The Brothers Austrian

Zero Hedge notes that gold has reached an all time high in Euros. Today, the DXY threatens to break out and Elbert Edwards of Societe Generale says that the Euro will fall 25% versus the US Dollar (I agree, but, wow, seems hard to believe with helicopter Ben at the helm). The market confusion volatility in currencies is the unfolding of a major global currency crisis.

Meanwhile, back at club med in Greece, customs agents go on strike,  exacerbating Greece’s economic woes by hindering exports. Greece’s citizens are rightfully angry that their wages and lifestyles will likely have to be trimmed back. After all, most of Greece’s citizens made the best decision for the families by working for the federal government (Fed employees are 20% of Greece’s workforce). Now they will likely have to except a pay cut or be retrained in another industry. There simply is no easy “human” decision to be made.

Meanwhile, gold is attempting to return to its real worth, zero, which would place gold at a value of 6,000 US DOLLARS! At which time the governments of the world will blissfully ask that its citizens hand over its metal in exchange for toilet paper as it did in the 1930s.

Andrew Jackson is howling from his grave as we speak, while Nicholas Biddle lies in his with a smile.

Wendall Wilkie Gold, Inflation dollar, euro, fiat currency, Gold, greece

With talk of a second stimulus package already in the works, many are wondering who is going to pay for all of this?  Well, as William Graham Sumner famously said, it will be the “Forgotten Man.”  Well, certainly we will all have to pay for stimbailtarpitis, in some way or another, but it is the Forgotten Man who will pay the most.  This will likely come in the form of inflation.

As any good Austrian knows, inflation will hit the Forgotten Man (especially the poor Forgotten Man), first and hardest.  Many will counter and say, what about all of those people who got jobs from the stimulus package?  Well, yes, but they are not the forgotten ones.  If one were to take a cynical view they are merely the ones closest to those wielding influence over policymakers.  Nevertheless, they will benefit from the stimulus, but only at the cost of the rest of society.  As Henry Hazlitt eloquently explains, those who receive additional money (from the stimulus) will be willing to pay more for goods and services.  Anyone who understands basic supply and demand will agree with this.  Stimulus receivers now have more of something (dollars) and therefore each will inherently mean less to them.  This will lead to price inflation.

The Forgotten Man, however, is now stuck in an even worse situation.  Now, not only does he feel worthless for not getting stimulated, he also has a lower standard of living than before.  Why?  He did not receive an immediate impact from the stimulus, but higher prices stared him in the face shortly after the dole was passed out to his neighbor.  His standard of living will go down.

I will leave with a parting shot from Mr. Sumner.  Keep in mind how relevant this is and remember, he is writing in 1883, not 1983.

In all jobbery the case is the same. There is a victim somewhere who is paying for it all. The doors of waste and extravagance stand open, and there seems to be a general agreement to squander and spend. It all belongs to somebody. There is somebody who had to contribute it, and who will have to find more. Nothing is ever said about him. Attention is all absorbed by the clamorous interests, the importunate petitioners, the plausible schemers, the pitiless bores. Now, who is the victim? He is the Forgotten Man. If we go to find him, we shall find him hard at work tilling the soil to get out of it the fund for all the jobbery, the object of all the plunder, the cost of all the economic quackery, and the pay of all the politicians and statesmen who have sacrificed his interests to his enemies. We shall find him an honest, sober, industrious citizen, unknown outside his little circle, paying his debts and his taxes, supporting the church and the school, reading his party newspaper, and cheering for his pet politician.

Teacherman Inflation, Interventionism austrian, forgotten man, Hazlitt, stimbailtarpitis, stimulus, william graham sumner

What haunted Henry Hazlitt, still haunts us today: Governments focusing on only what the immediate effects of a policy will be. He refers to their actions as “half truths”. The seen and unseen. The seen of this bailout is that a few hundred thousand auto workers are still employed and the employees/retirees will have benefits.

The unseen: What about the workers that are not part of the auto industry that did get laid off? What about the worker whose 401k is down 40% with no pension plan? What about the guy who saves and saves and saves, only to have the value of savings dwindle via inflation in order to pay for the bailout of the auto worker (I am sorry let’s be honest here, this is a bailout of a group of people that have political pull, not the saving of a so called iconic “American” industry)?  What about the capital resources that are redirected to the auto sector versus another, more viable sector? What about the effect on bond investors?

In a NYT op-ed piece James Glassman claims that this might  “Drive the bond market to ruin”. This is the what I call the “Obama Button”.  It’s like the reset button. What would happen if we pressed the reset button? Who knows right? All bets are off! If I am a bond investor I have to price in whether or not an industry will be “bailed out”.  While the immediate effect is saving a few hundred thousand jobs, the long term effect is that there will be more market volatility because we never no who is next to be part of our “bailout nation” or even how to price the possibility of a bailout. Will the bailout lead to the bonds being “made whole” like they were for Citigroup or will do I price in huge discount in case the government tries to super cede me in the capital structure (think Chrysler secured bondholders).

Wendall Wilkie Government Spending, Inflation, Interventionism, Taxes, Uncategorized auto industry, bail out, bond market, citigroup, henry hazlitt, obama button

A co-worker of mine recently put me on to a great op-ed that was in WSJ Monday morning by on Bubble economics by Steven Gjerstad and Nobel Laurelate Vernon Smith. The whole article is fantastic but I want to focus on one small part of it that really baffled me:

“In 1983, the Bureau of Labor Statistics began to use [for CPI] rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.

With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since “owners’ equivalent rent” is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.

With nominal interest rates around 6% and inflation around 6%, the real interest rate was near zero, so household borrowing took off. As measured by the Case-Shiller 10 city index, the accumulated inflation in home-ownership costs between January 1999 and June 2006 was 151%, but the CPI measured a mere 23% increase. As the Federal Reserve monitored inflation in the early part of this decade, home-price increases were no longer visible in the CPI, so the lax monetary policy continued. Even after the Fed began to slowly raise the fed-funds rate in May 2004, the average rate remained low and the bubble continued to inflate for two more years.”

So what does owners equivalent rent really mean according to the BLS?

“(The) BLS asks each homeowner for their estimate of the house’s implicit rent and what occupants would get for their rent (how many rooms, etc.) if the owner did rent their home.”

When the Bureau of Labor and Statistics do their surveying for shelter index portion of CPI they ask the following question (verbatim):

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

Man I would love to get one of these calls.

If you ask someone about their home value, that is something they probably know about, but if you ask someone about their house’s implicit rental equivalent is, now that is a different story. Most people do not understand the economics of rental properties well enough to give such an opinion. Furthermore, how many people living in Mc-Mansions can even contemplate what their monthly rent would even be when they live in a neighborhood that may not even have on housing unit that charges on a monthly rent basis?

I think Gjerstad and Vernon know what Hazlitt knew decades ago: inflation numbers are blatantly cherry picked and scrubbed to make it seem like the COLA estimates are much lower then they really are.

Furthermore the BLS states that, “Because rents are not volatile, the CPI can use a longer interval between pricing observations than it uses for other consumer items.” I guess we will have take that statement about volatility at face value.

Click here for more information regarding the housing index and CPI

Wendall Wilkie Inflation, Real Estate, Uncategorized cpi, Hazlitt, housing bubble, Inflation

There are many, many, micro inputs that collectively have combined to culminate into this massive credit crisis. The creation of the Federal Reserve, coming off the gold standard, the invention of the credit card, the invention of asset backed bonds, subprime lending, etc etc etc. Who could have ever thought that all of these things would culminate into a crisis this big? Well Hazlitt knew the problem was on the horizon in the 1950’s and make no mistake, Hazlitt was woefully aware of how devastating inflationary policies could be.  Have we forgotten about what the fall of the German mark  ultimately lead to? The below statement actually strikes the fear of god into me!

“Like every other tax, inflation acts to determine the individual and business policies we are all forced to follow. It discourages all prudence and thrift. It encourages squandering, gambling, reckless waste of all kinds. It often makes it more profitable to speculate than to produce. It tears apart the whole fabric of stable economic relationships. Its inexcusable injustices drive men toward desperate remedies. It plants the seeds of fascism and communism. It leads men to demand totalitarian controls. It ends invariably in bitter disillusion and collapse.”

-Henry Hazlitt (Economics in One Lesson)

· Discourage prudence and thrift- government encouraging spending ?

· Gambling and speculation -Flipping houses, LBO’s-?

· Desperate remedies-monetizing debt-?

I believe that the above statement by Hazlitt not only summarizes how we got into this “credit crisis” but also summarizes where we will end up. Monetizing debt is just the start of the desperate remedies. I fear that the impudence of the governments of the world will lead to further instability. Now, as brutal is this instability may end up being it is my job, I still look for future investing opportunities.  That’s why I have coined the GGO Investment Theory- Guns, Gold & Ordinance (perhaps we should substitute oil for ordinance?). That is not to say that I recommend running out and buying stocks, because I actually wholeheartedly believe that equity indexes will cough up another 40%–that’s right I said 40%–within a year. When the cough up comes, however, I will be ready to pick up some defense stocks on the cheap. As far as gold goes, well you better have some of that before that cough up comes, because otherwise you will be paying up to own the bullion.

Wendall Wilkie Gold, Inflation, Stock Market defense stocks, economics in one lesson, Gold, Hazlitt, Inflation, oil

I posted last week about the growing unease of the Chinese Central Bank toward its US investments.  Now China (along with Russia) has manifested its unease with a call for a new global currency, led by the International Monetary Fund.  As scary as this notion is, I wanted to highlight the growing unease with the US dollar.  While it appears unlikely that China is willing to take an investment hit in order the skewer the US, it is clearly setting up for a dramatic shift away from supporting the issuance of dollar debt.

How China Sees the World (Economist.com)

China understands that the only way for the US to service its debt is through monetization.  It’s unlikely that they ever imagined a US recession would lead to this type of monetary expansion:

As the US dollar currency in circulation approaches $1 trillion, China is finally trying to find a new safe haven for cash.

Is it likely that we will see another Bretton Woods soon?  I don’t think as it stands now.  But maybe, just maybe, China is setting the framework for a future day when it dumps its treasuries and punishes the US.  This certainly would be painful for Beijing, but what is this investment actually worth anyway?  It may be the perfect catalyst for a Shanghai version of Bretton Woods in 2010.  Could a new currency order with China leading the way be worth its investment loss?

Teacherman Federal Reserve, Inflation bretton woods, china, debt, dollar, global currency

The Obama administration took steps over the weekend to reassure the Chinese government that its investment in US treasuries was sound.  The Chinese primier Wen Jiabao had shared his trepidation over the potential decline in the US dollar.  A former Chinese central bank advisor complained the administration’s reckless policies are eroding China’s investment in US treasuries.

We really have to stop and note the irony here.  We have a communist country chiding what is supposedly the world’s great bastion of capitalism on government spending.  Even more indicative of the situation is the clear power the Chinese government over this country, as the administration rushed to reassure the Chinese that all is well.  I doubt that China will dump its US treasuries en masse, but I think that this does signal that the credit gravy train for the US government may be coming to an end, let’s hope so anyway.  Admittedly, all signs up until now have pointed to the contrary as China has continued to gobble up treasuries in recent months.  There perhaps is some false hope that China’s reluctance to purchase US debt will keep government spending in check.  Ok, fine, keyword false.

Teacherman Government Spending, Inflation, Politics capitalism, china, communist, obama, treasuries

“Often the masses are plundered and do not know it.”

Ah, yes, nary a week should go by without hearing from our good friend Frederic Bastiat.  The French economist, who died too early and too soon after his emergence as a economist.  Bastiat died at the age of 49, only six years after truly finding economics, as a theoretical study, at the age of 44 (thanks Wikipedia!). In that time Bastiat published some real economic gems.  This from his Selected Essays on Political Economy:

“But what relief can the landless find in the proclamation of the right to employment? In what respect will this new right increase the amount of food or the number of jobs available to the masses? Is not all capital employed in giving them work? Will it increase by passing through the public treasury? By taking it away through taxation, does not the state close at least as many sources of employment on one side as it opens on another?”

Fast forward to today and we face a similar, but different problem for the masses.  In all of their zeal to get reelected save the economy, the government spending trillions of dollars.  Some of these ’stimulus projects’ will help select portions of the masses, but in the end, the only real stimulus will be in the green ink industry.  What will the masses be left with?  At the very best significant inflation, at the very worst hyperinflation.  Inflation always falls upon the masses the hardest.  And thus, the masses are being plundered without even knowing about it.

Teacherman Government Spending, Inflation, Politics economist, employment, frederic bastiat, hyperinflation, Inflation, masses, political economy