to breathe the dusty air and scuttle about finding real solutions to real and, unlike in macroeconomics, solvable problems.]

2. Second is the very boom-bust process itself. As some economists have been saying, a country or set of countries cannot go on a hugely unsound leveraging binge without going through a terrible hangover afterward. The duration of the pain will correspond to the height of the crazy leveraging; and deleverage we must. The slog ahead could be long and difficult, like in Japan. (And John Mauldin [see below] calls Japan "a bug in search of a windshield.")

3. Government debt. The US is playing with fire as it blows the greatest liquidity bubble of all time on the back of the world's faith in our good credit. As the AP article states, the QE1 and 2 bond-buying programs have been "controversial. Supporters say the bond purchases have kept interest rates low and encouraged spending. Low long-term rates make it easier to buy homes and cars and for companies to expand."

The same cheerleaders argue "that those lower rates have fueled a stock rally. Since Bernanke outlined plans for the program last August, the Standard & Poor's 500 index is up 24 percent. Lower rates made stocks more attractive to investors than bonds, whose yields were still falling."

But how many asset bubbles can we blow, and how much indebtedness can the country carry, especially when we hear simultaneous chastisements from Bernanke himself about the very same debt behind the bubble? According to John Mauldin and Jonathan Tepper in Endgame, the End of the Debt Supercycle and How It Changes Everything, this explosion of debt cannot go on forever. And what cannot go on forever must therefore stop. And it won't be pretty. (This book is a very good read, by the way.)

Gold, all through this, has bode its time and held onto its glitter, which is fine with me. I don't know whether it's an accurate reflection of the over-issuance of the dollar, or of coming price inflation, or current asset bubble price inflation, or of international insecurity, or all of the above; whatever it is, it's still my best friend. And I'll go with my golden instincts over Bernanke's uncertainty (feigned or real, but certainly justified) any day.

Bogeyman Economics

2011-05-20T19:34:00.000-07:00

I'm just a buffoon, and I love a little laughter. We all need a little comic relief from time to time, so I like to make light of the economic mess we're in. However, when surly individuals with Ph.D.s and/or lots of government power start making spooky declarations and rattling their chains, I get a little nervous. After all, they could hurt somebody.

[Thanks to Zoogstercostumes.com for the image.]

Take Ben Bernanke, Timothy Geithner, and Alan Blinder, for example.

A few months ago, Dr. Bernanke looked Steve Croft straight in the eye and declared his absolute faith that the Federal Reserve can keep our economy stable and, at the same time withdraw the Fed's monetary support as soon as prices rise too much in the U.S.

I guess he thinks prices outside the country can rise as much as they want and it's not our problem. Yet credible researchers argue that U.S. monetary looseness is directly behind the current international rise in dollar-priced commodities. (See this Steve H. Hanke article for a breath of fresh common sense.) And rising food and raw material prices around the world cause misery, poverty, and death. (See this report by the World Bank.)

Then almost in the same sentence Bernanke went on to tell Steve about controlling "market expectations." Now, which is it, Sir? Does withdrawal of monetary support really stop incipient price inflation, or is price inflation merely the result of "market expectations"? Because in the latter case, you must believe that the Fed's words are more important that its actions.

But even Bernanke seems to admit that, sooner or later, the Fed will have to correct the situation; yet I don't see how the Fed can withdraw liquidity without causing a rise in interest rates and a second serious economic dip. So I suspect Bernanke and his colleagues are hoping against hope they can keep liquidity high, convince the markets that price inflation isn't going to happen, and then -- Voila, no price inflation, i.e. an economic miracle. Good luck to you, Doc. When it goes awry, either with price inflation or a second dip, don't say I didn't tell you so.

Then there's our Secretary of the Treasury, Mr. Timothy Geithner, warning us that the debt ceiling must be raised or America could default. Now, you and I know this is nonsense. (If you're not sure, read this common sense piece from Michael D. Tanner.) But no matter to the all-powerful Mr. Geithner. Recently his main purpose in life has been to scare debt-wary Republicans into believing they're driving the country into default. But, Mr. Geithner, what happens when Congress does raise the ceiling? Obviously, it condones the debt spending. But wait a minute, don't you get it, Sir? We don't want any more debt. How much of "No more!" don't you understand? You may not care if the U.S. retains its credibility, but we do.

Professor Alan Blinder, a Keynesian voodoo-economics professor at Princeton, declares that "if we crash into the debt ceiling ... it's not likely to be pretty. [WSJ commentary.] ... "At some point," says Blinder, "Mr. Geithner could wind up brooding over horrible questions like these: Do we stop issuing checks for Social Security benefits, or for soldiers' pay, or for interest payments to the Chinese government? Such agonizing choices are what make default imaginable."

Sounds like plain old scaremongering to me. This guy is the kind of academic soothsayer who furnishes politicians like Geithner with serious-sounding, credentialed ammunition. Shame on you, Professor. You're lucky you won't have to pay for the mess when U.S. debt explodes off the charts and we can't even pay the interest anymore.

Blinder goes on: "[S]uppose the federal government actually does reduce its expenditures by 40% overnight. That translates to roughly $1.5 trillion at annual rates, or about 10% of GDP. That's an enormous fiscal contraction for any economy to withstand, never mind one in a sluggish recovery with 9% unemployment. Even contemplating such a possibility is evidence of a dark, self-destructive impulse."

So Professor, which is the more self-destructive party: the academics like yourself, along with the politicians and their voters, who have gotten the U.S. into the worst pickle of its history, or those who would try to save us from people like you? No, you can't scare me -- well, wait; actually, you DO scare me. But not for the reasons you think.

American jurisprudence is missing one important element: Political Accountability. American citizens should be able to hold individuals in positions of power accountable for their recommendations and actions, other than just voting them out of office. If people want the power, they should get the liability.

There should be a law that anyone in a position of power who makes policy decisions that later turn out to be wrong should be held responsible and should give up everything they own or will ever earn, in order to pay back a fraction of what is owed to all those who have been harmed.

Drunk bus drivers who cause accidents are fired and penalized, even put in jail. Politicians inebriated by the headiness of power, and academics swollen with their sense of self-importance, can cause billions of losses to defenseless citizens with no fear of reprisal. What do they get when they screw up? A comfortable pension, full retirement benefits, and a book deal.

That's Bogeyman Economics for you.

The Biggest Show On Earth Is Coming to Town

2011-04-25T13:51:00.000-07:00

Got your agenda marked? The Federal Reserve Board meets this week, and for the first time Chairman Ben Bernanke has decided to face the public immediately afterward in an effort to increase transparency.

[Thanks to Circus Contraption, at SeattleTwist.com for the photo.]

Bernanke will be giving his first real press conference on Wednesday, April 27, 2011, at 2:15 p.m. EDT.

This particular Fed meeting is crucial, because on June 30, 2011, the Fed is planning to end its second round of quantitative easing (Fed purchases of treasury bonds). Through this program they are currently purchasing up to 85 percent of the bonds issued by the U.S. Treasury since November 2010. What will the Fed do next, stop altogether or phase the program out? Future Fed actions are based on current statistics, and the Board might do either, or they might just decide to continue easing a bit longer if the numbers so indicate.

The consensus seems to be that the Fed will stop their purchases but continue trying to hold down interest rates in other ways. However, a consensus does not a crystal ball make.

Bernanke is probably hoping he doesn't gaff and send the world's markets into fits of dyspepsia. The slightest misplaced word, sudden bead of sweat, or uncontrolled twitch of Ben's brow could add an unknown dimension of insecurity to his studied words. Will the end of QE2 cause bonds to fall into a tail spin? Will it turn the recent stock market recovery into a bursting bubble? Will it cause a flight from the dollar? Will a misplaced comma or tremble of the voice start World Recession III?

The other possibility is that the markets see the end of QE2 as they did QE1, i.e. as business as usual. The slight retraction of liquidity could simply displace a sum of money from the stock market to the assumed security of the bond market, without necessarily causing significant disruption in either. Two very prominent U.S. bond dealers are debating this very issue as I write. (See Gross versus Rieder at this Wall Street Journal article.)

My slow-motion movie on "The Economic Crisis of 2008" is unfolding even slower than I thought it would. We've had to wait three years for the denouement even to approach the horizon, but I think it's finally coming.

The next months will be fascinating. Not only do we have the QE2 situation, but we also have much to learn about the upcoming federal budget and debt ceiling, about the candidates for the 2012 election, about the future of the U.S. dollar's hegemony over other fiat currencies, and about the world's opinion of the safety of U.S. treasury instruments as a secure store of value. Any unexpected disruptions in the latter could throw a hard ball to all the Modern Portfolio Theorists, as real life tends to do.

Some even think there's the possibility that America's heyday is coming to an end, just as England's did at the turn of the last century. (See the article at Marketwatch.) I don't believe this quite yet, and I refuse to until I see the results of the latest silent-majority push towards smaller government. If it fails in 2012, i.e. if Obama passes again and both Congress and the Senate weaken in resolve and/or shift towards the left (whether it be Republicans or Democrats), then maybe we should start to worry.

While all this is going on, what can one do with one's money? I'm not an investment advisor, and I'm just as frustrated as the next person with 0.05 percent interest. When people remark that I have been right about gold until now and then ask whether they should get into it at this point, I still must respond that I just can't predict what gold will do in the next year. I do permit myself to say that it looks like we're headed for one of two scenarios:

1. 1970s-style price inflation with a significant rise in gold, and then the subsequent obligatory tightening a-la-Volcker with its healthy contractionary forces (not so much a recession as a readjustment of the previous misalignments of money flows), accompanied by a subsiding of the gold price to a more stable level; or

2. A Japanese-style twenty years or more of stagnation, with prices and GDP remaining relatively tame, held in check by the squeezing of the ordinary wage earner through a bad employment market, caused in turn by political dithering of the kind we saw in the 1990s when Gingrich and the Republicans lost their mojo.

I'll be heating up the popcorn come Wednesday.

Income Disparity: A Disease or Just a Symptom?

2011-03-05T17:15:00.000-08:00

My husband used to be a French socialist. It only took him about five years in America and three years of running his own business to see the light, but every now and again something will cause an angry populist sentiment to spring forth from his gut. And sometimes I do empathize with him.

[Thanks to Wikipedia for the image of Robespierre, who was besieged by such sentiments.]

Just this morning, we picked up the Saturday Financial Times from our doorstep and out fell the "How To Spend It" section. Once a month even I, the faithful daughter of a capitalist Constitutionalist, cringe with shame to see the opulence displayed in these pages: ads for Rolex, Chopard, Graff, Boodles, and other names only the wealthy (or the curious like me) would recognize; multiple pages of dour-lipped, smokey-crayon-eyed mannequins slinging million-dollar accoutrements about their gaunt frames; grand estates and haute-design resorts the likes of which one never sees in real life because they're hidden beyond impenetrable walls, inaccessible distances, or elevators that require a key.

How can the best newspaper in England continue to push this boom-time candy, at the same time as the impoverished masses of the Middle East are risking their lives with rusty AK-47s and RPG-7s for a tiny crumb of the democratic pie?

The answer is obvious, of course. The head honchos at Financial Times Limited are simply responding to market demand. So are the editors of the Wall Street Journal, who pointed out just yesterday that real estate prices in Aspen, Colorado, are climbing off the charts. The rich are still as rich as ever.

When I spoke of the irony to my husband this morning over the breakfast table, his lip curled in disgust and his gut fired up an instinctive retort about the injustice of it. During his worker days in France back in the 1970s, French union leaders had him and others burning tires in front of the CEO's brand new Mercedes to express their demands for higher salaries.

Readers may recall that the '70s were extremely inflationary, and they also may note that much of the world today is in the grips of a terrible food price squeeze. As I peruse the Patek Philippe page I think to myself that obviously something is wrong.

My heart absolutely gets why uninformed citizens jump to the conclusion that all rich people are thieves ripe to be taxed. But my mind struggles, wary of this negative emotion. There must be a way to explain that the solution to income disparity is not a show of force between classes, at least not in democratic Western societies with a well-entrenched rule of law. If we let violence rise, we are just dooming ourselves to be divided and conquered. We must first analyze the cause.

I reason this way:

Why does Wall Street management, for example, pay out such high salaries and benefits, while some fifteen percent of the U.S. employable population can't find a job? Answer: imbalanced employment markets. Skilled-employee opportunities exist in the financial sector, and not enough job applicants have the necessary training and talent. In order to find competent people, companies must pay outrageous sums. (As my husband noted, the current chief economist of the Abu Dhabi sovereign investment fund is a former big wig of General Motors. Just imagine his compensation package.)

On the other side of town, there are fifty to a hundred unskilled or semi-unskilled workers for every position that comes up. Given the excess of supply over demand for labor, wages stagnate, even in the face of record profits and a rising cost of living.

This disequilibrium can go on for years, creating a disparity between the two factions: the well compensated and the strugglers. And the gap can become huge before anyone really notices, especially in high times when equity is rising and unwise homeowners are building up debt by pulling credit out of their over-assessed abode.

So what causes employment markets to display this kind of imbalance? I hypothesize there are a number of reasons, among which two are flagrant. First: Regime Uncertainty. This phrase is Robert Higgs's term for our malaise regarding the country's political future. Industry leaders must make decisions regarding thousands, millions, and even sometimes billions of dollars of investment in capital expenditures, and Regime Uncertainty makes them cautious.

Before spending a penny and creating one job, CEOs must ask themselves, Which party will be in control in 2012? What will the multitude of alphabet agencies on federal and state levels do to regulate our industry? What will our tax situation be over the next year, over the next decade? Is there a country out there than can give me a better deal?

Second: Monetary Uncertainty. They're asking, How cheap or expensive will credit be in the future? How much long-term debt can our company afford? What will happen to prices? What will the dollar be worth next year, next month? Will the dollar maintain its reserve-currency status? Would we do well to invest in euros, or yuan, or gold? Maybe our best bet is to bide time with short-term speculations on Wall Street?

'Nuff said. You know what they have decided to do.

So let's not fight the symptoms. We'll just tear each other apart, and maybe destroy the country in the process. We must fight the cause of the illness. Let's give industry something they can bet on, i.e. a sound political climate and a more stable, more robust monetary policy. (See other posts for suggestions.)

Only then can American industry put us all back to work, on the path to a better standard of living and more equitable income distribution.

International Money: Big-Government Solution or Trust and Honesty?

2011-02-18T11:49:00.000-08:00

Robert Zoellick is back in the news with advice about international monetary policy. His Financial Times commentary starts out with the admission that "[n]ew agreements may be in short supply when finance ministers of the Group of 20 heading economies meet this weekend in Paris."

Paradoxically, he ends up his commentary recommending that the G7 should "issue a statement to reflect" ... the "agreement" "establishing an important norm: to maintain flexible exchange rates, without intervention, unless the group agrees special circumstances warrant action." I guess he thinks agreement is more easily reached among seven than among twenty.

As to be expected from someone who is the acting President of the World Bank Group, he recommends that an international agency, specifically the IMF, should act as a "referee, able to blow the whistle on the appropriateness of external policies" of nations, with the IMF having no power to "impose penalties." Right. That should work, just like it has in the past ... Oh, that's right, it hasn't.

But that doesn't prevent Zoellick from advising us to expand the IMF's responsibilities even more. They should also "sharpen the multilateral review" of certain policies, which review should "compare national policies with international information indicators, including commodity prices such as gold." At least he got that right.

He goes on to list a few more ideas of how a world agency such as the IMF and the WTO could, by working together, offer incentives or disincentives to world governments. I suppose two international agencies is better than one. I say, Good luck.

Much more reasonable, and much more in line with human nature, would be something more resembling what historically had worked pretty well for many decades in the free markets of 19th and 20th century Western civilization. Take, for example, the ideas offered up by Rep. Ron Paul and Lewis Lehrman in their book The Case for Gold. This book was written after the 1982 Gold Commission, which, according to some who were present, was something akin to a sham. (I'm referring to comments made by Anna J. Schwartz in 2004, set forth in the AIER book entitled Prospects for a Resumption of the Gold Standard referenced at the end of this post.)

[Thanks to Google, Creative Commons, for the image.]

The Case for Gold is now being re-released by Mark Calabria, Director of Financial Regulation Studies at Cato Institute. Download it for free here.

Here are a few poignant quotes from Calabria's description of the book:

"Its authors argued that while persistent and high inflation, a weak economy, and high unemployment were the direct result of misguided Keynesian policies, the answer was not monetarism. For the basis of monetarism is still allowing a government monopoly on the issue of money. We have again found ourselves in an environment where both Keynesian and monetarist policies have failed us. The necessity for alternate options is pressing."

"Paul and Lehrman remind us that when government has the ability to abuse our trust, as in the case of purchasing its own debt or debasing its currency, it will inevitably betray that trust.... The Case for Gold is the case for limited government, a case for applying the rule of law to our monetary arrangements, as opposed to the highly discretionary rule of man which now governs our monetary system. With the public's renewed interest in constitutional government, it is only fitting that such an interest extends to money."

"Paul and Lehrman remind us that the ultimate purpose of a monetary standard is not price stability, but 'trust and honesty.'"

The American Institute for Economic Research held a symposium in May of 2004 on the very subject of resumption of something resembling the gold standard. The results are set forth in one of their booklets, available here. Contributing to the conference were Lawrence H. White, Anna J. Schwartz, Gerald P. O'Driscoll, Jr., H. David Willey, Hugo Salinas Price, John C. Hathaway, Michael T. Darda, Richard Sylla, Michael W. Crook, Robert E. Wright, and John H. Wood.

Both works are an excellent read.

Ben Bernanke: "Let Them Eat Cake!"

2011-02-04T16:58:00.000-08:00

[Photo of Marie Antoinette from Wikipedia]

According to Robin Harding's article in today's Financial Times, our Federal Reserve Chairman is convinced the Fed's QE2 program has nothing to do with worldwide rising food prices. In response to a question on the subject, Bernanke says:

"I think it's entirely unfair to attribute excess demand pressures in emerging markets to US monetary policy, because emerging markets have all the tools they need to address excess demand in those countries...."

I will not harp on the fact that I don't agree with Bernanke. First of all, no one really cares what I think; and secondly, I don't have the scientific ammunition to prove him wrong, even though evidence to the contrary is clear to me.

What I can point out, however, is his twisted sense of noblesse oblige. To make the above-quoted statement, he must have made one of the following assumptions:

A. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP has no effect on foreign nations; or

B. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP may have an effect on foreign nations, but they can control that effect by tinkering with their own monetary unit, which tinkering is effective and has no deleterious effect; or

C. An increase in the issuance of U.S. dollars without a corresponding increase in U.S. GDP may have an effect on foreign nations, but who cares.

Bernanke may not have the gall to choose C, as did Nixon's Treasury Secretary, John Connally. Faced with a similar question, Connally is reported to have said: "[T]the dollar is our currency but your problem...." No, this would sound too flippant, too frank, and would not correspond to Bernanke's more academic, more convoluted style.

So let's assume Bernanke has chosen B above.

In support of this assumption, Bernanke might cite the example of China. China has simply absorbed any excess dollars by investing them in U.S. treasury bonds. (Don't look now, but China clearly has no other choice. If it stops squirreling away its excess foreign reserves, the dollar will tank even faster and take the value of the reserves with it. And by the way, if you look hard enough you'll notice that China is slowly diversifying away from U.S. dollars.)

Bernanke doesn't seem to care that other countries may not have China's leeway. He explains, "They can, for example, use monetary policy of their own. They can adjust their exchange rates, which is something they've been reluctant to do in some cases."

But ... isn't that illegal currency manipulation? In fact--isn't that what we're doing??

Oh well. I guess two wrongs make a right.

If you ask me, Ben and Marie Antoinette have something in common. It's called Hubris.

The "Swindlers' Encouragement Commission" Strikes Again

2011-01-20T17:28:00.000-08:00

Today brought a warm rush of joy to my heart when I read Jonathan Macey's commentary in the Wall Street Journal about the "SEC's Facebook Fiasco."

This government agency has been on my mind quite a bit recently, because I'm writing the biography of my father, economist and investment adviser Edward C. Harwood, who spent five of the last seven years of his life fighting the Commission back in the 1970s.

Harwood gave this grave-faced government body the nickname "Swindler's Encouragement Commission," due to the fact that the public thinks the SEC is protecting them from evil people but in reality, as we have seen most recently from the Madoff case, it is not.

My Dad won, in effect, his case against the Commission. In the end, the SEC had to back down from its claims. This is rare: usually the very rumor of the agency's presence in the room is enough to cause most investment advisers to turn to dust. The business is built, after all, upon reputation. Once that's gone, it's over, at least for most people.

Not for my Dad. He stood up to the SEC challenges, and alongside him, believe it or not, were his very courageous investors. Together, with Judge Gerhard Gesell's help, they proved that a contract is worth more than the paper it's written on--at least back then.

My version of the story will come out, for those who are interested, within the next few months. I'll keep you posted. Meantime, may the gods smile upon brave souls like Jonathan Macey who have the courage to tell the SEC like it is.

Here are a few excerpts:

"...[T]he commission's rules regarding stock sales are crippling for U.S. investors."

"Thank to SEC regulation and the litigious atmosphere it fosters--not to mention Sarbanes-Oxley's onerous burdens on corporate executives--the whole capital formation process is moving offshore."

"The SEC's fundamental approach to regulation involves depriving investors of opportunities in order to protect them." [Oh, how this rings true. But it lost one of those battles in 1978.]

"... [A]ccording to the SEC, all investors large and small must be protected against the danger that they will succumb to a feeding frenzy of enthusiasm when given the opportunity to invest in a new deal. For example, the SEC rules governing the Facebook offering until Goldman pulled the plug include the requirement that the stock being sold 'cannot be the subject of advertising, general promotional seminars or public meetings in connection with the offering.' The concern here is that publicity about a deal might, heaven forbid, create interest among investors."

Read the whole commentary (subscription required). It's really a hoot, and right on target.

My father would be pleased to see that there are those who follow in his faded but indelible footsteps.

Price Shock: M&Ms hit 99 cents a pack!

2011-01-09T14:56:00.000-08:00

Doing a bit of shopping the other day, I was horrified to find my staple pack of M&Ms up to $1.29 at Office Depot. Stunned into a reality check, I decided to find out what the current supermarket price is. It's 99 cents.

Most of us look at the items we purchase regularly as an indication of how prices change. The price of M&Ms is my own personal CPI indicator. To take this particular item in a pseudo-scientific study (click on the image for a larger version):

- When I was an adolescent in the 1960s, a one-portion pack was 5 cents.

- I remember a few years later when the pack size began to vary a lot. Mars and the other candy makers started offering Jumbo Packs with twice as much for three times the price and other hoaxes like that, so they could hide the price increase.

- My next statistical indicator comes from the mid- to late-1990s when I owned a small coffee shop and market. I sold my M&Ms portion pack (who knows how many ounces by this time) for 55 cents.

- Today, ten years later, they're at 99 cents, almost double.

Something's happening.

Moving to my reliable source of price inflation information, AIER.org's Cost-of-Living calculator calculates that my 5-cent candy in 1955 should be priced at something like 41 cents today, assuming the portions are approximately the same. Of course, they may not be; but in your estimation, in which direction would the portions vary? Larger, or smaller? Well, let's not denigrate the candy companies. Let's just say that the ounces are the same.

So, I conclude that my M&Ms have increased in price at a rate of double the national average. Which brings me to the subject of the coming world food crisis.

According to Robert Zoellick, the President of the World Bank Group and the fellow I heralded for having dared to bring up the dead subject of the gold standard, the world can take many steps to "put food first." The G20 should "empower the poor" to ensure "the availability of nutritious food." In his piece in the Financial Times of January 6, 2011, world governments can and should take eight steps to achieve this goal in face of rising food prices.

The steps include improvement of weather forecasting (good luck), exempting "humanitarian food aid from export bans" (good luck), establishing "small regional humanitarian reserves in disaster-prone, infrastructure-poor areas (good luck), and helping "smallholder farmers become a bigger part of the solution to food security" (good luck).

I thought Mr. Zoellick had a grain of good common sense when I read his piece about gold's helpful role as a barometer of worldwide inflating. He is letting me down. If I read correctly from this article, he is just another bureaucrat ... but how silly of me. What was I expecting from someone at the World Bank?

Why doesn't he see that the price of sugar is not a supply problem? It is a monetary problem. If it were a supply problem it would be the only commodity with a rising price. However, as the charts reveal, all commodities are rising to record levels, with few exceptions. Take a look at this chart from Indexmundi.com.

There is no question but that the world is headed into a food price crisis. But my analysis of the problem does not point to governments or government agencies as the solution. The real long-term solution lies in finding an anchor for the world's monetary units, whether it be gold or something else.

More close to home, the question, as I have said before, is: Will this wave of commodity price increases translate into a CPI index rise in the U.S.? We have already got higher gasoline prices, and now higher M&M prices. Will it spread to everything else?

That depends on several factors: (1) the turn of U.S. political winds; (2) the health of U.S. and European banks, which in turn depends on the health of the real estate/banking sector in the U.S. and the PIIGS situation in Europe; and (3) the effect of the above on the interest rate markets, which in turn will have an effect on (2).

Some analysts expect the Fed's and other central banks' monetary actions will produce widespread price inflation worldwide. But this can happen only if the deflationary hot air can blow out of depressed economies. What if (1), (2), and (3) turn negative? And/or what if the deflationary pressures underlying our current crisis turn out to be ongoing? The Fed can "print" all it wants, but it cannot (a) force prices up, or (b) force interest rates down against the will of the gods of markets.

This is the infamous rock-and-hard-place I have mentioned in previous posts. My slow-motion movie climax is approaching. Keep your eyes open over the next few months.

The Climax is Coming

2010-12-15T12:57:00.000-08:00

I have said in the past that this Great Recession is playing out like a slow-motion movie. Every scene takes forever--months even--to occur. Ben Bernanke is our hero/anti-hero, and he has implemented his last tactic: QE2 (a second round of Quantitative Easing, another enormous expansion of the Federal Reserve balance sheet), just as he announced he would.

At least he doesn't mess around. He has put his--oops, our--money where his mouth is.

For Jon Stewart's take on all of this, watch this hilarious clip.

So if everything goes as Bernanke expects (or hopes), inflation, i.e. the general price level, will rise a bit, to around two percent. The banks will remain solvent in spite of the fact that they are still carrying billions of bad loans and that real estate will continue to fall in value. Freddie and Fannie will survive. The unemployed will begin to find jobs. U.S. Bonds will continue to sell at low interest rates and the Treasury will be able to finance the biggest budget in history. The U.S. dollar will retain its reserve status because the Chinese and other U.S. financiers will continue to play the game, in spite of the fact that the dollar will continue to lose purchasing power relative to other store-of-value items (e.g., gold and perhaps other currencies). And all will go well in the world.

On the other hand, if things don't go as he expects, commodities will blow off the charts. Retailers will find themselves forced to pass along costs, and general prices will start to rise even though real estate will continue to tank. U.S. bonds will take a big hit and reveal themselves to have been in bubble territory up until two months ago. Banks will find themselves in the interest-rate squeeze. Foreign trading partners will continue the currency race to the bottom and impose more restrictions. The American workforce will profit from the additional year of benefits the government might hand out, and the unemployment figures will not budge or may get worse. General unrest will rise in parts of the world that depend upon commodity prices remaining stable.

Whatever happens to us, all of Europe is, and will continue to be, in a wrestling match with their unions. Usually this is good for the dollar. However, it is not Europe's troubles that will save the U.S. when Moody's downgrades our bonds. Up to now, whenever Europe trembled, the markets fled to the safety of U.S. bonds. But with this new federal spending bill, the current and upcoming battles between the two parties in Congress, and the insecurity of the next two years, we are in for some mind-bending, rule-bending times.

The big question is: Will the world markets accept U.S. profligacy for another round, or will they demand correction? The answer depends upon factors that are unforeseeable at the moment. Even Bernanke couldn't suppress a tremble of the upper lip during his interview on 60 Minutes. I cringed when he declared "100 percent certainty" of his capacity to reverse gears whenever he chose. I imagined I could feel his fear.

I have grave doubts about any such human capacity, and even about Bernanke's sincerity. He has fallen into the Great Hubris Trap. When Japan was on the hot seat, he was full of bravado and advice. Now he is on the hot seat, and he has to make good on his theory. I suppose he might get lucky; but he also might get what he deserves, i.e. a collapse of the U.S. dollar and pandemonium. The problem is, we don't deserve it.

The Chinese are waiting patiently in the wings. They have taken steps to liberate their yuan on the currency markets, and the results have surprised everyone. Hong Kong is scrambling to handle all the business. It seems doubtful that China's currency will become the next world reserve unit, given their efforts to control everything; but what will the markets decide? That is the real question. The Chinese, as the French say, have forgotten to be dumb ("ils ont oublie d'etre cons").

We may have to be patient as this movie plays itself out, but play itself out it will. And the speed can change unexpectedly.

Is Gold Back?

2010-11-13T17:36:00.000-08:00

I couldn't suppress a grin as I read the headline in Saturday's Financial Times: "In gold they rush. World economy: Bullion's sharp rise in price is prompting a rethink for the first time in four decades about whether the metal should have a monetary role, write Robin Harding, Javier Blas and Alan Beattie."

My Dad, economist Edward C. Harwood, predicted that gold would one day reassert itself in world monetary affairs, with or without the permission of the politicians. In February of 1963 he wrote this to his colleague John Exter:

[Photo of one-ounce gold piece
with Edward C. Harwood's profile on it.]

"Perhaps the ultimate return to the gold standard and monetary health will be a slowly progressing evolutionary type of development beginning here and there and finally accepted on a wider scale as it works in practice. It is too early to visualize details of procedures, but almost surely freedom to contract in terms of and ready availability of gold, perhaps in metric weight units for universal convenience, will be aspects of the final solution. Such are my present random thoughts."

Most economists don't know this, but a real return to gold has already happened, at least in the minds of the public. In fact, some of us never left it. My mantra has always been: You can take gold out of the standard, but you can't take the standard out of gold.

However, convincing the power brokers of its value as a barometer of monetary value will be difficult. After all, taking away the world's central bankers' raison d'etre will not be done without a fight.

The editors of the Financial Times scoffed at Zoellick's mention of gold in his recent communique to the press. Although the FT's journalists who wrote this piece today give it a more fair trial, they are still skeptical. Here are their doubts, which I will dispel for you one by one:

1. "The very extent of the rise in its price ... shows the difficulty of using gold as money. Since the turn of the millennium, ... the price of gold in dollars has risen by 498 per cent.... [In terms of the general price level, this equates to] [d]eflation of 75 per cent in a decade.... 'Gold is a very poor reference point because it fluctuates so widely' says Fred Bergsten of Washington's Peterson Institute for International Economics."

The FT and Bergsten have forgotten one important detail: Gold was the U.S. monetary standard from the 1870s until the 1970s, as it was also for other countries. When the world went off this standard, the need for banks to hold gold ceased, causing a glut of supply. Ever since, central banks and international institutions have been selling off tons at a time. Also, this coincided with a return to more conservative monetary policy during the time of Reagan and Volcker. (Note that the world's central banks have not been so stupid as to sell it all off.)

When the Fed got back into the inflating business in the 1990s, it didn't take long for the public to realize that gold had not lost its luster after all. Their increased demand started gold back up to its real value. Therefore, it is the inconsistency of central bank policy that has caused the great fluctuation in the dollar "price" of gold, not anything related to the nature of the metal itself. Gold is simply coming back into its own, and I doubt it will lose that luster anytime soon, at least in the public's eyes (and that's what really counts).

2. The authors also cite stagnant gold mining output, but their figures are misleading. First of all, remember that central banks and international institutions were net sellers of the metal until 2009 and that most of the gold in the world is stored in their vaults. Total new annual production represents only about 1.5% of total world supply. Second, world gold production has not declined as the article implies but rather will probably peak in 2010 at around 2,630 tons, according to the World Gold Council. The article cites production from only a portion of the current world sources. Third, in 2010 central banks were net buyers of gold. Increased demand will increase production.

3. The authors state that the movements of the gold price have "little connection to the price of things that people actually buy...." But no one is claiming that gold tracks the price of things. What gold tracks is the quantity of money circulating relative to the amount that should be circulating. This is what is so very valuable about gold: it actually tells us about money supply, through market sensitivity. To be fair, even the FT journalists do quote Derry Pickford of Sloane Robinson in London:

"Gold along with other asset prices can tell us if there is an erosion in the general purchasing power of money rather than jut the cost of current consumption."

4. The authors quote John Makin of the American Enterprise Institute, who complains that "Fed critics who cite the rise in the price of gold as a signal of incipient higher inflation have to acknowledge that they are in effect calling for the Fed to tighten policy." Not true, Mr. Makin. What we are calling for is that the Fed not loosen monetary policy right now, because by doing so they are going to cause a devaluation of our dollar and will very likely cause a bubble in assets and/or general prices that will come back to bite Dr. Bernanke (and the rest of us) in the backside. And according to Wal-Mart, price inflation is already happening as I write.

So don't let those gold skeptics dismiss its usefulness in future world monetary policy just yet. Harwood might be right, and before too long the world's monetary power brokers might just bring their own evolution forward as quickly as the public has done.

The Bernanke Putt

2010-10-27T18:35:00.000-07:00

Helicopter Ben is now turning to golf, according to an article by Jon Hilsenrath and Jonathan Cheng in today's Wall Street Journal.

I can't decide whether that feeling in my gut was pain, wrath, or an ironic chuckle, when I read the following:

"The Federal Reserve is close to embarking on another round of monetary stimulus next week ... despite doubts about the wisdom and efficacy of the policy among economists and some of the Fed's own decision makers.... Fed Chairman Ben Bernanke's push to restart the bond-buying program--a form of monetary stumulus known as quantitative easing [QE]--has been greeted with deep skepticism among some of his colleagues.... Mr. Bernanke has used the analogy of a golfer with a new putter: Unsure how it will work, he finds [the] best strategy is to tap lightly at first and keep tapping until the golfer figures out how best to use the putter."

All this is fine and good, Dr. Bernanke, but shouldn't you have gotten your golf practice in well before now, at some prior time when the whole world wasn't watching your every twitch? Do you have any idea of the potential consequences of a misjudgment on your part? According to the WSJ, one of the fellows on your own team, Thomas Hoenig, calls the Fed's up-coming actions a "bargain with the devil."

My previous posts have referred to a slow-motion movie that we are all watching. I have mentioned that at the climax the Fed will find itself between a rock and a hard place: the choice whether to act or not to act.

This is happening right about now, and the Fed has decided to buy bonds. Yet Bernanke has just blown the Fed's reputation as a team of expert economic monetarists capable of curing the second worst economic crisis the world has ever seen, by comparing it to a novice putter trying out a new golf club. Frankly, I'm not sure which is more disquieting.

So now we're pretty sure the Fed will perform QE. Everyone is now asking, will we get inflation or not? First, I'll have to refer you to my previous posts about the definition of "inflation," to remind you that when the media refers to "inflation" they are (incorrectly) referring most often to "price increases," and not the increasing of money supply.

QE is inflating (increasing of the money supply), under the true definition of the word. Whether or not it translates into general price increases is a separate issue that depends on other factors above and beyond the simple act of increasing money supply.

It depends, for example, on the business community's reaction to the results of the November elections, and on the future Congress's subsequent successes or failures. QE might translate into higher general prices, or it might just become higher stock prices, independent of the CPI. It might translate into higher bank bonuses, independent of the CPI. It will certainly translate into a much lower dollar, quite independent of the CPI.

Some recommend TIPS as protection against "inflation" (price increases), but already the TIPS are selling at a premium, so the protection they offer is eroded. And TIPS don't protect us against the effects of a weaker dollar as buyers of our regular bonds reduce their appetite for same. What is the consequence of this? We may soon find out.

What's certain is that Bernanke doesn't seem to care: he's out playing golf.

The Macro Forces Behind the Markets

2010-09-24T11:02:00.000-07:00

Today's Wall Street Journal brings us this front-page headline:

"'Macro' Forces in Market Confound Stock Pickers" -- Tom Lauricella and Gregory Zuckerman (9/24/2010)

[Thanks to Wikipedia Commons for Hokusai Kashushika's "Kanagawa", Big Wave]

Well, I have news for you: Macro Forces have been confounding American investors for the last century, in fact ever since Congress created the central bank.

The article states that "macro forces began moving stocks in a big way during the 2008 financial crisis...." I disagree. Macro forces have affected markets since the central bank starting making credit expansion a national and international issue, instead of the much more manageable local-bank issue it was at the turn of the 19th century.

The article states that one modern-day stock picker, John Burbank of Passport Capital LLC, "compares investing in the U.S. to investing in emerging markets, where he started his career. 'What is happening with the country, with the government, and what are their policies? These are the questions as an emerging-market investor that you ask before you do any bottom-up work on stocks,' he says."

Guess what, Mr. Burbank? The U.S. economy has been subject to government whim, just like the emerging economies, since 1913. Where have you been? You're probably too young to remember.

Example:

Leading up to the First World War and on into the 1920s, central-bank inspired credit expansion created the first big national boom. A few economists saw the bust coming, e.g., Edward C. Harwood, who wrote in August of 1929:

"[T]he time may not be far distant when the country will realize, in the light of a cold gray 'morning after,' that it has just been on another credit-splurging spree." [The Annalist, A New York Times publication, August 12, 1929.]

That time came two months later. He saw this because he was aware of the macro forces' effect on bank balances.

Another example:

At the end of the Second World War, Harwood saw from his statistics that there was a build-up of real savings capable of spurring on economic growth without help from the central bankers. He also noted that the central bankers were planning to continue their chronic inflating policies anyway. Having become by then an investment advisor as well as an economist, Harwood got his clients into the stock market. They did handsomely for the next ten years.

Then, as Harwood expected, the chronic inflating brought on a balance-of-payments problem, meaning that the gold standard was going to be trashed. He knew that the politicians would never discipline themselves enough to restore the dollar's gold-exchange value. He started getting his clients into gold in 1958. We all know how gold ended up in 1980. His clients did very well, although they got a little SEC harassment along the way.

Another example:

After a few years of sanity in the early 1980s, the central bankers went back to their inflating ways at the first sign of discomfort. The signs were, first, the savings bank crisis; then LTCM and the Latin American crisis; then the dot.com crisis; then the 9/11 worries; and now, S.A.S. (Stagnation Anxiety Syndrome). All these caused and continue to cause the central bankers to inflate, inflate, inflate. Where does that lead in fiat times? Bubbles. And not small bubbles; huge bubbles. Bubbles that are so big they have to be bailed out by the taxpayers or the world will come to an end.

I can't help but think that this final crisis isn't over, because no one can predict with certainly the outcome of the current central bankers' particularly egregious macro force known as QE2. If we get price increases, the stock market will do, because the stock market will simply incorporate the new pricing structure into stock prices. Inflation-adjusted TIPS will do, because they will incorporate the CPI. Gold will probably do, because it is a barometer of inflating. But what if we get no CPI price increases? This can happen; look at Japan.

Of the three, I know which I prefer: gold. I am not a short-term speculator and I need security. Gold is the ultimate monitor of macro forces in times like these.

PS: Congress must also be thinking along these lines. Have you seen the headlines lately about their going after gold dealers? Did you note they are enforcing the 1099 regulations relative to gold sales? I presume that's so no one forgets to pay the sales taxes or capital gains taxes; perhaps also because the gold sellers will have to maintain a record of who's buying the stuff. Don't you wonder what legislators are saying behind closed doors?

Bloated Government Still a Problem After All These Years

2010-09-16T17:10:00.000-07:00

What a pleasure today to open the Wall Street Journal and find a full-page open letter to the President signed by Cato Institute. It scolds him, like Alice shaking the King, that in November of 2008 he promised to eliminate waste in the federal budget "page by page, line by line"; and that so far he had not yet begun.

[Thanks to Mr. John Tenniel, illustrator for Alice in Wonderland.]

On the contrary, he and our profligate Congress (both sides of the isle) have been responsible for expanding our budget to a precarious size never seen before.

This letter reminds me of the good old days. Back in the 1950s, 1960s, and 1970s my father, Edward C. Harwood, published such open letters to the standing president, over the byline of his research organization, the American Institute for Economic Research. Very few have the guts to do this anymore.

Rereading from one of my Dad's open letters published in February of 1961 on the subject of inflation, I'm struck by the parallelism with today:

"The great inflation of the past two decades [1940-1960] has shifted about $200,000,000,000 [equivalent to $1.5 trillion in 2010 dollars] worth of assets from the Nation's thrifty citizens and from endowed institutions, in addition to an incalculable but perhaps even larger amount from all whose incomes have been relatively fixed (such as retired individuals ...), to those who have benefited from inflation's progress. One of the chief beneficiaries has been the Government, whose tax revenues have increased greatly; other beneficiaries have been the holders of monopoly privileges including some elements of organized labor as well as numerous others.

"Thus have been fostered dreams of an affluent society able to afford global foreign aid, costly Government intervention in agriculture with accompanying waste of resources, and expansion of business enterprises without sufficient consideration of costs here compared with those abroad.... By cutting in half the buying power of elderly retired persons, they have been stripped of the means to provide for illness and other economic burdens of old age. In these and other ways too numerous to list here economic growth has been retarded and the Nation's economy has been seriously distorted.

"Now, consequences of past money-credit follies confront us. Some Keynesian economists ... recommend more inflation by monetizing more Government debt. Although some Keynesians favor more spending, others favor tax reductions; but the basic notion is the same, i.e., that Government deficits should be monetized to restore prosperity....

"In addition to the dedicated Keynesians, convinced that their nostrum is a useful remedy, various pressure groups will clamor for what they think will promote their interests. Labor leaders who can see only the short-run benefits of more increases in wages instead of decreased wage rates in some industries, speculators in real estate and stocks (especially those speculating on thin margins), bankers whose investment-type assets are excessive and largely 'frozen,' and others who hope to gain from more inflation or fear to lose if deflation occurs will join in the clamor. And adding their not inconsiderable bit will be many intellectuals whose education in verbal facility failed to make them wary of perpetual-motion schemes such as those proposed by the Keynesian inflationists."

[Quoted from "An Open Letter to President Kennedy," 2/19/1961, the final proof document of either the NYT or the WSJ version.]

Ah, that I had the wherewithal to republish much of what he wrote when he was alive. It's all still valid today.

PS: By sheer coincidence, on the page opposite Cato's letter was a huge ad for gold investment in iShares. The ad comes from BlackRock, the gold trust's sponsors and one of the biggest hedge funds, now apparently investing in gold. This also brings back the old days when my Dad brought all his investment clients into gold. He began to do that in 1958, and judging from the results in 1980 when he died, his clients did well.

Central banks have been purchasing gold within the last few months. Would BlackRock be trying to position themselves to get in on a developing business of gold trading, involving bigger and bigger players?

Why Gold is Up in this Deflationary Environment

2010-08-28T10:41:00.000-07:00

I've run across an excellent commentary at The Privateer, entitled "Puzzling - Gold is Going Up Again." He is responding to an August 20, 2010 article on CNN's Money.CNN.com.

As the Privateer points out, some analysts are scratching their head trying to figure out why gold is rising even as inflationary fears are subsiding. This seems counterintuitive.

[Thanks to Dhirajranka.com for the photo.]

Mr. Privateer puts his figure right on the answer to the quandary: monetary inflating. Some call it quantitative easing (QE). We could also call it Helicopter-Benning, or, as the more old-fashioned among us would say, printing money.

The U.S. central bank is finding itself between the proverbial rock and hard place. The rock: stagnation in the American economy. The hard place: The limitation of its power to do anything about it. But they can't just sit there; they have to act. They're supposed to be controlling this thing.

So the Fed Governors--at least a majority of them anyway--seem to have taken this line of conduct:

When in doubt, pull the checkbook out, and make the bogey-man pout.

Ben Bernanke, the figurehead of this majority, once swore to Milton Friedman that we would never see a deflationary episode like the Great Depression of 1929. Some astute analysts are claiming that we are indeed already seeing the deflationary episode, only it is disguised behind a wall of monetary inflating.

Mr. Privateer is one of them. Here are Mr. Privateer's words:

"Not only is 'quantitative easing' inflationary, it is the absolute last resort of the entire inflationary process. Inflation being defined as an INCREASE IN THE TOTAL STOCK OF MONEY. There are quite a few people out there in the world, and in the US too, who understand what inflation is. These same people understand that rising prices are one amongst very many RESULTS of inflation."

[Ah, a rational human being at last!]

"These same people understand that the destruction of 'wealth' measured in terms of money which has taken place over the GFC [I assume this means Global Financial Crisis] to date has more than offset the creation of new money which governments in general and the US government in particular have been desperately resorting to."

"There is not the slightest chance that there will emerge any GENUINE way out of the GFC until such time as the gargantuan malinvestments propelled by the credit money boom which has now collapsed are liquidated on a market. Every day that this is delayed makes the situation worse. Every new 'Dollar' created by governments and their banking system makes the situation worse. Every new Dollar created in this manner is inflation, pure and simple. The fact that prices are rising or falling has nothing to do with it. Inflation is an increase in the stock of money."

My heart pitter-pattered as I read this. One could hear my sighs of genuine relief at not finding myself alone in this cold world.

The author is correct. I would just add that the nation's "regime confusion" is also contributing to the stagnation. (Robert Higgs calls it "regime uncertainty.")

The question is: what do we do?

Here is the Privateer's response:

"The [CNN] article concludes with the assertion that once the GFC is 'over', there will be no reason to own Gold. The problem is that the GFC will not end - or even properly begin - until money can no longer be 'created' out of thin air. Today, while the Europeans are making some moves towards reducing their deficit spending and while Asia is losing its appetite for US Treasury paper, there is no sign of that happening."

Couldn't have said it better myself.

Politico-Economics and Religio-Politics: An Invitation to a Debate

2010-08-17T14:43:00.000-07:00

The current debate about the building of a mosque near Ground Zero inspired the following philosophical thoughts:

Economics used to be called Political Economy in its early days. Political science and economics parted ways, at least on the intellectual playing field, probably for reasons of academic specification. Scientists were attempting to differentiate certain phenomena from others, just as biologists need to separate veins from arteries so they can describe and understand the differences.

Such an effort by scientists does not mean, however, that politics and economics ever separated. They are still a unit, a functioning whole, a body with both veins and arteries that could not survive without both elements working together. Politics affects economics, and economics affects politics, inevitably and forever, on a constant basis, and in innumerable intermingled ways.

[Thanks to Wikipedia for the photo of Chang and Eng Bunker.]

So the attempted separation of economics from politics is only cosmetic, and in fact may have done more harm than good. No matter how hard we try to dissect things politico-economical, we cannot undo their intimate interaction. In fact, efforts to do so have led many a researcher down fascinating but futile paths. Unity between the two is part and parcel of the human societal condition.

The same can be said of certain religions and politics, up to a point. By this I mean that religion and politics have been bedfellows for millennia, mingling indistinguishably. But in the 17th century, leaders of Western society realized that, for social order to progress, two distinguishable provinces of action must be defined and kept separate through legislation: the religious and the political. Hence the notion of separation of church and state came about in 1648 through the Peace of Westphalia, a series of treaties and peace agreements credited with having ended the Christian wars of religion that plagued Europe for so long.

The separation of politics from religion was not, and is not, cosmetic; it is a fundamental tool, a sine qua non of our modern Western Civilization. The Peace of Westphalia was a recognition by Christians that, if society was to advance beyond the stage of constant bloody wars of religion, people would have to agree to disagree about divine or moral subjects, but at the same time agree to fully agree on certain inalienable rights belonging to each human by his very existence; and on the need for these rights to be protected by a political policing process that is divorced from notions of deity and morality.

The ancestors of our Founding Fathers, therefore, lived through the years in the mid-1600s when people came together to make these various agreements that constituted the Peace of Westphalia. These agreements collectively represent one of the most important evolutionary events of Western society. Our Founding Fathers, particularly Thomas Jefferson, most likely were inspired by these peace agreements (and by John Locke) when they adhered to the notion of the separation of church and state. (Observe, for whatever it's worth, that it is not separation of "religion and state," but of "church and state.")

Those who defend the Muslim community's right to construct a mosque near Ground Zero cite the First Amendment:

"Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; ..."

But certain faiths lend themselves more easily than others to the principle of separation of church and state. According to some thinkers, the problem does not lie in the site for construction of the building; it lies rather with the introduction of the Muslim faith into the United States, and into other states of the Western World where separation of church and state is a fundamental corner stone.

Perhaps those who drafted the First Amendment did not think to take into account the existence of (and therefore did not make an exception in the First Amendment for) religions of the world that still believe in the commingling of church and state, such as the Muslim faith, which contains an element of politics in its Sharia law.

I do not condemn the Muslim faith per se, and maybe most Muslims do believe in separation of church and state. In fact, I have no idea about this and know very few Muslims. But whatever they believe:

I advance the notion that the writers of the Constitution did not have to take such religions into account or make any exceptions, because proper analysis of the Constitution provides the best protection against any harm that might arise from allowing the Muslim religion into America, Sharia law or not.

Let's think this through. Here are the questions we should ask ourselves:

QUESTIONS

- Is the Muslim faith a "religion" referred to in the First Amendment of the Constitution? Probably.

- Should a Muslim mosque be allowed to be built near Ground Zero? Legally speaking, yes. Furthermore, a government representative cannot properly come out against it. According to my interpretation of the Constitution, there is no question that Muslims have a right to exercise their religion on that block of New York City. However:

- Can private citizens, including Christian church groups, try to convince the mosque organizers to move elsewhere, out of sympathy for the families of victims and for members of the public who are still sensitive on the subject of 9/11, or for whatever reason? Yes.

- Should the mosque organizers build the mosque near Ground Zero? No, especially if they are sensitive people and they don't want to stir a huge amount of enmity against their religion among Americans of other religious beliefs--certainly a counterproductive move for any group that wants to "reach out." I will go so far as to state that if they persist in the plan, they are snubbing their nose at our sensitivities and inciting future friction.

- Did our Founding Fathers intend to have these United States self-destruct by allowing political systems to exist, inside the borders of the United States, that do not hold to the notion of separation of church and state? No.

- Therefore should we forbid any Muslims who don't believe in this notion from living in the United States? No.

- Then should we ask them to sign a document stating they understand and support the notions of separation of church and state, equality of men and women, freedom of speech, and other such notions? New Muslim U.S. citizens already do: they swear to uphold and defend the Constitution of the United States, "so help me God." All of these notions are implied by the Constitution and spelled out in its Amendments. (See below* for a reprint of the oath all new citizens are required to take at the swearing-in ceremony.)

Having Said That:

- Should we watch them very carefully from the inside (perhaps even in secret) to see what they're up to? Yes.

- Are churches required to be open to the public? No, I don't think so.

- Can we prevent people from assembling within the United States and plotting against the Constitution of the United States? No. In fact, freedom of assembly and freedom of speech are two more founding principles of the country. We should welcome open nonviolent debate.

- Does a government have a right to suppress meetings to overthrow the government? No, not without a judgment or court order based on proof that the meeting attendees have specific plans to commit violent acts.

- Does a government have a right to protect its people by infiltrating private meetings and recording evidence, under authority of an official warrant, where persons are suspected of plotting to overthrow the government by force? Yes, subject to later confirmation in a court of law.

This same debate probably existed during the McCarthy Era about Communism, a quasi-religious political system that calls for the violent overthrow, by revolution, of any opposing government power structure. The ACLU has defended American Communists on the basis of the Bill of Rights.

Did the writers of the Constitution intend this country to allow the existence of a Communist Party within its borders? Probably. But my feeling (and perhaps that of the Founding Fathers) about Communism and other revolutionary philosophies is that everyone can believe any fool thing they want as long as they don't point a gun in my face. If they point a gun in my face, they should expect a response in kind, both from me and from the U.S. military that was established for the very purpose of protecting my rights to life, liberty, my property, and the pursuit of happiness.

Unfortunately, the less violent American "Communists" of the 1950s were probably relatively harmless Socialists who happened to have a flair for the dramatic. After all, weren't most of them involved with Hollywood? What really happened is they got themselves into a very bad misunderstanding enflamed by the mass hysteria of the day. And such flaming hysteria always attracts ugly moths like McCarthy.

We don't need more McCarthys. We do need citizens to understand the Constitution and the notion of separation of church and state. We also need openness among religions, and, without getting paranoid, we must have the wherewithal to protect ourselves in case of attack from within.

Having said all of this, there is one caveat: The American people must be very wary that its political representatives stick to the original Constitution. Any growth of centralized governmental power detracts from the Constitution's original strength and weakens our liberties. For example, any government agent's sanctioning of the mosque construction site is contrary to the Constitution. Bloomberg and Obama should have refrained from making any pronouncements on the subject because of their official occupation as unbiased representatives of the American people. Addressing the notion of Constitutionality is one thing; addressing the Muslim faith or the site near Ground Zero is quite another.

________________

* Oath of all new citizens:

"I hereby declare, on oath, that I absolutely and entirely renounce and abjure all allegiance and fidelity to any foreign prince, potentate, state, or sovereignty, of whom or which I have heretofore been a subject or citizen; that I will support and defend the Constitution and laws of the United States of America against all enemies, foreign and domestic; that I will bear true faith and allegiance to the same; that I will bear arms on behalf of the United States when required by the law; that I will perform noncombatant service in the Armed Forces of the United States when required by the law; that I will perform work of national importance under civilian direction when required by the law; and that I take this obligation freely, without any mental reservation or purpose of evasion, so help me God."

Blinder's Blindnesses

2010-07-20T11:44:00.000-07:00

Alan Blinder, the well-known professor of economics at Princeton, wrote an opinion piece in the Wall Street Journal today. He claims that the fiscal hawks who fear that the stimulus hasn't worked are wrong, and that their refusal to give in on the unemployment benefits issue is misguided--what he labeled "pretty anti-Keynesian thinking."

Well yes, Professor, that's on purpose.

[Thanks to for the image of Brueghel's Blind-Leading-The-Blind]

Blinder later specifies that he is referring to Keynes's recommendations to increase federal spending, and to the idea of reducing taxes so as to increase consumers' discretionary income and hence consumption.

But Blinder himself differs from Keynes (taking permission for his inconsistency from Ralph Waldo Emerson) in that he does not endorse tax reduction. Blinder's own Keynes-bis prescription is, on the contrary, to raise taxes by allowing the Bush tax cuts to lapse (because "we can't afford them"), and to "combine more stimulus in the short run with more budgetary restraint for the long run."

This means, I assume, that the government should allow the tax cuts to lapse and use the increased tax revenue to prolong unemployment benefits (basically a redistribution of income). Then Congress should increase federal stimulus deficit spending and worry about the consequences later (believing, I guess, that wishful thinking today will restrain tomorrow's budget in spite of itself).

Thus, he declares, "Obama's Fiscal Priorities Are Right."

I see several problems with his reasoning.

Problem 1. The spender-Congress's plan, to date, is to increase federal spending through more stimulus AND to raise future spending in the long run when the new health care laws kick in and when the coming baby-boom Social Security/Medicare/Medicaid entitlements explode. This is the opposite of Blinder's long-run recommendations.

Problem 2. By increasing both taxes and unemployment benefits Blinder thinks he is simply redistributing wealth, i.e. taking from Peter to pay Paul, justified by the arguments that (i) taking from the rich is not printing money or incurring more debt; (ii) giving $1 in unemployment benefits, or giving $1 in middle-class tax cuts, or giving a $1 cut to a wealthy taxpayer is "identical" in its impact on the budget; and (iii) more consumption will cure the recession.

This is unproven on three fronts.

a. Let's say we grant that an unemployed person is likely to spend the $1, and let's even grant that a middle-class wage earner will most likely spend it. How can Blinder maintain that a wealthy person, with his armada of lawyers, will still declare the same amount of taxable income if the taxes were to increase substantially? The Laffer curve seems to suggest that wealthy taxpayers will find a way to avoid paying taxes as the tax rate climbs to a more punitive level.

b. It may be true that unemployment benefits financed by the confiscated earnings of the wealthy might force GDP income to shift out of capital investment and land in consumption. But is this a proven recession-buster? It might just have the opposite effect, especially if it's on a large scale.

c. I think Zandi's quantitative model may need a little peer review, and preferably not by a Princeton economist. Today's Wall Street Journal mentions two NBER studies that indicate:

- "... a one week increase in potential [unemployment] benefit duration increases the average duration of the unemployment spells of UI recipients by 0.16 to 0.20 weeks" - 1990 study by Lawrence Katz

- "It is well known that unemployment benefits raise unemployment durations" - Raj Chetty of UC Berkeley

- Another study in March of 2010 by Michael Feroli (J. P. Morgan Chase) concludes that "lengthened availability of jobless benefits has raised the unemployment rate by 1.5% points."

3. Blinder says, "[W]e know one thing for sure: As the unemployment rate rises, the disincentives that worry conservatives become less important because there are fewer jobs to find...." Less important? That is nonsensical. He is saying that the chances of finding a job are reduced, but does this mean we have a better excuse to discourage people from accepting work?

I think the contrary. If people are under financial pressure, people will consider working in a different field than they're used to, or at somewhat lower pay, even if only temporarily. This is a GOOD thing, because the bubble economy created imbalances in the workforce that need to be rebalanced. However, if you throw them more benefits, the disincentives will operate to prevent people from hunting for, and accepting, alternative work, and skilled-labor job offers will continue to go unfilled--yes, that's right, skilled workers are hard to find, even today.

Lastly, I would respectfully ask Professor Blinder to drop the moralizing. It's namby-pamby and weak. He says, "In the 1930s, FDR taught us that heedless self-interest is both bad morals and bad economics." P-u-l-lease. He's beginning to sound like a climatologist: "Let's just do the right thing, whether we can prove it's actually beneficial or not."

Not my kind of morals, economics, or science.

Nature's Golden Standard Is Back (Whether The Macro-Managers Like It Or Not)

2010-07-10T18:03:00.000-07:00

The news about gold swaps on the back pages of the Bank of International Settlements report made a few waves last week. Some immediately reacted in shock, claiming this is potential bad news for gold bugs because it augurs a future glut of gold supply on the market if and when the swaps fall through.

But this is not potential bad news for gold bugs, only for gold speculators. Because I am a gold bug, when I heard the news my immediate reaction was, "Hey, this is great. Some financial entity out there got so desperate that they had to use their gold as collateral. It's probably a large European bank or even a central bank, and this may not be the last time it happens. Gold is definitely coming back into style."

[Thanks to BuyCostumes.com for the image of Mother Nature.]

A real gold bug like me believes that gold is Nature's monetary base, no matter how politico-academics try to manage their fiat (paper) money without it. The fact that central banks still store the yellow stuff is evidence in support of this, so when I learned that some important entity, perhaps even a central bank, was actually using gold as collateral in a borrowing transaction, I realized it was just more evidence in support.

Thus, in my e-mail update from Mineweb.com, I wasn't surprised to find a link to this article entitled "BIS gold swap--best news to hit gold in 30 years." Author Julian Phillips remarks:

"What is significant about this or these transactions is that gold is being used in international settlements after so many decades of being sidelined in the monetary system!"

This is surely what it looks like to me, too.

The poor speculators, however, unnerved by the slightest tidbit of information, are trying to figure out which way the gold price will move over the next few months. We gold bugs don't really care about the short run, because we know that in the long run there's too much paper money (or its equivalent) floating around, explaining gold's rise relative to a number of currencies. But contrary to us, the speculators don't see the joy here.

They think that gold is just a "hedge against future inflation." Therefore, their next question becomes: Will we get "inflation" (which to them means U.S. price increases) enough to spur the Fed to reign in the fiat dollars? The consumer and other figures suggest not. So should the gold speculators panic and sell it all?

I say that this double-dip will maintain prices, and therefore the Fed is not about to retire any fiat dollars for a while unless general prices start to rise. It would also surprise me if the Europeans manage to retire any euros, what with the PIIGS problem. So without a CPI increase does this mean we will not get "inflation" and the speculators should dump gold?

Well, that depends on how you define the word "inflation." I've been down this road before--it's one of my pet peeves--and I'll do it again by referring you to a modern web dictionary's definition of the word "inflation":

"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services."

Interesting that they used the word "or." When can one have a "persistent decline in the purchasing power of money" without an "increase in the level of consumer prices"? Simple: when credit doesn't reach consumers through an increasing paycheck, or through home equity. Where is it, then? In the pockets of speculators, corporations who don't care to invest just now (and rightly so), Wall Street, Freddie and Fannie--in fact anywhere but in the wallets of consumers.

Therefore, general prices will not rise. BUT: the price of gold will rise, because gold is Nature's golden standard, the barometer of "inflation" as defined above in italics. And this italicized inflation situation exists now and has been growing, according to my theory, since consumer prices stabilized in 2008, and perhaps even since earlier than that.

More proof that one can have a decline in the purchasing power of money at the same time as stable prices: Gold compared to the CPI basket of goods has remained stable over time, e.g. about 2.5 ounces/ basket in 2004, the same as in 1942. (Source: www.northerntrust.com/library/econ_research/daily/us/dd052605.pdf.) With the recent increase in its price relative to a number of currencies, however, gold will buy more goods now than is customary. So we have a relative "decline in the purchasing power of money" without an "increase in the level of consumer prices."

Another perspective: Purchasing power in consumer hands is being syphoned off through higher taxes, higher corporate profits (they are not spending, but they are still pricing at the same level), a stagnation of average wages or loss of jobs, and decreasing home equity.

So who is bidding up the price of gold? Anyone with savings they want to protect from further erosion of purchasing power, including many small and large investors, huge hedge funds, enormous pension funds, sovereign funds--anyone who has money to save and who realizes that the dollar and some other currencies have been "over-printed," and that the central bankers are only watching the CPI.

So if the BIS report sent chills up your speculating spine, don't worry. The macro-managers are about to mess things up good, and Mother Nature has yet to sing her last song.

The Evils of Fiat Money: Voice from the Past

2010-07-02T15:42:00.001-07:00

[Thanks to the-gold-market.blogspot.com for the image.]

In doing some research I came upon the following quote:

"Whenever commodity prices are far removed from a stable relationship with the alleged gold content of the monetary unit concerned, there is something, probably more than one thing, seriously wrong. Included in the maladjustments may be extensive abuse (misuse, unwise use) of the banking system with resulting inflation, serious overexpansion of capital facilities in various lines, unwise speculation in tulip bulbs, commodities generally, Florida lots, common stocks, Canadian mining stocks, or what have you, and possibly serious distortions among wages with steel workers getting more than college professors, etc.

"How anyone can imagine that all such distortions, maladjustments, abuses, etc. can be miraculously cured by devaluation is beyond me. Devaluation simply satisfies the most ardent pressure groups for the time being and greases the skids for the next slide by gradually destroying the stable middle-class element of society; it confirms all the unwise in their unwisdom; makes unsound banking look like sound banking; and, after two or three doses, virtually assures the ultimate destruction of the monetary unit as the strengthened pressure groups demand more and more. Such, in my opinion, is the obvious lesson of history, ancient, medieval, modern, and recent. Perhaps things will some day be different, but I doubt that."

As I read this I couldn't help but think how right he was. Everything he described has come to fruition today.

The date? 1953. The writer? Edward C. Harwood, founder of the American Institute for Economic Research. Would that such wise men were still around today.

Is This The Climax Yet?

2010-06-28T15:03:00.000-07:00

I particularly enjoyed this non sequitur today in my inbox, from one of my favorite news providers, BusinessInsider.com:

"The G20 has agreed to pursue programs of austerity while also preserving and enhancing the recovery."

When I clicked on the link, I got the real headline:

"G20 Officially Reveals Its Total Pointlessness."

Yes, the politicians are stymied. The only good thing going for them is that they are finding lots of occasions to practice their talent for talking out of both sides of their mouth. But the straight-talking intellectual academics aren't faring much better.

A few blogs ago, I described this slow-motion movie we're all watching as this recession unfolds. The movie's climax will approach when the Federal Reserve finds itself in front of a dilemma: They must withdraw central bank assistance to maintain credibility in the U.S. bond and dollar, but when is the right time to begin?

[Thanks to Affordablehousinginstitute.org for the image.]

Their problem is that no one seems to know. Bernanke and his colleagues are reportedly hunkered down as I write, trying to figure out how to handle what is looking increasingly like another slowdown, or to be precise the second V in the W. But this is not what they expected to happen. This is not AT ALL what they expected to happen.

Modern macroeconomic theory tells us that during crises the Fed's role is to maintain super-affordable interest rates (for the debtors, including the big banks) and to stabilize prices (keeping them high for the creditors and producers, which, by the way, is seriously detrimental to consumers). The idea is to keep panic in abeyance, to make the great middle-class savers pay through the nose without feeling any pain, and to give us all the impression that things are relatively normal compared to, say, the Great Depression with a D.

If the Great Recession were acting according to the textbooks, the various stimuli and bail-outs would have had their salutary effect and the economy would be reviving about now, allowing the Fed to start gradually pulling out its support as things normalized. But the economy is not cooperating (surprise, surprise) and the Fed Governors are stumped.

What the Fed and the politicians don't seem to realize is that you cannot push a string ... good heavens, do we have to bring out that old cliché again? Well, yes, apparently we do. You cannot force consumption or production. All you can do is borrow or create money and then either play with it or burn it until the real action characters in our movie, the consumers and producers, decide the climate is right to go back to normal. (That is what the Stimulus Package does: borrow or create, and then burn, money.)

But how can consumers and producers go back to normal when (1) the consumers are paying the bill through artificially maintained prices, artificially low interest rates on their savings, and old and new taxes; and when (2) the producers don't know what the Fed and government are going to do tomorrow, never mind next year? It's a vicious circle. One group is waiting for the other, at least until November of 2010 when the producers will have a better idea where the politicians will be heading.

So stay in your seats. The moment of truth is arriving, albeit at a snail's pace. (Meanwhile, hold onto your gold.)

See this good article for another person's expression of the same idea. Enjoy the cartoon halfway down, too.

Inflation or No Inflation, That Is The Question

2010-04-15T12:35:00.000-07:00

Once again, the question of future inflation is boggling the minds of many a financial forecaster. Are we headed for a rise in prices that will carry the Dow up and away, hopefully carrying the rest of us with it, or are we going to suffer the second leg of the W Recession as commercial property and/or the inevitable rise in interest rates hits the skids?

[Thanks to Commons.wikipedia.org for the photo.]

The questions I would pose are quite different. We are already engulfed in a sea of inflated purchasing media that is constantly roosting, taking off, and re-alighting in its search for new quick profits. Unfortunately, given the current labor market, it won't even be dipping a little toe in the ordinary person's paycheck on its way by, at least not anytime soon.

So where is it now, and what is going on? It is where it has gone for the last two years, to wit ten years or more: into speculative investment, biding its time. In America, at least, it isn't going into production, and it isn't going into salaries. It's going into profits and speculative investments, instruments like Greek bonds and credit default swaps so popular with the hedge fund crowd.

This means that the answer to the introductory question is yes, inflation, but be careful how you define it. As I have harangued before, the word is used flippantly to mean at least two things: on the one hand, price increases represented supposedly by the CPI; and on the other: excess purchasing media, the kind that used to cause price increases before the market got savvy, but that now finds itself blowing bubbles while maintaining general prices that should be falling so that the ordinary consumer gets a break. This definition we could differentiate by naming the process "inflating."

We've got the price stabilization, and we most certainly have got the bubbles blowing again. The excess "money" is now keeping Wall Street afloat--in fact higher than ever, bonuses and all, while stable prices buoy the record private sector profits we've been hearing about (which they're using to increase inventory, speculating on a price-rise opportunity), and while the Fed's funny-money sustains the whole U.S. residential real estate market.

If I were a businessperson these days, I would most certainly not invest in much capital equipment or labor, at least not until I find out:

- What the CPI is going to do over the next months, only because of its effect on what the Fed will do;
- Whether the Fed will really stop buying Freddie and Fannie issues, and/or start to raise interest rates, and/or take some other action to counter their recent balance sheet explosion and any eventual rise in the CPI;
- Whether the commercial real estate market will implode, with the resultant double dip in the economy;
- Whether we'll get a second wave of mortgage foreclosures and a second dip in the residential market, with the obligatory double dip in the economy;
- What the FDIC will look like at the end of 2010;
- What the Pension Benefit Guaranty Corporation will look like at the end of 2011;
- What will happen to the health bill;
- What Congress will look like in November;
- What party will run the country starting in 2011;
- Who will win the election of 2012;
- What the national debt projections will look like over the next two years;
- Whether or not the Chinese, Japanese, and Arabs will continue to buy and/or hold US Treasuries at the rate they are today, and what the U.S. bond market will do in response;
- What else?

Frankly, it's a wonder that the real economy turns at all.

This country is at a crucial point, both politically and economically. Will we affirm the liberty protected by our Constitution by turning away from government intervention in our lives, or will we succumb to the temptation offered by larger and larger handouts from an increasingly intrusive, blood-sucking, and short-sighted public sector?

Just as in the 1930s the electorate and the businesspeople of America are waiting to see what we, collectively, will do. In the 1930s the public sector won, and the private sector lost. After Roosevelt's about-face (his 1932 platform included reducing the debt and reinforcing the gold standard--I'm not kidding!) and after seventy years of inflating the currency, we are seeing the measure of that loss today, and the inflating continues to the detriment of all of us. What is the denouement?

In times like this, I prefer the security of gold and related investments. One thing that history has taught me is that gold tends to retain its purchasing power over time as the paper currencies lose their value. And I'm betting the dollar will lose its value compared to gold, sooner or later.

Uncertain Times for Business and Investors

2010-03-07T16:01:00.000-08:00

I don't know how many times I have made the remark to friends and family that this Great Recession is occurring like a slow-motion movie. We saw the bodies sailing through the air in our peripheral vision--the Ken Lewises, the Alan Schwartzes, the Martin Sullivans, the Richard Fulds. The stock market implosion took several weeks to come crashing to the floor, and the resultant slow-blooming dust cloud looked thick and impenetrable from a distance, yet translucent and impressionistic up close. With our telephoto lenses we could capture snapshots of the flustered figures scurrying for cover, the fragmented federal institutions falling by the wayside, the thick unbreathable hot air billowing, and the knee-jerk uninformed decision-making with its domino effects.

[Thanks to Wikipedia commons for the photo.]

There are good reasons to cast blame on multiple characters in this film. The financiers were short-sighted and egocentric--and they still are, with no market force intervention to change their behavior. The overseers were, and are, just as short-sighted and egocentric. No market forces ever touch their behavior, except maybe during elections. Even the central bankers were, if not shortsighted and egocentric, at least somewhat smug and over-confident, which is also to be expected since no market forces ever touch their behavior, except perhaps the flux and reflux of Presidential favor.

(Aside about central bankers: In spite of this huge macroeconomic booboo, these economic engineers of our monetary system seem as impervious as ever to the naked insufficiency of the academic tools at their disposal. One gets the feeling that their tinkering with monetary policy is the equivalent of NASA physics experts deciding they know enough right now to send a spaceship to Venus.)

Massive disruption is common in boom-bust business cycles, but in the more minor cycles the cool wind of reality has managed to blow away the burning dust so we all could get back to business within a reasonable period. This time, however, just as in the 1930s, things are not clearing up. I can see two big reasons why.

First of all, in both Great Events we did not take our just desserts. We could have bowed to natural forces and let the excess speculative credit blow out of the system by allowing the big investment houses to go bust and putting up with a really bad year of unemployment and disarray. If we had done this, we would have feared the worst while it was happening, and some pretty innocent people would have suffered just as they indeed have; but after a few months business would have been able to pick up the pieces and get back to work on a more sound monetary foundation. In this hypothetical scenario--quite imaginary and improbable--the government would have done little except perhaps review its choice of central bankers and its banking system.

Instead, we panicked. Certain players, feeling the finger of blame turning towards them were they to do nothing, threw more credit at an already full-to-bursting credit bubble. By doing so we propped up the misaligned investment houses (in the process, creating another precariously speculative Wall Street finance house-of-cards and another salary bubble), and we shifted the malady from the private to the public sector in the hope that the world's credulity and our credit will hold up for at least one more election cycle.

Secondly, and most unfortunately, our 2008 election results made Congress believe that our political pendulum has swung to the government-interventionist side; but this is a misreading of public sentiment. What the politicians have mistakenly interpreted as a national tendency to look to government for solutions to all problems has caused them to take a number of actions that are putting off even further any hope of a return to reality. It's the borderline alcoholic going on the biggest binge of his life in order to cure his withdrawal symptoms.

The binge won't last. This political pendulum swing won't rest long at the apex. By 2012, there will be a new Congressional mix. But until then, I ask you: What businessperson in his or her right mind would invest for the longer term under the present conflictual circumstances?

Robert Higgs of the Independent Institute has a wonderful byline for our current malaise: Regime Uncertainty, he calls it. He wrote a paper on this topic in the spring of 1997 that is finally getting some well-deserved attention. In his more recent commentary "Regime Uncertainty--Now Maybe People Will Take The Idea Seriously," he notes:

"[B]usinesspeople may be more or less 'uncertain about the regime,' by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action.... [T]he security of private property rights rests not so much on the letter of the law as on the character of the government that enforces, or threatens, presumptive rights. 'What does provide some degree of protection,' notes Andrzej Rapaczynski (1996), 'is the political system, together with the economic pressure groups that ensure that the state does not go “too far” in interfering with the owner’s control over assets. This politically determined thin line may be understood as the real definition of property rights conferred by the state, as distinct from the somewhat fictitious legal notion of property rights. How broadly property rights are defined in this real sense and how effective states’ (largely nonlegal) commitment is to their security is a more serious problem than the issue of legal protections against the more traditional form of takings. (93)'"

See also Higgs's article about the Great Depression entitled "New Deal Orgy No Model For Current Binge," in which he writes:

"The reason the Depression lingered long after the Roosevelt administration launched its hydra-headed recovery effort was because businesspeople in general, and investors in particular, feared the president’s assault on private property rights posed a potentially fatal threat to the market system."

This rings true for today's circumstances. Professor Higgs has done some excellent analysis of business cycles. In and of themselves, busts tend to create political turmoil no matter what the existing environment. That we should have havoc today, therefore, is not surprising given the scope of this event.

So, like our businesspeople, until I see respect for property take its deserved spot on our political agenda, I will not invest in our economy. In the meantime, give me a safe haven. I am not an investment adviser, but in times like these when no one can be sure whether we are headed for a flight from the dollar (or from all paper currencies), or towards another huge wave of inflationary misalignment that just puts off the day of reckoning for another decade, or for the third option that is a decade of Japanese-style stagnation with a big question mark at the end, I can see no better investment than gold and gold-related assets.

It's true, their price will tend to fluctuate in terms of paper currencies, and the politicians will always find ways to tax away any real advantages; but the underlying gold will never lose its innate value, no matter which politicians are in charge.

Bernanke's Moment of Truth

2010-01-08T22:30:00.000-08:00

Once again, Bernanke is the object of my funny bone. The day is coming soon when his mettle will be tested.

(Click on the image for a larger version.)

Hear, Hear, John Kay

2010-01-06T10:43:00.000-08:00

As a followup to my post yesterday, I would like to invite Ben Bernanke to read (if he hasn't already) the perfect analysis of the problem by John Kay of the Financial Times. Other than extending Mr. Kay's time-line to include every financial crisis since 1913, I haven't a word to add; so I'll just link:

Unfettered finance has been the cause of all our crises by John Kay of the Financial Times.

But Ben, A Bubble Has No National Boundaries

2010-01-04T11:21:00.000-08:00

Ben Bernanke is showing himself to be more of a Big-Government politician than a scientist. In his latest speech, he has tried to defend the actions of his predecessors by claiming that their easy-money monetary policy only holds five percent of the responsibility for the high real estate prices that ignited the boom-and-bust bubble that almost broke the back of the global economy.

According to his analysis, 30 percent of the responsibility goes to what he has been calling the "global savings glut." The other 65 percent, he says, belongs to the inferior standards of the US mortgage market. Therefore, his argument seems to be saying that if we cure the standards we cure the problem.

He attempts to prove his point by demonstrating through charts that other countries had even looser monetary policy than the US, and yet they did not show a worse real estate boom; therefore, he concludes, loose monetary policy does not cause bubbles.

This sounds convincing, coming as it does from the highest-placed economic academician in the land. But his logic is flawed.

There are two problems with his argument. First, you cannot isolate these particular variables as he has done. To do so is the equivalent of saying Michael Phelps eats a lot, and he is not obese, therefore a high-calorie diet does not cause obesity. (Michael Phelps is the Olympic medalist swimmer who purportedly eats around 8,000-10,000 calories a day. A scientist could probably prove that he also spends almost 8,000-10,000 calories a day in his sports activities.)

[Thanks to Allfavoriterecipe.com for the image.]

Second, although Bernanke seems to accept the wisdom that a nation's monetary looseness can create excess purchasing media that can then chase relatively fewer goods, he doesn't seem to admit that there is no economic law that restricts a purchasing media's use to its country of origin, at least not in an immediate temporal sense.

Although US dollars must ultimately come to roost back in the US, they may station themselves in any number of places for many years (to wit, China's Current Account Surplus, for example) before they find their way here; and while so stashed, they can be used as collateral for any number of ventures in the meantime, in any currency--say, for example, to buy Spanish pesetas to be invested in Spain's real estate boom.

By the same token, a loose yen, for example, can go on a bubble-blowing spending binge in the US through the carry trade (borrowing in yen to obtain dollar-denominated instruments, or even cash dollars).

Bernanke's effort is a perfect example of the econometrician's Achilles Heel: narrow-sightedness. Markets are fluid, complicated, convoluted, multifaceted mishmashes of changing signals and events. For his analysis to work it must include a variable for each relevant event, not just an isolated one or two.

I find it strange that high-powered government officials feel justified in using such flawed science to defend themselves, even if they were to claim they do it for some lofty cause like the preservation of market confidence.

Keynes's Blind Spot: Consumption is Production Shared

2009-12-28T18:30:00.000-08:00

Bret Stephens has written a nice opinion piece in the Wall Street Journal of December 23. He cites poet Rudyard Kipling and author George Melloan who wrote The Great Money Binge: Spending Our Way to Socialism.

Melloan's work, according to Stephens, shows "in exacting detail, not only how we came to our current crisis--thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay--but where [their flawed logic] is destined to take us again."

All four of these politicians--yes, Greenspan is one of them--seem to subscribe to Keynes's theory of what some have called "demand-side economics." This theory says that consumption is the answer to an economic bust cycle, and that it's okay to create the credit to pay for it through central-bank-created funny-money.

Stephens, citing Melloan I presume, and parodying Kipling, counters Keynes's theory using the supply-siders' argument:

"'[C]onsumption must be paid for with production" ... if you don't work (i.e. produce) you die (i.e., can't consume)."

[Thanks to Allposters.com for this image.]

Stephens and Melloan have understood the evils of Keynesian spending-for-prosperity, to be sure; but they have missed an essential point, which is this:

Consumption is purely a mechanism by which producers share among each other what they have already produced.

(See this post and the subsequent two posts for a more detailed example of this process.)

You see, production and consumption are two sides of the same coin, and production always comes first. One is given life by the other. Consumption cannot exist without production. We divide our production among ourselves on a global basis through the exchange among ourselves of small or large portions of what each of us has produced; and this action is called consumption.

We have gotten a distorted picture of this process, because often we see something we want and we think we have to work to procure the money to buy it. However, in reality the production of that thing came first, and the producers of that thing took their share of the product they produced by accepting a sort of warehouse receipt we have collectively come to label "money" instead of the produced thing itself. When we go to work, we simply become part of the exchanging group, much as a poker player buys chips to participate in the game.

Keynes obviously did not agree with this idea. He wrote as though he believed money has become a tool to be manipulated by politicians and their academic agents, as though it were a vague exchange medium representing nothing more than grease facilitating the performance of our monetary machine.

Like most people, Keynes also confused money (actual warehouse receipts, representing a share of production) with credit (a promise to repay a certain amount of warehouse receipts). Credit is not the warehouse receipt itself, but rather an expectation to receive warehouse receipt(s) within a specific timeframe, based upon the lender's faith that the creditor will hand over warehouse receipts in the short-term, when he or she has actually produced something and receives warehouse receipts as payment (or sells something he or she already owns).

Problems arise when credit promises are not fulfilled. For example, banks sometimes issue credit to market participants over and above producers' capacity to sell. Our current monetary system actually encourages banks to do so to an excessive degree, for reasons that I have treated elsewhere. (See this article, Page 1, Page 2, Page 3, for example.)

It is normal that at some point in every business cycle, banks will become overconfident and begin over-expanding credit by making bad loans. As a result, producers will manufacture (and sellers will purchase, stock, and try to sell) excess production. Under a healthy banking system, slower sales cause sellers' inventories to rise. As a result, they stop ordering, producers stop producing, and things return to their original equilibrium.

However, in an imbalanced banking system, credit starts to circulate, which means that buyers keep buying, profits keep rising, and sellers keep selling at higher and higher prices (too much money chasing too few goods). Producers receive increasing orders and on that basis get even more credit from the bank. They hire more workers, creating a misallocation of labor.

Then, with profits rising inordinately, a speculator instinct wakes up inside some otherwise normal businesspeople. These market players realize that instead of working, they can make lots of easy money borrowing credit, gambling on the stock market, betting on derivatives, playing the foreign-exchange gambit, or flipping real estate, i.e. making fast profits producing nothing.

Bad credit begets bad credit in an ever-climbing spiral. The boom game has begun, misallocating huge sums of what appears to be real money (warehouse receipts), but which in fact is only bad credit.

Then one of the sectors hits a snag. Very often it starts in the financial sphere when someone over-bets his credit. He can't pay; the bank calls his loan. His creditors don't get paid. When this mini-bust occurs, it infects other sectors that depend upon the flow of easy credit collateralized by real or imaginary profits.

Much misappropriated "wealth" just disappears into thin air, which is actually where it came from; but unfortunately ordinary people also suffer as producers of speculative production go bankrupt and misallocated workers lose their jobs.

Fearful people stop consuming until the bad credit is gone and equilibrium returns. This is the normal process, and if left alone it can take several painful months to wind itself down.

But Keynes and today's central bankers think they can outsmart the process. I can hear Keynes say, "Wait a minute. The warehouses are full and people are simply not buying. The wealth seems to be there, because production has already taken place. Somehow, the 'warehouse receipts' have been stashed, or misplaced, or destroyed by the bust mechanism, and all that is needed is for the central bank to prime the pump."

What he doesn't realize is that this Keynesian "solution" just creates more bad credit and throws it at consumers who--quite properly--just don't want to consume. This time, bad credit comes from both the Federal Reserve and the Treasury in the form of zero-interest loans, "stimuli," government purchases of private companies like AIG, and bank bail-outs, which further misallocates money distribution away from the real economy (that can't absorb it) and towards the speculators who know how to play what has now become a funny-money political game. While this is going on, the serious participants in the economy are laying low with uncertainty, wondering what the Fed, the Treasury, plus the IRS, Congress, the EPA, and all the other alphabet agencies, will do next.

Kipling, Stephens, and Melloan seem to understand this game and have tried to call the politicians' bluff. But the politicians will ignore them, because they have found they can fool most of the people most of the time, and a few they can't fool can be bought.

And this game of Pied Piper goes around and around until the people take back control of their money. And they are doing so, through the purchase of gold, gold-related instruments, and other such store-of-value investments. Hopefully, they will not let the government take that right away from them.

The People's Wisdom: A New Gold Standard

2009-12-20T17:41:00.000-08:00

In a most insightful commentary published in the Financial Times of last Wednesday, Martin Taylor, himself a former banker, quipped:

"All business people know that you can carry on for a while if you make no profits, but that if you run out of cash you are toast. Bankers, as providers of cash to others, understand this well. They just do not believe it applies to their own business."

The reason bankers have trouble judging their own cash flow, he writes, is that "[i]n general, banks have no measures of cash flow that work for banking." He describes (with a great sense of humor) how bankers got us into this Great Recession by paying out "colossal accounting profits" in cash that were "largely imaginary.... Not only has the industry--and by extension societies that depend on it--been spending money that is no longer there, it has been giving away money that it only imagined it had in the first place. Worse, it seems to want to do it all again." (He's referring to the banking bonuses, which are at a new high.)

He ends the piece perfectly:

"How depressing the shame and folly of it all is, when one considers that the system was brought down not because risk management was deficient (though it was), nor because greed was rampant (though it was), but because bankers could not count. Merry Christmas."

This really states it all in one newspaper column.

[Thanks to Britannica.com for the image.]

It also causes one to think: Do we really want the world's money supply punch bowl to depend upon government-employed academicians and government-fed bankers, through a government/bank monetary power hierarchy?

For that is what we have today. With the too-big-to-fail policy, we now have fewer and bigger banks than we did before the crisis, and a government that is too worried about its own survival to care what happens to us, the Forgotten Men and Women. The Fed has been pumping billions of dollars into the banks and into certain markets, like the mortgage market. By doing so, the Fed is trying to juggle the general price level, the mortgage rates, and unemployment--to wit, the whole economy.

Taylor's astute observation about bankers' inability to judge their own cash flow is key here. The observation also seems to apply just as well to Federal Reserve bankers. As long as the Fed offers the opportunity to turn short-term credit into cash, bankers apparently will take advantage of it. This is Taylor's point. No one knows how full the punch bowl really is, nor do they care.

The Fed believes that it can judge the proper amount of created cash through observation of the CPI. But bankers' pay, no matter how outrageous, will never raise the general price level. So the upside potential for this game is limitless.

As long as the Fed's generosity only extends to the small community on Wall Street, they can continue to inflate the bonus bubble at will, along with the speculative and unfair redistributive profits their actions engender. No matter what they do to the dollar, to our savings, or to our purchasing power, they can say they were "just doing their job."

How can we protect ourselves?

In another very good Financial Times article entitled "On the flip side," written by Javier Blas, these lines jumped off the page at me:

"For the first time in decades, investors are allocating a fraction of their portfolios to gold on a long-term basis. That marks a return to normality, some argue. For centuries, gold has been central to savers. 'The aberration had been the last 20-30 years in which gold moved out of most investors' portfolios,' says Mr. [Jonathan] Spall [a director at Barclays Capital in London and author of Investing in Gold: The essential safe haven investment for every portfolio.]."

Once again, we the people are smarter than the politicians or the bankers. We have taken up a kind of individual gold standard, to take the place of the one the politicians and bankers destroyed when it got in their way starting in 1933 and ending in 1971.

Gold may be only a speculative commodity to some, but to many it is still an ideal store of value and the only weapon at our disposal to combat (1) political expediency, (2) the legalized embezzlement that is monetary inflation (with or without price increases--see this post and this post for more on this detail), and (3) bankers' inability to count.

I don't believe gold has hit its high yet. Push must still come to shove if and when the general price level does start to rise. At that point, to prove their goodwill and their capacity to control prices, the Fed would have to make a show of starting to increase rates and stopping "printing money;" but at the same time, they will have their other eye on unemployment.

If unemployment doesn't start to decrease, they will see their choices as between doing nothing, thereby allowing some inflation (general price increases as measured by the CPI), or raising rates thereby stopping the employment "stimulus." My bet is they will choose some inflation, in the wild hope that unemployment figures will improve soon.

Their inaction will signal to the marketplace that they will tolerate a further devaluation of the dollar, and gold will rise up again. How far this game will go is anyone's guess.

If the CPI remains low, they can continue to "stimulate" as long as the bond market will absorb it. This is also good for gold, and for the bankers, if somewhat less so for the Chinese, Japanese, Arabs, and the others who hold US bonds.

Remember:

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

Devolution of the U.S. Businessman?

2009-12-14T15:13:00.000-08:00

While reading a most interesting piece in the Financial Times called "Who won the revolution?" I was struck by a paradox of human economic behavior.

The article's author, Alec Russell, just revisited Romania twenty years after having first reported on the situation during the ousting of Ceausescu. The revolution was an apparent success; but according to Russell, the same power structure that existed back then remains in place today.

[Thanks to Roembus.org for the image.]

Instead of welcoming capitalism with open arms and starting afresh, the people somehow allowed the same corrupt elite to stay in power. During the transition these individuals were astute enough to keep their government connections alive and profit from them when the time was ripe.

Today, according to Romanian writer Stelian Tanase, who had dared to challenge the communist system under Ceausescu:

"'The best question to ask is who won the revolution: for Romania, the winner is the former nomenclatura [the high officials in Ceausescu's government]. They lost the revolution but won the power. The former promoters of communism simply became the promoters of capitalism.' He reaches for a copy of the Romanian edition of Forbes' Rich List, which details the country's richest people. 'Eighty-five per cent of the first 100 are former nomenclatura.'"

But how can that be, you ask. Very simple. It takes a Mafia mentality to run a communist government with any success, and for a wily Mafiosi, the transition from gangster communism to gangster capitalism is simply a change of name and of game plan. The underlying tactics and maneuvers are the same.

Russell also interviewed Mircea Chirila, a former security intelligence officer under Ceausescu:

"Is it fair that former Securitate officers are becoming big businessmen? It is, he contends, a natural trend. 'It is a biological evolution.'"

Ah yes. A Darwinian evolution. Survival of the fittest. This makes perfect sense.

My immediate next thought turned to Jeffrey Immelt's embarrassing mea culpa last Thursday in the Financial Times. Immelt seems to have been born again, preaching socialist-style "morality" from the bastion of capitalism on the other side of the globe.

No doubt, he is faced with pressures from shareholders and from factors within the current nationalization-inclined political majority. So instead of looking at history like a good Ayn-Rand capitalist and calling calmly and rationally for the preservation of free markets with stricter rules for fiscal and monetary policy, he flails himself in public and confesses to having succumbed to capitalism's supposed Original Sins--"meanness and greed."

But it's not that he has lost his mind. Just as the Romanian nomenclatura are evolving by adapting to the circumstances, he's simply evolving--or devolving as the case may be, in the Darwinian sense--to the new political culture.

The difference is that he's letting himself be drawn backwards towards centralized, socialized government. At least the Romanians have taken a step forward away from it. They have an excuse.

So what is Immelt's? Is he so vile as to have an ulterior motive? And if so, what does he hope to gain? And at whose expense? Why is he willing to sell America's freedoms down the river?

Francesco Guerrera's Financial Times article makes the answer to this question quite clear: "GE wants to win a large slice of the infrastructure projects funded by governments around the world in an effort to kick-start their economies." Oh, I see. So now we prostitute ourselves? Who is worse, the Romanians, or the American businessmen like Immelt who have sold their soul?

Ayn Rand's innocent, amoral businessmen must get a moral backbone. Mr. Immelt, Lloyd Blankfein, all you CEOs who are being attacked by socialist idealism through the lure of government assistance and political and financial pressure, don't let yourselves devolve into a new American nomenclatura. If you go down that road, you may live to regret it. (Just ask Ken Lewis.)

Bernanke Credibility

2009-12-11T08:45:00.000-08:00

Bernanke is always a good target for a cartoon, especially now. So here's my latest.

(Click on the image for a larger version.)

The Treasury, the Fed, and Gold

2009-12-09T12:50:00.000-08:00

Last week, two experts on the Treasury and the Fed gave a very interesting talk about the two entities' balance sheets. This is especially timely as the President is talking about applying the "leftover" TARP money to a new stimulus venture, and the Treasury is about to vote federal employees an unconscionable pay raise.

This conference was sponsored by the Cleveland-Marshall Libertarians and the Cleveland-Marshall Federalist Society and was called "U.S. Monetary and Fiscal Policy: Going Exponential."

[Thanks to Mathwarehouse.com for the image.]

Just to give you a taste, the following are excerpts from a good review by Kevin Lovach, the Co-Editor in Chief of The Gavel, CSU Ohio:

"[Walker] Todd is a former C-M professor who served as an officer of the Federal Reserve Banks of Cleveland and New York. He joined Case Western Reserve University Professor Emeritus William Pierce in analyzing the Federal Reserve’s monetary policies and federal deficit spending. Pierce served previously as Chair of the Case Economics Department and is a former Libertarian Party gubernatorial candidate.

"Stressing his view that the problems stem from Washington, D.C. and the banking-heavy northeast, Todd said 'the existing Federal Reserve leadership needs to be booted out.' He quipped, 'I’d like to see the Board of Governors hanged first, the New York Fed hanged second, Boston hanged third.'

"Pierce put federal deficit spending for the 2009 fiscal year at 9.9-percent, a figure topped only by spending during and immediately after World War II. He argued that while the economy can handle deficits of three-percent of gross domestic product 'forever,' anything substantially higher 'becomes real money.'"

For the whole review, see Page 9 of The Gavel for December 2009, which you can download at this Cleveland State University page:

The Gavel

To see the conference in its entirety, go to the following page and click on the links. They are around nine minutes each and well worth your time if you want to understand the problems and implications surrounding our exploding national debt and the current precarious Fed balance sheet. They also mention gold as a safe haven and discuss the few other options around.

U.S. Monetary and Fiscal Policy: Going Exponential

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

2009-11-14T08:45:00.000-08:00

In the latest Buttonwood post at the Economist entitled "Paper promises, golden hordes," the writer notes that gold is coming back into vogue. The price has tripled over the last six years, says another researcher, David Ranson of Wainwright Economics.

It looks like the public has decided that paper money isn't so attractive at this conjuncture, and even some central banks are thinking along those lines, to wit Russia, China, and India.

All this makes perfect sense. Gold is not only a store of value; it's a barometer for currencies.

This flies in the face of a recent paper by Barry Eichengreen and Douglas Irwin, cited in the Buttonwood post. These two economists have come to the conclusion that "[d]ropping gold did work" i.e. that abandoning the gold standard has somehow shortened recessions and reduced the inclination to raise as many tariffs.

Other economists would disagree. They hold that, in fact, dropping the gold standard and instituting a process of monetary expansion through a central bank is what caused the distortions in the economy in the first place, which in turn led to the recessions and even the Great Depression itself.

I particularly love this statement: "When countries on the gold standard suffered a shock [my italics] they had to let the real economy, rather than their currencies, take the strain." Countries don't just "suffer a shock." Distortions in the economy cause shocks. And according to some economists, central bank responsibility is involved in every recession and depression since the Fed's creation. Like SUVs, economies don't just drive off the road.

We may never find ourselves back on a gold standard as that institution was understood in 1900; however, I believe the world is on a de facto gold standard, by the very nature of this unique metal. Push will come to shove soon, as the Buttonwood post explains:

"[F]oreign creditors have a right to be more suspicious of debtor countries. Even if they do not resort to outright default, they can always achieve partial default through currency depreciation.

"Indeed, the law of volatility can be invoked again. Developed-country governments have attempted to control bond yields through quantitative easing and to support stock markets through ultra-low interest rates. But they cannot support their currencies as well without risking problems in the bond and equity markets. Gold's surge may indicate that investors fear the next stage of the crisis will occur in the foreign-exchange markets."

You can bet your bottom dollar on that one. And with jawboning for China to reevaluate its currency (watch out what you wish for), Australia hiking its interest rates (twice already), and the dollar reaching new lows (how low can it go?), gold will start to look better than ever.

Are Markets Efficient?

2009-10-04T08:05:00.000-07:00

There are investment advisors who claim that their clients should not worry about investing in the stock market because markets are inherently efficient, or rational. Are they efficient? That depends upon your definition of the word "efficient." Are they rational? That depends on your definition of "rational."

[Thanks to Hamiltoncountyfirefighters.com for the photo.]

I have pointed out previously that vocabulary is important, all the more so in any discussion of scientific subjects. Here are some definitions taken from Merriam-Webster:

Efficient:

1. being or involving the immediate agent in producing an effect
2. productive of desired effects; especially: productive without waste

Markets are efficient-No.1 in the sense that they produce an immediate effect. Are they efficient-No.2? Do they produce desired effects, or productive, unwasteful effects? That is the question.

If you are advising an investor to believe in markets because they are efficient, are you stating that they are efficient-No.1 or efficient-No.2? Isn't it possible that markets are efficient-No.1 but that they are not efficient-No.2, because they produce unproductive and wasteful side effects? And isn't it possible that one of the victims of those side effects is your client?

Rational:

1.b. relating to, based on, or agreeable to reason

Reason

1.c. a sufficient ground of explanation or of logical defense

Reasonable

1.a. being in accordance with reason
1.b. not extreme or excessive
1.c. moderate, fair
1.d. inexpensive

Markets are rational in the sense that there is certainly a logical sequence of events behind every movement, and those movements may have a logical defense, even if we are unable to discern their every step. But are they "reasonable," in any other sense than 1.a.? Hardly.

Markets are a machine. They function with all the givens and with nothing else, like an automobile. In a true free market (perhaps impossible to achieve), one might assume that markets would hand out justice where justice is due over the medium to long run, maintaining the course in spite of some waste. However, in markets such as we have today, with lots of government entities fighting over the driver's seat of our automobile, the result is a bunch of vehicles that can veer all over the road and hit a tree or each other in a most to-be-expected rational way but resulting in wasteful self-destruction.

Overseers of the markets cannot force them into productivity, efficiency, or fairness. I believe there is partial validity in the statement by certain economic theorists that all markets are efficient-No.1, and rational as explained above; but from there to assume, as certain investment advisors have done, that we should invest as though government had no destructive effect on markets, is a travesty.

The More Things Change ...

2009-09-09T07:32:00.001-07:00

Gold has just hit $1,000 and seems to be staying there. China has revealed that it is divesting its dollar holdings into gold and other assets in order to save their sovereign-fund investments. Even the UN is getting into the act. (Do they see a future role for themselves?)

[Thanks to Wikipedia/commons for the photo.]

The more things change, the more they stay the same. So this seems as good a time as any to recall what was said by a subsidiary of the American Institute for Economic Research back in July of 1975 when the Institute's founder, E.C. Harwood, was still alive. Much of it is still relevant today.

"Removal of the gold reserve requirement for Federal Reserve notes (your paper money) in March 1968 and closing of the so-called gold window in August 1971 eliminated the last barriers to inflating continually the Nation’s purchasing media. As long as a substantial gold reserve was required by law, the money-credit managers were confronted with a restraining influence.

Now, only the wisdom and determination of the Nation’s money-credit managers can prevent the ultimate decline of the buying power of the dollar until it becomes nearly worthless. To what extent the citizens can rely on the wisdom and courage of those 'responsible men' can be judged by events of the past [seven] decades, including loss of 70 percent [how much today?] of the buying power of savings and life insurance, the increasing rate of depreciation in recent years, loss of much of the Nation’s gold, and the fact that several of these managers have been among the most persistent in advocating the removal of all restraints. Truly wise and responsible men would not want to be without the guidance of such an objective criterion as a gold reserve requirement; and unwise, irresponsible men should not be relied upon to act properly without such guidance.

The dollar appears doomed to continue losing buying power, the only question being, 'How long before it will be practically worthless?'

We, as well as others, have foreseen this possibility for many years. [Six] decades ago advising investors how to protect themselves against substantial depreciation of the dollar was relatively easy. Most domestic common stocks then were available at prices approximating the prewar level, and a long continued upward trend of windfall profits for U.S. corporations was practically assured by the World War II inflating.

Now, however, the situation is different. No longer is there a large reserve of idle purchasing media such as that accumulated during World War II, which was used to augment business expansion during the earlier postwar decades. Rather, there now exists a huge amount of debt incurred during the prolonged period of inflating. Debt liquidation may have a cumulative effect on business failures.

CONCLUSIONS

We have concluded:

1. … Recently Government authorities have been more concerned with attempting to avoid a severe depression than with reducing the rate of inflating.

2. That the various “welfare state” obligations, including the unfunded Social Security obligations, constitute a self-destruct mechanism reducing the standard of living, and consequently the birth rate as well, for a majority of the Nation’s population.

3. That prolonged past inflating has fostered initiation of innumerable businesses lacking adequate capital, widespread speculation “on margin” in real estate and securities, and installment borrowing on an unprecedented scale by individuals.

4. … Even if [there are] chances of a temporary recovery induced by deficit spending … the adverse possible consequences of a severe depression are so great that we do not recommend gambling on a near-future cyclical recovery.

5. Finally, that continuation of the international financial crisis justifies placing much of one’s funds abroad before exchange controls are ordered, which may occur at any time….

RUPTURE OF ECONOMIC RELATIONSHIPS IN WESTERN CIVILIZATION

The consequences of nearly four decades [make that seven in 2009] of almost continuous inflating are becoming more evident with each successive international monetary crisis. All currencies have been and are being degraded steadily. All now have lost about three-fourths, at least [nine-tenths as of 2009 for the U.S. dollar], of their pre-World War II buying power, and all seem destined to depreciate much more in the next several years, perhaps for as long as a few decades before they become practically worthless.

Clearly, what the world needs is a relatively stable money or accounting unit. In the absence of such a unit long-term promises including bonds, life insurance, and pension plans are like a mirage in the desert and business depreciation schedules are misleading distortions of alleged facts. Unfortunately, the world is getting a continuing flood of paper 'money' that has neither a reliable exchange value nor any assurance that it will retain future purchasing power. Without these two essential ingredients, confidence in fiat paper 'money' will continue to diminish, until the flight from currencies overwhelms the efforts of monetary and political authorities to cope with the chaos.

Politicians generally insist on remaining in their Politicians’ Paradise where lavish promises in order to obtain votes are fulfilled with inflationary purchasing media created to finance government deficits. Their accomplices in embezzling the savings and life insurance of the people in Western civilization are the central bankers of the leading nations. Without exception they choose to remain in their Banker’s Heaven, where promises to pay are, as John Exter pointed out, simply 'I owe you nothings.' And the people of Western civilization are beginning to endure the Hell that has been paved with the good intentions of those who would save the world (and incidentally retain power, or is it vice versa) by the money-credit manipulations.

We see little possibility that there will be a return to sound money-credit procedures until after some bitter lessons have been learned during a future depression.

Meanwhile, each succeeding crisis in the foreign-exchange markets for currencies will tend to spread the realization that paper profits are more easily reaped than retained, and that the purchasing power of hard won savings is ephemeral unless those savings are invested in a tangible asset whose exchange value is not subject to manipulation by the monetary and political authorities. Among such tangible assets, gold has proved throughout the centuries of history to be unsurpassed both as a unit of account and as a store of value. Therefore, projecting an increasing demand for gold in its various forms during the period of unstable monetary conditions that almost surely lies ahead appears to be warranted in the light of both recent experience and earlier history.

The more the politicians and central bankers struggle to free themselves from the so-called 'tyranny of gold,' the more that governments endeavor by controls of one kind or another to counteract or conceal the consequences of their money-credit follies, the more they endeavor to seize the wealth of citizens by increased taxes of all kinds in the hope of maintaining a semblance of monetary order, the greater is the incentive of the citizens of every country to get gold. As a safe and sure means of holding wealth, of avoiding the grasp of the tax collector, and of assuring the economic future of families, gold never has had a peer in the history of mankind. Those who would demonetize gold in order to facilitate their embezzlement of private wealth and maintain their positions of power in governments and central banks are following policies that must inevitably teach every intelligent citizen the usefulness of gold. The money-credit managers are defeating their own ends at a price that almost surely will include serious retrogression within Western civilization."

Aren't these remarks still valid today? I'll just leave you with my mantra:

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

Interview with William Black re fraud in financial services

2009-08-14T06:15:00.000-07:00

Just a short post today to point you to an interesting interview of William Black at American Institute for Economic Research on the topic of fraud in the financial services industry. He discusses techniques for prosecuting fraud and also the characteristics of your typical fraudster, including Madoff and how the SEC missed him.

Interview with William Black is linked at AIER.

Hyperinflation Not an Option, Say Some

2009-08-02T08:56:00.000-07:00

Friday I attended a Symposium on hyperinflation at the American Institute for Economic Research. Participants were Thomas Glaessner of ICG at Citigroup, Peter Heller of the International Monetary Fund, Gerard Caprio, Professor of Economics at Williams College, and Joshua Rosner of Graham Fisher & Co.

[Thanks to Virginmedia.com for the image of Zimbabwe's 100-trillion dollar notes.]

Glaessner had much experience with the hyperinflations of Brazil and Argentina; Heller did also but from the angle of the IMF. Rosner gave his own analysis, and Caprio served as moderator.

Glaessner and Heller both felt that hyperinflation was only a remote possibility due to the strength of various factors within the U.S. They both expect inflation at some point, but think that the Fed will somehow pull it off. Glaessner pointed out that the EU was in no better shape, in fact was worse off, and that the euro was not a real competitor to the dollar.

Rosner was more pessimistic in that he felt the Fed had lost some credibility and that the underlying problems that got us where we are today have not yet been addressed. He had predicted our current trouble well before it began, but no one would take him seriously. He now expects another strong deflationary downturn before things get better but also thinks inflation is a distinct possibility once the next downward swing has had a chance to run itself out. After questioning, he did agree that there existed a possibility that there might be a flight from the dollar. They all agreed that China might just find another medium of exchange with some of its trading partners.

Rosner pointed out that the securitization market had become the principal avenue of financing over the last dozen or so years, and he thinks that the recovery will depend upon the revival of this market, because the banks must accumulate capital and are not in a position to take back that function. They all agreed that the reforms of the OTC marketplace will be helpful if they are done correctly (and useless if done incorrectly), and the major OTC market participants are very active currently in trying to see that it is done well.

Gold was only mentioned in passing and time ran out before I could bring it up, which is a pity. I'd have liked to ask whether they thought there might be some more action. In my view, this deflationary cycle is the result of the previous inflationary cycle, and trying to buck the trend to preserve the price level is not going to solve the problem, but in fact make it worse. Judging from past idiotic government attempts to do so, such frontal conflict with deflationary momentum always ends in distortions, and I don't see why this time will be any different.

What does this mean? It means that the deflation will continue until the market finds its sea legs again, but because the underlying problem hasn't been solved, the market will not get those legs until the toxic cancer has been cut out and the financing channels are reestablished. When that will be is anyone's guess.

Meantime, government meddling with interest rates, the dollar, spending, and credit will backfire as usual. The interesting part will be to observe what happens this time. The country and the world might just not accept another inflationary spiral as they did in the 1950s, the 1960s, the 1970s, the 1990s, and the 2000s. Then again, I suppose there is a chance they will.

Rosner argued that there were too many debtors in the country who would all be quite happy with inflating their debt away. But I argue that this only works when wages rise, and I don't think businesses will let wages rise this time, all the more because unemployment doesn't look like it'll moderate any time soon and it'll be an employers' market (except on Wall Street). Non-banking business is getting too savvy about inflation. Rather than pass through any profits to labor, the extra cash will flow back to speculating (as it has already started to do), and we'll get even more disequilibrium between Main Street and Wall Street. (Seen those bonuses?)

We are in a 1929 situation with 2009 tools and a 2009 government mindset, but also with a 2009 public and business mindset. Whatever we get, whether it be deflation, inflation, or a mix of the two with or without hyperinflation, this is going to be interesting.

Bonus Bubble! Thanks to our Government's Intervention

2009-07-21T12:04:00.000-07:00

You have no doubt seen the news. Goldman Sachs and AIG are paying out bonuses bigger than even at the height of the boom. There is too much competition out there to pay any less, they say. This may be true or it may not, but what is certain is that just about every big Wall Street investment house should be busted right now, which would have thrown thousands of well-paid financial wizards out into the street. If things had gone the way things should have gone without government intervention, there would be so much competition for Wall Street jobs that the remaining few employers could get away with paying one-tenth, maybe, of what they're paying today thanks to us taxpayers.

So I can't resist expressing my frustration.

[Click on the image for a larger version.]

And don't bother commenting that without government intervention we'd all be out in the street. I don't buy that argument, although I admit no one can prove what Might Have Been. (We didn't die after Lehman, did we? We could have declared a bank holiday for a week, gotten the crap off the balance sheets, and moved forward with a healthy but skinnier bottom line--maybe.)

PS: Apology to Messrs. Blankfein and Liddy: I do not incriminate you in this sad story. You, Messieurs, are only doing what comes naturally, i.e. what wolves do. They devour. I do, however, accuse the people who run around in the red-white-and-blue costumes calling themselves "Uncle Sam" and "Auntie Samantha." They are the sneaky wolves in sheep's clothing, the ones who say to us, "Let us fix all that ails you. Everything's going to be okay." And we're so dumb we fall for it.

Not funny.

Time to Throw Out the Efficient Markets Theory

2009-07-12T14:03:00.000-07:00

Over the last few months, I've not been surprised to read that recent events have thrown a bit of doubt on the Efficient Markets [EM] theory. As defined in an article this weekend in the Financial Times, EM is "the theory ... that market participants are governed by rational expectations and markets are self-correcting."

[Thanks to Greenwichroundup.blogspot.com for the image.]

If I understand this theory correctly, the correlation in practicality is that the most prudent long-term investment portfolio for the modest, ordinary investor, i.e. the one with the best risk-security ratio, would be something with a lot of Dow-type common stocks, because the collective markets take all factors into account quicker than any individual can do it.

The evidence behind this theory was provided, in part, by Jeremy Siegel of the Wharton School at the University of Pennsylvania in 1994, in a book entitled Stocks for the Long Run. Siegel analyzed data going back to 1802. According to another article this weekend in the Wall Street Journal, he based his statistics on data provided by two other economists, Walter Buckingham Smith and Arthur Harrison Cole.

However, the WSJ article points out two problems with Siegel's argument: (1) the stock samples chosen were "cherry-picked" and not "comprehensive," and (2) as of June of this year "U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years."

Oops.

Ever heard Benjamin Disraeli's phrase, "There are three kinds of lies: lies, damned lies, and statistics"?

I've always had a suspicion about the EM theory. It just seems too pat, too profitable to the Wall Street types, and not really adapted to the little guy: the forgotten men and women who just want to hold onto their hard-earned savings and gain a little real income from them.

I observe that Wall Street market players are not long-term thinkers who spend even a nanosecond worrying about the future of Western Civilization. They're the ultimate Instant-Gratification Kids, worried only about their next buck. "To hell with tomorrow," or such esoteric concepts as the "Forgotten Man."

Even more so today, as we slide into this second phase of our current recession, we realize that the Efficient Markets Theory--and even its supposed alternate, the "Treasury Bond Theory" (I'm inventing the name)--may both have failed us. This will be especially true if inflation hits us, as some predict (and I believe it will, when it comes time to put the Federal Reserve and Treasury credit genies back into the bottle).

The truth of the matter is that there is no stasis. No theory works all the time. As we slide up, over, and down the recessional curve, the corresponding statistical charts will prove first one theory and then the other, depending on where you start and where you stop the x axis.

So where does that leave us?

I would be very interested in some research comparing three model portfolios since approximately 1900 (more precisely, a year in which the market can be considered to have been healthy and balanced): an Efficient Markets portfolio, a Treasury bonds portfolio, and a Gold portfolio (one invested primarily in good gold stocks). To be fair, we would allow modification of common stock, bond, or gold stock picks, but only over the longer range to insure diversification, company soundness, and regular dividend issuance, and only according to some strict rule.

But such research is not easy to come by. Current advisers are not thinking in terms of the erosion of the dollar. Most of them take the dollar as the only game in town.

There was a fellow who tried his best to give us good information: Economist Edward C. Harwood. Up until his death in 1980, he took the position that inflation was the most pernicious waster of wealth we had to face, and that any safe investment must insure against excessive business cycle fluctuations and loss of purchasing power through manipulation of the currency by inflationary monetary policy. For the latter part of his life (1950s to 1980), his investment research pointed to recommendations based on a high percentage of gold holdings. (Or course, we have to keep in mind that the world was on a gold standard until 1971, and he was not alone in seeing the then-coming collapse of the dollar.)

Today, the current strength in the "price" of gold (in fact, it's really not the price of gold, but rather the weakened gold-exchange rate of the dollar) demonstrates once more that the world has not forgotten the role of gold as a monetary metal and does not have blind faith in the dollar, in spite of what the central bankers would like us to believe; and that inflation and possible dollar weakness is still very much on our minds.

You've probably noted over the last few months that China and Russia have made quite a show of recommending the return to gold as a store of value in place of the U.S. dollar. (See this Financial Times article, and my previous post about the Russian fellow Sterligov.)

These outbreaks, although embarrassing to the U.S., don't seem to worry anyone just yet. However, it would be a mistake to write off the sentiment behind them, which is probably shared by more Westerners than our politicians would like to believe. Note also that even our central bankers have slowed their gold sales in recent months. (Do you suppose they themselves are aware of its present and future potential "price"?)

There is a risk in holding gold. Roosevelt gave us the precedent: in the 1930s, he simply made it illegal for American citizens to hold any gold and forced them to accept the dollar. Nothing excludes that from happening again, especially with popular sentiment against "the rich" and "the speculators."

The dollar may have a few more years in it; but in the longer run, it may be just such market sentiments that will force our politicians and academic theoreticians to recognize the simplicity and efficacy of gold as a monetary metal, in some future international role.

I would love to believe that this must happen in my lifetime; and if it does, gold will find its true "price," well above what it is today, Efficient Market theory be damned (and along with it Modern portfolio theory).

I could be pipe dreaming. Meantime, my mantra still holds:

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

Golden Hero From ... Russia?

2009-06-26T09:14:00.000-07:00

I had to put aside my very pressing work on the biography of Edward C. Harwood to honor my subject's great respect for the gold standard and sound commercial banking, when I saw an ad on the front page of Section 2 of the Financial Times today. Unfortunately, I can't locate a link to the ad itself, but it says:

"THE FAST TRACK OUT OF THE CRISIS
The New Global Payment Unit
Troy Ounce Fine Gold 999.9
Paper money or real gold?
It's your call."

I immediately realized this was the handiwork of either a madman or a genius, or some combination of both, and so I set about finding out more about the fellow. Indeed, he is both.

He is a Russian billionaire named German Sterligov, and he has come up with a new, yet age-old idea: Using gold in international exchange transactions. He has ordered to be stamped under the label "ASCENT" (Anticrisis Settlement & Commodity Centre) 1.1 million Troy ounces of gold, acceptable at any ASCENT office worldwide in international trade deals done through his offices.

This fits in with the rest of his business, which is international barter exchange, a transaction style dear to the Russian heart according to some of the information I found on his US website.

On the European version, I found these two short videos featuring the madman-genius himself--a most intriguing character.

Interview with CNBC on June 23, 2009

Interview on Aljazzeera on May 4, 2009

I think I could grow to like the guy. He became rich in his twenties; he lost the Russian Presidential election to Putin in 2004; and now he raises goats.

[Thanks to Farmtoconsumer.org for the photo.]

I assume he has squirreled his riches away somewhere (and I bet I know where that is).

I agree with everything he says about gold, its historical use, and its potential to help rectify much that ails the world today. On the other hand, I fear for his life, because for this system to become a reality, many central bankers and the politicians who use them will find the competition unbearable.

I will watch this with great interest. Mr. Sterligov, please watch your back. You are playing a game with potentially some very powerful and nasty opponents. If you have any success at all, you will soon be challenged by all the armaments the current monetary authorities and legislators of the world can summon from their reading of the law, and from their judges and alphabet hit men. After all, centralized government's very survival depends upon the powers derived from fiat paper currency.

You could use some help from some small-government politician with the foresight to see the potential of your idea to get the forgotten men and women back to center stage, someone who has the guts and the personality to seize the moment and make a run for it. More power to you and this rare politician, Mr. Sterligov.

Get Your Gold Right Here!

2009-06-17T06:35:00.000-07:00

In Germany, the art of the vending machine is at the forefront of its game. See this one in Wolfsburg, where you can choose your Volkswagen:

[Thanks to Jalobnik.com for the photo.]

Elsewhere, a fellow named Thomas Geissler has started a company that is installing 500 vending machines in various spots, and what do you suppose he sells?

Gold.

That's right, buyers have a choice among a 1 gram wafer for 30 euros, a 10 gram bar for 245 euros, or various gold coins.

There is a slight hitch: He has added a 30 percent mark-up to the cheapest products. Most dealers will ask only around 5 to 7 percent for bullion coins. And of course, prices are monitored and changed every few minutes.

See an article on this by Murray Wardrop at the UK Telegraph. And here's another at Reuters, and a third at Geissler's website.

Economist Edward C. Harwood introduced the notion of selling gold by the gram and potentially using it as an exchange medium back in the 1960s, and he even got his face on a one-ounce gold coin, in honor of his efforts. I don't know if he was the first; but his story is a fascinating one that I may be able to tell at some point relatively soon. I'm now working on his biography.

Meantime, I've often maintained that the gold standard can come back through various doors:

1. Official re-adoption by the politicians (but as my friend the former Columbia economics professor says, don't hold your breath);

2. Partial re-introduction, i.e. official acceptance of gold as legal tender so the public could use it as an alternative to the dollar in contracts and for repayment of debts public and private (I wouldn't hold my breath for this one either, because the politicians know how much this would limit the scope of their financial activities);

3. Demand by the public.

Now, this third avenue may just arrive in spite of a lot of skepticism. US gold coins are in short supply due to the huge demand in the US. Other countries are more aware even than we are of the importance of gold in the historical money markets. This experiment in Germany may tell us just how likely it is. If the public is willing to pay a 30 percent premium to own gold from a vending machine, then the urge to own something of value instead of fiat paper currency must be deeply ingrained indeed.

Mr. Geissler has surely thought this thing through, and has invested in some pretty heavy equipment (500 very solid machines, plus something to make the 1-ounce wafers) and security systems to see that his operation has a chance to succeed. I will be watching this one closely.

Remember my mantra:

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

Skidelsky: The Economic Pendulum Has Swung Again

2009-06-12T08:04:00.000-07:00

In his commentary in today's Financial Times about the economic policy of government stimulus of the economy, Robert Skidelsky, the noted British author and authority on John Maynard Keynes, declares:

"What is fascinating is that it is an almost exact rerun of the debate between Keynes and the British Treasury in 1929-1930."

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

I have already posted about this earlier. He is right, we are right back where we started. In the 1930s Keynes argued against then-current classical economic theory, holding that government spending would put people back to work. At the time, few economists dared to refute his pronouncements. (One notable exception: Edward C. Harwood.)

But the classical school of economics wasn't dead yet. Spearheaded by Milton Friedman, it girded up its loins and made a comeback, using new geeky esoteric mathematical formulas that were effective in shooing the Keynesians. Today, we see the latter group charging forth again to reclaim their territory.

This swinging back and forth says nothing good about economics as a science, and more particularly macroeconomics. There have been no decisive victories in this field since its inception. This is a scary thought when you think that economists are running the show right now.

This unscientific outcome is typical of a number of the social sciences. As Skidelsky points out:

"It is characteristic of the social sciences that their battles are interminable, temporary defeats being followed by the regrouping of the defeated forces for a renewed assault."

I agree, with a nuance. He seems to be saying that the social sciences are ... well, just different kinds of science. He implies that the natural sciences are like a man: logical, Darwinian, forward-looking; and that the social sciences are more like a woman: emotional, spiteful, revengeful.

I think an endeavor is either a science, or it is not. Skidelsky errs in his designation as science the quixotic behavior of certain persons he calls "economists." They may be generally recognized as economists, but they are not scientists.

The debate then becomes: Is the term "economic science" an oxymoron?

This is a very good question, and perhaps THE fundamental question. There are two possible answers.

1. Either it is an oxymoron and economists should re-designate the field of inquiry as an art form; or

2. Economics can be a science, in which case the methodology has gone awry, given the "interminable, temporary defeats being followed by the regrouping of the defeated forces for a renewed assault", i.e. no progress is being made, the pendulum is merely swinging back and forth. In this case, optimists would hold that the methodology can be fixed.

In the early 1950s, a group of scientists formed a group called the Behavioral Research Council to study this very phenomenon in the social sciences. To make a long story short, they premised their foundation upon the hypothesis that the social sciences did have the potential to be just that, i.e. real sciences in the true meaning of the word; but that much gobbledygook must be lifted off the real science that did exist, in order for the various fields of endeavor to make any real progress.

They published two books:

- Useful Procedures of Inquiry, by E.C. Harwood and Rollo Handy, based upon specific dialogue on methodology between two fellows named Dewey and Bentley; and

- A Current Appraisal of the Behavioral Sciences, edited by the above two gentlemen and authored by various social scientists whose work the group respected.

The first is still pertinent to our discussion, pointing out the very flaws in the methods of research in fields like economics, to which Skidelsky makes oblique reference. Apparently, nothing has improved--a scary thought when you think that our economic future depends upon the work of good-intentioned people like Bernanke and his ilk, who believe in policy research that is unscientific in the judgment of a good portion of their own fellow economists.

The second is out of date but still of interest, because it gives the status of each social science as of the last printing. An update of this text would be useful someday.

I'll conclude this post by stating that my observations of human nature, and specifically of those who would call themselves economic scientists and those who would call themselves political scientists, point toward the conclusion that we have a long, long way to go before they start thinking of us and of their science, and not of themselves. Meantime, look what we have allowed them to do to us all.

PS: Keynes had the potential to be a true economic scientist, but I believe he was too enamored of his own glib persona to limit his mutterings to the truly useful, in the scientific sense of the word. Lawrence H. White, on the other hand, is one of the modern economists who counters this new policy swing back to Keynesianism. Read his latest piece over at Cato to learn a scientific economist's analysis of the Great Depression of 2007 and why the Keynesian stimulus idea can't and won't work in the long run.

Angela Merkel, Lone Ranger

2009-06-06T09:13:00.000-07:00

Among all of the Heads of State, Ms. Angela Merkel is the only one with the courage to denounce the policies of the world's most powerful central bankers, Ben Bernanke, Mervyn King, and Jean-Claude Trichet. Bertrand Benoit's piece in today's Financial Times describes the important ending of her otherwise uninteresting speech Wednesday.

[Thanks to Costumeco.com.au for the photo.]

She gave "a vitriolic attack on the world's three mightiest central banks"--something which she has never done in the past. People who know her well confirm that it was no slip of the tongue, that she is always careful to mean what she says and say what she means. She said that she is "sceptical" about the powers of the US Fed to control the flood of purchasing media and credit they continue to create, alongside their European counterparts.

According to those who surround her, she "does not blame the implosion of the subprime mortgage market for the economic crisis. She does not see securitisation as the culprit. Rather, she thinks the loosening of monetary policy under Alan Greenspan's Fed chairmanship fuelled the creation of asset price bubbles and encouraged excessive leverage within and beyond the financial sector." [You and my spell checker will have to excuse the apparent typos, but I'm quoting a British text.]

She reminds me of Mrs. Thatcher back when the English Prime Minister touted the economics of the Austrian, Professor Hayek, who if he were alive today would surely agree with both ladies about the origin of our problems.

This recession is being described as a quadruple whammy: The first round seemed to come from the imaginative excesses of the residential mortgage market and the Wall Street math geeks who played with them. The second is coming now from the equally imaginative over-expansion of the commercial development financing market and is undermining some major banks' already fragile balance sheets. The third will soon appear within the retail credit sector. And the fourth is the credit derivatives wild card.

The source of all four, however, according to Merkel, Hayek, and me, is the combined actions of the monetary and fiscal authorities, (1) whose decisions are not predictable, (2) who have too much power to distort our money supply, and (3) whose constant interventions can and will, everywhere and always, throw even the best-performing economies into havoc.

What makes this even worse is that omnipotent power attracts those who would profit from it. Just listen to the big market players--the seemingly indestructible huge banks and automobile companies--as they turn their sheepish bahs towards Washington. (Try out this website to hear what this sounds like.)

We are approaching an interesting crux of this recession. Economists and market players alike are split into two camps: those who think the principal danger (or speculative opportunity) is depression and deflation, and those who think it is inflation.

I'm in the inflation camp, alongside Ms. Merkel. I don't know whether the coming series of monetary bubbles will take one year or ten to appear and burst; but I feel very sure they are coming. When it comes time to pull the punch bowl away, this Fed will be no stronger than any other has been in the past (with perhaps the exception of Paul Volcker, but how short-lived his wisdom was). Our Fed governors' task will be complicated by their lack of real control of interest rates: Just when they will want to reign in credit, the rates will go up, putting them in a quandary.

As far as I know, and in the longer run, there has never been a nation in history that has survived the chronic debasement of its monetary unit. Ironically, this time it's Germany (or at least her Head of State) that seems to be the one ready to speak up. As Ms. Merkel puts it: "The most complicated phase will come when the crisis is over."

Quick Speculative Thoughts about Possible Future Trends

2009-05-03T13:04:00.000-07:00

In reading the daily commentary of the American Institute for Economic Research for April 29, 2009, my speculative little crystal ball began to light up. AIER is the only serious business cycle analyst group that points out reality, and reality is that contraction is everywhere in the stats, in spite of the recent "good news" in the stock market. (Desperate exuberance, anyone?)

So let's think it over.

We all agree that the government and the Federal Reserve think they are doing their best to prevent a deflationary spiral, to un-freeze credit, and to save major industry players from precipitating us all into a deep depression. Money supply creation is high, and we can see that the Fed's balance sheet has never been in a more inflated state.

According to some signs, these policies seem on the surface to be taking effect. Sales of existing homes are turning around, and the stock market is maintaining its rally. Meanwhile, the money supply is expanding by an annual 8.1 percent, while at the same time the CPI is stable or falling.

If past experience is any indication, it would seem logical that we are headed for an arrest--and perhaps even a reversal--of price deflation; and if the money creation continues unabated, as would seem inevitable given current Fed policy and the expansionary will of the administration, inflation should be the outcome. Some are even talking about hyperinflation.

But I have a slightly different crystal-ball image (which could of course change tomorrow). Keeping in mind that this is just a game, and that no one's fortune telling is better than anyone else's, just for fun I thought I'd throw this out on a rainy Sunday afternoon.

[Thanks to Crystal-cure.com for the photo.]

Hyperinflation is not in my crystal image. This is not post-WWI Germany or Zimbabwe, in spite of the way things look. What is the reason? It's certainly not because there is no monetary excess going on; it's because, unlike the world of speculative finance, a good part of American industry is too savvy to get caught up in the exuberance.

In fact, American industry has been savvy for a long time, at least one century or more. In pre-1929, over-issued money supply did not all pour into consumers' hands, where it must be before it can create hyperinflation. In the decade leading up to 1929, prices were relatively stable, yet money supply grew. Where did it all go? It flowed into the stock market, for one, which experienced a huge run-up that subsequently burst and started a cyclical downturn.

Why didn't the country experience general price inflation? Economists speak of nominal inflation versus real inflation. Nominal inflation can remain low or non-existent, even as real inflation grows. Prices are stable, whereas they should be falling. This is what happened in the 1920s. And American industry knew this, while the Fed governors pretended not to (or were too inexperienced to realize it).

Later, during the long inflationary run of the second half of the 20th century, industrial market players and their public adjusted to chronic price increases. It's similar to what we do as we grow older (if not wiser): We get used to living with low-grade arthritis pain. This chronic inflating, however, culminated in another stock run-up and the acute crisis of the 1970s, which some say was deeper than that of the 1930s in real terms.

But we got over it and it didn't take too long to get back to our arthritic monetary ways during the 1990s, helped by urgencies in the savings bank industry and in the commercial banking industry's politically motivated foreign investments. This time, the inflationary run popped in 2000 and 2001, having inspired another stock market bubble. By now, we were so good at putting up with pain that we returned immediately to our bad habits, creating the real estate and credit-speculation bubbles that have dropped us to where we are today.

Instead of taking our medicine once and for all, we're off to the races again. Today's crystal ball tells me that we will get a renewed stock market mini-hyperbubble, along with a government stimulus maxi-bubble targeted to specific groups of rent-seekers (special interest groups like financiers, government workers and programs, construction conglomerates, unions, and the like). While this is going on, general prices will remain fairly stable, and banks and investment houses will go right back to their speculative games. Gold and commodities may go through a mini-hyperbubble as well.

But the business cycle really wants to contract. This time, the arthritic pain is too acute. Look at the stats at AIER. It's possible that real industrial GDP may not progress, even though government stimulus money may creep in, pushing up the digits for a while. But keep in mind that government stimulus must be paid back by future capital, depriving us in the coming years of investment in real industrial GDP. The figures will mislead us all. But American industry knows this.

So to conclude, we could get some short-lived hyperbubbles in the stock market and commodities, but they might deflate and run out of exuberance for a while. The maxi-stimulus fake bubble will run out of public support for sure. GDP will eventually dive again and will become chronic stagflation as the increasingly impotent government and Fed blow stimuli through the system like air bubbles in a fish tank. Most of the new air will dissipate through short-lived financial speculation. (Japan, anyone?)

Keep in mind that, having exposed my insights to you today, I'll probably rethink this whole crystal vision by my next blog. But if the deflationary business cycle fights back and ultimately wins this contest between it and our desperate government and Fed efforts, expect bubbly stagnation for a good while, until industry decides it's time to make a come-back. Then we'll probably get the inflation we've been fearing.

The Stress Test: Inspecting the Stable After the Horses Have Gone

2009-04-26T10:46:00.000-07:00

[Thanks to Americaswildhorses.com for the photo.]

Even if it's too late, it's good to know that the US Treasury, other Government agencies, and the Federal Reserve are able to do what they were supposed to do all along, i.e. monitor the health of the US banking system. This Federal Reserve white paper amply demonstrates their know-how by detailing the accounting verification procedures they applied in their infamous "stress test" of 19 major US banks, the results of which they now hesitate to divulge to the public for fear of instigating another wave of panic.

This fear harks back to my growing list of examples of government running amuck through inappropriate intervention. Instead of intervening too late, they should have been minding the barn back when it might have turned up some loose beams and posts and kept the horses inside.

What makes this tragic situation worse is that since 2001 the BIS (Bank of International Settlements) has been discussing what to do about what central bank representatives had clearly identified as imbalances in international bank leveraging (e.g. assets vs. capital ratios) and as excessive fiat credit creation.

So where have our central bankers been? Why did it take so long?

Unfortunately, I have no answer to this question.

"[T]he Federal Reserve Board has regulatory and supervisory responsibilities over banks that are members of the System, bank holding companies, international banking facilities in the United States, Edge Act and agreement corporations, foreign activities of member banks, and the U.S. activities of foreign-owned banks. The Board also sets margin requirements, which limit the use of credit for purchasing or carrying securities." [Source. See also this and this.]

Looks like the Fed has spent the last nine years sleeping on the job. Maybe we should start a class action suit for negligence? (Just joking, I think.)

Government Intervention Run Amuck No. 20: Bank Intervention

2009-04-19T12:10:00.000-07:00

My list of examples of the unintended consequences of government intervention in the marketplace gets longer and longer. This time, I'm going to point out the latest irony: Investment banking's profitable last quarter.

[Thanks to Thevoiceforschoolchoice.wordpress.com for the photo.]

This would be wonderful news if it were genuine, but looking a little deeper reveals the truth. First, in one of Barron's feature articles by Andrew Bary, we learn about a little-discussed fact: Goldman Sachs has only been able to issue low-cost debt due to the backing of the FDIC through a program called the TLGP, or Temporary Liquidity Guarantee Program.

I suppose this program is no secret, but somehow it had escaped me that Goldman, JP Morgan, Morgan Stanley, and others are relying heavily on it to survive, at the same time as they are declaring profits and claiming that they want to return the TARP money in a show of strength. In fact, it's all show and no strength when you look at the facts.

Here's another thing that raises my cockles. Goldman has stated first quarter earnings as $1.8 billion. As Alan Abelson points out in his weekly Up & Down Wall Street column, Goldman's profit statement all but ignores results for December because of a fluke fiscal-year switch. "Goldman lost some $780 million in December," says Abelson. This brings the four-month profit down to $1.02 billion, which is still respectible; but somewhere else in Barron's (I can't find it now) we learn that Goldman made most of that profit through a risky bet on bond futures.

Isn't risky betting what got us into this mess? And aren't firms like Goldman now gambling with our tax dollars? Aren't we rewarding and encouraging the very behavior that helped get us where we are today? And is there any guarantee that they will make good bets (with our money) in the future? Shouldn't these people be market-dead?

Abelson conjectures, furthermore, along with his source Zero Hedge, that some of Goldman's $1.8 billion profit may have come from payments by AIG, who "'gifted the major bank counterparties with trades which were egregiously profitable to the banks.' This would largely explain, according to Zero Hedge, why a number of major banks actually, as they claimed, were profitable in January and February. But the profits, it is quick to point out, are of the one-shot variety, and ultimately, they entailed a transfer of money from taxpayers to banks, with AIG acting as intermediary."

My free-market instincts have always told me to hold onto my resentment of big bonuses and the new divide between the rich and the "middle class," as illustrated in the supplementary section to this weekend's Wall Street Times, with glossy pictures of dozens of fabulous mansions for sale around the country. And echoing my own sentiment, Gregory J. Millman chides me in his Barron's piece this weekend, "let's not go ape about fairness." He's right--or he would be, in a free-market society.

But Mr. Millman, this market isn't free and hasn't been for decades. How can we talk about free market when the banking barons are divvying up our hard-earned tax money, thanks to the largesse of those who didn't earn it, our legislative representatives? How can we talk about fair competition when the playing field is rigged in favor of the big boys, and the small businessmen and women just have to suck it up when they learn from their subsidized bank that they can't have any of the handouts? How can we talk about a deflationary correction, elimination of the unhealthy business models, and a return to saner plain-vanilla banking, when our legislators continue to reward foolhardy risk-taking?

We're headed in the wrong direction. More limited government is the answer, not bail-outs of bankers who should be dead by any Darwinian-Schumpeter standard; not Treasury-instigated bank "stress tests" that will soon go bang in the night, raining multiple unintended consequences; not back-room cronyism in the name of "saving the system."

Taylor's (and Friedman's) Error

2009-04-13T16:18:00.000-07:00

In a book review by Clive Crook in todays Financial Times, we read about the new work Getting Off Track by John Taylor, creator of the "Taylor Rule" for monetary policy. According to Taylor, if the Federal Reserve had followed his famous Rule instead of their own discretion over the last decade, we wouldn't be in the mess we're in today.

Taylor's Rule gives a mathematical formula for the calculation of monetary policy. As Crook describes it:

"The rule says central banks should set the short-term interest rate equal to one-and-a-half times the inflation rate; plus half of the gap between actual and trend gross domestic product; plus one. For example, if the inflation rate is 5 per cent and the output gap 3 per cent, the Taylor rule says make the interest rate 10 per cent: one-and-a-half times 5, plus a half of 3, plus 1."

His idea is similar to the formula of Milton Friedman, which at one point economists called the "k-percent rule." Friedman would have had the Fed increase the money supply annually by a fixed percentage. He is essentially Taylor's precursor.

Both economists advocated a fixed, formulaic determination of the expansion of money supply because they were wary of a discretionary monetary policy open to the whims of central bankers and the politicians who appoint them.

Where both these illustrious gentlemen err is in their naive belief that any political appointee(s) would be capable of limiting themselves to a non-discretionary monetary policy once they have the power not to.

In a July 2006 e-mail exchange with the Wall Street Journal's Tunku Varadarajan, Friedman wrote: "There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare." WSJ Archives.

Rare indeed. Didn't he realize that "rare" is in the eyes of the rate-setter?

Friedman's incongruous naivety is at odds with his skeptic personality. In his own book Capitalism and Freedom, he says:

"As matters now stand, while this rule [the k-percent rule] would drastically curtail the discretionary power of the monetary authorities, it would still leave an undesirable amount of discretion in the hands of Federal Reserve and Treasury authorities with respect to how to achieve the specified rate of growth in the money stock, debt management, banking supervision, and the like."

So why does he even bother with the k-percent rule in the first place?

Both Friedman and Taylor seem to be aware of the fallibility of agency intervention into the supply of money; and yet, inexplicably, both seem in the end to take for granted that the agency in question will be willing to renounce discretion when push comes to shove.

This is equivalent to sitting two-year-old Dick and Jane in a room with a big box of chocolates, telling them they can have only one each, then leaving the room. It just won't work.

[Thanks to www.lib.udel.edu, the Univ. of Delaware Library, and The New Fun with Dick and Jane, Chicago: Scott, Foresman and Co., 1956.]

And it's not Dick or Jane's fault. Dick and Jane are only two years old. Monetary policymakers are just humans. Humans are control freaks. They are tinkerers. It is a rare economist who, once appointed to the position of Federal Reserve Board Member, can look deep down inside existing economic science and declare the truth of what he finds, i.e. that no one knows how to control monetary policy, with or without a formula.

For one illustration of the mindset of our FRB Members, read this speech by Governor Mishkin. It's an eye-opener, revealing just what the more rational economists like Taylor and Friedman are up against. These Governors see themselves as monetary artists, not scientists.

For a second example of Federal Reserve mindset, take a look at this astonishingly self-serving article by Alan Greenspan in the Wall Street Journal last month. We perceive between the lines that there's a nasty feud going on between Taylor and Greenspan, and rightfully so. Taylor is Jane's older brother (he's six) and Greenspan is little Dicky.

Now children: I guess we'll just have to take that box of chocolates away, now won't we? (Gold standard and sound commercial banking, anyone?)

The PPIP Drip

2009-04-06T17:20:00.000-07:00

Another version of my April 4th cartoon, suggested by a friend. Which one do you prefer? (Click on the image for a larger version.)

PPIP: The Right Medicine?

2009-04-04T18:16:00.000-07:00

These tense times need comic relief. (Click on the image for a larger version.)

Economics: A Science for Schizophrenics

2009-03-31T17:41:00.000-07:00

An editorial in today's Wall Street Journal brings home a fact that I've known for a long time: Economists tend to be schizophrenic.

[Thanks to Greenpacks.org for the photo.]

The article mentions Larry Summers's double talk. Summers commented on Obama's latest budget by saying, "There are no, no tax increases...." The article points out that there are tax increases, namely the death tax that will be returning to its 2009 parameters, instead of disappearing as it was scheduled to do in 2011. That wouldn't be more than a fib, but the story gets worse.

In 1980, Summers co-authored a study at the National Bureau of Economic Research supporting the elimination of the estate tax.

Go figure. Schizophrenia, anyone?

Another example of economic split personality is one of my favorites: Milton Friedman, a Nobel Prize-winning genius, a great man, and one of our best economists--but just a bit split when it came to monetarism, as noted by lesser economist Edward C. Harwood.

Friedman would say things like this, quoting from "Capitalism and Freedom":

"The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system, is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country. It may be that these mistakes were excusable on the basis of the knowledge available to men at the time--though I happen to think not. But that is really beside the point. Any system which gives so much power and so much discretion to a few men that mistakes--excusable or not--can have such far-reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic--this is the key political argument against an 'independent' central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an 'independent' bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers."

Clearly, Friedman didn't believe a central bank could carry out its intended function because of an inherent defect in its makeup, i.e. its dependence upon humans.

That doesn't prevent him from recommending, in the same work, indeed in the same chapter, that human legislators be given the power to control the money supply: "... [I]t seems to me desirable to state the rule [the legislative rule for monetary policy] in terms of the behavior of the stock of money. My choice at the moment would be a legislated rule instructing the monetary authority to achieve a specific rate of growth in the money supply."

The rest of his work is so monumental that we could almost forgive him, if it weren't for the fact that the whole world took his admission of the validity of centralizing the control of money supply as a justification for their central bank--which is what got us where we are today. Sorry, Milton, but it's partly your fault.

Our third example of inconsistency is the original Accident of Personality himself, Alan Greenspan. In his chapter entitled "Gold and Economic Freedom" published by Ayn Rand in her "Capitalism: The Unknown Ideal," Greenspan says the following about the faulty reasoning of the Federal Reserve in 1927:

"The reasoning of the authorities involved was as follows: If the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates. The 'Fed' succeeded: It stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market--triggering a fantastic speculative boom."

Strange words from a man who did exactly that in 2004.

Perhaps you can now understand why I named my economics blog after Sybil, the star among multiple personalities.

What Went Wrong with Commercial Banking?

2009-03-26T13:22:00.000-07:00

Part III

In Tuesday's post, Part I of this series, I told you about economist Edward C. Harwood's 1928 prediction of the 1929 Great Depression in published and unpublished articles. He saw imbalances in the banking sector that were leading us into a breakdown of the economy through a misuse of the banking system.

In Part II of the series, I gave Harwood's description of sound commercial banking, as read in an unpublished article entitled "A Sharp Distinction Should be Made Between Capital Funds and Commercial Credit." He uses the metaphor of characters in a play. Let me remind you of their names: The Earners, the Investor, the Manufacturer, the Retailer, and the Bank. I recommend that you read Parts I and II first, so that you can make better sense of what follows.

[Thanks to Dreamstime.com for the photo.]

I had described his understanding of the relationships among the players and how the Bank's main purpose is to facilitate the distribution of production into the hands of all who contributed to it and therefore deserve a share.

In Act I, the Bank's power to create credit is limited to an amount representing actual products or services coming to market. This is one of the essential characteristics of sound commercial banking, the foundation of any economy.

At the end of the last post, Earners had placed a small portion of their claims to production (otherwise known as purchasing power, or money) in savings accounts at the Bank. They did this for safety and convenience, and also to derive a little income from the Bank's judicial placement of these savings into the hands of proven wise investors like Investor, who is asking for some of these claims (money) to buy more stock from Manufacturer.

Manufacturer has seen that his products sell well and that he could profitably expand by issuing more stock. The savings department of the Bank agrees and offers a loan to Investor, holding Investor's stock as collateral. Note that the Bank's savings department does not create any credit here; quite the contrary. They extend claims already in existence (Earners' savings), taking only a conservative calculated risk on their return with interest.

So far, this Act I scenario represents the correct use of commercial credit and of capital funds. All's well that begins well in our sound commercial banking system.

Act II

Here the situation starts to go awry. We are 1913. Congress thinks it wise and useful to create a national entity that would have two functions: to apply modern technology to grease the wheels of check clearance, and to serve as a back-up reserve of funds to avoid the destructive effects of irrational, panicky bank runs.

Simultaneously, a war is brewing abroad and some in government foresee a need for a source of emergency financing for the military industrial sector should the US get involved.

They hit upon the formula of establishing a master bank that would have the two first functions, and a third function as well: to create credit--temporarily of course--by "monetizing debt," or "buying" US bonds with credit created out of thin air--claimless "money," if you will. (See how real money is actually claims on production in Wednesday's post.)

This extra claimless "money" would circulate throughout the economy and become indistinguishable from real money as it flowed first through those industries that would receive government checks to arm the military machine, and then on into the rest of the economy. Our master bank is named the Federal Reserve, Fed for short.

The formula works well. The war is won, thanks in part to this stimulus scheme. The Fed must now withdraw all that excess credit; but this causes a recession and pain, like withdrawal symptoms. Instead of taking his medicine and cleaning the toxic credit from the banking system, our Fed decides to relax his standards and allow the credit to remain in circulation.

In doing so, he loses control of the amount of credit he has created and finds himself in need of a less painstaking measuring stick. He settles on the price level. This, he thinks, will be just as good a measure of the supply of money, because it is well known that excess money creates general price inflation. This is not always true; but the Fed has good intentions and lots of faith in his knowledge of things monetary. (But we know what the road to hell is paved with, don't we?)

This illusion of wealth and the apparent stability of prices deceive all of our players. The Manufacturer converts his arms factory back into peacetime production. The Investor puts all his savings, plus as much as he can borrow from the now credit-stuffed Bank, into buying the Manufacturer's stock for further expansion. Optimism reigns.

Seeing the success of the Investor and plush with cheap "cash" (really only claimless credit) issued by the Fed, the commercial department of the Bank starts to think of new ways to make money. They begin to create credit accounts for Investor's investments, instead of letting the savings department lend real savings. This credit is not collateralized by sales documents as normal commercial credit would be, but is based only on a mutual appetite for risk-taking--not the commercial Bank's proper function. Leveraging creates more claimless "money" and makes the situation even worse.

(Note that there is a place for speculative investment, but it is not within a healthy commercial banking system. True speculators are fully informed of the risks involved and must be forced to withstand the full consequences of their actions, down to the last penny.)

A few Earners, seeing Investor becoming increasingly wealthy through his stock investments, begin to do likewise. They take their money out of the conservative savings account that now offers only a paltry interest, given that the Bank is flush with Fed "credit" and doesn't need Earners' savings anymore. Earners also start requesting loans from the Bank, and the Bank, now having lost itself in this adventure, begins to provide even more claimless credit "money," based on nothing but Earners' stocks, the Bank's optimistic and foolhardy assessment of risk, and also on the Fed's own example. Remember too that the Fed's mere existence has now "guaranteed" the banking system's equilibrium. (Economists call this "moral hazard.")

Times are good. Even Manufacturer and Retailer put a little of their profit aside to speculate in the stock market, sending stock prices sky high, even though general prices are stable. What's the first thing you think of when you get your first extra income? Buying a home, of course. Money (or this claimless credit hybrid it has become) turns towards the real estate market. A housing boom ensues.

More conservative Earners note that their wages seem to be stagnating, and that a good number of individuals around them are becoming extraordinarily rich. Manufacturers and Retailers are not expanding jobs like they used to, engrossed as they are in making it rich through speculation.

Once again, let's stop the carousel. This is starting to look like a game of musical chairs. When the drugged music of easy credit wears off, as it inevitably will (there being nothing but speculative and ephemeral gains to be claimed with all this claimless money), many Earners will be left chairless, and/or some will be sharing useless pieces of a chair when a rise in general price inflation sucks the value out of their real wealth.

Here we are in 1928, at the brink of the Great Depression.

"Act III remains to be played. Just when it will begin is a problem, but it is certain that the actors will not fail to appear. It must be confessed that this drama is a tragedy. The third act may be readily imagined by those who have seen depression before. It is unfortunate that this is what we must expect, but such will always be the price of inflation."

Harwood's phrases. "Inflation" as he uses it here refers to the inherently risky "claimless" credit expansion, to be contrasted with healthy expansion spurred by sound commercial credit creation as described in Part I.

Act III takes place one year later in 1929 with the collapse of a stock market bubble and a bursting real estate boom, much like the ones we find ourselves in today.

What makes today's situation worse than 1928 is that back then, the country observed the gold standard, which guaranteed the value of the dollar and limited the amount of risk-credit expansion that could occur. It was indeed the scarsity of gold that forced the Fed to retract credit in 1929. But both gold and the Fed were only doing their job, something the academic community dismisses today as primitive misguided meddling in free markets, which it was not. On the contrary, it was playing by the rules on a gentleman's playing field. Today, it's a game of Scoundrel Takes All, at least until the public wises up--not through more government intervention, but through a reestablishment of basic rules.

Standardization of the monetary unit referent to something of generally perceived and constant value is the second characteristic of sound commercial banking, whether it be gold or something better. (I know of nothing better.)

Today, we have no such disciplinary tools in place, and "claimless" credit expansion has been allowed to expand to a degree never before seen in history. What remains to be seen is whether the very people who allowed this expansion to take place can now persuade it to retract in an orderly manner.

(The public is not blameless. It is we who elected the 1913 Congress in the first place.)

What Is Sound Commercial Banking?

2009-03-25T13:04:00.000-07:00

Part II

In yesterday's post I told you about economist Edward C. Harwood's 1928 prediction of the 1929 Great Depression, in published and unpublished articles.

He saw imbalances in the banking sector that were going to lead the country into a quagmire (although he could not have predicted the depth to which it would sink through government and global mismanagement).

In his unpublished article entitled "A Sharp Distinction Should be Made Between Capital Funds and Commercial Credit," written in mid-1928, he gives us a layperson's understanding of sound commercial banking by explaining the relationships among the various participants as though they were characters in a play. Let me introduce you: The Earners, the Investor, the Manufacturer, the Retailer, and the Bank.

- Earners - all who are entitled collectively to a share in a country's GDP, i.e. those who participated in its production. In other words, all of us who work for a living. In reality, all of the characters are Earners, but some have different functions.

- Investor - the risk-taker who lends his capital funds to the Manufacturer in exchange for a piece of the profits.

- Manufacturer - the producer of all products, agriculture, and services.

- Retailer - the selling agent for Manufacturer.

- The Bank - the financial intermediary between Manufacturer and Earners, between Retailer and Manufacturer, and between Earners who save at the Bank and the Retailer or Manufacturer, to name a few of the relationships.

[Thanks to JohnDClare.net for the photo.]

In Act I, all goes well. Manufacturer receives a loan (capital) from Investor with which to buy his building, equipment, and raw materials. Then he plans an amount of production based on expected sales. With the help of Earners, he produces goods (or services) to ship to Retailer for selling to the public. Retailer promises to buy the products and signs the purchase order.

At shipping time, the Manufacturer wants to be able to pay Earners even though he hasn't received payment from Retailer for his products, because Retailer will need to sell the products first, and guess who are his customers? Why, Earners, of course. (What goes around, comes around.)

Here is the first point to remember about a healthy monetary system: Manufacturer always distributes 100% of his gross sales among his expenses, his profit, his Investor, and his Earners; and the only way he can do this at this point is to get a loan at the Bank, and give each Earner a claim for the value of that portion of the products each has helped to produce, so that the claimant can claim it (or its equivalent) when he wants it.

A particular Earner may not want the five cars his annual work entitles him to; he may want down payment on one car, some bread, some meat, rent money--any number of things. Money is, in essence, a claim--no more, no less, and it is generic, accepted everywhere, as long as its value is guaranteed. (More about that later.)

So to give the claims (we could have named them "purchasing power") to each participant, the Manufacturer goes to the Bank with Retailer's order for the goods. On the basis of the order the Bank grants Manufacturer a loan by creating credit out of thin air, so to speak, and puts the credit representing almost the total future sales in a checking account to allow the Manufacturer to pay Earners. (The rest is Bank's income.)

Once the goods are ready for shipment, Manufacturer pays himself and the Earners, including the Investor, in cash or equivalent; and everyone accepts these claims (paper cash bills, a check, or an electronic transfer) representing a piece of the production.

It is important to retain the notion that the income from the wholesale sale of the product is divvied up between the Manufacturer and the Earners, because they each are entitled to a share of the whole production, down to the last penny. There can be no more or less money (claims) handed out than the total wholesale price of the things manufactured. This is an essential point. Also realize that the wholesale sale value is only a part of the final retail sale value. This is normal, because there are others who are going to participate in the distribution process who will also have a right to claim a share representing the work they have done to get the product to market.

Next, the Manufacturer will require Retailer to make good on his signed purchase order and pay the wholesale price before the items are sold. So Retailer too goes to the Bank as soon as he receives the title to the goods in shipment; and the Bank, on the basis of the title, grants a loan (credit) and deposits the sum in a checking account so that the Retailer can pay Manufacturer for the goods, who in turn pays back his own loan from the Bank.

The Bank then destroys Manufacturer's loan document and finds itself with a new loan document signed by Retailer for a higher amount. The Manufacturer's loan account is zeroed out, all sums being paid. Remember, the credit previously issued to Manufacturer and paid out is now claims in the hands of those who produced the products and who deserve their share of its value.

Retailer, who now owes the Bank, sells the products within a few months and pays back his loan. The Bank then destroys the Retailer's loan document. The Retailer, like the Manufacturer, pays the remaining sales proceeds to cover expenses, then himself, his own employees (earners), and investor (another earner), and they all become owners of claims to a piece of the production value.

Soon, someone will have bought all the products that were manufactured, ending the cycle. A few of the paper claims will end up in a savings account at the Bank.

Let's stop the carousel here and take stock of things. What I have described above is the commercial relationship of every company in the world with its bank's commercial department. In the past, banks created credit (in the form of checking accounts) that was self-liquidating, as described here. They did not create any other credit. To do so would have been risky unsound banking, proven in the past to lead to trouble.

In Part III of this series on sound commercial banking, I will delve into how banks dealt with savings.

The Origin of This Whole Mess: 1913

2009-03-24T17:39:00.000-07:00

Part I

Economists disagree on the identity of the true culprit behind our current crisis. Some blame Wall Street; some blame the progressive politics that pushed Freddie Mac and Fannie Mae beyond their capacity; some blame the profiteering loan brokers, the foxy house flippers, and the naive subprime home buyers in their rush for quick profits. Some blame the Federal Reserve, including me from time to time.

[Thanks to James Montgomery Flagg, the artist, and Wikimedia.org. The image is in the public domain.]

In reality, all of the above had their role, but they are just players in a game, the rules of which are defined by politicians. The origin of the problem lies in the rule changes that caused the demise of sound commercial banking back in 1913.

Before then, good commercial banking had been functioning well, both in England and and the US, for about a century. Business cycle fluctuations, although sometimes painful, managed to keep the profession on the right track. The invention of the Fed in 1913 was supposed to allow banks to weather business cycle downturns without going completely bust because of irrational panic withdrawals that had no justification in the real data.

Morphing onto a national stage out of private banking functions already in development, the Fed's check clearing services and temporary commercial loan facilities were indeed a clever and useful idea. But the politicians discovered that, once the Fed found it could take over the centralized monopoly of legal tender issuance and then credit creation, it could be used for other things than just stabilizing the banking system. And everyone believed the Fed could control this new-found usage and that it would not do any harm.

In preparation for WWI, the government turned to the Fed credit-creation facilities to finance the war. It was a great success. The Fed managed to wrest most of the genie back into the bottle after the war by early 1920; but the temptation was too great and the discipline and privations too onerous, so they allowed over-issuance of credit to continue, ostensibly to help the country out of the recession the war disruption had caused.

The downturn ended in 1921; but the credit issuance continued. The result was 1929. As Doug Noland says in this week's article at Prudent Bear:

"It was understood at the time [during the Great Depression] that our fledgling central bank had played an activist role in fueling and prolonging the twenties boom - that presaged The Great Unwind. Along the way, this critical analysis was killed and buried without a headstone."

How true. Very few economists today remember the Fed's role in inflating credit previous to the Depression. On the contrary, everyone, from Keynes to Friedman to Bernanke, believed and continue to believe to this day that the problem lay in too little credit.

Many base their hypothesis that the Fed did not over-expand credit in the 1920s on the fact that the price level was relatively stable. Economist Edward C. Harwood pointed out in published articles that an economy can present over-expansion of the money supply even in a climate of stable prices; and furthermore, that this held true in the 1920s. Outside factors can cause real prices to fall, while an excess of money supply camouflages these factors by keeping prices at the higher level, with no one the wiser.

Furthermore, what these theorists ignore entirely is that the Fed's newly assumed power to unleash the credit genie destroyed sound commercial banking in pretty short order. ("Power tends to corrupt; absolute power corrupts absolutely." Lord Acton)

In an unpublished article written around May of 1928, Harwood described the process by which the art of commercial banking became tainted and was eventually lost. He compared it to a play in three acts. After describing the players and the events of the first two acts, he wrote:

"To date [May 1928], recent business history has paralleled acts one and two of this drama of commerce. Act III remains to be played. Just when it will begin is a problem, but it is certain that the actors will not fail to appear. It must be confessed that this drama is a tragedy. The third act may be readily imagined by those who have seen depression before. It is unfortunate that this is what we must expect, but such will always be the price of inflation."

He correctly predicted the depression that came one year later. He is one of the few, unfortunately forgotten today.

In the next parts of this blog post, I will go into the details of sound commercial banking, how it was allowed to self-destruct by the creation of the Federal Reserve, and how its destruction led to today's crisis.

Fed Credit: The Latest And Perhaps Next-To-Last Bubble

2009-03-21T11:33:00.000-07:00

I can't claim to be the origin of the Fed Credit Bubble idea, because it occurred to me as I read a fantastic piece by one of my favorite analysts, Doug Noland of Prudent Bear.

We've just come out of a huge bubble that consisted of inflated real estate investment and speculative finance credit. The bubble burst and the market began to correct itself, menacing to take a lot of nations' economies with it.

The reaction of our economic leaders was and continues to be to try to maintain a minimum of stability by propping up the various players on the world financial stage as they began to totter, one by one: first the real estate sector with aid to Freddie Mac and Fannie Mae, then the banking sector by saving Bear Stearns and loans to other institutions, then the insurance sector by bailing out AIG, then the automobile sector with handouts to GM and Chrysler, more money and loans to the banking and real estate sectors, more to AIG, recently some more to auto supply companies, more to AIG, and now the credit card and other large ticket item credit sector--an endless list, it would seem.

The central banks of the world, to a varying degree, are performing their propping-up role as the ultimate insurance company, the lender of last resort; and the US Fed, given the universal role of the US dollar as reserve currency, is the one that will be the buck-stops-here Last Lender of All Last Resorts.

As Noland points out, however:

"Our federal government has set a course to issue Trillions of Treasury securities and guarantee multi-Trillions more of private-sector debt. The Federal Reserve has set its own course to balloon its liabilities as it acquires Trillions of securities. After witnessing the disastrous financial and economic distortions wrought from Trillions of Wall Street Credit inflation (securities issuance), [it is possible that] the Treasury and Federal Reserve have set a mutual course that will destroy their creditworthiness - just as Wall Street finance destroyed theirs."

He's saying that the Fed is going to create the Bubble of All Bubbles, right there in its own house.

[Thanks to Bouncehousesnow.com for the picture]

But just how much air can the US Fed balance sheet withstand, without bursting its own skin? The inflationist central banks are acting on the assumption that they can right the "market failure" (see PS below) through this "temporary" remedy, that the market cannot right itself alone, or at least not without disastrous consequences. But aren't they trying to add air to an already burst bubble?

Instead of curing the problem, they are acting contrary to the market's instinctive corrective hiatus and will end up distorting events even further. How can arbitrarily selective bailouts and the forced financing of government projects--projects that otherwise most likely would not have been financed--do anything except further distort the admittedly slow and cumbersome but essential market reevaluation process?

"[T]he seductive part of [the optimistic] view is that unprecedented policy measures may actually be able to somewhat rekindle an artificial boom – perhaps enough even to appear to stabilize the system. But seeming 'stabilization' will be in response to massive Washington stimulus and market intervention – and will be dependent upon ongoing massive government stimulus and intervention. It’s called a debt trap. The Great Hyman Minsky would view it as the ultimate 'Ponzi Finance.'”

Precisely. The ultimate Bubble, created by those who are supposed to help us avoid them altogether.

So how will the world react when this latest bubble bursts? At some point, investors looking to preserve the value of their wealth will realize that there is no investment denominated in an existing national currency that does the trick, and they'll turn to gold, always the last fat lady to sing before the curtain falls and reality sets back in. (By now, you've figured out that I'm somewhat of a gold bug.)

_______

PS: We have no market failure here. On the contrary, the market is functioning perfectly. It is waiting to discover the real price of toxic assets, if only the government and its allies would let it. Rather, it is the market players who have failed us, and more specifically those who would pretend to manage our monetary units. For more on the true source of the real estate and credit bubbles, find yourselves a copy of the March 16, 2009 Research Reports out of the American Institute for Economic Research (annual subscription), and read the piece by Walter M. Cadette entitled "Greenspan the Goat."

The Inflation Boat Is Leaving the Dock

2009-03-19T15:01:00.000-07:00

Last night we learned that the Federal Reserve is going to put into practice its announced plan to buy US government debt. Today's Financial Times article by Krishna Guha gives the gory details.

Everyone knows that this action by the Fed increases money supply, and most are aware that it increases the probability that at some point in the future the amount of money created will be excessive with regard to the actual needs of the marketplace, which in turn will tend to lead us towards a state of price inflation, or bubble inflation. Another article by Javier Blas on the early signs of this in the commodities markets is a fun read on the subject.

As the Fed sees the problem, then, they must feed us with money supply while the banks are frozen in a state of rigor vivus, and then in future, just at the right moment, they will take steps to prevent the normal outcome of price or bubble inflation by reversing the process.

[Thanks to 1stchoicecufflinks.com for the nice photo.]

This sounds logical. As an obscure economist named Edward C. Harwood wrote during our last episode of purposefully inflationary Federal Reserve intervention ("the ill-fated Operation Twist in the 1960s"), during a time when we were still trying to adhere to a modified form of the global gold standard:

"Once inflationary purchasing media have been placed in circulation, there are two ways in which sound money-credit relationships may be restored: (1) by means of devaluation, that is, reducing the gold weight of the monetary unit so much that the increase in the number of (smaller) gold dollars equals or exceeds what had been the inflationary portion of total purchasing media; or (2) by means of deflation, that is by removing inflationary purchasing media from circulation." [See this article from the American Institute for Economic Research website [AIER.]

Let's take these in order. In the 1960s during the last years of the gold standard era, the word "devaluation" had by definition a specific political action attached to it. We could say it was an official public confession to a previously committed inflationary crime, the central bank's admission of guilt and acceptance of their incapacity to rectify the situation. To devalue a currency was ripe with ominous significance, and central banks were supposed to take pains to avoid the embarrassment by not inflating the currency in the first place.

Today, however, the devaluation of our currency takes place painlessly for most of us (except for importers), and effectively the Fed gets away with it on a regular basis. In fact, without a gold or any kind of standard, the inflationary purchases of debt instruments that the Fed has already made, plus those it intends now to make, are already devaluing the dollar as I write. We don't have to wait for an official recognition and adjustment of any standard; it just happens on a day-to-day basis.

Under these circumstances, an official announcement of devaluation, therefore, will have no corrective effect. Quite the contrary, inflation will take place simultaneously with the devaluation of the dollar--a double whammy, if you will.

But we don't want prices to skyrocket, so the inflation will still need correction. Let's turn to the other option, deflation. Paradoxically, the Fed is taking its present inflationary action to fight fear of deflation. They are afraid that a banking panic and a lack of credit could cause the system to collapse in what is called a "deflationary spiral." So it will be a while before they feel comfortable with using the deflationary tactic.

Nevertheless, the Fed scientists and governors do believe that it will be possible for them, at some appropriate moment in the future, to begin a controlled deflation of money supply that will not upset the apple cart.

Harwood does write this about the possibility of a controlled deflation:

"That a period of gradually declining prices can be a period also of great economic growth has been amply demonstrated in the past. For example, between 1875 and 1895 while prices decreased substantially, the Nation's productive capacity and output of goods and services increased at a very rapid rate. The often heard assertion that an economy cannot grow unless prices are rising has no basis in fact....

"With gradual deflation, a longer time would be required to eliminate all inflationary purchasing media and reach an equilibrium between the remaining (noninflationary) purchasing media and prices and wages, but the traumatic events that are a feature of rapid deflation would not occur. The Nation would 'outgrow' the inflationary condition as part of the savings of individuals, businesses, and perhaps of the Government were used to pay off inflationary bank loans and thereby cancel both the loans and the checking deposits that the loans had created. Although gradual deflation would be accompanied by decreasing prices, wages almost certainly would decline less or might even be sustained by greater productivity due to technological and other developments."

(For more on why deflation is not always bad thing, read this research by David Beckworth at Cato.)

So it would seem that a gradual well-timed deflation is what Bernanke and his cohorts are counting on. But... there are a few minefields here. One is that we are no longer on a gold standard. We have no point of reference as to where the dollar should end up. I won't go into the reasons why this makes Bernanke's task more difficult, but it does.

Second, how will we know when prices begin to inflate or when bubbles start to form? Alan Greenspan is famous for having remarked that it is impossible to detect when a bubble is appearing. It's true that we all knew the real estate mania was a bubble (or at least I did; didn't you?), but our financial wonks at the Fed either preferred not to recognize it or couldn't prove it to their own satisfaction, at least not to a point where it would have forced them to take action. (I'd add that they may have had incentives not to want to find reasons to take that action, but that would be unfair speculation, so I won't.)

And what if prices remain the same? Does this necessarily mean that we don't have an inflationary maladjustment in the money supply that maintains prices at an artificially stable but too high level? What if the stimulus package spending turns out to be wasteful to some significant degree? Isn't that like blowing bubbles? Example: Bailout-funded Wall Street bonuses.

Third, and here's the real rub, we have not practiced what Harwood calls "sound money-credit principles" since the Fed was created. These principles mandate a specific equilibrium in the commercial banking system between true reserves, deposits, savings, and short-term commercial paper on the one hand; and loans and investments that are speculative and/or based only on some form of collateral, on the other, where these more risky activities would be allowed only outside the strict commercial banking system. (For more on sound commercial banking, find a copy of Harwood's book "Cause and Control of the Business Cycle," 1974 edition, at your local library, or in the AIER catalog. I will delve into the idea of sound money-credit banking in a future blog.)

Fourth, the Fed cannot reverse its current trajectory and start to take deflationary action until the time is right and the worst of the credit crisis is past. Will nothing unexpected disturb their plans? They are relying on deflationary scenario computer models where "all else is equal," meaning when outside factors remain stable. What if the market does something surprising that will make a controlled deflation either inadvisable or even impossible, at the very moment when it must happen? For example, US treasury bonds could become radically less popular among our foreign buyers as a result of the dollar devaluation the inflation will cause; and as nations all over the world scramble to inflate their own currencies, we may find that we have a lot of competition in the bond market.

Personally, I'm betting (and I disclose that I have put a little money where my mouth is by investing in gold-related products) that the Fed will be hard-put to time and measure the controlled deflation.

Why gold? Because, as I've said many times: You can take gold out of the standard, but you can't take the standard out of gold.

Future Inflation: Taking Lessons From Those Who Know

2009-03-05T15:10:00.000-08:00

When I think of the potential for future inflation from the combined current actions of the Treasury and Federal Reserve, I need a little comic relief.

[Click on the image for a larger version.]

Nationalization, By Any Other Name

2009-03-01T11:52:00.000-08:00

The word "nationalization" has put fear and trembling into the American marketplace, and understandably so. It rings of socialism, of the European model, of the Third-Way progressive compromise. It's the death knell of the American form of free-market capitalism that is the foundational pillar beneath our symbolic hegemony over the rest of the world.

Apparently our current administration and its Congress don't believe this for a minute, because they haven't yet caught onto the fact that the word needs more than just denial; it needs replacement.

So far, they have been very quick to grasp the emotional impact behind words, to wit their choice of name for their stimulus package, The American Recovery and Reinvestment Act of 2009. We all know that this latest effort is really The Wild Attempt to Save Our Butts From Depression Act of 2009, but to use such blatant language would be ... well, depressing. Our savvy legislators know this, so they found a nicer name for it.

In the same vein, I wonder why no one has yet come up with the suggestion that our government's bailout actions--looking more and more like nationalization--be renamed something more palatable, rather than simply denying that nationalization is what's going on.

Let's take the example of Citigroup. So far, the government:

1. Has pumped billions of taxpayer dollars into their finances to avoid its collapse;

2. Will convert some $25 billion of preferred shares to common stock, effectively diluting existing shareholders' stake by 74%;

3. Has discussed "whether to require the removal of Citigroup Chief Executive Vikram Pandit" but decided that it is "impracticable to oust him" mainly because there's no one to replace him;

4. Is forcing the replacement of every Board member;

5. Is watching every move Citi makes, and management is trying desperately to mind their Ps and Qs.

(Source.)

If that isn't nationalization, I'm not sure what the word means.

Webster's relevant definition is:

"2. to transfer ownership or control of (land, resources, industries, etc.) to the national government"

So let's stop kidding ourselves. A rose, by any other name.... But wait. In fact, as any politician knows, Shakespeare was wrong. You can change the scent of a rose; all you have to do is call it something else.

So instead of watching the public wallow in self-pity as the US government denies nationalizing Citigroup, they need to find another name for it. Something "du jour," something we can empathize with and latch onto.

How about "recycling"? After all, isn't that what we do with smelly trash these days? We pull out what is useful, save it, and bury the rest. The government has no intention of "nationalizing" Citigroup; they simply want to carve out the rot and sell what's left back to its private shareholders, right? So let's not hear this "n" word anymore.

[Thanks to Ncdc.gov.uk for the photo.]

We're In For The Long Haul, In Spite of the Stimulus

2009-02-22T11:05:00.000-08:00

Barron's has an article by Alan Abelson that expresses my sentiments better than I could today. Here's the crux:

"House prices, in our bloodshot view, have another 20% or so to fall before hitting bottom and, at the earliest, we're talking sometime next year. And, possibly more important, a meaningful brightening of the current, profoundly bleak jobs picture, isn't in the cards for certainly as long, if not longer."

A sad assessment of affairs, with which I agree.

[Thanks to CDIN.org for the touching image.]

He bases this conclusion on a study by ISI Group (not web-accessible) and its two charts that really tell the picture like nothing else I've seen recently. They can be found on the second page of his article. They are (1) the ratio of house prices to rents, and (2) the median house price divided by median family income.

Both of these long-term lines, drawn from 1975 or before to date, demonstrate with stark clarity that house prices are still on the high downside slope of this bubble.

A majority of people believe that government intervention of the kind our legislators have just put in place can stop this "drop" (read "re-normalization") of housing prices. But this legislation has a good chance of missing the mark, at least as far as arresting housing price falls is concerned. As Abelson says:

"While fewer foreclosures are likely to slow the rate of decline, they won't reverse the downtrend or determine 'where homes prices end up.' ... [G]iven the remorseless rise in unemployment, which, if anything, is destined to accelerate in the months ahead, the simple fact that so many people are too strapped to afford to buy a home, is, we believe, the most formidable barrier to even a tepid housing recovery."

Right on. It's called pushing the string. (See my cartoon on this subject.)

And frankly, I think it would be criminal to deprive us of the benefits of lower prices, whether it be for food, gas, or housing. Lower prices enrich us all.

Personal footnote: I am a commentator, not a researcher. I do not claim to have a Ph.D. in economics. For those readers who would like the academic nuts and bolts under my skepticism, start here, here, here, and here. You will find the deeper research papers accessible on other pages of their website.

Some may object that all of these come from the same think tank, Cato, with its libertarian-oriented research team. This is true. I happen to follow their reasoning on most subjects, having yet to come across a more "progressive" reasoning that can hold a candle to it.

Academics can provide us with some very useful thinking and writing, but they don't have a monopoly on logic. There are many non-academics who have contributed valuable work. There are also academics who have steered us astray. Here are some examples of both:

A few non-academic leaders: Henry George, Mark Twain, Bill Gates (honorary doctorates only), and Benjamin Franklin, to name only four.

Academics who should have had more humility: Robert C. Merton and his economics Nobel Prize partner at LTCM, Myron Scholes; and Margaret Mead, to name only three.

Let Those on the Floor Speak

2009-02-19T11:06:00.000-08:00

The country is very divided now about whether or not the "stimulus package" will work. I have already expressed my opinion that it will not, provoking much heated debate among my commentators. I'll be adding more gas to that fire soon.

Meanwhile, I found out today that I'm not the only one who's frustrated with the American people's lack of understanding about the economics underlying the Keynesian spending, government intervention, and wholesale destruction of free-market values (e.g. respect for contracts) that will soon be taking place, the likes of which we have never seen to this degree before, ever.

Listen to these people who have their ear to the ground, the traders in Chicago:

Chicago Traders Video

It's heartwarming to see that there is someone else out there who gets it, even though I can already hear the retort: "But those guys are Wall Street, or the equivalent. They're the bad guys."

It looks like Ben Franklin and the others will continue to spin for a very long time, while Mr. Marx chuckles with glee.

[Thanks to Nightviewproductions.com for the image.]

Why a Spending Bill Won't Cut It

2009-02-07T11:12:00.000-08:00

Last night, I had to chuckle and cry at the same time as I watched Rachel Maddow's "Bull Puckey" speech.

Rachel's declarations about the job-creating values of spending are about as insightful as Janeane Garofalo's outburst on the radio in 2005, paraphrased thus: "... those free-market wackos with their 'invisible hand' mumbo jumbo."

Both ladies' understanding of the workings of the market typify the overconfidence of those who jump to conclusions without looking at the whole story.

Rachel claims that spending in and of itself is sufficient to create jobs and get the country out of a recession. Obama has embarrassed himself by making the same point. They have both overlooked that the statistical link between government spending and long-term job creation doesn't exist. To illustrate:

Spending:

Let's take an extreme and therefore abstract example. We can hire 15 million workers (10% workforce unemployed) to dig holes and fill them up. Cost: $800,000,000,000. 100% job creation. After the job is done, they go back on unemployment. Job creation for one year: 15 million. Job creation after one year and a half: Zero. Capital available for permanent job creation: X minus $800 billion. And don't give me the argument that the government intends to do more than just dig holes and fill them up. Building bridges and roads that we can't pay for is just as bad.

[Thanks to Swop.net for the photo.]

Permanent Job creation:

At the other extreme, let's say we do nothing, and therefore the government does not sap the marketplace of $800 billion. Cost: Zero. The money is thus available to businesses, small and large, to rev up their engines as this recession starts its uptick. Jobs created during one year: Admittedly, perhaps zero. Jobs created after one year and a half, or sometime thereafter: 7 million, year after year, as unemployment falls back to around 4% or less. These jobs are permanent.

The lenders of the $800 billion know this, as we will soon find out when the US government finds it harder and harder to finance its debt. Why isn't this difference clear to the President and to his supportive progressives? Because these people are short-sighted, and they grasp at whatever supports their political culture instead of looking at all the facts.

Rachel quotes Moody's statistics. Example: "Most Stimulative Spending: Non-refundable tax rebates: $1.00 = $1.02/economic activity. Infrastructure: $1.00 = $1.59/economic activity." These stats make no mention of the duration of job creation in each instance, what kind of jobs are created, and what money was used to do it. Statistics can be the best liars when you don't tell the whole story.

More twisted logic:

- Who will be employed on the construction sites of the Spending Package's bridges, railroads, and roads? Will the government try to pick and choose among the unemployed? Can legislators get the most expensive unemployed (Wall Street workers, lawyers, and others like them) onto the dirt? Does the construction industry worker deserve a job more than an investment banker or lawyer?

- Rachel says that people on unemployment don't spend. Isn't she forgetting that they receive unemployment benefits that are paid out of future income from existing tax structures and not borrowed 100% from the world's capital pool? Then she turns around and almost makes the argument that we should all go on Food Stamps. This is strange thinking.

- We are all (including me) complaining about the big bonuses and the Las Vegas junkets, but isn't this also spending a la Rachel? Aren't we forgetting that jets are made by American workers, that pilots fly those jets, and that lots of people work in Las Vegas? We are also forgetting that the rich spend a portion of those bonuses and invest the rest in things like the stock market, i.e. in the very same instruments that are in all of our 401(k)'s, which could use a little help right now. (Don't get me wrong, those bonuses give me goose bumps; but I believe their size was determined by excessive money and credit supply and by the competitive marketplace, not only by individual greed. See this post, for example.)

- We want to put American manufacturing back on track by recommending we all "buy American." Aren't we forgetting that if we refuse to buy foreign products, foreigners will refuse to buy ours? And that this type of thinking is what ultimately repressed the world economy in the 1930s?

- We want China to allow their currency to rise in value, but aren't we forgetting that for this to happen, China has to stop buying our debt? Do we really want that?

Much illogic should be examined here.

Why Isn't the Market Listening?

2009-01-31T17:14:00.000-08:00

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

2009-01-17T19:39:00.000-08:00

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?

2009-01-16T12:54:00.000-08:00

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

2009-01-11T18:14:00.000-08:00

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

2009-01-09T16:55:00.000-08:00

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

2009-01-08T11:27:00.000-08:00

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

2009-01-05T16:34:00.000-08:00

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

2009-01-02T11:53:00.000-08:00

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.

How Many Strings Can We Push?

2008-12-31T15:26:00.000-08:00

At the suggestion of my friend William F. Ford, Professor of Economics at MTSU and Summer Research Fellow at the American Institute for Economic Research, I have recreated the "string" cartoon as you see it here. Enjoy, and don't forget to eat, drink, and be merry because tomorrow....

[Click on the image for a larger version.]

Is Small Government Dead?

2008-12-29T09:31:00.001-08:00

I present you today with both sides of the question of whether or not there is any life left in the small-government philosophy.

[Thanks to Crosstitch.com for the cross stitch pattern photo.]

We have the optimist's viewpoint expressed by Richard A. Viguerie in today's LA Times article.

With no sense of humor whatsoever, Mr. Viguerie, author of Conservatives Betrayed: How George W. Bush and Other Big Government Republicans Hijacked the Conservative Cause, expresses his hope that someone with a Reagan touch can revive our somnolent but innate comprehension of the original intent of the Constitution's Founding Fathers.

On the other side, and with his usual unique comic flare, we have the pessimist view of P.J. O'Rourke in this Cato article (also published at the Weekly Standard). His humor turns quite black at the end. The title says it all: "We Blew It."

These two writers are so eloquent that I won't excerpt them or add superfluous comment here. You'll enjoy the reads.

I once asked another proponent of small government, Robert Higgs of the Independent Institute, how he managed to find the courage to continue the battle for the idea of small government. He replied that he had no hope whatsoever for winning the war; but that his motive has become that of "bearing witness" through public condemnation of those who strip us of our liberties, whether anyone cared to take note or not.

Honorably said, and I concur. At the moment, as the sky grows prematurely dark at 5:00 p.m. on a December afternoon, I feel the same depressing lack of hope. But tomorrow I will wake up to daylight with enough energy to toll the bell once more.