Margaret Thatcher On The Income Gap

Since the Canadian Broadcast Corp has blocked our prior video clip of Maggie Thatcher, herein we enclose another great Maggie video:

Hayman Advisor's Kyle Bass: The Pattern Is Set

As we've said many times, we hate us some dollar and we hate us some yen even more than the dollar. The euro is an enigma. Other fiat currencies are subject - long-term - to the same issues. That leaves us with gold. Apparently Hayman's Kyle Bass agrees with us. This should come as no surprise to long-time TILB readers as we've highlighted Kyle's work/talks several times.

Below is the text of Hayman's most recent letter to its clients following the European debacle this weekend. TILB's immediate reaction was "holy shit, I don't want to own the euro", in spite of most Wall Street participants claiming this was a great showing of support for the euro. Our view was this "show of support" was more akin to a roadmap for self destruction. The euro's rally than recent retrenchment seems to support our initial take.

We lifted the below text it from First Adaptor's blog (click here for First Adaptor). Make sure to follow First Adaptor on Twitter.

The Pattern is Set - Betting the Bank on a Keynesian Free Lunch by Kyle Bass

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Dear Investors:

With the avalanche of announcements over the weekend out of Europe and the IMF (and even the US Federal Reserve), I think it is important to communicate our views. The Lisbon Treaty explicitly prohibits direct monetization of fiscal deficits (i.e. printing money out of thin air in order to perpetuate deficit spending) because central bankers are (or I guess at least "were") aware it is the path to severe inflation or even hyperinflation. Just as the Romans did time and time again, the EU has now decided to change from the rule of law to the rule of man when it suits them. With none of the sixteen members of the currency union forecasted to be in compliance with the Maastricht Treaty (the foundation on which the EMU is built) in 2010, today's actions further attempt to eliminate the natural policing role that markets play with respect to egregious economic behavior. It looks like there will be no consequences for fiscal profligacy... no negative implications for continuing to spend far beyond one’s means... there will be nothing but moral hazard for running massive deficits as member countries can now hold hostage the entire EU (as Greece has done).

The ECB’s monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to "solve" a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more "bail-outs" and debt financed spending. This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future.

Germany weakened itself as it has now abandoned the core bargain of the Euro (which was that they would never be responsible for another country’s debt) by opting to be the largest guarantor of a new loan program that essentially makes European countries joint and severally liable for emergency funds for the worst fiscal offenders in the EU. It has begun a process of ceding its fiscal sovereignty to the over-indulgent countries. I still cannot believe Germany has done this. No wonder Merkel’s government is so unpopular. Meanwhile, I guess that Trichet must have decided on the lesser of two disastrous outcomes for fear that the very existence of their European Union was being called into question. He must have believed this to be the case as it would be the only rational reason to agree to such drastic measures – despite his blanket opposition to such policies just days ago and against the explicit wishes of the Bundesbank, Germany’s central bank.

We believe that there is a “Keynesian End” to the policy du jour that governments can solve all their fiscal and economic problems with more debt and more cross guarantees (aided and abetted by desperate central bankers). We at Hayman believe this theoretical endpoint is reached when debt service exceeds government revenues. Of course, any particular country has certain fixed expenses beyond debt service; therefore, the real endpoint occurs significantly in front of our definition. Outside of Greece and “Club Med” countries, Japan will begin to grace the front pages of newspapers very shortly. Japan has already reached a point where its central government tax revenues are eclipsed by debt service and social security payments alone. Coupled with its debt and demography problems, the world's second largest economy is about to enter a real bond crisis.

Attached is a Bank of International Settlements working paper that I highly suggest you read [TILB - link to referenced working paper here]. Please pay particular attention to the chart on the top of page 11 and remember the numbers you are seeing are as a percentage of GDP and NOT government revenue. This paper takes a very conservative view of interest rates (it essentially assumes they stay flat from the low levels of a few months ago – regardless of changes to debt levels or savings rates) and extrapolates current fiscal projections and even assumes pretty robust global growth. Even in this somewhat utopian scenario, the Keynesian End arrives in many of the world's countries much sooner than is popularly believed.

The competitive devaluation will begin in full force with Japan needing a weaker Yen to grow exports, the US needing a weaker dollar in order to double our exports (under the current Obama plan), and the EU really needing a weaker euro in order to grow their own exports. It is no wonder that Bretton Woods failed so miserably in prohibiting “cheating” via currency weakening. It is also no wonder that the IMF and World Bank were created at that very same meeting in 1944.

We have also attached a chart showing total IMF commitments to member countries as a percentage of each respective country’s IMF quota. The magnitude of the initial EUR 30 billion commitment to Greece trumps all other commitments made throughout this crisis by multiples. This does not even include the EUR 250 billion announced for the broader Eurozone this weekend. By granting Greece more than 30x their quota, they are making a mockery of their own rulebook.

This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors. In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a “sea change” in public opinion towards government spending and deficits. We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well.

Sincerely,

J. Kyle Bass
Managing Partner

Kyle is clearly cut from the Austrian cloth.

Keynesianism Is So Nuanced

[This will be a multi-part series that discusses inflation, what money is and why it has value. We begin with some basics through the lens of Keynesianism's "attractiveness".]

I was on an email string recently about The Carnegie Endowment for International Peace's Uri Dadush. I made the statement that Dadush is simply a Keynesian, albeit one that is well connected and understands there are many difficult challenges that need to be addressed. In response to my email, a long-time friend of TILB and fellow liberty loving free marketer - though he is still finding his legs with regards to understanding the implications of his beliefs - responded to me that he has spoken at length with Dadush and that he's more nuanced and "complex" than being simply called a Keynsian. Here's a quote from Dadush's recent FT OpEd:

There are ways to mitigate the pain. For example, Germany and other countries could adopt more expansionary fiscal policies for a while. Or, more powerfully, the wider euro area could adopt more expansionary monetary policies for several years. Today, this second option is anathema as the “inflation fundamentalists” will have none of it.

Nuanced? I guess.

Here's what my friend said (mind you, he's an avowed libertarian - though he's still figuring himself out so to speak) - light editing for privacy reasons or clarification:

I met with the guy for 2 hours, and I would not classify him as such [a "strong Keynesian with fairly mainstream opinions"]. If anything, he is complex – and clearly what he says on CNBC and in NY Times oped is not what he can say behind closed doors. While Keynesian, he is not a classically academic Keynesian, sitting in a library dealing with only theory. He counsels governments facing massive social unrest and high unemployment, and he approaches his work with a much deeper appreciation for the human situation than we can. So while espousing money creation below, he was also very pragmatic with me about the moral hazard of this choice, the continued low interest rates, our over-reliance on debt, etc.

I am sympathetic with his situation. We often throw around our ideas without considering the reality of what will inevitably happen – at least in the short term – if our ideas were implemented. I know you will vehemently disagree with me on this, but the fact is that – again, in the short term – what you and I want ideally is economically wishful thinking and politically impossible. Yes, the opposite will bankrupt the world, and we are largely already insolvent. There’s no argument there. Should we suddenly balance our budget, shrink government dramatically, stop stimulus, war, and over-regulation, the result could be 50-60-70% unemployment rates – in the short run. I do believe the LT benefits of Austrian economics are obviously far superior to the Keynsian ponzi scheme.

However, no one talks about the transition, and what it would really mean for us. If you take a heroin addict, and suddenly “reform” him with complete withdrawal and going cold turkey, he will often die from this. His body cannot handle the shock.

Uri had just met with the Italian Finance Minister prior to seeing me – I can imagine that conversation. How do you convince someone like that that what he really needs is to leave the EU, get on the gold standard, balance his budget, cut taxes – and face assassination b/c 100 million are thrown into convulsions?

My point is that Uri deals with the reality of our current situation, while we do not. We read letters and books, then pontificate and rant without a good understanding of what it really means. It will kills us eventually, yes. But it will be a long, slow death probably instead of a quick one.

Lastly, I’ve read Ron Paul, Murry [sic] Rothbard, etc. They all talk about how wrong things are – and I agree with them. I have yet to see a transition plan, so if you know of anything they have written on how to get off the system we are currently addicted to, I’d love to read it.

I decided not to send him a reply by email. Instead, I decided to bring the discussion to TILB, as it's a more productive forum for this sort of thing. To be direct, I disagree with a number of his assertions.

In my opinion, what you described is in fact classic Keynesianism. No self respecting Keynesian would claim that running large deficits and printing money is a long-term viable solution or economically healthy approach. That is simply the tag line non-Keynsians use to belittle the Keynsian approach. It's the politicization the word "Keynesian" but not the reality. Dadush is a classic, behind-the-desk academic Keynesian. He provides advice based in theory as does every other economist, Austrian or otherwise.

The Keynesian argument is always more nuanced or "complex". The argument is generally that goverment needs to implement aggressive and targeted public spending policies during difficult economic periods because taking the hard medicine in the middle of a recession would (they believe) be too painful and counterproductive. By putting it into human terms it becomes very powerful (for obvious reasons) even if - in my opinion - the Keynsian trade is to attempt to avoid some human pain today in exchange for accepting much more human pain in the future.

What's here is tangible and it matters more to voters than tomorrow's pain.

So if we can just take a few easy money bong hits and confuse our body into thinking it's healthy, we can take the hard medicine then. We'll do what needs to be done, but just not yet. Tomorrow. Always some day in the future.

As you know, the issue is that the recession is not the problem, the recession is the cure. It's the cure to profligacy; a recession is simply a period of excess savings that offsets periods of excess spending and consumption.

Switching from a societal bias toward spending to one of savings is painful because society was confused by the profligacy into setting up a structure that serves society's apparent "needs" as if the profligate period is normal. The profligacy is full of false/unsustainable demand signals that trick people into creating/investing in the wrong kinds of businesses or in the wrong amount. The longer the cure is postponed by inflicting more easy money and socialist disease (e.g., Dadush's prescription), the more painful the necessary recession will be because the imbalances are greater and become more depended on.

It's not just imbalances as defined as switching from spending/borrowing to saving/investing. It's that entire industries were created to serve an unsustainable consumptive demand rather than productive advancement. It requires more than just saving new capital, but shifting existing capital from entire industries and possibly geographies to others. A human toll is left in the wreckage of these corrections. It is, however, unavoidable.

What is avoidable is compounding the problem through continued interference with the needed correction.

Bernanke/Bush/Obama's current postponement means the next recession (assuming we are - in fact - past "this one") will feel worse than this one. Their fight of postponement is really an attempt to induce even more capital to become malinvested toward less productive industries and to have us become even more dependant on unsustainable behaviors. So there will never be a period in which the hard medicine can be comfortably consumed because the hard medicine IS the recession and the imbalances it wants and needs to address continue to grow in the meantime. So avoiding taking the hard medicine means avoiding curing the disease; allowing it to metasticize, take root, grow and spread.

You know me well and you are correct: I do vehemently disagree with your statement. Short of a major North American landwar, there is virtually no scenario in which a society as productive as ours would experience anything like "50-60-70%" unemployment rates, even if one mistakenly changes the whole system in one yank.

Ron Paul and others have addressed transition plans. They logically begin with the easiest part: balancing the budget while cutting taxes. By taxing less and borrowing less, capital remains in private (productive) hands and out of public (unproductive) hands. Sounds hard, but if you are of the opinion that most of government is value-destructive, it's actually easy. First, bring the troops home and end the American military empire abroad (foreign military bases). Those two actions are somewhere in the $500 billion to $750 billion annually of savings (1/3 to half of our expected deficit this year and 100% of our deficit from three years ago). Other than for providing a platform for safe living and investment, military is a non-productive expense, by definition. Then end most of the "Department ofs", as I call them. Dept of Education, Dept of Interior, Dept of Energy, Dept of Homeland Security, etc. and slash the size of those you keep, emphasizing of course a strong defense (not offense - defense). This is key, bringing home the military does not mean having a weaker defense. It means changing the nature of it and allowing us to invest in true defense rather than wasting investment on overseas bases.

These cuts are - importantly - phased in but transparent and forecast so that the change is digestible.

That's the easy part. The harder part (though made much, much easier by having already shifted to a smaller government that runs a balanced budget) is moving to a harder currency. This involves ending the Fed and installing free banking, which means a banking system that doesn't "create" money with customer deposits. My personal view is the only way to do that is a slow, planned, well understood phase-in. It might take two decades to let happen so that the adjustment is manageable. I believe the huge benefits reaped from freeing capital from government hands would unleash such a lollapalooza of positives on society that shrinking the banking system would actually shift from an economic headwind to a tailwind by the latter years of the process.

As a final aside, in contrast to your assertion, I am not actually a government-installed-gold-standard man, because it relies on government to be well behaved. I am for market-based money, but that's a discussion for another day.

Liberty Quote Of The Day: Jens O. Parsson

Jens Parsson discusses how the persistent debasement of money kills society in his 1974 book "Dying of Money: Lessons of the Great German and American Inflations". The below quote is reminiscent of Murray Rothbard's description of the early "fun" portions of an inflation as a "heady wine" (click here for Rothbard's in-depth essay on German hyper inflation).

In any case, Parsson makes the point that monetary inflation always ends in a trail of tears, because it is addictive and requires an increasing volume of inflated money in order to keep the party going. As soon as the spigot is turned off, pain comes, so the spigot is never turned off. In fact, it is provides a constantly accelerating flow and ultimately either tragically deluges society in an out of control hyperinflation or, if discipline is somehow re-instituted, ends in a painful deflationary liquidation. Read on for Parsson's quote:

"Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and an ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation."

- Jens O. Parsson, Dying of Money: Lessons of the Great German and American Inflations (1974)

[HT: LB]

The Fabian Socialists Are Winning

The Fabian Socialist movement, first begun over one hundred years ago, is moving faster today than ever before. The success of their slow evolutionary drive toward central planning was highlighted a few days ago when we presented our Depressing Chart of the Day, shown to the right. It shows that the total of federal, state and local government spending as a percent of GDP has skyrocketed over the past few years, approaching 50% of all GDP.

By coincidence, your intrepid author is in the midst of Hayek's "The Road to Serfdom". In the excellent book is the excerpt that follows. TILB highlighted several points below [all emphasis added], but most important is the emphasis on Germany in 1928 (immediately prior to Nazi rule).

Of additional note is the description on how socialism is most effective in a republic or democracy - by taking the power away from elected leaders and handing it to non-elected bureaucrats (a modern day example would be the Federal Reserve's central planning role in determining the amount and price of money).

The words that follow are from Hayek published in 1944.

We can rely on voluntary agreement to guide the action of the state only so long as it is confined to spheres where agreement exists. But not only when the state undertakes direct control in fields where there is no such agreement is it bound to suppress individual freedom. We can unfortunately not indefinitely extend the sphere of common action and still leave the individual free in his own sphere. Once the communal sector in which the state controls all the means, exceeds a certain proportion of the whole, the effect of its actions dominate the whole system. Although the state controls directly the use of only a large part of the available resources, the effects of its decisions on the remaining part of the economic system become so great that indirectly it controls almost everything. Where, as was, for example, true in Germany as early as 1928, the central and local government authorities directly control the use of more than half of national income (according to an official German estimate then, 53 per cent), the control indirectly almost the whole economic life of the nation. There is, then, scarcely an individual end which is not dependent for its achievement on the action of the state, and the "social scale of values" which guides the state's action must embrace practically all individual ends.

It is not difficult to see what must be the consequences when democracy embarks upon a course of planning which in its execution requires more agreement than in fact exists. The people may have agreed on adopting a system of directed economy because they have been convinced that it will produce great prosperity.

In the discussions leading to the decision, the goal of planning will have been described by some such term as "common welfare," which only conceals the absence of real agreement on the ends of planning. Agreement will in fact exist only on the mechanism to be used.

But it is a mechanism which can be used only for a common end; and the question of the precise goal toward which all activity is to be directed will arise as soon as the executive power has to translate the demand for a single plan into a particular plan. Then it will appear that the agreement on the desirability of planning is not supported by agreement on the ends the plan is to serve.

The effect of the people's agreeing that there must be central planning, without agreeing on the ends, will be rather as if a group of people were to commit themselves to take a journey together without agreeing where they want to go: with the result that they may all have to make a journey which most of them do not want at all.

That planning creates a situation in which it is necessary for us to agree on a much larger number of topics than we have been used to, and that in a planned system we cannot confine collective action to the tasks on which we can agree but are forced to produce agreement on everything in order that any action can be taken at all, is one of the features which contributes more than most to determining the character of a planned system.

It may be the unanimously expressed will of the people that its parliament should prepare a comprehensive economic plan, yet neither the people nor its representatives need therefore be able to agree on any particular plan. The inability of democratic assemblies to carry out what seems to be a clear mandate of the people will inevitably cause dissatisfaction with democratic institutions.

Parliaments come to be regarded as ineffective "talking shops," unable or incompetent to carry out the tasks for which they have been chosen. The conviction grows that if efficient planning is to be done, the direction must be "taken out of politics" and placed in the hands of experts-permanent officials or independent autonomous bodies [TILB - see the Federal Reserve for a modern day socialist example].

The difficulty is well known to socialists. It will soon be half a century since the Webbs began to complain of "the increased incapacity of the House of Commons to cope with its work."' More recently, Professor Laski has elaborated the argument:

"It is common ground that the present parliamentary machine is quite unsuited to pass rapidly a great body of complicated legislation. The National Government, indeed, has in substance admitted this by implementing its economy and tariff measures not by detailed debate in the House of Commons but by a wholesale system of delegated legislation. A Labour Government would, I presume, build upon the amplitude of this precedent. It would confine the House of Commons to the two functions it can properly perform: the ventilation of grievances and the discussion of general principles of its measures. Its Bills would take the form of general formulae conferring wide powers on the appropriate government departments; and those powers would be exercised by Order in Council which could, if desired, be attacked in the House by means of a vote of no confidence. The necessity and value of delegated legislation has recently been strongly reaffirmed by the Donoughmore Committee; and its extension is inevitable if the process of socialisation is not to be wrecked by the normal methods of obstruction which existing parliamentary procedure sanctions."

And to make it quite clear that a socialist government must not allow itself to be too much fettered by democratic procedure, Professor Laski at the end of the same article raised the question "whether in a period of transition to Socialism, a Labour Government can risk the overthrow of its measures as a result of the next general election"-and left it significantly unanswered.

It is important clearly to see the causes of this admitted ineffectiveness of parliaments when it comes to a detailed administration of the economic affairs of a nation. The fault is neither with the individual representatives nor with parliamentary institutions as such but with the contradictions inherent in the task with which they are charged.

They are not asked to act where they can agree, but to produce agreement on everything--the whole direction of the resources of the nation. For such a task the system of majority decision is, however, not suited. Majorities will be found where it is a choice between limited alternatives; but it is a superstition to believe that there must be a majority view on everything.

We are fast approaching a tipping point. In the course of a decade, we have gone from the government representing an already egregious one third of economic outpoint to one that represents 44% of our economy. It seems likely not to shrink as the current administration clearly believes in its just and beneficent wisdom and will impose that wisdom upon us, whether we want it or not.

To be fair, the trend of the graph at the top of this page is party neutral - both donkeys and elephants share the blame - having built over the course of 80 years. The acceleration, though, is perhaps most frightening of all. TILB is not sure what will cause a secular shift back toward freedom and away from centrally planned oppression. We suspect that, in the end, the will of the people must exert itself and reclaim lost liberty.

Lord hear our prayers...

Hayek Vs. Keynes

DJ Freddy Hayek b-slaps DJ Maynard, in this rap video.

Our Peter Schiff Man Crush Grows

Watch Connecticut's refreshing senate candidate Peter Schiff just absolutely embarass this poor Columbia professor David Epstein that espouses mainstream "Keynesian" economics in this excellent debate. Epstein plays a perfect foil to Schiff in this long, thoughtful debate. I think the main lack of understanding of mainstream economists is a fundamental lack of understanding of what "money", productivity, and the pricing system really are and what they serve. This leads to all sorts of decisions to promote government deficit spending as "cures" for economic ills without the understanding that the government does not have a capital base to invest from without first taking it from the private market. This perpetuates and compounds the problem, preventing healing.

Enjoy.

Liberty Quote Of The Day: Frederich Hayek

Amongst the collection of brilliant attendees of Mises's weekly seminars back in Vienna, Frederich Hayek would distinguish himself as first amongst equals when he later won a Nobel Prize for building on Mises's groundbreaking work in developing an understanding of the impact of credit creation in business cycles.

Hayek was a proponent of liberty and understood that the government could not solve man's inherent problems (they are inherent) and that in its efforts to do good, it would generally have a multiplier of negative unintended consequences. This is Hayek's second Liberty Quote of the Day.

"What our generation has forgotten is that the system of private property is the most important guarantee of freedom, not only for those who own property, but scarcely less for those who do not. It is only because the control of the means of production is divided among many people acting independently that nobody has complete power over us, that we as individuals can decide what to do with ourselves."

- Frederich August Hayek - The Road to Serfdom: 1944

Liberty Quote Of The Day Friederich Hayek

Brilliant economist of the Austrian school, Friedrich Hayek, gave us the below quote which is very much along the lines of an earlier TILB posting about Equality of Outcomes vs. Equality of Choice.

“From the fact that people are very different it follows that, if we treat them equally, the result must be inequality in their actual position, and that the only way to place them in an equal position would be to treat them differently. Equality before the law and material equality are therefore not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time.”

- Friedrich August Hayek