Natural Order

In a recent article in the WSJ, the head of the Bank of Japan (BOJ), Haruhiko Kuroda, reiterated a commitment to do “everything possible” to push the rate of increase of consumer prices to 2%.

He also assurances that if the BOJs unconventional monetary pumping (aka, quantitative easing or QE) showed signs of triggering asset bubbles, that steps would be taken to avert them.

It is a tribute to the naivete of journalists reporting on this that no one bothered to ask Kuroda how successful BOJ has been in detecting and seeing off bubbles in past!

Or any other central bank for that matter!

As it is, central banks tend to limit their attention to measuring the effect of monetary policy on price indices as the primary, if not sole, indicator of the efficacy of their efforts. As such, they have a dismal track record of detecting bubbles, as is the case with most mainstream macroeconomic analysts.

Meanwhile, it is unlikely that the BOJ is able to detect how much of the new liquidity will be bled off into foreign markets through the carry-trade, thereby sparking asset or commodity bubbles elsewhere.

According to FHFA, conventional home-financing data for February 2012 to February 2013 shows that newly built & existing homes in 2013 sold for 9% & 15% more than during the previous year.

In turn, some economists believe that the addition of more than a trillion dollars in additional home value will spur a “wealth effect” to get consumers spending again.

Hey, this has gotta be good news.

But then, didn’t the NBER announce that the recovery officially began in June 2009. (Hmmm, it seems some people in the real world did not get that memo.)

Ok, let’s see if any of this makes sense. Consider that real incomes of American workers were nearly stagnant, rising by about 2% over past year & barely offsetting price inflation.

So, how could & why did home prices rise?

The simplest answer is found in monetary pumping, aka, quantitative easing (QE).

With mortgage rates on new & existing homes down by up to 1% compared to last year, monthly financing costs for new homes remained same & went up by 3% for existing homes.

And so the housing “recovery” has been conjured up with historically-low interest rates, guarantees on almost 90% of all new mortgage debt with 1/2 half of all home purchase made with no equity at closing. Meanwhile, the Fed is buying $40B in mortgage-backed securities each month (plus another $5B in Treasuries).

Anyone that thinks this sounds just like the last monetary & government policy housing boom/bubble; raise your hand!

And now remember that average mortgage rate during early 2000s were just over 6% while they now average less than 3.5%.

If mortgage rates were to go back to 6%, the US housing market cannot remain buoyant unless incomes rise by 1/3 or house prices fall by 25% or lending standards become even more lax.

Something tells me this cannot end well….

Pope Benedict XVI delivered his message for peace day that included a call for a new economic model & “ethical regulations” of markets.

His competence as a biblical scholar & an expert on Church doctrine is unquestioned. But one has to wonder if he has read any reports from the late 20th Century up to now…?

Has he not heard of the failed social experiments with the welfare state that have crippled economies across Europe & threaten to do the same for the US economy…?

His comments show that he accepts the canard that the global financial crisis offers evidence of the failure of capitalism. Equally troubling, he suggested that markets do not protect the weakest members of the community.

In his missive, Pope Benedict issued a condemnation of something that the world has never known, “unregulated capitalism”.

He also denounced “the prevalence of a selfish & individualistic mindset which also finds expression in an unregulated capitalism, various forms of terrorism & criminality”.

But the most systematic source of injustice & evil throughout history has always been enforced by the coercive force of governments. As it is, more than 250 million souls perished due to democide, genocide & war over the 20th Century.

Those that believe that governments are at the mercy of capitalism should see that the answer is to reduce what governments can do.

In his most recent book, Antifragile, Nassim Taleb points out that government interventions to reduce risks can make systems more prone to failure, even collapse.

In his mind, increased complexity of a system means that it is more necessary for it to encounter shocks that allow it create adjusting mechanisms so that the system can survive. As such, systems fare better if they embrace disorder rather than have an outside force try to impose order on them.

Any good economist should never be pessimistic too long. For evidence that things usually improve over time, it is helpful to consider the work of Julian Simon whose magisterial work, The Ultimate Resource, shows how free-enterprise capitalism can channel human efforts & lead to continual improvement of the human condition.

It seems that the Londom-based Spectator magazine has picked up the optimism bug (“Why 2012 was the best year ever“):

“It may not feel like it, but 2012 has been the greatest year in the history of the world. That sounds like an extravagant claim, but it is borne out by evidence. Never has there been less hunger, less disease or more prosperity. The West remains in the economic doldrums, but most developing countries are charging ahead, and people are being lifted out of poverty at the fastest rate ever recorded. The death toll inflicted by war and natural disasters is also mercifully low. We are living in a golden age.”

Ironically, these positive outcomes are under continuous assault from political forces that act on the premise that they wish to do “good” for other people. Each new regulation or tax imposed for redistribution to expand the welfare state undermines the capacity of individual initiatives to serve the interests of others through voluntary exchange.

So-called progressive (“social democrats”) see productivity as an instrumental tool that allows wealth redistribution to expand government intervention in the name of “fairness” or to achieve some subjective notion of “social justice” that pleases their constituencies. However, they tend to impose regulatory overreach that throw sand into the gears of the economy, supports unionization that may hamper productivity gains, & place higher tax burdens on innovators. Social democrats also tend to promote a fantasy that governments can create risk-free life by imposing regulations on an expanding range of human activities & do so without any attendant long-term costs.

If there was a better understanding of Julian Simon’s insights, there might be room for more optimism for the future.

Perhaps the focus on the interpretation of doom in the Mayan calendar was misplaced & that the apocalypse was about the economy rather than the end of the world.

Don’t blame me for the pessimism herein as I am not the architect of the policies that have wrought such perilous conditions. Being the messenger of bad tidings is never a pleasant task….

As it is, the US economy (as well as many other industrialized & emerging economies!) is in the midst of a debt-fueled bubble that gives an illusion of prosperity whereby more wealth is being consumed than is actually being produced. The inevitable bursting of this bubble is likely to be followed by a long & very painful economic “correction” that could stretch to decades, much like what happened in Japan after its “bubble economy” imploded.

When I was younger, most of my most stimulating debates were with Marxist economists. I was always optimistic then, inasmuch as I was well enough informed about their models to know why it would fail. In most instances, this was a one-sided debate in my favor since I knew more about what their terms of reference than they knew about mine. This was a simple matter that I read much of what they read while they were woefully ignorant of what I read.

Yet now I feel a bit of despair as the forces aligned against the basic individual freedoms that underpin economic growth are more formidable not in their intellectual strength but in their slippery nature. While Marxists operated along a predictable logic defined by their models, “progressives” (social democrats) are a slippery amorphous group that treat economies as geese that lay golden eggs that they redistribute according to populist whims rather than principles.

It is my impression that the US economy is in a condition rather like a soldier struck by a bullet on the battlefield. As it has passed through the body, the serious damage may not be immediately clear.

Both major political parties in the USA advocate some sort of “military Keynesianism” that is linked to “faith-based” economic theory. In the end, a belief in mythological spending multipliers is used to denounce cuts in defense spending or to justify increases.

Similarly, officials of local government officials insist that preferred public works projects, e.g., expensive sports stadiums for professional teams, add super-charged boost to local economies.

The White House has stated that it will respond to any & all online petitions that attract at least 25,000 signatures.

One petition exceeded the threshold: to have the US government build a Death Star.

This foolish application of democracy would allow (or require) public officials to pursue costly but unnecessary policy measures. It could also be a pretext for cherry-picking to undertake those that had scant support among the citizenry but were desired by politicians or bureaucrats.

Most environmentalists hail the introduction of renewable energy sources citing claims that besides being “cleaner” & that they can contribute to economic growth & job creation. Such assertions tend to ignore economic realities associated with the impact of subsidies & the costs of using renewables.

One problem arises from blending erratic sources of electricity generation (e.g,, most renewables) with those conventional sources (e.g., fossil fuels) that can be continuously available.

A new study from the OECD Nuclear Energy Agency looks at the costs of introducing erratic renewables (like solar & wind) to an electrical grid system based on reliable sources of electricity (e.g., coal, gas & nuclear), aka, dispatchable technologies.

The study considers 6 technologies (nuclear, coal, gas, onshore wind, offshore wind & solar)where dispatchable technologies have system costs of less than $3 per MWh. System costs for renewables are up to $40 per MWh for onshore wind, $45 per MWh for offshore wind and $80 per MWh for solar.

Actual costs for renewables depend upon the country, technology & penetration levels such that system costs are higher when there is greater penetration of renewables.

For their part, erratic renewable sources tend to reduce revenues for the more reliable sources. As such, subsidies for renewables undermine the use of dispatchable technologies & make it unlikely for them to be replaced when they reach their end of life such that there may be less security of electricity supply.

Original & fruitful insights from my brilliant young friend, Adrian Ravier:

“Don Bellante & Roger W. Garrison (1988) compared 2 alternative approaches
to monetary dynamics: those based on a vertical long-run Phillips Curve & those
derived from analysis of Hayekian triangles. The conclusion the authors reached is
that the only factor differentiating the two models is the “process” whereby the
initial cause is converted into the final “neutral” effect. This article refutes that
conclusion. To do so it suffices to demonstrate that the long-term effect of
monetary policy is never neutral. While it is true that after the boom-bust cycle the
economy returns to the natural rate of unemployment, the crucial point is that the
‘natural rate’ at the end of the cycle is quite different from the one evident at the
start. This requires an ‘Austrian’ Phillips Curve with a positive slope.”