Economics is not physics. It does not obey the laws of physics. In truth, economics is not even a science – not yet, anyway. This is why Adam Smith was the chair of moral philosophy at Glasgow University and not, say, an actuary.
Smith’s moral philosophy was the study of choices people made with money. The money was a secondary phenomenon.
The basis for choice – the rules that govern what we do and why we do it – were primary. Smith and other economists thought those rules were moral. Today, some economists tell us those rules are natural, but have benign moral consequences.
Human action is not based on cold, hard, rational economic calculation. It is based on fear, greed, hope, jealousy, kindness, pettiness, love, hate, and indifference. That is why any science of economics will always be somewhat philosophical.
The discussion of what is moral is really a discussion of what is good. And who can pretend to know what is good without at least examining the issue a bit? And even then, who can presume to know what is good well enough to order other people around?
Still, there are general rules in life and in economics. These rules form the basis of an environment that even people who radically disagree can live in.
In America for example, we call those general rules the Constitution and ‘the free market.’ What you and I do behind closed doors might be completely different, but our Fourth Amendment and property rights allow us a wide degree of liberty upon which the government (or nosy
neighbours) cannot constitutionally intrude. If the house is a-rockin’, don’t bother knockin’, unless I’m disturbing the peace.
With the law, the fewer the rules the better, and general rules work best. Everyone knows what they are, and the laws don’t favour any one group over another. That leaves people free to fail and succeed on their own merits.
The tendency to tinker with the law to make people ‘more free’ or make things ‘more equal’ is the same tendency economists have when they talk about maintaining equilibrium. They believe that the economy is not a dynamic and open system (like common law, for example), but a static thing that needs to be tinkered with and then frozen in time and kept in the same working order with the same fixed relationships, forever and ever, Amen.
In nature, static is dead. Closed systems don’t have access to energy inputs. Without them, nothing new is created. Resources are eventually exhausted.
Thankfully, despite the tinkering of the rationalists, the world remains a dynamic place, if not an entirely open system. Luckily, the enemies of an open system and a free market (governments) are not immune from the forces buffeting the world.
They face the same threats that every institution faces in a world that demands adaptation. Guns can stave off those threats for a long time. So can taxes. But the more closed a system is, the more likely it is to die. It takes a lot of energy to hold a gun to the head of your population forever.
Sooner or later, unless you’re Castro (who seems to get his energy from some ungodly place), you’ll tire and fail and your system will collapse. Sic semper tyrannus.
Outside places like North Korea and Cuba, the behaviour of individuals is governed by simple rules, rules that each individual knows or learns without being told.
Using those rules, people – or agents in an economic system, if you prefer – adapt. They adjust when the anthill is kicked over. An innate survival strategy kicks in. For those who fail to learn the rules or those who flout them, no survival strategy emerges. The individual dies, or in Darwinian terms, is selected against.
Adaptation is a crucial survival skill, then, especially in periods of volatile and violent change. When the environment around you is changing quickly, you have to Observe it, Orient yourself correctly to the changing conditions, Decide what to do about them, and then Act with effectiveness. That is, weary long-time readers will note, a short version of John Boyd’s OODA loop.
Boyd was the former US Air Force fighter pilot turned strategist and theorist whose ideas on fighting fourth-generation warfare have found an application today. Why today?
The pace and scale of global commerce is shaking the post-war system to its foundations, not least the global monetary system. In a world without a gold standard, all values seem relative. Without a solid point of reference – whether it’s gold, God, or the Constitution – the world is just a mishmash of things moving and colliding relative to one another.
But what if I told you that this seeming chaos really signalled the emergence of a new system? Call it the system of the world. This system will determine how money and commerce works and return us to how value is determined (through exchange of course, but through a stable medium of exchange that acts as reliable store of value).
This system will preserve the elements of some existing institutions. Other institutions like Fannie Mae and its culture of fraud – entire nations, even – will be demolished.
And importantly for this month, this system that favours smaller, adaptive, innovative, and imitative firms and individuals will have a different kind of energy input. If the previous cycle of global growth favoured size and centralization and flawless global logistics and distribution of raw materials and goods by virtue of cheap energy and cheap credit, the next cycle and system will favour independent and self-sufficient actors who have their own sources of energy, capital, and ideas.
Other types of firms will exist, of course, just as the crocodile remains at the top of the food chain in its ecosystem, despite few adaptations or innovations in the last few million years. People will still work for the crocodile firms and enjoy job security.
But the new growth in the world, the revolution in how wealth is accumulated and kept, will be led by the people and companies who adapt to the conditions of the new system best. That new system will be characterized by more expensive capital, more expensive energy, gradually more expensive labour, and more expensive raw materials. Nothing about it is getting cheaper. And competition is getting more intense. That’s a tough world to survive in. You’d better have a good organizational DNA.
The news from the housing market has been amusing, astounding, upsetting, and absurd, by turns. But has it presented us with any new chances to profit? The answer is yes, but it involves two different kinds of action and two different kinds of risk.
The first is the simplest: favour real assets and ‘stuff’ over financial assets and ‘paper.’ That means mostly resources and energy stocks. Sound like a broken record? The risk of owning mostly precious metal, resource, and energy stocks is that your stocks get taken for a ride by hedge funds and the press. A mini-euphoria ensues and things get overheated.
Then you get a correction like we’ve had in May, where even a solid company can fall 15-20% in a skittish sell- off. This is the main risk with taking the ‘stuff’ position and shunning the more popular sector rotation.
You don’t shuffle your money around in the latest, greatest thing. You invest it in the strongest, most durable trends in the economy. And then you ride out the volatility.
It’s going to be volatile. Economist Hyman Minsky points out that ‘Stability breeds instability.’ We’ve had a period of unusually low volatility for the last three years. If patterns hold, that means we’ll have unusually high volatility going forward. And because the resource sector is the dominant sector, the price swings will be nauseating. But there’s no need to lose your lunch.
By Dan Denning for The Daily Reckoning. You can read more from Dan and many others at www.dailyreckoning.co.uk.
Dan Denning is the editor of Strategic Investment, one of the most respected ‘big-picture’ investment newsletters on the market. A former specialist in small-cap stocks, Dan has been at the helm of Strategic Investment since 1999 – where, drawing from his network of global contacts, he has designed an investment strategy that takes into account global political and economic trends.
And to read more on the resources bull market, see the report below…
Category: Economics