Philosophy

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Krugman Claims He Has Been Right About Everything

I don’t think Krugman’s descriptive work on global trade patterns is bad. I don’t even think he has been completely wrong about the post-2008 economic depression. He certainly hasn’t been wronger than the people who are in charge in Europe, or the people running the Fed; he did, after all warn in 2005 that the Fed was “running out of bubbles” to reinflate, while Bernanke was still claiming in 2007 that subprime was contained.

I do think his defence of broken windows is facile, and I think the notion he has advanced that World War 2 ended the Great Depression is not just wrong but dangerous.

He’s a good polemicist; he defines himself through big, bold, wildly partisan claims. But if he’s going to claim that he’s been right about everything — as he just did — he might want to make sure he’s not directly contradicting statements he made just a week previous.

On June 18th Krugman posited:

I (and those of like mind) have been right about everything.

However on June 11th Krugman wrote:

People like me may not have been right about everything, but have accumulated a pretty darn good track record over the past 5 years.

So, um, which is it?

Nobody can be right about everything. Claiming that you have been is just silly hyperbole which will end up making you look bad especially when your record is, in reality, quite mixed. And if his goal is to convince policy-makers to ditch austerity (a goal that I share, at least for the time-being), he’s not going to do it by sticking his foot in his mouth.

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Time to Get Out of the Middle East

It takes a lot of time and effort to try to understand American counter-terrorism policy today.

Personally, I think the status quo is like trying to treat a cocaine overdose with methamphetamine. It’s like trying to cure chlamydia by having sex with multiple random strangers in a park. It’s like trying to cure a broken nose by punching oneself in the face.

Or, as Glenn Greenwald puts it:

I absolutely believe that another 9/11 is possible. And the reason I believe it’s so possible is that people like Andrew Sullivan — and George Packer — have spent the last decade publicly cheering for American violence brought to the Muslim world, and they continue to do so (now more than ever under Obama). Far from believing that another 9/11 can’t happen, I’m amazed that it hasn’t already, and am quite confident that at some point it will. How could any rational person expect their government to spend a full decade (and counting) invading, droning, cluster-bombing, occupying, detaining without charges, and indiscriminately shooting huge numbers of innocent children, women and men in multiple countries and not have its victims and their compatriots be increasingly eager to return the violence?

Isn’t it painfully obvious? The interventionist policies — occupation, drone strikes, cluster-bombing, indefinitely detention, false vaccination programs and so forth — in the middle east advocated by both “liberal” and “conservative” hawks that are supposed to prevent terrorism are creating anger, creating enemies, and creating terrorists. I too am amazed another 9/11 hasn’t happened. I despise jihadism and Islamism. It is contrary to everything I stand for. That’s exactly why I oppose a foreign policy that serves as a hugely effective recruiting tool for the totalitarian jihadists. 

Yemeni lawyer Haykal Bafana explained the rationale last month:

Dear Obama, when a U.S. drone missile kills a child in Yemen, the father will go to war with you, guaranteed. Nothing to do with Al Qaeda.

Or as convicted terrorist Faisal Shahzad put it:

Well, the drone hits in Afghanistan and Iraq, they don’t see children, they don’t see anybody. They kill women, children, they kill everybody. I am part of the answer to the U.S. terrorizing the Muslim nations and the Muslim people.  And, on behalf of that, I’m avenging the attack.  Living in the United States, Americans only care about their own people, but they don’t care about the people elsewhere in the world when they die.

Or as former CIA counter-terrorism expert Michael Scheuer noted:

The idea that has been pushed by President Clinton and President Bush and Mr. Cheney and Barack Obama and Senator McCain, that America is being attacked [for its freedom] is a disservice to the population of the United States. This war is not against Americans because we’re Americans, it’s motivated by the activities of our government and its allies in the Muslim world.

So why do we keep doing this? Two reasons: hubris and greed.

First, the hubris. We know Ron Paul was booed in South Carolina for advocating that we should do to others as we would like done to us:

My point is if another country does to us what we do others, we’re not going to like it very much. So I would say that maybe we ought to consider a golden rule in — in foreign policy. Don’t do to other nation what we don’t want to have them do to us.

But that’s just the propagandistic nature of being a superpower. Years of prosperity, military supremacy and pro-war propaganda have made it normal to believe strongly in the idea that America is intrinsically better, and wherever America goes America brings freedom, and anyone who doesn’t agree with that needs to be waterboarded until they do.

Yet however many times as the phrase “they hate us because we are free” is repeated, mantra-like by a Rick Santorum or a Newt Gingrich, it does not become truer. It is just an illusion, just a fantasy. While the jihadis were always anti-American, anti-democratic and anti-capitalistic, Osama bin Laden, Ayman al-Zawahiri and Sayyid al-Qutb — the fathers and grandfathers of modern Wahhabism, jihadism and al-Qaeda — became anti-American militants because of America’s role in the middle east.

As bin Laden himself said:

Those who kill our women and innocent, we kill their women and innocent, until they refrain.

And even more clearly:

Free men do not forfeit their security, contrary to Bush’s claim that we hate freedom. If so, then let him explain to us why we don’t strike Sweden, for example.

Second, the greed. America is in the middle east because America likes cheap energy. That myth of America as liberators flourished first as a justification for America’s petrodollar foreign policy.

And people get rich from America being at war — so far in the region of $4 trillion has gone to fighting since 9/11. A lot of weapons contractors are happy with the status quo.

So the military-industrial complex — the lobbyists, the weapons makers, the media — may accept it if Obama kills 14 women and 21 children to get one suspected terrorist. More terrorism means more weapons spending. For the lucky few it’s a self-perpetuating stairway to riches. Yet for wider society it means spending time, money and effort on war, instead of on domestic prosperity. It means the constant threat of terrorism. And it means the loss of our liberty, as the security state adopts increasingly paranoid anti-terrorism measures.

We should do to others as we would have done to ourselves. That means — unless we are comfortable with the idea of ourselves living under military occupation and drone strikes — getting out of the middle east, and letting that region solve its own problems — forget another costly and destructive occupation in Syria. Slash the war and occupation spending, and redirect the money to making America independent of middle eastern energy and resources.

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Keynesianism & Eugenics

The theory of output as a whole, which is what The General Theory of Employment, Interest and Money purports to provide, is much more easily adapted to the conditions of a totalitarian state.

John Maynard Keynes

In looking at and assessing the economic paradigm of John Maynard Keynes — a man himself fixated on aggregates — we must look at the aggregate of his thought, and the aggregate of his ideology.

Keynes was not just an economist. Between 1937 and 1944 he served as the head of the Eugenics Society and once called eugenics “the most important, significant and, I would add, genuine branch of sociology which exists.” And Keynes, we should add, understood that economics was a branch of sociology. So let’s be clear: Keynes thought eugenics was more important, more significant, and more genuine than economics.

Eugenics — or the control of reproduction — is a very old idea.

In The Republic, Plato advocated that the state should covertly control human reproduction:

You have in your house hunting-dogs and a number of pedigree cocks. Do not some prove better than the rest? Do you then breed from all indiscriminately, or are you careful to breed from the best? And, again, do you breed from the youngest or the oldest, or, so far as may be, from those in their prime? And if they are not thus bred, you expect, do you not, that your birds and hounds will greatly degenerate?  And what of horses and other animals? Is it otherwise with them? How imperative, then, is our need of the highest skill in our rulers, if the principle holds also for mankind? The best men must cohabit with the best women in as many cases as possible and the worst with the worst in the fewest,  and that the offspring of the one must be reared and that of the other not, if the flock is to be as perfect as possible. And the way in which all this is brought to pass must be unknown to any but the rulers, if, again, the herd of guardians is to be as free as possible from dissension.  Certain ingenious lots, then, I suppose, must be devised so that the inferior man at each conjugation may blame chance and not the rulers and on the young men, surely, who excel in war and other pursuits we must bestow honors and prizes, and, in particular, the opportunity of more frequent intercourse with the women, which will at the same time be a plausible pretext for having them beget as many of the children as possible. And the children thus born will be taken over by the officials appointed for this.

Additionally, Plato advocated “disposing” with the offspring of the inferior:

The offspring of the inferior, and any of those of the other sort who are born defective, they will properly dispose of in secret, so that no one will know what has become of them. That is the condition of preserving the purity of the guardians’ breed.

In modernity, the idea appears to have reappeared in the work first of Thomas Malthus, and later that of Francis Galton.

Malthus noted:

It does not, however, seem impossible that by an attention to breed, a certain degree of improvement, similar to that among animals, might take place among men. Whether intellect could be communicated may be a matter of doubt: but size, strength, beauty, complexion, and perhaps even longevity are in a degree transmissible. As the human race could not be improved in this way, without condemning all the bad specimens to celibacy, it is not probable, that an attention to breed should ever become general.

Galton extended Malthus’ thoughts:

What nature does blindly, slowly and ruthlessly, man may do providently, quickly, and kindly. As it lies within his power, so it becomes his duty to work in that direction.

Margaret Sanger — the founder of Planned Parenthood — went even further, claiming that the state should prevent the “undeniably feeble-minded” from reproducing,  and advocated “exterminating the Negro population”.

And these ideas — very simply, that the state should determine who should live, and who should die, and who should be allowed to reproduce — came to a head in the devastating eugenics policies of Hitler’s Reich, which removed around eleven million people — mostly Jews, gypsies, dissidents, homosexuals, and anyone who did not fit with the notion of an Aryan future — from the face of the Earth.

Of course, the biggest problem with eugenics is that human planning cannot really control nature. Mutation and randomness throw salt over the idea. No agency — even today in the era of genetics — has the ability to effectively determine who should and should not breed, and what kind of children they will have.

As Hayek noted:

The recognition of the insuperable limits to his knowledge ought indeed to teach the student of society a lesson of humility which should guard him against becoming an accomplice in men’s fatal striving to control society – a striving which makes him not only a tyrant over his fellows, but which may well make him the destroyer of a civilization which no brain has designed but which has grown from the free efforts of millions of individuals.

Keynes’ interest in this topic appears to have descended from his contempt for the individual, and individual liberty. He once wrote:

Nor is it true that self-interest generally is enlightened; more often individuals acting separately to promote their own ends are too ignorant or too weak to attain even these.

The common denominator in all of these examples — and in my view, the thing that brought Keynes toward eugenics — is the belief that the common individual is too stupid to be the captain of his own destiny. Instead, the state — supposedly equipped with the best minds and the best data — should centrally plan. Eugenicists believe that the state should centrally plan human reproduction, while Keynesians believe that the state should centrally engineer recovery from economic malaise through elevated spending. Although it would be unwise to accuse modern Keynesians of having sympathy for eugenics, the factor linking both of these camps together is John Maynard Keynes himself.

Keynes’ description of an economic depression — that a depression is a fall in the total economic output — is technically correct. And many modern Keynesian economists have made worthwhile contributions — Hyman Minsky, Steve Keen, Michael Hudson, and Joe Stiglitz are four examples . Even the polemicist Paul Krugman’s descriptive work on trade patterns and economic agglomeration is interesting and accurate.

The trouble seems to begin with prescriptions. Keynesianism dictates that the answer to an economic depression is an increase in state spending. And on the surface of it, an increase in state spending will lift the numbers. But will momentarily lifting the numbers genuinely help the economy? Not necessarily; the state could spend millions of dollars on subsidies for things that nobody wants, wasting time, effort, labour and taxes and thus destroying wealth. And the state can push a market into euphoria — just as Alan Greenspan did to the housing market — creating the next bubble and the next bust, requiring an even bigger bailout. State spending creates additional dependency on the state, and perverts the empirical market mechanism — the genuine underlying state of demand in a market economy — which signals to producers what to produce and not produce. Worst of all, centralist policies almost always have knock-on side-effects that no planner could foresee (causality is complicated).

So Hayek’s view on the insuperable limits to knowledge applies as much to the economic planner as it does to the central planner of human reproduction.

While eugenicists and Keynesians make correct descriptive observations — like the fact that certain qualities and traits are inheritable, or more simply that children are like their parents — their attempts to use the state as a mechanism to control these natural systems often turns out to be drastically worse than the natural systems that they seek to replace.

As Keynes seems to admit when — in the German language edition of his General Theory — he noted that the conditions of a totalitarian state may be more amenable to his economic theory, the desire for control may be the real story here.

Keynesianism brings more of the economy under the control of the state. It is a slow and creeping descent into dependency on the state. As we are seeing in Europe today, cuts in state spending in a state-dependent economy can cause deep economic contraction, providing the Keynesian more confirmation for his idea that the state should tax more, and spend more.

That is, until nature intervenes. Just as a state-controlled eugenics program might well spawn an inbred elite suffering hereditary illnesses as a result of a lack of genetic diversity (as seems to have happened with the inbred elite Darwin-Galton-Wedgwood clan), so a state-controlled economy may well grind itself into the dirt as it runs out of innovation as a result of a lack of economic diversity. Such a situation is unsustainable — no planner is smarter than nature.

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The Fabled Greek Mega-Bailout

In a truly eyebrow-raising CNBC interview, Matthew Lynn alleges that Europe shall be saved! (As if by the grace of God!).

With Europe on the brink yet again Germany will act.

The Greeks can’t carry on with the austerity being imposed on them. No country can be expected to endure annualized falls in GDP  of 7 percent or more,” he said, “and 50 percent youth unemployment for years on end.

On Tuesday we learned that the Greek economy shrank by another 6.2 percent in the latest quarter. It simply isn’t acceptable” Lynn said.

But Germany and the rest of the EU could come up with a Marshall Aid-style package for Greece. Very little of the bail-out money so far has gone to the Greeks. It has all gone to the bankers.

Forget talk of a ‘Grexit’. There will be a mega-bail-out—a ‘Grashall Plan’—instead.

And when it happens, the markets will rally on the news.

At various stages in the last two years everyone from China, to Germany, to the Fed to the IMF, to Martians, to the Imperial Death Star has been fingered as the latest saviour of the status quo. And so far — in spite of a few multi-billion-dollar half-hearted efforts like the €440 billion EFSF —  nobody has really shown up.

Perhaps that’s because nobody thus far fancies funnelling the money down a black hole. After Greece comes Portugal, and Spain and Ireland and Italy, all of whom together have on the face of things at least €780 billion outstanding (which of course has been securitised and hypothecated up throughout the European financial system into a far larger amount of shadow liabilities, for a critical figure of at least €3 trillion) and no real viable route (other than perhaps fire sales of state property? Sell the Parthenon to Goldman Sachs?) to paying this back (austerity has just led to falling tax revenues, meaning even more money has had to be borrowed), not to mention the trillions owed by the now-jobless citizens of these countries, which is now also imperilled. What’s the incentive in throwing more time, effort, energy and resources into a solution that will likely ultimately prove as futile as the EFSF?

The trouble is that this is playing chicken with an eighteen-wheeler. While Draghi might be making noises about “continuing to comply with the mandate of keeping price stability over the medium term in line with treaty provisions and preserving the integrity of our balance sheet” (in other words, not proceeding with the fabled “mega-bailout” even if it fractures the Euro), we may well see a full-blown financial meltdown (and of course, the ramifications of that on anyone who is exposed to the European banking system) unless someone — whether it is the ECB, or the Fed, or the IMF — prints the money to keep the system liquid.

There are really two layers to bailing out the insolvent nations: the real bailout is of the banks who bought the debt, and the insolvent nations are just an intermediary. Should the insolvent nations become highly uncooperative, it seems more likely that the insolvent nations will just be cut out of the loop (throwing their citizens into experiencing a forced currency redenomination, bank runs, and even more chaos) while policymakers continue to channel money into “stabilising” the totally broken global financial system — because we know for sure that a big disorderly default will likely cause some kind of default cascade, and that is something I am sure that (based on past form) policymakers will seek to avoid.

How close to the collapse we will come before the money gets printed is another matter.

Given that it is predominantly Germans who are in charge of Europe for the moment — with their unusual post-Weimar distaste for monetary expansion —  it seems to me like just as we have seen so far, the money will come at the last minute, and will just keep things ticking over rather than actually solving anything.

And ultimately, I think it is the social conditions — particularly unemployment levels — that matter more than whether or not the financial system survives. If the attendant cost of ad hoc bailouts (in the name of pretending to stick to the ECB mandate) is a continued depression, and continued massive unemployment and youth unemployment then politicians are focusing on the wrong thing.

The problem is that as conditions continue to fester and as solutions seem distant and improbable that Europe’s problems may become increasingly political. As the established (dis)order in Europe continues to leave huge swathes of people jobless and angry, their rage and discomfort will be channelled toward dislodging the establishment. As we have seen in Greece and France, that has already produced big lifts for both the Far Left and Far Right.

We already know, I think, that in Greece’s upcoming election the outsider parties will crush the establishment, with SYRIZA most likely emerging on top. A key metric for me in the next few weeks will be Golden Dawn‘s proportion of the vote.

Let’s not forget history:

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Double or Nothing: How Wall Street is Destroying Itself

There’s nothing controversial about the claim— reported on by Slate, Bloomberg and Harvard Magazine — that in the last 20 years Wall Street has moved away from an investment-led model, to a gambling-led model.

This was exemplified by the failure of LTCM which blew up unsuccessfully making huge interest rate bets for tiny profits, or “picking up nickels in front of a streamroller”, and by Jon Corzine’s MF Global doing practically the same thing with European debt (while at the same time stealing from clients).

As Nassim Taleb described in The Black Swan this strategy — betting large amounts for small frequent profits — is extremely fragile because eventually (and probably sooner in the real world than in a model) losses will happen (and, of course, if you are betting big, losses will be big). If you are running your business on the basis of leverage, this is especially dangerous, because facing a margin call or a downgrade you may be left in a fire sale to raise collateral.

This fragile business model is in fact descended from the Martingale roulette betting system. Martingale is the perfect example of the failure of theory, because in theory, Martingale is a system of guaranteed profit, which I think is probably what makes these kinds of practices so attractive to the arbitrageurs of Wall Street (and of course Wall Street often selects for this by recruiting and promoting the most wild-eyed and risk-hungry). Martingale works by betting, and then doubling your bet until you win. This — in theory, and given enough capital — delivers a profit of your initial stake every time. Historically, the problem has been that bettors run out of capital eventually, simply because they don’t have an infinite stock (of course, thanks to Ben Bernanke, that is no longer a problem). The key feature of this system— and the attribute which many institutions have copied — is that it delivers frequent small-to-moderate profits, and occasional huge losses (when the bettor runs out of money).

The key difference between modern business models, and the traditional roulette betting system is that today the focus is on betting multiple times on a single outcome. By this method (and given enough capital) it is in theory possible to win whichever way an event goes. If things are going your way, it is possible to insure your position by betting against your initial bet, and so produce a position that profits no matter what the eventual outcome. If things are not going your way, it is possible to throw larger and larger chunks of capital into a position or counter-position again and again and again —mirroring the Martingale strategy — to try to compensate for earlier bets that have gone awry (this, of course, is so often the downfall of rogue traders like Nick Leeson and Kweku Adoboli).

This brings up a key issue: there is a second problem with the Martingale strategy in the real world beyond the obvious problem of running out of capital. You can have all the capital in the world (and thanks to the Fed, the TBTF banks now have a printing-press backstop) but if you do not have a counter-party to take your bets  (and as your bets and counter-bets get bigger and bigger it by definition becomes harder and harder to find suitable counter-parties) then you are Corzined, and you will be left sitting on top of a very large load of pain (sound familiar, Bruno Iksil?)

The obvious real world example takes us back to the casino table — if you are trying to execute a Martingale strategy starting at $100, and have lost 10 times in a row, your 11th bet would have to be for $204,800 to win back your initial stake of $100. That might well exceed the casino table limits — in other words you have lost your counter-party, and are left facing a loss far huger than any expected gains.

Similarly (as Jamie Dimon and Bruno Iksil have now learned to their discredit) if you have built up a whale-sized market-dominating gross position of bets and counter-bets on the CDX IG9 index (or any such market) which turns heavily negative, it is exceedingly difficult to find a counter-party to continue increasing your bets against, and your Martingale game will probably be over, and you will be forced to face up to the (now exceedingly huge) loss. (And this recklessness is what Dimon refers to as “hedging portfolio risk“?)

The really sickening thing is that I know that these kinds of activities are going on far more than is widely recognised; every time a Wall Street bank announces a perfect trading quarter it sets off an alarm bell ringing in my head, because it means that the arbitrageurs are chasing losses and picking up nickels in front of streamrollers again, and emboldened by confidence will eventually will get crushed under the wheel, and our hyper-connected hyper-leveraged system will be thrown into shock once again by downgrades, margin calls and fire sales.

The obvious conclusion is that if the loss-chasing Martingale traders cannot resist blowing up even with the zero-interest rate policy and an unfettered fiat liquidity backstop, then perhaps this system is fundamentally weak. Alas, no. I think that the conclusion that the clueless schmucks at the Fed have reached is that poor Wall Street needs not only a lender-of-last-resort, but a counter-party-of-last-resort. If you broke your trading book doubling or quadrupling down on horseshit and are sitting on top of a colossal mark-to-market loss, why not have the Fed step in and take it off your hands at a price floor in exchange for newly “printed” digital currency? That’s what the 2008 bailouts did.

Only one problem: eventually, this approach will destroy the currency. Would you want your wealth stored in dollars that Bernanke can just duplicate and pony up to the latest TBTF Martingale catastrophe artist? I thought not: that’s one reason why Eurasian creditor nations are all quickly and purposefully going about ditching the dollar for bilateral trade.

The bottom line for Wall Street is that either the bailouts will stop and anyone practising this crazy behaviour will end up bust — ending the moral hazard of adrenaline junkie coke-and-hookers traders and 21-year-old PhD-wielding quants playing the Martingale game risk free thanks to the Fed — or the Fed will destroy the currency. I don’t know how long that will take, but the fact that the dollar is effectively no longer the global reserve currency says everything I need to know about where we are going.

The bigger point here is whatever happened to banking as banking, instead of banking as a game of roulette? You know, where investment banks make the majority of their profits and spend the majority of their efforts lending to people who need the money to create products and make ideas reality?

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Is China a Currency Manipulator?

Mitt Romney thinks so:

China has an interest in trade. China wants to, as they have 20 million people coming out of the farms and coming into the cities every year, they want to be able to put them to work. They want to have access to global markets. And so we have right now something they need very badly, which is access to our market and our friends around the world, have that same– power over China. To make sure that we let them understand that in order for them to continue to have free and open access to the thing they want so badly, our markets, they have to play by the rules.

They’re a currency manipulator. And on that basis, we go before the W.T.O. and bring an action against them as a currency manipulator. And that allows us to apply tariffs where we believe they are stealing our intellectual property, hacking into our computers, or artificially lowering their prices and killing American jobs. We can’t just sit back and let China run all over us. People say, “Well, you’ll start a trade war.” There’s one going on right now, folks. They’re stealing our jobs. And we’re gonna stand up to China.”

The theory goes that by buying U.S. currency (so far they have accumulated around $3 trillion) and treasuries (around $1 trillion) on the open market, China keeps demand for the US dollar high.  They can afford to buy and hold so much US currency due to their huge trade surplus with America, and they buy US currency roughly equal to this surplus.  To keep this pile of dollars from increasing the Chinese money supply, China sterilises the dollar purchases by selling a proportionate amount of bonds to Chinese investors.  Supposedly by boosting the dollar, yuan-denominated Chinese goods look cheap to the American (and global) consumer.

First, I don’t really think we can conclusively say that the yuan is necessarily undervalued. That is like assuming that there is some natural rate of exchange beyond prices in the real world. For every dollar that China takes out of the open market, America could print one more — something which, lest we forget — Bernanke has been very busily doing; the American monetary base has tripled since 2008. Actions have consequences; if China’s currency peg was so unsustainable, the status quo would have collapsed long ago. Until it does, we cannot conclusively say to what extent the yuan is undervalued.

What Romney is forgetting is that every nation with a fiat currency is to some degree or other a currency manipulator. That’s what fiat is all about: the ability of the state to manipulate markets through monetary policy. When Ben Bernanke engages in quantitative easing, or twisting, or any kind of monetary policy or open market operation, the Federal Reserve is engaging in currency manipulation. Every new dollar that is printed devalues every dollar out in the wild, and just as importantly all dollar-denominated debt. So just as Romney can look China in the face and accuse them of being a currency manipulator for trying to peg the yuan to the dollar, China can look at past U.S. administrations and level exactly the same claim — currency manipulation in the national interest.

While China’s currency policy in the past 40 years has been to attract manufacturing, technology, resources and investment into China (and build up a manufacturing base to provide employment to its low-skilled population) by keeping its produce cheap, America’s currency policy has sought to enjoy a free lunch made up of everyone else’s labour and resources. This has been allowed to develop because of America’s reserve currency status — everyone has needed dollars to access global markets, and so America has rested on her laurels and allowed her productive industries to decline. Why manufacture the bulk of your consumption when China can do it cheaper, and Wal Mart has no problem with slave labour? Why manufacture your military hardware when China can do it cheaper? Why produce your own energy when you can instead consume Arab and Latin American oil?

Former U.S. ambassador Jon Huntsman raised this issue in an article from China Business News in a cable that was eventually leaked via Wikileaks:

The U.S. has almost used all deterring means, besides military means, against China.  China must be clear on discovering what the U.S. goals are behind its tough stances against China. In fact, a fierce competition between the currencies of big countries has just started.  A crucial move for the U.S. is to shift its crisis to other countries – by coercing China to buy U.S. treasury bonds with foreign exchange reserves and doing everything possible to prevent China’s foreign reserve from buying gold.

If we use all of our foreign exchange reserves to buy U.S. Treasury bonds, then when someday the U.S. Federal Reserve suddenly announces that the original ten old U.S. dollars are now worth only one new U.S. dollar, and the new U.S. dollar is pegged to the gold – we will be dumbfounded.

Today when the United States is determined to beggar thy neighbor, shifting its crisis to China, the Chinese must be very clear what the key to victory is.  It is by no means to use new foreign exchange reserves to buy U.S. Treasury bonds.  The issues of Taiwan, Tibet, Xinjiang, trade and so on are all false tricks, while forcing China to buy U.S. bonds is the U.S.’s real intention.”

Romney and others of his ilk might brush this off, believing that China’s $3 trillion dollar reserve hoard was gained through unfair means — slave labour, cutting corners in quality, the aforementioned “currency manipulation”, etc, and that that somehow gives America the right to inflate away its debts and screw its creditors. To some degree, they have a point. If China had a problem with America inflating away its debts, it should never have put itself so deep into dollar-denominated paper. If China recognised that America’s debt position was unsustainable, it should never have put so much into something so unsustainable, irrespective of supposed American pressure.

In the short term, though, I think escalating the trade war through the imposition of tariffs is a very bad idea. America is a consumption-led economy, and with middle class incomes already squeezed, a constriction of the supply of cheap and readily available goods is likely to put a lot of downward pressure on consumption. And it’s not just consumption — in today’s hyper-globalised world, a huge proportion of manufacturing — including military hardware — at some stage flows through China.

As Vincent Fernando noted:

Most of America’s key military technologies require rare earth elements, whose production China holds a near-monopoly over.

It’s thus perhaps no surprise that China has made the threat of rare earth export restrictions a new political bargaining chip.

American corporations could gradually pull out of China and shift to manufacturing and extracting resources elsewhere including America (which has large rare earth deposits), but it would be a challenging process. Rebuilding an industrial base is hard: skilled and experienced labour takes time to develop (American labour is rusty and increasingly unemployed and disabled), and supply chains and webs have all agglomerated in China. Building up domestic supply chains takes time, expertise and entrepreneurial zeal. And any destabilisation could spook global markets.

So let’s make no mistake: in the short term America needs China far, far, far more than China needs America. The notion that China needs America as a consumer is totally false; anyone can consume given the dollars or gold, and China holds $3 trillion, and continues to increase its imports of gold.

Peter Schiff summarises:

The big problem for countries like China and India is that they still subsidize the U.S. They buy our Treasury bonds and lend us all this money so we can keep consuming. That’s a big subsidy and a heavy burden.

They can use their money to develop their own economy, produce better and more abundant products for their own citizens. It’s a farce to think that the only thing China can do with its output and savings is lend it to the U.S. government, especially when we can’t pay it back.

Mitt Romney seems intent on destabilising this fragile relationship. American policy that incentivised globalisation and the service economy has very foolishly drawn America into this fragile position where its economy is increasingly fuelled not only by energy coming out of the politically and economically unstable middle east, but also by goods coming from a hostile and increasingly politically and economically unstable power.

And make no mistake — although China has done well to successfully transform itself into the world’s pre-eminent industrial base and biggest creditor, it has a lot of bubbles waiting to burst (particularly housing), stemming from the misallocation of resources under its semi-planned regime. Which makes this entire scenario doubly dangerous. Any shock in China would surely be transmitted to America, simply because it is becoming increasingly pointless for China to continue subsidising American consumption (through buying treasuries) when they could instead spend the money raising the Chinese standard of living. That could mean a painful rate-spike.

The real problem is that Romney is trying to address a problem that is very much in the past. If Romney was elected as President on this platform in 2000, things might be different. But China got what it wanted: by keeping its currency cheap and its labour force impoverished it became the world’s pre-eminent industrial base, the spider at the heart of the web of global trade, and a monopoly on important industrial components and resources. China used American demand, technology and investment during the 00s to develop. Now the imperative is not to grab a bigger share of global manufacturing, or a bigger hoard of dollars, it’s to leverage that position toward the ultimate aim of returning China to its multi-millennial superpower status. The promise of Chinese primacy is quite simply the strongest tool for the CPC to retain its (increasingly shaky) grip on China.

However we should not discount the possibility that bursting economic bubbles may stoke up some kind of popular rebellion against the Communist authorities in some kind of Chinese Spring. A new more pro-Western regime is surely America’s best hope of containing China, while gradually manoeuvring itself out of dependency on Arab oil and Chinese goods. But that may just be wishful thinking; it is possible that a new Chinese regime may be vehemently anti-Western; the Opium War and China’s 20th century humiliation still ring deeply in the Chinese psyche.

So it is unclear what is next for China, and the relationship between China and America. But having the world’s biggest manufacturing base and a monopoly over rare earths is a strong position to be in if your ultimate aim is to manufacture huge quantities of armaments in the pursuit of an aggressive, expansionist foreign policy…

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Paul vs Paul: Round #2

Bloomberg viewers estimate that Ron Paul was the winner of the clash of the Pauls (Ron Paul fans, of course, are very studious at phoning in their support him for). But that is very much beside the point. This wasn’t really a debate. Other than the fascinating moment where Krugman denied defending the economic policies of Diocletian, very little new was said, and the two combatants mainly talked past each other.

The first debate happened early last decade.

To wit:

And so, round two. Krugman wants more inflation; Paul is scared of the prospect. From Paul’s FT editorial yesterday:

Control of the world’s economy has been placed in the hands of a banking cartel, which holds great danger for all of us. True prosperity requires sound money, increased productivity, and increased savings and investment. The world is awash in US dollars, and a currency crisis involving the world’s reserve currency would be an unprecedented catastrophe. No amount of monetary expansion can solve our current financial problems, but it can make those problems much worse.

Or, as Professor Krugman sees it:

Would a rise in inflation to 3 percent or even 4 percent be a terrible thing? On the contrary, it would almost surely help the economy.

How so? For one thing, large parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years; this debt burden is arguably the main thing holding private spending back and perpetuating the slump. Modest inflation would, however, reduce that overhang — by eroding the real value of that debt — and help promote the private-sector recovery we need. Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recover.

Ron Paul believes that inflationary interventions into the dollar economy will have unpredictable and dangerous ramifications. Paul Krugman believes that a little more inflation will spur economic activity and decrease residual debt overhang. Krugman gives no credence to the prospect of inflation spiralling out of hand, or of such policies triggering other deleterious side-effects, like a currency crisis.

The prospect of a currency crisis is a topic I have covered in depth lately: as more Eurasian nations ditch the dollar as reserve currency, more dollars (there are $5 trillion floating around Asia, in comparison to a domestic monetary base of just $1.8 trillion — the dollar is an absurdly internationalised currency) will be making their way back into the domestic American economy. Will that have an impact?

I don’t really know how much of this is to do with the Fed’s reflationary policies, and how much is to do with the United States’ endangered role as global hegemon. I tend to think that the dollar hegemony has always been backed by American military force, and with the American military overstretched, the dollar’s role comes into question. If America can’t play the global policeman for global trade, why would the dollar be the currency on global trade?

However it must be noted that America’s creditors do believe that their assets are threatened by the Fed’s inflationism.

As the Telegraph noted last year:

There has been a hostile reaction by China, Brazil and Germany, among others, to the Federal Reserve’s decision to resume quantitative easing.

Or as a Xinhua editorial rather bluntly put it:

China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.

Of course, China may be totally bluffing, or getting it wrong on the danger of inflation to its assets.

If the reflationism is angering the exporter nations perhaps it is a cause for concern. After all, if America’s consumption-based economy is dependent on China’s continued exportation, and Krugman is advocating inflating away their debt-denominated financial assets, then to what extent do Krugman’s suggestions imperil the trans-Pacific consumer-producer relationship?

And this is a crucial matter — there is nothing, I think, more crucial than the free availability of goods and resources through the trade infrastructure. Getting into a fight with China is risky.

As commenter Thomas P. Seager noted yesterday:

[The situation today] is directly analogous to the first Oil Shock in 1973. In the decades prior, the US had been a major oil producer. However, efficiency gains and discoveries overseas resulting in an incrementally increasing dependence of foreign petroleum. Price signals failed to materialize that would caution policy makers and industrialists of the risks.

Then, the disruption of oil supplies from the Middle East caused tremendous economic dislocations.

Manufacturing is undergoing the same process. The supply chain disruption from the Japanese earthquake and Tsunami was merely a warning shot. Imagine if S Korean manufacturing were taken off-line for any length of time (a plausible scenario). The disruption to US industry would be catastrophic.

In the name of increased efficiency, we have introduced brittleness.

Time will tell whether Krugman’s desire for more inflation is wise or not.

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Krugman, Diocletian & Neofeudalism

The entire economics world is abuzz about the intriguing smackdown between Paul Krugman and Ron Paul on Bloomberg. The Guardian summarises:

  • Ron Paul said it’s pretentious for anyone to think they know what inflation should be and what the ideal level for the money supply is.
  • Paul Krugman replied that it’s not pretentious, it’s necessary. He accused Paul of living in a fantasy world, of wanting to turn back the clock 150 years. He said the advent of modern currencies and nation-states made an unmanaged economy an impracticable idea.
  • Paul accused the Fed of perpetrating “fraud,” in part by screwing with the value of the dollar, so people who save get hurt. He stopped short of calling for an immediate end to the Fed, saying that for now, competition of currencies – and banking structures – should be allowed in the US.
  • Krugman brought up Milton Friedman, who traversed the ideological spectrum to criticize the Fed for not doing enough during the Great Depression. It’s the same criticism Krugman is leveling at the Fed now. “It’s really telling that in America right now, Milton Friedman would count as being on the far left in monetary policy,” Krugman said.
  • Paul’s central point, that the Fed hurts Main Street by focusing on the welfare of Wall Street, is well taken. Krugman’s point that the Fed is needed to steer the economy and has done a better job overall than Congress, in any case, is also well taken.

I find it quite disappointing that there has not been more discussion in the media of the idea — something Ron Paul alluded to — that most of the problems we face today are extensions of the market’s failure to liquidate in 2008. Bailouts and interventionism has left the system (and many of the companies within it) a zombified wreck. Why are we talking about residual debt overhang? Most of it would have been razed in 2008 had the market been allowed to liquidate. Worse, when you bail out economic failures — and as far as I’m concerned, everyone who would have been wiped out by the shadow banking collapse is an economic failure — you obliterate the market mechanism. Should it really be any surprise that money isn’t flowing to where it’s needed?

A whole host of previously illiquid zombie banks, corporations and shadow banks are holding onto trillions of dollars as a liquidity buffer. So instead of being used to finance useful and productive endeavours, the money is just sitting there. This is reflected in the levels of excess reserves banks are holding (presently at an all-time high), as well as the velocity of money, which is at a postwar low:

Krugman’s view that introducing more money into the economy and scaring hoarders into spending more is not guaranteed to achieve any boost in productivity.

As I wrote last month:

The fundamental problem at the heart of this is that the Fed is trying to encourage risk taking by making it difficult to allow small-scale market participants from amassing the capital necessary to take risk. That’s why we’re seeing domestic equity outflows. And so the only people with the apparatus to invest and create jobs are large institutions, banks and corporations, which they are patently not doing.

Would more easing convince them to do that? Probably not. If you’re a multinational corporation with access to foreign markets where input costs are significantly cheaper, why would you invest in the expensive, over-regulated American market other than to offload the products you’ve manufactured abroad?

So will (even deeper) negative real rates cause money to start flowing? Probably — but probably mostly abroad — so probably without the benefits of domestic investment and job creation.

Nor is it guaranteed to achieve any great boost in debt relief.

As Dan Kervick wrote for Naked Capitalism last month:

Inflation only reduces debt overhang in a significant way for households who are fortunate enough to see their nominal wages rise along with the general rise in prices. In today’s economy, workers are frequently not so fortunate.

Again, I have to bring this back to why we are even talking about debt relief. The 2008 crash was a natural form of debt-relief; the 2008 bailouts, and ongoing QE and Twist programs (which contrary to Professor Krugman’s apologetics really do transfer wealth from the middle classes to Wall Street) crystallised the debt burden born from a bubble created by Greenspan’s easy money policies. There would be no need for a debt jubilee (either an absolute one, or a Krugmanite (hyper)inflationary one) if we had simply let the market do its work. A legitimate function for government would have at most been to bail out account holders, provide a welfare net for poor people (never poor corporations) and let bankruptcy courts and markets do the rest. Instead, the central planners in Washington decided they knew best.

The key moment in the debate?

I am not a defender of the economic policies of the emperor Diocletian. So let’s just make that clear.

Paul Krugman

Actually you are.

Ron Paul

Ron Paul is dead right. Krugman and the bailout-happy regime for which he stands are absolutely following in the spirit of Diocletian.

From Dennis Gartman:

Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 301 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control.

Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

While Krugman does not by any means endorse the level of centralism that Diocletian introduced, his defence of bailouts, his insistence on the planning of interest rates and inflation, and (most frighteningly) his insistence that war can be an economic stimulus (in reality, war is a capital destroyer) all put him firmly in Diocletian’s economic planning camp.

So how did Diocletian’s economic program work out?

Well, I think it is fair to say even without modern data that — just as Krugman desires — Diocletian’s measures boosted aggregate demand through public works and — just as Krugman desires — it introduced inflation.

Diocletian’s mass minting of coins of low metallic value continued to increase inflation, and the maximum prices in the Edict were apparently too low.

Merchants either stopped producing goods, sold their goods illegally, or used barter. The Edict tended to disrupt trade and commerce, especially among merchants. It is safe to assume that a gray market economy evolved out of the edict at least between merchants.

And certainly Rome lived for almost 150 years after Diocletian. However the long term effects of Diocletian’s economic program were dire:

Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began.

Have the 2008 bailouts done the same thing, cementing a new feudal aristocracy of bankers, financiers and too-big-to-fail zombies, alongside a serf class that exists to fund the excesses of the financial and corporate elite?

Only time will tell.

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Anything the Government Gives You, the Government Can Take Away

From the Guardian:

A majority of doctors support measures to deny treatment to smokers and the obese, according to a survey that has sparked a row over the NHS‘s growing use of “lifestyle rationing”.

Some 54% of doctors who took part said the NHS should have the right to withhold non-emergency treatment from patients who do not lose weight or stop smoking. Some medics believe unhealthy behaviour can make procedures less likely to work, and that the service is not obliged to devote scarce resources to them.

And that’s the trouble with services and institutions run from the taxpayer’s purse, administered by centralists and bureaucrats. It becomes a carrot or a stick for interventionists to intervene in your life. Its delivery depends on your compliance with the diktats and whims of the democracy, or of bureaucrats. Your standard of living becomes a bargaining chip. Don’t conform? You might be deemed unworthy of hospital treatment.

It seems innocuous to promise all manner of services in exchange for taxes. Citizens may welcome the convenience, the lower overheads, the economies of scale. They may welcome a freebie, and the chance to enjoy the fruits of someone else’s labour. They may feel entitled to it.

Many words have been spent on the problems of dependency; that rather than working for an honest living, the poor may be sucked into a vortex of entitlement, to such an extent that they lose the desire to produce. A tax-sucking multi-generational underclass can develop. Individuals can live entirely workless lives, enjoying a semi-comfortable existence on the teat of the taxpayer, enjoying the fruits — financial handouts, free education, free healthcare, a free home — of social engineers who believe that every problem under the sun can be remedied by government largesse and throwing money at problems. And who can blame them? Humans have sought out free lunches for as long as there have been humans.

Welfare dependency is generally assumed to be viewed negatively in the corridors of power. After all, broad welfare programs mean greater spending, and that very often means great debt. And why would a government want to be in debt? Surely governments would prefer it if more of the population was working and productive and paying taxes?

But it is easier to promote behaviour desired by the state when a population lives on state handouts. And for states that might want to influence the behaviour of their citizens — their resource consumption, their carbon footprint, their moral and ethical beliefs, or their attitude toward the state — this could be an attractive proposition. It might cost a lot to run a welfare system, but it brings a lot of power to influence citizens.

And increasingly throughout the Western world, citizens are becoming dependent on the state for their standard of living. In the UK, 92% of people are dependent on the socialist NHS for healthcare. 46 million Americans receive food stamps. That gives states a lot of leverage to influence behaviour. First it may be used in a (relatively sensible) attempt to curtail smoking and obesity. Beyond that, the sky is the limit. Perhaps doctors or bureaucrats may someday suggest withholding treatment or dole money from those who exceed their personal carbon or meat consumption quota? A tyrant could even withhold welfare from those who do not pledge their undying allegiance or military service to a regime or ideology (it happened many times last century). An underclass of rough and hungry welfare recipients is a fertile recruiting ground for military and paramilitary organisations (like the TSA).

With the wide expansion of welfare comes a lot of power, and the potential for the abuse of power. Citizens looking for a free lunch or an easier world should be careful what they wish for. Welfare recipients take note: you depend on government for your standard of living, you open yourself up to losing your liberty.

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Mining the Skies

In August last year I wrote:

Concerned about resource scarcity? There’s plenty more up there. Last year, scientists confirmed that there was water on the moon. And there are metals and hydrocarbons abundant in asteroids. Metallic asteroids  possess copper, silver, gold, and all other such elements as well, though not in abundances anywhere near as large as those of their primary constituents.

It’s an age old trope, going back to John S. Lewis’ book on the subject, and one of my greater interests.

I know that Earth is finite. I know that in some limited sense Malthus — my great intellectual nemesis, albeit one who has been proven wrong and wrong again and again — could be proven right. Earth’s resources are limited simply by the fact that Earth is a limited space. If we don’t leave Earth behind, and we continue to expand we will hit Earth’s limits, if not by the end of the century (unlikely, in my view) then by the end of the millennium.

But my key message on this subject is this: Malthus will only ever be proven right if we screw up. It’s a big expansive universe, and we are smart, flexible, ingenious creatures. We don’t know how big, but the amount of resources out there seem far, far beyond the scope of the human imagination. Malthus will always be there with us, a shackle around our necks, forewarning us not to be too gluttonous, or to expand too far too fast, and to maintain an awareness of our access to resources, particularly water and sustenance. Forewarning us, I might add, of the dangers of our own arrogance. But resource pressures are something we can always conquer without resorting to any kind of nasty authoritarianism.

For just as I expected — and not a moment too soon — a cohort of the wealthy are putting their economic weight behind the idea of going out and getting more resources.

From the Telegraph:

Power players including Eric Schmidt, the Google chairman, and James Cameron, the film director, are planning to mine the final frontier: space.

They are among the backers of a new venture that will reach for the riches lying elsewhere in the solar system. Planetary Resources will be a “space exploration company to expand Earth’s resource base” according to scant information released ahead of the start-up’s launch in Seattle on Tuesday.

“The company will overlay two critical sectors – space exploration and natural resources – to add trillions of dollars to the global GDP,” was the bold claim. “This innovative start-up will create a new industry and a new definition of ‘natural resources’.”

Mr Schmidt and the internet giant’s co-founder Larry Page are listed alongside Mr Cameron, the director of Titanic and Avatar, among the venture’s investors and advisers.

The company was founded by Eric Anderson and Peter Diamandis. “Since my childhood I’ve wanted to do one thing, be an asteroid miner,” Mr Diamandis told Forbes earlier this year. “So stay tuned on that one.”

While the costs of space travel are high, the hope is that riches contained in asteroids would make the sums worthwhile. Studies suggest that gold and other metals in the earth’s crust originated from asteroids that collided with the planet during its early life.

This is not the end of the road, but the start.

In any new industry there will be failures, some dramatic. Solar energy is a wonderful principle, but Solyndra was a terrible company.

But it is a pleasing start. Human civilisation just took a step in the right direction. And the ghost of Malthus just took another crashing blow.