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Inflation? Deflation? - What Matters About the News From Europe

Posted on Thursday, January 22, 2015 No comments

Thursday, January 22, 2015

Here we go again...

Mario Draghi - the European counterpart to Janet Yellen (and Ben Bernanke before her) is announcing that the European Central Bank is going to do what the agreement that created the Euro expressly said would not be done - directly fund European governments' deficit spending.

OK, now at this point I realize a few things: 1) It is very likely you thought "Mario who?  Isn't that the guy from Donkey Kong?" (I just dated me and my Asteroids-champion self.); 2) If it's morning and you're working on your coffee you probably just thought "good grief, it's too early for this!" and 3) "Hold on, didn't the President just say the crisis has passed?  Why are you people still writing about this stuff?"

Well, mainly, because of economic gravity... what goes up must come down.  And if it went up fast, be assured, it'll come down fast.

Let me start by pointing out an economic measure: The "Shiller Price-to-Earning Ratio" is a multiple that expresses how the stock market values a share of stock.  If the "P/E" ratio is 10, it means each share of that company's stock is priced at 10 times earnings per year, per share.  Robert Shiller has created a model for this number that takes into account relative profit margins during periods of economic growth (when profits will be strong) and contraction (when they will be weak).  The reason I think this is worth your attention is it makes what is happening today easy to understand.

First, if you click on the link above you will see a chart that shows you the history.  This shows a "mean" P/E of 16.58 all the way back the late 1800's.  Anything below that means the market is "deflated."  Anything above that means the market is "inflated."  In order to understand what is happening in our economy, we absolutely MUST start with this historical context.

So when we hear central bankers like Draghi talk about "deflation," the very first thing we need to do is look at where the P/E ratio is against its historic mean.  When we see that it is at 27.10 (as of this writing) against a mean of 16.58 - and all we hear on the news is hand-wringing about "deflation" - we should be putting on our critical thinkers' hats and start asking some tough questions.

Again, at 27.10, the market is incontrovertibly inflated from its historic mean.  So what do they mean when they say they are going to create more money to avoid "deflation?"

They mean they do not want to let the air out of the balloon.

They are assuming we start with valuations as they are today, and that if the balloon loses air, that will be "deflationary."  And they (politicians and their bankers both) know full well what happens when their bubbles burst.  The politicians lose their jobs... and the money printers lose their sponsors.

The jig is up, the news is out, we finally found them...

Let me try to show here why they're fighting a losing battle:

If you have ever repaid a loan, you know part of each payment goes to interest.  And you may recall a time when you could put money in a savings account and get paid a few percent in interest on your savings.  Well, money works by the laws of supply and demand like anything else.  The more money is out there, the cheaper it becomes.  But that price is expressed as an "interest rate."  And you cannot go lower than zero.  Well, you can, but if the interest rate on your savings account is in the negative, you are actually paying to have the bank hold on to your money for you.  At that point you're better off pulling it from the bank and sticking it under your mattress.

The lesson in simple terms?  There is a limit to how much money central bankers like Draghi can create before the entire idea of money - and the banking system with it as people yank their deposits instead of paying the banks to hold onto them - begins to fall apart.  If anyone should know better it is the Europeans, who have seen this movie before in the "Wiemar Republic."  This was the German government predecessor to Hitler's Third Reich, and their money printing to pay debt (exactly what Draghi has announced they are going to start doing) is what created the economic circumstances which then gave rise to the Third Reich.

Again, Europe has seen this movie before.  It did not end well the last time.

This is, actually, quite easy to understand.  Try blowing up a balloon.  Just ignore that sneaky suspicion that the rubber is being stretched to its limit and keep on blowing.  In terms of money, the closer interest rates get to zero, the more persistent that sneaky suspicion should become.  But if you want to ignore that sneaky suspicion, just keep on creating new money (blowing).  Even you jocks out there should figure out how this ends without too much difficulty.

The reason the P/E ratio is the number to watch here is because the stock market has become the dominant "inflation sink."  Here I'll reach into my computer geek hat for an analogy. The laptop I am writing this post on is a few years old and the system fan is starting to stress out and make noise.  The chip in this laptop has a "heat sink" which dissipates the heat generated by the chip as the fan blows air over it.

What happens when extra money is created is prices act as a "sink" to dissipate the excess money. Before the computer, new money had to actually be printed, and so it would be dissipated among ordinary consumer products - prices would rise across the board.  But because of the computer, when banks want to invest their reserves (all the excess money) they deploy that money mainly into the stock market (and real estate to a related extent).  And so we see a spike in the valuation of stock prices as well as real estate.  The best way to track those spikes is the Shiller P/E Ratio (and the Case/Shiller Home Price Index).

The other way to track this is income inequality.

Wealth is measured more and more in terms of stock and real estate, and more and more of this wealth is going to fewer and fewer people.  The problem with the Occupy crowd is all they do is rail about this without really understanding the underlying cause.  The problem with conservatives is they think any effort to correct this distortion is an attack on the free market.  The Occupy crowd needs to realize the same politicians who strike their populists poses are the ones calling for more money printing.  Conservatives need to disabuse themselves of the assumption that we even have a free market to attack.  We haven't had a free market since 1971.

No matter how good you are (were?) at Donkey Kong or Asteroids (or Call of Duty if you're of the younger set), there will eventually come a time when the screen will say "GAME OVER."  The higher the Shiller P/E number gets against its historic mean, and the lower interest rates fall, the closer we are to that point.

You heard it here first... Donkey Kong will eventually prevail.

P.S. TO MY READERS IN THE UKRAINE: Stay AWAY from the Euro.  Stay as far away as you possibly can. Chart your own course. In the Euro lies a mathematically inevitable collapse. In your hearts lies the future of Europe.  Please, show us a future of industry, innovation and wealth creation; of an exceptional people among whom is the greatest possible room for all ethnicities, their languages and their religions.

The Ukraine and the Future of Europe: Marking Out a Different Path

Posted on Wednesday, January 7, 2015 No comments

Wednesday, January 7, 2015

Imagine a place where people from a wide range of ethnicity, subject in the past to the political designs of other countries, yet whose national identity has stubbornly refused to be driven from the popular imagination.  Its people are very aware of their diverse bloodlines, and celebrate them.  Its government encourages the flourishing of diverse ethnic identities and the cultivation of their languages.  Its national identity seems bound up more in a unshakeable self-determination than in any of the many ethnic and religious identities which have intersected within its borders.

It all sounds very American... but it predates the American experiment by hundreds of years.  We are witnessing in the heart of Europe the rebirth of a fundamental human instinct.  It is this instinct for freedom and self-determination that flowered into the American idea of freedom of religion as the Pilgrims fled the tyranny of the English Crown..  It is flowering again in the heart and minds of the beautiful people of the Ukraine, and in their historic cities which are the home of an ancient baroque architecture.

I have come to write this post by way of a statistical curiosity.  I track the visits to this blog, and am able to see where the audience comes from.  A while back I started noticing hits from the Ukraine.  When I go back over the stats, it looks like it started after I wrote my post on what "American Excpetionalism" means.  And this month, for the first time, I am starting to get more hits from the Ukraine than from the United States. (Hits for today, as of this writing, are 27 to 9 in favor of the Ukraine).  Something must have struck a chord and has left me wondering...  So I started to Google and read up on Ukrainian history and culture.

I think I am starting to understand.

In a YouTube video available here, various Ukrainian people explain their bloodlines.  Some are speaking in Russian, others in Ukrainian, but they show that they are both aware and proud of their ethnic heritage.  But they are Ukrainian.  There must be something about their national identity which transcends their ethnicity and religion.  They have translated their national anthem into English (and by meter and rhyme, have done so admirably well) and they sing it for the video.

In recent days Russian leaders have taken to the podium to denounce the idea that America is exceptional.  Vladimir Putin himself published a letter in the New York Times in which he wrote:
It is extremely dangerous to encourage people to see themselves as exceptional, whatever the motivation. There are big countries and small countries, rich and poor, those with long democratic traditions and those still finding their way to democracy. Their policies differ, too. We are all different, but when we ask for the Lord’s blessings, we must not forget that God created us equal.
And in a speech to the United Nations, Russian foreign minister Sergei Lavrov leveled the following charge:
Insouciant Americans are told that as they are the exceptional, indispensable people, their government has a right to be unaccountable to law. Law is what Washington imposes on others. Washington’s hegemony over others is the right of the “exceptional nation.” No other country counts or has any rights.
One of two things seems to be happening here.  Either the folks at the highest level of the Russian government have a gravely distorted understanding of exactly what we Americans believe when we claim to be exceptional, or they know full well what we mean... and realize the people of the Ukraine are exceptional in exactly the same way.

Russia's national identity is bound up in their ethnicity, their language, and their religion.  This is the story of the history of the human race.  Until recently, I thought our Founding Fathers were the first to conceive of a national identity of ideas that purposefully created a maximum amount of room for the flourishing of ethnicities, their religions and their languages.

It is an immense pleasure to discover that I was wrong.

This instinct of human freedom predates us.  But it has been suppressed over the centuries among the people of the Ukraine by the designs of others who would promote national identities of ethnicity and religion at their expense.  But it is now flowering again where it once appeared in times past.

I suspect Russia understands well the ramifications of a national identity of ideas flowering again in the Ukraine.  They seek a return to Cold War "spheres of influence," the Ukraine being the strategic fulcrum of their designs.  Armies can fight, and one can beat another.  Putin claims to be able to capture Kiev in two weeks.  As for territory, I don't doubt him.  As for the hearts of the people of the Ukraine - who are discovering their own exceptionalism exactly as we Americans have - Putin doesn't stand a chance.  There is no army which can conquer the human instinct toward freedom.
This leaves me wanting to say something to two distinct audiences. (I also see a decent number of hits on this blog from Russia.)  To my Russian readers:

When we say America is exceptional, we are not saying we - conceived in terms of our ethnicity or religion (I am of German stock, from the Roman Catholic parts of Germany, but am now an Evangelical Protestant) - are better than anyone else.  We are just as subject to the tyranny of the mob or of the oligarch as any society.  This is why we have a Constitution - it circumscribes the power of the majority that the natural rights of the minorities in our midst would be protected.  We still struggle with this... but we struggle openly and freely, hopefully more aware with each passing generation of the obligations our national creed places upon us.

You misunderstand us because being Russian means being ethnically Russian, speaking the Russian language, and perhaps to a large extent being part of the Russian Orthodox Church.  Being American means none of these things, as they might otherwise appear here in the United States.  It means committing ourselves to always defending the rights of those who do not speak our language, who do not go to our church, or do not share our bloodline.  The degree to which you can imagine a national identity of ideas rather than of ethnicity and religion is the degree to which you can understand us.

To my Ukrainian readers, let me begin here: Ukraine Has Not Perished!

But to sing this, I believe you to sing of the idea of the Ukraine.  Where people of all bloodlines can live freely, celebrate and nurture their languages, their cultures and their religions.  As you yearn for this exceptional life, though, please take note of the history around you.

To your west you should see that a sweet life of government-provided benefits will only end in bankruptcy and disaster.  The government which is big enough to provide everything you need will be powerful enough to take everything you have.  (On account of your history, you know this much better than we.)

When you step outside your home and see something in your neighborhood which needs fixing, do not wait for the government to come and fix it!  Own it yourselves!  What you own, you take responsibility for.  And as you take responsibility for your own communities you will discover your neighbors with that same sense of pride.  You will form a dynamic civil society which will always be superior to political society when it comes to meeting your needs and promoting a prosperous future.  And then those who are in need of social services will enjoy the dignity of being lifted up by someone who knows their name.

Do not let anyone deceive you about wealth.  It is created by improving things.  And improving things requires failure.  If you are to be free to succeed, you must also be free to fail.  Almost every story here in America of a successful business person is a story of failure: they tried something, and it failed.  They pulled themselves together and tried something new.  And they kept at it until they succeeded.  We are struggling here in America to remind ourselves of this.  You need not look to natural resources - or their lack - for the wealth of the future.  You will find that in the hearts of your people when they strike out to innovate, change and improve things - but you must let them fail.

Lastly, about your peril.  You live in a historic and tragic land.  You know deprivation and famine like nothing we can imagine here in the U.S.  The words of a journalist from the Philippines who survived the brutal dictatorship of Ferdinand Marcos still strike me as powerfully today as they did when I first read them in 2003:
I pray that through all the imperfections and confusions of our tenuous democracy, those who are too free to be intimidated outnumber those too timid to be free.
The Ukraine has not perished because its people are too free to be intimidated.

La Dolce Vita: Greece and the Future of Europe

Posted on Saturday, January 3, 2015 No comments

Saturday, January 3, 2015

Greece is in the news… again.

Having failed to form a government across three ballots, the Greeks will vote in a snap election later this month.  The far-left party who promises to renegotiate the last bailout deal – the last time the Greeks were in the news – is leading at the polls.

And now Germany is saying they are prepared to stand by as Greece leaves the Euro.  There is no telling where this will end, but it is certain to end badly.  The Europeans are groping hopelessly for a way out.  Some think outright U.S.-style ‘Quantitative Easing’ is the answer.  Its failure here should disabuse Europe of the folly.

The answer is actually right in front of them.  It’s called work.

Upon visiting Strasbourg recently, Pope Francis spoke of his hope for Europe:

“How, then, can hope in the future be restored, so that, beginning with the younger generation, there can be a rediscovery of that confidence needed to pursue the great ideal of a united and peaceful Europe, a Europe which is creative and resourceful, respectful of rights and conscious of its duties?”

Francis’ description of a future where its people are confident, “creative and resourceful” is a place to pivot on the cultural differences between Europe and America.  Europe’s fiscal challenges are posed principally by its cultural orientation toward political society (the State, its organs of government and their constituent bureaucracies) to secure those conditions.

Finding Security in Work

It has been widely observed that Europeans work significantly fewer hours than Americans.  The easy explanation for this has been that Americans value “stuff” (the “accumulation” of “wealth”) where Europeans value time and leisure (la dolce vita – or “the sweet life” in Italian).  But this supposed difference in priorities is skewed by the degree to which European society depends on government benefits to make “the sweet life” possible.

Each of those benefits – and “the sweet life” as an aggregation of benefits – represents something which otherwise would have required transacting in the economy – working – to obtain.  And among those benefits, political society’s priorities are determined by the short-term ambitions of those in office.  When benefits are principally obtained by transacting in the real economy, individuals calibrate their priorities very differently than bureaucracies.

In an article published by the Minneapolis Federal Reserve, data from Organization for Economic Cooperation and Development (OECD) countries showed that GDP discrepancies between Europe and America are best explained by the disparity in hours worked. That, in turn, is best explained by Europe’s relatively larger “wedge” between labor and its wages – also known as taxes.

It is important at this point to understand that a “tax” is a price attached to a transaction.  It might be a percentage of the price (a “sales tax” on goods or services or an “income” tax on salary) or it might be a fixed price by volume (an “excise” tax on a gallon or liter of gasoline).

For example, it is a common myth that gasoline is more expensive in Europe than in America.  It is not.  When government subsidies, relative labor costs and taxes are accounted for, the price of the gasoline itself appears relatively stable between the U.S. and Europe. The taxes are not part of the price of the gasoline; they are the price of the transaction.

This, then, gives way to an immutable law of economics Europe’s political elite seem to understand quite well on other issues.  If you want more of something, you make it less expensive.  If you want less of something (e.g. carbon emissions) you make it more expensive.  Since a tax is a price attached to a transaction, making those transactions more expensive will only guarantee you get fewer transactions in the economy.  The larger income tax rates in Europe simply make work (transacting one’s time and skills) more expensive than la dolce vita.  Europe’s cultural preferences have followed this math quite logically.

Work and Wealth

At the heart of the difference between American and European attitudes toward work is how it relates to wealth.  Europeans tend to think Americans are caught up in the accumulation of wealth because they equate wealth to consumer goods.  Americans, on the other hand, speak often of the creation of wealth. The American preference for work cannot be understood apart from the underlying idea of creating wealth, as opposed to merely accumulating it.

A place to live is an example.  Next time you drive up to either your house or apartment/flat, imagine the place before anything was built.  Nearby hillsides will probably give you an idea of what it looked like.  Then a builder brought in “utilities” like water, sewer, electricity, and in some places natural gas.  These things are rightly called “utilities” – they make the land useful for stable shelter.

Then the developer builds homes or apartments/flats.  Once the development is complete, the value of the land with these improvements – utilities and a place to live – has increased because it has been made more useful.  The difference between that new, higher value and the prior value of the land “unimproved” is exactly what new wealth is.

So, using the single-family house as an example, the buyer makes arrangements with a bank for a mortgage.  While this is certainly a form of debt, the homeowner has a liability on the right side of the sheet and an asset on the left side to balance her finances.

Then, conventionally, over 30 years she will pay principal and interest.  The principal part of each payment is her gradual acquisition of this new wealth.  Note that this is neither transfer nor accumulation of wealth.  This is acquisition of new wealth.  Then having secured one of the most fundamental of human needs – stable shelter – the homeowner is freed from a significant demand on her time.  She can “retire” to a life of service to others.  That life might be as simple as looking after her grandchildren while her children work to acquire new wealth of their own.  It can also be a life of working with others in civil society to ensure the dignity of the poor is not overlooked.

Work as a Third Choice

Thus the present European debate between “stimulus” and “austerity” is stale.  It offers a false choice, neither of which present a path to the Pope’s vision of a “creative and resourceful” Europe.  This future is unattainable among a people who, when faced with civic problems wait for political society to come solve them.

Creativity and resourcefulness in political society expresses itself mainly in devising new ways to spend public money to maintain a future claim on that same public money – that claim being their budget.  And when the public’s money runs out supporting 30 year old students and 50 year old retirees, that creativity then turns to finding new ways to tax the few between 30 and 50 who remain in the workforce.  The creativity and resourcefulness of civil society – the European people – is then naturally funneled into tax avoidance (rather than wealth creation), furthering the need for more public debt and ever more confiscatory taxation.

And so we see a death spiral: La dolce vita only appears less expensive than work. The sweet life of government benefits has perverted the creativity of political society towards more debt and taxation, and has perverted the creativity of civil society towards leisure and tax avoidance.  It has perverted the understanding of wealth, making it synonymous with money and “stuff.”  There is no one left to innovate and improve – to actually create wealth.  It is especially discouraging to see no less than the Pope himself succumb to these misunderstandings.

Stimulus – which is to double down on government spending to perpetrate the myth that la dolce vita is sustainable – is certainly not the answer.  But neither is austerity.  A third option commends itself:


Innovate.  Improve things.  Apply resourcefulness toward the creation of new wealth.  This cannot be legislated by political society.  It must come from the European people themselves.  They must first insist not only on forming organic institutions of civil society, but on civil society owning most of the civic problems for which they have traditionally relied on political society to address.

When something is broken, fixing it is not someone else’s job.

When the people of Europe discover that their own initiative in civil society is far superior to the benefits of political society in improving their own lives and the lives of their neighbors, their creativity and resourcefulness will naturally turn to innovation and improvement of other things in the economy.  The new wealth they will create will gradually erode the need for confiscatory taxation and along with it the need for ever-expanding government.  But those who depend on social services will not be left to fend for themselves – they will find in the creativity and resourcefulness of civil society the dignity of being lifted up by a neighbor who knows their name.

Alexis de Tocqueville wrote of his observations of 19th Century America:

Everyone works, and the vein is still so rich that all who work it succeed rapidly in gaining the wherewithal to achieve contentment… Restlessness, which harrows our European societies, seems to abet the prosperity of this one. Wealth is the common lure, and a thousand roads lead to it.

But this “common lure” was not just the natural resources of the New World.  It was the creativity and resourcefulness required for exploring it.  And that creativity and resourcefulness was always turned – and is still turned in America today – toward innovating and improving things.  A new orientation away from la dolce vita and towards work to create new wealth offers Europe the future envisioned by the Pope.

At the heart of all of this is the heart of the European person.  In America Thomas Jefferson spoke to the heart of the American individual when he cautioned us: “The government big enough to give you everything you need will be powerful enough to take everything you have.”  When Europe’s people purpose themselves to work toward the creation of new wealth, and to share that new wealth in civil society, they will see the dawning of a prosperous future.  And that dawn will reveal to them that their creativity and resourcefulness will always be superior to any government bureaucracy in securing a prosperous future for their children.
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