A lesson in history, politics and economics

The Economic Sense in Game of Thrones

[Editor's Note: This article is spoiler-free.]

The popular HBO series Game of Thrones is ending its third season this Sunday, amid fan concerns over its rapidly dwindling cast of characters. The show is based on George R.R. Martin’s intricate fantasy series, A Song of Ice and Fire, which has become an inspiration for commentary of all stripes. And while its complex and morally ambiguous characters have attracted many political and literary analysts, there are important economic lessons to be learned from the books as well.
Martin’s story touches on a variety of economic issues, from the implications of not having an economic system at all, to the problems of money and public finance. In another article (and in an interview), we have discussed these latter problems, and explained how the rulers of the continent of Westeros resort to the traditional methods of public finance: taxation, borrowing, and inflation.

The Political and Economic Means

In this article we will be discussing some of the other economic implications of the series, especially ideas about the social order and the role that peaceful cooperation, trade, and money play in the organization of society. Franz Oppenheimer famously distinguished between the “political means” and the “economic means” of organizing society. The former involves the forcible redistribution of wealth; wealth, however, is only created by those involved in the economic means of organization, which consists of peaceful production, trade, and exchange (1926, pp. 24-27).
This distinction shines through quite clearly in A Song of Ice and Fire. For instance, peoples as different as the Dothraki and the ironmen are stark examples (no pun intended) of the political means. Both societies produce little or nothing of their own, instead thriving on violence and plunder. A perfect illustration is found in the “words” (motto) of House Greyjoy, which proclaim, “We Do Not Sow.” The implication of course is that the men of the Iron Islands only reap the fruits of what others have sown.[1] The Greyjoy words are a very apt description of the state, which is a fundamentally parasitic institution depending for its survival on the plundering of a productive populace.
But the distinction between the political and economic means appears in more subtle cases as well. Even in the relatively peaceful parts of the kingdom where civil order is maintained, and exploitation is less obvious, it is clear that the interests of the rulers and ruled are different, as are the means for obtaining prosperity. Martin cuts to the heart of the matter in a conversation between Daenarys Targeryan and her companion, Ser Jorah Mormont. Daenarys believes the kingdom her family once ruled will rise up in support of her brother’s claim to the throne. She remarks that, “the common people are waiting for him. Magister Illyrio says they are sewing dragon banners and praying for Viserys to return from across the narrow sea to free them.” The reply she receives is simple, but insightful:
“The common people pray for rain, healthy children, and a summer that never ends,” Ser Jorah told her. “It is no matter to them if the high lords play their game of thrones, so long as they are left in peace.” He gave a shrug. “They never are.”
The idea that political behavior is essentially criminal plundering is common in A Song of Ice and Fire. In another passage, Davos Seaworth reflects on the career of his friend and fellow sailor, Salladhor Saan, who is “a smuggler… as well as a trader, a banker, a notorious pirate, and the self-styled Prince of the Narrow Sea.” Davos then concludes to himself, “When a pirate grows rich enough, they make him a prince.” [2]

Money and Society

In addition to discussing the essence of government, the series contains other economic ideas as well. One prominent example is the narrative’s strong understanding of the role money plays in society. In particular, the unfolding story provides snapshots of different stages of economic development, and these are closely tied to different cultures’ perceptions of economic activity and money.
Obvious examples are the Dothraki horselords, the decentralized group of warring tribes who roam the eastern continent. The Dothraki do not trade at all, and the closest they come to peaceful social interaction is a somewhat vague system of gift exchange. They therefore use no money, and their civilization thoroughly reflects this fact.
Without a system of indirect exchange, they are unable to develop capital goods, relying instead on the redistributive gains from conquest in order to survive. They are largely nomadic, lacking the ability (or desire) to produce or trade. In fact, the only permanent structures in the city of Vaes Dothrak are constructed by foreign slaves, using plundered materials. The lack of a complex society can be attributed to their refusal to engage in economic activity and consequently to adopt a medium of exchange. Since money makes possible the entrepreneurial decisions needed for economic development, economic calculation is therefore just as impossible for the Dothraki as it is for a socialist society.
A second phase of economic development is represented by the “wildlings” who live beyond the Wall, to the north of the Seven Kingdoms. They have no centralized political authority, and proudly refer to themselves as the “free folk.”[3]While not as developed as the economy of the Seven Kingdoms, and also without money, the wildlings are more advanced than the Dothraki. Economic activity does exist, in the form of barter relations between some relatively peaceful groups. Nevertheless, due to constant war with the peoples south of the Wall, the free folk cannot engage in sustained commerce, long-term planning, or social cooperation. Forcibly ostracized from society, they are restricted to eking out an existence in a resource-poor environment, achieving no more than the bare minimum of economic development.
Thirdly, the ironmen, such as the Greyjoys, are a more intermediate case as far as money is concerned. Their obsession with conquest leads them to downplay commerce and the use of money, which they deride as “paying the gold price.” Within their culture, men must instead pay the “iron price” for any finery they wear or luxuries they enjoy; in other words, anything of worth that one owns must be taken from the body of a slain enemy. Despite having been partially integrated, by force, into the economic and social life of the Seven Kingdoms, the ironmen make a conscious effort to maintain their ancient way of life based on expropriation. Consequently, they restrict their use of money to a relatively narrow sphere.
A higher level of economic sophistication can be found in the Seven Kingdoms of Westeros. The politics of the Seven Kingdoms are similar to those of a feudal society, where “men became rich by war and conquest and through the largess of the sovereign ruler. Men became poor if they were defeated in battle or if they fell from the monarch’s good graces” (Mises, 2006, pp. 158). Whether you have read the books or not, the story is a familiar one. Facing the difficulty of financing a seemingly-endless war, the Master of Coin (a position equivalent to a finance minister) invents new taxes; but these last only so long as the population is able to pay. The rulers are painfully aware that “half the lords in the realm could not tell taxation from tyranny and would bolt to the nearest usurper in a heartbeat if it would save them a clipped copper.” Borrowing also serves the crown. Yet, although it gives the illusion of providing a free lunch, it is nevertheless costly and does not offer lasting solutions. At one point in the story, Cersei Lannister dreams of founding her own bank as a permanent source of funds. The last resort then is to create money, which Lord Littlefinger does through the (historically common) practice of coin-clipping.
Although not as militaristic as the ironmen, the frequent wars between the ruling families of Westeros periodically destroy the accumulated wealth of the “small folk,” as the nobles call them. Due to the near-constant strife, many people in the Seven Kingdoms struggle to live from one day to the next. Saving, for example, is almost impossible for the common folk, and even knights and noblemen have a difficult time setting anything aside. It is not surprising then that the economy does not generally develop beyond the early stages of capital accumulation, and appears to have been stuck at the same level of development for thousands of years. The industries that do seem to thrive, and feature the most technological development, are the war industries, to the detriment of peaceful and productive enterprise. The armorers and boat builders, for example, are clearly described as profiteers benefitting from the political turmoil.
Given the centralization of rule in the Seven Kingdoms, and the complex network of rent-seeking and power-brokering relations that comes along with it, it is no surprise that blatant examples of wasteful government spending are common. Robert Baratheon’s tourney requires a total of “ninety thousand gold pieces” in prizes alone. Additionally, because Robert wants a “prodigious feast,” the Master of Coin pays, among others, “cooks, carpenters, serving girls, singers, jugglers, [and] fools.” The Council is quick to argue—leaning toward the broken window fallacy—that “the realm prospers” from such events, and that the lavish spending for tourneys also brings “the great the chance of glory, and the lowly a respite from their woes.” The same reasoning is used to justify other outrageous expenses, such as King Joffrey’s extravagant wedding.
The most developed economies in A Song of Ice and Fire are found in the so-called Free Cities. The nine city-states across the Narrow Sea boast “a score of temples and towers and palaces,” twice as large as those found in Westeros, and are well known for their trade in tapestry, carpets, lace, wines, and spices. Cosmopolitan and polyglot, the Free Cities have very profitable money-lending sectors as well: “Each of the Nine Free Cities had its bank, and some had more than one, fighting over every coin like dogs over a bone.” The banks provide financial aid to outsiders, especially the noble families of the Seven Kingdoms, and their reputation makes them a key player in the game of thrones: “when princes failed to repay the Iron Bank, new princes sprang up from nowhere and took their thrones.”
The Free Cities are no strangers to political struggle, obtaining what freedom they have at great cost. Braavos, now the youngest and most powerful city, was founded by refugee slaves, who have since striven to eliminate slavery elsewhere in the Free Cities.

Others have learned harsh economic lessons as well. Volantis was the oldest and largest of the Free Cities, but lost its wealth in a vain attempt to conquer the others. Volantene rulers “favored the sword, while the merchants and moneylenders advocated trade. […] After a century of war, Volantis found herself broken, bankrupt, and depopulated.” Only after renouncing its military aspirations and renewing peaceful commercial activity did it return to prosperity.
To conclude, it is worth pointing out that A Song of Ice and Fire is itself based largely on medieval history, which saw more than its share of warfare and economic destruction. Whether history or fantasy, the game of thrones (the use of the political means) prevents the spread of sound economic ideas, and precludes good economic policies. Thanks to the Seven Kingdoms, and their addiction to the game of thrones, when it comes to the peace and prosperity of Westeros, the only thing we can be sure of is that Winter is Coming.

Matt McCaffrey is an Instructor of Economics at Auburn University, and editor of Libertarian Papers. Send him mail.

See Matt McCaffrey's article archives.

The Game Of Thrones Is A Game Of Coins

Opinion

• Text size:
• A A A

• 0
• 239
• 6
• 1
• MORE+

By Matt McCaffrey and Carmen Dorobăț | April 17 2013 11:31 AM

There has been a good deal of buzz in the past few weeks about the premiere of the third season of HBO’s hit series “Game of Thrones.” But for those who have found the show to be too enthralling, never fear, the economists have arrived to ruin the entertainment by turning it into a learning experience.

• 
  Helen Sloan/HBO

  Tyrion Lannister was injured during a battle in the second season.

	Sponsored Link
	Missing Out on the Hottest Stock Trades?

As it turns out, though, economic lessons are more often found in George R.R. Martin’s original novels than in the recent adaptations, so we need not spoil the story. What we hope is to give viewers a glimpse beneath the surface of the events that occur in the series.

One of the inevitable problems of adapting the novels into a television series is that some of the richness is lost. In the series, the game of thrones is usually played with more obvious weapons like swords and other more … human assets, and the battlefield is more likely to be a boudoir than a bank. However, Martin’s epic is nothing if not a study in the logic of government and the tools it uses to extend its sphere of influence.

But in addition to incorporating conventional methods of politics, Martin’s books also pay close attention to the economic problems of ruling the Seven Kingdoms.

What makes these elements of the story so fascinating is that, despite the fantasy setting, they describe traits of government that are universal and relevant in the world today. And Martin’s view of his subject is far from random, being supported through detailed historical research that underlies his descriptions of the economic workings of government.

A deep understanding of history shines through particularly in the descriptions of public finance, one of the persistent difficulties in governing any kingdom, but especially one perpetually at war. It's conventional in economics to say government has three methods of finance: taxation, borrowing, and inflation. And each of these methods is tried by the Lannisters in their efforts to retain power.

The chief financial mischief is carried out by Lord Petyr Baelish, also known as “Littlefinger,” who serves as the king’s master of coin. In addition to persistently hatching his own schemes, Littlefinger also proves himself a shrewd financier in his efforts to provide the crown with the gold it needs to survive the war.

One of Littlefinger’s first fiscal policies is a tax on refugees from the war who wish to enter the capital city, thus taking advantage of their desperation to fleece them of all they own. Yet, once safely inside the city walls, there's little way for the refugees to generate additional income for the crown.

Later in the story, to avoid their own potential “fiscal cliff,” more effective taxes must be tried. In an attempt to pay for King Joffrey’s wedding, Tywin Lannister even taxes brothels, disguising the tax as a way to “improve the morals of the city.”

The next clear option is borrowing, and this Littlefinger’s treasury does in large amounts. Its primary source of loans are foreign banks (especially the Iron Bank of Braavos), but as the war drags on, the Lannisters find it increasingly difficult to always pay their debts. The master of coin becomes an artful dodger, and the lenders become aware that the terms of trade are not to their advantage.

Neither lending nor borrowing comes without a cost, and the balance of power is affected by both. While governments try to force the hand of their creditors, those who finance governments also seek to influence them in return. Sometimes, the bankers even threaten to finance other frontrunners in the competition for the crown.

Eventually, power accrues to those who make themselves indispensable sources of spending. The financiers become “political entrepreneurs,” pulling strings behind the scenes. This is exactly what Tywin Lannister does; even before he becomes the Hand of the King (technically, becomes Hand again) it's clear that his will governs the kingdom -- his will, and his purse strings.

Martin then adds a finishing touch on the debt problem by looking into the thoughts of Cersei Lannister. Frustrated by the crown’s obligation to repay its loans, Cersei concludes: “We need our own bank … the Golden Bank of Lannisport.”

This is another brilliant illustration of the logic of public finance. Rulers throughout history have realized that the key to financing the state isn't to simply prey on the wealth of citizens, or rely on the goodwill of lenders, but to directly control the money supply through a central bank.

This leads to the last and most devious method of finance: inflation. In the medieval world, inflation occurred through a simple form of currency debasement called “coin clipping.” Martin makes occasional reference to the practice, and implicates Littlefinger in a coin clipping scheme. Littlefinger’s chosen method of finance is described as minting gold from goldenrod, implying that he's diluting the metallic content to produce low-value coins that can be passed off at face value. This practice provides ample funds for the crown, but at the expense of the rest of society.

Is it necessary to point out the familiarity of this story -- a heavily taxed population, a massive public debt, and a government rapidly inflating the money supply to sustain itself and its chosen elites through an endless series of wars?

A constant theme in Martin’s books, and human history, is that the game of thrones does not change. But those who desire a different outcome should take note of one point Martin’s epic makes abundantly clear: It does not matter who sits the throne, the problem lies in the throne itself.

Matt McCaffrey is an Instructor of Economics at Auburn University, and editor of Libertarian Papers. Carmen Dorobăț is a PhD candidate in economics at the University of Angers, and Instructor at the Bucharest Academy of Economic Studies.

The Muslim outreach

Obama's outreach to Muslims has come to this!  The idea that the Obama administration has decided to unilaterally change the mission of NASA, maybe the only successful federal agency, is not only likely unconstitutional but outrageous.  Perhaps it's time for Congress to defund and to shut down NASA until we have a leader who understands the Constitution and priorities.  This is an alarming story.

The Not-So-Veiled Threat to Non-Muslims in Tennessee

By Janet Levy

The attempted snow job by the American Muslim Advisory Council (AMAC) of Tennessee which sponsored the joint Department of Justice/FBI event, "Public Disclosure in a Diverse Society," Tuesday night in Manchester, Tennessee, did not work with the 2,000 attendees. Claims that American Muslims are loyal citizens, partners in counterterrorism investigations, part of radicalization prevention efforts, and an integral part of American society for centuries fell flat, especially coming from the host organization that was formed only two years ago in response to anti-shariah legislation in the Volunteer State.

A well-informed crowd responded with calls of "taqiyyah" when members of AMAC, a group that bills itself as "a bridge between the Muslim community and law enforcement," touted Muslim contributions to U.S. society and their dedication to upholding American values. (Taqiyyah doctrine obligates Muslims to deceive infidels as part the required effort or jihad to institute Islamic doctrine or shariah). In actuality, Muslim organizations have specifically instructed Muslims not to cooperate with law enforcement and have demanded that all counterterrorism-training materials be expunged of critical references to Islam and Muslims, as well the training instructors fired or retrained who fail to follow along.

When it became clear at Tuesday's event that the promulgation of lies was falling on deaf ears, one AMAC speaker resorted to shaming the audience for their alleged rudeness and intolerance. In the crowd's defense, the passionate response was one of righteous anger against a doctrine that increasingly threatens Western civilization and values in the wake of the Boston bombings and the murder and beheading of British soldier Lee Rigby. That indignation was also a response to the hypocrisy of a program designed to falsely portray Muslims as victims of prejudice in dire need of special civil rights protection from hate crimes. No mention was made of jihadist acts, honor killings, demands for special accommodations, and the Muslim disinclination to assimilate to American cultural norms.

To further insult the crowd, the AMAC speaker showed a condensed version of the video "Welcome to Shelbyville" in which Tennesseans were portrayed as ignorant, bigoted rednecks. The rejection of the Muslim presence in Tennessee was explained away by previous resistance to integrating blacks and Hispanics. The situation was addressed as one of racism and fear of the unknown rather than a very real fear of what Islamic doctrine requires Muslims to do. This was an educated crowd well aware that Islamic doctrine clearly states that Muslims must not befriend non-Muslims and are required to wage jihad to establish a global Islamic government under shariah. Attendees appeared very familiar with the enemy threat doctrine, Muslim aspirations to replace the Constitution with shariah, and ubiquitous calls from Muslims for "death to America" and "death to Christians and Jews."

It is particularly telling that no other group in the United States has been the focus of such a degree of attention and outreach, although FBI religious hate crime statistics from 2009 indicate that Jews are more than eight times more likely to be victims of religious hate crimes than Muslims. Yet there is no special protection afforded to Jews, no events announcing the prosecution of individuals who post material offensive to Jews, nor outreach programs to the American Jewish community to better serve their interests. When it comes to Jews and Christians, offensive remarks and portrayals are permitted under the First Amendment.

It is truly remarkable that the mission of an entire government agency, NASA, was reconfigured from space exploration and aerospace technology to Muslim outreach by the Obama administration in 2009. At that time, Obama required NASA to reach out to Muslims and help them "feel good about their historic contributions to science, math, and engineering."

Recently, Obama announced that he was launching the Muslim Outreach Summit to elicit feedback from American Muslims on how the government can better serve them. It is unprecedented for any group in the U.S. to receive this level of special consideration.

Following the Benghazi attack, Obama went to the UN and announced, "The future does not belong to those who slander the prophet of Islam" and that "Intolerance is a form of violence." He didn't reference the desecrations of images of Jesus Christ and churches or voice concern about Holocaust denial. He mentioned only the criticism of Islam as a cause for concern and a reason to curtail free speech rights. Let us not forget that in the "Audacity of Hope," Obama avowed, "I will stand with the Muslims should the political winds shift in an ugly direction."

DOJ attorney Bill Killian addressed the crowd by reading statutes verbatim from PowerPoint slides that defined hate crimes, civil rights violations, and federally prescribed violations and penalties. Prior to the event, he had released this statement: "This is an educational effort with civil rights laws as they play into freedom of religion and exercising freedom of religion.... This is also to inform the public what federal laws are in effect and what the consequences are." However, the DOJ and FBI have not scheduled meetings addressing the concerns of any other group but Muslims. Twelve such outreach sessions are planned for Tennessee alone.

FBI Special Agent Kenneth Moore ridiculed the idea that the evening was intended to threaten citizens with the possibility of prosecution and imprisonment for offending Muslims. He pointed out that despite the raucous conduct exhibited during the event and the protests, no one would be arrested that evening as evidence of the government's commitment to the First Amendment. However, the crowd remained unconvinced that their free speech rights were not in jeopardy at some future point as part of the government's program to accommodate the demands of Muslim and Islamic doctrine.

The event presented messages on two levels. Overtly, Muslims attempted to airbrush their image in America as having nothing to do with supremacy, triumphalism, and terrorism. A few hijabed members of the AMAC even sported T-shirts with messages supporting the First Amendment to apocryphally showcase their dedication to American principles and laws.

As for government officials, they ostensibly conducted an informational session on legal statutes related to offensive statements and reassured the crowd that arrests would not take place. But the covert message was clear: This event was held to reinforce the supremacy of Muslims and their civil rights as no other group has been afforded this level of deference or accommodation. It was a veiled threat to non-Muslims that Muslims and Muslims alone will receive special protection by the government and hate crime prosecutions are on the table at some future point. Americans beware.

Read more: http://www.americanthinker.com/2013/06/the_not-so-veiled_threat_to_non-muslims_in_tennessee.html#ixzz2VYG5nM2m
Follow us: @AmericanThinker on Twitter | AmericanThinker on Facebook

Investors' dilemma

Worth pondering.

Following the Fed to 50% Flops
By John P. Hussman, Ph.D.
One of the most strongly held beliefs of investors here is the notion that it is inappropriate to “Fight the Fed” – reflecting the view that Federal Reserve easing is sufficient to keep stocks not only elevated, but rising. What’s baffling about this is that the last two 50% market declines – both the 2001-2002 plunge and the 2008-2009 plunge – occurred in environments of aggressive, persistent Federal Reserve easing.
It’s certainly true that favorable monetary conditions are helpful for stocks, on average. But that average hides a lot of sins.
There are many ways to define monetary conditions using policy rates, market yields, and variables such as the monetary base or other aggregates. But given the strong relationship between monetary base/GDP and interest rates, these measures overlap quite a bit, and the results are quite general regardless of the precise definition. For discussion purposes, we’ll define “favorable” monetary conditions here as: either the Federal Funds rate, the Discount Rate, or the 3-month Treasury bill yield lower than 6 months prior, or the last move in the Fed Funds or Discount Rate being an easing. Historically, this captures about 52% of historical periods. During these periods, the total return of the S&P 500 averaged 13.5% annually, versus just 8.8% annually when monetary conditions were not favorable.
This is a worthwhile distinction, but it doesn’t partition the data enough to separate out periods where the average return on the S&P 500 was below Treasury bills. So historically, using this indicator alone would have suggested holding stocks regardless of monetary conditions. One might expect to do better by taking a leveraged exposure during favorable monetary conditions, and a muted exposure during unfavorable conditions, but this strategy would have invited intolerable risks. Strikingly, the maximum drawdown of the S&P 500, confined to periods of favorable monetary conditions since 1940, would have been a 55% loss. This compares with a 33% loss during unfavorable monetary conditions. This is worth repeating – favorable monetary conditions were associated with far deeperdrawdowns.
If this all seems preposterous and counterintuitive, consider the last two market plunges. While investors seem to have forgotten this inconvenient history, the 2001-2002 market plunge went hand-in-hand with continuous and aggressive monetary easing.

Ditto for the 2008-2009 market plunge. Persistent monetary easing did nothing to prevent a 55% collapse in the S&P 500.

From an asset allocation perspective, even simple trend-following methods have performed far better historically than following monetary policy. For example, since 1940, when the S&P 500 has been above its 200-day moving average, the total return of the index has averaged 14.2% annually, versus just 4.5% when the index has been below its 200-day average. That separation in returns is meaningful, because the return during periods of unfavorable trends did not exceed Treasury bill returns, so it would not have harmed long-term performance to be out of the market during those periods (at least, before transaction costs, taxes and slippage). The deepest loss of the S&P 500, confined to periods of “favorable” trends and reflecting occasional whipsaws, was -26%, versus -53% during unfavorable trends.
As I noted a few weeks ago (see Aligning Investment Exposure with the Expected Return/Risk Profile), all of the net historical benefit of favorable trend-following has occurred in periods where “overvalued, overbought, overbullish” characteristics have been absent.  In the presence of this syndrome, the average total return of the S&P 500 collapses below Treasury bill yields, on average. The same is true, on average, when favorable monetary conditions are coupled with overvalued, overbought, overbullish features.
Hands-down, the worst-case scenario is a market that comes off of such overextended conditions and then breaks trend-support in the context of an economic downturn. That’s not something we observe at present, but it is something to keep in mind, as I doubt that we will avoid that sequence over the completion of the current market cycle.
Part of the reason that monetary policy was so ineffective during 2001-2002 and 2008-2009 is that these market collapses were preceded by overvalued, overbought, overbullish euphoria, and then gave way to economic downturns. Though monetary policy certainly fed the preceding bubbles, monetary policy did not prevent or halt those recessions, and those recessions were not broadly recognized until stocks had already lost about 30% of their value. At least in post-war data (Depression-era data is more challenging), the proper investment approach has generally been to accept market risk in the presence of favorable market action, particularly if monetary conditions are supportive, to start walking when overvalued, overbought, overbullish conditions emerge, and to run once momentum rolls over (as it has already). There’s a grey area when such overextended conditions are cleared, which can allow for recovery rallies if market action is still supportive. But regardless of monetary policy, investors should avoid risk in richly-valued environments once market action deteriorates, and buckle up hard on signs of economic weakness once an overvalued market loses trend support.
The following point should not be missed. I am not saying that monetary conditions are unimportant. Indeed, provided that trend-following conditions are favorable and overvalued, overbought, overbullish conditions are absent, favorable monetary conditions have contributed to stronger total returns for the S&P 500, and reduced periodic losses, in data since 1940. Favorable monetary conditions are most useful in confirming and supporting favorable evidence on other measures. My concern here,  however, is that investors seem to believe that favorable monetary conditions are a veto against all other possible risks, regardless of whether those risks are financial (e.g. overvalued, overbought, overbullish conditions) or economic. This is dangerously incorrect.
There is no question that Fed action can affect economic outcomes when it relaxes some economic constraint that is actually binding (for example, during bank runs, when Fed-provided liquidity is essential). But there is little evidence of any transmission mechanism whereby a greater supply of idle bank reserves promises to make a dent in the economy beyond occasional and short-lived can-kicks. There is also no question that interest rates matter, given that stocks must compete with bonds. But stocks are much longer duration securities than investors seem to appreciate, and the relationship between stock yields and interest rates is not even close to one-to-one, despite what Fed Model proponents might suggest.
Even so, investors have come to believe that there is a direct cause-and-effect link from monetary easing to rising security prices. The historical evidence is much less supportive. Interestingly, if we look at conditions that have been most generally hostile for stocks on average (S&P 500 below its 200-day moving average, or overvalued, overbought, overbullish conditions in place), more than half of these periods were accompanied by “favorable” monetary conditions. Stocks proceeded to underperform Treasury bills anyway, on average, with steep interim losses.
Conversely, monetary conditions have been unfavorable in nearly half of historical periods where trends were supportive and overvalued, overbought, overbullish features were absent. In those periods, the average total return of the S&P 500 was still quite strong, and returns were only slightly lower than when monetary conditions were favorable under otherwise similar conditions (15.6% vs. 18.9% at an annual rate), while periodic drawdowns increased only slightly.
So again, the point is not that favorable monetary conditions are irrelevant. The point is that they are not omnipotent – and that the most severe market losses on record have been accompanied by aggressive easing. Without question, quantitative easing has been very effective in suppressing spikes in risk premiums in recent years. More recently, it has been effective in removing any perception that stocks have risk and creating the impression that easy money is enough to override every possible economic or financial concern. But that is where perception has moved beyond reality. There is no evidence in the historical record for such optimism. Indeed, even the recovery from the 2009 lows was more directly linked to the change by the Financial Accounting Standards Board to eliminate “mark-to-market” accounting (keeping banks from insolvency even if they were technically insolvent) and the shift to an outright guarantee of Fannie Mae and Fredd ie Mac debt by the U.S. Treasury. It is superstition to believe that monetary easing is a panacea. Investors who recognize (actually, simply remember) this now are likely to fare better than those who are forced to relearn it later.
Needless to say, all of this will be summarily ignored by speculators who have been rewarded by the strategy of following the Fed in a mature, overvalued, overbought, overbullish, unfinished half-cycle that recently hit new highs. Advice from Kenny Rogers – you never count your money when you’re sittin’ at the table.
Economic Notes
We’re observing some very wide dispersion in regional economic surveys in recent reports. On one hand, the Chicago Purchasing Managers Index surged to 58.7 last month, with the important new orders component jumping to 58.1 (a level of 50 on the PMI is neutral). This sort of strength, if sustained over several months and joined by strength in the Philadelphia Fed index, would help to ease our economic concerns here, as several months of strength on these two measures are among the more reliable leading indicators of economic shifts.
On the other hand, in nearby Milwaukee, the PMI collapsed from 48.4 to 40.7, while the Philadelphia Fed index itself dropped into negative territory, falling from +1.3 to -5.2, with the new orders component deteriorating from -1.0 to -7.9. That general weakness was much more in line with what we’re observing from other surveys, including the Chicago Fed National Activity Index, Empire Manufacturing, Dallas Fed, and Richmond Fed.
When we plot “outliers” (where the Chicago PMI deviates from the average of the other surveys), against subsequent changes in the Chicago PMI, what results is a clearly downward-sloping scatter, meaning that positive outliers, as we presently observe, are typically corrected by subsequent disappointments in the Chicago PMI. Conversely, however, outliers in the Chicago PMI are typically not related to subsequent positive surprises in the other indices. Again, joint strength in the Chicago PMI New Orders component and the Philly Fed index, sustained over a period of 3-4 months, does tend to lead broader improvements. This is not what we observe here.
In short, the coincident and leading economic evidence is deteriorating, not improving. Even the chart below incorporates a strong Chicago PMI figure that appears to be a temporary outlier. Employment data is a well-known lagging indicator, and is always somewhat “rear-view”, but it’s fair to say that given what is now the lowest labor participation rate in 30 years, the relatively restrained level of new claims for unemployment has been a bright spot.

It seems to be universally assumed that surprisingly strong data on the economic and jobs front would pose the greatest risk to the market, as it would accelerate the “taper” of quantitative easing. To the contrary, the largest risk here would be an acceleration of disappointing economic data, as it would further reinforce the case made by former Fed Chairman Paul Volcker that the benefits of quantitative easing are “limited and diminishing.” Disappointments on the economic front may be met with knee-jerk enthusiasm. But the quickest path to an extended bear market would be a deteriorating economy, coupled with recognition that quantitative easing has an even weaker benefit/cost tradeoff than is already plain.

What's happening in Turkey

Having been to Turkey now 4 or 5 times over the last 15 years, what's been happening there in the past week or so comes as no surprise. Tyap Erdogan has been the head of state for over 10 years and during that period of time Turkey has turned abruptly from a Western leaning country to an anti-Israel, anti rule-of-law Democracy toward a single party Islamist model.  The population, particularly in Istanbul, the crown jewel city in the Middle East, has been alarmed and now is in open revolt over the policies of the Erdogan regime. And it appears the revolt has spread to other cities in Turkey, including Ankara, the Capital.  What follows is a succinct summary of  what's happening, from NRO online.

Erdogan’s Agenda | National Review Online

Later today, President Barack Obama will sit down with Turkish prime minister Recep Tayyip Erdogan in the Oval Office. It will be a friendly reunion. Obama has said Erdogan is one of the few foreign leaders with whom he has developed “friendships and the bonds of trust.” Speaking to the Turkish parliament four years ago, on his first trip abroad as president, Obama declared, “Turkey is a critical ally. Turkey is an important part of Europe. And Turkey and the United States must stand together — and work together — to overcome the challenges of our time.” These challenges are many — among them, Syria, Iraq, Iran, and the Israeli–Palestinian conflict.

While Turkey and America partnered for the greater good throughout the Cold War, no amount of White House praise can hide the fact that Turkey today is less a bridge between the West and the Islamic world and, increasingly, a force undermining trust and cooperation.

Erdogan, who is now in his second decade of power and quite openly plotting for his third, has transformed Turkey from an imperfect democracy based on rule of law into an increasingly dictatorial state rooted in religion. By tweaking university admission formulas, he privilegedstudents from religious high schools, who had long been denied acceptance because they lacked a solid liberal-arts foundation. In order to help these unqualified graduates enter the civil service, Erdogan imposed a new interview process, transforming a meritorious civil service into a mechanism for political — and religious — patronage.

The Turkish military, once the envy of the Middle East, is now a shadow of its former self. Despite the recent peace accord with the leaders of the Kurdish insurgency, the Turkish military has trouble controlling large swaths of the southeast. And the Turkish air force continues to lose planes — the latest earlier this week — along the Syrian border when, in contrast, Israel has run high-risk missions without any casualties. The reason is simple: Like Josef Stalin, who gutted the Soviet military in the years prior to the Nazi invasion, or Ayatollah Khomeini, who did likewise to the Iranian military in the months before the Iraqi invasion, Erdogan has done his best to destroy his country’s military. One in five Turkish generals rots in prison, many on dubious charges and most without even a court date.

American diplomats initially cheered the reforms that excised the military’s role in politics — after all, ending military influence over politics is a noble goal. But since Erdogan’s government did not construct any alternative system of checks and balances, excising the military allowed him to pursue his agenda without regard for rule of law. He and his aides were not shy about seizing the opportunity. In response to judicial vetoes of the prime minister’s religious and social initiatives, Bulent Arinc, then speaker of the parliament and now Erdogan’s chief deputy, threatened to dissolve the constitutional court if it continued to find the ruling party’s legislation unconstitutional. More recently, in a fit of pique, Erdogan told parliament, “We want to raise a religious youth.”

Women and minorities have suffered disproportionately. Erdogan has forced Turkey’s minority Alevis to attend Sunni religious classes, and he has flushedwomen from top levels of the state bureaucracy, advising them that instead of pursuing a career they should have at least three babies and ideally more. And Turkish women today find not just their careers at risk, but their lives. In 2011, Turkey’s justice minister reported to parliament that, between 2002 and 2009, the number of women murdered each year had increased 1,400 percent. Some of that is the result of better reporting, but the bulk appears to be due to a sharp rise in the number of honor killings: Would-be perpetrators are no longer deterred by fear of prosecution, as the increasingly conservative police forces sympathize with the Islamist notion of honor. Obama once quipped that he had turned to Erdogan for advice on raising teen daughters. Perhaps for the sake of his two girls, he had better find a new role model.

In most democracies, the press holds the government accountable. That is no longer so in Turkey. Erdogan’s security forces arrest journalists with impunity; in ten years, according to Reporters without Frontiers, Erdogan has transformed his country into “the world’s biggest prison for journalists.” After first stacking once-independent banking boards with functionaries trained exclusively in Saudi Arabia, Erdogan has used their financial pronouncements to justify seizure of opposition newspapers. Turkey now ranks below even Russia, Palestine, and Venezuela in press freedom. When career American diplomats like Daniel Frieddescribe Erdogan’s Justice and Development Party as “a kind of Muslim version of a Christian Democratic Party,” they appear so wrapped in the bubble of political correctness that they have become detached from reality.

American policymakers might shrug off Turkey’s domestic turn away from rule of law if it did not presage a transformation of Turkish foreign policy. Erdogan’s agenda has more to do with the promotion of Islamic solidarity than a fight against terrorism or dictatorship. The days of Turkey’s being “a vital and strategic partner of the United States,” as Condoleezza Rice once described it, are over.