Some people doodle pictures, but I’m the type who mucks around random bits of historical price data just to see where it goes. For example, I love charts of the Dow Jones Stock index in the 1920s – it me it tells a vivid story of hopes and dreams and pain mixed with desperation. The wild fluctuations in the early 20’s, the solid gains of the mid 20’s then the euphoria and ensuing panic, well.. you know the rest.
A while a go, I came across a quote;
With an ounce of Gold, a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson…
What does a ‘fine suit’ cost today? Well, an ounce of Gold is just short of £700. If you went into Harrods, and asked for a fine suit, would that see you into an Armani or Zegna number? I think so.
So, the maxim seems to ring as true today as it ever did.
So my mind got to thinking – if an ounce of gold seems to buy the same stuff over the centuries as it does today, then it would seem to be a great proxy for true purchasing power.
The problem with looking at historical charts of stock movements, especially if you are trying to learn the lessons of history, is that the picture is muddied by the fact that the unit of account – i.e. money, does not do a very good job. It is rapidly decaying so when you compare over time, it just gives the wrong impression of what is going on.
For example, look at the stock market over the whole of the 70’s, and you think that equities didn’t do too badly. But adjust for inflation, and you soon realize that stocks lost over three quarters of their value in the first half of the 70’s!
So, the idea dawned on me: the price of stocks and shares are only represented in terms of money. What if you priced them in Gold instead of pounds and dollars?
Firstly: what data? Well, I stuck to the UK, and I chose the FTSE all share index. I took the index value for each day, going back a few decades. I then converted them into ounces of gold. The chart gave me a pretty shocking picture.
But then I realised I’d missed something pretty important. Stocks pay dividends. So, I added a 5% annual dividend return, and then reinvested it into my index. Surely that’d make my chart look less ridiculous? Erm, a bit… but not by very much.
What I was left with was a completely different view of history, and some pretty worrying revelations.
Firstly, my chart had nothing to say until the 70’s. This is because until then, money was gold – therefore priced in money or gold – it didn’t make a difference. In essence, the chart had no surprises.
But in the 1970’s, money was cut loose from gold, with some pretty shocking results.
FTSE All Share in terms of in oz of Gold (click to enlarge)
Some salient observations.
1. The mayhem of the early 70’s had some pretty catastrophic consequences for the world, and recovery only came in the 1980’s. From over 12 ounces of gold, down to nearly 1 ounce of gold is a pretty insane move.
2. Real growth took off in the 80’s, but something happened in the mid 90’s – the internet. This was a period of real economic growth, that morphed into a bubble, thanks to some pretty silly policy mistakes by Greenspan et al.
3. What happened in the 00’s? Wasn’t that supposed to be the ‘NICE’ decade? Wasn’t the stock market supposed to have risen back to its peaks?
My answer to this is that the noughties were a period of stagnation, economic misalignment, and we were all swamped by a money fraud.
The authorities were in such a blind funk in 2001, with the overriding perception that we were facing a 1929 style collapse, that they turned on the money gusher, and flooded the whole world with liquidity. This found its way into the greatest worldwide property bubble the world has ever seen.
But… this was not true growth – at least for the Western economies. Sure, great advances were made in some sectors of their economies, but huge misalignments of capital were occurring, and this decade of false signals to producers, but especially to Western consumers, is why we had the economic crisis of 2008.
Look where we stand now. In ruinous debt. Shackled to low interest rates and nervously watching retail sales and property prices. This is a direct consequence of our societies living the high life for ten years, without actually realising we were in decline.
We have been living like cannibals. Hollowing out ourselves out, yet living the high life. And this is all down to a pseudo neo-Keynesian/monetarist aggregate kabala fetish.
I feel a sense of panic looking at this chart, so what is the solution?
I see the panel of economic experts that is the acting industry have latched onto the Tobin tax, now re-branded the ‘Robin Hood Tax’. Never mind that Robin Hood fought against unjust taxes by tyrants: the modern day bogey man is the banker.
Now funny thing is, I do agree with a lot of the sentiment expressed by the morally indignant of Primrose Hill.
Yes, the financial world has grown out of all proportion to the real world
Yes, the rewards for participation in this job seem ludicrously high
Yes, bankers have been bailed out by tax payers and are now furiously spinning the wheels of casino capitalism faster than ever before.
Yes, we should do something about it.
But. Not this.
Firstly, why financial markets are important. The good that these things do is provide a price on the future. They allow us all to insure ourselves against the unknown, whether that be a fixed rate mortgage to buy your house, or a bond issue that allows a company to grow.
Financial markets provide sellers for the shares you want to buy, insurers for risks you want to avoid and lenders when you need to borrow.
Attack the market, and you attack its ability to do this job efficiently. The price will be paid by you.
It is said that the market will absorb the Tobin/Hood/Luvvie tax. Anyone who says this clearly underestimates the ability of a bank to pass on its increased costs. You will either pay directly by higher fees, or indirectly, as the cost of everyday things get more expensive.
And more expensive they will be as the Luvvie tax will infect its way through the whole system. At every stage of production, financial markets are used to quantify and reduce costs. Commodity futures allow manufacturers to fix input costs, freight derivatives allow shippers to control cash flow, forward foreign exchange allows import/export companies to insure against wild market swings, credit insurance allow insurance against default and so on and on.
But surely a tiny transactional tax would pass unnoticed? Well, it may seem tiny, but to many market participants this Luvvie tax will be huge. What people fail to understand is that a regular and competitive price in many instruments come from institutions that are prepared to turn over huge volumes in order to make a net margin often much smaller than the Luvvie tax. In one fell swoop, you make a huge proportion of this trading unprofitable, therefore you take away the ability of the market to provide a price. It’s always the way of ill thought out taxes: unintended consequences. Some arbitrary decision is made, and a myriad of economic activity suddenly becomes futile.
So what? Who needs them? Well, you do. Every time you want to invest in your pension, you will (indirectly) need to buy a bond or some shares. Where do you think the seller comes from? Charity? No, it is the myriad of active traders that act as the buffer between ‘real’ buyers and sellers of these things.
In the end, you will pay by being poorer as a pensioner, by paying more interest on your mortgage and by generally being gouged more by the banks.
And so, we turn to the banks. The true villain of the piece.
The problem with financial markets is that banks are allowed to actively participate in this trading game. It would be less problematic if banks used the markets merely to reduce their risks, but this is not what they do. They see markets as a lucrative opportunity to enhance their profits, and they seize it with both hands.
Why is this bad? Because they punt their customer’s demand deposits. They take the money set aside to pay your gas bill, multiply it up tenfold, then wade onto the casino floor. What allows them to do this with some level of (misplaced) confidence is the myriad of legislative favours, monopoly rights, tax payer protection and political pressure arrayed to support them.
Here at the Cobden Centre, we’ve bleated on time and time again about how fractional reserve banking conjures money out of thin air, but it is worth repeating. You deposit £100 of notes and coin in your current account, and this becomes the property of the bank to do with as they wish. You sign it over to the bank, who lend most of it out. £100 of cash, becomes £197 of purchasing power. Whomever gets £97 loan, deposits it at their bank, and the same happens again and again.
Are you happy that the £100 you think is being safely held aside for your weekly food shopping is being used to fund £1000 of credit default swaps? I thought not.
At the end of the day, what consenting adults do in the privacy of their own bedrooms is of no concern to you. What hedge funds do with their willing clients’ money does not concern anyone but the investor. What pure trading companies do with their retained capital is of no worry to you.
The problem is the banks. An the best way to put a stop to their nefarious influence is not by taxing them and innocent parties. Not by robbing pension funds. Not by forcing you to pay higher fees to manage your financial affairs (as you surely will). No, they way to deal with the problem that banking has become is simple:
On inflation, unemployment, especially desperate youth unemployment, and the stimulus. Consider, in the lows of the first years of the century, there were 2.8 people seeking every job; the ratio is now 6.3.
The Financial Times has an item up about the weight of investor pressure to sell the euro, taking the view, no doubt, that the financial crisis affecting debt-laden Greece could raise the chances of a breakdown in the single currency bloc:
Traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis.
What interests me about this saga are not the specifics of the Greek financial debacle – which is, in my view, a particularly egregious example of fiscal incontinence by that country’s government – but rather what the FT story tells us about the benefits of short-selling.
The practice of shorting, which describes the process of temporarily borrowing a financial instrument such as a currency, selling it and repurchasing it at a cheaper price to pocket a profit, has sometimes been politically attacked. About two years ago, the UK government decided that those wicked investors who had been shorting the securities of banks such as HBOS needed to be warned off. It was if the very idea of seeking to profit by taking a negative view of a stock or bond was “unpatriotic”. In their defence, policymakers might argue that they were trying to prevent frenzied attacks on a company or country, but all too often, attacks on shorting turn out to be a classic case of “kill the messenger”. I hold no great admiration for George Soros, given his political views, but he certainly did the UK a favour, in my view, in shorting the pound in 1992, a process that eventually helped drive the UK out of the European fixed exchange rate system at the time.
Likewise, in the latest example of foreign exchange drama, traders who are shorting the euro are sending out a powerful message: this currency has a great big flaw in it. Can, for example, the relatively big economies of Germany and France be expected to bail out Greece in the way that say, the Federal US government might have to bail out California, a state that has been teetering on the brink of collapse for months? Such a bailout would only raise the question of whether countries doing the bailing out were entitled to have a more direct say about the fiscal policies of a member state.
Healthy Shorting, in any event, is part of a healthy, liquid financial market. Without those who are willing to sell, buyers cannot operate (a point so obvious that I feel a bit embarrassed to have to even mention this on this site). If we want efficient price discovery to work in markets, then it should be possible for operators to profit not just from when a price rises, but when it falls. Shorting can enable financial players to hedge risks.
Of course, part of the issue for those monitoring the markets is that the routes by which an investor can short a stock have multiplied. You don’t have to be a big hedge fund with access to a powerful prime broker such as Morgan Stanley or Deutsche Bank. You can, for example, short a security through derivative-type products such as contracts for difference (CFDs) and spread-betting, both of which are instruments open to the retail investor, given certain constraints. These processes can be accessed online via firms such as IG Index, for example.
So armed with such instruments, traders can express a bearish, as well as bullish, opinion. And the FT story is striking about what the euro bears think. For example, the report says that traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, “amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis”.
Figures from the Chicago Mercantile Exchange, which are often used as a proxy of hedge fund activity, showed investors had increased their positions against the euro to record levels in the week to February 2.
It has been one of the ironies of the financial turmoil that when problems first arose, it was easy for the European nations such as Germany and France to hint that their systems were so much more robust than the approach taken by those cowboy Anglo Saxons. But in truth, EU countries, many of which now have levels of debt that are alarming investors, have big problems. Short-sellers are simply expressing the wider worries that investors have about the viability of the euro and the willingness of euro zone states to operate a sound currency.
Via FT.com, Ofgem urges a shake-up of the energy market,
Sweeping reforms of the UK’s energy market must be brought in urgently to protect energy supplies, reduce greenhouse gas emissions and deliver the £200bn investment needed in the power sector, the energy regulator said on Wednesday.
Ofgem said options for reform would include placing more stringent legal obligations on energy suppliers, and “improved market signals”, which could include a higher price on carbon dioxide emissions. More drastic options could include a centralised renewables market and a central buyer of energy for the whole of the UK.
Which all seems very well, until you realise that this is the fruit of an ideological aversion to the free mutual cooperation of individuals and corporations. Ofgem apparently tell us, “It would mean taking away the market’s role in delivering that investment.”
We need to make our minds up about whether planned or free economies can provide us with the means of our survival and prosperity. History’s answer is clear: planned economies cause misery and then collapse.
I have just accepted an invitation from that great London free market networker, Shane Frith, to address an excellent group he is involved with called Progressive Conservatives.
Not being a Conservative myself (I consider their general disassociation from much that I regard to be progressive and liberal off-putting), the chance to speak to a group professing Progressive Conservatism in the liberal sense greatly excites me.
My talk is scheduled for 22 February 2010 and the current title is ‘Free Market Thoughts on the Political Atmospherics of Money, Banking and Finance’.
This article from Tocqueville Asset Management is a must to read for anyone interested in the role gold plays in the investment portfolio of the public and of the Contrarian. It is simply one of the best articles written on the matter:
Is gold a “bubble” because it has now become popular or is there still worthwhile upside? As a contrarian, it is more difficult to reconcile the metal’s recent popularity with the prospect of future rewards. Is the investment consensus always wrong, or can it be right for extended periods? Does the perceived flood of new investment mean the jig is up?
…
The effect of four digit gold has been magical on investment psychology. Day after day, the financial media publishes glowing reports on the metal’s prospects while never failing to trash the beleaguered U.S. greenback. Hardly a day passes when I do not receive another meticulously researched, solemn tome on the merits of gold written by a market strategist or hedge fund manager. My office has stacks of them, all basically saying the same thing: paper currencies are bad so buy gold. In the parlance of the contrarian, gold is no longer a “thin file” investment idea.
The financial crisis of 2008 has challenged the reputation of the free-market economy in the public imagination in a way that it has not been challenged since the Great Depression. The intellectual consensus after World War II was that markets are unstable and exploitive and thus in need of government action on a variety of fronts to counteract these undesirable characteristics. In the United States, this intellectual consensus did not result in nationalization of industry, but in detailed regulation and heavy government involvement in economic life.
The stagnation of the 1970s reversed this trend of public policy, at least in regard to the related rhetoric. A new sense of reliance on the market’s capabilities and a fear of the government’s overreaching took hold of the public imagination. By the end of the 1980s, communism’s collapse throughout eastern and central Europe and in the former Soviet Union reinforced a sense of intellectual triumph for market- oriented thinking over the demands for government regulation and control. The consensus in favor of the free-market economy proved fleeting, however, as the difficulties of transition, the plight of underdeveloped countries, and the tensions of globalization all came to represent, in the eyes of several pivotal intellectuals, the failings of the free-market system.
With the stock market losing 50 percent of its value over the past year, major banks failing, real estate values collapsing, and unemployment creeping toward dou- ble digits, claims about the superiority of the market economy over government intervention are difficult for many to view with credibility. But this situation arises from previous intellectual failings in the discourse concerning the nature of the market economy, the failings of socialism, the costs of government intervention, and the role of public policy. Simply put, we must always remember that bad economic ideas result in bad public policies, which in turn produce bad economic outcomes. The economist’s role must be to counter the first step and defeat the promulgation of bad economic ideas. Doing so is no easy task given the counterintuitive nature of economic reasoning and the role of vested interests in the development of public policy in democratic systems. But if the economist does not do the job, market corrections may be transformed into economic crises by the implementation of ill- fated government policies, and economic crisis may be transformed into political and economic catastrophe as bad ideas are joined with opportunistic politicians who, in the name of meeting the challenge of the crisis, persuade the public to trade their liberties for the promise of security.
In a time of extreme economic adjustment, it is important to remind everyone how markets in fact work. Falling asset prices, business failures, and reallocations of resources (including workers) evince efficient-market adjustments to changing cir- cumstances as much as the exploitation of profit opportunities and the exhaustion of mutual gains from exchange do. In fact, they are the flip side of one another, just as maximizing profits and minimizing costs are. The market process is a profit and loss system. Prudent economic decisions are rewarded, and imprudent decisions are penalized. The market economy in this regard is indeed a ruthless, unrelenting, and ceaseless process of economic change.
Sean Corrigan of Diapason Commodities Management packs more sound applied economics into this report than ever: Toby Baxendale provides a commentary. This is a great Christmas read for us all: download the report here.
Bastiat's Iceberg
On the Errors of GDP Accounting
For the USA economy, Corrigan shows the utter futility of using the conventional GDP measure. The same applies for any of the OECD countries who use the same measure.
Business spending in 2006 in the USA was $31 trillion vs a GDP of $13.4 trillion.
Businesses were spending $4.30 for every $1 spend on personal consumption.
Policy makers from around the world, if any of you are reading this article, please take note of the significance of this fact!
This focuses on something that all Austrian economists know: the desire by the mainstream economists is not to double-count. In the end, they do not count much at all!
As a catering fish monger myself, I buy fish off farms, boats and auctions around the world. I cut and prepare the fish and send it to my customers, the hotels and restaurants of the UK. Yet none of my spending exists in the GDP figures! My wealth and that of my suppliers does not exist as far as the authorities are concerned. I only wish that I could get the tax man to take this view like his economist colleagues in the Revenue Department!
I had this discussion with a member of the MPC some months ago: how if my salmon was bought at the fish farm for £1 per kg and we put a £1 mark-up on after cutting it up and the end user put a £1 mark up on, it is double counting as far as he was concerned. He reasoned that to count all of the stages of production when it only finally gets sold for £3 would be an overstatement as the price of the inputs is in the final price of £3. They miss out the significance that I and my supplier have our profit to the spend in the wider economy after we have spent our companies’ resources on continuing investment and consumption. This is all real activity! This is the danger of having statisticians running the economy.
All that matters, we are told, is that GDP is composed of 70% of final consumption expenditure. In reality, the final consumption element is more like a quarter of real GDP, once the production sector is included.
As I have always said, the health of the production sector is driven by its ability to invest in replacement capital to make more efficient production techniques, to supply more goods and services to people at better prices and with better service levels. This is the essence of entrepreneurship, the essence of wealth creation and the essence of the recovery: magic tricks perpetrated by the economic witch doctors, who wish to pursue a policy of QE or similar, will only consume capital and not replace it with some better means of production.
This is a great news report from Zimbabwe via Al Jazeeera. It examines the ‘fantastic returns’ on the Zimbabwe stock exchange – and how traders are becoming ‘paper millionaires’. ‘Traders are astounded by the performance’. ‘Stock soar despite inflation’. I kid ye not.
