On Economy

     

 

 

Economic Nirvana

“Inflation is always and everywhere a monetary phenomenon,” economist and Nobel Prize recipient Milton Friedman once remarked.  He likely meant that inflation is the more rapid increase in the supply of money relative to the output of goods and services which money is traded for.

 

Famous Monetarist School representative Milton Friedman thought the US should adopt a constitutional amendment limiting monetary inflation to 3% – 5% per year, putting inflation so to speak on autopilot. But why should there be any central bank-directed inflation at all? To his credit, in 1968 Friedman wrote the following in the American Economic Review: “[M]onetary action takes a longer time to affect the price level than to affect the monetary totals and both the time lag and the magnitude of effect vary with circumstances. As a result, we cannot predict at all accurately just what effect a monetary action will have on the price level and, equally important, just when it will have that effect. Attempting to control directly the price level is therefore likely to make monetary policy itself a source of economic disturbance because of false stops and starts.” This is quite correct and was the reason why he thought discretionary central bank policy should be replaced with some fixed rule, while naively adding thatPerhaps, as our understanding of monetary phenomena advances, the situation will change.” Of course the situation will never change – the failure of the bureaucracy to centrally plan money is simply a special case of the socialist calculation problem, which cannot be overcome (as an aside, it is not all clear why students of economic history should accept that central banks have been established for anything other than nefarious reasons). The most elegant solution would of course consist of simply replacing central planning with a truly free market in money. But that would mean abandoning a major tool of political and economic control that benefits the State and its cronies. Moreover, a great many economists would have little to do in such a free market, as central banks have essentially bought the entire profession. Naturally, most economists know better than to bite the hand that feeds them.

Photo via mises.ca

 

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Incrementum Advisory Board Meeting Q4 2017 –  Special Guest Ben Hunt, Author and Editor of Epsilon Theory

The quarterly meeting of the Incrementum Fund’s Advisory Board took place on October 10 and we had the great pleasure to be joined by special guest Ben Hunt this time, who is probably known to many of our readers as the main author and editor of Epsilon Theory. He is also chief risk officer at investment management firm Salient Partners. As always, a transcript of the discussion is available for download below.

 

Ben Hunt, author of Epsilon Theory and chief risk officer of Salient Partners

 

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Expensive Politics

Instead of a demonstration of its overwhelming military might intended to intimidate tiny North Korea and pressure China to lean on its defiant communist neighbor, President Trump and the West should try to learn a few things from China.

 

President Trump meets President Xi. The POTUS reportedly had a very good time in China. [PT]

Photo credit: AP

 

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Introduction

Mark Thornton of the Mises Institute and our good friend Claudio Grass recently discussed a number of key issues, sharing their perspectives on important economic and geopolitical developments that are currently on the minds of many US and European citizens.

A video of the interview can be found at the end of this post. Claudio provided us with a written summary of the interview which we present below – we have added a few remarks in brackets (we strongly recommend checking the podcast out in its entirety –  there is a lot more than is covered by the summary).

 

Mark Thornton and Claudio Grass

Photo via mises.org

 

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Big Crunch or Big Chill

Physicists say that the universe is expanding. However, they hotly debate (OK, pun intended as a foreshadowing device) if the rate of expansion is sufficient to overcome gravity—called escape velocity. It may seem like an arcane topic, but the consequences are dire either way.

 

OT – a little cosmology excursion from your editor: Observations so far suggest that the expansion of the universe is indeed accelerating – the “big crunch”, in which the expansion not only stops, but reverses as it is overcome by gravity, is no longer deemed likely. Observation of distant supernovas and their red-shifts in the late 1990s pointed clearly to an accelerating expansion; this was the meantime confirmed by other data as well, such as those on fluctuations in the density of baryonic matter (baryon acoustic oscillations), which are evident in the large scale structures visible in the universe (ever larger structures are discovered, the record is currently held by the Hercules–Corona Borealis Great Wall, which measures an estimated ~3 gigaparsecs or roughly 10 billion light years across). The precise shape of the universe remains open to question, but recent evidence strongly suggests that it is a flat, Euclidian universe (thus, dark energy is assumed to be driving the acceleration of the expansion – a hyperbolic or saddle-shaped universe with a matter density below the critical value would expand forever anyway). The second and third image above show the current ideas about the timeline of the universe since the big bang. It is held that the current era of accelerating expansion started about 7.5 billion years ago. Ever since, all galaxies  – indeed all objects in the universe – are flying apart at continually increasing speed. The last image shows the size of the observable universe, which has a diameter of 28.5 gigaparsecs, or 93 billion light years (i.e., we can “see” 46.5 billion light years in every direction). Readers will notice that this is much larger than the age of the universe would suggest. Shouldn’t the size of the observable universe be limited by the speed of light, and hence correlate roughly with the age of the universe? Actually, on account of the ongoing expansion of space-time, the light from the oldest, most distant galaxies we can currently see comes from objects that have moved much farther away from us in the meantime (a process referred to as “co-movement”). Over time, we will see more rather than fewer galaxies, as light will have had more time to travel and the light from even more distant galaxies will begin to reach us. The observable universe will grow, but there is a strict limit to this. The effect will reverse at an estimated threshold radius of 62 billion light years (compared to the current 46.5 billion), i.e., the maximum diameter of the observable universe will be capped at 124 billion light for all observers, regardless of where in the universe they are (note: all observers subjectively believe that they are at the center of the universe, as all of them can “see” a spherical volume of the same size surrounding them). Once this threshold is reached more galaxies will begin to red-shift out of visibility than will become newly visible, and eventually, darkness will descend on us, or rather, our descendants (trivia: the most remote quasar so far recorded by the Hubble telescope is a dark red blotch 31 billion light years from here). What is there beyond the boundary of  the observable universe? Estimates of the size of the “causally disconnected” part of the universe (which we will never be able to see or interact with) range from 3×1023 times the size of the observable universe, up to a volume 101010122 times larger than what is visible to us. Both the “big rip”, in which the universe becomes cold and dark in a mere 22-50 billion years as the expansion accelerates to such an extent that every shred of matter is literally torn apart, or the “big freeze”, a slow heat death, in which maximum entropy is reached about 100 trillion years from now, remain possible alternatives for the end of everything. As the big freeze approaches its end, the last remains of baryonic matter will begin to degrade at temperatures a mere sliver above absolute zero, with protons and neutrons decaying into electrons and positrons that may form bizarre atoms light years in size (a.k.a. “positronium”), which will orbit each other at the ultimate snail’s pace, moving just one centimeter in a million years – in complete darkness, natch. All of this could still turn out to be wrong: our measurements may well be flawed; misled by effects caused by a relatively low matter density in our own sector of the universe and the nearby voids, which only make it appear as though the entire universe was expanding at an accelerating pace. It is also possible that as result of an unusually inhomogeneous distribution of matter (differences >20%), denser regions are actually already collapsing inward, but their contraction looks similar to an expansion from our perspective, due to the differences in the curvature of space in regions with varying matter density. Note that no “dark energy” would have to be invoked if that were the case. [PT, end of astronomy lesson]  – click to enlarge.

 

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A Flawless Flock of Scoundrels

One of the fringe benefits of living in a country that’s in dire need of a political, financial, and cultural reset, is the twisted amusement that comes with bearing witness to its unraveling.  Day by day we’re greeted with escalating madness.  Indeed, the great fiasco must be taken lightly, so as not to be demoralized by its enormity.

 

Symphony grotesque in Washington [PT]

 

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Net Present Value

Warren Buffet famously proposed the analogy of a machine that produces one dollar per year in perpetuity. He asks how much would you pay for this machine? Clearly it is worth something more than $1.00. And it’s equally clear that it’s not worth $1,000. The value is somewhere in between. But where?

 

We are not sure why Warren Buffett invoked a money printing machine of all things – another interesting way of looking at the concept is by e.g. considering land. Why does land have a finite value? After all, a piece of land that can be used to grow wheat can conceivably do so in perpetuity (even if it is merely valued as standing room, such as a plot of land on 5th Avenue in NYC, it can render that service forever. The only important attribute is that the land in question be capable of generating rents, or is at least expected to become capable of doing so in the future). Why then isn’t it worth an infinite amount? Land values are appraised the same way the values of other factors of production are appraised, namely (to paraphrase Mises) according to the services they will render at various future time periods, with time preference taken into account (if society-wide time preference is high, the natural interest rate will be high as well and land values will be affected negatively; conversely, land values will tend to increase amid declining time preference and falling interest rates). By applying a discount to a series of consecutive future time periods, one will arrive at a sequence of values converging to zero, hence the price of land is finite (sub-marginal land that cannot conceivably yield any rents will have no value at all, or at best a speculative value). This is just considering the basic ceteris paribus (or equilibrium) framework, as in the ever-changing real economy numerous other factors will also influence the appraisal of land values; still, it is fair to say that the quality of the land concerned (how much output it is expected to produce per input of labor and capital) and time preference (which determines the height of the interest rate used in the discounting procedure) are the most important factors (and it is important to recognize that they are distinct factors, completely independent of each other. Originary interest is not a function of productivity). Other factors can of course overwhelm these basic considerations – these concern mainly various types of government intervention in the economy (such taxes levied directly on land or on land rents, the security of property rights, etc.), or other developments that impact expectations (for instance, if a major volcano outbreak is expected to be imminent, the value of land in the vicinity will probably decline quite a bit). As Keith explains below, time preference is a fundamental pillar of all human action. We are mortal and in our perception of time, there is always a “sooner” and a “later”. Therefore time preference will always exist and be positive. It cannot be any other way, as all provisioning for the future would otherwise cease. Thinking of time preference declining to zero or becoming negative is akin to attempting division by zero, i.e., it simply makes no sense whatsoever. If it actually were to happen, we would consume all existing capital and slowly die of hunger thereafter. [PT]

Photo credit: Bob Embleton

 

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Simple Classifications

Let’s begin with facts.  Cold hard unadorned facts. Water boils at 212 degrees Fahrenheit at standard atmospheric pressure.  Squaring the circle using a compass and straightedge is impossible.  The sun is a star.

 

The sun is not just a star, it is a benevolent star. Look, it is smiling…  sort of. [PT]

 

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Political Correctness Hampers Honest Debate

What would the world be like today had Europeans never colonized Americas, Africa, the Middle East, Australia, New Zealand, and South Asia?

 

Jayant speaks about Democracy, Welfare and Migration: The West’s March to Self-Destruction [PT]

 

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Amassing Unproductive Debt

Last week, we discussed the marginal productivity of debt. This is how much each newly-borrowed dollar adds to GDP. And ever since the interest rate began its falling trend in 1981, marginal productivity of debt has tightly correlated with interest. The lower the interest rate, the less productive additional borrowing has in fact become.

 

Left: the first IKEA store located in Älmhult in Sweden, near the residence of the company’s founder (nowadays the store is a museum); right: a Task Rabbit car. Given the valuations at which TaskRabbit was able to raise funds recently, it is a good bet IKEA paid a small fortune to take it over (waiting for the QE-induced bubble to burst may have been cheaper). [PT]

 

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Switzerland: Far from Flawless, but still a Unique Country – An Interview with Claudio Grass

Our friend Claudio Grass has discussed Switzerland in these pages before, and on one of these occasions we added some background information on country’s truly unique political system (see “The People Against the Establishment” for  the details). People are generally aware that direct democracy in the form of frequent  referendums is a major characteristic of the Swiss system, but how many people know that the country’s executive is essentially modeled after the system established in the city states of ancient Greece?

 

The Sphinx observatory on Mt. Jungfraujoch in the awe-inspiring Swiss alps.

Photo credit: Jungfraubahnen

 

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Discounting the Present Value of Future Income

Last week, we discussed the ongoing fall of dividend, and especially earnings, yields. This Report is not a stock letter, and we make no stock market predictions. We talk about this phenomenon to make a different point. The discount rate has fallen to a very low level indeed.

 

We add this chart to provide a slightly different perspective to the discussion that follows below (and the question raised at the end of the article). This is a very simple ratio chart, which focuses on non-financial corporate debt in particular, as neither consumer debt nor government debt can be considered “productive” by their very nature – the latter types of debt are used for consumption, which they “pull forward” (as an aside, we don’t believe there is anything wrong with consumer debt per se, but it is not “productive”). As the recommendations of Keynesians on combating economic downturns indicate, they have a slight problem with the sequencing of production and consumption. They favor measures aimed at boosting demand, i.e., they want to encourage consumption, which is tantamount to putting the cart before the horse. The chart above shows the ratio of GDP to total non-financial corporate debt – and obviously, GDP is not really an ideal measure for this purpose, as Keith also mentions below (GDP has many flaws, and its greatest flaw is the underlying idea that “spending” is what drives economic growth; not to mention that it seems not to matter what the spending actually entails – even Keynesian ditch digging or pyramid building would “add to GDP”, but would it represent economic growth? That seems a rather audacious assumption – in fact, it should be obvious that such activities would diminish rather than enhance society-wide prosperity). In that sense it would actually be more useful to compare corporate debt to gross industrial output (for the sake of completeness we add the chart in the addendum). We noticed though that it doesn’t make much of a difference in terms of the general trend, and we don’t have pre-2005 data for gross output, so we decided to go with GDP. This allows us to depict a very long-term chart of “debt productivity”. We should add that we believe this is quite a legitimate way of presenting it – Keith compares growth ratios, which seems to be very useful in highlighting business cycle fluctuations, but slighgtly less useful in showing the long term trend in the relationship between debt accumulation and economic output. [PT] – click to enlarge.

 

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