Two questions on productivity

A couple of quick ones:

1. Turn on, tune in, drop out

Robin Hanson says we are living in a "dream time", when survival instincts have been dulled by wealth so that Nature has (temporarily) let us get away with acting stupidly. I recall the old saying, "From clogs to clogs is only three generations" (i.e. the middle generation spends it all).

In this context, it's also interesting to note how at a time when we're drugging children and old people to stop them being a nuisance, libertarians are calling for young adults to have the right to zombiefy themselves with "harmless" mind-altering substances. Yes, they will still be able to work, some of them, for some time; I guess the same argument goes for functioning alcoholics. Dream on... until, as the Germans say, "Aus der traum, lieber Freund."

I've known black people who maintain that drugs liberalisation (and the associated laissez-faire approach to law enforcement) is a plot to keep their children in subjection. I tend to put it down to middle-class selfishness, instead; but I can see why they might think that.

2. Think big, think small

As higher taxation looms, some are already trying to draw a distinction between "productive" and "unproductive" workers. Well, effectively, practically everybody (including the poor) pays 40% tax already, when you look at the combination of income tax, National Insurance and sales taxes; though I do agree that a proposed 50% higher-rate income tax rate is likely to generate various avoidance strategies that will mostly wipe out the hope-for extra revenue.

But if Mish's friend "BC" is right, we are entering a "Schumpeterian Depression", during which big biz uses its access to finance to crush small enterprise; and so it may be a decade before young entrepreneurs develop the muscle to get out from under and start to succeed.

Besides, how much big business is founded on destroying small businesses and the self-employed? What, for example, if we looked at it closely, would be the real, total net benefit of the giant supermarkets? Weigh up the cheaper prices against the exploitation of their suppliers and the ruination of small shopkeepers - and the smashing of one of the ladders by which the aspirant working class - and their children - could rise and become self-supporting.

Credit contraction is outpacing monetary stimulus

"... the Eurozone, the UK, Japan, and essentially every county on the planet is all attempting some sort of stimulus plan or other. This is bound to cause a major distortion at some point, as no country has anything remotely close to an exit strategy for this. What kind of distortion and when cannot be certain because we are indeed in uncharted territory, worldwide."

- Mish.

The more I read around, the more uncertain I become. All I have is my instinct, that things are out of control and we're being told fairy stories to lull us.

Mish's argument is that "The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model." If he's right, it's cash is king, for a long time to come.

What's happening to houses?

Mish gives us a few interesting graphs on the US housing market and asks whether it's hit bottom yet. I did leave a comment but it disappeared, so here's the gist:

It looks as if most of the air has come out of the balloon - in the US. Houses doubled in 5 years, and in some cities have now halved again.

As the tide recedes, it uncovers evidence that the market is segmented - look for example at New York compared to the others. The "best" areas are holding up better, and I'll bet the best houses within those areas ditto.

I think this segmentation will continue to be important, because of growing inequalities of wealth. This has been going on over there since 1980, but also historically (as Fischer in "The Great Wave" points out) the rich get comparatively richer in times of crisis.

I also think that the not-the-best-but-better-than-average housing sector will enjoy support for some time, because I suspect that there are not a few people downshifting from the most sought-after areas. These will be aware that they could have got more if they'd sold in 2007 (when I was mooting a caravan to my dearest), but have still done okay and so will not haggle too hard to get that nice little place in the country, especially since many sellers are hanging on stubbornly, waiting for an upturn.

Here in the UK, we have much less land available for residential development, and nothing like the oversupply of housing that exists in the US, so quite possibly our house price bottom will not be so deep. Of course, if our government hadn't encouraged the (legal and illegal) import of masses of poor people who also need a roof over their heads, the picture might have been somewhat different.

In both countries, we still face long-term economic decline; lower real wages as we continue to lose our manufacturing sector, higher energy and food prices and so on. So I expect house prices to continue their decline in real terms over the next generation.

On average, that is. I think we can take the Blair's real estate coup in Connaught Square as not untypical of what will happen in the best end of the market. Speaking of whom, I note that Tony's practising the "sneer of cold command" these days. Pitiable, really.

Cash vs the stock market: an inconvenient truth

Mish looks at certificates of deposit vs returns from stocks. Investors, take note.

The folly of buy-and-hold may also apply to houses.

"Holding stocks, you have to hold your breath, as the smell may be fatal" - wepollock (htp: Jesse)

Global monetary inflation and the threat to peace

Last week, I suggested that we could be entering an era of competitive currency devaluation. Now, Mish sees it happening in Russia, Mexico, Indonesia - and hints of intervention in Japan. The Canadian National Post predicts a drop in the US dollar, too (htp: Jesse).

Can the Euro -already strained by member countries moving in different directions - take this pressure? A friend told me recently of an old restaurant incident involving people he knew, where first one "did a runner", then another, so that the last man left at the table was stuck with the whole bill. This is a game that punishes the virtuous.

Gold is supposed to be a haven in such conditions, but is already above its long-term post-1971 trend, as I show here. So the bold investor might buy in now, knowing it's high but hoping it'll go higher (or fearing that other things will go lower still). Others say silver, or oil, or agricultural land. "The best lack all conviction, while the worst / Are full of passionate intensity."

These are tricky times. As in revolutions generally, it's hard to see which faction will be victorious, but loss, injustice and confusion are certain: "we are here as on a darkling plain / Swept with confused alarms of struggle and flight / Where ignorant armies clash by night."

This may seem over-dramatic; but when money ceases to be dependable and deadly dull, everything else becomes much too exciting. If the middle classes suddenly find their savings wiped out by inflation, their assets generally devalued and their businesses and employment under threat, watch out.

Rolling back the State

... won't happen. Only a major disaster is capable of breaking the hands that are strangling us. But maybe that is what is now on its way.

Mish reported yesterday how the banks are insolvent, and in his opinion monetary reflation can't work , for three reasons:

1. Putting more cash into the system to create inflation to reduce the real burden of debt, won't create jobs, raise wages, or stop outsourcing (China's nominal GDP per capita is $2,483, America's $45,725, according to IMF figures).
2. But "quantitative easing" - monetary inflation - will lead to a currency drop (if it succeeds) and the reaction will be a raising of interest rates as lenders try to protect the real value of their loans.
3. And if government creates jobs directly, it again skews the economy, giving higher importance to the objects it chooses than the market would, if left to itself; in short, what economists call "malinvestment".

A longish essay over on Mises looks at how the State has seized the wealth and assumed many of the functions of the private citizen, and how the First World War and subsequent events helped accelerate a process that had begun long before.

Back in the 70s, I came across the work of Ivan Illich. His general thesis was that the State takes over activities that previously we performed ourselves - teaching our children, tending to our sick and injured, etc. These functions are then made into organisations with big buildings, many workers and officials, and large budgets - all paid for by taxation. Sociologists call this "reification". It increases the size and power of the State - and here we are.

They don't even do the job well.

As someone in education (as well as finance), I don't subscribe to the airy assertion that "our youngsters leave school illiterate", but they don't read or write as much or as well as they did, and what the liberals have done to the curriculum in English (for example) is painful to see. Heads of English in secondary schools in the 70s literally burned or threw out their schools' textbooks and coursebooks (I remember hearing of three separate cases); but the temptation to micromanage returned. It's like the historical irony that saw the French kill their King and end up with an Emperor.

And having seen the medical service in action on my wife a few years back, I no longer have the blind faith in doctors that I used to have. Phil Hammond (the GP/journalist/entertainer) tells us that the NHS kills or maims about 10% of its hospital patients, and Illich was ahead of him again (Medical Nemesis, 1974).

That's not to say we don't need doctors or teachers, but once created, institutions develop a will to live and purposes of their own, and can drift perilously off-task. Individuals who join them can become sidetracked by career opportunities and political hobby-horses, and in any case have to accommodate themselves to working in a structure run by others who have already done so and altered the operational rules to fit their interests.

Looks like the banks have done the same.

We have to hope that, however painful, after the coming changes there may be some better balance between the citizens taking care of their families, and that black hole of wealth and power, the State.

Very scary

Mish doesn't come across as eager for Armageddon, which make his posts today really worrying. Is it time to get one's cash out of the dispensing machine, to avoid the Argentinian corralito?

The replacement of democratic government by carte blanche

Secret inflation: Mish relays a Telegraph article about yet another unscrupulous legal change to make government less accountable - the BoE will be able to increase the money supply without reporting it.

Increasingly, the British Government seem to me to have become a coup by loophole.

The next wave of bailouts

It's not just the banks that are short of money. Many US States and local authorities are also suffering financial problems, and this is affecting the trade in their bonds, i.e. their borrowings on the money market. ("What are bonds, exactly?" - see here.)

Michael Panzner reports that municipal bonds ("munis") offer a better yield than US Treasury bonds, but the difference is still not enough to pay for the extra risk. Professional investors are short-selling "munis". i.e. betting that they will fall in price. A steep fall may indicate imminent bankruptcy, and some say this is on the way for many authorities, as Mish reported at the end of December.

So, what will happen when the US Government is seen to be buying everybody's bad debts?

People (even here in the UK, where we tend to wait patiently for our wise rulers to solve all) are beginning to worry about inflation, and are thinking about investing again. An article in Elliott Wave International warns us not to be panicked into parting with our cash, and reminds us:

... there are periods when inflation does erode the value of cash. I mean, look at the seven years leading up to the October 2007 peak in U.S. stocks: big gains in the stock indexes, while inflation was eroding cash. No way did cash do as well as stocks during that time.

Right?

Wrong. Cash outperformed stocks in the seven years leading up to the 2007 stock market high. That outperformance has only increased in the time since.

Since this is the view I took and communicated to clients in the 1990s, you will understand that I didn't make much money as a financial adviser. But it was certainly good advice, even if it was based on strongly-felt intuition rather than macroeconomic analysis.

Not that analysis guarantees results, in a world where the money game's rules are changed at will by politicians with a host of agendas that they don't share with us ordinary types. But my current guess is that the stockmarket will halve again in the next few years, when compared with the cost of living.

Stock market could halve again

As you know, I've been doing my own extrapolations recently, based on the Dow since 1928, and the implication is that the low point could be as deep as c. 4,000 points, i.e. another 50% off where it stands today.

Now, "Mish" looks at revised earnings estimates for companies and relates them to stock prices, applying various price-earnings ratios. His conclusion is broadly the same.

As Michael Panzer predicted* (reviewed here in May 2007) there's been a flight to cash, and now (as he also predicted) it looks as though inflation is set to roar. This will disguise what's happening to stocks, but underneath it I see that decline. As in the '60s-'80s. it may take some years after the apparent turnaround before real values increase again.

Provided you trust the government to pay up when due, and to calculate inflation fairly, National Savings Index-Linked Savings Certificates (or US TIPS) may be a valuable weapon in your anti-inflation armoury.

*"He predicts first a credit squeeze, which makes cash king and ruins our credit-dependent lives and businesses wholesale; then hyperinflation, as the government prints money to keep the system from complete collapse.

In this scenario, at first, stocks, corporate bonds, property, commodities (including gold), even government bonds and savings certificates, all decline in value against hard cash as everybody scrambles to settle their own debt, collect what's owed to them and continue to pay the bills. Then the hyperinflation hits and everybody tries to offload their currency."

WeaselWordWatch update: "Quantitative Easing"

Okay, it's a phrase, not a word. But 4,094 references on Google News in the last 24 hours. And Mish is at it, too, though of course in an ironic way.

Bookends: deflation and inflation

On one side, the redoubtable Mish scorns those who think inflation is a clear and present danger:

...Those who think inflation is about prices alone were busy shorting treasuries, and looking the wrong direction for over a year. Only after the stock market fell 50% and gasoline prices crashed did the media start picking up on "deflation". Only those who knew what a destruction in credit would do to jobs, to lending, to retail sales, to the stock market, to corporate bond yields and to treasury yields got it right...

Those who stick to a monetary definition of inflation pointing at M3, MZM, base money supply, or even Money AMS, are selecting a definition that makes absolutely no practical sense. Worse yet they do it screaming about bond-bubbles at yields of 5% or higher, all because they refuse to see or admit the destruction of credit is happening far faster than the Fed is printing...

The trick now is to figure out how long deflation will last, not whether we are in it. Humpty Dumpty is of no use, he cannot even see where we are.

On the other end, Jesse recalls Moscow in 1997, before the currency popped:

...They were desperate times, and you could see that there was a climactic crisis coming. It is easy to talk about this sort of thing, a thousand to one devaluation of your home currency, but harder to understand the impact. Imagine that you have $500,000 in savings for your retirement. Now imagine that within two years it is effectively reduced to $5,000 or less, and you will understand how disconcerting a currency crisis can be.

If you don't think a financial panic is possible here in the US, just take a look at the negative returns on short term T bills, and you will get a taste of the leading edge.

One of the best descriptions of the Weimar experience I have ever read was by Adam Fergusson titled "When Money Dies: The Nightmare of the Weimar Collapse." It is notoriously difficult to obtain, but it does the best job in describing how a currency collapse can come on like a lightning strike, although in retrospect everyone could have seen it coming. Denial is a strong narcotic. People believe in their institutions and ignore history until they are staring on the edge of the abyss.

Hurray for a radical

I sympathise with Mish; but getting it done would be like a goat persuading a tiger to turn vegetarian.

If deflation is not the problem, what is?

The problem is fractional reserve lending that allows banks to leverage lending 12-1 and broker dealers like the now defunct Bear Stearns and Lehman 40-1. It does not take much to cause a run on the bank when leverage is 40-1. Fannie Mae is leveraged many times more than that.

Without that excessive leverage, no one would be in trouble over falling prices. Actually everyone would benefit. The cure is not to defeat deflation, the cure is to embrace deflation and stop fractional reserve lending and the serially bubble blowing activities of the Fed.

I support abolishing the Fed and the elimination of fractional reserve lending. Those are the only long term cures to the problems we face.

Cruising for a losing

Mish's graph suggests houses could lose another 40% or so over the next 7 years.

Looking back, looking forward

UPDATE: "This secular bear market will last a lot longer and be much deeper than anyone thinks. Sadly, very few are prepared for it." - Mish.

This gels with what Marc Faber was saying quite some times back, that the market had further to drop than many people thought. Equities may seem to be fair value in terms of multiples of their earnings, but when the earnings fall, valuations have to be reassessed.

All in the same boat

Mish notes that because it's a global crash, everyone is printing money and the relative value of the dollar has not plummeted as many expected:

... Looking ahead, it is quite possible that if all pegs were removed and the Renmimbi allowed to freely float, that the Renmimbi, not the US dollar would crash. Certainly the pound could crash (I think that is likely), and the EU might even break up.

Guessing the low points

I looked at trends in the Dow earlier this year and guessed that the Dow's low might be 7,000. Now, Mish reports that Nouriel Roubini is saying the same.

The FTSE is currently hovering around 4,000, which is lower than the line I drew in June. But then, the line passed through, not under, the lowest negative spike in 2003. I seem to recall Wolfie predicting 4,000 in one of his comments here recently; well done, old chap.

Elliot Wave again

Like Robert McHugh, "Mish" also follows the Elliot Wave theory:

In Elliott Wave terms the index is in an impulsive wave 3 down. At some point there will be a corrective wave 4 up, with still more down to follow in wave 5. A lower low can be expected.

Snap! And crackle...

On Thursday, I noted that, in the last 12 months, America has paid over $400 billion in interest payments on "the debt", AND increased the debt outstanding by around $1 trillion, making a total of $1.45 trillion. (I know I'm adding apples and oranges, but both elements are burdensome obligations.)

Now, noting the drop on the Dow and the cost of rider-bribes to the bailout bill, Karl Denninger is at the fruit-summing game:

Bailout Bill $700 billion
Additional Pork $150 billion
Dow (-484) in 3 hours $600 billion
Total carnage to you, The Taxpayer $1.45 trillion

The government is feeding the woodworms. Mish is convinced that deflation is inevitable ("There has never been hyperinflation in history with falling home prices.")

So you'd be forgiven for thinking, "What's the point in destroying even more money on this bonfire? Cut out and burn the rotten wood first, then rebuild the house."

Not so easy. The situation is especially bad because it's spilling over into international relations. Some American official (I forget who) flew over to China last year to get the Chinese to buy into mortgage-backed securities. Did the US really think a powerful partner would allow itself to be cheated when the package turned out to be rotten? (And didn't the Chinese know that, anyway? Isn't it possible they bought the rubbish because they were confident they could force the US Government to make good on it?)

I would almost say, buy into the packages the Chinese bought; but I expect there are ways to make the Chinese the preferred creditors and stiff everybody else.

Remember that Denninger has been saying recently, buy a good home safe and get your cash out of the bank? Let's see how unreasonable his doomster position turns out to be.

Not the end, as long as you and I breathe

Looks like the US is in the process of nationalising the banks and the stockmarket, loosely speaking, and the UK is following suit; now Mish says Russia and China are doing the same. All is falling into government hands.

I've been wondering recently: if, in the idealistic pursuit of universal peace and justice, we ever did manage to establish a World Government, and it became (as all human institutions do), inefficient, bureaucratic, undemocratic, corrupt and more or less evil, how would anybody escape? Where could we go to?

And Denninger is now singing a requiem for American government and democracy; perhaps prematurely - hasn't the often-mocked blogosphere uncovered a depth of feeling among the people in favour of liberty?