Accounting Magic: Double Economic Growth Overnight, Nigeria Edition

All it takes for Nigeria to magically double the size of her economy is to apply some accounting-statistical trickery.

From Simon Black at the Sovereign Man (bold mine)

Over the weekend, Nigeria’s government made an accounting adjustment in how it calculates its GDP statistics.

By changing the base-year in GDP calculations from 1990 to 2010, Nigeria increased the reported size of its economy by 89% over the weekend.

So with a stroke of a pen, the West African nation leapfrogged South Africa to become the continent’s largest economy.

And in doing so the country’s debt-to-GDP ratio fell below 20%. The ratio of bad loans in the banking system when compared to the overall size of the economy also dramatically declined in proportion.

The same thing happened in Poland last year when the government there made a grab for private pensions, then counted those new assets against government debt.

It was just another accounting scam. But it dramatically lowered Poland’s debt-to-GDP ratio on paper, even though the government had not actually gotten any ‘richer’.

And how the same accounting-statistical manipulation can be seen applied to the balance sheets of the ECB and the US Federal Reserve. Again Mr. Black

Just hours ago, the European Central Bank released its 2013 annual report, showing a massive 44% surge in profits.

Diving into the numbers, though, it turns out that most of the ECB’s profits come from funny accounting tricks—revaluing a permanent swap line they have with the Federal Reserve, and moving funds from the “risk provision” column into the profit column.

I’m also reminded of the Federal Reserve’s own admission that they had $50+ billion in ‘unrealized losses’ due to the erosion of their portfolio of US Treasuries.

This is almost as much as their entire capital reserve… meaning that the Fed is practically insolvent by its own admission.

Not to worry, though. The Fed gets to employ its own accounting tricks to make these losses disappear, marking the assets on the balance sheet at their much higher ‘book value’, rather than the much lower ‘market value’.

Of course, the US government does exactly the same thing… often conveniently leaving out huge portions of its total debt such as the non-marketable securities it owes to the Social Security trust funds.

All of this really just goes to show how absurd it is to rely on these numbers conjured by politicians and central bankers.

And I’ve been repeatedly saying that since government issues all the accounting based statistics they will show what they want to show rather than what really has been.

To give you more example of fallacies of mainstream statistics,  the great dean of the Austrian school of economics Murray N. Rothbard exposed on the flagrant errors of the Keynesian multiplier. Mr. Rothbard’s case more lucidly explained by Professor Steven Landsburg: (bold orginal)

If you studied economics from one of the classic textbooks (like Samuelson) you might remember how this goes. We start with an accounting identity, which nobody can deny:

Y = C + I + G

Here Y represents the value of everything produced in (say) a given month, which in turn is equal to the total income generated in that month (because producing a $20 radio allows you — or perhaps you and your boss jointly — to earn $20 worth of income). C (which stands for consumption) is the value of the output that ends up in households; I (which stands for investment) is the value of the output that ends up at firms, and G (which stands for government spending) is the value of the output that ends up in the hands of the government. Since all output ends up somewhere, and since households, firms and government exhaust the possibilities, this equation must be true.

Next, we notice that people tend to spend, oh, say about 80 percent of their incomes. What they spend is equal to the value of what ends up in their households, which we’ve already called C. So we have

C = .8Y

Now we use a little algebra to combine our two equations and quickly derive a new equation:

Y = 5(I+G)

That 5 is the famous Keynesian multiplier. In this case, it tells you that if you increase government spending by one dollar, then economy-wide output (and hence economy-wide income) will increase by a whopping five dollars. What a deal!

Now, though I cannot seem to find a reference, I have a vague memory that it was Murray Rothbard who observed that the really neat thing about this argument is that you can do exactly the same thing with any accounting identity. Let’s start with this one:

Y = L + E

Here Y is economy-wide income, L is Landsburg’s income, and E is everyone else’s income. No disputing that one.

Next we observe that everyone else’s share of the income tends to be about 99.999999% of the total. In symbols, we have:

E = .99999999 Y

Combine these two equations, do your algebra, and voila:

Y = 100,000,000 L

That 100,000,000 there is the soon-to-be-famous “Landsburg multiplier”. Our equation proves that if you send Landsburg a dollar, you’ll generate $100,000,000 worth of income for everyone else.

The policy implications are unmistakable. It’s just Eco 101!!

See how accounting identities can create a paradise for everyone?

Quote of the Day: Perpetual price inflation as means to assure full employment

…And these were the policies that Keynes did his best to try to overthrow in the pages of his book, "The General Theory." He argued that a market economy was inherently unstable, open to swings of irrational investor optimism and pessimism, which resulted in unpredictable and wide fluctuations in output, employment, and prices. Only government, he believed, could take the long view and rationally keep the economy on an even keel by running deficits to stimulate the economy during depressions and surpluses to rein it in during inflationary booms. He therefore attacked the notion of annual balanced budgets; instead, government should balance its budget over the “business cycle.”

To do this job, Keynes said, governments should not be hamstrung by the “barbarous relic” of the gold standard. Wise politicians, guided by brilliant economists like himself, had to have the flexibility to increase the money supply, manipulate interest rates, and change the foreign-exchange rates at which currencies traded for each other. They required this power so they could generate any amount of spending needed to put people to work through public-works projects and government-stimulated private investments. Limiting increases in the money supply to the quantity of gold would only get in the way, Keynes insisted.

Keynes believed not only that the market economy could not keep itself on an even keel he also believed that it would be undesirable to allow the market to work. He once said that to have the market determine prices and wages to balance supply and demand was to submit society to a cruel and unjust “economic juggernaut.” Instead, he wanted wages and prices to be politically fixed on the basis of “what is ‘fair’ and ‘reasonable’ as between the [social] classes.”

The level of wages imposed by trade unions, for example, was to be viewed as sacrosanct, even if many workers were priced out of the market because the level was higher than potential employers thought those workers were worth. The government, instead, was to print money, run deficits, and push up prices to any level needed to make it again profitable for employers to hire workers. In other words, perpetual price inflation was to be the means to assure “full employment” in the face of aggressive trade unions demanding excessive wages.

This is from libertarian author and economics professor Richard Ebeling on the myths of Keynesianism published at the Epic Times.  (hat tip Bob Wenzel) The Keynesian policy prescription essentially means two wrongs (interventions and inflationism) make a right.

Why Nassim Taleb Disdains the Economic Profession

My favorite Iconoclast author and philosopher Nassim Nicolas Taleb disdains the economic profession

The Businessinsider compiled 12 vitriolic quotes by Mr. Taleb on them (hat tip EPJ)

1. An economist is a mixture of 1) a businessman without common sense, 2) a physicist without brain, and 3) a speculator without balls.
2. A prostitute who sells her body (temporarily) is vastly more honorable than someone who sells his opinion for promotion or job tenure.
3. The artificial gives us hangovers, the natural inverse-hangovers. The joys of post-exercise, breaking a fast, meeting a friend, helping someone in trouble, or humiliating an economist are examples of inverse hangovers. Antifragility = series of earned inverse hangovers. They don't come for free.
4. Those with brains no balls become mathematicians, those with balls no brains join the mafia, those w no balls no brains become economists.
5. To have a great day: 1) Smile at a stranger, 2) Surprise someone by saying something unexpectedly nice, 3) Give some genuine attention to an elderly, 4) Invite someone who doesn't have many friends for coffee, 5) Humiliate an economist, publicly, or create deep anxiety inside a Harvard professor.
6. A trader listened to the firm's "chief" economist's predictions about gold, then lost a bundle. The trader was asked to leave the firm. He then angrily asked him boss who was firing him: "Why do you fire me alone not the economist? He is too responsible for the loss." The Boss: "You idiot, we are not firing you for losing money; we are firing you for listening to the economist."
7. Discussing growth without concern for fragility: like studying construction without thinking of collapses. Think like engineer not economist.
8. OPEN DISCUSSION: Back to skin in the game. It looks like skin in the game does not necessarily work because it makes people more careful, rather but because it allows the risk taker to exit the gene pool and stop transferring the risk to others. A bad driver exposed to harm would eventually die and stop killing people on the road; shielded from harm he would keep killing others ad infinitum, as if he were an economist a la JS or PK.
9. Success in all endeavors is requires absence of specific qualities. 1) To succeed in crime requires absence of empathy, 2) To succeed in banking you need absence of shame at hiding risks, 3) To succeed in school requires absence of common sense, 4) To succeed in economics requires absence of understanding of probability, risk, or 2nd order effects and about anything, 5) To succeed in journalism requires inability to think about matters that have an infinitesimal small chance of being relevant next January, ...6) But to succeed in life requires a total inability to do anything that makes you uncomfortable when you look at yourself in the mirror.
10. [On his greatest disappointment]: That I am unable to destroy the economics establishment, the press.
11. Friends, I wonder if someone has computed how much would be saved if we shut down economics and political science departments in universities. Those who need to research these subjects can do so on their private time.
12. Being nice to the wicked (or economist) is equivalent to being nasty with the virtuous.

Here is the latest (from Mr. Taleb’s Facebook) 

The problem is that academics really think that nonacademics find them more intelligent than themselves.

For instance when the economic mainstream holds that savings is bad and debt based spending is good, ignoring the fact or reality that ALL financial crisis has been a function of debt, then I share most of Mr. Taleb's sentiment.

Quote of the Day: Four Old Fashioned Monetarist Heresies

1) For any given growth rate of aggregate spending, lower actual rates of price and wage inflation mean higher levels of output and employment;

2) For any given growth rate of aggregate spending, higher expected rates of price and wage inflation mean lower levels of output and employment;

3) An increase in the growth rate of aggregate spending is not the same as an increase in the equilibrium rate of inflation;

4) An increase in aggregate spending succeeds in raising the rate of inflation only in so far as it fails to increase output and employment.

I submit these old-fashioned monetarist heresies for the consideration of all those who think that an increased target rate of inflation will help us out of our present economic quagmire.

(italics original)

This is from economics Professor and Cato Institute senior fellow George Selgin at the FreeBanking.org.  In short, Inflation ≠ Real Economic Growth

Thomas Sowell on the Yellen’s Keynesianism

Thomas Sowell addresses the prospective Keynesian economic policies from incoming Fed chief Janet Yellen.

Writes Mr. Sowell at the Townhall.com

Ms. Yellen asks: "Do policy-makers have the knowledge and ability to improve macroeconomic outcomes rather than making matters worse?" And she answers: "Yes."

The former economics professor is certainly asking the right questions -- and giving the wrong answers.

Her first question, whether free market economies can achieve full employment without government intervention, is a purely factual question that can be answered from history. For the first 150 years of the United States, there was no policy of federal intervention when the economy turned down.

No depression during all that time was as catastrophic as the Great Depression of the 1930s, when both the Federal Reserve System and Presidents Herbert Hoover and Franklin D. Roosevelt intervened in the economy on a massive and unprecedented scale.

Despite the myth that it was the stock market crash of 1929 that caused the double-digit unemployment of the 1930s, unemployment never reached double digits in any of the 12 months that followed the 1929 stock market crash.

Unemployment peaked at 9 percent in December 1929 and was back down to 6.3 percent by June 1930, when the first major federal intervention took place under Herbert Hoover. The unemployment decline then reversed, rising to hit double digits six months later. As Hoover and then FDR continued to intervene, double-digit unemployment persisted throughout the remainder of the 1930s.

Conversely, when President Warren G. Harding faced an annual unemployment rate of 11.7 percent in 1921, he did absolutely nothing, except for cutting government spending.

Keynesian economists would say that this was exactly the wrong thing to do. History, however, says that unemployment the following year went down to 6.7 percent -- and, in the year after that, 2.4 percent.

Under Calvin Coolidge, the ultimate in non-interventionist government, the annual unemployment rate got down to 1.8 percent. How does the track record of Keynesian intervention compare to that?

So expect more bubbles, a build up of systemic fragility from a pileup of debt and more Wall Street friendly policies such as implicit guarantees and (explicit) bailouts at the expense of main street.

Quote of the Day: On the New Keynesian Liquidity Trap: Every law of economics seems to change sign at the zero bound

New-Keynesian models produce some stunning predictions of what happens in a "liquidity trap" when interest rates are stuck at zero.  They predict a deep recession. They predict that promises work: "forward guidance," and commitments to keep interest rates low for long periods, with no current action, stimulate the current level of consumption.  Fully-expected future inflation is a good thing. Growth is bad. Deliberate destruction of output, capital, and productivity raise GDP. Throw away the bulldozers, let them use shovels. Or, better, spoons. Hurricanes are good. Government spending, even if financed by current taxation, and even if completely wasted, of the digging ditches and filling them up type, can have huge output multipliers.

Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible.  Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.

In short, every law of economics seems to change sign at the zero bound. If gravity itself changed sign and we all started floating away, it would be no less surprising.

From University of Chicago Professor John H. Cochrane at his blog: The Grumpy Economist

Asian Markets Jump on Rumors of US$106 Billion Railway Stimulus

Asian markets posted strong gains today led by Chinese Equities.

It appears that steroid addicted markets has found another inspiration from rumored or unofficial plans for a railway stimulus by the Chinese government.

From Bloomberg:

The government may spend more than the originally planned 650 billion yuan ($106 billion) on railway construction this year, the China Business News reported today, citing an unidentified person close to senior government officials. New high-speed rail lines could help reduce over-capacity in industries such as steel and cement, the Shanghai Securities News reported today, citing railway officials.

The Shanghai composite leapt by 1.95%. ASEAN markets spiked too.

The floated rumors are signs that the policies of the newly installed Chinese officials will hardly distinguish from the previous administration in terms of bailouts and rescues, except via the form of interventions. Policies to "reduce over-capacity" will extrapolate to short term gains that would lead to capital consumption and that will exacerbate on the current unsustainable imbalances.

But the good news is that the Chinese government has also liberalized caps on lending by the banking system last Friday. This should be positive over the long term growth. 

But this will hardly resolve on the current debt based malinvestments and the runaway property bubble brought about by the previous policies which has prompted a shift towards the huge $2.4 trillion shadow banking system.

One thing seems clear, there has to be promises for more inflationary interventions by global governments to guide the markets higher. And this collective jawboning-the-markets communications strategy appears to have become a daily activity.

Yet, my question is will these constant promises of easy money policies experience diminishing utility or diminishing returns? We will see.

Nonetheless, interesting developments.

Humor: A Modest Bury-Dig Keynesian Employment Proposal

From Simon Black of the Sovereign Man:

Decades ago, John Maynard Keynes famously wrote in his book The General Theory:

“If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines. . . and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again. . . there need be no more unemployment.”

To Keynes, all that mattered was that people were employed doing something, anything. The quality of employment didn’t matter.

Clearly this line of reasoning worked out well for the Soviets; as was said of their economic system producing mounds of left boots with no right boots, “We pretended to work, and they pretended to pay us.”

Today, famous Nobel Prize-winning economists like Paul Krugman echo Keynes’ sentiment.

Krugman has even suggested that spending trillions of dollars to defend against a phony alien invasion would save the economy.

This, coming from a man who has won society’s most ‘esteemed’ prize for intellectual achievement.

Given several years of a ‘print money with wanton abandon’ monetary policy, it seems like Ben Bernanke goes to bed at night with Keynes’ General Theory on his bedside table.

But following these principles, Mr. Bernanke has backed himself into a corner. He has printed so much money that the mere suggestion of scaling back his bond-buying program sends financial markets roiling.

He’s now forced to speak from both sides of his mouth– on one hand suggesting that he will “taper”, and on the other hand that the Fed is “by no means on a preset course.”

In other words, they have no plan or exit strategy. They’re just making it up as they go along.

Bernanke further claims that his money printing and bond buying will remain in effect until the unemployment rate falls dramatically.

This is a perplexing qualifier since unemployment remains quite high despite trillions of dollars created over the last few years.

Considering that the ‘quality’ of jobs doesn’t matter in this Keynesian worldview, though, I’ve come up with a simple idea.

The Fed is now printing $85 billion / month… roughly $1 trillion annually. So if they really want to move the needle, I propose that Mr. Bernanke cuts out the middleman (i.e. the ‘economy’) and hires workers himself.

To do what, you might ask?

Count. Specifically, count the amount of money he’s creating.

It’s simple. You assign everyone a range of numbers and have them count as he prints.

On average (I’ve tested this), it takes about 5-6 seconds per number.

Sure, one two three four is quick. But how long does it take to say 16,847,512,971…? (You’re saying it right now, aren’t you?)

I’ve calculated that it would take a special workforce of roughly 1 million people, including supervisors and support staff, in order to count the amount of money that Mr. Bernanke is creating.

This assumes that these folks count eight hours per day, with two weeks of paid vacation and ten federal holidays. This is, after all, a cushy financial sector job.

At $50,000 per worker, Bernanke would be adding substantially to the economy… not to mention really moving the needle on the unemployment rate.

“Oh but this is ludicrous…” Of course it is. And so is conjuring trillions of dollars out of thin air to monetize the debt.

And it’s a hell of a lot easier than putting together an alien invasion hoax. Besides, I’m sure the government could never bring itself to stage a false flag operation. Not in the Land of the Free… right?

Quote of the Day: Quackroeconomics

In discussions of macroeconomic policy in Washington and in the press, these four propositions are taken as given:

(S) Spending is what drives the economy. Spending creates jobs, and jobs create spending. When unemployment is high, the problem is too little spending.

(M) Monetary policy must steer the economy carefully between overheating and slumping. Doing so requires high levels of skill and intellectual resources.

(F) Fiscal policy is just as important. When there is unemployment, monetary policy cannot do the job alone, because the Federal Reserve also has to keep an eye on inflation. So the Federal government must engage in deficit spending to stimulate the economy.

(C) Computer models are essential tools that enable economists to forecast the economy and assess the impact of alternative economic policies. Using computer models, the Congressional Budget Office is able to score the number of jobs a particular policy will add to or subtract from the economy.

These four propositions are what I term quack macroeconomics, or quackroeconomics for short. Like quack medicine, quackroeconomics is unproven, unreliable, inconsistent with the views of leading researchers in the field, and possibly dangerous.

This is from economic blogger and author Arnold Kling at his blog. 

I would add to quackroeconomics the mistake of rigidly interpreting statistical (historical-empirical) data as economic analysis.

Quote of the Day: Inflation is music to the ears of stock market investors

Stock market investors care about the bad news in Europe, the United States, and China. They care deeply. The looming decline of all of these economies will let central bankers inflate with abandon, just as they have ever since 2008. Inflate! That is music to the ears of stock market investors.

Of course, it’s not called inflating. It’s called easing.

It’s not called counterfeiting. It’s called accommodation.

It’s not called debasement. It’s called active monetary policy.

The worse the economy gets, the better it is for Wall Street . . . until it gets really bad. Then Wall Street rolls over and plays dead.

Wall Street wants counterfeiting by the FED. So do Keynesians. The word “taper” terrifies Wall Street. It terrifies Keynesians, too. And as for “exit,” Wall Street and Keynesians unite: “No exit!”

That’s what the federal budget deficit offers: “No exit.”

That’s what the unfunded liabilities of Social Security and Medicare offer: “No exit.”

That’s why the Great Default is coming.

This is from Austrian economist Gary North at the TeaPartyEconomist.com

I would call this substance abuse only in the form of inflation.

How Financial Experts Bamboozle the Public

Money pros had been taken to the woodshed according to the Global Association of Risk Professionals. (hat tip EPJ) [bold mine]

Americans would like an apology from Wall Street for the financial crisis.

They probably aren't going to get it.

But how about giving the number crunchers and investment managers a "time out" to reflect a little on the era of financial alchemy and greed that did so much damage?

That's what was happening in Chicago this week, where about 2,000 of the financial industry's quantitative minds and investment professionals gathered for their annual CFA Institute conference. They got some verbal punishment from some of the industry's stalwarts, who were admonishing their chartered financial analyst peers to think rather than allow mindless financial models and dreams of success to drive them to endorse the kinds of aggressive investment decisions that can create riches for themselves -- and destroy wealth for others.

"If you are attracted to a job in finance because the pay is so generous, don't do it," said Charles Ellis, one of the elder statesmen of the profession. "That's a form of prostitution."

Rather, Ellis said, his profession needs to return to the days he knew in the 1960s, when the emphasis was on counseling investment clients and not on churning out esoteric products and pushing people to buy them blindly.

Today the emphasis too often is on "complexity rather than common sense," said James Montier, asset allocation strategist for investment manager GMO. "In finance, we love to complicate. We rely on complexity to bamboozle and confuse."

In the local arena, such conflict of interests has hardly been about “churning out esoteric products” but about the pervasive cheerleading of politically colored quack statistics into “pushing people to buy them blindly”. "Them" here is applied to conventional financial assets.

More on the use of aggregate model based analysis:

Too many in his profession, Montier said, are trying inappropriately to apply physics to investing, where it doesn't belong, and they are ignoring inconvenient truths. Complex mathematics is valued but not necessarily used honestly, he said.

"A physicist won't believe that a feather and brick will hit the ground at the same time, and they won't use models to game the system. But that's what finance does with models," Montier said. "They take them as though they are reality."

Montier, speaking to financial professionals who design, evaluate and sell investment products to individuals and institutions, warned that all professionals in finance need to be thinking more, rather than following the herd.

"Who could have argued that CDOs were less risky than Treasurys with a straight face?" he said. But that's what happened. "Part of the brain was switched off, and people took expert advice at face value.

True. Mathematical and statistical formalism serves as the major instrument used by “experts” to hoodwink the vulnerable public on so-called economic analysis. The public is usually awed or overwhelmed by facade of numerical equations and economic or accounting terminologies.

These experts forget that economics hasn’t been about physics but about the science of incentives, purposeful behavior or human action.

As the great dean of Austrian school of economics wrote, (italics original, bold mine)

Indeed, the very concept of "variable" used so frequently in econometrics is illegitimate, for physics is able to arrive at laws only by discovering constants. The concept of "variable," only makes sense if there are some things that are not variable, but constant. Yet in human action, free will precludes any quantitative constants (including constant units of measurement). All attempts to discover such constants (such as the strict quantity theory of money or the Keynesian "consumption function") were inherently doomed to failure.

Governments love Wall Street models too

Government regulators and the Federal Reserve are guilty, too, of blindly putting their confidence in flawed models, he said. And if his profession and the regulators continue to ignore the dangers of financial concoctions involving massive leverage and illiquid assets, financial companies again will create an explosive brew that will result in calls for another government bailout.

This means because authorities has embraced economic bubble policies as a global standard, which engenders boom bust cycles, we should expect more crisis ahead. Thus the prospective “calls for another government bailout.”

To add, in reality, the government’s love affair with models has been undergirded by an unseen motivation: the expansion of political power.

Every crisis bequeaths upon the governments far broader and extensive social control over the people via bailouts, inflation, more regulations higher taxes and etc...

This legacy quote from a politician, during the last crisis, adeptly captures its essence

You never want a serious crisis to go to waste..This crisis provides the opportunity for us to do things that you could not do before.

Bottom line: many financial experts seem to in bed with politicians to promote political agendas either deliberately or heedlessly. Thus, financial expert-client relations usually embodies the principal-agent problem.

Nassim Taleb would call such mainstream experts as having "no skin in the game", thus would continue to blather about nonsense while promoting fragility.

Finally one doesn't need to be a CFA to know this. As James Montier in the above article said it only takes "common sense" which experts try to suppresss with "complexity". 

I would add to common sense; critical thinking.

Iceland’s Recovery: Hardly about Currency Devaluation

Alan Reynolds at the Cato Institute blog explains, (italics original, bold mine)

Iceland’s recent devaluation was highly orthodox policy condition for wards of the IMF (strings attached to a $2 bn. loan). Unfortunately, such devaluations often backfire by inflating commodity costs, interest rates and the burden of foreign debt. The Icelandic krona fell from 64 to the dollar in 2007 to 123.6 in 2009, before strengthening with the economy to nearly 116 in 2011.

Since oil, grains and metals are priced in dollars, the 2008-2009 devaluation inflated Iceland’s cost of production and cost of living.  Inflation rose from 5.1 percent in 2007 to 12 percent or more in 2008 and 2009; real GDP fell by 6.8 percent in 2009 and 4 percent in 2010.  Faced with a collapsing currency, the central bank interest rate was hiked to 18 percent by October 2008.  It could have been worse.  If Iceland’s Supreme Court had not nullified loans indexed to foreign currencies in June 2010, devaluation would have doubled the cost of repaying foreign debt.

Devaluation was supposed to boost GDP by making imports costly and exports cheap, thus narrowing the trade deficit. The current account deficit did fall after 2008, but that always happens when recessions slash imports. Ireland had a current account surplus from 2010 to 2012 without devaluation, even as Iceland’s current account deficit was still 7-8 percent of GDP.

Iceland’s economy grew by 3.1 percent in 2011 when the currency appreciated and the budget deficit was deeply cut to 4.4 percent of GDP.  Devaluation explains the previous spike in inflation and interest rates, but little else. 

Iceland’s statistical growth recovery following the 2008-2011 crisis.

Some notes from the above:

Devaluation policies serves the interests of political agents and their affiliates, allies or cronies than of the general economy.

The devaluation panacea oversimplifies a complex economy operating spontaneously on millions of independently moving parts. The natural result from such conflict: policy failure.

The devaluation snake oil therapy, which operates on the principle of getting something for nothing, also deals with solving short term quandaries that comes with larger long term costs.

Bottom line: Micro issues can hardly be resolved by using macro tools which mistakenly sees the economy as a mechanical machine. Individuals think and act on purpose. Macro economic policies assume otherwise.

Iceland’s recovery has largely been allowing for markets to clear (by not saving banks), and importantly, by the reversal of inflationist policies.

US Federal Reserve’s James Bullard: Why Unemployment Targets Won’t Work

For the mainstream, macro-policies such as inflationism has been immensely expected to solve “micro” problems. The popular wisdom specifically fixates on the “money illusion” or “price illusion” effects of inflationism, where experts see people as having the tendency to think of currency in nominal, rather than real, terms (wikipedia). 

In short, so-called experts think that people hardly think at all. Everyone of us, except them, are boneheads.

The premise where people can hardly feel, notice and respond to the changes in the purchasing power of their nominal currency serves as justification for governments to manipulate money supply intended to DECEIVE people into attaining so-called economic objectives, like lowering real value of wages. (So much for so-called "virtuous" and "transparent" governments) 

Well it does seem that even some officials of the US Federal Reserve recognize the folly of such premise.

Austrian economist Joseph Salerno at the Mises Blog refers to the dissent by US Fed President of St. Louis James Bullard on unemployment targets: (bold mine)

The Fed has committed itself to maintaining its zero interest rate policy as well as quantitative easing for as long as the unemployment rate remains above 6.5 percent (and inflation rate below 2.5 percent). James Bullard, the President of the Federal Reserve Bank of St. Louis, heroically dissents from this policy of unemployment targeting, which is basically a reversion to the crude and discredited Old Keynesian doctrine. In a speech last month entitled “Some Unpleasant Implications for Unemployment Targeters”, Bullard, himself a New Keynesian inflation targeter, stated:

Attempts to address the various labor market inefficiencies solely with monetary policy do not work very well because improvements on one dimension are simultaneously detriments on other dimensions. . . . monetary policy alone cannot effectively address multiple labor market inefficiencies, and so one must turn to more direct labor market policies to address those problems.

Unfortunately, President Bullard did not articulate those “more direct labor market policies,” but they would include: the repeal of minimum-wage legislation, which destroys jobs for the unskilled; the repeal of the National Labor Relations Act, which coerces employers into collective bargaining and privileges union “insiders” against non-union “outsiders” causing unemployment or lower wage rates among the latter; and the phasing out of unemployment “insurance,” which encourages unemployed workers to spend an excessive amount of time in “searching” for jobs.

In short, mainstream’s oversimplification of micro conditions as merely driven by a SINGLE variable (price levels) signifies as arrant myopia. 

There are many more or equally important factors, such as the state of property rights and other political hurdles (regulatory environment, taxes, mandates, unionism and etc..) that influence people’s incentives to conduct commercial activities.

Moreover, price level manipulation theories hardly ever consider the invisible (opportunity costs) and the secondary effects of such policies: particularly price instability (boom bust cycles, stagflation, hyperinflation) and economic discoordination.

The reality is that so-called economic objectives have been used as front or as excuse for the real design: transfer of wealth from society to the political class and the politically connected groups.

Ironically, the gist of the wisdom of economic talking heads which mainly belittles on people’s capacity to think, is founded on self-deception (from highly flawed model based assumption) and on the pandering to the political class.

Yet many fall prey to the political contrivance, "lies told often enough becomes the truth"

Abenomics: Japan’s McDonald’s to Raise Prices by 25%

Lo and behold! This is one example of the supposed magic of Abenomics, Japan’s McDonald’s will raise prices of their products by 25% in order to offset losses!

From Bloomberg

McDonald’s Corp. (MCD)’s Japan business will raise some prices by much as 25 percent next month, the fast food chain’s first increase on burgers in the country since 2008.

Hamburger prices will go up to 120 yen from 100 yen and cheeseburgers will rise to to 150 yen from 120 yen in Japan in May, McDonald’s Holdings Co. Japan Ltd. said in a statement today. The hikes are part of the company’s plan to boost profitability, it said.

McDonald’s is raising the prices after the Japanese unit reported a 12 percent drop in operating profit last year. Fewer discounts drove March same-store sales 3.6 percent lower at the local business, the 12th consecutive monthly decline.

Of course basic economics tells us that higher prices leads to lesser demand. Thus a fall in purchasing power should extrapolate to lesser sales in terms of quantity (and also quality) which eventually should put pressure on profits. 

Chart from Yardeni.com

Yet given Bank of Japan’s recourse to inflationism which hasn’t been anything new, as the Japanese government has been doing this since the start of the new millennium, but has only become more aggressive since 2008, McDonald’s has been suffering from poor sales which isn’t supposed to be the case, especially at the onset of expansionary boom. 

The employment of such poilcies embodies precisely the definition of insanity specifically "doing the same thing over and over again but expecting different results."

Inflationism will hardly bring a boost to the economy, why? Because it inhibits economic calculation and the division of labor by distorting market prices.

As the great Murray N. Rothbard explained (bold mine)

Inflation has other disastrous effects. It distorts that keystone of our economy: business calculation. Since prices do not all change uniformly and at the same speed, it becomes very difficult for business to separate the lasting from the transitional, and gauge truly the demands of consumers or the cost of their operations. For example, accounting practice enters the "cost" of an asset at the amount the business has paid for it. But if inflation intervenes, the cost of replacing the asset when it wears out will be far greater than that recorded on the books. As a result, business accounting will seriously overstate their profits during inflation--and may even consume capital while presumably increasing their investments.  Similarly, stock holders and real estate holders will acquire capital gains during an inflation that are not really "gains" at all. But they may spend part of these gains without realizing that they are thereby consuming their original capital.

By creating illusory profits and distorting economic calculation, inflation will suspend the free market's penalizing of inefficient, and rewarding of efficient, firms. Almost all firms will seemingly prosper. The general atmosphere of a "sellers' market" will lead to a decline in the quality of goods and of service to consumers, since consumers often resist price increases less when they occur in the form of downgrading of quality. The quality of work will decline in an inflation for a more subtle reason: people become enamored of "get-rich-quick" schemes, seemingly within their grasp in an era of ever-rising prices, and often scorn sober effort. Inflation also penalizes thrift and encourages debt, for any sum of money loaned will be repaid in dollars of lower purchasing power than when originally received. The incentive, then, is to borrow and repay later rather than save and lend. Inflation, therefore, lowers the general standard of living in the very course of creating a tinsel atmosphere of "prosperity."

This only means that in a highly inflationary environment McDonald’s and other Japanese firms will be compelled to either reduce quality or to continually raise prices in order to survive or even speculate, which is contradictory to bring about ‘competitiveness’.

Yet any elevated accounting figures boosted by higher prices will be exposed when the BoJ desists from pursuing inflationist policies—the boom bust cycle.

Moreover, given that Japanese households are said to be ‘risk averse’ where 56% of their liquid assets are in the form of cash and where liquid ‘cash’ financial wealth accounts for 319% of Japan’s GDP, while only 5.8% have been invested in equities and .08% in foreign assets, one should expect that the massive fall in the purchasing power of the yen, will lead not to more investments, but to yield chasing masked as capital flight.

Former Morgan Stanley analyst now managing director and cofounder of SLJ Macro Partners Stephen Jen quoted by SNBCHF.com 

The first stage is foreign leveraged funds shorting the yen, acting on the rhetoric from the Abe Administration. This stage is coming to an end, to be followed by the second stage: Japanese investors selling yen

We have already seen signs where Japanese firms would rather raise financing from foreigners than to deploy domestic cash to investments.

So it would signify as a grotesquely obtuse idea to blindly believe (yes inflationism isn’t economics but religion based on heuristics) that inflation will save the day for Japan. Doing the same thing over a decade hasn't help, why should it be different this time? Because of the shock and awe?

One can only look at Argentina and Venezuela’s transition from stagflation to hyperinflation to see how disastrous a policy inflation makes.

Abenomics will only hasten Japan's path to a crisis.

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.