THE BEAR'S LAIR Decade of deception
by Martin Hutchinson
The Japanese public has dubbed 2007 the ''Year of Deception''. Expected
Japanese GDP growth for the year has been revised down from 2.1% to 1.3% and
the stock market has fallen by 10%. I’ll return to whether the Japanese are
right later, but the concept itself appears more generally applicable. There
has in recent years been an excessively snake-oil-salesman quality to the
policies and promises of politicians, monetary authorities and financial
intermediaries.
In the United States for example, the country’s economic policymaking since
1995 has involved not just a ''Year of Deception'' but a decade of it. In
examining the record, one is tempted to quote Mary McCarthy’s verdict on
Lillian Hellman’s
autobiography: ''Every word she writes is a lie, including 'and' and 'the.' ''
Some examples:
In 1996, the Bureau of Labor Statistics adopted ''hedonic pricing'' by which
price statistics were ''corrected'' for improvements in quality. There were two
problems with this. First, it counted quality improvement in the tech sector by
raw processing power, which experience has shown to be wrong: functionality of
tech equipment rises at best logarithmically with processing power. Second, it
did not include the additional costs imposed on consumers by companies as a
result of such innovations as automated telephone answering systems, which
hugely increase the time and effort expended in conducting necessary consumer
transactions. The result of hedonic pricing was to reduce consumer price
increases by close to 1% per annum, producing an entirely spurious decline in
reported inflation and a corresponding increase in ''real'' gross domestic
product growth.
The second deception chronologically, though in many respects the most
important, was Fed chairman Alan Greenspan’s ''recognition'' in 1997 that a new
era of faster productivity growth had dawned, so higher stock prices and lower
interest rates were justified. Part of this ''acceleration'' was just random
fluctuation (much of which was eliminated in later statistical revisions), part
was the result of increasing capital intensiveness in the US economy, caused by
lower real interest rates, and part was the effect of hedonic pricing, which
artificially inflated GDP growth and hence productivity. The reality, when you
look at the series over a long term, was that well over 100% of any rise in
productivity in the late 1990s can be explained by these factors. The
''miracle'' was a mirage and lower interest rates and higher stock prices were
wholly unjustified, inevitably leading to huge misallocations of capital.
As the bubble intensified, in 1999-2000, the Fed moved to the pretense that it
was impossible to know when a bubble was taking place, so monetary authorities
couldn’t burst it. One may well in that case ask what is the point of having a
monetary authority; an automatic system, whether a ''Gold Standard'' or a fixed
monetary growth rule, would cause interest rates to rise in a bubble, thus
deflating it automatically. Of course a monetary authority can deflate a
bubble, as has happened many times; the Fed under Alan Greenspan and Ben
Bernanke has however been a thoroughly political institution that doesn’t want
to incur the temporary unpopularity from doing so.
Connected with the last point is the monetary authorities’ obfuscation of the
monetary basis, both domestic and international, of their job. From 1993, the
Fed abandoned the entirely sound Paul Volcker-era practice of money supply
targeting, which had successfully brought inflation down with only moderate
pain. Allegedly, in the new world of technology, monetary aggregates were no
longer accurate enough to steer policy by. It is no coincidence that
immediately after this change, the Fed embarked on its program of reckless
expansion of M3 money supply, by almost 10% per annum for a decade when nominal
GDP was growing at only 5-6%. The Bundesbank and initially the European Central
Bank (ECB) resisted this laxity, but since Jean-Claude Trichet took over the
ECB in November 2003 that too has been printing money supply, in its case M2,
as if its directors were paid by the banknote. Then in March 2006, the Fed
compounded this error by the unparalleled arrogance of ceasing to report M3,
presumably hoping that by this means its monetary misdeeds would go unnoticed.
In 1999-2000, Wall Street sold dot-com and telecom stocks to investors on the
basis of non-existent earnings. They were aided in this by corporate top
management, which proceeded to pay itself vast sums by means of stock options,
while pretending these had no cost to shareholders. Again, deception.
In the political arena, one may note the ''bait and switch'' tactic of the
George W Bush administration in foreign policy. Bush came to office promising
to pursue a ''modest'' foreign policy, avoiding expansionist Democrat ''nation
building.'' Needless to say, the 9/11 attacks, similar in kind albeit larger in
scale to a myriad terrorist attacks in Europe, were used as an excuse for a
180-degree reversal of this, inaugurating a foreign policy that would have
fulfilled Woodrow Wilson’s wildest power fantasies. The policy merits of this
switch are still being determined (though at this stage one has doubts); what
is clear is that a single act by a small group of fanatics caused a complete
reversal of the program on which Bush had been elected.
On public spending, too, the electorate can reasonably claim to have been sold
a false bill of goods. The Republican Congresses elected after 1994 initially
pursued an admirably tight fiscal policy. However, after Newt Gingrich was
replaced as Speaker of the House of Representatives by Dennis Hastert in
December 1998, Hastert and Tom DeLay proceeded to go hog-wild at the public
trough, using it for innumerable corrupt pork-barrel schemes, to which Bush
joined fatuous and counterproductive public spending boondoggles like the ''No
Child Left Behind Act.'' It is little wonder Hastert and DeLay were thrown out
in 2006; the electorate reasonably felt that if it wanted wasteful public
spending and inventive new social programs, it could get them from the
Democrats, traditionally expert in such matters.
After the stock market bubble burst, the Fed cut interest rates viciously,
decimating the income of US savers and thereby causing a savings dearth and a
huge balance of payments deficit. The Fed justified this by claiming to see a
''deflation'' for which there was no evidence whatever, as retail prices
continued rising gently, stock prices remained overvalued by historical
standards and house prices were soaring. Once again, deception was used to
justify a mistaken policy.
In January 2004 and through June 2007, the Bush administration announced that a
top priority would be to legalize the 12 million illegal immigrants who had
mysteriously appeared in the country. No significant attempt was made to
enforce immigration laws, either at the borders or more importantly among
employers. The administration spent a huge effort claiming, entirely contrary
to the evidence, that uncontrolled low-skill immigration had no effect on the
earnings of domestic workers of modest attainments. The reality was that,
however useful the illegal immigrants in erecting millions of ugly, unnecessary
houses for which there would soon be no market, by doubling or more the supply
of unskilled labor the immigration had the obvious economic effect of
depressing low-skill wage rates to subsistence levels. Again, breathtaking and
unjustifiable deception.
In housing itself, the modern housing finance market has been built on
deception. Instead of assessing a credit risk and making a loan, the modern
housing financier merely collects a fee and passes the risk off to some unknown
investor, preferably a foreign bank. Needless to say, this has resulted in a
substantial percentage of housing loans being entirely fraudulent. It is
increasingly becoming clear that a large proportion of modern finance rests on
similar deceptions, with asset backed commercial paper, securitization in
general, and much of the derivatives market resting solely on aggressive
obfuscation of economic reality in pursuit of fees.
To return to the Fed (who may have been thinking I had finished with it), its
recent activities have rested on two further deceptions. First, it pretends
loudly that ''core'' inflation, stripping out food and energy, is all it needs
to worry about. This is economically nonsense, and it knows it to be so –
naturally when the economy is overheating food and energy prices are the first
to rise, providing valuable signals of inflation in general. Second, the Fed
and the ECB have now decided that the inevitable illiquidity in the interbank
market following exposure of the banking system’s defalcations in housing and
elsewhere can be cured by cutting interest rates aggressively and pumping $600
billion of taxpayer money into the banking system. Needless to say, such
activities do not restore a systemic confidence that has proved itself
unjustified; they simply prop up the stock market and cause an increase in
inflationary pressure, pushing oil prices up over 30% in four months. Again,
it’s quite literally a confidence trick, which will be exposed during 2008.
Turning now to Japan, whose people came up with the ''year of deception'' line,
one is puzzled to find where the deception lies. Yes, economic growth in 2007
will be 1.3% compared with the 2.1% projected, but that is a modest difference,
caused partly by the fiscal tightening in Japan’s 2007 budget, which was both
essential to fiscal stability and in the long run economically beneficial as it
reduces the burden of Japan’s excessive government debt.
There is a certain amount of deception in the monetary area. The Bank of Japan
has kept its key interest rate at 0.5%, on the pretence that deflation is
rampant. In reality, with energy and commodity prices having increased so
rapidly, Japan is now suffering significant inflation, so its short-term rates
are negative in real terms. For the health of the economy, and above all the
income of Japan’s numerous hard-saving retirees, Japan’s short-term interest
rates should be increased to a more normal 2.5-3% as soon as possible.
Nevertheless, it does not appear that the damage done by this mistake has yet
been severe, so one can hope it will promptly be corrected.
A third example of alleged ''deception'' is the loss of 50 million pension
records by the Japanese government. However, the responsible minister resigned,
as is proper, and Britain shortly thereafter, by losing 25 million social
security records of its own, proved that this was not a Japanese problem but a
universal problem of placing excessive reliance on computer systems managed by
incompetent government bureaucracies. One can also ask oneself where there is
more risk of serious identity theft: in a country with almost no immigration
and a well-established domestic criminal class that helpfully identifies itself
by means of tattoos, or a country that has completely lost control of its
borders and sold most of the prime real estate in its capital to the Russian
mafia.
Naturally, a primary reason the Japanese investor class regards 2007 as a
''year of deception'' is that the Tokyo stock market has dropped 10%, the only
large market to have done so. However, in a year of a major international
financial crisis, in which several medium-sized banks have collapsed and $600
billion in emergency funds has been pumped into the interbank market, it may
reasonably be questioned why any of the world’s stock markets should have
risen.
It appears that the Tokyo stock market is currently the only major market in
the world that is NOT ruled by deception!
Martin Hutchinson is the author of "Great Conservatives" (Academica
Press, 2005) - details can be found on the Web site www.greatconservatives.com
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