Toilet Paper

There’s something special about toilet paper. Perhaps, in addition to the obvious benefits in comfort and hygiene, it has become something of a symbol of civilization. It is widely believed that its inability to deliver adequate quantities of toilet paper triggered the downfall of the Soviet Union. As recently as 2009, the government in Cuba was facing unrest for the same reason. The political upheavals in Venezuela clearly highlight a shortage of toilet paper as a major grievance.

The common element in these situations is not toilet paper, but the government’s belief that it can control the economy to conform to socialist ideals while continuing to grow national wealth, production and employment. The shortage of toilet paper is merely a common, albeit not universal, symptom of the failure of centralized government economic management.

As we come to the end of 2015, we see that this belief in central planning has become widespread despite many failures. Keynesian economists have asserted that they can indeed achieve this nirvana by monetary manipulation, and so elected politicians have turned over the central banks to them. The result has been unprecedented volatility in financial asset prices as the inability to accurately forecast the results of monetary actions leads to wider and wider swings.

Sadly, there is no reason to believe that the Keynesians have learned anything from their failures. John Hussman says:

On the other side of the recklessly speculative advance of recent years is not only the likelihood of brutal market losses, but also tremendous opportunity. I fully expect the S&P 500 to double, and to double again over the coming 10-12 years, and yet I also expect the total return of the S&P 500 over that period to be zero. Both aspects of that expectation are likely because markets move not diagonally but in cycles. How did the S&P 500 trace out a total return of zero between 2000 and the end of 2011? By first losing half its value, then more than doubling, then losing more than half its value, and then doubling again. Across history, extreme valuations have invariably been followed by similar behavior – wide cyclical swings, yet only modest overall returns over the following decade.

Dr. Hussman’s assessment, based on history, is likely to understate the volatility of the outcome as the central banks, led by the Fed, will probably act to amplify the cyclic volatility, rather than dampen it as they should. As far as I can tell, nobody at the Fed has the slightest notion of control system theory. Since it has no reliable economic forecasting mechanism, there is no way for the Fed to look forward. Therefore it can only look backward – the Fed calls this “data-driven.” Control based on such feedback can work, but only when properly designed. The delays in the data and the action of any control inputs the Fed might make are probably too high to make any such control system stable.

The end point must be some sort of global economic revolution as socialism, or at least the form of socialism that requires continuous injections of new money to sustain itself, is finally rejected. Getting to that point will be tough as the beneficiaries of big government and redistribution far outnumber the victims, the workers who actually contribute value to the world’s economies. Navigating this series of economic tempests will be difficult. I remember once buying a copy of “Sail” magazine that purported to provide insight in how to excel in light air. The advice boiled down to “sail fast and avoid the holes.” Right. True, but not helpful. In the same spirit, “buy low and sell high.” Happy New Year.

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