Inflationary Policies Have Vastly Been Changing The Market Landscape

``During a boom, inflation creates illusory profits and distorts economic calculation. What the free market does best is penalize the inefficient and reward the efficient. But when you get a boom, the rising tide lifts all boats…Because of these illusory profits, everybody wants to get in on the boom. Everyone thinks they can do everything…Furthermore, during inflation, the quality of work goes down. Everyone tries to manufacture products as quickly as they can. There's no emphasis on how long things will last…In general, people become enamored with get-rich-quick schemes. In fact, entire countries have done this with the collateralized debt obligation (CDO) market. Iceland, for instance, has become one big hedge fund. And now we're going to have entire countries go broke.” Doug French, Bubble Economics: The Illusion of Wealth

In the field of politics, rendering social services for the people is always bruited about as the ultimate goal.

Unfortunately, the harsh reality of life is that policymakers or political leaders and their bureaucracy are only concerned with their self interests. But the sad fact is that their erroneous interventionist policies have lasting adverse consequences on the society’s standard of living.

Worst of all, is that a big segment of the public have been deluded to adamantly embrace the promises of politicians and of the attendant false ideologies in support of their “robbing Peter to pay Paul” policies.

Also, in no way do inflationary policies work better than the market forces.

Another proof?

From an earlier article Myths From Subprime Mortgage Crisis, Ms. Yuliya Demyanyk of the Federal Reserve of Cleveland wrote how policies aimed to increase homeownership has markedly failed.

Again from Ms. Yuliya Demyanyk (bold emphasis mine)

``The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

``Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership."

That’s why it pays never to trust politicians.

So in general, society vastly suffers under the artificial nature of bubble cycles caused by government interventionism.

Moreover, it isn’t just me this time bewailing how interventionism or how inflationary policies have been obscuring traditional means of evaluating financial markets.

Mr. David Kotok of Cumblerland Advisors in a fantastic discussion about Ricardian Equivalence [or as defined by investopedia.org as ``An economic theory that suggests that when a government tries to stimulate demand by increasing debt-financed government spending, demand remains unchanged. This is because the public will save its excess money in order to pay for future tax increases that will be initiated to pay off the debt”] demonstrates this.

From Mr. Kotok, (bold highlights mine, all caps his)

``We are issuing massive amounts of debt in order to finance loads of current consumption. Rational expectations would have the markets immediately adjust prices for the future tax burden associated with the servicing of the debt. But more than HALF OF THE WAGE EARNERS IN THE COUNTRY ARE NOW NOT PAYING ANY SIGNIFICANT INCOME TAXES. Sure, they are paying Social Security withholding and state taxes, but their share of the federal personal income tax receipts is very small. They are positioned with inconsistency when thinking about Ricardian equivalence, since they do not experience nor expect to experience the tax burden associated with the huge debt…

``The taxing decisions that impact the minority of the American wage-earner population are not made by them. Those decisions emanate from the Congress and the White House. Those policy makers have a time inconsistency which conflicts with successful Ricardian equivalence. Their time horizon is mostly less than two years until the next election. In the case of Obama it is less than four years, and the handlers of his political apparatus are already at work on the re-election campaign.

``So we have two inconsistencies at work. Agent inconsistency exists, wherein only the minority of the taxpayers is paying the longer-term burden of the substitution of debt for taxes. And time inconsistency, where the decision-maker's time horizon is much shorter than the expected debt-load servicing time horizon. Two inconsistencies equal a failure of the Ricardian equivalence.

``For portfolio managers this poses a difficult dilemma. We know about the inconsistencies. We can estimate the impacts when they are finally resolved. But we have no way to estimate WHEN the inconsistencies will emerge as the force that alters market values. And we cannot be sure of the method by which they will impose their imprint on the markets when they do. Sure, it could be higher taxation or slower growth or more inflation or a weaker dollar or flight of citizens or less productivity or diminished innovation. There are many such characteristics of a society that has overextended itself and has to pay the price. But WHEN and HOW and at WHAT COST? These are the imponderables.”

Again, parallel to the China example, the conflict of interests between the interests of policymakers and their preferred policies relative to the consequences to markets and the political economy are evolving to become major variables in the asset pricing dynamics and have increasingly been contributing to the growing state of non-Priceable Knightean uncertainty conditions.

When a group of distinguished economists wrote to the Queen of England explaining why “no one foresaw the timing, extent and severity of the recession”, they failed to explain to Her Majesty the following:

1) mainstream economics (via monetary and fiscal inflation) had been the primary cause of it, and since they’ve been the principal advocates they wouldn’t undermine the underlying theories that support it. In other words, mainstream economists are blighted with a bias blind spot.

As Murray N. Rothbard explains in Money Inflation and Price Inflation, ``There are very 'good reasons why monetary inflation cannot bring endless prosperity. In the first place, even if there were no price inflation, monetary inflation is a bad proposition. For monetary inflation is counterfeiting, plain and simple. As in counterfeiting, the creation of new money simply diverts resources from producers, who have gotten their money honestly, to the early recipients of the new money-to the counterfeiters, and to those on whom they spend their money.” (emphasis added)

2) mainstream economics deal with superficialities and unrealistic models and is constrained by the short term outlook.

``I think it is the inability to reconcile a reasonable treatment of radical uncertainty with the strictures of out-of-control formalism” observed Professor Mario Rizzo.

3) it isn’t true that no one foresaw the crisis since even US congressman Ron Paul saw this crisis and along with Dr. Marc Faber, Jim Rogers, Stephen Roach, Nouriel Roubini, Gerald Celente, George Soros and many more (this includes us) especially the underappreciated Austrian School of Economics.

The point is mainstream economics and financial models have failed miserably.

In a world where inflationary forces are fast becoming the dominant factors in asset pricing dynamics, traditional fundamentalism have been ineffective in keeping apace with the underlying structural changes in the risk equation.

So the mainstream can dream about the financial fiction of PE, Book Values, or etc… when money printing bubble cycles are becoming the chief dynamic in pricing stock markets as well as in the other asset markets.