Tuesday, January 25, 2011

Where Economics Goes Horribly Wrong- The Psychology of Depressions.

We are in a Depression.

Forget about the statistical term “recession” because that term is completely meaningless. The Powers that be are rallying around the published data that says Nominal GDP is rising, yet no one is considering that nominal GDP MUST RISE when the currency creation machine is cranking along at full output.

In August 2010, I wrote an essay for rickackerman.com that challenged the use of the terms “inflation” and “deflation” in the context of a macro-economic cause and affect analysis:

In today’s essay, I’m going to go one further. Today I’m travelling way out onto the thinnest of limbs as I try to convince readers that there is no reason for the inflation versus deflation debate at all; because inflation and deflation are the by-products of the EXACT SAME phenomenon when you strip away all the statistics, and look at the bare psychological core that forms the basis of human economics.

Anyone who watched Ben Bernanke’s “60 Minutes” interview on Dec 5th knows that The Fed is more concerned publicly  about deflation (the Fed’s preferred term for generally falling price levels) than they are about inflation (rising price levels), but it is my studied opinion that the Fed (and most other people for that matter) have it all wrong.  Almost everyone believes that market activity, and therefore inflation and deflation, all pivot on price levels; a very dangerous premise, as I hope you’ll see as we move forward through this analysis.

Everyone sees the inflation/deflation dynamic as a big teeter-totter, with prices acting as a fulcrum, while “more money and lower interest rates” sits on one seat, and “less money and higher rates” sits on the other seat. As the price pivot point shifts toward one end, the Fed shifts its policies to favor the other end, and this is supposedly how the Fed maintains “balance” in the system.

I contend that the Fed’s Teeter Totter model has a major, and potentially catastrophic design flaw, and I’m going to cite some very specific examples (both historical and current) that should demonstrate that the teeter-totter’s back and forth action is dependent on something far more delicate (and far less understood) than general price levels.

Teeter Totters do not shift directions without the force of gravity, and for the purpose of this discussion, we can assume that gravity is a universal physical constant (as mass increases, the force of the gravity by that mass upon other massive objects also increases).

To their credit, the Fed’s “money supply to price” balancing model is a little bit more complex than that. The Fed does not use a constant for the gravity proxy. The Fed’s model allows the downward force applied to their Teeter Totter’s seats (economic sentiment indicators) to vary over time, but they temper this variability by mandating that the rate of change be constant (they use monthly sentiment metrics). This is where their model has the potential to break down. The reason I say this is that rising prices do not necessarily inspire less spending, and falling prices do not necessarily inspire more spending; and neither of these actions can be used to forecast or correlate shifting sentiments at all; therefore the force applied to the alternate sides of the Teeter-Totter is never a constant to the mass of the money supply factor(s) sitting in either seat.

Ok, we should pause for a moment here, because the statement “that rising prices do not necessarily inspire less spending, and falling prices do not necessarily inspire more spending” probably needs more elaboration, because I’m sure it failed to pass through the common sense filter of most readers.

Naturally, everyone is more inspired to purchase when prices are lower, right? Well, it’s not really that easy. True, people are more inspired to spend when prices are low and liquidity (available capital/money) is high, but there is a relatively unknown (yet well documented by history) breakdown point where monetary saturation fails to inspire further spending, at which point supplies start to rise, and prices start to fall; and yet somehow these factors are unsuccessful in re-starting the spending engine.

Sounds kind of like the real estate crunch that kicked off in 2007, right? Well, it also correlates to the sentiment breakdown that occurred as the roaring 20’s came to a screeching halt and the economic declines of the 1930’s took charge of the common psyche . To use the current housing collapse as an example- we have reached a point where people are simply not inspired to move into another house, regardless of how cheap the process of buying houses has become.

Likewise, there are economic conditions where prices are rising,spending is falling, and thus money supply and interest rates are loosened up via policy, and yet the spending party still never gets back in gear- until suddenly, items begin leaving store shelves again, and policy makers, confusing this activity with economic growth, fail to shut down the money spigot, until eventually items begin leaving shelves at alarming rates. Then panic ensues, and spending goes parabolic (as if the gravity on the “less money, higher rates” side of the Teeter Totter suddenly develops into a black hole, forcing more and more “policy” to be thrown on the “more money, lower rates” seat. History is replete with examples of such events (Weimar, Zimbabwe, etc)- and for those who insist “it could never happen in the US”, I’ll remind you of the Continental currency of the Revolutionary War, and of the Lincoln Greenback during the Civil War- both of which died horrific hyper-inflated deaths.

So, using this inflation/deflation Teeter-Totter and the nebulous, unquantifiable gravity-proxy that is economic sentiment, we can address the central premise of my thesis that inflation and deflation are simply mirror image definitions of the same dynamic:

That premise is simply that money does not really buy things. Everything you think you know about using currency to purchase items in trade is an illusion. I use the term illusion because, once again, sentiment (the desire to purchase) is unquantifiable in absolute terms.

Simply put, people do not work for money. When you peel off all the statistical layers of the economic onion, you are left with a very simple, and rather elegant concept: People work for only two reasons:

1)      To appropriate those things they need to ensure survival and longevity.
2)      To appropriate those things which they desire to own.

Simple, right?  Number 1 relates to living (something we all must, and want to do), and number 2 relates to “standard of living”; That is, the level of arbitrary societal convention that seemingly elevates the importance of one person’s existence above others.

Standard of living is only a manifest of reason number 2 above.  Therefore, the desire for money (whether it be for capital gain, or the extinguishment of debt), falls exclusively and 100% into category number 2. While there is no question or argument that monetary currency, serving as a medium of exchange, definitely “lubricates” the process described in number 1, it certainly does not mandate it.

You might have to think through my reasoning a couple of times before this concept sinks in, but remember that I do not distinguish between “ownership for purpose of use” (like cars and wrist watches) versus “ownership for purpose of embellishment” (like Ferrari’s and Rolex’s); nor do I distinguish “ownership for purpose of non-essential consumption” (like tobacco or alcohol) or “ownership for purpose of enhanced efficiency” (like tractors and conveyor belts): all these things fall into category number 2 when you reduce them to their lowest common denominator- the desire to “own”.

Try to keep your focus on the simple fact that labor can nearly always be traded directly for food, shelter, and clothing, and that even during periods when one of these three are in scarce supply, there is nearly always the probability that more work will successfully secure the requirement. In the context of number 1 above, money is always and forever a proxy for work (a store of value, or a vehicle to secure future access to required supplies, to employ a couple commonly used definitions). Just as many of you may have learned in Econ101, money is not a mandatory component of the most basic trade based economic system.

So, it’s time to zero back in on the controversial premise of this discussion: Inflation and Deflation are mirror images of the same dynamic. Simply put, both phenomena are triggered at the moment in time that the unquantifiable factor (sentiment) begins to shift from being relatively stable (exerting equal force on both seats of the teeter totter) to being horrifically unstable (wildly shifting from side to side, with highly variable intensity).

Whether this shifting sentiment finally manifests itself as a reduced willingness to use currency as a proxy for work in exchange for real goods (deflation), or a decreased willingness to accept currency as a proxy for real goods in exchange for work (inflation), the basis of either outcome is still rooted in the underlying common psychology moreso than in statistical economics…

We all spend too much time debating about how the event will manifest itself, instead of focusing our collective energies on how to stabilize the rapidly shifting collective force that has lost its sense of harmony and balance, because when this force decides which side of the teeter totter it’s going to zero in on, the result isn’t going to be good for anyone sitting in either seat.

Gravity (sentiment) is shifting wildly, frequently, and seemingly uncontrollably. When the psychological aspects of an economy become destabilized, the more accurate term for the sensation is Depression (a psychological term) as opposed to Recession (a statistical term)…

We are in a Depression.

Sunday, January 9, 2011

Why The Precious Metals Market Manipulation Argument is Moot.

January 4, 2011 saw a marked decline in the spot prices of Gold and Silver, and naturally, this event inflamed the ongoing debate about collusion and manipulation in the precious metals markets which allegedly undermine the natural price discovery mechanism of these markets.
Now, I have immense respect for Ted Butler, Harvey Organ, Bill Murphy and GATA, and all the other metals market analysts out there who have dedicated themselves to exposing the seemingly malicious price suppression activities that have been a frequent hallmark of Precious Metals market trading patterns for a decade or more. I'm not going to debate the conclusions of any of these analysts, because I agree in principle with the logical and statistical conclusions of their premises), but I am going to (respectfully) challenge the common opinion regarding the underlying intention of these practices.
We've all read about Robert Rubin's "strong dollar" policy that, when viewed with increasing scrutiny, seemed more designed to strengthen the dollar against Gold as opposed to strengthening it against the competitive basket of foreign currencies that comprise the dollar index; and we've all read about the "8 or less" Bullion traders on the weekly Commitment of Traders and Bank Participation reports that are short a collective 3+ Billion ounces of silver (which represents an amount greater than all verified or perceived above ground silver supplies in existence).
The common theme is that the "Powers that Be", aka the "Gold Cartel" frequently, as they did on Jan 4, sell a pre-orchestrated, nearly infinite amount of paper futures contracts into the London and New York Bullion exchanges, with the intention of driving weak long holders into fleeing in fear, so that the Big traders can then proceed to vacuum up these dumped long positions to buy their shorts back at lower prices.
The argument that this practice is collusive, manipulative, fraudulent, and probably illegal is almost certainly valid, seeing as how General Motors is not allowed to sell millions of promises to deliver new Mustangs at prices below MSPRP to willing buyers with the intention that Ford (who manufactures the Mustang) would then have to lower the MSRP by a corresponding amount in order to remain competitive.
The second that General Motors started buying these lower priced Mustangs directly from Ford to deliver to the people who bought GM's forward sold promises, GM would be busted cold for price fixing and antitrust violations.
In essence (and ethics), the practices are identically fraudulent; but since Gold and Silver are not clearly defined as money in commerce case law history (case law treats gold and Silver as commodities, not money), it likely won't be until someone manages to get a case in front of the US Supreme court arguing that what the Bullion Banks do is in violation of the 10th Amendment, that any legal mechanism to stem these practices will come into being. (Perhaps all these recent civil antitrust lawsuits against HSBC and JPMorgan will be the first step in the process of forcing the Supreme Court to legitimize the 10th Amendment within the context of legal tender case law). 
Yes Virginia, The precious metals market is rigged, manipulated, and centrally planned, but not necessarily for the reasons you may think.
So, why do the government regulators look the other way and allow the "Big 8" to seemingly get away with what they are doing?
The answer may not lie in the statistics that underpin technical and fundamental market analysis. Statistics only represents half of economics- the real answer may lie in psychology- the unquantifiable inverse side of the economic behavior coin.
My studied opinion is that the Politicians and Central Bankers may be capitulating to Gold and Silver's perceived superiority as money, but they are doing it in a way that will ensure that the metal's ascent does not evolve into a price driven panic (as it did in 1979-1980). Rather, they are attempting to manage the monetary ascent of the metals so that the public abandonment of fiat paper can be orderly and (relatively) calm, as opposed to chaotic and unruly, as Jim Rickards (another analyst whose point of view I hold in the highest regard) has pointed out in a CNBC interview and a series of articles back in September 2010.
It is not the intention of the big Bullion Traders and their government and Central Banking money printing backers to prevent the price of the metals from rising, nor is it to prevent or discourage the world's population from fleeing fiat currency en masse into Precious Metals.
The real reason Gold and Silver are experiencing these sudden sharp price corrections, I believe, is simply to prevent a societal monetary panic. Think about it for a minute: The market makers in Gold and Silver have tripped off these rapid, waterfall declines in gold and Silver numerous times per year for the past 8 years, and every time they do, the end result is that more open interest gets generated on the exchanges, more physical bullion is taken off the exchanges in good delivery form, and the price ends up recovering and rising to yet newer highs. As a method of driving the market down and “chasing people out”, they are failing in the most spectacular way. However- as a practice of influencing the rate of price ascent, they are demonstrating a degree of success that suggests that the practice could continue in the interest of preventing a riotous rush into the bullion markets by a panicked public that loses control of their collective fear of being left behind.
Could these huge Bullion Bank shorts and their Central Bank paper-backers really be so stupid as to think every time they play this little smack down charade that they will thrust the metals into a bear market? Are they really thinking "This time it will work, and the world will finally understand that our paper is a superior form of wealth"? Seriously, are they that dumb?
Look, Ben Bernanke is not an idiot. Neither is Jean Claude Trichet, and neither is Zhou Xiaochuan. These guys know that money is not what THEY say it is; money is what the population of Earth tells THEM it is... 
The only other data I have to support my contention is the fact that these frequent price smack downs by the big bullion shorts are not making them any profits- at least, they are not making them any profits that are not offset by even bigger losses that are stretched out over a longer time horizon; but this fact may be all that is necessary. I mean, any of us faced with having to pay an ungodly sum of money immediately in cash, as opposed to stretching it out on a payment plan would certainly prefer the latter option, yes? Everyone with an inkling of knowledge of the Bullion markets (Jeffrey Christian included) knows that the Bullion Banks can't settle their current commitments with good delivery grade bullion, so their tactics are intended to make the payments that they can afford to make today, and keep the "collections agencies" (aka the longs who are standing for delivery) at bay as long as they can while they scrounge up the money/gold to make next month's payment.
The necessary consequence of this is a slow, deliberate long term rise in the price as opposed to a sudden, parabolic move that would certainly incite a very different public reaction to the re-monetizing of the metals. The story of the tortoise and the hare teaches us that slow and steady wins the race; but slow and steady also tends to make the race less exciting- precisely the way that "The powers that be" would like this particular race to be run.
With all due respect to GATA, Richard Russell, Ted Butler et al: From the standpoint of human nature (and the standpoint of peaceful co-existence), isn't it preferable for paper currencies to die a slow, lingering death alone in a hospital bed, as opposed to dying a sudden, violent, train wreck of a death fraught with unimaginable collateral damage to society, manifest as hyperinflationary riots, wars, and the invalidation of decades of work toward peaceful global relations...?
They say "seek the truth and the truth shall set you free." Well, if the truth is that gold makes better money than the debt based "full faith and credit" of corrupt governments, then it should also stand to reason that the real Utopia we should all aspire for is a world where money simply "exists" and is not "issued", while price discovery is a function of markets, centralized governments are non-intrusive (if not obsolete), and people maintain peaceful relations via the process of fair and friendly commerce.
I know, I know... Utopia is fantasy; but the scenario mentioned above is far more preferable to me than a world of arbitrary borders and the wars that they stimulate, and I don't believe that I am the only one in this camp. It is far more honorable to fight for a cause that is just than it is to fight for a cause born out of territoriality, bigotry, hatred, greed, or fear.
I actually wonder whether the process for re-instating a currency system devoid of government fiat has actually been underway since Alan Greenspan took over the reins at the Fed? I'm sure that such a controversial point of view will not go by unchallenged, but let's consider a few points:
1) It was Greenspan who wrote in 1966 of gold as the protector of the masses from the insidious process of government sponsored wealth confiscation through inflation.
2) It has been widely rumored (although still factually unsubstantiated to the best of my knowledge) that Greenspan was the creative force behind the Fed's "Roota" comic books. (Please go read the story of Roota if you haven't already- it is a trip down Alice's Rabbit Hole, and you will have to force yourself to remember that it is the US Federal Reserve that published the work.)
3) Most notably- it was Greenspan who created more dollar currency during his tenure than every Fed Chairman prior to him in aggregate.
Think about that last point. Greenspan has been vilified by hard-money supporters as a "turncoat" to his own 1966 thesis, but it is also possible that he was the ultimate contrarian- That old cat printed fait money every time he was presented with ANY reason to do so.
 Whether Greenspan's policy of debasement was intentional and deliberately opposite to his 1966 philosophy, or whether it was coincidentally opposite, will probably never be known, but in spite of that, his actions may end up being regarded by history as the lesson that taught humanity that truth is rarely what “government officials” say it is, and if this history actually comes to pass, I will not be afraid to applaud Mr. Greenspan for his efforts, regardless of what his actual intentions were.