Masterly inactivity

Before we really get into the detail this week, let us just deal with one simple canard: this idea that if the US Congress does not immediately roll over and allow the Administration to have its head in consuming the capital of the nation at its present, unsustainable rate, the whole house of cards will come crashing down around its members’ ears.

Not least of the reasons for our rejection of this cheap exercise in scaremongering is that the $43 (and not the bruited $85) billion or so which will supposedly be trimmed back in the course of the next fiscal year, should the dreaded ‘Sequester’ actually take place, is no more than the amount of new money the Federal Reserve has pledged to inject into the system each and every month by way of purchases of USTs, for ever and ever, Amen.

It would also be remarkable if the fictional Keynesian ‘multiplier’ – so remarkable in its absence when the government was spending an extra $1 trillion annually with hardly any unequivocally attributable addition to jobs (Solyndra, anyone?) – will now become so magnified in its effects that a trimming of that largesse 1/24 the scale will instantly cause 700, 000 positions to evaporate. Right! What we are being asked to swallow whole is the idea that if government spending slips back by no more than 0.75% of its inordinately large total – a proportion which is actually more like 0.125% of total, economy-wide, annual turnover and which is equivalent to no more than 35-40 cents per head per day – then the Apocalypse will be ushered in forthwith

Well, your author, for one does not believe that the economy – any economy – is THAT fragile. After all, the sum in question is roughly of the order of half the official tally of retail sales of sporting goods. Where Nike goes, there goes America??

Nor is he convinced that the state controls or even monitors its budgets with that degree of accuracy in the first instance. Just think ‘Pentagon’, not to mention ‘black-ops budget’. In that light, $43 billion would be all noise and no signal even it were not a ‘reduction’ in a posited increase rather than an outright cut. Finally, if none of this has assuaged your worries then, by implication, you must believe that we are now locked in to spending over a $1 trillion more than revenues in perpetuity. If so, stop selling your gold, for heaven’s sake, give your assault rifle a quick once-over, and make sure the axle has been greased on your wheelbarrow.

Partly this lack of comprehension is just another example of the strategy of the ‘Big Lie’ as instituted by Bernays, refined by Goebbels, and institutionalized ad nauseam by today’s cradle-to-grave, career-politician spin-doctors. Partly it emanates from the dreadful  pseudo-mathematical juggernaut which is macroeconomics and its intellectually impoverished inability to recognise that its devotees’ cherished time series aggregates are nothing more than a pale, fictional reflection of the joint actions of millions upon millions of disparate individuals, each ceaselessly selecting from their non-ordinal and ever-varying lists of subjective preferences in order to achieve a momentary elevation in their psychic and material condition.

It is bad enough that we routinely forget just how approximate all these numbers are when we apotheosize them to the status of the fundamental laws of nature by which we must ‘govern’ the running of our rigid economic machinery (another pernicious, but all-pervasive metaphor which obscures clear thinking about the functioning of what is really a complex, evolving ecosystem of interpersonal exchange).

But when we then lose sight of the underlying reality itself; when we put effect before cause and come to regard those numbers’ temporal trajectories as an end in themselves, we really begin to do mischief. All anyone can really ask of ’policy’ is that it provide the most conducive institutional conditions under which the average citizen can attempt to satisfy his own unique desires as best he can, and as only he knows how to do. Far from encouraging some Hobbesian, zero-sum hell, such a minarchist approach can only maximise our collective good fortune in that this is something the individual will find extremely hard to effect without contributing something in return to the well-being of the fellows with whom he interacts under a mutually enriching division of labour and subject to a clear and consistent rule of law.

If we, as policymakers, manage to achieve that—or, more realistically, if we refrain from acting in a manner likely to jeopardize it—then, as and when we next take a rough reading of the temperature of all the myriad economic processes currently underway, we may well be pleasantly surprised to see that it is has undergone a modest and entirely wholesome rise. If, however, we construct a spurious mechanics of the nation-at-large and start throwing levers willy-nilly because some statistical fiction or other seems to have had a fleeting numerical correlation with that temperature in the past—and if, moreover, we have already conflated an increase in this one scalar reading into our ultimate end of an improvement of the common weal—even if it should subsequently rise at all, we have no way of knowing whether this is all to the good, or whether this is because the organism is now suffering heatstroke, a fever, or is, indeed, spontaneously self-combusting.

To reiterate; instead of fretting that we have “blundered in the control of a delicate machine”, let us recognise that there is no such construction: that we must not rely on what are essentially static, equilibrium relations between non-existent, top-down concepts to guide our tinkering, but we must learn to deal—and very much at arm’s length!—with a dynamic, non-equilibrium, emergent order, bubbling up from the smallest scale; that what we are dealing with is a process not a pattern—a becoming not a being.

It is therefore not Keynes or Kuznets to whom should be looking, much less the ineffable Krugman, but the shining example of Sir John Cowperthwaite whose enlightened strategy of what he called ‘positive non-interventionism’ in 1960s Hong Kong—coupled with a near blanket ban on the collation of official statistics for fear their provision would tempt men into meddling (“If I let them compute those statistics, they’ll want to use them for planning.’’)—allowed the entrepot to more than quadruple its GDP per capita (it really is a hard habit to break, isn’t it?) in comparison with its colonial masters in dour, socialist Britain, in the space of single generation. 

A man who eschewed tariffs in an era of protection; who abstained from government borrowing at a time when his peers were fast becoming ’all Keynesians now’; who capped income taxes at a modest 15% in an age when the rich were being ‘squeezed until their pips squeaked’; and who resolutely refused all blandishments to shower corporate welfare upon the taipans, Cowperthwaite’s assessment of his own role was nonetheless characteristically modest, once declaring that, as regards his contribution to Hong Kong’s success,

I did very little. All I did was to try to prevent some of the things that might undo it.

Today, when we are plagued with the grossest of governmental interventions, the maddest of monetary manipulations, and the most invidious of attacks on individual wealth, it might serve to reflect upon some of Sir John’s expressed principles. 

On capital controls:

… money comes here and stays here because it can go if it wants to. Try to hedge it around with prohibitions and it would go and we could not stop it and no more would come. 

Re the role of the state vis-à-vis the private sector in production:

…when government gets into a business it tends to make it uneconomic for anyone else.

On what we Austrians would call the great ‘knowledge’ problem—so routinely overlooked by the meddlers in office:

In the long run, the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralized decisions of a government, and certainly the harm is likely to be counteracted faster.

Or this:

For us, a multiplicity of individual decisions by businessmen and industrialists will still, I am convinced, produce a better and wiser result than a single decision by a Government or by a board with its inevitably limited knowledge of the myriad factors involved, and its inflexibility.

And again:

I must confess my distaste for any proposal to use public funds for the support of selected, and thereby, privileged, industrialists, the more particularly if this is to be based on bureaucratic views of what is good and what is bad by way of industrial development. An infant industry, if coddled, tends to remain an infant industry and never grows up or expands. 

Are you listening, Mr Cameron; écoutez-vous, M. Hollande?

 But, setting aside the political philosophy for now, let’s return to the humdrum business of commenting upon that laboratory of central bankers, that Petri dish of those armed with the printing press, that we touchingly refer to as the ‘market’.

Much of the week has been an exercise in Google-translated rune-reading from China’s ongoing ‘Two Meetings’ at which the formal handover of power will be undertaken. Largely monopolized so far by the outgoing crew, we have to wonder whether Wen Jibao’s effusiveness reflects policy as it will be or whether it is simply a wistful, legacy-minded expression of policy as it should have been.

For what it’s worth, there has been plenty of open criticism of the GDP-at-all-costs model and some frank recognition of the scale of the malinvestment already in place. For example, NDRC chairman Zhang Ping candidly admitted that ‘a rising number’ of heavy industries were making losses and ‘lamented’ the overcapacity in steel, aluminium, cement, glass making and coking coal. Plants in these sectors, he said, were running at just 70-75% of capacity, while the once booming solar industry was operating at just 60%. To address their ‘huge difficulties’, Zhang said he was pushing to increase the pace of mergers in these sectors, but also confessed that such an approach has had ‘little success’ in recent years.

The financial flipside to this was made plain by Li Yining, professor at Beijing University, who warned a CPPCC press conference of nothing less than ‘a possible financial collapse caused by over-investment amid the country’s new urbanization wave.’ – you know, the same ’wave’ on which all the CCP’s hopes are being pinned for the coming years. 

In the midst of this, we were treated to the release of the Chinese trade numbers for February which, for reasons of LNY calendar variability, are best combined with those for January when we attempt to gauge the state of play. Intriguingly, imports—not the least imports for number of key commodities, such as copper, iron ore, and oil—were relatively subdued and hence,  in keeping with anaemic showing of neighbouring Korea and Taiwan. But, despite this, exports took a major jump, rising by almost a quarter on the same two months of 2012.

How did that happen? Had China suddenly and dramatically reduced the erstwhile heavy contribution of foreign inputs to its output? Was this a staggered liquidation of product built up in QIV’s hothoused burst of activity? Or was it perhaps an exercise in good, old fashioned, tax and subsidy arbitrage and/or chicanery aimed at evading the current account restrictions?

We ask this because, although they, too, rose in absolute terms, exports bound for the United States—after all, the fastest growing of all the large, net-deficit economies and hence there most likely destination—fell to a modern-era record low share while those to round-trip Hong Kong soared 60% to a new outright and relative share high. At the same time, the country saw record foreign exchange inflows of more than $100 billion—a marked contrast to last year’s hefty drain of hot money. Not coincidentally, this was a period in which the traditional speculative vehicles, the markets for stock and property, both, were on a violent upward tear.

So, were exports—possibly greatly overinvoiced—again being used to wash funds through the somewhat porous capital account barrier, picking up tax rebates along the way? Was this a means to exploit the yen’s twice-in-a-lifetime rate of decline by clandestinely borrowing some of that excess valuation in Abe-san’s fast depreciating currency? We have no way of knowing, of course, but we remain duly suspicious. 

As for Japan itself, the yen’s fall has now matched the peak pace of that of the Sakakibara devaluation which started in the spring of 1995. In the sixteen months prior to that episode, it was the Chinese who had devalued, cutting the nominal yen-yuan cross in half before Mr (Anti)-Yen drove it up again by 80% in the succeeding three-and-a-bit years, and moving the ratio between the pair’s real effective exchange rates 110% higher along the way.

Lest it be lost in the mists of time, such gyrations were heavily implicated in, if not entirely responsible for, the last, least productive phases of the hot-money boom and the ensuing collapse in competiveness and shattering bust of most of the rest of Asia—‘Tiger’ economies and all.

Though technical targets for the Yen can initially be sketched to the Y110 level, a full-blown repeat of the mid-90s experience would take it all the way back to the mid-Y140s. Surely that couldn’t happen again, could it? Could it? It would surely take a heroic exercise of irresponsibility on the part of Kuroda & Crew even to contemplate; something crazy like—oh, let’s say—using derivatives to undermine the Yen.

Notwithstanding our initial lack of enthusiasm for the longer-term effects of the forex move on Japanese business profits and hence, employee and shareholder income, the market has not allowed any such cavil to hinder its rush to cut back on what is a widely-shared and long-entertained underweight position. This past three months, foreign buying of Japanese stock has hit, Y3.6 trillion, levels not seen since early 2007, while margin account balances on domestic exchanges have inflated by two-thirds in three months, jumping from near the lowest mark in 3 1/2 year to hit the highest in 4 1/2.

This has not only done some serious damage to charts of the Nikkei v other indices, but has also pushed it up beyond a grand trend-line in USD drawn off the unrivalled, Xmas 1989 high, the tech bubble peak, and all post-LEH recovery attempts.

Another 15% or so to the overall mid-point (with said trendline as a stop-loss area) is not beyond reasonable expectation, especially since the P/E is no longer in a league of its own (at 21.0 on the Topix v the same on the ASX, 22.8 on the Bovespa, 24.8 on the TAIEX, 37.1 on the KOSPI, 21.1 on the BE500, 18.3 on the FTSE, and 15.3 on the S&P), not to mention the fact that the index dividend yield—at 1.85%—is beyond anything on offer in the JGB market, exceeds any UST of under 9 years’ tenor, any Bund of less than 14 years to run, or any Gilt with less than 8 years remaining to maturity.

That may be crazy, but it’s certainly an accurate reflection of the world in which we live and of the policy intent of our lords and masters.

As for US equities, what is there left to say? Successive new highs are effortlessly being made on a daily basis; record buybacks are taking place (Miller-Modigliani and ESOP rules, OK!); multi-year heaviest mutual fund buying is underway; volatility is the merest whisker off its Crisis Era lows; margin debt is rising as fast as in 2000 and 2007; put-call ratios are depressed; the cumulative A/D stretches into the stratosphere; junk bonds are near yield lows; leveraged loan prices are back at Blue Sky, mid-2007 levels—and now the jobs numbers are giving everyone an all-over warm glow of Recovery-with-a-capital-R. 

The only thing to argue against this is that it’s simply all too good to be true; that it’s a function of the crazed, macroeconomic theorizing of a sixty year-old, wannabe-Oz sitting in an office on 20th St. and Constitution Avenue in Washington, D.C., a man who almost got on the Congressional record last week waspishly telling his interlocutor to quit belly-aching about the income on his aged mother’s savings and to get her into stocks instead.

For all that we are able to surmise that this is just the latest in a long series of bubbles, each one inflated in its turn in the attempt to ward off the reckoning due from the collapse of its lengthening family tree of predecessors, this all-encompassing experiment – not just with our livelihoods but with the wider structure of our very society – shows no signs of being called off. Rather, if anything, it seems it will be intensified in scale and extended in geography, to what ultimate end we can only dimly glimpse in our darkest imaginings. While that assumption holds general sway, the line of least resistance for risk assets is upward, no matter how otherwise groundless their rise.