Last week marked the 100 Anniversary of the beginning of World War I. That war, which produced over 37 million casualties, not counting the related famines and epidemics that came in the war’s wake, also destroyed the political systems of numerous countries, setting the stage for fascism and communism in Europe. In the United States, and of course also throughout Europe, the war led to paranoia and political repression rarely seen during the previous century, and in the United States, the Wilson administration’s “anti-sedition” efforts led to a large-scale destruction of basic American liberties unmatched even by the Alien and Sedition acts of the eighteenth century.
For Americans especially, the war and the more than 100,000 American war dead gained nothing more than a post-war depression. While some Europeans could at least claim to be fighting against physical invasion, the Americans fought for nothing except to defend some authoritarian regimes from some other authoritarian regimes. The idea that the war had something to do with “democracy” was obviously untrue even at the time, and in retrospect, the claim is all the more ridiculous given the rise of totalitarianism, which was fostered by the Treaty of Versailles.
The deadly effects of the war, the repressive measures enacted by supposedly enlightened regimes, and how the war paved the way for its even bloodier sequel twenty-five years later, have been covered by a number of excellent historians and economists, including Ralph Raico, Robert Higgs, Hunt Tooley, and Murray Rothbard. The war led to revolutions in ideology, public administration, government, and war itself. Few of these changes improved the lives of ordinary people, and most of these changes led to the commodification and cheapening of human life and human freedom.
The revolutionary nature of the war is little disputed today, but rather than focus on the war itself or its aftermath, it may also be helpful to consider what the war relegated to the dustbin of history.
The Economics of the Bourgeois Century
What some historians now call “the bourgeois century” was the ninety-nine years between the Napoleonic Wars and the beginning of the First World War. From 1815 to 1914, there was no major war in Europe and the standard of living increased far beyond anything ever witnessed before as industrialization, mechanization, and the resulting increases in worker productivity spread throughout the continent.
During the middle of the century, free trade became more widespread than ever, with labor and capital enjoying never-before-seen freedom to move across national borders. Throughout much of central and western Europe, no passport was necessary to move between nation states. Indeed, passports and border checkpoints became associated with despotic and backward countries like Russia.
It was during this period that we saw the rise of the Cobdenites (also known as the Manchester liberals) in Britain who, beginning with the Anti-Corn Law League, slowly rolled back the mercantilist rule of the landed nobility who opposed free trade. The rise of the middle classes both economically and politically were buttressed by mass movements of classical liberalism Europe-wide that demanded greater economic freedoms for themselves and fewer tax-funded privileges for the ruling classes.
As free trade spread, and lessened the advantages of controlling foreign colonies, imperialism receded as well, and an international peace movement arose with John Cobden, dubbed “the international man” as one of its celebrities.
At the same time, many luxuries became available to the middle classes, and this was a time when much of what we now take for granted was quite novel. It was during this time that something that might be recognized as “the weekend” became known. For most people it was still just a one-day affair (Sunday), but it was the first time in human history that average people had the ability to not only stop work for a few hours, but to actually spend some money on recreation such as a short trip to the seaside, or shopping, organized sports, or a trip to a museum, play, or other cultural event.
The new economic realities led to major changes in families as well. For the first time, a large number of parents could afford to formally educate their children in schools or with books. More leisure and income also meant that parents could give children individual attention, play games in the home, read books as a family and more. Fewer and fewer children needed to work to help the family maintain a subsistence living. With the economic liberation of children also came much better conditions for women who became far better educated, and became valued for their ability to manage complex tasks such as the education of children, household hygiene (no small matter in a nineteenth century city) twice-a-day food shopping and more. Moreover, men and women began to engage in the odd practice of marrying for reasons of “sentiment and physical attraction” as marrying for financial reasons became less a matter of life and death. Just as leisure on Sundays allowed for more public recreation, leisure time within the family allowed for more “private” recreation as well, which was complimented by marriage manuals, such as those found in France, that reminded men to tend to women’s sexual needs.
The Rise of Imperialism and the Road to World War I
Naturally, sex, family, and an afternoon at the beach struck many conservative politicians and “deep thinkers” as frivolous wastes of time. Family time and leisure was wasted on mere ordinary people when far more “honorable” pursuits such as nation-building, colonial adventurism, and the art of war were being neglected.
Certainly Otto von Bismarck, a great enemy of the liberals, was expressing contempt for such domestic pursuits when he declared his disdain for the Manchester liberals as “Manchester moneybags” who were concerned not with the glory of the nation-state, but with making money.
By the late nineteenth century, bourgeois liberalism was in decline. Assaulted on one side by the Marxists and other socialists, and on the other side by conservatives, nationalists, and imperialists, the great powers of Europe began to sink back into mercantilism, nationalism, and imperialism. The Scramble for Africa was representative of the new imperialism as the European great powers looked ever more aggressively for new colonies. Meanwhile, the British tightened their grip on India while inventing the concentration camp in its efforts to starve the Boers into submission.
In the late nineteenth century, Bismarck was hard at work inventing the welfare state and hammering together Germany into one unified nation-state. By the turn of the century, one of the few remaining liberals, Vilfredo Pareto in Italy, was able to declare that socialism had finally triumphed in Europe.
In the decade before the First World War, The generation of European liberals such as Gustav de Molinari, Cobden, John Bright, Herbert Spencer, Eugen Richter, and others were dead or near death. There were few young, new liberal scholars to replace them.
At the same time, trade barriers abound throughout Europe as the great powers turned to the economics of imperialism characterized by mercantilism, tariffs, border controls, regulation, and militarism.
Europe during the bourgeois century was certainly no utopia. The new cities were filled with disease, pollution, and crime. Medical science had yet to achieve what it would in the twentieth century, and of course, standards of living remained low when compared to today. But even if we consider these problems, which plague many societies even today, the enormous gains made for ordinary people, thanks to industrialization and the rise of free trade, were fostered all the more by the rise of classical liberalism which actively sought to avoid war, political repression, and economic intervention as the means to a more prosperous society.
Indeed, historian Daniel Yergin would come to refer to this period as the time of “the first era of globalization” and to note that “the world economy experienced an era of peace and growth that, in the aftermath of the carnage of World War I, came to be remembered as a golden age.”
Liberalism was already deeply in decline by 1914, but the First World War was perhaps the final nail in the coffin. Following the war, depression followed, and for Europe, this was followed by hyperinflation in many places, political instability, a declining standard of living — and finally — fascism, communism, and war. In the United States, which managed to avoid most of the destruction of the war, prosperity was achieved during the 1920s, only to be lost and followed by fifteen years of depression and war.
One hundred years after the beginning of the end for bourgeois Europe, we are fortunate to be looking on a new classical liberalism, now known as libertarianism, which is not in decline, but instead is making great strides globally in the face of a still-ascendant ideology of interventionism, mercantilism, and war. We can hope that a third world war will not bring it all crashing down.
[Editor's Note: We will keep our readers apprised of developments in the exchange between Paul Krugman and The Cobden Centre regular Ralph Benko.]
Professor Paul Krugman, in his New York Times blog last week, says my most recent column, about him, is “funny and scary.” Last week’s column here inferred that Prof. Krugman is leaving Princeton in quiet disgrace. It drew pretty wide attention.
It also drew over 150 comments. Many commentators merrily berated me. (Comes with the territory.) The column, quite flatteringly, even drew a riposte from Prof. Krugman himself, in hisTimes blog, entitled Fantasies of Personal Destruction:
A correspondent directs me to a piece in Forbes about yours truly that is both funny and scary.
Yep, scurrying away with my tail between my legs, I am, disgraced for policy views shared only by crazy people like the IMF’s chief economist (pdf).
One thing I’ve noticed, though, is how many people on the right are drawn to power fantasies in which liberals aren’t just proved wrong and driven from office, but personally destroyed. Does anyone else remember this bit from the O’Reilly scandal?
“Look at Al Franken, one day he’s going to get a knock on his door and life as he’s known it will change forever,” O’Reilly said. “That day will happen, trust me. . . . Ailes knows very powerful people and this goes all the way to the top.”
And people wonder why I don’t treat all of this as a gentlemanly conversation.
English: Paul Krugman at the 2010 Brooklyn Book Festival. (Photo credit: Wikipedia)
Prof. Krugman’s prestige, and the immense influence provided him by the New York Times, gives his opinions enormous political weight. What he writes has impact in liberal, and Democratic, quarters. Yet he by no means is infallible.
The critique this columnist offered drew on commentaries by figures of real stature. One of these is Niall Ferguson, economic historian, Harvard professor (and Senior Research Fellow of Jesus College, Oxford University, and Senior Fellow at the Hoover Institution, Stanford University). The other commentary came from Paul Volcker who made a disparaging comment fairly interpreted as aimed at Prof. Krugman.
What’s really odd about Prof. Krugman’s Fantasies of Personal Destruction is its abrupt segue into likening my critique to a statement made by someone this columnist never met to someone this columnist never met. What could have motivated this non sequitur?
Perhaps some psychological force is at work? Prof. Krugman, echoing a clever critique by Keynes, himself has invoked Freud as key to understanding proponents of the gold standard. Freud,speculating on subconscious associations between excrement and money, referenced the Babylonian doctrine that “gold is the feces of Hell.” Thus, implies Prof. Krugman, proponents of a gold standard are stuck in an infantile “anal-retentiveness.”
Keynes, perhaps not getting it quite right, alludes to Freud in Auri Sacra Fames(September 1930):
Dr. Freud relates that there are peculiar reasons deep in our subconsciousness why gold in particular should satisfy strong instincts and serve as a symbol.
I’ve been saying for a long time that we aren’t having a rational argument over economic policy, that the inflationista position is driven by politics and psychology rather than anything the other side would recognize as analysis. But this really proves it beyond a shadow of a doubt; if you really want to understand what’s going on here, the Austrian you need to read isn’t Friedrich Hayek or Ludwig von Mises, it’s Sigmund Freud.”
Put aside the demonstrable fact of Prof. Krugman’s consistently sloppy conflation of gold investors and gold standard proponents. Put aside his failure to engage with the arguments of the many gold standard proponents not predicting imminent virulent inflation. (Such as this writer.)
Eruditely ridiculing gold proponents as, well, full of s*** is clever. It likely will tickle those readers who find monkeys flinging poo at each other hilarious. Ridicule is much easier, and cheaper, than grappling with scholarly analyses such as that from the Bank of England which provided, in 2011, Financial Stability Paper No. 13, a genuinely interesting critique of the real world performance of fiduciary currency.
That paper is a rigorous analysis of the empirical performance of the fiduciary Federal Reserve Note standard in comparison to the Bretton Woods gold-exchange standard and the classical gold standard. It does not, at least not explicitly, advocate for either predecessor standard. It simply assesses that the Federal Reserve Note standard in practice has proved substantially worse than its predecessors (and calls for the exploration of a rule-based system). A thoughtful response by Prof. Krugman to this paper would be far more interesting, and edifying, than sly scatological insults.
One of the wittier of the commentators to last week’s column accused me of impudence. Guilty as charged. This writer confesses to having committed, in broad daylight, an act of lèse-majesté against the Great and Imperious Krugman. My critics are right to point out that this columnist is a minor figure. Still, do consider: the counsels of integrity to Pinocchio by the tiny Talking Cricket proved, in the end, well founded. One, also, could wish that more of Prof. Krugman’s defenders would tender more persuasive arguments (say, fact-based) than their many variants of “How dare you!”
In responding to my column Prof. Krugman states that “many people on the right are drawn to power fantasies in which liberals aren’t just proved wrong and driven from office, but personally destroyed.” Given Prof. Krugman’s vilification of his adversaries this could be dismissed as rich with irony. Yet there may be more to say.
Consider Prof. Krugman’s public admission that he does not regularly read that which he presumes to criticize. Prof. Krugman states forthrightly:
Some have asked if there aren’t conservative sites I read regularly. Well, no.
Carefully reading one’s opponents’ arguments is not a requisite in life. Yet critiquing arguments one has not thoroughly assimilated is lazy, louche, intellectually slovenly, and — one might fairly infer — unacceptably beneath the standards of, say, Princeton University.
Prof. Krugman dismisses me as “funny and scary.” My several columns pointing out the errors of fact and unsupportable interpretations in his op-eds had been — and surely again will fall — beneath his notice. Still, inaccurately presenting that which one is criticizing is just bad journalism. Readers should be able to rely on editors to assure that a columnist is shooting straight.
As many of my commentators correctly point out I do not command (nor do I presume to deserve) the elite social status of Prof. Krugman. Yet had Prof. Krugman taken even a moment to aim before he fired he could have discovered a right winger who has offered many respectful words, and, when warranted, praise for Barack Obama,Hillary Clinton, Elizabeth Warren, George Soros, MoveOn.org, and Occupy Wall Street (among others with whom he has disagreements). There’s no agenda of “personal destruction.”
If Prof. Krugman had dug a little deeper he might have discovered that my columns routinely are informed by The New York Review of Books, the New Yorker, theAtlantic Monthly, and, yes, the New York Times, all of which I read regularly, usually with pleasure. He would discover that my use of them is not, by and large, to ridicule but to learn and, when in disagreement, to present their claims fairly and dispute them honestly.
Scary stuff? Prof. Krugman, if you find the words of this extremely minor pixel-stained wretch “scary” … what does that say? Perhaps speaking truth to power is scary … to those with power? Yet let me speak a little truth to the powerful, and indispensable,New York Times.
The Nobel Prize in Economics is one of the greatest laurels bestowed in that field. Should Prof. Krugman be permitted to rest on this laurel? Joseph Pulitzer’s directive still applies: “Put it before them… above all, accurately….”
It is not the purpose of this column to see Paul Krugman driven from his virtual office within the paragovernmental New York Times. This columnist makes only a modest call for the Times to assign an editor to fact check his work and help him refrain from reckless disregard for the truth.
Ralph Benko is senior advisor, economics, for American Principles in Action, in Washington, DC, specializing in the gold standard and advisor to and editor of the Lehrman Institute's The Gold Standard Now. He is editor-in-chief of thesupplyside.blogspot.com. With Charles Kadlec, he is co-author of The 21st Century Gold Standard: For Prosperity, Security, and Liberty available for free download here. Benko and Kadlec are co-editors of the Laissez Faire Books edition of Copernicus's Essay on Money. He also manages the Facebook page The Gold Standard. Follow him on Twitter as TheWebster. | Contact us
23 July 14 | Tags: Essentials, Krugman | Category: Economics, Ethics | Leave a comment
The following text is from the notes I made of a talk that I gave to the “End of The World Club” at the Institute of Economic Affairs on 18 April 2014.
If there is one feature of human society that makes it successful, it is the capacity that human beings have of choosing to satisfy short-term appetites or to defer gratification. This ability to distinguish between short term and long term interests is at the heart of economics.
But why defer consumption? Why save at all?
One reason is the transmission of wealth from one generation to the next. Another is to ensure security in hard times.
A complaint of American academics about French savings in the 19th century is that they were too conservative. Easy for them to say.
The population of France grew more slowly than any other industrialising nation in the 19th century (0.2% per year from 1870 to 1913, compared with 1.1% for Germany and 0.9% for Great Britain). The figures would be even worse if emigration from the British Isles were added to the headcount.
This slower rate of population growth would tend to mean a slower rate of economic growth: smaller local markets, fewer opportunities for mass production. This was well known to be a problem in France. In fact Jean-Baptiste Say was sent to England in 1815 to study the growth of English cities such as Birmingham and its effect on the economy (here in French).
The causes of low investment must surely include political and social instability.
Here are the changes of regime in France during the 19th century: 1800-1804: The Consulate
1804-1814: The Empire
1814: The First Restoration
1814-1815: The Return of Napoleon
1815-1830: The Return of the Restoration
1830-1848: The British Experiment
1848-1851: The Second Republic
1851-1852: The military coup-d’état
1852-1859: The Empire Strikes Back
1860-1870: The Free Trade Experiment (supported by Richard Cobden)
1870-1871: Three sieges of Paris, two civil wars, one foreign occupation
1870-1879: The State Which Dare Not Speak Its Name (retrospectively declared to be a republic)
1879-1914: La Belle Epoque (including the anarchist bombings 1892-1894 and the Dreyfus Affair 1894-1906)
If instability discourages savings, it is remarkable how much there actually was.
Five billion francs in gold, raised by public subscription to pay for the German army of occupation to leave France after the Franco-Prussian War. The amount was supposed to be impossible to pay and designed to provide an excuse for a prolonged German occupation. It was paid in full in two years. 80% of the money (equivalent to over two and half times the national government’s total annual spending, was raised in one day).
What the modern academics decried was that these sorts of sums weren’t invested in industry or agricultural technology. In 1880, French private investments amounted to 7.3 billion Francs, but this was less than half of all investments (48%), versus 52% for government bonds.
You can’t pick up your factory machines and run away from the Uhlans, or the Communards.
Gold was one preferred wealth storage option. It still is in France.
Government bonds were generally considered a good deal: backed by the power of taxation, and, unlike gold, they earned interest.
One constant concern of French governments in the 19th century was the diplomatic isolation enforced by the 1815 Congress of Vienna. Various attempts were made to break this, some successful like the split of Belgium from the Netherlands in 1830, the Crimean War (co-operation with the British), others failed (Napoleon III’s Mexican adventure, the Franco-Prussian War).
By 1882, Germany looked like getting economic and military supremacy in Europe, with an Triple Alliance with Austria-Hungary and Italy. With the British playing neutral, the best bet was to build up Russia.
The first Russian bonds sold in France were in 1867 to finance a railroad. Others followed, notably in 1888. At this point the French government decided on a policy of alliance with Russia and the encouragement of French savers to invest in Russian infrastructure. From 1887 to 1913, 3.5% of the French Gross National Product is invested in Russia alone. This amounted to a quarter of all foreign investment by French private citizens. That’s a savings ratio (14% in external investment alone) we wouldn’t mind seeing in the UK today!
A massive media campaign promoting Russia as a future economic giant (a bit like China in recent years) was pushed by politicians. Meanwhile French banks found they could make enormous amounts of commission from Russian bonds: in this period, the Credit Lyonnais makes 30% of its profits from it’s commission for selling the bonds.
In 1897, the ruble is linked to gold. The French government guarantees its citizens against any default. The Paris Stock Exchange takes listings for, among others: Banque russo-asiatique, la Banque de commerce de Sibérie, les usines Stoll, les Wagons de Petrograd.
The first signs of trouble come in 1905, with the post-Russo-Japanese War revolution. A provisional government announced a default of foreign bonds, but this isn’t reported in the French mainstream media or the French banks that continue to sell (mis-sell?).
During the First World War, the French government issued zero interest bonds to cover the Russian government’s loan repayment, with an agreement to sort out the problem after the war. However, in December 1917, Lenin announced the repudiation of Tsarist debts.
The gold standard was abolished, allowing the debasement of the currency, private citizens were required to turn over their gold for government bonds.
Income tax was introduced (with a top rate of 2%) after the assassination in Sarajevo of the Archduke Ferdinand and his wife.
In 1923, a French parliamentary commission established that 9 billion Francs had effectively been stolen from French savers in the Russian bonds affair. Bribes had been paid to bankers and news outlets to promote the impression of massive economic growth in Russia. Many of the later bonds were merely issued to repay the interest on earlier debt.
For the next 70 years, protest groups attempted to obtain compensation, either from the Russian government or from the French government that had provided “guarantees”. You won’t be surprised to know that some banks managed to sell their bonds to private investors after 1917, having spread false rumours that the Soviets would honour the bonds.
Successive French governments found themselves caught between the requirements of “normal” relations with the USSR and the clamour of dispossessed savers and their relatives.
In November 1996, the post-Soviet Yelstin government agreed a deal to settle the Russian bonds for $400 million. The deal covered less than 10% of the families demanding compensation. Despite this, 316,000 people are thought to have received some compensation, suggesting that over 3 million families were affected by the Russian bonds scandal.
There are similarities with the present day but also significant differences.
First, the role of government guarantees and links with favoured banks, ensuring savers were complacent.
Second the manipulation of economic data by the Russian government, which looks a lot like what’s been happening in China.
Third the fragility of the situation: war can break out. All sorts of assumptions we can make about safe investments go out of the window.
One specifically French response to all this is something I would like to see an academic study of. What changes to consumption and savings would follow from growing up in a family where savings have been wiped out by government action (Russian or one’s own)? If three million people were directly involved, most French people would have known someone who had deferred consumption and been robbed. To what extent does the post-1945 explosion in mass consumption in France reflect a view that deferring consumption is foolish when savings can be stolen with the connivance or lack of concern of one’s own government?
Editor’s Note: This article was previously published in The Amphora Report, Vol 5, 09 May 2014.
“Capitalism is not chiefly an incentive system but an information system.” -George Gilder
“Don’t shoot the messenger” is an old aphorism taken primarily to mean that it is unjust to take out the frustrations of bad news on he who provides it. But there is another reason not to shoot the messenger: News, good or bad, is information, and in a complex economy information, in particular prices, has tremendous value. To suppress or distort the information industry by impeding the ability of messengers to do their jobs would severely damage the economy. As it happens, messengers in the price signals industry are normally referred to as ‘speculators’ and the importance of their economic role increases exponentially with complexity. So don’t shoot the speculator. Embrace them. And if you feel up to it, consider becoming one yourself. How? Read on.
IN ADMIRATION OF SPECULATION
Back in high school my sister had a boyfriend who was quite practical by nature and, by working odd jobs, saved up enough money for the down payment on a 4WD pickup truck before his 18th birthday. It was a powerful truck and as a result he was able to generate additional business doing landscaping and other work requiring off-road equipment transport.
His truck also had a winch, which was of particular use one night in 1982. A severe storm hit, flooding the primary commuting routes north of San Francisco. Hundreds of motorists got stranded in water on roads stretching all the way to the Sonoma County borders. The emergency services did their best but the gridlock severely curtailed their ability to reach many commuters, who ended up spending the night in the cars. Fortunately, it was not particularly cold, and the conditions, while unpleasant, were hardly life-threatening.
As word got round just how bad the situation was, among others, my sister’s boyfriend headed out in his truck and sought out stranded commuters to winch out of the water. Sure, he wanted to help. But he also had payments to make on his truck. And he needed money generally, not being from a wealthy family. So naturally he expected to get paid for his services. What he didn’t expect, at least not at first, was just how much he could get paid.
As he told the story the next day, at first he was charging $10 to winch a car to safety. But as it dawned on him just how much demand there was and how few motorists he could assist-attaching a winch to a car and pulling it to safety could take as long as 20mins-he began to raise his prices in response. $10 became $20. $20 became $50. By midnight, stranded drivers were willing to pay as much as $100 for his assistance (Marin County is a wealthy county so some drivers were not just willing but also able to pay this amount.)
I forget exactly, but I believe he earned nearly $3,000 that night, enough money to pay off the lease on the truck! He was thrilled, my sister was thrilled and my parents were duly impressed. Yet the next day the local papers contained stories disparaging of ‘price-gouging’ by those helping to rescue the stranded commuters, who also noted and complained about the lack of official emergency services.
This struck me as a bit odd. The way my sister’s boyfriend told the story, he thought he was providing a valuable service. At first he was charging very little but as people were obviously willing to pay more, he raised his prices in return. The price discovery went on into the wee hours and reached $100 in the end. Did he plan things that way? Of course he had no idea he would be in the right place, at the right time, to make nearly $3,000 and pay off the lease in one go. But to hear some of the stranded commuters talk as if he was a borderline criminal just didn’t fit.
I didn’t think of it at the time, but as I began the study of economics some years later and learned of the role that speculators play in a market-based economy, I recalled this episode as one that fit the definition rather well. Speculators provide essential price information. Yet their most important role, where they really provide economic value, is not when market conditions are simply ‘normal’-when supply and demand are in line with history-but rather when they help to determine prices for contingent or extreme events, such as capacity constraints. Without sufficient capacity for a rainy day-or a VERY rainy day such as that in 1982-consumers will find at critical times that they can’t get access to essential services at ANY price.
In that rare moment, when prices soar, it might be tempting to shoot the messenger-blame the speculator-but this is unfair. Sometimes they take big risks. Sometimes they take huge losses or reap huge rewards. But regardless, they provide essential price discovery signals that allow capacity to be built that otherwise might not exist.
Consider those who speculate in electricity prices as another example. Electricity demand naturally fluctuates. But electricity providers are normally contractually required to meet even unusually large surges in peak demand. Occasionally, due to weather or other factors, there are extreme spikes in demand and capacity approaches its limit. If there is a tradable market, the price then soars. At the limit of capacity, the last kw/hr goes to the highest bidder, much as at the end of an auction for a unique painting. Such is the process of price discovery.
Absent the unattractive option of inefficient and possibly corrupt central planning, how best to determine how much capacity should be made available? Who is going to finance the infrastructure? Who will assume the risks? Well, as long as there is a speculative market in the future price of electricity, the implied forward price curve provides a reference for determining whether or not it is economically attractive to add to available capacity or not, with capacity being an option, rather than the obligation, to produce power at a given price and point in time.
My sister’s boyfriend’s truck thus represented an undervalued ‘option’ with which to winch cars to safety. Under normal conditions this option had little perceived value. But on the occasion of the flood, it had tremendous value and the option was ‘exercised’ at great profit. Valuing the truck without speculating on the possibility of such a windfall would thus be incorrect. And failing to appreciate the essential role that speculators play in building and maintaining economic capacity generally, for all goods and services, can result in a temptation to shoot the messenger, rather than to get the message.(1)
HOW DO SPECULATORS SURVIVE?
If speculators are the ‘messengers’ of market economies, how are they compensated? Obviously, those who are consistently right generate trading profits. But what of those on the other side who are consistently wrong? How can speculators as a group, right and wrong, make money? And if they can’t, how can they exist at all? (Of course, if they are too big to fail, they can count on getting bailed out. But I’ve already flogged that dead horse in many a report.)
This was once one of the great mysteries of economics, but David Ricardo, Ludwig von Mises and others eventually figured it out. Speculators do more than just speculate, although from their perspective that is what they see. Speculators also provide liquidity for hedgers, that is, those who wish NOT to speculate. And they charge a small implied fee for doing so, in the form of a ‘risk premium’. This risk premium is what keeps them going through the inevitable ups and downs of markets. They assume risks others don’t want to take and are compensated for doing so. In practice, it is impossible to determine precisely what this implied fee is, although economists do have ways to approximate the ‘liquidity risk premium’ that exists in a market.
Hedgers can be those who have a natural exposure to the underlying economic good. Take wheat for example. A highly competent farmer running an efficient farm might want to concentrate full-time on his operations and leave the price risk of wheat to someone else. He can do so by selling his estimated production forward in the futures markets. On the other side, a baked goods business might prefer to focus on their operations too. In principle, the farmer and the baker could deal directly with one another, but this arrangement would give them little flexibility to dynamically adjust hedging positions as estimated wheat production or the demand for bread shifted, for example. With speculators sitting in the middle, the farmer and the baker needn’t waste valuable time seeking out the best counterparty and can easily hedge their risk dynamically. Yes, they will pay a small liquidity risk premium to the speculators by doing so, but advanced economies require a high degree of specialisation and thus the professional speculator is an essential component.
While it is nice to receive a small risk premium in exchange for providing essential price information and liquidity, what speculators most want is to be right. Sadly, pure speculation (ie between speculators themselves, not vis-à-vis hedgers) is a zero sum game. For every ‘right’ speculator there is a ‘wrong’ speculator. While there is an extensive literature regarding why some traders are more successful than others, I will offer a few thoughts.
THE UNWRITTEN ‘RULES’ OF SUCCESSFUL SPECULATION
There are several unwritten rules in speculation, and I would confirm these through my own experience. The first is that it is the rare trader who is right more than 60% of the time, so most successful traders are right within the narrow range of 51-60%. Then there is the second rule, that 20% of traders capture 80% of the available profits. Combining these two rules, what you have is that 20% of traders are correct 51-60% of the time: So 0.2 * 0.5 or 0.6 = 0.10 to 0.12 or 10-12% of all trades initiated are winning trades for winning traders. The remaining 88% are either losing trades or they are winning trades spread thinly amongst the less successful traders.
These numbers should make it clear that successful traders are largely just risk managers: Yes, they succeed in identifying the 10-12% of trades that really matter for profits but they are also wrong 40%+ of the time so they must know how to manage their losses as well as when to prudently take profits on the 10-12% of winning trades.
Internalising this negative skew in trading returns is an essential first step toward becoming a good trader. Just accept that something on the order of 50% of trades are going to go against you, possibly even more. Accept also that only 10-12% of your trades are going to drive your profits. Focus on finding these but keep equal focus on minimising exposure to the other 88-90% of trades that either don’t matter, or that could overwhelm the 10-12%.
At Amphora, we have an investment process that we believe is particularly good at identifying and isolating the most attractive trades in the commodities markets. Sure, we make mistakes, but our investment and risk management processes are designed to keep these mistakes to a minimum. Indeed, we miss out on many potentially winning trades because we are highly selective. So while speculation may have a cavalier reputation of bravado trading, day in and day out, the Amphora process is more patient; an opportunistic tortoise rather than a greedy, rushed hare.
CURRENT OPPORTUNITIES IN THE EQUITIES AND COMMODITIES MARKETS
In my last Report discussing the financial and commodities markets outlook, 2014: A YEAR OF INVESTING DANGEROUSLY, I took the view that the equity market correction (or crash) that I anticipated from spring 2013 was highly likely to occur in 2014, for a variety of reasons (2). While I did not anticipate that the Ukraine crisis would escalate as much as it did, as quickly as it did, thereby causing some concern, I did expect that corporate revenues and profits would increasingly disappoint, as they most certainly have done year to date. This is due in part to weaker-than-expected economic growth, with the drag from excessive inventory growth plainly visible in the Q1 US GDP data. But the news is in fact much worse than that, because labour productivity growth has gone sharply negative due to soaring costs. These costs may or may not be specifically associated with the ‘(Un?)Affordable Care Act’ depending on who you ask, but the fact that productivity has plunged is terrible news for business fixed investment, which is the single most important driver of economic growth over the long-term. While a recession may or may not be getting underway, the outlook is for poor growth regardless, far below what would be required to justify current corporate earnings expectations, as implied by P/Es, CAPEs and other standard valuation measures. For those who must hold an exposure to equities, my key recommendation from that previous Report holds:
[I]t is time to rotate into defensive, deep-value, income-generating shares. These could include, for example, infrastructure, consumer non-discretionary and well-capitalised mining shares, including gold miners. That may seem an odd combination, but it so happens that even well-capitalised miners are trading at distressed levels at present, offering unusually good value.
Turning to the commodities markets, I expressed a preference for ‘defensive’ commodities in the Report (Although I did recommend taking initial profits in coffee). Indeed, basic foodstuffs, in particular grains, have outperformed strongly of late, continuing their rise from the depressed levels reached last year. However, the large degree of such outperformance now warrants some rotation out of grains and into industrial metals, including copper, aluminium, iron and nickel. Yes, these are exposed to the business cycle, which does appear to be rolling over in the US, China, Japan, Australia and most of Asia, but the extreme speculative short positioning and relative cheapness of industrial metals at present makes them an attractive contrarian play.
Precious metals have not underperformed to the same degree and they are normally less volatile in any case, but given the nearly three-year bear market, attractive relative valuations and the potential for a surge in risk-aversion, I would add to precious metals. Silver in particular looks cheap, although gold is highly likely to be the better performer in a risk-off environment. My recommendation would be to favour gold until the equity markets suffer at least a 15-20% correction. At that point, incremental rotation into silver would be sensible, with a more aggressive response should equity markets suffer a substantial 30%+ decline.
Turning to the platinum group metals, palladium is unusually expensive due to Russian supply concerns. While this is entirely reasonable due to the Ukraine crisis, the fact is that near-substitute platinum is much cheaper. And the on-again, off-again strikes at the large platinum mines in South Africa could escalate in a heartbeat, providing ample justification for platinum prices to catch up to palladium. Alternatively, should the Ukraine crisis de-escalate meaningfully, palladium is highly exposed to a sharp downward correction, and I would recommend a strong underweight/short position at present.
(1) Perhaps one reason why many fail to appreciate the essential role that speculators play in a market economy is that mainstream, neo-Keynesian economics treats speculation as mere ‘animal spirits’, to borrow their classic depiction by Keynes himself.
Currently serving as the Chief Investment Officer of a commodities
fund, John was previously Managing Director and Head of the Index Strategies Group at Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, systematic quantitative strategies for global interest rate markets.
A cum laude graduate of Occidental College in California, John holds a Masters Degree in International Finance and Economics from the Fletcher School of Law and Diplomacy, associated with Harvard and Tufts Universities.
Follow John Butler on twitter! @ButlerGoldRevo | Contact us
22 May 14 | Tags: Economics, Enterprise, Keynes, Markets, Risk | Category: Economics, Ethics | Leave a comment
Matt Ridley, in The Times [paywall restricted], considers the political relevance of the values of 19th century Liberals, including Richard Cobden.
Surely wanting government to stay out of the economy should go with wanting government to stay out of society too. They went together in the 19th century, after all. Radical liberals who campaigned against war, colonialism, slavery, politicial patronage and the established church were usually furiously free-market libertarians on economics: people such as Richard Cobden, Harriet Martineau, Herbert Spencer or WE Gladstone.
Cobden, said one of his biographers, “believed in individual liberty and enterprise, in free markets, freedom of opinion and freedom of trade.” But he also was an implacable pacifist and refused a barontcy from a monarch he disapproved of. Nobody would have dreamed of calling him a rightwinger.
Mr Ridley also suggests that these values would be useful for politicians to build a coalition around: people who want the government out of “the boardroom and the bedroom.” That is not a cause that the Cobden Centre has any business getting involved in. But it is nice to see someone noticing the relevance of Cobden’s ideas.
Antoine Clarke was the Economic and Political Adviser to the Finance Minister of the Slovak Republic, and a member of the Slovak Prime Minister’s Policy Unit. | Contact us
31 March 14 | Category: Ethics, Law | 4 comments
What the Bank of England is trying to do is restart the money creation process which dropped us into this mess while keeping expectations of inflation low. It’s an extremely dangerous game, one which Hayek explored in his Nobel lecture: it is a policy which cannot create sustainable prosperity but which may create massive inflation, with all its destructive effects.
Having mostly failed to see this crisis coming before failing to predict even the general pattern of events, senior economists now want more of the medicine which already nearly killed the patient. This may look like madness or stupidity to those of us without a high level of formal education in economics. It is neither. Contemporary economists are trapped in an intellectual prison founded on now-old errors of method and epistemology: the knowledge and simplifications necessary to make their mathematical models work are unavailable and invalid respectively.
As a result, economists and central bankers in particular think it is their task to intervene when the choices and actions of tens of millions of people produce aggregate statistics they, and politicians, don’t like. Massive economic disruption and misallocation of resources — ultimately, human suffering — is the result. Unfortunately, it looks like those few who hold the terrible power of monetary policy are determined to test their ideas to destruction.
Following the UK credit rating downgrade, I gave Newsnight an interview. They chose a couple of sentences in which I pointed out the reality that welfare, health, education and debt interest are about 3/4 of spending on 2012 figures and that they will have to be cut eventually if we are serious about the state living within its means. You can find it at 17:00. If I had been given longer, I would have said those things you can find in this interview with RT:
We have been on a merry-go-round of deficit spending, excruciating taxes, heavy borrowing and easy money for most of 40 years. That merry-go-round is now running down and will stop. Attempts to spin it up through monetary policy are extremely dangerous: they will store up worse trouble for later.
If the Government does not act to end expansionist policy in time by a return to balanced budgets, by ending government borrowing from the commercial banks, by stopping quantitative easing and by letting the market determine the height of interest rates, then it will have chosen the German way of 1923.
I do not doubt that the Government is sincere in its wish to make Britain “open for business” and to deliver greater life chances through reform of the welfare state. I gave some time to the Centre for Social Justice and now I see many of their ideas filtering through to public policy. I support those reforms from both a practical perspective and in view of their moral necessity.
The Prime Minister is correct to talk of the culture we have lost, particularly in respect of private shame. I am put in mind of C S Lewis’ book The Abolition of Man: there is, after all, such a thing as right and wrong. Lewis predicted humanity’s ultimate destiny on the path which embraces subjective morality: a dystopian society in which “we find the whole human race subjected to some individual men, and those individuals subjected to that in themselves which is purely ‘natural’ — to their irrational impulses.”
Some readers will recognise the problem and the dangers but reject the state’s role in finding a solution. However, we do not live in that world where the state is comprehensively rejected. There is a welfare state and it needs reform. The Government is getting on with it, and in the right direction too.
However, what the Government is not addressing is the de-civilising effects of inflation, that is, increasing the money supply.
What is commonly called “inflation” – a rise in the general price level – is an automatic consequence of debasing the currency. And currency debasement has been fierce in our lifetimes: the consequences have been and remain profound.
There is a presentation which, in one form or another, I have given many times. It shows, in a few charts:
How the state has grown inexorably since 1900,
How taxation reached an apparent limit at rather less than the scale of state spending, remaining there since 1971 or thereabouts.
Where our debt projections are heading,
How our money has been debased, particularly since 1971.
By the end of the presentation, I have explained our banking, fiscal and economic crisis. Given that what it shows is a monetary and fiscal catastrophe, people receive it surprisingly well. As far as I can tell, people can handle the truth and they want it.
One of the key slides is a price index from 1750-2003:
The grotesque debasement since 1971 – when Bretton Woods finally collapsed – hides the detail of the nineteenth century on a linear scale, so I include the same chart on a log scale. The log chart shows that, despite a number of crises and fluctuations, a pound in 1900 bought about the same basket of goods as a pound in 1800.
In contrast, money has lost almost all its value since the Second World War.
To appreciate the disruptive nature of inflation in its full extent we must keep in mind that it springs from a violation of the fundamental rules of society. Inflation is what happens when people increase the money supply by fraud, imposition, and breach of contract. Invariably it produces three characteristic consequences: (1) it benefits the perpetrators at the expense of all other money users; (2) it allows the accumulation of debt beyond the level debts could reach on the free market; and (3) it reduces the [purchasing power of money] below the level it would have reached on the free market.
While these three consequences are bad enough, things get much worse once inflation is encouraged and promoted by the state. The government’s fiat makes inflation perennial, and as a result we observe the formation of inflation-specific institutions and habits. Thus fiat inflation leaves a characteristic cultural and spiritual stain on human society
He goes on to write of inflation’s tendency to centralise government, to extend the length of wars, to enable the arbitrary confiscation of property, to institutionalise moral hazard and irresponsibility, to produce a race to the bottom in monetary organisation, to encourage excess credit in corporations and to yoke the population to debt. He explains how “The consequence [of inflation] is despair and the eradication of moral and social standards.”
That all sounds familiar.
Hülsmann’s work is not scripture of course, but neither are his ideas isolated. Consider Ayn Rand:
Whenever destroyers appear among men, they start by destroying money, for money is men’s protection and the base of a moral existence.
It is my firm view that inflation – the debasement of money – was the primary cause of the banking crisis. That inflation was a deliberate policy choice of welfare states. You may recall Eddie George’s remarks in 2007 and now Mervyn King has said, “Of all the many ways of organising banking, the worst is the one we have today.”
Moreover, if Hülsmann, Rand and other scholars including Mises and Hayek are to be believed, then inflation is also a major contributor to the moral and spiritual decline of our country. No amount of welfare reform alone will solve that.
All is not lost however. To return to that log-scale price index, money’s value was substantially more volatile in the first half of the nineteenth century than in the second. In 1844, the Bank Charter Act, Peel’s Act, took from the banks the privilege of extending bank notes in excess of specie (coins of inherent worth). It was recognized that this extension of candy-floss credit un-backed by prior production of real value was a systemic cause of economic and banking crises.
Unfortunately, that Act left the banks unmolested in their ability to create deposits. As our system of money and bank credit has evolved, that loophole, combined with central banking and the socialisation of risk, has delivered us into our present predicament.
It falls to our generation to solve this problem and that is why we established The Cobden Centre.
As Martin Wolf wrote in the Financial Times on 9th November 2010, “The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending.” And then we wonder why house prices have raced out of reach. We wonder why the basement garages in Canary Wharf are full of supercars while what was once our industrial heartland languishes in state dependency.
I admire the Prime Minister and the coming welfare reforms. I will back them gladly. But, until we end inflation as a way to fund the promises of the welfare state, we shall not have done the decent thing. We shall not have established objective morality in banking and in that lifeblood of society: money. Honest money is a prerequisite for social progress and it must be delivered if reform is to succeed.
One of the great discoveries of the 20th century concerns the origins of economic science in the late middle ages in Spain and Italy. Long before Adam Smith wrote, many scholastics from the 14th through the 17th centuries were writing systematic economic theory.
No spot on the planet was as fruitful as the School of Salamanca in Spain. Here was the world center of economic research. The writings by the intellectuals gathered here explained price, value, money and its function, saving, entrepreneurship, inflation, contract and exchange, and so much more – and they closely engaged the modern world that was being born at that time, providing at theory and a rationale for the rise of prosperity.
For me, it was a particularly memorable and moving trip. I took the call informing me that I had been shortlisted for the Wycombe Parliamentary selection procedure, against all expectations, while sitting in the departure lounge at Girona after a week’s skydiving in Empuriabrava. I arrived at the Summit, knowing it was suddenly possible I would be an elected politician within the year.
Moreover, it’s no secret that I am a Christian, so it was reaffirming to discover that classical liberalism can be traced to men of God who developed their theory on the basis of morality, jurisprudence, theology and reason. An early speaker at the Summit was a contemporary Spanish friar whose passion for the poor and whose commitment to liberalism transcended the barriers of language. He knew as I know that the proper formula for widespread prosperity and the improvement of mankind is the doctrine of liberty: peace, equality before the law, freedom from arbitrary government, property and the family. In Cobdenite language, we might call for honest money, free markets, free trade, peace and the classical rule of law.
The Archbishop of Westminster, Vincent Nichols, criticised the Prime Minister’s flagship policy as lacking “teeth”. The archbishop has been one of the most prominent supporters of the Big Society, but he told The Sunday Telegraph that he feared communities hit by the economic downturn would suffer if they did not get support.
The head of the Catholic Church in England and Wales said Catholics were afraid the Coalition was “washing its hands” of its responsibilities to communities and expecting volunteers to fill the gap.
“It is all very well to deliver speeches about the need for greater voluntary activity, but there needs to be some practical solutions,” he said.
The Archbishop asks,
“Has the Conservative part of the Coalition simply seized the economic crisis as an opportunity to push through the unfinished neoliberal agenda of the last Conservative administration? We should not forget the enormous social division that was entailed in this. It signalled the end of a humanist and humane consensus in British society.”
How far the Archbishop has come from the scholastics of Salamanca. Yet the Archbishop is on to something:
“The poorest are taking the biggest hit while at the same time you see huge bank bonuses and profits and this is not right,” he said.
Now we have a point of agreement. We know we have the worst of all possible banking systems – the Governor of the Bank of England has told us so – and one of its effects is to distort the economy into unsustainable patterns thereby unjustly widening wealth inequality, driving the business cycle and precipitating banking crises, such as the one from which we are apparently recovering and at enormous cost to society. It is a statist banking system characterised by government monopoly, central planning, legal privilege and the socialisation of risk.
That very statism is the origin of the injustice the banking system is meting out to the rest of us.
The various doctrines of statism have failed. For those of us who wish to live in an ethical society which benefits all its members, it is time to rediscover that moral tradition of social thinking which began formally in Salamanca. It is time to refine and apply the doctrine of justice, peace, prosperity and fulfilment which is humble about the uses of coercive power and optimistic about the potential of individuals cooperating in society.
It may be true that those who wear the badges of ethical authority reach often for the coercive power of the state, but those of us with an intellectual, moral and practical basis for another way would do well to remember both the origins of our school of thought and the motto of one of our inspirations, Ludwig von Mises:
Do not give in to evil but proceed ever more boldly against it.