Economics, Art or Science?
Research for Online Investors

by John Dalt

9/28/10

Economics as a course of study surely is a Bachelor of Arts not Science.  How else do we explain the differing views in the “Art” of economics?

Nassim Taleb, the author of Black Swan, was in Canada yesterday.  In a Montreal speech, Taleb said “Obama did exactly the opposite of what should have been done.  He surrounded himself with people who exacerbated the problem…total debt is higher than it was in 2008 and unemployment is worse.”

The National Bureau of Economic Research reported this week that the 2008 recession was the deepest since the Great Depression.  Taleb believes the government should have strengthened the economy by paying down the federal debt rather than balloon the deficit to stimulate growth.

Obama passed the $814 billion stimulus bill and has continued to spend out of the $700 billion TARP fund.  This week he proposed $180 billion in business tax breaks and infrastructure spending to promote job growth.  Total U.S. Federal Government debt now stands at $13.5 TRILLION.

Taleb said “Today there is a dependency on people who have never been able to forecast anything.  What kind of system is insulated from forecasting errors? A system where debts are low and companies are allowed to die young when they are fragile. Companies always end up dying one day anyway.”

In other words, you can make mistakes if you are not in debt, or leveraged too hard.  This lesson is learned by all traders soon in their career, but the government does not understand.  The deleveraging process for the government will be full of pain.

Canada has the lowest debt to GDP ratio in the Group of Seven at 14%, in 2007; the U.S. debt-to-GDP is currently at 40% and will rise to 80% in the next four years according to the International Monetary Fund (IMF).  You can read more about Taleb’s comments on Bloomberg.

The Federal Debt at $13.5 trillion does not include the almost $2 trillion in Quantitative Easing (new money) on the Federal Reserve’s balance sheet.  David Tepper of Appaloosa management makes the argument that Federal Reserve quantitative easing money almost guarantees equities will move higher.  This is founded on a belief that the money makes it into the economy resulting in fatter bottom lines and more liquidity in the equities market.

A new discussion paper on the Federal Reserve’s web-site questions this thesis.  Titled “Money, Reserves and the Transmission of Monetary Policy:  Does the Money Multiplier Exist?”

You can read the missive that is analogous to inspecting one’s navel hair.  The take away is the economists at the Federal Reserve are flummoxed that because of the quantitative easing done by the Federal Reserve; bank reserves are up 2,173% from September 10, 2008 AND bank loans are down 11.4%!  Bank reserves went from $47.3 billion to $1.1 trillion but M2 (bank deposits and money held by consumers) has only increased 11.4%.

Economist’s money multiplier models predict that money growth and bank lending should have moved higher with reserves, thus stimulating economic activity and boosting inflation.

We have discussed multiple times that inflation occurs not because there is more money, but because of the “velocity” of money.  Money hidden under a mattress, or sitting in bank reserves does not create inflation or economic stimulus.  When that money starts chasing goods and services the “velocity” creates inflation.

We wrote on August 10, in Money Flows Part 2 that the effect of the Fed raising short term rates would force banks to make retail loans.  Lowering the long term rates through quantitative easing has the same effect.  It reduces the “interest rate spread” the banks can make buying treasuries.

We live in a muddled world of economic theory.  Many promote a view that serves their political interests.  We know there will be inflation, we just don’t know when or how bad it will be.  We have a video of Jim Rogers from 2008 on the web-site under MarketToday Archive that you really have to watch.  This was before Obama was elected, watch Jim Rogers assassinate the Fed and Timmy Geithner at the New York Fed here.

To the mailbag:
Where are your comments on the Republican plan unveiled last week? No outrage over any specifics? As the old commercial said "where’s the beef" It was just more rhetoric. This country is in trouble. Both parties need their feet held to the fire. We need moderates from both sides.  On Harry Reed, I would love to vote for someone else, but Sharon Angle?— subscriber P.P.

John’s reply:  Could she do worse than Harry Reid?  When will you learn?  Look at every state or municipality that is in financial trouble.  Liberals hold the levers of power.  How long has it been since a conservative was mayor in Detroit?  Sixty years?  How long do you want to live in squalor?  I have not looked at the republican promises or whatever they are.  Don't care, vote for the most conservative candidate available.  The only answer is less government, less interference.  Is Angle more conservative than Reid?  Vote for her, or you deserve what you get.

"Moderate" simply means "I am a socialist too, I just want to get there slower."  Were there any moderates that signed the Declaration of Independence and pledged their life and fortunes?

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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