Friday, April 30, 2010

Border Patrol

Something in the way you love me won't let me be
I don't want to be your prisoner so baby won't you set me free?

Interesting article on the role of borders in creating political competition and choice. Must admit that I hadn't thought this thru, but it's true. As the author states, "Macro borders with competition enhance liberty."

He also observes that politicians can erase these borders to reduce competition. But politicians, who act in their own self interest like the rest of us, are reluctant to do so because it would mean few positions for them. Nicely done.

The current event along these lines is Arizona's new law to put more authority for identifying illegal immigrants in local police hands. The federal government, particularly those on the Left, doesn't like this.

Arizona states their motivation as one of security for its citizens. The Feds states their motivation as one of preserving individual liberties. These are their stated motivations but their real motives, of course, may be different. The Republican-controlled Arizona apparatus may be seeking to throw a wrench in Democrats plans for amnesty, or perhaps they want to shield local jobs from competition. The Democratic-controlled federal apparatus sees a large bloc of Latin American voters that it would like to pocket for the Fall elections.

To me, putting more control (for just about anything) in the hands of individual states is desirable as it strips power from remote authority. Local government is easier for citizens to monitor and to tailor to their needs.

However, states can not compromise individual liberty. Even if well intentioned, laws that give authorities the power to stop people and question them about personal matters threatens the freedom on which this country was founded.

It essentially boils down to this: Do you want to be safe, or do you want to be free? Liberty and security are largely incompatible, as Patrick Henry famously observed.

btw, the riff between Democrats and Republicans on this issue once again demonstrates the inconsistencies in both parties' behavior--and how they're more alike than different.

Republicans say they're for liberty, but are willing to compromise it in the name of physical security.

Democrats say they're for liberty, but are willing to compromise it in the name of social security.

Big government in either case.

Thursday, April 29, 2010


I've been feeling so much older
Frame me and hang me on the wall
I've seen you fall into the same trap
This thing is happening to us all
--Crowded House

A fair amount of this conversation is noise rather than signal, but former President Clinton's comments related to gold and the extreme amounts of leverage in the system are on the right track.

"What is the source of all this leverage?" should be the questions folks should asking. Most, of course, won't like the answer if they due their diligence.

position in gold

Wednesday, April 28, 2010

Origins of the American Welfare State

"Back where I come from, we have universities, seats of great learning, where men go to become great thinkers. And when they come out, they think deep thoughts and with no more brains than you have."
--Wizard of Oz

Interesting article by Rothbard (1996) tracing the origins of the welfare state in the US. He dismisses poverty (general standard of living increased), growing income disparity (income spreads narrower here than in 3rd world), alienization from industrialization and urbanization (cities tended to facilitate local community in 1800s/early 1900s; no correlations found between industrialization and social insurance programs), unionization (max penetration was 5-6% of workforce) as primary factors.

As Rothbard is prone to do, he first identifies groups whose economic interests were promoted by growing the welfare state, and then works his way backwards. Two groups in particular gained from the movement. One was a growing legion of intellectuals, technocrats, and the 'helping professions' that sought power, prestige, subsidies, jobs as well barriers to entry in their fields in the form of licensing. The other group was big business who, having failed to gain monopoly power in the free market, turned to government for subsidies, contracts, and, especially, forced cartelization.

At the turn of the 1900s, Rothbard observes, the interests of these two groups coalesced and overlapped, thereby creating a powerful coalition of weath and opinion-making that accelerated growth of the welfare state in the US.

Heading back to the beginning, then, Rothbard proposes these primary factors in the run up:

Post millenial pietism (PMP). A primarily Protestant movement in the early 1800s that scorned formal church organization and, particularly in the North, encouraged believers to devote their energies toward establishing the perfect society in American thru social and political means. Early initiatives to inculcate civic virtue and obedience included prohibition laws and the first American public schools.

Unlike today, the Democrat Party was the champion of free markets, limited government, and separation of church and state at the time (it was so until being overthrown in the late 1890s by the William Jennings Bryan crowd). As the PMP movement ensured, the Democrats saw a huge influx of religious groups opposed to Yankee theocracy.

Where did the PMP folks head? Why, they ultimately gravitated to the Republican Party, promoting it as the 'party of great moral ideas.'

Big Business. In the mid-late 1800s, big business began jumping on the bandwagon of state privilege and joined the Republican coalition. Early supporters were the railroads who were dependent on government coercion for expansion and lugging a mountain of debt, and iron and steel who were chronically inefficient and dependent on tariffs to shield them from competition.

Feminist movement. What began as an offshoot of the PMP movement among mid- to upper-class women, particularly in the North, led to 'Woman's Crusades' for suffrage, prohibition, and statist programs for government intervention and social welfare. By the 1880s, feminist groups were pushing mandatory work rules, government shelters for the children and poor, federal aid for education--particularly for mothers, and government vocational training for women.

Progressive movement. Driven by a cohort born around 1860, the PMP movement was losing its religious undertow and becoming secularized by the late 19th century. Rothbard suggests that emphasis shifted 'more and more toward a Social Gospel, with government correcting, organizing, and eventually planning the perfect society.' (p. 205) Mix in the socialist ideas eminating out of Europe at the time, and you have a powerful cocktail that became the Progressive movement.

Instrumental in the Progressive movement were academics who obtained their doctorates in socialist Germany (PhD programs were rare here until after 1900) and then returned here to teach. One of Rothbard's real strengths as a historian of political economy is his ability to trace out 'supply chains' of political influence. German trained professors and their offspring populated institutes in higher learning. The Elys, the Commons, the Deweys trained future government officials as well as rising to positions of power themselves.

Women progressives. By the late 19th century, female activism became professionalized and was expressed largely by social work. This movement particularly attracted unmarried women from wealthy backgrounds who had both time and resources to bring to the cause. A primary expression of the movement were settlement house initiatives which became magnets for government programs for social reform and change.

Rothbard traces the movement of many of these women thru the welfare supply chain built by Progressives from the early 1900s thru the New Deal. I also found it interesting how many of these people came from Rockeller, Morgan, Harriman, and other industrialist lineage.

New Deal. After the runup in welfare activities over the previous 100 yrs, the New Deal seems almost an afterthought. Rothbard demonstrates the extent to which New Deal programs were populated by individuals who had essentially been in training for State posts for many years. By this time, men were following in the footsteps of the women pioneers in welfare and social work organizations.

Social Security and big business. While Social Security was a New Deal program, coming on line in 1938, Rothbard highlights it due to its interesting assembly. In the early 1930s, big business, especially those under the Rockefeller umbrella, got behind the idea of a social insurance program. At the time, most large businesses were lugging around pension and other benefit programs for their employees. Smaller, more entrepreneurial organizations had not committed to such obligations and opposed social insurance. Big business was particularly adamant that no business escape social security tax obligations.

Hopefully you see what went on here. Big business used their support of social insurance to gain ground on the superior cost structure of smaller and  nimbler competitors. Corporatism at its finest.


Rothbard, M.N. 1996. Origins of the welfare state in America. Journal of Libertarian Studies, 12(2): 193-232.

Tuesday, April 27, 2010

Mind Over Money

Money, it's a gas
Grab that cash with both hands and make a stash
--Pink Floyd

Just took in this PBS show per my sister's heads up. The show trots out the big names to pit the rational vs behavioral arguments w.r.t. financial decision making.

Simple observation suggests a behavioral component to decision-making of all stripes--not just finance/econ. Yesterday chewed thru a very interesting paper in JBF along these lines.

It's interesting to observe the Gene Fama's of the world argue that behavioral, emotional components don't matter in economics and finance.

The PBS show did leave me wanting from a couple of angles. The show's producers seemed to imply/assume that the behavioral component that helped shoot housing prices higher and collapse credit mkts over the past few yrs occurred in the context of a free, unhampered market.

This is an inaccurate assumption. The interesting and intellectually honest question is how might the installed based of regulation interact with behavioral components to exacerbate natural optimism/pessimism cycles?

The show also implied that, because financial decisions involve an emotional component that can cause folks to sometimes behave irrationally, then financial markets are ripe for regulation. As we've already noted, markets are already regulated. The PBS show in fact shows clips of both Alan Greenspan and Ben Bernanke chatting up the health of the housing mkts as bubbles blew in 2005.

If regulators are people too, and suffer from the same behavioral flaws as others, then how can we expect effective oversight and control? The answer, of course, can be found in observing financial regulators' behavior and effectiveness over the past few yrs.

Born Aegean

"Everything I found out, I want to forget."
--Jason Bourne (The Bourne Identity)

Dominos are starting to tumble in Europe as Greece bail out sputters and sovereign bond ratings get cut. When the EU formed in the late 90s, I wondered how so many diverse countries and cultures would be able to manage a common monetary and fiscal policy--particularly given the socialist structure of so many EU members (as Margaret Thatcher once noted so eloquently, the problem with socialism is that you eventually run out of other people's money).

When things get tough and member deficits run deep, as they are now, we should get a pretty good stress test of the solidarity of this configuration.

The immediate question is one of contagion. We know that Euro banks are in worse shape than US counterparts (which is saying something). Banks especially in Europe also have considerable sovereign bond exposure. I'm also wondering who is short all those credit default swaps that rocketing in value.

The smartest guys I know suspect that many are underestimating the risks here.

Stocks here had their worst day in a while altho admittedly they were due for a breather. Two month uptrend is now clearly broken. Interestingly, gold was strong in the face of a stronger USD.

Next coupla days should prove interesting.

position in SPX, gold

Recursive Verse

No clue of what's happening to you
And before this night is through
Ooh baby, the rhythm is gonna get you
--Miami Sound Machine

Have been jumping around Rothbard's four volume set Conceived in Liberty to get a better feel for Colonial and British view of the revolt. Here's an interesting passage from volume 4:

"The British, like all counter-revolutionaries always and everwhere, scoffed at the Revolution as being a movement of a small fanatical minority rather than a majority, and as a movement of a weak and inferior breed of men. All counter-revolutionaries tend to gravely underestimate their enemies by treating rebellion as the work of a small subversive band of dogmatic and fanatical idealogues." (p. 70)

The rhyme of history.


Rothbard, M.N. 1979. Conceived in liberty, Vol. 4. New York: Arlington House, Publishers.

Monday, April 26, 2010

First User Advantage

"Unexpected, this is. And unfortunate."
--Yoda (Return of the Jedi)

A triumph of the modern State has been convincing people that inflation should be defined in terms of changing consumer prices. Higher consumer prices mean higher inflation.

Prior to the early 1900s (amazing how that period keeps coming up), inflation was classically defined in terms of quantity of money and credit. More money and credit meant higher inflation.

It doesn't require a PhD to sense a relationship between money/credit quantity and prices. Create more money/credit and higher prices should result.

So, doesn't that mean that the modern and classical definitions of inflation are equivalent?

Nope. Today, most money in the system actually takes the form of credit. And the ultimate suppliers of credit in modern systems are central banks. The supply chain generally works like this: central banks lend to big commercial and retail banks; big commercial and retail banks lend to big borrowers such as investment banks big corporations, hedge funds, and regional banks; investment banks and regional banks lend to smaller borrowers such as smaller companies and local banks; local banks lend to individuals and small firms.

It is important to understand that the credit creation process proceeds with successive creditors lending out more than the value of their capital. Banks, for instance, can lend out $9-10 for each dollar in deposits. Investment banks lever up at 20-1 or higher ratios.

The degree of systemic leverage resulting from this approach should be easy to sense. Indeed, when credit is really flowing, $1 from a central bank might pyramid into $50 to $100 of new credit money created in the system.

The classical definition of inflation, you see, focuses purely on the amount of money/credit created by this pyramid scheme.

Here's the thing. We never know where all this money and credit, once created, is going to go--at least right away. Suppose, for example, that big banks borrow $100 billion from the Fed. Instead of lending it, however, they decide to invest it--in stocks, bonds, mortgage backed securities, etc. Little of this money makes its way to the retail end of the supply chain and into the hands of consumers--at least in the short term.

Suppose we have two categories of prices: consumer prices (milk, break, cars, etc) and financial prices (stocks, bonds, etc).

Given the above scenario, which category of prices is more likely to increase: consumer or financial? The financial category, of course, because of increased demand for stocks, bonds, etc. flowing from banks.

Do you see the implications? In our example, $100 billion in new money has been created. But since there has been no measurable effect on the 'consumer price index,' officials proclaim that no inflation is present.

This is precisely what's going on currently. Trillion$ in new credit money have been pumped into the system, but most of it has stayed with the banks, who have used it to buy financial assets. The S&P is up nearly 100% from the March 2009 lows when new money creation went into hyperdrive.

And yet officials report that there is little inflationary pressure because consumer prices haven't moved much.

If you've been wondering how those 'fat cat' bankers get so fat time and time again, you're looking at the primary reason. Our system is rigged to provide financial institutions with 'high powered money'--particularly during times of crisis. This is money created out of thin air that has high purchasing power for those able to use it first. Since big banks are upstream in the supply chain, they get first dibs on it from the Fed. So they use it to buy financial assets and bid prices up.

By the time this money filters downstream to the retail end of the supply chain, much of its purchasing power has been lost because there's much more of it. This pushes prices of consumer and finanical goods higher. Any money held by consumers prior to this inflationary process declines in value as well due to increased money supply.

The implications of this process are many: widening gaps between rich and poor, middle class families increasingly troubled making ends meet, serial financial market bubbles followed by deleveraging busts...

It starts with the Jedi Mind Trick of inflation.

position in SPX

Sunday, April 25, 2010

Simply Red

"Listen, I'm a politician which means I'm a cheat and a liar, and when I'm not kissing babies I'm stealing their lollipops. But it also means I keep my options open."
--Jeffrey Pelt (Hunt for Red October)

Ironically, in the same radio address that proposed increased regulation to stop tax payer funded bailouts, President Obama defended his administration's auto industry bailouts, presumably based on recent reports that GM plans to repay an $8 billion bailout loan by summer.

In early 1980 the Carter administration bailed out Chrysler, providing $1.5 billion in loan guarantees when the company was about to go under. Chrysler repaid these loans in 1983. The deal was hailed as successful since it saved 200,000 jobs. But over the next 20 years, many of those jobs disappeared as Chrysler continued to produce unpopular cars with a bloated cost structure.

In 1998 Chrysler was purchased by Daimler Benz for about $36 billion; in 2007 Daimler sold it to Cerberus Capital for $7 billion. Losses and debt continued to increase while market share declined.

Then, accompanied by GM, Chrysler was back at the bailout table in 2009 as a casualty of the credit market meltdown. Why should credit market probs matter to these two? Their business models had migrated toward more focus on financial products such as car loans than on car production. Moreover, they had both assumed crushing debt loads to keep operations afloat. As credit markets collapsed, both were unable to finance more debt and faced insolvency.

In unhampered markets, inefficient operators lose control of productive resources when they fail to create economic value. In centrally planned economies, such failures are not permitted to occur and losses are socialized.

But with GM preparing to pay back their bail out loan, perhaps this time things 'worked', as the president suggests.

In the short run, employees of GM and associated supply chain operators may indeed benefit as everyone else subsidizes their jobs. All others are worse off. Let's list some specifics:

Less capital for future investment. Resources that could have been freely applied toward other endeavors have been confiscated from their owners and given to the auto folks. Because we have no net savings, this transaction is one of capital consumption. It consumes capital that could have been applied toward productive investment in the future (imagine dipping into your nest egg to fund a lavish vaction and you'll start to get the picture of what we mean).

Prudent decision makers penalized. Automotive operators and entrepreneurs who made prudent decisions are also hurt. This group stood to gain from a Chrysler and GM liquidation as resources changed from weak to strong hands. When inefficient operators are allowed to persist, the prudent operators, including those who may have entered the industry given the opportunity, are penalized.

US citizens poorer. The $8 billion in GM debt only scratches the surface of government stimulus programs to keep the wheels on the economic wagon. These programs required borrowing and money printing in the $trillions. Claiming that the amount going GM's way stopped at $8 billion is disingenuous, as spillovers ranging from low Fed borrowing costs to cash for clunkers have served to help keep GM afloat. This company has received much more than $8 billion in corporate welfare here.

We also lose all future innovation and efficiency gains that would have occurred had entrepreneurial operators assumed GM's role in the system.

At both the company and government level, debt problems cannot be solved with more debt.

no positions

Saturday, April 24, 2010

The Oversight of Regulation

The lights go out and I can't be saved
Tides that I tried to swim against
Have brought me down upon my knees
Oh I beg, I beg and plead

In his weekly radio address, President Obama claims that increased financial regulation will end tax payer funded bailouts and 'put an end to the cycles of boom and bust that we've seen.'

Not likely. Such claims ignore the root causes of boom/bust cycles to begin with, and the role that government has in exacerbating them.

Underlying business cycles are patterns of inflation followed by deflation. Classically defined, inflation is an increase in the quantity of money and credit. In today's monetary systems, the majority of money is in the form of credit, meaning that during inflationary periods, there must be both supply of credit and folks who want to borrow. In free markets there is likely to be a natural ebb and flow to this cycle. This is because there is a group component, or herding impulse, to economic behavior--i.e., collective optimism followed by collective pessimism.

In free markets, there are 'natural regulators' that reign in optimism during expansionary times. One is the price of money, or interest rates. For example, as folks borrow more to fund expansionary and speculative projects, interest rates that creditors charge rise to offset the risk of increased leverage in the system, making further borrowing less likely and slowing down expansion.

Another natural regulator is outright failure. In free markets, poor decisions are penalized by loss of economic resources. Fear of loss tempers feelings of greed, thus reducing potential for exorbitant booms.

But today's markets are not free. Interest rates, for example, are no longer under pure market control. The Federal Reserve and other central banks manipulate interest rates to fix the price of money at non-market levels. Central banks also have power to create money and credit out of thin air, which greatly increases capacity for systemic inflation during boom periods. It didn't take long after the Fed's founding in 1913 before financial system leverage began increasing dramatically.

Increased regulation and oversight can also distort signals of value and risk. For example, FDIC insurance 'guarantees' deposits at participating financial institutions, thus reducing propensity among buyers to kick the tires of financial instituations where they park their money and investments. Conditions of moral hazard develop as folks are prone take more risk, thinking that government has their back if things go bad.

The consequences of this? Potential for much more leverage during expansionary periods than was ever possible in free market situations. Cheap credit, unlimited money creation capacity, and no fear of loss fuels a 'crack up boom' that inevitably spawns a deflationary bust as projects that should never have seen the light of day go to zero value.

Appropriate solutions to this situation are not grounded in more government control, but less. Remove price fixing central banks and their monetary printing presses, and regulations that atrophy buyers' motivation for managing risk, and watch big financial meltdowns disappear.

Like bureaucrats that have preceded him, however, Mr Obama will likely add more fuel that will ignite an even bigger fire down the road.

Friday, April 23, 2010

US Public Debt, Summary

Welcome to your life
There's no turning back
Even while we sleep
We will find you
--Tears for Fears

In previous posts we observed patterns in US Public Debt from 1790-1900, 1900-1980, and 1970-2009. Generally, it appears that the first period could be labelled as one of prudence or frugality when it came to debt management, while the middle period was one of exorbitance. The last period? Well, you label it.

We noted last time that although Public Debt and nominal GDP generally share similar exponential growth patterns over the 1790-2009 period, that Public Debt has been growing about 3x as fast.

Another way to examine this relationship is directly compare Public Debt to GDP. When we do this, we obtain a measure of leverage--the higher the ratio, the greater the leverage.

Above we see US Public Debt as a percentage of nominal GDP from 1790 till 2009. Before diving into the graph, let me first note that obtaining authoratative US GDP numbers for the entire period is impossible, because no one tracked it prior to the 1930s. Reconstructing pre 1930 GDP has literally become an academic exercise. The source I'm using is here. Their reconstruction method seems reasonable.

Now, what can we observe from the graph? As noted in previous analyses, Public Debt as a % of GDP always spikes during war time (we 'lever up' for war) but then recedes back toward previous levels. The 1800's were a period of relatively low leverage. In fact, prior to the Civil War, leverage was negligible for many decades.

Things changed in the 20th century. For the first time, leverage increased during a non war period (1930s). A similar pattern took hold in the late 70s/early 80s.

As of 2009, Public Debt level exceeded 80% of GDP--a level unmatched in peace time. The only time our country has been this leveraged was during WWII.

At the beginning of our study we suggested Public Debt as a useful measure of fiscal responsibility of the US Federal government. Our analysis casts little doubt that debt management practices have changed over the past 200+ years. After what appeared to be a general distaste for leverage during the 1800s, the Federal government 'levered up' during the 20th century.

Currently, our degree of leverage suggests that we're taking an historic amount risk. A simple definition of risk, btw, is potential for loss.

Of course, there's a general relationship between risk and reward. Perhaps increased leverage helps explain the big increases in our standard of living during the 20th century. (Personally, I have little doubt it helps explain large leaps in asset prices of most types).

But high levels of leverage means that there's more debt to pay back. And at some point, the debt load becomes unmanageable.

While no one knows exactly what that point is, it is hard to argue that risk has not been going up.

One final note: we've been focusing on Public Debt. There's also private debt (debt held by private sector individuals and entities--which is at least the size of public debt). Then there are unfunded future liabilities such as Medicare, Medicaid, Social Security, the New Health Care. Factor these in and you get a picture of leverage that is many multiples of GDP.

Thursday, April 22, 2010

The 95% Delusion

"Music to drown by. Now I know I'm in first class."
--Tommy Ryan (Titanic)

The Left continues to churn out propaganda aimed at countering the Tea Party movement. One of the latest themes suggests that 95% of US taxpayers received a tax cut in 2009, and that surveys indicate that the majority of Tea Partiers surveyed were not aware of this 'fact'--once again implying Tea Party individuals as ignorant or stupid.

First, let's remind ourselves what propaganda is:

Any systematic, widespread dissemination or promotion of particular ideas, doctrines, practices, etc. to further one's own cause or to damage an opposing one.


Ideas, doctrines, or allegations spread in a deceptive or disparaging manner.

This, of course, characterizes nearly the entire universe of political media. The rule of thumb, therefore, is that if it's political in nature, then it's likely to be biased and one sided. Achieving more balance requires that we put our critical thinking caps on.

In early 2009 the Obama Administration indeed enacted tax cuts as part of various stimulus initiatives to counter the economic slowdown. For earners between $200,000 (singles) and $250,000 (fams) (which currently does reflect nearly 95% of workers), then paycheck withholding was reduced to reflect annual reductions of $400 (single) to $800 (fam).

But the relevant question along these lines should not be 'Did you receive a tax cut?' but 'Did you pay lower taxes in 2009?' The real answer to the latter question won't be known until all returns are in. But my guess is that far fewer than 95% paid less taxes in 2009 than in 2008. For example, if you were single and made $50,000 in 2008 and received a 3% raise in 2009, then the incremental tax you paid on your additional wages in 2009 just about offset your 'tax cut.'

Despite the slow economy and bleak job picture I believe I have seen data showing that the majority of workers actually saw wage increases from 2008 to 2009, albiet lower than in the past.

The tax cut question as framed by the Left also ignores other taxes. Estate, state, local, property. Factor the whole package in and I believe, tilts things the other way. I for one paid far higher taxes in 2009 despite a wage freeze at my place of work.

If I could place an over/under bet on the fraction of workers paying lower total tax in 2009 vs 2008 = 95% of workers, I would be all in on 'under'...

It also must be noted that tax cuts of a few hundred dollars per capita are meaningless when government is spending, borrowing, and inflating by the $trillions. $1 trillion in debt burdens each US worker with upwards of $10,000 in principal alone. Government's spending, borrowing, and inflating activities amount to transfers of resources from citizens to government. Some of those transfers occur right away; others later.

Think deck chairs and Titanic...

The Tea Party focus is not a myopic one on taxes. Instead, the concern is fiscal resonsibility, limited government, and liberty.

Should the Left truly believe the underlying message of its propaganda--that 95% of workers are better off now under the policies of this administration--then this group is delusional.

US Public Debt, 1970-2009

If we took a holiday
Some time to celebrate
Just one day out of life
It would be, it would be so nice

Previously we observed patterns in US Public Debt in the 1790-1900 and 1900-1980 periods. Today we look at the recent period from 1970 through 2009.

The chart indicates the exponential growth pattern that we observe in so many series during this period (stocks, real estate, etc). The sheer size of Public Debt increase is breathtaking--from about $400 billion in 1970 to approximately $ 12 trillion in 2009--a thirty fold increase.

Note the inflection point in the 2001-2002 area. Since then the slope steepens.

Keep in mind that this period saw massive world change--globalization, technology, etc. Despite the improvements that improved resource efficiency, debt load of the US Federal government increased thirty fold.

If we take a step back and look at the entire 1970-2009 period, the rocket ship rise in Public Debt in the past few decades overwhelms most of the earlier patterns in the data.

Some folks would argue that the geometric pattern observed above is merely a function of compounding at a low growth rate over time.

Here we see nominal US GDP over the same 1790 to 2009 time period. Like Public Debt, nominal GDP shows a similar exponential growth pattern. It turns out that the average annual change in nominal US GDP has been +5.6% during this period.

If we take the estimated US GDP in 1790, which was ~$200 million (!), and compound it at 5.6% annually for 219 periods, we get the above pattern--which is very similar to actual US GDP growth over 220 years.

So, perhaps this entire exercise is much ado about nothing. Public Debt is growing exponentially because general economic activity is growing exponentially. This argument seems problematic, however. Why should debt necessarily rise hand in hand with economic activity? As economies become more productive, isn't it reasonable to expect less borrowing to generate a particular standard of living? A wealthier people have more resources to allocate toward present day consumption without incurring debt.

Moreover, we have already observed that, during the first century of post Constitution US history, there were significant periods where Public Debt was flat or decreasing despite economic growth.

We should also not that the similar patterns in Public Debt and GDP appearing above mask differences in the underlying annual growth rates of these two series. While nominal GDP has been growing about 5.6% annually for the past 220 years, Public Debt has been growing at 17.4% annually--over 3 times as fast.

It takes no genius to understand that debt cannot grow 3x faster than income perpetually--and the consequences of doing so for an extended period of time are likely not to be good.

In a final missive, we'll compare Public Debt to nominal GDP growth directly, and wrap this study up.

Wednesday, April 21, 2010

US Public Debt, 1900-1980

"If this thing blows up, the Feds will be the least of our problems."
--Kid Twist (The Sting)

Last time we examined US Public Debt from 1790 till 1900. The turn of the 20th century brought big changes in debt policy by the Federal government.

We previously observed that the steady pay down in Civil War debt reversed itself in the last few years of the 19th century. This reversal corresponded to the nascent days of the Progressive era (President McKinley followed by Theodore Roosevelt). The uptrend continued in the early 1900s, although the magnitude is masked somewhat on the graph above due to the chart scaling.

World War I saw a massive increase in Public Debt. Then began the steady post war paydown process once again--the final time, in fact, that we'll observe post war debt extinguishment.

The Great Depression followed in the 1930s. FDRs New Deal policies required what was up until that time the largest non-war increase in public debt ever seen in the US. Public debt during this period increased from about $18 billion to just under $50 billion.

Then came World War II. Because we keep changing the y-axix scale on each successive chart to fit the magnitude of debt, the above graph does not do justice to the leap in debt as a result of the War. Public Debt jumped over five fold, from a prewar $50 billion to a postwar level of about $275 billion.

Unlike previous postwar periods, however, Public Debt did not subsequently decline. Instead, it marched higher in pretty much straight line fashion until around 1970. The 1970s were defined by a more geometric increase such that, but 1980, we were closing in on $1 trillion in Public Debt. This represents nearly 4 times the debt level coming out of WWII.

We see, then, that debt patterns during the early to mid 20th century period differed significantly from the first century of post ratification US history. Unlike the previous century where the dominant pattern was level or down, the 20th century Public Debt pattern was decisively up. Approximately $2 billion in debt in 1900 morphed into $908 billion in 1980. That's a 45,000% increase for those keeping score.

We can also conclude that the pattern of debt paydown following war time ended with World War II.

But it was peace time debt expansion, a pattern that began in earnest during the 1930s and went geometric by the 1970s, that really put Public Debt into hyper drive.

Were we to generalize about the two periods, we might attach a 'frugal' or 'thrifty' label to 19th century debt management policy by the Federal government, while the 20th century period examined thus far seems to merit an 'exorbitant' label.

This does have me wondering how we'll accurately label the debt management policies of the Federal government in our final period of study...

Next time we'll examine the most recent period encompassing the go-go 1980s till present day.

Tuesday, April 20, 2010

US Public Debt, 1790-1900

"I can't think about that right now. If I do, I'll go crazy. I'll think about that tomorrow."
--Scarlet O'Hara (Gone With The Wind)

A primary driver behind the rising tide of what I'll call libertarian activism (activism aimed at achieving individual liberty rather than State dependence) is a perceived decline in fiscal responsibility exhibited by the US Federal government.

Fiscal responsibility concerns money management. Central to money management is prudent management of debt. Debt is incurred when an entity borrows resources to create a higher standard of living today than permitted by current income alone. After all, if current income were high enough, then higher standard of living could be funded by soley from resources streaming from income.

Because people possess insatiable desires (2.2 here) that they prefer to satisfy now rather than later (4.1 here), it becomes desirable for some groups to enlist government as an agent for satisfying those needs via political means rather than thru economic effort (3.3 here). Since government has no resources of its own, it must obtain them from productive individuals. While taxing is an infamous approach for doing so, debt usually becomes politically preferable when needs are large.

A primary measure of debt incurred by the Federal government is Public Debt. This is debt incurred thru sale of Treasury debt securities of various durations. Currently Public Debt stands just shy of $13 trillion.

A big number, to be sure. Current Public Debt approaches one year's worth of GDP.

Recently I wondered about levels and trends of Public Debt throughout US history. So I grabbed historical data on Public Debt and graphed away. Because the changes over time are so dramatic, I found it useful to carve up the series into a few subsets in order to get a better feel for various historical periods. Don't worry, we'll display the big picture before we're all done.

Up first is our initial century or so after the Constitution was ratified. The first noteworthy thing is that, from 1790 till 1860ish, level of public debt was relatively flat. Yes, we experienced an uptick in debt with the War of 1812 (it should become apparent before we're done here is that wars generally increase debt). Overally, however, debt didn't change much. In fact, there was actually a stretch during the 1830-1850 period where Public Debt was essentially zero.

The Civil War changed that, and Public Debt shot to unprecedented levels. After the Civil War, note the gradual decline as efforts were made to pay off debt. This trend lasted about 30 yrs until we saw the first ever non-war uptrend in Public Debt starting close to the turn of the century.

This period corresponds to the nascent days of the Progressive era.

What can we conclude from our first century of debt management? First is that debt did not increase every year, in fact there were significant stretches of debt decline. Second, war increases debt, usually dramatically. Third, the first century of Constitutional America found the Federal government paying down debt incurred from war.

Also note from the above chart that the Civil War apex amounted to less than $3 billion in debt. Given today's level of $13 trillion, the final thing to conclude is that a whole lotta debt is still to come.

In an upcoming missive, we'll examine the early to mid 20th century period.

Monday, April 19, 2010

Fannie's Friends

When the walls
Come tumblin,' tumblin'
Crumblin,' tumblin'
--John Mellencamp

You'll never see clips like this one on mainstream news outlets. The timeframe is 2004 when the Office of Federal Housing Enterprise Oversight OFHEO, a government agency charged with overseeing the government sponsored entities (GSEs) of Fannie Mae (FNM) and Freddie Mac (FRE), reported issues with FNM's accounting practices.

As shown in the video clip, Democrats rushed to defend the GSEs and did their best to discredit the OFHEO report. They claimed that the report unearthed problems that didn't exist. They even trotted out racism as a motive for the negative findings.

To be sure, the producer of this video is clearly partisan with the other side of the aisle, and insinuates that the Republicans in the video represented the 'good guys.' But Republicans at the time were mostly calling for more regulation of the GSEs--which was not the right thing to do.

Ironically, btw, if you fast forward to the Goldman (GS) situation today, then the roles of Democrats and Republicans are pretty much reversed.

The point of the matter is that politicians tend to staunchly defend their special interests, even in the face of evidence that suggests a catastrophe ahead. And they have no problem turning their hats around if they smell political gain.

How did the FNM situation turn out?

The time bomb went off about 3 yrs later. The thinly capitalized GSEs quickly became insolvent, and their implosions occurred at ground zero of the credit meltdown.

The right thing to do in 2004 and now is not more regulation and oversight of the GSEs. Instead, these entities need to be taken apart and tossed on the scrap heap of history. Unfortunately, FNM and FRE are now wards of the State--which means We the People own them. And...they're back at the heart of the mortgage business once again.

As they are apt to do, politicians have built a new bomb. And it's ticking.

no positions

Sunday, April 18, 2010

Spreading the Wealth

"I'm looking, and I don't like what I see."
--Bud Fox (Wall Street)

I ran across this year old NYT piece discussing growing income inequality in the US. If we accept the NYT measure of income capture as limited to the fraction of all income earned by the top %1 of US households (many studies I've seen use a more inclusive percentage such as top 5, 10%), then in 2007 the top 1% claimed 24% of the total--a fraction matched before only by the runup before the Crash of '29 (which should right away give some hint as to source of the spread).

The article suggests that 'market forces' drove much of the increasing spread. But this claim holds little water as our markets have been becoming less free over the past 100 yrs, not more free. Interestingly, btw, the time period for the data reported was 1913 forward--which corresponds roughly with the advent of the Progressive Movement. 1913, btw, saw the passage of both the Federal Reserve Act and the Sixteenth Amendments as part of President Wilson's 'New Freedom' initiative.

So shouldn't the obvious and intellectually honest question go something like this: Why in a century of 'progressivism, where markets became less free and government intervention, which included the institution of a progressive tax code, increasingly became the norm, did we get periods of record income spreads between high and low earners? Could it be some combination of the interventions themselves that drives periods of bigger spreads?

While not addressing this question directly, the article does note that the spread has widened since 1980 (the beginning of the great bull market in stocks), and that most of the increase in high earners comes from stocks and bond investments. It also indicates that the wealth spread is coming in with lower stock prices.

Those seriously looking for insight into the causes of increasing income spreads in the US over the past century, then, might want to start with questions such as:

-->What interventionary policies have triggered big run ups in stock prices (look at a chart of the S&P 500 since 1980 and ask youself if that represents 'normal' market behavior)?
-->What policies help the wealthy to lever up risk capital beyond what would be facilitated in free markets alone?
-->What policies help the wealthy protect huge gains from being wiped out if (when) excessive risk taking goes awry?

Few people seem to want to go down this road.

position in SPX

Saturday, April 17, 2010

Let's Pretend

Step right up and don't be shy
'Cause you will not believe your eyes
--The Tubes

Nice piece by John Hussman on the overvalued nature of the stock market plus our 'extend and pretend' approach for accounting for financial assets. 'Extend' the period by which firms can use overinflated values for the assets on their books (in the meantime doing things that might actually jack them higher, such as the carry trade using free money from the Fed), and in the meantime 'pretend' that the banking system is solvent.

Simple, really, and based on fantasy games we conjured up as kids.

The question, of course, is how long such pretense can last. Dr John wonders whether the game won't be up soon. Others think the fantasy could persist for years, thereby jacking stock prices to new all time highs while pretending that the emperor is wearing clothes.

position in SPX

Friday, April 16, 2010

Unhealthy Choice

Laugh and say I'm green
I've seen things you've never seen
Talk behind my back
I'm off the beaten track
--The Who

Interesting tidbits on US health care history in this piece. The first century of our country's history found three types of docs: eclectics (plant remedies, bed rest, steam baths), homeopaths (various medicines in small doses while letting body heal itself), and allopaths (blood letting and high dose injection of heavy metal compounds).

The allopaths were able to establish themselves mainstream medicine, despite their poor performance record, and founded the AMA in 1847. The allopaths and the AMA worked with government to reduce competition, raise barriers to entry, and effectively provide monopolistic privledge to AMA docs (higher prices, reduced supply).

There are also interesting accounts of the hospital and health insurance industry. The key takeaway should be that health care has been anything but a 'free market' in this country for many, many years. That we have consequentky experienced rising costs, lower quality, lack of access should not be the least bit surprising.

At the end of the piece, the author suggests that many of features included in the recent health care bill were actually devised or at least endorsed by Republicans. This should also come as no surprise, as both sides of the aisle have demonstrated proclivity for big, intrusive government thru their behavior.

btw, I saw the interview the author refers to between Mitt Romney and Bill O'Reilly. Despite Romney's parries, O'Reilly would not let Romney off the hook for implementing the costly state health plan in Massachussetts (In my view, O'Reilly's capacity for staying on point makes him one of the sharper interviewers out there and why he attracts a large audience. That he is a 'tough interview' is also why many avoid him).

If critical thinking is indeed enjoying a renaissance in this country (and growing sense is that it is), then politicians on both sides of the aisle are going to have rough times justifying their value as elected officials in the eyes of many voters.

Thursday, April 15, 2010

David's Shield

Reached out a hand to touch your face
You're slow disappearing from my view
Disappearing from my view
--A Flock of Seagulls

Russell opines that there's increasing chance that Israel attacks Iran. The Stratfor folks have been handicapping this also.

The basic thought process goes like this.

-->The US wants to appear more balanced in the region, so it has moved further away from Israel and has been largely non-interventionary in Iran's activities. (I'm not suggesting that this is a bad thing, btw)

-->Iran knows this and is exploiting a more hands off US to ramp its nuclear efforts.

-->Israel, who time and again has been verbally threatened by Iran, feels increasingly insecure and thinks it needs to take matters into their own hands.

You should be able to fill in the rest.

How would such an event impact the nascent economic recovery and financial markets? Crude's been strong (perhaps it sniffs something), and one would think a pop towards $100 would be 'easy.'

Stock markets have been stronger than a mule's breath and sentiment levels are at extremes. Hard to imagine that an Israeli strike is well priced in.

position in SPX

Wednesday, April 14, 2010

Central Question

"Virtue will slumber. The wicked will be constantly watching. Consequently, you will be undone."
--Patrick Henry

In 1833, former Supreme Court Justice Joseph Story wrote Commentaries on the Constitution of the United States. In it, Justice Story articulated support for strong centralized government as expressed by the Constitution.

While Commentaries was widely acclaimed, some disagreed with Story's premise. One such man was Abel Parker Upshur. In 1840, Upshur, a lawyer from Virginia, penned a critique of Story's work entitled A Brief Enquiry into the Nature and Character of our Federal Government. In Enquiry, a portion of which can be found here, Upshur argued that the Constitution as written contained flaws that over time would increase the power and scope of the federal government far beyond the intent of the Founders. As such, his views were similar to those of the Anti-Federalists of fifty years prior.

Upshur was particularly critical of blending centralized legislative authority and democratic principles. In a population of heterogenous interests, opportunity exists for an oppressive tyranny, of the majority over the minority. Government bureaucrats are only too happy to comply with majority wishes under a democracy since the majority holds the votes from which political power flows. Upshur offers that government becomes tyrannous and oppressive in proportion to its democratic principle--a nice claim.

Upshur believed that 'true political liberty requires protection against itself' and that 'government is founded in the vices, not the virtues, of mankind.' He was pessimistic about the Constitutional system of checks and balances to provide adequate protection for individual liberty. The democratic principle and political interest would drive virtue from the checkpoints, first as the legislative arm becomes a lapdog to the majority, then to executive branch because of the State's historical tendency to raise an executive above the people. Subsequently, an interested court ices the cake.

One hundred and seventy years later, one can present compelling evidence that he was not far off in his forecast.

In Upshur's view, the best check rests with decentralization. Bringing more power to state and local levels improves people's capacity for monitoring and engagement, as well as permitting government to focus in localized needs.

Upshur's focus on state power rather than central government power is a good one and, again, one shared by many in the Anti-Federalist camp a half century before his time. The questions that flow from his premise are obvious: Is it even possible at this point to rebalance power away from the Federal government and toward the states? How could this be done given our current condition?

Tuesday, April 13, 2010

Cover Charge

"Who are you, tenth man on the deal team, last to know?"
--Gordon Gekko

Cover stories like this one gracing this wk's Newsweek put my contrarain antennae on red alert. Yikes.

Inspection vs Prevention

Most of freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world
--Tears for Fears

Early in my industrial career I learned that problems with a production process could be addressed in one of two ways. We could increase inspection of the process and its output to reduce the probability that 'bad' output would slip out the door to customers. More inspection was a straightforward, easy solution--simply a function of slapping more regulatory oversight, usually in the form of more eyeballs, on the process.

The other alternative was to engage in problem solving to unearth the root cause (or causes) of the problem. This approach was complex, time consuming, and often times painful. Painful not because of the monetary costs involved, which while often considerable were really investments in improvement, but because when we really dug deep toward the true root of the problem we uncovered issues that we didn't care to face. More often than not, the root causes of problems were management controllable decisions that had been poorly made (e.g., equipment design choices, workplace configurations, unclear operating procedures, lack of customer input in product design, making promises we couldn't keep to sales folks, etc). Correcting these type of problems requires an admission of being wrong in the first place--an admission difficult for the human ego.

As such, the tendency was to avoid problem solving if possible.

The issue, however, with going the inspection route was that the underlying causes of problems were never discovered and, like Ground Hog Day, they would rear their ugly heads over and over. Further, oversight could not guarantee that defective output would not sneak thru--even when inspecting 100% of the output. Human fallibility, in the form of attention lapses, confirmation biases, etc, increases the likelihood that regulatory breakdowns will occur.

I'm reminded of these lessons learned when reading commentary such as this by Treasury Secretary Geithner, where he asserts that more regulation and oversight is what we need to prevent future financial system meltdowns. Of course, an added incentive for him in promoting the 'more inspection' alternative is that it's good for government--more regulators and bureaucrats necessary to oversee things.

Once again, it appears we're destined to repeat the mistakes of the past. More regulation provides the illusion of corrective action, but does little to address the underlying problem. Think about it--the root cause of a problem can not be that there was not enough regulatory oversight. Something must be causing the defects that a regulatory process hopes to detect.

Choosing the regulatory approach virtually guarantees--a word that I don't like to use lightly--that we will repeat the crisis of the past couple of years, perhaps on a greater scale.

It's also a certainty that, were government officials to engage in true problem solving of the recent financial meltdown, they would unearth root causes that point directly at themselves.

Hazard of Happiness

The landlord say your rent is late
He may have to litigate
Don't worry, be happy
--Bobby McFerrin

With recent increases in consumer spending, an interesting question is how much of the spending uptick comes from 'strategic defaults'--i.e., people who have elected not to pay their mortgages because they are upside down or, perhaps because they see their neighbors getting rewarded for not paying their mortgages. This frees up funds for discretionary spending.

Data that support this proposition include increasing revolving credit and retail sales in the face of declining home prices, mortgage delinquencies, and foreclosures.

Perhaps the thinking is, 'Since the government has my back, I might as well spend some more...'

Monday, April 12, 2010

Out of Africa

"Are we there yet?"
--Michael 'Slo' Slowensky (Tears of the Sun)

At some point, Sub-Saharan Africa may be a fantastic place to invest. Resource-rich, and hard working people. As this post demonstrates, it's still too early. No rule of law. Corruption and chaos dominate.

If the people here throw off tyranny and get free, then this area of the world could be one productive place.

In and Out Burger

"What Jefferson was saying was, 'Hey, you know, we left this England place 'cause it was bogus. So if we don't get some cool rules ourselves, pronto, we'll just be bogus too.'"
--Jeff Spicoli (Fast Times at Ridgemont High)

Unwound about 2/3 of my long exposure today. Consistent with past behavior, I have trouble keeping them on my sheets when my macro gauges point south.

Am pretty much neutral right here w.r.t. risk profile, with longs and shorts about one to one on a dollar basis. Any further jig higher will likely find me parsing out remaining upside exposure.

Sentiment gauges are awfully stretched toward excessive optimism. And we know that when complancy sets in, risk increases.

Hard for me to trust 'em here.

position in SPX

Sunday, April 11, 2010

Does Freedom Ring in Our Markets?

Benjamin Martin: "May I sit with you?"
Charlotte Selton: "It's a free country. Or at least it will be."
--The Patriot

Whenever I encounter commentary about our ‘current free market’ system, my skepticism gauge usually ticks up a few notches. Few have witnessed truly free markets on a large scale in our lifetimes.

Classically defined, a free market, or capitalistic, economy is a form of social cooperation where the means of production, which for our purposes will be broadly construed to include all commercial and transportation activities, are privately owned. Although entrepreneurs make the production and distribution decisions, it is consumers who hold sovereign power in market economies. Buyers, through their purchasing decisions, signal value to sellers who must constantly strive to serve the wishes of consumers lest their positions in the supply chain become endangered.

Government’s role in a market economy is limited to upholding the property rights of market participants. Often this entails protecting against fraud or contractual violations.

In the United States, it has been quite some time since the scope of government involvement has approached the free market ideal. Today, government interference pervades markets. This interference assumes a number of general forms, including (Mises, 1998):

Restriction. By restrictive measures government forbids production or sale of certain output (e.g., tariffs, legal tender laws, alcohol during Prohibition), prohibits certain methods of production (drilling for oil in Alaska, short sellling bans, patents), or makes production more difficult or expensive (mandatory licenses or certifications, environmental regulations).

Price controls. Government fixes prices, wages, or interest rates above (e.g., minimum wage laws) or below (current Federal Reserve monetary policy, rent controls) those prevailing in an unhampered market.

Inflation and credit expansion. Government engages in monetary and fiscal policies that encourage increase in money and credit supply (e.g., Fed ‘quantitative easing, government sponsored entities such as Fannie Mae (FNM) and Freddie Mac (FRE) that facilitate ‘cheap’ loans, FDIC insurance).

Confiscation and expenditures. Government engages in the confiscation of property (e.g., taxation in general), subsidies (ethanol, solar, farming), transfer payments (Social Security, health care, shovel-ready projects, etc.), and direct ownership (various equity positions, such as the stake in Citigroup (C), taken during the recent credit crisis).

Nearly all of the above examples were brought to life in the past 100 years, with many originating or escalating dramatically in the past few years. Those who claim that the last decade or two saw a net reduction in government interference have yet to present a compelling case. On the contrary, broad proxy measures such as tax receipts, federal government spending, purchasing power of the dollar, number of government agencies and employees, and national debt levels suggest that the rate of government interference has been increasing on a longitudinal basis.

If ‘market economy’ is indeed an inappropriate label for our current condition, then what is a more valid one? At the other end of the economic spectrum is socialism, or planned economy. In the socialist state, all means of production are publically owned. Government makes all production and distribution decisions, and is therefore intimately involved in all facets of economic activity.

In between is the interventionist state. Also known as managed capitalism or mixed economy, interventionism involves private ownership of productive means, but government interference, through various forms of command and interdiction, forces participants to alter their behavior from the free market ideal. Practically speaking, most if not all economies in the world fall somewhere in this interventionist middle ground.

Over the past few months, I’ve been chewing thru classic work for insight into the character of this in-between economic form, particularly with respect to its stability. Nearly all of the thinkers that I have encountered, including Hayek, Mises, Rothbard, Marx, and Schumpeter, see the interventionist middle ground as unstable and transitory—i.e., interventionist states are fluid in nature; they migrate toward either the market or socialist poles. Where these minds differ is on predictability and persistence of the directional pull, and on the inevitability of an ‘endgame’ destination.

Mapping our present position, it appears, is relatively straightforward. Charting our future path, however, is altogether more challenging.

Mises, L. 1998. Interventionism: An economic analysis. Irvington-on-Hudson, NY: The Foundation for Economic Education, Inc.

Lost and Found

Music can be such a revelation
Dancing around you feel the sweet sensation

Milton Friedman once claimed that inflation is always and everywhere a monetary phenomenon. The implication is that it's an issue of supply, which of course in modern day economies is controlled by central banks.

But modern money is not primarily denominated in paper bills. Instead, it's in the form of credit. And no matter how much supply central banks offer (and their general tendency is to offer a ton of it), credit needs demand (i.e., borrowers) in order to come to life.

As such, I think deflation and inflation are not monetary phenomena at all. They are social phenomena related to collective views on risk.

A deflationary situation is grounded in collective risk aversion. Folks shed risky assets, pay down debt, and shun loans because they have little appetite for potential loss.

Inflation is characterized by the opposite. Folks buy stocks, houses, and junk bonds, and lever up because their appetite for risk is high.

Perhaps the key question to be asking right now is, "Which direction is the collective appetite for risk heading?"

Bulls are pointing to higher stock market prices and collapsing credit spreads as indicators that risk appetites are returning to markets.

Bears point to slow real estate markets and low levels of bank loans as indicators of persistent risk aversion.

I must admit that, after thinking that we've entered into a secular period of risk aversion, I'm flinching on that thesis a bit. Stocks jam higher, and those credit spreads, which have been very effective forecasters of risk appetite in the intermediate term, suggest folks want more risk.

We may be at an inflection point here. Will collective risk appetites resume their 20+ yr groove after a brief sabbatical?

Saturday, April 10, 2010

Axioms 1.0

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

Let's see if we can stich together a basic list of natural laws from previous missives (here, here, here, here). These are basic, what Jefferson might refer to as 'self-evident,' truths, grounded in nature and human behavior, that any social system needs to cope with.

1.0 State of Nature

1.1 Diversity. Nature is grounded in diversity. Variation, in fact, is necessary to advance the evolutionary cycle. Humans are like the rest of nature. Simple observation shows that we differ physically, of course. It is just as apparent that we differ inwardly as well. We differ in skills and abilities, taste preferences, risk tolerance, emotional content, goals, drive for success, and cognitive abilities--among other things.

1.2 Scarcity. Although Earth abounds with resources, many of them are in a raw form not immediately useful for human consumption or use. Contrary to first impression, in its unalterated form, nature presents a state of scarcity for supporting the human condition.

2.0 Human Behavior

2.1 Self-interest. Humans behave in a self-interested manner. This does not necessarily mean that we behave 'selfishly' or 'materialistically' in the common sense of those words. Human behavior may be altruistic; the income gained from human action may be psychic, e.g., we feel better by helping others, or we get satisfaction from seeing the world configured according to our vision. Nonetheless, people behave in a manner that helps them fulfill their own desires.

2.2 Insatiable desires. Humans constantly seek a more abundant life. When lower level wants are satisfied, individuals will then seek satisfaction of higher level wants. Essentially, human desires are unbounded.

2.3 Ability to prioritize. Unlike others in the animal kingdom, humans can prioritize their wants. Humans generally possess a consciousness of comparable desires, and can make choices based on priorities.

2.4 Bounded rationality. Although the upper bound differs among individuals (1.1), people are limited in their cognitive abilities. The more complex the situation, the more difficult sensemaking and decision-making becomes.

3.0 Labor

3.1 Requirement for production, labor. Because the raw state of nature is one of scarcity (1.2), sustainable human life requires production. Production is the application of labor to raw materials in order to transform conditions of scarcity into abundance that can be applied toward the satisfaction of human desires (2.2).

3.2 Aversion to labor. When prioritizing (2.3), people prefer leisure over labor. Humans engage in work because they want to satisfy desires (2.2) and production is necessary to satisfy them (3.1).

3.3 Law of Parsimmony. Because of insatiable appetite for satisfying desires (2.2) and aversion to labor (3.2), humans seek the greatest amount of satisfaction relative to the labor given up. Taken to the extreme, the urge to get the most benefit for the least effort, or cost, stretches into a drive for 'getting something for nothing.'

4.0 Consumption

4.1 Now preference. When prioritizing (2.3), people prefer to satisfy desires (2.2) today rather than tomorrow.

4.2 Diminishing marginal utility. When satisfying a particular desire (2.2), greater consumption toward that end leads to less satisfaction per unit consumed.

Again, the idea here is to build a list of axiomatic 'truths' that any social system needs to navigate. We've surely omitted some things; this list will be revised as other axioms become apparent. But this should serve as a nice working list for future thought.

Friday, April 9, 2010

Greek Week

"You can't corrupt it. And you know why? Because to corrupt it, you've gotta show how corrupt you really are."
--Theo Kojak (Kojak)

Eyes will be on Greece this wkend. Will the EU step in to avoid a Greek Tragedy? General stock markets trade like there will be no problem. Perhaps markets have become complacent. Will be interesting to see how things unfold.

Thursday, April 8, 2010

Of Bulls and Bullion

We are strong
No one can tell us we're wrong
Searching our hearts for so long
Both of us knowing
--Pat Benatar

The most bullish chart on my radar? Gold. Regardless of the horizon, the setup appears strong to me.

Not sure what story the charts may be reflecting. Economic pickup and inflation? Across the board currency debasement? Fear of a Greek contagion?

Of course, this could all be one big headfake and gold winds up falling out of bed tomorrow.

In any event, I've stepped up my intake of physical bullion. Am also building positions in the gold ETF (GLD) and miner ETF (GDX).

positions in bullion, GLD, GDX

Balancing Bonds

"Better learn balance. Balance is key. Balance good, karate good. Everything good. Balance bad, better back up, go home. Understand?"
--Mr Miyagi (Karate Kid)

Fantastic debate between Jim Grant and David Rosenberg on whether government bonds are a buy or sell over the next few yrs. This is really a debate about the propsects for inflation/currency debasement vs. deflation (which may be the most important issue of our time) by two of the better thinkers out there.

Very compelling arguments by both sides.

Personally I plan to rewatch this vid multiple times so I can better align w/ both of these thought processes.

Wednesday, April 7, 2010

Labor Pains

Acting on your best behavior
Turn your back on Mother Nature
Everbody wants to rule the world
--Tears for Fears

My sister and I were discussing the validity of minimum wage laws last nite. Reaching decisive conclusions on such an issue using moral or ethical arguments is unlikely, because we know that people vary in their beliefs of what is right and just. For example, some people believe that it is right that individuals should be free to decide how to deploy income earned from their labor, while others believe that it is right that some of an individual's income should be appropriated to satisfy the needs of others.

A decision to implement a minimum wage law is therefore a political one, dependent on a group's ability to get its brand of justice enacted via the political system.

What we can do is evaluate minimum wage rules from an economic standpoint--to see if policies proposed by special interest groups actually lead to the results that their advocates desire. As a body of scientific thought, economics is incapable of rendering ethical or political judgement. But because economics is grounded in laws that govern nature and human behavior, it is quite possible to assess minimum wage rules, or any other social arrangement for that matter, in light of predictable economic and social consequences.

Minimum wage laws are a form of triangular intervention. Triangular intervention occurs when an invader compels a pair of people to make an exchange or prohibits them for doing so. In the case of minimum wage laws, the triangular intervention takes the form of a price control, where the State prohibits the exchange of labor below a certain price. The State enforces this 'price floor' by police action, inflicting penalty on all violators.

In free markets, each person's wages tend to be valued relative to the individual's potential for uniquely adding to an operation's productivity. A minimum wage law means that those whose marginal value is below the legal minimum are prevented from working. The worker is willing to take the job, and the employer wants to hire the worker. But the decree of the State prevents exchange from taking place.

The effect is compulsory unemployment. Compulsory unemployment removes competition for marginal workers and raises the wage rates of the workers remaining.

Although the commonly articulated aim of minimum wage law is to improve the condition of marginal workers, the actual effect is just the opposite. Minimum wage laws render marginal workers unemployable at legal wage rates. The higher the minimum wage rate relative to free market rates, the greater the resulting unemployment.

There are other, longer run issues to consider as well, such as the influence of minimum wage laws on a) an employer's propensity to move elsewhere in search of cheaper labor, b) potential for higher prices of goods and services as consumers absorb higher labor costs, and c) capacity of those workers whose job is protected by minimum wage laws to adapt to environmental change.

However, the direct effect should be clear enough. Put a floor under gas prices at, say, $4/gallon, and it is likely that less gas will be bought. Put a floor under labor at the current legal rate of $7.25/hr, and it is likely that less labor will be bought.

If the purpose behind minimum wage laws is to protect or enrich special interest groups (e.g., labor unions, political parties, etc), then there is a case to be made that the policy will be effective--at least in the short run.

However, if the purpose behind a minimum wage policy is to improve the condition of the marginal worker, then this policy is sorely ineffective, because these workers will be largely unemployed.

Tuesday, April 6, 2010

Playground Battleground

When I was a child, I spoke like a child, I thought like a child, I reasoned like a child. When I became an adult, I put an end to childish ways.
--1 Corinthians 13:11

The degree to which behavior in the political arena parallels behavior on the playground continues to amaze me. Typically, the process begins when someone does something that provokes an emotional response from you. When we were kids, the provocative behavior might have been hanging with a group of people you didn't like, cutting in front of you in line, making fun of your clothes, skin color, etc.

Not knowing any better, 'victimized' kids respond to such stimuli in a largely scripted manner. First comes emotional response--feelings of anger, guilt, sorrow, frustration, etc. This is often followed by a more overt response that is typically retaliatory in nature: name callling, pushing back, making fun of the other person, etc.

Now the original perpetrator feels victimized and retaliates back in similar fashion.

The process escalates, of course, until either an adult who 'knows better' intervenes, a physical altercation settles it, a new crisis insues, or kids just forget and move on.

What kids are supposed to learn as they 'grow up' is that their emotional response to procative behavior is their choice. That is, we can choose to let the behavior of others bother us, or we can dismiss it and walk away. Adults understand that they control their emotions and response to social stimuli.

You wouldn't ascertain such from watching behavior in the political arena. Provocative behavior fosters vocal tirades 'outrage,' retaliatory name calling, etc. If someone espouses different beliefs, then the 'offended' party endeavors to pick apart that person's appearance, or to defame that person's character or affiliations as hateful, or racist, or bigoted. By doing so, of course, the offended party displays the bigotry that it claims to despise.

The behavior displayed by political partisans suggest that most never grew out of their playground habits, suggesting perhaps a 'Do as I say, but not as I do' approach when attempting to teach their children.

Monday, April 5, 2010

Tear Drops

Watch me clinging to the beat
I had to fight to make it mine
That religion you could sink in neat
Just move your feet and you'll feel fine
--Culture Club

Over the past few days I've had pangs that this market wants to head substantially higher. Yes, many sentiment indicators and oscillators are streched toward extreme optimism, and valuations and structural issues suggest that there is unfinished business on the downside, but my growing feeling is that risk appetites are coming back as prices head go up--sorta like 'the coast is clear' feeling.

Moreover, after getting pounded in the approval ratings following their health care jam session, you have to think that this administration and majority Dems in Congress are going to do everything in their power to make the electorate 'forget' come November. What better way to shorten memories than to send folks another gift in the form of a liquid tide for the economy and markets. I mean, what do they have to lose after pushing things this far?

Call it the government bubble or whatever, but in my view the chances of significant upside are increasing over the next few months.

As such, I'm gradually putting on some upside risk, primarily in terms of commodity-related ETFs and stocks. Am also swapping more cash for physical bullion.

I have little doubt that this thing will end in tears that will make the previous decline look tiny. But perhaps Ms Market needs to suck more folks in before the crying game begins.

positions in commodities, gold, SPX

Saturday, April 3, 2010

Boundary Spanning

Acting on your best behavior
Turn your back on Mother Nature
Everybody wants to rule the world
--Tears for Fears

Some believe that we are all one people on the planet. However, since early days of civilization, societies have erected boundaries around their turf. These boundaries reflect differences not sameness. Today, we see this not only at the country level, but inside countries at state/province and even county level.

Because boundary drawing has such a long history, it seems plausible that staking off societal boundaries is part of the natural state of things. And indeed, if you take a step back and look down at the boundary structure, it certainly has the fractal look--i.e., similar patterns at macro (national) as well as micro (local) level--evident thruout nature.

What, then, drives the natural condition of boundary drawing?

One argument is that turf drawing is a natural defect of the human condition. We are inappropriately possessive, for example. Or, the boundaries help manage security (e.g., the Great Wall of China). However, we see the boundary drawing phenomenon even in communist countries where property rights are not respected, and among relatively secure countries where raising fortress-like security barriers, physical or otherwise, seems unnecessary.

Perhaps the answer lies more in economic motivation. We might draw boundaries to facilitate local trade. There may be some validity to this, but benefits from trade increase when geography broadens. Absent intervention, trade on a global level irrespective of country borders raises standard of living for all.

It seems, rather, that the primary driver behind border drawing is social. Folks who have similar belief systems with respect to, for example, religion, or the importance of individual liberty prefer to live close to each other. They erect laws based on their belief systems and expect those who live inside the borders to abide by them. They practice customs unique to their people.

The borders reflect a society's belief in their right to act independently for the happenings inside their borders. The borders reflect a claim on sovereignty.

Perhaps, then, human tendencies toward sovereign living space merely reflects a natural condition of social diversity.

Friday, April 2, 2010

The Government Bubble

We mention the time we were together
So long ago, well I don't remember
All I know is that it makes me feel good now
--The Motels

Peter Schiff suggests that perhaps the biggest bubble of all is forming right now: a bubble in government.

He uses the recent move of the US government to monopolize the student loan market as an example. The Obama administration's argument is that loans would be cheaper if intermediary banks were cut out of the supply chain. No, we'd be better off if government were not involved. State involvement not only reduces efficiency and innovation in the system, but the artificially cheap loan terms guaranteed by the government also works as a subsidy, which boosts demand, jacks tuitions higher, and bloats campuses around the country with new infrastructure projects.

Quoting Schiff:

"Whether it is in education, housing, health care, automobiles, insurance, or banking, government involvement in the economy means higher prices, lower productivity, more bailouts, bigger deficits, increased taxes, diminished industrial capacity, fewer private sector jobs, less freedom, and a falling standard of living."

This, btw, is the core argument behind the Tea Party movement. Opponents to this movement are trying to deflect attention elsewhere, because they realize the difficulty in countering the TPs core argument.

Upper Bound

Here comes the rain again
Raining in my head like a tragedy
Tearing me apart like a new emotion

Russell observes the bullish technical setup in the miners. Saw the same thing yesterday and scooped some of the Market Vectors Golder Miner ETF (GDX). Over the past few months I've been assigning more chance to the deflationary scenario but that's not what the charts are saying.

As Russell notes, countries around the world are in debt up to their eyeballs and continue to engage in policymaking certain to destroy the value of paper currency over time. Gold does indeed seem the riskless currency given the situation.

positions in GDX, gold

Thursday, April 1, 2010

Jury Duty

"It's always difficult to keep personal prejudice out of a thing like this. And wherever you run into it, prejudice always obscures the truth. I don't really know what the truth is. I don't suppose anybody will ever really know. Nine of us now seem to feel that the defendant is innocent, but we're just gambling on probabilities--we may be wrong. We may be trying to let a guilty man go free, I don't know. Nobody really can. But we have a reasonable doubt, and that's something that's very valuable in our system. No jury can declare a man guilty unless it's SURE."
--Juror #8 (12 Anrgy Men)

A couple of nites back I watched the classic film 12 Angry Men. Henry Fonda plays a juror who, unlike his eleven peers, does not believe that a murder verdict is a slam dunk in their particular case. Instead, he argues that the accused has a right to equal treatment under the law, and that members of the jury, despite their biases, are responsible for carefully considering the evidence vis a vis the law.

One premise that grounds our legal system is that an individual is innocent until proven guilty. The accused is not required to say a word in his/her behalf. Instead, it is the responsibility of the prosecution to make the case.

Another premise is that the basis for determining guilt is careful consideration of the evidence versus the law. The law is the reference standard for right vs wrong. The evaluation is done by a jury. Once the evaluation is completed, the jury votes on whether the accused is guilty or not.

Perhaps the most compelling feature of this process is that a guilty verdict cannot be rendered unless the jury vote is unanimous in that direction. Presumably, this reduces the probability of an error interpreting the evidence versus the law, which could occur even when the evaluation is done objectively--i.e., an 'honest error.' It also reduces the chance of subjective bias, particularly one held by the majority of jurors, can tilt the vote.

How would this process differ if a guilty verdict was based on a democratic, or majority, vote? The movie certainly suggests the consequence that many more guilty verdicts would be rendered--and rendered based on personal bias rather than on objective comparison of the evidence versus the law.

My sense is that most people, if asked, would not want demcracy in this process. "In matters of the law, we want to be as sure as we can," might be the rationale.

Yet, how can we reject democracy for rendering judgement on the law if the underlying law has been developed democratically? Are not the same individual biases present when we develop law as when we interpret law? How can we ensure that the law itself provides for equal treatment if a majority vote can inject the whims of the many against the few?

Many of the Founders expressed concerns about democracy for this reason. In the Constitution, the primary explicit safeguard against this was a required 2/3 'supermajority' in passing laws that had been previously vetoed by the president. However, no such supermajority was specified for 'first pass' legislation.

Why the inconsistency in the Constitution? The best answer I can produce is that the Founders were betting that judicial review would check bad bills produced from bad legislative (and executive) process from becoming law. That check disappears, however, when the court possesses interest.

As it stands, I'm not sure how true justice can be rendered when the underlying basis for legal interpretation, the law, is written by mob rule.