Tuesday, November 24, 2009

When the Invisible Hand is the Government

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

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Adam Smith in his Wealth of Nations pictured an invisible hand that operated behind the scenes to make capitalist markets operate efficiently. When that invisible hand becomes the government, you no longer have capitalism, nor do you have efficiency. The self-correcting mechanisms of capitalism are also done away with and the market loses the ability to fix itself. Three pieces of news out recently - China trying to reign in bank lending, the U.S. 3rd Quarter GDP report, and the Bank of England admitting to secret loans to big banks during the Credit Crisis - are representative of how important government's hand in the global economy has become.

China is the growth success story of the world. It's economy is indeed humming along. The tune it seems to be singing however is bubbles are here to stay. Along with freezing the exchange rate of the yuan at artificially low levels in 2008, the government has pumped incredible amounts of money into the financial system in the last year in order to maintain a high growth rate. Anecdotal stories out of China indicate that a lot of the money is is being used to build empty office buildings, unused infrastructure and even empty cities. The government's warning to banks to control lending seems a bit hypocritical to say the least. Markets around the globe sold off on the news however, which tells you just how important Chinese growth is viewed as a cornerstone for recovery from the Credit Crisis.

The U.S. could learn a thing or two from China on how to goose up a flagging economy (as for government hypocrisy, the U.S. is way ahead). Revisions to the third quarter GDP indicate that growth was only 2.8% instead of the originally reported 3.5%. Cited for lowering the numbers were a bigger trade gap, lower commercial construction, consumers didn't spend as much and business inventories fell more than expected. None of these are surprising and they are all probably still considerably overstated. Without Cash for Clunkers program and the federal housing purchasing subsidies, there would have been no economic growth and U.S. government officials wouldn't have been able to shout from the rooftops that the recession is over. This reminds me of the press conference that Herbert Hoover gave in June 1930 announcing the depression was over (there were three more grueling years ahead before the U.S. economy even hit bottom). If he had today's government statisticians, he could have produced the numbers to prove it.

The Bank of England today admitted that it secretly lent over $1 billion dollars to two major banks - the Royal Bank of Scotland (RBS) and HBOS PLC - to keep them afloat during the height of the Credit Crisis in late 2008. HBOS was later merged with Llyods Banking Group (and you can probably guess which invisible hand brought them together). Both banks have since been nationalized with the UK government owning 84% of RBS and 43% of the Lloyds/HBOS combined firm. Lloyds in now in the process of raising a massive amount of new capital. One would have to be pretty naive to believe these were the only secret government dealings during the Credit Crisis. What could have happened in the U.S. boggles the mind. The Federal Reserve is an unaudited entity and operates in secrecy as is. Fed chair Ben Bernanke has refused to provide information requested by congress about the bailouts. If there's nothing to hide, why is he hiding it?

Disclosure: No positions.

NEXT: Why You Can't Trust U.S. Weekly Jobless Claims

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.