Poker Bluffing FOMC: Probable Stop in Bond Buying

Here we go again. Authorities of the US Federal Reserve in an implicit pabulum about “exit strategy”.

From Yahoo news:

The Federal Reserve will keep buying bonds indefinitely to try to keep long-term borrowing costs low. It's just not clear how long indefinitely will be.

Minutes of the Fed's last policy meeting show that officials were divided about when to halt the purchases.

Some of the 12 voting members thought the bond purchases would be needed through 2013. Others felt they should be slowed or stopped altogether before year's end. This group worries that the bond buying is keeping rates so low for so long that it could ignite inflation or encourage speculative buying of risky assets.

The Fed last month ended up approving open-ended purchases of $85 billion a month in Treasurys and mortgage bonds to replace an expiring bond-purchase plan and maintain its level of purchases.

The minutes covered the Fed's Dec. 11-12 meeting. In a statement after the meeting, the Fed said it planned to keep a key interest rate at a record low even after unemployment falls close to a normal level — which it said might take three more years…

The minutes showed that "several" Fed policymakers thought the bond buying should probably stop well before 2013 ends.

They babbled about “exit strategy” in 2010. They tattled of withholding QE 3.0 in 2011.

At the end of the day: the US Federal Reserve ended up with the opposite: escalation of their balance sheet via increasing asset purchases (chart from Cleveland Federal Reserve).

That’s why I call them the Poker Bluffing Fed.

A ‘probable end’ to bond buying translates to higher interest rates.

This will mean more than just ideology, this entails how the Fed authorities views the world and their path dependent ways of implementing policies (solving problems) in accordance to such purview: particularly demand based management, the wealth effect and the portfolio balance channel.

Of course, higher interest rates will likely ruffle or pummel financial markets severely which monetary authorities have been so sensitive to protect. 

These include the stock markets which has been Fed Chair Ben Bernanke’s once held basic creed for ‘smart’ central banking, and the bond markets where the US government—as well as global governments—and key US and international financial institutions have substantial exposures, if not deep dependency, on credit easing policies.

Just to give a few examples:

The opaque derivatives markets have been mostly anchored on interest rate based derivative contracts whose maturity has been shortening.

Notes the Bank of International Settlement:

Interest rate contracts have become increasingly short-term in recent years. Notional amounts of contracts with maturities of more than five years fell by 9% in the first half of 2012 to $117 trillion, or 24% of total interest rate contracts. By contrast, the volume of contracts with a maturity of up to one year went up by 4% to $207 trillion, or 42% of the total. In the mid- and late 2000s, longer-term contracts accounted for up to 35% of all interest rate contracts.

Higher interest rates would likely increase the counterparty and default risks for the humongous derivatives market.

The recovering US real estate market has also been latched to recent low interest and credit easing policies by the US Federal Reserve

Given that the Fed holds substantial mortgage securities and where the Government Sponsored Enterprises (GSEs) account for 99.5% of the mortgage market, a possible rise in interest rate will likely undermine their portfolio holdings (of the Fed and the GSEs) at the taxpayer’s expense (chart from Freddie Mac)

Also, given that the US Federal Reserve has financed practically 61% of US treasury debt in 2011, a desistance of support by the US Federal Reserve on US treasury debt enhances the risks of a debt default by the US government. 

US Treasury securities held by the FED has been programmed to grow through the recently implemented QE 4.0 (chart from the St. Louis Federal Reserve)

Likewise, given that publicly held debt by the US will continue to expand, higher interest rates possibly means amplified credit and rollover risks for the US government. (charts from the Heritage Foundation)

Of course foreign currency swaps, the marked difference between total bank deposits and loans in the US banking system, devaluation as an official policy, and many other factors have become dependent on the backings and credit easing policies of the US Federal Reserve.

Thus the (possible histrionic) dissension among FED authorities may be interpreted as the following possibilities:

-trial balloon to see how financial market responds (yes commodities down, but stock markets losses were marginal so far),

-spur of the moment sentiment by Fed authorities that will easily shift once downside volatility resurfaces

-an attempt to manage or control “inflation expectations” via indirectly targeting commodity prices. Gold prices bore the brunt while the US dollar rallied from yesterday’s announcement. This could also be part of the surreptitious design to suppress gold prices

Yes current policies are unsustainable. But FED authorities are unlikely to tergiversate on the direction of policymaking which has been adapted by almost every central banker around the world since 2008.

To repeat, authorities of developed economies whom has embarked on credit easing policies via ZIRP and balance sheet expansions account for 95% of the USD 98.4 trillion global bond markets, where 45% of the share of the bond markets are government bonds.

The bottom line is that current credit easing policies have been deeply intertwined or embedded with the interests of the status quo or particularly the political-economic cartel of the welfare-warfare state, crony banks and central banking.

Authorities of the FED will most likely evade the responsibility from the financial market bloodbath or meltdown that may ensue once interest rate substantially rises.  And like Pontius Pilate, they will likely be washing their hands and leave tightening to the marketplace.

Unintended Consequences from the French Financial Tax Experiment

Desperate governments scrounging for money via more taxes and regulations (financial repression) have been getting an unexpected pushback from the marketplace.

From Businessinsider.com (bold original)

One suggestion that has gained popularity in the post-crisis regulatory debate is a tax on financial transactions.

Proponents suggest that the tax would raise revenues for governments (at a time when such revenues are badly needed) and curb the excessive speculation that contributed to the global financial crisis.

In August 2012, France became the first eurozone nation in the wake of the financial crisis to implement such a tax, and so far, it's been a total failure.

In an article for Risk.net, Hannah Collins explains that in France, the tax – which amounts to 0.2 percent on transactions involving buying or selling of shares of stock – is actually just shifting investors out of equities and into even riskier, more opaque products like derivatives and derivatives-based ETFs:

Investors who own French shares are selling them and taking positions on them through derivatives instruments such as contracts for difference, structured products and ETFs, according to a Paris-based lawyer. "Most structured transactions remain outside the tax," he says. "It is due only if you have actually purchased the shares."

In other words, instead of curbing excessive speculation, the tax is simply forcing those speculative activities into darker, less-regulated corners of the market.

People’s incentives to act are also shaped by social policies.

Instead of moving in accordance to the intended goals set by politicians, the financial markets resort to regulatory arbitrage—finding legal loopholes from the new legislation from which to operate on.

And the incentive to reduce transaction costs by eluding the Financial Transaction tax would likely extrapolate to the nurturing of shadow derivatives-banking system where in this case has been signified as driving “investors out of equities and into even riskier, more opaque products like derivatives and derivatives-based ETFs”.

In short, politicians create or spawn their own Frankensteins.

The Fiscal Cliff Deal and Crony Capitalism

Yesterday’s bipartisan last minute “Fiscal Cliff deal” exhibits or signifies an example of the unjust and immoral distribution of political-economic privileges (which favors those with political connections or the political class)

From ABCNews.go.com (hat tip Zero hedge)

The “fiscal cliff” compromise has been heralded as a saving grace for middle class taxpayers, their families and the unemployed.

But buried in the fine print of the 150-page deal are also some lesser-known New Year’s gifts to some of Washington’s favorite industries.

So what industries are these?

From the same article (bold original)

$430 million for Hollywood through “special expensing rules” to encourage TV and film production in the United States.  Producers can expense up to $15 million of costs for their projects.

$331 million for railroads by allowing short-line and regional operators to claim a tax credit up to 50 percent of the cost to maintain tracks that they own or lease.

$222 million for Puerto Rico and the Virgin Islands through returned excise taxes collected by the federal government on rum produced in the islands and imported to the mainland.

$70 million for NASCAR by extending a “7-year cost recovery period for certain motorsports racing track facilities.”

$59 million for algae growers through tax credits to encourage production of “cellulosic biofuel” at up to $1.01 per gallon.

$4 million for electric motorcycle makers by expanding an existing green-energy tax credit for buyers of plug-in vehicles to include electric motorbikes.

Unnamed in Washington’s favorite industries is Warren Buffett’s Burlington Northern Santa Fe who will be one of the major beneficiaries (perhaps compensation for being Obama's mouthpiece).

Add to the above:

Wind farms, motorsports tracks, global banks and other businesses won revived tax breaks in a $75.3 billion package included in a last-minute budget deal Congress passed yesterday… (Bloomberg)

Political power blocks, special interest groups and pet projects of politicians accounts for as the main beneficiaries of the latest fiscal deal.

The above hardly has been about "unregulated capitalism", but about cronyism via state capitalism or participatory fascism

As Professor Thomas DiLorenzo at the Mises Institute aptly described, 

It is a system of crony capitalism financed by a central bank, government borrowing, and pervasive taxation. It is a system that is of plutocratic elites, for plutocratic elites, and by plutocratic elites (to paraphrase Abraham Lincoln, the true founding father of this system). The massive welfare state is merely used to buy enough votes to maintain the “legitimacy” of the system.

Vatican’s Scapegoating Capitalism

The easiest way of blaming social evils has been to bash capitalism. 

A good example has been the recent New Year homily by the Catholic Pope Benedict XVI who condemned “unregulated capitalism” for sowing “hotbeds of tension and conflict caused by growing instances of inequality between rich and poor” due to "the prevalence of a selfish and individualistic mindset which also finds expression in an unregulated financial capitalism” (BBC)

In the eyes of the Pope, the world operates on unregulated or unfettered individualism. 

In reality, the world is being suffocated by mounting regulations that has essentially been shifting the balance of social power from the markets to politicians.

Proof?

In 2012, in the US 29,000 laws came into existence in the state laws with more coming.

From CNBC.com

In 2013 in Illinois, motorcyclists will be able to "proceed through a red light if the light fails to change." In Kentucky, releasing feral or wild hogs into the wild will be prohibited. And in Florida, swamp buggies will not legally be considered motor vehicles.

On Jan. 1, as crowds of people toast to a new year, more than 400 news laws across the country will take effect — and possibly improve life for some.

"The laws that state governments deal with are really the laws that impact people on a daily basis," said Jon Kuhl, a spokesmanfor the National Conference of State Legislatures, which tracks the bills. "Whether amending or updating laws or enacting brand new legislation, it was an active year."

In addition to the new laws of 2013, more than 29,000 laws were passed by state legislatures this year, Kuhl said. Many dealt with healthcare, education, gay rights, child safety and the Internet.

And that’s aside from Federal laws. (MSNBC estimates the above at 40,000 laws including federal)

Another fact is that US tax code has ballooned from 400 to 72,000 words.

As Voxxi notes (chart theirs)

We have more professional tax preparers in the United States than law enforcement officers (765,000) and professional firefighters (310,400) combined.

But we need them. Consider this: in  1913, we had 400 pages of federal tax code in law. Today, its more than 72,000 pages.

Fear of being audited has led to this boost in tax preparers.

In short lobbying, tax avoidance, corruption and other means to influence political institutions to acquire favorable treatment becomes the commonplace operations.

 

And the above is just a segment of the overall political picture.

In other words, the Pope got his perverted idea of social malfeasance backward. Either the Pope has been misinformed or has not been forthright.

The Pope only needs to see how government debt levels in developed countries has been skyrocketing and how central banks have been bailing out the the privileged bankers. This has hardly been a function of individual-market based greed but of greed by those in power and their cohorts.

What the Pope and the Vatican seem to really rebuke hasn't been unregulated capitalism but state capitalism, corporatism or cronyism.

Yet in truth, individuals are not innately evil. It is mainly political power that debauches morality.

As the great John Emerich Edward Dalberg-Acton, 1st Baron Acton, popularly known as Lord Acton [Online Library of Liberty] pointed out

I cannot accept your canon that we are to judge Pope and King unlike other men, with a favourable presumption that they did no wrong. If there is any presumption it is the other way, against the holders of power, increasing as the power increases. Historic responsibility has to make up for the want of legal responsibility. Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority, still more when you superadd the tendency or the certainty of corruption by authority. There is no worse heresy than that the office sanctifies the holder of it.

I am inclined to think that institutions like the Catholic church have used capitalism as convenient scapegoats when they are underfire, i.e. to deflect on the raging controversies, such as charges of institutional corruption and sexual abuse  which like the Australian Catholic Church admits and apologized.

Is it not that the Bible warned that “He that is without sin among you, let him first cast a stone”? (John 8:7)

Does this not apply to the Vatican too?

Quote of the Day: Price controls Create a Population of Liars

Economists are trained in theory, statistics, modeling, and other skills. Historians are trained in the careful scrutiny and interpretation of historical sources. Neither economists nor historians, unfortunately, are trained to use common sense in their work. Postwar proponents of the reimposition of price controls have often pointed to the success of such controls during the war. Yet, despite thousands of employees and an army of volunteer monitors associated with the Office of Price Administration and despite the U.S. Attorney General’s prosecutory zeal in hauling alleged violators into court, the government’s price-control efforts during World War II failed to stem the tide of rising prices set in motion by the huge contemporary increases in the money stock.

Price controls, at most, only create a population of liars. True prices continue to do what the existing economic conditions cause them to do. No one can control the amount of precipitation by passing a law against reporting more than a stipulated amount of rain and snow.

This is from Austrian economist Robert Higgs at the Independent Institute on the evils of Price Controls

Quote of the Day: To Achieve Liberty, Envy and Intolerance have to be Overcome

To achieve liberty and peace, two powerful human emotions have to be overcome. Number one is "envy" which leads to hate and class warfare. Number two is "intolerance" which leads to bigoted and judgmental policies. These emotions must be replaced with a much better understanding of love, compassion, tolerance, and free market economics. Freedom, when understood, brings people together. When tried, freedom is popular.

The problem we have faced over the years has been that economic interventionists are swayed by envy, whereas social interventionists are swayed by intolerance of habits and lifestyles. The misunderstanding that tolerance is an endorsement of certain activities, motivates many to legislate moral standards which should only be set by individuals making their own choices. Both sides use force to deal with these misplaced emotions. Both are authoritarians. Neither endorses voluntarism. Both views ought to be rejected.

I have come to one firm conviction after these many years of trying to figure out "the plain truth of things." The best chance for achieving peace and prosperity, for the maximum number of people world-wide, is to pursue the cause of LIBERTY.

If you find this to be a worthwhile message, spread it throughout the land.

This excerpt is from the stirring farewell speech by Ron Paul at the US Congress

Happy 2013!

Wishing you the best of 2013!!!

(updated to add: I would like to thank my daughter for the image above)

Live life. Love Liberty. Love life.

Quote of the Day: The Illusions of Pundits

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Anatomy of the Socialist Brain of a Liberal Democrat

Source Libertarian Girl at Facebook

Robert Higgs: Strategy for Winning People Over to Libertarianism

Austrian economist Robert Higgs at the Independent Institute articulates on how the ideals of libertarianism can be won through the premises of consequentialism (utilitarian) and deontology (ethics) 

[bold mine, italics original]

In any event, after the more recent decades of my libertarian journey, I am now struck by a different aspect of this longstanding debate, which has to do with our strategy for winning people over to libertarianism. Strategy 1 is to persuade them that freedom works, that a free society will be richer and otherwise better off than an unfree society; that a free market will, as it were, cause the trains to run on time better than a government bureaucracy will do so. Strategy 2 is to persuade people that no one, not even a government functionary, has a just right to interfere with innocent people’s freedom of action; that none of us was born with a saddle on his back to accommodate someone else’s riding him.

In our world, so many people have been confused or misled by faulty claims about morality and justice that most libertarians, especially in the think tanks and other organizations that carry much of the burden of education about libertarianism, concentrate their efforts on pursuing Strategy 1 as effectively as possible. Hence, they produce policy studies galore, each showing how the government has fouled up a market or another situation by its ostensibly well-intentioned laws and regulations. Of course, the 98 percent or more of society (especially in its political aspect) that in one way or another opposes perfect freedom responds with policy studies of its own, each showing why an alleged “market failure,” “social injustice,” or other problem warrants the government’s interference with people’s freedom of action and each promising to remedy the perceived evils. Anyone who pays attention to policy debates is familiar with the ensuing, never-ending war of the wonks. I myself have done a fair amount of such work, so I am not condemning it. As one continues to expose the defects of anti-freedom arguments and the failures of government efforts to “solve” a host of problems, one hopes that someone will be persuaded and become willing to give freedom a chance.

Nevertheless, precisely because the war of the wonks—not to mention the professors, pundits, columnists, political hacks, and intellectual hired guns—is never-ending, one can never rest assured that once a person has been persuaded that freedom works better, at least in regard to situation X, that person has been won over to libertarianism permanently. If a person has come over only because of evidence and argument adduced yesterday by a pro-freedom wonk, he may just as easily go back to his support for government intervention tomorrow on the basis of evidence and argument adduced by an anti-freedom wonk. As John Maynard Keynes once cleverly replied to someone who asked him about his fluctuating views, “When the facts change, I change my mind. What do you do, sir?” If libertarians choose to fight for freedom solely on consequentialist grounds, they will be at war forever. Although one may accept this prospect on the grounds that “eternal vigilance is the price of liberty,” this kind of war is deeply discouraging, given that the anti-freedom forces with which libertarians must contend possess hundreds of times more troops and thousands of times more money for purchasing munitions.

In contrast, once the libertarian has persuaded someone that government interference is wrong, at least in a certain realm, if not across the board, there is a much smaller probability of that convert’s backsliding into his former support for government’s coercive measures against innocent people. Libertarianism grounded on the moral rock will prove much stronger and longer-lasting than libertarianism grounded on the shifting sands of consequentialist arguments, which of necessity are only as compelling as today’s arguments and evidence make them. Hence, if we desire to enlarge the libertarian ranks, we are well advised to make moral arguments at least a part of our efforts. It will not hurt, of course, to show people that freedom really does work better than state control. But to confine our efforts to wonkism dooms them to transitory success, at best.

If we are ever to attain a free society, we must persuade a great many of our fellows that it is simply wrong for any individuals or groups, by violence or the threat thereof, to impose their demands on others who have committed no crime and violated no one’s just rights, and that it is just as wrong for the persons who compose the state to do so as it is for you and me. In the past, the great victories for liberty flowed from precisely such an approach—for example, in the anti-slavery campaign, in the fight against the Corn Laws (which restricted Great Britain’s free trade in grains), and in the struggle to abolish legal restrictions on women’s rights to work, own property, and otherwise conduct themselves as freely as men. At the very least, libertarians should never concede the moral high ground to those who insist on coercively interfering with freedom: the burden of proof should always rest on those who seek to bring violence to bear against innocent people, not on those of us who want simply to be left alone to live our lives as we think best, always respecting the same right for others.

Mr. Higg’s proposition of libertarians making “moral arguments at least a part of our efforts” has been the bedrock of my “policy analysis” which some have mistakenly construed as being partisan.  

For clarity purposes, libertarianism is a cause to advance a free “non-aggression based” society and not to promote superficial and delusory "personality based politics" predicated on the principles of aggression.

Quotes of the Day: Ronald Coase on Economic Theory

Yesterday, proponents of free markets commemorated the 102nd birthday of the distinguished Nobel prize winner and University of Chicago Ronald Coase.

I will sharing snippets of his precious wisdom

But a theory is not like an airline or bus timetable.  We are not interested simply in the accuracy of its predictions.  A theory also serves as a base for thinking.  It helps us to understand what is going on by enabling us to organize our thoughts.  Faced with a choice between a theory which predicts well but gives us little insight into how the system works and one which gives us this insight but predicts badly, I would choose the latter, and I am inclined to think that most economists would do the same.

The above quote has been lifted from Café Hayek’s Don Boudreaux, which is from pages 16-17 of Ronald Coase‘s 1994 collection, Essays on Economics and Economists; specifically, it’s from Coase’s 1981 G. Warren Nutter Lecture in Political Economy, entitled “How Should Economists Choose?”

The point is what really matters is the soundness of the theory rather than its predictability which serves as consequence. For instance, unsound economic theories implemented through social policies may produce the desired effects over the interim...but at a tremendous price or at the expense of the future; look no further than today's lingering crisis in the developed world, which has been a product of the crucible of manifold interventionism via inflationism (boom bust cycles), welfare-warfare state, debt based consumption policies, cronyism and politicization of economic opportunities.

Importantly, theories can be manipulated to suit certain ends, particularly political ends for the benefit of vested interest groups.

This has been one of the recent admonitions of Mr. Coase at the Harvard Business Review (hat tip Prof Mark Thornton)

Economics thus becomes a convenient instrument the state uses to manage the economy, rather than a tool the public turns to for enlightenment about how the economy operates. But because it is no longer firmly grounded in systematic empirical investigation of the working of the economy, it is hardly up to the task. During most of human history, households and tribes largely lived on their own subsistence economy; their connections to one another and the outside world were tenuous and intermittent. This changed completely with the rise of the commercial society. Today, a modern market economy with its ever-finer division of labor depends on a constantly expanding network of trade. It requires an intricate web of social institutions to coordinate the working of markets and firms across various boundaries. At a time when the modern economy is becoming increasingly institutions-intensive, the reduction of economics to price theory is troubling enough. It is suicidal for the field to slide into a hard science of choice, ignoring the influences of society, history, culture, and politics on the working of the economy.

(bold mine)

The bottom line is that simplification of a complex world expressed through political means will likely have dire effects on the economy in the fullness of time.

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

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

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

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

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

The Economist notes,

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

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

The same Economist article subliminally acknowledges this,

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

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

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

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

Video: Miltion Friedman on the Difference Between Pro Free Enterprise from Pro Business

Associating capitalism or free markets with pro-business agenda remains a popular or common misperception, which the late illustrious Nobel awardee Milton Friedman eloquently refutes in the following video. (hat tip AEI Carpe Diem's Prof Mark Perry)

Aside from the above, Mr. Friedman makes an important point in dealing with social problems which plagues mainstream thinking

(3:38) we must separate diagnosis of problems from cure…

Quote of the Day: Government Redistribution Tends to Bring Out the Worst in Us

the creation of wealth is edifying. When only voluntary transactions are permitted, the creation of wealth requires cooperation, and this brings out the best in us.

Piles of wealth, however, tend to be corrupting. The fixed nature of a pile is all about apportionment, not cooperation, and this zero-sum game tends to bring out the worst in us.

It follows directly that no matter how noble the ends, government redistribution (which is hardly voluntary) tends to bring out the worst in us. Rising government redistribution over the past 75 years has produced ample evidence of this point.

We are in this mess because we have allowed our culture to be dominated by those who are bent on spreading the false and self-serving narrative that our economy is a giant zero-sum game.

As such, we might as well have the government do the dividing.

Small wonder why our politics have become increasingly about who you are for rather than what you are for.

(italics mine)

This spectacular quote is from University of Missouri-St. Louis Professor of economics David C. Rose at the letters section of the Wall Street Journal (hat tip Prof Don Boudreaux)

Direct or indirect beneficiaries of government programs will staunchly defend on what they perceive as unalienable entitlements, even if such programs are economically unsustainable and immoral, to the point of bringing out the worst in us.

Such political apportionment programs are mainly channeled through inflationism (for instance participants in the financial markets as bankers, stock market participants, bond holders and etc…), welfarism (welfare beneficiaries), bureaucratic politics (political appointees via mandates, regulations, prohibitions), warfare state (defense contractors and related interests) and cronyism (politically distributed economic opportunities).

In defending the status quo, these politicized agents resort to more than just stridently deceptive denunciations on those who question them, but to the recourse of violence ala the unfolding events in Greece. 

Politics does tend to bring out the worst in people.

Quote of the Day: Nobody is More Generous than the Miser

In this whole world, there is nobody more generous than the miser—the man who could deplete the world’s resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide.

If you build a house and refuse to buy a house, the rest of the world is one house richer. If you earn a dollar and refuse to spend a dollar, the rest of the world is one dollar richer—because you produced a dollar’s worth of goods and didn’t consume them.

Who exactly gets those goods? That depends on how you save. Put a dollar in the bank and you’ll bid down the interest rate by just enough so someone somewhere can afford an extra dollar’s worth of vacation or home improvement. Put a dollar in your mattress and (by effectively reducing the money supply) you’ll drive down prices by just enough so someone somewhere can have an extra dollar’s worth of coffee with his dinner. Scrooge, no doubt a canny investor, lent his money at interest. His less conventional namesake Scrooge McDuck filled a vault with dollar bills to roll around in. No matter. Ebenezer Scrooge lowered interest rates. Scrooge McDuck lowered prices. Each Scrooge enriched his neighbors as much as any Lord Mayor who invited the town in for a Christmas meal.

Saving is philanthropy, and—because this is both the Christmas season and the season of tax reform—it’s worth mentioning that the tax system should recognize as much. If there’s a tax deduction for charitable giving, there should be a tax deduction for saving. What you earn and don’t spend is your contribution to the world, and it’s equally a contribution whether you give it away or squirrel it away.

 This is from author and University of Rochester economics professor Steven Landsburg on the virtue of savings.

Quote of the Day: We are Pattern Seekers

We are pattern seekers, believers in a coherent world, in which regularities appear not by accident but as a result of mechanical causality or of someone’s intention. We do not expect to see regularity produced by a random process, and when we detect what appears to be a rule, we quickly reject the idea that the process is truly random. Random processes produce many sequences that convince people that the process is not random after all. You can see why assuming causality could have evolutionary advantages. It is part of the general vigilance that we have inherited from ancestors.

This is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his splendid book Thinking, Fast and Slow  p.115. 

While pattern seeking impulses had been necessary for the survival of our hunter gatherer ancestors, ignoring the role of luck and randomness in today's world extrapolates to perspectives detached from reality.

Charts: Stock Market Boom Bust Cycles and Interest Rates

I’ve been saying that stock market boom bust cycles have principally been driven by manipulations of interest rates or as consequence to interest rate policies by central banks.

Here are some charts to exhibit their correlations

Going into the close of 2012, this year’s crown holder as the best stock market performer has been Turkey whose main benchmark has been up by nearly 50% (as of last Friday’s close).

[Note: I excluded Venezuela's case since her stock market's nearly 300% gains appear as part of the symptoms of a brewing hyperinflation]

Like the Philippines, Turkey’s central bank has aggressively been pruning interest rates. Most of which has been implemented during the third quarter of the year which has coincided with the last quarter spike for Turkey’s stock market.

Asia’s uncontested star: Pakistan has been up by almost 50% (as of last Friday’s close) and has been in a spitting distance with Turkey.

Pakistan has also been in an interest rate cutting spree since 2011. This year, particularly during the last half, Pakistan’s central bank serially trimmed interest rates to a 5-year low.

Mexico hasn’t been in the roster of this year’s best (up by about 17% as of Friday), but since her bellwether trades at record highs I included this.

All three shares some common characteristics

1. Bold reduction of interest rates have spurred stock market booms

2. When interest rates have been marginally raised, stock markets consolidated

3. When interest rates have been significantly raised, stock markets decline meaningfully (as depicted in 2008).

One of Asia’s laggards Bangladesh’s Dhaka down by 20% this year, shows of the other half of story above…

Since Bangladesh began tightening in January of 2011, which I featured here, her stock market has lost nearly half from peak to-trough

Note: All charts above from tradingeconomics.com

Inflationary booms create the misimpression or the illusion of prosperity (which are adapted by governments for political reasons), but in reality they are unsustainable for the simple reason that they signify as unsound economic policies.

As the great economist and professor Ludwig von Mises admonished,

But increases in the quantity of money and fiduciary media will not enrich the world or build up what destructionism has torn down. Expansion of credit does lead to a boom at first, it is true, but sooner or later this boom is bound to crash and bring about a new depression. Only apparent and temporary relief can be won by tricks of banking and currency. In the long run they must land the nation in profounder catastrophe. For the damage such methods inflict on national well-being is all the heavier, the longer people have managed to deceive themselves with the illusion of prosperity which the continuous creation of credit has conjured up

And another thing…

China’s Shanghai index has rallied markedly yesterday to erase her year to date losses.

Going into China’s stock market boom bust cycle-interest rate policies, we see the same story playout

Video: Hayek: Social Justice is a Meaningless Concepcion

The great Austrian economist and Nobel laureate Friedrich A von Hayek in a discussion with Firing Line host William F Buckley Jr. and George Roche III (Hillsdale College) on Social Justice (source LibertyPen, hat tip Mises Blog)

Hayek (5:06)

There are no possible rewards of a just distribution in a system where the distribution is not deliberately the result of people bringing it about. Justice is an attribute of individual action. I can be just or unjust toward my fellow man. But the conception of a social justice to expect from an impersonal process with nobody can control to bring about a just result, is not only a meaningless conception, it’s completely impossible. You see everybody talks about social justice, but if you press people to explain to you what they mean by social justice…what to accept as social justice, nobody knows.

Happy Holidays!

(I would like to thank my daughter for the image)

Wishing you all a Merry Christmas and a Happy, Healthy and Prosperous New Year!

I will be having a holiday season break with my family out of my area of operations, which means I may have little access to the internet.

Thank you for your patronage and support.

Predicting the End of the World: The Mayan Calendar

Armageddon is upon us. That’s according to some people predicting the apocalypse based on the 5,000 year Mayan Calendar which ends today December 21 2012.

Yes doomsday predictions has always been with us.

From the Economist,

IT IS not only wild-eyed prognosticators, in lonely towers with an owl for company, who predict the exact date of the end of the world. It has been marked in the diaries of popes, preachers and reformers. It has shivered the blood of a navigator nearing the edge of the globe, a delicate painter of the rites of spring, a serial killer, and the great brooding scientist who uncovered the secrets of gravity and light. It has been calculated from the alignment of planets, the track of comets, the birth of Antichrist (variously identified), the rate of global warming, nuclear build-up, intriguing palindromes or symmetries in dates, or the ever-gathering entropy of wickedness in the world. Some forecasters place it safely in the far future; others expect it imminently. Some, forgetful of the old tale about crying wolf, put out a prediction regularly. The most terrifying give no date exactly, like the hen in Leeds, in northern England, whose owner wrote “Christ is coming” on her eggs and pushed them back up again. The date to squawk about? 1806.

In short the above represents a string of failed doomsday predictions.

As for the supposed Mayan holocaust, the Washington Blog notes that even modern day Mayan leaders dispels the "end of the world" predictions alluded to them  (bold and italics original)

But the truth is that the Mayans never said the world will end in 2012.

Archaeologists recently found a cache of Mayan calendars which goes thousands of years past 2012.

And current Mayan elders say that the world ain’t ending this year.

In addition, from the same source, Mayan leaders have turned the table suggesting that “the doomsday theories spring from Western, not Mayan ideas.”

Doomsday predictions sells because it rouses the base human emotions of fear or anxiety or insecurity.

And an even important point is that Armageddon forecasting has political implications. Vested interest groups sell fear in order to promote social policies, such as ecological or environmental agenda, which has had a poor track record.

Prediction is very hard, especially about the future a quote attributed to Yogi Berra a member of Major League Baseball's Hall of Fame. This applies to doom mongers as well.

Bank of Japan’s Abenomics: 50 Trillion Yen Monetary Stimulus in 2013

So the electoral victory of Shinzo Abe has finally ushered the era of "Abenomics" or Mr. Abe's economic policies based on the elixir of inflationism

From Central Bank News:

Japan's central bank will inject more than 50 trillion yen in new funds over the next 12 months aimed at boosting economic growth and will review its monetary policy goals next month, fueling speculation that it will raise its target for inflation.

The Bank of Japan (BOJ), which launched its asset purchase program in October 2010, said it would increase the size of the program by a further 10 trillion yen to about 101 trillion, buying 5 trillion yen of Treasury discount bills and 5 trillion worth of Japanese government bonds.

The additional purchases over the next 12 months, inclusive of those already decided, will amount to about 36 trillion. In addition, the BOJ regularly buys bonds at the pace of 21.6 trillion annually.

Under the Stimulating Bank Facility, which was launched in late October, the bank expects lending to reach more than 15 trillion yen. The new facility aims to provide long-term funds at a low interest rate, without any limit, to financial institutions at their request.

Combining these two programs, the BOJ said the amount outstanding would exceed 120 trillion yen.

Central banks of major economies have been ramping up the ante of digital era inflationism anchored on hope for a magical outcome. 

For the meantime yes, such huge amount of money should be expected to favor or boost asset prices not only in Japan, but should also spillover to parts of the world. Yet all these will have unintended consequences overtime.

And as for the Japanese government’s 50 trillion yen (US $595 billion) monetary stimulus combined with 1 trillion yen ($12.3 billion) fiscal stimulus, as I previously wrote,

It has been said that desperate times calls for desperate measures, but such measures of desperation are likely to speed up the coming government induced train wreck for the Japanese.

Talk about doing the same thing over and over again and expecting different results and not learning from the lessons of history.