24 Aug 2008

Schiff versus the Establishment

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Peter Schiff is a very interesting guy. He has been basically spot-on for the last few years with his warnings about the US economy. Are you surprised to learn that many big gun finance gurus mocked him along the way? Below are three good examples:

(1) Schiff versus Arthur Laffer (8/28/06)

(2) Schiff versus Steve Forbes (June 2008, I believe)

(3) Schiff versus Bob Murphy (!?!)

Yes, I didn’t care for Schiff’s explanations on why trade deficits are bad. (I still think his analogies are a bit misleading.) However, in the grand scheme he was obviously right, and I should have realized it much sooner. I don’t claim to be omniscient folks, but when I make a mistake I admit it quickly and try not to repeat it.

24 Aug 2008

Is the Fed Inflating or Deflating?

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At first you would think this should be an easy question for economists to answer–much like asking a doctor, “Is the patient’s fever getting worse?” However, there is actually healthy disagreement on the point even within the narrow group of very-free-market economists. Hard money guys like Peter Schiff have been warning that the US dollar is dead as a doornail, while Gary North (pdf) has actually been warning of deflation for over a year. (Note on nomenclature: For North, “deflation” means a falling money supply, which should tend to lead to lower prices. But the price movements are not the definition of inflation/deflation for him.)

Part of the problem is that some things are zigging instead of zagging, and we economists don’t like change. As I explain in this piece, normally when the Fed cuts its target rate, this goes hand in hand with an increase in the money supply (however you want to define it). But since the credit crunch, the Fed has slashed interest rates even while the rate of growth in aggregates such as the base and M1 is very tame, by historical standards. Hence, some economists are aghast at the “easy money” Fed policy, while others are screaming that Bernanke is insane for putting on the brakes while the credit markets are frozen.

Below is a chart (reproduced from my article linked above) showing that the textbook relationship hasn’t held during the credit crunch. Note that by Feb 2008, total bank reserves had fallen more than $1 billion since the previous summer, even though the Fed had cut the target rate 225 bp by that time. That’s not how things used to work on the blackboard when I taught at Hillsdale College, I can tell you that!

As always, the explanation for all this is that in economics, its laws are only true when you hold “everything else equal.” In September 2007 and beyond, certain key interest rates (apparently) were falling on their own because of the new conditions. In that context, it’s hard to say whether the Fed was “contracting” or “expanding.” Part of the problem is that the very presence of the Fed distorts market behavior; it is impossible for the Fed to truly “follow the market” and “not intervene,” as some economists recommend. That’s like telling the Soviet planners to mimic what the market would have done.

We will return to these issues often in future posts. The lesson is that we need to be careful before applying rules of thumb that are inapplicable because conditions are different from previous downturns.

24 Aug 2008

Time Says Oil Prices Rigged

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In a piece that starts out harmlessly enough and then descends into absurdity, Time argues that oil producers themselves are probably buying futures contracts in order to fatten their earnings. You might think manipulating the world oil market would be risky and expensive, but you (apparently) would be wrong, according to these writers:

The point is, it would only take about $9 billion to control the entire long position in oil. That sounds like an enormous amount of money, but some of the major individual players in oil are bigger than the market itself: Sultan Hassanal Bolkiah Muizzaddin, of Brunei Shell Petroleum, is worth about $23 billion; Saudi Prince Alwaleed Bin Talal Alsaud is worth about $21 billion; Russian Vagit Alekperov of LUKoil is worth about $13 billion…

All an oil supplier would have to do to raise prices is buy up futures contracts.

It’s not even that risky. Either the suppliers/investors risk an insignificant fraction of their gargantuan fortune, or they entice other investors to share the risk. With virtually unlimited resources and an actual tie to the underlying commodity, oil suppliers are in a far better position to accomplish this manipulation than, say, the Hunt brothers were during their attempt to corner the silver market in the 1970s.

There are lots of holes in the overall piece, and I will dissect them in an upcoming issue of The Freeman. For now, those readers who are dying to know why speculation in the futures markets isn’t causing record oil prices, should refer to my report for IER, or the geekier discussion at EconLib.

24 Aug 2008

"Is My Bank Safe?"

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Robert Wenzel over at EconomicPolicyJournal gives us his thoughts on protecting yourself from bank runs.* On a related note, in years past my wife and I had used Emigrant Direct as a way to take money out of our checking account (where we might spend it) and get it earning interest but in a very accessible place. It paid much better rates than what our bank’s saving accounts offered, and it was all online.

Well, I’m not sure we want to continue using Emigrant Direct for our alternative savings account anymore, because its business is basically home loans, which (so I hear) isn’t the best bet at the moment. Anyone have any thoughts on ED (not to be confused with a disappointing condition)? ED’s accounts are FDIC insured, but still, if the point is to have a place to store your months’ worth of savings in case you get laid off, you don’t want the hassle of a bank closure.

* Did you know that bank runs are not a fact of life, but rather the result of government-sanctioned fractional reserve banking? Read Murray Rothbard’s The Case Against the Fed (free pdf) for the juicy details.

24 Aug 2008

Recession Does Not Mean Low Inflation!

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There is a myth that during an economic downturn, the one silver lining is that pressure is taken off prices and so inflation rates come down. This mentality oozes from the financial press, and even Ben Bernanke endorsed it Friday during the Group Think session in Jackson Hole, Wyoming. Even though the PPI just hit a 27-year high, the Chairman isn’t worried. From the above NYT article:

Mr. Bernanke, while acknowledging “an increase in inflationary pressure,” reasserted his view that in the near future, the upswing in inflation from the oil and food shocks was likely to moderate.

“The recent decline in commodity prices as well as the increased stability of the dollar has been encouraging,” he said. “If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.”

Now folks, I realize this is going to sound crazy at first, but Bernanke’s view is exactly backwards. Other things equal, if you tell me that economic growth is going to slow, then that tends to make prices go up, not down. What is the lay explanation for inflation? “Too much money chasing too few goods.” So during a recession, there are fewer physical units of products and services getting cranked out, while the number of dollar bills (and checking account balances, etc.) hasn’t dropped.

For a fuller analysis, see my previous LRC article on why central banks–the Fed in the US–are to blame for rising prices, not “robust economic growth.” (Incidentally, Ron Paul backed Bernanke into a corner one time, and got Big Ben to basically admit that an increase in real output actually tends to lower prices–because the same stock of money is chasing more goods. Unfortunately, I can’t remember enough about their exchange to find it for you.)

If I’ve got you wavering with my verbal arguments, click on the graph below, constructed with the Fed’s own data. It shows quite clearly that inflation often spikes during recessions.

23 Aug 2008

Basic Steps to Prepare for a Possible Crisis

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I am pessimistic about the U.S. economy‘s prospects for the next five years. So let’s go over some very basic and obvious steps every household should take, as quickly as possible. Note that the goals don’t have to be achieved overnight, but setting those goals should be done ASAP.

(By the way, I admit that what I am talking about in this post is nothing brilliant. But it’s like going to church every week to hear a sermon on what you ought to be doing. You know what you’re going to hear, but you need someone else to say it once in a while.)

OK so here are some basic steps every American household should take:

(1) Set up a monthly budget that has a long-range view. Make it very convenient for yourself, to be able to just change a few entries and then see how, say, saving an extra $100 per month, impacts your net worth in five years.

(2) Don’t pay off dollar-denominated debts, even credit cards. Rather, defer those as best you can, and use the freed up dollars to tackle steps (3) and (4).

(3) Figure out how many months you would need, in order to find a job that could pay the bills, assuming you lost your present source(s) of income. People throw around rules of thumb, but I think that’s ridiculous; individual circumstances are very different. For example, in my case I have bounced around quite a bit, and do most of my work on a laptop. So I figure I really only need about two months’ worth of regular income in terms of very liquid reserves. That’s because if something happened and I lost my major source of income right now (I’m a consultant so I don’t have “a job” to lose), we could go into austerity mode and make two months’ of normal income stretch out for three, and I am certain that I could at least partially restore my income flow within three months. Even if I were in a car accident, I could still work unless I died (in which case my life insurance would cover things).

Yet for somebody else, maybe someone who works at a factory but doesn’t have obvious alternatives if that factory should shut down, maybe that household ought to have six months’ of income in the bank. Also remember that if you lose your job because of a crisis, then a lot of other people will be looking for work too. So the question isn’t, “If I quit tomorrow, how long to find another comparable-paying job?” No, the question is, “If I get laid off tomorrow, how long…?”

(4) If you currently do not have the liquid funds that you figured out in step (3), then start working towards that amount. When doing so, consider acquiring actual gold coins as at least a portion of your liquid savings. Again, some might quote you formulas for what percentage of your reserves should be dollar-denominated, and what percentage should be in gold coins, but it will depend on the individual’s tastes. Some people might feel like Indiana Jones if they kept $15,000 in gold hidden around their house, and economics can’t say that preference is irrational. People spend lots of money on fancy sports cars too; there’s nothing wrong with spending your money in a way that pleases you. So by the same token, if it excites you to own gold–maybe you are a libertarian and think you are giving a nod to a time when the dollar was tied to gold–then go ahead and make a larger fraction of your liquid fund consist of gold coins. On the other hand, if gold seems really scary and volatile to you, then invest in government bonds to supplement your checking account. (In future posts at Free Advice, we will develop more formal analyses as to “smart” investments, but a lot will still ultimately depend on subjective tastes.)

One final thought on gold: Unless you have to deal with tax consequences (because you have an IRA etc.), I would recommend getting the actual physical gold, rather than gaining exposure to a gold ETF in your portfolio. In the type of scenario where you might really need to access those emergency, liquid funds, the government could quite easily declare a financial crisis and suspend withdrawals from commodity ETFs. So in such a calamity (after a terrorist attack, or if Israel starts bombing Iran suddenly), you would be in a much more secure position if you held the actual coins in your possession.

23 Aug 2008

The Unintended Consequences of Bailouts

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“Despite” the federal government’s recent assurances, Freddie Mac and Fannie Mae continue to struggle. From today’s Washington Post:

A major credit rating agency cut the preferred share rating on Fannie Mae (FNM.N) and Freddie Mac (FRE.N) amid mounting concern about the ability of the two largest U.S. home funding providers to access capital, in the latest blow before a widely expected government bailout.

Gee, why is this happening? Oh, maybe this guy can help us:

Early in the day, influential stock market investor Warren Buffett told CNBC there is a “reasonable chance” that Fannie Mae and Freddie Mac stock will get wiped out in a government rescue, reflecting market sentiment that has slammed the companies’ shares toward 20-year lows this week.

This is why government interventions in the economy never work as they “should.” At first it sounds odd that stock could get wiped out by a “rescue.” What’s happened is that the government was very austere in its handling of the Bear Stearns meltdown, so as not to set up a “moral hazard”–where investors become reckless because they think heads-I-win, tails-the-feds-bail-us-out.

Yet ironically, they now have the opposite problem. Now if there is a financial firm that’s on the ropes, the very presence of the government, waiting in the wings to “help” with a rescue that is very bad for regular shareholders, distorts the situation. People are less likely to pump in new capital, and so the fear of an austere bailout becomes a self-fulfilling prophecy.

Here’s a thought: Instead of trying to micromanage the financial markets, maybe the people in DC should have some humility. They don’t exactly have a good track record when it comes to financial discipline.

If the regulators would just stop interfering in the market, the morons on Wall Street would get weeded out and everybody could get back to work.

(For a related article, here I discuss the absurdity of restrictions on naked short selling.)

23 Aug 2008

The Importance of Tithing

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Folks, this is going to sound corny, as if I’m doing my gosh darnedest to sound like Gary North or Charley Reese. So be it: My wife and I are Christian and so we tithe, meaning we set aside 10% of our monthly income and give it to the Church. (This book gives an in-depth explanation of tithing’s Biblical origin, whether tithing on only after-tax income means you’re going to Hell, etc.)

I have noticed that without fail our monthly budgets are overflowing with money when we are tithing, and we are living paycheck to paycheck when we are not tithing. Really, I am quite confident that this statement accurately describes my household, and I bet it does yours, too.

The principle can work for secular people as well, but it doesn’t have the supernatural implications. Here, the idea is one important reason to form a budget and make long-term savings goals, is that it gives you discipline to get your finances under control. After all, you have to know how much you make each month, and how much you spend, in order to make long range forecasts. Finally, if you keep a meticulous budget like this, it will be painfully obvious to you what you are sacrificing by eating out every day, rather than brown-bagging it. Your budget shows you quite clearly that this is preventing you from taking a Vegas trip in x months. Really? Is Arby’s that much better than a deli sandwich you can make in your kitchen? Do you really need to hit Starbucks every morning?

Incidentally, this is a great illustration of my view that everything “supernatural” that God does in someone’s life, is also perfectly consistent with the laws of physics. So when you start tithing–and think, “Oh no, if things were tight before, how can I give up an additional 10% of my money off the top??”–all of a sudden your nets are overflowing with fish. And people think, “A miracle! The Lord kept His promise.”

But the atheist accountant could point out all the pragmatic and psychological reasons that the very decision to begin tithing, had on monthly inflow and outflow. Nothing magic here!

Right, and that’s how God controls everything. It’s not just miracles but also everyday life that He controls. It’s far more elegant that we can discover simple laws governing subatomic particles, and that this all yields the tremendous complex beauty of the macro world.

So if you are a believer and have been feeling guilty, start tithing. If I told you that a certain prayer would give you an extra 5% income per month, you’d say the prayer. Well I’m telling you that if you start tithing as you know you ought to, then you will get paid for it, literally.

Finally, if you are a skeptic: You understand that the above appeal didn’t really depend on belief in an omniscient Deity. So if you want to multiply your paycheck, adopt a long-term budget in Excel (or something comparable), so that you can really see how much your current behavior influences the trend of your standard of living. Now here’s the kicker: Go ahead and every month donate 10% to your favorite charity(ies). (Steve Landsburg argues it’s “rational” to concentrate your entire donation into one lump sum for the most important organization, but I disagree.)

I think that if you designate a truly altruistic use for 10% of your income, that somehow keeps you objective and you can more dispassionately assess your financial situation. It probably also makes it harder for you to just skip “doing the budget” for a few months because things are crazy at work, you caught the flu, your girlfriend dumped you, etc. But hey, if you’re just saving for your future retirement, then you’re not hurting anybody by spending recklessly in the present…

So if I’m right about that last observation, then that gives a good, secular explanation for why it’s not a burden but actually a blessing if people really think they have a duty to give 10% of their income to something much more important than their consumption.