The Cobden Centre

The Liquidation Phase and Profit Margins:
Getting Back to Breakeven
Paul F. Cwik, Ph.D.
Associate Professor of Economics
Mount Olive College
and
Harry C. Veryser, Jr.
Coordinator of Graduate Studies,
Department of Economics
University of Detroit Mercy

Austrian Scholars Conference 2011

Abstract

The Austrian theory of the business cycle has been gaining attention in the popular press and in political circles since the onset of the most recent recession (December 2007).  While the artificial boom and subsequent malinvestments fit the Austrian theory, the question in the popular press is, “Which economic policy is the best to alleviate the recession?”  However to an Austrian economist, this question is miscast.  It should be, “Which economic policy best converts the malinvestments into economically viable capital structures?” since only through a regenerated structure of production can sound economic growth take place.  This paper analyzes, from a firm’s point of view, the various policies that are currently in use (modern Keynesianism) to cure the recession and contrasts these policies with those which an Austrian analysis of the business cycle would recommend.

Introduction

The collapse of the housing market has renewed interest in business cycle theories.  The Austrian theory of the business cycle has been gaining attention in the popular press and in political circles, because Austrian theorization of the boom fits the housing bubble better than the mainstream theories do.  Unfortunately, the major focus of the Austrians has been explaining how the boom inevitably leads to a bust, leaving aside the liquidation and recovery phases.  In essence, the Austrian Business Cycle Theory (ABCT) has not emphasized the effects of the recession as much as other major schools have.  This paper attempts to fill in these gaps and explore the mechanics of how businesses convert malinvestments into usable capital structures.

In standard ABCT, the boom is generated by an expansion of credit, lowering interest rates and misshaping the term structure of interest rates.  Entrepreneurs are misled by these false signals and start to build up malinvestments.  This boom is artificial and cannot be sustained.  The upper-turning point of the business cycle comes as a crisis.  It reveals itself as a credit crisis, a real resource crisis, or a combination of the two.  A credit crisis appears if the central bank slows the rate of monetary expansion or stops it entirely.  A real resource crisis appears if the lack of actual capital goods manifests itself.  The result of the artificial boom and build up of malinvested capital is a misalignment in the capital structure of the economy.

To rectify this situation, the malinvested capital needs to be reallocated.  The reallocation of capital to a sound production structure is the Liquidation Phase of the business cycle (a.k.a. “The Recession”).  The Liquidation Phase is necessary to realign the capital structure.  Austrians have long said that the solution to the recession is to “liquidate the malinvested capital,” but what does this actually mean?  How do companies do this?  What is it like from their point of view?  At the extreme, it is through the bankruptcy of some businesses that capital can pass from inefficient uses to more efficient uses.  However, not all businesses fail in the liquidation phase.  How do the firms that are accumulating losses, but not yet ready to fold, convert their malinvested capital into profitable structures?  It is within this context that we will now turn to the point of view of a business or firm.

Getting to breakeven

When a business is in crisis—that is, constantly losing money—its goal should be to do everything it can to reach a breakeven point, where they stop incurring losses.  The idea is that once a business is at breakeven, it can then plan for profitability.  Let us examine the two approaches to reaching breakeven.

Consider a business with the following situation: It manufactures a product in which the gross margin is 25%.  This means that the labor and material constitutes 75% of the cost of production (its variable costs).  As long as a business is able to meet its variable costs, it will stay in business.  If the firm is not able to cover its variable costs, it crosses the shut-down point.  If the remaining 25% only covers its fixed costs (its overhead), it will break even.  When a business accumulates revenue above fixed and variable costs, it begins to make profits.  This crossover is the breakeven point.

Let us assume that the business described above has fixed costs (the overhead) at $10,000 a month.  This means that the firm must sell $40,000 a month just to break even ($30,000 pays labor and material, and $10,000 pays the overhead).

Now, let us assume that the economy is in a downturn and that the firm is losing money, say $2,000 a month.  The business is able to cover its variable costs, but it is not breaking even.  This problem can be viewed either as having insufficient sales or having excessive overhead (fixed costs).

If the business could magically expand sales, it would have to first create more product, which means that the variable costs would increase.  In this example, the gross margin is 25%; and let’s assume that the margin and the costs are held steady.  Therefore, in order to cover the monthly shortfall of $2,000, the firm would have to increase sales by $8,000, in which $6,000 (75%) will go to variable costs.

However for every dollar by which the business can lower its overhead (and other fixed costs), it no longer needs to generate four dollars in sales.  By cutting costs, it can operate profitably with lower sales figures.[1]

A firm in financial trouble has a greater multiplier in cutting costs than it does in increasing sales.  In this case, the multiplier is four times.  This fairly obvious point is resisted not because it is some magical or accounting trick.  The reason why this is resisted is that no person wants to have his salary cut and no department wants to have its budget slashed.  It is very difficult to look a person in the eye and tell him that there is a cut.  Nevertheless, it is a necessity.  This is why, during a business downturn, most prudent companies immediately turn to cost-cutting.

Cost-cutting measures help to turn the malinvestment into proper capital structures.

In the context of the business cycle

Suppose that a firm overextended itself when, during the boom, it purchased new capital equipment.  There was a miscalculation by the firm because it was reading false market signals—the interest rate was too low.  With the downturn of the economy, the firm is squeezed on both sides: revenues shrink and input prices grow.  The firm must do something to stay in business.  If it is unable to stay in business, then the firm’s assets are sold to other businesses that can better employ those resources.  The malinvestment of the failed firm is either put back into the economy through the liquidation process or it is scrapped.

However, let us suppose that this firm does not close its doors.  How do cost-cutting measures help transform the malinvested capital?  Let us add some detail to our example to help clarify our point.  Suppose at the beginning of the business cycle that the natural rate of interest is 6% and our firm is examining a project that has a discounted cash flow of $104,000.  If the upfront costs are $100,000, the internal rate of return is 4%.  The firm will not take up this project at this time.  Now, suppose that the central bank expands the money supply and market interest rate falls to 1%.[2] At this rate, it makes sense for the firm to borrow the money and start the project.  During the boom phase, liquid capital is converted into capital goods and equipment.  As the new money works its way through the economy, prices and interest rates begin to rise.  When interest rates return to the original level of 6%, the firm will begin to suffer an economic loss of 2% (or $2,000 per period).  In order for the firm to make up this difference, it either must raise revenue by the $8,000 as described above, or it must cut $2,000 out of its overhead costs.

So far, we have assumed that the level of sales and costs have remained constant.  We can consider this to be the best case scenario.  In a recession, the volume of sales tends to drop off and input prices tend to rise.  Thus, profit margins are further squeezed, thus shrinking the gross margin.  If, for example, the gross margin falls to 10%, then it will take an increase in gross revenue of $10,000 to cover the $2,000 shortfall.

Governmental policy to help firms get back to breakeven

The need for politicians to do something grows as the severity of the recession deepens.  With regard to active fiscal policy, there are two broad approaches to alleviating the recession: increasing spending or cutting tax rates.  The Keynesians have argued that the best policy to cure a recession is to stimulate aggregate demand.  With an injection of spending through individuals, households and firms, business revenues will climb and these firms will make up for the shortfalls.  Suppose that the government chooses to stimulate Aggregate Demand by directly increasing the purchase of consumer goods.  If the firm is experiencing a $2,000 shortfall, the amount needed in additional sales is $8,000, assuming constants costs and a gross margin of 25%.  In other words to turn the malinvestment into a sustainable capital structure, it will take $8,000 of direct and sustained government purchases.  On the other hand, to get the same effect, it will only take a reduction of taxes on the firm of $2,000.  Thus, in general, the tax cut approach will place a lower burden on the government (taxpayer).

Active fiscal policy

The manner in which the government injects economic stimulus into the economy has different implications.  Four injection channels will be briefly examined: grants, direct cash to consumers (e.g., the Bush Rebates of 2001 and 2008), government contracts to businesses, and tax cuts.

Grants

The most significant positive aspect of a federal grant to an institution is that the grant is a direct infusion of cash that can be used to cover any shortfall in revenue.  If a non-profit institution has a shortfall of $2,000, then a $2,000 grant will cover the immediate crisis.  However, such an action is merely temporary; it only lasts as long as there is a flow of money coming from the grant.  Furthermore, when institutions spend this money, they create further distortions in the economy, a Cantillon Effect.  A basic principle of Say’s Law is that we must first produce and add to the level of societal output before we can gain the wherewithal to consume.  When the government grants additional purchasing power to institutions that have failed to sufficiently contribute to the social product, the result is a distortion of the normal market patterns of production.  A further consequence is that when the grant runs out, the distortions will have to be corrected.  Any amount of malinvested capital will have to be subsequently liquidated as well.  Finally, standard public choice analysis recognizes the creation of perverse incentives that are created by these injections.  They, too, will eventually have to be corrected.

Cash directly to consumers

In 2001 and again in 2008, the Federal Government directly injected cash into the economy by giving tax rebates to those who filed tax returns.  In 2001, the tax rebate was between $300 and $600 depending on whether the recipient’s filing status was single, married or head of household.  In 2008, a similar tax rebate stimulus program was enacted that gave most taxpayers a rebate of $600 (single) $1,200 (married) and a $300 tax credit per child.

The design of these plans was to increase the amount of consumption spending by the public.  The naive approach to macroeconomic recovery is the focus on GDP, while ignoring the underlying capital structure problems.  The intense focus of GDP misleads one into recognizing that consumption is the largest component and therefore, if one merely stimulates consumption, then GDP will rise and the recession will be over.  Such thinking views the problem with the economy is that there is insufficient aggregate demand.  Unfortunately, we cannot consume our way to prosperity.  The key to economic growth is a properly aligned capital structure that is guided by market forces.

To the extent that the tax rebates went into savings and to pay down personal debt, it was a good thing because this additional savings (deferred consumption) can now be used for the realignment of the capital structure.  However, the portion of the stimulus that went into buying consumer goods does nothing to realign the capital structure.  Instead, consumption spending promotes the maintenance of the misaligned capital structure and is also subject to the problem of overcoming the gross margin.  In other words, the malinvested business with the $2,000 loss will need $8,000 in additional sales to cover the shortfall.

Furthermore, the tax rebate stimulus plan is a one time occurrence.  It is temporary.  Even if the firm was able to overcome the shortfall this period, what happens next period?  The liquidation process is delayed; and during this time some capital goods, which could have been converted into other industries, are now no longer able to be converted into more profitable industries.

Government contracts to businesses

There was much discussion by the politicians about adopting “Shovel Ready” plans to stimulate the economy.  Clearly such projects do not help realign the capital structure into patterns that market forces desire.  Instead, they are distortionary, perpetuate the problem and usually make it worse in terms of recessionary duration and depth.  Any benefit to a particular firm is also subject to the duration of the government contract.  Additionally, perverse incentives are created by this relationship.  The firm now has an incentive to lobby the government for an expanded role in the economy so that it can gain future contracts.  If these contracts do expire, then any distortions created from the government’s artificial demand will also have to be liquidated and realigned.

Tax cuts

There are two major points that should be elaborated upon.  The first is that, in general, the broader the tax cut, the fewer distortionary effects it will have.  Perhaps, the term distortion should now be explained.  The economic pattern that emerges from the market is not distorted if prices are free to fluctuate, if individuals are able to buy and sell on the open market, and if private property rights are enforced.  A distortion is when an exogenous entity (government) is able to override the normal market signals by directly buying or selling on the market, or by implementing rules and regulations that disrupt the market’s normal pattern.  In light of this fact, a tax on a particular good or service is distortionary.  Thus, the repeal of a particular distortionary tax will also reduce the amount of economic influence of the government.  The larger point is that anything that has been distorted will have to be realigned in the future, or the distortion will grow over time, building pressure as water does on a dam.

Malinvested capital comes in many different forms.  Sometimes capital is malinvested when something is created when something else should have been created instead.  Consider the situation where mining equipment was built but cash registers should have been made instead.  However, a broader definition of malinvested capital is that where there is not enough savings to sustain the capital project to completion.  If more savings could be obtained, then the capital project would be converted into a proper investment.  Cost-cutting measures are a form of internal corporate savings.

The second major point is that a tax cut is more economical than that of attempting to stimulate sales.  The distressed firm that has been our example would benefit directly from a tax cut of $2,000.  Such a tax cut would return the firm to the breakeven point.  The reduction of taxes on savings, retained earnings, or corporate income in general will free up resources for businesses to use to realign the misaligned capital structure.

Austrians versus Keynesians

We have been arguing that when an economy is in a downturn, cost-cutting is much more powerful than stimulation by government.  The fastest way out of a recession or depression is to bring down the cost to business.  Companies that can begin to profit at a lower scale of business can then prepare to expand as they achieve profitability.  If government lowers the cost of business through simplified taxes and making the relationships between business and government as low a cost as possible, profitability will return much more quickly.

The Keynesian argument and program is to attempt to stimulate spending on behalf of the public.  This was the idea behind the so-called “cash for clunkers” program.  The government tried to stimulate the sales of automobiles, hoping to restore profitability to the companies and thus stop the layoffs or even increase employment.

It should be mentioned that there are liberal and conservative Keynesians, but both subsets agree on the paramount imperative of increasing sales rather than cost-cutting.  Conservative Keynesians would argue for fiscal stimulus by cutting taxes.  This was the approach of the Kennedy administration (1961 to 1963) and it provided an argument for what would later be called supply-side economics.  President Kennedy lowered tax rates significantly, but did not decrease spending by the federal government, and thus ran deficits.  He did not significantly cut government intervention and regulation.

Liberal Keynesians favor increased government spending to stimulate sales in the economy, which is the policy of the Obama administration and was the policy of the previous Bush administration.  The concept was to stimulate sales through government spending and tax rebates.  Both presidents increased the amount of regulation and direct costs on business substantially.  The results so far are that the stimulus package has seemingly little effect.

The Austrian solution is a combination of cutting both governmental expenditures and tax rates.  Probably the best example of this policy was during the Harding administration (1921 to 1923).  President Harding cut both government spending and taxes by about 25% and in about six months pulled the country out a severe recession in which unemployment rose to 12%.  It was one of the quickest and most successful efforts dealing with a business downturn in U.S. history.[3] The Harding administration later made several mistakes, including raising tariff rates and allowing the Federal Reserve to inflate the currency.

The Austrian multiplier

This emphasis on lowering business costs and taxes might be called “The Austrian multiplier.”  While Keynesians claim to have a spending multiplier, it has yet to be seen.  The Austrian multiplier would vary from business to business depending upon its gross margin.  For every dollar of costs cut from a business’s bottom line (e.g., through a tax cut), there will be a multiplier equal to the reciprocal of the firm’s gross margin.  The one advantage of the Austrian multiplier is its immediacy; it does not have to go through a government bureaucracy or depend upon the spending habits of the public.

The Austrian multiplier effect can be seen when government regulation and taxes are increased. For example, if a business is operating at a 33% gross margin and government implements an expensive round of new regulations, to pay for that regulation, the firm will have to increase its sales by three times the cost of regulation or cut other business expenses. Cutting and downsizing become especially true if the company cannot raise its prices to tax the consumer to pay for the cost of regulation.[4] However, the effects of reducing regulation would stimulate businesses become subject to the Austrian multiplier effect all the while having little to zero effect on the federal budget.  In fact, with fewer regulations there could be more business activity, which lead to higher tax revenues and, without the rules and regulations to enforce, the size of the governmental payroll could also shrink thus adding to the fiscal health of the government.

Conclusion

In summary, the point that can be drawn from the above analysis is the Austrian multiplier which emphasizes cost-cutting.  Reducing government regulation and tax cutting are far more potent toward helping the economy than any Keynesian attempt to increase spending and sales.  Cutting the costs across the board helps all firms.  Whereas Keynesian government spending programs are specifically aimed towards particular industries and can cause malinvestment in those areas.  We conclude that the Austrian approach will improve employment opportunities, enhance the structural productivity of firms, and slow falling government revenues far better than the Keynesian solution.

[2] While in the market there are many different interest rates, we are supposing that the relevant rate for our firm, in terms of risk and duration, falls to 1%.

[3] See Benjamin Anderson, Economics and the Public Welfare, Chapters 8-11 and Brian Domitrovic, Econoclasts, pg. 35.

[4] Companies will try to shift the burden onto the consumers as best they can.  However, the incidence of a tax depends upon the elasticities of supply and demand.  Since supply is never perfectly elastic, the producer will always bear some of the burden of a tax.

Harry C. Veryser, Jr. is the Coordinator of Graduate Studies and teaches in the Department of Economics at the University of Detroit Mercy.  His primary interest is in Austrian Economics and he has a forthcoming book on the current economic situation entitled, It Didn’t Have To Be This Way.

It was a signal feature of the week that one of the few Grand Wizards of the global Oz in which we live not to give vent to a risible display of reality denial and sophistry was none other than ‘Blackhawk’ Ben Bernanke.

The occasion for the Fed Chairman’s uncharacteristic distinction in this regard was the post-FOMC press conference when he not only openly confessed to not having a clue about why the US economy seemed to be stuttering, once more, but when he next ruefully responded to a Japanese interlocutor that, yes, it had been easy enough for him to make an academic name for himself by pontificating on what the BOJ should and should not have done to escape the clutches of the country’s (supposed) economic stagnation, all those years ago, but that his experience as a policy-maker had since taught him to be far more forgiving of his predecessors in office.

As for the first, we are not so much surprised at his cluelessness, per se, (we are Austrians, after all), but at his admission thereto. As for the second burst of illumination, we would dearly like to know whether this was the first glimpse of a newborn humility, fostered by the demoralizing effects of a partial realization of the limits of his powers, or simple fatigue at the political brickbats he must suffer being hurled at him during their exercise.

Being of a cynical bent, we rather suspect the latter.

In contrast, the little bald men behind the curtain at Threadneedle Street could only retreat, this week, into a form of casuistry to gladden the heart of a mediaeval theology student.

Here, we were treated to a particularly pathetic from of special-pleading which we characterized as ’Johnny Foreigner ate my inflation target’.

The argument here was that the Bank was not to blame for missing its inflation target (yet again), or for missing it by a widening margin, or for not being able confidently to predict when the disparity between hope and expectation might at last be eradicated, but rather it was all the fault of ’imported inflation’ and government tax hikes.

That the only way to ‘import’ inflation is either to authorise use of a second country’s surplus money inside the realm, or to freely exchange any such influx for newly-created money of one’s own, seems not to have registered with the great and good of the MPC. Nor can one lean too heavily on a state impost to explain rising prices since, if the ad valorem were used to fund a level of welfare payments whose disbursement was previously reliant on the printing press, this must serve to reduce overall monetary demand and so lead to a lower volume of sales, lower prices, or some combination of both.

Naturally, high prices have nothing to do with the fact that the Bank (along with one or two key members of its international peer group) have slashed rates and monetized the state’s enormous deficit (directly during the first year of the crisis and indirectly via the commercial banks in the past twelve months). Nor was it a consequence of the rather sharp decline in Sterling (second only to the one suffered by the Icelandic krona) brought about as a deliberate act of policy which, incidentally, Thou Holier than Me, helped inflict a 15% ‘haircut’ on the foreign holders of long-dated Gilts.

Nay, nay, and thrice nay! Nothing the Old Lady did was responsible for this offshore:onshore split, or for the rather more loudly barking dog that what the country has undergone is not just a shift in RELATIVE pricing (arguably to the good, to the extent that it needs to address its chronic external deficits), but a major one in ABSOLUTE pricing, to boot.

The real concern here – as elsewhere that such specious reasoning is being advanced – is that the false distinction with which the Bank is trying to exculpate itself implies that any reduction in the ‘domestically-generated’ price component will give it free rein to repeat the dosage, all the while grumbling about what mischief the untrustworthy blaggards east of Calais are about.

The second contender for this week’s award for a mix of extremely wishful thinking and blatant propagandising has to be China’s Premier Wen, currently en route for a much-trumpeted visit to Europe (whose own elite we have deliberately excluded from the competition for fear of lowering the bar to entry too deeply).

On the eve of his departure for London, Wen (or, more accurately, his speechwriters) issued an editorial, duly published in the FT, which contained a whole litany of Swiftian enormities as, for example, when he preened that:-

“China has moved swiftly to fight the financial crisis, adjusting macroeconomic policy to expand domestic demand, and introducing a stimulus package to maintain growth, advance reform and improve people’s lives. By taking these steps, we have overcome extreme difficulties and laid a solid foundation for China’s development.”

Our emphasis shows that this might have been better promulgated in the pages of The Onion, rather than in the august columns of the Pink’Un, but unconscious irony is not exactly in short supply these days, so perhaps the satire was not broad enough for the former’s editors.

After delivering a long list of  triumphant materialist achievements (though, alas, for those nostalgic for a whiff of the rhetorical style of Communist mass-murders of yore, no mention of any records in pig-iron production), Wen then went on to claim that, despite the gargantuan stimulus delivered, the state finances had actually been improved – well, yes, but only if you exclude all the overstretched lower tiers of government, or the subsidy-bloated, price-capped SOEs, or the true capital position of the ’policy-lending’ banks).

Apparently, thanks to the enlightened guardianship of the central planners, growth in money and credit supply has ”returned to normal”, allowing him to declare victory in the war on inflation as the “overall price level—we presume he means rate of change in that level—“is within a controllable range and is expected to drop steadily.”

So no worries that his own apparatchiks are currently warning of further gains in the pace of price rises in the coming months, or that these are only as modest-looking as they have been, thanks to a toxic combination of capital-destroying price caps, governmental menace, volume and quantity downgrading in the product mix, and outright exclusion from the reference basket of all manner of inconveniently uncontrollable, privately-supplied goods and services.

No mention either of the fact that the cronyism which runs deep through this most oligarchic of states has seen the full brunt of what credit restriction there has been fall upon the unprotected shoulders of the SMEs—forcing many of them to cover working capital needs, via kerb lenders, at usurious rates of up to 15% a month (a mere 435% APR).  Funds often sourced through the collusive cheating of regulatory restrictions by those able to import copper, zinc, and possibly even soybeans, on term credit abroad (presumably the SOEs with the aid of their pet banks).

If you are basing your world view on China being able to establish some new, Third Way utopia of benign central planning in order to show us degenerate Westerners the way to the Land of Milk and Honey, you are in for the same sort of disappointment as was suffered by those earlier intellectual ‘second-hand dealers in ideas’ who thought the Soviets were about to do likewise, eighty years ago, while the West which had nurtured the eggheads, but which they so abhorred, was struggling with the self-inflicted travails of a Depression they were libellously describing as the ‘failure of capitalism’.

There is even a potential paradox here, for those who are interpreting Wen’s PR fluff as a substantive guide to a switch in policy objectives from one of capping price rises to one of again boosting what passes for growth in the land of cadres, clipboards, and top-down targets. This is that while the knee-jerk trade will be to bid up the price of commodities on any relaxation of credit in China, if this were to obviate the need to use raw materials on anything like the rumoured scale as collateral for the import of foreign credit to the grey market, an awful lot of metal—and perhaps—agricultural products will instead be looking for a buyer.

China may be the big spider at the centre of the web, but do not lose sight of the fact that she is a screwdriver factory for many of the products of her more advanced neighbours, into the bargain, with her trade surplus with the US almost exactly offset by her combined deficits with Taiwan, S. Korea, and Japan, for example. Nor should we overlook the nation’s pivotal role in the seemingly currency-inelastic success of high value-added exporters from the likes of Switzerland and Germany.

Recent data shows those satellites may just be beginning to wobble, with German IfO Expectations (if, not yet, the Current Assessment) index falling for four successive months; with Korean business investment flagging badly; with Taiwanese commercial sales growing at their slowest pace since the Crash; and with estimated world industrial production not only crawling along at the bottom of the range experienced during the pre-Crash cycle, but decelerating at an alarming rate as it does so—making commodities look rather expensive (and, hence, overly QE-II dependent) in the process.

It may be a task beyond the ken of all but the wildest-eyed visionary to encompass, but imagine—just for a moment— that we operated in a milieu characterised by the sort of rational markets which the portfolio peddlers and DSGE pseudo-mathematical planners assure us—in the face of all the evidence to the contrary—does actually prevail.

Now, suspend your disbelief for one further moment and suppose that some Emmett Brown-type bursts out of his tumbledown laboratory, crying ‘Great Scot!’ at the top of his lungs and waving around a gleaming glass phial which—when he has finally succeeded in calming himself—he explains contains a miracle compound which will henceforth provide humanity with a near costless, readily-scalable, pollution-free source of energy.

Having set this somewhat unlikely stage, let us now consider what should be the reaction of all rational actors in the world’s financial markets.

Obviously, the prices of oil, natural gas, coal and their derivatives should plunge, taking with them all the securities issued by those companies whose revenues depend upon them, as well as the currencies of those countries whose external surpluses are largely predicated upon their sale.

But, ipso facto, we should also expect the prices of all other commodities and all other equities to rise since these should immediately benefit from a vast redirection of expenditures toward them from the now liberated portion of everyone but the oil and gas men’s budgets. [Granted, such a titanic reallocation would not proceed without a range of secondary and higher-order effects as those whose incomes are dependent upon the now-redundant energy businesses also dry up, but let us keep matters simple here].

Thus, where the householder used to spend $100 a week on gasoline and home heating, he can now buy an extra iPad and so push up the shares of Apple, Foxconn, the rare earth miners, and so forth.

Where the businessman was starved of the necessary capital to expand his existing line or to introduce another, the cash flow spared from his energy needs (as well as those entrained in all the other goods and services he buys in) can be used to buy plant and equipment, potentially pushing up the price of steel and copper, not to mention paper, paint, and plaster.

To the extent that, before Dr Brown’s most singular intervention, a high and rising price of energy was being blamed for throttling the life out of all manner of other consumptive activities—both exhaustive and productive—the revelation of the fruits of his genius should give rise to a burst of well-founded optimism about the prospects for everyone for whom energy was a cost and not a source of profit.

So, on a decidedly more mundane scale, what was the market’s reaction to the news that the governments who clothe the naked pursuit of their national interest in the diaphanous fabric of the IEA had decided to release 60 million barrels of oil from their emergency stockpiles, ostensibly to smooth out the disruptions caused by the loss of Libya’s light, sweet crude?

To sell WTI and Brent, RBOB, Heat and Gasoil, obviously. Just as obviously to narrow the anomalously wide spread between them (since European refineries were the obvious beneficiaries of the decision). Again, obviously, to collapse the steep backwardation as the immediate physical scarcity was alleviated. With a touch more subtlety, to erode US crack spreads as more refiners can compete on a lower cost base for their production and sale. To push ethanol, natgas, and coal lower, in their turn.

But what it also did, for several long hours after the announcement, was to drive the price of ALL other commodities southwards, in company with 468 out of 486 European and 465 out of 500 major US equities!

A more clear-cut demonstration could not be had of the sorry truth that, in place of a transparent and reputable forum wherein far-sighted participants combine to allocate scarce capital among the most promising suitors for its use, what we really have is a grimy favela, teeming with indexed and basketed, algo-conducting, ticker pimps—each one a member of a relentless swarm of highly leveraged, nickel-before-a-steamroller, financial scavengers, high on the freebase of near-zero central bank margin provision.

Fundamentals?? Rationality?? Scientific asset allocation?? Come on—what do you take us for?

In truth, the IEA’s decision was a little strangely timed, given that oil prices were already in retreat and with intimations from the Saudis that they would make good the Libyan lack (albeit that it is not within their capability to provide the right blend of the stuff to suit the needs of the Colonel’s former customers), but perhaps this was just as much a publicity stunt aimed at deflecting some of the growing criticism of NATO’s role in that country’s internal affairs as it was a shot across the bows of an OPEC otherwise in disarray.

Whatever the Realpolitik behind the move, it has helped further discomfort the oil bulls and the contagion effect has spread the unease to other sectors among which Wen’s intervention has offered only a partial respite from the downdraught.

Everywhere we look, trend lines and the Mo-crowd’s favourite moving average indicators have been threatened or violated outright and a number of individual commodities, as well as several sub- and comprehensive indices itself, are either a whisker, or an on-close confirmation, away from breaking prominent head-and-shoulders formations and throwing wide the trap–doors creaking ominously below.

Assuming the Greeks do not emerge from their wooden horse and lay waste the Palladion of the Eurozone in the early part of the week, the usual month, quarter, half-year end window dressing might stave off a total capitulation for a few days longer, setting the optimists up nicely for another trial with the NAPM numbers and the US non-farm report before we write again.

Whatever the short term gyrations to be endured, nothing so far has changed our long held view that HII’11 will be a tough one to negotiate as the Austrian imperatives of empowering entrepreneurs and allowing for the full and fair pricing of all goods and service offered for sale continue to be neglected in favour of the currency doctors’ quack nostrums and the collectivists’ fatal conceits.

In the absence of the fundamental political and social shift needed to provide an environment conducive to the sustainable achievement of material progress across the whole range of activities, we are therefore left with a sickly reliance on artificial excitements—whether these occur in the boardroom or on the trading floor.

Unless and until another source of extra monetary crack can be exploited—and, so far, none of the critical quartet of the Fed, the ECB, the BOJ, or the PBoC seem either willing or able to provide one—the easiest direction remains downwards and, while that remains the case, all the vainglory of soon-to-be retired politicians and all the insincere cheerleading of stock touts and asset harvesters will only make limited and transitory headway against the unflagging pull of gravity that grim probability entails.