Why capital accumulation is important and how it effects the price structure

 

The title of this blog post is directly related to a key tenant in Austrian economics, which says that the joy of consuming wealth is derived from the self evident supply of given good or rendered service X,Y,Z.  We shall skip the semantics regarding resource transformation to fulfill this desire.

The primary goal of creating any supply of capital is to sustain the individual for a lengthy period of time in order for him to complete other tasks he deems satisfactory or necessary to bring him in a state that he strives to. Capital accumulation in a free market is a wonderful process because it is based on voluntary compliance of a mass of individuals, each seeking its own end.

This process is disturbed when a self appointed entity with a monopoly on the judiciary system can appoint how and what resource may be effectively employed in a certain endeavor. This entity compounds the problem when it, through the banking system, legalizes the counterfeiting of the currency through fractional reserve banking, creating an artificial boom in the capital goods industry and subsequent inflation.

According to business.hr, the inventory of the manufacturing industries fell 12,3% YOY. While this may be a bullish sentiment for commodity broker dealers, who may just take a long position in a certain commodity and with the same demand dynamics that prevail YOY expect to profit from a spike in inventory products, this is bad for the average consumer, because it will eat away a part of his income when purchasing the final product.

Unfortunately, this is what happens when the economy is shaking of the addiction of cheap credit from the banking system. When the boom faze is over, the manufacturers are forced to dump their inventory onto the market at deep discounts in an attempt to salvage themselves from insolvency. Sometimes, they go under. The subsequent step in this process, is the curtailing of expansion, brought by lower inventory levels.

Some of this inventory had to be sold at a deep discount, as some inventory, due to the artificial boom, have been used in an accelerated manner as the boom faze continued, as more often in industries where day were wasted in suboptimal projects. So, now, it will take time for these stocks to be replenished.

If the government stays out of this process, the recovery will happen sooner than later. If the government interferes in this process through subsidizes of purchases or outright price controls, there will be even less inventory numbers YOY.

The market has to clear. The malinvestments must be liquidated and capital must be freed in optimal projects. If the government inflates it will only lead to more resource consumption and with that lesser inventory numbers.

To reiterate what was said at the beginning, capital formation makes economies tick. A greater unused level of inventory that is known to satisfy future demand in certain industries boosts the economy. Artificial credit gives a artificial boost and excess inventory consumption.

The government better let the market clear and make it easier for producers to sell their products in lines of production which are most profitable for them. Until that happens, expect more inventory volatility…

Cracking Krugman on Croatia

 

Princeton Professor of Economics Dr. Krugman was interviewed by Jutarnji list newspaper a couple days ago regarding the way Croatia should get itself out of an economics rut it has been it for the past couple of years.

The headline reads: “Spend, spend, spend!”

Now, I am sure that Krugman doesn’t spend all of his salary on consumer goods and therefore surely “deepening” the depression in The US, lets just briefly skim across the interview and make some short assessments of what he said.

The following unbiased short excerpts are:

“In a recent manifesto, which tries to primarily to summon economic reason in TheUS - hence the title "Manifesto for Economic Sense" - Krugman and his collaborator on the project is Richard Layard of the London School of economics,  put forward the thesis that the assertion of the majority of today's politicians and economic policymakers that the main cause of the present crisis is irresponsible borrowing countries is completely wrong. Krugman and Layard exception is Greece, which broke all reasonable limits long before the catastrophe that has happened to her.”

So according to Krugman, it is the “level” of “excess” spending that is to blame for Greece’s mess, but not for Spain’s nor Italy’s mess. Too bad he couldn’t specify what “level” of spending this is.

Next, no mention of a credit expansion in these countries, that manifested itself in the capital goods market that brought on a subsequent boom. But, before we dive into that, the following line is also intriguing:

- If you save your income so you do not buy from me, you destroy my income and my sinking jointly deepen the crisis.

Again, what magical level of personal consumption is sufficient to satisfy Krugman? Which level won’t worsen the crisis? 20%? 60? 130?

I ask the question, why do I have to save then? Lets look at the 100% option. I spend all my resources on consumer goods. I cannot purchase durable consumer goods, which qualify as capital goods, because an automobile (a durable consumer good) is purchased with a lot of resources. So, with my salary, I am priced out of this market. To buy a car I will have to lever up. I will have to go into debt. OK. Cool. So, someone will have to give me funds, WHICH ARE SAVED SO I CAN PURCHASE THIS VECHILE. Nope, can’t do that, everyone else is also spending all of their funds on consumer goods as well.

Hmm, I really hope that factories that produce consumer goods will able to keep up with all this demand. I wonder, how will factories that produce machinery which, sell them to other consumer producing factories be able to obtain funds, if all the funds that directly hit the consumer goods industries bid for factors of productions for their immediate disposal (selling clerks, janitors, new corporate automobiles, computers etc.)? They have a choice (the consumer producing industries), to bid for resources (even outbid) to satisfy the demand for their products, or save the funds and investment them in PP&E. THEY CAN’T HAVE BOTH AT THE SAME TIME.

We haven’t even discussed the effects that new money entering the economy has on the capital structure. Again, lets postpone this question for a little later. Lets assume that there is no new money in the economy. The money supply is highly inelastic.

Nobody can consume above the level he earns, unless there are individuals that refrain from immediate consumption. So, how does a factory get built? Can people chill on the beach and drink a pina colada from the pina colada factory if there is no factory? Well, I don’t think so. So, what do they have to do?

They will have to sacrifice a confortable time at the beach and drinking the colada for working on the factory. But since that they haven’t got a product (colada) to drink, their consumption level is zero. (Their consumption level is also zero if they stay on the beach, the colada doesn’t magically appear out of nowhere. I am sure that there is a demand for the colada, but without supply, good luck drinking one!). So these people will have to SAVE (refrain from consumption that doesn’t exist due to a lack of supply) whatever resource they can to sustain themselves while building the factory! This may be, for simplicity’s sake, dirt that grows on trees. They will have to use their own labor and time to accumulate dirt that grows on trees, to be able to sustain themselves while building the pina colada factory. What if they eat all their accumulated dirt that grows on trees before they finish the factory? They will have to USE THEIR TIME TO COLLECT MORE, WHICH COULD HAVE BEEN USED TO COMPLETE THE FACTORY! Again, they cannot make the cake and eat it too.

Enter credit expansion. According to ABCT, credit expansion creates the Cantillon effect and the subsequent reverse Ricardo effect that impoverishes the capital structure which is A MUST to maintain a certain level of consumption. If new money enters the economy in the capital goods industries, a boom will occur, if it enters the consumer goods industry, it will impoverish the capital structure, setting inflation, high nominal wages, and no capital structure to produce these goods.

Krugman gives no mention of what these effects have on the economy. He of course doesn’t even consider what occurs when you run out of loanable funds (present supply of resources that sustains you through the investment process). He acknowledges a need for a minimum level of inflation, of around 3%. Why not 5%? It is only marginally higher. Why not 30%? Things would really take off then.

Professor Krugman is confused of how economies function. He adheres to John Law and other monetary cranks and fiscal charlatans, such as John Maynard Keynes.

The art of spending money must not be confused with the art of creating wealth. Because, according to Krugman, people who are stupid enough to save  during the boom years, are at fault at causing the present crisis. Which means, under consumption is to blame for a depression, and not consuming more what you don’t have. That is, consuming capital to create false GDP growth.

The logical argument of Krugman’s assertions fall on the first pillar of growth. How does he get around the notion that if you wake up on a desert island, or if you are dropped of in the jungle, HOW ON EARTH, CAN YOU CONSUME SOMETHING IF THE RESOURCES HAVEN’T BEEN ACCUMULATED (SAVED)  TO SUSTAIN YOURSELVE THOUGH THE PRODUCTION PROCESS?

Professor, I encourage you to go to a location where there isn’t a trace of modern civilization (you can bring your co-author as well) and try to build up the skyscrapers as in New York, by spending your way to prosperity. 

Until then, go brake a window, since you will be helping the economy by creating demand for a window manufacturer…

Supply in a market will always find demand

 

Ina free market economy, in which the rule of private property is sacrosanct, and individuals are free to engage in any and all forms of competitive entrepreneurialism, any product that finds its way in the market will be sold in the market. Unlike the classical economists and todays neomercantilists  who suggest that cost determines price, the demand for a good will pinpoint its price through the aggregate subjective wishes of market participants in the form of an objective market price.

Due to recessionary trends across Europe, young people have decided to travel light and spend as little as possible on accommodation. This is best seen through cheap accommodations that have sprung across Zagreb, Croatia this past year.

According to business.hr:

“Opening of cheap accommodation for backpackers has become the most lucrative tourist industry in the metropolis, […]just this year opened seven hostels. Fierce competition from some 19 hostels in Zagreb will not survive even in the first six months of this year, 41 854 nights, nearly 4,000 more than the same period last year.

Instant business has become a popular tourist branch in the capital, according to latest data of Zagreb Tourist Board, according to which only the first half of the 2012th Open seven hostels, mostly in attractive locations in the city center.”

I have seen these “resorts” pop up and it is a brilliant way for youth who are on their way to the Adriatic coast to stop in Zagreb and get a feel of Zagreb during the summer as well. Since the unemployment rate of youth is morbidly high across Europe as well as escalating living costs, the market economy has adjusted in such a manner to bring about the best possible solution in such troubled times.

I believe cheaper prices will be expected in the future from these hostels, as more demand brings about greater competition and more square meters per guest with more attractive venues and business activity between the hostels and tourism outlets.

Unless the government decides to bump in and set hostel prices, as well as mandatory insurance coverage (government insurance coverage), young people should have no problem coming here and being afraid that they might be priced out due to higher prices. If anything, this sort of business activity should be encouraged, as well as quick capital mobility in case of shifting demand for hostel services in different locations.

10 Reasons Why Austrian Economics Is Better Than Mainstream Economics

 

BY: JAKUB BOŻYDAR WIŚNIEWSKI (Original Post)

1. Austrian economists make it their priority to make sure that the theorems they formulate are derived from self-evident axioms and constructed according to the proper rules of logical deduction. These considerations are at best of secondary importance to their mainstream colleagues.

2. Austrian economists make it their priority to make sure that the assumptions they base their theorems on are thoroughly realistic, i.e., corresponding to the state of the world as it is. Mainstream economists, on the other hand, admit that their hypotheses are based on deliberately false assumptions.

3. Austrian economists make it their priority to make sure that the theorems they formulate elucidate exact causal connections between economic phenomena, rather than deliberately assuming away their existence or importance by falling back on the physics-inspired notion of mutual determination.

4. The predictive track record of Austrian economists is incomparably superior to that of their mainstream counterparts (see, e.g., here and here).

5. The theorems and conclusions of Austrian economics are perfectly comprehensible to every intelligent layman, which cannot be said about the mathematical puzzles of mainstream economics.

6. In terms of their views on the method and aims of economic theorizing, Austrian economists have a much better claim than their mainstream colleagues to being the heirs and successors of the classical economists, such as Smith, Hume, Say, and Bastiat.

7. Austrian economists never tire of emphasizing the strictly value-free character of their discipline. Thus, unlike their mainstream counterparts, they never presume that the existence of any non-voluntary extra-market institution is justified, and, a fortiori, never make any “public policy recommendations” based on such presumptions. On the contrary, they confine their scholarly research to investigating the logical origins and outcomes of various economic processes and phenomena as they are, not as they would like them to be.

8. Identifying the concept of demonstrated preference as the keystone of economic analysis allows Austrian economists to avoid the twin pitfalls of behaviorism and psychologism, which their mainstream colleagues cannot navigate in any principled and methodologically robust manner.

9. Austrian economists reject academic and professional hyperspecialization in their discipline, thus stressing the holistic, integrated nature of the science of economics. In the words of F. A. Hayek, “the physicist who is only a physicist can still be a first-class physicist and a most valuable member of society. But nobody can be a great economist who is only an economist – and I am even tempted to add that the economist who is only an economist is likely to become a nuisance if not a positive danger”.

10. Austrian economists cannot retreat into the safe haven of epistemological nihilism when the logic of their arguments turns out to be faulty. Mainstream economists, on the other hand, when the facts fail to correspond to their hypotheses, can always claim that “this time things are different”, which is a straightforward implication of the fact that any given set of sufficiently complex empirical data is compatible with a number of mutually exclusive empirical (but not logical) interpretations.

Does a novice entrepreneur need to understand the quantum mechanics of a product he is selling?

 

I have been pondering on an idea of late, and have decided to put it on paper. It coalesces around the idea of absolute knowledge from the side of the entrepreneur in every day business activities.

Before we start, lets make a few assumptions that we will delve into and therefore try to answer the question in the heading. Lets assume that person “A” decides to open a bakery (I wanted to give an example of a sofa manufacturer, but since I ate a nice bun this morning, lets stick with whole grain products shall we). Before he even considers opening a bakery, he must ask himself one crucial question: According to my time preference, am I able to generate a return higher than or at least equal to the opportunity cost of a similar investment? If the answer is “Yes”, he will ask subsequent questions and make further assumptions.

We will assume that person “A” will need idle retail space for his bakery. He will need to hire staff for production, sales, accounting, maintenance. He will need to find suppliers, a customer base etc.

Lets assume also, that he can hire skilled bakers, people that have been employees in other firms or idle workers with knowledge in the craft of baking bread.

Lets further assume that he has a vision of a product but doesn’t have any background in design or mechanics of designing a product (the input tools, shapes, special ingredients). He can than hire someone that does know.

And to keep this mental exercise short, we shall also assume that he understands that he may fail and lose everything, and that he may also succeed and reap the benefits of his endeavor.

Does the novice entrepreneur need to understand how bread rises in the oven? Does he need to know how long does it takes for the bread to be baked? Does he need to know the chemical processes taking place in the oven? Does he need to know how the alarm system at the front door using motion sensor technology detects burglars during the night? Well, frankly, not necessarily.

You see, the market has an ingenious built-in system of solving problems that require fine tuning and specialization. Entrepreneurs, that are seeking for the next best thing to satisfy desires and consumer wants, “paste” together various resources and makes assumptions on those actions. He is either rewarded or punished for his actions. Punishment might seem rather harsh in the form of bankruptcy, but it the “invisible mechanism” that gives out signals if person “A” is doing something right or wrong. If person “A” manages to put together correctly the pieces of the puzzle, he will get the correct picture – a profit, which is nothing more than a time component of receiving additional future goods, that would not have been created if not for the entrepreneurs efforts.

Without person “A” and without this “signal” (profit), nobody would really know for sure if certain human actions of resource usage were productive or not. Person “A” is rewarded for taking risk, providing employment and indirectly, accomplishing the goals of his employees in the process in the form of salaries and their own time preferences.

So, unlike in todays world, where person “A” is thought of as being an exploiter, and a social pariah, he is the social champion, the provider of goods and bearer of good news.

Government run sport events, aka The Olympics

 

I wanted to write a post concerning the current Olympic games that are being held in London, but before I did, I wanted so see if there was any economics, reasonable to comment on and maybe give a positive or a negative response. SO, instead of giving my own thoughts regarding the games, a 2002 article from mises.org will suffice, and I will give my own comment for the current games.

This article was written by Christopher Wesley:

“I didn't watch any of the Winter Olympics that recently concluded in Salt Lake City, but it was hard not to hear of the controversies that defined them.  Early in the games, the tempest over the judging of the figure-skating competition dominated the news, after gold medals were awarded, first to the Russian pair, and then to the Canadian pair two days later.  Similar controversies arose in speed skating, skiing, and hockey.

The question is whether judging is actually as impartial as possible or whether pressure is being placed upon judges to effect specific results that are in line with the desires of both image-conscious politicians and revenue-conscious Olympic organizers, be they on Olympic committees or television network boards.

Needless to say, no one is happy with the situation.  The Russian team has threatened to boycott the 2004 Olympic Games to be held in Athens, Greece.  Winners now wonder if the metal in their medals has been debased, given the uncertainty implied in the judging process.  While everyone concedes that there must be some element of subjectivity in refereeing any sport, the very notion that every effort to allow results to be determined in the field of play are not being taken threatens to delegitimize future Olympics competitions for an entire generation.

The hullabaloo created by this turn of events is heartening.  It illustrates the inherent attraction of the human person to competition, and the disgust felt when the results of competition have been determined in an a priori manner, showing that the best efforts of egalitarians over the course of several decades to squash this spirit through reeducation have failed.  

The free-enterprise system is based in part on this characteristic of the human person.  It focuses the drive to compete in a way that maximizes the benefits derived by consumers in the form of better products offered in a wide variety and at ever lower prices.  

This explains why, just as many are outraged at the suggestion that judges may have been taking cues from network executives or bribes from home country bureaucrats, so many were sickened byreports that, in 1996, Enron executives received a $1-billion, taxpayer-subsidized loan to keep the firm in business for an extra year or two.  Absent this intervention in the competitive process, the market very well may have shut down Enron sooner than later, before it could do any more damage.  

In the same way, the average sports fan would rather have the competitive process, as much as possible, determine whether Country A's hockey team proceeds to the next level and whether it is told to unlace its skates and go home.  If Country A benefited from any other factor, then its continued presence in the games calls into question the results of other forms of competition as well.  

Of course, this situation is nothing new to an economist.  Since people are self-interested, it is essential that no one person, firm, or state be allowed to set the terms under which competition takes place, whether the competition is in the marketplace or the sports arena.  To allow otherwise would be to allow the reappearance of mercantilism.

Mercantilism describes state intervention in the competitive process in order to bring about specific results that support its goals.  This system defined global trade patterns at least until the end of the eighteenth century, after which time the classical liberal economists of the 1800s--the champions of individual freedom and private property--did their best to crush mercantilist doctrines.  However, neomercantilist thought had emerged by the end of the late 1800s, and in the twentieth century, the continued acceptance of this doctrine complemented the growth of the nation state.

In other words, some bad ideas just won't go away, especially if belief in them supports the expansion of state power.  

When mercantilism is practiced successfully, it serves to expand the power of the state while smashing the incentives of the human person to express any creativity and ingenuity outside of any non-state-approved venues.  Why would anyone have wanted to compete with Enron in the late 1990s for the loyalty of consumers, knowing that the state was actively pursuing a strategy that forbade the firm from failing?  For that matter, why would anyone from a politically insignificant country want to compete in the Olympics if he thought that the results of competition were biased in favor of rivals from other countries?  

In the sports industry, fixing outcomes is detrimental to the bottom lines of the firms that finance competition, and efforts are made to provide a sufficient amount of private regulation to minimize problems resulting from the desire to predetermine outcomes.  None of us will watch the Super Bowl, or any of the Super Bowl-related commercials, if we think it is likely that the result has been previously decided.  Such beliefs directly effect revenues.

Unfortunately, the same analysis can't be said to apply to the Olympics, which is largely a state-sponsored, mercantile event.  When the state heavily finances any project, including the training of Olympic athletes or the staging of Olympic games, its efforts seem foolish or wasteful when its intended results do not come about.  This applies as much to taxpayer funding of curling events as it does to both the corrupt AmeriCorp and the FreedomCorp programs, none of which would receive much attention from private investors in a truly republican society.

The solution to these problems is to remove state influence from all aspects of Olympic competition.  Let private clubs compete among each other for the right to represent their countries, and let private firms stage the events.  Until the Olympics becomes a completely private enterprise, we can expect many years of such controversies, as well as a waning interest in the results of Olympic competition.”

I would have to agree on Mr. Wesley’s points. No games in modern times are unbiased against the competing athletes, or against host nations. In 1980, The USA boycotted the games in Moscow, and the Soviets retaliated four years later. I am no expert in these matters, but the question that pops to mind is: Who decides which sports are going to be represented by the games? What is the quota per country per discipline. I can guarantee that because of this quota, not all athletes, even if they made the “norm” get into the discipline they wanted. Such crazy things happen, as individuals that have learned how to swim a couple months prior the Olympics, are allowed into the games, because it goes along the line of “it is important to be a part of the games, medals are a bonus”.

I wonder, how people of an impoverished country feel, if some individual was granted a pass to the Olympics and gifts funded from tax payer money?

The thing gets worse, as they are in these games, when athletes allegedly from Greece got to spend insurmountable amounts of money at the governments expense. (I have seen this news update, but cannot find the news feed, I will post when I finds it). The Olympics are usually touted as a being a huge boost to the country's’ GDP and an investment for the future. New aquatic centers, gyms will be built for the young to qualitatively fill out their time. If this were the case, Greece should be booming.

They did host the 2004 summer Olympics didn’t they?

Regulated leverage, or imposing endogenous market regulation?

Before I start writing todays post, I am glad to announce that I have successfully mastered a milestone in the CFA program, and passed the Level I exam. Due to future career prospects I may get with having passed this exam, I have decided to enroll in the second leg of the curriculum.

The former chairman and CEO of Citigroup appeared on CNBC to share his views on the ailing economy and about prospects for future reform concerning the banking industry. Since I am unable to embed the video file in this blog post, I will write out the main tenants of his monologue.

Sandy Weill said:

- break up investment and commercial banking

- manage a system that will not allow excessive leverage, somewhere in the 15 to 18x debt to risk adjusted capital

- force banks to book derivatives on their balance sheets and not manage risks off balance sheet

- protect taxpayer funds from having to bailout TBTF banks

Now, with all due respect to Mr. Weill, who also stated that the biggest banks were also the main providers of capital and growth in the global economy in the past two decades, he is putting the cart before the horse on some of these issues.

To be fair, he did state that investment and deposit banking should be broken up. I put commercial because in the mainstream, the two coincide with one another. But the problem with this reasoning is that somehow deposit taking and making commercial loans will make the investment banking business much to tied up with the former and the latter will be in a constant conflict of interest which will force the government through regulatory measures to force financial institutions to construct “Chinese” walls between departments so no kickbacks may occur and no hefty commissions be generated. To Mr. Weill’s point, it is not the commingling between these activities that cause the problems, but the fraudulent nature of loan origination that occurs in todays economy through secondary deposit creation.

His second point deals with leverage. Leverage as an instrument of magnification, may boost returns that may not be generated without the debt standing behind it. But capping this somewhat arbitrary number will again not solve the problem. Especially when banks, in response to a low yield environment must be forced to generate returns sufficient enough to satisfy customer needs, as well as not losing their revenue base to alternative investment vehicles or pools of funds. Also, on this point, different industries operate on different degrees of leverage. (To make a point, there is a difference between operating leverage, which shows the effect of fixed assets and gross profits on revenue, as well as financial leverage, which shows the difference that operating profits have on net income).  

Now, in respect to derivatives, I do agree that these instruments, as like any other that abide to commercial law, must be placed on the balance sheet as a source (asset) and flow (income) to the company. The problem with derivatives, is that, any change in price stemming from the contract (variation of the instruments fair value), and especially if the instrument is booked as AFS under IFRS, doesn’t show as an unrealized gain or loss in the income statement, but rather as a change in the OCI component at shareholder’s equity. That is point one, and point two, if companies, wish not to keep it on their books, in the form of a SPE, they can do whatever they want; but if there are guarantees and contingencies, they ought to be represented as a liability when calculating financial ratios.

And finally, to protect taxpayer funds, why bailout anybody? Why the need for this made up TBTF notion? They are a drag to the economy and should be allowed to reorganize and selloff unsound units and business ventures.

But all in all, someone that sat at a ranking position should have had the courage to speak out regarding these problems in foresight, and not in hindsight.

Gun control–a logical a priori or a posteriori by Karl Denninger

 

Even though I like writing my own thoughts, I feel that sometimes, the best thing to do is just paste an article from a fellow blogger because it gets into a more in-depth and solid view of a subject that maybe I lack thereof.

Karl Denninger, from market-ticker.org, wrote a article regarding the recent gun violence in Colorado, USA which ended in the death of more than a dozen and injured considerably more. Here is his blog post:

“I was not going to comment in a political context on this tragedy until I saw the following:

New York Mayor Michael Bloomberg, a long-time advocate of gun control, called on both candidates to address what they would do to help prevent such tragedies.

“No matter where you stand on the Second Amendment, no matter where you stand on guns, we have a right to hear from both of them concretely, not just in generalities --specifically what are they going to do about guns?” Bloomberg said today on WOR Radio. The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

Gun control is why this murderous assailant managed to kill 20 people and nobody had a crack at shooting him, as they were unarmed.

Let's look at the facts of this event.  Metal detectors and searches would have done nothing to prevent this, but would have treated every patron as a felon.  The assailant came in through a back door, which means he tampered with a crash-bar equipped exit at some previous time or had "help."  Those exits are necessary for fire safety purposes.

Reports are that the assailant was wearing body armor.  This would have made him much more difficult to shoot and stop for an armed citizen, but body armor is not "bullet proof"; it is bullet resistant, and if you take a round in the chest while wearing it the energy is still dissipated on your chest -- it just doesn't make a hole.  Continuing to shoot people while being punched in the chest (pretty much what the shooter would be experiencing) would be difficult -- but not impossible.

The presence of a bunch of openly-carried or concealed weapons might have done nothing.  A pistol against a guy toting a rifle or shotgun is not a "fair fight" but it beats nothing, which is what the victims had.  The option to fight back is better than no option at all, whether you can or do choose to use it or not.  Oh, and let's not forget that it appears that Cinemark, the company that owns the theater, appears to prohibit by policy law-abiding citizens carrying concealed weapons.  If the assailant knew this (and it is, apparently, posted on signs at the ticket counter of at least some of their theaters) then he knew that every patron in the place was literally a walking target unable to defend him or herself as law-abiding citizens are disarmed by signs -- but criminals are not.

We do not know what the shooter's beef was with the theater or the people in it.  We will likely learn at least some of that in coming days and weeks.  The alleged shooter is in custody and reportedly has no prior criminal record, so clues are not to be found there.

The simple fact of the matter is that there is a tiny percentage of people who are cracked in the head.  Walking into a theater armed to the teeth and carrying incendiary devices to intentionally drive people to where you can more-easily shoot them is the act of a depraved mind and evidences obvious premeditation and intent.  The criminal justice system will mete out the punishment it is able for this circumstance, which will be wholly inadequate as you can only take a murderous thug's life once with capital punishment.

The Second Amendment and fully-recognized Constitutional Carry is the only means available to mitigate these sorts of events.  Firearms and smoke bombs are neither difficult to acquire nor can they be made difficult to acquire or even construct for someone with murderous intent, and as such the idea that "gun control" will ever do anything other than disarm law-abiding citizens is the worst sort of crap argument from ethically and morally-bankrupt fascists who themselves employ armed security around them at all times.

Mayor Bloomberg can pontificate on whether Constitutional Carry should be prohibited and the Second Amendment amended, which is the only lawful means to alter it, if and when, and only if and when, he dismisses all of his own armed security and turns over his own firearms -- all of them.”

Bashing a company to help expropriate funds to the government

Microsoft is in the headlines again. This time the fuss is regarding its operating system Windows 7. In the following report from WPCentral, the EU commission is looking into punishing Microsoft for the apparent breach of customer service when selling their software. The following bellow is the full article:

“The European Commission announced plans today to open an investigation to determine whether or not Microsoft has failed to comply with its browser choice commitment, which was applied in 2009. The commitment saw the software giant presenting customers of its Windows operating system with a screen listing available alternatives to Internet Explorer. This was put in place due to Microsoft being found guilty of abusing its dominant position with IE in the browser market.

Joaquín Almunia, Vice President of the Commission in charge of competition policy, had the following to comment.
"We take compliance with our decisions very seriously. And I trusted the company's reports were accurate. But it seems that was not the case, so we have immediately taken action. If following our investigation, the infringement is confirmed, Microsoft should expect sanctions"

Competing browsers have previously spoken publicly about the potential antitrust violations Microsoft is dancing around by preventing third party browsers access to the same APIs IE uses in Windows 8. With the down-spiral of IE and the massive increase in users for both Firefox and Chrome, is it worth penalizing Microsoft heavily for a ballot box screen, which arguably adds little value to the user experience?

According to the announcement, the EC believes that Microsoft may have failed to implement the browser choice screen from February 2011 onwards with the release of Windows 7 SP1. It'll be interesting to see the outcome of this investigation, especially from a financial standpoint, with a possible fine of up to 10% of Microsoft's total annual turnover, should it be found guilty of breaching the commitment.”

Now, this is the dumbest case of government expropriation from a bunch of unelected bureaucrats this year. (I am putting aside the shadow banking bailouts, because those concern finance.) 

This “malpractice” coming from Microsoft had to do with an earlier massive fine it had to pay for “monopolizing” the market in browser software. The Commission seized the opportunity to pounce on Microsoft because it violated its commitment to give the option to the customer of choosing an alternative to IE. The Commission is furious because Microsoft neglected making to make this change.

First of all, The Commission should have left the doings of a private company alone. If a customer was dissatisfied with the product he purchased and the service rendered for the amount paid, there are civil courts where these matters are disputed. In my view, I am certain, that the customer couldn’t care less about this option, because Windows 7 allows you to download an alternative to IE.

And even if Microsoft did promise to make this change, and it failed to comply with this regulatory statement, any customer could have complained. I haven’t heard of any complain against Windows for not installing an optional step in the installation process of its software.

The part of the article that struck me most was the following:

“Competing browsers have previously spoken publicly about the potential antitrust violations Microsoft is dancing around by preventing third party browsers access to the same APIs IE uses in Windows 8. (italics added)

It seems that the competition wants a free ride on the back of Microsoft and is using the government to do their bidding. According to Wikipedia:

“An application programming interface (API) is a specification intended to be used as an interface by software components to communicate with each other. An API may include specifications for routines, data structures, object classes, and variables. An API specification can take many forms, including an International Standard such as POSIX or vendor documentation such as the Microsoft Windows API, or the libraries of a programming language, e.g. Standard Template Library in C++ or Java API. (italics added)”

The competing vendors are complaining because Microsoft’s API language doesn’t allow for competing vendors API to be successfully integrated into Windows.

My answer is: And, so what?

Microsoft, as a private company doesn’t need to comply with the whims of the competition. If individuals didn’t enjoy the service provided by Microsoft, it would leave Microsoft and buy a different software provider. Now, the case comes, where Microsoft is accused of being a monopolist. It is too massive and too expensive to compete against them. But this surely is not the case.

Google Chrome, Firefox and others have successfully pummeled IE into the ground. They have successfully integrated their browsers to work with Windows. They have therefore worked around this supposed stranglehold that Microsoft has.

But, to a bigger issue. If Microsoft is fined 10% of yearly turnover, which amounts to about 20*4 billion= 80 billion dollars of revenue according to Microsoft Investor Relations, the fine would be around 8 billion dollars Now, where is this money going to go to? Is it to the competition? Is it to the EU coffers?

In any way, Microsoft will later be forced to contract business, as well as the inability to possibly fund this request by the EU Commission.

This next image is also a revelation that IE cannot be charged of being a monopoly product: Google Chrome has overtaken IE, with Firefox close behind IE. Even if Google or Mozzila had to pay a license to Microsoft, it still managed to create a better product, forcing Microsoft to rethink IE and make itself a better browser.

This would be the equivalent as Apple suing Microsoft for on being able to run their OS Leopard or Lion on any other hardware other than on Mac’s. Which is absurd, because Apple designed their OS specifically for Mac’s.

This is just another attempt for the government to rake in a substantial amount of cash for their dwindling budget. And, since the EU is giving away money to shore up the bankers reckless behavior, they would probably be able to bailout Cyprus with this money:

“The little island of Cyprus became the fifth European country to request a bailout for its struggling banking sector, and the estimated 10 billion euros needed to set things right would amount to more than half its total economy.”

I am sure to get the remaining 2 billion, the ECB will just lower some reserve requirement and get the desired excess liquidity. Wouldn’t it be interesting to see the possible statistical correlation of this possible expropriation and the bailing out of Cyprus? Wouldn’t be surprised if it brought on a p-value < 0,0001 in the tails of the distribution.

President Obama’s speech shows the person behind the Presidency

 

The following quote has been taken from Zero Hedge, which cites the President at a rally who knows where in The US. It clearly shows what’s wrong with the Presidency at the current moment and the feel of politics in America.

“There are a lot of wealthy, successful Americans who agree with me -- because they want to give something back.  They know they didn’t -- look, if you’ve been successful, you didn’t get there on your own.  You didn’t get there on your own.  I’m always struck by people who think, well, it must be because I was just so smart.  There are a lot of smart people out there.  It must be because I worked harder than everybody else.  Let me tell you something -- there are a whole bunch of hardworking people out there.  (Applause.)
 
If you were successful, somebody along the line gave you some help.  There was a great teacher somewhere in your life.  Somebody helped to create this unbelievable American system that we have that allowed you to thrive.  Somebody invested in roads and bridges.  If you’ve got a business -- you didn’t build that.  Somebody else made that happen.  The Internet didn’t get invented on its own.  Government research created the Internet so that all the companies could make money off the Internet.
 
The point is, is that when we succeed, we succeed because of our individual initiative, but also because we do things together.  There are some things, just like fighting fires, we don’t do on our own.  I mean, imagine if everybody had their own fire service.  That would be a hard way to organize fighting fires.
 
So we say to ourselves, ever since the founding of this country, you know what, there are some things we do better together.  That’s how we funded the GI Bill.  That’s how we created the middle class.  That’s how we built the Golden Gate Bridge or the Hoover Dam.  That’s how we invented the Internet.  That’s how we sent a man to the moon.  We rise or fall together as one nation and as one people, and that’s the reason I’m running for President -- because I still believe in that idea.  You’re not on your own, we’re in this together.  (Applause.)”

So, if you did something, it was through the collective spirit, not through the profit seeking motive of the individual.

Brilliant.

Using other peoples money to finance projects of grandeur

 

I am happy so say that after a week of absence (summer vacation), I can resume writing my blog and continue to comment on everyday economic events.

There hasn’t been word of the late “Peljesac” bridge project for some time, so I have decided to touch on this subject for a bit. Browsing through todays online business news, I stumbled upon an article concerning this government project. It was the idea of the previous administration to solve the problem of Croatia’s territorial discontinuity by building a massive bridge that would connect Croatia’s mainland with the Peljesac peninsula, thus enabling Croatians and others to get to Dubrovnik and the rest of the south of the country, and not having to go trough the city of Neum, Bosnia and Hercegovina.

As, the article reads: “HSP Ante Starcevic against the construction of the Peljesac Bridge - The solution for the Peninsula is immersed tunnel”. The HSP Ante Starcevic political party wrote an open letter to the government requesting a tunnel, rather than a bridge, be built to connect the Croatian territory.

Now, I am sure that the political party has good intensions in mind, and they even give the plan a technical feel to it by elaborating that the same practice has been implemented by other nations as well. It would also benefit the domestic construction industry.

Now, not once (at least in the news article) is it mentioned the source of financing for such a venture. How will the government open the bidding for the construction companies is also a mystery, coupled with the fact that, are there sufficient funds in the government coffers to spend on a wasteful project and subsidize the construction industry as well.

I am not going to go into the technical aspects of such a project, since I am not a construction engineer, nor geologist, nor by the look of things (as this political party advocates) a maritime engineer, I am an economist and the economics just don’t work out. Usually, governments build bridges, roads, social infrastructure as a necessity. These projects are placed into the “natural monopoly” category, are deemed as such, because conventional wisdom states that such projects are too large for the private sector to complete.

What is really meant, is that the government can easily and with no trouble expropriate by force (taxation) the funds necessary to build such a project. Why the government doesn’t think that a private contractor and later owner can manage to bridge at a profit, is beyond me.

I do know is that if a study is done on the feasibility of the project, and this usually includes discounting cash flows, finding similar projects that carry proportional risk to arrive at the desired discount rate (delevering asset beta of similar project and relevering project equity), payback periods, WACC estimates and project duration, it will be excepted or rejected. The component leg would include checking for viable materials, natural geological movements which include geological shifts, sea level changes, wind resistance, corrosive elements, and so on.

If massive companies can finance massive constructional endeavors such as the Burj Khalifa, Tokyo International Airport, Wal-Mart, Apple and so on, why such clearly political motivated economic prevail? The largest boondoggle in history must be the interstate highway system built in The US under the auspice of boosting aggregate demand. This system hasn’t been maintained in over forty years. Just in moments of economic recession, the government calls for more public works. It didn’t occur to them that maybe a level of savings had to be generated to maintain such a vast system?

Running a perpetual budget deficit doesn’t really help in such a situation.

An attempt to soak the rich on the global level

 

The United Nations, as reported by Reuters, and rereleased by index.hr, has committed to a massive redistribution plan to “aid” the most poorest countries. It is asking for a global tax on billionaires (some 1226 of them) to pay for this “aid”.

Well, the IMF has given a trillion or so more to sub-Saharan countries in the past decades and nothing much has changed. The only thing that might have changed is the debt level of these countries. How is this money really lent out? Who gets it first and for what endeavors? We may be inclined to ask the simplest of questions: Why are the poor, well, poor?

Even tough this may seem as an easy question which contains an even simpler answer, the mass science of modern “new” economics has dumbfounded analysts, researchers and the rest to explain why such poor performance persists in the presence of such grandiose ventures. Reading von Mises, it is easy to unlock the answer of wealth creation versus wealth destruction. A poor country is one which has a low capital base. I.e., it doesn’t have sufficient savings to bring forth a larger and more roundabout capital structure. The individuals living in some of the remotest areas, are unable to accumulate capital because their time preferences are so high, that they survive by living day by day.

Now, it is true, that some regions of the planet are more abundant in resources, than others and the know-how isn’t capable of delivering sufficient results, but that doesn’t negate the fact that, in order to be wealthy, one has to sacrifice and sustain form present consumption. In the “Third World”, if there is capital formation, there is no real system of private property to ensure a viable and peaceful exchange of goods and services. Europe, nor America weren’t rich in the 1100’s as they are today, but the natural resources were still there, people still lived, technology improved and so forth, but the absence of a cohesive legal and economic structure, the “Third World” can resort to nothing but barbarism.

Taxing the wealthy will just mess up,in the margin,time preferences between their wishes and consumption/investment patterns with one of coercion and anti-entrepreneurialism. If the tax is marginally high, why keep the capital structure intact? Why not consume present goods, as they will bring about a lesser tax burden. Let socialism prevail and all we be well. Not to mention, the ability to  create fake “aid” through inflation and redistribution to the privileged few.

A global tax won’t fix the problem, it will only aggravate current unsound financial positions, wherever they may be located, whether geographically or on an industry basis. Soaking someone with aid, rises the price of those goods at home and creates a disincentive to produce on your own and built up a viable capital structure in the process.

This is however, not the first call, for such a feat. There has been, over the past few years, of a global derivatives tax, dubbed the Tobin tax. Instead of recognizing that the problem of a massive global derivative position, notionally, many times larger than the GDP of planet Earth, is a function of rapid credit expansion and fractional markets in the stages furthest from the initial expansion taking place at the commercial banking level, as well as the negative real interest rate loans provided by the central banks, subsidizing the very originators of fraudulent debt.

If the UN wants to help, it should start by looking itself in the mirror and explaining why their employees are exempt from paying income taxes in their home districts, as well as special subsidies for housing and medical costs…

How the privileged few have access to a massive subsidy

 

Remember, how in life, people say: “it’s the little things that make life great”. In this case, it’s the little things that make life a complete clusterf*ck. If the next picture is so blatantly shown to the public, just what happens behind close doors?

The next list shows bus fares from the city of Zagreb to the town of Novalja on the Adriatic Coast.  The foremost right numbers are the prices represented in the local currency – HRK (1$ = 5,5 HRK). The “J” stands for the price in one way, while the “AR” stands for a return ticket. 202 HRK is a one way ticket to Novalja, while students, the blind pay 134 HRK and small children 104 HRK for one way. 202 HRK, 300 HRK and 241 HRK are paid by children, adults and students and the blind respectively. The bus ticket purchased for a return trip is valid for 180 days.

This is all fine, if not for the yellow bolded part I highlighted. The highlighted part reads: Parliament members pay 6 HRK= 1,2 dollars. And this was decided by the Parliament.

So, I wonder, in the aggregate and in at the margin, how much am I subsidizing these royal individuals? Well, it depends on the average price on the average bus fare for all citizens. And, since its law, all carriers are FORCED to subsidize these passengers. This means an explicit marginal loss for the carrier.

Brilliant.

0     Rezervacija.     6,00
1     Karta za 1 SMJER     202,00
1000     ZASTUPNICI u HRV.SABORU ! ( odluka Sabora )     6,00
1035     J / 35% / STUDENTI, +65 god., SLIJEPE OSOBE!     134,00
1072     J / 50% / DJECA 5-10 g.     104,00
5072     AR / 50% / 60 D/ DJECA 5 -10 g.     202,00
5329     AR / 25% / 60 DANA     300,00
5330     AR / 40% / 60 D/ STUDENTI,+ 65 go.,SLIJEPE OSOBE !     241,00
LEGENDA: J - Jedan smjer, AR - Povratna karta, 180 D - Vrijedi 180 dana, X-ica - Studentska iskaznica

Unemployment in Europe as a precursor for more stimulus

 

BRUSSELS (AP) — Unemployment in the 17 country euro currency bloc hit another record in May as the continent continued to be buffeted by its debt crisis, official figures showed Monday.

Eurostat, the EU's statistics office, said unemployment rose to 11.1 percent in May from 11 percent the previous month. That's the highest rate since the euro was launched in 1999, and compares badly with an unemployment rate of 8.2 percent in the United States and only 4.4 percent in Japan.
In total, 17.6 million people were out of work in the Eurozone in May, 1.8 million higher than a year earlier.

Unemployment has been edging higher for over a year as concerns over the debt crisis and the future of the euro currency itself have weighed on economic activity.
There are huge disparities across the Eurozone. The labor markets of those countries at the front line of the debt crisis, such as Greece and Spain, are suffering in the wake of stringent austerity measures and recession. The highest unemployment rate across the Eurozone was recorded in Spain, where 24.6 percent of people were out of work in May. Even more dramatically, 52.1 percent of the country's youth were unemployed.

Other countries in the Eurozone are faring fairly better. Germany's unemployment rate, for example, stood at only 5.6 percent. However, a raft of surveys in recent weeks have pointed to tougher times ahead in Europe's biggest economy.

Across the wider 27-country European Union, which includes non-euro countries such as Britain and Poland, unemployment edged up to 10.3 percent in May from 10.2 percent the month before.

Does the ECB need to intervene while the EUR is at 1,226?

There has been talk lately, coming from analysts in the financial district for the ECB to continue easing. The ECB has already been active in the market for the past two year by propping up the sovereign markets and buying wholesale government debt loads.

The goal was to make the term structure of the government debt in the Eurozone periphery more manageable. It also induced a short stock market rally. But with every new dose of stimulus, the hangover is ever so greater. In my opinion, it is not the government that need the bailout, but the banking industry that has been supplying cheap credit to the governments are let holding a lot of illiquid debt on their books.

The ECB is risking the fallout of its interventionist policies, that will be in the form of additional moral hazard, higher interest rates and more TBTF banks. You cannot shore up unsound positions by accumulating more debt in the same positions. Bad debt must be liquidated and the nominal price levels must reflect pricing realities.

As the amount of leverage in the system grows, and as the implicit guarantees by the ECB to peripheral debt continues, there will be GDP growth, financed with ex nihilo deposit origination. Any uptick in the GDP will be followed by further capital consumption and a lower standard of living.

The ECB is trying to stimulate its way out of a problem it itself created. You cannot forcefully feed money in an unsound position if there is no demand at the other side. And, even if there is demand, the government will have to redistribute resources from somewhere else to manage the implicit or explicit guarantees. If rates fall for instance as the central banks ease to support the real estate market, rates will rise elsewhere. Pushing rates toward the ZIRP boundary will encourage speculation and consumption, but not rebuild the capital stock which is desperately needed. The ECB is here to help the banking community avoid any losses they might occur, while at the same time devaluing the currency, subsidizing borrowing costs to the banks.

So, no. The ECB has to retrench and take the hit now on its asset side. Will the ECB manage this shortfall with printed Euros it will ignite the shadow inflation currently in the system. What is also needed is a structural reform of the labor market. Minimum wage laws, price floors on wages must be abolished. The notion of a fiscal union is just absurd. If the monetary union wasn’t a transfer mechanism in of its own, do we really need an automatic stabilizer on a supranational level? A stabilizer put in place to shore up the problems the monetary system will continue to produce?

No thank you.

Wow, an open discussion in Congress about fractional reserve banking. This is a must see.

 

The panel consists of Dr. Salerno, Dr. Cohran, and Dr. White. To see Misesians in Congress discussing true monetary reform is really a step in the right direction.

Written statements can be downloaded from here.

Enjoy.

Free healthcare? Subsidies for healthcare? Healthcare is governed by the laws of supply and demand? Really???

 

Enjoy. The bears are back, this time as humans.

If you can’t succeed, just rig the auction

In the following video clip, author and journalist of Rolling Stone Magazine, Matt Taibi, discusses the ongoing trial of one of the largest municipal fraud that has been perpetrated over the past decade.
This time, the state colluded with the key underwriters who floated state bonds, raking in a hefty kickback in the process.
To view the video, go to: http://www.foxbusiness.com/on-air/imus/index.html#/v/1699988827001/municipal-bond-rigging-robbing-americans-of-billions/?playlist_id=87057.
Enjoy.

The use of holistic aggregate systems as an excuse for government intervention

 

I actually believed that unlike the mainstream financial outlets in The States or elsewhere in Europe, my country would have a more grounded and unbiased picture of the state of the economy.

Unfortunately, I was mistaken. In a recent article in business.hr, there is an article named: “Do Croatian citizens have more purchasing power than their neighbors?”

“Gross domestic product (GDP) per capita in Serbia according to the criterion of purchasing power is 35 percent of EU average, it is evident from the data that was presented this week by the European statistical office Eurostat.

Among the countries of former Yugoslavia, according to Finance, Slovenia passed with 84 percent of EU average.

Lower standard than the Serbian, according to the criterion of purchasing power in Europe, were the only two countries - Bosnia and Herzegovina, with a GDP per capita last year reached 31 percent of the EU and Albania, whose GDP per capita was 34 percent of the EU average.

Among the countries of former Yugoslavia, Slovenia recorded the best result with 84 percent of EU average. This is followed by Croatia with 61 percent and better than Serbia, also last Montenegro and Macedonia.

The richest country in terms of purchasing power is Luxembourg. Luxembourg's GDP per capita in purchasing power of the criterion was 274 percent of the EU average. Followed by the Netherlands (131 percent), Austria (129 percent), Ireland (127 percent), Sweden (126 percent), Denmark (125 percent) and Germany (120 percent).

From countries outside the EU, Norway has reached 189 percent of average, 151 percent of Switzerland, Iceland 110 percent, which is considerably less than before the crisis.”

The first error in this analysis is comparing a meaningless holistic concept such as National Income and dividing it by the citizenry. It is impossible to grasp the concept such as subjective wealth, nor does it take in consideration of any discrepancy between the various differences between the groups of individuals who actually contribute to growth in societal welfare.

Second of all, it uses an ideologically bankrupt national accounting metric, called the GDP. In my view, any increase in GDP has to be incorrect because it accounts for the rise is nominal money supply that somehow adds to the nations productive structure. It doesn’t. Some would then argue, that the nominal number is deflated (removing inflation) to represent real growth. But again, this is wrong because as Ludwig von Mises stated nearly a century ago, it is the productive structure of the economy that matters, not the stock nor flow of money in the economy.

GDP is also a term that has the word “gross” in it. Because it counts the differences in inventory growth from quarter to quarter. But this is in no way gross, because it doesn’t include the nominal values of intermediary goods which are used up in the productive structure. This is omitted because it would amount to double counting. But, adding in this value would get a picture of the capital stock of the economy and the total “capital buffer” in case of rampant consumption.

The government likes to use these numbers because they can point at discrepancies between per capita GDP among nations and neighboring countries and rationalize intervention as a prelude to boosting nominal GDP. The tarnished GDP metric is closely used with the “Gini coefficient” to measure income inequality. Government sees that any discrepancy from a solely chosen arbitrary number is a pretext for meddling and redistribution. If that doesn’t work, they try to figure some other holistic form of gauging the wealth of nations, such as the HDI or the “happiness” index. Trying to correlate happiness by weighting certain variables in a model such as the number of vacation days in a year, number of children in the family or the marginal difference in taxation between different income groups is futile. According to the HDI, Ireland was called developed because it had a 0,959, which is excellent, until their economy crashed and it fell to 0,908. Even though it is a high number, how does a bailout of the banking system funded by taxpayer austerity amount to a high HDI?

Maybe if the government would stop deficit financing through monetary expansion and wasteful resource allocation, it would see that the market in its own virtue, distributes income to individuals who are rewarded serving the consumer.

The difference between the effects of a legitimate default on a loan issued by an inflationary banking system and a noninflationary banking system

 

When trying to differentiate the positive from the negative impacts of modern banking on todays complex economy, we have to understand the mechanics behind the process itself. And by process, I mean the way the intermediary institution of banking operates.

We shall, first of all, separate two very distinct, but in the evolutionary banking process, blurred phenomena. One is deposit banking and the other loan banking. Well shall focus only on loan banking. Deposit banking is the art of safekeeping ones possession. In this case, the possession is money. In loan banking, the accumulated funds are loaned out of the bank to an entrepreneurial endeavor.

In this second case, funds are shifted from the saver to the lender, leaving the bank for an agreed upon time. In any case, these funds that leave the bank cannot be redeemed at any time at their nominal value. The funds shall be relinquished only after the term of the saved funds at interest only if the mirror image of the savings – the loan, is to be returned to the bank. The bank is rewarded for its services as an intermediary and the saver is rewarded with additional purchasing power with which he/she can purchase additional goods and services (more than if the saved funds were consumed at the beginning).

The question we pose is: What happens when the entrepreneur defaults on his loan in an inflationary banking system, and one in an noninflationary banking system?

In the first case, diverted funds which are legitimately loaned out. What this means is that funds are diverted from legitimate savings and NOT from deposits which are redeemable on par. If for example, these funds are saved for a 3 year period and loaned out for exactly the same period, the money supply hasn’t expanded nor contracted. It remains the same, just the term structure of accumulated resources are utilized in a different manner. If the entrepreneur overestimates his future revenue stream, he is in trouble, and unable to return the loan. In this case, any capital goods that are diverted to his/her project will be lost as they do not successfully fulfill the consumer demands along the structure of production.

These capital goods, to be of any use must be firstly liquidated to have any meaningful purpose. This usually involves high conversion costs, trapped idle resources and a lower standard of living. The lower standard of living is reflected in higher nominal wages as the funds flow back to the stage of production closest to consumption. With more units of exchange a deficient amount of goods can be purchased to satisfy greater desires, as the resources are trapped (momentarily or permanently) in useless lines of production. Society does get poorer in this case, but there is NO business cycle, NO contraction in the money supply.

The second case is when the commercial banks flush with excess reserves from the central bank decide to expand demand deposits in the economy, by pyramiding on a fraction of cash deposits. This exerts an artificial impact on the economy’s structure of production. An inflationary loan adds “shadow” savings in the economy as a fake euphoria (optimism) enters the economy. Capital goods rise in price as well as the general price level, and unlike the previous example, inflation exerts its negative influence on the productive structure. A loan that defaults in this sort of environment will exert a negative cascading effect on the entire economy, because, just as easily as new loans are brought into existence through credit expansion, the elasticity of the money supply reverses and collapses in on itself leaving a POORER capital structure than before. The loan itself will default if not for an ever accelerated dose of monetary expansion than before. If it happens sooner than later, not only will their be losses on the created loan, but a depleted capital structure as capital consumption is also experienced as the malinvestments are worked through.

This is a rough exposé of what happens in different systems. To fully understand this process is to thoroughly grasp capital theory and the impact of credit expansion on intertemporal preferences among the various economic actors. I would suggest reading Jesus Huerta de Soto’s masterpiece – Money, Credit and Business Cycles and for a short treatment of this subject:  A Reformulation of Austrian Business Cycle Theory in Light of the Financial Crisis by Joseph Salerno.

Two wrongs don’t make a right

 

The following excerpt is from Euro Pacific Capital’s website and is authored by Peter Schiff.

Peter is one of the few CEO’s and respected businessmen in the financial spectrum who correctly called the housing collapse and testified on a Senate subcommittee regarding additional loan guarantees provided by the FHA for multifamily housing. The following can also be found as a video clip on Youtube.

“I was invited to testify about the Federal Housing Administration's (FHA) policy in the apartment lending market. Although this was a fairly narrow issue, I told the congressmen the same thing I did last year when I was invited by a different subcommittee to testify about job creation: government programs don't solve problems, they just create new ones. While I thank the Committee for inviting me, I believe the congressmen may have gotten more than they bargained for. […]

The subcommittee was considering whether to expand the activity of the FHA to insure loans for multi-family (apartment) buildings. The mechanism to achieve this was to extend FHA guarantees to pools of collateralized mortgages backed by multi-family residential housing units.

I have absolutely no objection to the idea that a healthy rental housing market is needed. However, I believe that market forces are sufficient by themselves to create it. The average American family now only has $7,000 worth of savings, which would not be nearly enough to afford a 20% down payment on the average American house. This means that most Americans should be renters and not owners. […]

Normally, these simple facts would attract investment capital to build affordable rental properties. However, these forces have been blunted by Federal tax and housing policies that have exaggerated the economic benefits of home ownership and have drawn excessive amounts of investment capital into that sector. To correct the distortions, the Subcommittee was considering, you guessed it, more distortive regulations. It never occurred to them to simply scale back the original regulations that are the root of the problem.”

Government officials liken the idea that whenever there is a problem that cannot be serviced immediately by the free market, they have to jump in and make a utter and complete mess regarding the “apparent” problem at hand.

Taking money from John to give to Jim and dismantling the capital structure in the process

 

There is really no end to the constant political influence of our representatives when the economy (locally or on the state level) is concerned. The next headline comes from www.zagrebancija.hr.

In the article which is making headlines all across Zagreb, a massive government spending program is being initiated. The following picture that was taken shows the construction team in place already demolishing the previous meadow. This meadow is adjacent to the National Library Building. The meadow is really huge and one of its purposes used to be walking dogs, recreational walks and the such.

 

Our great major, Mr. Bandic has decided to implement a 20 million HRK project to build a fountain. Yes, that’s not a typo – he is spending 20 million HRK ( = $3,6 million) to build a fountain.

Now, a typical Keynesian economist will say that the G in GDP = C + I + G + (X – N) is government spending, and an increase in this variable will lift the national income statistic and give a boost to GDP. Arithmetically, this is true; economically, this makes no sense. The government in its infinite wisdom has decided how to spend my money and transfer this purchasing power to the construction company which I am sure got a deal with a large premium over the market. The building materials and labor hours will be wasted in the process and the lost factors of production and resources will be diverted from either home building, sewage construction or just used as idle capital stock as an insurance in case of future economic need for real purposes.

An economy doesn’t grow by spending money. Especially in this way when to generate this growth, you have to take the resources from the economy and implement such a project. In essence, this pork barrel project is nothing but a large shell game. A wasted resource is undermining the capital structure of the industries that need these resources, creating a permanent loss for the local government budget.

The main point is, spending money doesn’t do anything. Its resource utilization that matters. Why not build 1000 fountains? Because it makes no sense. This so called meritorious good benefits only the individuals that have a direct contact with this good or service. In this case, only the construction workers that will get a boost to the detriment of the rest of fellow Zagrebites and the politicians are ensured a sure vote.

Present goods in form of money are wasted in such projects and society therefore gets poorer.

A bankers dream: Subsidies and bailouts

During the recent bubble in real estate in Spain, banks amassed a nice gargantuan sum of loans (created more or less ex nihilo through the fractional banking process) which are now not worth their carrying value.
To match their balance sheets with reality, they are forced to write these assets at market value. This will mean a massive balance sheet contraction and a subsequent unwillingness of banks to further expand credit due to losses, and a weak economic outlook forces them to retrench without additional credit demand.
According to business.hr, Spanish banks need 65 billion euros of fresh capital.:

“Eurozone finance ministers agreed on Saturday that the Spanish government needs to borrow up to 100 billion euros to help banks after the bursting bubble in real estate markets and banks have problems with uncollectible loans.”

Well, this is what happens when you try to short circuit the wealth generation problem through credit expansion. Interest rates shoot up to signal a shortage of available savings to complete the initiated projects and the asset side of the balance sheet contracts. Gee, I wonder where the money is going to come from? Savings? Future taxes? Credit expansion?
Its really unbelievable that even after the crash, politicians are still fixated on generating overall aggregate demand to offset the credit collapse. They are fixing a debt issue with more debt. Brilliant. And after the banks receive this cash, just as they did with LTRO and LTRO II, where are they going to use thus liquidity? To increase loaning out to business ventures. I doubt it. They will use these funds to offset their loan losses and add to their loss provisions.
Certainly, they will pay no taxes in the immediate future, thanks to the tax carry forward loss.  Lavish bonuses will be paid and everything will look fine until the bill is due once more and the loan has to be rolled over at an even higher yield.
The ring-around-the rosy continues.

Common economic sense

 

I’ve decided to post an interesting cartoon that may escape the most literate mainstream economist of our day – the simple truths are the ones that evade us the most.

Straight from the Circle Bastiat, a glimpse into the puzzling world of “why does GM manufacture cars that nobody wants”. Enjoy.

Hedging vs. asymmetric hedging

 

Due to the large viewership of the blog post titled A short explanation on J.P. Morgan’s Derivatives Loss, I have decided to delve a little deeper and explain the difference between hedging and a strange phrase dubbed asymmetric hedging.

Jamie Dimon, CEO of J.P. Morgan Chase Corp., has attributed the recent massive losses due to asymmetric hedges the firm took. These losses were revealed in advance and ahead of the Q1 earnings report. What is interesting is the manner that the CEO described the loss, calling it a hedge gone wrong.

Now, to reiterate, to hedge means, to offset. An example would be to go long in an interest rate swap contract, in which J.P. Morgan pays a fixed rate of 500 basis points + spread between a AAA corporate bond and the 10 year Treasury security and receives 500 basis points + LIBOR. The transaction is settled quarterly and netted. This means that if at the settlement date, LIBOR is higher than the 10-year spread, J.P. Morgan, receives the interest difference between the two. This discrepancy is usually based on historical returns and current market fluctuations. In this case, the cash flows usually cancel each other out.

Now, in an asymmetric hedge, an example would be as follows: J.P Morgan would agree on a swap that includes paying 500 basis points + LIBOR and receives 500 basis points + the return on a thinly traded security or index. Now, in this case, the probability of small netted returns and cash flow netting is smaller, than in the previous example.

If for example, the thinly traded index fell 40% at the settlement date, J.P. Morgan would not only pay its cash flow, but the difference in the index between the two dates as well. It would have to book a massive loss for doing so.

That is an “asymmetric” hedge. Using leverage compounds the loss, and offsetting the position can also be very costly if the ongoing fundamentals for the swap is negative for J.P. Morgan.

The example doesn’t even resemble a classic hedge, but rather a speculative position. Even if J.P. claims that is making a market and offsets the position with its client through the hedge, seeking asymmetry is more something a hedge funds would do.

Fraud as the final step in a credit boom

 

There has been great many discussions about introducing new legislature concerning the overhaul of the financial industry. There has been calls for Glass-Stegall to be re-introduced. The Dodd-Frank overhaul act of 2010 is a massive 800 page juggernaut aimed against the “egregious” acts committed by Wall Street during the latest  recession. But, do laws really help against fraudulent behavior or are there deeper roots regarding this problem?

During the boom faze of the credit cycle, prices of factors of production and capital goods rise in value, the stock market rises and there is a sense of general euphoria. Companies are willing to go into debt to finance and expand entrepreneurial projects. They are romanced by the banking sector and the cheap funds that are all of a sudden granted to businessmen almost at no cost. Profits soar, and the balance sheets of companies have never looked stronger.

Assets are inflated in value, along with revenues. Projections based on current sales and expenses are prolonged into the future with expected double digit YOY growth. Companies in this period don’t really run high capital buffers to protect them in case of a sudden fall in ongoing revenue. They rarely engage in any accounting for reserve losses on their accounts receivables and a hectic schedule of ever increasing demand reduces their inventory amounts. The demand can be so excessive, that companies frequently neglect the qualitative value of there assets, as the only goal is to satisfy the voracious appetite of the consumers at large.

However, the fairytale economy built on money creation is an illusion, and soon companies will find themselves in trouble. The first thing that comes about is a cry for more liquidity; that is, the business community starts holding a grudge against the government due a “note shortage”, a situation where there isn’t enough funds in the economy for completing there projects of longer durations. Businesses are frightened due to rising interest rates and higher costs of going into debt or rolling over their current debts. Funding becomes an issue.

The only way for businesses to appear in good health is to engage in deceptive accounting or sometimes go so far and engage in embezzlement and fraud. Companies, which are first effected try to get rid of poor performing assets. But, instead of selling them, they usually engage in complicated repo transactions, where they try to ”window dress” their current financial mess.

(This closely resembles the situation and fraud perpetrated by Olympus in Japan. They tried to hide losses for over a decade in an ingenious scheme that finally unraveled a couple months back. For an accounting description of what happened read this post by an independent CPA from San Francisco located on retheauditors.com.)

But the window dressing and repo shams can last only for so long. The company will eventually run into problems paying back their vendors. They again decide to engage in aggressive accounting techniques using vendor financing. The troubled firm will sell their account payables for note payables. The cash injection will be recorded on the cash flow from operations (under IFRS) and when the note comes due, they may resort to booking it on the financing portion of the cash flow to make it appear that the firm is on steady grounds when its core business is concerned.

Fraud, in this context was generated not by an evil ambition of the businessman, but by a desperate attempt to stay afloat. That is usually what happens in a boom period. I am not vindicating this behavior, just stating the catalyst that brought such dubious behavior.

In a “normal” economy, these things happen as well, but are more profound during the end of the boom faze. Some other ways to manipulate earnings or financial statements is to: book revenue without shipping the product (bill and hold), booking a revenue when accrual accounting doesn’t allow it, lowering contra accounts to artificially prop up assets, capitalizing an expense when conditions are not made for it to be capitalized, engaging in aggressive securitizations, manipulating the life cycle of an asset, booking future profits, lowering the carry of defined pension benefit plans, using an asset as an operating lease instead of properly booking it as a finance lease etc.

The politics of employment

 

It is really sad that in todays world, one would get a job not because of his/her merit, but because of politics. This next article from business.hr really makes me sick:

“Minister of Environmental Protection and Nature Mirela Holy, in a written request addressed to the President of Railways Holding Renu Valcic tried to save one secretary from being fired reports HRT Broadcasting.

The written request in the first sentence emphasizes that the  the secretary is the wife of  a party colleague, but the CEO of Railways Holding Valcic rejected this request. Holy says that it is not a political intervention, but it is a recommendation for a humane attitude toward an employee of the Railways, the reports of HRT.  I appealed. I sent an official request from the mail, but mail from the party to a party colleague, "said the show 'Open'.”

Not a political endorsement? Humane attitude? This is one of many real life situations in which individuals wishing to resume a status quo situation are left begging to the government to save their rightfully earned workplace.

Insomuch, I wouldn’t be surprised if this individual earned twice as much as she would have earned in an unsubsidized industry subject to the laws of supply and demand for wages.

Fractional reserve banking and its effect on maturity mismatching

 

The following is an excerpt from my presentation at the 3rd International Student’s Conference: Time to Rethink Economics, Beyond Frontiers that took place in Zagreb, Croatia in June, 2011. The title of the working paper is: Dangers of maturity and currency mismatching in a fractional reserve banking system with the example of Iceland and a look at alternative banking models.

Fractional reserve banking and its effect on maturity mismatching

For one to understand modern banking, history is an essential backbone unto which the pillars of modern financial intermediation are to be analyzed. The first and foremost example is Ancient Rome and the introduction of Roman Classical Law. In the time of great advances in philosophy, the beginnings of primal government structures and other forms of key institutions, a form of so-called jurisprudence evolved. Jurisprudence came about from the nature of societal and human understandings championed by Roman scholars, as” […] they embarked on an interpretation of legal customs, exegesis, logical analysis, the tightening of loopholes and the correction of flaws; all of which they carried out with the necessary standards of prudence and equanimity.“ (de Soto, p. 24)

The work of the jurisprudence was subsequently archived thanks to Emperor Justinian during the middle of the six century, as to be later on compiled into one monumental book, the Corpus Juris Civilis. Roman legal scholars, as part of this jurisprudence came to a conclusion that haunts modern banking to this very day. The pivotal conclusion regarding not only banking, but the core social edifice of society, but in the realm of banking, was the distinctive and fundamental difference of demand deposits which represent a sum of money deposited at a depositary institution, receiving the name of a monetary irregular deposit (to be shortly explained) also known as a tantundem, and a loan contract, under which an individual relinquishes his/her monetary sum for a distinctive period of time, at interest, also known as a mutuum contract.

A monetary irregular deposit stems from the notion of fungible goods deposited at a depository. This means, that if someone wishes to place a certain good at a bank for safekeeping, for example, oil, grain and so forth, it is in the depositories obligation to immediately relinquish this good at the demand for the depositor. Since grain and oil are by nature fungible, it is economically inappropriate to keep these goods separated or compartmentalized for the marginal cost would be too great. Therefore, grain and oil are kept together, since no qualitative or quantitative standards are violated.

Moreover, this fungible asset is, in its essence, a demand deposit. Any failure of delivery results in a law suit against the depository not being able to bring about this demand to its rightful owner. “In other words, the owner of the grain warehouse or oil tank can use the specific oil or grain he receives, either for his own use or to return to another depositor, as long as he maintains available to the original depositor oil or grain of the same quantity and quality as those deposited“. (de Soto, p. 59)

A demand deposit is not relinquished for any time. It does not represent a transfer of present consumption for future consumption, unlike a loan (mutuum). A loan transfers present for future consumption, in line with consumer preferences. One of the key roles here is the charging to interest.

Why banks grant interest payments to depositors? There is clearly no transfer of consumption patterns when a deposit is kept for safekeeping. A monetary loan on the other hand signifies a transfer of ownership where a demand deposit does not. In that case, banks are obligated to maintain a 100% reserve requirement for demand deposits.

However, fractional reserve banking manipulates this legal and economic understanding of not only ownership transference, but time transference of funds. Notable examples of this misconception derive all the way from ancient times to modern day banking with the clear deviation from logic, adopted in Anglo-Saxon Law. The practice of loaning out demand deposits and concealing them as loans is a concept known in the Middle Ages as depositum confessatum.

Under this veil, banks had the ability to pay out interest to depositors, even though it should be reversed, the depositors for various reasons, decide to safe keep their funds, and must pay a service fee, not the other way around!

Economic activity is therefore altered, for confusion enters the market, and one doesn’t know if funds are genuine savings, as in loaned out, or funds are safe-kept, to be instantly used. Primary examples include the government sponsorship of these actions in the past, so-called ius privilegium. Under such circumstances, banks were allowed to create credit out of nothing, loaning out deposits that should have been backed by a 100% cash reserve.

Fractional loaning of demand deposits, therefore, when visualizing from an accounting perspective, transfers leverage and unjustified profits from society to banks practicing this form of intermediation, creating a profound and unjustified act of usury.