Simplicity and Causality

Friday, 5 December 2008 - 4:22 AM (journal:Daily Journal[2008\12\05+042254734])
Simplicity and Causality

We are living through a time of financial turmoil; what I find startling are the fancy theories "experts" are using to explain the solutions to our current situation. To my mind the fact that we find ourselves in this financial mess was so glaringly obvious to all, not just a few, it was greed that blinded us to believe that the show will carry on. We were all scared to miss the boat in case this time things were different or our neighbours would somehow enjoy more of the largesse than we would. There is a cliché my father taught me that is so apt for the current malaise, "easy come easy go".

Markets have existed in some shape or form alongside man for 1,000's of years. Yes innovation has allowed the pattern of market behaviour to develop in different ways often tricking us into believing this time is different; but the axis on which the wheels of the market turn are the same - supply and demand remain. All that changes is our interpretation or quantification of supply and demand. For those of you who like economic history like I do "The phrase "supply and demand" was first used by James Denham-Steuart (http://en.wikipedia.org/wiki/James_Denham-Steuart) in his Inquiry into the Principles of Political Economy (http://en.wikipedia.org/w/index.php?title=Inquiry_into_the_Principles_of_Political_Economy&action=edit&redlink=1), published in 1767. Adam Smith (http://en.wikipedia.org/wiki/Adam_Smith) used the phrase in his 1776 book The Wealth of Nations (http://en.wikipedia.org/wiki/The_Wealth_of_Nations), and David Ricardo (http://en.wikipedia.org/wiki/David_Ricardo) titled one chapter of his 1817 work Principles of Political Economy and Taxation (http://en.wikipedia.org/wiki/Principles_of_Political_Economy_and_Taxation) "On the Influence of Demand and Supply on Price".

I recently spent some time in the US; sitting on an airplane observing a 20yr old girl next to me feverishly texting as if she were sending an SOS to save the world it dawned on me how far we have strayed from the basics. It is a simple fact of life that you cannot always get what you want (great song). It is not a sin or something to be embarrassed about it is a simple fact. However, financial engineers in all their many disguises would like us to believe that most things are attainable. What a load of rubbish, and we believe it because we want to. Lets face it some of us will earn enough money to buy the $2m house and gas guzzling SUV, but most of us wont. Lets not fall for it will only cost us $10k a month bull when we are only earning $12k.

There is no rocket science we are a society that is living way beyond our means. How can we expect to build lasting wealth when we are consuming more than we have. Adam Smith that famous economist who coined the free market term of the "invisible hand" spent far more time examining mans moral behaviour ("The Theory of Moral Sentiments") than economics as we think of it today as represented by Marshall and Walras's demand and supply curves. What I am saying is that we don't have an economic problem but rather a moral one, TARP or SHMARP are not the answer, the answers are very simple but are we ready to face them?

What has been put on the table by political and business leaders infuriates me, we haven't seen lasting solutions, all we get is political soothsaying and the part that angers me most is that the so called intellectuals have bought this crap. Lets just try and think about this logically. The leaders have all agreed the mess we find ourselves in today is because of a housing and credit bubble, yes this is part of the reason, ok so lets work within this framework. How can the solution be more easy credit via lower interest rates and propping up bad mortgages with government purchases, surely someone must pay for the mistakes?

The equation is very simply "easy come easy go". The perceived wealth we experienced over the last few decades is quickly evaporating and there is nothing we can do about it because there was nothing really there. No government or business can stop the process of easy come easy go it is a law of nature, and until such time as nature has taken its course we are at the mercy of civilization grappling with "fair value".

Is it reasonable to think that the engineers of the problem are likely to be able to fix it? I think not when the tools being used are infected with disease. Ludwig von Mises the great Austrian Economist and his disciples Murry Rothbard and Ron Paul clearly explain that our banking and monetary system are flawed. They in fact go much further and claim we are being extorted by government in a massive fraud. You should all do yourself a favour and buy Congressmen Ron Paul's book "Pillars of Prosperity" for a lucid critique and solution to many of today's problems. Let me simply say that a system that enables a government to create money out of thin air
can only result in an erosion of the value of this money through inflation. Giving government a free reign on the printing press will always lead to the solutions we are currently witnessing whereby more and more money is added magically to the system so that government is able to inflate away the costs of its debt. The system is flawed, the system is corrupt and the system will die.

The many solutions the Fed and Treasury have put to work clearly demonstrate that the powers that be are far from ready to relinquish their grip on society and far from the free market principles the founding fathers of the USA constitution envisaged. We live in a time of increased intervention and government interference. Nobody from government is shouting about what was allowed to develop, it is very hard to shout at oneself. Government and its market interference is to blame for today's financial crisis and until such time as policy makers stop bailing out protagonists and rather step back to allow the market to heal itself we are going to continue to witness booms and busts on the grand scale we are currently experiencing.

You are probably saying to yourself what the hell does this guy know, we have the greatest minds in the world working on a solution. If you are thinking this then you don't get it. The system is the problem and the people telling you they are working on a solution are part of that system so until the system dies there are no solutions only further problems disguised as a way out. This isn't a conspiracy theory, we are currently living in a massive economic experiment and I am sad to say we are the null hypothesis.

I have probably upset most of you with what I have said but the sooner you start accepting that you have to live within ones means and that a consumption society will inevitably self-destruct the sooner will a solution develop to lead us forward. We all know the folklore of the shoe shine boy trading tips at the time of the Great Depression and the hairdresser, etc trading tips during the dot.com bubble well I feel that today we are currently witnessing the same thing in reverse. Everyone has an opinion today on what is going on in the financial crisis. From the cab driver to the au pere. We clearly have a long way to go on the downside with all this market interest. As Robert Prechter says we will know we are near a lasting bottom when stocks and all things economic are reviled. When people want nothing to do with the stock market and fancy schemes. At the moment people are scared and panicked but I have not yet seen disgust. I believe we are years away from a lasting bottom, as the economies continue to misfire due to their band-aid solutions. Inevitably we will see true change. Not the kind of change Barrack Obama has in mind but change of the whole system. There is likely to be unrest with this change and I foresee a surge in civil unrest as people lose hope in a system that has no hope.

If you haven't pressed delete already I am going to throw out one last controversial theory that I believe drives the process of economics. This is not my theory it is Robert Prechter Jnr, and it relates to the causality of economics and the market. We have all been taught that the stock market is forward looking in that it discounts what it forecasts the economy to do in the future. So a falling market using this theory would imply that the market is anticipating a weakening economy. This is what I was taught in university and it is what every mainstream market commentator believes. I would go as far to say that 99.9% of people who have a view on the fundamentals of stock market valuation would believe this link. Prechter turns this theory on its head and explains the causality link as follows: the stock market behaves endogenously based on its participants collective moods and the economy in turn is reflective of this mood expressed in the stock market. So if the market is going down, this reflects a negative mood and the resulting downturn in the economy isn't reflective of a discounting process but more profoundly by the causal link of negative sentiment (pretty neat).

So where are we in this cycle? Clearly the mood is extremely negative and if you are one who believes that the pattern of mood behaviour can be forecast on a probability scale then it is likely that the mood will get far worse. We are starting to see the manifestation in the real economy of this negative mood. For those of you not inclined to patterns but staying with the more esoteric, psychology teaches us that mood operates through feedback loops and both positive and negative inputs have the ability to drive perceptions beyond their underlying reality. This is an extremely foreboding insight into the road ahead.

Comparisons with the Great Depression have thus far been restricted to economic comparisons, if we want to get a real insight into how severe the current financial meltdown is likely to be we need to start comparing the collective mood we are experiencing now and what pervaded society in the lead up to and during the Great Depression. Economics is not about financial engineering and measuring utils, it is about understanding mans moral makeup and the collective psychology of man acting in groups.

Good luck

Michael Berman