The Notion of Safety

There is so much that I read about economics that strikes me as not just flawed, but so completely idiotic that it makes me want to light my hair on fire. I ran across just such an article this morning

http://www.forbes.com/sites/steveforbes/2014/05/19/why-one-ivy-league-economist-thinks-the-u-s-dollar-is-invincible-and-what-this-means-for-investors/

Forbes Magazine interviewed Cornell economist Eswar Prasad on his view of how the dollar became invincible. He started out making a very salient point, the massive issuance of Fed liabilities and government debt should have weakened the dollar considerably. It has not as there has been nearly infinite demand for dollars and dollar receivables.

I agree with this. As I have pointed out in other posts, the Asian crisis of 1997-8 convinced the emerging countries of Asia that having large dollar balances were needed to protect themselves from periods of sustained financial outflows during periodic bouts of panic.

They then went on a binge of dollar accumulation, and we see from IMF COFER reports that foreign exchange reserves held worldwide grew nearly seven fold between 1999 and 2013.

This has been a fundamental driver in allowing the U.S. to experience three major asset bubbles over this time.

Professor Prassad:

Now, emerging markets want a lot more foreign exchange reserves, which need to be held in government bonds. Financial institutions have to hold more safe assets, and private investors want more safe assets. The supply has shrunk, the euro zone isn’t quite what it seemed like it was—the safe part of the euro zone is quite small, actually. Germany and a handful of other countries.  Japan and Switzerland, don’t want money coming into their economies. So, who’s left?  The U.S. And the U.S. is doing its bit for the world by prodigiously providing large amounts of safe assets. That is U.S. government securities.

What I want to challenge here is the good professor’s notion of safety.

Yes, the U.S. started issuing prodigious amounts of securities after the financial crisis as budget deficits were running at nearly 10% of GDP per year for a while. What I don’t quite understand is just how anything in the financial world that is issued in prodigious quantities can be considered safe?

Even today, the budget deficit amounts to about 4% of GDP while government debt yields next to nothing and GDP growth limps along at Depression era rates. Someone that has to borrow 4% of GDP per year in a system where GDP grows less than 2% per year is going to have a financial accident at some point.

Additionally, government tax receipts are artificially high currently given the out of control explosion in equity prices driving massive capital gains tax payments for the government.

I have a hard time viewing these securities as safe under these conditions. Unfortunately, an even bigger issue exists, holders of Treasury debt must compete with other asset classes as well and this problem is monumental.

There is an old children’s riddle; which weighs more, one pound of cotton or a pound of lead? The answer, of course, is that they both weigh the same.

Applying the same rationale, which is more valuable, $1000 in equities or $1000 in Treasury debt? Again, they both have the same value and are exchangeable for the same amount of goods and services.

Just looking at the prodigious amounts of Treasury debt that has been issued is pretty meaningless since we must look at how fast we have been issuing other dollar based claims (stock values, other new debt issuance, real estate increases, the value of small businesses etc.) as well to see if Treasury holders have an increasing, decreasing or constant claim on the amount of goods and services that exist in the system.

If a Treasury holder earning his 100 basis points per year sees an infinite number of other dollar based claims being created each year he just might want to consider that the debasement is making him worse off over time. Wouldn’t an investment that buys much less tomorrow be an unsafe security holding?

You can see where I am going with this. According to the Fed’s Z.1 reports, we can see that Household Net Worth (total dollar receivables) has increased $31 trillion over the past ten years, or about $3 trillion per year (and this excludes those dollar based receivables that foreigners are piling up in Prasad’s dash for safety). Given that GDP averaged about $15 trillion per year over this time frame, we can see that dollar claims grew at a rate of about 20% per year relative to GDP. Unfortunately, real GDP growth averaged less than 2% per year and savings as a percent of GDP averaged about 1% over this time period. Real goods and services to back up all of these incremental dollar based claims do not exist. Either the value of these dollar based assets must fall or the value of goods and services must increase enough to balance all of the claims we have been creating. This would mean CPI type inflation.

Dollar based assets cannot be considered safe. The inference of safety here neglects the basic notion that these dollar based receivables are claims on goods and services and these claims are growing far faster than the goods and services that back them up. This is the fundamental economic imbalance of our time. All dollar based assets are being debased and are very unsafe if one wants to preserve purchasing power.

In the investing world we often see that good ideas in the beginning become silly when everyone starts to participate. Tech stocks were a good idea in 1990 and a very bad idea in 1999. Las Vegas real estate was a good idea in 1999 and a very bad idea in 2007. For the emerging market countries having dollars in 1997 would have been a good idea and, it seems to me, a very bad idea today.

What Professor Prassad hasn’t noticed is that the emerging market countries have started to change their behavior over the past couple of years. As I noted in my initial post on this blog, holdings for foreign central banks at the New York Fed have been falling of late and have fallen in each instance of emerging market turmoil since 2011. Perhaps they have already discovered something that the good professor has not; dollars issued in infinite size aren’t all that safe any longer. The move by China and Russia to conclude their huge gas deal recently, almost certainly to be settled in a currency other than dollars, is another indication that emerging markets aren’t viewing the dollar as the safe haven that they once did.

Anything issued in near infinite amounts, as we see with dollar based assets today, cannot be considered safe. I have a word for economists who think otherwise, gullible.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

Along the Roads to Damascus, Moscow and Beijing….

Niall Ferguson is alarmed.

His fear, the United States isn’t aggressive enough in the foreign policy arena, leaving openings for the evil Russians and Chinese. He warns us that this is making the world a more dangerous place as the unipolar world where the U.S. was completely dominant and was acting as the world’s policeman slips away. Ferguson is terrified that the American public doesn’t have the attention span required to expand the Empire.

Mr. Ferguson does so love his empires and, begrudgingly, I may have to admit that he does have a point. A unipolar world historically has been a fairly orderly place.  I would argue that the last time that the world was such a unipolar place was during the Roman Empire, and it was nothing if not orderly.

From Vermont Royster’s In Hoc Anno Domini which appears every year in the Wall Street Journal on the last publishing day before Christmas:

When Saul of Tarsus set out on his journey to Damascus the whole of the known world lay in bondage. There was one state, and it was Rome. There was one master for it all, and he was Tiberius Caesar.
Everywhere there was civil order, for the arm of the Roman law was long. Everywhere there was stability, in government and in society, for the centurions saw that it was so.

Behavior unacceptable to the Romans was dealt with swiftly and effectively. Unfortunately, especially if one wasn’t a citizen of Rome, something was just not quite right about all of this orderliness. Royster saw it like this:

But everywhere there was something else, too. There was oppression—for those who were not the friends of Tiberius Caesar. There was the tax gatherer to take the grain from the fields and the flax from the spindle to feed the legions or to fill the hungry treasury from which divine Caesar gave largess to the people. There was the impressor to find recruits for the circuses. There were executioners to quiet those whom the Emperor proscribed. What was a man for but to serve Caesar?

There was the persecution of men who dared think differently, who heard strange voices or read strange manuscripts. There was enslavement of men whose tribes came not from Rome, disdain for those who did not have the familiar visage. And most of all, there was everywhere a contempt for human life. What, to the strong, was one man more or less in a crowded world?

Yes, orderliness came with a price, a contempt for human life.
Today, as Vladimir Putin calls for a multipolar world, do the non-occidental countries and people of the world feel as persecuted as those subjects of Rome felt? Is the price for American imposed orderliness too high for many of them?

The answer is clearly, yes. America’s military presence on the borders of Russia and China has clearly pushed these countries into an alliance aimed at halting U.S. interference in their traditional spheres of influence. Additionally, the exorbitant privilege that the U.S. has enjoyed in being able to print the world’s reserve currency has extended, in the eyes of these two, far too much power to those in Washington and these countries will move to change this.

Ferguson believes that this will be a more dangerous world.

Perhaps.

Royster, on the other hand, saw something that entered the world during the Pax Romana that would change everything and offer a new hope:

Then, of a sudden, there was a light in the world, and a man from Galilee saying, Render unto Caesar the things which are Caesar's and unto God the things that are God's.

And the voice from Galilee, which would defy Caesar, offered a new Kingdom in which each man could walk upright and bow to none but his God. Inasmuch as ye have done it unto one of the least of these my brethren, ye have done it unto me. And he sent this gospel of the Kingdom of Man into the uttermost ends of the earth.

This message was quite revolutionary and it didn’t sit well with the Roman authorities of the day. It was, however, a necessary precursor for the development of all individual liberty that was enjoyed by much of Western civilization during the past many centuries. Atheist Murray Rothbard on the sudden light that entered the world:

I am convinced that it is no accident that freedom, limited government, natural rights, and the market economy only really developed in Western civilization. I am convinced that the reason is the attitudes developed by the Christian Church in general, and the Roman Catholic Church in particular. Christianity, with its unique focus on (a) the individual as created in the image of God, and (b) in the central mystery of the Incarnation, God created his Son as a fully human person- (this) means that each individual and his salvation is of central divine concern….

Thus, even though I am not a believer, I hail Christianity, and especially Catholicism, as the underpinning of liberty.

Though it is hard to ignore, and not be somewhat fearful of, what was lost after the fall of the Roman Empire, something better had already been introduced. Yes, it was more than one thousand years between the building of the Pantheon and Brunelleschi’s dome at the Cathedral of Santa Maria del Fiora in Florence, but the concept of natural law had been firmly rooted by then and would be developed further by Catholic and Protestant scholastics and this would allow the concept of liberty and natural law to flourish in many parts of the world for centuries. Perhaps there exists today in some distant part of the American Empire another insignificant and destitute individual who will rise to prominence and remind us again of the critical importance of natural law.

The internet had a parallel during the heyday of Rome, the Roman network of roads. It was along this road network that the message of the importance of the individual was transmitted by Christ’s apostles. Hopefully, today’s network can again successfully spread the message of the importance of the individual, diminish the clamor for empire, keep America’s Empire from going too far down the same road with regards to the contempt for human life that developed in Rome and help us to extend the notion of natural rights and individual liberty further than ever before.  Royster however, knew that St. Paul was deeply concerned about how this would all play out with future empires and future Caesars and he concluded In Hoc Anno Domini with this reminder:

Along the road to Damascus the light shone brightly. But afterward Paul of Tarsus, too, was sore afraid. He feared that other Caesars, other prophets, might one day persuade men that man was nothing save a servant unto them, that men might yield up their birthright from God for pottage and walk no more in freedom.

Then might it come to pass that darkness would settle again over the lands and there would be a burning of books and men would think only of what they should eat and what they should wear, and would give heed only to new Caesars and to false prophets. Then might it come to pass that men would not look upward to see even a winter's star in the East, and once more, there would be no light at all in the darkness.

And so Paul, the apostle of the Son of Man, spoke to his brethren, the Galatians, the words he would have us remember afterward in each of the years of his Lord:

Stand fast therefore in the liberty wherewith Christ has made us free and be not entangled again with the yoke of bondage.

Ferguson doesn’t quite grasp that the American form of orderliness has convinced much of the rest of the world that their liberties are being infringed upon by the American Empire. He doesn’t recognize that in their eyes the U.S. has been willing to trample the notion of natural law in order to achieve its own vision of orderliness that many find rather abhorrent. These people just may recognize that order and rule of law are not ends in and of themselves. They may feel that they are only means by which their natural rights are to be protected. Much of the world believes that America has forgotten this, that America expects the world to give up its birthright to serve Washington and the words of St. Paul, therefore, remain as relevant as ever to these people. He misses that it is a Russian leader that is reminding the world to avoid the yoke of bondage. It never dawns on Ferguson that much of the world sees the American Empire as the danger. Empires are about force and subjugation and are always an affront to natural law and this hasn’t changed since the days of Rome.

Valdimir Putin as he targeted the U.S. yesterday:

The model of a unipolar world has failed. Everyone can easily see it today, even those who try to act in the usual manner, to keep their monopoly, to dictate their rules of the game in politics, commerce and finance, to impose their cultural and behavioural norms,

The world is multipolar, people want to decide their own destinies, preserve their cultural and historical identities and civilisations.

In the China-Russia alliance the overextended American Empire has met a powerful force, and this could be a very good thing for the U.S. The cost of empire to the American public will be exposed as the de-dollarization begins in this China-Russia led alliance. The exorbitant privilege extended to the U.S. via their ability to print the world’s reserve currency has hidden much of the cost of the Empire. As this crumbles, the ability of the U.S. to project power throughout the world will collapse, centralization of power will diminish and an increase in individual liberty should result. This multipolar world will be very different from the one seen during the Cold War. Today, in contrast to the Cold War, Russia and China are in a position to offer better economic and individual liberty concessions to other countries than the U.S. is currently offering. The playing field is far more level than before and this will be ever more apparent as the dollar fades as the world’s reserve currency. It will be quite the paradox for those of us who grew up during the Cold War if it winds up that Russia and China are the ones that keep us all from being entangled in the yoke of bondage.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.

Elon Musk Should Heed Albert Einstein

If I had an hour to solve a problem and my life depended on the solution, I would spend the first 55 minutes determining the proper question to ask, for once I knew the proper question, I could solve the problem in less than five minutes.

Albert Einstein

Like everyone, I often fall behind in starting many of the tasks that I assign myself. Having undergone a little shoulder surgery recently, I was grateful for the chance to just sit and clear up some reading that I have been meaning to get to. Fortune Magazine (which I still receive in paper form) had an article on Elon Musk (as Fortune’s Business Person of the Year) that looked interesting last December and I finally settled in to read it last week.

The article was one of the best summaries that I have read on the new philosophical direction of our society: technology as destiny and our summum bonum. We can see how far our society has moved towards technology as our summum bonum (highest order) when the author of the article quotes a physicist, David Deutsch, regarding his definition of an optimist. According to Deutsch, optimists are those who believe that any problem that doesn’t contradict physics can be solved. I think that Aristotle, Plato and St. Thomas Aquinas would beg to differ.

Much of the article focuses on two of Musk’s companies, Tesla and SpaceX and the comparison of Musk to Steve Jobs of Apple and Pixar fame. For me however, the crux of the article comes from its focus on how Musk is using technology to seduce mankind to move towards an electric (Tesla) and solar powered future here on an ecologically challenged Earth and if we fail in that, SpaceX can help us colonize Mars.

What could be wrong with that you might ask?

Nothing in so far as the technology goes, but Musk, violating the Einstein method above, is asking the wrong question in my opinion. He is focused on the question, how do we save mankind on a planet we seem determined to destroy with pollution?

The more important question is, is mankind worth saving?  There is another question that Musk should also be asking before he spends precious resources figuring out how to colonize Mars; if we place technology at the apex of our society, do we lose something that is more important than a clean planet? 

To get a better idea of where Musk has run off the rails I am going to turn to the thoughts of C.S. Lewis, largely borrowing from his book The Abolition of Man.

For Lewis, following Natural Law (or the Tao as he called it) must be our summum bonum, or goal, as it has been throughout most of history. Natural Law, in contrast to today’s moral relativism, tells us that some things are objectively good or bad and that we are to use our free will to follow this natural law. For example, if a fire breaks out we may feel two competing instincts; the flight to safety impulse would be a strong one. We would also feel the need to help others before we ourselves should flee. Natural Law tells us which of these two instincts is the correct one.

Lewis became quite concerned that technology was replacing natural law as our summum bonum and the result was The Abolition of Man.

For Lewis, technology represented man’s power over nature. In Abolition, he used three examples of technology: the airplane, wireless and contraceptives. His view was that technology could be withheld from some men by other men. It could be withheld by those who sell the products, by those who allow the sale (government) and the owners of the sources of production. Man’s power over nature is thus the power of some men over others. 

As man modifies the environment today, he obviously exercises power over successor generations as well. Additionally, in modifying the environment bequeathed to it, today’s generation rebels against tradition and limits the power of the predecessor generations.

He points to the idea, perhaps many centuries from now, when one age will by scientific education, genetic manipulation and propaganda be able to exercise complete power and be able to make its descendants whatever it pleases. All who will come after this point will be nothing but patients, or trousered apes in the parlance of Lewis. They will be incapable of utilizing their free will to follow natural law. They will no longer, therefore, be men. The conquest of nature will be the conquest of everyone by a few.

And what of these few, those whom Lewis called the controllers? What is to guide these controllers? If technology is their summum bonum, they must eliminate natural law, otherwise man’s conquest of nature is incomplete. All that will be left to guide them will be their own urges and instincts.

Since these controllers will be able to eliminate natural law and free will from the minds of men and replace it with whatever they choose, they will no longer be men but they will be gods. The paradox however, will be that these gods will be controlled by their urges. The conquest of nature by man will, in reality, be nature’s conquest of man, the abolition of man. Man will cease to exist.

For man to exist natural law and free will must exist and they must be our purpose, our summum bonum.  The concluding question here should be, what is the point of colonizing Mars with trousered apes? What is the point of a clean planet if everyone is left with a polluted soul?

The Fortune article ends:

George Bernard Shaw famously said, “The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.” By that definition Jobs and Musk are the ultimate in unreasonable men. And the world is much better for it.

Shaw, and Fortune, could not have been more wrong! After all, just what is it that Shaw’s unreasonable man is progressing towards?

Peter Kreeft in his book C.S. Lewis for the Third Millenium wrote:

Aristotle rated (technology) as third on the hierarchy of values after (1) knowledge of the truth for its own sake, and (2) practical knowledge, or knowledge for living, for acting. The modern world has simply turned this hierarchy upside down as it has turned man upside down.

Some things are objectively true and we must always place a desire to understand this above other things, including technology. Without that, we cannot right ourselves.

 Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.