The Austrian Economics Quiz: Nearly An Austrian

The Ludwig von Mises Institute recently proposed a quiz at their website "Are You An Austrian?", which I recently took....

Pls. click on the image to direct to link

According to Mises.org editor Jeffrey Tucker, "the purpose of the quiz is to highlight the difference between the Austrian School (not just theory) and the other schools of thought (Marxist/institutionalist, Keynesian/neoclassical, Chicago/RatEx) and these schools do not regard their theory and policy as separate."

And here is my quiz result...

Perhaps this makes me... "Nearly an Austrian"

Marc Faber: 2009 Very Volatile Environment

Some of Dr. Marc Faber's outlook for 2009 (hat tip: gold of the moon)

-global recession will last very long time

-2009 is going to be a catastrophic economically speaking

-monetary polices over the past 10 years are responsible for financial crisis

-treasury bonds bubble

-Asian stocks are probably ok, but can go down more because of global recession

-very volatile environment, huge swings

-less about investing than about trading at the present time

-Chinese economy will suffer very badly they’ll have a bad recession

-geopolitical tensions are up

-rebound may occur in Emerging Markets more than in the US markets

-Dollar is a disastrous currency, but others are not much better

-All currencies will lose value against hard assets

-bullish on: gold, gold miners, oil, oil companies, big mining companies

Part 2

The Myth of the Great Rebalancing

The "great rebalancing" is a concept where trading partners of the US should be required to adjust domestic policies in order to "rebalance" the large discrepancies in the global current account.

The "Great Rebalancing" is a fantasy conjured by liberals.

We can’t have a “great rebalancing” under the US dollar standard. Why? Because the US dollar standard operates on the principle of FREE LUNCH. Back to basics tell us that US issues (bank) notes in exchange for goods and services of the world. So essentially the US gets something (real goods-imports) for nothing (Dollars as IOU-exports). And because it operates on a something for nothing platform, you’d naturally have DEFICITS because the US doesn’t need to or simply WON’T produce enough. Why produce when I can acquire goods with my IOUs? And to fund balance of payment (BoP) deficits means increasing sales or exports of more IOUs in terms of either US dollars, US treasuries/agencies or US private financial claims. This is elementary.

So the idea that China should follow the dictates of the Keynesians and Hamiltonists to revalue their currency to INCREASE internal demand is a fantasy. Why should China or the rest of the world need to do so if isn’t in their perceived interest? It’s like getting services of a prostitute, where after being satisfied I DON’T pay up. Naturally the next time around, either the hooker won’t agree to service me or ask to pay upfront first, unless she falls in love with me! For China and others to follow the advices of these sacrosanct liberals is like getting forcibly screwed repeatedly for FREE!

And the Chinese recognize this. Proof? From Gao Xiqing president of the China Investment Corporation in an interview by James Fallows ``People, especially Americans, started believing that they can live on other people’s money. And more and more so. First other people’s money in your own country. And then the savings rate comes down, and you start living on other people’s money from outside. At first it was the Japanese. Now the Chinese and the Middle Easterners.

``We—the Chinese, the Middle Easterners, the Japanese—we can see this too. Okay, we’d love to support you guys—if it’s sustainable. But if it’s not, why should we be doing this? After we are gone, you cannot just go to the moon to get more money. So, forget it. Let’s change the way of living.”

Today’s private sector deleveraging doesn’t change the equation. The leverage simply shifts to the public sector but the principle remains the same- a free lunch US dollar standard. Forcing adjustments on US trading partners to accommodate ‘rebalancing’ will only extend the unsustainable free lunch operations. It’s a beggar thy neighbor prescription, which only punishes those that have not engaged in reckless speculation in the same way present global central bank policies are doing. Yes sir, Pope Benedict, central bankers are FORCING PEOPLE to borrow and speculate or to be “greedy”!

Of course, because constituents benefiting from the “something out of nothing” privilege, the natural consequence is for them to turn into to speculation-that’s why the US had the “dot.com” bubble, and that’s why it shifted to today’s imploding “real estate bubble” and now to the US treasury bubble.There simply is little incentive to produce.

Thus, the principle of free lunch begets the illusions of perpetual wealth based on consumption over production, expanding leverage and speculation or the “inflation mentality”, all of which fosters a psyche of entitlement.

Besides, importantly the lack of self adjusting discipline mechanism from the US dollar standard ensures the perpetuity of humungous BoP imbalances.

In short, the free lunch principle of the US dollar standard means perpetual BoP deficits for the US, because there are less incentive to produce goods. And perpetual deficits mean that the US will depend on rest of the world to provide goods and financing. And because deficits means the continual selling of financial claims, it thus perpetuate bubble conditions. Remember, IOUs for goods and services.

Ultimately, the Mises moment deals with the structural imbalances of the free lunch principle of today’s currency standard, the ultimate Ponzi scheme. If the system can’t bear enough of free lunches then it will collapse, similar to the unmasking of Bernard Madoff and the unraveling of today’s Ponzi financing mortgage securitization credit bubble.

The "great rebalancing" is predicated on false premises and thus a fairy tale that can’t survive the real world order.

Nassim Taleb is right about these so-called experts, ``The fraud can be displaced only by shaming people, by boycotting the orthodox financial economics establishment and the institutions that allowed this to happen.”

Happy New Year!

Amazing video from Disney.. Happy New Year to all!

The US-China Symbiosis: The Natural Outcome of the US Dollar Standard

This is an interesting depiction of the tightly intertwined political economic dynamics of the US and China from Mark Mark Landler for New York Times and International Herald Tribune.

First the wonderful Charts….

Next, some excerpts from the article (emphasis mine)…

``A new economic dance

``The United States has been here before. In the 1980s, it ran heavy trade deficits with Japan, which recycled some of its trading profits into American government bonds.

``At that time, the deficits were viewed as a grave threat to America's economic might. Action took the form of a 1985 agreement known as the Plaza Accord. The world's major economies intervened in currency markets to drive down the value of the dollar and drive up the Japanese yen.

``The arrangement did slow the growth of the trade deficit for a time. But economists blamed the sharp revaluation of the Japanese yen for halting Japan's rapid growth. The lesson of the Plaza Accord was not lost on China, which at that time was just emerging as an export power.

``China tied itself even more tightly to the United States than did Japan. In 1995, it devalued its currency and set a firm exchange rate of roughly 8.3 to the dollar, a level that remained fixed for a decade.

``During the Asian financial crisis of 1997-98, China clung firmly to its currency policy, earning praise from the Clinton administration for helping check the spiral of devaluation sweeping Asia. Its low wages attracted hundreds of billions of dollars in foreign investment.

``By the early part of this decade, the United States was importing huge amounts of Chinese-made goods, toys, shoes, flat-screen televisions and auto parts, while selling much less to China in return.

``"For consumers, this was a net benefit because of the availability of cheaper goods," said Lawrence Meyer, a former Fed governor. "There's no question that China put downward pressure on inflation rates."

``But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States.

``It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency, primarily dollars, that they earned from foreign trade and investment.

``As foreign trade surged, this hoard of dollars became enormous. In 2000, the reserves were less than $200 billion; today they are about $2 trillion.

``Chinese leaders chose to park the bulk of that in safe securities backed by the American government, including Treasury bonds and the debt of Fannie Mae and Freddie Mac, which had implicit government backing.

``This not only allowed the United States to continue to finance its trade deficit, but, by creating greater demand for United States securities, it also helped push interest rates below where they would otherwise be. For years, China's government was eager to buy American debt at yields many in the private sector felt were too low.

``This financial and trade embrace between the United States and China grew so tight that Ferguson, the financial historian, has dubbed the two countries Chimerica.

Finally, my comment:

One very important matter missed out by this insightful article is that these prevailing dynamics operate under the principle of FREE LUNCH or “something out of nothing” concept of the US dollar currency standard.

Basically, the US issues its notes backed by the “full faith and credit” of the US government in exchange for real goods and services from the rest of the world. Thus the natural consequence from the operating platform is to see enormous current account imbalances from the global economy framework-again, where the US exports financial claims (US dollar and US dollar assets) to fund its balance of payment debt driven deficits while it import goods and services elsewhere.

And one major consequence has been the aberrant global “vendor financing scheme” which had been quoted by Mr. Landler at the prologue of the article as…``Usually it's the rich country lending to the poor. This time, it's the poor country lending to the rich."- Niall Ferguson.” (Hey Pope Benedict, don’t you think your campaign against greed should to start with this greed fostering "something for nothing" system?)

And it is also the principal reason behind the serial bubble (inflate-deflate) cycles around the world...

In Japan then…

[M. Landler] ``At that time, the deficits were viewed as a grave threat to America's economic might. Action took the form of a 1985 agreement known as the Plaza Accord. The world's major economies intervened in currency markets to drive down the value of the dollar and drive up the Japanese yen.

``The arrangement did slow the growth of the trade deficit for a time. But economists blamed the sharp revaluation of the Japanese yen for halting Japan's rapid growth…

And in the world today...

[M. Landler] ``This not only allowed the United States to continue to finance its trade deficit, but, by creating greater demand for United States securities, it also helped push interest rates below where they would otherwise be. For years, China's government was eager to buy American debt at yields many in the private sector felt were too low.”

And because of the boom bust character emanating from such framework, trade policies have accordingly been shaped to the operating environment.

[M. Landler] ``But in classical economics, that trade gap could not have persisted for long without bankrupting the American economy. Except that China recycled its trade profits right back into the United States.

``It did so to protect its own interests. China kept its banks under tight state control and its currency on a short leash to ensure financial stability. It required companies and individuals to save in the state-run banking system most foreign currency, primarily dollars, that they earned from foreign trade and investment.

And so the idea being peddled by some experts that trade protectionism needs to be raised via the currency “lever”, aimed at improving the state of global balance of payments, doesn’t square with the realities of the operating framework of the present system which NATURALLY prompts for these anomalies. The fundamental reason is that the present monetary system lacks the self-adjusting mechanism traditionally seen in the gold standard.

Blaming simplistically the US for “overconsumption” or China for “exporting overcapacity” via the currency "manipulation" channel seems like the proverbial “pot calling the kettle black” and deals with cosmetic issues.

Yet the policy prescriptions from these experts appear directed at salvaging the statusquo of inflation driven economic growth models of the US dollar standard system. [M. Landler] ``"It is sometimes hard to change successful models," said Robert Zoellick, who negotiated with the Chinese as a deputy secretary of state. "It is prototypically American to say, 'This worked well but now you've got to change it.' "

In short, for as long as the US dollar functions as the backbone of the world's financial architecture, we should expect to see the persistence of the phenomenon of highly skewed global balance of payments and “mercantilist” policies which help shapes them.

Desires to remedy such imbalances without dealing with operating platform of the present global currency standard seems likely a "tooth fairy" approach. This unsustainable system will likely persist until it crumbles under its own weight (like a Ponzi house of cards), possibly fast tracked by the adoption of destructive policies recommended by the "omniscient" liberals, or by a concerted political thrust to overhaul the system.

But since governments are typical reactive agents and where a systemic reconfiguration translates to an admission of a shift in the distribution of geopolitical power, the latter option seems unlikely.

This makes a crisis as the only catalyst for change. Here Secretary Paulson got it right, [M. Landler] ``"One lesson that I have clearly learned," said Paulson, sitting beneath his Chinese watercolor. "You don't get dramatic change, or reform, or action unless there is a crisis."

Broken Window Fallacy: The Vicious Hidden Costs of "Holiday Economics"

``There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

``Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.”- Bastiat, Frédéric (1801-1850)

In the tradition of Frédéric Bastiat’s Parable of the Broken Window or the precept of “That Which is Seen and that Which is Unseen”, we apply this analytical methodology to the so-called “Holiday Economics”.

That Which is Seen

Public Holidays are declared to commemorate dates of historical, religious or cultural significance.

But by virtue of the current administration’s “Rationalizing the Celebration of National Holidays (R.A. 9492), public holidays have been made adjustable. The promulgated reason behind this law is to “to reduce disruption to business and production schedules, encourage domestic tourism and give employees long weekends.” (inq7.net)

In addition, the administration using moral justification, says the law would “encourage quality time” among members of Filipino families.

That Which is Not Seen

The zeitgeist of this law has been primarily economics, hence called as “holiday economics”. Weekends juxtaposed with holidays have been alleged as encouraging domestic tourism.

If one goes by the contribution share of the tourism industry to the Philippine economy we note of the following data from World Travel and Tourism Council:

In terms of GDP share, `` Philippines's T&T Direct Industry is expected to contribute 3.9% to Gross Domestic Product (GDP) in 2008 (PHP285.2 bn or US$6.8 bn), rising in nominal terms to PHP646.6 bn or US$10.9 bn (3.7% of total) by 2018. The T&T Economy contribution (% of total) should decline from 8.8% (PHP636.4 bn or US$15.1 bn) to 8.7% (PHP1,522.1 bn or US$25.7 bn) in this same period.”

In terms of employment, ``Philippines's 1,377,000 T&T Direct Industry jobs account for 4% of total employment in 2008 and are forecast to total 1,564,000 jobs or 3.7% of the total by 2018.The contribution of the Travel & Tourism Economy to employment is expected to fall to 3,541,000 jobs in 2008, 10.3% of total employment, or 1 in every 9.7 jobs to 4,119,000 jobs, 9.7% of total employment or 1 in every 10.4 jobs by 2018.”

Additionally, the Philippine government economic agency, the National Statistical Coordination Board (NSCB) further says that in 1994-1998, ``The share of internal tourism consumption to GDP was 5% and 7% in 1994 and 1998, respectively.”

In short, Holiday Economics arbitrarily promotes an industry which contributes to only about 9% of country’s GDP (5-7% of domestic tourism) and 10.3% (direct and indirect) to total employment coming at the expense of the OTHER industries with larger contribution to the domestic economy!!!

Inflationary Impact

Moreover, such distortive law is obviously inflationary or can contribute to higher prices of goods and services to the society and the further impoverishment of the society.

How?

In a non-working holiday, if a business decides to operate, it would have to absorb increases in labor wages as mandated by law. On the other hand, forced vacations mean suspensions of business activities in compliance to the fiat.

In other words, the said policy affects the production structure of the Philippine economy by

1) skewing capital investment incentives heavily to one industry,

2) increasing the costs of doing business,

3) lowering profit margins,

4) diminishing labor productivity and

5) reducing relative output.

The obvious economic implication is that of higher risk premium for the economy and stiff hurdle rates which diminishes the attraction of capital investments thereby raising the prospects of unemployment levels. Moreover, the policy induced economic imbalances will reduce production output which means pressures of HIGHER prices of goods and services.

Worst of all, the accrued negative impacts would suggest for GREATER government spending and MORE future interventions, as media will focus on the effects than the cause which will generate popular demand and pressure policymakers to oblige, and from which, politicians will willfully administer. But, beyond public knowledge, this should translate to the prospects of higher taxes, lower purchasing power of the Peso and lower standards of living.

On the government side, more intervention and more government budget for “welfare or entitlement” spending means more opportunities for corruption and the never-ending farcical investigations (turned into soap operas) aside from the economic dislocations emanating from such skewed political policy.

Moreover, the truth is that domestic tourism will be limited to the income capacity of Filipinos. Lengthening of vacations do not automatically translate to hefty progress in the domestic tourism industry if the citizenry's incomes remain marginalized. And any advances of the industry based on credit instead of genuine wealth creation will only lead to temporary booms followed by a nasty bust. Profligacy isn’t a sound way to enrich a country. Besides, the squeezing of other industries will only put a kibosh to Filipino incomes.

Think of it, instead of promoting education, Filipino children with reduced school hours will be cultured towards indolence, intellectual inertia and hedonistic lifestyles, which runs contrary to the avowed objective of attaining quality family time. The derivative value formation from such policies doesn’t signify as sound economics or translate to better economic prospects over the long run.

Fatal Conceit

Besides, “quality time” accounts for as a fallacious argument of “begging the question”. More vacations do not automatically guarantee more quality time for the family. Quality time stems from personal virtues of responsibility and time management than from government’s controlling of people’s action. If a person insists on staying with a paramour than with the legal or connubial partner and or the family, no amount of “vacation” will change the person’s preference or priorities. More vacation may, on the other hand, even further such an immoral lifestyle.

And it goes the same with business, the idea that government knows the interest of business more than the industry itself is a concrete example of the Hayekian “Fatal Conceit”. The law’s stated aim of reducing “disruption to business and production schedules” runs contrary to its goals. Raising the cost of business disrupts production schedules instead of facilitating them. And some business groups as the American Chamber of Commerce have raised this issue.

Finally there is also a cultural dimension for the “holiday economics” debate. The major reason for such holidays is mainly for the celebration of the historical significance of the particular dates. By moving these, with the aim of attaining tenuous economic goals, vastly erodes the meaning of such rites. What good is it to remember history, if we only opt to look beyond its very essence?

Holiday Economics is representative of the inflationary, distortive and bad economics which is what Frédéric Bastiat admonished against. At worst, it is prejudicial to the Filipino heritage. The unseen costs look patently greater than its superficial and immediate benefits. The law deserves to be repealed or revoked.

Happy Holidays!

The stock market recently formed a Christmas tree image from 2004-2008...

Source: Bespoke Invest

But the angel said to them, "Do not be afraid. I bring you good news of great joy that will be for all the people. Today in the town of David a Savior has been born to you; he is Christ the Lord. This will be a sign to you: You will find a baby wrapped in cloths and lying in a manger." Suddenly a great company of the heavenly host appeared with the angel, praising God and saying, "Glory to God in the highest, and on earth peace to men on whom his favor rests." Luke 2: 10-14

Happy Holidays!

Industry Trends During Recessions

The common impression is that when an economy undergoes recession, the entire range of industries sinks altogether. This isn’t always true since recessions signify a mismatch between the balance of goods and services in the economy. The industries that incur the gist of the imbalances or 'malinvestments' suffer most from the market clearing adjustments.

McKinsey Quarterly shows the shift in spending patterns during the previous 2 recessions 1990-1991 and 2001-2002.

To quote McKinsey Quarterly, ``Many companies can anticipate the performance of their sectors in a recession. McKinsey research shows that during the 1990–91 and 2001–02 downturns, for example, US consumers reprioritized their spending rather than cutting it across the board. Consumer spending dropped in discretionary categories like dining out, personal care products, and charitable donations. But expenditures for groceries, reading materials, and other options that substitute for more expensive ones actually rose. So did outlays on insurance, health care, and, above all, education.”

So basically NEED based industries tend to do well (as defensive industries) while WANT based industries bear most of the brunt (as people scrimp to adjust to the new environment).

Courtesy of Bespoke Invest (as of December 22^nd)

Although if today’s stock market performance should be used as gauge of the overall activities of the economy, it would seem that in general every industry seems affected.

Boston.com: 2008 In Pictures

Check out nifty pictures on Boston.com’s Big Picture

Samples…

[in part 1]

"world's first man to fly with a jet-powered fixed-wing apparatus"

James Bond-like gadgets come to life.

in Part [2]

Hurricane Ike

Lonesome Survivor

in Part [3]

US Presidential Elections

Obama's Magic

Great stuff

Cartoon of the Day: The Madoff Model

source indystar.com varvelblog

Philippine Politics: Our Comments on ex-President Aquino’s Apology to ex-President Erap

Here are some of my comments on former President Corazon Aquino’s recent apology to former President Joseph Estrada for participating in the latter’s ouster during the past EDSA 2 revolution.

-``Under democracy one party always devotes its chief energies to trying to prove that the other party is unfit to rule - and both commonly succeed, and are right.”- by H.L. Mencken.

By the apology, President Aquino’s actuation can be read or interpreted as trying to undermine the present administration more than simply being remorseful. As one of the inspirational leaders of the People Power 2 revolution, doesn’t she deserve to equally apologize to the Philippine nation for calling on Erap’s ouster and thus ushering the unpopular and similarly "tainted" PGMA’s regime?

This reeks of odious politicking.

-There are no permanent allies and no permanent enemies, only permanent interests…especially when vested political interests are not in power!

-``It is fascinating to watch politicians come up with ‘solutions’ to problems that are a direct result of their previous solutions. In many cases, the most efficient thing to do would be to repeal their previous solutions and stop being so gung‐ho for creating new solutions in the future. But, politically, that is the last thing they will do.”-Thomas Sowell

Thomas Sowell's quote applied to the local politics,

“…politicians come up with ‘solutions’ to problems”: OUST PGMA.

“…direct result of their previous solutions”: EDSA II or Estrada’s ouster

“the most efficient thing to do would be to repeal their previous solutions”: avoid personality based politics

“…and stop being so gung‐ho for creating new solutions in the future”: adopt less dependence on government and expand economic freedom!

-``As for politicians, forget about expecting them to change. It's not going to happen. Just sit back, relax, and watch them fall, one by one. At least it makes for great entertainment.”-Robert Ringer

Exactly!

The Transitioning Political Phase: Shadows of Smoot Hawley and Financial Crisis Claims First Government-Belgium

We are now entering into the political phase of the current global crisis.

To begin with, the modern day version of the Smoot-Hawley Act seems to be in the process of resurrection.

This from Washington Post (bold highlights mine),

``Only a few weeks after world leaders vowed at a Washington summit to reject trade protectionism and adhere to free-market principles as they combat the global financial crisis, a host of nations are already breaking that promise.

``Moving to shield battered domestic manufacturers from foreign imports, Indonesia is slapping restrictions on at least 500 products this month, demanding special licenses and new fees on imports. Russia is hiking tariffs on imported cars, poultry and pork. France is launching a state fund to protect French companies from foreign takeovers. Officials in Argentina and Brazil are seeking to raise tariffs on products from imported wine and textiles to leather goods and peaches, according to the World Trade Organization.

``The list of countries making access to their markets harder potentially includes the United States, where critics are calling the White House's $17.4 billion bailout of the U.S. auto industry an unfair government subsidy that would put foreign competitors at a disadvantage.

``Though still relatively narrow in scope, the moves, observers warn, in the coming months may grow into a broader wave of protectionism. That could worsen the global financial crisis by further choking world trade, which is already facing its first decline since 1982 as the world economy sharply slows and demand dries up.

``In hard times, analysts say, nations are more inclined to take steps that inhibit trade, often with dire consequences. Trade restrictions imposed by countries trying to protect domestic industries in the 1930s, for instance, escalated into a global trade war that deepened and prolonged the Great Depression.

``Exporting firms tend to be innovative, dynamic and capable of generating good job growth," said Eswar S. Prasad, a professor of trade policy at Cornell University and senior fellow at the Brookings Institution in Washington. "If trade restrictions caused by trade wars shut them down, their suppliers shut down, job losses get worse, and you can quickly have a spiraling downward effect on the entire economy."

``To be sure, most of the measures taken to date appear to be within the limits of current international trade treaties, which grant countries some room to raise tariffs and contain loopholes that can be exploited to protect domestic industries.

``But the general trend toward protectionism could undermine what has been the steady march of free trade during the era of globalization, with export-dependent countries such as China standing to lose the most."

So the unintended consequences of bailouts are partially contributing to such movement.

Next, we have national governments falling under the weight of the financial crisis.

Belgium is reportedly the first of the victim.

This according to the Financial Times, ``The Belgian government last night became the first national administration to fall as a direct result of events linked to the global financial crisis.

``Belgium's King Albert II formally accepted the resignation of the coalition government led by Yves Leterme, prime minister - but ordered it to stay on in a caretaker capacity to deal with "day-to-day" business.

The political ramifications of the crisis carries a big weight to trade, migration and capital flows dynamics, hence requires to be monitored.

For us, protectionism is one major threat or risk that can bring about the modern day version of the Great Depression.

Video: Ron Paul/Peter Schiff: The Campaign For Liberty

If the crisis was predictable and is explainable, why did no one listen? It’s because too many politicians believed that a free lunch was possible and a new economic paradigm had arrived. But we’ve heard that one before--like the philosopher’s stone that could turn lead into gold. Prosperity without work is a dream of the ages.-Congressman Ron Paul, The Austrians were Right November 20, 2008

(hat tip:Barry Ritholtz)

Welcome To The Mises Moment

``We have seen that each new control, sometimes seemingly innocuous, has begotten new and further controls. We have seen that for governments are inherently inflationary, since inflation is a tempting means of acquiring revenue for the State and its favored groups. The slow but certain seizure of the monetary reins has thus been used to (a) inflate the economy at a pace decided by government; and (b) bring about socialistic direction of the entire economy. Furthermore, government meddling with money has not only brought untold tyranny into the world; it has also brought chaos and not order. It has fragmented the peaceful, productive world market and shattered it into a thousand pieces, with trade and investment hobbled and hampered by myriad restrictions, controls, artificial rates, currency breakdowns, etc. It has helped bring about wars by transforming a world of peaceful intercourse into a jungle of warring currency blocs. In short, we find that coercion, in money as in other matters, brings, not order, but conflict and chaos.”-Murray Rothbard, What has Government Done To Our Money

No investor today can rely on traditional metrics to ascertain investment themes since the financial markets have been living on government steroids.

Government has fundamentally usurped the role of gods as they determine the winners or the losers or which industries or businesses deserve to live or perish.

Such evolving shift towards the consolidation and expansion of government’s power in the marketplace or ‘state capitalism’ will mold a new risk environment from which will determine risk capital’s rate of return and how capital resources would be deployed overtime.

Yet most of the current policies applied are designed to impact immediate concerns and appear to be shrouded with unintended consequences. Hence, any serious investor would need to read into government actions and project their repercussions to the investing sphere.

Government actions today appear to be in unison with the goal to combat threats of “deflationary” recession. The collective belief is that the slack in ‘demand’ prompted by falling asset prices will induce the public to hold onto cash instead of generating consumption via the restoration of the credit cycle.

Thus government policies led by the US appear to be directed at patching up the lapses from an imploding bubble.

The Bernanke Doctrine

The direction of policy actions or what I would call as the ‘Bernanke doctrine’ has been telegraphed to the public since 2001 and has been his deflation fighting manual. I guess most central bankers have adopted his strategy so the seeming “collaborative” and “concerted” efforts.

The US Federal Reserve recently cut interest rates from a fixed target to range between 0 and ¼% which it expects to hold “for sometime”. And now that the US central bank has moved rates to near zero level (Zero Interest Rate Policy-ZIRP), which leaves them limited room to use interest rate as ammunition, they are left with the terminal option of balance sheet management. The Fed recently announced that they would:

1) purchase assets directly from the market- “will purchase large quantities of agency debt and mortgage-backed securities” and “evaluating the potential benefits of purchasing longer-term Treasury securities”,

2) provide credit directly- “will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses” and

3) expand the use of the printing press “consider ways of using its balance sheet to further support credit markets and economic activity”.

Notice that these endgame tactics involve the short circuiting the banking system which basically has not been different from Zimbabwe’s Dr. Gideon Gono’s strategy of using the printing presses aided by the an expansive government.

The aforementioned FED monetary policies, combined with the present fiscal package and the purported $850 billion inaugural program for the incoming President Barack Obama, which are allegedly aimed at jumpstarting the economy, seems headed for such direction.

And the buck doesn’t seem to stop here.

``The biggest fear is that people will do too little…like a start-up that fails because it didn't do enough”, the Wall Street Journal quotes an anonymous Democratic leadership aide on President Obama’s inaugural stimulus program.

This captures what we’ve been saying all along…political motives will shape policy decisions more than economic concerns. Officials will use the cover of popular demand to continually spend taxpayer money organically meant to keep afloat its US dollar standard fractional banking system even to the point where Ben Bernanke could resort to the nuclear option of the printing press based currency devaluation to inflate away the unsustainable debt levels.

The desire to print money to solve economic ailments can only lead to further financial or economic disorders.

Bernanke’s Asymmetric Playing Field

Yet the shift from interest rate to balance sheet or money supply management policy comes with many unknown effects.

One, the directives of US monetary policy seems to revolve heavily towards Ben Bernanke. This makes him, unknowingly to the public, the most powerful man in the world, an unelected official. Remember, the world operates around the US dollar standard system from which Bernanke’s clout has been strengthening.

As we pointed out in Is Ben Bernanke Turning The US Federal Reserve Into A Dictatorship?, the concentration of powers towards the center, by bypassing legal requirements or procedures and circumventing organizational hierarchy in the decision making process, could signify as consequence to the ongoing policy directional shift from ZIRP to the money supply.

According to Economist Bob Eisenbeis of Cumberland Advisors, ``The size of the Fed’s balance sheet is largely dependent upon the Board of Governors and its lending programs and is not the province of the FOMC”, and since balance sheet management involves day to day decisions ``it is neither feasible nor practical for the Reserve Bank Presidents to move to Washington and meet daily.” Thus, the FOMC would probably be “mothballed” until ``the return of normalcy to policy formulation.” This explains the rational behind the apparent arrogation of power by Ben Bernanke.

Thus, the fate of the US and the world’s financial system (markets and banks) and even the economies now resides in the palms of Mr. Bernanke, see figure 1; ironically the same person who wrongly predicted the containment of the subprime crisis.

Figure 1: Cato.org: US Credit Triangle

Two, informational changes in the size and composition of the balance sheet or Bernanke’s present actions will be critical to market participants. The assets which the Fed buys today or in the future will give undue advantage over the assets it won’t be buying. Thus the fate of the markets depends on Mr. Bernanke’s biases, values or priorities (marginal utility). As we always say, inflationary policies always favor those with closest ties to the government.

Three, since the Fed relies on 17 primary dealers (including some foreign affiliates) to implement its purchasing activities, the said institutions will have “real informational advantage” (since they have access to Fed activities) or an information asymmetric edge over most market participants. Essentially, such developments makes markets today tilted towards an insider’s game.

In all, Ben Bernanke has altered the global financial market’s landscape into a casino like environment by playing with a loaded the dice, constantly changing of rules in the middle of the game to suit his predispositions and fostering an uneven playing field-where he assumes the role of the house. His newly assimilated omnipotent powers will likely shape world markets, economies or even implicitly political developments which could be laden with a minefield of unforeseen consequences. Hence, the risks are that policy mistakes made by omission or by commission will exacerbate further suffering to the world.

Global Central Banks Adopt The Bernanke Doctrine

The switch from interest rates to balance sheet policy management isn’t a development restricted to the US as Japan and Switzerland has also joined the trend of consolidating central bank power to wrench open the spigot of money supply with the goal to “stimulate” their respective economies.

The Bank of Japan (BoJ) cut rates from .3% to .1% last week and declared that it would increase purchases of government bonds, including inflation-linked bonds, floating rate bonds and 30-year bonds, aside from commercial paper. It will likewise consider buying corporate debt products (forextv.com).

The Swiss National Bank (SNB) also slashed rates by half a percentage point, last week, from 3-month Swiss franc LIBOR rate of 0.50-1.50 percent to 0.00-1.00 percent, its fourth cut in two months.

With policy rates at zero levels, the SNB is said to consider “quantitative easing” (running printing press) through unsterilized currency intervention by possibly buying ``Swiss franc bonds to lower borrowing costs or try to weaken the franc either by verbal or physical intervention.” (IHT.com).

According to Morgan Stanley’s Joachim Fels (highlight mine), ``the may choose to implement QE partly through unsterilised currency intervention, i.e., buying foreign currency without offsetting the impact on their balance sheet through open-market sales of other assets. The reasoning behind this is that for small open economies like Switzerland, the exchange rate is a more important driver of the economy than mortgage rates or other interest rates, and in the case of Japan, currency intervention might help to stem the recent sharp appreciation of the yen.”

Both the SNB and BoJ basically will be utilizing the same Bernanke’s textbook approach!

So as global central banks become more desperate they are likely to resort to their home printing presses aimed at devaluing their currency against everyone else. This raises the risk of a currency war or a tumultuous upheaval in the present monetary system, especially when Mr. Bernanke opts for the nuclear option.

Again this reminds as again of Ludwing von Mises who presciently wrote in Human Action, ``The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”

The currency markets will be the natural release valve for all these accrued government actions in 2009.

Welcome to the Mises Moment.

Madoff Ponzi Scam and Boom-Bust cycles

“At any given time there exists an inventory of undiscovered embezzlement in — or more precisely not in — the country’s business and banks. This inventory — it should perhaps be called the bezzle — amounts at any moment to many millions of dollars. It also varies in size with the business cycle.”- John Kenneth Galbraith, “The Great Crash of 1929”

``Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic, with their motto of sauve qui peut induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud” wrote Charles Kindleberger in Manias, Panics and Crashes.

When people generally feel safe, they take in more risk than is necessary even to the point of dispensing with the necessary appraisal or due diligence.

The recent boom bust cycle underscores this; for instance, institutions that bought into financial assets backed by questionable collateral did so because they put their trust on credit rating agencies, they reached for additional yields, they believed that they can “time” (or exit) the markets, they believed that the boom cycle was in a perpetual motion and most importantly, because everyone else have been doing it (herd mentality). And when the tide did go out, most of them got caught swimming naked, to paraphrase Warren Buffett.

Thus, it is no different when Bernard Madoff bamboozled $50 billion off from the who’s who list which includes top rated financial institutions among them banks, (e.g. BNP Paribas, Banco Santander, Fortis Bank Netherlands, HSBC Holdings, Nomura Holdings, Royal Bank of Scotland and etc.) insurers (CNP Assurances, Clal Insurance, Harel Insurance) and Hedge funds (Tremont Group Holdings, Fairfield Greenwich).

To consider, these institutions account for as supposedly smart money outfits since they are backed by an army of “elite professionals”, e.g. economists, accountants, risk managers, quants etc…). Yet at the end of the day, smart money seemed like everybody else; they got what they deserved because they substituted prudence with fad.

When something turnouts too good to be true they always end up as being a fleeting anomaly or a scam.

Yet markets can’t be blamed for these, in fact, there had been some efforts to expose the Madoff PONZI scheme (a fraudulent scheme which involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business-wikipedia.org) from the private sector as Aksia, a firm that does due diligence on investment advisers or by trader Harry Markopolos, who in 1999 wrote that "Madoff Securities is the world's largest Ponzi Scheme," in a letter to the SEC (WSJ).

Figure 2 Wall Street Journal: US SEC budget

Unfortunately, the Security and Exchange Commission, as the oversight body with about 3,371 employees (as of 2007) and with a ballooning (almost tripling) of budget (see figure 2) has failed to detect the fraud until the recent bust conditions heightened risk aversion which ultimately forced the unraveling of the grandest fraud.

This only goes to show how bureaucracy almost always lags the social or market dynamics because to quote Ludwig von Mises in Bureaucracy, ``The bureaucrat is not free to aim at improvement. He is bound to obey rules and regulations established by a superior body. He has no right to embark upon innovations if his superiors do not approve of them. His duty and his virtue is to be obedient.”

Another, again it’s that feeling of safety but this time from the comfort of regulations that exposes people to more risk taking. As James Grant recently argued “the commission is worse than useless because not only is it always behind the curve, its very existence gives many investors a false sense of comfort that a big agency is looking after their interests.”

Regardless of boom or bust conditions it is our duty to conduct the necessary due diligence and depend less on government or its bureaucracy to their work for us, otherwise suffer from similar consequences of fools parting with their money as above. We should never keep our guards down because there will always be a prowling Charles Ponzi or Bernard Madoff in different forms.

As the Wall Street Editorial goes, ``There's a lesson here for investors and Congress. Instead of shoveling more money and power to the regulators who already had plenty of both, let's take care not to overregulate the people who actually warned about Mr. Madoff's miracle returns. Law enforcement is useful in punishing wrongdoers after the fact, which will deter some crooks. But expecting the SEC to prevent a determined and crafty con man from separating investors from their money is no more sensible than putting your life savings with a Bernard Madoff.”

Finally today’s environment brings other possible scams to the surface that have not been widely reported as in Colombia’s Ponzi DMG card and Canadian hedge fund run by Otto Spork dealing with glacier investments.

Yet the Madoff Ponzi scandal also reflects on today’s crisis which stemmed from the debacle of the previous credit bubble borne out of Ponzi financing “securitization-derivatives-shadow banking” structures.

As an aside, possible future crisis emanating from similar Ponzi type of operations, but are clothed with legitimacy as the Social Security entitlement program (AEIR, James Quinn) and the Fractional Reserve Standard (JS Kim, Dr. Ellen Brown) should be closely monitored.