An Economic Lesson from History

Thomas E. Woods, Jr. provides here a history lesson that BHO and his favorite economists need to study closely. Of course, they will not, and we will suffer the consequences, as people did when FDR and his Dems tried the same bankrupt policies. FDR and his minions hadn't learned the economic lessons of history either, even though the lesson was only a decade old in their time.

The simple bottom line of this economic history lesson from the recession of 1920 is that credit that comes from money creation is vastly different than credit that comes from households saving. Thomas Woods explains why. The federal government can't bring about economic prosperity by expanding credit that's founded on money creation. But that's exactly the plan BHO, the Dems, and the Fed have in mind.

Today's near-zero short-term interest rates are exactly the wrong prescription for economic recovery. Banks continue to acquire loanable funds at a near-zero cost, thanks to the Fed's holding down short-term interest rates (price fixing, plain and simple). The Fed's misguided monetary policy also encourages ever-growing federal government debt.

Debt costs less when interest rates are low. With near-zero short-term interest rates, the U.S. Treasury (under the direction of the 545) can keep spending money it doesn't have indefinitely. It was banks' and shadow banks' giddy, heedless credit expansion to unworthy borrowers, all founded on credit from money creation instead of households saving, that brought on the recession in the first place. Now, we're told that more of the same is the way out of the woods? Simply stupefying.

Yes, economic theory can be eye-glazing (and yes, even boring for some folks), but what we're seeing from the 545 and the Fed today isn't really that difficult to see through. Just follow the money. Who wins and who losses due to the fiscal policies (deficit spending run rampant) and monetary policies (exceptionally low interest rates coupled with financial bailouts) that are now underway?

1. Responsible savers lose; interest rates are now so low that retirees and near retirees who thoughtfully and prudently saved to support their golden years are now in danger of outliving their savings.

2. Irresponsible spendthrifts win; poorly run banks, poorly run auto manufacturers, and poorly run financial institutions (AIG, Bear-Sterns, Fannie Mae, Freddie Mac, GM --- need I go on?) are bailed out (too big to fail, you know); they get the profits, but not the losses.

3. The federal government (the 545)and other apologists for big government win; due to economic and financial crises the 545 created, we are now told that even more regulation and more government control of the economy will be necessary (to hell with voluntary exchange; dangerous, you know).

4. Middle-income tax payers and young tax payers lose; socialized health care will significantly transfer income from middle-class and young tax payers to the oldest generations in society (older folks need far more health care than younger folks).

5. Recipients of the federal governments' spending win; good time to be government contractor or a bureaucrat; good time to be in any industry the 545 favor (how do you spell "green")

6. In the end, working stiffs of all stripes will lose (that would be most of us); history shows us with abundant examples that economies that aren't based on voluntary exchange just don't work. Socialism, fascism, communism, and all other forms of government directed economies cause poverty and squalor. You can look it up.

This time it will be different, right?

Not Even a Small Chance

What do you think are the odds for the proposed 28th amendment to the Constitution presented below?

Proposed Amendment 28 to the US Constitution!

"Congress shall make no law that applies to any citizen of the United States that does not apply equally to all US Senators and Representatives and Congress shall make no law that applies to any US Senator or Representative that does not apply equally to all citizens of the United States . All existing laws and regulations that do not meet these criteria shall be declared null and void!"

The Not-So-Bright Economic Future

For those so inclined, the arguments presented here by Representatives Hensarling and Ryan will be dismissed as Republican rhetoric. The mention of Ronald Reagan will doubtless send any number of folks into a tizzy fit.

But critics of Hensarling's and Ryan's arguments should focus on the arguments and leave the authors' political party affiliation aside. What they have to say is solid economics. We didn't have a decade long recession in the 1930s for no reason. It wasn't an accident. You can read about it here.

Are BHO and his Dems setting the table for another extended recession? Hensarling and Ryan think so. What do you think?

Chew On This One

Nobody ever reads this stuff, I guess. That's how we the people get what we've got.

News Alert!

One wonders why the news alert below is supposed to be news. Why would anyone pay the slightest attention to what the CBO has to say about the "cost" of BHO's and the Dems health care bill? Is there some occasion or event about which the CBO has ever been correct? If there is, please show us.

The part about reducing the federal budget deficit is especially hilarious, if you can find it in yourself to laugh at such absurdities. With any luck, the WSJ will be running an Op-Ed piece shortly that shows us the absurdity of the CBO's pronouncement.

News Alert

from The Wall Street Journal

----------------------------

Sponsored by NASDAQ OMX

----------------------------

Senate Democrats' health-care legislation has been estimated to cost $849 billion and to reduce the federal budget deficit by $127 billion over 10 years, according to a senior Senate leadership aide. The estimates, from the Congressional Budget Office, also showed that the bill would reduce the number of uninsured people in the U.S. by 31 million people. The result, the aide said, would be that 94% of Americans would have health-insurance coverage.

http://online.wsj.com?mod=djemalertNEWS

The Efficient Market Hypothesis

Here, Robert P. Murphy takes defenders of the Efficient Market Hypothesis to task. My students of finance and investing will find Murphy's arguments and his links to other articles particularly interesting.

Murphy's basic observation is that the EMH is a tautology. If that's so, then the EMH cannot fail to be true any more than 2+2=4 can fail to be true, or that Bob=Bob can fail to be true. Tautologies are true by definition --- true because of what we mean by the words or symbols we use to make the statement.

It is certainly true that market prices for financial securities incorporate "all relevant and available information." To the extent that the EMH said nothing more than this, it would be a fairly unremarkable statement. For what would it mean if market prices did not include all available and relevant information? It would mean that traders, investors, and money managers were buying or selling securities randomly; that they were making buying or selling decisions on what they, as individual buyers or sellers, took to be non-information or false information. That would be preposterous, of course.  Conclusion: Murphy is right. The EMH is abundantly true; it cannot fail to be true, given what we mean by "information."  The real question is, so what? What are the implications of the EMH being true?

What the EMH says beyond this very reasonable proposition is that financial markets are efficient in the sense that they incorporate all relevant and available information really quickly, and even if only a few participants in the market know and act on the information.   

Most defenders of the EMH conclude that if the EMH is true, then an individual investor cannot "beat the market" consistently over the long run (here, the term “long run” does not focus mainly on calendar time, but on repetition; beating the market over and over, reliably and consistently). What does "beat the market" mean? It means to earn a risk-adjusted rate of return that is higher than the rate of return experienced by an appropriate risk-matching index of the broad market. In the terminology of stock traders and money managers and Wall Street, it means earning “alpha,” through the application of what are taken to be superior skill and understanding of the implications of information.

In financial theory, we speak of the "market portfolio," which comprises all assets in the world! Obviously, no such real portfolio exists. But we do have highly diversified index funds and ETFs that we take to give us a decent estimate of the rate of return for the market portfolio. Holding one of the available S&P 500 index funds, or the Wilshire 5000 index fund, or the Vanguard Total Stock fund comes close enough to the market portfolio for most practical purposes.

So, does a true EMH imply that individual investors cannot ever earn a rate of return higher than the rate of return available from holding a Wilshire 5000 index fund?  No.  The EMH doesn’t rule out any particular investor earning excess returns.  That outcome can and does happen routinely.  The EMH implies that investors cannot systematically and consistently earn excess returns over a lengthy time horizon of several years.   

Some notable investors have outperformed the market over a long enough period to rule out chance.  Warren Buffet flies to mind (at least over the first half or so of his notable career); Peter Lynch might qualify (although Lynch’s success with the Magellan fund might not have been measured appropriately on a risk-adjusted basis); William O'Neil and the CAN SLIM program might qualify; the Value Line System appears to "beat the market" (although some researchers argue that neither CAN SLIM nor the Value Line System earn “alpha” after considering all costs of using those systems).  Logically, if someone devises a system that can consistently and reliably earn excess returns on a risk-adjusted basis, that someone better keep the system a secret.  For if everyone comes to know the system, excess returns will be arbitraged away.  Economists who conduct research about the EMH claim that no one has ever devised a market-beating system.  Well, maybe someone has, but keeps the system a closely-held secret, in which case, the researchers will never learn about the system.

Some investors and money managers have predicted market crashes with what appears to be enough time-frame accuracy to avoid the large losses suffered by most investors when the stock market plunges. Some people (but only a few) do avoid market crashes by exiting stocks and bonds before a market crash occurs.  What is not clear is whether the so-called “smart money” headed for the exits soon enough by luck, or by calculated and skillful interpretation of information, or perhaps even by possessing insider information.

The EMH says that market prices already have "baked in" all "relevant and available" information. We can quibble about what "relevant and available" means (which is just what the three forms of the EMH --- weak, semi-strong, and strong --- do), but that really isn't the point either.  The EMH really says that no other superior source of information is available to tell investors whether a financial asset is over or underpriced, aside from the market determined price itself.  In other words, the market price simply is the best estimate of the value of the asset, given all relevant and available information at the instant the market price is formed.

People often ask how could it be that market prices for securities were unbiased, best measures of value on day 1, when on day 2 the market crashes, losing 10% of its value.  Weren’t prices on day 1 obviously “wrong.”  No.  Prices on day 1 were not “wrong,” except from the vantage point of day 2.  Looking backward is very different from looking forward.  The EMH says that security prices on day 2 are no more nor less “right” than prices were on day 1.

Market prices reveal information about what “others” think value is.  We ourselves may have a different judgment of value.  We may turn out to be right, when “later on,” others come to the same value judgments we already hold before the “others” do.  Or, we may turn out to be wrong, when we “later on” change our judgment of value.  What seems entirely clear, though, is that security prices formed through the interaction of voluntary exchanges among suppliers and demanders necessarily reflect what “others” think value is. 

If an individual investor is somehow going to “beat the market” consistently and reliably,  that investor is going to have to somehow reach judgments about future value of financial assets that a multitude of “others” somehow do not reach.

How could someone reach those superior judgments of value, leading to outperforming an appropriate (risk adjusted) market index of financial securities? First, they could be lucky. But we wouldn't expect someone to be lucky over a large number of trials.  So, Warren Buffet does not appear to be just lucky.  Second, someone could have information that guides her trades that no one else has. No mystery here.  Possession of insider information and the ability to use it without detection of regulators would certainly generate excess returns.  But because the volume of trades made using inside information would ordinarily be insignificant compared to total volume in a particular security, changes in market prices for the assets traded would  likely be imperceptible.  A third way for someone to earn excess returns is to interpret the same information that everyone has, but interpret it differently and more “appropriately” for buying and selling financial assets.  Perhaps this possibility explains at least part of Warren Buffet’s phenomenal success.  Or, maybe Mr. Buffet has just been lucky in an extended run of trials.  The theory of probability does not eliminate that possibility, it just makes it highly unlikely.

What can we conclude? The EMH is certainly tautologically true, just as Murphy observes.  But does a true EMH rule out the possibility of some investors outperforming the market portfolio consistently, measured over many trials on a correctly measured risk-adjusted basis?  No.  The EMH does not rule that possibility out.  But the EMH does rule out the possibility that we all can somehow earn excess returns, if only we knew a little more or could exercise a little more skill.

As for inside information, we probably wouldn't have laws against it if it weren't something that happens. As for interpreting the same information differently and more correctly, we wouldn't have some investment advisors that get paid millions per year, year after year, if what they were selling had absolutely no value. You really can't fool all those high-net-worth individuals year after year for ever, do you think?  Abraham Lincoln’s thoughts about fooling people comes to mind.

So, Professor Fama is certainly right; financial markets (at least in the developed world) are definitely efficient. But the assertions that some writers about the EMH routinely make are not correct.  What is doubtless true is that only a few investors are able to outperform the market consistently. They are those with great luck, those with inside information, and those with unusual insights into what information means for the future. But the huge majority of investors (literally, most of us) will not be able to outperform the market consistently over the long haul. If the EMH and its implications were stated that way, I doubt if anyone would argue much about it.

Fiscal Stimulus Didn't Work --- Duh

Here, Michael Boskin gives us an update on lack of results from BHO's Pork Barre ... er, excuse me, Fiscal Stimulus bill rammed through Congress last year by the Democrat election victors. Promise the people pork and they will vote for you. That's BHO's legacy and we the peoples' disgrace

Of course, Professor Boskin knows full well that the so-called fiscal stimulus bill wasn't passed to stimulate the economy, and in my opinion, BHO's bought and paid for economists knew it wouldn't from the beginning.

The $787 billion bill was payoff spending for the Democrat base, clear and simple. No serious economist is even remotely surprised that the government's largess didn't save us from a 10.2 unemployment rate.

Professor Boskin lays out a fist full of sensible policy prescriptions to get the economy working again. Do you think BHO and company will pay attention? Neither do I.

We Actually Do This On Purpose?

Greg Mankiw explains here how our tax code helps keep some folks down. Do we really do this on purpose, or just through ignorance?

Origins of the Fed

What you will find here is a long read, but if you really want to understand how we got the Fed, you will find it here.

The Fed Bumbles Along

Judy Shelton writes here about ongoing Fed monetary policy and its rather obvious flaws. I say obvious because the flaws are obvious to me. But maybe they are not nearly obvious enough to Americans in general.

Anyone paying attention over the past 24 months or so surely has no reason to have even a slight bit of confidence in the Fed. It is the Fed that caused the so called "asset bubble" (translation; malinvestment in subprime mortgages and commercial real estate). Yes, the Fed had help from Congress, but nonetheless, the Fed is the chief culprit, controlling as it does the nation's money supply.

Long ago, Milton Friedman explained why the Fed is a menace to the economy. Discretionary monetary policy is a ruse, a sham, a con game, and destructive. History --- including recent history --- shows this truth without equivocation. Yet, on we go, pretending that the Fed has some special crystal ball and some magnificent benevolence, able to conduct monetary policy (in secret of course) for the benefit of all.

If some one of the glorious Fed apologists who call themselves economists could explain to me why the price we call interest rates is a price that should be under the control of the Fed, I would be happy to listen. Any decent student in ECON 101 understands that price controls benefit some and hurt others. See if you can guess who the Fed benefits through its manipulation of interest rates.

Money is not real goods and services. Inflating the money supply does not cause real goods and services to expand, but it does benefit people who get to spend the new money first. See if you can figure out who gets to spend lots of the new money first when the Fed increases the monetary base. If you came up with the federal government as an answer, good for you. If you didn't come up with that answer, better luck next time.

See, also, if you can figure out who benefits from access to money at a near zero rate of interest, but turns around and lends that money to businesses and consumers at rates of interest closer to 10%. Now there's a real puzzler. The only puzzle I see is how so many Americans continue to be conned by the Fed and the banking system it heads.