Monthly Archives: December 2009

Understanding Money and the Division of Labor in Ten Minutes

Excellent Video:

Understanding Money and the Division of Labor In Ten Minutes – video lecture by Walter Block


How to End Recessions Forever

Economics Professor Huerta de Soto explains:

Huerta de Soto advocates “bringing the fall of the Berlin Wall to its culmination in the financial sector.” As long as central banks continue to exist as “central planning agencies in western countries,” this follower of the Austrian School believes cycles of artificial credit expansion will repeat themselves again and again.

“Central banks insist on dictating manu militari what should be the freest of market prices (the interest rate), and on managing the money supply. Austrian theorists showed that a central planning agency could not possibly gather all the information necessary to make its commands meaningful. This is the principle of the impossibility of socialism. Monetary authorities trigger and reinforce economic cycles instead of stopping them.”

Huerta de Soto’s solutions would be “first, to eliminate planning agencies” and second, “to establish a system in which bankers are subject to general legal principles. In other words, there should be a 100% reserve requirement on all demand deposits and equivalents. This way, bankers could act solely as pure financial intermediaries: they could lend only what had been lent to them. This would separate the business of financial intermediation from the business of money creation.”

Without central banks, who would generate the money supply? The professor advocates “a return to the gold standard, since growth in the stock of gold is independent of human will. The world’s stock of gold grows between one and two percent per year, and hence we would eliminate the possibility of manipulating the financial system. All loans would be granted against prior saving, and there would be a balance between saving and investment. Recessions would then be history.”

You can read more here.

Economic Observations by Austrian-influenced Investors

From Barrons:


Shorting the Economic Recovery

A Q&A WITH KEVIN DUFFY AND BILL LAGGNER: Two hedge-fund managers predict the economy’s next leg down. Shorting Goldman Sachs.

PERHAPS ONE OF THE greatest failings in the run-up to the financial meltdown was a lack of perspective — an inability by many market participants to see the big picture. Not so with Kevin Duffy and Bill Laggner, principals of the Dallas-based hedge fund Bearing Asset Management. With the help of their proprietary credit-bubble index, developed in 2004, the managers sounded early warnings on housing and credit excesses, and capitalized handsomely on their forecasts by shorting Fannie Mae, Freddie Mac, money-center banks and brokers, builders, mortgage insurers and the like.

Students of the Austrian school of economics, which espouses a free-market philosophy that ascribes business-cycle booms and busts to government meddling with interest rates, the pair is solidly in the contrarian camp, believing that the worst for the markets may be yet to come.

The two established Bearing in June 2002 after running their own money and, before that, a stint by Duffy at Lighthouse Capital Management and by Laggner at Fidelity. Bearing now has about $60 million under management, and they have returned on average an impressive 18.28% annually since setting up shop. They hold refreshingly against-the-grain views on what’s ahead.

Barron’s: You’ve said that perhaps the most redeeming feature of capitalism is failure. Please explain.

Duffy: Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.

Capitalism is primarily attacked by two groups: utopians who wish to impose a more “compassionate” system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.

As a country we’ve become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on “capitalism.”

What would you have done differently as the credit bubble was bursting and the Fed and the Treasury were declaring that the world would come to an end without an $800 billion bailout package?

Duffy: Allow those who essentially bet wrongly to fail, instead of bailing out people with friends in high places.

What about the argument that a financial panic would have ensued and crushed the little guy?

Duffy: The little guy actually has been crushed. Nobody is asking where this money is coming from. And the money has to essentially flow into the political economy at the expense of the real economy. The little guy is always going to be the last one in the soup line. So he will get a bone tossed to him, like cash for clunkers. But if you are Goldman Sachs or if you have got essentially the red bat-phone to Washington, D.C., you are first in line.

Laggner: AIG made sure its creditors received 100 cents on the dollar. Essentially you have the socialization of risk, but the survivors are still highly leveraged. There is still a multi-trillion dollar shadow banking system that FASB [the Financial Accounting Standards Board] wants to address next year. The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them.


What else could have been done?

Laggner: We could have isolated the money centers and put them in temporary receivership. Then, we could have created — with a mere $100 billion — a thousand community banks. If you believe in fractional reserve lending [in which banks lend multiples of their deposits], something we don’t support, they could have created a trillion dollars in new credit that would have flowed to small and medium-sized businesses. Those are the parts of the economy that are choking. Because there has been no reform, it looks like we are going to be spending more money. We are going down this very treacherous path, where debt continues to skyrocket. Private-sector debt is being offset by the public sector. Meanwhile, the cost of funds for small and medium-sized businesses has gone up, while the cost of borrowing for the survivors is little to nothing, and they are speculating with that money, as opposed to letting it flow through into the real economy.

What kind of financial reform would you like to see?

Laggner: We don’t believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer — that whole model is broken and needs to go away.

How would you refashion the system?

Duffy: To get to the heart of the problem, we need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles — and the system will keep perpetuating itself.

Where are we in the deleveraging process?

Laggner: We had a massive real-estate bubble and credit growth, thanks to off-balance-sheet banking that went to four or five times gross domestic product in the latter part of this decade — and of course it burst. Because of huge government commitments, we now have rolled the credit bubble into a sovereign-debt bubble.

The question is, how is the government going to service all this debt? As the real economy contracts and as the political economy expands, this coordinated global debasement strategy ultimately fails.

How do you play that?

Duffy: The immediate risk is the economy. We’ve had a nine-month rally. We think it’s a false rally. Some sentiment levels have returned to the extremes of optimism of 2007. We are essentially doing a long-short strategy — long physical gold, short the Standard & Poor’s 500. At the 1980 peak, the ratio of the gold price to the S&P was about six times; at the low in 2000, it got down to 0.2; today it is at about one. We can go to two, three, four times.

Do you see the S&P 500 retesting its lows of this year?

Duffy: It’s difficult to know. It depends on how much money gets printed. In real terms, can we get cut in half from here? We think so. S&P earnings are distorted because of accounting changes for banks and brokers; if banks were marked to market, S&P earnings next year could fall to $45 a share. Bullish sentiment is rivaling the 2007 top, and volatility has fallen dramatically. We like the VXX, an exchange-traded note that’s based on S&P 500 short-term volatility as measured by the VIX index. It’s down 67% this year, and fits into the whole idea that complacency is very high.

Indeed. Are there any sectors of the market that you do find attractive?

Duffy: We are long consumer staples, discount retailers and pharmaceuticals. One way to participate is through the Gabelli Healthcare & Wellness Trust [ticker: GRX]. It holds roughly half health care and half global consumer brands in high-quality names like Danone [DA], Nestlé [NSRGY] and CVS Caremark [CVS]. It trades at a 20% discount to net asset value, though it has a fairly high expense ratio of 2.16%. If you look at Big Pharma, during the tech-stock and growth bubble of 2000, these companies traded as growth stocks, with an enterprise value to annual research and development spending of about 50 times. Today they’re trading at 10 to 15 times. We like fallen growth stocks that are cheap, like Wal-Mart Stores [WMT]. The stock has gone nowhere in the last decade, but gross profits have grown 2.7 times.

What are your other themes?

Laggner: We are heavily short Japanese and U.S. government long-term bonds. Greece’s deficit to GDP is approaching 15%. If you look at the proposed debt-ceiling increase in the U.S. [the Senate voted Thursday on a near-term increase to $12.4 trillion from $12.1 trillion] and at the current administration’s planned spending, we are probably going to be at roughly 13% deficit to GDP this fiscal year, so basically we are Greece, where 10-year-bond yields rose 160, 170 basis points. [A basis point is a hundredth of a percentage point.] U.S. bonds are down about 20% this year, so we see a process in which creditors just shy away from funding our long-term obligations, and long-term rates keep creeping higher.

The Fed has controlled the long end by monetizing Treasuries and mortgage-backed securities. If they see the long end getting away and decide to come back into the market and buy, that will result in a much lower dollar and higher gold prices. Gold is reflecting not just inflation but instability around the world related to these business models that have been adopted by governments.

Yet the EU said it won’t bail out Greece.

Laggner: Maybe we’re at a turning point, where the bailouts have been so extreme that both our central bank and the ECB say we just can’t continue to do this, otherwise we are going to have currencies evaporate overnight. But we haven’t seen much of anything in the way of just cutting government spending, either here or in Europe.

What about the big banks? When do we see the denouement?

Laggner: There is some deleveraging in the consumer space, but little or none in the professional-speculator space, the bank money-center space. Credit Suisse is apparently allowing its hedge-fund clients to return nearly to the leverage levels at the peak, in ’07. Assuming financial-accounting regulators reinstate off-balance-sheet rules on securitizations early next year, Barclays estimates it will bring roughly $500 billion in off-balance-sheet assets back onto bank balance sheets in 2010. That is going to force the banks to raise capital. A lot of structured finance is carried on the books of banks at close to par.

The FDIC [Federal Deposit Insurance Corp.] took over Corus Bank and Guaranty Bank and liquidated their books, and that debt is going for anywhere from 33 to 37 cents on the dollar. Until the regulators force banks to realize these losses, it’s like the entire financial sphere is in suspended animation. A large chunk of CMBS [commercial-mortgage-backed securities] aren’t being serviced. The same with residential mortgages, whether in the loan-modification-market program or not: Banks are able to carry a lot of these loans as performing loans, even though they are not performing. Japan tried the same thing, and it just lengthened the process. And we are going down that Japanese road.

That can’t be good for the banks.

Duffy: We’re essentially short the political economy, and the most politically connected firm is Goldman Sachs [GS]. It has two sides: a highly secretive and profitable trading operation, and a more pedestrian public business. Our suspicion is that their secret sauce is access to friends in high places, and that the model breaks when it either flies too close to the sun or a public backlash opens them up to scrutiny. Trading and principal investments account for 67% of net revenue this year, the highest level ever. Goldman, aggressively plying the risk trade, is vulnerable to the next leg down.

Speaking of a backlash, we now have Goldman managers toting guns to protect themselves from populist rage. At what point will society demand some sort of change from the government?

Laggner: A client sent me an e-mail the other day in which the tea-party demonstrators are getting a higher approval rating than the Democrats or Republicans. There is a backlash building, and that’s a very good thing. But it’s a process. As the arrogance level of central bankers or the money-center banks continues to grow, 2010 and the mid-term elections will be very exciting.

Duffy: Last year, 70% of the people were opposed to the bailout. And so far, through these massive interventions, government has been able to stabilize the financial system. But you have this divergence between the real economy and the political economy. People are still hurting. Consumer confidence has not rebounded like investor confidence has. If we are right, and we are heading for the next leg down, that’s when I think all bets are off. If the political economy and some of those who got bailed out are back asking for another bailout, that’s when the backlash really starts to heat up.

For bear markets to end, they have to teach lessons. But the people who didn’t see this bus coming 2[frac12] years ago — they’re back in droves, and they’re bullish. We haven’t changed behavior, and this bear market will not end until we do.

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Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved

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Human Behavior and the Broad Social Trends Driving the Global Financial Crisis, Globalization and the Economy in 2010 – Part II

Second installment in a new Series by Ty Andros (Disclaimer:  Mr. Andros offers a commercial service and our link to his post is not to be construed as an endorsement.   He is an excellent social commentator with a distinct Austrian Economic viewpoint and we find his postings valuable.)

Click here to read Part II

Climate Control Socialism

The following post echos our arguments made in Environmentalism, Liberty, and the Socialist Agenda:

See Plentiful Petroleum by George Giles

A Hell of a Decade by Peter Schiff


A Hell of a Decade
by Peter Schiff

In its recent look back on the first ten years of the century, Time magazine proclaimed the period to be “the decade from hell.” The editors made their case based on what they saw as the signature events of the last ten years, notably the ravages of terrorism, failed wars, and a global financial crisis. Taken together, these factors produced an era that Time is convinced will be remembered as one of the low points in our history.

As the media hates to dwell on the negative, the commentary was rife with notes of optimism about pending recovery. It could hardly be accidental that in the very next issue, Fed Chairman Ben Bernanke was named “Man of the Year” for his supposedly Herculean efforts to keep the economy afloat as we departed the Naughty Aughties. Although Time takes pains to point out that the “Person of the Year” honor reflects impact rather than adulation, its profile of the chairman was triumphant.

Even if you believe the “survived the worst/turned the corner” narrative offered by Time, it still should strike anyone as ironic that Chairman Bernanke, a chief architect of the economic problems that surfaced in 2007, should be held in such high esteem.

Apart from its misplaced reverence for the Fed Chairman, I would take issue with Time’s entire characterization of what has now become history.

Under no circumstances could the past ten years be described as “the decade from hell.” In fact, in terms of economic good fortune, the period shares parallels with the Roaring Twenties. I would describe this as a decade of sin that paved the way to hell.

Yes, we had spectacular problems like September 11th and the invasion of Iraq – which were horrific for those who were directly affected – but for most Americans, it was a time of unexpected wealth and unearned prosperity. Up to the days of the stock market crash, the economics of the decade will be remembered for cash-out refinancing for millions of homeowners, no-doc liar loans, no-money-down car purchases, eight-figure Wall Street bonuses, cheap Chinese imports, and trample-to-death holiday sales. In other words, the decade now closing gave us the biggest and most irresponsible spending orgy in U.S. history. The past decade was the party; the one ahead will be the hangover.

The fact that Time completely ignored these issues shows how poorly the mainstream media understands the forces bearing down on our economy. Yes, they were able to identify some of the adverse consequences we experienced this decade. That’s the easy part. But as far as seeing the causes behind the effects, they haven’t a clue. As a result, Time has no ability to see the underlying pattern and will happily encourage our leaders to repeat the mistakes of the past on a grander scale.

For now, Congress and the President remain as clueless as Time. To show its resolve to “get to the bottom of things,” the Obama Administration has impaneled a commission to investigate the causes of the financial crisis. Do not expect the proceedings, which are just getting underway, to come up with anything but the most politically useful explanations.

Blame will be laid at the feet of “ineffective regulators” who failed to “get tough” with industry, banks, and corporate leaders who held the “public good” hostage to their “personal greed.” There is no hope that anyone who actually saw the crisis coming will actually be asked to testify. If they called me, I would be happy to give them an earful. Unfortunately, the only way my views will ever be heard by the powers-that-be is if I am elected to the Senate – which is exactly what I plan to do next fall in my home state of Connecticut.

My sincere hope for the coming decade is that I can help our leaders see what Time cannot: we need to stop committing the economic sins that are leading us to hell, so that our stay down there will be as brief as possible. We need everyone to stop spending more than they earn. That is true not just for individuals, but for our government as well. Just this week, the Treasury Department removed its internal caps on bailout funds to Fannie Mae and Freddie Mac. Meanwhile, another bailout was proffered to ailing GMAC. If we continue the same bad behavior, it might not just be one decade from hell, but several.

However, if we can confess our sins, and vow to reform our ways, perhaps this will merely be a decade in purgatory. Perhaps we can turn it into the decade of hope, hard work, individual liberty, savings, production, investment, sound money, de-regulation, exports, budget surpluses, capitalism, limited government, and respect for the Constitution. These traits will harden us to withstand the fallout from our reckless past.

As of yet, our troubles continue to snowball – and I don’t like a snowball’s chances if we have a real decade from hell.

December 31, 2009

Peter Schiff is president of Euro Pacific Capital and author of The Little Book of Bull Moves in Bear Markets and Crash Proof: How to Profit from the Coming Economic Collapse.

Copyright © 2009 Euro Pacific Capital

Quote from Star Wars: Episode III

The Emperor: [to the Senate] In order to ensure our security and continuing stability, the Republic will be reorganized into the first Galactic Empire, for a safe and secure society which I assure you will last for ten thousand years.
[Senate fills with enormous applause]

Padmé: [to Bail Organa] So this is how liberty dies… with thunderous applause.