Tanking Gold and Commodities Prices and the Theology of Deflation

One of the bizarre and outrageously foolish or patently absurd commentary I have read has been to allude to the current commodity selloffs to what I call as the theology of deflation, particularly the cultish belief that money printing does not create inflation. 

Yet if we go by such logic, then hyperinflation should have never existed.

Doug Noland of the Credit Bubble Bulletin debunks such ridiculousness:

With global central bankers “printing” desperately, the collapse in gold stocks and sinking commodities prices were not supposed to happen. Is it evidence of imminent deflation? How could that be, with the Fed and Bank of Japan combining for about $170bn of monthly “money printing.” Are they not doing enough? How is deflation possible with China’s “total social financing” expanding an incredible $1 Trillion during the first quarter? How is deflation a serious risk in the face of ultra-loose financial conditions in the U.S. and basically near-free “money” available round the globe?

Well, deflation is not really the issue. Instead, so-called “deflation” can be viewed as the typical consequence of bursting asset and Credit Bubbles. And going all the way back to the early nineties, the Fed has misunderstood and misdiagnosed the problem. It is a popular pastime to criticize the Germans for their inflation fixation. Well, history will identify a much more dangerous fixation on deflation that spread from the U.S. to much of the world.

I see sinking commodities prices as one more data point supporting the view of failed central bank policy doctrine. For one, it confirms that unprecedented monetary stimulus is largely bypassing real economies on its way to Bubbling global securities markets. I also see faltering commodities markets as confirmation of my “crowded trade” thesis. For too many years (going back to the 90’s) the Fed and global central bank policies have incentivized leveraged speculation. This has fostered a massive inflation in this global pool of speculative finance that has ensured too much market-based liquidity (“money”) has been chasing a limited amount of risk assets. Speculative excess today encompasses all markets, including gold and the commodities. Over recent months, these Bubbles have become increasingly unwieldy and unstable. Commodities are the first to crack.

In the theology of deflation espoused by monetary cranks, financial markets and the economy operates like spatial black holes, they are supposedly sucked into a ‘liquidity trap’ premised on the ‘dearth of aggregate demand’ and on interventionists creed of "pushing on a string" or of the failure of monetary policies to induce spending. Thus the need for government intervention to inflate the system (inflationism) to encourge spending.

Further money cranks tells us there has been no link between inflation and deflation.  Or that there are hardly any relationship of how falling markets could have been a result of prior inflation. 

Bubbles are essentially nonexistent for them. Inflationism has been seen as operating in a vacuum with barely any adverse consequences because these represent the immaculate acts of hallowed governments. Whereas deflation has been projected as “market failure”.

Yet we see plummeting commodity prices, contradictory to such obtuse view, as representing many factors. 

Global financial markets (stocks and bonds) have been seen as having implicit government support (e.g. the Bernanke Put or Bernanke doctrine), thus the safe haven status may have temporarily gravitated towards government backed papers rather than commodities.

Notice that safe haven alternatives as gold and bitcoins have recently been sold down.

Yet this doesn’t entail that endless money printing will not or never generate price inflation. Again such logic anchored on free lunch, simply wishes away the laws of economics.

Second, falling commodity prices doesn’t mean the absence of price inflation but rather monetary inflation has been manifested via price inflation in assets or asset bubbles so far. 

The “don’t fight the central banks” mantra has led the marketplace to go for yield hunting by materially racking up credit growth.

The surge in Japan’s stocks via “Abenomics” policies has prompted for massive jump in margin trades in Japan’s equity markets (chart from Zero Hedge). This mirrors the record performance of US equity markets. 

Both markets suggests that government policies has heavily influenced market actions to chase yields by absorbing or accruing more unsustainable debt.

China’s massive money growth backed by financial expansion have masked the marked deterioration in her economy.  This perhaps supports the essence of the broad based gold led commodity panic.

And as Mr. Noland points out, cracking commodity prices may be portentous of the periphery to the core symptom of a coming crisis.

Falling commodity prices will initially hurt the emerging markets and could likely spread through the world. 

Commodity exports plays a substantial role in emerging economies (IMF)

This means that global growth will be jeopardized thereby increasing the risks of bubble busts from the periphery (emerging markets and frontier markets)

Emerging markets are supposed to comprise nearly 50% of global growth this year. (chart from the Daily Bell)

I also earlier pointed out that Indonesia's boom has been popularly attributed to commodity exports, even when latest developments suggests more of a property bubble. The Financial Times warns of an ASEAN bubble and notes of an unwieldy boom in Indonesia's luxury real estate projects.

Ciputra Development, which builds luxury condominiums, said that while prices in central Jakarta, the capital, had been growing at a rapid clip – about 30-40 per cent a year – a new trend had emerged.

If woes from Indonesia's commodity exports will spread through the property sector, then the Indonesian economy will become highly vulnerable. This makes the region including the Philippines susceptible too.

Boom will segue into a bust.

 

Yet the recourse to eternal money printing will one day set another path. (chart from Zero hedge).

Inflationism comes in stages. Thus every stage commands a different outcome.  We are still operating on bubble cycles from which the current gold-commodity pressures signify as the typical the denial stage from inflation risks provoked by Fed policies.

As the great Ludwig von Mises predicted. (bold mine)

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services.

These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them.

In short we are in a stage where people have yet to become aware of a price revolution ahead even when policies have been directed towards them.

We have seen such setting before.

Gold prices surged from $35 in 1971, which began during the Nixon Shock or after the closing of gold window based on the Bretton Woods gold exchange standard, to about $190 in 1975 or 4.4x the 1971 level. Following the peak, gold prices plunged by about 45% to around $105 in 1976. (chart from chartrus.com)

The returns from Gold’s recent boom from $ 300 to $ 1,900 has been about 5.3x before today’s dive. So there may be some parallel.

Then, the interim collapse has served as springboard for gold’s resurgence. Gold prices evenutally hit $850 in the early 80s. (chart from chartrus.com)

Of course, the stagflation days of 1970-80s has vastly been different than today.

Debt levels of advanced economies has already surpassed the World War II highs. (from US Global Investors) This is why advanced economies has resorted to derring-do or bravado policies of unprecedented inflationism from central banks.

Most of which has been meant to finance fiscal deficits, increasing the likelihood of the risks of price inflation and debt default over time. Such has been the typical outcome based on EIGHT centuries of crises according to non-Austrian Harvard economist Carmen Reinhart (along with Harvard contemporary Kenneth Rogoff).

Monetary cranks essentially tells us that “this time is different”. They believe that they are immune from the rules of nature. They denigrate history.

Moreover there has been a global pandemic of bubbles, which simply means that the path dependency for governments policies will be directed towards sustaining them.

Authorities will resort to bailouts, rescues and further inflationism in fear of  bubble busts in order to maintain the status quo.

This will not be limited to advanced economies but will apply to emerging markets including the Philippines as well.

Another difference is that, then, US monetary policies had been severely tightened which caused a spike in interest rates and two recessions. US Federal Reserve’s Paul Volcker had been credited to have stopped the inflationary side of stagflation or the “disinflationary scenario”, according to the Wikipedia.org

Today, there has been a rabid fear of recessions

Globalization too, from the opening of China, India and many emerging markets, led to increased productivity which essentially offset inflation levels. A 2005 study from the Federal Reserve of Kansas City notes that

Rogoff also credits the “increased level of competition—in both product and labor markets—that has resulted from the interplay of increased globalization, deregulation, and a decreased role for governments in many countries” as contributing to the reduction in global inflation.

Today with almost every economy indulging in bubble policies and therefore serially blowing bubbles, capital consumption leads to decreased productivity, heightening the risks of price inflation.

The Royal Bank of Scotland recently pointed out that Asia’s credit bubble has been accompanied by decreasing labor productivity. When the public’s activities having been directed towards financial market speculation than production, then evidently labor productivity has to decline.

Of course, direct confiscation of people’s savings via the banking system ala Cyprus will also become a key factor for the prospective search for monetary refuge.

Third, in the world of financial globalization, speculative bubbles translates to immensely intertwined markets, such that volatility in global markets, particularly in JGBs may have prompted for massive reallocation or a shift in incentives towards government backed securities.

This Reuters article gives us a clue:

"The scale of the decline has been absolutely breathtaking. We tried to rally and that just didn't get anywhere ... there hasn't been any downside support, it's like a knife through butter," Societe Generale analyst Robin Bhar said.
The pace of the sell-off appeared tied to volatility in the price of Japanese government bonds, which has forced certain holders to sell other assets to meet the risk modeling of their investment portfolios.

Fourth is that such selloffs has deliberately been engineered by Wall Street most possibly to project support on Fed policies for more inflationism. Wall Street, thus peddles the inflation bogeyman to spur political authorities to maintain or deepen inflationism which benefits them most

In my edited response to a friend on the recent record levels of US markets, I explain the redistribution of Fed Policies to Wall Street to the latter's benefits

Given the relative impact (Cantillon Effects) from the Fed’s money printing, those who get the money first, particularly Wall Street, e.g. primary dealers and bondholders who sell bonds to the FED via QE, the 2008 bailout money (TARP), proceeds from the Fed’s Interest Rate on Excess Reserves and etc, may have used such to speculate on the stock markets and the credit markets (e.g. junk bonds, revival of CDOs) rather than to lend to main street. Thus the parallel universe: economic growth has been tepid, but financial market booms.

There has also been the interlocking relationship between bond and stock markets as I earlier pointed out here

Since December the politically connected Goldman Sachs has called for the selling of gold which has been followed by a coterie of Wall Street allies

From the Star Online:

Several renowned global financial institutions such as Credit Suisse Group AG, Goldman Sachs Group Inc, Nomura Holdings Inc, Deutsche Bank AG, UBS Ag, and Socit Gnrale SA (SocGen) have already turned bearish on gold in recent weeks, and cut their gold-price forecast for 2013 and 2014.

So current selloff cannot be dismissed as having been a purely market dynamic and not having been influenced by a grand design to promote further inflationism.

Lastly, as I noted during the start of the year, gold’s 12 year consecutive rise has been ripe for profit taking.

Although, so far, with the exception of gold, no trend has moved in a straight line, so it would be natural for gold to undergo a year of negative returns.

Expect this selloff in gold-commodity sphere to increase risks towards a transition to a global crisis, and for central banks to engage in more aggressive inflationism. 

Such transition will eventually bring about the risks of stagflation.

The Political Pretense called Currency War

A geneticist recently claimed that human intelligence has been on a gradual decline due to the extensive use of fluorides in the water supply, pesticides, high fructose corn syrup and processed foods. 

I have a different opinion. If true, then I would say that the main culprit has been the public’s worship of state, from which untruths, as conveyed by media, politicians and their apologists, envelops its essence. Blind belief in political falsehood makes people lose their intellectual bearings.

Just recently the Japanese government has been blamed by her counterparts as Russia, South Korea and the Bundesbank for inciting, if not escalating, a “currency war” via open ended bond buying program to devalue the yen. The implication is that Japan’s “currency manipulation” polices signifies as “beggar thy neighbor” policies that have been implicitly designed to hurt other nations.

A “currency war” is another term for competitive devaluation which according to Wikipedia.org represents “a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency” where “states engaging in competitive devaluation since 2010 have used a mix of policy tools, including direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing.”

Yet one would notice that the balance sheets of major central banks, all of which have been skyrocketing, and which allegedly reflects on “direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing”, currency wars in the light of competitive devaluation has been an ongoing event since 2008 as shown in the chart above. 

In short, neither has this been an exclusive Japan event nor has been a fresh development.

And this has also not been limited to major central banks but extends all the way to emerging Asia and to China as well, the Philippines included. (chart from the Bank of International Settlements)

In short, global central banks have been in a state of “currency war” or “currency manipulation” since 2008.

This article is not meant to absolve Japan's policies but to expose on what seems as political canard.

In reality “currency war” or “currency manipulation” or competitive devaluation is simply nothing more than inflationism. The great Ludwig von Mises defined inflation as

if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.

While there may be technical difference on what a central bank buys to expand her assets through a corresponding expansion of currency liabilities, the fact is that “quantity of money is increased”.

The assets of Swiss National Bank have mostly been in foreign currency reserves (as of November 2012) while the Bank of Japan has mostly been in JGBs (as of September 30, 2012). Table from (SNBCHF.com)

American neo-mercantilists have labeled “currency manipulation” on nations, who allegedly use of accumulation of currency reserves as exchange rate policy, from which they call their government to impose protectionist countermeasures such as China.

As I wrote previously this represents naïve thinking.

While the technical reasons why countries accumulate foreign currency reserves are mainly for self-insurance (for instance Asia reserve accumulation has partly been due to the stigma of the Asian Crisis) and from trade, financial and capital flows (NY FED), the real “behind the curtain” reason has been the US dollar standard system. Such system allows for a “deficit without tears”, or unsustainable free lunch by the use of the US dollar seingorage to acquire global goods and services that results to seemingly perpetual trade deficits. 

Deficit without tears, as the late French economist and adviser to the French government Jacques Rueff wrote in the Monetary Sin of the West (p.23), “allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.” 

And this has been the main reason for America’s “financialization” and the recurring policy induced boom bust cycles around the world, which essentially has been transmitted via the Triffin dilemma or “the conflict of interest between short-term domestic and long-term international economic objectives” of an international reserve currency

Thus blaming China or even the Philippines for reserve currency accumulation seems plain preposterous and only represents political lobotomy.

Currency war or currency manipulations serves no less than to “cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics”, to quote anew the great professor Ludwig von Mises from which “to advance plausible arguments in favor of the policy of reckless spending; they simply could not find a case against the economic theorem concerning institutional unemployment.”

And may I add that pretentious public censures account for as ploys to divert public’s attention or serve as smokescreens from homegrown government “inflationist” policy failures.

Since major central bank represented by the G-20 knows that by labeling Japan as instigator of currency wars would be similar to the proverbial pot calling the kettle black, they went about fudging with semantics to exonerate Japan’s political authorities.

From Bloomberg,

Global finance chiefs signaled Japan has scope to keep stimulating its stagnant economy as long as policy makers cease publicly advocating a sliding yen.

The message was delivered at weekend talks of finance ministers and central bankers from the Group of 20 in Moscow. While they pledged not “to target our exchange rates for competitive purposes,” Japan wasn’t singled out for allowing the yen to drop and won backing for its push to beat deflation.

This doesn’t look like a “war”, does it?

At the end of the day, currency war, or perhaps, stealth collaborative currency devaluation (perhaps a modern day Plaza-Louvre Accord) maneuvering means that central bank shindig will go on; publicity sensationalism notwithstanding.

Gary North on Irving Fisher: The Most Influential Economic Crank in American history

Austrian economist Gary North on a smackdown of the late Irving Fisher. (hat tip Bob Wenzel) 

Fisher was the most influential economic crank in American history. Fisher offered a simple formula that supposedly enables economists to understand the complexities of monetary policy and its effects on the price level: MV=PT. It relies on an intellectual construct, namely, the price level. This must be created by statisticians and economists. The formula does not explain cause-and-effect in terms of the transmission and spread of newly created money throughout the economy. It is totally an aggregate concept. It ignores individuals who make decisions: in government, central banks, commercial banks, and specific markets.

Ludwig von Mises' theory of money begins with real central banks, real borrowers, and the spread of fiat money over time: none of which is considered by Fisher or Friedman.

Fisher proved in 1929 that he was the most highly educated economic fool in the world. He went public with two predictions.

"There may be a recession in stock prices, but not anything in the nature of a crash." (i>New York Times, Sept. 5, 1929)

"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months." (Oct. 17, 1929)

http://www.gold-eagle.com/editorials_01/seymour062001.html

Then, over the next four years, he lost his own personal fortune. He was so poor in 1933 that Yale University had to subsidize housing for him. Yet this consummate fool, whose economic theories not only led to a catastrophic personal error, but which to a great extent were responsible for the original monetary policies of the Federal Reserve, which it pursued in the late 1920s, is now heralded as some kind of economic genius. Friedman regarded him as "the greatest economist the United States has ever produced." (Money Mischief, p. 37).

Fisher was a crank, and Mises exposed him as a crank within a year of the publication of Fisher's 1911 book. If you want to get an idea of how different their theories are, read Mark Thornton's article. Fisher believed that we can safely trust the government or its central bank to formulate monetary policy. He opposed the gold coin standard, because he thought it is inefficient. That was also true of Friedman. Neither of them ever understood that the free market is capable of providing a sufficient quantity of money, by means of gold mining, for a market economy. Supply and demand for goods and services are regulated by means of a private currency system that itself is created by market processes. Neither Fisher nor Friedman ever believed this. They both believed that the government must intervene in order to create a reliable monetary system, so that there can be economic growth, market clearing processes, and individual liberty. They both believed in the wisdom and power of the state with respect to the central commodity in an economy, namely, the money supply.

Ironically Irving Fisher has been regarded as the “greatest economist of the last century” by some.

Nonetheless, I find Mr. Fisher’s sequential description of debt deflation as useful

Mr. North also points out that Mr. Fisher was also a eugenics crank

Read the rest here.

Quote of the Day: The Idea of a Strong Man Rule

The IDEA of a STRONG MAN, a czar and a dictator, appeals to many people, and this directly supports the STATE. Those people who become disenchanted with democracy or with Congress or with partisan politics and debates, and of course the potential czars and dictators, like this idea. Add this notion to the other supports, such as the "public good", "nationalism", and the communistic ideas that are in the Communist Manifesto and have already been enacted into law. The strong man concept might be invoked as an independent means of efficient government, or else as a support to the nation, or society, or the people, or the public good, i.e., as a complementary means to these. However the strong man idea is evoked, it too invades susceptible minds. This leads directly into the virus of STATISM and the STATE.

This is from Professor Michael Rozeff at the Lewrockwell.com. 

Populist state worship or what Mises would call Statolatry frequently leads to dictatorship, which eventually backfires.

The Philippines has been no stranger to this.

Video Jon Stewart on the $1 Trillion Platinum Coin: It's a Stupid F*cking Idea

Hat tip: Mises Blog

The Daily Show with Jon Stewart
Get More: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

Let me add Cumberland Advisors' Bob Eisenbeis sensible remark on such outrageous proposition:

a tongue-in-cheek proposal that was getting traction in DC was that the Treasury (and thus the Administration) could solve its funding problems by simply exploiting a loophole in the law that would permit the Treasury to mint a trillion-dollar platinum coin, deposit it in the Treasury’s account with the Fed, and write checks on that account to cover operating costs. Shame on us that we are even talking about the possibility, and even Paul Krugman has weighed in on the issue. To mint the coin would be to print money, and we know from history that printing money doesn’t solve a debt problem. The Spanish found that out when they scoured the world for gold. The more of it you have in circulation, the less valuable it becomes. The Germans found it out during the Weimar Republic, and the Argentineans found it out in the latter half of last century. Krugman claims it isn’t printing money because the Fed would offset Treasury spending, which would put new money in the hands of the public, with asset purchases. But he is wrong, since he is assuming behavior by another governmental entity to offset the Treasury’s spending and hasn’t apparently looked recently at the Fed’s exploded balance sheet. As the result of its quantitative easing programs, there are no offsetting transactions and wouldn’t likely be such transactions. [italics added]

When experts resort to surrealistic ideas as space aliens and platinum coins as solutions to economic fragility, you know how debauched, not only the economic spectrum has been, but importantly, the public's moral standings by virtue of its popularity.

As the great Ludwig von Mises warned, (bold mine)

There are still teachers who tell their students that “an economy can lift itself by its own bootstraps” and that “we can spend our way into prosperity.” But the Keynesian miracle fails to materialize; the stones do not turn into bread...

There is no use in arguing with people who are driven by “an almost religious fervor” and believe that their master “had the Revelation.” It is one of the tasks of economics to analyze carefully each of the inflationist plans, those of Keynes and Gesell no less than those of their innumerable predecessors from John Law down to Major Douglas. Yet, no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.

Quote of the Day: The Illusions of Pundits

People who spend their time, earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options. Even in the region they knew best, experts were not significantly better than non-specialists.

Those who know more forecast very slightly better than those who know less. But those with the most knowledge are often less reliable. The reason is that the person who acquires more knowledge develops an enhanced illusion of her skill and becomes unrealistically overconfident. “We reach the point of diminishing marginal predictive returns for knowledge disconcertingly quick,” Tetlock writes. (Philip E. Tetlock, University of Pennsylvania in 2005 book Expert Political Judgment: How Good is It? How Can We Know?—Prudent Investor) “In this age of academic hyperspecialization, there is no reason for supposing that contributors to top journals—distinguished political scientists, area study specialists, economists, and so on—are better than journalists or attentive readers of the The New York Times in ‘reading’ emerging situations”. The more famous of the forecaster, Tetlock discovered, the more flamboyant the forecasts. “Experts in demand,” he writes, “were more confident than their colleagues who eked out existences far from the limelight.”

The above quote is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his insightful book Thinking, Fast and Slow p.219

There are many reasons not to trust pundits, aside from overconfidence, which essentially oversimplifies human action.

I believe that the substantial chunk of “expert errors” emerge from the influences of conflict-of-interest relations, particularly the principal-agent problem, where “experts” tend to promote the interests of employers, sponsors, donors, grant providers and or even political agents (perhaps through implicit ambition to be part of the political institution) whom are sources of the self-interests of such pundits.

Forecasting inaccuracies may also be linked to the rigid application of ideology and or on the overreliance on math models (scientism).

Add to this the desperate desire by “experts” to attain social acceptance via social signaling.  Such would include making extreme (media attracting) projections or providing the veneer of expertise on what truly is about populism—forecasting based on what is popular, or as I previously wrote 

For many, thus, expertise signify more as social signaling (posturing or seeking social acceptance) and or “telling people what they want to hear” but predicated on certain technically based paradigms which produces an aura of supposed superiority rather than representative of the true domain knowledge.

Dr. Kahneman suggests that to determine “true expertise” from merely displays of the “illusions of validity”, one should identify conditions where pundits have excelled in “an environment that is sufficiently regular to be predictable” and from their having “to learn these regularities through prolonged practice” (p 240). In short, in an unpredictable world, expert opinion should be less trusted.

However by simply associating expertise with “regularity” and “prolonged practice” seems to contradict logically his earlier critique of pattern seeking behavior (which is about the human psychological propensity to seek regularity or constancy through patterns while at the same time underestimating the role of randomness). The nuance will be on the marginal efforts applied by practitioners via  “prolonged practice” in dealing with such regularities. 

The point is despite being able to minimize the influences of “expert or non-expert” intuition on decision making that may result to lesser degree of judgmental errors, behavioral economics/finance will not lead to omniscience or come close to solving the knowledge problem: a complex society will always be subject to irregularities and unpredictability from the dynamic and intricate feedback mechanism of human action and of environmental changes. Dr. Kahneman acknowledges this: "Errors of prediction are inevitable, because the world is unpredictable" (p. 220)

Nevertheless the best way to acquire “expertise” is primarily through investing in oneself

Quote of the Day: The Illusion of Stock-Picking Skill

Professional investors, including fund managers, fail a basic test of skill: persistent achievement. The diagnostic for the existence of any skills is the consistency of individual differences in achievement. The logic is simple: if any individual differences in any one year are entirely due to luck, the ranking of investors and funds will vary erratically and the year-to-year correlation will be zero. Where there is skill, however, the rankings will be more stable…

There is general agreement among researchers that nearly all stock pickers, whether they know it or not—and a few of them do—are playing a game of chance. The subjective experience of traders is that they are making sensible educated guesses in a situation of great uncertainty. In highly efficient markets, however, educated guesses are no more accurate than blind guesses.

This excerpt is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his insightful book Thinking, Fast and Slow p.214

Well Mr. Kahneman’s thesis seems to have been recently validated as passive long term investment funds (via equity bond index) has trumped active fund management represented by hedge funds 

The Economist notes,

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds...

The widening disparity means that randomness or providence or lady luck has increasingly played a bigger role in determining the performances of the fast expanding hedge fund industry. 

The same Economist article subliminally acknowledges this,

The average hedge fund is a lousy bet, and predicting which will thrive and which will disappoint is a task that would tax even a Nobel prizewinner.

Yet in the finance industry where many of the participants believe that they possess presumptuous knowledge which in reality exhibits inflated egos, the role played by luck/randomness exists in a vacuum. 

Why? As Mr. Kahneman from the same book p 216 explains,

The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions—and thereby threaten livelihoods and self esteem—are simply not absorbed. The mind does not digest them. This is particularly true of statistical studies  of performance, which provide base-rate information that people generally ignore when it clashes with their personal impressions from experience.

Manny Pacquiao Didn’t Let Fans Down, Prodded by Media Fans Deluded Themselves

I empathize with boxing legend Manny Pacquiao for undeservingly feeling “guilty” over public pressures, following his stunning KO loss which he suffered from older Juan Manuel Marquez, a few days.

From MSN News

"The low morale, the sadness, I accept that. This is my job.... But the reaction of the Filipinos, the many who cried, especially my family, it really hurts me," he said in an interview on the GMA network.

The former eight-division world champion wiped tears from his eyes listening to his wife, Jinkee, make a tearful appeal on camera for her husband, who turns 34 next week, to hang up his gloves. 

Pacquio shouldn’t be so hard on himself. He lost because he is just human. 

A random one-punch shot, in a round which he so-dominated, at the last two seconds virtually changed the outcome to his opponents favor.

Nassim Taleb would have called this Pacquiao’s black swan.

Failure to adhere to reality has made Pacquiao’s loss unwarrantedly controversial. This is hardly about the lack of conditioned training, the charge on Marquez’s alleged use of steroids, and other rubbish attributions. Religion has even been absurdly imputed on this. Others have used this as pretext to try to impose political correctness on the contrasting opinion of the others.

He lost because he lost. He was at wrong place at the wrong time. Period. The rest of supposed 'expert' rationalization represents post hoc fallacy.

It has been my impression that the media has made the public believe that sheer nationalism or the force of nationalism by itself would lead to Pacquiao’s sustained invincibility, immortality and everlasting string of victories. 

Pacquiao’s decisive loss exposed such hogwash. In the same way, belief in extreme nationalism has been demolished after 60-78 MILLION lives had needlessly been lost due to World War II.

Pacquiao didn’t let his fans down. The fans have no one else to blame but themselves, for unduly placing extremely high expectations in his supposed ‘superhuman’ capabilities, and importantly, for falling prey into mainstream media’s hype. 

This is a great example of bubble psychology. The same lessons which will permeate and eventually apply to the Philippine capital markets.

As British essayist, critic, poet, and novelist Gilbert Keith Chesterton once sarcastically remarked, 

"Journalism is popular, but it is popular mainly as fiction. Life is one world, and life seen in the newspapers is another."

Reality simply dealt false dogmatism a rude and painful awakening.

Quote of the Day: Why Regulation Does Not Work

Regulations do not make markets safer, more efficient, or work better for consumers in anything but a superficial sense. Regulation only provides “confidence” and assurance that only leads to crisis. Regulation does not produce harmonization of markets or insurance for consumers.

Regulation simply does not work. It is designed with hopes of success, but with no mechanism to achieve this success. We hope for efficiency, but what we get is bureaucracy. We hope for effectiveness, but what we get is rules and red tape that serves neither producer nor consumer. We hope for safety, but what we eventually get is chaos.

This is from Austrian economics Professor Mark Thornton at the Mises Institute.

Professor Thornton cites as examples of the highly regulated financial industry that nurtured Bernie Madoff's Ponzi and the housing bubble. Yes, Washington had “over 12,000 bureaucrats devoted to financial regulation”. 

Professor Thornton also mentions stringent regulations on the oil industry which led to the BP Gulf oil spill and to the Enron scandal.

Professor Thornton concludes: (italics original, bold mine)

The regulator is portrayed as a public-spirited specialist. They know the public good. They know the results that are expected. They know how to bring about those results. It is as simple for them to regulate their corner of the economy as it is for Emeril Lagasse to make crab cakes or for Martha Stewart to make a simple doily.

The public is told that regulators do not cause problems; they prevent them. They police the economy. They are the watchmen that have been endowed with the wisdom, ability, and selfless devotion to the public good.

There are indeed many people who work as government regulators that are very smart and well-trained that have public spirit and the public good in their hearts. There are also plenty of cads and knuckleheads that work as regulators.

The problem with government regulation is that you cannot fine-tune the regulations: nor can you perfect the regulatory work force in such a way to make regulation work in anything but a superficial way. The truth is that regulation instills confidence in the public so that they let down their guard and makes them less cautious while at the same time distorting the competitive nature of firms in the marketplace.

After every economic crisis there are calls for new regulations, more funding, and more controls. Economic wisdom dictates that we be ready to contest those calls when the next crisis of the interventionist state occurs.

Quote of the Day: Golden Handcuffs

When the public had access to gold coins prior to 1914, individuals controlled banking policy. They also controlled government fiscal policy. They could take their coins out of commercial banks if they did not approve of government policy. This is why national governments annul or restrict gold-coin redeemability whenever a major war breaks out. They do not want to face the citizens' veto. 

With the repudiation of any gold-coin standard since 1914, citizens no longer understand the case for a gold-coin currency. They do not understand that widespread gold ownership was the number one restraining factor on the expansion of state power in the economy. The uncoordinated individual decisions of millions of people could overturn any government policy that required central bank inflation to fund it. The politicians resented this. So did the central bankers.

The politicians were under restraints: golden handcuffs. They decided that it was better to turn the money-creation power over to the bankers. The central bankers promised to buy government bonds at low rates: lender of last resort. This made the central bank the counterfeiter of last resort.

This is from author Gary North on the religion of inflationism-central planning versus free markets at the Mises.org.

Quote of the Day: Money Printing will lead the Sheep to Slaughter

The fallacy of the belief that countries that print their own currency are immune to sovereign crisis will be disproven in the coming months and years. Those that treat this belief as axiomatic will most likely be the biggest losers. A handful of investors and asset managers have recently discussed an emerging school of thought, which postulates that countries, as the sole manufacturer of their currency, can never become insolvent, and in this sense, governments are not dependent on credit markets to remain fiscally operational. It is precisely this line of thinking which will ultimately lead the sheep to slaughter.

(italics original)

 

This excerpt is from Kyle Bass, American fund manager and founder of Hayman Capital, from his November 15th newsletter (source Zero Hedge)

For many, the laws of economics don’t apply. Inflation is not about monetary expansion. Money printing has neutral effects and supersedes everything else. This myth which will eventually be shattered.

Video: Milton Friedman on the Path to Totalitarianism

In the following video, the distinguished Milton Friedman channels on the great F. A. Hayek's The Road to Serfdom

Comments Professor Don Boudreaux at the Cafe Hayek

The fantasy that the democratic act of centralizing and concentrating decision-making authority and responsibility in the state ensures that decisions are made better and more wisely and more ‘scientifically’ and in ways likely to promote greater human flourishing is the most absurd and dangerous – yet widespread – fantasy that afflicts modern humanity. It is a fantasy to which academics, along with Hollywood celebrities, cling with special and remarkably steadfast faith.

Quote of the Day: If Democracy Isn’t Working, It’s Not Democracy’s Fault

The idea of democracy is sacrosanct. To question it implies that you are in favor of despotism and tyranny. Democracy fans conveniently ignore the fact that despots and tyrants are freely elected every year.

President Hugo Chavez retained power in Venezuela this year, winning comfortably despite running his country’s economy into the ground with his socialist revolution of nationalizing key industries, tight exchange controls, and price controls on certain basic goods.

As the European economy continued to lurch toward meltdown, French voters elected Francois Hollande in 2012. The first three things Hollande did were raise the minimum wage, reduce the retirement age from 62 to 60, and raise the top tax rate to 75%. A conspiracy theorist would assume Hollande is deliberately trying to demolish what’s left of the French economy with these policies.

In Moscow, Vladimir Putin was again elected president of Russia. Despite police repression and the thuggery of the previous Putin regime, pro-Putin rallies were much more popular than anti-Putin rallies. “This is the time to build a bridge to Putin, before the most talented people move out of Russia,” said curator Marat Gelman.

As the United States elections draw near, the incumbent president is leading or tied in the polls. In his four years, he has not really deviated from his predecessor’s policies that were generally reviled by those in his party. He has presided over the largest expansion in public debt in world history, with the result being economic growth that is the weakest since the Great Depression. And this guy is likely to win. If he doesn’t, his opponent will govern just as he (and the ones before him) did.

Those of us paying attention are left to merely sigh and roll our eyes, reminded of H.L. Mencken’s line, “Democracy is the theory that the common people know what they want, and deserve to get it good and hard.”

Meanwhile, democracy continues on unquestioned. The politicians may be crooked, the taxes ruinous, the bureaucracy unwieldy, and the regulations outrageous, but the source of these outcomes is never questioned. The hope of democracy depends on the idea that all we need is the right people in power.

If democracy isn’t working, it’s not democracy’s fault. The problem is only that the right people have not been elected yet. This theory has been tested for hundreds of years and the results are the same, yet people still hope and believe. The worst rise to the top in politics, F.A. Hayek explained. To be elected, politicians must appeal to the least intelligent and most gullible. And because democracy makes politics and power available to everyone, it attracts those seeking status, fame, glory, recognition, attention, appreciation, dignity, and even dominance. The right people will never be attracted to politics, only the wrong people will.

This is from Mises Institute President Douglas French at the Laissez Faire Books on the popular delusion of the democratic utopia.