Tag Archives: markets

by | February 10, 2009 · 2:14 am

The One Minute Case against the SEC

Markets regulate themselves

Long before the existence of the Securities and Exchange Commission, medieval guilds and trading houses established common standards, accreditation agencies, and accounting rules that have evolved to the present day. The system of English common law has been evolving since the 12th century 1, and the accounting system used today was codified in 1495.2.

Numerous non-governmental bodies have continued to develop accounting rules and set auditing standards for public organizations.3 It is the American Institute of Certified Public Accountants, not the government, which sets ethical standards for the profession and U.S. auditing standards for audits of private companies; federal, state and local governments; and non-profit organizations.

Voluntary oversight organizations are embraced by their participants because they provide executives with a value – they allow them to discover waste and fraud and advertise honesty to partners and customers. Unlike government regulatory bodies, they are flexible, efficient, and competitive. When the compliance costs of accounting rules exceed their value, or when lax controls lead to unethical or risky behavior, the markets embrace new standards. The Securities Act of 1933 and the Securities Exchange Act of 1934 did not begin the process of regulating markets, but nationalized much of the auditing market and turned it over to politicians and bureaucrats.

Regulations hinder competition and raise costs for investors

The SEC subsidizes politically connected corporations at the expense of smaller firms, hindering innovation and encouraging corruption. Established corporations lobby the government to create burdensome regulations that smaller investment funds and markets cannot afford, thus creating coercive monopolies that raise profits a few firms at the expense of investors.4 Government bodies like the SEC, the MSRB, the FTC, the USITC, the Fed, the Treasury, the IRS, the OTS, the MSRB, and the state attorney’s offices issue hundreds of thousands of laws, rules, opinions, bulletins, comment letters and threats and require numerous reports, statements, forms, notices, and approvals that investment firms and public companies must obey. 5 This creates an artificial scarcity of investment products that benefits large corporations and discourages savings and investment. Smaller companies cannot afford to raise money by issuing stock, and investors are forced to choose between public but expensive mutual funds and secretive and risky hedge funds with entry fees that only the rich can afford.

The SEC creates corruption

Rather than making Wall Street honest, regulatory agencies are the primary instruments of fraud and corruption on Wall Street. Politicians who control regulatory agencies have an incentive to use their power to extract benefits for themselves and their constituencies, rather than to keep markets honest and efficient. Power hungry politicians like Eliot Spitzer use the power of the SEC to go on crusades again innocent businessmen 6, and thus force regulatory bodies to hide the evidence of real corruption.7 By blocking outsiders from seeing its records, the agency is makes it harder for investors to discover real fraud.8

The case of Bernie Madoff is a typical case study in how the SEC encourages fraud. Investors figured out that Madoff couldn’t possibly make the profits he claimed, and have been writing the SEC since 1999, urging them to put a stop to Madoff’s Ponzi scheme. However, Madoff used his close family ties to the SEC, and was instrumental in founding key regulatory bodies – and then nominated his family members to serve on their boards. When skeptical investors inquired about the irregularities in his fund, Madoff told them that the SEC had already investigated and cleared him over a period of three years.

While Madoff stole $50 billion dollars under their noses, the SEC’s budget surpassed $900 million dollars, and grew at record rates during the two Bush administrations. In response to this outrageous case of nepotism and corruption, the government will likely increase its budget and staff once again.9

The SEC makes markets more volatile and risky

By banning crucial market functions like short selling10 and “insider trading” 11 the SEC hinders the market’s ability to react to new information, and makes markets more unpredictable and expensive.

The SEC cannot even oversee itself

While the SEC is charged with enforcing regulations like Sarbanes-Oxley, it consistently fails to control and report on its own processes and receives failing grades from the government’s own auditing body.12 This is not surprising – like any socialist organization, it has no incentive to be efficient or responsible to stockholders.

The chief source of fraud and corruption in the United States is not Wall Street, but Washington D.C.

Notes

  1. Medieval English common law: foundations for 21st century legal systems
  2. Wikipedia: The history of accountancy
  3. Self-Regulation in Today’s Securities Markets: Outdated System or Work in Progress?
    CFA Institute Centre Publications (September 2007)
  4. See How the SEC Subsidizes Stocks by Jeff Scott and SEC: Protecting Investors Or Uncompetitive Companies?
  5. (There are so many regulations that the department charged with publishing them can only report that “The Office of the Federal Register Library now contains more than 550 cubic feet .. which has the force and effect of law.” – History of the Federal Register
  6. The Cost of the “Ethical” Assault on Honest Businessmen by Alex Epstein and Yaron Brook (Silicon Valley Biz Ink, July 8, 2003)
  7. Deafened by the S.E.C.’s Silence, He Sued
  8. The S.E.C. Prevents Investors From Discovering Accounting Fraud
  9. The SEC Makes Wall Street More Fraudulent by Robert Murphy
  10. See the One Minute Case for Stock Shorting
  11. See Inside Insider Trading and Should Insider Trading Be Legal? by Yaron Brook
  12. GAO Finds Material Weakness in SEC’s Controls

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by | October 2, 2007 · 3:18 pm

The One Minute Case for the Austrian Business Cycle Theory

The Austrian Business Cycle Theory was developed by the economist Ludwig von Mises to explain the phenomenon of business cycles. It provides crucial insight for understanding the cause of cyclical boom/bust cycles and their connection the government’s manipulation of the economy. To understand the Austrian Business Cycle Theory, an analogy is helpful:

Imagine an economy with just one actor: Robinson Crusoe on an island. Crusoe loves fish, so he spends half of each day fishing so he can enjoy fish in the evenings. Additionally, Crusoe spends Friday mornings maintaining his fishing dinghy and nets. In order to have fish on Friday, he must fish for an extra hour every other day of the week. In economic terms, Crusoe has a savings rate of one hour per day. His savings rate is also his investment rate, or the percentage of present income he sets aside to maintain or increase future consumption.1

Crusoe doesn’t have a fridge, so he preserves his catch by throwing it in a small, dark pond. He can’t see how many fish are in the pond, so he keeps a stack of small rocks near it. Every time he adds a fish, he adds a rock, and every time he eats one, he removes one. The rocks are his money supply.

Suppose that Crusoe shares the island with some mischievous monkeys, who see Crusoe adding rocks to his pile. They decide to imitate him, so every time Crusoe ads a rock, they sneak in and add one as well. The monkeys are inflating the money supply by injecting currency into Crusoe’s investment fund.2

One day, Crusoe suddenly notices that his “savings rate” of fish is double the usual. He decides to compensate by eating some of the fish he catches during the “savings hour.” This is the consumption-side of the boom phase of the business cycle. Crusoe also decides to take some extra time each day to start building himself a new hut. This is the investment-side of the boom phase of the business cycle.

Crusoe now believes that the cost of saving fish is half the usual, while in fact his savings rate is too low for the investments he is planning.

Before long, Friday comes around. When it comes time to eat his midday meal, Crusoe suddenly realizes that he’s out of fish – despite having a surplus of rocks. He’s exhausted his investment capital because the additional currency snuck into his money supply did not represent a real increase in his productivity or savings rate. He doesn’t have the capital (fish) to maintain his previous consumption rate, much less increase it. He is forced to cut his investment rate (he must spend some of his Friday fishing) just to have some fish for Friday’s dinner. He must also abandon his incomplete hut because he does not have the time to finish it. The abandoned hut is an extravagant expenditure that represents a loss of capital.3 This is the bust phase of the business cycle.

To review, here’s the overall impact of the monkey’s trickery: Sunday-Friday, Crusoe catches the same number of fish, but consumes more, and therefore saves less. That’s the boom period. Friday, Crusoe consumes less fish, and spends less time for maintaining his nets (capital). Some of his investment/consumption time must now be spent in production. That’s the bust period. If Crusoe’s initial savings rate allows him to just break even each week 4, his nets will gradually get worse and worse and he will eventually go hungry.5

Notes

  1. Crusoe prefers to enjoy his fish sooner rather than later, but he is willing to put aside some of his catch to get more fish later. The discount he gives to eating a fish Friday is his time preference, or his originary interest rate. (To that, he adds the risk that the fish will spoil by Friday to get the market or “real” interest rate.)
  2. As long as the monkeys keep contributing one stone for every fish, Crusoe can account for their trickery. But if the monkeys are unpredictable, it will be impossible for Crusoe to set the proper savings rate.In the real world, the originary interest rate reflects the average time preference of all savers. If someone starts monkeying around with the interest rates, it becomes impossible for investors (or the monkeys at the Fed) to know what the real rate of savings is even if they know that the rate is being manipulated.
  3. That abandoned hut represents investments which exceed the ability of the actual savings rate to complete. The resources it takes to build compete with worthwhile investments (such as repairing the fishing nets) by raising the prices for all capital. Ridiculous business models and sky-high salaries during the dot-com boom, as well as over-extended sub-prime mortgages likewise compete with legitimate business models, salaries, and mortgages. Manipulating the money supply makes it difficult to distinguish bad investments from good ones, so no one can escape the inevitable crunch.
  4. That is, zero net profit, an equilibrium rate of savings, or “the evenly rotating economy” in Mises’ terminology.
  5. Suppose Crusoe decides to ignore his hunger and work on his nets all Friday. In other words, he trades current production (and therefore consumption) for higher future consumption (that is, economic growth). If he does so voluntarily, there’s nothing wrong with that. But there’s nothing inherently more desirable or efficient in spending some of one’s time starving just to increase future production (that is, in valuing economic growth over present consumption.) Note that the longer Crusoe delays the shift back to production, the more severe the miss-allocation of resources (and his hunger) becomes. The monkey’s trickery does not actually make Crusoe to become a better saver – he is more likely to start saving less because of uncertainty over the future.

Further reading

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by | June 5, 2007 · 6:28 pm

The One Minute Case For “Price Gouging”

“Price gouging” is a derogatory term for “unfair” prices on goods, typically in an emergency.The problem is that the perception of “unfairness” is totally arbitrary and stems from an ignorance of basic economics.Rather than create “fair” outcomes, “price gouging” regulations create the very problems they are supposed to solve.

What are prices?

A price is the value demanded by a seller in exchange for a good.The money paid for goods makes production of more goods possible.When the demand for a good suddenly goes up or the supply goes down, sellers raise prices to avoid a shortage.Higher prices cause consumers to limit their consumption.Higher profits pay for money to be invested in expanding production, and encourage other producers to redirect production from other uses to the goods most urgently demanded.

The disastrous effects of price controls during disasters

Consider what happens when politicians attempt to control a run on gas precipitated by an imminent hurricane:

When price controls are imposed, the market’s ability to respond to an emergency is paralyzed  Rather than distributing gas to those who value it the most, products are distributed to those who buy it first. This encourages those with time to wait in endless lines, or the most panicky individuals to rush to fill up their cars at the first sign of trouble. Runs begun whenever a minority of people expects a rapid increases in demand, and the entire stock is quickly consumed by a few.

Whereas a free market would quickly respond to higher prices by shifting supply to the stricken area, outside sellers have no incentive to make an effort to bring additional supplies to the stricken area when prices are fixed. To recoup the higher costs of delivering gas in emergencies and offset the risk of a run, gas stations keep prices at a higher overall level for a longer time.

Price gouging saves lives

Absent price controls, gas stations raise prices in an emergency to a level where everyone who is willing to pay the new price is able to buy gas.Badly needed resources are delivered to those who need them most.Rather than buying out stocks, consumers ration usage of expensive goods.Those in the most vulnerable areas are able to pay a higher price for the gas they desperately need, while individuals who are less vulnerable wait until stocks are replenished.

Price gouging remedies shortages

In addition to distributing existing stocks more efficiently, high profits pay for the higher cost of delivering supplies to a dangerous area.They also encourage stocks in other locations to be redirected to where they are most needed.The market’s natural response to shortages is far superior to government planning of how much of everything is needed and where. This was aptly demonstrated after Hurricane Katrina, when FEMA paid truckers exorbitant amounts to ship thousands of tons of badly-needed ice around the country before finally throwing it out.

Price gouging is the best solution to price gouging

A rapid price increase in anticipation of an emergency reassures buyers that supplies will be available if necessary, resolving the problem of runs caused by false alarms. In the long run, a high price on gas during an emergency encourages consumers to be better prepared for emergencies and find alternate means of transportation and encourages and pays for suppliers to increase production.Rather than face dry pumps during emergencies, consumers in vulnerable regions will pay a slightly higher price for fuel stations and stores to maintain higher reserves.Ultimately, the market’s natural response to shortages dampens price increases and shortens waiting lines.

Further reading:

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by | May 29, 2007 · 8:36 pm

The One Minute Case For Free Trade

Why not be self-sufficient?

Do you make your own shoes? If you invested some time learning shoemaking, you could save the money you regularly spend on new shoes. What about butter – why not churn your milk? If, like cavemen, everyone was entirely self-sufficient, our monthly spending would be zero. That would be fortunate, because our income would be zero as well, since no one would buy anything from us either.

Everyone outsources

We don’t make everything ourselves because we don’t have the time to produce everything we want. Humans learned long ago that it is beneficial to trade our specialized labor in one field for the labor of others in another, with money as the means of exchange. The difference between the short hardscrabble lives of a hunter-gatherer society and our relatively luxurious existence is due to the gains in efficiency made possible by voluntary exchange.

Everything is outsourced

In “I, Pencil”, Leonard Read writes that there isn’t a single person on earth who knows how to make a pencil. The process of acquiring and assembling the cedar, lacquer, graphite, ferrule, factice, pumice, wax, and glue that compose a pencil are performed by thousands of people all over the world. No one individual is capable of understanding all the processes involved or arranging all the transactions that deliver the necessary supplies to the right step. Voluntary exchange between individuals who know only their immediate trading partners makes possible a process that no central planner could design. None of the participants engage in it because they need a pencil, but because they want the goods and services others produce in order to buy a pencil.

A policy of free trade is beneficial even when it is unilateral

Some isolationists argue that foreigners have “unfair” advantages due to lax labor or environmental regulations, industry subsidies, or restrictions on imports abroad. But such arguments miss the whole point of trade. Capitalism is not a zero-sum game where profits are redistributed from one producer to another. Consumers who buy cheap foreign goods make their money available to buy other products, increasing everyone’s living standards. Domestic producers who lose sales to cheaper foreign goods benefit from increased consumer spending at home, and foreigners with dollars clamoring to spend them on domestic industries.

Governments that subsidize export industries only rob their taxpayers to pay foreign buyers. When France subsidizes steel exports, American steel foundries lose money, but Americans get cheaper consumer goods, and “free” Euros to buy goods that would have belonged to French taxpayers. Ultimately, restrictions on trade based on international borders are arbitrary and just as destructive as internal barriers.

Trade deficits and surpluses are natural states of economic development

The U.S. has a trade deficit when foreigners accept more U.S. dollars for their products than vice versa. If a deficit were to continue indefinitely, Americans would have a permanent supply of “free” foreign goods, since dollars are worthless if they are never spent. Foreigners trade at a deficit with America because they are confident that the we will have products they want sometime in the future. Likewise, we accumulate foreign currency in the belief that foreign goods will be valuable. Surpluses and deficits are natural states that every nation experiences as it varies between being a net recipient of investments or a net investor.

Further reading:

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by | May 20, 2007 · 1:57 am

The One Minute Case For Unrestrained Profit

Profit is the engine of production

Restraining profit by taxing it or limiting it has the effect of limiting production. Restraining profit means an economy will produce fewer goods, of less variety, and at higher price. Innovation suffers. As a result, to the extent profits are restrained, all consumers suffer. Profit drives production in several ways:

Profit is the incentive for production

The profit motive is the supreme motivator of productive business activity. The creativity of scientists, the entrepreneurship of businessmen, and the resourcefulness of financiers are all motivated, in whole or part, by the pursuit of profits.

Profit provides the means of production

Profits and savings are the ultimate source of the investment capital (money) that finances construction of factories, research laboratories, distribution centers, ships, warehouses, and all of the equipment that is used to invent, produce and distribute the goods that we consume. To restrict profits is to deny a source of capital necessary for production.

Profit directs capital to the production of goods most urgently wanted

The highest profits are earned by the businessmen who can supply the goods most wanted by customers. iPods, portable generators after a hurricane, personal computers, fashionable clothes, and all of the goods consumers want most, are made by those who make the greatest profits. The profitability of an enterprise is the ultimate measuring stick of how well it has satisfied its customers. A money losing business is either making products consumers do not want or charging too much for them.

Profits result in everyone’s gain

Profits do not come from the net loss of anyone. On the contrary, profit results from the creation of goods that people voluntarily buy in the marketplace. A businessman who makes a huge profit makes things that are good enough that many people want them and willingly buy them from him.

Profit is property

Profits are the property of the shareholders and other investor/owners of the business. Restricting or taxing profits is not just impractical, but is theft.

Honest profits are an essential feature of capitalism

A profit honestly earned in a capitalist society is beneficial and good for all. Profits must be distinguished from the money a businessman might get because of special governmental favors, such as tariffs, regulations or subsidies. These interventions are contrary to capitalism and allow some businessmen to gain at other people’s expense. Their gain is not profits, but a form of theft.

Further reading

  • Capitalism: The Unknown Ideal by Ayn Rand
  • Atlas Shrugged by Ayn Rand
  • “Profit and Loss” by Ludwig von Mises

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