Oh! what a tangled web we weave

When first we practice to deceive!

– Walter Scott, “Marmion”

First, let’s check the markets. The Dow fell 66 points yesterday. And gold sold off too – down $10 an ounce.

In August, our hypothesis was that we would see falling US stock markets and rising gold prices as the dominant trends of fall. So far, we haven’t seen much in the way of trends at all.

Last week’s Fed “no taper” announcement should have been followed by robust increases in stock and gold prices.

But what happened instead?

After the first day, both stocks and gold headed down.

Some possible causes…

What if the economy were not really recovering at all? You’ve seen the evidence. Lowest household income since 1984. Falling wages. Fewer people working (as a percentage of the working age population) than ever. Industrial output barely positive.

And what if Fed policy is the main driver of US stock prices? And what if investors had already priced in “QE Forever”?

Then where could they go? Only down, right?

The Great Wealth Transfer

Every government wants to manipulate the value of its currency. It will always say it’s acting in the name of some public good – to protect citizens’ savings… to promote employment… or to stimulate a recovery.

You don’t have to be a crusty cynic to understand the real reason: to help the ruling elite transfer more power and money to itself.

Rarely has that been more apparent than in Venezuela, where Hugo Chavez restricted free trading in the local currency, the bolivar, to promote his own political ambitions.

Most prominent among those ambitions was his desire to be re-elected. And the way to be re-elected is to give (or appear to give) something to the masses that they couldn’t get on their own.

That, dear reader, is why 7 out of 10 American families get more from the feds than they pay in taxes. Government confers on its favorites the right to lie, cheat, steal… and even to murder other people.

In a democracy, the will of the majority must be won with these tools; they are all government has to work with. (Government produces no wealth, so it has nothing to offer otherwise.)

Typically, shrewd leaders offer giveaways to the poor; dollar for dollar, their votes come cheaper than those of the rich. One of those giveaways is artificially low consumer prices.

The demagogue announces to the masses, for example, that he will “not permit the evil capitalists to raise prices on milk and bread and other basic food items.” That’s always a crowd pleaser.

But the demagogue runs into problems when he is simultaneously ripping off rich and poor by exploding the monetary base. This can cause prices to rise.

If he isn’t careful, people will catch on. So, he is forced to lie about the source of inflation and put on price controls.

Shortages inevitably follow, causing inappropriate investment, consumer binges and other problems… which eventually overwhelm the economy.

But the lying, cheating and stealing can be fun while they last – which can be a long time. In Mr. Chavez’s case, they lasted longer than he did.

No Fly Zone

And here we have an update from Caracas from Reuters:

If you live in Venezuela and want to fly abroad, get in line.

Flights are booked solid months in advance, not from a new interest in exotic destinations but because locals are profiting from a play on the nation’s tightly controlled currency market.

The airline scramble has added to shortages, power cuts and runaway prices as another symbol of the Byzantine economic challenges facing the new government of President Nicolas Maduro in the South American OPEC nation.

“It’s like you’re trapped here,” said travel agent Doris Gaal, telling a customer he would be better off taking a boat to a Caribbean island because the daily flights are fully booked. “It’s all because of these stupid dollars!”

After a decade of currency controls set up by late socialist leader Hugo Chavez in 2003, the disparity between the official and black-market rates for the local bolivar currency is higher than ever. Greenbacks now sell on the illegal market at about seven times the government price of 6.3 to the dollar.

There are strict limits on the availability of dollars at the 6.3 rate, but Venezuelans are cashing in on a special currency provision for travelers. With a valid airline ticket, Venezuelans may exchange up to $3,000 at the government rate.

Some are not even flying, leaving many planes half empty.

The poor travel agent has it wrong. The dollars are not nearly as stupid as the bolivars.

But both are ignorant in a crucial and destructive way. Prices are information. They are supposed to give us important cues. Low farm prices tell farmers to plant less on the lower 40. High prices of old phonographs tell householders to go look around in the attic. High prices for credit tell lenders to lend more and borrowers to borrow less.

Lying about the real value of the bolivar, the Venezuelan feds have created an awkward mess.

But the US feds lie too. Prices are set, not by willing buyers and sellers for their mutual benefit, but by the Fed for the benefit of the feds’ favorites.

The Fed swaps newly created bank reserves for Treasury and agency-backed mortgage bonds, thus artificially driving up bond prices (and driving down yields).

Low yields tell borrowers a fib: that there are more resources available to be borrowed than there really are. Borrowers take the miscues. They add more debt. And the entire web of yields, currency values, consumer prices and asset values becomes even more tangled.

Eventually, it is so tangled that it cannot be untangled. Like the Gordian knot, it must be cut…