Shooting At the Wrong Target
We were quite surprised, to say the least, when a friend pointed us to a recent article at Marketwatch, entitled „Grantham wonders if Marx was right after all“, sub-titled „Capitalism will gladly sell the rope used to hang itself“, which is a reference to one of Lenin's often quoted bon-mots (which went along the more active line of: 'The capitalists will sell us the rope which we will hang them with').
The article also contains a link to the (pdf) in which Grantham is engaging in all the aforementioned wondering. Ominously it is called the 'Longest Letter Ever'.
Al Lewis, the author of the Marketwatch article, leads off by pointing out the differences between the recent letter Warren Buffett sent to Berkshire Hathaway shareholders and Grantham's more pessimistic missive.
“Buffett, in his widely anticipated letter, is content to repeat platitudes, such as “America’s best days lie ahead.” The Oracle of Omaha proclaimed “the banking industry was back on its feet” and even managed to find the bright side of foreclosures: “Large numbers of people who have ‘lost’ their house through foreclosure have actually realized a profit because they carried out refinancings earlier that gave them cash in excess of their cost.”
Grantham, however, takes a longer view, and isn’t so “aw shucks” about the future of our broken economic system. “Capitalism,” he writes, “threatens our existence.”
We will grant that Warren Buffett's 'aw shucks' approach to the issue is not particularly enlightening or constructive. As it were, his assertion that the 'banking system is back on its feet', is easily refuted by people who do thoughtful and thorough analysis of US bank earnings reports and balance sheets.
We urge readers to compare the insightful analysis of Bank of America provided by David Trainer, who actually made the effort to read even the financial footnotes in the bank's voluminous 10-K report. His conclusion: the reported profits are an accounting illusion and the tangible net value of the bank is negative. In a free market without a central bank backstopping the banks, it would likely have gone bankrupt three or four years ago already. Given its negative value, its stock can not possibly be cheap enough. with the
However, Grantham's assertion that 'capitalism threatens our existence' really astonished us. Even Buffet's 'aw-shuckism' is probably preferable to such a sweeping indictment.
“Already, capitalism is proving that Karl Marx and Friedrich Engels were at least partially correct. They “looked forward to globalization and the supranational company because they argued it would make capitalism even more powerful, overreaching, and eventually reckless,” Grantham writes.
Globalization “would … offer the capitalists more rope to hang themselves with … rope … bought from briskly competing capitalists, eager till the end for a good deal.”Grantham, who is British, studied economics at the University of Sheffield and has an MBA from Harvard Business School. He started his investment career as an economist with Royal Dutch Shell before starting GMO in 1977.
He says capitalism does almost everything better than any other economic system. It’s just that its two or three main flaws are potentially fatal and have gone largely unaddressed. A sustainable economic system, for instance, can’t be based on ever-increasing debt, corporations can’t be allowed to run governments and loot treasuries, and “growth at any cost” is a recipe for planetary suicide.”
The problem with all of this is that A) Marx and Engels were not 'proven right' (as a reminder: their communist system eventually collapsed in what was the greatest bankruptcy in all of human history), because B) what Grantham bemoans has nothing to do with capitalism. Capitalism, as we understand the term, describes the form of economic and social organization that is probably better referred to as the free market economy. The 'three major flaws' according to Grantham are definitely not flaws of the free market.
- the 'ever-increasing debt' problem is a result of our financial system, i.e., the central-bank-led banking cartel, being a socialistic construct. If anything, it proves that socialism and central planning don't work, it certainly does not say anything at all about capitalism. Does it really need to be pointed out to an experienced and well-read money manager like Grantham that our monetary system is not based on the free market, and hence can not be called capitalistic? Apparently it is necessary, so we are hereby doing it. Ever since even the last vestiges of gold's role in the monetary system were removed, a period of vast growth in credit and money supply began, with oodles of credit and money created from thin air, which ended up to be used for consumption or as capital malinvestment. Central bank manipulation of interest rates and the money supply has falsified economic calculation for so long that the system has finally has found itself in a major crisis, just as supporters of the free market predicted all along. It is ludicrous to blame 'capitalism' for this fact. Central bankers are socialistic bureaucrats – they are not 'capitalists' by any stretch of the imagination.
- 'Corporations running governments and looting treasuries' are certainly to be condemned, but this once again has nothing at all to do with 'capitalism'. It can be called corporatism or fascism, which is in fact an off-shoot or variant of of socialism. It describes a system where government and large corporations are in cahoots in a fight against free market capitalism. It may be granted that since this system can also be referred to as 'state capitalism' or 'crony capitalism' that it would probably be better to alter ones terminology permanently and henceforth refer to true capitalism only as 'the free market system'. State capitalism is definitely not free market capitalism. It is indeed unsustainable and ultimately impoverishes the great mass of consumers in favor of powerful politicians, bureaucrats, corporate chieftains and their respective apologists in the intelligentsia. Alas, it is dangerous to blame 'capitalism' for the flaws of this fascistic/socialistic variant of it.
- this is in reference to the Malthusian worldview Grantham has lately adopted (we have criticized his views on the matter before – scroll down to 'Is There a Paradigm shift in Commodities?). Now, we may concede that Malthus had a point that population growth can not continue indefinitely. Moreover, we concede that resources are finite, but we would note that if anyone had told Malthus that the global population would reach nearly seven billion people in 2011, he certainly wouldn't have believed it.
What Malthus and many that have followed in his footsteps have always underestimated is human ingenuity and the power of the free market to overcome the seeming 'limits' imposed by nature. As we noted in our earlier critique, whenever commodity prices have risen for a while, economists and laymen alike have begun to spot 'peaks' in supply, such as e.g. Stanley Jevons, who in 1864 lamented about impending 'peak coal'. Now, consider the rise in commodity prices over the past decade. Could it be that the global expansion of the money supply is the major reason for this rise in prices? It could not only be, it almost certainly is the case. The US broad true money supply TMS-2 has increased by over 190% since early 2000, in other words, it has nearly tripled. Over this time period, some prices have risen more than others and the prices of non-specific capital goods far removed from the consumption goods stages (i.e., raw materials) are among those that have risen most. There is no need to conjure up visions of the planet running out of resources to explain this phenomenon. Money supply growth alone is very likely responsible for the great bulk of the price increases.
The continuous commodity index CCI – most of the price appreciation can be explained by monetary inflation – click chart for better resolution.
US true money supply TMS-2 since 1960, via Michael Pollaro – the culprit behind rising commodity prices – click chart for better resolution.
Some Thoughts on the Scarcity of Resources
We would also like to make a few points about the so-called 'peak oil' phenomenon here (and related theories of 'the planet running out of resources'). The scarcity of factors of production is of course an undeniable fact of life. If it did not exist, there would be no need to economize. However, we find that many of the theories dealing with the problem of the finiteness of resources miss the mark in several crucial points.
One favored method of the supporters of the peak oil theory is to create an 'energy equation' to illustrate the fact that 'cheap oil' is ever more difficult to find and exploit. The point of this type of equation is to show 'how much energy must be expended to find and produce an equivalent amount of energy in the form of fossil fuel'.
Naturally, it is held that the less energy is needed to produce a given amount of new 'stored up' energy in the form of fossil fuels, the better it is.
However, what is overlooked in this type of approach is that economic calculation already contains all these deliberations. The price of crude oil on the market already reflects all the necessary appraisals of supply and demand and likely developments in the future. Moreover, it also contains an additional form of appraisal: namely, how much economic output can be produced per unit of energy expended.
When we look at this, we find out that as economies grow and progress, they become ever more 'energy efficient'. Should fossil fuel production become uneconomic, it would eventually cease and the market would no doubt begin to look for economically viable alternatives. It is entirely wrong to assert apodictically that no such alternatives exist. We simply do not know what will be possible in the future. Just look at various predictions made about the future state of the world a few decades or a century ago and you will marvel at how completely wrong nearly all of them were – in particular, most exhibited a tendency to completely underestimate human ingenuity and the economic and technological progress it would enable. If here should be a problem with energy supplies, the best course of action would be to leave it to the free market to find a solution. As everyone knows, E=mc². There is more than enough energy in the universe – the only question is how to attain the know-how that is necessary to economically exploit it.
We would also point out that more than 80% of the world's crude oil production is in government hands. It is no wonder that this doesn't work as well as it could and should. It is a good bet that in a truly free market, energy prices would be a fraction of what they are today. Furthermore, as so-called 'conventional' sources of crude oil diminish, ever more 'unconventional' ones are discovered or become economically viable due to technological progress.
Lastly, the unspoken but implicit claim of all those who worry about 'the planet running out of resources' is that it would be better to just leave those resources in the ground. But how can that possibly be true? How can anyone possibly benefit from resources that are left in the ground? How will we attain the progress that is necessary to overcome the problems of the future if we do not make use of the land factors at our disposal?
We should also note here, labor remains more scarce than land, even now when seven billion people inhabit the planet. It is of course true that this may not remain so. There is an unknown threshold – a limit beyond which the planet's resources can no longer be expected to support the population or enable further growth. Alas, this limit is pushed ever further upward as economic and technological progress continues. In addition, it has turned out that in developed economies, population growth tends to flatten out and eventually reverses. This sociological phenomenon is due to the increase in wealth, which makes dependency on a large cluster of offspring in old age less of a priority. Due to the construction of 'pay as you go' pension systems in the modern-day welfare states this kind of calculation may actually turn out to be problematic as societies are 'graying'. However, it is to be expected that the wealthy societies will eventually be forced to adapt to the fact that rising longevity and falling birth rates create an overhang of elderly people – people's working lives will simply have to become longer. Such reforms are already underway in Europe, where several of the welfare states in the euro area have seen their fiscal flaws exposed earlier than was expected due to the fact that the supranational central bank is not financing governments directly.
Finally, one major problem we have with almost all the 'peakers' is that their stance is often 'anti-economic', in the sense that they do definitely not trust the free market to be the most likely vehicle to offer a solution to the problems they worry about. Instead they are clamoring for government intervention, as though governments had ever proved capable of actually solving economic problems. They want government to impose restrictions on consumption and production – and naturally such restrictions will have to be imposed by force. We confess that we don't know for how long the current consumption of crude oil can be maintained. However, we are 100% certain that if there is a problem brewing in connection with 'peak oil', then governments are the very last institutions capable of finding a solution to it and neither restrictions on consumption nor restrictions on production will be conducive to the ends sought. The only institution capable of solving such problems is the free market, or in other words, capitalism.
In his letter, Jeremy Grantham approvingly cites the recent series of articles in the usually viciously statist Financial Times about the alleged 'crisis of capitalism', which we have discussed here before. Grantham writes:
“The Financial Times has had a plethora of recent articles examining possible deficiencies in capitalism. The general opinion is that this is not capitalism’s finest hour. The financial crash revealed a chronic weakness in establishment economic theory, whose trust in efficiency of capital markets encouraged deregulation and helped land us in our present trouble. Hyman Minsky’s work that suggested that recurrent financial crises were “well-nigh inevitable” could not have been more completely forgotten. Only a handful of the hundreds of senior economists and bankers seemed to see what was coming.
Debt has also proven troublesome, with both governments and individuals allowing debt ratios to become unmanageable at great risk to the economy, while government policies and taxes in particular encouraged the slide rather than moved to control it.”
To this we would once again note that Grantham is misidentifying the problem. It is not 'capitalism' and most certainly not the entirely mythical 'lack of regulations' that is to blame for the financial and economic crisis. It is a crisis that is mainly the end result of central economic planning on the part of central banks and governments. He is correct when he notes that 'establishment economic theories' proved incapable of predicting the crisis and offering advice as to how to avoid it or how to get out of it. But he fails to make the connection to the central planners, whose actions are after all informed by these 'establishment' economic doctrines (this is to say, Keynesianism and monetarism for the most part).
We have also critically discussed the Neo-Keynesian Hyman Minsky in the past, noting that his 'stability breeds instability' theory is flawed, as it ignores the fact that only a central bank backstopped fractionally reserved banking system based on a fiat money standard can actually create instability on such a scale that it becomes a threat to the whole economic order. It is erroneous to assert that stability as such will 'breed instability' as Minsky claimed. The instability is a result of the credit ex nihilo expansion enabled by the monetary system currently in place, which as we must once again stress is not a product of the free market. It is simply untrue that economic instability due to the accumulation of ever larger piles of unproductive debt is an inherent feature of the free market economy.
Grantham then continues with a number of remarks with which we largely agree:
“In the last 20 years, corporate ownership began to look odd. The nominal owners – stockholders – typically traded every few months and took on the part of institutions, with little or no interest in corporate affairs, with the result that corporate officers appeared to own the companies and behaved accordingly. Stock option programs transferred ownership from shareholders to managers in giant dollops and were awarded on short-term results. One consequence of this was a distorted incentive that encouraged leverage and other forms of going for broke with other people’s money. Boards of Directors demonstrated little timely intervention and typically only found their claws in situations of complete disaster, when it was too late. Total remuneration in the U.S. for senior officers, unopposed by typical boards, rose as a percentage of the average worker’s pay from 40 times in Eisenhower’s era to over 600 times today, with no indication of any general improvement in talent. Few rewards were carefully related to long-term results. Pretax income inequality rose in most countries and was offset by tax adjustments in very few. In the U.S., oddly, the tax changes accentuated the shift. Such an increase in inequality was caused by all of the benefits of the substantial productivity flowing to a few, while the average hour’s pay stayed unprecedentedly unchanged for 40 years! This risks making economic progress both slower and bumpier as the stressed average worker reaches for debt and then, in a crisis, is forced to retrench.”
It is certainly true that corporate managers have become wedded to short term performance goals and have become grossly overpaid. Their incentives have become skewed: they profit from the profits they help to produce, but suffer little consequence in the event that they produce losses. It is up to shareholders to change that. For bank managers not even catastrophic losses present a danger: their companies will simply be bailed out, while the managers sail off into retirement with vast golden handshakes.
Alas, Grantham fails to note that growing wealth inequality is in the main a side effect of monetary inflation as well. It is no coincidence that the real incomes of the middle class and workers have begun to stagnate precisely from the point in time when the full fiat money standard was introduced.
“Presumably, economists will slowly digest the lessons of the last few years and will develop realistic and useful theories. We can at least hope. Trial and error, reform, and common sense seem reasonably likely to be a match for all of these problems eventually. They are irritating and debilitating problems today but they will not bring us to our knees. There are some problems, though, that have surfaced seldom or never in the Financial Times discussions that very well may. In my opinion, they threaten even our survival and it is these problems I would like to concentrate on.”
The 'useful and realistic' economic theories do not need to be developed anew – they already exist. They have merely been suppressed by the etatiste establishment. There is nothing about basic economic laws that is not already known. The chief error of the modern economic orthodoxy is that it believes that the social science of economics should be run along the lines of the natural sciences. We do not need 'trial and error' to develop a sensible economic theory. All that is required is logical deduction – economic theory is antecedent to empirical observations.
Grantham then launches into the problem of 'externalities' as though it were new (although he does admit it has been discussed extensively). He continually mixes up criticisms that are well deserved – mainly his critique of crony/state capitalism – with other topics where he goes astray. The 'tragedy of the commons' problem is not chiefly amenable to 'regulation' as he avers. It can only be ameliorated by property rights. For example he says that
“Damage to the “commons,” known as “externalities” has been discussed for decades, although the most threatening one – loss of our collective ability to feed ourselves, through erosion and fertilizer depletion – has received little or no attention. There have been no useful tricks proposed, however, for how we will collectively impose sensible, survivable, long-term policies over problems of the “commons.” To leave it to capitalism to get us out of this fix by maximizing its short-term profits is dangerously naïve and misses the point: capitalism and corporations have absolutely no mechanism for dealing with these problems, and seen through a corporate discount rate lens, our grandchildren really do have no value.”
To this topic we would recommend that readers take a look at Roy Cordato's excellent essay ''. A brief excerpt:
“The "social cost" approach to environmental economics has led to the "dehumanization" of issues related to the environment. Pollution or "tragedy of the commons" problems are not problems because of the damage that some people may or may not be inflicting on others, but because they create what amounts to disembodied harms. A problem occurs because some goods are "overproduced" while other goods are "underproduced." In its more extreme form this has led to a separation of the concepts of costs and harm from human beings completely, substituting notions such as "costs to the environment," and damage to the ecosystem. For example, Pearce and Turner in making a case for a tax on packaging claim that "environmental damage from packaging waste is not reflected in the prices of packaged products" and that "the size of the levy needs to be related directly to the environmental damage done by the production and consumption of the packaging, or to the costs of restoration to the environment" (Pearce and Turner 1992, p. 6). Nowhere in the article is there mention of actual people who are damaged. Costs are associated with "restoration to the environment" not compensating victims. Once the concept of costs is separated from individual human beings, i.e., from the act of choosing, it looses its footing and so does the economic analysis.
Pollution as Interpersonal Conflict
Economic analysis of the environment that starts from a praxeological perspective shifts the focus from maximizing the social value of output or equating price to marginal social cost, to efficient intra- and inter-personal plan formulation and execution, i.e., the internal consistency between the means that people use and the ends that they desire to achieve. Within this context, pollution problems that are indeed problems create an interpersonal conflict over the use of means and therefore obstruct efficient plan formulation and execution. Pollution is therefore not about harming the environment but about human conflict over the use of physical resources. Generally formulated, a pollution or environmental problem arises when individual or group A and individual or group B are simultaneously attempting or planning to use resource X for conflicting purposes. Unless emissions into the air, discharge into a river, or the extraction of fish from the ocean give rise to such a conflict then there is no economic, i.e., efficiency problem. Humans cannot harm the environment. Instead, they can change the environment in such a way that it harms others who might be planning to use it for conflicting purposes.
Most of the classic "textbook" environmental cases can be formulated in this context. Whether it’s the problem of a factory discharging chemicals into a river and destroying the fishing downstream, or the odors from an animal farm fouling the air in nearby housing developments, or Coase’s classic cases of straying cattle or railroads emitting sparks, they can all be seen as interpersonal conflicts. In each case people are simultaneously making conflicting plans with respect to the use of a physical resource, and it is this conflict that allows us to identify what is transpiring as an environmental problem. If there were no recreational users of the river or housing developments downwind from the pig farm there would be no pollution. Environmental problems are not really problems for or with the environment, but human problems of mutual plan formulation and the achievement of goals. From an Austrian perspective, Robinson Crusoe cannot be a polluter.”
While under most circumstances and for most uses the ocean is essentially a noneconomic good, it may not be in terms of its use for harvesting certain kinds of fish. Or while the air may be considered a noneconomic good for many uses, it may not be if one of those uses is to emit odors from certain farming activities. As Menger argued, the only "practical solution" to conflicts that arise over the "economic" aspects of these otherwise "noneconomic" resources is private property.
For Austrians then, if the defining characteristic of pollution is that it is the consequence of a human conflict over the use of a resource, then it is logical that both the origin and the solution of the problem is to be found in a lack of clearly defined or enforced property rights. This property rights approach to negative externalities can be found in the work of most Austrians who have written on the subject. But what has gone unrecognized is that the writings of Mises, Rothbard, and others on this subject have been an application of insights found in Menger regarding the nature of and the solution to human conflict in a world of scarcity.
We recommend reading the entire article, which will probably prove a real eye-opener for many people. The excerpts above merely serve to illustrate that what Grantham bemoans has all been thought about extensively already. It is not a new problem and Grantham is simply wrong when he asserts that such problems of 'externalities' are not amenable to solutions in a free market context.
Finally, here is the full quote of Grantham's regarding Marx and Engels alluded to above and in what respect they were allegedly 'right' about something.
“However, Marx and Engels certainly got the part right about globalization and the supranational company increasing the power of capital at the expense of labor. To interfere with Marx’s apocalyptic vision, we need some enlightened governmental moderation of the new globalized Juggernaut (even slightly enlightened would be encouraging) before capitalism gets so cocky that we have some serious social reaction.”
In other words, Mary and Engels were 'right' with their 'iron law of wages' hypothesis, which stated that workers would be kept at mere subsistence by capitalists who would be arrogating the entire 'surplus value' created by labor to themselves. All of the history of free market capitalism so obviously and clearly contradicts this assertion that it seems hardly worth discussing it. Even the poorest classes in the modern industrialized world today have amenities at their disposal that were utterly out of reach for the kings of yore. Hundreds of millions of people have escaped abject poverty over the past few decades alone, as China and the former Eastern Bloc command economies ditched the communist system and adopted capitalism instead. Grantham makes the grievous error of concluding that the stagnation in real wages in the industrial nations over the past few decades that is the result of the socialistic centrally planned monetary system is somehow an 'inherent flaw' of capitalism. And so he pleads for even more 'enlightened' government intervention to 'fix' what government intervention has wrought in the first place!
Grantham concludes his jeremiad as follows:
“But for me capitalism’s complete fixation on growth at all cost that Marx concentrated on is not as important as the other issues discussed here. Capitalism, by ignoring the finite nature of resources and by neglecting the long-term well-being of the planet and its potentially crucial biodiversity, threatens our existence. Fifty and one-hundred-year horizons are important despite the “tyranny of the discount rate,” and grandchildren do have value. My conclusion is that capitalism does admittedly do a thousand things better than other systems: it only currently fails in two or three. Unfortunately for us all, even a single one of these failings may bring capitalism down and us with it.”
Capitalism is not 'ignoring' the finiteness of resources. It makes use of finite resources that would otherwise not benefit anyone. It is completely vain to speculate about an alleged necessity to no longer 'fixate on the discount rate' but on a future that is a century or longer away. Neither Grantham nor anyone else knows what the world will look like in 150 years. Fossil fuels may be nothing but a historical curiosity by that time. Perhaps there will be portable nuclear reactors the size of a wristwatch powering everything from homes to vehicles – who knows? Contrary to the oft-repeated myth, the biodiversity of the planet is not decreasing, as e.g. Bjorn Lomborg has found out and documented.
The one thing that can bring the capitalist order down is the fact that it is being transformed it into a more socialistic order by the day in the regulatory democracies of the West. It is precisely this fact that our economic order is becoming less capitalistic that we should be worried about. The most pressing problem of all is probably what is to happen with the life-blood of the economy, namely money. Money must be returned to a free market footing. The four decades old experiment in a centrally planned fiat money is failing catastrophically before our very eyes. This problem is not even mentioned once by Grantham, in spite of its central importance.
The one point on which we fully agree with Grantham is his condemnation of crony capitalism – the fact that big corporations can and do buy the government and get it to enact laws and regulations that favor them and put countless obstacles in the way of upstarts that are trying to compete with the established big industries and firms. This can however not be ameliorated by introducing even more regulations and red tape. On the contrary, the exact opposite approach is required. As to this 'regulatory-industrial complex' we recommend that readers take a look at this . Two brief quotes:
“In every administration, the tools of inflation, borrowing, taxation, and regulation are used to transfer wealth from the people to the government and its cronies.”
OSHA, CPSC, EPA, HUD, SEC, ICC, FCC, DOA, FTC, FDA — I could go on and on, through the entire alphabet from Hell. I have only scratched the villainous surface. But according to the average history or economics text, these agencies emerged in response to public demand. There is never a hint of the regulatory-industrial complex. We're told that the public is being served. And it is: on a platter.”
Amen to that.
Karl Marx was not right. The labor theory of value he took from Ricardo and his contemporaries was misconceived and the 'iron law of wages' has been disproved by many decades of capitalist progress.
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A Soaring Market On January 20 2017 Donald Trump will be sworn in as the new president of the United States. On the stock market his victory has triggered a lot of advance cheer already: the Dow Jones Industrial Average rose by a sizable 7.80 percent between the election and the turn of the year. Two big winners: the DJIA and Donald Trump - click to enlarge. Many investors are now wondering what effect the change in government will have on stock prices in the new...