Espousal of the Fattest

Austrian school crusader, Sean Corrigan, on why rate cuts won’t salvage the post-bust economy…on either side of the Atlantic.

As the matronly European Central Bank hoists up her skirts to join in the mad whirligig being danced by the Fed and the Bank of England, I’d like to try to show you how today’s easy money – with interest rates at 40 year lows – might actually be causing the current problems afflicting British and American business, not curing them.

To begin with, let me state an assumption: no business – unless protected by a government-imposed monopoly – has the power to set its own realized selling price. Instead, the firm’s customers express their own individual sets of preferences by interacting on the free market. It is the customers who establish what they are willing to pay for what the company offers for sale.

In a free market, the most rarefied form of democracy exists: we all get precisely one vote for each and every dollar we have at our disposal. If one group of people has access to more dollars than you, those people will be outvoting you. They will be outbidding you and possibly pricing resources out of your grasp – whether these be directly or indirectly employed labor, raw materials, unfinished goods, plant and equipment, office or factory space.

If the extra dollars were earned fairly and squarely on the market, that’s not only your tough luck, it’s absolutely intrinsic to the way the free market functions to improve everyone’s lot in life. It’s how successful businesses accrue the advantages which tend to reinforce their success; a success which can only be gained in the first place by satisfying their customers better than all their competitors could.

But if the extra dollars are derived from sources outside the market, it’s not only unfair, but it risks short- circuiting the whole positive feedback loop and stultifying growth in the economy. The negative effect is instantly recognizable if we are talking about theft, fraud, protective tariffs, or government subsidies. But what people don’t recognize is it also applies to people who borrow newly printed money, too. Effectively ‘free’ money turns our commercial Survival of the Fittest into a venal Espousal of the Fattest.

During the bubble years, the people with the extra dollars were the Tech and Telecom companies, the pass-the-parcel,, Pie-in-the-Sky POs and the bankers and lawyers who were at the front of the queue when the money spigot was opened wide. People in genuine, productive businesses were losing out, except where they could redirect some of their own output to serve these misjudged, misreported, or plain misdealing, enterprises in their heyday.

That’s how we ended up with 500 million miles of fiber optic cable laid, but we were short of many drugs and other forms of medical provision; why we spent billions on unused 3G phone licenses, but ran short of refinery capacity; and why new power stations proliferated to the point where there is now perhaps a 30% oversupply, yet basic transport is as problematic as ever.

When the Bubble finally collapsed under the weight of its own contradictions, the overcapacity in select industries was revealed and is now widely understood. But what far too few people have yet worked out is that bubble era companies got to ‘vote’ all those unearned dollars purely because of a credit boom; a boom that was at best tolerated, and at worst enthusiastically endorsed, by central banks with their twisted view of the world. (Thank you, Chairman Greenspan!)

What, in turn, have the central banks attempted to use as a remedy for the credit boom in the months since…and why hasn’t it seemed to work?

Well, We, the People, though it has cost us dear, have taken away the right of the fantasists and fraudsters to vote with unearned dollars. The structure of the economy, at least, is no longer so heavily overweight in these capital intensive, technologically saturated companies. But what has replaced them? A different batch of people voting with unearned dollars: the almighty consumers!

Despite record levels of personal debt, the economy now rests on the hope that consumer spending will be an effective replacement for the lost bubble dollars…and that businesses left gasping on life-support can collect just enough of these extra dollars in their cash registers to avoid embarrassing their anxious creditors any further than they must.

Since everyone of us is a consumer – whereas very few of us worked for, or profited from WorldCom, Enron or Boo! – this doesn’t seem like grand larceny so much as a little innocuous fiddling with our expenses. Very few consumers, however, have been taught to worry about the perils of over-consumption, so the expense fiddling goes unnoticed and unconsidered…but over-consumption is still responsible for giving rise to damaging imbalances.

For proof of misplaced investment during the boom, you only have to look at the gleaming corporate headquarters of hubris – what a friend of ours calls the ‘Edifice Complex’…or Marconi’s share price…or central London property vacancy rates.

Today, consumers voting with unearned dollars is just as surely rigging the auction: distorting price-cost relationships everywhere; driving a wedge between consumption and production; swamping the honest demand which can only arise from our taking part in valuable production; and throwing demand in general so out of kilter with supply that it sets the economy at war with itself.

Worse, while there remains hope that bubble companies may accidentally end up justifying their existence, bubble consumers are like spoilt five-year-olds whose doting parents keep giving them treats today in return for dubious promises of better behavior tomorrow. The Tech and Telecom bubble may have burst, but we consumers are just as surely putting resources out of the reach of many businesses by bidding them up beyond the point where they can reasonably expect to make a profit.

No expectation of profit means no investment and no expansion into the gaps left by the failed bubble companies – despite the flood of easy money. That means less income for workers, suppliers and shareholders. That means we all become ever more reliant on accessing credit – this time to maintain the pretence that our material standard of living hasn’t been jeopardized by the boom years.

The demand for credit becomes more and more insistent even as our creditworthiness spirals lower and lower. And the hullabaloo we raise about our discomfort? It induces the central bank to seek novel ways of adding ever more unearned dollars to the system – even though they were the root of all the problems.

That’s why Easy Money equates to Hard Times…and why we shouldn’t keep mindlessly bleating for the Fed, the Bank of England or the European Central Bank to continue reducing rates to ever more artificially depressed levels.


Sean Corrigan,
for The Daily Reckoning
December 11, 2002

P.S. That crafty old pirate William Paterson, inspiration behind the founding of the Bank of England, came to understand only too well that being ‘the man’ who controlled the creation of the unearned dollars meant he could reap more benefits for himself than he ever could in the days when the Jolly Roger flew from his flagstaff. But, even canny old Cap’n Paterson might not have fully appreciated that the creation of easy money also does just as much to disrupt the patterns of honest trade and that such disturbances leave everybody poorer as a result.

Editor’s note: Sean Corrigan is the founder of Capital Insight, a London-based consultancy firm which provides key technical analysis of stock, bond and commodities markets to major US, UK and European banks. Corrigan is a graduate of Cambridge University and a veteran bond and derivatives trader from the City. Corrigan serves with distinction as The Daily Reckoning’s ‘man-on-the-scene’ in London’s financial district.

All we can tell from The Times of London is that the Dow went up and the price of gold went down yesterday. So, we leave the rest of the financial reporting to Eric today and move on to more serious matters.

"I am sorry," says the front page headline in The Times, hanging over a large picture of the Prime Minister’s wife like a prison sentence.

We searched high and low in the paper to try to find out what Cherie Blair was so sorry about. She is no "Superwoman," she admitted. Permitting itself an opinion in prime time news space, it was the "tortured cry of career mothers everywhere," continued the headline.

Career woman, lawyer, mother, Prime Minister’s wife…Cherie was "juggling a lot of balls," the paper explained. Was it any wonder she let one or two drop?

"Sometimes I feel I’d like to crawl away and hide," Ms. Blair continued. Yet, after several pages of newsprint, we were still not sure what ball the woman dropped.

The poor woman is "crumbling down…" She had to delay her press conference by 40 minutes for "fear of cracking up."

All of Britain now knows how she feels. And how the press have made her life difficult and how tough it is for a modern woman to ‘have it all,’ – career, family, friends, investments, politics. All now know, for example, that Cherie is Catholic, has at least a few dodgy friends, including one ‘lifestyle advisor’ that must have gotten incarcerated on a bum rap…and that she does exercises to ‘release sexual energy’. But at least, from the Times account, few would be able to spot Cherie’s lost balls unless they tripped over them.

Your editor thought he saw one. Cherie Blair, he believes, is one of the first victims of the housing boom. It appears (and much of this is guesswork) that Blair bought apartments in Bristol, hoping to take advantage of a bull market in housing. Her mistake was that she did so in the company of a man whom the British are trying to deport, for various crimes and misdemeanors unmentioned in the Times’ Wednesday edition. Asked about it by nosey reporters, she seems to have forgotten key conversations.

But whatever she did, the Prime Minister’s wife said she did no wrong and pledged not to do it again.

Eric, the financial news, please…


Eric Fry from New York…

– Once again, pigs flew over Wall Street. What might seem miraculous out on the farm is a fairly routine event at the corner of Wall and Broad. Yesterday’s porcine aviators included Lucent Technologies, which flew 8% higher and Nortel Networks, which soared 19%. Several other stocks also took flight, as the Dow climbed 101 points to 8,574 and the Nasdaq gained about 2% to 1,390.

– After so many down days, a "relief rally" was probably overdue. But we doubt it will provide very much relief, or for very long. The biggest problem with bear-market rallies is that there’s no good reason for them. So they tend to disappear from the scene as abruptly as they first appeared. "2003 could be the year when the earnings forecasts of analysts might actually – for once – be trustworthy," writes Barron’s Michael Santoli.

– On the other hand, 2003 might turn out to be the fourth straight year of woefully errant forecasts from the pin- striped prophets. And wouldn’t it be interesting if the market fell for an unprecedented fourth straight year…But that could NEVER really happen, could it?

– "Right now," says Santoli, "the consensus view from analysts of 2003 operating profits for S&P 500 companies is about $55, up 14% from this year. That’s down from an expected 17.8% gain as of Oct. 1." Remember that $55 number…It may be a very long time before you see it again, at least in the same sentence with "operating profits for S&P 500 companies."

– I’m heading off to Nicaragua tomorrow, just to see for myself what this Central American El Dorado is all about. But before I go, I thought I’d fire off one more salvo about inflation…just to be sporting.

– To refresh, I anticipate resurgent inflation, not because I trust the Fed to "create" it, but because I do not trust the Fed to prevent it. Currencies degrade. That’s just what they do. And they degrade even faster when central banks are established to prevent them from degrading.

– To borrow from the Second Law of Thermodynamics: all matter tends toward greater "entropy" – a.k.a. disorder. And the forces of monetary entropy have always tended to promote inflation and to erode the value of paper money. Or as Bill artfully put it, "Mediocrity is always in style. While we aim for excellence in cheese and liquor, it is the mean, the normal, the ordinary that we look for in stocks, business and politics…we’ve noticed that that is the way things work."

– So it is with currencies and inflation. The US dollar has been excellent for far too long. Now the Fed aims to make it no better than mediocre. We think the Fed will "succeed." Mediocrity, therefore, is what we should expect. That means a falling dollar and rising inflation.

– "Despite the Fed’s ‘guarantee’ to prevent deflation, there is no assurance that they can create substantial inflation," Bill Gross reasons. "But a determined Fed and a spendthrift Congress that may at some point in the next 24 months produce a $500 billion fiscal deficit are a powerful combination – the deflationary China card notwithstanding."

– Although some financial markets are starting to "detect" a whiff of inflation, most are still priced for a deflationary – or at least, a disinflationary – economy. A 10-year bond yielding 4.05% does not exactly scream, "Inflation!" If inflation is returning to any measurable degree, therefore, bonds are still expensive, the dollar is expensive, gold is cheap and most other commodities are also cheap.

– In other words, it’s not too late to "invest in inflation". For example, the inflation-phobic investor might trade a few paper dollars for some of the shiny gold stuff that old- timers call "real money." Or maybe sell bonds and buy TIPs – the government’s inflation-protected bonds. TIPs would seem to offer a low-risk way to invest in inflation.

– As Paul Kasriel explained in yesterday’s Daily Reckoning: "The spread between the Treasury note maturing on 2/15/11 and the inflation-protected Treasury note maturing on 1/15/11is about 1.45 percentage points. These inflation-protected notes preserve an investor’s return against a rising CPI…Why not buy the inflation-protected note and short the unprotected one? Isn’t the current spread between the two likely to widen with inflationistas in control at the Fed?"…Good question.

Hasta luego…


Back in London…

*** "Santa is dead, priest tells horrified children." For some as yet unexplained reason, the British press loves stories of naughty and absurd vicars.

"The Rev. Lee Rayfield told children and their parents…that Santa’s reindeer would burst into flames if they went [fast enough to deliver all the presents on Christmas eve]… killing [Santa]," says the page 7 Times story.

The vicar is, of course, a fool. Here at the Daily Reckoning, we rise to Santa’s defense as if it were an invitation to a free drink: if reindeer could resist the law of gravity, dear reader, why could they not also resist the law of combustion?

*** We get away with nothing. Our readers are too smart for us:

Hello Editor,

Hugo Stinnes was not Germany’s Central Banker in the late teens and early 1920’s. Stinnes was a huge German industrialist. He owned coal mines, iron mines, steel mills, shipping lines, hotel chains, even his own bank in Holland, where he kept money for safe keeping. But in the end, even he came to grief both physically and financially. He dropped dead and his entire enterprise built on inflation fell in ruins.

Reichsbank President was Rudolf Havenstein. As a point of interest, German universities cut themselves off from classical economic thinking 50 years before. They developed what they called the "Historic school" of economics, and this dominated the universities where all of the economists were trained. Of course, we now all know that "historism" come Marxism was a dry gully.

But we have not learned much, as Keynesianism has dominated Western economic thinking for about 65 years or so. We are about to learn that it, too, is yet another dry gully.

In the past, U.S. economists have been badly misled by Irving Fisher in the thirties, and in more recent times, regretfully, by anti-gold monetarist Milton Friedman.

Only the Austrian school, led by the late Ludwig von Mises and then F.A. Hayek and a number of Mises’ students, has led the way to economic sanity.


Ronald Kitching Australia
December 11, 2002

P.S. The Austrian school is now brilliantly coordinated by the Ludwig von Mises Institute at Auburn University Alabama. Interested people can learn about them at

The Daily Reckoning