Thoughts at a Crossroads

I’m becoming more and more skeptical of the human capacity to organize political society in a way that doesn’t end in catastrophe sooner or later.

Example: Both Republicans and Democrats plunged into this opportunity to lavish mirage-credit on the public. And as we know from experience: (1) corruption appears on such largesse like flies on a dungheap; and (2) mirage-credit must ultimately evaporate, taking with it all that depends upon it.

Taking this line of thinking a bit further, perhaps even towards more sardonicism:

I suspect that we humans are in a Catch-22: We don’t have enough enemies from the outside, so in order to test ourselves, societies “need” to make enemies of each other. That usually happens when (NB: not if) something disrupts supply and order, which, if violent enough, can cause shortages, anxiety, distrust, and fear for survival.

If we are to judge by known history, this ALWAYS happens. I hope we will not head down that path, at least not before I croak – that sounds selfish, and I guess it is. I've been lucky as a Baby-boomer. Maybe every generation must live through a period of strife and want, in which case mine is coming.

On a different but related subject, what is the main difference you see between the following two photos?

By Unknown author or not provided - U.S. National Archives and Records Administration, Public Domain, https://commons.wikimedia.org/w/index.php?curid=17057587

https://www.dailymail.co.uk/news/article-8169519/Motorists-line-mile-drive-food-bank-ensure-social-distancing-coronavirus.html#i-904e9fd9bd37e5ec

The Climax is Coming

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.

Uncertain Times for Business and Investors

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.

Skidelsky: The Economic Pendulum Has Swung Again

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

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

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

[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.)

Why a Spending Bill Won't Cut It

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?

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.

Queen Wears Same Dress Twice: Recession Proven

Yes, according to an article appearing in LeMonde.fr, a French newspaper website, "the Queen wore the same red coat that she wore for a ceremony at the Sandhurst military academy in the autumn of 2005. During a ball in Slovenia, she wore the same twenty-year-old evening gown.... The Duke of Edinborough had readjustments made to a pair of pants dating back to 1957. The well-published night club excursions of the Princes William and Harry have become more rare. 'The economic situation is atrocious': Her Majesty, who never comments on the news, lost her cool during a ceremony at the London School of Economics, asking her hosts, 'Why didn't anyone realize what was going on?'"


[Thanks to Martinaitchison.co.uk for the great artwork.]

Very good question, Your Highness.

The answer is that many people did realize what was going on. They just didn't have the guts and/or the power to stop it. See some of my previous blogs and links to the Bank of International Settlements' ruminations about the problem since the early 2000s.

We learn a number of interesting things in the French article. For example:

- The Queen is only 264th on the list of wealthy Brits.
- She has no checking account, no credit cards, no money on her person.
- Her fortune is worth about 320 million pounds (about $477 million).
- A new book by Jon Temple, Living Off the State, accuses the royal accountants of confusing the State's assets with their own private interests.

Ah, the English. The royal family can always bring us a smile, even in the direst of times.

Yes Virginia, The Big Recessions and Depressions ARE the Same

Here we go again. Although every recession is unique in the details, this one and those the country has experienced since the 1800s have at least one fundamental underlying similarity: The boom that preceded them.


[Thanks to Themeparks.about.com for this image of Tatsu, a new ride at Magic Mountain.]

Let’s compare what is happening today to what happened during the Great Depression. In the 1920s after World War I inflating of the currency, Florida underwent a damaging real estate boom and bust cycle. Florida’s experience was so violent that one contemporary economist in 1928 called it "the Florida gamble."

"When Florida land first started its upward course there were good substantial reasons for advancing prices ... [but] advancing prices drew those individuals who were speculatively inclined as molasses draws flies. ... Large building projects gave an appearance of substance and worth to the whole affair. In 1924, pessimists were nearly all united that the Florida boom must soon end. But the mass of people, than whom there are no greater gamblers, had Florida fever. ... Then the bubble broke, as they always have and always will. In the wake of the boom followed disaster, defunct banks, and depression."


Hmm. Real estate bubble. Sounds familiar.


In 1925 through 1928 as the Florida gamble unwound, the concomitant US stock market boom was showing foreboding signs of euphoria. The article continues:

"The [stock market] boom has not collapsed, and, from all appearances, is stronger than it has been for some time. That seeming invulnerability and capacity for unlimited progress is a market feature of all such speculative periods as they near an end. It is to be hoped that the Florida bubble will not be completely paralleled [in the stock market]. Banks all over the country have entered on a new experiment in the past few years, the practice of loaning large amounts against securities [italics added]. [Also sound familiar?] A collapse in the stock market would make thousands of banks unwilling investors, very much as the Florida banks found themselves in the real estate business after 1925. Such an experience, with the inevitable blood-letting at the hands of receivers for the least fortunate, would be a blow to our progress that would force upon the country many months of painful convalescence." [Quote from an unpublished paper, "Stock Speculation Versus Florida Memories," E.C. Harwood, 1928.]

As we now know, the Florida real estate bust of 1925 was followed by the stock market crash months after Harwood wrote this prescient article.


Hmmm. Stock market bubble. Again, sounds familiar.

Between 1800 and 2008, Americans have experienced boom and bust cycles; yet economists as a class are known for their disagreement about the cause, with two notable exceptions.

One is the Austrian school of economists, scholars like Von Mises and Hayek, to whom our attention seems to turn cyclically after every recession, but of whom we tend to lose sight as soon as we get another taste of easy credit. They've been warning about credit imbalances and poor banking practices for over a century.

A more scientific thinker, this time from among the empirical economists, is the author of the articles noted above. Through extensive study of banking statistics, Harwood concluded that markets in general, and international markets in particular, work best when unhampered; but that they can only function well when the trading medium is staid. Like the Austrians, he concluded that fluctuating fiat currencies and/or poor banking standards are a catalyst for excessive credit creation, resulting in speculative boom/bust cycles. Using his analysis, he predicted the 1929 crash as evidenced in his articles published in The Annalist of 1928 and early and mid-1929. He also predicted the devaluation and flight from the dollar of the 1970s.

Furthermore, he maintained that the world would continue to suffer damaging speculative peaks and crashes until voters realize that it is our incompetent monetary policymakers who create them. Legislators must acquire enough humility to admit that human agents cannot micromanage the quantity of money—a failing even Milton Friedman feared—and that government’s only role should be to support the natural money-creation process through the establishment and maintenance of sound banking principles and of some form of currency measuring stick.

Both Harwood and the Austrians believe that, to date, the only such device that has succeeded for any length of time is the gold standard in one form or another. The duty of our economic wizards is to find the version of it that fits today’s parameters.

What are the chances our present or future administration will see fit to look for this solution? About zero. Expect more rides in the future.

See more about Edward C. Harwood at the American Institute for Economic Research.

To Raise or Not to Raise: That is the Question

This article by Thomas Kee over at Seeking Alpha raises some commentary in my brain.


[Thanks to Laurence Olivier and classics.www5.50megs.com for the image.]

He suggests that the Fed should raise rates now before wages start to rise, in sum nipping any core inflationary trend in the bud.

He notes, as I have also here recently, that the inflation figures are rising fast. In fact, today for the month of April the compounded annual seasonally adjusted rate has gone up two points from 4.7 to 6.7%. It will probably modulate, but these figures are alarming.

He wisely points out that even non-core prices, although more volatile, at some point become important to the pocket books of the citizenry; that these non-core prices, even though they may be subject to geopolitical concerns, can also sometimes be reacting to the same inflationary money-supply factors as core prices; and if this is the case, any sustained non-core inflationary price increases will at some point spill over into core prices. And he assumes they will. I agree, given the symptoms around us of a global bubble economy.

I would like to point out several things:

1. If the increases in non-core prices are due to geopolitical concerns, the increases should be ignored. At some point, things will readjust, or alternatives will be found. The Fed doesn't need to take any action whatsoever. In fact, any action merely adds another uncertainty to the game play.

2. If the increases are due to inflationary concerns, the cause for the increases should indeed be eliminated; but this should only happen when the economy can take it, and now is not the time. Today's tight labor market is putting pressure on salaries, which is actually a good thing, because it means that finally, the poor salaried worker is going to get the pay raise that he needs to cover the increase in prices. Let him get his pay raise. Don't raise rates now before he gets it, because you will just make a bad situation (higher prices) worse (diminishing real wages.) The poor guy is in the caboose of the inflationary train. Let him get up over the hill. Let him be compensated in just measure. Of course, non-core prices will rise; but this is just the natural denouement of the inflationary situation that already exists. Let it play out. And then, of course, most importantly, the Fed should in future refrain from instigating any measures whatsoever that inflate prices again, adding insult to injury. These measures are counterproductive. They distort the market pricing mechanism, destroy our dollar, and exacerbate economic inequality -- the very things the Fed is supposed to control.

3. At this point, assuming either (1) or (2), we are at a critical juncture in the business cycle, i.e. we are about to enter a contraction. (See my previous post.) The coming contraction, combined with high non-core prices, will be sufficient to control expansion. If the Fed tightens now, it will turn the contraction into a recession. To do so now will just deprive our poor worker of the raise he deserves and enrich the speculators whose profession it is to ride the roller coaster of business cycles. For these fellows, the wilder the ride the more they love the thrill, even if only a few reap the rewards (the lottery principle.)

So I disagree with Mr. Kee. The Fed should leave the rates where they are. (And of course they should definitely not lower rates, which they are also capable of doing at the slightest sign of business contraction, unfortunately.) At some point in the future, when the business cycle bottoms out naturally and when the economy starts to climb back up again, only at that point should the Fed adjust the rate so that it can remain permanent -- 5.5, 5.7, or whatever it is.

Then the Fed should put themselves on the back burner, only coming into action when there is a need for some reassurance -- and by action, I mean clearing house, short-term punctual self-eliminating measures, and jawboning. We don't need any more pumping up of the money supply, whether it be through interest rates or through purchases of treasuries.

Let the system handle the money supply. Put a few basic rules in place, i.e. reserve requirements, banking standards -- every banker knows what they are. (The gold standard would be nice, but I'm not living in a dream world.)

Central banks of the world, leave us alone. Stop playing roulette with the standard of living of the salaried worker, the small to medium business entrepreneur, and the emerging economies. You are killing us little by little, driving us towards government intervention and the death of the American experiment and of the US leadership role in the world.

Minneapolis First in Foreclosures - Isolated Incident, or Recession in the Works?

Seeking Alpha points to an article in the Star Tribune about the amazing number of foreclosures in North Minneapolis.

Most impressive is the chart with the red dots, showing how the delinquencies are distributed throughout the county.

Is this just a hot spot of bad sub-prime mortgage lending? Or is it the first in a long string of falling dominoes?

No one really knows, of course. Some say the markets have already taken into account the pretty poor outlook for the housing market. Some say that the dollar's slow demise will help the manufacturing sector and keep the country out of deep recession.


[Thanks to traum-geschenke.de for the image.]

I have no particularly unique crystal ball like Alan Greenspan thinks he does, but my favorite and the only truly scientific economic research institution that I know of is now predicting that business cycle conditions point towards a likely recession.

The institution in question is the American Institute for Economic Research. I like these people. Their news can sometimes be tepid (what truly non-partisan organization issues earth-shattering statements every few days like the IPCC? [Intergovernmental Panel on Climate Change]) But when it's time to rumble, they rumble loud and clear.

Here's an excerpt:

"The yellow caution lights of recent months have now turned red. Conditions have continued to deteriorate: both the percent of leaders expanding and their cyclical score are now at levels that preceded prior recessions. A contraction of general business activity is more probable than continued expansion.

"Last month we were hesitant to assert that recession was imminent because one of our key indexes, the cyclical score, had not weakened sufficiently to confirm the signal from the percentage of leaders expanding. However, new and revised data now indicate that the cyclical score has been considerably weaker and for a longer time than previously thought, confirming the recessionary signals given since January by the percent of leaders expanding. The weakness among our primary leading indicators of business-cycle conditions continues to spread and a recession now appears imminent.

"Very few forecasters share our view. Aside from a few Wall Street 'permabears,' business economists and forecasters seldom, if ever, predict a recession. As many have put it, such pronouncements are 'bad for business.' This is, of course, a disservice to themselves, their employers, and their clients. We, on the other hand, are completely independent and committed to giving our readers our analysis of business-cycle changes, and the evidence behind our conclusions, for better or worse."

[Source: Research Reports, April 23, 2007, AIER, Great Barrington, MA 01230]

Bravo. Keep up the good work. Predicting 24 of the 21 most recent recessions sounds like a good batting average to me.