Friday, October 31, 2008

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. 

Thursday, October 30, 2008

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

Tuesday, October 28, 2008

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

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.

Monday, October 27, 2008

Senior Liberation Act

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.

Tuesday, October 21, 2008


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. 

Monday, October 20, 2008

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."]

Thursday, October 16, 2008

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!"

Thursday, October 2, 2008

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.