On Economy

 

Bureaucrats versus a Dynamic Free Society

In the preface to his 1944 book “Bureaucracy”, Ludwig von Mises tried to elucidate the difference between the German and the American mentality as he saw it at the time. In Germany, classical liberalism had been thoroughly suppressed in the decades following the failed revolution of 1848. Of Germany's youth Mises remarked: “They had one aim only: to get a job as soon as possible with the government.”

To this day, the ideas of classical liberalism find very little resonance in continental Europe. It is no wonder that the UK – in spite of having become a welfare state as well – is continually clashing with the EU's socialistic super-state bureaucracy in Brussels. It is simply its very different tradition that is coming to the fore. We dare to predict that the UK will eventually break with the EU, unless the centralizers and harmonizers are thoroughly rolled back and the principles of subsidiarity are once again considerably strengthened. That seems however rather unlikely at this juncture, given that the arch-federalist and habitual professional liar JC Juncker has just become the new parliamentary leader in Strasbourg, while the only other guy who was considered as an alternative for the position was the German socialist technocrat Martin Schultz, one of the few prominent EU politicians worthy of even more contempt than Juncker!

However, let us get back to Mises and how he tried to explain the German notion of the “Obrigkeits-Staat” to his US readers (the term can by the way be loosely translated as “authoritarian state”, but this translation does not really convey its meaning):

 

To the American mind the notion of an Obrigkeit, a government the authority of which is not derived from the people, was and is unknown. It is even extremely difficult to explain to a man for whom the writings of Milton and Paine, the Declaration of Independence, the Constitution and the Gettysburg Address are the fountain springs of political education, what this German term Obrigkeit implies and what an Obrigkeits-Staat is.

Perhaps the two following quotations will help to elucidate the matter. On January IS, I838, the Prussian Minister of the Interior, G. A. R. von Rochow, declared in reply to a petition of citizens of a Prussian city: "It is not seemly for a subject to apply the yardstick of his wretched intellect to the acts of the Chief of the State and to arrogate to himself, in haughty insolence, a public judgment about their fairness."

This was in the days in which German liberalism challenged absolutism, and public opinion vehemently resented this piece of overbearing bureaucratic pretension.

Half a century later German liberalism was stone dead. The Kaiser's Sozialpolitik, the statist system of government interference with business and of aggressive nationalism, had  supplanted it. Nobody minded when the Rector of the Imperial University of Strassburg quietly characterized the German system of government thus:

"Our officials . . . will never tolerate anybody's wresting the power from their hands, certainly not parliamentary majorities whom we know how to deal with in a masterly way. No kind of rule is endured so easily or accepted so gratefully as that of highminded and highly educated civil servants. The German State is a State of the supremacy of officialdom-let us hope that it will remain so."

Such aphorisms could not be enunciated by any American. It could not happen here.

 

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John Hussman's Latest Comments on the Bubble

In his newest weekly column, John Hussman talks about a feature of the current echo bubble era that we believe will turn out to be an extremely important one. Readers of this site know of course that we have frequently sung from the same hymn sheet, but it is a topic the significance of which cannot be stressed enough.  After briefly recapping the history of the housing bubble and the ensuing credit crisis, Hussman writes:

 

“Now, as we observed in periods like 1973-74, 1987, and 2000-2002, severe equity market losses do not necessarily produce credit crises in themselves. The holder of the security takes the loss, and that’s about it. There may be some economic effects from reduced spending and investment, but there is no need for systemic consequences. In contrast, the 2007-2009 episode turned into a profound credit crisis because the owners of the vulnerable securities – banks and Wall Street institutions – had highly leveraged exposure to them, so losing even a moderate percentage of their total assets was enough to wipe out their capital and make those institutions insolvent or nearly-so.

At present, the major risk to economic stability is not that the stock market is strenuously overvalued, but that so much low-quality debt has been issued, and so many of the assets that support that debt are based on either equities, or corporate profits that rely on record profit margins to be sustained permanently. In short, equity losses are just losses, even if prices fall in half. But credit strains can produce a chain of bankruptcies when the holders are each highly leveraged. That risk has not been removed from the economy by recent Fed policies. If anything, it is being amplified by the day as the volume of low quality credit issuance has again spun out of control.

 

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Enriching Life with Gloom and Depression

It is cool in Paris. We have put on a sweater. To bring you fully into the picture, we are sitting at a sidewalk café in the 16th arrondissement, having a café crème with our mother.

We have periods of real joy in our lives, but we count on our natural tendency towards gloom and depression to get us through them. Our mother lacks this essential quality.

A woman walks down the street, trailed by a small, white dog. The poor old girl looks sorely used, we think. As if she ran over her other dog… and got beaten up by her husband.

 

 

ParisCafe

Café de Flore, Paris.

(Photo via Wikimedia Commons)

 

Mother: “Oh… look at that cute dog.”

Two gypsy women came along.

“Watch your purse,” was the thought that rose to your editor’s lips.

“I love their dresses,” said his mother. “They are so colorful.”

A handsome, well-built man, with a full head of jet-black hair, comes ambling down the street. He looks friendly, happy, confident…

“Jerk… boulevardier… flâneur,” we think to ourselves.

“What a nice looking young man,” says mater familias.

We don’t know how much more of this looking on the bright side we can take.

“Mom, do you have any idea how many people have been driven mad by cheerfulness?”

“Okay… I’ll try to control it. Look… there’s a poor man with a sad look on his face,” she said, pointing to a grumpy SOB getting out of his car.

“No… you just don’t get it. You’re not supposed to be sympathetic. He probably deserves to be sad.”

But we realized it was hopeless. There is just no helping some people.

 

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Challenges and Extra Points

On Friday, the Dow fell 123 points. On Saturday, our youngest son, Edward, returned from Africa. He had escaped capture by a rebel army in the Democratic Republic of the Congo… walked 50 miles through the jungle… and eventually made his way to the US embassy in Kinshasa, where he was given a new passport.

 

Bull-bear

Statues of the two symbolic beasts of finance, the bear and the bull, in front of the Frankfurt Stock Exchange

(Photo credit: Eva K.)

 

As to the Congo, Edward reported to his grandmother: “Rich country (in natural resources). Hard place to do business. The local people are nice. Until they decide to kill you.”

Grandmother: “Why would you want to do business there?”

Edward: “Because it’s there. It’s a challenge. It’s an adventure.”

Grandmother: “You don’t get extra points in life by doing things that are not worth doing.”

 

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Deflecting Attention, Greenspan-style

Alan “Bubbles” Greenspan is back in the news. At 88 years old, his mind is still sharp as a tack. He still sees his own interests clearly. And he is still clever enough to distort the facts to suit them.

 

20140725-DRE-ISSUE

(Photo credit: Steve JurvetsonBubble Rain)

 

Asked in an interview what he thought of Janet Yellen’s recent IMF speech, in which she maintained that bubbles should be addressed with more regulation, he replied:

 

“Bubbles are functions of unchangeable human nature. The obvious question is how to manage them. All bubbles expand, and they all collapse.” 

 

You see, it wasn’t his fault that the largest bubble in half a century blew up a year after he left his post as Manipulator-in-Chief of the world’s largest economy. It was just human nature.

 

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China's 'Eco' Ghost Town

Back in 2006, Hu Jintao was excited when he visited Caofeidian, the “the world’s first fully realized eco-city”, built on land reclaimed from the sea. Since construction began in 2003, it has devoured the princely sum of $100 billion, most of it provided by banks. One million resident were once supposed to live there. It is a ghost town today, sporting only a few thousand inhabitants. Practically no-one has ever stayed in the city, and the buildings are already deteriorating. In fact, many of the buildings have been left half-finished, as credit eventually ran out.

The Guardian has posted a number of haunting pictures of this monument to massive capital malinvestment.

As the Guardian notes:

 

The ‘eco-city’ was made possible through huge bank loans. Once it was half-built, these loans were halted and many projects suspended due to the rising cost of raw materials and a lack of government support.”

 

A few of the pictures are reproduced below:

 

bridge to nowhereThe city's obligatory bridge to nowhere – only the ten pylons have been erected, then the project had to be abandoned.

(Photo credit: Gilles Sabrie)

 

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Behold the Monet

​Economics is like a Monet painting.  Stand too close and all you see is a bunch of seemingly random paint strokes.  Back up a few steps and an image emerges.  

The painting of bubblenomics started with the Plaza Accord, September 1985, where five nations agreed to manipulate the dominant currencies at the time.  Japan enjoyed a 50% devaluation of the US$ vs the yen, artificially enriching its citizens so they could travel the world in busloads with eighty pounds of cameras around their necks. 

The consequences of that bubble have yet to be corrected.  Twentyfour years of fiscal and monetary accommodation led Japan to sport the world's largest public debt-to-GDP ratio.

​The next big one was the US dotcom bubble, which was generating great wealth during the 1990s.  More importantly, it started the era during which income and savings became “old school”. Everyone could live off and retire on never ending asset appreciation.  When that bubble burst, in came Greenspan with the mother of all bubbles – the sub-prime bubble.  

 

San-Giorgio-Maggiore-by-Twilight-by-Claude-Monet-OSA071Monet's famous “Twilight of the Bubble”

(Painting: San-Giorgio-Maggiore by Twilight, by-Claude-Monet)

 

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The Russell 2000 Index and the Modified Davis Method

The Russell 2000 Index (RUT) has spent this year oscillating in a wide range, making very little net progress:

 

RUT

Russel 2000 index daily – no progress this year – click to enlarge.

 

The problem is that it is therefore underperforming the big cap S&P 500 ever more. Given that outperformance by the Russell has been a hallmark of the cyclical bull market since the 2009 low, this development should be of grave concern to investors.

 

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Connecting Dots

There are thousands … millions … gazillions of dots in the universe. Today, we connect two of them.

First, let us note that so Zen-like and calm are investors that the worries of Thursday – triggered by the downing of Malaysia Airlines Flight MH17 over eastern Ukraine – were forgotten by Friday.

The Dow closed up 123 points on the last day of the week. Gold sold off. So, let’s return to our dots. The first one is epistemological. The second is an important observation about investing.

 

black-swan-122983_640

Hi! I'm from Australia and I do exist …

(Photo via Fotoagentur Holgi)

 

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Equal Opportunity Offender

Let us begin with some criticism from a reader:

 

“What you said about Janet Yellen is disrespectful to All Women. You said you meant no disrespect, and then you go ahead and say most women her age are baking cookies for their grandchildren and saying she has soft shoulders.

You would not make the same kind of sexist comment about a man holding the position that she does. You should grow up… your comments are so old fashioned and out of touch. If you are going to put someone down because you don’t agree with what they are doing, resorting to sexist commentary as a metaphor only makes you look like the fool.”

 

Ouch! We thought we headed off this kind of complaint with our frank alert a few weeks ago. Didn’t we warn readers?

 

260px-Symbol_venus.svg_

 

Sexist … ageist … religionist … racist … abilityist … intelligencist. We are an equal opportunity offender. We disrespect all groups without favor or distinction. Especially those we like.

Besides, didn’t we advise those with delicate feelings and hypersensitivities to cover their ears and eyes, lest they discover some calumny?

The dear reader says she speaks for “All Women.” We don’t know if she’s polled them all… but wow! We offended half the world’s population in a single paragraph. And without even breaking a sweat.

And we stick by our point: It’s better to bake cookies than to wreck the world’s biggest economy! So, let us divert the conversation, from our personal failings to the coming disaster.

 

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Outlook for Gold, Stocks, Economy by Incrementum’s Advisory Board

In March, we released the minutes of the first Advisory Board meeting by Incrementum Liechtenstein, see the summary Will Inflation Make A Comeback In 2014 When The Consensus Worries About Deflation

As discussed, Incrementum had launched the “Austrian Economics Golden Opportunities Fund,” a fund that takes investment positions based on the level of inflation based on their proprietary “Incrementum Inflation Signal.” Incrementum Liechtenstein has Ronald Stoeferle, author of In Gold We Trust, as managing partner, and Mark Valek as partner.

The key topics that were discussed at the time:

 

  • The Incrementum Inflation Signal started showing rising inflationary momentum after a period of 19 month of disinflation.
  • The usefulness of the CPI as a decision making tool is highly questionable.
  • Incrementum’s Advisory Board sees a lot of strength in the gold market.
  • Is the stock market topping or in a bubble?

 

Not much later the inflationary trend stalled and a new disinflationary trend started, leading precious metals and miners to lower prices.

Meantime, the second Advisory Board meeting has taken place, in which all relevant and important topics for gold investors have been discussed.The economic situation and China in particular, a monetary policy update, the geopolitical situation, a stock market review, and precious metals and miners market update.

 

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The Price of Shipping Is Collapsing

A recurring theme of mine is that one cannot understand the world in terms of the linear Quantity Theory of Money. Let’s look at the cost of shipping.

The money supply has certainly been expanding since 2008. And yet the price of shipping has almost completely collapsed. From a high over 11,000 it’s now down to 755. This is a drop of almost 94%.

The Baltic Dry Index is a dollar price of moving the major materials by sea. The chart shows from just before the acute phase of the crisis to today, July 16, 2014.

 

chart-1-Baltic DryI like to look at the Baltic Dry because, unlike commodities, there is no way to speculate on it and hence drive up the price. (If readers are aware of some sort of futures market or other way for speculators to use credit to bid up prices, then I encourage them to please contact me.) – via Monetary Metals, click to enlarge.

 

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A Dangerous Misconception

Ever since the echo bubble went into overdrive due to the Fed adding what by now are nearly $5 trillion to the broad US money supply TMS-2, while keeping the administered interest rate practically at zero, people have been looking for excuses as to why the latest bit of asset boom insanity will never end (few of them wanted to be long “risk” in 2009, but they sure are eager to justify their exposure now).

One popular theme gets reprinted in variations over and over again. Here is a recent example from Business Insider, which breathlessly informs us of the infallibility of the yield curve as a forecasting tool:  “This Market Measure Has A Perfect Track Record For Predicting US Recessionsthe headline informs us – and we dimly remember having seen variants of this article on the same site at least three times by now:

 

“There are very few market indicators that can predict recessions without sending out false positives. The yield curve is one of them.

At a breakfast earlier today, LPL Financial's Jeffrey Kleintop noted that the yield curve inverted just prior to every U.S. recession in the past 50 years. "That is seven out of seven times — a perfect forecasting track record," he reiterated.

The yield curve is inverted when short-term interest rates (e.g. the 3-year Treasury) are higher than long-term interest rates (e.g. the 10-year Treasury yield).

"The yield curve inversion usually takes place about 12 months before the start of the recession, but the lead time ranges from about 5 to 16 months," wrote Kleintop in a recent note. "The peak in the stock market comes around the time of the yield curve inversion, ahead of the recession and accompanying downturn in corporate profits."

The Federal Reserve has been signaling that tighter monetary policy is on its way, which means short-term interest rates should move higher. Is this something we should be worried about? Kleintop offered some context:

How far the Fed must push up short-term rates before the yield curve inverts by 0.5% depends on where long-term rates are. Even if long-term rates stay at the very low yield of 2.6% seen in mid-June 2014, to invert the yield curve by 0.5% the Fed would need to hike short-term rates from around zero to more than 3%. Based on the latest survey of current Fed members that vote on rate hikes, they do not expect to raise rates above 3% until sometime in 2017, at the earliest…

Lots of economic and market factors drive what happens with interest rates. So the shape of the yield curve is definitely worth paying attention to. "The facts suggest the best indicator for the start of a bear market may still be a long way from signaling a cause for concern," he said.

 

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Portuguese Banking Group's Woes Deepen

When we wrote about the troubles at Banco Espirito Santo yesterday (our post was written before European markets opened) information was still fairly scant. However, on the very same day the situation continued to escalate. Here is an excerpt from the WSJ providing further details:

 

Shares in the troubled Portuguese lender have been under pressure since May, when the bank disclosed that an audit ordered by Bank of Portugal into Espírito Santo International SA, the conglomerate that indirectly holds a stake in the bank, had found Espírito Santo International was in a "serious financial condition" and had uncovered accounting irregularities. But the declines mounted drastically Thursday after investors learned Espírito Santo International had delayed coupon payments relating to some short-term debt securities.

Switzerland-based Banque Privee Espírito Santo SA, which is owned by Espírito Santo Financial Group, said in an emailed statement Wednesday that Espírito Santo International has delayed the repayment of short-term debt sold to some of its clients. It said the repayment is the sole responsibility of the conglomerate. The conglomerate declined to offer a separate comment.

The bank's stock dropped more than 17% before trading in its shares was suspended. Trading in Banco Espirito Santo's controlling shareholder, Espirito Santo Financial Group SA, listed in Luxembourg and Lisbon, was also suspended earlier Thursday. The Portuguese markets regulator banned short selling, or betting against, Banco Espirito Santo shares in Friday's session.

 

 

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They Haven't Been Praying Enough

According to press reports, Espirito Santo Financial Group, one of Portugal's largest financial groups and the biggest shareholder in Banco Espirito Santo (i.e., the Holy Spirit Bank, BES), is about to miss interest payments on some of its short term notes. The event prompted a sell-off in Portuguese government bonds as well. 10 year government bond yields have declined from more than 16% at the height of the sovereign debt crisis to about 3.25% at their recent lows, but have shot up by more than 60 basis points in recent weeks.

The chart of BES suggests that the troubles at the Holy Spirit Bank must have been on the minds of market participants for a while already. We have a feeling a costly scandal is brewing.

 

Banco Espirito SantoThe Holy Spirit Bank inflicts some very unchristian pain on its shareholders – click to enlarge.

 

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