Tuesday, December 31, 2013

Inflation and Capitalism Don't Mix

Don't go around tonight
Well, it's bound to take your life
There's a bad moon on the rise
--Creedence Clearwater Revival

People erroneously associate inflation, defined here as higher prices or lower purchasing power of money, with capitalism.

But inflation is not endogenous to capitalism. In fact, capitalism puts downward pressure on prices. As productivity increases, a particular quantity of money is spread over more units of production, resulting in generally lower prices per unit.

This is merely another way of saying that capitalism improves prosperity--more economic resources per unit of effort. More purchasing power per unit of production.

If you question where inflation comes from, the answers lie elsewhere.

Monday, December 30, 2013

Actuarial Value and Obamacare

Sometimes you picture me
I'm walking too far ahead
You're calling to me
I can't hear what you've said
--Cyndi Lauper

Nice insight into one of the drivers of health insurance policy cancellations under Obamacare.

In order to be compliant with the Affordable Care Act (ACA), an insurance policy must have an actuarial value (AV) that falls within one of four bands:

Platinum: estimated to cover 90% of enrollee's costs (AV = 90), plus or minus 2%
Gold: AV 80 +/- 2
Silver: AV 70 +/- 2
Bronze: AV 60 +/- 2

A plan outside of these bands is noncompliant under the ACA. So, for example, a policy that covers 95% of enrollee costs is too generous and is substandard under the law.

If the AV of your policy is 59, 72, 80, or 91, then "you can keep your plan." However, if your policy has an AV of 64, 76, 87, or 98 then your plan will be cancelled.

To demonstrate the pointlessness of this policy, a plan with an AV of 98 is deemed to pay too high a percentage of an enrollee's health care costs. To be ACA compliant, this plan must provide fewer benefits, and enrollees will face higher out-of-pocket costs.

A plan offered in 2013 can have any AV. But beginning January 1, 2014 all ACA compliant plans must fall within one of the four AV bands noted above. Approximately 15 million Americans with individual policies will be the first segment affected. Later in the year, tens of millions of Americans who get insurance through group plans will face cancellation when their policies come up for renewal.

As deductables, out-of-pocket maximums, and prices of medical goods and services change in future years, so will the AVs of particular plans--meaning that plans that are ACA compliant one year could be non-compliant the following year.

Why did Congress write this pointless standardization into the law? As they jammed the health care bill thru the system in late 2009, ACA proponents famously said that the bill needed to be passed to find out what was in it.

While the consequences were predictable at that time, bureaucrats behind the law still do not understand what they have wrought.

Sunday, December 29, 2013

Cato's Letters

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

In the 1720s, wealthy Englishman John Trenchard and his young protege Thomas Gordon penned Cato's Letters, a series of essays that radicalized libertarian principles put forth by John Locke and others by applying them to concrete, contemporary problems of government.

Cato argued that government is always and everwhere the potential or actual aggressor against the rights and liberties of the people. Power stands ever ready to conspire against liberty. To counter the threat, people must strictly limit government scope, and be ever vigilant and hostile to the inevitable tendencies of government to encroach upon liberty.

Liberty was "the power which every man has over his own actions, and his right to enjoy the fruits of his labour, art, and industry, as far as by it he hurts not the society, or any members in it, by taking from any member, or by hindering him from enjoying what he himself enjoys. The fruits of a man's honest industry are the just rewards of it, ascertained to him by natural and eternal equity, as is his title to use them in the manner which he things fit: And thus, with the above limitations, every man is sole lord and arbiter of his own private actions and property."

Cato also made clear that the rights and liberties were individual and not those of the majority. The despotism of the majority can be as bad as the tyranny of the few. "It is a mistaken notion in government, that the interest of the majority is only to be consulted, since in society every man has the right to everyman's assistance in the enjoyment and defense of his private property; otherwise the greater number may sell the lesser, and divide their estates amongst themselves; and so, instead of a society, where all peaceable men are protected, become a conspiracy of the many against a minority."

American colonists of the 1700s eagerly devoured Cato's thoughts. Demand for Cato and other like publications impressed the value of a free press upon the colonists as well.

They would apply these lessons in the second half of the 18th century.


Trenchard, J. & Gordon, T. 1965. Cato's letters. In D.L. Jacobson (ed), The English libertarian heritage. Indianapolis: Bobbs-Merrill Co.

Saturday, December 28, 2013

Ten Year Yields at 3%

Drawn into the stream
Of undefined illusion
Those diamond dreams
They can't disguise the truth
--Level 42

Ten year Treasury note yields closed the week above 3%--the first time they have done so since July, 2011.

The previously observed cup-and-handle pattern on the weekly charts is now more pronounced.

Bulls argue that higher yields are simply a signal of economic strength. Bears counter that the Fed is losing control of interest rates despite its aggressive policies aimed at suppressing rates.

What we do know is that there are huge leveraged positions in Treasuries that are feeling increased pain with each tick higher in rates (bond prices go down when yields go up). If rates should break decisively higher from here, then get ready for some fireworks.

Blend that with lopsided sentiment and you get a high risk mixture.

position in SPX

Friday, December 27, 2013

Bubble Sentiment

Sitting with the thinker
Trying to work it out
It's a traffic jam of the brain
Makes you want to scream and shout
--Sly Fox

As US equity indexes mark more new highs, sentiment predictably gets more lopsided. The Investors Intelligence newsletter survey captures the optimism:

In fact, the difference between II bulls and bears has never been higher:

The log periodic bubble model appears to be playing to completion in a buying panic.

Risk is high.

position in SPX

Thursday, December 26, 2013

Liberty or National Security?

--Miyagi (The Karate Kid)

Jacob Hornberger argues that Americans must choose between freedom and the national security state. We cannot have both.

Our ancestors understood this well. John Quincy Adams said that, while brutal tyrannies could be found elsewhere in the world, America does not go abroad "in search of monsters to destroy." If America would do so, then "the fundamental axioms of her policy would change from liberty to force...She might become the dictatress of the world. She would no longer be the ruler of her own spirit."

James Madison added, "A standing military force, with an overgrown Executive will not long be safe companions to liberty. The means of defence against foreign danger have always been the instruments of tyranny at home."

As the national security state grows, liberty shrinks.

Wednesday, December 25, 2013


"Therefore the Lord himself will give you a sign. Look, the young woman is with child and shall bear a son, and shall name him Immanuel."
--Isaiah 7:14

Today we celebrate the coming of Christ. By his birth, Christ demonstrated God's most important gift: life. By his coming, He also gifted us with freedom.

Veni veni, Emmanuel
captivum solve Israel,
qui gemit in exsilio,
privatus Dei Filio.

God is with us.

Tuesday, December 24, 2013

Advancing Interests Through Political Means

And the men who spurred us on
Sit in judgment of all wrong
They decide and the shotgun sings the song
--The Who

Drawing from Nock's 1935 work, this missive reminds us that there are two earthly ways to advance one's interests. One way is through production and voluntary exchange. This is advancing one's interests through economic means.

The other way is through uncompensated appropriation of wealth produced by others. This is advancing one's interests through political means. Because they seek the most benefit for the least cost, people will be tempted go the political route because it requires less exertion.

The State is the organization of political means. Because it is legalized force, the State stands as a strong armed agent for hire. It becomes a primary distributor of economic advantage.

Nock argues that, similar to parasitic disease, the depletion of economic means by the State cannot be checked past some point. Historical evidence, he says, shows not one instance where assimilation of State power has not resulted in complete and total collapse.

My head knows that he is right. But in this Christmas season of hope, I pray that he is wrong in our case.

Monday, December 23, 2013

US Central Banks and Treasury Note Yields

Under pressure
That burns a building down
Splits a family in two
Puts people on the streets

Nice chronology of 10 yr Treasury yields. Note the vertical line in 1913 denoting the beginning of the Federal Reserve.

The Fed was not America's first central bank. The First and Second Banks of the United States operated during the first few decades of the nation's existence with the Second Bank losing its charter in 1836. As such, another vertical line denoting the end of our early experiment with central banking could be drawn in the mid 1830s.

It is readily apparent that oft-heard claims of enhanced interest rate stability under central banking regimes are ludicrous in the face of the empirical evidence. The wildest moves in Treasury yields have occurred during periods of central bank governance.

On the other hand, the near eighty year period where the nation was free from central bank control--the period ranging from the mid 1830s until 1913 (with the exception of Lincoln's Civil War years)--saw the lowest volatility in sovereign debt yields in the history of the United States. Moreover, yields trended steadily lower during this period. This is indicative of growing economic strength that caused lenders to view the United States as an increasingly attractive credit risk.

Under central bank regimes, lower yields do not imply the same thing. Central bankers spend most of their time trying to suppress yields. To the extent that they are successful, then rates go down. When central bankers can no longer hold them back, then rates pop higher.

These secular ups and downs are readily evident in the post 1913 Fed period. The Fed's first large scale program to suppress rates came in the early 1920s. This dovish period lasted until the end of WWII. Over the next 30 years, market forces took over. Interest rates went higher despite efforts by the Fed to suppress yields.

In the early 1980s, the Fed regained the upper hand. The subsequent thirty year secular downtrend mirrored and retraced the previous move higher.

So here we are once again--at the bottom of a 30 year suppression program...and with the Fed in the process of losing control of yields...

no positions

Sunday, December 22, 2013

Jesus and Political Action

"I know this man!"
--Judah Ben-Hur (Ben-Hur)

Joseph Sobran observes that, even though many Christians support the State, Jesus never urged people to take political action.

But what about 'The question about paying taxes' that appears in the gospels of Matthew 22, Mark 12, and Luke 20? All of them read similarly. The Pharisees frequently questioned Jesus hoping to trap him in his words. One question they pose is whether it was lawful to pay taxes to the emperor. Jesus chastizes them for putting him to the test. He then asks them to identify the head on a Roman coin and they do so as Caesar. Then give to Caesar what is Caesar's, and give to God what is God's, Jesus says.

Statists offer this as proof that Jesus legimitized political action.

This interpretation is questionable, particularly given the context. Jesus knew that he was responding to a trick question put forth by his enemies--the intellectuals of the day. He was not preaching to his followers. He certainly did not recognize the authority of pagan emperors who claimed divinity and demanded idolatry.

Jesus' reply can easily be construed to mean, "Give Caesar nothing, and God everything."

If Jesus was truly a proponent of the State, then the gospels should be full of supporting evidence, with Jesus taking the lead in political action. In particular, we would expect to see Jesus exhorting the merits of using government aggression to achieve ends such as 'social justice.'

Instead, the gospels convey messages of free will, freedom in the truth, and non-aggression. And, of course, we have Jesus's murder at the hands of the State.

Statists looking for compelling evidence of Jesus' support of political action will not find it in scripture.

Saturday, December 21, 2013

Inflation and Unemployment

Standing in line marking time
Waiting for the welfare dime
'Cause they can't buy a job
--Bruce Hornsby & The Range

Frank Hollenbeck suggests various flawed rationales for the Fed's current monetary policy, including the proposition that greater inflation reduces unemployment. This claim seems so preposterous that most would dismiss it out of hand.

But economists, it seems, have no general claim on straight thinking. The rationale traces back to a paper by Phillips (1958) where he reported a negative relationship between unemployment and change in wages in the UK:

It should be noted that the 100 years of data used by Phillips corresponded to a period when Britain was on the gold standard and general price inflation was low. Therefore, the original 'Phillips Curve' can be seen as reflecting the relationship between higher real wages--the result of higher productivity--and unemployment.

Stated differently, the higher the productivity (which raises real wages), the lower the unemployment.

Over the years, however, economists have bastardized the relationship. Today's Phillips Curve removes the original gold standard/higher productivity context and merely posits a negative relationship between inflation and unemployment:

The prescription is straightforward. Simply print more money and unemployment should fall. Of course, money is a unit of exchange--not an economic resource. Printing money only changes who gets claims on economic resources--not the total amount of economic resources in the system.

The prescription is problematic on several other fronts as well. There is no guarantee that money printing gets into the hands of producers--newly printed cash might find its way into other channels. Even if the cash does make its way into worker's hands, nominal rather than real wages would be increased. Nominal wage increases are likely to push up the general price level, leading to upward price spirals that can be difficult to control (see Revolutionary France and Weimar Germany).

This has led some economists to rationalize a possible short term benefit of inflation with respect to unemployment. In the short term, inflation lowers a worker's real wages and these lower real wages make hiring cheaper workers more attractive to employers. However, once workers figure out that they have been duped and are working for less, then they will demand reparation either from employers or from the government. All of which makes any reduction in unemployment temporary at best.

John Hussman has studied the empirical evidence and finds a positive, not negative, relationship between CPI inflation and the unemployment rate one year later:

However, when current unemployment is related to subsequent wage changes then the negative relationship revealed by Phillip's (1958) original study comes back into focus:

Hussman summarizes the resulting relationship simply. Wages rise, relative to other prices, when unemployment is low and labor is scarce. Wages fall, relative to other prices, when unemployment is high and labor is abundant.

This is simple ECON 101 supply and demand stuff. It is not a relationship that can be manipulated to create jobs or lower the unemployment rate.

Unless/until central bankers and other policymakers figure this out, the economy will sputter until the money printing causes interest rates and prices shoot higher.

Then real economic malaise commences.

position in gold


Phillips, A.W. 1958. The relationship between unemployment and the rate of change of money wage rates in the United Kingdom, 1861-1957. Economica, 25: 283-299.

Friday, December 20, 2013

Freedom's Unpredictable Certainty

Shine sweet freedom
Shine your light on me
You are the magic
You're right where I wanna be
--Michael McDonald

Professor Gary Galles observes that while we can't predict precisely what freedom will produce if government-imposed restraints are removed from people's lives, we can be certain that improvement will follow.

We know this will occur because of the axiom of self-interest, the insatiable desire to improve one's circumstances, means that improvements will be sought. Moreover, when individual rights are protected, then prospective improvements require voluntary agreement. No one can force worse interests on others.

A world governed by state intervention does not possess these features. Improvement under such condition is restrained.

Precisely what improvements freedom produces is unpredictable. But freedom's capacity for improvement is predicatably unlimited.

Thursday, December 19, 2013

Governance by Secret Law

"Lighthouses, John. Lighthouses in a foggy world."
--Henry Connel (Meet John Doe)

Days after the NSA ruling, another federal judge has ruled against the practices of this administration. The judge ordered the Obama administration to release a foreign aid document that it had previously rendered secret.

As Judge Nap notes, the federal government cannot arbitrarily render its activities secret. Rather, the presumption is that of public oversight--that the people have the right to see all that government does. If the government believes that a particular activity or document should be kept secret, then it must prove why this is so.

In her ruling, the judge states, "The government appears to adopt the cavalier attitude that the president should be permitted to convey orders throughout the executive branch without oversight, to engage in what is in effect governance by 'secret law.'"

Judge Nap proposes that these rulings suggest "that the administration is accumulating power in the executive branch not sanctioned by federal law, and not permitted by the Constitution."

Government's lust for power is chronic and long precedes this administration. But the effects are cumulative and likely, at some point, to capture that attention of the people. Perhaps the brazen power grab by this administration is doing just that.

Budget Buddies

The only one for me is you
And you for me
So happy together

The recent budget deal co-sponsored by 'conservative' Paul Ryan once again demonstrates the paper thin difference between Republicans and Democrats.

On the political landscape, the two parties are next door neighbors.

Wednesday, December 18, 2013

Boston Tea Party

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

A few days ago marked the 240th anniversary of the Boston Tea Party. As noted here, this infamous act of civil disobedience was a reaction to much more than an increase in taxes.

Lew Rockwell observes that the Tea Party was a protest against the State's use of trade to benefit some at the expense of others.

Will quote his conclusion, as I could not have said it better:

"Our agenda today should be exactly that of the Sons of Liberty in Boston: the right to economic enterprise should be unimpeded by taxes or special privileges. This is all that true free traders, in the tradition of the American revolutionaries, have ever demanded."

Tuesday, December 17, 2013

Unconstitutional Monitoring

"The government's been in bed with the entire telecommunications industry since the forties. They've infected everything. They get into your banks statements, computer files, email, listen to your phone calls. Every wire, every airwave. The more technology used, the easier it is for them to keep tabs of you. It's a brave new world out there. At least it'd better be."
--Brill (Enemy of the State)

Yesterday a US District Court judge ruled that the NSA's bulk phone records collection program, a program that was secret until revealed by Edward Snowden last summer, violates the Constitution. The judge granted a 'preliminary injunction' and then stayed his decision pending anticipated appeal by the federal government. This is another ruling that appears destined for the Supreme Court.

Jacob Hornberger suggests that the ruling marks an appropriate time for Americans to ask some fundamental questions. At the top of the list is this one: Is the NSA (and the entire national security apparatus) compatibale with the principles of a free society?

Even cursory reflection renders the answer. Freedom requires a zone of privacy--one that is immune to the prying eyes of government. People cannot live free if they are constantly being monitored by a strong-armed institution.

The framers understood this, as the colonists had experienced discretionary search and seizure first hand. They wrote the Fourth Amendment to prohibit this activity.

Achieving true freedom requires abolishing, not reforming, institutions such as the NSA.

Demark Remarks

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

I've been revisiting discourse (e.g., old blog posts, shows/movies about event, etc) from the credit market meltdown. Why? I'm getting that 'feeling.' And if my mind isn't right then I will have trouble acting appropriately should a similar cascade commence.

Thought this interview with Tom DeMark was interesting. I met Tom back in 2005 at a Minyanville event, and sat in on his seminars in 05 and 06. Tom's technical speciality is tracking 'trend exhaustion' and forecasting trend change. His work interests me because, being a contrarian by nature, I am attracted to prospects for 'fading' (rather than riding) trends.

Recently Tom has been studying current US equity index price action relative to other major trend reversals and 'crash-like' events. He notes that current patterns bear much similarity to 1929, 1987, 2007/8.

Of course, past is not necessarily prologue. In fact, Tom notes that his methods for timing trend changes have not been particularly effective in US equity markets during the past couple of years. He suspects this has to do with the enormous amount of monetary intervention done by the Federal Reserve.

Regardless, it appears that the convergence of analogs and patterns has DeMark concerned. His work points to 'warnings' that appear 'obvious' to him.

His work also suggests downside trend exhaustion in gold and a pending major trend reversal.

positions in SPX, gold

Monday, December 16, 2013

Camp Washington

"The trouble with a bath is that by the time you're through you're just as hot."
--Emma Jones (Street Scene)

Captivating 1934 video of Camp Washington, an urban Cincinnati neighborhood. The silent film provides a sense of 1930s era urban life as seen through the eyes of merchants and street walkers of the time.

I have watched this clip several times over the past couple of days. Unlike many of the jerky black-and-white films of the period, this one seems so vivid--and so local. Although actual intent is unknown, it seems the filmmaker sought to the document the neighborhood's human element for posterity's sake.

Perhaps the filmaker sensed that the street scene would soon change...

Getting its name from the area's role as an army camp during the Mexican War, Camp Washington was established in 1846 and was the site of the first Ohio State Fair in 1850. Camp Washington's evolving role as a transportation corridor shaped its destiny. A nice review of this evolution can be viewed here.
Three early transportation routes--the Mill Creek which defines its western border, Colerain Avenue (later US 27) cutting north/south thru the neighborhood, and the Miami Erie Canal shaping its eastern border--were all in place by 1830, creating supply chain infrastructure that attracted early industry to the area.

Installation of a rail line in the late 1860s cemented Camp Washington's centrality to the industrial corridor that became known as the Mill Creek Valley. In the second half of the 19th century, Camp Washington featured a large concentration of meat processers and meat packers as well as noteworthy clusters of machining and chemical processing concerns. With those businesses came expanding rail lines and more streets, such as Spring Grove Avenue north/south and Hopple Street east/west.

By the 1930's, Camp Washington's street fabric included Central Parkway (the paved over Miami Erie Canal) and the Western Hills Viaduct. However, the neighborhood's first main road, Colerain Avenue, remained the 'main drag.' As is evident in the 1934 video, thoroughfares were thick with small businesses and road/sidewalk traffic that, even during the Depression Era, appeared to complement larger industry in the area.

The video suggests Camp Washington as a vibrant neighborhood--a place of healthy growth and change. As the neighborhood celebrated its centennial twenty years later in the 1950s, however, another change that dwarfed all previous changes in significance was in the wind.

The Federal Aid Highway Act was passed in 1956. The act authorized construction of a national interstate highway system. At the time, some pieces that were to become the Interstate 75 run through Cincinnati were already in place north of the city. The Evendale/Lockland/Paddock Road legs were constructed from Erie Canal and WWII infrastructure in the 1940s and the Norwood Lateral/Ludlow Viaduct legs were completed in the 1950s.

By the end of the decade, I-75 stopped at the northern doorstep of Camp Washington. To gain a sense of the building and street fabric density of the time, the above photo shows Cincinnati's West End looking north toward the south side of Camp Washington in the late 1950s. I-75 would eventually cut through the center of this urban mass--running parallel and just to the right of Western Avenue--which can be seen at the top of the image running past the right field fence of Crosley Field.

Neighborhood demolition proceeded in the early 1960s for the route south through Camp Washington and the West End to the river. With it went the relevance of Colerain Avenue. It was cut off in the north and the south of Camp Washington by the interstate run. Most of the east/west street fabric was torn as well. The above picture of Crosley Fied on Opening Day in 1962 provides some sense of the neighborhood divide wrought by the interstate construction. The leg through Camp Washington to the Ohio River was completed in 1963.

Fifty years later, Camp Washington is still trying to recover from this change. Many businesses large and small are gone. However, what remains is not totally barren. For example, the CSX rail yard on the west side of Camp Washington is one of the larger yards in the country. And neighborhood rebuilding efforts continue.

But re-capturing the vibrance depicted in the 1934 video has proven difficult.

Sunday, December 15, 2013

Be Different

"Go on, lean in. Listen...you hear it? Carpe...hear it? Carpe...carpe diem. Sieze the day, boys. Make your lives extraordinary."
--John Keating (Dead Poet's Society)

Social pressure pulls behavior like a magnet to the status quo. Be like us. Don't be different.

Why is this so? Being different takes effort. Not just blind imitation of others.

It also requires risk. If the difference results in a mistake, then the herd feels self-righteous. "You were foolish to break from the pack," chastises the status quo.

If the difference results in something good, then the herd looks wrong. "You're making us look bad," warns the status quo.

Being different is a can't win situation, it seems.

Until one realizes that we are not accountable to the status quo. Christ's birth tells us that each of us was put on this earth to make a difference. By definition, improvement and innovation requires breaking from the status quo.

Take a deep breath and be different.

Saturday, December 14, 2013

History of Federal Spending

Drawn into the stream
Of undefined illusion
Those diamond dreams
They can't disguise the truth
--Level 42

These pages have shown variations of this chart before. For the majority of the nation's history, the United States operated with federal spending of 3% of GDP or less. Today, federal spending exceeds 20% of GDP. In fact, federal spending is at record non-war year highs.

Policies are in motion that seek to institutionalize current levels of spending. The question that must be asked is why should current levels of spending be regarded as more valid than those in place for the first 100+ years of the country's existence?

It should also be noted that, for those claiming that we currently operate under a 'free market capitalism' system or that capitalism is becoming more 'unfettered' than in the past, this chart is one piece of evidence that invalidates such claims. The more resources that government controls, the less free the markets.

The chart reflects the trend toward less freedom in markets, not more.

Friday, December 13, 2013

Anti-Libertarian Absurdity

Welcome to your life
There's no turning back
Even while you sleep
We will find you
Acting on your best behavior
Turn your back on Mother Nature
Everybody wants to rule the world
--Tears for Fears

Nice discussion of the absurd argument against libertarianism put forth by many intellectuals. The daisy chain of thought goes like this:

(1) Humans are social animals that require deep social connections to thrive. They develop much of their sense of self via their social environment. Humans live better when working together in a framework of mutual respect and reciprocity rather than in isolation.

(2) Big government is the only political system compatible with (1).

(3) Libertarians oppose big government.

(4) Therefore, libertarians reject (1).

The absurdity, of course, is that libertarians do not reject (1). Axiomatically, people cannot advance their standard of living without exchange with others. That trade may be material or psychic in nature.

Instead, it is because libertarians accept (1) that they reject (2). The basis for (1) is voluntary cooperation among individuals. (2) is incompatible with (1) because the basis of (2) is involuntary coercion--some individuals forcing their way on others. The social connections that develop in settings of voluntary cooperation degenerate in settings of coercive force.

Stated differently, (2) undermines the very sort of social flourishing (1) describes.

As the author observes, intellectuals "just can't envision a society where the state isn't free to use violence to compel nonviolent citizens can function."

Libertarians propose peaceful exchange, non-aggression, and no goverment-supported factions as the best path to prosperity. Statists propose (2) as the best path to prosperity.

It is the logic behind these two competing propositions that should be on the table.

Statists, of course, prefer to avoid this debate.

Update on the Tens

Don't you know we're playin' with the fire
But we can't stop this burnin' desire
--Donnie Iris

The reverse head-and-shoulders pattern in 10 yr yields observed a couple of weeks back is still in play.

T-notes continue to trade heavy, and the technical level of lore of remains TNX 30 (3%).

no positions

Thursday, December 12, 2013

Protection Racket

"The same government that trained me to kill trained you to protect. Yet now you want to kill me while up on that roof I protected you."
--Mitch Leary (In the Line of Fire)

One of the oldest crimes is the protection racket. B solicits payments from A. In exchange, B agrees to 'protect' A from harm done by...B.

I am reminded of the circularity of the protection scheme when I hear statists argue in favor of taxes. The now infamous "You didn't build that alone" claim suggests that public works assembled from tax dollars helped you build it. But those resources were obtained by aggression or threat of aggression.

The argument boils down to, "Our capacity for aggression benefits you, so pay up."

The State has learned the protection racket well.

Wednesday, December 11, 2013

Strategic Beauty

The beat goes on
The beat goes on
Drums keep pounding a rhythm to the brain
--Sonny & Cher

In strategic management, competitive advantage is only as sustainable as a strategy is inimitable. When competitors can copy what you are doing, then success is fleeting.

In this context, strategic beauty is the strategy that everyone can see as working...yet no one can imitate it.

Dell's strategy in the late 1990s/early 2000s was a good example. Combining prowess in just-in-time (JIT) production with dedication to a direct distribution channel, Dell took market share and profits from the hides of Hewlett Packard (HPQ) and others who pushed production primarily through traditional "two-step" (distributor->retailer) channels.

Everyone in the world could see what Dell was doing. Yet, HPQ and other traditionalists couldn't follow, because doing so would have been too painful. HPQ et al would either have to leave their traditional distribution channels behind, or endure massive channel conflicts--e.g., HPQ is a supplier to Best Buy (BBY) in its traditional channel, but would be a competitor to BBY in a direct channel.

I am reminded of strategic beauty when I see the federal government engage it its wealth redistribution scheme. Unfortunately for many statists who would like to force a levelling of wealth, current policies are forcing wealth toward a more uneven skew.

But the statists are largely silent. If they complained, then they would be admitting that one of their sacred tools for controlling economic activity, the monetary printing press, was not working properly.

And statists, by definition, have real trouble admitting that anything government does is not good.

So the strategy keeps working...and the beat goes on.

no positions

Tuesday, December 10, 2013

Socialism and Fascism

And the parting on the Left
Is now parting on the Right
And the beards have all grown longer overnight
--The Who

People sometimes associate socialism with the political Left and fascism with the political Right. This is not quite correct. Fascism is a flavor of socialism. Socialism is State control of production and distribution. In some forms of socialism, this control is overt thru direct State ownership of property. When that ownership is communal, then socialism takes the form of communism.

In other forms of socialism, rather than owning productive assets outright, the State retains decision rights on how productive assets are employed. The State might dictate what gets made, how it is made, who makes it, and/or who gets the output. 'Profits' are split between the State and the 'owners' of the productive assets. This form of socialism is fascism.

Of course, it is debatable as to what extent fascism materially differs from other forms of socialism. After all, if 'owners' of productive assets are not free to dispose of productive assets as they see fit, then this is not consistent with private property and property rights. With fascism, it appears the State merely carves out dividends for operators of State-controlled verticals.

History books have largely misplaced the fact that features of the New Deal, particularly those related to the National Recovery Administration (NRA), were patterned from the Mussolini brand of fascism that was all the rage in the 1930s.

A strong nationalistic bent often accompanies fascism. In 1930s Germany, for example, Nazi was short for National Socialist Party.

In his 1944 work The Road to Serfdom. Hayek contended that although the allies were intent on fighting Nazi fascism, similar socialist tenets were already being operationalized in the United States, England, and elsewhere. Unless the US et al reversed course, Hayek posited that we would become the very ideology that we proposed to be fighting a war against.

Fast forward to today and there is compelling evidence that Hayek was right.

Monday, December 9, 2013

Portfolio Hedging

"I run risk management. It just doesn't seem like a natural place to start cutting."
--Eric Dale (Margin Call)

Interesting take on the rumored Volker Rule requirement that would not permit banks to engage in 'portfolio hedging' trades.

At first glance, one would think that this would cut into fiduciary duty to clients. After all, hedging can be a prudent risk management strategy, and disallowing seemingly ties the hands of money managers.

However, as ZH and the WSJ note, banks might frame hedging in ways that extend beyond traditional risk management practices. For example, a bank might rationalize that the 'risk' to be managed is a general economic recession and or portfolio underperformance. To 'hedge' against those events, banks might put on huge directional trades. that are not at all hedged in the traditional sense.

JP Morgan's (JPM) 2012 'London Whale' derivative trades that lost the firm $billions were initially described as portfolio hedges by management.

The Volker Rule without portfolio hedging language has not yet been passed. If or when it does, prop trading by the banks will be affected.

You see, unlike you or I, banks have to justify every investment position to bank regulators. Regulators do not like to see large directional bets in bank investment portfolios. However, banks are currently using more than $2 trillion in excess reserves as collateral for leveraged directional trades of all types. How are banks getting away with taking on so much risk? Simple. They justify the positions as 'portfolio hedging' to the regulators.

If regulators will not longer accept that rationale, then banks will either have to find other justification for their leveraged directional trades, or take the trades off.

Unwinding those trades off would...well, let's just say that unwinding those trades and prohibiting them in the future would significantly impact financial markets.

position in SPX

Sunday, December 8, 2013

Cantillon Effect

"You watch your tail, cowboy."
--Nick Conklin (Black Rain)

These pages have used the term 'first user advantage' to describe the benefits that go to those who are the first to get their hands on newly printed cash. While the advantage seems obvious in the case of 'counterfeiters' who print dollar proxies and use them to buy things, it is equally applicable to governments that print cash by fiat.

It turns out the first user advantage is part of what is known as the Cantillon Effect. Richard Cantillon was an Irish-French economist who opposed the inflationary policies of John Law. By understanding the flaws of Law's ponzi-like schemes, Cantillon profited handsomely by taking the other side of trade in the Mississippi and South Sea Bubbles.

Around 1730, Cantillon wrote The Essay on Nature of Commerce in which he conducted pathbreaking analysis of monetary and political economy. Cantillon's Essay remained relatively obscure until resurrected by William Stanley Jevons, the famous English economist of marginal utility fame, more than a century later.

Cantillon was the first to coin and advance the term 'entrepreneur.' Cantillon saw entrepreneurs as non-fixed income earners who pay known costs of production but earn uncertain incomes due to the speculative nature of selling products to buyers with unknown demand.

Cantillon's Essay made several central points concerning inflation. He demonstrated that increasing money supply can have short term positive effects on the economy, but over time the positives would turn to negatives as prices rise and imports increase.

He also showed that inflation does not affect all prices equally or at the same time. Instead, prices are be affected sequentially depending on the spending behaviors of money holders along the channels of money flows.

Those positioned upstream in the channel spend newly minted cash first and get the most bang for their buck. That is first user advantage--part of the Cantillon Effect.

Saturday, December 7, 2013

Repeal Day

"What are you prepared to do?"
--Jim Malone (The Untouchables)

A couple of days back marked the 80th anniversary of the repeal of Prohibition. Prohibition was legalized by the 18th Amendment which was ratified in 1919. It was reversed by the 21st Amendment ratified in 1933.

The repeal of Prohibition teaches a couple things. One is that bad law, law that opposes the natural rights of human beings, never lasts. From the day bad law is passed, forces of nature work against it until the law is inevitably thrown off.

Second is that laws enacted in ways that make them difficult to reverse can still be repealed. This holds true even for constitutional amendments.

Amending the Constitution of the United States requires: a) a proposal by either Congress or a constitutional convention assembled at the request of at least 2/3 of the state legislatures, b) congressional proposals require a super-majority 2/3 of the membership in each house, c) ratification by at least 3/4 of the states either by their legislatures or by ratifying conventions.

This is a high hurdle for any proposed amendment to clear. If an amendment does clear this hurdle, then it seems nearly impossible to reverse the process to take that amendment off the books.

But the repeal of Prohibition demonstrates that it can still happen. Bad laws, even sweeping, 'signature' ones, can be undone.

Friday, December 6, 2013

What a Fool Believes

But what a fool believes
He sees
No wise man has the power
To reason away
--Doobie Brothers

The following image was tweeted by Barack Obama on December 4th. The corresponding post read, "Here's how to improve our economy and create thousands of jobs. #RaiseTheWage"

Anyone with a modicum of economic understanding knows that the cause-effect suggested above is absurd.

The obvious question is this: why stop at $10.10/hr? Why not raise the minimum wage further and generate even more prosperity? For instance, at the going rates suggested above, raising the wages to $5000/hr would double yearly GDP, allow us to pay off most of the federal debt, and eradicate most national unemployment.

This president is either a fool, or he hopes that you are.

Thursday, December 5, 2013

Conditions for Valid Contract

"Nonsense. We have a contract. Your first performance is tonight. Be there or I'll sue."
--General Thomas Waverly (White Christmas)

A contract is an agreement between two or more parties that facilitates and governs exchange.

What conditions must be met in order for a contract to be valid? Seems to me there are several, including:

Voluntary. The contractual agreement must be voluntary. If a party is 'forced to sign,' then a contract is not valid.

Representation. Contracts must be negotiated by the parties involved in the exchange. If the parties are not present in person or in principal via individuals expressly serving as negotiating agents, then a contract is not valid.

Clarity. Terms of the contract must articulated in a manner that is not intended to deceive a party involved in the agreement. If it can be reasonably construed that deception was intended, then a contract is not valid.

Ownership. Parties must possess clear title on what will be traded. If parties do not own items to be exchanged, then a contract is not valid.

Measurable. At any time, it must be clear whether parties are meeting the terms of the agreement or not. If compliance cannot be measured, then a contract is not valid.

Remedy. Remedies must be available to a party in the event that counterparties do not meet the terms of the agreement. If alternatives are not available should there be a breach, then the contract is not valid.

Wednesday, December 4, 2013

Bank Industry Concentration

"What about moral hazard?"
--Bretton James (Wall Street: Money Never Sleeps)

Interesting data presented by Zerohedge on the changing structure of the US banking industry. The industry is getting more concentrated.

Since the mid 1980s, the number of banks has fallen by about 60% while total deposits have tripled. Using the numbers below, I estimate that the average 1985 bank had almost $150 million on deposits while the average bank today has about $1.4 billion in deposits--an 8 fold increase in concentration of deposits.

Another measure of concentration, one the ZH does not include, is the market share controlled by the largest banks. A common metric in this regard is known as the CR4. The CR (concentration ratio) 4 measures the fraction of the total market going to the four largest operators.

Reliable data in this regard are not at my fingertips, but this analysis reports that the CR4 of total bank industry assets increased from 25% in the late 1990s to 68% by the end of 2003. That's a huge increase but actually seems pretty accurate due to the buyouts and bailouts of the period.

Plus, it is hard to imagine that bank industry CR4 has gone anywhere but up since then.

The I-O (industrial organization) economics rule of thumb is that industries with CR4's north of 60% are more likely to be structured in ways that impair competition. As competition is impaired, the franchises of imcumbents are protected. Large is favored over small. Entrepreneurial entry is discouraged. Pressure for productivity improvement declines. Consumers are worse off.

ZH does offer some sense of today's large bank dominance by reporting the fraction of total derivative exposure held by the top four banks:

The four largest banks carry nearly all of the $200+ trillion derivative exposure out there. Derivatives are a form of leverage that creates outsized profits during good times but hastens collapse during bad times.

Remember that during the Next Time Down, when the bigger-than-ever banks once again show up hat in hand for a bigger-than-ever bailout.

Tuesday, December 3, 2013

Inflation's Friends

"It's the story of the greatest wealth transfer in the history of the world."
--Jacob Moore (Wall Street: Money Never Sleeps)

Government: "We need (insert policy such as minimum wage laws, cost of living adjustments) because people need to keep up with inflation."

Wall Street: "You can't just keep your money in a savings account. You have to invest it in stocks and other securities in order to stay ahead of inflation."

For those people who buy into these lines of thinking, ponder these questions: How does inflation come about? Where does inflation come from?

Monday, December 2, 2013

Bears Capitulate

Did you ever sleep in a bear pit
With apple cores and mice along?
Did you ever lay on ice and grit
Or search for a place where the wind was gone?
--The Who

John Hussman notes widespread capitulation among money managers of all stripes. The Investor's Intelligence survey of bearish advisors has plunged to levels lower than what was seen at the 1987, 2000, and 2007 stock market peaks.

Bubbles grow on the backs of some real factor taking on exaggerated importance in the minds of investors. In the late 1990's it was the "New Economy" defined by the Internet. In the mid 2000's it was the belief that real estate prices always go up. Today it is belief in central banks and their ability to manage the economy while keeping interest rates low.

Mix these beliefs with easy credit and corresponding leverage and you have created the ideal bubble environment. Can the current bubble inflate further? Most certainly.

But when it pops it will be hard to remember today's state of collective exuberance.

position in SPX

Sunday, December 1, 2013

Be Ready

Roland Steele: Are you ready for this, champ?
Rudy Ruettiger: I've been ready for this my whole life.

Advent begins this week. The theme of today's readings is preparation and watchfulness. Paul (Romans 13: 11-14) advises "You know what time it is, how it is now the moment for you to wake from sleep."

Jesus (Matthew 24: 37-44) recounts the story of Noah, observing that people ignored the warning signs and partied right up until the day that the floods came and swept them away. Noah, on the other hand, heeded the warnings and entered the ark. "Keep awake, therefore, for you do not know on what day your Lord is coming."

Stark words that resonate. So often we focus on what is in front of us that we ignore winds of change blowing around us. When the change hits, we are not prepared.

God obviously does not want us to develop such complacency. Jesus warns, "Understand this: If the owner of a house had known in what part of the night the thief was coming, he would have stayed awake and would not have let his house be broken into. Therefore, you also must be ready, for the Son of Man is coming at an unexpected hour."

The challenge this advent season is to be alert. To be ready.

TNX Redux

I've been looking so long at these pictures of you
That I almost believe that they're real
I've been living so long with these pictures of you
That I almost believe that the pictures are all I can feel
--The Cure

Stepping back from the daily chart and examining a longer horizon, the set-up for 10 yr yields appears bullish as well.

On a multi-yr weekly chart, the TNX looks cup-and-handlish.

Technical analysis 101 posits that similar conclusions drawn from analysis of multiple time horizons strengthens the message.

Remember that when the technical picture for bond yields is bullish, the picture for bond prices is necessarily bearish, as yields and prices move in opposite directions.

no positions