Befuddled Clown or a Criminal?

In the post modern world wealth is simply a combination of what everyone believes and the techniques of monetary manipulation to make it so. There is no absolute reality to worry about and having forced the models to telling us what we want we can believe about monetary policy then age old techniques of printing more money to create wealth can be used with little reservation. The last week has been a clear combination of this.

Firstly, Bernanke, and anyone else they can garner, tells the world that they see light at the end of the tunnel for the US recovery and a return to growth in 2010, even though the market has told us that the Greenspan growth we are returning to wasn't actually growth at all. But none of this matters to an alchemist. All that is required is that everyone believes that the recession is ending then it will and the destruction of wealth of the Greenspan years will just become irrelevant.

Secondly, Bernanke has just injected 1 trillion dollars of new money into the US economy so we must be 1 trillion dollars more wealthy and with that kick to the economy we will be even richer when the multipliers set in.

The fact that money, one of mankind's great a priori inventions to facilitate the economy and the production of wealth, is not wealth but an information signal is lost on this poor man who understands nothing about the function of money. Just to remind him the function of money is to be a store of value, a medium of exchange and a unit of account and all of these are being destroyed as he sets off to create wealth.

The conjuring up of non market money leads to the misallocation of resources and corruption which he is aware, as is the entire world, as clearly the bad investments of the likes of Golman Sachs and bonus obligations of people who made these failed investments are being covered. So we must not discount the possibility that Bernanake is not a befuddled clown but someone who knows fully what he is doing and is engaged in criminal activities. Take your pick but can some please take this man off the stage before he really does some irreparable damage

Blaming Something That Doesn't Exist.

Since market forces began trying to move asset prices downwards in early 2001, when the irrational exuberance of the technology boom became apparent, the US Federal Reserve has tried every trick in and out of the book to prevent this downward trend. Some success was achieved by flooding the economy with cheap money but as wealth was actually destroyed in the longer run due to misallocation of capital it was only a temporary success. With one engine gone fiscal policy and out right protectionism has been engaged in to stimulate the economy and save the world.

Incredibly now after all these years of monetary and government authorities manipulating the economy the common consensus is that the current downturn proves that the free market has failed. Beyond that if we examine the economic system in terms of gains and losses over time and the production of wealth we can see that the free market approach is rarely allowed to operate and if it does it does not operate for long.

1) Socialise the gains and losses

An example of this would be Cuba after the revolution where all economic activity was directed by the government and hence all gains and losses were socialised. Unfortunately, the economic wealth of the country plummeted and when funding from Russia dried up after the Berlin wall came down it moved to the next model.

2) Socialise the gains, privatise the losses

When the Cuban economy broke down it moved to this system. In order to be able to quickly provide services to tourists Castro granted licences for some private activity (bed and breakfasts). The private system and network sprang up very quickly but incensed by the profits Castro quickly began to tax such operations heavily causing many of them to abandon their businesses. So the wealth effect began to decrease quite significantly

3) Privatise the gains, socialise the losses

This is the system currently in operation in the United States as the losses of private companies are being absorbed by the government. The effect on wealth of using capital to keep non productive companies in existence is clearly downwards. In addition the clear inequality of the system does open the door to some larger scale wealth destruction due to social unrest.

4) Privatise the gains and losses

Non distorted markets, which reward organisations that have made correct investment decisions according to consumer choice, and allows them to fail when they have not, creates wealth and minimises waste of resources. The only way to ensure that this system does not break down once underway is to prevent successful organisations influencing government to remove their competition. Due to the influence of wealth this system rarely exists for long.

As the taxpayers of the world are having their funds used by large private businesses that have failed it's important to note that their demands are done to actually prevent the working of the market and the free market that is supposed to be the cause of all the troubles is never allowed to exist.

Consensus Building, Government Action, Good Words, Bad Actions

When a financial crisis comes along the many mistakes government made on the road to the crisis become apparent. Luckily in the time of crisis the past must be left in the past and the government sets about trying to fix the mess.

In the face of a serious financial crisis, where assets are no longer worth what the paper magic of Wall St made them appear to be, there are only three actions a government can do.

1) Intervene a bit to attempt support these assets (there by supporting the paper magic of Wall St)
2) Intervene hugely to attempt support these assets (there by supporting the paper magic of Wall St)
3) Do nothing - ie allow market forces to determine the value of these assets

Obviously the third option is hard to consider for governments and their economic advisers. If the crisis was allowed to happen on their watch and their stepping aside is the best solution to the crisis then they are not the saviours but the problem. High positions attract people with high ambition and opinions of themselves so the 'do nothing' choice is hard to rationalise. They usually try the first choice and when that doesn't success it leads them strongly to the second choice. Even if things get worse they have the luck of never knowing the other outcome and claim that things 'would have been even worse' but for their action. There is also the belief that enough money and brain power will eventually move the economy toward the right outcome so it's just a matter of effort and time. Therefore the road not taken, even if it could have been better, was not a big blunder at the end of the day and if everyone can be brought along with the government thinking then all the better.

So it doesn't really matter what points are made, re inefficiency, fairness of bailing out bad banks, corruption etc the government action is going to happen and eventually the solution will be achieved. Unfortunately as Mises in Human Action points out nothing can save a society from ideological inconsistencies.

"Logical thinking and real life are not two separate orbits. Logic is for man the only means to master the problems of reality. What is contradictory in theory, is no less contradictory in reality. No ideological inconsistency can provide a satisfactory, i.e., working, solution for the problems offered by the facts of the world. The only effect of contradictory ideologies is to conceal the real problems and thus to prevent people from finding in time an appropriate policy for solving them."

For a quick resolution to all of this we have to hope that Mises is wrong which seems very, very unlikely.

Misallocation Of Funds

Obama and his team voiced outrage after the New York comptroller reported USD 18.4 billion in 2008 bonus payouts to the Wall Street bankers. The simple economic theory behind avoiding government intervention and spending is that such funds will be used inefficiently due to a lack of knowledge of the administrators and/or vested interests of people with the knowledge and influence to direct such funds toward themselves. In the current bailout the latter is being made all the more easy by the refusal of the Federal Reserves to disclose the recipients of the $2 trillion of emergency loans, despite Bloomberg news filing a suit under the Freedom of Information act in a desperate attempt to get this information. However, not even the Freedom of Information act can get the details out of Bernanke and Paulson who only managed to get congress to agree to this huge amount of money with guarantees of transparency. So it's no surprise the money is being pocketed by the former colleagues of Hank Paulson but what is a surprising is that Obama is surprised by this. He's obviously not a naive man. No matter though, it would be good to see him doing something beyond simply handing out a scolding to those concerned. Even if their criminal facilitators, messieurs Bernanke and Paulson are removed, the recipients of the money will keep on taking and lying until the cost of doing so outweighs the benefit and it will take a lot more than scolding.

Connected to all of this, and even more ridiculous, is the justification these banks give for having to pay these bonuses now they have been discovered. The claim is that it's important that such money is paid to prevent these talented bankers from walking out the door with all their expertise. One has to wonder at how people who managed to destroy a decade of savings belonging to their customers, the banks they work for and also deliver the world into the biggest financial disaster since the 1930s are considered to have a talent that is worth paying for. It would be better for any financial institution left standing to see that kind of talent walking out the door. In a sector where job levels are collapsing it's hard to believe that they'd be off anywhere else anyway, bonus or no bonus.

Lost Governments

The aim of Economics is to give the best outcome to society for a given amount of resources so governments looks to economic theories to achieve this result. This simple aim becomes quite complex when the different schools of economics compete to influence governmental action. Empirical and mathematical methods are used by some schools to support their claims which makes them more influential in a world with much belief in science and mathematics. Beyond the limitations in the scope of the theory (the minds that conceive it), data analysis and unrealistic simplifying assumptions there is also the social fact that what is understood and implemented by governments is often not even what the theory, rightly or wrongly, was suggesting. Governments are made up of politicians and some economists, from whatever school is being looked to for solutions at the current time, or have the political connections for gaining power.

The story over the past twenty years is that Marxian government planning and intervention of the economy was proven wrong once and for all with the collapse of the Soviet Union. Free market capitalism was declared the clear victor and over the next 15 years assumed it was what was being implemented and was giving the best outcome to society. The fact that the Federal Reserve has been intervening in the market since the late 90s to prop up the vested interests of large investment managers cannot be understood by commentators, who influence politician and the public. These commentators believe, probably because the Federal Reserve deals with money and business, that the Federal Reserve is a free market institution.

Suddenly, now that a big collapse has occurred under the supposed free market system, a new differnt theory must be found. There are only a couple of approaches for resource allocation in economics so some out of fashion school comes back into fashion. As complete free markets were the old story then the new story has to involve more control of the resources by government, which of course suits the politicians who are only too willing to spend money. Luckily there is the Keynesian school of economics which allows for government intervention without using the name of Marx.

In reality though, the collapse was caused by intervention of the Federal Reserve in the market, by overexpanding the supply of money and the bailing out of failed firms (failed due to incorrect business models and shifts in consumer demand [Asia was producing the cars, electronic goods, etc that Western consumers wanted]). However as the wrong culprit has been identified, intervention is being used to save an economy destroyed by intervention and we have ended up with confused politicians. So now we have confused governments who are believing in a hodge-podge of ideas - most recently the US government claiming it was "abandoning free market principles to save the free market"!. The extra years of economic theory since the great depression has only led to confusion, making leaders bereft of logical thinking to address the problems of the real world.

Chancers In Charge

What is incredible in the current economic crisis is how many of the people who made decisions that led countries that are feeling the worst effects of the downturn, such as America, Britain and Ireland, are being looked to for solutions. The Alan Greenspan spawned approach of no regulation/intervention at all until something too big to fail must be saved is the worst possible economic model of all. If bailouts are in the model then so must regulation to prevent ridiculous risk taking.

In early 1998 when Brooksley E. Born, the head of Commodity Futures Trading Commission (the federal agency that regulates options and futures trading), began putting forward a proposal for derivatives regulation she was firmly knocked back by Alan Greenspan, Robert Rubin and his protege Laurence Summers. Unbelievably they claimed that her attempts at regulation would actually lead to a financial crisis:

In early 1998, Mr. Rubin’s deputy, Lawrence H. Summers, called Ms. Born and chastised her for taking steps he said would lead to a financial crisis, according to Mr. Greenberger. Mr. Summers said he could not recall the conversation but agreed with Mr. Greenspan and Mr. Rubin that Ms. Born’s proposal was “highly problematic.”

As the derivative market is being blamed for the huge build up in fictious wealth and risk that set the foundation for the crash one must wonder why Summers and Rubin are advisors to Obama. We should thank our lucky stars that Alan Greenspan has retired although unfortunately we are left with his equally clueless pupil Bernanke.

One of the biggest chancers of them all though has to be Gordon Brown who has now found a crisis to cover up his floundering. He is leveraging on his love of crisis and dourness to distract the British people from the reality that he was the one who actually got them into the mess in the first place. As Britain's economy and banking sector began to crash in 2008 we have to wonder at his economic stewardship as chancellor of the exchequer in the preceding decade (2 May 1997 – 27 June 2007). This is all the more laughable when he prided himself from being the chancellor of the party that would take Britain out of the boom bust cycle as he boasted at the Labour party conference in 2000.

Breaking from the chronic and flawed Conservative short-termism and implementing Labour values; planning for the long-term; economic responsibility; building from strong foundations. Determined to protect hard working families from a return to boom and bust.

As invented paper assets are being blamed for this whole mess his understanding of banking has to be questioned with his sell off of gold in 1999. He cost the Britain at least £2 billion then when he sold off more than half of the country's gold reserves at stagnated price levels.

We have to assume that these people did not see any of this coming and just lacked any understanding of economics at a level required for making national and international decisions. As long as they remain in their positions the prospects of a quick resolution to the financial crisis are zero.

Nothing New Going On

The character in one of B Traven's novels uses his understanding of the business cycle to achieve a goal and in doing so Traven describes this age old cycle:

"The speed-up of production and the slow-down in delivery played so quietly, gradually and cleverly that not even the sharpest coal competitor dreamed that an historic manoeuvre was going on under their very noses, for this was during months of flush, bored-with-business boom-time, which usually precedes the dawn of a real depression, though rarely apprehended and correctly analysed by busy bankers and aggressive corporations; and if a few clever financial commentators do predict it, they are damned as defeatists, or, worse, as unpatriotic prophets.
And thus,on a quiet business day when all was rosy as a May-time sunset a crash was heard. Just a little one.
But the crash was exactly as hard and as heavy as Collins had predicted it would be, during his many months of cunning preparation.
At first, the blow did not jar the world of big business, for it didn't hurt big business. It was a local blow; it was like tossing a nut of coal onto a slumbering giant, and watching him wake up, yawning contentedly from his sweet dreams of extra dividends.
No hurry. Nobody hurt. The giant isn't angry, for he doesn't even know who or what ended his sleep. But any man with a good nose and a sharp eye could smell a storm coming up. And some of them said so. Perhaps five sharp financial commentators smelt it, and perhaps one of each thousand among millions of readers believed them, and picked up their profits and got out while the going was good, leaving the multitudes of investors to continue adding up their "margin assets" and paper-profits."

(The White Rose, B Traven, 1931)

Never as bad as the 1930s - Why Not?

There has been a timeline of confident comments used to argue down anyone who dared to question the senseless financial actions of the federal reserve and Wall St and point out the large black clouds appearing on the horizon. One by one they have slowly been disproved as the global economy moves in a giant wave unfurling itself as it wills despite the worlds central banks and governments.

'Monetary policy is stellar, the US economy has never been wealthier or in better shape'
'The sub prime shake won't extend to the larger economy'
'There is simply a slow down in economic growth but we should skirt recession'
'With the actions the fed has taken we will avoid recession'
'With the action the fed and treasury has taken we will avoid a deep recession'

We have now come to 'no matter what' qualifier.

'No matter what happens it will never be as bad as the great depression'

The obvious question is why not?

The assumption is that the new technology and better economic understanding of the latter part of the 20th century will protect the global economy from falling to great depression levels. When we look at these claims though there must be concerns.

Firstly, the technological advances that generated the 1990s technology bubble were no more of an advance beyond the technological advances of the early 1900s (flight, electricity, radio, cars etc) that generated the 1920s boom.
Secondly, the clear surprise of the US economic authorities at the lack of traction of their policies is beginning to show that all those advances in Macro theory may not have been much of an advancement at all.
Thirdly, those advances had Alan Greenspan expand the monetary supply after the 2001 technology bubble collapse to unprecedented levels which led to distortions and destruction of wealth at new levels.
Fourthly, as a result of these financial policies the US is now entering this dark period as a major debtor nation when it entered the great depression as a major creditor nation.

Already there are signs that a 1920s level downturn is on the cards. Unemployment is the key and granted unemployment reached 25% of the labour force and we're a long way from that. But are we really only at 7% unemployment? As Reuters points out if unemployment were still tallied the way it was in the 1930s, today's jobless rate would be closer to 16.5 percent. They have learned a few tricks about economics along the way!