warren buffett

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Australia just scrapped its debt ceiling. America should, too.

Debt ceiling fights, it seems, have become a permanent fixture in American politics. Twice in the last couple of years, the United States has been days away from potentially irrevocable economic damage because Congress refused to raise the debt ceiling and let the Treasury issue more debt. The next debt ceiling fight is slated for March 2014.

But isn’t there a better way to increase a borrowing limit — and one that doesn’t freak out markets, investors, and, well, just about everyone every few months?

Read More At TheWeek.com

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Why the Left Misunderstands Income Inequality

There is a widely-held notion on the political left that the key economic problem that our civilisation faces is income inequality.

To wit:

America emerged from the Great Depression and the Second World War with a much more equal distribution of income than it had in the 1920s; our society became middle-class in a way it hadn’t been before. This new, more equal society persisted for 30 years. But then we began pulling apart, with huge income gains for those with already high incomes. As the Congressional Budget Office has documented, the 1 percent — the group implicitly singled out in the slogan “We are the 99 percent” — saw its real income nearly quadruple between 1979 and 2007, dwarfing the very modest gains of ordinary Americans. Other evidence shows that within the 1 percent, the richest 0.1 percent and the richest 0.01 percent saw even larger gains.

By 2007, America was about as unequal as it had been on the eve of the Great Depression — and sure enough, just after hitting this milestone, we plunged into the worst slump since the Depression. This probably wasn’t a coincidence, although economists are still working on trying to understand the linkages between inequality and vulnerability to economic crisis.

I mostly agree that income inequality is a huge problem, although I believe that it is a symptom of a wider malaise. But income inequality is an important symptom of that wider malaise.

Here’s the key chart:

However it is just as important, perhaps more important to identify the causes of the income inequality.

I have my own pet theory:

The growth in income inequality seems to be largely an outgrowth of giving banks a monopoly over credit creation. In 1971, Richard Nixon severed the link between the dollar and gold, expanding the monopoly on credit creation to a carte blanche to print huge new quantities of dollars and give them to their friends.

Unsurprisingly, this led to a huge growth in the American and global money supplies. This new money was not exactly distributed evenly. A shrinking share has gone to wage labour.

However the dominant explanation on the left is that this is down to the tax structure. I can’t falsify this theory, because the data supports it:

But why has the government chosen to tax corporations less, and payrolls more?

Who owns the government? Political donors — they finance the political system. Before one vote is cast candidates tailor their platforms to meet the criteria of donors. Who are political donors? Well, they are people with spare capital to expend in the name of getting politicians elected.

Here’s a side-by-side comparison of the presumptive 2012 Presidential nominees:

(Even bigger money flows through the Super PACs. A full breakdown of Super PAC donors can be found here; the same donor profile emerges).

So who are the biggest donors? Banks & large corporations: the very people who have benefited most from the post-1971 tidal wave of fiat credit creation.

So not only has an exorbitantly high proportion of new credit gone into corporate and financial profits, but the beneficiaries have used these fruits to buy out the political system, thus ensuring that they keep an even higher proportion of their incomes, while making up for this slump with greater borrowing, and greater taxation of payrolls.

The political left — epitomised, I suppose, by the Occupy movement — often call for “taking the money out of politics”. By this, they seem to mean holding elections that are not funded by private money, where all candidates are given the same resources. The reality of this, of course, is that such a measure would require a change in the Constitution, as privately-funded political advertising is protected speech under the First Amendment.

But let’s assume — just for the sake of argument — that a law “taking the money out of politics” could be enacted by simple majorities in the House, the Senate, and a Presidential signature (after all, President Obama’s legislative program has not maintained much respect for the original intent of the U.S. Constitution). Even under those implausible circumstances, why would Congress pass such a law when the entire political system is dominated by financial donors who want their money to very much be in politics? After all, it is not just for the sake of tax avoidance — government largesse produces lucrative contracts for contractors. The more money the government has to redistribute, the more incentive there is to spend money to get your people into office redistributing it, and government has more money to distribute — both in absolute terms, and as a percentage of GDP — than at any time since World War II.

The other (and simpler) proposed solution from the left is raising taxes on the rich, so that they pay a “fair share”. There are two problems with this. Firstly, that raising taxes during an economic depression is contractionary, and will (like the misguided and destructive European austerity programs, which of course include tax hikes) depress economic conditions further. And even if this was a good proposal (it isn’t), the political class will fiercely resist such proposals. Today, the Democratic-controlled Senate voted down the so-called Buffett Rule, that would have imposed a 30% floor on taxation for incomes over $250,000. (Buffett — as a top recipient of Federal Reserve bailout cash — would have no problem paying such a rate, unlike those far poorer than him who never took a penny of bailout money. Buffett would do well to spend less time in the bath thinking about Becky Quick, and more time using his capital to create jobs, to end this depression.)

Income inequality is a symptom of a grave problem: corporatism.

From Professors Ammous and Phelps:

Now the capitalist system has been corrupted. The managerial state has assumed responsibility for looking after everything from the incomes of the middle class to the profitability of large corporations to industrial advancement. This system, however, is not capitalism, but rather an economic order that harks back to Bismarck in the late nineteenth century and Mussolini in the twentieth: corporatism.

In various ways, corporatism chokes off the dynamism that makes for engaging work, faster economic growth, and greater opportunity and inclusiveness. It maintains lethargic, wasteful, unproductive, and well-connected firms at the expense of dynamic newcomers and outsiders, and favors declared goals such as industrialization, economic development, and national greatness over individuals’ economic freedom and responsibility. Today, airlines, auto manufacturers, agricultural companies, media, investment banks, hedge funds, and much more has at some point been deemed too important to weather the free market on its own, receiving a helping hand from government in the name of the “public good.”

The costs of corporatism are visible all around us: dysfunctional corporations that survive despite their gross inability to serve their customers; sclerotic economies with slow output growth, a dearth of engaging work, scant opportunities for young people; governments bankrupted by their efforts to palliate these problems; and increasing concentration of wealth in the hands of those connected enough to be on the right side of the corporatist deal.

A realistic program to  “take the money out of politics” — in other words, to return America’s form of government to its original constitutional intent, like the program advocated by Ron Paul — would do a lot to decapitate corporate power and the military-industrial-financial-corporate complex, who are mostly dependent upon government largesse, favourable regulation, bailouts, and moral-hazard-creating fictions like limited liability — for their very existence. But that won’t fly with either the political kingmakers, or the welfare-loving hordes of  voters (and often for good reason — many of us have paid taxes toward welfare all our lives, and don’t want to lose out of something we have paid for).

The real conclusion of this is that the status quo is not sustainable. Corporatism and oligopoly is almost never sustainable, because of the dire social consequences. Today, almost 20% of young people are unemployed, wasting on the scrapheap. The median net worth of the young is lower than it was 30 years ago. The number of long-term unemployed has spiked to an all-time-high. Prison populations are at all time highs — and the highest in the world, both proportionally, and in absolute terms. America’s former industrial belt rusts; American manufacturing (what’s left of it) has often been reduced to re-assembling foreign components. America is heavily dependent on foreign oil. The American imperial machine is suffering from a lack of manpower. America’s strengths are melting away in a firestorm of misguided central planning, imperial waste, and corporate corruption. America’s social culture is fiery and combustible and individualistic. Young people denied opportunity by a broken system will do something about it. Occupy Wall Street and the 2012 Ron Paul Presidential campaigns were the first manifestations of the jilted generation dabbling in politics.

The political left misunderstands the causes of income inequality — confused by the belief that government can somehow challenge the corporate and financial power it created in the first place — and thus proposes politically unrealistic (non-) solutions, particularly campaign finance reform, and raising taxes on the rich and corporations. Yes, the left are well-intentioned. Yes, they identify many of the right problems.  But how can government effectively regulate or challenge the power of the financial sector, megabanks and large corporations, when government is almost invariably composed of the favourite sons of those organisations? How can anyone seriously expect a beneficiary of the oligopolies — whether it’s Obama, McCain, Romney, Bush, Gore, Kerry, or any of the establishment Washingtonian crowd — to not favour their donors, and their personal and familial interests? How can we not expect them to favour the system that they emerged through, and which favoured them?

In reality, the system of corporatism that created the income inequality will inevitably degenerate of its own accord. The only question is when…

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The Fed Confronts Itself

From Matt Taibbi:

Wall Street is buzzing about the annual report just put out by the Dallas Federal Reserve. In the paper, Harvey Rosenblum, the head of the Dallas Fed’s research department, bluntly calls for the breakup of Too-Big-To-Fail banks like Bank of America, Chase, and Citigroup.

The government’s bottomless sponsorship of these TBTF institutions, Rosenblum writes, has created a “residue of distrust for government, the banking system, the Fed and capitalism itself.”

I don’t know whether to laugh or cry.

First, this managerialism is nothing new for the Fed. The (ahem) “libertarian” Alan Greenspan once said: “If they’re too big to fail, they’re too big.”

Second, the Fed already had a number of fantastic opportunities to “break up” so-called TBTF institutions: right at the time when it was signing off on the $29 trillion of bailouts it has administered since 2008. If the political will existed at the Fed to forcibly end the phenomenon of TBTF, it could (and should) have done it when it had the banks over a barrel.

Third, capitalism (i.e. the market) seems to deal pretty well with the problem of TBTF: it destroys unmanageably large and badly run companies. Decisions have consequences; buying a truckload of derivatives from a soon-to-be-bust counter-party will destroy your balance sheet and render you illiquid. Who seems to blame? The Fed; for bailing out a load of shitty companies and a shitty system . Without the Fed’s misguided actions the problem of TBTF would be long gone. After a painful systemic breakdown, we could have created a new system without any of these residual overhanging problems. We wouldn’t be “taxing savers to pay for the recapitalization of banks whose dire problems led to the calamity.” There wouldn’t be “a two-tiered regulatory environment where the misdeeds of TBTF banks are routinely ignored and unpunished and a lower tier where small regional banks are increasingly forced to swim upstream against the law’s sheer length, breadth and complexity, leading to a “massive increase in compliance burdens.”

So the Fed is guilty of crystallising and perpetuating most of these problems with misguided interventionism. And what’s the Fed’s purported answer to these problems?

More interventionism: forcibly breaking up banks into chunks that are deemed not to be TBTF.

And what’s the problem with that?

Well for a start the entire concept of “too big to fail” is completely wrong. The bailout of AIG had nothing to do with AIG’s “size”. It was a result of systemic exposure to AIG’s failure. The problem is to do with interconnectivity. The truth is that AIG — and by extension, the entire system — was deemed too interconnected to fail. Many, many companies had AIG products on their balance sheets. If AIG had failed (and taken with it all of that paper, very generously known as “assets”) then all those companies would have had a hole blown in their balance sheets, and would have sustained losses which in turn may well have caused them to fail, bleeding out the entire system.

The value that seems to matter in determining systemic robustness is the amount of systemic interconnectivity, in other words the amount of assets on balance sheets that are subject to counter-party risk (i.e. which become worthless should their guarantor fail).

Derivatives are not the only such asset, but they make up by far the majority:


Global nominal exposure is growing again. And those derivatives sit on global balance sheets waiting for the next black swan to blow up a hyper-connected counter-party like AIG. And such a cascade of defaults will likely lead to another 2008-style systemic meltdown, probably ending in another goliath-sized bailout, and another few rounds of the QE slop-bucket.

The question the Fed must answer is this: what difference would it make in terms of systemic fragility if exposures are transferred from larger to companies to smaller ones?

Breaking up banks will make absolutely zero difference, because the problem is not the size but systemic interconnectivity. Losses sustained against a small counter-party can hurt just as much as losses sustained against a larger counter-party. In a hyper-connected system, it is possible for failed small players to quickly snowball into systemic catastrophe.

The Fed (as well as the ECB) would do well to remember that it is not size that matters, but how you use it.

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Warren Buffett Priced in Gold

Can you say bubble? Or, more to the point, can you say bursting?


Warren Buffett loves to bash gold — claiming that stocks are inherently superior, because they produce a return, whereas gold just sits.  Trouble is, stocks (and all paper assets) are subject to counter-party risk, whereas physical gold isn’t. Gold doesn’t overcompensate its CEOs, it doesn’t leverage its productive capital in toxic derivatives, it doesn’t cause industrial disasters like Deepwater Horizon, its value isn’t dependent on central banking, or securitisation, or American imperialism, or the machinations of the military-industrial complex. It just sits, retaining its purchasing power.

Warren Buffett had a great ride: he grew his wealth and businesses in an era of unprecedented growth powered by OPEC oil, and later by Chinese industrialism. That era — the era of the American free lunch — is coming to an end.  His insights are applicable to that era. Today is a different world.

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Old Hatreds Flare Up…

It looks like I’m not the only political commentator to evoke the spirits of the past on Europe’s current breakdown (or breakdowns).

From the Daily Mail:

Greeks angry at the fate of the euro are comparing the German government with the Nazis who occupied the country in the Second World War.

Newspaper cartoons have presented modern-day German officials dressed in Nazi uniform, and a street poster depicts Chancellor Angela Merkel dressed as an officer in Hitler’s regime accompanied with the words: ‘Public nuisance.’

She wears a swastika armband bearing the EU stars logo on the outside.

Attack: A street poster in Greece has depicted Angela Merkel in a Nazi uniform with a swastika surrounded by the EU stars. The accompanying words describe her as a 'public nuisance'
The backlash has been provoked by Germany’s role in driving through painful measures to stop Greece’s debt crisis from spiralling out of control.

From a Greek perspective, it seems shatteringly obvious. For them, the Euro has become a battering ram for a kind of fiscal austerity that is set to benefit Germans (price stability) and penalise Greeks (austerity).

As advantageous as the Euro once seemed, it is becoming ever clearer that the union is suffering from deep political fracture. It is a union built without a common language (other than perhaps the belief in bureaucracy — and an unwillingness to give bankers haircuts), without a political head (or even a coherent political structure) without a common culture of work, and without an integrated economy.

That’s why decisive action is proving impossible, in spite of all the rhetoric.

Worse (because it shows contagion at work), it looks like Portugal is about to sink into the mud.

From Ambrose Evans-Pritchard at the Telegraph:

Cashflow problems (making it much, much harder to pay down debt) — that’s what you get when spend-as-much-as-we-want-and-then-print-money mediterranean nations entrust their nation’s monetary to stern-looking austerity-minded German central bankers.

Most startlingly, it looks like Paul Krugman finally got something right:

European leaders reach an agreement; markets are enthusiastic. Then reality sets in. The agreement is at best inadequate, and possibly makes no sense at all. Spreads stay high, and maybe even start widening again.

Another day in the life.

Of course, his solution — much, much deeper integration, with a good dose of money printing — is politically impossible, so whether or not it would work (clue: it won’t) is irrelevant.

Meanwhile Americans smoke their hopium (“GDP is up! Stocks are up! The recovery is here!“) hoping that the whirling Euro conflagration will just go away.

It won’t just go away. The global financial systems is an interconnected house of cards — a full Euro breakdown will bring down American banks with European exposure, like Morgan Stanley. Hank Paulson was telling the truth — either the thing is bailed out (again and again and again) or it will collapse under its own weight.

Creditors — starting with China (who are acquiring gold and Western industrials at a rapid rate) — will be hoping that the system can hold on for a few more years while they try to cash out with their pound of flesh.

Debt-ridden Americans and European would be forgiven for accelerating its collapse…

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China Hysteria

I’ve already gone over the problems with both the rabid Sinophile “China will bail out the world” view, and its rabid Sinophobe “hard landing will crush China” equivalent.

Both views are broadly wrong with a few small kernels of truth.

Here’s a reminder of the problem:

China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

The “China as central-planning disaster” brigade got a leg-up today, with the announcement that China’s GDP had missed predictions of 9.3% growth, instead hitting 9.1%.

Representing the Sinophobe camp, Zero Hedge raised an interesting point:

Suddenly everyone is a China expert, yet doesn’t realize that 9.1% is effectively the equivalent of a 1.1% stall print in an economy where 8.0% growth is the minimum threshold for social order and stability

Now I’m not enough of a China-expert to pluck an arbitrary growth figure out of the air as a “minimum threshold for social order and stability”, but if we want to talk about “social order and stability”, perhaps we should look closer to home — at the #OccupyWallStreet protests that have spilled across America.

From Xinhua:

The distrust and resentment manifested by Occupy Wall Street protesters towards the U.S. financial system could bear precarious consequences on the future of the United States, experts have told Xinhua.

Although the protesters account for only a small percentage of the national population, their frustration with the current economy and some of the government’s policies are shared by many, they said, citing similar rallies in dozens of other U.S. cities as evidence.

“America is in the midst of a massive ideological debate about the future of the country — what its economy will look like, and the role of capitalism and big government in America,” Richard Wottrich, a senior managing director at the McLean Group, told Xinhua.

Though it is still too early to tell what would be the legacy of the protests, the ongoing social movement may prove influential in determining the future course of the country at this difficult hour in its history, Wottrich said.

Luigi Zingales, a professor of entrepreneurship and finance at the University of Chicago Booth School of Business, echoed that the protests are “an indication of all the underlying forces that lead to some form of popular revolt or popular dissatisfaction.”

To get the protestors off the street and quell the fury, Obama and corporate America need to create jobs. Here’s what is needed to get back to pre-Depression employment:

That’s 256,000 jobs a month. Now, I’m not foolish enough to pluck an arbitrary figure out of the air as a “minimum growth rate to maintain social order and stability”, but if I was I’d say 8% growth was a realistic figure.

Of course, this entire argument is blind to the fact that a little social disorder (creative destruction) might be a good thing, and a few riots and bankruptcies might well fire up the engines of creation on both sides of the pacific rim. Of course, this doesn’t change the fact that the means of production are squarely located on the Chinese side of the divide, and that China stands strongly to benefit from this whether or not the CIA can successfully stir up Arab-spring-style protests in Beijing, Shanghai and Guangzhou (probably not).

The likeliest outcome remains that China will have to bail out its real estate and local government securitisation messes; but at least the funds to do it are equity from its trade surpluses, and not new money printing. Of course, new money printing on the other side of the pacific will come as soon as China starts liquidating treasuries. After all — someone has got to keep demand for US Treasury paper artificially high to keep interest rates artificially low and keep America’s debt obligations affordable…

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The Dangers of the Era

Modern civilisation has its problems but right now it works. Electrical grids, water systems, mass agriculture, global shipping, the internet, road networks, governments and financial markets are all still functional, and life for the majority is significantly easier and more colourful than for most of history. In the presence of civilisation, most of our basic needs (food, water, shelter, culture) are fulfillable, even if civilisation is highly fragile.

Nonetheless, many people are angry. Angry with the system, angry with authority, angry with society. We see it in #OccupyWallStreet. We saw it in the spontaneous thievery and riots in England in August. We saw it in the ongoing Arab Spring. We see it in Greece‘s protests against IMF-imposed austerity. We saw it in the Tea Party’s shades of “mad as hell and I just can’t take it anymore“.

People are mostly angry about some combination of poverty, angry about inequality, angry about rising joblessness, lost civil liberties, the loss of Western manufacturing, economic weakness, bailouts, or simply perceived unfairness. This isn’t a partisan issue; it exists as much in so-called left wing (like anti-austerity protests) and right-wing (Tea Party) camps.

The essential problem (that affects everyone who is not part of the elite) is that while civilisation functionals reasonably well for a vast majority, it functions significantly better for a tiny minority.

If nurses, teachers, soldiers, electricians, tradesmen, scientists (etc) are getting $50,000 a year for their labour, and traders on Wall Street who were bailed out after their businesses failed are getting $5 million bonuses, eventually the majority will start to seethe with questions like “why are they more valuable to society than we are?“, “if they failed to see the last recession coming, why are they still getting rewarded?”, “if unemployment is so high the economic system cannot be working, can it?, and so forth.

Corporations — and by extension, governments — have much reason to be fearful.

From the Washington Post:

Recent protests—Occupy Wall Street, of course, but also the Tea Party movement as it first began—rise out of a profound rage over unfairness in this country. The scale of this unfairness and inequity makes it hard to know where to direct that rage, to know what to do. Occupy Wall Street has the right target; but where their rage will go, nobody today knows. I am certain, though, that any alert board should be instructing their managers to do three things: admit the problem exists, take positive steps to make the corporation function fairly, and consider what other steps would address the concerns of the protests.

Simple? Not quite. But necessary? You bet.

If the present Occupy Wall Street protests do not create an unignorable threat, they certainly raise the prospect of one in the near future. Rage at unfairness is not easily quenched and once started can be hard to curtail. We’ve seen this time and again throughout history. Shareholders may think of themselves as victims of CEO power, as innocent shareholders , but we need only look to the Russian and French Revolutions to see that everyone having anything to do with fallen power, or in this case “guilty corporations”, may be attacked and injured—even if, like shareholders, their only crime is doing nothing.

But the real danger of all of this is not to corporations, or governments, or Wall Street, or the power elite. The danger is to society itself. Corporate and financial hygiene is at an all-time low, and the global financial infrastructure is an interconnected hyper-leveraged house-of-cards ready to come crashing down. The higher joblessness and wage inequality go, the  sooner the smouldering embers of fury we see today will be transformed into a burning conflagration of rage in wider society. If people with electricity, water, food and Chinese consumer goods are getting furious today, while civilisational is still functioning reasonably well, imagine what might happen if another financial crash caused by a Euro-default raised unemployment another 5%? If gasoline costs rose another 50% in response to an oil shock? If a new conflict or war significantly raised the cost of imported goods?

Establishments need to quell the furies of the population before they reach tipping points by letting bad banks and businesses fail, by reforming the tax code so that everyone pays a fair share, by creating jobs, and by finding ways to reduce citizens’ and institutions’ debt burden. Unfortunately, I believe that the global financial and political systems are so entrenched that at this stage deconstruction (rip it up and start again) is impossible because vested interests make any such changes highly unlikely.

The real danger is that in desperate times people will follow any charlatan who can offer food and security. In the 20th Century, Germans, Italians, Russians, the Spanish, the Chinese, the Vietnamese, the Libyans and others all discovered the dangers of overthrowing corrupt entrenched establishments, and replacing them with new regimes with no respect for individual liberties, religious freedoms, the freedom of speech, the freedom of association. I want the revolutionaries of the 21st Century to understand that the problem is not capitalism, nor liberal democracy. The problem is that a tiny minority are rigging the system to enrich themselves.

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Steve Jobs, Jobs and Reincarnation

Readers will know that my feelings toward Apple are profoundly mixed.

As I wrote back in July:

The notion of well-oiled blue-shirted brigades of lanyard-wielding corporate minions dancing, speaking and thinking in line to the beck and call of Steve Jobs goes beyond running an efficient operation. It’s obsessive-compulsive, and downright creepy. In my view, the sooner a competitor arises that delivers minimalist, solid and sleek computers at a similar price and without all this peculiar control-freakery, without the backdoor surveillance, and without the cultlike undertones, the better. I will jump ship as soon as I possibly can. But right now? Apple has no real competitors.

But there is no doubt Apple has a vast array of good qualities beyond having great products. There are three crucial ones: value creation, job creation and innovation.

From Sovereign Man:

While people like Warren Buffet are pleading with the government to raise their taxes and give away their wealth to sycophantic bureaucrats, Jobs showed time and time again that the best way to improve people’s lives is to create value and be productive.

Steve Jobs was one of the most productive human beings to have ever lived; he started several successful companies which directly employed tens of thousands of people. Indirectly, his businesses improved the livelihoods of millions across the globe, from Chinese factory workers to iPhone app programmers to Apple shareholders.

In building an empire and unimaginable wealth for himself, Steve Jobs enriched the lives and livelihoods of others by creating value. Not by forced redistribution. Not by giving things away. By creating value.

Ironically, just as I write this I am watching President Obama on Bloomberg Television trying to explain how many jobs his new plan will create– 1.9 million in his estimate:

“We’re just going to keep on going at it and hammering away… until… something gets done. I would love to see nothing more than Congres act… so aggressively.”

Politicians would do themselves and their constituents a great service by comparing their own track record for enriching people’s lives against Steve Jobs’ performance, and then kindly stepping out of the way. The path to prosperity is not paved in votes, but rather in freedom: the freedom to create, produce, risk work hard… and be rewarded for your efforts.

Well, amen to that. Our markets sorely need new value, new innovation and new jobs, and the answer to that conundrum — as I painstakingly pointed out here — is creating new wealth, not new taxes as many currently seem to advocate.

In my view, Jobs greatest contribution to the philosophy of economics (and something I have hammered on in recent months) is the importance of failure:

If you can’t succeed or fail, it’s really hard to get better.

The story of Jobs’ life, and the story of free market capitalism is very much one of trying and trying and trying again, learning from experience, and gradually improving. Look at the difference between a Power Cube G4 and a Mac Mini. The difference between a first-generation iPod and the new iPhone. Lisa and Mac OSX.

Sadly, as American Presidents heap praise on Jobs and his innovations, they’re not exactly heeding his advice. As I point out on an almost-daily basis, the highly interconnected global financial system has experimentally shown itself to be fundamentally flawed, and systematically broken. The establishment response — at both a national and global scale — has not been to put failures to one side and try new systems (hopefully ones that allow for less interconnection, less leverage and less risk — and subsequently less fragility) but to pump money and bail out failures to make the same mistakes all over again on a bigger scale.

So as Steve Jobs’ body begins its journey back into nature, back into the oxygen, carbon, nitrogen and hydrogen cycles — to be reborn, as we will all be, as new organisms — perhaps it is time governments started listening to his advice? Perhaps it’s time for the global financial system to die and be reborn…?

Farewell.

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The Only Chinese Hard Landing Will Be On America’s Head

A lot has been made of the so-called Chinese property bubble. And after 2008, when America’s subprime bubble was the straw that broke the camel’s back, who can blame those who see China as low-hanging fruit? In the hedge fund world, both Hugh Hendry and  Jim Chanos (among others) are significantly outperforming the market by shorting Chinese companies.

But the naysayers will be proven sorely wrong.

There are many differences between the Chinese situation and the American one but there is one that outsizes all the others. Over-inflated American (and by-extension, Western) property was being used as a spring-board to fund consumption. Growing home equity allowed real-estate owners to remortgage, and use their surpluses to buy boats, cars and trips around the world; i.e., living beyond their productive means. Once the property bubble burst, not only were many home-owners left underwater, but all of that excessive consumption came to a halt, with a significant negative effect on GDP. China simply doesn’t have that problem. The Chinese nation and its government are not net-borrowers but net-savers.

In addition, there is no evidence that China has the same problem with widespread securitisation that America had in 2008. The subprime bubble created huge systemic risk in the financial sector by bundling up subprime debt in mortgage-backed securities and collateralised debt obligations, and spreading it around American and European balance sheets. This made the system very fragile — as a few defaults, could lead to a global cascade of margin calls and defaults.

In fact, Chinese leverage levels are dropping.

From RBS:

Chinese firms are generally in good financial conditions. The latest data suggests that Chinese companies actually have seen their leverage ratios decline in the past three years, on the back of strong profitability and retained earnings. Most sectors have seen a decline in leverage. Property development was the only main sector that shows the opposite trend of rising leverage but it accounts for only about 6% of total loans. In fact, the average leverage ratio of Chinese companies is one of the lowest among key economies and emerging markets. At the same time, they have maintained one of the strongest profitability.

Chinese GDP (and profitability) is ballooning (and will continue to do so) because of global demand, even on the back of the recessions in Europe and America. That’s because China does everything much more cheaply, and so now controls crucial supply chains in components and products. Now that the world is flat, manufacturing such components in other places is not economically viable, so the supply chains no longer exist, and manufacturing-oriented labour markets are stagnating.

China’s good fortune is its high population levels and high population density.

From Noahpinion:

It is expensive to move products around. This means that if you have a factory, you want to locate it close to where your customers are, to avoid paying a bunch of shipping costs. Now consider two factories. The workers in the first factory will be the consumers for the second factory, and vice versa. So the two factories want to locate near each other (“agglomeration”). As for the workers/consumers, they want to go where the jobs are, so they move near the factories. Result: a city. The world becomes divided into an industrial “Core” and a much poorer agricultural “Periphery” that produces food, energy, and minerals for the Core.

Now when you have different countries, the situation gets more interesting. Capital can flow relatively easily across borders (i.e. you can put your factory anywhere you like), but labor cannot. If you start with a world where everyone’s a farmer, agglomeration starts in one country, but that country gets maxed out when the costs of density (high land prices) start to cancel out the effect of agglomeration. As transport costs fall and the economy grows, the industrial Core spreads from country to country. Often this spread is quite abrupt, resulting in successive “growth miracles” that get faster and faster (as each new industrial region starts out with a bigger global customer base). The evidence strongly indicates that agglomeration is the driver behind developing-world growth.

Looking at global population density — with American taxpayers subsidising the cost of a flat global marketplace — where can we expect productivity to agglomerate?


Of course, China does have a property bubble and a scary-sounding $1.6 trillion in local government debt. But $1.6 trillion of local government debt is still significantly less than China’s dollar and treasury hoard. The bottom line is if that China’s real estate market collapses, China can bail itself out with money it has saved from the prosperity years, not through new debt acquisition. This was the lesson of John Maynard Keynes — governments should save in the boom years, to spend in the bust years and even-out the business cycle — a lesson which seems lost on Western policy-makers, who seem to believe that you should borrow massive amounts every year.

So taking the absolute worst-case-scenario, China has plenty of leeway to bail itself out. Of course, this would mean China might decide to liquidate a significant amount of its treasury holdings — especially seeing as bonds are at all-time highs.

Could such a liquidation be the event that finally bursts the Treasury bubble, sending yields soaring and making it much more difficult for America to acquire new debt?

With 10-year yields now well below 2%, that sure looks like a bubble to me.