Thursday, October 31, 2013

Playing With Fire

In the sweet old country
Where I come from
Nobody ever works
Nothing ever gets done
We hang fire, we hang fire
--Rolling Stones

After news broke yesterday that the administration has been warning insurance company executives to stay quiet about Obamacare, I am beginning to wonder whether this president will make it thru his second term.

Beyond presiding over various scandals, massive debt and deficit spending, unprecedented money printing, and, of course, the Obamacare circus, President Obama and his administration have engaged in vindictive behavior against those who disagree with them.

This president is playing with fire and, with his approval ratings marking lows, appears vulnerable should the fire spread.

Consider the economy and financial markets, which are being held together by massive interventions certain to erode in effectiveness. If the wheels come off the fire wagon and a bonfire erupts, then this administration might not be able to survive the political heat.

Wednesday, October 30, 2013

Insurance Pool Problem

Creasy: The gunshot holds no fear. Say it.
Pita: The gunshot holds no fear.
Creasy: You welcome the sound. In fact, it's the sound that sets you free. You are a prisoner on this block until that sound sets you free.
--Man on Fire

Peter Schiff reminds us that the Obamacare website problems are the tip of the iceberg. While the website problems are fixable, the design of the program is fundamentally flawed.

Schiff focuses on what might be called the insurance pool problem. One objective of Obamacare is to provide approximately 30 million Americans who currently do not have health insurance with policies that permit them to consume health care resources like everyone else. Meanwhile, those who already have health insurance policies are supposed to be able to consume pre-Obamacare quantities of health care resources with no increase in cost.

Anyone with a modicum of economic sense quickly recognizes the folly of this design. Health care resources for 30 million people must be paid for. If those 30 million people do not have the ability to pay, then those costs must be borne by those who can pay. Health care costs for those who can pay must go up--directly thru insurance premium increases or indirectly by higher taxes--to support those who do not pay.

And, quite predictably, we are already witnessing those rising costs.

The problem does not stop there. Think of health care insurance as a pool of actual health care resources--doctors, medicine, hospitals, etc. Those with insurance policies dip into the pool and consume some of those resources. At any point in time the quantity of health care resources in the pool can support only so much consumption. If enough people simultaneously claim large quantities of resources, then the pool runs dry.

Insurers cope with this problem in various ways. One way is simply to raise the price of a policy either thru higher premiums or higher deductibles. Higher premiums add more healthcare resources to the pool and higher deductibles require policyholders to purchase some quantity of healthcare resources out-of-pocket before dipping into the pool.

Another coping mechanism is risk pooling. Because it is deemed unlikely that a) all people will demand high quantities of healthcare resources at the same time, and that b) people who possess certain characteristics (young age, healthy lifestyle, etc.) are less likely to draw large quantities of healthcare resources from the pool, insurers might try to reduce the cost of policies by attracting healthier policyholders to offset the risk of a small fraction of very unhealthy policyholders emptying the pool of resources.

Stated differently, if an insurance plan is to work, then many, perhaps even most, policyholders must pay more health care resources into the pool than they take out. These policyholders subsidize those who draw out more resources than they pay in.

In the context of the ACA, Obamacare needs young, healthy low risk people to enroll into the risk pool. They need to pay much higher premiums than they would otherwise to support a) the 30 million new health care consumers in the pool, and b) all of the sick and elderly who will draw more healthcare resources from the system than they will pay in.

Currently for the young and healthy, the fines associated with not enrolling in Obamacare are much smaller than cost of an Obamacare-sanctioned health insurance policy.

If the young and health opt out, electing instead to pay the fine and either self-insure or buy some minimal catastrophic coverage (which is what they would likely do anyway), then the pool of Obamacare health care resources runs dry.

Tuesday, October 29, 2013

Advertising, Government, Propaganda

You tried to speak between lines of oration
You could only repeat what we told you
Your axe belongs to a dying nation
They don't know that we own you
--The Who

Statists often point to advertising as a prime reason why government intervention is necessary in markets. Advertising can be biased and can cause people to get confused and make wrong choices, statists claim. Better to have government oversee advertising process and content to ensure that it is clear and accurate and that people do not get manipulated. Perhaps government should just decide for the consumer, rather than having individuals collect information on their own and then make potentially erroneous choices.

The irony, of course, is that politicians spend $billions each election season to spew their own brand of biased advertising. What supposedly is bad for consumers when choosing among goods and services is good for voters when choosing among political candidates.

State involvement in media extends beyond the campaign trail. Governments have vertically integrated into advertising. The advertising apparatus is extensive. Information collection and reporting bureaus, press conferences, and other channels are managed directly. Political action groups and partisan media outlets are managed indirectly.

Advertising and media in the political sphere go by another name: propaganda. 

Monday, October 28, 2013

Capitalism Funds Socialism

When it gets too much
I need to feel your touch
--Bryan Adams

It is unlikely that the degree and duration of socialistic practices that we endure today would have been possible without a prior period of largely unhampered markets. Because socialistic designs require more resources than can be produced by hampered market structure, a prior store or wealth is necessary for socialism to last any more than a very small period of time.

The greater the wealth that precedes socialism, the longer the period under which socialists are deluded to believe that their programs are working.

But that fantasy ultimately ends. As Margaret Thatcher observed, "Socialist governments do make a financial mess. They always run out of other people's money."

The socialist fantasy could never get off the ground without seed money from capitalism.

Sunday, October 27, 2013

Statists Face Headwinds

Yeah, a storm is threatening
My very life today
If I don't get some shelter
Lord, I'm gonna fade away
--Rolling Stones

Statists are people who seek to employ the strong arm of government to get what they want. What they want may be tangible economic resources or intangible psychic income from seeing others being forcefully restrained.

Statists face a problem, however. Using force to get one's way conflicts with natural law. Not only is the application of aggression on others morally wrong, but it conflicts with axiomatic behavior that defines economic man.

Thus, although statists might feel a sense of finality when government programs such as Obamacare or QE or the Sixteenth Amendment are passed or upheld by courts, it isn't over. Natural forces build in opposition until they no longer can be restrained. When those forces of nature finally let go, statist initiatives get wiped away and social order returns.

Statists face relentless headwinds intent on removing aggression and restoring peace to the social system.

Saturday, October 26, 2013

Noise Pollution: Then and Now

So you think we have a lazy time
You should know better
--Quiet Riot

Interesting article about efforts to catalogue noise data collected by the Noise Abatement Commission in NYC in the late 1920s. This video provides a sense of the roving 'noise collector' of the time.

The commission was a response to complaints about noise. One result of the studies was this taxonomy of city noise:


Noise is an example of a negative externality. A's activities produce a racket that interferes with B's pursuits. If it can be reasonably demonstrated that B's pursuits have been impaired by A's activities, then B has the right to defend his pursuits against A's interference.

B might negotiate with A. For instance, B might ask A to tone it down.

If that doesn't work, then B might call the police with a 'disturbing the peace' complaint.

This is an appropriate role for government. When negative externalities can be demonstrated to invade an individual's property rights, then government can assist the individual in defending those rights.

The problem is that government often abdicates its role here. Like other types of pollution, invasive noise is often seen as an unpleasant but necessary consequence of 'progress.' In the mid 19th century, courts began shifting their views pertaining to nuisance and negligence from protecting individual property rights to favoring 'the public good.'

Such rulings effectively legalize pollution, and reduce markets incentives for devising entrepreneurial solutions for reducing unpleasant externalities such noise pollution.

The proper response for NYC government was not to commission a public works project to study noise with aims of scientifically reducing it. That is the job of entrepreneurs who see opportunity in developing solutions to noise pollution. Government's role is to protect B from invasion by A.

This is why, despite an octave or two of difference in the car horns, pile drivers, and elevated trains of 1929, the sound of today's NYC streets largely remain the same.

Friday, October 25, 2013

Parallel Form

"I guess you guys aren't ready for that yet. But your kids are gonna love it."
--Marty McFly (Back to the Future)

Thinking the stock market madness during the late 1990s stock bubble was a one off event? This chart posted on the Buzz at Minyanville suggests how short memories can be.


The lines defining the dot.com bubble uptrends and the current uptrend in place since 2009 are nearly equal in length and slope.

Dot.com meets gov.com.

position in SPX

Thursday, October 24, 2013

Obamacare Theater

"Define irony. Bunch of idiots dancing on a plane to a song made famous by a band that died...in a plane crash."
--Garland Greene (Con Air)

Although the end promises to be one of tragedy, it is difficult not to laugh at the political theater that is Washington. First, a small group of Tea Party types stand in opposition to Obamacare and refuse to raise the debt ceiling unless the healthcare program was restrained.

Their ultimate goal was and remains to reverse this law. But they were willing to compromise and settle for a delay the rollout of healthcare program that might at least untangle some of the problems already visible with the implementation.

At first glance, it is hard to understand why Democrats did not jump at the chance. Here was an offer to delay rollout of a high profile program that was obviously in trouble in exchange for a pass to do more borrowing and spending that the Democrats (and many big government Republicans) love. Democrats could keep egg off their faces, blame Republicans for the delayed rollout, and run with the money.

But the Democrats said no. As the standoff morphed into partial government shutdown from lack of debt-driven funding, Democrats watched gleefully as public opinion polls turned down for Republicans who the mainstream media clearly painted as the bad guys in the government shutdown story. "Let's press it here," the Democrat machine must have said, "and put the Tea Party out of business."

Feeling the poll pain, big government Republicans sided with the Democrats in a vote to raise the debt ceiling with no delay in Obamacare.

Ironically, this vote coincided with the introduction of the healthcare.gov website intended to be the primary mechanism for enrolling people into Obamacare. This rollout has failed miserably.

From the president on down, Democrats are now tasting the egg.

Tea Party concerns receive some validation.

And, yes, there is chatter in Democrat ranks about the need to postpone Obamacare.

Wednesday, October 23, 2013

Oswald's Motives

"That's the real question isn't it? Why? The how and the who is just scenery for the public. Oswald, Ruby, Cuba, the Mafia. Keeps 'em guessing like some kind of parlor game. Prevents 'em from asking the most important question: Why? Why was Kennedy killed? Who benefited? Who has the power to cover it up? Who?"
--X (JFK)

Jacob Hornberger considers various theories of why Lee Harvey Oswald might have killed John F Kennedy.

One is that Oswald was just a crazy loner who assassinated a popular, powerful man in order to achieve fame. The problem with this thesis is that Oswald denied doing so. He did not remain at the scene and boast that he did it. Instead, he left the site and, when apprehended, Oswald denied any role in the assassination.

A variation of this theme is that Oswald not only sought the notoriety of killing Kennedy but also the satisfaction of getting away with it. However, Oswald left a clear trail of guilt. For example, he purchased a rifle by mail when at the time he could have walked into any Texas gun store and bought a gun without any restriction or background check. His mail order gun was a cheap Italian rifle that was ostensibly inferior to many locally available models. Oswald left the gun in his sixth floor sniper's nest after the shooting. None of these actions would have been likely if Oswald sought to kill Kennedy and get away with it.

Perhaps the motivation was ideological. Maybe Oswald was a devout communist who hated Kennedy and what he stood for. After all, Oswald was a purported defector to the Soviet Union, he pamphleteered on behalf of Cuba, and espoused Marxist sentiments.

The problem here is that Kennedy was acting favorably toward communist regimes. Kennedy had assured Castro that the US would not invade Cuba following the Cuban Missile Crisis, he ordered the CIA to shutdown training camps for Cuban exiles, he entered into the Nuclear Test Ban Treaty with the Soviets, he proposed joint Soviet/American space programs, he was pulling the US out of Vietnam.

In his efforts to foster a more peaceful co-existence, Kennedy seemed to have a bigger bone to pick with the national security state than with communist regimes. Moreover, killing Kennedy meant putting Johnson in office. LBJ's proclivities toward the national security state clearly opposed JFK's.

Perhaps, then, Oswald was part of a conspiracy to kill Kennedy and Oswald was the trigger man. But if this were true, it is hard to explain Oswald's statements after his arrest. A central rule of large scale conspiracies is this: if caught, say nothing and wait until we send an attorney to represent you.

Oswald didn't do this. Instead, he began talking and even fielded press questions. He claimed that he didn't shoot Kennedy and that he was being framed. Why would Oswald talk and raise the specter of conspiracy to the authorities and to the media?

Absent a motive that garners clear support, perhaps Oswald was who he claimed to be: a "patsy"--someone who was set up. As JH observes, it is only under this scenario that evidence falls into place with few anomalies. Oswald was an intelligence operative recruited by the Marines to infiltrate the USSR, Cuban, and other communist institutions during the height of the Cold War. Oswald becomes the perfect set-up guy. It explains his association with a host of intelligence figures. It explains the easy mail order rifle trace. It explains why Oswald claimed that he was being set up. It explains keeping Kennedy's autopsy in military hands. It explains why Oswald needed to be killed right away. It explains why records of JFK's assassination are being kept out of the US public's hands for 75 years.

It also explains the media's ambivalence toward this story over the years.

As diligent investigators, who by and large are not mainstream media or government officials, continue to uncover findings, the "patsy" thesis seems positioned to gain further traction.

Tuesday, October 22, 2013

Bureaucratic Priority

Leave it till tomorrow to unpack my case
Honey disconnect the phone
--The Beatles

Connected to the previous post, the only way that a particular socialist program can approach the performance of unhampered markets is by bureaucratic priority. For example, bureaucrats might designate Obamacare as a 'succeed at any cost' program and then proceed to redistribute more and more resources toward its development.

Thus, the healthcare.gov website that has had hundreds of $millions diverted in its direction receives an even greater resource endowment in order to make it functional.

But that resource allocation comes at great opportunity cost. These resources have been taken from private hands that, by definition, had other uses for those resources if their owners were free to allocate them.

If bureaucrats see Obamacare as a top political priority, then they will divert as many resources as it takes to obtain something deemed workable in the eyes of the public.

If so, that is what will be seen.

What won't be as apparent is the damage wrought elsewhere in the name of bureaucratic priority. Other endeavors will be starved of resources that are forced toward Obamacare.

The Soviet Union offers the classic precedent. Soviet bureaucrats identified military programs as top priority, and then proceeded to force more and more resources toward military program development. At the program's apex, central planners were diverting massive quantities of economic resources, perhaps half of the country's annual output, toward military uses.

Yes, the USSR developed a competitive military. The trade-off: millions of Russians lived and died in squalor.

Obamacare and Bureaucratic Error

Only the beginning
Only just the start
--Chicago

It was inevitable, I suppose, that the botched roll-out of the Obamacare website would grab headlines. Some supporters of the healthcare law probably expected, while others certainly hoped, that the introduction would be 'glitch' free. That it didn't created the perception gap that the media turned into 'news.'

The real surprise, of course, would have been a roll-out that was not botched. The consequences of socialized medicine are as certain as any socialistic program. Costs rise, quality falls, availability (supply) falls.

In socialistic programs, bureaucratic errors are certain, large, and persistent. They dominate the process and restrain standard of living.

The website problems are merely a harbinger of a future burdened by centrally planned bureaucracy if this law is not thrown off.

Monday, October 21, 2013

Popularity Contest

Dressing up in costumes
Playing silly games
Hiding out in tree tops
Shouting out rude names
--Peter Gabriel

Suppose that opinion polls suggest that the majority of voters favor having a minority hand a portion of their production over to the majority. Sensing political opportunity, many elected officials get busy proposing legislation that reflects 'the will of the people.'

Some elected officials disagree, however. They claim that the rights of the some individuals would be violated if they were forced to work for others. Such legislation robs some people of their property. If they are forced to hand over production to others, these people become slaves. This group does what it can to stop the legislative movement in its tracks.

The media takes opinion polls to gauge the popularity of the two groups of politicians: those who support and those who oppose the legislative movement?

What are the likely results of these polls?

Sunday, October 20, 2013

Currency vs Money

Now that ain't working
That's the way you do it
Let me tell ya them guys ain't dumb
--Dire Straits

This video nicely distinguishes currency from money.


Currency is said to have the following attributes: medium of exchange, unit of account, portable, durable, divisible, fungible (interchangeable). Money is all of those things plus a store of value over long periods of time.

A US dollar is currency but not money, because the USD loses value over time due to inflation. An ounce of gold, on the other hand, is money, because it holds value over long periods of time.

One thing that I would revise in this video is the position that money is a tool for trading time. This is not precise enough. Money is a tool for trading productive time. Money reflects production. Before coins and currency, people traded their production directly in what today we call a barter system. Bread was money. Chopped wood was money. .

Because currency can be created at a whim, it does not reflect actual production. Instead, currency is a claim on someone else's labor. Someone who possesses one of these claims can call away production made by someone else without having to produce something and engaging in trade.

That currency enables people to take production from others without trading their own production is the reason why all currencies fail over time.

position in gold

Saturday, October 19, 2013

Excellent Monetary System Video

The cracks between the paving stones
Look like rivers of flowing veins
--The Who

Here is perhaps the best video that I have seen describing how our monetary system works and the effects that it brings.


The steps outlined in the video are as follows:

1) The federal government creates glorified IOUs (e.g., Treasury bonds).

2) Government sells those IOUs to banks which in turn sell the IOUs to the Federal Reserve. On the other side of the trade, the Fed creates currency out of thin air which it gives to the banks in exchange for the IOUs which in turn gives the cash to the government (after taking a nice cut for themselves, of course). I would have added that the Fed also provides banks with low cost bridge loans (also created out of thin air) in the form of the Fed Funds Rate and other institutional devices to further liquefy the exchange environment. When all is said and done, IOUs gravitate toward the Fed and currency gravitates toward the banks and government.

3) Government spends their currency on promises, public works, social programs, and war.

4) People work to obtain some of that currency. Much of the earned currency is deposited in banks. Fractional reserve lending by the banks multiplies the supply of currency exponentially. Banks use this leverage to speculate in stocks, loans, and other projects. This is where much of the currency comes from that employers use to pay their workers (from debt and equity projects funded by the banks).

5) Some of the currency earned by workers is taken by the government in the form of taxes. Government uses the tax receipts to pay principal and interest to the Federal Reserve--the institution that bought the original IOUs with a check from...nothing.

6) The debt ceiling must continually be raised lest the entire system, which requires ever more borrowing to pay back debt created by dollars linked to IOUs, collapses in a deflationary bust.

7) The owners of the Federal Reserve, a privately owned corporation, take their cut.

It is interesting to hypothesize what occurs when this inherently unstable system approaches the breaking point. Personally, I wonder whether, as things get dicey, policymakers might elect to create dollars that are not directly linked to IOUs. For example, why not print $17 trillion and pay off the federal debt, and then print another few $trillion and drop currency from Ben Bernanke's infamous helicopters into the hands of the people?

You don't have to be a PhD to know why this would be...bad. But it is easy to posit that our increasingly desperate situation will spawn increasingly desperate measures that increasingly conflict with reason.

I wholeheartedly agree with the recommendations near the end of the video. Watch it until you can explain our monetary system to others. Also, share the video with your network.

I would add that if there are portions of the video that are unclear or that you don't agree with, do some research or think it through until you personally know what the truth is.

Friday, October 18, 2013

Our First Law Is Clear

Just a little more time is all we're asking for
'Cause just a little more time could open closing doors
--Corey Hart

Reflecting on the escalating insanity of our economic and financial situation, the author here concludes that returning government to it original scope, the scope defined by our nation's first law, is the best solution.

Indeed, Jefferson was clear. The purpose of the national government is to secure our natural rights. If a government exceeds that scope, then the people are justified in throwing it off in favor of one that is more capable of securing our natural rights.

It is also clear that the current scope of the federal government far exceeds those boundaries defined by natural law. We are blatantly violating our first law.

The author suggests that the recent debt ceiling squabble has awakened more people to this reality. I hope and pray that he is correct.

I would be lying, however, if I said that I thought people are waking up fast enough.

Thursday, October 17, 2013

Cave Man

And the parting on the left
Is now parting on the right
And the beards have all grown longer overnight
--The Who

Part of John Boehner's statement rationalizing why he would not stand in the way of a Senate sponsored bill to raise the debt ceiling reads as follows:

"Blocking the bipartisan agreement reached today by members of the Senate will not be a tactic for us. In addition to the risk of default, doing so would open the door for the Democratic majority in Washington to raise taxes again on the American people...With our nation's economy still struggling under years of the president's policies, raising taxes is not a viable option."

Setting aside how taxes can be raised when his party controls the House, Boehner's claim that failure to raise the debt ceiling increases the likelihood of further taxation reveals one of two things. Either he is ignorant, or he hopes that you are.

By voting to raise the debt ceiling, Boehner himself has chosen to raise the tax burden on Americans. This tax confiscates wealth directly via the tax system and indirectly via inflation (printing money to pay off debt).

To the extent that the bulk of the bill falls on our children, yesterday's vote further condemns them to lives as indentured servants.

For those keeping score of who caved and who stood firm, here are the roll votes for both the House and Senate.

Wednesday, October 16, 2013

Exceptional Debtor Status

In violent times
You shouldn't have to sell your soul
In black and white
They really, really ought to know
--Tears for Fears

Jim Rogers speaks out about the Washington charade, one that has been repeated dozens of times over the past decades, surrounding the debt ceiling. The only thing exceptional about America, he says, is our exceptionally high level of debt.

The solution is taking a "chainsaw" to spending. But this involves surrendering our artificially high standard of living today. We need to cut back consumption and save.

Politicians, of course, have no stomach for this. They fear that too many of their constituents will punish them at the ballot box for taking away resources deemed to be entitlements.

Thus, in Groundhog Day-like fashion, politicians squabble in their political theater and then kick the can down the road once again. This will work until creditors no longer lend to the US.

"Eventually the market's gonna say, 'We don't want to play this game anymore. We're not going to lend you money at any price.' And America will go into sudden and steep decline just as has happened in the UK, in Spain, and in many other countries over the past 200 years."

This process is already underway, as countries such as China and Japan have cut back on their US sovereign debt purchases and are diversifying out of dollars. To compensate for lower market demand for Treasuries, the Fed has stepped in to buy much of new Treasury debt issuance--thus keeping interest rates lower than they would otherwise be.

But this effect is temporary. Expect the Fed's buying to escalate with diminishing marginal effectiveness in suppressing rates. That is when the wheels are likely to come off.

America's exceptional debtor status portends exceptional collapse.

Tuesday, October 15, 2013

Fear the Repo

All our times have come
Here, but now they're gone
--Blue Oyster Cult

Stress continues to build in the short term Treasury market. T-bill yields are ripping higher (read: supply) as are prices of 1 yr Treasury credit default swaps (read: demand). Why the extra stress on the short end of the curve? Because markets are figuring that any technical default on Treasury debt (currently estimated at 6.5% by 1 yr CDS) will have an outsized effect on near-term borrowing.

Few groups are likely more nervous right now than the big banks. Banks have been exchanging collateralized securities for short term loans to fund huge speculative trading operations. These trades, known as repurchase agreements or 'repos,' enable banks to lever up big time (30:1 or more) while, because of their short term nature, steering clear of regulators.

US Treasuries, particularly shorter dated ones, provide the bulk of collateral that banks use to obtain their repo funding. If the price of US debt continues to fall, then the value of bank collateral falls as well, which could render highly levered banks severely under capitalized or insolvent.

The repo market would grind to a halt as would interbank lending. At least $600 billion in liquidity would likely drain from the banking system.

Stated differently, the big banks have been exploiting the 'full faith and credit' feature of US securities, that to this point has come out of the hides of US citizens in the form of taxes and crushing debt, to take on extraordinary risk in pursuit of $billions. They are praying that Capitol Hill will once again cave to pressure that keeps their nefarious, monster sized, repo-funded carry trade alive.

Plus, if things go bad, the big banks figure the Fed will step in and bail them out as always.

This set-up is similar to 2008, which demonstrates once more how little has structurally changed over the past five years.

The Fed, Debt, and Forecasting

There's a room where the light won't find you
Holding hands while the walls come tumbling down
When they do
I'll be right behind you
--Tears for Fears

Wanted to reflect on some thoughts expressed by Fleck in his fine Rap last night. The hysteria in Washington could not have reached this point without the Federal Reserve. The Fed has been the great enabler.

Although the predicament we now face was ensured when the Fed was chartered into existence one hundred years ago, the situation clearly escalated in the 1990s. Fed chair Alan Greenspan forced conditions of easy money during a vibrant economy and consequently blew a huge stock market bubble. When that bubble burst in the early 2000s, Greenspan eased monetary conditions further, and then handed the baton to Ben Bernanke who did more of the same.

The result was a massive real estate bubble that almost took down the financial establishment when it popped. Fortunately for the big banks, the Fed came to the rescue once more. It lifted 'troubled' assets from bank balance sheets in exchange for cash, it provided access to near no-cost loans that enabled banks to regain their speculative form, it influenced changes in accounting regs that no longer required banks to mark troubled assets to market, and it undertook bond buying programs that allowed banks to lock in sweet profits from bond purchases.

This last step, which as come to be known as 'Quantitative Easing,' has also been important to the federal government. Because it is buying $40-45 billion/month of Treasuries, the Fed has created demand for US sovereign debt that would not be there at these prices. By monetizing debt, the Fed is keeping borrowing costs of the federal government well below free market rates.

Fleck contends that despite all the disaster the Fed has wrought on this country, people still view this institution as a capable manager of financial and economic systems. He is amazed at how foolish or at least how gullible people can be.

He may be right, but a counter view is that many people, particularly those who shape power structure, know exactly what is going on. They understand that the Fed has massively distorted financial and economic systems to the point where failure is nearly certain. However, they believe that the day of reckoning remains far off, and that it might even be pushed farther out into the future. Meanwhile, these people are interested in grabbing as much as they can before, as Chuck Prince once famously alluded, the music stops.

Because the Fed's inflationary actions almost magically transfer wealth into the hands of the power structure, these people will be the last ones to call out the Fed.

Overspending and massive debt are classic consequences of central bank policy. The Fed has blown this debt bubble. The greater the debt, the shorter people's time horizons. This is because growing leverage drives greater sensitivity to smaller unanticipated changes in price. If action isn't taken on these unanticipated price changes, the system can quickly slide into insolvency.

Unfortunately, the shorter people's time horizons, the lower the capacity for accurate forecasting--meaning that people are less capable of anticipating the very price changes that they must anticipate in order to manage a hyper-leveraged system.

Perhaps this is the most severe consequence of all. The policies of the Federal Reserve are destroying our capacity to reasonably peer into the time tunnel and anticipate the risk of an oncoming train.

Monday, October 14, 2013

Liabilities, Debt, and Default

Here come the world
With that look in its eye
Future uncertain
But certainly slight
--INXS

A and B engage in trade. A exchanges resources up front for B's promise to pay his end of the bargain. That promise to pay usually has an explicit or implied near term time horizon. For example, furnace technician A inspects a furnace and then bills B for services rendered. The bill might provide a 30 day time window to pay. B has incurred a liability because B has received a benefit for which he has yet to pay.

A might reduce risk by requiring B to sign a formal contract up front. A is more prone to require this when his upfront resource outlay is substantial. Thus, roofer A may ask B to sign a contract in which B promises to pay A an agreed to amount once a new roof is installed. The contract might also specify the penalty to be incurred if B fails to pay within an agreed-to period.

B can also borrow money from A with the promise to repay principal with interest over some mutually agreed to period of time. If A and B engage in this kind of trade, then B incurs a special type of liability. B is borrowing economic resources in the present period with a promise to repay according to terms of the agreement in a future period. That repayment usually includes interest to be paid to A. Borrowing commonly requires a formal contract that is written and agreed to up front.

These features in combination--repayment in future periods, repayment with interest, and strong contract law context--make debt a particular type of liability. All debts are liabilities. But not all liabilities are debts.

If B fails to meet the terms of a debt agreement with A, then B is in default. Usually this involves B not paying the requisite amount of interest and/or principal on the requisite date. B has taken property from A with no or insufficient repayment. In a just system and if the contract is valid, A can take legal action against B to reclaim property or to enforce terms of the debt contract. A's legal recourse is stronger if the debt contract was 'secured' by assets of B.

If B fails to pay a bill owed to A for services rendered, then B is not in default. Instead, B has failed to live up to his end of a trade. Whether a formal contract was signed at the outset, this trade is still governed by contract law because the two parties agreed to exchange property and B has taken property from A with no or insufficient repayment. In a just system and if the contract involving the trade was valid, A can take legal action against B to obtain payment or to get his property back. However, A's legal recourse is stronger if a formal contract had been signed at the outset.

Sunday, October 13, 2013

Treasuries Not Impressed

You would cry too if it happened to you
--Leslie Gore

Rumors of a budget deal and nomination of Janet Yellen as next Fed chair sent stocks flying higher into the end of the week. Treasuries, however, have yet to join the party.


While not textbook in appearance, ten year yields are getting a cup and handlish look to them.

If the T-note continues to trade heavy, the 50 day (2.75%) and then 30.0 (3.00%) will be the resistance levels of lore for the TNX.

position in SPX

Saturday, October 12, 2013

Peak Entitlements

"Well, ladies and gentlemen, we're not here to indulge in fantasy but in political and economic reality."
--Gordon Gekko (Wall Street)

Since 1990, GDP is up 75%, while federal current expenditures are up over 300% and transfer payments are up 500%.

Meanwhile the ratio of full time employed people to Social Security beneficiaries has fallen to 2:1 and promises to fall more in years to come.

Productivity per person is up 58% during this period.

This is clearly unsustainable. How close are we to Peak Entitlements?

Friday, October 11, 2013

Get the Picture

I've been living so long with my pictures of you
That I almost believe that the pictures are all I can feel
--The Cure

Banks are piling up huge amounts of 'excess reserves' courtesy of the Fed. Through its various asset buying programs such as QE, the Fed has been lifting bonds and other assets off bank balance sheets in exchange for freshly minted cash.

During 'normal' times, banks would turn around and make loans on those reserves, perhaps to the tune of $10 in loans for every $1 on deposit. Multiply by 2-3 layers of banks and other intermediaries and the pyramid effect might run close to 100:1 in new credit money creation.


But these aren't normal times. Banks aren't lending much. Total loans stand where they were during Lehman in 2008. Instead, most courtesy-of-the-Fed deposits are piling up as 'excess reserves'--i.e., deposits in excess of loans. Currently, excess reserves total about $2.3 trillion.

So, are banks just keeping these reserves on standby waiting for the lending landscape to look more favorable? No, they are using these reserves as collateral for speculation.

Thus the relationship between Fed balance sheet assets and stocks. Fed creates money out of thin air...then puts it in banks in form of 'deposits' in exchange for bonds of various sorts...then banks use these deposits to buy stocks and other securities.

Rather than owning securities outright, banks are prone to use deposits as marginable collateral to buy derivatives such as futures. Why? Because derivatives provide leverage--more bang for the buck.

Looking for the next train wreck? How about vanishing excess reserves when prices moves against banks levered in equity and other markets.

Meanwhile, people working at these institutions are getting wealthier at your expense.

Be smart. Know what is going on here. As a sage type suggested to me during the housing bubble run-up: "If you have eyes, see. If you have ears, listen."

position in SPX

Thursday, October 10, 2013

Help vs Hurt

"There will be a day when you will wish that you had done a little evil to do a greater good."
--Sybilla (Kingdom of Heaven)

Federal welfare programs are sometimes justified using some variation of the following: Yes, the programs are subject to abuse. But even if just a few are helped, then the programs are worth it.

Why is this argument any more valid than one that focuses on those hurt by these programs? For example: Yes, the programs help some people. But even if just a few are hurt, then the programs are not worth it.

All government programs that provide resources to some require that those resources must be forcibly taken from others.

Is not aggression on anyone for any purpose...bad?

Wednesday, October 9, 2013

Fear Mongering

Par-a-noia strikes deep
Into your life it will creep
It starts when you're always afraid
Step out of line, the man come and take you away
--Buffalo Springfield

Fear mongering is the use of scare tactics to influence the actions of others toward a specific end. Bureaucrats often utilize fear mongering when they want to maintain or increase State power. Usually, the idea is to make people afraid of what would happen if some government activity didn't exist or went away.

Government officials use scare tactics because they often work. Indeed, fear mongering is grounded in principles of human behavior under conditions of threat.

Many people believe that fear mongering affects others but not themselves. When people advise, "Don't believe the fear mongering..." they often imply "...because I don't."

But maybe you do. Test yourself:

Do you believe that the consequences would have been disastrous and unacceptable if government hadn't bailed out the banks in 2008/2009?

Do you believe that the consequences would be disastrous and unacceptable if the NSA, Patriot Act and other agencies and laws that enable and expand government surveillance of the citizenry were not in place?

Do you believe that the consequences would be disastrous and unacceptable if military spending was cut by 90%?

Do you believe that the consequences would be disastrous and unacceptable if entitlement spending was cut by 90%?

Do you believe that the consequences would be disastrous and unacceptable if the federal debt ceiling is not raised?

If you answered "yes" to any of the above, then how do you know that you have not been influenced by the fear mongers?

Tuesday, October 8, 2013

Back on the Line

It's not in the way that you hold me
It's not in the way you say you care
--Toto

Back to fish or cut bait time for the SPX. After today's move lower the index is sitting on the uptrend line (drawn with a crayon rather than with a fine point) defined by last November's lows.


Shorts have to be skittish due to the possibility that at least temporary budget agreement is reached in Washington. Bulls likely continue to expect such an agreement in Pavlovian, moral hazard fashion. That bulls maintain hope and bears lack the stomach for much commitment seems bearish on the margin. Moreover, daily stochastics are just now inching into oversold territory, but nowhere near levels suggesting deeply oversold conditions.

In summary, this is where we've bounced several times in the past few months. Would think the bulls will try to once again extend the pattern. On the other hand, there is technical 'room' lower if the uptrend line is pierced with authority.

position in SPX

On the Record

Why don't you do what you say
And say what you mean
One thing leads to another
--The Fixx

Brilliant remark and position by Senator Obama in 2006.


Being on the record is a heckuva thing.

T-Bills Not So Quiet

Lord I've got to say
It's no disgrace
I'm in no hurry
--Quiet Riot

Following up on the previous post, we should note that although the long end of the Treasury curve has been quiet, the short end has been, um, less so. New T-bill auctions have not been well-bought, and yields on 3 month bills have lifted north of 0.3%.

While certainly not huge on an absolute basis, these yields are more than 10x higher than they were on new auctions held just a couple months back. Plus, they constitute levels last seen during the 2008 melt-down.

no positions

Quiet Treasuries

"Quaffable but...far from transcendent."
--Miles Raymond (Sideways)

Am finding the sideways action in the ten year interesting given the government shutdown and debt ceiling contexts.


Seems unlikely that this quiet time lasts much longer.

no positions

Monday, October 7, 2013

Inheriting Squalor

Another night in any town
You can hear the thunder of their cry
Ahead of their time
They wonder why
--Journey

The old generation, the one that is in the process of dying, has generally been a group of savers. They eschewed debt, preferring instead to limit their consumption (a.k.a. standard of living) to a fraction of their incomes while putting the remainder aside for the future. People in the old generation were also early beneficiaries of federal welfare programs. In any ponzi scheme, those who get in early benefit off of those who get in later. Because they have realized far more in entitlement benefits than they have paid into the system, the old generation has been able to keep more of their savings into old age.

The mature generation constitutes those people in their prime to latter working years. This group has preferred a lifestyle that has required more resources than their incomes have brought in. Moreover, this group has been funding the old generation's welfare program. As as result, this generation has borrowed heavily and has little set aside in the future. Low interest rate policies of the Federal Reserve have enabled this generation to take on their debt to extraordinary levels.

The mature generation does have an ace in the hole, however. They are inheriting the sizable nest egg that the old generation leaves behind. Undoubtedly, many in the mature generation are counting on this inheritance to help make them whole. While their inheritance will help the mature generation get closer to even, this group's lifestyle preferences plus their transfer payments to the old generation reduce the likelihood that they will have much savings into old age. Therefore, the mature generation is also counting heavily on the welfare system to bail them out as they get older.

This leaves the young generation. These are young adults in their early work years plus the children. This generation faces a difficult situation. Many who have entered the work force cannot find work that seems commensurate for their level of schooling. They struggle to pay their bills. Some are already deep in debt.

This should not be surprising. The mature generation's profligate lifestyle coupled with requisite transfer payments to previous generations have robbed the system of savings. With less savings, there is less capital. With less capital, there is less investment in productivity improvement. With less investment in productivity improvement, there are fewer good paying jobs. Standard of living stagnates, then declines.

The young generation also bears the burden of paying for the mature generation's welfare draw. In classic ponzi fashion, this welfare draw is likely to be orders of magnitude higher than the draw of the old generation.

Unfortunately, the young generation will have little inheritance to fall back on. The current set up suggests that the mature generation is likely to die largely penniless, leaving the young generation with an inheritance of squalor.

Sunday, October 6, 2013

Fool's Paradise

Well, you're looking for another end
Anytime
But you still can't turn away
--Ric Ocasek

Jim Rogers encourages investors "to know that you're in a fool's paradise. Be careful."

His concern is grounded in his observation that central banks worldwide are acting in unprecedented, synchronized fashion. They are suppressing short term interest rates near zero and creating money out of thin air to buy assets from bank balance sheets. Governments are also borrowing at epic levels. And central bank bond buying is facilitating the process because it provides a non-economic buyer for $trillions of sovereign debt issuance. This is what is known as 'monetizing debt.'

These activities have floated the world "on an artificial sea of liquidity" which has in turn artificially boosted asset prices. Someday the artificial sea is going to disappear, he says, and "when it does, the catastrophe will be even worse."

Despite his bearish view, Rogers is hesitant to act on it here. He's not buying shares, but he's not selling either, "because I am concerned that this might turn into a huge bubble. So I'm sitting and watching."

He says if markets go up big from here over the next few months, then he might begin selling short. But the unclear path between 'right now' and 'ultimately lower' has him sitting on his hands for now.

JR thus joins a group of 'big picture' bears that are hesitant to act now on what they believe to be a high probability outcomes--although they seem confident that they will be able to recognize the right time to act in the future (presumably ahead of others).

I increasingly wonder whether that will be possible. One thing that is certain: all will not be able to elude the moral hazard that has been placed in this market.

position in SPX

Saturday, October 5, 2013

Conservative Hypocrisy

And all my instincts
They return
And the grand facade
Soon will burn
--Peter Gabriel

Jacob Hornberger wonders why conservatives, who frequently claim to support free markets and limited government, are currently fixated on repealing Obamacare. If they truly supported free markets and limited government, then why aren't conservatives going further to repeal the entire socialized health care system which includes Medicare and Medicaid? After all, these programs have long been the elephants in the room when it comes to federal spending and escalating future liabilities.

Conservatives might counter that you can't transform the system in a day. You have to start somewhere and build a stream of compromises toward a longer term goal. The ends justify the means...

A counter to that argument is that there is little evidence that previous compromise approaches have been effective. There is an equally if not more compelling argument that the compromise strategy is prone to move in the other direction--i.e., away from freedom and toward the institutionalization of State programs however poorly conceived and implemented.

The evidence suggests that, going back at least to Lincoln and the early days of the Republican Party, conservatives, while often talking a good game, are prone to act similar to the statists that they claim to oppose.

Friday, October 4, 2013

Productivity and Minimum Wage

"You know what, Mrs O'Rourke? You don't know me at all. I broke up with my girlfriend this year. I lost my job at All American Burger and two other places. I wake up at 5:30 to go to work at Mi-T-Mart. Then I go to school and go back to Mi-T-Mart. My grades aren't that bad. And you're telling me the fun is over. Man, I'm still waiting for the fun to start!"
--Brad Hamilton (Fast Times at Ridgemont High)

We have frequently observed that minimum wage laws amount to compulsory unemployment. This video employs a productivity argument to demonstrate.

California's recently passed minimum wage law does not require employers to pay at least $10/hr to every worker. It forces employers to pay $10/hr to every worker they choose to keep. Workers who are laid off, or who never get hired in the first place, get $0/hr.

For example, an owner of a hamburger restaurant hires workers perceived as being sufficiently productive. Productivity equals output / input. The primary objective of an operation is to produce output that is worth more than the input. This is not just a self-interested entrepreneurial goal. It is in society's best interests as well, because production that results in the opposite--output that is worth less than input--squanders scarce resources. Society is worse off when scarce resources are inefficiently employed.

Suppose the restaurant owner hires three workers of varying abilities (i.e., the productivity of each worker is different) to flip burgers. Workers A, B, and C produce 110, 120, and 90 burgers per hr respectively. If the owner makes $0.10 on each burger sold before paying workers, then A, B, and C produce $11, $12, and $9 per hour in pre-labor expense value to the owner.

Suppose that the owner pays each worker $8/hr. After paying the workers, the owner makes $3, $4, and $1 per hour per respective employee.

An important point to make is that, despite differences in individual workers productivity, the owner is motivated to retain all workers that generate a profit for the owner. In fact, the owner is motivated to look for additional workers whose productivities can generate even more profit.

Now let's inject California's recently imposed $10/hr minimum wage law. Productivity of A, B, and C doesn't change, meaning that they still produce $11, $12, and $9 per hour of pre-labor expense value. However, the owner is now forced to pay $10/hr to any worker that is employed at the restaurant. If the owner pays the three workers accordingly, then the owner makes $1, $2, and -$1 per hour per respective employee.

C no longer generates a profit for the owner; he generates a loss. The owner would be $1 per hour better off if C was fired.

A and B are better off. They now earn $2/hr more than before. But if C is fired, he is now $8/hr worse off. In relative terms, A and B each gain 20%, but C loses 100%.

And unemployment has just increased by one person.

As the video observes, one way to view the impact of minimum wage laws is that they benefit more productive workers at the expense of less productive workers. But is a minimum wage law even necessary to help more productive workers? After all, owners are motivated to raise the wages of productive workers because if they don't, competitors are motivated to hire those workers away to improve their own situations.

Meanwhile, marginally productive workers such as C who are willing to work for lower than the legal minimum wage are forced to the sidelines.

While they may be well intentioned, minimum wage laws exert the most pain on those people that the laws are purportedly intended to help.

Thursday, October 3, 2013

Transaction Cost Theory in Motion

Now's the time
That we need to share
So find yourself
We're on our way back home
--Supertramp

Nice discussion of Microsoft's (MSFT) recent purchase of Nokia (NOK) assets in the context of transaction costs and contracting, including some snippets from Ronald Coase.

Transaction costs are costs associated with using the market pricing mechanism. Examples include negotiations, drawing up of contracts, and arrangements for settling disputes.

Coase's key contribution in the 1930s was his observation that these transaction costs are often greater than zero and significant. This may seem obvious to us today but it challenged the zero transaction cost mindset that dominated economics at the time.

As transaction costs escalate, it is increasingly tempting to take the associated exchanges 'off the market' and put them into a managed hierarchy anticipated to reduce the cost of exchange.

The article cites file sharing difficulties in one particular MSFT/NOK alliance that likely was part of the motivation for MSFT's buyout. By exerting more control over the transaction via direct ownership, MSFT thinks that it will be able to reduce the hangups that made trades less efficient.

Transaction cost theory helps explain why buyouts, mergers, and vertical integration happen.

no positions

Wednesday, October 2, 2013

Shrinking Government

"Shut it down. Shut it down NOW."
--Telco Supervisor (Die Hard)

It should be apparent by now that Mitt Romney's statement last year understated our dependence problem and its various enablers. The circus taking place in Washington is instructive in that regard. Both sides of the aisle and the president himself are busy pointing fingers of blame for the federal government 'shutdown.' No one wants to be the seen as the one who shuttered any part of the State apparatus--however temporary it is likely to be in this case.

They think that you and I will nod our heads in agreement like robots. Making the federal government smaller is bad, we drone mechanistically, because we would rather be ruled than be free.

I long for the day when we see the opposite. When politicians no longer apologize for shrinking the size of government. Instead, they trip over themselves to take credit for permanently disposing of another portion of the State. And you and I, no longer willing to trade our liberty away, cheer.

We cheer because we know that we are transferring another increment of power from the State back into the hands of the people.

Tuesday, October 1, 2013

Throw It Off Here and Now

Ben Gates: You know, of all the ideas that became the United States, there's a line here that's at the heart of all the others: 'But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security.'
Riley Poole: Beautiful...I have no idea what you just said.
Ben Gates: It means the if something's wrong, those that have the ability to take action have the responsibility to take action.
--National Treasure

If you did not previously realize the extent to which Statism infects the GOP, then you should now be more informed. Conservatives have come out of the woodwork declaring that Republicans should not stand in the way of raising the debt ceiling or defunding Obamacare because the public will blame the GOP.

Others claim that they are with the Tea Party in principle, but not in tactics.

Right...and totally predictable years ago.

One proposal floated by Old School conservatives is that Republicans should just stand back and let Obamacare unfold. As the trainwreck piles up, people will realize that Democrats created the disaster and will consequently bear the brunt of people's wrath.

But this is just another variant of Statist thinking. Obamacare is a program of aggression. Standing back and letting it unfold makes you a party to force being applied to others. This is wrong.

Moreover, expecting that a poorly designed and implemented government program will be reversed once people see how bad it is seems extremely na├»ve. My guess is that some original opponents of the income tax, Social Security, Medicare, and other socialist boondoggles had similar thoughts--let's just let it happen and they'll get the blame when their program falls flat.

The problem, of course, it that, once put in motion, bad government programs rarely get reversed. Instead, they become institutionalized. Once implemented, government programs become bottomless money pits, attracting ever more resources to protect and grow the institution.

No, the right thing to do is to do one's best to throw it off here and now.

Debt as Solution to Debt

"It's a basic principle of the universe that every action will create an equal and opposite reaction."
--V (V for Vendetta)

Only statists can rationalize that the solution to our debt and spending problem is more debt and spending.


Of course, statists can also rationalize that our debt and spending problem is not a problem...