How Christmas saved the world from starvation

The world was flat until 1600. Not the shape of the planet. According to the best economic history, standards of living even in 1800 AD hardly differed from those of 5000 BC. TV shows dealing with the ancient past assume a gradual slope of progress and portray Egyptians or Abraham and Sarah as if they were primitive South American tribes still stuck in hunting and gathering mode.

But if economic historians are correct, Egyptians in 3000 BC lived as well as the eighteenth century French. Famine and mass starvation were common. Nobel-Prize winner Robert Fogel wrote in Escape from Hunger and Premature Death that in eighteenth century France 20% of the people could get only enough calories each day to fuel a short walk to the spot where they begged.

Of course, some ancient capitals did better than others by looting conquered nations but per capita wealth never increased; it just sloshed from one conqueror to the next. Rome enjoyed wealth and splendor because it had stolen stuff from defeated nations.

Stop dancing to the Fed's fiddle

For the first time in almost a decade the market shrugged off a significant move by the Fed when it increased its rate by 0.25%. Of course, the market had anticipated the increase for a year and so priced it in earlier. And euphoria over the president elect trumped Fed policy. This is a good time to reassess the logic of dancing to the Fed’s fiddle.

Mainstream economists used to dance to the tune of Keynes and fiscal policy until the disaster of stagflation in the 1970s. Fiscal policy, they cried, suffered from too many lags to be effective, as if the lags were the only reason it couldn’t be effective. There were no problems with lags during the 1930s under FDR and it still wasn’t effective.

Fickle as teenage groupies, mainstream economists switched their adoration to the Fed. The Fed could save us all when Uncle Sam failed. Adulation for the Fed climaxed with the financial media’s crowning of Fed chairman Alan Greenspan as the “Maestro” who could orchestrate the economy as he wished with a wave of his wand.

Then housing landed on the economy and caused the Great Recession (GR). Ben Bernanke waved his wand but the economy wouldn’t perform. It couldn’t get out from under the house. Eight years later, confidence in the Fed has evaporated and mainstream groupies are bailing out on the Fed and returning to their first love, fiscal policy.

Investors to get slapped by the invisible hand

The great American economist Benjamin Anderson wrote Economics and the Public Welfare: A Financial and Economic History of the United State, 1914 – 1946. Most mainstream economists get the history of that period, especially the Great Depression, wrong. If you want to know what really happened and why, read Anderson's book. In a chapter on the stock market crash of 1929, Anderson related the following story:

One able Jewish investment banker said in the summer of 1928 that he did not understand what was going on. He said, “When I do no understand I do nothing.” He had withdrawn from the market. He had turned his holdings into cash, and he was waiting until he understood.

Trickle-down economics still doesn’t work

The Bureau of Economic Analysis elevated its estimate of third quarter GDP from 2.9% to 3.2% last week. They intend the decimal points to give an illusion of accuracy when they know there is a lot of slack in the numbers. Corporate profits rose in the third quarter on a year-over-year basis 2.8%, the first rise in profits in five quarters.

Tossed with expectations about Trump’s spending and tax cuts we should have a salad that promises improving health for the economy. It should end business cycles and bear markets, except for the fact that we have seen similar scenarios before. Mainstream economists gathered around the casket of the business cycle in the late 1990s, just before the recession of 2001. Bear markets are wedded to recessions for the most part, so the death of business cycles would mean the death of bears, too.

If that sounds too good to be true, then join me in looking into the numbers a little more closely. The Bureau of Economic Analysis (BEA) explains the jump in GDP this way:

The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, and federal government spending, that were partly offset by negative contributions from residential fixed investment and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased...

Considering job gains, wage increases and low debt levels, Bloomberg quoted Russell Price, senior economist at Ameriprise Financial Inc. in Detroit on the topic:

Growth is going to remain heavily reliant on the consumer, but consumers are in very good position to lead that charge...Overall, it’s an encouraging sign for the path ahead.

Goldman Sachs rains on Trump honeymoon

Traditionally, a new president enjoys a “honeymoon” period during his first few months in office but it seems that Goldman Sachs doesn’t like tradition. The investment bank tried to puncture the euphoria in the stock market over Donald Trump’s victory by issuing a sober forecast of what the US can expect from his regime next year. Their conclusion:

The prediction comes as part of the team’s annual not about the top ten market themes for 2017. Theme No. 1: Utter disappointment.

Actually, the theme was closer to “more of the same.” GS thinks stocks are pricey already and the economy won’t improve enough for profits to relieve some of the altitude in valuations. They are probably right and things might actually get worse if we get the long overdue recession.

Trump proposes welfare for Mexican immigrants

Last week the Dow index hit records highs largely on the assumption that a Trump presidency will mean massive new spending on infrastructure to shock the economy back to life like a paramedic putting the paddles on a patient whose heart has quit. That’s sad because it reveals how Keynesian and medieval the economic thinking of too many investors has become.

Bush allocated $800 billion to jolt the economy after the Great Recession. Can anyone tell me what we got for it? Of course, the medieval economists counter with “The economy would have been worse without it.” But they don’t know that. They have no data on what might have been, and for a field that is supposed to be data driven they make a lot of decisions based solely on their imagination.

Yes, they have the new-Keynesian models that “prove” the spending helped, but what do you expect from math models constructed with the assumption that state spending drives the economy?

Economics Trumps polling

One of the big news stories today is how the national polls got the results of the presidential election so wrong.

Part of their problem was the demonization of Trump by the media. When media bias turns a policy or person into the instantiation of evil as they did with Trump, those who favor that policy or candidate will not want to side with that “evil” when answering poll questions. So they tell pollsters what they think people want to hear.

One older lady told me she planned to vote for Trump but asked me not to tell anyone. I read about a rabid Clinton supporter who wrote that his mother had promised him she wouldn’t vote in this election because she didn’t like either candidate. But when he wasn’t looking she slipped out and voted for Trump. The media shot themselves in the foot on this one.

Back in July I wrote a post on economic models that were Trumpeting a win for the Republican candidate or modestly admitting the outcome was too close to call. The accuracy of those models showed that people consider the economy their most important issue.

Investors are becoming aggressively passive

Last week the Wall Street Journal ran several articles on the tectonic shift in investing from actively managed funds to passive index funds. In “The Dying Business of Actively Picking Stocks,” the Journal reported that “Over the three years ended Aug. 31, investors added nearly $ 1.3 trillion to passive mutual funds and their brethren— passive exchange- traded funds— while draining more than a quarter trillion from active funds, according to Morningstar Inc.”

Even Warren Buffet jabbed a knife between the ribs of active fund managers by stashing his wife’s inheritance in an index fund. One active manager proclaimed passive investing to be worse than Marxism for the future of capitalism.

The standard charges against actively managed funds are that only a few outperform indexes like the S&P 500 and they charge higher fees, says the Wall Street Journal.

Trump's tariffs could sink Washington

Politicians have figured out that bashing China is a good way to attract vote. That’s why Donald Trump is doing it. It appeals to people who work and see jobs lost to cheaper products made across the Pacific. Hillary can’t appeal to those people because most of her constituency doesn’t work at all or works in government jobs that don’t compete with anyone anywhere.

But if Trump becomes president, as is likely, and he succeeds in raising tariffs on Chinese imports, he could destroy the federal government here’s why:

The federal government is spending about a trillion dollars per year more than what it takes in through taxes. That means it must borrow a trillion dollars. Who has that kind of money? The American people don’t because we don’t save enough and if we did we certainly wouldn’t loan it to that deadbeat Uncle Sam. Europe doesn’t have the savings. Japan has some but not enough. So most of what the federal government borrows comes from China.

Now the federal government requires US dollars, not Chinese yuan (officially the renminbi, but who can pronounce that?) No one can spend yuan in the US. Chinese save about 30% of their income, but in yuan. How can they get the dollars to loan to the US? They do it by selling stuff to US consumers for dollars. They sell those dollars to the Chinese government for yuan they can use in China to buy more Chinese made Cadillacs and ride their bullet trains. The Chinese government then uses those dollars to buy US debt and fund the US federal government deficit.

Caterpillar needed the Austrian business-cycle theory

Caterpillar is facing its fourth year of declining sales, the longest in its history. It expects total revenue this year to be 39% below its peak in 2012 and profits will be down 68%. Its stock is now 25% below its peak. Through the first six months of 2016, the company’s overall revenue was down 21% from the same period in last year.

CEO Doug Oberhelman is stepping down, but when he took the reins in 2010 the world, especially China, couldn’t get enough metals. Prices were soaring and everyone thought the good times would last. That’s the first mistake most investors and businessmen make – linear forecasting instead of thinking in terms of cycles. Oberhelman should have understood cycles after working for Caterpillar for 35 years. The capital goods sector is the most volatile in the business cycle. But he didn’t understand them. Caterpillar’s problems began when it invested heavily at the peak of a cycle according to an article in the Wall Street Journal:

How over confidence destroys earnings

“The curious task of economics,"  wrote Nobel Prize winner in economics Friedrich Hayek "is to demonstrate to men how little they really know about what they imagine they can design."

In other words, good economists are humble and that shows how few good economists live in the US.

Investors should be humble, too, and researchers have provided the proof. Two professors at the University of Maastrict published a paper at the beginning of this year on the question of “How Does Investor Confidence Lead to Trading?” The problem is not that initial successes spur investors to greater confidence.

Hence, we find evidence that our measure of investor confidence refers to a certain type of individual, as it is stable over time...Moreover, there is no evidence that any of the small fluctuations in investor confidence are driven by past returns, that is, that high returns lead investors to learn to be overconfident...That is, confident investors generally have lower returns (because of their higher turnover, see Section 5.1), but variation in those lower returns does not change their confidence.

In other words, the overly confident investor is always confident whether winning or losing. And men don’t have a monopoly on excessive confidence:

China inflates its real estate

I have a Chinese friend who used to teach in a university in China. He reads news from home that doesn’t make it into the US media and tells me the more interesting stories. 

Lately he has been reading about real estate. He is a frustrated that many of his family members in China have become wealthy through real estate speculation while he missed out. They had tried to get him to invest with them years ago but he was certain at the time that prices would never rise as they have.

He told me recently the Chinese media reported that total value of real estate in the top three cities, Beijing, Shanghai and Shenzhen, is priced more than all of the real estate in the US. Apartments with a thousand square feet in those cities sell for several million dollars.

My friend told me that China doesn’t have a property tax and just recently added a deduction for mortgage interest in order to encourage more speculation. He said the government wants prices to continue to rise because the state owns most of the land, so it reaps huge rewards when prices rise.

Deutsche Bank - the snowflake that could trigger an avalance

Avalanches build up one special snowflake at a time. The last snowflake launches the avalanche. Financial avalanche specialists are wondering if the troubled Deutsche Bank will earn the honor of being that last special snowflake, the Lehman Brothers of the latest recession.

After Brexit, the IMF warned that the bank was the most significant contributor to systemic risks. Experts have expressed fears about its undercapitalized state for several years. Alt-M’s Keven Dowd confirmed that those fears are justified in his post “Is Deutsche Bank Kaputt?” He wrote that the bank claimed a leverage ratio of 3.5 percent in its 2015 annual report:

What’s an investor to do when the market won’t cooperate?

What is an investor who follows the Austrian school of economics supposed to do with a market that has traded in a narrow range for almost two years and refuses to bend to the reality of falling profits and a slow economy? After all, we may already be in a recession, as Peter Schiff thinks, but the market is clueless.

A couple of posts ago I wrote about the fetish with randomness that afflicts mainstream economics and finance. One result of that fetish is the dogma that no one should try to time the market; just pick good stocks and stay with them. The high priests ridicule those of us who make any effort at looking into the future.

The left's long lingering history of racism

Listen to the news about the immigration of Syrians to Europe and you think free marketeers are racists because the media labels opponents of immigration the “extreme right.” After all, promoters of freedom are positioned to the right while socialists are on the left, right? But the historical facts tell a different story.

Economists of the mid-nineteenth century opposed slavery. The greatest, David Ricardo, was a Jew and knew something about racism and oppression. The advocates of slavery opposed the economists. Thomas Carlyle, a socialist, dubbed economics the “dismal science” because the freedom that economists demanded would create a “dismal” world in which white people were equal with the “inferior” races, such as the people of Africa.

Leftist regressives, who called themselves Progressives, invented the truly dismal science of eugenics in order to suppress the population of minorities in the UK and US and force them to reduce their birthrates. They introduced the minimum wage in the US to prevent minorities such as Jews, Africans, Chinese, Mexicans and Native Americans from getting jobs. Regressives assumed that if those minorities couldn’t get jobs then they wouldn’t marry and have children. For details check out Princeton scholar Thomas C. Leonard's book Illiberal Reformers: Race, Eugenics and American Economics in the Progressive Era. 

Socialists stuck on luck

In May of this year The Atlantic offered another hymn to the goddess of luck. Not only is worshiping the goddess a good thing according to the author, but agnostics are stingy and selfish:

Seeing ourselves as self-made leads us to be less generous and public-spirited...

A recent study by the political scientists Benjamin Page, Larry Bartels, and Jason Seawright found that the top 1 percent of U.S. wealth-holders are “extremely active politically” and are much more likely than the rest of the American public to resist taxation, regulation, and government spending. Given that the wealthiest Americans believe their prosperity is due, above all else, to their own talent and hard work, is this any wonder? Surely it’s a short hop from overlooking luck’s role in success to feeling entitled to keep the lion’s share of your income—and to being reluctant to sustain the public investments that let you succeed in the first place.

Traditionally, religion explained what we couldn’t understand. Today, it’s randomness. Choosing randomness, or luck, is a description, not an explanation of a phenomenon, and an admission of ignorance. There are quite a few books promoting the goddess of luck. Keynes blamed recession on the “animal spirits” of businessmen, an allusion to randomness and not pagan beliefs. Nassim Taleb’s books on black swans was my first introduction to her. Then I read Burton Malkiel’s A Random Walk Down Wall Street: A Time-Tested Strategy for Successful Investing. Recently, The Drunkard’s Walk: How Randomness Rules Our Lives by Leonard Mlodinow came out.

The Fed is flummoxed – ABCT has the cure

Last week the Wall Street Journal printed a report card of Fed activity for the new millennium. The writers think the Fed failed most of its curriculum.

"In the past decade Federal Reserve officials have been flummoxed by a housing bubble that cratered the financial system, a long stretch of slow growth they failed to foresee and inflation persistently undershooting their goal."

Part of the Fed’s problem is that it believed the media’s hyperbole about former Fed chairman Greenspan, referring to him as the maestro during the “Great Moderation” of the decade of the 1990s. Fed officials didn’t comprehend that the mainstream media is very socialist and will grossly exaggerate every apparent success by a government agency. The Fed and most mainstream economists took the praise from the media to heart and began to believe they were invincible. They even announced that they had slain the dragon of business cycles. Meanwhile, Austrian economists warned that the corpse resembled a wind mill more than a dragon.

Shocking! NIRP causes savings not spending

The whole point of negative interest rates (NIRP) in Europe and Japan was to force people to spend by punishing them for clutching their cash. The rationale goes deep into the middle ages before modern economics: the economy is sluggish because people are saving too much instead of spending. Good economists thought they had buried that monster by the 1930’s, but Lord Keynes resurrected it and gave it a title of nobility. That’s how medieval economics came to dominate mainstream academics and central banks for 90 years. If you don’t believe in zombies, you haven’t followed mainstream economics for long.

The rich are getting richer - Baptists and bootleggers

Hillary and Bernie dusted off and hoisted aloft the old medieval standard “the rich get richer while the poor get poorer” during their primary contest. Republicans tended to respond with, “So?” During the Olympics, Hill promised to make the rich pay their fair share in her TV ads. Hill and Bernie imply that the rich have become wealthy at the expense of the rest of us, another medieval economics principle.

Attacking the wealthy always inflames envy, draws a crowd and extorts campaign contributions. That’s why politicians use it so often, as Helmut Schoeck noted in his masterpiece, Envy: A Theory of Social Behavior.

The truth is that Bernie and Hill are half right: inequality is growing. They're just wrong about the reasons. However, free marketeers do a lot of damage to the cause by ignoring the issue or denying that anything is wrong. Worse, some even defend growing inequality. 

Where's the growth?!!!

Decades ago an old lady yelled, “Where’s the beef?” when handed a burger in a fast food commercial. It became a catch phrase for occasions when people wanted to advertise that an idea lacked substance. So while the media proclaims the virtues of the current economy, many economists are asking, “Where’s the growth?”

The Bureau for International Settlements (BIS), the central bankers’ bank, recently issued a report card on the efforts of their client central banks to boost growth since the last recession and given them a failing grade. In the report “Unconventional monetary policies: a re-appraisal,” the BIS economists wrote:

We reach three main conclusions: there is ample evidence that, to varying degrees, these measures have succeeded in influencing financial conditions even though their ultimate impact on output and inflation is harder to pin down;

Free trade can't help a socialist nation

Good economists, that is, free marketeers, are appalled by Republican nominee for President Donald Trump’s attacks on free trade. All of us have examined and approved David Ricardo’s theory of trade and comparative advantage. Trade is not a form of war. Exports do not enrich a nation any more than imports impoverish it. It does not matter if the trading partner isn’t playing “fair.” Trading even with a communist country will benefit the home nation.

As Mises wrote in Omnipotent Government, “...the inference from Ricardo’s free-trade argument was irrefutable. Even if all other countries cling to protection, every nation serves its own interest best by free trade. Not for the sake of foreigners but for the sake of their own nation, the liberals advocated free trade (OG 75).”

Trump wins election, not that it matters

For someone who despises politicians as much as I do it’s really hard to avoid political news lately. But there is a nexus between the presidential election and economics: most voters think the president controls the economy. The evidence for that is the fact that economic models predicting the winners of presidential elections are the best forecasters, far superior to the myriad of polls, except the exit polls, and vastly superior to the legions of political pundits in the media. On the superiority of simple regression models over that of experts for forecasting anything, even the price of wine, read Super Crunchers.

One economic model predicting presidential elections using just GDP growth shows that the economy must grow at an annual rate of 2.5% in the second quarter of the election year in order for the incumbent party to win. Based on the latest release showing Q2 growth at an annual rate of 1.2%, Trump has virtually won.

The model created by Ray Fair at Yale University agrees, according to a story on NPR: "It's based on economic growth per capita in the four years before the election. According to Fair, because of the sluggish growth in this recovery, his model now predicts the Republican candidate will win. Fair's model has picked the winner in all but two elections since 1916."

What the market has in common with Trump

Watching this market is like watching Trump’s candidacy. Everyone is waiting for both to crash and burn but they keep climbing to greater heights. Even Fox News appears to oppose Trump without much effect just as the stock market sets new records in the midst of gloomy economic news all around.

The market has set new records even as profits are expected to have fallen for the fourth consecutive quarter. Earnings season is upon us and we will soon understand how bad the damage in the second quarter was. Thomson Reuters has predicted that profits in Q2 will be down about 5% from the same quarter last year. Revenue will have fallen 0.8%. It blames oil prices, low interest rates, and a saturated cell phone market.

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...”

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.

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.

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.

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.

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.

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.

Golf, economics and fundamentalist investing

Scottish people will always have trouble getting into heaven because they have tempted humanity with two infamous inventions: golf and economics. They’re trying to make up for it with their whiskey, and doing a pretty good job, but the final judgment is up to someone else.

Golf offers a few lessons that would help economists as investors if they would pay attention. The chief lesson is get back to the fundamentals. Fundamentalism has become a curse word lately, but in Christianity it originally meant one who held to the doctrines of the virgin birth, deity, death and resurrection of Jesus Christ, that is, the fundamentals of the faith. Fundamentalists were distinguishing their concept of Christianity from the modernists who denied all of the fundamentals but for some strange reason, or out of pure dishonesty, continued to call themselves Christians. Twenty years ago a few journalists intent on advertising their ignorance began misusing the word and today a fundamentalist is the vilest murderer on the planet.

We should rescue the term from ignorant journalists. (Other words need rescuing as well, such as liberal and justice.)Those who practice the fundamentals of any discipline are fundamentalists and the fundamentals are important in most areas of life. In football the fundamentals are blocking and tackling. With investing, fundamental analysis is extremely important. In golf they’re grip and swing, according to the golf masterpiece, Harvey Penick’s Little Red Book. Penick recommends revisiting the fundamentals when you’re golf scores suffer from inflation. Are there any fundamentals in economics that could rescue the field from the macro confusion that threatens it today? Yes. The fundamentals of economics are in micro.

Two schools of macroeconomics exist – Austrian and mainstream. But the mainstream world is split between paleo-Keynes, neo-Keynes, monetary and neoclassical. In spite of their common origins, they imitate their socialist counterparts in other fields by fracturing and fighting over insignificant details. All of them pretend that micro doesn’t exist and try to build their systems through correlations of aggregates, such as aggregate demand, aggregate supply, savings, investment, exports, money supply and GDP.

On the other hand, Austrian economics builds up its macro on the certain fundamentals of micro. There are no schools in micro. Micro is just micro because the principles of micro are the most certain in all of economics. No good economist disputes the laws of supply and demand, or diminishing marginal returns, though mainstream macro pretends they don’t exist.

The focus of Austrian economists on the fundamentals has enabled them to craft the best business-cycle model in the field. Mainstream economists are still stuck, after eighty years, with “crap happens!” They call it “shocks,” but it’s the same thing.

So if you find you investing landing in the rough, try getting back to the fundamentals: the market follows profits and profits follow the business cycle, the Austrian business-cycle.

Party like it's 1999

 The lyrics to one of the late Prince’s songs, “Party like it’s 1999,” seem more appropriate today as writers applaud new tech companies. In the late 90s, all an entrepreneur had to do to raise money for an idea was attach the suffix “dot com” to his company name and hot money would rain on him. That enthusiasm for tech stocks drove the NASDAQ to the stratosphere where the lack of oxygen makes people hallucinate. The crash that followed in 2000 punished the dreamers severely.

A similar euphoria is gelling around the fintech, or financial technology, that intends to transform finance. One fintech company is SoFi, a San Francisco based company whose founder claims it will do to banking what Uber has done to taxis. You may have seen its Super Bowl 50 ad, “Great loans for great people.” 

The first Austrian economist - Washington Irving

Washington Irving is best known for his short stories "The Legend of Sleepy Hollow" and "Rip Van Winkle," but he also wrote many essays. Before he lived by the pen he was a business man and one essay proves that he was a good economist as well. He wrote about the Mississippi Bubble in France of the 1720’s which he published as part of the “Crayon Papers” essays.

At the time Irving wrote this essay, in the 1820’s, there were no good business cycle theories. The most common ideas blamed a shortage of money (gold or silver) or a general overproduction. Say, the French economist, distilled his famous law as part of an effort to debunk the overproduction theory. The Manchester school in England didn’t attempt its explanation until the middle of the nineteenth century and of course Mises didn’t put it all together until early in the twentieth century. Somehow, Washington Irving figured out the essence of the Austrian business cycle theory long before.

Democratic fascism kills growth

Bob Bryan at Business Insider had an interesting column on why economic growth in the US is dying. For the cause, he defers to Mike Thompson of S&P Global Market Intelligence:

Instead of continuing to invest in the business and focus on growing over time, according to Thompson, managements are trying to undercut possible disruptions by showing constant earnings growth and streamlined companies.

This activist-style, short-term attitude is exactly what Blackrock CEO Larry Fink decried in a letter to all S&P 500 CEOs at the start of 2016. Thompson said that these larger firms are most susceptible due to their size.

Revenue growth is predicated on economic growth and innovation,” he said. “We don’t have that sort of economic growth, and, let’s be honest, big companies simply aren’t that innovative. So instead these big companies shift their focus.

Thompson claims that large corporations are doing three things: 1) cutting costs; 2) creating shell companies or doing inversions to reduce taxes; and 3) buying back shares in order to boost earnings per share.

Trucking and profits drive off a cliff

Not long after the 2001 recession I took a job at a large long-haul flatbed trucking company as a rate analyst and one of the first things I noticed on the job was a graph of truck tons/mile. The line grew to the right at a steep grade as a result of Greenspan’s artificial expansion of the economy through money printing in the late 1990s. Then just before the recession, tons/mile drove off a cliff and dived for months until crashing.

Last week, the WSJ reported that “orders for new big rigs plunged and inventories of unsold trucks soared to their highest levels since just before the financial crisis, as uncertainty about future demand and a weak market for freight transportation weighed on truck manufacturers.”

Will we never see another Soros or Buffett?

The Global Guru wrote recently that investing has changed so much over the past two decades that we will never see investors like Buffett and Soros who could earn 30% returns for 30 years.

Nicholas Vardy wrote, “George Soros’ investment track record made him the equivalent of a .400 hitter in baseball.” But then his luck changed:

Soros quietly left the hedge fund scene in 2011, turning his fund into a family office. But his last few years in the game were hardly like his first. Indeed, 2010 was Soros’ worst year since 2002, with his flagship fund up a mere 2.63%. The following year was even worse, with his famed Quantum fund reportedly down 15%.

How mainstream econ promotes socialism

Milton Friedman is a good example of a great champion of free markets whose economics betrayed his philosophy. Few economists enjoyed the ear of the common man in the way Friedman held it. He wrote regularly for popular magazines, appeared on TV talk shows and produced a wonderful documentary series for PBS on the miracles produced by free markets. Yet the mainstream economic theories he championed undermined his speech. Here is how.

The first clue comes from the fact that economists trained in the German historical school , known as socialists of the chair, created the American Economic Association to promote German style socialism in the US. Bismarck, the prime minister in Germany in the late 1800s, had implemented almost all of the socialist agenda by the 1890s in what became known as the “welfare state.” Convinced that Germany was inventing the cutting edge of history, the American economists determined to bring such “progress” home.

Another market head fake

In the world of real bull riding, as opposed to nominal bull riding, or investing, the cowboy (investor) must anticipate the spins and leaps of the bull. Riders often study video of bulls engaged in previous games of cowboy tossing. A wrong guess sends the cowboy flying then landing awkwardly absent a score and without money.

So what can we make of the January plunge and recent recovery of the bull market? I am betting that the bull’s real intention is to plunge into a bear and that the latest rise in stocks is a head fake to trick the cowboys to overcompensate in anticipation of a continued ascent. Instead, the bull will reverse direction and slingshot the cowboy (investor).

Some of us are mystified by the recent rise in stock prices, but as the great Austrian economist Ludwig Lachmann wrote, moving the deeply anchored expectations of investors out of their comfort range for prices on the market requires extraordinary events. Some of us have seen indicators as early as two years ago, such as the hedge fund manager Mark Spritznagel, author of The Dao of Capital: Austrian Investing in a Distorted World.

Bank for central bankers confirms ABCT

The popular press blames Wall Street shenanigans and banker greed for the most recent recession as the movie The Big Short demonstrates. Politicians digest the economics of the mainstream media and that is the reason Congress passed the Frank-Dodd Act increasing regulation of banks. It was punishment for what politicians perceived as banker sins.

Congress passed the act in spite of the fact that no mainstream economist I know of has blamed Wall Street or banks for the crisis. In the minds of mainstream economists, recessions are random events. The economy naturally spins in equilibrium like a top until an unforeseen “shock” slams into it, makes it wobble and sling thousands of people out of work. I like to call it the “crap happens” theory of business cycles.

A much better explanation of recessions come from the Austrian school of economics in which credit expansion causes misallocations of capital that accumulate during an expansion. The weight of those misallocations eventually crushes the expansion and a recession follows. The most robust explanation of the mechanism is Hayek’s Ricardo Effect [link] in which nominal profits guide the allocation of capital.

Central bankers made bull riding necessary for survival

Bull riding has become a lucrative sport for those with the talent to ride, earning the top riders hundreds of thousands of dollars per year in spite of a few broken bones. Central bankers have made learning to ride the leaps and spins of the stock market a necessity since the early 1980’s. Why has the market been so volatile since 1980? Two factors have caused it:

1. End of Bretton Woods and rise of floating FX.

2. End of fiscal policy and rise of monetary policy.

The existing international system of floating rates doesn’t have a cool name like Bretton Woods, but it came about after the death of the former fixed rate system. The Bank for International Settlements (BIS), the central bankers’ bank, doesn’t like what its member banks are doing under the current system. While the media and politicians, especially Bernie Sanders, preach fire and brimstone damnation of Wall Street and condemn it for the Great Recession, the BIS body slams the world’s central bankers:

Rescuing turtles - How the ABCT can help trend followers part II

Last week I introduced readers to trend following strategies of Michael Covel. Those who follow trends are sometimes called "turtles." Covel and others admit that trend followers have sailed into troubled waters lately.

The Austrian business-cycle theory can help trend followers by taking some of the uncertainty out of trend directions. During bull markets, such as characterized the first six years after the recession, the trend was up about 90% of the time with small dips because 1) the Fed was printing new money like a counterfeiter and inflation rose; 2) profits rebounded as the economy naturally turned around ,and 3) growing risk tolerance drove PE ratios to the sky.

Covel recommends trading the long term trends in his books and the expansion phase of the business cycle is one of the longest, lasting on average about six years. An trend following investor familiar with the ABCT will not mistake dips for trends.

Rescuing turtles - how the ABCT can help trend following investors part I

Futures magazine wondered in 2013 if trend following as an investing strategy was dead:

In 2012, the aggressive and persistent actions by central banks and other authorities worldwide served to maintain an unfavorable market environment that began in 2009 for most trend following systematic programs. Many short, medium and long-term trend following CTAs, as well as other trend following hedge fund strategies performed poorly... While these indexes all reported losses for the second year in a row, the S&P500's climb (+13.4%) continued through year end. Although markets for hedge funds generally were better than for CTAs,... the HFRX Global Hedge Fund Index rose only 3.5% in 2012...the Newedge Trend Following CTA Sub-Index is down 5.89% since the bottom of the financial crisis in March 2009. 

This performance contrasts sharply with longer term numbers, particularly in the CTA space. Since 1980, as measured by the Barclay Hedge Btop50 Index of CTAs, managed futures have returned three times that of the S&P500, approximately 32 times an initial investment vs. 11times an original investment for the S&P 500. And in 2008 the S&P was down 45% while the Btop50 was up 14%.

Japan’s 4th quarter torpedoes Market Monetarism

Japan’s GDP fell 0.4 percent from the third to fourth quarters, which translates into an annual rate of -1.4 percent as it is commonly reported. The shrinkage dealt another blow to Abenomics, the term the press invented for the Prime Minister Shinzo Abe’s economic plan to boost the Japanese economy through massive money printing. Last month, and before the latest data, the central bank of Japan drove interest rates into negative territory in further hopes of jump starting the economy.

"The latest data show that it is difficult to say that the Abe government has achieved of its goal of a 'virtuous cycle' of rising incomes, wages, and investment," said Tobias Harris, political risk analyst at US-based consultancy Teneo. 

"It's getting clearer that Abenomics is a paper tiger," said Seiya Nakajima, chief economist at Office Niwa, a consultancy, referring to Prime Minister Shinzo Abe's policy mix of monetary easing, spending and reform. 

Year ahead forecast - stormy

Austrian economists are not huge fans of forecasting as are most mainstream economists, especially those who add a decimal point to lure the gullible into thinking the forecast is accurate. But that doesn’t mean Austrians don’t forecast. Hayek wrote in his Nobel Prize acceptance speech that... 

"Without such specific information about the individual elements we shall be confined to what on another occasion I have called mere pattern predictions - predictions of some of the general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up."

I call Hayek's concept of forecasting, pattern predictions, or qualitative forecasting vs quantitative. In other words, Austrian economists can tell what will happen next but not exactly when or how much.

That doesn’t mean that Austrian economists don’t ever use numbers in forecasting. Obviously, I have provided a few of those. But I hope readers interpret those forecasts as tendencies and illustrations of theory, not as point-accurate forecasts.

Oil can sink lower than we think

Everyone is wondering how low the price of oil can go. It’s well below the profitable level in the US, but the pumps keep pumping. In this earlier post I showed that oil companies will continue to pump at a loss as long as the revenue covers variable costs because the costs of shutting down an oil well can be very high.

But how long will they continue to operate with prices around variable costs? One analyst says they will do so until the cash runs out:

How the Fed creates bulls and bears

If you grasp this you will be light years ahead of most economists. Bull and bear markets can't exist without the Fed manipulating the money supply. Here's why.

Assume the stock of money is fixed. For example, say there exists only $1 trillion in gold and banks have lent out nine times that amount so that the total money supply of gold plus credit equals $10 trillion because the required bank reserves are 10%. Also assume the population remains constant. If nothing changed, prices would remain the same and the economy would be in a state that economists call equilibrium. Profits would equal the cost of credit, say 5%.

Now we have to look at how many times the $10 trillion is turned over, or changes hands, in order to figure out the total sales for the year. We’ll assume that the turnover, or velocity, of money is five. Then total sales for the year would come to $50 trillion. A profit of 5% would mean $2.5 trillion. Now let’s assume the PE ratio, the measure of risk tolerance, is 15. The market cap would be $37.5 trillion.

With a fixed stock of money, productivity increases at zero and the population remaining constant, the stock market would show the same values every day. Planned investment equals real savings.

Poking the bear - what happens next to the market?

The S&P is down about 9% for the year and 10% from the highs last year as of this writing. By the time you read this, the index may be even lower. The bear has been hibernating for seven years and may be waking up. If so, he’ll be hungry for your nest egg. 

Technicians will be looking for the lows of last year for support as if nothing has changed. But a lot has changed. Profits for the fourth quarter of last year are expected to fall over 5%, according to data provider FactSet. And even if you leave out the disastrous energy sector, profits are expected to be flat.

China, Brazil, Europe, Japan are in worse shape. US manufacturing has been in a recession for months. Oil, gas and mining are in recessions. We are beginning to see the effects in the consumer sector as retail sales from the Christmas season sunk below those of last year.

This is a good time to look at where we are in the business cycle using insights from pages 105-107 in my book Financial Bull Riding:

Big Short – good movie, bad economics

The outlaw couple Bonnie and Clyde was not only famous for their bank robberies in the 1930s, they were popular. They lost some of their appeal when they began murdering policemen, but people loved the fact that they robbed banks because the people hated banks. They had watched banks foreclose on farm families during the Dust Bowl and depression. Committing the economic sin of fixating on the seen while ignoring the unseen, an error first identified by the great French economist Frederick Bastiat, they blamed the bankers for the farming disasters.

People have loved to hate bankers for centuries, often for good reason. Until the creation of the FDIC, depositors occasionally lost their life savings to bank failures. Now they don’t, but the people see banks constantly bailed out by governments when they make bad decisions and then foreclosing on borrowers who have made decisions that were no worse.

So it was no surprise that the movie The Big Short blamed greedy bankers for the recent Great Recession. I reviewed the book on which the movie was based, Michael Lewis’ The Big Short: Inside the Doomsday Machine, here. As I noted then, Lewis’ economics is terrible, but the book is a great read because at its heart it glorifies the difficulties, hard work and genius of entrepreneurs and the heroes of the film are entrepreneurs.

Market crash overdue says Spitznagel

According to the legendary hedge fund manager and author of The Dao of Capital: Austrian Investing in a Distorted World, Mark Spitznagel, the stock market should follow Canadian geese and head south any day now. I reviewed his book here because he uses the Austrian business-cycle theory (ABCT) to guide his investment decisions. It has proven the most popular post I have written.

Spitznagel created his own index for tracking the market cycle he calls the Equity Q Ratio. Calculating the ratio starts with the relationship of the cost of titles to capital (stock prices) to the cost of the capital the title represents. That part is roughly comparable to a price-to-book value. Then Spitznagel compares the actual ratio to the historical average. The deviation from the historical average is the Q Ratio. The stock market in October was 71% above the long term average. It was higher only just before the dot.com crash of 2000.