Reservations About the Market Economy?

I’m writing this not to pick on this guy in particular, and also not because I find this topic in itself particularly interesting or relevant.

I’m rather doing it to show how intellectuals these days have significant white spots when talking about economics in general, and markets in particular.

And this is not necessarily this guy’s fault, it is an inevitable result of the “education” that millions of people, myself included, have received year after year in schools and colleges around the world.

So here it goes, the piece is called “Reservations About the Market Economy”:

How restaurants take reservations may not seem like typical topic for the Sift, but bear with me on this. A recent article about this particular niche of the economy says something interesting about how the economy as a whole works. is a service that allows you to make restaurant reservations online. It claims to handle 15,000 restaurants, and though it seems concentrated on upscale restaurants in the major cities, its reach extends all the way up here to Nashua, NH. It provides reservation-tracking software to restaurants. Its web site lets prospective diners check which of their favorite restaurants have tables open, and helps travelers find restaurants in unfamiliar neighborhoods.

Diners pay nothing, and in fact get loyalty points (exchangeable for free meals) for booking with Open Table. They also get to rate restaurants and see the ratings and comments of other diners. Restaurants pay installation costs, monthly membership fees, and a fee for each reservation. The business model seems to work. Open Table went public in 2009 and (at Friday’s closing price of $67.83) has a market capitalization of $1.6 billion. (That’s a little over $100,000 per restaurant. Hmmm.)

OK, so here is the first thing that he might want to elaborate a little bit further on, lest he mislead the reader. Since this is ( at least seemingly supposed to be) an article about the free market economy, at least nominally, he might want to point out that OpenTable, by going public on the US stock exchange, essentially left that field which more or less deserves to be referred to as a free market, and entered a highly government subsidized and manipulated field, as I explained before in The Root Causes of the Financial Crisis (in this case I was explaining the sources for artificially high demand for securities, such as mortgage backed securities):

Tax Policy and Incentives

You may, at times, ask yourself a very simple question: Why do so many people care about the stock market? Why is there so much money sloshing around in it.

This is a very important question. The pieces of paper called mortgage backed securities, which promise the buyer a share in the monthly mortgage payments of homebuyers were being purchased by numerous mutual funds and stock market investors all other the world. (I already explained above why the agencies rating those investment vehicles had no competitive pressure to perform.)

There is a reason why there was so much money available to be invested in such securities, amongst others of course. Governments across the globe fundamentally encourage investing in the stock market in one way or another, be it mutual funds, government bonds, or outright securities.In the US this is done through retirement plans like 401k and ROTH IRAs.

The concept is simple: Invest a portion of your money or else the tax collector will gladly take it away from you. This is how trillions of dollars are herded into the stock market, ready for mutual fund managers to be played with.

One major player in the stock market is … you guessed it … the government itself. Currently about $12 trillion is invested in government Treasury securities. To give you some perspective: As I outlined before, the total invested in US stocks is just about $10 trillion!

Is it conceivable that such incentive policies might possibly have played some sort of role in the huge demand that was created for mortgage backed securities at one point or another? Could it be that, for the sake of propping up demand for government bonds among other things, government officials will always have some significant incentive to herd money into the stock market? Could it be that they will do everything they can on their end to ensure people will stay invested for as long as humanly possible?

You might also be interested in this clip as far as this topic is concerned:

He may also have wanted to point out that on top of large scale institutionalized government controlled herding of money into the stock market, the President’s Working Group on Financial Markets has been reported several times to have intervened in addition to to all of that:

The President’s Working Group on Financial Markets aka ” The Plunge Protection Team”

The market is a system of elements that are in constant flux.

In a free society where individuals are allowed to make choices by themselves so long as they don’t infringe upon their fellow men’s life, health, and property, entrepreneurs use natural resources, transform them and/or combine them with previously produced factors of production, and turn them into either consumer goods or other factors of production. They employ workers in the process who provide the production factor labor.

They exchange consumer goods on the market against money obtained from consumers. They exchange factors of production against money obtained from other entrepreneurs.

When a business squanders factors of production which, from the consumers‘ point of view, would satisfy more urgent and/or ample needs in other lines of production, it operates at a loss. This sends a signal to the entrepreneur running the business to do one of the following, lest his operation contribute to a deterioration of the welfare of society:

– find a better use for the factors of production employed (produce different, more demanded goods)
– find more effective ways to employ them (increase the output of the factors employed)
– abort the operation, make the factors available to entrepreneurs who plan to employ them in more urgent lines of production, thus releasing them from their current occupation (declare bankruptcy)

Those are the choices he has under a capitalistic system on a market where the consumer, the common man, is supreme, a market based upon voluntary action. Any of these steps would swiftly remedy the misallocation of the resources and align them to the benefit of the common people, the consumers.

If an investor has invested in a company stock at a price that he deemed to be reflective of that company’s future earnings, but it turns out that consumers actually do not demand the company’s goods as expected, then the investor is punished via a drop in the stock price. This ensures that investors tend to try and invest in businesses which produce the most urgently demanded goods first, all ultimately in the service of the consumer.

However, when a group of people within society obtains resources via the initiation of violence or the threat thereof, then we are leaving the realm of the market and of voluntary choice and we enter the realm of compulsory action, viz. the government.

The government always and by definition manipulates the transfer of money in a way that is contrary to people’s voluntary value preferences. If it uses the money it has obtained in order to purchase stocks with the intent to support its price, it messes with the fundamentally most important indicator of a company’s performance in meeting consumer demands. It creates an environment of uncertainty and corruption, as investors will immediately flock toward this powerful group in order to ensure they get such special treatment. It prolongs the period during which a business engages in activities that it should and would have stopped engaging in much sooner, and thus always sets the stage for speculative booms and subsequent abrupt crashes in the future.

Such is the case with The President’s Working Group on Financial Markets, also known as the “Plunge Protection Team”:

The Working Group on Financial Markets (also, President’s Working Group on Financial Markets, the Working Group, and colloquially the Plunge Protection Team) was created by Executive Order 12631,[1] signed on March 18, 1988 by United States President Ronald Reagan.

The Group was established explicitly in response to events in the financial markets surrounding October 19, 1987 (“Black Monday“) to give recommendations for legislative and private sector solutions for “enhancing the integrity, efficiency, orderliness, and competitiveness of [United States] financial markets and maintaining investor confidence”.[1]

As established by Executive Order 12631, the Working Group consists of:

“Plunge Protection Team” was originally the headline for an article in The Washington Post on February 23, 1997, and has since become a colloquial term used by some mainstream publications to refer to the Working Group. Initially, the term was used to express the opinion that the Working Group was being used to prop up the markets during downturns. Financial writers for British newspapers The Observer and The Daily Telegraph, along with U.S. Congressman Ron Paul and writers Kevin Phillips (who claims “no personal firsthand knowledge” and is “not interested in becoming a conspiracy investigator”) and John Crudele, have charged the Working Group with going beyond their legal mandate. Claims about the Working Group, which are labeled conspiracy theories by some writers, generally include that it is an orchestrated mechanism that attempts to manipulate U.S. stock markets in the event of a market crash by using government funds to buy stocks, or other instruments such as stock index futures—acts which are forbidden by law. In August 2005, Sprott Asset Management released a report that argued that there is little doubt that the PPT intervened to protect the stock market. However, these articles usually refer to the Working Group using moral suasion to attempt to convince banks to buy stock index futures.

I will not here try to figure out as to weather or not this PPT has actually intervened in the markets. There are so many other ways via which the government overtly interferes way out in the open that the accuracy of the above claims does not matter in the slightest to assess the validity of the theories I am presenting here.

I will merely say that it is undeniable that plausible evidence exists to corroborate the idea that the government is using the PPT as yet another means to manipulate events on the market.

And he might finally have wanted to point out that by going public OpenTable has turned itself into a publicly traded company, the most regulated and liability shielded form of corporation where the investor’s liability past money invested is virtually zero. And this concept of the corporation, too, is not a market concept, but rather a government created one, as I wrote in that same article:

The corporation is a legal entity created by the government to bestow privileges and government protection upon certain people. It allows individuals to invoke the power of the state to avoid taking responsibility for their own actions and for violating others’ property rights. It has absolutely and 100% NOTHING to do with a free market, a system in which everybody’s property rights are respected and protected. It is, in fact the exact opposite of a free market concept. So please … stop throwing the poor free market in one cage with that beast that is the corporation. It’s not a very nice thing to do … :-/

I mean, this stuff is not really rocket science. When you get the opportunity to make immediate millions/billions from an IPO, facilitated by an environment of heavy government subsidies, manipulation, and privileges granted, then as a manager you are not very likely to be all that concerned about or constrained by consumer feedback and long-term thinking.

Anyway, keep all of the above in mind as you read on what our friend has to say about the “market economy”:

Services like this benefit from what is called a “network effect”. In other words, each user makes it more valuable for all the other users. (The standard example of a network effect is a phone system. If you’re the only person on a phone network, there’s nobody you can call. You want to be on the network that everybody else is on.) A small table-reservation service is quirky and has patchy coverage. But a big one has lots of restaurants, lots of ratings, lots of comments, and the resources to put all the latest bells and whistles on its web site. The more you use it, the better it gets at recommending restaurants you’ll like and tailoring promotions to your tastes.

Left to their own devices, markets with a strong network effect tend toward monopoly — one network to rule them all. As this happens, the power relationship changes: Rather than simply connecting diners to restaurants, Open Table is becoming a gatekeeper. It controls the relationship with the customer. It decides which restaurants succeed or fail.

Restauranteurs are starting to see the writing on the wall. In a post that gives a fascinating glimpse into the restaurants’ side of this relationship, San Francisco restauranteur Mark Pastore asks:

Have the ascent of OpenTable and its astronomical market value resulted from delivering $1.5 [now $1.6] billion in value to its paying clients, or by cunningly diverting that value from them? What does the hegemony of OpenTable mean both for restaurants and for the dining public in the long run?

He asked a dozen of his fellow restauranteurs in SF and New York about Open Table, and found only one who was happy. The others report feeling “trapped” and one says that his payments to Open Table amount to more than he makes from his 80 hours a week spent running the restaurant.

You see, once a service approaches monopoly, the dark side of the network effect appears: When only a few restaurants had Open Table, they might imagine that it was delivering new customers to them. But if all the restaurants have it, it’s just shuffling customers around. Checking Open Table might cause you to book with Amelio’s rather than Antonio’s, but you were going out to eat somewhere anyway, and you probably would have spent just as much money. At that point, Open Table’s fees are just siphoned out of the restaurant system without providing any systemic value.

Pastore concludes:

by permitting a third party to own and control access to the customer database, restaurants have unwittingly paid while giving away one of the crown jewels of their business, their customers.

And customers, by taking advantage of the short-term freebies Open Table provides, may ultimately wind up with fewer choices: If restaurants are less profitable, more will close. It’s already a tough business, and anything that makes it tougher is bound to push marginally profitable restaurants over the edge.

So I’m finally able to explain why this is a Sift topic: When people defend our skewed distribution of wealth or argue that the rich should pay lower taxes, their rhetoric usually implies that the free market rewards the “productive” members of society. But when you look into markets more deeply, that’s obviously false.

Think about the best restaurant meal you’ve ever eaten. Who should you thank for producing that experience? The master chef who perfected the recipe, the production chef who prepared your meal, the waiter/waitress who took care of you, the farmers who raised the ingredients, and even (though you probably never think about this) the cleaning staff. You might also thank the owner, who in a small restaurant was probably one or more of the people I’ve already listed.

But none of those people — probably not even the owner, the “small businessman” that conservative rhetoric idolizes — is making much money. None of them approach the wealth of Open Table’s founders, or even of the investment banker who managed Open Table’s IPO, or the speculators who have run up its stock price.

You see, our market economy doesn’t reward producers, it rewards gatekeepers. You don’t make money by building roads. You make money by finding (or creating) bottlenecks and setting up toll booths.

It is instructive, and kind of funny actually, that he uses the metaphor of government roads and toll booths to refer to market concepts. =)

The kindest thing I can say about the above is that I would like to give this fella the benefit of the doubt. The crucial word he sneaked in above is “our market economy”, since the economy he is describing is precisely the opposite of a free market economy.

But it is dishonest to then use that word and lead millions of innocent and less knowledgeable people to conclude that more government intervention, rules, subsidies, controls are needed to tame our oh so strangely deranged “market economy”. (Yes, even if he didn’t say this explicitly … he knows exactly that that’s what people will conclude and it is this that I vehemently and genuinely detest about this kind of writing.)

One more thing I would lament about this guy’s approach to research: Why in the world is he so focused on ONE company, namely OpenTable, to point out supposed shortcomings of the market economy?

I wonder … could there be examples that confirm my thesis above? Could it be that, in spite of heavy government intervention, there are competitors out there who, say, did not go public, and stayed leaner and less bureaucratic and monopolistic?

What about I personally always use Yelp to find out whether I should or shouldn’t patronize a restaurant in my city. (At least I can assure you that neither I myself nor anyone else I know feel particularly helped by the ranking that a restaurant has on the San Francisco Department of Public Health’s website when it comes to making an educated decision.)

And if Yelp doesn’t do the job … then there will be those greedy profit seeking entrepreneurs who will try to capitalize on that and thus keep the so called gatekeepers in check.

This is precisely the whole point of an unbridled market economy!

That is, of course, unless the authorities destroy that unbridled market economy by making it difficult and costly to start your own business.

Oh wait … they do?

So to sum it up:

This guy points out that a corporation (a legal concept invented by the state) that has raised huge sums of money in a heavily government subsidized, propped up, and manipulated stock market, enjoys some monopolistic powers, insufficiently checked by new entrepreneurs in an environment where authorities across the country make it burdensome to become an entrepreneur in the first place, while ignoring the free market competition that has arisen in spite of all of this, and he seriously blames … the market economy.

Ladies and gents, I give you … the current state of intellectual discourse in today’s world.

Update: I can’t wait to see this guy write an article on how the antitrust authorities now undoubtedly need to intervene to strip OpenTable off its unjustly earned monopoly powers.

The good old rule of interventionism comes to mind: Politicians intervene on the market, create problems, and then intervene in order to cure the problems created by their own intervention, creating yet bigger problems, upon which they intervene to … oh well, you get the point. :)

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Insiders Sell Shares at Record Pace

As markets have headed down south again the Financial Times reports Pessimistic executives cash out of shares:

Growing pessimism about the prospects for a global economic recovery sent stock and commodity prices tumbling on Monday while new data showed that leading US corporate executives were cashing out of their share holdings at a rapid pace.

And it is certainly likely that commodity and stock prices are headed lower while gold will outstrip them all – the deflation trade as Mish calls it.

US government bond yields followed equity prices lower, confounding analysts who had expected that Treasury rates would rise this week as the federal government auctioned off a record $104bn of debt.

I should point out that I was not among those who expected Treasury rates to rise, in fact I said that I expect them to go lower in Inflation Fears vs. Reality. How people can think that $104 billion alone will create a flight out of treasuries in a $10+ trillion market remains to be explained. Does anyone look at the demand side of things?

On another note, what I said in that article about silver applies to all other commodities to a much larger degree, in fact I think silver will recover once those who bought in for the wrong reason, namely inflation fears, are washed out.

Analysts said the market mood was captured by a World Bank report that said the global economy would contract 2.9 per cent this year, compared with a previous estimate of a 1.7 per cent fall. A White House spokesman said later in the day that the US unemployment rate was likely to rise to 10 per cent in the next couple of months.

The downbeat commentary reinforced the view that investors should be more worried about the impact of economic weakness on corporate profits than the possibility of higher inflation and interest rates.

Yes, inflation expectations where out of whack with reality as I pointed out already.

“We have had a great run in equities, emerging market currencies, credit and other risky assets, now people are struggling to justify lofty valuations,” said Alan Ruskin, strategist at RBS Securities. He added: “The ‘green shoots’ argument for the economy was very tentative to start with.”

Executives in charge of the largest US companies sent a signal of their concerns by selling far more shares than they bought this month, according to data based on Securities and Exchange Commission filings.

Share sales by so-called company insiders are outstripping purchases so far this month by more than 22 times. TrimTabs, the investment research company, said insiders of S&P 500 listed companies have unloaded $2.6bn in shares in June, compared with $120m in purchases.

“The smartest players in the US stock market – the top insiders who run public companies – are not betting their own money on an economic recovery,” said Charles Biderman, chief executive of TrimTabs.

The S&P 500 index fell 3.06 per cent to 893.04 – its first close below 900 this month. Analysts noted that the index closed below its 50-day and 200-day moving averages. “This is evidence that the rally since March has been a correction and not necessarily the start of a meaningful multi-year rally,” said Jack Ablin, chief investment officer at Harris Private Bank.

The yield on the 10-year Treasury fell 10 basis points to 3.68 per cent. Crude oil prices fell $2.62, or 3.77 per cent, to $66.93 a barrel.

Earlier, the FTSE Eurofirst 300 index slid 2.6 per cent while London’s FTSE 100 index fell 2.3 per cent. Emerging market equities also fell sharply, with Russia leading the retreat.

Even if for some reason we see another temporary bounce up in the stock and commodities markets, for the mid term it may make sense to look out and be prepared for a continuing implosion of consumer credit, declining production and sales of consumer goods, falling home prices, falling consumer prices, falling interest rates, a stronger dollar and, after a minor initial sell off, a solid and possibly rising gold price.

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A Stress Test Called “The Market”

In a usual display of incompetence Bank Regulators Clash Over U.S. Stress-Tests Endgame:

The disarray highlights what threatens to be a lose-lose situation for Treasury Secretary Timothy Geithner: If all the banks pass, the tests’ credibility will be questioned, and if some banks get failing grades and are forced to accept more government capital and oversight, they may be punished by investors and customers.

“There are plenty of ways to go wrong here,” said Wayne Abernathy, executive vice president of the American Bankers Association in Washington. “It might have sounded good at the time, but now looking back, it has far more risk than benefit.”

Hey Mr. Geithner, why make it so hard on yourself? What are you trying to accomplish? You say you want to find out which banks are sound enough to weather the storm. There is a pretty interesting concept to find out. It’s called the “market“. You know, that place where producers go to sell goods and services to consumers. You heard about that, right? I am saying “heard” because you obviously haven’t experienced it in your life as government bureaucrat and bank executive.

It’s that place where entrepreneurs exchange their consumer goods and services against money offered by consumers. It’s also the place where entrepreneurs obtain the resources to produce those goods. When they obtain these scarce resources they withdraw them from other uses. Then follows the stress test: If the goods produced are more demanded by consumers than the previous occupation of these resources, they make an entrepreneurial profit. If they are not they incur a loss. If they incur a loss they have to change what they are doing and listen to the consumers, or they need to release the resources they are squandering and make them available to entrepreneurs who know what the consumers are asking.

But this thing called market presupposes voluntary choice on the part of the consumers and entrepreneurs. Nobody can force them to buy or sell something. It is the concepts of liberty, peace, happiness, and prosperity in action.

When, due to the interventions of a government backed central bank, the majority of people in society is withdrawn from productive sectors and employed in an industry whose main objective is to make loans day in day out, the market will send a signal at one point. Some banks will report losses. This means they have failed the stress test. They need to adjust their operations or release their resources. Some banks will remain profitable. Those banks have passed the stress test.

If you keep using tax money or newly created fiat money in order to bail the failed banks out, you are doing the opposite of a stress test. You are giving their executives what is commonly referred to as a free ride. It’s really pretty harmful. Because they will be inclined to keep doing what they have been doing. They will make the majority of the people poorer and poorer.

It’s very simple, this neat little thing called market. You should try it out sometime, unless you want to be remembered as the worst Secretary Treasury this country has ever seen.

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The Objectives of Economic Policy

It is important to point out again and again the ultimate objectives of economic policy. Economic policy comprises all actions taken by a government‘s bureaucracy that have an impact on market data.

Goods, that is land, factors of production, consumer goods, and media of exchange on planet earth are limited. These scarce goods need to be utilized in a manner so as to satisfy the most urgent needs of the largest number of people at any given point in time. But every individual aims at different objectives and prefers different goods. What he prefers to what and by how much is determined by his value preference.

Prices on the market put into relation and reconcile different individuals’ value preferences, interest rates accomplish the same for differing time preferences. On the market different actors have a natural incentive to attain an optimum utilization of all goods. If there are factors of production that are not being utilized in lines of production where they satisfy the most urgent consumer needs or the needs of the largest number of consumers, opportunities to reap an entrepreneurial profit arise. Entrepreneurs have an incentive to withdraw those factors of production and put them into new lines of production where they produce goods that satisfy more urgent or simply a higher number of consumption demands.

The ultimate objective is to reach the theoretical state of market equilibrium where no further demands need to be satisfied. The market enables individuals and goods to be allocated in a way so as to move toward this market equilibrium. It shall hence be the objective of economic policy to do everything that enables the market to move as quickly as possible and as closely as possible toward the state of market equilibrium.

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