Out of the Mouths of Economists

I read a lot of different perspectives from different angles on the state of our economy. I expect opinions to vary in what I read. In fact, I need the different perspectives to help give me the complete picture, but sometimes what I read is so outlandish that I almost spit my drink out onto my monitor. Case in point is John Mauldin’s recent “Outside the Box” guest column written by Dr. Lacy Hunt and Van Hoisington. 

Rather than expect you to read it, I’ll summarize it for you:

  1. Tax cuts are a better way to stimulate the economy rather than one-off stimulus checks because people are more likely to spend an increase in permanent income rather than a temporary windfall. 
  2. The annual turnover rate of each dollar in circulation (termed velocity by economists) is going to slow down because of deflationary pressures despite Ben Bernanke’s best efforts. 
  3. In prior economic downturns, consumer prices have continued to fall for sometime. Because of this, long-term government bonds have proven to be excellent investments during these deflationary contractions. Since we’ve got a ways to go with ours, go load up on Treasury Bonds.

It was the last suggestion that made me lose my cookies. At first I thought I must have misread the concluding sentence of the column, but when I went back, there it was: “As a hedge against a recurrence of a prolonged debt deflation, some investors may want to consider even larger positions in high quality, long term Treasury securities.” WHAT!

How on Earth could two people pen an article that starts off talking about how furiously Ben Bernanke is running the printing presses and conclude with ‘go long on bonds’? Aren’t these people educated? Oh wait, I think I see the problem. The article was written by “Dr. Lacy Hunt.” You see, any ignorant person can spout off some bit of economic nonsense, but it takes a PhD in Macroeconomics to really strike gold when it comes to nonsensical statements. As I wrote in my book, “What Do You Mean My Money’s Worthless?” Macroeconomics is a junk science devised by a hack named John Maynard Keynes. To say it’s littered with fallacious concepts is to not understand the nature of the problem; it’s not littered with fallacies, it’s based on them! Should macroeconomists get anything right it’s not because of their economic training, but in spite of it. 

The problem that this article makes is based on the fallacy that the an economy can be understood as a mathematical phenomenon rather than as a psychological one. Don’t get me wrong, I have nothing against mathematical descriptions of complex systems. I got my BS in Chemistry. I can tell you all about them. But the economy is not a buffer solution and Ben Bernanke is not a chemist trying to calculate the right about of acid to add to bring the pH of the solution back from being overly basic.
Economies are simply collections of people and resources. Economics then is a study of how individuals or societies make decisions regarding how to allocate their labor and resources, and how those decisions can be improved. To look at them as impersonally as a chemist monitors a pH electrode is to assume that you can not only understand what’s going on, but can be in control of it. Of course, that’s exactly the illusion that government bureaucrats love, which is why Macroeconomics exists at all.

This article supposes that we in the United States are undergoing an economic crisis similar to the Great Depression or 1872-1894 series of banking panics or Japan’s Lost Decade. Long term government bonds did well in those times, so they should do well now. What seems completely lost on the authors is that, in two of those crises, the currency in question was backed by gold. In all three of these crises, the countries in question were running a trade surplus and were nations made of savers. That is nothing like the crises we are in right now. We are a nation of debtors and we are finding ourselves simply unable to take on any more debt. Into this breech steps our fearless central banker to create all the money anyone would want to spend; arm in arm with the central banker, is our government that, as always, is here to help. It figures it can borrow and spend all the money that the consumers won’t.

It’s ironic, but these economists who seem the US economy as a series of cogs and gears don’t seem to understand the concept of an open system. In chemistry, an open system is free to gain or lose energy from outside. Therefore an open system does not have to reach equilibrium because it can be receiving energy that keeps it constantly out of a state of equilibrium. It is only when the system becomes closed and is no longer able to receive energy from the outside that it must seek an equilibrium and, eventually, cease being dynamic.

These economists are looking at the US as a closed economy where the economy is slow to respond to the printing of money from the central banker. They don’t seem to understand that it is actually an open system receiving a great deal of energy from the outside in the form of continual infusions of goods and services from our trade partners who may want to get paid back someday. Are we to expect that the other nations of the world are just going to continue to loan us money as interest rates hover at zero, the central banker has gone on a printing spree, and our government has dedicated itself to running trillion dollar deficits until moral improves? Do we not expect that some other nation might want to use some of its savings for itself and, should that happen, interest rates will go up and not down. That’s ignoring, of course, the possibility that the United States might simply default on the debt entirely.

Perhaps, instead of comparing our situation to past economic crises, these two should have compared it to the economic collapses that dot the third world? Or perhaps they should have studied Chemistry.

10 thoughts on “Out of the Mouths of Economists”

  1. Now I’m curious… what happens when a country defaults on its debts? Somebody else absorbs the loss, I presume, but then what? What happens to the country?

    I agree that economics must be a collision of mathematics and psychology. There are too many human players in the economy for human psychology to be ignored.

  2. Lacy Hunt’s thesis is that deflation is going to prevail despite the money printing the FED does. The money base supply has indeed shot up from 2B to 600B USD. But that’s nothing compared to the private debt of the US (some 40T USD). So to counter deflation, at least the FED must print a truckload of tens of trillions of USD. This is not palatable politically.

    If your argument is printing (monetizing) will bust the dollar & make treasurys plummet, look at Japan. It has been monetizing the long-term JGB in late 1990s. Where do we see the JGB yield now? 1.2-1.3%! There’s treasury bull in JGB. Why? The Japan printing simply can’t keep up with the bust in private debt. They are still in deflation despite massive printing! Now, Japan was better because Japan’s savings rate was very high when they enter their deflation. With US very low in savings entering the crisis, expect the deflation to be much much worse.

    And as we all know, deflation is the green pastures for treasury bulls. Why? In deflation, the relative value of money (cash) increases. Treasurys provide those steady incomes (interests) and there is no one doubts the ability of the FED to print (to pay for those interests).

    It seems that you didn’t bother reading the whole report. Well, I suggest you read it carefully and understand it in its entirety. These two people actually are the best minds out there, with extensive historical perspectives almost no one has.

  3. On the contrary Roger, I read it multiple times in order to synthesize it down for the blog. I know exactly what she’s saying and I can tell you she’s dead wrong. Long term government bonds are already down far more than the stock market this year and they will crater in value as the year drags on. Far from being the “best minds” out there, they are recommending economic suicide.


  4. This is an article to consider that no one is going to stop financing the US Debt:

    And to add a point, JGB market is the largest govt bond market in the world at 8.7T USD. Japan’s public debt is some 170-180% of its GDP. Compare that to US, which is only about 50% its GDP.

    Worried about trade deficits? Since 2005, US trade deficit has been going down as % of GDP. At peak it was around 6%, now it stands at around 3%. We should expect it to get lower as the deflation exacerbates, possibly going to 0 in the next 5 yrs.

  5. These 2 guys are actually making a lot of money last year from treasuries. 38% in 2008, and it has been 7.56% annually the last decade. The record is somewhere in marketwatch.com website. I’ll try to supply you if possible.

    Well, no doubt there was a fear bubble recently in treasuries, making the 30-yr shot up to 2.5% yield. But if you look at Lacy’s chart on how the treasury yields doing in crisis, it’s been anything but linear & smooth (and she said that, too). Look at JGB, for example, it went down to 3%, then shot up to almost 5%, before continuing the downtrend in yield (uptrend in JGB price).

    Eventually, we all agree that inflation will come someday, but I believe it will be a very distant future (not sure if it’s 15-20 yrs as she said, but not within the next 2 yrs at least). Preparing for it too early (such as by shorting treasuries) will hurt really bad and can possibly bankrupt someone who prepares too early. Jim Rogers, Peter Schiff, and some other guys with strong inflation/hyperinflation rants are a few examples of those preparing way way way too early. They got hurt really bad.

  6. Here is the marketwatch link of Lacy Hunt’s Hoisington performance:

    An additional point, comparing the US to a third world country is inappropriate. 3rd world countries like Argentina, Mexico, emerging markets in Asia, they are all owing money in other country’s currency (i.e. US Dollar). The US is owing money in its own currency that it can print.

    Furthermore, extreme indebtedness is pretty much the state of affairs of everyone – not just the US. Europeans, both Western & Eastern but especially Eastern, are in much worse shape than the US. The Chinese? Transparency has never been its revered quality, with hundreds of thousands of factories (not employees — factories) imploding, I’m sure the banks’ loans are mostly unrecoverable, rendering them insolvent. But the govt is always hiding the truth, that’s what a communist govt can do. Growth at 6.8%? Anyone with just a small dose of common sense won’t believe that. How can an economy with mammoth sizes of layoffs grow 6.8%.

    We all focus on US banks & how rotten they are, the others are not in much better shape, if not worse. If the USD is going to collapse, you have to ask… against what?

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