Why The Current Market Volatility Does Not Imply A Repeat Of 2008

``The confusion of inflation and its consequences in fact can directly bring about more inflation.”-Ludwig von Mises

Every time financial markets endure a convulsion, many in the mainstream scream “DEFLATION”!

Like Pavlov’s dogs, such reaction signifies as reflexive response to conditioned stimulus, otherwise known as ‘classical conditioning’[1] or ‘Pavlovian reinforcement’.

Where the dogs in the experiment of Russian Nobel Prize winner Ivan Pavlov would salivate, in anticipation of food, in response to a variety of repeated stimulus applied (although popularly associated with the ringing of bells, but this hasn’t been in Ivan Pavlov’s account of experiments[2]), the similar reflexive interpretation by the mainstream on falling markets is to allege association deflation as the cause.

Not All Bear Markets Are Alike

Yet not all bear markets are alike (see figure 1)

Figure 1 Economagic: S&P 500, CRB Commodity Index and 10 year treasury yields

As one would note, the bear markets of the 70s came in the face of higher treasury coupon yields, represented by yields of 10 year treasuries (green line), which accounted for high inflation. This era of ‘high inflation-falling market’ phenomenon (or stagflation) is especially amplified in the recessions of 1974, 1980 and 1982 (shaded areas) as markets have been accompanied by soaring commodity prices (CRB Index-red line).

Thereby, the 1970s accounted for ‘deflation’ in terms of stock prices, borrowing the definition of the mainstream, amidst a high inflation environment, as referenced by rising consumer prices. As you would also note, the term ‘deflation’ is being obscured and deliberately misrepresented, since markets then, adversely reacted to the recessions brought about by a high inflation environment.

I’d also like to point out that surging inflation and rising stocks can be observed in 1975-1981, in spite of the 1980 recession. Although of course, the real returns were vastly eroded by the losses in purchasing power of the US dollar.

But in anticipation to the objection that high interest rates and high inflation extrapolate to falling stock markets, this isn’t necessarily true. As shown in the above, stocks can serve as an inflation hedge. And one can see a present day paradigm of this ‘surging inflation-rising stock markets’ dynamic unfolding in Venezuela!

Comparing 2010 To 2008

We always say that markets operate in different environments, such that overreliance on historical patterns could prove to be fatal. While markets may indeed rhyme or have some similarities, the outcomes may not be the same, for the simple reason that people may react differently even to parallel conditions.

For us, what is important is to anticipate how people would possibly react to the incentives provided for by current operating conditions.

We have been saying that this isn’t 2008. There is no better proof than to show how markets have responded differently even if many are conditioned to see the same (see figure 2) out of bias.

Figure 2: stockcharts.com: Market Volatility of 2008 and 2010

If one would account for the major difference between 2008 and 2010, it is that markets today appear to be pre-empting a 2008 scenario.

In 2008 (chart on the left window represents the activities of the year 2008), the post Lehman bankruptcy saw the S&P crash first before other markets followed, particularly oil (WTIC), and the Fear Index (VIX).

Even the US 10 year treasury yields (TNX) reacted about a month AFTER the crash in the S&P 500. This belated impact could be due to the spillover effects from the large build up of Excess Reserves (ER) to interbank lending rates as the increased in supply lowered rates at the front end, aside from ‘flight to safety’ reasons, which curiously emerged a little past the peak of the crash.

This time around (right window is the 2010 year-to-date performance), the market’s reaction has been almost simultaneous, this perhaps partly reflects on the Pavlov conditioned stimulus. And this could be the reason why many cry out “deflation”, when they seem to be deeply confused about the referencing of the term.

As we’d like to repeat, falling markets don’t reflexively account for ‘deflation’. Dogs do not think, but we do; therefore, we must learn to distinguish from the fallacies of ‘conditioned stimulus’ with that of the real events.

Besides, the fixation on ‘conditioned stimulus’ can account for, in behavioural science, as ‘anchoring’ effect, or where people’s tendency is to “rely too heavily, or "anchor," on a past reference or on one trait or piece of information when making decisions (also called "insufficient adjustment")[3]”. In short, trying to simplify analysis by means heuristics through anchoring is likely to be flawed one. And investors would only lose money from sloppy thinking.

Yet it is also worth pointing out that price level conditions of 2008 appear to be different.

In today’s market tumult, the fear index (VIX) has been rising but is still far away from the highs of 2008; where the highs of today are the low of 2008! Moreover while oil prices have dramatically fallen, an equally swift reversal seems to be in place!

Gold Sets The Pace

Figure 3: stockcharts.com: The Faces of Gold and Silver in 2008 and 2010

Another feature in 2008 which looks distinct today is the reactions in the precious metal markets (see figure 3).

In 2008 (left window), gold prices reacted instantaneously with the collapse in the S&P 500, but recovered about a month after, just as other markets displayed the aftershocks. Gold’s recovery portended a strong rebound in risks assets thereafter.

In 2010 (right window), we seem to be seeing an abridged (déjà vu?) version of 2010 for gold only. Gold appears to have responded in the same fashion by falling with the initial shock in global stock markets. But this seems to be ephemeral as gold prices appears to have bounced back strongly.

Yet Gold prices are only a stone throw’s distance from its record nominal highs. And if Greece would serve as an indicator of the direction of Gold’s prices, which reportedly were recently priced at 40% premium of the current spot prices or at $1,700 per ounce, then we could see gold prices closing this gap over the coming months.

Nevertheless, if inflation and deflation are defined in the context of changes in the purchasing power of money (the exchange ratio between money and the vendible goods and commodities), then gold, which isn’t a medium of exchange today, but a reserve asset held only central banks, are unlikely to function as a deflation hedge for the simple reason that our monetary system operates under a legal tender based fiat ‘paper’ money standard[4].

In an environment where people scramble for cash or see an enormous increase in the demand for cash balances, gold which isn’t money (again in the context of medium of exchange), won’t serve as a hedge. It is counterintuitive to think why people should buy gold when cash is what is being demanded.

Figure 4: Uncommon Wisdom[5]: Rising Gold Prices In Major Currencies

Hence rising gold prices represents either expectations of increases in inflation or symptomatic of a burgeoning monetary disorder. And since gold prices are up relative to all major currencies (see figure 4), then obviously, it would appear to be the latter.

So it would be another flagrant self-contradiction to argue for ‘deflation’ when markets are signalling possible distress on the current currency system.

And when people lose trust in money, this is not because of ‘deflation’ (where people have more trust in it), but because of inflation—the loss of purchasing power.

One very good example should be Venezuela. As Venezuela’s President Hugo Chavez regime seems hell bent to turn her country into a full fledged socialism, the bolivar, Venezuela’s currency, seem in a crash mode. Capital flight has been worsening in the face of soaring inflation. The Chavez regime is reportedly trying to arrest ‘inflation’ and the crashing ‘bolivar’ by raiding the foreign exchange black market[6]. Mr. Chavez does not tell the public that his government has been printing money like mad.

One objection would be that the US isn’t Venezuela, but this would be a non-sequitur, the point is people flee money because of inflation fears and not due to ‘deflation’ expectations. So rising gold prices are indicative of monetary concerns and not of deflation.

The Difference Of Inflation And Deflation

On a special note, I’d like to point out that it is not only wrong to attribute the impact of deflation and inflation to unemployment as similar, this is plain hogwash and signifies as misleading interpretation of theory.

Here, deflation is being referenced as consequence of prior policy actions of inflationism, which leads to unemployment. In other words, unemployment is the result of unwinding of malinvestments from previous bubble policies from the government which isn’t caused by ‘deflation’ per se.

Where the rise in purchasing power means cheaper goods and services or where people can buy more stuff, how on earth can buying more stuff (deflation) and buying less stuff (inflation) be deemed as equal?

Besides, based on the political aspects of the distribution of the credit process, inflation benefits debtors at the expense of the creditors, and vice versa for deflation. As Ludwig von Mises clearly explained[7],

``Many groups welcome inflation because it harms the creditor and benefits the debtor. It is thought to be a measure for the poor and against the rich. It is surprising to what extent traditional concepts persist even under completely changed conditions. At one time, the rich were creditors, the poor for the most part were debtors. But in the time of bonds, debentures, savings banks, insurance, and social security, things are different. The rich have invested their wealth in plants, warehouses, houses, estates, and common stock and consequently are debtors more often than creditors. On the other hand, the poor-except for farmers—are more often creditors than debtors. By pursuing a policy against the creditor one injures the savings of the masses. One injures particularly the middle classes, the professional man, the endowed foundations, and the universities. Every beneficiary of social security also falls victim to an anti-creditor policy.

``Deflation is unpopular for the very reason that it furthers the interests of the creditors at the expense of the debtors. No political party and no government has ever tried to make a conscious deflationary effort. The unpopularity of deflation is evidenced by the fact that inflationists constantly talk of the evils of deflation in order to give their demands for inflation and credit expansion the appearances of justification.” (bold highlights mine)

And this is apparently true today. Governments (global political leaders and the bureaucracy), the global banking and financial system and other political special interest groups (e.g. labor union in the US), which have benefited from redistributive “bailout” policies, have done most of the borrowing (see figure 5).

Figure 5: Businessinsider[8]: Total Debt To GDP by Major World Economies

Yet, the current inflationist policies, e.g. zero interest rates, quantitative easing, bailouts, subsidies and etc.., have been designed to filch savings of the poor and the middle class to secure the interests of these debtors.

So deflation isn’t a scenario that would be easily embraced by these interest groups, who incidentally controls the geopolitical order. Where deflation would reduce their present privileges ensures that prospective policy actions will be skewed towards the path of more ‘inflationism’.

Hence the political aspects of credit distribution, variances in the changes in purchasing power from politically based policies and the ramifications of inflationism does not only translate to a difference in the impact of inflation and deflation on every aspect of the markets and the economy, but importantly, tilts the odds of policies greatly towards inflationism. And eventually these policies will be reflected and/or vented on the markets.

For deflation to take hold would extrapolate to a major shift in the mindset of the mainstream politics.

Again deflation-phobes try to justify inflationism by the use of specious, deceptive and fallacious reasoning.

Groping For Explanation And The Bubble Mechanism

Another reason why today is going to be different from 2008, is that during the last crisis, the public single-mindedly dealt with the busting of the US housing bubble. First it was the collapse of mortgage lenders, then the investment banks, and the eventual repercussion to the US and global economies.

Today, the public seems confounded about the proximate causes of market volatility; there have been many, including the default risks of Greece, a banking system meltdown in the Eurozone, dismemberment or collapse of the EURO (!!!), another housing crash in the US, a China crash, and for fans of current events the standoff in the Korean Peninsula[9]!

And all these groping in the dark for an answer or for an explanation to the current market circumstances implies rationalization or information bias arising from “people’s curiosity and confusion of goals when trying to choose a course of action”[10].

When the public seems perplexed about the real reasons, then this volatility is likely a false signal or a noise than an inflection point.

Moreover, the alleged collapse of the Euro seems the most outrageous and symptomatic of extreme pessimism. Not that I believe in the viability of the Euro, I don’t. But such myopic assumptions ignore some basic facts, such as the recently reactivated swap lines by the US Federal Reserve--which incidentally have been insignificantly tapped, to which could possibly be indicative of less anxiety; according to the Wall Street Journal[11] ``reduced demand indicates that conditions are stable enough that overseas banks aren’t willing to tap into the swaps”--and that the IMF will contribute to the “bailout” of the Eurozone[12], which makes the Euro bailout a global action mostly led by the US.

Of course if the conditions will worsen in Europe, then it is likely that the US Federal Reserve may reduce its penalty rate to these emergency facilities to encourage increased access.

All these simply reveals of the cartel structure of global central banking system. This means that central banks around the world will likely work to buttress each other, as we are seeing now, to ring fence the banking system of any major economy from a collapse that could lead to a cross country contagion.

The Wall Street Journal quotes, Federal Reserve of St. Louis President James Bullard[13], ``Major nations “have made it very clear over the course of the last two years that they will not allow major financial institutions to fail outright at this juncture.” Since these “too-big-to-fail guarantees are in place, the contagion effects are much less likely to occur.” (emphasis added)

The sentiment of Mr. Bullard illuminates on the prevailing mindset of the monetary and political policymakers. Hence governments will continue to inflate, which has been the case, as we have rightly been arguing[14].

However, inflation as a policy is simply unsustainable. Hence, in my view, the current paper money system will likely tilt towards a disintegration sometime in the future. That crucial ordeal is not a matter of IF but a question of when. Of course, the other alternative, that could save the system, would be through defaults. But since debt defaults are likely to reduce the political and financial privileges of those in and around the seat of power, it is likely a contingent or an action of last recourse.

This means that default, may be an option after an aborted attempt to ‘hyper or super’ inflate the system. Where the consequences may be socially traumatic that would lead to a change in the outlook in public sentiment, only then will these be reflected on the polity.

Yet, both these scenarios aren’t likely to happen this year or the next, for the simple reason that consumer inflation is yet suppressed, which is likewise reflected on current levels of interest rates. And these artificially low rates allow governments more room to adopt popular inflationist measures[15].

And 2008 could be used as an example for this boom bust mechanism, where oil prices soared to a record high of $147 per barrel even as the economy and the markets were being blighted by strains from the housing bubble bust. The record high oil prices, weakening of the economy, the spreading of the unwinding of malinvestments and the mounting balance sheet problems of the banking and financial system all combined to serve as manifestations of a tightened monetary environment that seem to have immobilized the hands of officials relative to market forces. Eventually the culmination of these concerted pressures was seen in the ghastly crash of global asset markets.

Again this isn’t the case today.

Influences Of The Yield Curve, China and Political Markets

This also leads us back to our long held argument about the impact of the yield curve to the markets and to the economy[16].

The Federal Reserve of Cleveland demonstrates the effects of the yield curve to the real economy (see figure 6)

Figure 6 Federal Reserve of Cleveland: The Yield Curve May 2010

Inverted yield curves have been quite reliable indicators of recessions and economic recovery or the business cycles.

Yield curves tend to have 2-3 years lag. The recession of 2008-2009, was clearly in response to or foreshadowed by an inverted yield curve in early 2006-2007 (right window). Since the world went off the Bretton Woods gold dollar standard in 1971, the yield curve cycles have had very strong correlations, if not perfect (left window) with market activities and the real economy.

It is true that the past may have different influences in today’s yield curve dynamics, as Joseph G. Haubrich and Kent Cherny of the Federal Reserve of Cleveland[17] writes,

``Differences could arise from changes in international capital flows and inflation expectations, for example. The bottom line is that yield curves contain important information for business cycle analysis, but, like other indicators, they should be interpreted with caution.”

Nevertheless in contrast to the mainstream, which has patently ignores this important variable and instead continually blether about liquidity trap and ‘deflation’, one reason to depend on the reliability of the yield curve is due to the “profit spread”.

Again we quote anew Murray N. Rothbard[18],

``In their stress on the liquidity trap as a potent factor in aggravating depression and perpetuating unemployment, the Keynesians make much fuss over the alleged fact that people, in a financial crisis, expect a rise in the rate of interest, and will therefore hoard money instead of purchasing bonds and contributing toward lower rates. It is this “speculative hoard” that constitutes the “liquidity trap,” and is supposed to indicate the relation between liquidity preference and the interest rate. But the Keynesians are here misled by their superficial treatment of the interest rate as simply the price of loan contracts. The crucial interest rate, as we have indicated, is the natural rate—the “profit spread” on the market. Since loans are simply a form of investment, the rate on loans is but a pale reflection of the natural rate. What, then, does an expectation of rising interest rates really mean? It means that people expect increases in the rate of net return on the market, via wages and other producers’ goods prices falling faster than do consumer goods’ prices.”

In short, interest rates which fuels boom-bust cycles, also represents the profit spreads in the credit market as seen in the context of ``saving, investment, and the rate of interest are each and all simultaneously determined by individual time preferences on the market.[19]”

And considering that all the major economies are now on zero bound interest rates (which is likely to be extended), has steep yield curves and are engaged in some form of quantitative easing, while interest rates remain low, as seen in the long term yields of major economies sovereign papers and muted consumer price inflation, it is my impression that there won’t be any crashes, as peddled by the perma bears.

Of course, this is conditional to the surfacing of tail risks such as political accidents e.g. outbreak of military clash in the Korean Peninsula, unilateral call by Greece to default or secede from the European Union, and a crash in China etc...

And speaking of China we learned the authorities have shifted gears from “tightening” back to an “accommodating” policy (see figure 7).

Figure 7: Businessinsider[20]: China Is Back To Pumping Liquidity Into Its Financial System

Again this gives more credence to our view that policymakers approach social problems by throwing money at them, by regulation or by taxation or by a change in leadership[21]. All of which are meant to resolve the visible short term effects at the expense of the future.

Finally, Ludwig von Mises[22] on the deliberate distortions of the terms of inflation and deflation,

``The terms inflationism and deflationism, inflationist and deflationist, signify the political programs aiming at inflation and deflation in the sense of big cash-induced changes in purchasing power.”

In short, everything about the markets is now politics.

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[1] Wikipedia.org, Classical Conditioning

[2] Wikipedia.org, Ivan Pavlov

[3] Wikipedia.org, Lists of Cognitive Bias

[4] See In Greece, Gold Prices At US $1,700 Per Ounce!

[5] Brodrick, Sean, Get Your Gold and Silver Coins Now, Uncommon Wisdom

[6] Businessweek, Chavez Says Unregulated Currency Market May Disappear

[7] Mises, Ludwig von Interventionism: An Economic Analysis by Ludwig von Mises

[8] Businessinsider, Here's Everyone Who Would Get Slammed In A Spanish Debt Crisis

[9] See On North Korea's Brinkmanship

[10] Wikipedia.org, Information Bias

[11] Wall Street Journal Blog, A Look Inside the Fed’s Balance Sheet

[12] See The Euro Bailout And Market Pressures

[13] Wall Street Journal Blog, Fed’s Bullard: Europe Woes Unlikely to Trigger Another Recession

[14] See Why The Greece Episode Means More Inflationism

[15] See Global Markets Violently Reacts To Signs Of Political Panic

[16] See Influences Of The Yield Curve On The Equity And Commodity Markets

[17] Haubrich, Joseph G. and Cherny, Kent, Federal Reserve of Cleveland, The Yield Curve May 2010

[18] Rothbard, Murray N. America’s Great Depression

[19] Ibid

[20] Businessinsider: China Is Back To Pumping Liquidity Into Its Financial System

[21] See Mainstream’s Three “Wise” Monkey Solution To Social Problems

[22] Mises, Ludwig von Cash-Induced and Goods-Induced Changes in Purchasing Power, Human Action, Chapter 17 Section 6

Does High Debt And Falling Credit Lead To Deflation?

``The chief source of the existing inflationary bias is the general belief that deflation, the opposite of inflation, is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable. But, as we do not know how to keep prices completely stable and can achieve stability only by correcting any small movement in either direction, the determination to avoid deflation at any cost must result in cumulative inflation." Friedrich A. Hayek

Many say that huge debt loads carried by the world today would lead to deflation.

While there is some truth to this, the answer isn’t straightforward.

This mainstream view is best represented by economist Irving Fisher’s description of the events of the Great Depression, which we covered in 2008[1], ``Debt liquidation leads to distress selling and to Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes A fall in the level of prices, in other words, a swelling of the dollar.”

This simplistic narrative makes an impression that all debts are similar. Yet, this does not take into consideration the many other factors that hold sway to such an outcome, such as the monetary standard that the Great Depression operated on, regulations that limited interstate branch banking (McFadden Act[2]) which prevented banks from diversifying portfolios, the legal tender laws from central banking which prohibited the US banks from issuing their own notes[3], ‘bank holidays’ which denied depositors access to funding which equally increased uncertainty[4], and importantly the boom bust cycle or the clusters of malinvestment created by earlier monetary policies to uphold certain political interests.

According to Murray N. Rothbard[5], (bold emphasis mine)

``But a more indirect and ultimately more important motivation for Benjamin Strong's inflationary credit policies in the 1920s was his view that it was vitally important to "help England," even at American expense. Thus, in the spring of 1928, his assistant noted Strong's displeasure at the American public's outcry against the "speculative excesses" of the stock market. The public didn't realize, Strong thought, that "we were now paying the penalty for the decision which was reached early in 1924 to help the rest of the world back to a sound financial and monetary basis." An unexceptionable statement, provided that we clear up some euphemisms. For the "decision" was taken by Strong in camera, without the knowledge or participation of the American people; the decision was to inflate money and credit, and it was done not to help the "rest of the world" but to help sustain Britain's unsound and inflationary policies.”

So such storyline, which looks intellectually formalistic, sells well to the mainstream. What seems plausible is accepted without question or examining its basis.

But of course not all debts the same.

There are debts that are funded from savings and there are debts financed from ‘money from thin air’. The distinction is important because this defines the conditions that affirm or debunk the dynamics of Fisher’s debt deflation.

Dr. Frank Shostak[6] explains, ``when Joe lends his $100 to Bob via the bank, this means that Joe (via the intermediary) lends his money to Bob. On the maturity date, Bob transfers the money back to the bank and the bank in turn (after charging a fee) transfers the $100 plus interest to Joe. Observe that here money never disappears or is created; the original $100 is paid back to Joe.

"A fall in normal credit (i.e., credit that has an original lender) doesn't alter the money supply and hence has nothing to do with deflation."

``Things are, however, quite different when Joe keeps the $100 in the bank warehouse or demand deposit. Remember that by keeping the money in a demand deposit, Joe is ready to employ it at any time he likes.

``Now, if the bank lends Bob $50 by taking it from Joe's demand deposit, the bank will have created $50 of unbacked credit, out of "thin air." By lending $50 to Bob, the bank creates $50 of extra demand deposits. Thus, there is now $150 in demand deposits that are backed by only $100.

``So in this sense, the lending here is without a lender. The intermediary, i.e., the bank, has created a mirage transaction without any proper lender. On the maturity date, when Bob repays the money to the bank, that money disappears. The money supply falls back to $100, dropping by 33%.”

Robert Blumen[7] argues from the gold standard perspective,

``Suppose that on an isolated island the total money supply consisted for 1000 oz of gold and there are no fractional reserve banks. Now suppose that people lend either other various sums of money. Total debt could expand if the same money were lent and re-lent by the borrower more than once (which happens with a lot of securitized financial instruments). Suppose that total nominal debt reached 2000oz of gold, twice the money supply. Now if all of this debt defaulted (not realistic but for the sake of discussion), would there be any general deflation? No, because the money supply remained the same.”

In short, bank credit deflation as described by Mr. Fisher is conditional to debts funded by fractional banking system which causes contraction in the money supply.

According to Joseph Salerno[8],

``During financial crises, bank runs caused many banks to fail completely and their notes and deposits to be revealed for what they essentially were: worthless titles to nonexistent property. In the case of other banks, the threat that their depositors would demand cash payment en bloc was sufficient reason to induce them to reduce their lending operations and build up their ratio of reserves to note and deposit liabilities in order to stave off failure. These two factors together resulted in a large contraction of the money supply and, given a constant demand for money, a concomitant increase in the value of money.”

Yet if large debts presumptively results to a reduction in demand or a slack in credit takeup which leads to ‘deflation’, as linearly thought by the mainstream, inflation would be an imaginary event or that we would be seeing a fall in prices everywhere (see figure 8).

Figure 8 St. Louis Fed and TradingEconomics.com: Fall in credit and inflation

The upper window in figure 8 is a favourite chart by perma bears who love to spook themselves with the deflation phantom. It shows of the falling demand for credit, which according to them should be ‘deflationary’.

Yet since 2008, commercial and industrial loans have serially declined, yet inflation has been rising, after a short “foray” in the deflation territory in middle of 2009 until the end of the year.

So the deflation theory does not match real events. The reason for this is that there are many other factors, as government spending, QE, zero interest rates, steep yield curve, globalization and etc... that influences these financial, economic and political conditions.

But I see more problems for the perma bears. Commercial and industrial loans at all banks seem to cease declining and could be bottoming out. And if I am right, where the response to the yield curve will prompt for a material improvement in the health of the credit conditions by the end of the year, this chart will be excluded in the presentation for deflation.

Last word, today’s markets have been tidal driven, and there is little substance to argue for a micro based ‘decoupling’. Although inflationism has relative effects, global markets generally move in synch with the actions of the US markets. But this can be differentiated by the degree of gains or losses.

As such, the only way for the Philippine or Asian markets to outperform is for the US markets to trade sideways or head higher. Asian markets can’t and won’t defy a US crash. Nevertheless, we remain bullish with Asian markets for the simple reason that we don’t see a crash in the US markets or a redux of 2008.

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[1] See Demystifying the US Dollar’s Vitality

[2] Wikipedia.org, McFadden Act

[3] Wikipedia.org, Federal Reserve Note

[4] Wikipedia.org, Emergency Banking Act

[5] Rothbard Murray N., Reliving the Crash of '29, Mises.org

[6] Shostak, Frank, Does a Fall in Credit Lead to Deflation? Mises.org

[7] Blumen, Robert Massive Debt Deflation in Store? Mises Blog

[8] Salerno Joseph T. An Austrian Taxonomy of Deflation

Hugh Hendry: 'I would recommend you panic'

Here is an interesting discussion on Newsnight with Hedge Fund manager Hugh Hendry, economist Jeffrey Sachs and Financial Times' Gillian Tett.

The fascinating part is the engagement between Mr. Hendry, supposedly a fan of Austrian economist Jesus Huerta de Soto, and the mainstream camp whose views seem to be represented by academist Mr. Sachs. (hat tip Mises Blog, Jeffrey Tucker)



Some important comments by Mr. Hendry (courtesy of the comments posted at the Mises Blog)

~2:30 “When you bring on a professor and when you bring on a politician, they are unaccountable. If Jeffery’s wrong, he will survive in tenure. If I’m wrong, I go bankrupt. Who do you want to bet with?”

And,

~4:50 “I don’t know, was Jeffrey skiing two months ago? Because I was working and Julian was working. So we can tell you about the real world, because it doesn’t look like two months ago.” To which Sachs responded “please watch your language.”

Again more reasons not to trust presumptuous mainstream (ivory tower) views.

Update on Global Stock Markets

Here is a rundown of the performances of select stock markets around the world.


The table, from Bespoke, is calculated in US dollar and local currency terms, but ranked according to returns based on the US dollar.

According Bespoke,

``European equity markets look much worse in terms of dollars given the weak performance of the Euro so far in 2010. Spain is down 21.06% in local currency year to date, but it's down 32.36% in dollar terms. It's been a tough, tough year already for Spain. Italy is down the second most in dollars of the countries highlighted at -28.22%. China, which pegs its currency to the dollar, is down 18.96% in yuans this year, which is the second worst when looking at local currency performance. Mexico and Malaysia are the only two countries that are up year to date in dollars. Sweden is the only country up in local currency. Finally, Germany is the fifth worst country year to date in dollars, yet it's the second best in local currency. Oh the Euro. Don't worry Germany, the US can certainly feel your pain."

The Philippine Phisix as of Friday's close was up 6.55% both in local currency and US dollar terms, that's because the Peso has almost been unchanged at 46.19 where at the end of 2009 it was at 46.2. This should make the Phisix one of the top performers.

While it is true major markets are down, this seems hardly a replica of 2008.

Contracting Money Supply, Deflation Bugaboo And Dubious Statistical Models

In a recent article UK Telegraph's Ambrose Evans Pritchard cites the risks from contracting money supply to the economy and quotes an expert for reference to amplify these on concerns,

``"It’s frightening," said Professor Tim Congdon from International Monetary Research. "The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly," he said."

Of course these experts have long used contracting money supply to argue for a deflation scare, in order to justify more inflation or money printing as a cure.

Here is a relevant chart of different money supplies from John Williams' Shadow Government Statistics

And compare them to the movements of asset markets below...
If you look at the money supply chart, although mostly positive, the monthly rate of changes have been on a decline since 2008 (except for M3-now negative)! So given the trend of declining money supply, theory goes that markets ought to be collapsing (!) or at the very least we won't be seeing any material rallies in the markets!!

The chart above shows of the 2 year trends of the global stock market index (DJW), the commodities index (CCI), an index of US government securities (USGAX) and an emerging market debt fund (XESDX).

Despite the falling rate of money supplies, all of these asset classes, which competes for everyone's money, have been on the rise in spite of the recent volatility--a scenario in stark contrast to what's being painted.

This only goes to show that there must be some major loopholes or that global dynamics must have changed alot for these statistics not to capture the developments in the asset markets.

Yet the mainstream has been using the same models to anchor their bugaboos and argue for more zombie-fication of the markets.

We earlier dealt with the lack of reliability of models in Beware Of Economists Bearing Predictions From Models, and this seems like a good example.

In Greece, Gold Prices At US $1,700 Per Ounce!

In Greece, Gold prices are reportedly being traded at nearly 40% premium of current spot prices.

According to Coin Update News, (bold highlights mine)

``The fear running through the Greek populace is that the nation’s government may default on some of its debts."

``Since 1965, the Greek government has imposed restrictions on trading British Sovereign gold coins (gold content .2354 oz). Despite those restrictions, the Bank of Greece reports that it is selling an average of more than 700 coins per day to worried Greeks.

``In the first four months of 2010, the Greek central bank sold more than 50,000 sovereigns at its main downtown Athens office. Bank officials estimate that at least 100,000 other coins changed hands on the black market. The Bank of Greece has received as much as $409 per coin, which works out to a price of more than $1,700 per ounce of gold! Prices paid on the black market are reckoned to be even higher. A popular spot for street vendors to sell their coins is near the Athens Stock Exchange. There the traders wait for citizens to bring payments received from unloading their paper assets like stocks and bonds.

``The US government and some state governments such as California are in financial straits as bad as or even worse than Greece. How long will it take before American buyers will have to wait in lines to pay outrageous premiums for what are now bullion-priced gold and silver coins? More than one analyst thinks those days will come within a few months or sooner."

So how does "panic over default" translate to a stampede towards gold, considering that for the mainstream, these events are deemed as "deflationary"?

In a deflationary environment, gold isn't likely to be seen as 'safehaven' because gold isn't money in the sense similar to the function of paper money today, which have been imposed via legal tender laws, and subsequently used as the predominant medium of exchange by the consuming public worldwide.

Yet, one can't make an apples-to-apples comparison with the Great Depression era to highlight the case of gold's supposed refuge status under deflation. Then, gold was part of the medium of exchange known as the Gold standard. Today we have the paper money standard or the Fiat Money standard, where gold remains as reserve assets only for central banks.

In a deflationary environment, the real price of the currency or money's purchasing power increases or that the demand for cash relative to other assets is significantly greater. Hence, deflation and gold as an asset of sanctuary would seem inconsistent under the present fiat money conditions.

And Robert Blumen explains why the assumption that debt defaults leading to deflation isn't necessarily true,

``The only way that debt default is deflationary is if the debt that is defaulting was created out of nothing by a fractional reserve bank. The default of that sort of debt is deflationary. Because the price system is an integrated single market, all debt competes against all other debt, and all money supply changes affect all prices. So in a system like ours where some debt is created by banks as bank deposits, while other debut, such as bonds only transfers existing money, default of non-bank debt will eventually work its way through the price system and have some effect on bank debt." (emphasis added)

In other words, not all debts are created equal or derived from the fractional reserve banking, which is why it would be overly simplistic to account for deflation under concerns over debt default.

Moreover, following the monster Euro bailout by the Euro and the world, surging gold prices in Greece could likely exhibit symptoms of growing Monetary disorder, more than just inflation. Perhaps in the anticipation that a default may risk an expulsion from the Eurozone, which with the reintroduction of the drachma would extrapolate to massive inflation.

Another way to see this is that prices of Gold in Greece could be portentous of gold prices in all other currencies, as we see the same feedback mechanism applied by policymakers towards the global debt problem.

European Debt Crisis Explained

This spoof is hilarious. (hat tip Steve Horwitz)

Beware Of Economists Bearing Predictions From Models

Max Borders explains (emphasis added)

"So what do all these macroeconomic models have in common?

-They’re rendered either in impenetrable math or with sophisticated computers, requiring a lot of popular (and political) faith.

-Politicians and policy wizards hide behind this impenetrability, both to evade public scrutiny and to secure their status as elites.

-Models vaguely resemble the real-world phenomena they’re meant to explain but often fail to track with reality when the evidence comes in.

-They’re meant to model complex systems, but such systems resist modeling. Complexity makes things inherently hard to predict and forecast.

-They’re used by people who fancy themselves planners—not just predictors or describers—of complex phenomena."

The point is, according to Richard Ebeling, ``The inability of the economics profession to grasp the mainsprings of human action has resulted from the adoption of economic models totally outside of reality. In the models put forth as explanations of market phenomena, equilibrium — that point at which all market activities come to rest and all market participants possess perfect knowledge with unchanging tastes and preferences — has become the cornerstone of most economic theory."

Yet many people stubbornly refuse to learn from the lessons of the last crisis.

The mainstream hardly saw the last crisis from ever occurring:

This is why the Queen of England in 2009 censured the profession's failure to anticipate the crisis.

This also why US investment banks became an extinct species in 2008 as remnant banks were converted into holding companies, as losses strained the industry's balance sheets, which forced these banks into the government's arms.

This also why Ponzi artist Bernard Madoff gypped, not only gullible wealthy individuals but importantly a slew of international financial companies.

And this is also why contrarian John Paulson was able to capitalize on shorting the housing bubble via Goldman Sachs, which became a recent controversy, because the other side of the trade had been 'sophisticated' financial companies.

In retrospect, not only was the mainstream composed of highly specialized institutions, which were not only model oriented, but had an organization composed of an army of experts that have not seen, anticipated, predicted or expected these adverse events.

It is also important to point out that not only are the models unrealistic but those making these models are people with the same frailties whom they attempt to model. These people are also subject to the same biases that helped skew the models, which they try to oversimplify or see constancy in a dynamic world. They are also subject to Groupthink and the influences of Dopamine in their decision making process.

Adds Mr. Borders, (emphasis added)

``What does this mean for economics as a discipline? I think it’s time we admit many economists are just soothsayers. They keep their jobs for a host of reasons that have less to do with accuracy and more to do with politics and obscurantism. Indeed, where do you find them but in bureaucracies—those great shelters from reality’s storms? Governments and universities are places where big brains go to be grand and weave speculative webs for the benefit of the few.

``And yet “ideas have consequences.” Bureaucracies are power centers. So we have a big job ahead of us. We’ve got to do a seemingly contradictory thing and make the very idea of complex systems simple. How best to say it? Economists aren’t oracles? Soothsaying is not science? Ecosystems can’t be designed?

“The very term ‘model’ is a pretentious borrowing of the architect’s or engineer’s replica, down-to-scale of something physical,” says Barron’s economics editor, Gene Epstein. “These are not models at all, but just equations that link various numbers, maybe occasionally shedding light, but often not.”

Bottom line: Incentives and stakeholdings largely determine the mainstream's fixation to models.

Many are driven by ego (desire to be seen as superior to the rest), others are driven by politics (use math models to justify securing the interests of particular groups), some by groupthink (the need to be seen in the comfort of crowds), some because of personal benefits (defense of political or academic career, stakeholdings in institutions or markets or businesses) and possibly others just for the plain obsession to mathematical formalism.

At the end of the day, logic and sound reasoning prevails.

Quote of the Day: Lula da Silva: “Before being a socialist, you have to be a capitalist”

Here is Brazil's Lula da Silva in an interview,

“The country had no credit, had no working capital or financing or income distribution. What kind of capitalism was that? A capitalism without capital. I decided then that it was necessary to first build capitalism, then make socialism, we must have something to distribute before doing so."

In this vein, the president added that “if the country does not have anything, there is nothing to distribute, and employers need to know that they have to pay slightly higher wages so that people can buy the products they manufacture. Henry Ford already has said this in 1912. “

Translation: Fatten them before the slaughter.

Lesson: Lula's admission is that capitalism leads to wealth creation. However he has another unstated political agenda--which is to keep power by redistribution of wealth through votes.

As Ayn Rand once said, ``Whoever claims the right to redistribute the wealth produced by others is claiming the right to treat human beings as chattel."

On North Korea's Brinkmanship

One of main "reasons" attributed to the recent turbulence in the markets have been due to the brinkmanship stance shown by North Korea's leadership.


This from the Economist,

``ONE of the odd features of the dispute between North and South Korea since the torpedoing of the Cheonan by North Korea in March, is that the non-military responses available to the South and its allies are rather puny. Only a few hawkish South Koreans think a military response is desirable. Hillary Clinton, America's secretary of state, said that “the international community has a responsibility and a duty to respond” when she arrived in Seoul at the end of her Asian tour. For the international community, read China, which is reluctant to censure Kim Jong Il. The North's shortfall in everything from food to energy has been met by a mixture of trade with its southern neighbour and presents from China. The suspension of inter-Korean trade now leaves the poor North more dependent than ever on Beijing." (emphasis added)

This leaves us the following question can a North Korea wage a war against South Korea?

The answer is yes, but this would be suicidal for the following reasons:

Because this would unlikely benefit the heir of President Kim to which allegedly was the reason for the bellicosity. A losing war won't be in their interest simply because North Korea is so poor and isolated as to win a full scale war.

Next, considering that North Korea is in "shortfall in everything" waging war means it can only happen with China's consent.

Considering that it would not appear to be in the interest of China to escalate the region's troubles which could only ruffle her "successful" economic and geopolitical momentum, North Korea could only be trying to extract some marginal concessions.

Unless of course, China could be using the North to divert possibly international attention (e.g. from pressure to appreciate the Yuan).

Third, like most of the past troubles, North Korea as said earlier, may be just using the incident to extract more deals. Considering the diminishing returns from recent actions (missile test and etc.), this seem like a new approach, but again would be subject to China's approval or rebuke.

In short, unless North Korea's leadership has gone berserk the odds for a Korean Peninsula military conflict seems remote.

However, the longevity of the incumbent regime in North Korea is almost totally dependent on China. This only means that once China decides for a change in North Korea's leadership, there is little the Kims can do, and maybe could also serve as reason for this unfortunate event.

Finally, North Korea's predicament only reveals how socialism is a very inferior way of distributing resources to a society as exhibited by the "shortage in everything" and near utter dependence on China for most of her needs.

The lack of pricing signals and economic calculation in determining profit and loss factors has led to massive misallocation of resources (mostly to military spending).

Of course, there is also the issue of the paucity of motivation or incentives for her people to work which has been subject to collective distribution.

As Ludwig von Mises explained, ``What must be realized is that within a market society organized on the basis of free enterprise and private ownership of the means of production the prices of consumers’ goods are faithfully and closely reflected in the prices of the various factors required for their production. Thus it becomes feasible to discover by means of a precise calculation which of the indefinite multitude of thinkable processes of production are more advantageous and which less. “More advantageous” means in this connection: an employment of these factors of production in such a way that the production of the consumers’ goods more urgently asked for by the consumers gets a priority over the production of commodities less urgently asked for by the consumers. Economic calculation makes it possible for business to adjust production to the demands of the consumers. On the other hand, under any variety of socialism, the central board of production management would not be in a position to engage in economic calculation. Where there are no markets and consequently no market prices for the factors of production, they cannot become elements of a calculation."

This is a real time experiment failing right before our very eyes and should serve as a lesson, especially to the mainstream who frequently romanticize the role of government.

In my view, the current North Korean regime (Kim and his heir) isn't likely to last in the next 3-5 years. Either hyperinflation will undo North Korea or China forces a change in leadership. But the regional political volatility will remain until such transition occurs.

Gary North On Why Asia Will Surpass The West

Here is Professor Gary North on Why Asia will Overtake the West,

``How is it that Asia has had a huge trade surplus with the United States? Because its people work long hours. They are finally getting access to capital. This capital increases their productivity. The tools they need to compete are made available through thrift. Then they put capital to use in a long work week. They have little time for leisure. They are at work many hours per day.

``In contrast, Americans are losing capital through consumer debt and withdrawal from the labor force. I don't mean unemployed people. I mean underemployed people. The person who watches TV for 4 hours a day is consuming his most precious capital: time.

``When we see a society committed to work, we see a society that has the basis for economic growth. If people work hard to get ahead, they will accumulate capital. Their work will become more efficient. If they work merely to buy spare time for play, then they will not experience economic growth.

``Asia is growing economically, because of the people's future-orientation. The United States is barely growing, because of its present-orientation. We see this in the waste of time associated with entertainment. This is a culture-wide phenomenon. It has been accelerating in the West for at least 85 years. The rise of radio and the movies marked the transition. World War II delayed the advent of the entertainment culture. The 1950s produced the first teenage subculture. It had its own movies, music, and entertainment. Why? Disposable income from parents and part-time jobs. The money went into our pockets. That was my generation. We spent as children spend, but we spent more money than children ever had spent in history. We got used to entertainment. The counter-culture, 1965–70, was even more committed to entertainment. It even turned cultural revolution into entertainment.

``This happened all over the West. It was not a uniquely American phenomenon. The student revolt in France in 1968 was worse than anywhere else.

``We now live in a nation that has suffered capital consumption. Foreigners are providing capital for us. Asians buy something like 40% of Treasury debt sold to the public. This will not go on indefinitely.

``When we learned to waste time and money in our youth, we developed bad habits. These bad habits are not easily broken. Asians never developed these bad habits. The youth of Asia headed for the cities to get jobs, not entertainment."

While it is true that attitude, behavior and time preference are key factors necessary to an Asian outperformance, I think these are insufficient.

Accumulation of capital can only come from a political and economic environment that permits it to do so. As Ludwig von Mises wrote, ``The masses, in their capacity as consumers, ultimately determine everybody's revenues and wealth. They entrust control of the capital goods to those who know how to employ them for their own, i.e., the masses', best satisfaction."

In other words, Asia will be able to surpass West only if Asians pursue and maintain a more capitalist society or an environment of greater economic freedom which allows her people save and accumulate capital, from competition and production of more goods and services to serve the masses, whom as Mr. von Mises said, determines the wealth of the society.

Why Are Intellectuals Pessimistic?

Author Matt Ridley in an interview says,

"my answer is that pessimism gets attention – from funders, from the media, from governments. Also, for reasons I do not fully understand, it sounds wiser than optimism." (emphasis added)

I'd add that aside from personal interests in terms of attention and reputation, political agenda can always be a major motivating factor for advancing pessimistic agenda by the intellectuals.

Fear, brought about by intense pessimism, are often justification for interventionism or inflationism. As 2nd US President John Adams once said "Fear is the foundation of most governments; but it is so sordid and brutal a passion, and renders men in whose breasts it predominates so stupid and miserable..."

Matt Ridley has great insights in the interview (on technology and the environment). And here is an example where pessimism could be used as a political tool...

Again Mr. Ridley, ``Many times in history, promising bursts of openness, trade, innovation and growth have been snuffed out by the erection of barriers to the free flow of things and thoughts. It happened to Phoenician Tyre, classical Greece, Mauryan India, Ming China, Abbasid Arabia, imperial Rome, golden-age Holland. It happened to America in the 1930s, to Latin America and India after the second world war, to China after the communist take-over. Protectionism, tariffs, piracy, war, or imperial plunder – they all have the same impoverishing effect if they interrupt trade. Liberalization, by contrast, dramatically raised the standard of living of Hong Kong, China after 1980, India after 1990, South Korea versus North Korea and so on. And there are always short-term incentives pushing people to recommend protectionist or plundering measures." (emphasis added)

Yet most of the current interventionist policies are rooted on such pessimism (which ironically have been caused by the same set of prior actions).

Can Governments Be Trusted To Implement Self-Discipline?

If past performance is to be reckoned with, based on the Euro Zone, the answer is NO.

This from Bloomberg, (bold emphasis mine)

``Euro-area governments breached their own fiscal rules more than half of the time since they began trading the single currency, according to data compiled by Bloomberg News.

``With Greece’s debt crisis now exposing the weakness of fiscal oversight in the 16-nation economy, governments missed one or both of the European Union’s two budget requirements 57 percent of the time since they adopted the euro. Those rules limit debt to 60 percent of gross domestic product and budget deficits to 3 percent of GDP, as set out in the 1997 Stability and Growth Pact.

``The pledge by countries to meet their fiscal rules turned out to be “rhetoric rather than reality” and contributed to the debt crisis, David Blanchflower, a Bloomberg News contributor and former Bank of England policy maker, said in an interview from Dartmouth College in Hanover, New Hampshire, where he teaches economics.

``Of the economies that have been in the euro since it started trading in 1999, Belgium and Italy missed one or both of the targets in all 11 years. Greece failed in all nine years in which it used the euro. Finland and Luxembourg satisfied both goals every year."

Read the rest here (hat tip: Professor Antony Mueller)

Here is a Bloomberg interactive graph:

click on the image to direct you to the interactive graph at Bloomberg or click here

As the illustrious Milton Friedman explains about the 4 ways money is spent -where the fourth way is about people spending other people's money on other people,

``In this case, the buyer has no rational interest in either value or quality. Government always and necessarily spends money in this fourth way. This guarantees inefficient public spending because the spenders have no vested interest in efficiently allocating those funds." (bold highlights mine)

So in absence of discipline the next recourse is to print money! So who says we're in a crisis?

The Zombie-fication Of Financial Markets

World markets appear to be increasingly transmogrifying into zombie markets.

This from the New York Times,

``A week after rattling global bourses and annoying allies with a unilateral ban on some forms of financial market speculation, Germany went much further Tuesday, proposing a law that would greatly broaden restrictions on several instruments that investors use to bet against stocks, bonds and currencies.

``Despite criticism that market regulation will be toothless unless it is enacted globally, the German finance minister, Wolfgang Schäuble, on Tuesday proposed extending a ban on what the draft legislation called “certain transactions that amplify the crisis.”

``There is broad support for such measures among leaders on both sides of the Atlantic, and some of the proposed rules are already in effect in the United States. Other European nations, however, have complained about Germany’s decision to act alone.

``“What the Germans are doing would be all the more effective if it were done at a coordinated European level,” Chantal Hughes, a spokeswoman for Michel Barnier, the European Union internal markets commissioner, said Tuesday.

``The draft law, released Tuesday by the German Finance Ministry, expands a ban on so-called naked short-selling to all stocks that have their primary listing in Germany, as well as on government bonds issued by euro countries.

``The law, which will take at least until September to win passage in Parliament, would also ban naked short-selling of the euro, and enshrine a ban on use of so-called credit default swaps to bet against European government bonds."

What the news reveals is how mainstream politicians think. They believe they can:

1.control or manipulate the markets at will, with no unintended effects. (yes, they seem to think that as deified entities, they are far superior to market forces and above the laws of scarcity)

2. prevent markets from revealing their natural state by controlling price signals. Thus, a market collapse markets isn't in their books. (yet the markets have been collapsing)

3. paper over solvency issues with massive liquidity injections and price control measures.

More demand for zombification...

From BCA Research,

``History shows that whenever authorities limit the commitment to a particular value, it encourages investors to quantify their worst case scenario (which during times of financial sector strains can be horrific), leading to a panic and meltdown. It is only once policymakers provide a credible unconditional commitment to put an end to the turmoil that investors’ fears calm, allowing financial markets to stabilize. Unfortunately, the “open-ended” nature of European policmakers’ commitment has come into question: German authorities moved to prevent speculative attacks by banning naked short selling for 10 German bank stocks as well as for CDS on regional government debt. Similarly, the ECB continues to reiterate their intent to sterilize purchases of public and private debt securities, i.e. not quantitative easing. The decision on short selling should not be a large surprise given that the primary motive of German politicians to participate in any rescue package has been to protect their domestic banks. The only good news is that German lawmakers have approved its country’s share of the $1 trillion bailout package. Still, the ECB will need to be much more forceful in its reflationary efforts. Bottom line: The ECB should reassure markets that any expansion of its balance sheet will be unwound in an orderly fashion once the economy is on a stable footing. In the meantime, substantial quantitative easing must be undertaken."

First of all, the claim of "history" as reference is dubious. That's because all these debt binges, rescue efforts and reflationary measures, have been unprecedented in scale and in scope, so there is basically no basis for comparison.

Besides in our own Asian crisis, an open-ended rescue was not an option, instead we were prescribed to adapt "austerity" programs via structural adjustment programs (SAP).

Only today, do we see the "need" for massive or aggressive substantial quantitative easing. In short, money printing as a policy is selective and conveniently applied, where it involves the developed nations. It becomes not only a fashion but a false sense of entitlement.

Yet as we keep pointing out, even Keynesian Hyman Minsky believes that massive government intervention leads to systemic bubbles by engendering the moral hazard conditions that sow the seeds of a bubble.

And likewise, as noted above, substantial QE's or money printing won't solve the solvency issues. They merely "kick the can" or defer and even aggravate the day of reckoning. Yet, history has never been quite digested, but misrepresented.

In the words of Thomas Paine, ``I remember a German farmer expressing as much in a few words as the whole subject requires; "money is money, and paper is paper."

``All the invention of man cannot make them otherwise. The alchemist may cease his labors, and the hunter after the philosopher's stone go to rest, if paper can be metamorphosed into gold and silver, or made to answer the same purpose in all cases."

If printing money is, indeed, the elixir to the world's problem, then Zimbabwe should have been the most prosperous and the world's largest exporter.

Besides, based on this line of reasoning, why do we or anyone need to work, if, at all, money printing can solve the issue of scarcity? Why do we even need the markets?

Evidence Of Inflationism: Competitive Devaluation In The Eurozone

Here is an example why the paper money-central banking regime is in peril or can't be expected to last. And also why we should expect inflation, in spite of the recent market volatility.

This from Bloomberg, (bold highlights mine)

``Swiss central bank president Philipp Hildebrand is finding himself in a tug of war with currency markets and he may be on the losing side.

``Concern that the Greek fiscal crisis will spread through the euro area is pitching the Swiss National Bank against investors, forcing the Zurich-based central bank to sell francs at an unprecedented pace to fight the currency’s appreciation against the euro. With the SNB’s foreign-currency holdings now accounting for 68 percent of its balance sheet, economists say Hildebrand may have to spend even more to maintain the resistance.

“Greece is giving the SNB a major headache,” said David Kohl, deputy chief economist at Julius Baer Holding AG in Frankfurt. “We expect the SNB to continue to lean against the appreciation for as long as possible, but they won’t be able to keep up the pace of currency purchases much longer.”

``Hildebrand is already stepping up the fight as the franc strengthened to a record 1.4003 per euro on May 17, 14 months since the SNB began its intervention campaign to insulate Swiss exports and deflect deflation threats. The central bank added 28.5 billion francs ($24.6 billion) to its currency reserves in April, the biggest increase in at least 13 years, as Greece’s turmoil undermined the euro."

``The franc has strengthened 5 percent against the currency of the 16-nation region in the last six months."

Global central banks like the US Fed, the ECB and the SNB as shown above, are not only printing money in massive scale but absorbing assets of dubious quality...

Swiss Franc-Euro Trend

...with the aim of maintaining certain exchange rate levels for whatever goals (yes interventionism is always politically designed, but camouflaged by economic intent).

The problem is that market interventions almost always lead to unintended consequences.

A warning from Ludwig von Mises, (bold highlights mine)

``If one looks at devaluation not with the eyes of an apologist of government and union policies, but with the eyes of an economist, one must first of all stress the point that all its alleged blessings are temporary only. Moreover, they depend on the condition that only one country devalues while the other countries abstain from devaluing their own currencies. If the other countries devalue in the same proportion, no changes in foreign trade appear. If they devalue to a greater extent, all these transitory blessings, whatever they may be, favor them exclusively. A general acceptance of the principles of the flexible standard must therefore result in a race between the nations to outbid one another. At the end of this competition is the complete destruction of all nations' monetary systems."

When the public awakens to the reality that central bank balance sheets represents as the "emperor with no clothes" and that the power to tax has reached its limit, then the crack-up boom is likely to emerge.

In The US, New Businesses Surge in 2009!

In the US, the Kauffman Institute claims a record surge of new business activities in 2009.
Here is an excerpt of the press release "Despite Recession US Entrepreneurial activity Rate Rises In 2009 To Highest Rate in 14 years" (hat tip: Mark Perry)

"Rather than making history for its deep recession and record unemployment, 2009 might instead be remembered as the year business startups reached their highest level in 14 years – even exceeding the number of startups during the peak 1999-2000 technology boom.

"According to the Kauffman Index of Entrepreneurial Activity, a leading indicator of new-business creation in the United States, the number of new businesses created during the 2007–2009 recession years increased steadily year to year. In 2009, the 340 out of 100,000 adults who started businesses each month represent a 4 percent increase over 2008, or 27,000 more starts per month than in 2008 and 60,000 more starts per month than in 2007.

"Challenging economic times can serve as a motivational boost to individuals who have been laid-off to become their own employers and future job creators,"said Carl Schramm, president and CEO of the Kauffman Foundation. "Because entrepreneurs drive the economy, the growth in 2009 business startups is encouraging and hopefully points to a hopeful trend in terms of our economic recovery.”

Read the rest of Kauffman's press release here.

My comment: While the Kauffman institute does provide some details over geographical distribution of entrepreneurial activities (press releases naturally provides limited info), it doesn't make a breakdown on the industries where these activities have seen the surges.

My suspicion is that they'd probably be centered on technology or technology related activities.

But the point is, it's simply wrong to write off the elan of entrepreneurs, in spite of all the troubles (aftereffects of bubbles cycles, government intervention, bailouts, prospective high taxes, growth of government relative to the economy and etc..).

The ramifications of the deepening knowledge based economy is one of the x factors that can sustain free enterprise.

Plus Ca Change: President Aquino's Policy On Jueteng

It's been argued in this space that the new administration will unlikely provide a meaningful change in the way current things are being done.

For instance, the declaration of war against corruption will be unmasked as nothing more than demagoguery or posturing, for the simple reason that we cannot solve "corruption" by mere virtuosity because governance is about laws. And laws affect the way people conduct their business or individual actions. And in most occasions, official malfeasance function as a product of arbitrary laws.

Well, events are indeed turning out the way we see it.

President Aquino seems likely to begin his term by taking upon a populist stance.

This from the Inquirer,

``Presumptive president-elect Benigno “Noynoy” Aquino III has thumbed down a proposal by his uncle to legalize “jueteng,” a numbers racket that brings in millions of pesos in cash to operators and their protectors.

“Jueteng is against the law and we will enforce the law,” Aquino told reporters."

Nice.

Whether it is the church, media or politicians, the simpleminded solution to any social problem will always be the visible...in the case of jueteng, a numbers game used for grassroots gambling--by prohibition.

There has been nary an attempt by the domestic academe or by any institutions to study or analyze the impacts of these laws on society or how prohibitions can lead to corruption.

Incidentally, accepting jueteng money had been used as the main basis for the indictment of former President Joseph Estrada's plunder trial in 2001 to 2007.

For the mainstream, enforcement issues are merely a matter of virtue.

And it is why for the economically misinformed public, the solution is to change the people in charge, rather than to examine the net effects of the law. And it is also why eradicating corruption has been an ever elusive task.

And President Aquino's actions seem no better than his priors.


The fundamental problem with prohibition laws is that it does not deal with demand.

It mistakenly assumes that if you do away with supply, so will demand. That's where things go awry. Demand does not go away, but supply is now controlled by illegal elements through the backdoor with apparent blessings by those in charge. The huge profits from restricted supply and monopoly, thus, allows for mass payoffs along the layers of government's bureaucracy and to media.

Here is Professor Mark Thornton on the supply side impact of the Economics of Prohibition.

"Prohibition is a supply-reduction policy. Its effect is felt by making it more difficult for producers to supply a particular product to market. Prohibition has little impact on demand because it does not change tastes or incomes of the consumers directly. As supply is decreased, however, the price of the product will rise, the quantity demanded will fall, and demand will shift to close substitutes. For example, consumers of narcotics might shift their demand to alcohol and tranquilizers as their prices become lower in relation to narcotics as a result of prohibition."

In the case of jueteng, or the poor man's gambling game, this represents as an alternative (substitute) to horse racing or casino or Jai Alai which are legalized.

Ironically, the disparity of application of laws makes it appear that the poor have no right to engage in the same activity as the rich or the middle class. Hence, in my view, such laws are not only arbitrary and unenforceable but also discriminatory.

So whether rich or poor, where some people are inclined to gamble, the choice of horse racing, jai-alai or jueteng becomes an issue of accessibility or as substitutes to the poor.

Jueteng, in short, is a niche market for grassroots gamblers.

Nevertheless another negative effect of prohibition laws: waste of resources.

Again Professor Thornton,

"Efficiency in economics is the search to equate the marginal cost of an activity with its marginal benefit. For the individual, this means that the number of apples consumed depends on each apple's being valued at more than its cost. In public policy the situation is more problematic.

"In simple terms, the marginal cost of prohibiting one unit of a product is the cost of the law enforcement necessary to bring about this result. Every dollar spent on prohibition enforcement means one less dollar that can be spent on alternative public policies such as national defense, shelters for the homeless, or Congressional postal privileges. If taxes are increased to fund prohibition enforcement, individuals will have less to spend on food, medical insurance, and lottery tickets. Initially, the declaration of prohibition, the use of excess law-enforcement capacity, and the existence of marginal users make expenditures on prohibition enforcement highly productive.

"Also, these resources can be diverted away from the least important policies or consumer expenditures and therefore can be obtained at a low cost. After these initial conditions, the price of additional enforcement increases, its productivity declines, and the cost of expended resources increases."

So resources that could be spent on worthier social programs are wasted on law enforcement which has little benefit to the society. In short, society suffers from a net loss/deadweight loss (cost greater than benefit) on jueteng prohibition.

And here is the corrupting influence of prohibition laws...

Again Professor Thornton,

``Another motive for enacting prohibition legislation is to reduce corruption of both public officials and the democratic process. People have sold their votes for money or drugs, and the alcohol industry tried to influence elections and public policy. Politicians could also be subject to corruption and blackmail because of alcohol and drugs, and drug use can have a corrupting influence on the actions of political leaders. For these reasons, prohibition was promoted as a means to maintain the integrity of democracy and government.

[my comment: same here, the only difference is that good intentions backfires]

``In general, however, prohibition results in more, not less, crime and corruption. The black markets that result from prohibitions represent institutionalized criminal exchanges. These criminal exchanges, or victimless crimes, often involve violent criminal acts.

``Prohibitions have also been associated with organized crime and gangs. Violence is used in black markets and criminal organizations to enforce contracts, maintain market share, and defend sales territory. The crime and violence that occurred during the late 1920s and early 1930s was a major reason for the repeal of Prohibition (Kyvig 1979, 123, 167). The nondrug criminal activity of heroin addicts has been associated with the economic effects of prohibition laws and is viewed by Erickson (1969) and others as a major cost of heroin prohibition.

``Corruption of law-enforcement officers and other public officials is also a familiar manifestation of prohibited markets. Experience with prohibition has shown it to be a major corrupting influence. The corruption of the Prohibition Bureau proved to be a major stumbling block to the effective enforcement of Prohibition and was also cited as a reason for repeal. Most important, this corruption penetrates beyond the enforcement bureaucracy to government in general. Recent experience has shown that worldwide multidrug prohibition is a major corrupting force in several national governments, such as Colombia and Mexico."

So whether it is about drugs, abortion or jueteng, these issues have fundamentally the same grounds: Prohibition induces corruption but does not stop or limit these activities or that the unintended effects are greater than the supposed benefits the law aims to achieve.

So President Aquino's first act demonstrates more of the same things, an administration that seeks popularity or desires to look and feel good (public choice theory again!) but seems tolerant of law induced corruption and wastage of government resources from feckless Prohibition laws.

More On "Are People Inherently Nihilistic?"

I stumbled upon this interesting interview with Yale Professor James C. Scott who teaches political science and anthropology.

Here is an interesting piece... (bold highlights mine)

``The state, or centralized political organization, has been with us for the last 4000 years. Even when this state was not all-pervasive or all-powerful everywhere, it was always there. So even if certain spaces or people were ‘outside’ the state—in the so-called state of nature—they always coexisted with the state and interacted with it dialectically. So saying that there are people living inside and with the state, and others outside and without it, and that supposedly they will behave completely different, is a difficult hypothetical.

``I have, for instance, the idea that life was not ‘brutish, nasty and short’ outside of the state as Hobbes argued, partly because the population levels were so low that the way of dealing with conflict was simply moving out of the way. A lot of the things people struggled and died over, were essentially commodities. So if by the state of nature we mean people living outside the state in a world in which states already exist so they are at the periphery of states, then this is a completely different thing.

``We know, for instance, that pastoralism is in fact always organized in order to trade with agrarian states; it is not some previous form of subsistence that is superseded by agriculture. Another example: in the 9th century the people in Borneo were considered to be very backward and they were a typical example of a hunting and gathering society. What were they gathering? Certain kinds of feathers and resins and the gall bladders of monkeys, all stuff hugely valuable in China at the time! So they were gathering these things for international trade with an already existing state; their hunting and gathering is a hunting and gathering performed in the shadow of states. So which ‘state of nature’ are we referring to? When Rousseau speaks of the savages he has met, he sees people that strategically respond to representatives of an organized state, pursuing their interests and behaving politically. So the concept, perhaps, hides more than it reveals."

read the rest of the interview here

my comment:

Professor Scott, who ironically is a "'Marxist' inclined towards anarchism by convictions", suggests that people operate in the same manner in and out of the state, aside from the groups at the periphery ("living outside the state") interacting with the state.

In other words, people instinctively operate on the basis of trade under a spontaneous political order, similar to what we pointed out in our earlier post, Are People Inherently Nihilistic.

Again, arguments that assert that people are endemically atavistic and self destructive beings that require government is simply not proven by facts.

Multiple Intelligence And Human Freedom

Marketing guru Seth Godin makes another fantastic insight about the multiple intelligence of the individual which he calls ironically calls multiple dumbness.

``About twenty five years ago, Howard Gardner taught us his theory of multiple intelligences. He described the fact that there's not just one kind of intelligence, in fact there are at least seven (1 Bodily-kinesthetic, 2 Interpersonal, 3 Verbal-linguistic, 4 Logical-mathematical, 5 Intrapersonal, 6 Visual-spatial, 7 Musical, 8 Naturalistic). This makes perfect sense—people are good at different things." (emphasis added)

In other words, dumbness or intelligence depends on the relative comparison of traits, as no person can claim a monopoly or absolute superiority in all traits.

And such uniqueness makes man superior and complimentary, which highlights the case for human freedom.

Quoting Murray N. Rothbard from Inequality,

``If men were like ants, there would be no interest in human freedom. If individual men, like ants, were uniform, interchangeable, devoid of specific personality traits of their own, then who would care whether they were free or not? Who, indeed, would care if they lived or died? The glory of the human race is the uniqueness of each individual, the fact that every person, though similar in many ways to others, possesses a completely individuated personality of his own. It is the fact of each person's uniqueness, the fact that no two people can be wholly interchangeable, that makes each and every man irreplaceable and that makes us care whether he lives or dies, whether he is happy or oppressed. And, finally, it is the fact that these unique personalities need freedom for their full development that constitutes one of the major arguments for a free society." (bold emphasis added)