 | | The Daily Reckoning | Saturday, September 3, 2011 |
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- The aftermath of political stupidity left in Irene's wake,
- More on what Hell or what Heaven, if any, do we men deserve?
- Plus, all this past weeks issues, neatly archived for your labor- less weekend reading...
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URGENT Crisis Alert: Where's the Bottom of this Market Correction?
Trillions in wealth has vanished from the stock market in the past month. Europe's on the brink of economic collapse. China's growth is slowing down.
Making matters worse, banks around the world scramble to avoid complete failure (again!) And the US public has finally stood up to years of reckless federal spending...
How do you beat it all? Watch this right now for the answer. Hurry — time is short.
|  | | | | A Lesson Worth Learning | | | |  | | Joel Bowman | Checking in from Buenos Aires, Argentina...
The lesson of Frederic Bastiat’s “That which is seen and that which is unseen” essay is so important that most modern economists have gone out of their way not to learn it. Chris Mayer, editor of Capital & Crisis, revisited this timeless piece of wisdom in the aftermath of Hurricane Irene...and the debris of political stupidity it left in its wake.
Your managing editor couldn’t explain it any better than the always- thoughtful Mr. Mayer...so we’re not even going to try. Here’s Chris’s essay, our feature column of the week.
[This week’s feature essay was originally published in The Daily Reckoning on Wednesday, August 31, 2001.]
| | | | | The Daily Reckoning Presents | | The Broken Window Fallacy | | |  | | Chris Mayer | So hurricane Irene is over with, but it didn’t take long for economic commentators to make fools of themselves.
David Kotok is the chairman and chief investment officer of Cumberland Advisors. He was on the radio with Larry Kudlow, who asked him about the economic impact of Irene. Kudlow noted how Irene tracked over 1/10th of the nation’s economic output. Here is Kotok writing about it to his investors afterward about Cumberland’s response:
“We are now upping our estimate of fourth-quarter GDP in the US economy. Billions will be spent on rebuilding and recovery. That will put some people back to work, at least temporarily. We speculate that Washington may set aside the usual destructive and divisive partisan political wrangling and act in the interest of the nation. That means there will be a flow of federal financial assistance to the disaster areas.”
This is horrible, horrible reasoning. It is the old broken window fallacy, which we see trotted out by otherwise intelligent people anytime there is a natural disaster. These people say that destruction is an economic boost, as we busily rebuild what was lost.
It’s a shame people continue to repeat this. The great economist Frederic Bastiat killed this idea decisively in an 1850 essay, “That Which Is Seen and That Which Is Unseen.” It remains a classic essay on economic reasoning.
In his usual witty manner, Bastiat wrote a parable about a boy who breaks a window. The “seen” is the glassmakers who have new business they didn’t have before. That’s what people like Kotok focus on. But as Bastiat wrote:
“It is not seen that as our shopkeeper has spent 6 francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his 6 francs in some way, which this accident has prevented.”
Kotok’s point about federal assistance is particularly depressing, because he seems unable to recognize that this is simply money taken from someone else.
Please don’t fall for the broken window fallacy. And please correct anyone you hear using it. It seems the first step in basic economic literacy. Hurricane Irene was a dead loss for the economy. Period.
By the way, Frederic Bastiat is an old favorite of mine and was influential in shaping my economic views early on. I have a handsome two-volume collection of his works, put out by the Ludwig von Mises Institute. I highly recommend the set for anyone looking for sound logic applied to economic questions. Bastiat is enjoyable to read and not like any economist you’ve ever read.
Our friends at Laissez Faire Books will take 20% off Political Economy — collected Bastiat essays — including “That Which Is Seen and That Which is Unseen.”
Claim your discount by going to this link.
For those not inclined to read that much, I recommend Henry Hazlitt’s Economics in One Lesson. Hazlitt devotes a whole chapter to the broken window fallacy. His book is my No. 1 recommendation for anyone looking to learn the key ideas of economics. It’s a classic.
Laissez Faire Books will give you 20% off when you go here.
Now, let’s turn our attention to the volatile stock market...
The market is rallying off its recent lows. This rebound is surprising if you focus on the bad economic news and the potential for another recession. But it’s not surprising if you look at stocks compared with what else you might do with your money.
A couple of weeks ago, I wrote about how “relative to Treasuries, stocks haven’t been this attractive in more than 30 years.” Shortly after the panic, lots of money came out of the market and went to Treasuries. It was a tidal wave of money, which pushed the short- term T-bill negative for a brief moment. But it would be irrational to stay there for long, given where stocks are.
James Bianco, of Bianco Research, added to that thesis in a report to clients. His chart shows price-earnings ratios for the last half- century, along with his projection of 2011 earnings. Take a look:
“Low rates benefit p/e (price-earnings ratios) more” than slowing economic growth hurts them, Bianco maintains. Based on the 10-year Treasury rate of 2.2%, he thinks fair value for the S&P 500 would be at least 14 times earnings. That’s 1,358 on the S&P, which would mean a 13.5% rise from here.
Of course, you could poke holes in this a few different ways. Interest rates could rise. And earnings could fall. So far, neither has happened. Corporate profits for the first half of the year have been strong, for example.
I find the above interesting, but I don’t really care all that much either way. In my investment letters, Capital & Crisis and Mayer’s Special Situations, I never recommend “buying the stock market.” I recommend buying specific stocks. Specific businesses. And I look to hold onto them and not trade them. I will use the market to add to or sell when prices suit me. But otherwise, I let the market do what it will do.
Still, it can be helpful sometimes to have a sense for the backdrop on the overall market. In the late 1990s, it helped to understand the market was frothy. By 2000, it made no sense at all, with even ho-hum companies like Coca-Cola commanding a price-earnings ratio of 50 times. It helped to know in the late 2000s that there was a housing bubble. It meant you skated around banks, real estate and housing stocks.
Today, though, there are no such extremes in the stock market as a whole. I think the market is in some gray middle area — neither cheap nor dear.
Regards,
Chris Mayer,
for The Daily Reckoning
Joel’s Note: It is exactly this kind of patient, rational, non- “modern economist” thinking that has led Chris to the kind of success he and his readers have enjoyed in both Capital & Crisis and Mayer’s Special Situations. His next investment alert is due out this coming Friday. Find out how to get yourself on his mailing list here.
| | | | | Who gives a damn about America’s credit rating? |
I’m SICK of hearing about Keynesian vs. Austrian, fiat currency vs. Gold, US credit ratings and other BORING economic theories you have ZERO control over.
“WHO CARES!?”
Truth is, if you want to make money in the markets, none of that stuff even matters!
Let me prove it to you by showing you.
| | | | | | ALSO THIS WEEK in The Daily Reckoning... | | | 33,500 Reasons to Like Aircraft Suppliers
By Chris Mayer
Gaithersburg, Maryland
You know how high oil prices tend to create boomlets in certain businesses? Alternative energy, small car manufacturers and the like get a boost. Aircraft suppliers may also see a boost. Fuel is the largest expense for the airline industry — at 30% of operating costs. And the airline industry faces pressures to cut costs. Recently, the Air Transport Association forecast that the airline industry would make $4 billion this year, down 78% from last year. So there is pressure (again) to cut costs.
2008, Redux
By Byron King
Pittsburgh, Pennsylvania
Who says there’s no such thing as time travel? It’s starting to feel like the fall of 2008 all over again. Indeed, the demons of 2008 are like those characters you see in the Halloween horror movies. You can kill and bury the monsters, but a few scenes later, they reappear.
The “Good Fed” and Other Fairy Tales
By Eric Fry
Laguna Beach, California
“World stock markets rallied on Wednesday,” the Associated Press explains, “as investors hoped that the Federal Reserve would respond to mounting signs of weakness in the global economy by providing more stimulus to the US economy.” In other words, the worse the outlook for the economy, the brighter the prospects for the stock market.
Political Promises and Wall Street Tripe
A WBAL Interview with Addison Wiggin
“They [Daily Reckoners] have experience with the real world, so they’re looking for ways to manage their own money primarily, but they’re skeptical of political promises and even the kind of tripe that we get from Wall Street from time-to-time.”
| | | The “Lost” Gold Bible Congress Never Wanted Anyone To See |
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| | | | The Weekly Endnote... | Today’s reader mail is a little longer than usual...but so is your weekend, so stop complaining. This delightful musing comes from reckoner “Bill D.” We’re not sure if Mr. D. wishes his name to be shared or not, so we’ll err on the side of caution. All the same, a fantastic essay awaits. Please enjoy...
Thanks for some very interesting articles on economics and gold. First, I’ll address the issue raised by your question “What Hell or what Heaven, if any, do we men deserve?” The issue is not what we men deserve, it’s what basic economics dictates we will get. So what does basic economics dictate?
IF we continue down the present fraudulent money creation road, a return of another dark age is inevitable. Sounds really radical huh? Let’s examine a little basic economics and history and see if such a conclusion is justifiable.
When money is created without a corresponding increase in commodities, prices rise. This is because prices in the long run are determined by the ratio of the quantity of money to the quantity of commodities. This is usually expressed in such ratios as dollars per pound of potatoes. For example when the quantity of money increases but the quantity of potatoes is kept the same, it will take more dollars to buy a pound of potatoes. This is known as the quantity theory of money, which is explained in detail in Ludwig von Mises book “The Theory of Money and Credit.” As Professor Mises explains, other factors, such as the subjective theory of value, also affect prices on a short term basis, but long term, the quantity theory holds. Next let’s apply this well known relationship between money and commodities to present day monetary policies.
The Federal Reserve System (FED) has been creating fraudulent money ever since it went into operation in 1914. Between 1914 and 1920, wholesale prices increased 126.7% (see “Economics And The Public Welfare” by Dr. Benjamin McAlester Anderson, economist for the Chase National Bank from 1920 to 1939). Why? Because the quantity of money in circulation increased faster than the quantity of commodities. Of course the destruction of commodities during WWI didn’t help.
The “roaring twenties” were fueled by FED created money and it didn’t end with the 1929 crash. Here are statements made during hearings of the House Committee on Banking and Currency, September 30, 1941. Eccles was Chairman of the Federal Reserve Board at the time of these hearings.
Congressman Patman: “How did you get the money to buy those two billion dollars worth of Government securities in 1933?
Governor Eccles: “Out of the right to issue credit money.”
Patman: “And there is nothing behind it, is there, except our Government’s credit?”
Eccles: “That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.”
Of course fraudulent money creation by the FED continued during WWII and has never stopped. The focus of attention seems to be on money creation to fund government debt, but this is only the tip of the iceberg. The money created by the banks to fund private, public and business debt is purchasing power that drives prices higher. When banks approve a loan, the debt created is used to purchase things and is therefore a demand on commodities, domestic and foreign. Thus Eccles was absolutely correct, debt is our money system and when it’s included in the money supply the numbers make $9 trillion look like penny ante.
Since creation of the FED on December 23, 1913, enormous amounts of this fraudulent money has been created, large sums of which are being held by foreigners. For example foreigners hold more than $8 trillion due to the trade deficit alone. This does not include foreign aid to 158 out of 192 countries in the world, or bank loans to third world countries, or dollars (or claims to dollars) loaned to foreign countries through the IMF. The IMF has estimated that there are close to $200 trillion in derivatives held by banks and investment firms — where did that money come from? There is only one entity in the United States that can legally counterfeit money, it’s called the Federal Reserve System.
When new money is created which is not backed commodities, it drives prices up as described above. The next time the FED, or politicians, want to “stimulate” the economy, they must pay the higher prices caused by the previous money creation. This process continues until such enormous amounts of money are being created, and its purchasing power is dropping so fast, that no one will accept it in exchange for commodities any more. IF that happens, the U.S. will return to the barter system. Now can you even imagine what this country will be like on a barter system?
This is not some phantasy tale, it’s exactly what happened to France between 1789 and 1796 and to Austria and Germany in 1922 and 23. From a basic economics viewpoint it’s also what happened to Rome, except they didn’t do it with printing presses and paper money. They did it by alloying cooper with the silver denarius until it lost 98% of its purchasing power and Emperor Diocletion (284-305 A.D.) was minting 300-pound bags of copper coins.
In one month, the month of November, 1923, German printing presses churned out 397quintillion 833 quadrillion marks in the process of “furnishing credit.” (A quintillion is a 1 with 18 zeros behind it) In the closing months of 1923, Germany reverted to a barter economy.
But neither France, Austria nor Germany collapsed into a dark age like Rome. Why? Because they were isolated cases and there were other countries surrounding them with whom they could trade and dig themselves out of a hole. In his book “When Money Dies”, Adam Fergusson gives this account of the salvation of Austria in 1922:
“Refusing to await supinely the approach of ruin, Dr. Seipel at last resolved to trade part of his country’s independence in return for its survival at all. 'Now was seen’ said one commentator, 'the hitherto unparalleled spectacle of an Austrian Chancellor touring Europe offering his country to the highest bidder.’”
But Rome was an empire and the coin of the realm was the denarious. When Rome fell the Empire fell and there was no one to bail out Rome. Here’s a few quotes that illustrate the dire conditions that brought Rome to its knees.
From “Caesar and Christ”, a history of Rome by historian Will Durant:
“As the state had not yet discovered the plan of public borrowing to conceal its wastefulness and postpone its reckoning, the cost of each year’s operations had to be met from each year’s revenue. To avoid returns in depreciating currencies, Diocletion directed that, where possible, taxes should be collected in kind: taxpayers were required to transport their tax quotas to governmental warehouses, and a laborious organization was built up to get the goods thence to their final destination. ... Since every taxpayer sought to evade taxes, the state organized a special force of revenue police to examine every man’s property and income; torture was used upon wives, children, and slaves to make them reveal the hidden wealth or earnings of the household; and severe penalties were enacted for evasion.”
From “Legacy of Freedom” by George Charles Roche III, former President of Hillsdale College:
“... the receivers of taxes began to be more in number than the payers, so that by reason of consumption of husbandmen’s goods and by the excess of land taxes, the farms were left waste until the lands turned into forest ...
“... when by various evil deeds he (Diocletion) caused a prodigious scarcity, he essayed by law to fix the prices of goods in the market. Then much blood was shed for trifling in faulty wares, and through fear nothing appeared in the market ...” This last quote is from an eyewitness account by Lactantius, a teacher of rhetoric appointed by Diocletion.
When government consumes most of the people’s production and they stop producing, there’s nothing to support government and it collapses into anarchy and eventually a dark age. This is exactly what happened to Rome and we are following in Rome’s footsteps. IF we continue, the result will be the same because we are also an empire and there will be no one big enough to bail us out. Furthermore, the rest of the world will be in essentially the same condition.
This will raise a question of timing — how long will it take for this to happen? I don’t profess to know, but I would be astounded if it takes more than 30 more years. The economy is in much worse shape than most seem to realize.
Isn’t China the bright star of the future? Absolutely not! China is still a Communist country and communism is simply an advanced stage of socialism. Anyone who has read Professor Mises’ book “Socialism” knows that it is an inherently self-destructive system that can not survive.
Yes, it’s presently putting on quite a show to distract the world from the underlying rot, but it will fail. Socialism consumes wealth, it does not produce it. It should be remembered that Russia put on a similar show in the late 20s and early 30s while six million people were starving to death. As Mises proved in his book, calculation is impossible under pure socialism and if you can’t calculate, you can’t plan. If you can’t plan, natural resources are distributed by official edicts, which consume more than they produce. Obviously, consuming more than is produced will destroy the economy of a country; we don’t have to visit China to find that out, we can watch it happening at home.
Regards,
Bill D. ---
As always, we welcome your thoughts. If you’ve got a few spare minutes this weekend, feel free to email them to the address below and...
..enjoy your holiday break.
Cheers,
Joel Bowman
Managing Editor The Daily Reckoning
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Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com
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