Category: Economies

Market Rallies Don’t Always Make Sense

Market Rally FollyStimulate Economy - Red Button

Can government infrastructure spending, or “fiscal stimulus,” create more wealth? The stock market certainly seems to think so. As financial publications have recently opined, the stock market has been hitting record highs (Dow 20,000!), at least partly because investors believe the new Administration will usher in an era of government spending on things like roads, bridges, telecommunications and defense. While this may give some companies a boost, it will be a drag on long-term economic growth.

The Seen Versus the Unseen

The art of economic thinking is always to consider the seen versus the unseen. In the case of infrastructure spending, what is seen is the widening of highways, the new suspension bridges and the faster internet cables being buried underground. It is easy to see how this spending could be a good thing because the wider highways and faster internet probably enhance productivity.

Furthermore, any government spending – even on bridges to nowhere – is seen as beneficial, due to the Keynesian idea of the “multiplier effect.” This theory posits that governmental spending gives the construction workers more income, who then go and spend the income on other goods and services such as restaurants or new cars.

This in turn gives those restaurant staff and car manufacturers more income, which they then promptly spend. Each dollar the government spends is therefore “multiplied” throughout the economy.  

The Unseen Hand

What is missing from this analysis is the unseen. For government to spend any money, it must first get that money from somewhere; taxes are the most direct method and borrowing is another option, but this only means higher taxes in the future to pay for the borrowing.

While the government technically can’t print money directly to finance spending, it can do so through other means, which cause inflation and which are – you guessed it – just another form of tax.

Therefore, since taxes can only be taken from those who are creating wealth (for example taxes on profits or income), or from the existing base of wealth (such as real estate taxes), then by definition, government spending can only be accomplished through the transfer of wealth.

But Isn’t Infrastructure Useful?

Proponents of government spending may agree there is a transfer of wealth occurring, but that wealth is being employed into productive uses, such as infrastructure. After all, the construction and maintenance of roads allows businesses to ship their goods all over the country more easily.

It is true that things like roads, bridges and electrical grids are useful. But the pertinent question is how useful? If money is taxed away from a business to build a road, that business may no longer be able to build another manufacturing plant and provide an increasing number of products at a lower price, employing more workers in the process.

In other words, infrastructure spending faces a calculation problem. While politicians can hazard a guess that a wider highway or a public transportation project has some value, it is impossible to know (or prove) that the project is more valuable than what the private sector would have spent those tax dollars on.

If this calculation problem were enough to give cause for concern, there is also a problem of incentives. Infrastructure projects that are likely to be funded are those that will create the most jobs or please the most constituents, not the ones that make the most economic sense.

This logic means that the Keynesian “multiplier effect” does not exist, because every dollar spent to begin with does not come out of thin air but must instead be redirected from something productive. In fact, some of the latest rigorous academic research has confirmed the government spending multiplier to be negative, not positive (see a nice summary of this research from Dr. Lacy Hunt of Hoisington Management).

Employee IncentiveWhat this Means for the Stock Market

The stock market is always forward-looking, and it is likely making new highs for a host of reasons on which financial journalists can only speculate. It is also true that increased fiscal spending could give select companies a lot of extra business in the short term.

However, valuation levels for broad market indices such as the S&P 500 are currently at some of the highest levels in history, exceeded only during the dot-com bubble and the brief run-up before the Great Depression. At current levels, the stock market would have to decline by anywhere from 40% to 60% just to return to historical norms!

To be clear, valuation tools are not timing indicators, and anything is possible in the short term, including a continued bull market in the months ahead. However, what valuation models of the stock market can reveal is that, over the longer-term (10-12 years), investors should expect very low returns (low single digits annually) if they invest at these elevated levels.

Diversify across All Asset Classes

The best strategy is to stick with a plan of being diversified across asset classes, including hard assets such as precious metals, other commodities and real estate.

And don’t let any infrastructure spending plans fool you into thinking it will be a huge boost for the economy and the stock market!


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Inflation is the 24 Hour Tax on Everything

Wallet and stethoscopeInflation is the 24-Hour Tax on Everything

The Wall Street Journal recently reported that inflation, after “being given up for dead,” is coming back to life. While that may appear to be the case on the surface, inflation has been alive and well – hiding out beneath the official government statistics for years.

The WSJ is referring to the data released last Friday by the Bureau of Economic Analysis, known as Personal Consumption Expenditures (PCE), which measures the change in actual spending and prices and is the Federal Reserve’s preferred measure of inflation.

More specifically, the article was referring to Core PCE, which is PCE excluding food and energy, and is currently at a two year high of 1.7% on a year-over-year basis. The other measure of inflation is the Consumer Price Index (CPI), which has also been markedly higher, coming in at a 1.5% annual increase as of this past September.

Inflation is NOT a Good Thing

With inflation getting closer to the Fed’s 2% target, WSJ’s columnist Greg Ip casually comments that “This isn’t bad news. To the contrary, markets and central bankers alike will be relieved the world is no longer skirting a deflationary abyss.” But while central bankers might welcome this news, consumers will not.

Sustained inflation in consumer prices is never a positive for any economy, and is also not necessarily an indicator of a growing one. Prices may rise due to changes in supply and demand, and therefore help to reallocate resources and signal those changes; but an overall and sustained increase in prices is different.

If the price of an item rises for consumers, they will then stop buying it or switch to a cheaper item or cut back on another category in order to accommodate the household budget. Therefore, the only way for all prices to rise indefinitely and consistently is for new money to be constantly created and injected into the economy.

This of course is merely a tax on consumers because the new money and consistent increase in prices makes the consumer poorer. Contrary to popular economic theory today, there is no threat of a“deflationary abyss”. During the nearly 100 year history of the classical gold standard, prices gradually declined an average of 2% to 3% per year as technology and productivity increased, giving consumers the benefit of these advancements in the form of lower prices.

Inflation is Worse Than Reported

This week, Visual Capitalist made a stunning infographic using AEI’s Mark Perry’s (equally as interesting) inflation observations. Over the past 20 years, from 1996 to 2016, total inflation has been 55% as measured by the CPI.

However, digging into the Bureau of Labor’s data and then channeling down to the various items that make up the CPI basket of goods, you can see that inflation varies greatly from one type of good to the next.

For example, things that have increased more than the average 55% include tuition (up almost 200%), childcare (122%), medical (105%), food and beverage (64%) and housing (61%) – in other words, virtually all of the living essentials needed to survive or raise a family.

Counteracting this, items that fell in price included TV’s (96% decline!), toys (67% decline), and software and cell phone service (66% and 45% respectively). Clothing and furniture declined slightly, while new cars increased only slightly.

Obviously the dramatic decline in electronics, software and toy prices has brought wonderful benefits, but these are still largely discretionary items, and they take up a much smaller portion of most household budgets. The average family is therefore likely facing more than the average 55% increase in prices over the last 20 years.

Indeed, in his latest book, David Stockman has modified the CPI to put heavier and therefore more realistic weights on the four essential items of everyday life: food, energy, shelter and medical care. Using this measure, he finds the actual inflation rate over the past 29 years (when Greenspan became Fed Chairman) has been 3.1% per annum, rather than the official CPI rate of 1.7% per annum.

How to Protect Yourselfdates falling dollar

Unfortunately, inflation will continue to be a problem for any person living in a country whose money is a fiat currency that is being debased by their government – which includes nearly all modern economies today.

Thankfully, there is nothing stopping you from converting some of that fiat paper money directly into your own store of hard currency: physical gold and silver. During the past twenty years, while the official CPI increased 55%, gold has increased in value 235% and silver 282%.

Time to buy gold and silver, perhaps?

Greek Bartering Reveals The Essence of Money

Barter-Chickens_for_SubscriptionThe Greek fiscal crisis has receded from the 24-hour news cycle, but unfortunately for Greek citizens, their problems are far from over, especially with strict capital controls still in place and likely to remain so for months. We previously noted how the capital controls were suffocating economic activity and giving rise to parallel currencies such as private scrip. Now many Greeks are resorting to barter as well. It is a very unfortunate situation, but one where we can observe what money is and how it evolves.

We are all familiar with barter, and it may even be something we do from time to time in our daily lives, trading a few small services and goods with friends and family without using cash. It was also this way in Greece until the capital controls arrived. As Reuters notes:

“In the past, [barter] was mostly on a family and individual level, but now it is expanding due to the developments in the banking sector and capital controls. Now it is a more structured and organised phenomenon.”

In fact, it has become so organized that citizens are formalizing it and increasingly using websites to facilitate barter:

Tradenow, a website started three years ago to facilitate barter of everything from food to technology, says the number of users and the volume of transactions have doubled since capital controls came into effect on June 29.”

Examples of those using the website range from car repair shops exchanging tires and a burglar alarm company trading services for advertising. Another internet company that operates barter on a larger scale is Mermix, which allows farmers to share heavy machinery in return for cash or cashless transactions.

All of this is certainly a step backwards for the Greeks as it slows the gears of exchange. When bartering, it takes longer to calculate what is a fair exchange; it also takes time and energy to find someone who is willing to trade. Economists call this the “double coincidence of wants problem.” Not only do you have to locate the person who has the thing you want, but you also have to make sure you have something the other person wants.

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1) On Writing the Surprising Design of Market Economies


2) On the Necessity of Good Government


3) On Healthcare


4) On Libertarianism


5) On Anarchy


6) On Socialism


7) On the Private Sector


8) On the Notion of Free Markets


9) On Cities as Corporations


