Krazy Economy

A Note on Greek Banks Recapitalization

2012-02-11T18:32:00.000-08:00

A Note on Greek Banks Recapitalization

You might have noted in the news stories about the Greek government debt problem that there was talk of needing to recapitalize the Greek banks later. What is going to happen, one way or another, is that the Greek banks, as well as other banks all over Europe eventually (and maybe a few elsewhere), will have to recognize, on their balance sheet, that the Greek government bonds that they hold are worth less than when they were purchased. It is true that the Greek government debt has been worth less on the secondary market for some time, but accounting rules do not necessarily require that that change be recognized on a balance sheet at that time. (I will let an accountant explain that issue, which isn’t necessarily corrupt.)

For the bondholder, buying the bond is the same as loaning money. The bond will pay a certain interest rate for its lifetime, and at a certain point, the issurer, which could be a government or a business, will return the borrowed amount, called a redemption. It is a timed, interest-only loan.

The bank holds the loan as an asset, just as it does all of its loans. But it does have to evaluate the loans that it has on its books. Are they performing? That is, is the borrower following the terms of the loan? Will the borrower be able to pay back the loan?

Accounting rules for banks recognize that loaning money is a risky business. Borrowers can get into trouble and fail to pay the interest and fail to repay the loan itself. In order to protect itself, a bank has to maintain reserves against potential default of a borrower. With this reserve the bank is protected from becoming insolvent and bankrupt when borrowers default. The reserve is actually capital. The more reserves a bank holds against potential loan losses the more of its capital it has tied up. That capital cannot be working and adding to the revenue or profit of the bank when it is held as a reserve. (Do confuse reserves the bank has with “reserves” required by banking authorities, such as the Fed. Those are not reserves in fact, but deposits that provide no protection or income for the bank.)

Due to the standard statist misunderstanding of how banking works, how capitalism works, and what the real benefits of government controls are, governments have established regulations as to what percentage of reserves a bank must have in its loss-loan reserves for different types of loans. Banks in the European Common Market have been heavily regulated for at least as long as U.S. banks, most likely much longer. They are well used to doing what they are told. I think that the experience and knowledge of how to properly rate the risk of most loans does not exist in Europe. Furthermore, the government decisions as to what percentage of a loan the bank must hold in reserve is heavily influenced by political considerations and populist biases. Certainly, if the ability to repay debt were a consideration, the debt of most of the European nations would be rated very low.

The developed governments of the world have gotten together over the years in Basel Switzerland to establish international standards of loan-loss reserve percentages, hence, the Basel Accords and Basel I and Basel II (Basel III is in the works, I think). They agreed that loans to sovereign, national governments required either low or zero percentage reserves. That’s right, a loan to Greece was considered safer than a loan to Apple or Microsoft or GE.

What banks did was to load up on government loans because those loans required fewer reserves. Reserves cost money, that is, reserves are idle cash. If no reserves are required, then the bank’s funds can be loaned and contribute to operating income, and maybe profits and bonuses for employees. Even European banks have some characteristics of a business.

In addition, European banks are much closer to their governments than U.S. banks. They are sensitive to the interests, biases, policies, and intentions of the ruling politicians. They have to be. The politicians have a lot of power and use it against the banks if they wish. What the politicians have wanted, in all of the European countries, is for the banks to help fund the government spending, cheaply. The banks have helped the central European bank and each country central bank to keep interest rates on government debt low by buying significant amounts of government bonds. The Greek banks have done this perhaps more than others and hold massive amounts of Greek government debt (which is a direct path of the country’s savings into the hands of the government, which spent it in a continuous, drunken shopping spree – buying votes, really). The estimate I have seen is 50B euros.

As a result of the various government actions and the way the governments have set things up, the Greek banks are now looking at losses on Greek government debt of seventy percent or more, yes, that is 70% losses. Losses for which they have little or no loss reserves. This degree of loss means that the banks’ total capital, its investment from its shareholders, whatever profits it has ever retained, and all of the reserves of any kind, have been wiped out. The Greek banks are bankrupt. They are bankrupt right now. It just hasn’t appeared on their balance sheet yet.

So, if there are to be any banks in Greece, they need to have an injection of capital. Not loans, but new ownership money. The requirement being discussed is ten percent of loans by 2013. Remember, Greece is something like five percent of the Euro zone. I have seen estimates that the recapitalization of all Euro zone banks, with all of the Euro debt problems, is one trillion euros, which is about $1.3T.

Who would want to put money into Greek banks? Not foreign investors. Not domestic investors (if there is anyone with real money to invest). No, there is only one source: the government.

Yes, the bankrupt Greek government is going to put money into Greek banks. The Greek government doesn’t have any money so it aquire the funds from outside the country, just as the government is doing for all of the other help the government is getting. The way it will probably work is that some one like the IMF, the European Central Bank, or one of the two entities that have been created to deal with the sovereign debt crisis will give/loan the money to the Greek government which will then put the money into the banks.

But, the Greek government won’t just hand over the money to the banks. No. It will “invest” the money, i.e., it will buy stock. The Greek government will nationalize the banks. There is some talk about making the stock the government buys a special, non-voting stock, thus preserving an illusion that the original owners have some standing in the bank’s ownership. But, that is what it is, an illusion. The banks will be even more tied to the Greek government than they were.

So, as an overview, here is what we have:
The Greeks (actually you can insert any European Common Market country you want because the pattern is consistent throughout) borrowed from anywhere they could for a massive spending spree.
They required the banks to be a major lender.
They required the banks to have little or no reserves against the loans to the government.
The government can’t repay the loans.
The banks are failing.
The government, with money acquired from elsewhere because it has done stupid, insane things, is going to buy the failed banks.
The banks are even more tied to government policies than before.
The government has ownership and control of the banks.
Does anyone think that the Greek banks will be better off?

Makes sense, doesn’t it. When you live by force, you “win” by force. And you all go down the tubes together. Moreover, I have seen no comment or hint that anyone writing about the European situation has anything to say about the matter. Perhaps they haven’t even noticed.

But the failure of putting two and two together is a common theme in the entire European debt crisis. It is most blatant with the Greeks.

This week there have been more “strikes,” riots, and protests against the terms required by the agencies that would bail out the Greeks. Many of the chanted slogans and posters and banners declare that the foreigners are dictators and imperialists. The protestors want the politicians to “resist”! The Greeks appear like angry four year olds who have been told that they can’t have the toy on the shelf because mommy doesn’t have the money. How and what are the politicians suppose to resist? They are suppose to resist the requirement that they do not incur more debt. They are suppose to resist the requirement that they try to pay back their existing debt. They are suppose to resist the requirement that if they are given money they spend it wisely instead of like a drunken sailor (my apologies to sailors). The Greek protestors have no contact with reality. None. They have no idea that money has some connection to real things. That real things are made by someone who wants to be paid for their efforts. That borrowing actually means that the lender expects to be paid back. The Greek country is a testament to modern education and economic “thinking.”

Process of Leaving the Euro Currency Block

2012-01-03T09:18:00.000-08:00

Many people are convinced that some euro zone countries will have to change to their own country specific currency. They all acknowledge that doing so would be expensive and have cause an international economic downturn. One of the commentators who I watch, John Mauldin (who is better than some, but far from excellent), quoted a private newsletter from the Boston Consulting Group, written by Dan Stelter. Mr. Stelter set out the steps that a country would have to take to exit the euro. They aren’t pretty and smack of totalitarianism: complete control of private assets. I have set these steps out below.

Note that there is already significant outflows of capital from all of the poorly performing euro countries, i.e., Greece, Spain, Ireland, and Portugal. If you have funds or assets there, including through mutual funds, consider moving them to somewhere that safer. There really is no safe place for large amounts of assets. Just keep the overall and the country specific issues in mind.

Steps for a country to stop using the euro and introduce a new currency:

Announce and immediately impose capital controls.

Impose immediate trade controls (because companies would otherwise falsify imports in order to get their money out).

Impose immediate border controls (to prevent a flight of cash).

Implement a bank holiday (to stop citizens from withdrawing their money and running before the devaluation) and although this is somewhat hard to imagine stamp every euro note in the country, converting it back to the national currency.

Announce a new exchange rate (presumably not floating at the beginning, given capital and exchange controls) so that trade could continue.

Decide how to deal with existing outstanding euro-denominated debt, which would probably entail a major government and private-sector debt restructuring (that is, default). This might be easier in the case of government debt, which tends to be governed by domestic law, in contrast to the debt of major corporations, which is normally governed by U.K. law (but we would assume enactment of laws declaring a haircut here, as well).

Recapitalize the (insolvent) banks to make up for losses from defaults.

Determine what to do with the non bank financial sector, the stock and bond markets, and every company account and commercial contract in the country.

Any breakup would lead to significant turbulence in financial markets just think about the number of credit default swaps outstanding and a worldwide recession. The OECD has warned that a breakup of the euro zone would lead to "massive wealth destruction, bankruptcies and a collapse in confidence in European integration and cooperation," leading to "a deep depression in both the existing and remaining euro area countries as well as in the world economy."

According to UBS, the economic costs of a breakup would be huge. Depending on whether the country leaving the EU is a "weak" or a "strong" country, the costs would range from Ä3,500 to Ä11,500 per inhabitant per year. Besides these implications for the countries of the euro zone, the world economy would be severely affected, with negative implications for the U.S. amplifying existing recessionary and potentially deflationary pressures and also for the emerging markets that depend on exports to the West.

Current Decline in the Availability of Pharmaceuticals

2011-12-03T13:33:00.000-08:00

In the criticism directed at ObamaCare and socialized medicine in general, there were many consequences seen that would be detrimental to the health of men and women. One consequence that wasn’t predicted (as I recall) is occurring now. From what I have seen in various reports recently (listed below), when socialized medicine collides with high levels of government debt, which it must eventually, the results are decidedly unhealthy.

In Greece and Spain, and also in Italy, even in the United States, we are seeing disruptions in the supply of pharmaceuticals. The disruptions are being caused by two related government actions. Especially in Greece and Spain, the governments are not paying their bills. Surprisingly, the companies making the drugs are beginning to refuse to send additional supplies. I say surprisingly because I would bet that there has been some attempt to get the companies to ship regardless of the status of payment for past shipments.

The other cause of shortages, which is already happening in the U.S. and is probably happening in Europe, is that certain drugs aren’t being produced because the prevailing price, i.e., the price that the government is willing to pay, is too low to justify making the drugs. In the U.S., we are seeing pharmaceutical companies selectively choose to not make certain generic drugs because there is little or no profit in the price at which they can sell the drugs. These companies have limited production facilities and they choose to use them to produce the most profitable product. Duh!

There is another factor that is spreading the problem wider. In Europe, many countries have laws that require the government to pay the lowest price being paid by any European government. So, say Greece unilaterally decides, as it has, that to “save” money they will lower the price of some or all drugs. It doesn’t really matter what price they choose, the price is way below what the drug companies would charge if free to do so, so whatever price the Greek government chooses will be a disincentive. Then other countries’ low price law kicks in. If the drug is going to be available to patients, the drug company has to ship at the new, lower price. The moral and health consequences are very obvious. The drug companies no longer have any say in the revenue for which they are working. That is unadulterated authoritarianism. It isn’t that different from how doctors are treated by Medicare in the US.

As far as I know or have seen, there is no law saying that the drug companies have to ship, have to continue to make the medication. Slavery has not progressed to that point. If not today, then soon, the drug companies will not be able to continue shipping product on which they constantly loose money. Supplies will become smaller. Shortages rampant, not just in Europe, but worldwide. Companies may go bankrupt. Drug formula may be lost.

Some of the European drug companies are now saying that their ability to do research and create new drugs is being threatened. I expect that they are being a little timid in making known their concerns. I expect that the drug companies are not in a strong political position. Someone is probably keeping a close eye on drug company research numbers. Too bad the mainstream press isn’t interested in actually reporting news like that.

Since the widespread government debt and fiscal deficit problems is going to be a major problem for some time, one should expect the problems in Europe to get worse. The governments will have more difficulty in paying for medical care. The problem will be spreading beyond drugs and supplies to include doctors, support staff, and hospitals. I wonder if someone is paying the electric bills? A private company would be constrained from cutting off power to a hospital. A government electricity monopoly may not be so constrained.

No doubt the problem of non-payment extends to other sectors of the economy as well. Someone said that Spain in particular had determined that keeping cash and not paying bills made the government look much closer to solvency.

What bill is or is not paid is a function of the decisions by bureaucrats. These people have not learned the lesson that 70 years of Soviet economics taught: there is no substitute for a market. What drug or service is available or not will depend upon accidents, pull, and ignorance. Actual health issues and medical need will not be ignored so much as it will be unknown and unimportant. I mean the mere fact that there could be medical need will be unknown. It is government money and it will be paid to the concerns the bureaucrats choose. The fact that there is a reality is overlooked in the regulations. Good luck to us all.

Keep your eyes open. This news, that has come to us in a trickle, leaking into the mainstream in little droplets. So far the press has not be recognized the debt issue as impacting people’s health. Even if they do, there isn’t anything that can be done about it, however. Many of the European governments do not have the money to pay those bills, even if they wanted to do so. How much longer will their citizens have drugs? How long until we are in the same situation? How much will the loss of several European markets affect drug availability in the U.S.? Who knows?

Having gone to the pharmacy regularly, it would seem almost unimaginable that the drugs we rely on could cease to be there when we need them. Those of us who do depend upon them daily, for example, the millions who keep their blood pressure low or those who survive diabetes with medication, could see those meds disappear in the next few years.

Sources:

Greek crisis takes heavy toll on health
http://www.reuters.com/article/healthNews/idUSTRE7982UN20111009

Spain health service chokes in crisis
http://www.reuters.com/article/healthNews/idUSTRE79A1S120111011

Drug shortage in US
http://www.reuters.com/article/healthNews/idUSTRE79D4GI20111014

BO to take executive action on drug shortages
http://www.reuters.com/article/healthNews/idUSTRE79U23D20111031

More pain for Euro drug makers (includes information about lowest price laws and the threat to research)
http://www.reuters.com/article/healthNews/idUSTRE7A93C220111110

UK pharmacists sound alarm about shortages
http://www.reuters.com/article/healthNews/idUSTRE7A901F20111110

HIV gains ground in Greek crisis
http://www.reuters.com/article/scienceNews/idUSTRE7AA37P20111111

US employer health insurance offerings reach new recent low
http://www.reuters.com/article/healthNews/idUSTRE7AA4AI20111111

R&D proposed in Europe over superbugs
http://www.reuters.com/article/healthNews/idUSTRE7AG0VA20111117

Cancer cost becoming unsustainable
http://www.reuters.com/article/healthNews/idUSTRE78P26B20110926

A Chance to Have Input for a Book

2011-11-15T12:48:00.000-08:00

Recently there have been several articles dealing with claims made by some Republicans that regulation hampers job growth. Mostly, these articles (for example) attempt to reject that claim. To me, and I suspect many of my readers, it seems almost obvious that when you restrict someone’s business activities, their ability to create jobs would be hampered. On the other hand, I don’t know of any book or study that documents that connection. Doing so would be a good thing. Hence, let me draw your attention to a planned book I just read about.

I receive a weekly email newsletter from John Mauldin about the economy and its impact on investing. If you keep in mind that his frame of reference is basically mainstream, with a dash of the reality of trying to deal with real businesses and their futures, then his stuff isn’t bad. I have used some of the information that he has found in this blog. He published a book last year called “Endgame” in which he discusses the world build up of debt and its impact. I don’t really recommend it, as his analysis is severely limited and warped by his basic poor understanding of economics and his conventional morality. Its redeeming feature is that he is emphatic in that the debt will be a disaster.

Now he is going to write a book about job creation. It could be decent because he seems to understand that only business can create “meaningful lasting” jobs. This is the wrong focus, of course, (it should be on how business can freely create wealth) but jobs are a consequence and if businesses can create jobs, they will be creating wealth. (I know that this wrong focus could backfire. However, it is also true that people need to know how jobs are created. If that is explained properly, i.e., as a result of creating wealth, then it will point people in the right direction.) Anyway, he is calling for examples and ideas, so why shouldn’t he get some good ones. If you want, send him an email.

He says:
“You can't read any serious economic analysis of late that does not talk about jobs, whether in Europe or the US or Asia. And not a lot of it is pretty. Politicians offer "plans" for jobs, most of which go to great lengths to illustrate the sympathy they have for people out of work, but without offering any real ideas on how to create meaningful, lasting jobs. Some are actually destructive of jobs, far from creating any (these are of the "I'm from the government and I'm here to help" variety).

I have been having a rather lively email conversation with several serious thought-leaders about what we should do to get us out of the current job malaise. The ideas we are discussing are worth a wider audience, so Bill Dunkelberg, who is the Chief Economist for the National Federation of Independent Businesses and I have decided to write what we hope will be a short book on employment (I know, I have never done a short book yet). How are jobs created? What policies should governments adopt to help create jobs? How do we get back to full employment in the US in a Muddle Through economy that needs at least 125,000 jobs a month just to keep up with population growth? (Today we learned that in October new employment was just 80,000.)

Stupid Government Tricks

The book will be US-centric in its focus, but the policies we will be talking about can be adapted to almost any country. I should note that Dunk and I will be getting a little help from our friends, and we want your help in some very specific ways.

First, I know my readers are among the smartest on the net. If you have an idea about how to increase employment, send it to us. Put "jobs" in the subject line.

Also, most of America is familiar with David Letterman's occasional skit called "Stupid Animal Tricks." We want to do a section on government policies that hurt job creation. At all levels, from local to national. Send us your anecdotes and notes on odd rules and laws that destroy jobs and opportunity, rather than create them. Almost everyone has a story about how government is hurting their business. Tell us yours.

And at the same time, what do you see that is working? Why do some states seem to attract businesses and others lose them? Again, send your comments with the subject line "jobs." And, you'll get a footnote if we use your suggestion. (Hey, I love being footnoted!)”

John@FrontlineThoughts.com

The Financial Realities of Individual Retirement

2011-10-13T21:16:00.000-07:00

I am writing this for several reasons but one important one is to further establish the importance of paying attention to the real world when attempting to make policy recommendations like some recent suggestions as to how to deal with the entitlement mess.

To begin, let’s review the current situation:

1. The current ideal is to retire at age 65 and live in blissful non-productivity for 20 to 30 years.

2. Up until the 90s, it was expected that a worker would accumulate pensions from his employers over the years and when he retired he would receive a fixed income to support him. These pensions have been disappearing steadily for decades and there only a few left for new hires. The health of company savings to support existing pensions is in question. There is a federal agency that would supposedly put funds into a failing pension fund, but it is underfunded itself and could not rescue an economy wide problem (such an agency shouldn’t exist, either). (For example, see)

3. Self-funded retirement plans, such as the 401(k), have been shown by repeated surveys to be insufficiently funded by employees to provide for their retirement. The gap is very large. Employees also have the tendency to remove the funds from retirement accounts at various times for various reasons.

4. Survey after survey has documented that Americans have a very poor grasp of how to manage their savings and investment, including retirement accounts. The primary element driving most decisions is fear of loss. The sources of their fear are stories about the Great Depression, reading newspaper headlines, incomprehensible discussions of investment options, stories of thief and greed, and the economic chaos around them.

5. Retirees are becoming increasingly dependent upon Social Security and Medicare after retirement (see below).

6. The government dominated economy has resulted in two major recessions in the last ten years resulting in the current period that is described by the government and press as a recovery but feels very much like a bad, senseless downward spiral.

Consider the situation of a reasonable, hardworking, educated baby-boomer who has been successful from the standpoint of the quality of jobs and his level of income. Let’s call him Max. Max is 62 and all his life he has accepted the idea that age 65 he will retire. As a responsible person, he has saved and tried to make sound investments his entire life. He has not hired professional help other than talking to various stockbrokers. He began working as adult in 1972 but didn’t begin paying attention to the issue of savings for several years. His initial experience in the 70s was with high inflation and then the recession that ended in 1982.

But Max has now entered what will surely be remembered as the golden years of investing for the baby-boomers. From 1982 until December 1999, the market rose nearly continuously (for example, 1987, which is remembered as the year of a crash, was actually up slightly for the calendar year.) The later 90s were somewhat skewed by the inflation fueled tech boom, but overall, the period was the best of the Twentieth Century.

Since 1999, the investment markets have flattened or worse. Consider that the inflated high of the Dow Jones Industrial Average of December 1999 was 11497. As I write the Dow is 11471 (and in my opinion, it is over priced). After nearly twelve years, the Dow sits at the same place, nominally. I say nominally because the dollar today is not the dollar of 1999. If we accept the government Consumer Price Index as a real measure of consumer prices over time (I am not advocating using the CPI, but I don’t know of a good alternative.), since 1999 the dollar has fallen over two percent a year. According to the Department of Labor’s online inflation calculator, it takes $1.36 today to buy the same stuff as one dollar in 1999, or today’s dollar is worth $0.73. (The same calculator gives the today’s figure of $234.76 in relation to 1982.) That means that if you correct for inflation today’s Dow is 73% of what it was, or 8434, not 11471. Even if you add in dividends and subtract taxes (capital gains taxes as well), you have a result that a general investment in American productive assets for the last twelve years has been a very large loss. Max has suffered a major blow to the prospect of a comfortable retirement. Maybe Max may not be able to retire at all, even with Social Security, although I am not sure that there would a job for Max when he needs it.

How could Americans prepare for retirement in such an economy?

Most prescriptions offered for investing for retirement assume an economy that is growing. Those recommendations didn’t work in the decade ending in 1982 and they aren’t working now. There are recommendations for periods of crashes and depressions. If these ideas work at all, they generally don’t work for prolonged periods of time. There are other approaches that do work to a certain extent and are good. However, they tend to be complex and assume knowledge that few have. They also wouldn’t work if widely practiced (which is to say that I am here concerned with the general situation and not how an individual could protect himself). For the vast majority of people, there is no good investment option today that will help them through to their last years.

Another little known fact is that those people who have saved some assets for retirement have often not actually planned. Their accumulation was based on what they could save and invested in what made sense at the time. Many, when they retired, accepted the conventional wisdom that retirement income needed to be “income without undue risk” and placed significant amounts in bonds. These people will tend to run out of money even faster during retirement. They don’t have enough to support their rate of spending for very long. Nor do they or their advisors have the tools to recognize the threat and make changes early enough to make a difference. They have not made provision for consumer price inflation or the rapidly rising cost of medical care. They aren’t prepared for 20 years or more of idleness. They just don’t know how to plan financially and don’t know they should.

For the many people who keep whatever they have managed to save in “safety of principle” accounts (fixed annuities, savings accounts and CDs) or fixed income accounts (bonds and pensions), they have seen their assets and income slowly decline as the Fed has kept interest rates low, inflation continues, and the what small income they receive is taxed. People with bonds have seen their principle increase as interest rates and their income have declined. But, if they are paying attention, they know that the future probably holds higher interest rates (see Greece, Spain, and Italy today), and their principle will drop like a rock if they still hold those bonds.

Beyond that it should not be surprising that very few people have any idea of how to invest. They do not know how the economy works. Where would they get that knowledge? It isn’t taught in schools at any level nor do the academics actually know anything about the real economy. They don’t know how retail businesses work. They don’t know how manufacturing works. They don’t know how businesses make profits. They don’t know how international commodity or currency markets work. They really don’t know why stocks have the prices they have or why they change, short term or long term. The ignorance about economics or our economy is more than widespread. It is terminal. Who suggests that it is important to know? People learn about their own professions, but often not much beyond that. Business schools are not good sources, either. Most businesses have to retrain business school grads, even MBAs. It is no wonder that few people are able to save and invest in a manner that will successfully support them into their 90s, especially if they retire later than normal. The number of people who do adequately save and invest has to be less than five percent.

A realistic look at today’s economy would suggest that the foreseeable future does not hold the promise of better results. There is no indication that anyone in authority has a clue as to what makes an economy grow and contract. They do not even understand that only productive, profitable jobs are worth creating. Government debt will continue to pile up. The Fed will continue to add stimulus, achieving nothing but a huge financial overhang that may fall and crush us. Don’t forget that the regulations required by all of the reform bills after the Meltdown in 2007-8 have yet to be released and implemented.

It seems to me that any criticism of people for not being prepared for retirement is not based upon a recognition of the facts of the real economy. Only a very few are going to have found a method to invest their savings in such a way to be able to support themselves if they retire.

To sum up, it is very difficult for salaried or wage paid individuals to save and invest successfully for their retirement, standard pension plans have suffered significantly due to the economic conditions, and from other sources we know that Social Security and Medicare can not continue for very long. So, what can we conclude? My conclusion is that the mixed economy, the welfare state in the United States, cannot support the coming old age of the baby boomers, with or without Social Security.

These problems that people have with their savings and investment, the nature of our economic situation, and the poor future prospects are not the fault or the responsibility of individuals. The responsibility lies with the people who control the dominate actor in our economy, the Federal government in its many aspects: the President, the Congress, the Fed (and the intellectual leaders who guided them).

What else did you expect from 100 years of constant legislative attacks on capitalism and the businesses in the United States. That the problem has not been big until now is a testament to American perseverance. It couldn’t last forever.

For the future to achieve the promise of a happy old age, not to mention prosperity for everyone, in the US, a couple things have to happen:

1. The economy has to be freed up to become productive and prosperous. In other words, our country needs to become a capitalist nation. The process of transforming ourselves from a welfare state to a nation that recognizes right must do so in a manner that does not further victimize the present day population, as I discuss elsewhere.

2. People need to revise their thinking about retirement and work. Work is not the onerous thing most people make of it. Retirement for 20 or 30 years, after working for 40, is not generally feasible in good situations, let alone the one we are in today.

This Post is one of three that deal with the issues connected with the entitlement mess and how to resolve it. All three should be read in order to fully understand the issues. The other two Posts are:

A Flight of Fancy (Not Fantasy)

The Right Way to Solve the Entitlement Problem

Thank you.

C.W.

The Right Way to Solve the Entitlement Problem

2011-09-17T11:54:00.000-07:00

It is important that I first am clear that I am against the use of government, i.e., the use of force, against the inhabitants of our nation, to provide for benefits of the retired, the sick, the unemployed, business, anyone. Such action by the government is wrong morally, wrong politically, and very bad economics. It should be stopped. It must be stopped. Okay? Is there any question about my position on this (for the justification see Ayn Rand’s “The Nature of Government”).

What I am concerned with in this post is that I have seen people, good, solid, rational people, suggesting solutions to the entitlement problem that I think are not good choices. It is possible that they are not completely setting out their solutions, but what has been offered are insufficient to change the situation.

I want to begin my comments with a question: What do we want to achieve? My answer to this question is that, ultimately, what we want to achieve is a productive, rational society in which we are free to pursue our own goals based upon our own judgment. We want to achieve freedom, capitalism.

Further, we want to achieve this result with the least chaos and human suffering as is possible. We see that if capitalism isn’t achieved we and our fellow man will be in for a lot of suffering, and possibly worse. We may completely lose our freedoms. We may completely lose our stand of living. In an interview on The Dailer Ticker, Yaron Brook emphasized these very points. Stop gap measures will not work. There needs to be a change in philosophy.

Our goal is capitalism, not merely lower government debt or fewer people depending upon the government. Anything but actual capitalism would not be safe or permanent, but would merely delay reinstatement of the government activities that we had managed to reduce. In an interview on The Dailer Ticker, Yaron Brook emphasized these very points. Stop gap measures will not work. There needs to be a change in philosophy.

More broadly, capitalism is the only system in which anyone who puts forth effort can and will find a way to maintain themselves, and to achieve the success they are capable of. Those who do not or cannot put forth the effort will be dependent upon the voluntary support of someone who does. There is prosperity. Capitalism does not support suffering. Contrary to criticism, capitalism does not support poverty, hunger, hopelessness.

The problems with entitlements, in addition to the moral issue, is that in the present situation, entitlements and other government wealth transfers, such as unemployment insurance, are necessarily resulting in massive government borrowing and are moving us inextricably to bankruptcy (in one form or another) and depression. Depression for an advanced country like the United States will be an unprecedented event.

It is obvious to anyone who is honest enough to look that the current situation will result in disaster. The entitlements and wealth transfer payments have to be eliminated. The rapid, dramatic growth in the government debt has to be stopped and brought down. There is no choice. Not doing so will result, as I indicated above, in disaster.

It is at this point that people are then offering some suggestions as to how the entitlement programs could be stopped. However, solutions that focus on the entitlement programs as the main issue are making an error. Stopping these programs at this point will not achieve anything but chaos and massive poverty and illness.

Consider the numbers of people who are dependent upon government programs today. The number of unemployed, (very) underemployed, and that have given up looking for work is close to thirty million people. If you add in their dependents you probably have forty to fifty million. The number of people receiving Social Security is currently sixty million (over forty million aged 65 and older). The number on Medicare is nearly forty million. Those receiving food stamps is nearly forty million. Some of these numbers overlap. Some are gaming the system and fraudulent. But the totals are overwhelming.

Another group of people dependent upon government transfer payments are government employees, federal, state, and local. A fairly recent figure for this group (excluding the military) is nearly twenty million. If you also add in the employees in the private sector who’s responsibility is keeping up with government regulations, you have another large group who are not engaged in productive work and whose indirect reliance on government money has to come to an end. (The government figure does include some who are rationally required, but it is a small percentage, I think.)

In a country of over 313 million people, over thirty to thirty-five percent are wholly dependent upon government funds and are immorally living off the productiveness of others and are an enormous drag on the economy.

The bad news is that if they all, or just the most obvious. were turned loose from their dependency and the government money were turned off, their desperate situation would become a major, immediate cause of riots and distress.

You might say a couple things, for example, that the money freed up will enable the economy to do better, or that the change will happen more slowly. The current problems in the economy is not a question of money, employment, or actually resources but government controls and interference. The constant stream of new government orders, crises, and attacks is finally, after nearly a century, dragging down the possibility of growth in the economy. Merely stopping some government transfers would not be sufficient. It would only possibly delay the result. Nor would the speed of change matter. The economy still couldn’t handle it. That is to say that these people would not be put to productive use. New, productive jobs would not appear in the numbers needed. There would be constant pressure to reinstate the programs or for something worse.

For those people who are retired, the suggested methods of replacing Social Security and Medicare, that is, putting money into their hands based upon some calculation relating to what was taxed in the past would not be sufficient to support them over the remainder of their lives, even if there were no additional general consumer price increases. Nor would they know what to do with the money, since few ever acquired the necessary knowledge.

But besides those points, very important consideration is that the economy would not be productive enough to support the massive number of people who are expected to retire.

All of the problems are interconnected. It is one economy. No freedom, no productive economy, no support in any fashion for the large number of retired people that are in the baby-boomer generation. The issue of the debt hides the fundamental problem of the welfare state. It saps the productive ability of the economy to the point that it can no longer support itself. The build up of government debt is the easiest way for today’s welfare state to finance its programs, but it could use other ways such as massive taxation and high levels of inflation, which would also lead to failure. The problems are the result of the welfare state: its morality and its economics combined.

Let me say this again. The point needs to be emphasized. Our economic structure today and into the foreseeable future will not support the expected number of people retiring over the next decade or two. That is so with or without the entitlement program. Something more has to be done than just ending the programs.

But, more important, the focus is wrong, confused, and misleads us into forgetting our goal. The entitlement programs are a symptom of the wrong philosophy supporting today’s trends in government and the economy. Do not focus on the symptoms. Focus on the philosophy and our goal.

Focusing only on the entitlement programs is also terrifying to those immediately affected and their families. It would terrify anyone who does not want to see wide spread poverty and illness. I am certain that we don’t wish to see that either.

Taking the steps to achieve the establishment of capitalism will also allow us to easily, cheaply, and happily eliminate the negatives (which we should expect would be the result of the achievement of productive values).

The initial steps of establishing capitalism would be the freeing of the productive, creative businessmen. When asked what should be done first to change the economy, Ayn Rand answered, “Start decontrolling the economy as fast as rational economic considerations permit. I speak of “rational economic considerations” because today, every part of the population is dependent on government controls. Most professions have to function under controls, and their activities are calculated on that basis. So if anyone were to repeal all controls overnight, by legislative fiat, that would be a disastrous, arbitrary, dictatorial action. What a free country needs to give all the people concerned sufficient notice to readjust and reorganize their economic activities. Therefore, after working out with economists the kind of program necessary to decontrol the country, and what controls should be repealed first, I would then advise passing legislation announcing that certain controls will be abolished within three years, say – the period calculated to allow people the opportunity to readjust their activities. In a free economy, no change happens out of the blue and overnight. Every economic change, every development, is gradual. Therefore, in a free society, there are no immediate and disastrous changes. But given our present situation, any sudden changes could create disastrous dislocations, and so we should decontrol gradually.” (Ayn Rand Answers, p. 49) She goes on to suggest that the anti-trust laws can be gotten rid of immediately, especially laws that jail businessmen. She points out that the decontrol of the economy will then pretty much eliminate our economic problems. That means, today, that the debt issues and the economic aspects of the entitlement programs will be come easier to solve. Decontrol would also result in the creation of lots of new, productive jobs.

This prospect, the resulting productivity, prosperity, and creation of wealth, will be the foundation, along with the morality of self-interest, for convincing people that ending the entitlements is going to cause, at worst, only a brief period of difficulty and the long-run result will be significantly better than Social Security and Medicare. (I have written about how these programs can be funded for those unable to rejoin the job market.)

Within a few years the older population will be the majority of voters. Many of the arguments for changing the system have to be aimed at them. They have to be shown that they will not be abandoned, that they will do okay. Merely coming up with a nice sounding set of steps will not work. It shouldn’t. Do you expect the average American retired person to accept an idea that requires him to live in abject poverty for the remainder of his life? If you want the support of intelligent people you need to show precisely how it will work. You say that they can’t expect that things will go wonderfully. No. And if you do your job right and make clear that if they don’t allow the change to happen, if they do not clamor for the change to capitalism to happen, they necessarily will live in abject poverty for the rest of their lives, then they will be able to put up with some discomfort.

Let me say this again: People have to learn that the current situation is going to result in misery. It can not survive. Depression is our future. That is their choice: depression or capitalism.

Winning the war to put man on a rational course requires both the moral and the economic argument, with full knowledge of the consequences for everyone of each step. We have to communicate and justify the idea that capitalism will be a real road to prosperity and that there is no other road. The argument is not just the moral. It is about all of reality, with a major focus on the economics. People do not know the economics of capitalism (or the world they live in now) any more than they know the morality. Neither will be a strong enough argument by itself. Combined, they are intellectually overpowering. All it takes is finding people who are willing to look at reality and showing it to them.

Volatility

2011-08-26T12:51:00.000-07:00

In the week of August 8th to the 12th, the world saw the equity markets swing very wildly from up to down and around again. It was, I am sure, very disconcerting, probably frightening. And people are confused because after a lot of reforms, laws, regulations, planning, stimulation, and quantitative easing, which was suppose to make things better, we are having big, dangerous, damaging swings.

In recent days I have seen several suggestions in the media that volatility would continue, at least for a while, because of the uncertainty as to what direction the stock market would take. These comments have a very narrow focus and fail to recognize wider causes and implications. They do not recognize that it is not just the stock market that has volatility. Currently, well, in fact I am not aware of any international market that isn’t suffering higher levels of volatility. Currency markets, commodity markets, bond markets (except very short term, which are basically pegged by Fed policy), you name it, are all experiencing significant volatility.

The biggest reason is “uncertainty”. What is meant by uncertainty is much more than an understanding that the future is not known. The future is unknowable, but, in many circumstances, it is predictable and can be expected to behave in a comprehensible manner when unexpected changes do occur. If you are a competent investor or businessman, you have confidence in your ability to respond to change. No, this uncertainty goes way beyond the basic unknowable future.

Nor is it just that the international community faces problems. There are always problems, issues that need to be addressed and dealt with. Again, competence leads to confidence.

What is causing the foundation of today’s uncertainty is the lack, one could say the nonexistence, of ideas, solutions, intelligence, willingness, leadership of governments around the world. It is as if there was a contagious disease that has afflicted every ranking member of most of the major governments of the world. They fight, they seek their own political advantage, they evade, they do nearly anything except face the reality of the problems facing them. For months we have been waiting for the leaders of the governments of the eurozone to solve the sovereign debt problem facing several of their members. Several times they have announced triumphantly that they had solved the problem only to see that the market regarded those steps as insufficient. Now a few countries are in extreme recessions. As their economies shrink, their bond problems become worse. No one in Europe (or in most countries) seems to understand how an economy grows, with or without heavy debt. The stimulus steps are not working (as they aren’t in the US, as we shall see shortly). Data released this last week showed that the German economy was not growing as fast as thought. Germany is generally regarded as the backbone, best source, the money source of last resort of the euro system. If it isn’t strong, the eurozone will have much more difficulty in solving the problem of sovereign debt, let alone actually experiencing growth.

It also appears that the US has not grown much at all in the first half of 2011. Nearly everyone was expecting that because of QE2 the economy would be on its way to a normal recovery with growth powering along toward 6%. Now many people are talking about a recession this year. The government policy has failed. People don’t know what to make of that. They are confused, and uncertain.

It is being recognized, slowly, that the Fed has run out of options. In the last couple weeks in announced that it would not raise interest rates above effectively zero for at least two years. Obviously, the charge of uncertainty was heard. But this is recognized as a dumb move. The stock market tried to rally, went up wildly, and then continued downward, just as wildly. There are some at the Fed who understand some of the problems facing banks and businesses in America. For example, read this speech (not saying it is perfect, but he recognizes some important points.)

In addition, and as important, in most of the developed world, laws passed over the last few years have unleashed massive new regulations and restrictions on banks and businesses. Most of these new regulations have yet to be formulated and announced. Bankers and businessmen have little idea as to what to expect, except that it will not be supportive of normal, intelligent, profitable banking and business practices. Everyone is waiting for the shoe to drop – on their heads.

So we have uncertainty hounding us from two angles, the failure of the government policies that were suppose to save us and the impact of new, arbitrary regulatons.

With the Fed’s hands tied from all but the most crazy ideas (The Fed is run by helicopter Ben, after all.) and the Administration and Congress tied up over the astonishingly large deficit already on the books, one wonders what the government could think that it could do if we go into another recession. Will they try to enforce wage and price controls? Will they try to force a command economy? Will they watch in wonder?

Let’s say that they find that they can do nothing. Let’s say that Geither in the Treasury doesn’t go off into nether-nether land as he did in 2007-9 and write lots of checks he can’t pay. Let’s say the economy is on its own (I expect that even the Republicans will try to do something.). Is the economy strong enough and free enough to recover? If it doesn’t, will that give the anti-capitalism crowd more leverage? Is our time to fight shorter than any of us figured?

Many are thinking that foreign currencies and businesses are safe havens from the problems in the US. Actually, these safe havens are more in Asia or the BRICs. But, this is the era of globalism, of international markets and money movement. When the US and Europe are in recession Asia and the BRICs do not have markets to sell to and their economies also decline. Some of the stronger currencies may still be relatively stronger (Japan is a disaster waiting to happen.), but you need to be very careful. If and when recession comes to China, for example, and the real estate market crumbles, it will be interesting to see what the Communist government does, that is unless you live there, they it could be frightening. Remember too, that the government leaders and central bankers all went to the same schools, read the same books, heard the same speakers, and hold the same ideas as those in Washington. There is no country that is a financial and intellectual island. Differences are relative, in degrees, not fundamentals.

So the volatility we see is the result of the confusion and dismay. People see the failure of the promises of the political, economic, and intellectual leaders and do not know what to think. Even the more experienced traders are suffering whiplash by news and promises. People rush from hope to fear, back and forth. They have no foundation for understanding what is happening. The mainstream media is just as ignorant.

The hole that Keynesian policies have dug for us is very deep. The process of fighting over who will be heard and who will lead will cause constant turmoil. The inept attempts at solutions will add to the problems. Lost time in actually solving the problems will result in the problem becoming larger and exerting more strain on the international economy. Volatility will continue, sometimes becoming wilder, sometimes hitting a lull, but as the confusion and fear will not be reduced and the problems will reemerge, the volatility will return, probably in greater, wilder swings.

There will competitors offering answers and solutions. The Christian right, fascists of Christ, will offer answers. There could be an even more extreme, pro-government Democrat emerge who would rival BO in his willingness to use force to achieve the ends of destruction promised by altruism. Competition for the minds of Americans could become fierce.

People are looking for answers. This is an opportunity. Objectivism and capitalism have answers, good ones, ones based on reality. The books and ideas of Ayn Rand need to be spread further. People might be willing to listen.

Truth must be heard.

Inflation Watch: News!

2011-08-19T14:47:00.000-07:00

There is in fact something to report. Get it here, few others are going to have this news. It might mean something, it might not, but it at least is a change.

In a recent blog about the money supply I talked about how to read the graphs we get from the Fed, that to understand the meaning of the information, you needed to keep the steepness of the curve and the relative amounts in mind. Now we have a example of what I meant. It is a nice example for illustration purposes; it is a bad example if it foreshadows things to come.

The US money supply, as controlled by the Fed, is generally fed by way of bank loans. Generally, the level of bank loans is the best place to look first to get a good idea of what is happening.

Surprise, a graph! Well, you can see that the recent activity, after several months of steep decline, there has been some rebound, but that seems to leveled off, at least briefly. I put no importance on such brief changes, even though it is a little unusual. But, here is the important part, while BO has been railing at banks to loan money (regardless of his criticism that the financial meltdown was because banks loaned money – to the poor), the regulatory agencies, The Comptroller of the Currency and the FDIC, for example, have been engaged in very heavy handed tactics to force banks to adhere to what the regulators consider, sound banking practices. They insist the banks have lots of collateral and keep minute, intrusive records about the borrowers. Further, banks are still trying to replace the capital and loan loss reserves that disappeared in the meltdown. Those who carry on about bank profits just are not taking the responsibility to find out what they are talking about.

After looking at bank loans, lets see what the money supply is doing. Ee have a choice where we look, since there are a few different indicators. What the hell, lets look a several.

First is M1, which is the basic money supply category and includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order of Withdrawal (NOW) Accounts. So, this is the money you use to buy stuff with.

M2 is a little broader, it includes M1 plus all time-related deposits, savings deposits, and non-institutional money-market funds. This is money that is one small step from the availability to be spent.

Then we have the one I consider most useful, MZM, which is all money in M2 less the time deposits, plus all money market funds. It measures the supply of financial assets redeemable at par on demand, or all the money that can be realily spent.

Also available from private sources (because the government stopped publishing it) is M3, which is M2 as well as all large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets. The “other larger liquid assets” includes Eurodollars, which means here we can see the overhang that could drop on us. Eurodollars are dollars held in foreign, private accounts. Thus, this measure does not include dollars held by foreign central banks as reserves (if the money has been invested somewhere, and not just held as cash, it will show up in one of the Ms).

I showed you M3 for the sake of completeness, but for our purposes, in this post, let’s use the other three, focusing on domestic dollars.

I am sure that you can readily see that each seems to currently be heading straight up. Up until now, the graphs had been moving more or less on a trend line that was fairly consistent from the 1980s. These are linear graphs, meaning that a change of $100B at the bottom of the graph was the same size on the vertical axis as a $100B at the top. That means, from a practical perspective, that a recent $100B change in the money supply was not as significant as one 30 years ago. Today, $1000B is small potatoes. So if the graph was sloping the same angle, the rise in the money supply was having less and less effect.

Now, the slope has definitely increased. If it continues, the impact of the growth in the money supply will be greater. The question is, will it continue to grow at that rate or faster?

You might ask, well if the banks are not loaning more money and that is how the Fed pumps money into the system, how is the money supply expanding?

The answer to the question is that there three other sources of growth in the money supply (that have played little or no role hitherto): 1) In QE2, the Fed was playing a little with its processes and managing to get some money directly into the hands of the Treasury (see the several comments under “Making Claims About the Money Supply), and that expanded the money supply. Whether that explains this jump is unclear, at least to me. 2) Money that was in other instruments, and not available for immediate spending may have been moved. It would take a large and noticeable move to result in this jump, but this change could explain part of it. 3) Dollars kept overseas could have been moved back to the US. This is my choice. In the recent turmoil in Europe people and businesses have been fleeing the euro and the eurozone. We could easily see billions of dollars moved, not just into dollars, which has made the dollar “stronger”, but move to be deposits within the US.

If the last of my three options is the reason for the rapid increase in the money supply, I don’t think that it is sustainable and then not a threat for our consumer prices. The reason being that there is only so many dollars that can be moved quickly. There are many financial and business obligations overseas that are paid in dollars. If too many dollars come here, they will just have to go back. It would take time for those obligations to be unwound and the dollars freed up so that they could remain here. If that begins to happen, then we will see a significant influx over time and a consequent increase in dollars for asset investment and spending. We will either have another asset boom, a general consumer price inflation, or both.

But, in order for the role of dollars to begin declining in international trade and finance, there would have to be a replacement. People overseas would have to find a currency that they were willing to trust as much as they trust dollars today. It would have to be a currency that is as available as dollars are (a large quantity). There isn’t one. Nor is there one on the horizon. (I mean in terms of the recognition of the people overseas, not as a potential.) Therefore, if I am correct in my suggestion as to the source of the increase in the money supply, we need not worry about that problem right now. But we do need to keep our eyes on it.

But, we have to keep an eye on what the money supply is doing anyway. It isn’t optional, because it foretells what we will have to face.

FOUR BOOKS: One Great, Two Good, One to Avoid

2011-08-17T19:00:00.000-07:00

Objective Economics
By Dr. Northrup Buechner

Good to Great
By Jim Collins

Manias, Panics, and Crashes: A History of Financial Crises; 5th ed.
By Charles P. Kindleberger and Robert Aliber

This Time is Different
By Carman M. Reinhart & Kenneth S. Rogoff

Objective Economics is the triumphant entry of man, the rational, thinking man, into the study of economics. For the first time, man is the focus. This is in contrast to the “blind market forces”, “invisible hand” and disembodied supply and demand that has populated economics previously. Here, man makes choices by the use of his reasoning power based upon the facts of reality. Certainly, irrationality is recognized, but so are the consequences (i.e., failure). The book also presents a method of objective science, focusing on the facts of reality, and notes specifically where more information is needed. It does continue in the tradition of the best economists in that it is exhaustive, discussing the various important issues in detail and making note of the differences in this book vs. its predecessors. In this regard, Dr. Buechner’s consistent references to the three classifications of philosophy, i.e., the intrinsic, subjective, and objective, are important and helpful.

Good to Great has much to offer. It clearly presents what is actually a very objective (in the proper sense) look at the reasons why certain companies met a very high standard of greatness as businesses. The conclusions are very interesting and useful. The method and the clearness of the thinking are enjoyable and instructive. What is also interesting is that, clearly, the author and his research staff do not have the knowledge to understand and elucidate the character of the great businessmen they discuss (neither do the businessmen). People familiar with Objectivism will understand.

A facebook “friend”, someone who is considered an Objectivist by himself and others that I respect, referred to Charles Kindleberger as a good source to understand economics. I hadn’t really heard of Kindleberger, being as I left school before he began writing. So I looked around and the only book that I could easily access was Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger and Robert Aliber (Aliber does not seem to figure much in this, somehow). I was greatly surprised to see a glowing recommendation for the book on the cover by Paul Samuelson, the Keynesian author of one of the worst college texts ever forced on the innocent. Samuelson’s recommendation was well deserved. I haven’t discussed this book with the facebook friend, yet. But this indicates that he is sadly wrong. Kindleberger is strongly for government control of the economy, has no ability to distinguish between different economic events, is unable to understand the concept of causality in economics, and writes in a style designed to bore and obfuscate. I found one, accidental, modest idea in the book that might suggest some further thinking. One.

On the other hand, This Time is Different, although written by two economists who do not seem to have found anything in mainstream economic theory to question, do have some respect for facts, and wondrously, actually go and search for them. The detail and organization of the facts sometimes are a little difficult to get through, and much of what the two authors have to say is superficial. Yet, on some important points, they are very good and do provide some understanding that is important. The point of the book is that excesses in credit and money creation in every instance leads to disaster. This time is never different. I am not recommending this book to anyone who is not serious in their studying of economics and history. It certainly does have major significance to today, both here, in Europe, Japan, China, and most of the world.

Self-Fulfilling Fantasies: US Treasury Bonds

2011-08-14T13:01:00.000-07:00

Number one on my list of fantasies is the US Treasury Bond. (Just for the record, in this context I mean nightmares. I do have good fantasies!) People feel US Treasury Bonds are safe. Are they?

The usual reason given for the safety of US Treasurys is that they are backed by the ability of the US government to dip into the pocket of the most-wealthy nation on earth to meet interest payments and redeem the bond upon maturity. Well, yes, that is true, still true. But that proposition does have limits, limits that have not been stated or acknowledged before, but need to be seriously considered, soon. (Notice that the wakeup call of the S&P downgrade of US Treasury Bonds has not resulted in honest reconsideration of the path of the Obama administration, but has caused several loud calls for destroying the remaining limited independence of the credit rating companies.)

There is also another issue that isn’t addressed in the basic reasons for the safety of the US Treasury Bond, prices. You see (and I am sure that many of you do see) the price of the bond is related to the interest rate that it pays, which in turn is related to the interest rates paid on other bonds around the world. If interest rates begin to climb, and the secondary market for Treasury Bonds (where bonds purchased from the Treasury are resold), even the Treasury itself, need to compete for funds, the interest rates for the bonds will climb. The consequence will be that the price of the bonds will fall. So Treasury Bond prices do change. If interest rates move, say, a whole percentage point upward what happens to the price? The current benchmark 10 year Treasury Bond has a yield (interest rate) of about 2.4% (the date of my first draft being somewhat different from my publishing date). So I am suggesting that it went from 2.4% over time, however long you want, to 3.4%. The latter interest rate is still very low. Historically, this bond has been much closer to 5%. Even at 3.4%, with taxes at roughly 25% and inflation around 2%, the bond isn’t making you any money (at 2.4% you are taking a loss). (Of course, foreign governments aren’t paying taxes!) But, a bond purchased originally at 2.4% will not yield the new market rate and can’t be sold for the original purchase price (nominally $10,000). Instead it must be sold for the amount that will bring the current market rate of 3.4%. (or $240 – the actual dollars paid in interest – divided by the new interest rate) which is close to $7058 ( there are issues of time to maturity, when you receive back your $10,000 that will adjust the actual sell price). You have lost roughly 29% of your principal. You see, relatively small moves in interest rates will have significant effects on the market value of your bond.

This example demonstrates that bonds are no safer in terms of maintaining your principal than any other asset, unless you hold to maturity. How safe is that? Depends upon the inflation rate doesn’t it. When thinking of long-term monetary values, don’t think in terms of currency, that is, fiat currency. Think in terms of some real, basic thing that you use in daily life, like a loaf of bread, or a pound of ground beef, or a latte in Paris, whatever. You will connect the rate of inflation to your currency denominated assets and be able to better realize what is happening to your capital. The bottom line is that US Treasury Bonds are very risky. (I won’t even go into the fact that you have put your savings into the hands of people like Obama, Bernanke, and Geithner.)

Many, if not most investors know these facts, so why are they still running to US Treasuries? Context. Or, a perhaps better way of putting it, where else are they going to put their money? There are a couple currencies that are considered strong, i.e., the Yen and the Swiss Franc. Both of these have been bid up sky high (much to the dismay and panic of the authorities and business people in those countries). There isn’t any real room there for more money. Other currencies are not considered safe by the populations of those countries. The best current example of that is the eurozone. This group of “developed countries” have people making decisions who are more concerned about voters than solvency. People who wish to protect the value of their liquid assets are scared of what these politicians will do (not to mention the so-called economists who do not think stability or production as important to economic health). The person holding liquid assets wants to put his property somewhere that the whims of the politicians can’t destroy it.

The bond markets for stronger countries, such as German and Austrailia, are small, very small in comparison to that of the US, and can realistically take only a small portion of the available funds. So for anyone wanting to get out of their home market, out of their currency, out away from their authorities, the US is still a better place. It just gives you a good idea of how bad it is elsewhere that the US dollar and the US Treasury Bond are about as good as it gets.

The result is that Obama, Bernanke, and Geithner feel pretty strong and confident, in spite of the downgrade of US government bonds by S&P. Again, isn’t it amazing that the politicians in other countries scare their populations more than the US trio of idiots.

The above discussion also gives you some idea of what could be the future for the cost of gold in fiat currencies. The gold market is smaller than the market for the Yen or even the Swiss Franc.

At this point I should explain how the bid/asked market functions: it is the margin that moves a market, especially a auction market like stocks, bonds, currencies, commodities. It is not the total demand or ownership. It is the most recent orders, their size, their volume, and which side of the transaction they are on, buy or sell, that moves the market. The traders do what they can to meet the reqirements of the open orders, moving the price as required to elicit corresponding orders (a buy order to match the existing sell order) to clear the market. Higher volumes of demand for a item, like gold, will send the price up. The higher the volume, the faster and larger the price movement.

So if people really begin to consider gold as safe and a real alternative to fiat currencies, the current price will be considered very low. Any kind of movement into gold from these other markets will send the gold price to astounding heights and will really scare a lot of people.

What will be interesting to watch (but not to live through) will be the point at which people begin to doubt that US government assets are a good idea, including the dollar. We don’t even have to worry about China or Japan for things to get ugly. If just foreign banks, businesses, and individuals begin to sour on our debt, its yield will move strongly upward and its market price downward. The budget deal and all of the carefully crafted, make-believe scenarios will be revealed as so much fantasy. These scenarios (models) are also among my favorite nightmare fantasies.

Debt, Ceiling, and The Issue

2011-08-07T16:40:00.000-07:00

So many people are reacting to the recent bill to raise the debt ceiling as if it meant anything. It did mean something, but not what people are whining about and not what the Dems or the Republicans are suggesting.

You should have expected that the debt ceiling would be raised, and probably by the arbitrary date that had been set. If anyone in Congress had suggested that the US go into even partial default, they weren’t being taken seriously. When the government has been shut down before, the Republicans have taken the blame and felt the pain on election-day. They weren’t going to do that again. No, they were going to raise the debt ceiling.

I am a little surprised that they raised it as much as they did, although the actual number was rarely mentioned in the press. No wonder, since the increase was about the same amount as the announced reduction in spending – that is suppose to occur over ten years.

Add in the fact that actually less than a trillion dollars of spending reduction was identified in the bill that was passed and the remainder is suppose to be selected in a special legislative committee, we have a bill that doesn’t mean much. Nor are the effects to begin for the next two years, except to raise the debt ceiling by over $2T.

The “reasoning” behind not having any cuts in the next two years is strictly Keynesian economics. It is accepted by both sides that government spending is a good thing for an economy that is not growing sufficiently (if at all). No one questioned this claim. The Republicans went right along with it. If you think about it, it makes even less sense in this case. I mean they are accepting the idea that not reducing the spending that BO wants in 2012 means that the economy then will do better than if his budget was reduced. This is just amazing. It this thinking is correct, the correct thing for Republicans to do would be to push for more spending, regardless of the deficit, to have even better economic performance. Well, of course, we are now talking Ben Bernanke’s language.

Many people are claiming that the loser was BO. They say that he didn’t get the increased taxes on the wealthy that he insisted upon. Maybe. There is always tomorrow, of course, or after the next election. The way the Republicans are going, BO will look great. I am sure that he hasn’t given up on raising taxes on the most productive members of our nation, he will find another time to push this through.

The bill hasn’t made our immediate situation any worse. If you understand that the debt limit was going to be increased and the whole thing was a game (a game that was taken very seriously by all participants), then you just hoped they didn’t do anything more stupid than normal. There are no new immediate taxes, no new spending, no explicit attacks on our freedom.

There is one bright spot, I think. It is that the very issue of the debt was brought forward and made a big deal. It gained the attention of the media and many people in the country for a couple weeks. It also seems that the Republicans did latch on to this issue and maybe they will try to keep it in the forefront of their public comments. That is a good thing.

Yet, as I say that I also remind myself that they did not make clear to the American public that Social Security and Medicare are doomed, no matter what the Dems do about it. Those programs have a cost that no nation could pay, and certainly not one as encumbered and regulated as this one.

The Republicans also undercut their case when they fought for such small potatoes. Cuts of $2.7T (or whatever the final advertised number was) spread over ten years do very little to impact annual deficits of over $1T a year. It was such a big fight over so little.

But actually, it is even worse because what they were fighting over weren’t cuts at all. The Congress uses terms differently than us common folk, and the “Tea Partiers” fell right into it. The budget projection process assumes that most programs will continue to expand over the years. What Congress fought over was the rate of increase of those programs. They weren’t cutting anything at all.

The expectation that reducing the increase will make a difference assumes that the income side of the budget would grow at a certain rate, meaning that if income continues to climb, and we reduce the increase in spending, we will see a reduction in the deficit and we will borrow less. But, where is this increase of revenue coming from? Well, two options: price inflation or actual growth. Along with price inflation often means increases in income as well and thus increases in tax revenue. Historically, however, income lags, meaning that our standard of living lags, and tax revenue lags. So, price inflation would only partially support a decrease in the growth of the debt.

Really, Congress is assuming that the economy will grow. I do not know what growth rate was used to figure out that their numbers would work and the deficit would not grow as fast as it has. I expect that it had some relation to our history since WW2. The growth rate over the last ten years has been much lower, however. We may not expect our growth rate to achieve the historical average any time soon, since we really haven’t recovered from the last recession. There are lots of reasons to think that the last recession is continuing and tending downward. You can be certain that the framework of this “Deal” didn’t assume a recession in the ten-year timeframe. The entire underpinning of the “Deal” is flawed.

The bottom line is that the “Deal” that was suppose to cut spending will have little effect on what will happen in the economy over the next ten years. It is a nothing. It has many fraudulent characteristics. Worse, it may make some people relax and think that things are in better shape.

That is one reason why I don’t understand the people who were so disappointed that the “Deal” was done. The bottom line was that the Republicans were fighting for show, not for real results, and not passing the debt ceiling was just too real for them (as a group, anyway).

And now (have to write more cuz stuff is happin’), S&P has actually shown up. I think that their explanation is pretty good, except that they should have mentioned that the politicians got us into this fix in the first place. I have seen two different kinds of responses, well, three, but the third, “It’s about time!”, is a very small minority.

One response is surprise that the downgrade is occurring now since the US government can meet its obligations of paying interest and paying back bonds. This is as short-sighted a view as we see from the Congress. The issue isn’t about today’s payments, but the payments during the life of the bond, which is in doubt, really.

The other response is from the Administration and the Democratic members of Congress. They apparently believe that anyone who disagrees with their view, their very subjective view that whatever they want to do is good, is at best mistaken and probably evil. Don’t be surprised to see the FBI visit S&P headquarters. If Obama actually realizes what the meaning of the downgrade means, he will look for ways to use the power of the government to change the rating of his debt.

Many of the supposed financial experts interviewed that I have seen have been unwilling to predict what we will see tomorrow when trading restarts around the world. I certainly don’t know. We may see some pause as people try to come to grips with the revised situation. Many of the organizations that currently hold Treasuries as assets that must be AAA rated may be calling their attorneys to find out what they must do. Prudence would require that they change their assets in an orderly manner and not wildly sell. But then, we could see some panic selling. Either way, a lowering of the rating of US government bonds should see an increase in the interest rate being demanded in the market. How much is very much open to question. The Treasuries will still be a major holding by many different international and domestic organizations.

But think what the downgrade does for the “Deal”. The whole plan did assume a certain cost of borrowing. That is, paying the interest on the debt is a large portion of the federal budget. That portion has just gotten larger. I bet that the projection of future spending used in shaping the “Deal” assumed pretty much the same interest rate on bonds for the entire 10 years. It certainly assumed a continued AAA rating. Now that rating is gone at the very beginning of the 10 year timeframe, and it is unlikely that the Administration or the Democratic members of Congress will do anything that will provide reasons to change the downgrade. The supposed cuts will be off set by the higher cost of paying the interest on the debt. So much for the entire hoopla and the “Deal”.

We need to focus on the primary thing, which is the education of the American people. If a sufficient number (say 20%) understand the situation, their voice concern will cause Congress to move in the correct direction. As long as the American people believe that, for example, Social Security and Medicare can be viable over the long term, nothing will be done.

As we move into the forth year since the bust of 2008 and there is no real recovery, we do have an opportunity to point out the reality of the Keynesian policies of the government. The American people do not want to live this way. I think that even the ones receiving government payouts may be willing to listen more than their counterparts in other countries because they are still Americans. In any event, we have our opportunity. Let’s make the most of it.

The Continuing Story in Greece, Europe, and the World

2011-07-09T09:20:00.000-07:00

I’m not giving you a blow-by-blow account of events in and around Greece. I am trying to give you some perspective on the situation, which seems hard to find. I am beginning by offering you some stuff that I have found here and there that adds to the picture. They show that the possibility of Greece growing out of its current difficulties is impossible, because real growth is impossible. Read this article from the BBC to get an idea of how the government and business get along. It makes many of our state governments look brilliant by comparison (but not Obama). I found another article about a village that had attracted major industrial investment, but is now dying and businesses that can are moving out of the country (sorry, I proceeded to lose the address of the article). There is also plenty of evidence that money is fleeing from the country. Bank deposits are declining relatively quickly. None of that is good for the survival of Greece without major disruption.

For you one note medical issue people, read this note form a recent weekly email that I receive from John Mauldin (6-24-11):

“But there are very sad things going on. It is not just banks that are losers here. Pharmaceutical companies are starting to refuse to deliver to Greek hospitals, as they are up to two years behind on their payments. It turns out that Greece owes some €6 billion to private businesses like hospitals and simply cannot pay. Those costs are rising, and much of it is to hospitals for medical care supported by the government. They are issuing bonds (shades of California) for the debt in some cases, which sell for a discount of 50%, if they can be sold. And we thought finding €12 billion was a hard thing. This is not just a Greek problem, it is a concern in many countries that are having financial difficulties.”

The Greeks are being asked to make some very tough decisions. These decisions would be difficult for brilliant, well-trained, market oriented professionals to make, but what the Greeks are depending upon are politicians who claim to be socialists. Their entire operating mode is making promises, throwing around government money (they have no idea where the money comes from), and taking graft (It would be sort of interesting, in a pathological sort of way, to do a study on the number of “socialists” who have become rich and expect luxury since they became politicians, like the Frenchman arrested on rape charges in NYC, Straus-Khan). If the world press was able to look beyond the superficial, and report more on actual events besides government pronouncements and “protestor” activities, we would see that the Greek economy is barely functioning. To me, the problems in Greece bring into question much of the current plan. For example, the Greeks are required to raise E50B by selling off nationalized businesses. But these companies are most likely very badly managed and their assets may have been looted, many of their employees are protesting the entire program in the streets, and the prospect of profitability in the Greek economy is bleak. Who would bid on these companies? Would the Greek government get more than 10 cents on the dollar?

The entire program is based upon premises that have not been substantiated. There is very little connection with reality in the entire effort. Part of the reason is that none of the countries, including the supposed healthy countries like Germany, could comfortably face the same reality oriented scrutiny that Greece should be facing. I am sure, as a semi-reality oriented premise, i.e., the German reputation, that German nationalized companies and German government management is better than that in Greece. But I’ll also bet that it does not rise to the standard of German private enterprise, let alone American private enterprise. So the problems that the Greeks face very likely exist to some significant degree in every European country and at some point down the road, they will each face default and depression.

If Greece defaults, do not be surprised if other countries don’t follow suit. Iceland is expected to walk away from its debt at any time. As for Ireland, from all I have seen, it is a country plunging down the economic hole. Portugal is pretending that it is functioning and will not need another bailout, but it isn’t growing. Spain is seeing massive internal dissent aimed at its austerity programs. But, back to Greece.

So, in the last week the Greek parliament voted to further reduce spending and sell off government “businesses”. This is just the briefest of stop-gap measures (the popular phrase is that they are just “kicking the can down the road”) and it is not considered to be sufficient. More cutting and so on will be needed next year.

Some commentators wonder if the actual events will occur. All that has actually been passed are general bills. The legislation that will provide the details will be offered later, including the specifics of the asset sales. It is noted that the current government originally built its power base on the employees of the government and these government companies, promising them heaven on earth, regardless of the cost, productivity, or sanity of their programs or “businesses”. To sell off these enterprises would be a complete reversal, and it is wondered if these politicians can do it. Politicians of this stripe are great at making promises, but recognize the difference between policies that will get them reelected or appointed and those that no one will pay any attention to. Since these politicians are hardly connected to reality, they could easily declare that they will not act against the “interest of the Greek people”, and say to hell with the bankers, and not sell the assets. It would be a disaster and fairly soon those “businesses” would have to close down, since no money would be available to subsidize them, but the politicians would probably be reelected.

But, even if all of that goes fine, the Greeks will still need over E100B next year. I don’t know how they figured that, but if they are depending upon the Greek economy to assist in the government’s efforts to remain solvent, they will be very disappointed. I expect that the Greek economy will decline faster than they expect. Relatively speaking, it is an advanced economy, probably one of the top 20 or 25 in the world. It is more advanced than the US was in 1930. It is more corrupt and probably more productive, but in terms of interconnectedness and of business practices, it is more advanced. When even a relative small, advanced economy begins to fail, things will unravel rapidly. The politicians in charge will be like military leaders, who are said to always be ready to fight the last war. The politicians (and the economists) do not really know what is going to happen. They are basing their reasoning upon assumptions that most likely have little to do with present day economies. (Since the last depression occurred 80 years ago, we have little actual experience for rational economists to base their expectations. No one knows what will happen. But the irrational people in charge now won’t even realize things aren’t going right for some time.) So the needs of Greece next year will most likely be larger than presently expected. Larger than the current leaders in Germany and France are telling their people they are committed to cover. Politics in those countries will be rather interesting to watch.

But then, even before that point we have the French and German leaders coming up with another wrinkle, witch will cause great stress. They are saying that the “private sector” needs to participate in saving Greece. Now, considering that the “private sector” has already put itself out on a limb and bought a lot of Greek debt, it would seem the private sector has already engaged in significant participation. Why anyone in their right mind would do such a thing is beyond me. Then, much of that debt was purchased before the rating agencies really took the Greek government’s ineptitude into account and began lowering the credit rating of Greek debt, meaning that interest rates for Greek debt have gone up, a lot. Interest rates on the open market are now in the upper teens, say 16% or 18%. Say you bought Greek bonds at 8% and it is now 16%. You have lost half of your capital on the secondary market. Your only chance of getting your capital back is to keep the bond until maturity. It will probably still be a loss (due to the declining value of the currency), but perhaps not as much (figuring this out calls for some very complicated math). But now the French and Germans are telling the private sector that they will have to roll over their bonds, that is let the Greek government keep the money, with a new maturity date (I haven’t seen any indication of what duration.), but with interest rates probably lower than market. This is a clear loss for the bond-holder, and in any rational world, would be called a default, as the credit rating agencies have clearly stated.

Given a deserved black eye because of the goings on during the residential real estate boom, the credit rating agencies are trying to act like real credit raters. That is not what politicians want, actually. Welfare state politicians generally do not like letting people know the truth about things. Just in the last couple days, the leaders of Europe, especially that crazy lady in Germany, have attacked the credit rating agencies. It is an ad hominem argument, accusing the agencies of having a bias against Europe. Yes, if you don’t get your way, if someone calls your spade a spade, accuse him if bias. The best defense is a good offence. Offend every one you can.

Well, I can now get to one of my biggest reasons for writing this post. Greece is really small potatoes. I mean, Greece has a small economy, although if it does (which is to say that when it) defaults, the repercussions will be significant, because a lot of banks have significant amounts of Greek debt. But there are also two other small countries in the EU who might take the same opportunity to default on their loans, i.e., Ireland and Portugal. I’m not sure how seriously to take this, but Ireland is in dire straights and Portugal is not improving either. Then anyone who looks sees that Spain and Italy are both in situations not that much different than Greece. The “contagion” effect could go far, especially if these countries have major financial issues when Greece fails. I mean banks failing and soaring private bankruptcies will be dangerous in every country.

Then, hidden and ignored, is the plight of France and Germany (which is to actually say all of the European developed welfare states) that cannot sustain their own spending and borrowing as their populations age and shrink (and go Muslim). The problems in France and Germany are greater than that of the US in the long run, i.e., next few years.

That means that to the extent that France, Germany, and the other apparently healthier countries weaken themselves bailing out Greece, Ireland, Portugal, Spain, and Italy, they bring on their own problems that much sooner.

More broadly, the world is awash with debt. Every major economy that you can name that appears strong has got major debt, and rapidly growing debt. Japan, for example, with the reconstruction it now has to address, was beginning to feel overextended before the earthquake and tsunami. The Japanese economy is under great strain, yet the regional governments, businesses, and the population are all making new insistent demands on the national government to spend more money. The brics, Brazil, Russia, India, and China, that are growing fast depend upon the developed countries for markets, are themselves heavily controlled by their governments, are awash with government spending and debt (domestic and international), and at least three of the four (I don’t know enough about Brazil to say) are rife with corruption. In no way can we say that they are healthy economies, no matter how rapidly they are actually growing.

In spite of the international financial meltdown in 2008, there is little real difference in the way the international economy is functioning, except there is a lot more government debt worldwide and much more government interference. Consistently, they have all blamed the financial problems on the banks and, in fact, made the banks weaker.

The results from this will not be good. I am not predicting the end of the world nor utter catrosphie, I just don’t know enough to do so. But nothing good can come out of the current mix of debt, government controls, ignorance, and purposeful pursuit of policies that have never worked. It can not help but be worse than 2008.

We can avoid the meltdown here, but only by getting hold of things and making real change, to freedom, to capitalism. We will still suffer because there is no avoiding the problems of the rest of the world. But we can survive in fairly good order, if we do it.

The End of QE2

2011-06-30T10:06:00.000-07:00

QE2, i.e., quantitative easing two, the program by the Federal Reserve Board of buying longer-term government bonds to “support the economy” ($600B this time) is slated to come to an end June 30, 2011, today. One might ask what this round of low interest rates and easy money has done? I am sure that the governmental types will proclaim to the land that they have averted major disasters and saved civilization by their actions. Sure. Others will say that the results are a significant additional amount of inflation. Perhaps. One can definitely say that the level of reserves that the banks who are members of the Federal Reserve System (nearly all banks) have risen to new, even scarier heights. Before September 2008, the total reserves of these member banks were in the $50B range. Soon after that fateful September, the reserves rose to over $1T! Now the reserves are about $1.6T. What is good is that the “money” (which the Fed merely created out of the air) is sitting in the reserves and not roaming around the economy. Other than inflating the reserve figure, I don’t see anything beneficial that the QE2 creation of an additional $600B has done. The economy is not doing well. And much of the damage of the run up to the 2008 meltdown has not been undone, either.

Maybe what has happened is that the economy has floated along on the Fed cushion for the first half of this year. It is growing slightly, say less than 2%. At this point in most “recoveries” the economy has achieved much higher growth. The current economy has not gotten back to even, yet. Some prices have fallen, e.g., real estate. Residential real estate prices have probably not fallen enough and the sector is still in poor health, with foreclosures still happening at a high level. Employment as a percentage of the working population is still low. It is even lower when the actual productivity of the many of the new “jobs” is taken into account (i.e. government “jobs” that produce nothing). Moreover, for various reasons, some having to do with money creation around the world and some having to do with enforced shortages in the face of growing demand, the prices of some basic commodities are high, meaning a lower standard of living for all.

So QE2 comes to an end. Many suggest that the economy, left to its own resources does not have the strength to continue to grow, or, if at all, at a very low level. Employment, which is only doing better because of some statistical manipulation by the Labor Department, will suffer. Our standard of living will continue to fall.

The counter trend to the government’s activities is that there are millions of people in our country running businesses and working to be more productive and profitable. In spite of all the government does, some very basic elements in our economy are growing. So much of what I see from Objectivists assumes that the government is all-powerful and ignores what the non-government sector is capable of doing. Remember, the practical attack on capitalism has been going on for over 100 years (as opposed to the philosophical attack that has been going on much longer). The attack is still only partly successful because the ingenuity of the American capitalist works around and through the laws, regulations, and direct interference put in place by our politicians. The failures, when they occur, can be big, e.g., the Gulf oil spill. But on the whole, American businesses have coped pretty will with the interference. There is a limit to how much they can overcome, and we may be getting close to that limit (re. Atlas Shrugged), but American capitalists and their workers are trying, still. Whatever QE2 and its aftermath, the real economy will influence the results. This is a major reason why the consequences of government actions are so hard to predict. It is also why people do not take the predictions of doom seriously. Long-term doom just doesn’t seem to happen (as opposed to short-term doom like the sub-prime/financial meltdown). Things don’t seem to change much on the surface. We seem to still have capitalism. To the extent that capitalism has been undermined, we are in for a rough time, unless change for the good happens. (We are experiencing long-term deterioration, but we are experiencing it like a lobster in a tub of heating water, and we aren’t noticing our losses.)

To the extent that QE2 has been propping up the economy, that support will disappear. To the extent that participants in the economy thought that QE2 was providing some real support for the economy, the loss of that support will make them weary and less confident. To the extent that QE2 has been fueling the rise in the stock market and commodity prices around the world, that fuel will disappear and perhaps those prices will drop. To the extent that QE2 has been keeping longer-term interest rates low, they will now begin to rise. To the extent that QE2 has been glossing over problems in the economy those problems will reassert themselves and they will have to be addressed by the markets in a more rational manner.

The end of QE2 will be a good thing if the government and the Fed do not start tinkering again. There is another program that the Fed has ongoing, that is not changing. It has a lot of bonds and mortgage-backed securities, say about $1T. Those securities are maturing and being paid off as time goes on. The Fed has been taking that money, and buying Treasuries, about $250B a year (according to news reports). This isn’t really a good thing, since the original funds to purchase these “toxic” securities was made-up money. It would be better if the money was retired, and the member bank reserves reduced (that is actually where the money went in the first place). But at least it isn’t new made-up money.

There is a lot of talk about the reappearance of Fed “support”, say QE3 at some point within the next year if the economy begins to founder. Right now the pressure in the much of the world is for interest rates to rise. For instance, the Bank of International Settlements issued a statement that criticized developed countries for keeping interest rates so low. Other countries have raised their rates recently. Raising rates now is inconsistent with any of the Fed’s QE’s. To engage in another round of quantitative easing the Fed may have to fight a worldwide trend. Such a trend of rising interest rates would put further pressure on U.S. Treasuries since money would tend to seek higher rates of return, and Treasuries would have to have higher rates to compete for funds. This is especially true with the recent public statements from S&P and the IMF regarding the Treasuries deteriorating soundness. The U.S. government may be ignoring the negative evaluations of U.S. government debt, but the rest of the world isn’t. (On the other hand, with the problems in the Eurozone, Treasuries are viewed as very safe by comparison and there could be no significant upward interest rate pressure on them. When things are going bad, it isn’t going to be very clear what will suffer and what won’t. That kind of uncertainty is the nature of government-induced instability.)

Once interest rates begin to rise, we shall see how badly the Fed is prepared for the real world. It is suggested that to avoid significant consumer price rises the Fed will have to aggressively soak up all the liquidity that they have put into the system since 2008. That is so even if that liquidity resides only in “member’s reserves”. “Sopping up the liquidity” means doing just the exact opposite from what the Fed has been doing the last three years. It means doing just the opposite from what Ben Bernanke has built his professional life around and what he has been hailed a hero for doing. Does anyone think that the Fed is really ready to reverse course in any significant way? If there is any reason to give credence to the hyperinflationists it is the prospect of interest rates rising and the Fed allowing the policies of the last few years to run their course. It is definitely the reality that if the Fed keeps things as it is now we could see hyperinflation. Our immediate future may depend upon how the Fed reacts to rising interest rates. To that extent our future rests in the hands of a few deluded, self-proclaimed geniuses.

I am not going to forecast what will happen over the next couple years. (I have been expecting interest rates to rise for over ten years.) We just need to keep a very careful eye on events here and abroad, especially in Greece and the Eurozone. We could also see problems in China.

Let me tie my most recent Inflation Update to the end of QE2. In the inflation update I am talking about the money supply and its effect on prices. The end of QE2 will reduce the upward pressure on the money supply some. Keep in mind that QE2 was aimed at longer-term Treasuries, thinking that lower longer-term rates would spur major borrowing. The Fed is still aiming to keep short-term interest rates low, and will continue buying Treasuries where necessary to keep those interest rates in the target area of zero to 0.25%. This upward pressure on the money supply will continue.

Let us suppose that QE2 did act as Bernanke anticipated. Businesses were attracted by the lower interest rates and did invest. Then, with the end of QE2 and interest rates increase because there is less money available to loan, then we should see less borrowing, less investing, less hiring, lower growth, and perhaps less money for the equity market. And still there will be pressure on the money supply, high commodity prices, and probable upward pressure on consumer prices (from various sources).

So, the bottom line is that the next few months offer even greater uncertainty than we have been living with since the residential real estate mortgage crisis began. I think that the only thing we can be certain of is that our governmental leaders, who have nearly unlimited sway over the money taps and financial/legal gimmicks that they can produce, are going to generally make wrong decisions.

I have final note about interest rates. I have seen reports that foreign central banks, big buyers of Treasuries in the past were absent in the last Treasury auction (and the Fed stepped in and made up the difference – indirectly). As the Fed will stop buying at the end of June, if the foreign central banks do not return, the Treasury is going to have to raise rates to attract buyers, from somewhere. I don’t want to suppose at all what levels the rates are going to have to be to sell the bonds that they need to. Actually, hitting the debt limit may be helpful to the Fed’s program because the Treasury will be limited in the quantity of bonds it can offer for the next few months. The interest rate tale will begin after the debt ceiling is lifted.

It is difficult to see what the foreign central banks are doing. There just aren’t many places for them to put the excess cash they are accumulating. Probably Japan is expecting to spend a lot on its reconstruction (meaning that their money supply will expand and the Yen vs. other currencies will get stronger as the central bank buys yen). But there really isn’t another source of even decent, high grade (which is a relative term), large volume bonds besides the US government. China has told the EU that it will continue to “support” them in the face of their expanding credit crisis. I haven’t seen an exact definition of “support”. It may mean that they won’t sell out of European bonds. It may mean that the Chinese will continue buying as they had before. I doubt that it means China will increase their buying. Europe is certainly not a candidate to replace the US as a place to park hundreds of billions of dollars a year. Remember that China has a large trade surplus with the Eurozone that rivals its dollar surplus and it is already buying lots of bonds from Europe. Is China just keeping cash? We shall see.

As was pointed out in an analysis I read (an email), the funds that the Treasury can attract to replace the foreign central bank buyers would be from the US private sector, who would want higher yields. But, if the money goes to the Treasury, it won’t go into equities or other investments, and thus, for sure, the stock market’s fun days will turn into sad ones. Also, the prospects for job creation, productive jobs, will diminish further (if that is possible). Unkle Ben is expecting a rebound in the last part of the year. HA!

So what would Bernanke do then, when interest rates start going up and the true lack of recovery is obvious? What does he advocate for every instance? What has he done? Make-up more money! Watch for QE17!!

More Reasons Why Oil Prices are Going Up

2011-06-28T09:26:00.000-07:00

For all of you “oil price equals inflation” enthusiasts, watch what happens with Japan’s nuclear power industry. Reports are that after April of 2012 Japan will have no working reactors. They will have all shut down permanently for various, mostly irrational, reasons. To still provide power, Japan will have to import fossil fuel, oil, to the tune of about $30 B a year. Think that won’t have some impact on international oil prices?

Coal fired power plants in the U.S. are expected to be shut down over the next few years because of environmental regulations. Where that power will come from is not clear as far as I can see, at least publicly, but oil may play some role (I would like to hear form someone with accurate information).

Those people in the U.S. who are losing their coal-fired power plants will see a double attack on their standard of living. Not only will their electric bills go up by an estimated 40% to 60%, but their bill for fuel for their car will stay high or also go higher. Who will they blame?

In other words, for various reasons, mostly having to do with government regulations, we are going to see a necessarily higher demand for oil over the next few years. If the large developing nations, especially China (I have written about China’s potential difficulties, so its oil demand is not a sure thing.), continue to demand more oil, and the nations of the world continue to restrict the oil industry’s attempts to find, develop, and produce from oil exploration (government owned “oil companies” are not competent to fill this need), we will see oil prices stay high, very high. As of this writing, oil prices are about $90 a barrel for light crude. (The price is lower than it was because a few countries, including the US, released oil from reserves. This is a short-term bandaide and will only mask the problem until they stop releasing oil or can’t release any more. No one is moving to free the oil companies.) If China continues its present demand level, we can expect to see oil prices rise. If China has economic problems (as I think it will) then oil prices will merely stay near their present levels as all of these regulations and irrationalities play out.

Are you watching the events in Greece?

2011-06-21T23:18:00.000-07:00

What you are seeing in Greece you will see repeated often in the next few years. Other Eurozone countries who did not control their borrowing will also experience the same problems as Greece, Portugal, and Ireland. These were mainly Socialist governments that bought elections by promising what could not be delivered. Spain could be next, and Italy, then soon in France. The bigger countries will each have a larger impact on the world economy. Other Eurozone countries will be weakened significantly by the attempts to prop up the failing countries and then in the dissolution of the Eurozone. They will also be weakened by the decline of international trade, as countries cannot afford to buy internationally. We could see tariffs spring up again, as in the mid-1920s. If these countries default, you will see large bankruptcies in other countries and economic dislocations, that will be a recession and, perhaps, depression. Although US banks have made few loans directly to Greek banks or the government, they have insured many of the European loans. A default will touch us, hard. And we aren’t out of our own recession.

Notice that the endless rounds of intense discussion and bargaining, with actions that, if rationally based, would result in significant improvement in the situation, only that a few months later the same events occur again. And notice, no one is really surprised. In the blogs you find people just calling these intense efforts, “kicking the can down the road”. That is, everyone seems to know that these actions will not produce any legitimate results and that the future only holds more of the same, until bankruptcy or default occurs. These events, with the seriousness, intensity, pretend efficacy, and intellectual bankruptcy, are right out of Atlas Shrugged, complete with consistent failure.

In the next few years, as Europe spirals downward, we will see a similar failure occur in Japan, and ultimately in the U.S. The big difference for us will be that there won’t be anyone to pretend to bail us out. The IMF and other rich countries will have used up all of their resources by then (but then, most of the IMF resources came from us).

I always knew that these countries would suffer major economic disasters. I knew that they could not keep their welfare systems functioning in the long term. I was wrong, however, in the mechanism. I thought that the problem would be the aging of the population. The Ponzi scheme of taxing to pay current welfare state benefits would hit population problems (an application of Maltus that he didn’t foresee!). Okay. So I was wrong. It is the debt! Debt. We have seen several debt crises over the last decades. What is coming will make the earlier problems appear as minor ripples. Obama has really brought it all to a head for us. Our chance.

For those who are focusing solely on health care, what do you suppose it is like in Greece, or will be over the next few years, or will be when Greece defaults on its debt and has no money in the government till, or leaves the Eurozone and has to depend upon its own resources and inflates its currency? That will be our fate in a few years. Which will happen first, ObamaCare or our own depression? Even if you save us from ObamaCare, you will lose to the depression.

I did look at the Greek protesters as complete idiots, protesting the end of their gravy train paid for by others. But I have reconsidered. One commentator I read explained the reaction of the protesters by saying that the prospects offered by the government were very bad, and that default wasn’t significantly different, by comparison. They are protesting the dead-end view of the Greek economy. Unemployment was skyrocketing, production down, and government debt – what all the fuss is about – was way up. In fact, every account I have read of what is expected in the future for Greece, including those who are very critical of the Greek protesters, say that without the government spending, the economy will continue to spiral downward. No one that I have read expects the Greek economy (or the Irish or the Portuguese) to improve. Every commenter, even “conservative” ones, regard the government as a prime mover. Its reduced presence means continuously lower production and growth, they say. Now this is patent nonsense. Yet, it is also the case that these economies will die, not because the government is the prime mover, but because these countries have removed the prime mover from the economy by law and ideology. That is, the individual is forbidden to seek his own way and make his own decisions. Self-interest is not allowed to flourish. Laws restrict initiative, hiring, firing, and generally doing things – producing. By law and ideology, they have forced the atlas to shrug.

We can see the same thing happening today in our country. Businessmen continually say that in the current climate of uncertainty and forthcoming, vague regulations, they are not willing to hire or make plans. The decision makers are frozen. Major corporations are sitting on hoards of cash, but don’t know what to do. They are stopped in place by Obama and his willingness to arbitrarily assert control over men. Greece is an advanced example of our same system.

I am an admirer of Greece, Ancient Greece. One cannot forget, however, that the present inhabitants of Greece bear little resemblance physically and intellectually to the ancients. The ancient Greeks were heroic both physically and intellectually. The present Greeks are not. The ancient Greeks laid the foundation for Western Civilization, and all that it could be. The present Greeks have no knowledge or desire to know what the ancients learned. The ancient Greeks made possible the United States of America. Unfortunately, Greece is our future, but not like Greece was our past. Unless, of course, the descendants of the ancients stand forth and don’t let their world go.

Inflation Update: Mid 2011

2011-06-16T14:40:00.000-07:00

The U.S. Bureau of Labor Statistics just released its monthly announcement of the CPI (Consumer Price Index). The index showed some modest growth in consumer prices, .03% over the previous month. These numbers did not meet expectations, but the differences are small. Then there is the “core” and the broader index. The core is supposedly more important because it represents consumer goods that are less susceptible to short-term market swings, and thus are more dependable as indictors of the direction of prices. Maybe. It is obvious that there is a lot of manipulation of the data that the Statistics Department uses for the CPI. If that manipulation is for political reasons, as many suspect, or not, the consequence is that the index tends to be far removed from what residents experience on a daily basis.

More importantly, so what? What both the average economist today and most hyperinflationists tend to think is that if prices are going up there is inflation. What it means for that average person, on the other hand, depends upon whether his own income is rising at least as rapidly as the price increases. If a person’s income is not increasing as rapidly, it means making some difficult choices and seeing a constant drop in living standards. It a person’s income is increasing as fast, it means that one isn’t any better off. It is only an illusion.

But inflation is not increasing consumer prices. Inflation is the expansion of the money supply by a government. The expansion of the money supply is a form of taxation, making our incomes and savings worth less, It also makes government debt easier to pay off and defrauds the lender. That is one of the reasons it is popular with governments.

Looking at the data available from the Fed, it appears that our two-year hiatus from the threat of increases in the money supply is coming to an end. First, business loans, after a dive, have begun increasing. We will have to keep a careful watch on this, but the seeds of destruction are beginning to take root. If the interest rates were something near a market level, an increase in business loans would be a good sign. With interest rates as low as they are, the new loans could be anything from meaningless to bad news. Again, we have to watch.

The money supply indicator that I watch, MZM, has also begun to climb upward again. This isn’t surprising since the Fed has been trying to get it going upward for a couple years now and it was bound to happen sooner or later.

I want to point out a couple things about that chart that are important. I want you to avoid the knee-jerk response that many will have that the sky will fall immediately. This is a thirty-year chart, ranging from $1T to $11T. The dollar increments are evenly spaced per $1T steps. The slope of the recent increases is closely in line with the slope on the chart from 1995 to the present. (Admittedly, it is a little difficult to tell how steep short-term changes are on this small chart. The actual data is available, but it is too soon for us to tell the actual trend. For the sake of this discussion, let’s go with the appearance.) An increase of, say, $100M dollars in the money supply in 1985 moves the slope up at the same rate as an increase of $100M today. But the base from which it increases is considerably higher today. A new $100M today has much less impact than it did in 1985. Today, such an increase wouldn’t be noticed. The rate of increase we see beginning in 1995 and running nearly continuously through today, with two brief recessionary periods, has resulted in modest amounts consumer price increases, relatively speaking (you will find that I have damned even small levels of continuous consumer price inflation elsewhere in my blog, but here we are making comparisons to hyperinflation). For the rise in the money supply to have the impact it did even ten years ago, it is going to have to be an increase of a larger amount and a steeper rate of climb on the chart. For it to cause hyperinflation, the increase in the money supply, as shown on the MZM chart, will have to be nearly straight up.

The Fed wants to see a rate of price inflation (what it mistakenly calls inflation) running around 2%. This is already a betrayal of the American population. Any inflation is a disaster for all savers and those on fixed incomes. For many years, the Fed policy was to be willing to accept inflation of between 1 and 2%. Now it wants 2%. In a couple years it will be 3 or 4%. Such is their level of intellectual honesty and responsibility. Anyway…

So the Fed wants 2% of price inflation. The money supply is moving up, business loans are moving up, the Federal deficit is moving up, and, although commodity prices have backed off a little, they are still very high. Employment is not improving. What makes the Fed think that when price increases hit a two percent annual rate they are going to do anything but continue to increase faster and faster. We don’t have to postulate hyperinflation (20% or more annually) to suggest that increasing prices aren’t going to become a prominent news item. The Fed is going to have to react and the only thing it can do is to raise interest rates and take money out of the system. It is going to have to work hard and fast on the money removal program because of the amazing overhang of Fed member reserves that are just sitting there. If (I mean, when) prices begin to increase faster than the Fed wants, its curative actions will take some time to have any impact, even by its standards of the last twenty years, because of the $1,4T in excess member reserves just sitting there. The Fed is going to show itself as unprepared, intellectually ignorant, and ineffective. It will not be pretty. They do have one amazing, strong, successful capability: they blame everyone besides themselves. Ultimately, as has happened every time things have not gone well in the last century, it will be capitalism that will be blamed.

As I have often suggested, continue to watch your own situation. Be prepared for higher prices (these increases will not occur evenly, but in certain segments of your budget), and try to not be exposed to rising interest rates, i.e., don’t own bonds, have long-term fixed debt obligations if you can.

I don’t see this disruption from the Fed’s difficulty with interest rates as necessarily a step toward an economic depression. Government figures may show a recession (in the real sense, we haven’t left recession, not with our high unemployment).

My list for depression triggers is the Federal debt (higher interest rates could bring that issue to a boil), the default of one or more of the Eurozone countries (that situation could make the residential real estate mortgage meltdown of 2008 look modest), or the disruptions and craziness of the implosion of the China real estate market (who knows what kind of rioting, mayhem, crackdowns, and blaming of capitalism that could happen in that country).

Since the end of 2008 and that meltdown, the U.S. economy has kind of been drifting, not recovering, not being obviously self-destructive. That period couldn’t last for long. Since the powers-that-be weren’t willing to let the economy heal, our only real choice for the future will be difficulties. The possibilities range from painful to the worst depression in history. To some extent what will happen is in our hands. Let’s see if we can turn things back toward reason, freedom, and prosperity.

Uncle Ben Spoke, and a couple Economics Lessons

2011-06-04T10:42:00.000-07:00

Uncle Ben had a press conference a couple weeks ago – a first for a Fed Chairman. (Uncle Ben Bernanke, Chairman of the Federal Reserve Board.)

And didn’t really say anything. Transparent! Transparent = Nothing! Fits.

So, Ben said that inflation expectations are low and that core inflation is low and the Fed isn’t responsible for anything that might be bad and everything that the Fed is responsible for is good and coming along, perhaps slowly, but coming along. Notice that when he discusses his policies he refers to the models and intellectual justifications, not to the results and consequences, not to the facts of reality.

Bernanke’s history at the Fed has shown that he does not believe that any of the problems that the economy has experienced are the result of the Fed’s policies. The Fed does the right thing and somehow, some other source of economic action causes things to go wrong. The Fed, Bernanke, is always right. He knows that he is right. He doesn’t know why things go bad.

More fundamentally, no result could cause Bernanke to question his beliefs. He is not reality oriented. He also hasn’t seen anything bad that was coming. In 2004, 2005, 2006, and 2007 he kept saying that everything was just fine. Then, in 2008, he said things weren’t doing so badly. Then, in 2009, he said that his actions had saved us all.

He does have the power, by being the Federal Reserve Board Chairman, to manipulate the economy. And he is intent on doing so. We are at his mercy, at the mercy of his mistaken views, at the mercy of his lack of contact with reality. We, the American people and the world, will continue to suffer.

But here is where I get very upset with the people who are criticizing him, those who post blogs and comments, etc. I include many Objectivists. The only thing they apparently see is inflation. Apparently, if commodity, food, and oil prices weren’t rising, they would have no problem with Bernanke. Well, they would probably howl that Bernanke’s policies would lead to inflation, but it would always be inflation, inflation, inflation. One note Johnnys.

It is certainly the case that the Fed’s only purview is monetary policy, i.e., pumping money. But controlling the money supply has other consequences, and to ignore those consequences is to leave Bernanke and his fellow government manipulators a free area of activity, damaging activity, deadly activity, immoral activity.

For example, one of the actions of the Fed is aimed at keeping interest rates low (the activity they have some direct control over, as opposed to the money supply, which is controlled indirectly) completely distorts a basic, key price in the economy. Interest rates are important in an economy and impact many decisions and other prices. People are just not able to make rational decisions in such an environment. I mean, since rationality consists of observing reality and acting accordingly, without basic, accurate information about the economic situation, rational decision-making is not possible.

I know that some argue that businessmen are smart and know that the interest rates do not reflect reality and adjust their thinking. I am sure that they do. But how much do they adjust? What can they think is the reality of the situation? I mean, without the facts, the businessman is only guessing. It might be a smart, experienced, wise guess. But it is still a guess, not knowledge. As a guess, it could still be way off. It could still be damaging. Further, since it has been literally decades since a market for capital has existed, any guess cannot be based on any actual market experience. A businessman’s wisdom is not an argument that changes the significance or the damage done by the manipulation of interest rates by the Fed.

The impact of the Fed is much wider than real or potential rising prices. People need to stop thinking that inflation is the only or even the major issue in every situation.

By the way, I was looking at copper and corn, two of the “commodities” that people are referring to when they say that “commodity” prices are rising. It may not be significant (you can’t really tell until sometime later), but both have backed off their recent high prices. I don’t know why yet, that is, I don’t know if it is a lowering of demand or if new production has come into the market, but if this trend continues, or if they just don’t keep going up, the contention that the Fed causes every bad economic consequence in the world will be even more questionable. Then the problem of being unscientific, i.e., not looking for causes, will have bigger consequences because it will make all criticism of the Fed look unsupported.

There is another error in the thinking of many about the economy. It is thinking that by knowing at least some of the consequences of the actions of government in the economy that one knows something about economics. Recently I have seen people dismiss comments I have made merely because I didn’t attribute what they viewed as negative economic consequences to a government. It is as if the only economic actor who has any efficacy is the government. Certainly, they conclude, that if anything happens that they don’t like it must be the fault of the government. There are several fallacies involved in such thinking, e.g., affirming the consequence, but the most basic fallacy is just not having taken the effort to learning the subject.

As a reader of Ayn Rand, we have learned that one must use one’s own judgment. This is important for many different, fundamental reasons, including moral ones. There is, however, an important context: a judgment without knowledge is not rational. That is, in order to decide, judge, conclude, make any kind of rational decision, one has to have knowledge of reality. Making a statement, declaring a judgment about an economic subject means you have to know economics, the fundamentals, and not marginally.

The fundamentals of economics involve the actions of individuals, people, acting as producers and consumers. It involves markets, prices, costs, production, and making economic choices. The actions of government overlay the reality of production and consumption. The actions of government affect what people do, the prices resulting from market actions, what people ultimately produce and consume. But the governmental actions are not fundamental to an economy, or its study. The fundamentals are the reason for the existence of markets, prices, and the creation of wealth. People acting for their own benefit are efficacious. Government action only corrupts.

It is often next to impossible to foretell what the results of government action is going to be because of the complexity of an economy, of the large number of actors, of differing interests and motives. In that government action is intended to get people to act differently than they would normally, the results cannot be good. But to identify and understand those results, you have to include the primary market participants. To ignore them is to drop the context. The primary actors are the individuals.

Japan, Disasters Natural and Economic

2011-05-20T14:19:00.000-07:00

Let’s start, not with economics, but with the scare of the century: nuclear energy.

Japan has now demonstrated that it is no more advanced or science savvy than any other country in the world. Its politicians are picking up on the irrational fears of a portion of the population and have begun pushing the country toward energy policies that will not only take them away from the safest and (if allowed to be) cheapest energy source, but will lead the country toward bankruptcy much faster than their current pace.

One thing that really astounds me, angers me, too, is that the media and popular frenzy over the problems at the Fukushima Daiichi power plant has apparently overshadowed the real, desperate plight of hundreds of thousands of their fellow citizens.

Further there is such a disparity between the real and, at best (worst?), potential danger. Where is the disaster? Think of it, all of the deaths and missing from the earthquake and tsunami versus all of the deaths and missing from the nuclear accident. Wait, what deaths? What missing. So the actually dead and missing from the actual disaster have been shuffled aside because of uneducated, poorly founded, hysterical fear of a potential. (At this time three employees of the electric company have died, two from the tsunami. I have not seen a report as to the cause of the third death.) Even the property damages are not comparable. The tsunami destroyed, obliterated, thousands of homes, businesses, and all of the infrastructure for over five hundred thousand people. Around the power plant, all of the homes and belongings are there, and, at this point, there has been no scientific suggestion that the contamination from radiation that there might be is anything but short lived. Some of the radioactive material that has been mentioned has a half-life of a few months and much of the material that has reached the ground around the plant will be washed away. Of course, we will not know the actual damage until the problems at the power plant have been solved. But that is what is missing here, knowledge. We have hysteria, not thought.

Granted, one has to recognize that Japan, alone among nations, has some reason to feel more concern about radiation. It has its own history. I do not want to belittle or underestimate the personal feeling many Japanese may and do feel. But I think that the Japanese who are voicing their fears and declaring nuclear energy to be evil have not given their personal connection to radiation proper respect, either. Rationally, you would expect someone to do research and learn about the reality that concerned them. Knowledge is the first and best way to deal with a subject, especially one that has such a scientific foundation. But, no, there is no evidence that the protestors or whimpering, crying “victims” have made any attempt to gain knowledge. They expend all of their energy beseeching the government to protect them and make Japan nuclear free. Instead of knowledge they went for dumb and are unquestioningly giving more power to the politicians, who go for dumb by definition (by choice).

Also ignored is the fact of the unprecedented size of the earthquake and tsunami. The earthquake is one of the largest man has experienced. There hasn’t been an earthquake to rival the recent one for over a thousand years in Japan. The tsunami was equally out of the ordinary. The preparations at the Fukushima Daiichi Power Plant protected it from a wave three houses high. What it got was one four houses high. One wonders that if the planners had proposed protection from such a massive tsunami, and insisted on funding the required cost, would the government regulators in Japan have allowed such an expense. The entire controlled planning process is ignored.

We see the same type of reaction from hysteria and ideology in California. People are shown on TV trooping down the beech near a nuclear power plant, claiming that if there were to be a big earthquake there, the power plant would suffer the same fate as the one in Japan. Yet, if you were to discover that the power plant has been built with a 8.5 magnitude earthquake and not a 9.0, you would still have to wonder about the protestors. If such a disastrous earthquake occurred along the California coast, the fatalities and missing from the earthquake and tsunami would be enormous. Where is their concern about the actual event? The fact that they are ignoring the obvious real, immediate consequences and worrying about what would be a mere potential, a maybe, indicates that they really aren’t concerned at all, but are engaging in thinly veiled ideological attacks on nuclear power, technology as part of the industrialized world, and capitalism.

At least those people in California can be ignored, since they would be swept out to sea by the tsunami never to be heard from again. They wouldn’t have to worry about potential radiation. But, in Japan, it is disheartening to see such ignorance paraded in a country that was so proud of their educational system and their recognition of technology as an important foundation to their prosperity and liberty. It indicates that the attack on the mind epitomized and lead ay Immanuel Kant has spread far and wide. His influence is not merely a Western phenomenon. When someone says that Western culture is spreading we know now that the spread includes the entire package. (I do realize that the historical culture in Japan isn’t particularly supportive of independent thought and learning. So the Japanese are being intellectually undercut by both influences.)

We can also see the spectacle of supposedly modern Western countries banning Japanese products without regard to the actual area of potential radiation. Apparently the Europeans do not have maps of Japan or have a clue as to its size. It is certain that there is little regard for science or reasoning in Europe, only the appearance of the authorities “protecting” the public. And by protecting, we mean stopping international trade and prohibiting free, voluntary exchange of goods and services. In the name of safety, we get lowering standards of living and a more rapid move toward poverty.

In the face of the reaction of Western Europe, one can hardly criticize a backwards country like Russia or even other Asian countries for similar hysteria.

Back to Japan, look at what is happening economically because of the earthquake and its consequences. Before the March 11 earthquake, the Japanese government was talking about finding new sources of revenue to cover the growing needs of the elderly and retired. They knew that the current arrangement, and the debt they expected to require would not be sustainable. They were headed for major difficulties. Now, with a small, but significant part of the country almost completely destroyed and over a hundred thousand evacuees living in shelters with their lives completely disrupted, not to mention the businesses of all kinds that no longer exist, plus the other consequences of the disaster, the Japanese government is being asked, demanded, to do much more. The government is being asked to backstop the damages that the utility company that owns the Fukushima Daiichi power plant in paying damages to the people and companies forced to evacuate from the area immediately around the power plant. (One hopes that there were actual dangers involved and not government hysteria.) The government is intent upon cleaning up the areas destroyed by the tsunami, building temporary housing, and, no doubt taking care of the survivors for some time. Communities across Japan are asking that their nuclear power plants be closed, and that the national government provide compensation for the resulting economic cost. The list of new demands on the Japanese government just keeps growing without any regard for reality.

The government is now asking for a supplemental budget from the Diet to cover their initial expenditures. At the same time, the current government is getting a lot of criticism. It appears that the governmental leaders haven’t spent enough or made sufficient promises.

The Japanese government just released figures that show their economy going into recession earlier this year (meaning output is falling). They expect the decline to continue throughout most of the year. So, the government is spending more, borrowing more, receiving less in taxes (or taking a greater percentage of the national and personal income in new, higher taxes) in a declining economy. They think that the governmental expenditure will help turn the economy around. They have not noticed that governmental expenditures haven’t help much over the last twenty years. No one there actually looks at the results of what the government does. They just make demands.

Japan is the world’s third largest economy. On a per capita basis, it is also a prosperous one (national figures don’t mean much, really). That it is in decline means a great deal internationally. It will hurt the Asian economy. It will hurt everyone. We are seeing again how the world economy, world production, is interconnected.

But one thing that you won’t see internationally from Japan is a government credit default. The problems we see in Europe won’t happen in Japan. Greece, Ireland, Spain, and the others have sold their debt, government debt, to a great extent to non-citizens, mostly foreign banking institutions. If Greece were to default on its debt, the problem would be felt in other countries, and we would have an international banking crisis, as we have had in the recent past.

Almost all of the Japanese debt is owned by its citizens, not by its banks (although I am sure that some is), but by individuals. Much is owned by the elderly. No wonder the elderly are dependent upon the government. They invested heavily in government bonds (the Japanese were, are, great savers) and the government has been repaying them by keeping the interest rate very low, about 1.25%! Japan doesn’t have a lot of price inflation, but it isn’t a cheap place to live. Getting 1.25% on your investment has got to make life very difficult.

When the Japanese government gets into trouble, because of all of the obligations it has, the people who will suffer will be its own citizens. The government will not be able to support them, pay their medical bills, or pay them the interest or principle on their savings. It is going to be a very great tragedy. The March 11 earthquake and tsunami will be relegated to secondary importance (Of course, a nuclear accident, with no deaths from radiation, will always be bigger than any other event. Just ask about Three Mile Island!)

When the U.S. gets to the point where its debt is so large that it can no longer support it, we will go more like Greece, and take the world with us.

The Downturn in Commodity Prices

2011-05-16T12:20:00.000-07:00

So here is an opportunity for a lesson in observing the economy. In the last few days some commodity prices that have risen significantly in the last couple years, including oil prices, have backed off their highs. I have seen several articles claiming that this price drop proves that the Fed and other inflationary forces are not to blame for the price rises.

Now anyone who has read this blog may remember that I am not convinced that the the Fed's activities the primary cause of the rise in oil and other commodities’ prices. I see real, actual economic causes at work. But I can not allow my analysis to then infer that recent lowering of those prices proves me right, or proves anything particularly at all. Short-term changes in prices offer little evidence of anything.

Frankly, I think that looking at short-term events is an indication of a lack of thought. It is a knee-jerk reaction. It is a sign that the source has little understanding of actual economic processes and is instead seeking to support his own predetermined ideological position.

Of course, the recent downturn could become something more than short-term, meaning that it is too early to tell if the drop in prices means anything. If the declines continue, then we have something to consider.

Suppose the drop in prices becomes a trend. We would need to ask why the drop is taking place. The first thing to do is to look at production. If production has increased, then we can regard that as a significant element of the price drop. As government actions, especially money creation, haven’t changed much, changes in production would be the major factor.

If there has been no change in either production or government activity, then we are faced with a weakness in the actual demand for the product. That is, economic activity is lessoning, and we may be seeing the first steps toward a downturn in the world economy.

What changes in commodity prices, prices that are more responsive to market changes than most, means depends upon the details. We should never accept knee-jerk reactions that look solely toward the government.

A China Update

2011-05-05T14:22:00.000-07:00

The Chinese government is rightly concerned with the rising level of prices within their economy. (Some here blame China’s problems on our own Federal Reserve System. While the economic actions of our governmental bodies certainly add to the economic problems in the world outside our own borders, we should not underestimate the ability of nearly all other governments to make decisions as bad or worse. China’s problems are mostly of their own making.) China has certainly been creating new made-up money with gusto. And don’t forget that the banking sector in China consists of (at least mostly) banks owned and controlled by the government. The Chinese equivalent of the Fed is aware that domestic prices are rising faster than is good for the economy (as if any consumer price inflation is good for anyone). They are now trying to slow the price rises and not bring their real growth to an end. It is going to be difficult, especially since they are using the same tactics that the Fed would use in the U.S.

To slow things down the Chinese government has been trying to reduce the growth in bank lending. They are not only using interest rates but are also trying to take cash out of the system. Their problem is that there is just too much cash running around. They will have to tighten up a bunch more to have sufficient impact, and that might, probably, increase interest rates sufficiently to reduce growth. When interest rates start up, they will then begin attracting money from other sources, which will not help their situation. That attraction will mean that other borrowers will have to compete and raise interest rates, maybe the U.S. will, also. Most countries are deathly afraid of rising interest rates. Higher rates are associated with slowing growth. This is just the opposite from actual economics. In a free economy, higher interest rates would signal that there was significant demand for capital. Higher interest rates would attract more savings and the rates would tend to do down. In this world controlled by central bankers and based upon fantasy economics, the supply of funds to loan is controlled by governments, and the supply is unlimited (and worthless, ultimately). Higher rates means that the governments are trying to slow the rise of prices and the fears of “overheated” economies, read worsening price inflation.

China’s problems are worse, however. According to one report, the real estate price boom has been raging. It said that prices for condos in the big cities has risen by over 50% in the last two years. 50%!!! One city has passed a law restricting the people who may buy these properties: not people from out of town nor speculators (plus a few other types). Real estate in China has reached the extremes of a boom market. It will reach a point, and I would think soon, that the last buyer will have bought (this is even more likely since many potential buyers are forbidden to purchase!). When that last buyer buys, the market will begin to fall, just like it did in the U.S. a few years ago. The fall will wipe out a lot of apparent value (paper profits) and will have significant, adverse consequences for the fake Chinese banking sector (fake because the banks are hardly real, independent actual banks). It will be interesting to see what happens. It certainly will be difficult for any company doing business in China. It will be difficult for Asia, coming on top of the Japanese losses due to its natural disaster (natural vs. man-made in China). It will be difficult for the BRICS, as tied together as they are. It will be difficult for Europe and North America, as dependent as we are for Chinese products. Maybe China will realize that a currency valued openly has some merit?

Whatever the actual results, what matters is how people understand the causes of the Chinese mess. More than likely, many people will point to the apparent greater amount of freedom the Chinese have had, i.e., the more their economy appeared to be capitalistic. They will ignore the degree of control the Chinese government continued to have, especially within the banking sector. Some may point to the currency controls the Chinese had, but many will also blame the Fed (not that it is bad to heap blame on the Fed – just be accurate). It is important that the proper cause be identified. We are the only ones who can do it.

A Real Warning

2011-04-28T10:49:00.000-07:00

Many people have been saying that the U.S. government debt level is too high. Even people that the government sometimes listens to, such as Helicopter Ben (Bernanke), although he doesn’t really make a good case and is a horrible example. But they have been ignored. Certainly, policy makers and legislators have ignored anyone who starts off with an appeal to reality. The only real voice that the government types will listen to are those who can sway the voters. That is the politician’s only “reality”, the voters, i.e., those people who keep the politician in office, in power. If the voter can remain blind to the real situation, today’s politician doesn’t care.

Or at least that was what many of us were thinking. But we forgot some actors on the national scene who can upset the politician’s applecart. There are people connected with the bond markets who can shake up things in Washington, by shaking up their spending source. One of the underlying premises of the “plans” being proposed by both the Dems and the Repubs is that interest rates stay low. It has been so long since the interest rate on government debt was above 5% that I am sure that most of those people have forgotten that rates can actually rise that high. But they can, and dimly, the politicians remember that somehow it isn’t good for them if interest rates do rise.

One set of actors with a voice that can influence markets are the companies that evaluate the credit worthiness of debt. Events in the last few years have led some to regard the credit evaluators as less than useful. Standard & Poor (S&P) and the others did a very poor job, almost to the point of committing fraud, in evaluating the mortgage-backed securities. They tended to let their cozy connections with the government and outfits like Fanny Mae cloud their professional judgment. As with the bankers, I am sure that there were significant elements in the management of those businesses who were appalled at what their company had done. I suspect, as with the bankers, that they are attempting to regain their self-regard as professionals. Today, when they see a spade they intent to call it a spade, errr, bad debt is bad debt, even when the debt is that of the U.S. government.

So, S&P says that they have judged that the credit worthiness of U.S. government debt is deteriorating (surprise) and the people in charge (and the opposition Republicans) aren’t going to do anything about it. So they, S&P, spoke up. Washington, on the other hand, firmly believes both that the real world does not pertain to their activities, so they are merrily playing S&P’s announcement to suit their own political agendas, and that no good deed goes unpunished. I’m sure that the Dems are plotting revenge on S&P. The only people who really paid any attention (as far as we can see at this point) were those who already thought that things were out of control. The Dow lost some ground for a day, but has since hit new highs in the current market. It will be interesting to see if S&P sticks to their guns and lowers the rating for U.S. government debt in the future.

Then, a day or two later, the IMF (International Monetary Fund), of all people, popped up and declared that Washington has no credible plan to return to fiscal rationality (my paraphrase). (Note that the IMF would be happy if the debt was just not increasing so fast. Its standards for “rationality” are somewhat low.) I’m not sure if the IMF is talking from a principled conclusion or just using the opportunity to take a potshot at Washington. Either way, their observation happens to be true. Neither the Dems nor the Repubs have any clue how to deal with the situation. It should not be a surprise that they have no creditable plan. It is a surprise that someone mentioned it out loud.

Then there is the poll released this week that shows the American public doesn’t want to give up their entitlements. Whatever solution there might be to the debt, the American public is apparently saying, they don’t want to give up what is causing the problem. And here we have the fundamental problem. They think they have a choice. The American public is just as confused and deluded as the Greeks, the Irish, and the populations of the other Western mixed economies. They all think that they have a choice as to having their wonderful “safety nets” or “social programs” and the altruistic, state controlled economies. They don’t. No choice. Reality is coming and it is all going to fall down and go BOOM.

Certainly the leaders and even some of the followers of the movement supporting the funding of the entitlements are doing so because they are sworn to altruism without regard to the consequences. It will be reality they curse when their programs fail. But there are many, perhaps a majority, of the supporters of entitlements in America, whose support is founded on altruism (in some form), but who do not want the country to self-destruct. Our way out of this mess is to bring the reality of the situation to these people. We must remove their delusions and confusions.

Actually, it is easier than you might think. We don’t have to provide some argument founded on what might appear as a convoluted, discarded economics, i.e., capitalism. We can merely point to the coming tsunami of retiring baby boomers and the catastrophe of funding Medicare and Social Security. We can’t really fund them now. It shouldn’t be hard to communicate the rest, the whys and the alternatives.

What really bothers me is that from what I can see, few of my fellow Objectivists seem to have figured all of this out. There was tremendous energy during the days of the ObamaCare fight. But, the coming depression seems to be as insignificant and unreal to them as it is to most of the country. Really people, if we don’t get something done on this in the next few years, the depression will be unavoidable. And it will be a depression that will make the 1930’s look like a picnic. The consequences for capitalism and freedom will be catastrophic.

MAKING CLAIMS ABOUT THE MONEY SUPPLY

2011-03-12T16:31:00.000-08:00

The concept of the money supply is central to understanding events and prospects in modern, mixed economies. What the money supply is doing, and what the manipulators of the money supply are doing, are key indicators of immediate and intermediate economic events. In my blog, I refer to the money supply often. Analysts and writers who are influenced by the Austrian school of economics, and here, as always, I am referring to von Mises and his predecessors, will refer to the money supply in understanding business cycles in modern, mixed economies. So, how do we know what is happening with the money supply?

From the U.S. government we have several measurements of the money supply, called M1, M2, and M3 (no longer published). There is also MZM, my preference generally. There are also indicators such as the balance of payments, for indications of the outflow of money. Another important tool to keep in mind is the changing level of bank loans. The past two asset price inflation events have both been created by bank loans. Finally, there are some private measurements available at various websites.

As with any measurement, it is absolutely necessary to clearly understand what is being measured, how, and how those measured elements relate to your conceptual framework. You must also know how the measurement in question performed in the past, i.e., what the results meant and how the economy performed.

All too often, what I see when reading other authors is that they have chosen tools that reinforce their own expectations. They ignore other tools that currently are pointing in other directions. That is especially true of the people who are expecting hyperinflation in today’s world. I certainly sympathize with the hyperinflationists. There is reason to be concerned, from what I can see. But I do not accept their knee jerk approach.

My approach is to look at all of the indicators that I have identified and try to make sense of them and what is happening in the economy.

One indicator can also be the interest rate set by the Federal Reserve Board. One influential online group recently used the argument that since the Fed had set the Reserve rate at zero, there had been billions of dollars created. In other words, it was automatic. If the interest rate is set well below a market rate, then money will be created. This same reasoning occurs when the Fed creates reserves. For example, in 2008, the Fed created nearly $1T in member bank reserves. People immediately said that the Fed had created billions of dollars in the economy. But, there is a difference here. Lowering the interest rate and creating reserves are not the same as actually printing money. Printing money and shoving it into people’s hands through government handouts or expenditures or payrolls put money into circulation immediately. That money is in play.

But the actions of the Fed are different. The Fed can create reserves and lower interest rates, but the Fed depends upon the banks and businesses to actually put the money into play. If the banks do not lend (which requires a borrower) then nothing happens. That is what we have seen over the last two years. The Fed has tried to put more money into play, but the banks have not cooperated. The Fed’s influence is not automatic. The claim that low interest rates have created massive amounts of money is not substantiated by the level of bank loans and other indicators, e.g., MZM. It is important to objectively understand how this stuff works.

I saw an argument that claimed that it is wrong to argue if the money supply has expanded or not. According to this person, looking at the facts was not thinking in principles. Instead, he said that we should state that the Fed is, “The reality is that money has been created out of nothing and it therefore will alter behavior (otherwise why do it?). … that this money has created price increases in several sectors, commodities and oil among them, despite the ‘we haven't really increased the money supply’ theory.” Somehow, for this person, thinking in principles does not include relating one’s ideas to the real world nor having a sound, fact based argument for our position. We merely sate that the government has made money that raised prices without being able to even demonstrate it, not to mention, prove it. It does not include looking at the present, specific situation and making sense of it or presenting your position in the context of the crisis we actually face. I do not know how this person thinks that we can be convincing or persuasive.

Some will then point out that the Fed has recently been buying Treasuries from the Government directly, thus putting newly made money directly into the economy. That is true. That step leads directly to expanding the money supply and to affects in the economy, generally, to increases in consumer prices. However, given the size of the economy vs. the amount of purchases the Fed has made, the effect is not particularly significant. We would have to see closer to $1T of Fed direct purchases from the Treasury for the Fed to trigger consumer price rises.

Potentially more significant would be the return of sizable amounts of the dollars held overseas via Treasury Bond purchases. With a $1.7T deficit, if $1T was financed from overseas, we would see a mammoth flooding of dollars flooding our markets. This returning money, often as much as $500B in the past few years, has been a source of some of our price inflation. Higher amounts would put more pressure on prices.

Yet another recent argument that I have seen implies that in today’s world, real market forces (as opposed to governmental influences) have no impact on prices. The field of play, this person held, is controlled completely by governments. Again, there was no attempt to demonstrate how this is so. The position was presented as necessarily following from the fact that governments act and have bad influences, there were bad events happening (the raising of oil prices), therefore, it was completely because of government intervention. No facts about the current situation were necessary.

Thus, it is important to look at the various moving parts of the make up of the money supply and their impact. Then, it is imperative that your understanding relates these different measuring tools to the real world in an objective manner. For example, look at M2 http://research.stlouisfed.org/fred2/series/M2?cid=29 , the simple view would be that inflation is rampant and that prices should be going through the roof. But have they? I just saw an observer on PJTV who kept track of his expenditures of a few items over the last year. His personal stats did show across the board significant price increases. What is your experience? Mine has been that there has been little change for some time, with some bigger increases just recently. Even if prices are going up, does that mean that the hyperinflationists are correct in saying that general, average price increases of 20% or more (hyperinflation) are beginning soon? That is a big jump.

Some argue that because certain prices went up, there is inflation. Most recently, these are the prices of gold, oil, and food commodities. But prices go up and down for various reasons. That is especially true in a “mixed economy”, where government actions have hidden, unforeseen, and often weird, effects. You have to be careful when attributing reasons for price movements, which means actually finding a cause and effect. For example, the decades old efforts by governments around the world to control oil discovery and production in many different ways means that there are restrictions on production and supply. The result is an artificial shortage of oil. Supply shortages would mean higher prices, given level demand. In our situation today, and for the last several years, demand is actually growing. So you have three different factors pushing the price of oil upward, including whatever inflationary pressure there might be. But the price would be going up anyway. When discussing the price of oil, you cannot objectively leave out the supply restrictions and all of the reasons for increases in demand.

Turning back to the analysis of the money supply, my overall point is that many things are happening within an economy that will affect whatever actions governments take to manipulate the money supply. How it plays out and what the ultimate effect will be depends upon those factors. To accurately explain events, you need to have identified the actual causal connections and explained other details that may seem to be contrary to your conclusion. A site or writer who ignores those contrary elements only means that they are pushing their pet theory without actually relating it fully to reality. Economics is a difficult science, but it is a science. Economics is about the real world, and one’s standard of truth must be consistency with reality.

The Fraud of Waste and Fraud

2011-03-10T12:08:00.000-08:00

“There are widespread misperceptions about the state of the federal budget. A majority of voters incorrectly believes the federal government spends more on defense/foreign aid than it does on Medicare and Social Security (63%). Also, a similar majority (60%) incorrectly believes problems with the federal budget can be fixed by just eliminating waste, fraud and abuse.”

This quotation is from a recent poll. Read the top of the second page.

There we are. People are believing the politicians, especially the liberals. People are not connecting any legitimate idea of waste to a $1.7T deficit. There is a disconnect. This disconnect is going to get us into bigger trouble than any of the other fears that we have considered. This disconnect means that when the meltdown into depression begins people will again be open to the claim that capitalism is at fault. Potentially, our only safeguard will be that the meltdown will be bigger than the last one and the authorities will not be any more prepared than they were last time. They will not have an organized, planned capability to meet the various challenges that a meltdown in a complex civilization like ours will create.

Please allow me to offer my small support to Yaron Brook. He is absolutely right that the immediate present is the best time we have ever seen to make our point, that capitalism, freedom, egoism, and reason are the correct path to take. We may not have another chance.

It is sometimes a bad sign when someone suggests that their own particular area of interest is the most important. I don’t wish to suggest that other areas, say, health care or the war on terror, are minor or less scary. I merely want to say that if we don’t focus on the debt and the deficit and get that turned around, we won’t have the time or energy to spend on other things. A depression in the U.S. will be very bad because we have so far to fall and we depend upon very complex and highly sophisticated economic interrelationships. Just look at the problems we begin to face when the price of gas goes up some. Think of the problems we might have if the supply of gas is greatly reduced. Just think of the process of getting food into our cities, not to mention medications.

Let me suggest another way of looking at your activities. It seems to me that there are several ways of deciding what to focus on. One, which I would normally think is the best, is to focus on what interests you the most. If your interest, for whatever reason, is running a business, for example, it would be appropriate for you to spend your time and energy to free up business practices.

But, consider this, if there is a tidal wave coming at your shoreline residence, you are risking you life by arguing about business regulation. The deficit and debt issues facing us today and the next few years are the economic equivalent of a tidal wave. It will sweep everything before it. We need to either stop the tidal wave or protect ourselves from it as best we can. Look at what is happening in economies much less developed than our own that are having to face up to their debt. What is bad for them will be worse for us.

On the “Front Page” on JPTV, Yaron Brook and his friends try to emphasize that what is happening with our debt is not just another big deficit, like we have seen in the past. The ObamaDeficit is larger by several orders of magnitude, and projected to become bigger. That is bad enough, until you remember that Obama’s predictions are based upon rosy estimates of the economy. It is a tidal wave.

So what do we need to do? There are two avenues to pursue to achieve a solution to this problem. As with any question of budgeting, there is income and there is spending. Most addressing this issue are focusing on spending, especially the entitlement programs. I don’t want to imply that cutting spending isn’t important, it is. Certainly, much of what Obama has added to the budget can be safely discarded (like his medical programs).

Attacking the entitlement programs is a problem. It isn’t that people, especially younger people, aren’t able to accept cuts in entitlement programs. But you do have to find a way to communicate that you don’t want to kill all the old folks. If we can get people to consider financial sanity, a way can be found to ramp down the entitlement programs with out creating a class of impoverished old people.

What I think would help the most is focusing on getting capitalism working, that is, remove the restrictions and regulations. Kill the mixed economy. A few years ago we went through a phase of semi, sort of, half-assed deregulation. There was actually significant results from just the minor changes we saw. If we can begin building on the importance of letting people have the freedom to act, we can “grow” our way out of our mess. I think that the central driving force of our efforts needs to be: make America capitalistic! In this case, focusing on business regulation will help divert the tidal wave.

Instead of going off in many directions, let’s focus our energy and thought on pushing capitalism and the truth about the nature and impact of the Federal debt.

The Debt and the Republicans

2011-02-24T13:19:00.000-08:00

I saw an announcement from the Obama Administration that the Federal Deficit for 2011 would be $1.7T. This morning I see big headlines about a momentous fight in the House over cutting $60B from the next budget. The article called it a massacre and suggested that it was the biggest cut in history! This is absolutely part of the big lie, from all concerned. The Republicans, and everyone else, know that $60B in one years budget is a rounding error. It is meaningless. The American public is being sold another big lie.

Also, historically in these things, these really aren’t cuts, but a reduction in the new spending levels. In other words, making up an example, if the spending on these areas last year was, say, $600B, and the new level is $700B, the actual level, after the great cuts by the Republicans, would be $640B, or still an increase of 6.67%. In typical fashion, the news article does not make it clear what has been “cut”.

What are we to make of BO’s announcement that the deficit will be $1.7? HA! As I noted in my recent post on the debt, last years deficit was announced as $1.7, but in fact the increased debt on the Treasury’s balance sheet was $3.3T. So, two things: First, it is unlikely that the deficit will only be $1/7T. The government will overspend and under collect. Employment will not improve as predicted and Social Security and Medicare will require more cash from the budget. Interest rates will also probably be higher than predicted. The deficit will be much wider than his public statement. Second, the “off the budget” obligations will further balloon the actual debt, which, after all, in reality, is what will soak up any real savings the public accumulates. In spite of all the posturing and back patting, the Republicans will have done nothing to keep us out of a depression. Who will tell them?

Treasury Grab of Retirment Assets: So Far

2011-02-22T12:55:00.000-08:00

As far as I can find, there has been no public comment or action from the government regarding this issue since the hearings last September. The IRS, in its December annual statement about planned new regulations, etc., included annuities and pension plans in its list, without any indication as to what it has in mind.

The news reports about the combined Treasury and Labor Departments’ hearings last September do not mention any discussion regarding the fears that I and others have voiced. Our fears is that the Federal government will soon try to take some action that will force Americans to place our retirement savings in U.S. Treasury Bonds. The government need not take our savings, just control where we put it. Putting our savings into Treasuries will reduce our potential retirement income flow, remove more money from the productive economy, and further destroy our freedom of action. If, as I expect, interest rates on Treasuries begins to climb, the size of our investment portfolios will shrink.

There were two sets of themes in the testimony during the hearings. Those who are self-styled experts on retirement focused on what they perceive as the failure of American’s to properly prepare for retirement. They are concerned that people will not make good choices about their savings after retirement and that retirees will run out of money. They regard a guaranteed lifetime income option as vital. I doubt that these people were confronted with the question of forcing the poor, misguided Americans to place their savings in lifetime income vehicles. That is really the question. Somehow, the thinking seems to be, just having the option will be the solution. Later, the experts will discover that the option isn’t being used, at least sufficiently, and the experts will cry that further measures need to be taken to take care of us.

The other theme was the concern of industry representatives, almost entirely members of the insurance industry. Beginning in the mid-90s, critics of the insurance industry, including many regulators, have attacked the industry for putting annuities within pension plans and IRAs. In the critics’ view, pension plans and IRA’s provide tax deferral, which annuities also provide. The criticism was that there were cheaper investment vehicles than annuities to put into a 401(k) or Simple Plan. Critics, such as Susie Orman and the industry regulators, claimed that the only reason annuities were sold were much higher commissions and profits. These complaints ignored the actual commission rates of the majority of mainstream insurance companies (as well as other issues). These critics also tended to ignore features of annuities that weren’t provided by other investment vehicles, such as the lifetime-income feature and the insurance element.

The comments of the insurance representatives at the Treasury and Labor Departments’ hearings was that these criticisms had to be addressed. Their companies would not participate if they were exposing themselves to legal harassment, even if the harassment was ultimately baseless. I expect that the criticisms of annuities by regulators is the primary reason why annuities aren’t available in 401(k) plans now. It is also possible that the government will use the intent of private insurance companies to profit from their business as a justification for creating a government annuity, thus fulfilling the fear that all of this is just a ploy to force retirement plan money into funding the U.S. government.

I saw no mention of any consideration of what kind of annuity that should be offered, e.g., fixed (like a bank CD) or variable (which allows investments in stocks and bonds with in the annuity). If the intent is to put more money into Treasury Bonds, variable annuities would not be allowed. Nor did I see any mention of the interest rates that would be paid on a fixed annuity. With the Federal Reserve Board forcing interest rates to be very low for long periods of time, the income available to an annuity holder would be very small. For someone who lived a long time, an income resulting from a low interest rate would suffer financially, especially if there were any level of inflation, even 1%. Fixed annuities only make sense in a gold standard, where even a low rate of interest would provide a growing standard of living.

We are now left waiting for Treasury and the Labor Departments to take the next step, if any. It may be that the next step would be to propose a law for Congress to consider. It is another shoe that we are waiting to hear from.

Debt and Depression: Our Present and Future

2011-02-10T13:27:00.000-08:00

In my last post I tried to be as clear as I could be regarding inflation in the U.S. To reprise: Inflation isn’t here now, even though some prices of important products in our economy are rising. We may get inflation, but don’t get excited about it until it happens (which doesn’t mean that we shouldn’t get excited and angry about actions taken by BO, the Treasury, the Congress, and the Fed that will lead to inflation).

My unhappiness with the inflation hawks is that their constant focus on inflation detracts from other issues. Inflation is not the only bad economic calamity that can afflict us. Right now the increasing level of debt being taken on by the Federal Government is a greater threat. As Yaron Brook has stated, the level of debt the U.S. Federal Government has taken on and will take on will likely result in an economic depression. The consequences will be no better than the results of the current recession or the 20C depression. Our economic and political leaders resist learning from experience. We will experience long-term suffering.

There are two recent bits of information that prompt me to write this post. First, I saw the news release that the Congressional Budget Office expects that Social Security, which is now running a deficit, will continue to do so. That is, Social Security will be a drain on the Federal Budget from now on. It was expected that Social Security would no longer produce a surplus for our Presidents and Congress to play with at some point but not for another few years. Because of the recession, and the very low levels of employment and consequently lower Social Security tax collections, deficits for that “entitlement” program began last year. Add to that the deficits in the Medicare system and you have reached the stage where the major entitlements are drawing on the general fund.

The other piece of information I learned was that the actual federal debt level is significantly higher than the figures that Washington bandies about. The figure they use is high enough, shamefully high, dangerously high. The reputed Treasury Debt, the amount authorized by law, which we will reach shortly, is $14.3T. When you add in bailouts, Fannie Mae, Freddie Mac, student loans and other “off-balance” sheet funding, it becomes $20.173T, which is 44.75% higher. Supposedly, the deficit for the last fiscal year was something like $1T, but when you look at the actual Treasury balance sheet, the obligations of the Treasury grew by $3.3T. In other words, our debt, which is threatening to put us into a severe depression, is growing faster than the politicians will admit. We look more like Greece than Germany.

Looking forward, we see that the spending programs that BO has pushed into law will continue to add piles of debt, that the growth of the numbers of Americans over 65 will require more and more spending (Medicare will be the biggest drain!), that the unfunded entitlement of retired federal workers pensions and medical benefits will add more demand on the federal budget, and there will be more disasters in the economy that the government will feel required to remedy by spending money it doesn’t have.

The damage that this debt exacts is two fold. First, it removes savings from the economy that could have gone to productive activities. We are being deprived of the possibility of improving our lives, or even maintaining our standard of living. When government officials admit that it could be years before employment reaches earlier levels, it is this drain on savings that is really the reason. Second, it will increase the amount of interest payments that the federal budget has to cover. Currently, and for the last few years, the Fed has done all it could to keep interest rates low, very low, often near zero. But the Fed is not omnipotent, although it seems to think that it is all knowing. As the U.S. Federal Government continues to need to sell more and more bonds to cover its obligations, the only way that it will be able to attract more savings will be to raise the interest rate it offers. Even the U.S. Government must compete for money on the market. Since the market is international, neither the Treasury nor the Fed can control the real interest rate that the market will demand. When interest rates go up, the drain and strain on the Federal Budget will be immense. The federal politicians and bureaucrats, who look no further than their own immediate whims and power, will be surprised, and will have no means of acting to counter (although some will want to push for higher levels of inflation, which will make things worse, of course). When interest rates go up, all of those who trusted the government and bought the Treasury Bonds that financed all of the spending, will see their beloved assets fall in (dollar) value. It will be a just reward.

Debt is the threat. Debt is the danger. And we are not focusing on it. We are allowing it to sneak up on us. Wake up and pay attention.

What to do? That is, what is the solution? First, what the politicians and bureaucrats propose isn’t a solution. We will be in worse shape with more laws, more regulations, more spending, and more made-up money by the Fed.

Many focus on the spending and suggest that we should stop spending on Social Security and Medicare, not to mention BO’s massive programs. While we will have to stop the spending, this battle is a very difficult one. Included in the resistance to this idea are all of those who are depending upon those programs. Part of the solution will have to be some way to avoid massive losses of older people.

I think that there are other things to do first. These steps aren’t easy either, in the political sense, but they don’t threaten to destroy people and the results will include the solution to our problems. What do we do? We free the economy. We get rid of regulations and government interference. We get rid of many government employees. I wrote about this before, so I won’t repeat myself. But the point is that with a productive economy, we can clean up the debt and find a way out of the obligations that the government has foolishly undertaken.

To achieve the goal of freeing up the economy to be productive we have to teach our fellow man the truth about capitalism, both its moral worth and its real success. That means we ourselves must know about it. Learn what capitalism is. Learn how it functions. Learn its history. Learn how the economy you live in works. We cannot teach what we do not know. I assume most of you have read and understood “Capitalism: The Unknown Ideal”. If you haven’t, read “The Capitalist Manifesto”. Read Hazlitt and Bastiat. Read the great Austrian economists, von Mises and his predecessors. Read “Meltdown” by Thomas Woods. Keep an eye on the debt, the money supply, and the prices you pay. Realize that there is no free market in the United States. None. Every market has elements of government controls and interference. Talk to your neighbor and the man in the street. Remind them that capitalism has been attacked and subverted for over a century in the U.S. Spread the word. Capitalism can save us. Only capitalism can save us. The others have tried and failed. Let’s return to our greatness.

INFLATION PRIMER

2011-01-28T13:27:00.000-08:00

More and more people are getting on the inflation and hyperinflation bandwagons lately. There may be reason to worry about inflation, several, in fact. But, for the most part, the reasons that are being offered for today’s bandwagon do not justify the conclusions that people are making.

My position is this: Real inflation is a major cause of economic disturbance and the destruction of economic value. Inflation needs to be eradicated from our lives and our political system. To remove inflation from our economy would require that we understand it at it’s root and have an accurate history of its influence. Instead, what these people tend to offer is just pointing at some prices that have risen that are special to us or in the news. Even when they mouth reference to the money supply, they do nothing to relate the money supply to the price increases they are seeing. They are just adding confusion. So, I am offering another post about inflation with a slightly different focus.

First, of course, rising prices is not inflation. Rising consumer prices may be a consequence of inflation, one of them, but it is only a consequence, not a cause, and it is the cause that we want to understand clearly. It is the cause that is the actual problem. It is the cause we need to eradicate from the economy.

The Austrians (and as further explained and expanded by Ayn Rand) are the ones who identified inflation accurately. Inflation is government manipulation, read expansion, of the money supply. When more money is pushed into the economy, prices, at least some prices, will rise. There are two important points.

First, prices cannot rise without there being more, new, made-up money. Without more money, some higher prices would just mean that fewer of those products could be sold. People would still have only so many dollars to spend. Higher prices for some goods means that the standard decisions people make as to what to buy and not buy must now account for a different price structure than before. Prices are always changing. All prices could not be rising at the same time without there being more money in circulation. Stuff would be left sitting on the shelves. Consequently, if some prices rise, other prices would have to drop, or production would have to be reduced. There are only so many dollars.

Some people try to avoid the basic physics of the issue by talking about the velocity of money, suggesting that if a unit of currency changes hands faster there is the opportunity for prices to rise without more money actually being created. No attempted explanation of inflation using the velocity of money that I have seen actually lays out how that is suppose to work. I can’t figure it out. Try it. The vast majority of people get paid on a regular rotation, i.e., weekly, biweekly, or semi-monthly. How do you fit a higher velocity into that arrangement? You can’t. Higher velocity is out.

Second, the Austrians determined that the entry point for new money makes a difference, meaning that new money does not effect the entire economy the same way, but ripples out from the point of entry. Over the past twenty plus years, the entry points for new money have been limited to just a few parts of the economy. It is easy to identify those connected directly to the Federal Budget because the prices of related items have been going up rapidly and consistently for all of those years. The list connected to Federal Government spending includes medical services and related products and higher education. Recently, Federal employee salaries can be added to that list.

Besides the budget, the other main entry point of new money is by way of the activities of the Federal Reserve System. I have gone into detail how that happens in this blog, so I am not going to restate it. The consequences of the Fed expansion of the money supply normally hit asset prices first. Stock prices and housing prices are pushed by the expansion of the money supply by the Fed – sound familiar? (Constant deficits in our Balance of Payments can also only be explained by the expansion of credit.)

Okay, so that is inflation, i.e., increases in the money supply. Well, take a look. Is the money supply expanding? Ahhhh, no. It isn’t. So where is this inflation?

What the people who are declaring that inflation is upon us are pointing to are certain, specific prices. Right now the major ones are oil, food, and commodities. Certainly, these prices are going up. But, is it inflation?

I would add another sector to the list of higher prices, the U.S. stock market, which has gone up a bunch in the last couple of years. Why has it gone up? The facts about the U.S. economy don’t support that kind of optimism. The actions of the U.S. government continue to make things worse. The market is being pulled along by a ton of money sitting around. It is the same thing that happened in the late-1990’s and mid-2000’s.

So what about the prices of oil, food, and commodities. Okay. Fact one. In any economy (where individuals can make decisions at least to some extent), in any situation, for all kinds of reasons, prices will be on the move. Some prices will go up, some will go down. We do see prices going down all of the time in our world. That is especially true of high tech stuff. Prices change because people’s preferences change. Demand changes. The supply changes because of new technology, new business structure, new sources, governmental action. There are a host of different reasons. You have to look at specific industries to understand the price movements. More than that, if it is inflation that is causing consumer prices to rise, the general trend would affect the entire economy, in a ripple effect. When the price rises are confined to specific sectors of the economy, it is necessary to look closely to determine what is happening. In is not proper to just declare that it is inflation. Looking closely at medical services, oil, and commodities results in very different conclusions for each sector. That is especially true when the best data available on the money supply (admittedly government data, but not sufficiently corrupt) show that the money supply is not expanding to speak of and credit has contracted.

I have already discussed the constant rise in the prices of medical services, which is a direct consequence of government spending. Let’s try oil. The price of oil is an international price. For its price rises to be a consequence of inflation, it would be necessary for there to be inflation of significant amounts in many countries. But, there are more obvious and immediate explanations as to why the price of oil has gone up, and may continue to rise. Two explanations, actually. First, as a result of the anti-industrial movement (which includes the ecology movement), the production of oil has been forcefully reduced nearly worldwide. In a few countries, the production is kept lower than those countries are capable of for the reason of attempting to influence the price (OPEC, of course). We all know that the supply of oil is less than a free market is capable of providing. Second, we have a couple large countries, very large countries, that have finally begun to open their economies up sufficiently that they have produced a modicum of wealth. These countries are now also buying oil in larger quantities than they have in the past. Just a little increase from these very large countries has a significant impact on the price of oil. So, we have a supply that is less than possible and a significant increase in demand, and, surprise, oil prices rise. Standard stuff. Inflation is not necessary to explain the price of oil. To the extent that there is inflation, the increase in the price of oil will be worse. If a specific country has inflation, its currency will tend to buy less internationally over time, and the price of oil in that country will rise faster.

The second half of the analysis of the oil price applies to commodities, including food. There is more international demand. Higher demand means higher prices for basic, auction-derived prices such as commodities. China and India are buying more than they did a few years ago. If there is the possibility of greater production, the higher prices will attract more supply and the price may go down, but that does not happen overnight.

Food prices, especially within a large country like the U.S., is more dependent on local factors. I have not seen sufficient reports to make a well-founded conclusion as to why prices have begun to move upward. International grain prices have moved upward, but really have only a minor impact on the prices of consumer goods in the U.S. The cost of wheat in a loaf of bread in the U.S. is only a small fraction of the price at the store. Transportation, i.e., oil prices might be more important. Weather is important. The important point is that the factors causing our food prices to rise are not an increase in the money supply and are somewhat different that the reasons why oil and other prices are rising.

Then there is the issue of inflation here vs. inflation there, in the present day case: inflation the US vs. inflation in China. China is experiencing inflation, both asset and consumer price inflation. It is also experiencing sufficient growth that allows people and businesses to buy basic materials on the world market that they couldn’t before. Both of these factors make up the fact that China is a major reason why international prices are increasing. To fully understand what the impact of China’s rise (as well as India’s) means, it is necessary, as always, to gain perspective. Don’t just focus on selected markets that fit with a particular expectation or world-view. Look at the big picture.

What is my suggested perspective maker? French wine! The prices of good French wine have gone through the roof, up maybe as much as 3 or 4 times what they were a couple years ago. The reason is that a very small percentage of China’s 2,000,000,000 people have discovered the good stuff and have the money to start buying. They have bid up the prices. The Chinese are bidding up the prices of many things right now. The world has been rolling along with a few industrial countries and a lot of undeveloped ones as the status quo. Imagine the situation if many countries were to open up their economies to individual efforts and wealth. The demand for basic commodities would skyrocket! The old, restricted level of production would not be able to respond, shortages would ensue, and prices would rise. That scenario is pretty much what we are seeing. Newly freed countries would mean periods of economic adjustment as changes in distribution patterns developed. Ultimately, either we would see greater production, and thus higher standards of living all around, or we would see massive shortages and breakdowns in the world economy. In this respect, the emergence of China and India as economic powers will be good for all of us. Countries that refuse to deregulate, like the Europeans are blindly doing, will be faced with falling standards of living and fiscal nightmares, as is happening. For those who have tied their thinking to the dominance of the U.S. in the world economy, there will be confusion. In a world that is free and prosperous, the U.S. would be a great competitor, but not the richest nation. It is not the biggest country. But it would be incomparably richer than it is now. Higher productivity and creativity worldwide would mean greater wealth for all, and we would benefit.

But, back to the point of this post, greater demand for commodities, or anything, and subsequent rises in prices is not inflation. Only increases in the money supply by government action is inflation. Keep your causes straight.

China and the world economy

2010-12-18T16:01:00.000-08:00

Over the last two centuries there have been many obvious examples of different political economic systems in practice. It all began with the Industrial Revolution that occurred in capitalist countries. Latter, there was the rise of communism and its moral/economic attack on human life. We had the immediate comparison between East and West Germany. For years there has been the obvious comparison between North and South Korea and Cuba and the Cuban refugees just a few miles away in Miami. Now we have the fascinating spectacle of communist China having an apparent capitalist bent. Still, with all of this obvious evidence, there are few people paying attention and noticing the consequences.

But even many of the people watching the Chinese economy are not noticing what is happening, not really. The closet socialists in the U.S. bemoan that America can’t act like the Chinese government and just get things done. We have all of those antiquated laws and protections in place. The Chinese, people are saying, have a better approach to making an economy run well. On the other hand, we have some advocates of capitalism who tout Communist China as a sort of new birth of freedom. Neither of these evaluations are correct. China has opened up options for personal action that the Chinese have never seen. It is a heady feeling, and the Chinese citizen is taking this opening and stretching it as wide as fast as he can. But his feeling is based upon the opportunity and not the reality. The reality is that China is still a communist country. It isn’t free. It still embraces the old prerogatives that communism teaches, plus, the government is attempting to become an economy manager in the manner it perceives the Western governments to be. This is not a good mix for the long-term.

My comments are about the problems that underlie Chinese economy today and the big crisis that is coming. But, if my information is correct…

When China bursts and falls, it will be the capitalist elements that will be blamed. Just watch!

People are very surprised about the success of the Chinese over the last 10 years. They tend to forget that the same Chinese government has killed millions of its citizens. They forget the destruction of the democracy movement just a few years ago. In their minds, China seems to have just come out of nowhere recently.

It is the case that there is a lot of productive energy being used by the Chinese citizen for his own benefit. People living in the right areas are seeing an enormous increase in their standard of living. There is real capital accumulation and utilization. Markets are working. People are finding productive jobs. There is a lot of good happening. The productive aspect of the Chinese economy is not an illusion, unlike the Russian economy which was an illusion during the Soviet era. Yet, there are major problems.

The problems revolve around the fact that the government has not renounced either its own communist nature or the general approach that every other government in the world accepts, namely the twisted Keynesian approach to government controls. This communist government isn’t using the traditional five-year plan, but it is attempting to act as if it can perfectly control the economy by using the “mixed economy” rules that have constantly failed in the West.

It has greater control over the banking system than any Western country does. The banks are either owned outright by the government or controlled sufficiently to make no difference. Consequently, the standards for making loans and evaluating the banks soundness are much poorer than in the West. Estimates are that anywhere from one third to two thirds of all loans made by Chinese banks are not performing, i.e., payments are not being made and the loan will be a loss. That is a percentage far higher than any Western bank has had. You can be sure that the Chinese banks do not have the capital or the reserves to cover those losses. When the weakness of Chinese banks is recognized and begins to affect the economy, the Chinese government will step in and create reserves, i.e., it will inflate the money supply even more than it is already doing now.

The real estate market is in much worse shape than it was in the West. There are reports that the Chinese built an entire city for something more than a million people in the interior. This city stands empty and is, no doubt, beginning to deteriorate. In the real cities, reports are that 60% of the apartments that have been sold are not drawing electricity, i.e., no one is in them. Yet the Chinese are continuing to build at a rapid pace. For those who buy, not having the mortgage system that Western countries have (which is not necessarily a benefit for the West because much of the structure is government created, and thus is not efficient or market driven) the Chinese buyer has a much higher percentage down payment on the property. When the Chinese real estate market fails, the losses are going to be more centered on the productive individual rather than on the banks. Suddenly losing a large part of their new wealth will place a strain on the population of the cities. Things may not remain stable.

At some point, some unforeseen event will stop the continued upward spiral of real estate building and price increases. The last buyer will buy, and all that will be left are sellers, and prices will fall, buildings will go empty, loans will be recognized as losses, banks will either fail or have massive amounts of made-up money shoved into them. Inflation in China could increase dramatically.

What will be the immediate economic consequences? Questions that perhaps cannot be answered in advance include, what will the Chinese do with their hoard of dollars, Euros, and foreign exchange? What will they do with their U.S. Treasury Bonds? There are observers who have been suggesting that China is looking to sell off the U.S. government securities. I haven’t thought so, for no other reason than that the Chinese really don’t want to see the value of those holdings to dive. It made no sense for the Chinese to start selling. But when their economy goes puff!! Who knows what they will do? The degree of collapse cannot be appreciated. There has been no economy of that size, with that many people, so connected to world trade, that has had the size of bubble that China now has. Yaron Brook suggested that their bubble is larger than any seen before. So may be the consequences.

We can easily see that one immediate consequence for the rest of the world will be a hit on the commodity markets and those countries that are depending upon the Chinese, e.g., Brazil. These countries will see an immediate fall in revenue. Commodity prices will fall, hard.

For ourselves, the consequences will also first connected to the commodities. The price decline will include gold. The number of buyers will decline and the sellers, especially the Chinese sellers will expand. At least during the crisis and for a while afterward, gold prices will be lower. Other commodities will also decline, especially those that the Chinese have been big buyers, e.g. oil. (See what happened in 2008.) The upward pressure on prices for goods in the U.S. that are tied to commodities will be reduced. Consumer prices could even decline.

What will happen after that is hard for me to predict. The Chinese economy is not as closely tied to other countries as ours is. Their banking system, for example, is pretty isolated, from what I can see. Would companies producing for export be forced into closing? Would their exports suffer? Imports would suffer. To the extent that the gap between imports and exports widened, there could be problems. To the extent that the wealthier countries depend upon exporting to China there would be adverse consequences. We will have to see how all of that plays out.

We have no clue what precisely Chinese government would do, except that they are wedded to the belief in the power of the government. To the extent that they see their citizens’ reactions to be threats to communist power, they could unleash the military again. They could try Western style mixed economy solutions, and expand and lengthen any possible recovery. It is unlikely that they would somehow learn that the governmental actions in the economy do not produce prosperity.

No doubt, in the West, government after government will step forward to save the day. At this point, with interest rates on short-term money at near zero, it is laughable that any might think that their theories are going to have any beneficial results. But, our great leaders are also wedded to their theories. Remember, their theories are not based upon any real evidence, but make believe. That they haven’t worked in the past will not hinder their efforts. The Western world might still be in “recovery” when China blows, which means our “recovery” will dip. Our economy will certainly suffer.

The stock market in the U.S. will definitely decline. Since the financial center may not be hit as badly as before, the decline in equities might not be as large, but it will not stand up to this bad news. I am firmly in the camp that considers the market’s recent rise to be pushed by inflation, i.e., government created money. Riding U.S. stocks is a very risky endeavor today. I don’t see a fundamental justification for stocks to have risen. New pressure from China will undercut the equity market.

Frankly, only commodities seem to me to offer any opportunity for increasing wealth today or even just protecting what you have (besides owing a successful business that can deal with economic shocks). I don’t mean riding commodity prices upward. I mean being able to take advantage of the up and down volatility of the prices of commodities.

When China does blow, as people have done in the last sixty years, there will be a flight into the dollar (another reason why commodity prices will drop for those of us in the U.S.). As badly as the dollar is managed, it will look better than any option (other than gold, maybe). Eventually, the damage done to the U.S. economy will be apparent and the dollar will lose strength. Still, when considering the alternatives, no other currency will look stronger. We are now seeing the weakness of the Euro. Bailing out a couple of Euro zone countries with new loans only broadens those who must suffer under the debt burden. Analysts do their calculations and bemoan the apparent fact that there is no way out for an economy with so much debt. Opening up their economy so that it can actually be productive never enters into their consideration.

When is China going to implode? Sooner or later? China is now experiencing some problems with price inflation. For years, as part of the creation of all of that real estate, the Chinese have been expanding bank credit and thus the money supply. They thought that everything was okay until prices began to rise during their “recovery” from the mortgage-backed securities crisis. In response to the crisis, the Chinese government did its stimulus gimmick, spent a lot of money it didn’t have, patted themselves on the back for the apparent recovery of their economy, and now consumer prices are rising. Surprise! Now the Chinese government has to act again. Since interest rates are still very low, they are having to increase the reserve requirement, i.e., banks there, just as they must under our Federal Reserve System, must keep a percentage of their deposits in accounts at the central bank. The higher the reserve percentage, the lower percentage of loans a bank can have outstanding. The Chinese central bank has now increased that percentage for the third time in the last few months. Further, officials in China have placed price controls on certain items, which as anyone knows, does not work. So we are now seeing some significant cracks in the Chinese economy. I don’t know if these cracks are sufficient to cause the bust, but they are at least the beginning. We can look forward to Bernanke like statements about how there is no problem, how the problem is small, then that the problem is only in one sector, and then how the Chinese government saved the world from another evil consequence of capitalism. Plan on it.

What we can do is to start telling people ahead of time what they can expect to see, especially the “capitalism did it” excuse. Maybe fewer people will believe it this time.

The Attraction of Free Medical Care: Egalitarianism

2010-10-28T17:37:00.000-07:00

I have seen several different facebook entries, blog posts, and articles about how bad medicine under state control is. I am sure that an actual effort to put together a history of medical care in Canada, for example, would provide more horror stories and causes for fear than we could imagine. Socialized medicine, medicine under the rule of force, is bad medicine.

What is even more disturbing is that the citizens who live under government controlled medicine know very well what is happening to them. They are the ones who have to suffer the mistreatment, poor service, lower standards, and rationing that state controlled medicine inevitably leads to. Why haven’t we heard from these victims? Why are they silent?

There are mundane answers to those questions, for example, the fear that speaking out would result in being treated even worse by vindictive administrators and “doctors” who have bought into the “free” system. Fellow citizens also may inflict punishment on “complainers”, who, after all, are threatening a service that everyone has a right to receive, in the local accepted prejudice.

But there is something deeper I think. This isn’t just the ideal of altruism, because socialized medicine isn’t solely, or predominately, based upon the sacrifice for the sake of others or even the state. This is worse. It is egalitarianism. This is the enforced requirement that everyone be treated equal, and lower quality, equally bad medical care is acceptable. To not accept it would require questioning the premise. A person cannot argue that they should have good medical care, because that would be demanding something that cannot be offered to everyone within a socialized country. To demand good medical care is to demand that you be treated as an individual.

In “The Age of Envy”, Ayn Rand offered this example of egalitarianism, “Suppose a doctor is called to help a man with a broken leg and, instead of setting it, proceeds to break the legs of ten other men, explaining that this would make the patient feel better; when all these men become crippled for life, the doctor advocates the passage of a law compelling everyone to walk on crutches – in order to make the cripples feel better and equalize the “unfairness” of nature.” (The New Left, p. 170)

In practice, if that term has any meaning, the medical practice in a socialized country will not go around breaking legs. That would be even too obvious for most people. What it does do, however, is almost the same. Instead it makes treatment egalitarian by limitation (not to be confused with rationing). That means that the treatment a person can receive has to fall within a certain range of acceptability, of equality. This restriction to a range is justified by citing the funding limits. But is actually the reverse. It is the principle of egalitarianism that mandates the “equality” of treatments. Even if funding was unlimited, treating individuals differently would violate the fundamental tenant of egalitarianism.

Thus the result is not that the doctor has to go around breaking legs. He only has to say that available resources and funding limits restricts the treatment options available to different cases, regardless of the severity of their illness. Thus someone with a leg that is severely damaged would suffer amputation or permanent disability, rather than receive treatment that is significantly beyond what a broken leg would normally receive. Then, as funding levels do decline, doctor availability and capability decline, as standards of the population decline, the level of treatment will continue to decline over time, with no noticeable reaction from the populace.

The egalitarian application to health care also means that any medical treatment that is considered optional, such as hip replacements, would be eliminated, as has been the case in Canada for decades. It is not egalitarian to offer options.

Just this week there was a long article on the current status of Canadian health system on Yahoo. In the article there is a significant glorification of the size of the operation, ranking it internationally as a business. There is criticism of some spending shortcomings, as you find in the criticism of many government operations in this country. They are only concerned with waste and fraud, ignoring the inherent incompetence of government bureaucrats attempting to deal with such a complex subject as medical care. The article attacks the elements of the Canadian “system” that still contains some element of individual choice (the doctor’s choice of business organization and medical decisions). It goes on to discuss future funding issues. Nowhere does it discuss the actual level of care a Canadian resident receives. This subject is irrelevant!

You find the disconnect between the promise of government run health care and the quality of the care in every discussion of government run health programs. You find this disconnect in the arguments for government health care in the U.S. The proponents of health care provided by force do not actually care about the quality of care. They do not care about the consequences for the individual recipients of government run health care. Neither, apparently, do the proposed recipients, who seem only to care that they are receiving “free” health care. They only care about the implementation of force by the government. The supporters of freedom fail to point this out. It needs to be emphasized.

To my knowledge there has not been a study of the level of health care in any of the Western nations that have socialized medicine. It is quite puzzling. This study needs to be done. A study of the Canadian experience would be most helpful, since it is the most recent and most like our experience would be. (If anyone knows of a study, please tell us.)

As these arguments go on, and egalitarianism becomes more entrenched, at least implicitly, it will be harder to dig out. We must not forget the ideal of egalitarianism in our arguments and protests. It is a special application of altruism and needs its own special attention. Otherwise we shall see continued adverse consequences from both the liberal left and the religious fundamentalists. Both will push egalitarianism.

This is the way mankind pulls back from civilization, from industrialization, from the digital world, from large populations, from survival. What is killing us is egalitarianism.

Gold is Undervalued

2010-10-17T14:24:00.000-07:00

I have come to the conclusion that gold as a financial hedge or currency is undervalued, probably by a very large factor. Actually, a better way of saying that is that today’s currencies, all of them, are very much over valued in terms of gold as a standard of value. A further way of saying this is that as the world population begins to realize the problems that fiat currencies, social programs, high debt, and reduced freedom have created, they will at least try to flee to gold to some extent, and the limited quantity of gold in existence will result in an amazing increase amount of fiat currencies required to purchase a troy ounce.

My conclusion may seem to be obvious, maybe even trivial. My point is that the current price level is not something to be seen as high or remarkable. The current price level is the result of a few people out of our total population, worldwide, who have decided to use gold as a store of value. The current portion of our wealth that is placed in gold is a very small portion.

Currently, the gold market goes up and down (trending upward in what is really a fairly slow assent) as a result of daily random news releases about things of little, long-term significance. None of these news events about government activities or economic events addresses the underlying problems or will stop the consequences of those problems.

What is up in the air, I think, is whether the consequences will be swift and catastrophic or wind us down painfully over a longer period of time. But, the reality of the situation is absolute. Some of those people who claim to be gold bugs who pay any attention to the daily or short-term prices changes, including trumpeting new “highs”, are missing the point. Sure, point out the new high level of fiat currency needed to buy gold, but also keep people’s eye on the necessity of the price going higher. The price is still low. By keeping your eye on the fundamentals, you will not get caught up in day-to-day irrelevancies. If the price of gold should fall for a while, keep in mind that nothing has changed in the fundamentals, you should not be concerned. It is actually a buying opportunity.

The relationship between gold and the present day currencies is just as any other market relationship. There is a limited supply of gold, more so than most items for sale, even more so than most commodities. A higher demand for gold will elicit a greater production, as the prospect for profit encourages a search for more sites to mine and makes it possible to mine ore that would be unprofitable at lower levels of demand. Yet the amount of new production has rarely been sufficient to have much impact on the supply and demand balance. New production will not change the fundamental problem of fiat currencies. New production of gold will not sufficiently affect the day-to-day prices to enter into any purchase decision.

The amount of currency that is needed to acquire a troy ounce of gold depends then on the amount being offered for all the gold for sale. If the amount of fiat currency being offered raises, then the amount per ounce will raise. Supply and demand is a root an exercise of arithmetic. The relationship between the current level of fiat currencies and gold would require a much higher exchange ratio than currently exists. Since nearly all countries are continuing to inflate their currency, the amount of those fiat currencies necessary to buy an oz. of gold will rise even higher.

Gold has reached its current quantitative relationship with the currencies of the world in an environment in which few regard it as a real alternative to today’s fiat currencies and few are willing to take the risk of placing their liquid assets in a mere commodity. Gold has reached a high dollar “price” with only a few people actually using it as a value repository.

When gold was last widely known to be a store of value, the earth’s population was less than a quarter it is today. A century ago, there were perhaps only 5% the number of dollars in existence as there are today (the dollar has lost 95% or its purchasing power since 1913, and there is more loss to come). There are more currencies today and much more of each currency. I doubt that there is more than twice the amount of gold in human hands today than 100 years ago, maybe even less.

How many people own significant amounts of gold, say even $1000? How many people own gold as part of their portfolios? How many Objectivists own gold? The quantity of each has got to be very low, even after the last monetary crises.

As long as people with assets continue thinking that moving into dollar assets, especially U.S. government debt is a “safe” move, the upward pressure on gold will be slight. Probably enough to keep it rising and hitting new “highs”, but not enough to push it toward a realistic value in today’s world. Keep an eye on these people who are using U.S assets for safety. When the U.S. dollar assets are also viewed as less than safe, gold will begin moving upward on a steeper angle. At this point I don’t know what is required for people to realize the dollar’s weakness. The added debt, the continued current account deficit, the lack of movement in the U.S. economy, and the threat of more “stimulus” should have everyone worried. It seems that people worldwide have not accepted that gold could have a real role to play. The attacks by the Keynesians have had some impact. Instead, people are bouncing between the Yen, the Euro, and the dollar. At some point you would think that they would get tired of the bouncing and look for some actual safety. Given the state of the gold market, it would not take many new buyers for the dollar price to balloon. It won’t be an asset inflation, but a dollar fall.

If and when people become worried and there is a more concerted movement toward actually safe, real assets, the number of dollars or other currency necessary to acquire an ounce of gold will skyrocket. We haven’t seen anything yet.

THE CHINESE CURRENCY: A BIG SHOE THAT COULD DROP!

2010-09-24T11:32:00.000-07:00

For over a year the U.S. economy has been just chugging along without any apparent stresses. I mean, nothing has happened within our economy to cause panic or increase the level of fear people are feeling. Certainly, the economy is far from healthy. It is not growing to speak of. Unemployment is very high and few jobs are being created. Some communities appear to be in depression, while others are only marginally affected.

In the political area, the focus related to the economy is all of the promises made and no results. The current administration isn’t being blamed for making things worse, just not making them better. The government has declared that the “big drop” is over, the recession has ended, but the signs that growth is occurring or may happen in the future are muted at best.

My own mood is that of waiting for the other shoe to drop. Well, there are many shoes that could drop. And any of them could be more disastrous than the big dip of 2007. Which one will it be? Or perhaps the question to ask is which one will be first? Only time will tell. Let’s think about one potential shoe, the push to have the Chinese revalue their currency.

One issue that the politicians are focusing upon is the international value of the Chinese currency. It is contended that if the Chinese currency is valued more in line with real relative national purchasing power, the U.S. dollar would be stronger and the U.S. would benefit from a greater demand for its products. There are several things that are difficult about this. It is true that China’s approach is the old, thoroughly discredited view (among those who are aware of the history of economic ideas) that a nation’s wealth is achieved by hoarding valuables. At the beginning of the exploration of the New World, for example, countries would scour for gold and silver in the Americas, bring it home, and put it in a vault and declare that they were wealthy. So, several Asian countries, including Japan and China, insist on controlling the exchange rates (although Japan is trying counter balance that now) and hoarding the dollar and the Euro (China has a large surplus with the Euro Zone as well).

Of course, hoarding anything is not wealth. A dollar, or any currency is only as valuable as what it will buy. A currency, especially a fiat currency, in international trade is a claim on that country’s production.

On the other hand, a country does need reserves (speaking within today’s structure), i.e., a stash of cash available when and if needed to settle international debt or payments. What cash is available? Well, they aren’t going to begin using gold, if for no other reason than that the process of beginning to use gold would cause the value of the dollar to die. The same problem holds for any other currency that could be chosen other than the dollar. If the process of changing to another currency was done slowly, perhaps the dollar wouldn’t collapse. Unfortunately, such a process should have started a couple decades ago.

As it is, the international system is stuck with dollars into the foreseeable future. Okay, but there is no need for countries like China and Japan to continue accumulating dollars. They have more than they need, and they are worried about the constant flow of dollars and what that means for the future. What they could do is to turn around and begin buying stuff from us with the dollars that they would have hoarded, the current cash flow. Sounds good, right?

We will even ignore the probable, immediate consequence that the dollar would lose significant value just because it wasn’t being hoarded as before. Forget that. Forget that immediately, foreign goods would be significantly more expensive. Let’s just concentrate on our own goods.

The mainstream economists think that to create growth, what is needed is consumption, more spending. That is why they set things up to expand the money supply. More money, more spending, more wealth, they think. Great, huh! So, these same economists would be happy for foreigner to be spending more in the U.S. It means more demand. They felt the same way years ago when the economy seemed to be humming right along, with very high employment, and very low unemployment. We had what some called “full employment”. I always wondered what they thought was going to happen. The unions, progressives, Keynesian economists all thought that more money running after our goods was going to be good, when there was no one to produce them.

Today things are a little different. We have a large number of people unemployed and lots of capacity that is sitting idle. It is not the most efficient capacity, but it is there. What we don’t have is a significant amount of raw material sitting around. Nevertheless, as foreigners began to send those dollars that they don’t hoard back to the U.S., we will now see more dollars running around. At first, the new demand will cause some shortages, and prices will begin to rise, since the actual stock of good will be unaffected, at least for a while. Then, over time, more capacity will be used, more people rehired, more produced. But, then the real bottleneck appears. Or rather two bottlenecks. One will be the need for raw materials for the higher level of production. Costs will have to rise to compensate for the higher costs of materials as users bid for the material available. The other bottleneck is that some new investment will be needed, but the government has soaked up all available savings for its deficit. To get loans or attract investors, businesses wanting to expand will have to bid against the government for savings. That will also tend to raise costs, and the cost of government borrowing will also increase.

What this really means is that the return of all of the money we send out in a year for foreign trade will result in higher prices, both for domestic goods and much more so for foreign goods. It is unlikely that we would see the “gentle” 1-3% inflation we have seen with few exceptions over the last couple of decades. It will be higher.

Now why would we see higher inflation just because foreigners spend the money that we sent for goods? It certainly wasn’t the case throughout our history, right? Wouldn’t it make sense for there to be a balance? Well, yes. But our situation over the last decades is very different. It is hard to understand, apparently. Some supposedly free market bloggers don’t accept my thinking here.

For decades we have had not only a trade deficit, but a cash-flow deficit, called a current account deficit. While the trade category covers trade, obviously, it doesn’t include investment flows between nations and government transfers. Normally, if a country has a trade imbalance, the difference is made up by the return of the deficit in investment, or the purchase of government bonds, for example. Even then, if the current account is not in balance one year, it swings back the other way the next, or at least over time a country’s current account will balance out. This has not been the case for the U.S. for a long time. The current account deficit will be less than the trade deficit.

One way to understand what is happening would be to imagine that you are a country and buying from other people – countries – often. Your purchases are all made by check. You send out many checks and everybody honors them and sends you the merchandise you want. But, you find out, by analyzing your checkbook that some of your trading partners are not cashing your checks. They are just keeping them (for some strange reasons – your crazy cousin has all kinds of weird theories as to why, saying that they want your checks as reserves, that your partners use them as cash with other people, etc.). So, you have both the things you bought and the money you with which you thought you bought them. Sounds like a good deal. It is sort of. But, if your honest, and know that there is a future, you might be somewhat worried about what happens when all of those checks come wondering back, especially if they all come back at once!

Let’s take 2009. The U.S. bought more stuff than it sold by $374 B. The current account difference was $378 B (usually, the current account deficit is smaller than the trade deficit). You can look at the history of the U.S. current account here. So, there have been billions upon billions of dollars that have left the country and not come back, not even as loans to our government. My discussion in this post is limited just about this year’s money not returning. (Think how bad things would be if the money from past years returned as well!)

Under a gold system, if money left every year and didn’t return, the money supply would continue to shrink and there would be a corresponding drop in prices. There would be ramification of a continued outflow of dollars. There are ramifications under the present circumstance, just not the ones that would occur in a rational economy. In the present circumstance, the U.S. price level actually continues to creep up. That is because the money supply continues to creep up. The money supply creeps up in spite of billions of dollars being lost every year to foreigners. Where is the money that is being lost coming from? I am sure that you know the answer. It is the Fed., the official U.S. money maker upper!

One key fact to remember about international trade is that it functions completely on credit. When an importer buys, he sends a letter of credit, which does not pay the exporter until the goods are received and accepted by the importer. The letter of credit is a bank document, and is what it says it is, a credit, a loan. Purchases by U.S. importers are financed by bank credit pushed by the Fed. We see that even though banks in the U.S. are not making loans to businesses for new production, they are making loans for importing, i.e., we still have a big trade deficit. The money we have been exporting for years is all made up, Fed. produced money. So the Fed increased the money supply, we sent it overseas to buy stuff, and those people kept the money, just like the example with your checks. (Why? See my discussion of Schiff’s book, Crashproof. The “Why?” is even more a big question after they have kept so many dollars after so many years.)

The situation is not good for the Chinese and other countries that have built up big surpluses of foreign money (which is mostly in digital form). Recently, there was a push to move away from dollars toward a “basket” of currencies, including Euros. The wisdom of that idea was demonstrated this summer as many of the Euro Zone countries have been shown to be in financial difficulties. Maybe people will begin to realize that fiat currencies of any stripe will not stand up to normal, mixed economy political processes. The dollar became strong, i.e., higher priced against the Euro, for a while because the dollar again looked like the strongest, safest currency. That view will fade. So the Chinese, to use them as the example because they have the biggest hoard, are sitting on vast sums of dollars, some of which are “invested” in U.S. government debt, a little of which is invested in other countries, both real assets and government debt, and some of which is sitting as reserves, as gold would sit. If and when the dollar falls, the value of these massive holdings will fall, which would not be good for the Chinese economy. Thus, the Chinese are walking a tight rope, trying to keep the dollar from a death dive, which also means their currency at a lower price, and make small moves to reduce their dependency on the dollar. Everyone is watching them. They have to be careful.

Which also means that they are confused by the U.S. political leaders constant demands that they increase the value of their currency. The Chinese realize to some extent the consequences of that action. They can only be astounded by the U.S. politicians. Those fine people, the Congressional leaders don’t seem to have much understanding of international economics (not surprisingly, since they don’t have much understanding of domestic economics, either). They do understand that the jobs issue plays very well in this country. They see that demanding that the Chinese buy more U.S. stuff there might be more U.S. jobs, and play it for all they can. Real consequences are far out weighted by political appearance. They can always blame someone else for the unexpected consequence.

But if the Chinese, and the other Asian countries begin spending those dollars on U.S. goods, we begin to see those made up dollars running after the few goods we have purchased and prices begin to rise, interest rates begin to rise, and the quiet calm that we have had, a quiet calm in which we have been able to have good fight for our lives, will end and who knows what could happen then.

Update: Treasury Attempt to Control Retirement Assets

2010-09-08T19:02:00.000-07:00

The Labor and Treasury Departments have announced hearings that are the next step in their attempt to control and probably divert individual retirement savings. These hearings are next week.

There is nothing new here particularly. The wondrous workings of bureaucracy require many obtuse steps working toward making recommendations to the legislature. The hearings are that next step. At this point the apparent goal is still just requiring employers of offer a lifetime income option as part of a 401(k) plan. A lifetime income option that is not a pension is called an annuity. (Most non-government pensions are effected by the employer buying an annuity for the pensioner.) The step to government seizing or controlling retirement savings is contained in the justification for beginning this process: retirees are not adequately managing their retirement assets to provide for their entire lives. (I won’t go into the entire discussion on this point. For that discussion see my original post and this for background .)

The only comments of the government’s interest in this issue that I have seen is in the far right blogs and in a couple liberal think tanks. The right has immediately jumped to the conclusion that the government intends to grab the assets, which isn’t irrational. They also propose that this is BO’s idea, which I tended to endorse in my earlier posts. I wonder. I think that the Labor Department is quite capable of thinking this one up on its own.

The blogs ranting about this issue have included IRA’s as threatened by the Labor Department’s intensions. At this time IRA’s have not been mentioned.

The interesting question now is will this process continue if the Dems lose control of the legislature this November. I bet that it will. I think that the process has just as good a chance of succeeding with the Republicans. They are just as paternalistic as the Dems, just as eager to show concern for people’s retirement. After all, Social Security reform was a Republican “achievement”.

The initial legislative step would be to pass a law requiring employers with standard 401(k) plans to offer a lifetime income option. At that point the lifetime income option would probably be an annuity provided by an insurance company. The bad thing about this law would be the added expense and waste of time needed to meet the requirements, plus the fact that the new option would add another bad element for the participant from which to choose.

Soon, the Labor Dept. would discover that few people were choosing to put their money in the annuities, and that, in the opinion of the Labor Dept. the population was still failing to adequately manage their retirement funds. It would also be determined that the insurance company annuities were too expensive (dirty capitalist, profit mongering, insurance companies). Something more would need to be done. Then they would start the hearing, etc. process over again to come up with the need for the government to offer the annuity and that at least a certain percentage of retirement fund contributions be placed in that annuity.

There we are, a large new source of government financing.

(I edited the title because people were getting the wrong idea. The Treasury & Labor Depts will want to control where you can put the money and fund the U.S. debt, but there is no evidence that their intent is to steal those assets.)

Combating Altruism

2010-09-05T11:27:00.000-07:00

In a previous blog posting I argued that it is important for the supporters of capitalism, freedom, and reason to know what capitalism is from the economics standpoint and to understand the economy in which they live. If we want people to support it, we must be able to explain it. That position is still a correct one. Many supporters of capitalism do not know the economics and certainly do not know what is happening in today’s economy.

Recently I reread Ayn Rand’s 1960 speech, “Faith and Force: The Destroyers of the Modern World” and had the opportunity to deeply examine chapters 2-5 of Andrew Bernstein’s The Capitalist Manifesto. These writings have again underscored to me the importance of the moral arguments. The central point in both works regarding the morality of the altruist is that altruism is independent of reality, of reason. Pointing out the necessarily disastrous consequences of the policies proposed by an altruist will not influence his commitment to the irrational.

In recognizing that position, we must realize that the altruist politician and policy maker and their supporters are somewhat immune to our direct, pointed statements about the consequences of those policies. That group of people includes many of their supporters in the electorate. We must recognize that that we need to attack their own closely held beliefs. I don’t think that they will be influenced by our arguments, but they will be harder for them to ignore, perhaps. They seem to be able to ignore nearly anything.

More useful will be making those attacks when arguing publicly, i.e., articles, editorials, and lte. I don’t think that a philosophical discussion of altruism is helpful. Generally there isn’t enough word count to do so and readers might not stay with you. I propose that instead we use the consequences, that is, we spell out the “human” cost of these policies in the context of morality: We talk of the suffering of countless Americans. We talk of the loss of the ability to acquire the items that make our lives better or even comfortable. We talk of the potential of depression and hardship. We talk of the recent dire recession we are living in. We talk of human sacrifice. We spell out how these policies are going to make life harder and worse. We talk of how the politicians do not care about the consequences of their policies, only that they fit with their morality of human suffering. We talk about the disconnect between reality and their policies. But these consequences must be discussed within a moral perspective. The discussion has to focus on specific consequences of the morality being used. It seemed to me that the accusation that ObamaCare included “Death Panels” was effective. It carried the idea and the real meaning of ObamaCare. This type of tactic needs to be carried further. We must not mince words or be “nice” or polite. Being nice and polite allows the evader wiggle room.

Clarity and the relation between the altruist’s policies and the welfare of the reader are what are important. We don’t talk about their rational self-interest, but the values that are rational that they have, for example, their families. We talk about how these anti-man policies are going to impact their families. How their hopes for their futures and the futures of their children are being destroyed by the specific, destructive policies being offered and made into law. We talk about how their children will not have their parents around as long as they expected. We talk about how their children are not going to have a better life. We talk about their children’s shorter life span. We talk about their children’s not receiving the inheritance either expected. We talk about the lower standard of living that their children will have. We talk about the fact that this will be the first American generation to leave their children worse off.

Offer real images to the reader contrary to their general morality, i.e., what are they going to say to their child when they complain about their illness and the government run health plan won’t help? Are they going to tell them that morally it is good for them to suffer? Are they going to give them stories about helping poor people when in fact they themselves are now poor and there is no help for them? Being too nebulous will not bring the point home. Talking about paying back the current debt will not be useful mainly because these predictions in the past have not had an impact on the current economy (at least that people have realized).

What we must keep in mind is that the explicit or implicit holder of the morality of altruism does not regard consequences of his actions as pertinent. That is why Congress rarely examines the consequences of the laws it passes. Consequences are not important. What is important is taking actions consistent with altruism, “helping others”, sacrificing for the good of others. We know that this cannot be practiced successfully. We know that individuals cannot and do not practice this morality personally. They just support their government’s actions. What can only break through this compartmentalization by concretizing the consequences they will connect to themselves. Using concretization in a directed manner, utilizing our reader’s own values will help bring the real meaning home.

It will help you to also keep clearly in focus the consequences of failing to stop the direction of the federal government. Too often we are seeing the future in terms of economic consequences, i.e., reduced standard of living and opportunity. We are thinking in terms of loss of being able to state our views. These images are too peaceful and mild. This is the most complex, interconnected economy in mankind’s history. It will not be able to maintain its cohesion if several parts come apart. In Atlas, the trains stopped. Food could not reach New York City. Food shipments stopped. In our world, oil deliveries will be imperiled and food deliveries will become undependable. What will happen in our cities if food is not readily available, not to mention other requirements of living? Digital systems will prove to be fragile. As the economy comes apart, so will the society. There is much more anger, fear, and resentment today than during the 1930’s, for example. We have riots today over court cases. Just think about food riots. Just think of a lack of food and starvation in American cities. This is what human sacrifice looks like in practice. That’s right, human sacrifice. Not ritual sacrifice, but the human sacrifice that results from the government’s practice of altruism.

I am not trying to be alarmist here. I am not projecting a crash within the next few months, or even the next couple of years. The election coming up will give us a good indication of what our immediate future holds. I am only saying that our arguments must keep in mind the fact that holders of the morality of altruism (or the god oriented version) do not consider consequences to be an issue. To be effective and meet the threat, we must shape our arguments accordingly. The moral context and the real consequences have to be pared and driven home.

If in the next election we have a Republican Congress, we will then talk about the Christian right and that they have the same mind frame. They are not interested in the welfare of individuals. They are interested in making their god happy. Human happiness doesn’t help. They require suffering, just as the progressives do.

To reduce the role of altruism as the dominant political philosophy and replace it with reason and capitalism, we need to make our arguments as effective as possible.

Outlook: The Economy and Inflation

2010-08-31T18:13:00.000-07:00

If I haven’t mentioned this before, let me do so now: keep an eye on “business news”. So many people are focused on the political issues that they don’t take time to look at the business pages. People also tend to consider business news as very specialized, I think. I mean that the stories involve finance and accounting concepts that are not sufficiently understood by the average, intelligent person. I would agree if the articles on the business pages in the normal daily newspaper or news web site were about actual businesses and markets, etc. Most articles, unfortunately, are actually about the government and its activities. What would pass as actual news in the business world is ignored there just as real news is ignored in the other sections. Further, the “reporters” in the business section are not people with an education in business, finance, or economics. Nor do they have business backgrounds or even a history of intelligent investing. They are people with journalism degrees who could not make it to the front pages. Years ago someone did a survey of the people writing for Money Magazine. They found that few of the writers had any investment background. The writers for Money Magazine were young, inexperienced, and had bought into the Money Magazine “philosophy” (and advertising strategy) without question.

So it would seem that I have just given you good reasons to ignore the business pages. Well, even so, it is the reports on the government that you need to look out for. A few of those reports are considered significant enough to reach the front page. Many of the others are important to know about. You need to have a broader view of the economy we live in and its prospects to better understand what could happen in the future. You need that for yourself, to better plan for yourself and your family.

For example, some people are carrying on about high inflation and you might think that inflation is raging and creating havoc. Look around you. Do you see prices in general going up? Significantly? There is some, of course, but nothing big has happened as of yet and may not for a while. People who are carrying on about inflation happening now are ignoring the actual situation. (I am not suggesting that there is no threat of inflation or hyperinflation. There is. But it is a threat, a possibility and can be avoided.) Many people are ignoring the issues of Social Security and Medicare and their impact on the budget, today. You don’t keep track of this stuff without looking at the business section (and reading this blog, of course!).

Okay, so lets talk about outlook, or what I have called the Inflation Watch in the past. This time I am broadening my focus.

In spite of all the pushing, money pumping, stimulating, and general noise making, the government, including BO and Bernanke, has been unable to get the economy functioning, producing consistently, and growing. They don’t know why. Their mental framework, the “understanding of the world” they utilize to make decisions, has not brought them to the shining success they expected. But don’t despair; they know why it didn’t work. We didn’t cooperate, we being the banks, the business, the capitalists, the consumers, all of the non-government types. It is our fault. They will just have to try harder. Don’t worry. They, BO and his gang and Bernanke and his colleagues, will not question their ideas.

In the meantime, the economy is floating along, not improving, deteriorating marginally in areas that are hidden. More houses are being foreclosed upon (funny how there are few if any news reports about foreclosures these days, which was big stuff a year or two ago). BO is considering “restructuring” Fanny Mae and Freddy Mac. You know that won’t be good.

There is more unemployment and few new jobs, relative to the available workforce. (Notice that in my area, just outside of Washington, DC, unemployment is low. Isn’t that strange. Notice also the various comparisons between federal government employee incomes and the private sector.) Industrial production rose for a while, but has now slowed, if not stopped growing. Imports are again exceeding exports significantly, and the gap is growing. The balance of payments (all money transfers as opposed to just trade) shows that foreigners are still keeping dollars (idiots).

Not to be left out, foreign governments are doing just as much to screw things up as the U.S. government. Many who are looking at the Chinese to be shining stars are ignoring the fact that their Communist government believes in doing the same thing that the U.S. government does. We are the great capitalist nation and the Chinese are emulating us.

Someone could reasonably say to me that it isn’t really today that we need to be worrying about. It is the future, maybe the intermediate future. I agree. There are certainly significant seeds of terrifying doom planted in today’s economy, i.e., the debt, the made-up money at the Fed, the lack of any savings available for investment, the flood of new regulations, etc. The list is very long. Even worse is the lack of understanding of the true nature of the situation where the decisions are being made or where the decisions are being evaluated, i.e., the press.

Nevertheless, the American economy is not just the government or the Fed. There are millions of other actors who are seeking their best interest and working to achieve their own goals. These people have learned over the last century how to work around and within the government actions to minimize the consequences of those regulations and laws. Their ability to do so is not unlimited. But they have shown amazing creativity and resilience. We aren’t necessarily doomed.

Just as the government and mainstream economists don’t question their premises, those who have cried doom often in the last decades don’t seem to question why that doom hasn’t occurred. At root, they seem to give the government a kind of power in the economy that means that the non-government population is completely helpless and their actions have no consequences. Destruction is inevitable. Consequently, these doomsayers tend to pounce upon any small indication that things are coming apart as proof to the government’s power.

We must keep perspective.

The economy today is wallowing. The people making decisions are idiots. In many respects the average American cannot be relied upon to make good decisions. Even so, there is a lot of good stuff going on in our economy and society (including us). We can make it through with only a little damage. It would help if people listened to us. It would help if the American voters put in a non-Dem house of the legislature. Unfortunately, we can’t count on those events.

So what is the “Outlook”? At best it is very uncertain. Under current conditions and leaders, the best we can look forward to is more of what we have had over the last couple of years: no growth and floundering. With some positive results in November, maybe things will move toward the early part of this decade (not really good but better than now). But the potential is there for disaster. It isn’t unavoidable, just a potential.

Inflation and the International Wheat Market

2010-08-22T12:18:00.000-07:00

One site that I monitor that discusses inflation is loudly trumpeting the recent rise in wheat prices as proof of their longstanding belief that we will be seeing lots of inflation, and future hyperinflation. They have forgotten or did not know that inflation is a domestic issue, revolving around a nation’s currency, that price inflation is a rising of the general price level, and that many different things can cause a specific product’s price to change, even without regard to any government activities. They also do not seem to understand the importance of looking at the context of the facts of reality, in this case the international wheat market.

Before looking at the wheat market, I want to emphasize that there is no free market in the world. All markets, including international markets, are affected by individual nation’s attempts to manipulate their own domestic currencies and product markets. Nearly all nations today are manipulating domestic markets directly or indirectly with little restraint. International markets are the total sum of the actions of each nation, plus the actions of individuals and associations of individuals (companies) both to meet normal business objectives and to avoid government restrictions. Whenever international markets are discussed today, these basics must be remembered. If someone talks as if markets were free of interference, we know that they are missing, ignoring, or evading current conditions. It is true that international markets do act independently of any one nation and that the controllers of a nation’s economy are often unhappy with what happens in different world markets. But the markets themselves are fundamentally affected by the actions of different governments, which often overcome real, purely economic or business factors.

Occasionally, and maybe surprisingly within today's context, a market will move as a result of events, real events, not government activity. That is what has happened in the world wheat market. Interestingly, the Russian economy after communism (notice I didn’t call it “capitalistic”) has turned its production of wheat into an export crop. Before, under the communists, Russia had to import wheat, in spite of its very fertile agricultural regions. Russia, as a mixed economy has managed to become a major exporter of wheat. Even so, Russia is not an advanced economy, not even where agriculture is concerned, so that it is more vulnerable to “mother nature”. Russia is suffering from a major draught (see news stories about fires around Moscow, too). Its wheat production has fallen dramatically (the Russian government has now banned wheat exports), and the world price for wheat has risen as supply has fallen, as you would expect.

A rise in a commodity’s price due to a shortage is not inflation. Certainly, if there is inflation, the situation would be worse, which is true today in nearly every country, but they are still two different things. Someone who doesn’t notice the difference does not understand the issues or the economy.

The price of oil is similar to that of wheat, with some additional provisos. The effects upon the international oil market of the actions of individual governments are more obvious, to anyone who looks, that is. The most important result of government action on the oil market is that of reducing the supply of oil, enforced shortage. Governments in many nations have restricted the search for and the recovery of oil. Further, many oil rich nations do not allow private companies to operate in their country, so their search for oil and its production is generally less competent and less successful.

If you have read my earlier posts you will have seen that I have been expecting oil prices to rise to close or above the prices from earlier this decade. The basis of my expectations were that the reasons why the prices was above $100 a barrel would exist again, i.e., increasing demand from the two largest populated countries in the world, India and China. Chinese demand for oil has resumed. India doesn’t seem to be as strong as it was, however. What we have seen is a price that has gone up, but still is significantly lower than it was earlier this decade. I think that the lower price is due to lower demand in the U.S., and probably Europe as well, due to the fact that neither area has recovered from the 2008 recession. Neither area is poised to actually recover, so for the immediate future, we can expect world oil prices to remain lower than the earlier highs. This may be true even though U.S. production of oil is bound to be further constrained by the backlash from the Gulf of Mexico oil spill.

To further my point in this post, oil price increases are not necessarily the result of inflation, either. International oil prices are going to be generally impacted more by direct manipulation by each countries domestic controls. There are so many examples besides the obvious restrictions on drilling and refining, which predominate in the U.S. Most of Europe has taxes on gasoline that make it very expensive, thus cutting demand. Some countries subsidize gasoline sales to consumers, increasing demand. Many of the oil rich countries have nationalized oil ownership and production. It would be interesting to research Indian and Chinese government policies regarding the discovery of oil reserves, production of petroleum products, and the importation and distribution of oil and gasoline. Regardless of those policies, both countries currently require significant importation of oil to support their growing economies, and their increasing requirements will tend to push international prices up. Which is not inflation. An investor, in a fairly rational context, would look upon the emergence of large economies that were actually developing as opportunities for enormous profit.

To that let me add a note regarding commodities in general. I want to talk about the basic stuff of production, i.e., metals, not foodstuffs. Consider a world in which all economies, all countries, were becoming capitalists. The initial supply of the basic materials of production would be stressed to meet the demand of newly productive economies. New mines and processing facilities would be competing for investment funds. Initially, prices for these materials would increase and products worldwide would become more expensive. This would continue for a while because the new mines would be producing material that was harder to extract and more expensive to mine or process. Over time, new mining and processing technology would be discovered which would tend to reduce the cost. Some of the upward pressure on commodity prices is happening now with the emergence of more productive economies. There are opportunities both in the short-run and longer term for investment, profit, and creativity.

INFLATION, WHERE?

2010-07-12T14:02:00.000-07:00

With the efforts of BO, the Congress, and Progressives everywhere, the federal budget, the federal debt, and the Fed. balance sheet would seem to be doing all that would be necessary to push consumer prices upward very fast. My question is, “What are prices doing?”

The statistic offered by our friendly federal government, the CPI, suggests that there is little in the way of prices rises. Food prices, according to the CPI are volatile, but not soaring upward. The shadow stats offered as a more realistic indication of inflation shows something higher reaching 6 to 7%. If this is so, people would be starting to make some noise, I think. There are a number of people who are forecasting hyperinflation within the next few years. On the other hand, there are many analysts who maintain that we are staring deflation in the face

My approach has been to suggest to people that they pay attention to their own situation to assess what is happening. Hence, this post.

Readers, what are you seeing in your own shopping? Are you seeing prices moving upward? Significantly? Please respond. Thank you.

Deflation

2010-06-27T13:22:00.000-07:00

As with inflation, there is a great confusion as to what deflation is. The people who steadfastly insist that inflation is raising prices are consistent in insisting the deflation is falling prices. This is why, time and time again, since the 1930s, they insist that prices need to be kept at least level when the economy hits a bad spot. They hold this position in the face of overwhelming evidence to the contrary, but that is another issue that involves considering their philosophy. Maintaining price levels has resulted in some of the most insane actions that we have seen in the free world. The classic is FDR’s requirement that crops be destroyed and land kept out of production when there were bread lines and people going hungry.

That dropping prices are not a bad thing has lots of evidence. The best I think refers to the time period from the end of the Civil War to the end of the 19C in the U.S. I have seen some suggestion that prices tended to stay level during this period, so there needs to be some more research (anyone know of some good references?) but there is also strong evidence that prices tended downward. Certainly, several important products saw sharp price declines as new technology was applied, including better business management techniques (e.g., Standard Oil managed by J.D. Rockefeller).

In today’s world we see prices dropping for many important items in spite of the continuous inflationary pressure of new made-up money being pushed into the economy. But overall, even the much maligned CPI shows some upward trend of consumer prices. The “core” inflation rate (which excludes what is considered volatile, energy and food; isn’t that really dumb) is slightly up year on year at less than a percent. Those who figure that the CPI has been manipulated for political reasons and to keep the masses from getting restless prefer the shadow statistics analysis that says we are seeing closer to 6 or 7% inflation this year, especially in food. Bottom line though is that we are definitely not seeing falling prices.

Those who are deathly afraid of falling prices would be demanding that the Fed, the White House, and the Congress do something, anything, if prices do start to fall. They fear a depression. If prices do begin to fall, we will see such a massive pumping of money, demands for price controls or supports, and really weird stuff that will take our breath away.

It was the fear of falling prices that prompted many of the actions at the beginning of the recession in 2008. The consequence of that was the prevention of the liquidations and readjustments necessary in the economy to allow it to return to productivity. It is why we are still in a mess. More actions to keep prices level would not be helpful.

Another group, to which I belong, regards deflation as a reduction of the money supply. The money supply indicator for the U.S. that I use (MZM) has dropped about 3%, but has now stabilized. The main driver of the money supply in the past 50 years has been the expansion of bank credit, primarily to businesses, but also to consumers. Bank credit has decreased almost 25% in the last 18 months. Even so, the money supply has not shrunk. Further, we are continuing to have balance of payment shortfalls, which means we are sending dollars we don’t miss out of the country.

So what? What would it mean to us, now and into the future? Remember that one issue of inflation is the entry point of new money. In the same way, in deflation, it matters where the money is being taken from. Right now, money is being injected into the economy via federal payments, i.e., stimulus, medicare, “jobs” programs, social security, and other payments. Where has money being taken from? Loans to businesses are decreasing, as I mentioned before. What isn’t? Loans to government. The Federal Budget is in massive deficit in 2010, and will be so in 2011 and thereafter unless something extreme happens. Money is not being taken out of the economy so much as savings is being diverted from any activity except government debt.

The question I keep coming back to in the discussion of deflation is how actual deflation could possibly happen. Those who argue for deflation of the money supply do not actually explain how it could come about. They merely point to certain trends and extrapolate from there. That’s fine. But the trends have not actually reached deflation. And those trends have now been going on for a while, and still no deflation.

So how could the money supply decrease? One idea given is that if we go into (further into?) recession again now, business lending will decrease further and total checking deposits will fall. Checking is ready money, which is the backbone of the money supply. So far, however, bank loans have decreased 25% and money supply has remained flat, even with the export of dollars as our balance of payments have remained in deficit. The fall in banks loans is not leading to deflation.

As I see it, the federal budget deficit and BO’s expansive spending (he wants more stimulus) is pushing on the money supply faster than any deflationary trend. If, somehow, BO were to stop spending, the budget deficit stabilized, someone figures out that we don’t need more fake jobs and production-killing regulations, and no panic response comes from Congress or the Fed, we could wonder into deflation. Yeah, that is likely to happen.

An actual deflation would do some good in that it would wipe out more made-up money. The real issue, of course, is what happens to savings and actual productive investment. It doesn’t matter that much what the money supply is doing (if the government is not actively inflating it), if there is actual savings and the savings is being put to use productively, profitably. In fact, real money supply deflation is fine if savings is invested productively. In deflation, a saved dollar is becoming more valuable, i.e., can buy more as time goes on, and, therefore, saving a dollar automatically increases one’s wealth. Putting it into the hands of someone who can turn it into a profitable endeavor makes the dollar even more valuable. All of this doesn’t happen when the government is sopping up every dollar it can find to fund its deficit.

The bottom line isn’t whether we are in deflation or not. It is what the government does. Since there is no one in position to make decisions that holds principles in ethics, politics, or economics that are connected to reality, we can be certain that what they will do will not be beneficial. But that is true whether we have inflation or deflation. They are right now taking every bit of savings, and with the recent new law increasing the regulation of the financial sector, the power and flexibility of our system for funding production is further damaged.

Deflation, then, is a fake issue. It is another way in which analysts, politicians, bureaucrats, commentators, bloggers, and journalist can feel as though they are grappling with the important economic issues and evade reality.

Reich: From Regulation to Restructuring

2010-06-17T18:26:00.000-07:00

In the second article by Dr. Robert Reich that caught my eye recently, the good doctor is actually criticizing BO and his gang. BO is not being assertive enough and thus the problems that both BO and Reich want to “solve” are not receiving the best solution, according to Reich.

First, Reich addresses the failures in the financial reform bill in Congress. He reiterates the criticisms that I mentioned in my last blog, i.e., that banks are being subsidized to cover their derivative activity (amazingly he includes the AIG transactions, which were actually straight insurance purchases).

But Reich’s primary criticism is that the banking system is not being “restructured”. Reich wants the major banks to be broken up and prohibited from reaching a (unspecified) size. (I wrote about that issue in a previous blog where I pointed out the very drastic consequences for the U.S. and world economy.) His reason is that he does not want them to be “too big to fail”, and thus be bailed out by the federal government if, rather, when things go bump again. Reich is not willing to consider the notion that maybe the government shouldn’t be bailing out banks or anyone. No, he thinks that part is fine. He thinks that the government is “protecting” the economy by bailing out people. Reich wants to break up the banks. I liken it to wanting to play tinker toys with real world businesses.

He does recognize that there may be adverse competitive consequences for U.S. banks, but he brushes those objections aside. This part of his argument is very strange. He says, “…since when is it up to taxpayers to guarantee profitability at America’s largest banks relative to foreign ones?” But, the Dems have never suggested that they wanted to undercut American businesses. Their claims before have always been that their “solutions” for the American economy have been beneficial to all. Reich is propounding a new attitude, a new policy that says that American businesses, and thus its citizens, should be “restructured” in spite of the obvious disadvantage that results.

To further make his case for restructuring, he turns to the healthcare industry. He says, “Similarly, the underlying system of private for-profit health insurance is a key driver of America’s bloated and ineffective health care delivery. We can try to regulate it like mad, but no amount of regulation will cure this fundamental problem.” Similarly, in this case, the problem is the “private for-profit health insurance”. Again, we need restructuring, i.e., a single payer system, socialized medicine.

Regulation for Reich is an attempt to “mend” capitalism. Instead, “The only way to have a lasting effect on industries as large and intransigent as banking and health care is to alter their structure.” And he further lets the cat out of the bag, “That was the approach taken to finance by Franklin D. Roosevelt in the 1930s, and by Lyndon Johnson to health care (Medicare) in the 1960s.” The former maintained a depression that lasted over a decade and LBJ can be thanked for the current mess in healthcare in the U.S., which no one, either Democrat or Republican, is willing to admit. So, all of the past attempts to deal with capitalism’s failings have themselves failed.

Reich’s criticism of regulation, especially in the two industries that he is using as his examples in the article, is that lobbyists and the industries can wiggle out of the intended consequences. He says, “A regulatory approach allows for more bargaining, not only in the legislative process but also, over time, in the rule-making process as legislation is put into effect. It’s always possible to placate an industry with a carefully-chosen loophole or vague legislative language that will allow the industry to continue to go on much as before.” That is, the victims can try to make some decisions of their own and try to run their own lives and businesses. He says, “And that’s precisely the problem.” The problem is that there is some semblance of freedom. That is unacceptable.

The problem in the American economy, according to Reich, is structural. What is the structure now, in Reich’s view. It is capitalism. It is for-profit. It is what the bankers are doing, basically by themselves, without Reich’s approval. The solution is for the government to mold the structure of the economy. Mold the activities of the people. Mold the people themselves.

As I said at the beginning of the first of these two posts, Dr. Robert Reich is a Marxist economist.

This article is unusual for two reasons. He explicitly proclaims that the actions of government should not be considered for their benefit for the economy or business but should be taken in the face of adverse consequences. He is admitting that the left’s solutions should be taken regardless of consequences. Instead, he calls for sacrifice (my word) for the benefit of the “taxpayers”. Second, his demands that the economy be restructured signal a new strategy. Regulation is now something that will be regarded as merely a accommodation to capitalism and rogue businessmen. What is needed is structural change, changes that make the government the direct controller in the economy. Regulation tends to be set up in terms of what business can’t do or what it must do to assure safety or fair play or some supposed good. Reich’s articles are pushing the government to become the primary force in determining the make up of businesses and the economy. Next, it will be the five year plan.

Robert Reich: Stop Subsidizing Wall Street

2010-05-31T12:00:00.000-07:00

Robert was on a roll this last few days. He has published articles that have popped up on different web scans as significant comments.

Dr. Reich is an academic that loves to serve his fellow man. He has been a member of three Democratic administrations and believes that he is an expert on “public policy”. Surveying his “policy” recommendations, I conclude that he feels that he was born too late. He would have been very happy to be a leading Marxist economist. At every turn he has recommended turning away from capitalism toward state control of all aspects of the economy. He regards actions taken by the government as wiser and morally superior to individual action. The use of force is okay with Dr. Reich.

What brings him to mind is that I came across his blog. This particular entry is entitled: “Financial reform bill unlikely to end taxpayer subsidy of derivative trading on Wall Street”

This may not sound particularly controversial because the federal government subsidizes many industries and companies. Handing out federal money is a major activity of both political parties and nothing at all new.

You might ask, which specific taxpayer subsidy is he talking about? How are the taxpayers subsidizing derivative trading. One answer could be that our government has decided that financial companies who traded derivatives were bailed out because of the “too-big-to-fail” irrationality. That is, some financial companies got carried away trading derivatives, lost gobs of money, and the government bailed them out by giving them money. That would be a subsidy, you say. Sorry, no. That is not what our Dr. Reich has in mind.

Just like any other sector of the economy, existing banks do receive a portion of the public dole. Considering how convoluted and contrived federal spending and the means of providing subsidies and support has become in the U.S., there are possibly many different actual subsidies that the banks receive. I have not researched it. But, upon reflection, I can think of two. One is that a considerable proportion of the money that the bank lends comes with no expense. It comes from the expansion of the money supply by way of the Fed. When the Fed. expands bank credit the bank receives new money in its reserve/deposit account at the Fed. The bank can then take that money into it’s own coffers and loan it out. The bank’s only expense or risk is that the Fed. may decide that the amount of money it has put into the economy should be reduced and begin a process of restriction and shrink the reserve accounts, which would require the bank to call in loans. The risk of restriction is small. It rarely happens.

Another benefit that existing banks receive from the current situation is a considerable reduction in competition. The regulatory burden on banks (and the rest of the financial sector as well as the economy as a whole) is extremely large. Even someone who has some understanding of banking would be staggered by the amount of paperwork, filing, extraneous record keeping, staff, and expense of the regulations. Just keeping track of all of them, and learning about and implementing new ones takes a considerable staff and administrative expense. The cost of regulation is one of the factors leading to bank consolidation. The economies of scale of a larger bank make it easier to cover the cost of regulation. Competition is reduced by the consolidation and by the tremendous expense and risk involved in starting a new bank of any size.

But none of these means of supporting the current banking establishmen is what Dr. Reich means is that banks are protected against their folly by government guarantees of customer deposits. What he is referring to is the Federal Deposit Insurance Corporation, which isn’t a corporation at all but a government entity. You see its initials all the time. Somewhere on its promotional and contractual material, every bank has placed “Member FDIC”. I’m not sure that “membership” is optional, but the marketplace, supposedly, would punish any bank that wasn’t a member. I mean, who wouldn’t want their deposits insured?

The FDIC collects funds from the banks, just like insurance, and guarantees that if the bank defaults, the FDIC will cover the difference between the bank’s assets and the deposits, up to $250,000 per customer (not per account). The FDIC was created during the depression to try to give people some confidence in their banks. Banks had been failing at a rapid pace for want of capital. People were afraid that they wouldn’t be able to get their money. Deposit insurance seemed the ticket.

But it is a fraud. It isn’t insurance. The fees collected by the FDIC could not cover much, and are certainly not sufficient for the size of the major banks today. Even when it was created it was recognized that the FDIC could not stand on its own, so it was backed with federal government guarantees. When the FDIC runs out of money, the federal purse bails it out. It did, too, during the 70’s when Thrifts began failing in large quantities (more government malfeasance). So, today, everyone who has paid attention knows that if banks begin failing the feds will have to pony up more money to cover the FDIC’s obligations.

Now along comes Dr. Reich, who wishes to expound on the virtues of government and, since it is popular to bash banks these days, bash the “rich” bankers. He capitalizes on the ignorance and poor education of most Americans, and forthrightly declares that the banks are being subsidized.

He has to ignore that the precarious situation of the banks over the last five years is directly related to the cheap money policies of the Fed., the efforts of the federal government to eliminate sound credit practices in the mortgage industry, and the forced semi-nationalization of the largest banks. Ignoring facts and reality is a way of life for Dr. Reich.

So the subsidy that Dr. Reich is referring to is actually no subsidy at all but a insane obligation left over from the 30’s that could put the federal government on the hook for trillions. Now, does Dr. Reich want to end the subsidy? No. He thinks that the FDIC is a fine organization. Instead, he is focusing on the derivative trading.

Not just any derivative trading, but the defensive or hedge trading. There are really two different approaches to derivative trading. One approach is intent on making money, just like most investment. This derivative trading is generally short term and is a form of speculating, i.e., expectations of advantageous price changes. This kind of trading can often result in significant losses, just like speculating on the price of a stock. You expect the price of the stock or derivative to go up, but it often goes down, and until you sell it, you lose money on the market price. Not all derivatives function that way.

A defensive or hedge approach to derivative trading is exemplified by the corn farmer, perhaps the source of one of the first derivative markets. When the corn farmer plants his crop he founds his expectations on the current price of corn, or perhaps on what his experience suggests the price will be when he harvests and delivers his crop to market. But of course, the future is not known. The price could be very different in a few months. It the market price for corn is lower, the farmer is sure to lose money. So the farmer buys a derivative. He buys a financial product that will pay him money if the price falls. He buys what is called a put option. If the price of corn on his delivery date is the same as the put or higher, the farmer reaps his expected profits and is happy. The money he paid for the put is lost. If the price of corn has dropped, the farmer makes up for his losses from his crop by the return on the put. The farmer has maintained his position.

The put option is purchased from another party who holds the same view of the future as the farmer, that the corn prices in future will be the same or better than today. He knows that he has a risk of lower prices, but he has factored that into his business, and has either reserves or a hedge of his own to cover potential losses. The farmer regards the cost of the put as a business expense and the seller of the put regards the potential loss as a factor in his business. The transaction and the decisions are done in a very businesslike manner.

So the bank has certain exposures to interest rates. If the interest rates change in a manner that is unprofitable, the bank will lose money. To offset potential losses, the bank buys derivatives just as the farmer did. For these derivatives to make sense, they must offer significant return with little cost, just like the corn farmer’s put option. The bank regards this as a business expense. It is a good banking practice.

What Dr. Reich does is confound the two different types of derivative activities. It may be true that some, most, or even all banks engage in both types of derivative trading. But it is clear that Dr. Reich is trying to have it both ways in that he yells “derivatives” in such way to capitalize on the danger of volatile aggressive trading, while also mentioning in an aside that banks are using hedge derivatives.

Reich says, “If derivative trading is so useful to them in order to “mitigate the risks” of other banking activities, the banks should be willing to foot the bill.”

Dr. Reich wants it to seem that the taxpayers are getting ripped off by overly aggressive banks who are risking huge taxpayer funds by aggressive, semi-rational derivative trading. He says that taxpayers are footing the bill. This is the same thinking that considers tax breaks or reductions to be a government expense. No money is going to the banks (in fact it costs the banks money to “belong” to the FDIC). As noted above, the reason the taxpayer may pay any money is if the Fed. policies drive many banks to the brink of default. If one or two banks fail because of poor business practices or banking decisions, for example, the FDIC will generally be able to meet its obligations. The problem is when there is a systemic or broad problem. But, according to Reich’s thinking, the bankers have a sweet deal: if the bankers have “bet” right, they pocket lots and lots of money; if they “bet” wrong, the taxpayers will have to pay. He says, “Derivatives can generate huge risks for the economy unless carefully regulated. Neither logic nor experience suggests that you and I and every other taxpayer should be subsidizing this gambling.” But none of his argument is related to reality from start to finish.

Let me make one observation about derivatives and the banks. The derivative tools banks and other intelligent large volume traders use are the result of brilliant inductions from highly complex, high-speed, high volume, international trading. They are intellectual marvels. But, at root, the banks and other financial traders are being taken for a ride. The tools work very well when the basic data they depend upon are real, but the data isn’t. Instead, the data, which is interest rates and money flows, is contrived and manipulated by governments around the world, mainly the U.S. In the long run, and when they need it most, the banks will be let down by their tools precisely because the tools depend upon being connected to reality, and the governments interfere. This situation is an excellent example of von Mises observation that prices are cognitive tools.

At the beginning of this entry I mentioned that Dr. Reich had two articles of interest recently. I will discuss the second in my next blog, hopefully in a day or two.

What next? Negative Interest?

2010-05-22T14:50:00.000-07:00

A couple months ago I saw an analysis that showed the rate of interest targeted by the Fed Open Market Committee had declined over the last twenty years or so. Each cycle showed the targeted interest rate to be lower than the previous cycle. The question posed was, what would happen the next time, and if the economy gets going again, there will be a next time, But the Fed is already at zero. What will they do?

The target interest rate is what we hear called the Federal Funds rate or the Discount Rate. It is the rate the Fed charges banks, members of the Fed, to borrow from the Fed to maintain the minimum level of their deposits (sometimes called reserves) at the Fed. The law that set up the Fed. requires all member banks to maintain deposits (reserves) at the Fed. These funds are not available to the bank to use for any purpose except the Fed’s manipulation. The amount of the deposits that a bank must have with the Fed is a percentage of its demand deposits, called checking accounts by you and me. The Open Market Committee decides what percentage of demand deposits a member bank must have on hand, currently 10%.

If a bank’s deposits falls below 10% at any point, the bank must either deposit funds, borrow from another bank, or borrow from the Fed. And the Fed charges an interest rate, which, as I said, is called the Discount Rate or the Federal Funds rate. This is the interest rate that you hear or read about all the time in the popular press. It is considered a big deal. “Investors” buy or sell on expectations about the rate, banks connect their “Prime Rate” to the Discount Rate, mainstream economists connect their predictions on the economy based upon the Discount Rate, and so on.

The Discount rate is not maintained by decree, actually. It is a market rate, which is why it is called a target. The Fed. maintains the rate by adding or subtracting the amount of money available for bank member borrowing to cover minimum Fed. deposits. Ultimately, this is how the Fed. manipulates the money supply, but adding or subtracting money in the member banks Fed. deposit accounts (see elsewhere in my blog for a detailed explanation).

Therefore, the Fed. lowers the discount rate by adding money to the economy through the banks deposits. Currently, the Fed. Discount Rate is 0.00 to 0.25%, or nothing. The rate has been zero for well over a year. Supposedly, when rates are low, banks will loan more money, and, in current “thinking”, the economy will whiz along. Oh. You noticed no whizzing? What a surprise. Actually, banks have been contracting lending for well over a year, both to businesses and to consumers. Even with a zero percent interest, the Fed. can’t get the economy going. Even with the “stimulus” packages, they can’t get the economy going. What a surprise.

The chart I mentioned at the beginning suggests that future efforts of the Fed. will have a problem. That each successive round of encouragement from the Fed. has required lower interest rates. Well, you can’t get lower than zero. Free money would seem to be the ideal from these people. Hmmmm. The current situation is somewhat confused by the fact that the Fed. is paying interest for the first time ever on the Fed. member bank deposits. Before September, 2008, the way banks made money on expanded Fed. deposits was by taking 90% of the dollars the Fed. had given them in their member deposit account into their bank and loaning those dollars out (theoretically, there was nothing stopping them from just creating new demand deposits in their bank that equaled ten times the new Fed. deposits, but accounting niceties kind of made that difficult). Because the Fed. had created a massive amount of member bank deposits, about $1T vs. the normal $50B, the Fed. wanted to encourage the banks to keep the money at the Fed. so it began paying interest (not much, but more than zero). It turned out that it wasn’t necessary to offer interest, since the banks aren’t lending.

The Fed. keeps talking about the time when the economy begins growing again and it can raise interest rates, absorb all that money it created, and wallow in its self congratulations. But, here we are, a few months from two years of Fed. and BO encouragement, and no recovery. Some slight good news is published and everybody gets excited, and the next week there is new bad news and everyone feels worse. Unemployment figures continue to look bad. Well, I won’t dwell on the sorry picture.

So the chart I mentioned implies that if and when things get going, to the extent they can go at all with the huge burdens the BO has saddled us with, the Fed. is going to have to keep interest rates lower than in the last cycle, which was lower than the cycle before that. Of course, that will mean huge flows of made-up money, both in bank credit expansion and government spending, asset inflation, price inflation (currently 2.4% in the much criticized CPI), and probably very slow, real growth. Then, a couple years down the road the next bust comes (in a shorter cycle, I would think), the Fed. will have nowhere to go. The interest rates for the boom would be very close to zero, say 1-2%, and zero will not do much, probably even less than now. True to his convictions, Bernanke, the Fed. Chairman, will have flooded the country with more made-up money (we need to start calling him “Flood Money” Bernanke), and the next recession will just continue. We can expect more condemnation of capitalism, more destruction of our productive capacity, further crippling regulation of our financial system, a move toward greater violence and despair, and no economic growth or future. At least the cycle of boom and bust might have come to an end.

A Prediction from Henry Hazlitt, Meaning for Us

2010-05-09T14:06:00.000-07:00

Recently I was searching for a book on telescopes in my library when I came upon a book that I didn’t recall owning. It was obvious why I owned it, when I bought it, and from whom. I just didn’t remember it. I probably haven’t read it. I will. The book is The Inflation Crisis, and How to Resolve It, Second Edition (1983), by Henry Hazlitt. I read the Preface to the Second Edition and was shocked. It was written in March,1983 and suggested a future far different than what we lived through. I have copied all but the first couple paragraphs:

I do think it necessary, however, to call attention here to a development of the last two or three years that was not analyzed in my earlier book because it had not occurred up to 1978 – at least not to such a dramatic extent. This has been the sudden and sharp rise in real interest rates to a level that brought about a deep recession in business and consequent mass unemployment.

Economists have long pointed out, of course, that in an inflation that has gone on for some time, and is expected to continue, nominal interest rates rise. Lenders want not only a normal rate of return, but a “price premium” to compensate them for the expected fall in the purchasing power of their dollars when they get them back. I discussed this in my 1978 book. (Ch. 17, pp. 121 et seq.)

But the rise in interest rates in the summer of 1982 was much grater than the general expectation of the future inflation rate prevailing at that time would have brought. It was a “real” and not merely “nominal” rise in interest. It made private borrowing almost prohibitive.

This was a result of a combination of two factors. The first was a sharp increase in the size of the deficit. The second was the refusal of the Federal Reserve System to monetize the debt to any but a minor extent.

The deficit for the fiscal year 1982, which ended Sept. 30 of that calendar year, was $110.7 billion (compared with an average deficit in the tree preceding years of $48 billion). If the Federal Reserve had bought the government’s securities in the open market to an equivalent amount – a frequent practice in the past – this would have led immediately to an accelerated inflation. But it refrained. The result was that the government’s enormous borrowings in the open market sent interest rates soaring, and “crowded out” part of the private borrowing that would otherwise have taken place for business expansion or even for continuance of normal production.

As long as deficits of the dimensions of fiscal 1982 continue there is a prospect of either prohibitive interest rates or galloping inflation in the immediate future, depending on how the deficits are financed. We could easily have a combination of both.

Yet this is precisely the policy that is now officially planned. The President’s budget message of Jan. 31, 1983 projected a deficit of $188.8 billion for the fiscal year 1984. And even on the assumption that his proposed cutbacks and freezes in spending are adopted, his budget message forecasts deficits of $194 billion in fiscal 1985, $148 billion in 1986, $142 billion in 1987, and $117 billion in 1988. When we consider that we have already had 44 deficits in the 52 years since 1930, that future budget deficits have been chronically underestimated, and that President Reagan himself, at the beginning of his term, projected a balanced budget for the fiscal year 1984, the outlook at the moment of writing this is frightening.

Now I have several things to say about this, the foremost being that every time I write or say something about the future of the economy I am well aware that it might be just as far off as Mr. Hazlitt’s remarks. There are just so many potential influences on an economy that it is very difficult to get a prediction correct. This is especially true when predicting gloom and doom in the American economy. Americans do not want to experience declining standards of living. They’ve seen it and want no more of it. So, in spite of what the government might do, Americans will work very hard to avoid really severe consequences.

Another comment that can be made is that Mr. Hazlitt did not and probably could not anticipate the understanding and competence of Fed Chairman Volker or the advisors supporting Reagan. Volker did not want a return to the inflation of the 70’s, and he led the Fed away from the actions that would “monetize” the federal debt. Reagan put money back into the hands of actually productive people by reducing taxes. So, in spite of the apparent level of deficits, the economy had room to grow. Of course, we have neither of these benefits in today’s government.

But probably, most of all for me to point out is the lesson for the reader. Economic predictions by those who oppose the government are often presented as definite, precise conclusions. People offering products or who have prominently presented a prediction will argue that their expectations will come true regardless of other, unforeseen events or influences. It doesn’t mean that their reasoning is wrong so much as that they do not realize the limitations of predictions in an economy as complex as ours.

The worth of my last set of comments can be seen in today’s financial crisis. Many, reasonably drawing on the insanity of U.S. government actions, have predicted the continued drop in the dollar. It isn’t happening. Why? Because of higher levels of insanity in other governments, plus a crisis in minor countries attracts as much attention as any other crisis. How long will the idiots in other countries keep acting in such a way that people don’t notice how poor an asset the U.S. dollar is? Who knows? There are literally dozens of other countries with their own set of idiots and insane economic programs. In comparison, the dollar might be a better option. How long will this situation favoring the dollar continue? Again, who knows?

What is a person who wants to protect themselves from the very bad policies of the U.S. government going to do? After all, the current situation is one of high risk. The dire predictions that I have been referring to and my own comments in this blog are all grounded in well thought out economics and accurate information. This is why caution, diversification, vigilance, reading, and just paying attention are all important. Patience, too. Be prepared for bad news, and do not react, by which I mean, do not be one of those who makes big changes on bad news (and be selective on the good news you react to).

In a wider perspective, Mr. Hazlitt’s comments suggests that there are some epistemological issues to consider about economics. Some contend, for example, that Ludwig von Mises is really, at root a rationalist. His presentation is seemingly deductive. I understand the source of that accusation, but in reading, for example, his Theory of Money and Credit I see significant references to events that support his position or counter the claims of another economist. He seems to me to be very grounded in real events. But, at the same time, economics is not a science that allows the type of isolation of causal factors that a physical science does. Even in the analysis of past events, in which all the information may be available, separating out the events and identifying the causal factors is far from easy and often open to ambiguity. The question of which analysis you accept ultimately falls to your understanding of the process of production and of human action (to coin a phrase). It is exactly like history. What factor in human action do you identify as primary: human intelligence, individual genius, geology, or philosophy? If your understanding of mankind is correct, your understanding of history, and also economics will tend to be correct also. Exactly how that works out in a specific situation, however, may be very complex, and the uncertainties in predicting what will happen before the event sufficient to throw off apparently well-reasoned expectations.

The lesson: figure it out as best you can, and hedge your bets. Don’t tie your actions to specific expected events but to the general trends, and don’t be surprised when actual events go against you. The point to remember is that when living within a generally irrational culture, the irrational will happen.

Inflation and Economic Update, April, 2010

2010-04-24T17:55:00.000-07:00

This week we saw big headlines touting the growth in spending by consumers on stuff. This is big news to the “mainstream” economists and drove the stock market higher. Prosperity, economic growth, they say, is beginning.

At the same time, employment has not begun to increase, new unemployment claims continue at high levels, the government keeps extending benefits for the unemployed, production has gone up a very small amount, and bank lending of all kinds has continued to decline.

Housing in an interesting sector. Last month’s housing purchases were significantly higher, much higher than expected. The increase in home purchases, of course, was trumpeted by the administration and its media cheerleaders as a great success. Ignored by them was that the tax credits for home buying that the administration had pushed through were set to expire soon, at the end of April, a few days from now. People were rushing to take advantage of the government giveaway (i.e., the government would take less of your money in taxes). April’s figures for home sales will look good, too. Just wait until after May. Reality will set in. Without artificial support, the housing market will tend back to its original course downward in terms of sales and prices. In the meantime, foreclosures are increasing.
So, why do they say that the economy is recovering?

One of the unquestioned tenants of mainstream economics is that consumer spending is a primary driver of an economy. If “consumers” are spending, then the economy will grow and wealth will increase. I put “consumers” in quotation marks because the mainstream economists disconnect the “consumer” from any kind of productive activity. A job, they reason, is merely the process by which a consumer receives his money to spend. That is why government jobs, subsidies, handouts, dole, public works, infrastructure construction, and government money projects ad nauseum are all equated with jobs in private, productive companies. It isn’t that anything is produced, it is that people have money to spend. They don’t think that government spending per se is important, just that it gets money into the hands of consumers, who are the motive power in our economy.

Ayn Rand, in “Equalitarianism and Inflation” published in the Ayn Rand Letter in June and July, 1974, offered to bring in savages from around the world to help out in the spending.

If asked, they might say that the increased demand will elicit more production. They will suggest that the increase will come from the manufacturer bringing on unused productive capacity. Bernanke, from the Fed, would say that when production has reached full capacity, we could see some prices begin to rise, but he will also, deep down, expect to see more capacity created, somehow. It is not clear to them. It isn’t real. Most important, it isn’t production that is important, but spending.

So, since consumers last month started spending more, the mainstream economists believe that the economy is recovering.

But, you ask: Where is this money coming from? What does it really mean?

I think that there are two sources for this upsurge in spending. First, it does look as if the economy is bottoming out, and people are a little relieved that the downward spiral is not continuing. That relief, plus the government and cheerleader hype, make people feel as if they do not need to keep a lid on their plans and personal spending. Things have worn out, things are out there beckoning to be bought, people miss their old lifestyle of buying, buying, buying. Off they go and spend some money. So, some of the increase in consumer spending is coming from people who had recently been paying off loans or saving, but are now putting money into the consumer market. This isn’t necessarily bad (nor good), but if these are productive people, their spending isn’t directly harmful. I don’t think that we have a means to tell if this is a large portion of the upsurge in spending.

The rest, and an important part of the upsurge in consumer spending, comes from non-productive people, and is therefore, harmful. This is money from all of the government programs, including, but not limited to: unemployment benefits, “shovel ready” programs, graft, handouts (individual or corporate), new government employees, corporate bailouts, and on and on and………. We have more dollars chasing a limited amount of goods, and prices will tend upward.

I saw a presentation by an inflation watch group that claimed some food prices had climbed over 50% recently. The price for oil is continuing upward, especially as the large developing countries actually develop for a change and new car sales continue rising there.

Boom-bust cycles are fed by credit expansion. There is no credit expansion right now. We are not going to see asset booms for a while. Someone said we have a boom in government. We do. The government is spending. To the extent that the money is made-up stuff, we have a direct feed into prices and they will rise. When the money funding the government comes from previously exported dollars (i.e., China buying Treasury Bonds), it is made-up money, and prices will rise. To the extent that the money comes from our own economy, it is savings that is being consumed rather than invested for wealth creation, and we will continue to stagnate. Neither is good. Back to the 70’s, back to stagflation. Since BO and his gang do not look at history, we could see price controls again. We could see the FBI back in corporate offices again. We will see more attacks on capitalism and more destruction of our way of life, of our freedom.

WE CANNOT IGNORE OBAMA’S ATTACK ON BANKS

2010-04-17T09:06:00.000-07:00

For many very good reasons Objectivists and others became very active and vocal on the issue of health care. Destroying our health care industry, in this case by attacking the health care insurance industry, gives the government more power in fundamental ways and undercuts our ability to enjoy our lives, or actually stay alive. ObamaCare needed to be stopped. It needs to be reversed.
In very much the same ways, Obama’s attack on our economy will have the same effect. With an economy hindered, we will have less time and strength to fight for our freedoms, we will have more people dependent upon the government and thus reluctant to stand up to him. We will have more lawlessness. We will have a bigger fight to wage.
Central to a modern economy is the financial industry. We have seen how important a sick financial industry is and what the results can do to not just the U.S. economy, but to the world economy. At this time, Obama’s main target is the banks. He is threatening to hamstring them, shrink them and limit their size, and place even more controls on them than any sector of our economy has seen. He is encouraging the international community to do the same.

In a recent radio speech, Obama said, "Every day we don't act, the same system that led to bailouts remains in place, with the exact same loopholes and the exact same liabilities. And if we don't change what led to the crisis, we'll doom ourselves to repeat it. Opposing reform will leave taxpayers on the hook if a crisis like this ever happens again."

All of that is true, but it isn’t the loopholes and liabilities in the banks that create the problem, but the government. This story needs to be told and distributed. We need the Tea Party people to know this, we need the population to know this.

I see two parts to our problem. One, many people see the health care fight as a universal one in which everyone has a stake. They do not see the same for the attack on the bankers. This is a case where Obama is using the standard tactic of divide and conquer. Not only that, but many people who support the resistance to ObamaCare view the bankers as villains, or view regulation of banks to be a minor, separate issue that will have little effect on themselves. It is an ignorance of economics and of how business functions.

Second, Objectivists have no better understanding of economics and the importance of finance. Generally, our understanding of economics is little better than that of the man in the street, and for basically the same reasons. Further, most have not seen a reason for looking into economics. We understand the importance of knowing something about capitalism as a political system. We also understand the importance of business creativity, production, and markets. But we know little about how it all works and how the various parts will effect our daily life. We are thus vulnerable.

Expanded bank regulation, especially the attempt to shrink the banks needs to be opposed with significant effort. We need to make clear that our ability to have freedom and prosperity depends upon strong, market-driven banks. That government interference in banking is detrimental to everything we hold dear. We cannot let Obama have a unopposed path to destroying the economy.

What to do? The same things we have done already for healthcare. Plus, learn. Ask questions.

In a recent PJTV program discussing the mid-April Tea Parties, Dr. Yaron Brook said that this is the time to stand and work for freedom. This point in time is the best opportunity that he has seen. He also said that it might be our last chance, that is, if we fail now, it will be more difficult and perhaps impossible in the future. He means that in the future we will be too busy trying to stay alive and the forces opposing us would be armed and unwilling to let us speak. One vital key to our economic health and political freedom is the financial industry. We must try to save it.

Background notes: Annuities, Retirement Plans, and the Government

2010-04-07T20:07:00.000-07:00

After seeing comments by Burgess Laughlin on my earlier post about the Treasury request for comments on “life-time payments”, I realized that there were some underlying history and understandings that I had not included. This background is not general knowledge and it would be helpful, I think, for this information to be available. This is not a research paper. I am not including references and quotes from “authorities”. I am giving you my understanding of the situation, which provides some of the foundation as to why I came to the conclusions I did in the earlier post.

Annuities are one of the oldest financial products. Originally, an annuity was purchased when a person was ready to receive an income stream. It is purchased from an insurance company because the insurance company has the expertise in computing life expectancy and using long-term, incoming producing assets. When purchased, the life expectancy of the person to receive the income was computed, the current interest rate considered, and the income stream is determined. The income stream continues for the entire lifetime of the annuity owner. Some owners die early, some late. If the insurance company has made good life expectancy computations over sufficient number of owners, it will be able to meet all lifetime payments and make money.

Two things have changed over the years. One, annuities became tax shelters. You can purchase what is called an annuity without beginning the income stream, or as it is called today, annuitizing it. The interest rate may be fixed at purchase, or the interest rate may be adjusted before annuitizing as the market changes. The interest rate is not adjusted after the income stream is begun. When you purchase the annuity and don’t begin the income stream, it accrues interest, that is the principle grows, deferring income taxes until the income stream begins. Actually, there is no requirement that you begin the income stream. You may withdraw cash as you wish from the annuity until it is all withdrawn, and will have some taxes to pay. Under current law, if you withdraw money prior to 59½ there will be an additional 10% tax penalty. If you annuitize it, you will also pay taxes on the growth.

The other development is the creation of “variable” annuities. After hearing severe criticism that interest-bearing vehicles provided poor returns, the insurance industry created annuity vehicles with “sub-accounts” that were similar to stock and bond mutual funds. The poor returns of fixed annuities are actually worse than most critics argued. After internal costs, i.e., the insurance company’s costs and profit margin, taxes, and inflation, the return on an fixed annuity tends to be negative. Variable annuities are almost identical to what were now called fixed annuities in tax treatment and structure, but their return was based upon the results of the stock and bond sub-accounts that the owner selected. Of course, as opposed to an interest bearing account, returns based upon stock or bond markets might show declines in the principle. Some insurance then added optional benefits to variable annuities to try to overcome some elements of the potential negative return, adding costs and complexity.

After the tech stock crash ten years ago, another type of annuity gained popularity called the indexed annuity. Its return was tied to a stock market index, but did not actually contain stocks. The returns were lower than the market to allow the annuity company to engage in hedged trading to counteract equity market declines. An owner could have higher return than a fixed annuity but not have the fear of the declines in the stock market.

Annuity products came under attack from several quarters. It was claimed that annuities themselves had higher internal costs than they needed, and thus the insurance companies were making too much money at the publics expense. Since these products were offered to the public through normal sales channels that insurance companies used, it was claimed that salesmen were taking advantage of the public to earn huge commissions, especially when the owner was elderly. Finally, it was argued by the Federal Regulatory authorities as well as others that placing an annuity within a retirement plan or IRA was often a bad idea because the retirement plan already deferred taxes, so a major reason for purchasing an annuity before retirement was not applicable and were sold within retirement accounts only to earn the insurance companies excessive profits and salesmen huge commissions. (Regarding some of these accusations, it is true that that some of the products offered on the market had excessive expenses and commissions.)

Thus, for the federal government to now suggest that annuities are important and to suggest that they should be a required option in a retirement plan is a complete change.

What is interesting is not just that there seems to be a change in attitude, but where this change is taking place.

There is no part of the federal government that concerns itself directly with the retirement income of individuals. Even with Social Security, the administration only follows the law. It is the Congress that has had some concern over the years, putting in place various tax-advantaged options as incentive to retirement savings.

You might say that the Treasury has some connection with pensions because its responsibility for pensions paid to retired government employees. Actually, there is no comparison. The only similarity to a federal government pension and that paid by any other organization, including, I believe, state and local governments, is that the recipients are retired. The federal pension is financed in the same manner as Social Security, that is, it is paid from current revenue. In addition, federal pensions are indexed to inflation. Pensions paid by others are funded at retirement and placed in annuities, which is a lifetime stream of income at a fixed rate of interest. The Treasury doesn’t have to concern itself with the funding, just the cash flow.

Three government agencies have interests in tax-deferred retirement plans: the Labor Dept., the IRS, and the SEC/FIMRA (was NASD). The interest of the Labor Dept. is to ensure that lower level employees are treated the same as the managers (e.g., upper management is penalized if the lower level employees don’t contribute sufficiently to defined contribution plans). The IRS is responsible to make sure that regulations are complied with to maintain the tax-deferred status of the plan. The SEC and its little “independent” regulators oversee the compliance with security regulations if securities are offered within the plan. The system has no governmental body that is concerned with the success of a plan or the decisions of the employee during their work years or retirement.

Now the Treasury is leading such an effort. Not the Labor Dept., although it seems to be tagging along with the Treasury. But why is the Treasury involved at all?

There can be only one connection. One of the primary investments for fixed annuities for the insurance company is “safe” government bonds. Insurance companies don’t use only government bonds, but it is certainly a major component. If a significant number of people began buying fixed annuities, the market for government bonds would expand.

If you look at the questions for which the Treasury wants answers you will see a concern about the costs of annuities. My expectation is that they will find that using private insurance company fixed annuities would be too expensive. This conclusion fits with the anti-business philosophy you find in many different parts of the economy, the financial sector, and the current administration. They want to cut out the middlemen, including the salesman and the profit seeking business. As with the justification for removing funding of college tuition, they would see supplying government created annuities as a cost savings to the retiree. They would also be able to fund the annuity entirely with government bonds.

So, as a result of their “studies and analysis” they would ask the Congress to allow the creation of government annuities and require all employers above a certain size who have 401(k) retirement plans to offer the annuities for “investment” or for an income stream at retirement. Then, brick wall. You see, offering them and not selling them will not have the results the Treasury is expecting. Few people will buy annuities, even with the government backing. Certainly any advisor, money oriented writer, or publication will point out the complete lack of benefits for the buyer.

No. If the Treasury wants to see bonds sold to retirees in the form of annuities, they will have to require the bonds to be “bought”. It isn’t going to happen any other way.

That is why I say that the Treasury is going to grab retirement accounts. That is why I am concerned. That is why I wrote the post I did.

This process may take a couple years. It might not come to pass. There are certainly many obstacles that stand in the way.

But if they could sell ObamaCare, they can sell this. If they can legally require people to buy health insurance, requiring them to buy annuities to keep them from needing welfare in later years will not be a big jump. All the government wants to do is to “assure” retirees that they will have an income for the rest of their lives. It is the same type of justification that Obama has used for other intrusions into our lives. It is in line with the justification for Social Security. If it can be done, I am sure that Obama and his Gang can figure out all the buttons to push to get what they want.

Treasury Grab of Retirement Assets, Personal Consequences

2010-04-03T09:45:00.000-07:00

I have been thinking more about the consequences of the Treasury’s grab of retirement assets. It is what the Treasury is calling the issue of providing a “Lifetime Income Option in Retirement Plans”.

The idea is that they will take control of assets in defined contribution retirement plans, probably only 401(k) plans because those show the largest accumulations. The owners of the retirement accounts would then receive a government issued annuity backed by Treasury Bonds, i.e., the interest paid on Treasury Bonds will be used to fund the annuities and provide for the periodic payment to the retiree when he retires. There are a lot of details that are uncertain. For example, I have seen the suggestion that accounts under $250,000 are too small and won’t be touched.

Right off, there are several problems, not only for the retiree but all of us. In this post I am not considering the unparalleled damage done to the economy by removing such a huge pool of savings from private hands. Nor am I including the additional amazing damage to the rights and concept of property that seizing retirement accounts would entail. (a good blog on these points, see Bokor) My focus for this article is on the financial consequences that are more immediate.

It is somewhat difficult to predict exactly what is going to happen because none of the details are available, and may not be until the Treasury begins moving retirement accounts into the annuities. The following is clear. At some point the government will begin seizing accounts. It may seize only the accounts of retirees and those it deems close to retirement. It is unknown if they’ll seize more. But it will at least seize those and issue annuities for at least those who are retired. This may not be for just the newly retired, but anyone who is retired and has an account large enough to be attractive to seize. Since the reason for seizing retirement accounts is to use the money for government purposes, it will convert the assets to cash to buy government bonds, probably a newly created special class. The government will sell the securities in the seized retirement accounts.

This point is absolutely necessary to understand: The government will be selling the seized securities.

Since it will be selling at least the securities of the retired and the soon to be retired, we can count on those securities entering the market. What will happen when these securities hit the market? Who will buy them? Where is the money going to come from to soak up all of the securities being offered? Remember, the government is beginning to soak up funds for the massive amount of new Bonds due to BO’s deficits. The Fed may try to pump in the money, but it will take maybe up to a trillion dollars to cover the securities being offered by the Treasury, if they only offer amount for retirees and the soon to be retired. Even the Fed would be wary to begin pumping that much money. The Fed is currently trying to find a way to remove nearly $1T from the economy without letting interest rates rise.

Further, as people realize what is going to happen, there will already be selling. The market will have dropped significantly already by the time the Treasury begins selling the newly seized retirement accounts.

What is going to happen is that the markets for stocks and possibly bonds will both tank (and interest rates will skyrocket). With the amount of selling pressure that the Treasury will exert upon the markets, the stock market will see drops beyond anything in its history.

Generally, I am not an alarmist. I am not one of those who have expected the stock market to dive at various points in over the last forty years. I didn’t take Harry Browne or Peter Schiff particularly seriously. So my thoughts here are not the conclusions that I reach in most circumstances. I am saying that I am very concerned about the consequences of this particular potential action by the government.

The drop in the stock market in the recent panic occurred because it was a panic. The media began pushing the idea that our economy was failing months before real signs could be seen. The government didn’t really react one way or another at that time (I mean in terms of immediate actions that pushed the market lower.). Much of the dive was panic and fear, and not due to immediate economic factors.

The stock market dive in 1929 had much to do with the attempts of the Fed to stop price inflation by sharply reigning in the money supply (see Economics and the Public Welfare by Benjamin Anderson). Then the panic was due to government caused economic factors.

The panic and dive of the stock market as a result of the seizing of retirement accounts will be due to massive selling pressure from the government trying to raise money by selling stolen securities. It will be very obvious. Even if they try to do it in a phased manner, e.g., over the course of a year, it will be steady and relentless. And since everyone will know what is going on, there will be few buyers.

Let me compare the potential situation with another scenario. There are some commentators who suggest that as the baby-boomers retire, they will be selling off their retirement assets causing the market to decline. It might be suggested that there is little difference between the government doing it and the actions of the retirees. I suppose that there are some retirees who will sell all of the stocks on retirement day and buy bonds to have an income in retirement. It would be a bad idea, but there are many bad ideas floating around out there being used to “guide” people in their personal financial decisions. The difference here is that the government is going to seize all of the assets of this group and sell them off comprehensively. For the two to be similar, all of the baby-boomers retiring that year would have to sell all of their stocks without regard to current market conditions. I am expecting the Treasury to ignore current market conditions because they have the requirement to come up with the money. There certainly will be some heat, at some time, but will it be soon enough, loud enough, and principled enough to stop it? The Treasury won’t stop before the markets come down. They may later, but there will already have been much damage.

One factor in the Treasury’s “thinking” that should not be forgotten is that their justification for seizing retirement assets and issuing annuities is for the benefit of the retiree. The Treasury is doing a good thing for those poor, innocent, clueless old people. The rationalization will see the Treasury through any disaster that occurs. It won’t be their fault, but the market, capitalism.

You might think that the extreme drop in the equity markets would be a good buying opportunity. It isn’t. This sell off is planned to be a continuous thing, because the Treasury is aiming at all of the retirement assets of everyone (at least over a certain size of account). It will need the following years of stolen securities even more because the people at the Treasury will not be expecting the drop in market value that will occur. As every politician in history has planned on things not changing when they enact their plan to extract money from the economy, the Treasury and its supporter will not expect the market drop, so their plans on what to do with the money will be thwarted and they will need more. Lots more. If there is any economy left after all that BO has planned for us, the markets will only begin to recover when the retirement plan windfall dries up and the government has no more to sell. That is, the market will recover if the government hasn’t taken all other assets as well.

The bond market may react a little differently. Many of these retirement accounts have significant government bonds, which the Treasury might just hold as is. Depending upon when this occurs, since BO’s deficits already requires expanded bond sales, interest rates may already be higher and the Treasury may not want to put more bonds on the market. Some of the money that came out of the stock market before the Treasury begins selling the stolen securities may have gone into the bond market, especially if the interest rate had begun to rise. There are too many variables, including the foreign Treasury Bond investors. How the foreigners will react, and how the dollar will be affected will take much consideration. Certainly a sell off of our stock market will not be considered a good thing for the dollar. It should drop.

For the retirees and the others that had their assets seized by the government the situation will be dire. They may have said to themselves that at least they would get an annuity equal to their retirement account. But instead, they will get what the government received for their assets as the market fell. Don’t expect the government to keep tabs on whose account held what. Expect that the original owners of the retirement accounts will be treated very badly. Explicitly, the original owners of the seized retirement accounts could receive $0.50 on the dollar, $0.35 on the dollar, $0.10 on the dollar. Who knows? We can count on these victims to end up with a government annuity worth much less than their original retirement account, that it will not payout a significant percentage, and since the government may go broke, that it may not last as long as needed (if our failing health care system doesn’t do them in first). If what the government provides is a standard annuity, the income will be fixed, and all of the retirees will be left defenseless to the continuing price inflation. Given the potentials for rising price inflation in the next several years, the retirees could experience severe hardship.

What should you do? Right off, regardless of your age, when you see that the government is going to be able to get its hands on retirement assets, stop contributing to your retirement plan. Stop! Get your friends and relatives and colleges and everyone to stop contributing. Save your money from being taken. Next, to the extent you can, withdraw your assets from all retirement accounts. Yes, there is a tax penalty. For anyone over the age of 59½ it will be a straight shot of income tax. For those younger, it will include a 10% penalty for early withdrawal. You have to do the math, but to leave the money in the retirement accounts is to subject yourself to the risk of the government seizing it.

Don’t put any money into the markets. Keep cash. Sell what securities you own in any taxable accounts that you can. I expect many more will be doing the same, so try to be the first. The market is going to go down and down, even before the Treasury starts liquidating the retirement accounts it has seized. Some cash from those sales is better than less. Liquidate. You might try foreign investments. You might try commodities. You might try monetary metals. You might try foreign cash. As people flee the Treasury’s asset grab and the equity market, the government may attempt to put in place controls to achieve its purpose of seizing assets. If so, many of these avenues may be closed off. Again, keep up to date on news and make cautious decisions.

What we can do now is to express our opposition to the Treasury’s plan. We also have to keep a careful watch on the progress of their plan and, if it gets approved, its implementation.

"Too Big To Fail": Financial Reform

2010-03-30T20:16:00.000-07:00

As you would expect, the mainstream “experts” have it all wrong. Their idea of reform of the financial market is to attack the companies. They, the “experts”, decided when the financial crisis hit that some financial companies were “too big to fail”, and that the government must step in and “save” them by pouring mountains of money down drain holes. These companies were insolvent and needed to be liquidated, but the “experts” argued that the government must not let that happen, the consequences, they said, were too dire. But, people in general didn’t really buy off on that. There was enough of a ruckus about the massive amount of money spent in the bailouts that the “experts” then argued that something had to be done to avoid this problem in the future. Now, of course, that “something” did not include any suggestion that bailouts shouldn’t be made, or that the cause of the problem in the first place might be to government policy.

Now the Congress is considering what to do. We are now hearing from those same “experts”. As pointed out elsewhere (e.g., Meltdown by Thomas Woods) these “experts” are the same people who said that the rise of residential real estate prices was not a problem, that the types of mortgages being offered wasn’t a problem, that the increasing foreclosures wasn’t a problem, and that the initial problems with financial institutions wasn’t a problem. Why is anyone listening to these people now? Apparently, no one in the government and the media has the capability to learn from past mistakes. They certainly do not posses the ability to question any belief that they hold, let alone the ideas of the “experts”.

So the Congress is considering the issue of “reforming” the financial industry. The answer is of course, more regulation, which will mean more unproductive cost and layers of government employees with arbitrary power. But there is one proposal to which we should pay particular attention.

The answer to the “too big to fail” problem, it is shouted, is to reduce the size of the American financial companies. This is said, ironically, in the face of the fact that the solution to the potential failure of many financial companies was to push them off on other not-so-bad-off large financial companies, making the resulting companies much bigger. All of those companies that assisted in the “solution” to the last bust are now to be reduced in size.

One of the architects of the original mess, the crisis, the bailouts, and the lack of recovery, the Chairman of the Federal Reserve Board, Ben Bernanke, was recently speaking to a banking conference. He said, “If, in the end, funds must be injected to resolve a systemically critical institution safely, the ultimate cost must not fall on taxpayers or small financial institutions, but on those institutions that are the source of the too-big-to-fail problem,” Bernanke continued in his speech to the Independent Community Bankers of America. “It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms,” Bernanke said. “If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.”

Any history of the world financial markets will record that the push to increase the size of the major financial firms came from two sources, one is the market and the second is the actions of governments. The market would make the scope and range of activities in our world market pushing toward the ability of a financial firm to meet the demands of large, international companies, both in the lower costs of scale of a large company and the ability to work in the large size of the transactions required. The governmental actions were, to name a couple examples, the additional costs that regulations impose, which are easier to absorb for larger firms, the fact that the size of the funds is made larger than necessary by the constant inflation that central banks create, and the success of larger firms in receiving government handouts and favors (and giving the support that legislators require; this list of government influences is not meant to be exhaustive).

To the extent that American financial firms are forced to downsize, in contrast to their competitors in other countries, American firms will encounter a competitive disadvantage. The financial center of the world could and most likely will swing away from New York toward the East. We will see a self-imposed degradation of the United States and its ability to maintain a competitive position. American non-financial firms will tend to move toward foreign companies to meet their international financial requirements. American financial firms, being smaller, may be picked off and purchased by the larger Eastern institutions.

It may be the case that the U.S. government “experts” will attempt to encourage their foreign counterparts to follow their lead and downsize foreign financial firms. To the extent that all financial firms are downsized, we will see a curtailment of international activity as financing becomes less available. But, some countries will see the benefit of being financial giants, in a world of pigmies.

We will be seeing another step in the continuing destruction of the United States of America as a economic powerhouse and standard of freedom and individual liberty.

PARALLELS, NASTY ONES

2010-03-27T14:22:00.000-07:00

My perspective is economics, not that I am unaware of or concerned about the philosophic, moral, or political issues, but other people are writing about those and doing a fine job. I don’t see a reason for duplication. I don’t see much written about the economic implications and that is more where my experience and education lies, so, with that in mind, let me ask:

Do you notice the parallels between FDR and BO? Both began office after a huge dive in the economy: the stock market dove spectacularly in both cases, unemployment has soared to similar heights, there were financial crisis in both cases, both were preceded by Republicans who are regarded as somehow pro-capitalism but aren’t, both have pushed through public works bills, both pushed for overhauls of major parts of the economy, both are presenting themselves as saviors, and both are more concerned with power than any other issue. I am sure that there are more economic parallels.

Here we are into the second year of BO’s presidency, and, in spite of what the Fed and other government economists say, we are still in the recession. Unemployment is expected to remain high for years to come. Businesses and banks are unsure as to what to do because of the uncertainty as to what BO and his Congress will do to them in the near future. Further, what BO has done recently promises to weigh down the economy with massive expenses, higher federal debt, and tighter restrictions on production.

In other words, we have no good reason to think that our future will be any different now than the people in the 1930’s experienced. (It is true that BO has not started destroying food. Don’t put it past him.) To say this correctly, we are currently headed for continued recession that could last for years. Since BO, Treasury Secretary Geithner, and the Fed’s Bernanke do not know why the economy is not recovering, and would not consider freedom as an acceptable solution to the lack of recovery, we can expect more “solutions” that will sap our savings, and drive us further into recession/depression. Last time the Great Depression lasted 16 years without any questioning of the doctrine that kept us from prosperity. Even after the economy began working again, in 1946, when FDR was dead and Truman had put in his own people, no one questioned how the economy recovered without the government’s input. Today, no one is asking why the “recover” is so slow. Instead, they are doing everything possible to prevent recovery.

Further, after 70 or so years of encroachment by anti-capitalist measures, our economy has less vitality and room to maneuver than it did in the 30’s and 40’s. The government has more tools to manipulate and degrade economic performance today than it did before.

On the other hand, in some ways current businesses are more flexible and know more about their businesses than business managers in the 1930’s. Further, American businessmen have nearly a century of experience of how to work around government regulations and manipulation. That is not to say that they can bring our economy out of the recession, but they may be able to maintain their own and be modestly profitable. The large number of businesses dependent on government handouts will be a drag, as they continue to absorb savings and made-up money. It might sound as though this paragraph contradicts the previous one, but I am looking at the problem from first the restriction side and then the victim side. I don’t know which one will dominate, but both trends exist.

Frankly, what we have is uncertainty all around. But, keep in mind that uncertainty, in this circumstance, is a better condition than outright deterioration or a further dive.

In terms of your own situation, the best advice is to keep flexible. That doesn’t mean to stay in cash, including foreign cash, because cash is a guaranteed loss in a time period longer than a year. That doesn’t mean all gold, because the gold price, as we have seen over the last year, is bounced by many factors besides being a store of value. It doesn’t mean all foreign investments, because foreign economies are being buffeted by the same factors as the U.S. economy, including their own governments and central bankers. Foreign economies are also very dependent upon the U.S., so if we are failing, the likelihood of their flourishing is low.

What I think your best position includes is diversity, more so than ever, including foreign and domestic stocks, cash, foreign cash, and etf gold (least expensive way to hold it). No bonds of any kind. You do not want to be a lender in these circumstances.

Residential real estate is risky. If the situation is that your job could be in jeopardy, trying to hold on to the house could be a major problem. Buying today, even at low rates and lower prices is no guarantee that the purchase will work out for you in the next five years. If you have owned the house for some time and have equity in it, and the payments are relatively low, and you have some reserves, you are in a decent position. The biggest problem in these times is that the mortgage payment will tie you down, reduce your flexibility, and tend to present an inducement to remain in a perilous circumstance.

More than ever, you need knowledge. You need to know how these markets work. You need to know how the dollar relates to other currencies and foreign assets. You need to know how to watch your countries inflation monitors. You need to know what sources you can trust.

How long will this uncertain-stage last? It has lasted for several months so far, since the rush to dump employees slowed. We are waiting to see what effect BO’s massive new debt will have, we are waiting to see what the Fed does with all the money it created, we are waiting to see what consequences the new wave of regulations on all parts of the economy will have, we are waiting to see if BO can carry forward his massive expansion of government, and we are waiting to see if people are actually beginning to resist BO and the Dems. Combined, all of these issues are bad for even maintaining the current lull.

Prosperity is very unlikely if even a few of these economically stressful government activities come to fruition. I do not expect prosperity without at least some movement away from the future the present government and Congress have planned. Let’s say the Republicans win significantly in November. Will that mean that they will back us off of what BO will have instituted in his two years? It is unlikely. They may just decide that it is an opportunity for their brand of fascist state.

We could also see the economy begin a slow dive, not a panic, but just a decline as businesses find that they are not able to pay their debts or payrolls. This decline will not be signaled by any specific event. It could even be hid by the government’s statistical procedures. Just keep an eye out for a lack of growth, lack of non-government hiring, government talk of some segment or other of the economy failing to do their part, and the housing sector seeing more foreclosures and lower sales.

We may end up wishing we had a John Galt to unplug the minds keeping this thing alive.

Now, my focus is our economy. But as I said at the beginning of this post, I know that there is connection between the moral, political, and the economic, i.e., without freedom we cannot have a productive, prosperous economy. Without the morality of reason, of self-interest, we cannot have freedom. I am an advocate of individual rights and lazi-faire capitalism, of the virtue of selfishness.

I am talking to those whose fight is to achieve freedom. I merely want you to protect as much of your personal wealth and wiggle room as possible.

"Eliminating Reserve Requirements"

2010-03-22T18:58:00.000-07:00

There is one thing that is wondering around various commentators that I hope that you do not get caught up in. Ben Bernanke, Chairman of the Federal Reserve, is quoted, correctly it seems, in saying that he would like to see the eliminating of the reserve requirement.

Every commentator that I have seen so far is screaming and carrying on about how horrible this is that the Fed wants to eliminate bank reserves. They are a little confused. They apparently do not realize how banks function, especially within the United States and within the Fed.

Each bank in fact has two reserves. The bank keeps on hand possibly five layers of reserves. There is the cash on hand to meet the daily cash requirements of its customers. There is the digital balance it keeps on hand to meet the demand for check transfers and transactions. They also have reserves to cover loans that go bad, so that they can replace the demand deposit (checking account) balances. There is also part of their loan portfolio that consists of government bonds and other assets that may be turned into “cash” quickly. Finally, there is the capital account, made of the equity that was invested by the shareholders. (Note that the loan-loss account and the capital account may be kept in government bonds or other liquid assets.) Bernanke’s proposal has nothing to do with these account and reserves. He is not suggesting anything to do with a bank’s operating methods or what passes for safety in today’s banking environment.

The bank has one other “reserve”. It is the percentage of its demand deposits that it has to have deposited with the Fed. This deposit, called a reserve by the original legislation that set up the Fed, is not a reserve in any rational sense. The bank has to have these funds on deposit with the Fed by law and if by chance the percentage of the deposit vs. the amount of its demand deposits in the bank falls below the current requirement (today it is 10%, including cash in the bank’s vault, which is as low as I know of in the history of the Fed), then the bank must either move money immediately or borrow it from another bank (the inter-bank rate) or the Fed (the discount rate or Federal Funds rate).

It is this totally useless Fed deposit that Bernanke is suggesting be done away with. Which, on the face of it, doesn’t seem like a bad idea. I am interested in how Bernanke is going to carry forward the purpose of the Fed, which is to manipulate the money supply, expand bank lending, and make inflation a constant in our lives. It will be interesting to find out.

Actually, this isn’t anything worth paying much attention to, since it will not affect much that will make a difference. We will still have the Fed destroying our assets and ignoring that they are doing so.

Fed and the Money Supply: Details

2010-03-17T11:53:00.000-07:00

A thoughtful consideration of my articles on how the Fed works to expand bank credit, the Fed’s massive expansion of Member Reserve Deposits, and the steady decline in bank loans could easily result in some head scratching. My explanation of expanding bank credit (similar to what you find in Meltdown by Thomas Woods) would lead you to think that bank lending would be going crazy now, with the reserves built up to such a massive amount. There are, however, other factors at work in the process that I did not include in my discussion. I thought that my explanation of the Fed’s basic activities was long, complex, and convoluted enough without adding many other things in as well. I should also say that the degree of complexity is not really apparent until something like the present situation occurs.

What other factors? Well, there are basic banking practices, bank profitability, bank capital and loss reserve needs, and other regulators. This last factor is not minor. The banks have a galaxy of people looking over their shoulders. These regulators insist, and have the power to insist, that the banks follow certain “risk” and accounting standards. It isn’t that everyone of these standards are necessarily bad, but that the application can be arbitrary and outside of context. The standards change constantly, especially in their detail, which sometimes makes what the bank was doing in accordance with the regs yesterday, but today, that practice is wrong and subject to penalty. How this is working out in today’s circumstance is explained in this Forbes article. The author is an administration cheerleader, but he inadvertently gives you a very good idea of what is happening.

Most basic in considering a bank’s standard method of operating is that it is a business, with shareholders, employees, balance sheets, and standard operating practices that have been developed over centuries. Banks are in business to make a profit. Sound banking, to the extent that it can be found amid all of the nonsense required of banks today, also includes of many of the practices that any business needs to follow if it is to be profitable.

In addition, especially within today’s funny-money environment and the uncertainty of future of changes in regulation and government activity, a bank has to protect itself (think of the uncertainty BO’s TARP Tax created). The bank has several different accounts of its own that it maintains for financial protection. It has a capital account, what you could also call equity. The bank’s capital is reduced if it operates at a loss or if other assets are lost. The bank also has a loan-loss reserve, which is an account of cash that the bank keeps to cover bad loans and the failure of other assets, e.g., mortgage backed securities. During the financial crisis, many banks saw significant shrinkage in these two accounts. In order to restore the health of a bank, these two accounts have to be built back up. Banks cannot and will not expand their loans again until they have a healthy capital account (which would be a certain ratio to its obligations) and loss-loan reserve (also a certain ratio to outstanding and new loans). In the normal course of events, these accounts would be increased by either by going to the capital market or by retaining profits. The capital market is not functioning well right now, especially for banks, and profits are hard to come by. Sensible banking is standing in the way of the government’s (read BO and the Fed) demands for increased loans.

One might suggest that a bank could take some of the excess reserves that the Fed has given the bank and put that in either of these important accounts. But it can’t. There is no legitimate accounting method to do so. It is exactly the same problem for someone who wants to take stolen money or drug profits and put into a business. There is no way to account for it.

A bank can take money the Fed has created and placed in a bank’s “reserves”, but there is only one use that it can put that “money” toward: loans. When I wrote that a bank with an increased reserve could then make loans, I was implying a practice that is not the norm. I am not aware of any restriction preventing a bank from just expanding its loan portfolio when its reserves have been expanded, assuming that the capital and loan-loss reserves are sufficient. It may be that the accounting techniques available do not support that approach. For whatever reason, banks tend to take a different approach.

What happens is that the bank will take excess funds out of their Fed account, presumably a percentage that leaves the required deposit in their Fed account. This “money” (in quotes because it is stuff that the Fed created) the bank then loans.

The process probably goes like this. The Fed has selected a target interest rate below market for the Federal Funds/discount rate. To maintain that low rate, the Fed will be buying Federal bonds from institutions. When the bank presents the check for the purchase of the bonds to the Fed, the Fed puts the funds into the “reserve” account of that bank at the Fed. The bank now has more funds in their “reserve” account than they need for the demand deposits held by the bank. If a “qualified” loan applicant is available (qualified in quotes because low interest rates distorts, undercuts the real criteria needed to make loans, i.e., a market interest rate), the bank takes the “money” out of the reserve account, leaving at least sufficient funds to cover its reserve requirement, and loans the “money” to the applicant. And thus the money in circulation has been expanded. The funds loaned are used to pay bills related to the purpose of the loan, which means that the “money” shows up in other banks’ demand deposits, which those banks use as they use any money. They adjust their Fed reserve account to reflect the increase in demand deposits, and loan out a portion in new loans. After this process continues through its natural course of movement from bank account to bank account, the ultimate increase in the money supply comes close to equaling the reserve ratio. Today, large city banks are required to have 10% of their demand deposits in their Fed accounts (currently, they can count cash in their own vault as part of the “reserve”). Thus, an increase in the “reserves” of $1B can see an increase in the money supply of $10B.

As much as the Fed and, today, BO, would like to see an automatic process whereby the Fed can force up the money supply, just by increasing the Member’s deposits, as we see above, there are some countervailing forces. How long those forces will remain in effect is the current question.

It is also the case that as much as the Fed wants banks to begin lending again, it doesn’t want them to be lending as much as the current massively, over-funded Member’s accounts would allow. Currently, there is over $1T in excess reserves. That is more than any historical period by a factor of close to 100,000! Even the Fed, which normally ignores the actual pumping of money, is concerned about the amount of reserves currently sitting there.

But what is the Fed to do? Bank loans are actually still declining. Interest rates, according to mainstream economics, have to remain low to stimulate the economy. As soon as the Fed starts withdrawing the excess reserves, interest rates will start up, especially long-term rates, and all kinds of unwanted consequences will result, including increased interest expenses in an already bloated federal budget. BO will start yelling at the Fed and the Congress will start “investigating”! Also, the stock market will dive, (the dollar might actually strengthen, who knows?) housing purchases will decline as mortgage rates go up, and the economy will tend to slow. If it weren’t that we are all living in the middle of this circus, it would be fun to watch.

As of yesterday, the Fed again reassured everyone that interest rates will remain low. Aren’t they nice?

My Return; Four Comments

2010-03-03T19:12:00.000-08:00

Storms, cat sitting (my good friend, George), being sick – for way too long, and stuff have put me way behind. I haven’t touched this for weeks. I hope to get back to my efforts.

For today, let me hit a news story or two, err…four.

HEALTH CARE

Recent announcements from people who keep track of it put government spending on health care at almost 50% of the total this year and more than 50% next year. After that, especially with Medicare and then whatever BO gets into the system, government spending will soar!

What does this mean? You know already. More of the same annual inflation of the cost of health care, plus probable rationing, attempts at price controls (MA is approaching that now), and a lowering of the quality and quantity of health care in America. Because of the recession, the loss of our high health care standards will happen earlier than we might have expected. It is all interrelated, the economy and our quality of life.

RECESSION

Speaking of the economy, the recession is lingering. Yes, some have proclaimed the recession over. Maybe in some respects it is, but even then, it is a very marginal thing. I see no immediate reason to declare that our standard of living is recovering. In fact, it is just the opposite.

Now there are stories in the press that the economy will suffer a decline again very soon. You might say that it is good that the press is recognizing the failure of the approach accepted by both Dems and Republicans alike (does “Repub” sound like a nice fit with “Dems”?). You would be wrong. These “economists” who are forecasting renewed recession are doing so because the government hasn’t interfered sufficiently or in quite the right way for their taste. They want more government activity, in areas they think are important. How bizarre. The disconnect with reality is so severe for today’s “economists” that no level of failure will cause them to reevaluate their position.

As the decline in January of the housing market indicated, the stimulus programs that BO put in place are failing to get the economy going. In stead, the economy is still pretty much not going anywhere. Job losses have flattened, bank lending is still falling, and businesses are trying to do the best they can.

PRICE INFLATION

If BO does get some more of his programs in place I think that we will begin to see some more significant price inflation. He will be pumping massive amounts of money, new, made-up money (by way of selling bonds overseas or through the Fed), directly into the economy (as opposed to the method used when new money is created by the Fed via bank credit expansion), which will chase after the stuff already available, and prices will rise. We won’t be seeing the asset or commodity bubbles because bank lending is still declining. Price rises will confound everyone, including the Fed, and we may revisit price controls. We certainly will not see spending reductions from the Federal government for the next three years, even if the Dems lose a lot of seats in the coming election.

GLOBAL WARMING

I don’t write much about this because it is well covered by others and I don’t have anything new to contribute. I did see this on facebook, so I thought that I might mention it.

This was referenced by some conservatives as a good reply to the global warming croud. I’m not sure why. It may be a put up job. It certainly is a denunciation if you regard religion as wrong, but it is offered by the conservatives (?). It does take the science out of the global warming movement, which is a good thing. It doesn’t give any importance to the political aspect of the global warming people, which is their main objective.

GRAB FOR RETIREMENT ACCOUNTS

This subject should make you very concerned, if you have any significant amount of money in what are called qualified retirement accounts, i.e., IRAs (Roth or traditional), 401(k)s, Simple Plans, Money Purchase Plans, etc. The government, under the assertion that most investors are mismanaging their retirement assets, are suggesting that the funds be turned into annuities. Annuities give you a stream of income that lasts as long as you are alive.

The intention of the government is to move that money into government securities, i.e., bonds. Thus, it won’t matter what China or other overseas bond buyers do in the future, the government will have trillions of dollars to use from the retirement accounts.

There are many downsides to this plan for you, financially speaking. The biggest is that an annuity offers absolutely no protection form inflation. You are on a fixed income. But that, of course is a secondary point. Most important is their plan to forcibly separate you from your assets. Watch this carefully. If they get close to bringing their plan to fruition, you will want to pay the taxes and move whatever money you can to a non-qualified account. In the meantime, you will need to talk to your representation to stop it.

Like the attempt to subvert your health care, this attack on your retirement assets has personal repercussions on you. If you talk to make comments to the Treasury, I think that it is important to point out the principled and practical consequences on you, both moral and financial. You don’t want to lose this battle because the authorities did not realize that you feared for your financial health as well as your freedom. If they don’t care about your freedom, they still might be concerned about the other. We don’t know. Don’t leave out either issue.

Social Security, Medicare Update: Problems Start Now

2010-02-05T11:56:00.000-08:00

I have referred to the dire warning sent out by John Lewis a few months ago about Social Security, Medicare, and Federal Spending. Dr. Lewis used a report written by a former government budget official, which was based upon current information at that time. Well, surprise, the recession has had an impact.

According to a report (here) Social Security is experiencing a shortfall in its revenue this year, many years before the last Social Security report expected. It will need to draw on the “Trust Fund” this year. The SSA won’t need much to meet its needs, but the real problem is that SSA revenue was expected to exceed it needs and add to money to the Federal Budget. So the deficit will be larger than they expected.

Further, as long as the number of workers contributing to Social Security remains less than needed to meets its needs, we will see Social Security dipping into income tax revenue and the deficit will become larger.

I am sure that there is consternation in the Treasury Dept. I am sure that BO and most of his gang aren’t paying any attention.

It doesn’t mean that the problems that John Lewis warned us about will happen that much sooner, because that mess is more dependent upon the age of the population.

What we will see is larger deficits, larger Treasury Bond auctions, more resources removed from real economic activity, slower growth, slow job growth, more recession, more made-up money being created, and probably higher price inflation.

The Question of Obama

2010-02-03T18:28:00.000-08:00

When I look at the next few years, one of the big questions that I have is the real nature of Obama. Every time he presents another of his ideas it seems more extreme than I could have expected, more cut off from the real world, more bazaar, more like we are living in Venezuela. I am serious, Obama is envious of Chavez, just as FDR was envious of Mussolini. Therefore, I want to ask a question:

Does Obama have any sense of restraint? Can he restrain himself?

I ask because I have seen no restraint in any of his actions so far. In each of his major proposals and attempts to push forward his program, he seems to go for the full effect at once.

His health care plan was nearly full socialism. And in spite of growing resistance to his health care plan, he still seeks a way, any way, to pass the thing.

In the face of an economy that is showing no real start of a recovery, he has presented a budget that will spend outrageous amounts. Actually, I don’t have an adjective that fully expresses the audacity of the “thinking” that is behind this budget.

With no sign that his previous “stimulus” packages have provided any benefit, he is demanding a big new one.

With the Supreme Court sitting immediately in front of him, he criticizes their pro-free speech ruling.

He barges into the Republican retreat and plays gangster, and then pleads with to give him all the power he wants to do things his way.

He criticizes people for wanting to have fun and offends another Dem.

He verbally attacks anyone who he thinks the public will allow him to bludgeon, like banks or major corporations.

Practically in the same day he demonizes the banks for taking on too much risk and then for not taking risks when he wants them to do so.

I am sure that the list can go on a lot longer, but you’re saying, “yes, we know”.

What is he going to do when he becomes really frustrated? What is he going to do later in the year or next year when it is clear that the economy is not going anywhere? What is he going to do when low tax revenues are making the Treasury borrow sums of money that is causing the market to choke and long-term interest rates go soaring. And then criticism becomes more severe. Is BO going to retreat? Or is he going to become more aggressive, call on his still loyal, younger supporters and demand change. Is he going to instruct his loyal people in the administration to nationalize the businesses that are not bending to his will? Is he going to …?

What is he going to do?

I don’t know. In the past we have been confident in the willingness of politicians to follow the legal procedures of office. But we have seen actions in the last two years that completely ignore property rights and there has been no real protest within the Washington establishment. It began with Bush, and BO is quite willing to follow in Bushes footsteps and beyond. I wonder if BO has any restraint. I wonder if BO is willing to accept any significant opposition to his desires.

Do you have a feel for the man? Will he accept frustration? If, as I suspect now, that in the next election he will lose the majority he has in at least one House of Congress, will accept defeat?

What do you think he will do?

Bernanke's Confirmation: No! Err... Well....Okay

2010-01-27T19:37:00.000-08:00

Ben S. Bernanke, the Chairman of the Federal Reserve Board, is facing some opposition in winning a confirmation for his second term as Chair. As a man who is nearly universally proclaimed as the savior of the American economy from a deep depression, it seems amazing. The mainstream press has been a cheerleader and books have been written extolling his heroics. What is happening?

My own view of the man is spread throughout this blog, especially in my comments on his speech on January 2nd. He practices a science that is tailor made to not learn of causal relationships. He gives the impression of being non-political. He appears to be the ultimate academic bureaucrat.

Bernanke always appears poised and rock solid in his pronouncements and prognostications. This is his view of how a Fed Chair should be. Unfortunately, he appears rock solid regardless of the veracity or wisdom of his statements. Here are some examples: He appeared poised and rock solid when he said that there was no problem with the rise in housing prices a couple years ago. He appeared the same when he said that the problems with foreclosures would have no impact on the economy. He appeared the same when he said that Fannie Mae and Freddy Mac were in excellent financial health. He appeared the same when he and the Treasury nationalized the failing Fannie Mae and Freddy Mac a few days later. He appeared the same when he began nationalizing banks and put a couple trillion dollars into the economy. He appeared the same when he said that events that coincided with injections of money were coincidences. He appeared the same when he said that the probable cause of the foreclosure problem was the use of risky mortgages offered to substandard credit borrowers, even though he knew that the Fed had pushed with the rest of the Federal government for lowering credit standards for mortgages for years. The guy has an appearance that does not connect to the real world.

I also think that any man who accepts the chair of the Fed has to be regarded as having a questionable psychology. This is one of the most powerful, political positions in the world. Anyone willing to accept that much power over his fellow man has problems.

At this point, there is very little suggestion in the mainstream press that the Fed is responsible for the house price bubble. As I mentioned, there is nearly universal acclaim for his leadership in keeping the U.S. economy from depression. Why then is his confirmation being opposed by several Democrats?

The good news is that several democrats are criticizing Bernanke for the bailouts. The bad news is that they are criticizing the bailouts primarily because these politicians think the companies bailed out are unpopular. It is a play of the class warfare card.

It is okay, they think for the Fed to have pumped a trillion or two into the economy. It is okay for him to have wielded the power he has, along with the Treasury.

One set of criticisms of Bernanke is that he gave too much money to AIG and did not add conditions. These criticisms aren’t that Bernanke bailed out AIG, but that he didn’t do it in a certain fashion. Somehow, in his headlong dash to dole out all the money he could create, Bernanke was suppose to make sure that the money wasn’t suppose to be used for AIG’s actual business, which, in this case, was to insure certain investments tied to mortgage backed securities. If AIG failed to meet its contractual obligations, those companies would suffer sever difficulties and many would fail. What was AIG suppose to do with the money? These congressional critics are all for the use of government money as a means of manipulating the economy, confiscate assets, and generally extend the government’s reach, but they are outraged that the money was used for contracted, normal business activities. It is just another example of the attitude of the political climate that the importance of contract is ignored and denied. The worthiness of attacking a person because their actions inadvertently helped a company that can be attacked for political gain.

One criticism that I have heard only a little is that he has lied at several stages of the bail-out. He lied to BoA on the financial health of Merrill Lynch, and then when they found out the depth of the problem he threatened the Bank’s leadership and implied that he would put someone in their place who would do what he, Bernanke, wanted. The man feels as though he may do as he pleases with his power. He lied about the AIG deal and his representatives at the New York Fed told AIG to keep quite (for which the AIG officials are blamed with the suggestion that AIG instigated the deceit, when it was obviously the Fed). He has lied about the role of the Fed in the lowering of credit standards for sub-prime mortgages, implying that it was the nefarious and evil mortgage brokers, who had only their jobs and businesses to loose. The man apparently feels that any statement he makes is acceptable because he is “saving” the country from depression. He must “do all it takes”, which means forcing people to do what is not in their best interest. At best, Bernanke believes in sacrificing others for the sake of “the greater good”. Not to psychologize, but it is just as possible that he just likes the power.

I have seen that many people are happy that Bernanke may be rejected. They are joining the chorus, albeit a small one at the moment, in calling for his confirmation to fail. Bernanke should be fired, at the very least. He should not continue in a post that he doesn’t understand and mishandled so badly. I cannot deny that I too would feel good about the Senate sending him home. But. But! BUT! There is a small, okay, a big problem.

If Bernanke, the lying, self-deluded, power craving, freedom destroying, bureaucrat loses his job on Sunday. What happens? Obama gets to appoint a new Fed Chairman. Obama. Obama gets to appoint the person who is quite possibly the most powerful person in the world economy. Obama.

I am afraid. The prospect of Obama placing a person in the Fed Chair frightens me more than Bernanke does.

I have not kept track of Obama’s appointments. But from what I can tell, his people are radical, anti-freedom socialists and fascists. I am not aware of a single competent person. The guy at the Treasury is the one who forced through much of the current economic plan as head of the New York Fed. He came to the government from Goldman Sacks, and he turns out to be a pragmatist of the first order, willing to use government power to control and manipulate. He is not a capitalist. If there are people in Obama’s administration who do not want to actively expand government power, they haven’t made an impact.

So, what can we expect from an Obama appointment that could get through the Senate confirmation process? Anyone who has paid their taxes, including their nannies taxes, who will use the Fed as the means to further corrupt, undermine, and destroy what little remains of our freedom and capitalistic system. Is that better than Bernanke? Bernanke’s one little bitty redeeming piece of character is that he is an academic, as corrupt and pragmatic as that is. He is not overtly political. He is certainly not a supporter of capitalism, and he has shown no willingness to oppose any of Obama’s drive to fascism. Nor will his policies help stabilize and strengthen the economy. But, he is not going to act as Obama’s pawn or tool in the manner that Obama’s own selection would. It is a small difference, but sufficient that I am willing to argue for Bernanke’s return for another term.

If you want to argue that putting Obama’s person into the Fed will make our current situation much worse and that people will rebel against Obama and the destruction of our freedom I am willing to listen. But, I think that it is too early for us to do that. People don’t know any more about freedom and capitalism than they did three years ago. It is still too soon. I think that we can use more time in a slowly deteriorating situation to further our efforts to save our freedom and the United States of America. I want more time.

Social Security and Medicare: "Trust Funds"

2010-01-20T15:43:00.000-08:00

A few months ago John Lewis published a “dire warning” about the future of the economy. [http://theobjectivestandard.com/blog/2009/08/dire-message-of-mr-david-walker.asp] This article concerns the near future proportional increase in retirees, the Baby Boomers, and their impact on the costs of Medicare and Social Security. To say the least, it will make all of today’s arguments regarding the budget superfluous. All of the facts and figures are in the material that Dr. Lewis references. I will not include them here. This post is meant to talk through the things that are going to happen, especially the impact of the “Trust Funds” of Social Security and Medicare.

You will hear some politicians argue quite loudly that, even if there may be a problem down the road, it is not now because both programs have trust funds that will provide money for several years. The date that the government has to begin adding funding to both programs is, thus, some time in the future and they don’t worry about it now.

Well, yes, both programs have “Trust Funds”. That is, both programs have had more money paid into them over the years by taxpayers than the programs have paid out. This “surplus” has been put into a trust fund. Each trust fund has securities in it that may be exchanged for cash as needed, and the cash is then paid out in benefits. So, these politicians are correct, right?

The recent annual report of the Medicare Trust Fund revealed that this program is already spending more than the Medicare Tax is bringing in. The short fall began in 2008. Medicare has begun redeeming “Trust Fund Assets”. Because of the recent short fall, they now expect the “Trust Fund” to be exhausted in 2017.

The Social Security Trust Fund is still taking in more money than it is spending, but the recent troubles in the economy have, no doubt, changed the “projected” dates as well.

When the Medicare Administration projects that they will fall short of Medicare claims they will not cover 19% of the annual cost of the program. As these claims are “entitlements”, the shortfall would have to be made up by general Federal Government revenue, or taxes and the proceeds of bond sales. So, according to our politicians, we have 8 years to solve this problem, right? We have even more years to solve the Social Security problem.

Ahhh. Let’s take a look at those “Trust Funds”. That money is invested in securities, right? Well, depends upon your definition. What the administrators were allowed by law to buy with their “surplus” is a special class of Treasury Bonds. These bonds pay interest, which are probably close to market, so they are accumulating assets, right? Okay, we are at the crux of the issue now. The Treasury of the United States sells these special bonds to the “Trust Funds”, and guess what the Treasury did with the money? They put the money into the General Fund, and spent it as they did with all the other tax money and the proceeds from bond sales. And the accounting, you ask? The money from the “Trust Funds” reduced the annual deficit of the Federal Government. The Treasury had to sell fewer bonds.

Administration after administration has been spending the Social Security and Medicare surpluses and pretending that it was general revenue, not some future debt. In many cases the administration crowed about the way it was decreasing the Federal Deficit.

In this case, however, it isn’t like the standard Treasury Bond that no politician expects to ever pay back. These special “Trust Fund” bonds have to be paid back as the two entitlement programs fall short of meeting their required payments from the FICA taxes. In practice, it means that the Treasury will have to sell more standard bonds. Did anyone say Ponzi?

I ask you, what is the difference between taking money from taxes and the proceeds of bond sales and redeeming special bonds for covering Medicare expenditures, and giving the money directly to Medicare after the “Trust Fund” Bonds are depleted? The Trust Funds are a standard government fiction, which allows some (many, most?) politicians to duck the issue.

Social Security is “projected” to need to dip into its “Trust Fund” in the middle of the next decade. Like any government projections, the government planners have foretold of wonderful years of tax collection because the economy will be booming and employment will be below 5%. Even if you count all of the non-employed as tax payers, there are far more than 5% unemployed, and current prognoses, even from the most optimistic government hack is that the employment part of the recovery will be slow. The number of retirees is growing, maybe even faster than expected (for Social Security), thus the outflow is growing at least as fast as expected, but the income is less, probably a lot less. That means that Social Security will begin drawing on its “Trust Fund” sooner, and more Treasury Bonds will need to be sold, more money will be taken from the economy, which means either less capital for investment and slower growth (if any) or more made-up money, i.e., inflation.

All of this will be on top of whatever programs our beloved leader can manage to get passed.

Some of you are eager for the end of the year when the Democratic strangle hold on our government will hopefully be reduced. I tend to think that a mix of Dems and Republicans is a nice safe government. But it won’t help this situation, because it will require a direct look at reality and the willingness and ability to tell the American citizen, especially the older American citizen, that the cupboard is pretty skimpy. The Republicans, who are after all, working to “conserve” the New Deal, have shown just as much willingness to ignore reality as the Dems.

In the meantime we can watch the drama being played out in Japan. Their problems with the same issue are more immediate and proportionally larger than ours. More than half of their population is dependent upon the government pension. Their elderly tends to depend upon their children, but that percentage is declining. The aging of the Japanese population is more rapid than other industrial countries. At the same time the population is shrinking.

The government has been steadily pushing up the retirement age and the age that government pensions begin. Japanese use to retire at age 50, now it is 60. The government pension begins at age 65, up from age 55. So a Japanese has a 5-year period that has to be filled in somehow.

But, get this, the taxes to support the retirees is a combined 30%, down from 40%. Part is paid by the employee and part by the employer. In the U.S. the combined tax is 15.3%.

Where are they going to get the income to support their elderly? The same place we will? We may be seeing real tragedies both at home and abroad. The European countries are heading for the same problem at various speeds, most of them will begin to see major problems before we do.

When we get done with the health insurance thing, whichever way it goes, we need to begin beating upon these people about this coming storm.