Category Archives: Economy and Meltdown

The Gaping Maw Of Centrally-Planned Surreality


There was a time when the market led, and the economy followed. That’s when the market was still a discounting mechanism, a long, long time ago. Then came a time when the clueless market, after every illusion it held about a Dow 36,000 future was shattered, would respond with a slight, millisecond delay to every flashing red economic “surprise” headline and thanks to HFTs exaggerate the momentum of the move spectacularly, leading to delirium-inducing volatility, and even further confusion. But what we have now, under the final advent of the central planner New Normal, when the economy is clearly going one way (the wrong one), while the S&P is dogedly chasing the opposite direction and completely ignoring any and all downside macro surprises, is something never seen before. One thing is certain: the gaping maw of the alligator: the red and the blue arrows will converge, and sooner or later the convergence will not be in the direction that the central printer, and his Liberty 33 henchmen, request.

Courtesy of John Lohman

Guest Post: QE3 And Bernanke's Folly – Part II


Submitted by Lance Roberts from StreetTalk Advisors, Click Here For “QE3 And Bernanke’s Folly – Part I

QE3 And Bernanke’s Folly – Part II

Mark Twain once wrote that “History doesn’t repeat itself, but it does rhyme.”  While this is a statement that is often thrown around by the media, economists and analysts – few of them actually heed the warning.  It has been even worse for investors.  Over the past 800 years of history we have watched one bubble after the next develop, and bust, devastating lives, savings and, in some cases, entire countries.  Whether it has been a bubble created in emerging market debt, rail roads or tulip bulbs – the end result has always been the inevitable collapse as excesses are drained from the system.

On September 6th, 2008 I gave a presentation discussing the December 2007 recession call we had made (NBER officially stated the recession started in December 2007 a full year later) and the potential for a substantial crisis ahead (the market began its collapse one month later.)  During the presentation I showed the following slide discussing history and why this time was “not going to be different.” 

Each previous bubble was predicated on expansion of credit, lax lending policies, inflation, speculation, unique investment opportunity (tulip bulbs), or leverage which ultimately led to speculative fervor.  The speculative fervor occurs as the bubble becomes fully developed and sucks the last of the “buyers” into the market creating a vacuum when sellers emerge.  

Since that presentation in 2008 many of the predictions that we had made at the time came horrifically true.  Today, we once again have to ask ourselves whether the markets are repeating history or if this time is “truly” different?  Unfortunately, the answer is most likely “no.”

Over the past couple of months the markets have advanced sharply in anticipation of a third round of Large Scale Asset Purchases (LSAP) by the Fed which has become affectionately known as QE3.  The Fed delivered not only the expected QE3 program but expanded it by making it an open-ended program that will last until “employment reaches an acceptable level.”  This is quite a departure from the previous two programs, which were finite in nature, and has a lofty goal of boosting the economy to boost employment.  The problem is that an artificial intervention program of this magnitude leads us once again into the realm of “unintended consequences.” 

History is replete with examples of interventions that go wrong.  The chart below shows the actions by the Federal Reserve in the past and the subsequent “crisis” that those actions bring.  What the media misunderstands is that it is the policy of artificially manipulating interest rates that creates the bubble.  It is when interest rates rise that has historically been the “pin” that popped it which explains much about the Fed’s stance on ensuring that rates do not rise – ever again.

Since the turn of the century the U.S. economy has been subjected to the bursting of the stock market “tech” bubble that was driven by investor fervor followed by the collapse of the real estate bubble created by excessive credit and leverage.  Since the end of the last financial crisis the Federal Reserve has remained consistently engaged to try and stabilize the financial system.  By injecting trillions of dollars of liquidity into the system the Fed has made a concerted effort to reduce the probability of another financial crisis caused by a freezing of the credit markets.  However, in the endeavor to prevent one event they may unwittingly be creating another.

The Federal Reserves goal has been clearly stated that by boosting asset prices consumer confidence will be lifted supporting economic growth.  The chart below shows the balance of excess reserves at Federal Reserve banks as compared to the market, consumer confidence and GDP.

What is evident is that while QE programs have flooded the excess reserve accounts of Federal Reserve banks there is little evidence that it translates to anything other than higher asset prices and a boost to the profitability of the banks through trading activities.  However, these increases in bank liquidity, which are ultimately transformed into proprietary trading activities, is something that we witnessed during the real estate bubble from 2004-2008.

As we stated in our weekly missive: While no two markets are ever the same – in this case, however, the issuance and repackaging of mortgage debt previously supplied massive liquidity to banks.  This liquidity was then funneled into proprietary trading operations which drove markets higher.  Today, the Fed is buying the mortgage bonds from the major banks in turn providing excess liquidity which again is funneled to proprietary trading desks. The net result is same.”   The importance of this is that the Fed was blind to the asset bubble being built in late 2007-2008 just as they will most likely be blinded by a focus on employment to the exclusion of risks building elsewhere in the system.

One of the signs of a potentially burgeoning asset bubble in stocks is valuations.  As opposed to the previous QE programs where earnings were rising sharply – during the recent market advance leading up to QE3 valuations have risen by more than 2 points as prices advanced in the face of declining earnings.  Recent manufacturing and corporate reports are citing the weakness of the continuing recession in the Eurozone now beginning to impact the U.S.

These rising valuations show a clear detachment between price and underlying fundamental and economic realities.  The risk to investors is that a liquidity induced stock market rally creates a further disparity between fantasy and reality.  It is the disillusionment, as the dream turns into the next nightmare, which devastates market participants.

There has been much commentary about how the market can support higher valuations due to lower interest rates.  This is a fallacy of the Greenspan era that has continued to be perpetuated (see full analysis here.)  With interest rates artificially suppressed by the actions of the government the theory loses much of its integrity.  

The risk that the Fed is running is the creation of another “unrecognized” asset bubble in stocks one again.  The chart above shows the Shiller cyclically adjusted P/E based on trailing reported earnings.  Historically when P/E’s have reached a level of 23x earnings, or greater, it has normally been indicative of the end of a bull market cycle.  The major exceptions were the 1929 and 2000 stock bubbles.  With valuations currently at 22.5x earnings the stock market, even in a low interest rate environment, are no longer “cheap” by many measures.  This puts investors at risk of a sharp decline in equity prices as valuations adjust to the underlying fundamentals.

I am not saying that an asset bubble exists at this particular moment.  What I am saying is that Bernanke’s folly of thinking that asset purchases that flood Wall Street with liquidity will improve housing, employment or the economy.  There is currently no evidence of that.  However, there is clear evidence that the continued suppression of interest rates is forcing unwitting investors into chasing yield which can most dangerous to their financial future.

Most likely the markets will push higher in coming months as liquidity floods the system pushing commodity prices and interest rates higher while devaluing the U.S. dollar.  This will be great for the major banks trading profits but will impose a harsh tax on the consumer which ultimately impacts aggregate end demand for businesses.  It is this degradation of the consumer that will likely push the economy towards the next recessionary drag and is something that yield spreads are already warning of.

While Bernanke has high hopes that QE3 will support the economy long enough for a grid-locked Congress to enact fiscal policy to support the ailing economy – the reality is that we already may be closer to the next asset bubble than we realize.

Take the Test to See If You Might Be Considered a “Potential Terrorist” By Government Officials


There have been so many anti-terrorism laws passed since 9/11 that it is hard to keep up on what kinds of things might get one on a “list” of suspected bad guys.

We’ve prepared this quick checklist so you can see if you might be doing something which might get hassled.

The following actions may get an American citizen living on U.S. soil labeled as a “suspected terrorist” today:

Holding the following beliefs may also be considered grounds for suspected terrorism:

  • <a href="http://publicintelligence.net/do-you-like-online--you-may-be-a-terrorist/” target=”_blank” title=”Liking online “>Valuing online

Many Americans assume that only “bad people” have to worry about draconian anti-terror laws.

But as the above lists show, this isn’t true.

When even Supreme Court Justices and congressmen worry that we are drifting into dictatorship, we should all be concerned.

Guest Post: The iKrug


Submitted by Pater Tenebrarum of Acting Man blog,

A Cell Phone Will Save the US Economy

It appears it is after all not Scott Sumner who ‘saved the US economy‘ by urging the helicopter pilot to create even more money ex nihilo than hitherto. What will save us instead is Apple, or rather, its latest product, the iPhone 5. Who needs Bernanke when this wondrous device stands ready to pull the economy up by its bootstraps?

A story has made the rounds lately – propagated by ‘economist’ (we should use the term loosely…) Michael Feroli at JP Morgan, that sales of the iPhone “could potentially add from one-quarter to one-half of a percentage point to the growth rate of U.S. gross domestic product in the final quarter of the year”.

If we were to assume that he is correct, then what this would mainly tell us is how useless a statistic GDP actually is. However, there are some reasons to doubt the results delivered by his abacus. According to a Bloomberg article:

 

 

 

“Here’s Feroli’s math: Assume sales of previous-generation iPhones continue “at a solid pace,” while the new model from Apple (AAPL) sells about 8 million units in the last three months of 2012. Assume the average selling price for the new models is about $600. (True, people who get the new phone as part of a calling plan pay less than the sticker price, but the sale gets reported to the government for what it would have cost on a stand-alone basis.)

Out of that $600, about $200 is the imported cost, leaving $400 as the value captured in the U.S. Multiply $400 times 8 million and you get a pop of $3.2 billion, which is enough to boost the annualized growth rate of the economy by one-third of a percentage point. Feroli, the bank’s chief U.S. economist, expects the U.S. economy to grow at an annual rate of about 2 percent in the fourth quarter, and says the iPhone will “limit the downside risk” to that projection.“

 

Now, before we continue, a few words about the iPhone 5. It is undoubtedly a marvel of engineering (as a friend and card-carrying Apple fan told us, the aluminum unibody alone is a stunning achievement of modern-day milling methods). However, many observers seemed to agree that apart from a sleeker design combined with lower weight and a somewhat bigger screen than the predecessor model, it offers only incremental improvements.

Its new map application is generally regarded as a letdown compared to the previous Google map app. All in all, the phone allegedly lacks, as one journalist at Reuters put it, a ‘wow’ factor.  Mind, we are not trying to put the new iPhone down – we merely want to make the point that its release has not exactly made the iPhone 4 (or previous models) completely outdated or unusable.

 


 

The iPhone 5 – will its release add to economic growth?

(Image via Apple.com)

 


 

Another somewhat more famous economist has chimed in on the topic, the man who has forever destroyed what was left of the nimbus attached to the Nobel Prize for Economics by somehow winning it, namely Paul Krugman.

Not surprisingly, Krugman used Feroli’s line of argument regarding the iPhone  to fashion a screed designed to convince readers of his column that more government spending is called for. We kid you not.

 

Broken Windows, Carts and Horses….

Krugman’s article on the topic in the NYT is entitled „The iPhone Stimulus“. Below are a few excerpts:

 

„So is the new phone as insanely great as Apple says? Hey, I’ll leave stuff like that to David Pogue. What I’m interested in, instead, are suggestions that the unveiling of the iPhone 5 might provide a significant boost to the U.S. economy, adding measurably to economic growth over the next quarter or two.

Do you find this plausible? If so, I have news for you: you are, whether you know it or not, a Keynesian — and you have implicitly accepted the case that the government should spend more, not less, in a depressed economy.“

 

Wow. So if that is what it really means, then some readers may already decide on the spot that Feroli’s theory has just been disproved. Seemingly unwittingly, Krugman is shooting his whole intellectual house of cards down in this first paragraph. However, you will be surprised just how deluded this political hack actually is. Bear with us.

 

„The crucial thing to understand here is that these likely short-run benefits from the new phone have almost nothing to do with how good it is — with how much it improves the quality of buyers’ lives or their productivity. Such effects will kick in only over the longer run. Instead, the reason JPMorgan believes that the iPhone 5 will boost the economy right away is simply that it will induce people to spend more.

And to believe that more spending will provide an economic boost, you have to believe — as you should — that demand, not supply, is what’s holding the economy back. We don’t have high unemployment because Americans don’t want to work, and we don’t have high unemployment because workers lack the right skills. Instead, willing and able workers can’t find jobs because employers can’t sell enough to justify hiring them. And the solution is to find some way to increase overall spending so that the nation can get back to work.“

 

The short version of the above paragraph is: we can consume ourselves to prosperity. And if you accept that premise, then you must of course  accept what comes next. After bemoaning the reluctance of businesses and consumers to engage in an orgy of mindless spending (except of course when there’s a new i-gadget released), Krugman reminds us of  his solution: the government must jump into the breach.

 

„Why not have the government step in and spend more, say on education and infrastructure, to help the economy through its rough patch? Don’t say that the government can’t add to total spending, or that government spending can’t create jobs. If you believe that the iPhone 5 can give the economy a lift, you’ve already conceded both that the total amount of spending in the economy isn’t a fixed number and that more spending is what we need. And there’s no reason this spending has to be private.“

 

Yes, why not, indeed? We’ll explain that in just a moment, but let us first point out what the fundamental error in this whole iPhone/GDP story is.

It is actually a variation on the ‘broken window fallacy’ – it completely ignores a basic economic concept that we would normally expect every economist to be aware of, namely opportunity cost. We mentioned above that the predecessor of the iPhone 5 remains perfectly serviceable in order to underscore this crucial point.

By buying the iPhone 5, the buyers will no longer be able to buy something else. Every buyer of the new iPhone has a personal scale of valuation that ranks the items he wants to spend his funds on. Obviously, for all those who actually go out to buy the new iPhone, some goods or services that are ranked lower on their value scale will end up not being bought.

Would people cease to buy smart-phones if there were no new iPhone? Of course not – but it is a good bet that at least some users of the predecessor model would not yet junk it. It is highly questionable given the incremental improvement the iPhone 5 represents that they are really gaining much more than the satisfaction that comes from owning what is held to be the latest and greatest gadget (but we are not arguing with that – they want it, and that means they feel it is useful to them). It seems likely though that absent the new iPhone, they would spend the funds on something else instead – so the argument that “total spending” in the economy  will increase is standing on a very flimsy foundation.

Let us assume though that instead of spending the funds on consumption, they were to decide to save instead. Would that be ‘bad’? According to Keynesians like Krugman, the answer is yes.

However, we would not even have this discussion if no-one had first produced the iPhone. How do things get produced? To make production possible, one must invest in capital goods. And savings are what funds these investments – they are the sine qua non.

Note here that it is not money created from thin air by Ben Bernanke that can fund production. What funds production is the pool of real funding.  Unless at least some people refrain from consuming their entire economic output, no new additions to the economy’s capital structure will be possible. In fact, there must be savings to merely maintain the existing production structure (for a brief overview of capital theory, interested readers might want to check out our previous essay on the production structure that summarizes the essential points).

In other words, when Krugman insists that more spending and consumption will bring the economy back on track, he is putting the cart before the horse. Increased consumption is an effect of economic growth, not the cause of it.

What about his suggestions regarding government spending? Is there not something to be said for ‘infrastructure’ or ‘education’ spending’?  Are these not worthy causes?

The problem with this line of argument is that the government is the one organization that is the least able to decide what types of spending are economically sensible. Since the government has no profit motive – it ultimately obtains all its funding by means of coercion – it has no way to engage in proper economic calculation (although the people it hires to implement the spending can up to a point make inferences by observing the private sector).

In other words, once again the main problem is opportunity cost. Say for instance that government decides to finance the building of a bridge. How can it possibly know if the resources expended on building the bridge would not have satisfied more urgent consumer wants if they had been employed differently? The answer is, it cannot possibly know that. Without a profit motive and without economic calculation enabling it to compare input costs to expected income, there simply is no way to know.

This is also the reason why socialism is literally impossible: a socialist community has no market for the means of production, and hence lacks the very basis of economic calculation, as calculation without money prices is obviously not possible. Chaos is the inevitable result, or as Ludwig von Mises pointed out (in ‘Calculation in the Socialist Commonwealth’):

 

“Without economic calculation there can be no economy. Hence, in a socialist state wherein the pursuit of economic calculation is impossible, there can be—in our sense of the term–no economy whatsoever. In trivial and secondary matters rational conduct might still be possible, but in general it would be impossible to speak of rational production any more.”

 

Of course we are luckily not living in a command economy. Ours is still a market economy, if a severely hampered one. And yet, the basic problem of being unable to calculate confronts every government agency, regardless of the fact that the problem is even more acute in full-blown command economy.

Therefore, Krugman is wrong when he asserts that “there’s no reason this spending has to be private”. There is a very good reason: government spending is extremely likely to waste scarce capital and liable to induce intra-temporal discoordination in the production structure – in other words, its spending will create a configuration of the economy’s capital structure that is not in accordance with consumer wants.

Apple’s iPhone offering is certainly different in this regard: it obviously does conform to consumer wants. Apple’s profits provide ample proof for this assertion – in fact, it is the most profitable company in the world. However, this does not mean that one  can safely ignore opportunity cost when arguing that spending on the new iPhone will add to overall economic growth.

 


 

The performance of Apple’s stock price speaks for itself – click for better resolution, chart by StockCharts.

 


 

Krugman Discovers A ‘Theory’

However, what really takes the cake is a small posting of Krugman’s on the same topic that we discovered incidentally when searching for the article discussed above on Google. Apparently Krugman felt the need to address the topic of obsolescence in more detail and on this occasion lets us in on the fact that he has indeed heard about the ‘broken window’ before. The post is entitled “Broken Windows and the iPhone 5”.

When seeing the headline, we at first thought that Krugman would attempt to refute that the broken window fallacy appealed to him. Far from it!

 

“The key point is that the optimism about the iPhone’s effects has nothing (or at any rate not much) to do with the presumed quality of the phone, and the ways in which it might make us happier or more productive. Instead, the immediate gains would come from the way the new phone would get people to junk their old phones and replace them.

In other words, if you believe that the iPhone really might give the economy a big boost, you have — whether you realize it or not — bought into a version of the “broken windows” theory, in which destroying some capital can actually be a good thing under depression conditions.”

 

(emphasis added)

Once again, this man has actually won the Nobel Prize for Economics. Perhaps it is time for the prize committee to consider demanding its return. 

So it is the ‘Broken Window Theory‘ now, is it? Actually, as noted above, the concept is known as the ‘Broken Window Fallacy‘. It was originally formulated in the form of a parable by the great French economist Frederic Bastiat, who explained that in economics, one must not only consider that which is immediately seen, but also that which is not seen.

It is a fallacy to believe that destruction can make us richer –  in fact, Krugman admonishes us to simply deny that opportunity costs exist in what he refers to as ‘depression conditions’. The implication of this assertion is that fundamental economic laws magically cease to apply whenever the economy suffers a downturn.

This view is erroneous – economic laws are not dependent on economic conditions. This is akin to arguing that the laws of nature will cease to be operational on Wednesdays. Not surprisingly, Krugman is also a supporter of the view that ‘war is good for the economy’ – even if it is war against imaginary space aliens, or what we might call Krugman’s version of  ‘Plan 9 From Outer Space‘.

 


 

Paul Krugman: getting ready to break some glass to save the economy. In Krugman’s capable hands, a fallacy becomes a ‘theory’.

The US Will Spend Between $3 And $7 Per Gallon Of Gasoline "Saved" By Consumers Driving Electric Vehicles


Sometimes you just have to laugh – for fear of the hysterical crying fit that would ensue from recognizing our shameful pathological reality. To wit: Reuters is reporting on a CBO study that shows the US electric car policy will cost $7.5bn by 2019. The report finds that the government’s policy will have ‘little to no impact’ on overall gasoline consumption. 25% of the cost of the program is going up in Fisker Karma-inspired smoke as part of the $7,500 per vehicle tax credit and the rest of the cost is in grants to such well-deserved and successful operations as GM’s Chevy Volt – which will backfire since the more electric vehicles the automakers sell (thanks to government subsidy) the more ‘higher-margin’ low-fuel-economy guzzlers it can sell and still meet CAFE standards (re-read that – amazing!) In 2012, 13,497 Chevy Volts and 4.228 Nissan Leafs have been sold (all that pent-up demand) as the CBO notes that despite the $7,500 subsidy, the cost-differential to conventional cars remains too wide – inferring a $12,000 tax credit would be more comparable.

 

Via Reuters: US electric car policy to cost $7.5 bln by 2019-CBO

U.S. government standards mandate that by 2025, automakers to show corporate average fuel economy (CAFE) of 54.5 miles per gallon or about 39 miles per gallon in real world driving.

… The federal tax credits apply to the first 200,000 electric vehicles sold by each manufacturer. But these sales will leave room for automakers to continue to sell models with low fuel economy, the CBO said.

 

The more electric and other high-fuel-economy vehicles that are sold because of the tax credits, the more low-fuel-economy vehicles that automakers can sell and still meet the standards,” according to the report.

 

 

While drivers of these electric vehicles use less gasoline and emit less greenhouse gas such as carbon dioxide, the cost to the government can be high, the CBO found. The U.S. government will spend anywhere from $3 to $7 for each gallon of gasoline saved by consumers driving electric vehicles.

 

 

The costs of electric vehicles — fully electric and plug-in hybrid electric — are much higher than similar-sized gasoline vehicles, and the federal tax credit of $7,500 per vehicle is not enough to bridge the gap, the CBO said.

 

The CBO said an average plug-in hybrid vehicle with a battery capacity of 16 kilowatt-hours is eligible for the maximum tax credit of $7,500.

 

“However, that vehicle would require a tax credit of more than $12,000 to have roughly the same lifetime costs as a comparable conventional or traditional hybrid vehicle,” the CBO said.