On virtually every alternative news site you visit these days—and many mainstream sites as well—you will find predictions of economic collapse and coming calamity. The bizarre thing is not that these articles exist, but rather that we have somehow adapted to them and taken them in stride. In this essay, I have set out to determine how this came about—how did one of the most developed and educated civilizations in history come so close to the economic brink?
I was especially curious to determine if the core mechanics of demand and supply, the stuff you learn in the first 10 minutes of your very first lecture in Economics 101, were still functioning as they should be…
Apparently not! What I found instead is that our society, our culture, has tacitly allowed traditional economics to be deliberately suborned and subverted by forces of highly dubious intent. What I found, in essence, is that the people we have entrusted to run our economy have, either deliberately or accidentally, thrown out the economic baby while stubbornly holding on to the dirty bathwater.
Start at the Beginning…
In the 1980s, I had the wonderful privilege of teaching business law at a university ranked as one of the top 50 in the world. My course included basic economics, as well as an explanation of the most common financial instruments.
Then, as now, most financial paper (excluding derivatives) can be classified as belonging to one of three main categories: cash or money market, debt, and, of course, equity.
Cash being cash, you get the most safety, but the least return. Debt provides a higher return than cash but more risk; albeit, the risk, in theory, is mitigated by the fact that hard assets usually stand behind the debt.
Then, as now, students always showed the greatest interest in common stocks. Everyone had at least one story stock they had followed vicariously, which had made someone they knew rich.
I was careful to explain (at that time) that common stocks, by their nature, are subordinated to company debt and even to preferred shares. They are backed essentially by shared hopes and dreams…and that’s about all. In the event of a catastrophe, even a stock trading at triple digits on a Monday can potentially be worthless by Friday.
At the end of the day, I would explain, it is always the market that has the last laugh. The market, I emphasized, is the final arbiter of demand and supply. The market sets the price both to buy and to sell. The key to the whole system, the finger in the dyke that keeps everything from falling apart, is the market.
Three-and-a-half decades later, when I look at the financial landscape today and reflect back on the course I taught, I cringe. If back then someone had told me that as markets became progressively more digitized and computerized, powerful groups would form to exercise stratagems that would come to be known as “financial engineering,” I would have been flabbergasted. I would have argued that such distortions would signify the removal of the traditional price discovery mechanism from daily market transactions and demark the replacement of those mechanisms with tricks, tropes, and schoolboy shenanigans.
“Nothing good will come of that,” I might have predicted.
Which brings us to the economy of today. Where indeed nothing good has come of what the central planners and their pals have wrought.
The politically correct euphemism “financial engineering” has two specific purposes overall. The first purpose is to present assets, generally, as a better and more attractive value proposition than traditional economics might otherwise suggest. The second is to move the control and timing mechanisms of these asset prices away from the impassive, neutral, market and, instead, grant power over such mechanisms to the very same groups of individuals who developed these dubious techniques in the first place.
Moreover, the icing on the cake, all of this has somehow happened with the full consent and blessing of the very regulatory bodies that one might otherwise have expected to intervene to protect the market mechanisms that were being so badly abused.
Looking back, I believe that if I might have caught even an inkling, a glimmer, of what was coming, I would have shuddered. Moreover, if I had understood that our economic futures would contain not only engineered asset prices, but that the puppet-masters pulling the strings would themselves represent a bizarre cross-section of interests from the governmental, banking, and corporate worlds—I might possibly have broken down and cried.
In Search of an Honest Market…
Most of us will remember the story of the Greek philosopher Diogenes (from the fourth century B.C.E., approximately) and his search to find for himself “a single honest man.” My purpose in this essay is even simpler. I am setting out to see if any financial market today is offering legitimate price discovery, where prices are still set by true market-based demand and supply…
Let’s look at just a few:
* Forex: If you were to put up a cautionary signpost on the road to the Forex market—metaphorically—it might possibly read, “The Hypocrisy Starts Here.” Because for as long as anyone can remember, no matter how much a country claims it is allowing its currency to “float,” currency exchange rates are so important that most sovereign nations will launch brute-force Forex interventions at the mere drop of a hat.
Assuming, of course, they have the resources and the ammunition with which to do so. Therefore, if you are looking for a meaningful deviation between what politicians say and what they actually do, Forex is always a great place to start. It is a marketplace where demand and supply generally receive lip service and little else.
(Canada is a good example. The few times the loonie has strengthened above the greenback, the phones in Ottawa start to ring off the hook and shortly thereafter, rates mysteriously stabilize as Canada’s central bank starts dumping currency overboard, quietly taking massive Forex losses. These interventions invariably remind me of the saying, “the operation was a success but the patient died.” Far too much of Canadian industry is based not on organic efficiency or value, but upon “relative value” contrasted against a perpetually weak loonie.)
* Debt: Here is where things start to get really interesting. It was always one of the worst-kept secrets in the marketplace that, no matter how exciting the equity pits were, the debt markets were where the action really was. Because, while everyone likes exotic food now and then (i.e., stocks), they need meat and potatoes to live (i.e., bonds and debts). Until the Japanese debacle of the ’90s—which is the Frankensteinian lab where most of our current financial engineering projects were originally incubated—debt used to be sacred and untouchable. Those days are long gone. Interventions in debt markets worldwide are today at levels that stagger the imagination. Worse, this is done in full view of a voting public that refuses to grasp the mechanisms used or the implications of that usage.
I have written on several occasions that quantitative easing (QE), for example, is merely a crude magic trick that even a fifth grader could see through—the left hand issues the debt and the right hand snaps it up so quickly that Mr. Market is “fooled” into thinking demand for that debt is so outrageously high that the interest rate offered should (correspondingly) be outrageously low.
I have also written about a regime called “financial repression,” in which governments deliberately engineer lower rates in this manner, claiming it is for the good of the voters, but in reality it merely serves to allow them to rollover and manage their own interest payments (to foreigners) more cheaply, and avoid the consequences of their incompetent stewardship.
* Cash: Cash markets, especially the so-called carry trade markets, tend to follow the debt markets. Mess with the former and you invariably mess with the latter. Plus, all that talk of going cashless to make the world a better place is merely an extension of that selfsame financial repression doctrine. You herd the animals into the corral because you really do not want them to have a lot of options about what happens next.
* Equities: As I said, Japan initially develops and perfects the “crazy,” and then the west injects it into our system on this side of the ocean. A recent Zerohedge headline makes the case more eloquently than I can: the Japanese government is now effectively the largest buyer (market mover) for some 90% of the stocks on their exchange.
You just can’t make this stuff up. In Japan, demand is not only dead and buried, but supply was assassinated when he showed up to pay his respects at demand’s funeral. (Source: “Japan Top Holder in 90% of Equities,” Zerohedge, April 25, 2016.)
Worse, as earnings—the traditional measure of a company’s worth—decline, stocks continue to pop based not only on interventions from the central banks, but also on financial engineering tricks, such as borrowing cheaply to buy back your own stock, thereby reducing the pool of available shares (thus, creating more demand, and higher prices for the smaller share float that remains).
Organic earnings? Current earnings are about as “organic” as the fast food meals that one scientist left standing for two years to prove they did not degrade or go bad. (Source: “Fast Food will not Rot after Two Years,” Business Insider, January 7, 2015.)
And then you have the delicate issue of clandestine interventions in equities, which, unlike QE and other rah-rah programs with cute-sounding names, are never, ever discussed in polite company or in front of the neighbors.
Globalintelhub recently made the following observation: “We’ve known for a long time about the infamous ‘Plunge Protection Team’ designed to prop stock markets in the event of a 1987 style crash. They even have entities in the Caymans funded by the Fed ready and waiting — they’ll start with buying futures on the S&P, then options, then if that fails, they’ll just go into the market directly. Anyway, technically speaking, DTCC owns 99% of US securities being the only custodian for investors. Why should it be surprising that the Fed operates a Cayman based hedge fund specifically designed to prop the markets in the event of a crash?” (Source: “America’s Big Red Button,” Zerohedge, May 1, 2016.)
Finally, I will add that a discussion of the impact of so-called high-frequency trading (HFT) is beyond the scope of this essay. However, the mere fact that it is generally accepted—and is, astonishingly, legal!—for firms with a faster digital access to trading information (than their peers and competitors) to “front run” orders is, to me, a symptom of a market mechanism that has completely lost its way within a society which itself is no better off. No less a source than Eric Hunsader, the founder of the Nanex exchange, became himself a whistleblower this spring and tried to draw attention to the current state of affairs that the rest of us take for granted. (Source: “‘The System is Absolutely, Positively Rigged’,” Zerohedge, April 19, 2016.)
* Real Estate: The crisis of 2006, where phony paper based on defective purchases was repackaged and redistributed to the four corners of the globe, is what lawyers would call “prima facie” proof of how damaged the real estate market is. More recent reports argue convincingly that many of today’s “hot” markets are working independently of demand and supply and are merely depositories for “scared money” from Asia looking to find a parking spot. The sheer volume of this hot money is so great it can distort pricing across entire countries. (Source: “Rotting House in Vancouver Listed For 7.2 Million,” Zerohedge, March 4, 2016.)
* Precious Metals: I have argued, in over a dozen essays here, that we are now completing the third iteration of a major precious metals suppression/rebound cycle. Governments work with bankers to constrain the precious metals because it is perceived these assets tend to move inversely to fiat currencies. Anything that potentially hurts the fiat is considered a matter of national security and is, therefore, worthy of being dealt with “at extreme prejudice.”
The recent confession by the financial behemoth Deutsche Bank that, working with other parties, it has rigged gold prices for literally years is merely the icing on the cake. In fact, an argument can be made—one I agree with—that the precious metal market is the most distorted of any market on the planet. (Source: “Deutsche Bank Admits Gold Rigging,” Zerohedge, April 14, 2016.)
The key, of course, to the whole scheme is redirecting the trading of paper gold (imaginary gold, gold that does not exist in our physical universe) to set the price for real gold. This is “the tail wagging the dog” on a scale never before seen in the history of economics.
As Dr. Jim Willie recently observed, “On individual trading days, more gold changes hands within contract trading (paper shuffling) across the London market than all the available gold in the world. Yet no metal moves anywhere, in a grand charade.” (Source: “Jim Willie on Gold Breakout,” Silver Doctors, April 28. 2016.)
* Commodities: Again, the action in the precious metal pits is evidence that if you can monkey with one commodity market via paper trading at (arguably) insane levels, you can, in theory, monkey with any commodity that has a paper trading component—which, of course, is all of them.
Generations of the future may well ask if oil prices would have risen as high as they did without paper oil markets (including off-the-books derivatives) and if, correspondingly, they would have fallen so far and so fast without those same paper machinations?
* Collectibles: Since these are generally private, non-governmental transactions without a paper or derivative component, an argument can be made that they do still represent the accurate mechanisms of demand and supply in the modern world. (See also my discussion of eBay, below).
* Cryptocurrencies: in a very recent essay, I argued that the rise of cryptocurrencies like bitcoin has less to do with fulfilling a legitimate need for such a construct, and more to do with simply finding a way to avoid government interference, and inject true demand/supply back into a viable and accepted medium of exchange.
I also pointed out that governments (and their banking pals) are gob-smacked and horrified that this phenomenon happened in the first place, and are spending fortunes to try to tie up the tech entirely for their own nefarious ends. They will not succeed. (See: “Blockchain—This Could Be Bigger Than the iPhone.”)
Whereas in the 1980s, the core assumption was that most assets were fairly priced by the market and that mal-pricing was the exception, not the rule, that paradigm has been turned upside down in this second decade of our new millennium.
Moreover—and more astounding, as indicated in the aphorism “fish have no opinions about water”—this process has been handled so subtly and yet so deftly that the vast majority of hard-working people don’t seem to have a clue.
Thank you, politicians of all stripes and parties (both elected and UN-elected, hey, just look at the EU!) for doing something in my lifetime I would have thought otherwise impossible. I just wish you would’ve done it on a theatrical stage in Vegas rather than on the economic stage of the world I actually have to live in!
Thank you for damaging all economic markets so badly that it is no longer a question of “when” they can be fixed, but rather of “if” they can indeed be fixed at all?
(The secondary irony, of course, is that the very same politicians who caused this problem in the first place are themselves painfully aware of how entrenched the damage is, which is why they tried to side-step the issue in 2006 by telling the voters—as if they were addressing small children—that the behemoths they have allowed to take over civilization as we know it were, in fact, too big to fail.
As I have remarked before, this is similar to the story of the young teenager who kills his parents to get access to the estate and, when caught, asks the judge for leniency “because he is an orphan.”)
eBay: The Final Sanctuary of Demand and Supply?
For those who are curious, I did, in fact, find one market still functioning more or less as it should.
Although the auction mechanism upon which eBay was originally founded has shrunk to represent only a very small portion of its overall business, it still exists and, at any moment of any day, you can log in to one and bask in the bright perfection of the market model it offers up.
During an eBay auction, buyers from all over the world converge briefly to bid on a single item in a time-sensitive and impartial forum. Very often the item will ultimately sell for either much more or much less than the price one would have initially associated with its value. Suggested prices become just that—a suggestion only—and it is the raw determination and dexterity of the bidders who move along the price discovery process. Demand and supply at their shining best.
As I said, for those who remember the Econ 101 lessons they used to teach years ago, it is a joy to watch. (Although some degree of financial engineering has entered even the eBay arena, as multiple services now exist online to handle the entire bidding process by proxy, using sophisticated computers to hammer in last-minute bids.)
The Good News?
Lest readers of this essay follow the example of this writer and start to reach for the tissue box, I want to end this essay on an optimistic note.
As I have written before, the recent launch of the Shanghai Gold Fix—two daily gold fixes based entirely on demand and supply impacting real metal in real time—suggests that, with the will and the right tools, it is indeed possible to pull the world economy back from the brink that our alleged “betters” have taken it to.
For almost a century, the gold pits in London and New York had been based on little more than wishful thinking, vicious bullying, collusion, cronyism, and rampant greed.
History, I suggest, will show that the emergence of the SGE in early 2016 will ultimately bring the precious metals markets back to reality and undo literally one hundred years of damage in—I am guessing—36 months or less. So, the lesson here is that it can be done—if people want it done and are prepared to actually do it.
Imagine in your lifetime a world where the value of assets—be they cash, debt, equity, commodity, or whatever—are set once again by true demand and supply…
It could happen, should happen, and might happen. One can always dream, right?