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State of Global Markets 2017 - Report

In a Lawless World, Rules STILL Matter

Economics / Economic Theory Jan 08, 2017 - 03:22 PM GMT

By: Andy_Sutton


While economics is a science and should be treated as such, economic forecasting is both a science and an art at the same time. However, anyone can forecast. Just like anyone can forecast the weather. To do so accurately and furthermore to do so frequently is a true talent. We think of it along the lines of the ability to hit a major league fastball; a gift granted to maybe 1 in 500 or a thousand babies each year. Then add to that the ability to hit a major league fastball for an average of .300 over an entire career and we’re talking a few babies in an entire generation.

Economic forecasting is no different. Anyone can take the classes, read the textbooks by all the proper authors, write the research papers, the thesis, and the dissertation, and still muddle around in the dark for the entirety of a career, issuing bum forecast after bum forecast. We would surmise at that point that there might be a problem with the assumptions going into the exercise of forecasting. Think of the scientist who starts conducting chemistry experiments without knowing Boyle’s Law or the Ideal Gas Law, etc. Or maybe has no clue about Avagadro, let alone the number ascribed to him. Your scientist is going to waste a lot of time and produce nothing of value.

Before we go any further, we are NOT forecasters. We are analysts. There is a big difference between the two. While we both delve into ‘forecasting’ in certain strictly limited areas, we don't do macroeconomic forecasting. We look at policy and the state of affairs then apply the laws of economics and analyze what has taken place. From these analyses, we draw conclusions about what would need to happen to maintain a current path or change it.

Why spend so much time talking about this? Surely there is something better to write about in the middle of what has been one of most active political, geopolitical, and geoeconomic time periods in recent memory. The reason is that there are hundreds, maybe thousands, of self-acclaimed ‘forecasters’ who really aren’t forecasting. They’re not even analyzing. They’re saying what they think people want to hear at the time in an effort to make money. We think it is important that you know the difference. Analysis involves the deployment of the scientific method – after all, economics is a science, not a debating society. There are rules and even some formulas. While these rules may not be as well-known as Newton’s laws or Avagadro’s number, they’re just as important because to ignore them means guaranteed failure.

As we prepare to throw out the 2016 calendars and hang up the 2017 versions, we look back on a year where once again, America got away with an awful lot. The day of reckoning was postponed yet again; at least for the majority of us. The sad part about all this is that people have become so conditioned to getting away with it that they think it will go on forever. Like the dotcom bubble. Like the housing bubble. At the time, foolish ‘forecasters’ said these circumstances would continue pretty much forever; many books were written and much money was made, and it was all a lie. Maybe not an intentional one, but a damaging one nonetheless. As we enter 2017, there are even more lies about all manner of things. The laws of economics continue to be ignored. We are often asked how we can say that is so. How can we prove that the laws of economics are being ignored or that there are any laws to begin with? It’s a valid question, considering all the propaganda, fake news, and downright diarrhea of the mouth that goes on 24/7. We thought we’d take this initial installment for 2017 and get into the topic of how we can PROVE there are laws of economics.

1 – Debt is a Two-Way Transaction

There are many ‘rules’ or laws within the field of Economics. One of the biggest reasons there is so much debate about economics and economic principles is because people go into the study of economics with a false set of assumptions. They assume it is not a science, but rather an abstract form of art because that is what they were taught. Once you take away the fact that economics is a science and turn it into an art, the laws and rules become guidelines and are thus open to interpretation. This is where the train goes off the tracks very early in the upbringing of most people.

Debt is a fantastic example of this and that is why we harp on debt so much in this column. There are many falsehoods regarding debt, but the most blatant of these comes from a group of folks – we are not sure what to call them other than misguided – who think that debt equals prosperity. Let us explain. They will tell you that when the USGoverment, for example, borrows money from the Chinese, by accounting function it makes the US richer. They look at the fact that the US just got say $10 billion from an auction of fresh USBonds. So we’re $10 billion richer?

These people, many of whom claim to be accountants, obviously don’t know much about accounting because for the debit in the general fund or whatever account the $10 billion from the Treasury auction went into, there must be a credit somewhere else – under a liability. The very wording makes one wonder if the USGovt didn’t get $20 billion – the accounting terms certainly make it sound that way.

Let’s look at it another way, however, and use a balance sheet, which is a valid accounting instrument. On one side are assets. On the other side are liabilities and owner’s equity. For the balance sheet to be correct, assets = liabilities + equity. Ok, so when the US borrows the $10 billion from China, the $10 billion itself – the cash – shows up as an asset. But there is another half of the equation! The same $10 billion shows up in the liabilities section as well, either under short or long term debt depending on what type of bonds were sold. Performing the two transactions as we described above keeps the balance sheet equal. Assets still equals liabilities + equity because we added $10 billion to each side.

Breaking all this down, that means that at some point the money must be PAID BACK. There is also interest that needs to be paid as well. There are other transactions to deal with the interest in order to keep the balance sheet equal, but the point is that it costs more than $10 billion to borrow $10 billion. So how exactly does the USGovt become ‘richer’ by borrowing the $10 billion – or any amount?  To listen to these unique individuals talk, you’d almost get the idea that they don’t even consider the fact that the money has to be paid back.

Having said all of the above, that doesn’t mean that borrowing money is always a bad thing. If you have a venture you’d like to pursue and you feel you could generate a profit of $10,000 each year after your expenses, taxes, etc. are paid, it would make sense to borrow $50,000 get such a venture started. You’d invest the $50K you borrowed and if you make $10K each year, your Return on Investment (ROI) is a very nice 20%. In a few short years, you’ll be able to pay off the loan and then be able to keep the profit for yourself. We understand this is an oversimplification, but we are trying to make the point that we are not against borrowing – when it makes sense to do so.

What we are against is borrowing and then using the money on projects, toys, or other somesuch that never has a chance of paying for itself. Even that being said, there are some items where we don’t expect a payback in tangible terms. It might be a more comfortable bed for example. It’s not going to pay for itself in dollar terms, but it still adds value.

Put another way, we are against borrowing as a matter of normal everyday living for things we don’t need. The laws of economics state that the money must be paid back – almost always at interest – unless you have a rich uncle perhaps. While we believe most people have the knowledge that debts must be repaid, way too many people are acting like repayment is an optional exercise. The necessity of repayment becomes especially true when you start talking about a nation. It can’t die like an individual and stick it to its creditors.

What nations CAN do, however, is use inflation to devalue the money that they use to pay back their creditors. This is one of the reasons why a growing number of countries are endeavouring to conduct business in units other than the USDollar. This is also why countries such as the BRICs and others are buying large amounts of gold. They understand the laws of economics. They understand how the US (and others) are trying to bend this particular law in order to maintain the illusion that the US is the richest nation on Earth when in fact it is among the poorest. How is such an illusion propagated? It’s very simple – focus on the assets side of the balance sheet and ‘normalize’ the liabilities. Desensitize people with constant reminders of the national debt and pretty soon nobody cares about it so much because it isn’t pleasant. Looking at the plush McMansions, luxury cars and so forth is much more pleasurable and that is where people will place their attention.

We suppose this is a good reason why Economics is often referred to as ‘The Dismal Science’.

2 – More Money Means Higher Prices

This ties very nicely into the first law of economics. By the way, the numbering of the laws does not in any way represent importance. They are all important. This said, one of the ways to try to wiggle out of paying off debts is to inflate the money supply with the idea that the dollars that were borrowed are worth more than the dollars that are being returned to the creditor. Following the law of marginal utility, it is true that each subsequent dollar created has less value than the one created before it, which is true with the global supply of dollars even though we are talking about infinitesimal changes in value. In this case, if the USGovt borrows $10 billion in 1986 and repays it in 2016, the idea is that the same number of dollars are repaid (plus interest), but that the value of the 1986 dollars borrowed is much higher than the value of 2016 dollars paid back.

One might look at the above circumstance and say it’s a great idea since it appears as though the USGovt is essentially getting something for nothing. However, there are consequences. One is price inflation. When the money supply grows, the value of subsequent currency units decreases and therefore more of them are required to purchase a fixed good such as a gallon of milk. When the rate of price inflation exceeds the rate of wage inflation, the consumer suffers a loss. The government also suffers a loss, but the government isn’t nearly as concerned as the consumer because the government has several means of getting however many additional dollars it needs through taxation, even more borrowing, or working in conjunction with the not-so-USFed, creation of additional dollars.

This is why many people are becoming advocates of precious metals as money. Fiat federal reserve notes do not fulfill one of the requirements of a money – they are not a reliable store of wealth. The corrupt central bank’s own websites and other material readily admit this. We’ll use a simple example to illustrate. The last year the US minted silver coins for general circulation was 1964. In that year you could fill the family car with gas for roughly two dollars – paper or silver. Today, even with the price of silver grossly depressed, two Peace Dollars, which are 90% silver, will come pretty close to filling the family car with gas. See how far you get with two paper ‘dollars’. Not even one gallon. The above example can be applied to many other homogenous products from the two time periods and is proof positive that increases in the money supply translate to price inflation. The gallon of gas hasn’t changed much, but it is the fact that the medium used to purchase them has changed – particularly the paper ‘dollar’.

Keep this in mind the next time you hear some politician, ‘economist’, or banker talk about there not being enough inflation – or even worse – that deflation is occurring. Deflation is good for consumers, yet the government and bankers are deathly afraid of it unless it fits into their agenda for a given time period. If you take nothing else away from this article, we hope this point sticks because it tells you whose side these folks are really on. No amount of political tomfoolery can change that fact. However, we must point out that with the rather Draconian laws just passed regarding the press (and sites like ours), we may have a harder time getting the word out to you. Remember, now it is your government who decides what is truth and what is propaganda. Very dangerous.

3 – You Cannot Consume (Spend) Your Way to Prosperity

This is a myth that loosely ties into #1 on our list, but is separate enough to warrant its own discussion. Let us provide you a bit of what the Austrian school has to say about this portion of economics, then provide you with the alternate espoused today by ‘economists’ like Ken Rogoff, Mike Norman, and their narrow-minded brethren. Oh by the way you guys can send us even more emails cursing us out, but remember, we offered you a chance for an open and fair debate where both sides presented their case and the people could decide, but you weren’t interested in that. We will not be bullied. To our readers, we apologize for that bit, however, it is quite nasty down in the trenches of Economics – especially considering it is considered a debating society by most in the field!

Anyway, to our simple Austrian example. We use the man stranded alone on an island because it makes for the perfect illustration. If time and space allow we’ll add additional actors to the equation to show that the laws don’t fall apart when we take our case from the hypothetical to the real. Our poor fellow is stranded and obviously he has certain needs. He has some very basic needs like food, water, and shelter. Think Maslow’s hierarchy. Our fellow isn’t worried about a Lamborghini right now. There are 24 hours in a day. He decides that he’ll work 16 of those hours and sleep 8. So he does this for a time and finds a fresh water supply and various food sources such as berries, fish, and so forth. His 16 hours of work a day provides him with enough sustenance to last that day. He decides that he would be able to better catch fish by crafting some spears from branches and allocates 4 hours of one day to making a half dozen spears. Here we have our first law: Sacrifice equals temporary loss, but long-term gain if used wisely.

Our island fellow finds the next day after making the spears that he is able to catch a day’s worth of fish in an hour instead of the 4 hours he was spending previously. So he sacrificed 4 hours and went a little hungry for one day to save 3 hours for as many days as it takes him to lose or destroy his half dozen spears. Here’s our second law: Sacrifice towards a productive effort yields capital. In our case, the three extra hours a day are the capital. So our fellow now has another choice. He can leisure for those three hours or he can spend them working on something else. He decides he needs some shelter and allocates the three hours saved fishing to constructing a shelter. Notice our fellow is no worse off. He’s still eating the same amount of food and getting the same sleep, but he’s beginning to accumulate tools and shelter.

We could keep this story going for a long time, but the general principle of sacrifice leading to capital formation holds fast. Put in 2017 terms, we make a thousand dollars a week. We decide to save (sacrifice) $100 a week and put it away towards the purchase of an item that will allow us to save either more money or time or some other commodity which is limited to us. We might purchase a tractor/mower with the money we saved and instead of spending 3 hours a week pushing a mower around, we now do it in 45 minutes. It’s the same idea.

However, let’s take it the opposite way now. Our island fellow, after sacrificing and building up capital (time) to dedicate to other projects has accumulated a very nice shelter, found a source of salt for preserving his fish, has an ample supply of firewood for when it is chilly, and has created a drying device for drying fruits for when they are out of season. He has found that instead of spending 16 hours a day working that he can spend 4 hours working just to maintain what he has and enjoy 12 hours of leisure time, then get his 8 hours of sleep. At this point he stops accumulating capital. He stops making progress and goes into a holding pattern. If he does this long enough, he’ll find out that his shelter will fall into disrepair along with all of the other tools he’s cleverly constructed. At this point we’ll add a second actor on the other side of the island who is much more zealous about work than our fellow. Our fellow ends up borrowing items and materials (spending) from the other side of the island and begins to run a tab. He pays enough back to keep the other party lending, but eventually his tab is such that he is back to working 16 hours a day and 12 of those 16 hours are spent paying his creditor. Has he spent his way to prosperity? He has the items he needs, but he’s spending 50% of his entire day just trying to pay down his debt. He has no time to dedicate to forming additional capital of his own. He’s scraping by, eking out a subsistence level of survival while slaving away to pay his creditor.

This is precisely what America (and many other countries) has done. Not too long ago, America had the most capital of anyone in the world. We got it by foregoing consumption (sacrifice), and setting aside the sacrifice as additional capital. We built a superpower on this very simple concept; this law of economics. The Austrian school of economics often gets the credit for this, but the law was always there, way before Bastiat, Rothbard, and von Mises were ever thought of. They were the men who merely elucidated the laws and put them into words and terms we could all understand.

Today, America as a whole sacrifices nothing. We borrow and spend, then call ourselves rich because we are rich with goods. We are also spending ever increasing amounts of our time working to pay off creditors. It has become a way of life. We have forgotten that sacrifice is good because it gives us the capital to do even more, like our fellow on the island. He started out working 16 hours a day and got to the point where he could have worked just 12, but chose to keep working 16 and improve his standard of living. Surely, once his basic needs were met, he could have taken time off and enjoyed leisure and not fallen behind. There is no difference with us today. A little bit of sacrifice and you can put yourself in a position to be able to enjoy some leisure. But the America of today doesn’t want to sacrifice and even worse, must have everything right now, whether it is needed or not.

Our leaders at all levels of government have also engaged in this same self-destructive ‘lifestyle’ if you will. Buy now, pay later. Run deficits, then run them up some more. Many think America will get away with this gross miscarriage of justice because it has the ability to inflate its way out of the debt. We are willing to wager a war will happen before America is let off the hook in such a manner. In fact, we believe that the jobs will come back to America, however, the fruits of the labor will go mostly to our creditors. This may take quite a bit of time to develop, but we believe that is where things are headed. He who has the gold makes the rules and more and more we’re finding that not only don’t we have the gold, we are equipped only with a criminal, corrupt central bank and a military to back up our economic sins.

4 – The Minimum Wage Causes Unemployment, not Prosperity

We wrote on this topic several months ago and are linking that article for your reading list if you haven’t already had a chance to look it over. Since the article focused more on the debate surrounding the question of whether or not America should have a national minimum wage, let’s spend just a bit of time reinforcing the law that price controls are almost never Pareto efficient and usually end up hurting many more actors than they assist. Further, the minimum wage is a price control, meaning that it takes equilibrium – where prices and units demanded are set by the market – right out the window. The state sets the cost of labor. Notice in the states where the minimum wage has been dramatically increased that human workers are being replaced by self-serve kiosk type systems. This is  most prevalent in the fast food business – so far. By our research earlier this year, we found that only 3.9% of the population was actually making the minimum wage. By doubling it or whatever is done based on what the states/feds actually end up doing, many more people will be working for minimum wage. A good portion of those workers won’t be working at all. If a $7.50/hr worker can’t generate $15/hr of value for the business, there is no need to keep that person. Businesses will and are cutting staff in these areas where drastic changes have already been implemented.

Furthermore, drastic jumps in the minimum wage will force some companies to close altogether. We are particularly referring to businesses who fall into the category of having the prices they charge under control of the government, such as utilities and ambulance companies.

Another intended consequence is that a higher minimum wage will drive up prices, which will result in higher sales tax revenue for states and more inflows into hopelessly bankrupt programs such as Social Security and Medicare. Contributions to these programs are wage based. On the flip side, the employees laid off due to the increase in minimum wage won’t be contributing at all anymore. Instead they’ll be on unemployment.

The bottom line on the minimum wage – and we tried to make this point in the article dedicated to the subject – is that these jobs were never intended to be career jobs. Many of us, ourselves both included, began our working careers at fast food restaurants making minimum wage. We weren’t trying to support a family. Neither were the vast majority of our co-workers. There were some who were there for a second income, but between the two of us, we could only come up with one person that we could remember who was trying to run a household off the wages at a fast food restaurant. She had two such jobs and worked around 80 hours a week. Today, that effort would produce an income of around $31,000 – before taxes. Working 80 hours each week, 52 weeks a year. These jobs were never intended to provide the level of income that so many people now need. If the minimum wage is doubled, our 80 hour/week 52 week/year employee will make over 62,000 – IF she is able to keep her jobs.

Graham Mehl is a pseudonym. He currently works for a hedge fund and is responsible for economic forecasting and modeling. He has a graduate degree with honors from The Wharton School of the University of Pennsylvania among his educational achievements. Prior to his current position, he served as an economic research associate for a G7 central bank.

By Andy Sutton

Andy Sutton is the former Chief Market Strategist for Sutton & Associates. While no longer involved in the investment community, Andy continues to perform his own research and acts as a freelance writer, publishing occasional ‘My Two Cents’ articles. Andy also maintains a blog called ‘Extemporania’ at

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