Wednesday, December 30, 2009

Keynes Promoted the Destruction of Free Market Capitalism

This is part four of our discussion of John Maynard Keynes and his 1936 book The General Theory of Employment, Interest and Money.  So far, we have uncovered some very interesting ideas buried in the famous economist's most well known work.  Here is what we discussed in parts 1-3:
This will not be our last post on Keynes but it will probably be our most important.  All the way back in 1936, Keynes laid out the game plan that government officials and central bankers have followed until this very day.  Last post, we noted that Keynes was the source of Bernanke's economic stimulus game plan.  Today, we will show that Keynes's influence goes far beyond this.  His influence is the guiding policy for our entire economic and political system.  To put it bluntly, Keynes promoted the destruction of free market capitalism.  Skeptical?  We will provide the proof right here.  Let's get to the quotes and you can be the judge...

All quotes below can be verified for their accuracy by referencing the full text, which is available online for free here.

Chapter 22, Section III
In conditions of laissez-faire the avoidance of wide fluctuations in employment may, therefore, prove impossible without a far-reaching change in the psychology of investment markets such as there is no reason to expect. I conclude that the duty of ordering the current volume of investment cannot safely be left in private hands.

Did you get that? Keynes declared that free markets must be removed of their role of allocating capital, which is the very backbone of capitalism.  Those promoting themselves as Keynesians are in favor of something that is very different from free market capitalism.

Chapter 24, Section III
The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment..

I suppose that since Keynes only wanted a "somewhat comprehensive socialisation of investment" that he was somewhat more in favor of free market capitalism than Karl Marx.  How wonderful.  You have to laugh at the ignorance or gall that it takes for someone to declare themselves both a Keynesian and a free market capitalist.

Chapter 24, Section III
It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to determine the aggregate amount of resources devoted to augmenting the instruments and the basic rate of reward to those who own them, it will have accomplished all that is necessary. Moreover, the necessary measures of socialisation can be introduced gradually and without a break in the general traditions of society.

This is perhaps the most prescient quote of the entire 20th century.  Keynes is saying that the government can come to wrestle control from the free market, not by the forceful confiscation of private property as characterized by Communism, but by merely determining the rules behind who gets the property.  Today, we call one extreme form of this mechanism a government bailout.

Further, he noted that if the socialization is done gradually then there is no need for a violent and abrupt upheaval, as found via a Coup d'├ętat.  Does this not precisely describe what has taken place over the past century?  A slow, steady creep of socialization has conquered the western world.

Passages like those found above are why I do not believe in conspiracy theories.  Who needs them when the great stories of history are laid out for you in black and white?

I'll leave you with one final thought.  When economists speak of Keynesian economics, the above ideas are what they are promoting.  If they do things and promote ideas that seem antithetical with free market capitalism, now you know why.

Tuesday, December 22, 2009

Jim Rogers: Advice for Tiger Woods

Jim Rogers has a knack for making great sound bytes but his latest interview has maybe my favorite one to date:

Why are we listening to Mr. Geithner?  Why are we listening to any of those guys down there [in Washington]?  They said in writing that the solution to our problem is to spend more money, to spend our way out of this.  That's what got us into this problem - too much debt, too much consumption - and now we're going to solve it with more debt and more consumption?  That's like saying to Tiger Woods - if you get another girlfriend you'll solve your problems.  Five more girlfriends and you'll solve your problems.

Watch the full video of Jim Rogers on CNBC:

Monday, December 21, 2009

Stock Market Update

It's confessional time and we make no bones about it.  We missed the stock market rebound this year.  We did not think stocks would go down necessarily, we just decided to not take on any big stock trading positions either long or short this year.  Luckily, we caught the rebound in several commodities and also managed to time the rise in gold nearly perfectly so don't be fooled - we will indeed have a very merry Christmas.

With that disclaimer out of the way, I wanted to provide a quick stock market update in regards to two technical indicators that we watch.  On October 25th, we noted that the S&P 500 was rapidly approaching its 500 day moving average. We believe that this is an important technical level for the stock market because throughout the bull markets of the 1990s and 2003-2007, the S&P 500 stayed above this level. The market also stayed below this level during the bear markets of 2000-2002 and 2007-present.

Since that time, the S&P 500 has risen cleanly above its 500 day moving average:

On October 31, we noted that volatility skyrocketed as stocks sunk.  On that day, the volatility index (VIX) rose nearly 24% and broke out of its downtrend.  We stated that unless the VIX fell back down to the low 20s (from 30 at the time) that stocks were likely to continue falling.  Much to our chagrin, the VIX fell 5.49% today and closed at 20.49:

Taken together, both technical indicators point towards continued strength in stocks.  One can come up several indicators that present bearish stock cases (a breakout in dollar being a big one) but at the least, there is just not a convincing case to be made that stocks are going to crash any time soon.

Sunday, December 20, 2009

DuckTales of Hyperinflation

DuckTales is a Disney animated show that aired from 1987 to 1990.  The show is based on the Uncle Scrooge comic books and follows the adventures of Scrooge McDuck, the richest duck in Duckburg, and his three nephews Huey, Dewey and Louie.

I highlight DuckTales not because it was an excellent cartoon (it was) but because it has the distinction of having not one but two episodes about hyperinflation.

Episode 82, Dough Ray Me, first aired on November 3, 1989.  In this episode, the inventor Gyro creates the multiphonic duplicator, which is a device that is capable of making exact copies of any object.  Huey, Duey and Louie test out the device by duplicating a number of things, including money.  Things soon go awry when the duplicated money begins to spontaneously duplicate on its own.  Duckburg is quickly over run with duplicated money, causing prices to skyrocket.  In one scene, a child needs a red wagon full of coins to purchase an ice cream cone, reminiscent of Weimar Germany or modern day Zimbabwe.  Later on, money becomes so hated that it is considered trash.  Three bank robbers from the Beagle Boys family are cheered on by the customers and encouraged to take as much money as possible by the bank staff.  In the end, the duplicated money implodes and things return back to normal in Duckburg.

Episode 79, The Land of Tra-la-la, first aired on September 18, 1989.  In this episode, Scrooge McDuck has a nervous breakdown because of stress stemming from his finances.  His doctor recommends that he go on vacation to a place where the people have no concept of money, so Scrooge and the rest of the DuckTales crew head off to the remote land of Tra-la-la.  Once there, a native finds a bottle cap discarded by Scrooge.  Fenton, Scrooge's accountant, notes that it is just an old bottle cap but since nobody in Tra-la-la has ever seen one before, it is scarce and thus valuable.  Upon showing the bottle cap to others, the native is offered seven sheep for his rare, shiny metal.  Upon discovering that Scrooge McDuck has many bottle caps, he is soon badgered by inhabitants wanting to purchase them.  Scrooge tries to remedy the situation with a dose of socialism by handing out one bottle cap to each resident.  The plan is foiled when one man manages to acquire two bottle caps, making him twice as rich as any other man.  The inhabitants are outraged, so to pacify them Scrooge arranges for the delivery of millions of bottle caps.  At first, the natives are pleased with their newly acquired wealth.  After the delivery of more and more bottle caps, however, they quickly grow infuriated by the bottle caps, which they now deem as litter.  The locals even threaten to kill Huey, Dewey and Louie if the bottle cap deliveries do not cease.  In the end, the crew clean up all of the bottle caps and head home safe and sound.

After watching these episodes as a kid, I would not have been able to define economic terms such as supply, demand, scarcity or hyperinflation but I knew inherently what they all meant.  These episodes and others are littered with quality messages for children, such as the idea that you can never get something for nothing aka there ain't no such thing as a free lunch.  DuckTales managed to educate me despite my best wishes at the time so I salute the Disney corporation for their fine work.

Watch part 1 of the DuckTales episode Dough Ray Me:

Watch part 1 of the DuckTales episode The Land of Tra-la-la:

Saturday, December 19, 2009

Money as Debt II

A few years ago I stumbled upon a video on YouTube titled Money as Debt.  The short animated film discusses the problem with building a monetary system comprised primarily of debt issued by private banks.  It is perhaps the best concise explanation of why bad things seemingly keep happening to our economic system.

A few months ago a sequel, Money as Debt II: Promises Unleashed, was released. This new film goes into even more depth than the first and shows how the recent economic crisis is directly related to the structure of our monetary system.

Key points to think about after watching these videos:
  • Money supply is comprised primarily of debt issued by private banks and not newly issued bills by the government, as is commonly believed
  • Ever expanding levels of debt are required to keep the system intact.  A good analogy would be to think of certain sharks, such as Great Whites and Hammerheads, which need to continually swim to breathe.  Now think of our economy as a shark that needs to continue to swim at an ever increasing speed in order to breathe.
  • It is no accident that consumers and the government are encouraged to continually rack up ever increasing levels of debt.  Even a plateau in the debt levels would cause the economy to come crashing down.
  • Eventually, the debt payments will consume such a large part of the economy that it must collapse under its own weight.  Think of it as our shark reaching the point where it is swimming at the speed of light.
The great thing about these videos is that they can help a person who would never read a lengthy economics article understand how our monetary system works.  If you want to reach out to friends and family, this is a good starting point.

Watch part one of Money as Debt:

Watch part one of Money as Debt II: Promises Unleashed:

For better video quality, you can also purchase these videos on DVD from

Sunday, December 13, 2009

Food, Inc.

Food, Inc is a documentary film about the business of big agriculture in the United States. Down the winding road of the film you will begin to understand how a few large corporations have come to dominate food production in the United States all while implementing unsanitary and, depending on your viewpoint, immoral production practices.

In many scenes, we are shown the poor and often bizarre conditions in which animals are reared.  In one scene we watch chickens continuously waddling along for a few steps and then falling due to their purposely unnatural size.  There are also slaughterhouse scenes featuring chickens and cows which are mildly gruesome.  Thankfully the director decided to not skew too graphic in these scenes and so we feel most people will not have a problem making it through the movie.

The filmmakers argue that the unsanitary conditions in which animals are held and slaughtered has lead to outbreaks of E. Coli and Salmonella.  In one powerful segment of the film you meet Barbara Kowalcyk, a woman who lost her two year old son due to E. Coli poisoning.  This segment is sad but it is not done over the top like something found in your typical Michael Moore film.

A good portion of the film is spent discussing the company Monsanto.  In the last decade, Monsanto has come to dominate the seed industry with its genetically modified seeds.  Farmers who buy seeds from Monsanto are not legally allowed to plant seeds from the crops grown using Monsanto genetically modified seeds.  Based on this, a farmer who is not using genetically modified crops can have his crops infected by the genetically modified seeds spread from neighboring farms.  If this farmer tries to save his seeds, Monsanto can come after that farmer legally.  Monsanto uses its army of lawyers to harass small farmers and drive them out of business due to ever escalating legal bills.

Those that are well versed with how the financial industry has come to dominate Washington DC will be amazed at the striking levels that big agriculture  has also come to dominate DC in the same manner.  We now have a "self policing of industry" and a "revolving door between industry and regulation."  Also related to the financial industry, we are told of chicken farmers who are strapped with enormous debts from the costs of launching their businesses and keeping their facilities to code that they can never hope to repay them.   This should all sound familiar.

We give Food, Inc 3 stars out of 4.  You can pick up a copy from (whom we are no longer boycotting).  It is also currently available on demand through many cable and satellite services.

Monday, December 7, 2009

Keynes's Guinea Pigs

Back in January of this year we wrote a post titled The Fed Will Buy All Treasury Bonds in Existence if Necessary.  The aim of that post was to settle an argument over whether the Fed would actually follow through with its threat at the time to buy long dated treasury bonds.  We argued that Ben Bernanke gave a speech in 2002 that covered the topic, and he explicitly stated that he believed the Fed could control both short and long term interest rate by outright purchasing treasury bonds.  Sure enough, on March 28, 2009, the Fed announced its program to buy $300 billion in treasury bonds over the coming months.  Since that time, the Fed has become the largest purchaser of treasury and agency debt in the world.  We still aren't quite sure why so many were unwilling to believe that the Fed would do this.

Moving on, in August, President Obama nominated Bernanke for a second term as Fed Chairman.  The word used over and over to describe Bernanke was "creative."  See the following quotes...
How creative has Bernanke been really?  After reading John Maynard Keynes, it becomes obvious that at least one of Bernanke's so called creative ideas should properly be credited to Keynes.

First, let's examine briefly what Bernanke said in his now famous 2002 speech:

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero?

One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities.

[One direct method] would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years).

The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields.

If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities, say three to six years. Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association).

Bernanke held true to his words from 2002 and enacted these very programs in 2009.

John Maynard Keynes wrote similar thoughts all the way back in 1933, in his famous work The General Theory of Employment, Interest and Money:

Chapter 15, Section III
Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds [English government bonds] of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management.

The monetary authority often tends in practice to concentrate upon short-term debts and to leave the price of long-term debts to be influenced by belated and imperfect reactions from the price of short-term debts; — though here again there is no reason why they need do so.

There is the possibility, for the reasons discussed above, that, after the rate of interest has fallen to a certain level, liquidity-preference may become virtually absolute in the sense that almost everyone prefers cash to holding a debt which yields so low a rate of interest. In this event the monetary authority would have lost effective control over the rate of interest. But whilst this limiting case might become practically important in future, I know of no example of it hitherto. Indeed, owing to the unwillingness of most monetary authorities to deal boldly in debts of long term, there has not been much opportunity for a test. Moreover, if such a situation were to arise, it would mean that the public authority itself could borrow through the banking system on an unlimited scale at a nominal rate of interest.

I am sure Keynes would be thrilled to know that a test of his ideas would eventually be enacted, with us modern day folks being the guinea pigs of this experiment.  It only seems appropriate to describe the current situation we are faced with by using a quote from Keynes himself:

Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.

Sunday, December 6, 2009

Gold Market Thoughts

Gold spot prices fell more than $50 on Friday, its largest decline in 20 months. This translated to a loss of $4.95 (-4.17%) to $113.75 on GLD, the SPDR Gold ETF. We have been trading GLD rather successfully since 2005 so we wanted to post an update on the five year price history of gold, how we are currently positioned and how we are looking to position ourselves going forward.

Let's start by taking a look at a current six month candlestick chart of GLD with Bollinger Bands.  Notice that GLD rode the top of the band for the entire month of November.  The big drop on Friday did not even bring the current price down to the middle of the band, a reasonable short term entry point (click on images for larger views):

Next let's look at the same chart with the 100 and 200 day moving averages.  Notice how far GLD moved above its trend lines and how far the current price still is from these lines:

The steepeness of this ascent is more apparent by examining a five year chart with the 200 day moving average.  Shaded in grey are two other periods where GLD extended far beyond its moving average:

From March 23 to May 11, 2006, GLD rose from $54.70 to $71.03, a rise of 29.85% in less than two months.  We remember this period fondly because we went long GLD for the first time in November of 2005 and promptly exited our position in the first week of May, an admitted stroke of luck since we knew very little about gold at the time.  From May 11 to June 14, GLD fell back to $56.62, a fall of 21.70%.  GLD fell below its 100 day moving average but stayed above its 200 day moving average.  It took four more months of choppy trading action for GLD to fall below its 200 day moving average and make its final bottom:

We rebuilt our position in GLD slowly throughout the rest of 2006.  GLD had a rather smooth if unspectacular rise though most of 2007 until it broke out in September.  After a brief correction in November and December, GLD rose from $78.67 on December 20, 2007 to $96.50 on March 17, 2008, a rise of 22.66% in less than 3 months.  Like the previous time GLD got so extended, we again exited or position and spent the rest of the year concentrating on the banking crisis and very little time watching gold.  This was fortunate because GLD fell back to $83.99 by May 1, a fall of 12.96% and below GLD's 100 day moving average but above its 200 day moving average.  Further collapses occurred in Autumn, where GLD finally made a bottom on October 24 at $70.65, a fall of 26.79% from its peak in March.  This time GLD fell below both its 100 and 200 day moving averages:

As the banking crisis began to wind down and GLD moved back above its moving averages, we rebuilt our position in GLD from March to June of 2009.

Over the last two weeks and before Friday's decline, we have closed out 80% of our position. Our reasoning was that this run up had quickly begun to resemble the peaks in 2006 and 2008, so a sell off was imminent. Friday turned out to be the day of reckoning and we think this is just the beginning of a much larger correction.

If previous peaks are any indication, this correction will last at least one to two months for the initial fall, where GLD will fall 15-20% and below its 100 day moving average but stay above its 200 day.  This should place GLD somewhere around $100, with a gold spot price of $1000.  GLD will then trade sideways to down for the next four to seven months, where it will reach its bottom below its 200 day moving average sometime in the spring or early summer.

We feel fairly confident about the first scenario playing out but only mildly confident about the second scenario.  We don't give investment advice but we will personally be buying back in full under $100 on GLD and $1000 on spot gold.  If gold falls even further, we will likely be buying even more, and could end up with an outsized portion of our net worth in the yellow metal.

We have shown how under $1000 is a good technical entry point but it is also an excellent area from a psychological perspective as well. Back in November, Marc Faber proclaimed that gold will never fall below $1000 again. Faber has been very astute since we have been following him so we don't dismiss his ideas lightly.  With that being said. we see no reason why $1000 should hold and in fact we feel that when gold does break this level, there will be final capitulation selling where gold will fall to $950-980 where we will have an excellent entry point.

Wednesday, December 2, 2009 Lifts Their Ban

Last week we noted that banned the documentary film The Secret of Oz from being sold on their website. This caused us to call for a boycott of Amazon and we asked readers to get proactive. We, along with many others in the financial blogger community, contacted Amazon to voice our displeasure and it seems to have worked. Today we received word that Amazon has since changed their stance and The Secret of Oz is again available for purchase.

I would like to thank Nathan Martin of Nathan's Economic Edge and Karl Denninger of The Market Ticker for helping to bring this issue to light.

Tuesday, December 1, 2009

My Approval Rating for the Federal Reserve is ...

... thumbs down
Picture taken at the Federal Reserve building in Washington, DC