Tuesday, April 30, 2013

Capitalism and Discrimination

"My old man was so full of hate that he didn't know that bein' poor was what was killin' him."
--Agent Rupert Anderson (Mississippi Burning)

Some people do not like capitalism because of the profit motive. Businesses "are only in it to make money," they say.

Many of these same people support legislation that prevents business from discriminating against people of a particular race, point of origin, sexual orientation, etc.

Can these people not see that these two positions are incompatible?

A business cannot be both "only in it to make money" and discriminatory at the same time. A business that refuses to serve people because of, say, their skin color, leaves money on the table. Such a business is clearly not driven solely by the profit motive.

In a capitalistic system a business that does discriminate loses receipts to competitors who choose not to discriminate. Discrimination is thus an expensive endeavor that weakens competitive advantage and, given enough time, is bound to put bigots out of business in unhampered markets.

Discrimination can only flourish in markets that are hampered. For example, regulations and other laws raise barriers to entry that impede entrepreneurs from competing away bigotry. As markets become more free, discrimination declines.

Capitalism, driven by the profit motive, is a bigot's nightmare.

Monday, April 29, 2013

Market Structure and Flash Crashes

So I guess the fortune teller's right
I should have seen just what was there
And not some holy light
--Natalie Imbruglia

Last week someone hacked into the Associated Press Twitter account and tweeted that the White House had been bombed. In less than a minute, the S&P sank about 20 handles before snapping back after the fake tweet was refuted.

Punctuated by the May 2010 'flash crash,' the phenomenon of big, sometimes sudden downdrafts are becoming notewothy in indexes and individual issues alike.

Rick Santelli et al discuss them in light of how market structure has evolved over the past decade or so. Previously, markets were dominated by a few high volume exchanges that attracted huge numbers of buyers and sellers. Today that concentrated model has been replaced by a fragmented model where many smaller exchanges operate in a satellite configuration with fewer buyers and sellers populating each exchange.

On the surface, the previous concentrated exchange model seems superior from a liquidity standpoint. Because it attracted many buyers and sellers, the concentrated exchange structure provided 'deep pools' of buyers and sellers seemingly capable of absorbing large waves of selling during times of market stress. Conversely, the 'shallow pools' of the fragmented model seem less capable of absorbing big supply.

However, the concentrated-to-fragmented evolution in market structure cannot satisfactorily explain the increasing flash crash phenomenon. If buyers in a particular satellite market complete dried up and prices began plummeting in a 'bid wanted'-like situation, then modern arbitragers electronically scanning the various exchanges for mispricings will quickly seize the opportunity and operate to close the price gap between one market and the others.

In fact, it could be argued that fragmented markets reduce the risk of flash crashes in the sense that the behavior of buyers and sellers is less correlated--at least in the very short term. Because the price action can vary between exchanges and arbs can diminish price gaps that theoretically shouldn't exist, then the fragmented exchange model should be more resistant to 'bid wanted' downdrafts.

Other structural factors are likely in play. We'll consider some more in a future post.

position in SPX

Sunday, April 28, 2013

Student Loans

Interviewer: What you've got is college experience. Not the practical, hard-nosed business experience we're looking for. If you'd joined our training program out of high school, you'd be qualified for this job by now.
Brantley Foster: Then why did I go to college?
Interviewer: You had fun, didn't you?
--The Secret of My Success

The escalating student loan situation exemplifies what occurs when government meddles in markets. Such government intervention may be motivated by good intentions, i.e., "more people should be afforded a college education."

But good intentions do not justify the use of force to enact a program. In this case, resources in private hands earmarked for other uses have been confiscated by government in order to fund student loans.

Moreover, getting more people into college necessarily requires lowering barriers to matriculation. This is primarily accomplished by government sponsored loan programs that make it easier for students to borrow.

College enrollment is therefore subsidized. From ECON 101, we know that when behavior is subsidized we will get more of it. Demand enters the market. This pushes tuition prices higher. It crowds the classrooms and reduces teacher:student ratios and encourages colleges to add capacity.

It also results in a glut of college graduates. The market cannot absorb the oversupply except at lower prices. Lower prices mean lower salaries for college grads. Lower salaries mean less income that can be applied toward paying back student loans.

Sadly, this situation was predictable up front. Similar to its outcomes in other aspects of welfare and warfare, central planning in college education has grossly mis-allocated resources in a manner that stunts standard of living.

Saturday, April 27, 2013

Liberty is Peace

Always searching for the real thing
Living like it's far away
--Michael McDonald

Forty years ago Floyd 'Baldy' Harper died suddenly of a heart attack. Harper was a standard bearer for liberty, always looking for ways to advance understanding of freedom.

Liberty, said Harper, is "the absence of coercion of a human being by any other human being."

Stated simply, liberty is peace.

Friday, April 26, 2013

Slanting the Reinhart and Rogoff Error

"You'll be happy to know that stupidity is not hereditary. You acquired it all by yourselves."
--Margaret Garrison (Deadline U.S.A)

During the reporting of the Boston bombing, I heard one pundit state that we should consume media info using 'the 75% rule', meaning that media consumers should assume that only 75% of what is presented about a breaking story is actually true.

For many stories, it seems like 75% is far too generous.

Take, for example, reports surrounding the error in the Reinhart and Rogoff (RR) research about the relationship between sovereign debt and economic growth. A central finding of RR's work, work that we have considered a number of times on these pages, is that higher debt is associated with longer term economic growth. At some point, the debt becomes insurmountable and generally leads to default either directly or via inflation.

That these findings should be considered surprising suggests how far off the rails from basic economic understanding that we have travelled. Nevertheless, it took a multi-century empirical study of debt escalations and economic collapses by high profile researchers to bolster the legitimacy of basic ECON 101 findings in the eyes of some.

Last week three academics from UMass produced a working paper claiming significant errors in the analysis of two RR working papers from 2010. Note the term 'working paper,' meaning that all three of the works--the two RR papers and the UMass critique, should be considered to be works in progress and have not been published in any peer reviewed outlet to date.

That said, it does appear that some of the findings from the two RR working papers have spilled into some work that has been published. See, for example, Reinhart & Rogoff (2011) and Reinhart, Reinhart & Rogoff (2012).

Now, calling out researchers on their findings is a serious matter that cannot be dismissed. RR must answer to those charges and they have indicated that they will.

However, challenges w.r.t. the magnitude of RR's empirical results do not alter the underlying theoretical framework. Higher debt is associated with lower economic growth. As demonstrated here, RR results adjusted for the UMass observations do not alter the negative relationship between debt and growth--something that the UMass researchers, despite the title of their paper, do not seriously contest.

The disagreements between these academics will be resolved over time via the traditional back and forth process. That is the power of formal, written thought process for advancing the truth.

Unfortunately, the media do not follow such a process. As observed in this missive, the media have once again revealed their bias in the way they have treated this story. The sensationalistic headlines speak for themselves. For example:

LA Times: How an Excel error fueled panic over the national debt
Business Week: The Excel error that changed history

Responsible journalists would have a) waited for the full RR rejoinder, and/or b) considered the UMass claims in light of materially altering the implications of the original RR study before writing. Instead, many media outlets have engaged in slanting the UMass study in a manner that can easily be construed as agenda driven.

It is straightforward to conclude that many in the media do not like the idea that government spending and debt constrain growth, and that journalists are jumping at an opportunity to discredit the idea.

This morning I heard a 'financial expert' suggested that the UMass study gives government greater license to spend our way out of problems.

Rather than offering well thought perspective about the merits of such a suggestion, the media's recent efforts appear to endorse it.


Reinhart, C.M. & Rogoff, K.S. 2011. From financial crash to debt crisis. American Economic Review, 101: 1676-1706.

Reinhart, C.M., Reinhart, V.R., & Rogoff, K.S. 2012. Public debt overhangs: Advanced economy episodes since 1800. Journal of Economic Perspectives, 26(3): 69-86.

Thursday, April 25, 2013

Public Safety Exception

I have spoke with the tongue of angels
I have held the hand of the devil
It was warm in the night
I was cold as a stone

Near the bottom of this piece, Judge Nap explains the rationale of the public safety exception to the Miranda warning. It permits arresting officers who perceive imminent danger in the arresting environment to ask questions like "Where is the gun?" in an effort to protect themselves prior to securing suspects and reading them their rights.

Properly executed, the public safety exception is fleeting and temporary--meant to last until the arresting environment is secure.

In the case of Boston bombing suspect number two, the US attorney general advised told FBI agents to pretend that threats to public safety still existed even after the arrest was made local government officials sounded the all clear. Officials began questioning the suspect, who had yet to receive his Miranda warning, in the hospital days after his arrest.

Such behavior is clearly unconstitutional. As the judge observes, it wholly consistent with government tendency to appropriate freedom during times of crisis.

This tendency is as progressive as government appetite for power is insatiable.

Wednesday, April 24, 2013

Why Saving Matters More than Consumption

These changing years
They add to your confusion
And you need to hear
The time that told the truth
--Level 42

Nice little video explaining why it is saving, not consumption, that creates a vibrant economy over time. Yes, standard of living is higher when consumption increases. But consumption cannot occur unless goods are first produced. And production cannot significantly increase unless investments are made to improve productivity (more output per hour of labor).

Investment can only come from some fraction of production is set aside and is not consumed. The example shown in the video is that people who are making productivity-enhancing tools cannot simultaneously produce food to eat. Thus food must be set aside to feed the workers who are making the tools.

If such resources are not set aside (saved), then productivity and standard of living cannot be improved.

When savings decline, capital is consumed. Capital consumption is akin to killing the goose that lays the golden eggs.

Tuesday, April 23, 2013

Doubling Down at Barron's

So glad we've almost made it
So sad they had to fade it
--Tears for Fears

Barron's is doubling down on its recent contribution to the cover story indicator phenomenon with a new cover suggesting that Dow 16,000 is within our grasp (the Dow currently trades at ~14,500).

The most recent Barron's Big Money Poll found 74% of money managers identifying themselves as bullish or very bullish, a record for the poll that dates back more than 20 yrs. These findings are consistent with my reading on sentiment among professionals at the RISE conference a few weeks back.

John Hussman demonstrates the contrarian nature of cover indicator, with major market prognostications glancing Barron's cover near major market tops.

Dr J also suggests that the resolution to this will be a broad 'forced liquidation,' as leveraged market participants sell indiscriminantly when prices move against them, resulting in a cascade lower. He suggests that the action in gold last week is a harbinger for what awaits the broader market (something we have mused about as well).

Deflationary, should it occur...

position in SPX

Monday, April 22, 2013

Divergence Between Paper and Physical Metal

There's something happening here
What it is ain't exactly clear
--Buffalo Springfield

Wanted to record observations that, after last week's meltdown in the paper precious metal markets, we have seen little change in physical metal prices--particularly silver. Some of the data points include:

Big demand surge in Asia. Retailers report months' worth of business done in a day or two last week. On Ask Fleck, a retail customer in Hong Kong reports: "The guy in front of me bought over $1 million USD in gold. He paid in cash and walked out of the door with the bullion in a Nike bag."

Prices of $10 face rolls of 1964 Kennedy halves (a favorite 'junk silver' denomination) on ebay have fallen about $10, from $250-$255/roll down to ~$240/roll, despite a ~20% decline in spot silver. Premiums between spot and Kennedy rolls have thus increased rather than decreased.

Apmex and other precious metal dealers are nearly sold out of silver bullion products. One dealer calls the current physical silver market 'ugly.'

Even high end coin dealers such as Legend Numismatics report very little decline in bid/ask on common old gold like as 'generic' ms66 Saints.

The data suggest a growing divergence between paper and physical markets. Lower prices are bringing out buyers for physical, which is what ECON 101 would suggest. The paper metals markets are dominated by leverage and subject to being pushed around, meaning that they are not subject to the same economic laws--at least in the near term.

Can't help but wonder whether we get a price flip at some point. The paper markets collapse as people lose confidence in the ability of the futures markets to make good on underlying physical metal. Investors subsequently pile into the physical market.

In such a case, bids for paper gold will be near zero; bids for physical gold will be, um, large.

position in gold, silver

Miranda Warning

Will Roper: So, now you give the Devil the benefit of the law!
Sir Thomas More: Yes, what would you do? Cut a great road through the law to get at the Devil?
Will Roper: Yes, I'd cut down every law in England to do that!
Sir Thomas More: Oh? And when the last law was down, and the Devil turned 'round on you, where would you hide, Roper, the laws all being flat?
--A Man for All Seasons

Even before Boston Marathon bomber 'suspect number two' was taken into custody Friday evening, the media were already chirping that, if the suspect were taken alive, then his 'Miranda warning' would likely be omitted. The Miranda warning is the legal requirement that people being arrested must be clearly formed about their rights under the Fifth and Sixth Amendments.

The justification for not reading this person his Miranda rights is the 'public safety exception,' which is another variation of the notion that extreme situations call for extreme measures.

Stated differently, when the going gets tough, the rule of law that protects freedom should be suspended in favor of discretionary rule that reduces freedom--even if the freedom that is reduced applies to a single individual who is suspected of a crime.

But it is precisely in times of strain that the rule of law must be upheld, because freedom is most likely to be lost when people feel threatened and emotion trumps reason.

No matter what rancor a person might hold toward this individual, no matter what threat this person's connections still may be to others, there is no legitimate justification for stripping this person of his rights.

Sunday, April 21, 2013

Can Security Persist in a Police State?

We can go where we want to
A place they will never find
And we can act if we come from out of this world
Leave the real one far behind
--Men Without Hats

These pictures of Boston during last week's lockdown after the Marathon bombing provide a sense of what happens when we trade freedom for security. We are more safe when we stay inside while gun-toting agents patrol the streets the around us. But such a police state leaves us less free.

The same is true economically. People can become more economically secure when resources are taken from some for the benefit of others. But enhancing economic security compromises freedom.

It is questionable whether security obtained at the expense of freedom can persist in the long run. When people are less free, actions to improve and innovate are restrained. Productivity, defined as the amount of output per unit of input, under such conditions is unlikely to advance. As population grows, the amount of wealth per capita is likely to decline at some point, leaving fewer economic resources to spread around in the name of social or economic security.

With less resources to spread around, security is likely decline over time--even in a police state.

Saturday, April 20, 2013

Don't Make Assumptions

"You assumed!"
--Anthony Judson Lawrence (The Young Philadelphians)

The first agreement was be impeccable with your word. The second agreement was don't take anything personally. The third agreement is don't make assumptions.

We assume that we know what others are thinking and doing. The problem with doing so is that we believe that these assumptions are true. Assuming that assumptions are true is the basis for misunderstanding.

Engaging in idle talk or rumors about the private matters of others, a.k.a. gossip, is a prime environment for assumption-making. When someone tells us about a third person's behavior, we make assumptions about the motives, morality, effectiveness, etc of that third person. We even make assumptions about the truth of the second hand gossip. Through gossip, we form opinions about people that we do not even know.

We often make assumptions because we have made agreements to communicate this way. It can be safer not to ask questions or to seek clarity because we assume others will view us as foolish or excessively critical. Moreover, asking questions and seeking clarity takes time and effort; making assumptions is quicker and easier.

We can also make judgments about ourselves grounded in assumptions. "I will never be a fast runner." "I am a good judge of character." "I am terrible with numbers." These judgments drive us to over- and underestimate ourselves and keep us from being the best that we can be.

One way to keep from making assumptions is to ask questions. Ask questions in order to understand. Also ask clearly to convey wants, rather than trying to maneuver others.

Another way to keep from making assumptions is to gather information first hand, rather than relying on second hand information from others--which is likely chock full of assumptions and error. This has implications for how I consume media.

The more questions I ask, the fewer assumptions I make. The more I seek information from primary sources rather than from secondary sources, the more clearly I understand..

Friday, April 19, 2013

Social Identity Theory

"This is a mistake. We don't belong here. These people are different."
--Eddie Wilson (Eddie and the Cruisers)

Social identity theory, developed principally by Henri Tajfel and John Turner (e.g., Tajfel & Turner, 1979; 1986), offers perspective on social psychology by extending previous work on group identification (Tolman, 1943) and the influence of identification on motivation (Foote, 1951).

The central concept of social identity theory is that people seek out affiliation with groups in order to enhance self-esteem. To do so, people classify themselves into various social categories such as nationality, organizational membership, religion, race, gender, and age cohort. The individual thereby assumes characteristics thought to be possessed by members of the group. Group affiliation provides a sense of oneness or belongingness to some human aggregate.

To further self-esteem, however, individuals must believe that they are in the 'right' group. This creates the need for enhancing the status of the groups to which a person belongs. Social identification is thus relational and comparative (Tajfel & Turner, 1986) because people define themselves relative to individuals considered to belong to other categories.

Self-esteem is increased when individuals elevate the status of their groups ("Our school is great."), and when they lower the status of other groups ("Their school sucks."). Through the process of social categorization, individuals divide the world into "us versus them." In social identity theory, "us" is the "in-group" and "them" is the "out-group."

An implication of social identity theory is that, because of the natural tendency for in-group and out-group categorization, people have an inherent tendency to discriminate. In order to enhance self-esteem, people are likely to discriminate and hold prejudiced views against others deemed to belong to out-groups.


Foote, N.N. 1951. Identification as the basis for a theory of motivation. American Sociological Review, 16: 14-21.

Tajfel, H. & Turner, J.C. 1979. An integrative theory of intergroup conflict. In W.G. Austin & S. Worchel (Eds.), The social psychology of intergroup relations (pp: 33-47). Monterey, CA: Brooks-Cole.

Tajfel, H. & Turner, J.C. 1986. The social identity theory of intergroup behavior. In S. Worchel & W.G. Austin (Eds.), Psychology of intergroup relations (pp: 7-24). Chicago: Nelson-Hall.

Tolman, E.C. 1943. Identification and the post-war world. Journal of Abnormal and Social Psychology, 38: 141-148.

Thursday, April 18, 2013

Changes of Mind Pt 4

"Would you tell me please, Mr Howard, why I should trade one tyrant three thousand miles away for three thousand tyrants one mile away? An elected legislature can trample a man's rights as easily as a king can."
--Benjamin Martin (The Patriot)

Part 1, Part 2, Part 3

Democracy. Prior to my return to the history books, I used to think that America was designed as a democracy. Democracy is a governance system where laws are established by majority vote. But our original design was not a democracy. The US was built as a federal republic.

Much ink has been spilled on these pages that chronicles my mind change w.r.t. democracy. I have come to realize that democracy can threaten liberty because it facilitates discretionary rule rather than the rule of law. Those in the dissenting minority are forced to comply with the wishes of the majority. Law becomes arbitrary, and depends on the whims of whomever can martial the most support. Majority rule is a form of positivism.

Under the auspices of natural law, all individuals are endowed with inalienable rights to life, liberty, and the pursuit of happiness. In this legal system, as Jefferson astutely observed, the inalienable rights of the individual are self-evident and require no vote or approval.

What must be established are the authorities and limitations of government. The authority of government is necessarily limited, lest individual liberty is compromised. Procedures are also established to make the restraints on government difficult to loosen by discretionary vote. The Constitution was the framer's imperfect step in the direction of establishing rule of law rather than discretionary rule by men.

Rather than perfecting the rule of law set forth in the Constitution, we have been rendering it irrelevant as one special interest group battles another in a quest to gain control of central government power via majority vote.

Government. At least as far back as my generation, American students have been taught that the federal government is a benevolent entity. There is little discussion of the 'healthy distrust' of government that shaped the views of those who framed the initial design.

It took me a long time to realize that government is force. This truth is rarely put forth in classroom studies.

Government force is put to valid use when it is employed to help individuals protect their property (broadly construed) from aggression by others.

Government force is illegitimately used when it goes on the offensive--forcefully invading the life, liberty, and property of some for the benefit of others. When it does so, government becomes a strong-armed agent for hire and, as Bastiat astutely observed, society slides down a slope that is difficult to reclimb.

The issues noted in this and the three preceding missives constitute major changes of mind for me over the past 10+ years. Because quest for truth is never-ending, more changes of mind undoubtedly await.

Wednesday, April 17, 2013

Standard of Living is Falling

If I only could
I'd make a deal with God
And I'd get him to swap our places
--Kate Bush

Richard Russell claims that American standard of living has declined since he was a teenager, meaning since the late 1930s/early 1940s. This seems a preposterous claim on the surface. After all, today's Americans live longer and enjoy goods and services that people could not even imagine 70 years ago.

But RR's point is that the average American has to work much more now to enjoy a similarly comfortable lifestyle of someone then. What took a single parent's income then now requires two parent's income + borrowing today.

Families from Russell's era commonly lived off the single breadwinner's current income only. They were reluctant to borrow to extend their lifestyles beyond their production.

Not so with today's families. Even with two parents working, families feel compelled to borrow to make up the difference between their desired lifestyle and the lifestyle defined by current income.

"Debt," Russell observes, "is the modern family's way of keeping up their standard of living." They have "little in the way of savings and a lot in the way of debt."

The implication is that productivity for average Americans is falling, not rising.

Left unrestrained, market forces would be correcting this situation. Consumption would be falling, debt would be paid back, and eventually savings would rise as production and consumption regain balance.

Policymakers, of course, are going all in with a bet that they can circumvent the natural re-balancing effect of market forces and force prosperity from ever more borrowing and consumption.

Russell believes that these policymakers are playing a fool's game. He notes, "It's immoral to create money without working or assuming risk. Real, moral money is a call on someone's labor. The current monetary system is immoral and an outrage. As such, its years are numbered."

Sagely said.

Tuesday, April 16, 2013

Changes of Mind Pt 3

The moon looks mean
And the crew ain't stayin'
There's gonna be some blood
Is what they're all sayin'
--Jay Ferguson

Part 1, Part 2

Intellectual property. It used to be 'obvious' to me that intellectual property (patents, trademarks, copyrights) were truly property and deserved protection under the law. Leonard Read and others have since persuaded me otherwise.

Laws to protect property rights are necessary when property is scarce. Tangible goods fit this requirement. Taking goods from a person denies that person the use of the good. IP does not meet the scarcity requirement. IP can be infinitely reproduced--without denying use of the IP to a claimed 'originator.'

Moreover, ideas that serve as inputs to IP do not have clean title. A new idea is an extension of old ideas. Clearly establishing ownership of a new idea is impossible.

Granting Congress power to grant exclusive rights to ideas is one of the inconsistencies found in the Constitution. When people are granted legal monopolies over ideas, innovation is curtailed and markets are less free.

Sovereign debt. Treasuries and other country bonds were just another asset class to me. The 'safety' of Treasuries made them particularly attractive during times of turmoil.

However, government-issued debt can only be repaid on the backs of citizens. Buyers of government bonds tacitly condone the use of government force to confiscate economic resources from the citizenry so that bondholders can be repaid. Taxpayers who do not like the terms of the deal cannot walk away; they are forced into the arrangement at the point of a gun.

In effect, bondholders are contracting with government agents to shake down its citizens. It is in this way that debt markets resemble slave markets.

I endeavor never to own sovereign debt again.

More to come...

position in Treasuries

Monday, April 15, 2013

Log Periodic Bubbles

Maverick: He's going vertical, so am I.
Goose: We're going ballistic, man!
--Top Gun

Another excellent weekly missive by John Hussman. In this letter (which should be read mult times), he makes many lucid points. Investors have faith in alchemy--of the positive influence of printed pieces of paper (or bits and bytes) on economic performance. Although central banks are trying to create maximum discomfort in owning these printed pieces of paper, that does not change the fact that all of these dollars must be owned by someone.

Meanwhile, discomfort with owning dollars is driving investors in a search for yield. This is bidding up prices of all securities under the sun that generate income. Thus, the bubble is inflating in yield producing securities.

This gets us to the 'new ground' part of Dr J's missive for me. Bubbles hit their apex as dip buyers become increasingly more aggressive. As the bubble builds, every little dip is bought. Buying the dip becomes so frequent that dips disappear into a 'melt up.'

Hussman demonstrates this phenomenon using a 'log periodic bubble' model. Several examples from 1929, oil in 2008, stocks in 2011, and...stocks now. Here is the 1929 model:

What this model demonstrates is the tendency of prices to experience increasingly frequent but shallower dips that culminate into a spike higher at the apex of the up move. Here, btw, is the model corresponding to the stock price action since 2010.

Belief in quantitative easing et al has inspired confidence in buying dips. Mindless yield seeking behavior should produced the type of bubble pattern that is now becoming evident.

As Dr J notes, conditions that have preceded other major market losses are now well in place.

position in SPX, Treasuries

"This is a Giant Ponzi Scheme"

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

Cavuto chats with David Stockman about the state of our current financial system. Stockman has written a new book that is drawing fire from both Left and Right--a sure sign that he is right on track.

We have reflected on Stockman's thoughts on these pages before. His message to Cavuto, who obviously is uncomfortable with what Stockman is saying, is that we've created a gigantic Ponzi scheme built on debt and leverage with little underlying equity.

Central banks reside at the epicenter of the Ponzi which is best expressed currently in the bond market where the Fed is buying $85 billion/month of our own debt with money printed out of thin air.

In his view, a major dislocation awaits us within the next two years. I, of course, wonder if it will not be sooner...

position in SPX, Treasuries

Melting Gold

You got me runnin,' goin' out of my mind
You got me thinkin' that I'm wastin' time
--Electric Light Orchestra

Gold getting crushed again this am. This is what 'forced selling' looks like. Blow ups are undoubtedly occuring; they're carrying folks out on stretchers today.

Personally, I continue to try to use lower prices to my advantage.

A thought going thru my mind is that perhaps gold is signalling a broad deflationary decline ahead. With so much printed money and leverage in the system, however, it is difficult to separate signal from noise in these market movements.

position in SPX, gold

Sunday, April 14, 2013

Changes of Mind Pt 2

"It's my life. Don't you understand, IT'S MY LIFE!"
--Andy Dufresne (The Shawshank Redemption)

Part 1

Death penalty. I used to be a hardcore death row guy. Capital punishment for capital crimes. The argument often offered against the death penalty is that a conviction is never certain. There is a chance, however slight, that an innocent person could be put to death.

True, but the primary issue to me is that execution is a lethal form of aggression. Lethal force applied in self-defense can be justified, but capital punishment is offensive rather than defensive force. Only God has authority to render a death sentence.

Abortion. Growing up, I embraced the Catholic position on abortion. A fetus is a person whose life cannot be arbitrarily taken. I still generally agree with this position.

Moreover, my journey over the past 10 years has informed me that, constitutionally, a baby in the womb has the right to equal protection under the law.

But pregnancy is not a risk-free endeavor for the mother. And in extreme cases such as rape or when an unforeseeable complication threatens the life for the mother, the woman has the right to choose whether to assume the risks of pregnancy or to abort.

One person cannot be forced to take risk for the benefit of another.

This principle, btw, applies to cases beyond abortion as well.

Saturday, April 13, 2013

Smashing Lincoln Myths

Sgt Major John Rawlins: Not sure I'd be wanting this, colonel.
Colonel Robert Gould Shaw: I know exactly how you feel.

Tom DiLorenzo challenges various Lincoln myths, something that we have occasionally done on these pages as well (often with DiLorenzo's help). The myths are put forth in an interview of a 'Lincoln scholar' by a socialist web site.

It should not be surprising that Lincoln's behavior attracts socialists like a magnet. Lincoln embodied the Statist authoritarian figure seen as central to enacting a socialist agenda.

Toward the end of his missive, DiLorenzo connects the dots as to how the 20th century may have been different had Lincoln not 'kept the union together.' American may have remained a constitutional republic rather than becoming a centralized nation state. Capitalism may have prevailed instead of the blend of corporatism and neo-mercantilism that rules the day. Rather than seeking to build a militaristic empire that facilitated world war, the US would have served as a counterexample of peace and freedom to the world.

Many of our problems can be traced back to Lincoln's aggression.

Friday, April 12, 2013

Changes of Mind Pt 1

People talking
They're sayin' that you're leavin'
So unhappy
With the way that you've been livin'
--John Waite

Since 9/11, I have engaged in self study to expand my understanding of liberty. Frankly, prior to 9/11 I hadn't thought much about freedom and I took it for granted. My studies have focused on various areas ranging from comparative analysis of Austrian economics vs other branches of economics to scrutiny of pivotal periods in US history such as the American Revolution and Great Depression.

While the quest for truth is never ending, nuggets unearthed here and there have caused me to change my mind on a number of issues since 2001. Here are some of my changes of mind realized over the past decade or so.

Income taxes. I used to think income taxes for some purposes were valid. For example, levies that supported particular public works such as the zoo, special ed, or senior citizens seemed reasonable. No more. I now realize that when I vote for an income tax, I am partnering with strong armed agents to forcefully take someone else's production. A one time income tax is equivalent to robbery while a routinized tax is akin to slavery. I will never again support a tax on someone else's production; I do not want to be a thief or a slavemaster.

The framers concluded that the only valid direct tax is a head tax (which, btw, is not a flat % of income tax) where all citizens are taxed the same amount (regardless of income, status, etc) to support the necessary functions of government.

War. With rubble of the Towers smoldering behind him, President Bush promised terrorists that pretty soon they would hear from all of us. Eager for retaliation, I cheered. I now know that I was wrong. Emotion got the best of me. While revenge is a common motive for war, it is never a valid one. There is no valid application of offensive force in a free society (a.k.a. the 'nonaggression principle'). The only valid use of force is for purposes of defending oneself against attack from others. When freedom is broadly attacked, then self-defense equates to exercising the natrual right of revolution.

Viewed through this lens, the only valid wars prosecuted by the US government have been the Revolutionary War and War of 1812. The South's response to invasion by the North during the Civil War was also valid, but having seceded from the US, the Confederate government was no longer affiliated with the Federal government. In fact, the US government was the aggressor in this case.

Our military budget could easily be cut by 75% right here. Military expenditures should be limited to honing capacity for self-defense. This means closing all military installations abroad, and concentrating self-defense resources on securing the nation from invasion.

This concentration must be done in a manner that liberty is not compromised. For example, borrowing money to fund defense of freedom is self-defeating, as debt reduces freedom. I now grasp the idiocy of borrowing $trillions over the past ten years to fight wars of aggression in other lands--for the expressed purpose of 'preserving freedom' at home. That freedom has been preserved by fighting these wars is an illusion, as we are certainly less free under the crushing burden of debt that we owe creditors.

Sadly, I am confident that Bin Laden et al foresaw our foolish response while still mapping paths of planes into buildings.

More to come...

Gold Free Fall

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

Gold getting hammered this morning. Down $50+, or nearly 5%. Silver also down nearly 5%. Am seeing lots of comments from emboldened bears as well as bulls throwing in the towel. Whether this is a classic blow out low remains to be seen.

Personally, I'm just digging lower prices.

position in gold, silver

Thursday, April 11, 2013

Unemployment Among Black Americans

All the way from Washington
Her bread winner begs off the bathroom floor
"We live for just these twenty years
Do we have to die for the fifty more?"
--David Bowie

GMU prof Walter Williams discusses the unemployment situation among black Americans. Black unemployment has been double that of whites for more than 50 years. Among black youths, the unemployment rate is more than 40%. In some cities, unemployment among black working age men exceeds 50%.

It hasn't always been this way.

In the first half of the 20th century, black male labor force participation rate equaled or exceeded that of white males. Black youth unemployment was equal to or was less than white youth unemployment. Average duration of black unemployment was 15% less that white unemployment; today it is 30% longer.

Obviously, as they used to say in problem solving class, something has changed.

As WW observes, blaming racial discrimination for today's high black unemployment rates rings hollow. It is difficult to argue that discrimination is higher now than during the early 20th century period when employment among blacks was much stronger.

Williams himself recounts the multitude of jobs he worked while growing up in North Philadelphia's housing projects. Youngsters who sought after school, weekend, or summer jobs found them.

Few of those jobs are available today. The reason is minimum wage laws. As we have noted many times on these pages, minimum wage laws are a form of compulsory unemployment. Marginal workers willing to take jobs for less than the minimum wage are prohibited from doing so.

Minimum wage laws hit the young and uneducated particularly hard because these people usually seek low paying jobs. Over the past 60 years, the scope of minimum wage laws has expanded to cover nearly all jobs--forcing low skilled black out of work.

Williams also observes the backing of minimum wages laws by unions--which is no surprise because minimum wage laws protect union franchises from being undercut by non-union black workers willing to work jobs for less pay.

Public education constitutes another explanatory factor as blacks populate K-12 public school systems at higher rates than whites, particularly in urban areas. The poor performance of US public schools has also been discussed on these pages. The restraining effect of public schools on young minds therefore hits black youths particularly hard.

The underlying cause of high black unemployment, therefore, can be tied to government intervention in labor and education markets. As long as government hampers these markets, then high black unemployment is likely to persist.

As uncomfortable as it may be for those who have put their faith in the State, the solution is for government to back away from these markets.

Wednesday, April 10, 2013

Savings, Capital, and Productivity Improvement

Drawn into the stream of undefined illusion
Those diamond dreams, they can't disguise the truth
--Level 42

Productivity is the amount of output produced per unit of input. Improving productivity is critical to organizations because the more output generated per costly unit of input, the greater the economic value (and profit) created.

Improving productivity is critical to society as well. As more output is generated per unit of scarce economic resource, more wealth is created and conditions of scarcity are reduced. Improved productivity is inextricably linked to higher standard of living.

There are two strategies to improve productivity. One strategy is to make extant production processes more efficient. This approach to improving productivity requires relatively small amounts of capital. The focus is on rethinking how current processes should be configured so that less resources are needed to produce a certain amount of output.

Because it involves existing processes, this productivity improvement approach is the most common one employed by managers. It requires less investment and is usually perceived has being less risky. When managers seek to improve productivity, they usually start here.

The other strategy for improving productivity is to create new production processes. This approach requires large amounts of capital because economic resources must be acquired and allocated toward something new. It is often associated with entrepreneurial ventures seeking to do something radically different from the status quo.

Because it involves creating new processes, this productivity approach is less commonly employed by managers. It requires more investment and is usually perceived as more risky. When managers seek to improve productivity, they usually entertain creating new processes only after they have exhausted efforts to make extant production processes more efficient.

It can be argued that managers have been exhausting efforts to make extant production processes more effiicient for decades. They are approaching that point in time where significant improvement in productivity can only be achieved by radically altering production processes.

There is a problem, however. We have been saving progressively less of our incomes. Household + government saving as a % of GDP is negative. As such, little capital is available for major productivity improvement projects.

Our declining capital base is stunting capacity for major advances in productivity (and in general standard of living) from here.

Tuesday, April 9, 2013

Modern Banking's Promise of Fraud

Second time around
I'm still believing
Words that you said
--Naked Eyes

No one was more relentless in his criticism of fractional reserve banking than Murray Rothbard. Here he discusses it in the context of the 1980s S&L meltdown.

During bank runs, it is often said that 'good' banks get taken down with 'bad' banks. But how can a bank be 'good' if problems elsewhere wind up taking it down? Clearly there must be a systemic flaw that drives such indiscriminate failure.

That flaw, observes Rothbard, is excessive leverage--what in the industry is known as fractional reserve banking. Banks only keep 10 cents (or less) in the vault for every dollar deposited. Should all depositors show up at the same time to claim their deposits (a.k.a. a bank run), their demands are impossible to honor.

Fractional reserve banking is therefore a fraudulent scheme. Banks make contractual promises (i.e., we will return your deposits on demand) that they know they cannot keep. Modern banking thus becomes a confidence game. If depositors lose confidence that they will be able to withdraw their funds on demand, then the game is up.

To prop up confidence, governments provide 'insurance' to depositors. The State promises to make depositors whole on deposits up to a certain amount in the event of a bank failure. But this too is a fraudulent scheme, as the deposit insurance fund is so under capitalized that it would be unable to pay out claims amounting to even 5% of insured deposits--much less a system-wide failure.

Although some depositors recognize this deficiency, they play along anyway. Why? Because they believe that if push came to shove, government would print money in order to make insured depositors whole. But should it come to pass, this too is a fraudulent scheme. Although money printing might return nominal dollars to depositors, the purchasing power of those dollars would be vastly reduced.

Stated differently, depositors would get their paper dollars back, but not the economic resources that the original paper dollars could buy.

Observe the number of times 'fraudulent' appears in the above discussion. In criminal law, fraud is intentional deception or perversion of truth in order to induce someone to part with something of value.

Our modern banking system promises fraud.

Monday, April 8, 2013

Hitting the Education Wall

We don't need no education
We don't need no thought control
No dark sarcasm in the classroom
Teacher leave them kids alone
--Pink Floyd

My freshman college roomate was endowed with a nice turntable and a large record budget. I can therefore recall a rather inordinate number of artists who released albums during that school year. Springsteen, the Pretenders, Seger, even the Knack.

However, no album released that year was more memorable than Pink Floyd's The Wall. And no song on that album was more memorable than Another Brick in the Wall (Pt 2, officially).

The lyrics were accompanied by cryptic video at a time when MTV was settling into its own. There was a longer version and a shorter animated one.

The song told the story of collectivist education and the consequences of not conforming. In the videos, children were seen as being processed through a meat grinder.

Once processed by professors hammering home collectivist ideology, students would march in lockstep with the State.

These memories were evoked as I viewed this video yesterday. A poly sci professor from Tulane argues that public education would be better off if parents would cede responsibility to the 'collective.'

Of course, we have already been moving in this direction. Hundreds of billions have been poured into public education as parents have outsourced the development of their children to public schools. Results have been true to Floyd--declining academic performance, general predilection for homogenous thinking, and healthy sympathy for the State.

Not to mention yawning budget deficits that cannot be repaid by graduates who are not productive enough to cover the costs of the program.

It remains to be seen how much of the Tulane prof's arguments parents will continue to  slurp down. Hopefully it won't matter. As the song suggests, rebellion to Statist education ultimately comes from the kids.

As with all other aspects of the socialist agenda, public education is destined to hit The Wall.

Sunday, April 7, 2013

Bearish Bonds, Bullish Stocks?

You must have heard the cautionary tales
The dangers hidden on the cul-de-sac trails
--Pete Townshend

As interest rates have been driven lower by zero interest rate policies (ZIRP) worldwide, people are turning negative on Treasuries and other sovereign debt, while remaining bullish on other asset classes such as stocks.

This makes little sense.

Asset prices are floating on an ocean of liquidity created by ZIRP, as investors borrow cheap funds from central banks and invest the proceeds in the securities of all stripes.

When Treasury yields rise, the carry trade will come off, and those securities bought with cheap credit will be sold.

If you are bearish USTs, then shouldn't you be bearish on all asset classes linked to low Treasury rates?

position in SPX, Treasuries

Saturday, April 6, 2013

Perfect Storm for Income-Producing Securities

"He's no saleman for sure. Unless he's peddlin'...dynamite!"
--Doc T.R. Velie, Jr (Bad Day at Black Rock)

Perhaps the greatest challenge noted by participants at this year's RISE conference was increasing difficulties finding income-producing securities at an attractive price. This search is being driven by interest rate suppression by central banks, which is driving investors out of 'risk-free' Treasuries toward other asset groups. In fact, there was broad bearishness in Treasuries. USTs were labeled by some as being 'return free' rather than 'risk-free,' and perceived by some as possessing more risk than stocks at current prices.

BlackRock reps noted that they are recommending, and their funds are investing in, dividend paying stocks, corporates (including 'high yield' or junk bonds), Asian sovereign debt, and even securitized bank loans as alternative income generators. A gentlemen from a firm in Chicago noted that he was recommending non-agency mortgage backed securities to his firm's investment committee.

So, investors are once again walking the risk plank, bidding up prices of riskier, less liquid instruments.

Policy makers are getting what they want--they are forcing people to take more risk.

The timing couldn't be worse. We are coming off a credit bust that, if left to its own devices, would surely be raising rates and rewarding savers to clear away the bubble that inflated over the past decade. Current policies, however, do the opposite.

Compounding the problem is that more and more Boomers are retiring, which elevates the number of people looking for income than in the past as they move from 'accumulation' to 'distribution' phases of their investment years.

As investors reach for yield, prices of income-producing securities are rising much higher than the free market rate.  Increasingly, fixed income investors are overpaying.

This sets up a near perfect storm for this asset class during the next time down.

position in SPX, USTs

Friday, April 5, 2013

Distributing Financial Services

"Now you can concentrate on the big-ticket retail!"
--Lynch (Wall Street)

The first RISE session I atteneded this morning, "Investment Life Cycle," was hosted by four people from BlackRock and one from UBS. BR is the largest asset manager in the world with about $3.7 under management. This is split between actively managed mutual fund type products and the rest being passive ETF products (BR owns the i-share series of ETFs).

Two of the BR people were strategist types advising their portfolio managers as well as about 75ish BR wholesaler/consultant types who essentially market BR products to firms managing money for clients. The UBS guy, a senior VP who oversees about $600 million regional client accounts for the firm, is an example of a 'customer' of the BR supply chain.

The BR wholesaler meets with the UBS guy ~quarterly to share new products/service and to understand client needs.

This sketch provides just one of a mindnumbingly large number of ways products and services are distributed in the industry. It adds to my quest to better understand (examples of previous lessons learned at RISE here, here) how the financial services industry is structured and how it operates.

Thursday, April 4, 2013

RISE 2013

Go closer hold the land
Feel partly no more than grains of sand

For the 3rd consecutive year, I am attending the RISE (Redefining Investment Strategy Education) conference at the University of Dayton. RISE is one of the largest student-centered conferences on investing. I would guess that there are about 3000 attendees this year.

The first day is always a 'macro' day at UD arena where industry leaders and pundits gather to discuss broad issues and trends. I missed the morning sessions, which included a panel discussion with two Fed bank presidents, Charles Evans (Chicago) and Dennis Lockhart (Atlanta). Apparently they signaled that the Fed intends to maintain its zero interest rate policy (ZIRP) for the next two years, which is really no news given recent FOMC statements.

An afternoon "Markets" panel featured Liz Ann Sonders of Schwab, Phil Orlando of Federated Investors, Stephanie Link of TheStreet, and Barry Knapp of Barclays. All were bullish; the only negative voice was the moderator, David Asman of Fox Business. I was reminded of a similar situation two years ago where a moderator from Bloomberg provided a lone cautionary voice.

Three of the four discussants were very bullish on stocks, citing the usual reasons (easy Fed, equities as the only game in town given interest rates, Fed model type valuations, stong corp balance sheets, skeptical retail investors, etc). Only Knapp voiced reservations about the near term, noting that various indicators were 'flashing warning signs' to him. If there was a correction, "I would buy it," he said.

None of the panel felt that low interest rates or massive bond buying by the Fed were significant issues. Rather, these are plusses for equities, in their view.

Perhaps the best question came from a sharp student, who asked whether he should be concerned that all panelists are clearly bullish. To which the panel essentially replied that not all people are bullish--just them (presumably they are the 'smart ones').

Data obtained from attendees suggested general bullishness among attendees, with the average forecast for the Dow at year end being between 15 and 16K.

The final panel of the day discussed the future of the financial services industry. While the content of the discussion was interesting, I was particularly impressed by panelist Roger Ferguson, a former Fed governor who is now CEO of TIAA-CREF. He certainly holds some views that I do not agree with, and he's been affiliated with institutions that have done big time damage. But I found his comments, particularly on questions coming from students, thoughtful and spirited.

Also notewothy: throughout the entire day, I heard not one mention of commodities.

position in SPX, Treasuries, commodities

Wednesday, April 3, 2013

When Epochs Change

If you wanna make the world
A better place
Take a look at yourself
And then make a change
--Michael Jackson

Nice reflection (!) by Bill Gross on linear thinking--the tendency of extrapolating the past into the future. He terms particular market periods 'epochs,' and suggests that investors who simply follow the trend that defines the current epoch are often successful.

But "What if the epoch changes?," he asks. For example, what if the secular trend in easy credit comes to an end? The 'easy trade' in this epoch has been to borrow profusely and go long financial assets. Carry traders have gotten rich on this strategy--particularly as monetary and fiscal policy have bailed them out whenever the cost of carry has inconveniently turned against them.

While epochs often outlast the investors the populate them, no one knows when one epoch ends and a new epoch begins. Employing old strategies in new epochs is a likely a ticket to the poor house.

Try your best to read the tea leaves of change, and be prepared for a new epoch.

position in SPX, Treasuries

Tuesday, April 2, 2013

Remember the Feeling

I tell myself that I can't hold out forever
I said there is no reason for my fear
--REO Speedwagon

When dot com stocks were soaring day after day, it felt like they would never go down. Then the trend changed, and it was hard to remember what the tech bubble action felt like

When housing prices and related financial instruments were soaring day after day, it felt like the trend was unstoppable. Then the trend changed, and the feeling associated with the housing ATM vanished.

Once again the trend seems relentless, as stocks and bonds levitate on an ocean of central bank-induced liquidity.

Do what you can to preserve this feeling, because soon it will be nowhere to be found.

position in SPX

Spending Future Tax Receipts

Don't ask me what I want it for
If you don't want to pay some more
--The Beatles

George Reisman discusses an increasingly popular tactic by big government types. The tactic is often framed something like this. It is assumed that $X in taxes will be collected from some entity Y at some point in the future. So, let's just go ahead and treat those future tax receipts as if they are already collected.

Subsequently, if some fraction of those $X taxes are not collected, then it is 'costing' the government money. The government is 'giving' Y a tax break. Or, perhaps more appropriately as seen thru this lens, it is gving money to Y that is rightfully the government's.

Reisman calls this 'tax expenditures.' Essentially, it is treating future tax receipts as if they were current assets.

We see this approach employed in various contexts. When the president or Congress talk about 'spending cuts,' they are usually not talking about cuts at all. Instead, they are talking about reducing the rate of future government spending from some previous level determined by estimating future tax receipts. Tax reductions are therefore seen as 'expenses' (e.g., 'spending on tax cuts').

Recently, I read an argument that profits of US-based corporations residing in tax-sheltered overseas accounts should be forcibly repatriated because those funds are 'our money.' No, the money is the property of someone else, and that someone is seeking to preserve it from confiscation.

Reisman notes that reducing spending truly means reducing the amount of money the government takes in. Reducing the amount of money the government chooses not to take in is the same thing as an increase in taxes.

Only when government spending is limited to its core function of helping people defend themselves against aggression does the freedom of citizens improve. As freedom to spend one's own earnings increases, so does standard of living.

Monday, April 1, 2013

Opening Day

"You know what we get to do today, Brooks? We get to play baseball!"
--Jimmy Morris (The Rookie)

Baseball is back, but it's always extra special here in Cincy. Our family has been part of the tradition. In the early days Dad was covering the Reds. He was always extra stressed putting together that Opening Day section for the paper. Mom would head down to Crosely with the usual group.

In the 1970s it was Riverfront. I remember listening to The Hammer hit 714 in seventh grade science class.

Now Great American Ball Park is ground zero for the fanfare.

The venues have changed but the feeling is the same. It's a wonderful day in Cincinnati.