Market Crash Confirms Some of My Thesis on Gold and Decoupling

The recent market meltdown confirmed many realities of the several thesis that I have been writing about.

Aside from the boom-bust cycles, the recent crisis debunks the decoupling theory.

When faced with the increased risks of a global liquidity contraction, market actions have converged to tighten correlations of the risk asset markets almost across the board.

As almost every markets fell, the US dollar and US treasuries became the temporary safehaven.

ASEAN markets, whom initially seemed defiant from the unfolding crisis in the West, has not been spared; even debt default risks, represented by prices of Credit Default Swaps (CDS), of ASEAN and Asian bond markets have begun to rise.

The US Dollar’s Temporary Role as Flight to Safety Haven

I’d like to further point out that the temporary status of the US dollar as refuge is largely due to the unraveling crisis of the Eurozone, or that the relative immediacy of the impact of the Euro debt crisis has been more than that of the US.

The US is NOT and will NOT be IMMUNE to the laws of economics as absurdly suggested by political zealots; the US also faces a prospective fiscal crisis from the continuing profligate ways of the welfare-warfare addicted government. The recent S&P downgrade[1] has been portentous of this.

The current record low or near zero rates almost across the yield curve, which for some represents as opportunity for the US government to further rack up expenditures, is not and will not be a permanent state. More welfare based extravagance ensures the erosion of the US dollar as safehaven status overtime.

Also since the US has largely been less reliant on cash transactions, thus US sovereign securities have temporarily assumed the role of moneyness or as an alter ego to cash.

Most importantly, the US dollar remains as the world’s premier foreign currency reserve as shown above where the US dollar represents about 60% of reserves held by governments and various institutions[2]. In addition, the US dollar represents 85% share of forex transaction in April 2010 down from a peak of 90% in 2001[3]. And of the $95 trillion size of global bond markets in 2010, the US accounted for the largest share at 39%[4].

This means that in a period of dramatic loan margin calls, redemptions or liquidations, and where most of the international payments and settlement system have been based on the US dollar, then it would be OBVIOUS that the US dollar becomes the de facto safe haven. The liquidations in the Eurozone only amplify on such dynamics.

It would be foolish to believe that the US is protected by some mantle of magical or supernatural powers. The only forces that has been giving the US dollar its current strength has mainly been the relatively worst current conditions of the Eurozone, global financial market’s perception of insufficient liquidity* and Ben Bernanke’s dithering on QE 3.0.

*Banking and state insolvencies are valid issues but central banks have been covering such shortcomings with the panacea of liquidity injections. Except that today, financial markets seem to discern that the current state of liquidity injections has not been enough.

Debunking Gold as Hedge Against Deflation and Fear

Another myth demolished by the present crisis is the assumed role of gold.

Many say that gold will function as hedge against deflation. Another camp says that gold functions as refuge against fear.

Both have been proven wrong.

The day Ben Bernanke inhibited the deployment of QE 3.0, gold prices along with the broad based commodity spectrum came crashing down together with global financial markets.

Where the perception that monetary expansion will not be applied, asset liquidation has dominated and gold prices had not been exempt.

So much for the deflation refuge. May I emphasize that asset deflation does not automatically suggest of consumer price deflation or an economic wide deflation-recession.

Also crashing equity markets around the world has been coincidental with falling gold prices. Essentially this discredits the idea that gold serves as refuge against fear.

True, many central banks will continue to inflate—such as the ECB, Swiss National Bank, National Bank of Denmark, Bank of Japan and others—but current state of markets suggest that their actions has not been satisfactory to warrant maintaining lofty record gold prices.

Either these central banks would have to inflate intensively, or more importantly, that team Bernanke joins the bandwagon to deliver the meat of what the market expects.

Also, while gold may be in a natural correction mode given its previously severely overbought conditions, I would think less about the importance of the technical conditions.

I believe that the Fed’s current inaction is temporary. Ben Bernanke would want to see more market pressures to justify QE in order to stave off deflation. In his recent public appearance he again raise the deflation bogeyman[5]

"If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation"

And since price trend of gold seems correlated with the actions of ASEAN markets, a wobbly gold price trend would translate to an uneasy or apprehensive markets for the Phisix or ASEAN equities.

Thus, unless I see gold prices make a substantial recovery, I am predisposed to say that ASEAN equity markets could be susceptible or vulnerable to significant price retrenchments for the time being

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[1] See Misleading Discussion on US Debt Downgrade Crisis, August 9, 2011

[2] Wikipedia.org Reserve currency

[3] Marketwatch.com Daily foreign-exchange turnover hits $4 trillion, September 2001

[4] Wikipedia.org Bond Market Size Bond market

[5] See Ben Bernanke: Falling Markets will Justify QE 3.0, September 30, 2011

Phisix: Internal Market Actions Reflect on Boom Bust Conditions

Market internals reflect on the highly volatile bubble conditions.

The steep gyrations in both directions over the past two weeks had been equally reflected on market internals in the US or in the local markets.

Those stubbornly insisting that stock prices are about ‘earnings’ should explain the deepening unorthodoxy of the price actions in the equity markets or the growing discrepancy between price actions and ‘fundamentals’.

Current price actions in the local or in the US markets increasingly reflect on tidal flows[1] which are symptomatic of boom bust cycles.

Market breadth has been lopsided during downturns and in as much as in upturns.

Sectoral performances reflected on the same patterns. The meltdown a week ago which exhibited a broad based decline, had been reversed last week.

Bizarrely despite the furious volatility, foreign outflows remain limited.

Such dynamic appears to be reflected on the Philippine Peso which curiously still remains at the mid 43 levels despite the current turbulence. On Friday, the Philippine peso closed at 43.72 which was little change from last week’s 43.58.

Finally, there has been a huge spike in the weekly average of total number of issues traded even as markets moved sharply in both directions.

The extreme signs of volatility suggests of a very emotional state of the markets, which again highlights boom-bust conditions.

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[1] See US Equity Markets: More Signs of Tidal Flows, September 29, 2011

Celebrating Unsung Heroes of Capitalism: Wilson Greatbatch

From analyst Andy Kessler at the Wall Street Journal (emphasis added)

Wilson Greatbatch, 92, died this week a wealthy man. Investing $2,000 of his own money way back in 1958 and tending a garden to feed his family, Greatbatch invented the pacemaker. He licensed it to Medtronic, a company now valued at $36 billion that sells and continues to improve pacemakers and defibrillators. Greatbatch did his part to improve society, create wealth and increase, quite literally, our standard of living. But apparently that's not enough. President Obama suggested under a Cincinnati bridge this month that "if you've done well . . . then you should do a little something to give something back."

Give something back? Greatbatch did well specifically because he provided something that society needed. His and Medtronic's profits are what you and I are willing to pay above costs for these life-enhancing devices. This is true of Apple iPhones and Genentech Herceptin and Google Maps and Facebook Likes.

Ever since the mid-19th-century era of so-called Robber Barons, this country has had a philosophical divide over the role of business in a democracy. It's time to set the record straight.

History has proven that the road to increased standards of living and wealth was built on productivity—doing more with less. It was the Industrial Revolution that got us out of the growing fields and into factories, which allowed us to pay for roads and teachers and civil servants. And now the move out of factories into air-conditioned offices is creating anxiety. It shouldn't. Labor replacement is productivity. James Spangler's vacuum cleaner. The Walker brothers' dishwasher. Clarence Birdseye's flash freezing. DuPont's Kevlar. And John Simpson's guidewire catheter for angioplasty and heart stents—the list goes on. Each invention generated wealth because it improved our lives, not because someone "gave back."

Thanks Mr. Greatbatch, RIP.

I hope that people will learn to treasure those whom have truly contributed to our wellbeing through the markets.

Can Bear Markets happen outside a Recession? China’s Shanghai and Bangladesh’s Dhaka Indices

While bear markets usually accompany economic recessions, the cause and effect does not always hold.

Proof?

The following is China’s Shanghai Index (Bloomberg)

The Shanghai composite melted away nearly one year ahead of the global collapse brought about by the Lehman bankruptcy.

Since October the peak of 2007, today, the SHCOMP still is about 60% off the peak.

Peak to trough, from October 2007 to October 2008, the major Chinese composite lost 70.6% in one year, which means that from 2008-2011, only 10% of the accrued losses had been recovered.

However, the resultant world economic slowdown from the Lehman episode only diminished China’s economic growth rate (tradingeconomics.com) but did not lead to a technical recession.

China’s economic growth rate peaked in 2007 at around 13% and bottomed at 6% in 2009.

That’s partly because of China’s humongous $586 billion stimulus program which temporarily shielded the economy but has led to massive malinvestments.

One would note that money supply incrementally grew (red lines) from 2005-2007, but accelerated when the enormous stimulus packaged had been unleashed.

What has been palpable was the growth had been in new loans (chart Guinness Atkinson), which seemed unaffected by the stock market crash.

However, the Shanghai Composite bear market began or coincided with the regime's monetary tightening.

Bank reserve ratios had been serially increased, aside from interest rates which rose in 2007 until February of 2008. (chart from IMF)

However as noted above, the stimulus only prompted speculation to shift money from the stock market towards real estate (see below)

Yet the Chinese government has been attempting to contain the ballooning bubble via the same tools it used against the stock market plus some additional features as financial markets worked around government regulations.

Again from the IMF, (bold emphasis mine)

The central bank has used both reserve requirements and higher interest rates to slow credit but still relies heavily on direct administrative limits on loan growth. The central bank has also introduced a supplemental “dynamically differentiated reserve requirement,” which varies across banks and through time based upon the pace of credit growth at the bank, the capital adequacy ratio, and other factors. Staff argued that this focus on quantity limits has limited the supply of bank credit but with little impact on the cost of capital or demand for new loans.

In addition, with guaranteed loan deposit rate margins, the banks still have strong incentives to expand lending. As a result, the control of monetary aggregates through direct limits on bank lending is already being disintermediated. There has been a significant rise in off-balance sheet provision of loans (e.g. through trust funds, leasing, bankers’ acceptances, inter-corporate lending, and other means) and a growing intermediation of credit through nonbanks and fixed income markets. In addition, over the past several months, there have been large loan inflows from offshore entities recorded in the balance of payments (as Chinese companies go abroad to offset credit restrictions at home). Such avenues were already partially counteracting the impact and effectiveness of monetary tightening and that tendency was likely to increase in the coming years.

The central bank indicated that it was committed to moving gradually to more price based tools of monetary policy, noting that loan and deposit rates had been increased four times since October. The central bank was also now monitoring a broader measure of “social financing”—which includes bank loans, off balance sheet lending, as well as funds raised in the equity and bond markets—in order to better judge financial conditions. They felt that the existing array of tools and the expanded scope of their surveillance would be sufficient to contain disintermediation risks. They also indicated that, to some degree, lending limits could be viewed as an effective microprudential device in a system where risk management and risk monitoring were still insufficiently developed.

The rise of off balance sheet financing would be symptomatic of what Hyman Minky’s would call as speculative financing of a credit cycle. This would somewhat replicate the role of the shadow banking system during the US mortgage crisis.

Bottom line: China’s continuing bear market has been a product of her government’s boom-bust policies.

One more example:Bangladesh

Bangladesh recently experienced a stock market crash that seems detached with the actions of global markets.

The Dhaka index still remains in a bear market since its apex in December of 2010… (Bloomberg)

…but there has been no signs of economic recession (tradingeconomics.com) accompanying the bear market

The apparent reason seems to be same: The reversal of the Bangladesh government’s previously induced boom policies with policy tightening that resulted to a stock market bust.

See my earlier explanation here

Depending on some other factors such as depth or penetration level of local investors on the domestic stock market or for other more reasons, actions in the stock markets can occasionally be detached from the real economy.

Self-Promotion: Prudent Investment Newsletters at the Wall Street Journal

I was surprised to see this…

My article featured in the Onespot section of the Wall Street Journal; click on the image to go to the link or this link.

Another shameless self-promotion for the Prudent Investor Newsletters

Stagflation, NOT DEFLATION, in the Eurozone

Some Keynesian diehards reach a state of egotistical orgasm, when they see the financial markets crashing, accompanied by record low interest rates.

They extrapolate these selective events as having to prove their point that today’s environment has been enveloped by a deflation induced liquidity trap- or the economic conditions, which according to Wikipedia.org, when monetary policy is unable to stimulate an economy, either through lowering interest rates or increasing the money supply.

Let’s see how valid this is.

The Dow Jones Euro Stoxx 50 or an equity index representing 50 blue chip companies within the Eurozone is down by about 28% as of yesterday’s close from its peak in mid-February.

For the month of August, the Stoxx 50 fell by a dreadful 16%.

Yet according to the Bloomberg the Eurozone’s inflation has raced to the highest level in 3 years.

European inflation unexpectedly accelerated to the fastest in almost three years in September, complicating the European Central Bank’s task as it fights the region’s worsening sovereign-debt crisis.

The euro-area inflation rate jumped to 3 percent this month from 2.5 percent in August, the European Union’s statistics office in Luxembourg said today in an initial estimate. That’s the biggest annual increase in consumer prices since October 2008. Economists had projected inflation to hold at 2.5 percent, according to the median of 38 estimates in a Bloomberg survey.

Chart above and below from tradingeconomics.com

So low growth, high unemployment and elevated inflation in the Eurozone characterizes a stagflation climate and NOT deflation, in spite of the stock market meltdown.

While it is true given that commodity prices have crashed lately, which should temper on or affect consumer price inflation levels downwards, this is no guarantee that deflation in consumer prices will be reached. Perhaps not unless we see a nasty recession or another bout of a funding crunch. So far global central banks continue to apply patches in the fervid attempt to contain funding pressures.

Besides, contra-liquidity trap advocates, everything will depend on how monetary policies will be conducted in the face of unfolding events.

The ECB has actively been purchasing bonds (Danske Bank).

Yet despite these actions, the ECB has adapted a relatively less aggressive stance compared to the US in 2008. This implies that the policy response has continually lagged market expectations, and importantly, has been continually hobbled by political divisions, which has led to the ensuing turmoil.

This is not to say that aggressive responses by political authorities would solve the problem, but as in the US, they could serve as a balm. These are the “extend and pretend” actions that eventually will implode. For me, it’s better to have the painful market adjustments now, than increasingly built on systemic fragility which eventually would mean more pain.

Yet, despite current hurdles central bankers have not given up.

Denmark will unleash the same inflationism to bailout her banks. According to this report from Bloomberg,

Denmark’s central bank said it will provide as much as 400 billion kroner ($72.6 billion) as part of an extended collateral program to provide emergency liquidity to the country’s banks.

Lenders will also be able to borrow liquidity for six months, alongside the central bank’s existing seven-day facility, at a rate that tracks the benchmark lending rate, currently 1.55 percent, the bank said in a statement today.

The country’s lenders face a deepening crisis that threatens to stall a recovery in Scandinavia’s worst-performing economy. Two Danish bank failures this year triggered senior creditor losses, leaving international funding markets closed to all but the largest banks. Lawmaker efforts to spur a wave of consolidation and help banks sidestep Denmark’s bail-in rules have so far failed.

For as long as central bankers fight to preserve the political status quo by using expansionary credit easing tools or inflationism, deflation remains a less likely outcome.

Will IMF’s bailout of Euro Reach $ 3.5 trillion?

From the Daily Mail,

Christine Lagarde, the managing director of the IMF, said the current war chest of around £250billion ‘pales in comparison with the potential financing needs of vulnerable countries’ and needs to be expanded to deal with ‘worst-case scenarios’.

Sources in Washington said the IMF’s pot of cash could be expanded to £2.6trillion although officials in London said that figure looked ‘incredibly high’.

Mrs Lagarde’s warning came as U.S. President Barack Obama said the debt crisis in Europe was ‘scaring the world’ and that eurozone leaders were not dealing with the issue quickly enough.

And a top Bank of England economist urged leaders around the world to stop the world plunging back into recession. ‘It’s doing something rather than just saying something that counts,’ said Ben Broadbent, a member of the Bank of England’s Monetary Policy Committee charged with setting UK interest rates.

Danger: U.S. President Barack Obama said the debt crisis in Europe was 'scaring the world'

Britain is liable for 4.5 per cent of IMF funding – meaning it would have to contribute around £115billion to an enlarged bailout fund, or £4,600 per household.

It is conceivable that figure may turn out to be slightly lower because Britain’s share is falling as rapidly growing economies such as China contribute more.

Britain has already handed over £12.5billion in emergency loans to Greece, Ireland and Portugal to help prop up the euro.

The staggering rescue package proposed by the IMF signify that the rest of the world will be included. This would be led by the United States which reinforces their backdoor participation (aside from the monetary channels).

(Wikipedia.org: IMF)

And the proposed bailout implies of the inclusion of ASEAN and the Philippines with 3.94% voting share.

IMF: IMF Executive Directors and Voting Power

Yet such humongous bailout scheme, if it does become a reality, would adversely impact global economic growth as resources are shifted from productive use towards saving the skins of Euro bankers and the political class. Filipinos will pay for this with higher taxes or inflation.

Moreover, there are no guarantees that shock and awe bailout tactics will work over the medium term or the long term. Just look at what has been happening to the US, whose economy continues to flag despite the trillions of dollars expended by the US Federal Reserve and the US government.

Also, by funneling large amounts of resources to current rescue programs, the world would have depleted or drained their resources should another crisis arise anytime.

Lastly, the use of scare tactics to secure political deals, seem to be acknowledged by politicians. Except that for some, they pretend to fight them, when they in truth—they have impliedly been promoting them.

Ben Bernanke: Falling Markets will Justify QE 3.0

From Ben Bernanke’s public appearance last night [source: Reuters] (bold highlights added)

Federal Reserve Chairman Ben Bernanke said on Wednesday the central bank might need to ease monetary policy further if inflation or inflation expectations fall significantly.

In his first public remarks since the Fed launched a fresh measure aimed at keeping down long-term borrowing costs, Bernanke indicated a willingness to push deeper into the realm of unconventional policy if economic growth remains anemic.

"It is something that we're going to be watching very carefully," Bernanke said in response to questions from the audience at a forum sponsored by the Cleveland Fed.

"If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation," Bernanke said.

My deciphering or translation of the above: ‘Despite the vocal protestations of my critics, a continuous decline of markets should validate my imposition of QE 3.0, which will absolve my position.’

The above statements serve as more evidence that Mr. Bernanke’s current policy actions appear to be constrained by politics. Global markets have already substantially fallen, with MSCI All- Country World Index of 45 nations breaking into the bear market territory last week, yet Chairman Bernanke’s favorite instrument has been in absentia.

Additionally, these statements can be construed as more indications that markets are being used as negotiation leverage or manipulated for political goals.

Could Mr. Bernanke, then, be wishing for the markets to endure further strains?

Has Germany and Ireland been printing their own Currencies?

I have seen some unconfirmed reports or rumors where EU member states as Ireland and Germany have been re-issuing their native currencies prior to joining the EU, particularly the Irish pound and the German deutschmark

From Moneynews.com

Ireland's central bank reportedly is printing Ireland's old currency in case the country leaves the eurozone. At least that's the rumor circulating in Dublin, notes Alan McQuaid, chief economist at Bloxham stockbrokers in that city.

McQuaid, writing a guest commentary for The Guardian, says he's not sure if the rumor is true. But he does hope Ireland has contingency plans in case the euro disintegrates.

Then again, given the record of European leaders, a lack of backup plan wouldn’t be surprising.
As Greece struggles to remain solvent, the European monetary union is scrambling to stop the debt crisis from spreading. If the crisis does spread, Ireland might be next in line.

Some pundits say Ireland should drop the euro.

Being master of your own destiny does have appeal, McQuaid admits. If it returned to the punt, Ireland could boost exports by devaluing the currency and reduce its debt burden.

Also, a known political insider Philippa Malmgren, special assistant to Special Assistant to the President for Economic Policy on the National Economic Council for ex-President Bush and was also a member of the President's Working Group on Financial Markets, aka, the Plunge Protection Team, at Sweden's largest business paper, Dagens Industri says that she expects Germans to return to the Deutschemark and have already ordered its re-issuance (hat tip: Bob Wenzel)

Germany refuses more emergency loans and prepares the reintroduction of the D-mark. They have already ordered the new currency and excites the printers to rush. It says the U.S. economy Doctor Philippa Malmgren.

"My impression is that the German Government sent us a number of signals that, from their perspective there is no other solution (than to leave the euro)," writes Philippa Malmgren, formerly an advisor to former U.S. President George W. Bush and global strategy director the banking giant UBS in his blog.

The validity of these reports are unclear.

Nevertheless, when markets are usually exhibiting signs of depression as this, they could signal a bounce or an important inflection point.

Otherwise if these reports are true, then a realization of Euro’s disintegration would likely mean intensely turbulent times for the financial markets—as the “newly” independent European central banks would likely embark on saving their respective national banking system by printing tsunami of money to counter waves of deflationary defaults.

In this case, we should expect even more massive gyrations both on the upside and downside that could make hearts palpitate rapidly.

Fasten your seat-belts.

Global Wealth Convergence

Economist Timothy Taylor writes, (bold emphasis mine)

It is possible that although inequality within many countries is rising, global inequality is actually falling. After all, a number of countries with lower levels of per capita income, like China and India, have been experiencing rapid growth. Perhaps from a global viewpoint, the gap between high and low incomes is diminishing even though within countries, that gap has been rising.

What looks more like Aristotle’s the “whole is greater than the sum of its parts” is what I call as the global wealth convergence dynamic

Mr. Taylor quotes an IMF study suggesting that China and India has been key factors that have been led to this,

What is the evidence on global inequality? Branko Milanovic offers a useful figure, where inequality is measured by the Gini coefficient. For those not familiar with this term, the quick intuition is that it is a measure of inequality where 0 represents complete equality of income and 100 represents complete inequality (one person has all the resources). Here is a figure showing Gini coefficients for relatively equal Sweden, the less equal U.S. economy, the still-less-equal Brazilian economy, and the world economy.

Milanovic writes: "Global inequality seems to have declined from its high plateau of about 70 Gini points in 1990–2005 to about 67–68 points today. This is still much higher than inequality in any single country, and much higher than global inequality was 50 or 100 years ago. But the likely downward kink in 2008—it is probably too early to speak of a slide—is an extremely welcome sign. If sustained (and much will depend on China’s future rate of growth), this would be the first decline in global inequality since the mid-19th century and the Industrial Revolution.

One could thus regard the Industrial Revolution as a “Big Bang” that set some countries on a path to higher income, and left others at very low income levels. But as the two giants—India and China—move far above their past income levels, the mean income of the world increases and global inequality begins to decline."

My intuition is that globalization has functioned as one of the most critical variable contributing to the global wealth convergence.

China and India’s merchandise trade has ballooned from 10% in 1976 to over 50% and 30% respectively even after the 2008 crisis. That’s because trade is a mutually beneficial action which leads to prosperity.

From Ludwig von Mises, (Nation, State and Economy p.165)

Economic history is the development of the division of labor. It starts with the self-contained household economy of the family, which is self-sufficient, which itself produces everything that it uses or consumes. The individual households are not economically differentiated. Each one serves only itself. No economic contact, no exchange of economic goods, occurs.

Recognition that work performed under the division of labor is more productive than work performed without the division of labor puts an end to the isolation of the individual economies. The trade principle, exchange, links the individual proprietors together. From a concern of individuals, the economy becomes a social matter. The division of labor advances step by step. First limited to only a narrow sphere, it extends itself more and more. The age of liberalism brought the greatest advances of this sort.

Commemorating the 130th Birthday of Ludwig von Mises

Today is the 130th birthday of one of my inspiration and role model: the great Ludwig Heinrich Edler von Mises…

Asia’s Demographic Inequality

Demography isn’t destiny, so argues the Economist, (bold emphasis added)

INVESTORS are often lured to countries like India and Vietnam by their demographic promise—by their fast-growing population of workers and consumers. Likewise, investors in China often worry that it “will grow old before it grows rich”. Demographics are not destiny, but they are a noteworthy determinant of economic potential. Youngsters and retirees do not work, which harms growth directly. And because these dependants make a claim on a country’s income without adding to it, they also depress savings, thereby slowing the accumulation of capital and the growth of productivity. In its latest Asian Development Outlook, the Asian Development Bank calculates the contribution of Asia’s youthful demographics to its economic success over the past decade. The bank also projects the impact of a greying population on Asia’s growth from now until 2030.

I concur that demographics represent only part of destiny. The economic destiny of every nation depends on the extent where people are allowed to accumulate and use capital efficiently (via economic freedom and free trade).

The Fallacy of Luddite Economics

We are told that by this Wall Street Journal article that business spending on machines than labor is bad news for the US economy. (bold emphasis added)

The man-vs-machine situation, however, presents a huge negative to the outlook. In an economy based on consumer spending, the lack of jobs and income growth means consumers can’t spend.

Businesses’ preference for equipment — while understandable from a cost perspective — is also a big reason why policymakers are stymied to find ways to ignite job creation.

Indeed, the Federal Reserve‘s pursuit of low interest rates only widens the cost gap. That’s because it cheapens the borrowing costs for capital projects while doing little to hold down payroll expenses.

The reasons cited why businesses spending have been substantially tilted towards machinery have rightly been attributed to political factors:

Aside from the Fed’s policies, again from the same article, (bold added)

You can’t fault companies for investing in new machinery rather than hiring new workers. As two news reports detail, labor costs are rising, a function of both private and public pressures.

First, employers face a jump in health insurance costs. The Kaiser Family Foundation reported a 9% average increase in the premiums paid by employers this year. The average yearly cost to cover a family hit a record $15,073, up sharply from $13,770 in 2010.

Second, companies must deal with higher taxes to replenish state unemployment-benefit coffers. According to Wednesday’s Wall Street Journal, employers will get hit by higher tax bills as many states have to pay back Washington for benefit money borrowed during the recession.

So while politics has been a factor, this misses out the more important factor: Investments in machines are about added productivity and a higher standard of living, which eventually brings about more jobs.

The great Henry Hazlitt demolishes this myth in the must read classic Economics in One Lesson p.41-42. Here is an excerpt: [bold emphasis added, italics original]

it is a misconception to think of the function or result of machines as primarily one of creating jobs. The real result of the machine is to increase production, to raise the standard of living, to increase economic welfare. It is no trick to employ everybody, even (or especially) in the most primitive economy. Full employment—very full employment; long, weary, back-breaking employment—is characteristic of precisely the nations that are most retarded industrially. Where full employment already exists, new machines, inventions, and discoveries cannot—until there has been time for an increase in population—bring more employment. They are likely to bring more unemployment (but this time I am speaking of voluntary and not involuntary unemployment) because people can now afford to work fewer hours, while children and the overaged no longer need to work.

What machines do, to repeat, is to bring an increase in production and an increase in the standard of living. They may do this in either of two ways. They do it by making goods cheaper for consumers (as in our illustration of the overcoats), or they do it by increasing wages because they increase the productivity of the workers. In other words, they either increase money wages or, by reducing prices, they increase the goods and services that the same money wages will buy. Sometimes they do both. What actually happens will depend in large part upon the monetary policy pursued in a country. But in any case, machines, inventions, and discoveries increase real wages.

By the article’s main premises—where consumption drives the economy and where machines signify a threat to consumption—then we must conclude that the medieval era or even the stone age would be a much wealthier and ideal society than today.

US Equity Markets: More Signs of Tidal Flows

Anyone who argues that stock market valuations have been about contemporary fundamentals should see this.

The market breadth of the US S&P 500 has increasingly been either about floating or sinking ships from tidal flows.

This great observation from Bespoke Invest, (chart above from Bespoke)

We consider 'all or nothing' days in the market to be days where the net daily A/D reading in the S&P 500 exceeds plus or minus 400. With today's A/D reading of -470, there have now been 42 'all or nothing' days for the S&P 500. At this rate, 2011 is now on pace to see 57 all or nothing days, which would eclipse the record high reading we saw back in 2008.

The most shocking development of late is how common 'all or nothing days' have become. Up until a few years ago, these types of days were pretty rare, but in the 42 trading days since the start of August, more than half of them (22) have been 'all or nothing'.

This exhibits how US and global equity markets have been massively distorted by sundry government interventions, such that intense ebbs and flows into the marketplace are increasingly manifestations of internal boom bust cycles at work.

So sharp market volatility on both directions should be expected or has become the 'new normal'. This makes stock markets seem more like a gamble, since steep gyrations encourage short term actions rather than long term investments. Yet the above dynamic basically tilts the benefits to those whom are proximate or personally close to policymakers at the expense of the public.

Again, such skewness is courtesy of the politicization of the financial markets by political stewards led by Mr. Bernanke et. al.

Web Wars: Internet Activists battle against Web Censorship

From the Chronicle (opednews.com), [bold emphasis mine]

Computer networks proved their organizing power during the recent uprisings in the Middle East, in which Facebook pages amplified street protests that toppled dictators. But those same networks showed their weaknesses as well, such as when the Egyptian government walled off most of its citizens from the Internet in an attempt to silence protesters.

That has led scholars and activists increasingly to consider the Internet's wiring as a disputed political frontier.

For example, one weekend each month, a small group of computer programmers gathers at a residence here to build a homemade Internet—named Project Byzantium—that could go online if parts of the current global Internet becomes blocked by a repressive government.

Using an approach called a "mesh network," the system would set up an informal wireless network connecting users with other nearby computers, which in turn would pass along the signals. The mesh network could tie back into the Internet if one of the users found a way to plug into an unblocked route. The developers recently tested an early version of their software at George Washington University (though without the official involvement of campus officials).

The leader of the effort, who goes by the alias TheDoctor but who would not give his name, out of concern that his employer would object to the project, says he fears that some day repressive measures could be put into place in the United States.

He is not the only one with such apprehensions. Next month The­Doctor will join hundreds of like-minded high-tech activists and entrepreneurs in New York at an unusual conference called the Contact Summit. One of the participants is Eben Moglen, a professor at Columbia Law School who has built an encryption device and worries about a recent attempt by Wisconsin politicians to search a professor's e-mail. The summit's goal is not just to talk about the projects, but also to connect with potential financial backers, recruit programmers, and brainstorm approaches to building parallel Internets and social networks.

The meeting is a sign of the growing momentum of what is called the "free-network movement," whose leaders are pushing to rewire online networks to make it harder for a government or corporation to exert what some worry is undue control or surveillance. Another key concern is that the Internet has not lived up to its social potential to connect people, and instead has become overrun by marketing and promotion efforts by large corporations.

At the heart of the movement is the idea that seemingly mundane technical specifications of Internet routers and social-networking software platforms have powerful political implications. In virtual realms, programmers essentially set the laws of physics, or at least the rules of interaction, for their cyberspaces. If it sometimes seems that media pundits treat Facebook's Mark Zuckerberg or Apple's Steve Jobs as gods, that's because in a sense they are—sitting on Mount Olympus with the power to hurl digital thunderbolts with a worldwide impact on people.

This simply shows how technology facilitated markets will work around regulators as the latter will try to bring back the industrial age by imposing vertical flow of information.

Also this exhibits how 20th century top-down political organizations will furiously struggle to resist the snowballing 'bottom-up' forces fueled by the internet revolution.

Ben Bernanke Wants You to Beg For More Stimulus

From Marketwatch.com (bold emphasis mine)

The nation's weak labor market was "a national crisis" that required attention from the White House and Congress, Federal Reserve Chairman Ben Bernanke said Wednesday. "We've had close to 10% unemployment now for a number of years, and of the people who are unemployed, about 45% have been unemployed for six months or more. This is unheard of," Bernanke said in a question-and-answer session following a speech in Cleveland. He called for policies "that could help them find work, train for work and retain their skills." Bernanke also urged policy makers to consider "strong housing policies to help the housing market recover." Better housing policies would "clearly be very useful," and would allow the low mortgage rates stemming from easy Fed policy to have more effect and help the economy recover.

Ben Bernanke, as well as the US government, has been applying ‘strong policies’ even prior to this crisis which has essentially led to the current bubble bust conditions… through cheap credit, tax policies which skewed financing towards borrowing than equity, administrative policies via mortgage subsidies which encouraged speculation and bank capital regulation which rewarded securitization that spawned the shadow banking system

Additionally, the policy response to the current crisis has been for the Fed to buy $600 billion worth of mortgage securities in QE 1.0

The current Operation Twist has also partly been designed for this. Yet this innovative measure, will likely be another futile exercise, and at worst, with possible unintended effects.

Bloomberg’s chart of the day commentary,

The Federal Reserve’s effort to reduce borrowing costs is unlikely to help the housing market enough to bolster the economy, according to Andrew Milligan, Standard Life Investments Ltd.’s head of global strategy.

“Mortgage refinancing remains little different” from last year even though the Fed’s plan to buy longer-term debt and sell shorter-term securities sent rates on home loans to record lows, Milligan wrote two days ago in a report.

The CHART OF THE DAY compares the Mortgage Bankers Association Refinancing Index with the average rate on 30-year refinancings, as compiled by Bankrate.com. The index’s reading for the week ended Sept. 16 was about the same as last November, while the 30-year rate dropped to 4.10 percent this month, the lowest in eight years of data and down from last year’s 4.75 percent average.

Fannie Mae and Freddie Mac are doing too little to aid refinancings, according to Edinburgh-based Milligan. The mortgage-finance firms have operated under U.S. conservatorship for the past three years after loan defaults pushed them close to collapse. The lack of support is among “structural impediments to the housing market” that will limit the effectiveness of the Fed’s so-called Operation Twist, he wrote.

It’s not really about doing “too little” but rather after having done soooo sooo much with hardly any impact means that these policies have not met their targets (policy failure) and are not neutral too.

On the contrary, these policies may have lasting negative consequences.

As Professor Steve Horwitz observes (bold emphasis)

if we look at the loanable funds market, we might get a handle on the situation. If this program is designed to increase investment by driving down rates, it's not going to work if that demand for loanable funds curve is highly inelastic. Borrowers are just not going respond to the lower interest rate if they have major concerns about the future…

In other words, we shouldn't be twisting yield curves to increase the quantity of loanable funds demanded, we should be adopting a better policy regime so that the demand for loanable funds increases.

And ‘concerns about the future’ are likely to have been exactly prompted by these political interventions that has only heightened “regime uncertainty” or as per Professor Robert Higgs,

widespread inability to form confident expectations about future private property rights in all of their dimensions

Bottom line: All the measures thrown have only forestalled the necessary adjustments in the marketplace. The market’s function of discoordination and coordination has been obstructed by increasing concerns over future private property rights via various interventionist policies.

And this also reveals how the law of economics (or price controls) can’t be rescinded by political policies. And measures designed to mitigate effects of prior bubble policies, represent as band aid solutions that only defers on the day reckoning. Notice that when political intervention has been withheld, exactly the same set of problems resurfaces.

However for Mr. Bernanke, who seem to have been hobbled by mounting political opposition, appear to be using the markets as leverage. He would have you beg for more short term patches ["a national crisis" that required attention from the White House and Congress] before giving it to you. Fear signifies as the best tool to justify political intervention.

German Minister Calls Tim Geithner’s Bailout Plan ‘Stupid’

From Telegraph’s Ambrose Evans Pritchard, (bold highlights mine)

German finance minister Wolfgang Schauble said it would be a folly to boost the EU's bail-out machinery (EFSF) beyond its €440bn lending limit by deploying leverage to up to €2 trillion, perhaps by raising funds from the European Central Bank.

"I don't understand how anyone in the European Commission can have such a stupid idea. The result would be to endanger the AAA sovereign debt ratings of other member states. It makes no sense," he said.

Mr Schauble told Washington to mind its own businesss after President Barack Obama rebuked EU leaders for failing to recapitalise banks and allowing the debt crisis to escalate to the point where it is "scaring the world".

"It's always much easier to give advice to others than to decide for yourself. I am well prepared to give advice to the US government," he said.

The comments risk irritating the White House. US Treasury Secretary Tim Geithner has been a key driver of plans to give the EFSF enough firepower to shore up Italy and Spain, fearing a drift into "cascading default, bank runs and catastrophic risk" without dramatic action.

The danger for Germany is that America will lose patience, with unpredictable consequences. The US Federal Reserve is currently propping up the European banking system in a variety of ways, including dollar swaps.

Continuing political schisms will add to concerns over liquidity conditions and will likely continue to pressure financial markets whom have been mainly dependent on steroids. It will take bailout policies with a scale of "shock and awe" to reflate financial markets which implies coordinated actions.

Quote of the Day: Keynesian Cultism

Keynesianism is one big fallacy, and a cult fallacy at that. It violates the Law of Cause and Effect by declaring that effect really is cause. And it wants us to assume that work is nothing more than a transmission mechanism for money, and it does not matter what government pays people to do, just as long as it provides money so that they can spend it and make us prosperous.

This isn't economics. It is nonsense.

This is from Professor William L. Anderson.

I’d add intellectual fraud to Professor Anderson’s description, as Keynesianism is used by zealots to promote the religion of government or socialism.