I just spoke to a friend, Skinner Layne, who is from Arkansas, but now lives in Santiago, Chile. He emigrated there and is now heading a startup enterprise that is showing great promise. It is called Exosphere. I asked him about the backstory to the company. It turns out that he moved in 2008, six months before the U.S. real estate markets blew up. He left to escape the worst of it.
How did he know that the downturn was coming? His answer came quickly: “The yield curve inverted.”
I was just reading about this very indicator in Mark Skousen’s new book, A Viennese Waltz Down Wall Street. Here, Skousen, investor and economist, explains how the teachings of the Austrian School provide some excellent rules of thumb that allow us to anticipate, and act on, the big turns in the business cycle.
In the Austrian view tracing back a century ago, interest rates indicate the preference for goods sooner, rather than later. If you don’t have the money to get the stuff, you borrow for some period of time. Borrowers pay a higher rate if their payback term is longer. That’s because the risk is higher — who knows what’s going to happen in 30 years? — and lenders expect a higher payoff to wait longer for their money. So naturally, the yield curve should show lower overnight rates than five-year, 10-year, or 30-year rates. That’s why the normal yield curve is positive — that is, upward sloping to the right.
What does it mean for the yield curve to be negative? It’s a bit like water running uphill. You can be pretty sure that there is some seismic shift going on. Usually, it means a Fed tightening. Or it could mean that investors are expecting bankruptcies in the future. It is highly predictive of a coming recession.
When it happens, you can also be sure that hordes of television pundits and economists will emerge to say that there is nothing unusual here. It is a perfectly normal thing, and it’s even healthy — certainly nothing to be alarmed about.
My friend Skinner knew better. How? He had been reading the work of F.A. Hayek and Ludwig von Mises for years. He knew that there are certain constants in economic forces that do not change, no matter what government does. In fact, government and central bank attempts to manipulate the market can have exactly the opposite effect of the advertised results.
TV pundits are quick to agree with everything the Fed does. To spot the policy errors requires special knowledge that comes from reading sound economics.
That doesn’t mean that once you learn economics, you can predict the exact timing of events. In fact, this is also one of the observations of the Austrian School: There are no predictable quantitative relationships in the world of human action. This too differs from the mainstream view, which is forever seeking the magic formula to predict price movements.
I like the way Skousen describes financial markets. He says that prices in markets are like a dance. There are patterns and habits at work. But there are also surprises and improvisations going on. That’s part of the spirit of dance too. But the crucial thing here is that it takes two people to coordinate their moves in a dance, just as in markets, it takes buyers and sellers to make a price. Financial markets bring people together to their mutual benefit.
Nice image, isn’t it? It’s one that he elaborates on at length. In the course of his argument, he criticizes other points of view that don’t account for human decision-making and don’t account for the parameters of those decisions as set by economic reality. For example, just as dancers can’t start flying, markets can’t sustain parabolic price increases in one sector forever, even with Fed intervention.
Why did Skinner choose Chile as his home? Well, he knew it to be the most pro-enterprise country in Latin America, at least so far as he could tell. His reading in the Austrian tradition helped him see why this is important.
And he likes Latin America because it is the new world and doesn’t have economies bogged down by bad habits and massive welfare and regulatory bureaucracies. There is far less sludge in the system to harm economic growth. For this reason, he is very bullish on the whole region — and bearish on the U.S. and Europe.
This too reminds me of something else explored in the Skousen book. He discusses how institutions affect economic growth and can help people make better predictions about coming economic booms. A regime that is friendly to free enterprise might lower taxes or cut regulations. Even a little bit helps. Economies are like sponges for this stuff. Just a bit of encouragement — or, more precisely, just a bit of relaxation of the fetters — can spark huge economic booms.
This is why Skousen strongly suggests following the politics of a country to understand its economic future. He goes so far as to slightly scold fellow Austrians for holding a permanent bearish view on economies. He says that this point of view causes investors to miss economic booms such as, say, those in the 1980s and 2000s. And he is right to this extent: If your goal is to play the markets, it makes sense to be able to discern their upside, as well as their downside.
Monetary policy figures in here substantially. As Skousen says, an economy without a huge debt overhang that is emerging from rough economic times can find itself on an upswing if the Fed is pumping money at a rapid pace. Under this rule, you might have bought stocks in 2009. The problem is that this approach to economic policy cannot last. It creates new problems that cry out for correction. The tricky thing is to be able to spot the turning points.
What do Austrian economics imply about today’s precarious situation? Well, the Fed is making loud noises about pulling back its stimulus program. If the drug of new money is cut off, we could see short-term rates rise and blow up the balance sheets of many businesses, not to mention governments.
The beauty of the Austrian School is, fundamentally, this: It sees economics as an extension of human choice. There is nothing mechanical and predictable about it. But there are certain patterns that emerge just from the logic of human action itself. Skousen’s purpose here is to elucidate that logic and illustrate it with examples from the business pages. The results are interesting: You can gain insight into both worlds. In this book, the rubber of finance truly does meet the road of economics.
I’m intrigued at the confidence with which my friend Skinner took the step to move. Five years later, he has a thriving business and a happy life. He only did it once he had intellectually seceded from mainstream thinking. But just as important, he did it with the aid of solid economic thinking.
Now with Skousen’s book A Viennese Waltz Down Wall Street, anyone can gain access to that knowledge. A selection like this makes a mighty contribution.
Jeffrey TuckerOriginal article posted on Laissez Faire Today
According to one economics professor, Janet Yellen is "more qualified" for the job of Fed chair than any of her predecessors. In fact, that same professor thinks she can positively impact his daughter's economic future. Doug French explains why this line of thinking is wrong and worse, potentially disastrous. Read on...
I'm executive editor of Laissez Faire Books and the proprietor of the Laissez Faire Club. I'm the author of two books in the field of economics and one on early music. My main professional work between 1985 and 2011 was with the MIses Institute but I've also worked with the Acton Institute and Mackinac Institute, as well as written thousands of published articles. My personal twitter account @jeffreyatucker FB is @jeffrey.albert.tucker Plain old email is firstname.lastname@example.org
Pingback: Love Letters For Her
McDonalds stock is getting crushed right now. Shares have been in a tailspin since June. But it’s not just Mickey Dee’s. Coca Cola shares are in freefall, too. Bad news for them. But if you want to rake in a pile of easy money, it could be great news for you. See, Americans just aren’t choking down this junk like they used to. The fast food burger, fries and a Coke are just down payments on an early coronary - and Type II diabetes. And everyone’s finally gotten the message. So how can you play the trend? Greg Guenthner explains…
Panopticon goggles? Severe market panic in 2018? Gold confiscation by 2020? Jim Rickards' shocking thought-piece in the spirit of A Brave New World or 1984. Click to see how markets, economics, your money, gold, privacy, wealth building and more look a decade from now in the year 2024...
I believe we are in the midst of one of the greatest profit opportunities you’re ever going to see in your lifetime. Stop listening to what the government is telling you. Turn off CNN. Forget what you see on the news. And for God’s sake, forget about the market crashing. Right now, we are in the early innings of the greatest profit opportunities of the 21st century. A biotech boom that’s about to hit epic proportions thanks to Ebola. If I’m right, we are going to see Ebola in New York, Los Angeles, San Francisco and Miami. And when this happens, every single stock that has anything to do with Ebola is going to soar. Let me explain to you how I believe this huge Ebola bubble is going to unfold.
Right now we’re seeing a surge of strength in the U.S. dollar, as the bottom falls out of our competitors’ currencies, and Jim Grant has the best analysis of what it means for investors. For one, it means the Federal Reserve can’t keep interest rates low forever. And mainstream investors may be very surprised when the Fed gives in…
Breakthrough technologies can hold the most undiscovered money-making potential. What we’ve accomplished in a quarter century with cancer research could make you serious money and save countless lives. Ray Blanco has more on this ground breaking story...
Another one of Wall Street’s broken forecasts has plopped a new trade in your lap. If you’re listening to the lunatics on the financial news, you’re hearing that there’s no hope for the markets. Just get rid of your stocks and pound sand. Better safe than sorry—none of these talking heads want to get bullish on anything right now because they’re afraid to look like an idiot if the market keeps dropping. For them, selling stocks now is your only chance to make it to the end of the year without pawning the family cat to buy Christmas presents. Can the market survive? Greg Guenthner explains…