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Chris Ridder
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MSc Inventment Managment 2005 Cass Business School City University of London I started trading when I was 20 years old by shorting orange juice futures! And yes the results were not pretty.... Here is my public performance at Marketocracy which the long fund started November of 2000:... More
  • Debunking A "Response ... to Austrians" 0 comments
    Feb 17, 2011 11:48 AM | about stocks: MSFT

    Again I am finding myself having to reply to a post and point out the various fallacies and inaccuracies written by another author.  The post is titled “ Response to Chris Ridder and Other Austrians” (seekingalpha.com/instablog/475264-tim-ay...), which was a response to an article I wrote (seekingalpha.com/article/252331-debunkin...). Well partners, you now have to sharpen your intellectual spurs and saddle up for a longer journey, for unfortunately the fallacies have multiplied.
     

    In the second paragraph the author states, “To prove that he does not understand the current monetary system in which we live, Chris ends his article with: ‘I do recall a while ago that the central bank head of Zimbabwe said his bank was just doing the same thing the FED was. This is not the type of neighborhood I would like to take even a short visit to.’ This comment alone shows that he does not understand the monetary system in which we live because he assumes the leader of Zimbabwe's Central Bank did. I am not sure of the benefit one derives in getting their understanding of economics from the leader of a failed state…” I made no such assumption about the understanding of the leader of Zimbabwe's Central Bank (Dr. Gono) into modern monetary theory and certainly did not receive my education in economics from Dr. Gono.
     

     I have an undergraduate degree from Biola University and I further studied undergraduate classes in economics with Dr. Alex Taber, a University of Chicago PhD, at Santiago College and at the London School of Economics during their summer session in 2003. In 2005 I received my Masters of Science degree in Investment Management from the City University of London.

     

    The author has erred by assuming that I used the article to exposit the same sentiments as the editors of an online newspaper. Instead, I used the article to substantiate my claim concerning Dr. Gono’s comments as a source.  Notice, I wrote in the original article, “I do recall a while ago that the central bank head of Zimbabwe said his bank was just doing the same thing the FED was.“ I made no assertion that the US is identical to Zimbabwe. Now, I will make the argument a bit more formal. The propositions are 1) Dr. Gono was using poor economic policy tools. 2) The US central bank began using similar economic policy tools. With the conclusion being 3) the US central bank policy had at least some common tools as that of the Zimbabwe central bank which are poor.   Let us now examine what was said, by Dr. Gono in the article, ‘’I've been condemned by traditional economists who say printing money drives inflation, … But once the IMF advised America to print money, I decided God was on my side and had come to vindicate me.” Hence the author’s assertion, “We are not … Zimbabwe”, could be rebutted, by showing the use of an economic policy tool common to both parties, with the understanding it was not a claim that the US and Zimbabwe are totally identical.
     

      I will also point out the author’s fallacy of begging the question by asserting “To prove that he does not understand …” as a premise in his argument  and then coming to the conclusion, “This comment alone shows that he does not understand the monetary system in which we live because he assumes the leader of Zimbabwe's Central Bank did.”   Continuing on in the fourth paragraph one comes across these statements, “These countries were required to print their own currency to satisfy debts denominated in another currency. This basic understanding is foundational to any argument he might want to lay on the current situation in the U.S. in regards to hyper-inflation.” First, I never mentioned hyperinflation or even high inflation in my article; one can do a word search for verification.  Second, in regards to the first sentence one country will always lower the value of its currency, ceteris paribus, if it supplies more of it. What an oddity that a country can think it can buy more German Marks if it simply prints more Dinars!  Here is a link to an article that discusses the hyperinflation that occurred in Yugoslavia in 1993-94 (www.sjsu.edu/faculty/watkins/hyper.htm and scroll down a bit).


    It states, “Under Tito Yugoslavia ran a budget deficit that was financed by printing money. This led to rates of inflation of 15 to 25 percent per year. After Tito the Communist Party pursued progressively more irrational economic policies. These irrational policies and the breakup of Yugoslavia … led to heavier reliance upon printing or otherwise creating money to finance the operation of the government and the socialist economy. This created the worst hyperinflation in history up to this time. “ While, the Yugoslavia dinar would depreciate against the German Mark, there bye making Marks scare, no mention is made of a foreign currency debt. This empirical data refutes the claim that to have hyperinflation a country will have a problem with debt denominated in a foreign currency.  If anyone has data of Yugoslavia having a more than trivial external debt at this time please present it.


    Next we come across this statement, “He wants to show that the Oakland A's will never win the Super Bowl, when in fact he doesn't understand the Oakland A's don't play football.” This is a straw man fallacy.


    In the fifth paragraph the author revisits the numerical example he gave and addressed the mistake I brought up in his compounding math. Let me be clear that I was not asserting a 10% growth rate for China and 3% for the US for the rest of time. I was only using the hypothetical specifics given and pointing out the flaw in reasoning. One can google “US and China GDP convergence rates” and begin to shift through more scholarly articles and reports than the ad hoc example given by the author. “What Mr. Ridder forgets to include in his argument was that I stated we are in fact China's largest customer. “ Here I will rebut by using the mainstream understanding of GDP; the formula Y = C + I + G + (X-M) or GDP = Consumption + Investment + Government Spending + (Exports – Imports).  The author has forgotten to include possibility of increases in China’s Consumption, Investment, or Government Spending to reach a hypothetical growth rate of 10%, even if their “largest customer” is growing slower. The author states, “He missed the forest for the trees in that the U.S. is possibly decades away from being overtaken and losing reserve currency status.” I would rebut that I wrote, “the OECD showed that the EU-27 had a larger economy than the U.S. in 2009.” in response to his claim, “ The biggest economy in the world should be blessed with the reserve currency”; and this point, about when all 27 nations would adopt the Euro, was not addressed in the author’s reply.  


    Continuing on in paragraphs 6-15 the author discusses comments made about deficits. The author states that Rothbard, and hence I, do not understand the current monetary system because the analysis was done when the US was under the “gold standard” and that now the US government does not need to borrow money to spend if its spending is greater than its income.  Rothbard’s position on when the gold standard was abandoned is 1933 and not 1971 as shown here, “We have already described one part of … the abolition of the gold standard by Franklin Roosevelt in 1933, and the substitution of fiat paper tickets by the Federal Reserve as our ‘monetary standard.’” (http://www.lewrockwell.com/rothbard/frb.html) This refutes the belief that Rothbard’s analysis was attached to the gold standard.  He wrote extensively about fiat central banking in various articles and books, such as “The Mystery of Banking”, “Case Against the Fed” and “What has the Government Done to Our Money?”. The author finishes by claiming, “The U.S. does not need to ask China or its citizens to borrow money so they can go spend.”  



    Now exactly were will this money come from if the government spends more than its income and it does not borrow it? Obviously, it would have to be printed (or electronic equivalent now days). The author quotes from Wray who totally side steps the question of inflation by stating, “One method that is almost universally scorned is for the government to issue non-interest-bearing debt - currency - to finance deficits. This can either be done directly by the Treasury, or indirectly through the central bank. Because government deficits financed in this manner would directly cause the money supply to expand, many economists claim this would directly cause inflation. We do not intend to explore these positions in more detail. “ This is the Modern Monetary Theory (NYSE:MMT) response to an economist questioning the inflationary aspect of this approach. Other questions left unanswered are who will decide how to spend this printed currency? How will it be kept free from corruption? Should the government have this power to be able to purchase resources with a currency creatio ex nihilo? I think these questions and more could take up several pages so I will just stop here and move on to topics discussed in the post.



    Next the author refers to the work of a Mr. Roche, who is the owner of PragCap.com in paragraphs 19 – 27, with paragraph 27 having 8 numbered bullet points.  However, lets begin with this statement in paragraph 23, “ In reality, our bond market funds nothing …It has nothing to do with funding the government. “ Now clicking on the link leads to an article explaining how there are always primary dealers there ready to buy US Treasuries. Okay I understand that and so did Rothbard, “Let's assume that the Fed buys $10,000,000 of U.S. Treasury bills from some "approved" government bond dealer (a small group), say Shearson, Lehman on Wall Street. The Fed writes out a check for $10,000,000, which it gives to Shearson, Lehman in exchange for $10,000,000 in U.S. securities. Where does the Fed get the $10,000,000 to pay Shearson, Lehman? It creates the money out of thin air. “ (http://www.lewrockwell.com/rothbard/frb.html) It would seem that Rothbard understands very well the function of primary dealers, the role the Fed plays, and money creatio ex nihilo used for debt. Next one has to address a few issues about these bonds if they do not fund the government as claimed. Who is receiving the money and paying the interest? The US Government (used in the example) as stated in the bond indenture. It would seem the most reasonable conclusion is that there must be some relation to the US Government even if there are financial intermediaries in between that most people are unaware of.  



    Next in point 1 of paragraph 27 Mr. Roche writes, “Someone who understands the modern monetary system understands that a sovereign government with monopoly supply of currency in a floating exchange rate system has no solvency issue.  “ Now in 1998 the Russian the government decided to default on its domestic ruble debt (Atlanta Fed Pdf Study and Russian crisis ).  This shows that a sovereign government can default on its own domestic debt. Although this historical fact does not fit Mr. Roche’s stricter limits of a having a freely floating exchange rate, the Russian government still should have been able to meet its own domestic currency obligations through printing, even while defaulting on foreign obligations.  



    In point 3 of paragraph 27 Mr. Roche again writes, “Fear mongerers want you to believe that the Fed is the evil entity that “prints money”.  The truth is that the Fed can do no such thing.  Only Congress can print money …” I will question this claim that only Congress can “print” money; for how did the Fed pay for its purchase of over $1 Trillion dollars of Mortgage Backed Securities and expand its balance sheet from over $900 Billion, in 2008, to $2500 Billion in 2011 (
    Data Here)? Obviously, it printed it and paid this to the sellers of the securities it bought.  



    Next, in point 7 we come across this claim, “Quantitative easing (QE)
    does not increase the money supply …“ Now of course this depends upon how one defines the money supply so more clarification would be helpful here to better understand this claim. A recent article briefly explaining various definitions of the US money supply can be found here (Money Definitions). However, some questions come up to me immediately if QE does not increase the money supply. Why even do QE if the amount of money in the economy will remain the same? How is the economy “helped” if money is not increased?  Is the author mistakenly talking about an asset swap? Does not the term “quantitative” in conjunction with “easing” mean an increase of something, and if so what? I think that until these questions are answered the claim and its following conclusions should be set aside.  



    In point 8 Mr. Roche writes, ”Monetization is achieved by act of Congress via deficit spending and is independent of the Fed’s monetary policy. … In a strict technical sense, monetization is always done by act of Congress...” These statements do not hold when one examines the data of the Fed’s balance sheet (
    Data Here) and the increase in US Government debt  (Data Here) between the dates 9/03/2008 and 11/12/2008. The Fed’s balance sheet rose from about $906.7 Billion to $2,214.4 Billion over this time frame for a difference of $1,307.7 Billion. During this same period of time US Government debt went from $9,667.7 Billion to $10,618.5 Billion for a difference of $950.9 Billion. This means that the Fed expanded its balance sheet $356.8 Billion more than the US Government borrowed. The Fed might not have been monetizing US Treasuries, but it was clearly monetizing securities and these empirical facts clearly refute the assertions and claims made in point 8.  This in turn refutes the claim in paragraph that follows, “Welcome to the current reality in which we live.”  



    In paragraphs 29-36 the issue of my assertion that the author fell into the labor theory of value is discussed. As I stated in the original article, “I only hope the author was intending to discuss real wages and unfortunately used poor wording that accidently came out as in favor for the labor theory of value.” The author again provides a hypothetical example but leaves out the wage rates, which is crucial in explaining the concept of real wages. I would also point out this data of the average real wage in the U.S. found at the Federal Reserve Bank of Atlanta.   This data shows that the real wage received by hourly workers has not been climbing consistently. This refutes the proposition that if real wealth is defined as what one can purchase with an average hourly wage then real wealth has to climb over time; which I believe is the author’s argument as he states, “My argument has nothing to do with the cost of labor being put into the production, only to compare the burden of buying something that is needed, say gasoline, with the effort one must put forth to buy it.”. Once can see the large drop in the real average hourly wage from approximately 1973 to 1996. 



    One can then go to this link to find an inflation adjusted chart of the Dow Jones Industrial average over this time and see it rising:
    http://www.thumbcharts.com/1319/dow-jones-industrial-average-since-1913  


    Now further down in that link there is a chart of real compensation that is shown to grow over time. However the distinction must be made between “nonwage forms of compensation -- health care benefits, employers' share of social security contributions” and wage compensation. By definition nonwage compensation cannot buy gas. If a worker is at a firm that does not supply health insurance the first example more certainly holds, especially when one considers that workers below the age of 62 cannot spend social security.
       



    Next, the author then proceeds to use a quote from Adam Smith:
    "The real price of everything, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it.... But though labor be the real measure of the exchangeable value of all commodities, it is not that by which their value is commonly estimated.... Every commodity, besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour." - Adam Smith, The Wealth of Nations, 1776    

    The interesting thing is the beginning of this exact quote is used by Murray Rothbard in his examination of the fallacies of Adam Smith:

    “It was, indeed, Adam Smith who was almost solely responsible for the injection into economics

    of the labour theory of value. And hence it was Smith who may plausibly be held responsible for the emergence and the momentous consequences of Marxism. Side by side and unintegrated with Smith's cost-of-production theory of the natural price lay his new quantity-of-Iabour-pain theory. Thus:

    “The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour, as much as what we acquire by the toil of our own body... They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity.”  (Adam Smith) 

    Thus goods exchange on the market for equal quantities which they 'contain' of labour hours, at least in their 'real', long-run prices. Immediately, Smith recognized that he faced a profound difficulty.”

    (From: “An Austrian Perspective on the History of Economic Thought: Volume 1”  by Murray Rothbard page 453)

     

    The Author then writes, “Next is a quote that fits Mr. Ridder and all Austrians who seem to think this is a fallacy: "What is a cynic? A man who knows the price of everything and the value of nothing." - Oscar Wilde, Lady Windermere's Fan, 1892.” Again, here we find Rothbard a useful scholar as he writes:

    “Adam Smith's doctrine on value was an unmitigated disaster, and it deepens the mystery in explaining Smith. For in this case, not only was Smith's theory of value a degeneration from his teacher Hutcheson and indeed from centuries of developed economic thought, but it was also a similar degeneration from Smith's own previous unpublished lectures. In Hutcheson and for centuries, from the late scholastics onward, the value and price of a product were determined first by its subjective utility in the minds of the consumers, and second, by the relative scarcity or abundance of the good being evaluated. The more abundant any given good, the lower its value; the scarcer the good, the higher its value. All that this tradition needed to complete its explanation was the marginal principle of the 1870s, a focus on a given unit of the good, the unit actually chosen or not chosen on the market. But the rest of the explanation was in place.(Ibid. pages 448-449)

     

    Fortunately, the Austrians in the 1870’s helped develop a theory of values that establishes a price traded in the market. Rothbard continues to dissect and expound his analysis and includes comments and analysis by other economists and scholars. The section on the analysis of Adam Smith’s theory of value is ten pages and readers are encouraged to go to the original source if they have further interest and the section is found on pages 448-458.

     
    Next, I know this is very long (!), in paragraphs 37-43 the author counters my argument that no wealth was made in the last 20 years in Japan as measured by their stock market. “If Mr. Ridder some how thinks that stock prices are the only measure of wealth creation, he misses the point of what businesses do.” The author criticizes the use of the stock market as the wealth metric used. I used the stock market because this web site, where the discussion takes place, is named “Seeking Alpha”.  I could not find with a simple Google search data for the average real hourly wage of Japanese workers. However, look at the US example of how over a period from 1973 to 1996, 23 years, the real Dow Jones index climbed while real average hourly wages fell.  Granted economists have struggled as to exactly how to define wealth, however this forum largely deals with the financial markets and not the products or services of businesses (although they might be discussed as to how they would affect the valuation of a financial asset). How would an investor like to give their money to a bank to invest in the whole stock market, and have that whole stock market decline about 75% over 20 years and then be told you have “gained wealth”?
     



    Included is this graphic, from the author’s post, showing Japanese Real GDP, Nominal GDP, and a commercial real estate (CRE) land price index.  One can look at the level of Real GDP in 1990 and it is about 450 Trillion Yen. The data ends in 2008 with Real GDP at a level that looks like 575 Trillion Yen, for an increase of 27.78%. Now I find it hard to see how an investor gained wealth, in being able to purchase goods & services, if something they owned fell in price 75% while at the same time the entire economy only gained 28%. Look also at the CRE price index. It dropped over 80% during this time. Not a good situation for investors of these assets. The only situation this was good for was the bank; as usually money managers charge a fee of approximately 1% a year to “invest” a clients assets. At only 1% most of the purchasing power gained over 20 years was lost in fees paid to the bank, if one hired an investment manager and they advocated a passive index approach to stock investing (Obviously, the exact amount lost is path dependent).
     
     

    One can also look at see, at least to my eyeball, that from 1997 until 2002 Real GDP remained flat. Five years is a long time to have no wealth creation if one switches to using the Real GDP metric.
     


    The author continues, “I find it interesting that he wants to use 20 years ago, which was the peak in their market, as the foundation for wealth creation in Japan. So, Mr. Ridder, 20 years ago when the Nikkei was at its peak, businesses were at the height of their wealth creating abilities? Since then, they have not created any wealth?” Obviously there was not any wealth for the investors holding a passive stock market index, and did not create wealth for periods of up to 5 years if the Real GDP metric is used, as just discussed above. Notice I never asserted that a stock price level is equal to the ability of a business or country to create wealth. I claimed that Japan followed Keynesian policies that did not create wealth and used the stock price index as a metric, as I explained above.  



    Further, the author writes, “Price of the stocks have nothing to do with whether or not these businesses are creating wealth and employing people.”  My assertion is that over time a stock index, especially of a whole country, should reflect whether its economic policies have resulted in wealth creation. I made a claim over time (flow) and not just at one point (stock) argument.  The ability of the shareholders of a company to purchase more real goods and services should be increasing if that company sells goods and services into the marketplace and profit expectations were met or exceeded. If the expectations were to high then shareholders would loose some wealth, such as the case with Microsoft; and if the expectations were unrealistic then all of the shareholders apparent wealth at one point in time would disappear when the reality of the companies prospects becomes know, as in the case with Pets.com. 
     



    “I have already pointed out that he does not understand the monetary system due to the fact he believes the government needs to borrow money to spend, let alone his belief that we are identical to Zimbabwe. Using Japan's stock market valuation as a rebuttal of my piece is an even larger swing and miss.” I hope the reader come to the conclusion that I have refuted the assertion that I do not understand the monetary system. I most certainly don’t hold the belief that the US is identical to Zimbabwe, which is just a non sequitur, as I have laid out my arguments. Using data provided by the author I showed Japan did not create wealth over periods as long as five years, as measured by Real GDP. Further I showed that investors were certainly worse off and this is what Seeking Alpha is about.  



    “… stop focusing on the never ending calls for doom and gloom happening via hyper-inflation or some type of bond market collapse. “ I will point out these are fallacious statements, as I never mentioned doom and gloom, hyperinflation, or bond market collapse. One can further research, if one so desires, my other articles and posts on Seeking Alpha to verify these are just ad hominem attacks. The author made claims that Rothbard and I do not understand the current monetary system. This claim is in error as I showed in the analysis above. The author did not include basic empirical research that refutes his claims, since the real average hourly wages in the US could be shown to have declined over a period of 23 years (although this metric has risen lately). The US Government paying people to pick their ears will not lead to wealth creation, as the author claims (
    seekingalpha.com/instablog/475264-tim-ay...). The Austrian school of thought can explain why, however I won’t undertake that even longer exposition now (Thank Goodness!). I encourage the readers unfamiliar with its thinking to begin reading the works of Mises, Hayek, Rothbard, Heurta de Soto and various others.  A very informative web site is www.mises.org. Finally, we come to the end very long trail. Thanks for riding along with me.
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