August 2012

The apologists are out in full force. The “White Coat Syndrome” being utilized to the maximum.

Richard S. Grossman is a professor of economics at Wesleyan University in Middletown, Conn., and a visiting scholar at the Institute for Quantitative Social Science, Harvard University. He is the author of “Unsettled Account: The Evolution of Commercial Banking in the Industrialized World Since 1800.”

Rather than be overly impressed by all the credentials, let’s take a look at his arguments, you know, the substantive ones.

The Republican Party platform calls for the creation of a commission to look at restoring the link between the dollar and gold.

True enough.

As an academic, I am all in favor of scientific study. But in this case, a call for further study is just code for “This is a bad idea, but let’s try it anyway.”

Leaving aside the problem of the scientific method, viz. positivism, being wholly unsuited to the study of social phenomena, how did he arrive at this is “code?” I think we can dismiss this statement as nonsense.

The argument is similar to that put forward by those who want more research on the “link” between childhood vaccinations and autism. Extensive scientific investigations find absolutely no such link. Yet the die-hard believers continue to press for more wasteful spending on an idea that flies in the face of the evidence.

The scientific method, as already stated, is wholly inappropriate for the social sciences. But once again, ignoring that fact, this statement rather shifts the focus from gold and money to quite possibly a legitimate objection, and then stating they are the same. Are they really? How? This is not an argument, this is an opinion.

The gold standard’s shortcomings should be obvious by now, but apparently the Republican platform committee — seeing the gold standard as a bulwark against a nonexistent inflation problem — needs a refresher course.

The good professor hints at numerous problems, but uses “inflation” as the example. Inflation is the expansion of money and credit. Has the Federal Reserve and government expanded the money supply?

Rather, our dishonest professor implies that “inflation” is measured by a change in CPI prices, or some other metric. Inflating money and credit will distort prices, but that is only part of the answer when considering the question. Also important are the questions: what cash balances are being held by individuals, what saving/investment? Today, also, you need to ask – what is the default rate in the banking system on loans? The reason being that under fractional reserve lending, loan default is leveraged to the downside, contracting credit.

If the United States established a gold standard, the Federal Reserve would be required to exchange dollars for gold at a fixed price.


But what price? During the last 10 years, gold has fluctuated between $300 and $1,900 per ounce. Set the price too low and the Fed will run out of gold in a matter of hours; set it too high and the Fed will be flooded with gold. And even if Congress could find the “correct” price for gold, given worldwide fluctuations in the demand for gold, it is unlikely that the price would remain “correct” for long

Money is a commodity. Like any commodity, money responds to the changes in the supply of, and demand for money. Price changes are how those two variables are brought into momentary equilibrium, viz. an exchange is made.

History provides ample evidence that the gold standard is a bad idea. After World War I, the major industrialized nations established the gold standard, which is widely seen as having contributed to the spread and intensification of the Great Depression. The gold standard tied the hands of monetary policymakers, forcing them to maintain high interest rates in order to maintain the price of gold, thereby making a bad economic situation even worse.

The “gold standard” was a standard that allowed governments to cheat. Money supply expansion could still take place, although not as egregiously as today. From Friedman & Schwartz, A Monetary History of the US, pg 222:

The Reserve Board was aware that Bank discount rates were below current market rates throughout 1919, that this was contributing to monetary expansion, and that monetary expansion was contributing to the inflation.

Had we been on the gold standard when the subprime crisis broke, the Federal Reserve would have had to raise interest rates instead of lowering them. Given that our economy was — and still is — struggling despite historically low interest rates, higher interest rates would have been devastating.


It rather appears that the “cure” for the recession/stagflation of the mid-seventies to the early eighties, was, high interest rates.

And if there is any doubt about the folly of tying the value of a currency to something outside a nation’s control — and the price of gold is well outside the control of any government or central bank — look to Europe

Possibly we might be provided with an argument that actually holds a drop of water now?

Instead of fixing their currencies to gold, the 17 members of the Eurozone fixed their currencies to a new currency, the euro. The euro worked well during its first decade, primarily because there were few strains on it. But starting in 2009, the stress became obvious: Greece had fiscal problems, Ireland and Spain had real-estate bubbles that burst, Portuguese consumers spent themselves into trouble, and Italy’s economic policy was a complete mess.

And why, in 2009, did the problems start?

Oh, is that, money expansion?

If these countries had not been members of the Eurozone, they could have instituted expansionary monetary policies that would have helped their economies, such as devaluing their currencies to increase exports or lowering interest rates to stimulate economic growth. Instead, countries as diverse as Greece and Germany are stuck with the same monetary policy — and it is not working well for either of them.

Surely you jest.

That is a $1.2 Trillion euro expansion.

How much lower do they actually need to be before our good professor admits that artificially controlled interest rates are detrimental, not helpful.

The Republican Party proclaims itself to be the party of conservatism. But being a conservative should not mean promoting policies that have not worked for 100 years. Reestablishing a link between the dollar and gold would be a huge mistake. Establishing a commission to “study” the idea is a waste of time and money.

I won’t even bother getting into a definition of “conservative” as it is irrelevant. So has our good professor managed to convince you of his case against gold?

Rights and freedoms are of course connected to each other. That is the reason why libertarians want to restrict the meaning of the concept of freedom to only negative freedom – the absence of coercion. Not any kind of coercion, but only when persons exercise coercion is freedom held to be restricted. If social structures and property rights deny people access to food, education and safety, no one’s freedom is said to be restricted.

Not really. Freedom requires an understanding of scarcity. Freedom is an economic good, it is scarce, it isn’t just automatically available, viz. a right. Property rights are the way that freedom can best be gained or allocated, utilizing the Rule of Law.

The highlighted conclusion refers to economic goods. Economic goods are scarce. Property rights are the best way to ensure that as many individuals as possible enjoy access to scarce economic goods, freedom, food, education and safety.

Managing money is tough because:

Not because the financial markets are global and 24/7. Not because the markets are full of extremely driven and intelligent competitors. Not because the emotional highs and lows can be soul crushing. It is because of the constant and measurable competition against passive benchmarks.

Benchmarks are the most ferocious of competitors. They show up for work everyday. They never get sick. They don’t take vacation. They are always 100% invested so their results are continuously compounding. Most importantly, they’re not aware of their own performance. The S&P 500 will never enter the 4th quarter feeling it needs to really press to have good numbers for the year. Nor will it take December off to “lock in” a good year.

Which is precisely why they can be beaten. To beat an index, you have to buy low and sell high. The selling part is how you lock in profits, that can then be recycled into increased stock holdings when you buy low. It is all about market timing. It is about absolute returns, measured against [relative] returns of the market.

This inconvenient truth is like a little voice in the head of every successful investor – “Am I really good at this or have I just been lucky?”. A voice that never goes away as it only takes a couple bad years to destroy an lifelong track record.

True. But if you truly have skill, and haven’t just been lucky, you will already know how to manage this and prevent it.

Often, a takeover deal, if taken seriously, will be greeted with a jump in the target company’s share, and a more muddled move in the acquiring company — particularly if the acquisition doesn’t seem to make obvious sense, or if there are worries about paying too much.

Lately, though, we’ve been seeing plenty of investor goodwill toward companies bold enough to try and swallow another company in the rocky environment. That suggests investors are liking the deals, and seeing plenty of value in these target companies, according to John Buckingham, chief investment officer at Al Frank Asset Management in Aliso Viejo, Calif.

Buckingham has been particularly encouraged by three recent deals. Last Monday, health-care giant Aetna shot up 5.6% after announcing it had struck a deal to buy Coventry Health Care. Aetna has since come back some, but remains higher than before the deal was announced. (Coventry, needless to say, jumped 20%.)

Merger’s can help the stock market. Essentially mergers should have the more efficient producers buying out the inefficient, and putting their capital to work more efficiently. In this way the total capacity of an industry is changed/modified for the better.

That’s only of course if the deals make sense. CEO’s have an unfortunate track record however of acquiring assets that don’t make much sense. Buffett and Berkshire are serial acquirer’s and have done very well from it. It is about cashflow.

In the above case, Insurance, the merger makes sense. Insurance is an industry that benefits from scale. Pooled risk is the name of the game, and purchasing another Insurer makes all the sense in the world as long as a few important caveats are observed.

Tail risk is the one you need to watch. Has the insurer that you have just acquired, carry long exposures into the past? The classic example was the asbestos risk that killed a number of private names in Lloyds syndicates a while back.

Mergers done well, indicate that there is value available. If there is value available, there is profit potential, which suggests careful, selective purchases in the market, will reap investment returns going forward. It also helps the bulls, especially if the spark triggers a fire.

Ever since the current bull market began in early 2009, the most oft-cited criticism is that volume has been weak. Even the most casual market observer has heard the complaint that rallies on light volume are unsustainable, and in effect, don’t count. The argument sounds good in theory, but followers of this logic would have essentially missed out on what is now the ninth strongest and longest bull market (and more) in the history of the S&P 500.

In order to illustrate the fallacy of this argument, the chart below shows the performance of the S&P 500 since the bull market began on March 9th, 2009 along with its performance if we take out all days where volume (as measured in SPY) was below its 50-day moving average. So far during this bull market, the S&P 500 is up 108.5% (blue line). If you back out all days (up and down) over the same period where volume was below average, however, you come up with a decline of 30.1%.

Just another variable, that historically, has changed. The market is never quite the same, it changes its nature, which makes strategies relying on that variable, tough to follow. Volume has never been a particularly big deal for me, so although I’ve noticed the low volumes, I haven’t obsessed on it.

Gold it seems, is endlessly exposed to propaganda, the reason being fairly obvious, it ends governments monopoly on the money supply. Let’s look at just another one of many.

In 1981, President Ronald Reagan created the Gold Commission. The purpose of the commission was to appease conservatives who wanted to see the country return to the gold standard. The conclusion of the Commission? That’s a clown idea, bro.

Really? Reagan expanded government. Possibly more than most. Reagan perpetuated the military race with the Soviets, building “Star Wars” amongst the more traditional paranoia based expansions of the military.

“Restoring a gold standard does not appear to be a fruitful method for dealing with the continuing problem of inflation,” the Commission reported. They even rejected the halfway measure of issuing a limited number of bonds backed by gold as a way of “introducing gold into our monetary system.”

Really? Where are the arguments supporting this assertion? There are none. Clearly new supply of gold mined, does add to the quantity of gold and hence the money supply, which is inflationary, but it is so small, as not really worth worrying about. Spain back in the 1500’s did kick off an inflation with the theft of South American gold, but the quantities increased dramatically, and quickly. Theft however is not the same as production.

So, to recap, in 1981, amidst a serious inflation problem, Reagan created a commission to study a gold standard. You couldn’t have picked a more sympathetic president, or a more sympathetic moment, to the gold standard. And they still rejected it.

That’s your argument? That a President, rejected it? You must be fucking kidding me.

Now fast forward 30 years. There’s no inflation problem. The head of the Federal Reserve was originally appointed by George W. Bush and is credited by most observers as having headed off a potential Great Depression through creative monetary policy. And so what does the Republican Party want to do? Well, according to a draft of the party’s platform, they want another Gold Commission.

Bush, quite possibly the worst President ever. Ignoring that however, why is inflation low currently? Simply the rate of debt destruction and low velocity has offset the tremendous expansion in the money supply. The inflation rate is the change, which is far higher than the CPI headline.

Try 6.88%. That is serious inflation. Serious enough to turn the real return of all save possibly junk bonds into negative numbers. This is why the pro’s are in the stock market and gold.

You might dismiss this as a meaningless capitulation to Ron Paul’s delegates. But that’s not what Rep. Marsha Blackburn, co-chair of the GOP’s platform committee, says. “These were adopted because they are things that Republicans agree on,” Blackburn told the Financial Times. “The House recently passed a bill on this, and this is something that we think needs to be done.”

Well at least some in Congress are actually trying to do something positive.

One of those House Republicans is Paul Ryan. To my knowledge, Ryan has not, in fact, endorsed a gold standard. He’s too smart for that. Instead, he endorsed something that sounds better than a gold standard but is functionally identical. “The best way to guarantee sound money is to use an explicit, market-based price guide, such as a basket of commodities, in setting monetary policy,” he wrote in the Wall Street Journal.
A moment of explanation: A “gold standard” means that the dollar is backed by gold. The problems with the gold standard are legion, but the most obvious is that our currency fluctuates with the global price of gold as opposed to the needs of our economy.
Pegging the dollar to a basket of commodities works the exact same way. Now the currency fluctuates alongside gold, soybeans, oil, and whatever else we choose to put in the basket. And, like with a gold standard, those commodities don’t follow the needs of the American economy. As Slate’s Matt Yglesias writes, “it means that if a drought devastates the corn crop or a war disrupts Persian Gulf oil supplies, we automatically respond with tight money and a demand-induced recession. Alternatively, if someone discovers a cheap pollution free method of generating unlimited electricity we’d end up with a ton of inflation.”
But it’s not just that a gold or commodity-based standard doesn’t make long-term sense. It’s that it’s a violation of everything the last few years should have taught us. In 1981, the country really was facing an inflation problem. It made sense that people would be looking for radical alternatives that would help control inflation.

The commodity basket. Ben Graham wrote a book on this, “Storage & Stability” in 1937. Right about the time of the double dip back into the “Great Depression.” While he was a great security analyst, he was a horrible economist.

First and foremost, money can never be stable. It was never meant to be. Prices are meant to fluctuate, to allow adaption to changing circumstances. Money is a commodity in the same manner as oil or wheat. Its price must, and should fluctuate.

Second, even if you wanted to stabilize money, you can’t, because you can’t measure the changes in prices when you add/subtract money from the system. You distort all the previous price relations.

Third, you would all have to agree on the ratio’s of commodities that formed your commodity basket, then their weighting, then creating some index number to measure changes. Pure nonsense.

Today, inflation is about as low as it’s ever been, and if you look at market expectations — you do believe in the market, don’t you? — it’s expected to stay low. Moreover, we’ve just come through a financial crisis in which the entire global economy might well have collapsed if the Federal Reserve hadn’t stepped in as the lender of last resort after the credit markets froze. We’ve been watching as the euro zone dissolves amidst fears that the European Central Bank won’t act as a lender of last resort.

And why did the Fed have to step in? Because banks, allowed by government to operate fractional reserve lending, created a credit bubble so massive, that, when it popped, it threatened to take down the entire financial system.

The answer is so simple. 100% reserves using gold. No fractional reserve lending. I go to the bank to withdraw my demand deposit – no problem, they have it, 100% reserve you see. Only time deposits, which are contracts of risk, are allowed to become loans. You invest your money, it is at risk. Only the prudent banks will remain in business. The dimwits, which is pretty much all of them currently, would go under – good riddance.

But as economist Barry Eichengreen writes, a gold standard would mean ”the Fed would have little ability to act as a lender of last resort to the banking and financial system.

Don’t need the Fed. 100% reserves.

The kind of liquidity injections it made to prevent the financial system from collapsing in the autumn of 2008 would become impossible because it could provide additional credit only if it somehow came into possession of additional gold. Given the fragility of banks and financial markets, this would seem a recipe for disaster.”

Without fractional reserve lending, the credit expansion that the banks created would not be possible. Hence, any problems with bad loans would be confined to the investors, via their proxy, the banks. Those banks would likely go out of business.

Unlike 1981, in other words, when the gold standard made a kind of superficial sense as a response to our problems, 2012 is a moment when a gold standard would clearly have worsened our problems. Dramatically. As Eichengreen concludes, the idea’s “proponents paint the gold standard as a guarantee of financial stability; in practice, it would be precisely the opposite.”

The problem is government. Government and banks created the problem. Gold would prevent another debacle like the current one. Anyone who claims that gold created the Great Depression seriously needs to examine the historical record. Once again, the culprit was government, operating through the banking system, expanding the money supply.

Opening trade of the week now. I’ll post the chart at the end of the week along with the trade.

Libertarianism takes its point of departure from a formulation of a theory of natural rights, where the rights are looked upon as sacred. Why we have to accept these rights‟ exceptional status is, however, not obvious. Rights and freedom make possible the realisation of our life-plans and ideas of the good life. But they cannot – as often pointed out by Amartya Sen – be considered absolute and inviolable restrictions.

Sen, poor chap is obviously confused. Natural rights, Natural Law, are “Property Rights.” That is the right of property in self, and ones production. Of course they are sacred, if they weren’t, then slavery would be a natural ethical position for humans.

Say again confuses “rights” with “freedom.” They are related, but different. Economics seeks to explain scarcity. Freedom falls under scarcity. Freedom is not “free” in the economic sense, it is scarce, and must be earned. Without property rights, freedom, or any economic good, becomes an impossibility.

Probably best to quote the man himself prior to undertaking Marx and his criticism.

It is worthwhile to remark that a product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus the mere circumstance of creation of one product immediately opens a vent for other products. (J. B. Say, 1803: pp.138–9)[6]

Keen notes that Keynes’ own formulation and refutation of Say’s Law was clumsy and turgid. Instead, Keen opts for Marx’s critique, which was far more concise and lucid. Keynes actually included Marx’s critique in his 1933 draft of The General Theory, but eventually eliminated it, probably for political reasons.

The problem of Keynesians everywhere, inaccuracy.

Say’s Law relies on a simple claim: the structure of a market economy is Commodity-Money-Commodity (C-M-C), where people primarily desire commodities and only hold money for want of another commodity. But Marx pointed out that, under capitalism, there are a group of people who quite clearly do not fit this formulation. These people are called capitalists.

Hardly a surprise there. Does Marx provide his reasons?

Capitalist production does not take the form of C-M-C, but of M-C-M: a capitalist will invest money in production in the hope of accumulating more. As Marx put it, “[the capitalist’s] aim is not to equalise his supply and demand, but to make the inequality between them as great as possible.”

The important element that Marx omits is the element of time. Capitalists provide the wherewithal, saved goods, to allow the production of goods that take time. The more advanced the goods, the longer the production process. Therefore, the “profit” is the discounted value of present value as against the time taken to produce the goods in question.

Say’s Law could be said to apply in a productionless economy, but capitalism is characterised by the value or quantity of produced goods and services exceeding the value or quantity of the inputs. Hence, there will always be a surplus of money needed to satisfy capitalist accumulation, and the economy will continually be characterised by excess demand for money, and hence insufficient demand for commodities.

Incorrect. The commodities/goods consumed in the waiting period reduce the total quantity of goods available to exchange against money. The shorter the production period, the less saved goods will be consumed, but, the less goods will be produced.

It is the production of increased goods that constitute an advance in wealth. Therefore advances in capital and technology that increase the amount of goods produced, lowers their money prices, increasing the standard of living for all.

The cash balance is an insurance against the uncertainty of the future. The more uncertain the future, the higher on the value scale a cash balance may be. Always some income will, and must be consumed, and excess not being consumed or held, is saved, which is analogous to investment.

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