Speculation on Margin

Just a quick note:

The problem is not the Federal Reserve. The existence of a central bank or common currency is not all that problematic.

The problem is fractional lending. With fractional lending, a bank makes multiple loans from the same dollar. It is fractional lending that creates the business cycle. Even worse, fractional lending multiplies the debt of a society and creates systemic fault.

People love to hate speculators. IMHO: Speculators play a positive role by providing valuable pricing information to a market.

Problems occur when speculators speculate on margin. A margin play happens when a speculator borrows money for their speculation or places a short order ... which involved borrowing the stuff to sell.

The margin plays sends tainted information into the system. Margin plays also have the effect of magnifying the ill effects of the business cycle.

As we enter a debate about the Federal Reserve, I hope people realize that the real problems lie with this debt culture and margin plays and not with the Fed creating a common currency.

To develop the Two Bit Diner project, I've followed the spot price of silver which follows silver on centralized exchanges. The price appears to be manipulated by margin requirements. The fact that people buy and sell precious metals on margin clearly artificially inflates the price and leads to greater instability.

Good v Bad Business Practices

Libertarians and conservatives have a nasty happy of assuming that all business is good and all government is bad.

The founders of this nation discovered that a limited government focused on protecting property and overall security of the people is a good government. A classical liberal recognizes that there is an area in which government is good.

When government moves beyond its limited confines, the government tends to become a source of oppression.

I contend that this same dialog needs to take place in regards to business. I contend that some business models are good and others are bad.

For example, if I created a business model in which I stole or extorted from others, I would prosper, but my business model would diminish society.

It seems to me that, if we wanted to preserve our freedom, we need to engage in a discussion about good versus bad business models.

Libertarians tend to shy away from discussions about good and bad business models fearing that such discussions would lead to demand for more government regulations.

I contend that the exact opposite is true.

It is our unwillingness to engage in a fundamental debate about the differences between good and bad business models that lead to the call for regulation.

Good business models that enhance freedom and produce wealth do not require regulation. If one has a society filled with freedom centric businesses, there is not a call for regulation.

It is the proliferation of companies using negative business models that lead to the call for regulation.

Rephrasing the comment: if there is a business model that begs government regulation; in all likelihood, the business model itself is anti-market.

Health insurance is a great example of this principle. Attempts to pay for individual consumption with a pooled resource depends upon regulation and micro management of the health care industry.

The fact that the business model demands regulation is a blaring signal that the industry is anti-market.

A fundamental debate about business practices would lead to a discussion about alternative business models.

The Medical Savings and Loan is a business model in which financial institutions provide tools to help individuals self-fund their care. The Medical Savings and Loan does not require the regulation or micromanagement needed by the insurance industry.

If we engaged in the fundamental of good v. bad business practices, we would remove the demand for regulation.

The libertarian assumption that all businesses are equal creates a market where there is a loud demand for every greater regulation.

Engaging in the fundamental question about good v. bad business models does not lead to regulation. If we engaged in the discussion of building affirmative business models, we would effectively remove the calls for regulation.

(END NOTE: My experience is that the left actively encourages the development of bad business models, as such business models lead to the call for regulation. This process has been going on since Marx penned "Das Kapital" which laid the foundation for modern capitalism.)

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Summary of Reforms

Our financial institutions were designed to the desires of the central bankers--Not for the needs of the investing public.

Because of this our financial institutions artificially concentrate power in the hands of bankers while undermining the wealth creation process within the community.

The solution to this problem is to redesign financial products around the needs of the investing public.

We need actions. Not just complaints.

In this blog, I've made four very concrete proposals for financial reform. The common thread in these four reforms is that they replace financial tools geared to the needs of banks with tools geared toward the need of the investing public.

The reforms are:

• The Medical Savings and Loan: This reform replaces insurance with a system of structured savings and supplemental grants to secure medical coverage.
• Shared Equity Financing: This reform replaces mortgages with direct investment in housing.
• The Real Time Open Source Exchange is a product that replaces black box stock exchanges with an open source program that executes trades in real time. Executing the trades in real time eliminates naked short selling.
• The Object Oriented Tax. The object oriented tax is an interesting program that taxes an object between income and spending.

The first two proposals are concrete ideas that could be implemented by small companies.

The OSRTX is more theoretical. It could be implemented by a collection of companies or investors seeking to share ownership in equities. The primary goal of this project is to demonstrate the short selling is the creation of anti-market regulations.

The Object Oriented Tax is a political solution. This program taxes an object between income and consumption. It combines the best of a progressive income tax with a consumption tax. Essentially, everyone will have two accounts: An Investment and Spending Account. The system charges a progressive tax when people transfer money from the investment to the spending account.

With the OOT, people can make their investment decisions without having to calculate the effect of taxes. People would have to pay a progressive tax on what they spend. The system empowers individuals in saving and investing. The system eliminates the capital gains tax, but taxes capital gains spend on consumption at a progressive income tax rate.

Empowering the Investor

Each of these reforms arises from the same thought process which seeks ways to empower the individual in our economic system.

Even if I find no backers for thes programs, I believe a vigorous discussion of the reforms directly address the underlying problems with our current financial structure.

For example, the programs fit well in discussions about the difference between the free market and capitalism.

In the free market, the free mind of the individual is supreme. The theory of capitalism overemphasizes the role of paper money.

Implementing the Reforms

It would be easy for small organizations to implement the first two reforms. I designed the Medical Savings and Loan as a method for reverse engineering an insurance company. A company seeking to reduce the cost of health care benefits could implement the Medical Savings and Loan.

An investment firm could offer SEF-Liens as an alternative to mortgages. (A SEF-Lien is pegged to the local realty market. One would never see a house financially "underwater" because the lien would automatically drop in value if housing prices dropped.

Yes, it is true that businesses implementing either the Medical Savings and Loan or Share Equity Financing will make less profit per client than insurance or mortgages; however, people in need of financial services are likely to choose the products that offer best security.

I believe that, if the programs were implemented, they would be a hit in the market as they provide a better service to the public.

Conclusion

To restore the American experiment, tea party patriots simply must start engaging in a positive discussion of the ways that the free market and limited government can solve the problems created by our over centralized banks.

The structures discussed in this blog could be part of such an effort.

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Mortgage Backed Insecurity

Patrick Byrne of Deep Capture repeats an interesting rumor. The rumor is that a sizeable portion of the loans in the toxic mortgage-backed-securities bundles that crashed in 2008 were actually fraudulent loans. The "paperwork errors" holding up foreclosures are tiny things like houses that don't exist or mortgages that don't have liens on titles.

Possibly some of the bad loans aren't just loans made to people who can't repay, but were fraudulent loans from the start.

The convolutions of mortgage backed securities, CDOs and credit default swaps make my eyes curl up in their sockets.

However, this much I know.

These bizarre derivatives all came from the insurance industry.

The idea behind a mortgage backed security is that centralized banks can manage risk by bundling large number of mortgages into packages that are then traded on the market.

Freddie Mac and Fannie Mae are GSEs (Government Sponsored Enterprises) that bundled, insured and served as an exchange.

The exchanges created a convoluted complex of derivatives such as CDOs and credit default swaps to facilitate the trade of the securities and promised the ability manage risk.

The exchange system for mortgages failed miserably.

I repeat that. The exchange system for mortgages failed.

The exchange system for mortgages failed.

The exchange system for mortgages failed.

The exchange system for mortgages failed.

The heart of ObamaCare, and other current approaches to health care reform replicate the failed centralized exchange system of the mortgage industry.

The system where traders sit in towers and speculate on the risks of others will simply replicate the failed mortgage system. It will be rife with fraud while those needing care will be spun off onto the public coffers.

The better approach to health care reform is to march in the opposite direction. Rather than created convoluted group pools in which the elite control health care, we should develop a system where people self-funded their care (with supplemental grants and loans).

Hmmm, I wonder if anyone has come up with such a thing.

I've watched the news, read the papers, hit the tea party web sites.

I haven't found any.

Hmmm. If only some would work on such a system, it would be great.

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What is Capital?

This post is a reply to a tweet.

Before engaging in high level debates, it is useful to think about the terms used in the debate.

For example, we often use the term "capital." But what exactly does one mean by "capital"?

Wikipedia we find the term capital referring to different things. In classical economics it referred to a real physical thing ... a factor of production.

In Marxian economics capital refers to an abstract entity called "money."

It is possible to create or destroy money without actually producing any physical benefits. This is what the Federal Reserve does.

In common discourse, people tend to use a muddled definition where it refers to both the physical factor of production and the money used in investment, but in actually trying figure out how things work, one finds that different definitions of capital work differently.

Things become even more convoluted with the absurd convention of using the term "capitalism" to refer to the free market economic system favored in the United States.

Definition of Middle Class

I believe that the distribution of wealth is far more important than the distribution of income.

Income refers to the amount of money that a person receives in a year. Individual wealth refers to the resources that one owns over a life time.

In the scheme of things, one's income is derivative of ones wealth. Income is simply a slice of one's life long wealth.

I contend that if a society has a healthy distribution of wealth, it will naturally have a health distribution of income.

Conversely, a society with a healthy distribution of wealth might have an uneven distribution of income as people make different amount during different years of their life.

My last post spoke about the changing definition of the Middle Class.

The original definition of middle class was based on the distribution of wealth.

One could split the ancient regime into three primary classes. There was a small ruling class, a very large working class of peasants and workers and a middle class between the two.

The ruling class derived its wealth and power from the state. The working class sold its labor for subsistance.

The middle class learned to re-invest the proceeds of the labor to improve their productivity. This middle class of merchants and manufacturers re-invested the profit from their endeavors to build capital.

Note, both the ruling class and working class were largely dependent on the state. As the middle class built capital, it gained a certain amount of independence from the state.

Intellectuals despised this middle class with its independence.

Because this despised middle class was very good at creating wealth, it systematically pulled millions of people out of poverty and the ranks of the capital owning middle class swelled.

In this traditional paradigm, the term middle class (bourgeoisie) was based on the distribution of wealth. The distinguishing feature of the middle class was that it owned and controlled capital.

Progressives hate this property owning middle class with a deep abiding passion.

Progressives took a tool developed by Hegel and perfected by Marx called sublation. Sublate is a process which one can use to turn a term into its opposite.

The defining characteristic of the middle class was the ownership of capital (its wealth). Progressives simply made income, not wealth, the defining characteristic of wealth.

Income, like most statistical phenomena, falls into a simple bell curve. Progressives took to calling the middle section of the bell curve of income "The Middle Class."

For a variety of economic reasons, the reported incomes of the ruling class, middle class and upper segment of the working class will fall in the middle of the bell curve of income. The really successful business owners fall in the upper section of the bell curve, unsuccessful workers make up the bottom of the bell curve.

By changing the focus of the middle class from wealth to its derivative income, progressives successfully sublated the term "middle class."

Middle class no longer refers to the productive business owners who built up the wealth of the nation. It now includes the parasitic ruling class and some of the higher paid workers.

The term "middle class" now means its opposite. The group of capital owners who sat between the rulers and working class is now in a separate vilified class, while the proletariat is lionized as the middle class.

Of course the progressive definition of middle class is absurd. By simple economic laws, most people will fall in the middle of the distribution of income.

It is the distribution of capital that matters! With a centralized economy, control of the wealth of the nation falls into an increasingly small number of very corrupt hands.

While progressives pound the sublated definition of "middle class" the real middle class that gave us our prosperity is being systematically destroyed.

Formula for Disaster

Anyone watching the Debt Clock knows that our nation is in a perilous state. I looked today. The National Debt is at $13 trillion, personal debt is at $16 trillion. Unfunded liabilities stand at $111 Trillion.

The reason for this sad state of affairs is the stupid way we fund things.

We do several stupid things: The first is that we adopted a fractional reserve banking system. Banks lend out multiple dollars for each dollar saved. Anyone familiar with math knows that fractions show up as multiples when looked at from a reciprocal perspective.

A fractional reserve banking system effectively multiplies the debt of the people.

Oddly, the fractional reserve devalues savings. It is the bank that gets to multiply savings, not the saver. The dollar I put in the bank is equal to all of the other dollars on the market. It has to compete with the dollars created when the bank uses it as a base for multiple loans.

The history of fractional reserve lending is bleak. Historically banks that create their own fractional reserve scheme have failed. They get rich and implode in a panic when investors realize the bank has inadequate reserves to pay investors.

A fractional reserve banking system depends on constant regulation to stave off panics.

One can argue that, by increasing debt, fractional reserve banking creates systemic risk. One can also argue that fractional reserve banking is counter to the free market. In the market described by Adam Smith, people re-invested the profit of real capital. Fractional reserve banking creates a multitude of paper money for each real dollar increase in capital.

A well regulated bad idea is simply a study in stupidity.

A second stupid mistake that we made was to move from save-and-pay systems for health care and retirement to ill conceived pay-go schemes.

The idea behind both Social Security and Insurance is that people can fund basic human needs through a stable Ponzi Scheme. A Ponzi Scheme is an investment scam where a con artist builds market credibility by paying higher than average returns from the investments from other schmucks in the system.

Ponzi schemes tend to implode when investors discover their investments are at excessive risks. Small insurance companies tend to fail because they develop inadequate reserves for their promised benefits.

Bernie Madoff had a Ponzi scheme that ran for several decades before investors realized their billions of dollars of savings were fluff.

Through the years, a large number of people have been hurt by insurance schemes that failed to maintain adequate reserves.

To maintain stability, insurance requires substantial regulation.

The need to regulate insurance is interesting in that the promise made by insurance is that insurance would help people regulate their health care expenses by placing their health care money in a pool.

The deregulation that took place in the Clinton years failed because we removed the political regulation away from financial schemes that were dependent on regulation. Bush failed because he did not figure out basic laws of finance.

Many people would like to transition away from the Federal Reserve and fractional reserve banking.

To do so requires a concurrent effort to increase savings.

Wouldn't it be wonderful if someone happened to have a plan to replace insurance with a system of structured savings?

Golly, if only there was someone who's been talking about the need to move from insurance to structured savings for the last several decades. Such a person might even have a ready made product that allowed companies to replace their insurance benefit with some sort of Medical Savings and Loan.

For progressive minds driven by wealth envy. I should point out that it's the fractional reserve system that created the disparity of income between the rich Wall Street bankers and middle class. Transitioning back to save and pay would have the reverse effect and decrease the gap between rich and poor.

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Production v. Manipulation

There are two sources of income: production and manipulation.

When the income of the rich comes from production, we shouldn't tax it heavily for we all benefit from the production.

When the income is from manipulation, our attempts to tax and redistribute the income tend to fail because the people good at manipulation will find ways to game the system.

Every economy includes both production and manipulation.

Attempts to achieve social justice through taxation and redistribution usually results in a society that places onerous taxes on production while increasing the amount of manipulation.

The fact that it is difficult to achieve income redistribution does not mean that we should not worry about income inequality. It means that we have to think about the problem differently.

If we find our society that generates great fortunes without producing wealth for the society at large, then we clearly have a society where the forces of manipulation have taken root.

Correcting this society is not a matter of taxing the wealth but a matter of examining the sources of the wealth.

If we find sources of wealth which are primarily manipulative, then we need to eliminate the source of the manipulation.

Most of the sources of manipulation are intrinsically anti-market. Hedge funds were created to protect the ruling elite from changes in the market (hence the name hedge fund). Short selling is a violation of property rights. Government backed re-insurance is a scheme to protect insiders from changes in the market.

As these tools are inherently anti-market, removing them would be pro-market. N'est-ce-pas?

Sadly, rather than looking at the roots of the matter, our political class has an unfortunate history creating additional manipulative tools to overcome the manipulative tools of the last generation.

The call for onerous new tax policies to redistribute the incomes made from market manipulation is but the latest of such fallacious thinking. The new tax burden will fall heaviest on the productive segment of the market and concentrate even more power in the hands of the manipulators.

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Sarbanes-Oxley Revisited

We all know the metaphor that George W. Bush drove the economy off a two thousand foot cliff in to jagged rocks swarming with alligators. The Honorable Senator Al Franken provides a dramatic enactment of this metaphor.



Most of the people I know believe in Al Franken and believe this metaphor.

I, unfortunately, have developed the nasty habit of looking beyond the colorful metaphor to see what really happened. If Bush killed the economy, as is claimed, then shouldn't we be able to find a smoking gun in the legislation passed during the Bush years. (yes, I am mixing metaphors)

I dislike that Bush passed a tax cut without a corresponding decrease in spending.

NOTE: The Economic Growth and Tax Relief Reconciliation bill passed on June 7, 2001. Economic conditions changed slightly on September 11, 2001. Planes slamming into the World Trade Center disrupted several markets.

The primary financial legislation of the Bush years was called the Sarbanes-Oxley Act of 2002. This law "mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud, and created the 'Public Company Accounting Oversight Board,' also known as the PCAOB, to oversee the activities of the auditing profession."

This bi-partisan law strengthened financial regulations and created severe penalties for fraudulent financial reports. The accountants involved with Sarbane-Oxley reporting claim that compliance involved a great deal of work, and there is good indication that bill achieved some improvement in the quality and accuracy of financial statements.

During the financial collapse, few people were calling to question the accounting which showed Mortgage Backed Securities worthless.

Republicans in the Bush years complained about financial irregularities at Fannie Mae and Freddie Mac … which were systematically pooh-poohed by the mainstream media.

Other financial acts of the Bush years included a major bi-partisan expansion of Medicare with the prescription drug bill and a major bi-partisan expansion of CHIP (Children's Health Insurance Program).

Back to the Bush car crash metaphor.

There is an incessant partisan drumming that Bush drove the economy off a cliff. The current president uses the metaphor to justify pushing his political enemies into the back seat.

The metaphor is compelling. But, I can't help but wonder: if Bush is the one who drove the economy off the cliff, why aren't his finger prints on the mortgage backed securities, the community re-investment act, the credit default swaps, the mortgage backed securities, the CDOs, the Enron-style hedge funds, the currency manipulation and derivatives that imploded.

Many of the things at the heart of the economic collapse were created or expanded in the Clinton years.

Bush is to blame for many things. His primary fault is that he did not go after Freddie Mac, and he did not repeal the Security Modernization Act of 2000. But how could he make the political case for repealing laws that no-one really understood?

The Sarbanes-Oxley Act was a stab at a reform that people did understand. People did understand that fraudulent reporting undermined the market. Sarbanes-Oxley failed because cause of our economic duress was the absurd mix of derivatives traded on Wall Street. No matter how well accountants recorded these transactions, they could not change that fact that securities themselves were simply creating instable fluff.

Bush and the Republicans failed to identify and address the root cause of economic instability. When the Democrats took control of the economy in 2006, it was clear that the tax cuts without decreases in tax spending and the mix of toxic assets accumulated through the years would lead to sour economic times.

Yes, Bush is guilty of failing to identify the source of economic instability. All of the hard work invested in Sarbanes-Oxley compliance did not stave off the economic reality that our complex financial system created by progressives is inherently instable.

Unfortunately, Obama's economic policy based on projecting all financial ills onto his political enemies will not lead to any meaningful financial reforms.

The economy is interconnected and involved everyone. Obama's method of shoving his political enemies in the back seat is unlikely to result in prosperity as Obama's Moaist ways impoverish those he struggles against.

Although Sarbanes-Oxley misidentified the root of economic instability, at least it was bipartisan.

Zero Summary

The last post (Money is a Zeron Sum Game) provides a great example of how we get tied up with words.

We use the word "capital" for both physical resources in the economy and as a synonym for money.

With the application of our creativity, rationality and time, we can invest physical resources to create more physical resources.

The real economy is a plus sum game. Playing the game well creates wealth.

Money, however, is zero sum game. Money is simply a tool we use to simplify trade. The value of money comes from its scarcity. The value of the dollar in your pocket depends a limited supply of dollars on the market.

The creation of new money shows up in the system as inflation.

Clever schemes that make money from money show up in the system as a wealth transfer or as inflation.

As the word capital refers to both real goods and paper money, the use of the word can get confusing. Real capital produces benefits when properly re-invested. Clever schemes that make money from money simply generate fluff.

This confusion can translates into broader economic and philosophical debates. In the Wealth of Nations, Adam Smith was talking primarily about the investment and re-investment of real capital. In Marx's Das Kapital, he spoke primarily about a ruling class that gains power through the manipulation of paper capital.

The unraveling of the American financial system shows an extremely corrupt system in which a ruling class is looting our nation through the manipulation of paper capital.

Unfortunately, our culture war focusses exclusively on the question of whether or not capital should be owned by the state or privately owned. In this war, the culture warriors fail to make subtle distinctions about the quality of the capital.

To win the war for freedom, people engaged in the debate need to ask what a person means by "capitalism" before defending capitalism. The monetary manipulation going on in our nation's bank is simply paper fluff that is sytematically impoverishing our nation.

It is the health of our real physical capital and not the health of the corrupt financial service sector that matters, yet our politicians rush to the aid of the banks to the cost of the industry and small businesses that produce the real wealth.

Money is a Zero Sum Game

I heard a stupid phrase on a TV news show: The announcer said: "Money is not a zero sum game."

I suspect the announcer meant to say: "Economics is not a zero sum game."

But the sentence gave me pause.

People who fail to understand the difference between money and the real economy are apt come up with destructive economic policy.

As you see. Money is a zero sum game.

It has to be a zero sum game to work.

The goal of a monetary system is to create a stable unit of measurement for trading goods.

With a stable unit of measurement, I can place a monetary value on my efforts. You can place a value on your efforts. This information simplifies the transaction of goods and services.

The stability of money comes from the limited supply of money. The value of the dollar bill in my pocket is determined by the total amount of money in circulation.

A central bank can affect the value of money by printing more money or by taking money out of circulation.

In the American economic system, the Federal Reserve carefully monitors the monetary supply with a variety of tools to gauge inflation and economic growth. One tool is to create a basket of goods. On a regular basis, the Feds will tally up the basket of goods to measure inflation. If the currency is deflating, the feds can put more money into the system, if inflation is high, they can pull money out the system.

NOTE: The Federal Reserve created a funky fractional reserve banking system. They create money by lending to banks which then make multiple loans backed by the same dollar.

Some people think a steady rate of inflation is good. As such, the Feds gradually increase the money supply. This gradual increase in the monetary supply devalues the dollar in your pocket. A 2010 dollar has less purchasing power than a 1913 nickel. (The New American has a graph of inflation).

When the Federal Reserve was passed, a dollar bill was about as common as a hundred dollar bill is today.

Inflation works a little bit like a tax. The newly printed dollar is as good as the rest of the money in the system. The on the inside of the money creation system get quite wealthy.

Much of the concentration of wealth in our society is a direct result of the Federal Reserve.

A fractional reserve banking system also has the perverse effect of multiplying the debt in the nation.

The Federal Reserve was created by large banks. The Federal Reserve Act was written by a Senator Nelson Aldrich. His daughter married John D. Rockefeller and produced Nelson Aldrich Rockefeller who became vice president under Ford.

Folks of the Austrian School of Economics prefer the gold standard. The gold standard fixes the price of a currency to the precious metal gold and effectively caps the monetary supply.

Back to the thesis of this post.

The economy at large is not a zero sum game. As people reinvest the gains from the intelligent use of their resources, they effectively create more resources and more wealth.

Money is simply a tool that facilitates trade. The ideal money supply is stable. This stability comes from caps on the money supply.

While it is possible to create prosperity through the re-investment of real resources, attempts to make money from money results in inflation (devaluation of the currency).

Now, here is the problem: Our financial education takes place in schools which are detached from real world economics. As such, our scholars are drawn into studying the vagaries of money at the cost of real world economics.

Our economists, banks and financial institutions have created a vacuous system that creates billions of dollars in paper profits by trading trillions of dollars in paper money and derivatives of paper money. This fake economy has grown to such an extent that it is systematically choking and destroying the real economy that produces wealth.

Schemes that try to create money from money result in inflation which has the same effect on the real economy as a tax.

A Note on Capitalism

I really hate the term "capitalism." The term came into widespread use with the translation of Marx's "Das Kapital" into English. The term capital refers to both physical resources in the real world and to the abstract representation of capital in the monetary system.

Money and real world resources are separate entities obeying different mathematical laws. One can produce wealth by reinvesting real resource. Money is a zero sum game. Games where people make money from money diminish society as a whole.

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Opening the Royal Treasury

Today it was announced that the Lord President of the United States would open the royal treasury and lend $30B to small business.

Guess what?

I am skeptical of this measure.

I worry that President Obama does not have a solid understanding about the way economies produce wealth.

The economy described by Adam Smith in The Wealth of Nations was where companies invested real resources, produced real wealth, then reinvested portions of this real wealth.

The faltering American economy is being driven by paper money. The government borrows paper money from China. It lends this paper money through banks to make leveraged plays against the market.

In this paper economy, there is more money in the shuffling of paper than in the creation of real wealth.

The out of control paper economy did not start with Barack Obama. Recent decades have seen a steady increase in the manipulation of paper money with idiotic ideas like Enron, Credit Default Swaps and hedging formulas taking precedence over the actual production and valuation of wealth.

The 30 billion in loans might help start the economy. Like all margin plays, the small business loan it is a gamble. The $30B in loans must come back out of the economy in the form of inflation, taxes, or liquidation of assets.

If the people who borrow the $30B do a good job and invest the funds at a higher rate than the cost of the money, then we would see a boost in our well being.

If the money from the loans crowds out the investments of traditional wealth centric capital, the loans will do little more than start yet another paper economic boom that will result in a deep bust.

I titled this post "Opening the Royal Treasury" as Obama's economic action appears to be more in line with the economic interventions of the failed monarchies of the ancient regime than the wealth producing actions of the Liberal tradition of Adam Smith and the US Founders.

A Tall Ship In Rough Seas

Imagine a tall ship sailing through rough seas.

The rich passengers on the upper decks discover that they can dampen the rough sailing by attaching massive lead weights to their bunks. These weights shift against the waves to provide localized stability.

They call these massive lead weights a hedge.

The massive lead weights become a craze, and all the passengers living in the upper decks (above the center of gravity of the ship) get one.

A pundit on the ship makes the casual observation that the hedges used by the rich passengers will regulate the rough seas for all the passengers. And so the captain of the tall ship encourages the installment of massive lead hedges throughout the upper decks.

Then, one day, a wave broadsides the top heavy ship and all the hedges swing starboard. The people panic and start throwing their weight to the port when a second wave hits and the hedges swing violently toward port.

And so it came to pass that that the heavy lead hedges designed to even out the bumps in moderate seas caused the top heavy boat to capsize in the waves … and all the passengers drown.

Who Caused the Recession?

Obama ran a successful campaign against George W. Bush in 2008. It looks like he is gearing up for another campaign against Bush in 2010.

Despite the fact that the ideas behind our current financial structure came from the left, the mantra of the Anti-Bush campaign is that the free market loving right created the current economic malaise.

I contend that one can lay the economic collapse on the left just as easily as the right.

The first observation is that most universities lean left. The ideas that come from universities have a far bigger impact on the economy than the president.

The second thing to note is that the Compassionate Conservatives and Neocons of the Bush Administration aimed to capture the center. To do so, they moved the Republican Party to the left. During the Bush Administration, the Democratic Party moved even further left. With both parties moving left, the county as a whole swung leftward during the Bush years.

We can see the effect of this leftward movement in uncontrolled spending and record deficits.

The International community moved left as well. At the beginning of the Bush Administration the emerging markets were the primary engines of economic growth for the world. In response to unpopular wars, many countries of the emerging market fell under the yoke of communism, stunting growth and falling back into third world status.

We see similar trends in the European Economic Union where countries moved leftward in response to unpopular wars.

So, prior to the economic crash the entire world was unified in a massive leap to the left. The direction a country has a bigger impact on investment than where it's just been.

Back in the United States, the Democrats took both the House and Senate in 2006. This new majority was substantially further left than the Democratic Party of the Clinton years who were trying to sustain their power by moving to the right.

For those of you who took new math and can't reason: The year 2006 is a member of the set of years that is less than 2007.

We blame the economic collapse on Bush and the right, but it happened in a time when Bush was a lame duck and the Left had a solid hold on the United States and most international governments.

In the days prior to crash, Bush had a single focus of winning wars that the press said was lost. He threw the last of the political capital of the right into staving off the possibility that the Iraq war would culminate in a Cambodia style genocide.

Jumping back to the economy, let's make a gigantic assumption. Let's assume for a moment that businesses invest for the future and not for the past.

Businesses saw their allies in government in a full scale retreat, while the rhetoric and ideology of the newcomers demanded radical change with greater government control, a reversal of tax cuts and substantially more regulation.

During the economic crash, the drum beat was that America lost the war and that radical change was on the way.

Holding to the wild-eyed assumption that businesses hire people for work that they will do in the future and not for work done in the past, businesses hearing the drum beat of defeat and radical change would be wary about hiring people.

With the prospect that taxes would soon increase and employees would become a major liability in the near future, businesses that anticipated troubling times would not only freeze hiring, but would actively seek to cash out in the economy.

An economic crash happens when businesses cash out en masse.

Of course, there were many other big problems in the economy. Banks like Golden West and Washington Mutual had hundreds of billions in questionable loans. Madoff had a $50 billion Ponzi scheme, and the mortgage backed securities hawked by Freddie Mac and Fannie Mae as cash equivalents were in fact debased.

The bulk of political donations from these groups flowed toward Democrats and Obama.

It is also important to note that one of the greatest financial manipulators of all, George Soros, had a single minded focus on destroying George Bush and bringing Democrats to power.

The wild rise in energy prices that took place during the crash shows that there was a great deal of financial manipulation going on in the background.

Many people blame the economic collapse on derivatives. The derivatives in question were created by the Security Modernization Act of 2000 that was signed by Bill Clinton, and not George Bush.

It is true that the Bush Administration hadn't a clue about how to regulate such derivatives, but very few people really understand the affects of the new mix of derivatives, much less a president whose primary focus was on handing wars.

I am not a fan of George W. Bush; however, I reject that the economic collapse was caused by the free market. There is a much more compelling case that the crash was caused by the leftward shift that took place during the Bush administration, and an intellectual elite that created self-destructive derivatives (The derivatives of the Security Modernization Act of 2000 is not the free market, it was a set of regulations to give the elite an edge on the market). This would mean that Bush's primary fault was that he moved to the center and failed to make a compelling case for the vision of freedom.

The economy collapsed in a time when an unpopular Republican was President. The House and Senate (which control the purse strings) were controlled by the dynamic Democrat duo of Pelosi and Reid. The world and the nation had taken a massive swing to the left.

The economic collapse of 2007/2008 was much like the start of the Great Depression in that it followed back to back progressive presidents. There is a stronger case that the collapse happened because we were veering away from a free market to the case that it was caused by the free market.

Markopolos' Paradoxical View on Regulation

I just completed Harry Markopolos' financial thriller No One Would Listen (buy at Overstock.com). The book tells the story of an unsuccessful whistleblower in the Bernie Madoff fraud case. The book details the negative experience the author had trying to report one of the largest frauds in history to the SEC. As the SEC failed to listen, the Ponzi scheme played out until investors lost $65 billion.

The book provides an intriguing first hand look at the difficulties faced by people trying to work within the system to prevent fraud. Unfortunately, the solutions offered in the epilogue fall short and fail to provide us with a useful paradigm for reform.

Paradoxically, Markopolis ends his book on the systematic failures of regulation with a call for even more regulation. Markopolis's call for more regulation is even more bizarre as Markopolis himself points to the reason why regulation fails [pg. 269]

"Security Laws [regulations] are outdated almost as soon as they go into effect, because new financial instruments are created to skirt these laws [regulations]."

Regulations tend to become obstacles for honest companies. Meanwhile, conniving companies study the weaknesses in regulations and form products specifically to skirt the regulations. Such products generate income, but don't generate value.

In the same paragraph, Markopolos notes:

"The purpose of laws is to deine the lowest form of acceptable behavior between people, but ethics are the higher standard that the SEC security lawyers have successfully ignored.

So, what we need are higher ethics.

As to the investigation of fraud, the best approach is to develop investigatory programs that sees if companies are adhering to ethical standards, then to vigorously pursue investigation of fraud when companies are caught lying.

As was pointed out time and time again in Markopolos's investigation, the Madoff ponzi scheme had been breaking laws and lying to clients for at least 18 years.

When there is no effective investigation or enforcement of existing regulations, adding new regulations simply add to the regulatory burden with no benefits to the people.

Markopolos' book is a good read, but does not provide any real solutions to the ethical problems facing Wall Street. He makes a strong case that there should be greater rewards for whistleblowers, but completely fails to address the problem of fraudulent whistleblowing.

Nova's Been Misbehaving

I just watched a horrifically bad episode of Nova titled "Mind Over Money."

The thesis of the piece is that the financial meltdown disproved something they labeled "rationalist economics" and proved Keynesian theory and behavioralism.

The program begins by projecting irrational absurdities on rationalism. For example they assert that rationalism demands that rational person would never pay a penny over the real price of a good.

Nova then proves that the irrational absurdities that they project on their enemy "rational economics" leads to irrational absurdities.

Guess what? most irrational absurdities lead to more irrational absurdities. Straw men are made of straw.

Nova pointed out that folks in the Chicago School of Economics spend a lot of time analyzing mathematics models of trading behavior. Nova then made the bold claim that these mathematical models of trading behavior are the beating heart of the "rationalist school" of economics.

They completely failed to acknowledge that the emphasis on mathematical models of behavior were developed by behaviorists and were central to Keynesian economics.

The claim of the show is that the rationalist theory of economics boils things down to a set of equations that are supposed to always seek equilibrium.

They then go on to assert that the deeper thinking behaviorlists have a more holistic approach to economics that examines the reasons people trade the way they do.

I wanted to jump into the screen. Grab the idiot announcer by the scruff of the collar and bang his head against historical fact.

A truly "rationalist economics" would make the rationality of the individual the central focus of economics. A rationalist approach to economics would examine the reasons for individual behavior.

It is behavioralism that makes the mathematical model of trading behavior the central focus.

The propagandists at Nova turned the theories into their opposite.

Now, it is of historical interest that the Chicago School of Economics adopted the methodology of behaviorism.

My understanding is that the founders of Chicago School of Economics adopted the methodology of behavioralism largely because the theory of economics a half century ago was so thoroughly dominated by the Keynesian school that one had to include mathematical formula and behavioral models to get published.

The Austrian School of Economics, which is much closer to a truly rationalist approach to economics, disparages the Chicago School for its addiction to mathematical models.

Interestingly, Austrian economics seems to be a lot more in tune with business cycles and financial bubbles than those schools hypnotized by mathematical models. Adherents of the Austrian School of Economics were the first to scream about the likelihood of a major economic collapse.

I am sad that Nova produced such a poor quality show on the economic crisis.

The vary fact that financial institutions are and schools of economics are so fixated on mathematical models of behavior indicate that behaviorialism might be one of the root causes of the economic collapse.

I think it would be worthwhile to examine a truly rationalist approach to economics would work. As rationality is about reason, such a theory would make reason, not mathematical models, the central focus of study.

I find it unlikely that an economic system that made the rationality of the individual its focus would have the bizarre mix of short selling, insurance pools and derivatives that define our current economy.

The bizarre financial system that we have today is clearly evolved from the behaviorist approach to social science.

Insured Trading

As I understand, a major overhaul of financial regulation is one of the next items on Obama's social agenda. The theme of the reforms is that greedy investors took unnecessary risks and that we need the oppressive weight of big government on business to prevent risk taking.

The actual history of business is that risk taking leads to innovation which leads to better products and a higher quality of life.

I reject the partisan theme that risk taking is the problem. The question is the form of the risk taking.

A little known fact is that, for the last decade, the financial markets have been influenced by a little known 10,000 page piece of legislation passed in the lame duck session of the Clinton Administration called "The Securities Modernization Act of 2000."

This 10,000 page regulation is often called "deregulation." The regulation creates a slew of derivatives dreamed up in the University that were supposed to help banks and hedge funds control their risks.

The goal of these derivatives was to create a paradigm in which large banks and hedge funds could hedge their investments and essentially insure their trading.

Many of the mathematical formulas for trading came directly from the insurance industry as people hoped to manage investment risks in the same way that they managed physical risks.

The new dergulation-regulations essentially created an environment where investors thought they could insure there lending and trades.

Please note, the mathetical formulas and regulations designed to let large investors hedge against market forces are inherently anti-market.

HEDGE FUNDS ARE ANTI-MARKET!!!

What happened in reality is that the investors created a great deal of financial fluff and hot air as they traded abstractions like credit default swaps.

As there was no real physical backing to the securities, the market went up in a puff of smoke.

The sad legacy of the 10,000 page regulation marketed to the financial communinity as "deregulation" is that pundits are able to project the failure of a set of inherenly anti-market regulations onto the free market.

A Margin Play in a Declining Market

A margin play in a declining market simply hastens the decline. The term "margin play" refers to a situation where one takes out a loan, invests it, and hopes the return on the investment is greater than the interest on the loan. It is a form of legalized gambling.

In all likelihood, the person making the margin play does not have better knowledge than the rest of the market. In a declining market, people making margin plays will need find some way to cover their margin.

Of course, in some cases a player might have insider knowledge. For example Tim Geitners' friends in Goldman Sachs had insider knowledge on undervalued equities in the economic collapse. The special loans by Paulson and Geithner to Goldman Sachs allowed the firm to leverage its insider knowledge and make out like bandits in the economic turmoil. However, these special deals did not produce any global benefit. It simply allowed those with insider connections to reap the benefits of economic chaos.

The idea that we will stop this declining market by extending billions in loans to small businesses runs the risk of being nothing more than a margin play in a declining market. There might be some transfer of wealth from the community at large to businesses with insider access. The result of the margin play is likely to be nothing more than an acceleration of the centralization of the economy with little benefit for society at large.

NOTE: Margin plays in a growing market appear, at first, to be a good idea. A margin play in a growing market has the effect of increasing the rate of incline. The problem is such leveraged positions end up creating market bubbles which inevitably burst.

If we wish to have long term stability, we need a system where people develop and build equity. We need a system like the one advocated by Adam Smith and we need to move away from the Marxian/Keynesian systems.

On the Redistribution of Income

Conservatives make a big mistake when they get all lathered about the redistribution of income.

In the left/right culture war that has dominated civilization for these last centuries, the "redistribution-of-wealth" is nothing more than a slogan. It is an empty promise made by politicians in the quest for power.

To move beyond the culture war, people need to look past the slogan to strategy. The strategy behind the slogan of redistributed wealth is the ancient technique of pitting the ends against the middle. The technique of pitting the ends against the middle was precisely the technique used by Caesar in the destruction of the Republic of ancient Rome and has been used numerous times by groups seeking to rise to political power.

Emperor Napoleon pitted the ends against the middle in his moments of fame.

Using the dialectical methods of Hegel, Karl Marx penned a compelling philosophy around the strategy that has hypnotized more than one academician.

The Marxist tradition formed an alliance of the intelligentsia and the proletariat in a class struggle against the bourgeoisie. The term "intelligentsia" refers to the political and academic world. "Proletariat" refers to workers and the lower class, and "bourgeoisie" refers to the middle class.

Marxism is a class struggle that pits the ends (the ruling class and under classes) against the middle class.

The ruling class uses the promise of redistributed wealth in the class struggle. However, the redistribution of income rarely happens.

The promised redistributed income is actually paradoxical. Were the process to redistribute income as promised, it would simply create a new middle that one would feel compelled to struggle against again.

The form of the revolution in both ancient and modern times is that the ruling class will promise a redistribution of income to unite the ends against the middle. The ruling class says that if you give us unbridled power, we will use that power toward the end of social justice.

Inevitably, the consolidation of power becomes the means unto itself and the promise of redistributed justice devolves into an overall impoverishment of both the middle and lower classes.

We see that the modern revolutions that pit the ends against the middle have resulted in a series of epic atrocities with hundreds of millions perishing in famine and war.

The process of uniting the ends against the middle is paradoxical and flawed.

Unfortunately, the public debate gets dominated by people like Sean Hannity and Glenn Beck who get caught up in arguing against the slogan and fail to understand that it is the strategy behind the slogan (not the slogan itself) that leads a society to ruin.

Attempts to argue against the slogan of redistributed wealth allow agitators of the left the opportunity to employ the most effective tool in their arsenal: Wealth Envy.

To win the debate, defenders of freedom must talk about substance and not slogans. After all, there really is nothing wrong with a redistribution of wealth.

For that matter, the great irony of the modern debate is that the free market, when properly implemented, has proven to be one of the most effective mechanisms for equitably redistributing wealth, while the consolidation of political power (favored by the left) tends to lead to a concentration of wealth.

When one understands the strategy behind the leftist slogan of "redistributed wealth," one realizes that the problems we face lie not with the worthy end of an equitable society, but with the fact that the strategy of pitting the ends against the middle will not result in an equitable society.

People often call the more equitable distribution of wealth in the American system social mobility. It is common for Americans who apply themselves to experience different levels of income in their lives.

Sadly, the cries for redistributed wealth usually end with the consolidation of power in an entrenched ruling class and overall impoverishment of society.

The better approach would be for people to realize that growing disparity in wealth that we see in America today is not the result of the free market, but the result of the ongoing consolidation of political and economic power. The growing disparity in income seems to coincide with the growth of government.

In conclusion, the solution for our economic frustrations is not a bigger government with the power to forcibly redistribute income. The solution is to find ways to restore the free market system that was first envisioned by the founders of the United States.

Institutions Impoverish

I find it troubling that, in our day of advanced communication and technological proficiency, that there are many areas that suffer intractable poverty. For this reason, I am looking forward to the PBS Special the The Power of the Poor scheduled to air October 8^th at 10PM EST. Check your local listings. This special features the work of economist Hernando de Soto who contends that impoverished areas contain immense wealth. The problem is that the political and legal systems lack the ability for people in the area to realize the benefits of their wealth.

In the lead up to this program, the Free to Choose Network is sponsoring a blog contest asking people to answer the following question:

“What institutions can enable the world’s poor to realize their power
and achieve prosperity?”

Truthfully, I find the question troubling as I have gradually come to see "institutions" as the source of entrenched poverty. For example, the institution slavery held African Americans in abject poverty for centuries. After emancipation, the political class constructed the institution of Jim Crow laws to continue the oppression.

Many institutions have a form which concentrates benefits on an inside group while externalizing costs on outsiders. This can happen in extremely subtle ways. For example, a successful school might create a structure where its graduates hold positions of power. The graduates instinctive discriminate against outsiders based on the mannerisms that they learned in the school.

In the area of regulation, one finds that the writers of the regulations have inside knowledge which they use for their benefit and the exclusion of competitors.

Charitable Organizations often make the mistake of attempting to impose the institutions that benefited the founders of the charity on an impoverished area. Such imposed institutions can create entrenched poverty by concentrating benefits on a few at the cost of the many.

For example, well meaning efforts to extend property rights in colonial days created a landowning class and an impoverished tenant class.

Institutions are not inherently evil. Institutions create benefits for some, and costs for others. By understanding the nature of institution one realizes that the internal make up of a group is less important than the relation between the community at large and its constituent institutions.

In this last decade, I have been engaged in the Community Color project. This project involves a detailed examination of organizations in select communities of the American Mountain West.

What astounded me was the diversity of organizations that exist within each of the studied communities. This leads directly to the conclusion that a strong community has people engaged in numerous efforts that provide benefits at different levels.

Rich societies have a complex relation with institutions. This relation allows multiple groups to exist with the community. This multiplicity can help societies created by efforts that concentrate benefits on some at the cost of the many. So, an institution might concentrate benefits on a group. Those excluded would counter by creating a competing institution.

In a rich society, there is an ongoing influx of new organizations. Old organizations often diminish with time and disappear. It is this process of institutions evolving within the community that creates the wealth of the people.

Attempts to impose institutions on a society often destroy the natural evolutionary process within a society. The imposition of institutions creates a world of haves and have-nots. The answer to poverty is an internal change to a given organization but an overall change in the relation of the community that allows the evolution of diverse constituent institutions.