The Signs

The signs of out-and-out recession are finally back.  Of course, most of us with any sense know that we have been in a recession the whole time and there was never any real recovery, but the papering over is now wearing thin and the ugly truth is starting to show through.

Everyone has probably noticed that stock prices are down --

Chinese markets are really getting hammered --

But so is oil --

And gold prices --

The Other Kind of Welfare...

..has apparently been known to have been with us for a long time:

Whenever, in the actual state of things, a fresh issue of notes comes into the hands of those who mean to employ them in the prosecution and extension of profitable business, a difference in the distribution of the circulating medium takes place, similar in kind to that which has been last supposed; and produces similar, though of course comparatively inconsiderable effects, in altering the proportion between capital and revenue in favor of the former.  The new notes go into the market as so much additional capital, to purchase what is necessary for the conduct of the concern.  But, before the produce of the country has been increased, it is impossible for one person to have more of it, without diminishing the shares of some others.  This diminution is affected by the rise of prices, occasioned by the competition of the new notes, which puts it out of the power of those who are only buyers, and not sellers, to purchase as much of the annual produce as before:  While all the industrious classes -- all of those who sell as well as buy -- are, during the progressive rise of prices, making unusual profits; and, even when this progression stops, are left with the command of a greater portion of the annual produce than they possessed previous to the new issues.

-- Thomas Robert Malthus, 1811, from
Prices and Production by F. A. Hayek

Malthus apparently noticed that the issue of new notes created a boom in prices of capital goods, and that it caused wealth to accumulate preferentially to business owners -- "sellers as well as buyers" -- as opposed to wage earners and those living on fixed incomes -- "those who are only buyers, and not sellers."

Now, if he'd only followed through on that observation...

Aaron Was Right -- And Some Great Graphs To Prove It

Awhile back, I 'corrected' Aaron that in the course of the business cycle there isn't really a problem with 'overconsumption.'  As it turns out, I was the one that needed correction.

In defense of myself, I will here blather uselessly for a few moments about why it did (and in some ways, still does) not seem reasonable to think this way about the problem.  Firstly, the business cycle is caused by the issue of excess credit above the rate of savings.  The extra credit is used to increase demand for capital goods, shifting the ratio of expenditures in favor of capital goods versus consumer goods.  Thus, how could there be an excess of both investment and consumption at the same time, in a universe in which materials are generally understood to be conserved?

Secondly, the partition of demand between present (consumption) and future (production) goods is given by the time preference of the society in question.  This is an intrinsic property of the population.  It is time preferences which determine interest rates.  The hypothesis of overconsumption would tend to suggest that FED policies had in fact influenced time preferences -- that the manipulation of interest rates had changed the time preferences of society.  This is a case of the tail wagging the dog, and begs the chicken-and-egg question.  Do interest rates determine time preferences, or time preferences determine interest rates?

Hard Examples

I have a theoretical mind. I can't help it. I have always been that way, and being trained as a scientist hasn't made it any better. It is both a strength and a weakness. It is a strength in that I can sift through situations and ideas that most would find immensely boring, and then apply my theoretical understanding to new circumstances usefully. It is a weakness in that many people are not so oriented, or at least not so heavily so, and I have a difficult time relating to them.

'Hypertheoreticalism,' which is what I'm dubbing my mental malady, is an excessively Greek outlook. The Greek way of explanation and understanding is through chains of reasoning – if A, then B and not C, and so on. Think Euclid's Elements. Most people, truth be told, prefer Hebrew explanations and understanding – 'Let me tell you a story.' This is the narrative way of understanding, which is a long way of saying that most people like hard examples that they can relate to. I do too, when it comes down to it, and my mind can't handle the theory I'm throwing at it.

I have a second problem as well. I was once a sort of mini-expert on the Myers-Briggs personality type model, where this shortcoming was revealed to me. In the Myers-Briggs model, personality characteristics are assigned as four sets of paired dichotomies, the most important of which – at least as far as learning and understanding is concerned – is the final quality, whether one tends to perceive, or to judge, as his primary means for ascertaining new knowledge or truth. I am a Perceiver, which means that I look for consistencies or patterns across a wide range of observations, but neglect strict internal consistency within my ideas. Judgers, on the other hand, tend to neglect observation and instead derive new knowledge on the basis of trusted information which they already know. Thus they focus on rigorous internal consistency at the expense of breadth.

Most people – especially the argumentative types that one encounters on the blogsphere – are Judgers, so again, I tend to fail to impress. This same orientation is reflected, I think, in an old description of philosophers as being either bees – who fly about all over from flower to flower, taking whatever there is to offer – or spiders, who weave their intricate, perfect webs in a tiny corner somewhere and rarely venture out. Again, I am a bee, and most people seem to be spiders.

Narratives have generally been useless to me unless I have had a theory against which to understand the story. Unfortunately, it is stories which most people need to see the utility and relevance of theory. So, I have typically been dealing in theories and generalities, when it appears that narratives and particulars are what is most needed. I admit that this is my weakest suit but I shall here try to oblige.

The following three examples, I think, reflect the theories I have been dealing with in action. At least, I will try to show that they do, though I am not a professional economist and am not really equipped at actual practice. But I will try. They will also still at least have some generality to them, as I wish to protect identities.

The Distributists

About the same time that Ludwig von Mises was writing his Theory of Money and Credit, and Thorstein Veblen was writing his Theory of Business Enterprise, yet a third – and somewhat more obscure – group of social theorists was busily trying to come to grips with the faults and failures of the economic system around them. Like the others, they also thought that things were becoming too centralized, and did not trust to the general benevolence of such arrangements. Unlike the other groups, they had a strong religious bent informing their views. The two principal proponents of this view were lay Catholic writers, G.K. Chesterton and Hillaire Belloc, who even in their day were known more for their political journalism, religious writings, and fiction than their economic opinions. In fact, they were not even economists at all, and appear to have been less concerned with the efficiency of any production scheme than with its being well suited to the lives and dignity of those who participated in it. The group I am speaking of is the Distributists. Today, their views live on in the books of these two prolific writers as well as some few modern adherents to their views.

Greek Bank Run and a Debt Downgrade

Wise Greeks have begun withdrawing their savings and holding them as cash --

In one of the biggest banks in the centre of Athens a clerk is explaining how his savers have been thronging to pull out their cash.

Wary of giving his name, he glances around the marble-floored, wood-panelled foyer before pulling out a slim A4-sized folder. It is about the size of a small safety-deposit box – and those, ever since the financial crisis hit Greece 18 months ago, have become the most sought-after financial products in the country. Worried about whether the banks will stay in business, Greeks have been taking their life savings out of accounts and sticking them in metal slits in basement vaults.

The boxes are so popular that the bank has doubled the rent on them in the past year – and still every day between five and 10 customers request one. This bank ran out of spares months ago. The clerk leans over: "I've been working in a bank for 31 years, and I've never seen a panic like this."

This is the modern version of a bank run.  Greeks are apparently increasingly coming to terms with exactly what the consequences will be of the situation they are facing.  Ultimately, deposit insurance that would repay them in the event of bank failure is funded by the government treasury.  If the government fails AND their bank fails, their deposits will be lost.

Paper money, however, is part of the monetary base -- under a fiat regime, anyway.  Under a gold standard, it is not. As such, its supply cannot be contracted or destroyed by bank failures, while mere bank deposits can.  By holding 'cash,' -- not bank deposits --wise Greeks are are protecting themselves.  Their government has no way to nationalize the ECB or to force it to inflate or to save the financial system, though obviously in its own self interest the remainder of Europe's banks would prefer the Greek system not to fail.  This is a fairly unique juncture.

Our own threatened 'default' of the past few weeks is not analogous, as evidenced by low Treasury interest rates here vs. Greek rates.  Greece is at the end of its rope, while we still have a few more feet to fall.  There is no such threat here and now, but that does not mean there will never be.

S&P has downgraded Treasury debt -- notably on a Friday evening after markets had closed, so that nobody could do anything about it. That was very considerate of them. Whether that will actually raise interest rates remains to be seen. Theoretically, it should, but theoretically, where is an investor to put his money these days?

Whatever happens over the next few days, at some point America's lenders will balk at further funding -- even including the FED.  There will be a choice to make -- nationalization of the FED, or default.  When that day comes, remember this day in Greece.

Forewarned is forearmed.

New Feudalism VI - The New New Feudalism

So -- what happens next? How will this conflict resolve itself?

There are actually some fairly good guides as to what might happen when one order is supplanted by another -- in these very two works by Burke and Veblen, no less. One 'pattern' that I have seen pointed out in other places is to look at the various colonies that spun off of the British Empire over the past few centuries. Early to break away was America, which based its governing principles on the early Enlightenment ideas that were swirling about at the time, mostly along the lines of the ideas of John Locke. Much as the revolution was about kicking the British out, structurally and philosophically, America based its governing principles on the Britain of that day.

Later came Canada and Australia, once the Enlightenment's more strongly libertarian elements had faded and a more 'pragmatic' approach to statecraft had taken over that began to try to accommodate both the so-called 'positive and negative' freedoms. John Stuart Mill would probably best characterize the thinking of that period.

Later still came India in 1947, after Britain had spent a number of years in the grip of Fabian socialism. Unsurprisingly, Indian democracy proved highly bureaucratized, though that may also be a reflection of India's long tradition of social regimentation. Lastly, Hong Kong was transferred to China mostly in the image of Thatcherite free-market conservatism.

Today we see the Middle East in the throes of revolution, and the rhetoric of the upstarts mostly revolves around 'democracy.' Even if their actual articulations may be fairly shallow and that may not be what they eventually get, nevertheless, for most it is the animating motivation. It also, for better or worse, happens to be the popular mantra of the day.

This all falls in line pretty well with Burke's description of the Glorious Revolution's codification into written law what had already been the custom of common law for many years. It is also consistent with Veblen's observation that major changes in the order of society come in the wake of a major shift in commonplace habits of thought of people and their understanding of reality. Where the existing order fails to reflect reality as people observe and understand it in everyday affairs, it is displaced to reflect the new understanding.

The questions one must answer then, it seems to me, is 'what basic assumptions about life are broadly entertained by Americans at this point in time' and 'where do these conflict with the present order'? Those are the attitudes that are likely to find their way into law and custom in the future. So, one finds himself playing armchair psychologist of the American people, of which I'm probably not going to be the best practitioner. But I'll give it a whack, trying to stick mostly with the subject of economics. I'm sure others will be able to contribute better where they have special insight.

The New Feudalism V -- The System and How It Works

Here I lay out the basics of The New Feudalism.

The Crux of the Matter

Economic conservatives have long been able to identify nefarious practices that distort markets to the benefit of some over others. These would include, among others –

• Tax-and-spend redistribution schemes
• Punitive Tariffs and Subsidies
• Government Regulation

Note that these activities are not only thought of as unfair, but they are rightly blamed for distorting the entire economy in a destructive manner.

The Austrian school adds another source of such economic distortion, plus a predictive theory for how this distortion works. It believes that manipulations of the money supply by the banking system, and especially central banks, create distortions to the economy that not only create winners and losers, but produce the economically destructive business cycle. These negative consequences of tampering with the money supply arise because changes to the supply of money subvert its accounting function. The supply fluctuations are created by the nonsensical financial accounting of the banking system, in which deposits of money are both 'spendable and lendable' at the same time.  

Those of us who believe in free markets and sound money have to this point contended that, this being the situation, the destructiveness and unfairness can be practically eliminated simply by 'setting the rules right.'

What Veblen has contributed, which I believe is unique, is the idea that markets may be subverted within the basic legal framework of the free market. This is made possible by the increasing interdependence of market participants as the division of labor increases. The tactic is very simple – use contracts and legal maneuvering to secure legal rights that allow the creation of some sort of market restriction, or more generally, a stream of 'free-income.' The supply restriction (or other contractual installation) essentially subverts the accounting function of money by rewarding the restriction rather than a value contributed to the market. It is like being paid for punching other economic actors in the face -- businessmen start punching one another in the face and getting paid for it, rather than serving the consumer. It also distorts the price structure, causing other actors to adjust their behavior inefficiently in response to spurious market valuations.

The market restriction provides a 'something-for-nothing,' -- a violation of economic reality. 

The New Feudalism IV: Intermission

There is so much ground covered by these two works that it is hard to begin to put them into modern perspective.  They call to mind so many ideas about the present and recent past, it would be impossible to comment on everything.  And no, I haven't managed to pull together a 'final analysis' yet.  Here are a select few ideas as a sort of intermission until I can get things done.

Burke, Veblen, and the New Feudalism: Part III-ii -- Veblen the Economic Historian and Sociologist, cont.

The previous section focused mainly on the historical lead up to the modern social order and the conflict it has with the modern economic order.  This section will focus on the state of the nature of that conflict as it stood at the turn of the 20th century.

***

Burke, Veblen, and the New Feudalism: Part III-i -- Veblen the Economic Historian and Sociologist

Introductory Note:  Normally, I enjoy material that challenges my deepest assumptions and makes me question the way I look at the world.  Reading Veblen has certainly done that for me.

Normally this kind of exercise leaves me in a sort of mildly elated state, having stretched myself with ideas that have left me feeling that I really understand things better, or have at least imagined big things which turned out false, which is one of the reasons I continue on doing it.  I was exhilarated when I began digging into the Austrian school's take on economics, and the way it finally explained things I had struggled with for years.  This material, I think, is of that same order.

But I must confess to being a bit overwhelmed this time.  I am confronting ideas that I find very difficult to handle.  Many of the isolated points Veblen makes, I have known for some time -- that the extremely rich become so almost exclusively by skillful maneuvering of a broken monetary and legal system, that the markets are rigged and artificial, easily milked by people who know how, that something very wrong has happened to the West beginning in about the late 19th century and progressively eats away at it today, near to the point of destruction.  But he puts everything together in a way that has hit me very hard.  He has answered my hard questions with much harder answers.

Are Businessmen Really Parasites?

Before going much further in this series on the Enlightenment and its relationship to the modern economy, I thought that I would stop and address a couple of fairly controversial ideas that appeared in the second essay – namely, whether businessmen really are economic parasites, and the idea that an ideal economy would have near zero profits.  I thought that I'd start with the second one first, because it is a little less controversial and easier to explain.

Burke, Veblen, and the New Feudalism: Part I -- Reflections on Edmund Burke

Introduction

Almost every great lesson and important truth I have ever learned was not by direct rational argument. I either learned it obliquely, for example by encountering it unexpectedly while in pursuit of something completely unrelated, or by some experience or anecdote that I happen to run across. Rarely have I found another's arguments persuasive enough to convince me of anything important which I did not already believe, though I suppose they do serve the purpose of 'planting seeds' that flower later. Serendipity, in other words, has been a least as great a part of my adult education as anything I have rationally undertaken, and its direction seems to have been due as much to random chance or acts of God as any kind of direction I have tried to give them.

Probably the first important truth I so discovered (at least, that I can recall clearly) was that one absolutely cannot trust modern accounts, even from highly respectable sources, of the writings of ages past. If you want to know what some famous historical figure really had to say you absolutely have to read his writings for yourself. When you do, you will invariably find that the modern 'pop-culture' versions are horrible distortions of the original. Sometimes they are so bad as to be unrecognizable.

In my case, it was Robert Thomas Malthus' Essay on the Principles of Population, horribly mangled versions of which I had repeatedly encountered in college. Why this book? Because it struck me as silly that people would still be making fun of something a man said two centuries after his death. If he really was such an idiot, why were people still talking about him? Why would anybody remember him among so many others?

As it turns out, his book is primarily an economic argument against contemporary schemes for the collective ownership of property, not a biological thesis on the behavior of populations. He did not predict that the population would explode and then humanity would starve to death, and from what I can tell, he's largely been proven correct with respect to the main points of his argument. But you wouldn't know it if you listened to practically any modern recounting. Almost every mention you will encounter today will twist his arguments in knots and make him out to be either a devil or a clown.

This book is also where I got my first inkling that people of the past, and in particular the eighteenth century, were more 'developed' in many respects than we are today. I had never encountered a comparable modern work at the time, and that really made an impression on me, given how much I had read from present times as compared to the past. I still haven't seen anything by a modern author that compares, with the possible exception of C.S. Lewis, who hardly qualifies as modern.

Repeated encounters of superior work from earlier days had convinced me that somehow the nineteenth century was some sort of Western human pinnacle. However, two recent 'encounters' have convinced me that I need to rethink that idea, as well as quite a few others.

Why You Should Never Believe a Commie Mercantilist...

...or the financial reporters who cover them:

BEIJING (Reuters) - China's foreign exchange reserves soared to a record of more than $3 trillion by end-March, while its money supply growth blew past forecasts, threatening to aggravate the nation's inflation woes and trigger more policy tightening.

Chinese banks extended 679.4 billion yuan ($104 billion) in new local currency loans in March, while the broad M2 measure of money supply rose 16.6 percent from a year earlier, both above market expectations.

Tapping the brakes on money and lending growth has been a crucial part of Beijing's campaign to rein in inflation, which probably hit a 32-month high of 5.4 percent in the year to March, according to local media reports.

After making progress at the start of the year in mopping up excess cash, the People's Bank of China appeared to lose some ground in March.

This after months and months of reports that the PBoC was tightening, the PBoC had given up stimulating exports, and the Chinese government was moving the economy towards serving "domestic consumption."

Don't believe a word of it.  Old habits die hard, and crusty old corporate racketeers don't like to lose money.  Like our own situation, I doubt the Chinese elite and the government that serves it will change its "economic model" until that model has left the country a smoking ruins.

The Debt Aesthetic

I have just finished a (very) long househunting campaign. I have come to the conclusion that there are several ironclad rules of homebuying --

1) Women are the choosers.
2) Men have veto power and some influence on the price.
3) You will never get what you want if you want it too badly.

Only once the first two rules are clearly understood can househunting be undertaken in anything approaching an efficient manner. Once the third is understood, the likelihood of success in negotiation is much improved. Those who do not hew to these rules will find their efforts frustrated.

I made several other important discoveries in the process, most of which saddened me a bit. These phenomena all seem to have one thing in common -- the housing market is dominated by the whims of women and debt.

Random Stuff

Possible PPI-CPI Trainwreck Ahead

The BLS announced that producer prices increased at an alarming rate compared to consumer prices --

The Producer Price Index rose 1.6% in February alone, the Labor Department reported Wednesday, the biggest jump in nearly two years. The rise was far worse than the 0.6% increase that economists surveyed by Briefing.com were expecting. Overall, prices rose 5.6% from a year ago....

Despite rising gasoline prices over the last month, economists surveyed by CNNMoney are forecasting only a 2% rise in overall consumer prices over the last 12 months, and a 1.1% rise in core-CPI.

This, naturally, is unsustainable.  How will it resolve itself?  That depends on what exactly is going on to cause it.

Classical theorists would say that as crude goods' prices increase, they will drive up the price of finished goods as costs increase.  That is also what most meathead business reporters think.  The problem is that finished goods producers can only raise prices if their own buyers are able to pay.  If they can't, those expensive goods are either going to sit around rotting, or more likely, the companies that produced them are going to sustain losses when they sell them. 

Of course, it may be true that the final buyers really do have the money to pay, and we will see higher CPI in the near future.  Even meatheads get it right sometimes.

My own guess is that the recent increases in the money supply are principally available to banks and corporate borrowers, who have used it to drive up prices of crude goods since we are at the latter stages of the business cycle, but not to most consumers, a large fraction of which are unemployed or desperately clinging to the work they have.  If that is the case (and it doesn't change relatively quickly), there will be less 'passing on costs to consumers' than producers would like.  Either prices will fall, causing losses, or sales volumes will diminish and production will be cut until the inventory clears.  That would also reduce pressure on prices upstream, moderating the disparity.  But that is just a guess.  I could be wrong.

But why is this happening in the first place?

Four Free Books

Of late I've done a bit of intense reading, which is one reason I've been somewhat quiet. I happened on several extremely good, thought-provoking books that just happen to be freely available on Google books.

And since I've been reading so much, I'm a little short of blog discussion topics, so they'll have to do.

The Theory of Education in the United States -- Albert Jay Nock

This is a little different from my normal fare, but I've read Nock before and have spent enough time in the field of education that, even with the dry sounding title, I thought this book might have a slight chance of being interesting.

This is possibly one of the most extreme cases of exceeding expectations I have ever encountered.

QEII Update

Well, we're approximately one month into QEII.  So...what's the score?

Hard to say.  The FED has conveniently stopped updating its handy graph showing the makeup of its balance sheet since about the time the program began.  I'm sure that an inquiry into this oversight would reveal that they are just a little behind because of the Thanksgiving holiday.  It's tough being a government bureaucrat.

Consulting the raw numerical data, we find that the asset base has indeed expanded since the program began:

So, in the first month of the program, it appears the FED has added about $37 billion to its asset base, somewhat less than the $75 billion per month of new asset acquisitions it had announced.

But -- lo! and behold! -- the monetary base has hardly budged:

What To Do About Chinese Mercantilism

This is probably one of the toughest economic nuts to crack -- what is a free-trader to do about mercantilist trading partners? Specifically, what should the US do about Chinese mercantilism?

I have seen many attempts to square the circle on this question, and though I've seen many good ideas on the topic, I've never found any particular approach that I could point to and say "This guy's got it figured out. He's got the right idea." I myself have given the question considerable thought, and I must say that even if I allow myself 'perfect world' scenarios -- i.e. I could trust that a particular plan would actually be implemented and faithfully executed by the authorities in question -- I find it very difficult to come up with anything that the free-trading side can do to counteract the meddlesomeness of the foreign government.

To Better Illustrate...

...why the Chinese economy will have great difficulty transitioning away from its dysfunctional export driven mercantilist system to a more healthy one that respects consumer sovereignty, I think I must come up with a better example than the division of labor arguments I have advanced so far.

Up to now, I've mostly made my case on theoretical 'arm-waving' grounds, which I think is my penchant as a scientist -- to see everything from an abstract, theoretical vantage point. Being a chemist just makes it worse, because I have to deal with things on a daily basis which I can neither touch nor see. I have to use abstract reasoning because I have little else to work with. So I happen to like arm-waving arguments -- I'm comfortable with them, so that's what I tend to produce, though I will confess that I often have trouble putting them into words. So, I suppose I can't really blame people for not being too convinced by inarticulate arm-waving. That's usually not very convincing to most people. Hard examples are usually better. And I think I finally have a good, hard example for my skeptics.