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.

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 Today that concentrated model has been replaced by a fragmented model where many smaller exchanges operate in a satellite configuration with fewer buyers and sellers populating each exchange.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

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.

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.

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.

References

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.

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
--U2

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.

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.

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

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.