What have the Romans ever done for us?

I very much enjoy reading Izabella Kaminska’s postings at FT’s Alphaville. She provides wonderful insights on what money is and there is a lot to learn from what she writes. Her description of how the banking system creates (different) money from the one issued by central banks is a very good and easy to understand explanation of a complex phenomena that most people (that are supposed to know about this matters) completely ignore. But I often have the feeling she fails to spot the big elephant standing in the middle of the room trumpeting loud for her attention.

Her last post on the Bitcoin series is a good example, she wrote:


Bitcoin may be many things: a cheaper and more efficient payments mechanism, a decentralised form of QE, an extreme way to break through the ZLB, a worthy private substitute for cash, an opportunity to stick it to the man or even a speculative investment opportunity of a lifetime.

What it isn’t, however, is a fair distribution of income.

Why should it? Or better still, is there something that is?

I am not a big fan of Bitcoins. I don’t understand its utility other than for being a means of payment so I don’t understand why it is sought after mainly as a reserve of value. Don’t get me wrong, I understand how the value of something increases once it starts to be used as money (be it gold or cigarettes), but that it is the first and only known use sort of puzzles me. It strikes me as starting to build a house by its roof. A symptom produced by a monetary system that is deeply flawed rather than the actual cure.

The only money creation central banks allowed (outside their own) under their monopoly was that of the banking system. People need money that allows them to satisfy their needs and central bank monopoly prevented the knowledge of how to produce (and distribute) better kinds of money from surfacing. Bear in mind that the internet is probably one of the few places where it is hard for governments to tamper with the creation of money. Internet isn’t necessarily the best solution but it could be the best one available.

When government-issued fiat money no longer satisfies individual’s needs, it is only natural that they turn to something else. The altercoin movement is a truly entrepreneurial process of discovery and satisfaction of people’s needs when it comes to money. The motivation, like always, is profit and off course people stand to lose a lot (and that is why it is only natural that someone invested in Bitcoin grows weary of the looming threat of competitors – what if they made the wrong bet?), but at least they stand to lose their own wealth and there is no danger of losses being socialized.

In any case, if Bitcoins do half of what Kaminska says they do it is a case for asking:

What have the Romans ever done for us?

On Rational Expectations

Today I came across Niels Jensen’s The Absolute Return Letter, via John Mauldin’s weekly newsletter Outside the Box. It is a very interesting piece of work that I definitely recommend everyone reading. You can find it here http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/2013_12_03_OTB.pdf

Jensen argues that QE is a dangerous experiment and I couldn’t agree more. He says that it is inherently deflationary and, although I disagree, I know this is only due to a different definition of inflation. Yet, he starts by telling us that QE was the right call and it was only the extension of this program (QE2, QE3/4 and other non-standard measures) that turned it into something harmful, and this is where I cannot follow his argument. In fact I don’t seem to find one, just a conclusion from what some might consider empirical evidence.

According to Jensen, the first QE prevented the post-Lehman financial meltdown while sustaining economic growth in terms of GDP growth. Again it is not so much that I don’t agree QE managed those things (it seems I am only making it worse for myself) it is that those things are extremely overvalued. To make my point I would have to go through a lengthy, yet hopefully entertaining, process. So I will do that probably tomorrow.

Meanwhile, so I don’t leave you completely empty-handed I will just say something about the “rational expectation hypothesis”. Jenson, again correctly, mentions inflation expectations as an important part of price formation in interest rates (It is very hard not to agree with the man). He argues, or so the hypothesis leads to conclude, economic agents make rational decisions based on expectations, thus when central banks say they will keep interest rates low, economic agents postpone their borrowing decisions.

Far from me to want to imply economic agents act irrationally. If anything, I would defend the opposite: individuals cannot act but rationally. My problem with this hypothesis is that it implies that by acting rationally they would all act the same way, t.i. the “right way”, as if differences in cognition, quality of information, past experience, etc. would not make each agent unique and their responses to the same piece of isolated economic data diverse.

True a central bank stated policy works in a way to try to homogenize interest rate expectations, but one thing is what central bankers aim at and a very different thing is what they achieve. The postponement of borrowing due to the expectation of lower rates in the future would not, in theory, prevent borrowing from taking place. We all know computers go down in price or, alternatively, a new more powerful model comes and replaces the old one for the same price. In reality we do not know this, we have expectations that this will continue to happen in the foreseeable future. Yet everybody would rather achieve their goals sooner than later. Individuals possess a time preference that impels them to act to achieve their goals rather sooner than later. Having a computer today is worth more than having one in the future for people who value it as a means to achieve an end, or as an end in itself. Cheaper computers in the future do not prevent people from buying one today. Some people wait for a better or cheaper model but prices on the current models don’t go down until the arrival of the new model (and its wholesale price) is a near certainty.

To postpone a business opportunity today (that by some reason some seem to believe is ready to happen tomorrow) has an opportunity cost that must be taken into consideration. It has to be lower than the expected benefit accrued by those expected lower interest rates. It is a lot of expecting to do and uncertainty to endure. Some potential investors might be doing just that, but it is probably simpler and more accurate to assume no such business opportunities abound than to believe they are waiting for lower interest rates to be grabbed.

The Funk Soul Brother

The other day I got to see this graph. I’m sorry I cannot say where it comes from but I got it in a e-mail that somebody sent to somebody who, in turn sent to somebody else. Over and over, so I’m afraid I cannot give due credit to the author.

S&P vs Balance sheet

Anyway, I believe the reality it describes is pretty much clear to everybody: ultimately the increase in Fed’s balance sheet is not only sustaining but also driving up equity prices. This is the helicopter theory at its best, the fundamentals behind the rally ever since March 2009.

In reality it is not such a clear cut deal. The Fed began its balance sheet expansion before equity markets did pick up. At first, most investors run for cover and prefered hard currency to uncertain ventures. It is only when they began to trust business as usual would find support that they gradually came back. But, what about now? (The funk soul brotha, right about now…)  Back they are, so how come the FED is not reversing their policy?

The answer is, of course, it can’t. I know there are talks of taper but talking is cheap. What the balance sheet expansion aims at is to make interest rates low enough to make any financial asset an attractive investment, irrespective of how low its productivity is in satisfying human needs. If leveraged the better. There is no turning back. Massive savings are now supporting expensive and hardly profitable capital structures. The largest and less productive of these is called “the government”.

I do not know if this is an intended or non-intended consequence of central bank policy (I suspect the later), but I do know that the only way for governments to keep their promises to creditors, voters and supporters alike is by exacting more resources, a.k.a. wealth, from their subjects in the future. Those wealth producers, in turn, will have less to go around with. Believing the possibility of creating virtually infinite amounts of money (more accurately money substitutes) equates to being able to almost infinitely increase capital is an illusion. It ignores the decreased quality of that specific capital good that is being “produced” in exponential amounts. The rally will continue for as much as the illusion that wealth is being produced is maintained. New ventures backed by promises of future wealth will be issued, while in reality capital is being destroyed/malinvested  throughout the whole process.

Crossing the Rubicon – II

While a new, apparently perpetual, monetary stimulus gives equity markets a semblance of the health they manifestly lack, Japan tries to regain the lead as the world’s most distorted capitalist economy. Bear in mind that this was a place they rightfully owned for much of the 1990s. Back when Americans scornfully though this whole idea of not letting companies sink was oh so Japanese, all those fancy ideas about samurai honour. It could never happen in the US where, of course, no company was too big to fail. Continue reading

On Money

Marinus van Reymerswaele, The Money Changer and His Wife, (1539), Museo del Prado, Madrid

Marinus van Reymerswaele, The Money Changer and His Wife, (1539), Museo del Prado, Madrid

Money is the outcome of a process of entrepreneurial discovery for solutions to the coordination problems of the division of labour: time and space mismatches between production and consumption.