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Tuesday, July 30, 2013

Pacific Rim Economy

"If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months. … There was a Twilight Zone episode like this in which scientists fake an alien threat in order to achieve world peace. Well, this time, we don't need it, we need it in order to get some fiscal stimulus."

- Paul Krugman (Nobel Prize Economist) on CNN's "Fareed Zakaria GPS", August 21, 2011

Yes, the above is an actual statement which made its way out of a Nobel Prize winning economist.  The Keynesian economic logic or view that in a world wrought with war time policies, economies have no other choice but to ramp themselves up in order to keep up with what seems to be an incessant demand for the war machine as its violent appetite for more resources seems to never be sated.

To put this contemporaneously, let us imagine for a moment that the movie pacific rim transplants its fictional story arc into reality.  WARNING:  Spoilers.  The world is invaded by extra-dimensional creatures of giant proportions (Kaijus) which wreak havoc on large centers of population.  Conventional weaponry proved to be ineffective in taking down these beasts due to them lacking the necessary firepower to quickly quell these 'Kaijus.'

As a response to this inefficiency after the first victory and realizing that more of these monstrous beasts would appear intermittently throughout this [unconventional] 'war' the governments of all nations around the world got together and re-purposed several factories, engaged in ubiquitous research and development which required quite a bit of new resources in order to come up with the right weaponry to combat these invaders; thus the 'Jaeger' program came into being.

Giant mechanized units controlled by two pilots connected neurologically to the machine's AI in order to guide it through its battles was the solution presented and proven effective in subsequent Kaiju encounters.  However, as the Kaiju grew in strength some of the older generation Jaegers began to be destroyed.  This quick global demoralization led to new generations of Jaegers up until all nations decided to once again divert precious resources to the building of sea walls to protect the major coastal cities around the area in the pacific ocean where the extra dimensional rift was found.

In the above briefly described scenario, in Krugman's and many other modern economists' views, this would be a boon for employment and production for economies around the world partaking in the entire division of labor involved in the entire process of manufacturing a Jaeger and its maintenance.  Let us quickly put this fallacious argument to rest.

First of all, large cities endured the massive destruction that these encounters often brought.  Instead of a boon to the construction industry this put further strain in the economy as more resources had to be once again utilized in rebuilding efforts and repairs.  In essence, less resources were available than before.  Moreover, factories, business, or homes that were destroyed during these attacks put a halt to whatever productive measures those entities may have been engaged in at that moment.  The factory no longer will be producing (less goods available overall), the business stops its service, and the home owner(s) or resident(s) may lose their shirts entirely, thus decreasing the pool of capital that was hitherto in existence.

Secondly, factories were re-tooled and re-purposed to become dedicated manufacturing and maintenance facilities for Jaegers.  Ergo, whatever private goods that particular factory was producing before was no longer its final output.  Therefore, the amount of available consumer goods diminished causing a strain the the supply line which would result in an increase in prices as demand remained constant and [forced] rationing would more than likely be the most "rational" (pardon the word pun) action that the governments would undertake (as it did during the world wars).  The same would be applicable to commodity goods being diverted to these efforts such as metals, fuel, et al.  This would indubitably lead to a lower standard of living for all involved.

Thirdly, the precious resources diverted to the war effort were no longer being put towards the betterment of private society and voluntary exchange.  Instead it was being sent directly into the line of fire to their potential destruction.  This action would erase those carefully acquired resources from existence and what could have otherwise been used for an increase in the standard of living is instead squandered.

Lastly, more people would be employed by the public sector (or indirectly by private contract bidding) to work for these purposes.  Again, the labor pool would be constrained and working towards the ultimate resulting destruction of their own efforts.  This would be a wasteful job with non productive qualities.  These otherwise valuable professions which would certainly be involved in this vast project could have instead been focusing on private research for the betterment of society.

Now under the circumstances presented in this film, the Jaegers were borne out of immediate necessity and perhaps their existence justified.  This does not however cause the erroneous axiom that war brings prosperity to be true.  Even though humanity may have been able to protect itself and posterity in the movie, the economic consequences would still ring true regardless, but it is after all just a movie and not reality.  If such actions were truly beneficiary for sundry economies globally, wouldn't it just make sense economically to create a fake war scenario (or alien invasion) and start engaging in the aforementioned actions en masse in order to jump-start the current economic malaise into full production?  The simple answer; no.

Saturday, July 20, 2013

Detroit Bankruptcy: Developments

Reason magazine gracefully captured recent events in a post bankruptcy more below:

Interesting events in Detroit are beginning to take place, the community has been getting together for their own mutual benefit of improving the conditions of their surroundings through charities, church groups, and groups of volunteers sharing their own precious time to mow lawns, keep vacant homes boarded up to bar criminal squatters, private security has become more prevalent in an effort to maintain order in neighborhoods, new police cars and ambulances were purchased by wealthy charities, but unfortunately the latter two items will be provided to the city government who has been progressively decreasing basic services because of a lack of funds.    

However, these will also probably end up being driven by volunteers if things continue on their current path.  After all, why provide a municipal government that has been an utter failure with fresh resources taken out of private funds voluntarily?  Why reward failure?  Why give to an entity that has failed to meet its very basic function (protection)?  An entity which would rather try and keep its authoritative hand by removing a simple bench voluntarily built by a community at a local bus stop so that commuters would have a place to sit and relax while waiting for their ride because it does not comply with local transportation department standards.  

An agency which uses expropriated private property through taxation to fund itself will engage in an action that will remove a simple wooden bench put together by those very tax payers.  It is akin to taking money out of my wallet to pay to remove something I have done (paid for privately and voluntarily) that does not meet your expectations.  Indeed it is correct to ponder, how can a public protection agency which monopolizes this sector be responsible for private property when in order for it to function is must expropriate from that very property (its owners) which it has been tasked to protect.  A bigger contradiction cannot exist.

Rising Oil Prices

Global government demonstration premium priced into Oil, devalued units of Dollars chasing less goods.

Oil is the very substance which allows the many gears of the global economy to continue to function.  Add a premium to this important element and watch the grinding commence.

As oil reaches higher prices per barrel, it is apparent that there cannot be an economic recovery.  This type of price rise is 'bullish' some talking heads on television will say; nay, it isn't.  Crude oil being an input cost is crucial for any business operation, manufacturing operation, mining, etc.  As its price rises, all labor becomes more expensive and a higher share of capital has to be diverted to this most important factor of production.  Investment in other areas will be temporarily put off until the price of oil lowers once again, which it may or it may not.  At this juncture any form of prediction is akin to saying the next roll of the dice will land on a specific number combination.  Which in all honesty may be easier to do considering the number of variables involved vis-a-vis the current manipulated market, but I digress...

These input costs will eventually work their way down to the consumer level, i.e., lower order goods.  However, as oil is a precious commodity for business, so it is for the consumer.  After all, transportation is a necessity for most activities in the United States and as it is the case with most, it requires this all too important commodity to make it happen.  As more income which would have otherwise been used elsewhere is spent on gasoline (a derivative of oil), less is available for other expenses such as products and goods from the very businesses suffering from increased input costs.  

Moreover, just in time inventories which depend upon nation wide logistics of simultaneous truck movements is also powered by this aforementioned derivative of the commodity discussed; oil.

In an almost self fulfilling prophecy that comes full circle, the business sells less goods and therefore fails to meet its revenue targets.  Ultimately in a real scenario, which in this [temporarily] centrally planned economy need-not-apply, this would cause a downward pressure in companies' stock prices which would be reflective of the very price rise in oil deemed 'bullish' by some.

There is nothing at all bullish about added pressure on the lives of those in a fragile economy consisting of ever increasing volatility, uncertainty, and a schizophrenic Fed yelling "Polo!" before markets can even say "Marco!"   

Thursday, July 18, 2013

Detroit Bankruptcy

Detroit files for bankruptcy. In a world where the market could operate freely without being hampered by the tentacle of government, this scenario could present people with an opportunity that has heretofore not been seen in a really long time.

Imagine the city's government itself having to be disbanded in droves and liquidating its assets on the open [international] markets at heavily discounted prices with extremely low to zero tax rates. Depending upon demand, certain areas may be snatched up by corporations and individuals looking to create their own vision of what a revitalized Detroit may look like. This may lead to an overall cleansing of the city's current decrepit condition and make way for new structures, perhaps parks, private natural trails, new company buildings and factories. Those areas not at first snatched up would slowly gain in value and at some point obtain a buyer as its surroundings reawakened and flourished with activity by private demand. The city itself could become a roadmap for how to achieve success and be a competitive city state rivaling entities such as San Marino, Monaco, Hong Kong (Formerly), and Singapore. Since it would be composed of minimal to no public administrative monopolizing entity, it could petition itself to secede from the state and subsequently the union. Granted this is nothing but a silly illusory scenario, but imagine what sort of message and chain reaction would reverberate throughout the rest of these United States and globally. Perhaps a migration of job-seekers and productive entrepreneurial individuals would make their way there and as other locations saw its success, policies would be set in place to emulate it.

Just a quick thought I had concerning the 28 days later like situation going on in Detroit city. This isn't by any means a serious discussion...

Wednesday, July 17, 2013

FOMC - Federal Reserve Bernanke Admission of Printing

Today's exchange summed up in two lines:

Q: Are You Printing Money?
Bernanke: Not Literally

Of course he is not printing money, since he cannot replicate gold with his printers.  However, he is indubitably massively digitizing and printing fiat into perpetuity.

If the Fed were to tighten policy, the economy "would tank"

Should they turn the spigots off and seal the continuous flow of liquidity onto an ever filling up sink with a clogged drain (water pun need not apply), it is obvious that this temporary illusory 'recovery' would back track completely as the support levels for the financial markets, real estate, and bonds would be crushed downward and a major [temporary] deflationary correction would take place (a much needed one).  This would result in heavier subsequent intervention by the Fed which would ultimately unleash inflationary madness in order to maintain the status quo.

Saturday, July 13, 2013

Understanding Inflation


It seems that the true definition of inflation has been subject to change in recent times when focusing in the economic reaction to its action.  The original meaning of the word still suffices as a definition that places it in accordance with its monetary results; “to blow into,” “to puff-up.”  However as stated above, inflation’s true origin is forgotten and it is conventionally recognized only as a rise in the price of goods in any given market.  Ergo, it is apparent that the true malicious purpose which inflation serves from time immemorial is seldom understood and is a subject relegated to esotericism.  This is why it is important that inflation’s point of origin and its subsequent myriad forms be defined and explained.

First of all, one must understand how inflation occurs.  Returning to its original definition of to blow into or puff up; inflation does just that to the monetary supply of a nation.  It expands it typically under the auspice of some central planning authority, or bank which by has been granted such rights by government decree.  This decree deems the bank’s notes legal tender for all debts to be paid and therefore a monopoly on money is effectively created.

Central banks expand the nation’s money supply through a few methods.  Primarily as it is the case with Federal Reserve today, it purchases assets on the market through quantitative easing.  It currently does so by its asset buying program to the tune of $85 billion per month.  Should an asset be directly purchased from a bank, then this new money is added to its reserves and the stage is then set for multiple credit expansion if it is loaned out due to the fractional reserve banking system.  However, the preferred asset of central banks are typically government securities.  This serves as an insurance for government that demand will continue to exist for its own securities.  Ergo, allowing for new expenditures in an ever growing debt.  By issuing new bonds, governments quickly inflate the money supply.  Since the central bank is ordered to purchase these securities, a new [supported] price floor is set, thereby causing an influx of treasury bonds into the bank subsequently leading to [seeming] perpetual inflation, i.e., expansion of the monetary supply or base.

Via the asset purchasing program effectively called QE, direct injections of liquidity are made into the open markets leading to a state of Permanent Open Market Operations (POMO) which is quickly evidenced by prior bail out programs and other injections such as operation twist and former quantitative easing(s).  When the market attempts to contract and cleanse itself of malinvestments created by artificial inflationary booms, the aforementioned action helps to instill a sense of security -although temporary - in the economy for it is being supported by the central bank.  This drives equity markets upwards due to increased demand as both institutional and retail investors clamor to ride this wave of easy money into higher returns, effectively chasing ever higher yields since savings provides zero returns due to extremely low interest rates set by the central bank.  This becomes a vicious cycle of further buying that may temporarily take the market to new heights nominally without any real fundamental improvement done to the economy.  Consequently, there is a collective sigh of relief during this illusion known as the wealth effect whereby portfolios, 401k plans, pension plans rise creating a false sense of security that the economic scenario has once again restored itself to previous norms.

In what could only be called a financial pincer movement by central banks to prevent deflationary busts - which are only market corrections - not only are liquidity injections the remedy du jour, but interest rates are arbitrarily and artificially lowered to encourage more spending.  The lower interest rates signal that there are more funds readily available for investment than there actually is, this is an attempt at manipulating the economy back into a ‘boom’ period of frivolity in spending savings that it does not actually have.  This repeated action only exacerbates the issue concluding in another deeper contraction at a later point in time requiring further stimuli by central banks.  This pattern has been recently seen in the dotcom bubble of 1999 and the real estate bubble of the 2000s where by lower rates drove new credit directly into these sectors of the economy creating anomalies which later needed to be divested.

Moreover, as new currency is artificially created, more money is chasing the same amount of goods leading to a devaluation in its purchasing power and an increase in the price of goods.  Due to its [current] global reserve status, the US is in a position to theoretically expand its monetary base without much visible [immediate] effect to its populace since its inflation is concurrently exported to other nations needing Dollars to purchase necessary imports for their own economies, such as oil (petrodollar).  Demand is therefore constant for these new Federal Reserve notes.  As the United States continuously inflates its supply of money so must other nations lest they become less competitive in the export and import market. 

Theoretically, debasing a country’s currency makes its exports more attractive as they become cheaper in the broader global market which consequently leads to a temporarily higher trade surplus or narrower trade deficit depending upon the current account balance the country has with regard to its imports and exports.  However, this a fallacious theory due to the fact that imports themselves become more expensive leading to a lowered standard of living domestically as those goods become gradually less affordable since purchasing power is diminished.  Imported raw materials from other nations will also rise in price due to debasement leading to higher input costs which eventually trickle down to the consumer good’s final price.  This action results in an increased cost of living that progressively chips away at the ability to maintain current standards within the nation.

However, given the velocity of money the above consequences may take a long time to be felt throughout the remainder of the domestic economy.  If the banks which received fresh supplies of reserves do not loan these out and the credit market remains stagnant and in a contraction, the monetary base has indeed expanded, but since the money has not been put into circulation there is no resulting price inflation.  Until such time, inflation’s negative effect is not immediately felt. 

When the money does start taking its effect on the economy and input costs rise they are quickly seen in the supermarket shelves by consumers.  Fortunately for central planners, these prices have been rather slow to rise and to the untrained eye they are not as obvious to spot.  Another manner with which producers can conceal inflation is by decreasing the size of the product’s container or lessen the amount of its contents, e.g., less chips in a bag, smaller rolls of toilet paper, etc.  This is in fact a form of indirect price inflation. 
Furthermore, as the natural interest rate of the market wants to return itself to a level reflective of daily activity, more pressure is placed upon the artificially low rates set into place by the central bank.  This result is seen in higher rates for mortgages and other forms of loans.  Those that suffer specifically are the individuals which are exposed to adjustable rates which consists of a large portion of households in the United States.  Even a small percentile increase can be the difference of tens of thousands of dollars in interest over the life of the loan.  This decreases the amount of monthly disposable income that would otherwise be put to use for home necessities or savings as the mortgage payment rises.  Once again this results in a gradual lower standard of living since a higher percentage of income is put towards the payment of the loan.

Although governments release official inflation figures, these are often fudged statistics that quell public sentiment and quiets those that do not see the rise in prices of goods reflective of the published data.  Often these figures are also backward looking statistics of a basket of goods (of the government’s choosing) to represent the past year or quarter price increases.  Taking alternative calculations utilized by the government in prior decades, percentages for inflation rise when compared to the current method of data collection and calculation.  It is sometimes better to look to commodity prices as forward looking inflation statistics.  It is important to remember that the prices of these goods aren’t rising, but rather the value of the currency in which they are denominated is decreasing leading to the need of more units to acquire the same amount previously requiring less units.

One consideration and often rare caveat to inflation is the pace with which technology allows for further improvements in the daily lives of humans.  These can often be of a big enough positive change which acts as a shield against rising prices.  Newer processes which hasten otherwise clumsy and old manufacturing assembly lines cause input costs to decrease resulting in a potentially less expensive price for a lower order consumer good.  However, should inflation be critical enough then the aforementioned would not be successful in halting or lowering overall prices of a specific good whi
ch its process has been marginally improved by innovative ideas and inventions.

Therefore, it can be rightfully concluded that no matter in which form inflation arrives it is detrimental to the health of any economy.  It is indeed an additional tax on the earnings of a nation’s labor force which diminishes their purchasing power whereby standards of living go down as a result.  This fleecing of the populace has been occurring in grand style since the Federal Reserve Act created the central bank which further consolidated what was once a decentralized banking system which kept a better check on inflationary pressure.  With a central bank observing monopoly rights over the creation of money, it serves as a tool for officials to grant subsidies to their constituency in exchange for votes and it finances all programs which result in government largess that would be impossible in a truly free banking system based upon a commodity standard.  Warfare and welfare would be relegated to exorbitant direct tax increases instead of inflation on the population and the effects of such policies would be heavily felt upon citizens resulting in a much more limited legislative body constrained by the true consent of its people.