Wednesday, February 29, 2012

Free Falling

I wanna free fall out into nothing
Gonna leave this world for awhile
--Tom Petty

Metals slammed on the back of Benanke's Humphrey Hawkins testimony. Earlier in the day, LTRO 2 came in at huge 'over.'

SLV looking at an ugly outside day and is currently down about $2. Almost poetic after yesterday's gappy (and certainly unexpected by me) move higher. Gold down ~ $60 today.

Metals only group really responding to today's events so far. Stock began to melt but now almost back to even.

position in gold, silver, SPX

Tuesday, February 28, 2012

Corporate Tax Fraud

I know I could break you down
But what good would it do?
I could surely never know
That what you say is true
--Information Society

Classic example of media bias. CNN graphic groups US corporate tax rate with five other central govt tax rates at 30% or higher. The commentator then suggests that the US is 'competitive.'

Of course, what's missing is a representative sample. The five comparative countries selected for the graphic happen to be the other top corporate tax rates among OECD countries. Twenty seven OECD countries have lower corporate tax rates, with Switzerland at the bottom at 8.5%.

Once again, we find media commentators either being ignorant (coupled with selective reasoning) or downright disingenuous.

Monday, February 27, 2012

Four Rallies, Same Pattern

"I remember you!"
--Mason Storm (Hard to Kill)

Over the past two years, we have seen four rallies with strikingly similar characteristics. Each one has been a straight up move of about three month's duration, during which time the SPX has advanced about 175 points.

Each of these rallies can be related to major central bank interventions as well. Rally 1 corresponded to QE1. Rallies 2 and 3 corresponded to QE2.

Rally 4, the one that we are in now, corresponds to the EU's LTRO program.

We should see shortly whether Rally 4 remains true to the 3 month/175 point pattern. Or whether it breaks the mold.

position in SPX

Herding Inflation

"A king may move a man. A father may claim a son. But remember that, even when those who move you be kings or men of great power, your soul is in your keeping alone. When you stand before God you cannot say 'but I was told by others to do thus' or that 'virtue was not convenient at the time.' This will not suffice. Remember that."
--King Baldwin IV (Kingdom of Heaven)

Mises describes the folly of inflationism as a function of the Depression years. The propaganda machine has burned into our brains the idea that there is a 'good' rate of inflation. The Fed is now serious about 'targeting' a certain rate of inflation, say 2-3% annually.

Unless we engage our brains, such policy will be the end of us. As Mises observes, "At the end of this race is the complete destruction of all nations' monetary systems."

Mises notes that inflation is essentially a political device that bureaucrats use to respond to pressures of public opinion. This does not absolve politicians or the intellectuals that condone such policies:

"This does not excuse the officeholders who could resign rather than carry out policies disastrous for the country. Still less does it excuse authors who tried to provide a would-be scientific justification for the crudest of all popular fallacies - inflationism.

Sunday, February 26, 2012

Genuine Disingenuousness

There's things going on behind her back
Oh, they'll give you a heart attack
--Flesh for Lulu

On the heels of yesterday's release of Berkshire Hathaway's annual shareholder letter, I was chatting w/ friends and family about some of Warren Buffett's commentary. Characteristically, my commentary turned negative. It is no secret that I have soured on this man's approach over the past few years, and these pages have recorded such.

I do not like disingenuous behavior. In my view, WB's 'aw shucks' reputation serves as a disingenuous facade. For example, in his recent letter, Mr Buffett rails against the 'ugly result' of government policies that debase the value of money. He notes:

"Systemic forces will sometimes cause them [governments] to gravitate to policies that produce inflation. From time to time such policies spin out of control." (p. 17)

Were this of real concern to WB, he is in a strong position to do something about it--particularly given his cozy relationship w/ the Obama administration. For example, he could use his editorial page power to note how existing monetary policies serves to gut the wealth of savers, particularly older people. He could observe how these policies widen the divide between rich and poor. He could testify before Congress that central bank policies are destroying the value of the dollar and shouldering future generations with unworkable levels of debt.

But he doesn't.

Instead, he has used the media platform to condone such policies, suggesting that people should thank their lucky stars for the interventionary policies of Ben Bernanke & Co.

Even the most superficial review of Berkshire's business model finds a leveraged entity that depends on inflation. This model has been a beneficiary of government's interventionary policies to the tune of eleven or twelve figure size since 2008.

Crony capitalism at its finest.

That, my friends, is what irks me. WB could use his influence to make the system better. Instead, his behavior reinforces what is wrong with the system.

Friday, February 24, 2012

Markets and Stability

Tell you straight, no intervention
To your face, no deception

A common claim is that free markets are inherently unstable, and are therefore in need of government intervention in order to keep them on even keel. The Fed's charge for 'price stability,' for example, presumes price instability were markets to do their own thing.

Let's set aside the question of precisely how a bureaucrat is capable of recognizing instability and competently reducing it--this issue merits dedicated discussion elsewhere. Here, let's consider unhampered market behavior and whether it is indeed likely to trend toward instability.

Unhampered markets are places of voluntary exchange. Exchange occurs because people seek to satisfy needs, and because people perceive that they can better satisfy those needs by trading with others than by acting independently.

Axiomatically, people will engage in trade to the extent that both sides perceive benefit from exchange. If one side of a potential exchange does not judge a favorable situation, then trade will not occur.

Assessing the attractiveness of a trade requires an estimate of the degree of benefit (i.e., Am I likely to gain? How much am I likely to gain?) versus what must be given up in trade (i.e., How much will this trade cost?). The greater the likelihood of gain perceived by both parties ex ante, the greater the likelihood of trade.

Errors in judgment are possible, of course. A perceived benefit does not occur to the extent that it was forecast, and the trader experiences a loss of material resources. More benefit may have been possible than was estimated ex ante, and the party that passed on a particular trade experiences loss of economic opportunity.

It is the assessment of risk versus reward that shapes behavior in unhampered markets. Balancing the potential for gain against the potential for loss attenuates market behavior, keeping it from getting lost in extreme conditions of either risk seeking or risk aversion.

Pro-interventionists sometimes argue that human wiring defects (e.g., overconfidence bias, confirmation bias, loss aversion) cause risk:reward assessment to be less than rational which drives errors in calculation that necessitates a mediator. Cognitive biases surely exist, but in free markets errors of bias sting with the penalty of loss, which is likely to drive behavior in the other direction. Moreover, cognitive biases must be systemic rather than random in order to impact overall market stability. Even in such cases where 'herds' might move toward extremes under the auspices of systemic cognitive bias, the penalty of loss still stings, which once again motivates a reversal of behavior--even if it is the behavior of a crowd.

Indeed, it seems more likely that the cognitive bias problem is likely to be much more consequential in a hampered market, where biases and their influence are concentrated with the mediator, rather than distributed and buffered among many actors in a free market.

Claims of inherent instability in free markets are not supported by reason. Natural laws regulating human behavior administer rewards and penalties that keep greed and fear in check. Fundamental forces governing free markets are inclined toward equilibrium rather than disorder.

Thursday, February 23, 2012

Communism in Virginia

Eli Lapp: It's not our way.
John Book: It's my way.

While the birth of communism is often associated with the writings of Marx and Engels in the mid 1800s, communistic societal structure had already been attempted around the globe for centuries, with predictably sad results.

Rothbard recounts communism in the Jamestown settlement originated in 1607. People contributed the fruits of their labor according to their ability, and withdrew from the storehouse according to their need. This communism was not voluntarily contracted by the colonists, but imposed on them by their master, the Virginia Company.

Results were as expected. Lack of incentive to work coupled with a hostile environment collapsed standard of living to an extent that survival rates were one in four or lower. Moreover, lack of compliance with the rules was met with torture or death.

It took more than 10 years before the social design was altered significantly toward representative government and respect for property rights.

Perhaps it was this authoritarian beginning that subsequently shaped Virginia into the most outspoken champions of liberty among the states.

Wednesday, February 22, 2012

United State of Fascism

I'll move myself and my family aside
If we happen to be left half alive
I'll get all my papers and smile at the sky
Though I know that the hypnotized never lie
--The Who

During a recent campaign speech, Ron Paul suggested that the United States increasingly resembles a fascist state. Fascism is a political structure that itself can be characterized by a number of 'isms' such as:

Corporatism - dominant influence of special interest groups in government action.

Militarism - use of force both inside and outside the country to enact national objectives, including occupation of ground in other sovereign states.

Nationalism - subservience of the interests of the individual in favor of the interest of interests of the nation, often expressed as 'patriotism.'

Exceptionalism - belief that the country is uniquely gifted and plays a supervisory role in the affairs of other sovereign states.

Welfarism - forced reallocation of economic resources by government in the name of 'equality' or 'fairness' which commonly creates dependency among those who receive distributions.

There can be little doubt that behavior has been intensifying in each of these areas for many years in the United States.

Lew Rockwell notes that fascism was an outcome of the Progressive movement. One of the early fascist regimes was enacted in Italy under Mussolini. By the early 1930s, Mussolini's brand of fascism won broad support worldwide. New Deal programs such as the NRA were patterned directly from Mussolini's government-controlled verticals.

Indeed, the 1930s can be viewed as the decade during which fascist regimes sprouted round the world. Italy (Mussolini), US (Roosevelt), Russia (Stalin), Germany (Hitler). Hindsight suggests that betting on subsequent world war was one of the easiest wagers in history.

I do have to disagree with Lew Rockwell on one point. During the video interview (about 4:20), Lew compares fascism with socialism, implying that socialism is also political ideology. It is not. Socialism is a design for economic organization grounded in government ownership and/or control of productive capacity.

All fascist regimes employ socialistic economic systems. This of course was one of Hayek's primary messages in his 1944 work. Enact socialist policies and head down the road to serfdom, a serfdom that could easily be expressed under a fascist regime.

Tuesday, February 21, 2012

Active Rest

I close my eyes
Oh god I think I'm falling
Out of the sky, I close my eyes
Heaven help me

One of my more active mkt days in a while. Began position in gold miners (GDX). Am sensing that miners may (finally) be in for a period of outperformance vs the metal. I like the group's oversold position here vs the tape in general and w.r.t. bullion. Should we indeed get another inflationary lift here, then prospects for this group seem favorable.

Also took a trading position in oil services (BHI). Services have lagged crude and the producers during the recent run up.

Sold down some commodity ETF positions after another gappy move in crude (9 month high) and gold. DBC and SLV are off the sheets.

Also added a slab to my index equity short position. I know...seems ill-advised in this trending tape but once again sensing that a trend reversal may be close. Today, for example, the tape seemed to sag once the Greek bailout news soaked in a bit.

Am once again net short by a few percent.

positions in GDX, BHI, SH

Greeks Like a SIV

To the heart and mind
Ignorance is kind
There's no comfort in the truth
Pain is that all you'll find

By today's Greece bailout actions, Peter Atwater suggests that EU leaders have 'all but guaranteed themselves a Lehman moment' if a second country should hit the skids.

His rationale is that the Greek bailout package resembles a special investment vehicle (SIV) structure reminiscent of the heady days of structured finance. The Greek SIV essentially seeks to slice and dice Greek tax receipts among various classes of public and private creditors.

As he examines the financial engineering plan, Atwater sees 'ghosts of crises past.' What makes the Greece situation unique is that investors have been placed into this 'sovereign SIV' retroactively. Henceforth, private holders of troubled sovereign debt have to realize that they too are likely to be forced into a SIV-like arrangement should things turn ugly. The moment the issue becomes potential loss of capital and who gets what haircut, then bondholders are likely to flee together.

Policymakers have created far greater likelihood of binary behavior in Euro sovereign debt markets.

Monday, February 20, 2012

The Ultimate Matrix

"Unfortunately, no one can be told what the Matrix is. You have to see it for yourself."
--Morpheus (The Matrix)

I wonder whether fiat money might not be the ultimate 'Matrix' of our times. After all, most people equate a stack of dolars with a stack of wealth. And it may very well be wealth to those who can get their hands on that pile of paper early enough in the game when there is still some value to be had.

But that is the problem with fiat money. Its wealth properties are transitory. 'First users' can lay claim on relatively high amounts of resources. But those who hold fiat currency for prolonged periods of time, or those who take ownership of paper currency late in the cycle, are able to claim far fewer resources.

The process is slow enough that the 'late users' do not realize that they are being robbed. Meanwhile, oceans of paper printed by the govt create the illusion of prosperity as the silent transfer of wealth takes place.

Quite the ingenious invention of the State, really, when you think about it.

Sunday, February 19, 2012

Inflation Ebb and Flow

Here by the sea and sand
Nothing ever goes as planned
--The Who

One argument against Big Inflation from here is that if inflation expections do indeed pick up, then bonds will be sold and yields will rocket. This should be true even at current central bank buy rate, which may be in the neighborhood of 70% of new issues.

Higher rates will fracture the economy. As economy sags, asset prices decline. And more deleveraging follows.

As such, seems like ebb and flow of inflationary expectations. Every time they ebb, upward pressures met w/ deflationary counter force.

This should continue until significant deleveraging takes place. We've hardly started this process.

If this thesis is valid, then general trend of asset prices should be lower, altho not in a straight line.

Saturday, February 18, 2012

The Inflation Narcotic

Doctor please, some more of these
Outside the door, she took four more
What a drag it is getting old
--Rolling Stones

Russell has it right. Inflation is a political method of avoiding economic pain--pain that comes from living beyond one's means for excessive periods of time.

The pain takes the form of austerity. Living below one's means to in order to reduce debt. Because people prefer pleasure to pain, austerity is undesirable.

Thus people create political institutions that administer drugs that avoid the pain. The narcotic of choice is inflation.

As Russell notes, we have been on this drug for a long time. But how much longer can we medicate? It seemed that we were hitting bottom last year. But recent coordinated central bank inflations suggest that another round of drugs may be doing the trick once again.

As with the addict, however, each new round requires a larger fix than before--for lesser and lesser effect.

If we do not voluntarily get off the drug, then two endgames dance with each other on the spectral floor of chance: a) hyperinflationary overdose from too big of a fix b) deflationary withdrawal when drug providers refuse to provide another fix.

Friday, February 17, 2012

Government Sponsored Externalities

Col Isaac Johnson: Do we allow America to be ruled by thugs?
Bobby Lee Swagger: Sure, some years we do.

While wrapping my head around externalities recently, a related thought struck me that seemed appropriate for a later post. This video reminded me to follow up. It also testifies that my follow-up thought is not very original.

Externalities are often linked exclusively with free market behavior, which supposedly justifies intervention by government to reduce mitigate spillover costs. By extension, one would be led to believe that in socialistic systems, externalities would not exist--or at least be greatly reduced.

This seems highly unlikely. The reason is that government can be seen as an externality-creating machine. Nearly everything government does is a forceful intervention on the behavior of people. This intervention nearly always benefits some entity at the expense of others. A socialist economic system where bureaucrats allocate resources by discretionary will do similar--i.e., satisfy the needs of some at the expense of others.

As the person in the video notes, the profit-seeking motive of market systems is likely to address externalities more effectively than the vote-seeking motive of politicians. This is because the profit-seeking motive is driven to allocate scarce economic resources to best satisfy the needs of consumers. The vote-seeking motive, on the other hand, is driven to allocate scarce economic resources to best satisfy the needs of special interest groups.

Under which situation is standard of living likely to be higher?

SPX1360 is Here

"The Americans are here!"
--Col Felix Cortez (Clear and Present Danger)

We've been opining that this rally had 'room' to 1360 we are. This level equals the high off the early 2009 lows marked last summer. It is from the 1360 level that bottom fell out last summer.

Will be watching to see how prices act around these levels. In a vacuum, hard to construe the back and fill motion here as anything but bullish. A break higher suggest SPX 1430ish as next significant layer of resistance.

Before you load up long, let me disclosue that I had a similar bullish sense last summer at these levels before the late summer swoon began...

position in SPX

Thursday, February 16, 2012

Zen and Deflation

"Man who catch fly with chopstick accomplish anything."
--Miyagi (The Karate Kid)

Straightforward article that offers a zen-like conclusion: If you fear deflation, then stop inflating.


Wednesday, February 15, 2012

Austrian Business Cycle Theory

Shake my fist, knock on wood
I've got it bad, and I've got it good
--Robert Palmer

While observing the newly created Federal Reserve beginning its first real inflation following WWI, Mises began a series of essays to explain the repercussions of central bank intervention into the money and credit markets. Those essays continued thru the 20s boom and 30s bust.

His work, subsequently packaged into a book called The Causes of the Economic Crisis, presciently forecast the Great Depression. It provides the framework for what is commonly referred to as Austrian Business Cycle Theory.

It's simple, really. Holding interest rates below market induces an artificial boom. People take more risk than they otherwise would. At some point, it becomes apparent that many projects undertaken with artificially cheap funds will not pay off, which sets in motion a deflationary bust.

This is why it is likely that those folks who have recently jumped on 'the economy is recovering' bandwagon will likely be disappointed. We keep adding more waves of spending and debt creation to a system that has already been distorted by past waves of spending and debt. Market forces want to clear the system, but no one wants to feel the pain.

Any further upside that is realized here is like the additional fix for the addict. Temporary reprieve from an escalating pathology.

Sooner, rather than later, we will be back in the same predicament--only with more distance between us and bottom.

position in SPX

Monday, February 13, 2012

Top Crony

If he makes you feel like a million dollar bill
Say oh, oh, say oh, oh
--Whitney Houston

This article argues that Warren Buffett's current successes are more about his political genius than his investment genius. We have positing such on these pages for some time. Nice rundown of his crony activities from end of Bush into the Obama administration.

Do the math yourself, but appears to me that Berkshire was direct or indirect recipient of 12 figure size in government support during the credit market meltdown, from which his firm easily cleared 11 figure size in profits.

And, as the article points out, WB is not done working his political connections.

Warren Buffett, political entrepreneur.

Live and Let Die

Bittersweet memories
That is all I'm taking with me
So goodbye. Please don't cry
We both know I'm not what you need
--Whitney Houston

Am certainly in Dr J's camp currently. We have indeed seen this movie before, it seems. And history suggests that the more uncomfortable it feels to be bearish, the more likely we are approaching a signficant trend change.

Doesn't mean they can't scream higher from here. But as John notes, history tells us that in set ups like this, investors will generally have trouble holding onto these gains.

position in SPX

Sunday, February 12, 2012

Health Care Tyranny

"I don't trust discipline. I know, at that crucial moment, I'd cop out."
--Rachel Marron (The Bodyguard)

On cue from yesterday's missive, Dan Mitchell observes that issues with the health care mandate go far beyond violating beliefs of religious organizations. The administration's shifting of contraception costs from religious organizations to insurance companies is a diversion "that everyone with an IQ above room temperature a meaningless cosmetic change."

Health care markets, he notes, have been distorted foryears by govt interventions. These interventions have served to price many consumers out of the market. Interventions have also quelled innovation and productivity improvement.

The path to cheaper health care for all is for government to leave the market so that the distortions can be ironed out by market forces.

Instead, we follow a different path. One that leads to loss of freedom, and tyranny over health care choice.

Shorts Uninterested

How will I know?
(Don't trust your feelings)
How will I know?
--Whitney Houston

After peaking last fall at multi-year highs, NYSE short interest has collapsed to multi-year lows. The only time it has been this low over the past coupla yrs was, yep, the deja vu period last spring.

You can see from the chart that low short interest is not a good predictor of near term trend reversals. But it is a data point in support that this rally is in its late stage and that there's a fade trade on the horizon.

position in SPX

Saturday, February 11, 2012

Getting Religion?

Archbishop of NYC: Officially, the church won't take any position on the religious implications of these phenomena. Personally, Lenny, I think it's a sign from God, but don't quote me on that.
Dr Peter Venkman: I think that's a smart move, Mike.

Two weeks after mandating that Catholic organizations would not get an exemption from requiring employees to pay for contraception, the Obama administration reversed course. Instead, insurance companies will be required to provide 'free' contraceptives to employees who ask.

While Catholic organizations might congratulate themselves for sidestepping some direct costs, the ruling does nothing to address the constitutional issue. The opening phrase of First Amendment reads:

"Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof."

Exempting Catholic organizations clearly does not make the ruling constitutional. Pro-life Catholic managers and shareholders of insurance companies are still being forced to provide contraceptives to their customers. And, of course, these 'free' contraceptives are ultimately being funded by taxpayers, many of whom will be forced to part with economic resources to fund programs against their religious beliefs as well.

btw, Catholic organizations are being hypocritical if they bless this current ruling yet do not object to government forcing others of Catholic faith to comply.

The abortion/contraception issue is but one aspect of health-care-by-government-force that is so very against the Constitution and natural law. Authoritarian health care follows a path to squalor rather than to utopia.

Friday, February 10, 2012

Freedom Watch Cancelled

He said shut up, he said shut up
Oh god, can't you keep it down?
Voices carry
--Til Tuesday

Viewers of Freedom Watch know that Judge N blasts the Big Govt Right as much as the Left. It appears the Right leaning Fox could no longer take it. Yesterday, the network announced that it was cancelling Freedom Watch.

Freedom Watch is the only nightly show dedicated to Constitutional liberty on Big Media. It would be a shame to dump it.

Tom Woods notes that ratings were good for the show, which airs in the competitive 8-9 pm prime time slot. He includes some email addresses and links to some petitions. Take action if you're so inclined.

Have to think that old school Republicans see the Judge similar to Ron Paul--a divisive threat to the party in a presidential election year. As we noted two years back, there would come a time when the Big Right would quit riding the Tea Party's coat tails.

That time is now.

Thursday, February 9, 2012

Buffett's Gold Bubble

Help I'm stepping into the twilight zone
Place is a madhouse, feels like being cloned
My beacon's been moved under moon and star
Where am I to go now that I've gone too far?
--Golden Earring

In a preview of his annual letter to Berkshire Hathaway shareholders to appear in FORTUNE, Warren Buffett disses bonds and gold in favor of stocks. He suggests that gold's huge rise over the past 10 years resembles bubble like proportions. As in the past, he refers to gold as a 'non-productive' asset. It pays no dividend. It does no work.

Very true. But what he does not address is gold's function in since the beginning of economic exchange as a store of value. Buffett goes to some length seeking to demonstrate gold's overvalued nature versus 'productive' assets such as cropland and Exxon (XOM). But gold's value is not, as Adam Smith called it, 'value in use.' Gold's value is tied up in 'value in exchange.'

Buffett says that he would rather have all of US cropland +16 Exxons + $1 trillion USD rather than the total world's supply of gold (currently worth about $9.6 trillion). Stated differently, gold seems overvalued to him.

To others, of course, the opposite seems true. If all the gold in the world can buy only 16 large oil companies and one country's worth of crop land, then there is not enough gold in the world to pay for all other productive assets in the world.

Stated differently, perhaps US cropland and XOM are over valued. There are good arguments to be made here, with the market cap of XOM north of $400 billion. If this is indeed the case, then either the price of productive assets needs to come down, or the price and/or quantity of gold must go up.

One other point is that 'productive assets' like those represented by stocks require capital. But in today's debt-laden world, where more and more resources must be allocated toward debt service, real capital available for productive investment is vanishing.

Capital has been consumed rather than saved.

Printing paper money will not alleviate this capital shortage. With less capital, productive assets cannot function fully. If productive assets cannot function fully, then their value declines.

Then perhaps gold will be worth US, EU, and South American farmland, and 300 Exxons.

position in gold, agriculture, SPX

Wednesday, February 8, 2012

Bulls Rush In

Fools rush in
Where angels fear to tread
--Elvis Presley

Toddo notes a couple more big name pundits jumping into the bull side of the boat, which is already getting crowded. One of those is Nouriel Roubini, affectionately known as Dr Doom for his prognostications related to the housing bubble.

Perhaps Dr Doom is now Dr Bloom.

Hey, he may be correct. But like Toddo, my contrarian antennae are starting to get pretty active.

position in SPX

Tuesday, February 7, 2012

Been There, Done That

"For all of my career, I've been trying to catch people after they do something horrible. For once in my life, I'd like to catch somebody BEFORE they do something horrible, all right. Can you understand that?"
--Doug Carlin (Deja Vu)

Yes, I recognize the deja vu. About one year ago I began reallocating assets to reflect a more inflationary posture. That posture lasted only a few months. Last summer's debt ceiling debate coupled with the EU debacle squelched my incremental inflationary expectations, and I peeled off risk positions in favor of a more balanced posture.

Fast forward to now. Once again I find myself adding long exposure in lieu of a tape that seems to be taking the Fed's "0% till 2014" promise to heart.

Will this action once again prove temporary in a world that's drowning in a debt bubble that wants to deflate? Not sure, but currently my actions need to express a perceived uptick in the odds of Big Inflation on the horizon.

position in SPX

Monday, February 6, 2012

Jefferson and Judicial Review

Cromwell: I have evidence that Sir Thomas, when he was a judge, accepted bribes.
Duke of Norfolk: What? Goddammit, he was the only judge since Cato who didn't accept bribes! When was there last a Chancellor whose possessions after three years in office totalled one hundred pounds and a gold chain?
--A Man for All Seasons

Interesting talk by Tom DiLorenzo on how the Constitution has been dismanteled over the years. I found the real nugget of this discussion at ~21 minutes on the legitimacy of judicial review.

Judicial review is a principle established from the Marbury v. Madison ruling. It states that the Supreme Court has the power to determine whether a law is constitutional or not. This ruling is typically held up among freedom lovers as wholly consistent with natural law.

Apparently, Thomas Jefferson did not see it that way. Citing an 1819 letter, DiLorenzo notes that Jefferson discounted the Supreme Court's claim of judicial review. Jefferson did not view the Supreme Court's opinion of constitutionality as any more legitimate than that of the legislative or executive branch. Or of the people in the states.

Jefferson viewed the Tenth Amendment as the cornerstone of the Constitution. The Tenth Amendment states that all powers not expressly delegated to the federal government are retained by the people and the states. DiLorenzo suggests that the Jeffersonian view was that it was insanity to rest the interpretation of law on the shoulders of 5 lawyers given lifetime high court appointments. Would the colonists fight a bloody revolution only to put the fate of liberty in the hands of five tenured people on the high court? Particularly when it was well known that courts throughout history had proven themselves generally incapable of remaining disinterested judges of the law?

This is an OUTSTANDING observation. I have long considered the framers' 'assumption' that the high court would provide a last and durable line of defense for the Constitution's limited government design as deeply flawed--with benefit of hindsight, of course.

But perhaps this is because that was not the framers' assumption at all. The Constitution itself does not grant the Supremene Court power to interpret constitutionality. The opinion of chief justice John Marshall (who subsequently demonstrated in his rulings to be partial to the Hamiltonian big government view) in Marbury v. Madison did that.

It can certainly be construed from the Constitution as written that all stakeholders had jurisdiction on what constituted constitutionality (!). And if people in various states felt that law was being unjustly interpreted by the federal government, then it was their right to walk away from the union.

Rather than depending on an interested court, which history suggested would be likely at some point, the people would retain the ultimate power themselves.

Yes, indeed.

Sunday, February 5, 2012

Progressive Income Tax: Unequal Treatment Under the Law

"Hope is a good thing, perhaps the best of things. And no good thing ever dies."
--Andy Dufresne (Shawshank Redemption)

Nice review of the history of progressive income tax in US. As the article notes, the founders entirely rejected the notion of income tax, as they had just fought a war in part to end a tax holocaust with Britain. The framers clearly saw taxes in light of uniformity (Article 1/ Section 8), later to be reinforced by the Fourteenth Amendment with the notion of equal protection of citizens.

We can be certain that the founders would not approve of today's progressive income tax--one specifying that the more you earn, the more you pay.

During the first 130 years following the Constitution, the federal government complied with the founding principles of uniformity and equal protection--with two exceptions. Lincoln instituted a progressive income tax to help pay for the Civil War. This was repealed in 1872.

The other exception was news to me. Congress passed an income tax law in 1994 aimed at the top 2 percent of all wealth holders. Subsequently, the Supreme Court put this law down as unconstitutional. Justice Stephen Johnson Field penned a prophecy as part of his opinion, stating that even a small progressive income tax "will be but the stepping stone to others, larger and more sweeping, till our political contests will become a war of the poor against the rich."

Marx and Engels (1848) knew this all too well, which is likely why instituting a progressive income tax was near the top of their list of actions necessary to overthrow a free society.

Field's prophecy would get in motion 20 years later with the passage of the Sixteenth Amendment. The progressive income tax opened a major pipeline of resources for use in the market for political favor.

The Sixteenth Amendment stands out as wholly inconsistently with the rest of the Constitutional framework. It violates the principles of equal treatment under the law and due process expressed by the Fifth and Fourteenth Amendments.

It replaces rule of law with discretionary rule of men.

My sincere hope is to witness the repeal of the Sixteenth Amendment in my lifetime. Absent its repeal, my fear is that we will instead engage in civil war in my lifetime.

Saturday, February 4, 2012


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

As we've noted many times on these pages, US (and world) economic systems have been moving away from the free market ideal for some time.

This article notes that our system resembles corporatism. The wording is somewhat unfortunate, because uninformed minds connect corporatism to corporations. As originally put forth, however, corporatism refers to a system where large groups (companes, non-profits, labor groups, environmentalists, etc) uses its size and influence to gain favor from political process.

Stated differently, corporatism is the market for political favor, where special interest groups trade with politicians.

Corporatism is only possible when the scope of government extends into wealth redistribution (socialism). Otherwise, SIGs would have no incentive to trade.

Want to stop corporatism? Then eliminate government's ability to forcibly control economic resources.

This article also points out that concentration of wealth increases under corporatism. SIG who can buy political favor get richer off the backs of others.

Friday, February 3, 2012

The Economic Establishment and Gold

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

The University of Chicago recently surveyed economists at big name institutions about their views on a gold standard. Specifically, they asked whether a gold standard would promote better price stability and employment outcomes for average Americans.

Out of 40 respondents, 100% said no.

Not sure why I should have expected anything different from the economic establishment, but I must confess that these findings raised an eyebrow. Perhaps this was due in part to the novel reporting format, which permits inspection of each respondent's vote and any comments that they included.

First reaction to these findings: time to ratchet up the probability of a total monetary collapse a few more percentage points (assuming there's still room below 100%, of course).

Second reaction to these findings: I don't have nearly enough gold.

position in gold 

Negative Externalities and the Public Domain

Magically bored on a quiet street corner
Free frustration in our minds and our toes
Quiet stormwater, m-m-my generation
Uppers and downers, either way blood flows
--The Who

In our previous discussion of externalities, we observed that negative externalities can be viewed as failures of government rather than as failures of free market operations. Government is the agency charged with enforcing individual property rights in free market systems. If individual property rights were enforced, then it would be difficult for negative externalities to persist in market systems.

Rather than the private sector, it is the public domain that seems a more likely breeding ground for negative externalities. In economic systems that have been socialized to some degree, ownership and control of some productive assets are moved from private to public hands. Private property rights have been outlawed to some extent.

Consider the case of public property. Suppose that chemical runoff from privately owned farms kills fish in a nearby river. The river is public property. Many individuals that use the river may be negatively affected--fishermen, boaters, etc. Since none of these people owns the river and its contents, however, they have no direct claim on the damages, and they are in no position to negotiate with the farmers for satisfactory resolution.

It is common for government to represent the collective in pursuing remedies in situations such as this. Unfortunately, the preferences of the individuals in legal negotiations are likely to be varied, while government is likely to pursue a monolithic objective. This implies that some individuals represented in the collective will not realize satisfactory resolution.

Moreover, since individual lack property rights to negotiate solutions that 'internalize' the externalities, the externalities are likely to persist in the face of costly bureaucratic regulatory processes. It is not at all clear that social welfare has been advanced in this case.

Note that this problem largely goes away if public property was privatized. Privatization would put negotiating power in the hands of individuals who could use local knowledge to permit adequate internalization of the negative externalities.

The public domain is also likely to foster negative externalities in public works projects. In the United States, the notion of public works can be traced at least as far back as the Whig's American System, which proposed government-sponsored 'internal improvements' to enhance general welfare. Canals, roads, dams, tree planting, space travel, green energy, et all have all been posited to benefit the general public.

If true, then the beneficial spillovers would make public works projects a case of positive, rather than negative, externalities. Naturally, government officials would like you to believe this to be the case for any program that government is involved with. Indeed, President Obama's state of the union speech last week was full of such claims (here is a critical review of one of these claims related to government and nat gas).

Unfortunately, it is difficult to reason in favor of positive externalities for public works. This is because public works projects are funded by resources forcefully taken from private hands. Obviously, private owners had other plans for those resources, otherwise no government programs would be necessary. While some individuals may certainly benefit from the government project, we know with certainty that other individuals--those who had their capital forcefully expropriated--were harmed.

Moreover, long run spillovers of public works projects may not be positive either. While public works infrastructure such as roads and dams may seem beneficial, what is unknowable is what might have happened if that capital had remained in private hands and been invested using risk/reward heuristics. Quoting Mises (1951):

"The gullible masses who cannot see beyond the immediate range of the physical eyes are enraptured by the marvelous accomplishments of their rulers. They fail to see that they themselves foot the bill and must consequently renounce many satisfactions which they would have enjoyed if the government had spent less for unprofitable projects. They have not the imagination to think of the possibilities that the government has not allowed to come into existence." (655)

There seems little difference between viewing public works projects as negative externalities and viewing those projects as applications of the Bastiat's broken window fallacy (Hazlitt, 1946).


Hazlitt, H. 1946. Economics in one lesson. New York: Harper & Brothers.

Mises, L. 1951. Human action. New Haven: Yale University Press.

Thursday, February 2, 2012

Of Cups and Handles

You can never understand
We can always be like water
Flowing on to find our way
Just get on with the game
It's a game
What a game
--Tarney Spencer Band

Am noticing lots of cup-and-handle patterns in many large cap equity charts. Some of the patterns span a few days while others are multi-month in nature.

Moreover, the action 'feels' bullish. The tape is consistently bid. Weakness is being bought regardless of news.

Feels too risky to be net short here. As such, I've been adding some long side exposure to balance things out. I've been buying some of my fave blue chip names (CSCO, JNJ, PG). Today I added a little commodity exposure via DBC.

To be clear, I'm in 'rent' rather than 'own' mode here. But I want to reposition my near term stance in this bullish tape. I'm now a coupla percent net long.

position in CSCO, DBC, JNJ, PG, SH

Wednesday, February 1, 2012

Drop Zone

When the good times never stay
And the cheap thrills always seem to fade away
When will we fall?
When will we fall down?
--Toad the Wet Sprocket

Nice article detailing bipartisan nature of bailouts in the US. Author notes what anyone with a brain should have picked up during last week's State of the Union address. In one segment President Obama pledged to do 'no bailouts, no handouts,' etc while in another segment he took ownership of the auto bailout and promised more green energy investing.

Consistency, of course, is a characteristic not to be detected in most politicians.

One issue I do have is with the $125 billion estimate for corporate welfare. That number seems waaaay too low. If one factors in systemic interventions that are friendly to corporations, then the $trillions printed by the Fed alone amount to a huge gift to corporations. 

University Endowment Trends

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

This paper is somewhat dated (2008), but it still points out interesting trends in university endowments over a decade or so. Note big difference in endowment size between private (especially Ivy) and public. This really sticks out when examining endowment/student.

Asset allocation shows movement out of fixed income in favor of alternative assets. Some stats (medians):

2005 Overall

n = 726
endowment size = $72 million
return = 9%
AA equity = 59.6%
AA fixed income = 20.4%
AA alternative assets = 7.6%

Interestingly, Ivy League AA in 2005 was 38.1% equity/13.0% fixed income/37.1% asset allocation.

Of course, we now know that those increased allocations toward alternative assets were a source of pain during the credit meltdown of 2008-2009. Many alt investments, particularly illiquid ones, were crushed when bid/ask spreads fell thru the floor.

Still, the attractive characteristic of many alternative assets is that they can be less correlated with other asset classes, which makes them useful for diversification purposes.

position in SPX


Inside, outside
Leave me alone
Inside, outside
Nowhere is home
--The Who

Externalities (a.k.a. external economies or external costs) involve situations where the outcomes of A's activities impact B. These impacts on B, sometimes termed 'spillovers,' are usually regarded as indirect, perhaps even unintentional, outcomes of A's actions.

Spillovers that are beneficial to B are called positive externalities. For example, innovation that creates new products and industries can generate large positive externalities.

Spillovers that are costly to B are called negative externalities. For example, air pollution spewing from a factory smokestack can generate negative externalities for those living in nearby communities.

A complaint often levied against free market designs is that they ignore the problem of negative externalities. Polluting producers, it is posited, are motivated to think narrowly and act myopically in their own self-interest. While their situation improves, those producers harm others.

Early interventions to address this perceived market deficiency involved taxes and regulation intended to penalize or reduce the negative externalities. However, monitoring costs (read: bureaucracy) of these approaches are high, and may even offset the benefits incurred from reduced externalities. Moreover, these interventions bypass the voice of consumers, who in free markets demonstrate thru their buying actions what they truly value. Absent free trade where buyers and sellers can express their preferences thru voluntary exchange, estimating the costs of externalities by fiat is merely guesswork and subject to significant error (Rothbard, 1956).

Coase (1960) theorized that as long as property rights are clearly defined and transaction costs are low, then A and B can privately negotiate a solution that 'internalizes' the externality. Thus, if people living in nearby communities have a property right to 'clean air,' then the factory will have to negotiate with them in order to rightfully discharge waste thru the people's property.

There seems a compelling argument to be made that, rather than a failure of free market designs, cases of negative externalities can be seen as failure of government, whose purpose in a free market system is to enforce individual property rights against subtle forms of invasion. In the case of smoke control, the proper free market remedy is not the creation of a State bureau to prescribe smoke control regs. Rather, the appropriate remedy is judicial action to punish pollution damage to the person and property of others (Rothbard, 1962).

An additional advantage to the 'property rights' solution to negative externalities is that both A and B are motivated to determine ways to reduce the costs, which benefits social welfare over time.

Of course, market pressure alone may limit externalities. Those seeking organic foods, for example, vote with their wallets for produce that does not encourage negative externalities associated with chemical additives. Producers who do not follow the market's signal are penalized with declining trade.


Coase, R.H. 1960. The problem of social cost. Journal of Law and Economics, 3: 1-44.

Rothbard, M.N. 1956. Toward a reconstruction of utility and welfare economics. In M. Sennholz (ed.), On freedom and free enterprise: Essays in honor of Ludwig von Mises. Princeton, N.J.: D. Van Nostrand.

Rothbard, M.N. 1962. Man, economy, & state. Princeton, NJ: D. Van Nostrand.