Friday, July 23, 2010

A Complete History of Economic Thought

Economic thought can be broken down into three distinct periods. The first is lodged between the twenty two hundred years starting with the height of Greek civilization in 500 BC and ending in the early 1700s with the coming of the industrial revolution. This epoch is populated with the political philosophy of the likes of Socrates, Plato and Aristotle as they attempted to define liberty, justice, property rights and law. These ideals provided a theoretical foundation for economic thought in the coming years.

The second period of economic thought evolved because of the industrial revolution and ended in 2002. During this era Adam Smith, David Ricardo and Thomas Malthus combined the political philosophy of the Greeks with the new profit driven concepts of capitalism. This unwieldy combination of political ideals and financial concepts never evolved to become a science.

During this dark period philosophers believed that savings and increased productivity created a higher standard of living for future generations. It was conjectured that debt could increase a nation’s standard of living in the short term but must be avoided as a long term panacea.

Along with these other misconceptions there was the delusion that the debasement of a currency by a wise and equitable government could create a misallocation of resources that rewards political “favorites”. Simpletons like Thomas Jefferson, Edmund Burke, and Alexis de Tocqueville wrote tomes about this government manipulation and suggested that it was a form of tyranny.

Today these well intentioned treatises are viewed as nothing more than Voodoo economics. Most of these “dismal” economic philosophers have been relegated to the dust bin of history.

The simplistic thinking of our ancestors changed in 2002 as our government and our financial system merged into a single entity. This symbiosis has allowed the science of government directed financial management to replace the theoretical “invisible hand” of Adam Smith. It is fostered by the bounty of the endless money that is created by our Federal Reserve and then funneled directly into our financial system.

There were a few master theorists that foresaw our current managed economy.

While Jefferson, Burke and de Tocqueville were writing about ideals, Karl Marx was using ideas to plan a future economy. He explained why capitalism can’t work and why the government must intercede.

Joseph Stalin commandeered Marx’s concepts and showed us a glimmer of our future as he managed an empire that had seemed unmanageable in the past. Papa’s deliberate style of management used his military to direct his populace through the emotion of fear.

Our elected officials have taken this egalitarian ideal one step further. Instead of using just the emotion of fear to direct an economy, our politicians utilize the fear and the greed of speculators to gently push our economy to new heights.

Today we take this government “stimulus” for granted. Stalin’s economic direction is replicated by economic enticements by our government run financial sector.

Thanks to the Federal Reserve money is constantly pulled from our non productive savers to create new bubbles of economic growth. This growth is not enabled by theoretical capitalistic ideals but with scientifically micro managed "free markets" run by Wall Street economists.

The government stimulus creates permanent economic plateaus very similar to the one predicted by Irving Fisher of Harvard in 1929 with accompanying economic moderation as predicted by Professor Bernanke of Princeton in 2004.

Only these permanent exuberant periods or “bubbles” as they are sometimes called will be the solid foundation for future growth.

The philosophy and ideals of the past have been replaced by hard science.

This economic renaissance is like a roller coaster with all of the falls eliminated and replaced with permanent plateaus supporting prolonged periods of prosperity courtesy of the economic science of our government run financial system.

Sunday, July 11, 2010

History Never Repeats Itself Exactly

Anyone except for perhaps the nation’s highest paid Wall Street Economists should be able to understand our nation’s present predicament. We are in a situation very similar to 1930. Our nation is carrying a historically high total debt to GDP ratio, our investment markets are jittery and we are looking to the government to somehow fix the problem.

During the Great Depression the major economic threat that most people feared was inflation. So the government used politics instead of common sense to solve the problem. Since people feared inflation then it was deemed that the government should abstain from "substantially" increasing the money supply.

Thanks to our unwarranted fear of inflation and with help from the Federal Reserve our economy was locked into 10 years of grinding deflation.

Today our nation has an abject fear of deflation because of the memory of the Great Depression. No matter what the alternative we will go to any length to avoid the dreaded “D” word.

It was this ridiculous deflation fear that caused then Fed Chairman Alan Greenspan to flood the economy with money in 2003. The Greenspan faux pas added to the supply side largess from the Bush Tax cuts to create the biggest real estate bubble in the history of our nation.

Even after the incredible debt, waste and excess of the housing bubble our nation still lives in abject fear of deflation. We are demanding another bubble from the government.

Of course they are happy to oblige.

Chairman Bernanke has removed the bolts from the base of the money fire hydrant and liquidity is shooting high in the sky. I have no idea how he is going to reattach it in the future. Money is gushing into the government and the financial sector faster than the oil spew coming from the Gulf of Mexico.

The high end real estate markets and our commodities markets are still in a bubble. And our long term bond market is in a super bubble. The unrestrained spending of the government and financial sector make Imelda Marcos’ shoe purchases seem frugal.

Although we are in a situation similar to 1930, bad government policy has created the antithesis of the Great Depression. Instead of runaway deflation and economic starvation we are incurring massive bubbles, horrendous waste and historic misallocation of resources.

Speculators are bailed out 100 cents on the dollar paid for by our savers. The highest paid government employees retire as kings at 50 while teachers and police are laid off. The financial sector is receiving record pay raises and bonuses for destroying our economy. Education and health care expenses are on a space shuttle trajectory to the moon. If the public sector was an economy unto itself, it would be in Zimbabwe style hyperinflation.

The private sector is affixed in a position antipodean in relation to the public sector. The private sector must hire illegal aliens and ship jobs to foreign countries to pay higher and higher taxes. Private sector jobs are extinguished with the massive subsidies required by this bloated non productive bubble creating bureaucratic behemoth.

But amazingly, the taxpayer is not upset at this monumental misallocation of resources as long as they are protected from the monster of deflation.

So our fear of the deflation of the Great Depression is driving policy in the opposite direction. Our government will fight tooth and claw against deflation even if it means living from bubble to bubble, creating massive borrowing and waste with the day of debt reckoning being pushed onto our children’s scrawny overtaxed shoulders.

Our highly paid Wall Street economists are telling us that we are on the verge of another Great Depression and that we must use extreme measures to avoid deflation at all costs.

My only advice is to be careful what you wish for.

Stagflation here we come.

Wednesday, July 7, 2010

Our Orwellian Economy

Our economy is in the final acts of an Orwellian drama. Just as in Orwell’s fiction, the individual and the truth are usurped by the power of the state.

· Our Ministry of Housing had a goal to make homes affordable for the lower class. Now that these homeowners are desperately underwater, rich investors are buying up the lower end real estate. Many members of the lower class that were helped by the Ministry of Housing are destined to rent forever.

· Our Ministry of Lending had a goal to make mortgages affordable for all. Now, the indebtedness of our total mortgage market is equal to the value of our mortgaged housing stock. So in the aggregate, anyone with a mortgage is just a high priced renter locked into a 30 year lease.

· Our Ministry of Jobs had a goal to increase employment. It has heavily subsidized the non productive public and financial sector jobs market. To pay for these subsidies the productive private sector was heavily taxed. And now, even more taxes must be levied on the shrinking private sector to pay the unemployment benefits of displaced workers as their jobs are shipped overseas or staffed by illegal aliens.

· Our Ministry of Free Markets had a goal to create fair and stable investment markets. It has manipulated almost all market conditions and gamed the system by bailing out some to the most egregious speculators. This policy has created two of the largest investment bubbles in our nation's history. Not to be outdone the current ministry is using even more extreme measures to create the biggest bond bubble in the history of the world.

· The Ministry of Sound Investing had a goal to manage interest rates for the benefit of investors. It is now punishing savers with zero percent interest rates and using the windfall to bail out speculators.

· Our Ministry of Sound Money had a goal of controlling prices. One dollar in 1950 is now worth 12 cents.

· Our Ministry of Sound Government had a goal to reward citizens for voting appropriately. For the past 15 years our politicians have used ultra long term debt to purchase votes in the next election. Mathematically it has become impossible to pay back these promises with future income, so by definition it has become a Ponzi scheme.

· Our Ministry of Sound Accounting has created bookkeeping techniques to hide the Ministry of Sound Government’s Ponzi scheme.

Presently our Ministry of Freedom is saying that we need to borrow large amounts of money from hostile foreign nations to increase our children’s standard of living and keep them safe in the future.

Debt and consumption are good. Saving is very, very bad. Our non productive government and financial sectors must be heavily subsidized to create economic growth. The productive private sector must be heavily taxed to create more jobs. Up is down. And left is right.

There are many allocation problems with our economy today that are creating a high level of unemployment. Non productive government favorites receive ever increasing pay, benefits, pensions and subsidies. This must be paid for by the ever decreasing pool of private sector jobs.

As an accountant I don’t understand the math behind our policy choices in the ministry over the last 15 years. Why do our comrades in government feel that more borrowing for more subsidies to the financial and the public sector will produce more private sector job growth? It has not worked for the last 15 years. After massive spending and subsidies we have less private sector jobs today than a generation ago.

The pay and job growth in the non productive sectors of our economy have exploded.

Alas, in the end we must listen to the Ministry of Fairness when they say, “all citizens are equal.”

And, as good citizens we must understand that, “the government and the financial sector are more equal than everyone else.”

Thursday, July 1, 2010

The Herd of Irrational Investors is Here to Stay

Toward the end of 2007 I started accumulating a significant short position in the market as every economist and investment advisor in the country was sure that there where blue skies forever in the economy.

In March of 2009 I was pitchforking money into the stock market as most investment advisers were warning that we were on the verge of a financial meltdown. Before the recovery I ended up 90% market positive.

On March 17th of this year I went market neutral as the S & P index hit 1166. At that time most investment advisers were confident that our nation was on the road to a V shaped recovery.

Today, now that the S & P is trending toward 1000 and many economists are talking about a Depression, I am slowly buying into the stock market.

Maybe I am being a little too aggressive as my sleep at night portfolio is back up to 50% stocks and shorts on the long term bond market. I just think we have a couple more quarters of increasing corporate earnings before the next recession.

I would like to be accumulating a short position by the first quarter of 2011.

So does this make me a speculator. Absolutely not. I would suggest that in each case I am looking at the value of the market.

  • In 2007 the market was extremely overvalued as we were going into a recession.
  • In March of 2008 the market was extremely undervalued as the government was poring stimulus money into the economy.
  • In March of 2009 the S & P was 11% overvalued after the longest market run in the last 50 years.
  • Today the S & P index is 5% undervalued as we have 2 more quarters of corporate growth from the stimulus. And perhaps more stimulus.

In each case I based my decisions on the valuation of the market and only the valuation of the market.

But my moves seem to be the exact opposite of what everyone else is doing.

As I have said before in my blog. For the past 10 years our investment markets have been ruled by our nation of debt fueled speculators. People are getting very good at making irrational decisions and then the government bails them out. Which creates more market irrationality.

This dynamic isn't going to stop anytime soon.

When I invest I look at valuation. That is why I am renting a home today, why I am slowly buying into the stock market now as everyone is selling and why I am trying to accumulate a large short position in long term bonds.

What are the benefits of value investing? Mainly just piece of mind and low risk. I don't make investment decisions. I let the market make them for me.

Therefore I don't worry about my investments. I have not lost an hour of sleep worrying about my investments for the last 10 years.

Can you say the same thing?