Friday, December 12, 2008
All of these bailouts are making people mad. Mish Shedlock says,"Bankruptcy is the best possible result. I am sick and tired of taxpayer money funding corporate ineptitude. Nonetheless I am fearful that Bush and Pelosi will try one more time to revive the dead." Let's hope that the effort will not be resurrected. The industry has had 3 decades to restructure in the obvious face of global competition and innovation and, supported by easy credit, has not prepared adequately for the inevitable.
A couple of decades ago I read an article in the editorial section of the Wall Street Journal describing the demise of the British Steel industry at the end of the 19th century. In 1875 the British had 40% of the world production of steel and exported 40% of their output to the U.S. By 1896 their share of the world steel market had dropped to 22.5% and they exported little to the U.S. The Journal article attributed the demise in part to the industry's reluctance to ignore their sunk cost in the aging Bessemer process and reinvest in the more efficient open-hearth process. A history of the steel industry concurs: "[Etsuo] Abé explores the record of iron and steel firms in Victorian England by analyzing Bolckow Vaughan & Company. The leading problem of the company was its focus on the wrong technology, not switching to the open hearth furnace method until long after the technology was developed. It is apparent that the company was not focused on long-term decision-making."
Long-term decision-making in business is not only about developing a 3-year strategic plan to sell cars and compete in the existing market with existing resources. In a major corporation, it is not even limited to a 5-year investment plan. It also includes careful evaluation of product life-cycles and planning, at least tentatively, decades out, for the long term health and survivability of the corporation. There are established methodologies for doing that, which are well-known by sophisticated business people and which are regularly revisited by the best companies. Different strategies, such as grow, harvest, or exit, apply at different points in the life-cycle; and those strategies have different implications for investment and marketing. I have experienced such planning and seen it work quite well in a variety of industries from vacuum tubes to hard rubber. Whether or not there is planning for it, change happens (see, e.g. The End of the U. S. Piano Industry). It will either happen for you -- or to you.
I suspect that many company executives are reluctant to face the prospect of radical reorientation of their business when they have become emotionally and professionally committed to a product or a technology, or a location for that matter. It is not easy for an executive to step outside the day to day, or year to year, and think about the demise of a business that he and his employees have struggled for a lifetime to build. But that's what an executive and his staff need to do. And they need to do it well because choosing the wrong path can lead to unnecessary collateral damage -- negligent damage to people.
After the Japanese consumer electronics manufacturers overtook the American television industry in the early 1970s, they moved the fast-maturing manufacture of picture tubes and television sets to Taiwan and Korea and upgraded their home capabilities to higher technologies. It was not by accident -- and this in a culture that was committed to lifetime employment.
Peter Drucker wrote an excellent little book, The Effective Executive, in which he noted the importance of an executive's taking time off from day-to-day management to close his door and contemplate the future of the business. That is a tough thing to manage, but it is a key to developing an objective view of the business and the corporation's ultimate viability. And the CEO's resulting foresight should move the organization to understand and plan for the realities of a dynamic marketplace.
I don't know what kind of process the auto-makers undertook to address the long term rise and fall of automobile manufacturing in the U.S. As an outsider, I don't see individual transportation disappearing in the next 50 years. I expect that to be around. But, like 19th Century British steel, U.S. auto maker tardiness in adopting new technologies has lowered their sales potential; and their fixed costs, including union contracts, have left them unprofitable.
Let's Hope the Auto Bailout has Failed for Good . It will not be the end of the world as we know it. Bankruptcy just might provide the industry an opportunity to consider all options, including some that will allow a future in the United States.
Wednesday, December 10, 2008
Nobel Prize winning economist Joseph Stiglitz has written a critique of the financial crisis in Vanity Fair (see “Capitalist Fools”). But the critique is limited to an evaluation of where and how the “system” failed. And consequently any suggestions for avoiding future crises that he might have made or implied are limited to fixing his problems with the system – namely, elimination of the barriers between investment and commercial banking, non-existent or lax regulation, appointing as Chairman of the Fed, “a devotee of the objectivist philosopher and free-market zealot Ayn Rand” (a falsehood), tax cuts, opaque accounting practices, flawed incentive structures, and mismanagement of the bailouts. Having completed the critique, Stiglitz ends his piece with a conclusion that was not supported anywhere in his evaluation.
The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.
A free market is self-adjusting. But when government interferes in the market to eliminate the incentives, whether positive or negative, the market’s adjustments become distorted. The market then becomes moved, not by the invisible hand, but by an iron fist.
Had Dr. Stiglitz critiqued free market economic philosophy in his article, we might have been able to identify some specific point to debate, but alas, Dr. Stiglitz provides no statement of economic philosophy except the bare assertion that markets are not self-adjusting and that the role of government should not be minimal.
Oh yes, he does make an ad hominem argument against capitalist “ideology” – “a flawed economic philosophy” – by playing the Ayn Rand card. Such sophistry is certainly not beneath the likes of Henry Waxman, but you would think that it should be beneath the intellectual stature of a Nobel Prize-winning economist.
I guess not.
Stiglitz wants to perfect a system that itself is flawed to the core and cannot be perfected. He could have addressed the problem at the core – that the century-long experiment in central planning (the Federal Reserve System) has reached its logical conclusion. He might have engaged in a constructive discussion about how to establish a medium of exchange that is not subject to the whim of politicians or the coercive monopoly of a cartel of banks that are insulated from risk and indulge in moral hazards. See "Credit Crisis and Moral Hazards."
Instead, Stiglitz has revealed himself to be just another second-rate Monday morning quarterback.
P.S. The "flaw" in Greenspan's thinking was that he was attempting to apply free market principles to a system based on government control. If he were a "devotee" of Ayn Rand, he would have recognized the contradiction immediately and understood that one of his premises was wrong.
Thursday, December 4, 2008
John Tate has written a succinct and readable summary of Kant's core premises. Check it out. You will detect the familiar ring of the relativism and the self doubt that plagues the humanities, political science and journalism departments of many of today's institutions of "higher" learning. These notions, which have been advanced, refined and blended with the ideas of Rousseau, have permeated the main stream media and, through them, the less educated population who, it appears, represent the majority of voters. Of those who recognize the origins of such distortions of reality, few stand up and speak out against the assault on common sense.
For more, read David Kelley's Evidence of the Senses and Stephen Hicks' Explaining Postmodernism.
A country populated by people who doubt their own minds and believe that one morality is just as good as any other will be easily (mis)led by power hungry and avaricious men who, while pretending morality, care nothing about it.
More important to the advancement of civilization than the current economic crisis (although largely responsible for it) is the crisis of philosophy. The conventional wisdom that philosophy is for impractical people with their heads in the stratosphere is a myth. If you want to consider yourself educated, you need to understand and adopt a philosophy. Develop a conviction, progressively, about what is real (metaphysics), the validity of your knowledge (epistemology), how to reason (logic), what is right and what is wrong (ethics), and how to live with other people in a mutually beneficial society (politics).
Wednesday, December 3, 2008
Monday, November 24, 2008
I am not in favor of this bailout of course, but it is a far better scheme on the surface than blowing another $350 billion. The pertinent question is just how bad those $300 billion in assets will be. I doubt the Fed will disclose the assets it is guaranteeing.One of the main causes of the downward spiral in the markets is that no one knows (not even the banks) what the value of their intangible assets and off-balance sheet obligations of the banks are. And the Financial Accounting Standards Board has postponed a rule requiring their disclosure. The markets and the government operatives are driven by fear of the unknown and, not knowing, they must assume the worst case consequences of telling the truth.
Philip Davis in "Options Trader:Monday Outlook" says
90-95% of [Citibank's troubled assets being guaranteed] are part of C’s $Tn in assets that are "on balance sheet." The bank has another $1.2Tn of assets that are not reflected in their books, many of which are tied to mortgages that will still need to be addressed down the road. The assets affected under the government plan are largely loans and securities backed by residential and commercial real estate. "With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy," the Treasury Department, Fed and FDIC said in a joint statement issued late Sunday.
Whether this is enough to inspire long-term confidence in US financials or whether it leads to panics out of banks that are not given $300Bn by the government remains to be seen, but the immediate upshot of this is it is finally occurring to investors how far the US is willing to go to save the markets. Just looking at the mechanism put in place on the C deal, we can now see that $300Bn in TARP money can be leveraged by the Fed and Treasury into $4.5Tn of bailout funding WITHOUT further Congressional approval. The net effect of this is that gold is flying up in pre-markets as global investors are finally seeing how wet this flood of dollars might make us all (have I mentioned I like gold lately?).If you are an ardent follower of market developments and are interested in keeping current, return here frequently and check the Recommended Commentaries at the left of this page.
Reggie Middleton's BoomBustBlog has a good comment on the Citibank bailout-- "It's the government version of 3 card Monte - Betcha 'ya can't guess which company the cash is under"
So does Naked Capitalism -- "US Agrees to Bail Out Citi"
And Seeking Alpha -- "Citi's Underwhelming Bailout"
Thursday, November 20, 2008
I am not going to beat a dead horse by repeating explanations of why we need some kind of monetary standard tied to gold; but the bottom line is this: Either Bernanke is lying to the Congress (liar, liar, pants on fire) or we are doomed. We might escape a cataclysm greater than the Great Depression this time. We shall see. But there is no way to sustain a monetary system that is not tied to objective value and is run by politicians and bankers who reap the benefits of inflation and bubbles and pass the losses on to the little old ladies on fixed incomes and taxpayers.
Ron Paul: Just last week there was a report that Iran purchased 75 billion dollars worth of gold, took their reserves out of Europe, bought gold and put it in Asia. So is that a sign of the times, is that moving on?
My question is, in your meetings, and you had a meeting just recently with other central bankers, does this thought come up about a new international world reserve currency, and if so, does the subject of gold ever come up?
How do you restore the confidence? Have you recently had conversations with any central banker, and is there a move on to replace the dollar system, because the dollar system is essentially declared dead, because it’s not working, but this indeed was predictable because of these tremendous imbalances that were never allowed to be corrected, and they were always patched up. We always came in. We’d spend, we’d inflate, we would run up deficits, and since ‘71 we’ve been able to correct these problems.
Could you tell me what kind of conversations you’ve had regarding a new reserve currency?
Ben Bernanke: Yes, Congressman. I don’t think the dollar system is dead. I think the dollar remains the premier international currency. We’ve seen a good deal of appreciation in the dollar recently during the crisis precisely because there’s been a lot of interest in the safe haven and the liquidity of dollar markets.
And the Federal Reserve has been engaged in swap agreements to make sure there’s enough dollar liquidity in other countries because the need for dollars is so strong. So I think the dollar system remains quite strong.
I do agree with you very much on one point, which is about the current accounts. The current account imbalances have proved to a very serious problem. It was in fact the large capital inflows in those current accounts which created a lot of the financial imbalances we saw and have led to some of the problems we are seeing, and one of the silver linings in this huge gray cloud is that we’re seeing some improvement and greater balance in our current account deficits.
Ron Paul: But does the subject of a new regime ever come up?
Ben Bernanke: No, it doesn’t.
Ron Paul: And does the subject of gold ever come up in any of your conversations?
Ben Bernanke: Only in terms of the sales that the central banks are planning.
Monday, November 17, 2008
Thursday, November 13, 2008
The controversy centers around whether the Fed’s many actions to add liquidity to banks and restart the credit markets are inflationary. Those who say the actions are not inflationary say that the Fed is not increasing the supply of money and credit because the fed is taking collateral of equal value from the banks and, in any event, the loans are temporary. Those who say that it is inflationary include those who point out that the loans are proving not to be temporary and the collateral given to the Fed by the banks is garbage – so the banks are getting more than they are giving up. That means that the Fed is supporting the inflated values of paper held over from the credit bubble or they are adding new, good money to the system, which is an increase in value over the garbage it replaces. So it would seem to be important to know whether the collateral taken by the fed is worth the money loaned on it or whether the collateral is garbage as some allege.
Bloomberg, the financial news service, submitted a Freedom of Information Act request to the Fed to disclose information about the collateral it has taken from the banks. The Fed refused because much of its activity was undertaken using the Federal Reserve Bank of New York. So Bloomberg sued to get the information. It is noteworthy that the Fed argues that the Federal Reserve Bank of New York is not subject to the FOIA because the New York Fed is not a government agency. This is another official confirmation that the Federal Reserve System is a cartel of private banks, as I reported to you in March. Bloomberg is not giving up and political pressure is building for them to disclose the information.
The Fed is refusing to reveal information vital to us all – we need to know whether to be alert for and plan for the inflation that is going to be caused by the Fed’s actions. It is also refusing to allow the public to know whether taxpayers’ money is being poured down a black hole by taking clearly inadequate collateral from entities that under any rational accounting rules are already serious financial risks if not bankrupt.
As if granting a monopoly over money and credit to a cartel of private banks were not bad enough, allowing the national deficit to explode in one year and taking your money and giving it away in secret (part of which funds the bonuses of the clowns responsible for this mess) is beyond outrageous.
Secrecy is important when the enemy is a hostile foreign power. However, the enemy here is you -- they don't want you to know because you would act rationally to defend yourself and demonstrate that they are not acting upon your behalf but on behalf of their twisted concept of the greater good. In other words, the information is important to your financial well-being, which the government has placed in peril, and they don't want you to know it.
Making the citizenry the enemy is not unprecedented. When gold was confiscated in the 1930s, the World War I vintage Trading with the Enemy Act was amended to declare domestic gold “hoarders” enemies of the state when the President declared a “national emergency,” a term which is left undefined. Note the consistent position of the government that the current financial crisis is a national emergency.
As a general proposition, the politicians are learning that they can always get more power in an atmosphere of crisis. So the power-hungry will seek out and elevate crises before they seek more power. There are a great many potential crises out there, and there are a great many people promoting their special issue as an emergency. Just yesterday, former Vice President Gore said that President Obama “must make this January to begin an emergency rescue of human civilization from the imminent and rapidly growing threat posed by the climate crisis.” When someone cries emergency and crisis, it is a signal for you to look out. Once they frighten the population into giving the government more power and impairing the freedoms citizens once enjoyed, they never give them back.
Wednesday, November 12, 2008
Tuesday, November 11, 2008
It works because many conservatives have accepted the premises that greed is bad and that “society” has a moral obligation to help the children, et al. Then they proceed to counter the liberals' political programs by arguing that liberals need to temper their idealism with fiscal responsibility and recognize that they could wreck the engine of prosperity by excessive taxation and deficit spending. They also argue that too much paternalism will destroy individual incentives to work hard and create taxable wealth. In other words, they concede that the liberals own the moral high ground but argue that they need to be practical.
The left will always own the high ground under these circumstances and the political battles will continue to be fought only over how to keep from killing the goose that lays golden eggs.
The Christian right argues that life, liberty and pursuit of happiness are God given rights recognized in the Declaration of Independence and because they come from God those rights have moral superiority over others. These rights include the exclusive right to the fruits of one's labors. However, their arguments are inconsistent with the religious ethics of self-sacrifice and selflessness, to which many Christians subscribe and which should make them eager to support altruistic government programs. And the notion that property rights is a principle that is morally superior to self-sacrifice is not necessarily seen by all Christians as sanctioned by God. Even the Pope is a socialist.
Libertarians (including some self-styled conservatives) have much better arguments about limited government, property rights and individual freedom, but they stop short of supporting “greed is good” with an ethical philosophy. They argue simply that the political principle of freedom allows people to be greedy as long as they to not coerce others. Libertarians lose the moral argument because they do not make it.
The opponents of the left will never own the moral high ground unless they win it on the merits of their moral arguments. And unless they own it, they will fail progressively to defend your right to earn as much as possible and to keep your property and the fruits of your labors.
How can they persuade the majority of voters that their moral and political positions are superior to those of the left? First of all, they need to subscribe to a morality that accepts rational self-interest as one of the foundations of ethics and morality. The logical consequences of a failure to do so will keep us on the road to serfdom and cede the political system to those who wish to pretend that it is moral to redistribute your wealth (i.e., to take your property and give it to their political favorites, whether they be poor people or Wall Street investment banks).
Libertarians and conservatives need to change attitudes and shine the light of day on the unstated false assumption that people who are less fortunate than you have a right to your property and your life. And that change starts with you. Changing popular understanding begins in your neighborhood, in your business circles and in your associations. It is a daunting undertaking, but it most certainly will not be accomplished if those who understand its importance shrink from the task or retreat into cynicism.
Here are some suggestions:
Start using the word “force” when referring to the government and its actions. Make a point of noting that whatever the government mandates involves coercion. Taxation, especially taxation to pay for something that could be accomplished by private individuals, is money extracted from you at the point of a gun that would not otherwise be given voluntarily. To understand what “point of a gun” means, consider what would happen if you did not pay your taxes or obey government mandates.
Because the government holds a legal monopoly over force in order to defend your individual rights to be free from force, taxation is one way to fund the police and military. But taxes should be a way to raise revenue to cover the cost of that legitimate function, not a way to achieve a social agenda. Social trends should be left to the spontaneity of free individuals.
Avoid collective, anonymous abstractions like “public” and “society” when you can communicate your message better with more specific words like “government” and “individuals” – as, for example, in government schools rather than public schools, “the individuals in charge of the government” instead of “government.” Always use the most specific term appropriate.
Point out that there is no positive morality where there is no choice. Even if one assumes that giving to the poor is an act of moral virtue, there is nothing virtuous about giving to the poor at the point of a gun. That is not sacrifice. It is being sacrificed. The morality of undertaking to be your brother’s keeper is irrelevant when you are forced to do it. So the left has no moral argument – none, none – upon which to base the government’s claim to your property to support the children, the poor, the sick, homeowners, the banks or anyone else.
Challenge the morality of redistribution of wealth. It is not some abstract notion. “Wealth” is not a natural resource owned by the government. Government “benefits” represent money taken from you and your neighbor’s children by force and given to someone else (or given back to you less a huge fee for administration). Rush Limbaugh has come close to making that argument -- but he does not go far enough and explain why our right to our own property is more than a political principle. Rights is a moral principle deriving from our nature as individual entities. (See, e.g., “Is there a Right to HealthCare?").
A complete challenge to the left requires an ability to debate the nature of morality because that is their claimed source of their power over you. And understanding the nature of morality is fundamental to the political system that you want. By what moral principle do they justify laying claim to the money that you earned to support yourself and your family? What are their premises – that you are the property of the state, that the unfortunate have a claim on your property merely because they are unfortunate? The burden of proof of their moral superiority ought to be on those who propose to take your earnings and property.
Make people define the term “greed” every time you hear it. Use their attempt at a definition (or their attempt to evade defining it) to initiate an argument about a person’s right to keep the fruits of his honest labors, no matter how intently he pursues them. Why, you should ask, is it wrong to seek to profit from a voluntary exchange – even a huge profit if the other party is willing? (Of course, if he is not willing, that is his choice. If he is not able, then there will not be a huge profit.)
Defend every person’s right to be self-interested, even greedy. Why are you complaining about executive salaries and bonuses (unless you are paying for them)? What business is it of yours what terms strangers have agreed to in their private transactions? Don’t allow the left to appeal to your envy of others to justify their efforts to take money from the wealthy. Envy is for losers – ambition is for winners.
Be ready to distinguish coercion from voluntary transactions. For example, the antitrust laws are justified in part using the theory that a seller can “force” a buyer to purchase something simply because the seller has it and the buyer wants it. That’s absurd. The government can "force" an exchange because it has the guns. A commercial seller can’t. This is a major left-wing argument: that economic power is the equivalent of a gun, that need gives someone a right to your property, that your refusal to turn it over is coercion and justifies the application of a superior force (more guns) to make you give it up at the price the needy want to pay. It is simply not true that someone who possesses goods and wants to charge his own price is the equivalent of a thug with a gun. The proponents should bear the burden of proving the morality of why need justifies the use of force.
Demonstrate the foolishness of the “but what about . . ., who is going to take care of . . .” argument: “But what about the retarded and mentally ill?” The answer is, well, what about them? “But who is going to take care of them?” The answer is, well, whom do you suggest – me? “No, the government will do it?” Then you mean me; you mean my tax money. What if I don’t want to? What if I refuse to pay? “But you can’t” And why is that? (Silence. Silence because the answer is “we will force you to.”) Don’t get me wrong. I have spent over 30 years working with private nonprofit organizations that take care of the retarded and mentally ill but I have done it voluntarily, and that is how it should be done. And there is a similar answer for every group of victims that the left wants to force you to support.
Stop advocating government solutions to social problems by suggesting that your neighbor needs to be coerced. "There ought to be a law" is a bad idea. There are already sufficient criminal laws. All other laws are suspect.
The foregoing certainly requires a change in perspective for most people. But unless the majority of people change their perspective, the politicians will continue to have the ability to fool them into believing that it is moral to exploit and victimize you and your neighbors.
Tuesday, November 4, 2008
The science of chaos began when scientist Edward Lorenz was attempting to develop a computer model for weather. One phenomenon he observed was that when a tiny individual variation occurred, it could cause a huge reaction somewhere else in the system. It was called the “butterfly effect” after the idea that a butterfly flapping its wings in Tokyo could eventually cause a hurricane in the Caribbean. The problem is figuring out which butterfly is going to influence what kind of result. The scientists are still working on that one – there are too many butterflies, birds, sneezes and every sort of variable imaginable to contribute to the cause of who knows what. If it were possible to take into account every variable, accurate prediction would be possible. Alas, it is not. We still can only make educated guesses.
A butterfly flapped its wings in March with the bailout of Bear Sterns, setting in motion a chain of events the results of which remain to be seen. Those who warned of a moral hazard were correct. And the failure to go with the flow and bail out Lehman Brothers was another variable that changed the direction of the result, whatever that might have been or may be. (See http://18.104.22.168/index.php/2008/11/03/pandoras-box-is-open/) You might call that event a “tipping point” – much like the final grain of sand that causes an avalanche.
One variable influencing the economy is the supply of money and credit. Another variable is the aggregate view of businessmen regarding the direction of the economy and the investment choices they make based on that view. Another variable is consumers’ aggregate views about their own personal situations and futures. Another variable is the scarcity of natural resources. And there are many more, each of which can influence the other. Even the propagation of popular misconceptions is a variable because, notwithstanding the truth, those misconceptions can influence other variables.
One popular misconception is the definition of inflation. The popular understanding is that inflation is a general rise in the price levels of goods and services. That definition leaves one to wonder what caused the prices to rise and it allows demagogues to lay the blame on their favorite scapegoats. But when one understands inflation as monetary inflation, it is easier to identify one cause for a general increase in prices – an increase in the supply of money and credit, which is the Austrian economists’ definition of inflation and the one to which I subscribe.
Inflation does not necessarily cause a general increase in prices. There could be other, countervailing influences that keep the prices of goods and services down in an economy. And an increase in money and credit does not necessarily result in a runup in prices of consumer goods such as it did in the 1970s. In the past decade the prices of many (but not all) consumer goods in the U.S. were kept low by foreign imports while excessive credit caused a massive runup of prices in the real estate market. In the 1920s, consumer price levels remained low while there was a stock market boom fueled by inflation. So prices can increase in one segment of the market while they remain stable, or even decrease in another.
Deflation is the reverse of inflation. It is a contraction in the supply of money and credit. Today, we are experiencing a contraction of credit in a wide variety of areas. That contraction has originated within the banking system and it is affecting real estate prices and vice versa. Bank contraction of credit will also affect credit cards, commercial loans, municipal loans, student loans, etc., which in turn will affect consumer demand for goods and services, business investment, local and state taxes, university finances, etc., which eventually will influence the prices and business activity in the areas affected. They will be lower that they otherwise would have been.
“They will be lower that they otherwise would have been.” That is another concept that you need to get your arms (mind) around. Inflation does not cause prices to go up. It ultimately causes prices to be higher that they otherwise would have been. How do you tell, then, if there is inflation when the prices are stable? The answer is that you watch the supply of money and credit and you do not define inflation as prices going up. Otherwise, you could fail to be on the lookout for where the consequences of inflation will show up (as in – another bubble).
Another point of confusion is the fact that it takes months and sometimes years for an increase in the money supply to work its way through the economy and affect the general price levels. Thus an increase today may appear to have no effect. Indeed, some analysts predict that price inflation is a long way off because the countervailing deflation from the unwinding of the credit markets will take a very long time. As demonstrated over the past few months, however, the consequences of a decrease in the supply of money and credit can happen relatively quickly and be immediately visible.
We are in the middle of a deflation caused by a contraction of bank lending at the same time the Federal Reserve is inflating by pumping money into the system, trying unsuccessfully to get the banks to lend. (Check out these commentaries for more information: http://www.gold-eagle.com/editorials_08/ash110308.html and http://www.gold-eagle.com/editorials_08/degraaf110308.html and http://www.gold-eagle.com/editorials_08/captainhook110308.html .)
The pundits have been busy debating whether we have inflation or deflation. Those who fear the consequences of inflation argue that the Fed needs to stop pushing money and credit onto the banks, worrying that once the banks do begin to lend, the money will hit the market causing price to be higher than they otherwise would have been and/or creating another bubble somewhere. Those who fear the consequences of deflation argue that prices are not going up and they support the Fed’s efforts to unfreeze the credit markets to forestall a recession or, worse, a depression. Deflation is clearly occurring with the consequences visible in the near term. Inflation is also occurring with the consequences to come. Investors need to worry about both – how far down the current deflation will take the economy and, at the same time, where the inflation that is occurring simultaneously will take us in the longer term. It is confusing, but that’s chaos for you. You need to look for patterns.
Deflation historically has caused recessions and even depressions, stock market declines and crashes, bank and business failures. It also is an era of relatively low interest rates as the authorities attempt to forestall market corrections for the mal investments that resulted from the preceding inflation and get business activity moving.
Inflation historically has generated the boom and bust cycle, which tends to get progressively worse with each cycle – first inflation, then deflation, then inflation, etc. until inflation cannot be brought down. The “crack up boom” occurs, the currency is destroyed and with it the middle class, and a depression occurs. The aftermath of hyperinflation and currency destruction is a time ripe for a man on horseback.
A deflation brought on by market forces and allowed to return to equilibrium through the market, even if it causes a depression, is always preferable to resisting the deflation with inflation, which can end in a crack-up boom, hyperinflation and a depression. In the former case, the depression is painful but short-lived. In the latter, society as we know it could be over and, at a minimum, many things will be influenced in a direction that you will not like.
The Fed's attempts to forestall deflation by inflating are beginning to take effect. Banks are starting to lend again although demand for credit has been dampened. This might signal the end of the deflation scare that has panicked Washington. At some point down the road we should begin to see evidence of the consequences of the inflation in the prices of commodities and other assets and in an increase in market interest rates. If a public inflationary mentality develops, that would be the time to be alert to the signs of a crackup boom.
Those with a thirst for knowledge should read an account of Germany’s 1923 inflation and follow its consequences through the 1930’s. The Great Inflation is a great, concise book but it is out of print. Maybe it’s in your library.
Thursday, October 30, 2008
The conventional definition of socialism is in economic terms. It is an economic system in which the state controls and administers the means of production and distribution with a view to creating an egalitarian society. (Wikipedia) It is to be distinguished from capitalism. According to Wikipedia, “Capitalism is the economic system in which the means of production are distributed to openly competing profit-seeking private persons and where investments, distribution, income, production and pricing of goods and services are predominantly determined through the operation of a market economy in which anyone can participate in supply and demand and form contracts with each other, rather than by central economic planning.” The difference, then, is that in a socialist system the state controls the economy theoretically to produce an egalitarian society (in which those with the ability to produce support those who produce less) and in a capitalist system the state has no control and individuals are left free to pursue their own interests – state control versus freedom, and the goal of egalitarianism versus allowing the risks and rewards attendant to individual differences. In other words, socialists would force the more productive and affluent individuals (through taxation and regulation) to support those who are less productive and affluent. Capitalists would allow both the productive and the less productive to support themselves from their own efforts, abilities and conditions.
When controlling the activities of the state, the voters need to consider what kind of government they want – not only for their short term benefit (e.g., a government that allows me to vote money out of my neighbor’s pocket into my own) but also for their long term benefit (e.g., a government that does not inhibit achievement or reward dependency). And they also need to consider the morality of their choice. The Christian ethic preaches that one should be his brother’s keeper. Does that mean you should choose to be your brother’s keeper, or does it mean that you should coerce (tax and force) your neighbor to be his brother’s keeper?
In a recent article on the credit crisis in The New Individualist magazine, Eugene C. Holloway discussed moral hazard and the morality of the welfare state:
Alexis de Tocqueville warned that democracy would last only until Congress learned how to bribe the people with their own money. In the promises of the political candidates of the two major political parties, we see that this practice has now become ingrained. Beginning early in the history of the Republic, but exploding into the welfare state launched in response to the last great world financial crisis (also spawned by the Federal Reserve’s mismanagement), the federal government has pursued policies intended to relieve people of their personal responsibility to exercise due care, and has tried to eliminate reality’s harsh incentives, which train people to raise themselves from poverty. Not only has this not worked as intended and created a moral hazard among the beneficiaries; it has also preempted charity, good will, and benevolence. It has substituted inflation, taxation, bureaucratic control, government mandates, and political power for the work of voluntary organizations, cooperative associations, and philanthropists, causing people to resent being forced to become their brothers’ keeper. Where coercion is substituted for the freedom to choose, the morality of benevolence, charity, and good will is rendered irrelevant.Socialism would substitute government coercion for individual virtue, morality and benevolence. History has shown that it does not work. It is the tool of demagogues, power seekers and tyrants. And that is why Mr. Obama, who is more a socialist than Mr. McCain, protests being labeled a socialist.
The ultimate moral hazard is the growing expectation that it is the role of government to bail people out of every sort of misfortune, stupidity, and vice—which, in logic, does nothing but encourage the growth of misfortune, stupidity, and vice. Correspondingly, it diminishes the role of virtue, morality, and benevolence in our culture.
Consider the definitions and judge for yourself who is a socialist. In fact, you can find few politicians who are not. Control is their stock in trade. Leaving people alone is not what they do.
Wednesday, October 15, 2008
The pundits are now all pointing out, perhaps correctly, that it is fallout from the failure of Lehman Brothers that has resulted in the present seizing of the banking system. And they are blaming Paulson's wooden allegiance to free market principles (i.e., Capitalism) that caused the Administration to turn it's back on Lehman Brothers.
Wait a minute, folks! This is not Capitalism. None of it. It's economic fascism.
In the context of our corporativist/fascist economy -- which was constructed over the past century by the populists, collectivists, welfare statists, pro-fascist bankers and self-dealing big government politicians -- the appropriate short-term action for Paulson to have taken in mid-September 2008 would have been to bail out Lehman Brothers, moral hazard or no. Moral hazard started long, long ago. And Paulson's misguided token action has backfired.
It will take decades, maybe longer, and much popular and political will to deconstruct the impediments to free markets, to allow people to rise or fall on their own abilities without exploiting their neighbors, and to return to limited government. I will not live to see it. Nor will my children, nor yours. But you can make sure that the ideal lives on and that at least the trends show a popular understanding of the moral and practical efficacy of Capitalism, still an Unknown Ideal.
Saturday, October 11, 2008
Now George Reisman is a wise and knowledgeable man. He has written a huge tome entitled “Capitalism: A Treatise on Economics” and he understands how it all fits together. But he would be the first to laugh at you if you asked him to fix the economy. He has a blog on which he occasionally posts his comments. I invite you to read his August 30 entry, “Barack Obama and Sarah Palin on Taxing Oil Companies and Giving the Money to Others.”
The younger folks with a thirst for knowledge and understanding ought to read Reisman’s treatise and take his course on the Theory and Political Philosophy of Capitalism.
Thursday, October 9, 2008
In February (2008) after six months of watching the financial markets, I began to warn my family and friends about a coming downdraft in the markets. The decline in real estate and banks had already begun but I held my tongue until I knew I would feel guilty if I didn’t speak out and let them know that it was only a small precursor to what seemed inevitable.
After I began my warnings, I learned that I was going to need some major surgery – under the knife for 5 hours and out for 8. So I called my broker and said, “I really don’t need to be worried about this kind of market with surgery and recovery and the like going on. So put me into cash.” “You mean sell everything?” “Yup. Everything” “We’ll put it into our money market fund at 2.5%.” “No, I would feel better if we just put it into greenbacks. I don’t know how your money market fund makes its interest and I don’t have time to find out.” “OK, how about we just send you a check?” “Great! A check would work.” And so, my good friend at Lehman Brothers sent me a check, which I spread around to a few sound banks.
The surgery was successful. But about that time a brigade of geniuses armed with Band-Aids to apply to the jugular of the financial system, which was spurting and gushing its life’s blood in the streets, rushed on to the scene, like the Keystone Kops, eliminating any possibility that I would even think about investing in equities until the panic was over. So I just sat on it.
Possibly spooked by the surgery, my wonderful spouse was ready with an alternative to preoccupation with markets and the like. She took the opportunity of my semi-retirement from the corporate world of 12 hour days and truncated vacations to force me into weeks at the lake, extended tours, class reunions, weeks of visiting the children and grandchildren, and holidays at the relatives’. We are having a worry-free time but are scheduled to be home less than half of the remainder of the year. And I have committed that remaining time to my former employer and a few clients. How in the world will I find time to evaluate markets and companies in which to invest that cash?
Well, maybe it’s not so bad after all. The Dow closed today at 8,579.19, a nasty drop from February and 40% below last year’s all-time high. But yesterday, one of the financial newsletters suggested that a short term bottom is near, calling it a “dead bull bounce,” which I guess goes up a bit higher than a dead cat bounce. Short term bounces still don’t sound good. I guess I’ll keep my powder dry until January and have a Merry Christmas and a Happy New Year.