There are two false economic notions that I would like to address in this essay. I think the sad permissiveness of these false notions limits the scope of our economic understanding, inhibits our ability to comprehend our nation’s economy, and restricts or distorts the available policy choices.

1) "tax cuts" used to "incentivize" investment is better than government directly funding various investment projects.

2) the idea that nurturing "self-interest" creates the best society for all.

These are tenets of the modern neo-classicists called Libertarians. Their main appeal however is essentially a distaste for "big government." As the theory goes, since Government is either despotic or corrupt (or both), letting people make "individual choices" becomes perceived as more free and pristine, or less tainted by the sodden hand of government. Thus "tax cuts" as an economic policy becomes better than government investment. The evil corrupt government will just waste the money on things from which only a few people will benefit, and people know best how to spend their own money.

But listen carefully to this dualistic philosophy. One extreme is attainable only by avoiding its opposite extremity -- the avoidance of government investment "makes possible" independent, free actions by citizens who have a little more money in their pocket. This leads inevitably towards the desire to exterminate the "bad" in order to enjoy the unmitigated "good." Rather than viewing the cosmos as a composite mixture, this philosophy divides into 2 unbalanced camps, believing in the virtue of the individual above and beyond all else without recognizing that no one is independent of society, that no individuality occurs without feedback, guidance, and influences. People are even expected to "self-regulate" naturally according to some hyperactive versions of this paradigm.

Society is composed of individuals, it is true. That some individuals, by their nature, exert an influence on culture, technology, economic and political leadership is inescapable. However, this will be and is true no matter what type of government or economic philosophy gets applied. Human beings are genetically wired and instinctively capable of producing talented, intelligent, and charismatic individuals regardless of the nature of government. To base an economic policy solely upon the desired end of nurturing individualism is actually quite useless because Individualism, or lack thereof, is a political question, not an economic question.

Giving individuals more money through "tax cuts" in order to sponsor "demand" is not effective. Individuals will spend or save their money according to their own whims, and are widely dispersed in addition to being asynchronous in time. There is no aggregated focus for the funds that are involved in the "tax cuts". Once the profits filter up through the businesses benefiting from the spending, these profits are not guaranteed to be invested in any other way then by the demands of the investors. Although possible, the influence of some "superstar" CEO's "vision" on investment strategy buts against a long history that has proven time and again mankind's tendency to view short-term gain over the expense of long-term gain. Individuals quite often do not act towards something they cannot envision, and very few person's are disciplined enough to maintain focus for a very long term vision. Thus a very small percentage of the "tax cuts" winds up in the hands of these very few. The vast amount of funds is used up merely supporting short term consumption.

Only by direct government investment does all of the money get spent on a specific investment infrastructure. Citizens might have a few extra dollars in their pocket, but they won't get high-speed rail interconnectivity throughout the nation unless government begins to directly fund the 10 to 15 projects across the country that this policy would take. This initial investment is too large for any private firm to make, because the horizon of such a project is longer than 20 years, and the profitability of such a project is too small. There are quicker, safer ways to make money. However, enabling fast, cheap long-distance transportation within the United States is an undeniable social benefit that will pay for itself much as the national highway system did.

This was true about the creation of the national railroad system, the national telephone system, the electric grid, the internet, and every other massive long-term investment that has occurred. Railroad companies were given free land and subsidized bond financing. The eventual national railroad system that evolved through a series of state railroad commissions would never have gotten built otherwise, because there were too many competing fiefdoms, each corrupting the state officials and fleecing the public with high costs. Once the frontier of massive federal lands (confiscated from the Indians and Spanish) shrank by the early 1900's, government needed to rely on income and wealth taxes to be able to afford it's function in society. Larger and more concentrated populations demanded collective decisions and approaches to problem solving.

The needs of a populations is paid for by taxes. Instead of pretending we can cut the budget and continue to borrow profusely from foreign nations, we should simply pay for the previous years tax bill. If taxes need to be raised, then create a simple progressive formula that increases everyones burden according to their ability to pay. The necessity of a government proactively making the collective investments is fundamental. Society as we now know it would not have come to fruition without the concerted aggregate strength of the larger society represented by government. It is true that the halls of government can be corrupted, but only until such corruption is rooted out, and not without the aid of other members of government or citizen involvement. By contrast, a corrupt aristocracy is practically inescapable, as our forefathers once knew. We have forgotten their wisdom I'm afraid.

"Tax cuts" are a very inefficient investment strategy. The economic policy of "tax cuts" only creates an elite wealthy class at the expense of the socio-economic infrastructure. The very wealthy will gradually use their large tax cuts to pay for their own societal comforts at the expense of investments needed by society. Paying for private police, yachts, private schools, and private jets does nurture a sector of the economy, but these "investments" do not spread to the society as a whole. Over time, about 2 or 3 generations or 60 years, the system grows more economically stratified, until 90% of the people are poor, 9.9% are middle class, and 0.1% are very rich. Even while all those individuals made their own choices and exercised free independent decisions.

Human societies will drift towards aristocracy and plutocracy. This is what the writers of the Constitution all debated and understood. The document they created was their attempt to avoid this historical trend.

This comes from Bob Woodward, one of the 2 Washington Post reporters infamous from the Nixon Watergate years. One week ago, Mr. Woodward assessed the lessons learned from the Bush Presidency.

1. Presidents set the tone. Don’t be passive or tolerate virulent divisions.

2. The president must insist that everyone speak out loud in front of the others, even — or especially — when there are vehement disagreements.

3. A president must do the homework to master the fundamental ideas and concepts behind his policies.

4. Presidents need to draw people out and make sure that bad news makes it to the Oval Office.

5. Presidents need to foster a culture of skepticism and doubt.

6. Presidents get contradictory data, and they need a rigorous way to sort it out.

7. Presidents must tell the public the hard truth, even if that means delivering very bad news.

8. Righteous motives are not enough for effective policy.

9. Presidents must insist on strategic thinking.

10. The president should embrace transparency.

Hat-tip to Barry Ritholtz.

If History is any indicator, we are looking at 15 to 18 years of a downturn from now, the worst of which will be the first 8 or 9 years. So if we presume the beginning to be 2007, that means another 6 or 7 years hence before the unwinding completely unravels.

And notice that the recent dramatic rise over the last 17 years completely dwarfs the previous historical rises since 1871, by a factor of 2. This means the unwinding and longevity will be longer, hopefully not by a factor of 2. Or else, we are looking at potentially a full 12 to 15 years before the economy stabilizes.

Yes. It is really that bad. California is soon going to be out of money, unless money starts growing on trees or federal subsidization begins in another 2 months. The State Comptroller John Chiang has said California will run out of money by March or April if nothing is done. This is the guy who signs my paychecks.

1) supply-side economics only allows financiers more money with which to make foolish investments

2) tax rates alone are not an effective tool to “spur economic growth”, and do not diminish or limit the available investment opportunities

3) throughout all of history there has never been such a thing as a market that existed without government setting the boundaries and regulating the transactions … because no one wants the alternative

I think the sad permissiveness of these false notions limits the scope of our economic understanding, inhibits our ability to comprehend our nation’s economy, and restricts or distorts the available policy choices.

The following is the beginning of an opinion in the UK Telegraph by Rob Arnott (founder and chairman of Research Affiliates) and John Tamny (editor of RealClearMarkets). Both men are ideologues and charlatan's of economic theology.

Back in the dark economic days of the late 1970s and early 1980s, truly revolutionary change on taxation improved the economic outlook in both Great Britain and the United States.

With demand-driven Keynesian thinking having proved ineffective as an economic stimulant, classical thinkers possessing a greater affinity for the works of Adam Smith and John Stuart Mill successfully filled the gaping policy void. Nigel Lawson perhaps articulated the new/old thinking best when he noted Britain's fundamental economic defect "was not a shortage of demand but a failure of supply."

[SOURCE: Rob Arnott & John Tamny | UK Telegraph | 12 January 2009]

This is a high level statement of opinion. Yet it is an opinion that erroneously equates coincidental events without understanding or even acknowledging macro-economic developments. Raising or lowering taxes alone do not all by themselves stimulate the broad crescendo of economic developments that occur in any age: especially, in the absence of legitimate new investment opportunities (except buying and selling paper) or when self-interest demands forms of investment that are narrow-minded and monopolistic.

For instance, no increase or decrease of taxation would have changed the economic outlooks in 1252. Or 1811. Or 1888. Or 1935.

During the 1970s and 1980s, massive changes in consumer goods, consumer entertainment, electronic devices, and computer technology opened up a tremendous amount of investment opportunity. Videos created a video production industry, video stores, and VCR recorders. Ditto the cassette tape and the CD industry. Cable tv required electronic boxes that had to be installed, and cable programming boomed from 3 to 5 stations, to 30, 40, 80, and more than 100. Consumer goods created half of the food industry at the supermarket, and the aluminum can changed the the way soft drinks were distributed. Computers went from the size of a desk to sitting on a corner of the desk, and computers intervened everywhere in every single line of industry and service, from the assembly line of factories to the registers at retail outlets to the desks of accountants and journalists and college students.

Lax taxation did not create this historical situation, and high taxation levels would not have restricted what occurred at all. The changes to human culture was too tremendous.

If you buy something for $8 and sell it for $14 under the given tax conditions, raising taxes will increase the cost to $9, but then you can sell for $15. Notice that the increase gets factored into the cost. The resulting revenue is thus increased, and all salaries come out of revenue. Since the difference between sale and cost is still $6, nothing has occurred which changes the incentive of the business. This is true within a range of percentage rates. I am using a simple analogy as a metaphor for how taxation alone does not "open up", "release", or "create" investment opportunities.

This was known by John Stuart Mill during the 1800s. The same John Stuart Mill for whom (according to the Telegraph opinion) "classical thinkers" have a greater "affinity" by making insinuations quite antithetical to the original thinker's reality based ideas.

The median income since 1970 however has not changed, while larger and larger percentages of wealth accumulated to the top 0.5%. Like the galleons of Spanish gold, there was so much money and investment opportunity that no one paid attention to the unequal distribution of economic gains. Social costs increased on those who worked hard but earned less value from their wages. The rate of poverty has also increased. Government meanwhile created deficit spending and downsized investments in social and economic infrastructure.

Here's another silly statement.

But history says tax increases are rarely the revenue generators that they're presumed to be. As Adam Smith wrote, high taxes "frequently afford a smaller revenue to government than what might be drawn from more moderate taxes".

More importantly, history in both the UK and the US shows that the best way to increase tax revenue from top earners is paradoxically to tax them less. The percentage of federal revenues paid by the top 1pc of US earners rocketed (from 15 to 35pc) when the rate of taxation fell.

What?

Notice how the putative "fact" at the end does not have a date, or a context. It's just rounded-off numbers. The ACTUAL history is that if you have a lot of loopholes and a higher tax rate, you can cut out the loopholes and decrease the tax rate a small amount (from 90 to 70 for instance) and raise more money through taxation. This is true even while the opinion's quoting of Adam Smith is akin to finding a passage in the bible that justifies your favored predilection. The statement is anecdotal.

But the silliness continues throughout the "opinion". Here is the last statement in the Telegraph "opinion" piece.

When all's said and done, there is no company formation and there are no wages without capital. Rather than creating false growth through wealth redistribution, the better, more-proven path would be to reduce penalties on work and investment for all. If this were done, the UK economy would boom due to increased productivity and any lack of consumption would quickly become an afterthought

WRONG.

The cycle of investment opportunity is fickle. It's occurrence is due to historical timing. All taxes do is distribute the burdens of society and economic infrastructure as a cost to government, because making social and economic costs as an individual burden is exploitative and (more importantly) terribly inefficient. We tax ourselves and pay the costs because the alternative will cost too much and tend to focus on short-term profit at the expense of long term development, when a long term horizon of 20 or so years is necessary. Private investors can't wait 20 years before showing a 2 or 3 % gain.

This is the real lesson, if there be one to learn, by Mr. Obama.

But the authors of the opinion in the telegraph article only presume a specious policy decision, and then use it to attempt limitations on the issue of government involvement and government investment spending. This is like presuming that flushing the toilet will inhibit free-thinking, so the discussion gets focused on how to contain the smell, and everyone wonders why the pile of smelly shit just won't go away. Sooner or later someone will have the courage to admit the need to flush the toilet. Instantly the false prophets will raise a howler about the ramifications. Free-thinking will go away, they will say, but not everyone will be intimidated by the backward stupidity.

Free-thinking can't go away. Flushing or not flushing the toilet is not going to inhibit or promote free-thinking, but it will create a pile of stinky manure. Likewise, investment opportunity or the lack thereof is not a function of taxation.

This notion of taxation being able to create investment opportunity in absence of the context and the economic conditions is, like the toilet example, inhibiting the understanding of how we function as a healthy, creative, effective society. Similar to the above analogy, if you apply the wrong solution to a misunderstood problem, all you get is a bigger mess.

I didn't come up with this analogy, but the story is a relevant parallel to the economic situation between the United States and the Asian exporters that manufacture more than 95% of everything Americans buy.

7 people crash on a desert island, 6 Asians and one American. The 6 Asians are assigned jobs, one fishes, one hunts food, one collects firewood, one grows vegetables, one makes clothes and another builders shelter. The American’s job is to live in the shelter and consume the food and clothes. He feels good about himself - after all, the 6 Asians only have jobs because of him, he gives their day some purpose.

How long before the 6 realize they are better off kicking him off the island?

Proof once again that math is an architecture built upon assumptions. If the assumptions are wrong, so is the math.

For instance, 2+2 = 4 and 2 * 2 = 4 are both equal to 4. But that is because multiplying by 2 means adding the same number twice. If however we built an entire theory upon this happy coincidence we might start thinking 10 + 10 = 10 * 10 , and be wrong by 80 digits.

Click here for the webpage.

THE FLOWCHART THAT BECAME THE FINANCIAL CRISIS

picture courtesy of Barry Ritholz at ritholtz.com

Dr. Jurgen Zentek, a professor at the University of Veterinary Medicine Vienna, reported that he fed one group of laboratory mice traditional corn and another group GE corn made by the Monsanto Company. The GE crop is bred to survive being sprayed by herbicide and to produce its own insecticide. The mice maintained their diets for 20 weeks, long enough to produce four litters of offspring.

Zentek found that the mice who dined on modified corn had fewer litters, fewer offspring, and more instances of complete infertility than those receiving a conventional diet. Not only that, but the infertility of the GM-corn-fed rodents became more pronounced with each passing litter.

I'll source it later.

Anything that uses a GM corn product, or a derivative of corn, is tainted. This includes the infamous High Fructose Corn Syrup. Quite possibly the modified proteins that the DNA produce to credit its own insecticide is having a negative effect on the hormonal systems of the mice. Now ask yourself, what are the long term implications upon the human hormonal systems from something humans ingest every single day for 40 years?

This could easily be determined with more research and study. I wonder how much of the "Breast Cancer" and "Prostate Cancer" research is doing here. Or is that well-advertised fund merely creating drugs for the drug companies to sell?

It is my belief that the rise in cancer rates due to hormonal dysfunctions is related to diet : eating quantities of processed food, of which for most processed foods (soda included) is nearly 90% composed of GM corn or GM corn derived products.

These are a series of quotes from the blog of Barry Ritholtz.

Thank you Barry.

No one can argue that the trend has been down. Volatility often signals a trend change. For how long, i don’t know.

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It means that I can’t hold on to a position for a decent gain, and it means I get to practice trading through drawdowns. I hope this choppy period is over soon, but I’ll keep taking my setups as they come no matter what. All I know is that streaks happen, they’re unpredictable, and I sure like them better when they’re the winning kind!

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I think nasty choppy trade like this indicates lighter volumes and itchy trigger fingers. There isn’t much conviction out there in terms of market direction. We are clearly waiting for some significant macroeconomic event to drive the market in one direction or the other. Of course I think that this will be some kind of reflationary event.

It’s hard to know what might be the trigger but it is clear that the $ will not go to the sky, and treasury yields will not go to zero. I have been seeing quite a lot of volatility in the long bonds, and that often presages a fall in price, whatever the instrument.

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This is, in my experience, typical as markets progress toward capitulation. The tempo increases, as do the violence of the oscillations, until even the most dedicated traders are “thrown” from the horse or wisely decide to step back to the sidelines and let others’ blood be shed instead of their own.

Kinda like playing Space Invaders, or musical chairs.

We’re some time away from the end of this game, IMHO. We’re not seeing swings increasing in size … yet.

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today the Dow was up 150, but the Nasdaq was flat, the Philly semiconductor index was down 2%, and the XLF was down nearly 1.5%. This baby’s going lower; however, I’d rather not initiate a new short position unless we get a significant rally (at least 8%).

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The short interest data I have looked at recently tells me that hedge funds are not providing the liquidity they have in the past by shorting stocks. They are deleveraging and are basically hamstrung. They will get creamed with redemptions, as who will pay 2 and 20 for mutual fund type returns? The result is a market that has lower than capitulation volume with choppy trading. Also a market where no short squeezing can take place on a macro basis.

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As leverage leaves, paper stays, creating relatively light volume. Programs are moving levels quickly, as correlation rises. Arbs can’t hold positions.

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It’s bigger trouble than that because as equities continue to fall banks have less to loan. Why banks are all invested in each other I have no idea but it’s going to be part of what will cause the total collapse. The Asian banks are now taking it from falling housing. Each bank will take out the next. Who’s the next Lehman I have no idea. Puts are too expensive on banks.

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Well, the market will go lower. It is simple. “Leverage” is another word for “Margin Financing”. When the “outsourcing” of computer risk modeling is allowed…. the end result is extreme leverage on the non-fundamentally sound derivative CD “Swaps” or “Insurance” if you prefer. You have to admit a great “Marketing” job was done all-around. Question(Thinking)…. If there were less people around (Population) when the Great Depression occured (Industrial Economy, People with the means/mindset to survive)……. Since there are alot more people now (Financial Economy) would it stand to reason that with a low unemployment level say @10 to 15% and our special American social system (Unemployment Benefits and the like) in place could this lower rate now be just as financially devestating as the Great Depression rate of @25%?? I think it might be. I think an economic belief is dying. Monatary policy has its uses, but, when the pendulum swings further in one direction(Forced by a belief) it will swing back harder in the other. (Chicago School). Heterodox is the only way to go. Understand the systems as if it were a living, breathing entity.

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What I see in this is analogous to the screech when a mike gets too close to the speaker. Sometimes it is just unpleasant but it is sometimes destructive of the speaker cone or amplifier components if it is allowed to grow too loud or go on unchecked for too long. Even if not destructive, it is usually beneficial to stop the ringing so that the sound system can return to “normal” function (even thought the ringing is also a normal characteristic of such systems).

To correct the deafening screech, one must either move the mike away from the speaker (reduce the feedback coupling) or turn down the amplifier (increase the loss in the feedback loop) or change the time response (add delay) in the system.

If the analogy of amplifier feedback system analysis holds, in the economic feedback system of the stock market, to correct this ringing (price volatility), the system must have a loss and or delay introduced to prevent excessive instability. This solution is simple in concept but it is very difficult in the complexity of real world politics to make such an adjustment.