Sunday, 27 September 2009

British Pound Devaluation Delusions

"It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued."
Harold Wilson, British Prime Minister, after the Pounds devaluation in 1967

"A weak currency arises from a weak economy which in turn is the result of a weak Government."
Gordon Brown, During the Pounds devaluation after it was withdrawn from the ERM

Mervyn King the Bank of England's Governor has been causing a stir in the markets this week. Despite Sterling being a flawed currency it hasn't stopped Mervyn King from making comments that he feels a weaker currency is beneficial for the UK. Undeterred by the pound losing around a quarter of its value, it seems that the BoE still feel the need to send it lower. US-centric reporting has been emphasising the Federal Reserves draconian monetary actions, but yet it is the UK that leads the way in QE and the destruction of its currency. Labour Governments always seem to be in power when the pound gets a pounding. 1931, 1967, 1976 and recently 2008 and beyond. If Neil Kinnock had won the 1992 election like so many believed at the time, they would have got the whole set for the past one hundred years. So what does it matter that the pound has devalued of late? Is it as black and white as 'it will boost our exports', that the media and business pundits proclaim? I agree with the quote above, not Harold Wilson's, but Gordon Browns. Over the long term, Governments that use their currencies to try and solve their economic troubles are doomed to fail. If you try to alleviate trade deficits with this mechanism over the short term it may succeed, but eventually more devaluations will be required in order to 'boost' exports again.

Implications of Devaluations

An examination of the devaluation is required to understand what benefits/disadvantages it brings. Governments always claim that this will lower the cost of our exports, which it does, but no analysis is paid to what actually occurs. If we examine a factory that exports goods, they may be struggling to compete, say against similar German products. A devaluation would instantly lower the cost of the good on the export market. The German Government, for example, may hold steadfast and are not willing to allow their currency to depreciate by the same margin. The British company without doing anything have instantly gained a cost advantage, in effect a free handout. The German company on the other hand has to look for savings itself. Management immediately begin cost cutting, increase productivity or improving their processes. They look at their product, they start to innovate or add extra features or improve the quality to justify the short term price dynamic that has just occurred. The British management does not need to do the above. They can produce the exact same product, using the same processes as there is no immediate need to innovate.

Also something much worse occurs. For the sake of the example say the two products, German and British, now are priced at €500 and €400 respectively after the devaluation, whilst previously they were €500 and €550 respectively. The British management now can increase the price over the short term, to say €450 as they are still cheaper than the German products. This extra margin may go into inflating workers pay, or other company benefits. Not only have no product or business improvements happened, but the British company is also rewarding itself.

The Import Dynamic

Misreporting in the media leads us to believe that the cost of our overseas holiday is the biggest headache when the value of our currency goes down - if only. When the currency takes a fall the whole nation is immediately given a pay cut, all our imports now go up in price. If we have to buy raw materials or products produced abroad it now costs us more, our purchasing power has effectively fallen. In the example given above, if the British company has to import any materials to produce its end product these will drive up their costs. Also the public now have to pay more for the product in question. The cost may seem to have reduced to €450 but remember its all relative, the British people are still getting paid in pounds. People can't buy the same amount of products as imports go up. A price spiral starts. The mechanic who imports car parts from abroad must now charge the public more for car repair work. There are an infinite number of other business transactions that take the same format as the given example. All these costs eventually come back to the British company as their workers require higher wages to cope with the higher prices. This in turn keeps driving the cost of the product higher. Meanwhile in Germany, they have continued innovating lowering their costs through business improvements, driving costs down in order to compete and in turn producing a better end product. The end products cost after a year or two, could now be say €400 and €500, for the German and British companies respectively. The British company is back where it started but in a worse condition, as they have fallen further behind in terms of productivity and end product quality.

The above process can develop into a vicious spiral, with the British company loosing further export share and demanding further devaluation in order to 'boost' exports. There is no simple fix, if a currency goes down in value it doesn't help anyone.

What needs to occur is to let the market take the pain, not the currency. This may mean higher unemployment in the short term, but people and companies get competitive again. Any nation in history who has enjoyed an export boom has done so on the back of a strong domestic currency. Britain during the 19th Century, Germany and Japan through the second half of the 20th Century, the US when they rose as the global superpower. However times change. For the past 30 years or so US politicians have put forward the benefits of a lower Dollar for jobs and exports, but over the years it hasn't worked. Workers wages continue to decline, and US companies continue to disappear.

In Japan from the end of the second world war up until just before the lost two decades, the Yen dramatically appreciated against the US dollar. Yet Japanese exports during the same time frame also increased. Westerners used to joke that Japan only produced kimonos or tiny cheap ornaments. Japan subsequently underwent a huge economic development, beating the West on car manufacture and electronics to such a point that it has now become hard to name a handful of Western electronics companies. In 1970 the Yen was valued at around 357 to the US dollar. Within 20 years it was 146, more than doubling in value. During the lost two decades it hasn't moved much further, to around 90, however its worrying that its still appreciating despite the stagnation of the Japanese economy during this time.

Where does this leave the British Pound?

It's worrying when the people responsible for the defence of a currency welcome devaluation and even believe that this will solve the economic imbalances we face. You can't solve a domestic economies shortcomings by debasing the currency. The British Pound has resumed what it was prior to the late seventies and early eighties. It's once again the whipping boy in the currency markets. Investors beware, the British Pound will not be a place to be for the foreseeable future.

Friday, 18 September 2009

The 'China Hedge' and Western Zombies

Earlier this week the Chinese Government did something that Governments don't usually do. State television began promoting Gold and Silver as a good investment.

So why is the Chinese Government telling its people to buy Precious Metals? Of course I have previously mentioned the Chinese Government increasing their own holding of gold but now it is telling its citizens to follow the same strategy. To me it would seem their leaders must realise that the economy is in a bubble and whatever they try and do, China is heading for a hard landing. The trick with governing people is to try and provide the illusion of prosperity. Its what the West did during the housing bubble. Despite average workers incomes stagnating, people were content as their home was rising in value, giving them a false sense of wealth. People didn't mind that NHS waiting lists got worse, Governments role in the economy expanded along with deficits so long as their homes kept appreciating. When that disappeared, then people became restless. Recently with the 'green shoots' (read another dose of inflation from the government) people again believe how good it is that their houses will hopefully hold or increase in value and we can return to the old days of easy living. The problem comes when people realise the green shoots were in fact weeds, and that the asset prices will fall back - then we go back to unrest.

The Chinese Government aware of this dilemma, seem to be trying to hedge their citizens from the global depression. Their exports continue collapsing, millions of jobs are being lost, the Baltic shipping index is once more on the slide similar to 2008 before the financial carnage occurred. To cover their citizens against this and falling stocks and real estate they are encouraging people to buy precious metals. As recent as 7 years ago citizens were banned from owning such assets. This illustrates how radical the policy is. What does this mean for the price of such assets? I do not know. All I know is that the Chinese Government, again, seem to have studied their history and see where we in the West are now leading the whole world. China has grown phenomenally in the past 30 years, but its still America, Europe and Japan who have the most influential economies. It seems that we wish to create a new set of zombie institutions just like Japan did to try and maintain our illusion of past 'prosperity'.

Western Zombie Banks

"At the moment the investment slump is being compensated by public spending. As long as global growth is supported by public help, we cannot talk of sustainable growth"
Yves Mersch, ECB Council Member

Whenever I mention to people that what we are doing is creating Zombie Banks that will stagnate the economy for years just like Japan I am greeted with exactly the same comments before the housing bubble burst. "It's different this time", "We are not like Japan", "It won't happen here". Well it will happen and as the years go on it will become more evident to everyone.

We haven't learnt anything from the events last year. Bankers are getting their bonuses once more. Banks have merged creating even larger "too big to fail" institutions with the Government guaranteeing all of them. They will use Lehman from now on to scare people, to legitimise further government involvement. Politicians don't dare bring up any previous discussions regarding reforms as they all try to maintain this illusion of prosperity but it won't work. Earlier posts back before Lehman collapsed that I wrote had some hopeful comments, on what needed to be done - saving, the abandonment of wasteful consumption, independent thinking. However I thought we would try and prop up everything, repeating the same mistakes of history with everyone tricked into believing the governments 'solution'. We should have made sure there were more Lehman's. Its just finance. People would have rebuilt their lives. We would still would have all our tools, skills and infrastructure.

So how long will China pursue Gold?

As I have previously mentioned China are acquiring gold to try and build a reserve currency contender against the US Dollar. I have read many articles on how the USD is going to collapse or be replaced by the Euro or some other currency. But as I've said before where is the alternative? The Euro has too many soft nations such as Spain, Italy and Greece. If it was just the sounder economies such as Switzerland, Germany, France, Norway then maybe there would be a sounder alternative. The Chinese RMB is pegged and that's before we come onto the smaller size of the economy compared to the US. I can not see the government letting the RMB float freely while the current crisis is present, they will keep it under control not risking further dislocation that could ensue by allowing it trade in the markets. The Japanese economy has gone nowhere for two decades and despite what people may say that they are due a boom I can't see it happening. The Government has to walk the right path first and I'm yet to see it.

If China did wish to challenge the USD as an alternative world reserve currency then the only way I can see other nations taking up the offer would be to peg it to Gold. The Chinese could then say "sure you can have your paper dollars backed up by American Governments lies as they continue to devalue them, or you can use our currency, fully convertible into Gold". Whoever holds the reserve currency status has a huge advantage in that they can export their inflation to others just like the US has been doing for decades. China and Russia may discuss alternative world currencies but they would both secretly prefer their own nations currency as the reserve standard. In order for China to do this they still have to accumulate a lot of gold. The 1,000 tonnes they already have would not be enough. China still has a lot more to accumulate, just as the gold bull market still has a lot further to go.

Friday, 11 September 2009

The Social Question

"We need some more Lehmans so we can get out of this. Over the past 20 years Messrs Greenspan and Bernanke introduced crony capitalism to the West which is leading to a lost decade[s]. Market fundamentals are that failures should collapse and be replaced by creative new forces rather than being propped up as zombies... Marx is singing in his grave there in London as the US government now controls the auto, mortgage, insurance, banking, et al industries and he has not fired a shot. Letting Lehman fail was perhaps the only thing governments have done right during this whole drama."
Jim Rogers, Chairman Rogers Holdings (recent comments)

"I take advantage of one of the beautiful flaws of capitalism which is that the capitalist will sell you the rope to hang himself if he can make a buck. So they only think about money - they do not really care what I believe, which is upsetting on some levels."
Michael Moore, when asked about how he gained the funding for his new film

"They [financial crises] are all different, but they have one fundamental source. That is the unquenchable capability of human beings when confronted with long periods of prosperity to presume that it will continue...The bankers knew that they were involved in an under-pricing of risk and that at some point a correction would be made"
Alan Greenspan, recent comments regarding the financial crisis

Questions of equality have been asked for hundreds, even thousands of years, however it was not until the Industrial Revolution that the topic became a major talking issue for many intellectuals. The emergence of competitive markets did not create equality, the opposite was observed as income gaps grew and have continued to grow as time passed. Two forms of egalitarian views emerged, the Jacobin violent revolution in which people would be educated to accept the new system imposed on them, or a gradual evolutionary process where the people would demand Socialism. In short centralised totalitarianism or through democracy. The twentieth century will be seen as a great experiment with statism, country after country have attempted to plan economies through central authorities all of which have failed. The fundamental question is not how can we make societies more equal which is mistaken as the ultimate goal, but how can we raise everyone's living standards.

The quotes given above are from a range of individuals, each with a different viewpoint on the recent events and social system we live in. One fundamental premise of an economic system is how to best use societies resources. Despite what is told from romantic socialists we live in a world of scarcity. We only have a certain amount of natural resources, a limit on the hours we work and a finite labor force. These factors mean that society needs a mechanism in which to direct all of the above in the most effective way to meet peoples needs. There are generally two sides of this coin - a free market directed by prices or a centrally planned system whereby Government can direct the above. We currently live in a combination of the two.

Another key concept of economics is the idea of wealth. What is wealth? Is it money? Material items? Spiritual enlightenment? I am not a material person however such possessions is a good measure. It may be as simple as the food that we eat. We all take this for granted where we have the option to eat ourselves to death but our ancestors as near as 150-200 years ago experienced famine on a regular basis. Karl Marx's famous Communist Manifesto was written during the 1848 European uprisings against a backdrop of crop failure and mass starvation throughout the Continent (the most infamous was the Irish Potato famine). Therefore a good economic model is to supply an adequate amount of goods and services that people wish to consume. We all have wants and desires in life. We would all like to own fancy cars, extravagant homes with endless means to consume but we can't. To obtain these goods and services we have to produce and we are all only so productive therefore have a limit to how much we can consume. So how do we get the most bangs for our bucks? This is where the two opposing systems come into play. One promotes free markets where people will be driven to do things they want on their own accord. The other, is where the government has to plan to ensure we all can enjoy equal spoils of our labor.

A free market can only deliver more material goods for us all to enjoy. Central planning, as history has shown and economic theory proves creates stagnation and falling living standards. The principle behind free markets is to lower the price of goods and services thereby increasing societies purchasing power - the true driver of wealth, which is what free markets are so good at. I can buy infinitely more than my father could when he was my age, and likewise his father. A market ensures this process will occur by enabling entrepreneurs and capital in competition to innovate thereby increasing general productivity. The incompetent fail, leaving the competent to take over, as Joseph Schumpeter put it, creative destruction. The other viewpoint is that the government can handle this process. They can centrally plan and co-ordinate resources and supply goods and services for the good of people. The problem with this system is how do you determine the competent people? How can you ensure competition and that governments will not abuse their monopoly power.

Ludwig Von Mises, one of the greatest economic thinkers in history, proclaimed that Socialism was doomed to fail before it had even begun. When various states succumbed to Communist regimes everyone agreed that you may have issues with incentivising people. How would you get people to do the less desirable jobs, say work in a dark mine in dangerous conditions - even the Socialists recognised this issue, and tried to solve the problem with honour parades and so on. However Ludwig Von Mises ignored this concept. He assumed that you could create a society in which everyone worked for the cause, the collective. He said it would fail not because people wouldn't do the work but for another more rational reason. He argued how will the government know what to tell the people to do? Without prices how would the resources be channeled? Coining the phrase 'planned chaos' he said any socialist system for a complex modern society would inevitably collapse, it was only a matter of time. This wasn't at a time we find ourselves in now, where all these systems have collapsed, this was back in the 1920's when Socialism was the in thing.

Of course this idea was challenged. Many said "Well we have equations, we will just use these" or "We will just find the entrepreneurs and place them in government positions". Von Mises rebutted the above on quite logical grounds. If you give someone a cushy government job on a regular wage you take away the entrepreneur, his capital and his capitalist instinct. When an entrepreneur sets up a company he tries to meet a consumer demand. He risks his capital and his time and for these reasons he will work day and night, always on edge to ensure he delivers quality service or products better, than his competitors as cost effective as possible. Would Bill Gates have created Microsoft if he had been in a government job. Would Microsoft have turned out the way it did if he didn't quit university, did not work late nights and did not have to risk his own capital? I doubt it. Its all this that ensures effective use of economic resources, placing the competent who prove themselves in charge of economic resources. A bureaucrat on £60,000 a year will never do as good a job as someone with no such security.

When we come to equations this is always a distraction in economics. Back when Britain was the leader of the world, the nations leading classical economists such as David Ricardo, Adam Smith and John Stuart Mill were in an age when everything was being mathematised. Science and technology was conquering the planet. With this backdrop they began trying to use mathematics to explain economics, however their models never really worked. This tradition carried on, right up until the present where economists still try and use it for the macro sphere. Economics is not a science and it never was. In micro you have concepts such as prices, supply and demand but no specifics. Then we jump into macro and all the economists tell you we can 'predict' this or 'solve' this because we have equations. If it was like science then why couldn't they predict the credit crunch? Science can predict all types of natural events to pin point precision but economists can't seem to predict the future any better than the average person on the street. The problem is you can't mathematise human actions. You can't mathematise future trends and technologies. The future is uncertain and impossible to model.

Of course many could not see this, so again Ludwig Von Mises in his typical genius fashion, just accepted the formulas for the sake of argument. He said even if you could create formulas to model the economic picture, then how would you obtain the inputs for them? Collecting data is prone to error and a time consuming activity so as soon as you get the data it is already out of date. In a constantly changing world it would be impossible to create accurate models to direct the means of production. Central Bankers acknowledge this concept today by using the famous saying for constructing monetary policy 'its like trying to drive using the rear view mirror'.

In a market with prices, the most competent who anticipate consumer demand survive, while the ones who forecast less successfully go out of business, thus releasing societies scarce resources for the competent to use. Despite what the left proclaim about 'excessive profits', profits and loss are the markets pricing mechanism. The future is uncertain, therefore profit just means you forecasted in the correct direction, losses mean you made a wrong forecast.

In history too, we can see ample examples of Capitalism pitted against Socialism. Korea, a country that was split by war is a fine example. One nation followed state planning, the other free markets. Back in the fifties the South was actually poorer however it soon caught up and then some. Now we see how South Korea has elevated its people to some of the most prosperous living standards on the Continent while North Korea continues to decline. For years the economy has been contracting. As Ludwig Von Mises states, under Communism you are in a constant depression. Recessions and depressions can only occur under government involvement.

Russians for years had product shortages as the state set prices of goods too low. Newspapers were so cheap that people bought them not to read the news but for alternative uses such as wrapping paper. Prices had been fixed by the state for decades with no relation to the actual costs of production. Russia only lasted as long as it did due to its resources. It sold anything it could to the West in an attempt to hold the country together, Oil, Gas, Iron Ore, Gold. As the commodities boom ended in the early 1980's so did Russia's income of hard currency, leading to a gradual collapse from within.

Under a year ago I visited Cuba, a country still run under Communist principles. People were under rationing, I saw queues outside closed shops, the shopkeeper coming to the door occasionally before opening with people asking him if he had any particular products (there were not many shops though, you were also lucky to get your allocated rations). University graduates were working as luggage boys or laundry maids, wasting their education as there were no other options. Rather than tipping currency for the cleaning maids, we tipped shampoo and toiletries as these are far more valuable than the governments worthless currency that can't buy any goods. After recently being hit by a hurricane they are rebuilding their homes with asbestos. Despite the health hazards society is too poor to afford the alternatives. For decades Cuba was propped up by Russia, buying their sugar for four times the market price, and practically giving them oil. After Russia collapsed Cuba could no longer get hard currency and technology, Castro's solution was to open the gates to tourism. This is what saved the regime in recent times, again a free market propping it up. They still have major issues and you could sense the bitterness the local people have towards the economic system. As one of our tour guides remarked, "This is supposed to be our Leninist-Marxist workers paradise".

The solutions many social commentators propose are just the above. Government systems and they never work, its always the free market that has to prop them up. They denounce that the rich are getting richer while the poor are getting poorer, but the poor get richer too as long as they are in a free market. As society accumulates increased capital and productivity these gaps widen as other nations fall behind under kleptocratic regimes with dictators, for example continents such as Africa. Many areas in Asia were poorer than Sub-saharan Africa 50 years ago. Asia then decided to open up their economies, respect property rights thus encouraging capital and expertise to invest there. Japan is already treated as a first world nation despite 60 years ago been seen as a basket case by the West.

When commentators such as Naomi Klein or George Monbiot argue that Globalisation exploits the poor, it does the complete opposite by alleviating poverty, in fact it enriches us all. Costs are lowered thus increasing purchasing power of developed nations, and developing nations are given access to capital, not only for machines but enhancing their human capital to raise their living standards.

"It's human nature, unless somebody can find a way to change human nature, we will have more crises and none of them will look like this because no two crises have anything in common, except human nature."

A quote again from Alan Greenspan. Despite what he says in public he knows the real cause of financial bubbles and crisis. He may blame markets or peoples irrational behaviour, but history again has shown it to be expansive monetary policy. When he wrote with Ayn Rand he lambasted central banks for their interference in markets. As time passed he became more involved in government affairs. Reveling in the role, labeled by the press as the 'Maestro', how he lies in public I do not know. Like with most bubbles throughout history you will find a central banker or a government authority behind it, creating inflationary booms and busts which we now label as the 'business cycle'. In the past it was fraudulent Gold deposit banking which governments encouraged. It was a less transparent way to debase currencies through intermediaries such as banks, there was also the added bonus of a scapegoat too. Banks also benefited as profits could be privatised in the boom, losses socialised during the bust. This trick fools many Socialists into believing capitalism is unstable, or as Marx liked to think it overproduced thus creating inevitable booms and busts. But this isn't true free market economics. Governments are the cause of recessions and bubbles through economic mismanagement. Private banks didn't under price risk, they had too much money from the central banks therefore as the inflationary boom kept going they lent it out recklessly as they don't make money by sitting on it. They had already lent to all the creditworthy borrowers but were still being thrown money by the central banks, therefore lent it to individuals that could never repay the debts.

A free market is the answer to the social question, we just haven't lived in one. Disparities in wealth should not concern individuals, as it is just a measure of how productive an individual is compared with another. Many may look enviable at rich successful entrepreneurs but they create the wealth and jobs for us all to enjoy. They increase all of our purchasing power and drive up living standards by creating new processes and markets. We help them with our labor, but at any point we are all free to become an entrepreneur. Companies are there to serve consumers and have little power, its only Governments that can give them more power then they should such as the past two decades with the banks. If people no longer wished to drink Coca Cola then the company would cease to be. Markets give people choices and treats humans as individuals, respecting ones rights. They drive living standards up across society this is the end goal, not equality. Individuals will always be 'unequal', each one of us has different talents and a free market allows individuals to make the best use of those talents. This is the answer to the Social Question. Socialism can never solve the social question it creates "equality" by impoverishing us all. It is nothing more than slavery to the state.

"Liberalism and capitalism address themselves to the cool, well-balanced mind. They proceed by strict logic, eliminating any appeal to the emotions. Socialism, on the contrary, works on the emotions, tries to violate logical considerations by rousing a sense of personal interest and to stifle the voice of reason by awakening primitive instincts."
Ludwig Von Mises

"Capitalism means free enterprise, sovereignty of the consumers in economic matters, and sovereignty of the voters in political matters. Socialism means full government control of every sphere of the individuals life and the unrestricted supremacy of the government in its capacity as central board of production management."
Ludwig Von Mises