The Suddenness of Inflation

Bloomberg columnist, author and Council on Foreign Relations (CFR) analyst Amity Shlaes warns about the complacency of political authorities over inflation. (hat tip Professor Antony Mueller)

“Sudden” is more like it. The thing about inflation is that it comes out of nowhere and hits you. Monetary policy is like sailing. You’re gliding along, passing the peninsula, and you come about. Nothing. Then the wind fills the sail so fast it knocks you into the sea. Right now, the U.S. is a sailboat that has just made open water, and has already come about. That wind is coming. The sailor just doesn’t know it.

“Sudden” has happened to us before. In World War I, an early version of what we would call the CPI-U, the consumer price index for urban areas, went from 1 percent for 1915 to 7 percent in 1916 to 17 percent in 1917. To returning vets, that felt awful sudden.

The popular mainstream ‘begging the question’ argument on consumer price inflation goes something like this: inflation risk is minimal, because there has been little signs of inflation today.

Present and past actions have been construed as extending to the future, with little regards to the cause-and-effect relationship from implemented policies such as money printing or zero bound rates. In reality, these arguments have been pushed to justify more inflationist-interventionist policies: No inflation? Have more inflation.

Yet like natural disasters, inflation wreaks havoc at the least expected moments.

The volatile episodes of US CPI inflation coincided with wars (World War I, World War II and the Vietnam War). (chart from tradingeconomics.com)

In a relative sense, today’s US CPI inflation environment has been ‘calmer’ than the current periods. Even if the US has been engaged in numerous imperialist wars, along with the huge welfare state that substantially contributes to the ballooning record fiscal or budget deficits. (chart from the Heritage Foundation)

chart from Cleveland Federal Reserve

And this comes amidst the exploding balance sheet of the US Federal Reserve. The US Federal Reserve has topped China as the largest owner of US treasuries, which means that the US central bank has become the key source of financing for the US government.

And these banking based financing of public expenditures are inflationary. The great Murray N. Rothbard explained

Deficits mean that the federal government is spending more than it is taking in in taxes. Those deficits can be financed in two ways. If they are financed by selling Treasury bonds to the public, then the deficits are not inflationary. No new money is created; people and institutions simply draw down their bank deposits to pay for the bonds, and the Treasury spends that money. Money has simply been transferred from the public to the Treasury, and then the money is spent on other members of the public.

On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money, in the form of bank deposits, is then spent by the Treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately $10 billion of old Treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by ten times that amount. In short, the government and the banking system it controls in effect "print" new money to pay for the federal deficit.

Thus, deficits are inflationary to the extent that they are financed by the banking system; they are not inflationary to the extent they are underwritten by the public.

While we cannot exactly predict exactly when CPI inflation is bound to hit the US economy, given the recent actions by the US Federal Reserve and US Federal government, we understand though that inflation will eventually rear its ugly head.

The question is a WHEN rather than an If. And to what degree of inflation.

And worst, since the world has operated on a monetary standard based on the US dollar, the effects of US inflation will be worldwide.

The basis for such prediction is our theoretical understanding of the 3 stages of inflation

As the great Ludwig von Mises pointed out, (bold highlights mine)

In the early stages of an inflation only a few people discern what is going on, manage their business affairs in accordance with this insight, and deliberately aim at reaping inflation gains. The overwhelming majority are too dull to grasp a correct interpretation of the situation. They go on in the routine they acquired in non-inflationary periods. Filled with indignation, they attack those who are quicker to apprehend the real causes of the agitation of the market as "profiteers" and lay the blame for their own plight on them. This ignorance of the public is the indispensable basis of the inflationary policy. Inflation works as long as the housewife thinks: "I need a new frying pan badly. But prices are too high today; I shall wait until they drop again." It comes to an abrupt end when people discover that the inflation will continue, that it causes the rise in prices, and that therefore prices will skyrocket infinitely. The critical stage begins when the housewife thinks: "I don't need a new frying pan today; I may need one in a year or two. But I'll buy it today because it will be much more expensive later." Then the catastrophic end of the inflation is close. In its last stage the housewife thinks: "I don't need another table; I shall never need one. But it's wiser to buy a table than keep these scraps of paper that the government calls money, one minute longer."

A fundamental example has been the most recent bout of hyperinflation which buffeted Zimbabwe’s economy during the last decade, which I posted three years back.

When inflation strikes, it slams like a tidal wave. Zimbabwe’s hyperinflation produced a hockey stick like effect, similar to Weimar Germany’s experience.

While the risk of hyperinflation is not yet imminent, if the current path of inflationist policies is sustained, then this would enhance the probability of such a risk.

Why Socialists Hate the Internet

Writes Mary O’Grady at the Wall Street Journal, (bold emphasis mine) [hat tip Mark Perry]

'There's a reason the people in Cuba don't have access to the Internet. It is because the government [couldn't] survive it."

That was Florida Sen. Marco Rubio last week at a Washington conference titled "Cuba Needs a (Technological) Revolution: How the Internet Can Thaw an Island Frozen in Time." The event was sponsored by Google Ideas, a for-profit venture of the giant Internet search enterprise, and the nonprofit Heritage Foundation. I was asked to kick off things with a Rubio interview. So I began by asking him what he makes of the Cuban military's reference last year to technology that allows young people to exchange thoughts digitally as "the permanent battlefield."

Mr. Rubio responded that it isn't communication with the outside world that the regime fears the most, but Cuban-to-Cuban chatter. "I think Raúl Castro clearly understands that his regime cannot survive a Cuban reality where individual Cubans can communicate [with] each other in an unfettered manner." He called "unfiltered access to the Internet and social media" Cuba's "best hope" of avoiding "a stagnated dictatorship" for "the next 50 years that would survive even the death of Raul and Fidel."

The internet or the information age isn’t just about connectivity though. Rather the age of the internet is about the knowledge revolution or democratization of knowledge through “geographically noncontiguous communication” as author Jeffrey Tucker recently described.

The information age brings about unfettered opportunities to learn or to expand one’s horizon of wisdom. Say for instance anyone who wants to access literatures from libraries around the world may try openlibrary.org.

How about basic materials for self learning or home schooling? You may also try the revolutionary Khan Academy.

The political power of despots and their socialists supporters principally derives from ignorance. This is why the public has been vulnerable to fear and to mind manipulation—via indoctrination and propaganda.

People hardly realize that conventional education, for instance, has been surreptitiously designed for the worship of the state. The internet brought me to this reality and made me an apostate to the religion of the state.

The internet essentially provides the platform for the unceasing struggle to attain civil and economic liberties, through the effective neutralization of political manipulations of the people’s minds.

The chief proponent and inspiration of nonviolent resistance and civil disobedience, the great philosopher anarchist Étienne de La Boétie once wrote,

Obviously there is no need of fighting to overcome this single tyrant, for he is automatically defeated if the country refuses consent to its own enslavement: it is not necessary to deprive him of anything, but simply to give him nothing; there is no need that the country make an effort to do anything for itself provided it does nothing against itself. It is therefore the inhabitants themselves who permit, or, rather, bring about, their own subjection, since by ceasing to submit they would put an end to their servitude. A people enslaves itself,
cuts its own throat, when, having a choice between being vassals and being free men, it deserts its liberties and takes on the yoke, gives consent to its own misery, or, rather, apparently welcomes it. If it cost the people anything to recover its freedom

Thus enslavement and freedom is a matter of people’s choice. And the state of knowledge or ignorance by every individual in a society determines that choice.

The more the diffusion of knowledge in a society, the balance of power shifts towards individual sovereignty at the expense of political entities.

And that’s why welfare warfare based governments have been averse to the internet, and that’s why political authorities will continue to wage an all out war of control of the internet.

Phisix: Massive Global Credit Easing Policies Means Short Term Profit Taking

Economic weakness of China and of high oil prices, which supposedly threatens global economic growth, has been attributed by media as the cause for this week’s anemic performance by global stock markets[1].

The Perils of Relying on Media’s Availability Heuristics

It’s has been the intuitive inclination of media to oversimplify the causation process in the narration of events. In reality, such oversimplification represents the available bias or availability heuristic—judgment based on what we can remember, rather than complete data[2] or the fallacy of attributing current events to most recent market actions—than about the real forces driving the market’s action.

And applying heuristics to market analysis can lead one astray, and thus, amplifies the odds of erroneous decision making. One of Warren Buffett’s most precious investment advice has been

Risk comes from not knowing what you're doing.

This applies to sloppy thinking based on heuristics.

Financial markets rarely moves in a straight line.

If they do, then markets must be experiencing an episode of extreme stress, symptomatic of the ventilation of acute systemic imbalances on the marketplace. They appear in the form of a blowoff phase (climax) of a bubble cycle or of hyperinflation in motion.

Yes, stock markets soar to the firmament during episodes of hyperinflation. Although whatever gains seen is largely illusory as the local currency, enduring hyperinflation, depreciates so much faster than the nominal price gains in stock market values.

Zimbabwe which suffered from hyperinflation just a few years back saw its stock markets zoom[3], so as with the German stock market[4] during the horrific days of the Weimar hyperinflation.

Here, the role of stock markets shifts from intermediaries of capital to a monetary lightning rod. Of course, this cannot be explained by the orthodoxy of earnings or corporate fundamentals, since the public’s flight to safety motives has been driven by the desire to protect one’s wealth through ownership of real assets.

As one would note, stock markets becomes the fiduciary alternative to money under such conditions.

Yet in a normal bullmarket (or boom phase of a credit driven bubble cycle), intermittent profit taking sessions should be expected. This is where profit taking sellers of financial securities overwhelm the buyers that result to countertrend price actions. Nevertheless, financial markets tend to move in a general direction (uptrend, consolidation or downtrend) for a given period of time, despite interim countercylical fluctuations.

The pulsating surge of key global equity benchmarks suggests that this week’s retracement represents more of a profit taking process than signs of anxiety, where the losses (left window) have hardly dented on the enormous nominal local currency gains posted by the bellwethers of major economies since the start of the year (right window).

The US S&P 500 posted its second weekly loss in 12 weeks into 2012, while the Germany’s Dax, Japan’s Nikkei and the Philippine Phisix had 3 non-consecutive weekly losses. So far this translates to 1 week loss for every 3 weeks of gains for the latter 3 and 1 loss for every 5 weeks of gain for the S&P. Of course past performance is no guarantee for future outcomes.

In addition our ASEAN neighbors, Indonesia and Malaysia whom has largely missed the recent bullrun seems to defy last week’s profit taking mode. Instead they have posted modest gains, which in essence, incrementally closes on the gap between the region’s leaders the Philippines and Thailand and the laggards.

Moreover, Thailand has finally caught up with the Phisix.

So if we are seeing a rotational process among sectors and in the PSE and issues within specific sectors, then we seem to see the same process at work in global equity benchmarks.

The rotation in relative performances has been symptomatic of an inflationary boom.

As for media’s narrative, one week does not a trend make.

Huge Credit Easing Policies Means Profit Taking Will Be Short Term

If we examine the chart patterns of US equities, they seem to imply that this week’s profit taking mode might be extended.

And this could coincide with a breakdown of the ascending wedge pattern of the S&P 500 below.

Aside from the S&P, the Dow Jones Industrials and the Nasdaq chart patterns seem to tell the same tale.

What makes charts occasionally credible is that many believers can make such patterns a self-fulfilling process over the short run. And perhaps they can be augmented or complimented by trades based on algorithm or computer programs, which buy or sell triggers have been programmed to activate based on specific data points derived from chart patterns and or their corresponding indicators.

Yet any such breakdown could see some support at the 1,350 area. From Friday’s close, a downside move to this level will translate to about 3.3% retracement.

Yet chart patterns of the Philippine Phisix reveals of a subtle difference compared to the US benchmarks.

The Phisix seems to be partly in a symmetrical triangle—fundamentally this is a trend neutral pattern, which either signals continuity or a reversal[5]. Yet the recent double bottom pattern breakout also seems to suggest of a fresh upside trend at work. The implication is that any correction may be short term and shallow.

The Phisix and the S&P has had loose correlations from the last quarter of 2010 until late last year, where there had been numerous accounts of divergent actions between the two bourses. As a reminder, divergence does not represent decoupling.

Their correlations seemed to have tightened only from last October, where the combined actions of major central banks have forcibly led to major short coverings, as well as, yield chasing arbitrages that has painted an aura of ‘recovery’ as evidenced by resurgent global markets.

Another important reminder is that it is a misguided notion to assume that the current financial market developments have entirely been about ‘liquidity’.

Since 2008, political actions have included the widespread alteration of the rules of the game (such as changes in accounting rules[6], easing of collateral requirements[7], indiscriminate changes in the rights of private ownership to sovereign debt[8], arbitrary determination of credit event conditions for derivatives contracts[9]), direct and indirect bailouts, guaranteeing access to credit, implicit and explicit guarantees on assets, manipulation of the yield curve, interest rate payment on excess reserves, market making, buyer of last resort, lender of last resort, and etc..., has not only been about liquidity (liquefying of illiquid assets) but about arbitrary interventions in various forms and degree. In short, today’s financial markets have massively been in violation of various forms property rights of the private sector to the benefit of the banking system and the welfare state.

The mass politicization of the markets has been distorting price signals and has been misdirecting the allocation of resources. The piper in the fullness of time will be paid.

And given that the gist of the current tidal wave of major central asset purchasing programs have only been announced and put into action last month (such as ECB’s LRTO[10]), the effects of these massive cash infusions, compounded by the policy trends to adapt a negative rate regimes for many major emerging markets will likely put a floor on any recent corrections.

Thus it is unclear if the adverse signal emitted by these chart patterns, possibly signifying an extension of the corrective phase, will play out. And even if it does, any correction will likely be shallow.

Market Internals Reveal Profit Taking and Rotational Process

Yet market internals of the Phisix still exhibits some positive signs despite this week’s hefty correction.

True, decliners led advancers, but the spread between them has not deteriorated in a panic stricken scale as the previous sell-offs.

Moreover, of the 12 Phisix heavyweights representing 67% of the free float market cap last Friday, 3 posted gains and provided cushion to the index, specifically, Alliance Global [PSE:AGI], SM Investments [PSE: SM] and Bank of the Philippine Islands [PSE: BPI].

Meanwhile all the rest of the biggest caps posted losses led by SM Prime Holdings [PSE: SMPH], Philippine Long Distance Telephone [PSE:TEL], market leader Ayala Land [PSE:ALI] and Banco de Oro [PSE: BDO], all of which weighed on the index.

The decline as seen by the Phisix biggest market caps have equally been mirrored on the sectoral performance.

Again, we note that the mining index appears to have regained some appeal as many of the majors fell.

Finally foreign trades posted hefty net selling this week amidst a largely unchanged Peso.

But this came on the heels of the completion of the sale Alaska Milk Corporation[11] [PSE:AMC] from the seller, the Uytengsu family to the new owners the Dutch dairy giant Royal Friesland Campina for Php 12.86 billion.

My puzzle is that the buyer was a foreign group but the seller was a local group yet during the date of execution of the AMC trade, net foreign trade showed net selling almost to the tune of the AMC transaction.

Perhaps the foreign group incorporated a local company to execute the transaction, while the selling group, the Uytengsus’ equity ownership had been divested through a holding company incorporated abroad.

This could be another example of the inaccuracy of statistics which fails to capture the real developments behind each transaction.

The Political Imperative to Inflate the System

Bottom line: It is really very difficult to predict short term moves.

Nevertheless my basic premise still holds, the recent actions of major central banks combined with negative interest rate policy regime by the Philippine central bank, the BSP, as well as other emerging markets, will impact stock markets over the 3-6 months window as it has done before[12]. Most likely, we may see renewed selling pressures as these steroids come to a close.

Manipulating the financial markets including the stock markets has been part of the Bernanke’s doctrine[13] to save the banking system and indirectly to finance the welfare state. And the Bernanke creed seems to have been imbued as the de facto global policy handbook for central bankers.

And hawkish overtones[14] by some members of the US Federal Reserve or the ECB[15] may change as quickly, as so required by political exigency, especially when faced with the reemergence of selling pressures.

It would take a really big and nasty surprise and an equally static or passive or non response by central bankers to such event for the markets to feel pressure again.

And the only thing that may demobilize central bankers will be massive price inflation. As for politics, the arcane world of central banking has so far eluded the scrutiny of the benighted public.

---

[1] Businessweek.com Mounting global growth concerns push markets lower, March 23, 2012 Associated Press

[2] Changingminds.org Availability Heuristic

[3] Koning John Paul Zimbabwe: Best Performing Stock Market in 2007? April 10, 2007 Mises.org

[4] Nowandfutures.com Germany, during the Weimar Republic & the hyperinflation

[5] Incrediblecharts.com Triangles and Wedges

[6] Wikipedia.org Effect on subprime crisis and Emergency Economic Stabilization Act of 2008 Mark to Market Accounting

[7] The Euro Crisis Amidst the Cheer, Could the LTRO Be Storing Up Problems for Later?, February 29, 2012 Wall Street Journal Blog

[8] Kotok David R. Moral Hazard-CAC Cumber.com, February 23, 2012

[9] Reuters.com Deeper Greek losses 'unlikely' to trigger CDS -ISDA, October 27, 2011

[10] Weekly Focus, Concerns about fragile global recovery March 23, 2012 Danske Research

[11] Business.inquirer.net Uytengsus complete sale of Alaska Milk stake March 21, 2012

[12] Zero Hedge, Operation Twist Is Coming To An End: A Preview Of The Market Response March 19, 2012

[13] See US Stock Markets and Animal Spirits Targeted Policies, July 21, 2010

[14] Bloomberg.com Fed’s Bullard Sees Price Threat From G-7 Delaying Tighter Policy, March 23, 2012

[15] Bloomberg.com Asmussen Says ECB Must Start to Prepare Exit, Die Zeit Reports, March 21, 2012

Signs of Intensifying Political Woes in China?

Is it really China’s growth story that has distressed the markets as alleged by media?

Let us further examine what media imputes as the cause of this week’s profit taking—a purported slowdown of China’s economy

While recent economic data may have been a valid bearer of bad news, correlation does not necessarily translate to causation.

Movements of the China’s Shanghai index (right window) have not aligned with the motions of the China’s industrial production index (left window; blue line) which seesawed throughout 2010-2011.

In addition, the vigorous rally by the Chinese equity benchmark this year seems to have little relevance with the movement of the (HSBC PMI Index) manufacturing survey and of the ex-post statistical data.

China bulls have been arguing the case that the Chinese government would ease further[1] given the ‘moderating’ pace of price inflation attendant to the current slowdown. And they just may be right.

Almost as reports came where manufacturing in China’s economy contracted for the fifth month[2], the Chinese government selectively cut reserve requirements[3] for the Agricultural Bank of China, to supposedly boost rural credit.

With emergent signs of heightened political risks, a full blown economic crisis would magnify the prospects of a potential upheaval, which should compel authorities to resort to magical tricks by resorting to monetary palliatives.

Incipient signs political destabilization may have resurfaced. Aside from previous instances of riots[4], rumors swirled on the cyberspace of a coup attempt following the removal[5] of the Communist Party’s Chongqing city head Bo Xilai from his post as his deputy and has reportedly sought asylum in the US.

The rumors have been censored and have been temporarily concealed from the public.

But markets may have been exhibiting otherwise. China’s credit default swap or the cost of insuring China’s debts rose significantly the highest in four months[6] The Shanghai index staggered to close the week down 2% despite the monetary easing policies.

Nonetheless this is a revelation that there may have been intensifying political tensions from an ongoing ideologically based power struggle[7].

Entrepreneurs seem to have been gaining political clout in China, enough to exert influence on Communist party members to call for economic reforms based on liberalization.

Bottom up forces have been vastly eroding the command and control politics and thus the ideologically based political infighting.

As I said last October[8], China represents as my potential black swan (low probability high impact event). The risks from China’s unique political economic conditions have been substantially underrated. China, for me, has greater immediate term risk relative to that of the US or the EU, where political authorities of the latter seem to be working in close collaboration.

It should be noted that the political spectrum of the EU and the US seem to be deeply intertwined (e.g. Mario Draghi is a Goldman Sachs alumnus[9]) and has been manifested through revolving door relationships[10]. In short, vested interest groups through captured political authorities can coordinate policies, to the extent where the adverse effects from such policies may be deferred.

It’s a lot different in China.

China’s copycat of western Keynesian policies have led to massive internal bubbles, blatant misreporting of issued loans and financial innovative arbitrages by the political class, particularly the local governments, whom has circumvented party regulations by setting up 6,000 finance companies to raise funds for public works[11].

The negative effects of such top down policies have not only bred corruption, it has sown political conflicts which run the risks of escalation and transition to violent political uprisings.

The bottom line is that China’s behind the scene political struggles have been seeping out into the public and will be manifested through price signals in the marketplace, despite repeated attempts by political authorities to expurgate such developments.

This should be monitored closely.

Until further evidence shows of a serious deterioration of China’s political conditions, then my assumption would remain transfixed towards the politicized nature of today’s global marketplace which has been designed to support financial markets for the benefit of the banking system and the welfare state.

As for media, they could be looking at the wrong angle.

---

[1] US Global Investors Investor Alert - Appreciating China to its Fullest, March 9, 2012

[2] Bloomberg News China Manufacturing Contraction May Worsen, HSBC PMI Shows Bloomberg News March 22, 2012 SFGate.com

[3] Nasdaq Brace for more stimulus: Central Bank of China slashes reserve requirements, March 22, 2012

[4] See Does Growing Signs of People Power Upheavals in China Presage a ‘China Spring’? September 26, 2012

[5] The Economic Times, Censors block online rumors about coup as China battles infighting within ruling party March 24, 2012

[6] Thestandard.com.hk Business as usual after coup rumors spark jump in credit-default swaps March 22, 2012

[7] See China’s Coup Rumors: Signs of the Twilight of Centralized Government? March 22, 2012

[8] See Can China’s Slowdown Trigger a 1987 moment? October 23, 2011

[9] See ECB’s Mario Draghi’s Baptism of Fire: Surprise Interest Rate Cut, November 4, 2011

[10] Corporate Europe Observatory Block the revolving door, November 23, 2011

[11] Bloomberg.com China Banks Said to Underestimate Local Government Risks March 24, 2012

Graphic: The Virtue of Failure

The incredibly creative Ms. Jessica Hagy has a great illustration of what I have been lately discussing about as the virtues of failure (which she calls 2nd (and 3rd, and 4th) chances are vital)

Bottom line: Failure, generally, brings about improvisation via learning.

(of course there will always be exception to the rule—as some people adamantly refuses to learn from repeated failures, mostly political authorities and their zealots. Albert Einstein called this insanity—doing the same thing over and over again and expecting different results.)

Quote of the Day: How the Information Age has been Enriching People’s Lives

This is a rather long but substantially insightful excerpt from Jeffrey A. Tucker of Laissez Faire books on the unquantifiable benefits of the information age. [bold emphasis mine]

The most difficult-to-quantity aspect of digital media has been its contribution to the sharing of ideas and communication throughout the world. This has permitted sharing and learning as never before, and this might be the single most productive activity in which a person can participate. The acquisition of information is the precondition for all investing, entrepreneurship, rational consumption, division of labor and trade.

Step back and consider what a revolution this truly is. From the beginning of history until the 19th century, information could travel only as fast as we could run, walk or sail. There were also smoke signals, carrier pigeons, putting notes in bottles, waving lanterns in windows and the like. Finally, in the 1830s -- extremely late in a vast and grueling history in which humanity languished in poverty and sickness without knowledge broader than the immediate surroundings -- we saw the beginnings of modern communication with the glorious invention of the telegraph.

Here we had, for the first time, the emergence of geographically noncontiguous communication. People could find out more about what was going on in the world beyond their immediate vicinity, and that has had amazing implications for everyone engaged in the grand project of uplifting humanity. What could people then share? Cures, technologies, resource availability, experiences and information of all sorts.

This is also the period when we saw the first signs of the modern world as we know it, with a rising global population, extended lives, lower infant mortality and the creation and rapid increase of the middle class. Communication is what signaled people about new possibilities. From there, we saw huge advances in metallurgy, medicine, sanitation and industry. Then followed expansions of income; the division of labor; transportation via railroads; and, eventually, more of the thing that really matters: ever-better ways to share information and learn from others through telephones, radios and televisions.

But then 1995 represented the gigantic turning point in history. This was the year when the Web browser became widely available and the Internet opened for commercial purposes. It's remarkable to think that this was only 17 years ago. Unimaginable progress has taken place since then, with whole worlds being created by the day, all through the wondrous, spontaneous order of global human interaction in an atmosphere of relative laissez-faire. This was the beginning of what is called the digital age, the period of global enlightenment in which we find ourselves today.

And what gave it to us? What made it possible? This much we know for sure: The government did not make this possible. The forces of the marketplace caused it to come into being. It was the creation of human hands through the forces of cooperation, competition and emulation.

This alone refutes the common lie that the free market is all about private gain, the enrichment of the few. All these technologies and changes have liberated billions of people around the world. We are all being showered with blessings every hour of the day. Yes, some people have gotten rich -- and good for them! -- but all the private gain in the world pales in comparison with what digital commerce has done for the common good.

Yes, of course, we take it all for granted. In one sense, it has all happened too fast for us to truly come to terms with this new world. There is also this strange penchant human beings have for absorbing and processing the new and wonderful and then asking just as quickly, "What's next?"

No amount of empirical work can possibly encapsulate the contribution of the Internet to our lives today. No supercomputer could add it all up, account for every benefit, every increase in efficiency, every new thing learned that has been turned to a force for good. Still, people will try. You will know about their claims thanks only to the glorious technology that has finally achieved that hope for which humankind has struggled mightily since the dawn of time.

In short, the information age has been democratizing and fueling the knowledge revolution—a revolution that is bound to empower entrepreneurs and would topple 20th century vertically top-down structured (public and private) organizations and institutions.

Shale Oil Revolution: (Laissez Faire) Capitalism Deals Peak Oil a Fatal Blow

I used to believe in peak oil. That all changed when I got immersed in Austrian school of economics. I have come to realize that we are dynamic, and not static, beings whose actions are driven by time and value scale based incentives in response to the changes in the environment and to social developments. In other words, human action is what drives economic values of goods or services.

And given the opportunity or the right environment or a society tolerant for experimentation that rewards success and penalizes failure, people will find ways and means to employ resources in a more efficient manner in order to improve on our current unsatisfactory conditions.

“Peak oil” as a social phenomenon, and not in the engineering sense, is about to be vanquished [unless socialists cloaked as environmentalists succeeds to put a political kibosh on this sunshine industry].

The phenomenal pace of advances in engineering technology has been intensifying the Shale Oil Revolution

From the New York Times Green Blog, (bold emphasis mine) [hat tip Professor Mark Perry]

The revolution in production in Texas and across the country is partly tied to the rising price of oil over much of the last decade, which propelled aggressive technological experimentation and development. (Government encouragement over the last several administrations helped as well.)

Horizontal drilling and hydraulic fracturing have been around for years, but over the last five years, engineers have fine-tuned these and other techniques, even as many environmentalists worry about their impact on water and air.

Computer programs have been developed to simulate wells before they are even drilled. Advanced fiber optics permit senior engineers at company headquarters to keep track of drillers on the well pad, telling them when necessary where to direct the drill bit and what pressure to use in injecting fracking fluids. Seismic work has become far more sophisticated, with drillers dropping microphones down adjacent wells to measure seismic events resulting from a fracking job so they can more accurately determine the porosity and permeability of rocks when they drill nearby in the future.

Just a decade ago, complete wells were fracked at the same time with millions of gallons of water, sand and chemical gels. Now the wells are fracked in stages, with various kinds of plugs and balls used to isolate the bursting of rock one section at a time, allowing for longer-reaching, more productive horizontal wells. A well that once took two days to drill can now be drilled in seven hours.

For instance, when the Apache Corporation began drilling in the 100,000-acre Deadwood field in the West Texas Permian basin in 2010, there had only been a trickle of production there. The deep shale, limestone and other hard rocks had potential, but for years they had not been considered economically viable. The rocks were so hard, they would have likely sheared off the usual diamond cutters on the blade of any drill bit attempting to cut through.

But new adhesives and harder alloys have made diamond cutters and drill bits tougher in recent years. Meanwhile, Apache experimented with powerful underground motors to rotate drilling bits at a faster rate. Now, a well that might have taken 30 days to drill can be drilled in just 10, for a savings of $500,000 a well.

“By saving that money, you can spend more on fracking, which translates into more sand and more stages and better productivity,” said John J. Christmann, the Apache vice president in charge of Permian basin operations.

All these serves as empirical evidence of how the price signaling channel sets in motion entrepreneur’s incentives to fulfill market demands through the employment of savings or capital accumulation in shaping the fantastic advances in technology (in spite of the numerous government interventions) in a market economy.

As the great Professor Ludwig von Mises wrote,

What distinguishes modern industrial conditions in the capitalistic countries from those of the precapitalistic ages as well as from those prevailing today in the so‑called underdeveloped countries is the amount of the supply of capital. No technological improvement can be put to work if the capital required has not previously been accumulated by saving.

Saving—capital accumulation—is the agency that has transformed step by step the awkward search for food on the part of savage cave dwellers into the modern ways of industry. The pacemakers of this evolution were the ideas that created the institutional framework within which capital accumula­tion was rendered safe by the principle of private ownership of the means of production. Every step forward on the way toward prosperity is the effect of saving. The most ingenious technological inventions would be practically useless if the capital goods required for their utilization had not been accumulated by saving.

The entrepreneurs employ the capital goods made available by the savers for the most economical satisfaction of the most urgent among the not-yet-satisfied wants of the consumers. Together with the technologists, intent upon perfecting the methods of processing, they play, next to the savers themselves, an active part in the course of events that is called economic progress. The rest of mankind profit from the activities of these three classes of pioneers. But whatever their own doings may be, they are only beneficiaries of changes to the emergence of which they did not contribute anything.

The characteristic feature of the market economy is the fact that it allots the greater part of the improvements brought about by the endeavors of the three progressive classes—those saving, those investing the capital goods, and those elaborating new methods for the employment of capital goods—to the nonprogressive majority of people. Capital accumulation exceeding the increase in population raises, on the one hand, the marginal productivity of labor and, on the other hand, cheapens the products. The market process provides the common man with the opportunity to enjoy the fruits of other peoples’ achievements. It forces the three progressive classes to serve the nonprogressive majority in the best possible way.

As seen from the shale oil revolution, the illustrious economist Julian Simon has been right anew, human beings have indeed been the ultimate resource.

Buy Low, Sell High the Euro Crisis

Daily Reckoning’s Chris Mayer opines that the Eurozone crisis is a golden opportunity for investors because it represents “the biggest firesale in history”

Mr. Mayer writes,

Europe’s banking sector holds 2½ times as many assets as the U.S. banking sector. It’s huge. And it’s in big trouble. Europe’s banking sector needs cash — mountains of cash.

As a result, it will have to sell more than $1.8 trillion of assets, which will likely take a decade to work through. For perspective, it sold only $97 billion from 2003–10. “The list of asset sales is the longest I’ve seen in 10 years,” says Richard Thompson, a partner at PricewaterhouseCoopers in London. Knowing how these things work, the final tally could well be double that. The world has never seen anything this big before.

Where will the cash come from?

This is our opportunity. There is no better, more-reliable way to make money than to buy something from someone who has to sell. Bankers are the best people in the world to buy from. Believe me, I know.

I was a vice president of corporate banking for 10 years before I started writing newsletters in 2004. I would get at least three or four requests every year from some investor group asking if we had any assets we were looking to unload. Why? Because they know banks are stupid sellers…

But institutionally, banks can’t really hold bad debts for long. As soon as they report a big bad debt on a quarterly financial statement, some annoying things happen. It means they have to put aside more capital for this particular loan, which they hate to do, as it lowers profitability and requires a lot of paperwork. It can raise the attention of regulators, which banks hate. It can raise shareholder suspicions about lending practices, which banks hate. So the usual way to deal with bad debts is to clear ’em out as fast as possible. (Unless you’re swamped with bad debts in a full-blown crisis, in which case you try to bleed them out and buy time to earn your way out, and/or patch them up as best you can to keep up appearances while you pray for a miracle — or a bailout.)

With the EU banking sector loaded with trillions of stuff it must sell, the mouths of knowing investors drool with money lust.

The fundamental universal concept discussed above is “buy low, sell high”.

And bursting bubbles or bubble busts have presented as great windows of opportunities to acquire assets at bargain basement prices or at fire priced sale that should signify best value for one’s money (whether for investment or for consumption).

But it takes tremendous self-discipline to go against the crowd, to shun short term temptations, and to patiently wait for opportunities like these. And it also takes prudence and emotional intelligence to adhere to Warren Buffett’s popular aphorism of “be fearful when others are greedy and greedy when others are fearful”.

There is another major or important implication from the article above. The Euro crisis is far far far from over. And so with the US banking system (although to a much lesser degree relative to the Eurozone)

Euro banks have only sold a speck or a fraction of what has been required ($97 billion of $1.8 trillion) to cleanse their balance sheets to restore a sense of normalcy in their banking system.

This only means that the political path will come from one of the two options:

One, central banks, particularly the ECB, possibly in conjunction with the US Federal Reserve, will have to persist in massively inflating the system in order to prevent the markets from clearing. The policy of deferment (as seen today) allows for the banking system to gradually dispose of their assets at artificially inflated prices…

Otherwise, the second option means facing the consequence of a banking system meltdown, which should ripple to the welfare state—an option, which so far, has been sternly avoided by incumbent political authorities.

Of course, politicians and the vested interest groups have been hoping that economic growth will eventually prevail that would help resolve the crisis.

But this is wishful thinking as the direction of political actions, purportedly reform the political economies of crisis stricken nations, has little to do with promoting growth but to transfer resources from the public to the politically protected banking system.

Austerity has been a fiction peddled by the left.

chart from Bloomberg

Central bank assets have soared to uncharted territories, as taxes and numerous restrictive trade regulations have been imposed, while price inflation has been percolating through the system.

chart from tradingeconomics.com

In short, the fire sale of assets from Eurozone’s crisis afflicted banking system has yet to come.

And we should first expect more central banking interventions that would amplify such an outcome.

And I’d further state that the boom bust cycle fostered by global negative real rates environment will lead, not only to fire sales of financial assets to the Eurozone, but across the world—in the fullness of time.

Gold is Money: Turkey Edition

While Ben Bernanke and his ivory tower based cohorts do not treat gold as money, for the average Turks, gold is money.

From the Wall Street Journal,

The Turkish government, facing a bloated current-account deficit that threatens to derail the country's rapid expansion, is trying to persuade Turks to transfer their vast personal holdings of gold into the country's banking system.

The push to tap into the individual gold reserves—the traditional form of savings here—is part of Ankara's efforts to reduce a finance gap that is currently about 10% of gross domestic product.

Government officials say the banking regulator will soon publish a plan to boost incentives for consumers to park their household wealth inside the financial system. Banking executives said they are considering new interest-yielding gold-deposit accounts that would allow savers to withdraw gold bars from specially designed automated teller machines.

The moves come after the central bank in November announced that lenders could hold up to 10% of their local-currency reserves in gold, in part to tempt Turkey's gold hoarders to deposit their jewelry, coins or bullion at banks.

Economists say the policy shift is designed to change Turks' historic preference for storing a high percentage of personal wealth outside the banking system as a way to protect themselves against the economic volatility that has periodically hit Turkey in recent decades.

The effort is one front in a broader battle to encourage more savings while curbing the ballooning current-account deficit—a pressure point many investors fear could upend a fast-growing economy, estimated to have expanded more than 8% last year. Turkey's current-account gap has expanded faster than expected in recent weeks amid a surge in oil prices and data showing unexpectedly high consumer demand.

"Turkey has historically been hit by crises and inflation, so the tradition of holding gold outside the system could be hard to shift," said Murat Ucer, an economist at Global Source Partners, an Istanbul-based research consultancy.

The size of the gold haul stored outside Turkey's banking system is hard to quantify; no data reliably capture the scale of the informal economy. The Istanbul Gold Refinery estimates the figure at 5,000 metric tons, valued at $270 billion. Recent numbers show many consumers have boosted home-held deposits even as the country's tightly regulated banking system won plaudits for comfortably weathering the financial crisis.

Unlike India, whom recently announced plans to raise import duties on gold imports, Turkey’s government either has not yet reached a point of desperation to impose political controls over gold trades, or that they have come to realize of the futility of imposing antagonistic and oppressive policies. Instead, the Turkish government has, so far, resorted to wooing or appealing to the public to help the government.

However, I am inclined to the view that this as an initial or temporary step before any imposition of political controls. With institutional violence under their control (police or military power), the temptation to use force through tax or administrative policies will always be there.

It is also very important to note of how gold has served as insurance against political control via the banking system. It would appear that the average Turks, basically don’t trust the banking system, and thus keeps their savings in gold and stashed away from the prying eyes of political authorities. The average Turks, I presume, perhaps (culturally) understands that through the banking system, their savings or wealth could be faced with greater risks of confiscation through various political means as taxation.

Nevertheless this is a good remainder of the distinction between the world as seen by politicians and bureaucrats and of reality (which reflects on people’s sense of values.)

This quote, which I earlier blogged, attributed to Mr. Janos Feteke (who I think was the deputy governor of the National Bank of Hungary) seems very relevant

There are about three hundred economists in the world who are against gold, and they think that gold is a barbarous relic - and they might be right. Unfortunately, there are three billion inhabitants of the world who believe in gold

This is essentially why political actions that go against public’s desires eventually self-destructs.

Cartoon of the Day: Wind Power: All the Pain for Zero Gain

From Watts up with That (hat tip Professor Mark Perry)