Saturday, January 24, 2009

Confetti and Streamers

Regular readers know I have been less than subtle in taking to task some of the country's leading academics for their market and economic idiocy through the current economic debacle. I have been highly critical of not only their appraisal of how we arrived here but also their solutions which most often employ Keynesian "more of the same" garbage.

I want readers to know that not that I am an equal opportunity offender and will not hesitate to identify economic lunacy when it is on display regardless of your place in the food chain. In all fairness, not all of our leading academics should be painted with the same 'ignoramus brush' as I have done with the likes of Ken Rosen of Cal-Berkeley and Roger Farmer of UCLA.

So just so you all know I am not only a nit-picker and naysayer only finding fault, I want to get out the confetti and streamers for David C. Rose and Lawrence H. Wright.

David C. Rose is Professor of economics at the University of Missouri-St. Louis and Lawrence H. Wright is the F.A. Hayek (now talk about a real economist !!) Professor of economic history at University of Missouri and a fellow at the CATO Institute.

I would normally only post a link to their article entitled 'We Can't Spend Our Way Out of This Quagmire'. Instead, I am reprinting their piece below, in it's entirety for your enlightenment. I encourage you to take the time to read it. It is elegant in its simplicity.

We can't spend our way out of this quagmire


The cause of the economic crisis was not the collapse of the secondary mortgage market, policies aimed at increasing home ownership or the rise of exotic financial instruments. These factors affected the nature of the crisis, but the ultimate cause was the bursting of a real estate bubble made possible by excessive money growth.

Abundant money and lower interest rates spur buying, pushing up prices. Since the supply of housing is relatively inflexible, housing prices rise quickly. Beginning in 2001, rising house prices and a rallying stock market increased homeowners' perceived net worth. People believed they didn't have to save as much for retirement or for their children's college education. And they could borrow more against their increased home equity, allowing them to buy more goods, services, stocks and real estate. Credit-fueled spending reinforced the rising prices of everything, but especially real estate and stocks.

But the increase in real estate prices and the increased spending it supported were a fantasy. The economy's ability to produce real goods and services is determined by the amount of plant and equipment, the number of workers, the supply of raw materials, and so on. We inevitably moved into a period of general inflation, so the Fed eventually had to reign in its easy money policy. Borrowing became more expensive, so people scaled back their spending or began selling assets to sustain it. Either response puts downward pressure on the prices of real estate and stocks, so prices that everyone counted on to rise forever began falling. The bear stampede was on.

In 2001, the Federal Reserve began expanding the money supply. Year-over-year growth rose briefly above 10 percent and remained above 8 percent into the second half of 2003. The effect on interest rates was immediate; the Fed funds rate that began 2001 at 6.25 percent ended that same year at 1.75 percent. It fell further in 2002 and 2003, reaching a record low of 1 percent in mid-2003. But if the Fed hadn't increased the money supply from 2002 to 2006, increased demand for credit resulting from deficit spending and the increased demand for real estate would have pushed up interest rates. This would have discouraged borrowing. Rising interest rates would have thwarted the process by which an increase in borrowing by the government and by the public artificially inflates asset prices, begetting even more borrowing.


Most economists, government officials and politicians continue to believe the standard Keynesian explanation for recessions: Recessions are caused by consumers and firms becoming "spooked" for no meaningful reason, so consumption and investment spending falls below normal levels. This reduces demand for goods and services, which reduces employment, which reduces spending even further, and so on. Since the level of spending before the "spooking" was presumed to be sustainable, the solution to the problem is simple: Increase spending to where it had been during the boom.

In reality, excessive money growth drove asset prices up and drove interest rates down, making people feel richer than they really were and lowering the cost of borrowing money to facilitate more spending. Since the level of spending before the period of excessive money growth was just sustainable, the resulting level of consumption and business investment spending was unsustainable. The solution is to allow asset prices to fall to levels that accurately reflect what our economy can produce. This will make it clear to people that they are not as rich as they thought two years ago and thereby return spending to sustainable levels.

Still, virtually everyone agrees that we need to further stimulate the economy even though current attempts to solve our crisis by increasing spending is exactly the wrong thing to do. No one wants to bear the political cost for appearing to be uncaring by favoring a policy of "doing nothing." Out of political cowardice, the federal government is attempting to produce a solution that is penny-wise and pound foolish. You can't solve an excessive spending problem by spending more. We are making the crisis worse.

We have been down this road before. Most recessions start with the bursting of bubbles that grew large because of excessive money growth. But again and again, we presume a Keynesian cause and a Keynesian cure.

Our recent stock market and housing market crashes can prove to be the start of a sound and rapid recovery — if we will have the courage to let it be so.



My utmost congratulations to Professors Rose and Wright for the courage and brains to offer some meaningful, sober and common sensical ideas on addressing this issue. If only President Obama and his economic dream team were so inclined to entertain the counsel of this pair.

I also want to offer congratulations to the parents of any students enrolled in Professors Rose and Wright's classes as they most certainly learning and are getting 'value' for their tuition dollar. I would counsel the provost of the University of Missouri-St. Louis to keep these 2 happy as the school is fortunate to have these bright lights on staff.


Good speculating to you all and never forget that "an investor is a speculator who made a mistake and will not admit it".

Open Positions:
Long 2 units Ultrashort MSCI EAFE ticker EFU @ $89.80 stop at $89.80
Long 1 unit Ultrashort Financials ticker SKF @ $102.60 stop @ $148.18
Long 1 unit Ultrashort S&P500 ticker SDS @ $66.15 stop @ $66.15
Long 2 units Ultrashort Real Estate ticker SRS @ $55.23 stops @ $54.75/$55.670
Short 1 unit Darden ticker DRI @ $27.70 stop @ $28.70
Short 1 unit of Mantech ticker MANT @ $56.80 stop @ $60.14

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