We’re in bubble territory again, but this time might be different

Returns for investors are modest and could be negative over lengthy periods

Martin Wolf

Trader blowing a bubble on the floor of the New York Stock Exchange © Reuters

Asset prices are, some argue, in an “omnibubble”: prices of every important asset in the high-income countries — stocks, housing and bonds — are at such exalted levels that a devastating crash is inevitable. Moreover, at these prices, prospective returns are too low, which is plainly unfair to wealth owners. It is also clear who is to blame: the central banks. Off with their wretched heads, is the cry.

Is there much merit in these points?

Assets are indeed expensive by historical standards. Consider stocks. The Nobel-Laureate, Robert Shiller, developed the cyclically-adjusted price/earnings ratio, the so-called CAPE, to assess whether stocks are likely to be over- or under-valued. It is possible to invert this measure to obtain a cyclically-adjusted earnings yield which allows one to measure prospective real returns. If one does this, the answer for the US is that the cyclically-adjusted return is now down to 3.4 per cent. The only times it has been still lower were in 1929 and between 1997 and 2001, the two biggest stock market bubbles since 1880. We know now what happened then. Is it going to be different this time?

Yet the US is not the only market in the world, even if it is the most important. An estimate of CAPE for Germany and the UK gives cyclically-adjusted real earnings yields at 5.1 and 6.2 per cent, respectively. While the figure for the US is two-thirds of its average since 1983, that of Germany is at only 89 per cent, while the UK’s is 8 per cent above its average over this period.

On this basis, the other two markets are not so highly valued. Japan’s cyclically-adjusted earnings yield of 4.1 per cent is 42 per cent above its average since 1983. So, the US looks the exception, not the rule.

What about that other significant class of assets: housing? Here the story is somewhat different.

Real prices in the UK are close to their pre-crisis peaks. US house prices are 29 per cent above their post-crisis low, but also 16 per cent below their pre-crisis peak. In Italy and Spain, real house prices are well below peak levels. So UK house prices look most stratospheric.

This leaves us with bonds, a class of assets that is not only important in itself, but, to some extent, is the anchor for the rest. The crucial point is the long-term decline in real and nominal yields on safe bonds. The real yield on UK index-linked gilts has collapsed progressively, from 4 per cent in the 1980s to negative levels since 2011. Twenty-year US Treasury inflation protected securities are now yielding less than 0.5 per cent. America can also currently borrow for 30 years at nominal yields of 2.8 per cent, the UK at 1.8 per cent, France at 1.7 per cent and Germany at 1.1 per cent. This is very cheap money.

So US stocks look expensive and so do almost everybody’s government bonds. But are they unsustainably expensive?

One way of answering the question is by reference to current conditions.

With real interest rates on safe securities so low, asset prices should be high. That is basic economics.

Maybe, they should not be as high as they now are. But it is far from obvious they are in extreme bubble territory. The biggest exception, even given current low real interest rates, may well be US stocks.

So the question is whether current conditions — low real interest rates and low and stable inflation — will last.

One perspective is to note that real long-term interest rates have been in an extended period of decline. Furthermore, it is easy to think of long-term — or “secular” — reasons why this should be so. One might refer to a “savings glut” or low productivity growth. Inflation, too, has remained low in the big high-income economies. For these reasons, markets might reasonably expect short- and long-term interest rates to remain low for the indefinite future, even if not as low as today.

Another perspective is to blame low long-term real and nominal rates on central bank manipulation.

When monetary policy changes, it is suggested, the bubbles will burst and asset prices duly collapse. Yet this argument is largely unpersuasive. Central banks cannot on their own determine real rates over very long periods. These rates must largely reflect conditions in the real economy.

A final perspective is to insist, nevertheless, that ultra-low real interest rates will have to rise, in the end, even if not right away. That may be true. But nobody knows when. Rates may be not far from present levels for decades. If so, asset prices will still enjoy their support.

What might all this mean for investors and policymakers? The answer for the former is that prospective real returns in many asset classes are modest and could be negative over quite lengthy periods. At the same time it is hard to argue that most assets are vastly too expensive, because it is possible that things are a bit different this time.

Meanwhile, the test for policy is not whether asset prices fall: policymakers are not responsible for delivering any particular level of asset price. The question rather is whether asset prices can adjust without bringing down either financial system or economy. It is on this that policymakers have to be judged.

Will Traditional Retailers Get a Frosty Reception This Holiday Season?


Rosy-cheeked shoppers in snow boots rushing from one store to the next. Jam-packed malls glimmering with holiday lights and garlands, resounding with Christmas songs. Anxious parents waiting in ridiculously long lines to get their hands on the hottest new toy. Are these images of holiday shopping now out of date – particularly in a year that has seen one brick-and-mortar retailer after another announce bankruptcy filings and store closings or go out of business altogether? Do consumers increasingly prefer to order whatever they want, whenever they want it throughout the year, with just a few taps on a screen?

It’s kind of a false distinction, according to Wharton marketing professor Barbara Kahn.

Although a lot more shopping overall has moved online in recent years, many traditional retailers strive to make the experience with their brand seamless between online and offline.

Kahn adds that while online shopping has “definitely changed” in-store shopping, and many more purchases are being made online, “it doesn’t mean the physical store is not relevant anymore.”

Wharton marketing professor David Bell agrees. “I’m not really of the opinion that online has to be a substitute for offline…. If you do it correctly, you can turn them into supplements.”

Often consumers will browse or order electronically and then visit a store to pick up their merchandise, Kahn says. A big advantage for the retailer is that once the shopper comes in, there are opportunities for incremental sales, meaning the customer buys more items than he or she had originally intended. The well-known “impulse buy” in which you grab a candy bar strategically placed near the register to plunk down with your order is an example of this.

Incremental sales also can involve more expensive items, says Bell. “If I go online and buy my niece a bracelet at Tiffany.com and I have to go in and pick it up, when I get in there I might be stimulated to buy something else.” He notes that online retail can really help in-store retail as a “pretty big traffic generator.”

Incremental sales can occur during online shopping, too, says Kahn, but they’re much less likely. “Serendipity is more likely to happen when you’re walking around in a physical store.” 

And if the retailer can create an enjoyable holiday atmosphere to walk around in, that further increases the chance that people will make impulsive purchases.

Everyone Still Needs to Buy Gifts

Moreover, although today it’s easy and convenient to order things online all year round, shopping around the winter holidays isn’t going away anytime soon, say the experts. This is because our fundamental social behavior around times such as Thanksgiving, Christmas, Hanukkah and other winter holidays hasn’t changed. “People are engaged in gift-giving, getting together with family and friends,” says Bell. “To the extent that tradition doesn’t disappear or wane, there’s still a fundamental occasion or behavior behind a reason to shop.”

Kahn makes a similar point about why people continue to head to stores on Black Friday. It isn’t just for door-busters: “The day after Thanksgiving, a lot of people are home with nothing to do after having eaten a big meal, and they want to go out.” She also says that in-store shopping gets a boost around the holidays because many people buy gifts last-minute, well after online purchase shipping-date cut-offs. “If you look at the biggest shopping days, they’re still the two days right before Christmas.” People procrastinate, she says, and human behavior doesn’t change even though the shopping channel changes.

Certain products, too, are reliably purchased every year around the holidays. Bell says that one obvious example is Christmas sweaters. “There are products of that nature for which the holiday season is a big part of the demand.” He mentions that one enterprising retailer, an online company called Tipsy Elves, sells self-proclaimed “ugly Christmas sweaters” as well as apparel entertainingly decorated for Hanukkah, Thanksgiving, and even St. Patrick’s Day.

Both Kahn and Bell note that while traditional retailers continue to invest in in-store holiday promotions, they appear to be doing more (and should be doing more) than just dusting off last year’s Christmas garlands to wrap around the pillars. One example they both cite is Walmart, which is creating a buzz by throwing 20,000 holiday–themed parties in its approximately 4,700 stores.

The parties reportedly feature opportunities for kids to play with the top new toys, “holiday helpers” to assist customers in navigating the store, stickers for children to mark toy catalogs with what they want, product demos, party-planning advice for adults, and more. Visits with Santa will be part of the festivities, a tradition which Kahn notes may be the earliest known holiday retail promotion. “It started years ago as an event to draw people into the store with their kids because it’s fun. And while you’re there you go shopping.”

Bell believes that Walmart will get “tremendous foot traffic” out of these parties and that it will be a great opportunity for incremental sales. Other companies to watch when it comes to creative in-store holiday promotions are Nordstrom and Sephora, he says. Bell notes that these businesses generally use their in-store footprint very effectively so they’re likely to do so around the holidays, too.

A more radical approach to the holiday season, say the experts, is for companies to think about how they might invent their own special days. Two online retailers have had tremendous success with this, demonstrating that customers do respond to the idea of holidays or cyclical events (provided, of course, that good deals are also involved). Though Chinese e-commerce giant Alibaba didn’t really invent the November 11th holiday called “Singles Day” — a kind of anti-Valentine’s Day — the site has taken it from a little-known celebration to a retail phenomenon. This year, Alibaba’s Singles Day sales hit a jaw-dropping total of $25.3 billion, more than 40% higher than last year, according to The New York Times. Bell points out that Singles Day is the number-one shopping day in the world in terms of volume.

Amazon started something similar in 2015: “Prime Day” on July 11th, during which prices are slashed for Amazon Prime customers. Amazon has reported that sales this year were up more than 60% over the previous Prime Day, and surpassed the company’s sales for either Black Friday or Cyber Monday of 2016. It’s also notable that Amazon generated this business in the middle of the summer, normally a slow time for retailers.

An example of an innovative way that traditional retailers might handle the winter holidays — cited by Wharton marketing professor Peter Fader — was the outdoor clothing company REI’s unusual decision two years ago to start closing on both Black Friday and Thanksgiving. Fader says REI has promoted the fact that they are giving their employees the time off, along with the idea that customers and their families could spend Black Friday enjoying the outdoors instead of shopping. “They got all kinds of great buzz for it,” says Fader.

REI has enjoyed strong growth over the past two years despite giving up those sales days, according to Fortune. Although, the article notes, it may be more able than many retailers to absorb a short-term hit to its sales because it’s a co-op rather than a publicly traded company.

Fader thinks the REI idea is a good one. “There’s been a lot of talk this year as we approach the holiday season that some retailers are trying to back off a little bit, take their foot off the gas.” To Fader, this demonstrates that retailers may be realizing that “we really need to be good [businesses] throughout the season, that it’s not all resting on one day.”

Showing the Love to Customers — But Only Your Best Ones?

Overall, Fader thinks retailers need to break the habit he perceives of blindly encouraging frenzied holiday shopping. “Black Friday is a terrible, terrible thing [for retailers],” he observes. “It’s good for revenue but bad for profits, and even worse for long-run profits.”

He explains that back when retailers had no real way to track who was coming into their stores, their attitude toward having a big sale would naturally be, “Hey look! We’re selling a lot of stuff, this is fantastic.”

“But in an era where we can now tag and track individual customers, and we want to think in terms of future value that will be created or enhanced, Black Friday makes no sense at all,” Fader says. The tracking methods he refers to include online shopping patterns, loyalty programs, cell phone tracking, and biometrics such as facial recognition systems and fingerprint identification.

Fader notes that instead of slashing prices for everybody and trying to get as much foot traffic as possible, retailers should use the holiday season to thank and reward their most loyal customers. In his view, stores should not make their top customers wait on long holiday lines staffed by frazzled cashiers, being treated no differently from the “worst customers” who only drop in around the holidays to cruise for steep discounts. “It’s insulting and it actually hurts their value [to your business],” he says. He suggests offering this group perks like special opening hours, extra attention from the best salespeople and VIP events with food and drinks.

“It’s just much easier to know who’s buying what, when and for how much,” Fader says of customer analytics. “Retailers should leverage that information.”

Kahn, on the other hand, believes that evaluating customers through analytics has some limitations. It’s good at predicting what you’ll buy when you head out to shop for yourself, but not when buying for others. “In holiday shopping, a lot of what happens is you’re shopping for other people, and while you’re there you find something you want for yourself that you didn’t expect. Analytics are not going to predict that.”

She also doesn’t necessarily think retailers should pull back from the idea of attracting as many holiday shoppers as possible. In Kahn’s view, “This last quarter of the year is very important for retailers, and it always will be.”

Time To Talk About A Revolution

by: Eric Parnell, CFA


- Recent focus has been on the tax debate in Washington.
- The discussion about the trees largely misses the bigger problem with the forest.

- Where are the surpluses in one of the longest economic expansions in U.S. history with stocks trading at all-time highs for several years now.
- It is time to talk about a revolution in the way we think about economic policy going forward.
Who or what is next?
- This idea was discussed in more depth with members of my private investing community, The Universal. Become a member today >> 
Talk about taxes has shifted into high gear. The daily financial headlines are filled with play-by-play updates on how the development of prospective legislation on U.S. “tax reform” is evolving both in the House and the Senate. And the media airwaves have no shortage of debate about the nuances of the debate as it unfolds on a daily basis. But completely missing from the ongoing discussion is a much bigger issue. Instead of talking about tax cuts, it’s time to begin talking about a revolution in fiscal policy unlike anything we have seen in our lifetimes.

The Trees

The financial news media has been flooded as of late with discussion about taxes. What was once a dialog about “tax reform” has since evolved into talk about “tax cuts”. And it all makes for interesting headlines to follow as we quickly wind our way toward Thanksgiving here in the United States.
But here is the thing. The whole debate is largely pointless. For example, we read a headline about a prospective change being made to the legislation being put together in the House, and analysts will come together to opine over its implication for the economy and financial markets.
Securities prices might even move, sometimes dramatically, in knee jerk response to such headlines. But the fact of the matter remains that much of whatever ends up in the House bill is likely to disappear once the debate makes its way through the Senate and then to conference between the two chambers to create the final bill. All of this assumes that a bill can even make it through the House and then through the Senate. And all of this is supposed to happen by the end of the calendar year. Good luck, my friends.

Overall, the probability of any tax related legislation being signed into law by the end of 2017 is increasingly fading. According to PredictIt, the probability for individual tax cuts by the end of the year has fallen below 10% in recent days after odds were as high as one-in-three at the start of the month and fifty-fifty during the summer. The implied odds for corporate tax cuts are equally bleak at roughly 20%, which is down from 35% at the start of the month.
Put simply, the markets never had a high degree of confidence in recent months that “tax reform” or “tax cuts” were going to happen by the end of the year, and any lingering hopes for legislation are increasingly fading as the clock on the 2017 calendar year starts to run out.
The primary argument in favor of tax legislation getting done before the end of the year is a qualitative one. Simply, the thinking goes that Republican lawmakers simply have no choice politically but to get something done before the end of the year. But a similar case could have been made for healthcare reform, yet nothing was passed at the end of the day despite multiple attempts.
And it appears that too many internal conflicts may exist within the tax legislation debate to thwart agreement this time around as well. Such are the challenges of governing that are faced on both sides of the political aisle at various points throughout time.
What about 2018? The potential certainly remains for legislation to be passed sometime next year.
But the closer we draw to the mid-term election cycle, the more difficult it will become to get anything done from a legislative standpoint, particularly if a bill includes aspects that may prove controversial in the political debate with middle class voters.
Putting this all together, the “tax reform” debate that eventually evolved into the “tax cut” debate is largely moot. Despite the various ideas being discussed, it remains unlikely to happen in 2017 and potentially not at all. This is not at all a political statement. Instead, it is the reality implied by calendar and the betting markets.
The Forest
What is genuinely bothersome to me about the recent tax debate as it relates to fiscal policy is the following. Why the heck are we even having the conversation that we are having about taxes in the first place?
Consider the excerpt from an effectually factual update article shown below:

“The latest version of the House bill would add $1.7 trillion to the federal deficit over 10 years, said the nonpartisan Congressional Budget Office, which tallies the costs of legislation. That would violate a rule requiring the legislation to add no more than $1.5 trillion to the deficit. But Representative Kevin Brady, Republican chairman of the House tax committee, said he would revise the legislation on Thursday to bring it into compliance.” 
- Tax-cut debate in U.S. Congress swings to Senate bill, Reuters, November 8, 2017
Let’s get this straight. Legislation is being considered that needs to be whittled down to adding just $1.5 trillion to the Federal deficit over the next 10 years. This averages out to another $170 billion being added to the deficit in 2018, 2019, 2020, ..., and 2027. This is on top of an estimated Federal budget deficit for the current year of -$602 billion that is estimated to come in between -$450 billion and -$550 billion each year over the next five years according to the U.S. government itself in the Bureau of Economic Analysis that we all know will end up being more than -$450 billion to -$550 billion per year at the end of the day regardless of what party is in control in Washington.
What in the name of John Maynard Keynes is going on here!?! And why in the world is virtually nobody in the mainstream financial media even talking about the key fundamental problems that exist with what is even being debated in fiscal policy circles at the present time!?!
What exactly am I chirping about here? Why are we even having a discussion about tax cuts that are going to add $1.5 trillion to the deficit over the next ten years (once again, we all know it’s going to end up being a heck of a lot more than $1.5 trillion by the time we reach 2027). In fact, why are we even having a conversation about adding a mere penny to the deficit? Instead, where the heck are the surpluses!?!

Why surpluses, you might ask? For the following reason.
We are already currently in the third longest sustained economic expansion in U.S. history dating back to the mid-1800s. At 98 months, it is quickly closing in on the number two spot held by the 106-month expansion from February 1961 to December 1969. If it can stay on track for another year beyond that, it will claim the all-time top spot currently held by the economic growth period from March 1991 to March 2001. And if a recent note from Goldman Sachs (GS) is any guide, it is assigning a two-in-three chance that the current expansion will pull off becoming the longest on record.
Certainly, the recovery has been anything but robust in magnitude. But it has been extensive in duration. And it is showing no signs of letting up anytime soon under the current set of fiscal policy circumstances. Moreover, if the U.S. stock market (DIA) as measured by the S&P 500 Index (SPY) is any indication (I’m not really sure that it is anymore, but let’s just humor the thought for a moment), then the underlying economic outlook is much more awesome than the past and current economic data might suggest.
If we are already in what may soon become the longest economic expansion in U.S. history with a stock market that has been repeatedly trading at all-time highs for several years now, what then is the theoretical justification for more federal budget deficits? Spare me the “future growth will pay for today’s deficits” argument, as decades of past evidence as shown in the chart below more than confirms that the additional money ends up getting spent elsewhere other than going back into the Federal coffers at the end of the day.
I was generally supportive from a fiscal policy standpoint of the original debate around potential “tax reform”. For “tax reform” implies a larger change in the tax code where tax revenue resources can be redirected from inefficient and wasteful policies that are curbed or eliminated to areas that can support productive and sustainable growth while also creating greater fiscal flexibility for the government going forward. Put more simply, “tax reform” that involves tax cuts that are paid for by making the tax code more efficient with some money left over in the process (ideally surpluses, but I’ll even take a reduction in the deficit) makes good sense, particularly when we are in the midst of one of the longest sustained U.S. economic expansions in history.

But as the 2017 calendar year has evolved, it became increasingly apparent that “tax reform” in its true sense was simply not going to happen. Instead, the debate has slowly morphed into talk about “tax cuts” that are not going to be fully paid for by offsetting changes in the tax code. Put simply, fiscal policy makers are currently trying to figure out ways to spend even more money without the tax revenues to support it. And once again, they are trying to do so in the midst of one of the longest sustained U.S. economic expansions in history.
The Fundamental Problem
Why does all of this matter? So what if we continue to run deficits? Because the instance on continuing to run massive budget deficits not only in the U.S. but also across the globe despite the supposed economic growth and prosperity runs contrary to the economic theory first put forth by John Maynard Keynes and eventually implemented by much of the world’s free market economies during the Great Depression. The so-called Keynesian Revolution replaced the preceding neoclassical economic theory that operated under the principle that the free market would independently adjust itself over time and move toward full employment without government intervention. And since this revolution more than eight decades ago, the global economy has operated under the general direction of Keynesian economics.
The primary fundamental tenant of Keynesian economics is the following. When an economy falls into recession (or worse, depression), the government can intervene with increased spending and lower taxes to help fill the associated output gap and stimulate aggregate demand to promote economic recovery. In other words, the government can justify deficit spending to help smooth out the economic dips and get positive growth up and running again. Global governments include the United States get one mightily resounding check in this regard. Mission not only accomplished but also completely obliterated.
But there is a subsequent step involved with the proper implementation of Keynesian economics that has gone missing for the last half century now as evidenced by the budget surplus/deficit chart shown earlier in this report. And it is a missing step that has become increasingly worse over time. For the important counterbalancing next step of Keynesian economics is that once the economic recovery has been achieved, governments must subsequently run budget surpluses in order to eliminate the debt accumulated during the prior period of economic weakness. Stated more directly, the government can justify running up the Federal credit card during tough times, but only if it pays off these bills once things get better.

In short, properly implemented Keynesian economics is all about balance. But any effort to maintain this balance was abandoned decades ago now. It has been so long ago forgotten now that those in politics on either side of the political aisle as well as those in the financial media hardly even think to consider it anymore. Instead, simply not adding anything more to an already existing massive deficit is considered pious if not stingy, while how much more we can add to the deficit regardless to underlying economic prosperity becomes the crux of the discussion. The imbalance becomes perpetual and increasingly perilous in the process.
Another Revolution Coming To Washington?
Where have these imbalances brought us today in 2017?
We have seen three major economic crises in the past - the stagflationary period of the 1970s and early 1980s, followed by the bursting of two major asset bubbles in the 2000s. Upon reflection, it was no coincidence that each of these trying economic periods came in the wake of the two longest economic expansions in U.S. history. For the longer excesses are accumulated, the more likely they are to lead to increasingly traumatic consequences once they are finally released. It is also no coincidence that the real fiscal budget deficits were sustainably increased in the aftermath of each successive corrective episode, as an even greater amount of deficit spending is required to put out each successively new fire.
All of this brings us to 2017, where what was once described under Keynesian economic theory as government intervention in free markets in order to smooth the recessionary cycle has evolved over time to what has become today the government completely overtaking free markets regardless of where we are in the economic cycle with an overwhelming torrent of fiscal and monetary policy support. It has no longer become a question of whether the government will intervene at any given point but by how much it will intervene at all points in time.
So what has this excessive intervention yielded us? We have income inequality and a wealth gap that is increasingly widening with each passing year. We have real wages that have been stagnant to declining for years if not decades now. We have structural unemployment that has been deteriorating for years across many parts of the United States. We have corporations that have a greater incentive toward share buybacks and dividend distributions than to growth enhancing capital expenditures. And we have increasing social unrest not only in the United States but also across the globe that has resulted in the increasing popularity of politicians and parties that once resided on the left and right fringes of the political spectrum but are now increasingly making their way into the mainstream.

Imbalances continue to accumulate. Disparities continue to widen. People are becoming increasingly frustrated. All that is missing is a major economic event to spark the catalyst for change. And the longer and further that we continue down the current course, the less the question of change becomes about “if” and the more it becomes about “when”.
The Bottom Line
A revolution is coming in the theory that drives our global economies and financial markets.
Keynesian economics has lasted for more than eight decades now, but it is increasingly descending toward its demise in the coming years. It’s certainly not Keynes’ fault, as I strongly assume he would not have advocated the gross, one-sided mismanagement of the implementation of his economic theory for so many years. But the imbalances that have been created over so many years have culminated in extremes whose resolution will likely require the next John Maynard Keynes to soon step forward in the coming years with the next revolution in economic theory to lead our economy through the remainder of the 21st century and into the 22nd.
All of this may sound alarming. I can already imagine some sharpening their “doomsday” knives for the comment section. But the notion of long overdue change is not alarming. Instead, it is necessary to achieve the progress required to more successfully move forward. Today’s reality is that the U.S. and global economy has been increasingly stagnating for years despite the best efforts of policy makers to intervene along the way. We’ve been seeing it in Japan since the end of the 1980s, and we’re increasingly seeing it across the rest of the developed world since the start of the new millennium. The populace around the world is becoming increasingly restless for more widespread prosperity that extends beyond the highest echelon, and staying the course simply will not lead us to this outcome.
The global and U.S. economy is vastly larger today than it was during the Great Depression. And we have John Maynard Keynes and the revolution that resulted from his economic theory to thank for this tremendous progress. But we are now quickly moving toward the next crossroads where a now stale, eight decades old economic theory needs some major refreshing.

Maybe it will become some new modified form of Neo-Keynesianism. Then again, maybe it will be something entirely revolutionary. And it certainly may not require another economic depression to inspire such change depending on how proactively policy makers seek to adapt any potential new way of thinking.
But the fact that we are now watching a tax debate unfold that is contemplating how much further we may add to an already large deficit in the midst of one of the longest economic expansions in U.S. history demonstrates how far off the fiscal policy path we have gone on both sides of the political aisle from the original Keynesian economic framework and how inevitable an eventual change is becoming. Once again, it is becoming less a question of “if” instead of “when”.
Any such “when” will not happen overnight but instead will evolve slowly over time. But if it does come to pass, it is not likely to take place without disruptions to financial markets. This includes potential dramatic effects on stocks (IVV), bonds (BND), commodities (DJP), precious metals (GLD) (SLV), and the existing and still relatively young at 46 years fiat currency system as we know it today including the U.S. dollar (UUP). This is not to say that any of these assets will necessarily gain or lose value in any potential future transformation process. But what it does suggest is that the record low volatility (VXX) that investors have been enjoying during the monetary policy morphine drip years since the calming of the financial crisis more than eight years ago would almost certainly come to an end with much more dramatic swings in asset prices versus anything we have seen in recent memory taking its place. And with the looming end of net increases in monetary stimulus from global central banks starting in the coming months of 2018, this transformation may start to come sooner rather than later at this point. Only time will tell.
All of this highlights the importance of being prepared for what may lie ahead. Perhaps global capital markets will remain sanguine through it all. Perhaps we will finally achieve the more robust economic growth that has been so elusive throughout the post crisis period of “prosperity”. Then again, we may see something altogether different take place in the coming years. In the event that we do, capital markets will remain rich with upside opportunities that may even be far more attractive than what is on offer today. But such opportunities will not necessarily come easy and will require more work and a plan that extends beyond buying and holding the latest index fund du jour and hoping for the best. And those that are prepared in advance and remain watchful of what might unfold on the policy front in the coming years will be those that are best positioned to capitalize once something other than everything being absolutely awesome finally arrives on the global capital markets scene.

Continue to enjoy the stock market upside as we have for so long during the post crisis period.
But also remain watchful and prepared for what may lie ahead. For the latest tax policy debate is yet one more confirmation that a revolution may eventually be coming to the way we all think about economics going forward.

The Hyperinflation That Was Not

By: Keith Weiner

Last week, we made a very controversial statement. We are happy to write the truth, and let the chips fall where they may (e.g. our thoughtful disagreement with Ted Butler about price manipulation). We can accept the flak that we get for this, so long as our position is understood.

Some criticized our approach as mere technical analysis, and therefore insufficient to the task of explaining the dynamics of the gold and silver markets. But whether we quibble with this characterization of our work or not, we believe that the points we made and the unique data we published stand. No one, including Mr. Butler, responded substantively to our data or logic.

People can read and choose sides, and we’re OK with that.

But last week, we said something that we feel was not well understood. And it is one of the most important ideas in monetary economics, and the key to understanding banking.

The Federal Reserve, of course, is a key participant in this monetary inflation scheme. Does the Fed have a printing press? Does the Fed print?

Like any bank, the Fed borrows to fund its purchases of interest-paying assets. It earns a spread between what it pays (currently about 1.25%) and what its asset portfolio pays (over 2%)… Unlike any commercial bank, there is a law that obligates us to treat the Fed’s liabilities as if they were money.

Borrowing is pretty close to the opposite of printing. So how is it possible that there is so much contention on this issue? Perhaps it would be more accurate to say that, in Austrian circles, there is little contention: Monetary Metals are just heretics!

If the Fed printed, then hyperinflation would have come, and this is what many Austrians predicted.

For example, one famous personality predicted at FreedomFest in July 2009, that we would have hyperinflation by the end of that year.

Printing would create a flood of worthless paper. Apart from the sheer quantity of it (trillions), would be the absurdity, the meaninglessness of it. Though many call the dollar “worthless paper”, it is not worthless. It is still quite worthful—a dollar can buy over 24 milligrams of gold, not to mention food, fuel, housing, artwork, and laptops on which we can pontificate about matters monetary.

But suppose an organized crime ring printed up $3,500,000,000,000, and went on a shopping spree.

These forgers begin buy everything from cases of Cristal to paintings by Cézanne, from Maybach cars to Malibu homes. What would happen?

They would push up the prices of everything. Relentless buying by price-insensitive purchasers lifts all offers and keeps moving them up. Of course, if you have a printing press then it does not matter to you if Cristal is $200 or $20,000. You can easily print more. Price only matters to those who have to earn before they spend (or liquidate the family estate).

So the net result of printing would be relentlessly but probably steadily rising prices. At first. Until people begin to see the game and look forward to its inevitable denouement. Then something happens. Economist Ludwig von Mises described the “Crack Up Boom”:

But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears.

Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

We must reckon with the fact that this did not happen. Here is a graph showing the prices of crude oil and wheat from the start of the first “quantitative easing” to the end of “zero interest rate policy”.

Both commodities go up, though wheat went down first. They end lower than they start.

Notably, wheat (and other commodities) began to fall by late 2012. Oil was last to join the party (due, we believe, to geopolitical risks rather than monetary effects) in mid-2014.

We don’t want to quibble here. The question is not: “did oil go up proportionally to the increase in the quantity of dollars?” Oil went up about 133% from start to peak in April 2011, while M1 measure of money supply went up 20% during the same period. Then as M1 increased by an additional 63%, oil went sideways before declining 69% from its peak.

The question is: “what did the Fed do?” Obviously, it did not print and buy wheat or oil (nor give the dollars to someone else who did).

The Fed exchanged dollars for bonds (Treasury and mortgage). This leads to two questions.

One, what is the nature of a dollar and of a bond? Two, what does it mean for the Fed to make such an exchange?

There is much confusion today because we call the dollar “money”. In the classical gold standard, the paper dollar was redeemable. That is, anyone could bring dollar bills to a bank and exchange them for gold coins. The bill, or note, is a credit instrument. It is paper evidencing an obligation to pay money on demand. The gold is the money.

Now that the dollar is irredeemable, there is a temptation to use shorthand and say that the dollar itself is money, to define money as just a medium of exchange. But if the dollar is money, what is the difference between the dollar and the bond? Both are forms of credit.

The difference is duration.

The dollar is a current asset, whereas the bond matures sometime in the future. It is interesting how much debate occurs over the question of how to define and measure the money supply.

This debate occurs because everything in our monetary system is credit, and it’s hard to find a clear place to draw a line and say “this credit is money, but that credit is not money.” (One measure is called MZM—money of zero maturity.)

The dollar is the liability issued by the Fed. It issues this liability to fund its purchase of longer-duration credit assets. Why? As we said last week, the Fed earns the spread between the cost of issuing its liability and the yield it earns on its assets. This is what any bank does.

The issue of printing reminds us of those brain teaser paradoxes. Seven people go out to dinner at a restaurant, and the tab is $300. The first person puts in five tens, the second person puts in three twenties and takes a ten, etc. Somehow after the last person puts his dollars on the table, the pile of cash comes up short. Where did the money go? The key to understanding the paradox is that there is always a rhetorical sleight of hand.

It is the same with the key question of the fractional reserve debate: a bank takes in $1,000 and lends $2,000. Where did it get the money? The Fed buys a trillion worth of bonds, where did it get the money?

It is crucial to understand the nature of the dollar. It is not a positive value, an entity in existence.

Like a lump of metal. A dollar is a relationship between two parties, one of owing. One party owes the other.

When the Fed issues a dollar, it is a debt owed to the recipient. The Fed is borrowing from the recipient. When the Fed buys a Treasury bond from someone with newly-issued dollars, that party is exchanging one kind of credit for another. It exchanges one debtor party (the US government) for another (the Fed). It is exchanging a longer-duration asset for a current asset.

It is exchanging yield for liquidity.

Long-duration assets have duration risk. That is, the price varies inversely with the interest rate. The shorter the duration, the less the risk, and the dollar is the shortest with zero duration risk.

The Fed increases its balance sheet. That is, it has a new liability and a new asset. But it has no free “spending money”. It does not gain any equity in the bond-buying transaction.

The seller of the bond does not get free money, either. It exchanges one kind of credit paper for another. It likely does gain a small amount of equity, as the Fed is typically paying the offer price which is likely above what the seller paid for the bond originally.

We can look at the net result, and say it is printing and it is increasing the quantity of money. But that’s not useful, either as a description of what happened and certainly not as a predictor of what will happen next.

This is why we say the net result is that the Fed increases its balance sheet, the Fed takes on more duration risk, the Fed pushes interest rates down, and the seller gives up the yield it had. Most likely, the next step is for the bond seller to buy another asset, to invest and not hold cash.

There are two differences between the Fed and any commercial bank in a free market. We discussed one last week: the government forces us to treat the Fed’s credit as if it were money. Government schools and regulators strongly induce everyone to think in those terms.

The other is that the Fed is not a market actor, motivated to seek arbitrage opportunities to make a profit. It is a non-economic actor, imposing monetary policy to achieve political goals (based on rubbish economic theories).

A commercial bank could not buy bonds without limit. Its cost of credit would rise, while the yield it could obtain on bonds is falling. The compression of this spread is the signal to stop.

When a bank issues its credit paper to buy an asset, the seller is expressing a preference for the liquidity and lack of duration risk of a current asset. The bank is expressing a preference for assets that will earn it a yield. The seller gives up the yield, and the bank gives up some capacity for funding balance sheet expansion (i.e. takes on some liquidity risk).

It is counterintuitive to say it this way, but it’s vitally important to see the essence of it: the bank is borrowing from the seller of the bond. It is borrowing and buying, borrowing while buying. Borrowing to buy.

The above description should not be taken as a defense of the Fed, nor of the practice of duration mismatch by the banks. If we are to be monetary pathologists, we need to begin by correct observation. We must be able to look through a microscope at a slide of diseased tissue and saying “nope, it’s not cancer. It’s a different kind of tumor, and it will kill you in a different way.”

We live under an absurd monetary system. It is designed to sacrifice the savers—who don’t realize they are creditors—to the debtors. Savers cannot escape the credit pen, not even when they hold what they think of as money. They are disenfranchised. They can gnash their teeth as the interest rate falls to zero and beyond, but their protests are toothless. Meanwhile, debtors can borrow to repay principal when due.

Credit should be redeemable. And there is precisely one commodity which works better than all others for redemption. Indeed few others would even come close to working at all. Can you imagine crude oil? A week’s wages for the average person in America is about 850 gallons of oil. Would you like a driveway slick, a dead lawn, or do you have a big tank?

This is the argument for why we need the gold standard. The whole point of a Yield on Gold, Paid in Gold®, is to lead towards the gold standard. A yield on paper, paid in paper sure isn’t working any more.

The price of gold fell $7, and that of silver 24 cents. This was a holiday shortened week, due to Thanksgiving on Thursday in the US (and likely thin trading and poor liquidity on Wednesday and Friday). So take the numbers this week, including the basis, with a grain of that once-monetary commodity, salt. We will keep the market action commentary brief.

Here are the charts of the prices of gold and silver, and the gold-silver ratio.

Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio.

The ratio rose.

In this graph, we show both bid and offer prices for the gold-silver ratio. If you were to sell gold on the bid and buy silver at the ask, that is the lower bid price. Conversely, if you sold silver on the bid and bought gold at the offer, that is the higher offer price.

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph showing gold basis and cobasis with the price of the dollar in gold terms.

The cobasis (our measure of scarcity) of the Feb contract rose slightly, as the price of gold fell slightly.

The Monetary Metals Gold Fundamental Price is up 8 bucks.

Now let’s look at silver.

The story is the same in silver, with a bit larger rise in the cobasis.

Getting Technical

Can You Afford to Bet on Bitcoin?

By Michael Kahn

I didn’t want to address the parabolic rise in the price of Bitcoin, as it’s very difficult to apply reasonable technical analysis to something moving this quickly. Because of that, I can’t come to a conclusion on where this market might move next. But in either direction, the cryptocurrency seems to offer huge rewards, but with risks not seen in a long, long time.

Pundits now use the “B word”—bubble—to describe a market that gained nearly 1,000% this year. The problem with a bubble is that we really can’t know when we are in it. It’s easy to assess the situation after the fact, but we’ve already seen the word used to describe Bitcoin this year when it traded at $2,400, $4,200, and $5,700.

I even wrote about it in 2013, when Bitcoin traded at $1,242, with the obligatory comparison to the Dutch tulip bubble of 1637.

Considering it topped $11,000—albeit temporarily—in Wednesday’s trading, clearly the bubble callers were wrong.

So is it a bubble now at last? Maybe.

Does it matter? Perhaps for the fast and furious money playing it. But for the average investor, the chart shows incredible danger for both bulls and bears alike (see chart).

Can You Afford to Bet on Bitcoin?

We can all agree that trends do exist in all markets, and once they get going it takes real news from within or even without the market to change them. But there are trends and there are trends.

Long-lasting trends move higher at reasonable rates. Of course, the definition of reasonable is subjective. But the trend in a market that doubled from December to May, doubled again from May to August, and again from August to November cannot be sustainable.

The chart shows an ever-increasing slope, even on a semilogarithmic scale.

But as I wrote in 2013, “Perhaps Bitcoin…is indeed the future of money.… But the dangers of buying into a bubble are the same as attempting to sell it short. It could double from here just as easily as it could fall by half. Timing must be perfect with these levels of volatility and risk.”

That suggests that individual investors watch from the sidelines. Or, if they must be involved, keep it to a very small portion of their portfolio. After all, Bitcoin is really only a concept, yet it has a market capitalization larger than half of the component stocks in the Dow Jones Industrial Average.

I’ve observed before that when Wall Street or LaSalle Street in Chicago introduce new products to capture the demand for the hottest financial craze, it often marks the end of the current move. It takes time for the financial wizards to recognize the trend, develop the products, pass the regulators, and then bring them to market. By then, sentiment is usually very bullish, so much so that it becomes a contrarian bearish signal.

In the coming months, at least three Bitcoin futures markets may open for business. We already see ads for self-directed individual retirement accounts to let people “get in on the action.” Remember, IRAs are for safely building for retirement, not speculating.

All of this is tangential evidence that the end is near for the current Bitcoin rally, but as we’ve seen this week alone, that could still mean double-digit or even triple-digit percentage gains before the bears take over.

If and when they do, the descent back down is likely to be a mirror image of the rally. And as I have seen many times in many markets, the giveback can be 100% of the accelerated rally. That could mean a drop back to the top of the a long-trading range at the $1,200 level.

Sound impossible? Bitcoin actually did it before.

When I looked at Bitcoin in 2013, as it traded at $1,242, the parabolic rally had begun months earlier with a breakout above $250. The market worked its way back down to that area over the following year for an 80% decline.

I am not arguing about the future of cryptocurrencies, but rather warning that the current action is far too stomach-churning for the average investor. It feels great to ride this rocket on the way up, but not so much when even a reasonable correction finally arrives.

Bitcoin swings from bull to bear and back in a day

Cryptocurrency surged past $11,000 on Wednesday before falling to near $9,000

Eric Platt, Nicole Bullock and Joe Rennison in New York

After Lehman Brothers toppled in September 2008, it took 24 days for US stocks to slide more than 20 per cent into official bear market territory. Bitcoin, the new age cryptocurrency that has been breaking bull market records, did the same on Wednesday in just under six hours.

Investors and speculators watched the cryptocurrency rally to an all-time high of $11,434 — gaining 15 per cent in trading early in the day — before sinking as much as 21 per cent to $9,009 in volatile trading and then rebounding.

Bitcoin investors complained of outages and sluggish trade execution at some of the largest exchanges as the price whipsawed.

Early on Thursday morning in London showed that trading remained highly volatile, with bitcoin quoted at $10,395, having carved out an intraday range of $9,609 to $10,787.

At its $11,434 peak on Wednesday, bitcoin was up more than 12-fold for the year — or more than 1,100 per cent. The digital currency rose through both $10,000 and $11,000 levels for the first time, according to Bloomberg data.

The sharp rise in bitcoin has sparked analogies to past bubbles, from the tulip craze of the 17th century to the dotcom boom and bust at the turn of the millennium.

“We’re watching history,” said Rich Ross, the head of technical analysis at Evercore. “It is a classic bubble, and bubbles go up a lot. It is a mania and the best thing about it is you can’t value it, like trading technology stocks in the ’90s.”

The latest tumultuous trading comes as bitcoin has garnered increasing attention both for its meteoric rise this year and signs that it is moving from the periphery of finance towards the mainstream.

Nasdaq, the US exchanges operator, plans to launch bitcoin futures next year, a person familiar with the plans said on Wednesday, following similar plans by rival exchanges CME and CBOE.

The whipsaw trading does not appear to be scaring off existing traders or newcomers afraid they are missing out on the chance for quick, easy profits; in fact, it may be adding to the allure of being a part of the latest craze.

“Every three weeks it goes up, people take profits and then it goes down but money is still coming in so it will keep going up,” said David Drake, founder and chairman at LDJ Capital, a family office that invests in bitcoin.

Mr Drake thinks the cryptocurrency could hit $20,000 by the end of 2018. “It’s already hit $11,000 and it’s not even the end of 2017,” he said.

A slump in volatility in traditional asset classes to historic lows has also piqued the interest of the traditional trading community.

DRW of Chicago, one of the world’s largest proprietary trading companies, has about a dozen of its more than 800 employees buy and sell bitcoin at a subsidiary named Cumberland, which was established in 2014. Other companies have followed, including Jump Trading, DV Trading and Hehmeyer Trading + Investments, according to industry executives.

“It is not that it cannot go up more, but you have to expect the volatility that we saw today,” Mr Ross added. “In two weeks something has gone up more than 100 per cent so you have to expect the downside to be commensurate.”

Profiling Lebanon: The Western Front of a Proxy War

By Kamran Bokhari

If the Middle East is at least in part a proxy war between Saudi Arabia and Iran, then Lebanon may be called its western front. For nearly two generations, Riyadh and Tehran have vied for influence there, as the country has been, with a few interruptions of stability, at once a hostage to and the object of their competition. The competition resumed this week, and it appears that Saudi Arabia is losing.

On Nov. 4, Lebanese Prime Minister Saad Hariri announced his resignation in a recorded message aired on Saudi media. In the message, he criticized Iran for interfering in Arab affairs and criticized Hezbollah for holding his country captive. He resigned, he said, because there was a plot to kill him.

The next day, the Saudi minister of state for Arabian Gulf affairs accused Lebanon of declaring war on his country. Then, on Nov. 9, a Reuters report suggested that Hariri was coerced into resigning by the Saudis and is being held in the kingdom. The Saudi government has since called on all its citizens in Lebanon to immediately return home. Tensions have run high before, but the past week has been particularly acrimonious.

Lebanon prime minister
A poster of Lebanese Prime Minister Saad Hariri, who resigned in a televised speech, hangs on the side of a road with a phrase reading in Arabic “God protect you” in the northern Lebanese port city of Tripoli on Nov. 9, 2017. IBRAHIM CHALHOUB/AFP/Getty Images

A Country Divided

Lebanon is a country divided, home as it is to Shiite, Sunni, Christian and Druze communities. Civil war wrecked the country for 15 years until a power-sharing agreement was reached in 1989. The treaty was in part a reconciliation between Saudi Arabia and Iran, which told their proxy groups that participated in the war to settle their differences. The accord named Syria the overseer of Lebanon, and for the next two decades, Hezbollah, a Shiite Islamist movement backed by Syria and Iran, gradually became the most powerful force in Lebanon.

It owes much of its rise to the Israeli invasion in 1982. The Israeli military remained in southern Lebanon until 2000, and in doing so gave Hezbollah an excuse to maintain a massive armed wing – even after it joined the political mainstream. It drew criticism after an international tribunal found Hezbollah to be involved with Syrian intelligence operatives in the 2005 assassination of Hariri’s father, former Prime Minister and Saudi functionary Rafik Hariri. Syria was forced to withdraw tens of thousands of troops it had stationed in Lebanon, but it maintained its influence through intelligence assets and through Hezbollah, which was jointly managed by Iran.

For years, Hezbollah’s armed wing was more powerful than the Lebanese military. Nurtured by the Iranians, Hezbollah would later withstand the 2006 invasion by Israel, and its resilience only added to its clout – and, by extension, to Iran’s. It became so influential that it was able to engineer Saad Hariri’s ouster in January 2011. A few weeks later, the Arab Spring started, and by March it had reached Syria.

For Riyadh, the uprising in Syria was a godsend. The kingdom had been losing ground to Tehran for some time, so if the Sunni majority in Syria could topple the government of Bashar Assad – which was aligned with Iran – then it would have broken the otherwise uninterrupted arc of influence Tehran had from Iran to the Mediterranean Sea. It would also weaken Hezbollah.

But it was not to be. The Syrian government, backed by massive amounts of Iranian (and Russian) support, reclaimed territory it had earlier lost to the rebels. Six years later, the government is nominally still in place. Through it all the Saudis and Iranians wanted Lebanon to stay out of the conflict. The Saudis were losing Syria and Iraq to Iran, and they therefore could not afford to lose Lebanon as well. The Iranians, for their part, had the upper hand and had no reason to disturb that reality.

Saudi Arabia had meanwhile been supporting Salafist jihadists in the Syrian conflict, hoping that they could effect regime change where the Saudi military could not. Instead, Riyadh inadvertently empowered groups likes al-Qaida and the Islamic State. And their rise actually undermined Saudi Arabia’s position in Lebanon. The main political Sunni faction there, Hariri’s Future Movement party, was in a state of decay, having been challenged for years by Sunni hardliners. Non-Sunni factions were scared of what empowered radical Sunni groups in Syria would do to them if Assad lost the war. Hezbollah’s participation in the Syrian civil war, then, benefited Saudi Arabia’s enemies in Lebanon.

Few Options

The Lebanese peace agreement from 1989 was acceptable for Saudi Arabia – acceptable but not optimal. According to the agreement, the president would be a Christian, the prime minister would be a Sunni and the speaker of the parliament would be a Shiite. All major parliamentary factions would be represented in the Cabinet. The Lebanese presidency for years had been held by individuals who were neutral but sympathetic to Saudi Arabia. However, a key Hezbollah ally, Michel Aoun, was elected president roughly a year ago. The Saudis begrudgingly accepted Aoun’s presidency because it allowed them to negotiate Saad Hariri’s return from political exile.

But a lot can happen in a year, and Iran is more of a threat than it once was. The degradation of the Islamic State has strengthened Iran’s position in Syria and Iraq. The Assad government, now more than ever dependent on Iran, continues to reclaim territory. The Saudis, meanwhile, have been fighting a losing war in their own backyard. In Yemen, they have been unable to defeat opposition forces led by the pro-Iranian Houthi movement. Only a few days ago, Riyadh intercepted a missile allegedly launched by Houthis and allegedly supplied by Iran.

The only place Saudi Arabia can counter Iran is in Lebanon. If Riyadh can end the uneasy peace the country has had for the past few years, it could force Iran and Hezbollah to spend less time and attention in Syria and Iraq and more in Lebanon. But Saudi Arabia has its own problems and so is unlikely to be successful in this regard. Denouncing Lebanon is an admission of just how weak Riyadh has become.

Doug Casey on the Destruction of the Dollar

by Doug Casey

“Inflation” occurs when the creation of currency outruns the creation of real wealth it can bid for… It isn’t caused by price increases; rather, it causes price increases.

Inflation is not caused by the butcher, the baker, or the auto maker, although they usually get blamed.

On the contrary, by producing real wealth, they fight the effects of inflation. Inflation is the work of government alone, since government alone controls the creation of currency.

In a true free-market society, the only way a person or organization can legitimately obtain wealth is through production. “Making money” is no different from “creating wealth,” and money is nothing but a certificate of production. In our world, however, the government can create currency at trivial cost, and spend it at full value in the marketplace. If taxation is the expropriation of wealth by force, then inflation is its expropriation by fraud.

To inflate, a government needs complete control of a country’s legal money. This has the widest possible implications, since money is much more than just a medium of exchange. Money is the means by which all other material goods are valued. It represents, in an objective way, the hours of one’s life spent in acquiring it. And if enough money allows one to live life as one wishes, it represents freedom as well. It represents all the good things one hopes to have, do, and provide for others. Money is life concentrated.

As the state becomes more powerful and is expected to provide more resources to selected groups, its demand for funds escalates. Government naturally prefers to avoid imposing more taxes as people become less able (or willing) to pay them. It runs greater budget deficits, choosing to borrow what it needs. As the market becomes less able (or willing) to lend it money, it turns to inflation, selling ever greater amounts of its debt to its central bank, which pays for the debt by printing more money.

As the supply of currency rises, it loses value relative to other things, and prices rise. The process is vastly more destructive than taxation, which merely dissipates wealth. Inflation undermines and destroys the basis for valuing all goods relative to others and the basis for allocating resources intelligently. It creates the business cycle and causes the resulting misallocations and distortions in the economy.

We know the old saw “The rich get richer, and the poor get poorer.” No one ever said life had to be fair, but usually there is no a priori reason why the rich must get richer. In a free-market society the sayings “Shirtsleeves to shirtsleeves in three generations” and “A fool and his money are soon parted” might be better descriptions of reality. We do not live in a free-market society, however.

The rich and the poor do have a tendency to draw apart as a society becomes more bureaucratic, but not because of any cosmic law. It’s a consequence of any highly politicized system. Government, to paraphrase Willie Sutton, is where the money is. The bigger government becomes, the more effort the rich, and those who want to get that way, will put into making the government do things their way.

Only the rich can afford the legal counsel it takes to weave and dodge through the laws that restrict the masses. The rich can afford the accountants to chart a path through loopholes in the tax laws. The rich have the credit to borrow and thereby profit from inflation. The rich can pay to influence how the government distorts the economy, so that the distortions are profitable to them.

The point is not that rich people are bad guys (the political hacks who cater to them are a different question). It is just that in a heavily regulated, highly taxed, and inflationary society, there’s a strong tendency for the rich to get richer at the expense of the poor, who are hurt by the same actions of the government.

Always, and without exception, the most socialistic, or centrally planned, economies have the most unequal distribution of wealth. In those societies the unprincipled become rich, and the rich stay that way, through political power. In free societies, the rich can get richer only by providing goods and services others want at a price they can afford.

As inflation gets worse, there will be a growing public outcry for government to do something, anything, about it.

People will join political action committees, lobbying groups, and political parties in hopes of gaining leverage to impose their will on the country at large, ostensibly for its own good.

Possible government “solutions” will include wage and price controls, credit controls, restrictions on changing jobs, controls on withdrawing money from bank accounts, import and export restrictions, restrictions on the use of cash to prevent tax evasion, nationalization, even martial law—almost anything is possible. None of these “solutions” addresses the root cause—state intervention in the economy. Each will just make things worse rather than better.

What these solutions all share is their political nature; in order to work they require that some people be forced to obey the orders of others.

Whether you or I or a taxi driver on the street thinks a particular solution is good or not is irrelevant.

All of the problems that are just beginning to crash down around society’s head (e.g., a bankrupt Social Security system, federally protected banks that are bankrupt, a monetary system gone haywire) used to be solutions, and they must have seemed “good” at the time, otherwise they’d never have been adopted.

The real problem is not what is done but rather how it is done: that is, through the political process or through the free market. The difference is that between coercion and voluntarism.

It’s also the difference between getting excited, frustrated, and beating your head against a wall and taking positive action to improve your own standard of living, to live life the way you like it, and, by your own example, to influence society in the direction that you’d like to see it take—but without asking the government to hold a gun to anyone’s head.

Political action can change things. Russians in the ’20s, Germans in the ’30s, Chinese in the ’40s, Cubans in the ’50s, Congolese in the ’60s, South Vietnamese and Cambodians in the ’70s, then Rhodesians, Bosnians, Rwandans, and Venezuelans today are among those who certainly discovered it can. It’s just that the changes usually aren’t very constructive.

That’s the nature of government; it doesn’t create wealth, it only allocates what others have created. More typically, it either dissipates wealth or misallocates it, because it acts in ways that are politically productive (i.e., that gratify and enhance the power of politicians) rather than economically productive (i.e., that allow individuals to satisfy their desires in the ways they prefer).

It’s irresponsible to base your own life on what hundreds of millions of other people and their rulers may or may not do. The essence of being a free person is to be causative over your own actions and destiny, not to be the effect of others. You can’t control what others will do, but you can control yourself.

If you’re counting on other people, or political solutions of some type, most likely it will make you unwary and complacent, secure in the hope that “they” know what they’re doing and you needn’t get yourself all flustered with worries about the collapse of the economy.