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How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge
A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.
China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.
Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.
We will explain why below.
First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created out of thin air.
For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.
One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”
We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.
Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)
Just what are CCFDs?
The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.
As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.
While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:
the volume of physical inventories that is involved
commodity prices
the number of circulations
A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.
As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:
- China is heavily reliant on the seaborne market for the commodity
- the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
- the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
- the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.
Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.
Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.
Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.
In detail, Chinese gold financing deals includes four steps:
- onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
- offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
- onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
- repeat step 1-3
This is shown in the chart below:
As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.
Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.
However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”
Recall the flowchart for copper funding deals:
- Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
- Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
- Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
- Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.
In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!
Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:
We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .
Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!
Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:
- the China and ex-China interest rate differential (the primary source of revenue),
- CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
- the cost of commodity storage (a cost),
- the commodity market spread (the spread is the difference between the futures
- China’s capital controls remain in place (otherwise CCFD would not be necessary).
All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).
Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.
* * *
That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.
The answer is simple: the gold paper market.
And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.
Now we know for a fact. To wit from Goldman:
From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .
Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.
We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.
And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime. and not to mention market regulators themselves.
Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.
* * *
This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.
In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for. This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.
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How China Imported A Record $70 Billion In Physical Gold Without Sending The Price Of Gold Soaring | Zero Hedge
A little over a month ago, we reported that following a year of record-shattering imports, China finally surpassed India as the world’s largest importer of physical gold. This was hardly a surprise to anyone who has been following our coverage of the ravenous demand for gold out of China, starting in September 2011, and tracing it all the way to the present.
China’s apetite for physical gold, which is further shown below focusing just on 2012 and 2013, has been estimated by Goldman to amount to over $70 billion in bilateral trade between just Hong Kong and China alone.
Yet while China’s gold demand is acutely familiar one question that few have answered is just what is China doing with all this physical gold, aside from filling massive brand new gold vaults of course. And a far more important question: how does China’s relentless buying of physical not send the price of gold into the stratosphere.
We will explain why below.
First, let’s answer the question what purpose does gold serve in China’s credit bubble “Minsky Moment” economy, where as we showed previously, in just the fourth quarter, some $1 trillion in bank assets (mostly NPLs and shadow loans) were created out of thin air.
For the answer, we have to go back to our post from May of 2013 “The Bronze Swan Arrives: Is The End Of Copper Financing China’s “Lehman Event”?“, in which we explained how China uses commodity financing deals to mask the flow of “hot money”, or the one force that has been pushing the Chinese Yuan ever higher, forcing the PBOC to not only expand the USDCNY trading band to 2% recently, but to send the currency tumbling in an attempt to reverse said hot money flows.
One thing deserves special notice: in 2013 the market focus fell almost exclusively on copper’s role as a core intermediary in China Funding Deals, which subsequently was “diluted” into various other commodities after China’s SAFE attempted a crack down on copper funding, which only released other commodities out of the Funding Deal woodwork. We discussed precisely this last week in “What Is The Common Theme: Iron Ore, Soybeans, Palm Oil, Rubber, Zinc, Aluminum, Gold, Copper, And Nickel?”
We emphasize the word “gold” in the previous sentence because it is what the rest of this article is about.
Let’s step back for a minute for the benefit of those 99.9% of financial pundits not intimate with the highly complex concept of China Commodity Funding Deals (CCFDs), and start with a simple enough question, (and answer.)
Just what are CCFDs?
The simple answer: a highly elaborate, if necessarily so, way to bypass official channels (i.e., all those items which comprise China’s current account calculation), and using “shadow” pathways, to arbitrage the rate differential between China and the US.
As Goldman explains, there are many ways to bring hot money into China. Commodity financing deals, overinvoicing exports, and the black market are the three main channels. While it is extremely hard to estimate the relative share of each channel in facilitating the hot money inflows, one can attempt to “ballpark” the total notional amount of low cost foreign capital that has been brought into China via commodity financing deals.
While commodity financing deals are very complicated, the general idea is that arbitrageurs borrow short-term FX loans from onshore banks in the form of LC (letter of credit) to import commodities and then re-export the warrants (a document issued by logistic companies which represent the ownership of the underlying asset) to bring in the low cost foreign capital (hot money) and then circulate the whole process several times per year. As a result, the total outstanding FX loans associated with these commodity financing deals is determined by:
the volume of physical inventories that is involved
commodity prices
the number of circulations
A “simple” schematic involving a copper CCFDs saw shown here nearly a year ago, and was summarized as follows.
As we reported previously citing Goldman data, the commodities that are involved in the financing deals include copper, iron ore, and to a lesser extent, nickel, zinc, aluminum, soybean, palm oil, rubber and, of course, gold. Below are the desired features of the underlying commodity:
- China is heavily reliant on the seaborne market for the commodity
- the commodity has relatively high value-to-density ratio so that the storage fee and transportation cost are relatively low
- the commodity has a long shelf life, so that the underlying value of the commodity will not depreciate significantly during the financing deal period
- the commodity has a very liquid paper market (future/forward/swap) in order to enable effective commodity price risk hedging.
Here we finally come to the topic of gold because gold is an obvious candidate for commodity financing deals, given it has a high value-to-density ratio, a well-developed paper market and very long “shelf life.” Curiously iron ore is not as suitable, based on most of these metrics, and yet according to recent press reports seeking to justify the record inventories of iron ore at Chinese ports, it is precisely CCFDs that have sent physical demand for iron through the proverbial (warehouse) roof.
Gold, on the other hand, is far less discussed in the mainstream press in the context of CCFDs and yet it is precisely its role in facilitating hot money flows, perhaps far more so than copper and even iron ore combined, that is so critical for China, and explains the record amount of physical gold imports by China in the past three years.
Chinese gold financing deals are processed in a different way compared with copper financing deals, though both are aimed at facilitating low cost foreign capital inflow to China. Specifically, gold financing deals involve the physical import of gold and export of gold semi-fabricated products to bring the FX into China; as a result, China’s trade data does reflect, at least partially, the scale of China gold financing deals. In contrast, Chinese copper financing deals do not need to physically move the physical copper in and out of China as explained last year so it is not shown in trade data published by China customs.
In detail, Chinese gold financing deals includes four steps:
- onshore gold manufacturers pay LCs to offshore7 subsidiaries and import gold from bonded warehouses or Hong Kong to mainland China – inflating import numbers
- offshore subsidiaries borrow USD from offshore banks via collaterizing LCs they received
- onshore manufacturers get paid by USD from offshore subsidiaries and export the gold semi-fabricated products to bonded warehouses – inflating export numbers
- repeat step 1-3
This is shown in the chart below:
As shown above, gold financing deals should theoretically inflate China’s import and export numbers by roughly the same size. For imports, they inflate China’s total physical gold imports, but inflate exports that are mainly related to gold products, such as gold foils, plates and jewelry. Sure enough, the value of China’s imports of gold from Hong Kong has risen more than 10 fold since 2009 to roughly US$70bn by the end of 2013 while exports of gold and other products have increased by roughly the same amount (shown below). This is in line with the implication of the flow chart on Chinese gold financing deals: the deals inflate both imports and exports by roughly equal size.
Given this, that the rapid growth of the market size of gold trading between China and Hong Kong created from 2009 (less than US$5bn) to 2013 (roughly US$70bn) is most likely driven by gold financing deals.
However, a larger question remains unknown, namely that as Goldman observes, “we don’t know how many tons of physical gold are used in the deals since we don’t know the number of circulations, though we believe it is much higher than that for copper financing deals.”
Recall the flowchart for copper funding deals:
- Step 1) offshore trader A sells warrant of bonded copper (copper in China’s bonded warehouse that is exempted from VAT payment before customs declaration) or inbound copper (i.e. copper on ship in transit to bonded) to onshore party B at price X (i.e. B imports copper from A), and A is paid USD LC, issued by onshore bank D. The LC issuance is a key step that SAFE’s new policies target.
- Step 2) onshore entity B sells and re-exports the copper by sending the warrant documentation (not the physical copper which stays in bonded warehouse ‘offshore’) to the offshore subsidiary C (N.B. B owns C), and C pays B USD or CNH cash (CNH = offshore CNY). Using the cash from C, B gets bank D to convert the USD or CNH into onshore CNY, and trader B can then use CNY as it sees fit.
- Step 3) Offshore subsidiary C sells the warrant back to A (again, no move in physical copper which stays in bonded warehouse ‘offshore’), and A pays C USD or CNH cash with a price of X minus $10-20/t, i.e. a discount to the price sold by A to B in Step 1.
- Step 4) Repeat Step 1-Step 3 as many times as possible, during the period of LC (usually 6 months, with range of 3-12 months). This could be 10-30 times over the course of the 6 month LC, with the limitation being the amount of time it takes to clear the paperwork. In this way, the total notional LCs issued over a particular tonne of bonded or inbound copper over the course of a year would be 10-30 times the value of the physical copper involved, depending on the LC duration.
In other words, the only limit on the amount of leverage, aka rehypothecation of copper, was limited only by letter of credit logistics (i.e. corrupt bank back office administrator efficiency), as there was absolutely no regulatory oversight and limitation on how many times the underlying commodity can be recirculated in a CCFD…. And gold is orders of magnitude higher!
Despite the uncertainty surrounding the actual leverage and recirculation of the physical, Goldman has made the following estimation:
We estimate, albeit roughly, that there are c.US$81-160 bn worth of outstanding FX loans associated with commodity financing deals – with the share of each commodity shown in Exhibit 23. To put it into context, the commodity-related outstanding FX borrowings are roughly 31% of China’s short-term FX loans (duration less than 1 year) .
Putting the estimated role of gold in China’s primary hot money influx pathway, at $60 billion notional, it is nearly three time greater than the well-known Copper Funding Deals, and higher than all other commodity funding deals combined!
Under what conditions would Chinese commodity financing deals take place. Goldman lists these as follows:
- the China and ex-China interest rate differential (the primary source of revenue),
- CNY future curve (CNY appreciation is a revenue, should the currency exposure be not hedged),
- the cost of commodity storage (a cost),
- the commodity market spread (the spread is the difference between the futures
- China’s capital controls remain in place (otherwise CCFD would not be necessary).
All of these components are exogenous to the commodity market, except one – the commodity market spread. This reveals an important point that financing deals are, in general, NOT independent of commodity market fundamentals. If the commodity market moves into deficit, or if the financing demand for the commodity is greater than its finite supply of above ground inventory, the commodity market spread adjusts to disincentivize financing deals by making them unprofitable (thus making the physical inventory available to the market).
Via ‘financing deals’, the positive interest rate differential between China and ex-China turns commodities such as copper from negative carry assets (holding copper incurs storage cost and financing cost) to positive carry assets (interest rate differential revenue > storage cost and financing cost). This change in the net cost of carry affects the spreads, placing upward pressure on the physical price, and downward pressure on the futures price, all else equal, making physical-future price differentials higher than they otherwise would be.
* * *
That bolded, underlined sentence is a direct segue into the second part of this article, namely how is it possible that China imports a mindblowing 1400 tons of physical, amounting to roughly $70 billion in notional, demand which under normal conditions would send the equilibrium price soaring, and yet the price not only does not go up, but in fact drops.
The answer is simple: the gold paper market.
And here is, in Goldman’s own words, is an explanation of the missing link between the physical and paper markets. To be sure, this linkage has been proposed and speculated repeatedly by most, especially those who have been stunned by the seemingly relentless demand for physical without accompanying surge in prices, speculating that someone is aggressively selling into the paper futures markets to offset demand for physical.
Now we know for a fact. To wit from Goldman:
From a commodity market perspective, financing deals create excess physical demand and tighten the physical markets, using part of the profits from the CNY/USD interest rate differential to pay to hold the physical commodity. While commodity financing deals are usually neutral in terms of their commodity position owing to an offsetting commodity futures hedge, the impact of the purchasing of the physical commodity on the physical market is likely to be larger than the impact of the selling of the commodity futures on the futures market. This reflects the fact that physical inventory is much smaller than the open interest in the futures market. As well as placing upward pressure on the physical price, Chinese commodity financing deals ‘tighten’ the spread between the physical commodity price and the futures price .
Goldman concludes that “an unwind of Chinese commodity financing deals would likely result in an increase in availability of physical inventory (physical selling), and an increase in futures buying (buying back the hedge) – thereby resulting in a lower physical price than futures price, as well as resulting in a lower overall price curve (or full carry).” In other words, it would send the price of the underlying commodity lower.
We agree that this may indeed be the case for “simple” commodities like copper and iron ore, however when it comes to gold, we disagree, for the simple reason that it was in 2013, the year when Chinese physical buying hit an all time record, be it for CCFD purposes as suggested here, or otherwise, the price of gold tumbled by some 30%! In other words, it is beyond a doubt that the year in which gold-backed funding deals rose to an all time high, gold tumbled. To be sure this was not due to the surge in demand for Chinese (and global) physical. If anything, it was due to the “hedged” gold selling by China in the “paper”, futures market.
And here we see precisely the power of the paper market, where it is not only China which was selling specifically to keep the price of the physical gold it was buying with reckless abandon flat or declining, but also central and commercial bank manipulation, which from a “conspiracy theory” is now an admitted fact by the highest echelons of the statist regime. and not to mention market regulators themselves.
Which answers question two: we now know that of all speculated entities who may have been selling paper gold (since one can and does create naked short positions out of thin air), it was likely none other than China which was most responsible for the tumble in price in gold in 2013 – a year in which it, and its billionaire citizens, also bought a record amount of physical gold (much of its for personal use of course – just check out those overflowing private gold vaults in Shanghai.
* * *
This brings us to the speculative conclusion of this article: when we previously contemplated what the end of funding deals (which the PBOC and the China Politburo seems rather set on) may mean for the price of other commodities, we agreed with Goldman that it would be certainly negative. And yet in the case of gold, it just may be that even if China were to dump its physical to some willing 3rd party buyer, its inevitable cover of futures “hedges”, i.e. buying gold in the paper market, may not only offset the physical selling, but send the price of gold back to levels seen at the end of 2012 when gold CCFDs really took off in earnest.
In other words, from a purely mechanistical standpoint, the unwind of China’s shadow banking system, while negative for all non-precious metals-based commodities, may be just the gift that all those patient gold (and silver) investors have been waiting for. This of course, excludes the impact of what the bursting of the Chinese credit bubble would do to faith in the globalized, debt-driven status quo. Add that into the picture, and into the future demand for gold, and suddenly things get really exciting.
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World faces ‘water-energy’ crisis | GlobalPost
World faces ‘water-energy’ crisis | GlobalPost.
World faces ‘water-energy’ crisis
Surging populations and economies in the developing world will cause a double crunch in demand for water and energy in the coming decades, the UN said Friday.
In a report published on the eve of World Water Day, it said the cravings for clean water and electricity were intertwined and could badly strain Earth’s limited resources.
“Demand for freshwater and energy will continue to increase over the coming decades to meet the needs of growing populations and economies, changing lifestyles and evolving consumption patterns, greatly amplifying existing pressures on limited natural resources and on ecosystems,” the report said.
Already, 768 million people do not have access to a safe, reliable source of water, 2.5 billion do not have decent sanitation and more than 1.3 billion do not have mains electricity.
About 20 percent of the world’s aquifers today are depleted, according to the report.
Agriculture accounts for more than two-thirds of water use.
The World Water Development Report, the fifth in the series by the UN Educational, Scientific and Cultural Organisation (UNESCO), is an overview collated from data from scientific studies and investigations by agencies.
It said ever more freshwater will be needed for farming, construction, drinking, cooking, washing and sewerage, but also for energy production — 90 percent of which uses water-intensive techniques today.
The report gave this snapshot of the future:
– Global water demand is likely to increase by 55 percent by 2050.
– By then, more than 40 percent of the world’s population will be living in areas of “severe” water stress, many of them in the broad swathe of land from North Africa and the Middle East to western South Asia.
– Asia will be the biggest hotspot for bust-ups over water extraction, where water sources straddle national borders. “Areas of conflict include the Aral Sea and the Ganges-Brahmaputra River, Indus River and Mekong River basins,” said the report.
– Global energy demand is expected to grow by more than a third by 2035, with China, India and Middle Eastern countries accounting for 60 percent of the increase.
– In 2010, energy production gobbled up 66 billion cubic metres (2,300 billion cu. feet) of fresh water — more than the average annual flow of the River Nile in Egypt.
By 2035, this consumption could rise by 85 percent, driven by power plant cooling systems that work with water.
– Thirsty energy –
Shale deposits and tar sands, driving an energy boom in North America, are especially hefty in their demands for water to force out the precious gas and oil, the report said.
Even so, “they are outstripped by far by biofuels,” said researcher Richard Connor, who headed the study.
Renewable sources like solar and wind energy that use far less water are gaining ground, and accounted for about a fifth of global electricity output in 2011, the report said.
But they are unlikely to expand this share significantly if fossil fuels continue receiving the bulk of subsidies, it said.
Oil, gas and coal had subsidies of $523 billion (376 billion euros) in 2011, nearly 30 percent more than in 2010, compared to $88 billion for renewables, the report said, citing International Energy Agency (IEA) figures.
Africa, Latin America and the Caribbean have plenty of potential for hydro-energy, which reuses the precious resource, it added.
Hydro-electric dams have been extremely controversial. Big projects deliver gigawatts of power but critics say they are ecologically damaging and prone to massive cost overruns.
The review called for a global effort in efficiency gains, pointing the finger at the arid countries of the Middle East where between 15 and 60 percent of water is wasted through leaks or evaporation even before the consumer opens the tap.
The report also called for smart choices in allocating the trillions of dollars likely to be invested in water and energy infrastructure over the next two decades.
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World faces 'water-energy' crisis | GlobalPost
World faces ‘water-energy’ crisis | GlobalPost.
World faces ‘water-energy’ crisis
Surging populations and economies in the developing world will cause a double crunch in demand for water and energy in the coming decades, the UN said Friday.
In a report published on the eve of World Water Day, it said the cravings for clean water and electricity were intertwined and could badly strain Earth’s limited resources.
“Demand for freshwater and energy will continue to increase over the coming decades to meet the needs of growing populations and economies, changing lifestyles and evolving consumption patterns, greatly amplifying existing pressures on limited natural resources and on ecosystems,” the report said.
Already, 768 million people do not have access to a safe, reliable source of water, 2.5 billion do not have decent sanitation and more than 1.3 billion do not have mains electricity.
About 20 percent of the world’s aquifers today are depleted, according to the report.
Agriculture accounts for more than two-thirds of water use.
The World Water Development Report, the fifth in the series by the UN Educational, Scientific and Cultural Organisation (UNESCO), is an overview collated from data from scientific studies and investigations by agencies.
It said ever more freshwater will be needed for farming, construction, drinking, cooking, washing and sewerage, but also for energy production — 90 percent of which uses water-intensive techniques today.
The report gave this snapshot of the future:
– Global water demand is likely to increase by 55 percent by 2050.
– By then, more than 40 percent of the world’s population will be living in areas of “severe” water stress, many of them in the broad swathe of land from North Africa and the Middle East to western South Asia.
– Asia will be the biggest hotspot for bust-ups over water extraction, where water sources straddle national borders. “Areas of conflict include the Aral Sea and the Ganges-Brahmaputra River, Indus River and Mekong River basins,” said the report.
– Global energy demand is expected to grow by more than a third by 2035, with China, India and Middle Eastern countries accounting for 60 percent of the increase.
– In 2010, energy production gobbled up 66 billion cubic metres (2,300 billion cu. feet) of fresh water — more than the average annual flow of the River Nile in Egypt.
By 2035, this consumption could rise by 85 percent, driven by power plant cooling systems that work with water.
– Thirsty energy –
Shale deposits and tar sands, driving an energy boom in North America, are especially hefty in their demands for water to force out the precious gas and oil, the report said.
Even so, “they are outstripped by far by biofuels,” said researcher Richard Connor, who headed the study.
Renewable sources like solar and wind energy that use far less water are gaining ground, and accounted for about a fifth of global electricity output in 2011, the report said.
But they are unlikely to expand this share significantly if fossil fuels continue receiving the bulk of subsidies, it said.
Oil, gas and coal had subsidies of $523 billion (376 billion euros) in 2011, nearly 30 percent more than in 2010, compared to $88 billion for renewables, the report said, citing International Energy Agency (IEA) figures.
Africa, Latin America and the Caribbean have plenty of potential for hydro-energy, which reuses the precious resource, it added.
Hydro-electric dams have been extremely controversial. Big projects deliver gigawatts of power but critics say they are ecologically damaging and prone to massive cost overruns.
The review called for a global effort in efficiency gains, pointing the finger at the arid countries of the Middle East where between 15 and 60 percent of water is wasted through leaks or evaporation even before the consumer opens the tap.
The report also called for smart choices in allocating the trillions of dollars likely to be invested in water and energy infrastructure over the next two decades.
ri/mlr/fb
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The DJIA Is A Hoax Washington’s Blog
The DJIA Is A Hoax Washington’s Blog.
The Dow Jones Industrial Average Is a Farce
Guest post by Wim Grommen. Mr. Grommen was a teacher in mathematics and physics for eight years at secondary schools. The last twenty years he trained programmers in Oracle-software. He worked almost five years as trainer for Oracle and the last 18 years as trainer for Transfer Solutions in the Netherlands.
The last 15 years he studied transitions, social transformation processes, the S-curve and transitions in relation to market indices. Articles about these topics have been published in various magazines / sites in The Netherlands and Belgium.
The paper “The present crisis, a pattern: current problems associated with the end of the third industrial revolution” was accepted for an International Symposium in Valencia: The Economic Crisis: Time for a paradigm shift, Towards a systems approach.
On January 25 2013, during the symposium in Valencia he presented his paper to scientists.
The Dow Jones Industrial Average (DJIA) Index is the only stock market index that covers both the second and the third industrial revolution. Calculating share indexes such as the Dow Jones Industrial Average and showing this index in a historical graph is a useful way to show which phase the industrial revolution is in. Changes in the DJIA shares basket, changes in the formula and stock splits during the take-off phase and acceleration phase of industrial revolutions are perfect transition-indicators. The similarities of these indicators during the last two revolutions are fascinating, but also a reason for concern. In fact the graph of the DJIA is a classic example of fictional truth, a hoax.
Transitions
Every production phase, civilization or other human invention goes through a so called transformation process. Transitions are social transformation processes that cover at least one generation. In this article I will use one such transition to demonstrate the position of our present civilization and its possible effect on stock exchange rates.
A transition has the following characteristics:
– it involves a structural change of civilization or a complex subsystem of our civilization
– it shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other
– it is the result of slow changes (changes in supplies) and fast dynamics (flows)
A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.
Four transition phases
In general transitions can be seen to go through the S curve and we can distinguish four phases (see fig. 1):
- a pre development phase of a dynamic balance in which the present status does not visibly change
- a take off phase in which the process of change starts because of changes in the system
- an acceleration phase in which visible structural changes take place through an accumulation of socio cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding
- a stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning
A product life cycle also goes through an S curve. In that case there is a fifth phase:
- the degeneration phase in which cost rises because of over capacity and the producer will finally withdraw from the market.
Figure 1. The S curve of a transition
Four phases in a transition best visualized by means of an S curve:
Pre-development, Take-off, Acceleration, Stabilization.
When we look back into the past we see three transitions, also called industrial revolutions, taking place with far-reaching effect :
1. The first industrial revolution (1780 until circa 1850); the steam engine
2. The second industrial revolution (1870 until circa 1930); electricity, oil and the car
3. The third industrial revolution (1950 until ….); computer and microprocessor
Dow Jones Industrial Average (DJIA)
The Dow Index was first published in 1896 when it consisted of just 12 constituents and was a simple price average index in which the sum total value of the shares of the 12 constituents were simply divided by 12. As such those shares with the highest prices had the greatest influence on the movements of the index as a whole. In 1916 the Dow 12 became the Dow 20 with four companies being removed from the original twelve and twelve new companies being added. In October, 1928 the Dow 20 became the Dow 30 but the calculation of the index was changed to be the sum of the value of the shares of the 30 constituents divided by what is known as the Dow Divisor.
While the inclusion of the Dow Divisor may have seemed totally straightforward it was – and still is – anything but! Why so? Because every time the number of, or specific constituent, companies change in the index any comparison of the new index value with the old index value is impossible to make with any validity whatsoever. It is like comparing the taste of a cocktail of fruits when the number of different fruits and their distinctive flavours – keep changing. Let me explain the aforementioned as it relates to the Dow.
The False Appreciation of the Dow Explained
On the other hand, companies in the take-off or acceleration phase are added to the index. This greatly increases the chances that the index will always continue to advance rather than decline. In fact, the manner in which the Dow index is maintained actually creates a kind of pyramid scheme! All goes well as long as companies are added that are in their take-off or acceleration phase in place of companies in their stabilization or degeneration phase.
On October 1st, 1928, when the Dow was enlarged to 30 constituents, the calculation formula for the index was changed to take into account the fact that the shares of companies in the Index split on occasion. It was determined that, to allow the value of the Index to remain constant, the sum total of the share values of the 30 constituent companies would be divided by 16.67 ( called the Dow Divisor) as opposed to the previous 30.
On October 1st, 1928 the sum value of the shares of the 30 constituents of the Dow 30 was $3,984 which was then divided by 16.67 rather than 30 thereby generating an index value of 239 (3984 divided by 16.67) instead of 132.8 (3984 divided by 30) representing an increase of 80% overnight!! This action had the affect of putting dramatically more importance on the absolute dollar changes of those shares with the greatest price changes. But it didn’t stop there!
On September, 1929 the Dow divisor was adjusted yet again. This time it was reduced even further down to 10.47 as a way of better accounting for the change in the deletion and addition of constituents back in October, 1928 which, in effect, increased the October 1st, 1928 index value to 380.5 from the original 132.8 for a paper increase of 186.5%!!! From September, 1929 onwards (at least for a while) this “adjustment” had the affect – and I repeat myself – of putting even that much more importance on the absolute dollar changes of those shares with the greatest changes.
How the Dow Divisor Contributed to the Crash of ‘29
From the above analyses/explanation it is evident that the dramatic “adjustments” to the Dow Divisor (coupled with the addition/deletion of constituent companies according to which transition phase they were in) were major contributors to the dramatic increase in the Dow from 1920 until October 1929 and the following dramatic decrease in the Dow 30 from then until 1932 notwithstanding the economic conditions of the time as well.
Dow Jones Industrial Index is a Hoax
In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance. An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.
An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit. In less than ten years twelve of the thirty companies (i.e. 40%) in the Dow Jones were replaced. Over a period of sixteen years, twenty companies were replaced, a figure of 67%. This meant that over a very short period we were left comparing a basket of today’s apples with a basket of yesterday’s pears.
Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15571590501117 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:
Dow1985 = (x1 + x2 +..+x30) / 1
Dow2014 = (x1 + x2 +.. + x30) / 0.15571590501117
In the 1990s many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed. An increase in share value of 1 dollar of the set of shares in 2014 results is 6.4 times more points than in 1985. The fact that in the 1990s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 16,437 points. If we used the 1985 formula it would be at 2,559 points.
The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft), the engines of the latest revolution and 5 financial institutions, which always play an important role in every transition, were added to the Dow Jones.
|
Period |
Basket changes |
Stock splits |
Dow Divisor end period |
|
1930-1940 |
18 |
0 |
15,100 |
|
1940-1950 |
0 |
12 |
9,060 |
|
1950-1960 |
5 |
27 |
3,824 |
|
1960-1970 |
0 |
26 |
1,894 |
|
1970-1980 |
3 |
12 |
1,465 |
|
1980-1990 |
5 |
32 |
0,586 |
|
1990-2000 |
11 |
40 |
0,201 |
|
2000-2010 |
7 |
13 |
0,132 |
Table 1. Changes in the Dow, stock splits and the value of the Dow Divisor after the market crash of 1929
Dow Jones Industrial Average
Figure 2 Exchange rates of Dow Jones during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.
Overview from 1997 : 20 winners in – 20 losers out, a figure of 67%
September 23, 2013: Hewlett – Packard Co., Bank of America Inc. and Alcoa Inc. will replaced by Goldman Sachs Group Inc., Nike Inc. and Visa Inc.
Alcoa has dropped from $40 in 2007 to $8.08. Hewlett- Packard Co. has dropped from $50 in 2010 to $22.36.
Bank of America has dropped from $50 in 2007 to $14.48.
But Goldman Sachs Group Inc., Nike Inc. and Visa Inc. have risen 25%, 27% and 18% respectively in 2013.
September 20, 2012: UnitedHealth Group Inc. (UNH) replaces Kraft Foods Inc. Kraft Foods Inc. was split into two companies and was therefore deemed less representative so no longer suitable for the Dow. The share value of UnitedHealth Group Inc. had risen for two years before inclusion in the Dow by 53%.
June 8, 2009: Cisco and Travelers replaced Citigroup and General Motors. Citigroup and General Motors have received billions of dollars of U.S. government money to survive and were not representative of the Do.
September 22, 2008: Kraft Foods Inc. replaced American International Group. American International Group was replaced after the decision of the government to take a 79.9% stake in the insurance giant. AIG was narrowly saved from destruction by an emergency loan from the Fed.
February 19, 2008: Bank of America Corp. and Chevron Corp. replaced Altria Group Inc. and Honeywell International. Altria was split into two companies and was deemed no longer suitable for the Dow. Honeywell was removed from the Dow because the role of industrial companies in the U.S. stock market in the recent years had declined and Honeywell had the smallest sales and profits among the participants in the Dow.
April 8, 2004: Verizon Communications Inc., American International Group Inc. and Pfizer Inc. replace AT & T Corp., Eastman Kodak Co. and International Paper. AIG shares had increased over 387% in the previous decade and Pfizer had an increase of more than 675& behind it. Shares of AT & T and Kodak, on the other hand, had decreases of more than 40% in the past decade and were therefore removed from the Dow.
November 1, 1999: Microsoft Corporation, Intel Corporation, SBC Communications and Home Depot Incorporated replaced Chevron Corporation, Goodyear Tire & Rubber Company, Union Carbide Corporation and Sears Roebuck.
March 17, 1997: Travelers Group, Hewlett-Packard Company, Johnson & Johnson and Wal-Mart Stores Incorporated replaced Westinghouse Electric Corporation, Texaco Incorporated, Bethlehem Steel Corporation and Woolworth Corporation.
Real truth and fictional truth
Is the number of points that the Dow Jones now gives us a truth or a fictional truth? If a fictional truth then the number of points now says absolutely nothing about the state that the economy or society is in when compared to the past. In that case a better guide would be to look at the number of people in society that use food stamps today – That is the real truth
Share this:
The DJIA Is A Hoax Washington's Blog
The DJIA Is A Hoax Washington’s Blog.
The Dow Jones Industrial Average Is a Farce
Guest post by Wim Grommen. Mr. Grommen was a teacher in mathematics and physics for eight years at secondary schools. The last twenty years he trained programmers in Oracle-software. He worked almost five years as trainer for Oracle and the last 18 years as trainer for Transfer Solutions in the Netherlands.
The last 15 years he studied transitions, social transformation processes, the S-curve and transitions in relation to market indices. Articles about these topics have been published in various magazines / sites in The Netherlands and Belgium.
The paper “The present crisis, a pattern: current problems associated with the end of the third industrial revolution” was accepted for an International Symposium in Valencia: The Economic Crisis: Time for a paradigm shift, Towards a systems approach.
On January 25 2013, during the symposium in Valencia he presented his paper to scientists.
The Dow Jones Industrial Average (DJIA) Index is the only stock market index that covers both the second and the third industrial revolution. Calculating share indexes such as the Dow Jones Industrial Average and showing this index in a historical graph is a useful way to show which phase the industrial revolution is in. Changes in the DJIA shares basket, changes in the formula and stock splits during the take-off phase and acceleration phase of industrial revolutions are perfect transition-indicators. The similarities of these indicators during the last two revolutions are fascinating, but also a reason for concern. In fact the graph of the DJIA is a classic example of fictional truth, a hoax.
Transitions
Every production phase, civilization or other human invention goes through a so called transformation process. Transitions are social transformation processes that cover at least one generation. In this article I will use one such transition to demonstrate the position of our present civilization and its possible effect on stock exchange rates.
A transition has the following characteristics:
– it involves a structural change of civilization or a complex subsystem of our civilization
– it shows technological, economical, ecological, socio cultural and institutional changes at different levels that influence and enhance each other
– it is the result of slow changes (changes in supplies) and fast dynamics (flows)
A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.
Four transition phases
In general transitions can be seen to go through the S curve and we can distinguish four phases (see fig. 1):
- a pre development phase of a dynamic balance in which the present status does not visibly change
- a take off phase in which the process of change starts because of changes in the system
- an acceleration phase in which visible structural changes take place through an accumulation of socio cultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding
- a stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning
A product life cycle also goes through an S curve. In that case there is a fifth phase:
- the degeneration phase in which cost rises because of over capacity and the producer will finally withdraw from the market.
Figure 1. The S curve of a transition
Four phases in a transition best visualized by means of an S curve:
Pre-development, Take-off, Acceleration, Stabilization.
When we look back into the past we see three transitions, also called industrial revolutions, taking place with far-reaching effect :
1. The first industrial revolution (1780 until circa 1850); the steam engine
2. The second industrial revolution (1870 until circa 1930); electricity, oil and the car
3. The third industrial revolution (1950 until ….); computer and microprocessor
Dow Jones Industrial Average (DJIA)
The Dow Index was first published in 1896 when it consisted of just 12 constituents and was a simple price average index in which the sum total value of the shares of the 12 constituents were simply divided by 12. As such those shares with the highest prices had the greatest influence on the movements of the index as a whole. In 1916 the Dow 12 became the Dow 20 with four companies being removed from the original twelve and twelve new companies being added. In October, 1928 the Dow 20 became the Dow 30 but the calculation of the index was changed to be the sum of the value of the shares of the 30 constituents divided by what is known as the Dow Divisor.
While the inclusion of the Dow Divisor may have seemed totally straightforward it was – and still is – anything but! Why so? Because every time the number of, or specific constituent, companies change in the index any comparison of the new index value with the old index value is impossible to make with any validity whatsoever. It is like comparing the taste of a cocktail of fruits when the number of different fruits and their distinctive flavours – keep changing. Let me explain the aforementioned as it relates to the Dow.
The False Appreciation of the Dow Explained
On the other hand, companies in the take-off or acceleration phase are added to the index. This greatly increases the chances that the index will always continue to advance rather than decline. In fact, the manner in which the Dow index is maintained actually creates a kind of pyramid scheme! All goes well as long as companies are added that are in their take-off or acceleration phase in place of companies in their stabilization or degeneration phase.
On October 1st, 1928, when the Dow was enlarged to 30 constituents, the calculation formula for the index was changed to take into account the fact that the shares of companies in the Index split on occasion. It was determined that, to allow the value of the Index to remain constant, the sum total of the share values of the 30 constituent companies would be divided by 16.67 ( called the Dow Divisor) as opposed to the previous 30.
On October 1st, 1928 the sum value of the shares of the 30 constituents of the Dow 30 was $3,984 which was then divided by 16.67 rather than 30 thereby generating an index value of 239 (3984 divided by 16.67) instead of 132.8 (3984 divided by 30) representing an increase of 80% overnight!! This action had the affect of putting dramatically more importance on the absolute dollar changes of those shares with the greatest price changes. But it didn’t stop there!
On September, 1929 the Dow divisor was adjusted yet again. This time it was reduced even further down to 10.47 as a way of better accounting for the change in the deletion and addition of constituents back in October, 1928 which, in effect, increased the October 1st, 1928 index value to 380.5 from the original 132.8 for a paper increase of 186.5%!!! From September, 1929 onwards (at least for a while) this “adjustment” had the affect – and I repeat myself – of putting even that much more importance on the absolute dollar changes of those shares with the greatest changes.
How the Dow Divisor Contributed to the Crash of ‘29
From the above analyses/explanation it is evident that the dramatic “adjustments” to the Dow Divisor (coupled with the addition/deletion of constituent companies according to which transition phase they were in) were major contributors to the dramatic increase in the Dow from 1920 until October 1929 and the following dramatic decrease in the Dow 30 from then until 1932 notwithstanding the economic conditions of the time as well.
Dow Jones Industrial Index is a Hoax
In many graphs the y-axis is a fixed unit, such as kg, meter, liter or euro. In the graphs showing the stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from true! An index point is not a fixed unit in time and does not have any historical significance. An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs which are, however, very deceptive.
An index is calculated on the basis of a set of shares. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period the value is based on a different set of shares. It is very strange that these different sets of shares are represented as the same unit. In less than ten years twelve of the thirty companies (i.e. 40%) in the Dow Jones were replaced. Over a period of sixteen years, twenty companies were replaced, a figure of 67%. This meant that over a very short period we were left comparing a basket of today’s apples with a basket of yesterday’s pears.
Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the Dow Jones is calculated by adding the shares and dividing the result by a number. Because of changes in the set of shares and the splitting of shares the divider changes continuously. At the moment the divider is 0.15571590501117 but in 1985 this number was higher than 1. An index point in two periods of time is therefore calculated in different ways:
Dow1985 = (x1 + x2 +..+x30) / 1
Dow2014 = (x1 + x2 +.. + x30) / 0.15571590501117
In the 1990s many shares were split. To make sure the result of the calculation remained the same both the number of shares and the divider changed. An increase in share value of 1 dollar of the set of shares in 2014 results is 6.4 times more points than in 1985. The fact that in the 1990s many shares were split is probably the cause of the exponential growth of the Dow Jones index. At the moment the Dow is at 16,437 points. If we used the 1985 formula it would be at 2,559 points.
The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilization or degeneration phase. Companies in a take off phase or acceleration phase are added to the set. This greatly increases the chance that the index will rise rather than go down. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward 7 ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft), the engines of the latest revolution and 5 financial institutions, which always play an important role in every transition, were added to the Dow Jones.
|
Period |
Basket changes |
Stock splits |
Dow Divisor end period |
|
1930-1940 |
18 |
0 |
15,100 |
|
1940-1950 |
0 |
12 |
9,060 |
|
1950-1960 |
5 |
27 |
3,824 |
|
1960-1970 |
0 |
26 |
1,894 |
|
1970-1980 |
3 |
12 |
1,465 |
|
1980-1990 |
5 |
32 |
0,586 |
|
1990-2000 |
11 |
40 |
0,201 |
|
2000-2010 |
7 |
13 |
0,132 |
Table 1. Changes in the Dow, stock splits and the value of the Dow Divisor after the market crash of 1929
Dow Jones Industrial Average
Figure 2 Exchange rates of Dow Jones during the latest two industrial revolutions. During the last few years the rate increases have accelerated enormously.
Overview from 1997 : 20 winners in – 20 losers out, a figure of 67%
September 23, 2013: Hewlett – Packard Co., Bank of America Inc. and Alcoa Inc. will replaced by Goldman Sachs Group Inc., Nike Inc. and Visa Inc.
Alcoa has dropped from $40 in 2007 to $8.08. Hewlett- Packard Co. has dropped from $50 in 2010 to $22.36.
Bank of America has dropped from $50 in 2007 to $14.48.
But Goldman Sachs Group Inc., Nike Inc. and Visa Inc. have risen 25%, 27% and 18% respectively in 2013.
September 20, 2012: UnitedHealth Group Inc. (UNH) replaces Kraft Foods Inc. Kraft Foods Inc. was split into two companies and was therefore deemed less representative so no longer suitable for the Dow. The share value of UnitedHealth Group Inc. had risen for two years before inclusion in the Dow by 53%.
June 8, 2009: Cisco and Travelers replaced Citigroup and General Motors. Citigroup and General Motors have received billions of dollars of U.S. government money to survive and were not representative of the Do.
September 22, 2008: Kraft Foods Inc. replaced American International Group. American International Group was replaced after the decision of the government to take a 79.9% stake in the insurance giant. AIG was narrowly saved from destruction by an emergency loan from the Fed.
February 19, 2008: Bank of America Corp. and Chevron Corp. replaced Altria Group Inc. and Honeywell International. Altria was split into two companies and was deemed no longer suitable for the Dow. Honeywell was removed from the Dow because the role of industrial companies in the U.S. stock market in the recent years had declined and Honeywell had the smallest sales and profits among the participants in the Dow.
April 8, 2004: Verizon Communications Inc., American International Group Inc. and Pfizer Inc. replace AT & T Corp., Eastman Kodak Co. and International Paper. AIG shares had increased over 387% in the previous decade and Pfizer had an increase of more than 675& behind it. Shares of AT & T and Kodak, on the other hand, had decreases of more than 40% in the past decade and were therefore removed from the Dow.
November 1, 1999: Microsoft Corporation, Intel Corporation, SBC Communications and Home Depot Incorporated replaced Chevron Corporation, Goodyear Tire & Rubber Company, Union Carbide Corporation and Sears Roebuck.
March 17, 1997: Travelers Group, Hewlett-Packard Company, Johnson & Johnson and Wal-Mart Stores Incorporated replaced Westinghouse Electric Corporation, Texaco Incorporated, Bethlehem Steel Corporation and Woolworth Corporation.
Real truth and fictional truth
Is the number of points that the Dow Jones now gives us a truth or a fictional truth? If a fictional truth then the number of points now says absolutely nothing about the state that the economy or society is in when compared to the past. In that case a better guide would be to look at the number of people in society that use food stamps today – That is the real truth
Share this:
‘Cash-On-The-Sidelines’ Fallacies And Restoring The “Virtuous Cycle” Of Economic Growth | Zero Hedge
‘Cash-On-The-Sidelines’ Fallacies And Restoring The “Virtuous Cycle” Of Economic Growth | Zero Hedge.
As we explained in great detail recently, the abundance of so-called cash-on-the-sidelines is a fallacy, but even more critically the we showed the belief that these ‘IOUs of past economic activity’ would immediately translate into efforts to deploy them into future economic activity is also entirely false. Simply put, there is no relationship between corporate cash and subsequent capital expenditure, nor is the level of capital expenditure even well-correlated with the level of real interest rates. At this point, as John Hussman explains, it should be clear that the mere existence of a mountain of IOUs related to past economic activity is not enough to provoke future economic activity. What matters instead is the same thing that always matters: Are the resources of the economy being directed toward productive uses that satisfy the needs of others?
The fallacy of cash piles on the balance sheet meaning strong balance sheets…
US companies are carrying far more net debt than in 2007Another curiosity is this notion that US companies have substantially reduced their debt pile and are therefore cash rich. The latter is indeed true. Cash and equivalents are at historically high levels, but rarely do those who mention the mountains of corporate cash also discuss the massive increase in debt seen over the last couple of years.
In fact, debt levels have been growing to such an extent that net debt (i.e. excluding the massive cash pile) is 15% higher than it was prior to the financial crisis.
and Proposition 1: Corporate cash is high, and therefore, businesses should put that cash to work through capex.
Comments: This is the most obviously deceptive of the four propositions, hence Mark Spitznagel’s incredulous response when asked to address cash balances by Maria Bartiromo last week. As Spitznagel explained, it makes little sense to isolate the cash that sits on corporate balance sheets without netting the credit portions of both assets and liabilities. We last updated corporations’ net credit position here, showing that gradual increases in cash balances are dwarfed by rising debt.
A longer history further disproves the proposition; it shows that there’s no correlation between capex and corporate cash:
So how do we restore growth?
Via Hussman’s Funds’ Weekly Insight,
To the extent that such desirable activities exist – whether as consumption goods or as investment goods like machines, the act of bringing them forward not only engages existing resources (such as factory capacity and labor), but also creates new income that can be used to purchase yet other desirable products. This is what creates a virtuous circle of economic activity and growth. Not quantitative easing, not suppressed interest rates, not speculation. The resources of the economy must be channeled toward activities that are actually productive, desirable, and useful to others.
When this doesn’t occur – when companies produce output that isn’t wanted, when capital investments are made that aren’t productive, when housing is constructed at a pace that exceeds the sustainable demand and ability to finance it – the act of production and the resources of the economy are wasted. That is really the narrative of the past 14 years, and is largely the result of repeated bouts of Fed-induced speculation and misallocation. Robert Blumenthal recently wrote an excellent essay describing the economic costs of such “malinvestment.”
At the moment that a person uses their labor to produce something of value to others, that person’s own income is enhanced, and the ability to purchase the output of others is also created. As economist Jean-Baptiste Say wrote, “A product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value… Thus the mere circumstance of creation of one product immediately opens a vent for other products.”
In a healthy economy, the productive activity of one sector opens a vent for the productive activity of other sectors of the economy. The useful allocation of resources in one area of the economy reinforces the useful allocation of resources in another. Economic growth continues as the efforts of each sector focus on the production of those things that will be of demand and use to others. Each productive act is not simply an event, but contributes momentum to a virtuous cycle.
The difficulty emerges when something is brought into production that is not desired – that fails to align with the actual demand for it. In that event, the value of the product itself may be less than the value of the resources committed to its production. Since it is not consumed, it simultaneously becomes “savings” and “unwanted inventory investment.” Long-term growth is harmed, because economic effort and resources are wasted and fail to open a vent for other production. If this occurs at a large scale, jobs are lost, inventories build, and the economy suffers the long-term effects of misallocated activity.
When we review the economic narrative of the past 14 years, this is exactly what we observe.
The first insult occurred during the excesses of the tech bubble and the severe misallocation of capital that resulted. Next, in response to the economic downturn in 2000-2002, the Federal Reserve held interest rates down in the hope of reviving interest-sensitive spending and investment. Instead, the suppressed interest rate environment triggered a “reach for yield” that found itself concentrated in enormous demand for mortgage securities. Wall Street was more than happy to provide the desired “product,” but could do so only by creating new mortgages by lending to anyone with a pulse.
The resulting housing bubble became a second episode of severe capital misallocation, and led to the economic collapse of 2008-2009. In response to that episode, the Federal Reserve has now produced and largely completed a third phase of speculative malinvestment, this time focused on the equity market. On historically reliable valuation measures, equity prices are now double the level at which they would be likely to provide historically normal returns. As in 2000, three-quarters of the record new issuance of equities is now dominated by companies that have no earnings. The valuation of the median stock is now higher than it was at the 2000 peak. NYSE margin debt as a percent of GDP exceeds every point in history except the March 2000 peak. All of this will end badly for the equity market, but the real insult is what this constant malinvestment has done to the long-term prospects for U.S. economic growth and employment.
The so-called “dual mandate” of the Federal Reserve does not ask the Fed to manage short-run or even cyclical fluctuations in the economy. Instead – whether one believes that the goals of that mandate are achievable or not – it asks the Fed to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
What the Fed has done instead is to completely lose control of the growth of monetary aggregates, in an effort to offset short-run, cyclical fluctuations in the economy, so as to promote maximum speculative activity and repeated bouts of resource misallocation, and ultimately damage the economy’s long-run potential to increase production and promote employment.
In the face of our concerns about long-run consequences, some might immediately appeal to Keynes, who trivialized prudence and restraint, saying “In the long run, we are all dead.” But we are not talking about decades. The insults to the U.S. economy, to U.S. labor force participation, and to the long-term unemployed are the largely predictable result of policies that have been pursued in the past decade alone.
On the fiscal policy side, there are numerous initiatives that – when properly focused on productivity and labor force participation – could easily be self-financing for the economy in aggregate. Too much of our fiscal deficit has nothing to do with productivity or inducements that reward economic activity. Productive infrastructure (ideally projects that have large distributed effects, as opposed to notions like rural broadband), alternative energy, earned income tax credits, tying extended unemployment compensation to some sort of activity requirement (community, internship or otherwise), small business loans and tax credits tied to job creation and retention, investment and R&D credits, and other initiatives fall into this category. The objective is for the private markets to retain a vested interest and exposure to some amount of risk, so that losses and unproductive decisions remain costly, but also for fiscal initiatives to ease constraints that are binding on private decision-making.
On the monetary policy side, it’s simply time to change course to a far less “elastic,” rules-based policy. With $2.5 trillion in excess reserves within the banking system, even one more dollar of quantitative easing is harmful because it perpetuates financial distortion and speculative activity while doing nothing to ease any constraint in the economy that is actually binding. Fortunately, it actually appears that the FOMC increasingly recognizes this, as attention has gradually focused on questions about policy effectiveness and financial risk, and away from the weak hope for positive effects. We will have to see how long this insight persists, but statements from FOMC officials increasingly reflect the intention to “wind down” QE, and emphasize the “high bar” that would be required to move away from that stance.
The cyclical risk for the U.S. equity market is already baked in the cake, and we view downside potential as substantial. The economy would allocate capital better, and to greater long-term benefit, if interest rates were at levels that rewarded savings and discouraged untethered growth in fiscal deficits. The economy would also allocate capital better if equity valuations were closer to historical norms (unfortunately about half of present levels given the extent of present distortions). While the capital markets are likely to undergo a great deal of adjustment in the coming years, we don’t anticipate systemic economic risks similar to the 2007-2009 period. We do observe a buildup of inventories in recent quarters that, combined with disruptions abroad, seem likely to contribute to economic weakness, but there are numerous episodes in history when stock market losses were not associated with steep economic losses.
The largest economic risks are particularly likely to emerge in Asia, where “big bazooka” central bank policies and speculative overinvestment have also produced large and persistent misallocation. China and Japan are of principal concern, though many smaller developing countries outside of Asia also appear at risk. Policy makers should certainly focus on areas where exposure to foreign obligations, equity leverage, and credit default swaps would produce sizeable disruptions. In any event, I believe it is urgent for investors to recognize the current position of the U.S. equity market in the context of a complete market cycle. As I noted in the face of similar conditions in 2007, my expectation is that any “put option” still provided by the Federal Reserve has a strike price that is way out-of-the-money.
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'Cash-On-The-Sidelines' Fallacies And Restoring The "Virtuous Cycle" Of Economic Growth | Zero Hedge
‘Cash-On-The-Sidelines’ Fallacies And Restoring The “Virtuous Cycle” Of Economic Growth | Zero Hedge.
As we explained in great detail recently, the abundance of so-called cash-on-the-sidelines is a fallacy, but even more critically the we showed the belief that these ‘IOUs of past economic activity’ would immediately translate into efforts to deploy them into future economic activity is also entirely false. Simply put, there is no relationship between corporate cash and subsequent capital expenditure, nor is the level of capital expenditure even well-correlated with the level of real interest rates. At this point, as John Hussman explains, it should be clear that the mere existence of a mountain of IOUs related to past economic activity is not enough to provoke future economic activity. What matters instead is the same thing that always matters: Are the resources of the economy being directed toward productive uses that satisfy the needs of others?
The fallacy of cash piles on the balance sheet meaning strong balance sheets…
US companies are carrying far more net debt than in 2007Another curiosity is this notion that US companies have substantially reduced their debt pile and are therefore cash rich. The latter is indeed true. Cash and equivalents are at historically high levels, but rarely do those who mention the mountains of corporate cash also discuss the massive increase in debt seen over the last couple of years.
In fact, debt levels have been growing to such an extent that net debt (i.e. excluding the massive cash pile) is 15% higher than it was prior to the financial crisis.
and Proposition 1: Corporate cash is high, and therefore, businesses should put that cash to work through capex.
Comments: This is the most obviously deceptive of the four propositions, hence Mark Spitznagel’s incredulous response when asked to address cash balances by Maria Bartiromo last week. As Spitznagel explained, it makes little sense to isolate the cash that sits on corporate balance sheets without netting the credit portions of both assets and liabilities. We last updated corporations’ net credit position here, showing that gradual increases in cash balances are dwarfed by rising debt.
A longer history further disproves the proposition; it shows that there’s no correlation between capex and corporate cash:
So how do we restore growth?
Via Hussman’s Funds’ Weekly Insight,
To the extent that such desirable activities exist – whether as consumption goods or as investment goods like machines, the act of bringing them forward not only engages existing resources (such as factory capacity and labor), but also creates new income that can be used to purchase yet other desirable products. This is what creates a virtuous circle of economic activity and growth. Not quantitative easing, not suppressed interest rates, not speculation. The resources of the economy must be channeled toward activities that are actually productive, desirable, and useful to others.
When this doesn’t occur – when companies produce output that isn’t wanted, when capital investments are made that aren’t productive, when housing is constructed at a pace that exceeds the sustainable demand and ability to finance it – the act of production and the resources of the economy are wasted. That is really the narrative of the past 14 years, and is largely the result of repeated bouts of Fed-induced speculation and misallocation. Robert Blumenthal recently wrote an excellent essay describing the economic costs of such “malinvestment.”
At the moment that a person uses their labor to produce something of value to others, that person’s own income is enhanced, and the ability to purchase the output of others is also created. As economist Jean-Baptiste Say wrote, “A product is no sooner created than it, from that instant, affords a market for other products to the full extent of its own value… Thus the mere circumstance of creation of one product immediately opens a vent for other products.”
In a healthy economy, the productive activity of one sector opens a vent for the productive activity of other sectors of the economy. The useful allocation of resources in one area of the economy reinforces the useful allocation of resources in another. Economic growth continues as the efforts of each sector focus on the production of those things that will be of demand and use to others. Each productive act is not simply an event, but contributes momentum to a virtuous cycle.
The difficulty emerges when something is brought into production that is not desired – that fails to align with the actual demand for it. In that event, the value of the product itself may be less than the value of the resources committed to its production. Since it is not consumed, it simultaneously becomes “savings” and “unwanted inventory investment.” Long-term growth is harmed, because economic effort and resources are wasted and fail to open a vent for other production. If this occurs at a large scale, jobs are lost, inventories build, and the economy suffers the long-term effects of misallocated activity.
When we review the economic narrative of the past 14 years, this is exactly what we observe.
The first insult occurred during the excesses of the tech bubble and the severe misallocation of capital that resulted. Next, in response to the economic downturn in 2000-2002, the Federal Reserve held interest rates down in the hope of reviving interest-sensitive spending and investment. Instead, the suppressed interest rate environment triggered a “reach for yield” that found itself concentrated in enormous demand for mortgage securities. Wall Street was more than happy to provide the desired “product,” but could do so only by creating new mortgages by lending to anyone with a pulse.
The resulting housing bubble became a second episode of severe capital misallocation, and led to the economic collapse of 2008-2009. In response to that episode, the Federal Reserve has now produced and largely completed a third phase of speculative malinvestment, this time focused on the equity market. On historically reliable valuation measures, equity prices are now double the level at which they would be likely to provide historically normal returns. As in 2000, three-quarters of the record new issuance of equities is now dominated by companies that have no earnings. The valuation of the median stock is now higher than it was at the 2000 peak. NYSE margin debt as a percent of GDP exceeds every point in history except the March 2000 peak. All of this will end badly for the equity market, but the real insult is what this constant malinvestment has done to the long-term prospects for U.S. economic growth and employment.
The so-called “dual mandate” of the Federal Reserve does not ask the Fed to manage short-run or even cyclical fluctuations in the economy. Instead – whether one believes that the goals of that mandate are achievable or not – it asks the Fed to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”
What the Fed has done instead is to completely lose control of the growth of monetary aggregates, in an effort to offset short-run, cyclical fluctuations in the economy, so as to promote maximum speculative activity and repeated bouts of resource misallocation, and ultimately damage the economy’s long-run potential to increase production and promote employment.
In the face of our concerns about long-run consequences, some might immediately appeal to Keynes, who trivialized prudence and restraint, saying “In the long run, we are all dead.” But we are not talking about decades. The insults to the U.S. economy, to U.S. labor force participation, and to the long-term unemployed are the largely predictable result of policies that have been pursued in the past decade alone.
On the fiscal policy side, there are numerous initiatives that – when properly focused on productivity and labor force participation – could easily be self-financing for the economy in aggregate. Too much of our fiscal deficit has nothing to do with productivity or inducements that reward economic activity. Productive infrastructure (ideally projects that have large distributed effects, as opposed to notions like rural broadband), alternative energy, earned income tax credits, tying extended unemployment compensation to some sort of activity requirement (community, internship or otherwise), small business loans and tax credits tied to job creation and retention, investment and R&D credits, and other initiatives fall into this category. The objective is for the private markets to retain a vested interest and exposure to some amount of risk, so that losses and unproductive decisions remain costly, but also for fiscal initiatives to ease constraints that are binding on private decision-making.
On the monetary policy side, it’s simply time to change course to a far less “elastic,” rules-based policy. With $2.5 trillion in excess reserves within the banking system, even one more dollar of quantitative easing is harmful because it perpetuates financial distortion and speculative activity while doing nothing to ease any constraint in the economy that is actually binding. Fortunately, it actually appears that the FOMC increasingly recognizes this, as attention has gradually focused on questions about policy effectiveness and financial risk, and away from the weak hope for positive effects. We will have to see how long this insight persists, but statements from FOMC officials increasingly reflect the intention to “wind down” QE, and emphasize the “high bar” that would be required to move away from that stance.
The cyclical risk for the U.S. equity market is already baked in the cake, and we view downside potential as substantial. The economy would allocate capital better, and to greater long-term benefit, if interest rates were at levels that rewarded savings and discouraged untethered growth in fiscal deficits. The economy would also allocate capital better if equity valuations were closer to historical norms (unfortunately about half of present levels given the extent of present distortions). While the capital markets are likely to undergo a great deal of adjustment in the coming years, we don’t anticipate systemic economic risks similar to the 2007-2009 period. We do observe a buildup of inventories in recent quarters that, combined with disruptions abroad, seem likely to contribute to economic weakness, but there are numerous episodes in history when stock market losses were not associated with steep economic losses.
The largest economic risks are particularly likely to emerge in Asia, where “big bazooka” central bank policies and speculative overinvestment have also produced large and persistent misallocation. China and Japan are of principal concern, though many smaller developing countries outside of Asia also appear at risk. Policy makers should certainly focus on areas where exposure to foreign obligations, equity leverage, and credit default swaps would produce sizeable disruptions. In any event, I believe it is urgent for investors to recognize the current position of the U.S. equity market in the context of a complete market cycle. As I noted in the face of similar conditions in 2007, my expectation is that any “put option” still provided by the Federal Reserve has a strike price that is way out-of-the-money.
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The Failure of Keynesianism – Ludwig von Mises Institute Canada
The Failure of Keynesianism – Ludwig von Mises Institute Canada.
It’s hard not to agree with the old aphorism “history doesn’t repeat itself, but it does rhyme.” It’s nice to think we learn from our mistakes; yet we always seem to repeat them at some later date.
Reading the daily news, you would be hard-pressed to find mention that there is still an employment crisis unfolding in many industrialized countries. The New York Times recently reported that employers in the United States hired only 175,000 workers in February. This is apparently a cause for celebration among economists. The unemployment rate in the U.S. still remains at an historic high of 6.7%, and there appears to be no date in sight for a return of full employment, but no matter; the economy is supposedly gaining steam.
The only problem is, nobody seems to care much anymore. High unemployment is a constant reality now. Nearly six years of slagging job creation has created a cloud of apathy for most people. It’s just accepted that not everyone who wants to find work will be able to; or they will wander from low-wage job to low-wage job without any kind of security.
The current economic malaise is reminiscent of what the Great Depression was like. Persistently high unemployment with no conceivable end; massive government intervention in the marketplace; a changing industrial landscape; and even social and cultural transformation. We’re less than a century removed from the biggest economic hardship ever faced in America, and the same mishaps are unfolding in front of our eyes.
Then and now, something has remained perennial: the utter incompetence on government’s part to cure economic stagnation.
Newscasters, state officials, and academic economists all tell us government is capable of spending us into prosperity. No matter how much dough is thrown at the glob known as the “economy,” large numbers of people remain out of work. During the Depression, the glut of joblessness lasted for nearly fifteen years. Uncle Sam spent like a drunken sailor while swallowing up much of the economy in fascist scheme after fascist scheme.
The very same thing goes on today, all at the behest of Keynesian-type political actors who provide the intellectual ammunition necessary to justify government’s outstretched hand. With neatly obscure formulas and obtuse language, the apparatchik darlings of Keynes love branding themselves as deep-thinking scientists capable of engineering the perfect economy. When their policy is put to work, we get the opposite. Job creation stagnates, living standards slump, and misery spreads. The siphons of entrepreneurial growth don’t pump; they are bogged down with the grimy sludge of currency manipulation and government hubris.
After decades of constant failure, I mean this wholeheartedly: the followers of the Keynesian school don’t have a damn clue on how to fix the economy. Why my gauche phrasing? Their policy prescription is a complete and total failure. The Great Depression; the stagflation of the 1970s; the Great Recession we see today; in each instance, Washington was impotent to reverse the damage. Keynesians are either pathetically ignorant, or maliciously deceptive.
Taking rhetorical shots doesn’t mean much without some evidence. So let’s meet the Keynesians on their terms. First, economic science itself will be interpreted through the lens of positivism. That means data, in whatever form, will be used to justify whether something works or not. Of course the assumption will be made that spending is the driver of economic prosperity – not saving or investment. The same goes for boundless money printing, which is said to infuse the “animal spirits” with a rejuvenating elixir.
So what have they got for successes? Keynesians used to tout the efforts of Franklin Roosevelt (not so much Herbert Hoover, who was proto-Rooseveltian) during the Great Depression as vindication for their theory. I remember being told in no uncertain terms that Uncle Sam stepped up to save the downtrodden from excess capitalism in my American Presidency 301 class. Sure, it wasn’t an economics course; but it’s the same tale spun by economists anyway.
What does the data say? From 1931 to 1940, the unemployment rate never went south of 10%. From the onset of the Depression, Washington spending went up 97% under the Hoover Administration. According to the White House’s official statistics, the federal budget increased from $3.5 billion in 1931 to $13.6 billion in 1941, jumping in size year after year. A combination of deficit spending and tax hikes (admittedly not a Keynesian remedy) allowed for this gorge in consumption. Meanwhile, the Federal Reserve goosed the economy by first stabilizing the monetary base and increasing the supply of money after the initial contraction during the Depression’s early years. According to the Historic Statistics of the United States, the Federal Reserve increased its holding of U.S. securities from $510 million in 1929 to over $6 billion in 1942. During the same period, the central bank’s balance sheet went from about $5.5 billion to $29 billion.
That’s no small stimulus. And yet the unemployment rate failed to drop significantly during the Depression years. Most of Keynes’s disciples admit that nearly fifteen years of high unemployment leaves much to be desired on the part of muscular government. The counterfactual is then deployed that Roosevelt’s domestic efforts lightened the economic burden foisted upon America. What finally put the Depression to bed, they argue, was the incredible amount of spending during World War II.
But as economic historian Robert Higgs shows, measures of economic performance were highly skewed during wartime. Unemployment fell and production ramped up, but this was due to the draft and building of armaments. Rationing was widespread to the point where basic foodstuffs and toiletries were scarce. If a wartime economy counts as prosperity, then the homeless today are the living embodiment of luxury.
World War II is a bunk fantasy that in no way proves the Keynesian theory correct. The same goes for the fascist orgy known as the New Deal. Fast-forward to today, and the same charlatans are preaching from the gospel of government interventionism. They implore Washington to fight back against the Great Recession with the same blunted tools: spending and money printing.
When the housing bubble burst and the economy began to tank, then-Chairman of the Federal Reserve Ben Bernanke and crew nearly tripled the central bank’s balance sheet. As of right now, the Fed’s sheet stands at about $4 trillion. In 2008, it was at $800 billion. Not to be outdone, the federal government ramped up spending by running nearly-trilliondollar deficits year-after-year. Once again, all this effort has only made a slight dent in the unemployment rate.
From a strictly empirical perspective, the Keynesian theory is a disaster. Positivism wise, it’s a smoldering train wreck. You would be hard-pressed to comb through historical data and find great instances where government intervention succeeded in lowering employment without creating the conditions for another downturn further down the line.
No matter how you spin it, Keynesianism is nothing but snake oil sold to susceptible political figures. Its practitioners feign using the scientific method. But they are driven just as much by logical theory as those haughty Austrian school economists who deduce truth from self-evident axioms. The only difference is that one theory is correct. And if the Keynesians want to keep pulling up data to make their case, they are standing on awfully flimsy ground.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada. Send him mail
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Here come the wage and price controls
Here come the wage and price controls.
March 13, 2014
Belize City, Belize
Nearly four thousand years ago, King Hammurabi of Babylon laid out his eponymous “Hammurabi’s Code”, a series of laws that is still famous to this day.
Most people know Hammurabi’s Code as “an eye for an eye, a tooth for a tooth”. Yet what few realize is that the code was actually one of the original attempts at government wage and price controls.
Hammurabi’s Code decreed, for example, that the daily rate of pay for a tailor would be five grains of silver, and a farm laborer would be six grains of silver. The cost of hiring a small animal for field work would be four bushels of corn. Etc.
Of course, Hammurabi’s attempts to control prices didn’t work one bit. In his book The Old Babylonian Merchant: His Business and Social Position (published 1950), historian W.F. Leemans writes:
“Prominent and wealthy tamkaru [merchant traders] were no longer found in Hammurabi’s reign. Moreover, only a few tamkaru are known from Hammurabi’s time and afterwards . . .”
Despite the economic failures of Hammurabi’s experiment, though, wage and price controls have been tried again and again throughout history.
2,000 years later, Emperor Diocletian of the failing Roman Empire issued his Edict on Wages and Prices. The ancient Athenians tried (and failed) to set grain prices, and even had a small army of regulators to oversee the price controls. So did the the Zhou dynasty in ancient China.
Today you can see various forms of wage and price controls all over the world– from the blatant (Argentina) to the subtle.
Major farm subsidies in the United States, for example, are a form of price controls. Monetary policy (especially keeping interest rates at effectively zero) are a form of price controls.
Yet today President Obama is set to lauch another far more obvious form.
The central planner-in-chief is going to sign an Executive Order to require employers to expand overtime pay in the Land of the Free. This, on top of his recent proposal to increase the minimum wage 39% to $10.10 per hour (not that there’s any inflation).
Obviously this ‘decree by executive order’ strategy shows the political system for what it is: there is no republic, there are no checks and balances, there is no adherence to the Constitution.
They do whatever they want, however they want, with total immunity.
The troubling part about this executive order (aside from being yet another soon-to-fail wage control) is that it essentially abrogates millions of work contracts across the country.
Employers and their workers have long since agreed to terms of employment that may or may not include overtime pay.
Today President is unilaterally voiding any specific provisions about overtime pay in existing employment contracts, all in his sole discretion, and all without Congressional oversight.
The rule of law means nothing.
And even though any high school economics student can tell you that wage and price controls don’t work, the government is pressing ahead with vigor, damn the consequences.
Given their continued destruction of the middle class, perhaps it’s time we bring back ‘an eye for an eye, a tooth for a tooth.’
Olduvaiblog: Musings on the coming collapse 
