Thursday, July 14, 2016

How long can low rates last?

The charging of interest on loans is one of the most hated and worst understood concepts in human history. Aristotle claimed that money cannot beget money because it is dead, so charging interest on loans is immoral. Moses’ law forbid Israelis to charge interest on loans to the poor, but the Church interpreted that prohibition according to Aristotle’s economics and made charging interest on loans one of the worst sins that Christians can commit. Aristotle’s writings had almost equal weight with the Bible in many matters until Copernicus and Galileo trashed his astronomy.

But kings, nobility and popes needed to borrow money occasionally in order to keep up their conspicuous consumption, so Jews were allowed to commit the sin of usury. That gave Christians an excuse to persecute them regularly.

The church didn’t reform its economics until the 17th century when theologians from the University of Salamanca abandoned Aristotle for common sense. A letter from John Calvin to a friend on the topic may have helped. Calvin wrote that interest on loans was no different from charging rent on land, which everyone could understand.

Recently, an investing newsletter increased the confusion over interest rates for its readers. It claimed that interest rates have fallen naturally from roughly 50% in 5000 BC. “Fast-forward a bit and we see the Greeks expanded the credit system. In 600 B.C., they paid rates of around 16% in a quickly modernizing monetary system. By 100 B.C., though, a typical loan came with a rate of just 8%. And then things got interesting...”

Wednesday, July 6, 2016

The Damage that NIRP does

Bloomberg carried a story a few weeks ago on Denmark, which has been “blessed” with a negative interest rate policy (NIRP) longer than any other developed nation. The authors asserted that the horror stories about low interest rates with which economists have typically frightened us for decades haven’t come true in the Scandinavian country, so economics must be wrong.

Of course, the Bloomberg journalists have forgotten the primary caveat of economic reasoning – ceteris paribus, or all other things being equal. The horror of money printing, such as the disaster that nearly destroyed Germany in the early 1920s, caused hyperinflation and a plummeting exchange rate. Those haven’t afflicted Denmark, or any other major country, yet, because everything hasn’t remained ceteris or paribus.

When every nation reduces rates in concert, it has no impact on exchange rates. And it may not cause much inflation. The idea that it must cause price inflation or economics is wrong comes from a blockheaded view of the quantity theory of money. Again, ceteris paribus applies. Printing money (or technically credit expansion via low interest rates) will cause price inflation if nothing else in the economy changes. But money printing doesn’t work mechanically. Japan should know. The Bank of Japan has desperately tried to create inflation through money printing for the past 30 years.

Wednesday, June 29, 2016

Brexit! The UK's independence day!

Last week the Brits voted for independence from the European Union. Maybe now they better grasp why we colonists divorced King George over 200 years ago.

The Adam Smith Institute has the best pieces on Brexit here and here and with the video Brexit: The Movie.

I had hoped to avoid writing about the British exit from the European Union because I never saw it as an important event, but the hysteria drummed up by the media has made it difficult for me to keep silent. So here are my two bits.

First, why the hysteria? There are two reasons for it. One is that the media have but one purpose and that is to create hysteria. Fear keeps people tuned in and more people paying attention means greater advertising revenues. The great newspaper editor Mencken once wrote, “The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by an endless series of hobgoblins, most of them imaginary.” Because he was in the business, he blinded himself to the fact that the media is an accomplice of politicians in crime.

Wednesday, June 22, 2016

Sector rotation confirms ABCT

Mark Skousen in his excellent economics text, The Structure of Production, shows that professions on the front line such as accountants and investing experts, follow the Austrian business-cycle theory (ABCT) often without know it. Schwab confirmed that in March of this year with a chart titled “The Business Cycle: How Does Each Sector Perform.

The chart divides the business cycle into four segments – early expansion, maturing expansion, late expansion and recession – and shows which sectors perform the best in each segment of the cycle. I do something similar in Financial Bull Riding but use segments of the cycle described by Lord Overton in the mid-1800s.

Wednesday, June 15, 2016

How not to predict the stock market

Investing expert Bert Dohmen said that “Looking at earnings, dividends and P/E ratios in order to predict future stock prices are all a waste of time” in a recent Forecasts & Strategies email issued by the economist Mark Skousen. The email continued:
Dohmen explained, “If a P/E were meaningful for predicting future price performance, why is a stock like Facebook selling at a lofty P/E of around 90, and Amazon with a P/E of 300, both still highly recommended and rising, while other stocks, like Apple, with a low P/E of around 10, [are] declining and down 35%?”

He added, “Analysts tell us that ‘earnings’ are the most important thing affecting stock prices. Really?! Well, corporate earnings in 2015-2016 have had the largest decline since the crisis in 2009, but the DJI and the S&P 500 are within about 1% of making new record highs.”

Then Dohmen asked the all-important question, “So what is the major determinant of stock market trends?”

Of course, the answer is “future earnings.” Stock prices are always based on the forward-looking views of investors. That’s why high-priced stocks such as Facebook are selling for 90 times earnings. It also explains why Amazon is selling for 300 times earnings and Tesla is selling for $230 a share even though it has no earnings! Investors are upbeat about their future. Meanwhile, Apple is selling for only 10 times earnings because it’s not viewed as a growth stock anymore.

Tuesday, June 7, 2016

How D-Day teaches economics

June 6, 1945, Allied forces invaded the Nazi fortress of Europe. Not everyone cheered. General Douglass MacArthur said of the invasion that he would court martial the SOB who had planned it. Of course, he knew well the planner. He had worked as MacArthur’s aid for several years: General Dwight Eisenhower. The mass slaughter of Allied troops in the invasion horrified MacArthur. His philosophy had been to land where the enemy wasn’t and then attack. In dozens of amphibious landings MacArthur lost fewer men than the Allies lost at Anzio alone. Churchill had lobbied for the main landing in the south of France where the German presence was much thinner. Instead, Eisenhower and the Allied command chose to jump right into the the teeth of German troops in Western Europe.

The D-Day invasion succeeded in spite of being a very poor military strategy. But why? The Germans held a significant advantage and were very confident. The answer lies mostly in the field of organizational behavior, specifically, the issue of centralized versus decentralized decision making. In organizational theory, the larger and more complex the situation, the more decentralized decision making must become. Centralized decision making works best with routine and simple operations.

Thursday, June 2, 2016

Fundamentalist investing scores big gains

Last week I wrote about fundamentalism and I want to carry on with that theme this week. I’m late to the party. Research Affiliates launched their fundamental indexes over ten years ago, but I only recently read The Fundamental Index: A Better Way to Invest by Robert Arnott, Jason Hsu and John West.

The authors promote index investing because of the evidence of the failure of most active managers to match the percentage returns of indexes such as the S&P 500. For most part time investors, indexes are the best choice. Even Warren Buffet enlisted an index fund to sustain his wife’s wealth after he moves on.