GMAC - so sad

Nice post from Denninger. 

In short, GMAC (financing arm of GM) borrows money from the government at 8% and lends it to customers with below average credit ratings at 0% in to let them purchase cars that GM will lose money on. 

This is wealth destruction at its finest. Every time GM produces a car, thousands of dollars  in wealth are destroyed since the costs of building the car are thousands of dollars more than the price customers are willing to pay for the car. In a normal market, this would quickly drive a company out of business and shift production to more efficient companies that are meeting customer demands. Instead, the United States government levels the playing field by subsidizing the worst companies. After all, it's no fair that GM can't compete -- clearly, the remedy for this is to have the productive members of society (tax payers) subsidize GM inability to compete. It's as if the government were using Atlas Shrugged as its playbook.

Cops raid house growing Christman Trees

This is so freaking awesome.

KopBusters rented a house in Odessa, Texas and began growing two small Christmas trees under a grow light similar to those used for growing marijuana. When faced with a suspected marijuana grow, the police usually use illegal FLIR cameras and/or lie on the search warrant affidavit claiming they have probable cause to raid the house. Instead of conducting a proper investigation which usually leads to no probable cause, the Kops lie on the affidavit claiming a confidential informant saw the plants and/or the police could smell marijuana coming from the suspected house.

The trap was set and less than 24 hours later, the Odessa narcotics unit raided the house only to find KopBuster’s attorney waiting under a system of complex gadgetry and spy cameras that streamed online to the KopBuster’s secret mobile office nearby.

Vintage Keynesian propaganda

Oh my goodness. This is hillarious. I can't wait for Bernanke to appear in an updated video that explains how great inflation is. Of course, this is pure Keynesian nonsense. Got gold?

Not to be outdone, the government later came up with the Whip Inflation Now campaign three decades later. I guess the government decided inflation wasn't that great after all.

Austrian economics matters more than ever

Lew Rockwell speaks about why Austrian Economics matters more than ever.

Interview with Nassim Taleb

An interesting interview with Nassim Taleb on Charlie Rose (HT Vijay). Talking about Bernanke and other economsts, he says

It's just that class of people who are into economics, and have this illusion, [who] provide us with these analytics that provide us with the illusion of understanding the world and that I find very dangerous. Because the economic establishment, as a class, has been extremely incompetent in history. It's like medieval medicine. Medieval doctors killed more patients than they saved.. they can't predict better than cab drivers...And I blame this crisis on economsts, financial economists particularly.

This is very much similar to what Mises talks about in Human Action, which I cover in another blog post. 

Mainstream economists today such as Krugman and Bernanke use macroecomomic theories and build complex mathematical models using “scientific principles” to model the economy. These aren't built on axioms about the fundamenetal nature of human behavior but rather built upon historical data and events. They use the methods of science by measuring all types of indices in the economy such as unemployment and prices and then plug them into their models and formulas to decide how to intervene in the market in order to accomplish some type of policy goal. They look like they know what they are doing because they use the facade of science, but in reality, their economics is pseudo-science and their models are worthless, as we just learned again for the millionth time.

Human Action by Ludwig von Mises (Part 1)

I started reading Human Action which is the magnum opus of Ludwig von Mises, the great Austrian economist. I recently finished part 1 and the work is nothing short of brilliant.

Human Action is not for the faint of heart. Comprising over 900 pages, it is a very dense and methodical treatise on the nature of economic activity. In many ways, it is like reading a math paper rather than the typical economics book. This is because Mises starts with a small number of axioms and builds his entire theory of human action and markets upon them. It reminds me of studying Euclidian Geometry in 8th grade where one could prove all kinds of interesting results with just a handful of axioms about the properties of parallel lines and right angles.

Human Action is not the work I would recommend for those who want an introduction to Austrian economics. It's a real commitment and it's more interesting to tackle after becoming familiar with the principles of Austrian economics by reading more accessible works. I generally recommend Economics in One Lesson by Hazlitt and What Has Government Done to Our Money by Rothbard as good introductions.

The first 100 pages of Human Action provide the philosophical underpinnings of Austrian economics. Mises rejects positivism, i.e. the scientific approach, for understanding Economics. At first, this might sound kind of strange. Why would one reject the scientific method for trying to describe how economic activity works? As an engineer with a background in science, I was skeptical the first time I heard this -- I was trained to use science to understand and manipulate the world. As an aside, Mises' younger brother was a very prominent applied physicist.

Mises rejected the scientific method for economics not because he rejected science. Mises rejected it because the scientific method can’t help us understand economics. The scientific method works when one can run repeatable and verifiable experiments to test hypotheses. We all learned about hypotheses, theories, and experiments in grade school. The laws of physics and chemistry are constant and our theories for explaining them can be tested and falsified with experiments. This is why the scientific method works for understanding the laws of nature. The ultimate test for our scientific theories is how well they can be used to make predictions about the world.

Economics, on the other hand, involves human actors participating in the passage of time. The scientific method cannot be applied because there is no way to run repeatable experiments to test our theories. What caused the Great Depression? The scientific method can't help us with that because we can't go back to 1929 and run a repeatable experiment where we change a single variable to see if we still get a Great Depression. Without the ability to run experiments that use controls and manipulate one variable at a time, there is no way to use the scientific approach to test economic theories. Using the scientific approach just doesn’t work.

Besides the fact that there is no way to run repeatable experiments, the scientific method also does not apply because the laws of human action are not fixed like the laws of science. There are billions of humans in the world and they each act according to their own free will. There is no theory or scientific model that can model the actions of billions of humans. The Federal Reserve tries to build models for economic activity and it's no surprise they never get it right. Their models just can't account for understanding the subjective desires and actions of billions of people. And this isn’t just a matter of needing better models and computers. The model cannot work because human beings react to the model. The laws of physics do not change because we build a model for understanding force and energy, but humans do react to what the Federal Reserve does. It is impossible to model human action because humans will change their behavior based on the existence of the model. It's the ultimate uncertainty principle.

Mises explains, “We are faced with the same main differences between physics and chemistry on one hand and the sciences of human action on the other. In the realm of physical and chemical events, there exist constant relations between magnitudes, and man is capable of discovering these constants with reasonable degree of precision by means of laboratory experiments. No such constants exist in the field of human action.” He goes on, “The impracticability of the measurement is not due to the lack of technical methods for the establishment of measure. It is due to the absence of constant relations…Statistical figures referring to economic events are historical data. They tell us what happened in a nonrepeatable historical case.” This reminds me of those models used by the rating agencies. They used historical housing prices to claim housing would not drop in price and to justify AAA ratings for all those CDOs.

The reason this subtle point is so important to understand is that it is the fundamental difference between mainstream economics and Austrian economics. Mainstream economists today such as Krugman and Bernanke use macroecomomic theories and build complex mathematical models using “scientific principles” to model the economy. These aren't built on axioms about the fundamenetal nature of human behavior but rather built upon historical data and events. They use the methods of science by measuring all types of indices in the economy such as unemployment and prices and then plug them into their models and formulas to decide how to intervene in the market in order to accomplish some type of policy goal. They look like they know what they are doing because they use the facade of science, but in reality, their economics is pseudo-science and their models are worthless, as we just learned again for the millionth time.

The approach Mises takes is one based on a priori axioms. He builds up the theory as a mathematician would. He defines a framework called praxelogy for understanding human action. His primary axiom is that humans are actors with logical thought and they take actions in order to decrease dissatisfaction. It's not relevant what the end goal of the individual is, just that it is based on the individual's own subjective values. Humans prioritize their dissatisfactions and take actions one a time to reduce uneasiness associated with their dissatisfactions. Mises writes, “Human life is an unceasing sequence of single actions. But the single action is by no means isolated. It is a link in a chain of actions which together form an action on a higher level aiming at a more distant end.”

Another axiom is that acting man ranks his desires on a scale of values in order to satisfy his highest priority desires over his lower priority desires. This scale of wants only exists and can be observed through a man’s actions. Mises says, “Action sorts and grades; originally it knows only ordinal numbers, not cardinal numbers.” In other words, man does not decide what the absolute values of two commodities are. He only decides between definite quantities when given a concrete choice. He writes, "Acting man is not in a position whether he must choose between all the gold and all the iron. Hs decision in choosing between 100 ounces of gold and 100 tons of iron does not depend at all on the decision he would make if he were in the highly improbable situation of choosing between all the gold and all the iron. What counts alone for his actual choice is whether under existing conditions he considers the direct or indirect satisfaction with 100 ounces of gold could give as greater or smaller than the direct or indirect satisfaction of 100 tons of iron. He does not express an academic or philosophical judgment concerning the “absolute” value of gold and iron; he does not determine whether gold or iron is more important for mankind; he does not perorate as an author of books on the philosophy of history or ethical principles. He simply chooses between two satisfactions both which he cannot have together.”

Building upon these axioms, Mises develops a theory of returns and marginal utility. In part 2, which I haven’t started yet, he addresses how human action works within the framework of society. My sense from what I've read is that I will learn how the market forms from the aggregation of each individual's ranking of scarce goods. Ths should ultimately set prices for commodities and labor. More to come as I read more.

Academia's War Against Free Market Money

Gary North wrote a beautiful essay on how mainstream economists marginalize followers of Austrian economics, the people who predicted the recession while the mainstream economsts were patting themselves on the back for all the wealth that was being created due to the increase in housng prices.

I love this little jab at Bernanke, Krugman, and the likes:

The real market test is not what a guild of self-accredited academic economists write in the tenured safety of their tax-funded ivory towers. It is not what a committee of equally subsidized peers determines is fit for publication in the guild's unread and unreadable academic journals. It is the market outside the insulated halls of ivy that determines what survives and what does not.

He then uses the debate between Peter Schiff and Arthur Laffer as an example of how the main stream economists who manage the economy just have no clue.

The debate goes on. This time, however, it is between two real-world economists. One has a Ph.D. from the University of Chicago. The other has no Ph.D. Neither is in academia. They both sell their services as forecasters. Schiff saw this bust coming and said so on national television in 2006. Laffer responded on-screen, dismissing this prediction as nonsense. The video is here.

Schiff said that America would enter a major recession in 2007 or 2008, and that it would be long and deep. Laffer was contemptuous of Schiff's forecast. "I don't know where he is getting this," he said.

He was getting it from Mises. He was getting it from Murray Rothbard. In short, he was getting it from Austrian School economics.

He concludes

The debate between Mises and Fisher, Mises and the Chicago School, and Schiff vs. mainstream economists in 2006 boil down to this: Can we trust the Federal Reserve System? The Austrian School's answer: no. Why not? Because the Federal Reserve System substitutes the judgment of monopolistic central planners for consumers and investors. It substitutes the decisions of people with job tenure and little accountability for the decisions of people who put their own wealth at risk. It substitutes the judgments of non-owners for owners. We find that academic economists, either tenured or seeking tenure, side with Fisher. The textbooks side with the academic economists.

You would be wise to side with Mises.

Officially in Recession

We're in a recession according to the NBER. As Vijay said, "They're like a weather bureau who tells you what the weather was yesterday." 

SEC Shuts Down Prosper

According to TechCrunch, the SEC outlined its reasons for shutting down Prosper, the peer-to-peer lending network. As Vijay said, at least now we can sleep more easily knowing our financial system is safe. Good thing those guys are on the job since Prosper clearly was a huge contributor to the credit crisis.

Laying the groundwork for the next war

The NY Times is reporting Iran Said to Have Nuclear Fuel for One Weapon. Funny how this comes out just after the election. Are the elites laying the groundwork for the next war? Isn't this how the last war started?

Merrill's David Rosenberg discovers Rothbard

Merrill's David Rosenberg discovers Rothbard (HT Vijay). Maybe one day we will hear the expresson "We're all Rothbardians now."

With this in mind, we were fortunate to have a client mail us a book titled America's Great Depression by Murray N. Rothbard. We think it is an absolute must-read, on the scale of Amity Shlaes' The Forgotten Man. In this book, you will learn that the New Deal machinery was established by Herbert Hoover, not FDR, and that the scale of the government incursion into the economy was so farreaching that the multi-year program actually ended up doing more harm than good. What is amazing is the chapter on the Reconstruction Finance Corporation (RFC), which was like the TARP in its efforts to bolster government equity stakes in banks, and therefore, to perpetuate the excess capacity in the system. The RFC provided money to groups from financials to farmers (cotton loans were big) to railroads ("some $264 million were loaned to railroads during the five months of secrecy") to state governments. Sound familiar?

This RFC began with government capital of $500mn in 1932. Eventually, that grew nearly eight-fold, which is why we think the current TARP is really TARP1. You read this book and you get a glimpse of Hoover's "war on the stock market, particularly on short-sellers" and the new Federal bankruptcy law of 1932, which served to "weaken the property rights of creditors ... states also joined in the attack on creditors" ... as in most depressions, the property rights of creditors in debts and claims were subjected to frequent attack, in favor of debtors who wished to refuse payment of their obligations with impunity ... many states adopted compulsory debt moratoria in early 1933.

And get this, "the banks also received their share of Hoover's ire for their unwillingness to expand in those troubled times". Hoover actually lodged a complaint in the New York Times that "banks have not passed the benefits of these relief measures on to their customers". So, in the end, Hoover (Roosevelt, remember, inherited and expanded on this infrastructure) "and Congress agreed to transform the RFC from a generally defensive agency aiding banks and railroads in debt, to a bold 'positive' institution, making capital loans for new construction".

First Joseph Nacchio, now Mark Cuban

Joseph Nacchio was the only CEO of a telecommunications company to demand a warrant for the NSA wiretapping. He was later charged with insider trading. Many people believe he was prosecuted because he did not cooperate with the government.

Mark Cuban is now being charged with insider trading. Naked Capitalism has an article connecting the dots about how this may be retributon for his criticism of the financial industry bailout.

Fed's newest lending facility: ABCPMMMFLF

From Bloomberg, the Federal Reserve launched the ABCPMMMFLF. That stands for Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. It could buy up to $1.8 trillion dollars of short-term debt. This just boggles the mind. As I said in a previous post, the Fed is getting desperate and will do anything to prevent deflation. It looks more and more to me that they will destroy the nation's currency in the process. 

The Fed is getting really desperate

The Fed tells banks to lend or else. I wonder, "Or else what?"

The agencies expect all banking organizations to fulfill their fundamental role in the economy as intermediaries of credit to businesses, consumers, and other creditworthy borrowers. Moreover, as a result of problems in financial markets, the economy will likely become increasingly reliant on banking organizations to provide credit formerly provided or facilitated by purchasers of securities. Lending to creditworthy borrowers provides sustainable returns for the lending organization and is constructive for the economy as a whole.

...

The agencies will continue to take steps to promote programs that foster financial stability and mitigate procyclical effects of the current market conditions. However, regardless of their participation in particular programs, all banking organizations are expected to adhere to the principles in this statement. We will work with banking organizations to facilitate their active participation in those programs, consistent with safe and sound banking practices, and thus to support their central role in providing credit to support the health of the U.S. economy.

This is so interesting on multiple levels. On one level, the banks got into this mess by making bad loans to people who couldn't afford to pay them back. The Fed never complained while that was happening. In fact, it outright encouraged it. It set interest rates far below market rates and below the rate of inflation which punished savers and subsidized debtors. This resulted in investors taking excessive risks in order to keep up with inflation. Greenspan even encouraged exotic mortgages like pay-option ARMs. So now that the Fed helped create this mess by encouraging the banking system to lend to people who couldn't afford these loans, it now is coming down hard on banks for being conservative and trying to rebuild their reserves.

On another level, it is so clear that the Fed is just terrified -- absolutely terrified -- of deflation. And they can't reinflate the money supply without more lending and borrowing. But the Fed is not able to make that happen because attitudes toward debt are changing. There is a psychological shift going on where people are starting to reject debt. The Fed will do everything in its power to prevent this, but so far, it has been pushing on a string. The more vehicles the Fed creates to lend money to the private sector, the more it makes the private sector dependent on the Fed. Why should a company borrow from a bank at the risk-adjusted interest rate when the Fed will lend it money at below-market rates?

Finally, what we're headed towards is nothing less than full nationalization of the banking system. The banking system and the housing sectors are already the most regulated and manipulated parts of the US economy -- it's no surprise that this is where disaster stuck. Now that the banks have taken money from the Treasury, the next step will just be the Treasury and Fed ordering banks to do exactly what they say. The Fed and the Treasury can ultimately make the banks do what they want, but the results won't be good for the economy. They are trying to fight the market which is begging for liquidation, structural change, and ultimately the shift of capital from malinvestment to where it's actually needed. The more the government tries to prevent this, the more they are going to turn the US into Japan and create the deflation they so want to avoid.

I don't know why anybody at this point would want to own equity in a bank. This letter from the Fed makes it clear that the banks serve the US government, not their shareholders. And if that means destroying their balance sheets even further, that is what the banks must do.

Lew Rockwell on the Right's intellectual bankruptcy

Great article from Lew Rockwell about how conservatives sold out to the Bush administration.

But this reliable support by conservatives for the Republican president confronts what psychologists call “cognitive dissonance,” which is to say that people will not forever live with a massive contradiction between what they do and what they believe. Eventually, the beliefs come around. So it has been for the conservatives who, in the 1990s, blasted Clinton’s big budgets and nation-building and then ended up celebrating far larger budgets and a vaster military empire around the world. The result has been an amazing intellectual bankruptcy on the Right.

The culminating event was the financial bailout of the Wall Street plutocrats, which contradicts everything that conservatives allegedly stand for. It was socialistic in every way. It rewarded market failures. It ripped off average families for the sake of billionaires. It was the worst form of Keynesian planning. It was an open conflict of interest, as the ex-CEO of Goldman Sachs funneled vast sums to Goldman Sachs. It had exactly zero chance of helping the economy. In fact, by draining productive private resources necessary for economic recovery, it makes a bad situation worse.

And yet, no surprise, conservatives came around. You could check in with the Heritage Foundation or National Review Online and find rousing endorsements of this outrage, complete with pieties: “In normal times, we’ve been against government intervention, but these are not normal times…” And what did they get out of it? Nothing but the satisfaction of knowing that they helped sanitize and baptize what may be the worst piece of legislation in half a century

The Moral Hazard of Regulation

Wise words from Ron Paul.

The Moral Hazard of Regulation

by Ron Paul

Since the bailout bill passed, I have been frequently disturbed to hear "experts" wrongly blaming the free market for our recent economic problems and calling for more regulation. In fact, further regulation can only make things worse.

It is important to understand that regulators are not omniscient. It is not feasible for them to anticipate every possible thing that could go wrong with whatever industry or activity they are regulating. They are making their best guesses when formulating rules. It is often difficult for those being regulated to understand the many complex rules they are expected to follow. Very wealthy corporations hire attorneys who may discover a myriad of loopholes to exploit and render the spirit of the regulations null and void. For this reason, heavy regulation favors big business against those small businesses who cannot afford high-priced attorneys.

The other problem is the trust that people blindly put in regulations, and the moral hazard this creates. Too many people trust government regulators so completely that they abdicate their own common sense to these government bureaucrats. They trust that if something violates no law, it must be safe. How many scams have "It's perfectly legal" as a hypnotic selling point, luring in the gullible? Many people did not understand the financial house of cards that are derivatives, but since they were legal and promised a great return, people invested. It is much the same in any area rife with government involvement. Many feel that just because their children are getting good grades at a government school, they are getting a good education. After all, they are passing the government-mandated litmus test. But, this does not guarantee educational excellence. Neither is it always the case that a child who does NOT achieve good marks in school is going to be unsuccessful in life. Is your drinking water safe, just because the government says it is? Is the internet going to magically become safer for your children if the government approves regulations on it? I would caution any parent against believing this would be the case. Nothing should take the place of your own common sense and due diligence.

These principles explain why the free market works so much better than a centrally planned economy. With central planning, everything shifts from one's own judgment about safety, wisdom and relative benefits of a behavior, to the discretion of government bureaucrats. The question then becomes "what can I get away with," and there will always be advantages for those who can afford lawyers to find the loopholes. The result then is that bad behavior, that would quickly fail under the free market, is propped up, protected and perpetuated, and sometimes good behavior is actually discouraged.

Regulation can actually benefit big business and corporate greed, while simultaneously killing small businesses that are the backbone of our now faltering economy. This is why I get so upset every time someone claims regulation can resolve the crisis that we are in. Rather, it will only exacerbate it.

Savings Rate Rise in September

The Savings Rate is Rising

In this morning's report on personal income and spending, word came that the savings rate (after-tax income less spending) rose from 0.8 percent in August to 1.3 percent in September.

Uh oh - Keynesian economists are not going to stand for any fall in aggregate demand. Bernanke better get those helicopters fueled up. The proletariat isn't obeying orders to continue borrowing and spending. 

Redistributing Wealth

Redistributing Wealth (HT Anton)

On my way to lunch recently, I passed a homeless guy with a sign that read "Vote Obama; I need the money." I laughed. In a restaurant my server had on an "Obama 08" tie. Again I laughed. Just imagine the coincidence. When the bill came, I decided not to tip the server and explained to him that I was exploring the Barack-Obama-redistribution-of-wealth concept. He stood there in disbelief while I told him that I was going to redistribute his tip to someone who I deemed more in need—the homeless guy outside. The server angrily stormed from my sight. I went outside, gave the homeless guy $10 and told him to thank the server inside as I've decided he could use the money more. The homeless guy was grateful. At the end of my rather unscientific redistribution experiment, I realized the homeless guy was grateful for the money he did not earn, but the waiter was pretty angry that I gave away the money he did earn even though the actual recipient deserved money more. I guess redistribution of wealth is an easier thing to swallow in concept than in practical application.

—A. Hart, Forest Park

Moral Hazard in Action

Here's an example of moral hazard in action where I am the person taking advangate of the moral hazard. 

Recently I bought a 3 month CD from GE Bank at 2.5%. That was the best rate I could find for three-month CDs at the time. I don't really care who I am lending the money to because the government via the FDIC is insuring the CD against any loss. Otherwise, I wouldn't lend a dime to GE because I am not sure it is a solvent entity into the future. That's moral hazard in action. The government has allowed me to privatize the profit if GE stays afloat and socialize the loss if GE fails. 

This guarantee subsidizes GEs debt and allows them to pay a lower rate. By lending GE Bank some capital, that capital is not available to lend to a better institution. In this way, the government subsidy rewards the bad company and punishes the good company. This is a small example of how the government distorts the market and causes capital to be misallocated. This is becoming widespread right now because the government is insuring everything under the sun. Besides the delevaraging that is happening, one of the reasons businesses are seeing the cost of debt rise so much is because the government has made it even easier to buy debt that they have insured. Why should the government expect me to buy buy a corporate bond at 3% when I can make 3% buying FDIC-insured CDs all day long.

Incompetence in action: White House tells banks to stop hoarding money

White House tells banks to stop hoarding money

An impatient White House served notice Tuesday on banks and other financial companies receiving billions of dollars in federal help to quit hoarding the money and start making more loans.

 

"What we're trying to do is get banks to do what they are supposed to do, which is support the system that we have in America. And banks exist to lend money," White House press secretary Dana Perino said.

Though there are limits on how much Washington can pressure banks, she noted that banks are regulated by the federal government.

This is government incompetence at its very best. And on so many levels.

On one level, this is the reason the banks are in this mess in the first place. They made foolish loans that weren't backed by adequate collateral or were given to people with lousy credit and incomes. Now the banks have started to learn their lesson and the government now wants them to go back to making irresponsible loans.

On another level, it's just a fallacy that banks aren't lending. Banks are lending. There is a market for all kinds of loans. The Feds are just angry that the interest rates are too high. There is a market for debt with buyers and sellers of that debt. The banks are the buyers of the debt in this case and they are making their bids. Borrowers are setting the asks. The amount of debt and the price (interest rate) is based on the market clearing price for the debt. The government is just angry that the interest rate isn't lower. But the reason the interest rate is high is because the banks are finally starting to factor in the real risk of defaults. 

On the next level, the government has made this mess much worse. I am not even talking about the fundamental causes of the credit bubble and the subsequent crash. I've talked at length in this blog about that. I am talking about the proximate cause of this problem. The government has created an alphabet soup of lending facilities. They are now directly buying commercial paper. Debtors know that they don't have to borrow from the banks at market rates when they can borrow from the Fed at below-market rates. I wish the Fed would start a facility for buying Google stock. I would much prefer selling shares to the Fed at $700 than at current market prices.

This is right out of Atlas Shrugged. It would be amusing if it weren't so sad and frightening. Welcome to socialism.

Senior Liberation Act

http://online.wsj.com/article/SB122506801638770679.html

HT Ben. This is just wrong on so many levels. 

Senior Liberation Act

Why you can't get Social Security if you refuse Medicare.

For all of America's cherished belief in choice and freedom, it remains an astonishing fact that the U.S. government forces citizens over the age of 65 into a subpar health plan of its choosing. And so it is with some hope that we greet a new federal lawsuit that aims to allow senior citizens to flee Medicare.

The suit comes courtesy of Kent Masterson Brown, a lawyer who has previously tangled with the government over Medicare benefits. Mr. Brown represents three plaintiffs who are suing the federal government to be allowed to opt out of Medicare without losing their Social Security benefits.

Amazingly, this is not currently allowed. While the Social Security law does not require participants to accept Medicare, and the Medicare law does not require participants to accept Social Security, the Clinton Administration in 1993 tied the programs together. Under that policy, any senior who withdraws from Medicare also loses Social Security benefits.

Mr. Brown's plaintiffs are three men who do not want to be in Medicare, even though they paid Medicare taxes throughout their income-earning years and though they are not asking for that money back. The three instead saved privately to cover their health care expenses. They now prefer to contract with private doctors and health facilities that they believe are superior to those offered by Medicare.

They don't want to be rationed by a government program facing budget constraints. And they desire, for reasons of privacy, not to have their medical claims in the hands of a federal bureaucracy. One of the plaintiffs, Brian Hall, is a retired federal worker who contributed throughout his career to a health savings account. If required to take Medicare, he will no longer be allowed to make deposits for his medical expenses.

Meanwhile, the three plaintiffs also have contributed considerable sums to the Social Security trust fund. All three understandably want to be paid the monthly retirement benefits that they have duly earned. Yet to do that, they must agree to enroll in Medicare.

The Clinton Administration tied Medicare and Social Security together for the same reason Congress in the 1990s barred Medicare enrollees from supplementing their government care: They don't want a "two-tier" health system. Equity trumps freedom, even if it means poorer care. The Bush Administration has stuck with this misguided policy, despite a need to relieve pressure on runaway entitlement programs. If even 1% of Medicare-eligible retirees voluntarily opted out, Medicare expenditures would decrease by about $1.5 billion a year, and by some $3.5 billion a year by 2017.

The suit itself has strong legal merit. Not only have two Administrations implemented policy that has no root in the applicable laws, their "rules" are no rules at all. Neither Administration bothered to put its extraordinary policies through an official rule-making in which they would have been required to notify the public and invite comments.

Mr. Brown fears the feds will argue they have "administrative remedies" for these situations (say, allowing certain individuals to opt out) and that the suit should therefore be dismissed. No judge should buy it. Mr. Brown has included information from another individual who attempted to disenroll from Medicare by petitioning the Department of Health and Human Services. The agency refused to address his case.

D.C. Circuit Judge Rosemary Collyer should invalidate these policies and ask Congress to clarify the matter. Will Members really argue that prudent Americans shouldn't be allowed to pay for their own medical care or even make their own health-care choices?

Deflation and Liberty

Jörg Guido Hülsmann wrote an incredible essay called Deflation and Liberty (HT Vijay). It is one of the best explanations of inflation and deflation I've ever read and it is a must read for anybody who really wants to understand the monetary background for the credit crisis along with the political implications.

Why is understanding inflation and deflations so important? I'd say there's no topic more important in order to understand the current economic and political landscape. And if you are an investor, this is critical background information. 

We've lived in a world of monterary inflation for decades. In fact, we experienced exponential growth in the money supply courtesy of the Federal Reserve and the banking system (and most recently, the shadow banking system). Like most exponential processes, it come to an end. And that's what we're seeing right now. The unwinding of leverage and destruction of credit is causing all that inflation to run in reverse. This is having an enormous structural impact on our financial system. We depended on an ever increasing amount of money to pay back an ever increasing amount of debt. Since in our monterary system, money is nothing more than debt, this means we depended on an ever increasing amount of new debt to service our existing debt. Now that new debt issuance is decreasing, there is no way for the existing debt to be paid back. This is the reason why defaults are widespread. There will never be enough money to pay back the existing debt and most of the creditors are not going to get their money back. This is why there is a mad dash for cash and safe havens. It's like musical chairs where at best there are half as many chairs as people. And it may even be as few as one tenth the number of chairs as people. Of course, the government is doing its best to "print" new chairs as quickly as it can.

The inflationary regime had enormous benefits to the government, the banking system, and the businesses that were the recipients of the newly-created money. The government needed inflation to finance its budget deficits and pay back its debts with future debased dollars. The banking system benefited from inflation because it was the conduit by which all that debt was created and serviced and it allowed banks to borrow short at low interest rates and lend long at higher interest rates. The businesses that most benefited were the ones that were the biggest beneficiaries of government lagresse. For example, the military-industrial complex, the universities that depended on government grants and loans, the farmers who received subsidies, and the healthcare sectors that benefited from medicare and medicaid. And most importantly, the politicians who depended on promising new spending for special interests without having to raise taxes. The people that were most hurt by this were those furthest from Wall Street and the companies that were part of the welfare-warfare state. The average worker saw his income barely able to keep up with the inflation in the economy. Instead of one parent working, both had to work in order to maintain the same lifestyle. It encouraged the average person to borrow instead of save because negative real interest rates punished saving and rewarded borrowing. Instead of being able to buy a house with savings, Americans had to take on mortgages they couldn't afford and become debt slaves. This was the outcome of the inflationary regime.

Hülsmann writes

In short, the true crux of deflation is that it does not hide the redistribution going hand in hand with changes in the quantity of money. It entails visible misery for many people, to the benefit of equally visible winners. This starkly contrasts with inflation, which creates anonymous winners at the expense of anonymous losers. Both deflation and inflation are, from the point of view we have so far espoused, zero-sum games. But inflation is a secret rip-off and thus the perfect vehicle for the exploitation of a population through its (false) elites, whereas deflation means open redistribution through bankruptcy according to the law.

And this is why the government will do everything in its power to prevent deflation. The government itself depends on inflation to finance its own operations. The financial system is being destroyed by the asset deflation we're currently witnessing. The government is on borowed time for how long it can keep financing all its spending under the deflationary spiral. And if there's any doubt that the government will do everything in its power to prevent deflation: there's a reason why Bernanke is the Federal Reserve Chair. He gave a speech in 2002 called Deflation: Making Sure "It" Doesn't Happen Here. This is where he famously said that the Federal Reserve had printing presses and could drop money from hellicopters.

A deflation just fundamentally changes how one has to think about money and assets. Somebody said to me today that he was dissapointed he could only get about 3% yield on a 6 month CD. And I responded that he should consider this an amazing yield in these times. Even if he broke even in dollars, he should consider how much more valuable his dollars are worth today than they were just one year ago. If he converted his dollars to some other "currency" units like the DOW, the S&P, or houses, he could buy a lot more of each than he could in the past. Savers were punished under an inflationary regime but they are rewarded magnificently during deflation. Anybody who had the foresight to see this coming and moved their assets to cash is doing very well.

But again, one must consider tha the government will do everything in its power to stop the delfation. I suspect that if all these alphabet soup programs the FED and the Treasury have started don't work, the government will just start confiscating wealth directly. In Argentina, the goverment recently confiscated private pension funds. The Democratic leadership has already proposed doing the same here. I wouldn't be surprised if this happens under an Obama administration. Sorryto  those of you who have 401(k)s and IRAs -- the government wants to increase aggregate consumption and you savers are making that harder.

I am reminded of a couple quotes. The great Austrian economist Ludwig von Mises said

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

In other words, we're either going to have deflation or the destruction of the dollar. Maybe through some miracle the Fed will be able to reinflate the economy without destroying the currency. The Japanese tried this and failed. They lowered interest rates to 0% and then started printing money. They were still unable to stop delfation and they had decades of negative or negligible growth. In fact, their stock market recently hit a 26 year low. 

The Hülsmann essay explains why we shouldn't fear deflation. It's necessary to repair all the distortions of the past inflation. And it's like I've said before, we have way too many real estate agents, construction workers, bankers, and bomb makers. We need more teachers, doctors, nurses, and medical technicians. This deflation is the opportunity to realign our workforce around where the real market demand lies.

The other quote I am reminded of is one from Thomas Jefferson:

If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.

Until recently, I understood the inflation part, but I didn't understand the deflation part of his quote. It was obvious how inflation redistributes wealth and makes people poorer. But now I see how the deflation is transfering so many people's homes to the banks. People are likely to blame this on the crash, but the crash is the inevitable result of the bubble. The perverse part is that now we're using tax-payer money to recapitalize the banks. These banks will survive because of we won't let them fail and the result will be that they will end up owning a huge percentage of the homes in the country. Maybe that's what Jefferson had in mind. He anticipated that a central bank at the head of a banking cartel would always favor the banking system over the average citizen.

I really recommend reading the Hülsmann essay.

Hypocrisy?

Political Hypocrisy: Do As I Say, Not As I Do

Political Rhetoric: An Obama campaign ad says: “Today women work to help support their families but are paid just 77 cents for every $1 a man makes. It’s just one more thing John McCain doesn’t get about our economy.”

Factual Evidence: 

1. Obama pays his own female Senate staffers, on average, only 78% of what he pays male staffers (see top chart above), and females make up 53% of Obama's staff.

2. McCain pays female staffers 101% of what he pays men (see bottom chart above), and females made 62% of McCain's staff.

3. Women occupy seven of the top 10 highest-paid positions on McCain’s staff, and five of the top 10 highest-paid positions on Obama’s staff.

4. Women on McCain’s staff earn 24% more on average than women on Obama’s Senate staff. 

Politically Incorrect Guide To Politics

John Stossel's Politically Incorrect Guide To Politics

The Importance of Capital Theory

Vijay pointed me to a great article. This is a great read for getting another perspective on the housing bubble and bubbles in general. The way I see it, the capital goods we over-invested in were real estate agents, construction equipment, and home builders (and military/defense companies but that is part of a different story). We should have been investing in doctors, nurses, and more biotechnology. 

From an investment angle, I think healthcare prices will just continue to rise because the next administration is going to want to provide all Americans with healthcare. The fundamental reality is that there aren't enough healthcore workers and infrastructure to provide all Americans good healthcare. That is unless we ration our existing healthcare among more people, which would likely really upset Hollywood actors and New York laywers who donated a lot of money to Obama. At the end of the day, prices (at least in real terms in case we have overall price deflation) must go higher in order to lure all those new workers into the healthcare industry and to get the existing workers to work overtime. Or we need to invent some new technology that totally revolutionizes medicine and reduces the cost dramatically.

The End of Libertarianism (NOT)

This Slate article The End of Libertarianism by Jacob Weisberg is completely wrong. 

A source of mild entertainment amid the financial carnage has been watching libertarians scurrying to explain how the global financial crisis is the result of too much government intervention rather than too little. One line of argument casts as villain the Community Reinvestment Act, which prevents banks from "redlining" minority neighborhoods as not creditworthy. Another theory blames Fannie Mae and Freddie Mac for causing the trouble by subsidizing and securitizing mortgages with an implicit government guarantee. An alternative thesis is that past bailouts encouraged investors to behave recklessly in anticipation of a taxpayer rescue.

The author claims that libertarians are somehow surprised and now "scurrying to explain" this financial mess. The reality is that libertarians, and more specifically those that subscribe to the Austrian School of Economics, have been predicting this financial mess for years. For example, in 2003, Ron Paul predicted the Fannie Mae and Freddie Mac disaster. Followers of financial markets and  students of Austrian Economics such as Mike Shedlock, Bill Fleckenstein, Peter Schiff, have written for years about how easy credit from the Federal Reserve was the leading cause of the housing bubble. In fact, it would seem that libertarians were the only ones talking about this when housing prices were rising 20% each year while everybody else was seemingly applauding this false wealth creation. Of course, followers of Austrian economics naturally understood that bubbles always result in busts and the the bigger the bubble, the bigger the bust. It's sad that Weisberg hasn't done his homework. Fortunately, investors that understand these principles have been able to protect their wealth.

Weisberg is right on one point. We will likely see a new era of socialism, perhaps a second New Deal under the next administration. But socialism always benefits those that are most powerful and most connected to government, not the average masses it pretends to help. 

[Updated: Removed section about libertarians and students of Austrian Economics knowing how to protect their wealth in the future. Joachim corrected me when he said "Rather, we should predict that government is likely going to distort markets to an extent that not just slows down everybody's ability to create (and preserve) wealth.  It will also attempt to redistribute big time, and whether you can or cannot escape the looting has nothing to do with your political conviction or intellectual rigor."]

Drama behind a $250 billion banking deal

Vijay hit the nail on the head: "This is the very definition of crony corporatism. Can anyone imagine this happening in any other industry? Larry and Sergey, and Ballmer and Yang sitting around with the Secretary of Search and Chairman of Technology deciding how to divvy up the spoils of tax payer money. Awwwwyeaah free market!"

Drama behind a $250 billion banking deal

WSJ: Mackerel Economics in Prison

The Austrian School of Economics teaches that money is a creature of the market, not the state. A good summary of this is Rothbard's What Has Government Done to Our Money. An interesting article in support of this appears in the Wall Street Journal.

Mr. Levine and his client were prisoners in California's Lompoc Federal Correctional Complex. Like other federal inmates around the country, they found a can of mackerel -- the "mack" in prison lingo -- was the standard currency.

"It's the coin of the realm," says Mark Bailey, who paid Mr. Levine in fish. Mr. Bailey was serving a two-year tax-fraud sentence in connection with a chain of strip clubs he owned. Mr. Levine was serving a nine-year term for drug dealing. Mr. Levine says he used his macks to get his beard trimmed, his clothes pressed and his shoes shined by other prisoners. "A haircut is two macks," he says, as an expected tip for inmates who work in the prison barber shop.

There's been a mackerel economy in federal prisons since about 2004, former inmates and some prison consultants say. That's when federal prisons prohibited smoking and, by default, the cigarette pack, which was the earlier gold standard.

Prisoners need a proxy for the dollar because they're not allowed to possess cash. Money they get from prison jobs (which pay a maximum of 40 cents an hour, according to the Federal Bureau of Prisons) or family members goes into commissary accounts that let them buy things such as food and toiletries. After the smokes disappeared, inmates turned to other items on the commissary menu to use as currency.

Socialist States of America

The United States has been teetering on the edge between capitalism and socialism for quite some time now, but today I believe we have jumped off the cliff and there's no going back (revolution aside). There's going to be a $1.2T (yes that's trillion dollar) bailout of the banking system. The US taxpayer is going to take over responsibility for all the bad decisions made by Wall Street. Of course, the US government created the monetary and regulatory environment that made this all possible. I am at a  loss of words to describe this. Most people won't even realize how bad they are being raped. It's going to be the biggest transfer of wealth from the poor and middle class  to the most connected and powerful people in the history of the country. It will also be terrible for wealthy people who accrued their money through hard work and innovation. But it will be great for those who work in the banking system -- they will get to rebuild these companies at tax payer expense and reap the profits from that endeavor. As I've said many times before in this blog, they privatize the profits and socialize the losses. 

I predict we'll look book at this year as a pivotal point in US history. We're going to see innovation and capital leave the United States. It's not possible to have capitalism and innovation unless failure is allowed. Instead, we're now planting the seeds for the next round of massive malinvestment. This always results in less prosperity for the vast majority of people in the country. People want better healthcare, high quality education for their children, and opportunities to work hard and be rewarded for it. I think we can kiss that all good-bye. It's going to get much, much worse. And even if we have a Democratic president and a Democratic congress that promise to give everybody healthcare and a great educaiton, they are going to acheive just the opposite. It will be just like how Fannie Mae and Freddie Mac were supposed to make housing affordable yet the bigger those companies became, the more housing prices rose. 

I was talking to a pediatrician last night. He was saying how the salary for a pediatrician in San Francisco is about $80K/year because the cost of practicing medicine here is so high ancd the fees are pretty much set on a nationwide basis. And that's $80K/year for working 60 hour weeks. Why would anybody want to become a pediatrician at this point? I don't understand why anybody would put themselves through such an expensive and intense education and training to then work so hard and make so little for it. The same person could go to Wall Street and make that much in a month. And they will now because of this bailout. 

This is what the government doesn't understand and can't fix as long as they stick to these policies. We're going to see healthcare costs rise and the more they try to insure more people and reduce the costs, the worse it's going to get. At some point though, the financial system is just going to collapse because the debt levels are going to be unsustainable. And then maybe we'll have to start over. That is going to be a painful dislocation for the middle class. Of course, politicians won't blame themselves for the bad policies that caused the problem. They will just find scapegoats like short sellers. 

The argument people always come up with to rebut this is that many countries have socialized healthcare and it works very well. Well, actually their healthcare is usually pretty bad (waiting time for routine surgey is longer for people in Canada than for pets). What these people don't get though is that those countries don't spend a huge percentage of their GDP on their military. We're going to see military spending go up in the future. Both Obama and McCain want to expand the size of the military. If we spent the same on the military as other countries, we'd have great healthcare too and it wouldn't be because the government provided it. There would just more people going into medicine than creating the next generation of smart bombs and fighter aircraft.

In somewhat related news, this week was quite interesting for my investment accounts. I am just slightly up for the week, but had the biggest swings I've ever seen. I was massively short the financials and then I made the classic mistake of going even shorter just before the bailout and ban on short selling was announced. It's funny because even as I excuted those trades, I had this voice in my head saying, "Don't short the hole," but greed is a pretty powerful emotion and I knew these financial companies were going to zero. Given what I know about how politics work, I should have realized that they would never let that happened. So the finacials rallied massively and I was forced to cover resulting in a barely-up week. On the bright side, it's much better to learn those type of lessons this way rather than by taking huge loses. At some point though I may just start buying banks again. It's a pyramid scheme and there's no better business if you're at the right part of the pyramid. And now with a government bailout, these banks are likely to be able to create huge businesses again in the future. I mean, if we're going to transfer wealth from the tax payer to the banking system, I might as well try to profit from it. I will take a wait-and-see approach to guage when will be the right time to enter. A lot of things could still go wrong. There might be considerable backlash when the public notices the $1.2T number.

Jon's Political Ramblings in Syndication?

Without my knowledge, somebody appears to have syndicated content from my blog. Sweet! (HT to Vijay)

Is Deleveraging Bad for the Economy?

Great article (HT Vijay).

Ron Paul predicted Georgia Conflict Back in 2002

An interview in 2002.

The Russians now say ah ha, "What you're doing is nothing compared to what we want to do. We want to go into Georgia. Because you say there's terrorists and that the Iraqis are possible terrorists, that's why we want to go into Georgia and we want you to approve it." And that's why maybe they're looking to give in a little bit to us if we're willing to ignore what they do in Georgia.

British humor on school choice

Along the lines of my thought experiment (HT to Vijay).

Ron Paul predicted Fannie Mae and Freddie Mac disaster five years ago. We shouldn't be surprised though since this is just applying basic Austrian economics. Speech below (emphasis mine).

Ron Paul in the House Financial Services Committee, September 10, 2003

Mr. Chairman, thank you for holding this hearing on the Treasury Department’s views regarding government sponsored enterprises (GSEs). I would also like to thank Secretaries Snow and Martinez for taking time out of their busy schedules to appear before the committee.

I hope this committee spends some time examining the special privileges provided to GSEs by the federal government. According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone. Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board.

One of the major government privileges granted to GSEs is a line of credit with the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out GSEs in times of economic difficulty helps the GSEs attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a huge unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase GSE debt. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.

The connection between the GSEs and the government helps isolate the GSE management from market discipline. This isolation from market discipline is the root cause of the recent reports of mismanagement occurring at Fannie and Freddie. After all, if Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

Despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary, but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.

Mr. Chairman, I would like to once again thank the Financial Services Committee for holding this hearing. I would also like to thank Secretaries Snow and Martinez for their presence here today. I hope today’s hearing sheds light on how special privileges granted to GSEs distort the housing market and endanger American taxpayers. Congress should act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors who were misled by foolish government interference in the market. I therefore hope this committee will soon stand up for American taxpayers and investors by acting on my Free Housing Market Enhancement Act.

Socialism in the USA

Great quotes in The Daily Reckoning today.

The "Consumer Economy" was Always a Mockery

But, last week, the U.S. Senate bent down and pressed its large mouth onto those gaping traps of the mortgage twins - gurgling into them a corrupt breath of life. Since the two hold one out of every two mortgages in the nation, in effect, Congress is nationalizing the U.S. housing stock itself. Henceforth, citizens will pay not only their taxes to the government, but their mortgage payments too.

...

The cartoon capitalists did it all backwards; they are supposed to exploit the workers, not be exploited by them. But while consumers and investors were going nowhere, corporate managers and Wall Street hustlers were getting rich. The two Bozos running Fannie and Freddie, for example, pocketed about $32 million between them last year - during a period in which the companies lost almost $5.2 billion - not to mention the losses to shareholders. And on Wall Street, managers paid out $250 billion in bonuses in the 4 years leading up to the credit crunch. The firms declared a profit and paid bonuses when the bets were made; they didn't wait to see how they turned out. Thus did the big banks and big brokers become capitalists without capital, dependent on the gullibility of investors to keep them in business. And when investors began to wise up, they turned to the public for capital support.

What kind of scam is this? It may look like capitalism from a distance. But this is not real capitalism; this is cartoon capitalism - run by clowns, who sell freak investments to chump investors, and encourage the lumpen householder to ruin himself.

U.S. Economy is Still Growing but GDP Growth Rates Are Mostly Fraud

There are only so many hours in the day...and only so many resources to work with. The real question is what is done with them. If they are used to produce things, to build factories, and to add to the nation's capital, people become wealthier. If they are squandered - using up capital instead of adding to it - people become poorer. GDP figures don't tell you want is really going on. But when an economy becomes too dependent on credit and consumer spending, GDP figures actually become perverse; they measure the rate at which the nation impoverishes itself.

Good ole fashioned Keynesian stuff!

Paul McCulley of PIMCO wrote a great article called The Paradox of Deleveraging. The reason I think it's great is because it's completely wrong, but in a way that makes me smile. It explains the broken Keynesian view of the economy and the recession. It prescribes what the Keynesian-minded central bankers must do to fix our problems. McCulley is mostly just talking his book as PIMCO has invested heavily in the prescriptions he favors. Of course, these are the same theories that Bernanke and Paulson subscribe to, so it's no surprise that this is what we have been getting and will continue to get. My favorite quote from the article: "Good ole fashioned Keynesian stuff!"

Here is a good rebuttal of McCulley's view. It is in line with the Austrian school of thought.

Personally, I don't worry as much as I used to about this stuff. When I initially learned about the Austrians, I worried so much about all these government policies that were obviously wrong. Bad policy created terrible asset bubbles and then prescribed the wrong medicine. Reading authors such as Hayek, Hazlitt, and Rothbard was a great revelation for me. I felt compelled to campaign for Ron Paul, the only person in Congress who truly understands these issues. We had some successes along the way, but we weren't able to convince the American people. They have not yet woken up and they are such easy victims for people like Bernanke and Paulson who are more than glad to privatize the profits and socialize the losses under the guise of saving the financial system. Just look at Fannie Mae and Freddie Mac. One cannot fathom a better bailout -- while the Treasury sends them money to keep them solvent through the front door, they can continue paying dividends to their investors out the backdoor. Well, the Democrats and Republicans just love them too much. No surprise though -- they donate handsomely to their campaigns and the politicans can support them under the cover of trying to keep housing affordable. Right, housing was so affordable when prices were increasing exponentially. Well, maybe after another 30% to 40% drop, it will finally become affordable. Of course Fannie and Freddie will be doing everything in their powers to stop that.

After the Paul campaign started winding down for me in January, I realized how much all this economic knowledge was useful for investing. This influenced my decision to short and buy Jan 09 PUTs (bets that the price will drop) on Fannie and Freddie in Febuary. I later closed most of these positions just before the bailout was announced. During this period, Fannie's stock went from $28.70 to $8.55 and Freddie from $26.61 to $6.83.

The principles of Austrian economics predicted how this asset bubble would play out (the asset prices would eventually drop and the most leveraged participants would become insolvent) and the principles of Keynesian economics predicted what the Federal government would do about it (bailouts for the GSEs and the banks). Anybody who says that Austrian economics isn't practical surely didn't consider its application for investing. Of course timing is also critical. Austrian economics predicts what will happen but it doesn't make claims about the timeline.

I'd much prefer that we had sound money based on gold and I could invest in productive companies that create value for the economy and provide dividends to their investors. But since this government has taken that option away from me and continues to erode the value of the dollar through inflation, my only alternative is to make money by exploiting these bad policies. My one big fear though is that the entire financial market self-destructs and the dollar crashes with it. I think there's around a 10% chance of that happening. In that event, we're all going to be poor. In that scenario, I just hope I have enough gold, water, and food to weather that storm and come out the other side with enough to invest in the new economy that emerges from the ashes.

Greenspan: a fool for the ages

Greenspan in 2005:

A national bubble is unlikely because the U.S. real estate market is composed of individual regions with different pricing trends, making a collapse that damages the overall economy unlikely, Greenspan said. Home purchases and sales also have high transaction costs, making it hard to speculate, and most people buy homes to live in, he said.

There is ``considerable unlikelihood of a major decline'' in prices because that's ``very rare'' in the U.S., Greenspan said.

``Even if there are declines in prices, the significant run- up to date has so increased equity in homes that only those who have purchased just before prices literally go down are going to have problems,'' he said.

Greenspan in 2008:

The former chairman of the Federal Reserve, Alan Greenspan, said falling home prices in America are "nowhere near the bottom" and the resulting market turmoil isn't showing signs of abating.

It's amazing that anybody listens to this fool. His policies of bailing out the banks after the Internet bubble crash were the single biggest contributor to creating the housing bubble. It's not just Greenspan that is at fault though. The entire system is broken and always will be as long as a private banking cartel sets the cost of money (interest rates) instead of letting the free market do it. Things can only get worse from here with Bernanke in charge who was a very influential figure in the banking system during the times of these disastrous policies.

Do the rich pay for everything?

In reply to Thought Expirement, a reader commented

It's not that I disagree entirely with you but you build your satire around the assumption of the following extremes: the "rich" pay for everything - by rich do you mean MD rich ($300k / year) or CEO ($40 million annual income) rich? In your model is there a middle class whose collective resources benefit people of similar status?

I wasn't trying to imply that the rich pay for everything, but I could understand how somebody might draw that conclusion. With a satirical post, it's not always obvious which parts are satire and which parts are direct. What I was trying to suggest is that I think there are lot of people on the left who think that it's possible to pay for everything by taxing the rich. Their logic is that if the government needs more money to fund a program, it's only a matter of raising taxes on the wealthiest Americans. I believe this is fundamentally flawed and it has to do with the nature of money, wealth, and what it means to pay for something.

In terms of direct taxes, there are lots of statistics. The National Center of Policy Analysis has an article saying the wealthiest 1% pay 35% of the taxes. There are lots of studies about that, but I don't think they tell the full story. As I said, I am more interested in getting to the deeper nature of this question.

So let's take the most extreme example: people like Warren Buffet -- the wealthiest of the wealthiest. It should be possible to pay for many government programs by taxing these people more. The reality though is that even if we doubled the taxes paid by billionaires like Warren Buffet, it would likely have almost zero impact on their lifestyles or their consumption. Warren Buffet lives an extremely simple life. According to Wikipedia, "He lives in the same house in the central Dundee neighborhood of Omaha that he bought in 1958 for $31,500, today valued at around $700,000." I heard his typical dinner is a cheeseburger from the local diner.

So what does it mean to tax Buffet more? It pretty much means that we'll take capital that Buffet would invest in productive companies and instead give it to the government. As history has shown, governments are terribly inefficient at allocating capital. This is why socialism and communism don't lead to productive economies. Most of the money government takes in is consumed. Some of it may be used to build infrastructure like roads and bridges, but very little of it will be used to create the next generation of great companies that will help make the world wealthier. There is a good reason why companies like Microsoft, Google, Intel, and Apple are all products of the private sector. Most of the money the government takes in goes to the military or to really inefficient capital allocation like farm subsidies. Some of the money is redistributive. It may help feed some poor people today, but for the most part, it won't be a real investment in their future. Little of it will be used for productive capital that will provide them jobs in the future.

What I am trying to say is that the wealthiest wouldn't really be paying the cost of these taxes -- everybody would. There was some level of taxation that would have prevented companies like Google or Microsoft from coming into existence. And everybody would be a lot worse off without those companies. There are some companies that would currently exist if more capital had been invested by the private sector in things people want (longer lives, better education for their children, better healthcare) than those things politicians want (a military empire, corporate welfare for their cronies, lucrative lobbyist jobs after they retire, etc.,). So somewhere out there are a handful of people that aren't billionaires because they didn't get to create those companies, but that isn't the real cost to society. The people who paid those taxes were average Americans who now won't get the benefit of those companies that never were created. As Henry Hazlitt wrote in Economics in One Lesson, "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

Now Buffet is the extreme example, but I believe the same is true for the majority of wealthy people whether it be the "MD rich" or the "CEO rich". Certainly, many of these people spend a lot more on consumption and lavish lifestyles than the average person. But I think the majority of these people are saving the money and investing in it like Buffet is. Many people may think of the worst excesses associated with being wealthy and that is what is often reported on television. But that is the outlier case (though the most entertaining for sure). For the most part, wealth is being invested in future production that will help improve the lives of everybody in the future. If you tax these people a little bit more, it will mostly have an unnoticeable impact on their lifestyle but have a large impact on how capital is allocated. If you tax them excessively, it can destroy the economy altogether because it takes the incentive out of making money. If my tax rate were 90% for example, there would have been very little benefit to me working hard as a software engineer. I would have hung out at the beach instead of integrating chat into Gmail. And there probably wouldn't have even been a Google or a Gmail at all because the other people I work with would have probably have been at the beach with me.

I hope I answered the question of who really pays the taxes.

Thought Experiment

Here's an idea that I think my socialist friends in San Francisco might love.

We'll have the city of San Francisco open up a chain of restaurants. We'll make them completely free and the city will pay for them with taxes. We'll tax wealthy people the most so that the people without much money won't have to pay any taxes for this service. Since it's free, it will have the additional benefit of causing most of the profit-seeking restaurants in the city to close down. Even though they may sell better food, it's hard to compete with something that is free to the customer. But since there's little competition, the food quality in our public restaurants may suffer or vary too much from neighborhood to neighborhood. The people in the wealthier neighborhoods may try to help their restaurants get better ingredients, but that wouldn't be fair to people in lower income neighborhoods. To solve this, we'll create a central bureaucracy that will set food standards across the entire city. Although the overhead of this bureaucracy will cost about 20% of the total cost of the entire operation, it'll be worth it because we'll have uniform standards set by professionals who know what is best for us. And it'll be funded for by taxes from wealthy people who already have too much money.

Some super wealthy people may choose to go to private restaurants, but it will be a tiny minority because few people can afford to pay taxes once for their public restaurants and then pay a second fee to private establishments. Those establishments will be very expensive because they will only cater to the wealthiest and the tiny demand will severely limit competition. Although our leaders will all dine at these elite establishments, they will stand behind the quality and cost of the public restaurants.

Some other people may choose to pay for raw ingredients and eat at home, but we'll demonize those home-cookers as being anti-social and weird. We'll wonder why they don't want to eat with the rest of us? Is our food not good enough for them? It would be too dangerous to let this trend catch on. But it'll be okay -- eventually one of them will screw up and that's when we'll pounce. Perhaps, one of them will get food poisoning and we'll feign outrage. Although the incidence rate of food poisoning is the same at both public and home kitchens, the general population knows that statistics lie. We'll say we must protect these home-cookers from poisoning themselves and we'll demand they change their ways and eat like the rest of us.

Hopefully, this model will become so successful that we'll replicate it to the state level. And then other states will copy it. To ensure that things are fair from state to state, we'll pass "No eater left behind" legislation to ensure consistent standards. We'll have to raise more taxes though to fund the Department of Gastronomy.

Of course, no system is perfect. Problems may arise from time to time. For example, the workers at these state-run monopolies may realize they have a lot more leverage than they would in a free marker. Where would people eat if they went on strike? They will negotiate lucrative contracts that guarantee it's virtually impossible to get fired and everybody will get a fair salary based on seniority instead of based on the quality of their work. After all, how would it be fair to pay Michelle more than David just because Michelle works longer hours.

Some people though may not like the food they are getting. They will demand better from their state government. Some forward-looking free market thinkers may realize that we should give these eaters more choices. We'll allow a few charter restaurants to be created. They will receive funds from the state and the eaters will get vouchers to dine at these quasi-private establishments. These charter restaurants will be loathed by the public restaurants. The employees of the public restaurants will not like the employment practices at the charter restaurants such as firing waiters who are under-performing or giving some cooks bonuses because their food is better. They will say that these charter restaurants don't meet the same standards as the public ones and demand that this be fixed to protect eaters. The charter restaurants will be forced to comply with the thousands of pages of regulations created by the public food bureaucracy, but it will be very difficult for them because they don't have their own giant bureaucracy for ensuring compliance. Some charter restaurants will stay around but only enough to placate the most unhappy eaters and not so many that the overall system is destabilized.

Now, isn't this so much better than the current model of having those profit-seeking restaurants of varying quality all over the city. Some of them are mom and pop places that go out of business when their customers don't like their food. How unjust is that!

There are those of you who may think this is a pretty silly idea. But if it works so well for primary and secondary education, why not replicate it to other areas. Hopefully, I've convinced the naysayers.

Nine Republicans Break Party Ranks: Send Impeachment Article to Judiciary for Hearings

I can't even find info about this in the mainstream press. There must be a press blackout on it. But here is a link to an article saying

In a stunning development which fell with the silence of a feather yesterday, nine Republicans broke with their iron-fisted party to put country first, and voted to send Rep. Dennis Kucinich's article of impeachment HR 1345 to the Judiciary, where Chairman John Conyers will hold a hearings on abuses of power by the Bush administration, according to the Congressional Quaterly's CQToday. The final vote was: Yea 238 - Nay 180.

The Nine Republicans are: Congressman Kevin Brady (TX) Congressman Wayne Gilchrest (MD) Congressman Walter B. Jones (NC) Congressman Don Manzullo (IL) Congressman Tim Murphy (PA) Congressman Ron Paul (TX) Congressman Dave Reichert (WA) Congressman Christopher Shays (CT) Congressman Mike Turner (OH)

One of the Republicans, Walter Jones, represents Camp LeJeune in North Carolina, one of the largest Marine bases in the country, and one which has borne heavily the sacrifice of the Iraq War.

I am glad that Ron Paul voted for this. He is a true patriot.

Ron Paul on Kudlow

Video link

They are giving Ron Paul a decent amount of speaking time. I guess they finally are starting to realize that he's been right all those years. It's certainly looking like that now.

Inflation or Deflation (Taking Money Back - Part 2)

I was just rereading my previous blog post Taking Money Back and I think I could have done a better job connecting the dots. In the first paragraph, I talked about rising food and oil prices. In the second and third paragraph, I talked about monetary inflation and how this new credit and money was chasing too few investment opportunities. I didn't really explain how this is leading to higher food and oil prices. But before I get to that, I want to provide some more background.

There is a great debate among many economists that I read on whether we're experiencing inflation (the creation of money and credit) or deflation (the destruction of money and credit). And this is just among those who would consider themselves followers of the Austrian School of Economics. In one corner, there are people like Mike Sheldock of Mish's Global Economics Trend Analysis that argue we're seeing deflation. He points to the destruction of credit in the financial markets, the fall in housing prices, the downward pressure in wages of American workers, and the falling stock market. On the other side are people like Peter Schiff of Euro Pacific Capital who believe the Fed is inflating. He points to the rise in gold and commodity prices, the increases in M3 and other monetary measures, and the fall of the dollar. It is pretty interesting how economists that have very similar views on the market, the government, and central banks could disagree so dramatically on such a basic issue.

My opinion is that they are both partially right. As I pointed out in my previous post, we've seen global savings double in a very short period of time. This was due to massive inflation by central banks across the world. The Fed kept interest rates far below the market rate for years creating enormous amounts of credit and liquidity. The Bank of Japan had the most accomodating monetary policy imaginable with 0% interest rates. The Chinese and Middle Eastern countries were accomplices to the Federal Reserve with their dollar pegs that resulted in them inflating to keep up with the United States. This led to global savings doubling in such a short time. This wasn't simply real savings resulting in people deferring consumption in order to save for future consumption (what individuals do when they decide to save for a house instead of spending it on the movies). This was massive amounts of new money being created and lent out.

The reason this worked for so long is because we had massive productivity increases with the advent of computers, the Internet, and the growth in the BRIC economies. This helped mask the inflation. All these productivity gains should have caused prices to drop dramatically, but central banks fear falling prices and governments love inflation because it allows politicans to finance their pet projects. So we had years of massive inflation, but prices of most things we consume rose only modestly as the increases caused by the new money was somewhat offset by productivity gains and low wages of foreign workers. The purchasing power of savers should have rose dramatically, but instead it barely kept up.

But all that new money had to go somewhere and somewhere it went. Fixed income savings of $70T wants to get a good return. And getting a 1% return on treasuries when even the CPI is higher isn't a successful recipe for pension funds and insurance companies. All that money went into the biggest credit bubble the world has ever seen. And there's been plenty of good articles and blogs about this subject. I highly recommend This American Life's episode titled The Giant Pool of Money.

So now the housing bubble has popped. Billions if not trillions of dollars of credit are being destroyed. When somebody defaults on their house and the bank can only sell it for 60% of the mortgage, that other 40% is just gone. That's true deflation. That is destruction of money and credit. The money came into existence out of thin air when central banks and the financial system created it and when that loss is written off, it just goes back into thin air. This is the deflation Mish is referring to. But what is the inflation Peter Schiff is referring to? Ah, this is where it gets connected back to rising oil and commodity prices. While there may be some credit deflation happening, most of that $70T is still in existence and it's trying to find a new place to go to find a return. The interest rates on treasuries are very low partly because the Fed has dropped the fed funds rate to 2%. That is a negative real return on money when compared to even the understated CPI. If these investments can't get a decent return on bonds, some of it is going to go to other places like precious metals and commodities.

But this is still only part of the story. The United States created so many dollars in the past and the world just doesn't need that many more. China and the countries that supply us with oil receive enormous numbers of dollars, way more than they need to buy stuff that we produce that they want (i.e. the trade deficit). And because the dollar has been the world's reserve currency for decades, all the wealthy countries in the world have already accumulated huge numbers of dollars. And they are beginning to wonder why they should keep accumulating this paper. And basic supply and demand says that if the demand for dollars is decreasing, the prices of things denominated in dollars will rise. And they are. The entire world wants more oil and food. They want fewer dollars.

So that's pretty much the story and we can expect it to continue for a while. Even if there's lots of deflation happening in the credit markets, that deflation is small compared to what will appear to us like inflation if all the countries that have accumulated trillions of dollars start sending them back to us to purchase real goods. The purchasing power of the dollar will keep going down until the imbalances are fixed. And then it may overshoot because markets often overshoot. Politicans will predictibly blame "evil" speculators and the "dangerous" free market. Funny that they didn't blame speculators and the free market when housing prices were rising. At any rate, the blame lies fully with the government. None of this could ever have happened under a gold standard.