European Debt Crisis: Taxing the Economy to Prosperity

The Wall Street Journal editorial has a nice and trenchant discourse on Europe’s chosen course of action in working to resolve on their debt and financial crisis. (bold emphasis mine)

European leaders are meeting in Brussels today to craft their third attempt—or is it the sixth?—to end the Continent's debt crisis and avert a deep recession. So it seems an apt moment to review the economic policy record of the leaders seeking to set Europe back on course. It isn't pretty.

A large part of the problem is the state of Europe's intellectual debate, which pits government spending against "austerity" as the only two economic policy choices. The Keynesians are blaming Europe's looming slowdown on belt-tightening governments, as if public spending is the only way to spur economic growth. But the problem across most of Europe isn't a lack of government spending that typically represents about half of GDP. It's the failure to create the conditions for private investment and growth.

When the financial panic hit in 2008, the EU and International Monetary Fund urged governments across the Continent to spend like crazy to avoid recession. So they spent, only to discover that such spending is unsustainable. Now the same wise men are urging governments to raise taxes to offset all that spending and even to spend more "in the short term." The one policy none of these leaders has tried is the Reagan-Thatcher model of cutting taxes to spur growth.

Read the list of tax measures being imposed and or the rest of the article here (subscription required)

The mainstream, as rightly pointed out by the WSJ, offers a false choice where government spending has been portrayed as the elixir or magic wand that would bring about prosperity. So aside from the additional burden of taxation, the alternative option to finance government spending or private sector rescues has been the shrill clamor for the ECB to inflate the system or for peripheral states to leave the core to be able to inflate (allegedly to regain competitiveness, which has hardly been the reality).

There has been little regards towards incentivizing those who generate wealth—the entrepreneurs and the capitalists—or as per the WSJ “conditions for private investment and growth”.

Yet to the contrary, taxation and inflation demotivates or discourages investments.

So far, the direction of policies has been geared towards the preservation of the status quo or the political architecture of the welfare state—central banking—banking cartel at the expense of the wealth creators.

This political preference to redistribute rather than create wealth means that any ‘fiscal union’ risks not only the failure to attain the objective of saving ‘peripheral states’ so as to preserve the EU, but also risks undermining the credit standings of stronger or creditor nations. In other words, every nation that joins in the bailout bandwagon will likely get dragged into economic morass, where eventually there won't be enough resources from which to redistribute and the whole structure falls apart.

Politicians and the bureaucrats, desperately looking for short term nostrums, looks like they are digging themselves deeper into the hole.

And given such conditions, the crisis should be expected to linger on and that sharp volatilities will continue to be the common feature of the marketplace.

Sunshine Industry: Video Games Media

One of the likely fastest growing applications of the information age would probably the video game industry.

From the Economist, (emphasis added)

OVER the past two decades the video-games business has gone from a cottage industry selling to a few niche customers to a fully grown branch of the entertainment industry. According to PricewaterhouseCoopers (PwC), a consulting firm, the global video-game market was worth around $56 billion last year, and has grown by over 60% since 2006, when the Nintendo Wii console was launched. The gaming industry is more than twice the size of the recorded-music industry, nearly a quarter more than the magazine business and about three-fifths the size of the film industry. PwC predicts that video games will be the fastest-growing form of media over the next few years, with sales rising to $82 billion by 2015. The biggest market is America, whose consumers this year are expected to spend $14.1 billion on games, mostly on the console variety. Consoles also dominate in Britain, the fifth-largest gaming market. In other parts of Europe, and particularly Germany, PC games are more popular. China has overtaken Japan to become the second-biggest market, and is one of the fastest-growing, with sales rising by 20% last year.

How will the growth of video games be facilitated?

Again from the same article, (bold emphasis mine)

Now the ever-increasing computing power of mobile phones has put the means of playing games into the pockets of people who would never think of spending hundreds of dollars on a dedicated console or a PC. The simple games that came pre-loaded onto the mobile handsets of a decade ago have evolved into a subset of the industry in its own right, appealing to a more casual crowd who play them on trains, in airport departure lounges or while waiting for the washing to finish. Today’s smartphones pack far more computing power than the original PlayStation, and games are a big part of their appeal: the two most popular kinds of software on Apple’s App Store are games and entertainment.

The internet has played a crucial part in the rise of video games, enabling developers to get their products into their customers’ hands without the need for traditional shops or publishers. That has allowed small, independent developers to compete with the big firms who might spend tens of millions of dollars on developing a single title and as much again on marketing it. As a result the industry is becoming increasingly fragmented as its markets become more differentiated.

The internet has also become a games platform in its own right, making the hobby truly sociable by electronically linking gamers the world over. Millions of people spend many hours each week playing and working (sometimes the distinction is not clear) in virtual places such as “World of Warcraft” and “EVE Online”. Hundreds of millions more play free, simple, sociable games on Facebook, such as “Lexulous”, which is a bit like Scrabble, and “FarmVille”, a game with an agricultural setting. Increasingly the games themselves are free, but the virtual goods available in these online worlds—a stable for one’s electronic horses, say, or a particularly pretty shirt for one’s digital alter ego to wear—cost real money.

The internet will likely remain a hub for the introduction of many innovative applications due to its largely free market setting.

And video games, mobile commerce, mobile banking and digital healthcare or telemedicine are likely major growth application areas for consumers that will be powered by the rapidly exploding mobile internet platform as manifested by tablet sales.

Quote of the Day: Business Value of Austrian Economics

I came to Austrian economics because that is how business in the real world felt to me.

Bingo!

Professor Arnold Kling captures the essence of what has attracted me to Austrian economics…real world values applied to business and the finance.

Considering that my career has revolved around dealing with markets, I have long been immersed or indoctrinated with conventional methodologies based on formulaic sciences, pattern seeking models and of heuristics veneered as traditionalism that has only led to many frustrations and manifold errors.

Austrian economics has not only signified out of the box thinking, but most importantly has helped me survived the recent storms from its common sense approach to economic analysis, i.e. human action, law of scarcity, knowledge problem, and opportunity costs.

Cracks in South Korea’s Mercantilists Policymaking Mindset?

Mercantilist policymaking in South Korea may be exhibiting some signs of fissures.

Michael Han at Matthews Asia writes,

South Korea has long been an export-oriented economy; more than half its economy is still dependent on export-heavy industries such as shipbuilding, automotives and information technology. The government’s supportive political sentiment toward exports is understandable since these industries have been South Korea’s “bread and butter” ever since it began its transformation in the 1960s from one of Asia’s poorest countries. But Korea now needs to take a deeper look domestically, particularly in terms of its social welfare system.

Recently, the government’s ruling party members, including its president, have lost major elections and seen their approval ratings plummet to all-time lows as issues surrounding currency movements, inflation and overall monetary policy have plagued the country. Many domestic consumer companies and consumers feel policies primarily benefit exporters at their expense. And while the general sentiment, “What is good for Korea’s major global corporations is also good for the country,” was once widely held, that mentality is shifting.

If true, then reality must be sinking into the public’s outlook.

Over the years, Korea’s exports have reached 50% of the GDP, but at what price? (chart from Google Public Data explorer)

Foreign currency reserve of South Korea has been exploding.(chart from Bloomberg)

The acquisition of US dollars by the Bank of Korea, by printing and issuing won, have been reflected on inflation rates (chart from tradingeconomics.com).

Each policy that politically promotes certain industries always comes at the expense of another. The imbalances of which, especially in manipulating or suppressing currencies for export promotion, will eventually get ventilated on the economy via inflation.

And such imbalances has supposedly begun to permeate into the political realm.

The won has been higher since 2009, but would be a lot higher if not for repeated interventions.

The other proposed solution of welfare spending will simply add to the predicament as resources will be transferred from productive to non-productive uses (politicos and welfare parasites).

Nevertheless, the Korea’s Kospi has been showing similar trend manifestations or seeming tight correlations as with all of the above (won, inflation rate, foreign currency reserves and even mortgage growth-as shown below).

While there maybe some signs of a seminal property bubble brewing, the Korean cycle has yet to culminate. So far annual change has not risen to alarming levels (charts from global property guide)

Bottom line: Interventionists policies end up spawning bubble or boom bust cycles which eventually percolates into the political sphere. And South Korea has not been exempted from such process.

ECB’s Draghi Balks at More QE, Global Equity Markets Tumble

Need more proof that financial markets have been held hostage by politics?

This from Bloomberg, (bold emphasis mine)

European Central Bank President Mario Draghi cut interest rates and offered banks unlimited cash for three years while damping speculation the ECB will buy more government bonds to stem the region’s debt crisis.

Policy makers meeting in Frankfurt today reduced the benchmark rate by a quarter percentage point to 1 percent, matching a record low. They also loosened collateral rules so that banks can borrow more from the ECB and announced two unlimited three-year loans. The measures “should ensure enhanced access of the banking sector to liquidity,” Draghi said at a press conference.

Hours before European leaders meet in Brussels, Draghi kept the onus on them to solve the two-year debt crisis by repeating his call for a “fiscal compact” and denying he had hinted the ECB would automatically support such an initiative with more bond purchases.

Draghi’s comments roiled markets, with stocks and the euro rising on the bank-lending measures before falling after he damped expectations of more ECB bond buying. The euro sank more than 1 percent and traded at $1.3310 at 6:30 p.m. in Frankfurt.

This despite… (from the same article)

With the ECB’s focus on jolting banks into lending, Draghi made it easier for them to borrow cash from the central bank.

Credit claims such as bank loans will become eligible as collateral and the central bank reduced the rating threshold on asset-backed securities.

The ECB also cut in half banks’ reserve ratio, which determines the amount of money they have to deposit with their national central banks every month, to 1 percent of total assets.

Reserve requirements currently amount to around 206 billion euros ($275 billion), so the reduction means “a significant increase in available collateral to banks,” said Laurent Fransolet, head of European fixed income strategy at Barclay’s Capital in London.

Draghi said the new measures should encourage banks to lend to companies and households.

Easing bank lending conditions have not been perceived as sufficient. Apparently market’s addiction to inflationism has made them crave for more of ECB’s quantitative easing.

Yet the ECB seems to be using QE as leverage for the EU to attain a “fiscal compact” during today’s summit, a seemingly perennial event since the crisis emerged that hasn’t made any significant progress.

And like the September shakeout where Ben Bernanke jilted the markets over expectations of QE 3.0, yesterday’s selloff had been broadbased which included important commodity benchmarks as oil and gold.

Nevertheless today’s selloff hasn’t been in the same scale as the September episode.

So financial markets will continue to be heavily influenced by expectations of political actions which only means sustained significant volatility in both directions.

Yet considering how the ECB has been trying to ease the credit environment with assorted measures (e.g. reserve ratio, collateral eligibility), more QE from the ECB can’t be discounted.

ECB’s Draghi’s declarations looks more like posturing.

Global Warming Debate: Sea levels aren't rising dangerously

Popular ‘media’ hysteria on climate change have principally been based from math derived models.

Yet in contravention of the establishment consensus, an expert based on extensive field observation claims that ‘sea levels are not rising dangerously’.

From the Spectator.co.uk,

This week's Spectator cover star Nils-Axel Mörner brings some good news to a world otherwise mired in misery: sea levels are not rising dangerously – and haven't been for at least 300 years. To many readers this may come as a surprise. After all, are not rising sea levels – caused, we are given to understand, by melting glaciers and shrinking polar ice – one of the main planks of the IPCC's argument that we need to act now to 'combat climate change'?

But where the IPCC's sea level figures are based on computer 'projections', questionable measurements and arbitrary adjustments, Mörner's are based on extensive field observations. His most recent trip to Goa in India last month – just like his previous expeditions to Bangladesh and the Maldives – has only served to confirm his long-held view that reports of the world's imminent inundation have been greatly exaggerated for ends that have more to do with political activism than science.

Mörner's views have not endeared him to environmental campaigners or the IPCC establishment. A few years ago, when I mentioned his name in a public debate with George Monbiot, I vividly remember an audible hissing from sections of the audience as if I'd invoked the equivalent of Lord Voldemort.

The problem for Mörner's detractors is that, eccentric and outspoken Swedish count though he no doubt is, he also happens to be the world's pre-eminent expert on sea levels. Besides being responsible for dozens of peer-reviewed papers on the subject, he was also chairman of INQUA Commission on Sea Level Changes and Coastal Evolution. This means that his findings can not easily be dismissed as those of a raving 'climate change denier'.’

I’d be very cautious about heeding populist or the mainstream’s claims when much of them seem to be communism/socialism garbed in environmental mores.

Burton Malkiel: Why Developed Economy Government Bondholders will Lose Money

At the Wall Street Journal, Professor Burton Malkiel, author of the classic finance book "A Random Walk Down Wall Street", argues that government bonds will generate negative for investors. He writes, (bold emphasis mine)

For years, investors have been urged to diversify their investments by including asset classes in their portfolios that may be relatively uncorrelated with the stock market. Over the 2000s, bonds have been an excellent diversifier by performing particularly well when the stock market declined and providing stability to an investor's overall returns. But bond yields today are unusually low.

Are we in an era now when many bondholders are likely to experience very unsatisfactory investment results? I think the answer is "yes" for many types of bonds—and that this will remain true for some time to come.

Many of the developed economies of the world are burdened with excessive debt. Governments around the world are having great difficulty reining in spending. The seemingly less painful policy response to these problems is very likely to keep interest rates on government debt artificially low as the real burdens of government debt are reduced—meaning the debt is inflated away.

Artificially low interest rates are a subtle form of debt restructuring and represent a kind of invisible taxation. Today, the 10-year U.S. Treasury bond yields 2%, which is below the current 3.5% headline (Consumer Price Index) rate of inflation. Even if inflation over the next decade averages 2%, which is the Federal Reserve's informal target, investors will find that they will have earned a zero real rate of return. If inflation accelerates, the rate of return will be negative.

We have seen this movie before. After World War II, the debt-to-GDP ratio in the United States peaked at 122% in 1946, even higher than today's ratio of about 100%. The policy response then was to keep interest rates pegged at the low wartime levels for several years and then to allow them to rise only gradually beginning in the 1950s. Moderate-to-high inflation did reduce the debt/GDP ratio to 33% in 1980, but this was achieved at the expense of the bondholder.

Ten-year Treasurys yielded 2.5% during the late 1940s. Bond investors suffered a double whammy during the 1950s and later. Not only were interest rates artificially low at the start of the period, but bondholders suffered capital losses when interest rates were allowed to rise. As a result, bondholders received nominal rates of return that were barely positive over the period and real returns (after inflation) that were significantly negative. We are likely to be entering a similar period today.

So what are investors—especially retirees who seek steady income—to do? I think there are two reasonable strategies that investors should consider. The first is to look for bonds with moderate credit risk where the spreads over U.S. Treasury yields are generous. The second is to consider substituting a portfolio of dividend-paying blue chip stocks for a high-quality bond portfolio.

Aside from a portfolio of blue chip stocks, Professor Malkiel recommends tax exempt bonds and foreign bonds.

I’d add that emerging market equities should also be part of one’s portfolio.

Read the rest here

20 Signs of the Unsustainable US Nanny State

From The Economic Collapse Blog

The following are 20 signs that the culture of government dependence has gotten completely and totally out of control....

#1 If you can believe it, 48.5% of all Americans now live in a household that receives some form of government benefits. Back in 1983, that number was less than 30 percent.

#2 Way too many Americans believe that the government should just swoop in and solve all of their problems. For example, the plight of a single mother named Angel Adams made national headlines recently. Over the years her relationships with three different men have produced 15 children, and she was recently found living in a single motel room with 12 of those children.

As you can see in the video below, Adams is looking for the government to come in and rescue her. The following is what Adams told one reporter....

“Somebody needs to pay for all my children and my – for all my suffering. Somebody needs to be held accountable, and they need to pay.”

#3 The amount of money paid out to individual citizens by the government today is absolutely staggering. In 1980, government transfer payments accounted for just 11.7% of all income. Today, government transfer payments account for 18.4% of all income.

#4 According to a recent ABC News report, suicides in rural America are spiking, and experts say that cuts to Medicaid are partly to blame....

“Kathie Garrett, co-chairman of the Idaho Council on Suicide Prevention, says the problem has gotten only worse since the recession. "The poor economy and unemployment—those put a lot of stress on people's lives," she explains. To save money, people skip doctor visits and cut back on taking prescribed medications. Cuts in Medicaid have reduced the services available to the mentally ill.

"I personally know people who lost Medicaid who've attempted suicide," says Garrett.

#5 By the end of 2011, approximately 55 million Americans will receive a total of 727 billion dollars in Social Security benefits. In future years, this dollar figure is projected to absolutely skyrocket.

#6 When you total it all up, American households are now receiving more money from the U.S. government than they are paying to the government in taxes.

#7 It is being projected that the federal government will account for more than 50 percent of all health care spending in 2012.

#8 Back in 1965, only one out of every 50 Americans was on Medicaid. Today,one out of every 6 Americans is on Medicaid.

#9 According to the Congressional Budget Office, the Social Security systempaid out more in benefits than it received in payroll taxes in 2010. That was not supposed to happen until at least 2016.

#10 The federal government is expected to "take care" of their workers far better than the private sector does. If you can believe it, the average federal employee in the Washington D.C. area brings in total compensation worth more than $126,000 a year.

#11 Last year, federal employees "earned" approximately 447 billion dollarsin total compensation.

#12 Spending by the federal government accounts for approximately one thirdof the GDP of the entire Washington D.C. region.

#13 The federal government spent more than 50 billion dollars on "housing assistance" in 2009.

#14 The U.S. government now says that the Medicare trust fund will run outfive years faster than they were projecting just last year.

#15 The total cost of just three federal government programs - the Department of Defense, Social Security and Medicare - exceeded the total amount of taxes brought in during fiscal 2010 by 10 billion dollars.

#16 Right now, there are more than 45 million Americans on food stamps. That means that approximately one out of every seven Americans is dependent on the federal government for food.

#17 The number of Americans on food stamps has increased 74% since 2007.

#18 Sadly, one out of every four American children is now on food stamps.

#19 In 2010, 42 percent of all single mothers in the United States were on food stamps.

#20 According to one study, "64.3 million Americans depended on the government (read: their fellow citizens) for their daily housing, food, and health care" during 2009.

The following chart from Heritage Foundation shows that by 2049, Medicare, Medicaid and Social Security will consume 100% of taxes.

This excerpt from Professor Higgs (previously at quote of the day) has been so relevant…

As the ranks of those dependent on the welfare state continue to grow, the need for the rulers to pay attention to the ruled population diminishes. The masters know full well that the sheep will not bolt the enclosure in which the shepherds are making it possible for them to survive. Every person who becomes dependent on the state simultaneously becomes one less person who might act in some way to oppose the existing regime. Thus have modern governments gone greatly beyond the bread and circuses with which the Roman Caesars purchased the common people’s allegiance. In these circumstances, it is hardly surprising that the only changes that occur in the makeup of the ruling elite resemble a shuffling of the occupants in the first-class cabins of a luxury liner. Never mind that this liner is the economic and moral equivalent of the Titanic and that its ultimate fate is no more propitious than was that of the “unsinkable” ship that went to the bottom a century ago.

The laws of economics will not allow for its persistence, whereas beneficiaries will revolt over any cuts.

The ultimate end of the welfare state extrapolates to chaos or dystopia.

European Debt Crisis: Demand for US dollar Rises amidst Signs of Funding Stress

From Reuters,

A larger-than-expected take-up of dollars at a European Central Bank tender on Wednesday reflected euro zone banks' funding stresses but the fact banks were using the facility was seen as a positive.

Banks took more than $50 billion at a three-month operation, which was the first since the world's major central banks cut the cost of using dollar swap lines with the Federal Reserve last week to help institutions struggling with the fallout from the euro zone debt crisis.

That was well above the $10 billion median forecast in a Reuters poll of money market traders. Banks also took $1.6 billion in one-week funds.

But analysts said there was no reason to panic as dollar-funding stresses were widely acknowledged already.

"We view this as a positive first step -- it leads a string of potential policy actions as authorities attempt to break the negative feedback loop from the euro zone and limit contagion back to the U.S.," said George Goncalves, head of U.S. interest rates strategy at Nomura Securities International in New York.

Morgan Stanley estimated the take-up in the ECB tender was the most since December 2008, with banks able to borrow dollars for three months at 0.58 percent compared with around 1.45 percent before the coordinated central bank action to lower the cost.

So the US Federal Reserve may have reactivated QE operations via swap line funding to the ECB, as previously discussed here and here

And today’s EU summit may grant license to the ECB to conduct more asset purchases (QE).

Shale Oil Discoveries Goes International, Easing Peak Oil Concerns

Last week, Argentina and China reported major Shale oil discoveries

From Presstv.com

Argentina's YPF oil and gas company has announced a historic oil discovery in the country's southern province of Neuquen, Press TV reports.

Yacimientos Petroliferos Fiscales (YPF) new finding includes 927 million barrels of recoverable oil and natural gas, of which 741 million barrels is shale oil.

“They [YPF] have an important discovery, and they have to expand it. The major challenge is to develop the technology and raise the capital in order to produce at reasonable prices,” Daniel Gerold, an energy market analyst told Press TV.

From Independent.co.uk

The shale gas revolution spread to China yesterday as Royal Dutch Shell struck the rock-based fossil fuel while drilling, heralding the country's first commercial production.

In a joint venture with its local partner, PetroChina, Shell has drilled two wells and discovered a good flow of gas.

"It's good news for shale gas," said Professor Yuzhang Liu, vice president of Petrochina's Research Institute of Petroleum Exploration and Development. Shale gas is fraught with controversy because it is extracted from the rock with blasts of sand, water and chemicals through a process known as hydraulic fracturing, or fracking, that has been linked to earthquakes and water pollution.

However, the discovery of vast quantities of the gas in countries such as the US, Poland and the UK has the potential to provide a relatively cheap, secure source of energy.

In April, the US Energy Information Administration estimated that China may hold 1,275 trillion cubic feet of shale gas, 12 times its conventional gas reserves and almost 50 per cent greater than in the US.

With the spate of Shale oil discoveries which should be expected to increase, as I previously wrote,

Eventually the growth of the industry will likely reach a scale enough to incentivize a structural change or reconfiguration in the distribution of demand.

This implies an easing of relevance of peak oil.

From Platts.com,

The debate over whether the world's reserves of hydrocarbons have now peaked and are in decline has lost relevance over recent years as new technology allows oil companies to find and exploit new hydrocarbon sources, the CEO of Repsol Antonio Brufau said Tuesday.

Brufau said progress made in exploring and developing ultra-deepwater areas, unconventional oil and gas sources and the move into remote areas such as the Arctic, have been key to growing global reserves of oil and gas.

"The speed at which technology changes and its consequences have taken us largely by surprise. The peak oil debate, for example, has lost a great deal of its relevance in the past three years," Brufau told the World Petroleum Congress in Doha.

"The possibility that usable resources under commercially viable terms will run out is no longer a concern in the short or medium term," he said.

(Hat tip Professor Mark Perry)

Did the US Bait Japan into Bombing Pearl Harbor?

Today is the 70th anniversary of the infamous Pearl Harbor bombing which paved way for the US to declare war against Japan.

Contrary to mainstream history, the trigger happy US President FDR allegedly provoked Japan to launch the attack.

Writes Patrick Buchanan,

On Dec. 8, 1941, Franklin Roosevelt took the rostrum before a joint session of Congress to ask for a declaration of war on Japan.

A day earlier, at dawn, carrier-based Japanese aircraft had launched a sneak attack devastating the U.S. battle fleet at Pearl Harbor.

Said ex-President Herbert Hoover, Republican statesman of the day, “We have only one job to do now, and that is to defeat Japan.”

But to friends, “the Chief” sent another message: “You and I know that this continuous putting pins in rattlesnakes finally got this country bit.”

Today, 70 years after Pearl Harbor, a remarkable secret history, written from 1943 to 1963, has come to light. It is Hoover’s explanation of what happened before, during and after the world war that may prove yet the death knell of the West.

Edited by historian George Nash, Freedom Betrayed: Herbert Hoover’s History of the Second World War and Its Aftermath is a searing indictment of FDR and the men around him as politicians who lied prodigiously about their desire to keep America out of war, even as they took one deliberate step after another to take us into war.

Yet the book is no polemic. The 50-page run-up to the war in the Pacific uses memoirs and documents from all sides to prove Hoover’s indictment. And perhaps the best way to show the power of this book is the way Hoover does it — chronologically, painstakingly, week by week.

Read the rest here

Japan to Offer Gold Coins to Debt Investors

From the Bloomberg/Businessweek

Japanese Finance Minister Jun Azumi will be rewarding investors who buy reconstruction bonds with half an ounce of gold, an added incentive that could boost the return by nearly six times.

Individual investors who purchase more than 10 million yen ($129,000) in the debt with a 0.05 percent return and keep it for three years will receive a gold commemorative coin weighing 15.6 grams (0.55 ounces), the Finance Ministry said in Tokyo today, worth about $948 based on current prices for the precious metal.

The offer suggests the return could be boosted to 89,000 yen should gold prices remain at current levels, more than the approximate 15,000 yen one would receive from the bond. Azumi, whose hometown was devastated by the March 11 disaster, said today he bought 1 million yen of the debt to support rebuilding efforts from the earthquake and tsunami.

This can be viewed as tokenism—reward for not only buying government debt (thereby keeping politicians happy) but for also keeping them.

Even at the margins, such symbolism may be seen as enhancing gold’s image as safehaven asset. Yet this could serve as more evidence where gold will likely be used as prospective collateral for government/corporate debt issuance.

Lastly, with the rate of currency debauchery being undertaken by global central backs which includes the Bank of Japan, it would not be surprising that the current price differential of the gold 15.6 grams coin ($948) and the 10 million yen debt ($129,000) will most likely narrow overtime.

Chart from ycharts.com

Prices of gold based on the yen has more than doubled over a decade.

Quote of the Day: Austrian Economics in the 20th Century

The big issue of the century in economic theory and economic policy, spanning macroeconomics and microeconomics, was the contest between central planning and markets. Hayek and Ludwig von Mises were by far the most prominent economists who argued long and loud that central planning was disastrous, not just because of the viciousness of communist dictatorships, but because even under ideal conditions it could not generate and use effectively the knowledge necessary to maintain modern standards of living. For a long time they were considered to be naive. As late as 1989, Paul Samuelson was still writing in his best-selling economics textbook, "The Soviet economy is proof that ... a socialist command economy can function and even thrive." About a hundred million people died proving that Karl Marx, his followers, and credulous souls inclined to give central planning the benefit of the doubt, such as Samuelson, were wrong, and that Mises and Hayek were right.

That’s from Kurt Schuler at the Freebanking.org defending Austrian Economics from the tirades of the Keynesian Supremo.

Adding to the contributions of Austrian economics from Professor Peter Boettke here, Professor Russ Roberts here, Greg Ransom here and Bob Wenzel here

When intellectual opponents resort to ad hominem arguments, it is a sign that they can’t deal squarely with issues.

Austrian Economics even in the face of the so-called Keynesian revolution has never been a footnote.

War on Drugs: US Authorities Launder Drug Money, Corruption Risk Increases

In the war on drugs, the dividing line between prosecuting criminals and becoming part of the crime becomes indistinct

From the New York Times (bold emphasis mine)

Undercover American narcotics agents have laundered or smuggled millions of dollars in drug proceeds as part of Washington’s expanding role in Mexico’s fight against drug cartels, according to current and former federal law enforcement officials.

The agents, primarily with the Drug Enforcement Administration, have handled shipments of hundreds of thousands of dollars in illegal cash across borders, those officials said, to identify how criminal organizations move their money, where they keep their assets and, most important, who their leaders are.

They said agents had deposited the drug proceeds in accounts designated by traffickers, or in shell accounts set up by agents.

The officials said that while the D.E.A. conducted such operations in other countries, it began doing so in Mexico only in the past few years. The high-risk activities raise delicate questions about the agency’s effectiveness in bringing down drug kingpins, underscore diplomatic concerns about Mexican sovereignty, and blur the line between surveillance and facilitating crime. As it launders drug money, the agency often allows cartels to continue their operations over months or even years before making seizures or arrests…

It is not clear whether such operations are worth the risks. So far there are few signs that following the money has disrupted the cartels’ operations, and little evidence that Mexican drug traffickers are feeling any serious financial pain. Last year, the D.E.A. seized about $1 billion in cash and drug assets, while Mexico seized an estimated $26 million in money laundering investigations, a tiny fraction of the estimated $18 billion to $39 billion in drug money that flows between the countries each year.

And in the pretext to trap the criminals for evidence, officials themselves induce or encourage the engagement of such ‘criminal’ activities.

Yet the article does not only skim over any potential conflict of interests and the increased possibility of corruption that emerges from the aforementioned police operations, but also ignores the skewed priorities undertaken by officials in following the drug money which leads to more crimes.

Nevertheless what has been obvious is that the war on drugs has been a massive failure. Instead, the war on drugs has resulted to the swelling of the drug trade and surging number of drug related deaths.

Chart from Professor Mark Perry

Drug money laundering by US authorities has corrupted many officials. This can be deduced from the enormous difference between seizures and drug money flows, considering that US narcotics agents have functioned as significant operatives for drug laundering operations.

Corruption is the innate socio-economic response to any prohibition laws, be it drug, alcohol or anti-mining laws or etc…

As Professor Mark Thornton writes, (The Economics of Prohibition, p.131)

Corruption is a function of the price of the prohibited product. As enforcement increases, the price of a prohibited product and the costs of avoiding detection rise relative to the basic costs of production. We should expect that suppliers would be willing to pay to reduce their risk. A higher price involves both a greater risk of apprehension and a greater incentive to provide monetary payments to public officials.

As enforcement increases, the risk of apprehension rises and the quantity of output decreases. The divergence between price and the basic costs of production increases. Increased enforcement therefore increases the ratio of costs of risk to the cost of production. The result is an increased profit opportunity for entrepreneurship in avoiding detection. Many avenues exist by which entrepreneurs can reduce detection risks. They can use faster boats and planes, smaller and easier-to-conceal products, or deceptive packaging. One way to shift the burden of risk is to corrupt the public officials charged with the enforcement of prohibition. As enforcement efforts increase, corruption (like potency) will gain a comparative advantage in avoiding detection over transportation, technology, and deception.

We therefore expect corruption to increase with increased enforcement efforts, whether or not total revenues in the industry increase. This assumes that the underlying demand for the product, penalties for both prohibition and corruption, and the efforts to reduce corruption are held constant.

So the unstated motto of US drug officials seem to be “if you can’t beat them, join them”, just camouflage them with entrapment operations.

Quote of the Day: Entrepreneurship is a Story of Innovation and Creativity

Entrepreneurship is a story of innovation and creativity. One may disagree with the exact terminology (i.e. “discovery”), but the essential point to take away is that entrepreneurship is not a given. It is an act of creation; production is a function of both the physical input of accumulated producers’ goods and human creativity, which is unique to the individual. In Hayekian terms, if we imagine wealth as it exists today as a mass of “known” knowledge, it is the entrepreneur’s role to essentially jump into the sphere of the “unknown.” It is not just about “discovering” what has been as of yet undiscovered, but about adding to the body of knowledge (whether known or unknown).

Excellent excerpt from Jonathan M.F. Catalán at the Mises Blog

Video: Understanding Subjective Value

Professor Don Boudreaux explains subjective value (hat tip Professor Art Carden; Mises Blog)

Is the S&P trying to influence the EU Summit by Warning of Downgrades?

Is the S&P trying to influence the outcome of the EU Summit by warning of Downgrades?

From the Bloomberg,

Standard & Poor’s said Germany and France may be stripped of their AAA credit ratings as the debt crisis prompts 15 euro nations to be put on review for possible downgrade.

The euro area’s six AAA rated countries are among the nations to be placed on a negative outlook, and their credit ratings may be cut depending on the result of a summit of European Union leaders on Dec. 9, S&P said today in a statement. The euro reversed its gains and U.S. Treasuries rose earlier today after the Financial Times reported that the credit-ranking firm planned to reduce six AAA outlooks.

“Systemic stress in the eurozone has risen in recent weeks and reached such a level that a review of all eurozone sovereign ratings is warranted,” S&P said in a statement.

The downgrade warnings come as German Chancellor Angela Merkeland French President Nicolas Sarkozy push for a rewrite of the EU’s governing rules to tighten economic cooperation in a demonstration of unity on ending the debt crisis. With the fate of the currency shared by the 17 euro countries at risk, Merkel and Sarkozy presented a common platform for a Dec. 8-9 summit of EU leaders in Brussels that aims to halt the crisis now in its third year.

In my view, the answer could be yes, S&P may be using to credit rating standings as leverage. The timing of credit rating downgrade puts the S&P’s action in question. Although it seems unclear which agenda the S&P has been pushing.

Nonetheless, S&P’s warnings has lagged what’s been happening in the markets.

Chart from Danske Bank

In other words, the markets has already been downgrading the core Euro bonds, with current relief coming from the ECB’s bond purchases and the facilitation of swap lines from the US Federal Reserve.

How Capital Regulations Contributed to the Current Crisis

At the Wall Street Journal, American Enterprise Institute’s Peter J. Wallison explains how capital regulations are partly responsible for the current mess (bold emphasis mine)

Basel is the Swiss city where the world's bank supervisors regularly meet to consider and establish these rules. Among other things, the rules define how capital should be calculated and how much capital internationally active banks are required to hold.

First decreed in 1988 and refined several times since then, the Basel rules require commercial banks to hold a specified amount of capital against certain kinds of assets. Under a voluntary agreement with the Securities and Exchange Commission, the largest U.S investment banks were also subject to the form of Basel capital rules that existed in 2008. Under these rules, banks and investment banks were required to hold 8% capital against corporate loans, 4% against mortgages and 1.6% against mortgage-backed securities. Capital is primarily equity, like common shares.

Although these rules are intended to match capital requirements with the risk associated with each of these asset types, the match is very rough. Thus, financial institutions subject to the rules had substantially lower capital requirements for holding mortgage-backed securities than for holding corporate debt, even though we now know that the risks of MBS were greater, in some cases, than loans to companies. In other words, the U.S. financial crisis was made substantially worse because banks and other financial institutions were encouraged by the Basel rules to hold the very assets—mortgage-backed securities—that collapsed in value when the U.S. housing bubble deflated in 2007.

Today's European crisis illustrates the problem even more dramatically. Under the Basel rules, sovereign debt—even the debt of countries with weak economies such as Greece and Italy—is accorded a zero risk-weight. Holding sovereign debt provides banks with interest-earning investments that do not require them to raise any additional capital.

Accordingly, when banks in Europe and elsewhere were pressured by supervisors to raise their capital positions, many chose to sell other assets and increase their commitments to sovereign debt, especially the debt of weak governments offering high yields. If one of those countries should now default, a common shock like what happened in the U.S. in 2008 could well follow. But this time the European banks will be the ones most affected.

In the U.S. and Europe, governments and bank supervisors are reluctant to acknowledge that their political decisions—such as mandating a zero risk-weight for all sovereign debt, or favoring mortgages and mortgage-backed securities over corporate debt—have created the conditions for common shocks.

I have explained here and here how Basel capital standard regulations does not address the root of the crisis—fiat money and central banking—and will continue to churn out rules premised on political goals, knee jerk responses to current predicaments (time inconsistent rules) and incomplete knowledge.

A manifestation of the institutional distortions as consequence to regulations which advances political goals can be noted at the last paragraph where US and European governments and bank supervisors are “reluctant to acknowledge that their political decisions”, which have not only “created conditions for common shocks”, but has existed to fund the welfare state and the priorities of political leaders in boosting homeownership ownership which benefited or rewarded the politically privileged banks immensely.

Capital regulation rules will continue to deal with the superficial problems of the banking system which implies that banking crises will continue to haunt us or won’t be going away anytime soon despite all model based capital ratio adjustments. It's been this way since the closing of the gold window or the Nixon shock (see above chart from the World Bank)

Video: Study Praxeology

Learn the fundamentals of Austrian Economics. Start with the science of human action, see video below: (hat tip: lewrockwell.com)

Quote of the Day: How Interventions Destabilizes

The critical issue in both cases is the artificial suppression of volatility -- the ups and downs of life -- in the name of stability. It is both misguided and dangerous to push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability "tail risks" to disappear from policymakers' fields of observation. What the world is witnessing in Tunisia, Egypt, and Libya is simply what happens when highly constrained systems explode.

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to "Black Swans" -- that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

Such environments eventually experience massive blowups, catching everyone off-guard and undoing years of stability or, in some cases, ending up far worse than they were in their initial volatile state. Indeed, the longer it takes for the blowup to occur, the worse the resulting harm in both economic and political systems.

[bold emphasis added]

This one comes from my favorite iconoclast Nassim Taleb (hat tip Zero Hedge).

In short, interventions tends to disturb the natural flow of socio-economic-market systems, which results to unintended build up of destabilizing or unnatural or artificially imposed forces (e.g. economic malinvestments, imbalances in political representation) that eventually gets vented via “Black Swan” events.

This applies whether to financial markets or the political economy.

Russia’s Putin Loses Majority, Resurgence of Communists

Russia’s Vladmir Putin’s leadership appears on the edges.

From Reuters,

Russian voters have dealt Vladimir Putin's ruling party a heavy blow by cutting its parliamentary majority in an election that showed growing unease with his domination of the country as he prepares to reclaim the presidency.

Incomplete results showed Putin's United Russia was struggling even to win 50 percent of the votes in Sunday's election, compared with more than 64 percent four years ago. Opposition parties said even that outcome was inflated by fraud.

Although Putin is still likely to win a presidential election in March, Sunday's result could dent the authority of the man who has ruled for almost 12 years with a mixture of hardline security policies, political acumen and showmanship but was booed and jeered after a martial arts bout last month.

United Russia had 49.94 percent of the votes after results were counted in 70 percent of voting districts for the election to the State Duma, the lower house of parliament. Exit polls had also put United Russia below 50 percent.

And desperation against Putin’s autocratic crony capitalism has fueled the resurgence of communists.

From another Reuters article,

The Communist Party (CPRF) for most Russians evokes images of bemedaled war veterans and the elderly poor deprived of pensions and left behind in a "New Russia" of glitzy indulgence. Large swathes of society have appeared beyond the reach of the red flag and hammer and sickle.

Not that the Communist Party's doubling of its vote to about 20 percent presages any imminent assault on power. The memories of repression in the old communist Soviet Union, the labor camps and the "Red Terror" are still too fresh for many. But vote they did, if perhaps with gritted teeth.

"With sadness I remember how I passionately vowed to my grandfather I would never vote for the Communists," Yulia Serpikova, 27, a freelance location manager in the film industry, told Reuters. "It's sad that with the ballot in hand I had to tick the box for them to vote against it all."

For many Russians disillusioned by rampant corruption and a widening gap between rich and poor, the communists represented the only credible opposition to Putin's United Russia.

For some, desperation means jumping from the frying pan to the fire. The communist resurgence, who seem to base their preference by nostalgia, never seem to realize that Putin has been a product communism who used his position to snare power and to shape the current system.

They should rather realize that economic freedom and free trade will give them more chances of attaining prosperity than to depend on politicians, who will use all sorts of power grabs to enhance their status and privileges at the people’s expense.

Tradeoffs are a fact of life. The choice of politics over markets means greater risks of gaming of the system, corruption, wealth and power inequality, cronyism and poverty. It's a lesson that most people have yet to learn and digest.

Wall Street Journal Cites Austrian Economics in Dealing with China’s Bubble

Austrian economics has slowly but surely been spreading into the mainstream.

From the Wall Street Journal (hat tip Bob Wenzel)

China is a poster child for the Austrian school of economics' theory of the business cycle. After undertaking the biggest stimulus program the world has ever seen in response to the global financial crisis, the country is drowning in unproductive investments financed with credit.

The government spent 15% of GDP largely on public works projects in inland regions, financed with loans from the state-owned banks. Investment as a share of GDP soared to 48.5% in 2010, and the M2 measure of money supply ballooned to 140% that of the U.S.

Now comes the hangover. The public works projects are winding down, unleashing a wave of unemployment and an uptick in social unrest. The banks' nonperforming loans are rising, and local governments are insolvent. The country is littered with luxurious county government offices, ghost cities of empty apartment blocks, unsafe high-speed rail lines and crumbling highways to nowhere.

One effect of negative real interest rates was a nationwide bubble in private housing, with the average price of an urban apartment reaching eight times the average annual income. Real estate is the most popular investment for the wealthy, according to a central bank survey in September. Millions of luxury apartments are vacant, even as there is a shortage of affordable housing for the poor.

Property construction became "the most important sector in the universe," in the words of UBS economist Jonathan Anderson. It directly accounts for about 13% of the economy, 20% if one includes related industries like concrete and steel. It also provided 40% of local government revenues through land sales.

Worsening inflation forced the government to put on the brakes this year. As with most property busts, transactions dried up, followed by a free fall in prices. Land prices were down 60% year on year in September. Property developers are slashing prices of new homes to stave off bankruptcy.

Beijing recognizes the dangers of a property bubble and deliberately popped this one by telling banks to cut back loans to developers. The government seems to be determined to force some of the smaller developers to the wall, both to force consolidation in the industry and convince the remaining developers to get on board with the state-run program of building low-income housing.

Earlier this year banking regulators conducted stress tests that supposedly showed the financial system can withstand a 40% fall in property prices. Loans to developers and mortgages account for about 20% of the banks' loan books. But since the health of the wider economy is tied to property, China could face a scenario close to that of the U.S. in recent years. Because the private market for housing was tiny 10 years ago when the current boom began, the country has never experienced a broad-based decline in property prices.

The government and the more sanguine analysts say low-income housing construction will pick up the economic slack, as activity at the top end of the market contracts. The problem is that even if the government meets its goals, the program is still too small to save the economy. Barclays estimates that it will contribute one percentage point to growth in 2011, and 0.5 percentage points in 2012.

There is no easy way to avoid the bust that is coming. The silver lining is that China's increasingly state-led growth model will be discredited, and a debate will begin on restarting the reforms that stalled in the mid-2000s. A financial sector that allocates credit based on politics rather than price signals led China into this mess. Popular pressure to dismantle crony capitalism is building, and the Communist Party would be wise to get in front of it while it can.

Anyway I have dealt with how China's bubble seems playing right into the Austrian Business Cycle here

Yet Austrian economics gaining mainstream's attention seems another case of Gandhi’s rule:

First they ignore you, then they laugh at you, then they fight you, then you win

Commonsense economics finally gaining ground.