Getting Ahead Of The Curve

``Actually, the Fed is a public-private partnership, a coalition of large banks who are the owners working with the blessing of the government, which appoints its managers. In some way, it is the worst of both the corporate and the government worlds, with each side providing a contribution to an institution that has been horribly detrimental to American prosperity. In any case, William Greider is exactly correct that the advent of the Fed represented "the beginning of the end of laissez-faire." It turned the entire money system over to public management on behalf of political causes.” Dr. Ron Paul End the Fed

Author, economic professor and prolific econlib blogger Arnold Kling writes, `` The Fed has changed from a central bank to a piggy bank. Any economist who tries to interpret Fed policy from the standpoint of economic theory is playing a fool's game.”

Exactly. That’s what been we’ve been saying all along.

In a world where markets (especially in the US) have essentially been artificially patched up by different government measures and policies, such as lender, liquidity provider, buyer, investor, market maker, guarantor, spender, and other assorted roles of last resorts, repeated attempts to interpret these actions into conventional fundamentals (corporate fundamentals or economic theory) seems like a mug’s game-market actions haven’t been playing out most of its traditional roles.

Figure 1: Minyanville: US Earnings Volatility!

As you can see earnings volatility today in the US have spiked to the levels of 1930s due to increased “leverage” and “inflation”.

Kick The Can Down The Road

Yet I’ve been asked how should we get ahead of the curve? My reply would be simple: we should think out of the box.

Many if not most of the mainstream’s favorite experts- the financial or economic Op-ed writers, the academe bloggers turned opinion maker, celebrity gurus and etc.-have essentially misread the markets in 2009, yet are still patronized by many and in fact glorified by media.

Gullible followers fail to realize that for these talking heads, the cost of being wrong had been inconsequential.

Inaccurate analysis or misplaced forecasts don’t cost them their jobs or that they don’t even lose a dime, that’s because many of these so-called experts are even hardly invested in the markets. For most, they practice what popularly is known as being ensconced in the proverbial “ivory tower” thinking or from wikipedia.org “pursuits that are disconnected from the practical concerns of everyday life.” They mistakenly believe that models can substitute for human actions.

Yet these experts remain trustworthy sources of information because they provide mostly entertainment value- by confirming or echoing on the beliefs of the audiences. But what makes them even more believable is that their arguments has been embellished by scientism, such that, when a hunch is backstopped by math models, they seem intellectually credible, even if they have been repeatedly falsified. So it is not being accurate that matters but feeding on popular but mostly “delusional” creeds.

Worst, the avid spectators can’t seem to tell between propaganda masquerading as analysis from an objective and independent investigation.

For instance, many have been made to believe by the authorities and the mainstream that today’s collective policies have been “successful” in mending the markets.

It’s all a matter of perspective.

For us, it is known as a children’s game called “kick the can down the road”; for the short term yes, markets appear to be cosmetically pacified, but no, imbalances have merely transferred and deferred which eventually would unravel anew in a far more worst degree.

In short, merely delaying the day of reckoning does not solve the crisis. Obviously the laws of nature will ultimately compel adjustments overtime (see figure 2).

Figure 2: MoneyandMarkets.com: Bust Getting Bigger

In the same way as it recently had.

US government policies aimed at cushioning the losses in the dot.com bust (left window where loses had been estimated at $6.5 trillion) have led to a bigger housing bubble and the attendant larger “doubling” of losses from the recent bust (right window- $15.5 trillion).

And it is of no wonder why many who concur with this present day government actions seem paradoxically afraid of the future. They are allured to short term unsustainable fixes in the same way as drug addicts are temporarily satisfied by the infusion of toxic substances.

Such incoherence exposes the fatuousness of their beliefs- turning stones into bread by the magic of inflation. Yet no matter the realization of such chronically flawed principle, they embrace these as if it is an act of faith.

When Everyone Thinks Alike, Then Nobody Is Thinking

Bemedalled World War II US General George S. Patton once remarked, ``If everyone is thinking alike, then somebody isn't thinking.”

IF in the present environment, markets are shaped by political action, how does one get ahead of the mainstream?

For us the answer is by comprehending on the thought process that governs the mainstream.

Think of it, there are 3 research divisions of the US Federal Reserve which has a vast army of 450 economists from where about half of them of are Ph.D. economists!

So common sense tells us if we think in the line of the mainstream, 450 economists with their panoply of computer aided econometric models would have easily beaten us to the punch. That’s assuming if they’re right.

Yet, these do not include the scores of economists that are employed in the Fed’s 12 regional banks.

In addition, the tentacles of the Fed network are way far reaching more than what the public expects.

In essence, the US government, particularly the US Federal Reserve, influences or shapes its own public image (and of course ideas).

How? Through several factors:

1. Self-publication or by influencing the materials that are published in mainstream Journals

Cato’s Steve Hanke writes, ``One of the reasons the Federal Reserve gets so much good press is that it’s publishing most of it itself” (italics mine)

Mr. Hanke quotes Professor Gordon Tullock: ``Milton Friedman has pointed out that one of the basic reasons for the good press the Federal Reserve Board has had for many years has been that the Federal Reserve Board is the source of 98% of all writing on the Federal Reserve Board.” (bold emphasis mine)

Mr. Hanke also cites the work of Professor Larry White, ``In 2002, 74% of the articles on monetary policy published by U.S. economists in U.S.-edited journals appeared in journals published by the Fed, or were authored (or co-authored) by Fed staff economists.”

So the predominance of Fed friendly papers makes it appear that their methodology constitutes as the predominant and most acceptable thought.

2. Outsource jobs and offer privileges

Aside from having a say on the articles published on mainstream economic journals, Ryan Grim of the Huffington Post says that the US Federal Reserve has outsourced many of its work to the academia and has equally bestowed intangible benefits and privileges to them.

From Mr. Grim, ``The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009… Being on the Fed payroll isn't just about the money, either. A relationship with the Fed carries prestige; invitations to Fed conferences and offers of visiting scholarships with the bank signal a rising star or an economist who has arrived.” (all bold emphasis mine)

So the academe is not only paid by the Federal Reserve but latently coaxed into writing articles or papers in the Fed’s light.

Mr. Grim also cites a research by Robert Auerbach, a former investigator with the House banking committee who apparently scrutinized on the operating network employed by the Fed. Mr. Grim adds, ``Auerbach found that in 1992, roughly 968 members of the AEA designated "domestic monetary and financial theory and institutions" as their primary field, and 717 designated it as their secondary field. Combining his numbers with the current ones from the AEA and NABE, it's fair to conclude that there are something like 1,000 to 1,500 monetary economists working across the country. Add up the 220 economist jobs at the Board of Governors along with regional bank hires and contracted economists, and the Fed employs or contracts with easily 500 economists at any given time. Add in those who have previously worked for the Fed -- or who hope to one day soon -- and you've accounted for a very significant majority of the field.” (all bold emphasis mine)

3. Influencing public policies through the mainstream networks

One of the advantages of the Fed’s employment of a large external network is to be able to put pressure on public policies that favors its interests.

Huffington Post’s Mr. Grim addresses such conflict of interest issues by citing anew Robert Auerbach work, ``Auerbach concludes that the "problems associated with the Fed's employing or contracting with large numbers of economists" arise "when these economists testify as witnesses at legislative hearings or as experts at judicial proceedings, and when they publish their research and views on Fed policies, including in Fed publications." (all bold emphasis mine)

As in the case of the recent reappointment of Ben Bernanke as the Chairman for the US Federal Reserve, when politicians warned the public that a failure to extend his tenure would result to doomsday, you now know how the politics behind the Federal Reserve operates.

Profiting From Folly

But of course the goals of the investors and policymakers are different. The goals of the investors is to profit from making the right decisions in the marketplace while the bureaucracy and their externally based affiliates are no less than vying to eternally meet the ever elusive “appropriate” policies in response to the changes in the market.

As Professor Antony Mueller rightly observes, ``This challenge is quite different from textbook models, with their neat separation between a definite object, a tested theory, and a neutral observer. It is one thing to do academic economic research; it is quite a different task to decide and to act on the basis of incomplete, contradictory, and largely false data.

``It is hardly a wonder that Bernanke and his team are in a constant panic. The economic data they are so eager to get in order to make "rational" decisions are inaccurate, inconclusive, and always false: at the very moment when the data are gathered, economic constellations have already changed, often quite drastically.”

Like many terminally ill people who desperately would seek cures by resorting to quack medicines, the same applies to bureaucracy. Professor Arnold Kling, a former Federal Reserve and Fannie Mae officer, notes that quack medicine appear to have an inelastic demand in spite of “demonstrable failures”, that’s because ``People who are really sick tend to cling to unreasonable hopes” notes Professor Kling.

Prof. Kling germanely observes that, ``decision-makers with a lot of power are desperately needy for scientific solutions in the same way that individuals with serious afflictions are desperately needy for remedies. As a result, decision-makers fall for models the way sick individuals fall for quack medicine.” (bold emphasis mine)

In other words, the best way to think out of the box is to bet against unreasonable hope of the mainstream, which has been mostly borne from the market interventionist policies instituted by a presumptuous government desperate for immediate remedies.

And this means to quote Warren Buffett, ``Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

As an addendum, I’d like to add that this clearly looks like a case where taxpayer money is being ceaselessly drained in a seeming abyss of “sunk costs”- where the government spends more to sustain or promote its wellbeing than to serve the interest of the public.

Lastly, as for mainstream-ism applied to the local stockmarket; many market participants are enticed with rumor based “action” than from practicing prudence or from positioning on a risk-reward tradeoff. Hence most of the vulnerable participants subscribe to “action” based stimulating sources of information.

Well, since markets are mainly about profits and losses, people usually get what they deserve.