China Poised for Crash and Burn

Abrose Evans-Pritchard reports that all is not as well as it seems in the Orient:

Fitch Ratings has been warning for some time that China's lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected.

"With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary," it said.

"Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear."

"Able to bear," as in, financial collapse a la Iceland. China apparently chose to take extraordinarily loose monetary policy to deal with the economic slump, reducing the interest rate paid on reserves held with the central bank while simultaneously flooding the markets with freshly printed currency. Which means that if banks didn't lend their money out, they would be eaten alive by inflation. Naturally, banks obliged, lending far more than would be rationally advisable:

Bank exposure to corporate debt has reached $4,200bn. It is rising at a 30pc rate, even as profits contract at a 35pc rate.

The motive?

The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a "massive lending spree".

This, of course, is completely foolish. As I predicted some time ago, China should experience a very, very severe contraction, having committed itself to the consequences of mercantilism long ago:

China's Banking Regulatory Commission fired a warning shot last week. "The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy," it said.

Unfortunately, 40pc of the "real economy" consists of exports, mostly to the US and Europe, the consequence of a mercantilist export model that has crashed and burned. Chinese exports were down 26pc in May.

When 40% of your economy is down 26%, it's tough to break even, let alone show growth. Even if their domestic economy matched last year's product, they would already show the 10% loss I predicted way back when. But it is going to be tough to do even that when such an enormous fraction of your workforce has gone unemployed. And again, I note: this contraction has occurred despite the extraordinary actions taken by the Chinese government and governments across the globe to combat it! So maybe a few of my predictions for contraction were overblown. At least I got the direction right. My wife asked me a year or two ago when I would invest in Chinese stocks, back before the Olympics when their stock market was still on a tear. I told her "when Shanghai burns." It looks like that day might not be too far away. Not sure I'll still be a buyer, though. Poor fellas. They have some serious problems. Unfortunately, the solutions proposed by nearly all audible voices are the same, pathetic, horribly incorrect drivel:

Reformers know what must be done to boost consumption. China needs a welfare revolution. But creating a social security net takes time, and right now Beijing is facing a social crisis as 20m jobless workers retreat to the rural hinterland.

Sad, sad, sad. This is not going to get better any time soon. "Green-shoots?" Ha!

Halfway Through Liberal Fascism

From Liberal Fascism:

[Woodrow] Wilson shared with other fascist leaders a firm conviction that his organic connection with "the people" was absolute and transcended the mere mechanics of democracy. "So sincerely do I believe these things that I am sure that I speak the mind and wish of the people of America." Many Europeans recognized him as an avatar of the rising socialist World Spirit. In 1919 a young Italian socialist proclaimed, "Wilson's empire has no borders because He [sic] does not govern territories. Rather He interprets the needs, the hopes, the faith of the human spirit, which has no spatial or temporal limits." The young man's name was Benito Mussolini.

I am approximately halfway through the book, and I have to say, this was an eye-opening read. I do not care whether you are liberal, conservative, libertarian, completely apolitical or just think you are, you really ought to read this book. You may not agree with everything, especially if you happen to be a creature of the political left, but you will certainly be startled by the facts it contains. I was already familiar (and in agreement) with the basic thesis that fascism was a phenomenon of the extreme political left, not the extreme political right as so many would have you believe, so I thought I was in for a rather humdrum read. Not so. While the book can be dizzyingly fact-dense at times and occasionally borders on beating a dead horse, a great deal of it will simply leave you with your mouth hanging wide open, particularly quotes like the one above. There are some real jaw-droppers in there, some from people you only thought you knew. The intricate connections between the various political movements of populism, progressivism, nationalism, socialism, fascism, Nazism, and communism, and in America's case, their claim on leaders of both Democrats and Republicans leaves the reader with an eery sense that Jonah Goldberg has thrown light on some great political tentacle emanating from some fundamental, carnal human property that animates a great deal of the political world. One can't help but come to the conclusion that this fundamental human property is a failing and is decidedly evil, perhaps even the great human evil, or at least a direct descendent. The book is not religious per se, but addresses a great deal of religious material and contains many religious overtones. Goldberg himself defines fascism to be "a religion of the state." This appears to be roughly divisible into two distinct movements: the first, and more common, is the creation of a pagan state religion with man as god, the second the elevation of the state as an all-encompasing tool of God as described by an existing religion, not completely unlike a theocracy, but not exactly the same, either. (Note that I'm not trying to provide some kind of squirmy defense of theocracy, as I'm not even slightly pro-theocracy, but the two are a bit different.) For Christians, this book should hopefully leave you with a newfound caution for politicians and political philosophies that claim God's sanction, direction, or consistency with His ideals. This is not to say that all such claims are wrong, but upon reading the book one shudders at just how many people enthusiastically embraced totalitarian acts and policies which had been wrapped in a Divine mantle by their politician-salesmen, and how similar many of these acts and policies were to those proferred by the Nazi's and other fascist regimes. It is scary, and I have no doubt it could easily happen again, and probably will. Final word: read this book. No matter who you are, it will change your thinking about politics.

At Least One Economy Appears To Be Thriving

Why, its North Korea!:

SEOUL, South Korea (AP) -- North Korea's economy grew in 2008 after good weather boosted agricultural production, South Korea's central bank said Sunday.

The North's gross domestic product for last year was estimated at $24.7 billion, a 3.7 percent increase from 2007, Seoul's Bank of Korea said in a news release. The impoverished North's economy shrank 2.3 percent in 2007 and 1.1 percent in 2006.

I really don't have much comment. Just thought it was funny and ironical.

Potential Solution to the Housing Crisis

Bulldoze the suckers!:

US cities may have to be bulldozed in order to survive Dozens of US cities may have entire neighbourhoods bulldozed as part of drastic "shrink to survive" proposals being considered by the Obama administration to tackle economic decline.

The government looking at expanding a pioneering scheme in Flint, one of the poorest US cities, which involves razing entire districts and returning the land to nature.

Local politicians believe the city must contract by as much as 40 per cent, concentrating the dwindling population and local services into a more viable area.

I'm really beginning to eat crow over my comments that the government response to this depression isn't all that much like the response to the Great Depression. I was too impatient and too optimistic; it is turning out to be far worse today. In the 30's, they dumped milk in the street and slaughtered livestock to drive up agricultural prices. Today, it looks like we'll be bulldozing our way through a housing surplus. And in Michigan's case, a city surplus! Nothing like rampant destruction and wasted resources to turn an economy up! At least I suppose it is better than looting and burning our way through them. But we may be saving that approach as part of a more robust stimulus package in the coming years after the present plan wears off. You know, the one we implement before we turn fascist and start firebombing other countries.

Capitalism and the Value of Human Life

Gary North posted a brief article based on the following graph which sparked an interesting discussion on his website: This is a graph of Total Capacity Utilization, obtained from the FED's website, which is a description of the percentage of total possible output at which the economy is operating. Basically, if a factory is operating on all cylinders, cranking out as much product as it possibly can over a given time interval, capacity utilization is at 100%. If the factory is shut down, it is 0%. If only two of the three shifts are currently in operation, meaning that the factory is operating at full output 16 hours per day, and is idle 8 hours, capacity utilization is at 66.6%. Said another way, if the factory is capable of producing 100 widgets/day, but is only operating at 75 widgets/day, then capacity utilization is at 75%. Simple enough? Basically, the graph is a description of the employment of physical capital, the tools of production. It complements a description of unemployment, the employment of human capital, which looks like this: Obviously, the data here are plotted inversely, in that the first is a graph of employment and the second is unemployment, so you see spikes instead of dips during recessions (the areas highlighted with grey bars) in the second graph. But you are intelligent. You get the idea. During recessions capital is idled, leading to excess capacity and unemployment. During booms, capital is re-employed. By the way, unemployment of capital (and people) is the best way to judge recession. Next time the egg-heads are debating whether or not the country is in recession, check this graph. It's a no-brainer. What Gary North found interesting about this graph (and which I probably wouldn't have noticed) is that peak capacity utilization (the highest capacity utilization observed between recessions) is in a systematic, 40-year downtrend. The peaks get systematically lower and lower. This is to say that "excess capacity," i.e., the productive capacity still not being used at peak employment, is systematically increasing. There is increasing physical overcapacity for production in the United States. Why? Very interesting. Intrepid economical sleuth that I am, naturally I joined in. And I think I have the answer. I opined that this was the result of an ever increasing ratio of capital to labor. The perpetual accumulation of capital is a natural effect of the wealth building propensity of a capitalist system. Ever more and better tools of production are being placed at the hands of labor, increasing productive capacity. This is how capitalist nations become wealthier. A wonderful side effect of this phenomenon, however, is that as ever more capital is used to multiply the output of human effort, and the ratio of capital to humans increases, humans become relatively more valuable, both as a result of higher individual productivity and as the limiting agent in the productive process. As humans become more scarce in relation to capital, they become relatively more valuable. So, as the value of humans increases over time, it becomes increasingly preferrable for capital to sit idle than for humans to sit idle, or to become injured. What we are seeing in the graph is, I think, a reflection of human considerations taking priority over maximizing the output of physical capital as a simple result of humans being rendered more valuable by a capitalist system. For people who think much about economics, this is probably not an entirely unfamiliar phenomenon. We've all heard about the dreadful working conditions during the Industrial Revolution. Why were they so dreadful? Because industrializing economies were in the early stages of capital accumulation. Capital was scarce, labor plentiful, which meant that capital got priority. Machines and factories were kept in operation despite human costs that we would find unacceptable today. Did fingers get chewed off in the power looms? So what? Fingers were cheap. It was easy enough to just grab some other kid off the street and set him to work. But the loom had to stay in operation. It was expensive, and it was spinning money. A lot as changed for the better since then, and a lot of people, especially the unions, would like you to believe that it was government action and collective bargaining that improved conditions. Not true. Over time, as capital accumulates and becomes more plentiful, labor becomes increasingly limiting. Wages must increase as employers bid for workers. Entrepreneurship increases output through technological advancement as labor becomes limiting. Higher productivity allows workers to earn their subsistence more readily, further increasing their bargaining power (and leisure time!). In short, as capitalism got rolling, it made humans more valuable. And since one of the other great strengths of free-markets is the enforcement of accurate pricing, they were treated like it. The union's would have gotten nowhere if business didn't already know that they could still make a profit with higher salaries and better working conditions. Without that simple fact, higher wages and higher costs would have put them out of business. (Those annoying physical laws of the universe, always intruding...) Likewise today, most of this kind of labor is done in Asia. Why? Because in a macabre sort of calculation, Asian fingers are cheaper than Western fingers, Asian time cheaper than Western time, Asian sweat cheaper than Western sweat. Yes, yes, there is currency and market manipulation. I won't deny that; but even accounting for this there is still a vast differential in the capital to labor ratios which is responsible for a lot of what has happened. We can also actually see this in more everyday occurences, an excellent example of which was pointed out by another reader. He reports how, back in 1968, he and many other highly educated men made a living producing the punch-card programs for a university computer with less computing power than a modern desktop computer! The men, as in multiple people, were perpetually busy feeding programs into the computer to ensure that it was never idle! It was an expensive machine, after all! What a waste to leave a computer sitting idle! Today, of course, most computers spend most of their time sitting idle, waiting for a human to give them a command. Why? Because computers are cheap! Now computers are used to maximize the output of people, not the other way around. Even common secretaries almost universally have a computer at their own personal disposal nowadays. At a cost of only maybe ~$500/yr, it is a miniscule fraction of a secretary's personal salary of maybe ~$20k/yr. Why wouldn't you buy such a cheap tool to vastly increase a worker's output? You'd be insane not to. And why would you worry that such a tool spent some of its time idle? You'd worry more about the idle secretary who was costing you 40 times more money! This little metric is what makes the graph that puzzled Gary North so inspiring. Today, most factories and chemical plants (like the one I work at) still operate 24 hours a day. They are far more expensive than a computer, and too expensive to remain idle. Yet there is the graph, showing decreasing capacity utilization, probably not unlike what a graph of computer usage might have looked like had such data been recorded. How is it that entire factories and chemical plants experience such a phenomenon? One word: safety. Factories and chemical plants are dangerous places, and humans really have become that much more valuable than 40 years ago. I can vouch for it: my own plant is obsessed with safety. It costs too much for someone to get injured. The company would rather see somewhat lower overall productivity than time lost to injury and money lost to medical bills. I haven't been there that long, but the old timers inform me that it wasn't always that way. At one time, things were done a lot less carefully. Back then, an injury would get you taped up and sent back to work. Nowadays, it will get you fired. It is also obssessed with chemical spills. It would rather see lower efficiency than chemicals released into the environment or disruptive accidents. Again, human priorities taking precedence over maximizing output. I suppose a cynic could argue that this is just a matter of higher medical and litigation costs, environmentalism, regulations and the like, and isn't really something to be proud of. There probably is some of that. No doubt a fair amount of lost productivity can be attributed to frivolous concerns. But at the same time, the number one priority of an economy is supposed to be about serving human interest, e.g. satisfying consumer demand, and it also says a lot that we can afford such "indulgences." Indeed, it says a lot that we can afford to worry about things like safe working conditions and polluting our environment. A lot of places can't. We have come a long way, though some of us don't appreciate it much and don't want to admit it. We should also keep this effect in mind as we watch our government squander away our accumulated capital on its cursed "plans" and "initiatives." Especially as it is doing now, maximizing present consumption at the expense of accumulated capital. This is utterly foolish and self-destructive. We are consuming our own futures, as those of you who planned on retiring on your 401(k)'s have likely experienced more literally than you would like. The excesses of the past were just that -- excesses. They should be left behind, not preserved at all costs as we are doing now. The folks that should be most mindful of this (and are least likely to be) are those who think things like working conditions and environmental problems are important. As the capital melts away, I would expect at some point the effect to run in reverse. And one can expect that even legitimate human social concerns like these will eventually take a backseat to keeping one's belly full if this behavior continues. It may have already gone too far. I'd hate to think what it would be like to see that graph turn back upward. But on the basis of what is going on today, I have a feeling it will...

Uh, yeah, I'd like to buy a country....

Two Japanese men got caught attempting to smuggle $134 billion worth of US treasuries into Switzerland:

Two Japanese men are detained in Italy after allegedly attempting to take $134 billion worth of U.S. bonds over the border into Switzerland. Details are maddeningly sketchy, so naturally the global rumor mill is kicking into high gear.

Are these would-be smugglers agents of Kim Jong Il stashing North Korea’s cash in a Swiss vault? Bagmen for Nigerian Internet scammers? Was the money meant for terrorists looking to buy nuclear warheads? Is Japan dumping its dollars secretly? Are the bonds real or counterfeit?

The implications of the securities being legitimate would be bigger than investors may realize. At a minimum, it would suggest that the U.S. risks losing control over its monetary supply on a massive scale.

$134 billion dollars is a lot of money. To put that into perspective, it is approximately 15-20% of the total debt owed by the US to the nation of China. It would be a somewhat larger fraction of what is owed to Japan or Russia. It is larger than many nations annual GDP, as mentioned in the article. If the paper is legitimate, not counterfeit, there is really only one source it could have come from: a national government. Nobody else has pockets that deep. In fact, there are really not that many national governments that would have a stash of treasuries that big, as mentioned in the article. I seriously doubt that North Korea would even begin to make such a list. However, as the article goes on to discuss, the implication is clear: a lot of people are looking to unload these puppies, they don't want to be broadcasting it, and the reason this looks like such an ominous portent instead of just some bizarro story is that there is so much truth to the idea that in a logical, rational world people ought to be trying to unload these things in just such a manner. One more sign that the dollar is in trouble.

Scotty, where are you?...

My appologies for the recent lack of posting. To be fair, I haven't been commenting a lot on other blogs lately, either. I've been reading quite a bit, as I said before. I have to admit, both Inherit the Earth and Liberal Fascism are turning out to be spectacular reads. I cannot recommend them enough. I was skeptical about Liberal Fascism at first, as it is a modern book written by a fairly mainstream pundit (Jonah Goldberg), though I will say that he is one of the only mainstream pundits that I actually find to be a reasonably good read. Anyway, the book was a very pleasant surprise. Vox picked a good one. As for Gary North's book, I expected it to be good simply because he wrote it, but I did not expect that it would turn out to be exactly the book I had been looking for: a systematic overview of the principles of Christian economics. If you have any interest at all in the connection between Biblical ethics and the functioning of the economy, a more thorough Biblical justification of my older rantings, or in what the Bible has to say about economics in general, READ THIS BOOK. The PDF (which you can download for free) has an awful lot of typos in it, apparently from digital interconversions. But it is usually not too difficult to figure out what was supposed to be there. Or you can just buy it. As for the blog, I've been short of interesting news stories of late. I'm tired of commenting on the US debt/FED treasury buying conundrum/situation, though it seems that more and more mainstreamers are beginning to see that things are getting out of control. Just as my pet topic seems to have grabbed the limelight, I've grown silent. Anyway, I think the longer, more thoughtful (and hopefully thought-provoking) posts seem to have more value than a flood of the shorter news-commentary types. I have a mind to revisit the Index of Economic Freedom, with another big post. I've found some more interesting tidbits in the data, but I haven't finished enough of the analysis off to even begin writing. These kinds of posts take a lot of doing, and I've been slacking. I've got a mind to do several others as well, but they would also be long 'uns. Anyway, I'm off to do more reading. You probably should, too.

Regulating the Irregulable

Barry, Timmy & Co. propose just how the government can fix what it, in fact, caused:

NEW YORK (CNNMoney.com) -- President Obama will release details on Wednesday of his proposed overhaul of how the government oversees banks and financial companies.

The aim is to patch holes in the country's complex system of financial regulation.

The system "was fundamentally too fragile and unstable and it did a bad job of protecting consumers and investors," said Treasury Secretary Tim Geithner, who spoke at a Time Warner (TWX, Fortune 500) summit on the economy. Time Warner is the parent of CNNMoney.com.

I'm sure you don't need my opinion on this. You're going to get it anyway. The one thing, ONE STINKING THING, the government could actually regulate that would have made this a complete financial non-event is the freakin' money supply. Yet on this count it steadfastly refuses to do its job, even as it takes on new "responsibilities" that will do nothing but give the financial system a false appearance of security even as it makes things worse. This is the classic case of unintended consequences: the government attempts to achieve some desired effect by fiddling with the money supply, in reality causes an unintended catastrophe, then responds by trying to outmuscle the laws of cause and effect with yet more interventions. Can anyone take a guess as to where this is likely to end? Pathetic. This is not even a case of the perfect being the enemy of the good. It's a case of a crackhead's pipedream becoming the enemy of one of mankind's greates achievements: the the modern industrialized economy, which has lifted man out of the mire of scarcity of preceeding millenia and left the average modern wage earner living as well or better than the greatest kings of old. There is no perfect economy. Ever. This is because there are no perfect people, much less perfect populations. The economy will always be a little screwy. But a limited money supply, competitive marketplace, and that persistent, relentless enforcer of consumer sovereignty, profit-and-loss, do a far better job protecting us from the so-called "excesses of capitalism" than Timmy and his stupid accountants could ever dream of doing. Yet it is precisely these agents that Timmy & Friends insist on undermining and replacing with their own clumsy, self-deluded bureaucratic machinations that will do nothing but run this nation and its economy into the ground. Their regulations will solve nothing. Their tinkering will have no effect but to increase risk and make us all poorer. They cannot solve the problem. They are the problem.

Keynes Kwote of the Day

I rant and rave all too frequently about just how stupid Keynesian economic theory is, but I thought that for once I'd let the man speak for himself:

Ancient Egypt was doubly fortunate and doubtless owed to this its fabled wealth, in that it possessed two activities, namely pyramid building as well as the search for precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.

—John Maynard Keynes

You read that right: John Maynard Keynes thought that the building of the pyramids, e.g. the deliberate wasting of labor and resources, was in large part responsible for the wealth of ancient Egypt. You'd think that it would be obvious to any reasonably intelligent person that rampant waste would have a deleterious effect on an economy. You'd also think that a modern, advanced nation like the United States would have progressed beyond the primitive mentality of such an ancient civilization to the point that building gargantuan monuments for the deification of political leaders would seem like a preposterous idea. But you'd be wrong. More than a few have fallen for this kind of fallacy. In fact, a great many people will claim in all seriousness that a hurricane or a war help the economy by creating demand for repairs or weaponry. By this logic, we could all get rich by paying foreign armies to blow up our cities so that we could rebuild them. Evacuated beforehand, of course; otherwise, it would just be ridiculous. There are some (apparently quite brilliant) people who somehow manage to intuitively grasp the idea that the destruction of resources is not a good idea if one has a mind for increasing overall wealth. I trust that my reader is one of them. But somehow the idea of a central bank (e.g. a Federal Reserve) manipulating interest rates to keep an economy growing still makes sense to these folks, or at least confuses them enough that they can't be sure. The simple reality is that in doing so, the Fed is just instigating the building of pyramids by roundabout means. Let's take a look at it. Suppose that a business entity has looked into making a business venture in the interest of making a profit. This is one of those peculiar tendencies that businesses have. Plans are drawn up, and estimates are made of costs and profit. If there is a profit to be made, the plan will be undertaken and the business will make money, assuming they have planned and executed their plan well. The business has undertaken a constructive activity. If there is no profit, the venture will probably not be undertaken. Why? Because in the present business environment, in the real-world, open market as it stands, this activity is destructive of wealth, as reflected in profit and loss. A business that wants to grow wealth does not undertake destructive activities. Accounting helps with this estimation. Pretty simple. Now, enter our meddlesome central banker. He toggles the interest rate down a notch. Suddenly, the financing costs of business plans go down. A lot of those unprofitable plans look profitable. They are undertaken in the "new" business environment. See what is going on here? In the real world, these activities were known to be destructive. In the phony world distorted by central bankers, they look profitable. Central banks do nothing but monkey with accounting. They inflict Enron accounting on a national scale, with the net result that Enron-like activities are undertaken on a national scale. They look at an unprofitable, wealth-destructive situation, and think that they can render it otherwise in the real world by fudging the accounting. It doesn't take a rocket scientist to recognize that pretty much any artificial "stimulus" is pretty much the same thing: an attempt to render an unprofitable, wealth-destructive activity profitable on paper so that people will undertake it. Phony accounting cannot render any activity materially profitable in the real world. It cannot change reality. I do not think that this is a tremendously difficult concept to understand, yet apparently one can still manage to land a Nobel Prize by articulating ideas which fly in the face of such obvious common sense. How in the world is it that so many "smart" people become Keynesian, central banking apologists? I smell a conspiracy...

It is getting scary!

I don't propose to know much about the economy (or anything for that matter), but even and idiot can identify a stop sign (ok, so I did miss that question on my driving test, but it was tricky. So in my little cocoon of a life that really hasn't been impacted by the crisis, other that less headlines about Brittany and Lindsay and no raise this year, I have been picking up the hints in the media that Scott has been screaming. I guess for me I am getting scared when the mainstream media starts to point out what is obvious. I knew it was bad in my gut from the start, but now I feel a little better that it is in the mainstream:

Reuters

WSJ

Foxnews

Foxbusiness

And on a positive note:

Foxnews

with this happy outlook:

"Retail sales rose by the largest amount in four months in May... The May advance could be another signal that the worst of the recession is over."

For some reason I am not as optimistic :(

Reading Material

In case anybody else wants to participate, I'll be joining in on Voxiversity's reading of Liberal Fascism. So you'll probably be seeing posts about fascism anytime now. Assuming I decide to post things, as the whole blog thing is beginning to wear on me. First assignment is the intro, quiz on Saturday. I got the book in the mail yesterday and have already read the intro. It looks to be an interesting book. According to Goldberg, the French Revolution was the first fascist revolution, and that America itself temporarily became a fascist country... during World War I! Interesting. And probably useful too, as this seems to be where we are headed. It'll be nice to know what warning signs to look for as we try to survive the coming decades. Incidentally, I am also reading Inherit the Earth by Gary North, and The Case for Christ by Lee Strobel, more or less at the same time. So if I begin posting off-the-wall thoughts confusing assorted facts from economics, fascism, and Christianity, its because I have overloaded my circuits and my brain has been scrambled. OK, OK, so it is always scrambled...

Super-Bernanke: "We Can Hack It"

Our illustrious leaders assure us that everything is under control:

WASHINGTON (Reuters) - The U.S. central bank will be able to raise interest rates when the time comes to head off inflation, even with a bloated balance sheet, Federal Reserve Chairman Ben Bernanke said on Wednesday.

Bernanke told the House of Representatives' Budget Committee that deciding when to start withdrawing the money the Fed has pumped into the economy to stem its downward spiral would be a tough call to make, but he expressed confidence inflation would be averted.

"We want to be sure that we'll be able to remove accommodation at an appropriate time and an appropriate speed to ensure that we don't have an inflation risk down the road," Bernanke said.

"It's not going to be an easy call but we'll have to balance the risk on both sides -- not going too soon and stunting the (recovery) and not going too late and having a bit of inflation. But we will get price stability after we get out of this recession."

Of course, you don't really expect him to tell you that the time has come to panic, do you? I talked about the basic strategies the FED could use to contract the bloated money supply in order to "fight inflation" some time ago. In addition, the FED has said it may issue it's own debt, which I discussed here and here. I went into a fair level of detail in those posts, so I won't cough it all up again here. All are mentioned as possible solutions by this article. They are not. Suffice it to say, there really isn't much the FED can do in the long haul except raise the reserve ratio. The article mentions in particular having the FED issue its own debt, essentially borrowing money simply for the purpose of taking that money out of the market, kind of like borrowing money and burying it in a hole in the ground, but the FED will have to pay interest on this debt, and eventually redeem the notes or issue even more debt, which will result in even more monetary expansion in the long haul. All scenarios that involve tying up money at the FED also involve paying interest back into the market. These are not solutions. None of these strategies is sufficient to solve the FED's inflation problem. What the FED really needs to do is sell assets. But it has either sold or lent out almost all of its good assets. Its present assets, mostly bad mortgage paper, were bought at face value, far above market prices; they would not fetch anything close to this if sold today. The FED needs the inflation if it is to unload these assets at anything close to what it paid. I suspect the FED will get it, whether that is the intention or not. The fact that the FED is contemplating these tactics should scare us. As I said before, this is banana republic monetary policy. Our economy is increasingly resembling a third world backwater. Expect the same of our standard of living at some point.

Charles Wheelan Has an Epiphany

Charles Wheelan has written an insightful column over at Yahoo!Finance, in which he addresses the appearance and consequences of false market signals:

This isn't just a bad job market - it's the popping of a "human capital bubble." Wall Street and its assorted reckless offshoots didn't just squander much of our capital; the financial industry also sucked up human talent for the better part of a decade that should have gone somewhere else. It's the human equivalent of those empty subdivisions in foreclosure that never should have been built.

That's what happens with bubbles. Resources -- including people -- are allocated poorly because the market sends faulty signals.

Does "allocated poorly" in response to "faulty signals" sound familiar? Sounds hauntingly like he is articulating the basic idea behind "malinvestment" if you ask me. Why a market would systematically give false signals, which is precisely what markets are not supposed to do and is generally cited as the reason that market economies outperform command economies, appears to have concerned him, as it should:

After all, the whole point of a market, whether it is real estate or labor, is that prices send meaningful signals. Graduates take jobs with high salaries because that is where their skills will be most productive. Developers build new units where prices are high because that is where there is the most demand relative to supply.

To his credit, he doesn't fall for the old saw of blaming "greed:"

The problem was NOT greed; self-interest is and always will be at the heart of market behavior. The problem was that self-interest is a disaster when the market signals are wrong. It's like giving someone a bad map and then criticizing their driving when they show up in the wrong place.

This is precisely correct. Greed has always been around. It is an integral part of any market, and is precisely the reason that price signals work to allocate resources efficiently. Greed responds to pricing differentials; it doesn't create them. Actually, it destroys them by sending increased supply to meet demand, or for the more rapacious, by selling short on evidence of overpricing. Blaming greed is putting the cart before the horse. Or indicting rainfall for drought. Likewise, blaming the crisis on the dishonest behavior of characters like Bernie Madoff also does not make any sense, with one notable exception familiar to regular readers. Wall Street, and for that matter, Planet Earth, has always been full of greedy, dishonest con-men. To my knowledge, they have never managed to bring down the entire global economy with their evil deeds. Most commenters have focused on lax oversight by the government and less than rigorous regulation. But seriously, the long arm of the law has never been as reliable at keeping this type of behavior in check as a competitive and efficient marketplace. Even the commies couldn't keep an eye on everyone. These people have always been around, and always will. How is it that they managed to take us all in all at once? How did they last so long without getting caught by Mr. Marketplace? On top of that, far more losses have been chalked up to stupid behavior, and stupid is not criminal. How did it come to pass that so many patently stupid mortgage notes got written? How is it that so many actors, both criminal and stupid alike, managed to get away with such awful "investment" strategies for so long without the market tearing them to shreds? In an efficient market, none of these guys would have lasted five minutes. Yet this stuff has gone on for years. As I have said before, the operative question is not how they were allowed to get away with this stuff for so long, but how they were able to in a competitive marketplace. Why wasn't inefficient pricing corrected? Why weren't losses sustained earlier? Where were these false signals coming from, and how did they manage to persist for so long? Kudos to Dr. Wheelan on making some insightful observations and using his intuition to connect some of the dots, but unfortunately, he fails to come up with a plausible explanation for where the signals were coming from, so he doesn't have the complete answer for us. Of course, those who visit this site regularly already know quite well what the culprit is, and ought to be able to give a fairly complete description of how it all works at this point. I hope Dr. Wheelan continues with his line of inquiry and finds his answer. Perhaps we'll soon have another Austrian convert.

Is the Economy on a Run...

...or about to take a nosedive? What the heck is going on? GM declares bankruptcy, and the DOW is up 200+ points for the day. In fact, the DOW is up almost 30% from its March lows. Even more encouraging, a critical manufacturing index is up in China, as is consumer sentiment. Are good times here again? Is it all over? I'll do a little speculating. Across the globe, governments have been spending the last several months printing piles and piles of money in a global fit of "quantitative easing." (Meanwhile, of course, they have reprimanded their fellow governments for doing precisely the same thing. But I digress...) This is in contrast to normal policy, which is to print money slightly more slowly. The motivation for the fist act is, as we all know, to allow those who have run up bills that they can't pay to pretend to pay them and avoid bankruptcy. Especially politically well connected debtors, like large banks. Thus far, the government has been careful to keep the printed money "off the market," and safely locked away in the vaults of the FED. The motivation for the second, more routine act, is to "stimulate the economy" by suppressing interest rates. This money is freely allowed to enter the economy, and hence the fractional reserve banking system which multiplies it through its activities. Done a little at a time, it takes a very long time to show up in the CPI, which is the measure most people use to "measure" inflation. Incorrectly, mind you, but this is what they do nonetheless. It is amazing what kinds of business activity are profitable when there is an ever expanding pile of money available for paying one's bills. Now, when the FED stopped policy number 2, in response, in part, to $147/bbl oil, and ever so briefly before it started policy 1, the abject stupidity baked into the economy as a result of the slow trickle of money was revealed. Kind of like when you wake up after a night of heavy drinking and find that your aren't quite sure where your pants have gotten off to or how the furniture came to be set on fire. As a result, there was a "correction." With the quantitative easing now in full force, the "correction" has given way to something of a "recovery" over the past few months. Which is to say, an awful lot of rascals have gotten out of paying their bills, and the "stimulus" is making businesses look profitable again. (Amazing how easy that is when money appears out of thin air, as it were...) I expect that the next quarter's reports will probably look much improved over the previous two. I expect more "good news" on a variety of fronts. I expect a further rally in stock markets. However, I predict it will end. The seed of its destruction is beginning to appear. Oil is again nearing $70/bbl. Last month's CPI numbers were ominous. Thanks to the precipitous drop in gas prices since last years moon-shot, overall numbers were flat. But sans energy, they are up. Up quite a lot for it being the midst of the biggest recession since the 1930's. I expect that in a few months time, possibly sooner, overall CPI numbers will rise. Markets will fall in response, because they know what this means: the jig is up. Party's over, and its time for the hangover. The FED will either have to stop its money-printing binge, putting the brakes on paying old bills with new dollars and sending markets back into the pits of doom, or watch prices shoot through the moon, destroying the value of equities and sending markets back into the pits of doom. The two possible outcomes have tremendously different ramifications for various investments, of course, but don't bet on things getting better anytime soon. Pure speculation, of course.