Warren Buffett: Embracing Crony Capitalism

Warren Buffett used to be the person I wanted to emulate. Not anymore.

This is because Warren Buffett’s investment approach has radically changed. He has undergone dramatic transformation from a Graham-Dodd modeled value investor to a political entrepreneur-crony capitalist.

The Huffington Post writes, (bold highlights mine)

No matter what the government does, taxpayer bailouts of the financial sector will sometimes be necessary, according to the nation's second richest man.

As markets crashed in the fall of 2008, government officials feared that if certain financial institutions failed, the entire financial system -- or perhaps even the entire economy -- would come down with them. In the months after the government extended a $700 billion bailout to the financial sector, lawmakers have striven to ensure that no institution poses such a systemic risk that it would be too big, or too interconnected, to be allowed to fail.

But famed investor Warren Buffett, whose own firm profited handsomely from the bailout, said bailouts are an inevitable feature of finance, Bloomberg reports.

Buffett, who is personally worth at least $45 billion, told the government panel charged with investigating the causes of the financial crisis that its work would not prevent the phenomenon of "too big to fail."

Reading last night’s very timely article at Mises.org, Frank Chodorov wrote of how some capitalists have contributed to the advancement of socialism.

Mr. Chodorov wrote, (bold highlights mine)

The task of producing goods and services for exchange was accepted as a necessity, but the summum bonum was the acquisition from the king of grants, patents and subsidies that would yield them monopoly profits, that is, profits over and above what might be garnered in a competitive market. Their aim was to live like nobles who rendered no service for the rents they collected from their tenants.

It appears that such “rent seeking paradigm” seems to be Mr. Buffett’s newfound specialty.

Warren Buffett’s perceived “bailout-as-a-necessity” is due to the fact that he or his company profits from these. Yet, what is beneficial for him comes at the expense of ordinary people. Bailouts are basically redistribution of wealth from the average Americans to Mr. Buffett, his company and shareholders.

Nonetheless bailouts are not inevitable. Eventually a political economic system that persists in doing so will only degenerate. And this will likewise affect his company’s profits overtime.

Besides, bailouts or political concessions depend on patronage. Once Mr. Buffett’s political network has gone out of the loop then such privilege goes out of the window as well.

So instead of looking for economic opportunities to exploit on, Mr. Buffett and his executives will be focusing on lobbying.

This only goes to show how Mr. Buffett’s the time horizon has substantially narrowed. Maybe it’s because of age.

But Mr. Buffett has certainly been a disappointment, unlike his libertarian father, a staunch defender of the “old right”, Howard Buffett.

More Financial Globalization: Proposed Deutsche Boerse AG-NYSE Euronext Takeover

The trend towards further consolidation of global stock exchanges continues with the proposed takeover Deutsche Boerse AG's of NYSE Euronext.

Integrating national stock markets has been part of the ongoing financial globalization process that will only deepen the correlation of price actions among global bourses. In 2007, I wrote,

With the revolutionary advances in the field of communications and information technology-the advent of on-line electronic trading platforms makes it possible for real-time electronic transactions regardless of the geographical distance.

Grounded on this premise, the major exchanges appears to be in a rush to integrate financial services, to diversify and expand their market coverage, reduce transaction (bookkeeping, clearing and settlement) costs by achieving the economies of scale, to eliminate further inefficiencies by way of human intervention, provide for financial depth by attracting global investors (to augment the demand side), traders and listing companies (to increase supply side), to improve on liquidity by easily matching buyers and sellers, and finally, adapt to the ongoing changes in marketplace by being accessible to the growing significance of institutional investors [pension funds, hedge funds, mutual funds and insurance companies] as compared to retail investors in the past.

And stock markets have been evolving—the introduction of dark pools has also been prodding for such mergers as competition deepens.

Nevertheless with the proposed merger, the Wall Street Journal editorial rues on the apparent the loss of America’s leadership, they write

The merger is nonetheless one more lesson in how easily capital, both financial and human, can relocate. It's no coincidence that the heavily regulated equity business has languished or moved out of the U.S., while lightly regulated derivatives markets have boomed in the United States and elsewhere.

In the early 1990s, American exchanges played host to half of the world's new public companies. Last year, according to Dealogic, U.S. exchanges hosted 171 initial public offerings worth a total of $45 billion. But this U.S. deal-making was dwarfed by the action overseas, where 1,295 companies went public with a total value of $237 billion. The iconic NYSE now lags behind two Asian exchanges in IPO volume. This is partly the result of more rapid growth in developing economies, but it used to be that foreign companies wanted to float their shares in the U.S. Now they're as happy in Hong Kong.

U.S. over-regulation is certainly to blame here, especially the 2002 Sarbanes-Oxley law and its multimillion-dollar compliance burden on public companies. The Securities and Exchange Commission's own exhaustive 2009 survey of U.S. and foreign firms showed that the burden of complying with Sarbox remains a major deterrent to going public in the United States. Yet the agency still hasn't made a serious effort to pare these burdens. (bold emphasis mine)

The lesson is clear: interventionism diminishes competitiveness

Coming Soon: Atlas Shrugged The Movie

(hat tip: Robert Wenzel)

Inflation Expectations: The Widening Chasm Between Households And Experts

Despite mainstream experts blabbering about deflation, we’ve been defiantly predicting for a long long long long time that inflation would be coming and would pose as the next real risk (everywhere).

That’s because it has been the instinctive/intuitive approach by central bankers to use their printing presses as antidote to perceived economic predicaments. (Despite years of experience people never learn and always find ways to perpetuate policies anchored upon acquiring “something from nothing”-which I would call “political greed”)

And reemergent “consumer price” inflation represents as the “unintended consequence” and “symptoms” from such persistent policies.

This report from the Wall Street Journal’s Blog, (bold emphasis original)

Consumers see more inflation ahead. That views puts them at odds with Federal Reserve officials and private sector economists.

According to Friday’s consumer sentiment survey released by Reuters/University of Michigan, inflation expectations have been rising since late summer. Back in September, U.S. consumers expected the inflation rate one year out to hit 2.2%. In early-February, the one-year expected inflation rate is up to 3.4%.

Contrast that rate with the tamer forecasts at the Fed and among private economists.

On Wednesday, Fed chairman Ben Bernanke told the House Budget Committee that “inflation is expected to persist below the levels that Federal Reserve policymakers have judged to be consistent over the longer term with our statutory mandate to foster maximum employment and price stability.”

In the US, it’s hardly true that mainstream private sector experts have been on the “inflation risk” camp, many, if not most, have sided with officials to claim inflation hasn’t been a threat mostly because of “output gap", “capacity utilization”, “unemployment” conditions and etc...an example of this outlook can be read here

Yet the “man on the street” sees things differently.

More from the same article, (bold highlights mine)

How can households be more hawkish about inflation than the Fed?

Much of the dichotomy reflects which prices are in focus. The Fed and economists tend to pay attention to core inflation, which ignores food and energy and which better reflects underlying economic conditions. Households pay more attention to the items most frequently bought, in particular gasoline and groceries.

See the difference?

The expert-official camp fundamentally relies on statistical data which isolates real world variables.

Meanwhile, households feel the pressure from relative price changes that affects their overall purchasing power based budgets.

The end result: A massive detachment between expert-official opinions and real events which shapes household’s expectation.

The use of statistical data can be manipulated to the extent that it will be (has been repeatedly) used to justify the imposition of ideologically based policies (mostly predicated on mathematical models).

Again to quote Mark Twain,

There are three kinds of lies: lies, damned lies and statistics

Eventually statistical chicanery backfires, as the above developments shows.

Will Humans Achieve Immortality By 2045?

So says Ray Kurzweil, chief proponent of Singularity is Near –“an era in which our intelligence will become increasingly nonbiological and trillions of times more powerful than it is today—the dawning of a new civilization that will enable us to transcend our biological limitations and amplify our creativity.”

From Time’s Lev Grossman

Here's what the exponential curves told him. We will successfully reverse-engineer the human brain by the mid-2020s. By the end of that decade, computers will be capable of human-level intelligence. Kurzweil puts the date of the Singularity — never say he's not conservative — at 2045.

Read the rest here

Ray Kurzweil’s betting on the exponential growth of human ingenuity which converts technology into our life preserver.

We Are All Africans: Exposing the Falsity of Nationalism

This 2007 article says that all human origin is from Africa.

From Reuters, (bold emphasis mine)

An analysis of thousands of skulls shows modern humans originated from a single point in Africa and finally lays to rest the idea of multiple origins, British scientists said on Wednesday.

Most researchers agree that mankind spread out of Africa starting about 50,000 years ago, quickly establishing Stone Age cultures throughout Europe, Asia and Australia.

But a minority have argued, using skull data, that divergent populations evolved independently in different areas.

The genetic evidence has always strongly supported the single origin theory, and now results from a study of more than 6,000 skulls held around the world in academic collections supports this case.

I am asking forgiveness in advance to those Christians who might think that this may seem as heresy: But I just can’t help deduce, based on these findings, that our version of genesis or Adam and Eve could have their roots as Africans.

But this is beside the point.

Regardless if we all came from Africa or not, the scientific finding only reveals what has been obvious—that we are all human beings.

This means that the conceptualization of “anti-foreign bias” or “nationalism” practiced and preached by many have all been premised on falsehoods, whether applied to trade, migration, investment, culture or etc…

Instead, nationalism or a form of groupthink (me against them mentality) has actually accounted for as mainly a political scarecrow meant to manipulate the ignorant and to advance the vested interests of certain political classes mostly by imposing controls which ultimately inhibits people’s freedom to act and produce.

As Ludwig von Mises wrote,

Interventionism generates economic nationalism, and economic nationalism generates bellicosity. If men and commodities are prevented from crossing the borderlines, why should not the armies try to pave the way for them?

Nationalism has been a pivotal force that has led to many devastating wars like the World war I with estimated deaths at 15-65 million and World War II (40-70 million)

And given that we are all one, there simply is no justification (science, philosophical, economic or political) to raise barriers to advance social civility based on voluntary cooperation from free trade.

Ludwig von Mises and Bettina Bien Greaves explains,

The market is that state of affairs under which I am giving something to you in order to receive something from you. I don't know how many of you have some inkling, or idea, of the Latin language, but in a Latin pronouncement 2,000 years ago already, there was the best description of the market — do ut des — I give in order that you should give. I contribute something in order that you should contribute something else. Out of this there developed human society, the market, peaceful cooperation of individuals. Social cooperation means the division of labor.

State Aid and Political Centralization

The US appears to be headed for political centralization in spite of her Federal constitutional republic government framework.

And this is due to the growing dependence of US States on Federal Aid (“grants in Aid”) Programs.

Cato’s Chris Edwards enumerates why state aid programs negatively impacts the economy.

1. No Magical Source of Federal Funds

2. Aid Spurs Overspending

3. Aid Allocation Is Inefficient

4. Aid Reduces Innovation

5. Aid Is Intensely Bureaucratic

6. Aid Distracts Federal Politicians

7. Aid Breeds Irresponsibility

8. Common Problems Aren’t Necessarily Federal

Read Mr. Edwards explanation here.

The point is the broadening dependence of US states on federal government aid has been undermining the decentralized political power structure, and importantly, has been diminishing political and economic freedom.

And applied locally, even if the Philippines has yet to embrace federalism, any attempt to decentralize via Local Government Units would signify a sham if only to remain dependent on the largesse of the national government. (my latest article on MMDA should serve as an example)

Peak Oil Represents Government Failure

The beauty of the internet is that it has been leveling the playing field between the public and the governments in terms of information.

The web has placed much of government’s stealth activities in jeopardy.

A good example is the controversial Wikileaks which has recently revealed that Saudi Arabia could have been exaggerating the declaration of her oil reserves. Translation: Expect higher oil prices soon.

The Business Intelligence reports,

Saudi Arabia, the world's largest crude oil exporter, is unable to pump enough oil to keep prices from rising, the Guardian reported, citing confidential cables from the US embassy in Riyadh.

The cables from 2007 to 2009 made public by the website Wikileaks, urge Washington to take seriously a warning from a senior Saudi government oil executive that the kingdom's crude oil reserves may have been overstated by as much as 300 billion barrels, nearly 40%.

The report cites comments attributed to Saudi Aramco geologist and former exploration chief, Sadad al-Husseini, that Aramco couldn't reach the 12.5-million-barrel daily capacity needed to keep prices from rising.

According to the cables, which date between 2007-09, Husseini said "Saudi Arabia might reach an output of 12 million barrels a day in 10 years but before then – possibly as early as 2012 – global oil production would have hit its highest point." This crunch point is known as "peak oil".

Peak oil adherents may be quick to say “I told you so”.

However as we previously said,

While peak oil (via Hubbert Peak Theory) may be a valid engineering theory, it is a poor economic concept for the simple reason that engineering theories (like quant models) do not capture people’s behaviour.

The Wikileaks exposé only serve as a concrete example of how governments have steadfastly tried to manipulate every politically sensitive markets...and this includes the oil markets.

To consider, given the stranglehold control over oil supplies by different oil producing states, which accounts for more than 80% of the world’s proven reserves, if governments had the ascendancy to establish “equilibrium” then we won’t be bothered by prospective risks of shortages (via “Hubbert Peaks”) or suffer from elevated oil prices at all.

Graphs from the US EIA (includes BP Statistical Review and PRC Energy)

But obviously this hasn’t been the case.

Since governments are comprised by people—only that these elites have been politically mandated (which means they hold the barrel of the gun on us)—they suffer from the same frailties as anyone else.

Yet governments have been demonstrated:

-to lack access to the technology required to efficiently and productively utilize their oilfields,

-have had inadequate financing to invest to satisfy consumer demand,

-has revealed administrative incompetence in operating national firms or in the supervision of the 'choked’ industry, and

-most importantly, had been exposed for the paucity of knowledge to implement “equilibrium”.

It is worth emphasizing that with over 80% of proven oil reserves (supplies) controlled by global governments, this means there has hardly been a functioning free market in oil!

If Saudi officials are indeed guilty of withholding information then this reinforces the problems of the massive distortions in the oil markets which would likely implode on our faces-a negative externality as a result of government failure.

Otherwise, dynamic price signals in a free market would have reflected on the balance of demand and supply from which the marketplace would have adjusted accordingly.

What you have, instead, are vastly distorted oil markets that has been amassing intensive structural “supply-side” imbalances compounded by the manipulation of money supply by global central banks that has been contorting the “demand side”. A perfect storm in the making.

So what elevated oil prices suggest is not a validation of peak oil theory but one of the massive failure of government intervention or controls.

Paper Money System: Origin And Destiny

321gold’s Darryl Robert Schoon on the origin of paper currency (he quotes Ralph T. Foster’s book, Fiat Paper Money, The History and Evolution of Our Currency)

By 1661, China finally learned its lesson and the new Qing dynasty officially outlawed paper money. Regarding China’s 600 year experiment, Foster writes:

“Over the course of 600 years, five dynasties had implemented paper money and all five made frequent use of the printing press to solve problems. Economic catastrophe and political chaos inevitably followed. Time and again, officials looked to paper money for instant liquidity and the immediate transfer of wealth. But its ostensible virtues could not withstand its tragic legacy: those who held it as a store of value found that in time all they held were worthless pieces of paper. (page 29) [emphasis mine]

As the above excerpt shows, the paper money system has been an age old predicament for political leaders who always try to circumvent the fundamental laws of economics, but always ended up a failure.

Today, paper money has been repackaged and sold to the public as a product of modernity anchored upon central banking—operating on the platform of technology aided complex and sophisticated math or quant models.

And where lessons seem to have never been assimilated or learned, the same outcome should be expected as in the past. As Voltaire once said, “Paper money eventually returns to its intrinsic value…zero.”

Doug Casey On Corruption: Laws Create Corruption And Corruption Engenders Laws

Investment guru Doug Casey in this conversation gives a trenchant insight of the mechanics of corruption

On his definition of corruption: (all bold highlights mine)

a betrayal of a trust for personal gain

On the difference between private and public corruption

One can find corruption within corporations, as when directors betray their duty to the shareholders for personal gain. Or churches, as when priests, for pleasure, betray the trust of the young people under their guidance. Even a parent can be corrupt, if he fritters away on high living money intended to be left to his kid. But those types of corruption stem from personal weakness and personal vices. They're horrible – but corruption in government is much worse.

Only government can impose its will on you by law, and back it up with a gun. And with other sources of corruption you can – theoretically at least – go to the government for redress. But when the government is corrupt, it's hard to get the state's right hand to cut off its left. Not only that, but government – partly because its essence is force – concentrates corruption, and incubates it. If a company or church is corrupt, one can quit them. But citizens are stuck with their government – and they'll probably keep paying taxes to it regardless of their feelings toward it. A discussion about corruption is necessarily a discussion about government as an institution.

On the roots of public corruption:

As Tacitus said in the second century A.D., "The more corrupt the state, the more numerous the laws." It's absolutely predictable that as all these governments around the world – and I mean all of them – respond to the ongoing crisis with an ever-accelerating onslaught of new laws, there will be more and more corruption – and frustration with that corruption.

Tacitus was right. But he could just as accurately have said, "The more numerous the laws, the more corrupt the state," because lots of laws engender lots of corruption. In other words, corruption isn't the problem. The state and its laws are the problem, to which corruption is an unsavory and unaesthetic – but necessary – solution. Laws create corruption, and corruption engenders laws.

Every time a legislature convenes, they pass more and more laws. That's all they do, all day long. So the body of laws and the accompanying volumes of administrative regulations and procedures to implement them is constantly growing – the whole world over. Legislatures are horrible and dangerous things that bring out the absolute worst in the people who inhabit them.

Laws and regulations are like barnacles on a ship. They keep growing and growing, weighing the ship down, slowing it down. If they aren't scraped off from time to time, they will threaten the ship's structural integrity.

On the efficacy of anti-corruption laws:

Those laws necessarily have the opposite effect of what's intended. By raising the stakes, they just raise the level of bribery required, resulting in even more severe corruption. Like everything governments do, it' not just the wrong thing to do, but the exact opposite of the right thing to do....

The only way to fight official corruption is to reduce the amount of legal control of officials, particularly their regulatory power over the economy. If there were no government regulators, inspectors, assessors, auditors, and so forth ad nauseam, there'd be no reason for businesses and consumers to bribe them to get the hell out of the way.

On how free markets are self regulated:

There are many market forces that regulate business activity – and more broadly, cultural forces that regulate interactions between people. In the marketplace, reputation is a very powerful force. So is competition. And so is liability – it's a powerful negative incentive. More broadly, culture is a very powerful regulatory force, which is to say, peer pressure, moral opprobrium, and social approbation restrain people from being naughty far more than fear of police does. And there are also private institutions that have powerful regulatory influences, such as churches, Rotary, Lions Clubs, and the like.

On the public’s wrong impression on the significance of government:

People somehow imagine that because government regulations are backed with the iron fist of the law, they work better, especially when the matter is considered vital. This is simply incorrect. It shows an ignorance of both history and of the state of the world today. Regulation usually becomes so corrupt that it ends up doing the opposite of its intended effect. A business that pays officials to look the other way can do even worse things than they would do if there were no officials, because the official seal of approval falsely tells the people that all is well. That's why the SEC should be called the "Swindler's Encouragement Commission" – because it lulls investors, especially the novices, into feeling they're protected.

On the roots of regulatory corruption:

Strict regulation leads naïve people to think, "Everything is under control." That has two important effects. One, it makes them irresponsible – a belief that they don't have to concern themselves. That general attitude then permeates the society. Two, regulation always creates distortions in the market. It's like a lid on a pressure cooker. Everything looks under control until the whole thing blows up.

That's what lies at the root of the concept of "black swan" type unexpected events. The black swan lands when the amount of corruption necessary to evade laws becomes as onerous as the laws themselves.

On why corruption is a good thing:

There's good news and bad news in this.

In itself, corruption is a bad thing – it shouldn't have to be necessary. As I touched on earlier, insofar as it's necessary, it's also a good thing. If we can't eliminate the laws that give rise to corruption, it's a good thing that it's possible to circumvent these laws. The worst of all situations is to have a mass of strict, stultifying, economically suicidal laws – and also have strict, effective enforcement of those laws. If a culture doesn't allow people to work around stupid laws, that culture's doom is further sealed with every stupid law passed – which is pretty much all of them.

Read the rest here

MMDA’s Anti Smoke Belching Campaign

On the way to obtain the documents needed for the release clearance of my wife in the hospital, I chanced upon a platoon of enforcers in black t-shirts, along a major thoroughfare (Buendia near corner Urdaneta Avenue, Makati) whom were palpably on lookout for transgressors.

I asked the cab driver, “we might get caught for not wearing seatbelts”.

He replied “No, they are only after smoke belchers”.

“So what happened to the seatbelt law?” I asked the driver anew.

This time the driver kept mum.

I realized that a colleague of ours had been harassed by the same political authorities almost in the same vicinity.

Of course there is nothing really new to expect here considering the predominant political philosophy “social democracy” espoused by mainstream Filipinos—where a huge majority had been inculcated to believe that government is an indispensable part of most of our lives.

But the incident above only goes to show the following:

Arbitrary laws dominate the Philippine setting. Implementation of laws have not been “fixed and announced beforehand” (F. A. Hayek The Road To Serfdom) but are applied unequally and whimsically according to the priorities of the political authority.

Arbitrary laws can be used against anyone for many reasons to which favors the political class.

I would further presuppose that such law isn’t binding between people and authorities because exemptions will be conferred to politically connected class and their networks.

Further I am reminded by economist Bruce Yandel’s analogy of the Bootleggers and the Baptist-where both parties are for restricting the actions of other people through regulations but for different reasons: Baptists-for moral reasons while the Bootleggers for anti-competitive purposes.

I would suspect here that the Baptists represents the 'green' environmentalist groups, who advocates for “nature” friendly energy, while the Bootleggers are probably those who benefit from the phasing out of old cars or as signalling to industries that haven’t been under the auspices of the incumbent political authorities. At the end of the day, what is restricted usually grows.

It’s been pointed out here that import restrictions of used vehicles have led to smuggling, where regulatory restrictions could have been due to big car companies in bed with political authorities.

Of course, there is always the need to be seen to “do something”, which can be no less than public image management, considering that the Metropolitan Manila Development Authority (MMDA) is a national agency directly under the Office of the President.

Besides, it can also mean that the central government could flexing its political muscles relative to the local authority (Local Government Units) LGUs.

While MMDA says that they will attempt to meet their goals “subject to prior coordination with and consent of the local government unit concerned”, political goals of national and local government can lead to conflicts. And the national political leadership would always want to be seen on top.

Patron client relations could also be at work here. Since MMDA is fundamentally an overlap or a redundant organization amidst the legal existence of LGUs, having boatloads of idle government employees, whom are most likely political appointees (election rewards), may put up a bad image for the national government, thus the need to be seen at work.

There are many other reasons to fill in, which you may all add up.

But there is one thing I am sure of, MMDA is just one of the many “public service” organizations which inhibits Filipinos liberty and ultimately represents a waste of taxpayer money.

Update:

I stand corrected: those operating within the Makati zone are from the Makati LGUs. Nevertheless, MMDA still conducts its own operations at EDSA as shown here. (thanks for the pointer Noynoy Oplas)

Moreover, political incentives even applied to the LGU levels, are almost similar (aimed at generating positive image for election purposes, the bootlegger-preacher incentive and posturing or projecting "public servants at work" for political appointees).

In addition, smoke belching, wang wang and seat belts signify as arbitrary laws that taints the Philippine legal environment.

How Militarization Diminishes Economic Competitiveness

Some industries in the US have become significantly less competitive, NOT because of globalization or China or the Chinese yuan or the immanent bubble policies but because of the enormous influence of her gargantuan militarized economy.

From Armscontrol.org

From Google Public data

A militarized economy has not only distorted pricing and resource distribution but also negatively affected the political economic structure of industries that depended on it.

A good example is the machine tool industries.

The following is an excerpt of the enlightening and excellent discourse by Thomas E. Woods Jr. on this. (published at the American Conservative) [bold highlights mine]

Measurements of “economic growth” can be misleading if they do not differentiate between productive growth and parasitic growth. Productive growth improves people’s standard of living and/or contributes to future production. Parasitic growth merely depletes manpower and existing stocks of goods without accomplishing either of these ends.

Military spending constitutes the classic example of parasitic growth. Melman believed that military spending, up to a point, could be not only legitimate but also economically valuable. But astronomical military budgets, surpassing the combined military spending of the rest of the world, and exceeding many times over the amount of destructive power needed to annihilate every enemy city, were clearly parasitic...

The American machine-tool industry can tell a sorry tale of its own. Once highly competitive and committed to cost-containment and innovation, the machine-tool industry suffered a sustained decline in the decades following World War II. During the wartime period, from 1939 to 1947, machine-tool prices increased by only 39 percent at a time when the average hourly earnings of American industrial workers rose by 95 percent. Since machine tools increase an economy’s productivity, making it possible to produce a greater quantity of output with a smaller input, the industry’s conscientious cost-cutting had a disproportionately positive effect on the American industrial system as a whole.

But between 1971 and 1978, machine-tool prices rose 85 percent while U.S. industrial workers’ average hourly earnings increased only 72 percent. The corresponding figures in Japan were 51 percent and 177 percent, respectively.

These problems can be accounted for in part by the American machine-tool industry’s relationship with the Defense Department. Once the Pentagon became the American machine-tool industry’s largest customer, the industry felt far less pressure to hold prices down than it had in the past. That decreased pressure undoubtedly contributed to the negligible investment by the machine-tool industry in modern production techniques of a kind used routinely in Europe. No longer under traditional market pressure to innovate and lower costs, the machine-tool industry saw a considerable drop in productivity.

In the short run, the American machine-tool industry’s woes affected U.S. productivity at large. Firms were now much more likely to maintain their existing stock of machines rather than to purchase additional equipment or upgrade what they already possessed. By 1968, nearly two-thirds of all metalworking machinery in American factories was at least ten years old. The aging stock of production equipment contributed to a decline in manufacturing productivity growth after 1965.

Why Americans couldn’t have switched to lower-cost imported machine tools as soon as prices began to rise involves the reluctance of machinery buyers to change their suppliers. Not only do they prefer to deal with established firms with good reputations, but they also want to avoid unnecessary and costly downtime, so they patronize suppliers who can perform repairs and supply spare parts on short notice. In the long run, American firms did indeed begin to shift into imported machine tools, and by 1967 the United States for the first time imported more machine tools than it exported.

The military-induced distortion of the American machine-tool industry, and the industry’s correspondingly decreased global competitiveness, is not confined to the perverse incentives created by the Pentagon’s cost-maximization approach to procurement. Another factor is at work as well: the more an industry caters to the Pentagon, the less it makes production decisions with the civilian economy in mind. Thus in the late 1950s the Air Force teamed up with the machine-tool industry to produce numerical-control machine-tool technology, a technique for the programmable automation of machine tools that yields fast, efficient, and accurate results. The resulting technology was so costly that private metalworking firms could not even consider using it. The machine-tool firms involved in this research thereby placed themselves in a situation in which their only real customer was the aerospace industry.

Some 20 years later, only 2 percent of all American machine tools belonged to the numerical-control line. It was Western European and Japanese firms, which operated without these incentives, that finally managed to produce numerical-control machine tools at affordable prices for smaller businesses.

The distortion of business decisions and strategy that contributed to the decreasing competitiveness of the machine-tool industry is at work in thousands of American firms in rough proportion to their reliance on Pentagon contracts.

Read the rest here.

There are other unintended consequences from the military economic-corporatist framework, such as corruption.

This seems very relevant today in Philippine politics, where an ongoing expose over a supposed payola has triggered a former top military officer to suicide.

According to Carlos Conde of the Asia Times Online [emphasis added]

To be sure, corruption in the military is nothing new. In fact, the slush fund had existed even before the time of Reyes, as Rabusa himself admitted. A questionable practice in the armed forces called "conversion" - funds or budgets allotted for a specific purpose being used on something else, thus making it vulnerable to manipulation and kickbacks - has for years practically been the norm.

The practice allows commanding officers to bypass the military's slow-moving bureaucracy and deal directly with the suppliers of urgently needed equipment and weaponry, according to a military official familiar with the practice. Military officials, in turn, often ask for the cash equivalent of the equipment and then allow the supplier to process the papers and deal with the bureaucracy. The supplier often pads the cost of the equipment and gets approval from the comptroller, who will only sign if a kickback is assured, according to the official.

At the end of the day, a nation’s lack of competitiveness has almost always been a result of the many forms or faces of government interventionism, and this includes the military aspects—whether it is the US, the Philippines or elsewhere.

Yet the public or the mainstream only goes for oversimplified and superficial explanations rather than examining the roots of the issues.

With public ignorance of the structural issues, hence the vicious cycle.

When Public Education Backfires: Seeds To Egypt’s Revolt

Education equals prosperity is an immensely misguided concept.

It is a belief founded on an observation where prosperous societies are populated by educated people. The oversimplistic causation or applied syllogism which led to this conclusion says that education “caused” prosperity. Hence, many social policies adapted by nation states focus on getting people “educated”.

We have pointed out in this space that this isn’t (necessarily) true. Throngs of unemployed in many places as the Philippines have been “educated” people.

Here is an eye-opening insight from Troy Camplin who argues that Egypt’s free “public” education has backfired and has virtually sowed the seeds of the today’s upheaval.

We quote Mr. Camplin, (all bold highlights mine)

There are plenty of reasons to want to overthrow the sitting Egyptian government. But the irony is that the government’s largesse is part of the problem. The government provided free educations for its people, even though there was not a sufficiently complex economic system in place to create jobs for all of those people. In 2001, Alison Wolf argued in Does Education Matter? that “Egypt is a country whose government made a commitment to give (university) graduates first call on jobs in the public sector. It very quickly found itself with a vast and underemployed army of civil servants, and a huge queue of students aiming at comparable sinecures for themselves” (p.40).

There can only be so many government jobs. What happens when government can no longer absorb the excess college graduates? In the end, the Egyptian government created the current situation by creating a population too educated for its economic system.

Critics will immediately accuse me of arguing that we ought to keep the masses poor and uneducated, to ensure they don’t rise up. What I am in fact arguing is that we cannot create wealth by skipping steps, by leaping a country into a population whose education does not match its economic realities.

One of the side effects of an overly-educated population (overly-educated meaning there are more people with educations than jobs for them at that level of education) is that one has a population composed of people who are both dissatisfied with their lot in life and who know exactly what is causing their dissatisfaction. Their world is bigger, and the limits of their situation cannot contain them. It eventually spills into the streets.

Keeping people ignorant is one way to control people.

Also indoctrination in the form of public education is another form of control, as John Stuart Mill once wrote

A general State education is a mere contrivance for molding people to be exactly like one another; and as the mold in which it casts them is that which pleases the dominant power in the government, whether this be a monarch, an aristocracy, or a majority of the existing generation; in proportion as it is efficient and successful, it establishes a despotism over the mind, leading by a natural tendency to one over the body

Nevertheless, governments, as F. A. Hayek and Mises pointed out, can’t know everything and can’t calculate the nitty-gritty requirements of society. Thus, governments frequently institute policies that are noble sounding that comes with short term benefits, but has been laden self destructive traps, e.g. policies may eventually be used against themselves.

I am reminded of the nice apropos quote from A. Whitney Griswold (1909-1963: Essays on Education, 1954) who wrote,

"Certain things we cannot accomplish… by any process of government. We cannot legislate intelligence. We cannot legislate morality. No, and we cannot legislate loyalty, for loyalty is a kind of morality."

Education isn’t intelligence nor is it a source of political loyalty. The Egyptian Revolt seems to demonstrate this.

Is Mainstream Banking Bringing Gold Back as Money?

At the Huffington Post, structured securities expert Janet Tavakoli notes that US mainstream banking has began accepting gold as a collateral, she writes,

J.P. Morgan Chase & Co. announced on February 7, 2011 that it will accept physical gold as collateral for investors that want to make short-term borrowings of cash or securities.

Presenting gold to satisfy demands for performance bond collateral has been allowed on the London CME in a limited way since October 2009. As of November 22, 2010, the Intercontinental Exchange Inc. (ICE) has accepted gold bullion as collateral on all credit default swaps and energy transactions.

I don't recall the G-20 declaring gold a new currency. Yet JPMorgan Chase and a couple of financial market exchanges have effectively declared that gold is an alternative currency.

In other words, gold is money.

The market appears to be driving gold back to reassume its lost function—a role stripped away by ideological statists to advance their political agenda which has led to the grandest experiment of nearly 40 years: paper money via the US dollar standard.

And perhaps, such illusion—turning stones into bread—maybe coming home to roost.

As Professor Ludwig von Mises once wrote,

The return to gold does not depend on the fulfillment of some material condition. It is an ideological problem. It presupposes only one thing: the abandonment of the illusion that increasing the quantity of money creates prosperity.

How Socialism Failed: The Soviet Union Experience

Paul Craig Roberts gives a good account of this. [source:American Conservative] (bold emphasis mine)

The Soviet economy failed because it used more valuable inputs to produce less valuable outputs. The outputs would be measured as statistical product, but the values of the outputs were less than the values of the inputs. In other words, instead of producing value, the Soviet system was destroying value.

This was the result of ideological aversion to using prices and profits to allocate resources and investments. Instead of profit serving as a manager’s success indicator, managers were judged according to whether they fulfilled a plan measured in gross physical output, such as weight, number, square meters.

For example, the success indicator for the construction industry was the number of projects under construction. Consequently, Moscow was littered with unfinished projects because all activity was concentrated in starting new ones. The plan produced a housing shortage because the incentive was to start new constructions not to complete ones already underway.

If a shoe factory’s gross output indicator was a specified number of pairs of shoes, there would be plenty of baby shoes, but none for large feet, because the same amount of material could be used to produce one large pair or several small pairs.

If nails were specified in number, there would be small nails but no large ones. If specified in terms of weight, there would be assortments weighted heavily with large sizes. A famous Soviet cartoon shows the manager of a nail factory being awarded Hero of the Soviet Union for over-fulfilling his quota. In the factory yard are two giant cranes holding one giant nail.

If light fixtures were specified in number, they would be small. If in weight, they would be heavy. Nikita Khrushchev complained of chandeliers so heavy that “they pull the ceilings down on our heads.”

An abundance of natural resources with low extraction costs and the minimal allocation of resources to consumer needs permitted the Soviet economy to continue despite its enormous waste of resources in terms of consumer satisfaction and economic efficiency. But it couldn’t go on forever.

I am reminded of the great Ludwig von Mises who presciently augured for the demise of the Soviet Union’s socialism/communism:

A society that chooses between capitalism and socialism does not choose between two social systems; it chooses between social cooperation and the disintegration of society. Socialism is not an alternative to capitalism; it is an alternative to any system under which men can live as human beings.

Prof von Mises actually predicated his forecast based on the lack of property rights which resulted to the economic calculation problem that has been visibly demonstrated by the above narrative from Mr. Roberts.

Stock Market Prices: Inflation versus Corporate Fundamentals

Even in the US the supposed causal relationship between stock prices and earnings appear headed for irrelevance. That’s especially a conundrum for experts whom are fixated with “fundamentals” and seem at a loss on how market cycles occur.

Writes Vitaliy Katsenelson in A Sideways View of the World [via John Mauldin]

(bold highlights mine)

The stock market seems to suffer from some sort of multiple personality disorder. One personality is in a chronic state of extreme happiness, and the other suffers from severe depression. Rarely do the two come to the surface at once. Usually one dominates the other for long periods of time. Over time, these personalities cancel each other out, so on average the stock market is a rational fellow. But rarely does the stock market behave in an average manner.

Among the most important concepts in investing is mean reversion, and unfortunately it is often misunderstood. The mean is the average of a series of low and high numbers – fairly simple stuff. The confusion arises in the application of reversion to the mean concept. Investors often assume that when mean reversion takes place the figures in question settle at the mean, but it just ain't so.

Although P/Es may settle at the mean, that is not what the concept of mean reversion implies; rather, it suggests tendency (direction) of a movement towards the mean. Add human emotion into the mix and P/Es turn into a pendulum – swinging from one extreme to the other (just as investors' emotions do) while spending very little time in the center. Thus, it is rational to expect that a period of above-average P/Es should be followed by a period of below-average P/Es and vice versa.

People’s random-like personalities can’t create excessively wild swings in the stock market if the stock market is solely funded by the scarcity of savings.

In other words, greed and fear is no less than a symptom of a structural underlying cause—“circulation” credit inflation.

Mr. Katsenelson adds,

In sideways markets P/E ratios decline. They say that payback is a bitch, and that is what sideways markets are all about: investors pay back in declining P/Es for the excess returns of the preceding bull market.

We say no more that this represents a manifestation of a credit driven boom-bust cycle where investors overpay during a credit driven boom cycle and vice versa.

More from Mr. Katsenelson

Mean reversion is the Rodney Dangerfield of investing: it gets no respect. Mean reversion is as important to investing as the law of gravity is to physics. As long as humans come equipped with the standard emotional equipment package, market cycles will persist and the pendulum will continue to swing from one extreme to the other.

Mean reversion is simply the product of unsustainable booms.

This reminds us of Fritz Machlup who once wrote,

-A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.

-Any decrease in the effective supply of money capital is likely to cause disturbances in the production process.

-An inflated rate of investment can probably be maintained only with a steady or increasing rate of credit expansion. A set-back is likely to occur when credit expansion stops.

In short, the Austrian Business Trade cycle explains more the workings of the dynamics of stock market prices than mainstream’s “corporate fundamentals”. Even celebrity "former grizzly bear" guru Jeremy Grantham observed of this phenomenon but had a difficult time explaining it.

Economic Insights from My Weekend at the Hospital

I just can’t help it: economics is part of everything we do.

Some insights I gleaned from my weekend at the hospital.

1. Moral Hazard.

Free lunch is such a compelling idea. Financial intermediaries (health insurance) provide a huge incentive for both principal (doctors) and agent (patient) who sees ways to benefit from its use, even if confinement is not a prerequisite or a required procedure.

Said differently, when the cost of confinement is perceived as low (because it is paid for by a third party), then demand for its use is high.

The advantage (for us) is that health insurance financing provides the “confidence” factor arising from any lingering fears of serious diseases.

In our case, the goals were met: causality of the ailment had been ascertained and importantly the “confidence factor” was established. However, in my view, it would seem that my wife’s confinement as more representative of a placebo effect, because hospital procedures were more about the symptoms and that the treatment could have been done as an outpatient.

Translated into social policies. While private financial intermediaries are governed by profit and loss from the actuarial calculated premium and liability tradeoffs, extrapolated into social policies, free lunch from “universal” health insurance translates to massive demand for health resources. This would lead to rationing and resource allocation determined by the bureaucracy and subsequent skyrocketing prices in health related resources, aside from having less quality treatments.

2. Treating symptoms than the root of the disease.

I thought that I was conversing with an Austrian economist as one of the main attending doctors of my wife gave us a marvelous, or what I would deem as a medical, but economically sound insight: the importance of establishing the relevant causality in diagnosing health problems.

The veteran doctor said that symptom based treatment is a commonplace approach of typical doctors (for many reasons). From that approach, the risk could be one of misdiagnosis or a multitude of intake of prescribed medicines, from different doctors, that may lead to internal conflicts and or side effects which may be perceived by patients as serious ailment.

This very much reminds me of how mainstream economists and politicians recommend solutions to economic problems: they are mostly short term ‘symptom’ based whose solutions are predicated on the throwing money at the problem, changing the figurehead, or regulate or tax the problem—what I call the “Three Monkey Solution”.

So unforeseen consequences can be applied to individual health problems, in as much it is with social policies.

3. Murphy’s Law: Anything you try to fix will take longer and cost you more than you thought.

The fixation on ‘free lunch’ via third party financing was supposedly cost free on our part. At the end of the day, aside from the costs of dislocation, shuttling to and from the hospital to the house plus other petty cash items, a non-accredited doctor had to be paid with professional fees not covered by my wife’s policy—Murphy’s law applied.

4. Agency problem.

I don’t know how this applies with health industry participants (such as doctors) employed or enrolled with third party or financial intermediaries providing health care (in the case of my wife’s weekend experience).

While (principal) doctors aim to nobly serve the interests of their patients (agents), doctors are economic agents as well, who seek to be compensated for their efforts or through their services.

And I would suspect that as economic agents, there would be the underlying incentive to seek asymmetric gains from applying treatments; such as from having more procedures, or through confinement or through more consultations. Again, I can’t say how this applies to my wife’s case. But I am speaking in the general sense.

Aside from medical diagnostics, a lot of the professional fees also depends on the degree of social or interpersonal relationship with patients. In our case, the financial intermediary has built in fees covered with the policy which has not been reflected on the bill. Only the non-accredited doctor had to be paid for, but this is understandable.

This is not to disparage anyone, but the point is that individual incentives are very much in place even for the people in the health industry. (Incidentally, my wife had two great doctors)

And this could be one reason why many doctors, allegedly, resort to symptom based treatment (see #2).

The moral here is that we should be circumspect about dealing with free lunches (in anything), examine health problems via relevant causality (in cognition of the different incentives underpining the principal-agent relationship) and to judiciously weigh on cost-benefits of treatments.

After all, doctors like everyone else are just human beings.

And I thank the Lord that my wife is safe.

Blogging Hiatus, Again

A streak of unlucky months: my daughter got confined last December, now my wife.

I’d probably resume posting once conditions allow.

College Isn’t For Everybody

From Bloomberg (bold emphasis mine)

The U.S. is focusing too much attention on helping students pursue four-year college degrees, when two-year and occupational programs may better prepare them for the job market, a Harvard University report said.

The “college for all” movement has produced only incremental gains as other nations leapfrog the United States, and the country is failing to prepare millions of young people to become employable adults, said the authors of the Pathways to Prosperity Project, based at the Harvard Graduate School of Education in Cambridge, Massachusetts.

Most of the 47 million jobs to be created by 2018 will require some postsecondary education, the report said. Educators should offer young people two-year degrees and apprenticeships to achieve career success, and do more to ensure that students who begin such programs complete them, said Robert Schwartz, academic dean at Harvard’s education school, who heads the Pathways project.

Here in the Philippines, we share the same phenomenon.

The following charts from tradingeconomics.com...

College graduates constitute about 2/5 of Philippine unemployment!

13% of emigrants have been college graduates.

Both of the above represents fundamental evidences why “education is a right” fails.

More comments

-Education does not guarantee employment.

-Employment depends on Profits or the Rate of Returns on Investment, which is determined by many factors (mostly by the varying degree of government restrictions)

-Mass production of college graduates which doesn’t conform to the market’s demand (mismatching) leads to unemployment.

-Growing trade specialization patterns requires increasing skills specialization.

This also means tradition educational platforms will shift: where learning will occur from the unorthodox platforms (such as web based education) than from typical classrooms.

And because of this compulsory, learning will likely become shorter and not longer (as the Bloomberg article above shows) and this is why proposals impose regulations to extend years of education runs contradictory to the direction of the present trends and reeks of vested interests.

Education, writes futurist Alvin Toffler, will become more interspersed and interwoven with work and spread over the lifetime.

And this means trends towards learning through apprenticeship.

As Charles Murray of the American Enterprise Institute writes in a 2008 Wall Street Journal OpEd, (bold highlights mine)

Here's the reality: Everyone in every occupation starts as an apprentice. Those who are good enough become journeymen. The best become master craftsmen. This is as true of business executives and history professors as of chefs and welders. Getting rid of the BA and replacing it with evidence of competence -- treating post-secondary education as apprenticeships for everyone -- is one way to help us to recognize that common bond.

-Public funds spent for education that ends up in the unemployment statistics account for as enormous waste. Think 40% of unemployed, many of which comes from Public schools.

Further, the same unemployed will likely consume ‘safety nets’ which further bloats fiscal budgets. This should add to the lack of competitiveness which undermines investment and increases unemployment--thus a vicious cycle.

In short, the popular illusion that education automatically leads to jobs has been exposed. The welfare state fails.

-Even in the indoctrination to uphold state’s supremacy over the individual, technology has been eroding this, as information acquisition becomes increasingly decentralized.

-With lack of investment opportunities and the subsequent job opportunities, restrictions on migrations should be eased, if not lifted. This gives the people opportunity to learn and work where they think would best serve them or make them productive.

How Socialism Aggravates Harm from Natural Disasters: The Venezuelan Experience

The destructive side effects of Socialism are amplified by national disasters. Venezuela is an example.

Wall Street Journal’s Mary O’Grady writes, (bold highlights mine)

Most of Venezuela's democratic institutions have been destroyed by Mr. Chávez. But Caracas is still not Pyongyang or Havana, and a groundswell of popular dissatisfaction could yet unseat him. His favored strategy to deal with this risk is spreading government funds around and redistributing private wealth. Yet even as hundreds of millions of dollars have been reallocated under chavismo in the past decade, life for Venezuela's poor has been growing more difficult. Mr. Chávez's popularity has been dropping, as evidenced by the opposition's gains in Congress.

Then came the late November rains.

An estimated 130,000 people were left homeless when the northern tier of the country was hit with torrential downpours that lasted well into December. Their plight has become a main theme in all the president's speeches, and he has been scrambling to find them shelter. They have been sent to live in government clinics and offices, more than 150 hotels and even Miraflores, the presidential palace. At one point Mr. Chávez offered to pitch a Bedouin tent—a gift from the Libyan Moammar Gadhafi—in the garden of the palace to make room for flood victims in his home.

All of this has elevated a structural problem of housing shortages that many of Mr. Chávez's constituents expected him to solve when he came to power. Instead the problem has gotten worse.

According to Aquiles Martini, the president of the Real Estate Chamber of Venezuela, who I interviewed by telephone from Caracas last week, the growing population requires 80,000-100,000 new homes per year. But during chavismo, he says, the country has added, on average, only 40,000 units annually. Venezuela now has a housing deficit of two million units. This explains why so many Venezuelans live in fragile, shanty-town housing and suffer so greatly during natural disasters.

Mr. Martini says 2009 was a good year, with 92,000 new units added to Venezuela's stock. But in 2010 the number dropped to 50,000, and the forecast for next year is still fewer new homes. One reason is the nationalization of companies that produce cement and steel. Venezuelan steel output dropped last year by 40% and cement output by 12%, and this provoked shortages in construction materials.

There are other deterrents. Builders have traditionally protected against inflation, now 30% annually, by indexing their contracts with buyers to cover rising costs during construction. But in 2009 the government outlawed this practice. Last year, accusations that some builders were still trying to hedge led the government to threaten harsh penalties and even jail some individuals. Many private developers have since disappeared. Investors who might like to build an apartment for rental income have also withdrawn from the market because, according to Mr. Martini, landlords no longer have the right to evict if their tenants don't pay.

Natural calamity + a cocktail mix of inflation and many other forms of interventionism= More social suffering.