Market Update

Many apologies for my prolonged absence. Life seems to have hit a rough patch. Maybe someday the lesson will sink in that life is the rough patch, and that the successful learn to take it in stride. But for now, I'm going to mope about it and let it interfere with my bloggerly duties. At any rate, here is a quick rundown of moderately significant recent market happenings that you, intrepid reader, should know about. The FED Bernanke once again denied that the FED had any responsibility for inflating the housing bubble and causing the financial crisis. It wasn't the torrent of money that caused prices to rise to the moon and instigated a financial feeding frenzy. No:

“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,”

he says. It was entirely the fault of that cursed free market, you see. You can't just let people do what they please and expect the world to keep spinning on its axis, at least if your going to run a proper utopian scheme. You can't have a free market and a central bank. Raising interest rates and stabilizing the money supply just wouldn't have done the job. It would have had consequences, namely, that the country would have had to face economic reality. What you need is tighter regulations, more oversight, to make the central planner's dream work. We will achieve Utopia here, and you will do what you're told! AND SMILE DAMMIT! Note to idiot bureaucrats and politicians out there: it is difficult to defend yourself from charges of incompetence when the very thing for which you are responsible goes to the dogs on your watch. When you are running the show and things go wrong, it is, in fact, your fault. You will never, ever, be able to control it all. So, if you don't want to be blamed for every disaster that crops up, stop seeking to control every aspect of our lives! If the FED weren't in charge of running the economy, it wouldn't be blamed when the economy went into meltdown. Case closed. China Jim Chanos, short-seller extraordinaire, has chimed in that he thinks China is headed for a crash:

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

You have seen my reasons for believing China is likely headed for disaster in the short term and long term stagnation. I dealt with decidedly broader issues, but even focusing on the financial side of things as Chanos appears to be doing, things don't look good either. One simply doesn't inflate at 28%, have the government write stimulus checks equivalent to 18% of GDP, then suddenly tighten monetary policy and not get a nasty market hangover. You'd think that more folks would be in the China bear camp, but all the same, it is nice to be in the company of at least one actual investing genius. By the way, how is it that Thomas Friedman actually manages to sustain a career writing financial columns?

[I]t is easy to look at China today and see its enormous problems and things that it is not getting right. For instance, low interest rates, easy credit, an undervalued currency and hot money flowing in from abroad have led to what the Chinese government Sunday called “excessively rising house prices” in major cities, or what some might call a speculative bubble ripe for the shorting. In the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles. And that’s the point. I am reluctant to sell China short, not because I think it has no problems or corruption or bubbles, but because I think it has all those problems in spades — and some will blow up along the way (the most dangerous being pollution). But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us).

So, ummm..., China has a super easy money policy, and, then ... it ... ah, it goes and tightens said policy, but ...er, umm..., well Chanos just somehow isn't going to make any money shorting the market because he's just wrong. Go China! The fact that China's central bank is "edging up interest rates and raising the proportion of deposits that banks must set aside as reserves" is exactly why asset prices will fall at some point and Chanos will indeed make a lot of money if he has shorted them. It doesn't matter that a stable money supply is the correct policy and the PBoC is right to move in this direction, when you inflate prices with a credit binge and then throw on the monetary brakes, prices fall. It's not rocket science. Thomas Friedman couldn't possibly make a better case for shorting the Chinese market. Banking and the Housing Market If we are to believe certain government pronouncements, always risky thing to do, several big changes appear in the pipeline that are extremely bearish for the financial and housing markets. The FED has pledged to stop buying mortgage securities at the end of March. The housing tax credit is scheduled to expire this year as well. So far, our keepers in Washington have been holding the line on this declaration, unlike previous pledges to end the stimulus at various dates through 2009 which were all broken as it became apparent that this would put markets right back into contraction. The Austrian theory of the business cycles states that once capital prices become inflated due to an increase in the money supply, propping them up will only be possible with further increases to the money supply, so that continual increases are necessary to sustain a market boom. This is why stimulus doesn't work: the stimulus must remain permanent to have the desired effect. Keynesian's don't believe this; they think that a liberal fiscal policy can tide the market over until it finds sustainable footing. IF the FED honors its pledge, an admittedly big IF, I guess we'll get to find out who is right. I'm not holding my breath, though. Yesterday, Dear Leader Obama announced that the banking system should face restrictions on bank size and activities which sent the DOW skidding 200+ points. Today, it repeated the feat. What a joke. Virtually every financial policy of government of the past century has been to favor consolidation of banks into ever larger and fewer entities and encourage ever riskier behavior. In fact, the FDIC depends on this consolidation to curtail claims against its assets, as do other "bank rescue activities" associated with the FED. They couldn't function without it. The whole point of consolidation from an accounting perspective (which is the one that matters when you're talking about bankruptcy) is to merge healthy balance sheets with the garbage accumulated by croaking institutions to produce a mediocre, bloated, but non-bankrupt super-bank. (OK, yes ALL banks are technically bankrupt. Just so the Feds don't have to seize them. That's the point.) I don't think anything needs to be said of the effects of persistent monetary expansion and easy credit, "moral hazard," and "too big to fail" policies. Suffice it to say that gigantic banks have been explicit government policy for generations. This is central to the entire regime that governs modern finance. Don't expect anything to change. As for restrictions on trading activities MAYBE THE GOVERNMENT SHOULD CONSIDER NOT ACTING AS AN INSURER FOR STUPID BEHAVIOR AND ALLOWING THE FED TO PRINT GOBS AND GOBS OF MONEY WITH WHICH TO GAMBLE. Nah. Too easy. Bottom Line Two things are working against economic recovery. First, government efforts to "stabilize" markets are preventing prices from reaching market clearing levels. The result is a general seize-up, unemployment of capital and labor, and stagnation. Second, in an effort to keep the transactions flowing and prevent a breakdown of the banking system, the FED is expanding the money supply to provide cheap, subsidized credit and the government is running fiscal deficits to "spur aggregate demand," in Keynesian parlance. This means that transactions are taking place under deceptive conditions that do not reflect true market forces. They therefore are not generating wealth in an efficient manner and are a waste of resources. But room for monetary expansion is running out. Wages fell last last year while consumer price inflation was up around 3 percent. If you ask a Keynesian, that is not supposed to happen. If you ask an Austrian, prices should only rise when bidders, consumers in this case, have more money in their pockets with which to bid. So, where's the money coming from if wages are down? Hint -- one word, two syllables, starts with a W. Government spending is also an acceptable answer (oops! gave it away.) There's your stimulus for you -- higher prices, stagnant employment, government fostered dependency. The time is close at hand that the FED will likely curtail its expansion in response to pricing pressures. It may already be upon us. My expectation is another round of tightening, with consequent falling capital goods and commodity prices (houses, stocks, gold, etc.) and another round of layoffs. Private debt will contract as borrowers go into default. Government debt will expand as tax revenues fall and more stimulus and bailouts demand heavy borrowing. After the round of tightening and consequent recession, the FED will expand the money supply again, and we'll likely start another round of phony recovery at an even higher price than the last one. A greater fraction of the price increases due to monetary inflation will be seen in consumer prices rather than capital goods, e.g. housing and the stock market. The net result of these activities will be to slowly put ever more of the population on the dole, frustrate private wealth creation, increase the government's footprint, and erode savings, the standard of living, and the value of the dollar. When will the final inflation come? I don't really know. Maybe the next round is it. But one thing is certain -- the present is unsustainable and the government will not be able to pay its bills. Something will have to give, and every indication is that it will be the dollar. ...and, on the bright side, eventually the government.