Saturday, October 30, 2010

The Faux-Wealth Fallout

In reading the financial headlines over the last few months I've noticed a lot of outrage concerning individuals and organizations who feel they have been cheated out of their money by Wall Street when various finance and investment schemes they had entered into with Wall Street advisers went awry. I have no intention of defending any of these schemes or their promoters. Fraud is fraud and if fraud was the way some of these schemes were marketed, that's punishable.

What I think should be remembered, alongside acknowledging and punishing the frauds, is that the wealth that was supposedly lost by various individuals (and especially state and local governments) was wealth that never actually existed in the first place. It was faux-wealth that was "created" by unbacked credit expansion and the issuance of new paper ticket claims to the existing supply of real wealth. A lot of people got fooled initially when they made these faux-wealth investments into thinking that they actually controlled or were entitled to the real wealth these charades represented. Understandably, they are confused to the point of anger when reality reasserts itself and they find out that, not only do they not own the things they thought they did but those things never existed in the first place.

The reason I call special attention to the victims of these collapsing finance and investment schemes who find themselves to be the agents of state and local governments is because these people should be least surprised of anyone to have "lost" control of their faux-wealth. After all, they work for the government, an institution whose reputation the world over is one of producing no real wealth whatsoever yet nonetheless being the world's reigning champion at carelessly consuming any it might lay its hands on.

Government is home to the least financially-savvy individuals in a given society. It is home to the most corrupt, the least entrepreneurial, the least sophisticated, the most cluelessly detached from reality. Government employees live their entire lives producing nothing of value to anyone else (hint: that's why they finance themselves coercively) yet somehow maintain the illusion that they are entitled to a comfortable standard of living like the other, productive members of society off which they feed.

Is it at all surprising then that these people would be taken in, in large numbers and in large amounts, by some of the most hare-brained schemes cooked up by their kinfolk on Wall Street? Should it surprise anyone at all that they managed to consume billions of dollars in faux-wealth lost to addle-brained money-multiplication magic manipulations that now put their future ability to consume wealth at risk via shakey attempts to roll over their unsustainable debt burdens?

One "lesson" that kept going unlearned over the past several decades was how a country such as the US could be increasingly prosperous all while increasing the size and scope of government welfare programs and spending as well as total command over the economy. Doesn't free market economic theory tell us these two things should not be happening simultaneously?

Indeed it does! One thing to keep in mind is that the total wealth potential of the country was inhibited the entire time, that is, current levels of real wealth are far below where they actually could or should be had we enjoyed a freer economy. The other thing to realize is that the "evaporation" of all this government-controlled faux-wealth through these financing and investment schemes is the inevitable result of this lesson finally being learned. It signals the recognition phase, where reality slowly creeps back in and market participants come to terms with the simple truth that trade-offs still do matter. As it turns out, it wasn't a fluke and the theory wasn't wrong, it really wasn't possible to have increasing levels of private and public consumption simultaneously without anyone having to sacrifice anywhere along the line.

Now, forced to choose as reality reasserts itself in the Realm Economic, people are unwittingly or not choosing in the market that these obligations be shed and instead society as a whole stick to the basics of private consumption rather than sacrifice a private standard of living to enjoy the frivolities of a public one.

Faux-wealth is just that-- fake. It never existed, it was an illusion. Many people can't tell the difference between an illusion and reality until they reach out and touch it themselves. Consider the present circumstances in the financial markets those moments of authentic dexterity!

Wednesday, October 20, 2010

Mortar Keeping BRIC-Story Together Starting To Deteriorate

A theme I have begun exploring here at EPJ is the idea that the "BRICs miracle" is more like the "BRICs mirage", and that some or all of the BRICs are not contenders for world economic power status but instead are economic basket-case runners-up, happening right now.

Russia in particular stands out as a country with a lot of economic problems derived from its numerous political problems. For one, the country has had a love-affair with authoritarianism since at least the 16th century, a record which has stood uninterrupted even to the present despite numerous invasions, revolutions and imperial ambitions alike. Contrary to the secret wishes of Keynesian economic professors and orators everywhere (remember Keynes' special foreword to the German edition of his treatise?), authoritarianism is not an ingredient in the recipe for sustainable, organic economic growth.

In that vein, contributor Craig Pirrong commented on a recent FT article which disclosed that the Russian shareholders of a joint venture with BP have been urging the multinational supermajor to invest surplus funds outside of Russia, rather than exploring for new energy opportunities within its borders:
Interesting, isn’t it, that it’s the Russian owners of BP-TNK who are so anxious to invest outside of Russia? (Ditto Rosneft’s recent splurge for PDVSA refining assets in Germany.)

That desire by Russian firms to invest cash flows generated inside Russia outside the country even in the energy business (where Russia presumably has its greatest attraction because of the often-touted untapped oil and gas reserves there), says a lot about the investment climate there. And it doesn’t say anything good. We’re constantly lectured that Russian assets are undervalued; the investment prospects there are amazing; there’s a lot of money just lying around to be picked up.

If all that’s true, why don’t Fridman et al pick up the money and buy all those undervalued assets in Russia?

If Russian oligarchs aren’t too wild about investing their capital in Russia, Putin’s new initiatives to attract foreign investment are facing a serious uphill climb.
Indeed, it's very interesting. You'd think if anyone had a chance at recognizing and acting on "hidden value" in Russia it'd be some of the investors who actually live there. Now, you could say that relatively-speaking there are still better opportunities available in developed markets, such as the United States. But really, it seems like jumping the hurdle necessary to beat THAT competition is getting lower and lower everyday.

I'm going to keep my eye on the BRIC story. Something doesn't seem right about it, aside from the economic ignorance behind their promotion.