Archive for July, 2012

What Economic Recovery?

If one was to pay more attention to the mainstream media reports he’d be left confused with such conflicting reporting.  On one side, the economic recovery is just around the corner – and it has been for the past four years – and on the other side the unemployment is still high, consumer price index (CPI) is on the rise, more people on government support, and more bailouts from the Fed to stimulate the economy.  No wonder we keep on electing the same kind of politician; the one with little or no background in macro economics and monetary policy. That is because we really know little, if anything, about economics.

Truth is, with the continued implementation of the current Keynesian economic system a recovery is out of sight.  At the same time it could be very close, so close that within a year or two we could be out of the depression or recession…done, over, kaput.  But the only way to accomplish such a goal is to allow the free market to work, without the Keynesian interventionist approach.

To determine the events in a free market economic system we first need to establish the empirical fact that unregulated markets are not equivalent to chaos.  For example, jungles which are perceived as savage and chaotic environments, do in fact have a universal order.  Nature and animals have found a way to co-exist in a better system than most humans.  When man tries to disrupt the natural flow of life in the jungle through its interventions problems do arise and chaos does set in.  Similar effects are seen in the market economies where man causes economic bubbles through government and central bank imposed interventions.  Then government and central bank try to solve the initially caused problems through more intervention thus causing market dislocations.  Problem is not solved, it is only deferred.  And so we’re faced with a boom/bust business cycle that has been an “accepted evil” for at least a century in the Western world.

What is the Free Market?

In simple terms, the free market is one that is not tampered with, one that is allowed to flow according to the natural law of supply and demand.  The free market is not restricted by burdening laws, rules, regulations, taxation, and tariffs.  It does not entail favoritism to special interest groups.  It does not involve public subsidies, social or corporate welfare.  The free market does not and cannot survive without a sound monetary policy, one in which money is real – not debt as it is now, – and is backed by specie (such as gold).  A sound monetary policy also involves banks lending money they have on deposit without the ability to create credit – which later converts to money – out of thin air.  This is known as a full reserve banking system.

So now that we have defined the basics of a free economy it should be easier to understand what it takes for a real recovery.  But first, let me say that just by adding jobs paid for with public funds is not equivalent to a recovery.  Jobs must derive from a need of real production with the outcome of real production.  For example, a bureaucrat on the government payroll does not translate into productivity.  The bureaucrat’s salary is actually a public debt, one paid for with newly created money that ends up being owed by future generations.  It creates nothing of value but more regulations and intervention in the American business.  There is no shortage of bureaucrats today.  Productivity means creating real goods and services that people and businesses have a need for.  Yes, like what the Chinese and other Asian countries are producing…and like what America was engaged in back during the 1980’s.

The not so known Depression of 1920

Most Americans are familiar with the economic destruction of the 1930’s, the depression that lasted more than a decade.  After the 1929 stock market collapse the two presidents in charge, Hoover and FDR, did everything to save the economy by means of intervention.  The Federal Reserve, which served – and still serves – as the USA’s central bank, used stimulus after stimulus, while debasing the dollar, to get the country out of depression with less than positive results.  No one at the the time, except for Austrian economists, focused on a similar previous stock market crash back in 1920, when Warren Harding did nothing except cut the federal budget.  There were no government stimulation and no Federal Reserve bailouts.  The result was a full recovery in one year.  Failing businesses were allowed to go bankrupt and start fresh in the sectors driven by demand.   The world and the banking system survived despite the deflation that was the needed economic antidote.  Today, we could and should use the example of the economic recovery from the 1920 Depression.  After all, isn’t history the one we’re supposed to learn from?

Finally, if everything else appears too confusing or overwhelming, it’s worth knowing at least some simple basics.

The return to sound money under a gold standard is a necessary instrument of a sound economy.  Fiat money leads to its destruction.

Credit creation out of thin air leads to expansion of money supply.  Such credit ends up in newly created money.  Inflation of the money supply leads to debasement of the dollar.  The currency’s debasement leads to a reduction in the purchasing power of the average man.  The reduction of the purchasing power is equivalent to a lower standard of living.

Booms and busts are the result of the inflationary money policy.  Newly created money induces artificial price increase in various economic sectors.  Without the expansion of bank credit the booms would not reach such high devastating levels.  The correction of a Boom – also known as recession, depression, or downturn – is necessary whether man likes it or not.  The more intervention is applied by the state the bigger the market distortion and the harder the recovery becomes.

Our Western society has been led to believe that man is smarter than nature, that we can create our own rules by overruling and interfering with those of the universe.  The question remains how long and what will it take for us to discover that the market cannot be cheated?

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Defending the Slumlord

Mises Daily: Tuesday, July 17, 2012 by

To many people, the slumlord — alias ghetto landlord and rent gouger — is proof that man can, while still alive, attain a satanic image. Recipient of vile curses, pincushion for needle-bearing tenants with a penchant for voodoo, perceived as exploiter of the downtrodden, the slumlord is surely one of the most hated figures of the day.

The indictment is manifold: he charges unconscionably high rents; he allows his buildings to fall into disrepair; his apartments are painted with cheap lead paint, which poisons babies; and he allows junkies, rapists, and drunks to harass the tenants. The falling plaster, the overflowing garbage, the omnipresent roaches, the leaky plumbing, the roof cave-ins and the fires, are all integral parts of the slumlord’s domain. And the only creatures who thrive in his premises are the rats.

The indictment, highly charged though it is, is spurious. The owner of ghetto housing differs little from any other purveyor of low-cost merchandise. In fact, he is no different from any purveyor of any kind of merchandise. They all charge as much as they can.

First consider the purveyors of cheap, inferior, and secondhand merchandise as a class. One thing above all else stands out about merchandise they buy and sell: it is cheaply built, inferior in quality, or secondhand. A rational person would not expect high quality, exquisite workmanship, or superior new merchandise at bargain rate prices; he would not feel outraged and cheated if bargain rate merchandise proved to have only bargain rate qualities. Our expectations from margarine are not those of butter. We are satisfied with lesser qualities from a used car than from a new car. However, when it comes to housing, especially in the urban setting, people expect, even insist upon, quality housing at bargain prices.

But what of the claim that the slumlord overcharges for his decrepit housing? This is erroneous. Everyone tries to obtain the highest price possible for what he produces, and to pay the lowest price possible for what he buys. Landlords operate this way, as do workers, minority group members, socialists, babysitters, and communal farmers. Even widows and pensioners who save their money for an emergency try to get the highest interest rates possible for their savings.

According to the reasoning that finds slumlords contemptible, all these people must also be condemned. For they “exploit” the people to whom they sell or rent their services and capital in the same way when they try to obtain the highest return possible.

But, of course, they are not contemptible — at least not because of their desire to obtain as high a return as possible from their products and services. And neither are slumlords. Landlords of dilapidated houses are singled out for something that is almost a basic part of human nature — the desire to barter and trade and to get the best possible bargain.

The critics of the slumlord fail to distinguish between the desire to charge high prices, which everyone has, and the ability to do so, which not everyone has. Slumlords are distinct, not because they want to charge high prices, but because they can. The question that is therefore central to the issue — and that critics totally disregard — is why this is so.

What usually stops people from charging inordinately high prices is the competition that arises as soon as the price and profit margin of any given product or service begins to rise. If the price of Frisbees, for example, starts to rise, established manufacturers will expand production, new entrepreneurs will enter the industry, used Frisbees will perhaps be sold in secondhand markets, etc. All these activities tend to counter the original rise in price.

If the price of rental apartments suddenly began to rise because of a sudden housing shortage, similar forces would come into play. New housing would be built by established real estate owners and by new ones who would be drawn into the industry by the price rise. Old housing would tend to be renovated; basements and attics would be pressed into use. All these activities would tend to drive the price of housing down, and cure the housing shortage.

If landlords tried to raise the rents in the absence of a housing shortage, they would find it difficult to keep their apartments rented. For both old and new tenants would be tempted away by the relatively lower rents charged elsewhere.

Even if landlords banded together to raise rents, they would not be able to maintain the rise in the absence of a housing shortage. Such an attempt would be countered by new entrepreneurs, not party to the cartel agreement, who would rush in to meet the demand for lower priced housing. They would buy existing housing and build new housing.

Tenants would, of course, flock to the noncartel housing. Those who remained in the high-price buildings would tend to use less space, either by doubling up or by seeking less space than before. As this occurs it would become more difficult for the cartel landlords to keep their buildings fully rented.

Inevitably, the cartel would break up, as the landlords sought to find and keep tenants in the only way possible: by lowering rents. It is, therefore, specious to claim that landlords charge whatever they please. They charge whatever the market will bear, as does everyone else.

An additional reason for calling the claim unwarranted is that there is, at bottom, no really legitimate sense to the concept of overcharging. “Overcharging” can only mean “charging more than the buyer would like to pay.” But since we would all really like to pay nothing for our dwelling space (or perhaps minus infinity, which would be equivalent to the landlord paying the tenant an infinite amount of money for living in his building), landlords who charge anything at all can be said to be overcharging. Everyone who sells at any price greater than zero can be said to be overcharging, because we would all like to pay nothing (or minus infinity) for what we buy.

Disregarding as spurious the claim that the slumlord overcharges, what of the vision of rats, garbage, falling plaster, etc.? Is the slumlord responsible for these conditions?

Although it is fashionable in the extreme to say “yes,” this will not do. For the problem of slum housing is not really a problem of slums or of housing at all. It is a problem of poverty — a problem for which the landlord cannot be held responsible. And when it is not the result of poverty, it is not a social problem at all.

Slum housing with all its horrors is not a problem when the inhabitants are people who can afford higher quality housing, but prefer to live in slum housing because of the money they can save thereby.

Such a choice might not be a popular one, but other people’s freely made choices that affect only them cannot be classified as a social problem. If that could be done, we would all be in danger of having our most deliberate choices, our most cherished tastes and desires characterized as “social problems” by people whose taste differs from ours.

Slum housing is a problem when the inhabitants live there of necessity — not wishing to remain there, but unable to afford anything better. Their situation is certainly distressing, but the fault does not lie with the landlord. On the contrary, he is providing a necessary service, given the poverty of the tenants.

For proof, consider a law prohibiting the existence of slums, and therefore of slumlords, without making provisions for the slum dwellers in any other way, such as providing decent housing for the poor or an adequate income to buy or rent good housing. The argument is that if the slumlord truly harms the slum dweller, then his elimination, with everything else unchanged, ought to increase the net well-being of the slum tenant.

But the law would not accomplish this. It would greatly harm not only the slumlords but the slum dwellers as well. If anything, it would harm the slum dwellers even more, for the slumlords would lose only one of perhaps many sources of income; the slum dwellers would lose their very homes.

They would be forced to rent more expensive dwelling space, with consequent decreases in the amount of money available for food, medicines, and other necessities. No. The problem is not the slumlord — it is poverty. Only if the slumlord were the cause of poverty could he be legitimately blamed for the evils of slum housing.

Why is it then, if he is no more guilty of underhandedness than other merchants, that the slumlord has been singled out for vilification? After all, those who sell used clothes to Bowery bums are not reviled, even though their wares are inferior, the prices high, and the purchasers poor and helpless. Instead of blaming the merchants, however, we seem to know where the blame lies — in the poverty and hopeless condition of the Bowery bum.

In like manner, people do not blame the owners of junkyards for the poor condition of their wares or the dire straits of their customers. People do not blame the owners of “day-old bakeries” for the staleness of the bread. They realize, instead, that were it not for junkyards and these bakeries, poor people would be in an even worse condition than they are now in.

Although the answer can only be speculative, it would seem that there is a positive relationship between the amount of governmental interference in an economic arena, and the abuse and invective heaped upon the businessmen serving that arena. There have been few laws interfering with the “day-old bakeries” or junkyards, but many in the housing area. The link between government involvement in the housing market and the plight of the slumlord’s public image should, therefore, be pinpointed.

That there is strong and varied government involvement in the housing market cannot be denied. Scatter-site housing projects, “public” housing and urban renewal projects, and zoning ordinances and building codes, are just a few examples. Each of these has created more problems than it has solved. More housing has been destroyed than created, racial tensions have been exacerbated, and neighborhoods and community life have been shattered.

In each case, it seems that the spillover effects of bureaucratic red tape and bungling are visited upon the slumlord. He bears the blame for much of the overcrowding engendered by the urban renewal program. He is blamed for not keeping his buildings up to the standards set forth in unrealistic building codes that, if met, would radically worsen the situation of the slum dweller. Compelling “Cadillac housing” can only harm the inhabitants of “Volkswagen housing.” It puts all housing out of the financial reach of the poor.

Perhaps the most critical link between the government and the disrepute in which the slumlord is held is the rent control law. For rent control legislation changes the usual profit incentives, which put the entrepreneur in the service of his customers, to incentives that make him the direct enemy of his tenant-customers.

Ordinarily the landlord (or any other businessman) earns money by serving the needs of his tenants. If he fails to meet these needs, the tenants will tend to move out. Vacant apartments mean, of course, a loss of income. Advertising, rental agents, repairs, painting, and other conditions involved in re-renting an apartment mean extra expenditures.

In addition, the landlord who fails to meet the needs of the tenants may have to charge lower rents than he otherwise could. As in other businesses, the customer is “always right,” and the merchant ignores this dictum only at his own peril.

But with rent control, the incentive system is turned around. Here the landlord can earn the greatest return not by serving his tenants well, but by mistreating them, by malingering, by refusing to make repairs, by insulting them. When the rents are legally controlled at rates below their market value, the landlord earns the greatest return not by serving his tenants, but by getting rid of them. For then he can replace them with higher-paying non-rent-controlled tenants.

If the incentive system is turned around under rent control, it is the self-selection process through which entry to the landlord “industry” is determined. The types of people attracted to an occupation are influenced by the type of work that must be done in the industry.

If the occupation calls (financially) for service to consumers, one type of landlord will be attracted. If the occupation calls (financially) for harassment of consumers, then quite a different type of landlord will be attracted. In other words, in many cases the reputation of the slumlord as cunning, avaricious, etc., might be well-deserved, but it is the rent control program in the first place that encourages people of this type to become landlords.

If the slumlord were prohibited from lording over slums, and if this prohibition were actively enforced, the welfare of the poor slum dweller would be immeasurably worsened, as we have seen. It is the prohibition of high rents by rent control and similar legislation that causes the deterioration of housing. It is the prohibition of low-quality housing by housing codes and the like that causes landlords to leave the field of housing.

The result is that tenants have fewer choices, and the choices they have are of low quality. If landlords cannot make as much profit in supplying housing to the poor as they can in other endeavors, they will leave the field. Attempts to lower rents and maintain high quality through prohibitions only lower profits and drive slumlords out of the field, leaving poor tenants immeasurably worse off.

It should be remembered that the basic cause of slums is not the slumlord, and that the worst “excesses” of the slumlord are due to governmental programs, especially rent control. The slumlord does make a positive contribution to society; without him, the economy would be worse off. That he continues in his thankless task, amidst all the abuse and vilification, can only be evidence of his basically heroic nature.

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The Real Cost Of Not Owning Gold

By Felix Moreno de la Cova
via GoldMoney

Bloomberg recently published an illustrative slideshow titled “The Real Cost of Owning Gold”.  As usual when dealing with precious metals, in an attitude that is widespread among the mainstream financial press, the tone is dismissive, disdainful and almost mocking of those that advocate ownership of hard assets – and especially gold.

The reasons for this hostility are fairly obvious.  First, ignorance: precious metals have been out of fashion for over 30 years, and financial analysts (average age 35) know little about them.  Most would have came of age, professionally and intellectually speaking, during the early part of the last decade – at a time when gold investors were the crazy-old uncles of the investment world: deemed irrelevant and backward-looking by fashionable opinion.

A large majority of these analysts will have Economics degrees from well-respected universities, where they will have been taught that gold has no role in modern economics. They will then have likely received masters and further financial and accounting qualifications that promote “Modern Portfolio Theory”, and the idea that the investment world starts and ends at splitting money between stocks and bonds – with young investors encouraged to sink most of their capital into stocks, while older wealthier individuals are pushed into the “safety” of bonds.

The second and perhaps most important reason for the press’s antipathy towards gold and precious metals are their advertising incentives. Financial institutions, brokers and the financial press simply do not know how to make money from selling, buying or trading gold. In fact funds spent on gold have little turnover and earn few commissions, especially compared to banks’ favored products. Gold is just too simple. It does not require a PhD to understand, it doesn’t respond to complex valuation models, and it doesn’t generate juicy IPO flow. It just sits there, making portfolio managers and financial advisers almost obsolete.

Thirdly, and it is difficult to gauge how significant this factor really is, there is a positive and fierce dislike of gold for ideological reasons. As Alan Greenspan himself recognized in his famous essay Gold and Economic Freedom, those with a disposition towards deficit spending and Keynesian economics find gold a huge obstacle in pursuing their agenda of wealth redistribution and central planning. This antagonism, even if not always conscious, permeates much mainstream economic opinion on gold and is made explicit in the writings of some prominent opinion leaders.

A common accusation and one that is repeated in the aforementioned slideshow is that gold investors (or savers) are some kind of cult or religion. The juxtaposition is always between “faith” or “belief” in gold, versus “reasonable” investments.  Gold owners are said to suffer from paranoia, or misguided and superstitious “gold fever”.

I would contend that the opposite is true. Knowledge of economic history, understanding of counter-party risk, experience of inflation, awareness of systemic risk and how it affects our interconnected global financial systems and a rational desire to protect wealth from all these factors is what eventually leads many investors to gold.  The irrational faith is that placed in central banks and fiat currency in spite of overwhelming historical precedent.  As James Turk once wrote, it is central banks that are the real barbarous relic, not gold.

The Bloomberg presentation does mention some aspects worth considering, such as insurance, transport, storage and appraisal.  A gold buyer must consider all of these aspects carefully, but no more than the buyer of any other “hard” asset such as a house or a valuable portrait must.  Unlike financial products that are often no more than annotations in an electronic ledger, real stuff needs looking after.  Gold is, however, quite a bit easier to store, transport, assay and insure than most real estate or fine art, and companies like GoldMoney make it even simpler and cheaper.

Other objections are so ridiculous as to hardly warrant a mention, but I do find it comical that Bloomberg should worry about gold holders suffering from “anxiety” any more than holders of any stock. Continue to read.

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