Bastiat’s Iceberg: A Sean Corrigan Masterpiece for Christmas

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.

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.

On the Risk Inherent in Entrepreneurship

• Investigating the income statements of companies in the USA Corrigan shows us that three-fifths of the gains of a company go to labour.
• The State takes three quarters of anything left over!
• The Capitalist / Entrepreneurial Class may well end up with 5%.
• He questions why do we do it with a 13/1 chance of not getting anything at all: it is truly remarkable.
• I often ask that myself, especially with the latest tax raises that will hit us under the present scorched-earth driven 50% tax rate policy.

On the Exploitation of Labour (or not, as the case may be)

I am reminded of the teachings of Eugene Von Böhm-Bawerk, the Austrian Minister of Finance and teacher of Ludwig Von Mises, who pointed out in his withering critique of Marx, Capital and Interest, that labour can never be exploited as described by Marx and his socialist followers, as they are paid in advance for the results of their labour.

We should remember the capitalist and the entrepreneur have to wait until the product or service is made, sold and the money banked before we/they get paid! Who is exploiting whom?

On the Importance of Watching Business Outlays

• Sean measures the catastrophic decline in business outlays that IS STILL GOING ON in three of the major economies he is looking at.
• As he says “here we have a powerful gauge of the health, or otherwise , of the economy and one which largely goes unrecognized elsewhere, to boot.” But not, Sean, on this site: we are happy to promote these pearls of wisdom here.

On the Austrian Theory of the Business Cycle and the Yield Curve Oddities

• Following, but building on Garrison, Sean uses some very simple graphics to help you understand how cheap money / credit can fuel boom and bust and how the production sector is the overwhelmingly important sector to watch.
• A flat or inverted yield curve , the empirical observer says is the indication of stress in the economy. Corrigan sees it more as representation of a flood of liquidity and large scale capital over hang.

On Banks Being Able to Grow Their Own Balance Sheets

• As a side note, Sean provides an interesting and correct analysis that bank capital is in-fact “ephemeral.”
• Bank capital can be created ex novo by means of one bank buying the others’ debt and funding the purchase with a newly-increased line of credit, granted to this capital recipient!
• The wonders and mysteries of Alice in Wonderland Banking. And to think our whole financial system is under pinned by this kind of trickery!

On the Relentless Growth of Government

• In the USA, for only three years in the last 100 has the State ever shrunk. This is a reminder to all of us that the task facing the likes of our Shadow Chancellor, George Osborne is a Promethean one.
• I like the introduction of the concept of a “Soft Budget”, the type we only see in the UK nowadays.

On the Preferred Way out of this Mess: Inflation

• “is the default setting, for soft budgets and soft money are often inextricably linked in the destruction of a people’s capital”

On Mises and Hayek, to Deflate or Not to Deflate?

• On this site, we promote the Austrian School Theory of the Business Cycle as does Corrigan. A critic would often say that even if this theory is right, which we hold it is, then you still have no recovery plan.
• Liquidating bad boom-based investments is the key to a quick recovery for sure.
• A deliberate policy of money deflation is so brutal and it can be avoided and should be avoided. Mises was very critical of the British monetary authorities of 1925 for allowing this to happen.
• We on this site, watch the money supply levels via our Actual Money Supply measure and a massive money deflation has taken place already and is still going on at a slower rate with the consequences we see out there in the economy. Corrigan also shows this in his paper.
• 100% reserves would fix that overnight as you could not have a monetary contraction. This is not spelled out by Corrigan, but these are the Austrian recovery solutions.
• A move to a commodity-backed money could also stop that, as it is very difficult to destroy gold, but to destroy bank credit, which functions as money, is as simple as a business paying back its loan and credit not being extended again. Increasing capital ratios is one sure way of causing a money deflation.
• Hayek in his latter day did try to suggest that the flow of money could be stabilized — by for example QE — but that this would just trigger a another boom bust.
• “Alas, this is not the humility shared by today’s central bank chiefs who will try any degree of pecuniary CPR in order to get Lazarus to pick up his bed and walk.” Vintage Corrigan!

On the Woefully Bad Concept of Money Velocity

• The conventional wisdom says that if the velocity of money declines, we should offset this with putting new money in its place. We say it is goods and services for which money exchanges, unless you make more goods and services than before, all you will achieve by off setting this decline is make the price of the given goods more expensive.
• Corrigan points out that with credit, you have just deferred final settlement, so more credit will not in fact lead to more final settlements of real goods and services , it will just postpone as it all needs to come back into money to settle at some point. This is an interesting insight that I will need to think about more.

On the Crowding-out of the Private Sector

• “The evil Banksters won’t lend to us,” cry the small businessmen with whose salvation the banks are supposedly entrusted. Too right! Why go to the effort and expense of performing the diligence on the later monitoring of what amounts to a mere micro-credit compared to one of the surviving Behemoths when there are a host of sour, old positions to be nursed, a plethora of lucrative, new market gambles to be taken, and a torrent of steep yield-curve, zero risk-weighted sovereign paper to absorb, each at almost no charge and what seems like very little risk?”

What more can I say!

This is Corrigan at his best. You find more economic knowledge packed into these pages than you will reading the FT for a year or going to study economics at University.

Great Christmas reading!