Sunday, March 03, 2013

The Misallocation of Resources

This news release the other day leaves room for thought.
Bernanke said the Fed's policies mirror what other central banks around the world are doing.
"Long-term interest rates in the major industrial countries are low for a good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low," he said.
Interest rates are usually an expression of future risk. The more risk, the higher the rate charged. Interest rates are also a function of “you want it now" (three dollars now for five dollars on pay day). You either save up and pay cash or you borrow funds at some cost, to reward those who saved the money you are borrowing. The present rates are low only because of government intervention in the markets.

Bernanke claims to have studied the Great Depression at length, and so have I. His method for our recovery is not one I agree with. We survived the Great Depression. The major cause was a misallocation of resources. One sector of the economy took off and everyone piled on trying to get rich. And then it collapsed. It took quite a while for the economy to return to normal.

In Africa 40 years ago there was a cattle boom. The more cattle you owned the wealthier you were perceived to be. As the cattle population increased over time, more and more resources were devoted to feeding them. All it took was a drought and, the cost of hay skyrocketed. Most farmers found that they could no longer afford to feed their herds, let alone sell them to someone else. The cattle market collapsed. A lot of the livestock died from starvation. From there, families starved to death. Notice, it wasn’t a shortage of food that killed the people, it was a misallocation of resources. Their apparent cattle wealth disappeared, and they had little if any savings to buy food with.

We are trying to recover from a misallocation of resources in the real estate market. Guess what--- the government is not going to let the market collapse, just because people spent too much money on it ---they are going to keep it going. In Africa, the government could have stepped in and provided food for the cattle, but it wouldn’t have solved the problem. Resources would have been expended on items that were economically unfeasible. This is what our government has done to the housing bubble. It has enabled more resources to be spent on a project that has no real return. Notice that as long as the real price for raising cattle or real estate is subsidized by government forces, the market cannot return to normal. The government subsidies insure that the misallocation of resources will continue.

The questions that need to be asked, are; “Where does the Federal Reserve get the written authority to buy 85 billion dollars’ worth of bonds each month?” and “Where does the Federal Reserve get the mandate to set interest rates?”. We are talking about a government agency that has the ability to spend trillions of dollars a year, saving the banks and the housing market from ruin, on the assumption that this “herd of cattle can be fed” and sold later for the dollars loaned earlier. This is a government agency that has the ability to spend more in one year than Congress has funds to spend from taxes collected.

It comes to mind that we have a 85 billion dollar sequestration for a year that appears to be a real monkey wrench in the economy. And here's the Federal Reserve with that same amount for a monthly allowance with which to purchase bonds.--must be my imagination.

People over a lifetime saved their earnings for retirement expecting interest rates would reflect risk in the market. Does the Federal Reserve have the right to artificially manipulate interest rates to support this misallocation of resources? The Federal Reserve has saved the banking system and now they are working on Fannie and Freddie. Failure is rewarded with bailouts and individual risk is eliminated with government guarantees. Without the Federal Reserve interference, interest rates would be able to return to normal levels. That would be too bad for the housing market, but then maybe our kids could afford to buy a home, and Grandpa and Grandma, might get some real interest paid on their savings. Let’s return risk to our markets and reward success --- unfortunately Ben's going to save that real estate market, and avoid a Great Depression. Ben's got some great deals on 100 acre "farms" inside the city limits of Detroit and they're already zoned residential.


Anonymous said...

Sorry Jim...the Federal Reserve is not a government's a private bank.

Jim in San Marcos said...

Hi Anon 2:05

I beg to differ a tad.The Constitution gives Congress the power to coin money and set its value. Congress delegated this power to the Federal Reserve in the 1913 Federal Reserve Act, but still maintains oversight authority. The board of governors are appointed by the President and confirmed by Congress, who pays their salary's. They are independent of government control, but responsible to the Congress for their actions.

The Federal Reserve is the Central bank of the United States. A major portion of their job was as a clearing house for checks and the replacement of currency worn with age. With electronic banking today, check clearing is not a big item.

A main purpose of the banks back in the 1920's was to provide currency availability to the areas of the country where money was migrating from. A bank could have deposits but no currency on hand to issue to depositors.

I don't see how it could be labeled a private bank, it doesn't function like one in the least. I tend to accept it as a government agency for the mere fact that Congress can get rid of it if it wants.

Congress cannot get rid of the Supreme Court, but that also is a government agency. The amount of freedom a government agency has is determined by the constitution and the laws Congress writes

Sackerson said...

Hi Jim - I didn't know that cattle story, interesting analogy.

I've paused the financial side of the blogging simply because there's no point in shouting stop when the supersized truck has its front wheels over the cliff. Perhaps we need to say a few things about survival tips, instead?

Jim in San Marcos said...

Hi Sack

Welcome back.

I think at our age, maybe the survival tip might be to own gold silver, platinum, a home and a car.

The poor will lose nothing, it is the rich that will lose everything. If the currency is trashed, taxes don't go away. So if you have say several homes, you won't be able to pay the taxes on them all, and selling them, might not bring much under a new currency.

What most people don't understand about rich people is that they might have very little spare cash, its all tied up in investments. It wouldn't take much to collapse many of these empires.

I tend to favor precious metals, because the government can't print gold and silver. And you can bury it in the back yard. Use the buried assets to supplement your retirement under a new system when it kicks in.

Sackerson said...

Hi, Jim

... except the rich (a) have bought the government, (b) are themselves, I understand, quietly piling into precious metals and (c) moving wealth offshore/into other countries.

Are they not survivalists, but with more resources to start with?

Anonymous said...


What do you think of the current drop in gold prices? Louise Yamada's technical analysis indicates that if it falls below 1529 it could be headed towards 1400 or 1250?

Anonymous said...

Hi Jim,

"I tend to favor precious metals, because the government can't print gold and silver. And you can bury it in the back yard."

You've conveyed this idea a few times in previous posts. Send me your street address and I'll be right over! ;)

Jim in San Marcos said...

Hi Anon 7:43

My back yard wouldn't work. They used a jack hammer to put in the sprinker system. I had a hell of a time trying to bury my son's parrakeet when it died. You have to pay extra for dirt when you buy a home out here.

Jim in San Marcos said...

Hi Anon 3:58

Typically gold reflects a weeks wages. If we were to figure an annual wage of 52K a years that would suggest a bottom side on gold of 1,000 a troy ounce.

In normal times, holding precious metals provides no income, but with interest rates near zero, neither does cash in the bank. Plus with the low interest rates, speculation in commodities is very high because the costs of forward futures options have very little interest costs inherent in their price.

Of course, money could be coming out of the precious metals and into the stock market.

The one thing often overlooked about investors (when they need to raise cash) they sell the ones they made money on and hold on to the dogs hoping they come back.

As for the future price of gold, I expect wages to average about 85K in the next 5 years, so that would imply gold is within a fair trading range. The price of gold is only reflecting how much paper is being printed.

Gasoline is still less than 25 cents a gallon if you pay in pre 1964 silver coins.

Jim in San Marcos said...

Hi Sack

What I was talking about reminds me of the joke about the guy trying to sell a 2 million dollar dog. A multimillionaire asks him if he would take two million dollar cats in trade?

I think we will see these 80 million dollar painting and 200 million dollar horses drop down to a more realistic levels. In tough times, a 10 thousand dollar watch might fetch 600 dollars.

Many fabulously wealthy people of the early 1920, lost everything in the crash and died penniless.

People tend to associate wealth with being smart and that is just not the case. There is a lot of luck involved

Anonymous said...


I'm somewhat confused by two statements: salaries will average 85k in 5 years and a $10k watching will sell for $600. These outcomes seem at odds. Can you explain?


Jim in San Marcos said...

Hi Anon 7:20

I was referring to two different situations.

High inflation could inflate our wages by about 20 percent in the coming years.

I was also pointing out that if we had a currency collapse, you might not get very much for a very expensive watch. If everyone lost their savings in a currency collapse, earned income under the new system would be real funds. No one would have money to pay for the values under the old system. So a very expensive watch might sell for next to nothing if the seller was desperate.