Definitions of Freedom: Europe v. America

Americans like to believe that their country stands out as particularly free on the world scene. My recent travels around Europe remind me, however, that freedom is an ambiguous term. Americans generally have more freedom to own firearms, go shopping at any hour on any day of the week and create entrepreneurial businesses than Europeans. Europeans, however, enjoy other freedoms and quasi-freedoms.

Among the most obvious freedoms in Europe are the freedom of movement between countries and the considerably wider access to alcohol than in the United States, both in terms of locations of purchase and drinking age. There are fewer border restrictions travelling between countries in Europe than there are when driving into California from a neighboring state and they don't share the uniquely American folly of allowing citizens to vote before they can drink.

There are also some ambiguous freedoms. The bans on motor boat use on many European lakes could be considered a freedom from noise and water polution or a reduction of freedom to use public spaces. The lack of restrictions in Europe on taking animals into public places, including restaurants, is arguably an increased freedom in Europe. There seems to be less of an over-active fear of microbes on the continent than in the USA.

Restrictions, especially those involving employment and taxation, are often more apparent to locals than to visitors. Taxes, while high in both Europe and the United States, are distributed differently. The higher sales tax or VAT here in Europe is offset by considerably reduced property taxes. Whereas even a hermit without income who owns his home outright in the USA would soon lose his home for failure to pay property taxes, a German homeowner of limited means has almost no fear of losing his home for lack of abilty to pay taxes.

It is difficult to say which continent is the most desireable place to live, especially for retirees who are less affected by employment restrictions in Europe. If anything, the limitations of freedom are becoming more homogenous between Europe and the USA. The European Union is encouraging more commercial competition between hitherto national monopolies, and the United States is adopting more of the nanny state policies so common in Europe.

The (First) Unemployment, Anti-diversity and Outsourcing Encouragement Act of 2009

While Obama's first law, forbidding wage discrimination, sounds noble at first glance, it is ultimately destined to reduce employment and erode the possibility of merit pay. It effectively pushes businesses toward rigid, union-style pay scales based on easily-measurable differences like seniority at the expense of pay differentials based on intangibles like merit, reliability and market conditions.

The law forbids companies from having pay disparities based on gender, race, national origin, religion, age and disabilities. The problem lies in that the most noble reasons for pay disparities, market conditions and merit pay, are intangibles that are difficult to measure. This opens up employers to the potential for litigation if they don't follow a rigid pay scale based on seniority and measurable experience like diplomas and licenses.

It would be folly to argue that there are never injustices in pay structures, but the solution to such injustices is for workers to move on to work for employers who pay them their true value. In my own salary negotiations, I have found that there are few negotiating techniques more effective for a valuable, underpaid employee than seriously threatening to leave the company. Great employees are hard to come by and considerable worth a premium over other employees who may have the same race, education and years experience but not work as effectively.

Market conditions can also play a considerable role. During the Internet bubble of the late nineties, my company had such a difficult time finding workers that I ended up hiring less qualified workers than myself at higher wages that I was making. I knew, however, that if the wage disparity continued, I could move to another company or request a pay rise. Further, I was well aware that these new, highly paid employees would be the first to be fired when times were hard. Ultimately, my company raised wages of existing "underpaid" employees to curb the tempation to leave the company.

In bear markets like the current one, with rising unemployment, the expanding pool of skilled, unemployed workers will cause wage levels in many industries to fall. New hires are rationally paid less than existing employees, creating pressure for existing employees to work harder to avoid getting fired. If companies were forced to re-level wages to market conditinos every six months or to hire new workers based on a rigid, out-dated pay scale, they would be unable to effectively adapt to changing labor market conditions. Who would want to work for a company that re-leveled their wages to market conditions every year? Who would want to work for a company that paid mediocre and exceptional workers with the same seniority the same wage?

Perhaps the most ironic aspect of the new policy is that Obama also actively promotes volunteerism. In other words, he encourages people to work for free. We have a lot of unpaid volunteers at my school, for example, and they are mostly the wives of well-paid husbands who have their children enrolled. This new law makes a dangerous proposition of paying a modest stipend to such volunteers. Unless such volunteers are paid the same wages as other full-time employees performing similar functions, they cannot be offered a cent for fear of litigation under this new law. In other words, Obama would prefer that some people not be paid at all, rather than allow the possibility of them being paid at pay levels agreeable to both parties.

Most noble reasons for wage disparity are intangibles like work ethic, reliability and market conditions which are difficult to measure. This new law will force companies to try to defend such practices in court. Companies should be fearful of hiring new workers under these conditions and may very rationally consider outsourcing more of their operations to countries where merit pay is still legal. They might also be expected to hire a less measurably diverse work force, as gender, race, national origin, religion, age and disability diversity is now, more than ever, a liability. All hail the first unemployment, anti-diversity and outsourcing encouragement law of the Obama administration.

The Job Market: Zero Sum Game?

Over the past month travelling around Europe, I have been truly amazed by the general belief, even by otherwise reasonable folks, that there are more or less a fixed number of jobs available and that automation and delayed retirement can only ascerbate unemployment. These same intellectuals recommend, of course, that we avoid modernization of factories and encourage early retirement to make more jobs available to those entering the work force. The coup de grace is the misguided belief that automation causes wages to fall.

Such logic fails on a number of levels. First, there are unlimited number of potential jobs in a free market, otherwise everybody since Adam would have been unemployed. Given that there are millions more jobs available now than there were 100 years ago illustrates the point.

Secondly, it is healthy that some jobs disappear. The wagon wheel manufacturers and blacksmiths are not missed, nor are the scythe-wielding farmers. In terms of comfort, life was considerably harder back then, and more precarious. A doctor was as likely to make you better as he was to inflict additional injury via misguided treatments.

Some jobs evolved, while others disappeared and millions of new jobs like those involving information technology and the modern service industry appeared. Flight attendants and computer programmers were unimaginable 100 years ago. Any attempts to artificially keep wagon manufacturers in business beyond their usefullness would have led to enormous resource misallocations.

By allowing wagon manufacturers to slowly disappear as cars displaced horse and buggy, a sudden mass layoff was avoided and wagon manufacturers could gradually be integrated into other occupations as they became redundant.

As machines reduce the burden of repetative tasks, and populations become more educated and skilled, life gets better. Hong Kong and Singapore were the havens of low-paying, ¨sweatshop¨ labor only fifty years ago, but their populations have risen to become among the wealthiest and best-educated in the world as their skills and technology improved. At the same time that they have become wealthier, we in the West have not become poorer, nor has the total number of jobs in the West fallen. The common belief that low-skilled manufacturing in China and elsewhere will reduce quality of life world-wide has no foundation in history.

The number of available jobs and potential wages are limited only by restrictions on the elimination of redundant jobs and legal barriers to entry for new competitors or enterprises. Regulations restricting layoffs, working hours and days of operation, like Sunday opening restrictions, can only reduce employment. The true cause of unemployment and reductions in living standards is the lack of free market competition.

Socialism: Idealism meets Cynicism

Curiously, socialists both want to create a utopic society where there is no suffering

financial bail-outs just add to deflationary pressures

Ironically, the latest attempts to jump start the US credit markets are actually just adding to over-all deflationary pressures by increasing debt. Debt must be repaid, and leads to major economic contractions in downturns as we have seen in 2007 and 2008. All these efforts to create even more debt policy makers are just driving us towards an even deeper decline of asset valuations and an increase in the purchasing power of the dollar.

I guess the new US administration hasn’t heard about the Hippocratic oath.

In the new consumer-lending program, the Treasury provides $100 billion of
capital and the Fed uses that as a cushion against which it could make up to $1
trillion of three-year loans aimed at jump-starting markets and spurring
consumer lending.

http://online.wsj.com/article/SB123440381495875583.html?mod=testMod

Economic Crises Stimulate Community and Interdependence

When times are good, we are quite happy to share in the rewards of prosperity, willingly accepting more in bonuses and pay than they may have actually deserved. We even spend money we don't yet have, based on optimistic valuations of our homes and other assets, not to mention projected future income. We don't need to rely on friends or family or unions because we feel self-assured that we can get another job easily and pay for whatever services we might require without the inconvenience of reciprocating. We somehow feel we can afford to neglect nurturing our relationships to family and neighbours.

As times get worse, we have less money and feel more insecure about the future. New jobs are scarce as many employers layoff workers while others hire new workers at the lower wages of an increasingly competitive labor market. We look for ways of supporting each other by sharing time and resources and helping our neighbours. Suddenly, we can't count on paying for all of our needs with cash and must rely on our relationships with friends, neighbours and relatives. A natural, healthy community spirit becomes essential.

While we draw nearer to our own select communities, we become less tollerant of others that we deem to be outside of our community and who we perceive to be encroaching on our prosperity. We become more nationalistic. We spend more time with our neighbours, but vote for protective tariffs to discourage trade with "others." We criticise immigrants, especially illegals, because they are willing to work harder for less compensation than we are. Instead of recognizing that jobs and wealth are unlimited in the world (if not, then all new entrants to the world since Adam and Eve would be unemployed) and that all humans have equal value, we fall into fallacious economic assumptions about a zero sum game (jobs and wealth are arbitrarily limited and must thus be distributed among us) and actively cultivate categorizations of "us" versus "them."

Many of us are suddenly unwilling to accept the possibility of failure and considerable loss, even though we were quite willing to accept the unreasonable prosperity of recent times. We rejoiced when our investments miraculously rose by 50% over a brief period, but find it somehow intollerable that they should fall by the same amount. We want to savour the benefits of free markets without accepting the associated risks.

Political propositions of security, where the government promises that nobody will be allowed to suffer too much or fall too low become very attractive. During crises, security trumps potential future prosperity and people are willing to trade the latter for the former. Alas, freedom comes with responsibility. Like the farmer, if we want to reap the rewards of his bumper crops we must also accept our lot in times of drought. Voluntary associations can ease the risks, but ultimately, we cannot have freedom without responsibility.

Institutional Instincts Deepen Crises

As we move deeper into the current economic crisis, it is becoming increasingly clear how instinctive responses to the crisis can be counterproductive, both at the national and institutional levels.

At the national level, officials move towards protectionism when their intent is to expand trade and economic activity. Protectionism, including "buy American" policies, reduces trade and production by inducing trading partners to restrict our goods from entering their markets.

Governments also try to encourage easy credit and aggressive consumer spending when those are precisely the reasons for the economic crisis in the first place. The cure for excessive borrowing and spending is saving, but while savings help long term economic growth, they discourage near term consumption.

Individuals and families naturally save more and spend less when they feel that their assets are declining in value or that their sources of income are at risk of decline. The governments are actively discouraging this natural instinct because it means a decline in consumption in the near term which causes declines in perceived economic strength and hence government popularity. Without savings, however, there is less capital available for creating new companies and providing productivity-enhancing capital to workers in the medium to long term.

Because individuals cannot be easily discouraged from saving when they sense economic troubles, governments resort to taking the money individuals invest in government bonds and spending it for them. Instead of these savings going into the most productive industries and investments, it is turned into government make-work projects like bailing out poorly run companies and inefficiently building unneeded infrastructure projects. In short, these savings are diverted from achieving their natural role of encouraging long-term economic growth into short-term make-work projects.

The same short-sighted mistakes are made at the institutional level. Rather than simply reducing spending and production, organizations often choose to provide a lower quality product, thus diminishing their reputation and hurting their long-term growth. This is especially true of service organizations like private schools and colleges where it can seem more attractive to accept lower quality applicants who can pay full tuition than it is to offer scholarships or simply lower tuition so as to enable more high quality students to be able to attend. This latter requires some belt tightening, but it ensures that the quality of the product is maintained or even raised. Above all, customers demand value for their investment during crises. Schools and similar service-based organizations need to both reduce their prices and raise their quality.

Whereas the individual instincts to save money and look for better value during crises are very healthy, institutions and governments with short term economic objectives tend to make decisions which seem to be compelling in the short term, but which ultimately diminish the health of the country or organization. The role of crises is to improve value and savings, and resistance these ends will only protract and deepen the economic suffering.

Do No Harm

Lately, it seems that everyone is asking me for my thoughts on what I think the government should do to “fix” the economy. How can we prevent a deeper economic contraction, or (heaven forbid) a depression? The underlying assumption in all these questions is the belief that something can be done.

My standard response to such queries never goes down well. Few people are thrilled to hear my theories on how economic cycles are driven by generational patterns, and that there really isn’t anything that can be done to either ameliorate this current economic contraction, or prevent such things from happening again in the future. I can understand this attitude of defiance. Human beings are resilient creatures at heart, and we have never been willing to accept “no” as an answer. No matter how bad circumstances get, with wars, famine, or disease, we persevere, making the best of things.

Further, it’s in our nature to re-make nature to suit our needs. Why accept the ravages of floods or drought if we can discover how to engineer dams to regulate water flows? Why accept living in the cold when we can build fires, and make warm clothes? If we can create cures for terrible diseases, and put a man on the moon, why can’t we structure the economic system in a way that will ensure no catastrophes will happen ever again? In our modern era, with technology being so endemic in everything from smart phones to home pregnancy tests, why should we put up with chaotic economic cycles?

There are things that man cannot do – things that are best left alone. Yes, we can cure many ailments, but there are still numerous diseases that defy the modern medicine. In fact, there are times where the intervention of man has been found to actually make things worse. Attempts to snuff out every smoldering ember we find in the wilderness can wind up leaving the entire forest more susceptible to catastrophic fires that would otherwise be limited in scope if small fires were allowed to burn on a regular basis. Building levees around rivers, and dredging, to prevent floods can actually prevent the natural replenishment of fertile soils and result in coastal erosion. Dams can kill off fish.

No every attempt of controlling the environment succeed, and some can actually make things worse.

So it is with economies. The attempts to control and manage economies only results in creating bigger messes. It’s quite possible that all the sophisticated economic stewardship by central bankers and finance ministers over the last 50 years has only served to prevent small brush files at the expense of setting the conditions for a cataclysm. Why then should we now be so eager to create new ways to ensure that the economy should never again see a road-bump?

Nevertheless, the rallying cry for economic intervention is deafening. It would be wrong for policy makers to just stand by and allow suffering to run unabated, the masses shout. You must do something! And “something” is exactly what the policy makers are doing. The US government alone has already spent, or pledged to spend, over $14 trillion in all manner of stimulus and bail-outs.

Sadly, even the technocrats, and economists, crafting all this government largesse openly admit they don’t really know what actions (if any) will actually help the economy.

What utter insanity! If they don’t know that the various spending, or stimulus, programs will help, then why do them? Doctors don’t give medicine unless they know it will help (that’s the theory at any rate), so why should governments and central banks behave differently?

No, there is nothing the governments can do to “fix” the economy, nor is there anything that can be done to ensure that depressions never again walk the Earth. Worse, the very attempts to prevent them will merely cause far more grief and hardship.

Tech predictions for 2009

Here are my predictions for the technology industry and the economy in 2009.

Almost all of my predictions stem from one thing: 2009 will be the year when the global recession bites hard, and all companies begin to see major sustained impacts from the resulting severe economic slow-down.

• Emerging markets will see an even bigger decrease in electronics/technology consumption than developed ones. (e.g. China and India will each see actual negative economic growth by the 4th quarter, not just a slow-down in over-all growth)
• Mobile phone sales around the world will be very sluggish for the first half the year and actually wind up in contraction by year end, making 2009 the first year in over 20 years with over-all flat sales.
• The fastest (and perhaps only) growth area in mobile phones will be in pre-paid plans, and dirt-cheap handsets lacking any smart-phone features. This will largely occur as consumers try to save money by jettisoning expensive phone and data contracts.
• Apple will report significant contraction in sales (particularly iPhones and iPods) as consumers cut-back in spending, and will see its stock in the $40 range.
• Google growth will continue to slow in the first and second quarters and will report an outright contraction in business by the third quarter as advertising revenue gets hammered. Google stock will be in the $150 range by year end.
• RIMM will see a contraction in revenue, and see its stock in the $20 range.
• Virtually every tech firm there is will see contractions in business in 2009, and almost everyone will have hiring freezes if not actual lay-offs.
• Not one tech firm will go public in 2009. VC funding of start-ups will be 90% lower than in 2008.
• 2009 will be the year of tactical IT spending. Unless there is a provable 6 month ROI, or the existing systems are literally breaking, many companies will opt to conserve cash and forego any kind of up-grades, or long-term efficiency improvements. The products that succeed will be ones that show the customer will realize a benefit very quickly.
• Paradoxically, companies become less efficient when faced with economic business uncertainty. It is only during prosperous times that most organizations are willing to consider significant investments to improve over-all productivity.
• There will be a huge increase in sales of outsourced IT services, which allow customers to pay for usage. Companies will be very eager to control their costs as business changes in an unpredictable economic environment. Instead of hosting e-mail servers internally, just use an outside e-mail service that allows you to easily ramp up, or down, as your needs dictate. Why pay for unneeded capacity if you don’t have any orders next month and need to lay-off half your staff? This is not to say that every software service will succeed, but those that are tailored well (with the right pricing models) will see a big jump-start as more and more companies opt for pay-for-usage pricing models.
• Hardware prices (e.g. memory, displays, storage, PCs) will fall faster than they have in decades, as all tech firms find that they are over-producing when demand slackens dramatically, forcing them to slash prices to unload inventory.
• Investment in hardware R&D spending, and new product introduction will slow substantially. There will be far fewer new hardware standards, or technologies, emerging (e.g. wireless USB has almost stopped, now that most of the start-ups that were its driving force are finished). This will wind up having a knock-on effect of having fewer reasons for people to upgrade to new systems (i.e. because the technology isn’t improving as quickly as in the past).
• The portion of sales of “value” tech products (i.e. products targeted at the lowest price-points) will become a far bigger portion of over-all sales, with a dramatic contraction in “premium” products.
• The US dollar will defy all expectations and appreciate significantly against most other currencies. The Euro will see a significant loss in value as fractures begin to appear amongst EMU member states (e.g. with nations like Greece, Spain, and Italy spending profligately angering Germany and other “rich” nations). Emerging market currencies will be eviscerated, losing 50% of value vs the dollar or more.
• Interest rates will remain extremely low, but it will be hard for businesses to get any credit since the private credit markets will remain frozen and chartered banks will be unable to make up the difference.
• Oil will drop to the $30 dollar a barrel range by year end.
• Global stock markets will close be 40% lower at the end of 2009 than they were at the beginning of the year.
• Global stock markets will see incredible volatility throughout 2009 with rallies and crashes that break records. We will see at least one rally (that lasts more than 1 month) that sees the Dow Jones rise over 30% (only to lose it all again in a big crash).

Altruism v. Benevolence

At a Liberty Fund conference this last weekend, the discussion touched upon the role of informal institutions on cultural behaviour and, separately, why there seems to be a decline in honesty among the youth. After some thought, I postulated that the two subjects might be linked.

As our society increasingly emphasizes, both in theory and in practice, that one person's need implies an obligation of others to share. If somebody has less food, we should feel guilty that we have more and donate. If somebody has less money, we should pay higher taxes so that they can have a minimum of comfort. We use euphemisms for our guilt, like "paying it forward," or "giving back to society," when really we simply mean a morally mandatory redistribution of wealth.

Worse yet, we downplay greatness and achievement. Many of our schools, even private ones, offer financial aid on the basis of need alone while even their top students of any given year receive not a farthing in scholarships. Bill Gates, Rockefeller, and Carnegie, rather than being praised for realizing the American Dream by producing incessantly better products that improve the lives of millions at steadily declining prices, we vilify them. Instead, we worship volunteerism and pop stars who ask us to ask our government to help poor Africans.

Among this orgy of selflessness, is it surprising that students have less and less respect for the answers and property of others? If those who have less of anything have almost a right to receive from those who have more, why is copying wrong? Why is stealing wrong? If the government is morally justified in taking from the wealthy and giving to the poor, why shouldn't the private redistribution of wealth be equally justified? What if Johnny has a better brain than Jane, shouldn't Johnny have to share his intellectual wealth with the less endowed?

We have replaced benevolence, the voluntary, discriminate giving by one person to another whom he finds deserving, with a cultural obligation to engage in indiscriminate giving by all who have more to all who have less. Whereas benevolence engenders profound satisfaction on the part of the giver and gratitude on the part of the receiver, institutional altruism engenders resentment in the giver and entitlement in the recipient. Where weakness is rewarded and achievement scorned, we should expect life to once again become nasty, brutish and short.

the case for deflation - why stimulus spending won't help

At first blush, it would appear as if all the government bailouts and stimulus (to address the financial crisis) will wind up massively increasing inflation. After all, with government putting trillions of new dollars into the economy, how can this do anything other than to cause prices to rise and the US dollar to drop in value?

Unfortunately, this seemingly logically interpretation of government spending is flawed. Rather the causing inflation, government spending will contribute to the exact opposite result. An increase in national debt is DEFLATIONARY. It sucks money out of the rest of the economy, causing asset prices to decline even more (i.e. “deflation”).

The key thing to keep in mind is that debt is deflationary, and is not the same thing as printing money. At some point debt has to be repaid. Sure, increasing debt can also increase the money supply, but it also will lead to a contraction as well (i.e. when the debt is repaid). If the government was actually just “printing” money, instead of borrowing it, then I would agree we might be headed to a period of high inflation. But this is not what is happening.

Also, it is important to keep in mind that all this increased government spending (and the debt to back it) is a drop in the bucket when compared to the amount of debt creation which has VANISHED from the private sector. The global credit markets have been operating in the tens of trillions of dollars range for years ($40 to $60 trillion per annum), and this spigot of debt creation has virtually ceased to exist over the last 10 months. All the increased stimulus/spending of the world’s governments doesn’t come close to making the difference.
Consequently, this leads us towards deflation, since the velocity of money is contracting at a furious rate.

Even the people who are railing on banks to start lending more completely miss the point. As a matter of fact, the world’s banks have INCREASED their lending dramatically this year. The problem, however, is that it just doesn’t make up for the loss of the private credit markets. But this phenomenon is very opaque, and difficult for people to understand.

A given bank may actually be initiating a lower total volume of loans this year, but a FAR higher percentage of those loans are staying on the bank’s books. Over the last 20 years banks have begun to HEAVILY rely on the private credit markets to goose their lending capacity. A bank may lend $10 million to a company wanting to expand it’s manufacturing capacity, and then turn right around and re-sell that loan to mutual funds on the private market. In this way the bank becomes little more than a retailer, making a commission for the initial under-writing and on-going servicing of the loan. The actual loan itself, however, is owned by a 3rd party, and isn’t on the bank’s books at all.

Many companies became reliant on going directly to the private credit markets themselves, and side-stepping banks altogether, to get credit. Many firms became reliant on constantly selling their receivables as asset backed securities, and continuously rolling over that debt with new receivables every month. Unfortunately, this has almost completely ceased to happen over the last year, driving borrowing costs for these firms up enormously as they now have to go directly through banks (which always charged higher rates than the private markets).

In the last year, however, banks have had to place almost all the loans they write on their own books. The total loans the banks have on their books area increasing dramatically, but the actual value of the loans that they issue is down.

This is why we are facing deflation. The global credit markets are MASSIVE, and the virtual disappearance of them is a problem that no amount of stimulus or government spending can replace. The US government could undertake another $5 trillion in stimulus spending and it still won’t help. The Japanese government attempted to spur inflation with massive stimulus during the '90s, but that clearly didn't work either.

It’s possible the world’s governments could “print” money to stoke inflationary fires again, but doing so would pretty much destroy a national currency overnight. The days when governments can print money for months, or years, before the negative impacts are felt are over. Technology ensures that the markets will know when governments start printing and act swiftly.

The printing press (and electronic equivalent) is similar to having an arsenal of nuclear missiles during the cold war. In theory these missiles could be launched in a war, but the reality is that no leader will ever be willing to press the button on global thermonuclear war.

Central Banking Exacerbates Credit Crises

Some of the clearest analyses of banking principles come from the 19th century, when a general awareness of various banking options still existed. Today, with the nationalization of note issues and the ubiquity of fiat currencies and central banking, few remember the alternatives or understand the implications of our current system. A French economist, Charles Coquelin, wrote a number of lucid works, including a comprehensive analysis of credit and banks (in French).

In a shorter article by the same author explaining the role of credit in economic crises, Coquelin explains that only economies that use credit experience periodic crises, and that such crises are acerbated considerably in economies with central banks. While in 1864, the possibility of fiat currency didn't cross his mind, he could still see that the central banks of his day (e.g., Bank of England & Banque de France) distorted credit markets by their privileged status. With specific privileges beyond all other banks, central banks were considered more secure than private banks, and could both borrow and lend at lower rates of interest than their private counterparts as a result. This left largely riskier borrowers for the private banks and led inexorably to de facto national currencies which linked problems with one bank to those of others.

While there will (and should) always be periodic bank failures, as in any other industry, it is important that the full risks and losses of such failures be left with the investors and depositors of such banks so as to avoid taxing healthier banks to support their less healthy neighbours. In a free market, marginal institutions fall first and as their assets liquidated, healthier banks can buy them at discounted prices and shore up their own portfolios. This leaves the healthiest institutions standing at the end of the crises.

Alas, we have adopted the exact opposite policy in the current crisis. The weakest banks that fall first are bailed out by governments, along with every subsequent bank until the government can no longer issue more promises against future tax revenue. At that point, all of the "salvaged" banks fall at once when the government defaults on their debt obligations. Perhaps Coquelin was right in suggesting that the whole process is less painful if left to the free market.

Private Money = Stable Money

The monetary turmoil now underway is, in part, due to the fact that countries have adopted monopoly currencies and then proceed to abuse them without immediate consequences. The euro is about to collapse, as regional manipulation of interest rates and government deficit spending leads to the logical consequence. The solution is the anti-Euro, private, competitive currencies.

National and inter-national currency monopolies lead governments to eventually move to fiat money backed only by their threats against those who refuse to accept it and ability to tax the people to give it value. Currencies founded on intrinsically valuable specie money are always extinguished by central bankers. Once a monopoly fiat currency has been established, central banks proceed to over-produce bills, and entering into excessive debt, sustainable only through continued inflation.

In a private, competitive monetary environment, however, any private mint indulging in debasement of their coin would be punished by the markets. Their currency would trade at a discount, to the degree that it traded at all. Banks issuing banknotes bearing their own bank's name would, likewise, only put the issuing bank at risk for their value. An over-exuberant note-issuer would find their notes quickly discounted by the markets, forcing them to reduce their circulation or face a run.

Monopoly currencies are too tempting for governments to not leverage them as tools of indirect taxation. Once such currencies have been extensively over-leveraged, they collapse in an inflationary spiral. Only healthy currency competition between privately competing currencies in a free market can effectively discourage currency mismanagement.

Savings: Outdated idea?

It is easy to blame greedy bankers and Wall Street for the depth of the current financial turmoil, but the primary source is the encouragement of debt and discouragement of savings by the U.S. government. Inflation of the currency, both by blatent printing and debt expansion, always discourages savings, but the list is not limited to inflation-related incentives:

1. People are taxed on capital gains from their savings and investments, after paying tax on the original principle. If they just spend their money instead of saving it, they might even be able to deduct such purchases as business expenses.

2. "Profits" on long-held investments like homes are not adjusted for inflation, so even if the house lost money in real terms, it could be taxed heavily for capital gains due to inflation.

3. Idle cash must be invested or spent simply to keep up with the inflation rate. Cash balances lose money by default. Often even basic savings rates are lower than inflation rates, encouraging savers to seek higher yield, higher risk investments merely to keep from losing their principal.

4. Mortgage interest is deductable from income tax, encouraging people to borrow money for their home and discouraging renting.

5. There is an unlimited allowance for capital gains and income that is taxable, but only $3,000 in losses may be deducted per year. If you make $1 million one year and lose $1 million the next, the full $1 million will be taxed the first year, but only $3,000 may be deducted from taxes the second year. Even if you save the residual income after taxes from the first year, you cannot cover the loss of the second.

6. The arbitrary nature of breaking the tax year into specific segments. All expenses within a given tax year are deductable, but if profits are saved over a period of years to pay for an expense in cash, those profits are taxed every year before the ultimate purchase. If, however, money is borrowed to pay for an expense up front, its cost can be amortized over many years.

7. Richer people, who have more discretionary income to save, are taxed much more heavily than poorer people. The poor don't have much extra money to save to start with, so if we tax away the would-be savings of the rich, we impoversh our capital supplies.

8. Inheritance taxes encourage the consumption of accumulated wealth during one's lifetime rather than inter-generational savings and investment. If you know that a large portion of your life savings will be taken upon death, why not spend it now?

In short, the government creates considerable incentives to borrow and spend, especially via the various effects of inflation, and thus discourages savings. Any society that neglects savings long enough is sure to ultimately find itself with a lack of real capital, leading to a depression when the credit pile crumbles. A society which values savings is one with slower economic growth, perhaps, but fewer economic surprises.

Another Rate Cut, Another Failure

At last! The Federal Reserve, along with many other central banks around the world, have cut interest rates. This is what the markets have been waiting for, everything will be fine now. After all, the previous rate cuts over the last year have done so well that its obvious that a globally coordinated rate reduction will do wonders.

This is clearly poppycock. Interest rates are already at historic lows but that hasn't helped the economy. Lowering the cost of borrowing further won't do anything to encourage people to borrow more, or prevent a further decline in the value of assets. Japan has been trying to almost GIVE money away for nearly 20 years and that didn't re-ignite their economy, and there is no reason to suppose this recent rate cut is going to help anyone either.

Interestingly, rate cuts are one of the best sell signals an investor can find. Stocks almost always head lower in the weeks, and months, following a rate cut. This only makes sense, of course, since rate cuts are always made when central banks are concerned about the health of the economy. Ironically, the time to buy is when central banks start raising rates.

Actually, raising rates isn't as crazy as it sounds. Low interest rates themselves are a significant contributor to the economic crisis. It is difficult for anyone to make money lending at such ridiculously low rates. Why even bother making a loan at 5% when there is barely enough income to cover your costs, let alone compensate for the risk of default (which is greater today than at any time in the last couple decades)? I vote for a co-ordinated global strategy of raising rates, and ceasing mortgage subsidies (i.e. Fannie, Freddie, FHA, etc).

Such a policy of higher interest rates would absolutely hurt the economy in the short term, but it would help restore health to the financial system by making it profitable to lend once again. Unfortunately, no policy makers seem to be willing to accept any short-term pain, even it it will help reduce the depth of our coming depression.

Oh, and let us not forget that it was abnormally low interest rates which were a major cause of the economic mess we are already in. Central banks did indeed prevent a severe recession in the 2002 by lowering interest rates to historic lows, but wound up contributing to the blowing of asset bubbles all over the place with a crack-up credit boom. Alas, there are no more bubbles left to blow, and there is no one left with a clean enough balance sheet to take on more debt.

The Comfort of Conspiracy

The tin foil hat wearing conspiracy theorists, convinced that dark forces have made secret plans to control events, may not be the paranoid anti-social mal-contents most people assume. In fact, it is quite possible that the belief in (unproven) conspiracies is a perfectly rational response when the world around us feels out of control. It is far preferable to think that the bad, or seemingly unexplainable, events that occur are the result of devious plots by nefarious persons meeting in dark rooms than to accept that terrible things happen all on their own.

It shouldn’t be any surprise, then, that conspiracies tend to be particularly popular amongst the people most alienated or marginalized in society (be it ethnic groups, or just the average social outcast). These people are desperately seeking ways to explain just why it is that life has handed them a raw deal, and a conspiracy is a handy way to explain it.

Most of these conspiracy theories contain the seeds of their own disproof right in their very premise, yet the adherents will swear by them nevertheless. In recent years, for example, there has been a great deal of speculation amongst many gold investors that government intervention was artificially deflating the value of precious metals. But if this were true, why then did gold prices rise so dramatically in the years up to 2008? As soon as gold prices began to decline in 2008 there was a lot of talk (once again) about how this might be due to the collusion of global central bankers. However, if gold prices have been pushed down by a cabal of central banks in 2008, then why did they allow them to rise so breathtakingly fast since 2005?

The same flaw can found in the theories proclaiming that the credit crisis of 2007/2008 was engineered by big Wall Street bankers. Most of those banks actually wound up going bust, and having their shares made into worthless scrip. If there was a conspiracy it would seem to have been a singular failure. It’s particularly telling that most conspiracy theories are designed to explain “bad” things: no one ever considers that the good things that occur were the results of plots.

Of course, conspiracies do sometimes occur. In many cases they aren’t even all that secret, with governments or policy makers openly declaring their intent to manipulate currencies or economies. However, these actions are rarely successful, and most often fail quite spectacularly.

The one thing that remains constant with all good conspiracy theories is the firm belief that it IS possible to control events. By grasping at the belief that somehow things are controllable, we can then feel that at least life could get better if only the “right” people were pulling the strings.

Iceland: The Land That Credit Created

Iceland may be suffering now, as the credit crunch bites deeper than it has almost anywhere else, but in a few years it may prove that the swift decline and massive wave of defaults (as virtually everyone in the nation defaulted on their debts) was the best solution to the calamity. Other nations, with deeper resources (like the US) are delaying the inevitable with massive bailouts, which may ultimately do nothing more than prolong the pain.

The swift decline of Northern Europe’s economic superstar is a graphic illustration of the hollowness of the economic boom the world has seen over the last 20 years. It wasn’t long ago that Iceland was hailed by business magazines as an amazing success, to be emulated by others. The similarities to those Americans buying multi-million dollar McMansions with negative amortization financing, while driving around in SUVs purchased with home equity loan extraction is striking.

The fall from economic grace may be hard on Icelanders, and leave them a much poorer nation with limited economic growth for decades to come, but they may wind up better off than the larger economies that are digging themselves deeper holes in vain attempts to prevent the necessary reckoning from the Great Credit Binge. The irony is that while smaller nations may find their options limited when facing national economic ruin, the fact that they were forced to deal with their problems head on will be to their benefit.

Any who still think that the credit crisis is only an American problem really need to examine what is happening in places like Iceland closely. This is a GLOBAL calamity, that will leave many other nations in even worse shape than the USA before things have run their course.

Will Government Force Banks to Accept Bailout?

One question that has me perplexed by the (latest) government bailout plan is exactly which institutions would want to take the treasury department up on its offer of buying dud assets? My understanding is that in order to tap into the government funding the lenders will have to 1) agree to executive salary restrictions and 2) offer warrants to the government (there is even a provision in the bill that allows the treasury to demand stock in exchange for the financial help, but it isn’t clear if the treasury will exercise this right).

With terms like this, which financial institution would really want to avail itself of government help? Any CEO who accepts this deal will essentially be ending their career and the shareholders likely won’t be too thrilled with the potentially dilutive impacts of the warrants. Logically, it would seem as if most financial firms would rather just hang onto their toxic assets, and hope that the bailout ends the crisis and markets for these dubious goods return (at prices they like). After all, if the government manages to put a floor on prices for shunned credit instruments then why does it matter if they sell them or just keep them on the books, the end result is the same (i.e. they book the same price either way)?

This all assumes that the treasury was even willing to offer near full value prices for these assets in the first place. If the government somehow tries to offer a significant discount from face value (albeit still above actual market prices) then virtually no one would be interested in the bailout. For most institutions accepting any kind off significant price cut would render them immediately insolvent.

It all boils down to this: accept the bailout and lose your job and accept the potential of wiping out shareholders or hang on hoping that somehow markets recover. This really doesn’t seem like much of a choice. What manager would take the altruistic stance that it was ultimately in the best interests of the economy to restore the company to health even if to do so would hurt themselves (and existing shareholders)?

So what’s the government to do? Are they going to have to resort to forcing struggling financial institutions to accept the bailout?

Of course, even if the demand for access to bailout money is substantial, we have no guarantees that the credit markets will unfreeze. No bailout will change the fact that tens of millions of Americans can’t afford their debt payments and that default rates will continue to increase. Until all those defaults have run their course the underlying asset prices (e.g. mortgages, credit card and auto loan receivable securities, etc) will continue to fall, which will force lenders to continue ratcheting up lending criterion and terms. Why accept 10% down for a mortgage when there is a good chance the home will drop another 10% in the next year?

Original Sin

In all the rush to crucify the "greedy" Wall Street bankers and lax regulators for the current financial crisis the actual offender is going unnoticed.

It doesn't take a Nobel Prize winner to identify the underlying cause of the credit crunch as stemming from over-investments, which has left a glut of unproductive assets (e.g. real-estate around the world, factories in China, etc) that are dragging down the global economies. This mal-investment binge is so obvious that some pundits have even suggested a whole-scale demolishion of homes as a strategy for fixing the economy.

But what caused this horrendous buying (and construction) binge to begin with? Fortunately, we don't have to go far to find the underlying disease.

It is no cooincidence that real-estate prices have been appreciating at an historically abnormal rate after the Great Depression and World War II. The big changes that made this resurgence of real-estate possible are obvious: mortgage tax deductions and government subsidized mortgages (i.e. Fannie Mae, Freddie Mac, FHA, etc). Prior to the 1930s these government programs to foster home-ownership didn't exist.

It is these

Absolution

Any last hopes that the latest government financial bailout would stave off the economic downturn and cheer investors was put to rest when the stock markets tanked immediately after the bill was signed into law. This bailout can't possibly succeed, and will fail just as all the others have over the last year, but that hardly matters. The real goal of this bailout is to absolve the government of responsibility for the real troubles that lie ahead, and at this it succeeds in spades.

Had the policy makers not enacted a major intervention then they would have nothing to say for themselves months from now, as the economy continues to crumble and increasing masses of people lose their jobs. Instead, the nation's leaders have now absolved themselves of any responsibility for the disaster in the offing. When the Dow is below 8000, and home prices have dropped another 30% the US leadership can say, with a straight face, that they did their best to stop it. After all, the government spent $800 billion of tax-payer money in a valiant effort to stop the bleeding. Is it their fault that the bailout didn't work?

To be fair, I am sure that many policy makers actually doing what they thought would help, but for many others the cover this legislation gives them is well worth the tax-payer money they are spending, and more.

Of course, its not as if the government can do anything to stop the depression, but that won't stop the world's leaders from spending as much of their fellow-citizen's money as they can to make it look like they are trying.